ASSESSING THE FINANCIAL PROJECTIONS
Paper prepared for Land Solutions Ltd for submission to the Auckland Council
Keywords: Governance;
Summary Conclusions and Recommendations
S1: Were I an Auckland councillor or a citizen of Auckland I would be reluctant to agree to the financial components of the Draft Plan.
S2: The Draft Plan is misleading for the size of the borrowing to fund current activities is not transparent because some sources of capital funding are treated as current revenue. This can be readily addressed.
S3: It would make it clear that the Draft Plan proposes considerable borrowing for current consumption which occurs throughout the entire ten years.
S4: The Draft Plan is based on optimistic assumptions about the future of the economy and the willingness of central government to fund Auckland activities, with little attention to the real possibility that actual outcomes will be less favourable than the assumptions.
S5: There appears to be no flexibility to meet contingencies.
S6: Despite the optimistic assumptions, the projected debt path of the Draft Plan is high. Given the uncertainties and the favourable assumptions there is a possibility that the Council will face a major financial crisis, even before the decade is over, when lenders are no longer willing to roll-over existing debt nor advance new loans.
S7: This report suggests an alternative interpretation of the fiscal projections in the Draft Plan. They show there is a structural financial deficiency which generates a need for further sources of revenue (and so not relying as much on borrowing or on central government subventions) if major reductions in current spending and capital investment are to be avoided.
S8: In particular the report recommends urgent attention be given to
– markedly increasing and widening transport levies;
– introducing a region-wide tax, such as a sales tax.
S9: The report is dismissive of derivatives, asset sales and private public partnerships being able to make much difference to the financial situation over the entire decade of a plan (although it allows there may be other reasons for utilising them).
S10: While the report encourages refining user charges, it doubts that they can be raised or extended sufficiently to cover the gap.
S11: The financial component of the Draft Plan should only be adopted if its structural imbalance is presented more clearly and there is a commitment to seek alternative forms of financing or – if alternatives prove impossible – to cut back projected expenditures.
1. Introduction
1.0.1 My name is Brian Henry Easton. I am an economist, social statistician and public policy analyst. I hold a D.Sc in economics from the University of Canterbury, have other formal qualifications in economics, mathematics and statistics, and hold research positions in five New Zealand universities, including being an Adjunct Professor at the Institute of Public Policy in the Auckland University of Technology. I work as an independent scholar and consultant. I have considerable experience in the areas which I am about to address, some of which will be mentioned in the course of this submission. A fuller curriculum vitae is available on request.
1.02 I have been commissioned by Land Solutions Ltd to give an assessment of the financial aspects of the Draft Long-Term Plan 2012-2022 of the Auckland Council from the perspective of economics and public policy.
(1.0.3 While I have no expertise as an accountant, I have over the years, as a consequence of both my general work as an economist and because of various contractual projects, worked with, and become very fluent dealing with, the Public Accounts as prepared by the New Zealand Treasury. While accepting the Auditor General’s opinion that the Auckland City Draft Plan accounts (which is the focus of this report) meet the requirements of the Local Government Act 2002, in my opinion they are more difficult to follow than the Public Accounts.)
1.1 The Treasury Long Term Fiscal Projection
1.1.1 Before addressing the particularities of the Draft Plan some general issues need to be covered. The New Zealand Treasury is required by statute to prepare a Long Term Fiscal Projection at regular intervals. It is currently going through that exercise with an expected publication date in 2013, following the technical work and public consultation this year (2012). It is to be regretted that the Auckland Council has not had those Treasury deliberations available to it. There has been so much financial turmoil in the last five years that, in my opinion, the earlier 2006 Treasury projection cannot be used as an alternative base.
1.1.2 Instead the Council has instead consulted BERL, a group of respected economic consultants. I have not seen their report.
