In South Africa there is a perennial debate on the issue of whether local government is being given its fair share of nationally collected revenues through the local government equitable share. Municipalities argue that they are underfunded, while national government argues that they are not showing fiscal effort given the revenue sources available to them. Cornerstone developed this picture to bring clarity to the discussion and to define the following terms:

• Fiscal capacity is defined as the ratio between a municipality’s own revenue potential and the cost of meeting the demand for a defined set of municipal services.
• Fiscal gap is defined as the difference between a municipality’s own revenue potential and the cost of meeting the demand for a defined set of municipal services.
• Fiscal effort gap is defined as the difference between a municipality’s own revenue potential and the actual own revenues the municipality collects.
  Funding gap is defined as the difference between the fiscal gap and the national and provincial transfers to the municipality.

This picture appears in

• Barberton, C., 2010. ‘Is local government underfunded?’ National Treasury discussion document, 23 June 2010 (unpublished).

This picture illustrates the five components in the relationship between municipal finances and service delivery:

• The first component in the relationship is between the community’s demand for services that a municipality is responsible for providing versus the local government fiscal framework. As noted, the Constitution allocates particular functions to local government. In addition, national and provincial legislation may assign further functions to local government. Then there is the actual community demand for each of the services that fall within these functions. Against this there is the local government fiscal framework, which sets out what sources of revenue are potentially available to a municipality to fund these fiscal framework broadly aligned with the service responsibilities of municipalities? Are there any constraints on the fiscal capacity of local government that arise from certain policy choices? Ideally, the local government fiscal framework should provide municipalities with access to revenue sources that are commensurate with the powers and functions (or services) that they are responsible for performing.
• The second component in the relationship is between the local government fiscal framework and the actual revenues collected by a municipality. The key issue is whether municipalities are using the ‘fiscal space’ available to them to raise their own revenues. Or are municipal tariffs too low? Are the billing systems inaccurate? Is there poor debt management? Is the council giving away excessive free services, especially to non-poor households? In sum, is the municipality showing ‘fiscal effort’? Or are municipalities simply relying on and dependent on transfers from national and provincial government?
• The third component of the relationship relates to how each municipality chooses to use its available resources. This is generally reflected in the municipal budget. Key questions in this regard are: Is the municipality prioritising the delivery of basic services? What functions and services does the municipality prioritise? What is the balance between the operational budget and the capital budget? Is the municipality budgeting sufficient for repairs and maintenance? How much gets allocated to nonessential, non-priority items?
• The fourth component in the relationship relates to the municipality’s governance and management systems to implement the budget and manage service delivery. Are these systems effective and efficient?
• The fifth component relates to what actually gets delivered by the municipality. Are ratepayers getting value for money? Which communities benefit most from the services provided by the municipality? Is there an equitable distribution of services? Is the level of service being provided taking into account the ‘benefit principle’ and are any cross-subsidies sustainable?

Versions of this picture appear in:

• Barberton, C., 2010. ‘Is local government underfunded?’ National Treasury discussion document, 23 June 2010 (unpublished).
• National Treasury, 2011. ‘Chapter 3 - Intergovernmental relations and the local government fiscal framework’ in Local Government Budgets and Expenditure Review 2006/07 – 2012/13
  http://www.treasury.gov.za/publications/igfr/2011/lg/default.aspx

South African municipalities are permitted to raise revenues through a specific set of taxes, tariffs and surcharges. They are also required by various policies to provide free or subsidized basic services to indigent households, ensure tariffs are structured to promote cost recovery and promote the efficient use of services. Taxes and tariffs need to be carefully designed so as to achieve these different objectives.
This picture shows how a block tariff structure for, say, electricity or water seeks to reconcile these objectives.

A version of this picture appears in:

• Carter, J. 2015. “Cities’ Use of Tariffs to Promote Efficient Resource” in South African Cities Network, State of Cities Finances 2015, Johannesburg.
  http://www.sacities.net/knowledge-products/publications