Wellington City's inducement to Singapore Air

I'm not surprised the Auditor-General has declined to investigate Wellington City Council's underwriting Singapore Airline's extension of its routes into Wellington. There was a trail of decision-making stretching back 9 years that supported the actions of WCC CEO Kevin Lavery when he wrote SIA a big cheque in secret. Morally the whole process is pretty shabby but legally it is OK.

I guess many Wellingtonians were a bit stunned when they found out that the CEO of their council had paid Singapore Air a lot of (ratepayer) money to extend their Singapore-Canberra route through to Wellington. This payment would underwrite the commercial risk SIA were taking to trial this new route. There was no consultation, no public council meeting, and so no opportunity for the public or the majority of elected members to be involved.

Although it looked bad Lavery's action was perfectly legal. Council staff can spend money without recourse to elected members under certain conditions. In Lavery's case he was delegated to spend up to $1m in any one transaction as long as it was for an item in the already approved plan for the year. The main purpose for this delegation is to allow contracts for approved works to be accepted without all the delays formal council approval would require. But a delegation is a delegation. So, as long as the payment to SIA was pre-approved, Lavery was entitled to negotiate and sign the deal. In February 2016 Dave Armstrong wondered whether the tail was wagging the dog at WCC. He may have been right but the CEO's delegation also allowed a small group of elected members to bypass their colleagues as long as the CEO went along with them. It's not clear who was wagging what.

Elected members (mayor and councillors) have no executive power. Even Wellington's mayor could not have signed this deal alone. But, by dragging the CEO along, a small group of councillors could strike a deal and get the CEO to use his delegation to sign it. As I say the only stipulation is that the deal had to have already been approved in a Ten Year Plan or Annual Plan.

I couldn't find any reference to this plan in Wellington's 2015-25 Ten Year Plan. It turns out they consulted on it in the 2012-22 Ten Year Plan. There was no attempt to hide it then. This from the Strategic Direction section of the plan:

The Council has also made provision to support long-haul flights to Wellington by retaining funding of $200,000 (for the Council to administer for this purpose) and identifying a funding mechanism to rapidly respond to an opportunity should it arise.

Once this plan was approved by the Wellington City Council after public consultation in 2012 this deal was on the work plan and only required implementation. The only thing I would note is that this $200k is per annum and probably budgeted for in every year of the TYP. In a city the size of Wellington no-one would raise an eyebrow over a one-off payment of $200k but $2m over ten years? As for the funding mechanism for "rapidly respond[ing]", it could be anything but a guaranteed stream of revenue in perpetuity for this purpose would enable WCC to secure a credit line with any lender should they need it.

And there is a little more detail down in the Economic Development activity description:

Long-Haul Airline Attraction – we will continue to support the attraction of a long haul carrier to Wellington in the near future at a level of $200,000 per year. The Council will oversee the budget and work with the Wellington International Airport and Positively Wellington Tourism to achieve our long-haul objectives. Any costs associated with establishing a longhaul attraction fund as part of an agreement with an airline to provide long-haul services to Wellington, will in 2012/13 be met by retaining a portion of the Wellington International Airport Limited dividend, with future funding decided through the annual plan process.

What does "continue to support" mean? It turns out that the idea was first consulted on in the 2006-16 Long-Term Council and Community Plan. And the $200k ratepayer contribution started in the 2006/7 year. Their goals:

Positively Wellington Tourism and Wellington International Airport Ltd have developed a strategy aimed at attracting at least one daily longhaul air service to Wellington from a south-east Asian market. In the past, Wellington’s development as an international visitor market has been restricted because long-haul aircraft couldn’t land on the airport’s relatively short runway. From 2008, that will change. New Boeing and Airbus aircraft will be able to provide long-haul services from the existing runway

And the performance measure was having daily long-haul services to Wellington by 2008/9. As we know they never met their promise (flights to Australia don't count as long-haul) but WCC continued with the line item in each year's budget anyway.

By 2011 the idea got a new lease of life as a crucial (if not the most crucial) component of the Wellington City Economic Development Strategy:

Improving long haul air services, especially with Asia, is critical to improving Wellington’s access to international markets and to attracting talented people, international students and investors

 Once that strategy was adopted the idea of attracting long-haul flights into Wellington had morphed from a plausible idea that failed when tried into a sine qua non without which Wellington City would enter into a death spiral. And within a few months the proposal got that second airing in the 2012-22 LTP.

