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National Financial Sustainability Study of Local Government

Commissioned by the Australian Local Government Association

November 2006

48317

Disclaimer This Report has been prepared by PricewaterhouseCoopers (PwC) at the request of the Australian Local Government Association (ALGA) in our capacity as advisors in accordance with the Terms of Reference and the Terms and Conditions contained in the Consultant Agreement between ALGA and PwC. The information, statements, statistics and commentary (together the “Information”) contained in this report have been prepared by PwC from publicly available material and from discussions held with stakeholders. The Consultants may in their absolute discretion, but without being under any obligation to do so, update, amend or supplement this document. PwC have based this report on information received or obtained, on the basis that such information is accurate and, where it is represented by management as such, complete. The Information contained in this report has not been subject to an Audit. The information must not be copied, reproduced, distributed, or used, in whole or in part, for any purpose other than detailed in our Consultant Agreement without the written permission of ALGA and PwC. Comments and queries can be directed to: Scott Lennon

Partner – Infrastructure Government & Utilities PricewaterhouseCoopers 201 Sussex Street Sydney NSW 2000

Phone: (02) 8266 2765 Email: [email protected]

Photo credits Cover page photos all from relevant local council websites and feature: • Blacktown library (NSW) • Brisbane Botanic Gardens (Qld) • Redfern Community Centre (NSW), and • Alice Springs Swimming Centre (NT).

mailto:[email protected]

Acronyms Acronym Meaning

ABS Australian Bureau of Statistics

ACLG Australian Classification of Local Governments

ACT Australian Capital Territory

ALGA Australian Local Government Association

AMP asset management plan

CFO Chief Financial Officer

CGC Commonwealth Grants Commission

CPI Consumer Price Index

DOTARS Department of Transport and Regional Services (Commonwealth)

EU European Union

FAGs Financial Assistance Grants

FAGs Act Local Government (Financial Assistance) Act 1995 (Cth)

GDP gross domestic product

GST goods and services tax

LCIRF Local Community Infrastructure Renewals Fund

LGANT Local Government Association of the Northern Territory

LGAQ Local Government Association of Queensland

LGASA Local Government Association of South Australia

LGAT Local Government Association of Tasmania

LGB Local Governing Body

LGGC Local Government Grants Commission

LGIS Local Government Infrastructure Services, Qld

MAV Municipal Association of Victoria

MPMP Municipal Performance Measurement Program in Ontario, Canada.

NCC National Competition Council

NCP National Competition Policy

NSW New South Wales

NSW LGSA NSW Local Government and Shires Association

NT Northern Territory

NZ New Zealand

PwC PricewaterhouseCoopers

Qld Queensland

QTC Queensland Treasury Corporation

Acronym Meaning

RA Rural Agricultural (ACLG category)

RS Rural Significant Growth (ACLG category)

RT Rural Remote (ACLG category)

R2R Roads to Recovery Funding Program

SA South Australia

SCEFPA Standing Committee on Economics, Finance and Public Administration

SPP Specific Purpose Payments

SSS Qld “Size, Shape and Sustainability” Review

Tas Tasmania

UC Urban Capital City (ACLG category)

UCV Unimproved Capital Value

UF Urban Fringe (ACLG category)

UM Urban Metropolitan Developed (ACLG category)

UR Urban Regional Towns/City

UK United Kingdom

WA Western Australia

WALGA Western Australia Local Government Association

PricewaterhouseCoopers

Contents

Executive Summary 3

1 Introduction 18

2 Overview of the local government sector 41

3 Financial governance and fiscal relationships 87

4 Analysis of financial sustainability of local government 95

5 Potential options for reform 119

6 Conclusions and recommendations 150

Appendix A Terms of Reference 157

Appendix B Definition of Financial Sustainability Indicators 159


Executive Summary

The Australian Local Government Association (ALGA) has commissioned PricewaterhouseCoopers (PwC) to undertake an independent analysis of the financial sustainability of local government in Australia. The full terms of reference and scope are provided in Appendix A.

The objective of this study is to assist ALGA, in collaboration with state and territory local government associations, to develop a detailed plan to:

• enable councils to better meet their fiscal obligations as well as the growing demands for infrastructure and services, and

• provide a sound approach for targeted support to local government for consideration by other spheres of government.

In summary, the terms of reference for this study require PwC to:

• assess the current and long-term viability of the local government nationally and by council types including the trends and differences,

• identify the key financial issues affecting financial sustainability,

• develop recommendations for improved financial sustainability (eg financial skills and potential sources of additional revenue), and

• investigate the merit of reforming intergovernmental funding to develop a new model to improve sustainability.

The intention of this project is to provide a high level strategic national study that draws on the detailed analysis of a number of state based sustainability studies, in order to provide an indication of the sustainability of the nationwide local government sector. The resources available to complete this study preclude an in-depth and individual analysis of each of the 700 councils. The diversity of the sector also makes it difficult to provide a detailed “how to” guide for improving sustainability that would apply to the varying circumstances of each council. Therefore, this study assesses key characteristics that contribute to the councils currently at risk of sustainability problems, and develops a range of internal and funding reform options that target these issues to improve the long-term sustainability of the sector as a whole.

Background

Con ext of Local Government t

Local government in Australia is a dynamic and diverse sector that combines the individual character and operations of councils.

Executive Summary 3


Councils are very diverse in size and shape from Brisbane City Council (population 950,000 and annual expenditure of approximately $1.7 billion) to very small councils like Jerilderie Shire (population 1,908 and annual expenditure $6.8 million). Consistent with these diverse characteristics, the financial position of individual councils also varies substantially.

Local government plays an integral role in the Australian economy and within local communities. In terms of economic activity, local government has an annual expenditure of over $20 billion, which represents around 2% of GDP, and employs around 1.3% of the Australian labour force. Moreover, local government provides a significant proportion of the essential services and infrastructure that underpins all local and regional communities. For the numerous regional and more remote communities local government is often the only institutional presence and one of the key drivers of economic activity.

The key benefits of the local government sector, as outlined by the Australian Government1, include that the sector’s:

• wide and established national network of public administration, including a significant presence in rural and regional Australia

• strong links to the community and that it is accountable to the communities it represents

• practical service orientation and good organisational skills, which make it capable of innovative, speedy and flexible responses

• deep links with local business and industry, which put councils in a good position to foster a ‘bottom up’ approach to regional development

• ability to provide information to support Commonwealth regional policy development and implementation, and

• function as an ideal entry point for access to information about other governments’ services and programs.

Increase in local government service scope

Over the past thirty years, the functions undertaken by local government in Australia have evolved with a generally expanded scope. Council services now generally include a range of social and human services in addition to the physical infrastructure of roads and waste, with some jurisdictions also providing water and waste water. Most local councils, due to community pressure, state and Australian Government inducements and the withdrawal of services by other levels of government, now provide a growing range of social and human services. Some smaller councils, due to constrained budgets have, by necessity, needed to contain their scope to the traditional services. The Intergovernmental Agreement on Cost Shifting, coupled with greater caution by councils prior to expanding services, may moderate recent levels of service expansion.

1 DOTARS, Submission No. 103., p. 39., in House of Representatives, SCEFPA, 2003, Rates and Taxes: A Fair Share for Responsible Local Government, p. 91

Executive Summary 4


This diversity in size and subsequent income streams has meant that councils have differing capacities to fund the requests by their communities for greater services. Managing these demands is particularly challenging for many councils that have a narrow revenue base or a revenue base that has seen only modest growth. Particularly for the 60% of councils that are rural and remote councils, of which many have experienced static or declining population bases, this translates to stable or declining council revenue. This is an ongoing challenge in the context of strong economic growth, which typically sees communities demanding a corresponding increase in local infrastructure and services. Consequently, individual councils have had mixed success in managing and funding community demands for more services whilst retaining a healthy financial position.

Efficiency improvements

Over the past decade there has been growing awareness and progress across the sector about the need to improve the efficiency and sustainability of local government. As such a large body of work has been undertaken over recent years, driven by state associations in addition to state and Australian Governments that analyses the sector and compiles evidence that a large number of councils are facing financial difficulties. This is part of an ongoing process of ensuring that there is a robust understanding of sustainability issues at the state and federal level.

As a consequence, over the past decade a number of councils have implemented a range of successful reforms to improve their efficiency and sustainability. Significant efficiency reforms have been achieved through the following approaches:

• outsourcing non-core operations, which was formalised in Victoria by the compulsory competitive tending (CCT) policy during the 1990s

• structural reforms that have included mandatory and voluntary amalgamations in New South Wales (NSW), Queensland, Victoria, South Australia (SA) and Tasmania to consolidate the local government sector

• commercialisation of services in order to increase the returns to local government, for example, the recent Local Government Infrastructure Services initiative in Queensland (see section 2.6 for further details)

• regional service delivery is a widespread practice among councils to deliver a range of services such as waste services, purchasing and procurement, road and infrastructure maintenance, and recruitment, and

• shared services where either a council or the state association becomes the lead provider for service provision, particularly for corporate services such as finance, and HR.

State based sustainability studies

The results of recently completed sustainability studies commissioned and funded by state local government associations in NSW, SA and Western Australia (WA) provided some of the impetus for this study. Each of these studies was managed by an independent board, with the analysis undertaken by Access Economics (Access). SA was the first state to complete such a study, with the results published in August 2005. This was followed by NSW (May 2006) and then the WA report in August 2006.

Executive Summary 5


The Municipal Association of Victoria (MAV) has also led the efficiency reform process undertaking considerable work on analysing the trends and long-term sustainability of local government finances in Victoria. The MAV has developed a viability index to measure the long-term viability of individual councils. It combines factors such as borrowings, unfunded superannuation liabilities (USL) and the cumulative deficit/surplus in capital expenditure versus depreciation. The MAV index analyses data since 1997-98 and compares this debt (both financial and any underspend on renewals) against rate revenues. Based on 2004-05 data MAV concluded that 10% of the 79 councils in Victoria are unsustainable.

In collating the results of the MAV study and the three separate Access studies it appears that around 35% of councils across these states are not financially sustainable. Access found that the proportion of unsustainable councils varies between 25% in NSW and 58% in WA. However, in observing these results it is important to note that the Access approach excluded capital grants from the operating results, which paints a more urgent picture of the sustainability of local government. In this PwC study, capital grants are viewed as an ongoing and important revenue source, the exclusion of which can overstate the extent of sustainability difficulties of local government.

Overall, this PwC Study is seeking to provide a strategic-level national assessment of the degree to which financial sustainability is a significant concern and, if so, to recommend options to assist councils in need.

Assessment of current and long-term viability of local government and the differences between types of councils

The recent state based sustainability studies have confirmed widespread concerns from a number of commentators that a sizable proportion of councils face long-term financial sustainability problems. Where councils report operating deficits or, more specifically, operating cashflow deficits, there is a strong tendency to defer or scale back renewals expenditure to upgrade existing infrastructure. This deferral of renewals, particularly in community infrastructure (eg community centres, swimming pools, libraries), has been a key factor in creating a backlog of renewals work.

This tendency by some councils to defer community infrastructure renewals arises because the other two broad categories of infrastructure (being water/sewerage and roads) have specific user charges to fund renewals or Australian Government grants (eg Roads to Recovery or R2R) to support periodic upgrading. Even with R2R a sizable proportion of rural councils still have ongoing challenges funding the adequate renewal of their local roads.

Our ability to accurately assess the financial viability and sustainability of different types of councils across Australia has been constrained by a range of data limitations, including:

• mixed approaches to measuring and recording financial data associated with inconsistencies between states,

• the infrequent asset re-valuations (typically 5 yearly) as well as differences in assumed asset lives impacting the accuracy of reported depreciation levels, and

Executive Summary 6


Executive Summary 7

• incomplete financial and asset management records particularly for smaller councils, including a large proportion of Northern Territory councils. A key data shortcoming across a large proportion of councils across the nation is accurate information on capital expenditure and renewals expenditure and inconsistent separation of maintenance, renewals and capital expenditure.

PwC has subsequently utilised two approaches to assess viability, namely:

i. Financial ratio analysis using a survey of 100 councils: PwC has obtained data from state/territory grants commissions which was then stratified to match both the proportion of councils per state/territory and the proportion of councils in each of seven Australian Classification of Local Governments (ACLG) size categories established by the Department of Regional Transport and Services (DOTARS).

ii. Extrapolation from state based sustainability results: from the three Access based inquiries (NSW, SA and WA) and MAV study in Victoria, PwC has extrapolated to provide an indicative estimate of the national sustainability gap and infrastructure backlog. The Access approach used a more sophisticated method to defining financial sustainability based on forward looking renewals and own-source revenue capacity. Similarly, MAV was able to obtain a better breakdown of capital expenditure directly from councils so as to estimate the likely infrastructure backlog and has examined the trends in Victorian financial viability over the medium term. Extrapolation is required as this PwC Study has a strategic or national focus and the scope does not encompass detailed individual council analysis as utilised by the state based studies to evaluate sustainability.


Executive Summary 8

Financial ratio analysis

Table E.1 provides a summary of a survey of the financial viability of 100 councils within the seven ACLG size categories developed by DOTARS. A full explanation and definition of these financial key performance indicators (KPI) can be found in Appendix B.

Table E.1: Summary of financial KPIs by ACLG

Financial Sustainability Summary KPIs

DOTARS category

% Councils with Interest Coverage <3(EBIT/borrowing

costs)

Median Operating

Surplus as a % of Total

Revenue

% Councils with Deficit greater than 10% of Total

Revenue

Median Sustainability

Ratio (capex/

depreciation)

% Councils with

Sustainability Ratio <1

Median current ratio

(current assets/current

liab.)

% of councils with current

ratio <1

Median rates coverage (%)(rates as a % of total expenses)

% of councils with rates

coverage <0.4

Urban capital city 40.0 5.0 28.6 2.0 8.0 4.5 14.3 55.8 0.0

Urban regional 41.7 4.2 16.7 1.3 0.0 2.8 9.1 66.5 16.7

Urban fringe 37.5 14.1 12.5 2.1 16.7 3.4 25.0 62.5 0.0

Urban development 41.7 7.6 8.3 1.6 0.0 1.0 50.0 65.2 0.0

Rural remote 28.6 10.3 18.8 2.3 8.3 2.6 12.5 25.4 87.5

Rural agricultural 32.6 11.7 15.9 1.7 0.0 2.6 20.5 42.4 54.5

Rural significant growth n/a -8.0 n/a 2.4 n/a 2.4 n/a 47.5 n/a

Average 35.8 10.0 16.0 1.8 8.0 2.6 21.4 47.9 40.4

The results above indicate that:

• Approximately 36% of councils have an interest coverage ratio (EBIT/interest) of less than 3. The interest coverage level of 3 generally represents a threshold where credit risk begins to be more significant and a large unexpected event with adverse cash flow implications can potentially place pressure on ability to meet interest payments.

• Councils have a median operating surplus of 10% of total revenue. However this is an unadjusted operating surplus in that it includes revenues which are committed to specific purposes (eg Section 94 developer contributions). Some 16% of councils also have an operating deficit of over 10% of revenue. Such councils have a tendency to defer renewals expenditure which creates a risk of developing maintenance backlogs.


• The median sustainability ratio (capex/depreciation) in this sample was 1.8:1. Some 8% of councils have a sustainability ratio of less than 1. The proportion less than 1 is understated as council asset values are often conservative with infrequent updates and many assets still in active use have reached their accounting life and are fully depreciated. Hence in reality, if asset values and depreciation amounts were more accurate, the national median sustainability ratio is likely to be closer to 1:1. A ratio of less than 1 indicates that the capital being consumed in an accounting sense exceeds the capital being replaced into the asset base.

• Councils have a median current ratio (current assets/current liabilities) of 2.6, however 21% are less than 1. The ratio of 1 is a key threshold for testing liquidity issues. In particular the urban fringe, urban development, rural remote and rural agricultural categories all have potential liquidity problems with 12–50 % less than 1.

• Councils across the nation have a median of 48% of costs covered by rates, ranging from 25% to 66%. Of concern is the fact that 87% and 54% of rural remote and rural agricultural councils respectively have rates covering less than 40% of costs creating a dependence on government grants.

Extrapolation from state based sustainability results The Access Economics and MAV results for NSW, WA, SA and Victoria are summarised in Table E.2. Both approaches use four main KPIs:

• Backlog in infrastructure renewals

• Underspend on existing infrastructure renewals per annum

• The estimated funding gap per annum to rectify the underspend and clear the backlog, and

• The percentage of councils assessed as unsustainable.

We understand that both the Access and MAV approaches to estimating the annual underspend on existing infrastructure renewals has taken into account existing Australian Government support to clear backlogs, primarily in the form of the R2R Program. However, the Access results exclude other capital grants, based on the premise that their inclusion would overstate the revenue available for operational activities. The PwC analysis is different in that data constraints have meant that all capital grants are included. This approach also recognises that all capital grants form an important and necessary part of local government revenue, and hence PwC reports a slightly improved sustainability in comparison to the Access results.

It is important to note that the MAV estimates are for the period from 1997-98 to 2004-05 due to concerns about the accuracy of the data recorded for non-current assets under the different accounting standards that applied prior to this period.

Combined, the NSW, Victoria, SA and WA represent around 63% of total national councils, 76% of the national population and 72% of the nation’s local roads. This provides an adequate sample to assess the sustainability position across the nation.

Executive Summary 9


However, the results between states vary; for example the average NSW council underspend is $3.3 million per annum compared with $0.3 million in SA. The more favourable sustainability results for SA appear to be mainly explainable by substantial parts of rural and remote SA (approximately 85% of SA land area) being unincorporated, or not subject to local council governance. Accordingly, the extent of council backlogs and underspend varies widely between NSW, WA, SA and Victoria.

The extrapolation results also need to be interpreted with some caution as the 259 councils which are yet to be analysed across Queensland, Tasmania and the NT are likely to have substantial variation. This is due to differing asset bases and income levels, factors such as whether (or not) water/sewer services are provided, and that this sub-set contains proportionally more Indigenous councils (which generally have relatively less extensive asset bases). Further analysis of the specific renewals backlogs in Queensland, Tasmania and the NT appears to have merit and would reduce the need for extrapolation. Nevertheless, the results to date potentially provide sufficient data to extrapolate a range for the likely national position in term of backlogs, underspends and gaps. To develop this range we have applied three cases:

• Low case: where we apply the average of WA, Victoria and SA average result per council to 259 councils in Tasmania and the NT.

• Mid case: where we apply the WA, Victoria, SA and NSW average result per council to 259 councils in Tasmania and the NT. Under this approach, an indicative estimate of the potential aggregate backlog for all 700 Australian local councils across the country is approximately $14.5 billion with an annual renewal underspend of $1.1 billion creating a funding gap2 to clear the backlog and correct the underspend of $2.16 billion. Based on the results for NSW, WA, SA and Victoria, the jurisdiction analysis results also suggest that approximately 35% of councils are currently unsustainable.

• High case: where we apply the NSW, Victoria and WA average result per council to 259 councils in Tasmania and the NT.

In assessing the types of councils which are more viable, whilst there will always be numerous exceptions, the councils with stronger financial positions are generally those with reasonable scale in operations and population (more often, larger urban or regional councils). Such councils typically have stronger rates income and economic bases with more sophisticated asset management and financial governance systems. The less financially viable councils tend to be smaller (often rural, remote or small metropolitan), usually with constrained own-source revenue streams and a lack of economies of scale compounded by weaknesses in financial and asset management capabilities. However, there is also a proportion of larger councils with viability problems arising due to a range of factors. These include:

• significant expansion into new services

• a suppression of rates rises to improve voter appeal, and

2 In summary, the Access Economics methodology measures the annual infrastructure funding gap as the difference between the required annual spend on renewals as indicated by annual depreciation expense and the amount actually spent.

Executive Summary 10


• some elements of ineffective cost management whereby the level of expenditure controls and budgeting processes to manage cost growth may not have been adequate.

Table E.2: Infrastructure backlog estimate, extrapolated from Access Economics and MAV results

Access Economics & MAV Financial Sustainability Summary Results

Backlog in infrastructure

renewals ($m)

Underspend on existing

infrastructure renewals per annum ($m)

Est. funding gap per annum ($m)

(to cover backlog & annual underspend) to be generated via

savings or extra revenue/grants

Est. funding gap per council per

annum ($m)

% of councils unsustainable

NSW (152 LGBs - Access) $6,300 $500 $900 $5.9 25%

SA (68 LGBs - Access) $300/1 $20 $40 $0.6 38%

WA (142 LGBs - Access) $1,750 $110 $220 $1.5 58%

Vic (79 LGBs - MAV) $806/2 $81 $203 $2.6 10%

Total NSW/WA/SA/Vic (441 LBGs: 63% of LGBs, 76% population & 73% of local road km) $9,156 $711 $1,362 $3.1 35%

Low Case National Estimate (700 LGBs) (apply WA, Vic and SA average result per council to 259 councils in Qld, Tas & NT) $12,012 $922 $1,826 $2.6

Mid Case National Estimate (700 LGBs) (apply WA, Vic, SA and NSW average result per council to 259 councils in Qld, Tas & NT) $14,533 $1,129 $2,163 $3.1 35%

High Case National Estimate (700 LGBs) (apply NSW, WA, Vic average result per council to other 259 councils in Qld, Tas & NT) $15,305 $1,190 $2,281 $3.3

Notes: 1. Access estimate for SA based only the backlog developed over last 10 years and full backlog will be higher. 2. MAV estimate of infrastructure backlog is in 2003-04 dollars, for the period between 1997-98 – 2003-04, hence is understated.

The estimated funding gap to clear both the backlog and to cover the annual underspend on renewals is $3.1 million per council per annum or $2.16 billion nationally. The pie charts below compare the actual 2004-05 local government revenue base with the revenue base required for financial sustainability.



2004/05 local govt revenue, $21.4 billion & sources Required revenue pa $23.56 billion & sources including the

funding gap (mid case gap: $2.16 billion pa),

Funding gap

For financial sustainability this 9% funding gap must be covered over the medium term. This appears best likely to be achieved through a combination of initiatives including further increases in efficiency, higher user charges and rates, as well as further grants support from other spheres of government.

Synthesising the findings of the state based reports and the PwC Analysis The results of the Access and MAV state based sustainability studies and the PwC analysis both confirm that a significant part of the local government sector has financial sustainability problems. The PwC estimate that approximately 10% to 30% of Australia’s councils have sustainability issues broadly reflects the results of the state based reports that between 25% and 40% of councils, in the states analysed, could be unsustainable.

Common findings across these studies are that councils with sustainability issues are likely to be developing infrastructure backlogs due to service expansions, moderate operating cost growth, minimal revenue growth giving rise to persistent underlying operating deficits and constraints on renewal expenditure. Hence, such councils have a funding gap between current and required revenue to enable them to clear the backlog and lift renewals expenditure to the optimal level.

Further broad conclusions can be drawn from the PwC analysis, when the survey results are segmented into the seven DOTARS council categories:

• The majority of larger metropolitan councils are generally viable or have the ability to self-effect an improvement in financial sustainability. Some metropolitan council’s have become over stretched generally due to service expansions. Further use of community consultations and use of flexible user pays systems may assist in effective prioritisation of local government services and infrastructure.

9% Other 21%

Taxation Taxation revenue revenue (rates) (rates) 35%Other 38% 19%

Sales of Current grants Sales of goods Currentgoods and and subsidies and services

grants and services 9%28%31% subsidies

10%



• Urban fringe councils are mixed as some have large viability issues with some scope for internal improvements, while others are in a strong position with only minor scope for internal reform. Hence, only some of these councils appear to be dependent on additional government funding to restore sustainability.

• Rural remote and rural agricultural councils generally have more pronounced viability problems. These councils typically have relatively larger scope for internal reforms, however they often battle against lack of scale, and extra funding for renewal of existing community infrastructure is required for most.

While significant progress has been made by local government to increase their financial management effectiveness and understand the need for robust asset management plans (AMP), this analysis suggests internal reforms alone will not resolve sustainability issues for a large part of the local government sector. Hence, such councils may need to either reduce existing services/assets, or to seek additional revenue. As council own-revenue options are limited, this lends significant merit to consider reforms to intergovernmental transfers.

Key financial issues impacting financial sustainability The common characteristics of councils typically facing financial sustainability constraints often include:

• minimal (or negative) revenue growth

• cost growth which has typically exceeded revenue growth. Expenditures have been rising by an average of CPI +2-3% per annum. This cost growth is mainly due a combination of factors including a rising skill level required for most senior roles requiring higher remuneration, award wage rises of typically 4% per annum for most mid to lower level roles, stronger cost escalations in the maintenance and construction sectors as well as service diversification. The divergence between cost and revenue growth can lead to operating deficits which in turn are often partly funded by deferring some infrastructure renewals expenditure

• increasing involvement in non-core service provision due to escalating community demands, coupled with a related tendency by some councils to ‘step-in’ to provide a non-traditional service

• a tendency by some councils to run operating deficits creating a need to defer or underspend on renewal of infrastructure, particularly community infrastructure which is often repeated annually creating a backlog

• limited access for some councils to strong financial and asset management skills which are critical to identifying sustainability problems, optimising renewals expenditure and improving revenue streams, and

• a small proportion of councils also have limited access to rate revenue due to relatively small annual rate increases and a low initial rating base.



The sample of 100 councils together with the state based sustainability results indicate that local government needs to generate more cash flow to adequately maintain and renew infrastructure – particularly community infrastructure.

The recent sustainability inquiries have significantly improved the understanding of the local government sector of the sustainability problem. Councils have, and are, undertaking substantial ongoing efficiency reform programs to improve financial viability. However, for many councils (more often rural, remote and urban fringe), despite making sizable improvements in efficiency, there will be a need to either reduce services or downsize their asset base unless additional revenue can be secured. In assessing how to increase own-source revenues, the councils with sustainability issues often have limited options, which mean that a rise in intergovernmental transfers appears the most appropriate solution.

Some council’s are also experiencing financial challenges due to significant population growth (eg sea and tree change areas) as infrastructure is augmented to meet demand. However, over the longer term, once the transitionary impacts moderate, a larger scale population, coupled with a modern asset base and sound asset management practices, should improve the prospects for such councils to be financially sustainable.

What could be achieved through improved funding of local government?

Improved funding for local councils, particularly for the renewal of community assets, would assist local communities by enabling councils to return important community infrastructure to acceptable levels of condition. In conjunction with improved financial and asset management practices, more appropriate funding levels for local government infrastructure and related services would help to ease the pressure of operating deficits. In addition, such extra funding would support the clearance of backlogs in renewals expenditure (identified by Access and the MAV) and then also support more regular periodic maintenance to retain service levels.

Importantly, additional funding would assist local government to take full advantage of their ability to flexibly gauge and respond to the changing demands at a community level. With increasing demands for a broader scope and higher standard of community services and infrastructure, it is important that local government has the resources to ascertain the priorities of the community, and to subsequently inform and consult with the community on the trade-offs of council provided infrastructure and services.

Enabling a council to respond directly to the service and infrastructure demands of an informed community would:

• Strengthen local communities by ensuring an adequate standard of facilities for the ongoing provision of a range of significant social and recreational services.

• Provide for greater choice and consultation on council provided services and infrastructure, and encourage more participation in community activities raising levels of inclusion and wellbeing. This would promote increased community cohesion and safety, particularly in rural areas.



• Enable the implementation of local programs that recognise the diverse needs of communities and support cultural diversity, access and equity, equal opportunity, involving minority groups.

• Support sustainable environmental strategies for each community to improve local environmental outcomes.

• Enhance business and community links with regional areas to promote regional equity and development.

• Promote further economic development and the generation of employment benefits through links with the business community.

• Improve the quality of life of local residents through the support and alignment of health and welfare agencies within the area, and

• Support local recreation, arts and culture and an appreciation of heritage in order to promote vibrant and active communities.

Recommendations

PwC has developed recommendations based on a ‘twin track’ approach for improving financial sustainability through the pursuit of:

i. Internal reforms by some councils to improve their efficiency and effectiveness.

ii. Suggested changes to intergovernment funding for improved financial sustainability to primarily assist the types of councils with sustainability challenges).

Internal reforms required by some councils

Local government is a key sphere of government in its own right and it has management structures to competently deliver on its core accountabilities.

A sizable proportion of councils, including the vast majority of the larger councils, have made significant progress in reforming operations to improve efficiency and many of these councils now only need to focus on continued improvement through productivity gains, which all entities should pursue. While the sustainability report undertaken in SA indicated that sustainability is more linked to policy and skills rather than size, evidence from other states indicates that scale, and implicitly size, does assist in improving sustainability. It is likely that this divergence in results is largely due to the majority of SA being an unincorporated zone, which would minimise the incidence of rural councils that cover large areas with a small population base and limited opportunities for economies of scale. Overall, some council’s still have scope to further improve their efficiency and effectiveness mainly by improving their scale, financial management and asset management.



Recommendations to improve council internal performance practices are targeted at the four key objectives, outlined below. In making these recommendations it is acknowledged that due to the extensive divergence between councils, the applicability of each recommendation will vary between each council. Moreover, the sustainability work led by state based local government associations has led to the implementation of a number of focussed programs, with progress underway to address the key themes of these recommendations.

Improving efficiency, effectiveness and scale

• Further realise the gains from greater economies of scale and reduce unit costs via approaches such as regional or shared service provision, outsourcing, use of state-wide purchasing agreements etc.

Expanding own-source revenue

• Work with state government to remove or relax legislative impediments and improve the capacity of local government to raise revenue from its own sources.

Set clear and appropriate priorities

• Establish a robust long-term service plan which defines what council will provide and how services will be undertaken.

• Exercise caution prior to stepping in to attempt to resolve regional, state or national issues without a sound funding plan.

• Secure long-term funding (not just capital grants) prior to new services and infrastructure.

Deepen asset management and financial capacity

• Work with other spheres of government to facilitate improved asset management and financial skills through government-funding programs (eg the Size, Shape and Sustainability Review in Queensland and the MAV Step Program), to lift the skills in all councils to a reasonable base level.

• Use total asset management plans and systems to better manage asset renewals and replacement, and integrate into broader long-term council objectives.

• Undertake more regular asset condition reporting for key infrastructure.

• Develop nationally consistent local government financial and asset management data. There is a need for a new national program to improve the consistency and quality of council data to enable more robust and accurate analysis and planning and to produce a uniform national approach to measuring viability and financial sustainability. Ideally this would be supported by the Australian Government.



Suggested reforms to inter-government transfers

PwC sees significant merit in some reforms to intergovernment transfers, but these need to be targeted to primarily assist the types of councils with sustainability challenges. The specific suggested reforms to intergovernment transfers are:

• Establish a new Local Community Infrastructure Renewals Fund (LCIRF): this fund would support councils in the more timely funding of renewals work across a range of community infrastructure assets including community centres, aged care facilities, libraries, health clinics, sport and recreation facilities. The fund could be distributed based on relative need use the R2R or FAGs distribution methods, or perhaps through a new or hybrid approach. The size of LCIRF could be set so as to provide a similar level of renewals support as provided by R2R, which is around $200-250 million per annum.

• Revise the escalation methodology for FAGS from a mix of population growth and CPI, to a new escalation formula tailored more to local government cost movements (eg a combination of the ABS Wage Cost Index and Construction Cost Index coupled with population growth).

• Make funding for the Roads to Recovery Program permanent: this program has delivered substantial benefits and there would be significant merit in extending its duration and further augmenting funding levels (including escalating the program size by the ABS Construction Cost Index).

• State governments to provide funding support to encourage the local council efficiency and asset management reforms: a significant proportion of councils have inadequate in-house skills to improve efficiency and to establish robust asset management and financial plans. There would be significant benefit in state governments providing partial funding to aid the development of tailored state-based reform programs. This program might be along the lines of the support provided by the Queensland Government ($25 million over five years) in the Size, Shape and Sustainability Program, and the Step Program developed by MAV.



1 Introduction

1.1 Background

Over the past thirty years the role and functions undertaken by most councils in Australia have continued to evolve and expand. The changing structure of Australian governance has seen the scope of council services diversify from the provision of physical infrastructure, such as roads and waste, to greater involvement in advocacy, social and human services. This diversification has generally been met by a relatively narrow revenue base, often with limited opportunities for increases in funding or own-source revenue. Some smaller councils, due to funding constraints, have primarily retained the traditional services.

With over 700 individual local governing bodies, the local government sector is extremely diversified. Hence, the ability of individual councils to adapt to the changing financial and political environment has been mixed. Inevitably, for every conclusion drawn about particular types of councils there are always a number of exceptions.

Local government refers to councils established under state legislation as well as declared bodies, which are provided with Commonwealth financial assistance grants and are treated as councils for the purposes of grant allocations. Declared bodies do not have the same legislative requirements as councils, and include Outback Areas Community Development Trust in SA, the Roads Trust in NT, and certain Indigenous community councils and outback communities such as Tibooburra and Lord Howe Island. References to council throughout this report also include declared bodies.

The financial position of councils varies from larger population councils in metropolitan/regional areas with typically strong rate income and economic bases and more sophisticated asset management and financial governance systems, to rural/remote councils with typically small populations and extremely restricted own-source revenue streams compounded by problems associated with declining populations and skills shortages. Long-term financial sustainability is a growing concern for many council’s, not limited to the rural/remote councils, that are facing constraints to their managerial capacity and financial resourcing. Evidence from SA suggests that differences in council size and location play a relatively minor role in explaining the incidence of operating deficits and substantial infrastructure renewal/replacement backlogs, with this result being influence by substantial parts of SA being unincorporated (not serviced by local councils). By contrast, MAV analysis suggests that rural councils are more likely to have ongoing operating deficits and infrastructure backlogs whilst outer metropolitan councils are more likely to have operating deficits

Common characteristics of councils typically facing financial sustainability constraints often include:

• generally minimal or negative revenue growth. A small proportion of councils also have limited access to rate revenue due to relatively small annual rate increases and a low initial rating base

Introduction 18


• cost growth which has typically exceeded revenue growth. Expenditures have been rising by an average of CPI +2-3% per annum. This cost growth is mainly due a combination of factors including a rising skill level required for most senior roles requiring higher remuneration, award wage rises of typically 4% per annum for most mid to lower level roles, stronger cost escalations in the maintenance and construction sectors as well as service diversification. The divergence between cost and revenue growth can lead to operating deficits which in turn are often partly funded by deferring some renewals expenditure

• limited access for some councils to strong financial and asset management skills which are critical to identifying sustainability problems, optimising renewals expenditure and improving revenue streams

• increasing involvement in non-core service provision due to escalating community demands, coupled with a related tendency by some councils to ‘step-in’ to provide a non-traditional service, and

• a tendency by some councils to run operating deficits with a growing inability to meet all costs with available income leading some councils to:

− defer or underspend on renewal of infrastructure, particularly community infrastructure which is often repeated annually creating a backlog operating deficits

− increase use of overdraft debt, or

− extending the days until creditors are paid.

There is growing awareness of the financial difficulties facing a significant proportion of councils through the numerous local government inquiries and studies that have been completed in recent years. However, further work is required in developing tangible options to reform both funding and local government practices in order to improve the long-term financial sustainability of the sector.

Introduction 19


1.2 Objectives and scope of this study

The Australian Local Government Association (ALGA) has commissioned PricewaterhouseCoopers (PwC) to undertake an independent analysis of the financial sustainability of councils in Australia. The full terms of reference and scope are provided in Appendix A.

The intention of this project is to provide a high level strategic national study that draws on the detailed analysis in a number of state based sustainability studies, in order to provide an indication of the sustainability of the nationwide local government sector. The resources available to complete this study preclude an in-depth and individual analysis to be undertaken of each of the 700 councils. The extensive diversity of the sector also makes it difficult to provide a detailed “how to” guide for improving sustainability that would apply to the varying circumstances of each council. Thus, this study assesses key characteristics that contribute to councils becoming at risk of sustainability problems, and develops a range of internal and funding reform options that target these issues and attempt to improve the long-term sustainability of the sector as a whole.

The objective of this study is to assist ALGA, in collaboration with state and territory local government associations, to develop a detailed plan to:


• provide a sound rationale and model for appropriate and targeted support to local government for consideration by other spheres of government.

This is to be achieved through the completion of the following terms of reference:

• assess the current and long-term viability of the local government sector at the national, state and local level

• identify the key financial issues affecting the financial sustainability of local government at each level

• identify the trends and/or differences between groups of councils based on specified characteristics using the DOTARS council categories

• develop recommendations for improved financial sustainability of local government including financial governance and potential sources of additional revenue, and

• investigate the appropriateness of reform to intergovernmental financial transfers with a view to developing a new model for intergovernmental financial relations that will facilitate financial sustainability of local government.

Introduction 20


1.3 Our approach

In undertaking this study PwC worked with ALGA and state and territory local government associations to determine the key constraints faced by councils and to identify potential reform options to improve financial sustainability.

This study benefited from the growing body of work that has been undertaken in relation to the financial sustainability of local government in a number of jurisdictions across Australia. This includes both the sustainability reports commissioned by a number of state local government associations as well as reviews undertaken by the Australian Government. Hence, an extensive literature review of previous relevant reports was completed in order to ensure this study takes into account all previous findings and research approaches. The following reports were critical inputs to this study, with other useful sources listed in the bibliography:

• Financial Sustainability Review Board 2005, Rising to the Challenge: Towards Financially Sustainable Local Government in South Australia

• Independent Inquiry into the Financial Sustainability of NSW Local Government 2006, Are Council’s Sustainable?

