Financing large infrastructure projects is one of the biggest issues facing local authorities in both metropolitan and regional New Zealand.

Traditionally, the upfront costs of local infrastructure projects are funded by local authorities through income (usually from collected rates) or, more commonly, borrowings (usually on balance sheet and often secured against future rates). 

However, many local authorities are subject to debt ceilings, and do not have the capacity to take on further debt to finance projects that are desperately needed to support growth and replace aging assets. Those ceilings exist in various forms, including Local Government Funding Agency debt-to-revenue covenants, a local authority’s financial strategy (which under the Local Government Act 2002 must include quantified borrowing limits), and the fear of a credit rating downgrade (and associated rise in borrowing costs) if a local authority’s debt-to-revenue level soars too high. 
  
So, it is positive news that Phil Twyford, Minister for Housing and Urban Development and Transport, has prioritised the investigation of alternative financing models.

One alternative that has received considerable attention recently is value capture financing. But what is it and can it help solve New Zealand’s infrastructure needs? 

Value capture financing

While value capture financing has been used in various forms overseas, and recently become the subject of much attention in New Zealand, it is not yet well understood in this part of the world.

Broadly, value capture financing seeks to capture the future uplift in benefits and revenue from public investment and direct it towards the cost of that investment.

Properly used, such mechanisms can bridge the gap in timing between the upfront investment in public infrastructure and the flow of additional benefits and revenue (such as increased rates revenue) attributable to that investment.

TIF in the US

In the United States, individual states have for many years utilised a form of value capture called tax increment financing, or “TIF”, to help fund capital expenditure in particular districts. 

The TIF model relies on public investment in infrastructure leading to an increase in the value of the properties in a district, which creates an unearned benefit for the owners of those properties that can be tapped in order to help pay for the investment. For instance, landowners near a new railway station might realise a significant uplift in their property values, which in turn increases value-based property taxes payable in respect of those properties. TIF seeks to isolate, or capture, that uplift during a TIF period and redirect it towards the repayment of loans or bonds issued to finance the construction of the station. In that way, the project is paid for using the new value it created.

Once the TIF period expires, and the bonds or loans have been repaid, the relevant authority can collect and retain the increased tax revenue.

A new tax?

Value capture models have been implemented using a range of revenue sources, including property transfer taxes, stamp duties, general council rates and special or targeted rates, to name a few.

It’s important to note that they do not necessarily involve new taxes or rates. As in the TIF example, they may simply involve an equitable means of isolating and allocating an uplift in existing revenues. In each case, a horses-for-courses approach is needed.

Value capture in New Zealand?

There will be many hurdles to jump in order for the tool to be successfully implemented in New Zealand, but the benefits of doing so are obvious.

In order to fully realise the benefits, some legislative change may be needed to ensure the compatibility of the chosen model with the legal framework in New Zealand.

For instance, the US-style TIF model relies on the up front establishment of a set base level of tax revenue over a 20 to 25 year period (set on a no-investment basis). Additional revenue over this base level is directed into project accounts and used to repay project debt, while the base level revenue continues to be collected by the relevant authority to pay for the usual public services. In New Zealand, local authority rates are a potential existing revenue stream that could be subjected to value capture, however the Rating Valuations Act 1998 provides that a general rate must be set in the dollar of rateable value and every rating unit within a district must be revalued at least once every three years. The compatibility of those regimes is an obvious challenge. Similar issues exist in relation to targeted rates.

In addition, on its own, value capture financing will not solve the debt burden faced by local authorities. For that to happen, the bonds or loans used to finance the infrastructure investment must be off the local authorities’ balance sheets. Again, the welcome news is that the Government is already developing its policy on the use of SPVs in public infrastructure projects, which could be used to raise private debt and undertake projects, with the local authority redirecting the captured revenue to the SPV to support financing costs.

Precisely how the revenue is “redirected” is also likely to be critical to the structure, particularly if local authority rates are part of the equation. In many cases, all future general and targeted rates will have already been charged by the local authority to LGFA and/or the local authority’s bank lenders to secure its general borrowing programme.

The early indications are that the new Government is willing to invest in the resolution of these issues, and be an active partner alongside private business and local authorities in the delivery of much needed infrastructure. The solution will not be easy, but will, in our view, be a critical step towards solving New Zealand’s infrastructure conundrum.