National Financial Sustainability Study of Local Government

Transcription

1 National Financial Sustainability Study of Local Government Commissioned by the Australian Local Government Association November

2 Disclaimer 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) 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 Alice Springs Swimming Centre (NT).

3 Acronyms Acronym ABS ACLG ACT ALGA AMP CFO CGC CPI DOTARS EU FAGs FAGs Act GDP GST LCIRF LGANT LGAQ LGASA LGAT LGB LGGC LGIS MAV MPMP NCC NCP NSW NSW LGSA NT NZ PwC Qld QTC Meaning Australian Bureau of Statistics Australian Classification of Local Governments Australian Capital Territory Australian Local Government Association asset management plan Chief Financial Officer Commonwealth Grants Commission Consumer Price Index Department of Transport and Regional Services (Commonwealth) European Union Financial Assistance Grants Local Government (Financial Assistance) Act 1995 (Cth) gross domestic product goods and services tax Local Community Infrastructure Renewals Fund Local Government Association of the Northern Territory Local Government Association of Queensland Local Government Association of South Australia Local Government Association of Tasmania Local Governing Body Local Government Grants Commission Local Government Infrastructure Services, Qld Municipal Association of Victoria Municipal Performance Measurement Program in Ontario, Canada. National Competition Council National Competition Policy New South Wales NSW Local Government and Shires Association Northern Territory New Zealand PricewaterhouseCoopers Queensland Queensland Treasury Corporation

4 Acronym RA RS RT R2R SA SCEFPA SPP SSS Tas UC UCV UF UM UR UK WA WALGA Meaning Rural Agricultural (ACLG category) Rural Significant Growth (ACLG category) Rural Remote (ACLG category) Roads to Recovery Funding Program South Australia Standing Committee on Economics, Finance and Public Administration Specific Purpose Payments Qld Size, Shape and Sustainability Review Tasmania Urban Capital City (ACLG category) Unimproved Capital Value Urban Fringe (ACLG category) Urban Metropolitan Developed (ACLG category) Urban Regional Towns/City United Kingdom Western Australia Western Australia Local Government Association

5 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 Conclusions and recommendations 150 Appendix A Terms of Reference 157 Appendix B Definition of Financial Sustainability Indicators 159

6 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 longterm sustainability of the sector as a whole. Background Context of Local Government Local government in Australia is a dynamic and diverse sector that combines the individual character and operations of councils. Executive Summary 3

7 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 Government 1, 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 Executive Summary 4

8 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 This was followed by NSW (May 2006) and then the WA report in August Executive Summary 5

9 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 and compares this debt (both financial and any underspend on renewals) against rate revenues. Based on 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 6

10 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 7

11 Financial ratio analysis Table E.1 provides a summary of a survey of the financial viability of 100 councils within the seven ACLG size categories developed by DOTARS. A full 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 Urban regional Urban fringe Urban development Rural remote Rural agricultural Rural significant growth n/a -8.0 n/a 2.4 n/a 2.4 n/a 47.5 n/a Average 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. Executive Summary 8

12 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 % 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 to 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. Executive Summary 9

13 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 gap 2 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. Executive Summary 10

14 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 dollars, for the period between , 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 local government revenue base with the revenue base required for financial sustainability. Executive Summary 11

15 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), Other 21% Funding gap 9% Taxation Taxation revenue revenue (rates) (rates) Other 35% 38% 19% Sales of Sales of goods Current grants goods and Current and services and subsidies services grants and 28% 9% 31% subsidies 10% 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. Executive Summary 12

16 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. Executive Summary 13

17 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. Executive Summary 14

18 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. Executive Summary 15

19 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 statewide 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. Executive Summary 16

20 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 $ 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. Executive Summary 17

21 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 Introduction 18

22 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. Introduction 19

23 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. Introduction 20

24 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: Report on the Operation of the Local Government (Financial Assistance) Act 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 Introduction 21