Costing of Political Party Policies

Page updated 31 Aug 2011

The following information comprises high-level guidance on how to cost political party policy proposals. Treasury aims to facilitate a consistent approach to costing policy proposals across the public sector.

• Introduction
• Importance of Following Agreed Protocols in Relation to Costing Political Party Policies
• Treasury's Role in Costing of Political Party Policies
• Approach to Preparing Economic Costings
• Calculating the Effect of Policy Proposals on the Crown's Fiscal Aggregates

Introduction

This site provides high-level guidance on how to cost political party policy proposals. It draws attention to the more significant or sensitive aspects of cost-benefit evaluation and fiscal estimation. However, it stops short of providing a full manual on costing spending or revenue proposals.

The term ‘policy proposal’ should be interpreted widely. In particular it includes options under discussion, even if these are not formally proposed.

Importance of Following Agreed Protocols in Relation to Costing Political Party Policies

The State Services Commission (SSC) has published procedural guidelines for state sector agencies in relation to the 2011 election period (refer State Servants, Political Parties, and Elections: Guidance for the 2011 Election Period, which includes an appendix titled Guidelines for Costing Party Political Policies). Additionally there is guidance on the SSC site on the support for political parties engaged in negotiations to form a Government (refer Negotiations Between Political Parties to Form a Government: Guidelines on Support from the State Sector).

The SSC guidance anticipates that state sector agencies may become involved in the costing of political party policies in a number of situations, with differing protocols, as set out in the table below. It is important that the correct protocols be applied in each situation.

Regardless of the source of or reason for costing a policy proposal, all costings should be carried out in accordance with good-practice guidelines. The guidance that follows complements the published guidelines on the SSC website.

Treasury's Role in Costing of Political Party Policies

Treasury aims to facilitate a consistent approach to costing policy proposals across the public sector. As the primary economic and fiscal advisor of the Government, Treasury's normal business is to advise on the implications of Government policies. Additionally, as the SSC guidance indicates, there is scope for Treasury to play a key role in the development and/or review of the costings of political party (government or non-government) policy proposals.

The actual extent of Treasury's involvement in such costing exercises will be determined on a case-by-case basis, taking account of such factors as the source of the costing request, availability of required expertise in Treasury and the agency receiving the request, and whether Treasury holds relevant information that the agency receiving the request does not possess.

In many cases, Treasury will have an advisory rather than lead role in the costing of policies, and departmental chief executives will have prime responsibility for costing and reporting on policy proposals in accordance with the SSC published guidelines.

The level of Treasury involvement will be the extent necessary to ensure that the economic and fiscal costings provided to Ministers for decision-making are as complete and reliable as possible. All key aspects of the policy proposal should be captured in the costings, including the potential flow-on effects on tax revenue and/or transfer payments.

Approach to Preparing Economic Costings

The objective of preparing an economic costing is to model real resource flows at true market value. Modelling resource flows enables comparisons to be made of the social costs and benefits of a proposal using dollars as a common yardstick.

Economic cost-benefit analysis is important to decision-making. Calculating the economic cost of a policy proposal aggregates all the resource costs over time into a single estimate measured at a common point in time. Ministers can then compare these costs with the benefits, whether quantified or not, when deciding whether to proceed with a policy proposal.

Good economic cost-benefit analysis practice involves capturing all identifiable costs and benefits and including them in the analysis. However, there may be intangible costs or benefits (including costs or benefits resulting from behavioural changes). Therefore, a case-by-case judgement should be made as to whether to include a particular intangible cost or benefit in an economic cost-benefit analysis.

For most proposals the common costs and benefits to be included for analysis are:

• direct establishment costs (e.g. staff, information technology, rent, etc.)
• purchase of fixed assets
• indirect establishment costs (e.g. other overheads and negative externalities)
• direct establishment benefits (e.g. reduced operating costs)
• indirect establishment benefits (e.g. positive externalities)
• release of capital
• residual values
• positive or negative changes in outcomes (e.g. reduced traffic accidents)

A useful rule is to include only those costs and benefits that involve the actual use of resources and that would be affected by the proposal under consideration.

The specific assumptions that should be used when calculating the economic cost of a policy proposal are outlined below. Any departure from these default assumptions should be clearly stated and explained.

Discount Rates

Typically we use a 'present value' approach when estimating economic cost.  The appropriate discount rate to use in cost-benefit analysis has been the subject of much debate.  Since the 2008 election, Treasury has reviewed its real discount rate to be used in cost benefit analysis. The conclusion has been that the following real rates should be used:

For more information about how these discount rates were arrived at see Public Sector Discount Rates for Cost Benefit Analysis.

Calculating the Effect of Policy Proposals on the Crown's Fiscal Aggregates

In addition to understanding the economic merits of any policy, Ministers, taxpayers and others are typically also interested in knowing how a policy proposal will affect the Crown's fiscal forecasts and impact on fiscal aggregates such as gross debt.

Fiscal costings and long-run economic costings differ in five key respects, as follows:

• Economic costings include effects on all sectors of the economy, whereas fiscal costings focus upon the government sector only.
• Economic costings discount future cash flows associated with the policy over time, whereas fiscal costings estimate the nominal impact on the Crown financial statements over the forecast period, typically five years.
• Economic costings reflect real resource use, whereas fiscal costings can include resource transfers and accounting items such as depreciation, capital charge and financing costs (where relevant).
• Economic costings do not distinguish between capital and operating costs, whereas fiscal costings make that distinction.
• Income tax impacts, GST and other indirect taxes are included in economic costings of proposals that relate to Crown expenditure on goods and services, but are generally excluded from fiscal costings. This is because fiscal forecasts already include forecast tax flows and it is assumed that particular policy proposals can be funded out of existing spending provisions.

The relationship between economic analysis and fiscal analysis is illustrated in the schematic below:

Where long-run economic costings are materially different from the short-run fiscal costing (e.g. due to macro-economic effects, timing of spending, capital costs, etc.), these two costings should generally be identified and reported separately.

The focus of fiscal costings is on estimating the initial impact of proposals on fiscal aggregates over the forecast horizon (typically five years). Due to inherent uncertainty over the timing and impact of second-round effects, Treasury excludes these from its estimates of the fiscal impacts of policy proposals.

The fiscal items which may be relevant include:

• the initial impact on the operating statement in the Statement of Financial Performance
• any risks and contingent liabilities arising, e.g. from Government guarantees

and, if they differ from these initial impacts:

• the cash effect (in terms of operating, investing, and financing cash flows) and the initial impact on core Crown net debt
• the change in net worth
• any other significant changes within the Crown's Statement of Financial Position.

The specific assumptions that should be used when calculating the impact of a policy proposal on the fiscal aggregates are outlined below:

It may also be necessary to report the specific changes to appropriations, which may differ from the impact on the operating balance (e.g. if savings offset a portion of the cost). These are often not required until the later stages in a costing exercise, such as when specific options have been agreed.

Fiscal costs and benefits for the operating statement are allocated to fiscal years in accordance with accrual accounting concepts. They are recognised when they are incurred (i.e. when a good or service is delivered).

Notes: