ࡱ> j h M N O P Q R S T U V W X Y Z [ \ ] ^ _ ` a b c d k @ Vvbjbj00 6RbRb@%*H<<<>!\###$$2p2p2pryT $ 8. L:,T ,T$CR,#`"ȝ``"",TR ~1~1~1`"8,",(~1`~1~1t"p#6(, `m2prXt0 H 0($$""""(#hԫ(| ~1<4ȫ $$In1j$$nNational Financial Sustainability Study of Local Government Commissioned by the Australian Local Government Association November 2006 Disclaimer This Report has been prepared by PricewaterhouseCoopers (PwC) at the request of the Australian Local Government Association (ALGA) in our capacity as advisors in accordance with the Terms of Reference and the Terms and Conditions contained in the Consultant Agreement between ALGA and PwC. The information, statements, statistics and commentary (together the Information) contained in this report have been prepared by PwC from publicly available material and from discussions held with stakeholders. The Consultants may in their absolute discretion, but without being under any obligation to do so, update, amend or supplement this document. PwC have based this report on information received or obtained, on the basis that such information is accurate and, where it is represented by management as such, complete. The Information contained in this report has not been subject to an Audit. The information must not be copied, reproduced, distributed, or used, in whole or in part, for any purpose other than detailed in our Consultant Agreement without the written permission of ALGA and PwC. Comments and queries can be directed to: Scott Lennon Partner Infrastructure Government & Utilities PricewaterhouseCoopers 201 Sussex Street Sydney NSW 2000 Phone: (02) 8266 2765 Email:  HYPERLINK "mailto:scott.lennon@au.pwc.com" scott.lennon@au.pwc.com Photo credits Cover page photos all from relevant local council websites and feature: Blacktown library (NSW), Brisbane Botanic Gardens (QLD), Redfern Community Centre (NSW) and Alice Springs Swimming Centre (NT) Acronyms AcronymMeaningABSAustralian Bureau of StatisticsACLGAustralian Classification of Local GovernmentsACTAustralian Capital TerritoryALGAAustralian Local Government AssociationAMPasset management planCFOChief Financial OfficerCGCCommonwealth Grants CommissionCPIConsumer Price IndexDOTARSDepartment of Transport and Regional Services (Commonwealth)EUEuropean UnionFAGsFinancial Assistance GrantsFAGs ActLocal Government (Financial Assistance) Act 1995 (Cth)GDPgross domestic productGSTgoods and services taxLGANTLocal Government Association of the Northern TerritoryLGAQLocal Government Association of QueenslandLGASALocal Government Association of South AustraliaLGATLocal Government Association of TasmaniaLGBLocal Governing BodyLGGCLocal Government Grants Commission LGISLocal Government Infrastructure Services, QldMAVMunicipal Association of VictoriaMPMPMunicipal Performance Measurement Program in Ontario, Canada.NCCNational Competition CouncilNCPNational Competition PolicyNSWNew South WalesNSW LGSANSW Local Government and Shires AssociationNTNorthern TerritoryNZNew ZealandPwCPricewaterhouseCoopersQldQueenslandQTCQueensland Treasury CorporationRARural Agricultural (ACLG category)RSRural Significant Growth (ACLG category)RTRural Remote (ACLG category)R2RRoads to Recovery Funding ProgrammeSASouth AustraliaSCEFPAStanding Committee on Economics, Finance and Public AdministrationSPPSpecific Purpose PaymentsSSSQld Size, Shape and Sustainability ReviewTasTasmaniaUCUrban Capital City (ACLG category)UCVUnimproved Capital ValueUFUrban Fringe (ACLG category)UMUrban Metropolitan Developed (ACLG category)URUrban Regional Towns/CityUKUnited KingdomWAWestern AustraliaWALGAWestern Australia Local Government Association Contents  TOC \o "1-4" \t "Preface Title,5" Executive Summary  PAGEREF _Toc152745103 \h 3 1 Introduction  PAGEREF _Toc152745104 \h 18 2 Overview of the Local Government Sector  PAGEREF _Toc152745105 \h 40 3 Financial governance and fiscal relationships  PAGEREF _Toc152745106 \h 84 4 Analysis of financial sustainability of local governments  PAGEREF _Toc152745107 \h 92 5 Potential Options for Reform  PAGEREF _Toc152745108 \h 115 6 Conclusions and recommendations  PAGEREF _Toc152745109 \h 145 Appendix A Terms of Reference  PAGEREF _Toc152745110 \h 152 Appendix B Definition of Financial Sustainability Indicators  PAGEREF _Toc152745111 \h 154  Executive Summary The Australian Local Government Association (ALGA) has commissioned PricewaterhouseCoopers (PwC) to undertake an independent analysis of the financial sustainability of local government in Australia. The full terms of reference and scope are provided in  REF _Ref142821527 \n \h  \* MERGEFORMAT Appendix A. The objective of this study is to assist the ALGA, in collaboration with state and territory local government associations, to develop a detailed plan to: enable councils to better meet their fiscal obligations as well as the growing demands for infrastructure and services; and provide a sound approach for targeted support to local government for consideration by other spheres of government. In summary, the terms of reference for this study require PwC to: assess the current and long-term viability of the local government nationally and by council types including the trends and differences; identify the key financial issues affecting financial sustainability; develop recommendations for improved financial sustainability (e.g. financial skills and potential sources of additional revenue); and investigate the merit of reforming inter-government funding to develop a new model to improve sustainability. The intention of this project is to provide a high level strategic national study that draws on the detailed analysis of a number of state based sustainability studies, in order to provide an indication of the sustainability of the nationwide local government sector. The resources available to complete this study preclude an in-depth and individual analysis of each of the 700 councils. The diversity of the sector also makes it difficult to provide a detailed how to guide for improving sustainability that would apply to the varying circumstances of each council. Therefore, this study assesses key characteristics that contribute to the councils currently at risk of sustainability problems, and develops a range of internal and funding reform options that target these issues to improve the long-term sustainability of the sector as a whole. Background Context of Local Government Local government in Australia is a dynamic and diverse sector that combines the individual character and operations of councils. Councils are very diverse in size and shape from Brisbane City Council (population 950,000 and annual expenditure of approximately $1.7 billion) to very small councils like Jerilderie Shire (population 1,908 and annual expenditure $6.8 million). Consistent with these diverse characteristics, the financial position of individual councils also varies substantially. Local government plays an integral role in the Australian economy and within local communities. In terms of economic activity, local government has an annual expenditure of over $20 billion, which represents around 2% of GDP, and employs around 1.3% of the Australian labour force. Moreover, local government provides a significant proportion of the essential services and infrastructure that underpins all local and regional communities. For the numerous regional and more remote communities local government is often the only institutional presence and one of the key drivers of economic activity. The key benefits of the local government sector, as outlined by the Australian Government, include that the sector: is a wide and established national network of public administration, including a significant presence in rural and regional Australia; has strong links to the community and is accountable to the communities its represents; practical service orientation and good organisational skills which make it capable of innovative, speedy and flexible responses. has deep links with local business and industry which puts councils in a good position to foster a bottom up approach to regional development; provides information to support Commonwealth regional policy development and implementation; and is an ideal entry point for access to information about other governments services and programs. Increase in local government service scope Over the past thirty years, the functions undertaken by local government in Australia have evolved with a generally expanded scope. Council services now generally includes a range of social and human services in addition to the physical infrastructure of roads and waste with some jurisdictions also providing water and waste water. Most local councils, due to community pressure, state and Australian Government inducements and the withdrawal of services by other levels of government, now provide a growing range of social and human services. Some smaller councils, due to constrained budgets have, by necessity, needed to contain their scope to the traditional services. The Inter-Governmental Agreement on Cost Shifting, coupled with greater caution by councils prior to expanding services, may moderate recent levels of service expansion. This diversity in size and subsequent income streams has meant that councils have differing capacities to fund the requests by their communities for greater services. Managing these demands is particularly challenging for many councils that have a narrow revenue base or for which the revenue base that has seen only modest growth. Particularly for the 60% of councils that are rural and remote councils of which many have experienced static or declining population bases, which translate to stable or declining council revenue. This is an ongoing challenge in the context of strong economic growth which typically sees communities demanding a corresponding increase in local infrastructure and services. Consequently, individual councils have had mixed success in managing and funding community demands for more services whilst retaining a healthy financial position. Efficiency improvements Over the past decade there has been growing awareness and progress across the sector about the need to improve the efficiency and sustainability of local government. As such a large body of work has been undertaken over recent years, driven by state associations in addition to state and Australian Governments that analyses the sector and compiles evidence that a large number of councils are facing financial difficulties. This is part of an ongoing process to ensuring that there is a robust understanding of sustainability issues at the state and federal level. As a consequence, over the past decade a number of councils have implemented a range of successful reforms to improve their efficiency and sustainability. Significant efficiency reforms have been achieved through the following approaches: outsourcing non-core operations, which was formalised in Victoria by the compulsory competitive tending (CCT) policy during the 1990s; structural reforms that have included mandatory and voluntary amalgamations in New South Wales (NSW), Queensland, Victoria, South Australia (SA) and Tasmania to consolidate the local government sector; commercialisation of services in order to increase the returns to local government, for example, the recent Local Government Infrastructure Services initiative in Qld (see section  REF _Ref146686299 \r \h  \* MERGEFORMAT 2.6 for further details); regional service delivery is a widespread practice among councils to deliver a range of services such as waste services, purchasing and procurement, road and infrastructure maintenance, recruitment, etc; shared services where either a council or the state association becomes the lead provider for service provision, particularly for corporate services such as finance, HR, etc. State based sustainability studies The results of recently completed sustainability studies commissioned and funded by state local government associations in NSW, SA and Western Australia (WA) provided some of the impetus for this study. Each of these studies was managed by an independent board, with the analysis undertaken by Access Economics (Access). SA was the first state to complete such a study, with the results published in August 2005. This was followed by NSW (May 2006) and then the WA report in August 2006. The Municipal Association of Victoria (MAV) has also led the efficiency reform process undertaking considerable work on analysing the trends and long-term sustainability of local government finances in Victoria. The MAV has developed a Viability Index to measure the long-term viability of individual councils. It combines factors such as borrowings, unfunded superannuation liabilities (USL) and the cumulative deficit / surplus in capital expenditure versus depreciation. The MAV index analyses data since 1997/98 and compares this debt (both financial and any underspend on renewals) against rate revenues. Based on 2004/05 data MAV concluded that 10% of the 79 councils in Victoria are unsustainable. In collating the results of the MAV study and the three separate Access studies it appears that around 35% of councils across these states are not financially sustainable. Access found that the proportion of unsustainable councils varies between 25% in NSW and 58% in WA. However, in observing these results it is important to note that the Access approach excluded capital grants from the operating results, which paints a more urgent picture of the sustainability of local government. In this PwC study, capital grants are viewed as an ongoing and important revenue source, the exclusion of which can overstate the extent of sustainability difficulties of local government. Overall, this PwC Study is seeking to provide a strategic-level national assessment of the degree to which financial sustainability is a significant concern and, if so, to recommend options to assist councils in need. Assessment of current and long-term viability of local government and the differences between types of councils The recent state based sustainability studies have confirmed widespread concerns from a number of commentators that a sizable proportion of councils face long-term financial sustainability problems. Where councils report operating deficits or, more specifically, operating cashflow deficits, there is a strong tendency to defer or scale back renewals expenditure to upgrade existing infrastructure. This deferral of renewals, particularly in community infrastructure (e.g. community centres, swimming pools, libraries), has been a key factor in creating a backlog of renewals work. This tendency by some councils to defer community infrastructure renewals arises because the other two broad categories of infrastructure (being water/sewerage and roads) have specific user charges to fund renewals or Australian Government Grants (e.g. Roads to Recovery or R2R) to support periodic upgrading. Even with R2R a sizable proportion of rural councils still have ongoing challenges funding the adequate renewal of their local roads. Our ability to accurately assess the financial viability and sustainability of different types of councils across Australia has been constrained by a range of data limitations, including: mixed approaches to measuring and recording financial data associated with inconsistencies between states; the infrequent asset re-valuations (typically 5 yearly) as well as differences in assumed asset lives impacting the accuracy of reported depreciation levels; and incomplete financial and asset management records particularly for smaller councils, including a large proportion of Northern Territory Councils. A key data shortcoming across a large proportion of councils across the nation is accurate information on capital expenditure and renewals expenditure and inconsistent separation of maintenance, renewals and capital expenditure. PwC has subsequently utilised two approaches to assess viability namely: Financial ratio analysis using a survey of 100 councils: PwC has obtained data from state/territory grants commissions which was then stratified to match both the proportion of councils per state/territory and the proportion of councils in each of seven Australian Classification of Local Governments (ACLG) size categories established by the Department of Regional Transport and Services (DoTARS). Extrapolation from state based sustainability results: from the three Access based inquiries (NSW, SA and WA) and MAV study in Victoria, PwC has extrapolated to provide an indicative estimate of the national sustainability gap and infrastructure backlog. The Access approach used a more sophisticated method to defining financial sustainability based on forward looking renewals and own source revenue capacity. Similarly, MAV was able to obtain a better breakdown of capital expenditure directly from councils so as to estimate the likely infrastructure backlog and has examined the trends in Victorian financial viability over the medium term. Extrapolation is required as this PwC Study has a strategic or national focus and the scope does not encompass detailed individual council analysis as utilised by the state based studies to evaluate sustainability. Financial ratio analysis Table E.1 provides a summary of a survey of the financial viability of 100 councils within the seven ACLG size categories developed by DOTARS. A full explanation and definition of these financial key performance indicators (KPI) can be found in  REF _Ref145922044 \n \h  \* MERGEFORMAT Appendix B. Table E. SEQ Table \* ARABIC \s 2 1: Summary of financial KPIs by ACLG Financial Sustainability Summary KPIs DOTARS category% Councils with Interest Coverage <3 (EBIT / borrowing costs)Median Operating Surplus as a % of Total Revenue% Councils with Deficit greater than 10% of Total RevenueMedian Sustainability Ratio (capex/ depreciation) % Councils with Sustainability Ratio <1Median current ratio (current assets / current liab.)