Australia Economy and regeneration , Finance

State Regulation of Local Government Revenues: can it be justified?

Summary

  • In this opinion piece, Graham Sansom – former CEO of the Australian Local Government Association (ALGA), and director of the Australian Centre of Excellence for Local Government – looks into the regulation of local government revenues.
  • Local government’s capacity to raise adequate revenues has been thrown into sharp focus by the financial impacts of COVID-19 and the pressing need to find pathways to recovery. This briefing builds on recent LGiU Australia coverage of rating issues to explore how and why Australian state governments constrain local government revenues. What is the logic and purpose of this intervention in local affairs; what methods and mechanisms are being employed; and why does the federal government simply stand by and watch?
  • The briefing sketches the broader context for limits on local government revenues, considers some recent developments in New South Wales, South Australia and Western Australia, and considers their implications.
  • This will be of interest to councillors, CEOs, and senior executives grappling with financial sustainability issues, particularly in the aftermath of the economic impacts of COVID-19.

Briefing in full

Context

During the COVID-19 epidemic, local governments across Australia have lost revenue from the subsequent economic downturn and self-imposed freezes, reductions or waivers of rates, fees and charges. Many have also provided financial support to struggling businesses, households and community organisations. Those financial impacts have added to costs imposed by drought, floods, bushfires, climate change, rapid population growth and longer-term economic disruption or decline.

To address those challenges and remain financially viable, local governments must optimise own-source revenues and maintain high standards of financial management (as required by local government Acts). To varying degrees, however, all states and the Northern Territory have adopted policies that constrain local revenue-raising.

At the macro level, local government revenues are confined to just one tax – property rates – plus a range of fees and charges. Whilst this limitation is offset by local government’s relatively small range of mandatory responsibilities, it does mean that councils are inherently less able than might be required to respond to community needs for expanded services, or to play a greater role in the system of government.

But the principal cause for concern is when councils are in addition prevented from fully realising the revenue potential of their rates, fees and charges. Legislation provides opportunities for revenue-raising with one hand, and then takes them away with the other. A few states overtly ‘cap’ (or ‘peg’) property rates; most mandate concessions or exemptions with respect to rates, fees and charges, and also place limits on the amount of specific fees and charges that can be levied; some impose controls on borrowing; and several force councils to collect or pay special levies (such as for waste disposal or emergency services) that, at least in part, fund state responsibilities – whilst reducing the community’s capacity to pay rates.

In considering these issues, four points need to be made at the outset:

  • The services and infrastructure provided by local governments are vital elements of each state’s public sector that need adequate funding: if councils cannot raise sufficient revenue to do their job, then the state has to fund the gap from its own sources.
  • The 2009 ‘Henry’ tax review (amongst other inquiries) found that rates are an efficient and broadly equitable form of taxation, and it proposed that taxes on land generally should play a greater role in the tax mix.
  • Evidence from surveys and the long history of rate pegging in NSW shows that people are willing to pay modest increases to support adequate and/or improved services, infrastructure and facilities.
  • It is sound economic policy to recover the costs of some services – those in the nature of ‘private goods’ used only by identifiable sections of the community – through targeted fees and charges.

State governments often claim that interventions such as rate capping are necessary to reduce household costs. However, if there is evidence of unwarranted increases in rates, the first question should concern how best to respond. For example, before universal rate capping was introduced in Victoria in 2016, the local government Act already enabled the minister to clamp down on individual councils: those provisions were rarely, if ever, used. In 2013, the NSW Independent Local Government Review Panel (ILGRP) proposed a similar arrangement to ‘streamline’ rate pegging: benchmarking increases, plus a reserve power for the minister to intervene where necessary. That proposal was rejected.

Another justification for revenue controls is that local governments are monopoly providers of some services – but rates are a tax to fund government, not a service charge, and one based on wealth (property owned), not capacity to pay from recurrent income. There is undoubtedly a case for applying cost recovery principles to fees and charges to ensure they are imposed equitably; whether that justifies having those fees and charges set by state agencies is another matter.

