Posted by: kduston | April 6, 2009

Rodney Hide and the rates cap

There has been considerable media coverage of Rodney Hide’s determined attack on the ability of councils to increase rates, and growing discussion of using a capped rates system as a way of enforcing fiscal discipline on local government.

Hide’s proposal looks sensible on first blush, and taps a nerve with many people who have looked at escalating rates bills over the last few years with something approaching disbelief. And it’s true that at least some local government spending has been of poor quality, so it’s hard to argue that some fiscal boundaries wouldn’t be a bad idea.

However the devil is in the detail, so it’s useful to look at both the theoretical basis and practical implications of such a policy, particularly when it comes to transport.

The theory says that – like any other organisation – New Zealand’s councils need to live within their means. This seems self evident but is in fact somewhat simplistic. For instance, in Mr Hide’s beloved private sector there’s scant evidence that organisations function well within rigid budgetary constraints. Most commercial organisations are predicated on the basis of continual growth, part of the accepted capitalist dogma in the Western world. The vast majority of companies explicitly drive for increased revenues and decreased costs year on year; they are looking for a better return on shareholder capital, and in most cases there is no reward for a steady-state approach to running their business. Any CEO who approached their Board, shareholders and the market with a plan to never increase revenues above the rate of inflation would not be long for his executive suite.

The commentary around the current recession is illuminating; it is widely (and rightly, in my view) regarded as a crisis, where revenues and profits are expected to fall or at best remain static. This structural lack of growth is the cause of the debt restructurings and the layoffs that are occurring across the globe. While the causes of the credit crunch are exogenous to the vast majority of companies in New Zealand, there is a palpable air of crisis as a result of the sudden reversal of the growth paradigm.

Flexibility of budgeting allows flexibility to operate in this kind of dynamic environment. When the economy turns down – or conversely, an astounding export opportunity opens up – then companies expect to adjust their budgets accordingly. Very few companies assume their budgets (revenue, capex or opex) will remain static from year to year in real terms, yet this is what Mr Hide’s policy would put in place for councils.

So given the proposed tight constraints, how are councils meant to approach the inevitable ups and downs of the economic cycle, or the changing needs and expectations of their citizens?

California’s experience in this area is illuminating. Back in 1978 the US state passed Proposition 13, which capped property taxes (effectively rates) at 1% of the value of the property, and required the state to “live within its means”. This may well have been the ideological inspiration behind Rodney Hide’s approach.

The results for California haven’t exactly been an unqualified success. The first item to note is that the state is much larger than the local government entities we’re talking about in New Zealand – in fact, if it suddenly seceded from the rest of the United States, California would be the ninth-largest economy in the world, with a population of 36 million producing an annual GDP of about NZ$3.1 trillion. Even with these economies of scale, however, there are persistent and seemingly intractable deficits, with this year’s expected to be about NZ$27 billion.

The key problem, it would seem, is that a fixed budget can’t take account of altered circumstances. The world has changed a lot in the 30 years since Proposition 13 was passed, and the expectations on local governments have changed as a result; however the Californian straight-jacket appears to be constraining some of the necessary adjustment. For instance, the state currently funds major infrastructure projects largely through debt, but with the collapse of the international debt markets it finds itself unable to either roll over the existing debt burden nor take on additional commitments to fund new projects. As a result, some essential projects have simply been mothballed when part-way complete, as there is no ability to fund their completion. And thanks to Proposition 13, the state can’t increase property taxes to even pay staff wages, let alone complete water and sewerage projects.

As an aside, one of the ways California has attempted to work around the restrictions is through non-tax mechanisms such as development levies. Undoubtedly this would occur to New Zealand councils as well, which might well force up the cost of building a new home – a perhaps unintentional but otherwise entirely predictable outcome of Mr Hide’s proposal.

California’s example is one that should worry anyone concerned about public transport in New Zealand. (See, eventually there was a link to transport!)

As we saw from the run-up in the petrol price last year, there can be sudden and significant shifts from private to public transport modes – and half of all public transport funding comes from local authorities. But the kind of capped budgets proposed by Mr Hide are unlikely to allow sufficient flexibility to cope with these escalations in demand, leaving a massive shortfall in council budgets. And Mr Hide seems notably silent on how any shortfall should be met – from central government? From taking on more debt, thus hamstringing future budget? From defaulting on old debt? Either way, increasing rates won’t be an option.

Because their budgets are always fully committed, the only way a council could begin doing a new thing would be to stop doing an old thing. A new bus route to a new suburb would come at the expense of closing the local swimming pool or cutting the road maintenance budget or removing the bus service to another suburb. It would become a zero-sum game, where the council couldn’t improve services for one sector of the community without seriously disadvantaging another group.

Of course we all want the unachievable – lower rates combined with better services. Sometimes, some of these things can be achieved with better planning and greater efficiencies, and councils have been as guilty of poor quality spending as any other organisation. But putting a simplistic cap on council budgets – “no, you can’t have any more pocket money!” – shows an alarming lack of understanding of the complexity of modern New Zealand, or perhaps some truly cynical populism.

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