Fraser Colegrave: Raise income and company taxes and dump local rates

Opinion

General rates levied by councils have become the centre of spirited debate, with the underlying current of unrest reaching its peak during the 2003 Auckland Regional Council rates debacle.

Detractors of property-based rates cite many flaws in present rating systems. Indeed, even from a cursory glance, rating systems can appear inefficient and inequitable.

They are inefficient mainly because of the enormous transaction costs involved. At present, we have 74 territorial authorities and 12 regional councils all using separate rating systems to raise revenue, and all for a population of only 4 million. It just doesn't make sense.

They are inequitable for a number of reasons, most fundamentally because the contribution of each ratepayer bears little relationship to benefits received from council services or the ability to pay.

Individual usage (and hence the benefit) of council services is almost impossible to measure so cannot be used as a basis for funding - although it is often purported to be.

Reliable measures of ability to pay elude councils, forcing them to rely on property values (that is, wealth) as a proxy. This can place unfair burdens on certain sectors of society, such as senior citizens, who are often characterised as being asset-rich but income-poor.

A meeting of 60 mayors and council officers in Wellington to discuss new avenues for local government funding signalled the intentions of local and central governments to work collaboratively on these issues. This initiative is to be applauded.

However, notwithstanding the possible introduction of tourist-targeted taxes, such as a bed tax, it is unlikely the recommendations put forward by that work will depart significantly from the status quo.

Put differently, we are not likely to see the end of property-based rates for quite some time.

In fact, we need to take a further step back and consider property-based rates (and other forms of local government funding) in the wider context of government taxation. There is no obvious reason for local and central government tax to be contemplated separately.

Consider these two questions. Why do we even need to raise funds for local government through property-based rates in the first place? Why can't it all be raised through income tax and company tax?

Admittedly, I am at odds to answer these questions convincingly. It seems possible that abolishing rates and replacing them with slightly higher income and company tax rates could be hugely beneficial to New Zealand.

A back-of-the-envelope calculation suggests the $2.3 billion raised by councils as general rates in 2003 could be raised by increasing income and company tax rates by less than 1.7 cents.

Of course, we could also easily impose a differential so that businesses pay more than residents, or vice versa.

Centrally collected funds could be allocated among councils using a needs-based formula, such as that used to fund public-health organisations. The amount paid to each council for core services, such as libraries and rubbish collection, would depend on the size and demographic composition of the population it served.

A separate pool of funds would be maintained to fund capital works, which don't bear such strong relationships with population and demography and, hence, are not amenable to distribution via formulas.

Although there would invariably be difficulties during the transition from one system to another, the abolition of property-based rates would confer a host of long-term benefits.

First and foremost, the rationalisation of local and central government revenue collection would provide huge savings on administrative expenses and improve efficiency. The vast costs of operating and maintaining 86 collection systems would be overcome.

Of course, these efficiency improvements would need to be weighed against the potential losses associated with higher marginal tax rates, which can provide perverse incentives to work. However, in times of low unemployment, efficiency improvements would be the winner.

Second, centrally raised council revenue would negate many of the equity concerns associated with property-based rates. Most obviously, it would forge a direct link between the funding contribution of ratepayers and their ability to pay.

Finally, devolving revenue-raising responsibilities from councils would free up resources and allow them to concentrate more closely on the way they spend the money, rather than how they raise it. This would, arguably, allow councils to improve the efficiency of spending and maximise the social wellbeing of ratepayers.

Although the replacement of rates with slightly higher income and company taxes is unlikely to be a silver bullet, it could provide a way forward.

And given the mayoral forum's desire to "think outside the square", it would seem silly not to consider this option.

* Fraser Colegrave is a director of Covec, an applied economics practice in Auckland.