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Local Government Cost Index

2011

Municipal Association of Victoria

© Copyright Municipal Association of Victoria, 2011.

The Municipal Association of Victoria is the owner of the copyright in the publication2011-12 Local Government Cost Index

No part of this publication may be reproduced, stored or transmitted in any form or byany means without the prior permission in writing from the Municipal Association ofVictoria.

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The MAV can provide this publication in an alternative format upon request, includinglarge print, Braille and audio.

Table of Contents

12

3

2

Summary .................................................................................................................. 3Background .............................................................................................................. 4

2.1 Council Expenses – Major Components ................................................................ 6

2.2 Employee Costs .................................................................................................... 7

2.3 Contracts & Materials Costs .................................................................................. 8

2.4 Interest Rates ........................................................................................................ 9

2.5 Capex and Other Costs ....................................................................................... 10

Local Government Cost Index and Forecasts 2010-11 and 2011-12....................... 12

Title of Paper: Date ie <June 2007>

1 Summary

Council expenses and rate increases are generally evaluated against the ConsumerPrice Index (CPI). Funding provided by State and Federal Governments to councilsis also often closely linked to the CPI.

The development of a cost index that is representative for the sector is problematicfor a number of reasons, however, analysis shows clearly that growth in the pricespaid by councils continue to exceed the CPI.

In terms of a single indicator, council costs have more closely tracked movements inAverage Weekly Earnings (AWE).

The level of human services and capital spending undertaken by councils means thatshifts in related costs are the chief determinants of cost movements for the sector.The relative importance of each, or any specific costs, differs across Victoria’s 79councils, depending on their service responsibilities.

The MAV Local Government Cost Index (LGCI) forecasts an inflator of 3.6 per centfor the 2011-12 year. This compares with growth in the CPI of 2.75 per cent forecastin the State and Commonwealth budgets. The LGCI forecast is indicative for thesector as a whole and the calculation for individual councils would be influenced bytheir differences in responsibilities for infrastructure and services and levels ofemployment and out-sourcing. The LGCI does not take account of service growthand other factors and hence increases in council budgets would be expected toexceed the LGCI forecast.

3 Title of Paper: Date ie <June 2007>

2 Background

An understanding of movements in councils’ costs is important. Federal and Statefunding programs continue to be linked to, and council rates and discretionarycharges tend to be evaluated against, movements in the CPI.

The CPI is the best known index. It measures price movements in a standard basketof services that reflect household spending patterns. However, changes in pricesfaced by a household may not have direct relevance for particular businesses andindustries and it may be reasonable to develop alternative cost indices, as is the casefor local government.

The development of an index that may be used to forecast likely price increases forcouncils is problematic because of the breadth of services and the diversity ofcouncils. There are 79 local councils in Victoria. Local government provides a broadrange of facilities and delivers a wide range of services with different combinations ofinputs. For example, in 2009-10 spending on local roads ranged from 3 per cent toaround half of the total underlying expenses of individual councils. The profile ofcouncils varies enormously in terms of human services and infrastructurerequirements, the level of contracting and debt. The timing and rate of increase inemployees’ wages and salaries (in enterprise bargaining agreements [EBAs]) andthe prices that may be obtained from suppliers of goods and services are oftenmaterially different.

It should be noted that a price index is not used in isolation to develop councilbudgets. It is only one driver of expense (cost). Council budgets must also takeaccount of growth in service volumes, any expansion in the range of councilresponsibilities and changes in service standards (quality). There is no practicalmeans of accurately separating the actual impact of increases in prices paid forinputs (inflation) from these other things when analysing councils’ growth in totalexpenses and thus assisting the development of a meaningful sector-wide costindex.

The development of a price index should not be overly complex. It should takeaccount of the key spending components of councils and be sensitive to changes inthese. It should also lend itself to being modified by councils based on theirparticular circumstances.


AWE Continues to Be the Best Existing Single Indicator of Sector Costs

The MAV’s analysis over a number of years has shown that, in terms of existingsingle indices, movements in costs for the sector have more closely correspondedwith changes in AWE than CPI and Wages Price Index (WPI), all reported by theAustralian Bureau of Statistics (ABS).

AWE reflects shifts in the composition of the labour force, for example, the shift from“blue collar” (lower paying) to “white collar” (higher paying jobs), while WPI contrastsmovement in the wages paid for specific positions. The figure below summarisesthese movements. Total expenses have been discounted for the effect of populationgrowth (implied service growth) in order to better focus on pure price increases.

Figure 1

Movements in CPI, AWE, WPI & Local Government Expenses

ABS - CPI (Melb)

Total Expenses

ABS - WPI (Victoria)

Total Expenses per head

ABS - AWE (Victoria)

1.8

1.7

1.6

1.5

1.4

1.3

1.2

1.1

1.02000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

Note: 2010-11 and 2011-12 CPI and WPI are State Govt. Forecasts and 2010-11 AWE is the February quarteraverage recorded by ABS


2.1 Council Expenses – Major Components

Data indicate that employee and contracts and materials costs are significant forcouncils. This cost breakdown characterises the dual human service delivery andcore infrastructure provision roles played by councils.

