Who will pay for cleaner water?

The Government is setting higher standards that mean councils will have to spend over $15 billion on replacing and improving water infrastructure over the next decade. But Bernard Hickey argues they can't afford it without major changes to the way taxes are raised and shared.

There were many problems revealed in this week's second report on the Havelock North gastroenteritis outbreak, but the biggest was not talked about much in the subsequent debate about how to fix the "widespread, systemic failure" of the Ministry of Health and councils to both monitor and supply safe drinking water.

That problem? Who will pay to fix it and how.

Yet again, the central Government has identified local environmental problems and is set to create and enforce higher national standards that local councils will have to build the infrastructure for, and more importantly, pay for. The Havelock North report estimated fixing the pipes would cost $2.2 billion, while a Government review of the nation's water infrastructure last year estimated councils would have to invest $13.8 billion over the next decade to repair and replace drinking water, waste water and storm water infrastructure to meet acceptable standards.

Those councils will in turn have to use their single revenue raising tool, property rates, to pay for the better infrastructure, either directly with higher rates or by indirectly with higher rates to service higher debt. Those councils in high growth areas (Auckland, Hamilton, Tauranga and Queenstown) are already near their debt limits and are unable to borrow much more without significant rates increases that are often politically impossible.

In Auckland's case, it also can't borrow more without forcing a credit rating downgrade across all councils, and possibly the entire nation, that would put up everyone's interest bills. That's because Auckland is the dominant borrower within the Local Government Funding Agency and effectively sets the baseline for credit ratings all councils. It is also so big that the credit rating agencies may decide any Auckland downgrade would endanger New Zealand's sovereign credit rating.

New Zealand has accidentally arrived at a set of governing and funding arrangements where the central Government in Wellington sets the national standards and raises the overwhelming bulk of tax revenues, but it is local Government that has to deliver and fund the infrastructure to meet those standards.

This mismatch has driven much of the under-investment in the infrastructure needed for massive amounts of new house building and the need to improve quality of drinking water and natural water bodies such as lakes and rivers.

It has helped lead to an almighty blockage, where central and local governments blame each other for failures to build or maintain the necessary infrastructure, and neither stumps up the money to build it. Voters blame both for the failings, but are also unwilling to stump up the higher rates and income taxes to pay for the infrastructure. The end result is nothing seems able to break this logjam in the political economy, and housing affordability and water quality deteriorate.

The only time it has been broken in recent years was because of the Christchurch earthquake. An act of god forced the central Government to use those centralised pots of revenue and a strong balance sheet to fund the rebuilding of underlying infrastructure needed for the city to rebuild and operate. It's no accident that Christchurch is well on its way to solving its housing supply shortage because the central Government stumped up billions to build the underlying infrastructure (although Christchurch also has massive unsolved and unpaid for problems with its drinking, waste and storm water systems). House price inflation has been much lower in Canterbury over the last four years and rents have started falling.

The Government of the day (2008-2017) was able to point to acts of god (the earthquakes and the Global Financial Crisis) as the reason for borrowing heavily and increasing net Crown debt to GDP from nothing to over 23 percent of GDP from 2008 to 2016.

The current central Government has essentially tied its own hands to stop it from using the Crown's enormous balance sheet flexibility to borrow by promising to reduce net debt to 20 percent of GDP within five years. This is a slightly slower debt reduction track than targeted by the previous Government, but still leaves little room for the Government to use its balance sheet to solve this infrastructure deficit.

This funding mismatch between councils and Government and the artificial limit on debt set by the Government will underpin many of the big debates of the next three years around infrastructure funding. The debate will come back to these key questions every time:

Who should have the power to raise tax revenues?

Who should borrow the funds necessary to build infrastructure needed for a fast-growing population?

Who should borrow the money and service the debt to pay to replace and rebuild ageing infrastructure needed for higher environmental standards?

The councils want extra revenue raising tools to help pay for the extra debt and avoid big increases in rates. That has driven the recent debates about the need for some GST to be returned to the regions, or for regional fuel taxes to be paid to councils. Auckland is about to get a 10c/litre levy to help it pay for public transport and Hamilton is reported by Stuff to have decided yesterday to ask for an 11.5c/litre regional fuel tax to help it reduce a planned 15.5 percent rates hike to nine percent.

The debate over a tourism levy to fund local infrastructure is also driven by this funding mismatch. Councils want centralised revenue raising mechanisms to pay for local infrastructure.

There seems few places for this debate to be resolved. It has cropped up time and again over the last 20 years, but few central Government politicians want to give up those powers to tax and spend to the regions, and the regions were first unwilling and are now unable to use their balance sheets to pay for infrastructure. Ratepayers and central Government politicians are also sceptical about their own councils' ability to efficiently and cleanly handle any new taxing and spending powers if they had them.

The problem is now becoming acute because of the scale of the population growth seen over the last five years and the perceived (and in Havelock North's case real) need to improve water quality.

The new Labour-New Zealand First Government agreed in their coalition agreement to hold a public inquiry "A decade after Shand" to investigate the drivers of local government costs and its revenue base. The Local Government Rates Inquiry led by David Shand reported back to the then-Labour-led Government in August 2007 with this report. It recommended a share of GST be used to set up a contestable Infrastructure Equalisation Fund, and it proposed allowing councils to charge more user-pays fees for water, coastal access and roads through tolls. Those proposals went nowhere.

We will see where the son or daughter of Shand might go.

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