Dave Grimmond looks at the LGNZ revenue discussion paper and finds reasons to be sceptical, but also an option for 'fiscally neutral' change

Dave Grimmond looks at the LGNZ revenue discussion paper and finds reasons to be sceptical, but also an option for 'fiscally neutral' change
The image LGNZ used on their Funding Review discussion paper.

By Dave Grimmond*

Local Government New Zealand is investigating whether there are new ways for local councils to raise revenue, (see here).

Possible other funding methods suggested include:

• Local Income Tax

• Sharing Government Revenue

• User Charges

• Poll Tax

• Local Expenditure Tax

• Selective Taxes

• Regional Fuel Taxes

• Transaction Taxes

There are some legitimate reasons for exploring alternative methods for raising revenue, but it is important that the analysis does not confound two separate issues: how much funding should be raised and what methods should be used for raising these funds.

Ultimately the issue about funding levels is really about spending levels; the alternative to taxing more is always to spend less.

There is therefore a risk that initiatives to change the revenue base is simply a mask for raising tax levels.

In this sense the quote from Local Government NZ president Lawrence Yule raises some concerns:

We don't just want extra money for the sake of it. If we want a first-world level of service, we're going to have to find a way to pay for it.

At first blush it appears to be an assurance that citizens will get value for money, but to me it also suggests that the main purpose of the review is to find ways of raising the level of local taxes, and ideally without people noticing (or at least not until it is too late). 

The one clear advantage of the rating system is its transparency: people know how much they are paying in local taxes and it is obvious when councils propose rate increases.

The risk with introducing alternative revenue systems is it increases the ability of councils to mask effective tax rises. 

Access to more funding streams also increase governments’ abilities to “divide and rule”.  This is because different funding systems will have unequal financial impacts on different segments of society; a rate increase will have different relative impacts than a change in user charges or a local expenditure tax.

However, this differential impact is precisely a reason why there is a legitimate reason for exploring alternative local tax systems.

It is impossible to design the perfect tax system, and any system will be a compromise between taxing everyone equivalently, reflecting people’s ability to pay, and distorting people’s economic decisions.

Thus for example, although a poll tax taxes everyone equivalently, it makes no allowance for differences in people’s ability to pay, and is thus commonly considered to be an unfair tax system. 

There are many positives about a rates system.

It effectively has universal coverage of citizens (people have to pay either directly or indirectly through their rents) and it is a progressive tax that reflects people’s relative wealth and ability to pay.

On the other hand, it takes no account of people’s cash flow (it can therefore cause strains for people who are asset rich but with low incomes); it can distort marginal investment decisions away from land intensive activities, and there are boundary issues with other regions and the rest of the world. 

The last of these is probably the most serious weakness of relying on a rating system for local government finance. For example, commuters from neighbouring districts and tourists can impose costs on a council that must in the first instance be met by local rate payers.  Locals might increase their wage demands and businesses their prices to compensate, but the impact is potentially a loss of competitiveness that inhibits the local growth potential. 

More use of user charges could potentially help, but is likely to have limitations: it is difficult to charge visitors for their use of local roads, water reticulation, sewage, etc.   

Of the options suggested, the one that appeals most is the introduction of local expenditure taxes.  Local expenditure taxes:

• could build on the existing GST infrastructure,

• reflect an ability to pay as they are based on actual transactions,

• would raise revenue for local services where economic activity is taking place, and

• if the rate is set by central government it would provide a mechanism for fiscal responsibility. 

If introduced, it would ideally be undertaken in a fiscally neutral way.

That is, any increase in revenue from an expenditure tax would be balanced by an equivalent reduction in rate revenue.

A change in revenue base should be about improving fairness and/or reducing the extent that the tax system distorts economic decision making.

Increasing the amount of revenue collected by local governments is not about the tax system but rather about the appropriate size of local government operations, a decision that should be in the hands of the local electorate.