Figure 2

Council Recurrent Costs 2009-10

1%7%

17%39% Employee Costs

Contracts & Materials

Depreciation

Debt Servicing

Other

36%


2.2 Employee Costs

A number of factors influencing councils’ labour costs are relevant includingexpanded council responsibilities and labour shortages for particular professions(e.g. planners, environmental health officers, engineers) which tend to require theoffering of higher salaries. Things like salary progression, where council employeesmove to higher levels within relevant banding, may also have an impact.

The data show that employee costs per head have tended to track higher than bothAWE and WPI. The data suggest that population growth is too crude a proxy forcouncils’ increased service demands. For example, the greater application ofadditional day labour to the renewal of physical assets across a slow growing ordeclining population would influence higher employee expenses per head.

In 2007-08 and 2008-09 employee costs per head of population increased by5.5 per cent and 6.2 per cent while AWE increased by 4.8 per cent and 5.2 per cent.A relatively strong relationship is found when comparing the sector’s employee costsper EFT employee. This comparison better compares the pure price increases forcouncils’ labour related costs.

Figure 3

Employee Costs versus AWE and WPI

Employee Costs

Employee Costs per EFT Employee

Employee Costs per Head

ABS - WPI (Victoria)


2.20

2.00

1.80

1.60

1.40

1.20

1.002000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

Surveys undertaken by the MAV continue to show that negotiated future annualwage increases included in council EBAs continue to be around 4 per cent or more,which has been consistent with movements in AWE over recent years.


2.3 Contracts & Materials Costs

Contracts and materials include an enormous range of inputs including payments tocontractors, utilities, insurances, legal costs, fuel, road making materials, officesupplies, books and publications, plants, food, expensed furniture, tools andequipment, postage and various office and other consumables.

Councils make extensive use of contracts to undertake capital works and deliverother services as an alternative to in-house delivery. Future prices that councils facefrom contractors may be fixed in advance but commonly include rise and fallprovisions. These may be linked to various existing, modified or specifically devisedindices. Research indicates that, with only very few exceptions, councils’ purchasesof cost items other than contracted services constitute less than 10 per cent of thetotal of contracts and materials costs. For example, in 2009-10 utilities (electricity,gas, water, telecommunications) averaged 6 per cent and insurances 3 per cent ofcontracts and materials costs across 60 councils on which data were obtained1.

Figure 4

Contracts & Materials Costs versus AWE & CPI

Contracts & Materials Costs Victoria

ABS - CPI Measure (Melb)

Contracts & Materials Costs per head


1.80

1.70

1.60

1.50

1.40

1.30

1.20

1.10

1.002000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

The data show a substantially smaller increase in contracts and materials costs thanemployee costs and a rate of increase that was less than that in general prices.

1

8

Breakdowns provided in 2009-10 Annual Reports

Title of Paper: Date ie <June 2007>

2.4 Interest Rates

Borrowing costs accounted for only 4 per cent or less of the expenses of councils in2009-10. Clearly, the impact of interest rate rises may be significant for thosecouncils with large borrowings. Data show that councils have tended to lock-ininterest rates to minimise this risk.

The latest figures provided by the Reserve Bank (RBA) indicate a cash rate of4.75 per cent (April 2011) and a large business variable rate at around 6.7 per cent(December 2010).

Figure 5

Council & Benchmark Interest Rates

8.0%

7.5%

7.0%

6.5%

6.0%

5.5%

5.0%

4.5%

4.0%

3.5%

Average Weighted Council Rate

Large Business Variable

Median Weighted Council Rate

Cash rate

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Note: Rates are averages recorded over a year

The RBA has indicated a holding pattern for interest rates for the time being but hasforecast headline inflation to be at the top of its target band later this year. There areconsidered to be inflationary risks arising from a pick-up in business investmentwhich could lead to future upward adjustment. On the other hand personalconsumption spending and the housing sector are expected to soften. For councilswith a floating interest rate exposure a minimal increase might be a reasonableassumption.


2.5 Capex and Other Costs

The requirement to renew, upgrade and construct buildings and infrastructure assetscontributes significantly to councils’ costs. Councils’ depreciation expense isconsiderably higher than other spheres of government reflecting a more capitalintensive business relative to the Commonwealth and State. A significant numberface still face pressure to increase levels of asset renewal to account for historicaldeficiencies.

Capital spending on buildings and infrastructure fell slightly as a proportion of totaloutlays from a historical level of around 20 per cent to 17 per cent.

Figure 6

Non-Capital & Capex Spending 2009-10

7%

5%

12%

Other Capex

Building Capex

Construction Capex

Non-Capital

76%

Note: Other Capex is Land, Non-Construction Plant & Equipment & Other Assets

Local government is exposed to cost increases associated with non-residential andengineering construction, in particular where councils are responsible for extensiveroad networks. The cost index representing the sector needs to be sensitive to this.

Analysis shows that the movement in council’s capex on buildings and constructionhas significantly exceeded the trend for AWE and relevant indices produced byEcontech for the Construction Forecasting Council (CFC)2. Discounting for

2 Econtech, a private consulting and forecasting organisation, provides both historical and forecastannual figures on price movements, the latter twice yearly for the Construction Forecasting Council.The BTRE Road Construction and Maintenance Index was also previously consulted but has not beenreproduced after 2007-08.


population growth and local roads lengths does not alter this finding. The substantialdifference is likely to be explained in part by the inadequacy of the use of thesedrivers (population and road length) to isolate pure input price changes across therange of functions in which capex occurs, but a far greater contributor is likely to bethe increased renewal spending programs being implemented by councils.

Figure 7

Buildings & Construction Capex versus AWE & Econtech

Buildings

Buildings per head


Construction

Construction per km local roads

Econtech Non-Residential Construction

Econtech - Engineering Construction

3.50

3.00

2.50

2.00

1.50

1.002000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11


% Growth 2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

CPI 2.8% 3.2% 2.3% 2.0% 3.2% 2.6% 3.6% 2.8% 2.1%WPI 3.5% 3.6% 3.2% 3.9% 3.8% 3.6% 3.9% 4.0% 2.8%AWE 7.1% 6.7% 4.7% 4.3% 2.9% 2.8% 5.0% 5.3% 4.8%AWE/WPI 2.1 1.9 1.5 1.1 0.8 0.8 1.3 1.3 1.7Econtech* 3.6% 3.4% 8.6% 9.8% 5.4% 6.0% 6.8% 2.4% -3.6%Econtech# 4.5% 2.7% 3.1% 5.3% 5.6% 10.9% 5.7% 4.5% -1.9%LGCI 6.5% 6.0% 4.7% 4.8% 3.4% 4.1% 5.2% 5.0% 3.4%

3 Local Government Cost Index and Forecasts 2010-11 and2011-12

Arguably, forecasts of cost increases for the sector should be derived primarily fromanticipated movements in employee expenses. However, movements in employeeexpenses are not necessarily a good barometer for movements in the cost of capexand the local government cost index should be sensitive to this. It is not consideredefficient to incorporate separately components that account for the range of costsincluded in contracts and materials or debt servicing, although this will continue to bemonitored.

There are no forecasts provided for AWE, but there is for the CPI and WPI. There isa stronger correlation between movements in AWE and WPI than AWE and CPI3.The data show that while movements in AWE have generally exceeded the WPI thisis not always the case. Growth in WPI exceeded AWE in both 2005-06 and 2006-07.By contrast the biggest difference between AWE and WPI in nine years wasrecorded in 2009-10, 4.8 per cent versus 2.8 per cent. Individual councils mayalready be locked into increases provided in EBAs and hence forecasts may be oflittle consequence. Sectoral surveys undertaken by the MAV continue to expectincreases of 4 per cent or more in EBAs and therefore it is considered likely thatincreases may be higher than both Commonwealth and State forecasts for WPI (4.0per cent and 3.75 per cent respectively).

The MAV believes that a weighted index comprising construction (20 per cent) andother (80 per cent) continues to be a realistic basis for assessing cost movements forthe sector as a whole. While the proportion of former costs has declined slightly,representing 17 per cent of costs in 2009-10, the historical figure has been preferreduntil a change in longer term trend is confirmed. This approach recognises theprimacy of labour costs and the contrasting cost pressures that may impactconstruction. The Local Government Cost Index (LGCI) developed by the MAV isbased on the 20 per cent construction/80 per cent other costs approach, allocatingone third of construction spending to non-residential building and two thirds toengineering construction. Historical movements in “other” have been based on AWE.

Table 1: Historical Movements in CPI, AWE and LGCI

Notes:* Non-residential Construction# Engineering Construction

3 Measured by the standard deviation of the annual differences between the indices


Index Source2010-11 YrMarch toMarchActual

2010-11 2011-12

CPI ABS 3.19%

CPI C’wealth Budget 3.25% 2.75 %

CPI State Budget 3.00% 2.75%

WPI C’wealth Budget 4.00% 4.00%

WPI State Budget 3.75 % 3.75 %

Non-Residential Building Econtech 2.80% 2.52%

Engineering Construction Econtech 2.34% 1.69%

Local Government Index MAV 3.70% 3.60%

In the absence of a forecast for AWE, the movement in “other costs” have beenbased on 4 per cent and construction costs on the price indices prepared byEcontech for the CFC. The LGCI forecasts an inflator of 3.6 per cent for the 2011-12year. This compares with growth in the CPI of 2.75 per cent forecast in the State andCommonwealth budgets. The figure does not take account of service growth andother factors and hence increases in council budgets will materially exceed this level.

Table 2: Forecasts of CPI, WPI, Construction and LGCI

Notes:Local Government Cost Index based on 4% growth in employee costs


2011 cost index report (word - 416kb) web viewaverage weekly earnings (awe). ... to “white...

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