An assessment of rate-pegging in New South Wales local government

Rate-pegging has been in place in NSW for more than thirty years with broad support from all sides of politics. However, in late 2008 the NSW Government commissioned IPART to report on the adequacy of rate-pegging. IPART produced a Draft Report and then a Final Report, which has not yet been released by the NSW Government. Nevertheless, the NSW Government has made some changes to local government finance by way of capping developer charges, allowing IPART to make annual rate-pegging determinations, and enabling IPART to consider special variations in rate-pegging. Against this background, this paper considers the principles and practice of rate-pegging in NSW, the rationale for rate-pegging and counter-arguments on its desirability, as well as its economic effects on NSW local government finance relative to other Australian local government jurisdictions.


INTRODUCTION
New South Wales (NSW) is alone amongst Australian states and territories in employing a policy of rate-pegging designed to limit increases in property taxes that can be levied by local councils in that state l .This longstanding policy has been an ongoing source of bitter controversy in NSW itself and the cause of much bemusement in the broader Australasian local government community (Dollery, Crase and Johnson, 2006).While NSW had employed a form of rate-pegging between 1901 and 1952, which was discontinued due to its ' impracticality' (NSW Local Government and Shires Association , 2008, p.16), the genesis of the modern method of rate-pegging may be found in the 1976 state election campaign.period rose by 75 per cent and the rate of inflation was 56 per cent (Johnson, 2001, p.5).
While the mechanics of the rate-pegging process have been adjusted periodically, the basic principle has remained unchanged to the present day.However, on 27 October 2008, NSW Premier Nathan Rees announced to the annual New South Wales Local Government Association conference that his government was giving serious thought to removing rate pegging.It thus seems an opportune time to consider the nature of rate-pegging, the arguments surrounding its desirability, and its economic effects on NSW local government.This forms the aim of the present submission.
This submission is divided into four main parts.Section 2 provides a synoptic description of the principles and practice of rate-pegging.Section 3 considers the rationale for rate-pegging and various arguments on this question.Section 4 seeks to evaluate the impact of rate-pegging on trends in rates in NSW relative to other Australian state local government jurisdictions.The submission ends with some brief concluding remarks in section 5. per dollar so that total revenue does not increase by more than the percentage increase stipulated by the Minister (Department of Local Government, 2007).

PRINCIPLES AND PRACTICE OF NSW RATE-PEGGING
A simple example will serve to illustrate the operation of rate-pegging.Suppose the value of total rateable land in a given local council area is equal to $250 million in year 1.If the rate is 10 cents in the dollar for all categories of property, then income would be equal to $25 million.If total land value increased to $300 million, due to a 'growth factor', such as land being sold to the public, then notional 'general income' from land would be $30 million beginning year 2. But if the Minister set a ratepegging limit at 2.5 percent for year 2, then the maximum permissible level of income in year 2 would be $30,750,000 on a land base of$300 million.Assuming a general revaluation of land occurred at the beginning of the fiscal year 2, which raised total land value to $500 million in the local government area, with 'general income' limited to $30,750,000, then the council would have to set its rate at 6.15 cents in the dollar to accrue the permitted maximum of $30,750,000 from a land base of$500 million.In other words, owing to a land valuation increase stemming from a 'growth factor' and a 'general valuation', the rate had to fall from 10 cents in the dollar for all categories of property to only 6.15 cents in the dollar (Department of Local Government, 2007, p.75).
In terms of the Local Government Act 1993, 'general income' does not include various rates and charges, including rates on water supply and sewerage, annual charges for waste management and stormwater management services.Other sources of revenue are also not covered under' general income' , such as user charges, interest, grants, developer contributions, donations, and other forms of revenue, like fines and business activities.
Under Section 208(2), Section 508A and Section 548(3) (a) and (b) of the Local Governrnent Act 1993, councils can apply to the Minister for Local Government for permission to increase their general income by more than the rate-peg limit.This is called a special variation application.A council must include details of its intention to apply for a special variation in its draft management plan and consider any submissions received from the public.If approved, the Minister will specify the percentage by which the council may increase its general income as well as the period oftime over which rates may exceed the rate-peg.
Grounds for an exemption under a special variation are spelt out in the Local Government Act 1993.For instance, under Section 208(2), the council in question must demonstrate that it meets one of three conditions: (a) additional funding is required for a project which has regional significance or a regional economic benefit; (b) additional funding is necessary to finance new or improved local government services or facilities specified in the council's management plan; and ( c) additional funding is required to meet increases in state government charges (Department of Local Government, 2007).
With respect to the process involved in rate-pegging, the annual rate-peg percentage is typically set in March each year.In principle, 'this percentage reflects the projected annual increase in costs that a typical council delivering services at levels comparable to the previous year is likely to incur this year' (IPART, 2008, pA8).Following this announcement, individual councils can submit requests to the Minister for Local Government for a special variation to the rate-peg percentage.These submissions are considered by the Minister, who makes a final determination on each submission by June.This enables affected local councils to strike their rates to take effect by 1 July of each financial year.
Given the proposition that the rate-peg percentage is supposed to reflect the 'projected annual increase in costs' faced by councils, it is interesting to compare the rate-peg with the Consumer Price Index (CPI) over the past ten years.Source: Amended Table 7.1 (!PART, 200S, p.4S).  1 reflects the impact of the introduction of the GST, making it an unusual year.A second feature of the data contained in Table I is that, by way of a general trend, the rate cap and the CP1 track each other closely.Finally, it should be stressed that the CPI is a measure of the rate of increase of a given basket of goods and services, weighted to reflect Australian consumption patterns, rather than a measure of production costs.

