Australia Covid-19 , Economy and regeneration , Finance

Rate pegging in local government

Summary

  • Local government is under pressure from their communities to minimise rate increases during the COVID-19 pandemic, and governments are under pressure to remove financial impediments (via mechanisms such as rate and capping or pegging) to assist local governments stimulate their local economies.
  • Rate pegging was introduced in New South Wales in 1976. In Victoria, rate capping has been in place since 2017.
  • The focus of this briefing is on the impact of rate capping and pegging on Victorian and NSW local governments, and how COVID-19 may result in government policy changes
  • This briefing will be of interest to councillors, CEOs and senior executives who are faced with financial sustainability issues during COVID-19 restrictions, especially in Victoria and NSW

Briefing in full

What is rate pegging or capping?

Rate pegging (or capping) is a tool utilised by state governments to ‘fix’ the amount that councils can impose by way of rates in any financial year, and to ensure that the cost of rates remains consistent across the state. The amount of increase is normally represented as a percentage of permitted growth in the rate base, and set in line with inflation or some other agreed index.

The New South Wales (NSW) Independent Pricing and Regulatory Tribunal (IPART) (2008:55) summarised the arguments surrounding rate pegging that have been employed in NSW since 1976. In terms of the case for rate pegging, four distinct incentives were identified:

  • Revenue regulation through rate pegging prevents the abuse of monopoly power in the provision of basic local services.
  • Rate pegging assists in controlling ‘cross-subsidisation’, and imposes restrictions on the ‘provision of non-core services and infrastructure that might prove unsustainable to ratepayers’.
  • Rate pegging manages the risk of poor governance in the local government sector.
  • Rate pegging limits the ability of councils to divert funds from essential infrastructure to other projects, as well as expenditure on ‘marginal services’ that are better provided by the private sector.

IPART also identified four separate arguments against the use of rate pegging:

  • Rate pegging limits councils’ ability to provide local services.
  • Rate pegging prevents infrastructure backlogs from being addressed.
  • Rate pegging leads councils to impose higher user-pays charges which could result in pricing inequities.
  • Rate pegging contradicts the principles of democracy and accountability of local government.

This briefing looks at these arguments for and against rate pegging or capping based on the experience of each State and Territory.

Rate pegging or capping in Australia

In New South Wales, rate pegging was introduced by the State Labor Government in 1976. The introduction of rate pegging came as a result of councils increasing rates by close to 200 per cent over the course of three financial years. In particular, over the period 1973 to 1976, rates had increased on average by 188 per cent, largely as a consequence of increased local government expenditure, whereas average weekly earnings over the same period rose by 75 per cent, and the rate of inflation was 56 per cent.

The NSW State Government proposed that a rate pegging policy would result in increased accountability and responsibility of councils, and would give ratepayers confidence that their rates would not be disproportionately raised. The rate peg in NSW has been determined by IPART since 2010, and is based upon the NSW local government cost index. Councils can apply to IPART to increase rates above the annual limit, provided that they have a strong case that the funds are needed, and can demonstrate community awareness of what is involved.

Given the proposition that the rate-peg percentage is supposed to reflect the ‘projected annual increase in costs’ faced by councils, it is interesting to compare the rate peg with the Consumer Price Index (CPI). The following graph compares the annual rate peg with the CPI over the fiscal years 2008-09 to 2018-19. The rate peg exceeded the change in the CPI over the previous financial year in six out of the ten years recorded.

Rate pegging in local government

Figure 1: NSW rate peg versus CPI | Source: IPART and ABS

In Victoria, following an inquiry conducted by the Essential Services Commission (ESC) in 2015 (which found in favour of rate capping) the Victorian State Government resolved to impose rate capping in 2015, commencing in the 2016-17 financial year.

The Victorian model is slightly different to the NSW model in that it is the Minister for Local Government that determines the rate cap for each financial year based on a recommendation by the ESC. Victorian councils are able to apply to the ESC for an exemption to the rate cap by 31 March each year, similarly to NSW.

The ESC is required to provide a report to the Minister every two years on the outcomes of rate capping on Victorian councils. In its 2019 report for the 2016-17 to 2017-18 years (the first two years of the cap) the ESC found that growth in the sector’s total rate-per-property revenue contracted from an average of 5.1 per cent per annum in the three years prior to the introduction of rate capping to 2.4 per cent in 2016-17, and 1.9 per cent in 2017-18. This revenue includes both capped rates and charges as well as charges that are not subject to the cap (such as waste charges). This largely mirrored the minister’s rate caps of 2.5 per cent and 2 per cent in 2016-17 and 2017-18, respectively.

The following graph compares the annual rate cap with the CPI over the fiscal years 2016-17 to 2019-20, along with the three years prior to the introduction of rate capping.

