Are restrictions on local government funding mechanisms stifling the ability of our cities to grow at their best?

When running for mayoralty in 2016, Phil Goff made the following commitment on rates:

"Rate rises will be kept low and affordable at an average of 2.5 per cent per annum or less, if current council fiscal projections are correct and the consumer price index stays low."

The question of how much rates will rise — and the commitment to keep them as low as possible — are cornerstones of any recent Auckland mayoral bid. But there are concerns the current restrictions on local government's funding mechanisms are stifling the ability of our cities to grow at their best.

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Reliance on revenue from rates

In New Zealand, council revenue is largely separated from economic performance.

Local government is the core funder of transport and water services for new development, yet its revenue is derived from property rates — which are a cost allocation method linked to council costs, and not to the success of the economy or land prices.

Conversely, central government is the direct benefactor of growth: receiving increased GST, income tax and corporate tax when the economy grows.

Increased council costs mean an increase in rates, irrespective of economic performance, and any efforts made to charge ratepayers more to deliver additional services — including for those without homes who pay no rates — is consistently met with strong opposition from homeowners.

Councils see little funding benefit from growth, and as a result tend to have a culture of cost minimisation, heavily influencing their decision making at the expense of value creation.

"Importantly, from a local government economic development perspective, property taxes are not the best incentive to encourage councils to invest in infrastructure," says Local Government Funding Agency chair Craig Stobo.

"If council revenue streams were tied to their performance, successful councils would accrue more revenue, providing more choices for their communities."

This is not a new concern: a 2015 review into local government funding by Local Government New Zealand (LGNZ) found that the heavy reliance on property taxes to fund local services and infrastructure fails to incentivise councils to invest for growth.

The only other major source of revenue local government currently has in its toolkit is to lobby central government: Shane Jones' Provincial Growth Fund will see an investment boost in regional New Zealand, and the Housing Infrastructure Fund is aiding high growth councils to advance infrastructure projects that will help increase housing supply.

Yet the patience required for central government to fill the funding gap has seen growth issues turn chronic. Infrastructure New Zealand is concerned that private capital which could have filled the gap has been left searching for opportunities overseas.

Funding and finance inquiry

Local Government Minister Nanaia Mahuta acknowledges the funding challenges faced by local government and the constraints of rate rises, noting they are rising faster than incomes and cannot be the only solution. She says that — if not met — the funding gap will have consequences for local communities and for the entire country.

"Local government is facing increasing costs for things like three waters, roading, housing, and tourism infrastructure as well as adapting to climate change," she says.

And some of the councils facing the biggest cost increases also have shrinking rating bases."

Last month the Minister of Finance, Grant Robertson, asked the Productivity Commission to conduct an inquiry into how to fund and finance local government.

The inquiry will investigate:

● Cost and price escalation for services and investment, including whether this is a result of policy and/or regulatory settings
● Current frameworks for capital expenditure decision making, including cost-benefit analysis, incentives and oversight of decision making
● The ability of the current funding and financing model to deliver on community expectations and local authority obligations, now and into the future
● Rates affordability now and into the future
● Options for new funding and financing tools to serve demand for investment and service
● Constitutional and regulatory issues that may underpin new project financing entities with broader funding powers, and
● Whether changes are needed to regulatory arrangements overseeing local authority funding and financing.

Stobo says the terms of reference given to the Commission by Robertson are very good, and the requirement to consult with the sector is a helpful recognition of the expertise the sector can bring to the table.

"Prospectively this could lead to some devolution of tax setting and collection powers to local government, and a cessation of inefficient quota handouts from central government.

"The final results need to improve the incentives for councils to responsibly invest in local growth," he says.

The New Zealand Initiative's executive director, Dr Oliver Hartwich, is confident the Productivity Commission will produce good results.

"What is important for the Productivity Commission's inquiry is to consider the incentives under which local government operates, and the Terms of Reference certainly allow that," he says. "More specifically, it will allow the commission to consider the OECD's recommendation to the New Zealand government that councils should participate in tax revenue increases resulting from economic growth."

The commission's final report is expected to be presented by November 2019.

Calling for localism

Coinciding with the announcement of an inquiry, LGNZ and The New Zealand Initiative launched their Localism project, calling for a shift in the way public decisions are made in New Zealand by seeking a commitment to localism. LGNZ President and Dunedin Mayor David Cull says it is important the new funding options incentivise growth.

"[The Localism Project] will highlight how the right incentives and funding can build strong local economies and vibrant communities. The urgent need to properly empower councils is reinforced by the fact that decentralised countries tend to have higher levels of prosperity than centralised ones.

"New Zealand is among the most centralised countries in the world.

"We should not expect central government in Wellington to be the best decision-maker for every local problem. Communities often know best what they need."

The New Zealand Initiative's Hartwich adds: "After more than a century of centralism, New Zealand needs to go local.

"Councils and communities must be able to make their own decisions about their future."

A final report and publication of the Localism Proposal is expected in early 2020, and Hartwich notes there will be ample opportunity for the Localism report and the Productivity Commission inquiry to cross-fertilise.

Taking lessons from America

The city of Houston uses sales taxes to fund general activities.

Earlier this year, Infrastructure New Zealand led a delegation of NZ representatives to Portland, Denver, Dallas-Fort Worth, and Houston — four US cities that are growing more affordably than Auckland — to consider how they are doing what they are doing, and what New Zealand can learn from them.

The report, Enabling City Growth: Lessons from the USA, provides detail on the lessons learnt from the visit, including the following on how local authorities are funded:

● US cities have a number of funding mechanisms that are tied to their economic performance. Denver, Dallas, and Houston use sales taxes to fund general activities, and each has levied a 1 per cent sales tax to deliver improved public transport.
● Dallas and Houston have property taxes with a strong link to property value. In each case, the revenue of the city and its component institutions increases with the success of the city in growing the economy and delivering homes.
● Portland, the city with the greatest growth challenges, also has the fewest incentives to grow. There is no sales tax in Oregon, removing this option also for Portland.
● Instead, Oregon relies on comparatively high income and corporate taxes, but has not extended the ability for Portland to levy these direct.
● Property taxes in Portland have been tied to inflation since the early 1990s. Thus, property values have now become detached from property rates and the two are only reviewed when properties are significantly changed or redeveloped.