% of councils with current ratio <1Median rates coverage (%) (rates as a % of total expenses)% of councils with rates coverage <0.4Urban capital city40.05.028.62.08.04.5 14.355.80.0Urban regional41.74.216.71.30.02.8 9.166.516.7Urban fringe 37.514.112.52.116.73.4 25.062.50.0Urban development41.77.68.31.60.01.0 50.065.20.0Rural remote28.610.318.82.38.32.6 12.525.487.5Rural agricultural32.611.715.91.70.02.6 20.542.454.5Rural significant growthn/a-8.0n/a2.4n/a2.4 n/a47.5n/aAverage35.810.016.01.88.02.621.447.940.4 The results above indicate that: Approximately 36% of councils have an interest coverage ratio (EBIT/interest) of less than 3. The interest coverage level of 3 generally represents a threshold where credit risk begins to be more significant and a large unexpected event with adverse cashflow implications can potentially place pressure on ability to meet interest payments. Councils have a median operating surplus of 10% of total revenue. However this is an unadjusted operating surplus in that it includes revenues which are committed to specific purposes (eg Section 94 developer contributions). Some 16% of councils also have an operating deficit of over 10% of revenue. Such councils have a tendency to defer renewals expenditure which creates a risk of developing maintenance backlogs. The median sustainability ratio (capex/depreciation) in this sample was 1.8:1. Some 8% of councils have a sustainability ratio of less than 1. The proportion less than 1 is understated as council asset values are often conservative with infrequent updates and many assets still in active use have reached their accounting life and are fully depreciated. Hence in reality, if asset values and depreciation amounts were more accurate, the national median sustainability ratio is likely to be closer to 1:1. A ratio of less than 1 indicates that the capital being consumed in an accounting sense exceeds the capital being replaced into the asset base. Councils have a median current ratio (current assets / current liabilities) of 2.6, however 21% are less than 1. The ratio of 1 is a key threshold for testing liquidity issues. In particular the urban fringe, urban development, rural remote and rural agricultural categories all have potential liquidity problems with 1250 % less than 1. Councils across the nation have a median of 48% of costs covered by rates, ranging from 25% to 66%. Of concern is the fact that 87% and 54% of rural remote and rural agricultural councils respectively have rates covering less than 40% of costs creating a dependence on government grants. Extrapolation from state based sustainability results The Access Economics and MAV results for NSW, WA, SA and Vic are summarised in  REF _Ref144012449 \* MERGEFORMAT Table E.2. Both approaches use four main KPIs: Backlog in infrastructure renewals Underspend on existing infrastructure renewals per annum The estimated funding gap per annum to rectify the Underspend and clear the backlog The percentage of Councils assessed as unsustainable. We understand that both the Access and MAV approach to estimating the annual underspend on existing infrastructure renewals has taken into account existing Australian Government support to clear backlogs primarily in the form of the R2R Program. However, the Access results exclude other capital grants, based on the premise that their inclusion would overstate the revenue available for operational activities. The PwC analysis is different in that data constraints have meant that all capital grants are included. This approach also recognises that all capital grants form an important and necessary part of local government revenue, and hence PwC reports a slightly improved sustainability in comparison to the Access results. It is important to note that the MAV estimates are for the period from 1997/98 2004-05 due to concerns about the accuracy of the data recorded for non-current assets under the different accounting standards that applied prior to this period. Combined, the NSW, Victoria, SA and WA represent around 63% of total national councils, 76% of the national population and 72% of the nations local roads. This provides an adequate sample to assess the sustainability position across the nation. However, the results between states vary; for example the average NSW council underspend is $3.3 million pa compared with $0.3 million in SA. The more favourable sustainability results for SA appear to be mainly explainable by substantial parts of rural and remote SA (approximately 85% of SA land area) being unincorporated, or not subject to local council governance. Accordingly, the extent of council backlogs and underspend varies widely between NSW, WA, SA and Victoria. The extrapolation results also need to be interpreted with some caution as the 259 councils which are yet to be analysed across QLD, Tasmania and the Northern Territory are likely to have substantial variation due to differing asset bases and income levels due to factors such as whether (or not) water/sewer services are provided and this sub-set containing proportionally more indigenous councils which generally have relatively less extensive asset bases. Further analysis of the specific renewals backlogs in QLD, Tasmania and the NT appears to have merit and would reduce the need for extrapolation. Nevertheless, the results to date potentially provide sufficient data to extrapolate a range for the likely national position in term of backlogs, underspends and gaps. To develop this range we have applied three cases: A Low Case: where we apply the average of WA, Vic and SA average result per Council to 259 councils in QLD, Tasmania and the NT. A Mid Case: where we apply the WA, Vic, SA and NSW average result per Council to 259 councils in QLD, Tasmania and the NT. Under this approach, an indicative estimate of the potential aggregate backlog for all 700 Australian Local Councils across the country is approximately $14.5 billion with an annual renewal underspend of $1.1 billion creating funding gap to clear the backlog and correct the underspend of $2.16 billion. Based on the results for NSW, WA, SA and Vic, the jurisdiction analysis results also suggest that approximately 35% of Councils are currently unsustainable. A High Case: where we apply the NSW, Victorian and WA average result per Council to 259 councils in QLD, Tasmania and the NT. In assessing the types of councils which are more viable, whilst there will always be numerous exceptions, the councils with stronger financial positions are generally those with reasonable scale in operations and population (more often, larger urban or regional councils). Such councils typically have stronger rates income and economic bases with more sophisticated asset management and financial governance systems. The less financially viable councils tend to be smaller (often rural, remote or small metropolitan), usually with constrained own-source revenue streams and a lack of economies of scale compounded by weaknesses in financial and asset management capabilities. However, there are also a proportion of larger councils with viability problems arising due to a range of factors. These include: significant expansion into new services, a suppression of rates rises to improve voter appeal and, some elements of ineffective cost management whereby the level of expenditure controls and budgeting processes to manage cost growth may not have been adequate. Table E. SEQ Table \* ARABIC \s 2 2: Infrastructure backlog estimate, extrapolated from Access Economics and MAV results Access Economics & MAV Financial Sustainability Summary ResultsBacklog in infrastructure renewals ($m)Underspend on existing infrastructure renewals pa ($m) Est. funding gap pa ($m) (to cover backlog & annual underspend) to be generated via savings or extra revenue / grantsEst. funding gap per council pa ($m)% of Councils unsustainableNSW (152 LGBs - Access)$6,300$500$900$5.925%SA (68 LGBs - Access)$300/1$20$40$0.638%WA (142 LGBs - Access)$1,750$110$220$1.558%Vic (79 LGBs - MAV)$806/2$81$203$2.610%Total NSW/WA/SA/Vic (441 LBGs: 63% of LGBs, 76% population & 73% of local road km)$9,156$711$1,362$3.135%Low Case National Estimate (700 LGBs) (apply WA, Vic and SA average result per Council to 259 councils in QLD, Tas & NT)$12,012$922$1,826$2.6Mid Case National Estimate (700 LGBs) (apply WA, Vic, SA and NSW average result per Council to 259 councils in QLD, Tas & NT)$14,533$1,129$2,163$3.135%High Case National Estimate (700 LGBs) (apply NSW, WA, Vic average result per Council to other 259 councils in QLD, Tas & NT)$15,305$1,190$2,281$3.3Notes: 1. Access estimate for SA based only the backlog developed over last 10 years and full backlog will be higher. 2. MAV estimate of infrastructure backlog is in 2003/04 dollars, for the period between 1997/98 2003/04, hence is understated. The estimated funding gap to clear both the estimated backlog and to cover the annual underspend on renewals is $3.1 million per council per annum or $2.16 billion nationally. The pie charts below compare the actual 2004-05 local government revenue base with the revenue base required for financial sustainability.  For financial sustainability this 9% funding gap must be covered over the medium term. This appears best likely to be achieved through a combination of initiatives including further increases in efficiency, higher user charges and rates, as well as further grants support from other spheres of government. Synthesising the findings of the state based reports and the PwC Analysis The results of the Access and MAV state based sustainability studies and the PwC analysis both confirm that a significant part of the local government sector has financial sustainability problems. The PwC estimate that approximately 10% to 30% of Australias councils have sustainability issues broadly reflects the results of the state based reports that between 25% and 40% of councils, in the states analysed, could be unsustainable. Common findings across these studies are that councils with sustainability issues are likely to be developing infrastructure backlogs due to service expansions, moderate operating cost growth, minimal revenue growth giving rise to persistent underlying operating deficits and constraints on renewal expenditure. Hence, such councils have a funding gap between current and required revenue to enable them to clear the backlog and lift renewals expenditure to the optimal level. Further broad conclusions can be drawn from the PwC analysis, when the survey results are segmented into the seven DOTARS council categories: The majority of larger metropolitan councils are generally viable or have the ability to self-effect an improvement in financial sustainability. Some metropolitan councils have become over stretched generally due to service expansions. Further use of community consultations and use of flexible user pays systems may assist in effective prioritisation of local government services and infrastructure. Urban Fringe councils are mixed as some have large viability issues with some scope for internal improvements, while others are in a strong position with only minor scope for internal reform. Hence, only some of these councils appear to be dependent on additional government funding to restore sustainability. Rural Remote and Rural Agricultural generally have more pronounced viability problems. These councils typically have relatively larger scope for internal reforms, however these councils often battle against lack of scale and extra funding for renewal of existing community infrastructure is required for most. While significant progress has been made by local government to increase their financial management effectiveness and understand the need for robust AMP, this analysis suggests internal reforms alone will not resolve sustainability issues for a large part of the local government sector. Hence, such councils may need to either reduce existing services / assets, or to seek additional revenue. As council own-revenue options are limited, this lends significant merit to consider reforms to intergovernmental transfers. Key financial issues impacting financial sustainability The common characteristics of councils typically facing financial sustainability constraints often include: minimal (or negative) revenue growth cost growth which has typically exceeded revenue growth. Expenditures have been rising by an average of CPI +2-3% per annum. This cost growth is mainly due a combination of factors including a rising skill level required for most senior roles requiring higher remuneration, award wage rises of typically 4% pa for most mid to lower level roles, stronger cost escalations in the maintenance and construction sectors as well as service diversification. The divergence between cost and revenue growth can lead to operating deficits which in turn are often partly funded by deferring some infrastructure renewals expenditure. increasing involvement in non-core service provision due to escalating community demands, coupled with a related tendency by some councils to step-in to provide a non-traditional service a tendency by some councils to run operating deficits creating a need to defer or underspend on renewal of infrastructure, particularly community infrastructure which is often repeated annually creating a backlog limited access for some councils to strong financial and asset management skills which are critical to identifying sustainability problems, optimising renewals expenditure and improving revenue streams a small proportion of councils also have limited access to rate revenue due to relatively small annual rate increases and a low initial rating base. The sample