By the time recent immigrant Kevin Lavery got invited to the party the accumulated funds totalled millions and the proposal had the same orthodoxy as building an ocean outfall to improve sewage disposal. So in a legal sense Lavery was only doing his job.

The only legal quibble would be that consultation was conducted on the basis that direct flights to Asia were the goal. I doubt that a two-step flight via Canberra would comply given that existing trans-Tasman carriers serving Wellington such as Qantas could supply equivalent services already.

Personally I think the processes that lead to the deal were questionable given that they start a decade beforehand with some vague concepts and only tiny (but perpetual) funding. Without much public involvement the proposal initially fails then, rather than being canned, it gets incrementally changed from direct flights to SE Asia to long-haul flights to anywhere with the right to find emergency extra funding if necessary to make it happen. Promises were made in the Economic Development Strategy to providing business cases and further justification if extra funding was needed. If those analyses were ever carried out they have not been published by WCC.

There is a very good case for a joint investigation by the Auditor-General and the Ombudsman to determine whether (i) the overall decision-making process complied with the Local Government Act and (ii) whether the payment when it was made represented a good use of public money. It would be useful for the whole country to have light shone on the process as this incremental changing of goals is common enough in the public sector. Too often there is a gap between what was initially proposed and what was delivered. Our government and councils need to start over if they cannot deliver on their initial proposals. We shouldn't have to shake our heads and wonder how we got to some strange place.

LG Funding: Capital Funding Overview

If rates are almost always used to fund daily operating expenses where does the money come from to build or buy the big assets like pipes, roads and buildings? The answer depends largely on what the reason for the project is.

Councils carry out capital projects for a number of reasons but all projects will fit into one or more of three categories: new, upgrade or replacement. When we talk about how councils fund capital works we need to use these terms precisely since different funding streams attach to the three categories.

Replacement projects

All major assets will wear out eventually. The lifetime of pipes, roads and buildings is measured in decades but there will still come a point where, even with regular maintenance, an asset has to be replaced rather than patched up.

There is an existing funding stream for replacement via depreciation charges. The vital thing to remember is that the amount of funds collected assumes that assets will be replaced on a like-for-like basis. A narrow bridge attracts depreciation at "narrow bridge" levels not "4 lane motorway bridge" levels.

Over decades circumstances change so it is rare to see a pure replacement project except for some components like a water pump that has a much shorter life. We expect better quality buildings than the ones we built 80 years ago; and we expect better quality roads, water systems etc. For example Dunedin's covered stadium is technically a replacement project since the city was replacing the old Carisbrook facility. But no-one would tear down Carisbrook and simply rebuild it as was, so the new stadium has a lot of upgrade components to it to bring the sporting venue to modern standards (and a bit beyond). However, as the on-going saga of how to fund that stadium shows, depreciation doesn't pay for the new goodies, only for replacing the worn-out components.


New Assets

New means genuinely new. Either a new asset extends or enlarges an existing network or it provides a completely new service. So putting in new pipes in a subdivision creates new assets as does building a new pump station to service that development. Building a water activity pool next to a swimming pool adds a new asset.

When a project adds capacity to an existing service to cater for growth (as in the former example above) then councils can ask the creators of new properties (usually developers) to make a capital contribution to pay for new assets. These capital contributions can be either or both of financial contributions under the Resource Management Act or development contributions under the Local Government Act.

When councils simply want to do something new (as in the latter example) there is no dedicated funding stream and councils have to find new money themselves.


Upgrade projects

A pure upgrade project simply lifts the quality of an asset without changing its function or its capacity. A simple example would be replacing older windows in building with double-glazed units. The building has the same capacity and does the same job, it just does it better.

Upgrade projects should not be confused with life-extending capital works. Many assets will survive long past their design life if, from time time, some major money is spent on them to maintain their integrity. In this case it is normal to use accumulated depreciation to fund this type of work.

A reasonably common example of an upgrade project is re-aligning a road or intersection for safety reasons. A corner may be rebuilt or a road straightened but at the end of the project the road is still doing the same job for the same number of users albeit with a lower probability of a serious accident occurring there.

Most upgrade projects have no dedicated funding available. The safety upgrade I mentioned above might attract funding from NZTA under certain circumstances and from time to time there may be some nation-wide subsidy schemes operated by government that councils can take advantage of. But, in general, they have to find the money themselves for these sorts of projects.


Real Life Jumble

In practice capital projects rarely fall into those simple categories and many are funded from multiple sources. So councils have to exercise considerable judgement in deciding how much to fund a specific project from capital reserves (depreciation), how much from development contributions, and how much from debt or other sources. We have to hope they exercise good judgement because their mistakes may take decades to become obvious.



How well does the system work?

We can keep council assets going in their current state indefinitely under current arrangements. The Shand Inquiry was confident that councils would have no significant problems replacing assets over time. Their assessment was backed up by the Auditor-General who also saw no looming problem.

In theory we can also grow our cities using existing funding mechanisms but the system definitely works best when growing out rather than up. It is also a clunky and inflexible system that tends to lock councils into ten or eleven years of commitment that assumes a fixed and predictable rate of growth. As Auckland found out over the last decade assuming steady rates of growth is unwise.

If councils want to avoid levying capital via rates (and they should avoid that practice as it is manifestly unfair) then upgrading existing assets is always going to be difficult. The major source of funds for upgrades is debt. Once a council has reached its practical limit for carrying debt then it is in a difficult place if some new must-do project comes along.

The system works adequately as long as the following conditions apply:

• population growth is low-medium
• population growth is predictable
• the urban form and infrastructure allows for outwards expansion in preference to intensifying existing built areas
• there aren't too many external drivers of change at once

You will note that none of these conditions apply to Auckland.

Some specific problem areas

Intensification

Upgrading infrastructure to support higher density populations causes all sorts of financial problems. Working in a built environment is more costly than in open fields. But, worse, upgrading often means throwing away serviceable assets in favour of new assets with greater capacity. For councils there will almost certainly be a funding gap that can only be plugged through debt even though they will be able to use both depreciation and development contributions. Again, once a council has reached its debt ceiling it can't intensify any further until some of the debt is paid off. 

Stormwater

Councils have a huge off balance sheet liability staring them in the face right now: climate change. Stormwater and drainage systems have been designed for lower intensity rainfall events. They can't handle every event but most common ones they can. But we are already experiencing more frequent events at higher intensity levels and that will be the new normal. Dunedin is the most high-profile drainage failure but we have also had problems in Auckland, Edgcumbe, Hutt Valley and we can expect flooding problems to be more widespread around the country in the future. 

Councils have some accumulated depreciation to use to upgrade their systems but that's it. Who knows where the rest is going to come from.

Others

There are other problems heading our way: drinking water (in the aftermath of the Havelock North gastro outbreak), disaster resilience, tourism infrastructure are a few that leap to mind.

There will be funding problems for all of the capital projects that the public may expect or the government may mandate to deal with problems in these areas.

Funding tourism infrastructure

Paula Bennett has just announced funding for tourism-related projects in our smaller councils. A typical example is the Hurunui District's proposal to build toilets and a dump station for motorhomes at Culverden for $250k. The government is funding the construction with Hurunui District owning and operating the facility afterwards.

This contribution is certainly not nothing but it isn't totally generous either. There's an old saying that buying a car is the cheapest thing you ever do and that is certainly true of infrastructure like this. Taking advantage of the cash contribution of the government could well end up costing Hurunui ratepayers twice as much over the lifetime of the asset. In present value terms it's about half the lifetime cost of the asset. Not nothing but why isn't the government funding 100% of the lifetime cost?

Once Hurunui District have built their toilets they will immediately incur a whole bunch of operating costs which will have to be funded by ratepayers. Depreciation alone will rack up, say, $5k every year assuming a 50 year lifetime. Cleaning, carting away sewage, general maintenance, insurance, power, supervision etc will add at least another $5k p.a. Over 50 years that's about $500k. The present value of that cash flow is about $200k.

The figures will vary lots between projects but these representative figures indicate the government is contributing just over half the real cost. In practice I would assume that the contribution is less than half because the operational costs of looking after high use facilities is higher than the average for normal assets. There's more damage, more cleaning, more signage, more inspecting.

