LEADING THE RATES DEBATE VLGA Essential Mayors’ Weekend John Comrie 17 Jan 2013

Perennial challenge for all governments 2  Citizens invariably ask their governments to deliver more services than they wish to pay taxes to fund  A key responsibility of governments is to manage communities expectations re what’s possible  Over medium to longer term cost of services provided needs to be offset by revenue

Sources of revenue 3

Revenue trends 4

LG revenue prediction 5  Untied grants not likely to materially increase in next few years  councils that need to raise more revenue need to consider making greater use of own source revenue raising powers LG Act provides considerable flexibility Before making greater use need to consider whether existing means of raising revenue are fair and appropriate Most councils have reasonable capacity to manage own financial destiny

Responsible financial decision-making (1) 6  Not just about rates  Need to focus primarily on long run operating result  ie difference between operating revenue and operating expenses (inclusive of depreciation) result  Is the difference between cost of services & revenue received – an ongoing negative operating result implies service levels may not be sustainable

Responsible financial decision-making (2) 7  Need:  to be mindful of community preferences and affordability of range and level of services provided  Efficient and effective service delivery  Need good Council Plan & Strategic Resource Plan  Responsible use of debt (LG is asset intensive)  Use of reliable up-to-date asset management plan and long-term financial plan essential for good financial decision-making

Responsible financial decision-making (3) 8  All mayors should know and be able to explain to others:  Whether current and preferred future service levels are sustainable  What needs to be done to achieve/maintain financial sustainability  Whether their debt levels are reasonable  See eg VAGO assessments

LG reliance on property taxes (1)  Literature continues to support use as prime (but not only) source of revenue  Many LG services are public goods  Often property related  There are no legislative constraints on rate levels or rate increases  (Minister can over-ride) 9

LG reliance on property taxes (2)  Productivity Commission (2008)  Many local governments have the capacity to raise rates Particularly those in urban localities  Property taxes are modest in Australia  Councils should consider making greater use of their taxing powers where warranted  Eg where community prefers and is willing to pay for higher service levels 10

LG reliance on property taxes (3)  Property taxes often unpopular and perceived as unfair. Why?  Relative amounts payable not necessarily correlated with relative services?  Can adversely impact on asset rich/income poor?  Concerns re reliability of valuation data?  But do councils do enough to:  Consider various rating tool options?  ‘Sell’ rationale for their basis of rating?  Often possible to both address valid concerns and raise more revenue 11

Rating decisions (1) 12  2 issues  How much to raise? Do rates need to gradually rise?  How should amount to be raised be apportioned between different classes of ratepayers?

Rating decisions (2) 13  Mayors need to be able to satisfy themselves re appropriateness of their council’s rating system & be able to defend it to others. Eg:  How does level of rates and system of rating compare with elsewhere?  What is average amount payable?  Is the system fair – could it be improved?  If level of rates generated needs to significantly increase can this be readily explained?

Local Government Act 14

Role of local government 15  achieve best outcomes for local community having regard to long term and cumulative effects of decisions  Facilitating objectives  promote social, economic and environmental viability and sustainability  ensure resources are used efficiently and effectively  improve overall quality of life of community  promote business and employment opportunities  ensure services and facilities are accessibly and equitably provided  ensure the equitable imposition of rates and charges  ensure transparency and accountability in Council decision making

Revenue raising tools (1) 16  Choice of valuation base against which to measure property value  Capital Improved Value (CIV) - market value of the land plus buildings and other improvements;  Net Annual Value (NAV) – the current value of a property’s net annual rent; or  Site Value (SV) – the market value of the land only  Overwhelming majority of councils elect to use CIV – why?