1.1.3 I must mention that I am one of the consultants which the Treasury has approached to assist them with their Long Term Fiscal Projection. However my involvement in the work relevant to the Auckland Council Plan has yet to be undertaken. Therefore nothing in this report reflects the Treasury projections or understandings, although I am using the same analytical skills.
1.2 The Ten Year Economic Outlook
1.2.1 In the last few years the world economy has entered a different phase from the long boom which ended in about 2008. In particular the rich Western economies have been a period of slow growth or stagnation. No one is certain how long ‘The Long Recession’ will be. It is already much longer than a conventional business cycle. A not irresponsible view is that it may last another five years, but any forecast of the beginning of a strong upturn is subject to a wide margin of error.
1.2.2 The analysis is complicated because many developing economies including those in East Asia are still expanding strongly. Since they are a major export destination for New Zealand their stimulus to the economy has partly offset the depressing effect of the rich western economies’ stagnation.
1.2.3 Even so, New Zealand seems also to be in a long stagnation. While there is a tendency to assume that rich capitalist economies always grow, in a paper I gave to to the Treasury in July 2011 (and to the Australia and Pacific Economic and Business History Conference in February 2012) I pointed out that since 1860 (the historically quantifiable period) there have been five long stagnations in New Zealand. They cover about a third of the time. We may be in a sixth. Five Great Stagnations, http://www.eastonbh.ac.nz/?p=1515.
1.2.4 The implication is that we should be very cautious about assuming strong economic growth in the decade to 2022, especially over the next five years. The Draft Plan assumes an average growth in Auckland’s Regional Domestic Product of 2.88% p.a. over the ten year period, or 1.4% p.a. on a labour force productivity basis. (Volume Three, p.84) I have not seen the underlying papers which are the source of these projections, but they broadly correspond to trends before 2007.
1.2.5 The Draft Plan describes development growth assumptions (of population, dwellings and labour force) having ‘significant’ uncertainty, and the economic growth ones as having ‘moderate’ uncertainty. In my opinion the economic growth assumptions are more uncertain than the development growth ones; their downside risk is greater and the financial forecasts are less robust to this assumption.
1.2.6 It is useful to record here that the Draft Plan seems to be premised upon a growth of the nominal Auckland economy of about 6.5% p.a. over the decade, consisting of the aforesaid (real) volume growth rate of 2.9% p.a. and an inflation rate of 3.5% p.a. (Vol 3, p.87).
1.2.7 I have not contested the inflation assumption. In regard to real production and expenditure and the prudential ratios with which the report provides, long term forecasts are typically almost neutral to the inflation rate (on the assumption that real – not nominal – interest is correct).
1.3 Auckland in the New Zealand Economy
1.3.1 I was on the Prime Minister’ s Growth and Innovation Advisory Board which, in the middle of the last decade, was one of the drivers for the current transformation of Auckland. There are many factors which contribute to a policy as substantial as this one. Here is my interpretation of the economic ones.
1.3.2 Because much economic growth in the world occurs in large vibrant urban centres driven by the effects of the economies of agglomeration (in which local interactions reduce overall production costs), it was recognised that in order to reap the benefits of agglomeration it was necessary to accelerate and improve the development of New Zealand’s largest urban area, Auckland. Without that, key opportunities, industries and jobs would relocate in Sydney and Melbourne to detriment of the whole of New Zealand.
1.3.3 It was also observed that Auckland’s governance structures had been inhibiting that development and that much of its infrastructure was inadequate. This is the background for the governance reforms which have led to the Auckland Council and for the substantial investment in recent years by central government in Auckland’s infrastructure (especially the transport network).
1.3.4 There has been an implication of this strategy which may not be fully appreciated. Essentially the government is putting a lot of effort into Auckland – in effect subsidising Auckland above the rest of the country – because it expects there to be a return on its investment for all New Zealanders. Auckland cannot expect those exceptional subsidies to continue indefinitely. Instead at some stage the city economy is expected to ‘take-off’ and contribute to the national economy, rather than needing proportionally more subsidies than the rest of the country.
1.3.5 I have not formed an opinion when the take-off point occurs, but I would be astonished if it were after 2022. That means that Auckland has to expect some time during the plan decade that the exceptional central government spending will be wound back and that the city will have to be more financially self-sufficient.
1.3.6 This is offset by a second effect. Arguably all urban centres – and not just Auckland – suffer from a weakness in their funding base because of their over-dependence on property rates. This becomes a demand for central government funding which has greater powers of raising current revenue via its tax base. This point not particular to Auckland but to all urban centres (although it may be more acute in Auckland because it is the largest urban area). The consequence is a structural financial deficit and the need for an alternative sources of funding.
2. The Financial Strategy [1]
2.1 The Operating Funding Deficit Strategy
2.1.1 The financial strategy in the Auckland Council’s Draft Plan reflects the amalgamation of the past decisions and practices of the legacy councils which preceded it. In particular they were not fully funding their current spending, but borrowing to cover the gap with revenue. This was obscured by using some of the provision for depreciation to fill the gap. The economist’s term for this practice is ‘consuming some of its own capital’. The consequence is that there has to be borrowing to fund some of the replacement capital which has been depreciated.
2.1.2 The Draft Plan is explicit about this, stating:
Auckland Council’s starting position is not a balanced budget, primarily because the legacy councils did not fully fund their depreciation expense. The financial strategy proposes a move to fully funding depreciation expenses over the next 13 (sic) years. (Volume One, p.29) [2]
2.1.3 While one accepts that the transition to unified authority requires time that is, in my opinion, no reason to treat the consumption of capital in this way. The amalgamation offers the opportunity for a fresh start, and that should include the attribution of all the depreciation to a source for funding capital investment. (A similar issue may apply to the development contributions charged to current spending, to offset financial costs.)
2.1.4 To do this would result in the financial accounts showing a much larger operating funding deficit. According to the Draft Plan the Auckland Council is going to borrow to support its current spending – more than it admits – (just as the legacy councils did).
2.1.5 This peculiar treatment of depreciation and the, in effect, larger operating deficit will be evident enough to accountants, credit-rating agencies and lenders despite the obscurity in the accounts. Those likely to be misled by the appearance of the accounts as they are currently set out are the people of Auckland and their elected representatives.
2.1.6 The approach means that the financial accounts look more satisfactory than they are. Currently they imply that the Council plans to over-spend each year, perhaps by an accumulated deficit of about $740m over the decade, or around a dollar a week per Aucklander. In addition some $1417m of the provision for depreciation is not used for capital funding. The two together add to$2157m, which may give a better picture of the amount of net borrowing over the decade for non-investment purposes.[3]
2.1.7 Aucklanders are entitled to know that there is substantial borrowing for current spending (and to take some comfort that the planned operating deficit is on a downward track). Unless they know this they cannot understand the substantial financial challenges their council faces.
2.1.8 The point here is not to challenge the strategy of unification over a long transition period. What is important is that the accounts should be transparent about the consequences of a prolonged transition. One of the most important issues is that the Auckland Council proposes to borrow a substantial amount over a long period to facilitate the transition; that is not immediately evident from the accounts.
2.2 The Borrowing Strategy
2.2.1 The Draft Plan states that :
The council proposes to set limits on its borrowing to maintain debt at a sustainable level and provide flexibility to deal with shocks. While debt increases substantially over the next ten years, it is still at a prudent level in comparison to our income and can be managed within our limits on rates and debt. Council considers this increase in debt to be appropriate on the basis that it is primarily driven by investment in new assets and the benefit of the expenditure is spread over time, thereby promoting intergenerational equity. (Volume One, p.29)
2.2.2 The statement is evaluated in the next section. For the record the Prospective Prudential Financial Ratios are as follows (with the projected ratios in 2012 in brackets):
Net debt as a percentage of total revenue: less that 275% (219%)
Net Interest to total revenue: less than 15% (13.8%)
Net interest as a percentage of annual
rates incomes less than 25% (22.8%)
(Volume Three, p.35)
2.2.3 Note that if the accounts excluded depreciation (and the development) contributions the first projected ratio is 225% (rather than 219%) and the second would have been 14.1%, so both remain projected to be within the limits the Draft Plan sets for them.
