GST back to councils?

If a localist agenda involves punting more responsibility down to councils, then central government assistance in funding some of those responsibilities could make sense. 

If councils were only responsible for core infrastructure, that can and should be covered by rates revenue and user charges on use of the infrastructure. If the resulting rates charges are unaffordable because of low income in the district, that's generally a problem for central government redistribution policy. Central government takes a lot of money from higher earning households and redistributes it to lower earning households, particularly lower income households with children. 

And if central government wants the council to provide infrastructure services to a higher standard than the council's residents would choose for themselves, because of central government priorities, it's appropriate for central government to assist with the cost difference. 

But if a more localist approach would have councils taking on more responsibilities over social services, that should not be funded through rates. Social services are inherently part of the state's vast redistribution mechanism. If local councils funded education, or health, or other such services out of local revenues, then central government would need to look to mechanisms like those used in Canada for topping up the accounts of poorer councils so that comparable bundles of those services could be provided in different places. The education system is already fairly redistributive, with a lot more central government funding for schools serving poorer communities' needs than those serving richer communities - whether it's done through decile measures or the more recent index measure. 

Anyway, that's just background and what I've thought is fairly settled standard local public finance in NZ. 

A couple years before I joined the Initiative, Jason Krupp at the Initiative had been arguing for giving the GST on new housing builds back to councils. I argued against it because it's impossible to track GST that way. But they were simply using GST as shorthand. What they were, and have continued, to suggest is taking the value of new housing construction in a district, multiplying it by the current GST rate, and sending it to council as a grant to help encourage them to build more housing. They could put it toward defraying the cost of necessary infrastructure; they could build a golden statue of the mayor with it. So long as it made councils more likely to say yes to housing. And I think that all makes sense - there are substantial spillover costs on the rest of the country and on central government when councils don't enable enough housing in places where people want to live - up and out.

Yesterday, Politik newsletter reported on some work by Infometrics on returning the GST charged on local council rates back to councils.

This seems a tremendously bad idea. 

Brad Olson was quoted:

"Rates should still be charged GST, as councils are providing goods and services for local residents, ratepayers, and others. But given the constant discussion about the need to fund local Government differently, perhaps GST on rates should be collected and then returned to local councils," says Mr Olsen.

I completely agree with the first line. There's a populist line about GST on rates being a tax on a tax, but if it weren't there, it would cause no end of distortions. There are all kinds of margins on which ratepayers might prefer to shift service delivery from the private sector or from households over to council provision if council-provided services had a preferential tax treatment, and from user-charges set by council to general rates funding for things already provided by council. 

As simple example, Wellington currently charges a per-bag collection fee for trash and people can choose to contract with private waste collection services if they prefer that instead. It's all fine. User charging like this recovers the cost of landfill services while providing incentive to avoid generating more trash than would otherwise be optimal. I don't know whether council is charging the right amount relative to a full cost recovery model, but the bones of the thing are right.

And suppose that an average household spent $100 per year plus GST on trashbags from council for collection services. 

If council shifted that service to just being rates funded - put out as much trash as you like, and it's covered in your standard rates bill! - and if households did not change the amount of trash they put out, then council could charge the $100 extra on rates and get $15 back from central government. Or charge a bit less and get a bit less back such that they were back to cost-recovery. 

If households put out more trash because they faced no marginal cost, council would still be better off - so long as they didn't increase trash generation by more than 15%. But more likely, households would generate more trash than that, and then either rates would have to increase by a greater amount, or councils would start rationing trash bags by non-price mechanisms, or some combination of the two. It would be a mess. 

Don't do this.

Basic drill on local public finance, or as best I've understood it, is:

1. Set appropriate user charges on everything that can reasonably be user charged.
2. Use rates to cover the cost of services that cannot reasonably be user-charged. 

Rebating GST on rates to council pushes councils away from user charging on stuff that can reasonably be user-charged. It also distorts toward council over private service delivery - at the margin, some things best provided privately get shifted into council's wheelhouse because council provision is tax-preferred. 

And if you set it instead such that councils get a GST rebate on both rates and user charges, you still have the distortion toward council over private provision.