The 2007 Local Government Funding (Rates) Enquiry

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Funding Local Government

Report o the

Local Government Rates Inquiry

Pakirehua m ng Reiti Kaunihera -Rohe

www.ratesinquiry.govt.nz

August 2007


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Local Government Rates Inquiry

Pakirehua m ng Reiti Kaunihera -Rohe

Panel members:

David Shand, ChairGraeme Horsley

Christine Cheyne

itle: Funding Local Government

Author: Local Government Rates Inquiry Panel

Publisher: Local Government Rates Inquiry

Place of Publication: Wellington, New Zealand

Date of Publication: August 2007

ISBN 978-0-473-12567-7 (Print)

ISBN 978-0-473-12568-4 (Online)

Contact agency:

Department of Internal Affairs

e ari aiwhenua

PO Box 805

Wellington

New Zealand


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Letter o Transmittal

31 July 2007

Honourable Mark Burton M.P.

Minister of Local Government

Parliament House

Wellington

Dear Minister

Report o the Local Government Rates Inquiry

At the beginning of the Inquiry the Panel undertook to deliver to you by 31 July 2007 a high-quality report based on wide consultation and sound evidence and analysis. We are pleased todeliver our report, which comprehensively addresses the wide range of issues covered by our termsof reference.

Our report identifies many significant issues and proposes many significant changes. We acknowledgemany strengths in the existing system of local government funding, but have not adopted a businessas usual approach. Tis is a report that creates an agenda for change that needs to be pursued bycentral government and local government in partnership with other stakeholders.

INTRODUCTION

Consultation

In our consultation, the Panel

produced 6,000 copies of a background paper in February 2007 setting out the mainissues we expected to address and inviting submissions

produced 2,000 copies of a discussion paper for consultations on the impact of rateson Mori land

travelled extensively around New Zealand, starting in February, holding 14 meetingswith mayors, councillors, and council officers, 14 meetings with the general public, and12 hui with Mori

held separate meetings with a wide range of key interest groups

held meetings with a large number of relevant government agencies

developed an extensive website (www.ratesinquiry.govt.nz) containing backgroundinformation on the issues. All submissions are now publicly available on this website.

Tis consultative process resulted in some 926 submissions from individuals and organisations,covering approximately 10,000 pages. Te Panel members have read each submission. Tese

submissions came from individuals, community groups, farmers and people living rurally, peoplewith Mori land interests, companies and people with business interests, and local government.Submissions came from throughout New Zealand, but there were large numbers of individual

Local Government Rates InquiryPakirehua m ng Reiti Kaunihera -Rohe


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submissions from Nelson and the Auckland region. (A list of submitters is available on the RatesInquiry website.)

Evidence and analysis

During our meetings with interested parties, the Panel indicated that we were interested in constructivesuggestions not just complaints and in facts and information not just opinions. As a result,we have been successful in obtaining high-quality suggestions and information, notwithstanding therelatively short time frame for the inquiry.

Te Panel appreciates the information made available from a wide variety of sources. Tis includedthe extensive work undertaken by the Joint Central Government/Local Authority Funding Project,which reported in 2005 and 2006. o fill the many information and data gaps we commissionedresearch from several individuals and consulting firms. Some of this, such as the analysis ofaffordability of rates and analysis of capital expenditures, is original research that takes the stateof knowledge well beyond what previously existed. Our report identifies a number of major data

deficiencies that need to be addressed if the operation of local government is to be adequatelymonitored in future.

Scope o the terms o reerence

A number of comments at meetings and in submissions suggested that the Panels terms of referencewere too narrow in that they did not include any review of the system of local government per se.Tey submitted that any analysis of funding needs to also examine the structure, functions, andefficiency of local government. We consider that this exclusion from our terms of reference wasappropriate given that the Local Government Act 2002 (LGA 2002) is relatively recent legislation.An important part of our terms of reference required examination of the drivers of expenditures,which are the basis of many of the current concerns about local government funding. Our report

raises important management issues covering consultation, planning, and accountability, all ofwhich are designed to improve the quality of financial decision making in local government. Wehave therefore focused on systems. Any substantive review of the performance of local governmentwould require extensive data, much of which does not currently exist, and a much longer time framefor the inquiry.

Follow up o the report

Our recommendations are extensive, reflecting the wide range of issues covered by the terms ofreference. A number of recommendations require legislative change. Some require additional fundingfrom central government. Many require action by local government itself in terms of adopting goodpractice. A number require central government to pursue a lead role, in particular in fixing the vexedissue of the impact of rates on Mori land. However, we expect that central government itself willwish to ensure that the necessary reforms are driven hard and expeditiously. A high-level task force,involving both central and local government and other stakeholders, would be a useful means toaddress the recommendations.

PRINCIPLES GOVERNING THE PANELS RECOMMENDATIONS

Empowerment

Te first key principle we identified, enshrined in the LGA 2002 as a key attribute of New Zealandlocal government, is that of local empowerment. Local authorities are diverse in their geographical and

human composition. In their required promotion of the four well-beings of communities (social,economic, environmental, and cultural) each local authority will make different decisions about the

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desirable size and composition of its revenues and expenditures. It is not appropriate for centralgovernment to intervene directly in these decisions. We support the concepts of local autonomyand local choice, which is a strong feature of local government in New Zealand compared with thesituation in many other western countries.

But these decisions must be made with appropriate use of the decision-making framework coveringconsultation, planning, and accountability provided by the LGA 2002 and the Local Government(Rating) Act 2002. We identify a number of areas where both improvements to the frameworkand better adherence to it will improve local government financial decision making. However, wenote that in a number of respects the consultation, planning, and accountability practices of localauthorities are more advanced than those of central government.

Sustainability with restraint

Financial decisions must also be made within a policy framework that ensures affordability ofexpenditure and equity of funding over the medium to long term. In general local government is

paying insufficient attention to these issues. We identify changes that are needed to better achievethis. In particular, the Panel concurs with the view of the Auditor-General in his June 2007 report onthe 200616 long-term council community plans, that many authorities have insufficiently analysedtheir existing funding policies, particularly on the use of debt and the funding of depreciationexpense. As a result, the current and forecast level of rates appears to be higher than necessary to fundcurrent and forecast levels of expenditure. However, the Panel does not favour blunt instrumentssuch as rate capping to achieve this. We favour better analysis of revenue and financing policies andthe application to local government of principles that already apply to central government throughthe Fiscal Responsibility Act 1994 and the State-Owned Enterprises Act 1986. In particular, thisincludes councils establishing medium-term financial targets.

PartnershipA further key principle is that ofpartnership between central and local government. Both are deeplyinvolved in the four well-beings of communities and the pursuit of sustainable development. Althoughsome areas such as the Central/Local Government Forum work well, we believe this partnership canbe made to work better. Tere is a need for better analysis, coordination, consultation, and guidancein the development of central government policies that impact on local government. Tere isinadequate capacity and resources within central government allocated to monitoring the operationof the LGA 2002 and Local Government (Rating) Act 2002, the two major pieces of legislationgoverning the operations of local government. And as mentioned earlier there are shortcomings inthe database of information concerning local authorities.

In terms of our recommendations, the partnership involves central government providing someadditional funding for local government and providing two new revenue sources an increase in thecurrent Local Authority Petroleum ax and additional government funding for water infrastructure.Te partnership principle is also involved in the Panels recommendation to make all Crown land(except the Conservation estate, Parliament, vice-regal residences, roads, seabed, foreshore, lakes,and rivers) fully liable for rates and providing the legislative changes necessary to implement someof the Panels recommendations. In addition, local government should recognise that it is inherentlyinvolved in income redistribution, along with central government.

Public fnance principles

In examining the present funding system for local government we have applied generally accepted

public finance principles mainly those of efficiency, buoyancy, ease of administration, and equity.Te Panel also considers that rates, as a tax on property, need to be considered in relation to NewZealands overall taxation system, in which property is lightly taxed. Te macroeconomic impact (in

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inflation, growth etc) of any changes in revenue patterns for local government needs to be taken intoaccount in considering any major changes to the funding system.

Environmental sustainability

Te Panel was also conscious of the need to consider environmental impacts both on the revenueand expenditure aspects of its recommendations. On the revenue side this is the basis of our supportfor greater user charging for roads (through an increase in the current local authority petrol tax) andfor reasonable recovery of the costs of water supply and waste-water disposal through volumetriccharges. Both reflect the need for more demand management, which should reduce the needed levelof infrastructure. On the expenditure side we consider that local government needs to subject itsinfrastructure expenditures to close scrutiny to ensure accurate cost estimation, to avoid any goldplating, and to more fully consider deferring or spreading this expenditure over a longer period oftime. Tat said, greater central government financial assistance is needed for the funding of waterinfrastructure, much of which is required to meet higher national environmental standards.

CONCLUSION

We hope that the result of our inquiry will be enhancements to the processes of funding localgovernment. Te Panel believes that communities will benefit from the services of a local governmentthat applies to its financing the principles of sustainability with restraint.

We thank you for the opportunity to undertake this interesting and important work.

David Shand

Chair

Christine Cheyne

Panel member

Graeme Horsley

Panel member

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Report o the Local Government Rates Inquiry page vii

CONTENTS

Letter o transmittal

Panel membership xviii

Acknowledgments xix

Abbreviations xx

SUMMARY REPORT

Executive summary 1

Restraining expenditure and rates 2

A changed local authority unding pattern 3

Drivers o local authority expenditures (Chapter 8 o the report) 4

Current use o rating tools (Chapter 9 o the report) 6

Currently available non-rates unding mechanisms (Chapter 10 o the report) 9

Possible new sources o local government unding (Chapter 11 o the report) 11

Sustainability and afordability packages (Chapter 12 o the report) 12

Rating o Mori land (Chapter 13 o the report) 14

Exemptions (Chapter 14 o the report) 15Financial decision making in local government consultation, planning, and

accountability (Chapter 15 o the report) 16

Recommendations 19

PART ONE: INTRODUCTION

1 Background to the ormation o the Inquiry 29

Current or planned initiatives 29

2 Inquiry process 31

PART TWO: CONTEXT FOR THE INQUIRY: LOCAL GOVERNMENT PURPOSE,

PLANNING, AND FUNDING

3 Purpose o local government 33

4 Diversity o local government circumstances and activities 35

Diversity o council circumstances 35

Population size and growth rates variation among councils 35

Percentage o Mori variation among councils 36

Visitor numbers variation among councils 36Household income variation among councils 36


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Property values variation among councils 37

Local authority wealth variation among councils 37

Rural/urban mix variation among councils 37

Diversity o council activities 39

5 Local government revenue sources 41

Funding processes 41

Total unding by revenue source 42

Rates 43

General rates 43

Targeted rates 44

Diferentials on general and targeted rates 44

Uniorm annual general charges 45

Cap on xed charges 45

Discussion o the taxation principles behind rates 45

Other rating decisions 46User charges and ees 47

Central government unding transers 47

Development contributions 47

Investment income 47

Conclusion 48

6 New Zealand and international reports on local government unding 49

Earlier reports on unding o local government in New Zealand 49

Recent Australian reports on local government unding 50

Lyons Report, United Kingdom 51

PART THREE: MAJOR ISSUES

7 Current level o rates and rates increases 53

Summary o key points 53

Trends in the level o rates and rates increases 55

Data issues 55

Data reliability 56

TRENDS IN LOCAL AUTHORITY EXPENDITURE 57

Operating expenditure 57

Operational expenditure per rateable property 58

Expenditure on goods and services and employee costs 58

Interest paid, capital expenditure, and debt 60

Capital expenditures as a driver o rates 60

Trends in capital expenditure 61

Total debt 63

Interest costs 64

Depreciation 65

TRENDS IN LOCAL AUTHORITY REVENUE 66

Total operating revenue and total rates 66

Historical components o operating revenue 67

Rates and rating measures 68

Rates as a proportion o gross domestic product 68


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Contents

Rates per rateable property 70

Rates increases by size o council 70

Other non-rates revenue, excluding development contributions 71


Geographical diferences in rates increases 72

Comment on Local Authority Funding Project analysis 73Concluding comments 74

8 Drivers o local authority expenditure 75


The issue in context 78

OPERATIONAL AND EXTERNAL DRIVERS 78

Operating expenditure 78

Power o general competence 78

Growth as a driver o increased costs 80

Staf number/salary escalation 80

Price indices 81

Ununded mandates 82

Legislative requirements concerning consultation and nancial management 82

Additional roles placed on local government through legislation 83

Additional expenditure caused by central government withdrawal or scaling back 85

Costs o meeting increased environmental standards 86

Climate change 86

Weathertight homes 88

Costs rom increasing levels o visitors 89

Depreciation 90

INFRASTRUCTURE DRIVERS 91

Overview o inrastructure expenditure 91

Analysis o drivers o capital costs 92

Analysis o drivers in sample local authorities 93

Detailed analysis o drivers 93

Capital expenditure on transport 95

Conclusion on capital expenditure 95

Trends in operating expenditure 96

Conclusion on operating expenditure 96

Water supply and waste-water capital expenditure 97

Water supply 97

Waste water 98

Conclusions on water and waste-water capital expenditure 98

Comparing road transport data o councils and LTNZ 99

Operating costs 99

Cost increases 99

Transport capital expenditure 100

Local authority major transport projects 101

Conclusion on data reliability 102

Social and community inrastructure 102

Conclusion on social and community capital expenditure 103

Inrastructure issues 103

An inrastructure decit? 103

Standards relating to inrastructure 105

Construction industry capacity 105


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Overview o LTCCP capital expenditure orecasts 106

LONGER-TERM FUNDING POLICIES 106

Cash surpluses and unding o depreciation 106

Suggested change in policy 108

Financial reporting issues in this policy change 109Implementing a new long-term unding policy 110

THE AUCKLAND REGION 110

The current rating situation 112

The orecast Auckland region situation 113

9 Current use o rating tools to und services 117


What we were asked to do and the approach taken 118

Trends in rating tools usage 118

Choice o valuation base or general rates 119

General rates 120Uniorm charges 121

Targeted value-based rates 121

Use o property value or rating base 122

Transparency o rating policies 123

Equity o rating systems 123

Rates and property values 124

Ability to pay 125

Benets received 127

Intergenerational equity 128

Merits o targeted rates 128

Rating diferentials 130Business diferentials 130

Rural diferentials 132

Summary o uses o diferentials 133

Valuation issues 134

Accuracy o assessed values 134

Valuation methodology 137

Institutional arrangements or property valuation 137

Consistency in valuations 139

Territorial authorities valuation policies or rating purposes 139

10 Currently available non-rates unding mechanisms 141


Legislative basis or choice o unding mechanisms 144

Public nance principles 144

Transers rom central government 145

When grants should be used 145

Road and transport grants 148

Distribution o transport grants 149

Rationale or diferential road grants 151

Conclusions on central government transers or roads and transport 151

Possible new transers or water and waste-water inrastructure 151


Current situation 153


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Regional councils and government agencies 153

Conclusions on development contributions 154

Debt unding 154

Debt loadings o councils 155

Availability o debt 155Impact o additional borrowing on rates 156

Inrastructure bonds 156

Conclusions on debt nancing 156

Public-private partnerships 157

Income rom investments 158

Rationale or council ownership 159

Ports 160

Rates o return and asset valuation 161

Conclusion on investments 163

Other sources o revenue 163

User charges and ees 164Conclusions on user charges and ees 165

Fines, grants, and donations 166

Asset sales 166

11 Possible new sources o unding or local government 167


Criteria or assessing unding mechanisms 168

Assessment o the options 169

Property taxes (rates) 169

Citizens or poll tax 173

Payroll tax 173

Local income tax 174

Local consumption tax 175

General revenue sharing 175

Industry- and commodity-specic taxes 176

Regional and local petroleum taxes 176

Visitor bed tax 177

International visitor environmental levy 178

Environmental or eco taxes 179

Waste tax 180

Other road user charges 180

Meeting water inrastructure unding needs: an Inrastructure Equalisation Fund 181

12 Sustainability and afordability o rates 183Summary o key points 183

How we approached our task 184

What is sustainability? 185

What is afordability? 185

Distinguishing between afordability and willingness to pay 187

Determining an afordable level o rates or a residential household 187

Rates afordability 188

Afordability in low-income groups 189

Afordability in one-person households 189

Afordability by principal source o household income 190

Projected rates afordability to 2016 191


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Rates afordability or specic groups in the population 192

Rates afordability issues or diferent ethnic groups 192

Rates afordability issues or armers 194

Rates afordability issues or business 194

Impact o choice o rating tools on afordability 195Local Authority Funding Projects conclusions on sustainability and afordability 196

Rates rebate scheme 197

Rates rebate scheme take-up 198

Success o the rates rebate scheme in addressing afordability problems

or ratepayers 200

Management o the rates rebate scheme 200

Indexing o the thresholds 201

Design o the rates rebate scheme: criteria or eligibility 201

Impact o other government assistance packages 202

Accommodation supplement 202

Working or Families tax credits 204Local authority rates remission and postponement policies 204

Rates postponement policies 204

Optional rates postponement scheme ofered by a consortium o local authorities 205

Local authority rates remission policies 206

Assessment o home equity release schemes 207

13 Impact o rates on land covered by Te Ture Whenua Maori Act 211


The Panels task and its approach 213

The cultural context o Mori land 213Distinctive eatures o Mori land 214

Unproductive land and rates as a barrier to production 214

Landlocked land 215

Land made general by the 1967 amendment 215

Legal position o Mori land and the application o rating powers 215

Treaty o Waitangi 217

The impact o valuations on Mori land 218

Impact o rates on papakinga housing 219

Rates and the level o services 219

Relationships between Mori and local authorities 220

Rates arrears 220

Other relevant work on Mori land being undertaken by central government 222

Addressing the issues 222

A diferent and more active role or central government 222

A diferent approach to the valuation o Mori reehold land 223

A diferent approach to local authorities remission policies or Mori land 224

14 Exemptions rom liability or rates 227


What were we asked to do and what approach did we take? 228

What land is exempt? 229

Why was land exempted rom rates? 229

Impact o exemptions on councils 229

Impact o exemptions on the Crown 231Reasons or land continuing to be exempt 232


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Report o the Local Government Rates Inquiry page xiii

Contents

Conservation estate 233

Education and health 233

Religious and charitable 234

Transport

Consideration o the arguments or continuing to exempt land 234

The advantages and disadvantages o removing exemptions 235A special case or exempting Crown-owned land? 236

Retention o exemptions on specic categories 237

Transition issues 238

Conclusion on the uture o exemptions 238

Expanding the services or which targeted rates can be charged 240

Crown contributions in lieu o rates 241

15 Financial decision making in local government consultation, planning,

and accountability 243


Key issues 245Empowerment o local government 245

Improving consultation 246

Improving accountability 249

Dissemination o best practice 249

Improvements in the LTCCP and annual plan processes 250

Concerns about the nature and quality o citizen engagement in the LTCCP process 253

Improving reporting on proposed level o rates and rate increases 253

Rates assessments 254

Statement o revenue and nancing policy 255

Financial targets 255

Annual nancial reporting by councils 256

Better reporting on perormance 257

Training o elected members 257

Public education 258

Options to enhance accountability or dissatised citizens and community groups 258

Monitoring local government 260

Managing central government relations with local government 260

APPENDICES

List o appendices 263

Appendix 1: Terms o reerence 264

Appendix 2: Local authorities o New Zealand 266

Appendix 3: Inquiry process, meetings, and consultancy reports 268Appendix 4: Glossary o terms 272


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Contents

LIST OF CHARTS AND TABLES

Charts

Chart 4-1 Local government operating expenditure, year to June 2006 38

Chart 4-2 Average operating expenditure by activity as a percentage o total

expenditure by type o council (rural, provincial, and metropolitan territorial

local authority and regional council), year to June 2005 38

Chart 5-1 Sources o local government income, year to June 2006 42

Chart 5-2 Territorial local authority use o rating tools as a percentage o total rates

revenue, orecast year 2006/07 43

Chart 7-1 Local government actual operating expenditure, and as percentage o GDP,1994 to 2016 57

Chart 7-2 Local government operating expenditure per rateable property, nominal and

real, or the orecast period (2006/07 to 2015/16) 58

Chart 7-3 Local government actual operating expenditure by components, 1994 to 2006 59

Chart 7-4 Annual percentage change in employee costs, interest paid, and purchase o

goods and services, and other components o local authority costs,

1994 to 2006 60

Chart 7-5 Total capital expenditure o local government, 1994 to 2016 61

Chart 7-6 Capital expenditure o local government by activity, or the orecast period

2007 to 2016 62

Chart 7-7 Local government total liabilities, 2000 to 2016 63Chart 7-8 Total interest costs o local government, 1994 to 2016 64

Chart 7-9 Annual percentage change in depreciation costs o local government,

1994 to 2016 65

Chart 7-10 Local government operating revenue, 1994 to 2016 67

Chart 7-11 Local government operating revenue by category, 1994 to 2006 68

Chart 7-12 Local government rates revenue (by value and as a percentage o nominal

GDP), long-term series, 1961 to 2016 69

Chart 7-13 Local government rates and central government taxes as a percentage o GDP,

long-term series, 1961 to 2016 69

Chart 7-14 Local government rates per rateable property, nominal and real, 2007 to 2016 70

Chart 7-15 Development contributions as proportion o capital expenditure, 2007 to 2016 72

Chart 8-1 Forecast increase in rates against orecast growth in number o households

or all local authorities, 2006/07 to 2015/16 79

Chart 8-2 Selected price movements (transport ways and pipelines) within the Capital

Goods Price Index, and Consumers Price Index (all sectors), 2000 to 2006 80

Chart 8-3 Selected price movements within the Producers Price Index and Farm Expenses

Price Index, also Consumers Price Index (all sectors), 1995 to 2006 81

Chart 8-4 Depreciation expenses o local government, 1994 to 2016 90

Chart 8-5 Main drivers o capital expenditure or the 23 ocus councils, 2007 to 2016 94

Chart 8-6 Total capital expenditure by all councils, 11 major councils, and remaining 74

councils, 2007 to 2016 95

Chart 8-7 Total transport capital expenditure by all councils, six transport ocus councils,

Auckland City, and remaining 79 councils, 2007 to 2016 96


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Chart 8-8 Total operating expenditure o the 23 ocus councils or three waters and

transport, 2007 to 2016 97

Chart 8-9 Comparison o council and LTNZ data or transport operating expenditure

o our councils, 2007 to 2016 100

Chart 8-10 Local authority major transport projects, 2007 to 2016 101Chart 8-11 Capital expenditure on social and community activities by 23 ocus councils

according to the type o council 102

Chart 8-12 Capital expenditure on social and community activities according to type

o expenditure or Auckland councils (let), growth councils (centre), and

rural and provincial councils (right) 103

Chart 8-13 Estimated rates per rateable property (excluding GST) or selected local

authorities, 2006/07 113

Chart 9-1 Comparison o local authority rates by type o rating base, 2002/03 and

2006/07 120

Chart 9-2 General rates as a percentage o total rates revenue according to category o

local authority, 2006/07 120

Chart 9-3 Uniorm charges as percentage o total rates revenue, 2006/07 121

Chart 9-4 Targeted value-based rates as a percentage o total rates revenue, 2006/07 122

Chart 9-5 Payments to local authorities as percentage o household incomes 125

Chart 9-6 Meshblock income compared with meshblock land value, 2003/04 126

Chart 9-7 Meshblock income compared with meshblock capital value, 2003/04 127

Chart 10-1 Grants received, all local authorities, year ended 2006 145

Chart 10-2 Road grants per capita and population (local authorities) 149

Chart 10-3 Total (road + transport) grants per capita and population (regions) 150

Chart 10-4 Long-term debt and xed assets, all councils, 2005 155

Chart 10-5 Regulatory, sales, and other revenue as a percentage all income, all

local authorities, 2005 165

Chart 12-1 Rates and housing costs as percentage o household average household

income 190

Chart 12-2 Rates and housing costs as a percentage o average weekly household

income by number o persons in household 190

Chart 12-3 Rates and housing costs as a percentage o average weekly household

income by principal source o income 191

Chart 12-4 Use o proceeds o New Zealand reverse mortgages, settlements in 2006 208

Chart 14-1 Non-rateable Crown land by capital value, 2004/05 233


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Tables

Table 5-1 Investment income as a proportion o operating revenue, 2005/06 48

Table 7-1 Total operating expenditure in 2006/07, 2015/16, and throughout the

10-year orecast period, or local authorities categorised by population 59

Table 7-2 Capital expenditure in 2006/07 and 2015/16, and total over the 10 years,or major categories o expenditure 62

Table 7-3 Total debt in 2006/07 and 2015/16, by category o local authority 63

Table 7-4 Number o territorial authorities and regional councils according to orecast

ratios o interest costs to rates in 2006/07 and 2015/16 64

Table 7-5 Operating revenue in 1993/94 and 2005/06 or major categories o revenue 68

Table 7-6 Total rates in 2006/07, 2015/16, and percentage change over the 10-year

orecast period, by category o local authority 71

Table 7-7 Average rates per rateable property in 2006/07, 2015/16, and percentage

change over the 10-year orecast period, or local authorities categorised by

population 71

Table 7-8 Percentage change in total rates over the 10-year orecast period to June 2016,by geographical area 73

Table 7-9 Change in level o rates per household over the 10-year orecast period to

June 2016, by geographical area 73

Table 8-1 Total depreciation costs in 2006/07 and 2015/16, by category o local authority 90

Table 8-2 Major drivers o capital expenditure or our types o council, 2007 to 2016 94

Table 8-3 Major characteristics o Aucklands seven councils 111

Table 8-4 Rating systems used by the Auckland councils, 2006/07 112

Table 8-5 Key data or Auckland region and relationship to the total local government

sector, in 2006/07 and 2015/16 114

Table 9-1 Rates by type, 2006/07, showing percentage change on previous year 119

Table 9-2 Proportion o rates based on property value, 2006/07 122

Table 9-3 Business diferentials on general rates according to category o council,

2006/07 131

Table 9-4 Rural diferentials on general rates according to category o council, 2006/07 132

Table 10-1 Central government transers 146

Table 10-2 Major investments held by local authorities 159

Table 10-3 Local government ownership o ports 160

Table 10-4 Rates o return on assets o council investments 161

Table 10-5 Financial inormation rom ports 162

Table 10-6 User charges and ee income as percentage o total income, 2005 164

Table 11-1 Diferent taxes assessed against criteria o appropriateness, eciency,equity, and sustainability 170

Table 11-2 Potential revenues rom a regional petrol tax 176

Table 11-3 Gross annual revenues rom percentage visitor bed tax at diferent tax levels 178

Table 11-4 Projected revenues rom an international visitor tax 178

Table 11-5 Revenue rom a waste levy 180

Table 12-1 Annual median rates as a percentage o household income, 2006/07 193

Table 12-2 Annual median rates as a percentage o household income, 2015/16 193

Table 12-3 Annual median rates as a percentage o household income, change 2006/07

to 2015/16 193

Table 12-4 Continuum o regressiveprogressive rating tools 197Table 12-5 Rates rebate scheme payments under various income scenarios 199


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Table 12-6 Accommodation supplement income thresholds 203

Table 12-7 Accommodation supplement recipients by tenure and average weekly

accommodation supplement, year to June 2004 203

Table 12-8 Percentage o local authorities with particular types o rates postponement

policy provisions 205Table 12-9 Type o rates remission provision 207

Table 14-1 Summary o the categories o non-rateable land, Local Government

(Rating) Act 2002 230

Table 14-2 Efect on rates revenue o non-rateable properties in Dunedin City Council 232

Table 14-3 Suggested treatment o existing categories o non-rateable land,

Local Government (Rating) Act 2002 239


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PANEL MEMBERSHIP

A three-person panel conducted the inquiry. A list of the members and a summary of their experienceis noted below.

David Shand, chairperson. David Shand returned to New Zealand in 2006 after a number of yearsliving overseas. He has worked for three international organisations, most recently for over eight yearsas a public financial management specialist at both the World Bank and the IMF in WashingtonDC. Tis followed four years working with the OECD in Paris on public sector reform issues.

After joining the reasury in the mid-1960s Mr Shand taught accounting and public finance atVictoria University before moving to Australia in 1977. He left the Australian National University

in 1981 to start a career in the Australian public sector and held a number of senior positions instate and federal government, including Deputy Secretary of the Victorian reasury, First AssistantSecretary in the Australian Department of Finance and Queensland Public Service Commissioner.

In the 1970s Mr Shand spent six years in local politics as a Wellington City Councillor.

He is currently a director of Meridian Energy Ltd.

Graeme Horsley. Mr Horsley is a former partner of Ernst and Youngs corporate finance practiceand is widely recognised as an expert in property investment and valuation.

A Life Fellow of the New Zealand Institute of Valuers (NZIV), he was for 12 years the NZIVrepresentative on the International Valuation Standards Committee, and was chair of the Committee

between 1989 and 1993.

He is a professional director, chair of Ngti Whtua o Orakei Corporation, deputy chair of the Bayof Plenty District Health Board, and independent director of the AMP New Zealand Office rustmanagement company. He has held a number of other directorships including Carter Group Ltd,rustbank Wellington, and Housing New Zealand.

Mr Horsley also has international experience of the real estate sector undertaking consultingassignments in Asia, Australia and the Pacific Islands. More recently he has focused on majorcorporate and public sector issues in investment and economic analysis.

Dr Christine Cheyne. Dr Cheyne is a senior lecturer in Resource and Environmental Planning at

Massey University Palmerston North. Previously she worked in local government in planning andresearch at Palmerston North City Council. She has specialised knowledge of representation andpublic participation in local government and social policy. Her research has focused on annual andstrategic planning from local authorities, and public participation in local authority decision-making.She is currently a member of Horizons Regional Council Regional Land ransport Committee, asan environmental sustainability representative. She is also a member of the aranaki/WhanganuiConservation Board.


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Report o the Local Government Rates Inquiry page xix

ACKNOWLEDGMENTS

Te Panel extends its thanks to all those who made contributions to the Rates Inquiry and to thosewho supported the work of the Panel.

First our thanks go to the large number of people who met with the Panel as it travelled around NewZealand. Te meetings with councils, public and Mori landowners were central to the work of thePanel in gathering opinions and information. Submitters who took the time to think through thepoints of concern to them and convey their views in writing provided a crucial source of informationthat has been fully read and considered by the Panel. Tis material will continue to be a resource forthose considering our report and also provide a reference point in the future.

Te Panel has met with many councils and stakeholder groups that have a central interest in theissue of rates and local government funding. Tis has provided an opportunity to talk through anddiscuss particular points that have been central to meeting our terms of reference. Many of theseorganisations and individuals have also provided references and information in relation to bothpolicy and basic technical data that has assisted the Panel.

Government agencies have also provided important information and data to the panel and beenwilling to meet and discuss rate issues and local government funding.

Te Panel would like to thank the Chief Executive of the Department of Internal Affairs and theExecutive Government Support branch of Department of Internal Affairs for the secretariat andadministrative services and support provided by them.

Te Panel acknowledges the contribution by consultants contracted to undertake work on particularaspects of the inquiry and of those individuals who agreed to peer review material at the draft reportstage.

Finally the Panel would like to thank those who have worked closely with us and supported ourefforts in addressing the complexities associated with reviewing local government rates in NewZealand over a period of eight months. In particular we wish to thank John Gilbert, our ExecutiveOfficer; Advisors Paddy Gresham, Malcolm Tomas and David Stimpson; Executive AssistantRosemary Marshall; Researchers Nicholas Jessen and Rohan Wakefield; Communications AdvisorIain MacLean; Submissions Analyst Louise Fawthorpe; Submissions Support Officer Janet Weirand editor Barbara Hedley.


