Some Thoughts Around Infrastructure Bonds

Now that people have gotten around to the idea of increasing land supply (through removing the rural urban boundary) I’d like to look at how financing all the additional infrastructure is going to play out. The latest idea, as has been floated about, is for local authorities to issue infrastructure bonds, rather than charging upfront development levies (‘contributions’). Thus, instead of the householder borrowing an extra $100,000 (‘upfront’) to contribute to the cost of infrastructure (roads, parks, water, etc.) the council will be responsible for issuing a bond (nominally for the same value) which will be funded through a targeted rate on the relevant properties. In theory, this should reduce variability between lending conditions and result in a cheaper overall borrowing cost.

In principle, I have nothing against targeted rates and this particular form of finance (the council is the socialised provider of infrastructure, so it’s legitimate to discuss how this is going to be paid for). However, there are a number of caveats which will need to be resolved prior to this financing mechanism being taken more seriously:

  • Bond Duration – New Zealand has a very short-dated bond market. Bonds are issued, whether by companies, the government, or councils, on maturities of 3 – 10 years. If bonds are issued for longer than this period, they tend to have rate re-set points along the way. Having a re-set point means that the targeted rates won’t be fixed (which could have negative downstream consequences). Equally, if you don’t compel the council to set a repayment date it could accumulate vast debts, which is already becoming a problem with councils in NZ.
  • Rate Duration – You’ll need very specific protections for the ratepayers. Targeted rates, where they are linked to an infrastructure bond, need to be transparent and limited. Where a bond has been issued for, say, 30-years, the targeted rate should expire after 30-years (with a full repayment of the loan principal). This is akin to requiring that the bonds are structured like home loans. Like with the bond duration issue, I think having explicit limits (and mandating bond repayment) is the only way to stop certain problems arising from creative council officers and councillors.
  • Bond Limitations – The council should not be able to fudge things and infrastructure bonds should be ring-fenced so that the funds cannot be used for anything else. There will need to be very specific definitions put in place, as infrastructure could be used to justify all sorts of ‘additions’ beyond core purposes (why shouldn’t new homeowners, for instance, be paying ‘their fair share’ of the rail loop?).
  • Cost Variations – The management of costs, and the need for associated transparency, becomes increasingly importance under this funding model. If the council budgets $20m and ends up only using $15m, what do they have to do with the difference? (slushy machine, anyone?) Equally, if the project is set to cost $20m and comes in at $50m, who is responsible for the difference? This is quite critical, particularly given how poorly some local authorities have been around infrastructure projects in the past (is that Kaipara I hear calling?).

I am particularly concerned around how we’d introduce the bonds in the first place. One of the reasons we don’t have long-term bonds in this country is that there is no structural demand-side to the equation. In the UK (until recently) there was a large annuities market (through government fiat – you had to buy an annuity with at least part of your private pension) and large pension schemes (which required, as with annuities, the matching of long-term assets and liabilities). New Zealand has no equivalent structural demand for long-dated bonds and there is no political appetite, as I can see it, to introduce more government measures in this space (much to Chris Coon’s frustration in the past).

Equally, a good point was raised around offering tax incentives (for instance, similar treatment to US municipal bonds – although we lack the need to differentiate between what income tax is involved). I am very reluctant to consider this option, as it’s distortionary, and a tax break is just another cost anyway (if the State is offering a bond at 6%, but gives you a tax free return, then you might as well just say it’s an 8% bond, in substance – although the 2% extra is paid for by the Crown, rather than the council). So it might ‘kick-start’ the market, but only because you’re paying over the odds (in which case, easier to just offer a higher yield upfront).

On balance, I think infrastructure bonds are better than development contributions, and can be made to be far less discretionary (thus limiting councils in their capacity to use the funds for whatever other political purposes they fancy). Targeted rates mean that clearly defined stakeholders will want to know what their contributions are being used for, and how the cost is being managed (in the long-term), rather than just being an upfront tax that nobody really notices. However, as noted above, there are a lot of ‘pesky details’ that need to be resolved prior to declaring it a ‘good idea’. I look forward, if Labour and the Government really are up to this, to a balanced and sensible discussion (and, hopefully, subsequent developments).

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