New Zealand: Rating on land value may be fairer - Productivity Commission

Brief Counsel

Rating on land rather than capital value may be fairer and would promote best land use and discourage land banking, the Productivity Commission says in the local government funding and financing issues paper, released this week.

The trend among councils over recent decades has been in the opposite direction.

Submissions close on 15 February 2019.

Key issues

A key issue identified by the Commission is that economic and population growth is seen by local government as a drain on resources rather than as financially beneficial. Local Government New Zealand (LGNZ) and Infrastructure New Zealand have both made the same analysis.

Solutions they have suggested involve councils receiving a share of central government tax revenues arising from increased economic activity related to local intervention and investment.

This would go some way to remedy shortcomings in funding and incentive arrangements around infrastructure required for growth (much of the burden of which is shouldered by councils).

The Commission does not specifically back the proposal at this early stage but does ask how the current local government funding and financing framework could be changed to improve growth incentives.

The law requires that councils decide how much they are going to spend in the year ahead and set rates to cover those expenses. So it is council spending which drives rates, not economic growth or rising property values.

Spending trends

Local authority operating and capital expenditure has grown significantly since 2000 – much faster than population growth and faster than both GDP and the CPI. Some of the drivers behind this are:

  • an increased regulatory load - e.g. higher drinking water standards imposed in 2007. A proposed National Policy Statement on Indigenous Biodiversity could also create new obligations for councils
  • Treaty of Waitangi settlements – these often include co-governance or management arrangements over significant natural resources and reserve land. Central government makes a one-off financial contribution but it is usually nowhere near enough to cover the costs
  • climate change and natural hazard mitigation, and
  • rising input prices – the Local Government Cost Index (capital expenditure on pipelines, earthmoving and site work, salary and wage rates, raw materials like cement) rose 29% between 2007 and 2017, nine points higher than the CPI.

The problems are particularly acute in the high growth areas – the Golden Triangle of Auckland, Tauranga and Hamilton, along with Queenstown and Selwyn. Meanwhile, many provincial and rural councils are suffering depopulation and shrinking ratings bases. In some cases, the decline is severe - 25% for Ruapehu District, 20% for Wairoa.

Weaknesses in current funding arrangements

Councils rely heavily on rates income. This can create problems for asset rich, cash poor households and can raise issues around the quality of democratic engagement. The main consultation mechanism for infrastructure planning is through the 10 year Long Term Plan but:

  • the Office of the Auditor General found in a review this year that many councils missed the opportunity to engage effectively with their communities and that there was still room for improvement in how documents are presented, and
  • an analysis of the feedback on Auckland Council's 2015 Long Term Plan found that the age profile of the people who submitted was upside down in relation to the population as a whole and that Maori, Pasifika and Asian people were all significantly under-represented.

Councils are limited in what they can borrow through a variety of mechanisms – credit rating risk (in the case of the 24 largest councils, in particular Auckland Council which is close to its debt-to-revenue limit); regulations capping the amount councils can spend each year on loan repayment as a proportion of revenue, and the Local Government Funding Agency (LGFA) rules which drop the guillotine if a council misses a loan repayment.

Pay-as-you-go funding (essentially from rates) avoids these risks, but at a price. According to the Commission:

"Proponents of pay-as-you-go financing argue that it avoids interest costs, supports local government's fiscal flexibility, and maintains borrowing capacity. However, because pay-as-you-go limits investment essentially to what can be funded from cash in hand, it is likely to lead to large projects being delayed. Accordingly, it may not effectively or efficiently fund the infrastructure needed to support a growing population. The approach is also inconsistent with intergenerational equity. If pay-as-you-go is employed for assets with a long lifespan, the current generation of users bear all the costs. Future generations pay nothing yet still enjoy the benefits".

And many existing non-rate funding sources have limitations or design flaws.

Targeted rates – these can be used to fund infrastructure and services that benefit an identifiable group of ratepayers

Cannot capture increased property values arising from infrastructure investment (say, a new public transport route or a change in land use classification).

Are usually levied through a fixed charge or on a proportion of a property's value – neither of which strongly reflects the windfall gain to the landowner.

User charges – these can delay infrastructure costs by reducing demand Their use is limited. Only in Auckland is wastewater subject to a user charge, and road tolls require central government consent.
Development contributions – these are levied off developers to recoup the cost of growth infrastructure They are only paid when or after the development occurs but councils must pay upfront for the early infrastructure to service new subdivisions.

Borrowing options

Borrowing enables timely project delivery and reduces the need to divert funds from other essential uses – e.g. maintenance. Since its establishment in 2011, the LGFA has shot to the top of the class and now accounts for between 60% and 85% of all lending to local government. The Agency was set up to raise debt for local authorities on terms more favourable than they could secure themselves and is a joint venture between central government, which has a 20% stake, and 30 councils.

Other options are bonds, as used by Auckland Council, or the private sector – in particular institutional investors such as superannuation funds, which bring with them rigour and discipline.

The difficulty is to keep the debt off the council's balance sheet. Two suggestions from the Commission are:

  • to encourage private developers to finance large new subdivisions, service them with infrastructure and recoup the costs from new residents so that the debt is carried by households through their mortgages and
  • through 50 year infrastructure bonds offered to private investors by central government and backed by an income stream from targeted rates.

Timeline

The Commission hopes to release its draft report in June and to have its final recommendations with the Government by the end of November.

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.

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