Rates Rises (a perennial favourite)

The Taxpayers Union and the Ratepayers Alliance have done their annual roundup of council rates and, predictably, have complained about the higher-than-inflation council rates rises. Like most people these groups seem to hope that they can get a fabulous basket of public goods for a lower and lower price. Ratepayers do get a chance every year to say what they would like cut from the budget but very few ever offer a suggestion. So, general complaining about the level of rates rises is common but it is rare to hear a suggestion that the community tolerate bumpier roads or longer grass on playing fields in return for lower rates. (To be fair councils make it next to impossible for the public to understand what their choices actually are).

The easiest way to get costs (and possibly rates) down is to stop providing services. Councils would save a fortune if they closed their libraries. Disclaimer: I personally would fight against closing libraries but it is an example of the hard choices that need to be made if you are serious about rates.

The hope of many critics is that councils are somehow wasteful in their expenditure and that they could produce the same basket of goods with less inputs. The most common criticism I hear is that councils are over-staffed. While that's probably true in the same way that all large, complex organisations end up overstaffed, consider that a 5% cut in a council salary bill would only lop off about 0.5% from the rates bill. Odd though that seems, most councils only spend about 20% of their expenditure on staff salaries and the remaining 80% on purchases. While being appropriately staffed is a good discipline it's not really where the money is in territorial authorities.

Council purchases include energy, insurance, office supplies and IT, communications, advertising etc. So, the normal purchases any business would have. But the vast bulk of the purchased items is contracted construction and maintenance of roads, water infrastructure, buildings, parks and reserves, and sports grounds. Most households are familiar with what feels like astronomical rises in energy and insurance costs but what about civil construction costs? Statistics NZ helpfully track input costs like civil construction so it is possible to put together a chart like the following:

For ten years after the reorganisation of local government rates and construction/maintenance costs seem to have moved in line with CPI. Since about 2000 they have diverged significantly. What is probably a council's largest input cost has more than doubled compared to CPI in the last 18 years. Consumer price levels generally set the ratepayers expectations about what the rates rise ought to be but the civil construction price levels dictate what it actually costs a council to provide the infrastructure and related services.

I have no explanation for why this has happened. I note that it has occurred since it became commonplace for councils to divest themselves of their works departments and put all outside work out to tender. And tendering is not as competitive as you might think since public sector tendering rules tend to lock many smaller players out.

Whatever the reason, it's no surprise that people are grumbling about rates. An inquiry into why civil construction prices have risen so significantly would be useful. Until then it's hard choices like close the libraries if you want lower rates.

Are 1-in-5 really at risk?

One likely reason that will be given for taking responsibility for water services off councils is that they are not doing a good enough job at supplying safe drinking water. The sound bite goes something like "1 in 5 New Zealanders are at risk from their drinking water". This claim will play well in the media spreading a bit of fear, uncertainty and doubt but it is beyond inaccurate, it is meaningless.

Think about it. If that claim is true it's inverse must also hold: "4 in 5 New Zealanders are at no risk from their drinking water". And, if that strikes you as too good to be true you are right. The reality is that there are always possible threats to human health from water supplies. So, all New Zealand residents (and visitors to the country) are at some risk from drinking water; it's just a question of where on the risk spectrum they lie.

So how do we hold these threats at bay? Until 1995 it was entirely up to individual suppliers. From 2008 onwards water suppliers have had to register with the local DHB and meet compulsory performance standards. In between was a voluntary registration scheme.

Water Supply

An estimated 82% of people in the country get their drinking water from a registered water supplier. Almost all the registered suppliers are councils but there are some registered schemes run by the government (schools, defence forces and DOC), private operators and communal operators. There is no particular reason why councils are the main water supplier other than it has always been that way. Anyone can set up a commercial water supply if they want.

Those who cannot or do not want to get water from a registered supplier self-supply. So the remaining 18% of New Zealanders get their water from an unregulated supply (i.e. their own bore or the roof). But anyone might access an unregulated supply at any time (at work or visiting friends etc). With diseases like giardia present in some of our back-country streams anyone could get gastroenteritis simply by scooping up a drink while tramping.


Compliance with Drinking Water Standards

The main commitment registered water suppliers make is to take all practical steps to comply with Drinking Water Standards. Compliance involves a whole bunch of things. Mainly it's based on the results of continuous water testing. The water tests get divided into three main categories: bacterial, protozoal and chemical. If a scheme fails in just one category it is still deemed to be overall non-compliant. Note that a scheme can also be non-compliant for a few process reasons. For example, a scheme will be classed as non-compliant if the operator hasn't tested the water frequently enough. The "1-in-5" stat is estimated from the number of registered schemes that have officially failed to comply with every single standard.

Currently an estimated 20% of the people who get their drinking water from a registered scheme get it from a scheme that has failed at least one of the standards. This is actually 16.5% of the total population. And if you are going to be completely truthful about the number of people drinking water that has not met the standards then you have to add in the self-supply group. A more accurate statement about those "at risk" would be: 34% of the population regularly drink water that has not been proven to come up to standard. If you were worried about "1-in-5" then how worried are you about "1-in-3"?

The Review of Three Waters is unlikely to recommend any action that would apply to anyone other than councils. The self-suppliers will continue to be unregulated and the government can continue to operate its non-compliant supplies in Waiouru, Linton and Ohakea. Whatever the government chooses to do with council supplies, about 1-in-5 of the population will continue to drink water that does not meet the Drinking Water Standards. Which I think is where we came in.

Safe Water and Water Testing

So you are safe if you are on a compliant water supply? The existence of Drinking Water Standards and the 'name-and-shame' tables published by the Ministry of Health provide false comfort. Just because a water scheme meets the Drinking Water Standards does not mean that no-one will ever get sick from drinking its water. The Havelock North supply was passing all the tests with flying colours right up till the day 5,000 people got sick.

Water that complies with the standards is not pure water, it is safe enough water. All drinking water is allowed to contain low levels of contaminants. The bulk of the Drinking Water Standards specifies what those maximum allowable values (MAV's) for contaminants are. Interestingly the standards also specify how often a scheme is allowed to breach those MAV's during a year, by how much and for what length of time. As long as a water supplier doesn't breach the safety standards too badly they won't lose their compliance status.

The tests, themselves, are practical but not as precise as you might think. You can get sick from water that tests clear and you may be in no danger from water that fails a test. In the bacterial and protozoal categories the regular tests only look for indicators. In particular the practical daily tests for protozoal contamination can't tell the difference between the dangerous and the safe strains of those organisms. Operators and regulators take the cautious approach (as you would hope) of assuming that a positive indication does mean the presence of harmful contamination. But when those failed tests lead to name-and-shame or very important policy decisions they need to be treated with appropriate caution. On the other hand it seems there is no way of screening out the country's most virulent infectious disease, norovirus, from a water supply in the extremely unlikely event of it getting in there. So there is no test or standard for it.

The biggest hole in the testing regime is that in most schemes by the time you find out about a dangerous contamination it's too late. There is a clear preference in New Zealand for suppliers to get drinking water from a naturally safe source and to distribute it untreated. Generally that works well. But Havelock North showed us that it is possible in unusual circumstances for a supposedly safe source to get contaminated. In that specific case the effects of contamination were obvious in the community long before the test results indicated a problem.

Risk

One thing missing from all public discussion of drinking water safety is how many people actually do get sick from their drinking water. After all the whole point of regulating water supply is to reduce the incidence of water-borne illness. Accurate statistics relating specifically to regulated water supplies are not published. The Ministry of Health makes no attempt in its Annual Review of Drinking Water Quality to link the data it has on disease notification back to the performance of the water supply sector. The Ministry does publish an annual surveillance report that analyses the outbreaks of disease. Unfortunately the report sheds no specific light on regulated water supply as a source of disease so we have to infer what we can. Note also that this data only relates to outbreaks where more than one person gets sick because of a single cause. Also the reporting rate is probably below 20% for water-borne disease for the very good reason that the majority of the people who contract a water-borne disease don't get sick enough for them to need to see a doctor.

