Response to IPART Assessments: Coolamon, Gundagai, Junee and Temora Councils.
This report provides a response to the IPART Assessment of Council Fit for the Future Proposals: Local Government Final Report October 2015. IPART found Coolamon to be Fit as a Rural Council, but noted that ‘if Government does not adopt a Rural Council model, it is unlikely the council would be Fit for the Future’ (IPART, 2015, p. 177). The remaining three councils did not satisfy the ‘scale and capacity’ criteria. Junee and Temora did however satisfy the financial metrics. Gundagai failed to meet the ‘sustainability’ and ‘efficiency’ metric benchmarks (IPART, 2015, p. 219). It is important to note that the efficiency metric does not measure efficiency and provides a misleading indicator of municipal performance in this area (Drew and Dollery, 2015a).
Fit For the Future Considerations Applying to All Councils
Scale and capacity is a fundamental concern for all four councils with respect to the IPART assessments based on Fit for the Future criteria. The Independent Local Government Review Panel (ILGRP), Office of Local Government, TCorp and IPART have failed to provide any publicly available analysis of scale. The thresholds used by IPART in response to their terms of reference appear to be opinions without empirical foundation. Drew and Dollery (2015a) and Drew, Kortt and Dollery (2015) have conducted robust empirical analysis of scale in NSW local government using two prominent empirical methods. The results arising from multiple regression analysis clearly demonstrate that there are no municipal level economies of scale for councils outside of the Greater Sydney Region, although there is some evidence of economies of density (Drew and Dollery, 2015a). ‘Economies of scale’ is a term used to describe the decrease in average total cost as output increases (based on a proxy for size, generally population). It is important to note that councils can be over-scaled and thus exhibit diseconomies of scale: that is, increasing total average costs related to size. Economies of density relate to decreasing average total costs as population density increases. Economies of density cannot be manipulated through amalgamation. Drew, Kortt and Dollery (2015) conducted data envelopment analysis using the TCorp 2011 data set and found that 20 of the 23 ILGRP proposed council mergers would result in over-scaled councils exhibiting decreasing returns to scale.
It is clear that there is little reason to believe that most mergers will result in efficiencies arising from economies of scale. When one considers the range of goods and services provided by General Purpose councils it is clear that efficiencies associated with scale are likely to be function specific. Fahey (2015) in his Masters thesis (directed by his Principal Supervisor, Drew) conducted an analysis of economies of scale on the functional data found in Schedule 1 of the 2014 audited financial statements. Only three of the Schedule 1 functions had evidence to suggest that economies of scale may exist:
· Public Order: the evidence suggests economies of scale up to a population of 244,303 (which is the optimal size indicated by the econometric evidence). For General Purpose councils in NSW public order expenditure accounts for 3.1% of budget.
· Economic Affairs: the evidence suggests economies of scale up to a population of 36,835. For General Purpose councils Economic Affairs accounts for an average of 5.4% of total expenditure.
· Transport & Communications: the evidence suggests economies of scale up to a population of 74,810. Transport expenditure makes up, on average, 32.6% of General Purpose council budgets.
The evidence suggests that the savings from Public Order and Economic Affairs functions are negligible (increasing size of councils will only result in a saving which is a small fraction of the proportion of the existing budget: ie. a fraction of 3.1% and 5.4% respectively). The savings arising from these functions alone could never justify the one-off and ongoing costs associated with amalgamation. However, the potential savings in Transport & Communications are quite large and therefore worthy of attention. Most of these savings relate to exploiting excess capacity in road maintenance and construction. Amalgamation would capture potential savings in this function however, further analysis would be required to estimate the savings and also – most importantly – estimate likely losses in other functions which may partially negate Transport & Communications savings. The least risky avenue to exploit potential savings in this function is to established shared service arrangements for all Transport & Communications functions – ideally, entering into arrangements with a number of councils so as to get as close as possible to the optimal size in this function (74,810 capita).
Capacity is an ill-defined concept and owes more to the skills and experience of council officers and the elected representatives than to municipal size. There is a case for entering into strategic arrangements for region-wide matters such as planning and advocacy. However, once again, the least risky option for addressing this criteria is to employ strategic alliances: such as regional planning authorities and lobbying entities made up of representatives of constituent councils.
A number of peer reviewed academic publications in highly regarded scholarly journals have cast significant doubt on the validity of the metrics employed in the TCorp (2013) assessments and Fit for the Future assessments (2015) – see Table 1. In short it may not be reasonable to rely on the TCorp (2013) Financial Sustainability Ratings or OLG/IPART Fit for the Future metrics when making decisions regarding the future configuration of councils.
Table 1. Scholarly Research Relating to Fit for the Future
Author / Journal / MessageDrew, Kortt and Dollery (2013) / Local Government Studies / The Queensland amalgamations were poorly targeted and produce deleterious results for residents.
Drew and Dollery (2014) / Public Money and Management / ILGRP proposed amalgamations in Sydney will not improve overall TCorp measures of financial sustainability.
Drew and Dollery (2015b) / Public Administration Quarterly / Demonstrates that the allocation of the Road component of FAG grants are chaotic and empirically indefensible.
Drew and Dollery (2015c / Australian Journal of Public Administration / Demonstrates an empirically robust method for setting TCorp benchmarks (unlike the apparently arbitrary benchmarks actually used).
Drew, Kortt and Dollery (2015b) / Australian Accounting Review / Demonstrates that there is little relationship between ‘efficiency’ and municipal ‘sustainability’ ie. Government efforts to enhance council efficiency will do little to address financial sustainability.
Drew, Kortt and Dollery (2015a) / Administration & Society / Uses DEA analysis to demonstrate that 20 of the 23 ILGRP proposed merger Groups will actually be over-scaled and thus elicit diseconomies of scale.
Drew and Dollery (2015d) / Australian Accounting Review / Demonstrates that the TCorp financial sustainability ratings were grossly distorted by ‘inconsistent’ depreciation accrual data (bad data).
Drew and Dollery (2015e) / Public Administration Quarterly / Demonstrates the TCorp financial ratings are not in any way ‘facts’ – they owe more to the method TCorp chose to assess councils than actual performance.
Drew and Dollery (2015a) / Australian Journal of Public Administration / Details numerous problems associated with TCorp, IPART and the OLG metrics.
Abelson and Joyuex (2015) / Public Money and Management / Rightly addresses the role of rate pegging on financial sustainability.
Other Important Considerations Relating to Amalgamation
It is important to consider equity, service rate and fee harmonisation and political structure when contemplating amalgamation. With respect to equity an important consideration is the implicit and explicit liabilities which residents will assume from their neighbours in an amalgamation. Explicit liabilities include items such as loans and staff provisions – because these travel to the new merged entity, existing residents effectively assume a proportion of these debts. Implicit liabilities include items such as the estimated costs to bring assets up to a satisfactory condition. After amalgamation residents will effectively contribute towards addressing their neighbour’s backlogs. Clearly, any amalgamation will result in winners and losers thus requiring careful consideration from an ethical perspective.
Municipal goods and service provision will also need to be harmonised following amalgamation. The scholarly evidence suggests that service levels are invariably increased to the highest extant level of merging entities (see Steiner (2003); Dur and Staal (2008)). This, of course, results in additional costs to service residents from council areas which had previously received lower levels of services and may thus erode any projected savings associated with merger proposals. Fee and rate harmonisation will also mean that some residents will have direct imposts on their personal budgets as a result of amalgamation. It is also important to carefully consider the political structure following amalgamation in order to ensure that a merger rather than a takeover, results. Evidence from Canadian amalgamations suggests that, in the short-term, political representatives tend to vote as a block constructed according to pre-merger boundaries (Spicer, 2012). This behaviour can result in the elected body from one pre-merger entity dominating post-merger political decision making.
By far the biggest problem for the future sustainability of rural councils is that the financial assistance grants (FAGs) do not achieve the full horizontal equalisation objectives enshrined in the enabling legislation (Local Government (Financial Assistance) Act 1995). Drew and Dollery (2015b) have recently demonstrated that the algorithms employed to allocate the road component of the FAGs are chaotic and empirically indefensible. Moreover, the methodology for allocating the General Purpose FAG component is flawed on a number of counts: the standardised revenue adjuster is not compatible with actual revenue raising limitations, the standardised expenditure allowances appear contrary to s 6(3)(b) of the Act and the disability factors lack transparency and robust empirical evidence. When combined with s6(2)(b) of the Act (30% minimum payment based on population size) it is certain that rural councils are not being provided with sufficient allocations to achieve the legislation’s objective of full horizontal equalisation.
