7.2. Improving funding and financing

Te whakapiki i te whakapūtea me te tuku pūtea

Our infrastructure providers need access to funding and financing, to ensure the right investments are made.

Improving the way we fund and finance our infrastructure will improve results in the long-term. It will mean we can deliver more, as well as more fairly, and better meet our communities’ needs. We face infrastructure challenges that will require much greater investments by government and private providers. Good funding and financing policy, supported by good decision-making, will help us to meet these challenges.

We have choices in how we fund and finance projects. These choices have implications for how much infrastructure can be provided, the quality of that infrastructure and the willingness of users to pay for that quality, and equity implications for different groups in society.

For telecommunications infrastructure, users fund infrastructure services when they pay their phone or internet bills. The telecommunications companies finance their assets (cell phone towers, lines, roadside cabinets and exchanges) by borrowing money and issuing shares to investors. Rising customer demand provides companies with the incentive to improve telecommunications infrastructure and services and provide what consumers want. This has allowed telecommunications infrastructure to respond to a 10-fold increase in data consumption in the past decade.³⁴⁸

7.2.1. Context

New Zealand needs more infrastructure than we have plans to fund.

Both public and private sector investment has increased considerably over the past two decades,³⁴⁹ with particularly large increases in electricity and telecommunications.³⁵⁰ However, we still need more infrastructure than we currently have plans to fund (as shown in Section 3).

The many reasons for these pressures include:

• Providing growing cities and export industries with infrastructure.
• Changing expectations about quality and service levels.
• Shifting to a net-zero carbon emissions economy.
• Adapting to climate change and natural hazards like earthquakes.
• Funding operational costs in areas with a declining population.
• Renewing assets that have reached end of life.

Analyses of specific infrastructure sectors often shows a need for more investment. Examples include the Department of Internal Affairs’ review of three waters investment requirements³⁵¹ and Transpower’s estimates of the renewable electricity generation infrastructure that will be needed to remove carbon emissions.³⁵² Both of these reviews found that more infrastructure is needed. We have choices on how to respond to these challenges. Increasing infrastructure funding and financing will be part of that response. It must be based on good decision-making principles and be financially sustainable for infrastructure users and providers.

7.2.2. What we’ve heard

Through both our public consultation and stakeholder engagement, we heard that funding constraints are one of the biggest barriers contributing to the need for change. A clearer and more consistent approach to funding and financing is required across the system.

There was a general sense that the methods we use to fund infrastructure were under pressure, but that designing new methods was challenging. We heard there was a need to avoid breaking the ‘person who benefits pays’ (or benefit) principle and that there still needed to be a place for local decision-making on what to build and how much to pay.

Responses highlighted the need for greater central government funding of infrastructure, in particular lead infrastructure. This is infrastructure that can encourage development and growth, like transport connections. Suggested funding mechanisms were varied, but included a share of GST generated in a region, competitive development funds and a greater use of user-pays systems.

Stakeholders and submitters had different views on what is causing more problems for infrastructure: funding or financing. Generally, sectors where charging for services is common, such as electricity and telecommunications, felt that financing was a constraint. Sectors that rely on general funding pools, like transport, were more concerned with the impact of funding on infrastructure.

7.2.3. Strategic direction

Applying good principles to guide funding and financing decisions

Choices about how to fund and finance projects have broad impacts.

The way we fund and finance infrastructure affects what projects are built, which community needs are met, who can access infrastructure and how they use it. It also has a large bearing on when we pay for it, and given the long life and high cost of infrastructure, this can mean future generations need to pay for some infrastructure that’s built now.

A principled approach to funding and financing decision-making gives communities clarity on how infrastructure will be funded and when they’ll pay. Table 4 outlines six core principles for infrastructure funding and financing, based on best practice.³⁵³ These principles support the broader infrastructure decision-making principles outlined in Section 7.1.

Funding and financing principles are currently applied inconsistently across infrastructure sectors.

The energy and telecommunications sectors make funding and financing decisions that are better aligned with these principles. These sectors are largely commercial, funded through prices paid by consumers and financed by financial institutions, shareholders and debtholders. Competition drives pricing decisions. In areas where there isn’t adequate competition, an independent regulator makes sure that prices are fair. By contrast, funding and financing decisions in the water, transport and waste sectors are less consistent with these principles.

