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Outsourcing and user-charging are two among a number of devices increasingly used by governments since the early 1980's as part of New Public Management reforms which emphasised private sector styles of management to drive efficiency and effectiveness by making agencies more market-orientated and competitive. Public choice theorists argued that public servants, acting in their own self-interest, often work against the public interest in order to protect or inflate their budgets. This has given rise to the perceived need to separate activities associated with purchasing services from those associated with provision of services. That is, it was no longer necessary to presume that government must own and operate all public administration activities.
Outsourcing focussed public sector management attention on 'make or buy' decision where the structure of the organisation was ultimately determined by a consideration of the relative costs (including risk of a botched job or sub-standard quality) of outsourcing an activity versus performing the task in-house. The resultant efficiency gains, in terms of allocative and productive efficiency, it is argued will also improve access to services and increase equity through more widespread provision.
The rationale for introducing user charges for services is that the universal provision of "free" government services are subject to free-rider problems and moral hazard leading to a misallocation of resources. User charges may reflect either partial or full cost of services and are based on the notion that many services deemed to be 'public goods' (or public 'bads') often involve a degree of private benefits (or costs). This is what economist's term externalities, i.e., benefits (in the case of positive externalities) and costs (negative externalities) accrue to parties other than those involved in a transaction. On the one hand, charges provide a means of rationing public services and allow a better match between supply and demand (such as water pricing). They also allow the government to leverage community willingness-to-pay in order to expand overall service provision, such as occurred in higher education and health services. The introduction of the Higher Education Contribution Scheme (HECS), as a co-payment scheme for university education was based on the argument that students should offset the private gains from tertiary education. Evidence of the impacts of HECS 20-years post-introduction - according to Bruce Chapman, key architect of the HECS scheme - show that the higher education sector has grown by an amount equivalent to the aggregate student contribution, i.e., around 30%. Furthermore, there has been no change in the distribution of students attending university based on socio-economic status.
The effects of these reforms to date have been mixed and difficult to quantify and have depended to a large extent on how well thought out the principal-agent contracting arrangements have been and the political motivations underlying some reforms.
Benefits to agencies that have been identified include: the ability to deal with peaks and troughs in workloads; access up-to-date technical knowledge and expertise not available in-house; to permanently downsize government agencies; and ability to roll-out services quickly and to locations where an agency has no presence (eg., use of private training organisations). Outsourcing also allows government to deliver programs off-budget, such as major infrastructure utilising build-own-operate-transfer schemes, which has implications for financial reporting.
Conversely, a number of issues have inhibited effective outsourcing arrangements including: a loss of corporate knowledge; reduced staff morale; insufficient competition in some markets; a lack of pre-market testing; poor contract specification; and quasi-markets where governments, in attempting to inject greater degree of market forces, typically get the price wrong resulting in mispecified contracts and/or perverse incentives. Poor contract specification and monitoring, with an over-emphasis on cost reduction have been associated with offsets in quality, access and equity or failure to meet community service obligations.
While outsourcing reforms are aimed at reducing costs and improving accountability, the fact that government is less directly responsible for delivery through such arrangements does signal a concern in terms of public accountability. For example, where a firm awarded a government contract fails, who is responsible for delivery? This is a risk that must be managed and specifically addressed in contract preparation since outsourcing of government services does not diminish public accountability.
Generally successful outsourcing arrangements which have resulted in expanded levels consumer choice and expanded provision have been associated with pragmatic outsourcing. That is outsourcing based on economic efficiency principles and emphasises lower transaction costs to drive purchasing decisions.
Unsuccessful examples, in terms of political expectations, such as South Australia approach to IT services and compulsory competitive tendering in Victoria under Kennett, are characterised by tactical and systematic outsourcing. These approaches introduce a political dimension where governments see outsourcing as a either tactic to further other agendas such as organisational renewal or an ideological preference for private over public provision. Such motives will generally be inconsistent with the economic efficiency objectives associated with a more pragmatic approach.
5. Australia has the most centralised federation in the world in terms of taxation. What are the consequences of this trend? Do you think the federation framers intended our inter-jurisdictional system to work as it does now? Would greater balance in the vertical fiscal arrangements be an improvement (why? for whom? Who would be better off?
A distinguishing feature of Australia's federation is that our constitution has assigned the majority of spending and service delivery responsibilities to the States but provides limited capacity for states to raise the necessary revenues while the reverse is true for the Commonwealth. As a consequence, Australia has the greatest degree of vertical fiscal imbalance (VFI) of any federated country. Currently, the Commonwealth raises approximately 75 per cent of total general government revenue but is responsible for only around 60 per cent of total expenditure.