of 100 councils together with the state based sustainability results indicate that local government needs to generate more cashflow to adequately maintain and renew infrastructure particularly community infrastructure. The recent sustainability inquiries have significantly improved the understanding of the local government sector of the sustainability problem. Councils have, and are, undertaking substantial ongoing efficiency reform programs to improve financial viability. However, for many councils (more often rural, remote and urban fringe), despite making sizable improvements in efficiency, there will be a need to either reduce services or downsize their asset base unless additional revenue can be secured. In assessing how to increase own-source revenues, the councils with sustainability issues often have limited options, which means that a rise in inter-governmental transfers appears the most appropriate solution. Some councils are also experiencing financial challenges due to significant population growth (e.g. sea and tree change areas) as infrastructure is augmented to meet demand. However, over the longer term, once the transitionary impacts moderate, a larger scale population, coupled with a modern asset base and sound asset management practices, should improve the prospects for such councils to be financially sustainable. What could be achieved through improved funding of local government? Improved funding for local councils, particularly for the renewal of community assets, would assist local communities by enabling councils to return important community infrastructure to acceptable levels of condition. In conjunction with improved financial and asset management practices, more appropriate funding levels for local government infrastructure and related services would help to ease the pressure of operating deficits. In addition, such extra funding would support the clearance of backlogs in renewals expenditure (identified by Access and the MAV) and then also support more regular periodic maintenance to retain service levels. Importantly, additional funding would assist local government to take full advantage of their ability to flexibly gauge and respond to the changing demands at a community level. With increasing demands for a broader scope and higher standard of community services and infrastructure, it is important that local government has the resources to ascertain the priorities of the community, and to subsequently inform and consult with the community on the trade-offs of council provided infrastructure and services. Enabling a council to respond directly to the service and infrastructure demands of an informed community would: Strengthen local communities by ensuring and adequate standard of key facilities for the ongoing provision of a range of significant social and recreational services. Provision of greater choice and consultation on council provided services and infrastructure would encourage more participation in community activities raising levels of inclusion and wellbeing. This would promote increased community cohesion and safety, particularly in rural areas. Enable the implementation of local programs to meet and include the diverse needs of the community that support cultural diversity, access and equity, equal opportunity, involving minority groups. Support sustainable environmental strategy for each community to improve local environmental outcomes. Enhance business and community links with regional areas to promote regional equity and development. Promote further economic development and the generation of employment benefits through links with the business community. Improve the quality of life of local residents through the support and alignment of health and welfare agencies within the area. Support local recreation, arts and culture and an appreciation of heritage in order to promote vibrant and active communities. Recommendations PwC has developed 11 recommendations based on a twin track approach for improving financial sustainability through the pursuit of: Internal reforms by some councils to improve their efficiency and effectiveness (recommendations a-d). Suggested changes to inter-government funding for improved financial sustainability to primarily assist the types of councils with sustainability challenges (recommendations e-h). Internal reforms required by some councils local government is now a key sphere of government in its own right and it has management structures to competently deliver on its core accountabilities. A sizable proportion of councils, including the vast majority of the larger councils, have made significant progress in reforming operations to improve efficiency and many of these councils now only need to focus on continued improvement through productivity gains which all entities should pursue. While the sustainability report undertaken in SA indicated that sustainability is more linked to policy and skills rather than size, evidence from other states indicates that scale, and implicitly size, does assist in improving sustainability. It is likely that this divergence in results is largely due to the majority of SA being an unincorporated zone, which would minimise the incidence of rural councils that cover large areas with a small population base and limited opportunities for economies of scale. Overall, some councils still have scope to further improve their efficiency and effectiveness mainly by improving their scale, financial management and asset management. Recommendations to improve council internal performance practices are targeted at the four key objectives, outlined below. In making these recommendations it is acknowledged that due to the extensive divergence between councils, the applicability of each recommendation will vary between each council. Moreover, the sustainability work led by state based local government associations has led to the implementation of a number of focussed programs, with progress underway to address the key themes of these recommendations. Improving efficiency, effectiveness and scale Further realise the gains from greater economies of scale and reduce unit costs via approaches such as regional or shared service provision, outsourcing, use of statewide purchasing agreements etc. Expanding own-source revenue Work with State Government to remove or relax legislative impediments and improve the capacity of local government to raise revenue from its own sources. Set clear and appropriate priorities Establish a robust long-term service plan which defines what council will provide and how services will be undertaken Exercise caution prior to stepping-in to attempt to resolve regional, state or national issues without a sound funding plan Secure long term funding (not just capital grants) prior to establishing new services / infrastructure. Deepen asset management and financial capacity Work with other spheres of government to facilitate improved asset management and financial skills through government funded programs (e.g. the Size, Shape and Sustainability Review in Queensland and the MAV Step Program) to lift the skills in all councils to a reasonable base level. Utilise total asset management plans and systems to better manage asset renewals and replacement and integrate into broader long-term council objectives. Undertake more regular asset condition reporting for key infrastructure. Develop nationally consistent local government financial and asset management data. There is a need for a new national program to improve the consistency and quality of local government data to enable more robust and accurate analysis and planning producing a uniform national approach to measuring viability and financial sustainability. Ideally this would be supported by the Australian Government in order to achieve optimal results. Suggested reforms to inter-government transfers PwC sees significant merit in some reforms to inter-government transfers, but these need to be targeted to primarily assist the types of councils with sustainability challenges. The specific suggested reforms to inter-government transfers are: Establish a new Local Community Infrastructure Renewals Fund (LCIRF): this fund would support councils in the more timely funding of renewals work for a range of existing community infrastructure assets such as community centres, aged care facilities, libraries, health clinics, sport and recreation facilities of appropriate scale etc. The community infrastructure asset base is ageing with large parts established in the 1950s meaning it now requires renewals and upgrading. The fund could be distributed based on relative need eg using the R2R or FAGs General Purpose distribution methods or perhaps a new or hybrid approach. The size of LCIRF could be set so as to provide a similar level of renewals support as provided by R2R (e.g. around $200-250 million pa). Revise the escalation methodology for FAGS from a mix of population growth and CPI, to a new escalation formula tailored more to local government cost movements (e.g. a combination of the ABS Wage Cost Index and Construction Cost Index coupled with population growth). Make funding for R2R permanent: this program has delivered substantial benefits and there would be significant merit to extend its duration, and further augment the R2R funding levels (including escalating the program size by the ABS Construction Cost Index). State governments to provide funding support to encourage the local council efficiency and asset management reforms: a significant proportion of councils have inadequate in-house skills to improve efficiency and to establish robust asset management and financial plans. There would be significant benefit in state governments providing partial funding to aid the development of tailored state-based reform programs. This program might be along the lines of the support provided by the Queensland Government ($25m over five years) in the Size, Shape and Sustainability Program, and the Step Program developed by MAV. Introduction Background Over the past thirty years the role and functions undertaken by most councils in Australia have continued to evolve and expand. The changing structure of Australian governance has seen the scope of council services diversify from the provision of physical infrastructure, such as roads and waste, to greater involvement in advocacy, social and human services. Some smaller councils due to funding constraints have retained primarily the traditional services. This diversification has generally been met by a relatively narrow revenue base, often with limited opportunities for increases in funding or own-source revenue. With over 700 individual local governing bodies, the local government sector is extremely diversified. Hence, the ability of individual councils to adapt to the changing financial and political environment has been mixed. Inevitably, for every conclusion drawn about particular types of councils there are always a number of exceptions. Local governments refer to councils established under State legislation as well as declared bodies, which are provided with Commonwealth financial assistance grants and are treated as councils for the purposes of grant allocations. Declared bodies do not have the same legislative requirements as councils, and include Outback Areas Community Development Trust in SA, the Roads Trust in Northern Territory, and certain Indigenous community councils and outback communities such as Tibooburra and Lord Howe Island. References to council throughout this report also include declared bodies. The financial position of councils varies from larger population councils in metro / regional areas with typically strong rate income and economic bases and more sophisticated asset management and financial governance systems, to rural / remote councils with typically small populations and extremely restricted own-source revenue streams compounded by problems associated with declining populations and skills shortages. Long-term financial sustainability is a growing concern for many councils, not limited to the rural / remote councils, that are facing constraints to their managerial capacity and financial resourcing. Evidence from South Australia suggests that differences in council size and location play a relatively minor role in explaining the incidence of operating deficits and substantial infrastructure renewal / replacement backlogs with this result being influence by substantial parts of SA being unincorporated (not serviced by local councils). By contrast, MAV analysis suggest that rural councils are more likely to have ongoing operating deficits and infrastructure backlogs whilst outer metropolitan councils are more likely to have operating deficits Common characteristics of councils typically facing financial sustainability constraints often include: Generally minimal or negative revenue growth. A small proportion of councils also have limited access to rate revenue due to relatively small annual rate increases and a low initial rating base. cost growth which has typically exceeded revenue growth. Expenditures have been rising by an average of CPI +2-3% per annum. This cost growth is mainly due a combination of factors including a rising skill level required for most senior roles requiring higher remuneration, award wage rises of typically 4% pa for most mid to lower level roles, stronger cost escalations in the maintenance and construction sectors as well as service diversification. The divergence between cost and revenue growth can lead to operating deficits which in turn are often partly funded by deferring some renewals expenditure limited access for some councils to strong financial and asset management skills which are critical to identifying sustainability problems, optimising renewals expenditure and improving revenue streams increasing involvement in non-core service provision due to escalating community demands, coupled with a related tendency by some councils to step-in to provide a non-traditional service a tendency by some councils to run operating deficits with a growing inability to meet all costs with available income leading some councils to: defer or underspend on renewal of infrastructure, particularly community infrastructure which is often repeated annually creating a backlog operating deficits; increase use of overdraft debt or extending the days until creditors are paid There is growing awareness of the financial difficulties facing a significant proportion of councils through the numerous local government inquiries and studies that have been completed in recent years. However, further work is required in developing tangible options to reform both funding and local government practices in order to improve the long-term financial sustainability of the sector. Objectives and scope of this study The Australian Local Government Association (ALGA) has commissioned PricewaterhouseCoopers (PwC) to undertake an independent analysis of the financial sustainability of councils in Australia. The full terms of reference and scope are provided in  REF _Ref142821527 \n \h  \* MERGEFORMAT Appendix A. The intention of this project is to provide a high level strategic national study that draws on the detailed analysis in a number of state based sustainability studies, in order to provide an indication of the sustainability of the nationwide local government sector. The resources available to complete this study preclude an in-depth and individual analysis to be undertaken of each of the 700 councils. The extensive diversity of the sector also makes it difficult to provide a detailed how to guide for improving sustainability that would apply to the varying circumstances of each council. Thus, this study assesses key characteristics that contribute to councils becoming at risk of sustainability problems, and develops a range of internal and funding reform options that target these issues and attempt to improve the long-term sustainability of the sector as a whole. The objective of this study is to assist the ALGA, in collaboration with state and territory local government associations, to develop a detailed plan to: enable councils to better meet their fiscal obligations as well as the growing demands for infrastructure and services; and provide a sound rationale and model for appropriate and targeted support to local government for consideration by other spheres of government. This is to be achieved through the completion of the following terms of reference: assess the current and long-term viability of the local government sector at the national, state and local level identify the key financial issues affecting the financial sustainability of local government at each level identify the trends and/or differences between groups of councils based on specified characteristics using the DOTARS council categories develop recommendations for improved financial sustainability of local government including financial governance and potential sources of additional revenue; and investigate the appropriateness of reform to intergovernmental financial transfers with a view to developing a new model for intergovernmental financial relations that will facilitate financial sustainability of local government. Our approach In undertaking this study PwC worked with ALGA and state and territory local government associations to determine the key constraints faced by councils and to identify potential reform options to improve financial sustainability. This study benefited from the growing body of work that has been undertaken in relation to the financial sustainability of local government in a number of jurisdictions across Australia. This includes both the sustainability reports commissioned by a number of state local government associations as well as reviews undertaken by the Australian Government. Hence, an extensive literature review of previous relevant reports was completed in order to ensure this study takes into account all previous findings and research approaches. The following reports were critical inputs to this study, with other useful sources listed in the Bibliography: Financial Sustainability Review Board 2005, Rising to the Challenge: Towards Financially Sustainable Local Government in South Australia Independent Inquiry into the Financial Sustainability of NSW Local Government 2006, Are Councils Sustainable? Systemic Sustainability Study June 2006: Access Economics, Local Government Finances in Western Australia House of Representatives, Standing Committee on Economics, Finance and Public Administration (SCEFPA) 2003, Rates and Taxes: A Fair Share for Responsible Local Government: Final Report Department of Transport and Regional Services 2006, Local Government National Report: 2004/05 Report on the Operation of the Local Government (Financial Assistance) Act 1995. A widespread stakeholder consultation process was conducted in order to supplement the information and data available in the public domain. The local government association, department of local government and local government grants commissions in the majority of states and territories were consulted. These consultations provided an important insight into the specific issues and constraints faced within each jurisdiction. The stakeholder consultation process was instrumental in collating data and relevant information on the local governments sector in each jurisdiction. PwC then reviewed the available information and data in order to assess the financial sustainability of the seven upper level categories of the Australian Classification of Local Governments (ACLG). Our ability to accurately assess the financial viability and sustainability of different types of councils across Australia has been constrained by a range of data limitations, including: mixed approaches to measuring and recording financial data associated with inconsistencies between states; incomplete financial and asset management records particularly for smaller councils, including a large proportion of Northern Territory Councils. A key data shortcoming across a large proportion of councils across the nation is accurate information on capital expenditure and renewals expenditure and inconsistent separation of maintenance, renewals and capital expenditure; and the infrequent asset re-valuations (typically 5 yearly) as well as differences in assumed asset lives impacting the accuracy of reported depreciation levels. Hence, there is a need for programs to develop nationally consistent local government financial and asset management data in order to improve the quality of the analysis and recommendations to improve the local government sector. Ideally this would be led by the Australian Government in order to achieve optimal results. PwC has subsequently utilised two approaches to assess viability namely: Financial ratio analysis using a survey of 100 councils: PwC has obtained data which were then stratified to match both the proportion of councils per state/territory and the proportion of councils in each of seven Department of Transport and Regional Services (DOTARS) size categories. Extrapolation from the MAV and Access Economics state based sustainability analysis: from the three state based inquiries (NSW, SA and WA) and from analysis undertaken by the MAV, PwC has extrapolated to provide an indicative estimate of the national sustainability gap and infrastructure backlog. The Access and MAV approaches used more sophisticated KPIs to assess financial sustainability based on forward looking renewals and own source revenue capacity. Extrapolation is required as this PwC Study has a strategic or national focus and the scope does not include detailed individual council analysis as utilised by the MAV and Access to evaluate sustainability. A two-tiered suite of reform options to both the internal operations of the local government sector and the funding streams to the sector was then developed in collaboration with ALGA and the state and territory local government associations. Local Government and reforms across Australia Over the past decade there has been growing awareness across the sector about the need to improve efficiency and financial management skills to enhance financial sustainability. As such a large body of work has been developing over recent years that analyses the sector and compiles evidence that a large number of councils are facing financial difficulties. Resultantly, significant reforms have successfully achieved numerous improvements to efficiency and sustainability of local government across Australia. Improving the financial sustainability of the local government sector is not limited to Australia, with a large number of relevant international studies also being completed. This Report draws on this prior work and the section below summarises the key local government reviews and some of the reforms that have been completed in various jurisdictions, the findings of which will be incorporated into this review.  REF _Ref144018182 Table 1.1 below provides a summary of the number of councils, average population per council, and average geographic size (km2) per council. The number of councils used in this table are based on the number of local government bodies eligible for FAGs in 2004/05, hence the total number of councils in each jurisdiction may differ to information presented elsewhere. NT has the smallest population and average land area per council, as these averages only include the incorporated areas of each jurisdiction and sizeable parts of NSW, NT and SA are unincorporated (I.e. without council coverage and services. Aside from the ACT, Victoria has the largest average population per council due to the extensive amalgamations in the 1990s, while WA has the largest average council size due to the sheer size of the largest Australian state which is entirely incorporated. Table  STYLEREF 2 \s 1. SEQ Table \* ARABIC \s 2 1: Local government in Australia, by jurisdiction & size, 2004/05 Jurisdiction# of councils1Ave pop / council3Ave council size (km2)NSW15543,9005,200 km2Vic8063,0002,800 km2SA47425,1003,300 km2 WA14214,30017,800 km2Tas2916,8002,200 km2NT633,2001,060 km2Qld15725,50011,000 km2ACTna326,7002,400 km2Total National Ave. (excl. ACT)70026,8006,020 km2Source: DOTARS 2006, 2004/05 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p.5. Population est., December 2005. SA, NSW and NT estimate of ave. council size (km2 ) only includes the incorporated land area. The section below provides a summary of local council position in each jurisdiction. Existing Local Government Financial Governance and Audit controls All local councils across Australia are already subject to frameworks of financial governance, audit and other controls. These frameworks are generally specified in state based local government acts. The frameworks are designed to ensure a transparency and openness on financial arrangements and accountability of councillors and senior council management. In summary councils are generally required to: Present their financial accounts to an annual independent to audit finances are true and accurate. These audits are undertaken by state government audit offices or by chartered accounting firms with the auditor being specifically required by law to report any irregularity to the relevant Minister. The audit is generally against all financial and performance requirements contained within the Local Government Act and is conducted against international or national accounting standards. Obtain approvals from the state departments of local government prior to committing to major financial initiatives eg new debt, public private partnerships. Prepare a detailed annual management plan including budget and 5-10 of financial forecasts. Publish an annual report which is freely available and in some jurisdictions these are also tabled in parliament. Establish an Audit Committee to provide an additional oversight of the audit process and outcomes as well as on the effectiveness of internal control and risk management. The state local government associations, as well as some state departments of local government, have provided extensive support to councils in improving the effectiveness of their financial governance. South Australia The Local Government Association of South Australian (SA) commissioned the Financial Sustainability Review Board to undertake an independent inquiry into the current and future financial position and sustainability of councils in South Australia. The final report titled, Rising to the Challenge: Towards Financially Sustainable Local Government in South Australia, published in August 2005, found that 26 of SAs 68 councils, representing 38% of councils or one-third of the States population, are categorised as financially unsustainable. The report showed that the financial situation varied significantly across councils, with approximately one-third of SA councils estimated to be in a moderately comfortable position, whilst only a small proportion of these councils had policies and practices in place that lock-in their financial sustainability. The Inquiry also found that councils had large operating deficits and were funding them through decreasing their level of infrastructure maintenance. Currently, in aggregate, councils recorded annual operating deficits amounting to $49.2 million in the 2003-04 year. For the SA councils recording operating deficits in 2003-04, their average deficits were the equivalent of 12.5% of their annual rates revenue. The accumulated negative net outlays for infrastructure renewal/replacement are estimated to form a backlog in excess of $300 million. The following factors were found to contribute to the financial position of unsustainable councils: weaknesses in financial governance practices and policies of councils, as indicated by deficiencies in council spending and funding policy frameworks relatively low levels of Commonwealth and State government funding which are generally falling as a proportion of council revenue cost pressures on councils as a result of the increasing cost of complying with escalating regulations and real or apparent cost shifting primarily by the State government a State-government freeze on council rate rises in the late 1990s ratepayer pressure for rates increases below those necessary to fund increasing service levels past policies responsible for service levels and standards in excess of those which could be sustainability funded by councils themselves deficiencies evident in asset management practices and associated depreciation and asset valuation policies; and a widespread reluctance to borrow even when it is prudent to do so. In interpreting these results it is important to bear in mind that 85% of the land area in SA is an unincorporated zone, meaning it is not covered by a local government. As such, SA does not have councils with tiny populations spread over large remote areas, which are often the types of councils with the largest sustainability issues in other states. Thus, SA is in a better position to improve the sustainability of the local government sector as the local government sector does not incur the cost of servicing remote communities, as is the case in many parts of the NT, WA, Queensland and NSW. The SA Financial Sustainability Review Board made 62 recommendations primarily to the Local Government Association. All of these have been endorsed in full or in principle by the LGASA which has instigated a $400,000 Financial Sustainability Program in response. In response to these findings the LGASA has or is in the process of: establishing a Financial Sustainability Advisory Committee. finalising and publishing a series of information papers. finalised a Council and CEO Checklist to assist Councils and as a mechanism to survey Council progress. implementing projects designed to assist Councils with long-term financial planning and with infrastructure and asset management planning. developing training and briefing programs to further assist Councils. working with other governments on intergovernmental issues. New South Wales There are currently 152 councils in NSW representing some 6.7 million residents or almost 44,300 NSW residents per council on average.The Local Government and Shires Associations of NSW (LGSA) commissioned an independent inquiry into the financial sustainability of Local Government in NSW that was completed in May 2006. The Inquiry estimated that the deficiency in capital spending (infrastructure renewal gap) for all council purposes is between $400 million and $600 million per year. This represents an annual deficiency of between $2 million and $4 million per council or between $60 and $90 per head of resident population in NSW. The annual capital spend deficit contributes to a current infrastructure renewal backlog of over $6.3 billion which is equivalent to almost $42 million per council or close to $1,000 per head of resident population in NSW. Even before accounting for future infrastructure enhancements, this backlog is expected to grow to around $21 billion by 2021 if the ongoing renewal gap is not closed. The infrastructure renewal backlog is expected to increase at a rate of around 16% per annum while council per capita revenues and expenses are expected to grow in real terms by up to 9% per annum. In other words, in the absence of policy change, the gap that exists between infrastructure renewal requirements and council per capita revenues is expected to be around 7% per annum to 2021. The Inquiry reports that additional functions and pressures on local government