These examples highlight that institutional incentives affect how funding and financing tools are used in practice. As well as providing new funding and financing options, infrastructure providers need incentives to make better use of tools that are already available.

Better use of prices to fund infrastructure services

Infrastructure improvements can have different drivers and beneficiaries.

The need for infrastructure upgrades arises in several ways. Increased demand can mean that more services need to be offered (for example, new homes can drive the need for more water connections and roads) or the quality of the service needs to improve (for example, extending the opening hours for a library). Sometimes both an increase and an improvement in services are needed (see Figure 31).³⁵⁴

Funding requirements are affected by service quality and demand growth

Figure 31: Multiple factors can drive the need for investment

Charging those who benefit from an infrastructure service should be the main funding option.

Charging people directly for the services they get from the infrastructure they use has a range of benefits. Charging those who benefit gives infrastructure providers direct information on how many people are using the service and a revenue stream to fund upgrades where they’re needed. This helps providers to better plan for how they can improve their service to manage periods of high demand. It might mean planning to build new infrastructure, but it also encourages innovation. If the cost of providing infrastructure increases and users aren’t prepared to pay the higher price, providers have an incentive to find alternative ways to provide quality services at a lower cost.

Charging also encourages people to think about when they use infrastructure or whether they need to use it at all. For example, charging to use a busy road during peak times can encourage people to take public transport or travel at other times. This approach is already at used in sectors such as electricity.³⁵⁵ Prices are often higher during the business day than overnight or in the weekends, encouraging users to charge their electric vehicles and run their washing machines, clothes dryers and dishwashers overnight when there’s spare capacity. It can also encourage the use of technology that takes advantage of spare capacity, for instance through timers that automatically turn on hot water cylinders in the early hours of the morning.

The principle that the person who benefits pays applies to many infrastructure services:

• In wastewater, allowing local authorities to rate wastewater based on volumes creates an important link between the services provided and the costs to users. It encourages the use of water-efficient toilets and basic maintenance to reduce leaks.
• In water, a greater use of charging based on volume of water used (volumetric charging) encourages users to use less, making it an effective mechanism for water conservation.
• In transport, pricing that’s time, location and distance sensitive can reduce congestion on busy roads by smoothing peak demand. This helps avoid the need for costly infrastructure upgrades in complex urban environments.
• In tourism, a greater use of the tourism levy to fund tourism infrastructure could assist in closing a funding gap for councils that have a greater proportion of infrastructure demand growth from tourists than residents.

Changes in technology can spark changes to infrastructure pricing. For instance, the electrification of the vehicle fleet will cause revenue from fuel taxes to decline. This is a challenge because fuel taxes currently provide a large share of overall transport funding. Digital technologies enable road use to be priced in a more sophisticated way. There’s a need therefore, to reform the transport funding system.

Some infrastructure charges, like waste levies and parking fines, discourage behaviour that has negative social or environmental impacts, like landfilling too much waste or overstaying parking time limits. While we often use these, they can be set in legislation or regulation and infrequently updated. To ensure these charges are effective over time, they should be automatically adjusted for inflation.

The transport funding system will need to change.

Many of New Zealand’s existing transport funding tools have been world leading, but increasingly they’re in need of change. The existing transport funding system:

• Is a source of inequity between road users.
• Provides few demand management signals to resolve congestion issues or contribute to emissions reductions.
• Faces some long-term sustainability challenges as vehicles become more efficient or as modal shift increases.³⁵⁶

In addition, while revenue from traditional transport funding sources wasn’t declining prior to the COVID-19 pandemic,³⁵⁷ it’s increasingly insufficient to meet the requirements of new infrastructure. How New Zealand pays for large-scale transport projects is a challenging issue, particularly when these projects are intended to enable greater housing and urban renewal, as the users and the beneficiaries of the projects may not be the same. At the same time, debt limits are constraining local government’s contribution to land transport projects. Unlike other categories of infrastructure, transport funding is complicated by the fact that assets generally don’t generate revenue once built.

