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).

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.