Looking at the 2015 surveillance report (2016, the most recent report, is skewed badly by the Havelock North outbreak) we find that there were 89 reported cases of water-borne illness. 26 of these 89 cases were contracted during a school trip to Nepal. So maybe 63 cases were domestic (no guarantee). These were all situations, all circumstances, whether water was the primary source or just helped disease along later. So, the chance that you contracted a water-borne illness in New Zealand bad enough to warrant a trip to the doctor in 2015 was about 1 in 70,000. The probability that you got that illness from a council-run water supply was probably much lower.

To get a sense of perspective and a sense of the trends the following graph takes the data from all the available surveillance reports and normalises the data for changes in population:

Although there is a clear growth in the incidence of notifiable diseases in New Zealand between 2001 and 2016, water-borne illness is not contributing to that growth. In fact what is noticeable is that all the high profile interventions by the government have made no difference at all. In 2001 water supply was unregulated and compliance with the Drinking Water Standards was voluntary. By 2015 the Ministry of Health was regulating water supply and compliance with the standards was mandatory for the majority of supplies. Yet, between those two dates there does not appear to be any significant change in public health outcomes.

A more accurate risk assessment

We can do better than "1-in-5 New Zealanders are at risk from their drinking water". The phrase "at risk" has no meaning at all. We are all "at risk" from being hit by a meteorite, so what? The data suggests that the difference in risk from drinking water from a compliant water supply versus a non-compliant supply is not yet measurable. Specifically the probability that anyone will contract an illness from their drinking water is very low and, even if they do contract an illness the probability of of that illness causing severe problems is also low. It's doubtful whether bringing all the currently non-compliant water supplies to compliance levels would make any practical difference to our risk levels.

Of course it matters whether water suppliers are careful about the quality of water they supply.  The point is that the suppliers were already doing an adequate job before the government interventions of 2008. And, yes, they could do still better. The question is whether a mandatory set of upgrades of water supply schemes would be the best use of public funds today. I can't see any significant problem that would justify diverting funding in this direction.

Nationalising water, sewer and stormwater services (update)

Things have moved on a little since I last posted on this issue. Minister Mahuta has not been coy about the possibility of transferring the three water services out of council hands into some new entity. Call it an open secret that this is going to happen. Although we don't yet know what kind of entity it will be, the most likely is some kind of Crown-owned structure like an SOE.*

And what will happen is that the government will announce that it is transferring all the assets and liabilities related to water, sewer and stormwater out of council books and into the new entities. The tricky part for the government is not that the average person will be particularly outraged at some loss of local autonomy. More likely they will be confused, possibly outraged, that the government will not be paying for these assets.

Let's be clear there is no legal or financial reason why the government should buy the assets. But there is always this lingering idea that somehow the locals "paid for" these assets and should be compensated for their removal. It is a mistaken but deep-seated view that will be hard to handle politically.

There are some really good reasons for the restructure and there are some really bad ones. The two main good reasons are:

(i) the SOE's should be way more nimble in extending infrastructure to support urban growth. In turn this will contribute to making housing more affordable. I think it is now widely accepted that one of the reasons for under-building is simply that there is no infrastructure to attach new properties to; and

(ii) the SOE's will be in a better position to upgrade stormwater systems to cope with the expected increase in severe rainfall events. Councils have known for years that they need to invest heavily in upgrading stormwater but the difficulty of finding funds to do it has held them back.

So when it comes time to announce the restructure the government will have to deliver the unpalatable message to the public that 'their' water schemes are being taken from them and the only compensation will be higher water charges and a decrease in house value. Ugh! They will try to sell the idea that consolidation will deliver efficiencies but I don't think anyone will buy that these days.

The one pathway through this political nightmare requires demonising the councils. The message will become one of having to remove these services for the good of the public (putting water into fostercare?). The government won't have any problem with this one. Local Government New Zealand research has already revealed the low level of trust the public have in their local council. The audience is already primed to hear any negative message about council performance. So far the government have said little but the framing has already started in the media with some support from lobbyists.

What we are hearing is that 1 in 5 New Zealanders are "at risk" from their water supply and that we have a looming problem with ageing infrastructure and no plan to replace it. Neither is even remotely true but both charges will stick fast. The charges are plausible enough to induce major media outlets to report the announcement uncritically and to muffle any public outcry.

I will be sad to see water pass into other hands. During the heroic age of local government in the 19th Century councils transformed the lives of urban dwellers as they constructed water and sewer networks. On the other hand this is the 21st Century and we have other problems now.