2.2.4 There is a small but fundamental correction necessary to the overview. It states ‘Council group debt … is expected to increase steadily to reach a peak of $12.5 billion in 2021/22.’ (Volume One, p.37) It seems very unlikely that the debt reaches a peak in 2021/22. All the indications are that it can be expected to continue rise after that date.
2.2.5 The Draft Plan explains that it is raising the net debt as a percentage of total revenue ratio for the following reason:
The previous limit within the liability management policy limiting net debt as a percentage of total revenue to less than 175% was consistent with the financial projections in the previous Long–term plan. Given the new financial projections in this plan, it is necessary to reassess the appropriateness of this debt limit ratio. While the other debt ratios require no amendment, it is necessary to increase this ratio to reflect the additional investment within the region funded by debt. (Volume Three, p.244)
2.2.6. The explanation seems to be that since the Draft Plan cannot keep to the existing ceiling (it proposes crossing it in ) the ceiling is raised. The possibility that the existing ceiling was an indication of the infeasibility of the borrowing proposals is not considered.
2.2.7 any the upper limit needs to be accompanied by a long term target level, just as the New Zealand government sets a comparable upper limit but it also sets a lower level (which is about half the ceiling) which it aims for in the longer term. The Auckland Council Draft Plan has no long term target. Without one the ceiling becomes the target with the likelihood for the actual level to drift up to it and breach it.
2.2.7. One might have hoped instead to see the expected debt path to move towards a realistic ceiling and then turn down after, say, after five years and move towards the target level (probably below 100%) reaching it by the end of the plan decade (2022) or a little after.
3 The Debt Projections
3.0.1 Recent experiences of some countries following the Global Financial Crisis confirm what has been long known: the debt path is critical to the viability of any financial plan.
3.0.2 The Prospective Statement of Financial Position shows a substantial rise in the net level of debt from about $2.93b in 2012 to $8.43b in 2022, an almost trebling. It represents an average increase of 11.1 percent p.a.
3.0.3 That rate may be compared with the assumed nominal rate of growth of the Auckland economy of about 6.5 percent p.a., so the Council debt is projected to grow at about 4.4 percent p.a. faster, a rate which would double net debt to regional GDP ratio in 16 years or so. This is longer than the forecasting period, but warns that the Council may be committed to a large increase in its relative debt.
3.0.4 Whatever the citizens of Auckland may think about this rise (and part is matched against desired assets, although some borrowing is for current spending) the critical issue is what the lenders of the debt think. A detailed analysis would be speculative but we have guidance from their behaviour before and after the Global Financial Crisis.
3.0.5 In summary, we might expect at some stage the lenders may well become cautious – even anxious – about continuing to roll-over and extend loans to the Council at the rates environed in the Draft Plan. This issue is implicitly recognised in the discussion of the credit rating assumption which states that ‘the council has assumed that its credit rating will fall one notch from its current rating of AA to a revised rating of AA- in 2012’. (Volume Three, p.63)
3.0.6 The Treasury Management Policy adds an objective to the liability management policy for Council to maintain a minimum credit rating of ‘A+’”
The council’s credit rating from Standard and Poors rating agency is currently “AA”. The credit rating is currently on Credit Watch negative. It is appropriate to include a minimum credit rating objective so that any future decision making with regard to liability management will consider the impact on council’s credit rating. A credit rating is an assessment of the ability of an organisation to meet interest and principle payments on borrowings in a timely manner. Typically, a lower credit rating will lead to a borrower paying a higher interest rate on that borrowing. (Volume Three, p.244)
3.07 It makes no attempt to consider whether the objective is feasible in the light of the heavy borrowing proposals of the Draft Plan. It does suggests there is a moderate level of uncertainty of it maintaining its current AA- rating. (Volume Three, p.63) I would judge the uncertainty higher, not only because of the heavy borrowing discussed in this report, but because there is a low-to-moderate possibility that the national credit rating could be downgraded and other New Zealand institutions’ credit rating would follow. (The New Zealand government is very aware of this possibility and is working to minimise it.)