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page xx Funding Local Government

ABBREVIATIONS

AV annual value

BERL Business and Economic Research Limited

capex capital expenditure

CCO council-controlled organisation

CPI Consumers Price Index

CV capital value

DIA Department of Internal Affairs

DOC Department of Conservation

EBI earnings before interest and tax

FAR financial assistance rate

FED fuel excise duty

GAAP generally accepted accounting practice

GDP gross domestic product

HES Household Economic Survey

IEF Infrastructure Equalisation Fund

IFRS International Financial Reporting Standards

LAP local authority petroleum tax

LGA Local Government Act 2002

LGNZ Local Government New Zealand

LGRA Local Government (Rating) Act 2002

LCCP long-term council community plan

LIM Land Information Memorandum

LOS/LoS level of service

LRARA long run average renewals approach

LNZ Land ransport New Zealand

LV land value

MAF Ministry of Agriculture and Forestry

NLF National Land ransport Fund

NZIER New Zealand Institute of Economic Research

OAG Office of the Auditor-General

opex operating expenditure, operational expenditure

OI outgoings (on housing) to income ratio

RMA Resource Management Act 1991

SHERPA Safe Home Equity Release Plans Association

SOLGM New Zealand Society of Local Government Managers

SWSS Sanitary Works Subsidy Scheme

UAGC uniform annual general charge

Note that, in recognition of the length of this report, each chapter has its own treatment and explanation of abbreviations.

If a term appears only a few times within a chapter it is not abbreviated.


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Report o the Local Government Rates Inquiry page 1

SUMMARY REPORT

The ollowing two sections provide a summary o the report o the Local

Government Rates Inquiry and the 96 recommendations o the Panel.

The summary presents rst an overview o the local government sector

and the Panels general conclusions on how the unding o services to

communities could be made more exible and more equitable. Next

there is a more detailed summary o the inquirys ndings on specic

topics rom its terms o reerence.

EXECUTIVE SUMMARY

1. Te starting point is that, generally speaking, local government works well in meetingthe diverse needs of New Zealanders. It provides, at reasonable cost, a substantial range of basicservices, which can be broadly categorised as either network infrastructure (roads and publictransport, the three waters water supply, waste water and stormwater plus solid wastedisposal) or community and social infrastructure (cultural and recreational facilities), as wellas a range of regulatory activities. Overall it accounts for somewhat less than 5% of national

expenditure.

2. Te focus of this report is on the spending and funding decisions related to theseservices. Te funding system is under pressure because of significant growth in expendituresand growing affordability problems with the main source of funding, namely rates.

3. Overall, the Panel sees several significant problems, both in the financial decision-making processes in local government and the financial decisions that are being made. Primeresponsibility for addressing these issues rests with local government itself, and many of theremedies lie in self-management including the adoption of good practices, and the discipline ofthe democratic process including meaningful consultation with citizens.

4. Local government in New Zealand has substantial autonomy in its financial decisions.Tis is a major strength. But with this autonomy goes a requirement for accountability, basedon consultation and transparency both of which require the provision of relevant information.Tis autonomy also implies the need for expenditure restraint. Te Panel considers that somecouncils are showing insufficient financial restraint and paying inadequate attention to theequity and affordability of their plans. Te Panel also considers that many have adopted fundingpolicies that are leading to higher than necessary levels of rates.

5. Te main actions required from central government are

providing some new funding sources, some of which involve increased fundingfrom central government, to enable the level of rates to be held at sustainable levelsover the next 10 years


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page 2 Funding Local Government

Executive Summary

further improving rates affordability through the rates rebate scheme and othergovernment income support packages

legislating for some changes in the rating system to reduce complexity and improvetransparency and equity

improving coordination within central government on local government issues andliaising better with local government.

6. Te Panel has identified affordability problems for rates for some sections of the community,which will increase over the next 10 years. Tis means that under current practices rates will not besustainable in 10 years time. Rates currently account for around 56% of local authority operatingrevenues, and the long-term council community plans (LCCPs) forecast they will rise to 60% by2016.

7. Te Panel considers rates should remain as the major source of local government revenue butneed to be reduced to around 50% of total revenues. As a tax rates have many advantages efficiency,difficulty of evasion, and low economic deadweight costs and there is a reasonable relationshipbetween property values and incomes, even though overall rates tend to be somewhat regressive intheir impact.

8. Te Panel does not recommend any major new tax to replace rates. Tere is no need forany magic bullet to fix the problem, and indeed there is no such bullet available. However, it makesa number of recommendations to make the rating system simpler and more transparent, equitable,and sustainable.

9. Local government is not in financial difficulties, as it is in some Australian states. Te reverseis true. Its finances are generally in a healthy position, with low debt and in many cases significantlevels of income earning investments.

10. Te Panel makes significant recommendations below to address the many and complexissues concerning the rating of Mori land. Tese issues have been allowed to remain unresolved fortoo long and urgent action is needed to address them.

Restraining expenditure and rates

11. Local authority expenditure has been rising rapidly, driven by expenditure on infrastructurerenewal, expansion, and upgrading. A major item of increased operating expenditures is depreciationon the larger stock of assets, which most local authorities fund with cash raised through rates.However, over the next 10 years, local authority operating expenditure is forecast to stabilise in realterms (after adjustment for inflation) and decline as a percentage of GDP as capital expenditure and

rate of growth in the associated operating costs decline.

12. Rates, however, increased by 38% in real terms (that is, above the rate of inflation) over the12 years from 1993/94 to 2006/07. Te LCCPs forecast that rates will increase in nominal termsby 8% per year over the next few years but reduce to around a 4% per year increase by the end of the10-year period.

13. Local government needs to show more restraint in its expenditures, and to improve itsplanning function, which drives these expenditures. It needs to give more rigorous considerationto the desirability and prioritisation of expenditures, including consideration of deferral or pushingout of expenditures to later years. In general local government is not adequately presenting keychoices or alternatives in its LCCPs to facilitate useful input by citizens and to enable councillors

to adequately manage and prioritise expenditures.


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Executive Summary

14. Te Panel has analysed the LCCPs and concludes that the forecast expenditure figuresin the LCCPs are likely understated. However, questions must be asked as to whether all theproposed capital expenditure is feasible or needed within the 10-year time frame or needed atall if demand can be better managed through user charges. Te Panel considers there is a need for

councils to reassess the forecast infrastructure expenditures contained in their LCCPs.15. In addition, many councils are failing to adequately consider the affordability of rates increasesfor some of their residents. Tis is not simply a matter that can be left to central government incomesupport policies or the rates rebate scheme, which are valuable mechanisms in assisting affordability.Councils themselves need to undertake more analysis of affordability issues when deciding on totalexpenditures to be financed from rates and on the rating mechanisms to be used to distribute theburden.

16. Te Panel considers a cap on rates is too blunt an instrument to achieve restraint. It wouldnot recognise the different financial position and expenditure needs of different councils and in anycase would cover only the less than 60% of local government revenues consisting of rates. A cap

based on the Consumers Price Index (CPI) would not recognise either growth pressures or thatthe price of most local government inputs is rising faster than the CPI. Rather, the Panel considersall councils should be required to adopt clear and honestly measured financial targets, which wouldbe reflected in LCCPs and a three-year indicative budget. Tese targets would cover proposedincreases in operating expenditures as well as rates.

17. Many councils are not making the best choices in their funding policies, reflecting a strictor unquestioning adoption of the balanced budget requirement contained in the Local GovernmentAct 2002 (LGA 2002). Tere is scope for considerable reduction in or holding of rates by greater useof debt funding for long-life assets (which is an equitable way of funding such assets). Related to thisthere is also scope for reducing the extent to which depreciation is funded. Te Auditor-Generalsrecent report on LCCPs indicates that by 2016, despite record levels of capital expenditure, local

authorities as a whole will have low debt and will have accumulated significant cash reserves broughtabout by the funding of depreciation. In the forecasts contained in the LCCPs, by 2015 all capitalexpenditure could be funded from operating revenues and accumulated cash reserves, with no furtheruse of debt. Tis is a very conservative policy, which will lead to higher than necessary rates over the10-year period and achieve poor intergenerational equity.