Amalgamating councils will not address the deficiencies in FAG allocations. Moreover, amalgamation may well result in lower FAG allocations in the medium to long term. Indeed the Proclamation under subsection 6(4) of the Local Government (Financial Assistance) Act 1995 was made in response to the fact that some merged councils had received lower FAG (with respect to the sum of previous pre-merged allocations) subsequent to amalgamation. The Proclamation stipulates that merged entities must receive no less than the sum of individual allocations (based on pre-merged boundaries) for a period of four years following amalgamation. It is important to note that whilst the FAG freeze does represent a risk to the financial sustainability of councils the major problem is that FAGs are not being allocated according to the full equalisation objective. Amalgamation will not address this core funding problem and may indeed exacerbate same.
The final matter which must be considered is the cost of amalgamation. The Queensland Treasury Corporation (QTC, 2009) received claims following the 2007/08 amalgamations for an average of $8.1 million. In 2012 the QTC estimated the one-off costs for the de-amalgamation of Sunshine Coast Regional Council to be $11.02 million (Drew and Dollery, 2014). Moreover, there are on-going unquantified costs which should be considered. Accordingly, it is unlikely that the compensation provided by the NSW Government will come close to meeting the actual expenditure associated with amalgamation. This cost must be set against the projected savings arising from any amalgamation – but in many cases it appears that this has not occurred.
I now consider matters specific to the individual IPART assessments for the individual councils to which this report is addressed.
Coolamon
Coolamon was deemed ‘fit as a rural council’ and ‘satisfies the financial criteria overall’ (IPART, 2015, p. 177). However, the IPART (2015, p. 177) provided a caveat whereby ‘if Government does not adopt a Rural Council model, it is unlikely the council would be Fit for the Future’. Therefore, given the uncertainty regarding whether the Rural Council model will be progressed, it is important to consider the matter of Coolamon’s ‘scale and capacity’. As noted earlier, ‘capacity’ is an ill-defined term which relates more to the skills and experience of council staff and representatives than to size of the council. Moreover, strategic capacity can be enhanced through continued participation in the Riverina Eastern Regional Organisation of Councils (REROC). Indeed the IPART (2015, p. 177) report endorses the scale and capacity outcomes arising from REROC:
REROC demonstrates its success in increasing the scale and capacity of its member organisations on a range of measures and plans to become the pilot JO for the region.
It is thus extremely surprising that IPART deems other members of REROC (including Junee, Gundagai and Temora) to be lacking scale and capacity! One can only imagine that the analyst writing the report for Coolamon was different to the analysts employed on the Junee, Gundagai and Temora assessments. This inconsistency appears to be symptomatic of the rushed assessment process.
In point of fact data envelopment analysis (DEA) suggests that Coolamon is close to optimal scale in its current configuration (scale estimate based on 2013/14 financial data has been calculated at 0.953904, with increasing returns to scale[1]). It is thus quite likely that amalgamation of Coolamon would create an over-scaled council. Careful DEA scenario testing would be required to estimate the efficiencies or inefficiencies arising from different merger configurations.
Gundagai
Gundagai Shire fails on the ‘scale and capacity’ criteria in addition to the ‘sustainability’ and ‘efficiency’ criteria. Council is best advised to disregard assessments relating to ‘efficiency’ for the simple fact that the metric employed certainly does not measure efficiency. Efficiency relates to the conversion of inputs into outputs. The IPART/OLG metric assumes that a council’s output can be proxied by population size. This erroneous metric implicitly assumes that Council does not provide goods and services for (i) business, and (ii) road and transport infrastructure (which is negatively correlated with population size). It is therefore clearly an implausible and inadequate metric which fails to measure efficiency in any way and does not warrant serious consideration.
In relation to the ‘sustainability’ criteria, I note that Council plans to review fees for goods and services. This is a very important step for Council to take – not only will it increase revenue, but it will also address fiscal illusion (whereby residents demand greater quantities of services because the price signals are not adequate for them to appreciate the true cost of the services). IPART have suggested that Gundagai’s revenue projections are overly optimistic and have re-calculated same. I note that Council has engaged a Chartered Accountant – Teresa Boyd – who refutes IPART’s assertions based on the information provided to her by Council. It is possible that IPART may have re-classified some of the grant money (from ‘operating’ to ‘capital’ grants) and that this may explain some of the difference in calculations. I am prepared to accept the professional judgement of Ms Boyd in this instance. Moreover, it should be noted that PricewaterhouseCoopers (2006, p. 9) in its Report - National Financial Sustainability Study of Local Government - specifically drew attention to the inadvisability of excluding ‘capital grants’ from financial ratio analysis of municipalities: