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5.3  Partial or full cost recovery?

There are some circumstances where charging at less than full cost may be appropriate. A decision to charge at less than full cost recovery would need the shortfall to be made up from general taxation. The advice on cost recovery charges should provide a good case for why general taxation should contribute to the costs of an activity, as taxation has economic costs and also affects budget constraints.

In some circumstances full cost recovery would lead to a situation where the cost recovery regime undermines the policy objectives. In these cases a policy decision may be made to partially recover costs. For example full cost recovery of civil court proceedings may create a cost barrier that inappropriately limits access to justice.

Partial cost recovery may also be appropriate in circumstances where charges are being phased in. This can enable those paying charges to adjust to new charges.

When partial cost recovery is recommended, the advice should include options for different levels of partial cost recovery and an assessment of the impact of each option, as well as reasons for and against. The assumptions and evidence that underpin the advice should be well documented.

As always, care must be taken when estimating the full costs of recovery as often the statutory authority for charging will not extend to allowing for over-recovery. This can cause difficulties if an entity is trying to recover a deficit after a previous period of under-recovery. However, the entity can manage these issues provided that there is enough scope in the statutory authority, and if it is clear that the surpluses and deficits are being managed within a reasonable budgeting framework for managing costs and setting fees over a period of time. Memorandum accounts are one way of managing surpluses and deficits over time in a transparent way (discussed further in sections 5.6 and 6.5).

Charging at short run marginal cost

In some instances it may be efficient to charge at short run marginal cost, that is, what it would cost to produce one more unit,[4] rather than full cost recovery. Situations where this might occur could be the production of goods that are incidental to the provider's core business.

Example: Incremental costs

Government frequently receives requests for official information from the public. In some cases, a fee is charged to recover the cost of this activity. As the production of this output is incidental to the core business of government, it might be appropriate to charge on an incremental rather than full cost recovery basis.

Charging at the marginal cost (that is, the cost of producing one more product or service) can promote efficient levels of consumption, as well as the level of production over the short term. Whether it does so will depend on the extent to which demand and/or supply are sensitive to the price.

Revenue shortfall

If a shortfall from charging at short-run marginal cost cannot be made up from fixed charges, it has to be met from general taxation. Taxation has economic costs and also affects budget constraints.

Net benefits of charging at short-run marginal cost

The analysis should consider the trade-off between:

  • the costs resulting from poor decisions if charges differ from short-run marginal costs, and
  • the costs resulting from poor decisions and/or higher taxation if charges differ from long-run marginal costs.

Notes

  • [4] For example, if the agency had produced 60 units in a given period, the short run marginal cost would be what it costs the agency to produce the 61st unit.
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