A guest post by Cr Chris Milne:
How Council’s use accounting standards to over-charge residents and ramp up rates well above inflation.
This article is written from the perspective of a past chair of Hutt City Council’s finance & audit committee and the architect of the council’s previously very successful strategy to keep rates rises to a maximum of inflation. With the flick of an accounting switch, all that good work is being undone. HHHHere’s the story.
In many council’s across New Zealand ratepayers are being hit by rapidly rising rates with no apparent improvement in services, and even services going backwards. Many councils have now adopted the financial sleight of hand, described below, to extract vast amounts of excess cash from ratepayers.
Why are Council rates rising stratospherically? If you listen to the Council PR machine it’s all about “getting back to basics”. While investment in infrastructure is growing, that’s not the primary driver of higher rates. The real culprit is a 2020 change in the way Hutt City Council calculates its compliance with the Local Government Act’s section 100 requirement for a ‘balanced budget’, specifically the way the calculation is used to set rates.
Official information requests to councils across New Zealand have found that more and more councils are making this change.
At Hutt City Council the previous treatment of depreciation in relation to rate setting supported low rates increases, and had the international credit rating company, Standard & Poor’s, commending Council on its strong financial management. The previous treatment always passed the official Audit New Zealand audit with flying colours.
But Audit NZ, which audits most councils, is missing in action on the balanced budget calculation. Providing a formula is applied and explained they are happy to sign it off, even when the impact could be a difference of $1,000 per household in annual rates between councils adopting different approaches. They will even sign off, without demur, a change in calculation methodology from year to year, with massive impact on the rates calculation.
Audit New Zealand is agnostic about how Council’s use accounting standards to justify rates increases. It appears that overtaxing ratepayers which is no concern to them. They focus on compliance with accounting standards and ability to repay debt. Confused? You and many.
Let’s use an actual example. From borrowings, Hutt City Council built a new administration building for $26m. Assume a building life of 50 years. Depreciation is charged at 1/50th of the “depreciated replacement cost”. So, in the first year, the depreciation is 1/50th of $26m. Revaluations of replacement costs occur every three years. Over time, construction cost increases raise the depreciation cost basis from $26m to $30m to $40m and so on.
Over 50 years what cost ratepayers $26m will be depreciated by $57m, fully funded by rates (cash from ratepayers) to ensure a ‘balanced budget’ under the new formula. To put it another way, ratepayers will be overcharged by $31m (or 220%) over what they borrowed to fund the construction of the building. This isn’t a ‘balanced budget’ – it’s highway robbery.
Confused? Then here’s something everyone understands. Imagine you buy a house for $700k – $200k deposit plus $500k mortgage. Five years later your house valuation is $1m. Your mortgage is still $500k, less what you’ve paid off over five years.
But if you are the Council then under the new ‘balanced budget’ treatment of depreciation the increase in your house valuation gets added to your mortgage! You now have to pay back to the bank both what you originally borrowed and the valuation increase. In this example, your mortgage would increase from $500k to $800k, even though you only originally borrowed only $500k. Your repayments go up accordingly. Why should you pay $800k to the bank when you only borrowed $500k? Good question.
It gets worse. Take Naenae Pool. It’s budgeted to cost $68m. The government paid Council $27m as a Covid ‘shovel ready project’. So the cost to ratepayers is $41m. But the depreciation charged to ratepayers is based on $68m! Over the life of the pool ratepayers will be charged $149m in rates to fund depreciation – 360% more than the true $41m cost to Council. And this does not include the millions of dollars of operating deficits (entry fees don’t cover running costs) of the pool – subsidies – which are also paid out of rates.
It gets worse. Where central government subsidises capital projects by 50% – very common for roads and bridges – the eventual rates take is over 700% more than the original cost.
So where does all the extra cash go? Not into a fund ready to replace these assets when they reach the end of their lives. When the asset needs replacement the whole cycle starts again. Meanwhile, all the cash has been squandered on a myriad of pet projects, too many to list here.
One could argue that the real culprit here is poor expenditure control by Councils, but this ignores the practical reality of elected councillors, many of whom have no idea about accountating standards, working to a three year election timetable. Experience has shown there are few feasible ways of stopping Councils spending all the cash that comes into their possession. What could work is a change to the Local Government Act requiring Councils to be explicitly transparent about what cash they are collecting and for what, and how they are spending it. Hiding behind accounting standards where cash and non-cash accounting transactions are merged into one muddy puddle, opaque beyond any normal person’s to understand, facilitates Councils taking more and more cash via rates than can be justified to pay the bills.
If you want to delve into the mathematics of the above examples then it’s all in the link below. Note that there are multiple tabs with different examples.
DPF: I never realised that Councils depreciate on the replacement value of an asset, rather than the cost value.
I support depreciating an asset to spread the capital cost over the life of the asset. But to depreciate on the (always growing) replacement cost does mean a huge cash intake for Councils. This should stop.