1200 words (13 minutes reading time) by Colin Weatherby

A research article in the Australian Journal of Public Administration, titled ‘The other side of the local government ledger — The association between revenue growth and population growth,’ raises a crucial red flag for all councils currently grappling with population growth. The study, by Professor Joseph Drew and his colleagues, sheds light on the relationship between population growth and local government revenue. Professor Drew has made a video explaining the findings of the paper.

In local government, you hear a lot of talk about the rate cap, a limitation on property taxation imposed by the State government on councils, and the impact it is having on councils’ ability to fund services. I have posted previously on what I think councils should be doing in response to the spending gap arising from the rate cap. Most discussion in the sector has focused on the impact on expenditure.

Professor Joseph Drew and his colleagues are suggesting it is equally important, perhaps more important, to understand the impact on unit revenue. Unit revenue, representing the per capita revenue generated by a council, becomes pivotal when service demand stems from individuals residing in the municipality rather than the properties they occupy. The potential mismatch between service consumption drivers and revenue generators poses a substantial financial sustainability risk.

Professor Drew and his colleagues have analysed the sources of population growth and the impact on the revenue sources of councils.  It is disturbing reading and helps explain the vulnerability of growth councils to the rate cap, as revealed by the FinPro report in 2022.

Let’s start the discussion by looking at revenue. The majority of council revenue is from a property tax, commonly called the ‘rate’, which is dependent on the number of properties in the municipality. The way it works is that a council determines the total amount of funding it needs annually to deliver the services necessary to meet community needs and expectations, then divides that amount by the number of properties and levies a rate on each of them for their share of the required funding. The actual amount paid by each property depends on the value of the property and the type of land use.

In Victoria, the total amount of funding that a council can raise from rates has been limited by a rate cap imposed by the State government, which is determined annually by the Minister for Local Government based on advice from the Essential Services Commission. The basis for the annual rate cap is the Consumer Price Index and the rate cap applies equally to every council. Each council is able to apply for a higher rate cap, which may be approved if they satisfy the criteria set by the Essential Services Commission. 

The next most important revenue source is user fees. As Professor Drew and his colleagues point out, the most significant fees are access charges for the right to partake of a service and are determined by the number of properties paying the charge, not the number of people using the service. The best example is the Municipal Waste Charge. The other user fees are consumption charges that reflect the amount of a service consumed and the revenue from these fees will vary with the number of people using the service.

The last revenue source is intergovernmental grants from the State or Federal government. These are designed to address vertical and horizontal fiscal imbalances that exists across the nation or the state because higher levels of government are able to use a broader range of taxation measures. Some of these grants are based on population or the needs of people, and some are not.

In addition to their analysis of council revenue sources, the authors have also looked at the types of population growth occurring and its impact on unit revenues. There are two types of population growth. The first is organic growth that is a positive net difference between births and deaths in the municipality. This growth decreases unit revenue until children reach adulthood and require housing that then adds to the number of properties in the municipality. Until then, more people are consuming services and living in the same number of properties.

The second type of population growth is from migration. This can be internal if people move into the municipality from within Australia, or external if people move into the municipality from outside Australia. Either way, this growth can maintain unit revenue if the new people pay exactly the same amount in rates and charges as pre-existing people living in the municipality and they have the same number of people living in properties. 

It is important to note that population growth can impact on unit expenditure if the new people create demand for more, new or better services. This can be offset by unit expenditure reduction from scale economies arising from population growth, however, as the authors point out, these scale economies need to be large and have proven to be unlikely. In fact, municipal population increases arising from amalgamation of councils have actually increased unit costs.

So, what does this all mean?

Population growth leads to a decrease in unit revenue, challenging the notion of compensatory economies of scale. Breaking it down, organic growth lowers unit revenue from rates, migration growth tends to decrease it (especially with a rate cap), and unit revenue from fees and charges experiences a balancing act. Intergovernmental grants remain neutral in their impact.

While not explored in the research article, fines have emerged as an important revenue source for some councils, particularly from parking and property amenity offenses. If you assume revenue from fines will remain consistent with population growth, with no impact on unit revenue, it suggests a level of compliance or behavioral stability. If fines increase unit revenue, it could indicate that new people moving in to the municipality don’t understand what is required of them.

The authors don’t have any compelling advice for councils to address the decrease in unit revenue. Local government could get a share of the Goods and Services Tax (GST) raised by the Federal government, as originally proposed when the GST was being introduced. This is very unlikely. The rate cap could be removed. Again, very unlikely. The last suggestion they make is practical and feasible – more careful and accurate use of user fees and charges, and improving the nexus with consumption of services, for those services that are both excludable and rivalrous (see note below). Some progressive councils are already doing this:

For example, domestic waste collection ought to be charged according to both an access fee that covers the cost to pick up the bin as well as a weight or volume charge which would better reflect the cost to dispose of the material in landfill. Recent advances in technology mean that local governments can now more easily weigh and account for individual rubbish bins and doing so provides an example of how revenue might better capture organic growth.

The complexities of population growth and its impact on local government revenue go beyond a simple equation. Councils grappling with expanding populations must navigate intricate financial landscapes. This post merely scratches the surface; for a deeper understanding and valuable insights, a thorough reading of the forthcoming detailed research article is strongly recommended. It promises to be a valuable resource for councils seeking to understand and respond to the shifts in their revenue structures.

Note: Excludable and rivalrous

If a service is both excludable and rivalrous, it means that:

Excludable: It is possible to prevent or exclude individuals who have not paid for the service from enjoying or using it. Essentially, the provider can control access to the service and restrict it to those who have paid for it.

Rivalrous: The consumption or use of the service by one individual reduces the availability or utility of the service for others. In other words, there is competition or rivalry for the use of the service, and one person’s use directly affects the ability of others to use it.

A classic example of a service that is both excludable and rivalrous is a private good, such as a sandwich. The sandwich is excludable because the seller can prevent people who haven’t paid for it from eating it. It is also rivalrous because once someone takes a bite or consumes part of the sandwich, there is less of it available for others.

These characteristics contrast with public goods, which are non-excludable and non-rivalrous. Public goods are generally open for everyone to use, and one person’s use of the good does not diminish its availability or utility for others. Examples of public goods include clean air and national defense.