• Systemic Sustainability Study June 2006: Access Economics, Local Government Finances in Western Australia

• House of Representatives, Standing Committee on Economics, Finance and Public Administration (SCEFPA) 2003, Rates and Taxes: A Fair Share for Responsible Local Government: Final Report

• Department of Transport and Regional Services 2006, Local Government National Report: 2004-05 Report on the Operation of the Local Government (Financial Assistance) Act 1995.

A widespread stakeholder consultation process was conducted in order to supplement the information and data available in the public domain. The local government association, department of local government and local government grants commissions in the majority of states and territories were consulted. These consultations provided an important insight into the specific issues and constraints faced within each jurisdiction. The stakeholder consultation process was instrumental in collating data and relevant information on the local governments sector in each jurisdiction.

PwC then reviewed the available information and data in order to assess the financial sustainability of the seven upper level categories of the Australian Classification of Local Governments (ACLG). Our ability to accurately assess the financial viability and sustainability of different types of councils across Australia has been constrained by a range of data limitations, including:

• mixed approaches to measuring and recording financial data associated with inconsistencies between states

Introduction 21


• incomplete financial and asset management records particularly for smaller councils, including a large proportion of Northern Territory councils. A key data shortcoming across a large proportion of councils across the nation is accurate information on capital expenditure and renewals expenditure and inconsistent separation of maintenance, renewals and capital expenditure, and

• the infrequent asset re-valuations (typically 5 yearly) as well as differences in assumed asset lives impacting the accuracy of reported depreciation levels.

Hence, there is a need for programs to develop nationally consistent local government financial and asset management data in order to improve the quality of the analysis and recommendations to improve the local government sector. Ideally this would be led by the Australian Government in order to achieve optimal results.

PwC has subsequently utilised two approaches to assess viability namely:

i. Financial ratio analysis using a survey of 100 councils: PwC has obtained data which were then stratified to match both the proportion of councils per state/territory and the proportion of councils in each of seven DOTARS size categories.

ii. Extrapolation from the MAV and Access Economics state based sustainability analysis: from the three state based inquiries (NSW, SA and WA) and from analysis undertaken by the MAV, PwC has extrapolated to provide an indicative estimate of the national sustainability gap and infrastructure backlog. The Access and MAV approaches used more sophisticated KPIs to assess financial sustainability based on forward looking renewals and own-source revenue capacity. Extrapolation is required as this PwC Study has a strategic or national focus and the scope does not include detailed individual council analysis as utilised by the MAV and Access to evaluate sustainability.

A two-tiered suite of reform options to both the internal operations of the local government sector and the funding streams to the sector was then developed in collaboration with ALGA and the state and territory local government associations.

Introduction 22


1.4 Local government and reforms across Australia

Over the past decade there has been growing awareness across the sector about the need to improve efficiency and financial management skills to enhance financial sustainability. As such a large body of work has been developing over recent years that analyses the sector and compiles evidence that a large number of councils are facing financial difficulties. Resultantly, significant reforms have successfully achieved numerous improvements to efficiency and sustainability of local government across Australia.

Improving the financial sustainability of the local government sector is not limited to Australia, with a large number of relevant international studies also being completed. This report draws on this prior work and the section below summarises the key local government reviews and some of the reforms that have been completed in various jurisdictions, the findings of which will be incorporated into this review.

Table 1.1 below provides a summary of the number of councils, average population per council, and average geographic size (km2) per council. The number of councils used in this table is based on the number of local government bodies eligible for Financial Assistance Grants (FAGs) in 2004-05, hence the total number of councils in each jurisdiction may differ to information presented elsewhere. The NT has the smallest population and average land area per council, as these averages only include the incorporated areas of each jurisdiction and sizeable parts of NSW, NT and SA are unincorporated (ie without council coverage and services.

Aside from the ACT, Victoria has the largest average population per council due to the extensive amalgamations in the 1990s, while WA has the largest average council size due to the sheer size of the largest Australian state, which is entirely incorporated.

Introduction 23


Table 1.1: Local government in Australia, by jurisdiction & size, 2004-05

Jurisdiction Number of councils1 Ave pop/council3 Ave council size (km2)

NSW 155 43,900 5,200 km2

Vic 80 63,000 2,800 km2

SA4 74 25,100 3,300 km2

WA 142 14,300 17,800 km2

Tas 29 16,800 2,200 km2

NT 63 3,200 1,060 km2

Qld 157 25,500 11,000 km2

ACT na 326,700 2,400 km2

Total National Ave. (excl. ACT) 700 26,800 6,020 km2

1. Source: DOTARS 2006, 2004-05 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p.5.

2. Population est., December 2005. 3. SA, NSW and NT estimate of ave. council size (km2 ) only includes the incorporated land area.

The section below provides a summary of local council position in each jurisdiction.

1.4.1 Existing local government financial governance and audit controls All local councils across Australia are already subject to frameworks of financial governance, audit and other controls. These frameworks are generally specified in state based local government Acts. The frameworks are designed to ensure a transparency and openness on financial arrangements and accountability of councillors and senior council management.

In summary, councils are generally required to:

• present their financial statements for an annual independent in order to verify their accuracy. These audits are undertaken by state government audit offices or by chartered accounting firms with the auditor being specifically required by law to report any irregularity to the relevant Minister. The accounts are generally audited against all financial and performance requirements contained within the Local Government Act and is conducted against international or national accounting standards

• obtain approvals from state departments of local government prior to committing to major financial initiatives eg new debt, public private partnerships

• prepare a detailed annual management plan including budget and 5-10 years financial forecasts

• publish an annual report which is freely available (in some jurisdictions these are also tabled in parliament), and

Introduction 24


• establish an audit committee to provide an additional oversight of the audit process and outcomes as well as on the effectiveness of internal control and risk management.

The state local government associations, as well as some state departments of local government, have provided extensive support to councils in improving the effectiveness of their financial governance.

1.4.2 South Australia The Local Government Association of SA commissioned the Financial Sustainability Review Board to undertake an independent inquiry into the current and future financial position and sustainability of councils in SA. The final report titled, Rising to the Challenge: Towards Financially Sustainable Local Government in South Australia, published in August 2005, found that 26 of SA’s 68 councils, representing 38% of councils or one-third of the State’s population, are categorised as financially unsustainable.

The report showed that the financial situation varied significantly across councils, with approximately one-third of SA councils estimated to be in a moderately comfortable position, whilst only a small proportion of these councils had policies and practices in place that lock in their financial sustainability.

The inquiry also found that councils had large operating deficits and were funding them through decreasing their level of infrastructure maintenance. Currently, in aggregate, councils recorded annual operating deficits amounting to $49.2 million in the 2003-04 year. For the SA councils recording operating deficits in 2003-04, their average deficits were the equivalent of 12.5% of their annual rates revenue. The accumulated negative net outlays for infrastructure renewal/replacement are estimated to form a backlog in excess of $300 million.

The following factors were found to contribute to the financial position of ‘unsustainable’ councils:3

• weaknesses in financial governance practices and policies of councils, as indicated by deficiencies in council spending and funding policy frameworks

• relatively low levels of commonwealth and state government funding which are generally falling as a proportion of council revenue

• cost pressures on councils as a result of the increasing cost of complying with escalating regulations and real or apparent cost shifting primarily by the state government

• a state government freeze on council rate rises in the late 1990s

• ratepayer pressure for rates increases below those necessary to fund increasing service levels

3 Financial Sustainability Review Board 2005, Rising to the Challenge: Towards Financially Sustainable Local Government in South Australia, August 2005, p.4.

Introduction 25


• past policies responsible for service levels and standards in excess of those which could be sustainability funded by councils themselves

• deficiencies evident in asset management practices and associated depreciation and asset valuation policies, and

• widespread reluctance to borrow even when it is prudent to do so.

In interpreting these results it is important to bear in mind that 85% of the land area in SA is an unincorporated zone, meaning it is not covered by a local government. As such, SA does not have councils with tiny populations spread over large remote areas, which are often the types of councils with the largest sustainability issues in other states. Thus, SA is in a better position to improve the sustainability of the local government sector as the local government sector does not incur the cost of servicing remote communities, as is the case in many parts of the NT, WA, Queensland and NSW.

The SA Financial Sustainability Review Board made 62 recommendations primarily to the Local Government Association of SA (LGASA). All of these have been endorsed in full or in principle by the LGASA which has instigated a $400,000 Financial Sustainability Program in response. In response to these findings the LGASA has or is in the process of:4

• establishing a Financial Sustainability Advisory Committee

• finalising and publishing a series of information papers

• finalised a council and CEO checklist to assist councils and as a mechanism to survey council progress

• implementing projects designed to assist councils with long-term financial planning and with infrastructure and asset management planning

• developing training and briefing programs to further assist councils, and

• working with other governments on intergovernmental issues.

1.4.3 New South Wales There are currently 152 councils in NSW representing some 6.7 million residents, with almost 44,300 NSW residents per council on average5.The Local Government and Shires Associations of NSW (LGSA) commissioned an independent inquiry into the financial sustainability of local government in NSW that was completed in May 2006.6

The Inquiry estimated that the deficiency in capital spending (infrastructure renewal gap) for all council purposes is between $400 million and $600 million per annum7. This represents an annual deficiency of between $2 million and $4 million per council or between $60 and $90 per head of resident population in NSW.

4 Further information can be found at http://www.lga.sa.gov.au/site/page.cfm?u=769 5 Department of Planning NSW 2005, estimated resident population. 6 For further information see http://www.lgi.org.au/7 Independent Inquiry into the Financial Sustainability of NSW Local Government 2006, Are Councils

Sustainable? Final Report: Findings and Recommendations May 2006, p. 24.

Introduction 26

http://www.lgi.org.au/


The annual capital spend deficit contributes to a current infrastructure renewal backlog of over $6.3 billion which is equivalent to almost $42 million per council or close to $1,000 per head of resident population in NSW. Even before accounting for future infrastructure enhancements, this backlog is expected to grow to around $21 billion by 2021 if the ongoing renewal gap is not closed.8

The infrastructure renewal backlog is expected to increase at a rate of around 16% per annum while council per capita revenues and expenses are expected to grow in real terms by up to 9% per annum. In other words, in the absence of policy change, the ‘gap’ that exists between infrastructure renewal requirements and council per capita revenues is expected to be around 7% per annum to 2021.

The inquiry reports that additional functions and pressures on local government could result in council expenditure growth doubling in the absence of policy change. A move toward full cost-recovery and increasing rates, charges and fees to levels equivalent to the top 25% of councils as a means of matching this growth in expenditure with revenue growth, would be insufficient to eliminate the operating deficits of most councils.9

The inquiry reported that the long-term financial sustainability for at least 38, or 25%, of NSW councils is threatened without substantial grant and/or rate increases and/or disruptive expenditure cuts. These are councils whose prospects are for double digit operating deficit ratios after allowing for emerging pressures.

The study contained a suite of recommendations to reform both funding and internal local government practices in order to improve their overall sustainability. The recommendations revolve around:

• Boosting supply including through removing rate pegging (in whole or part), broadening the tax base, removing tax exemptions, accruing unpaid rates to estates with an interest charge and increasing statutory fees and fines.

• Reducing demand including through charging for services, and/or imposing or tightening eligibility rules

• Revising obligations through measures that include re-setting standards and re-negotiating with other tiers of government the nature or application of their statutory obligations

• Re-ordering priorities including through resisting future cost and responsibility from other tiers of government where legally possible and adopting ‘zero-based’ budgeting

• Pursuing efficiencies through measures which include benchmarking operational practices and results against other organisations, greater sharing of resources and changing procurement practices

8 ibid, p. 24. 9 ibid, p. 25.

Introduction 27


• Improving capacity through raising the management and governance capacity of both elected councillors and professional staff, which will include clarifying roles and responsibilities of each party, and setting milestones for monitoring performance.

As part of the proposed next steps, the inquiry recommended (recommendation 49) the establishment of an independent commission consisting of representatives from the LGSA NSW and the state to examine the problems facing local government and make recommendations for action. Subsequently the LGSA initiated the Strengthening Local Government Program to respond to the findings and recommendations of the inquiry. The program is led by the Strengthening Local Government Task Force comprising a range of local government stakeholders, and, as a permanent observer, the NSW Department of Local Government.10 The task force is supported by six working groups covering the following issues:

• intergovernmental relations and community relations

• financial management

• corporate governance and performance measurement

• resource optimising and capacity building

• promoting local government leadership, and

• land use planning.

10 For further details see: http://www.lgsa.org.au/www/html/1418-strengthening-local-government.asp

Introduction 28


Text Box 1: Queensland’s Size, Shape and Sustainability Review

Overview of the Qld SSS Review The Queensland State Government has committed $25 million to support SSS over five years, with approximately $3 million to be spent on investigations for participating councils and the balance spent on supporting the implementation of reforms. The program commenced in July 2006 and is expected to be completed by early 2008.

The SSS program encourages councils to examine (among others) four main options for change through a regional collaborative process. The options for change focus on resource sharing through service agreements, resource sharing through joint enterprises, significant boundary change, and amalgamation. To ensure the strengths and weakness of all options for change are thoroughly investigated, a comprehensive review framework has been developed by the LGAQ.

The key steps are:

1. Explore options and partners: involves scanning councils to identify those that could benefit from changes in structural arrangements. This scan is to reveal the key issues, reform options and resources to be provided to each council.

2. Information gathering, research and analysis: in-depth exploration of the issues raised by the scan and gathering information from the communities involved. This step will result in a preliminary report exploring the advantages and disadvantages of different structural arrangement options.

3. Community engagement: consultation with the community on reform options.

4. Councils determine structural change option: A decision is made regarding whether to implement any of the options examined.

In addition to providing a reform package, the LGAQ has recommended a number of models to obtain cost savings and improve sustainability, amongst which were:

• Retain processes that require unique ad hoc local knowledge and are strategic

• Outsource non-strategic, low risk, rule based activities or high volume transaction processing

• Share or outsource to gain access to latest technology without ongoing significant capital investment or a requirement for a specialist expertise; and

• Share or outsource to gain expertise, which the local government could not otherwise afford.

1.4.4 Queensland The local government sector in Queensland completed a series of reforms throughout the 1990s which focused on improving efficiency. The Local Government Association of Queensland (LGAQ) also drove a series of reforms between 2000 and 2004 including establishing:

• an investment and planning alliance with the Main Roads Department via 15 Regional Road Groups across the State

• a new more cost-effective arrangements for insurance covering public liability and workers compensation premiums, and

• new IT cost effective procurement and management services.11

11 Further details on the LGAQ achievements between 2000 and 2004 are available at: http://www.lgaq.asn.au/lgaq/general/LGAQ/Achievements2000-2004.pdf

Introduction 29

http://www.lgaq.asn.au/lgaq/general/LGAQ/Achievements2000-2004.pdf


This reform process is continuing with the structural arrangements of the local government sector in Queensland being re-evaluated in a joint initiative between the LGAQ and the Queensland Department of Local Government and Planning. Launched on 1 June 2005, the Size, Shape and Sustainability (SSS) program, aims to address the increased pressures on local government, impacting on its long-term sustainability and ability to effectively service its community and statutory obligations. Further details on SSS are contained in Text Box 1 above.

1.4.5 Western Australia The Western Australian Local Government Association (WALGA) undertook a Systemic Sustainability Study to investigate ways of addressing the sustainability of the state’s 142 local councils facing a range of challenges including growing community demands and expectations, limited revenue bases.

One component of this study was an assessment of the current state of council finances in WA. The findings of this assessment indicate that 80 councils in WA require a substantial (ie greater then 10%) increase in their own-source revenue to eliminate their underlying operating deficits. On this basis the assessment concluded that some 83, or 58%, of WA councils were ‘unsustainable’ on the basis that substantial adjustments appear necessary in order for the long-term finances to be put on a sustainable footing going forward. These councils serve approximately 21% of the state’s resident population.12

Other findings include:

• On average WA councils registered operating deficits in 2004-05 that amounted to 4.5% of their own-source revenue

• An infrastructure backlog of approximately $1.75 billion, or 14% of the total value of council non-financial assets, and

• the ‘unsustainable’ councils are mainly regionally located councils (93% of unsustainable councils representing 16% of the unsustainable council’s resident population). These councils typically represent most of the state’s smallest and declining population councils and point to structural problems.

The study reports that the underlying factors driving the adverse assessment include the prevalence of operating deficits and the tendency of councils with such deficits to also be developing substantial infrastructure backlogs. The study reported that these factors are symptomatic of the deficiencies in council spending as well as past cost shifting. The study also noted weaknesses in revenue policy frameworks and shortfalls in the level and escalation of grants from other governments.

12 WALGA 2006, Local Government Finances in Western Australia, June 2006 p vii and p 58

Introduction 30


1.4.6 Victoria Whilst Victoria has not been subject to a formalised sustainability inquiry similar to the Access led studies, the state and local governments are actively aware of the sustainability issues facing the sector and have engaged in significant local government reform over the past decade. Major reform and restructure of the local government sector was initiated in the early 1990s under the Kennett Government. Victoria engaged in major reform process of council amalgamations, which decreased the number of councils from 210 to 78. Consequently, the average population of Victorian councils per capita is now 62,700, which is the highest nationally.

Another key reform agenda in the early 1990s was the introduction of compulsory competitive tendering (CCT) which exposed the cost of providing services to competitive pressures and played a critical role in improving the efficiency, and hence, financial sustainability of local government. CCT forced councils to benchmark themselves against the performance standards of the private sector by placing a range of their services and operations out to public tender. When first introduced the CCT policy required 30% of local government services to be tendered, which then incrementally increased until 50% of services were tendered. However, due to the perceived inflexibility of the CCT policy it was repealed in 1999 and replaced with the ‘Best Value’ policy. The objective of this latter policy was focused on councils’ obligation to ensure they seek the best value in providing services, through a whole of organisation approach.

This process of local government reform provided the impetus for ongoing work to improve the financial practices of the sector in Victoria, particularly around effective asset management. A collaborative approach between the Local Government Division of the Department for Victorian Communities (DVC), with local government peak bodies, the Municipal Association of Victoria (MAV) and the Local Government Professionals have been instrumental in driving improvements in asset management. The Sustaining Local Assets policy framework was released in December 2003 to provide an overall guide the strategic management of council infrastructure assets such as local roads, bridges, public libraries and recreational facilities.

This policy draws on the following two important concurrent programs:

• MAV Step Program: developed in 2003 provides individual assessment, expert advice and mentoring to councils to build its infrastructure asset management capacity and application of asset management principles. Three core strategies are used:

− awareness raising

− providing tools

− self assessment and improvement framework

(Further details on the Step Program are contained below in Text Box 12 in section 2.8), and

• DVC Asset Management Performance Measures Project: developed a methodology to improve data collection and reporting to enable councils to measure their own performance in the management of infrastructure assets.

Introduction 31


The financial viability and long-term sustainability of the local government sector are key focuses of MAV’s policy programs and activities. For example, the MAV Asset Renewal Gap Program focuses on ensuring the appropriate quality and capture of relevant asset management data, in response to the questionable quality and integrity of data of many councils. Some innovative work has also been completed by the MAV on developing a viability index of councils based on data on population, roads, rates growth, and mean personal income, which is discussed further in Section 5 of this report.

1.4.7 Northern Territory Local government in the NT comprises 6 municipal and 30 community government councils; other organisations include 23 associations constituted under the Associations Incorporation Act, 3 associations incorporated under the Aboriginal Councils and Associations Act and one special purpose town, Jabiru, constituted under the Jabiru Town Development Act 1995.

Less than 5% of the land area of the NT is covered by local government and only 2% of the land area of the NT is rateable. Unlike local government in all other states, local government in the NT does not have the functions of planning (development assessment) or building regulation - the Territory Government retains these powers for all but Aboriginal land where these powers are vested with Indigenous traditional owners.

Some 92% of the NT population reside within a local government area. The ten largest councils in the NT provide services to approximately 160,000 residents with the 55 other councils providing for approximately 31,000 residents and the remaining 6000 residents being without a council (mining and tourist towns, pastoral properties). The average population serviced by non-municipal councils is 670.

It is understood that the NT Government is in the process of a major consolidation of councils. The emphasis is mainly on amalgamation of community or aboriginal councils with each other or existing councils to improve their capacity to deliver services to their community in an efficient, viable and sustainable way.

1.4.8 Tasmania

Local government in Tasmania comprises 29 councils covering some 484,700 residents13 or around 16,700 residents per council. Over the past six years, the Local Government Association of Tasmania has compiled a Key Performance Indicator (KPI) report on measuring council performance in Tasmania.

The KPI project aims to provide councils with a range of indicators to measure their organisational performance. In summary the KPI report aims to:

• enhance performance measurement by councils

• enable benchmarking and identification of best practice

• establish performance trends over time, and

13 ABS, Population estimate, March 2005

Introduction 32


• improve accountability to the community.

The 2004-05 report contains five year comparison data from which there are a number of emerging trends:

• a consistent downward trend in the debt-service ratio on a statewide basis

• city councils are raising a greater proportion of their revenue from rates relative to the smaller councils, and smaller councils are more dependent on grants

• a consistent reduction in the level of rates outstanding at the end of the financial year. Most councils have a level of rates outstanding at less than 5%, and

• a general increase in the number of employees per 1000 population. This may reflect the complexity of an additional range of services being provided by local government.

The KPI project reports increased efforts by councils to work in partnership and in regional and sub-regional arrangements and physical resource sharing is growing. Information sharing and management is identified as an area of opportunity.

1.4.9 ACT The majority of functions typically associated with local government are provided by the Department of Territory and Municipal Services within the ACT Government.

Due to the unique arrangements for the delivery of local government services in the ACT, the pressures facing local government in other jurisdictions are generally manifested differently within the ACT. The department essentially fulfils the role of a large metropolitan council and is in a better position to take advantage of economies of scale that may not be available to small regional and rural councils in other jurisdictions. Because the provision of local government services is so different in the ACT, the territory is not covered in much of the analysis of this report.

The ACT Government is developing an Integrated Asset Management System to enable better prioritising and management of local government asset maintenance through the collection of location, asset type and asset condition data.

1.5 Snapshot of funding approaches in international jurisdictions

In analysing sustainability and developing appropriate reform options for the local government sector in Australia, it is useful to consider successful funding approaches, and recent initiatives and reforms, internationally. Completion of this benchmarking analysis indicates that numerous local government sectors across the world suffer from similar issues associated with constant operating deficits, infrastructure backlog and asset management. While a number of jurisdictions have implemented a range of interesting initiatives to address these issues, both at a national and individual local government level, the applicability of these approaches to the Australian environment will need to be assessed.

Introduction 33


1.5.1 United Kingdom There are some 410 local authorities in England and Wales employing over 2.2 million people (2.1 million people in England and 164,000 in Wales). Local councils undertake an estimated 700 different functions. There is an average of 148,000 people per council, making UK councils on average 5.4 times larger than average Australian councils in population terms.

Local government in England and Wales is organised in two contrasting ways. In Wales and some parts of England, a single tier "all purpose council" is responsible for all local authority services and functions (Unitary, Metropolitan or London Borough). The remainder of England has a two-tier system, in which responsibility for services is divided between district and county councils.

Local councils are heavily scrutinised in an effort to ensure effectiveness and efficiency in their service provision. However, it is arguable that the central government has had mixed success in this aim. The majority of the scrutiny is undertaken through the Audit Commission's Comprehensive Performance Assessment (CPA). Councils are awarded ratings - excellent, good, fair, weak or poor - on the basis of their service performance. There are currently a total of 69 in the excellent category, 146 in good, 119 in fair, 44 in weak and 10 in poor.14

Local councils are funded by a combination of central government grants, council tax (a locally set tax based on house value), business rates, and fees and charges from certain services including de-criminalised parking enforcement. The proportion of revenue that comes from council tax is low (covering about 26% of all costs). Central government retains the right to 'cap' council tax if it deems it to be too much. This is an area of debate in British politics, with councils and central government at odds over council tax rises.

In July 2004, the British Deputy Prime Minister commissioned Sir Michael Lyons to undertake an independent inquiry (the Lyons Review) to consider the case for changes to the present system of local government funding in England, including the reform of council tax. The terms of reference were extended in September 2005 to include the function of local government and its future role as well as how it is funded.

The key finding from the second component of the Lyons Review was that greater local choice, not more central control, is needed to enable local government to manage increasing pressures on public expenditure, increase satisfaction and build more prosperous communities. The review calls for central government to set fewer and better-focused targets, reduce supervision of local government by central government and provide more untied funding to councils, while also challenging local government to achieve further improvements through stronger leadership, closer engagement with local residents, effective partnership with other services and the business community, and a consistent commitment to efficiency and cost effectiveness.

14 Note that these are the reported figures located at http://local.gov.uk/default.asp?sID=1088162663359 and do not reconcile with the stated total number of Councils.

Introduction 34

http://en.wikipedia.org/wiki/Central_government

http://en.wikipedia.org/wiki/Council_Tax

http://en.wikipedia.org/wiki/Tax

http://en.wikipedia.org/wiki/Business_rates

http://en.wikipedia.org/wiki/Decriminalised_parking_enforcement

http://local.gov.uk/default.asp?sID=1088162663359


The Government is currently conducting another review of local government in England. Details are unclear, but the creation of new unitary authorities is possible, along with an introduction of the "city region" concept.

In October 2006, the UK Local Government White Paper15 was released, which proposes a new approach to local partnership whereby local authorities are given more opportunity to lead their area, work with other services to better meet the public’s needs. The White Paper signalled a continued progressive shift in funding away from SPPs to area-based funding streams in order to give local public service providers maximum flexibility in how they deliver shared outcomes. The White Paper also encourages greater focus on a regional service delivery model utilising a "city region" concept. Some commentators have suggested the city region concept is a step towards the restoration of strategic authorities for the metropolitan areas. A report released by the Institute for Public Policy Research in February 2006, titled City Leadership: giving city regions the power to grow, proposed the creation of two large city-regions based on Manchester and Birmingham.

1.5.2 Canada Government in Canada is organised into three and often four levels: federal, provincial or territorial, and municipal (which is often subdivided into regional and local). The municipalities are created by the province or territory, and are essentially arms of the provincial or territorial governments. Similar to Australia, Canadian municipalities source their revenue through:

• taxes: consumption, property and, other taxes

• sales of goods and services

• investment income, and

• funding, which includes general purpose transfers and specific purpose transfers.

The intergovernmental transfers come from the two larger tiers of government in Canada, federal government and the thirteen provincial and territorial governments, the latter of which provide around 90% of overall funding to local governments. Also similar to the situation in Australia, there is municipal fiscal imbalance in Canada, which leads to operating deficit issues in some parts of the sector.

Canada has implemented a Municipal Performance Measurement Program (MPMP) that requires municipalities to report annually on 54 measures of effectiveness and efficiency in 12 key service areas. The MPMP was designed to strengthen local accountability by keeping citizens informed about municipal service plans, standards, costs and value. It was also meant to help municipalities improve local services by stimulating productivity and creativity.

15 See: www.communities.gov.uk/pub/98/StrongandProsperousCommunitiestheLocalGovernmentWhitePaperVol1_id1504098.pdf

Introduction 35

http://en.wikipedia.org/wiki/City_region

http://en.wikipedia.org/wiki/City_region

http://en.wikipedia.org/wiki/Manchester

http://en.wikipedia.org/wiki/Birmingham


The Federal Government of Canada is currently increasing the funding it provides to local governments for infrastructure programs to achieve the country’s overall objectives. As part of the 2005-06 Canadian federal budget, a decision was made to share 1.5 cents per litre of the 10 cent a litre gasoline tax with local municipalities, with $C600 million per annum to be shared with local government in a ‘Gas Tax Fund’. The budget also committed to providing larger Canadian cities with five cents per litre or $C2 billion per annum. The intention of the funding is to foster better collaboration between federal, city and local jurisdictions and to solve issues within communities such as the municipal infrastructure deficit, affordable housing and improving the transit systems. This new funding builds upon a $C700 million full rebate of all goods and service tax (GST) from municipal governments in Canada from 2004-05 onwards.

1.5.3 New Zealand In 1998, a number of reforms were introduced to local government by the Department of Internal Affairs to promote the social, economic, environmental and cultural well-being of communities for the present as well as the future.

These reforms resulted in the amalgamation of local governments reducing the number of councils from 675 to 86, the introduction of annual planning and reporting requirements, accrual accounting requirements, enhanced accountability for chief executives and consolidation of rating powers. These accountability plans include the development of long-term council community plan with a 10-year timeframe.

New Zealand councils now comprise 12 regional councils; 15 city councils; and 57 district councils (including four unitary councils which have regional functions). There is an average of 48,180 people per council, making NZ councils on average 1.7 times larger than Australian councils. Councils have a combined annual operating expenditure of $NZ3 billion, $NZ800 million in capital expenditure, $NZ31.2 billion in rate payer equity and contribute around 3.5% of national GDP.

The main functions of regional councils are:

• management of the effects of use of freshwater, coastal waters, air and land

• bio-security control of regional plant and animal pests

• river management, flood control and mitigation of erosion

• regional land transport planning and contracting of passenger services

• harbour navigation and safety, marine pollution and oil spills, and

• regional civil defence preparedness.

The main functions of territorial councils (district and city councils) are:

• community well-being and development

• environmental health and safety (including building control, civil defence, and environmental health matters)

• infrastructure (road and transport, sewerage, water/stormwater)

Introduction 36


• recreation and culture, and

• resource management including land use planning and development control.

New Zealand local government receives its revenue from five sources. These are:

• rates

• central government grants

• regulatory income, eg development applications

• investments, and

• user charges,

In the year ending June 2004 local government received some $4.6 billion in operating income. Around 57% ($NZ2.6 billion) of this came from rates, 12% ($NZ555 million) from central government assistance, 6.5% ($NZ300 million) from investments, 5% (NZ$231 million) from fees and fines, and 19.5% ($NZ900 million) from other sources.

The NZ local government sector is generally not heavily indebted, nor is it forecast to be so in the foreseeable future, with most local authorities within their self-imposed debt limits.

Rates amounted to $NZ2.8 billion in local government revenue in 2004-05. Rates as a proportion of revenue vary significantly between local governments, ranging between 2% and 16% or amounting to $NZ1,200 - $NZ3,700 per household. Rates per household have been set to increase by about 20% between now and 2012-13.

In the year to June 2004, land transport was the largest single expenditure category – accounting for 26% of operating expenditure ($NZ1.1 billion), followed by culture, recreation and sport at $NZ0.843 billion or 19%.

Since the 1998 reforms, local government has moved dramatically away from being static providers of traditional services, to become more strategically focussed in identifying and responding to local needs, and using innovative means to purchase local public goods and services.

It is reported that many councils continue to investigate the most appropriate local government structures to meet their community's needs and the more efficient delivery of services. This may involve looking at new structures for delivering services, such as contracting with inter-district or regional service providers, eg for library services and water supply management.

An issue of current debate in New Zealand is around the Rating Powers Act. Local governments seek to build on the improvements and savings of the last ten years by seeking changes to funding tools so that costs are more equitable, transparent and understandable. The general view of local government is that the Ratings Act is prescriptive, overly-complex, outdated and has failed to keep pace with recent reforms.

Introduction 37


Changes sought are:16

• the liberalisation of rating powers

• streamlining outdated or unnecessary procedural requirements

• providing for councils to charge actual and reasonable costs, and

• all land being rateable (including Crown and Maori land).

While local communities require that central government:

• complete the review of the Rating Powers Act to give local government a set of flexible, modern rating powers

• removal of prescriptive charging powers and their replacement with a power to charge actual and reasonable costs, and

• central government pay its own way.

In November 2006 the NZ Government commissioned a further review of the local government sector, focused on rates. The inquiry's objective is: 'to consider issues relating to current local government rating, and to other revenue raising mechanisms, and provide recommendations to the Government for enhancing rating and other funding mechanisms for local authorities.' As part of its process the inquiry will look into: the level of rates and related trends, drivers of local authority expenditure, and the sustainability of rates as the major revenue raising tool. The inquiry will report to the Government by 31 July 2007. Public submissions will be called for early in 2007.17 Implications of local government international review for Australia It is inherently difficult to undertake a direct comparison of the issues facing local government bodies in overseas jurisdictions. Differences in intergovernmental structural arrangements, combined with variations in role and responsibility sharing and funding arrangements between spheres of government mean that caution should be exercised when drawing out lessons and applications for Australia. However, the literature review results in some common emerging themes and trends with relevance to Australian local government. These include:

• a trend of consolidation through amalgamation of local government (UK, NZ) over the past decade or so

• recommendations for greater local government autonomy in terms of investment decision-making and reduced central government control

• a trend towards improved asset management practices and understanding of asset life-cycle costs

• a trend towards improving KPI reporting and benchmarking across aspects of local government performance

• often limited scope to increase revenue (similar to Australia) , and

16 http://www.lgnz.co.nz/lg-sector/role/ 17 For further details see: http://www.lgnz.co.nz

Introduction 38


• councils with operating deficits being relatively common, which can lead to underspends on infrastructure renewal.

Despite the limitations of drawing lessons from overseas jurisdictions in relation to the operation of local government in Australia, it would appear that many of the challenges faced overseas are similar to those in Australia, as are the principles underpinning local government reform. This study and associated analysis takes into account these emerging inter-jurisdictional trends, which are reflected in our observations and conclusions. Overall, because of the system of federation, Australia and Canada arguably face a more complex set of challenges in reforming role allocations and funding arrangements compared to the unitary systems of government present in the United Kingdom and New Zealand. Constitutionally the unitary system is framed around a single unit with power delegated to lower levels of government by the central government, who has the principal right to recall or modify the delegated powers. By contrast, federations, being assemblies of states, establish a constitution that allocates state and federal functions which cannot be unilaterally changed by the central government. In federations, state governments then later establish and delegate functions to local governments. Such a system of government with constitutionally defines the jurisdiction of each level of government, but has centralised revenue raising powers, is particularly vulnerable to vertical fiscal imbalances. Hence, funding and role reform processes are generally more protracted in federations due to the need for consensus and for any changes to be Pareto optimal (ie no level of government worse off).

Consequently, the international experience highlights that reform progress, particularly in federation based systems, is significantly more likely where win-win positions can be developed for all levels of government.

A key concluding observation from this brief overview of local government funding issues in other jurisdictions is that local government in the UK, Canada and NZ has typically taken greater accountability for providing a range of social services. In Australia providing social services is typically the constitutional responsibility of state and territory governments, however this has not precluded the need for local government to step in to cover service gaps in the area. Hence, local government is often in the position of taking even more responsibility for community services than occurs in other countries, without the corresponding funding streams. However, prior to fully taking such accountability there needs to be accompanying and effective funding support to ensure that local governments can meet all necessary operating and renewals costs on a sustainable basis.

1.6 Acknowledgements

In undertaking this Study PwC is grateful for the significant assistance from a range of stakeholders including:

• ALGA Board and staff

• MAV and staff

• the various state and territory local government associations, and

• Grants Commissions and Departments of Local Government in most states.

Introduction 39

http://en.wikipedia.org/wiki/Constitution

http://en.wikipedia.org/wiki/Central_government

http://en.wikipedia.org/wiki/State_%28subnational%29


PwC has also had the substantial benefit of drawing upon a range of recent local government studies, in particular the state based studies by Access Economics and the MAV. This work has been of substantial assistance in developing this national report and these prior studies are acknowledged in Appendix A.

1.7 Structure of this report

The remainder of this report is structured as follows:

• Chapter 2: provides a summary overview of the local government sector, including the role, revenue/expenditure patterns, and challenges to service delivery and efficiency.

• Chapter 3: outlines the key financial governance arrangements of local government, and describes the nature of intergovernmental relationships and fiscal transfers between local, state and federal government.

• Chapter 4: details the financial trend analysis of the seven ACLG categories of local governing bodies and assessment of financial sustainability.

• Chapter 5: contains the reform options suggested to improve financial sustainability of the local government sector through a two-tiered approach aimed at both internal and funding reforms.

• Chapter 6: summarises the key conclusions and recommendations of the study.

Introduction 40


2 Overview of the local government sector

Local government in Australia is a dynamic and extremely diverse sector that combines the individual character and operations of over 700 councils. Local government plays an integral role in the Australian economy and within local communities. The annual expenditure of almost $20 billion represents around 2% of GDP, while around 1.3% of the Australian labour force is employed by the local government sector. Moreover, local government provides a significant proportion of essential services and infrastructure which underpins all local and regional communities. For the numerous regional and more remote communities this role in the community and as a driver of economic activity is further accentuated.

In order to provide some context to the financial sustainability analysis of local government, this section provides a high level overview of the typical:

• role and functions of local government

• diversity and category breakdown of councils

• revenue and expenditure trends

• growing demands on local government

• relative efficiency of local government, and

• constraints facing some councils.

2.1 Local government’s role and functions

In 2004-05 approximately 700 councils were eligible to receive financial assistance grants from the Australian Government. Of these, 91 were Indigenous community councils in Queensland, the NT and WA. Overall, the average local government has a population of approximately 29,400 and a geographic coverage of 602 km2,, excluding significant unincorporated zones in some jurisdictions, see Table 1.1. All states and the NT have local governments. The ACT is the only jurisdiction in Australia without a local government sector with those functions undertaken by the ACT Department of Territory and Municipal Services.