could result in council expenditure growth doubling in the absence of policy change. A move toward full-cost recovery and increasing rates, charges and fees to levels equivalent to the top 25% of councils as a means of matching this growth in expenditure with revenue growth, would be insufficient to eliminate the operating deficits of most councils. The Inquiry reported that the long-term financial sustainability for at least 38 or 25% of NSW councils is threatened without substantial grant and/or rate increases and/or disruptive expenditure cuts. These are councils whose prospects are for double digit operating deficit ratios after allowing for emerging pressures. The study contained a suite of recommendations to reform both funding and internal local government practices in order to improve their overall sustainability. The recommendations revolve around: Boosting supply including through removing rate pegging (in whole or part), broadening the tax base, removing tax exemptions, accruing unpaid rates to estates with an interest charge and increasing statutory fees and fines. Reducing demand including through charging for services, and/or imposing or tightening eligibility rules Revising obligations through measure which include re-setting standards and re-negotiating with other tiers of government the nature or application of their statutory obligations Re-ordering priorities including through resisting future cost and responsibility from other tiers of government where legally possible and adopting zero-based budgeting Pursuing efficiencies through measures which include benchmarking operational practices and results against other organisations, greater sharing of resources and changing procurement practices Improving capacity through raising the management and governance capacity of both elected councillors and professional staff, which will include clarifying roles and responsibilities of each party, and setting milestones for monitoring performance. As part of the proposed next steps, the Inquiry recommended (recommendation 49) the establishment of an independent commission consisting representatives from the LGSA NSW and the state to examine the problems facing local government and make recommendations for action. Subsequently the LGSA initiated the Strengthening Local Government Program to respond to the findings and recommendations of the Inquiry. Theprogram is led by the Strengthening Local Government Task Force comprising a range of key Local Government stakeholders, and, as a permanent observer, the NSW Department of Local Government. The task force is supported by six working groups covering the following issues: Intergovernmental Relations and Community Relations; Financial Management; Corporate Governance and Performance Measurement; Resource Optimising and Capacity Building; Promoting Local Government Leadership; Land Use Planning. Text Box  SEQ Text_Box \* ARABIC 1: Queenslands Size, Shape and Sustainability Review Overview of the QLD SSS Review The State Government has committed $25 million to support SSS over five years, with approximately $3 million to be spent on investigations for participating councils and the remaining balance spent on supporting the implementation of reforms. Following a commencement in July 2006 the program is expected to be completed by early 2008. The SSS project encourages Councils to examine (among others) four main options for change through a regional collaborative process. The options for change focus on Resource Sharing through Service Agreements, Resource Sharing through Joint Enterprise, Significant Boundary Change and Amalgamation. To ensure the strengths and weakness of all options for change are thoroughly investigated, a comprehensive Review Framework has been developed by the LGAQ. The key steps are: Explore options and partners: involves scanning councils to identify those that could benefit from changes in structural arrangements. This scan is to reveal the key issues, reform options and resources to be provided to each Council. Information gathering, research and analysis: in-depth exploration of the issues raised by the scan and gathering information from the communities involved. This step will result in a preliminary report exploring the advantages and disadvantages of different structural arrangement options. Community engagement: consultation with the community on reform options. Councils determine structural change option: A decision is made regarding whether to implement any of the options examined. In addition to providing a reform package, the LGAQ has recommended a number of models to obtain cost savings and improve sustainability, amongst which were: Retain processes that require unique ad hoc local knowledge and are strategic Outsource non-strategic, low risk, rule based activities or high volume transaction processing Share or outsource to gain access to latest technology without ongoing significant capital investment or a requirement for a specialist expertise; and Share or outsource to gain expertise, which the local government could not otherwise afford. Queensland The local government sector is Queensland completed a series of reforms throughout the 1990s which focused on improving efficiency. The Local Government Association of Qld (LGAQ) also drove a series of reforms between 2000 and 2004 including establishing: an investment and planning alliance with the Main Roads Department via 15 Regional Road Groups across the State; a new more cost effective arrangements for insurance covering Public Liability and Workers Compensation premiums; and new IT cost effective procurement and management services. This reform processes is continuing with the structural arrangements of the local government sector in Queensland being re-evaluated in a join initiative between the LGAQ and the Qld Department of Local Government and Planning. Launched on 1 June 2005, the Size, Shape and Sustainability (SSS) program, aims to address the increased pressures on local government, impacting on its long-term sustainability and ability to effectively service its community and statutory obligations. Further details on SSS are contained in  REF _Ref144005903 \h Text Box 1 above. Western Australia The Western Australian Local Government Association (WALGA) undertook a Systemic Sustainability Study to investigate ways of addressing the sustainability of the states 142 local councils facing a range of challenges including growing community demands and expectations, limited revenue bases. One component of this study was an assessment of the current state of council finances in WA. The findings of this assessment indicate that 80 councils in WA require a substantial (i.e. greater then 10%) increase in their own-source revenue to eliminate their underlying operating deficits. On this basis the assessment concluded that some 83 or 58% of WA councils were unsustainable on the basis that substantial adjustments appear necessary in order for the long-term finances to be put on a sustainable footing going forward. These councils serve approximately 21% of the States resident population. Other findings include: On average WA councils registered operating deficits in 2004-05 that amounted to 4.5% of their own-source revenue An infrastructure backlog of approximately $1.75 billion, or 14% of the total value of Council non-financial assets the unsustainable councils are mainly regionally located councils (93% of unsustainable councils representing 16% of the unsustainable councils resident population). These councils typically represent most of the States smallest and declining population councils and point to structural problems. The study reports that the underlying factors driving the adverse assessment include the prevalence of operating deficits and the tendency of councils with such deficits to also be developing substantial infrastructure backlogs. The study reported that these factors are symptomatic of the deficiencies in council spending as well as past cost shifting. The study also noted weaknesses in revenue policy frameworks and shortfalls in the level and escalation of grants from other governments. Victoria Whilst Victoria has not been subject to a formalised sustainability inquiry similar to Access led studies, the state and local government are actively aware of the sustainability issues facing the sector and have engaged in significant local government reform over the past decade. Major reform and restructure of the local government sector was initiated in the early 1990s under the Kennett Government. Victoria engaged in major reform process of council amalgamations, which decreased the number of councils from 210 to 78. Consequently, the average population of Victorian councils per capita is now 62,700, which is the highest nationally. Another key reform agenda in the early 1990s was the introduction of compulsory competitive tendering (CCT) which exposed the cost of providing services to competitive pressures and played a critical role in improving the efficiency, and hence, financial sustainability of local government. CCT forced councils to benchmark themselves against the performance standards of the private sector by placing a range of their services and operations out to public tender. When first introduced the CCT policy required 30% of local government services to be tendered, which then incrementally increased until 50% of services were tendered. However, due to the perceived inflexibility of the CCT policy it was repealed in 1999 and replaced with the Best Value Policy. The objective of this latter policy was focused on councils obligation to ensure they seek the best value in providing services, through a whole of organisation approach. This process of local government reform provided the impetus for ongoing work to improve the financial practices of the sector in Victoria, particularly around effective asset management. A collaborative approach between the Local Government Division of the Department for Victorian Communities (DVC),with local government peak bodies, the Municipal Association of Victoria (MAV) and Local Government Professionals has been instrumental in driving improvements in asset management. The Sustaining Local Assets policy framework was released in December 2003 to provide an overall guide the strategic management of council infrastructure assets such as local roads, bridges, public libraries and recreational facilities. This policy draws on the following two important concurrent programs: MAV Step Program: developed in 2003 provides individual assessment, expert advice and mentoring to councils to build its infrastructure asset management capacity and application of asset management principles. Three core strategies are used: awareness raising; providing tools; and self assessment and improvement framework. Further details on the Step program are contained below in  REF _Ref142813365 \h Text Box 12 in section  REF _Ref143428740 \n \h  \* MERGEFORMAT 2.8; and DVC Asset Management Performance Measures Project: developed a methodology to improve data collection and reporting to enable councils to measure their own performance in the management of infrastructure assets. The financial viability and long-term sustainability of the local government sector are key focuses of MAVs policy programs and activities. For example the MAV Asset Renewal Gap Program focuses on ensuring the appropriate quality and capture of relevant asset management data, in response to the questionable quality and integrity of data of many councils. Some innovative work has also been completed by the MAV on developing a Viability Index of councils based on data on population, roads, rates growth, mean personal income, etc, which is discussed further in Section 5 of this report. Northern Territory local government in the Northern Territory (NT) comprises 6 municipal and 30 community government councils; other organisations include 23 associations constituted under the Associations Incorporation Act, 3 associations incorporated under the Aboriginal Councils and Associations Act and one special purpose town, Jabiru, constituted under the Jabiru Town Development Act 1995. Less than 5% of the land area of the Northern Territory is covered by Local Government and only 2% of the land area of the Northern Territory is rateable. Unlike local government in all other States, local government in the NT does not have the functions of planning (development assessment) or building regulation - the Territory Government retains these powers for all but Aboriginal land where these powers are vested with Indigenous traditional owners. Some 92% of the NT population reside within a local government area, The ten largest councils in the Northern Territory provide services to approximately 160,000 residents with the 55 other councils providing for approximately 31,000 residents and the remaining 6000 residents being without a council (mining and tourist towns, pastoral properties). The average population serviced by non-municipal councils is 670. It is understood that the NT Government is in the process of a major consolidation of councils. The emphasis is mainly on amalgamation of community or aboriginal councils with each other or existing councils to improve their capacity to deliver services to their community in an efficient, viable and sustainable way. Tasmania local government in Tasmania comprises 29 councils covering some 484,700 residents or around 16,700 residents per council. Over the past six years, the Local Government Association of Tasmania has compiled a Key Performance Indicator (KPI) report on measuring Council performance in Tasmania. The KPI project aims to provide Councils with a range of indicators to measure their organisational performance. In summary the KPI report aims to: enhance performance measurement by Councils enable benchmarking and identification of best practice establish performance trends over time; and improve accountability to the community. The 2004/05 report contains five year comparison data from which there are a number of emerging trends: The data indicates a consistent downward trend in the debt-service ratio on a statewide basis. In terms of the sources of total Council revenue, the data continue to show that the city Councils are raising a greater proportion of their revenue from rates relative to the smaller Councils, and that smaller Councils are more dependent on grants. there has been a consistent reduction in the level of rates outstanding at the end of the financial year. Most councils have a level of rates outstanding at less than 5%. There has been a general increase in the number of employees per 1000 population. This may reflect the complexity of an additional range of services being provided by Local Government. The KPI project reports increased efforts by Councils to work in partnership and in regional and sub-regional arrangements and physical resource sharing is growing. Information sharing and management is identified as an area of opportunity. ACT The majority of functions typically associated with local government are provided by The Department of Urban Services (DUS) within the ACT Government. Due to the unique arrangements for the delivery of local government services in the ACT, the pressures facing local government in other jurisdictions are generally manifested differently within the ACT. The Department essentially fulfils the role of a large metropolitan council and is in a better position to take advantage of economies of scale that may not be available to small regional and rural councils in other jurisdictions. Because the provision of local government services are so different in the ACT, the territory is not covered in much of the analysis of this report. The ACT Government is developing an Integrated Asset Management System to enable better prioritising and management of local government asset maintenance through the collection of location, asset type and asset condition data. Snapshot of funding approaches in international jurisdictions In analysing sustainability and developing appropriate reform options for the local government sector in Australia, it is useful to consider successful funding approaches, and recent initiatives and reforms in other international jurisdictions. Completion of this benchmarking analysis indicates that numerous local government sectors across the world suffer from similar issues associated with constant operating deficits, infrastructure backlog and asset management. While a number of jurisdictions have implemented a range of interesting initiatives to address these issues, both at a national and individual local government level, the applicability of these approaches to the Australian environment will be need to be assessed. United Kingdom There are some 410 local authorities in the UK (England and Wales only) employing over 2.2 million people (2.1 million people in England and 164,000 in Wales). Local councils undertake an estimated 700 different functions. There is an average of 148,000 people per council, making UK councils on average 5.4 times larger than average Australian councils in population terms. local government in England and Wales is organised in two contrasting ways. In Wales and some parts of England, a single tier "all purpose council" is responsible for all local authority services and functions (Unitary, Metropolitan or London Borough). The remainder of England has a two-tier system, in which responsibility for services is divided between district and county councils. Local councils are heavily scrutinised in an effort to ensure effectiveness and efficiency in their service provision. However, it is arguable that the central government has had mixed success in this aim. The majority of the scrutiny is undertaken through the Audit Commission's Comprehensive Performance Assessment (CPA). Councils are awarded ratings - excellent, good, fair, weak or poor - on the basis of their service performance. There are currently a total of 69 in the excellent category, 146 in good, 119 in fair, 44 in weak and 10 in poor. Local councils are funded by a combination of  HYPERLINK "http://en.wikipedia.org/wiki/Central_government" \o "Central government" central government grants,  HYPERLINK "http://en.wikipedia.org/wiki/Council_Tax" \o "Council Tax" Council Tax (a locally set  HYPERLINK "http://en.wikipedia.org/wiki/Tax" \o "Tax" tax based on house value),  HYPERLINK "http://en.wikipedia.org/wiki/Business_rates" \o "Business rates" Business Rates, and fees and charges from certain services including  HYPERLINK "http://en.wikipedia.org/wiki/Decriminalised_parking_enforcement" \o "Decriminalised parking enforcement" de-criminalised parking enforcement. The proportion of revenue that comes from Council Tax is low (covering about 26% of all costs). Central government retains the right to 'cap' Council Tax if it deems it to be too much. This is an area of debate in British politics, with councils and central government at odds over council tax rises. In July 2004, the British Deputy Prime Minister commissioned Sir Michael Lyons to undertake an independent inquiry (the Lyons Review) to consider the case for changes to the present system of local government funding in England, including the reform of council tax. The terms of reference were extended in September 2005 to also include the function of local government and its future role as well as how it is funded. The key finding from the second component of the Lyons Review was that greater local choice, not more central control, is needed to enable local government to manage increasing pressures on public expenditure, increase satisfaction and build more prosperous communities. The Review calls for central government to set fewer and better-focused targets, reduce supervision of local government by central government and provide more untied funding to councils, while also challenging local government to achieve further improvements through stronger leadership, closer engagement with local residents, effective partnership with other services and the business community, and a consistent commitment to efficiency and cost effectiveness. The Government is currently conducting another review of local government in England. Details are unclear, but the creation of new unitary authorities is possible, along with an introduction of the " HYPERLINK "http://en.wikipedia.org/wiki/City_region" \o "City region" city region" concept. In October 2006, the UK Local Government White Paper was released, which proposes a new approach to local partnership whereby local authorities are given more opportunity to lead their area, work with other services to better meet the publics needs. The White Paper signalled a continued progressive shift in funding away from SPPs to area-based funding streams (the Local Area Authority funding pot) in order to give local public service providers maximum flexibility in how they deliver shared outcomes. The White Paper also encourages greater focus on a regional service delivery model utilising a " HYPERLINK "http://en.wikipedia.org/wiki/City_region" \o "City region" city region" concept. Some commentators have suggested the city region concept is a step towards the restoration of strategic authorities for the metropolitan areas. A report released by the Institute for Public Policy Research in February 2006, titled City Leadership: giving city regions the power to grow, proposed the creation of two large city-regions based on  HYPERLINK "http://en.wikipedia.org/wiki/Manchester" \o "Manchester" Manchester and  HYPERLINK "http://en.wikipedia.org/wiki/Birmingham" \o "Birmingham" Birmingham. Canada Government in Canada is organised into three and often four levels: federal, provincial or territorial, and municipal (which is often subdivided into regional and local). The municipalities are created by the province or territory, and are essentially arms of the provincial or territorial governments. Similar to Australia, Canadian municipalities source their revenue through: taxes: consumption, property and, other taxes, sales of goods and services; investment income; and funding, which includes general purpose transfers and specific purpose transfers. The intergovernmental transfers come from the two larger tiers of government in Canada, federal government and the thirteen provincial and territorial governments, the latter of which provide around 90% of overall funding to local governments. Also similar to the situation in Australia, there is a municipal fiscal imbalance in Canada, which leads to operating deficit issues in some parts of the sector. Canada has implemented a Municipal Performance Measurement Program (MPMP) that requires municipalities to report annually on 54 measures of effectiveness and efficiency in 12 key service areas. The MPMP was designed to strengthen local accountability by keeping citizens informed about municipal service plans, standards, costs and value. It was also meant to help municipalities improve local services by stimulating productivity and creativity. The federal Government of Canada is currently increasing the funding it provides to local governments for infrastructure programs to achieve the countrys overall objectives. As part of the 2005/06 Canadian federal government budget, a decision was made to share 1.5 cents per litre of the 10 cent a litre gasoline tax with local municipalities with $C600 million pa to be shared with local government in a Gas Tax Fund. The budget also committed to providing larger Canadian Cities with five cents per litre or $C2 billion per year. The intention of the funding is to foster better collaboration between federal, city and local jurisdictions and to solve issues within communities such as the municipal infrastructure deficit, affordable housing and improving the transit systems. This new funding builds upon a $C700 million full rebate of all goods and service tax (GST) from municipal governments in Canada from 2004/05 onwards. New Zealand In 1998, a number of reforms were introduced to local government by the Department of Internal Affairs to promote the social, economic, environmental and cultural well-being of communities for the present as well as the future. These reforms resulted in the amalgamation of local governments reducing the number of councils from 675 to 86, the introduction of annual planning and reporting requirements, accrual accounting requirements, enhanced accountability for chief executives and consolidation of rating powers. These accountability plans include the development of long-term council community plan with a 10-year timeframe. New Zealand Councils now comprise 12 regional councils; 15 city councils; and 57 district councils (including four unitary councils which have regional functions). There is an average of 48,180 people per council, making NZ councils on average 1.7 times larger than Australian councils. Councils have a combined annual operating expenditure of $NZ3 billion, $ NZ 800 million in capital expenditure, $ NZ 31.2 billion in rate payer equity and contribute around 3.5% of national GDP. The main functions of regional councils are: management of the effects of use of freshwater, coastal waters, air and land bio-security control of regional plant and animal pests river management, flood control and mitigation of erosion regional land transport planning and contracting of passenger services harbour navigation and safety, marine pollution and oil spills; and regional civil defence preparedness. The main functions of territorial councils (district and city councils) are: community well-being and development environmental health and safety (including building control, civil defence, and environmental health matters) infrastructure (road and transport, sewerage, water/stormwater) recreation and culture; and resource management including land use planning and development control. New Zealand local government receives its revenue from five sources. These are: rates central government grants regulatory income, e.g. development applications investments; and user charges. In the year ending June 2004 local government received some $4.6 billion in operating income. Around 57% ($NZ2.6 billion) of this came from rates, 12% ($NZ555 million) from central government assistance, 6.5% ($NZ300 million) from investments, 5% (NZ$231 million) from fees and fines and 19.5% ($NZ900 million) from other sources. The NZ local government sector is generally not heavily indebted, nor is it forecast to be so in the foreseeable future, with most local authorities within their self-imposed debt limits. Rates amounted to $NZ2.8 billion in local government revenue in 2004/05. Rates as a proportion of revenue vary significantly, however between local governments ranging between 2% and 16% or amounting to $NZ1,200 - $NZ3,700 per household. Rates per household have been set to increase by about 20% between now and 2012/13. In the year to June 2004, land transport was largest single expenditure category accounting for 26% of operating expenditure ($1.1 billion), followed by culture, recreation and sport at $0.843 billion or 19%. Since the 1998 reforms, local government has moved dramatically away from being static providers of traditional services, to become more strategically focussed in identifying and responding to local needs, and using innovative means to purchase local public goods and services. It is reported that many councils continue to investigate the most appropriate local government structures to meet their community's needs and the more efficient delivery of services. This may involve looking at new structures for delivering services, such as contracting with inter-district or regional service providers, e.g. for library services and water supply management. An issue of current debate in New Zealand is around the Rating Powers Act. local government seek to build on the improvements and savings of the last ten years by seeking changes to funding tools so that costs are more equitable, transparent and understandable. The general view of local government is that the Ratings Act is prescriptive, overly-complex, outdated and has failed to keep pace with recent reforms. Changes sought are: the liberalisation of rating powers streamlining outdated or unnecessary procedural requirements providing for councils to charge actual and reasonable costs all land being rateable (including Crown and Maori land) completion of the review of the Rating Powers Act to give local government a set of flexible, modern rating powers removal of prescriptive charging powers and their replacement with a power to charge actual and reasonable costs; and pay its own way. In November 2006 the NZ Government commissioned a further review of the local government sector focused on rates. The Inquiry's objective is: 'to consider issues relating to current local government rating, and to other revenue raising mechanisms, and provide recommendations to the Government for enhancing rating and other funding mechanisms for local authorities.' As part of its process the inquiry will look into: the level of rates and related trends, drivers of local authority expenditure, the sustainability of rates as the major revenue raising tool. The inquiry will report to the Government by 31 July 2007. Public submissions will be called for early in 2007. Implications of Local Government International Review for Australia It is inherently difficult to undertake a direct comparison of the issues facing local government bodies in overseas jurisdictions. Differences in inter-governmental structural arrangements, combined with variations in role and responsibility sharing and funding arrangements between spheres of government means that caution should be exercised when drawing out lessons and applications for Australia. However, the literature review results in some common emerging themes and trends with relevance to Australian local government. These include: a trend of consolidation through amalgamation of local government (UK, NZ) over the past decade or so recommendations for greater local government autonomy in terms of investment decision-making and reduced central government control a trend towards improved asset management practices and understanding of asset life-cycle costs a trend towards improving KPI reporting and benchmarking across aspects of local government performance similar to Australia, there is often limited scope to increase revenue councils with operating deficits are relatively common and this situation can lead to underspends on infrastructure renewal. Despite the limitations of drawing lessons from overseas jurisdictions in relation to the operation of local government in Australia, it would appear that many of the challenges faced overseas are similar to those in Australia, as are the principles underpinning local government reform. This study and associated analysis takes into account these emerging inter-jurisdictional trends which are reflected in our observations and conclusions. Overall, the system of federation in Australia and Canada arguably face a more complex set of challenges in reforming role allocations and funding arrangements compared to the unitary systems of government present in the United Kingdom and New Zealand.  HYPERLINK "http://en.wikipedia.org/wiki/Constitution" \o "Constitution" Constitutionally the unitary system is framed around a single unit with power delegated to lower levels of government by the  HYPERLINK "http://en.wikipedia.org/wiki/Central_government" \o "Central government" central government, who has the principal right to recall or modify the delegated powers. By contrast, federations, being assemblies of  HYPERLINK "http://en.wikipedia.org/wiki/State_%28subnational%29" \o "State (subnational)" states, establish a constitution which allocates state and federal functions which cannot be unilaterally changed by the central government. In federations, state governments then later establish and delegate functions to local governments. Such a system of government with constitutionally defines the jurisdiction of each level of government, but has centralised revenue raising powers, is particularly vulnerable to vertical fiscal imbalances. Hence, funding and role reform processes are generally more protracted in federations due to the need for consensus and for any changes to be pareto optimal (i.e. no level of government worse off). Consequently, the international experience highlights that reform progress, particularly in federation based systems, is significantly more likely where win-win positions can be developed for all levels of government. A key concluding observation from this brief overview of local government funding issues in other jurisdictions is that local government in the UK, Canada and NZ has typically taken greater accountability for providing a range of social services. Whereas, in Australia providing social services is typically the constitutional responsibility of state and territory governments, however this has not precluded the need for local government to step in to cover service gaps in the area. Hence, local government is often in the position of taking even more responsibility for community services than occurs in other jurisdictions pattern, without the corresponding funding streams. However, prior to fully taking such accountability there needs to be accompanying and effective funding support to ensure that local governments can meet all necessary operating, renewals costs on a sustainable basis. Acknowledgements In undertaking this Study PwC is grateful for the significant assistance from a range of stakeholders including: The ALGA Board and staff The MAV and staff the various state and territory local government associations; and Grants Commissions and Departments of Local Government in most states. PwC has also had the substantial benefit of drawing upon a range of recent local government studies, in particular the state based studies by Access Economics and the MAV. This work has been of substantial assistance in developing this national report and these prior studies are acknowledged in Appendix A. Structure of this report The remainder of this report is structured as follows: Chapter 2: provides a summary overview of the local government sector, including the role, revenue / expenditure patterns, and challenges to service delivery and efficiency. Chapter 3: outlines the key financial governance arrangements of local government, and describes the nature of intergovernmental relationships and fiscal transfers between local, state and federal government. Chapter 4: details the financial trend analysis of the seven ACLG categories of local governing bodies and assessment of financial sustainability. Chapter 5: contains the reform options suggested to improve financial sustainability of the local government sector through a two-tiered approach aimed at both internal and funding reforms. Chapter 6: summarises the key conclusions and recommendations of the study. Overview of the Local Government Sector local government in Australia is a dynamic and extremely diverse sector that combines the individual character and operations of over 700 councils. Local government plays an integral role in the Australian economy and within local communities. The annual expenditure of almost $20 billion represents around 2% of GDP, while around 1.3% of the Australian labour force employed by the local government sector. Moreover, local government provides a significant proportion of essential services and infrastructure which underpins all local and regional communities. For the numerous regional and more remote communities this driver of economic activity and role in the community is further accentuated. In order to provide some context to the financial sustainability analysis of local government, this section provides a high level overview of the typical: role and functions diversity and category breakdown of councils revenue and expenditure trends growing demands on local government relative efficiency of local government; and constraints facing some councils. Local Governments role and functions In 2004/05 approximately 700 councils were eligible to receive financial assistance grants from the Australian Government and of these 91 were indigenous community councils in Queensland, the Northern Territory (NT) and Western Australia (WA). Overall, the average local government has a population of approximately 29,400 and a geographic coverage of 602 km2, excluding significant unincorporated zones in some jurisdictions, see  REF _Ref144018182 Table 1.1. All states and the NT have local governments. The ACT is the only jurisdiction in Australia without a local government sector with those functions undertaken by the ACT Department of Urban Services. State and territory governments have constitutional responsibility for local government, and provide the legal framework to give authority to councils operations. While the Commonwealth Constitution does not acknowledge local government, the Constitution Acts of each states and the Northern Territory recognise and refer to the sector. Specific legislation in each jurisdiction determines the legislative roles and responsibilities of local government. There are significant differences in the State systems responsible for overseeing the roles, functions and responsibilities of councils. In general, state legislation imposes few limits on what services local government can provide, with wide ranging powers to carry out a variety of functions. This wide scope of powers provided to local government is intended to enable local governments to provide services in response to the changing needs of the community. As councils have the freedom to make policy decisions on which services to provide, it is difficult to conclusively define typical roles and responsibilities of councils across Australia. The broad types of local government functions and services that are usually provided are summarised in  REF _Ref144016258 Figure 2.1 below. This demonstrates the spectrum of narrow vs. broad and commercial vs. social services that councils often provide. This diagram only attempts to illustrate the extensive range of services that councils tend to offer, and does not intend to suggest that councils should strip back to a narrow service offering. Figure  STYLEREF 2 \s 2. SEQ Figure \* ARABIC \s 2 1: Spectrum of typical council services  In general, the core, and perhaps most important, functions performed by local government are the delivery of essential services (waste, and sometimes water and sewerage) and maintaining corresponding infrastructure for local residents (roads, footpaths, drainage, etc). Most councils with small population and rate revenue bases have needed to contain their in-house service scope to a narrower range of services due to financial constraints. Such small councils instead often try to provide better linkages to non-government organisations who are providing social and community services. Taking on additional responsibilities for social functions has been a growing trend in the local government sector, with a move away from property-based services to human services (see section  REF _Ref146528582 \n \h 2.5 for further details). One of the strengths of local government is the ability to gauge the changing needs and priorities of the community and respond with appropriate services. The provision of services at the local / regional level can be expected to generally be more cost-effective and efficient due to relatively smaller overhead costs and associated bureaucracy. Diversity of councils The local government sector in Australia is an inherently diversified sector as it is comprised of hundreds of distinct and individual council. Each council operates differently as the role, responsibilities and service scope varies significantly between councils. Many of the differences have resulted from the historical development of councils which were set up to address specific local issues and local priorities that differ between each community. The divergence in service scope has been further driven by the creation of regulatory responsibility, service devolution and financial inducements by the Australian and state governments and limits on financial capacity of local government. These variations go beyond rural-metropolitan differences and include: Size and population Range and scale of functions Road length and infrastructure Fiscal position (including revenue-raising capacity), resources and skills base Physical, social and cultural environments Attitudes and aspirations of their communities; and State legislative frameworks. There is significant divergence in the nature and scale of councils between urban capital cities and rural-remote councils. This can be demonstrated when the large urban capital city of Brisbane is compared to the remote rural council of Yalgoo in WA. Yalgoo, located 524 km north of Perth, has 328 people spread over a large area with a population density of 0.01 people per km2. The challenge of providing services to this type of community is clearly different from that of Brisbane city council which has over 950,000 people and a population density of 707 per km2. Yalgoo receives $2,540 per capita in general purpose funding from the Commonwealth Financial Assistance Grants, compared with $16 per capita received by Brisbane, which reflects the different levels of support under a system which attempts to provide horizontal equalisation between the two councils. Such diversity of councils makes classification and trend analysis of the sector increasingly challenging. In response to this issue the ACLG was developed by DOTARS in 1994 to categorise local governing bodies that receive general purpose financial assistance grants as defined under the Local Government (Financial Assistance) Act 1995. ACLG categorises councils using population, population density and the proportion of the population that is classified as urban. The seven upper level categories of this classification system of local councils, shown below in  REF _Ref144018409 Table 2.1, will be used in this study to compare trends between similarly classified councils. In terms of the number of councils, the majority of councils in Australia are rural agricultural (42%), followed by rural remote councils (16%). Conversely, while around 58% of councils fall into these two categories, these councils only service 9.5% of the Australian population. The majority of people living in Australia are either serviced by urban metropolitan developed (35%) and urban regional towns/city (26%). Figure  STYLEREF 2 \s 2. SEQ Figure \* ARABIC \s 2 2: Proportion of councils in each ACLG by jurisdiction  Source: DOTARS 2005, 2003/04 Report on the Operation of the Local Government (Financial Assistance) Act 1995, p.3. Under the ACLG system, approximately 78% of local governing bodies are categorised as regional or rural.  REF _Ref146959474 \h Figure 2.2 shows the large differences in the composition of councils within each jurisdiction. In the majority of jurisdictions, rural agricultural councils dominate, with urban regional towns / city and urban developed also comprising a significant number of councils. NT is the only jurisdiction to depart markedly from this model with the majority of councils categorised as rural remote. Tasmania is differentiated by not having any rural remote councils and limited urban metropolitan developed councils, while Victoria has a more even spread between urban and rural councils. While the ACLG still groups together councils with different characteristics, challenges and priorities, it provides a simple and transparent tool to analyse and assess local government in Australia. Exceptions will be numerous in any generalisations made based on category alone, however in the absence of a more reliable over-arching classification system for local government on a national level, the ACLG remains the most appropriate basis on which to differentiate councils on and draw conclusions upon. Table  STYLEREF 2 \s 2. SEQ Table \* ARABIC \s 2 1: Australian Local Government Classification System CategoryCodeDescription% CouncilsPopulation range (2002)% of Australian PopulationUrban Capital CityUCUC Councils are the Capital City Council in each State/Territory. 1%8,733 917,2166.1%Urban Metropolitan DevelopedUDUD Councils an urban centre with a pop. of over 20,000 or a pop density over 600 persons per km2. Usually well established and surround the CBD of the capital cities.13%789 270,10934.6%Urban FringeUFUF Councils have at least 90% of pop classified as urban. Include outer developing / fringe areas of the capital cities and major regional centres.10%208 191,63519.6%Urban Regional Towns/CityURUR Councils have an urban characteristic with a pop density over 30 persons per km2. Encompasses major regional centres outside the capital cities.18%57 434,47326.3%Rural AgriculturalRARA Councils predominantly have agricultural focus, with pop >20,000 and a pop density of <30 persons per km2. 42%254 54,2268.8%Rural Significant GrowthRSRS Councils are rural with a pop <20,000 but > 5,000, with an ave. annual growth rate > 3%. Usually relatively close to a capital city and often have a tourism or retirement focus.1%7,636 24,3680.7%Rural RemoteRTRT Councils are remote where <10% of the population could be characterised as urban.16%392 13,6730.7% Source: DOTARS 2006, 2004-05 Report on the Operation of the Local Government (Financial Assistance) Act 1995. Revenue local government has three major sources of revenue: municipal rates (taxation), user charges, and grants and subsidies from other levels of government. As shown in  REF _Ref143939445 \h Figure 2.3 below, rates and municipal charges (38.1%) represent the largest revenue source, followed closely by user charges (30.7%). There is a significant disparity in the ability of different councils to raise revenue due to the diversity between each council. The size of a councils own source revenue, largely rates and user charges, is determined by the population size, economic activity, rating base and ability / willingness to impose user charges. Hence, while the national average for grants and subsidy revenue is 10.4% of local government revenue, this rises to more than 70% for some rural and remote councils where own-source revenue raising capacity can be severely limited. Figure  STYLEREF 2 \s 2. SEQ Figure \* ARABIC \s 2 3: Sources of local government revenue, Australia 2004/05  Source: Australian Bureau of Statistics, Government Finance Statistics, cat. No. 5512.0 Trends over the last few years have shown a decrease in the proportion of revenue derived from grants and subsidies, which has decreased from 13.1% in 1998/99 to 10.4% in 2004/05, and a decrease from 32.6% to 30.7% in user charges over the same period. Correspondingly local governments have increased revenue from other sources, from 13.6% in 1998/99 to 18.1% in 2004/05. This rise in other revenue reflects a combination of factors including greater effort of local government over the past 30 years to increase its own source revenue through the commercialisation of prices, increases to water charges in line with COAG requirements and the development of new revenue streams (e.g. fines and car parking fees) to improve sustainability. Rates and municipal charges local government taxation revenue is limited to rates being a charge on property owners generally based on land value for council provided services. In 2004/05, local government directly raised $8.1 billion in rates. The approach to calculating and application of rates vary significantly between each jurisdiction.  