Expectations of Fiscal Prudence and Value-for-Money (continued)

Purchasing from Non-Departmental Providers

Individual Ministers also have output agreements with Crown entities and other non-departmental providers. Usually, the management of these is undertaken by departments on behalf of Ministers and this management function becomes an output supplied by the department.

Non-departmental expenses dominate spending in some sectors. District Health Boards, for instance, are largely funded through non-departmental output expenses. School boards of trustees are funded from non-departmental other expenses. In other areas, non-departmental outputs deliver low cost but still crucial functions, such as tuberculosis control in livestock and the management of the New Zealand Superannuation Fund.

Managing these arrangements involves negotiation, monitoring, review and payment for outputs purchased from third parties. Departments managing delivery arrangements with other suppliers must provide their Ministers with timely advice on cost, performance and emerging risks.

Purchasing from non-governmental providers is also used to access the unique skills and capabilities of the private sector and non-governmental institutions. Significant purchases are typically preceded by competitive tendering processes that provide Ministers with valuable information on alternative ways to deliver good quality outputs, and the quality and cost of comparable services offered by government agencies.

Periodic Review of Costs and Value-for-Money

Boards and chief executives are expected to be fiscally prudent, providing the first line of defence against cost escalation. They are also expected to deliver better, faster and smarter services, and report on results.

Figure 4: Value-for-Money

Fixed nominal baselines, where budgets do not rise at the rate of inflation, incentivise agencies to become more efficient, eg, by reducing overheads or implementing more cost-effective production methods. Enforcing fixed nominal baselines helps ensure that additional (new) funding is used to purchase additional goods and services, which in turn improve outcomes.

When agencies argue they cannot become more efficient, some form of baseline review should be triggered. (A review of the New Zealand Defence Force in 2010, for example, identified savings of $300-400 million.)

Self-reviews and external reviews often start from similar issues but the emphasis and direction of reviews varies with the purpose of a review, information available and what reviewers find as work proceeds. Focusing on price, quantity and standards, reviews generally look at:

• government priorities and levels of demand for services
• the extent to which policy settings remain sensible and sustainable
• real trends in agencies’ budgets, wages and staffing levels
• benchmarking results, back-office costs and output costs
• real trends in output prices (in total and per unit produced)
• scope to reduce volume through better targeting
• whether evidence supports any claim that output quality increased[23]
• whether past increases in spending, etc, had an impact on outcomes
• how different outputs or business models might deliver better results.

Output Costs

Accurate costing is needed, regardless of who delivers goods and services. Good cost allocation systems provide information needed to assess value-for-money, inform purchase decisions, and alert managers to the need to take action when input and output costs rise rapidly or unexpectedly.

Output costs reflect the full accrual cost of specified outputs (including capital charges and depreciation), not just the cash required for inputs. Cost allocation establishes what direct and overhead costs are charged to each output, and allows agencies to control input and output costs.

Chief executives and boards are expected to control costs. To do this they manage inputs and identify the full cost of each output. The full cost of an output is the sum of the labour and materials required plus the appropriate share of overhead costs (including depreciation and capital charges).

Cost allocation is critical to the purchasing process. Under-estimation of costs means that the cost of one output gets subsidised by others (an 'implicit cross-subsidy'). Accurate costing ensures that:

• taxpayers and third parties are charged appropriately for services (see Chapter Six for the perils of over-charging)
• outputs compete on equal terms during competitive tenders
• appropriations reflect the true cost of goods and services, including depreciation and capital charges.

Capital Charge

Capital charges are applied by all departments and selected Crown entities. Departments pay a capital charge calculated on their net assets.[24]The Public Sector Discount Rate[25] is usually used as the capital charge rate and reflects the cost of the Crown's investment in an agency.

The cost of the Crown's capital investment may be a significant driver of the cost of goods and services, and an important element of the cost allocation process. Many agencies supply goods and services to third parties. If the prices charged for these do not at least equal production costs (including costs of capital), a government is subsidising those goods and services.

If fees are payable, however, full costs can be recovered (Chapter Six).

Capital charges do not increase the overall cost of government services to the taxpayer. They just help cost outputs accurately, encourage agencies to sell under-used or non-essential assets, and free up surplus capital. In turn, this reduces capital charge expenses and the total cost of production.