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Local government infrastructure financing meets COVID-19

Principal Advisor, Productivity Commission
20 May 2020

Last October, New Zealand communities elected their local government councillors and mayors. Well-informed sitting councillors knew they were facing serious funding challenges to address a myriad of infrastructure issues – from unsafe drinking water to serious coastal erosion and ongoing flooding issues.

None of those elected could have anticipated the pressures that COVID‑19 would visit on local government. In the middle of a new annual rates round, councils are struggling to find a way to balance the increased financial pressures faced by themselves and their communities against the need to meet their infrastructure investment challenges.

Revenue shortfalls and increased costs

Councils are keenly aware that many ratepayers have lost their jobs and many businesses have taken a financial hit as a result of COVID-19. Many councils have decided to put proposed rates rises on hold.

Councils must set their budgets and strike rates every year, in a way that is highly visible to their communities. Rates are usually set as an overall percentage increase on the previous year. The rate on each property is mostly based on historic property valuations; but, even if market values fall, the rate remains the same.

This system contrasts strongly with central government where most taxes are at a fixed percentage of personal or business income, or expenditure. If income or expenditure falls, the central government tax take falls as well.

With the lockdown, some councils have also taken substantial hits from other sources, like airport and parking revenue. Also, councils are having to adjust how they work to reduce the risks of COVID-19. This means their services will likely cost more; or they will have to reduce what they provide.

It is not surprising therefore that councils are looking for ways to trim their expenditure. They face significant income shortfalls and their ability to meet existing financial pressures, including for infrastructure, will reduce as a result.

How will the Government help?

The Government has signalled it will fund a large programme of infrastructure investments to stimulate the economy and reduce unemployment. It has invited councils to submit their “wish lists” of infrastructure investments that are ready to proceed. The response has been fast and comprehensive.

But should councils be careful what they wish for? More central government funding could alleviate some of their funding pressures. But substantial government funding of local infrastructure comes with risks for the role and autonomy of local government.

Water pump in a floodPhoto source: Hawke’s Bay Regional Council

Let’s look to the past…

In the past, sustained economic crises in New Zealand have led to a substantial shift in the relative roles and size of central government or a search for greater efficiency and better performance of local public services.

Leading up to the great depression, pressure on local government funding was steadily increasing.  Most health and education expenditure was funded locally at the time and expectations around the quality and extent of services were growing. Central government politicians were worried about the steady increase in local government rates, but it was the onset and aftermath of the great depression that tipped the balance. Between 1920 and 1940 central government taxes increased from around 10% of GDP to more than 25%. The need to fund relief for the unemployed was the first driver of the increase. The rapid expansion of the welfare state followed soon after, with centralised funding for health and education. Finally funding for the war effort kicked in.

In the meantime, local government rates reached a peak of around 5% of GDP in the early 1930s as the economy collapsed, and then quickly returned to their long-term average of around 2% of GDP, where they remain today. Responsibility for funding and providing education, health and other social services had shifted decisively from local to central government.1

Taxation as a percentage of GDP in New Zealand Graph

Source: Local government insights – Smith and Crawford

The economic crisis of the 1980s ushered in a search for increased efficiency and better performance in public services. Local government was not immune. While being made subject to similar fiscal disciplines to those applying to central government, local government was reconfigured. The longstanding proliferation of local authorities fell precipitously from 850 to 86. Entities that carried out commercial activities, such as electric power boards, harbour boards and airports were privatised or semi-privatised. Local authorities retained ownership of some commercial entities and took over diverse functions such as drainage, management of river catchments and pest control that were previously undertaken by separate entities. Regional councils were established with a focus on environmental protection and regional transport.

And to the present…

In New Zealand today, central government funding for local government infrastructure is rightly not unconditional. Funding for roading is an example. The NZTA works with councils through regional transport committees to establish priorities, agree on which projects will proceed and how the costs will be shared. NZTA also subsidises local roads using a formula that reflects the rating capacity of each district. This co-funding model could usefully be applied to help fund three waters infrastructure and infrastructure investments that some councils need to make to adapt to climate change. National interests are present in both.

What are the risks of receiving funds from central government?

Overly generous and erratic transfers may raise local government hopes that central government will bail them out of any financial crisis. Transfers can also reduce local government accountability to local communities for spending decisions. Ideally, central government funding should reflect the wider (national) benefits of local infrastructure; and local government contributions should reflect the value to the local community.

COVID-19 times are not normal times

Finding ready-to-go infrastructure investments (that have net benefits) to stimulate the economy is urgent. Unfortunately, this urgency could over-ride the principle of allocating costs according to how benefits fall across local and national interests. This risk could be mitigated by clearly identifying these investments as a one-off time-limited response to the COVID-19 crisis.

Roadworker with a go signPhoto source: Ready to go – Whangarei District Council

History suggests that central government may use its increased funding contributions to accelerate changes in the way that local government delivers three­ waters services to meet new and better-enforced standards. Changes could include the consolidation of some services across local government boundaries – bringing expertise that is currently lacking in some places.

Over the medium-term, further reorganisation and consolidation of local government is conceivable. Economic crisis and public sector policy reform in the 1980s led to the last major reorganisation of local government in New Zealand. Economic crisis may not lead to a shift in the size and role of local government, and local government in New Zealand is already very limited in scope on international comparisons. Even so, economic crisis will almost certainly accelerate the search for greater efficiency and higher performance in local government services.

Take outs

  • Economic crises of the past have led to a significant shift in the relative roles and responsibilities of central and local government in New Zealand;
  • Local government is currently facing significant funding challenges for infrastructure to meet higher health and environmental standards and to adapt to climate change. Central government has a larger role than in the past in helping local government meet these challenges.
  • Small rural councils are facing increasing pressure on rating capacity and may not be viable in the future.
  • The Government will fund an accelerated programme of local infrastructure investments to stimulate the economy and reduce unemployment resulting from the COVID-19 crisis.
  • The combination of existing funding challenges and economic crisis will likely lead to further substantial changes in the way in which local government organises its services.

 


Note
1. Demonstrating that nothing is inevitable, other countries with stronger traditions of decentralisation (especially in northern Europe) took another path – where responsibility for funding and delivering local social services was devolved to municipalities. Even so, in these countries central government typically keeps its fingers in the local pie through regulation, performance monitoring and fiscal equalisation policies.

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