Kicking the tyres of rates affordability

This article, the first of a series of articles on local government rates, considers factors relevant to assessing rates affordability.

At the risk of stating the obvious, local rates are levied on properties, and rates affordability primarily affects lower-income households. Assessing the affordability of rates for each household requires knowing who occupies the property and what their household income is.

This appears straightforward on the face of it, but every household is different. The affordability of rates, for a given house or apartment, will be different for a family with children, a single parent, a couple without children, retirees, and other household types.

Rates, while the primary source of revenue for local councils, are arguably somewhat blunt. For the same property, rates are levied regardless of the type of household living in it, and therein lies the challenge in comprehensively understanding affordability.
 

The first consideration for a council is the proportion of households that are owner-occupier or renting. Clearly, owner-occupiers bear the cost of local rates. But for tenants – how is the cost of rates shared with landlords, or is it fully passed on to tenants? This is important for understanding rates affordability because lower-income households are more likely to rent than own their home (retirees aside, which we will return to later in this article).

Rents are largely driven by income growth and rental supply relative to demand. Therefore, the proportion of the increase in local rates paid by tenants is a function of the tightness of the rental market in their city or district for a given level of income growth. A related “pass-through” argument can be made for rates levied on commercial properties.  

A technical, but important, consideration is that to date rates affordability has been assessed as a proportion of gross income. Comparing local rates to disposable income, that is, gross income after accounting for housing costs such as mortgages, rents, and insurance, provides a more comprehensive understanding of affordability.

Using disposable income to assess rates affordability brings into focus the case of retirees. On average, retirees have lower incomes unless they are employed (about half of 65-69-year-olds are in the labour force) and many, although not all, are mortgage-free if owner-occupiers. In those cases, they would have lower housing costs and comfortable net wealth.

About a third of people in the lowest disposable income group own their property but do not pay mortgages. It is likely that retirees make up a sizeable proportion of this group, although breakdown by age data is not readily available. In fact, more than 80 percent of those with a disposable income of less than $32,200 are either renting (446,000), and therefore potentially sharing the cost of rates with landlords, or are mortgage-free owner-occupiers (360,000).

Home ownership rates increase with age and are highest between the ages of 75 and 79 years (78.5 percent). Since 2018, individual home ownership rates have increased for the under-25-years-old and 75-years-and-older age groups, and decreased for all other age groups. 

Working-age and employed households have higher incomes but also higher housing costs, particularly if they have a substantial mortgage on their home. Hence, the case of owner-occupier retirees also raises the questions of whether, and how, to incorporate net wealth, and not solely use disposable income, into the assessment of rates affordability.

There isn’t a compelling case to reform local rates to account for affordability across households (acknowledging that rates rebates do exist). Instead, the upcoming reform concerns the expansion of funding and financing tools available to local governments. These tools include, for example, potential bed taxes for councils with high tourism activity, sharing GST on new builds with local councils, development levies replacing development contributions, and other funding tools such as congestion charging and value capture.

As local governments’ revenue sources diversify, a comprehensive assessment of affordability would need to go beyond rates alone and would require analysis of the full range of funding options used by local councils. In the meantime, rates currently generate about half of councils’ revenue. 

Finally, as issues around the level of rates increase, the flipside of the notion of rates affordability is what they pay for. Front and centre is our local infrastructure deficit, and how the cost of new and renewing assets is shared over time and across ratepayers. The policy debate around capping local rates is a related, but mostly separate, discussion from affordability, which we will address in future articles.  

The affordability of local rates requires the consideration of different perspectives to be comprehensive. These perspectives include the types of household in each local district, the proportion of owner-occupiers and renters and how rates are shared between tenants and landlords, using disposable instead of gross income, and considering how net wealth might be included alongside income to assess the affordability of local rates.

The answer for each council across New Zealand will depend on their respective household types, including ages and income levels, and their rental markets as well as their spending plans relative to their ratepayer bases.