Changing sources of local government revenue

Local Government New Zealand is investigating whether there are new ways for local councils to raise revenue, (see here).  Possible other funding methods suggested include:

  • Local Income Tax
  • Sharing Government Revenue
  • User Charges
  • Poll Tax
  • Local Expenditure Tax
  • Selective Taxes
  • Regional Fuel Taxes
  • Transaction Taxes

There are some legitimate reasons for exploring alternative methods for raising revenue, but it is important that the analysis does not confound two separate issues: how much funding should be raised and what methods should be used for raising these funds.  Ultimately the issue about funding levels is really about spending levels; the alternative to taxing more is always to spend less.  There is therefore a risk that initiatives to change the revenue base is simply a mask for raising tax levels.  In this sense the quote from Local Government NZ president Lawrence Yule raises some concerns:

"We don't just want extra money for the sake of it. If we want a first-world level of service, we're going to have to find a way to pay for it."

At first blush it appears to be an assurance that citizens will get value for money, but to me it also suggests that the main purpose of the review is to find ways of raising the level of local taxes, and ideally without people noticing (or at least not until it is too late). 

The one clear advantage of the rating system is its transparency: people know how much they are paying in local taxes and it is obvious when councils propose rate increases.  The risk with introducing alternative revenue systems is it increases the ability of councils to mask effective tax rises. 

Access to more funding streams also increase governments’ abilities to “divide and rule”.  This is because different funding systems will have unequal financial impacts on different segments of society; a rate increase will have different relative impacts than a change in user charges or a local expenditure tax.

However, this differential impact is precisely a reason why there is a legitimate reason for exploring alternative local tax systems.  It is impossible to design the perfect tax system, and any system will be a compromise between taxing everyone equivalently, reflecting people’s ability to pay, and distorting people’s economic decisions.  Thus for example, although a poll tax taxes everyone equivalently, it makes no allowance for differences in people’s ability to pay, and is thus commonly considered to be an unfair tax system. 

There are many positives about a rates system.  It effectively has universal coverage of citizens (people have to pay either directly or indirectly through their rents) and it is a progressive tax that reflects people’s relative wealth and ability to pay.  On the other hand, it takes no account of people’s cash flow (it can therefore cause strains for people who are asset rich but with low incomes); it can distort marginal investment decisions away from land intensive activities, and there are boundary issues with other regions and the rest of the world. 

The last of these is probably the most serious weakness of relying on a rating system for local government finance.  For example, commuters from neighbouring districts and tourists can impose costs on a council that must in the first instance be met by local rate payers.  Locals might increase their wage demands and businesses their prices to compensate, but the impact is potentially a loss of competitiveness that inhibits the local growth potential. 

More use of user charges could potentially help, but is likely to have limitations: it is difficult to charge visitors for their use of local roads, water reticulation, sewage, etc.    

Of the options suggested, the one that appeals most is the introduction of local expenditure taxes.  Local expenditure taxes:

  • could build on the existing GST infrastructure,
  • reflect an ability to pay as they are based on actual transactions,
  • would raise revenue for local services where economic activity is taking place, and
  • if the rate is set by central government it would provide a mechanism for fiscal responsibility. 

If introduced, it would ideally be undertaken in a fiscally neutral way.  That is, any increase in revenue from an expenditure tax would be balanced by an equivalent reduction in rate revenue.  A change in revenue base should be about improving fairness and/or reducing the extent that the tax system distorts economic decision making.  Increasing the amount of revenue collected by local governments is not about the tax system but rather about the appropriate size of local government operations, a decision that should be in the hands of the local electorate.

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