Published in The National Business Review (Auckland), 17 April 2014

Imagine a business that could charge anyone who just happened to pass by its shop window. Does that sound like a business that would strive to become better, more customer-friendly and more service-oriented?

Probably not. For why would it even try to do better when its revenue was that easy to generate?

Now think about the way in which local government is funded. The vast bulk of councils’ budgets comes from property taxes (that is, rates). They are payable by property owners and, while these owners may well be mobile themselves, their land and houses are certainly not. Even if the owners decide to sell their houses, there will still be someone liable for the rates – the new owners.

Comparing the way councils are funded with charging window-shoppers, it is clear councils have an even more secure revenue generator. At least you could avoid the window-shopping bill by walking at a safe distance from the shop.

The effect property taxes have on local government is, however, similar. Where revenue is easily attainable without much effort, service providers (which is what councils are) will become lazy.

So it is most welcome Local Government New Zealand last week announced an inquiry into local government finance. Its goal: To find other options to the over-reliance on property taxation for councils.

In its media release, LGNZ cites a number of reasons for why it thinks a new approach is necessary. For regions suffering from ageing and population decline, it fears “lower household incomes and reduced ability to cope with property tax increases and under-utilised infrastructure, with smaller and poorer populations over which to spread the cost of maintenance and renewal.”

At the other extreme, councils experiencing population growth are also struggling to make it work, according to LGNZ. Thanks to their infrastructure needs, “required growth in funding requirements will place severe pressure on a pure property tax model.”

All the reasons given by LGNZ are valid concerns. To my mind, however, the biggest problem with the funding local government is the question of incentives. A system that does not properly distinguish between a council doing a good job and one that isn’t sends the wrong signals to residents and councillors alike.

In New Zealand, unfortunately, we have separated the public costs and benefits of development. Taxes on economic activity – income, profit and sales taxes – typically end up in central government’s coffers. Yet costs associated with increasing economic activity – infrastructure spending but also losses of amenity – are borne locally.

It is this disconnect that makes Wellington a pro-development force and local government an obstacle almost by definition. This affects all sorts of development, whether it is about residential housing, new businesses or, still more controversially, oil and gas exploration and mining.

Clearly, some of the regions with mining potential could do with more economic growth. Take Northland, for example. It has the country’s lowest employment rate, with only 55% of the working age population actually in work. It also has one of the highest unemployment rates in the country, at 9%.

Isn’t it ironic, then, that in such regions one can often find the strongest resistance to anything that would offer economic opportunities? There is no shortage of vocal anti-mining groups in Northland. How much different would the climate around mining and oil drilling be if some of the tax proceeds from these activities stayed in Northland instead of going to Wellington?

Similarly, when Auckland was effectively instructed by central government to build more houses under the Housing Accord, why did government need to get involved with it in the first place? The answer is that, without such a push and the threat to be overridden, the council would have never increased completion rates on its own.

If, however, Auckland Council could have kept part of the income tax paid by new residents, they would not need to be told by Wellington that development is a good thing.

This is why LGNZ’s inquiry into local government funding makes sense. It should not stop there. In fact, what would be needed is an investigation into the role of local government, coupled with the question of how a new local government finance framework could incentivise councils to go for growth and development.

All of this is the easy part. The hard part will be to turn the findings of such an inquiry into something politicians at the national level are willing to implement – even if it will require them to give up and devolve some political and tax powers.