Local Government Rates Primer

Local government rates raised on property are the primary way in which local councils in Australia collect revenue for community services.

In Victoria councils are currently able to choose from three different systems for determining the base on which rates are levied: [1]

• Site Value Rating (SV): the value of land, not including any improvements
• Capital Improved Value (CIV): the value of land plus any improvements (ie. Buildings) on it
• Net Annual Value (NAV): rental value of land plus improvements (for residential this is taken as 5% of CIV rating)

Councils could raise rates based on SV, which results in better urban, social, ecological and economic outcomes than CIV (or NAV) rating.

Equity and capacity to pay

Keypoint: SV is better aligned than CIV (on average) to a ratepayer’s ability to pay. Under SV the majority of ratepayers pay lower rates.

A long misfounded assumption in the debate for using SV or a CIV rates base lies in arguments around equity and capacity to pay. It is often asserted that those who own more expensive/wealthier properties overall e.g. “Mansions”, pay more under CIV. This is assumed because CIV captures a larger portion of an individual’s total wealth.

These assumptions do not hold empirically. Murray & Hermans (2021) found that on all metrics of income, and socio-economic indexes (which include wealth and economic resources), SV was more concentrated among those with a greater capacity to pay. The wealthy spend a higher portion of their income and wealth on higher value land, than they do on bigger, better homes. That is to say,  a high-income person is more likely to live in a modest house in an expensive location, than a grand house in a far-flung neighbourhood.  In contrast, CIV was found to be effectively a flat/proportional base that is more evenly distributed. Subsequently rates on SV are more progressive than CIV, and would help to reduce wealth and income inequality.

In addition to this, land value is much more highly concentrated among fewer properties than CIV – the value of buildings has much less variation than the value of sites. This means on average under SV, rates will be somewhat lower for the majority of ratepayers. This is especially the case for homeowners, as unoccupied vacant lots and derelict properties would contribute more. As a consequence, concentrating rates on SV will reduce the price of vacant land and “renovators’ delights”, but lower rates on the majority of properties also would boost property (building) values without making housing less affordable.

Better, well-maintained buildings

Key point: CIV rating provides a financial disincentive to renovate and invest in properties, while SV maintains the freedom of homeowners to renovate without penalty

When property owners invest their own money into their buildings, improved values increase, so their rates increase under CIV. This is an obvious financial disincentive to keep homes and buildings well-maintained and up-to-date – the property owner is better off letting buildings deteriorate, as their rates would then be lower. As a result, amenity is reduced and neighbouring land values can fall.

In contrast, under SV, property owners would be free to improve their homes without financial penalty. The occupants (be they the owner or tenants) of the buildings could benefit from improvements, as would the whole community. Urban blight would be reduced, as attractive modern buildings or tastefully preserved heritage stock would not attract higher rates than deteriorating unfit buildings or unsightly vacant lots.

Renewable Energy

Key point: SV results in greater take-up of renewable energy and household energy storage than CIV rating

A house with solar panels is worth more than one without, and hence will attract higher rates under CIV. Site value rating, unlike CIV, will not increase taxes on building owners who have solar panels on their property, hence it will encourage take up of green energy, lowering carbon footprints and loads on the power grid. Household energy storage devices, which promote energy resilience and complement renewable energy installations, also increase the value of improvements, so are discouraged under CIV.

Reduced Urban Footprint

Key Point: SV promotes development in desirable areas, reducing sprawl

Larger buildings which accommodate more homes and businesses are more valuable in terms of improvements. Under CIV, they will attract higher rates, whereas under SV they do not. As a result, SV encourages higher density development in areas where it is permitted and economically viable. This development will take pressure off the urban fringe, reducing the pace of urban sprawl.

Benefits of this include:

• Less infrastructure pressures on the state government and outer suburban councils
• Shorter journeys
• Lower carbon emissions
• Less pressure on regional infrastructure from suburban users (eg. VLine)

Reduced Housing Stress

Key point: SV reduces housing pressures by boosting building activity, resulting in lower rents

SV encourages increased construction activity, resulting in a greater supply of housing stock. Murray & Hermans (2021) found that switching from a CIV to SV rates base is associated with a 20% increase in the value of new residential construction. This will put downward pressure on rents and prices for homes, making housing more affordable. (Investors would also gain as they would experience lower rates for their improved properties).

Economic Efficiency

Key point: SV has a lower excess burden than CIV

All of the above benefits from adopting SV over CIV-based rates arise from the fact that:

• land values arise from community activity and investment
• whereas improved values arise from the investment of property owners

As a result, a tax falling on improved values (such as CIV rates) will provide a disincentive for property owners to invest in their property. A tax falling purely on land values (such as SV rates) does not deter individual investment, and in fact captures the value associated with community investment.

Economic loss occurs when a tax changes behavior, resulting in an inferior outcome. This loss is captured in the notion of the ‘burden of taxation’. For every dollar of government revenue extracted via a certain tax, the cost in excess of that dollar is known as the ‘marginal excess burden of taxation’. Treasury research has shown that holding charges on land such as SV carry the lowest excess burdens of any tax levied by governments.

Additionally, SV rates are beneficial for economic growth, as they encourage land to be improved up to its best and highest possible use.

Overview: Rate capping

Key point: Rate capping reduces the revenue sovereignty and resilience of local councils

In addition to the suggested changes in the Local Government Review Act, the State Government has implemented a system of rate capping under the ‘Fair Go Rates’ system. This provides a statutory limit on council rate rises based on inflation.[2]

This capping system reduces the fiscal capacity and sovereignty of local councils – they must depend on state government grants to meet financial requirements (increasing cost pressures on state government too). Local councils can only raise rates in excess of the cap with the permission of the state government.

The IPART report ‘Fit for the Future’ found that 63% of local councils were not fiscally fit for the future, due to decades of rate-capping in NSW diminishing the ability of councils to raise their own rates. NSW councils on average only spent 55% as much as other states did on capital expenditure, resulting in a capital cost backlog for future generations. For Victorian councils to be subject to rate-capping would be to go down the same path of fiscal unsustainability, reducing the resilience of local government.

As seen on the above graph, municipal rates have some of the lowest excess burdens of any form of government taxation. Capping municipal rates will mean money must be raised by other means. Councils may raise fees associated with community services such as recreation centres and libraries (late fees), which disproportionately impact lower-income community members. Parking fines will increase. But lazy landowners will be encouraged.

Local councils are the level of government best poised to reflect the interests and values of their residents. Supporting local government should be a matter of civic pride and duty. Instead, the changes encouraged will weaken communities and councils, further undermining economic democracy.

For more on rates checkout our council rating portal.

Footnotes

[1] Act for the future – Directions for a New Local Government Act, DELWP 2016

[2] the formula is: average rate cap = (0.6 * CPI) + (0.4 * WPI) – efficiency factor

From A Blueprint for Change – Local Government Rates Capping and Variation Framework Review (September 2015)

Photo by Stephen Crowley on Unsplash