From the Exosphere
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From the Exosphere

COVID-19 response and recovery: An important role for local government

With Nick Davis, Director, and Harvey Brookes, Lead for Waikato and Bay of Plenty

The COVID-19 epidemic and its economic impacts are rapidly changing how governments work, what they fund, and how much influence they have over our daily lives. Much of the focus across the world over the past two months has been on national-scale responses from governments and central banks, including here in New Zealand.

The scale of that response in Aotearoa has been unprecedented. The government has already committed $50 billion in response funds, and the Reserve Bank has bought $33 billion of bonds, with more to follow. The scale of a recovery programme now being shaped up is still unknown, but it may well equal or even exceed these numbers.

Central government has shown the way

Our government has been leading the response, setting rules and enforcing them, mobilising resources, and making use of its strong fiscal position and its ability to borrow (or in the Reserve Bank’s case, the ability to provide quantitative easing by creating new money to buy central and local government bonds).

Borrowing in hard times is both fiscally sensible and practical — it introduces much needed liquidity into the economy and avoids the costly economic and fiscal consequences of large-scale business failure and unemployment.

Also, because the government’s taxation-derived income is tied to the performance of the economy, it can be confident that when times are better it will receive more income and be able to repay debt again (provided the debt burden doesn’t grow too large). This is what happened after the global financial crisis and the Canterbury earthquakes. Other things being equal, we should expect a similar process this time, albeit with a longer and slower recovery due to the scale of the pandemic and the associated economic shock.

To provide the necessary structure for its response, central government swiftly operationalised its emergency management and pandemic response machinery. The social welfare structures operated by MSD, Kāinga Ora, Te Puni Kōkiri and other service delivery agencies have geared up to support the many thousands of New Zealanders whose lives are being turned upside down.

Finally, the government has exercised its national leadership and communication role to great effect. During this emergency we have become accustomed to seeing our Prime Minister and key officials live-streamed into our houses every day: informing, directing and reassuring us. The access we have to these leaders has been a key element in our ability to cope with this event so far, including through our high collective compliance with lockdown restrictions.

Local government will have a big role to play

The response from local government will have a significant yet currently under-appreciated impact on how well New Zealand recovers. Alongside the other major governmental responses to the crisis, the Society of Local Government Managers, Local Government New Zealand, the Department of Internal Affairs and the National Emergency Management Agency have established a combined Covid-19 Response Unit. The unit has been responsible for ensuring that the essential services provided by local government, which often occur out of sight and out of mind, can continue to be provided alongside more immediate responses to COVID-19.

Voter turnout for local body elections in 2019 was significantly lower than for the 2017 general election. Image: Unsplash

New Zealand has 67 territorial authorities. In June 2018, local government owned fixed assets worth $123 billion, and had a yearly operating expenditure (opex) of $10.3 billion and an operating income of $9.9 billion. Local government employs around 23,000 staff. If it were a private company, local government would be by far the largest in New Zealand and we would most probably rate it alongside Air New Zealand or Fonterra as too big or important to fail. However, because it exists as 67 individual parts, each with its own governance and management, we tend to not see it quite that way.

Appreciation for the role of local government in our day-to-day lives is not high. Voter turnout for local body elections in 2019 was 41.7%, significantly lower than the 79% for the 2017 general election. Respondents to a 2015 survey by Local Government New Zealand gave the sector an overall reputation score of just 3 out of 10, even while most respondents acknowledged the importance of local government’s role.

As the Productivity Commission recently pointed out, local government is not a subsidiary of central government. Each council is a sovereign entity and can decide (subject to public consultation) what functions it undertakes, notwithstanding that many of the things it does are still mandated by government or required by statute. In many cases, local government provides the operational components of wider national systems — for example resource management, building controls, emergency management and civil defence, food safety, and transport infrastructure.

In some areas, local government is the major supplier to New Zealand households and business — for example drinking water, wastewater and stormwater services, community facilities, public transport services, parks, and community and economic development. Many of these services are essential to the health, safety and wellbeing of people and communities, but are often taken for granted as long as they continue to be available.

Our local government organisations are also the nearest form of representative democracy we have. In our smaller communities, councillors and community/local board members can be elected by just a few hundred votes, and Mayors just a few thousand. New Zealanders have a very high level of access to their local government politicians, who every day make decisions that affect how we live our lives. Mayors are a critical part of the fabric of democracy — they govern the machinery of local government, but are also the titular heads of our communities. Just like the Prime Minister, they are extremely visible, not just in ordinary times, but also in times of crisis when tough decisions are needed.

Can the local government sector afford to step up more?

Unlike central government, local government in New Zealand cannot raise local taxes directly from incomes. Instead, councils rely mainly on rates, supplemented by dividends from assets (such as ports and airports), and some commercial fees and user charges. Rates are tied to the value of property, with some variation depending on the type of ratepayer (for example business differentials). Property owners pay a share of the total rate-based income needed by the council based on the capital value of their property, relative to everybody else’s in that district or region. The more your property is worth, the more rates you pay, relatively speaking.

How do councils make sure they minimise their financial impact on households as incomes fall? And what rate increase should they be striking in June this year? Image: MartinJenkins

The system is efficient and consistent, and several inquiries — the 2007 Shand inquiry and the recently completed Productivity Commission inquiry — have found it to be the fairest way for councils to collect revenue. The system however comes with a few limitations.

First, it doesn’t have the income elasticity of tax-based systems. Councils are required by the Local Government Act to produce balanced budgets, so they can’t deliberately collect more income than they plan to spend. This means councils can’t plan for operating balance surpluses in the way that central government or businesses can during good times, later using that surplus to pay down debt during tougher times. When councils do produce surpluses, it is usually because they have deferred or rescheduled a work programme.

Councils are also required to set prudential debt limits. All councils with substantial borrowing are members of the Local Government Funding Agency (LGFA), a statutory organisation established to pool-fund local government debt on the best possible terms. Those councils must comply with LGFA debt covenants, of which the binding criterion is the debt to revenue ratio. Debt cannot be more than 250% of revenue for credit-rated councils (except Auckland Council, with a limit of 270%), and for an unrated council it cannot be more than 175%.

While this prevents councils from borrowing recklessly, maintains good credit ratings and keeps interest rates lower, it also means their ability to fund much-needed infrastructure can be very limited, even in good times. During tough times like now, their ability to debt-fund any meaningful capital infrastructure programmes to help kick-start their local economies may be, for some, practically zero, especially if their operating income reduces significantly.

A recent report from the Local Government COVID-19 Response Unit observed that many councils would be pushed closer to their debt covenant cap if their non-rates income decreased, or if they held rates increases to below previous forecast levels, or if they needed to borrow for unforeseen purposes, such as to meet operating costs in 2020/21 or to recapitalise distressed subsidiaries.

The report concluded that the overall impact is likely to be that councils are less able to fund existing planned work, or to bring forward ‘shovel-ready’ projects to help stimulate the economy. Unless there are major new sources of funding, this could put many councils in a tricky financial and political bind.

Scenario analysis by Auckland Council has estimated that in a protracted economic crisis, up to 150,000 households and 12,000 businesses in Auckland could struggle to pay rates for the rest of the year. Image: Unsplash

Rates — a central issue

The current system assumes that most property owners are solvent enough to pay their rates. In normal times this proves to be a fair bet and most councils have very few defaults on rates. The Shand Report found that rates that are remitted or postponed make up just 0.3 to 0.7% of total rates revenue, and this is easily covered off by most councils.

But a problem would arise if during a severe financial crisis, more ratepayers were unable to pay their rates. If that crisis hits businesses hard, councils that rely heavily on business rates would feel the impact even more. Across metropolitan councils, 29% of rates income is from businesses. That could lead to a cashflow crunch for some councils, which in turn could further curtail their ability to provide important local services. Scenario analysis by Auckland Council has estimated that in a protracted economic crisis, up to 150,000 households and 12,000 businesses in Auckland could struggle to pay rates for the rest of the year, causing a reduction in rates income of between 10 and 30%.

Councils’ balance sheets may also be sensitive to changes in their investment portfolios. Many councils own or part-own major utility infrastructure providers in their area, or have diversified portfolios of investments (equities and cash), the dividends of which are used to fund projects. For example, Auckland Council owns 100% of Ports of Auckland Ltd and just under 22% of Auckland International Airport Ltd. In good times the dividends from these investments reduce the cash demand on ratepayers. Right now, these cashflows have significantly fallen, leaving ratepayers potentially exposed.

The rates bill is the way that most of us are aware of councils’ financial processes — either directly as homeowners, or indirectly as renters/leasers. Annual rates increases vary across New Zealand but tend to be within 1 to 3% per year, with some notable exceptions. The Productivity Commission’s report this year found that rates increases have broadly matched income increases over the last 25 years for the typical household.

