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Careful What You Wish For: Rate-
Capping in Victorian Local
Joseph Drew* and Brian Dollery#
The new Victorian Government won the 2014 election on a
platform to inter alia introduce a cap on council rates in all
Victorian councils. This means that a rate-cap will be introduced
beginning with the 2016/17 financial year, with future rises in
rates pegged at the Consumer Price Index (CPI) after this date.
This paper provides a comparative empirical analysis of New
South Wales local government - the only Australian local
government system to operate a rate-pegging regime - and
Victorian local government with respect to rate-capping. We find
evidence to support the proposition that rate-capping has
deleterious effects on municipal revenue effort, equity, debt and
infrastructure maintenance. Moreover, our findings do not
provide empirical evidence in support of the claim that rate-
capping increases municipal efficiency. The paper concludes by
considering various alternative public policy instruments to rate-
capping.
Local government systems worldwide are subject to a myriad
of regulatory regimes, ranging from highly prescriptive to more
laisse faire, with Australian state and territory local government
* Post-Doctoral Fellow, Institute of Public Policy and Governance,
University of Technology Sydney.
# Professor of Economics and Director of the University of New
England Centre for Local Government.
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
jurisdictions typically at the former end of the spectrum.1 While
the nature of municipal regulation varies widely, state-imposed
limitations on council expenditure and revenue-raising represent
one of its more draconian manifestations. In particular, state-wide
limits on property tax increases, commonly known as ‘rate-
capping’ or ‘rate-pegging’ in Australian local government, are an
especially powerful policy instrument. In general, the rationale
for rate-capping is to restrict the spatial monopoly power of local
government to raise property taxes as it sees fit.2
In the Australian local government milieu, at present only
New South Wales (NSW) has a comprehensive rate-pegging
regime, although the Northern Territory (NT) caps mining and
pastoral rates. In NSW, rate-pegging remains contentious. For
instance, the recent Independent Local Government Review
Panel3 observed that ‘changes to the rating system and rate-
pegging are essential to generate the revenues needed to fund
infrastructure and services, and – equally as important – to make
the system more equitable.’ The NSW Government promised to
conduct a review of the rating system in response to the ILGRP
recommendations. However, rate-capping has considerable
populist appeal in Australia, as evidenced in the recent South
Australian and Victorian state elections. It is thus important to
empirically investigate the effects of rate-capping. Accordingly,
1 Brian Dollery, Suzanne O’Keefe and Lin Crase, ‘State Oversight
Models for Australian Local Government’ (2010) 28 Economic Papers
279, 290.
2 Judy Temple, ‘Community Composition and Voter Support for Tax
Limitations: Evidence from Home-rule Elections’ (1996) 62 Southern
Economic Journal 1002, 1016; Robert Hay and Steve Martin,
‘Controlling Local Government Spending: The Implementation and
Impact of Capping Council Taxes’ (2014) 40 Local Government
Studies 224, 239.
3 Independent Local Government Review Panel (ILGRP), Revitalising
Local Government (2013).
140
in this paper we analyse the likely impact of rate-pegging on
Victorian local government.
Following the electoral victory of the Australian Labor Party
(ALP) in Victoria in late 2014, the new Minister for Local
Government Natalie Hutchins announced that rate-capping -
linked to the Consumer Price Index (CPI) - will be introduced into
Victorian local government from the 2016/17 fiscal year onwards.
Victorian Premier Daniel Andrews (2014) justified the
introduction of rate-pegging on grounds that ‘councils will be
forced to limit rate rises and detail where every dollar will be
spent, because ratepayers deserve a fair go’, adding that ‘this
policy also sends a clear message that we expect councils to keep
their rates in line with CPI’.4
The timing of the Victorian Government’s foray into rate-
capping is not propitious. Not only has the Commonwealth
Government announced a three-year freeze on Financial
Assistance Grants (which represent a significant proportion of
Victorian municipal income), but Victorian councils have also
been subjected to defined benefit superannuation imposts in the
order of half a billion dollars over the past few years5.
Accordingly, if the Victorian Government proceeds with its plan
to cap rates – starting from the 2016/17 financial year – one (or
more) of three responses must occur (in the absence of an increase
in funding from higher tiers of government): (a) additional debt
must be incurred; (b) local services must diminish; or (c)
operational efficiency must increase. Against this background, in
this paper we examine empirically the likely impact of rate-
capping on Victorian local government in terms of equity
considerations, financial sustainability and municipal efficiency.
4 John Masanauskas and Christopher Gillett, ‘Labor’s Plan to Curb
Council Rates’ Herald Sun (Melbourne) 3 May 2014.
5 Municipal Association of Victoria (MAV), Defined Benefits
Taskforce – Final Report (2012).
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
The paper is divided into nine main parts. Section 2 provides
a synoptic review of rate-capping and the debate on its merits in
NSW. Section 3 outlines theoretical approaches to the analysis of
rate-pegging whilst Section 4 provides a brief summary of the
extant literature. Section 5 assesses the equity claims underlying
property tax limitations, Section 6 examines sustainability claims
for rate-pegging with respect to debt and infrastructure, and
Section 7 evaluates the efficiency claims for rate-capping. Section
8 considers various alternative methods of addressing problems
in local government identified by the application of personal
finance theory and agency theory. The paper concludes in section
9 with a brief discussion of the policy implications of the
empirical analysis.
2. RATE-CAPPING
Rate-pegging represents a sub-set of a larger category of
public sector regulation dealing with state-imposed limitations on
expenditure and taxation by local authorities, including property
taxes.6 Regulation of this kind has spawned a theoretical and
empirical literature with an overwhelming American institutional
focus7, largely since state-wide limitations on local taxes, fees and
charges, including property taxes, are relatively common in the
United States, often deriving from referenda.8 In addition to this
6 Temple, above n 2; Nathan Anderson, ‘Property Tax Limitations: An
Interpretive Review’ (2006) 59 National Tax Journal 685, 694.
7 See, for example, Mathew McCubbins and Ellen Moule, ‘Making
Mountains of Debt Out of Molehills: The Pro-Cyclical Implications of
Tax and Expenditure Limitations’ (2010) 63 National Tax Journal
603, 622; Daniel Mullins and Bruce Wallin, ‘Tax and Expenditure
Limitation: Introduction and Overview’ (2004) 24 Public Budgeting &
Finance 1, 14.
8 See, for example, David Figlio and Arthur O’Sullivan ‘The Local
Response to Tax Limitation Measures: Do Local Government
Manipulate Voters to Increase Revenues?’ (2001) 44 Journal of Law
and Economics 233, 257.
142
American literature, some scholarly work has been undertaken on
tax limitations in local government in other parts of the world,
including Europe9 and Australia.10
The economic rationale for rate-pegging is straightforward:
local government typically holds a monopoly in providing local
services. As a result, local councils can deliver these services at
excessive prices and/or inefficiently, thereby justifying regulation
by higher levels of government aimed at the efficient and
equitable provision of local services.11 Regulation of this kind
generally has two main objectives. Firstly, in terms of economic
efficiency, optimal regulation should strive to achieve (a)
allocative efficiency, where local community preferences should
be reflected in the range of local services, and (b) productive
efficiency, where local services should be delivered at least-cost.
Secondly, policy intervention regulation also should aim at equity
objectives, such as ensuring essential local services are provided
to all households at reasonable prices.
Effective regulation is notoriously difficult to implement,
including in local government.12 In the municipal realm,
intervention is further complicated since councils possess
taxation powers, absent in the private sector and most public
utilities. Finally, rate-pegging poses particular problems since
regulatory intervention does not target particular local services
9 Robin Boadway and Anwar Shah, Fiscal Federalism: Principles and
Practice of Multi-order Governance (Cambridge University Press,
2009); Jens Blom-Hansen, Martin Bækgaard and Soren Serritzlew,
‘Tax Limitations and Revenue Shifting Strategies in Local
Government’ (2014) 34 Public Budgeting & Finance 64, 84.
10 Brian Dollery and Albert Wijeweera, ‘Time for Change? An
Assessment of Rate-Pegging in New South Wales Local Government’
(2010) 6 Commonwealth Journal of Local Governance 56, 76.
11 Stephen Bailey, Public Sector Economics (Macmillan, 1995).
12 Ayre Hillman, Public Finance and Public Policy (Cambridge
University Press, 2005).
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
but instead the ‘tax-price’ of a basket of local public services
(which are mostly unpriced).
In NSW local government, the Independent Pricing and
Regulation Tribunal13 has identified four arguments in favour of
rate-pegging. In the first place, rate-pegging ‘prevents the abuse
of monopoly power’ in the provision of basic local services. In
addition, proponents contend it limits the ‘provision of non-core
services and infrastructure that might prove unsustainable to
ratepayers’. Furthermore, rate-capping may reduce ‘the risk of
poor governance in the local government sector’. Finally, it is
argued rate-pegging ‘limits the ability of councils to divert funds
from essential infrastructure to other projects’, especially outlays
on ‘marginal services’ better provided by private firms.
Two additional arguments for rate-pegging were advanced in
the Independent Inquiry into the Financial Sustainability of NSW
Local Government.14 Firstly, compared with other Australian
local government systems, NSW rate-pegging had been effective
in its primary aim of restraining increases in rates. Secondly, rate-
pegging had obliged NSW councils to become more efficient,
especially in limiting overheads and administrative costs.
Dollery, Crase and Byrnes15 proposed a public choice case for
rate-capping in Australian local government. Drawing on
Wittman16, they argued that the ubiquity of ‘local government
failure’ in Australia had simulated a demand by ratepayers for
strict regulatory oversight of councils by state regulatory
13 Independent Pricing and Regulatory Authority (IPART), Revenue
Framework for Local Government (2009) 55.
14 Local Government and Shires Association (LGSA), Are Councils
Sustainable?, Final Report: Findings and Recommendations (2006).
15 Brian Dollery, Lin Crase and Joel Byrnes, ‘Local Government
Failure: Why Does Australian Local Government Experience
Permanent Financial Austerity?’ (2006) 41 Australian Journal of
Political Science 339, 353.
16 Donald Witman, The Myth of Democratic Failure: Why Political
Institutions are Efficient (University of Chicago Press, 1995).
144
agencies, especially in financial matters. Accordingly, in NSW
rate-capping, ‘“watchdog” institutions will form an agency
relationship with local government voters to demystify fiscal
illusion by monitoring council revenue and expenditure decisions
on behalf of voters’.17
However, rate-pegging in NSW has also come under sharp
criticism. For example, IPART18 has pinpointed four lines of
attack: it ‘limits councils’ capacity to provide local services, it
prevents ‘infrastructure backlogs from being addressed’, it has
caused municipalities to impose ‘higher user pays charges which
could result in pricing inequities, and it runs counter to ‘local
democracy’.