Rate pegging in local government

Figure 2: Victorian rate cape versus CPI | Source: ESC and ABS

In South Australia, the Liberal Party has focused on the issue of rate capping for some years. When in opposition, it introduced a private member’s bill aimed at securing council rates, in the Local Government (Rate Increases) Amendment Bill 2016 (SA). While the Bill did not become legislation, the Liberals were elected to government in 2018, with rate capping making up one of its primary campaign commitments.

In June 2018, the newly elected government tabled the Local Government (Rate Oversight) Amendment Bill 2018 (SA) in the House of Assembly. The Bill aimed to calculate a cap amount for the various councils and classes of councils on a yearly basis. It then established a cap to the revenue that councils gather from general rates. Councils were able to make an application for a ‘variation’ to the cap, but only if it could show that it had engaged with its rate payers with a transparent view to its operational and financial plans. A similar process to that in Victoria.

Finally, the Bill also provided for a system of oversight. The management of this oversight system was to be done by the independent regulator, the Essential Services Commission of South Australia (ESCOSA). The ESCOSA was to be responsible for making all rate cap determinations, receiving and assessing ‘variation’ applications from local government, as well as reporting on the overall compliance and consequences to the responsible minister.

The rate capping legislation was ultimately voted down in the state’s upper house in 2019. The government has indicated they will again attempt to introduce a rate cap for South Australian councils in 2020.

In Western Australia, while there have discussions around rate capping (especially in the lead up to the 2017 election campaign) it has not gained any traction and councils still have full autonomy in setting their annual rates.

In the Northern Territory (NT), after a series of council amalgamations occurring between 2007 and 2010, rate capping was introduced for a period of three years. Similar to the experience in NSW, the rate cap resulted in a severe infrastructure backlog as councils were unable to raise sufficient funds to maintain, support or repair the infrastructure inherited through the amalgamations. The introduction of rate capping also exacerbated the somewhat restricted rating system in the NT, as unlike other states in Australia, councils are subject to a system known as ‘conditional rating’ whereby certain land is only considered rateable after a rating proposal has been approved by the Minister.

Tasmanian councils have full autonomy in setting their annual rates – however, as reported by the Local Government Association Tasmania in May 2020, the CEO of the Tasmanian Chamber of Commerce and Industry (TCCI) had again called for the introduction of rate capping in Tasmania. This is despite the issue having received no traction as part of the review of Local Government legislation, nor being supported by either major party in the leadup to the last state election.

Queensland councils also have full autonomy in setting their annual rates. Revenue capping has instead been applied to infrastructure charges on a range of property development types.

Rating capping in the UK

Rate capping was introduced into the United Kingdom (the UK) in 1984. Legislation was introduced to impose a rate cap on 15 local councils which the government deemed were ‘unjustifiably’ increasing rates. The legislation resulted in the affected councils refusing to set budgets for the 1985-86 financial year – in direct breach of the legislation – in an attempt to force the Government to intervene and provide those services that the councils could no longer implement. However, the councils ultimately failed to change government policy, with the affected councils conceding, and setting their rates in accordance with the policy.

While the UK rate capping policy is still in force to this date, the Government introduced the Council Tax freeze scheme for the 2011-12 financial year, whereby councils were offered cash bonuses by the government for ‘freezing’ rates. The scheme has seen certain councils impose five successive freezes, resulting in the government expending upwards of five billion pounds in grants. A further statutory limitation was introduced in 2013, which requires a referendum among constituents to be held if a council wants to increase rates above the limit imposed by the government,

The impact of rate capping on local governments in NSW and Victoria

The 2010 report An Assessment of Rate-pegging in New South Wales Local Government compared data on the per capita rate revenue for each of the states and territories. The graph is reproduced in figure 3 below:

Rate pegging in local government

Figure 3: Per capita rate revenue for States and Territories Source: DOTARS, 2007

The report noted that, at a glance, the graph evidences that an average per-capita rate revenue funding gap between NSW and the other Australian jurisdictions had grown over the seven-year period in question. Furthermore, it was noteworthy that NSW also had the lowest council rates per capita of any jurisdiction in Australia other than the Northern Territory.

The Western Sydney Business Chamber’s Economic Recovery Taskforce 2020 report Shovels Ready! Stimulating the Western Sydney Economic Recovery included a 2017-18 comparison with other States and Territories which showed a similar picture to the earlier analysis. This more recent data is reproduced in table 1 below:

Rate pegging in local government

Table 1: Per capita rate revenue for States and Territories | Source: ABS

As NSW has had rate pegging since 1976, it makes a good case study when considering the relative merits (or otherwise) of a rate peg. The NSW Independent Local Government Review Panel’s 2013 report Revitalising Local Government considered the financial impacts of rate pegging on NSW councils. It noted that the NSW Treasury Corporation (TCorp) had allocated all councils a Financial Sustainability Rating (FSR) on a scale from Very Strong to Distressed. A council needed to be assessed at a Moderate or higher level to be acceptable in terms of its sustainability. A Moderate level FSR is equivalent to marginally exceeding the benchmarks utilised in TCorp’s assessment process on average.