3.0.8 The debt to revenue ratio rises to above double the total revenue level in 2017, and continues above that level. It is projected to be 219.4% in 2022, and while it is slightly higher in 2020 (237.1%) there is no significant indication that it will fall back to a realistic medium term level shortly after.
3.0.9 Moreover given an unexpected adverse event or that the assumptions under-pinning the projections prove too optimistic the actual debt level could exceed the stated limit after 2017. Lenders may then be unwilling to advance further funds, or require a considerably higher interest rate. At which point the Council may face a financial crisis. Such an outcome is not certain, but there is a not insignificant possibility of this happening.
3.0.10 Lenders will be aware that if Auckland Council’s debt appears to be getting out of control there will be few of its assets which can be sold (i.e. privatised) to repay debt. Unlike a corporation, the vast majority of assets of a local authority are ‘non-performing’ in the financial sense of not producing a flow of revenue. Of course they contribute to the well-being of Auckland citizens who pay local authority rates in order to fund the assets they value and service the debt they generate. Ultimately then, the vast majority of the borrowings are secured by the revenue from the local authority rates.
3.1 Interest Rate Assumptions
3.1.1 The Draft Plan reports that ‘[n]et interest as a percentage of annual rate income rises from 11.9% in 2010 to 22.8%’, although it peaks at 24.0% in 2020 (quite close to the recommended upper limit of 25 percent). It is reasonable to assume that there will be some anxiety by lenders from this path (moreso as they will add in the capital revenue items treated as current revenue). There may also be less enthusiasm from ratepayers when they realise that almost a quarter of their rates are eventually planned to service debt.
3.1.2 On the other hand, rates revenue is projected to rise at 5.2% p.a., slightly lower than the growth of the region’s production (6.5% p.a.). This will give some comfort to lenders since they might assume that if things go wrong the level of rates could be further increased. This is not to argue that rates should rise faster, but to point out that the capacity to further raise them mitigates the risk of lender resistance (and possibly a debt crisis).
3.1.3 The average interest rate on the net debt is 5.7% p.a. in 2012, and is projected to rise to 6.2 % p.a. in 2022, or by half a percentage point (50 basis points). These projections are based upon bench mark assumptions of 6.04% p.a. in the 2013 year to 6.12% in the 2022 year, a smaller increase. (Volume Three, p.87-88) I take it the difference between the assumed and revealed rates reflects the effects of changes in the structure of the financial borrowings (as well as that new borrowing will be more expensive than past levels).
3.1.4 One could be more pessimistic. Real interest rates are at historic lows, reflecting the subdued state of the world economy. If the economy returns to a normal expansion – the implication of the economic growth rate assumption for Auckland – one would expect interest rates to return to historic levels. In mid-2007, just before the New Zealand economy entered its current stagnation (and about the time the US economy entered its one), interest yields on in the secondary market for government bonds were typically in excess of 7% p.a. (This was on a lower expectation of inflation than the 3.5% p.a. assumed in the Council Draft Plan.)
3.1.5 The Draft Plan states that ‘[t]he council’s treasury group has mitigated these risks with a prudent hedging programme.’ (Volume Three, p.87, see also Vol One, p.38). It is unlikely that any treasury group can, over a long period, reduce annual interest rates by 1 percentage point.