However, the Commission also found that for some districts — mostly small, rural and low-income ones — rates have been growing much faster than incomes since 2000. There can be many reasons for this, including:

  • councils taking on significant new activities or committing to major capital projects — either at their own discretion or when required by central government
  • councils looking to ‘catch up’ on historical under-investment in certain areas
  • population growth pressure — for example, the need to provide growth infrastructure where not all of the costs can be equitably attributed to those who benefit
  • depopulation pressures — where fewer ratepayers are available to spread the costs of maintaining existing services and infrastructure, causing a real increase in rates for those who are left.
Auckland Council owns 100% of Ports of Auckland Ltd and just under 22% of Auckland International Airport Ltd. In good times these investments reduce the cash demand on ratepayers. Right now, these cashflows have significantly fallen, leaving ratepayers potentially exposed. Image: Unsplash

Some councils were contemplating rate increases of between 9 and 12% for the 2020/21 year. For households and businesses with high levels of unemployment and financial distress, this could be seen by some as the straw that breaks the camel’s back. Even a council looking at a rate increase of say 3.5% could be asking an average household for another $75 to $100 over 12 months — not a big deal in good times, but an added stress during a major recession. With business differentials, this could be up to six times greater for operators facing the double hit of fewer customers and a payroll to sustain. Some people and businesses in financial distress who are facing the choice of paying more rates or paying for life’s other essentials may be tempted to default and test the council’s resolve.

The counter is that, if rates are frozen at current levels, councils may be forced to borrow more to maintain current levels of service, but with less cashflow to service that debt. The only way out of that situation would be to lower levels of service — and that could reduce both community wellbeing and the ability of households and businesses to recover on the back of the stimulation that local governments provide to their local economies. Any changes in service levels would require public consultation — which would at least provide councils with the assurance that any changes would come with the public understanding of the tough choices ahead.

Councils proposing increased rates rises can expect opposition and resistance from a potentially growing section of the community, notwithstanding that keeping councils and their services growing itself creates jobs and economic activity that can help in the recovery. Councils can also expect to come under pressure from the business community to cut certain services, or reduce salaries for council employees, reflecting similar cuts that businesses have had to make.

Some important questions that local government will face

As the current crisis unfolds, some of the pressures mentioned above will start to become much more apparent. The impacts of these are likely to be uneven, especially if councils are left to fend for themselves. Councils will face a series of important questions, and sometimes potentially conflicting choices:

  • How do councils keep providing essential services to citizens when cashflow is constrained?
  • All councils fund things that are, by any definition, discretionary — would the marginal financial headroom created by cutting these services justify the pain caused to the community?
  • As a major employer and procurer in New Zealand, how can councils make sure they do their part, directly and indirectly, to keep their local economies going and keep people employed?
  • Given tight budgets and limited debt capacity, how much scope do councils have to materially assist communities, businesses and iwi with response and recovery while not exceeding their mandate?
  • What can councils defer (or even cancel) until the crisis passes and cashflows stabilise, and what will be the wellbeing impacts from lower levels of service for six months, a year or two years?
  • How do councils make sure they minimise their financial impact on households as incomes fall? And what rate increase should they be striking in June this year?
  • Are calls for zero rates increases realistic, and what would no change in budget during these low-interest, low-inflation times really mean?
  • If a massive upscaling in infrastructure investment is a central part of New Zealand’s recovery, can councils and their ratepayers afford to invest in infrastructure through borrowing, without major increases in rates, financial strategies, access to capital and government co-funding?
  • Should constraints on councils’ debt capacity be relaxed during this crisis to enable councils to contribute to infrastructure stimulus and recovery packages? Or are there other funding and financing models not requiring an increase in rates that councils need to investigate with more urgency?

How councils, collectively and individually, work through these important choices will have profound impacts on how well New Zealand recovers from the COVID-19 pandemic. The scale and significance of these potential impacts are probably not fully appreciated by most people. Now, perhaps more than ever, this is not a time for apathy and disinterest in local government.

About the authors

Nick Davis is an experienced economist and public policy expert who has advised governments on a wide range of economic, regulatory and machinery-of-government issues. His key skill is breaking down problems to their essence, drawing on evidence and analysis to identify the best solutions, and packaging advice to decision-makers in ways that enable them to make confident decisions.

Nick has specialist skills in public policy analysis and evaluation, public sector financial management, and economic and financial analysis. Before joining MartinJenkins in 2004 he held senior policy roles at the New Zealand Treasury and Ministry of Economic Development, and worked as a regulatory analyst at Merrill Lynch International in London.

Nick Davis — Director at MartinJenkins

Harvey Brookes is a regional economic development expert with more than 25 years’ experience focusing on Auckland and the Waikato.

Harvey brings a strong inter-disciplinary and outcomes-based approach, and a proven track record of working with stakeholders and partners to develop enduring solutions to complex problems and opportunities. His approach blends together a unique combination of strategic thinking, applied science, performance excellence, public policy and industry development.

Since late 2015 Harvey’s main focus has been economic development in the Waikato, and he is now based in Hamilton. In 2015 he led the region’s economic development programme, and oversaw the design, funding and establishment of Te Waka — the region’s first economic development agency (EDA).

Harvey Brookes — Practice Lead for the Waikato and the Bay of Plenty at MartinJenkins

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From the Exosphere is a platform for sharing thoughts from the team at MartinJenkins. The exosphere is the last layer of atmosphere before space, offering an unrivalled view of our blue planet and where we might go next.

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