If not rates, then what? Possible new local government revenue tools explored
An AI-generated image of a tax collector trying to find new revenue streams.
On the back of news that most home owners were facing double digit rates increases this year, coming off the back of years of significant rate rises, media coverage of local government has been inundated recently with the same message: the rating system on which council’s rely on for their funding is unsustainable. Of course, this isn’t news for anyone who’s been involved with or followed local government, but the question that naturally follows is “if not rates, then what?”
First, it’s helpful to take a step back a look at how exactly local government is funded currently.
A 2019 report into local government funding and financing from the now defunct Productivity Commission broke down the funding sources across the sector as such:
Table showing the main sources of funding available to local authorities from the Productivity Commission's 2019 report
There is considerable variability between councils on this. For example, Gore District Council’s latest annual plan forecast 63 percent of their annual funding coming from rates, versus Auckland Council which sat at 35 percent. There are a number of factors which influence an individual council’s reliance on rates, for example owning all or part of a significant income generating asset can help (think major airports and ports). Conversely, the need (or often want) to own similar smaller assets in regional centres can be a source of major expenditure for councils in order to maintain them to a safe standard and subsidise their operations.
The other issue is that rates, unlike the revenue from income tax which central government collects, aren’t inflation proof on their own. With income tax revenue, wage growth progressively pushes people into higher tax brackets which nets central government additional revenue to help blunt the impact of inflation on central government’s expenditure. This happens quietly every year that wages grow and central government doesn’t have to lift a finger until they inevitably adjust income tax brackets or tax rates to give people a tax cut.
It’s great politics for those in the Beehive. Workers are subject to a sneaky tax increase every year and then central government gets to look great when they cut taxes. It’s why, despite a lot of talk about its merits, you’re never likely to see a Government index tax brackets to wage growth.
Rates revenues, on the other hand, have to be manually adjusted every year in order to account for inflation. This is why at a minimum you can typically expect council rates to increase at least by whatever inflation is forecast to be for the next year as a starting point even before you start factoring in any new infrastructure or additional unfunded responsibilities that have been generously devolved from central to local government.
This is terrible politics for councils. Every year they have to go out and tell everyone that their rates (basically a property tax) are going up just to keep levels of service the same, let alone paying for all the things that central government has decided councils should do on their behalf, or need to respond to, but haven’t funded. Elected representatives on councils get kicked about every year as a result.
In theory this system is meant to encourage fiscal responsibility from councils, but as we’ve seen with the state of water infrastructure around the country, it tends to result in cans being kicked down the road until things are completely broken.
And despite the rhetoric from Local Government Minister Simeon Brown telling councils that they needed to go line-by-line through their expenditure and only focus on core services (where he seems unaware that councils already do that every year in a far more accessible, transparent, and collaborative way than central government does through their annual and long-term plan processes), the reality is local government isn’t anymore or any less prone to wasting money as central government. Whether it’s the Wellington Town Hall or the Christchurch Convention Centre, both local and central government are just as good at each other at blowing their budgets.
For grants and subsidies, some of these are relatively predictable. For example councils generally know how much Waka Kotahi New Zealand Transport Agency (NZTA) is going to contribute towards the maintenance of local roads. Others can be much more arbitrary, such as the Provincial Growth Fund, the “shovel ready” funding provided during the pandemic, or the Better Off funding from the previous Government’s now abandoned three waters reform.
It’s also important that before we look into alternative funding tools that we separate local government funding from local government finance. While local government finance is an issue from the perspective of the levels of debt councils are carrying, where it’s sourced from, how much that debt is costing to service, and the comparatively short-terms that debt is issued on, the financing side of things becomes a lot easier if the funding is economically and politically sustainable.
So what are the alternatives?
As a starting point, rates aren’t necessarily going anywhere, it’s just that councils would like to be less dependent on them and have inflation resistant alternatives so that the yearly cycle of being flogged over what are ultimately unavoidable rates rises isn’t quite so bad.
Tax revenue sharing
One of the options that is most frequently brought up is some form of tax revenue transfer from central government to local government, usually put forward in the idea of GST sharing. This could be achieved in two ways. The first is the most simple - that councils are allowed to keep the GST which is collected on rates. As former Cabinet Minister Peter Dunne highlighted recently, this was actually the original intent of addressing the “tax on a tax” situation that exists, but it was abandoned as a quick revenue grab the year after it was implemented in order to address a recession, and never re-instated. The final report of the Review into the Future for Local Government estimated this would cost central government around $1 billion per year.
The other would be implementing a more complex system similar to Australia’s GST sharing system between the Federal and State governments. There the principle of Horizontal Fiscal Equalisation is applied, which is basically that government services should be delivered to a similar standard in all states, and a portion of the GST revenue collected centrally is then distributed back out to State Governments along these lines. It’s not without its criticisms, both from the complexity that would be required to administer such a system across New Zealand’s 78 regional and territorial authorities, but more so from the cross-subsidisation that inevitably occurs as places which generate a lot of GST revenue via their economic activity end up subsidising those which do not.
Another aspect of this were the GST sharing arrangements on housing developments proposed by National and ACT ahead of the 2023 General Election. The problem with these is that they’ll be largely at the mercy of fluctuations in the housing market and would be cumbersome to administer.
Value capture tax
Value capture taxes are less about funding the general operations of council and more about how you pay for big infrastructure projects. The idea is that when significant investment is made into infrastructure, and property prices increase as a result, when those properties are eventually sold that a small percentage of the increased value since the commencement of the infrastructure project is collected as tax in order to help pay for that specific infrastructure project. This is one of the funding mechanisms at play behind the Greater Manchester Combined Authority that Local Aotearoa wrote about two weeks ago when looking at city and regional deals.
