Funding local government infrastructure - some Trans-Tasman insights
First published 27 September 2019
I was excited to speak at the Property Council New Zealand Annual Conference in Sydney this week about lifting investment in infrastructure.
The NZ Productivity Commission Inquiry on Local Government Funding and Financing is coming to a conclusion, so I thought it would be interesting to focus on our respective systems for the funding and financing of local government infrastructure, to draw out the lessons and insights which we can learn from one another.
The NZ Property Council says New Zealand's current system for the funding and financing of local government infrastructure is broken because there is inadequate decision making which leads to constant under-investment. It submits that a holistic approach needs to be considered including how the NZ central government contributes to the funding of local government infrastructure and services.
Pressures on local governments
The pressures that local governments in each country are facing are similar.
The role played by local government in New Zealand is broader than in Australia, as New Zealand only has two levels of government, whereas Australia has three. Accordingly, local governments in New Zealand tend to provide not only what Australians would call 'local government services', such as waste management, local planning regulation, and sporting and recreation facilities, but also services that are delivered by state governments in Australia, such as transport, water and flood protection.
Despite these differences, the pressures on local governments are similar in both countries, particularly around:
the growing cost of providing these services, many of which require significant levels of capital expenditure;
the constraints placed on their ability to finance these capital costs through borrowings; and
their ability to raise additional funding by increasing rates.
Funding and financing options
Local governments in both countries have a similar range of funding options available to them, including the levying of rates, user charges (such as swimming pool admission fees, animal registration fees, parking fees, and fees for planning approvals) and development contributions. The proportion of income from each source varies between councils.
In both countries, local governments also have the ability to borrow money to meet capital expenditure requirements, and to therefore spread the burden of capital expenditure across generations. But like any entity, each council's ability to borrow is constrained by its future income earning capacity, and many NZ councils are hitting their debt limits.
Rates
Local councils in both countries generate the lion's share of their revenue by levying rates on landowners within the local government area. These rates take the form of:
general rates - which are paid by all landowners within a local government area; and
targeted rates - which are used to fund particular activities or services which benefit a subset of the landowners within a local government area. These rates are only levied on the sub-set of landowners within the relevant zone or area. In Australia, we sometimes call these special rates.
In both countries, despite common misconceptions, it is council spending, not property values, that drive increases in rates. Each council must decide what it will spend over the coming year, and then set total rates to be collected to cover those expenses. Improved or unimproved property values are then used to allocate the total rates across the local government community.
In New South Wales and Victoria, local council spending is constrained by the rate-pegging system which caps the maximum percentage amount by which a council can increase its general income for the year.
A unique example of rates being used to fund infrastructure comes from the Gold Coast in Queensland. The Gold Coast light rail systems was funded, in part, by a special levy (currently $126 per annum) that was imposed by the Gold Coast Council on all rateable properties within the local government area.
Development contributions
The concept of development contributions is similar in both countries. These are charges that are levied on developers under local government legislation to recover the cost of new infrastructure provided by council that is related to the relevant development. They can be charged for the capital costs of connections to trunk infrastructure (drinking water, wastewater, stormwater, roads and other transport) and community infrastructure (such as neighborhood halls, playgrounds and public toilets).
In NSW, these development contributions take the form of local infrastructure contributions (for local infrastructure) and/or Special Infrastructure Contributions (SICs) which cover the cost of regional and state infrastructure.
They are levied as a condition of the development consent (or resourcing consent, as it is termed in New Zealand)
Development Agreements / Voluntary Planning Agreements
In both countries there exists an ability for developers to enter into agreements with councils for the developer to provide local infrastructure, as an alternative to paying a development contribution so that council can provide it. In New Zealand these agreements are called Development Agreements. In New South Wales, they are called Voluntary Planning Agreements or VPAs.
VPAs effectively provide an opportunity for local councils to share in the uplift in land value accruing to a developer from a rezoning or development approval which allows a more intense and higher value use of the land. In this way, they can become a mechanism for value capture. They have become increasing popular in New South Wales because of the cap that was placed on development contributions in 2008, that wasn't adjusted, even for CPI, until quite recently.