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David Grimmond is a senior economist at Infometrics. You can contact him here »

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DG:  the issue of local expenditure taxes is very much one of practicality.  
It means that every business has to have a way of 'stacking' taxes, in their POS, their accounting back-ends and in their tax returns.  The US systems I deal with have always catered for city/state/federal tax levels, and in various combinations (e.g. the extent to which tax-on-tax applies and in what order).  For example, it immediately raises the notion of destination-based taxes (buy from an Auckland online firm, deliver to Invercargill, whose tax applies?)  This is handled in US systems by tax based on shipping details,   
But suggesting this in an NZ context would be a business and accounting nightmare for most SME's.   They simply are not geared up for anything of this nature.
Nice thought - not practicable unless over a 5-10 year minimum timeframe.
 
Whereas, and quelle surprise, the TLA Poobahs need their Moolah now.

WE DON'T WANT "FIRST WORLD" SERVICES

We *need* services we can _afford_

WHAT WILL IT TAKE TO GET THAT MESSAGE THROUGH?

Agree.
la la land some of these.

In 'agile' project management terms, this is known as the 'Minimum Usable Sub-seT, or 'musts'.
 
Whereas most TLA's, propelled as they are by their unelected staff, tend always to the 'gold-plated' solution, with resulting time, cost and quality blow-outs.....

It's ironic that the 2012 amendments to the LGA mandated your "Minimum Useable Sub-seT".
 
And people keep saying local government is a creature of statute. I laugh in their general direction.

"Of the options suggested, the one that appeals most is the introduction of local expenditure taxes.  Local expenditure taxes"
a) Except it is a regressive tax, hardly surprising then a right winger likes it.
b) With online sales pretty easy to dodge. Ditto driving to an alternative mall.
I'd suggest we need a transparent tax regime so ppl see what they are being charged for easily.  Seeing your rates rising 5% per year is simple and obvious.  I agree that hiding the tax base is a great way to tax more by stealth and I dont agree with it.
"to me it also suggests that the main purpose of the review is to find ways of raising the level of local taxes, and ideally without people noticing (or at least not until it is too late)." so agree.
I also agree with cowboy we need what we can afford, I stay in 3 star motels not 5 star, most of that extra luxury is simply a waste when you have to prioritise.
===edit===
Also a tax that is hard to dodge and is progressive, ergo I see no point in moving partially away from rates.

Don't get sucked into the Larry Yule vortex of self-pity.
 
Auckland Council raises only 42% of revenue via rates. All councils already use a blend of many funding sources. As well as rates significant sources of funds include:

  • government subsidy and payments (very significant in rural councils as it pays for a lot of teh Roading budget)
  • fees and charges (essentially pays for all regulatory activities)
  • vested infrastructure (counts as revenue even though its only a change of ownership of fixed assets)
  • petrol tax (betcha didn't know that although it is really very insignificant)
  • a handful of lucky ducky councils get investment income too
  • and, of course, for capital works only, debt

 
The main thing to know is that by law councils have to raise enough revenue to cover their operating expenditure. There is no shortfall on paying insurance, maintenance, energy or depreciation. There is no shortfall for replacing assets at end of life. It's all already covered.
 
Where councils struggle is raising new capital to either upgrade assets to a higher quality standard or to extend/add infrastructure to accommodate growth. How they do those things requires a very specific and focused discussion not the broad brush Yule is painting with.
 
 

To this can be added (thinking of ACC and CCC):

  • dividends (regular) from Council-Controlled Organisations (CCO's)
  • Capital injectioons from CCO's and investments (e.g. a share buy-back by a company in which a Council has shares)

So, to take the Cynic's POV, there is already a diffusion of revenue sources.
The power company, port, airport, City Care-type commercial enterprise or other CCO you may deal with in the ordinary course of business, has a proportion of your sales directed to the Council who owns them.....
And as these CCO's tend to infrastructure-type businesses, they can be very hard to avoid using (ports/airports are a good example).
The technical term is ticket-clipping, I believe.

and Auckland's debt has been rising how fast?
(and indeed many other councils, eg kapiti)

Debt can't be used to pay the sausage roll bill. Effectively it can only be used for capital works. And debt serves a very useful service in that it allocates costs for these big ticket, long-lasting assets fairly over time.
 