The high degree of VFI has been a feature of Australia's system since Federation when the colonies ceded their most important source of revenue, i.e., customs and excise duties, to the Commonwealth. Since then, and following the results of several referenda and High Court decisions the Commonwealth's financial powers have continued to increase at the States' expense. For example, the Commonwealth took control of income tax in 1942 (intended to be a temporary measure during the war); the High Court determination that state's taxes such as tobacco franchise fees were excise-based and therefore constitutionally reserved for the Commonwealth; and most recently, the introduction of the GST - an indirect growth tax, collected by the Commonwealth and distributed to the states on the proviso that they would abolish a number of state taxes.
As a consequence of this consolidation of financial power, the States have become increasingly dependent upon financial transfers from the Commonwealth in order to meet service delivery responsibilities. Such intergovernmental financial transfers have, since the establishment of the Commonwealth Grants Commission (CGC) in 1933, been concerned primarily with issues of horizontal fiscal equalisation. That is, revenue transfers are designed to provide each state with the capacity to provide services at a standard comparable with other states but without requiring that State to impose a greater burden of taxation. However, the basis of such transfers has been increasingly in the form of tied grants or Special Purpose Payments (SPPs) with a lesser proportion distributed as general purpose payments over which the states had discretionary spending control. The proportion of SPPs as a share of total grants has risen steadily and accounts for over half of all money received by the state/territory governments.
This concentration of financial power, which has enabled the Commonwealth to regulate State borrowing and to impose its priorities on the states, effectively threatens state sovereignty. Increasingly, neo-liberalist style reforms focussing on efficiency have lead to greater emphasis on principal-agent style contracting arrangements. In the case of Commonwealth-State financial relations, payments to the state and territory governments, as service delivery agents of the Commonwealth-purchaser, are increasingly conditional upon fulfilment of contractual obligations.
It is unlikely that our federation framers could have foreseen the extent of Commonwealth financial domination which was never the intent. The constitution was designed to preserve the powers of the States while reaping the benefits which would flow from federation, such as national defence and free trade between states. The framers of the Constitution recognised the need for a cooperative system of Federal-State financial relations to ensure the States were adequately resourced since they had given up their main source of revenue. The Constitution (section 87) set out transitional financial arrangements between Commonwealth and States providing for the first 10-years, 75% of all customs and excise revenue raise by the Commonwealth would be returned to the states. Section 94 also required that all surplus revenue collected be transferred to the States as the Commonwealth deemed fair.
One leading architect of Federation and eventual Prime Minister, Alfred Deakin, did foresee the current situation emerging when he wrote ' the independence of our States is doomedâ€¦ the rights of self-government of the States have been fondly supposed to be safeguarded by the Constitution. It left them legally free, but financially bound to the chariot wheels of the central government. Their need will be its opportunityâ€¦the Commonwealth will have acquired a general control over the States, while every extension of political power will be made by its means and go to increase its relative superiority'.
While the degree of VFI in Australia has been fiercely debated it seems unlikely that greater balance in vertical fiscal arrangements would lead to an improvement. The main criticisms of VFI are that it reduces government accountability; it forces the States to rely on narrowly-based and inefficient taxes for own-source revenue; diminishes political power of the States; and negotiation of agreements between Commonwealth and States involves unnecessary policy duplication and waste of resources. Despite these criticisms however, no serious attempt has been made to reverse this trend.
Advocates of VFI maintain that the Commonwealth is best placed to determine national interests; to pursue horizontal fiscal equalisation; provide administrative simplicity and equity via a nationally uniform tax and social security system; and stronger Commonwealth control over macroeconomic policy. It is also relevant that in a globalised economy with trade liberalisation and a floating exchange rate, the tyranny of distance which provided the motivation behind the separation of powers and the need for autonomy of states holds much less relevance. In order to give a coherent and transparent signal to prospective foreign investors then a centralised taxation system is required.
Moves to reduce VFI via a decentralised tax system would provide a direct benefit to those states who are currently 'donor' states under the CGC relativities calculations, i.e., NSW and Victoria. Conversely, those most disadvantaged by such a move would be Tasmania and the Northern Territory.
6. What are the financial and practical difficulties in defining and valuing assets in the public sector? How useful is asset valuation information to managers and taxpayers?