State and territory governments have constitutional responsibility for local government, and provide the legal framework to give authority to councils’ operations. While the Commonwealth Constitution does not acknowledge local government, the Constitution Acts of each of the states and the NT recognise and refer to the sector. Specific legislation in each jurisdiction determines the legislative roles and responsibilities of local government.

There are significant differences in the state systems responsible for overseeing the roles, functions and responsibilities of councils. In general, state legislation imposes few limits on what services local government can provide, with wide ranging powers to carry out a variety of functions. This wide scope of powers provided to local government is intended to enable local governments to provide services in response to the changing needs of the community.

Overview of the local government sector 41


As councils have the freedom to make policy decisions on which services to provide, it is difficult to conclusively define typical roles and responsibilities of councils across Australia. The broad types of local government functions and services that are usually provided are summarised in Figure 2.1 below. This demonstrates the spectrum of narrow versus broad and commercial versus social services that council’s often provide. This diagram only attempts to illustrate the extensive range of services that councils tend to offer, and does not intend to suggest that councils should strip back to a “narrow” service offering.

Figure 2.1: Spectrum of typical council services

In general, the core, and perhaps most important, functions performed by local government are the delivery of essential services (waste, and sometimes water and sewerage) and maintaining corresponding infrastructure for local residents (eg roads, footpaths, drainage). Most councils with small population and rate revenue bases have needed to contain their in-house service scope to a narrower range of services due to financial constraints. Such small councils instead often try to provide better linkages to non-government organisations that are providing social and community services.



Taking on additional responsibilities for social functions has been a growing trend in the local government sector, with a move away from property-based services to human services (see section 2.5 for further details). One of the strengths of local government is the ability to gauge the changing needs and priorities of the community and respond with appropriate services. The provision of services at the local/regional level can be expected to generally be more cost-effective and efficient due to relatively smaller overhead costs and associated bureaucracy.

2.2 Diversity of councils

The local government sector in Australia is an inherently diversified sector as it is comprised of hundreds of distinct and individual councils. Each council operates differently as the role, responsibilities, and service scope varies significantly between councils. Many of the differences have resulted from the historical development of councils, which were set up to address specific local issues and local priorities that differ between each community.18 The divergence in service scope has been further driven by the creation of regulatory responsibility, service devolution, and financial inducements by the Australian and state governments and limits on financial capacity of local government. These variations go beyond rural-metropolitan differences and include:

• size and population

• range and scale of functions

• road length and infrastructure

• fiscal position (including revenue-raising capacity), resources and skills base

• physical, social and cultural environments

• attitudes and aspirations of their communities, and

• state legislative frameworks.

There is significant divergence in the nature and scale of councils between urban capital cities and rural remote councils. This can be demonstrated when the large urban capital city of Brisbane is compared to the remote rural council of Yalgoo in WA. Yalgoo, located 524 km north of Perth, has 328 people spread over a large area with a population density of 0.01 people per km2. The challenge of providing services to this type of community is clearly different from that of Brisbane city council which has over 950,000 people and a population density of 707 per km2. Yalgoo receives $2,540 per capita in general purpose funding from the Commonwealth Financial Assistance Grants, compared with $16 per capita received by Brisbane, which reflects the different levels of support under a system which attempts to provide horizontal equalisation between the two councils.

Such diversity of councils makes classification and trend analysis of the sector increasingly challenging. In response to this issue the ACLG was developed by DOTARS in 1994 to categorise local governing bodies that receive general purpose financial assistance grants as defined under the Local Government (Financial Assistance) Act 1995.

18 Dollery, B. et al 2006, Australian Local Government Economics, UNSW Press, p.8.



ACLG categorises councils using population, population density and the proportion of the population that is classified as urban.19

The seven upper level categories of this classification system of local councils, shown below in Table 2.1, will be used in this study to compare trends between similarly classified councils. In terms of the number of councils, the majority of councils in Australia are rural agricultural (42%), followed by rural remote councils (16%). Conversely, while around 58% of councils fall into these two categories, these councils only service 9.5% of the Australian population. The majority of people living in Australia are either serviced by councils that are classified as urban metropolitan developed (35%) and urban regional towns/city (26%).

Figure 2.2: Proportion of councils in each ACLG by jurisdiction

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

NSW Victoria Queensland WesternAustralia

SouthAustralia

Tasmania NorthernTerritory

National

Jurisdiction

% o

f cou

ncils

in e

ach

AC

LG c

ateg

ory

UR UF UD UC RT RA RS

Source: DOTARS 2005, 2003-04 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p.3.

Under the ACLG system, approximately 78% of local governing bodies are categorised as ‘regional’ or ‘rural’. Figure 2.2 shows the large differences in the composition of councils within each jurisdiction. In the majority of jurisdictions, rural agricultural councils dominate, with urban regional towns/city and urban developed also comprising a significant number of councils. NT is the only jurisdiction to depart markedly from this model with the majority of councils categorised as rural remote. Tasmania is differentiated by not having any rural remote councils and limited urban metropolitan developed councils, while Victoria has a more even spread between urban and rural councils.

19 DOTARS 2005, 2003/04 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p.249.



While the ACLG still groups together councils with different characteristics, challenges and priorities, it provides a simple and transparent tool to analyse and assess local government in Australia. Exceptions will be numerous in any generalisations made based on category alone, however in the absence of a more reliable over-arching classification system for local government on a national level, the ACLG remains the most appropriate basis on which to differentiate councils and draw conclusions.

Table 2.1: Australian Local Government Classification System

Category Code Description % councils

Population range (2002)

% of Australian Population

Urban Capital City

UC UC councils are the Capital City council in each State/Territory.

1% 8,733 – 917,216 6.1%

Urban Metropolitan Developed

UD UD councils an urban centre with a pop. of over 20,000 or a pop density over 600 persons per km2. Usually well established and surround the CBD of the capital cities.

13% 789 – 270,109 34.6%

Urban Fringe UF UF councils have at least 90% of pop classified as urban. Include outer developing/fringe areas of the capital cities and major regional centres.

10% 208 – 191,635 19.6%

Urban Regional Towns/City

UR UR councils have an urban characteristic with a pop density over 30 persons per km2. Encompasses major regional centres outside the capital cities.

18% 5720 – 434,473 26.3%

Rural Agricultural

RA RA councils predominantly have agricultural focus, with pop >20,000 and a pop density of <30 persons per km2.

42% 254 – 54,226 8.8%

Rural Significant Growth

RS RS councils are rural with a pop <20,000 but > 5,000, with an average annual growth rate > 3%. Usually relatively close to a capital city and often have a tourism or retirement focus.

1% 7,636 – 24,368 0.7%

20 Ugar (Stephen) Island in Queensland is a UR category council with a population of 57 people.



Category Code Description % councils

Population range (2002)

% of Australian Population

Rural Remote RT RT councils are remote where <10% of the population could be characterised as urban.

16% 392 – 13,673 0.7%

Source: DOTARS 2006, 2004-05 Report on the Operation of the Local Government (Financial Assistance) Act

1995.

2.3 Revenue

Local government has three major sources of revenue: municipal rates (taxation), user charges, and grants and subsidies from other levels of government. As shown in Figure 2.3 below, rates and municipal charges (38.1%) represent the largest revenue source, followed closely by user charges (30.7%).21

There is a significant disparity in the ability of different councils to raise revenue due to the diversity between each council. The size of a council’s own-source revenue22, largely rates and user charges, is determined by the population size, economic activity, rating base and ability/willingness to impose user charges. Hence, while the national average for grants and subsidy revenue is 10.4% of local government revenue, this rises to more than 70% for some rural and remote councils where own-source revenue raising capacity can be severely limited.

21 Australian Bureau of Statistics, Government Finance Statistics, cat. No. 5512.0 22 Own source revenue includes: rates, car parking fees, property rental income, fines, development application

fees, user charges, etc. It typically excludes revenue transfers.



Figure 2.3: Sources of local government revenue, Australia 2004-05

Taxation revenue (rates)

38%

Sales of goods and services

31%

Interest income

3%

Other 18%

Current grants and subsidies

10%

Source: Australian Bureau of Statistics, Government Finance Statistics, cat. No. 5512.0

Trends over the last few years have shown a decrease in the proportion of revenue derived from grants and subsidies, which has decreased from 13.1% in 1998-99 to 10.4% in 2004-05, with a decrease from 32.6% to 30.7% in user charges over the same period. Correspondingly local governments have increased revenue from “other” sources, from 13.6% in 1998-99 to 18.1% in 2004-05.23 This rise in other revenue reflects a combination of factors including greater effort of local government over the past 30 years to increase its own-source revenue through the commercialisation of prices, increases to water charges in line with COAG requirements and the development of new revenue streams (eg fines and car parking fees) to improve sustainability.

2.2.1 Rates and municipal charges

Local government taxation revenue is limited to rates being a charge on property owners, generally based on land value for council provided services. In 2004-05, local government directly raised $8.1 billion in rates. The approach to calculating and applying rates varies significantly between each jurisdiction. Table 2.2 below provides a brief summary of the rates methodology in each state.

Table 2.2: States rate-setting methodology

State/Territory Land value assessment used to calculate rate charges

NSW Rate charges are based on the unimproved capital value (UCV) of the land. NSW has a fixed mandatory pensioner concession rate, 50% of which is directly funded by councils. NSW rates are also limited by a system of rate pegging that has been in place since 1977. There is also generally no rates on most state government owned property (eg public schools, National Parks, etc), while state owned corporations do generally pay rates. However, major local government activities do not pay payroll tax, with a few minor exceptions for some business activities. The NSW Government determines the allowable percentage increase but may allow a variation, subject to Ministerial approval, where community is consulted, robust AMP/financial

23 Australian Bureau of Statistics, Government Finance Statistics, cat. No. 5512.0



State/Territory Land value assessment used to calculate rate charges

management plans are in place and the purpose of extra spend has clear merit.

Victoria Councils in Victoria can choose between three valuation systems – capital improved value, net annual value or site value. Differential rates, where different rates in the dollar are struck for separate property classes, can be applied. Councils using net annual value or site value to determine rates are limited to applying three different rates. However, councils using capital improved value can strike a wide range of differential rates, so long as the maximum differential rate is no more than four times the level of the lowest differential. In addition, councils must justify all differentials when they use the capital improved valuation system. Seventy-two councils use capital improved value, six use net annual value and one uses site value.

Queensland Queensland follows a similar approach to NSW for rates, using UCV of the land as the basis for the rates. However, the Queensland Government does not impose limits on rate increases councils can apply.

WA WA uses gross rental value of the land, that is, the amount that could potentially be charged should it be made available for rent, as the basis for non-rural rates charges. Rural land is predominantly assessed on UCV of the land, however this can change depending on the extent of improvements or the primary use of the land.

SA SA councils can use a range of land valuation methods including UCV, site value or annual value. There is no differentiation for rural property in SA. Additionally some 85% of the State is unincorporated, that is, it is not serviced by a council and hence it is not subject to rates.

Tasmania Tasmanian rates are also based on one of the three criteria used in SA and Victoria. However, recent agreements in Tasmania between the State Government and councils means councils are now able to charge rates on selected State Government-owned land. The Partnership Agreement was negotiated on the basis of a revenue neutral outcome for both spheres of government. The outcome did not involve full reciprocity of taxation arrangements but involved a trade-off that saw the cessation of levies paid by councils, the payment of payroll tax and land tax by councils and the payment of rates by the State Government. The process has resulted in Local Government actually gaining revenue with the possibility of additional rate revenue as present unallocated Crown land is identified and valued.24

NT The Northern Territory allows individual councils to determine the method and extent of rate charges in the council area, although the calculation of rates is still based on the UCV, the improved capital value or the annual rental value of the land. Rates can be charged on a flat parcel rate, where all land is charged at the same rate regardless of use or value. Alternatively, a differential rate similar to that used in Victoria, or a uniform rate can also be used.

ACT The ACT uses the unimproved land value of the property averaged over the three previous years to calculate rates. The calculation of rates for residential and commercial properties differs to that for rural properties. For residential and commercial properties, rates are determined as a fixed charge levied on all properties plus a rate charged on the amount that the average unimproved land value exceeds a rate-free threshold. For rural properties, a fixed charge is not applied. A differential rate applies for residential, commercial and rural properties but the same rate-free threshold applies across the three property types.

Source: DOTARS 2006, Operation of the Local Government (Financial Assistance) Act 2004-05, p 28.

24 Local Government Association of Tasmania 2004, Submission to Rates and Taxes A Fair Share For Responsible Local Government, March 2004.



There is only modest consistency in the rates methodology used between the states, however there are broadly two approaches of either using UCV (NSW, Queensland and ACT), or allowing councils to choose between UCV, the improved capital value or the annual rental value of the property (Victoria, SA, Tasmania, and NT).

The method for calculating rates determines how the rates burden is shared between ratepayers. Changing methods does not increase total rate revenue in the short term. However, when the rates revenue between jurisdictions is compared, the states that allow councils to choose between the three rates calculation methods tend to have the highest average rate revenue per capita, and also the highest rate revenue increases over the five years to 2004-05. This outcome may be due to the greater flexibility provided to councils to choose a rate calculation method that best suits their operations. Another interpretation is that jurisdictions using CIV or NAV are likely to have completed significant efficiency reforms and they may have adopted this basis to:

• increase rating income, and/or

• improve the equity or cost reflectivity in the application of rates.

Arguably councils that are able to use market-value-based calculations through gross-rental and improved-capital-value based calculations are better able to develop cost-reflective rates.

There are also significant rate exemptions and concessions that are usually required by state governments, which typically include:

• pensioner concessions

• concession for charitable/benevolent organisations, including public schools and hospitals, which often receive rate exemptions, and

• concessions or exemptions for government-owned land.

Additionally, mining and pastoral properties are exempt from rates in some jurisdictions, which can deprive the local government sector from a significant revenue source. In some instances the state government does not fully fund councils for the exemptions and/or concessions. As a consequence, such councils can lose a substantial proportion of tax revenue, whilst still facing costs to meet the service and infrastructure needs of such exempt and concession status properties.

The rates revenue collected by local government comprises 3% of all taxation revenue of all three spheres of government, which is shown below in Figure 2.4. Local government own-source revenue has an extremely narrow base, and is confined to a non-growth tax in comparison to the tax revenue to the Australian Government which is largely comprised of income, company and goods and services taxes.



This vertical imbalance of tax collection is emphasised when compared to the proportion of non-financial assets managed by the local government sector. The total pool of non-financial assets in Australia is estimated to be worth around $910 billion, as at 30 June 2005, 25 while $279 billion in tax revenue was collected by all levels of government in the 2004-05 financial year. The figures below show that the Commonwealth Government collects almost 82% ($229 billion), of total tax revenue, whilst maintaining only 8% ($73 billion) of non-financial assets. By contrast, local government manage up to 36% ($328 billion) of Australia’s non-financial assets, but only have the authority to directly collect 3%, or $8 billion in tax revenue.

Figure 2.4: Comparison of proportion of taxation revenue and non-financial assets, by sphere of government, 2004-05

Tax revenue collected by sphere of government

Commonwealth Government

82%State

Government15%

Local Government

3%

Non-financial assets by sphere of government

Commonwealth8%

States56%

Local Government

36%

Source: ABS, Taxation Revenue 2004-05, cat. no. 5506.0; and Government Finance Statistics 2004-05, cat. no. 5512.0

Local government tax revenue is further constrained by state governments, which also draw a large proportion of their revenue from property taxes, as shown in Table 2.3 thus making this form of revenue even more politically sensitive to change.

The states share of taxation revenue from property taxes has increased from 31.9% in 1999-00 to 38.5% in 2004-05, which represents a 32.7% nominal increase in revenue.26 Hence, while property taxes continue to be a key revenue source for state governments, local governments may face challenges in increasing land rates and municipal charges and are effectively crowded out by state governments.

25 Australian Bureau of Statistics, Government Finance Statistics 2004-05, cat. no. 5512.0, p.16. 26 Australian Bureau of Statistics, Taxation Revenue, cat. no. 5506.0



Councils in NSW are also subject to formal rate pegging, which restricts the size of annual rate increases (further discussed in section 2.8.5). While rate pegging aims to contain local government cost increases, this can sometimes mean that when cost growth exceeds the peg such gaps can be partly funded by deferring capital renewals and upgrading. In other states and territories some councils self-enforce a form of unofficial rate pegging, with some councils not raising rates above CPI to demonstrate their fiscal responsibility and arguably to improve support from voters.

Table 2.3: Share of taxation revenue by source by sphere of government, 2004-05

Commonwealth (%)

State (%)

Local (%)

Taxes on income 71.1% - -

Employers' payroll taxes 0.1% 28.8% -

Taxes on property 0.0% 38.5% 100%

Taxes on the provision of goods and services 28.4% 18.9% -

Taxes on the use of goods and performance of activities

0.4% 13.8% -

Total 100.0% 100.0% 100.0%

Source: Australian Bureau of Statistics, Taxation Revenue, Table 1, cat. no. 5506.0

This structure of revenue generation between the spheres of government does not match the statutory expenditure obligations. The difference between the relative revenue and spending responsibilities of government is known as vertical fiscal imbalance (VFI), and is defined below in Text Box 2. Australia reportedly has the greatest degree of VFI of any federal country due to the domination of Australian government tax revenue, which is approximately 20% larger than its own-purpose outlays.27 For local government the concept of horizontal equity is also important, and relates to the concept of all councils within a state or territory being able to deliver a similar level of service.

27 Richard Webb 2002, Parliament of Australia: Research Note no. 13 2002-03, Public Finance and Vertical Fiscal Imbalance, Economics, Commerce and Industrial Relations Group 15 October 2002



Text Box 2: Defining Vertical Fiscal Imbalance & Horizontal Fiscal Equity Defining Vertical Fiscal Imbalance and Horizontal Fiscal Equity

These two technical terms are common jargon in the analysis of how total tax revenue is shared between the three spheres of government in Australia to ensure the intergovernmental transfers cover cost imbalances and so each jurisdiction or region has a common base level of services. In summary the two terms are defined as:

Vertical fiscal Imbalance is caused by the uneven distribution of taxing powers and expenditure functions. This is, local government and states have relatively large constitutionally-assigned spending responsibilities but few own-revenue sources, whilst the reverse is true at the Australian Government level. The Hawker report found that only an evening up of the local sector’s tax powers and expenditure responsibilities would reduce that sector’s VFI problems. Hence, FAGs assists in reducing, but not eliminating, VFI.28

Horizontal fiscal equalisation ensures that each local governing body in each state or territory is able to function, by reasonable effort, at a standard not lower than the average standard of other local governing bodies. It is akin to the concept of geographic equity between councils. It takes account of differences in expenditure required by those local governing bodies in the performance of their functions and in the capacity of those local governing bodies to raise revenue.

The adequacy of the intergovernmental transfers to share taxation revenue, and clear definition of service/expenditure requirements are critical to addressing VFI and horizontal fiscal equity.

2.2.2 Fees and charges User fees and charges is an area that has experienced significant growth in the past few decades. This is the result of a mixture of volume and price increases. In the 1970s, fees and user charges comprised 13% of total revenue. With the significant increase in the number, and diversity, of services offered by local government this revenue source has now grown to around 30%. Sales of goods and services typically include development applications and approvals and use of recreation and cultural facilities. In many jurisdictions the state government sets statutory limits on the fees and charges for these types of services, particularly in relation to development applications and consents.

Councils that provide water and sewerage services, such as those in Tasmania and Queensland, receive up to 40% of their revenue from the sales of goods and services. Under the National Competition Policy (NCP) local government businesses should aim to recover the full costs of a business activity, including recovery of renewals. The National Competition Council (NCC) has confirmed that the majority of councils with such businesses have successfully implemented pricing structures that ensure the competitive neutrality of such businesses, which has in turn maintained the sustainability of these assets.

Within statutory limits, councils could further expand revenue generated from user charges where they can increase cost reflectivity. While not an issue for councils with water and utility businesses that have been reformed to comply with NCP requirements, many councils do not have a clear understanding of the cost of services, such as development applications, approvals, etc. Greater work needs to be completed at either the state or national level to help councils accurately assess the cost of services.

28 House of Representatives, Standing Committee on Economics, Finance and Public Administration (SCEFPA), 2003, Rates and Taxes: A Fair Share for Responsible Local Government, October 2003, p.114.



2.2.3 Commonwealth grants and subsidies As the Australian Government collects around 80% of all taxes, the transfer of revenue through grants to local government, either directly or via state and territory governments, is critical to delivering horizontal and vertical fiscal equity. The Australian Government provides funding to local government through financial assistance grants, specific purpose payments, and direct program funding, each of which is discussed in the section below.

Financial Assistance Grants

Financial Assistance Grants (FAGs) are the key mechanism through which the Australian Government provides recurrent funding to the local government sector. FAGs are administered under the Local Government (Financial Assistance) Act 1995 (the “FAGs Act”) and distributed by the Local Government Grants Commission (LGGC) in each state and the NT.29 The FAGs Act details how the total amount of grant funds is determined and how the funds are to be distributed between the jurisdictions.

FAGs have two components which are both untied in the hands of councils:

• general purpose assistance: majority is distributed to councils within a state on the basis of general relative need, while 30% of the general purpose grants is distributed between councils in a state on the basis of population (the minimum grant). General purpose grants are distributed between the states on the basis of population shares and the distribution is adjusted annually, and

• untied road funding: distributed to councils within a state on the basis of relative road needs. The amount of untied road funding distributed between jurisdictions is based on set shares of relative roads needs, which were determined in 1991.

The value of the minimum grant in 2004-05 was approximately $15.80 per capita, with 87 out of 703 councils receiving the minimum grant. Further general purpose funding was provided to approximately 87% of councils that are deemed to face greater than average costs in delivering services, or suffer lower than average revenue raising capacity.

LGGCs are state and NT authorities that the Australian Government requires as a condition of the state receiving funding from the national government. The state determines the membership of the commission and provides the financial support for the LGGC operations, which are typically resourced as a branch of the state Department of Local Government. After the LGCC has determined the grant distribution, the State Minister recommends the allocation to the Federal Minister for approval. The FAGs provided are a tied grant to the states, although the grants are untied in the hands of local government. This gives councils discretion in determining local priorities.

29 In the ACT, local government is integrated with the ACT Government and as there is one entity completing local government functions there is no allocative role for a LGGC in the ACT.



Text Box 3: The purpose of FAGs The objectives of the FAGs Act

Subsection 3(2) of the FAGs Act sets out five objectives for providing financial assistance to local government. The CGC review of the Act provided the following interpretations of the each of the purposes.

1. Financial capacity of councils: aims to ensure that every council receives a share of the financial assistance provided by the Act. It is supported by the Minimum Grant and the Identified Road Component Principles.

2. Equitable level of services: aims to ensure that relatively greater funds are provided to councils which, because of the greater costs of providing services or because of the more limited ability to raise revenue, are more relatively disadvantaged than other councils. This purpose is supported by the Horizontal Equalisation, Effort Neutrality, Other Grant Support, Aboriginal Peoples and Torres Strait islanders and Minimum Grant principles.

3. Certainty of funding for councils: ensures funds are made available for councils.

4. Efficiency and effectiveness: aims to improve the efficiency and effectiveness of local government by imposing conditions on the allocation of financial assistance.

5. Aboriginal and Torres Strait Islander communities: relates to improving the provision of services by councils to Indigenous people and has an associated Aboriginal Peoples and Torres Strait Islanders principle.

Source: Commonwealth Grants Commission 2001, Review of the Operation of the Local Government (Financial Assistance) Act 1995.

The LGGC methodology used to calculate the size of the grants to each council varies in each state. The grant calculations are based on a large array of characteristics of each municipality, and typically include:

• population: size, density, growth, dispersion, proportion aged over 60, disability rates, proportion of Indigenous population

• road: lengths, proportion of sealed/unsealed roads; traffic

• number of dwellings

• types of expenditure services offered by each council: ie family and community services, aged services, recreation and culture, waste management, etc, and

• cost of providing services compared to revenue raising ability.

The current process is for FAGs payments to be adjusted annually using an escalation factor based on inflation and population growth. The policy intention of this escalation method is to maintain FAGs funding at a constant real rate per capita. This objective has largely been achieved with real FAGs funding remaining at approximately $16 per capita. However there has been a slight decrease of 2.2% from $16.11 real FAGs per capita at inception in 1995 to the current level of approximately $15.75.

However, as other Commonwealth taxes have grown faster than inflation, ALGA has reported that over the past 20 years the application of this escalation factor has resulted in a decline of FAGs as a percentage of total Commonwealth revenue. Figure 2.5 below shows FAGs as a proportion of the Australian Government’s revenue.



The declining trend in FAGs as a proportion of tax revenue from the mid-1990s was exacerbated by the decision in 1997 of the incoming Howard Government to escalate FAGs only by CPI, excluding the population component. It was reasoned that tight economic pressures at the time did not allow the full FAGs escalation. As there was no increase in CPI between 1996-97 and 1997-98, the quantum of FAGs funding saw a slight decrease of 0.1%, or $14 million. The cumulative effect of this decision has seen local government receive $171 million less in FAGs funding up to the end of 2006-07.

Figure 2.5: FAGs proportion of Commonwealth tax revenue

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Year

% T

otal

Com

mon

wea

lth R

even

ue

General Purpose Grants Identified Local Road Grants

Source: Australian Local Government Association

Under the 2006-07 Commonwealth budget, local government will receive $1.617 billion in FAGs funding. This is made up of a general purpose component ($1.120 billion) and a local roads component ($497 million) 30. This represents 0.7% of the estimated $217.2 billion in Commonwealth taxation revenue for 2006-07, with the proportion rising slightly when Specific Purpose Payments to local government are also considered.

Specific Purpose Payments

Specific Purpose Payments (SPPs) are federal funding provided to local government for policy purposes relating to particular functional activities, which are usually subject to conditions on expenditure. SPPs are either made direct to local governing bodies (for example Roads to Recovery funding) or through the state governments. Examples of SPP programs include Natural Heritage Trust, the Black Spot Program and the Regional Partnerships Program.

30 Australian Government 2006, Budget Paper No. 1: Budget Strategy and Outlook 2006-07, “Statement 5 Revenue”.



Significant SPP policy areas include child care, care for the disabled, and local roads, in addition to the following areas:

• arts and culture • community amenities and community development • economic development • education, health and welfare • environment and heritage • Indigenous development • law, order and public safety • sport, recreation and youth • telecommunications, and • transport.

This is becoming an increasingly popular funding option for the Australian Government due to the ability to provide focused and flexible funding to suit particular policy objectives. In 2004-05, the Australian Government provided $311 million in direct SPPs to local government, of which 80% was Roads to Recovery funding.31 This is equivalent to almost 20% of the general purpose FAGs funding.

SPPs carry some risk for local government in circumstances that require the development of service delivery programs that are dependent upon recurrent SPP funding, which is inherently subject to the discretion of the Commonwealth. SPPs are under constant budgetary review, and the growth and/or continuity of the funding is therefore uncertain.

31 DOTARS 2006, 2004/05 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p.20.



Text box 4 Roads to Recovery Overview of the Roads to Recovery funding program Roads to Recovery (R2R) is an SPP provided by the Australian Government for the maintenance of local roads. R2R was developed because a significant part of the local road infrastructure in Australia was approaching the end of its useful life and its renewal was beyond the financial capacity of councils. The Australian Government requires that signs acknowledging the Government’s support are placed along the roads that are being upgraded with R2R funding.

Over the life of the program, 14,980 projects have been funded. The majority, 30.6% of R2R projects were reconstruction, rehabilitation and widening projects with a value of $610 million (46% of total R2R). DOTARS have measured that on average, the benefits gained are 1.8 times the project cost.32

The first R2R funding package provided $1.2 billion boost in funding for local roads over four years from March 2001.

Over four years from 1 July 2005, the Australian Government, will provide further funding of $1.23 billion, in addition to its untied FAGs to councils for roads and other purposes. On 9 May 2006, the Australian Government announced that a further $307.5 million (including $7.5 million for roads in unincorporated areas) would be provided in 2005-06 as a supplement to the Roads to Recovery program. The supplementary funding must be spent by 30 June 2009 in accordance with funding conditions, which are similar to those of the current AusLink Roads to Recovery program.

The allocation of the available R2R funds among state and territory jurisdictions is based on population, road length and historic arrangements using a FAGs style formula approach. Each council in receipt of FAGs receives an allocation under the R2R program. Program funding conditions and guidelines are imposed on R2R recipients, which require councils to maintain their own spending on roads at a level equal to the average of their expenditure from 1998-99 to 2000-01.

R2R is popular with both local government and the Australian Government due to the flexibility it provides councils to implement their own priorities in terms of the projects and technical details of the work undertaken. R2R funding can be spent on either construction of new, conversion of unsealed to sealed, or general maintenance of roads, with each council determining the local roads projects in which to invest. This gives each council the ability to adapt the local roads work plan to the specific priorities and operational environment of individual councils. The three key strengths of R2R for councils identified in the 2003 review of the program include:

• local decision making, which has enabled them to implement their own priorities

• simple reporting requirements and other administrative arrangements

• direct funding to councils without state government involvement

Due to the achievement of successful outcomes through a popular and flexible process, there is significant merit in providing certainty on the future direction of the R2R program. This is discussed further in section 5.3.3.

2.2.4 State and territory grants The states (including the NT) provide some grant funding to local government for specific purposes and services. These grants are directed at a wide variety of purposes, which reflects the different functions required of local governing bodies.

It is inherently difficult to measure the quantum of funding from the states and NT to local government, as the figures reported to the ABS include contract payments to councils to carry out state activities rather than grants to councils for council activities. The most recent DOTARS Local Government National Report estimated that state and territory governments directly provided $1,159 million to local government in 2003-04.33 Using this estimate, Table 2.4 below shows that state/territory funding to local government comprises an average of 44% of intergovernmental grants. This varies considerably between jurisdictions from $25.29 per capita in Tasmania to $88.54 per capita in Queensland.

32 DOTARS 2006, Roads to Recovery Programme Annual Report 2004/2005, p.15. 33 DOTARS 2006, 2004/05 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p.20.



Table 2.4: Local government funding provided by State government, 2003-04

NSW VIC Qld WA SA TAS NT Total

Total intergovernmental transfers 718 678 627 339 154 62 63 2,641

Aust Gov’t transfers – FAGs1 488 356 286 174 107 50 21 1,483

Net state grants ($ m) 230 322 341 165 47 12 42 1,159

Net state grants per capita ($) 34 65 89 84 31 25 21 59

State funding as % of intergovernmental transfers 32% 47% 54% 49% 31% 19% 67% 44%

State funding as % of total local government revenue 3% 7% 6% 9% 4% 2% 14% 6%

Notes: 1. Australian intergovernmental transfers via FAGs include general purpose grants & local road grants.

Source: DOTARS 2006, Operation of the Local Government (Financial Assistance) Act 1995, p. 22.

Movements in state based funding to local government has been lumpy over the past two years, with a 25% decrease in funds in 2002-03 being balanced by a 37% increase in funding in 2003-04. However, as can be seen in Figure 2.6, despite inclusions of contract payments to councils for some state activities, there has been a general decline in state and territory funding as a proportion of total revenue in recent years is evident in many areas, particularly Tasmania, NSW and Queensland.

Figure 2.6: Net state grants as a proportion of total government grants to local government, 2000-01 to 2003-04

0

0.10.2

0.30.4

0.5

0.60.7

0.8

NSW Vic Qld WA SA Tas NT NationalAverage

2000/01 2001/02 2002/03 2003/04



Accessing s ate and federal grants t

Ensuring that councils fully access the broad range of existing grants programs would be a component of improving the financial management of councils. Both federal and state agencies offer a variety of grants to councils, which could provide an important additional revenue source for particular projects or general operations. Many of the larger metropolitan councils with suitable resources and skills are adept at acquiring such grants. For instance, the Warringah Council in NSW successfully obtained approximately $2 million in grant funding which contributed to a range of infrastructure and community projects with a total value of $3.7 million. The majority of grants were primarily sourced from state agencies, a few examples of which include:34

• Roads and Traffic Authority and NRMA provided a $5,000 grant to partially fund a road safety awareness campaign for primary schools

• NSW Department of Aged, Disability and Home Care provided a $34,000 grant to contribute to the construction of an accessible toilet at the Cromer Community Centre

• NSW Attorney General’s Department provided a $31,000 grant to partially fund a community awareness campaign on abuse of the elderly, and

• State Library of NSW provided full grant funding for an $84,500 technology research and promotion library project.

While the majority of councils which are rural and remote, do not typically have the time or resources to acquire such grant funding vis-à-vis larger metropolitan and regional councils, it may be necessary to increase their awareness of the possible scope of such additional funding. The availability of such grants could clearly provide a supplementary source of funding to assist councils, particularly with limited revenue sources, to deliver infrastructure upgrades and services that meet community expectations.

2.2.5 Other Local government has been increasing the revenue generated from other sources, which has increased as the financial capacity and awareness of councils has increased. On an aggregated level, income from these sources makes up approximately 20% of local government’s total revenue, and typically includes:

• interest income

• dividends

• fines, and

• user charges, which typically include:

− swimming pools fees

− land clearing fees

− library service fees

34 Warringah Council 2006, Warringah Council Newsletter: Spring 2006



− halls/community centre hire fees

− recreation fees.

Fines and infringement notices can comprise a significant proportion of a council’s user charges, particularly in metropolitan areas. For example one large metropolitan council derives 8.2% of total operating revenue from fines. Increasing technological advances have made fines a growing source of revenue by improving monitoring and distribution processes (eg electronic parking meters).

2.2.6 Is local government raising revenue at the level it should be? In the interests of promoting financial sustainability it is critical that councils ensure that they are raising rate revenue at an adequate level. The ability of councils to raise revenue depends on local political will, local household income, and any constraints that the state government may impose. Rates form an important source of own-source revenue for all councils that can be used autonomously to meet expenditure requirements. The reliance on rate revenue varies greatly with rates accounting for between 10% and 60% of total council revenue.

It is evident that there is significant divergence in the degree of rate raising efforts across different categories of council. This can be seen in the different average annual rate cost per residential household per annum. For example, the WA Sustainability Study found a substantial variation, with the lowest 10% charging less than $300 per annum and a councils in the top 10% charging more than $729 per annum. Hence, the councils in the lowest quartile may consider progressively increasing rate levels to lift their charge per assessment towards the average. A number of states have a minimum general rate with rates being set at the greater of the minimum or the UCV based rate; for example in Maroochydore the minimum rate is $675 per annum or 38 cents per UCV. A similar alternative reform option would be to establish a municipal charge (a flat rate charge that is placed on all properties within a municipality). Such a charge would reduce the ‘ad valorem’ component of the rates with this ideally being set to reflect the fixed costs of councils per property. However, both a municipal charge and minimum rate reforms represent a shift towards a regressive taxation approach that may create some hardship for fixed and low income earners and a progressive transition period may be required to mitigate such impacts. Overall, for councils yet to establish a minimum rate there is likely to be merit in establishing a municipal charge to reflect the fixed costs of servicing each property, whilst councils that already have a minimum charge should re-assess the level of fixed cost recovery of their minimum rate level.

The other measure of rating effectiveness is the extent of rate rises vis-à-vis council cost growth. On an aggregated level, rate revenue income has had an annual increase of 6.1% between 1998-99 and 2004-05, which compares to a compound annual CPI increase of 3.2%, and increases in council expenditure of 6.5% per annum over the same period. This reflects the higher cost growth of local government services, which are more closely aligned with the construction cost inflator rather than CPI, the increase in the standards of service, and the introduction of new services.

Hence, while the majority of councils have been active in seeking rate increases that match cost growth, there remains significant room for some councils in the bottom quartile to increase rates and hence, their financial capacity.



In addition, there also appears to be significant capacity for some councils to increase user charges where they are able to more accurately incorporate cost reflectivity. For example, the WA Inquiry reported that on average councils recovered 34.1% of the council’s own purpose operating (and depreciation) expenses through the fees and charges in 2004-05, while the minimum cost recovery ratios for councils in the highest quartile of effort was 38.1%. Hence, it was concluded that any council applying a cost recovery ratio below the upper-bound effort currently observed among WA councils possesses a potential additional source of financial capacity.35

Overall, the majority of councils appear to be utilising available revenue streams at reasonably adequate levels. Some refinements to financial management and governance of these revenue streams, further discussed in section 5.1, should assist in boosting the financial capacity of councils.

2.4 Expenditure

2.4.1 Expenditure items At $19.4 billion in expenditure in 2004-05, local government expenditure represents 2.3% of gross domestic product (GDP).36

According to the ABS Government Finance Statistics, the key local government cost drivers across Australia are employee expenses (38%) and other operating expenses (41%) which include all costs of providing goods and services and maintaining infrastructure.

Figure 2.7: Local government gross operating expenses, Australia 2004-05

Employee expenses

38%

Other operating expenses

41%

Depreciation 21%

Source: Australian Bureau of Statistics, Government Finance Statistics, cat. no. 5512.0

35 Access Economics 2006, Local Government Finances in Western Australia, for the Sysytemic Sustainability Study, July 2006, p. 49 - 50

36 Australian Bureau of Statistics, Government Finance Statistics, cat. no. 5512.0; and Australian System of National Accounts, cat. no. 5204.0.



Interestingly, Figure 2.7 shows that depreciation makes up 21% of local government expenses, which is significantly higher than that for the Australian Government (3.1%) and state and territory governments (6.7%) over the same period. This reflects both the size of the local government asset base, which makes up just over 20% of total assets, listed in the Total Local General Government Balance Sheet, and the nature of local government assets of which almost 94% are non-financial. Figure 2.4 above shows that local government manages up to 36%, or $328 billion, of Australia’s non-financial assets. By contrast, state and territory governments, which have the largest proportion of total assets (58%), manage a majority 56% of non-financial assets, whilst the Australian government only manage 8% of total non-financial assets.

2.4.2 Cost growth A recent trend observed by the local government sector is the increasing cost of providing services. In order to gain a better understanding of the expenditure requirements on local government, the LGAQ commissioned an economic consultant to develop a local council price index. For 2005, the index was 5.7%, which is almost double the Brisbane CPI for that year.37 This is driven by the high level of spending on construction, which represents 40% of local government expenditure in Queensland, and is significantly higher than construction spending by the other government sectors.

2.4.3 Expenditure trends Figure 2.8 shows the breakdown of expenditure according to service and infrastructure requirements aggregated on a national level. Some 79% of council expenditure is spread over the following four key categories:

• transport and communications (24%)

• housing and community amenities (23%)

• general public services (17%), and

• recreation and culture (15%).

These expenditure patterns spread over a number of different areas demonstrate the importance and diversity of the services and infrastructure that is being provided by the local government sector. This differs from federal and state spending patterns that have a large proportion of funds concentrated in specific areas, namely social security, health and education, with remaining spending over a large number of expenditure areas.

37 Hallam, G. 2006, “The Price of Growth is Increased Rates” in The Courier Mail, 30 June 2006, p.23.



Figure 2.8: Local Government expenditure by purpose, Australia, 2004-05

Housing and community

23%

Transport and

communications

24%

Recreation and culture

15%

Social security and

6%

General public

services 17%

Other 15%

Source: Australian Bureau of Statistics, Government Finance Statistics, cat. no. 5512.0

Over the past 35 years, the local government sector has been providing increasingly diverse services and functions. The Commonwealth Grants Commission (CGC) identified the following local government expenditure trends in its review of the Local Government (Financial Assistance) Act 1995:

• adding a range of social services to the traditional planning and building approvals, road maintenance and waste services

• increase in the relative importance of recreation and culture, and housing and community amenities

• expansion of education, health, welfare and public safety services, and

• a gradual decline in the relative proportion of road expenditure as spending on other services has seen faster growth rates;38

38 Commonwealth Grants Commission, Review of the Operation of the Local Government (Financial Assistance) Act 1995, June 2001, p. 53.



Figure 2.9: Composition of local government expenditure, 1961-62 to 1997-98

Source: Commonwealth Grants Commission, Review of the Operation of the Local Government (Financial Assistance) Act 1995, June 2001, p. 54.

Figure 2.9 below shows that the expense category ‘transport and communication’ has decreased from around 50% of local government expenditure in the early 1960s, to the current level of around 25%. For local government the key component of this expense category is road related expenditure, though there is some spending on community transport, and a more recent trend of spending on communication technology such as broadband. At the same time spending on ‘housing and community amenities’ has significantly increased from around 10% to 20%.

Text Box 5: Oamaru Blue Penguin Colony Corporatisation Corporatisation of tourist and recreational facilities in New Zealand

Tourism and recreational services is an emerging area in which local government is increasingly becoming involved. Through corporatisation, Waitaki Council in New Zealand successfully responded to public interest in developing the Oamaru Blue Penguin Colony (OBPC) which manage an eco-tourist attraction without draining the resources of the council away from core service provision.

In 1992, as owner of the Oamaru Harbour, Council supported an initiative from volunteer sector community groups to develop the potential of viewing Blue Penguins at a disused quarry in a corner of the Oamaru Harbour. In 1998-99 Council delegated responsibility to a Council-owned Company, the Waitaki Development Board, to develop a Visitor/Viewing Centre to cater for the growing visitors and to manage the facility.

The Council requires the OBPC to be managed to a standard that is appropriate for a major visitor attraction/destination, enabling the visiting public to view penguins arriving at the colony on a daily basis. The goal is to manage the attraction in an environmentally sustainable and financially viable manner.

Council’s support for this activity was to enable a new and unique activity to be established. This activity has made a substantial contribution to the emergence of a local tourism industry that is aiding local economic development. This is a key example of a council effectively managing growing pressures to support increasingly diverse services to the benefit of the community and the local area.

Source: Waitaki Council Oamaru Blue Penguin Colony Management Plan



2.4.4 Infrastructure A key responsibility of local government is to provide, develop and maintain infrastructure necessary to provide people with access to economic and social facilities and services. Local government infrastructure includes local roads, bridges, footpaths, regional aerodromes, water and sewerage (Queensland, regional NSW and Tasmania), stormwater drainage, waste disposal, public buildings, parks, and recreational facilities.

The local government sector in Australia is responsible for approximately $170 billion in assets (depreciated replacement cost), as of 2003-04. The estimated breakdown of this asset base is:39

• land: $50 billion

• buildings: $12 billion, and

• other construction infrastructure, including local roads: $103 billion.

There is a significant challenge in calculating a precise estimate of the value of local government infrastructure, as a large proportion of councils’ asset registers are not regularly indexed or re-valued. The majority of local government assets are still in their first generation of life and have yet to be renewed. Hence, councils have limited experience with major renewal and many do not fully understand the importance of asset management planning.40

Of the infrastructure requirements of local government, the maintenance of local roads is one of the most capital intensive. There are approximately 810,000km of public roads in Australia, of which around 80% (650,000km) are local roads. Around 33% of these roads are sealed, with the remaining unsealed.41 Routine maintenance of unsealed road costs $1,100/km, whilst an urban sealed road costs approximately $1,400/km and a rural sealed road costs around $3,300/km.42 Beyond regular basic maintenance, roads have significant periodic renewals expenditure requirements, such as resealing a sealed road, which costs around $20,000 – $22,000/km and is required every 15-20 years. 43 It is estimated that councils are currently spending $3.8 billion on road maintenance per annum, which is almost 10 times the annual sum of $384 million allocated in the recent R2R funding package for the four years to 30 June 2009 ($1.54 billion, including $308 million supplementary funding).

The review of the R2R Program showed that the majority of the R2R funding was spent on the existing asset, with approximately half being allocated to renewal and the other half to upgrading the existing road to a higher standard.44

39 DOTARS 2006, 2004/05 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p. 77.

40 Jeff Roorda & Associates 2006, Independent Inquiry into the Financial Sustainability of Local Government: The Present Condition and Management of Infrastructure in NSW Local Government, p.15.

41 DOTARS 2005, 2003/04 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p. 76 42 NSW Grants Commission estimate of standard road maintenance costs, 2006. 43 MAV Life Cycle Asset Management Database, accessed at

http://www.algin.net/mav/Public%20Section/background.htm 44 DOTARS and ALGA 2003, Report on the Roads to Recovery Program, February 2003, p.9.



The problem for local government is two-fold characterised by:

• a shortfall in funding to meet increasing community expectations, and

• the need to maintain and renew the existing road network.

It is clear from the information provided by councils that the R2R funding is used primarily to address the second shortfall as this is where councils see the majority of the backlog of works.

Text Box 6: One perspective on the drivers of infrastructure backlogs Administrator of Warringah Council – why maintenance renewals backlogs develop

“This week’s media carried reports of a NSW Auditor General’s report that identified that the Roads and Traffic Authority (RTA) has not been spending sufficiently on road maintenance. This startling revelation would certainly come as no surprise to anyone driving on our roads. To be fair, the same thing could be said about most councils in regard to their road maintenance.

Of course this is the very issue behind our recent introduction of a new special rate levy to increase expenditure on infrastructure. The problems caused by such under-spending are not limited to roads maintenance. In recent times we have all read about the problems in our schools, public housing and hospitals, as well as the well-documented problems with our ferries and rail infrastructure.

This raises the obvious question of “Why Does It Happen?”

The answer, in my opinion, is very simple. Politics. Political factors intersect with budget considerations on many levels. In most cases the input of elected representatives into decisions about resource allocation are both legitimate and appropriate. Who better to decide between national parks and extra police? In such cases the politicians answer to the people if they get it wrong.

With maintenance expenditure it is not nearly so clear-cut. While some maintenance is essential to perform on a regular basis, much of it fits into a class of being able to be deferred for a year (or two, or three, or …). In most of these cases the consequences are not immediately visible. It is my experience that many politicians, when faced with having to make a ‘hard’ decision, one that is likely to have negative political consequences for themselves, will take the politically easier way-out.

In many cases this easier way-out involves either not allocating enough for maintenance, or switching maintenance funds to cover a shortfall somewhere else in their budget. They choose to do this because three and four year election cycles mean they are unlikely to be held accountable for the consequences of under-spending on maintenance.

In my experience this is a feature of all governments regardless of political persuasion. It is unfortunate that it is usually far more expensive to deal with asset maintenance if regular maintenance has been under-funded. I know many readers were unhappy to have their rates increased above inflation. I hope people take some comfort from knowing that the special rate funds will only ever be spent on infrastructure, and cannot ever be diverted to cover other budget or service problems.”

Source: Dick Persson AM, Administrator of Warringah Council, see www.warringah.nsw.gov.au

Council operated airports and aerodromes A number of rural councils own and operate airports or aerodromes. These small airports generally cater for a low volume mix of private and commercial aviation operators and their passengers. Councils provide these facilities as they are seen as integral for better connecting their local residents to essential capital city services and attracting business and tourism investment. For many isolated or remote councils, their airport is often operated and retained to facilitate faster medical evacuations and support better access for other emergency-related services following natural disaster events. Some state governments attempt to provide smaller rural towns with more service stability, route development and continuity of services in air services by regulating competition.



For example, in NSW intrastate air routes (to/from Sydney Kingsford Smith Airport) with an annual passenger volume of less than 50,000 are regulated, with such routes being allocated to one operator under five-year licences with potential for opening a competitive tender process at licence expiry.45

The landing fees generated from such facilities are often insufficient to cover the costs of the maintenance program required to keep the runway in a safe working condition to meet Civil Aviation Safety Authority (CASA) requirements. Hence most small council owned and operated airports have a cash operating deficit which can place such councils under financial pressures, which then requires scaling back of other services. Some state based local council associations have been seeking new or enhanced subsidies from both state and federal governments to improve the viability of services to smaller regional centres.46 Local government believes that aviation security is a national security issue and as such security upgrades for regional airports, including any ongoing maintenance or staffing requirements, must be fully funded by the federal government and not passed on to councils. In this regard, DOTARS has established a range of programs to improve the security of regional aviation and airports.47

At the other end of the spectrum there are some larger council owned and operated airports, typically those which are a tourist area gateway, where the airport is a stronger business that can support the provision of a wider array of council services (eg Sunshine Coast Airport and Coffs Harbour Airport). However, these larger airports are also generally facing large capital expenditure programs to improve terminals, runways or security, which also can place the owning council under financial pressures.

Some of the key issues encountered by councils in operating airports and retaining air services are explored in the case study text box below, which examines the experiences of Inverell Shire Council.

Text Box 7: Inverell Shire Council Airport and Services Inverell Shire Council Airport and Services

Inverell Shire Council had annual cash operating costs of $96,000 (in 2005-06) to maintain the airport whilst total income (mainly from terminal leases) provides less than $3,000 per annum. The airport also has a depreciation cost of $40,000 per annum. Like most small airports, Inverell has a range of upgrading needs. For example ideally the airport would have an Automatic Weather Station (capital cost $65,000), however this item was omitted from the capital works list for 2006-2007 due to insufficient funds. For major upgrade needs, many smaller councils often need DOTARS support to fund the required works. In December 2005 Inverell Airport obtained $294,000 via a grant to fund upgrading of basic security measures (eg fencing, lighting, CCTV and access control).

The loss of air services has become a major concern for country towns that depend on a regular flight to Sydney. A large number of towns such as Kempsey, Cootamundra, West Wyalong, Forbes and Cowra have had periods (or are still) without air services when their airlines cease operations.

The commercial viability of providing airline services to Inverell has often been marginal. In 1998 the then operator (Tamair) went into receivership reportedly owing Inverell Council over $100,000. Some other operators sporadically serviced the route until services again ceased. Qantas withdrew flights to Inverell and Taree in 2003, which led to efforts by these communities to have their services restored and it opened the door for small airlines to fill the gaps.

45 NSW intra-state routes with annual passenger volume above 50,000 are deregulated (eg Kingsford Smith) Airport to: Albury, Armidale, Ballina, Coffs Harbour, Dubbo, Port Macquarie, Tamworth, Wagga Wagga and Williamtown). All other intrastate air routes not linked to Sydney Kingsford Smith Airport are also deregulated. For more information see: www.transport.nsw.gov.au

46 For example see: http://www.lgsa.org.au/www/html/314-aviation-and-airports.asp 47 For example see: http://www.dotars.gov.au/transport/security/aviation/regional/index.aspx



Following the loss of air services to Gunnedah and Inverell, private investors from these two communities, with support from the two Shire Councils and businesses in the region, combined to establish Big Sky Express (BSE) in 2004. BSE sub-contracts air operations to Transair, a Brisbane based airline which holds the CASA air operator certificate. To improve the viability of airline services, Gunnedah and Inverell Councils waived landing fees ,which in turn increases the airport operating deficits. BSE currently has two 19-seater aircraft (both Fairchild Metros) to service two triangular routes Sydney-Taree-Grafton and Sydney-Gunnedah-Inverell. BSE has expansion plans into other towns of NSW. It also formerly operated to Brisbane and Coonabarabran but has ceased these services.

A key challenge for an airline servicing towns like Inverell is that passenger volumes are light and parts of the community will prefer to commute to larger nearby towns (eg Armidale, Moree, Tamworth) so as to access larger planes with more regular services and also potentially cheaper fares. However, the commitment of local investors with the support of councils and business should hopefully see BSE continue to provide a viable, value for money and high quality local air service linking Gunnedah, Inverell, Taree and Grafton to Sydney.

Source: Inverell Council website http://www.inverell-online.com.au/dir205/InvOnline.nsf; Factiva Press Reports and Big Sky Express website https://www.bigskyexpress.com.au/solrs_FlightSearch.aspx.

2.5 Growing demands on local governments

Local governments have expanded their roles and service provision beyond those traditionally delivered by the local sector as shown above in Figure 2.9. They have increasingly taken on responsibility for social services, such as management of health, alcohol and drug problems, community safety and improved planning and accessible transport. Local government is also playing an increasing regulatory role in the areas of development and planning, public health and environmental management.

As mentioned above, the local government sector has been providing increasingly diversified functions. The CGC outlined the following reasons for the increase in local government functions:48

• devolution: occurs where Australian or state/territory governments require local government to take responsibility for services

• raising the bar: occurs where the complexity/standard of a local government services is increased by other tiers of government

• cost shifting: is the withdrawal of federal/state funding support to local government to provide a service previously provided by another level of government, or where local government steps in to provide a service withdrawn from another tier of government

• increased community expectations: where the community demands improvements in existing local government services, and

• policy choice: is where councils voluntarily choose to expand there service provision

The intergovernmental agreement on cost shifting signed in April 2006 should help to provide a better framework for further, bilateral and trilateral agreements covering the delivery of specific services and functions in order to avoid future cost shifting.

The reasons identified by the CGC are discussed further below.

48 Commonwealth Grants Commission, Review of the Operation of the Local Government (Financial Assistance) Act 1995, June 2001, p. 52 – 53. in House of Representatives SCEFPA 2003, Rates and Taxes: A Fair Share for Responsible Local Government, October 2003.


http://www.inverell-online.com.au/dir205/InvOnline.nsf

https://www.bigskyexpress.com.au/solrs_FlightSearch.aspx


2.5.1 Devolution Devolution occurs when state/territory or the Australian Government provides local government with a planned transfer of responsibility for new functions. Devolution has become a contentious issue due to the often modest extra funding received by local governments for taking on extra projects and responsibilities. Unplanned devolution is where state governments or the Australian Government wind back or rationalise services without a formal transfer, and responsibility migrates to the sole remaining government entity.

One major area of devolution to local government is health and welfare. Local governments are concerned that they have not been adequately provided with the capacity and resources in order to carry out efficient public health programs resulting in cost shifting (further discussed in section 2.5.3).

2.5.2 ‘Raising the bar’ ‘Raising the bar’ occurs when state/territory governments or the Australian Government increase the complexity level or standard at which a local government service must be provided, through legislative or other changes, and hence increase its cost. These changes have occurred in various regulatory and compliance requirements, including food regulation inspection requirements, environmental reporting requirements, privacy legislations, accounting requirements, water monitoring and town planning.

2.5.3 Cost shifting Cost shifting has occurred in Australian governance with two basic types of behaviour. The first is where local government agrees to provide a service on behalf of another sphere of government but funding is subsequently reduced or stopped, and local government is unable to withdraw because of community demand for the service. The second is where, for whatever reason, another sphere of government ceases to provide a service and local government steps in.

The House of Representatives standing committee on economics, finance and public administration, completed a report titled Rates and Taxes: A Fair Share for Responsible Local Government (The Hawker Report). This major inquiry into local government and cost shifting also revealed the underlying issues relating to governance arrangements between the three spheres of government. A finding of the Hawker Report is that cost shifting is, ultimately, a symptom of what has become dysfunctional governance and funding arrangements.

A recent example of this is Manly council stepping in to provide a weekday bus service from Manly to Warringah Mall after the state provided bus service was suspended. The council is currently providing a bus along this route three times a day, Monday to Friday.

Where adequate funding is not provided, the CGC stated that devolution, ‘raising the bar’ and direct cost shifting could all be examples of cost shifting, while increased community expectations and policy choice are a matter of local government choice and policy. Examples of cost shifting to local government that have occurred are highlighted in Table 2.5 below.



Table 2.5: Examples of cost shifting to local government

Cost shifting means Examples

Withdrawal or reduction of financial support

Health and Welfare – Many councils financially support the housing, travel, housing and salary of doctors and health professionals. In Victoria, the City of Casey’s maternal and child health unit’s cost per hour is grossly under-funded by the state government, resulting in $290,000 per annum costs to local government. Security and Safety – City of Perth’s local government provides video surveillance and security patrols at a cost of $922,000 per annum Power, Electricity and Water Provision – Councils in the NT provide water, sewerage and electricity on behalf of the Power and Water Authority. However, the contractual arrangement which compensates councils does not take into account costs such as recruitment and housing of staff. ALGA estimates that the cost to NT councils is approximately $62,500 per annum

Transfer of assets Airports – Commonwealth aerodromes were transferred to local government in the 1990s with some initial financial incentives. The choice for most councils was one of either accepting the opportunity or potentially losing the service to the community. The cost of operating small non-commercial aerodromes can be significant. For example, Flinders Island Council estimated that they are forced to spend up to 20% of their rate revenue to maintain the island’s airport. Roads – Some state governments have handed over responsibility for regional roads to local government. The state subsequently provided on an annual basis funding to councils to undertake maintenance. This funding however, has become inadequate due to the significant increase in road maintenance costs, given that input costs have grown by more than CPI and roads now need more expensive resurfacing. Furthermore, state government has no obligation to notify, seek the agreement of, or compensate councils when transferring a crown road to local government. For example Guyra Shire Council, NSW, now claims that they face new costs of $50,000 per annum, as well as having incurred a once-off cost of $1 million as a result of this transfer of assets.

Concessions and rebates provided without compensation

Pensioner Rebate Scheme – The majority of states and territories provide rate rebates or discounts for pensioners. In NSW, the scheme was originally fully funded by the NSW Government. However, this was cut back following the introduction of FAGs, with local government now incurring at least 50% of the cost of the rebate scheme. Tamworth Shire Council has estimated that rebates cost approximately $700,000 per annum or 5% of total council income. Non-rateable land – There is a considerable amount of Federal and State government owned land which is exempt from local government rates. In Queensland, the Diamantina Shire Council has had council revenue reduced by 12% as a result of 11,000 km2 of land being declared national park since 1991 with land being purchased by the Queensland Government from private holders.

Increased regulatory and compliance requirements

State of the Environment reports – Requiring data gathering and mapping, compulsory state of the environment reports have been introduced. It is estimated to cost Eurobodalla Shire Council alone $37,000 per annum. Town planning – SA local councils must now review their development plans every 3 years as opposed to every 7 years previously. This costs the City of Unley’s $80,000 per annum.

Failure to provide for indexation of fees and charges

Building licensing fees – In WA, the fee structure charged by local government is determined Regulation 24 of the Building Regulations 1989. The fee is based on a percentage of the value of works, with a minimum fee of $40 despite significant cost increase in recent years. Development Applications – NSW fees do not take account of the real costs associated with the processing of applications. As a result Rockdale City Council incurs increased costs of around $200,000 per annum.

Source: House of Representatives, SCEFPA, 2003. Rates and Taxes: A Fair Share for Responsible Local Government, p. 181-188



2.5.4 Increased community expectations and policy choice Local communities often demand an increase in services, or service quality, to cover a gap in the market or to match services provided by other local governments. The demand for increased spending on human services, such as health, welfare and public safety, has trebled in the past three decades. This has been at the expense of traditional services such as roads, thus contributing to the rundown of local roads and other infrastructure due to the deferral of renewals by some councils. The onset of an ageing population has also exacerbated this trend in some areas, resulting in some councils choosing to provide aged care services.

A further factor affecting the demand for services is the strong performance of the national economy. Notably, strong economic performance generates growth in demand for government services at all levels and demand for local government services has increased accordingly. As such, local government funding must increase in line with the growth in the economy if local government is to continue to satisfy legitimate community expectations, whilst also coping with legislated responsibility transfers from other spheres of government.

Policy choice is where local government bodies choose to expand their service provision voluntarily. This occurs because local government bodies identify a gap between the services provided by state and local government, and those needed by the community. Many of the increases in local government functions implemented through policy choice are a result of changing demographics and needs of the local population. These changes include the ageing population, population drift to coastal areas and the diminishing rate base in many rural areas.

It is critical in the context of expanding community demands that councils attempt to contain services to meet the reasonable and essential demands that are within the financial resources of the council. While state and federal governments have an obligation to support the operations of the local government sector, particularly in service areas from which they have withdrawn, councils equally have an obligation to ensure that they choose an appropriate mix of services that meet both community expectations and the financial resources of the council. Community consultation is crucial to managing and meeting these expectations.

2.5.5 Is local government providing the right mix of services? The historical and political development of local government has seen the sector under increasing pressure from a number of sources to diversify its services and support to the community. The resultant broad spectrum of services is shown in Figure 2.1. In the context of ongoing financial challenges, it is important for local government to assess whether they are providing an appropriate mix and scale of services with respect to their financial resources. The inherent diversity of the local government sector makes it difficult to define the “core” services that councils should be providing, nor is it considered appropriate to do so. One of the greatest attributes of local government is its ability to gauge and provide a flexible response to the specific needs of each community in a timely and innovative fashion.



However, further work needs to be undertaken by many councils to regularly ensure that they are providing services that they have a comparative advantage in providing and that are a priority for the community in the context of state and federally provided services. Generally, the degree of comparative advantage should be self-assessed, ideally using templates or guidance from state associations, in comparison to regional groups of councils. Some councils are using community survey tools to ensure their corporate planning outcomes (ie strategic direction, service delivery mix and performance) meet community perspective expectations.49 While the community may obtain significant benefits from certain council provided services or infrastructure, it is important that such services are only provided where it is within the financial means of the council. There are some council provided service areas that may warrant review where there is some evidence of duplication in the provision of services between the three spheres of government. The CGC estimated that the full extent of duplication and coordination costs of all levels of government is approximately $20 billion per annum.50

The intergovernmental agreement on cost shifting should make significant progress in avoiding devolution and cost shifting of services to local government without adequate support. However, local government also needs to ensure that it only agrees to take on service delivery where clear funding streams are identified, and where the services fit with the priorities of the community. Overall, other spheres of government must recognise their responsibility to fund local government when they are required to take on roles that belong to the Commonwealth or states, and local government must exercise strong caution prior to stepping in to deliver such a role.

A large part of ensuring that each council is providing the right mix of services that will not place pressure on their long term sustainability is to actively engage in consultations with the local community. This will ensure that councils pursue a service mix that meets the priorities of the community, whilst also raising community awareness of the associated costs and potential rate rises or trade-offs of particular council provided services. In addition to assessing the most suitable mix of council provided services, councils are also likely to benefit from being more active in raising community awareness about the range and value of services currently being provided. Anecdotal evidence suggests that many ratepayers are not aware of the large volume of local and regional infrastructure and essential services provided by councils. By better promoting the importance and value of the services provided by local government, councils may be better placed to manage community expectations and ensure effective service delivery.

49 For example see the LGAQ s Bi annual Community Attitude Survey. 50 House of Representatives, SCEFPA 2003, Rates and Taxes: A Fair Share for Responsible Local Government,

p.5.



2.6 Efficiency of local government services

The effective provision of services and infrastructure is dependent upon local government exhibiting both:51

• financial capacity to mobilise financial resources through revenue-raising and financing policies, and

• managerial capacity (in terms of effectiveness and efficiency).

Efficiency thus indicates how well a council can use resources to produce goods or services. The efficiency of each council varies considerably and depends on many factors, such as absolute population, population density, distribution and growth, other demographic characteristics, age and type of infrastructure, rainfall, topography, and soil types. These ‘non-discretionary’ variables cannot be affected by council performance and thus lie outside the range of managerial expertise.52 The cost of providing services in remote areas of Australia, without the economic, rating or skill base, will invariably mean that some councils will face significantly higher cost structures, with limited room to achieve savings through improved efficiencies. Furthermore, it is often difficult and usually very costly for rural and remote councils to attract the high calibre staff required to develop and implement robust asset management plans and financial strategies.

The efficiency of local government is critical to the delivery of key economic, social and environmental services to its communities. The importance of capitalising on the value that can be achieved by competitive tendering and local and regional service delivery, which can provide greater flexibility to meet the needs of the local community, has been recognised by numerous efficiency reforms in many jurisdictions. With over 700 councils across Australia that are largely engaged in delivering similar services, improving the efficiency of the local government sector is an ongoing challenge. However, for many rural and remote communities, the large distance between councils can be a significant impediment to increasing regional service delivery. While structural reforms through amalgamations are necessary in some instances, each potential amalgamation needs to be assessed carefully to avoid the risk of simply creating large inefficient councils.

Over the past decade there has been growing awareness and progress across the sector about the need to improve the efficiency and sustainability of local government. As a consequence, over the past decade a number of councils have implemented a range of successful reforms to improve their efficiency and sustainability. The local government sector has been actively pursing these types of reforms, often in a self-managed process, for a number of years. A few examples of such successful efficiency reforms that councils should continue to pursue in the areas of shared resources, financial planning, and governance, are provided below.

51 Independent Inquiry into the Financial Sustainability of NSW Local Government 2005, Background and Issues Paper, October 2005, p.7.

52 Dollery, B., 2005 Relative Effectiveness and Efficiency of NSW Local Government: Independent Inquiry into the Financial Sustainability of NSW Local Government, p.6



2.6.1 Outsourcing Outsourcing is defined as the contracting of non-core operations from internal production within a business to an external (third party) entity that specialises in that operation. It is a business decision that is often made to lower costs and/or to focus more on core services.

Outsourcing through competitive tendering has long been common place within local governments in Australia and spans the fields of IT and telecommunications, legal, office support, professional support, technical and operations, trade and industrial and sales marketing and communications. Local governments have increasingly outsourced the provision of services rather than providing these services themselves.

For example, through major reforms of local government in the 1990s Victoria formalised the concept of outsourcing through compulsory competitive tending (CCT), which was effectively the market testing of services to determine a competitive price. The policy was in place from 1994-95 until 1999, and required councils to develop service specifications, including measures of the cost of providing the service, which were then publicly tendered for the provision of a service through the open market. Overall, CCT had the positive benefit of driving councils to document clearly the requirements and expected cost of a service and exposed councils to more competitive cost structures.

The experience of the CCT policy indicated that it was the process of competitive tendering rather than the size of the tender that drove efficiency gains. Conversely, CCT also reduced the drive for efficiencies through collaborative partnerships of councils in providing services to communities.53 This loss in regional service collaboration, in addition to the rigidity of CCT, saw Victoria replace the policy with a more holistic approach that focuses on obtaining the best value. Further information is provided in Textbox 8 below.

Outsourcing can improve the efficiency of local government services in non-specialised areas where the cost provision for local government is much higher than the private sector. Outsourcing can also be critical in providing services in an area with pervasive skill shortages. However, it is critical that outsourcing is strategically aligned with the long-term service plan of the council, to ensure that outsourcing is not used as a way of overcoming poor internal management.

53 Department for Victorian Communities 2005, The Local Government Best Value Commission 2004 Annual Report, p.2.


http://en.wikipedia.org/wiki/Business_Operations


Text Box 8: Best Value Policy, Victoria Best Value Policy, Victoria

The Best Value Policy, introduced in Victoria in 1999, is a more holistic approach to outsourcing local government services, which removes the inflexibility of CCT and assists councils to build effective partnerships with their local communities. The Best Value approach aims to ensure that councils are primarily accountable and responsive to the needs of local communities.

The objectives of the Best Value Principles are to foster:

• Local accountability: councils are accountable to their own communities for the provision of services and the performance of the organisation in accordance with the Best Value Principles.

• Whole-of-organisation response: council implementation of the Best Value Principles by a whole-of-organisation response applied through its corporate planning responsibilities including all its services and functions.

• Consultation on performance: a council demonstrates its accountability for the implementation of the Best Value Principles by measuring and reporting on its performance to its community against objectives and targets that are set by the council after consultation with its community.

• Best Value outcomes: the Best Value Principles framework will deliver enhanced service and organisational performance across the local government sector and that the sector be able to demonstrate to the State Government that it has achieved these objectives.

• Benefits, not costs: implementation of the Best Value Principles framework will not incur costs that outweigh the benefits of applying the Best Value Principles framework, particularly in relation to small rural councils.

• Encourage innovation: the Best Value Principles framework encourages councils to adopt innovative and creative responses to service delivery, including a range of partnering relationships.

The Local Government Best Value Commission was established in December 2000 to advise and make recommendations to the Minister for Local Government on the implementation of the Government’s Best Value Victoria policy. Each year the Commission holds a series of meetings with councils and the peak organisations and associations to discuss issues arising from the implementation of Best Value, the benefits and innovative practices coming out of implementation and any identified gaps or problems.

Source: Local Government Best Value Commission Victoria.

2.6.2 Structural reforms Structural reforms have been adopted by councils in order to provide more cost-effective local services. Thirty years ago there were a much higher number of councils in Australia; over 100 councils have been consolidated over the past 20 years.54 NSW, Victoria, SA and Tasmania have undergone periods of municipal consolidation of differing degrees in recent years. Hence, many of the most unsustainable local governments have already been merged, although further voluntary amalgamations may achieve further efficiency improvements. Self motivated review processes such as the SSS Review being undertaken in Queensland, can provide the appropriate forum for voluntary structural reforms to emerge pending appropriate investigation and analysis.

The Hawker Report examined a range of factors affecting the viability of local councils, concluding that small rural councils in Australia’s inland face a multitude of challenges, including decreasing population, low rate base, deteriorating infrastructure, and increasing demand for better social services.

54 Commonwealth Government 1985, National Inquiry into Local Government Finance Report, p.3.



The local government sector in Victoria undertook a series of amalgamations beginning in 1992 and concluding in 1995 that reduced the number of councils from 210 to 78. The amalgamations, in addition to the introduction of compulsory competitive tendering, successfully resulted in an improvement in both financial viability and local government service provision. This experience highlighted that mergers can bring greater financial strength and stability to councils. However, simply merging a number of adjoining unviable councils is unlikely to increase financial sustainability and it may decrease effectiveness and result in greater disputes between councillors based on parochial interests. Often, councils facing chronic financial sustainability concerns are small rural councils with declining populations. Amalgamating these small rural councils, while improving the general financial health of councils, will not be a panacea to the ongoing structural concerns facing these councils. Hence, any amalgamation must be accompanied by other reforms to increase efficiency and effectiveness.

2.6.3 Corporatisation of commercial activities A local government owned corporation is a separate legal entity that is wholly owned by one or more local governments and is ultimately controlled by them, but whose operations and contractual and other legal liabilities are distinct and separate from those of the council itself.

However, some councils will face certain regulatory and financial limits to developing commercial entities. As an alternative to corporatisation, councils can establish commercial activities as a separate accounting profit centre that pursues the principles of corporate entities.

Text Box 9: Local Government Infrastructure Services, Queensland Local Government Infrastructure Services, Queensland

Under a joint initiative of the Local Government Association of Queensland (LGAQ) and Queensland Treasury Corporation (QTC) the corporation Local Government Infrastructure Services (LGIS) was formed to provide local government in Queensland with assistance in evaluating and delivering infrastructure in a cost effective and efficient manner. Since its official launch on 30 August 2005, LGIS has booked 4,000 consulting hours and is overseeing work to the value of $1.2 billion.

LGIS operates on a fee for service basis, and any decision to utilise LGIS, and the extent of that utilisation is left to the discretion of councils. LGIS provides the following benefits for local governments to ensure the best value for money is achieved in infrastructure provision:

• improved economies of scale for infrastructure projects in Qld, especially smaller projects

• increased bargaining power

• reduced costs associated with infrastructure provision

• expanded choices in assessing and implementing infrastructure projects, and

• accessible information on procurement issues.

LGIS expands the range of solutions available to local government to assist and facilitate local government infrastructure provision, without taking control of the process. The structure of the service enables participating councils to retain flexibility and control in the way in which the projects are delivered.

LGIS is likely to make significant achievements in improving the efficiency of local government in Qld given they are responsible for $48 billion in infrastructure and have total responsibility for urban water supplies and sewerage.



This is an example of positive outcomes from collaboration between local and state governments. The corporation was developed in response to a request by local government for greater with assistance infrastructure provision. It incorporates many of the different approaches to capture economies of scale, such as corporatisation, regional service delivery, and shared services.

Source: LGAQ

2.6.4 Regional service delivery and cooperation Many councils have been actively engaged in improving the efficiency of their operations through regional cooperation and service delivery. This describes the situation where a particular local government service is provided to a number of councils in a region or area either through:

• collaboration of the resources of the cooperating councils, or

• one council being the lead service provider for the area.

This model has been applied to a number of service areas such as: waste services, purchasing and procurement, road and infrastructure maintenance, park upkeep, and recruitment. A proven example of regional service provision achieving significant cost savings is where 67 of the 68 councils in SA collaborated in purchasing electricity and thereby achieved significant cost savings.

In addition, the more integrated and ongoing collaboration of the councils in the Hunter region of NSW, summarised in Text Box 10, also provides a good example of the success of such a model.

Text Box 10: Resource sharing by councils in the Hunter region Hunter Councils Regional Cooperation Strategy

Twelve councils in the Hunter region of NSW have been actively engaged in co-operation and resource sharing for nearly 50 years. The board of the representative organisation, Hunter Councils, is comprised of mayors and councillors from each of the member councils and it meets regularly to consider the major issues impacting the regional community.

With the assistance of the NSW Department of Local Government (DLG) and with the support of the Minister, a new ‘corporate’ model was adopted in 2002 to form Hunter Councils Ltd. This has provided a powerful platform for the councils to drive efficiencies and cost savings with the ultimate aim of creating a financially self sustaining environment.

With over 20 staff, the Hunter organisation has four major project arms including Learning and Development Division, Environment Division, Regional Procurement Program and Records Storage. A small administrative core supports these operations.

Examples of collaborative projects undertaken by Hunter Councils include:

• Joint purchasing program that determines areas of common procurement activity whereby a joint approach to the marketplace, dollar savings, and other advantages can be obtained for the benefit of all Hunter councils. Examples include traffic signage and advertising in the Newcastle Herald

• Regional and integrated planning process designed to involve state government departments in community service planning at the local and sub-regional level, and

• Human Resources & Joint Training Team whose main functions are to research, develop and coordinate training courses for member councils, which are cost effective and accessible locally.

Source: http://www.huntercouncils.com.au/


http://www.huntercouncils.com.au/


2.6.5 Shared services Shared services refer to the consolidation and sharing of services by different units within an organisation. Shared service projects have been progressively adopted both at a national and international level. They seek to take advantage of economies of scale as a proven method of delivering higher quality and productivity with fewer resources, and introduce cost savings from the elimination of redundant work and infrastructure.

A growing number of councils have been making greater use of shared services; for example see Text Box 11. Due to the lack of resources available to NT councils, they have had little choice except to pool assets and staff and provide shared services in order to adequately provide for the community. For the most part these services are provided by the NT LGA, particularly in the areas of financial management, information technology, human resource management, transport and infrastructure.

Overall, expanding the use of shared services is a key strategy to increasing economies of scale and decreasing unit costs to improve financial sustainability.

Text Box 11: Case studies of shared service delivery in Qld Queensland Road Alliance

An example of shared services is the Road Alliance between the Local Government Association of Queensland and Queensland Main Roads, established in August 2002. It is an alliance between state and local governments, and is responsible for approximately $150 million in road construction and maintenance expenditures annually. The Road Alliance will strengthen cooperation between the state and local government in managing Queensland’s road network. It provides a platform for making better decisions on road infrastructure investments, on the use of road funds, on project scheduling and resource sharing across agencies. The Road Alliance will also provide a uniform system for collecting, analysing and reporting data on the state’s roads. The Alliance will be funded through a five-year program.

Milestones achieved include:

• signing of the Memorandum of Agreement (August 2002)

• active involvement of 124 of the state’s local governments in the Alliance

• establishment of 14 Regional Road Groups and their associated Technical Committees

• release of the Road Alliance Operational Guidelines (August 2002)

• release of the Road and Bridge Asset Management Kit (January 2003)

• established a panel of suppliers for Asset Management Software (April 2003)

• development of the Regional Investment Strategy (for release in August 2003), and

• development of the Joint Purchasing and Resource Sharing Framework (for release in September 2003).

LGAQ Corporate Services

LGAQ provides a large range of shared services for its member councils including:

• procurement through Local Buy

• information technology in the form of hosted web applications, community portals, online information services in the form of Local Government Online through Resolute (LGAQ’s wholly owned IT subsidiary)

• financial and administration software package LGOne in conjunction with Technology One hosted via ASP to small to medium councils

• insurance and workers compensation through Local Government Mutual Liability Pool and Local Government Workcare, and

• industrial relations and human resources support through the LGAQ itself.



Queensland is making significant progress in improving the efficiency of the local government sector through the implementation of innovative programs to suit the needs of councils. These advancements are evidence of the progress that can be achieved where there is cohesive collaboration between the sector and state government.

2.7 Measuring local government efficiency

In 1997, the Australian Government engaged the former Industry Commission (which was replaced by the Productivity Commission in April 1998) to examine the feasibility of producing a nationally consistent approach to performance measurement in local government efficiency. This study was conducted as part of a legislative requirement and concluded that:

• a nationally consistent approach to performance measurement of local government was not warranted

• state and territory approaches to performance measurement have significant shortcomings, and

• there would be considerable net benefit to the community from improving state and territory approaches to performance measurement in local government.

Subsequently, the states have generally worked collaboratively with their local government associations to develop a performance improvement culture and develop state-wide indicators or range of indicators that have been adopted in assessing the overall performance of local government.

A summary of these initiatives are shown in Table 2.6 below.

Table 2.6: local government performance measures

State Efficiency Improvement Initiatives

NSW The Department of Local Government’s annual Comparative Information on New South Wales Local Government Councils reports on 36 performance indicators in 11 areas including finance, planning, environmental management and community services. The Department of Local Government produces four data collections relating to rates, finances, waste management and general information. The information has been used to calculate financial assistance grants, analyse councils’ financial health and check compliance of rates collected. To promote use, transparency and accountability, the publication and raw data is freely available on the internet.

A 1998 Independent Pricing and Regulatory Tribunal (IPART) review found that local government can reduce costs, improve accountability and provide better service to the community by undertaking performance benchmarking. The report recommended that benchmarking should be applied to those functions that constitute a significant share of total expenditure, in addition to broader changes to the environment local government operates under, particularly improved monitoring of performance outcomes through independent auditors.55

Victoria The Department for Victorian Communities’ annual publication Local Government in Victoria reports on rates, operating and capital expenditure, debt, infrastructure renewal, operating result, community satisfaction with overall performance, advocacy and engagement. Performance measures are analysed across groups of inner metropolitan, outer metropolitan, regional city, small shire and large shire councils. Some 77 councils voluntarily participated in the 2005 annual Community Satisfaction Survey.

55 IPART 1997, News Release: Benchmarking can improve Local Government Performance - But more is required, 18 December 1997.



State Efficiency Improvement Initiatives

Queensland The Department of Local Government, Planning, Sport and Recreation’s annual Local Government Comparative Information report includes comprehensive information on road maintenance, water, sewerage, waste management, library services, financial management and rates.

WA The Department of Local Government and Regional Development is developing a new system for monitoring the operations of councils to enable performance to be assessed in key areas of activity. The use of internet technology to collect data from councils is being explored.

SA The LGASA has continued its Comparative Performance Measurement Project in 2004-05. Twenty-nine councils are providing data against 18 KPIs for governance, community satisfaction, finance and asset management, and quality of life. Councils can compare their performance against the average results for councils grouped by sector. The 2005 project results will be made publicly available to facilitate comparisons.

Tasmania The Local Government Division within the Department of Premier and Cabinet released the fifth annual report Measuring Council Performance in Tasmania 2003-04 on councils’ key performance indicators. All councils voluntarily contribute data for the report. The reports over the last five years show a consistent downward trend in the debt service ratio and a consistent reduction in the level of outstanding rates at the end of the financial year. A committee, composed of officials from councils, the Local Government Association of Tasmania, the State Grants Commission and the Local Government Division, is reviewing use of the current key performance indicators; the outcome is expected to appear in the 2005-06 report.

NT The Northern Territory Government has been collecting comparable performance indicators since 1997-98. As smaller and remote councils have had difficulty providing information, the Department of Development, Sport and Cultural Affairs in conjunction with the Northern Territory Grants Commission requires all councils to submit an annual return of local government data which combines the requirements of both agencies and simplifies the reporting process for councils to provide financial and performance data.

ACT The ACT’s local government performance measurement is based largely on an annual report, which focuses on benchmarking and reporting on environmental management of waste, roads and urban parks and places. Roads ACT and Canberra Urban Parks and Places have also initiated improved asset management systems. There are also additional benchmarking activities under consideration.

National The Australian Government, via DOTARS, has increased its role with local government by examining national best practice across a range of functions. These initiatives include national awards for local government and leading practice seminars. The national awards for local government were established in 1986. The awards aim to foster and acknowledge innovation and excellence in local government in responding to current and emerging issues relating to councils’ core business and to reflect an issue or subject that is topical to better reflect changes in both federal and local government priorities and address the government’s broad policy initiatives. The Leading Practice Seminar series is a DOTARS initiative started in 2000. Since that time, entrants in the awards have shared their experiences and the lessons learned; and have had the opportunity to discuss their experiences first-hand with well over 200 other local government bodies across Australia.

Source: DOTARS, Local Government National Report, 2004-05 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p. 65 and p. 74 – 76.



2.8 Constraints facing some councils

There are significant differences between the ability of urban, rural or remote councils to increase rates and levy charges, and hence raise revenue.

2.8.1 Skills shortage There is a shortage of certain workforce skills across the Australian economy with insufficient qualified employees available to fill the market-place demands for employment. Australia’s skills shortage is a significant constraint on local government performance. Skills shortage in the labour market affects both the productivity and potential economic growth of local governments. The skills shortage has seen a significant increase in wages and salaries. For local government this has been partially offset by the inability to maintain full staffing levels which can provide some dampening of otherwise higher labour costs.

Skills shortage has been an ongoing issue for some time, and of particular concern in rural areas where financial incentives at above market levels are required to attract skilled workers from regional areas. When there are widespread shortages in the economy, local government, which generally pays less than private sector equivalent positions, struggles in the ‘fight for talent.’

The nation-wide skills shortage covers many industries which are directly related to local government, including financial services and accounting, urban and regional planning and IT. In addition to the impact on council operations, the skills shortage has also meant that rural and isolated councils often need to attract skilled people in the essential services of health and education. While this is a significant issue on a national scale, this comes at significant cost to local governments, which have to offer very attractive remuneration packages (often exceeding metropolitan salaries) and housing in order to attract doctors, pharmacists, nurses, teachers, and so on.

2.8.2 Declining population base Over the past 20 years many rural and remote communities, particularly those with an initially small base, have experienced either static or decreasing populations. This is associated with decreasing job opportunities in primary and agricultural industries, which often results in many people relocating either to larger regional rural centres or to metropolitan areas.

As outlined above, almost 60% of councils are rural and/or remote. Therefore the issue of static and dwindling populations is likely to affect a number of these councils. The key implication of declining populations for local government is the erosion of their rating base, and potential for increasing cost of services per capita. This ongoing trend, in conjunction with the associated skills shortage, poses a significant challenge to the long-term financial sustainability of many rural and remote councils.

While LGGC distribution methodology provides additional funding to councils with a small population base in an attempt to offset this constraint, it is difficult to achieve full horizontal equity. In response to this, some councils have become actively involved in implementing specific programs to expand and retain population, local businesses and tourism. The appointment of economic development officers to develop strategies to attract new residents and investors is an increasingly important part of councils’ operations.



While many of the smaller rural councils will often not have the spare capacity to appoint a dedicated economic development officer, specific projects can be pursued, particularly in conjunction with state local government associations, in order to successfully attract and retain population, businesses and tourists.

2.8.3 Asset management skills Local governments in Australia have large asset bases of predominantly long life assets. These asset bases include land, roads and public housing, and have significant replacement cost. Some small councils, often rural or remote, have struggled to recruit key staff with adequate training and skills to manage the valuable asset bases. Local governments also have problems hiring adequately skilled staff to manage assets as a result of the shortage of available funds for wages The lack of asset management skills can lead to premature expenditure on replacement instead of renewals and suboptimal maintenance of assets without application of whole-of-life cost minimisation analysis.

Overall there is a large range in the quality of asset management skills in councils across Australia. Some councillors and council employees also appear to be unclear on the critical role of effective asset management and hence, some local governments complete only high-level, council-wide strategic planning with regard to assets. As a result, asset management continues to often be neglected to varying degrees across some local councils. At the other end of the spectrum some councils have developed robust AMPs and financial strategies based on minimising whole-of-life costs.

As a response to the patchy depth in asset management skills, the MAV has developed an asset management program entitled the Step Program, which is summarised in Text Box 12 below.

Text Box 12: Step Program Overview of asset management improvement Step Program

The Municipal Association of Victoria (MAV) developed the Step Program in order to improve the sustainability of local government asset management capacity and management of community assets. The program aims to provide councils in Victoria with a whole-of-organisation perspective and a best practice framework to enable continuous improvement in councils’ asset management practices. Participating councils’ asset management practices were assessed and measured against key principles. Experts then worked with each council to provide:

• a self-assessment tool for asset management

• ongoing monitoring of status, and

• a structured plan to improve a clear focus on the processes that need improving.

The asset management planning and decision-making focuses on the following principles:

• ensuring service delivery needs form the basis of asset management

• integrating asset management with corporate, financial, business and budgetary planning

• ensuring informed decision making, incorporating a life-cycle approach to asset management

• establishing accountability and responsibility for asset condition, use and performance, and

• meeting sustainability needs, while sustaining resources for future generations.

The outcomes from this program provide a basis upon which councils can benchmark their asset performance.

Due to the success of the initial Step Program, it has been further developed as the skills of councils improve. The Advanced Step Program is being established and refined, and is expected to be finalised after 2008. The Victorian Government has assisted local government by providing grants to a number of rural councils to help them develop



asset management plans. It has also provided one-on-one support to a number of pilot councils to establish sound asset management planning, and organised a workshop for councillors on strategic asset management. Some 75 councils are now involved in the program, including some from Tasmania and SA.

Source: Municipal Association of Victoria

Queensland is also in the process of forming a Local Government Asset Management Steering Group and State Government Reference Group in response to the need to address the current lack of specific asset management skills.

2.8.4 Financial management skills Like asset management skills, strong financial management skills can be hard to find and retain within the local government sector. The patchy depth in financial management skills are in part a result of the national skills shortage. Local government can at times struggle to pay the market value required to attract skilled workers necessary for successful financial management. Some councils recognise they need to pay above market rates to attract the key senior staff they require.

As a result, some local governments do not maximise their financial performance. For example, some local governments generally have an aversion to using debt as a means of financing infrastructure, even where it has a sound income stream, due to the lack of knowledge and understanding regarding commercially acceptable levels and applications of debt. This is largely a result of the policy approach of both Australian and state governments to minimise debt, which has often come at the expense of large infrastructure upgrades. However, changes to council borrowing are also curbed by statutory restrictions on the borrowing limits and ability to use assets as security.

Whilst there is a variety of resources available to local government to guide their financial policies and practices, such as the Local Government Code of Accounting Practice and Financial reporting, Asset Accounting Manual and Best Practice Guidelines for Local Government Entity Audit Committee and Internal Audit, these documents alone do not replicate the strong financial and commercial acumen required by a local government Chief Financial Officer (CFO) to efficiently manage the complex financial situation of local government.

Text Box 13: Swimming pool grants An example of the need to secure long-term funding for asset/services development

A common example of SPPs that carry a risk of creating a greater future financial burden for councils is the provision of funding to councils to build a local swimming pool. A swimming pool or recreational facility can often represent a significant focal point for community activity in rural/regional areas, with recent capital costs typically between $3.4m (Longreach) and $6m (Bathurst). However, as capital grants by nature have no ongoing or recurrent funding component, many councils did not then have the capacity to meet the significant operating costs of the pool, such as life saver, chlorination, cleaning, and equipment replacement. This can place local councils under significant political and financial pressure. Average operating expenditure for a 50m unheated swimming pool is approximately $100,000-$ 200,000 per annum, and provision of heating can see this cost more than double. Additionally, pools require periodic renewals (eg new filter, partial re-tiling, change room refurbishment) and such renewals often have a substantial cost ($50,000-$100,000).

Ideally, councils could potentially avoid such situations where they have better understanding of the future financial implications of asset development and are proactive in securing long-term recurrent funding prior to developing such facilities.



2.8.5 Rating constraints One of the key constraints faced by councils across Australia is state and electorate imposed restrictions on rate revenue. This ranges from formalised rate pegging in NSW (whereby councils are not able to increase rates above a certain percentage as set by the state government), state imposed exemptions and rebates, to unofficial electorate demand for low rate rises.

Rate pegging was introduced in NSW in 1977 after a period of large rate rises. Rate pegging was introduced in order to impose strong incentives for cost management, where rate rises are controlled to stimulate pursuit of productivity gains and to deter growth in discretionary or non-core spending and price and wage inflation. In many cases the cap on rate increases is exceeded by other levies on councils, eg fire brigade levies.56

Most councils in NSW seek to prepare their budgets on a ‘balanced basis’ built around utilising the maximum permissible increase in the general activities rate income as defined in Section 506 of the Local Government Act. Additionally, NSW councils can apply to the Minister for a (special) rate variation over and above the pegging limit. For the 2006-07 rating year the NSW Government allowed rate rises of up to 3.6%, with around 40 councils obtaining a special rates variation. The variation application needs to address the criteria specified by the DLG. This includes demonstrating community support for the rise, robust AMPs and clear merit for the use of the extra funds. Pegging has had the impact of restricting councils’ revenue raising abilities and this has led to an imbalance between councils’ rate base and the rising community expectations for enhanced services.

Victoria has recently removed rate pegging, which was introduced as part of local government reforms between 1992 and 1999. This reform period saw the 210 councils amalgamated into 78 councils, which was accompanied by rate pegging and a one-off reduction in rates of 20%. The latter reform to rate pegging was a blunt policy instrument to drive efficiencies and priority setting. As a consequence councils hid the resultant deficit in assets, as data over the period of rate pegging showed that capex (renewals) spending remained constant, while recurrent expenditure (opex) continued to grow. These reforms did improve many areas of local government in Victoria, in terms of management practices and improved capacity to attract skilled professional staff and provide a greater variety of services. However, rate pegging was abolished due to the sense that local government had lost its local governance responsibilities in terms of autonomy and accountability – in favour of increased state control. Interestingly, since the abolition of rate pegging in the 1998-99, which was linked to performance indicators, rates in Victoria have been growing faster than in other states, suggesting that the original rate cut may not have been sustainable.57 In addition, this finding also suggests that the reduction in capital expenditure largely created an infrastructure backlog, which can transfer the burden of renewing infrastructure to current and future generations of ratepayers.

56 House of Representatives SCEFPA 2003, Rates and Taxes: A Fair Share for Responsible Local Government, October 2003, p.42.

57 The Proteus Management Group Pty Ltd 2006, Independent Inquiry into the Financial Sustainability of New South Wales – Local Government NSW Local Government Revenue and Expenditure Analysis, p.9.



As stated previously, NSW is not the only state with constraints to increasing rates. Unofficial rate pegging occurs in many areas with rate rise discretion due to electoral demands that rises greater than CPI need strong justification. Hence, efforts to substantially increase rate revenue are likely to be significant constrained by community expectations. The LGAQ stated that movements in rate increases in Queensland are indicative of unofficial rate pegging.58

State governments have also been observed to constrain the rating effort of councils through the reclassification of state entities. For example, the WA Government has transferred management of state provided public housing to community based associations that subsequently qualify for rate exemptions. Hence, the ability to increase the rating effort of many councils is constrained by the state government.

Formal rate pegging can create inefficiency, or laziness, in rate setting as it provide councils with the incentive to increase rates by the full cap irrespective of need, or worse, to accept the cap (and not pursue a variation above cap) to avoid local media attention and a risk that some local commentators may suggest there has been ineffective financial management. Pegging removes a council’s responsibility to set its own levels of taxation. This impacts on its ability to serve community needs and undertake large scale infrastructure renewal projects, as such expenditure lumps are more difficult to find in a rate capped environment.

In addition to the inefficiencies associated with rate pegging, there has also been significant change in the local government operating environment since its introduction in the late 1970s. The reforms associated with the NSW Local Government Act 1993 have liberalised the management of local councils, and made councils more accountable and performance oriented. 59 At the same time, Australian Government funding of local councils has declined as a proportion of total Commonwealth tax revenue and as a proportion of total local government revenue. Despite these developments the NSW Government has been reluctant to consider frequent calls to review the rate pegging policy, most recently in the 2006 Sustainability Study.

58 Communications between PwC and LGAQ, July 2006. 59 IPART 1998, Benchmarking Local Government Performance in New South Wales – Final Report, p 10.



2.9 Summary – Overview of the local government sector

Some 700 councils across Australia are responsible for providing local communities with traditional services (eg roads, waste, footpaths, libraries) with some councils also being responsible for the delivery of essential services of water and sewerage. These councils receive FAGs from the Australian Government to partially support their recurrent expenditure as well as a range of other capital grants from both the Australian and state governments.

In recent years, many local governments have also introduced additional social and human services such as health, aged care, Indigenous housing, and child care in response to cost shifting, devolution, ‘raising the bar’, increased community expectations and policy choice. Due to the limited revenue base of local government, many councils have been proactive in the use of initiatives to minimise costs and boost efficiency in order to maintain their increasingly diverse service delivery. There are numerous examples of successful initiatives including outsourcing, structural reforms, corporatisation of commercial activities, and shared services.

Despite the best endeavours of many councils, they are constrained by various limitations including relative isolation and declining population base for many rural councils, widespread skills shortages, limited asset and financial management skills, as well as rate pegging for NSW councils. Hence, support from other spheres of government is necessary to overcome these constraints and promote further efficiency gains within the sector.



3 Financial governance and fiscal relationships

Effective managerial capacity is an important contributor to the overall financial sustainability of a council. This determines the efficacy of the council’s resource management and will be significantly shaped by the:

• financial governance of local government, and

• fiscal relationships and transfers between local government, state/territory governments and the Australian Government.

While the skills and experience of the elected councillors and council staff are a critical input into the managerial capacity of the council, the nature and process of financial governance and fiscal relationships are also significant.

3.1 Financial governance of local government

Financial governance describes the process by which monetary decisions are made and implemented, in order to meet the financial goals and outputs of an organisation. The majority of councils are established as bodies corporate, with councillors given the role of governing key aspects of the council. Essentially, the elected councillors are accountable to ratepayers for the financial sustainability of the council.

The financial governance and management process determines the way in which organisations are directed, controlled and held to account. As a public entity it is critical that the financial governance processes are efficient, effective and transparent. The financial governance and principles of each council are typically shaped by state and territory legislation, and the historical/political character of each individual council.

Where a council is well governed it will be more efficient and more likely to produce effective outcomes. As noted by the NSW Inquiry, effective governance within local government will:60

• promote confidence within the community regarding councils

• result in better council outputs and outcomes

• enhance the value (and standing) of the organisation

• ensure that councils meet their legislative responsibilities, and

• focus councils on the requirements of their communities

A key aspect of effective financial governance within local government is extensive and regular consultation with the community to ensure that its interests and priorities are adequately reflected in financial decision-making processes.

60 Independent Inquiry into the Financial Sustainability of NSW Local Government 2006, Are Councils Sustainable? Final Report: Findings and Recommendations May 2006, p.232.

Financial governance and fiscal relationships 87


A number of challenges to effective financial governance of local government have been identified by the South Australian inquiry and include:61

• inadequate (and incomplete) setting of financial goals and targets

• low transparency in financial reporting, both external and internal reporting

• absence of a medium-term budgetary framework

• deficiencies in monitoring of financial performance against budgetary targets

• absence of effective accountability mechanisms and incentives, and

• slow take-up of accrual accounting concepts (and reports), and the continued reliance on traditional – and misleading – cash accounting concepts.

These constraints are exacerbated by the fact that many councillors are part-time representatives, despite the large task of local government financial management. In addition, there is no formal councillor training or educational requirements, although a large proportion of councillors have some vocational or tertiary training. Councillors are generally paid only a small monthly fee, which is more a compensation for travel and meeting costs than remuneration for the total time required to effectively complete their functions.

Where poor financial management practices persist in some councils this creates the risk of inadequate control on growth in operating expenses, a neglect of essential capital spending and inflexible and inequitable revenue-raising. These ongoing challenges have been exacerbated by skills shortages and lack of transparency in decision making and accountability.

However, anecdotal evidence suggests that the financial awareness and understanding of councils continues to improve, as there is evidence of more appropriate analyses of new spending decisions and the use of medium to long-term infrastructure, asset management and financial planning. Many councils are now subject to a statutory requirement to develop an Annual Management Plan. This is essentially the 'business plan' of the council providing an operational guide to how the council will deliver all key services, eg libraries, local road maintenance, waste management. The Annual Management Plan also contains a capital works program, and a budget for incomes and expenditures.

In addition, councils also have the benefit of an increasing array of resources and guidance material, such as the Certified Practising Accountant manual on Council Corporate Governance. Such documents can assist councils to develop robust practices and processes in the following areas: vision, roles and responsibilities, working relationships, decision making, financial management, risk management, accountability, performance measurement, independent review, and consultation.

61 Financial Sustainability Review Board 2005, Rising to the Challenge: Towards Financially Sustainable Local Government in South Australia, August 2005, vol 2, p.96.



3.2 Intergovernmental relationships

The nature of the relationships between local government and state/territory governments as well as the Australian Government impacts on their ability to efficiently provide infrastructure and services for their local communities. Hence, the historical development and context of these relationships can have a significant bearing on the expense response and revenue-raising capacity of each council.

3.2.1 Local and Australian Government The significance of the relationship between local government and the Australian Government is reflected by the quantum of funding provided to local government, which was in excess of $2 billion in 2005-06 including both FAGs and R2R. This represents less than 0.9% of total commonwealth tax revenue.

The Hawker Report stated that the federal/local government relationship has grown in importance as a result of: 62

• increasing focus on local delivery and devolution of a number of Federal programs

• local government input into some policy and program development, and

• reduction in financial support for local government by state governments, exacerbated by cost shifting.

General purpose assistance funding from the Australian Government was first provided to local government in 1974-75, under the Whitlam Government as a means to promote better geographic equity between regions. The Fraser Government (1975-1983) amended this initial funding program to distribute taxation revenue to local government under the Local Government (Personal Income Tax Sharing) Act 1976, in order to reflect the tax sharing arrangements with the state and territory governments. This shifted the focus from full equalisation to a method based partly on per capita grants (ie minimum grants) and partly on equalisation. Local government was provided with 1.52% of net personal income tax in 1976-77, which increased to 1.75% in 1979-80 and 2% in 1980-81. 63

Following an inquiry into local government in 1984, reforms were made to the level and form of Australian Government funding. The implementation of the Local Government (Financial Assistance) Act 1986 saw the introduction of FAGs and an end to the personal income tax sharing approach. FAGs were to be increased by the greater of either the 1985-86 level of assistance adjusted for inflation, (which was known as the ‘real terms’ guarantee) or the percentage change in the general purpose payments to states (which were escalated by CPI and population growth indexation). Since 1989-90 interstate distribution of grants has been on an equal per capita basis.

62 House of Representatives, SCEFPA 2003, Rates and Taxes: A Fair Share for Responsible Local Government, October 2003, p.98.

63 ibid, p.101.



Another review of the local government funding system was undertaken in 1993, which saw the introduction of the current FAGs Act. The main change under this Act was to require that national principles of intrastate funding distribution replaced state formulated principles. When GST revenue funding to states replaced financial assistance grants to states, the link between grants to states and grants to local government that was established under the 1986 Act was broken. Hence, the FAGs Act was amended in 2000 in order to maintain the escalation factor based on population growth and the increase in CPI.

The relationship between the Australian Government and local government has continued to evolve over the past 30 years, since financial support was initially provided. Over this period the Australian Government has increasingly recognised the potential strategic importance of local government in achieving national objectives in local and regional policy areas. The successful use of SPP and direct payments to local government, as discussed in section 2.2.3, particularly R2R, is evidence of the potential progress that can be achieved through collaboration between the Australian Government and local government. Text Box 14 below provides further details on the value and benefits offered by local government in delivering regional policy objectives of the Australian Government.

Text Box 14: Value of local government to the Australian Government Benefits provided by local government in delivering regional policy objectives of the Australian Government

The Australian Government, through DOTARS, has acknowledged the benefits of local government taking a stronger role in regional development and delivering regional policy objectives of the Australian Government:

• local government offers a wide and well-established national network of public administration which may be capable of taking on extra responsibilities and functions. This includes a significant presence in rural and regional Australia. (In some cases local government is the only institutional presence in small rural and remote areas)

• local government has strong links to the community and is accountable to the communities its represents. Its legislative basis makes it both durable and financially stable – unlike some community or interest groups

• local government has a practical service orientation and good organisational skills which make it capable of innovative, speedy and flexible responses. The integrated structure of councils can allow a high level of co-ordination between different activities

• the links between local government and local business and industry puts councils in a good position to foster a ‘bottom up’ approach to regional development

• local government is now playing an increasingly important role in providing information to support Commonwealth regional policy development and as a key stakeholder in the implementation of Commonwealth regional policy initiatives, and

• extensive contact /transactions between business and local government makes local government an ideal entry point for access to information about other governments’ services and programmes and a possible location for delivery of such services.

Source: DOTARS, Submission No. 103., p. 39., in House of Representatives, SCEFPA, 2003, Rates and Taxes: A Fair Share for Responsible Local Government, p. 91.



3.2.2 State/territory and Local Government The relationship between state/territory governments and the local government sector in each jurisdiction has significant bearing on the operations of councils. The nature of the relationship and the degree of trust and autonomy given to local government is reflected in the legislative framework and the level of funding support. Overall, the relationships and extent of collaboration between local government and state/territory governments differs significantly between jurisdictions. This is largely a product of the historical and political context in which the relationships have developed.

The quantum of state funding support to local government is a partial indicator of the nature of the relationships; however it also reflects the relative financial capacity of each state/territory government. As shown in Table 2.4, in 2003-04 Queensland and WA provided the highest net state grants per capita at $89 and $84 per capita respectively. State funding as a proportion of total intergovernmental transfers from all spheres of government is also among the highest in these states at 54% in Queensland and 49% in WA. The collaborative relationship fostered between the Queensland Government and local government is further evidenced by the state support of current SSS review (see section 1.4.4) and the Queensland Road Alliance (see Text Box 11). The hypothecation of vehicle registration revenue to local government may be evidence of a positive relationship with the WA Government, summarised below in (Text Box 15).

Interestingly, at $21 per person, NT provides the lowest net state grants per capita; however state grants comprise 67% of total NT local government funding. This is largely due to the relatively low quantum of FAGs provided to NT and the limited financial capacity and sources of own-source revenue of the local government sector in NT. At the other end of the spectrum, Tasmania, SA and NSW have the lowest state grants per capita and as a proportion of total intergovernmental transfers from all spheres of government. In NSW, which arguably has relatively high financial capacity, the nature of the relationship and trust in local government is reflected by policies such as rate pegging, and the propensity to dismiss councils and place them under administration and to override development consents with state building controls.

As a result of the recent focus on stemming cost shifting from state to local government, the adequacy of these grants are generally being re-evaluated. The areas and impacts of cost shifting are highlighted in section 2.4.3.

Text Box 15: Hypothecation of vehicle registration revenue, WA Hypothecation of vehicle registration revenue, WA

The WA Government has entered into a roads funding agreement under which 20% of all state government vehicle registration fees are hypothecated to local government. Hypothecation is a promise by government to spend the revenue raised from a charge on a predetermined activity. The funding is tied and must be spent on roads. This hypothecation agreement will provide $94.1 million in road funding to local government in 2006-07.

This is a favourable arrangement for local government considering vehicle registration fees are a growth tax in line with increasing car ownership and growth in road freight tonnages. It assists local government in addressing the shortfall of funding to allow adequate delivery of road services and improve funding certainty. There is some risk that vehicle taxes and charges could be reduced due to COAG National Competition Policy.



Overall, significant progress has been made in several states in terms of negotiating state-local government protocols covering areas of shared responsibility and, more recently, through partnership agreements. Partnership agreements are in place or under negotiation in Tasmania, SA, WA and Queensland. Although the nature of these agreements varies, they represent an attempt to clarify priorities and rationalise the distribution of powers and financial resources between state and local governments.

3.3 Intergovernmental transfers Local governments rely on intergovernmental transfers in order to adequately and successfully provide services to local communities. As stated in section 2.2.3 intergovernmental transfers accounted for 10% of local government revenue in 2004-05, with a relatively even split between state/territory governments and Australian Government grants. However, individual councils’ dependence on grants varies from less than 2% to more than 70% of revenue.

With ongoing financial pressures facing the majority of councils, the adequacy of intergovernmental transfers merits some consideration. Particularly, in context of substantial VFI in Australia, with the Australian Government maintaining 80% of total taxation revenue with limited statutory expenditure requirements, while local and state/territory governments have limited own-source revenue powers and significant expenditure obligations. Australian Government funding to local government is primarily composed of the general purpose assistance and untied local road funding under FAGs (established in the 1970s) and the widely acclaimed R2R program (which commenced in 2001). The objectives and quantum of the FAGs program may require re-assessment to better meet the current needs and issues facing local government. As discussed in section 2.2.3, over time the proportion of FAGs as a proportion of total tax revenue has significantly declined (see Figure 2.5). In 1996-97, FAGs represented 0.97% of Commonwealth taxation revenue, which will drop to 0.77% in 2006-07, and is estimated to drop even further to 0.70% by 2009-10.64 This decline in FAGs as a proportion of Australian Government tax revenue has been due to substantial growth in some federal taxes such as GST and company tax, which has been driven by the current resources boom.

The impact of this trend is partially offset by increases in R2R. When FAGs and R2R are aggregated they account from 0.9% of Australian tax revenue in 2004-05. Figure 3.1 shows the declining value of FAGs in comparison to the amount of funding that would be provided if local government was provided 1% of total Commonwealth tax revenue. While R2R funding has partially closed this gap, local government would still be significantly better off if its funding was linked to a growth tax.

64 ALGA Federal Budget 2006-07 Analysis



Figure 3.1: FAGs and R2R compared to 1% of Commonwealth Revenue

1000

1200

1400

1600

1800

2000

2200

2400

2600

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

$ m

ill

FAGs FAGs & R2R 1% of Commonwealth Revenue

With respect to the adequacy of state and government flows to local government, it is evident from the information reported in sections 2.2.4and 3.2.2 that the picture is quite mixed between the jurisdictions. While in general the proportion of state/territory government funding to local government has been declining in recent years, some states have resisted this trend and have significantly increased their funding support to local government. This generally reflects the financial capacity and nature of trust and relationships fostered between local government and state/territory governments.

Despite the relative constraints on the financial capacity of state and territory governments, there is significant merit in some states/territories reconsidering the adequacy of their financial support to local government. Some states and territories should consider the merit of increasing grants in order to maintain the real value of grants to local government. Greater transparency of the funding flows to local government is warranted.

Thus, in the context of declining state/territory funding as a proportion of total local government funding and decreasing Commonwealth funding as a proportion of total tax revenue, reforms to funding streams from both tiers of government warrant some consideration. Recommendations to intergovernmental transfers are discussed further in section 5.3.



3.4 Summary – Financial governance and fiscal relationships

Financial governance describes the process by which monetary decisions are made and implemented, in order to meet the financial goals and outputs of an organisation. The majority of councils are established as bodies corporate, with popularly elected councillors given the role of governing key aspects of the council and ensuring the financial sustainability of the council.

The financial governance and principles of each council are typically shaped by state and territory legislation, and the historical/political character of each individual council. Effective governance results in better council outputs and outcomes and ensures that councils meet their legislative responsibilities. The majority of councils have reasonably effective financial governance. However, a proportion of councils still have scope to improve the robustness and accuracy of their financial budgets, forecasts and reporting.

Local governments are to varying degrees reliant on both the Australian and state/territory governments to fund the services for their local communities. This support comes in the form of intergovernmental transfers, which in 2004-05 accounted for an average of 10% of local government revenue. Depending on the financial position of individual councils, the dependence on these grants for smaller remote councils can be over 70% of total revenues.

Grants are integral to the financial viability for a significant proportion of councils. Whilst FAGs funding levels have been maintained in real per capita dollars, FAGs as a proportion of total Commonwealth tax revenue has fallen. In 1996-97, FAGs represented 0.97% of Commonwealth taxation revenue, which will drop to 0.77% in 2006-07, and is estimated to drop even further to 0.70% in 2009-10. However, the Australian Government has established the Roads to Recovery Program, which has been an outstanding success and has also largely offset the reduced significance of FAGs. Overall, grants totalled over $2 billion in 2005-06, and the local government sector recognises that grants will form a key ongoing part of their revenue mix as the sector takes greater roles such as those arising from the trend toward regional devolution of services.

Local governments are also reliant upon state/territory governments. The relationship and extent of collaboration differs between jurisdictions. The quantum of funding support provided to local government is a partial indicator of the nature of the relationships, however it is also partly reflective of history and the relative financial capacity of each state/territory government. Overall, the grants received from state/territory governments over time have also declined as a proportion of total local government funding.



4 Analysis of financial sustainability of local government

4.1 Defining “financial sustainability”

One of the key initial tasks facing the recent local government inquiries has been to define “financial sustainability” in the local government sector. Through this process it has become evident that there is only a broad consensus within the sector on simple measures of financial sustainability, with data available proving to be a constraint to adopting more sophisticated and accurate measures of financial sustainability. Improving the long-term financial sustainability of local government across Australia will be assisted by a more cohesive understanding of the scope and nature of the term “financial sustainability”. This will allow the local government sector to develop consistent KPIs, which will enable effective data collection and reporting, and meaningful comparisons across the sector. Whilst a Productivity Commission Review in 2000 cautioned against using KPIs to compare jurisdictions and councils of different sizes, PwC suggests that there is more merit in analysing the KPIs than seeking to understand differences vis-à-vis completing no comparative evaluations.

The SA Inquiry determined that “a council’s finances can be judged to be sustainable in the long term only if they are strong enough – currently and in the foreseeable future – to allow the council to manage financial risks and shocks over the long-term financial planning period without having to introduce substantial or disruptive revenue (or expenditure) adjustments during that period.” 65 This definition, which was developed by Access Economics, was also used by the NSW Inquiry, for whom Access also completed a financial assessment of local government in NSW.66

Under this definition, financial sustainability is contingent upon the following conditions:

• currently healthy council finances, with only minor revenue (or expenditure) adjustment over the short-term

• healthy long term outlook based on continuation of the council’s present spending and funding policies and given likely economic and demographic developments, and

• sufficient margin of comfort in the council’s finances, currently and in the foreseeable future, to allow the council to absorb the impact of any financial risks and shocks with the necessity of substantial increases in rates or disruptive cuts in spending

65 Financial Sustainability Review Board 2005, Rising to the Challenge: Towards Financially Sustainable Local Government in South Australia, August 2005, vol 2, p.9 – 10.


Analysis of financial sustainability of local government 95


This approach of defining financial sustainability as having the capacity to manage expected financial requirements without needing to introduce substantial or disruptive revenue (and expenditure) adjustments is consistent with the approach of state and federal governments.67

Further, the NSW Inquiry stated that the financial sustainability assessment involves a comparison of a council’s long-term, ‘financial capacity’ with its long-term ‘financial requirements’, where:68

• financial capacity means the sum total of financial resources (both operating and capital), that a council can mobilise through its (present and prospective) revenue-raising and financing policies, and

• financial requirements mean the sum total of the spending (both operating and capital) that is necessary by a council to meet both its present statutory obligations and any expected additional functions, spending pressures and financial shocks.

Hence, where a council’s finances may be ‘unsustainable’ in the long term due to current revenue and expenditure policies, such finances can usually be corrected with substantial revenue increases and/or expenditure reductions.

With reference to these definitions of financial sustainability and the issues facing the local government sector across Australia, this study has developed a refined and simplified definition contained below in Text Box 16.

Text Box 16: Definition of ‘financial sustainability’

The financial sustainability of a council is determined by its ability to manage expected financial requirements and financial risks and shocks over the long term without the use of disruptive revenue or expenditure measures; which is determined by:

• healthy finances in the current period and long term outlook based on continuation of the council’s present spending and funding policies and given likely economic and demographic developments, and

• ensuring infrastructure renewals/replacement expenditure matches forward looking asset management plan expenditure needs.

For the purpose of this study, a number of KPIs have been adopted as proxy measures of financial sustainability, eg interest coverage, sustainability ratio.

67 See s(3)(1) Fiscal Responsibility Act (NSW) 2005, and Commonwealth Government, Intergenerational Report, May 2002.




4.2 Approach to measuring financial trends

The data set which was analysed and used to determine financial trends for local governments throughout Australia was based on a sample of 100 of the 720 local governments that currently exist in Australia. The sample group of councils were stratified on a pro-rata basis to reflect both the number of councils in each:

• ACLG category, and

• proportion of each ACLG within each jurisdiction.

These sample councils covered all sub-categories within each council group, which, as defined by DOTARS, are classified as extra small, small, medium, large and very large. This pro-rata council sample was developed in order to ensure a fair and representative sample was obtained encompassing all councils from which conclusions could be drawn. Conclusions were based on an overall average of the 100 councils and averages of council categories.

It should be noted that data for Rural Significant Growth (RSG) councils is not considered statistically significant as the pro-rata construction of the sample resulted in the inclusion of only one RSG council. Therefore the resultant conclusions should not be heavily relied on. As a result, all KPIs adopted that are a measure of percentage of councils within a category operating at a given level have been removed. This is because they result in an indicator of either 0% or 100%, which is misleading.

All councils in Australia are required to adhere to national public accounting standards. The financial statements produced in accordance with the accounting standards and published in the annual report for each council were used to determine trend analysis and financial sustainability.

This information, however, was sometimes difficult to source for all councils, particularly very small and/or remote councils due to copies of annual reports not being publicly available on council websites. All states provided a summary of revenue and expense data for each council in 2004-05, with the exception of NSW for which 2003-04 data was used. The availability of asset and liability information was mixed between jurisdictions, with no information available for some councils.

As identified earlier a key limitation with the data is the mixed consistency and accuracy of councils’ measurement and recording of capital expenditure and renewals. An example of a common inconsistency is the recording of say, a road reseal as an expense based on the premise that the entire road is one bundled asset, as opposed to capitalising the reseal based on the assumption that the road is segmented into the seal, road base, land, road curb, signs and lighting. Where a council pursues the first approach the book value of the asset remains unchanged with no capital upgrades recorded, whilst the second approach would change the value of the asset and be recorded as capital renewal. These two different approaches to recording the same road reseal emphasises the importance of prudent asset management practices and the need to move to a nationally consistent set of accounts.



Due to data availability constraints and differences in reporting between jurisdictions, the financial indicators considered in this study are relatively simple vis-à-vis the indicators used in the NSW, WA and SA state inquiries led by Access. We also note that PwC uses more sophisticated indicators (eg restricted current ratio, the ratio of outstanding rates and debt service ratio) to assess viability in our process of completing formal financial audits of a number of councils each year. Whilst both this PwC study and the Access approach factor in R2R funding into sustainability evaluations, the Access analysis excludes other capital grants or SPPs, which Access set aside to avoid overstating the revenues available for recurrent operations. However, PwC has retained all capital grants within operating position analysis due to some data sets not separating out grant by type, as well as a view that capital grants are an ongoing and important revenue source for councils. To exclude other capital grants from the financial sustainability analysis could potentially overstate the extent to which councils are unsustainable –assuming capital grants remain an ongoing funding tool for governments.

The SA Inquiry noted that financial sustainability relates to the long-term financial performance and position of a particular council, rather than to the finances of a sector in aggregate. Hence assessing the sustainability of the local government sector in aggregate is less relevant than examining the percentage of councils with sustainability problems.

The PwC financial KPI analysis in Table 4.1 uses four indicators, which are:

• Operating surplus (deficit) – is total operating revenue less total operating expenses. It is an indicator of a council’s ability to meet its operating expenses with its operating revenue stream. The analysis uses a benchmark operating deficit of 10% of total revenue as councils with deficits larger than this are spending well beyond its revenue base and potentially at risk of sustainability problems.

• Interest coverage – Interest coverage is determined as earnings before interest and tax (EBIT) divided by borrowing costs and it measures a council’s ability to pay interest on its outstanding debt. We have used an interest coverage benchmark of 3 which provides a generally guide to delineate a financially sustainable level of borrowing. An interest coverage value below 3 indicates that a council may have problems in repaying debt and associated interest.

• Sustainability ratio or capital expenditure divided by depreciation. This ratio is a measure of the net increase or decrease in the asset base. Results over 1.0 indicate that its overall asset base is increasing, or being replenished, at a rate above the consumption of assets whilst results under 1 indicate a declining asset base and potential sustainability risks. Council sustainability ratio results need to be interpreted with care due to factors such as infrequent as well as inconsistent asset revaluations and depreciation approaches.

• Current ratio (or current assets divided by current liabilities) is a measure of ability to meet short-term debt obligations. We have used a benchmark value of 1 for the current ratio with councils at below 1 being more at risk of liquidity problems.




• Rates coverage (total rates revenue as a proportion of total expenses) is a measure of a council’s ability to cover its costs through its own tax revenue. A benchmark result of 40% was selected as a point that measures adequate self-funding, with results below 40% indicating a greater dependence on other revenue streams such as grants, and hence more risk of sustainability issues.



This approach could either overlook:69

• examples of unsustainability at the individual council level, if finances of most councils are sustainable over the long term, or

• examples of sustainable finances at the individual council level, if most councils have a sustainability problem.

Table 4.1 summarises the financial results from the survey of the financial viability of 100 councils across the seven council categories. A full explanation and definition of these financial key performance indicators (KPI) can be found in Appendix B.

Table 4.1: Summary of financial indicators of ACLG

Financial Sustainability Summary KPIs

DOTARS category

% Councils with Interest Coverage <3(EBIT/borrowing

costs)

Median Operating

Surplus as a % of Total

Revenue

% Councils with Deficit greater than 10% of Total

Revenue

Median Sustainability

Ratio (capex/

depreciation)

% Councils with

Sustainability Ratio <1

Median current ratio

(current assets/current

liab.)

% of councils with current

ratio <1

Median rates coverage (%)(rates as a % of total expenses)

% of councils with rates

coverage <0.4

Urban capital city 40.0 5.0 28.6 2.0 8.0 4.5 14.3 55.8 0.0

Urban regional 41.7 4.2 16.7 1.3 0.0 2.8 9.1 66.5 16.7

Urban fringe 37.5 14.1 12.5 2.1 16.7 3.4 25.0 62.5 0.0

Urban development 41.7 7.6 8.3 1.6 0.0 1.0 50.0 65.2 0.0

Rural remote 28.6 10.3 18.8 2.3 8.3 2.6 12.5 25.4 87.5

Rural agricultural 32.6 11.7 15.9 1.7 0.0 2.6 20.5 42.4 54.5

Rural significant growth n/a -8.0 n/a 2.4 n/a 2.4 n/a 47.5 n/a

Average 35.8 10.0 16.0 1.8 8.0 2.6 21.4 47.9 40.4

69 Financial Sustainability Review Board 2005, Rising to the Challenge: Towards Financially Sustainable Local Government in South Australia, August 2005, p.8.


The results above indicate:

• Approximately 30-40% of councils have an interest coverage ratio (EBIT/interest) of less than 3. A ratio of 3 generally represents a threshold above which credit risk becomes less significant. For those with a ratio of less than 3, a large unexpected event with adverse cashflow implications could potentially place pressure on ability to meet interest payments.

• Councils have a median operating surplus of 10% of total revenue. However, some 16% of councils have an operating deficit of over 10% of revenue. Such councils have a tendency to defer renewals expenditure, which creates a risk of developing maintenance backlogs.

• The median sustainability ratio (capex/depreciation) in this sample was 1.8, with 8% of councils with a sustainability ratio (capex/depreciation) of less than 1. A ratio of less than 1 indicates that the capital being consumed in an accounting sense exceeds the capital being replaced into the asset base.

• Councils have a median current ratio (current assets/current liabilities) of 2.6, however 21% are less than 1. The ratio of 1 is a key threshold for testing liquidity issues. In particular the urban fringe, urban development, rural remote, and rural agricultural categories all have potential liquidity problems with between 12% and 50% less than 1.

• Councils across the nation typically have 48% of costs covered by rates, ranging from 25 to 66%. Of some concern is the fact that 87% and 54% of rural remote and rural agricultural councils respectively have rates covering less than 40% of costs. Where rates are less than 40% of council revenue, there is an indication that own-source revenue generating capacity is constrained and that the council is likely to have a degree of dependence on grants from other levels of government.

Whilst the majority of councils have indicator results at an acceptable level, there are councils within each category results operating at unsustainable levels. In particular, the higher proportion of the rural agricultural, rural remote and, to a lesser extent, the urban fringe categories are at greater risk of financial sustainability challenges.



4.3 Financial performance

In general, a council with healthy finances would run a modest operating surplus. An operating surplus indicates that the costs incurred in the year in question are being met by today’s ratepayers, and not being transferred to future ratepayers. A persistent operating deficit indicates that rate revenue is insufficient to finance current operations, which demands liabilities to be incurred, or assets to be liquidated, in order to finance ordinary operations.

Financial performance of a council should allow a margin of comfort to cope with financial risks and shocks, which typically requires: 70

i) an operating surplus rather than operating deficit

ii) no significant infrastructure renewal backlog, and its annual capital expenditure on the renewal or replacement of existing assets should on average over time be about the same level as the council’s depreciation expenses, and

iii) annual net borrowing should not be putting any pressure on the council’s targeted net financial liabilities ratio.

4.1.1 Expenditure Expenditure by local government in real terms has increased over time. Between 1999 and 2005, expenditure had a compound annual growth of 6.5%. This increase in expenditure reflects the expanding roles of local governments discussed in section 2.5, as well as strong cost growth rising at a faster rate than CPI. This substantial increase in local government operating expenditure in recent years may have reduced the extent of funds available for renewing infrastructure in some jurisdictions which may have been a factor in the development of the renewals backlogs estimated by Access Economics (see Table 4.2). However, this position will differ between states and between councils, with the MAV reporting that since 1999 there has been a significant improvement in the extent of infrastructure backlog in Victoria.

Operating costs

Depreciation is a major cost of many local governments. Depreciation costs average 26% across the sample of councils. This amount is significantly higher for rural remote councils, where depreciation accounts for more than 37% of operating costs for most of the councils within this category.

The accuracy of the reported depreciation costs is an area of significant concern. On the one hand some councils with high depreciation rates may be too quickly reducing the values of investments, often made through lack of understanding regarding prudent asset renewals programs, which drives significant reductions in the overall value and can impact the operating result and the perceived financial sustainability of the councils.




Other councils may have depreciation levels that are too low due to exaggerated asset lives or asset values which require updating.

It is worth noting that application of the various depreciation methods is not always consistent between all councils and some confusion exists about the most appropriate depreciation methods and how to accurately apply them. Training in specific technical skills may therefore be a useful means for better understanding depreciation and further renewals costs for councils.

For example, for account purposes local roads tend to be depreciated over a life of 50 years. In reality the road surface has a life of 20-40 years (subject to heavy vehicle usage, gradient, climate, soil stability, etc), and the formation has a far longer useful life of typically 100 years. The mix of replacement cost between these two broad components is typically 60% formation and 40% road surface. This has a significant impact on the accounting written down value of the asset and the actual physical consumption of the asset. For instance the replacement cost of a basic two lane, sealed local road is estimated to be $400,000/km, or $4 million for a 10km stretch of road. Under the accounting method the book value of the total asset base of the road would be written down by 2% or $80,000 per annum.

Alternatively, when using a weighted asset life of the formation and surface of around 72 years, the straight line depreciation would be 1.38% or $55,200 per annum. Even this depreciation estimate is relatively high as it incorporates the replacement costs of the formation, which in reality would typically not be necessary. A better approach may be to only write down the value of the surface of the road, which if the useful life is estimated at 30 years, the depreciation rate would be 3.33% of $160,000/km or $5,300 per annum. Evidently, applying accurate depreciation rates of assets can be complicated. In this example, the best depreciation rate is likely to be between the 72 year depreciation of the total road replacement cost, and the 30 year depreciation of the surface.

This example illustrates how councils can under and overstate depreciation whilst also not accurately estimating efficient future renewals costs. Once council data for asset management plans, depreciation, and renewals estimates are more robust, uniform, and accurate, it will be possible to better appraise the extent of funding gaps, optimal renewals spend, and any backlogs which may be present.

4.1.2 Revenue The divergent nature of local governing bodies means that there is a wide disparity in their ability to raise revenue, which is largely determined by population size, rating base and the ability/willingness to levy user charges.

Figure 4.1 below shows the large difference in local government’s revenue by source. Whilst all councils except for those in Tasmania use taxation as their largest revenue source, the reliance on grants and subsidies and sales of goods and services vary significantly.



Figure 4.1 Local government revenues by source, by jurisdiction 2004-05

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

NSW Vic Qld WA SA Tas NT

% o

f rev

enue

sou

rces

Taxation Revenue Sales of goods and services Interest Current grants and subsidies Capital grants Other revenue

Source: DOTARS 2005, Report on the Operation of the Local Government (Financial Assistance) Act 1995, p.25

General trends can be drawn from the data on the sample of councils. Urban councils tend to have a strong revenue base with rate revenue generally exceeding 40% and have the added benefit of an increased scope to extract user charges. Regional councils have a mixed ability to raise revenue, depending on the socio-economic mix of the community, whereas for rural councils revenue generating ability is very limited.

4.1.3 Rates and municipal charges Urban councils have more scope to extract diverse user charges than their rural and regional counterparts. This is due to the larger variety of services provided by urban councils, compounded by the smaller economic base of rural and regional local governments, which reduces their ability to significantly lift charges and rates to increase revenue for funding purposes.

Across the nation, councils average a rates coverage (defined as total rates received as a percentage of total costs) of 48%, however this ranges from 25.4% in the rural remote category to 66.5% in the urban regional category. The average rates coverage of 48% indicates that on average less than half of a council’s costs are recovered by rates. Rural remote and rural agricultural council categories also have the lowest percentage of councils with rates coverage less than 40%, with 87 and 54% of councils respectively not meeting this benchmark.



4.1.4 Grants As discussed previously in sections 2.2.3, and 3.2 the Australian Government provides FAGs, while state/territory governments provide a mixed range of grants and subsidies to local government.

The rate of economic growth and consequent rises in national taxation revenue means that grants have decreased as a percentage of both GDP and tax revenue. While at the both the national and state level, rising tax revenue collected nationally (and in the case of the states, redistributed back to them through the GST) has allowed those spheres of government to meet increasing demands for services (and/or to run substantial budget surpluses), this has not been the case at the local government level. Given the infrastructure backlog and genuine financial need of many local governments, an increase in funding pro rata with GDP and tax revenue seems justified.

Figure 4.1 below shows the reliance of local governments within each state and territory on total intergovernmental transfers or grants. It can be seen that grants make up between 12 and 20% of local government revenue for each state. Through an analysis of individual state data within the sample data however, it is apparent that the reliance on grants as a source of revenue varies hugely between different ACLG categories. Total revenue of urban capital cities and urban development councils have the lowest reliance on grant revenue at around 5% and 9% respectively, while rural remote (56%) and rural agricultural (33%) have the highest grants dependence. This largely reflects individual councils’ ability to generate revenue through its own sources of tax and user charges and hence generate own-source revenue to provide services to the community.

Figure 4.1: Intergovernmental transfers as a proportion of total revenue by jurisdiction, 2003-04

0

10

20

NSW Vic Qld WA SA Tas NT

Jurisdiction

inte

rgov

ernm

enta

l tra

nsfe

rs a

s a

% o

f to

tal r

even

ue

Source: DOTARS 2006, 2004-05 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p.28



4.1.5 Operating surplus/deficit Operating surplus/deficit is the key analytical indicator regarding local government’s annual operating activities. It is defined as operating revenue (including all intergovernmental transfers) less all operating expenses, including depreciation expenses, net interest expenses and taxes/transfers and dividends paid. It is an indicator of the ability of current rate payments to sufficiently cover all operating costs for local government. In interpreting this indicator, some caution is required as operating surpluses (or mild deficits) can be driven by understated depreciation costs, which in turn usually arise due to conservatively low valuations of council assets or infrequent updates to such valuations.

An operating deficit was recorded by 28% of councils in the study sample of 100 councils, with the average operating result for all urban capital and rural significant growth categories in deficit. This suggests that 28% of councils have a portion of costs incurred in the year not being met, as it should, by ratepayers. Whilst modest operating deficits do not pose a major concern to financial sustainability, operating deficits greater than 10% of total revenue indicate that a council is spending beyond its means and facing financial unsustainability.

Of the 100 council sample, the average council operated with an average surplus of 9.3%. The council categories with the worst operating result were urban development and rural significant growth, with 8.3 and 0% of councils respectively. These figures suggest that approximately 16.0% of all councils will therefore face sustainability issues as a result of operating deficit.

Operating deficits mean that current ratepayers need to fund the deficit by borrowing, or deferring renewal or replacement of existing assets and so shifting this burden onto future ratepayers.

It is worth noting, that due to data limitations, these ratios were developed with capital grants included in the operating revenue and so can be expected to have underestimated the proportion of councils running operating deficits. When Access Economics conducted its analysis of NSW local governments without the inclusion of capital grants, a total of 76% of councils were operating at a deficit, with 50% with a deficit larger than 10%. This is a concerning statistic, indicating that the majority of councils are currently unable to perform their operational activities with available funds.

If operating deficits continue for multiple periods for capital city councils, the compounded deficit creates debt levels which local governments are unable to repay, rendering them financially unsustainable. Whilst time-series data is required to determine whether the operating deficit is a trend for local governments who have a net operating deficit, the data available suggests up to one quarter of local governments are at potential risk of becoming financially unsustainable due to operating deficits. These councils are from all categories of councils except for the rural remote category. This is mainly due to a much smaller expenses base faced by these councils, however does not signal financial sustainability, as the operating surplus/deficit does not indicate whether infrastructure renewals/replacements is adequate, and whether adequate facilities are being provided to rural remote communities.



4.4 Financial position

The financial position, or balance sheet, of a council reflects the level and composition of a council’s assets and liabilities. The NSW Inquiry considered that the financial position of a council is healthy where the financial liabilities and debt are at levels where the resultant net interest expense can be met comfortably from a council’s existing annual rating income.

Ideally, the financial position of a council should: 71

i) be a modest net debtor, with borrowings (debt) comprising a minority of the total capital invested in the council’s infrastructure and other assets; and

ii) the associated interest expense burden should not be a substantial proportion of the council’s annual operating revenues.

4.1.1 Net debt Net debt is defined as total debt less cash reserves and is a key measure of the extent of local government gearing. It is a more relevant measure than total debt since many local governments have cash reserves accumulated from a range of functions including state grants and levies to fund future infrastructure spending paid by property developers.

One measure to determine the appropriateness of a local government’s debt levels is its ability to repay the debt and associated interest. One way to measure this is the interest coverage ratio. Determined by the earnings before interest and tax divided by the interest expense, if the ratio is three or greater, it suggests that a local government would have no issues associated with repaying debt and associated interest. The percentage of councils with a ratio above three is fairly consistent across all council categories, ranging from 54.5% in urban regional to 66.7% in urban development councils. This indicates that approximately 40% of councils across Australia may face financial unsustainability as a result of interest on outstanding loans. This is much larger than the 20% of councils estimated to be affected by financial viability due to operating deficits. Interest expenses were unavailable for Western Australia, and therefore no conclusions could be drawn about rural significant growth or rural remote councils, where Western Australia councils made up a large share of the sample.

Conversely, those councils with a very low ratio need to consider a more appropriate mix of debt and equity funding, where possible. More debt may be required in order for councils to grow financially and increase their asset base to generate revenue. Better training for local government may be required on appropriate uses of debt financing and its contribution to successful financial growth.

The value of, and access to, debt for local government as a sector is complicated by the legislative restrictions on councils’ ability to use their assets as security. Many local government Acts prohibit councils from using public land and buildings as security, while financial institutions have policies of not accepting grant income as security for loans.




This leaves councils often with only rate revenue as collateral for loans, which is very limited for many smaller councils.

4.1.2 Net financial liabilities Net financial liabilities are defined as the total liabilities less total financial assets. A particularly large net liability is an indicator of unsustainability, whereby councils have increased their asset base beyond the financial capacity of the council and are not in a position to repay the associated debt. A net financial liability, however, may be necessary for a council to grow and effectively increase its asset base. Currently, local councils have an average net liability ratio (net liabilities as a percentage of operating revenue) of 6.7%. The smaller council categories of rural remote and rural agricultural councils average negative net liability ratios of -15% and -2% respectively, which indicate that not all revenue from rates or borrowed funds is invested in community asset bases. This is further compounded by the fact that employee expense liabilities have increased at a rate faster than CPI, thus increasing liabilities without any marginal benefit to the community.

A useful benchmark is the Commonwealth net financial liabilities ratio of 11% and state governments such as NSW with a forecast ratio (for 30 June 2007) of 65% and South Australia with a net financial liabilities ratio of 73%. These figures indicate that there may be room to increase net financial liabilities within local government, particularly when these liabilities are associated with income-generating investments, albeit within the context of limited ability to use assets as security.

Another indicator of a council’s ability to meet short-term debt obligations is the current ratio (current assets divided by current liabilities). The higher the current ratio, the stronger the ability to meet liabilities. If current liabilities exceed current assets, then the council may have problems meeting its short-term obligations. Whilst the overall median of all councils is 2.6 which does not indicate problems, urban fringe, urban development, rural remote and rural agricultural have between 12 and 50% of councils with a ratio less than 1. This is of concern for councils’ debt-repayment ability and hence financial viability.

4.5 Capital expenditure

The capital performance of a council is considered adequate where its capital expenditure on the renewal or replacement of non-financial assets broadly matches the cash flows generated to cover its annual depreciation expense.

4.1.1 Capital expenditure In order to maintain financial viability, local governments should invest in capital expenditure at a level at least equal to depreciation expenses. This ensures that the asset base of councils does not diminish over time and reduce to a level where they cannot provide adequate infrastructure and services.



This study reveals that 8% of councils had levels of capital expenditure below their depreciation expense. The highest level of unsustainability with regard to capital expenditure compared to depreciation was evident in the urban fringe council category, where 16.7% of councils had a sustainability ratio less than 1, followed by rural significant growth with 11.4% recording a ratio less than 1. Urban regional, urban development and rural agricultural council groups all have no councils in the sample recorded as financially unsustainable, with zero councils recording a ratio less than 1.

Key reasons likely to be causing an underspend of funds by councils are inadequate free cashflow and a use of debt to fund infrastructure that is long life and has a revenue stream. This issue is discussed further in section 2.7.4.

There may be inaccuracies in this data as well as inconsistency in the use of depreciation rates that are applied to identical assets that operate under similar conditions. This could lead to miscalculation of annual depreciation expense, and under-estimation of infrastructure renewals gap. For example, councils in some states are not required to regularly update the value of their physical assets. As a result very few councils report their asset values at cost.72 This is a significant issue as annual depreciation based on historical cost will understate both the consumption of capital and the amount of capital expenditure necessary during the year to maintain the asset to the same condition as the start of that year. Hence the national median sustainability ratio result of 1.9 is more due to low valuations leading to low depreciation rather than any ‘gold plating’ of infrastructure. For example, in Victoria, where councils have arguably completed more efficiency and financial management reforms, MAV reports that the average sustainability ratio is only 1.05 (with no council being over 2.5). This suggests that a significant proportion of councils need to do more work to improve accounting and AMP to use more realistic inputs into sustainability ratio.

4.1.2 Net borrowing (lending) The annual net borrowing as a proportion of capital expenditure on new (growth) non-financial assets should not put any long-term pressure on achievement of the council’s targeted net debt or net financial liabilities ratio. The net borrowing measure deducts cash and near cash investments, as these could be readily used to decrease debt. Most councils do not appear to be under any financial pressure due to interest expenses, with many councils recording a net lending position. Given the growing renewals backlog discussed in section 4.2.3 below however, this tends to indicate poor financial management. Councils would enhance their financial standing by investing in income-generating assets. Councils can be constrained on increasing debt levels due to state based security limits. Additionally a large proportion of infrastructure needing renewal does not have an income stream, which makes use of debt funding less appropriate.




4.1.3 Renewals backlog One of the major financial problems facing councils throughout Australia is the infrastructure renewals backlog. The renewals backlog is often driven by the difference in growth rates between operating expenditure and operating income. Between 1999 and 2005, operating revenue grew by a total of 4.2%, which was outstripped by a 7.6% increase in expenditure, resulting in a deferral in capex and a growing infrastructure backlog.

One way to determine if a council is affected by a renewal/replacement backlog is by evaluating the asset renewal/replacement ratio. The net acquisition of non-financial assets for renewal/replacement purposes is the analytical balance appropriate with regard to the annual financial performance of councils on the renewal or replacement of existing assets. It is measured by the difference between capital expenditure on the renewal or replacement of non-financial assets on the payments side and cash flows generated to cover annual depreciation expense on the funding side.

Positive annual net acquisition of non-financial assets for renewal/replacement purposes occurs where capital expenditure on the renewal or replacement of these assets exceeds the annual depreciation expense on those assets. A positive asset renewal/replacement ratio relieves future ratepayers from renewing or replacing such assets consumed in the current period. Controversially, negative annual acquisition of non-financial assets for renewal/replacement purposes refers to the annual depreciation expenses exceeding renewal or replacement of these assets. In this situation, the responsibility for this portion of the renewal/replacement of such assets effectively shifted to future ratepayers.

This approach is used in this study due to existing data limitations and consistency between the jurisdictions. However, it is acknowledged that such an approach to measure the estimated backlog can understate actual spending requirements due to the fact that it includes:73

• land purchase, which has no associated deprecation expense, and

• upgrading existing assets and the purchase of new assets.

In spite of these challenges, given the data availability it is a method which gives a good indication of the likely size of the backlog, considering that any pattern of capex that is lower than the annual consumption of assets is likely be indicative of an unsustainable situation.

73 MAV 2005, Trends in Local Government Finance, October 2005, p.14.



Text Box 17: Local government’s financial management innovations

Three councils form financial alliance in central western NSW

Wellington, Blayney and Cabonne Shire Councils have introduced The Alliance, a body that combines the three councils to enable more extensive resource sharing and cooperative arrangements to increase efficiencies and achieve savings in a revenue-strapped area of NSW. The Alliance has created a body with a combined population of more than 30,000 and a total annual budget of $60 million. It has provided significant efficiencies through economies of scale and will improve integrated management and planning.

Through cooperative arrangements, joint purchases, and staff and resource sharing, it has developed initial savings of more than $720,000 per annum to the residents of the three member councils within the first 10 months of its operation. This initial saving represents only 1.2% of the combined alliance recurrent expenditure budgets for the three councils but management from The Alliance are keen to substantially build on this progress to deliver larger efficiency gains.

Source: see http://www.blayney.local-e.nsw.gov.au

Through the analysis undertaken for this study, the median renewal/replacement ratio is 1.8 across all councils.

The lowest ratios were recorded by urban regional, urban development and rural agriculture, all with median ratios between 1.3 and 1.7. The lower ratios do indicate that further investment in capital expenditure should be undertaken to reduce a backlog and future unsustainability of the councils.

A DOTARS R2R review (2003) estimates the local roads expenditure shortfall of $630 million per annum from 2003 to 2008. After the period, the backlog is expected to rise due to the increasing age of the assets. The implementation of R2R has successfully reduced this shortfall to approximately $400 million.

Access Economics studies into the sustainability of local government have estimated the backlog in infrastructure renewals for NSW, WA and SA. The values for the SA analysis are based on the backlog developed over the past 10 years, and therefore a full backlog figure will in fact be higher than those estimated. Based on Access figures, NSW local governments record the largest underspend, with an average of $3.29 million per council, with SA and WA averaging an underspend of $0.29 million and $0.77 million per council respectively. When interpreting these results it is important to note the limitations associated with the use of one year operating results, which would hence include abnormal events that occur within that year. The sustainability analysis conducted by MAV for Victoria found that the inclusion of abnormal events, such as the discovery of assets or the loss of assets/decrements in single years, can significantly distort sustainability findings. However, as this study develops results across the 7 ACLG categories rather than for individual councils, unless 2004-05 had particularly adverse outcomes across a range of councils, to some extent the variations will average out across the category.

MAV has also led and undertaken considerable work on analysing the trends and long-term sustainability of local government finances in Victoria. The MAV approach used to estimate the infrastructure backlog analyses the following:

• compares capex against average annual consumption (AAC) of capital


http://www.blayney.local-e.nsw.gov.au/


• compares capex excluding construction related to main roads, all purchases of land, transport and office equipment (assumed to be predominately purchases of new assets) against relevant AAC, and

• applies the infrastructure renewal expenditure ratio provided in council annual reports since 2001-02 to the deprecation expense associated with infrastructure.

Based on this approach, MAV has estimated that there is a shortfall of approximately $806 million (in 2003-04 dollars) between 19979-98 and 2003-04.74 It is important to note that the MAV estimates are for the period from 1997-98 to 2003-04 due to concerns about the accuracy of the data recorded for non-current assets under the different accounting standards that applied prior to this period.

Results from the Access and MAV sustainability studies were assessed and extrapolated in this study to determine a national estimate of backlogs in infrastructure renewals, underspend on existing infrastructure renewals per annum and estimated funding gap per annum to cover backlogs including annual underspend to be generated via savings or extra grants/revenues.

A mean, high and low estimation was determined for each of these backlog estimates, due to the large variation in each state’s average council backlog as estimated by Access. The methods for determining these three cases are highlighted below.

• Low case: This estimate applied the average of WA, Victoria and SA average result per local government to 259 councils in Queensland, Tasmania and NT.

• Mid case: This estimate applied the average of WA, Victoria, SA and NSW average result per council to 259 councils in Queensland, Tasmania and the NT.

• High case: This estimate applied the NSW, Victoria and WA average result per council to 259 councils in Queensland, Tasmania and the NT.

The extrapolation results below also need to be interpreted with some caution as the 259 councils that are yet to be analysed across Queensland, Tasmania and the NT are likely to have substantial variation. This is due to differing asset bases and income levels arising from factors such as whether (or not) water/sewer services are provided. This sub-set also contains proportionally more Indigenous councils, which generally have relatively less extensive asset bases. Further analysis of the specific renewals backlogs in Queensland, Tasmania and the NT appears to have merit and would reduce the need to rely on extrapolated estimates.

The results for this approach are highlighted in Table 4.2 below.

74 MAV 2005, Trends in Local Government Finance, October 2005, p. 15.



Table 4.2: Infrastructure backlog estimate, extrapolated from Access Economics and MAV results

Access Economics & MAV Financial Sustainability Summary Results

Backlog in infrastructure

renewals ($m)

Underspend on existing

infrastructure renewals per annum ($m)

Est. funding gap per annum ($m)

(to cover backlog & annual underspend) to be generated via

savings or extra revenue/grants

Est. funding gap per council per

annum ($m)

% of councils unsustainable

NSW (152 LGBs - Access) $6,300 $500 $900 $5.9 25%

SA (68 LGBs - Access) $300/1 $20 $40 $0.6 38%

WA (142 LGBs - Access) $1,750 $110 $220 $1.5 58%

Vic (79 LGBs - MAV) $806/2 $81 $203 $2.6 10%

Total NSW/WA/SA/Vic (441 LBGs: 63% of LGBs, 76% population & 73% of local road km) $9,156 $711 $1,362 $3.1 35%

Low Case National Estimate (700 LGBs) (apply WA, Vic and SA average result per council to 259 councils in Qld, Tas & NT) $12,012 $922 $1,826 $2.6

Mid Case National Estimate (700 LGBs) (apply WA, Vic, SA and NSW average result per council to 259 councils in Qld, Tas & NT)

$14,533 $1,129 $2,163 $3.1 35%

High Case National Estimate (700 LGBs) (apply NSW, WA, Vic average result per council to other 259 councils in Qld, Tas & NT) $15,305 $1,190 $2,281 $3.3

Notes: 1. Access estimate for SA based only the backlog developed over last 10 years and full backlog will be higher. 2. MAV estimate of infrastructure backlog is in 2003-04 dollars, for the period between 1997-98 – 2003-04, hence is understated.

The trends emerging from the Access Economics and MAV results in Table 4.2 include:

• It is likely that between 25% and 40% of councils could be unsustainable.

• NSW appears to have a relatively larger dollar value financial sustainability issues.

• The average underspend on existing infrastructure renewals per council per annum appears likely to be between $1.3 million and $1.7 million, and

• The estimated average funding gap per annum per council (to correct the current underspend plus to resolve the backlog) is likely to be between $2.6 million and $3.3 million.

To further support this PwC Study, the MAV applied their viability index to 315 councils covering almost all councils across Victoria, Tasmania, SA and WA. The results of the MAV’s analysis and a description of how the index works are in the text box below.



Text Box 18: The MAV viability index

MAV viability index

MAV has undertaken work to estimate the ongoing long-term viability of councils to identify those most at financial risk. The MAV approach assesses viability by evaluating a council’s:

cumulative long-term debt, comprising loans, unfunded superannuation and deficit/surplus in capital expenditure versus depreciation and compares this against annual rate revenue

cumulative underlying operating surplus/deficit, and

rate effort, rates affordability and population growth.

The viability index assumes that failure to renew assets over the medium term creates a long term liability. Such councils may appear to have stronger performance in their financial statements and the extent of any underspend can be difficult for the community to identify. Hence in the MAV viability index, a capital underspend is analogous to debt. Capital investment above depreciation levels is netted off any council debt. Next the MAV tests whether a council has a long-term underlying operating deficit with this in turn needing the generation of extra revenue to maintain viability. For this cohort the potential to achieve this is assessed against council’s current rate effort ie whether rate levels relative to local income are high or low. Lack of population growth can limit economies of scale, the ability to raise rates from new properties and local wealth. Councils are then identified most at risk that display the characteristics of high long-term debt relative to rate revenues, having already relatively high rate levels and declining, stagnating or very low population growth. Finally, MAV identifies councils with high long- term debt relative to annual rate revenue to highlight councils with potential viability issues. Accordingly, a low or particularly a negative viability index equates minimal net liabilities (ie stronger viability) and a high viability index (eg over 1.0) equates to high liabilities and viability risks.

To support this PwC Study, the MAV applied their viability index to 315 councils covering all of Victoria, Tasmania & SA and 98% of WA councils. Councils in Qld, NSW & the NT were not covered due to data limitations. The results, segmented into the DOTARS categories, are provided in the table below.

Table Distribution of viability index by DOTARS categories (315 councils in Victoria, WA, SA & TAS)

The results indicate the diversity in viability. Within the rural categories there are high percentages with viability issues & many councils with strong viability. This potentially appears due to two factors: (a) understatement of depreciation expenses and (b) the existence of factors that influence the sensitivity of councils to viability challenges. That is,. smaller councils (often low population but long road lengths) appear to be more sensitive to the effectiveness of council management - prudent management can strongly improve viability whilst poor management can quickly deteriorate viability. By contrast, the distribution of urban municipalities reflects a normal distribution, albeit with a mean in the ‘viable’ category. It is of interest to note that there are only a limited numbers of councils from urban areas across the sampled jurisdictions that exhibit characteristics of weak financial viability.



Overall, the MAV analysis of Victoria councils shows that viability has generally improved over the last eight years, largely as a result of increases in rates and grants. Common characteristics of these councils with sustainability issues include:

• persistent ongoing underlying operating deficits

• relatively high rate effort

• higher than average debt commitment, and

• decreasing or declining population growth and household formation.

In summary the MAV concluded that 10% of Victorian councils appear unsustainable unless they receive substantial additional external funding assistance.

4.1.4 Why are some smaller councils in reasonable financial health whilst some large urban councils face viability challenges?

In the same way as some individual people and companies encounter financial difficulties across a broad spectrum of income levels, almost any size of council can experience viability challenges if they do not have robust financial management and governance (including strong 10 year planning and detailed quarterly financial position reviews). In many ways councils operate as individual businesses and like any other industry sector there will be both good and badly performing organisations with scale being a viability advantage but not necessarily an advantage which can overcome poor management. For example, councils that practice tight cost control with regular use of competitive tendering typically have stronger financial positions with the scale of purchasing volumes being less significant in determining unit cost outcomes than how services are procured. Councils with financially skilled, disciplined, focussed and committed management are more likely to have a sustainable financial position as well as a clear vision and set of objectives with regular use of a robust suite of KPIs to measure performance.

Whilst larger councils can use their scale to reduce unit costs and improve their financial position, this scale advantage can quickly be more than offset if councils significantly and regularly expand the scope or quality of their services without corresponding increases in revenue to support those services. The financial strain of funding extra services is exacerbated where revenue streams are capped by government or where rate rises are suppressed by councillors to below required levels to attempt to improve their popular support. Additionally, a number of large (and small) councils have embarked upon capital projects (often with government grant support) without fully realising the ongoing operational or maintenance costs associated with these projects. This has further been a drain on council resources.

Overall, councils with scale have some advantages in achieving financial sustainability but strong management is a more important factor for overcoming viability challenges.



4.1.5 Can additional government funding on its own improve financial sustainability if management quality and scale are key constraints?

Additional government funding alone will not improve the sustainability of some local councils. Some rural and remote councils are already highly grant dependent whilst also accumulating infrastructure renewals backlogs and further rises in grant funding are likely to provide only some relief to their situation. Consequently, this study has focused on developing a twin track approach to improving sustainability focused around reforms to internal management with some suggested changes to intergovernmental transfers.