For a small district like Hurunui all these little costs add up and, while it would be nice to pass on those costs just to those local businesses that benefit from tourism it isn't practical to do so. All the ratepayers will have to share in these costs because there is no way to charge the tourists themselves.

In general I am not a fan of revenue-sharing but this is one situation where it is merited. Dr Eric Crampton recently:

International tourists currently contribute over a billion dollars in GST. If more of the tourists’ contribution to the government’s coffers turned into better facilities in the places tourists go, pressure on those places would ease, making a better experience for locals and tourists alike.

Where does the $1bn go? Good question. The two main contributions the government makes towards tourism is (i) funding Tourism New Zealand ($110m odd) and (ii) funding the Department of Conservation ($465m) The DoC funding benefits tourists and locals alike and covers activities that appeal to tourists and many that have no relevance to tourists. When you strip out the components of the funding that do not directly service international tourism you would be very generous to assume tourists benefit from any more than $300m of the taxes they pay. So maybe $400m all up is used by the government to support international tourism. Which leaves $600m profit per annum for the government to spend on other things. Needless to say private sector operations do not enjoy a 150% contribution toward profit from their expenditure. And small councils get nothing at all from their expenditure.

There is certainly a moral case for the government to hand over more of their tax take to councils to support tourism. It doesn't have to be huge. Bigger centres can handle the current number of tourists without noticeable distortions in their budgets. Auckland and Christchurch especially profit from their ownership stakes in busy international airports. But the smaller councils could do with more help. And that help should be annual operating support not just occasional capital contributions.

There is nothing new in the concept of targeting capital and operating funding to councils. The NZ Transport Agency has been doing it for years for roading. The government just needs to copy the method and apply it to tourism.

Ironically the Minister for Tourism, herself, has articulated the best case for revenue sharing. She recently rejected allowing councils to charge bed taxes on the basis that tourists already pay enough in GST. Fair enough. Now all she has to do is see that our international tourists benefit fully from the taxes they pay by handing over some of it to councils to build and operate better tourist facilities.

A "quiet" problem lurking all over New Zealand

How do we deal with situations where one person's activity on their property disadvantages a neighbour?

Dr Eric Crampton posted recently on the ability of one person to shut down the operations of the Barrytown Hall (close to Greymouth) after complaining about excessive noise:

I simply don't understand the mentality that leads people to move next door to music venues then push Council to shut them down. Even more baffling is why we have developed institutional arrangements that give every jerk a veto right.

I heartily endorse the sentiment but suggest that the veto right exists solely with the council: they both choose and enforce the veto themselves. And, as far as I can tell, the "jerk" has no standing after passing information  to the council and certainly has no legal veto right (even though in practice it feels a lot like it). 

We take notice of the Barrytown Hall because of its near legendary status within the national music community but what is going on there is hardly a one-off event. These kinds of reverse-sensitivity issues crop up all over the country. When you look at the law that governs how matters of "nuisance" are resolved it is probable that in most cases the person causing the nuisance will have to mitigate the nuisance or cease the activity altogether regardless of how long that person has been operating in exactly the same way and in the same place. What I think would come as a complete shock to most people is that most of what we think of as "existing use rights" are a fiction which are only waiting for the right trigger to be extinguished for good.

The three relevant strands of law that govern resolving issues of nuisance are:

1. English common law
2. Public health law (Health Act 1956)
3. Town planning law (Resource Management Act 1991)

There are also many other statutes such as the Fencing Act or the Dog Control Act that define how some other specific neighbourly disputes are resolved.

The right to sue

As a country we inherited a lot of law from Great Britain. There it has been possible for centuries to sue a neighbour who made excessive noise. And, in 1879, the English courts also found that someone who "came to the nuisance" still had the right to seek relief from that nuisance. It is bizarre but it is the law that you can buy property right next to some obvious, offensive activity and then seek to have it closed down. 

Although tort law is not directly relevant in this case it is interesting to note that the case law is not inconsistent with where we have ended up in the other legal streams. So, even if we didn't have the Health Act or the RMA, a suit taken by a neighbour of the hall is likely to have succeeded anyway.

