By Paul Hemsley and Julian Bajkowski

The Victorian Auditor-General’s Office (VAGO) has issued a stern warning that “small councils” could be left financially unsustainable due to their increasing dependency on state government and Commonwealth grants and rate hikes still not being enough to pay for rising costs.

The wake-up call is contained in a new report from the Auditor titled “Organisational Sustainability of Small Councils” that examines whether many of the state’s local governments sufficiently understand sustainability challenges and issues.

The audit also probes whether the councils it examined have developed appropriate strategies, evaluated the effectiveness of those strategies and whether Local Government Victoria (LGV) has provided them with appropriate guidance and support.

After sampling five small councils, the audit concluded that over the past five years their reliance on government grants has doubled from $33.7 million in 2007-08 to $72.4 million in 2011-12, an average increase of 25 per cent per year.

The councils put under the microscope were Buloke Shire Council, Golden Plains Shire Council, Strathbogie Shire Council, Towong Shire Council and Yarriambiack Shire Council.

Apart from the growing reliance on state and Commonwealth grants, the councils sampled were found to have increased their “rates and charges” from $35.714 million to $49.083 million for the period examined.

Those increases were helped along by a separate increase in “user fees and charges” $7.275 million to $8.810 million.

If those increases look outwardly generous there’s a big catch. When the rate hikes are evaluated in “real terms” they actually decreased as a proportion of total revenue for councils and thus have not been nearly enough to keep pace with a corresponding increase in council costs.

“Given current Commonwealth and State Budget positions and the economic climate, the audited councils' increasing reliance on grants may be unsustainable,” the Auditor-General’s report said.

The report provides recommendations for councils including improving their understanding of sustainability challenges, developing long-term financial plans and consulting with communities on their ability and willingness to pay for desired services.

The financial woes that Victorian councils are staring down may yet be compounded by wider issues including local government demands for additional funding from the Commonwealth.

The Australian Local Government Association (ALGA) has persistently pushed for local government to be recognised under Section 96 of the Australian Constitution to formally allow direct funding to councils from the federal government, which have previously come in the form of Roads to Recovery and Financial Assistance Grants (FAGS). A referendum on this issue is expected to take place on September 14th, 2013.

It is this kind of funding from the Commonwealth that small councils have become increasingly dependent upon, but if the referendum delivers in a “no” vote, the grants that councils receive from the Commonwealth are threat of abruptly ending if a High Court case finds that direct funding is unlawful.

The potential problems that could arise from the financial volatility of small councils in Victoria are by no means the only headache that councils are facing.

A shortfall in funding for defined benefits superannuation has been causing enough financial indigestion to prompt federal Financial Services Minister Bill Shorten to personally visit local governments hit by lower than anticipated returns.

A debt that has hung over from a Defined Benefit Plan for council employees that operated compulsorily from 1982 but was then closed to new members in 1993, the problem for councils is that they are forced to top-up defined benefits funding shortfalls in lean years rather than running unfunded liabilities like the state and federal governments.

The federal government has indicated it is not prepared to let the liabilities go unfunded.

That means that councils have to find funds from elsewhere in their budgets, like services, wages and capital works, to meet obligations that deliver little benefit to ratepayers.

The latest defined benefits shortfall surfaced in mid-2012 when the Auditor-General found that councils across the state collectively owe $396.9 million through their superannuation shortfall by 1st July, 2013.

If they are overdue, they face being slugged with a 7.5 per cent interest rate and will have to pay the owing amounts over time.

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