Fixing Council's Business Model

FIXING COUNCIL’S BUSINESS MODEL

Numbers have been rounded for simplification.

2019

• Hamilton’s population: 173,000
• Number of ratepayers (households): 53,000
• 3.2 people per household.
• Debt: $400 million
• Annual interest: $20 million

2025

• Hamilton’s population: 192,000
• Number of households: 60,000
• 3.2 people per household.
• Average rates per household: $3,000
• Debt: $1.2 billion
• Annual interest: $60 million

In 2019, Hamilton City Council was in a financial hole with deficits since 2002. Mayor Southgate continued the council’s plan to grow its way out of the problem. She did not understand that the council’s growth model created the hole in the first place. 

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The model used was ‘more people means more rates revenue’. While that is true, more people also means more expenses. Given the council was running deficits (i.e. revenue was less than expenses), Southgate should have understood that the business model was losing money on every new person. Instead, Southgate committed the council to a massive $800 million increase of generational debt to fund infrastructure development for growth. This resulted in a rise from $20 million to $60 million annually in interest costs.

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To put that into perspective, it is the entire rates income from 63,000 people (a third of the city’s population), just on interest, every year, not repaying any of the principle, or covering any of their operating costs. 

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The actual growth achieved by this was just 21,000 people. 

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Mayor Southgate’s growth model doesn’t work. With every new person arriving in Hamilton, the council is just digging a deeper hole. 

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Background

The purpose of a council is to provide local property and community services collectively where these can be provided more cost-effectively than the free market. Core services such as sewage treatment and roads benefit from economies of scale and common ownership. By comparison, competing networks of sewer pipes and roads would double the infrastructure cost which would need to be recovered from customers, with little to be gained from competition.  

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The cost of building, operating and maintaining these services is difficult or inefficient to allocate on a user-pays system. Passing through toll gates every time you drive your car down a different street creates more inconvenience than the price of payment, while paying per book borrowed from a library could create a price barrier that limits use by disadvantaged people. The practicality of fixed charges has a net benefit over the complexity of accurate usage.  

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This leads to a simple business model of a membership club. Pay your annual fee and you can use the services as much as you like. If the service is good, more people will want to join the club and your property value will rise, but if the fee is too high, people will leave and your property value goes down. There is a clear incentive for the community to get involved in managing the club properly with an elected board (mayor and councillors).   

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Historically, property value became the basis of the fee. Councils started before income tax existed, and land was easy to measure. Those with larger properties tended to have more tenants and customers to consume services, and higher property values gained more if the council did well. Therefore, the annual fees became percentage ‘rates’ of the land value, meaning wealthier residents pay more. 

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Debt - The Generation Game

Large assets like pipe and road networks, bridges, stadiums, and ports are expensive and would be an impossible burden on ratepayers in the year of construction. They have long lives and long pay-backs, often over several generations such as a bridge built for 100 years, so the only fair way to pay for them is to spread the cost over the lifetime of the use by borrowing upfront and repaying the loan using future rates income from the future residents who also benefit from the use of the asset. This is known as generational debt. It is sensible (assuming those future users get fair value), but it comes with an interest cost, just like a mortgage. 

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The basic model

Operating revenue (council rates) must cover operating expenses, including interest. This is called ‘balancing the books’. 

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Councils are allowed to make a surplus (profit). In fact, this is the only way councils repay the principal of generational debt, so it should be the norm, not the exception. Frequent high surpluses could all councils to cut rates or expand services.     

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Councils are not allowed to run deficits, because that is putting this year’s costs onto future ratepayers who don’t benefit from this year’s services. The Local Government Act sets this as a legal requirement. If a deficit is forecast, rates must be increased. 

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Councillors love spending other people’s money, but they know large rates rises to pay for that is politically unpopular. If they can get away with deficits, they will. The Act does allow deficits for emergencies. While covid and the GFC may have been reasonable excuses for two years, in Hamilton’s case, the council has run deficits every year for over twenty years. It is clearly breaking the law for the benefit of politicians at the expense of future generations, but no government has ever enforced the law.  

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The ideal growth model

As population grows, new ratepayers consume some city services such as water and rubbish (increase operating expenses) at the same level as existing ratepayers, therefore requiring new investment in infrastructure, such as more roads and pipes. This can be done with generational debt. 

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The cost of the new investment should be fully covered by the rates revenue from the new residents. Growth pays for growth. 

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The new ratepayers also benefit from some existing assets such as libraries, parks, and old roads. The cost of operating and maintaining these assets is now spread over a larger number of ratepayers, therefore average operating expenses goes down. 

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Therefore, each new ratepayer should generate a small surplus, thus growth is beneficial. 

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Unfortunately, Hamilton’s infrastructure construction and operating costs exceed the rates revenue to run it and repay the debt. The model doesn’t work and each new ratepayer is generating a small loss.  

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Fixing the problem

Legally, rates need to increase to cover operating expenses. However, this is a problem if people cannot afford higher rates. The council has committed to a 100% increase over 5 years, knowing that there is a cost of living crisis, and that rates defaults, homelessness, and hardship rebates are already growing. We cannot keep doing this.

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Philosophically, we should stop growing. Council has limited control over this because government policy is to grow the region. 11% of the Hamilton workforce is employed in construction which requires growth. It will happen regardless, and we are legally obligated to service the growth. 

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Our only option is reduce the cost of growth until there is a surplus per new ratepayer, which can be used to repay debt.

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We know NZ’s infrastructure cost is 4 x the OECD average. The ‘grow at all costs’ mentality is based on a flawed approach. Council decides it needs a new sewer, road, or library to support the growth, but does not do a cost-benefit analysis to scope the project in terms of a surplus per ratepayer. It scopes or specifies the project based on operational goals, not cost, then borrows the money and builds it. This is like a family that wants a new car so buys the latest model from a dealer on hire-purchase instead of a second-hand car that meets their needs.  

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Worse than that, council’s internal processes and overheads somehow manages to double the cost of every project. 

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The way infrastructure is delivered needs to be changed. Private Developer Agreements (PDAs which allow developers to use their own contractors and project managers) in Rotokauri and Rototuna have delivered infrastructure at half council’s budgeted cost. It is achievable, and it must be done.

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We need a new business model based on this. It will require a change in council leadership to prioritise financially responsible project management at every level to ensure growth projects only proceed if they generate a surplus per additional ratepayer. If that means altering the goals, design, specifications, or procurement, then that is what must happen.  If it means cancelling projects that don’t make financial sense, then that is what must happen. If rates double, then we are not going to get growth anyway because people won’t move here, and many Hamiltonians will be forced to leave. 

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We are working with experts in engineering, cost control, and project management outside council to develop a new business model and operating system to deliver the results the city needs.  

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