3.1.6 There is little room in the financial projections for contingencies (there appears to be no provision in the Draft Plan, although the New Zealand government fiscal statements includes some). If a event with a major negative financial impact were to occur there will be little room to respond other than by breaching the debt and interest rate ceilings which the Draft Plan sets.
3.1.7 In conclusion, the projected level of borrowings is high, and the cost of borrowing is probably underestimated. In my judgement the debt path is a more risky undertaking that the Draft Plan represents it.
4 The Funding of Capital Investment
4.0.1 The Draft Plan projects that over the ten years to there will a total capital expenditure (including watertightness claims) of $20.71b. (Volume Two, p.157) Some $0.468b of the funding comes from asset sales and $7.45b comes from ‘funded depreciation and operating surplus’. The remainder, which is the spending on net new capital, amounts to $12.79b. Of this $3.07b (24%) is projected to come from capital subsidies, $1.71b (13%) from development contributions, and the remainder $8.01b (63%) from borrowing.[4] Assessing each source of funding in turn.
4.1 Capital Subsidies
4.1.1 Capital Subsidies are contributions by central government to council works. In 2012 they amounted to $176m. They are projected to rise to $503m in 2015 and then decline in the following years to $177m in 2022, averaging $307m a year. Thus the Draft Plan depends upon an even greater central government annual contribution than the current level . As far as is known there is no agreement by Central Government that it will contribute at this level.
4.1.2 It seems unlikely it will, for at least two reasons. The first is the central government finances are currently under rigorous expenditure control, with the objective of attaining a fiscal surplus by 2015, the year when the Draft Plan makes the biggest demand upon it. Second, as already discussed, it seems likely that at some point the special treatment of Auckland will be wound back, so that any demand by the Auckland Council will be magnified by giving a similar treatment to the rest of the country. (This would have the effect of tripling the cost to central government of any capital subsidy to Auckland since it would be obliged to fund the other two-thirds of the economy at comparable levels.)
4.1.3 The likelihood, then, seems to be that unless the Council can make a greater contribution to capital works from its operating surplus, or can find new sources of funding, some of the works projected in the Draft Plan may not proceed as scheduled.
4.1.4 This assessment says nothing about the merits of the proposed capital works program; the reservations are whether it will be able to rely on capital grants from central government to the extent which is assumed.
4.2 Development Contributions
4.2.1 Development contributions are projected as a steadily increasing source of revenue. The sort of time profile the Draft Plan assumes is a reasonable approach given the contributions’ potential volatility. What is important is the extent to which capital spending can be altered if the contributions move markedly off trend. If there is a downswing in development spending can capital works be held over, since the Council probably does not want to, nor have the capacity to, borrow in addition to the current projections?
4.2.2 There is no need to apologise for drawing attention to the volatility problem. The Irish economy treated its revenue from such development activity as a current income. One of the current difficulties it faces is that when development reversed this revenue stream stopped, following the Global Financial Crisis, it faced a fiscal crisis (in addition to its banking crisis). New Zealand accounting practices would not permit such a financial mistake, but the problem of volatility of the revenue remains.
4.3 Borrowing
4.3.1 The issue of overall Council borrowing was covered earlier. An alternative way of presenting the data based on the cash flow projections.
4.3.2 In 2012 borrowings exceed the repayment of borrowings by $619 million. Five years into the 10 year period of the Draft Plan, new borrowings exceed repayments by $808 million. By the end of the period, repayments have increased significantly and new borrowings are only $429 million higher than repayments. The conclusion is that the Auckland Council is projected to be borrowing heavily throughout the period.
4.3.3 The report has already concluded that the borrowing track seems to be near the top of or above what is prudent, and that it relies on a willingness of lenders to roll over existing debt and provide new debt which may not continue. The implication is that if other sources of capital funding revenue prove weaker than projected, there is little capacity to borrow more to maintain the capital expenditure plans.