Public health nuisances

Many nuisances don't just affect one property; a factory emitting odour will affect multiple properties. Many classes of nuisance also have the potential to not just interrupt the "quiet enjoyment" of one's property but to cause health problems in the public at large. Relying on neighbours suing each other as the means of achieving decent public health outcomes, besides being excessively cumbersome, is never going to work. So central and local government entities have been given the obligation and the necessary powers to take action unilaterally against any public health nuisance without waiting for complaint.

The Health Act 1956 directs local authorities "to cause inspection of its district to be regularly made for the purpose of ascertaining if any nuisances [...] exist in the district" and "if satisfied that any nuisance exists in the district to cause all proper steps to be taken to secure the abatement of the nuisance". Noise nuisance is defined there as "where any noise or vibration occurs in or is emitted from any building, premises, or land to a degree that is likely to be injurious to health". What is interesting is that noise has to cause a health and safety problem in this legislation rather than just be annoying for it to count.

But the main point about this approach to nuisance is how the dynamic changes. Now the council is the complainant. The "jerk" who came to the nuisance merely supplied information. What's more they did not even have to have been affected by the nuisance - in theory it could have been a passing German backpacker who contacted the council. That's because the council should have already been inspecting the hall's operation for nuisance without waiting for anyone to ask. After receiving information it is the council that investigates whether a nuisance exists and, as it morphs seamlessly from complainant to prosecutor to judge, it is the council that also decides what the remedy will be. (Yes it could go to court but, in practice, most people will cease, mitigate or pay the fine as directed).


The Resource Management Act

If prevention is better than cure then the promise of town planning is that judicious placement of buildings and activities will minimise the potential for nuisance to arise in the first place. While it is a no-brainer to force noxious or offensive activities into specific locations away from everyone else our planners have doubled down piling all sorts of rules into district plans to prevent any number of nuisances arising. Not all of which are required for them to comply with the Resource Management Act.

Remember that the purpose of the RMA is "to promote the sustainable management of natural and physical resources". I struggle to see how rules on, say, the minimum size of balconies on apartment blocks contribute to that purpose. Even zoning is not required by the RMA and contributes nothing to achieving the Act's purposes. But there is nothing stopping councils from loading district plans with these rules so they have.

Anyhow in the case of Barrytown the RMA does have built-in requirements to control noise (the RMA repealed the earlier Noise Control Act):

1. Every occupier of land in NZ is required to "adopt the best practicable option to ensure that the emission of noise from that land or water does not exceed a reasonable level" (s16)
2. If a council receives a complaint about noise then it must investigate and if the officer decides that the noise is excessive then they "may direct the occupier of the place from which the sound is being emitted [...] to immediately reduce the noise to a reasonable level" (s327(1)). Under this section the council has powers to confiscate equipment.
3. Even if they don't receive a complaint a council can simply decide that noise from a property is excessive and issue an abatement notice (but without powers of confiscation) (s322).

So what is a "reasonable level" and what is "excessive noise"? In the absence of a National Environmental Standard "excessive noise" is whatever the council deems it to be. I am sure some national guidelines are floating around but they will be of the bureaucrat-to-bureaucrat variety and have less weight in court than statute or regulation. 

But the real point is that while we are focusing on a single complainant it could just as easily have been all the residents, any self-appointed busy-body from anywhere or the Grey District Council itself that triggered the abatement process. And that is because councils enforcing the rules in their district plans or in the RMA itself go by set standards, they don't need to prove actual harm.

And the other point to note is that if the Barrytown Hall is producing excessive noise today then it always has done since the RMA was passed in 1991. 

Grey District staffer, Ben Healey blames an increase in the number of functions at the hall for the need to start imposing limits on the Hall's activity. That may be so in a "common sense" way but Healey's quoted remarks leave an impression that the Council have just followed some rules and had no choice but to start the abatement and resource consenting process. I would disagree. If Grey District are going to take into account the impacts of function frequency and time of day of Hall functions on the local residents then they should have initiated a plan change. It is absolutely possible to embed the legitimacy of the Hall's traditional activity in the District Plan. Going through that process would allow all local residents to have a say as well as the residents of both the Grey and West Coast Districts who value the hall as a music venue. Grey District could have taken a totally balanced view that may or may not have over-ruled the original complainant but which would have been transparent and inclusive. No doubt enforcement is cheaper, easier and faster than a plan change but what is the point of local democracy if expediency is more important than making the right choice? 