18. Te Panel estimates that reductions in the forecast level of rates of between $300 millionand $500 million per year (and possibly more) would be possible by the adoption of this revisedfunding policy. Tis is equivalent to around 10% of current rates.

A changed local authority unding pattern

19. As mentioned, the Panel considers that the forecast level of rates is not sustainable becauseof emerging affordability problems for a significant section of the population. Rates in real terms,therefore, need to be held at current levels or reduced. Te Panel considers that this should beachieved by a combination of the following:

councils exercising greater restraint in their expenditures, particularly reviewing theirforecast capital expenditures

councils reducing the extent to which they fund depreciation from current revenuesand instead making greater use of debt to finance long-life assets, resulting in the abilityto reduce rates from forecast levels by between $300 million and $500 million per year and possibly more

councils using volumetric user charges to fund water and waste-water expenditures


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Executive Summary

some additional sources of funding being provided to local government, namely

- removal of Crown exemptions from rates, except for Department of Conservationand other conservation land, which will provide local government with anadditional $100 million per year (most of this funding to come from the central

government Budget)- increasing the current local authority petroleum tax, first introduced in 1970, by

2 cents a litre to be distributed to local authorities (this will provide an estimatedadditional $90 million per year)

- providing additional central government funding to a new InfrastructureEqualisation Fund to meet necessary water infrastructure expenditures of around$100 million per year, coming from a hypothecated share of GS.

20. It is important that these additional funds be used to replace rates rather than to increaseexpenditures. Although it is difficult to ring-fence such revenues, various measures to limit anycouncil profligacy in expenditure are possible, as discussed above.

21. If the above recommendations are adopted the result would be different funding mechanismsfor the two main functions of councils, each of which has different cost drivers.

22. Network expenditures would be largely funded from user charges and government transfers,plus debt representing a move away from rates to a funding mechanism that replicates the way suchassets are funded elsewhere. Tese networks are normally monopoly operators, and it is importantthat there are proper pricing and investment decisions. Currently the land transport network is apartnership between central and local government. Tere is a need to develop a similar partnershipfor the three waters infrastructure.

23. Tis would leave community and social infrastructure being funded by a mixture of debt

and rates.

24. Overall, ratepayers will see their burden lessened, or at least stabilised, if the Panelsrecommendations are adopted. However, the burden on individual ratepayers will depend on theimpact of the Panels recommendations on restructuring the rating system discussed below, whichwill differ between councils. Tese changes would remove the power to set differential rates anduniform annual general charges (UAGCs) (to be replaced to some extent by targeted rates) and seea move to volumetric charging for water and waste water. But to limit any possible regressive impactuniform targeted rates would be limited to 50% of total rates. Councils can also address any possibleregressive impacts and maintain affordability through the use of rates remission policies.

A summary of the Panels conclusions under specific parts of its terms of reference is set out

below.

Drivers o local authority expenditures (Chapter 8 o the report)

25. Te Panel has spent considerable time analysing this important part of its terms of reference.However, reaching firm conclusions is difficult because of data limitations and because of the needto make judgments about the accuracy of forecast expenditures in the LCCPs, particularly forcapital expenditures. Te Panels analysis suggests that the forecast capital expenditures may beunderstated, for a number of reasons detailed later in this report.

26. Capital expenditures have been increasing significantly but will peak in 2009 and are thenforecast to decline, particularly in transport and particularly in the Auckland region. It should be notedthat construction price indices are rising much faster than the Consumers Price Index. Te LCCPsforecast total capital expenditures of $31 billion over the 10 years 200616. However, analysis of


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Executive Summary

these trends is hampered by lack of historical data on the composition of capital expenditures.Te expenditure is dominated by network assets land transport and the three waters, whichaccount for 73% of the total (land transport covering both roads and public transport at 44%and the three waters at 29%), followed by community infrastructure assets (18%) and other (such as

economic development and harbours) at 9%. Local government roads expenditure is dominated byabout four major projects.

27. Te Panel has had this forecast infrastructure expenditure analysed to determine thereasons for its growth. Tese reasons include population growth, higher standards, and renewals ofexisting infrastructure, but these components clearly differ between high- and low-growth councils.It is difficult to determine the extent to which this expenditure represents a catch-up due to pastunderinvestment; this appears to be a factor in new roading construction (capital expenditure)and public transport. Tere is little evidence of past underfunding of maintenance and renewalsexpenditure.

28. Tis accumulated capital expenditure flows through into significant increases in operating

and maintenance costs and in the substantial increase in depreciation expense, most of which councilswill fund by way of cash. Depreciation expenditure has grown rapidly from 13% of total operatingexpenditure in 1993/94 to around 21% in 2005/06, and is forecast to continue to remain aroundthis level over the 10-year period at around 22% of total operating expenditure in 2015/16.

29. Although local government staff numbers have been increasing, this increase should be seenin context, given growth in the economy and population. Local authority administration staffingnumbers increased by 22% between February 2000 and February 2006, compared with increases of27% in central government administration and 24% across all industries. In terms of the impact onrates it appears that much of the increase is in regulatory areas such as building inspection, whichwill be largely recovered by user charges

30. Te Panel received many submissions suggesting that the LGA 2002 has been a major driverof increased expenditures in that it has encouraged councils to move into activities outside their corebusiness by giving them a power of general competence. Te Panel could find little evidence tosupport this. It notes that the provisions in LGA 2002 are little different from those in the LocalGovernment Act 1974. It also notes that many councils have been involved for many years in suchactivities as social housing, the provision of major cultural and sporting activities, and commercialoperations such as parking buildings and other trading undertakings. Only involvement in economicdevelopment strategies appears relatively new, and this does not account for a significant portion ofexpenditure.

31. Te Panel also carefully reviewed the many submissions that considered that centralgovernments passing of unfunded mandates to local government has been a major expenditure

driver. Overall, it considers this has some foundation but has been exaggerated. First the Panelconsiders that some of the issues raised, such as the requirement to prepare an LCCP and to haveit audited, are normal good practice management, which councils should undertake anyway. Teserequirements, which are part of the legislative framework within which local government operates,are not appropriately described as unfunded mandates, even if they involve some costs.

32. But the Panel accepts that local government has been required to take on a number of newfunctions that in total involve significant expenditures. Major ones are the management of ResourceManagement Act 1991 (RMA) processes and the requirements of the Building Act 2004, whichincrease the level and standard of building approval and inspection. However, with the exception ofany costs of policy development and staff training, as well as consultancy and litigation costs under

the RMA, the cost of these new functions should be covered by user charges.


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Executive Summary

33. Many smaller additional functions have been passed on to local government, such asinspection and licensing of licensed premises, gambling machine licensing and supervision, theregistration and inspection of brothels, and the implementation of micro-chipping of dogs. However,user charges should be set for these functions so as to achieve full cost recovery.

34. Te Panel notes that in some cases fees are set nationally, which may prevent full cost recovery,and recommends that in all such cases councils be given the power to fix their own fees, based on actual andreasonable cost recovery.

35. Te Panel also notes that all these functions are appropriately carried out by local ratherthan central government. Tis devolution may necessarily involve some additional expenditure bylocal government.

36. A number of local government submissions referred to central government giving theseresponsibilities to local government without adequate analysis, coordination, consultation, orguidance, a matter that is discussed further in Chapter 15 of this report.

37. Significant additional council expenditures (both capital and operating) arise from the needto meet increased environmental standards, such as the proposed drinking water standards underthe Sustainable Water Programme of Action and the National Environmental Standards for AirQuality. Te costs of meeting these standards appear to be high, but there is considerable disputeover the amounts directly attributable to the new standards. It can be noted that Local GovernmentNew Zealand now puts the estimated cost of meeting the drinking water standards at around $950million, although this figure is disputed by Ministry of Health.

38. Nevertheless, councils are planning to spend substantial sums in upgrading their systemscovering the three waters. Te Panel considers that in view of the national benefits and the highcosts to councils, there is a good case for additional government funding being provided to localgovernment to meet some of this expenditure.

