2.1 Establish the Assumptions and Scope
What assumptions need to be made to conduct the analysis? Early consideration of this question will make the identification of the costs and benefits much easier and can save a significant amount of time.
There are a number of general default assumptions that should guide the analysis:
- consider the impacts of a proposal across all sectors of the economy by thinking about the inter-relationships between sectors (economists term this ‘general equilibrium analysis’). Suppose, for example, a government supplies cheap power, transport, or some other subsidy to beef meat producers. This results in a lower price for beef, which in turn decreases demand for sheep meat. The net benefit needs to take into account both the beef and sheep meat markets
- include all intangible costs and benefits where they can be reliably estimated
- assume all resources in the economy are fully utilised (e.g. full labour employment, otherwise the costs and benefits of additional employment must be considered)
- include all subsequent or contingent costs/investments. For example, if the upgrade of an agency’s computer system requires the simultaneous upgrade of the telephone system, then the analysis must include both the computer and telephone upgrades, and
- exclude international impacts (unless these are explicitly being evaluated).
Treasury’s expectation is that ‘Cost Benefit Analysis’ will be undertaken from a national perspective rather than a government or departmental perspective wherever possible. This is often termed ‘economic Cost Benefit Analysis’ and is preferred because the actions of one agency or department can impose costs or benefits on individuals or the nation as a whole (e.g. increasing the size of a programme operated by a particular department may assist the operation of the department but may nonetheless require a large increase in income tax on individuals). Put another way, economic CBA seeks to capture all benefits and costs regardless of to whom they accrue.
An alternative approach to the national perspective is ‘financial analysis’ which considers the case when costs and benefits are limited to impacts on an individual agency or department. An example of this is a new accounting package for a department or a lease versus buy decision for real estate.[17]
Cost Benefit Analysis also needs to be distinguished from the fiscal costings which typically are included in a Cabinet or other approval paper (see section 5.3). The key differences between the different types/levels of analysis are summarised in Figure 2.1a.
Figure 2.1a: Levels of Analysis – Elements to be included
Default assumptions for economic Cost Benefit Analysis and possible variations are summarised as follows:
| Issue | Default Assumptions | Possible Variations |
|---|---|---|
| Scope of Analysis | National economy |
|
| Form of Analysis | Consider the impacts of a proposal across all sectors of the economy (‘general equilibrium analysis’) | Analyses the impacts from the perspective of a single sector or department (‘partial equilibrium analysis’) |
| Period of Analysis | Economic life of the underlying proposal or assets, subject to a maximum of 20 years | Longer than 20 years where benefits or costs to the economy emerge slowly e.g. early childhood education |
| Financing/Capital Charge costs | Exclude | Exclude |
| Depreciation | Exclude | Exclude |
| Intangibles | Include if these can be reliably measured (refer section 2.4) | Exclude and conduct a qualitative assessment if these cannot be reliably measured (refer chapter 4) |
| Taxes | Tax inclusive prices should be used |
|
| Transfer payments (e.g. social welfare benefits) | Exclude if there is no change in societal welfare |
|
| Discount rate | 10% real rate per annum |
|
These assumptions are explained in sections 2.2 to 2.4 below. Refer to chapter 3 for information on the selection of discount rates.
Notes
- [17]The key difference between ‘financial analysis’ and ‘economic cost benefit analysis is that the latter considers all benefits and losses regardless of to whom they accrue whereas the former only considers the benefits and losses to an individual agency or department. Other alternatives include ‘international analysis’ for proposals with impacts outside New Zealand, and ‘whole of government’ analysis which concentrates on the impacts from the perspective of the Crown as a whole.
- [18]WACC = Weighted Average Cost of Capital.