RATIONALE FOR RATE-PEGGING
The economic rationale for rate-pegging derives from the normative prescriptions of standard economic theory: Local government enjoys a monopoly in the provision of essential local services.Accordingly, like all other monopoly providers, it will provide these services at excessive prices and/or inefficiently and thus warrants regulation by higher tiers of government to ensure efficient and equitable outcomes (Bailey, 1999).However, it is important to immediately add the caveat that regulation must be carefully applied since bad regulation can make matters worse than no regulation at all (Hillman, 2005 A final and much more convincing public choice argument for rate-pegging has been advanced by Dollery, Crase and Byrnes (2006).Invoking Wittman's (1995)  (a) There are substantial differences in relative significance of different sources of revenue in the different states (Worthington and Dollery, 2001;2002).For example,   Report, 2006, p.207).
Similar insightful data have been assembled in the Allan Report (2006, Table 9.4, p.207), reproduced here in Tab le I, which reinforce the information in Figure 2.This proposition is worth considering in more detail.Table 2 provides information on the number of special variation applications submitted over the past seven years and the number of these applications that were approved by the Minister.Source: IPART (2008, p.56) andAllan Report (2006, p.50).
The information contained in Table 2 seems to vindicate the observations made by the NSW Local Government and Shires Association (2008), considered earlier in this paper, regarding the broader ' dampening ' effects of rate-pegging.Thus in the 2008/09 special variation round, only 26 councils applied -a mere 17 per cent of all councilsof which 24 were successful.Put differently, while only a small proportion of councils actually apply under the special variation system, a very high faction of these applications prove successful, ranging from a low of7l per cent in the 2005/06 round to a high of I 00 per cent in 2003/04.In other words, even though the great majority of special variation applications are approved by the Minister, comparatively few local authorities apply; a fact which thus must be ascribed to factors other than the prospects of success of an application.
A final aspect of special variations is their net effects on aggregate increases in rates in NSW local government through time.Figure 2 compares the long-term trends in the rate-peg with actual outcomes after special variations had been approved.1995•96 1996•97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 I--+-NSW Pegged Rates ----NSW Actual Rates I SOllree: Amended Figure 9.7, Allan Report (2006, Figure 9.7, p.208)The data contained in Figure 2 demonstrate that the impact of special variations on actual outcomes has little effect; the observed final growth of rates diverges minimally from the rate-pegged trend line.The Allan Report (2006, p.207) drew the same general conclusion; 'additional revenue allowed' as a consequence of the special variation system has 'not been large as a proportion of the total increase in the rate peg limit'.

