Dr Eric Crampton is Chief Economist of The New Zealand Initiative.

OPINION: New Zealand’s proposed three-water reform, which would force municipal water utilities to merge into four major providers under convoluted governance arrangements, is an attempt to solve a real problem. Just not very good.

I wonder about a better alternative.

A very short piece of legislation could allow councils here to follow U.S. local governments in issuing tax bonds — debt backed by project revenue, rather than taxpayers in general.

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This could address the real underlying problem that Three Waters aims to solve, without forced mergers and messy ownership structures. It could allow more rigorous monitoring of infrastructure maintenance. And that would open up opportunities for building other valuable infrastructure.

The real problem that central government officials are trying to solve with the reforms is not water quality and the consequences of the Havelock North campylobacter outbreak. A new water quality regulator is on the job, regardless of what happens with the ownership of water assets.

The real problem? Too many councils, like Wellington, have done a terrible job maintaining their pipes while loading their balance sheets with debt for the white elephants: convention centers and ridiculously expensive reinforcement of buildings that should be demolished.

And many councils cannot fund the infrastructure needed for urban growth.

Communal debt cannot exceed 280% of revenue without incurring penalties. A board at its debt limit cannot issue new debt to finance infrastructure unless that debt can be repaid very quickly.

Infrastructure that is expected to last for decades must pay for itself in a few years.

This is one of the root causes of our housing shortage. Councils use zoning and consent to try to stop people building in places where infrastructure funding is too difficult.

But there’s no reason to believe that simply lifting municipal debt limits would give us better water infrastructure. More scrambles are more likely.

The central government sees the housing crisis, sees the infrastructure deficit and worries that it will forever be called upon to bail out irresponsible councils when the pipes burst.

They therefore proposed a quasi-forced nationalization of communal water assets.

These merged entities need to take on debt to finance infrastructure renewal and growth. If they belonged directly to councils, it would be difficult. Their debt would be treated as council debt, subject to council debt limits. Rating agencies would know that the boards would support that debt with bailouts, if necessary.

The need for true balance sheet separation has resulted in a convoluted approach to ownership of water entities – and no clear accountability of these entities to the households and businesses they serve.

Revenue bonds can be a much better alternative. This is how American cities typically cover infrastructure costs.

This form of debt is only secured by the revenue generated by the project they financed – be it a water pipe, a subway system or a highway. According to Charles Schwab, general obligation bonds (like New Zealand’s standard municipal debt), backed by a council’s main balance sheet, only account for one-third of investment-grade US municipal debt. Two-thirds of municipal bonds are revenue bonds.

Instead of forcing amalgamation of council water assets into haphazard structures, the central government could pass very short legislation allowing councils, and council-controlled entities like water suppliers, to issue tax bonds long term. Boards would be prohibited from using general revenue to repay obligations.

If a council needed to fund infrastructure for higher density or for a new development, they would assess the cost of the kit and the levy that might be imposed on users or beneficiaries. He would put the proposal to investors in the bond market.

Riskier projects would incur higher interest rates than standard government debt, but that’s really not a problem. The lack of infrastructure is a real problem, as is the lack of a reasonable commercial assessment of the viability of too many projects. Bonds would be much better than contributions from developers, which end up loading into mortgages when people buy properties.

Bondholders bring another benefit. If continued bond payments depend on a continued stream of revenue from users of the infrastructure, bondholders will insist on monitoring that the promised maintenance is carried out.

Academic literature on corporate finance argues that one of the great benefits of having a large bondholder is this kind of vigilant oversight. The same would be even more true for municipal infrastructure, where some councils have obviously problematic histories.

Right now, councils can underfund depreciation for years and only win plaudits from local voters for keeping rates low and funding shiny new projects. If they had to cater to bondholders as well, ignoring maintenance would be a bigger problem.

And it could unlock funding for many projects beyond water infrastructure – as long as the projects could pay for themselves. And it would avoid forced merges.

Bring in the bondholders. We need them.