REF _Ref144018490 Table 2.2 below provides a brief summary of the rates methodology in each state. Table  STYLEREF 2 \s 2. SEQ Table \* ARABIC \s 2 2: States rate-setting methodology State / TerritoryLand value assessment used to calculate rate chargesNSWRate charges are based on the unimproved capital value (UCV) of the land. NSW has a fixed mandatory pensioner concession rate, 50% of which is directly funded by councils. NSW rates are also limited by a system of rate pegging that has been in place since 1977. There is also generally no rates on most state government owned property (e.g. public schools, National Parks, etc), while state owned corporations do generally pay rates. However, major local government activities are not pay payroll tax, with a few minor exceptions for some business activities. The NSW Government determines the allowable percentage increase but may allow a variation, subject to Ministerial approval, where community is consulted, robust AMP / financial management plans are in place and the purpose of extra spend has clear merit.VictoriaCouncils in Victoria can choose between three valuation systems capital improved value, net annual value or site value. Differential rates, where different rates in the dollar are struck for separate property classes, can be applied. Councils using net annual value or site value to determine rates are limited to applying three different rates. However, councils using capital improved value can strike a wide range of differential rates, so long as the maximum differential rate is no more than four times the level of the lowest differential. In addition, councils must justify all differentials when they use the capital improved valuation system. Seventy-two councils use capital improved value, six use net annual value and one uses site value.QueenslandQueensland follows a similar approach to NSW for rates, using UCV of the land as the basis for the rates. However, the QLD Government does not impose limits on rate increases councils can apply.WAWA uses gross rental value of the land, that is, the amount that could potentially be charged should it be made available for rent, as the basis for non-rural rates charges. Rural land is predominantly assessed on UCV of the land, however this can change depending on the extent of improvements or the primary use of the land.SASA councils can use a range of land valuation methods including UCV, site value or annual value. There is no differentiation for rural property in SA. Additionally some 85% of the State is unincorporated, that is, it is not serviced by a council and hence it is not subject to rates.TasmaniaTasmanian rates are also based on one of the three criteria used in SA and Victoria. However, recent agreements in Tasmania between the State Government and councils means councils are now able to charge rates on selected State Government-owned land. The Partnership Agreement was negotiated on the basis of a revenue neutral outcome for both spheres of government. The outcome did not involve full reciprocity of taxation arrangements but involved a trade-off that saw the cessation of levies paid by councils, the payment of payroll tax and land tax by councils and the payment of rates by the State Government. The process has resulted in Local Government actually gaining revenue with the possibility of additional rate revenue as present unallocated Crown land is identified and valued.NTThe Northern Territory allows individual councils to determine the method and extent of rate charges in the council area, although the calculation of rates is still based on the UCV, the improved capital value or the annual rental value of the land. Rates can be charged on a flat parcel rate, where all land is charged at the same rate regardless of use or value. Alternatively, a differential rate similar to that used in Victoria, or a uniform rate can also be used.ACTThe ACT uses the unimproved land value of the property averaged over the three previous years to calculate rates. The calculation of rates for residential and commercial properties differs to that for rural properties. For residential and commercial properties, rates are determined as a fixed charge levied on all properties plus a rate charged on the amount that the average unimproved land value exceeds a rate-free threshold. For rural properties, a fixed charge is not applied. A differential rate applies for residential, commercial and rural properties but the same rate-free threshold applies across the three property types.Source: DOTARS 2006, Operation of the Local Government (Financial Assistance) Act 2004/05, p 28. There is only modest consistency in the rates methodology used between the states, however there are broadly two approaches of either using UCV (NSW, Qld and ACT), or allowing councils to choose between UCV, the improved capital value or the annual rental value of the property (Vic, SA, Tas, and NT). The method for calculating rates determines how to share the rates burden between ratepayers, and changing methods does not in the short-term increase total rate revenue. However, when the rates revenue between jurisdictions is compared, the states that allow councils to choose between the three rates calculation methods tend to have highest average rate revenue per capita, and also the highest rate revenue increases over the past five years to 2004/05. This outcome may be due to the greater flexibility provided to councils to choose a rate calculation method that best suits their operations. Another interpretation is that jurisdictions using CIV or NAV are likely to have completed significant efficiency reforms and they may have adopted this basis to: increase rating income and / or to improve the equity or cost reflectivity in the application of rates. Arguably councils that are able to use market value based calculations through gross rental and improved capital value based calculations are better able to develop cost reflective rates. There are also significant rate exemptions and concessions that are usually required by state governments, which typically include: pensioner concessions, charitable / benevolent organisations often receive rate exemptions, which can include public schools and hospitals government owned land may either concessions or exemptions. Additionally, mining and pastoral properties are exempt from rates in some jurisdictions, which can deprive the local government sector from a significant revenue source. In some instances the state government does not fully fund councils for the exemptions and / or concessions. As a consequence, such councils can lose a substantial proportion of tax revenue, whilst still facing costs to meet the service and infrastructure needs of such exempt and concession status properties. The rates revenue collected by local government comprises 3% of all taxation revenue of all three spheres of government, which is shown below in  REF _Ref144018514 Figure 2.4.Local government own-source revenue has an extremely narrow base, and is confined to a non-growth tax in comparison to the tax revenue to the Australian Government which is largely comprised of income, company and goods and services taxes. This vertical imbalance of tax collection is emphasised when compared to the proportion of non-financial assets managed by the local government sector. The total pool of non-financial assets in Australia is estimated to be worth around $910 Bn, as at 30 June 2005,  while $279 Bn in tax revenue was collected by all levels of government in the 2004/05 financial year. The figures below show that the Commonwealth Government collects almost 82% ($229 Bn), of total tax revenue, whilst maintaining only 8% ($73 Bn) of non-financial assets. By contrast, local government manage up to 36% ($328 Bn) of Australias non-financial assets, but only have the authority to directly collect 3%, or $8 Bn, in tax revenue. Figure  STYLEREF 2 \s 2. SEQ Figure \* ARABIC \s 2 4: Comparison of proportion of taxation revenue and non-financial assets, by sphere of government, 2004/05  Source: ABS, Taxation Revenue 2004 05, cat. no. 5506.0; and Government Finance Statistics 2004 05, cat. no. 5512.0 Local government tax revenue is further constrained by state governments, which also draw a large proportion of their revenue from property taxes, as shown in  REF _Ref144014195 Table 2.3 thus making this form of revenue even more politically sensitive to change. The States share of taxation revenue from property taxes has increased from 31.9% in 1999/00 to 38.5% in 2004/05, which represents a 32.7% nominal increase in revenue. Hence, while property taxes continue to be a key revenue source for the state governments, local government may face challenges in increasing land rates and municipal charges and are effectively crowded out by the state governments. Councils in NSW are also subject to formal rate pegging which restricts the size of annual rate increases (further discussed in section  REF _Ref146024439 \n 2.8.5). While rate pegging aims to contain local government cost increases, this can sometimes mean when cost growth exceeds the peg that such gaps can be partly funded by deferring capital renewals and upgrading. In other states and territories some councils self-enforce a form of unofficial rate pegging, with some councils not raising rates above CPI to demonstrate their fiscal responsibility and arguably to improve support from voters. Table  STYLEREF 2 \s 2. SEQ Table \* ARABIC \s 2 3: Share of taxation revenue by source by sphere of government, 2004/05 Commonwealth (%)State (%)Local (%)Taxes on income71.1%--Employers' payroll taxes0.1%28.8%-Taxes on property0.0%38.5%100%Taxes on the provision of goods and services28.4%18.9%-Taxes on the use of goods and performance of activities0.4%13.8%-Total100.0%100.0%100.0%Source: Australian Bureau of Statistics, Taxation Revenue, Table 1, cat. no. 5506.0 This structure of revenue generation between the spheres of government does not match the statutory expenditure obligations. The difference between the relative revenue and spending responsibilities of government is known as vertical fiscal imbalance (VFI), and is defined below in  REF _Ref144014213 Text Box 2. Australia reportedly has the greatest degree of VFI of any federal country due to the domination of Australian government tax revenue, which is approximately 20% larger than its own-purpose outlays. For local government the concept of horizontal equity is also important, and relates to the concept of all councils within a state / or territory being able to deliver a similar level of service. Text Box  SEQ Text_Box \* ARABIC 2: Defining Vertical Fiscal Imbalance & Horizontal Fiscal Equity Defining Vertical Fiscal Imbalance and Horizontal Fiscal Equity These two technical terms are common jargon in the analysis of how total tax revenue is shared between the three levels of government in Australia to ensure the inter-governmental transfers cover cost imbalances and so each jurisdiction or region has a common base level of services. In summary the two terms are defined as: Vertical fiscal Imbalance: is caused by the uneven distribution of taxing powers and expenditure functions, i.e. local government and states have relatively large constitutionally-assigned spending responsibilities but few own-revenue sources whilst the reverse is true at the Australian Government level. The Cost Shifting report found that only an evening up of the local sectors tax powers and expenditure responsibilities would reduce that sectors VFI problems. Hence, FAGs assists in reducing, but not eliminating, VFI. Horizontal fiscal equalisation: ensures that each local governing body each state / territory is able to function, by reasonable effort, at a standard not lower than the average standard of other local governing bodies. It is akin to the concept of geographic equity between councils. It takes account of differences in expenditure required by those local governing bodies in the performance of their functions and in the capacity of those local governing bodies to raise revenue. The adequacy of the inter-governmental transfers to share taxation revenue, and clear definition of service / expenditure requirements are critical to addressing VFI and horizontal fiscal equity. Fees and charges User fees and charges are an area which has experienced significant growth in the past few decades, this is the result of a mixture of volume and price increases. In the 1970s, fees and user charges comprised 13% of total revenue. With the significant increase in the number, and diversity, of services offered by local government this revenue source has now grown to around 30%. Sales of goods and services typically include: development applications and approvals, use of recreation and cultural facilities, etc. In many jurisdictions the state government sets statutory limits on the fees and charges for these types of services, particularly in relation to development applications and consents. Councils that provide water and sewerage services, such as those in Tasmania and Queensland, receive up to 40% of their revenue from the sales of goods and services. Under the National Competition Policy (NCP) local government businesses should aim to recover the full costs of a business activity, including recovery of renewals. The National Competition Council (NCC) has confirmed that the majority of councils with such businesses have successfully implemented pricing structures that ensure the competitive neutrality of such businesses, which has in turn maintained the sustainability of these assets. Within statutory limits, councils could further expand revenue generated from user charges where they can increase cost reflectivity. While not an issue for councils with water and utility businesses, which have been reformed to comply with NCP requirements, many councils do not have a clear understanding of the cost of their services, such as development applications, approvals, etc. Greater work needs to be completed at either a state / national level to help councils accurately assess the cost of services. Commonwealth grants and subsidies As the Australian Government collects around 80% of all taxes, the transfer of revenue through grants to local government, either directly or via state and territory governments, is critical to delivering horizontal and vertical fiscal equity. The Australian Government provides funding to local government through financial assistance grants, specific purpose payments, and direct program funding, each of which are discussed in the section below. Financial Assistance Grants Financial Assistance Grants (FAGs) is the key mechanism that the Australian Government provides recurrent funding to the local government sector. FAGs is administered through the Local Government (Financial Assistance) Act 1995 (the FAGs Act) and distributed by the Local Government Grants Commission (LGGC) in each state and NT. The FAGs Act details how the total amount of grant funds is determined and how the funds are to be distributed between the jurisdictions. FAGs have two components which are both untied in the hands of councils: general purpose assistance: majority is distributed to councils within a State on the basis of general relative need, while 30% of the general purpose grants is distributed between councils in a State on the basis of population (the minimum grant). General purpose grants are distributed between the