The most significant viability drivers appear to be management quality and financial discipline. Hence the first priority for councils with viability challenges should be to secure good quality management. Management also needs the support via effective governance from councillors who in turn should be held to greater account for the overall delivery on the annual strategy and the financial performance/sustainability. Hence councillors should resist excessive involvement in day to day management issues, whilst clearly establishing what outcomes a community expects and then monitoring and guiding the management team to deliver on those outcomes.

Size is also important. Aside from assisting to reduce unit costs, larger councils are generally more able to attract better quality staff and also can appoint a diversity of staff with a range of different skill sets and experiences. Hence top-ups to grants are unlikely to provide a long term solution for most councils facing financial challenges.

Overall, additional government funding on its own is unlikely to provide a long term solution to councils with financial sustainability issue and councillors need to focus on ensuring they provide effective governance to a strong quality management team to improve viability.

4.6 Summary - financial sustainability of local governments

In order to evaluate the financial sustainability of local governments in Australia, financial data was analysed from:

i) a PwC survey of a sample of 100 councils within Australia segmented into seven DOTARS council categories; and

ii) reviewing the Access Economics and MAV sustainability results in state based studies completed in NSW, WA, SA and Victoria and assessing potential implications nationally.

However, these results must be assessed with a caveat on their accuracy due to previously discussed data quality shortcomings.



From the sample of financial data from 100 councils, 5 KPIs were developed to form proxy measures of financial sustainability for each council. From this analysis it is evident that a significant proportion of local councils across most of the 7 categories need additional revenue or cost efficiencies to maintain viability. The trends emerging from this study indicate that between 10% and 30% of councils have financial sustainability challenges. Key indicators that assisted in forming this view include 8% of councils having a sustainability ratio less than one, 16% of councils with an operating deficit over 10% of revenue and 21% of councils with current ratio less than 1.

These KPIs, and the percentage of councils below the benchmark for financial sustainability for each of these KPIs are highlighted in Table 4.3 below.

Table 4.3: Summary of the KPI results

KPI Description Benchmark Nationwide % of councils below

benchmark

Interest coverage Operating surplus less non-cash items eg depreciation, divided by net interest

<3.0 36

Operating deficit Total operating revenue less total operating expenses, divided by total revenue

operating deficit < 10% of revenues

16

Sustainability ratio Capital expenditure divided by depreciation expense

1.0 8

Current ratio Total current assets divided by total current liabilities

1.0 21

Rates coverage Total rates divided by total costs 40.0% 40.4%

When the survey results are segmented into the seven DOTARS council categories (see Table 4.1), the following broad conclusions can be drawn:

• the majority of larger metropolitan councils are generally viable or have the ability to self-effect an improvement in financial sustainability. Some metropolitan councils have become over stretched generally due to service expansions. Overall, further internal reform is the key to sustainability for most metropolitan councils

• urban fringe councils are mixed as some have large viability issues with some scope for internal improvements, while others are in a strong position with only minor scope for internal reform. Hence, only some of these councils appear to be dependent on additional government funding to restore sustainability, and

• rural remote and rural agricultural have more pronounced viability problems. These councils typically have relatively larger scope for internal reforms, however these councils often battle against lack of scale and extra funding for renewal of existing community infrastructure is required for most.



The trends emerging from the Access Economics and MAV results include:

• it is likely that between 25% and 40% of councils could be unsustainable

• NSW appears to have a larger dollar value financial sustainability problem vis-à-vis SA, Victoria and WA

• the average underspend on existing infrastructure renewals per council per annum appears likely to be between $1.3 million and $1.8 million, and

• the estimated average funding gap per annum per council (to correct the current underspend plus to resolve the backlog) appears likely to be between $2.5 million and $3.3 million.

Both analysis approaches confirm that a significant part of the local government sector has financial sustainability problems. While significant progress has been made by local government to increase its financial management effectiveness and understanding of the need for robust AMP, this analysis suggests internal reforms alone will not resolve sustainability issues for a large part of the local government sector. Hence, such councils may need to either reduce existing services/assets, or seek additional revenue. As council own-revenue options are limited, this lends significant merit to consider reforms to intergovernmental transfers, which are considered further in Section 5.



5 Potential options for reform

The assessment of the financial sustainability of local government in three states by Access Economics has indicated that approximately 40% of councils are currently not sustainable. PwC analysis of a sample of 100 councils has also confirmed that a significant proportion, say 10% to 30%, appear to have sizable financial sustainability challenges. Consequently funding reforms coupled with efficiency reforms are needed for some councils to improve financial sustainability. However, this report also recognises that the majority of councils appear to have sound financial positions and that many councils have made significant efficiency improvements over the past two decades, illustrated by various case studies throughout this report.

To recap, the objectives of this study were to develop a detailed plan to:


• provide a sound rationale and model for appropriate and targeted support to local government for consideration by other spheres of government.

These objectives are consistent with the findings of this study that a twin track approach to local government reform is necessary that includes:

• potential reform options for local government funding from Australian and state/territory governments, and

• a complementary set of further initiatives targeted at improving the effectiveness, efficiency and financial governance of councils.

While it is recognised that between 10% and 30% of local councils have financial sustainability issues which has seen most of these councils accumulate infrastructure renewals backlogs, aside from boosting incomes, councils also have an obligation to improve their cost efficiency and financial governance as part of a package of sustainability reforms. Some of the solutions to achieving greater financial sustainability lie in the hands of councils themselves, as is discussed below. Councils have been active, individually and through state local government associations, in pursuing efficiency and effectiveness improvements and will need to continue to do so. However, this will not overcome the fundamental problem facing councils, which can only be addressed by a significant increase in revenue through a major rise in rates or additional funding from the other spheres of government, or a major reduction in service levels for the community.

The reform initiatives available to councils might be accelerated through state government provision of funding support to improve the asset management and financial planning capabilities of councils.

Potential options for reform 119


5.1 Internal reform options

Reform options that build on past improvements to enhance financial efficiency and effectiveness should be part of the strategy to improve the financial sustainability of local government. Due to the significant diversity of each local governing body there is no single ‘silver bullet’ reform option that will solve the financial viability issues facing councils. The internal reform options set out below will not be applicable to all councils, and are intended to be implemented in addition to the funding reform options.

The internal reform options that are proposed echo recommendations from the state-based financial viability studies, and can be categorised at achieving the following:

• improving efficiency

• expanding own-source revenue

• setting clear and appropriate priorities, and

• broadening asset management capacity.

5.1.1 Improving efficiency

Regional/shared service provisions

Obtaining adequate economies of scale in local government service provision is critical to achieving efficient cost levels. Text Box 19 summarises the number of approaches available to councils to achieve significant cost savings through economies of scale.

Substantial savings can be gained through the bulk purchase or procurement of goods and services. As costs for most local government services are highly fixed, increasing the number or units of service completed can be critical to achieving an efficient cost per unit. While the individual operations of each council can be relatively small with relatively high unit costs, councils within a region or state can collaborate to purchase goods and/or services and therefore increase their buying power. However, in rural and remote areas regional service delivery can be limited by large distances between councils. Text boxes throughout this report have provided examples of successful collaboration of councils to delivery services on a regional area to achieve significant savings.

Another approach to gaining greater economies of scale is where a council in an area or a local government association becomes the specialised lead service provider for a particular service and is contracted by other councils to undertake such services. Examples of such regional specialisation include park maintenance, waste services, etc. Under such arrangements, each council is no longer required to employ separate labour and equipment, while councils with a comparative advantage in providing such services can develop a new source of revenue. Such an approach would require open and fair cost-sharing arrangements.



Text Box 19: Options to increase Economies of Scale Options to increase economies of scale

There are a variety of approaches that can be implemented by councils to gain better economies of scale and hence, improve their efficiency. The following consolidates a number of approaches that have been discussed throughout this report.

• Shared corporate services (eg payroll, accounts, human resources,).

• Regionally provided road maintenance and renewals (see Text Box 9).

• A single maintenance team between councils for shared parks and community infrastructure.

• Sharing cost of major new facilities between councils for use by all within a region.

• Outsourcing to private sector, eg cleaning, graffiti removal, painting, etc.

• Voluntary amalgamations.

• Regional waste arrangements via local government joint venture or lead provider model.

• Using state or nationwide bulk purchasing agreements, eg electricity in SA.

• Switching from (and avoiding) in-house provision of non-core services where the council does not have comparative advantage, (eg contracting private sector and if required offering in-kind or modest subsidy support).

• Establish ‘Expert Service Panels’ for essential services such as legal, engineering, etc. Using scale to seek rate discounts in addition to terms that require further discounts for expenditure above specific thresholds per firm per annum.

• Knowledge sharing, benchmarking and tracking best practice approaches by function.

• Develop stronger working relationships with other entities such as Catchment Management Authorities (CMAs) and roads departments to exchange services and collaborate to optimise joint expenditure.

Shared corporate services is a growing trend amongst the government sector, whereby a number of departments or divisions of government share the same back-office services, eg human resources, finances, IT, administration. Local governments, particularly those in rural and remote areas that are facing a skills shortage could achieve significant benefits from such an approach. This has been demonstrated by the successful implementation of shared services by a number of local government associations. With more than 700 local governments across the country, the potential cost savings that may result from shared services in each state could be substantial. Successful shared services initiatives can result in cost savings, productivity improvements, and better training for staff.

It is acknowledged that there is often reluctance on the part of individual councils to pursue regional service provision models. This is usually due to:

• some areas have few councils that are willing to be the lead service provider for other councils

• uncertainty about letting go of in-house control and the process available to councils to terminate contracted services where the regional services are not adequate, and

• a fear that regional service provision is the start of a process that is likely to lead to amalgamations of councils and loss of identity/local self governance.



Overall it is possible to separate the decision to increase scale via shared services and decisions regarding retention of local self governance. Ironically, the use of shared services by smaller councils is more likely to strengthen council sustainability and preserve local governance.

In the face of these challenges to the promotion of regional and shared services, an incentive or additional support may be necessary to drive such reforms. Incentives and support are best provided on a state basis due to different state/territory local government structures and responsibilities.

Overall, councils that continue to look for ways to collaborate with other local governments within their region may benefit from efficiency improvements that drive down the cost of service provision and hence may improve the long-term sustainability of councils that may be at risk.

5.1.2 Expanding own-source revenue

Fuller application of user pays and commercial pricing of services

It has been identified that there may be room for some councils, particularly smaller to mid-size councils, to improve the commerciality of the pricing and user charges of their services. The basic principle of total costing relates to the recovery of all direct and indirect costs involved in providing goods and services. The development of a commercial pricing policy requires:

• an effective costing system to calculate the full (direct and indirect) cost of its business activities, and

• valuation of assets to incorporate the financial cost of capital tied up with service provision.

A council need not always set a price which seeks to recover all costs. But the full cost recovery price should be a known target. While the council has the discretion to subsidise prices, it is important that they are aware of the size of any cross subsidy.

Councils that currently have a weakness in this area generally have difficulty in determining the actual cost of the services provided, eg the cost of a development application (DA). Anecdotal evidence from local government associations indicates that councils develop widely varying cost estimates for the provision of identical services in relatively similar operating environments. Councils can also be subject to a degree of gaming in some fees such as DA fees based on estimated cost of works where ratepayers have an incentive to understate likely actual costs. This indicates that some councils may lack the ability to verify the reasonableness of fee levels and similarly some lack a comprehensive understanding of the key cost drivers of their operations and how to set prices based on full cost recovery. Hence, some scope exists for local government associations in some jurisdictions to provide further or improved guidelines and templates to guide cost and pricing of services.



However, the application of more commercial pricing and user pays principles for some services may be restricted by statutory limitations. Services that relate to development applications or council approvals are often subject to state regulations, which may preclude the necessary flexibility for individual councils. However, where feasible, the application of more commercial pricing structures will assist councils to increase their own-source revenue, decreasing their reliance on grants and risk of underlying operating deficits and unsustainability.

A number of councils already have robust user charges and costing policies in place. For example, Marion Council in SA clearly sets out their policy to set fees and user charges to recover the full cost of operations or providing the good or service.75

Text Box 20: Bass Coast Shire Council user pays infrastructure funding Bass Coast Shire Council’s use of special levies to fund an accelerated completion of road & drainage projects

As a response to the limited borrowing capacity of councils and the lack of funding to meet the infrastructure renewal challenge, the Bass Coast Shire has developed a funding policy based on ‘user pays’ principles.

They have introduced a “special charge scheme” under section 163 (special rates and charges) of the Local Government Act 1989, which enables the local government to levy a scheme charge on rateable land, for the performance of any of council’s functions.

The process of the scheme is to identify priority residential road and drainage projects for upgrades and expansion. The council will then identify the potential scheme beneficiaries who will be charged the levy. The council will determine the total cost of the project and the distribution of the costs between the beneficiaries. Extensive community consultation on the details of the proposed plan is then undertaken through questionnaires, forums, meetings, reference groups.

For example, Bass Coast Shire Council is currently planning the construction of a number of roads to be called Hospital Drive, Clark Drive, Court and Easton Streets. This project includes the construction of two laneways, and additional underground drainage as part of the improvements to the area. The total cost of the project is estimated to be $491,000, which is to be recovered from land owners’ properties that directly abut the roads and laneways.

These land owners will receive special benefit by construction of the works, which includes improved vehicle access, amenity, safety for vehicular and pedestrian traffic, access to and egress from the property, drainage.

Bass Coast Shire Council determined that the distribution of cost of the scheme shall be based on charges by property land area with adjustment for street frontage length.

This scheme is not limited to roads and drainage and can be used for promotion schemes, car parking, footpaths, buildings, etc.

As a result of this process, 25 schemes have been implemented in the Bass Coast region in the past 10 years. These projects have varied in size from $80,000 to $8.6 million.

This approach provides the community and council with the flexibility to embark on infrastructure upgrades and renewals that meet the specific priorities and needs of the area.

SOURCE: Bass Coast Shire Council Website: http://www.basscoast.vic.gov.au, and Piasente, S. Engineering Services Manager – Bass Coast Shire Council “Funding Infrastructure from Special Charge Schemes” at 3rd Building and Financing Local Government Conference 2006.

75 City of Marion 2006, Fees and Charges Schedule – Pricing Policy Document, available at http://www.marion.sa.gov.au


http://www.basscoast.vic.gov.au/


Commercialise businesses

Where councils are engaged in providing business operations, such as waste, water, sewerage services, it is critical that the prices for such services are set at full cost recovery, to cover both the cost of capital and a commercial rate of return. If councils undertake commercial activities, they need to generate some positive return on assets so as to not reduce financial viability.

Ensuring that local government businesses are commercialised is a requirement not only for improved financial viability, but also under the ‘competitive neutrality’ provisions of the National Competition Policy. In terms of the provision of category 1 business activities, such as water services, the NCC requires that all levels of government:76

• review pricing methodologies to determine if it is cost effective to introduce ‘two-part tariffs’ (including a fixed service charge and a variable charge based on the volume of units used)

• ensure that prices reflect the actual cost of providing services (this includes the cost of building and maintaining infrastructure)

• consult with communities in setting prices, service standards, and

• conduct rigorous appraisal of economic viability and environmental sustainability prior to new investment.

For the most part, local government, along with other spheres of government with category 1 businesses, generally apply good commercial practices and comply with NCP principles. Overall National Competition Council states that governments’ (including local government) application of competitive neutrality to major government business enterprises and other significant business activities is well advanced. For instance an assessment of local councils’ NCP compliance in Victoria found that 77 councils were fully compliant and five needed to meet with the Victoria Competition and Efficiency Commission (VCEC) to clarify their CN policies.77

Where the state or Australian Government imposes any community service obligations (CSOs) on local government business operations, eg low cost water for schools and hospitals, any gap between the full cost and the revenue stream should be covered by governments as a subsidy. This requires the CSOs to be clearly identified with accurate measurement of the full cost of services.

76 National Competition Council 2000, Community Information: Local Government and National Competition Policy.

77 National Competition Council 2005, Assessment of governments’ progress in implementing the National Competition Policy and related reforms, Melbourne, p.2.2.



Increase the use of debt

Councils, like other spheres of government in Australia, are typically conservative in their use of debt funding with the average gearing ratios (net debt divided by total assets) being very modest. Only a quarter of the sample of 100 councils operate with a net debt. The conservative nature of debt levels is further evidenced by the fact that 64% of councils operate with an interest coverage ratio (EBIT/interest costs) greater than 3, indicating a relatively low level of interest relative to earnings.

As previously noted there are some state based statutory limitations on council borrowing in terms of councils’ ability to use public assets as security. However, in the interests of prudent financial management, councils should attempt to increase their use of debt, where feasible, to fund appropriate capital spending on long-life revenue generating assets where case reserves are not adequate. Greater use of borrowing will spread the cost of infrastructure over both current and future generations of ratepayers. Debt funding is appropriate where it is used to fund the acquisition of new infrastructure assets or the upgrading of existing infrastructure assets, which generate an income stream, to fully or predominantly fund interest payments. Debt should not be used to fund routine maintenance and renewal of existing infrastructure assets that do not have an income stream. Such costs should be funded out of current revenues.78

The greater use of borrowing by local government is in some states controlled by state governments setting clear limits on levels of debt, with reference to a council’s long-term financial capacity to service debt. The NSW Inquiry suggested that the upper limit for net borrowing as a percentage of capital expenditure on new or enhanced assets should be 60%, with a lower limit of 30%.79 However, the overall local government use of debt is generally prudent and there remains some merit in greater use of debt particularly for long life assets which have income streams.

Alternatively, councils should also consider the use of other sources of infrastructure funding, such as public-private partnerships (PPP), in addition to special levies and user charges, which are also discussed. The key features of infrastructure PPPs are:

• the private sector invests in infrastructure and provides related services to the government

• the government retains responsibility for the delivery of core services, and

• arrangements between the government and the private sector are governed by long-term contract. It specifies the services the private sector has to deliver and to what standards. Payment typically depends on the private partner meeting these standards.

78 Access Economics 2006, Local Government Finances in New South Wales: An Assessment; for the Independent Review Panel, p. iii – iv.

79 Independent Inquiry into the Financial Sustainability of NSW Local Government 2005, Background and Issues Paper, October 2005, p.2.



A successful example of local government using a PPP for infrastructure upgrades is the Wollongong City Council PPP for the development of City Beach Surf Lifesaving Club. For councils with the appropriate skills and capacity the use of PPPs provides a flexible alternative for infrastructure upgrades, which avoids the pressures of increasing local government debt. However, it is important to note that initiating a PPP can be an expensive and lengthy process that has a number of inherent risks and complexities, which will typically require the use of expert advisors in order to be appropriately managed. Overall, PPPs generally enable councils to reduce risk by allocating a number of risks that are often better managed by the private sector.

Greater use of special levies

Councils could increase their use of special levies to provide and maintain services or infrastructure that meets the demands of the community. Special levies are a transparent short-term approach to raising revenue for abnormal or irregular expenditure requirements. In most jurisdictions this would require the approval from state government in addition to community support. Similar to standard rates, particular ratepayers would be eligible for exemptions or concessions. In establishing a special levy it is prudent to undertake consultation to demonstrate the value and to obtain buy-in from ratepayers.

An example of a special levy that is currently being used by some councils across the country is an environmental levy charged equally to all ratepayers for high intensity programs of additional works that could otherwise not be budgeted for, eg to remediate a polluted mangrove, or more general programs targeted at bushland management and catchment management. The revenue generated from the environmental levy will contribute to specific environmental planning, projects and services required to deliver the specified outcomes. Such levies have been in use for over ten years in councils like Warringah in NSW.

The Bass Coast Shire Council use special levies on beneficiaries of particular infrastructure upgrades. This infrastructure levy summarised in Text Box 20, uniquely incorporates the concept of ‘user-pays’ and shows the available diversity and flexibility of special levies.

For NSW councils under rate pegging, special levies or ‘special rate variations’ are increasingly being pursued as a means of boosting council income without breaching the rates cap. An application is made to the NSW Minister of Local Government to approve the levy. For example, Warringah Council introduced an infrastructure levy in June this year, which results in an additional 6.5% increase in rates for residents of the area to be used on renewals and replacement of infrastructure. The Council expects that it will raise approximately $3.4 million in the 2006-07 financial year which has been earmarked for improvements to public buildings, roads, footpaths, drainage and recreational facilities.

While the use of special levies in most instances would not generate a significant level of additional revenue, it may provide an opportunity to diversify the council’s own-source revenue, and better match revenues with service demands.



Decrease discount and eligibility for rate exemptions and concessions

The majority of jurisdictions provide exemptions and concessions for a variety of rate payer categories. The exemptions and concessions, which do not always equitably reflect the ability of ratepayers to pay, can be very expensive for local government.

Pensioners can comprise a significant proportion of a council’s constituency, particularly in the context of an ageing population. Pensioners typically receive concessions for rates and water management service charges across all jurisdictions, as set by state/territory governments. In the NSW financial sustainability study, it was noted that NSW is one of the few jurisdictions that does not fully fund mandatory concessions.80 Pensioners, who can be asset rich in terms of property value but income poor, are required to make a lower contribution to council services and infrastructure. As noted in the NSW Inquiry, there could be some merit in further promotion and expansion of the system whereby the rates are instead deferred until the sale of the property or the settlement of the estate.

Furthermore, charitable and benevolent organisations are often exempt from rates. While this may be warranted for genuine charities, religious organisations and community services that operate on a non profit basis, many other organisations that qualify for the exemption tend to be quasi-commercial/private entities with significant asset and resource bases, such as private and independent schools, hospitals, retirement and aged care facilities. Moreover, the cost to councils for maintaining services and infrastructure for these organisations can be significant due to large land holdings and the traffic generated by their operations. State governments should review the scope of such rate-exempt categories to take into account the ability of these organisations to pay. Alternatively, local government should be fully compensated for such exemptions with the cost then being borne at the government level where the policy decision to provide such exemptions is made.

Rating basis & Rating Effort

Consideration should be given to changing the rating basis (ad valorem part) from UCV to a more cost reflective basis, eg mix of market value and assumed dwelling occupancy or improved capital value. This approach is arguably more appropriate due to the fact that council cost per dwelling varies more with potential occupancy (eg number of bedrooms), than UCV and if rate levels are to reflect capacity to pay, then market value is a better measure than UCV.

In the long term, any change would reallocate the rating pool between property owners over time. While this will not result in an immediate increase in the quantum of rates without an increase in rate levels, it could slightly improve the sustainability of councils by better linking revenue and cost drivers. However, there may be some challenge in pursuing this method where it has significantly increased rates for certain types of ratepayers or where it increases costs and administration of valuations.




A sizable proportion of councils have scope to increase their rating effort. Some commentators have observed that ‘unofficial rate pegging’ occurs across a number of councils where electoral demands mean that rises greater than CPI can be unusual and need strong justification. Hence, efforts to substantially increase rate revenue are likely to be significantly constrained by community expectations. Overall, there is significant merit in councils regularly benchmarking their degree of rate effort utilising the MAV approach of testing whether their rate levels relative to local income and rates elsewhere are high or low.

Phase-out and overhaul rate pegging in NSW

The policy of rate pegging in NSW limits the ability of some councils to broaden their own-source revenue and set rate revenue at a level that meets their operating requirements. The objectives of rate pegging are to contain the rate of cost growth and to provide incentives for productivity. Increasing improvements in the asset management and financial skills of councils provides strong grounds to remove rate pegging. As councils are responsible for their long-term sustainability and because their financial management skills can be evaluated in elections, they could arguably be trusted with the independence to autonomously set their required rate rise. The removal of rate pegging could be implemented through a progressive transition under which the cap is gradually increased to, say 10% per annum, and councils with robust asset management plans and strong financial management are able to determine their own rate increase.

The removal of rate pegging would give fuller local autonomy and responsibility to local governments to accurately estimate the rate rise required for their operations, based on robust AMPs. It would bring NSW into line with other jurisdictions and force more active and responsible financial management. Application of pegging is arguably a disincentive for council CFOs to complete AMPs and financial analysis to calculate the minimum necessary rate rise. It is likely that many councils set their annual financial budget based on a rise equal to the peg and scale back infrastructure renewal spending to balance the budget. However, the NSW Government is reluctant to remove rate pegging as they see value in the cost control and productivity signals provided by pegging, and are concerned that removing pegging could result in higher cost growth.

Other proponents of retaining pegging state that it has minimal impact on the less viable councils as such councils often have low rate levels and large rate rises will only provide a small increase in total revenue, and hence will not make substantial improvements to the viability of the council. For many smaller councils with limited rating bases this is true and highlights the need for additional funding through an increase in grants. Overall, other jurisdictions often put forward that the pegging in NSW is not too dissimilar to the electoral pressure they face to contain rate rises close to CPI. However, setting the annual rate rise is a key financial management task and there may be merit in progressively relieving councils from pegging when they have strong financial management capacity.



5.1.3 Set clear and appropriate priorities

Long-term service plan

An assessment and prioritisation of services provided by each individual council should be undertaken periodically. The increasing diversification of service provision in the local government sector, where it is undertaken within a planning environment focused on retaining financial sustainability can yield significant community benefits, and reflects the flexibility and freedom of councils to respond to community demands. However, some larger councils have stronger financial positions to fund the new services whilst other councils are stretching themselves beyond their financial capacity to deliver a growing number of services and infrastructure. The councils in a stretched financial position, who have diversified into non-traditional services with the subsequent additional costs, are often partly funding the new services by deferring maintenance and renewals on community infrastructure. Deferring renewal of community infrastructure to fund other services has benefits to users of these services but will create a renewals backlog.

During consultations, a number of state departments of local government echoed the comment that it is important for councils to effectively prioritise their services. This requires an robust assessment of:

• whether they are the most appropriate level of government to provide the service, ie councils can not solve national problems on their own and they need to exercise caution and establish long-term funding plans prior to ‘stepping in’ to provide non-core services

• whether there is an overlap with similar federal or state government provided services

• determination of the service and infrastructure priorities of the community through public consultations, and

• whether individual council delivery is the most cost effective and appropriate way for service delivery.

Each council needs to prioritise the services provided through the development of a long-term service plan. This long-term service plan is in addition to the total asset management plan that councils should also develop. The benefit will be to provide councils with a guide on the areas in which they should be focussing their resources, particularly in the face of external pressures for additional services both from lobby groups and other spheres of government. Councils should also be aware of the processes outlined in the Inter-Governmental Agreement Establishing Principles Guiding Inter-Governmental Relations on Local Government Matters (The IGA Agreement) when deciding on priorities. Community consultations throughout this process will be critical in:

• adequately reflecting the community’s key priorities

• managing community expectations and ensuring the community understands the tradeoffs between increasing services and increasing rates/charges

• increasing awareness of the vast number of council services and assets currently provided, and

• educating the community on the implications of not prioritising their service delivery.



Regional/state issues

A key finding of this study has been that some councils often spend a portion of their scarce resources in attempting to address service and infrastructure gaps that are actually regional, or state issues. Through consultations with key stakeholders, there were a number of examples of councils in this situation in areas such as health and medical services, attraction of skilled workers, emergency management plans for isolated communities, and decaying of major infrastructure such as drainage, harbour retention walls.

Both the state and local governments need to better recognise when such issues are beyond the capacity or responsibility of an individual council, and are actually issues of significance to a wider region or state. Clearly, such issues are better solved with resources and input from other regional councils, local government associations, and state and Australian levels of government. Where such issues are identified by a council, the state government should be more active in attempting to provide some resolution to the issue.

Secure long-term funding before establishing new services/infrastructure

Before accepting capital grants or seed funding to develop new infrastructure or services, councils need to better analyse the corresponding whole life costs, including recurrent operating costs, maintenance and renewals. Many councils have accepted capital grants to develop a service or build new infrastructure. A very common example is accepting grant funding for a swimming pool, with minimal consideration of funding for the ongoing operating costs that may be beyond a council’s financial capacity. Some councils can subsequently feel “trapped” into maintaining the services/assets because they fear a community backlash if the service is withdrawn. The asset’s operating costs are then in part funded by deferring renewals on community infrastructure, including the grant funded asset itself.

There is an example of a council in a remote part of Australia, with a population of about 400 people that has, with support from government capital grant funding, established a multi-million dollar sport and recreation centre, which opened in early 2005. To date the centre has averaged 30 admissions a day. While this will provide a focal point for community activity, the annual operating costs of the centre, including the staff and air-conditioning (which is high due to the extreme temperatures of the area), are often sizable and can push a council towards operating deficits.

This is a symptom of ineffective long term financial planning on behalf of both councils and other spheres of government that are providing such seed funding and grants. Where councils are going to seek and accept such grants, as part of their asset management strategy, they need to identify the whole-life costs of the assets and how these additional costs are going to be covered, either through a combination of additional grant funding, user charges or a special levy. The prioritisation by councils of which services and infrastructure their community actually needs is essential to improving their financial sustainability and avoiding this type of sustainability trap.



It is critical that the extent and scale of council facilities and services are efficiently matched to demand. Where usage is likely to be low, councils need to find more cost effective ways to provide its people with access to the respective services.

5.1.4 Broadening asset management capacity

Improve asset management and financial skills

One of the key financial constraints facing local government is the backlog in infrastructure maintenance and renewals. This backlog reflects a lack of funding but also may indicate a weakness in asset and broader financial management. While some councils are actively maintaining or developing an asset management system, often encouraged by particular initiatives by local government associations in their jurisdictions, a large number of mainly smaller councils currently have no asset management system, and no present intention or capacity to develop one. Training programs that focus on improving councillors understanding of financial statements and AMPs would be likely to have significant improvements in the overall financial management of councils.

There is a real need to develop the base of councils’ asset management and financial skills. When implementing the Step Program in Victoria (discussed in Text Box 12), MAV found that a large part of the task was to increase councils’ awareness of their asset management obligations and the need to accurately measure and address the consumption of their assets. Significant progress in achieving this objective could be made where councils actively engage in sharing achievements in good practice in order to enhance their skill bases.

Effective asset management policies develop a process to manage the whole life of an asset, from planning, purchase, operation, maintenance, and disposal at life end. Councils need to allocate sufficient funds each year for routine maintenance, backlog maintenance and renewal of infrastructure. The skills and awareness of councils can be improved in this regard through the use of tools and templates to assist in developing asset management policies, asset management strategies, asset management plans and operational plans. The implementation of good asset management practices will assist councils in extracting more value from their assets and property.

In achieving these objectives to improve the asset management and general financial management skills, assistance could be provided to councils through specially appointed consultants who would make regular site visits, identify priority deficiencies in asset management and provide training and improvement recommendations. This model used by the MAV Step Program has shown proven results, and recognises the difficulty facing councils in attracting suitably skilled staff in the current labour market conditions.



Text Box 21: Best practice principles for asset management The key principles of asset management for local government are:

1. Council makes informed decisions based on sound policy with knowledge of the confidence levels associated with the information provided

2. Long term community service needs have been identified

3. Council knows what it owns and is responsible for

4. Council knows the condition and performance of its assets

5. Council understands and responds to community expectations/priorities when setting levels of service

6. Council understands the risks involved in the assets they manage & have processes to manage the risk

7. Council knows the complete lifecycle costs of the service levels it is currently delivering

8. Council has AMP for all major classes of assets

9. Council has a long term financial plan that aligns with the requirements of AMP and addresses any funding gaps

10. Council has a whole of organisational approach to the integration of AMP

Source: MAV, Advanced Step Framework.

Develop total asset management plans and systems

In improving the financial capacity and asset management of councils it is essential that they develop total asset management plans using appropriate accounting practices. The plan will develop a long-term plan of infrastructure spending and funding, which should link in with their long-term service and financial plan. The asset management plan will need to cover for all assets:

• registration • valuation • depreciation

• condition assessment • planning • design

• acquisition • funding • maintenance

• operation • replacement • disposal

• whole-of-life cost analysis

For many councils with large infrastructure backlogs, greater understanding is needed of the funding required for the whole-of-life costs of the assets. This means the total cost to maintain any asset during the period of its expected life (excluding the initial cost of installation). The quantum of these asset costs will be determined by the asset standard determined by the council.

In order to minimise the whole of life asset costs it is important for councils to use the appropriate mix of the following renewals strategies:

• Right size: it is important that the selected asset base is of the right size to match the needs and priorities of the community. This concept fits in with the long-term asset management planning of councils.



• Just-in-time (JIT) renewal: based on the concept of completing regular condition assessments so that replacement occurs when asset close to life end rather than at a predetermined point based on accounting life. For example a footpath may have an accounting life of 30 years but its physical life may vary from 20 – 50 years. The benefit of this approach is renewal costs can be optimised with timing linked more to actual (rather than assumed) life end leading to cost savings over the life of the asset.

• Match asset scale to demand: assets can be maintained at a range of different qualities, from mint condition to a basic functional level. For the management of vast local government assets, it is important that each local government determines the scale of asset quality demanded by the community. Where it is determined that a moderate quality of asset is satisfactory councils may be able to further extend the value and life of the asset, hence minimising whole life costs. This will impact upon the required capital value and hence, the size of the renewals backlog.

It is evident that the requirement to revise their asset register, revalue assets and establish an assessment management system will be a challenge for many councils, which lack the resources and technical expertise. Therefore, it is essential that targeted funding is used to support councils in developing these systems. State and territory governments have an interest in improving the asset management of local government, as they have the ultimate responsibility for all (non-Commonwealth) public assets within their jurisdiction.

5.2 Implementing internal council reforms

The suggested internal reforms contained in section 5.1 are generally accepted in the sector as areas that would benefit from improvements in the policies, practices and skills of local government. Indeed, they have been highlighted as potential measures to drive sustainability improvements because they have been successfully employed to improve the financial position of many councils nationwide.

As discussed above, the application of these reform options will vary between individual councils, reflecting their individual finances and capabilities, legislative and regulatory environment, relationship with relevant state/territory government, and previous and current reform programs.

One of the key findings of this study is that there is strong merit in all spheres of government considering the implementation of specific programs to improve the financial sustainability of the internal practices of local government, with a particular focus on asset management skills and systems. Similar to the approach of the MAV Step Program and the Queensland SSS, such programs would provide individual assessment of the current level of asset management skills and systems, and provide intensive support in response to identified priority areas. Whilst it is recognised that the SSS and Step Program provide a sound platform to consider, there remains merit in each state evaluating its specific needs and then tailoring its own program to ensure maximum local engagement in whatever reform processes is pursued to improve sustainability.



In many cases state and territory governments are better placed to drive effective internal reforms across the local government sector, vis-à-vis reforms at an individual council level. In addition to facilitating reforms to improve asset and financial management skills, significant benefit could also be achieved through state/territory government involvement in:

• partnering with local councils and community organisations to expand community recreation facilities and programs

• better integration of local council and regional land use planning with catchment management initiatives, and

• driving improvements in land and water conditions via catchment action plans and strengthened incentive and compliance programs, and so on.

The overall success of councils implementing reforms to improve their internal practices would be maximised where targeted support and funding is provided. The best approach to provide such support needs to be determined by each jurisdiction. Providing local government with adequate assistance to implement robust and long-term improvements to their internal financial management is central to improving the long-term sustainability of the sector.

Text Box 22: Reform to improve AMP in New Zealand Regulatory requirement for AMPs in New Zealand

The Government was committed to modernising asset management practices in New Zealand. They subsequently introduced a mandatory requirement for local authority asset management. This has resulted in the following benefits:

• definition of and consultation of service levels

• a better understanding of demand and asset constraints

• the building of asset registers and a better understanding of asset life cycles, and

• a structured approach to funding asset maintenance, renewal and acquisition.

It was necessary for the NZ Government to provide additional funding of identified improvement programs, in addition to the need for increased human resources, in order to assist local government to comply with regulatory requirements for improved AMPs. Generally the larger metropolitan and regional authorities have managed to resource and fund their asset management practices better than smaller regional and rural authorities.



5.3 Funding reform options

Following the findings on the financial trends of local government in Australia, it is evident that reforms to the funding streams must be part of lifting the sustainability of the sector. Growing community expectations, increasing costs of services and pressure from the infrastructure backlog mean that local government will not be able to fix its problems solely through internal improvements within the current funding environment. There remains a need to increase the funding support to local government from both the Australian and state/territory governments. The current quantum of funding does not achieve the objectives of horizontal equity that is embodied in the FAGs Act, which is exacerbated by the inordinate level of VFI facing local government. This could be achieved through reforms to the current grants programs and through the development of new programs that address the current issues facing local government, particularly in the area of community infrastructure.

5.3.1 A whole new Australian Government funding model In evaluating the spectrum of potential funding reforms it is often useful to consider what approach would be undertaken if starting from a ‘clean slate’. Hence this would involve developing an entirely new funding program which would supersede existing programs (eg FAGS, R2R). This would provide the opportunity to develop a new system that more accurately reflects the present needs and challenges. A new funding approach might incorporate the following components:

• a funding component based on the size of the infrastructure backlog

• incentives for the use of measures to improve the efficiency of council operations, through regional service delivery, shared services, etc

• uniform and meaningful reporting on breakdown of capital spending, and

• removal of minimum grants to councils..

Overall, developing the ideal funding principles of a new local government system is relatively straightforward, but designing an effective funding model including a specific formula to reflect these objectives is decidedly more difficult. The other key challenges would be to achieve Pareto optimal outcomes (no council worse off) and to also achieve consensus from all three spheres of government on the new approach. While, the current approach may have some areas that merit further refinement, on the whole the current system is relatively effective and does not warrant a complete overhaul.



5.3.2 FAGs reforms The local government sector in Australia acknowledges the importance of FAGs to maintaining local government operations. For the past few years ALGA has lobbied for an increase in FAGs to 1% of total Australian Government taxation revenue (excluding GST), which would restore funding to levels achieved in the late 1990s. Their argument is based on the need to provide local government with financial certainty matching that of the other two spheres of government and to ensure local government’s financial resources keep pace with demand for service delivery and infrastructure provision. By linking Australian Government revenue transfers to local government to a fixed percentage of Commonwealth taxation, councils will gain access to a revenue stream that grows in line with the economy. While ALGA acknowledges the importance of other funding programs, such as R2R, in providing additional support to the sector, achieving FAGs funding as 1% of Australian Government revenue remains a medium term goal.

The current levels of funding arguably do not meet the horizontal equalisation principles under the FAGs Act, which aims to enable all councils to achieve the equitable levels of operational expenditure. However, the horizontal equalisation principle under the Act is compromised by the inclusion of the minimum grant principle for all councils and therefore exact horizontal equalisation is unlikely to be achieved. With some councils facing funding constraints, a proportion are diverting capital expenditure to meet operational needs, exacerbating the infrastructure backlog across the country. As local government is the custodian of a large proportion of Australia’s physical infrastructure, this is an issue of significant concern, not limited to the local government sector, which needs to be addressed on a national basis. There is a clear case for increasing the quantum of FAGs funding in order to support the sustainability of the local government sector. The following section discusses the available options to reform FAGs, and their relative merit in relation to effectiveness and ease of implementation.

Change FAGs escala ion method t

At present FAGs are escalated at the national level by CPI and population growth indexation. As discussed earlier in section 2.4.1 the intention of this approach is to maintain FAGs funding at a constant real rate per capita. As a result of this approach, local government has not shared in the substantial growth in federal taxes, which has been driven by the current resources boom. At the same time there have been growing expectations by the community of service delivery by all governments and the decision to allow local government to deliver a wider range of services under the move to general competence in all jurisdictions. As a consequence there is now a growing mismatch between service delivery responsibilities and revenue raising capacities, which reflects the vertical fiscal imbalance in the Australian system of governance.

Local government has repeatedly called for tax sharing arrangements that are supported by a growth tax to ensure that funding to local government grows at the same rate as Commonwealth taxes (and the same rate as community expectations of service delivery). If local government were provided with a growth tax the total pool of funding would better meet the horizontal equalisation objectives of the Act and issues associated with VFI. This would also recognise the important role of local government in the delivery of local infrastructure and its contribution to economic growth and the overall economic prosperity of the nation.



One reform option that would be relatively simple to implement would be to change the escalation rate of the FAGs. The following methods could replace the current mix of CPI and population indexation:

• set FAGs as a proportion of total Commonwealth tax

• set FAGs as a proportion of Commonwealth income tax, or

• escalate FAGs annually by a more realistic local government cost index.

The first two approaches arguably represents a better tax sharing arrangements to address the current VFI, providing local government with funding support based on a growth tax. Figure 3.1 shows the ALGA estimate of the higher proportion of funding that would be provided to local government in comparison to the current level of FAGs funding.

The second potential reform approach is to link funding increases to an increase in a more realistic local government cost index. As stated previously, local government costs have typically grown at about 2-3% above inflation, thus constantly eroding the value of the FAGs to local government. This option would provide better support to local government service delivery, putting less pressure on their capital renewals spending.

Reset FAGs quantum to 1990s levels as a percentage of tax revenue

This option suggests resetting the quantum of FAGs to 1990s levels of commonwealth tax revenue. In 1992-93 FAGs were 1.18% of total Commonwealth tax revenue, which has declined significantly to the present levels of 0.76%.

Pursuing such an approach would result in a substantial boost in the quantum of FAGs funding, which would increase to $2.5 billion in 2005-06, while also providing local government with a funding stream based on a growth tax. It would return FAGs to the level of importance it enjoyed as a source of local government revenue prior to the current growth period.

Top-up FAGs and distribute to councils in need

Another FAGs reform approach would be to provide a supplementary funding increase, which would not go into the general pool of funding but be distributed to councils most in need. Two potential approaches to estimate the broad quantum of the top-up could be a rise of:

• 10% from current FAGs funding levels, which would be approximately $160 million at 2006-07, or

• $171 million, representing the FAGs shortfall from not providing local government with both CPI and population index in 1997-98.

These two top-up options would result in similar outcomes.



This potential reform would address the issue of the declining value of FAGs as a proportion of Commonwealth tax revenue. The FAGS allocation approach sees 70% of the funding directed to councils most in need. This approach should aid progress towards greater horizontal equity and overall long-term sustainability of the sector. There may be some merit in linking the potential FAGs top-up funding to councils participating in programs to improve asset management planning and financial skills so as to encourage progress towards establishing more robust long term financial planning.

Progressively decrease minimum grants

Under the current Minimum Grants Principle of the FAGs distribution methodology, all councils receive at least 30% of their population share of the general purpose pool. Minimum grants were introduced in the 1976 Act and embody the funding certainty objective set by the Australian Government that ensures every council receives a share of the assistance.

Under these arrangements minimum grants councils receive more assistance than might be justified by their horizontal equalisation assessment, placing them in an above average financial position. Furthermore, minimum grants draw funding away from relatively disadvantaged councils that receive less funding than their horizontal equalisation assessment warrants. Consequently, this option suggests the progressive decrease of the minimum grant, possibly through a phased approach over a period of years may have merit.

The CGC review of the FAGs Act in 2001 considered the implications for achieving horizontal equalisation by increasing or decreasing the size of the minimum grants. It was found that reductions in the rate of minimum grants have only had a small effect on the grants of local governments that receive more than the minimum. At the time of the analysis, the reduction of minimum grants to 10% would increase the funding to non-minimum grant councils by 6%, while the complete removal of minimum grants would only increase the by a total of 9%.81 Hence, the CGC concluded that this relatively small increase in funding to non-minimum grants councils did not warrant a decrease in minimum grants, and maintained the importance of all councils receiving a minimum per capita grant.

Effectively there is a form of competition between councils for the fixed pool of FAGs funding. To discontinue minimum grants would penalise councils that may have worked hard to minimise their costs and increase their efficiency. Moreover, many minimum grants councils still have some viability issues that would be exacerbated if minimum grants where reduced or eliminated.

81 Commonwealth Grants Commission 2001, Review of the Operation of the Local Government (Financial Assistance) Act 1995, p. 22.



Other key limitations on this option include:

• the reaction of minimum grants councils, and associated political contention, at losing a long standing source of federal funding

• some minimum grants councils may still have significant long-term viability issues, and

• inconsistency with the Pareto principle, which stipulates that in any change all councils must be no worse off.

Furthermore, analysis by MAV has found no significant relationship between the per capita value of grants and councils’ viability and hence abolishing minimum grants may not necessarily improve sustainability.

On balance, there appears to be merit in progressively decreasing the minimum FAGs to provide more of the allocation to councils most in need. This could be implemented over five years in order to smooth the impact on minimum grants councils.

5.3.3 Infrastructure funding reforms As reported previously one of the issues facing the local government sector as a whole is the backlog in infrastructure renewals and replacement. While a lack of data makes it difficult to provide a definitive estimate of the size of this backlog, the available evidence clearly indicates that this is a significant, and worsening, problem for almost all types of councils. From the available information, it is estimated that the national infrastructure backlog is likely to be between $1.7 million and $3.3 million per council per annum.

In conjunction with reforms to improve the asset and financial management skills of councils, it is essential that existing infrastructure funding be maintained and further targeted funding is considered.

Refinement of R2R funding

The R2R funding from the Australian Government has proved to be a successful and popular means to address the backlog in road maintenance in Australia. As local government is responsible for 80% of the nation’s roads, R2R appropriately mobilises Australian Government funding to address this issue of national significance. The strong points of the R2R funding are the direct payment to councils, which avoids any transaction costs through state government handling and the transparent reporting arrangements of work completed with R2R funding, and hence the ability to measure the outcomes and achievements.

With an annual road maintenance underspend of $344 million per annum, (including R2R) there is merit in guaranteeing this stream of road funding in conjunction with a number of possible refinements to improve the operation of the program and obtain funding certainty for councils. Possible R2R refinements include:



• Focus R2R spending on maintenance: while only 5.2% of R2R funding over the life of the project is spent on new roads,82 there is some merit in ensuring that funding on new roads remains at this low level.

• Reallocate more towards rural/remote councils: the findings of this study have been consistent with the findings of other studies that councils in rural and remote areas have larger problems associated with asset management and infrastructure backlogs. In recognition of this trend, the initial formulation of a local roads funding assistance program was ‘rural roads to recovery’. While this was broadened to include all councils with road maintenance responsibilities in an effort to support all councils, there may be some merit in focusing R2R towards rural and remote councils. This approach would recognise the greater capacity of the typically larger regional and urban councils to access higher own-source revenue and to make stronger improvements from reforms to asset management and financial planning skills.

• Obtain longer term commitment and annual escalation: if the Australian Government committed to long-term provision of the R2R program to be escalated annually, councils development of medium to long-term asset management plans would benefit from greater confidence, accuracy and reliability. The current program funding is not escalated and so its real value is constantly being eroded. The funds are directed specifically to roads, and construction costs facing local government have increased on average by 6.1% per annum between 2000-01 and 2008-09. Ideally, the $308 million supplementary R2R funding that was provided in the 2006-07 budget would become a permanent base of the funding program. This supplement increased the total R2R funding to $1.53 billion or a 28% increase on the initial 2001 funding package. This larger base of R2R funding would then be escalated by a nominated index, such as the building and construction index, in order to maintain its value.

Community infrastructure renewal fund

Local government infrastructure can be categorised into three broad classes:

• roads – including bridges, footpaths, etc

• water/sewerage, and

• community – “social infrastructure” such as parks, reserves, town centres, libraries, health clinics, community halls, youth and recreation facilities, etc.

82 DOTARS 2006, Roads to Recovery Programme Annual Report 2004/2005, p.15.



The capital renewals spend and condition of each of these asset classes differs greatly. The current state of road and associated infrastructure has benefited from a targeted national funding program of R2R to redress the backlog. While, for the most part, the local government water and sewerage businesses are in a reasonable condition as a result of NCP reforms and pricing requirements. 83 However, the water and sewerage infrastructure in rapidly growing local government areas, such as south-east Qld and southern Tasmania, are notable exceptions.

The financial constraints facing local government, in addition to the focus on roads and water/sewerage infrastructure has arguably come at the cost of community infrastructure. Councils often have limited resources or capacity to address the growing backlog of community infrastructure. Some councils provide their communities with lists of infrastructure works that need to be completed but are not yet proceeding due to insufficient funds. For an example see Inverell Shire Council 2006-07 Management Plan Attachment 10.84

The viability of the sector would be significantly improved with a targeted Local Community Infrastructure Renewals Fund (LCIRF), in conjunction with improved asset management planning. Under the implementation of this approach FAGs and R2R funding would remain unchanged.

The LCIRF would support councils in the more timely funding of renewals work for over $12 billion in building assets covering a range of existing community infrastructure such as community centres, libraries, health clinics etc. The community infrastructure asset base is ageing with large parts established in the 1950s meaning it now requires renewals and upgrading. The fund could be distributed based on relative need using an approach similar to Roads to Recovery.

It is suggested that the size of LCIRF could be set so as to provide a similar level of renewals support as provided by R2R to roads (eg $200-$250 million per annum). Examples of how support from a LCIRF would be utilised to enhance local communities are listed in

83 National Competition Council 2005, Assessment of governments’ progress in implementing the National Competition Policy and related reforms, Melbourne, p.2.2.

84 http://www.inverell-online.com.au/dir205/invonline.nsf/aee96af964b30ea24a256b050025bc1c/42d24a4a65cde7f1ca25716a007ea9df/$FILE/MPlan%2006-07-iol%20version%201.pdf



Text Box 23.

LCIRF eligibility and requirements

The LCIRF would be distributed to all councils in order to provide assistance in renewing existing community related assets. Funding would not be provided for the development of new infrastructure, thus avoiding unnecessary spending on infrastructure that would then create the additional operating and maintenance costs. In order to monitor compliance with the requirement, and ensure transparent and measurable use of the funding, participating councils would be required to produce annual reports on how the funding was spent. Similar to R2R requirements, failure to provide adequate reports would result in the following year’s funding being withheld.

In order to avoid overburdening councils with additional reporting and compliance responsibilities, it is likely to be most efficient to incorporate this requirement into the current R2R reporting. Acknowledgement of funding in a manner similar to the R2R program would be expected.

Local Community Infrastructure Renewals Fund distribution method

There are a number of options to allocate LCIRF, such as:

• a distribution method similar to allocations under R2R

• the FAGs General Purpose distribution method

• through a new formula that targets councils with the highest need, or

• AusLink application approach.

Using the current R2R funding distribution approach would be the simplest and most transparent distribution method. This would distribute LCIRF funding based on an assumption that road infrastructure is a proxy for community infrastructure, in the absence of detailed information on community infrastructure. The development of a formula that targets councils with the greatest need may generate more horizontally equitable outcomes. However, the development of such a method may be difficult (unless LGGC are able to provide details of community infrastructure), and arguably the current funding distribution model, which has been subject to review and refinement, is the best available and most equitable distribution model.

The AusLink style application approach also has some issues. While merit based applications theoretically distribute funds based on relative needs of the applicants, this type of distribution model tends to see funding going to councils with a higher level of acumen and resources to develop robust applications. Overall, the specific distribution approach is perhaps best determined following further consultation with key stakeholders.

This type of funding stream has the possibility of being merged with R2R funding in the future. As the roads backlog is estimated to close in future years in some areas, there would be considerable merit in merging the two funding streams to provide councils with the flexibility to use the funding to renew a mix of both road and community infrastructure.



Source of Local Community Infrastruc ure Renewals Fund t

The LCIRF provides an alternative approach to reinstating the value of Australian Government funding to local government, and provides an opportunity to support and sustain local communities.

The development of a new infrastructure fund for local government could alternatively provide an opportunity for state and territory governments to increase their funding support, which has reportedly been decreasing as a proportion of total local government revenue as discussed in section 3.2.2. A potential approach would be for Australian Government funding of LCIRF to be matched dollar for dollar by state/territory funding.

While equal contribution to the LCIRF program between Australian and state/territory governments would be beneficial, it is widely acknowledged that most state and territory governments do not currently have the financial capacity for such investment. Moreover, gaining consensus on the design and implementation of funding programs that require equal buy-in between two levels of government is more challenging. Using a dollar for dollar approach may complicate the process and could impede the effectiveness of the program. Therefore, increasing state input is perhaps best focused at measures to improve the asset management base of councils, as discussed above in section 5.2.

Local Community Infrastructure Renewals Fund

The development of the LCIRF would generate a range of benefits for both the Australian Government and the local government sector, including:

• addressing the growing backlog in existing community infrastructure in order to support communities activity and life on a local scale

• leveraging off improvements to AMPs and increases the capacity of councils to effectively manage their asset base

• communities gaining more value and use of the existing infrastructure

• creating a new income stream to support the renewal of community infrastructure (and complement R2R funding support for roads renewals and the support from water user charges in funding water and sewerage renewal activity)

• enabling local government to lift the state of its entire asset base, to broaden the focus on asset renewals

• building on the success of R2R, and

• providing a significant boost to the long-term sustainability of the local government sector.



What could be achieved through improved funding of local government?

Improved funding for local councils, particularly for the renewal of community assets, would assist local communities by enabling councils to return important community infrastructure to acceptable levels of condition. In conjunction with improved financial and asset management practices, more appropriate funding levels for local government infrastructure and related services would help to ease the pressure of operating deficits. In addition, such extra funding would support the clearance of backlogs in renewals expenditure (identified by Access and MAV) and then also support more regular periodic maintenance to retain service levels.

Importantly, additional funding would assist local government to take full advantage of their ability to flexibly gauge and respond to the changing demands at a community level. With increasing demands for a broader scope and higher standard of community services and infrastructure, it is important that local government has the resources to ascertain the priorities of the community, and to subsequently inform and consult with the community on the trade-offs of council provided infrastructure and services.

Enabling a council to respond directly to the service and infrastructure demands of an informed community would see:

• stronger local communities through ensuring an adequate standard of key facilities for the ongoing provision of a range of significant social and recreational services

• provision of greater choice and consultation on council provided services and infrastructure would encourage more participation in community activities raising levels of inclusion and wellbeing. This would promote increased community cohesion and safety, particularly in rural areas

• implementation of local programs to meet and include the diverse needs of the community that support cultural diversity, access and equity, equal opportunity, involving minority groups

• sustainable environmental strategies for each community to improve local environmental outcomes

• enhanced business and community links with regional areas to promote regional equity and development

• further economic development and the generation of employment benefits through links with the business community

• Improved quality of life of local residents through the support and alignment of health and welfare agencies within the area, and

• support for local recreation, arts and culture and an appreciation of heritage in order to promote vibrant and active communities.

Some examples of how support from a LCIRF would be utilised to enhance local communities are listed in the Text Box below.




Text Box 23: Potential benefits from a LCIRF

How support from a LCIRF would be utilised to enhance local communities

If an LCIRF was established, it would quickly be drawn upon by individual councils to rectify a range of community infrastructure deficiencies and deliver a range of benefits to local communities. The LCIRF should have a focus on renewal/replacement of existing assets rather than supporting the development of new facilities. The ability to access a LCIRF should enable some councils to undertake more timely renewals to avoid developing backlogs. In some case it may see councils bring forward some renewal/replacement projects to reduce whole of life costs.

This study has consulted with a number of councillors and local government management to develop the list below of types of projects which could be completed with the support of a LCIRF:

i. renewal and refurbishment of community centres and public halls

ii. renewal of facilities which provide a base depot for home and community care activities

iii. renewal of childcare centres and kindergartens

iv. upgrading of senior citizens centres

v. renewal and refurbishment of theatres, galleries & museums

vi. enhancement of main streets and public squares

vii. upgrading of boat ramps, jetties and wharves

viii. upgrading of recreational facilities including swimming pools and playing fields

ix. Improvement of park equipment eg playgrounds, benches, BBQs

x. renewal of foreshore paths, seawalls, walking trails, board walks

xi. upgrading and major periodic maintenance of airports, aerodromes and air strips

xii. tourism information centres

xiii. libraries and information centres

xiv. refurbishment of kitchens in council facilities which provide Meals on Wheels

Whilst it is recommended that the LCIRF be limited to the renewal/replacement of existing assets rather than supporting the development of new facilities, there may be merit in funding some specific exceptions. For example, there may be merit in LCIRF supporting the establishment of new multi-purpose social service hub (providing childcare, maternal and child health, kindergarten etc) where such a hub replaces a series of older single purpose facilities requiring renewal.

It is recommended that the LCIRF is not suitable for supporting the renewal of some facilities or assets which are not directly utilised by the community (eg council offices) or where other grant funds/user charges already cover specific asset classes (eg local roads, sewer, water and stormwater).


5.4 Relative assessment of the reform options

There are a large range of options available to improve the long-term sustainability of councils with a focus on both the internal practices of councils and the funding programs to local government. Table 5.1 below summarise the relative merit of individual reform options, assessing the benefits, weakness and potential constraints to implementation.

Table 5.1: Summary assessment of reform options

Reform option Benefit Weaknesses Assessed merit

State funded program to support LGBs implement improvements to internal AMP and financial management practices.

• Provides targeted support to suit the needs of individual councils. Support can also be dollar matched by the local government to ensure commitment to reform.

• Provides an opportunity to make permanent improvements in the financial decision-making, asset management and skill base of councils.

• In conjunction with reforms to local government funding, has the potential to make significant improvements towards the long-term sustainability of councils.

• Requires the support and consensus of each state/territory government, which do not all have the financial capacity to support such a program.

• Inadequate training and/or funding support may not result in long-term improvements in the financial capacity of councils.

Strong merit

Change FAGs escalation method

• Provides opportunity for FAG increases to be linked to a growth tax, ie Commonwealth income tax.

• Address current vertical fiscal inequality.

• Would provide local government with a larger quantum of funding in order to improve sustainability which is linked to national economic prosperity.

• Limited response from Australian Government when suggested in the past due to:

o Cost to Australian Government;

o Would remove an important productivity incentive

Strong merit

Reset FAGs quantum to 1990s levels of proportion of total taxation revenue

• Provides local government with a significant boost in funding levels

• Address current vertical fiscal inequality.

• Would provide local government with a larger quantum of funding in order to improve sustainability which is linked to national economic prosperity.

• Substantial cost for the Australian Government

• Australian Government does not get strong visibility on outcomes achieved by FAGs which reduces the potential increase in funding.

Limited merit

Top-up FAGs by say 10% and distribute to councils in need

• Address current vertical fiscal inequality by increasing the total quantum of FAGs.

• Provides greater horizontal equity between councils, and hence improves the sustainability of councils.

• Application based distribution of funds would require councils to identify

• Potential to receive similar response from Australian Government as option to reset FAGs to 1990s levels.

• Some LGBs may argue that this approach rewards inefficient passive councils.

• Australian Government has had less visibility of FAGs

Some merit



Reform option Benefit Weaknesses Assessed merit

priority that require support. funding outcomes

Progressively decrease minimum FAGs grants over 5 years from 30% to 15% based on population

• Provides more funds for unsustainable councils, resulting in greater horizontal equity between councils, and hence improves the sustainability of councils.

• Progressive approach to removing minimum grants smooths the impact on minimum grants LGBs.

• Contrary to the objective of funding certainty under the FAGs Act.

• Would provide limited additional funding to non-minimum grant LGBs.

• Minimum grants LGBs would generally be unhappy if minimum grants were decreased or abolished.

• Some minimum grants LGBs still have long-term viability issues.

• Where the minimum grant was abolished it would contravene the Australian Government policy objective that all councils should receive at some portion of the funding pool.

• Some councils worse off, but 5 year transition limits impact.

Limited merit

Refinement of R2R funding

• Provide long-term certainty of funding for future to improve development of medium to long-term AMPs.

• Ensure councils focus on the maintenance of existing road networks as the backlog closes in some areas.

• Where R2R is reallocated more towards rural/remote will better achieve objectives of horizontal equity and long-term sustainability improvements.

• May reduce the flexibility of R2R funding which was one of the key strengths of councils.

• Arguably contradicts the original intention of R2R funding to be maintained until the backlog is cleared, rather than be an ongoing funding stream.

• Australian Government may be reluctant to commit to long-term funding of the program due to their preference for 3 – 5 year programs that are subject to close monitoring.

Some merit

Local Community Infrastructure Renewals Fund (LCIRF)

• Provides a means to address the growing community infrastructure backlog. Creates a 3rd income stream to cover renewals of community infrastructure.

• Provides more flexibility for renewals spending, hence maintaining the value of all classes within their asset base (in conjunction with R2R and commercial revenues form water/sewerage business, where relevant), and hence increase the overall sustainability.

• Builds on improvements to AMPs.

• Communities will benefit from upgrades to infrastructure which will support community activity and life.

• Will come at additional cost to the Australian Government.

• The Australian Government may in turn spark calls for more state/territory support, despite their relative lack of financial capacity to support such investment. Risk that the process could be frustrated.

Strong merit




m option Benefit Weaknesses Assessed merit

• Provides the potential flexibility to merge R2R and LCIRF when the most of the roads backlog has been closed.

• Builds on R2R success.

• Funding would be focused on renewals of existing assets to avoid increasing future total asset renewal costs.

New Australian Local Government Funding Model

• Enables the development of a fresh approach to funding local government that address present needs and issues.

• Design difficulties and challenges.

• Difficult to gain widespread consensus.

Limited merit.

Refor


5.5 Summary – Potential Options for Reform

In order to improve the financial performance and hence sustainability of local government, a number of reform options should be considered. These reform options can be separated into:

• internal reform options targeted at improving the effectiveness, efficiency and financial governance of councils, and

• potential reform options for local government funding from Australian and state/territory government

Overall, this section details approaches that can be used by a significant proportion of councils to further improve their effectiveness and efficiency. Three key themes emerged, which are:

• the need for councils to obtain adequate scale in their operations to reduce unit costs. This does not suggest a need for forced amalgamations. Better scale can be obtained through a variety of approaches (see Section 2.5) such as shared corporate services, regionally provided operational services, councils, outsourcing etc.

• the potential for a number of councils to expanding own-source revenue and improve rating effectiveness, and

• the gains which can be made where deep asset management and financial skills come together to develop robust AMPs and financial budgets/forecast.

This section also evaluated potential reform to intergovernmental transfers which may have merit in improving financial sustainability. The better performing options include:

• establishing a new Local Community Infrastructure Renewals Fund

• changing the escalation method and reducing the minimum grant size for FAGs

• extending the duration of the R2R program

• obtaining more state government assistance to fund, on a dollar matching basis with councils, reform programs like SSS to support council efficiency and asset management reforms

• establishing a program to develop national consistency/high quality local government financial and asset management data, and

• greater local government provision of Indigenous social housing.



6 Conclusions and recommendations

6.1 Conclusions

The current and long-term viability of local councils nationally and by council types The analysis within this report indicates that currently at a national level the local government sector has a substantial aggregate backlog of renewals expenditure. The exact size of this backlog is not currently known and to accurately estimate it requires completion of state-based sustainability studies for Tasmania, the NT, Victoria and Queensland.

PwC analysis of a sample of 100 councils indicates that:

• Approximately 30-40% of councils have an interest coverage ratio (EBIT/interest) of less than 3. The level of 3 generally represents a threshold where credit risk begins to be more significant and a large unexpected event with adverse cashflow implications can potentially place pressure on ability to meet interest payments.

• On average, councils have an operating surplus of 9% of total revenue. However, some 16% of councils have an operating deficit of over 10% of revenue. Such councils have a tendency to defer renewals expenditure, which creates a risk of developing maintenance backlogs.

• The average sustainability ratio (capex/depreciation) in this sample was 5.1 and only 8% of councils have a sustainability ratio (capex/depreciation) of less than 1. A ratio of less than 1 indicates that the capital being consumed in an accounting sense exceeds the capital being replaced into the asset base.

Hence the PwC results indicate that up to 10-30% of councils nationally may face sustainability challenges.

In relation to sustainability by council type, the PwC ratio analysis indicates that, of the 7 categories of council, rural remote and rural agriculture are the council types more likely to be experiencing viability problems, whilst a significant number of urban fringe councils are also facing challenges.

As a further interim estimate developed by extrapolating the Access Economics and MAV sustainability analysis of NSW, WA, SA and Victoria, under a mid case scenario:

• the potential aggregate backlog for all 700 Australian local councils across the country is approximately $13.6 billion (possible range of $11.5 billion to $16.1 billion)

• an annual sustainable funding gap of $1.1 billion (potential range of $0.9 billion to $1.24 billion), and

• the estimated funding gap per annum to cover the backlog and the annual underspend (which needs to be funded via savings or extra revenue/grants) is $2.0 billion (potential range of $1.8 billion to $2.3 billion).

Conclusions and recommendations 150


Overall, the Access Economics analysis indicates that across the three states evaluated to date, approximately 40% of councils are unsustainable and the PwC analysis indicates that between 10% and 30% of councils may experience financial sustainability challenges.

The key financial issues affecting the financial sustainability

Common financial issues typically facing councils with sustainability problems include:

• minimal (or negative) revenue growth

• cost growth that has typically exceeded revenue growth. Expenditures have been rising by an average of CPI +2-3% per annum. This cost growth is mainly due to award wage rises, stronger cost escalations in the maintenance and construction sectors as well as service diversification. The divergence between cost and revenue growth can lead to operating deficits that in turn are often partly funded by deferring some renewals expenditure

• increasing involvement in non-core service provision due to escalating community demands coupled with a related tendency by some councils to ‘step-in’ to provide a non-traditional service and some cost-shifting from other levels of government

• operating deficits creating a need to defer or underspend on renewal of infrastructure, particularly community infrastructure which is often repeated annually creating a backlog

• limited access to strong financial and asset management skills, which are critical to identifying sustainability problems, optimising renewals expenditure and improving revenue streams, and

• significant population growth (eg sea and tree change areas) means infrastructure is augmented to meet demand. However, over the longer term, once the transitionary impacts moderate, a larger scale population, coupled with a modern asset base should improve the prospects for a council to be financially sustainable.

Scope to improve the financial sustainability of local councils

As discussed in section 6.1.1, up to 40% of councils are potentially financially unsustainable. Hence there is a clear necessity coupled with reasonable opportunities for these councils to take strong action to improve their efficiency, and hence, their financial sustainability.

This report has identified a number of opportunities to significantly improve the financial sustainability of local councils.

These opportunities can be divided into two broad approaches:

• internal reforms largely controllable by individual councils to improve efficiency and effectiveness, and

• reforms to intergovernment funding to improve the sustainability.



The merit of reforming to intergovernment funding to improve the sustainability

The Access Economics analysis in this report indicates that up to 40% of councils are facing financials sustainability problems.

Rural remote and rural agricultural are the council types more likely to be experiencing viability problems whilst a significant number of urban fringe councils are also facing challenges. The narrow revenue bases and growing renewals backlogs in rural councils in particular, mean they are most likely to need some additional government support (as well as internal efficiency improvements) to achieve a financial turnaround and improve their sustainability.

This report has developed a series of options to reform intergovernment funding to improve the sustainability, particularly for rural and remote councils.

6.2 Recommendations

PwC has developed a series of recommendations based on a ‘twin track’ approach for improving financial sustainability being the pursuit of:

i) Internal reforms by some councils to improve their efficiency and effectiveness (recommendations a-d).

ii) Suggested changes to intergovernment funding for improved financial sustainability to primarily assist the types of councils with sustainability challenges (recommendations e-h).

Internal reforms required by some councils

A sizable proportion of councils, often the larger local governments, have made significant progress in reforming operations to improve efficiency. However, some councils still have scope to further improve their efficiency and effectiveness mainly by improving their scale, financial management and asset management. However, it is noted that a sizable proportion of councils are performing efficiently with only minimal scope for continual further improvement.

Recommendations to improve councils’ internal policy and practices are targeted at four key objectives:

Improving efficiency, effectiveness and scale

• Further realise the gains from greater economies of scale and reduce unit costs via approaches such as regional or shared service provision, outsourcing, use of state-wide purchasing agreements etc.

Expanding own-source revenue

• Work with state government to remove or relax legislative impediments and improve the capacity of local government to raise revenue from its own sources.



Set clear and appropriate priorities

• Establish a robust long-term service plan which defines what council will provide and how services will be undertaken.

• Exercise caution prior to stepping in to attempt to resolve regional, state or national issues without a sound funding plan.

• Secure long-term funding (not just capital grants) prior to new services and infrastructure.

Deepen asset management and financial capacity

• Work with other spheres of government to facilitate improved asset management and financial skills through government-funding programs (eg the Size, Shape and Sustainability Review in Queensland and the MAV Step Program), to lift the skills in all councils to a reasonable base level.

• Use total asset management plans and systems to better manage asset renewals and replacement, and integrate into broader long-term council objectives.

• Undertake more regular asset condition reporting for key infrastructure.

• Develop nationally consistent local government financial and asset management data. There is a need for a new national program to improve the consistency and quality of council data to enable more robust and accurate analysis and planning and to produce a uniform national approach to measuring viability and financial sustainability. Ideally this would be supported by the Australian Government.

Suggested reforms to inter-government transfers

PwC sees significant merit in some reforms to intergovernment transfers, but these need to be targeted to primarily assist the types of councils with sustainability challenges. The specific suggested reforms to intergovernment transfers are:

• Establish a new Local Community Infrastructure Renewals Fund (LCIRF): this fund would support councils in the more timely funding of renewals work across a range of community infrastructure assets including community centres, aged care facilities, libraries, health clinics, sport and recreation facilities. The fund could be distributed based on relative need use the R2R or FAGs distribution methods, or perhaps through a new or hybrid approach. The size of LCIRF could be set so as to provide a similar level of renewals support as provided by R2R, which is around $200-250 million per annum.

• Revise the escalation methodology for FAGS from a mix of population growth and CPI to new escalation formula tailored more to local government cost movements (eg a combination of the ABS Wage Cost Index and Construction Cost Index coupled with population growth).

• Make funding for the Roads to Recovery Program permanent: this program has delivered substantial benefits and there would be significant merit in extending its duration and further augmenting funding levels (including escalating the program size by the ABS Construction Cost Index).



• State governments to provide funding support to encourage the local council efficiency and asset management reforms: a significant proportion of councils have inadequate in-house skills to improve efficiency and to establish robust asset management and financial plans. There would be significant benefit in state governments providing partial funding to aid the development of tailored state-based reform programs. This program might be along the lines of the support provided by the Queensland Government ($25 million over five years) in the Size, Shape and Sustainability Program, and the Step Program developed by MAV.



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Municipal Association of Victoria 2005, Trends in Local Government Finance, October 2005.

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Waitaki Council Oamaru Blue Penguin Colony Management Plan, accessed at http://www.waitaki.govt.nz/NR/rdonlyres/4F5C1994-F65B-4A6E-9A5F-6A99DC4A1060/16987/wcp_vol2bluepenguin.pdf



Appendix A Terms of Reference

Project Outcomes

The purpose of the study is to develop a report which:

• assists ALGA, in collaboration with state and territory local government associations to develop a detailed plan to:

− enable councils to better meet their fiscal obligations as well as the growing demand for infrastructure and services; and

− provide a sound rationale and model for appropriate and targeted support to local government for consideration by other spheres of government

• assesses the current and long-term viability of the local government sector at the national, state and local level.

• Identifies the key financial issues affecting the financial sustainability of local government at each level

• Identifies the trends and/or differences between groups of councils based on specified characteristics using the Department of Transport and Regional Services (DoTARS) council categories

• Develops recommendations for improved financial sustainability including financial governance and potential sources of extra revenue

• Investigate the appropriateness of reform to intergovernmental transfers with a view to develop a new model for intergovernmental financial relations that will facilitate financial sustainability of local government.

Guidelines For The Development Of Project Outcomes

• The project should build on state based projects and work already undertaken and take account of the 2006 COAG reform agenda, House of Representatives Inquiry into Cost Shifting from State to Local Governments; the Commonwealth Grants Commission’s review of the Local Government (financial Assistance) Act and the proposed Productivity Commission study into local government revenues.

• PwC shall develop a data research plan to guide the collection of data and information at the commencement of the project.

• PwC research should help answer such questions as:

− What are the funding imbalances/gaps?

− Is local government raising revenue at a level it should be?

− Is local government providing services that the Australian Government requires?

− Is local government providing them efficiently?

Terms of Reference 157


The final report should included but not be limited to:

• definitions and key economic terms and concepts, including the a definition of financial sustainability

• discuss the context and history of Commonwealth/state/local government relations and funding, and not simply identify problems with local government

• identify how the Australian Government can assist local government and what local government can do for the Australian Government

• identify key barriers that effect local government performance

• provide recommendations or propose solutions to fiscal issues for the whole sector as well as, if appropriate, different categories of councils

• The report should provide a guide on strategic communications issues.

Terms of Reference 158


Appendix B Definition of Financial Sustainability Indicators

Operating surplus (deficit) – total operating revenue less total operating expenses

Operating surplus (deficit) is total operating revenue less total operating expenses. It is an indicator of a council’s ability to meet its operating expenses with its operating revenue stream. The analysis uses a benchmark operating deficit of 10% of total revenue as councils with deficits larger than this are spending beyond its revenue base and potentially at risk of sustainability problems.

Interest coverage – EBIT divided by borrowing costs

For the purposes of our analysis, EBIT is the operating surplus (deficit) to which we have added back borrowing costs; and borrowing costs are the reported borrowing costs or, in the absence of such costs being reported, the imputed borrowing costs. Accordingly, interest coverage measures a council’s ability to pay interest on its outstanding debt. We have used an interest coverage benchmark of 3: this is a generally adopted benchmark used to delineate a financially sustainable level of borrowing. An interest coverage value below 3 indicates that a council may have problems in repaying debt and associated interest.

Sustainability ratio (capex/depreciation) –capital expenditure divided by depreciation.

The sustainability ratio is a measure of the net increase or decrease in a council’s asset base. We have used a benchmark value of 1 for the sustainability ratio. Where a council records a value higher than 1 this indicates that its overall asset base is increasing, or being replenished, at a rate equal to, or higher than, the council’s consumption of assets. Conversely, a value less than 1 indicates a declining asset base, and may indicate financial unsustainability.

Current ratio – current assets divided by current liabilities

It is an indication of a council’s ability to meet short-term debt obligations. We have used a benchmark value of 1 for the current ratio. A council that records a value less than 1 may face potential problems in meeting short-term obligations.

Rates coverage –total rates revenue as a proportion of total expenses

It indicates a council’s ability to cover its costs through its own tax revenue. Based on the observed revenue streams of the councils sampled, a rates coverage result of 40% or higher may indicate a sustainable return from rates ie with rates providing an adequate revenue stream to meet incurred costs. Conversely, a result of less than 40% may indicate that rates cover an inadequate proportion of expenses, and that this could indicate potential financial unsustainability.

Definition of Financial Sustainability Indicators 159

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