Similar booby traps are littered throughout the district plans of every council in the country. Over many years we seen a steady stream of farmers, factories and other businesses discovering that decades of established practice count for nothing when their local council decides arbitrarily to enforce some rule. If the government really wants to reform the RMA then a review of how we manage nuisance and especially how much we want nuisance to be controlled via the RMA would be a good start.

All guns firing in Hawkes Bay

The Havelock North Drinking Water Inquiry has released its Stage 1 report and Inquiry Chair Hon Lyn Stevens QC has severely criticised just about everybody.

I will be interested to see what reaction the report gets. The mainstream media are only looking for someone to blame and will be disappointed. Hastings District Council Mayor Lawrence Yule has ruled out resigning while Hawkes Bay Regional Council Chair Rex Graham outright rejects some of the findings related to his council. But my first reading of the summary suggests at least one of the targets could seek a judicial review (there doesn't seem to be any step in the process where the core participants can respond to the report before it is finalised). The conclusions are very strong and may be too strong. The conclusions also tend towards criticism of the individual parties with no thought to the systemic weaknesses that allowed the outbreak to occur.

At the risk of over-simplification the Key Findings can be summarised as:

1. Hastings District Council drew contaminated groundwater up through its bore and distributed it to the town of Havelock North
2. The water was contaminated because the confining aquifer was way less secure than everyone had previously believed
3. All parties followed the rules in a strictly legal sense
4. But everyone was also too complacent and should have exercised a greater duty of care. Had they done so it would have been possible to avoid the outbreak.

The main point that the targets of Stevens' wrath will pick up on is "The failings, most notably by the Regional Council and the District Council, did not directly cause the outbreak" [Key Findings [10](d)]. Arguments over this report will probably centre on whether each party's actions and inactions were reasonable at the time and within the context of the perceived risks of the system and the assigned responsibilities under the new regulatory framework.

The Inquiry has had the luxury of 40/40 focused hindsight but the staff of the the councils couldn't ever focus 100% on this one scheme. Any judicial review would be asked to consider whether decisions (and inactions) taken by the councils leading up to the outbreak were reasonable in the context in which they were made. To be fair the Inquiry has mounted a strong argument that the warning signs were there from as early as 1998. And it is certainly the case that we can't really pass judgement on the report based purely on the overview. The detail in the review will be vital to understanding the conclusions.

But the findings do feel lop-sided. The Inquiry seems to have missed an opportunity to comment on the regulatory framework. The Terms of Reference of the Inquiry allow them to recommend changes to statute or regulation but there don't seem to be any findings related to the working environment the 2008 changes to statute created. 

One simple example is s. 69ZL (1)(g) of the Health Act 1956. This section defines the role of the Drinking Water Assessor inter alia as verifying the adequacy of water safety plans. What this section says is that once a DWA has approved a Water Safety Plan it is, by legal definition, adequate. It's pretty obvious to me that the highest priority for a district council is to get a Water Safety Plan approved regardless of content (especially given the $200,000 fine they would face for not having one). And if Hastings District Council had a current Water Safety Plan in place at the time of the outbreak it was, by statutory definition, an adequate plan. Clearly this is not a great piece of regulation but we apparently are unlikely to hear any criticism of it.

LG Funding: Rates

When it comes to funding local government, rates are usually top of mind. A lot of nonsense gets talked and written about rates as very, very few people genuinely understand what rates are and what they pay for. Even the Shand Report confidently talked about rates paying for local infrastructure which is technically untrue. So this post contains some more detail about the place of rates in the funding equation, what rates are spent on, and what affects the amount of rates charged.