A view from New Zealand 

In November 2019 – before COVID-19 – the New Zealand Productivity Commission reported on its inquiry into local government funding and financing. The report’s foreword commented as follows:

A fit-for-purpose funding and financing framework is vital to ensure councils can deliver quality infrastructure and services when and where they are needed, and that the services they deliver are effective, efficient and affordable… councils are struggling to deal with some big pressures… we have favoured targeted solutions that do not compromise councils’ autonomy, or their accountability.

Some key findings and recommendations were as follows:

  • The highly transparent rating system in New Zealand provides a healthy fiscal discipline ( 308), and councils are keenly aware of ability to pay when they make rating decisions (p. 12)
  • As a landowner, the Crown should cover the cost of council services from which it benefits, and pay development contributions ( 10)
  • Remove legal constraints on cost recovery, where fees have been set in statute ( 10)
  • Give councils powers to levy some form of value capture using targeted rates and road congestion charges ( 310)

The New Zealand government has yet to provide a comprehensive response.

Role of the federal government

The federal government is by far the largest provider of general-purpose funding support to local government. If federal financial assistance grants (FAGs) and ‘Roads to Recovery’ funding were withdrawn, the states would have to fill the gap – or hundreds of rural-remote councils would collapse.

The importance of optimising local government’s own-source revenues has been highlighted by the 2002-03 House of Representatives inquiry into cost shifting; the Productivity Commission’s 2008 report Assessing Local Government Revenue Raising Capacity, and its 2017 Productivity Review Shifting the Dial; as well as the 2009 ‘Henry’ review of Australia’ Future Tax System. Yet despite its clear political interest in getting full value for its outlays on FAGs and other grants programs – all of which are intended to enable local government to do more, not to keep rates and charges low – the federal government essentially stands aside while the states restrict councils’ ability to meet community needs and make substantial contributions to federal initiatives, such as City and Regional Deals.

To date, the federal government has only once addressed this issue. It adopted a recommendation of the cost shifting inquiry for an inter-governmental agreement to address, among other things, ‘State restrictions on local government revenue raising such as rate-capping, levies and charges and non-rateable land.’ That agreement was signed in April 2006, but apparently has never been used to tackle those restrictions, and was effectively abandoned during the past decade.

Recent Developments

New South Wales

In its 2013 report, the NSW ILGRP pointed to the huge loss of revenue being incurred by NSW local governments as a consequence of rate pegging. It concluded that (p. 42):

“… the rate-pegging system in its present form impacts adversely on sound financial management… The Panel can 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.”

The ILGRP also argued that the political sensitivity of rate increases had been overstated. Its research indicated that increases of $1-2 per week (5-10 per cent of the then average residential rate) would be acceptable to most ratepayers, provided the additional revenue was earmarked for specific improvements to infrastructure and services. Moreover, increases of that order would address many of the serious underlying problems of financial sustainability identified by the NSW Treasury Corporation in a study commissioned by the state government.

As well as ‘streamlining’ rate pegging, the ILGRP proposed an overall review of the rating system, including the many exemptions and concessions granted to various organisations, notably state-owned entities. The Independent Pricing and Regulatory Tribunal (IPART) subsequently conducted this review and reported in December 2016, but the government did not release the report for nearly three years. Its final response in June 2020 rejected most of IPART’s key recommendations, including any changes to exemptions and concessions. The NSW government’s mantra was to reject recommendations that have adverse impacts on vulnerable members of the community, such as pensioners or charities, affect regional jobs and economies, and/or substantially increase costs for taxpayers and the broader community.’ It noted ‘strong stakeholder views’ – those benefitting from the existing arrangements (including wealthy property owners, churches with commercial enterprises, private schools, developers, and state-owned entities) had effectively resisted paying more.

The NSW government also emphasised its ongoing commitment to rate pegging. It did agree to some adjustments to the mechanics of rating, including action to enable local governments in growth areas to secure additional revenue to help meet infrastructure costs, and to permit ‘catch up’ rates increases in later years when councils elect not to impose the full rate-pegging amount in a given year. There is also to be another review of developer infrastructure contributions. However, these changes appear unlikely to yield sufficient revenue and long-term financial sustainability.