As shown in the graph reproduced below, in 2012 around 75 per cent of NSW councils achieved a rating of Moderate or better. However, only five councils had a Positive Outlook. Nearly half of all councils rated Negative (73 councils). This meant that without corrective action, the overall position of the sector was likely to deteriorate, and that in a few years well over 40 per cent of councils could be rated Weak, Very Weak or Distressed.

Rate pegging in local government

Figure 5: Financial sustainability ratings with outlooks (NSW) Source: NSW Independent Local Government Review Panel, Revitalising Local Government

The Panel’s investigations indicated that rate pegging had significant unintended consequences, in particular:

  • Unrealistic expectations in the community (and on the part of some councillors) that somehow rates should be contained indefinitely, even though other household expenditures are rising.
  • Excessive cuts in expenditure on infrastructure maintenance and renewal, leading to a mounting infrastructure backlog.
  • Under-utilisation of borrowing due (in part) to uncertainty that increases in rates needed to repay loans will be granted.
  • Reluctance to apply for Special Rate Variations (SRVs) even when clearly necessary, because exceeding the rate peg is considered politically risky, or because the process is seen as too complex and requiring of disproportionate efforts for uncertain gains.

The Panel’s conclusion was that, whilst there was certainly a case for improving efficiency and keeping rate increases to affordable levels, the rate pegging system in its present form impacted adversely on sound financial management. It created unwarranted political difficulties for councils that really could (and indeed should) raise rates above the peg to meet genuine expenditure needs, and to ensure their long-term sustainability. The Panel could find no evidence from experience in other states, or from the pattern and content of submissions for Special Rate Variations, to suggest that councils would subject their ratepayers to grossly excessive or unreasonable imposts if rate pegging were relaxed.

While rate capping (the local analogue to pegging) has only been in operation in Victoria since the 2016-17 financial year, there are some emerging trends which allow for a useful comparison with the NSW experience. In the Victorian Auditor General’s Office (VAGO) 2019 report on the Results of the 2018-19 Audits for Local Government, VAGO made are number of comments about the impact of rate capping on the financial sustainability of councils. In particular, VAGO noted that while revenue had increased consistently since 2014-15, its composition had changed slightly most notably since the introduction of rate capping on 1 July 2016.

The following graph, which is taken from VAGO’s report, highlights the slight reduction in the proportion of the Victorian local government sector’s revenue generated by rates since 2016-17:

Rate pegging in local government

Figure 6: Revenue composition for the sector, 2014-2015 to 2018-19 (Vic) | Source: VAGO

Councils in Victoria had mostly accounted for this reduction through an increased reliance on developer contributions. There had also been a slight reduction since 2014-15 of user fees and fines as a proportion of total revenue, suggesting the sector was targeting revenue from sources outside of ratepayers and service users to offset revenue lost from capped rates and charges. Although expenditures continued to increase at around 4 per cent annually from 2014-15, council expenditure composition remained unchanged despite the introduction of rate capping, as shown in figure 7 below.

Rate pegging in local government

Figure 7: Expense composition for the sector, 2014-15 to 2018-19 (Vic)| Source: VAGO

VAGO’s review of profitability indicators showed that, while impacted by the introduction of rate capping, the sector as a whole continued to generate a surplus from operations. Metropolitan councils continued to report consistently strong adjusted underlying results. By contrast, large and small regional councils experience more fluctuation in their results with 33 per cent of these councils experiencing a negative result for 2018-19 (31 per cent in 2017-18).

The sector also continued to maintain a strong liquidity position, with $5.7 billion held in cash at 30 June 2019 ($5.1 billion at 30 June 2018). The sector continued to hold low levels of debt and the renewal gap indicator supported a continual prioritisation of asset renewal and maintenance by councils. Regional councils had a renewal gap indicator of 0.95, suggesting spending on existing assets was slower than depreciation.

It would seem at this early stage that on the whole, Victorian councils are still able to meet the community’s service needs, and to fund asset renewal requirements under the current rate capping regime. However, there are signs that rural and some regional councils are feeling the pinch of rate capping.

What is the impact of COVID-19 on rates?