My problem with this process is that we are now locked into proving that some other structure will be better than councils at sustainably delivering effective water services especially safe drinking water. But to a certain extent that is solving the wrong problem. The main reason councils don't roll out infrastructure more quickly and why they don't beef up their drainage is just good old-fashioned money. I have no problem with restructuring the sector but I sure wish the current effort was focused on the best way to finance infrastructure. Not what a terrible job councils are doing.


* It is very unlikely to be some kind of management company with councils retaining ownership of the assets. The main benefit of the restructuring is to get water services debt right out of council books. Any hint that councils remain ultimately liable for debts over water assets (i.e. because they own the assets) would prevent that possibility from the start.

The Nationalisation of Council Water Services

In June 2017 the National-led government launched a process that could lead to the nationalisation of the water, sewer and drainage services currently owned and operated by local councils. Nationalisation would be an extreme and draconian outcome so why would the government even consider it? It's hard to say because the "case for review" is thin; populated by untruths, half-truths and crucial omissions.

For instance the paper complains (para 16) that the sector has "minimal central oversight to provide transparency, address challenges, and actively encourage service improvements". This is simply untrue. The real problem is that central government is not organised enough to collate all the public information that is already available. For a start the provision of potable water is totally regulated by central government and their agencies. Any member of the public can go to the Ministry of Health's website and read reports on the performance of councils and other water suppliers with respect to the Drinking Water Standards devised and published by the Ministry of Health. The same Ministry of Health via District Health Boards is the absolute gatekeeper of whether a council is a registered water supplier. It is true that the rules about what sewer and drainage systems are allowed to discharge to land or water is set by regional councils during the consenting process but those rules are based on standards set by the Ministry for the Environment and the Ministry of Health. Those discharges are monitored and data kept by the regional councils. So, central government already sets the standards councils must meet through their water systems and the data already exists on how those standards are being met. Central government just needs to get its act together and collate the data if it wants re-assurance that its own rules are being complied with.

The Havelock North gastro outbreak gets a mention (as you would expect). It is worth bearing in mind that the Inquiry into the outbreak concluded that the most likely cause was a highly improbable combination of factors and that all players had followed central government rules to the letter. As for the Mangawhai Heads Sewer debacle at Kaipara District, it was simply a failure of governance; it could just as easily have been a library project as a sewer project. I wouldn't count either event as an indicator of problems in the provision of water services.

Unbelievably, rocketing house prices in Auckland are blamed on the inability of citizens to know what is going on in their water systems!

It will also be news to the Auditor-General that there is "little consistent, reliable information on the state and performance of three waters systems" (para 19). Since 2006 the A-G has required councils to base their Ten Year Plans on properly constructed asset management plans. These are assessments of the current state and performance records of all assets including the three waters. They include a pro-forma work-plan for anything up to thirty years for extending, replacing and upgrading assets. So this year's TYP round will be based on the fifth revision of council asset management plans.

There's more but, all in all, I found the case for the review entirely unconvincing and, in places, bordering on the incoherent.

The worst aspect of it is a significant omission: public health outcomes. If we had a current or emerging problem in water supply and to a lesser extent in sewer we would see it in the incidence of communicable disease outbreaks. Fortunately the Ministry of Health has been publishing a surveillance report on disease outbreaks for some years. The graph below shows the total number of cases of communicable disease each year normalised for population growth. Then broken out are the figures for water-borne and food-borne disease:

I have included the cases where water transmission is implicated in an outbreak but was not the primary mode of transmission. Had I only included the cases where water was the primary mode of transmission the numbers would barely have ticked above zero. By the way these figures include the Havelock North gastro outbreak which was the worst single outbreak of communicable disease since these reports began. Yes, it's that uptick in 2016.

The graph tells the story. Water just doesn't look like a problem either trending or relative to other public health issues. Any desire to fix the system, therefore, has to be based on fear of what might change one day.

Be careful what you wish for: Havelock Nth edition

At first I thought the Inquiry into Havelock North Water had missed the mark in its second report. Media reports indicate the report is highly critical of the Ministry of Health. I would have been more critical of the performance of the local DHB but, of course, DHB's are the Ministry of Health. It is specious to pretend otherwise when the majority of their boards are government appointed.

