National Financial
Sustainability Study of Local
Government
Commissioned by the Australian
Local Government Association
November 2006Disclaimer
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: scott.lennon@au.pwc.com 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
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
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
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
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.
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
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.
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 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 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.
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 $2.16 billion. Based on the results for NSW, WA, SA and Victoria, the jurisdiction analysis results also suggest that approximately 35% of councils are currently unsustainable.
• High case: where we apply the NSW, Victoria and WA average result per council to 259 councils in Tasmania and the NT.
In assessing the types of councils which are more viable, whilst there will always be numerous exceptions, the councils with stronger financial positions are generally those with reasonable scale in operations and population (more often, larger urban or regional councils). Such councils typically have stronger rates income and economic bases with more sophisticated asset management and financial governance systems. The less financially viable councils tend to be smaller (often rural, remote or small metropolitan), usually with constrained own-source revenue streams and a lack of economies of scale compounded by weaknesses in financial and asset management capabilities. However, there is also a proportion of larger councils with viability problems arising due to a range of factors. These include:
• significant expansion into new services
• a suppression of rates rises to improve voter appeal, and
2 In summary, the Access Economics methodology measures the annual infrastructure funding gap as the
difference between the required annual spend on renewals as indicated by annual depreciation expense and the amount actually spent.
• some elements of ineffective cost management whereby the level of expenditure controls and budgeting processes to manage cost growth may not have been adequate.
Table E.2: Infrastructure backlog estimate, extrapolated from Access Economics and MAV results
Access Economics & MAV Financial Sustainability Summary Results
Backlog in infrastructure renewals ($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) Other 35%
38% 19%
Sales of Sales of goods Current grants
Current
goods and and services and subsidies
grants and
services 28% 9%
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
• 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.
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:
• enable councils to better meet their fiscal obligations as well as the growing demands 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.
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.
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
• 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.
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.
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 km
2
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
• 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.
• 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.
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 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.
• 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