Revenue raising tools (2) 17  General rates  set via a uniform rate in the dollar applying to all properties or  by applying different rates to different property classes (differential rates)  Most councils have between 2 and 5 different rates

Revenue raising tools (3) 18  Differential Rates  Highest differential rate can be no more than 4 times lowest  wide discretion for differentiation if using CIV as valuation base Property classes may be specified by geographic location and/or planning zone and/or building types  Limited differential rates can be used when NAV or SV is a Council’s choice of valuation base. Property classes are restricted to Farm Urban farm Residential

Revenue raising tools (4) 19  Municipal charges  to cover some administrative costs but cannot exceed 20% of total revenue from the municipal charge and general rates  Also  Special rates & charges  service rates & charges  Rebates  waivers

Rating Theory & Practice 20

Extent of application of various rating tools 21  should have regard to:  Mix of property types, property values and ratepayers  Range of services provided  The context of the rating valuation base used  Principles of taxation

Principles of taxation (1) 22  Equity:  Capacity to pay (i.e. those with greater economic capacity contribute more).  Benefits (i.e. those who benefit more contribute more)  Simplicity – in terms of administration and compliance  Efficiency – minimal distortion to property ownership and development decisions

Principles of taxation (2) 23  Incentive - to achieve desired social outcomes  Sustainability – generate sustainable, reliable revenue that is durable in changing conditions  Cross-border competitiveness – promote competitiveness of locality  Competitive neutrality – similar entities/taxpayers treated similarly

Principles of taxation (3) 24  Tax decisions that improve satisfying of one principle will often result in decreased achievement of some others  Trade-off choices need to be made  Equity principle particularly relevant to LG given nature of its roles and capacity

Principles of taxation  Equity Other things being equal those with greater capacity to pay should pay more Other things being equal those who receive greater benefits should pay more  Benefits received and capacity to pay often not correlated and taxation decisions need to have regard to relevance of both factors trade-offs likely to need to be made (i.e. balanced approach) 25

Benefit principle  Land values have regard to relative accessibility to and benefits from local government services  LG services often enhance the value of property  Makes sense to tax property to fund such services  SV better accommodates benefit principle than CIV because benefits usually enhance value of land rather than the improvements again given modest magnitude of LG rates is usually not likely to be a significant factor in choice of valuation base Relative differences in SV & CIV affected by many factors not just relative LG services 26

Capacity to pay principle (1)  Income best indicator but not an option for councils  CIV far from perfect indicator but typically much better indicator of capacity to pay than SV  CIV is often a reasonable indicator of lifetime income (particularly if income from capital gains included) 27

Capacity to pay principle (2)  it is reasonable to assume legislators, decision-makers and community see capacity to pay as key criteria in determining rating system structure given that  most councils apply CIV and  that CIV is probably inferior to SV on most other grounds  But shouldn’t be only criteria, eg  Should a property with double CV of another pay double amount of rates? 28

Municipal charge  Use of municipal charge can enhance equity, eg  If some services benefit all properties equally or equally benefit people then could recover cost via municipal charge (benefit principle)  Extent of reliance on municipal charge can be tailored to vary extent to which property value influences amount payable (capacity to pay)  Is limited (to 20% of total of general rate and municipal charge revenue)  Most councils either do not apply or have very modest fixed charge – why? 29

Economic efficiency principle  A tax is economically efficient if it doesn’t distort behaviour  Site Value is more economically efficient than Capital Improved Value  Given modest magnitude of local government rates this is usually not a significant factor in choice between SV and CIV  Eg does CIV act as a material disincentive to invest in higher valued properties? Maintain/improve properties?  Need to look at other considerations to determine best valuation base 30

Incentive principle 31  Directly counter to efficiency – aims to alter behaviour  Effective application usually limited in practice due to  Modest level of rate burden relative to entity’s income  limited range of differentials  If aiming to promote particular behaviour - likely to subsidise those already undertaking desirable behaviour, without changing behaviour of others  If aiming to discourage particular behaviour – unlikely to change behaviour in practice  Trade-offs with other principles such as simplicity and consistency

Other principles of taxation 32  Shouldn’t ignore  Simplicity  Sustainability  Cross-border competitiveness  Competitive neutrality  Ultimately weighting of all principles is a judgement call but does warrant objective consideration

