Local government shoulders a significant burden in the provision of infrastructure in New Zealand. As attention on the national infrastructure deficit in New Zealand grows, so too does the discussion as to whether the current local government funding and financing model will be able to support the growing national infrastructure pipeline.

In a recent report, the New Zealand Infrastructure Commission | Te-Waihanga asks the question “is local government debt constrained?”, and suggests that it is not necessarily our local government financing tools that we should be seeking to change, but rather how we use them and the type of projects we are choosing to debt finance.

In this article, we discuss some of the conclusions of the report and share our thoughts.

The Report

In its report Is local government debt constrained? A review of local government financing tools (Report), the Commission evaluates whether the current financing tools relied on by local government unduly constrain infrastructure investment. The primary tools relied on by councils to debt finance infrastructure include borrowing from the Local Government Funding Agency (LGFA), issuing debt directly to investors and banks, and establishing special-purpose vehicles (SPVs) which can raise off-balance sheet debt on the strength of a levy approved under the Infrastructure Funding and Financing Act 2020 (IFF Act). 

Ensuring that the financing toolkit is fit for purpose is essential, given 24% of investment in New Zealand’s infrastructure in the last 20 years has come from local government (an average of $3.4 billion per year), and even greater infrastructure investment will be needed in the future if we are to combat our infrastructure deficit. However, all of these tools have their respective restrictions. For example, the primary source of funding for councils is through LGFA borrowing (and this is likely to remain the case). However, member councils in LGFA are subject to borrowing limits in the form of financial covenants, such as their debt-to-revenue limit. Councils could issue their own debt directly, but not all have the resources and scale required to directly access debt capital markets. And, while funding infrastructure through SPVs may provide a council more financial flexibility, borrowing costs will generally be higher than borrowing through LGFA and there is a rigorous approval process.

Against that backdrop, the Report considers whether new or modified financing tools are required, and/or if there are other steps we can take to facilitate access to the debt required to finance infrastructure investment. 

Do we need to modify our financing tools?

The Report leaves this question unanswered. However, some important observations are made along the way:

• Most councils are not close to approaching their debt limits. Only five out of 72 councils in LGFA have a debt to revenue ratio of over 150%.
• A small number  of our high-growth councils are however forecast to reach their LGFA debt limits in the next decade (coinciding with a time when they are likely to be facing greater demand for infrastructure investment given their high-growth status).
• While LGFA debt limits may become an effective constraint on borrowing capacity for those high-growth councils, the covenants do of course drive fiscal discipline and mitigate risk.
• High-growth councils could, nevertheless, leave LGFA if they wished to in order to potentially increase their debt capacity. The quid pro quo is likely to be a credit downgrade and higher borrowing costs for those councils, coupled with the risk of perceived fiscal recklessness. 
• Short of leaving LGFA, the options are limited. Some gains could be made through greater use of the IFF Act off-balance sheet financing tool, and debt limits could be eased by increasing rates revenue (albeit creating a maximum of only $2.8 of debt headroom per $1 of rates revenue raised). 

Ultimately, the Report concludes that there are competing schools of thought as to whether the existing financing tools are appropriate or not. The analysis does not conclusively demonstrate support for either view. 

Instead, the Report finds that greater gains can be made by focussing on how debt is used, rather than how it is raised. 

Good and bad debt

The Report proposes that a simpler and more effective strategy would involve more consideration of whether debt finance is appropriate for particular infrastructure projects, or whether projects should be financed in other ways. 

Paying for infrastructure can be done in three ways:

1. Using current revenue (pay-as-you-go)
2. Financing with debt and paying that debt off with existing revenue streams
3. Financing with debt and paying that debt off with new revenue streams. 

Historically, in periods of significant infrastructure investment (including 1920-36 and 1950-70), local government has incurred higher debt burdens than we are currently facing and sustained this burden through a commensurate growth in revenue (thereby keeping debt-to-revenue ratios in check). 

However, in the current growth period (since the mid-1990s), council debts have increased by 226% but revenues have only increased by 42%. This can be partly explained by the need for renewal and maintenance of existing infrastructure, which tends to increase debt but without the increased revenue that comes with growth. 

Regardless, the Report concludes that councils don’t necessarily need new financing tools - actions can be taken now to ensure that we are maximising our existing financing tools. 