The NSW Local Government and Shires Association19 – now
known as Local Government NSW – proposed a more general
argument against rate-pegging. In particular, rate-capping has
created ‘public expectations about maximum rate increases,
placing political pressure on councils to stay within the limit and
not seek special variations’. Similarly, rate-pegging enables NSW
local councils to engage in politically expedient ‘blame shifting’
onto the NSW Government. In particular, rate-capping offers
political ‘default option’ since all rate increases can be attributed
to the NSW Government agencies, community consultation is
avoided, and local authorities can ‘blame the state government for
their financial deficiencies’. It is claimed that these factors have
given rise to the ‘under-provision of community infrastructure
and services’ and a substantial local infrastructure backlog.
17 Dollery, Crase and Byrnes, above n 15.
18 Independent Pricing and Regulatory Authority, above n 13.
19 Local Government and Shires Association of NSW, Submission to
the Independent Pricing and Regulatory Tribunal of NSW’s Review of
Revenue Framework for Local Government (2008) 14.
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
Two conceptual approaches have been developed to explain
property tax limitations through rate-capping. In the first place,
agency theory20 holds that residents (as principals) are wary of
‘agency failure’ by local authorities (as agents), which could
result in excess expenditure above socially optimal levels. In most
Australian local government systems, councillors are typically
elected every four years, thereby providing residents with an
opportunity to remove elected officials if they believe these
persons are not representing their interests, although it might be
noted that the limited number of prospective candidates are
generally drawn from a small group of special interest parties. In
fact, in the last Victorian local government elections 26
councillors were returned unopposed.21
However, this political mechanism offers only limited
recourse given that (a) lengthy periods occur between elections
(b) high information costs may mean that residents are unaware
of excessive/unwarranted outlays and (c) ‘candidates come as
bundles, so that incumbents might be able to spend more and
maintain their position if they satisfy people’s views along other
dimensions’.22 Following agency theory, residents may seek state
government intervention through rate-caps to limit agency failure
by local councils.23
Secondly, ‘personal finance theory’24 holds that local
residents judge the value of local services received from
20 Michael Jensen and William Meckling, ‘Theory of the Firm:
Managerial Behaviour, Agency Costs and Ownership Structure’ (1976)
3 Journal of Financial Economics 305, 360.
21 Joseph Drew and Brian Dollery, ‘The Price of democracy? Political
Representation Structure and Per Capita Expenditure in Victorian
Local Government’ (2016) In Print Urban Affairs Review, DOI:
10.1332/030557316x14539914690045.
22 David Cutler, Douglas Elmendorf and Richard Zeckhauser,
‘Restraining the Leviathan: Property Tax Limitation in Massachusetts’
(1999) 71 Journal of Public Economics 313, 334.
23 Dollery, Crase and Byrnes, above n 15.
24 Cutler, Elmendorf and Zeckhauser, above n 22.
146
municipalities according to their local government tax burden.
Following this approach, the higher the perceived rate of property
tax, the more likely it is that a resident will support rate-capping.
In addition, significant increases to property taxes predispose
individuals to support rate-pegs. This line of reasoning is
particularly relevant to Australian local government given that
municipal rates are highly visible through quarterly rate bills sent
to residents by councils. An embryonic empirical literature offers
some support for this approach in the American municipal
milieu.25
Both of these perceptions are problematic since both presume
rate-pegging inevitably limits rate increases. However, this is not
necessarily the case: individual tax liabilities may still rise
significantly as a result of a rezoning of land use, new property
valuations in excess of the average valuation for the municipality,
or (as in NSW) as a result of a Special Rate Variation (SRV)
enabling rate increases in excess of the cap.
Unfortunately, to date there has been no attempt to
empirically analyse these questions in the Australian local
government context. Accordingly, we seek to address this gap in
the literature. In addition, a second aim of our paper is to address
the common misconception that rate-caps are the only reliable
method of addressing the potential abuse of monopoly power in
the local government. We show that viable alternative policy
approaches exist.
The empirical comparison of the only fully-fledged rate-cap
regime in NSW with existing Victorian municipal data
undertaken in this paper can provide an insight into the likely
response to the Victorian state government proposal.
25 Ibid.
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
4. EMPIRICAL EVIDENCE ON TAX LIMITATIONS
While comparatively little is known about the effects of
expenditure and tax constraints on local government, the
empirical literature has shown that these measures can have
substantial unanticipated effects.26 Thus Temple27 found evidence
which suggested that state-wide limits on property taxes induced
a relatively larger reduction in local services than local
administration. Similarly, Vigdor28 held that tax limitations
succeed because they allowed voters to lower tax rates in local
communities other than their own where they hold property,
invest or work, but have no vote.
Two findings in the empirical literature have significance for
Australian debates over rate-pegging. In the first place, property
tax limitations often induce local authorities to increase income
from other revenue sources. For instance, in a study of 29
American states, Shadbegian29 found many local councils shifted
income away from property taxes toward ‘miscellaneous
revenue’. Skidmore30 found similar results in his analysis of 49
American states. In their US study, Kouser, McCubbins, and
26 Mark Skidmore, ‘Tax and Expenditure Limitations and the Fiscal
Relationships between State and Local Governments’ (1999) 99 Public
Choice 77, 102; Thad Kousser, Mathew McCubbins and Ellen Moule,
‘For Whom the TEL Tolls: Can State Tax and Expenditure Limits
Effectively Reduce Spending?’ (2008) 8 State Politics and Policy
Quarterly 331, 361; Suho Bae, Seong-gin Moon and Changhoon Jung,
‘Economic Effects of State-Level Tax and Expenditure Limitations’
(2012) 72 Public Administration Review 649, 658.
27 Temple, above n 2.
28 Jacob Vigdor, ‘Other People's Taxes: Non-resident Voters and State-
wide Limitation of Local Government’ (2004) 47 Journal of Law and
Economics 453, 476.