In August 2020 the NSW Productivity Commission issued a Green Paper on ‘Continuing the productivity conversation.’ It highlighted the urgent need for a more efficient and effective tax system, especially in the wake of the COVID crisis. In particular, the paper noted that local government rates were among the most efficient taxes, that rates in NSW were much lower than in other states (citing ‘revenue foregone’ this century of $15bn compared to Victoria), and the need to ensure that councils have sufficient (i.e. more) funding to provide essential services. The Commission proposed that if pending adjustments to rate pegging and infrastructure contributions do not go far enough, proposals to abolish rate pegging should be put to local referenda on a council-by-council basis. Three business-focussed groups have echoed the Commission’s view, arguing that: ‘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.’

Meanwhile, another very recent development is the release of an IPART discussion paper on Domestic Waste Management Charges. Under the rate-pegging provisions, IPART already has the power to regulate those charges, but has chosen not to do so. It now seems likely to introduce some sort of monitoring and benchmarking based on a set of pricing principles. As noted earlier, a case can be made for such action, but there is an obvious risk that the scope and intensity of this additional regulation will increase over time.

South Australia

The election of a Liberal state government in South Australia in 2018 triggered a protracted dispute over its policy of introducing rate capping along similar lines to NSW and Victoria. The government’s argument (as first articulated in a minority report of the state parliament’s Economic and Finance Committee’s 2016 inquiry into rate-capping policies) was that it is: ‘… incumbent upon the state to intervene on behalf of ratepayers by capping rate rises. Ratepayers should not be held responsible for all expenditure not being carried out as efficiently as possible.’

After failing to secure Upper House support for its original proposals, the government recently settled on a greatly modified approach that has the qualified support of the local government association. A Bill is now before the parliament that would require the South Australian Essential Services Commission (ESC) to undertake reviews every three years (or more) of:

  • material amendments made or proposed to a council’s long-term financial plan and infrastructure and asset management plan, and the council’s reasons for those amendments
  • proposed revenue sources (such as revenue from rates, grants and other fees and charges) to be outlined in new 10-year funding plans
  • any other matter prescribed by the regulations.

The ESC would provide and publish advice to each local government on (among other things) ensuring that long-term plans are sound and that the financial contributions to be made by ratepayers are ‘appropriate’. The council concerned would then have to publish that advice and its response in its future annual business plans. Moreover, preparation of business plans and budgets would have to be more open to public scrutiny, and to comply with new guiding principles in the local government Act, stating that:

  • Council services, facilities and programs should be provided effectively and efficiently.
  • Provision of services, facilities and programs should be balanced with the financial impact on ratepayers.

It has been suggested that this scheme for independent oversight of councils’ financial management does not encroach on local decision making. However, each year the ESC would review the plans and revenue proposals of about a third of councils across the state, and would also have the power to issue statutory guidelines, so there is evident scope for the ESC to publish what could amount to an annual, albeit advisory, ‘rate cap’. Moreover, its remit would extend to publishing advice on the level of all fees and charges. There could be far more to this South Australian scheme than currently meets the eye.

Tasmania

The Tasmanian state government is in the process of formulating a draft Local Government Bill, to be released for consultation early next year. In particular, the bill is expected to introduce a series of new provisions for the setting of rates under which local governments retain a large degree of self-regulation. This contrasts with a previous proposal for oversight of council rates increases by the Tasmanian Economic Regulator. Tasmania has thus moved away from the approach taken in NSW, Victoria and South Australia.

The proposed legislative provisions now include:

  • A requirement for councils to consider the principles of taxation, such as efficiency, simplicity, equity, capacity to pay, benefit, sustainability, cross-border competitiveness, and competitive neutrality when determining how to distribute the rating burden.
  • Decision making by councils that reflects outcomes of consultation with the community when developing rates and charges policies.
  • Councils’ own Audit Panel chairs (who must be independent of the council) will review any proposed rate changes that deviate from a council’s Long-Term Financial Plan, and/or any changes to a council’s Long-Term Financial Plan.
  • Setting principles or guidelines to promote greater consistency in councils’ approach to setting fees and charges, but without prescription of the amounts themselves.