According to the Infrastructure Commission, these actions include: 

• Better evaluation of whether debt financing is appropriate for infrastructure investment, or whether in the case of renewal projects, which do not generate direct revenues or per capita growth, these could be financed through current revenues or funding depreciation. Debt finance can then be reserved for larger growth-targeted infrastructure projects, allowing councils to spread these bigger up-front costs over a longer period of time.
• Stronger asset management plans and project selection. Ensuring the right projects are selected will relieve the pressure caused by renewal deficits, and where renewals are needed, asset management plans can ensure these are timed well and can be adequately funded. 
• Use of more targeted revenue streams. Tools like user charges, targeted rates, levies, development contributions and value-capture provide revenue streams which can recoup the cost of infrastructure investments and ensure that these projects are paid for by the groups who benefit most from them. 

Our thoughts

To us, what the Report highlights is that we do not necessarily need considerable investment in new financing tools for local government. While some incremental gains might be able to be made by greater focus on how we use our financing tools, ultimately the spotlight needs to be on how local authorities can generate greater revenue in order to keep pace with investment requirements.

This brings into play the age-old questions of who should pay, and how? 

Should (and can) councils continue to increase general and targeted rates? What is needed to allow councils to access more targeted revenue streams (such as user- and beneficiary-pays charges) that could more fairly allocate the funding burden? How can we enable councils to generate greater revenue, without creating affordability issues for communities?

The key to tackling our infrastructure investment deficit lies in answering these questions, on the funding side of our funding and financing challenge. When funding is available, finance will be accessible. 

In this regard, some opportunities include:

• IFF: one of the key strengths of the IFF model is that it matches debt raised to invest in infrastructure with revenues linked to that infrastructure (in the form of a targeted levy). Having now been successfully used on two pathfinder IFF projects (Tauranga’s Transport Systems Plan and Wellington’s Sludge Minimisation Facility), the time is right to consider how we can get greater use out of this revenue-generating model, including for greenfields infrastructure.
• Development contributions: DCs were intended to be the primary revenue generation tool for growth infrastructure. However, in practice, they are often used conservatively due to relatively complex compliance requirements in the Local Government Act 2002 (at least when compared to rates), and a fear that imposing high contributions that fully recover the cost of growth-related network infrastructure may stifle growth (as the market will not meet those costs). Accordingly in practice, development contributions have been insufficient to fully fund the cost of growth-related network infrastructure, and needed to be supplemented with rating revenues. The Report also highlights that DC revenue does not count towards LGFA’s debt-to-revenue covenant (being a particular issue for high-growth councils, who rely more heavily on DC revenue but cannot access finance on its strength). A review of the DC framework to consider how we can super-charge this regime, and what would be needed in order to facilitate the hypothecation of DC revenue, is needed. 
• Time of use charging: The Government is currently evaluating options for time of use charging, in order to direct charges for transport infrastructure to those who use it, while also reducing peak demand on the roading network and potentially deferring the need for network capacity upgrades to accommodate peak demand. There is strong support for time of use charging in the draft Government Policy Statement on Land Transport 2024, as well as interest from councils in our major cities. It is yet to be seen if this will manifest in an amendment to the Land Transport Management Act 2003, and/or if councils will be given any level of autonomy over time of use charging in their cities and districts. But, given the dominance of private vehicle transport in New Zealand, the current lack of appetite to invest heavily in other transport modes (eg light rail), and the pressure on other funding sources whether they be local (such as rates) or national (such as the national land transport fund), a workable model is needed. 
• Value capture: “value capture” is the buzz word that gets bandied about whenever new funding sources are discussed, but there are many forms this can take. At its simplest, it could involve investing in real estate neighbouring (or forming part of) an infrastructure project, and realising the increase in value that arises when the infrastructure is delivered. Other, more technical, forms of value capture (such as TIF - discussed here) have also been used abroad with success. The challenge is to find the model(s) that will work in the New Zealand context. 
• Commercial revenues: It should not be forgotten that many councils have access to commercial revenues from trading assets. Not all revenue sources for local authorities come from the statutory toolkit. One option noted in the Report, is to shift these assets, and the debt associated with them, into a Council-Controlled Trading Organisation (CCTO). In some cases (where those assets can support their own debt, and where it has been agreed with LGFA), this approach can lead to that debt not counting towards the parent council’s debt-to-revenue ratio - thereby creating debt headroom for the council. Since 2020, such CCTOs can also access LGFA finance themselves, directly.

Disclosure: Simpson Grierson has advised on the development of many of the funding and financing tools and structures commented on in this article, including the development and operation of the IFF Act, the establishment of LGFA, development contribution reform, opportunities for TIF financing, and CCTO access to LGFA. However, the views expressed in this article are the views of the Simpson Grierson authors, only.

Please get in touch if you would like to chat with one of our infrastructure funding experts about anything we discuss in this article.

Special thanks to Katie Daly for her assistance in writing this article.