City of Newcastle has argued councils should be able to raise rates above the cap and that the current rate peg system had led to "excessive cuts in expenditure on infrastructure".
The council made the comments in a submission to a state government inquiry on the ability of local governments to fund infrastructure and services.
In the submission, council CEO Jeremy Bath said the amount councils receive in rates was usually not enough to cover increased costs associated with population growth, and in recent times, fell short of covering inflation pressures.
The rate peg is the maximum percentage by which a council is allowed to increase its income for the year. It is set by the Independent Pricing and Regulatory Tribunal.
Mr Bath said non-rate revenue and grant funding was "critical" with rate-pegging in place, but could be "onerous, complex and cause additional pressures".
"For example, grant funding that creates additional unfunded maintenance and depreciation expenses, grant programs that will only fund un-planned/budgeted projects or with a co-contribution and funding timeframes that do not align with local government planning cycles," he said.
Mr Bath also mentioned Newcastle's varying classification between metropolitan and regional for grant funding criteria which limits the council's funding pool.
The council's submission said independent reviews had found the rate peg created increasing financial hardship for councils as it did not allow them "to meet the risings costs of serving their communities".
"Any discrepancy between the peg and cost changes has long and on-going effects," Mr Bath said.
"It creates unwarranted political difficulties for councils that really can and should raise rates above the peg to meet genuine expenditure needs and ensure their long-term sustainability.
"This has led to excessive cuts in expenditure on infrastructure maintenance and renewal, leading to a mounting infrastructure backlog."
Mr Bath said rate-pegging was designed to prevent excessive increases in rates, and to encourage councils to become more efficient.
"We believe this has occurred but could also have been achieved without rate-pegging by allowing councils to set rates in consultation with residents," he wrote in the council's submission.
"While ratepayers benefit from what is characterised as unwarranted excessive rate increases, councils face constraints on financial flexibility and autonomy.
"Ultimately, councils are unable to fund essential services and infrastructure projects, leading to social and economic concerns about service quality and amenity levels."
In relation to special rate variations, Mr Bath said the process to apply was "onerous and complex" and applying came at a "significant financial, time and resource cost to the council".
The submission also called for the removal of the emergency services levy councils are required to pay the state government.
Lord mayor Nuatali Nelmes said Newcastle council was a "net payer" to the NSW government.
"We pay the NSW government more than we receive back in grants and contributions,," she said. "That is also an exceptionally unique position and not a good position. Other local government areas receive a lot more in grant funding and contributions."
Deputy lord mayor Declan Clausen said the council received just under $24 million in state government grants last year, but paid out $45 million in state levies and taxes for things like the emergency services levy and section 88 waste levy.
"That is pretty abnormal," he said. "That's not the way that vertical imbalances across the levels of government are meant to work it highlights the need for reform."