29 Ronald Shadbegian, ‘The Effect of Tax and Expenditure Limitation
on the Revenue Structure of Local Government, 1962–87’ (1999) 55
National Tax Journal 221, 237.
30 Skidmore, above n 26.
148
Moule31 established that most states increased charges and fees
following the introduction of tax limitations. In an analogous
vein, Mullins and Joyce32 examined 48 American states from
1970 to 1990 concluding that while tax limitations reduced local
taxes, these reductions were offset by increases in fees and
charges. In an analysis based on 1,400 American municipalities,
Preston and Ichniowski33 demonstrated that revenue limits
decreased property tax revenue but increase ‘other revenue’.
Secondly, available empirical evidence suggests that the
impact of tax limitations is not uniform across local authorities
and depends instead on the characteristics of local councils. For
instance, Brown34 found that in Colorado local government the
effects of limitations depended on council size and were more
potent in small councils. Similarly, Mullins35 established that
limitations were most effective in poor municipalities.
5. INTER-MUNICIPAL REVENUE EFFORT EQUITY
Residential tax effort measures the proportion of residential
rates paid as a percentage of the total annual incomes accruing to
residents in a given local government area. This is the most
relevant measure of inter-municipal equity given that ‘all taxes
31 Kousser, McCubbins and Moule, above n 26.
32 Daniel Mullins and Philip Joyce, ‘Tax and Expenditure Limitations
and State and Local Fiscal Structure: An Empirical Assessment’
(1996) Spring Public Budgeting & Finance 75, 102.
33 Anne Preston and Casey Ichniowski, ‘A National Perspective on the
Nature and Effects of the Local Property Tax Revolt, 1976–1966’
(1991) 44 National Tax Journal 123, 145.
34 Tom Brown, ‘Constitutional Tax and Expenditure Limitation in
Colorado: The Impact on Municipal Governments’ (2000) 20 Public
Budgeting & Finance 29, 50.
35 Daniel Mullins, ‘Tax and Expenditure Limitations and the Fiscal
Response of Local Government: Asymmetric Intra-Local Fiscal
Effects’ (2004) 24 Public Budgeting & Finance 111, 147.
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
levied by the city would ultimately be paid from the income of
the city residents regardless of the mix of taxes actually used’.36
The data for residential tax impost was obtained directly from the
notes to the Income Statement of individual NSW and Victorian
councils and includes general rates as well as fees and charges for
council services. It is important to include fees and charges in tax
impost data given that the empirical evidence from abroad
suggests that municipalities ‘game’ rate-caps by increasing the
fees and charges not subject to regulation.37 Total annual income
accruing to people residing in a given local government area was
obtained from the latest data i.e. the 2012 National Regional
Profile38: alterations were made to the data by including a
synthetic estimate of Commonwealth welfare payments and
excluding unincorporated business income.39 Residential tax
effort was calculated by dividing the total residential tax impost
for each council by the total income accruing to individuals
residing in the respective council.
Table 1 contains measures of the range and central tendency
of local council residential revenue effort for NSW and Victoria
as well as a comparison stratified according to urban and rural
categorisation (informed by the Australian Classification of Local
Government (ACLG) scheme). A number of noteworthy points
arise from the data. Firstly, the tax impost placed on residential
36 See Helen Ladd and John Yinger, America’s Ailing Cities – Fiscal
Health and the Design of Urban Policy (John Hopkins University
Press, 1989); Joseph Drew and Brian Dollery, ‘A Fair Go? A Response
to the Independent Local Government Review Panel’s Assessment of
Municipal Taxation in New South Wales’ (2015) 30 Australian Tax
Forum 471.
37 Blom-Hansen, Baekgaard, and Serritzlew, above n 9.
38 Australian Bureau of Statistics (ABS), National Regional Profile
(2014).
39 Quantum of welfare payments is not available on the ABS National
Regional Profile. An estimate of the quantum was made by
multiplying the number of recipients in each welfare payment category
by the appropriate rate of welfare payment.
150
ratepayers is remarkably modest even when one considers the
limited remit of Australian local government. In most cases, rates
are a fraction of the personal income tax paid by individuals.40 It
is thus surprising that rate-pegging enjoys so much popular
support. However, as noted earlier, the ‘visibility’ of rates
compared with other forms of taxation, such as salary deductions,
may be part of the reason (see also, Section 8 below).
Secondly, Table 1 provides evidence which suggests that the
almost four decade-long rate cap regime in NSW may have been
successful in limiting the tax burden on ratepayers. Finally, the
evidence seems to support the ILGRP’s41 claim that rate-capping
has reduced inter-municipal equity, as demonstrated by the fact
that the range of rate effort in NSW is considerably larger than
Victoria, which is particularly evident in the stratified summary.
Moreover, the standard deviation – which measures the average
‘scatter’ of individual councils with respect to the mean – is
relatively high and suggests quite a lot of variation within each
strata.
Inter-municipal inequity seems to be an unavoidable
consequence of any long-term rate-cap regime. This is because
rate-caps are applied in a compound fashion to rate levels existing
in the base year. If inequity exists in the base year, then the equity
gap will be exacerbated through time. Moreover, if demographic
patterns change as a result of urban sprawl or changes to local
economies, then inter-municipal inequity must follow in the
absence of SRV. The ILGRP42 cited the incongruity of average
rates of $484 in affluent North Sydney when compared with the
average residential rates of $957 in the more modest Penrith as a
40 In fact, local government rates represent only 3.4% of total tax
revenue collected by the various tiers of Australian government;
Australian Bureau of Statistics ‘Government Finance Statistics 2013-
14’.
41 Independent Local Government Review Panel, above n 3.
42 Ibid.
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
specific example of the inequity which can result from almost
forty years of rate-pegging.
Table 1: Revenue Effort Equity NSW and Victoria, 2012
(%)
Smallest Largest Median Mean Standard
3.30
1.39
1.39
0.51
(State)
Victoria 0.91
2.62
1.75
1.74
0.39
(State)
NSW
0.61
3.30
1.521
1.58
0.48
Urban
Victoria 0.91
2.62
1.69
1.69
0.38
Urban
NSW
0.33
2.37
1.12
1.17
0.44
Rural
Victoria 1.1
2.57
1.84
1.88
0.38
Rural
We examined two claims regarding the deleterious effects of
rate-capping on financial sustainability: (a) that rate-pegging
increases debt and (b) that rate-pegging reduces investment in
infrastructure. Both claims follow from the proposition that - in
the absence of increases in revenue from higher tiers of
government - rate-capping will probably result in lower levels
and/or quality of local services or higher debt loads. In the latter
case this also raises problems of intergenerational inequity.
Table 2 presents data for local government liabilities per
household for each council jurisdiction over the period 2009-
2013 inclusive (inflated by CPI to 2013 dollars). Total liability
data was extracted from the balance sheets of each council in the
relevant jurisdiction, while household data was extracted from the
152
Australian Bureau of Statistics (ABS) census data of number of
households in NSW and Victoria, adjusted by the annual ABS
Buildings Approval data. Liabilities were expressed per
household in response to Drew and Dollery43 who argued that
households – rather than population per se – are the optimal
functional unit for empirical analysis in addition to being a more
reliable and less volatile measure of council size (particularly in
inter-census periods).
It is clear from Table 2 that municipal debt in NSW is far
greater than Victoria. In fact, as at 2013 (the limit of ABS housing
data), NSW councils carried around 70% more debt than their
Victorian counterparts. Victorian municipal debt rose by an
alarming rate in 2012, with only slight moderation in 2013.
However, this can largely attributed to liabilities of about
$250/household which were incurred by Victorian councils as a
result of the defined benefits superannuation impost during this
period.44
Table 2: Liabilities per Household, NSW and Victoria 2009-
2013 ($’000)
2009
2010
2011
2012
2013
2.320
2.340
2.404
1.193
1.489
1.396
liabilities per
# all figures have been inflated to 2013 dollars.
43 Joseph Drew and Brian Dollery, ‘Keeping It In-House – Households
as an Alternative Proxy for Local Government Output’ (2014) 73
Australian Journal of Public Administration 235, 246.
44 Municipal Association of Victoria, above n 5.
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
Table 3 provides statistics on the average infrastructure
renewal45 ratio published by the regulatory authorities in NSW
and Victoria. It is important to note that the two ratios are not
directly comparable since each jurisdiction employs a different
measure for the quantum of assets consumed (i.e. the denominator
of the ratios): NSW uses depreciation accruals for the period
whereas Victoria employs current replacement cost (as new)
divided by useful life. Both use the quantum of asset renewals as
the numerator of the ratio and both have employed consistent
methodology over the period 2009-2012. Accordingly,
conclusions can be drawn by comparing the change in
infrastructure renewals over the four-year period. In this regard,
it appears that NSW councils have reduced infrastructure renewal
since 2009, while Victorian councils have held asset renewal at a
constant level for most of this period. However, some caution
needs to be exercised in judging progress on infrastructure
renewals given that both ratios employ estimates as the ratio
denominator.
45 Infrastructure renewals are defined as spending on existing
infrastructure assets which return same to original service potential.
154
Table 3: Infrastructure Renewal, NSW and Victoria 2009-
2011
2012
0.665
0.8088
Renewals NSW
-
2.74%
35.32%
21.32%
14.39%
33.49%
Renewal from
previous year
-
0.75
0.77
1.09
Renewals Victoria
38.95%
31.57%
Renewal from
previous year
30.55%
Infrastructure
We now test the final claim regarding rate-capping:
restricting rate revenue imposes financial discipline on municipal
behaviour thereby increasing council efficiency.
In economics, technical efficiency measures the conversion
of inputs into outputs in production processes. This is best
assessed using the sophisticated technique of locally inter-
temporal data envelopment analysis which accommodates
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
multiple inputs (generally specified as capital and labour costs)
and multiple outputs (best specified as length of municipal roads,
number of households and number of employing businesses).46
However, this technical type of analysis is beyond the scope of a
policy orientated article and we have thus decided to proxy
efficiency using expenditure per household (it should be noted
that the NSW government uses expenditure per capita to measure
local government efficiency47). In our analysis there is thus a
single input of operating expenditure and a single output proxied
by the total number of households in the jurisdiction.
Table 4 outlines the results from our analysis of expenditure
per household over the period 2009-2013. Total expenditure data
(less depreciation)48 was extracted from the audited financial
statements of each council within the NSW and Victoria local
government systems. We have again used households as the
proxy for local government output in response to empirical
evidence regarding its functional compatibility, high reliability
and low volatility49. The data in Table 4 does not provide any
conclusive evidence of a statistically significant difference in
efficiency between the two jurisdictions: NSW has slightly lower
expenditure per household from 2009 to 2012, but higher
46 Drew, Kortt and Dollery conduct a thorough analysis of the effect of
various DEA specifications on efficiency analysis and interested
readers are thus directed to: Joseph Drew, Michael Kortt and Brian
Dollery, ‘No Aladdin’s Cave in New South Wales? Local Government
Amalgamation, Scale Economies and Data Envelopment Specification’
DOI: 10.1177/0095399715581045 Administration & Society 1, 21.
47 Office of Local Government, Time series Data 2011/12 – 2013/14
(2015).