Western Australia

In late 2019, the Western Australian government appointed a Local Government Review Panel to recommend the framework for a new local government Act. The panel reported in May 2020. It recommended the current policy of no rate capping be maintained – but on the basis of a number of improvements to councils’ financial management. These should include a more strategic and transparent budget process, program budgeting, increased use of borrowings to fund long-life infrastructure, and separate charges for waste services. The panel also recommended a review of the rating system, particularly wide-ranging exemptions and concessions, as well as the application of cost-recovery principles to council fees and charges, including those regulated by state agencies. As a general rule the panel favoured increased local autonomy, and thus proposed that in future, councils’ fees and charges should be overseen by their local or regional audit committees, which should have a majority of independent members. This echoes the Tasmanian approach. The state government has yet to respond, and it also remains to be seen whether the local government sector itself will understand and accept the trade-offs inherent in the panel’s approach.

Comment 

As the NZ Productivity Commission spelled out: ‘A fit-for-purpose funding and financing framework is vital to ensure councils can deliver quality infrastructure and services when and where they are needed.’ This becomes even more important in terms of post-COVID recovery. So, it is very difficult to fathom the logic of states imposing restrictions on local government revenues, beyond the reasonable application of sound pricing, cost-recovery or competition principles. Neither the NZ Productivity Commission nor the NSW ILGRP could find evidence to suggest that, if left to their own devices, councils would impose grossly excessive fees, charges or rates increases. Moreover, states can and do mandate transparent financial management and budgeting processes. They can also establish monitoring and benchmarking systems with a reserve power for a minister or government agency to intervene if warranted on a case-by-case basis (as once was the case in Victoria). In all states except South Australia, local governments are now audited by the state Auditor-General, who is able to identify questionable or sub-standard practices.

All this suggests that the states are chiefly interested in maximising the space for their own revenue-raising, as well as securing political advantage through populist rhetoric and the selective support of vested interests – even though their actions may result in a weaker public sector overall, and diminished capacity to deliver local services. At the same time, they seem attracted to distributing largesse in the form of a myriad of grants programs for local projects, funded in part by collecting more revenue themselves instead of allowing councils to raise rates, fees and charges to fund projects directly, with much less spent on program administration.

Another factor at work is that, despite all expert opinion to the contrary, rates are still widely perceived (perhaps conveniently) as a service charge rather than a tax. This matches the view, also common, that local councils are really administrative arms of the states rather than separate democratic governments (regardless of the fine words about local autonomy in some local government Acts). Thus, rate capping is seen as an appropriate task for pricing tribunals whose purpose and expertise is otherwise focussed on regulating utilities. Do these tribunals (and their staff) always comprehend the complex interplay of the various issues involved when it comes to the broader governmental roles of local councils?

Finally, the federal government is missing in action. It could readily revisit the findings of its own inquiries and exercise its fiscal power to demand a more rational approach to managing the affairs of local government – a sector it so heavily supports. Its silence seems as illogical as the states’ policies.

Could local government itself do more to tackle these issues? To some extent councils have been their own worst enemies. Some still treat rates as a service charge, and see themselves as service delivery agencies, undertaking tasks handed down by the state,  and on the state’s terms, rather than responsible governments determining their priorities in partnership with the local community. Perhaps councils find it politically easier to ask for bigger grants than to talk to their communities about the need to boost own-source revenues.

A better course might be to demonstrate sound financial management, local accountability, and capacity for self-regulation through participatory budgeting, applying sound pricing and cost-recovery principles to fees and charges, more rigorous internal audit, and ongoing engagement with the community and key stakeholders around the need to maximise long-term financial sustainability: in other words, to make state intervention demonstrably irrelevant and unwarranted. At the national level, local government might usefully remind the federal government of the role it could play – in its own interests – and press for this issue to be considered by the new National Federation Reform Council, which includes the Australian Local Government Association, as an important element of post-COVID recovery.

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For more information on this briefing or to contact LGiU Australia email mzierke@sgsep.com.au