As work on a new transport funding system continues, it will need to consider:

• How to reflect adequately the cost of infrastructure provision to users, potentially including variations in infrastructure costs between locations.
• How social costs, such as peak-time urban road congestion and carbon emissions, are passed on to users.
• The role of technology and especially digital technology.
• The contributions from users across different modes.
• The extent to which equity considerations will be addressed directly within the funding system or need to be addressed outside the system.

Better communication is needed to improve public understanding of infrastructure funding options, including pricing for services.

It will be important to build public understanding and acceptance of the transition towards different ways of pricing and funding infrastructure. Pricing approaches vary across different infrastructure sectors (see the ‘pricing across the sectors’ box below) and existing approaches don’t always support provision of quality infrastructure in an equitable and efficient way. However, pricing mechanisms where those who benefit pay aren’t always well supported unless people understand the benefits of implementing them.

Better communication about infrastructure choices, including the link between how infrastructure is paid for and the quality of the services that are provided, could help improve community understanding and acceptance of pricing for infrastructure services and other funding options. This could be done through infrastructure providers’ regular communications with their customers, or new information campaigns.

Local government development contributions are a good method of funding infrastructure, but a standardised process is needed.

Councils charge developers of land for the cost of the infrastructure that’s needed to service new housing (like new roads, wastewater infrastructure, parks and libraries). These charges are called development contributions and are consistent with Principle 1, the benefit principle and Principle 3, the transparency principle (see Table 4). The purpose of development contributions is to recover a fair, equitable and proportionate share of the total cost of infrastructure necessary to service growth over the long-term. The aim is to create a clear link between the demand for new infrastructure (caused by more housing) and the cost of providing that infrastructure. In principle, this can be achieved by dividing the cost of building new infrastructure by the level of new housing demand. This amount would then be used to set what developers need to pay to fund the infrastructure costs associated with new housing.

Councils need to follow processes set out in legislation when calculating development contributions. However, in reality, the way these contributions are calculated is open to interpretation. This leads to debate between councils and developers on how much the developers need to pay, which causes delays. This can be especially challenging when a new development causes the need for a step-change in infrastructure capacity, making attribution for a single development more difficult. If development contributions are set too low, a funding gap can emerge. If they’re set too high, housing development might be impeded.

A single legislative process, similar to national building standards, would make it easier for councils to charge development contributions. A consistent, standardised process could reduce legal challenges, uncertainty and cost. This is unlikely to go as far as common charges for all locations, but it could standardise the calculation methodology for all local authorities to use.

Rating of Crown properties is consistent with funding and financing principles.

Taxes and rates raise money to fund central and local government spending. However, there are some cases where landowners and others who use infrastructure are exempted from paying taxes and rates, or making other payments in lieu. This can lead to a gap between the funds collected and the amount that needs to be spent on infrastructure. Those receiving the exemptions also have no incentive to try to reduce their use of infrastructure.

Currently, Crown property is exempt from local government rates.³⁵⁹ Exempted property include schools, hospitals and some defence force land, despite much of the property requiring substantial infrastructure investment by local government. There are also some non-Crown exemptions.³⁶⁰ However, in some cases they may pay for services, such as fees for waste disposal or volumetric water charging.

Removing rates exemptions would remove the disadvantage of Crown land falling within council areas and would allow each council to apply rates more fairly to properties in its area. A range of options should be considered for how this can be introduced. It will be important to avoid creating excessive and unexpected financial liabilities to the Crown. Options could include phasing in requirements over time, ringfencing activities that don’t generate demand for local government infrastructure, or implementing user pays systems for some services.

Sometimes the people who benefit from infrastructure are not just the users of that infrastructure.

When new infrastructure generates wider benefits, this should be reflected in funding arrangements. An example is when a train station is built, making it easy for people who live nearby to take public transport. This can benefit road users by shifting demand off congested roads and also increase the value of nearby properties.³⁶¹ In this example, the users aren’t the only group to benefit from infrastructure services. Funding should come partly from the wider group that benefits, especially if it’s difficult to recover the full cost by only charging the people using the service.

One way to do this is by levying charges based on the gain in property value. This is called ‘value capture’ charging. Value capture charging is consistent with the benefit principle. However, there can be practical challenges with value capture charges. Most importantly, people need to be made aware of the charge before property values increase. This may need to be before a project is built or even before it’s announced.³⁶²

A targeted, additional rate for those landowners whose property values increase could be used as a value capture charge to fund new infrastructure. While targeted rates are already widely used to fund improvements,³⁶³ further clarification is needed on whether councils can legally use a change in land value as the basis for a targeted rate.³⁶⁴ There are also other roadblocks to using them more widely, which arise from consultative processes at the local level.³⁶⁵ These should be considered as part of the review of local government.

Government funding is justified in some cases

There’s a place for a public subsidy when there are wider social benefits or it’s needed on the grounds of equity.

For some types of infrastructure, like schools and hospitals, charging users would not be enough to match the need for their services or the benefits they offer. Public transport is another example where the wider social and environmental benefits justify a public subsidy.³⁶⁶ There are also instances where vulnerable groups, which could be those on low incomes or with high needs, require some level of public subsidy. The primary health sector is an example of low-income consumers receiving targeted subsidies. In the energy sector, Work and Income administer the Winter Energy Payment that helps with the cost of heating over the winter months for at-risk New Zealanders.³⁶⁷ When subsidies are needed, they represent an exception to Principle 1, the benefit principle (see Table 4). However, consistency with Principle 3, the transparency principle, must remain by making the level of subsidy transparent and appropriately targeted.

Direct government funding is important, but must be managed carefully.

Central and local government will need to continue funding some infrastructure out of general taxes or rates, particularly where:

• It’s not practical to exclude users who do not pay direct prices. This applies, for instance, to hospitals, parks and footpaths.
• Wider beneficiaries are difficult to identify or are spread widely among the community. This applies to primary and secondary education.
• Infrastructure is provided for social equity reasons. This applies to libraries, schools, community facilities and social housing.

In these cases, a mix of government funding and direct pricing may be appropriate. Where this applies, there’s a case to increase infrastructure funding to address important challenges. However, these instances require careful management of public funds as the resulting cross-subsidies can mean that one group of people is required to pay for use by another group. Where this approach is taken, government subsidies for infrastructure should continue to follow the funding and financing principles.

Infrastructure often has implications for equity, but lowering prices isn’t always the answer.

The pricing of infrastructure services can lead to fairness and equity issues for low-income users if it’s not matched by appropriate policies to offset these effects. However, making changes to pricing isn’t necessarily the right way to manage these issues. This is because any policy decision to lower prices for all users below the cost of provision can result in funding problems that restrict infrastructure services. This can create other equity issues.

Prices need to be applied consistently to provide sustainable funding for infrastructure services and to encourage the efficient use of infrastructure networks. For example, charging for water use encourages all consumers to conserve water. Similarly, congestion pricing rewards those who choose not to travel during peak times and provides a source of revenue to fund public transport for those who still need to travel at those times. Well-designed pricing is essential for efforts to manage demand, but the benefits of pricing require policies to ensure affordability issues aren’t created for vulnerable New Zealanders. These could include targeted subsidies, discounts and rebates.

A comprehensive assessment of social assistance tools, particularly those held by government agencies outside the infrastructure sector should be undertaken when addressing infrastructure equity issues for vulnerable and disadvantaged New Zealanders to ensure they continue to have access. Assistance should be targeted to the vulnerable, as it’s often more effective when focused on people rather than places.^368,369 Place-based approaches to mitigating equity impacts can have unintended consequences as people move in to take advantage of improved infrastructure or cheaper prices. For instance, in certain circumstances New Zealand transport investments have been shown to raise land prices and increase the cost of housing in areas that benefit.³⁷⁰ However, a place-based approach can be appropriate for certain infrastructure and under certain circumstances, for instance when low-income groups show limited mobility (which can’t be addressed through other policies)³⁷¹ or where targeted groups have a strong connection to the land.

Consolidating capital funding of infrastructure can improve access to finance and value for money.

Central government has established various infrastructure-related capital funds in the last decade. A selection of these totalling $32 billion is shown in Table 5. Some of these funds are still active, while others have been exhausted or largely exhausted. Each fund has its own criteria for how it can be spent, repayment terms, and reporting and other requirements. Dedicated funding bodies that are responsible for the funds are usually created within relevant government agencies. This helps make the purpose of the funds clearer, but it also spreads expertise across agencies and can result in inconsistent project appraisal and delivery. Some also duplicate existing funding sources and can create uncertainty in a market that depends on a consistent, predictable pipeline of work.

Fewer consolidated funds in the future would result in better prioritisation and coordination of programmes at the national level (see Case Study 13). Reducing the number of funds would make it easier to apply consistent, rigorous and transparent criteria and ensure that project evaluation and selection is done by professional management and governance boards. Greater consolidation can also increase competition, improve the predictability and stability of funds, take advantage of economies of scale and build a capability to deliver best value for money. It may provide opportunities to improve access to financing by using a combination of grants, loans and investments (including domestic and international) to increase financing options.

A consolidated fund should be consistent with best practice principles, provide transparency and be required to demonstrate value for money through an agreed prioritisation and cost-benefit analysis methodology. It should deliver on the political expectations set out in Government Policy Statements. Consolidated funds could still allow for earmarking of funds to specific purposes when appropriate.

Table 5: Examples of recent infrastructure funds

System solutions to enable effective financing arrangements

Debt funding for long-lived infrastructure is equitable.

The financing of infrastructure is important because it exists for generations. Financing allows upfront costs to be spread across time, so funding can be more closely aligned with the use of services by current and future users. In principle, aligning financing decisions with the life of infrastructure can mean costs are more fairly shared across generations, something known as intergenerational equity. This results in a better overall outcome for society. However, this approach locks in infrastructure costs for future generations that might have preferred other options. This is particularly relevant in the age of climate change and rapid technology change.

Financing infrastructure can also speed up delivery compared to cash funding, although there‘s an interest cost associated with this. In general, communities will benefit from accelerating investments where they have clear benefits despite these interest costs.

Alternative ownership structures can improve access to funding and financing.

Some councils and local infrastructure entities are unable to borrow more money to finance the infrastructure they need to keep up with population growth, large asset renewals or service quality upgrades. This problem arises due to two factors:

• Debt incurred to build infrastructure sits on council balance sheets. This happens regardless of whether the debt has been incurred by a council directly or indirectly through a council-controlled organisation or an entity that’s majority-owned by the council.³⁹⁶ This means councils are ultimately liable for all debts associated with publicly provided local infrastructure.
• Councils can only borrow at favourable interest rates if their debt-to-income ratios remain within levels required by rating agencies (often called their ‘debt ceilings’).³⁹⁷ Taking on more debt without increasing rates and user charges brings financial costs and risks, but increasing rates and user charges is typically unpopular with voters.³⁹⁸

The Infrastructure Funding and Financing Act 2020 seeks to address this problem by using Special Purpose Vehicles (SPVs), where financing of local infrastructure can occur without affecting council debt levels. An SPV established under the Act is a standalone legal entity that’s not owned by a council, so debt isn’t on the council’s balance sheet. SPVs can charge levies on properties benefiting from infrastructure provided by the SPVs. Based on this funding source, the SPV can raise finance to undertake infrastructure development.^399,400

Public-private-partnerships are a viable option for delivering infrastructure.

A public-private-partnership (PPP) is a public-private risk-sharing framework that’s widely used internationally. Unlike traditional methods for delivering projects, PPPs involve the private sector and aim to boost efficiency and effectiveness through the project lifecycles. In New Zealand, a PPP is typically a long-term contract for the delivery of a service that involves the construction of new infrastructure or improvement to existing infrastructure that is financed from external sources. Full legal ownership of the assets is retained by the Crown.⁴⁰¹ This arrangement has the advantage of spreading project cost over an extended period, freeing up public funds. By accessing private sector financing, projects can also be delivered more quickly than they might otherwise.

There are currently eight PPPs⁴⁰² planned or underway in New Zealand and these have a combined total cost of $4.2 billion.⁴⁰³ There have been some high-profile examples of PPP project delays and cost overruns. However, the five PPP projects currently operational in New Zealand have generally been delivered on-time and on-budget for the Crown. Each operational project has experienced delays of less than six months.⁴⁰⁴

In the right circumstances, the PPP model can offer better value for money than more traditional procurement approaches. When looking at how to deliver new infrastructure projects, the government should rigorously test the potential for using a PPP as part of the procurement phase.

7.2.4. Recommendations