48 Depreciation has been excluded in response to many studies which
demonstrate that municipal officials regularly manipulate this accrual
item to manage earnings. Studies demonstrating this include: Joseph
Drew and Brian Dollery, ‘Inconsistent Depreciation Practice and
Public Policymaking: Local Government Reform in New South Wales’
(2015) 25 Australian Accounting Review 28, 37.
49 Drew and Dollery, above n 43.
156
expenditure per household in the final year under analysis.
Moreover, we need to be mindful that this is an approximation of
‘technical efficiency’.50 We conducted locally inter-temporal data
envelopment analysis (DEA) for all councils in the two
jurisdictions. Our analysis suggested slightly higher average
municipal efficiency for Victorian councils. Results are available
from the corresponding author. However, the important thing to
note is that there is no conclusive evidence to support the claim
made by proponents of rate-capping that it enhances municipal
efficiency.
Table 4: Expenditure per Household, NSW and Victoria
2009-2013 ($’000)
2009
2010
2011
2012
2013
2.810
2.944
3.033
expenditure per
2.902
3.170
3.024
expenditure per
# all figures have been inflated to 2013 dollars. Expenditure
excludes depreciation.
Perhaps the greatest misconception regarding rate-capping is
that it is the only feasible public policy instrument for addressing
the potential excesses of municipal monopoly power. In fact,
50 The authors have in fact conducted locally inter-temporal data
envelopment analysis (DEA) for all councils in the two jurisdictions.
This analysis suggests slightly higher average municipal efficiency for
Victorian councils. Results are available from the corresponding
author.
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RATE CAPPING IN LOCAL GOVERNMENT
superior alternative strategies exist.51 In general, policies to limit
monopoly excesses fall broadly under two categories which
respond to the two theoretical positions outlined in Section 3 of
this paper. Moreover, in terms of political realities, it is important
to note that alternatives to rate-pegging are just as critical for
NSW policymakers as they are for their Victorian counterparts,
given that there is a strong possibility that NSW rates will spike
if rate-caps are removed.
As we observed earlier, personal finance theory hinges on the
perceived value of local services relative to the tax burden
imposed.52 In Australia, the value of municipal services far
exceeds the local government tax impost, given substantial
federal government Financial Assistance Grants (FAGs)
(typically accounting for around one tenth of municipal
revenue).53 However, it is the perception of ratepayers not fact
which is the critical point under this theoretical approach.
One way to reduce the demand for rate-caps would be to
increase FAGs. However, this is most unlikely given the recent
freeze on FAGs for a period of three years.54 Furthermore, much
more can be done with respect to intergovernmental fiscal
relations. Firstly, there is a need for fairer distribution of FAGs so
that the horizontal fiscal equity principle embodied in legislation
- but absent in practice - is enforced. In this regard, Drew and
Dollery55 have demonstrated a failure by state Local Government
51 Patricia Florestano, ‘Revenue-Raising Limitations on Local
Government: A Focus on Alternative Responses’ (1981) 41 Public
Administration Review 122, 131.
52 Cutler, Elmendorf and Zeckhauser, above n 22.
53 The 2014-15 total Commonwealth financial assistance grants for
NSW and Victoria were $715.7m and $541.7 m respectively.
54 Keith Rhoades, ‘Abandon Grant Freeze or Communities Lose Out’,
Local Government Association New South Wales (Sydney) 18 May,
2014.
55 Joseph Drew and Brian Dollery, ‘Road to Ruin? Consistency,
Transparency and Horizontal Equalisation of Road Grant Allocations
158
Grant Commissions to allocate financial assistance grants in
accordance with the principles of the enabling legislation.
Secondly, there is a need for greater clarity surrounding the
sources of council funding. For example, residential rate notices
could clearly state the source and level of council service
subsidies. If residents are more aware of the quantum of local
government grant revenue, they may reassess their local tax
burden against value received. Thirdly, the fiscal imbalance
which characterises the Australian federation could be addressed
to provide local government sufficient and secure revenue to fund
the services it provides.56 Intergovernmental grants are just one
way to address fiscal imbalance. Other options include new tax
bases or quarantining taxes by higher tiers of government for
councils (similar to how the GST is collected by the federal
government for state governments).57
Finally, cost-shifting - wherein new mandates are forced on
local government with only partial funding by the higher tiers of
government previously responsible for provision – must be
addressed,58 if residents are to accurately appraise value relative
to cost for local services.
Perceptions of the value of local services relative to the tax
burden can also be enhanced through ensuring that the cost of
specific services is met by the parties receiving the benefit
in Eastern Mainland Australian States’ (2015) 39 Public
Administration Quarterly 517, 545.
56 Wallace Oates, ‘An Essay on Fiscal Federalism’ (1999) XXXVII
Journal of Economic Literature 1120, 1149.
57 Indeed under the Fraser government’s Local Government (Personal
Income Tax Sharing) Act 1976 (CTH) councils were to be allocated a
fixed percentage (2.00% in 1981) of Commonwealth personal income
tax collections. This approach provided secure and expanding sources
of revenue for councils as a way of redress the vertical fiscal
imbalance present in the Australian federation.
58 Brian Dollery, Lin Crase and Andrew Johnson, Australian Local
Government Economics (UNSW Press, 2006).