39. As discussed further in Chapters 10 and 11, the Panel recommends funding of around $100million per year to a new Infrastructure Equalisation Fund established for this purpose, using an earmarkedportion of GS.

40. One further area of expenditure growth caused by withdrawal from the area by centralgovernment is regional council expenditure on catchment management; however, data on currentlevels of expenditure are not available. Other smaller areas in which central government expenditurehas been reduced, but where council expenditure is more discretionary, include library services,social housing, and community safety initiatives.

41. Tere are possible significant future expenditures not included in LCCPs arising from

climate change and weathertight building litigation, but it is not possible to quantify these.

42. Because of the size and significance of the Auckland region in the rates debate the Panelhas carried out a separate analysis of the Auckland regions councils. Tis shows that although thereis some diversity between councils, rates are higher than the national average in all Auckland councilsand will grow in real terms per rateable property by around 11% over the period to 2016, drivenby capital expenditure on land transport and community infrastructure. Tese increases appearunsustainable and likely to lead to even greater affordability issues than elsewhere in the country.

Current use o rating tools (Chapter 9 o the report)

43. Te Local Government (Rating) Act 2002 (LGRA) gives councils considerable flexibilityin spreading the rate burden. Council rating policies are set out in the revenue and financing policyrequired under the LGA 2002. Although in general councils have not made extensive use of the


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Executive Summary

flexible rating powers, rating systems may still differ quite significantly between councils. Tis isappropriate given the objectives of the LGA 2002 to promote decision making that reflects localcircumstances and preferences.

44. Councils may levy a general rate, targeted rates for particular services, a uniform general

charge, and user charges as alternatives to rates. Te LGRA limits total fixed charges, (excludingwater and waste-water charges) to 30% of total rates revenues. Under the general rate councils mayset differential rates for different classes of taxpayers (such as businesses and farms, as opposed toresidential properties). Tey may levy rates at a different rate for different levels of property value although only two councils chose to do this. And the boundary between rates and some usercharges is moveable. For example, councils may levy user charges through water metering as partof the rating system, or user charges may be billed separately by a council-controlled organisation(CCO).

45. Although discussion about rates frequently revolves around property values, it shouldbe noted that less than two-thirds of rates are based on property values the balance being fixed

charges, volumetric charges, rates based on land area, and other permitted bases.46. Tus, although rates are a tax on property, the LGRA enables them to be set to at leastpartly reflect services consumed, for example through targeted rates. Tey are thus better regardedas a hybrid of a tax and a user charge.

47. With the increased use of differentials and fixed charges since the LGRA was introduced in2002, the rating system has in general become more regressive in relation to incomes. A significantnumber of submissions sought either an increase in the permitted maximum of 30% on fixed chargesor its abolition, which if exercised, would make the rating system more regressive. Te Panelsrecommendations for UAGCs are set out below.

48. Te Panel notes that there is considerable public misunderstanding about how the ratingsystem works.

49. First, many ratepayers believe that increases in property values by themselves increase rates.However, it is council expenditures that drive rates; property values are only a means to distributethe burden of rates. Te extent to which the rates on an individual property will rise will depend onincreases in expenditure to be funded from rates, the increase in the number of rateable properties,and the extent to which the value of the property increases by more or less than the average increasein property values in the rateable area.

50. Second, the flexibility given to councils means that the system adopted by many individualcouncils is complex, containing many different components. Te rating policy is explained in each

councils revenue and financing policy, required by the LGA 2002. However, key issues such as thebasis on which differentials or targeted rates are set are often not well explained, reflecting a widevariation in the quality of analysis behind the determination of these policies. Some councils haveundertaken a robust analysis of cost and benefits to different classes of ratepayers. In others there islittle analysis or transparency.

51. In the interests of transparency and equity the Panel recommends that the power to setdifferential rates and to use UAGCs should be removed.

52. Differentials and UAGCs tend to be set arbitrarily without explicit justification in terms ofthe services to be funded. Tere is little transparency of the criteria that are being used. With theremoval of differentials and fixed charges, the rating system would comprise only a general rate and

targeted rates plus the possibility of user charges. Tus higher rates charged to businesses througha business differential would be removed. Tat is not to say that businesses might not be chargedhigher rates based on targeted rates for particular services. But this would have to be based on the


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Executive Summary

requirements for setting targeted rates provided in the LGRA. And the removal of UAGCs wouldnot prevent councils setting uniform targeted rates. However, to constrain any possible regressiveimpacts the Panel recommends that there be a limit of 50% on uniform rates as a percentage of totalrates.

53. Overall, these changes recommended by the Panel would make the rating system lesscomplex and more transparent. However, councils would need time to develop new rating policiesin response to these changes and to consult with their citizens. Te Panel therefore suggests thatthe changes not be required to be implemented before the 2012/13 LCCPs, although consultationshould commence with a view to phasing them in before this time.

54. Te Panel also favours greater use of volumetric user charges for water and waste wateras a means of demand management, which would be expected to reduce needed infrastructureexpenditure, although it does not suggest this charging be mandated. Some councils have usercharges in these areas now, although not all are volume-based. Applying volumetric charging to wastewater is more difficult but not impossible, and councils should develop equitable policies based on

the volume of water used. Depending on the cost structure, these user charges would comprise amixture of an access charge and a volumetric charge.

55. Te Panel considers that all local authorities should be encouraged, where feasible, to usewater metering for recovery of water costs. It recommends that the Government consider providingfinancial assistance for the nationwide installation of meters where they can be used.

56. Te existing requirement that a CCO be formed before volumetric waste-water chargingcan be introduced has no logical basis and the Panel recommends it be removed.

57. Te Panel favours the promotion of a common system of valuation for rating purposes andstrongly favours the capital value system because of the closer relationship of capital values withhousehold incomes.

58. Te Panel considers that, in fixing their overall rating policies, councils should have regardboth to services consumed and to ability to pay. Te changes that it recommends above would likelychange the distribution of the burden between commercial and residential ratepayers and betweendifferent residential ratepayers. Unless councils make other adjustments to their policies they may beregressive in their impact. It is difficult to forecast what the full impact would be and it would differbetween councils. However, councils would retain considerable discretion in whether to use targetedas opposed to general rates and to mitigate any regressive impacts through rates remission policies.

59. Te Panel recommends that the LGA 2002 be amended to explicitly require councils to considerrates affordability to lower income ratepayers in designing their rating system.

60. Te Panel has considerable concerns about the overall quality of property valuations usedin the rating system. Although these are not intended to reflect actual sales prices, but rather to forma consistent base for the allocation of the rating burden where rates are based on property values,the Panel received considerable adverse comment on the property valuation system. Tis feedbackwas discussed with the Valuer-General. Although the Valuer-General does not concur with thecriticism, the Panel nevertheless considers that the quality of property valuations has deterioratedover the past 10 years. In a significant number of cases valuations are no longer adequate as a basisfor distributing the rating burden. Many councils do not appear to show sufficient interest in thequality of the valuation roll.

61. Te Panel recommends that the previous model of a central government valuation authority

be re-established to increase the level of professional resources being applied to rating valuations or thatadditional resources be provided to the Valuer-General to facilitate better quality control of valuations.


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Executive Summary

62. Te Panel also recommends that councils make more use of their flexible rating powers so thatthe rating burden better reflects value in use, rather than potential sale price. In the case of farmingproperties, this value in use basis would provide some redress for any current inequities in the ratingof farmland, particularly given the Panels recommendation that differentials be abolished.

Currently available non-rates unding mechanisms (Chapter 10 o the report)

Transers rom central government

63. ransfers from central government are an important and growing source of funding forlocal government. Although they cover many areas of activity, the greatest amounts are allocatedtowards roads (64%) and public transport (25%).

64. Te Panel considers that the existing pattern of financial assistance rates (FARs), fundedfrom the National Land ransport Fund (NLF), which average 50% of maintenance costs and60% of construction costs, are appropriate. Te actual cost sharing varies between councils based onan assessment of the relative costs of road construction and the rateable base of each council. It notesthat they are skewed towards more lightly used rural roads. It considers that the funding of majorurban arterial routes should be reviewed and possibly increased.