As Australia moves its focus from the initial health crisis to the ensuing economic crisis, many councils are adopting targeted economic support and stimulus packages, and identifying capital works projects which can be implemented to support their local economies during the recovery phase. Some councils are even considering zero rate increase in the 2020-21 year in response to community pressures.

In Victoria, the City of Melbourne announced a freeze on rates putting pressure on other Victorian councils to also keep their bills at current levels. Lord Mayor Sally Capp signalled the freeze in May as the city reeled from the impact of COVID-19, which is sending its annual budget $57 million into the red – its first deficit in 30 years. Inner-city councils (such as Yarra, Moreland, Port Phillip and Moonee Valley) have not followed in the City of Melbourne’s footsteps, having already flagged that their rates will rise 2 per cent for the year. However, regional and rural councils such as Ballarat, Wodonga, Corangamite, Murrindindi and Central Goldfields have followed the City of Melbourne in freezing rates. It might be argued that the smaller rural councils are least able to deliver rate freezes after having their finances significantly impacted by rate capping. Municipal Association of Victoria president Cr Coral Ross said not every council would be able to offer a rates freeze. “Council activities and income streams have been directly impacted by COVID-19 and they do not have the same revenue-raising capacity as state or federal governments.”

What is the impact of freezing rates for one year? Figure 8 shows the cumulative rates lost over ten years (assuming 0.5 per cent growth and an annual cap of 2 per cent) by freezing rates in the 2020-21 year for a range of rate bases:

Rate pegging in local government

Figure 8: Cumulative rate loss due to freezing rate in 2020-2021 financial year

For a council with a $20 million rate base, the cumulative loss over 10 years would be $4.5 million; for a $50 million rate base it would be $11.3 million; and for a $100 million rate base, foregone rates would total $22.5 million.

As shown in Figure 8, the most important thing councils can do during this depressed period is protect their rate bases. Rates are a secure and reliable source of revenue to fund the delivery of services to the community and, in the case of a state of emergency, councils still require cashflow to deliver critical services. While councils will feel under pressure to offer up zero or even rate decreases for the 2020-21 year, the long-term financial impacts of such decisions are significant given the compounding effect of changes in the rate base.

In NSW, councils that choose not to pass rate increases onto their communities (due to COVID-19, the summer’s bushfires, or the drought) will have the option of applying the increases in future years, under reported proposed NSW government reforms.

Business lobby groups have urged NSW Premier Gladys Berejiklian to abolish the system of rate pegging altogether, as part of the government’s post-pandemic recovery plan for the state. The Committee for Sydney and the Sydney and Western Sydney Business chambers say the COVID-19 crisis has created the “opportunity and the urgency” to uncap rates so struggling councils can maintain staff levels, provide essential services and invest in infrastructure.

“By uncapping rates and enabling borrowing, government can provide a partial solution to prevent further layoffs and cutbacks by local government areas without having to directly fund the operations out of state revenue,” the organisations said in a joint letter to Ms Berejiklian. “Councils would then have the opportunity to borrow money and repay the borrowing through rate increases over a number of years.”

In response, the Local Government Act (NSW) has been amended. “The change will allow councils to apply the rate peg more flexibly and respond to changing economic conditions or crises such as bushfires or drought,” Local Government Minister Shelley Hancock said. “With 128 councils across the state and all facing their own unique set of challenges, there needs to be flexibility in our rating system.”

Comment

This briefing provides a comprehensive discussion of the history of rate pegging/capping and the relationship between state/territory governments and local governments when it comes to monitoring rates.

There is pressure on local governments during the COVID-19 pandemic to stimulate their local economies by maintaining staff levels, continuing to deliver services and investing in infrastructure – as well as support local business. As income from non-rate sources is significantly reduced, in other states, local governments would simply look to fill the funding gap by adjusting rates: but rate capping and pegging in Victoria and NSW has become a major impediment restricting this flexibility.

While NSW is looking to introduce new legislation to allow local governments to catch up on any rate freezes in later years, business lobby groups are calling for rate capping and pegging to be removed altogether. A more palatable compromise might be to remove rate capping and pegging in the short term (say, for four years) and put in place some oversight measures to allow local governments to do their part to address the economic crisis. For example, requiring local governments to justify rate increases during this period on the basis of capacity to pay, link to recovery efforts, impact of low-income earners/disadvantaged groups as well as demonstrating support from their local community.

The cumulative impacts of freezing rates, as shown in this briefing, are significant. As councils balance the immediate needs of supporting their communities and the longer-term financial sustainability of councils, it is likely that the financial impacts of COVID-19 will extend beyond the 2020-2021 financial year.

This briefing is part of a series of briefings on local government finance, including the Financial impacts of COVID-19 on Australian local governments.

 

For more information on this briefing contact LGiU Australia by emailing mzierke@sgsep.com.au