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RATE CAPPING IN LOCAL GOVERNMENT
through more user charges,59 as well as timing rate increases to
remove periodic sharp rises. By ensuring that those who receive
the benefit pay the costs associated with the service wherever
practicable, residents can gain a more accurate perception of
value of the municipal burden. This strategy obviously cannot be
applied to pure public goods which are both non-rival and non-
excludable (such as local roads and pavements), which must be
met through rates. However, for some services, such as garbage
collection, development applications, and public health and safety
inspections, people receiving benefits could pay user fees and
charges which would more accurately reflect the cost of
provision.60
Unfortunately, the regulation of fees and charges – by IPART
in NSW and analogous bodies in other states – as well as the
failure of municipal accounting systems to accurately assess the
costs of services (particularly with respect to allocating indirect
costs and depreciation), has meant that full cost recovery rarely
occurs.61 The inevitable result is the cross-subsidisation of service
provision by ratepayers. While for merit goods this practice might
be defensible, merit goods typically represent only a small subset
of the local services provided by local councils. Moreover, where
services are subsidised, it is important that donors and recipients
59 James Buchanan, ‘Federalism and Fiscal Equity’ (1950) 40 The
American Economic Review 583, 599.
60 We recognise that fees are charged for many local government
services. However, it is not at all certain that fees are levied on a full
cost recovery basis; see, for instance, Judith McNeill and Brian
Dollery, ‘Calculating Developer Charges for Urban Infrastructure: A
Feasible Method for Applying Marginal Cost Pricing’ (2003) 48 The
Engineering Economist 218, 240.
61 Garry Carnegie and Brian West, ‘A Conceptual Analysis of Price
Setting in Australian Local Government’ (2010) 53 Australian
Accounting Review 110, 120; Garry Carnegie, Jacqueline Tuck and
Brian West, ‘Price Setting Practices in Australian Local Government’
(2011) 57 Australian Accounting Review 193, 201.
160
of the subsidy alike are advised on both the quantum and
reasoning involved.62
Perceptions of value can also be enhanced by removing
‘lumpy’ rate rises. This requires both a higher degree of strategic
planning, as well as the flexibility to increase rates on a more
frequent basis. Strategic planning which accurately assesses
municipal obligations five years or more into the future allows for
a measured increase in rates and avoids ‘rate shocks’. Similarly,
the ability to increase rates on a quarterly basis consonant with
the quarterly nature of rate invoices – rather than the current
annual practice – means that councils can respond quickly to
unexpected obligations and introduce rate increases over a longer
time period, thus avoiding sudden significant rate rises.
Finally, enhancing the actual value of local services can also
help to address public concerns underpinning rate-capping. This
can be achieved by decreasing the cost of municipal debt,
reducing the perceived municipal tax impost on residents, and
removing the legislative power of councils to levy charges for
goods and services which are not used or wanted. For instance,
Dollery, Kortt and Grant63 have demonstrated that the
establishment of a national local government infrastructure
finance authority would facilitate cheaper and more flexible
access to capital for local infrastructure investment and renewal.64
A second option would focus on eliminating the wide range of
rate exemptions which currently exist for state and federal
government commercial activities, religious and benevolent
foundations, select agricultural ventures (such oyster farming and
62 Carnegie and West, above n 61.
63 Brian Dollery, Michael Kortt and Bligh Grant, ‘Harnessing Private
Funds to Alleviate the Australian Local Government Infrastructure
Backlog’ (2012) 31 Economic Papers 114, 122.
64 Ibid.
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RATE CAPPING IN LOCAL GOVERNMENT
cattle dipping) and commercial sporting facilities (like the
Sydney Cricket Ground).65
Finally, removing the legislated power of councils to charge
fees for services not actually used would reduce the coercive
council monopoly power. For example, the current ability for
councils to levy a base water charge where a water line runs past
a vacant property, irrespective of whether the property is actually
connected, should be removed.
In contrast to the personal finance approach, agency theory
rests on the trust between residents (as principals) and municipal
officials (as agents) that the latter behave in a financially prudent
manner. Residents may have good reason to mistrust municipal
officials in view of various allegations of waste, excess,
corruption and pork-barrelling.66 Thus the exercise of greater
prudence in council spending is clearly an avenue to reduce calls
for tax limitations. Moreover, measures which reduce the
information costs for residents to monitor municipal officials or
enhance the opportunities for residents to sanction officials might
reduce the need for rate-caps.
With respect to a reduction in information costs, existing
practice in both NSW and Victoria involves the compilation of
comparative data published on an annual basis. This has obvious
merit,67 although the data currently disseminated – focussing
mainly on average levels of rates, financial ratio data and
expenditure according to functional categories – is generalised
and does not inform residents about the cost of specific projects
or where waste might be occurring. Moreover, in the absence of
65 Independent Local Government Review Panel, above n 3.
66 See, for example, A Current Affair ‘Council Spending Sprees’ Nine
MSN July 6, 2015. For evidence of pork-barrelling see Drew and
Dollery, above n 21.
67 See, for instance, Office of Local Government, Comparative
Information on NSW Local Government 2012/13 (2014); Department
of Transport Planning and Local Infrastructure, Source Data 2005-
2012 (2012).
162
data relating the number and quality of outputs for each functional
category, accurate comparisons between councils is all but
impossible. This could be addressed through an addendum to the
existing reports providing a higher degree of disaggregation, and
this in addition to details of the number and quality of outputs,
would increase the information value of these reports.
However, it is far from clear that the majority of residents are
aware that comparative data is available, let alone consulting this
data. There would thus seem to be a good argument that a
summary report of inter-temporal functional expenditure trends
should be included with the rate assessment notices issued
annually. Providing a report direct to residents further reduces
information costs as well as ensuring awareness of the existence
of comparative data. Moreover, detailed information of the cost
of specific programs – rather than broad functional categories
such as ‘recreation’ – is currently not available even in the annual
audited financial statements, but it is required if residents are to
closely monitor council expenditure. It could be argued that this
sort of detailed information should be available to residents
wishing to inquire into the costs of specific programs, although,
it appears that council accounting information systems would
need to be improved for this to occur.68 Finally, there is a good
case for requiring councils - perhaps by legislation - to provide
accurate costings for proposals to introduce new services. Ideally
these costings should be made available to residents prior to the
council meeting dedicated to considering the proposal.
