COMMENT:

Like the sound of your local body rates bill rising by 4 or 5 per cent per annum for years yet?

That is the projected increase, on average nationwide, based on the latest set of long-term (10-year) plans the councils have to produce. It would continue the trend for rates — which provide around half of local bodies' funding — to keep climbing relentlessly in real terms.

But in a hopeful sign for long-suffering ratepayers, the Productivity Commission is conducting an inquiry into local government funding and financing. It has released a paper outlining how it sees the issues and seeking feedback.

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The commission has turned its mind to many of these issues before, including an inquiry last year into better urban planning. It found instances where, because existing ratepayers meet the costs of growth, such as new and upgraded infrastructure, that engendered resistance to new development, making councils reluctant to embrace growth. In turn, that contributed to a sluggish supply of land for housing and worsening home affordability.

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Rising property values do not in themselves increase councils' revenue. The rateable value of a property determines its owner's share of the overall rates burden, but the size of that burden is driven by councils' spending and costs.

For years, rates have been growing faster than the population, faster than consumer prices and faster than economic output.

One suggestion on which the commission seeks feedback, which is favoured by Infrastructure NZ, would be to switch to local property taxes. Under that system, if the value of a property increases, the amount of tax the owner pays rises accordingly. (Where this system is used internationally, there are provisions which protect the revenue if property values fall.)

In principle, this would address a perverse effect of the status quo, where restricting the supply of new housing pushes up property prices and creates a windfall gain for current owners, without necessarily generating any additional income for councils.

Instead, if higher tax bills reduced the value of increasing property values to owners, there would be a political incentive to manage costs down so as to facilitate the supply of housing, Infrastructure NZ argues.

More generally, the commission is looking for ways to better align who bears the cost and who derives the benefits of new or upgraded infrastructure, on both efficiency and equity grounds.

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In some cases, like the provision of potable water, user-pays on a volumetric basis might be the way to go.

For other infrastructure it suggests "value capture" — a more direct application of the idea behind targeted rates, where windfall gains to property owners arising from public investment in, say, light rail are taxed. This would require legislative change.

The commission also seeks views on one way of getting private capital to take the strain of housing-related infrastructure costs — by allowing and encouraging developers to finance large new subdivisions and service them with infrastructure, and recoup the costs from new residents. So the debt required to finance the infrastructure would end up with the property owners, via their mortgages, rather than councils (i.e. ratepayers).

By contrast, the commission sounds pretty unenthusiastic about the possibility of introducing a local income tax or expenditure tax. While both can be found overseas, the local governments involved also have much wider responsibilities than is the case here.

Linking councils' revenue sources more closely with local economic activity through income or expenditure taxation sounds like a good way of incentivising councils to compete to foster growth.

But the commission warns that it is likely to make council finances more volatile, and for those facing population declines, leave them with an even greater funding shortfall.

Local income or expenditure taxes would also be costly to implement — prohibitively so, Local Government New Zealand reckons.

The commission is soliciting views on whether the longstanding trend to levy rates on capital value (which includes improvements) and not just the land value of properties is desirable.

The view has been that capital value is a better reflection of ability to pay and is therefore fairer. "However available evidence at a national level suggests that a system based on land values may be more progressive and therefore more equitable," it says.

At the margin, it might discourage land banking. But it would disadvantage farmers.

Inter-generational equity considerations suggest that long-lived infrastructure like drains and roads should be financed by borrowing rather than on a pay-as-you-go basis.

Councils generally are lightly geared, compared with central government or large corporations. The conspicuous exception is fast-growing Auckland, which is bumping up against the limits of how much more it can borrow without a credit rating downgrade and higher interest rates.

While Auckland suffers growing pains, at least 15 rural councils are expected to have declining populations over the next 20 years.

The option of raising capital by selling off council-owned assets is ruled out by the inquiry's terms of reference. "Substantial" privatisation is out of scope.

Unsurprisingly, the Productivity Commission believes productivity improvements offer an avenue for councils and council-controlled organisations to maintain or increase the quality or volume of services they provide without increasing costs for ratepayers. It invites submissions on ways that might be done.

One thing that is clear from the discussion document is that there is no one-size-fits-all, silver bullet reform that will put council finances on a sounder footing.

Local governments vary widely both in size and in the demographic challenges they face. While Auckland suffers growing pains, at least 15 rural councils are expected to have declining populations over the next 20 years and several provincial cities are likely to be essentially static in population.

That diversity suggests that any reforms or legislative changes flowing from the inquiry should be permissive rather than prescriptive. They should give a broader range of options.

The issues paper is open for submission until February 15 next year. The commission will deliver a draft report on its conclusions mid-year, with its final report after further consultation due at the end of November.