It pays to have some real numbers available when discussing council funding. To that purpose I have raided Hamilton City's Ten Year Plan 2015-25 and pulled out what they proposed to spend in the current financial year. I think of Hamilton City as an "everyperson" city: it is big enough for its council to be engaged in every standard activity but it has none of the special case characteristics of other cities like Auckland and Christchurch. And these are their numbers:

Other councils will be a little different. Rural councils, especially, get a higher percentage of revenue from subsidies (for roads) than urban councils. But these figures are roughly representative of a council budget. Some key points:

• Rates provide 74% of operating revenue for the significant activities
• The core functions of water, sewer, stormwater, transport and rubbish take 56% of rates
• Parks and recreation take another 15% with all the other activities of the council taking up the remaining 29%
• Generally, rates only fund operating costs
• Hamilton City has a couple of unusual inclusions. They have deliberately budgeted for a modest operating surplus (profit) on top of normal operating expenses and they are levying capital via rates to fund new transport and parks projects. Combined, the surplus and capital levies still only represent a very small percentage of overall rates.
• The operating surplus I show in the diagram is far from modest but almost all of it comes from depreciation charged on existing assets. The operating "profit" is very small by comparison.

Do we need a change?

Rates pay for the daily costs of owning and operating all the infrastructure and other services of councils. And they are as good as any other way of getting local people to pay for local services.As I said previously, the Inquiry into Local Government Funding did not find any glaring problems with the existing set-up. In the end they suggested a series of modest reforms rather than a radical overhaul.

Of course there are ways of funding local government other than by rates. One common suggestion is for more revenue-sharing - that is, central government handing over some oif its revenue to councils based on some pre-set formula. Options include population-based funding (capitation) or a share of sales taxes (GST) generated locally. Local Government NZ would take the broadening of the funding base even further through granting councils the powers to impose their own taxes such as road-tolling or bed taxes. I would not support any major shift away from the current rating system. Rating has its problems but, thanks to some quirks in how it operates, it does deliver a good result to its communities.

Councils tax in the opposite way to central government. They forecast how much it will cost to deliver the required local public goods and services and then strike a compulsory rate across all the properties in their territory to recover their costs. Central government, on the other hand, take a percentage of income and consumer spending and then work out what to spend it on. In the normal run of things, government revenues rise and fall with the economy which tends to focus the minds of the Cabinet as they formulate fiscal and other policy. Conversely, the problem with rating is that there is no direct link between a council's budget and local economic well-being. Auckland Council does not suffer financially when households and businesses have to cope with massive rises in housing costs even though, arguably, it was the Council's own policies and plans that caused that rise in costs.

The ratepayer experience is also different from the taxpayer experience. Central government takes a very large part of its revenue invisibly through PAYE, ACC, GST, fuel tax and other embedded taxes. Ratepayers (except for renters) make an explicit payment and tend to notice it when they do. And because we notice the amounts on our rates demand we also tend to question whether the amount is too high. Unfortunately we have no way of assessing the true value of rates. We cannot comparison shop and we tend to take most of the rates-funded services completely for granted anyway. Our only practical option is to compare this year's rates to last years's and be very suspicious if they go up "too much" (whatever that means!). In this climate councils tend to take the "fiscal envelope" approach.

The fiscal envelope comes from the strong desire for councillors to want to restrict rate rises for homeowners (=voters) so that rises are predictable and, preferably, at or not too far above CPI. They will play with timing on expenditure to smooth out rises. But more importantly they will reluctantly put aside any grand plans that can only be funded via rates if they are not absolutely necessary.

Sorry for being a bit long-winded but I hope I have shown that the rating system provides a natural brake on the spending ambitions of councils, a brake we do not want to lose. Important institutions that support the development of good quality public expenditure in central government (competitive advice, skilled economic analysis, and informed public scrutiny) are simply absent from local government. And, you don't have to go far to find examples of councils indulging in hare-brained spending. Any increase in non-rates funding must avoid the moral hazard of simply dumping "no strings" cash into the hands of councillors itching to turn their place into the "world's #1 <insert current buzzword here> city". You only have to look at councils like Wellington City Council to see what happens when a council has too much money.

So, I don't want to see a significant change in funding mechanisms for operating expenditure in councils.

Why do rates rise faster than CPI?

If there is a brake on rates rises as I claim then how come rates still rise faster than CPI? There is no simple answer. Although councils are not known for aggressively seeking cost savings I have never been convinced either by the claim that councils are out of control. There are plenty of ways they could save money but the savings would not compensate for a couple of other major cost drivers: input costs and ownership costs of infrastructure.