CONCLUDING REMARKS
We have seen that the case for rate-pegging seems to hinge only on three convincing• arguments.In the first place, as we have demonstrated in this paper, rate-pegging has achieved its basic objective of slowing increases in NSW council rates over time relative to other Australian jurisdictions (Allan Report, 2006).Secondly, a prima facie case exists which suggests that the constraints imposed on council revenue by ratepegging may have enhanced the administrative efficiency of NSW councils and reduced their overheads, at least in comparison with the NSW state government departments (Allan Report, 2006).Finally, rate-pegging has enjoyed ongoing and strong public support (IRIS Research, 2005), which appears to demonstrate the operation of an efficient 'political market' in NSW (Dollery, erase and Byrnes (2006) in the Wittman (1995)  apply to all NSW councils, which would accurately reflect the real costs impinging on local councils much more precisely than the CPI used at present.Tier 2 would replace the current special variation system with a method that took the circumstances of individual councils into account and allow councils to make their own variations above Tier 1 levels up to some stipulated maximum.
The Allan Report (2006, p.210) also presented a 'compromise' proposal to revise the rate-pegging system.The Report argued that 'the view of this Inquiry is that the peg should be made less discretionary (i.e.not subject to Ministerial fiat), be based on explicit criteria (e.g.local government unit costs), and be made more transparent (i.e. be published in full),.Moreover, 'any variations to the peg with respect to a particular council should be more fully disclosed and explained in terms of rational criteria that are applied consistently across all councils and not subject to capricious change'.
At a more general level, in its Revenue Framework/or Local Government, IPART (2008, pp.63/65) presented five alternative regulatory frameworks that could replace the current rate-pegging system.While a detailed evaluation of these options falls outside the scope of this paper, it is nonetheless worth briefly outlining these possibilities.Option 1 would retain existing rate-pegging arrangements, but publish the economic basis for the peg, modify the special variations process, and leave all other charges unregulated.Option 2 would develop a more' disaggregated form of rate-pegging' using specific pegs for specific categories of council.Option 3 would 'reduce the scope of rate-pegging to cover only local government revenue needed to fund operating expenditure', thereby excluding capital expenditure and all other charges unregulated.Option 4 would retain rate-pegging but exempt individual councils, provided they could demonstrate financial prudence and operational efficiency in various stipulated ways.Finally, Option 5 would remove mandatory ratepegging and simultaneously 'enhance accountability to the local community' using several criteria and the threat of a 'default rate cap'.
A detailed analysis of the characteristics of these five options has been conducted by the NSW Treasury (2008).It has also suggested several additional feasible approaches to NSW council rates regulation.Amongst all these alternative regulatory methods, the NSW Treasury (2008, p.27) argued that the objectives of the current NSW ratepegging regime could best be achieved at the least cost by retaining the existing ratepegging system, but with 'improved criteria'.
Under the Local Government (Rating) Further Amendment Bill, an interim type of rate-pegging was re-introduced by the victorious Wran Labor Government in 1977 and further refined into its contemporary form in 1978.The timing ofthe introduction of rate-pegging legi slati on into the NSW Parliament shou ld be seen against the historical backdrop of economic developments in NSW in the 1970s; over the period 1973 to 1976, rates had increased on average by 188 per cent whereas average weekly earnings over the same • Director of the UNE Centre for Local Government, School of Business, Econom ics and Public Policy, University of New England, Armidale, NSW 2351.Telephone: 61 26773250; Fax: 61 267733596; Emai l: bdollery@une.edu.auI The Northern Territory wi ll join NSW in imposing rate-pegging for a transitional three-year period beginning 2008 wh ile extensive structural reform is put in place (Productivity Comm ission, 2008, p.97).

Figure 1 :
Figure 1: Annual Rate Peg Percentage and Change in CPI, 1998/99 to 2008/09 Difficulties (a) and (b) are compounded by the fact that large disparities in the capacities of individual local councils to raise rate revenues also exist within given state jurisdictions, which hasbeen vividly illustrated in the Productivity Commission's (2008) Assessing Local Government Revenue Raising Capacity, especially Table3.1 in this Report.While this is probably mostly attributable to the socio-economic characteristics of different local government areas, particularly local disposable incomes and their impact on the ability of householders to pay rates, numerous other influences are obviously at play, such as 'differences between urban, rural and remote councils, in population, rating base and the ability or willingness of councils to levy user charges'(DOTARS, 2007, p.l2).With these caveats in mind, we now seek to determine the impact of rate-pegging in NSW local government in the larger Australian local government context.Figure I illustrates trends in local government rate revenue per capita by state and territory jurisdiction over the period \998/99 to 2005/06, expressed in constant 1998/99 dollars.

to set rates in NSW, which also operate in other Australian local govemmentjurisdictions.
ordinary rate each year on all rateable land within its jurisdiction.By contrast, a local council can exercise discretion on whether or not to levy a special rate under Section 495 of the Act.Special rates are aimed at the finance of particular projects, such as specified local infrastructure, and must be applied to all ratepayers if It terms of the Local Government Act 1993, NSW local authorities have six main sources of revenue: rates, charges, fees, grants, borrowings, and investments.With respect to income from property, under Section 493 of the Local Government Act 1993 local councils calculate and distribute rates among four defined categories of rateable properties in their respective local jurisdictions; farmland, residential, mining and business.Section 492 of the Act makes provision for two types of rates; ordinary rates and special rates.Section 494 of the: Act stipulates that every council must strike and levy an on the land value of the property; on a combination of the land value ofthe property and a fixed amount per property; and entirely on the land value, but subject to a minimum amount.Land value in turn is periodically determined by the Land and Property Information Division of the NSW Department of Lands (Department of Local Government, 2007).Part 2 of Chapter 15 of the Local Government Act 1993 allows the relevant Ministerto impose limits inter alia on a council's 'general income,2.With respect to the mechanics of rate-pegging, the NSW government sets.aceiling on the total amount of income that each council can raise from its rates and charges on land.This limit is termed the 'rate-peg percentage' and it is prescribed prior to each fiscal year by the Minister for Local Government.As a consequence of rate pegging, a given council's overall rates revenue cannot increase by more than the percentage increase approved by the Minister.Indeed, even if land values in a local government area rise in aggregate, local councils may have to reduce or otherwise adjust the amounts levied 2 In addition to rate-pegging, other budgetary arid legislative constraints operate on the ability of local councils These include the land and property valuation methods stipulated by state governments, constraints on the ability of local authorities to impose differential rates on different categories of ratepayer, exemptions made for various classes of ratepayers (

