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CAPITAL NEEDS ASSESSMENTS – FURTHER OBSERVATIONS
Further to its previous submission South Australia has the following additional
comments following staff level discussions on 11 October 2007.
1. Theoretical model
It would seem that Commission staff do indeed have in mind proposing to the
Commission a move away from the traditional operating statement based
equalisation framework to a Net Lending statement based framework. A socalled direct assessment of capital has been considered and rejected by the
Commission in previous Methodology reviews. It is of course possible that
new circumstances, or new analytical results and insights from Commission
staff might require a change in the Commission’s position. For the case for
change to be compelling it is desirable also there be clarity and transparency
in the new approach.
So far it would be accurate to say there is not complete clarity about how the
new approach works and its validity. Further, the only reason being put
forward that SA is aware of, to justify a change in approach, is that States’
infrastructure spending levels are commencing a major upswing. This is not
considered by SA to be a major new analytical result or insight.
The net lending framework effectively involves equalisation of cash flows in
respect of the acquisition of capital assets. The idea seems to be that GST
shares should contribute to the relative ‘banking’ requirements of States from
year to year on the assumption that relative needs for use of capital assets in
the future can somehow be identified in advance so as to allow needs for the
acquisition of physical assets in a particular time frame to be specified.
Under the operating statement approach the focus remains on the need for
delivery of services in the year of the service when demand and cost factors
are known. The assumption remains that there is no need for, or that fiscal
equalisation is not the vehicle for, mitigation of variation over time in new
money calls on financial markets (by NSWTC, QTC etc) to finance general
government capital expenditure.
Capital expenditure needs are to be assessed in two parts. The depreciation
standard and assessments from the operating statement model are to
transferred into the net lending statement model for so-called replacement
capital expenditure. While convenient, this relies on the implicit assumption
that relative needs for go forward total capital expenditure are substantially
indicated by today’s needs for the use of capital assets.
Assessed needs for non-replacement capital expenditure (ie the arithmetic
difference between depreciation and total capital expenditure) are to be based
on current relative population growth rates, presumably on the basis that
States with high population growth now, will have a greater need for
classrooms, hospitals etc in the future to service proportionately larger
populations in the future. Commission staff have not yet specified how
differential growth rates in population age groups, indigenous populations etc
will be brought to bear. (We are assuming that relative growth rates of
population sub groups would be relevant to functionalised non replacement
capital expenditure needs, since it is expected future levels of sub populations
which influence total capital expenditures of various types. Also presumably
those need assessments would appropriately cater for expected large
fluctuations in the functionalised standard, noting that functionalised non
replacement expenditures for individual States will indeed fluctuate greatly
and change sign from time to time.)
Further, it would seem to be the intention of Commission staff that needs be
recognised, in the Net Lending model at least, in respect of growth in the
stock of general government net worth (or some part thereof possibly general
government net financial worth or possibly net financial worth less net assets
of Public Non financial and financial corporations; or possibly even gross
financial assets. In what follows the terminology net worth or part thereof will
be used). These needs are described as an adjustment for the impact of
population growth.
The calculation of this proposed adjustment has not been specified by
Commission staff at this stage. Commentary in support of it has referred to the
notion of dilution of (part of) net worth from population growth. But the WA
argument for the existence of dilution needs in principle seems to relate to the
stock of net worth in full. (It is noted that leaving aside the degree of dilution
recognised, if the stock base for a ‘WA’ type calculation is anything other than
net worth, States would be motivated to implement balance sheet restructures
(with nil net budget impact), to pump up or down that stock base to influence
the calculation of such needs.)
Further, the direction of need as per the WA argument is not dependent (as
we are advised the adjustment for population growth would be) on the sign of
the standard budget result term. Net lending does change sign from time to
time. It is possible the difference in the indicative Commission view from that
of WA arises from the fact that the main source of net financial worth is not an
accumulated positive net lending amount, but rather valuation gains, which
are not reflected in the GFS transactions based Net Lending amount (unless
liquefied eg upon privatisation of electricity utilities).
SA reiterates that any consideration of net worth (or part thereof) needs on
account of population growth, if proposed, should have regard to valuation
gains from population growth.
2. Population dilution effect
We are advised that the adjustment for population growth has some
resemblance to one of the (opaque) elements in the current debt charges
methodology and may relate to the alleged stock of net worth population
dilution effect (c.f. Option 4 of the WA Submission). It is said that because at
the end of the year/beginning of the next year, the population share of a high
growth State is higher than the population share at the beginning of the year,
carried forward net worth or part thereof per capita is thereby too low for a
high growth State. SA queries this argument, and notes that the GST share
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obtained by the high growth State is in fact based on its mean population for
the year. This is akin to daily or continuous time equalisation. The high
growth State would seem to suffer no shortfall in its GST share or own
revenues that, for equal savings/surplus effort per head of mean population,
would prevent it from accumulating equal net worth or part thereof per capita.
3 . Simplicity of competing options
The Operating statement based framework is clearly simpler than the Net
Lending based framework because GST grant shares are determined in
respect of known total population sizes, known sub population sizes, known
cost factors for physical assets etc. In effect, even with the holding cost
adjunct, existing depreciation needs assessments are merely being scaled up
to recognise the holding cost of physical assets in a way which allows the cost
of an asset service to resemble an operating lease equivalent in some
measure.
Holding cost is a stable number for each State over time and by function.
Non-replacement capital in the net lending model by contrast is unstable over
time and indeed volatile in sign and magnitude at a functional level.
Under the operating statement model all net interest received is treated epc
on the basis that the primary transactions which contribute to accumulated net
worth over time are already equalised – there seems to be a
misunderstanding on this point.
Recognising needs in respect of changes to the stock of net worth or part
thereof is undoubtedly a deus ex machina in relation to a flow transaction
based operating statement model – but that is no less the case if such needs
were to be implemented as a perpetual interest amount in respect of the net
interest received standard, than if calculated as an upfront amount for the year
in which such needs are said to arise. .
In other words, if net worth or part thereof equalisation is considered justified
that can also be introduced into the operating statement model in respect of
the standard budget result term as is proposed in the CGC staff version of the
Net Lending model. For example if the Commission is persuaded that a high
growth State should be allocated an extra bit of GST each year because that
year’s population share of GST is not enough having regard to the fact that
that State’s population share will be relatively higher in the following year, that
can still occur in the relevant year in the operating statement model, rather
than spread over time in the form of a perpetual interest amount.
We hasten to add that the Commission should not be so persuaded, and if it is
accepted that certain net worth needs do not exist or are considered to fall
outside of the scope of a flow transaction based equalisation model, along
with other potential net worth equalisation needs, the operating statement
model is undoubtedly simple.
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SA favours the operating statement model with an epc assessment of both net
interest (earnings) received and the standard budget result term, (and no addons for change in net worth needs), on grounds of conceptual validity,
transparent implementation, continuity and simplicity.
South Australian Department of Treasury and Finance
October 2007
Contact officer:
Robert Schwarz
Assistant Under Treasurer, Revenue and Economics
08-82269433
[email protected]
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