Good examples in New Zealand which could’ve benefitted from value capture taxes would have been the likes of Transmission Gully and the expressways north of it in the lower North Island, or the City Rail Link in Auckland. Both of these projects have cost billions of dollars. Transmission Gully and the expressways have already helped the property markets of the Kāpiti Coast and Horowhenua boom thanks to the vastly improved access to Wellington, yet nearly all the benefits of those increases - only possible because of massive cross-subsidisation of those roading projects - have ended up in private hands.
Of course, value capture tax really only works when it comes to funding significant infrastructure projects. Things like upgrading water and waste pipes don’t quite lift property values in the same way.
Congestion charging, fuel taxes, road tolls
Making people pay for driving their vehicles into major urban centres through congestion charging is something that repeatedly pops up on the policy radar of both central and government, with central London’s congestion charging scheme often held up as the poster child. Both Auckland Council and Wellington City Council seem relatively keen on the idea, and Governments of both stripes usually make vaguely supportive noises without doing anything about it.
The problem is, as always, a political one. Auckland’s Heart of the City business lobby group is already probing around some of the potential concerns, and this could be expected to ramp up should the scheme start to move closer to reality. It doesn’t necessarily matter whether their concerns are grounded in reality or not (for instance objections to pedestrianisation often fly in the face of the clear evidence of their benefits), as it becomes an easy political issue.
There’s also the small issue of congestion charging really only being an option for the major metropolitan councils, namely Auckland, Wellington, and Christchurch. If you suggested congestion charging in Feilding, you’d be laughed out of town.
The now abolished regional fuel tax in Auckland was another similar tool, though much like taxes on fuel in general, it’s probably a bit of a dead duck given the need to switch to road user charges with the rise of electric vehicles. A regional road user charge could be an option when such a switch is made.
Tolling roads is another option, but again it only provides part of the solution with a recent Infrastructure Commission report suggesting tolls would only cover a quarter of the cost of most roading projects. Notably, these are new projects and they’re ones that are in central government’s court, so not really an option for local government unless they suddenly find building major new highways devolved to them.
Councils setting their own income taxes or a local government ACC-style levy
No one is seriously suggesting this happens, but it’s worth chucking in the mix purely because it is used in some cities in the United States where they can levy their own income tax. For example, New York City’s personal income tax rate of 3.876% is collected by the state government and then forwarded onto the city. This probably works in the United States because their taxation system is a mess anyway, so what’s one more layer of complexity on top of it? Whereas in New Zealand, our tax system remains relatively simple despite the creep of complexity via tax credits and rebates sneaking into it.
You could make this work by adding in an ACC-style levy to income taxes. From the collection side this would be very easy. Distributing it back out to council’s is where it could get trickier. Options here could be either based on where people live, via some sort of formula taking into account land area, geography, population, economic deprivation, visitor numbers etc, or a mix of the two. If you were to implement this option, that mix of methods would be the most likely option with the view to providing some equalisation of services to residents between council areas.
What’s more, an ACC-style levy has the benefit of being protected somewhat against being eroded by inflation, which is one of the biggest issues with rates.
The political reality though is that this is likely to be a no go. Even if National back-tracked on its pre-election commitment to rescind the “app tax”, they and their coalition partners are unlikely to be keen on being seen to introduce a new tax like this.
More easily set their own fines and penalties
Auckland Council’s Mayor Wayne Brown has been the champion of this issue, highlighting the fact that councils can’t set their own parking fines. While lifting parking infringement fees would only make a tiny dent in the revenue needs of councils, allowing councils to operate their own traffic safety cameras could do a bit more. Again, having councils install speed and red light cameras isn’t going to generate vast sums of money, but it would be another tool in the box. Not that traffic safety cameras should be installed as revenue generators and driving safety outcomes should always be the priority, but you can’t pretend it’s not a consideration.
Bed taxes and visitor levies
Always a controversial topic, as Auckland Council found out after years of legal battles (which they won) over their bed tax, but this is one option that frequently gets considered in areas with large numbers of visitors.
In Queenstown, which arguably has the most acute infrastructure challenges from a small rating base and large visitor numbers, the community voted overwhelmingly in favour of a bed tax, however the current National-led Coalition Government seems uninterested in progressing it. It’s a somewhat remarkable situation given the rhetoric of the three parties in Government about wanting to let councils make their own decisions about things, and Queenstown probably has the easiest case in the world to make for introducing such an area specific tax, but that’s politics for you.
It also seems unlikely that the Government is going to increase the International Visitor Levy by such an amount that it would generate enough revenue to make up the gap for districts like Queenstown. Or even if they did, the demands on any increased revenue raised by Government, and the likely painful and often arbitrary grant based nature of allocating the funding out increases the administrative burden on councils even more than just letting them get on with doing their own things.
Of all these tools, no single one is going to solve local government’s funding problem on its own, though several such as income tax/GST sharing or an ACC-style levy would make significant differences. Some form of value capture tax seems like it might be on the cards for city and regional deals if National’s pre-election warmth to the idea survives the dynamics of the coalition and their own political appetite. Things such as congestion charging are working their way slowly into consideration, while the idea of local government operating traffic safety cameras has probably been supplanted by the expansion of these cameras in the most recent Government Policy Statement on Land Transport.
Fundamentally though, if central government wants to keep pushing unfunded mandates down to local government, they need to step up and give local government more choices about the tools it can use to meet the funding needs required to deliver on those. After all, if a council decides to make use of a specific tax, levy, or fee, that’s a political decision that those elected representatives will have to wear, not MPs and ministers sitting in Wellington.