65. A number of submissions sought an increase in the level of FARs, with suggestions rangingfrom 75% to 100%. Te Panel considers that the existing sharing arrangements are reasonable anddoes not recommend any change except for the new category of major urban arterial roads discussedabove. It considers it important that councils bear a reasonable share of costs to reduce demands forfunding of low-priority or unnecessary projects. Some of these submissions saw such an increase asdesirable because it would avoid councils needing to allocate rates revenue to roads. Te Panel notesthat its recommended increase of 2 cents per litre in the existing local authority petroleum tax would

assist in achieving this.

66. Although there is a well-established and well-functioning system of central governmenttransfers for land transport (both roads and public transport), there is no such system for the othermajor area of infrastructure expenditure, namely the three waters water supply, waste water, andstormwater. Tere are currently only two relatively small subsidy schemes (plus an even smallersubsidy scheme for authorities having high visitor demand):

the Sanitary Works Subsidy Scheme available to small communities with highdeprivation levels, for which $150 million has been allocated over the 10 years from2003, all of which is now committed

the Drinking Water Assistance Programme, which also provides around $150 million

over 710 years for capital and technical assistance for small communities with highlevels of social deprivation.

67. It can be noted that both these schemes apply only to schemes for small communities andnot to council-wide schemes. Before the 1990s the Government provided substantial assistance forlocal water and waste-water schemes.

68. Te Panel considers that a strong case exists for greater central government transfers to meetthe cost of the three waters infrastructure and in Chapter 11 recommends new funding of around$100 million per year, hypothecated as a share of GS, through a new Infrastructure EqualisationFund.

69. Te Panel notes that the existing pattern of transfers from central government does notappear to be based on any consistent principles. Te Panel considers that a review of the scope and


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Executive Summary

amount of the current transfers is desirable, so that they better reflect equalisation principles, as partof the development of the new Infrastructure Equalisation Fund.

Development contributions

70. Development contributions are a means of recovering from developers the additionalinfrastructure costs arising from this growth. In 2006/07 these are estimated to amount to some7% of capital expenditure, rising to 17% by 2016. Tere has been considerable contestation by thedevelopment industry on the level of development contributions in some cases, and given recentsuccessful litigation by developers against the North Shore City Council, all councils will needto carefully review their development contributions policies to ensure that they meet the detailedrequirements set out in the LGA 2002. Te estimated revenue from development contributions inthe LCCPs may therefore be on the high side. Councils should carry out any review transparentlyin consultation with the development industry because continuing litigation on developmentcontributions is not in the interests of either party.

71. Te Panel considers that, properly applied, development contributions are an equitableand efficient means of funding new infrastructure. Regional councils are currently unable to levydevelopment contributions in respect of their infrastructure expenditures. Te Panel sees no reasonwhy this should be so and recommends that regional councils be given the right to levy developmentcontributions. Te Panel does not, however, support ransit New Zealand being able to levydevelopment contributions because the link between development and traffic growth on statehighways is not sufficiently direct.

Debt

72. As discussed above, the Panel considers that councils should consider using more debt to

fund long-life assets, as part of the move away from fully funding depreciation. Tis is both anefficient funding source given the relatively low rate of interest and an equitable way of spreadingthe cost of such assets over the users who will benefit from the assets. Councils currently have lowlevels of debt, with debt-to-asset ratios averaging only 4% across the country. Although the Panelrecognises that some councils perceive having low levels of debt or being debt-free as a virtue andmay regard borrowing as a licence to print money, it does not agree with this view. Councils shouldestablish appropriate fiduciary limits on such borrowing. In addition, their financial soundness willbe reviewed by the rating agencies.

73. Increased local government use of the capital market may also assist in the development ofthe market and stimulate community savings.

74. Te Government has recently indicated it will seek to amend the Securities Act to removethe requirement for councils to issue a prospectus should they wish to borrow on the capital market.Additional borrowing there will stimulate the development of New Zealands capital markets. TePanel also recommends that councils be permitted to borrow in foreign currency subject to appropriatehedging arrangements being made.

Income rom investments

75. A number of councils have significant investments in trading enterprises such as ports,airports, forests, and farms, as well as significant holdings of financial assets (often derived from thesale of shares in trading enterprises). Revenue from these commercial investments formed 6% of

total operating revenues in 2006.


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Executive Summary

76. Councils generally justify holding such investments as a means of generating other income,which enables rates to be held at a lower level than otherwise, and in the cases of ports and airportsas strategic investments, necessary for them to have greater influence in generating economicdevelopment. However, in some cases councils have sold such assets and used them to reduce debt,

thus reducing interest payments.77. Although the holding of such investments is a policy matter appropriately determined byeach council, the Panel notes that on average such investments earn less than a commercial return.Te Panel recommends that councils be required to transparently and accurately report on the rate of returnearned and to fully articulate the strategic reasons why such investments are being held.

78. Te Panel recommends that commercial undertakings controlled by councils should be formallyrequired to operate as a business, as applies to central government enterprises under the State-OwnedEnterprises Act.

79. However, a clear distinction should be drawn between such external commercial investmentsand subsidiary organisations such as CCOs that exist to provide council services such as water supply.Te Panel considers that these should operate on a cost recovery basis but that otherwise they should not beused as a source of revenue to cross-subsidise other council activities. It recommends that this be providedfor in an amendment to the LGA 2002.

User ees and charges

80. User fees and charges generated some 26% of total operating revenues in 2006, coveringcouncil regulatory activities for various permits and licences, as well as charges for services suchas water supply, waste water, and solid waste disposal. (Te LGRA permits targeted rates on avolumetric basis for water supplies, therefore such user charges may technically be part of the ratingsystem.)

81. Te Panel supports actual and reasonable cost recovery as far as possible for all regulatoryactivities. In some cases fees are currently set by central government and prevent full cost recovery.Te Panel recommends that determination of all such fees be a matter for councils.

82. As discussed earlier the Panel supports greater application of user charges for water supply,stormwater, and waste water, as well as solid waste collection disposal. However, the Panel recognisesthat some practical issues must be overcome to apply such charging to stormwater and waste water.Greater user charging is justified as a means of demand management, which is also expected toreduce infrastructure expenditure that would otherwise be required. It recommends a programme ofcentral government assistance towards the costs of installing water meters, where this is practicable.

Possible new sources o local government unding (Chapter 11 o the report)

83. Te Panel examined a range of possible new taxes or other sources that might fund localgovernment, either as an alternative to or a replacement of rates. It is important to place the currentsystem of funding local government in the context of New Zealands overall system of taxation. Ratesare a property tax, and property is only lightly taxed in New Zealand. In addition, New Zealandstax system appears reasonably well balanced between income and consumption taxes. Tis balancewould be disturbed by the imposition of any major new tax. Given the other advantages of ratesas a tax their relative efficiency, limited economic deadweight, relative low administrative costs,and difficulty of avoidance the Panel does not support replacing rates as the main source of localauthority revenue by any major new tax. Tere is no pot of gold sitting out there that is readily

available. Someone must pay, whatever the taxation source that is used.


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Executive Summary

84. Te Panel considered a range of possible new revenue sources, namely

a citizens or poll tax

payroll tax, including a transport versement tax

a local income tax a local consumption tax

general revenue sharing

industry and commodity taxes, including a bed tax

environmental or green taxes, such as a waste levy and road congestion pricing.

85. Te Panel does not support any of the first six possible new revenue sources. It considersall have varying disadvantages in terms of equity and economic impact. It does not consider they areworthy of further study. However, environmental taxes have potential value in the medium term.

86. Te Panel recommends that the existing local authority petroleum tax (LAP), first imposed in

1970 (approximately $30 million per year), be increased by 2 cents per litre, and distributed to councilsfor general purposes based on a revised formula that incorporates equalisation principles.

87. Tis would provide an estimated $90 million per ye

The 2007 Local Government Funding (Rates) Enquiry

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Transcript of The 2007 Local Government Funding (Rates) Enquiry