Councils need help to cover the cost of much needed infrastructure and the threat of climate change.
A review of local government funding by the Productivity Commission has found the system is working but changes are needed in the face of significant challenges.
The draft report has made 30 recommendations, including an accommodation levy, and more central government funding support for councils having to adapt for sea level rise and flooding.
"There's a number of instruments that councils have which they're not using very well in some cases, so they can make better use of what they've got available," Commission chair Murray Sherwin said.
"In a couple of areas they will need some law changes to accommodate some other things that would be helpful."
Most urgently, the report said local government needed help adapting to climate change with many councils frustrated about a lack of leadership.
"The first priority for central-government action should be to develop advice, guidance and legal frameworks to support decisions about land use," it said.
Councils were in a kind of "legal limbo" facing a no-win situation around whether to allow development on at risk land.
The Kapiti Coast District Council has already faced court action.
Mayor K Gurunathan said there had to be a centralised body to guide councils.
"What we have now is we have a plethora of local authorities trying to grapple with the same problems ... it's a nightmare."
Mr Gurunathan said the costs of adapting to climate change would be prohibitive and well beyond the area's 23,000 ratepayers.
"We've got 6000 properties that are flood prone and this is going to get worse because climate change projections are 15 percent increase rainfall in the winter season ... so we've got 300 stormwater projects costing $250 million over 60 years. The cost is out of this world.
Just one 900 metre section of seawall to protect a road and the properties behind it will mean spending $17m.
The commission is recommending the government help councils pay for more resilient infrastructure at risk of of sea level rise, storms, and flooding.
It suggested expanding funding of local roads by the New Zealand Transport Agency, as well as setting up a similar agency and "resilience fund" to help council's pay for the redesign and possible relocation of at-risk water infrastructure.
"Without central government leadership and support for climate adaptation, there is a real risk that adaptation will happen in an ad hoc and inequitable way, or focus only on the short term."
The report also pointed to tourism as another major pressure point which local government would need help on.
The rapid growth in international visitors had left many councils in tourist hotspots struggling to fund the roads, water, and facilities needed to cater to them from their ratepayers alone.
Attempts by Auckland to tackle the costs with a target rate on accommodation had proven difficult, it said, and the Queenstown Lakes District Council's move to introduce an accommodation levy was still waiting government sign off.
It was something the report said should be available throughout the country.
"The commission has recommended that, in addition to more direct user-charging, the best way to address the payment shortfall for mixed-use infrastructure is for central government to legislate to allow councils to implement local accommodation levies.
For those where costs couldn't be recovered from an accommodation levy it said the government should use funds from its new International Visitor Conservation and Tourism Levy.
The pressure on infrastructure was not just being felt from tourism, with the report also noting population growth and left some councils struggling to keep up.
"This has led to serious social and economic problems such as lack of housing affordability, homelessness and urban transport woes. "
Councils needed more incentives to fund infrastructure, the commission said, including considering a vacant land tax or funding boost for development.
"A relatively modest payment from central government, based on new building work within territorial authority boundaries, could incentives councils and their existing residents to embrace growth."
"This new incentive, together with other measures in the Urban Growth Agenda, could substantially overcome the shortfalls of housing supply relative to demand that have plagued New Zealand's urban centres in recent years. If they can do so, the prize would be a healthy housing market and a boost in social and economic wellbeing, particularly for younger generations."
As well as new tools, Mr Sherwin said many councils could make better use of ones already at their disposal.
"A lot of them could make more use of targeted rates and user charges in particular.
"In the area of water for instance it's very clear that where you get metering and charging for water you can make a big difference to the usage of water you can make a big different to the usage of water. Councils that have gone down that track, they can take 30 percent out of the use of water and that makes a huge difference to the need for new infrastructure.
Not enough, time for action
The president of Local Government New Zealand and Dunedin mayor, Dave Cull, says they've been telling government the current funding model isn't enough and it needs to act.
"It's really pleasing to see the Productivity Commission calling out issues that Local Government New Zealand has been raising for some time. We have been talking about the unsustainability of the funding model for councils, and as the Productivity Commission has pointed out, our funding model at the moment is insufficient to address a few specific cost pressures.
He said it wouldn't be credible for the government to ignore or dispute the recommendations.
"I think this adds considerable weight to what Local Government New Zealand has been arguing for some time."
The draft report is open for submissions until 29 August, with the final report to be released on 30 November.