What really caught my attention was RNZ's interview with Dr Stewart Jessamine, currently New Zealand's top public health official. During the interview Dr Jessamine blamed a "distributed" system where responsibilities for drinking water safety are spread between the Ministry itself, DHB's, and territorial authorities (technically water suppliers as there are many suppliers who are not councils). Jessamine could have also included regional councils.

Why do we have a "distributed" system? Because the Ministry of Health asked for it and Minister of Health, Pete Hodgson, saw the change through Parliament in 2007. I would call it more than disingenuous for Dr Jessamine to blame a system that was created by his own division of the Ministry of Health.

Prior to this time responsibility rested solely with the water suppliers. These water suppliers could voluntarily sign up for a grading system overseen by the MoH but it was not compulsory. Prior to 2008, the MoH had issued drinking water standards for many years. What was been good about the standards was that they were primarily performance based. Councils could be deemed to comply if the quality of tested water continuously met certain specific measures. Councils were free to set their own direction as to how they met these standards as long as contaminants stayed within specified limits.

The changes to the Health Act made in 2007 inserted the MoH (via DHB's) into a role of approving the plans by which councils delivered safe water. An examination of Cabinet papers from the time should show a recommendation from the Ministry of Health for it to be granted greater regulatory powers. And these powers did show up in the amended Health Act. Bearing in mind that the MoH has no capability at all in environmental engineering, the chances of the new regulatory system going off the rails increased quite markedly once the responsibilities for drinking water safety got spread out.

Just to be clear: DHB's (foot soldiers for the Ministry of Health) have the absolute power to control whether a council is a registered water supplier or not. Part of that power includes approval of how a council delivers safe drinking water even though neither the MoH nor DHB's have environmental engineering capability. But, if it fails to gain registration and continues to supply water, a council can be liable for fines of up to $10,000 and a further $1,000 per day that the offence continues. Councils have no choice but to do what the DHB (MoH) asks them to do.

In this context the Inquiry is fully justified in criticising the Ministry of Health for not taking the new responsibilities - responsibilities that it had sought for itself - seriously enough.

Depreciation pt 2: what happens to the money

In Pt 1 I outlined that calculating and funding depreciation is a mechanical accounting process that is common to just about every enterprise. I also mentioned that depreciation generates cash, so let's move on to what happens to the cash.

It's worth noting that what a ratepayer is paying for in depreciation is not really connected in any direct way to how the cash generated by depreciation is spent. Rates pay for service on a daily basis. Not wildly different to a mobile phone plan. When someone pays a water rate they pay for safe water flowing reliably out of the tap. As it happens part of the cost of making that possible is the wear and tear (depreciation) on the current physical assets in the water network. The cost of the wear and tear is added to all the other expenses when a council calculates its water rate. But what happens to that money after it is collected is not relevant to why ratepayers are asked to pay the money in the first place.

I labour this point because many people are convinced that rates "pay for" infrastructure and that it therefore follows that residents who have been paying rates for many years have some prior claim over newcomers. Nothing could be further from the truth: the ratepayer of 1 day and the ratepayer of 10 years have exactly the same claim (i.e. none at all).

Funding replacement assets

The first and best use for the funds that accumulate from charging depreciation is to pay for replacement assets. After many years use roads, pipes, buildings, plant etc will wear out and need to be replaced. If a council has been dutifully collecting the funds generated by depreciation it should have pretty much enough cash on hand for replacing aged assets.

In theory, once a council has all the assets in place to provide services to its public it can sustainably offer those services forever just through the cycle of charging depreciation and using those funds for asset replacement.

While the process of calculating depreciation may be pretty mechanical the application of the funds it generates requires judgement and some prudence. Adding new infrastructure to service growth or upgrading infrastructure to deliver higher levels of service (performance quality) does not qualify as replacement. Many modern projects actually end up combining aspects of all three and councils have to exercise judgement as to how much to allocate to each purpose for undertaking a project. The council must think very carefully about how much they will need for replacing worn assets in the future and make sure they don't dip too far into the reserves today.