sometimes offset by reciprocal tax arrangements),
local government sphere due to the fact that local councils possess the legal authority to tax; a monopoly power missing in both the private sector and in most other public utilities.Finally, in the special case of local council revenue regulation through rate-pegging, the regulatory agency faces additional problems since it is not regulating the prices of particular local services but rather the 'tax-price' of a whole genre of local public goods and services that are mostly unpriced.Australian local government jurisdictions has taken place away from 'services to property' towards 'services to people', including NSW.Much the same objection can NSW Treasury, 2008)is general proposition is recognised in the NSW debate over rate-pegging (see, for example,NSW Treasury, 2008).With respect to economic efficiency, optimal regulation should seek to secure allocative efficiency, where the mix oflocal services provided must coincide with local community preferences, and productive efficiency, where local services must be produced in the most cost effective manner.In addition, regulation should also try to ensure that equity objectives are met.For example, essential local services should be provided to poor households by local councils at affordable prices.The effective application of regulation is difficult in all spheres of economic activity, including the operation of the local government sector (80S, 1994).Moreover, regulation is further complicated in the (b) Rate-pegging assists in controlling 'cross-subsidisation' and imposes restrictions on the 'provision of non-core services and infrastructure that might prove unsustainable to ratepayers';(c) Rate-pegging 'manages the risk of poor governance in the local government sector'; and (d) Rate-pegging' limits the ability of councils to divert funds from essential infrastructure to other projects as well as expenditure on 'marginal services that are better provided by the private sector.Some of these arguments are less than convincing.For example, it is not at all obvious that rate-pegging can have any positive influence on the supply of essential local services under argument (a); indeed it seems more likely to curtail their supply by restricting funding.Similarly, in terms of (b), it hard to appreciate why •rate-pegging will dampen cross-subsidisation.Quite the opposite may occur if fees and charges are increased to counteract the impact of rate-pegging.Along analogous lines, argument (b) does not meet with empirical reality regarding 'non-core' local services.For instance,Dollery, Wall is and Allan (2006)have demonstrated that an ongoing shift in all 'reasonableness of all applications is scrutinised' which may 'enhance councils' accountability'.But this argument is partly undermined by that fact that only a small proportion of NSW councils -only 26 councils in 2008/09(IPART, 2008, Table 7.3,   p.56)-actually apply for special variation.Two further implied arguments for rate-pegging were put forward in the Independent Inquiry into the Financial Sustainability of NSW Local Government (Allan Report)(2006).Firstly, rate-pegging had worked well, compared with other Australian local government jurisdictions, if its primary aim was to constrain rises in council rates; an

Table 1 : Percentage Rate Increases by State Jurisdiction, 1995/96 to 2003/04
It is evident from Table2that that percentage increase in rates was substantially lower than in the other states; indeed, it amounted to less than half of the rate rises experienced in Western Australia and Victoria.From this and other data, the Allan

Table 2
sense.Secondly, the existence of rate-pegging has partly absolved local councils of full responsibility for their own financial affairs, with numerous deleterious consequences, not least a lack oflong-term planning.Finally, rate-pegging has undermined the democratic bedrocks of 'local voice' and 'local choice' in local government and thereby reduced local autonomy.Despite the announcement by NSW Premier Rees that his government is considering the abolition of rate-pegging, its continuing popularity seems to indicate that, at best, efforts will be made to improve the operation of rate-pegging and thereby at least ameliorate some of its harmful effects.If rate-pegging is indeed to be retained in NSW local government, over the years there has been no shortage of suggestions on how to improve its operation.For example, a Rate Pegging Taskforce, established by the NSW Local Government and Shires Association in 2001, called for a 'compromise' two-tiered rate-pegging system(Centennial Consultancy, 2004).Tier I would employ an annually determined index of local government costs, which would