5. The Risks the Financial Projections Present
5.0.1 The financial projections are subject to four caveats.
5.0.2 The first is about the macroeconomic context. While it is nigh impossible to get the forecast right, the concern here is that in the case of growth (especially in the first years of the projection period) and interest rates the assumptions are optimistic. The downside is more likely than the upside with the consequence that there is a substantial risk that the financial outcomes will be worse than projected.
5.0.3 The second is that the capital funding budget is optimistic (even unrealistic) as to the amount of capital subsidies the central government is likely to advance.
5.0.4 Third, the borrowing program is heavy and may well be at the upper limit of what lenders will advance. It is both close to the limit judged to be prudent, and there is no evidence of restraint after 2012 with a possibility that the borrowing requirement will exceed perhaps as early as a few years into the Draft Plan if some sorts of adverse events occur. Lenders may well be especially cautious given that they are being asked to finance current spending and not just capital spending.
5.0.5 Given the three caveats, the fourth becomes a large one. There are no contingency provisions and, except for delaying capital spending, there seems little flexibility if outcomes prove worse than projected. (Presumably, though, the promise to restrain rate rises could be abandoned, although this might well be unacceptable to ratepayers.)
5.0.6 In summary, the Draft Plan makes a number of assumptions which may seem overly optimistic. If outcomes are less favourable, the Auckland Council may face a major financial crisis towards the end of the plan period, or shortly after.
6. An Alternative Approach to the Financial Implications of the Draft Plan
6.0.1 An alternative interpretation of the financial projections is that they show that the Auckland Council faces a major structural problem in its finances. It does not have the financial resources to pursue the objectives that it has identified in its Draft Long-term Plan. That is the significance of financial projections which depend heavily – too heavily – on outside funding from the central government and lenders.
6.0.2 Given the structural imbalance, the Council might consider scaling back its ambition. Before taking that course it would want to consider the possibility of other funding options. There are four options that need to be quickly dismissed.
6.0.3 The Council should be prudent in the use of derivatives, using them to neutralise risks rather that address the structural imbalance. Otherwise it risks a major financial crisis as have some local authorities (e.g. Orange County) and businesses (e.g. Barings).
6.0.4 A program of privatisation of assets does not address the structural problem. There may be good reasons for some privatisation (e.g. assets surplus to requirements or which command a higher price in the private sector), but in financial terms the sale of an asset reduces borrowing requirements in the year of sale, but reduces revenue in subsequent years – the one normally offsetting the other over the long term. Thus they do not have much impact on any long term structural problem. (A good example of the failure of a privatisation program was that of the late 1980s which promised to reduce the central government’s debt but which still left the structural imbalance which was dealt with by severe expenditure cuts in the early 1990s.)
6.0.5 Similarly public-private-partnerships do not address the structural problem either. Again there may be other good reasons for them but, as in the case of privatisation, they simply change the revenue and spending flows, reducing outlays in one year and increasing them in others, without affecting the long-term structural problem.
(6.0.6 PPPs may seem a seductive means of funding new capital developments. They may be effective in particular circumstances, but the British experience is very relevant. Often they were used to keep capital commitments off the balance sheet while committing the government to a funding flow in the future, thus appearing elsewhere (and later) in the accounts, illustrating the principle that PPPs shift flows but do not resolve structural problems. What was unfortunate was that the British government often found itself taking all the downside risk when the financial projections for an individual PPP proved wrong; ultimately many proved a very expensive source of funding. The classic New Zealand example was the Major Energy Projects (Think Big) of the late 1970s and early 1980s, which were PPPs before the term was used. Again the government took almost all the downside risk, to an eventual considerable cost to the taxpayer.)
6.0.7 Raising the dividend requirements from Council owned enterprises is not really an option, in that the Council should have set its targets on the basis of prudent management and feasibility anyway.