Paying down debt

Surplus funds can also be used to pay down debt. So if some assets are debt-funded then the depreciation charged against them can be used to pay down the debt principal. In a simple model a council would have just finished paying off their asset when it was time to replace it. Actually there is nothing particularly wrong with renting infrastructure like this; it is easily the best way to allocate costs fairly across generations. It just costs more.

And there is no double dipping here. Unless a council has a compelling reason to do otherwise it will charge the same depreciation on an asset whether it is equity or debt funded. So ratepayers pay the same regardless. Although with debt funding ratepayers will also have to pay finance charges there is no need for any special rates or charges to pay off the loan principal.

As a bonus, inflation works in councils favour so that they can pay off debt and still build up some replacement reserves. Under current settings (finance charges=3.5% p.a., civil construction price index running at about 2% p.a.) an asset with a book life of 75 years will be paid off in about 45 years and will still attract depreciation for another 30 odd years which will help pay for replacement at a later date. And that is without doing anything special.

And in practice...?

Well that's the theory. Let's take another look at Hamilton City's books and see what they do in real life.

From their Ten Year Plan 2015-25 I am having a look at their Sewerage numbers. It's not that obvious but for the 2015-16 year they were budgeting for $9.9m operating surplus which was transferred immediately into the capital budget. Miles away in the footnotes they show depreciation for that activity at $8.1m so they purposefully collected $1.8m in surplus via rates and charges. Their Funding Policy declares that they may use rates income to pay off debt principal so that may be one reason for the surplus. But without having the real budget (enormous spreadsheets showing the real financials) it's pretty hard to see what's going on. There will almost certainly be recoveries for overheads like IT, HR and accounting built into these numbers but we can't tell how from the TYP.

Still, the point is that the vast majority of the surplus is depreciation. And what happens to that money? The primary source of funding for growth projects should be development and financial contributions but HCC's numbers show $5.5m being allocated to growth projects but only $2.9m of funding from those sources. Essentially some of the depreciation money is being used to fund new assets. This will be OK under a couple of circumstances:

1. HCC haven't split projects into growth and replacement components when they calculate how much they are spending on growth and how much on replacement. Most growth projects have an element of replacement as well.
2. There is no immediate need for replacement (i.e. the network is relatively young) so the capital can be put to better use now ( as long as they have done their homework and know when there needs to be money in the pot).


In real life funding capital projects is a bit messy. Hamilton City have chosen not to rely only on the designated funding stream for growth (financial and development contributions) and has dipped into some of their replacement funding. Bear in mind that there is no legal or accounting problem with that but they do have to think long-term about whether they will collect enough capital for replacing worn-out assets when the time comes. And, in places they have simply raised capital by rating for it.

Housing Infrastructure Fund

Will the government's Housing Infrastructure Fund finally make a dent in New Zealand's housing crisis? Probably not. It has elements of being a step in the right direction but, overall, it is way too tentative and doesn't solve the real problem anyway.

The underlying problem

If houses in Auckland were as affordable as they are in the Greater Tokyo Area (the world's largest metropolis and one of a handful of truly global cities) then the median house price would be in the region of $450k - $500k.

The main reason that they are actually double that price boils down to insufficient land being made available for development. What little is available has been bid up to astronomical levels reflecting the incredibly short supply. Unfortunately a speculation bubble has also formed on top of the normal price rise in response to the short supply.

Without going into all the ins and outs, any policy response to the high price of residential housing has to deal with two, inter-related problems: (i) there aren't enough dwellings to house the population of the country and (ii) speculators will keep bidding land and dwellings up out of the reach of normal people as long as they are convinced that authorities cannot or will not make it possible for enough dwellings to be built.

If building restrictions are just lines on maps then why don't councils simply allow more building? That was the theory behind Special Housing Areas. But fast-tracking permission to develop land for housing means nothing when there is no supporting infrastructure. You simply are not allowed to even start building a house in New Zealand unless you can demonstrate that basic services can be supplied.

The fact is that councils cannot find enough funding through normal channels to build enough basic infrastructure to get ahead of the demand curve for development. This is well known to the land bankers who can rely on council funding constraints when assessing the risks of land speculation.

The Housing Infrastructure Fund

Will the HIF break this log jam? Unlikely. Some of the reasons why: