FINANCIAL SUSTAINABILITY AND FINANCIAL

VIABILITY IN AUSTRALIAN LOCAL GOVERNMENT1

Brian Dollery & Bligh Grant
Centre for Local Government, University of New England
Armidale, NSW Australia

ABSTRACT
Sustainability has become an important ingredient in contemporary public policy. Howev-
er, considerable ambiguity surrounds the precise meaning of sustainability in concrete policy
contexts, such as financial sustainability in local government. Using recent Australian nation-
al and state public inquiries into fiscal sustainability in local government as an illustrative
example, this paper considers the tensions that derive from the dual role of local government
as local democratic institution and an efficient local service provider, and the difficulties in-
volved in defining fiscal sustainability adequately. It is argued that the concept of sustainabil-
ity cannot be meaningfully fully reduced to narrow accounting measures in local government.
Financial sustainability would thus be more accurately described as financial viability in lo-
cal government, with the term sustainability in local government employed to cover local ac-
tion directed at global sustainability.

1. INTRODUCTION

Sustainability has come to occupy an important role in contemporary public

policy discourse and this trend has also been reflected in the local government
literature. While the concept of sustainability has much to offer the analysis of
local government, especially the fact that it obliges scholars and practitioners
alike to consider the inter-temporal dimension of local government policy
making, significant difficulties exist in giving precise meaning to the term in
the local government milieu. The concept of sustainability first emerged in the
development literature through the work of the World Commission on Envi-
ronment and Development („Brundtland Commission‟) (1987: 8), which de-
fined sustainable development as a process that „meets the needs of the present
without compromising the ability of future generations to meet their own
needs‟. A key element of this definition lay in its conflation of environmental
concerns with economic growth which had previously been juxtaposed
(Romero-Lankao, 2000). As a consequence, the Brundtland Commission
(1987) definition was rapidly adopted by a wide range of writers since it
served as a unifying umbrella term for a diversity of perspectives on develop-
ment. However, the consensual nature of this definition came at the price of

1
The authors of the paper would like to extend their thanks to two anonymous referees of this
paper, who provided most useful suggestions for its improvement.

Public Finance and Management

Volume 11, Number 1, pp. 28-47
2011
PFM 11/1 29

ambiguity and imprecision (Adger and Jordan, 2009; Leuenberger and Bartle,
2009), which has now fragmented into „dozens of definitions are being passed
around among experts and politicians, because many and diverse interests and
visions hide behind the common key-idea‟ (Sachs, 1995: 8).

The disintegration of the earlier general consensus on the meaning of sus-

tainability into a raft of conflicting and frequently value-laden streams of
thought is evident in its application to local government. This should not be
surprising given the complex multi-dimensional nature of local government
with its democratic, economic, environmental, and social role in local service
provision and local community life. Nonetheless, the fact that there is current-
ly no satisfactory universal definition of sustainability in local government is
unfortunate because explicit recognition of sustainability forces local govern-
ment policy makers to give weight to the future consequences of current deci-
sions. It is thus worth exploring the nature of sustainability in the local gov-
ernment environment. The present paper considers the genesis of the term sus-
tainability and its application to the Australian local public sector, using the
thorny problem of fiscal sustainability in Australian local government as an
illustrative example. It is argued that the term fiscal viability is more appropri-
ate and sustainability in local government would be better employed to cover
local government action directed at global sustainability.

The paper is divided into three main parts. Section 2 considers previous
scholarly work on sustainability in Australian local government and the taxo-
nomic connotations which the term has taken. By way of an illuminative in-
stance of the specific problems which have been encountered in attaching op-
erational meaning to sustainability in local government, section 3 tackles the
difficult problem of fiscal sustainability in local government and the various
attempts at delineating it which have been made in recent Australian federal
and state public inquiries into local government financial sustainability. The
paper ends in section 4 with a more general assessment of the use of the con-
cept of sustainability in contemporary local government by concluding that
sustainability as an attribute of local government policy must place local gov-
ernment action in a broader context.

2. SUSTAINABILITY IN AUSTRALIAN LOCAL GOVERNMENT

In the specific context of Australian local government, the overwhelming

emphasis has fallen on financial sustainability, which we will examine in de-
tail in section 3. However, some effort has been directed at determining the
broader attributes of local government sustainability. For instance, Byrnes and
Dollery (2002) proposed five generic attributes which could account for un-
sustainable local councils, which they termed „local government failure‟:
„Voter apathy‟, where residents are characteristically disinterested in their lo-
30 Dollery & Grant

cal councils; „asymmetric information and councilor capture‟, where amateur,

part-time elected representatives are dominated by professional council man-
agers; „iron triangles‟, where standing committees of council, local govern-
ment bureaucrats and private firms adopt informal collusive arrangements
which exclude competitors; „fiscal illusion‟, where voters experience difficul-
ties in determining whether they get „value for money‟ from local service pro-
vision owing to the complexities of local expenditure and local finance; and
„political entrepreneurship‟, where elected councilors seeking higher political
office use local councils as platforms to propel their political careers. The
Byrnes and Dollery (2002) typology was attacked on grounds that it consid-
ered only „internal‟ factors to the exclusion of the „external‟ environment. For
instance, demographic, spatial and other influences were ignored.

In an attempt to remedy these deficiencies, Dollery, Byrnes and Crase

(2008) developed a new taxonomy of Australian „local government failure‟
which encompassed both „external‟ and „internal‟ factors that influence the
long-run sustainability of local councils in Australia. This typology hinged on
five main sources of local government sustainability: demographic factors;
council revenue; council expenditure; financial management; and governance.
A common thread running through demographic factors, council revenue and
council expenditure was the „non-discretionary‟ nature of the external envi-
ronment in which Australian local government is placed. In particular, tight
regulation of local councils by state government imposes rigid constraints on
outlays and receipts. Dollery, Byrnes and Crase (2008) concluded that local
councils thus cannot influence a great deal of their environment and are thus
largely unable to determine their own sustainability.

Dollery, Crase and Byrnes (2006) have adopted a rather different approach
to the problem of sustainability in Australian local government, which encom-
passed the fact that in Westminster-style democracies, local government occu-
pied a dual role (Aulich (2005, p.198). Firstly, local government provides a
voice to local aspirations for decentralized governance; this „local democracy
approach‟ emphasized „local differences and system diversity‟ and thereby
encouraged „local choice and local voice‟. Following this view, „a premium is
placed upon traditional democratic values‟ which fully embrace „access‟, „ac-
countability‟, „representativeness‟ and „responsiveness‟ (Stewart 1997). The
vibrancy of local democracy is a desirable outcome in its own right.

Aulich‟s (2005) local democracy approach focused on aspects of local

community life which may be subsumed under the rubric of „social capital‟
(Coleman 1988; Putnam 1993). In essence, social capital refers to those fea-
tures of social life which enable people to act together effectively in pursuing
shared goals. In the local government milieu, social capital engenders local
civic awareness which manifests itself in a variety of community projects,
PFM 11/1 31

ranging from the formation of local social associations and sports clubs to lo-
cal business initiatives. While the origins of local social capital are complex
(Quibria 2003), they include factors such as a „sense of place‟ and a „sense of
community‟ which are often attached to particular local council jurisdictions.

The local democracy engenders encouragement for „collaborative or plural-

ist‟ processes of reform rather than top-down „technocratic‟ policy interven-
tion that overrides local opinion (Aulich 2005), with representative local gov-
ernment a worthwhile policy goal on its own right, regardless of the costs in-
volved. Public policy should thus not focus exclusively on efficient service
local provision, but also on effective local democracy with a strong emphasis
on „bottom-up‟ local consultation and local policy formulation.

By contrast, the other fundamental role of local government in a Westmin-

ster system hinges on efficient local public service provision. In terms of this
perspective, local government is an organizational entity for meeting local
needs through local services in the most cost effective manner possible as a
provider of local public and quasi-public goods. In other words, „fiscal and
economic issues override other social and political concerns‟ and „tradition-
bound or value-orientated forms of political and social organization are re-
placed by purely instrumentally rational institutions‟ (Aulich, 2005, p.199).
Economic outcomes thus take precedence over political processes. In the
realm of public policy making, this „local service delivery approach‟ serves to
promote „state intervention to assert control over the local sphere of govern-
ment to ensure that the mechanisms are in place to advance efficiency and
economy‟. As a consequence, „there are inevitably greater pressures for uni-
formity and conformity and less tolerance for diverse outcomes‟ and a „lower
value is placed on collaborative processes, with top-down technocratic pro-
cesses being more typical‟.

While Aulich‟s (2005) dichotomization of the two contending roles in Aus-

tralian local government may not recognize that, in some respects, outcome
and process are inextricably linked, it is nonetheless useful for investigating
the nature of local government sustainability. For example, „financial sustain-
ability‟ and „fiscal sustainability‟ are obviously critical elements in the local
service approach. But what are the chief ingredients of the local democracy
approach with its focus on „community sustainability‟?

Dollery, Crase and Byrnes (2006: 9/10) proposed three „clusters of factors‟:
Firstly, the „vibrancy of local democracy‟ and its ability to engage maximum
local public participation. Secondly, local social capital and its capacity to en-
gender a „sense of community‟ and a „sense of place‟ that flow from living in
a local community whose members interact regularly. Finally, the „capacity of
32 Dollery & Grant

local government‟ which has two critical components: (a) A „well-functioning

elected leadership‟ and (b) „sufficient administrative and technical expertise‟.

Dollery, Crase and Byrnes (2006: 19) have added several caveats to their
analysis. They stressed the problems in conceptualizing „overall local govern-
ment sustainability‟, especially the „abstract and ephemeral‟ nature of „overall
sustainability‟, which make it „hard to define with any degree of precision‟.
They observed that „many factors clearly play an important role‟, including
„local government democracy‟, „local government capacity‟, a „sense of
place‟, „community sustainability‟, „local social capital‟, „local preference di-
versity‟, „local leadership‟ and „local economic development‟ and „environ-
mental sustainability‟.

It is thus apparent that the thrust of this embryonic literature on sustainabil-

ity in Australian local government has used sustainability as a proxy for the
ongoing smooth functioning of the local authority in terms of its relationships
with the local community, as well as its service provision and its fiscal viabil-
ity. In other words, sustainability has referred to the enduring continuation of
the local council itself rather than the contribution of the council to regional,
national and global sustainability. This thrust seems misplaced. It is worth
stressing that scholarly work on local government sustainability in other na-
tional contexts has focused much more on global sustainability, stressing envi-
ronmental sustainability. For example, Shah (2009: 41) has observed that „lo-
cal government sustainability initiatives have emerged in response to the
growing recognition of the importance of taking local action toward global
sustainability‟. Nevertheless, we are still left with confusion surrounding a
useful definition of financial sustainability in local government. It is to this
that we now turn.

3. FISCAL SUSTAINABILITY IN AUSTRALIAN LOCAL GOVERN-

MENT

Local government in all Australian jurisdictions has four main sources of

income: Property taxes or „rates‟; user charges and fees; dividends, interest
income, interest on grants and subsidies, and fines; and grants and subsidies
from state and Commonwealth government. The comparative significance of
these types of revenue has changed over time, For example, Crase and Dollery
(2005: 21) have observed that, since the mid-1970s, „user-charges have shown
the most rapid expansion (13% p.a.), followed by other revenue (11% p.a.),
financial assistance grants (10.8% p.a.), municipal rates (9.4% p.a.) and reve-
nue from the state government (6.6% p.a.)‟

If we decompose Australian local government income into its constituent

parts, property taxes represent the sole taxation power of local councils, ac-
PFM 11/1 33

counting for about 38 per cent of total revenue in 2003/04 (ALGA, 2005). In
contrast to consumption taxes, corporate taxes, and income tax used by higher
tiers of government, rates are calculated on land values which exhibit relative-
ly slow and discontinuous rates of growth. In addition, the NSW government
constrains growth in property taxes in that state through „rate pegging‟. As a
consequence, income from rates has experienced sluggish growth. Council
fees and user charges represent the second most important spring of revenue,
slightly in excess of 30 per cent in 2003/04 (ALGA, 2005). Crase and Dollery
(2005: 22) have demonstrated that municipal fees and charges have been a ris-
ing proportion of total receipts, which may be explained by the fact that coun-
cils have used fees and charges to offset „the shortfall in grant income from the
states and, to a lesser extent, income derived from municipal rates‟. The third
major source of revenue derives from interest income, dividends, interest on
grants and subsidies and fines. In total, this income amounted about 20 per
cent of local government revenue in 2003/04. Finally, intergovernmental
transfers, especially Financial Assistance Grants (FAGS) from the federal
government, comprise around 12 per cent of total revenue. The magnitude of
FAGS income has fallen since the 1970s, primarily because the real value of
these grants is adjusted on the basis of the consumer price index, which has
lagged local government cost escalation. However, to some extent the decline
in income from aggregate grants and subsidies has been partly offset by the
Commonwealth Roads to Recovery (R2R) program and its successor funding
initiatives (see, for example, Kelly, Dollery and Grant, 2009).

Against this background, all Australian local government jurisdictions have

experienced acute and intensifying financial pressures over the past several
decades. The brunt of this financial crisis has fallen on local infrastructure and
many local councils now face almost insurmountable problems in coping with
the problem of financing a massive backlog in local infrastructure mainte-
nance and renewal (Byrnes, Dollery and Crase, 2007; Byrnes, Dollery, Crase
and Simmons, 2008). The fiscal plight of local government has witnessed a
host of national and state inquiries into local government which have not only
provided valuable insights into the problems experienced by the sector, but
also investigated the question of financial sustainability in great detail.

Beginning with the Commonwealth Grants Commission‟s (CGC) (2001)

Review of the Operation of Local Government (Financial Assistance) Act 1995
early in the new millennium, at the national level, we have seen the House of
Representatives Standing Committee on Economics, Finance and Public Ad-
ministration („Hawker Report‟) (2004) Rates and Taxes: A Fair Share for Re-
sponsible Local Government, the PriceWaterhouseCoopers (PWC) (2006) Na-
tional Financial Sustainability Study of Local Government and the Productivi-
ty Commission‟s (PC) (2008) Assessing Local Government Revenue Raising
Capacity. At the state level, we have seen the South Australian Financial Sus-
34 Dollery & Grant

tainability Review Board‟s (FSRB) (2005) Rising to the Challenge Report, the
Financial Sustainability of NSW Local Government („Allan Report‟) (2006)
Are Councils Sustainable, the Local Government Association of Queensland
(LGAQ) (2006) Size, Shape and Sustainability Inquiry, the Western Australian
Local Government Association (WALGA) (2006) Systemic Sustainability
Study, the Local Government Association of Tasmania (LGAT) (2007) Review
of the Financial Sustainability of Local Government in Tasmania, the Queens-
land Treasury Corporation (QTC) (2008) Financial Sustainability in Queens-
land Local Government and the NSW Independent Pricing and Regulatory
Tribunal (IPART) (2009) Interim Review of the Revenue Framework for Local
Government.

While some of these inquiries have been highly politicized and yielded few
analytical insights into the nature of financial sustainability in local govern-
ment, such as the Hawker Report (2004), other reports have come to grips
with the challenge of defining fiscal sustainability (Dollery, Byrnes and Crase,
2007). In particular, the FRSB (2005), Allan Report (2006), PWC (2006),
WALGA (2006), LGAT (2007) and the QTC (2008) grappled with financial
sustainability, and serve as an instructive example of just how difficult it is to
formulate a satisfactorily definition of the concept. In this section of the paper
we critically examine these efforts as an illuminative case of the problems ex-
perienced in operationalizing sustainability in local government.

In its Final Report, the FRSB (2005) considered the problem of defining
„financial sustainability‟ as a means of assessing the long-term solvency of
South Australian councils. While the FRSB (2005: 10) argued that no univer-
sal consensus existed on the meaning of „financial sustainability‟ in Australian
local government, it proposed the following definition:

„A council‟s long-term financial performance and position is sustainable

where: (i) continuation of the council‟s present spending and funding policies;
(ii) likely developments in the council‟s revenue-raising capacity and the de-
mand for and costs of its services and infrastructure; and (iii) normal financial
risks and financial shocks, altogether are unlikely to necessitate substantial
increases in council rates (or, alternatively, disruptive service cuts)‟.

The FRSB (2005: 15) advanced four financial indicators „for assessing a
council‟s financial sustainability‟:

 Net financial liabilities as the chief financial indicator of a council‟s „in-

debtedness to other sectors of the economy‟;
 Operating surplus or deficit as the key financial indicator of the „intergen-
erational equity of the funding of the council‟s operations‟;
PFM 11/1 35

 Net outlays on the renewal or replacement of existing assets as the chief

financial indicator of the „intergenerational equity of the funding of the
council‟s infrastructure renewal or replacement activities‟; and
 Net borrowing or lending as the key financial indicator of the „impact of the
council‟s annual transactions – both operating and capital – upon the coun-
cil‟s indebtedness to other sectors of the economy‟.

The central conclusion of the FSRB (2005b, 19/20) came in the form of
Recommendation 2.3(1) which set out in a „statement of principles‟ governing
„key financial sustainability indicators‟, comprising six factors:

 A local council is financially sustainable financial if „its net financial liabil-

ities are at levels at which the associated interest payments (less interest in-
come) can be met comfortably from a council‟s annual income (i.e. by cur-
rent ratepayers) without the prospects of rates increases which ratepayers
would find unacceptable (or disruptive service cuts)‟;
 The net financial liabilities of a specified local authority „can be too low
where they are (a) associated with current ratepayers being asked to bear an
inequitable proportion of the cost of future service potential or (b) below
levels that include more than enough room to absorb unexpected financial
risks or financial shocks‟;
 Annual operating financial performance of a local council is sustainable „if
operating deficits will be avoided over the medium- to long-term, because
such deficits inevitably involve services consumed by current ratepayers
being paid for either (a) by borrowing and so by future ratepayers or (b) by
deferring funding responsibility for the renewal or replacement of existing
assets onto future ratepayers‟;
 A local authority‟s operating surplus can be too high „where it (a) is associ-
ated with current ratepayers being asked to bear an inequitable proportion
of the cost of the council‟s future service potential or (b) is above a level
that includes more than enough room to absorb unexpected financial risks
or financial shocks‟;
 The annual capital financial performance of a municipality is sustainable „if
capital expenditure on the renewal or replacement of existing assets on av-
erage approximates the level of the council‟s annual depreciation expense,
because any shortfall of such capital expenditure against annual deprecia-
tion expense would involve future ratepayers being left with an excessive
burden when it comes to replacing or renewing the council‟s non-financial
assets‟; and
 Finally, net borrowing of a local council can be too low „where, over the
planning period, it results in the council‟s net financial liabilities as a ratio
of non-financial assets falling well below the targeted ratio‟.
36 Dollery & Grant

In its deliberations, the Allan Report (2006: 276) prescribed the conditions
for a council to be „currently healthy‟ in financial terms: It should be „a mod-
est net debtor‟ with debt making up only „a minority of the total capital invest-
ed in the council‟s infrastructure and other assets‟ and at the same time „the
associated expense burden should not be a substantial proportion of the coun-
cil‟s annual operating revenues‟. This represented a minimum requirement;
„for a council‟s financial performance to be assessed as “currently healthy”‟
and to „involve a margin of comfort to cope with the usual assortment of fi-
nancial risks and financial shocks‟, the council must meet three further crite-
ria:

 The council in question should „generally be running an operating surplus

rather than an operating deficit‟;
 The local authority should not exhibit a „significant infrastructure renewal
backlog‟ and its capital expenditure over the financial year on infrastructure
renewal and replacement should „on average over time be about the same
level as the council‟s depreciation expenses‟; and
 Annual net borrowing should not be „putting any pressure on the council‟s
targeted net financial liabilities ratio‟.

The Final Report (2006: 283) stressed that financial sustainability is a „con-
troversial‟ concept, but concluded that „a council‟s finances should be consid-
ered sustainable in the long term only if its financial capacity is sufficient – for
the foreseeable future – to allow the council to meet its expected financial ad-
justments over time without having to introduce substantial or disruptive reve-
nue (and expenditure) adjustments‟. This assessment is very close to the con-
clusions of the South Australian FSRB (2005) Final Report, which may be ex-
plained by the fact that Access Economics (2006a) worked as a key consultant
in both inquiries.

Financial sustainability in the WA Final Report is based largely on Access

Economics (2006b); a feature in common with the South Australian, NSW and
PWC reports. It is thus not surprising that the definition of financial sustaina-
bility shares a great deal with these other three reports. The Access Economics
(2006b: 55) defined financial sustainability identically to the FSRB (2005)
(i.e. „a council‟s finances are sustainable in the long term only if its financial
capacity is sufficient – for the foreseeable future – to allow a council to meet
its expected financial requirements over time without having to introduce sub-
stantial or disruptive revenue (and expenditure) adjustments‟).

This definition of financial sustainability involves comparing long-run

fund-raising ability with long-term expenditure needs. In this context, „finan-
cial capacity‟ refers to the operating and capital finance which can be raised
using existing „revenue-raising and financing policies‟ as well as „any addi-
PFM 11/1 37

tional funding were the council to increase its revenue-raising efforts to levels
commensurate with those displayed with higher-effort councils‟. By contrast,
„financial requirements‟ has two components: Capital and operating expendi-
ture sufficient to meet statutory requirements and „expected spending pres-
sures‟ (both of which imply asset maintenance and renewal); and a „margin of
comfort‟ adequate to meet any „future financial shocks‟.

This approach to financial sustainability requires an analysis of individual

council accounts. It is made operational by examining a council‟s „underlying
operational deficit‟ as a proportion of its „own-source‟ revenue. According to
Access Economics (2006b: 56), „persistent operating deficits‟ thus imply a
council‟s revenue-raising efforts are „too low‟ whereas „excessive operating
surpluses‟ mean that a municipality‟s revenue-raising efforts are „too high‟. A
„benchmark‟ deficit of 10 per cent of the operating debt ratio was arbitrarily
set; councils with a ratio in excess of 10 per cent were assessed as „financially
unsustainable‟.

However, Access Economics (2006b, p.56/57) advanced four caveats

against the blanket application of the underlying operational deficit criterion of
10 per cent of the operating debt ratio:

 Councils failing to meet this cut-off mark are not necessarily unsustainable
„on the grounds that a 10 per cent deficit could be eliminated if necessary
by “manageable” increases in rates and other charges‟ since this deficit
could be eliminated by a one percentage point increase in rates and charges
over the „no-policy change‟ option in ten years.
 Current operating deficits do not take into account the „spending pressures
that will arise as councils address their infrastructure backlogs‟. Operating
debt ratios should thus be adjusted on the understanding that deferred infra-
structure maintenance and renewal has effectively subsidized current con-
sumption by councils. Nominal interest rates on the accumulated backlog
should therefore be notionally charged to account for this historic subsidy.
 Current operating deficits do not „allow for the additional financial capacity
available to those councils with below-par revenue-raising efforts‟. Thus
councils which have „under-charged‟ with rates and charges require ad-
justment to their operating deficits to the extent of this imputed under-
charging.
 Finally, „another candidate for the adjustment of currently-observed operat-
ing deficits when assessing the financial sustainability of councils would be
the impact of likely expenditure trends on a no-policy change basis on ac-
count of population shifts and ageing along with environmental imposts‟.
This latter category is sometimes termed „non-discretionary‟ variables in
the literature since it refers to costs over which councils have no control!
38 Dollery & Grant

The PWC Report (2006:6/7) stressed the difficulties involved in assessing

the „financial viability‟ across Australian local government, with three main
problems preventing the use of a common sustainability index: „Mixed ap-
proaches to measuring and recording financial data‟ and „inconsistencies be-
tween states‟; „infrequent‟ asset valuations and differences in assumed asset
lives; and „incomplete‟ financial and asset management records, especially in
smaller councils. These difficulties obliged the PWC report to adopt two tech-
niques in their assessment of financial sustainability:

 PWC applied financial ratio analysis to a sample of 100 local councils ap-
propriately weighted by state and stratified in proportion to the number of
councils in each of the DOTARS seven categories.
 PWC „extrapolated‟ from the Access Economics and Municipal Associa-
tion of Victoria (MAV) (2005) approaches using the Key Performance In-
dicators (KPIs) in the (FSRB, 2005), Allan Report (2006) and WALGA
(2006) state inquiries and the MAV „viability index‟.

The PWC (2006, 95) defined „financial sustainability‟ thus: „financial sus-
tainability of a council is determined by its ability to manage expected finan-
cial requirements and financial risks and shocks over the long term without the
use of disruptive revenue or expenditure measures‟. This involves two ele-
ments: (a) councils should maintain „healthy finances‟, given current expendi-
ture and revenue policies and foreseeable future developments; and (b) coun-
cils must ensure infrastructure expenditure „matches‟ asset planning.

This definition was applied to a stratified sample of 100 local authorities

using five financial KPIs:

 „Operating surplus‟ representing „total operating revenue less total operat-

ing expenses‟.
 If an operating deficit exceeds 10% of total revenue, then it places the
council at financial risk.
 „Interest coverage‟ measuring a council‟s ability to pay interest on its debt
and calculated as the ratio of „Earnings before Interest and Tax‟ (EBIT) to
„borrowing costs‟.
 A ratio value below 3 indicates unsustainability.
 „Sustainability ratio‟ or the ratio of capital expenditure to depreciation
which measures changes in the asset base of councils. If the ratio exceeds
unity, then the asset base is increasing. However, the PWC Report (2006:
97) stressed that the sustainability ratio must be „interpreted with care‟ due
to inconsistent asset valuation procedures.
 „Current ratio‟ or the ratio of current assets to current liabilities intended to
measure a council‟s capacity to meet its short-term debt obligations; a sus-
tainable council must have a current ratio at least equal to unity.
PFM 11/1 39

 „Rates coverage‟ or total rates revenue as a proportion of total costs. An

arbitrary „benchmark‟ of 40% was taken to indicate „adequate self-
funding‟.

The second approach adopted in the PWC report involved applying the
KPIs in the FSRB (2005), Allan Report (2006) and WALGA (2006), as well
as the MAV „viability index‟, to all Australian local councils in order to assess
infrastructure sustainability. The MAV „viability index‟ comprises three ele-
ments: (a) „Cumulative long-term debt‟ relative to annual rate income; (b)
„cumulative underlying operating surplus/debt‟; and (c) „rate effort, rates af-
fordability and population growth‟.

LGAT secured Access Economics to investigate financial sustainability in

Tasmanian local government. Access Economics considered the definition of
financial sustainability in some detail and contrasted it with the concept of „fi-
nancial viability‟ (LGAT, 2007: 23/25). In so doing it observed that „it is im-
portant to note that a council being classified as financially “unsustainable”
does not imply the council's financial viability is necessarily in question‟. In
other words, „financial unsustainability‟ in the long term refers only to the un-
sustainability of a council‟s current revenue-raising and expenditure policies
since council finances can „almost always‟ be adjusted with increases in rates
and/or expenditure reductions, even if this comes at „a considerable cost to
ratepayers and the community‟. Access Economics argued that „there can be
no doubt that the local government sector is, and will always be, financially
“viable” in the sense that it will always be able ultimately to meet its debt ser-
vice obligations‟ because „ratepayers are bound to meet all outstanding obliga-
tions under the Local Government Act‟ and therefore the ability of a local au-
thority to levy property taxes means that it cannot go bankrupt in the usual
commercial manner.

Following this reasoning, Access Economics defined financial sustainabil-

ity as „the extent to which a council‟s financial capacity is sufficient - for the
foreseeable future - to allow the council to fund the spending that is necessary
to meet both its existing statutory obligations and any associated spending
pressures and financial shocks without having to introduce substantial or dis-
ruptive revenue (and expenditure) adjustments infrastructure assets means
non-financial assets excluding any holdings of land‟ (LGAT, 2007: vii). It is
evident that this definition echoes earlier definitions developed in the SA, WA
and NSW inquiries, a point noted in the Final Report (LGAT, 2007: 24).

LGAT (2007: 1) observed that a council should set „target values for finan-
cial indicators based upon the following broad principles‟:
40 Dollery & Grant

 A local council's financial situation is in „a healthy state if its net financial

liabilities (and associated debt) and any infrastructure backlog are at levels
where the resultant and prospective net interest expense can be met com-
fortably from annual income (i.e., by current ratepayers) at the existing rat-
ing effort‟.
 A local council's operating financial performance is „satisfactory if it is
running a modest operating surplus before capital revenues, indicating that
costs incurred in the year in question (including both routine maintenance
and annual depreciation of non-financial assets) are at least being met by
today's ratepayers and not being transferred to tomorrow's ratepayers, with
revenues sufficient to finance current operations‟.
 A local council's capital financial performance is satisfactory if both (a) its
actual capital expenditure renewals broadly match the annual desired levels
of such expenditure and (b) its annual net borrowing does not put any long-
term pressure on achievement of the Council's targeted net financial liabili-
ties ratios.

The Queensland Treasury Corporation (QTC) assessed the financial sus-

tainability of 109 Queensland local councils participating in the LGAQ Size
Shape and Sustainability Program. This involved inter alia defining financial
sustainability, selecting suitable financial indicators, and developing an as-
sessment methodology and a rating scale. Its definition of financial sustaina-
bility drew on the South Australian FRSB (2005): financial sustainability in
local government means that a given council is able „to manage likely devel-
opments and unexpected financial shocks in future periods without having at
some time to introduce economically significant or socially destabilizing reve-
nue or expenditure adjustments‟ (QTC, 2008: 16).

The QTC (2008) decomposed this definition into several different ele-
ments, such as operating performance sustainability and depreciation sustaina-
bility, and then developed specific indicators for each of them and normative
values for these indicators. For example, „fiscal flexibility‟ was defined by the
QTC (2008: 42) as „the capacity of a local government to respond to changing
circumstances (including unforeseen financial shocks) by adjusting revenue
and/or expense levels or by maximizing balance sheet management‟. Fiscal
flexibility was deemed to have three core aspects: own-source revenue; self-
generated revenue; and debt capacity. Considering „self-generated revenue‟,
the QTC (2008: 44) defined this as „net rates, utilities and charges plus sales
(contract and recoverable works) and other fees and charges as a percentage of
total operating expenditure (including interest and depreciation‟. For self-
generating revenue, the QTC prescribed a „self-generated revenue ratio mini-
mum indicative measure‟ as „the QTC minimum benchmark ratio for self-
generated revenue‟ which represented „at least 60.0 per cent of operating ex-
PFM 11/1 41

penses‟. A similar approach was adopted for each the other aspects of the fi-
nancial operation of councils.

In essence, the QTC (2008) Financial Sustainability Review (FSR) assessed

financial sustainability in terms of the capacity of a given council to: (a) meet
its commitments in the short-run, medium-term and long-term; (b) manage
unforeseen financial shocks and adverse changes in its economic environment;
and (c) manage „core business risks‟. It considered past financial performance
and a long-term (10-year) financial forecast, an evaluation of several quantita-
tive and qualitative indicators, discussion with senior council officers on stra-
tegic objectives, as well as general macroeconomic factors.

What should we make of these attempts at defining financial sustainability

in the Australian local government milieu? In the first place, the most im-
portant feature of the six inquiries we have considered resides in their heavy
reliance on Access Economics. The SA, NSW, WA, Tasmania and PWC re-
ports all rested the Access Economics definition of financial sustainability and
accounting measures, including financial KPIs and associated benchmark val-
ues, to distinguish between financially sustainable and unsustainable councils.
In addition, even the QTC (2008) based its definition on the FSRB (2005).
Secondly, this excessive dependence on a single methodology is unfortunate.
For instance, in contrast to the Access-dominated reports, the QTC (2008) re-
port found the degree of financial unsustainability much less acute, which
seems to demonstrate how easily even basic KPIs can be modified to reach
dramatically different conclusions. In other words, even according to a narrow
accounting definition of financial sustainability in local government, signifi-
cantly different results can emerge.

Thirdly, it appears that the uncritical acceptance of the „accounting‟ ap-

proach to financial sustainability has allowed „ideology‟ to masquerade as ob-
jective „analysis‟ in some cases. For example, if we use operating deficits to
proxy financial capacity, then this will almost inevitably mark small rural
councils as unsustainable due to their low rate base, an artifact of „non-
discretionary‟ factors outside council control, such as very low population
density.

It is important in this context to distinguish between the accounting and

economic approaches to conceptualizing operating and capital costs. In stand-
ard accounting practice, costs generally represent the historical monetary value
of expenditures on inputs, such as labor and capital equipment, for use in the
local council in question. Put differently, accounting costs consist of the
monetary value denoted on invoices as price and recorded as either an expense
or asset cost. By contrast, to the economist, cost represents opportunity cost.
Opportunity costs consist of the alternative returns foregone by pursuing a
42 Dollery & Grant

given course of action. This difference has important practical implications.

For instance, it is possible in a local government context to have a significant
accounting surplus between total revenue and the total cost, but with little to
no economic surplus, yielding differences in estimates of financial sustainabil-
ity. However, opportunity cost itself must be used with caution in the Australi-
an local government context since a great deal of municipal services must be
provided in prescribed quantities and at prescribed standards stipulated by
state governments, with limited local council discretion. Finally, KPI-based
approaches have ignored the academic literature on the uncertain predictive
capacity of KPIs in Australian local government unsustainability. This litera-
ture has shown that KPI benchmark values are not always reliably correlated
with financial stress and since other factors, like governance failure, can play
an even larger role (Murray and Dollery 2005; 2006). Moreover, the meaning
of efficiency accountants attach to KPIs differs from the economist‟s interpre-
tation. Accountants infer from KPIs how well resources are being used to pro-
duce a given set of local services, or what economists term „productive effi-
ciency, whereas economists add an allocative dimension to resource use
known as „allocative efficiency‟ or „economic efficiency‟. However, it is again
important to stress that the lack of discretion in resource use in Australian lo-
cal government often reduces the allocative or choice element in practice.

4. CONCLUSION

In this paper we have considered the problem of defining sustainability in

local government as exemplified in the debate over fiscal sustainability in
Australian local government. In our analysis of the operational definitions em-
ployed in the six reports focused on the question of fiscal sustainability, we
have observed an unwarranted dependence on the Access Economics ap-
proach. This should not be interpreted as constituting evidence of a consensus
on financial sustainability as much as simply a coincidental institutional pecu-
liarity. Moreover, we have argued that the Australian approach to financial
sustainability in local government has not only conflated fiscal sustainability
with fiscal viability, concepts which are not at all the same, but it has ignored
the tensions between the „local democracy‟ and „local service provision‟ roles
of local government. Similarly, we have pointed out that an accounting-based
KPI methodology is misplaced given its poor predictive record and inherent
bias against small rural councils.

This conclusion draws international corroboration if we consider the formi-

dable conceptual and measurement difficulties in the financial performance
evaluation of local government. Indeed, despite a voluminous literature (see,
for instance, Honadle, Costa and Cigler, 2004: 18), there is not even „consen-
sus about the terminology surrounding fiscal health‟. Definitions abound. For
example, in the United States, scholars employ numerous terms, including
PFM 11/1 43

„fiscal health‟ (Berry 1994), „financial condition‟ (Lin and Raman 1998), „fis-
cal stress‟ (Pagano and Moore 1985), and „fiscal capacity‟ (Johnson and Ro-
swick 1991).

This lack of consensus should not be surprising given the complexities of

defining financial sustainability in a democratic non-profit local public service
provision environment. For example, should the financial circumstances of a
council be judged exclusively on financial magnitudes, such as operating ex-
penditure, operating revenue, indebtedness, and the like, or should the yard-
stick be standards of service provision, operational efficiency and community
expectations? Similarly, as we have seen, the inherent tensions between local
government democracy and local government efficiency further complicate
matters (Aulich, 2005).

While the aim of constructing comparative financial indicators to assess lo-

cal government system is laudable since it strives to develop an „objective‟
measurement tool to generate unbiased policy recommendations in a highly
charged political environment, numerous problems afflict comparative finan-
cial indicator indexes (Kloha, Weissert and Kleine, 2005: 316-17). These spe-
cific problems are amplified when we consider wider anomalies. For instance,
in reference to Australian financial KPIs, Worthington and Dollery (2000)
have stressed the significance of „nondiscretionary variables‟ in performance
indicators which cannot be changed by councils. In Australia, the immense
diversity between councils precludes the use of a „one-size-fits-all‟ method of
assessing local authorities (Dollery, Wallis and Akimov, 2010). Not only are
the expectations and needs of residents of metropolitan, regional, rural and
remote councils quite different, but the problems faced by these different cate-
gories of councils also vary. A given and fixed set of KPIs cannot hope to
cope with these subtleties. This means that other techniques are needed to
augment accounting measures and financial KPIs, including public opinion
surveys soliciting the views of the local community in question. For example,
a local council may be sustainable if the local community is reasonably con-
tent with its performance.

Finally, in common with much other scholarly work on sustainability in

Australian local government, the work of the public inquiries on financial sus-
tainability we have considered in this paper has inadvertently misrepresented
the meaning of sustainability. While some differences exist between the QTC
(2008) approach and the other inquiries, they share the misapprehension that
fiscal viability is synonymous with long-run sustainability. By contrast, we
have argued that sustainability quintessentially concerns the impact of a given
council on regional, national and global sustainability and not simply its own
ongoing capacity to function satisfactorily.
44 Dollery & Grant

Sustainability at the local government level in Australia can interpreted as

the need for each local council to meet defined environmental (both natural
and manmade), social and economic parameters. One way of interpreting fi-
nancial sustainability in this context – as distinct from financial viability – is
to explicitly link it with environmental and social objectives. In other words,
fiscal sustainability could be defined to comprise the programs, expenses and
other activities a local council must fund to meet the measurable environmen-
tal and social components of sustainability. Without prescribed economic re-
quirements to meet environmental and social sustainability objectives in local
government, it thus makes little sense to use the term financial sustainability in
isolation.

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