6.0.8 There are three relevant option already mentioned:
6.0.9 It may be necessary to delay or abandon some proposed capital projects.
6.0.10 The Council may raise the level of rates (abandoning the promise made in the Draft Plan to restrain them). Local authority rates are not a particularly effective tax for they hardly reflect ability to pay. The main justification for them is there are hardly any alternatives for local body funding. Even so, the logic of the current financial projections is that rates will have to be raised faster than promised and there will have to be spending cuts, unless an alternative source of revenue can be identified.
6.0.11 The council may also raise activity and user charges. It is assumed that they are already set at a fair, realistic and economic rational level.
6.0.12 Given the overall pressures the above list of options if implemented is almost certainly insufficient to fund the spending ambitions without high of levels borrowing. One is driven to considering alternative sources of revenue.
6.0.12 The Draft Plan properly raises the possibility of various direct transport levies such as road tolls. (Volume Three, p.86) They are attractive because the revenue implicitly offsets some of the interest charges which are generated from the roading capital works and may also be treated as contributing to the maintenance of the road system.
6.0.13 Typically such levies cannot be designed to fall exactly fairly on individual road users, but their incidence is fairer than charging the interest and other road costs to the public at large through rates (or to future generations through borrowing).
6.0.14 Moreover, well-designed levies can contribute to more efficient use of the transport network by discouraging low value uses or encouraging switching to times and routes where there is more capacity. They may even reduce the demand for some capital works.
6.0.14 Based on the structural problems in the Draft Plan there is an urgent need for consideration and implementation of a more extensive range of road user levies at as early a time as is feasible.
6.0.15 There is always a need to seek further user charges, although these should not compromise the fairness or efficiency of the service delivery.
6.0.16 However, while it is difficult to be certain from the provided financial accounts it seems likely that even were road charges extended there is a need to find a further source of region-wide funding as an alternative to higher rates. Among the options would be a sales tax or a surcharge on GST.
6.0.17 A central government is always jealous of the use of its power to tax, and would be reluctant to agree to the introduction of a region-wide tax (which would require a statute). There are two general points to offset this.
6.0.18 First, as already argued, there is some risk that the borrowing program currently envisioned in the Draft Plan will lead to a financial crisis, the resolution of which will certainly involve the central government and probably involve substantial central government financial subventions. Better to act now to prevent one than wait to act after the crisis when involvement will be more expensive.
6.0.19 A natural reaction from central government will be to scale back the Draft Plan’s proposed spending and investment plans. If the Council is confident that is what the people of Auckland want and are willing to pay for then the Council should resist unreasonable scale-backs, emphasising it is responding to the wishes of a democracy.
6.0.20 The second critical point is that the Government of New Zealand has established the Auckland Council. It must give it the tools to enable to pursue its mandate.
6.0.21 So the Auckland Council should give urgent attention to the imposition of a region-wide tax to be implemented early in the second half of the decade of the Draft Plan.
6.022 If alternative sources of revenue cannot be found, the indications are that spending and investment plans as set out in the Draft Plan will have to be substantially scaled down.
Notes
[1] The financial year of the Auckland Council ends in June. Unless there is an indication to the contrary all plan years referred to in the text are June ended years.
[2] Footnote 15 on page 158 of Volume Two adds that only a proportion of the depreciation is to be a source of capital funding. The proportion is to rise from 67% in 2012 to 90% in 2022.
[3] If it were decided that the development contributions are not really a current revenue item either, a further $164m would be added to the operating funding deficit.
[4] Correcting this by transferring the depreciation which is treated as current revenue to capital funding, the figures become
$8.87m comes from ‘funded depreciation and operating surplus’. The remainder, which is the spending on net new capital, amounts to $11.47b Of this $3.07b (27%) is projected to come from capital subsidies, $1.71b (15%) from development contributions, and the remainder $6.69b (58%) from borrowing.
Lenders would normally look benignly on a funding proposal in which more resources are being sourced from the borrowers’ own funds. However in this case, they are also being asked to fund current spending.