Good reason for public fury at rates

Comment by FRASER COLEGRAVE and JOHN SMALL*

There are at least three reasons for the outcry over the Auckland Regional Council's new rating policy, all of which were matters of choice for the council: the rate base; whether to treat business property differently; and transition paths.

The choices made by ARC have shifted the burden of property taxes from businesses to residents and from the wealthy to the poor without smoothing the adjustment process in any way. It is no wonder people are angry.

Until this year, regional rates in Auckland were collected indirectly through the seven city and district councils.

This year the ARC was required by law to apply its own rating policy and collect rates directly, so other things being equal, local council rates should fall on average by the amount they previously collected on behalf of the ARC.

If the ARC had simply mirrored the rating methods used by local councils, nothing would have changed (except for the 34 per cent increase, but that's a different issue).

The ARC chose instead to use different rating policies from those used by city and district councils to raise funds in the past.

The result has been to shift the rates burden between and within the main ratepayer groups: residents and businesses. In particular, the absence of business rating differentials shifts the burden from businesses to residents, while the use of capital value rather than land value for the rate base further shifts burden from relatively wealthy residents to relatively poor ones.

Most councils charge different general rates for each dollar of property value for different ratepayer groups. These differentials reflect the obvious fact that each group receives different levels of council services and has a different ability to pay.

Generally speaking, businesses pay a higher rate than residents, who in turn pay a higher rate than rural ratepayers.

The higher business rate stems from a much higher ability to pay, not least because rates are GST-refundable and tax-deductible, while lower rural rates acknowledge lower benefits typically received from council services, mainly because of location.

Because the ARC's new rating policy does not include such differentials, the move to direct rating this year has caused a major shift in rates burden from businesses to residential and rural ratepayers.

Rates are generally struck as some percentage of property value, but local government legislation requires each local and regional council to select a base to which this percentage is applied.

This is usually a choice between using each property's land value or its capital value, which includes the value of improvements.

The vast majority of councils use land value, although Auckland City uses annual value, which is a hybrid of capital value. In contrast, the ARC has elected to use capital value as its rating base. Within residential ratepayers, this shifts burden from wealthier residents to poorer residents. The reason for this is quite straightforward but requires some explanation.

When buying a property, people typically consider two things: the location of the house, and the quality of the house itself. It is clear, however, that wealthier households tend to place greater emphasis on the location of the house, while poorer households, knowing they are limited to cheaper locations, tend to place greater emphasis on the house.

The result is that the value of land varies much more than the value of the buildings on the land. Consequently, poorer households account for a larger proportion of total residential capital value than they do of total residential land value.

This is not just idle speculation. By linking income (census) data to property values across the jurisdiction of one council within the ARC region, we have found that the properties of decile 1 families (the poorest 10 per cent by income) make up 6 per cent of land value but 7.2 per cent of capital value, while the properties of decile 10 families make up 17.3 per cent of land value and only 15.6 per cent of capital value.

We found a similar pattern in the area governed by another council in the ARC region, so it seems typical.

These differences might not appear dramatic at first, but they drive a major impact when the rate base changes. Using the figures above, we can estimate the average impact on typical low and high-income households of changing the rate base from land to capital value.

Decile 1 households face rates bills 20 per cent higher while decile 10 households get a 10 per cent reduction. This shows what would happen on average if this particular council shifted to capital value rating without increasing the aggregate rate take.

There is nothing inherently wrong with councils changing their rating policies, of course. One could imagine, for example, that careful economic analysis might suggest that we would collectively be better off if business property was treated differently. In such cases, the reasons for change could and should be clearly explained.

The ARC's website does not attempt to explain its choices, however, and neither have recent statements from the chairwoman. The ARC's apparent reluctance to discuss their rationale creates the unfortunate impression that these decisions lacked analytical support.

But perhaps the most difficult thing for people to swallow is the size of the rate changes. The standard approach to painful but necessary rebalancing is, first, to explain the reasons clearly and, secondly, to ease the pain by phasing in the changes over several years.

As we are now seeing, governments ignore these basic principles at their peril.

* Fraser Colegrave and John Small are principals of Covec, an Auckland-based economics practice.