Councils don't go to the supermarket. They buy energy to light streets, heat pools and run pumps; they insure their assets; and they pay contractors to build and maintain roads, water schemes, parks and buildings. Even before the Christchurch earthquakes insurance premiums for councils were rising faster than CPI as were energy costs. But the biggie is contained in 4 letters: S2GC. This is the code for the Civil Construction Price Index maintained by Statistics NZ.  According to SNZ prices have been rising way faster than consumer prices for a long time. For example, in the 12 months ending December 2016 the Civil Construction Price Index rose by 3.12%. By comparison CPI only rose 1.3%. But these rising construction costs go way back to at least 2002.

Rising civil construction prices deliver a quintuple whammy to councils. Obviously the costs of capital projects are rising rapidly. But these rising costs also affect maintenance costs (same contractors, same charge rates), if debt-funding is used then there is more interest to pay, depreciation, and insurance. I will have a lot more to say about depreciation in the next post but if you consider that maintenance and depreciation are the the two biggest ticket items in the operating budgets for core network infrastructure then you see why rates are heading where they are.

The Operating Surplus

OK let's take a look at that massive operating surplus feeding into the capital budget. When I opened up Hamilton City's Ten Year Plan they did show both a deliberate "profit" and some capital levies via rates. But almost all of that operating surplus comes from depreciation. Depreciation is a big enough topic to require its own post. For now there are a couple of points to note:

1. This is absolutely orthodox accounting; if councils didn't depreciate their assets they would be breaking the law
2. Councils can do a handy thing because they are not subject to Income or Company Tax: they can transfer the surplus immediately into the capital accounts at the start of a financial year. It looks like they are rating for capital projects but really they are compressing into one year what private companies have to do over two.

So, in the end...

Rates (on the whole) are a pay-as-you-go scheme that effectively collects a daily charge for use of local public goods and services. Councils only take rates to fund legitimate operating expenses (more or less). In theory it doesn't matter whether you are a resident for 5 days or 50 years you pay your rates and use council services on an equal basis to everyone else.

The sustainability of rating doesn't appear to be an issue right now. Obviously we can't continue to have per-property rates rises in excess of income growth forever but we have no idea what the cutoff point is. Any limit you see published today is simply a number plucked out of thin air for the sake of having a number. How do you value supply of potable water to property against (say) takeaway food within a household budget?

Each resident of Hamilton (adults and children) pays about $85 per month through household rates for unlimited access to potable water, sewer, stormwater, roads and footpaths, parks and reserves; limited access to solid waste removal, libraries, art galleries; and subsidised access to swimming pool use. A monthly mobile plan for unlimited voice and text and limited use of the internet will set them back about $50. How do we compare the two plans?

Councils spend about 20% of revenue on staff salaries the rest goes to purchases and interest payments where the prices are supposed to be market-driven and competitive. Realistically, if we need rates to go down in real terms then the only option is to start cutting services.

LG Funding: A Big Picture

Any discussion on local government funding needs a big picture to help keep all the bits and pieces straight. As the picture below shows, councils  get their money from many sources. And those funds take different pathways through a council. This map applies mostly to territorial authorities not regional councils although the rules are the same for both.

Council budgets and accounts are structured into operating and capital components. The operating budget pays for supplies (maintenance contractors, energy, insurance etc), staff, payment of interest, and depreciation of assets. The capital budget pays for new and replacement assets as well as upgrades. These assets are both the public assets (roads, pipes, libraries etc) as well as internal assets (such as council buildings, IT, vehicles etc).

Notes:

1. Local Government uses standard accounting

All council accounting practices comply with NZ accounting standards. Some councils go even further and sign up to International Financial Reporting Standards. This means their accounts can be read in exactly the same way as Spark's or Fonterra's.

2. Local Government budgets backwards

Unlike central government, councils work out what they need to spend then work backwards to calculate how much they need to raise by way of rates and debt to fund the programme.

3. The Operating Surplus

The Local Government Act requires councils to balance their operating budgets and, as a rule, they do not budget for a profit or surplus. The surplus they do generate comes mostly from depreciation of assets. So this is the money they "put aside" to replace assets when they wear out. In practice they do not route the money through a reserve account and it goes straight to the capital expenditure accounts. If an activity does not need all that money for asset replacement in any one year then the capital surplus goes to the capital reserves. So I show a direct link from operating surplus to capital budget.