Rates should continue to be the main source of funding for local government, but they need to be bolstered by additional revenue streams, especially in cities experiencing rapid growth, says the Productivity Commission.
Its draft report into local government funding and financing, released yesterday, is unpersuaded by one of the premises underlying the Government's commission to undertake this inquiry: that rates have become increasingly burdensome, outpacing rises in incomes and in the costs local governments face.
On average across all local authorities, rates provide 47 per cent of revenue, supplemented mainly by grants from central government especially for roading (19 per cent), user charges (13 per cent) and development contributions (11 per cent).
The commission found that since the early 1990s rates have been notably steady relative to national income and to household disposable incomes.
And councils' spending in real per capita terms has increased at a compound annual rate of 1.2 per cent over the 10 years to 2017. That is in line with the 1.1 per cent compound annual growth rate in central government spending in real per capita terms over the past 20 years.
But looking forward, there will be increasing pressure on local government finances in fast-growing cities, especially Auckland, and conversely in regions whose populations are projected to fall (15 of the 26 rural districts).
On top of that there are particular issues in tourist hotspots, and arising from the need to cope with the relentlessly rising impact of climate change.
Another chafing point is "unfunded mandates", where policy decisions at a national level — for example, on the environment — impose costs on local authorities with no additional revenue to cover them.
So the commission's 300-page draft report covers a lot of ground. Let's focus on what it has to say about dealing with rapid urban growth, and the perception that from ratepayers' point of view as things stand growth does not pay for itself.
It notes, disapprovingly, the trend in recent decades to shift the rating base from land value to capital (improved) value. A land tax would be more efficient, especially if supplemented by targeted rates.
Two years ago, in its Better Urban Planning report, the commission recommended a legislative change that would give councils the ability to levy targeted rates as a mechanism for "value capture".
Property owners who enjoyed windfall gains in the value of their property because of nearby infrastructure funded by the public would be required to pay a portion of this gain to the council. The Government has yet to respond to this idea.
And for this inquiry, the Government also ruled out of scope the idea of removing the rates exemption it enjoys for Crown properties.
A new suggestion in the latest report is for central government to pay local governments a sum based on the increase in building work put in place.
That is a large potential tax base. Statistics NZ reports the total value of building work put in place last year was $22.7 billion.
The commission's justification for such a scheme is that it would help address a problem that is as much national as local: "The sluggish supply of infrastructure-serviced land and new housing in areas with fast population growth has been the major driver of the socially and economically damaging house price inflation of the past two decades."
The commission recognises problems with the existing mechanism of development contributions (DCs) levied on developers of subdivisions.
Any new council infrastructure project could be a mix of renewals and backlogs on the one hand or creating greater capacity to cater for growth on the other, but councils are only entitled to charge a DC for the latter.
Where multiple developments are involved, the cost must be allocated in line with how much each has caused the need for the infrastructure and benefited from it. All very tricky and rife with inconsistencies.
It recommends that the Government, Local Government NZ and the NZ Society of Local Government Managers work together to develop mandatory standardised templates for DC policy and assessments of individual property developments.
Another constraint, not least in Auckland, is debt limits. Where there is a case for spending to be debt-financed, on inter-generational equity grounds, some councils bump up against limits on borrowing where rating agencies will downgrade credit ratings, implying higher interest costs.
To mitigate that problem the commission favours the use of special purpose vehicles like that used for the Milldale development. Auckland Council, with Crown Infrastructure Partners, the Treasury and developer Fulton Hogan, have established a special purpose vehicle (SPV) that has raised nearly $50 million in long-term finance that will not sit as a debt on the balance sheet of the council (or the Crown), and therefore not count towards the council's debt limit.
The SPV will finance the cost of five bulk roading and wastewater infrastructure projects to connect a large new residential development — Milldale at Wainui 25, minutes north of Auckland — into Auckland's existing networks and provide for future growth.
The model entails property purchasers committing voluntarily to a charge over their properties, in effect putting debt on the balance sheets of new property owners who benefit from the infrastructure, rather than on the balance sheet of their council or the Crown.
The commission notes that officials are working on the feasibility of extending the model to brownfields developments, where it would have to apply to existing property owners.
The commission also addresses the issue of rates affordability for those property owners, often elderly, who are asset rich but cash poor.
In general it believes distributional issues are best left to central government, through mechanisms like the accommodation supplement.
The commission calls for axing the rates rebate scheme, on the grounds that it is unfair, in that it does not apply to renting households (who ultimately pay landlords' rates), and administratively cumbersome for a scheme that delivers at most $12 a week.
Instead it favours a national rates postponement scheme, where the local authority agrees to delay the due date of a rates payment until some specified event, like the sale of the property.
It ought not be beyond the wit of the financial services sector to devise mechanisms for managing the risks and flows involved, much as reverse mortgages do.
Finally, when Government dropped the idea of a comprehensive capital gains tax it asked the commission to examine the feasibility of taxing vacant land.
The commission has little to say about that in this draft, but seeks submissions on it, along with its 30 recommendations, by August 29.
Main sources of local authority funding:
• 47% - Rates
• 19% - Central govt grants
• 13% - User charges
• 11% - Development contributions