Whilst there are many positive benefits associated with the flexibility of VPAs, they have been criticized because they can give rise to a perception that councils are selling development rights (such as floor space or height uplifts).
Councils in New Zealand also receive a portion of their funding for infrastructure from central government in the form of grants and subsidies. This also occurs in New South Wales - the Local Infrastructure Growth Fund established and administered by the NSW State Government being one example.
Insufficient funding and financing tools in the toolbox
The NZ Productivity Commission's draft report suggests that the current funding and financing framework available to local councils is fit for purpose, and that any future system should continue to be based on the present system. But it also suggests that some new tools should be added to the funding and financing toolbox to help councils meet the growing cost pressures.
The additional tools that have been suggested include:
The ability to levy more user charges, including volumetric water pricing and road user charges. The use of user charges is limited, and councils are not permitted to charge volumetrically for wastewater. Auckland, where water services are delivered through the council-controlled organisation (CCO) Watercare, is the only area where volumetric charges are used for wastewater. It's similar in NSW, with households paying a fixed fee per quarter for their wastewater and storm water connections, regarding of the volume they put through them.
Current legislation also limits the ability of councils to apply user charges for roads. Tolls can only be applied to new (rather than existing) roads, and only with the approval of the central government's Minister of Transport.
The NZ Productivity Commission has previously recommended that councils should be allowed to set volumetric charges for waste water, and to price the use of existing local roads where doing so would enable more efficient use of the road network. Similar calls have been made by the Australian Productivity Commission, but politicians have been reluctant to champion them.
More targeted rates. Councils in Australia and New Zealand are unable to impose targeted rates based on changes in property value. This prevents councils from introducing 'value capture' funding mechanisms that directly capture a portion of the actual uplift in a property's value generated by taxpayer funded infrastructure investment. Under current legislation, councils can only use targeted rates to indirectly capture this benefit - by levying a fixed charge, or by levying rates on a proportion of a property's value. But neither of these approaches strongly reflects the actual windfall gain that a particular private landowner receives. The NZ Productivity Commission has previously recommended legislative changes to allow councils to directly tax the uplift in land value and thereby better capture the windfall gains afforded to landowners. Australia should be doing likewise.
Using SPVs to get debt off Council's balance sheet, like what Auckland Council has done for the new residential development at Milldale, where a Special Purpose Vehicle (SPV) has raised nearly $50m of long term finance to fund the bulk road and wastewater infrastructure needed for the new development, on the basis of future infrastructure charges that will be levied on landowners in the development, by Council as the agent of the SPV. The NZ Government is about to introduce new legislation that will enable SPVs to levy the equivalent of rates to fund the costs of providing local infrastructure.
Benefits principle
Like the Australian Productivity Commission, NZ Productivity Commission favours the favours the principle that those who benefit from, or cause the need for, a service should pay for its costs.
The application of this principle means councils should be seeking to tap their funding sources in the following order of priority:
User charges (eg entry fees) - should be used where infrastructure or service users can be identified and charged efficiently;
Development contributions/Development agreements - should be used to cover infrastructure costs that can be directly related to a particular development (eg connecting a development to wastewater facilities);
Targeted rates - should be used where infrastructure investment or service benefits an identifiable group of residents larger than those in a new development (eg a connecting road);
General rates - should be used to cover the cost where the infrastructure investment or service benefits the wider local government community;
Central government contribution - should only be used when the benefits go beyond the local government community.
Accordingly, calls in both countries for central government (i.e all taxpayers nationally) to contribute more towards local government infrastructure that only benefits a particular local government community are increasing likely to be disappointed, and for good reason. To encourage greater efficiency in the use of scarce local infrastructure capacity, those who actually consume the available capacity should be charged more than those who don't. Reforming local government funding mechanisms to enable councils to better implement the benefits principle will no doubt upset some, and therefore give politicians cause to hesitate. But reforms of the nature suggested by the NZ and Australian Productivity Commissions would create a net benefit for the community as a whole, and so should be pursued by publicly minded politicians in both countries for the greater good.