Even if residents are able to get detailed information on fiscal
prudence, there are limited opportunities to apply sanctions. For
example, in both NSW and Victoria elections occur on a
quaternary basis – a considerable time before a political sanction
can be applied. A partial solution would be to increase the
frequency of elections, perhaps reducing the term to three years
consistent with Commonwealth government elections. Moreover,
68 Carnegie, Tuck and West, above n 61.
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
council officers are not subject to political sanction and political
representatives are assessed on a bundle of attributes.69 Penalties
for councillor misconduct provided for under the respective state
local government acts seem inadequate: in NSW the maximum
penalty for councillor breach of duty is disqualification for 5
years whereas Victorian councillors can be liable for an $84,504
fine or 5 years imprisonment.70 These penalties only apply to
gross breaches of duty, such as an undisclosed interest or related
party transaction. Thus council officers spending money unwisely
and taking unwarranted (but legal) perquisites would generally
fall outside of the provisions of state legislation. The relevant
state ombudsman is another option for residents wishing to have
sanctions applied to council staff (but not councillors in Victoria).
However, the ombudsman’s remit is limited: the NSW
Ombudsman is generally unwilling to investigate complaints
regarding the merits of specific development approvals, the
adoption of particular council policies, the striking of rates or the
allocation of council resources, while the Victorian Ombudsman
only hears complaints concerning the ‘administrative action’ of
council staff. It thus seems clear that the existing avenues for
sanctioning councillors and council officers are inadequate with
respect to agency theory.
The NSW Auditor-General recently called for changes to
legislation to give the Office of Local Government ‘greater
powers to intervene, impose greater penalties and demand
compliance’.71 However, it is unclear whether the respective
departments have the judicial bearing and authority to adequately
enforce legislation. Moreover, the NSW Auditor General’s
recommendation could easily politicise disputes. Instead there
would seem to be a sound argument for establishing a dedicated
69 Cutler, Elmendorf and Zeckhauser, above n 22.
70 Audit Office of New South Wales, New South Wales Auditor-
General’s Report Performance Audit – Monitoring Local Government
(2012).
71 Ibid.
164
and politically independent local government ombudsman in each
state, with a broad remit and legislative powers to impose a wide
range of penalties for councillor and staff misconduct, rescind
unconscionable council policy or by-laws, oversee councillor
privileges and disclosures, and otherwise act as an avenue of
appeal for disgruntled residents. Without a dedicated ombudsman
willing to respond on a broad range of matters, it is difficult to see
how trust in council representatives and officials can be
improved.
As we have seen, Victoria is braced for a rate-capping regime
for its councils commencing in the 2016/17 financial year. Like
all tax limitation measures the proposed rate-cap seeks to place
limits on council monopoly power. In addition, proponents of
rate-pegging suggest that the measure will enhance municipal
efficiency through the fiscal discipline imposed by revenue
constraints. However, the scholarly literature suggests that a rate-
cap will precipitate a number of unintended consequences,
specifically a reduction in the financial sustainability of local
government and a reduction in inter-municipal residential
revenue effort equity.
To date no empirical evidence has been provided in support
of these claims. This paper thus seeks to fill a gap in the
Australian local government literature. In particular, we
conducted a comparative analysis between Victorian and NSW
local government to determine whether almost four decades of
municipal tax limits in NSW had produced any measurable
differences in equity, sustainability or efficiency. We found
evidence which prima facie suggests that NSW councils have
lower levels of inter-municipal residential revenue equity, higher
levels of debt and diminished levels of asset renewals. Our
analysis of efficiency provided no conclusive evidence to support
the claim that rate capping enhances municipal efficiency. We
(2015) 17(1)
RATE CAPPING IN LOCAL GOVERNMENT
thus conclude that our analysis provides little support for rate-
capping. Indeed, our findings support the unintended deleterious
consequences cited in the international literature on property tax
limitations.
Against this background, populist politics apart, it is difficult
to understand why the Victorian Government seems determined
to proceed with rate-capping, particularly in light of the ILGRP72
Independent
Local
Government
Review
Panel’s73
recommendation that NSW abandon its rate-pegging regime.
Moreover, the recent announcement of a three-year cap on
Commonwealth FAGs to local government, coupled with
extraordinary superannuation imposts on Victorian councils of
around half a billion dollars suggests that the timing of the
introduction of rate-pegging in Victoria is ill-advised.
Our exploration of alternative methods of addressing the
avenues indicated by personal finance theory and agency theory
suggested several methods by which the Victorian Government
could address the pressures for rate-capping and thereby avoid the
deleterious effects of rate-pegging on Victorian local
government. The remedies indicated by personal finance theory
include encouraging councils to practice user pricing for non-
public services, removing a wide-range of rating exemptions,
providing information on price subsidies, establishing a national
local government infrastructure finance authority, and enabling
councils to implement rate rises incrementally on a quarterly
basis.
Policy alternatives informed by agency theory focus on
reducing information costs for residents (by producing more
detailed information on a timelier basis) and establishing a
dedicated local government ombudsman with broad powers to
sanction elected representatives and officials. If these remedies
72 Independent Local Government Review Panel, above n 3.
73 Ibid.
166
are applied, it may remove the need to implement a potentially
deleterious rate-cap regime.
(2015) 17(1)
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