Use of Differential Rates 33

Reliance on differential rates 34  Differential rates can improve outcomes in some circumstances, but over-reliance can lead to undesirable/inconsistent outcomes & complexity  Can be a fairly ‘blunt tool’  Ratepayers can apply for review by VCAT  Should consider using other policy tools instead of or as well as eg service & special rates & charges and rebates and waivers

Differential rates guidelines 35  Government committed to issuing  Consultation draft about to be released  Rating decisions can be over-ruled if not consistent with guidelines

Differential rates  Probably reasonable to assume that material benefits arising from local government services and relative differences in services (or access to services) are reflected in property values  Justification for use of differential rates would seem to rely therefore more on  capacity to pay relativities less than or in excess of property value relativities - but often hard to make objective assessment of this  Higher or lower servicing costs not reflected in property values 36

Differential rates  For example;  Rural areas may have lower differential rates if perceived capacity to pay (eg income) is modest relative to property values  Commercial and industrial properties often subject to higher differential rates than residential rates – presumably because council rates perceived to typically be modest relative to income and other business expenses 37

Differential rates  Having lots of different property classes can undermine the simplicity principle  In the absence of clear and accepted principles to guide use of differential rates, councils are exposed to rent seeking behaviour and pressure for preferential treatment 38

Differential rates  Care should be taken when considering use of or adjusting differentials to take account of relative movements in valuations between different classes of property  If change in assessed value is long-term this suggests a change in relative capacity to pay  If change is short-term (due to volatility), applying a limit to rate increases for affected properties through use of a ‘cap’ (waiver) may be better 39

Other Issues in Developing a Soundly Based Rating System & Concluding Remarks 40

Service and special rates and charges  Generally appropriate for full cost recovery for private goods and other material services that benefit some classes of ratepayer and not others, eg:  Kerbside waste and recycling service Helps service recipients appreciate costs involved and provide feedback on value to service providers 41

Postponements  If rating system well designed then problem of ‘asset rich income poor’ best accommodated by deferral rather than rebate  Deferral effectively has no cost to council (or other ratepayers)  With increasing proportion of population being retired, ‘asset rich (or at least asset richer than many younger families) and income poor’ is going to become increasingly significant public policy issue 42

Economic incidence 43  Should be mindful of who actually bears the cost of a tax  eg landlords may pass higher rates on to tenants, businesses may pass it on to their customers

Rating responsibilities  Councils should regularly review and be able to defend their rating system relative to taxation principles  Eg in terms of equity, the benefits received and capacity to pay by different classes of ratepayers, by Locality Land use Social disadvantage/special need 44

Review of rating system  Any significant change in rating system will generate complaints and possible political/media agitation regardless of policy merit  Proceed carefully - staff can model impact on various classes of ratepayer of alternative options to help inform decision-making 45

Best rating system?  In practice hard for councils on CIV to entertain SV  Should consider  raising significant share of income from municipal charge  Postponement facilitation  Need to be able to defend justification for differentials 46

Other Options  Better utilisation of user service charging powers  New sources of revenue? Material increases in grants unlikely  Continual review of expenditure, service levels and efficiency  Consider rebates and waivers 47

The Politics? 48  Rating is a zero-sum game  A change that reduces amount payable for some ratepayers must result in an increase for others  Invariably those who are adversely impacted have more motivation to make their voice heard than others  A soundly based, up to date, well communicated rating policy is best defence against ‘squeaky wheels’

Further references  Access Economics (2010) ‘Valuation and Local Government rating in Tasmania: a robust framework for the future’, available at: Tas_DPC_Final_Report_29Oct.pdf Tas_DPC_Final_Report_29Oct.pdf  Comrie J, Smirl L & Sody S, “Rating policies – an ad hoc or principled balancing act?”, available at: f f  Comrie J, (2013), ‘Strengthening Local Government Revenue available soon through Australian Centre of Excellence for Local Government 49