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5.6  Other design considerations

Differential pricing

Differential pricing refers to a situation where different users might be charged different prices for the same output (eg, children are charged less than adults for passports, despite the fact that they are effectively the same product). When considering whether to use differential pricing, it is important to be mindful of the incentives on fee payers that might arise due to this kind of fee structure (eg the extent it encourages or discourages access to the service). Differential pricing is different to cross-subsidisation between different outputs, which should generally be avoided.

Cross subsidisation

Cross subsidisation occurs when the charges for providing one type of good or service are put towards the cost of providing another type of good or service. Cross subsidisation should generally be avoided, as the costs are not borne by the users. In this way it is not consistent with the efficient allocation of resources.

However, there may be situations where cross subsidisation makes sense for policy reasons.

The extent to which cross-subsidisation is lawful will always depend on the wording of the relevant empowering provisions and the entity is recommended to seek legal advice in these situations. Any cross-subsidisation must be clearly authorised and transparent, and the reasons for doing so clearly documented. External review organisations such as the Regulations Review Committee may consider the appropriateness of such a structure. The consequences of this are explained in section 1.4.

Assumptions and judgements

When designing cost recovery charges it is important to be mindful of:

  • the legislative parameters relevant to the specific cost recovery regime
  • the policy objectives
  • how transaction costs are managed
  • how to encourage efficiency in charging, and
  • equity implications.

In considering these issues, it is possible that assumptions and judgements will need to be made. Those that have been made in determining the design of a cost recovery charge should be clearly documented in the CRISs.

Refunds, exemptions and waivers

Payment of a fee or levy cannot be waived or refunded without authorisation from an Act. The Act (or regulations lawfully made under an Act) will identify the circumstances in which the fee or levy may be waived or refunded. A refund or exemption cannot be made unless the legislation authorises it.

Exemptions and waivers may also feature in the cost recovery regime. Fee waivers might be justified for charitable or volunteer organisations. When considering whether to include these, the overarching policy objectives will be helpful.

Estimating the volume to be produced in a given period, and the volume and cost of resources required

As part of the analysis, the entity should also consider the future demand. Volume is important for pricing and design. If forecasts are volatile then it might make sense to consider a floating vs fixed charge, or to set more frequent review periods.

Assumptions will be required (particularly in the case of new activities, where alternative sources of information will need to be sourced, and be reasonable and logical) and the analysis should be clear about these so that they can be tested by stakeholders.

The analysis should also consider changes and fluctuations in volumes over time, such as escalating volume as awareness and demand picks up, or an initial surge during peak seasons. This will help in determining the right level of charges, so that revenue will equal costs over a reasonable period of time.

Once the volume has been forecast, the entity can then estimate the required resources and their costs. Further assumptions will be required, such as the price that the entity expects to pay for the resources that it needs to produce the goods and services. Consideration should be given to both fixed and variable costs and the impact of inflation.

The analysis should identify a logical period over which the volume and costs should be based. If charges are reviewed every three years, then this would be a reasonable period to base the assumptions.

Testing and understanding efficiency and effectiveness

Efficiency and effectiveness in government involve making the proper use of available resources (people, money and other supplies) to achieve government policy outcomes. The question of how to create incentives for efficient and effective services should be a key consideration in the design of cost recovery regimes. However, incentives to be cost efficient are weak when there is little or no competitive tension, such as in the case of monopoly providers (as government providers of statutory services are).

It is important, therefore that in order to maintain the confidence of stakeholders, the entity is able to demonstrate it is efficient, even though this is challenging.

Charging entities should also ensure that they have mechanisms in place to ensure that they are not:

  • gold plating services or investments by building in unnecessary costs or delivering services at a higher standard than is necessary, or
  • using cost recovery charges to 'hide' inefficiencies in operations, by passing costs onto users who are unable to exert effective pressure to reduce costs.

Transparency will play a big role in creating incentives on entities to look for efficiencies. Cost recovering agencies should be able to explain the cost drivers and the way in which their outputs help deliver on the intended policy outcomes. The expectation is that this is collated in the CRIS templates and made public so that stakeholders can engage with the analysis.

Other ways of encouraging efficiencies include:

  • Using benchmarks for activity costs and processes against similar government activities and/or organisations in New Zealand or overseas. Benchmarking can be against either the whole activity, or where there is no directly comparable activity against part of the activity (eg, business processes). Benchmarking against the private sector may be possible but it should be noted that government entities have a range of accountabilities and that some cost recovered activities have unique cost drivers.
  • Preparing multiple options for different service levels and/or models and working through the costs of each.
  • Monitoring charges and output standards and levels (more on this in section 6.2).

To the extent possible, payers should be given the opportunity to provide feedback on the quality and quantity of a good or service via consultation and other stakeholder engagement processes.

Under-recovery and over-recovery of costs

The analysis should cover the question of whether it would be suitable to 'smooth' the costs of the service over an appropriate period of time.

User charges should match actual costs. However, charges will typically be set in advance of when they will be applied, and so a set of assumptions will need to be made. Where those assumptions don't correspond with the actual results, the revenue received by the agency will not match the actual cost of producing the good or service.

The appropriate period of time to consider whether revenue has matched costs will depend up on the specific situation, and factors such as the useful life of capital investments, likely changes in input costs, cyclical changes in volumes, and how constant (for example, airlines) or changing (for example, passport applicants) the set of payers is.

Although the general requirement is to match charges to costs as closely as possible, this is expected to occur over time. This recognises that it is not practicable to precisely match revenues to costs at a point in time and that there are downsides to frequent price changes, such as the extra costs of business process changes and communication to users. Where entities choose to use a period that is longer than a year for aligning expenses and revenue, that position must be justified. There must not be systematic over- or under-recovery of costs.

Memorandum accounts are one tool to help manage price smoothing and to be transparent with current status of under or over recovery. These are discussed in section 6.5.

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