An overly simple example: a town has one asset, the main road that cost $1m to build. Either all the residents were levied a capital charge up front or the town raised a loan. The rates cover normal maintenance and depreciation. If the road has a nominal life of 100 years then the town collects $10K each year in depreciation.
 
In the first scenario the town collects the depreciation and puts it aside. When the road needs to be ripped up and rebullt there's $1m in the bank to pay for it.
 
In the second scenario a finance charge is collected as well as depreciation. Now instead of putting the depreciation aside it is used to progressively pay down the loan principal. After 100 years the council has no reserve funds to replace the road but it has paid off the loan.
 
However you look at it Scenario 1 is grossly unfair on the residents who coughed up the capital levy. They will never get the full value from their investment. They will either die or move away before the full value of the asset is used up.
 
The thing is that loan funding is a bit like renting and I think councils are a bit funny about not owning things. Otherwise debt is under-rated as a funding mechanism.
 
Although its not  good ratio tu use ever the most indebted council in NZ has a debt-equity ratio of less than 10%.

That debt has to be serviced from rates.  I dont dismiss that some debt is essential, what I do consider that say "stadiums" are luxuries that it seems dont even pay for themselves ie the debt raised to build them it seems.
Actually your scenario1 isnt correct as the people paying for the "new" scenario 1 are not starting from scratch, there will be public works built in the past that they in effect enjoy for free or at a marginal cost. Also if they move away they cease paying for that road. 
Actually I think debt is over-rated as its dangerous, ie if in a depression the council's income collapses and the council defaults then the debt falls to the rate payers (and not even the renters, though they could loose their accomodation as its sold from under them).
"Equity" kapiti for one wanted to re-value the land under its roads so it could borrow more as it was in danger of breach of covenant I believe.  

Lots of points there.
 
Cost of capital. Yes you pay a finance charge for debt via rates. You would also pay a finance charge if you raised your own loan to cover your capital contribution. If you had the money in cash to hand over then you would not get any return from investing it in something else.
 
The difference is in how the principal is handled. In the debt scenario you pay your share of the debt principal as you go. In that example if you leave the town after ten years you have paid off 10% of your share of the cost of bulding the road and the person who buys your house takes over paying. In scenario 1 you pay the lot up front, the buyer of your house gets a free ride, and you get no refund of the 90% of the levy that you will never use. That's why debt allocates costs more fairly over time.
 
Moral hazard. I agree that debt funding enables councils to make poor quality spending decisions especially on supposedly commercial investments such as stadia and convention centres.

However when you buy the house you enjoy the use of all the assets already in place paid for by past generations, ergo I see it as a rolling cost thing, you win some, you lose some. 
I suppose it depends on the time scale, ie short term debt, OK but if the debt is spread over say 30 years that is a huge interest burden to contend with. 

Kinda but not quite. OK this is the bit I was building up to.
 
As a ratepayer/resident you pay for services not things. The council buys the things that deliver the services. 
 
It's a really fine distinction but your rates pay for water to flow from your tap you don't need to know or care how it got there. 
 
Your water rate has three components: operating expenditure (electricity, repairs, insurance, water quality testing etc), finance (interest on any debt) and depreciation. Note that there is no capital component in there at all; these are all operating expenses and it's all completely orthodox accounting.
 
Depreciation is the one to get your head around. When you drive your car 100km you have "consumed" 100km of its useful life, just as you have consumed fuel, tyre rubber, oil. One day's water rate includes payment for one day's "consumption"of the water network assets based on  what it would cost to replace the network tomorrow.
 
So here's the thing to get: what happened yesterday is largely irrelevant. How the assets got there and who paid for them, when is irrelevant to your service charge or rates.
 
Personally I think it is a neat trick. Effectively it means that the ratepayer of 30 years has no moral high ground over the ratepayer of 30 days. Everyone carries equal weight.

Similar is said for business equipment.  Customers buy their demand, not what the gear which produces it.  Customers want fenced off waterways, they need to be paying for fenced off waterways (what it costs "to make it happen").

This is the difficulty with the council types.  The figure that if there is an art center, then if they pay for the capital off one account, then all that has to be covered is a portion of it's services.  If it doesn't add up, blame inflation or the community or something else, and lift rates or income grabbing services.

They need to draw the bottom line.  the service includes the cost of the item AND the depreciation.   and it includes ALL the costs, every consultancy, every report and meeting, any time a dollar goes out it has to come in from somewhere.

Any asset which hasn't passed it's depreciation savings, or needs upgrading for whatever reason before it's paid of AND it's replacement value saved, is a management failure.

The buyer takes over your responsibiilties to pay the portion of the councils debts, that's why there's a clause in the Sale and Purchase Agreement tht specifical states that the purchasers agrees to take over liability to council and all responsibilities from the seller.

If the council handled their assets in a professional business-like manner this would work, as modern community costs plus the existing debt would be transferred, but councils do not as they have some weird "fair is what we say it is" rule that the new person might gain something iin the purchase, so try to ignore the purcahse debt, and charge for subsidising services that people can't effectively object to.

Risk of default. Unlike central government taxes council rates are not direclty linked to the economy. When the economy tanks government receipts tank with them. But, technically, councils can continue to set rates at whatever level they want. There is only a political/moral pressure to take into account the community's ability to pay.
 
Councils can't be wound up. Specific assets can be put into receivership and the receiver has the power to raise a targeted rate to repay that loan. So yes the ratepayer of the day would stand liable for a loan where it is secured by a specific asset.
 
Where councils have to exercise good judgment is in taking on debt when there is likelihood of significant population decline.

So morally if the council wont set a rate that it needs to pay the debt, some of its debt will default.  My concern is the debt just seems to keep building and building and at some satge it will be crippling if it isnt already for some.
 
 

Yes they can default on specific debts. It's a bad look and councils hate looking bad.
 
Debt levels.
 
All councils have a debt policy and they have imposed an upper limit on themselves based on the ratio of finance charges to rates income - it's an affordability limit.
 
I should also add here the point Bernard made a month or two ago that debt is not nearly as much of a problem to councils when there is moderate inflation. Right now councils can't inflate debt away as easily as they used to so it's a bit more obvious.
 
Anyway let's talk a little about where you even need to raise debt. As I said above normal operating revenues must match normal operating expenses so you can't take out a loan to pay a higher electricity bill you must put rates up.
 
There are three types of capital expenditure:
1. life-extending or replacement of existing assets - in theory paid for by reserves built up from depreciation charges. You pay for "consuming" assets then the council uses that money to replace worn-out assets.
2. additional assets for population growth: in  theory paid for by financial contributions (RMA) and/or development contributions (LGA). You pay this levy when you buy a new section; it is capitalised into the price of the section so you have no idea you have paid it. If you take out a mortgage you have raised the loan and you are paying the interest. At least you could recover it when you sell the place. Last year it became illegal to charge those levies to extend social infrastructure like libraries. If the library gets overcrowded there is no pot of money sitting around to apply to building an extension.
3. quality upgrades. replacing an existing serviceable asset with a better one of the same capacity. If you follow the saga of the Central Hawkes Bay DC you see a prime example. Basically they were forced by the Regional Council to put in a new sewer system to serve a declining population but one that emits less pollution. There is no pot of gold anywhere to pay for that either.
 
Debt can sometimes simply be bridging to smooth out cash flows. It may in future have to be used to pay for growth related upgrades to libraries and pools etc. But a lot of what you see by way of rising debt over the last 10-15 years has been due to mandatory upgrades to sewer and water systems that were forced on councils by regional councils and the Ministry of Health. The regional councils and MoH didn't have to pay for the work so they didn't care what it cost the communities.
 

Thanks for taking the time to explain this Kumbel. 

Theoretically the purchaser of a property has set a price which includes _all_ their interests in the building.  That's why CGT, fees, commissions, improvements all get rolled into the cost of the property sale.    Things like the rates paid historically are also considered to be a component of the "going concern" or settlement price -  the purchase is buying all the history, the goodwill, the rates previously paid, any resource contributions,   all that is summed up in the single figure of the purchasing price, so in no way can a incoming purchaser get a "free ride" - that is why CGT is a bad thing, is it ignores all those other balance sheet items and assumes any increase is profit

How much did the town raise, in full knowledge that the road upgrade would be needed, and based on proper usage and population demographics when did they start the fund raising and where did they invest the ante until it was ready to start?

What effort was made to ensure costs were kept down and wastage into reports and meetings and paperwork wasn't excessive?   In business, I must keep my revenue gathering to a minimal level to remain competitive or else it is too easy to "chase efficiency" by spending money on project management (and charging that to admin, not the project). 

Which person is the one responsible for seeing the "shelf price" stays acceptable to the "customer"

My Business has similar problems, I have a wish list that I too suffer to provide capital and upgrades.  And ALL my costs must also be passed to the consumers - but if I get it wrong I pay, I don't get to force it on the customer base.  I can put my price up, but only the willing will pay.

Every business is 100% about provided service to the customer.
That's what the customer is paying for - their needs that we fufil.

Every staff member must know that in my operations.  Even family members must know that.
We aren't here to build business or fill a philosophical niche or to nurse employees.
We are here to provide a service to a customer ... a customer is the person who provides revenue for their services they consume.  No customers constantly want to pay a business for services they don't want or can't use.  No customer wants to pay more than they can afford no matter how fancy the service.  
 Councils, like businesses, must learn to live within the means of their customer base.

If Councils really offered service first, they'd stop draining the wallets of their custys.

What about an expendicture tax that only targets local construction? At the moment if I build a house for $300K then the government gets about $45K in GST. What if some fixed proportion of that went to the local authority where the construction activity took place?
 
GST is the biggest fee or tax in the building industry and yet few people question the need for it or if the government revenue it generates should be better allocated?
 
The NZ Institute wrote a paper about this a while back. I think there was a minor flaw in that GST on land sales would also go to LG, which I think would be way to tempting for LG to bugger around with. But otherwise it is a sound idea.
 
The LG with the most growth therefore the infrasture need generate the most taxes.

Or possibly be routed into the LGFA to be lent out as ultra-long-term loans at very low rates. Could avoid some of the moral hazard.

Maybe? It is only the GST on land that has a moral hazard component becuase it incentivises councils to selfishly inflate property prices for their own benefit but at a wider cost to society.
 
Really it is a bit silly that their is a consumption tax on land. What is being consumed? I can understand taxing improvements - paths, pipes, earthworks...  because over a very long period they are consumed. But the land itself isn't. My preference would be that GST on the land is replaced with a land value tax, higher rates in other words.  
 
In reality Kumbel there probably is little difference between my suggestion and yours because the Councils would probably use a combination of ultra-long term loans as well as upfront payments when providing the new infrastructure.

I thought GST on land had been dropped ( as it basically reciprocate itself straight off the books, and had people swapping to invoice basis just for the free loan)

GST on rates is just a tax on a tax, why not drop it?

Agreed but that is not exactly what is being discussed, although it fits into the theme of central government screwing the scrum against local government. Other long standing issues also include central government not paying rates on its property.

How much of the leaky home problems is central government buggering up building consent reforms in the 90s and then leaving local government to clean up the mess? Reinforcing the conservative bias in councils and creating another layer of bureacracy to say "the computer says Nooo".

All of it.
 
Both Labour and National colluded to strip councils of their absolute right to set building standards and put that right into the newly formed Building Industry Authority (later the DBH and now MBIE).
 
Now councils could be sued for not consenting plans that complied with the national standards.
 
All of the materials and methods that caused leaky homes were approved by the BIA (i.e. central government).

There were large issues with the way councils were handling the standards and inspection and consent system.   What worked in one town might be completely unacceptable building or plan 20 minutes away.    It didn't help that some inspectors would sign off on a treehouse, while others were just ego manics with idealised memories of how they would have done it.
Many councils were making no attempt to clean house or build de facto standards, it was if each council saw itself as some kind of feudal baronry.