The need for asset valuation and management is directly linked to the New Public Management reforms intended to make government more business-like, promote competition, improve allocative and productive efficiency in terms of public sector resource utilisation and reduce the costs of service delivery. Traditional cash-based systems did not capture or monitor asset values or depreciation and resource managers did not bear the capital costs associated with their programs. In order to compare the true costs of service delivery in the public sector with private sector entities, a necessary first step was to require public sector managers to record and value there assets.
There are generally five accepted methods for asset valuation used in the public sector: historical cost; net present value; current replacement value; market price; or deprival value. While each method has its own advantages and disadvantages, there is no one accepted method which itself presents a practical difficulty.
Historical cost, which reflects the cost at time of purchase, provides an unrealistic valuation as time passes, particularly with appreciating assets such as land. NPV methods are useful where the asset in question generates an economic return however this is not the case with many public assets. Unlike private sector entities, the financial and physical assets held by the public sector are often intended to optimise net social costs and benefits and not for its own sake or for the creation of profit. NPV calculations in regards to assets used for social welfare programs therefore must account for any possible externalities (wider social and economic effects). Replacement value is a useful measure where like assets are readily available but due to rapid technological change may be superceded. Market prices likewise are relevant where the asset is readily available and a secondary market exists where a selling price can be established. However, this is not the case for many public sector assets, which are often specialised and may not be replaced or replaceable if destroyed. In recognition of this, the Department of Finance and Administration (DoFA) favour use deprival value where assets have no private sector equivalents, such as national parks. This valuation method is based on the idea of opportunity cost and requires some subjective assessment of what the asset is worth to the community.
Given that many public assets have no commercial value and are acquired by governments to provide mainly non-cash services to citizens, such as health, education, defence, environmental, heritage and cultural services, several accounting standards and guidelines have been developed to assist in determining 'fair value,'(e.g., Australian Accounting Standards Board, AASB 116) .' Fair value is measured having regard to the highest and best use for an asset. Where this cannot be observed from current market prices, for example, an asset's fair value under AASB 116 is measured at depreciated replacement cost.
Selecting an appropriate depreciation method once an asset has been valued poses additional problems in relation to public sector assets. For example, how do you depreciate rivers, coastline or radio spectrum, or do they appreciate in value as land and cultural art works do?
The lack of uniformity in valuing and depreciating assets can give rise to manipulation and political manoeuverings. Asset owners may seek to exploit valuation methods and various depreciation schedules in order to achieve a particular result. For example to manipulate debt-to-equity ratios, impacting a government's credit rating to ensure a lower interest and maintain borrowing capacity.
Asset information is very important for program managers, particularly in an environment of accrual budgeting. The move to accruals in Australia requires assets to be valued to provide full cost of delivery information, capital charges imposed and as a means of ensuring appropriate asset management strategies are in place. Such strategies are intended to maximise the value of existing assets and provide a strategic context for future investments. Specifically, they should provide an account of the systems and procedures in place to ensure: assets are adequately maintained and efficiently utilised; surplus assets no longer required for service delivery are disposed of; and resources released from asset sales can be reinvested in public services.
Where capital charges are imposed as a means of giving agencies an incentive to manage assets effectively, an issue for asset managers relates to whether they have any direct control over these assets or whether they are essentially administrative or custodial in nature. For example, a notionally economic asset such as a bridge or tunnel could earn revenues through charging tolls. However, this may be precluded where governments do not authorise user charging because of electoral or other political concerns.
The value of asset information to taxpayers is more indirect and is likely to be reflected in user charges for accessing certain assets. The issue of a government's credit rating and borrowing capacity also impact its ability to fund assets and the impact will be felt through taxation.
9. The major downsides of an accruals budgeting system are that it cashes out longer term liabilities in the immediate period (meaning agencies have to manage the funds) and its aggregate figures are more rubbery and fudged than a cash-based system. Discuss and provide reasons/evidence for your answer. Why does the Commonwealth Treasury prefer cash-balance figures to accrual fiscal balances?
Accrual accounting requires all expenditures to be recorded when they occur (not simply when they cash is paid out), affecting the timing of expenditure recording and making clearer the multi-year costs of decisions. Some of the more important differences between the cash and accrual reporting relates to the treatment of unfunded superannuation liabilities, provision for the depreciation of capital assets, and treatment of public debt interest. Advocates of accrual budgeting often stress the benefits of such differences over cash reporting, and claim that management of assets and liabilities has improved as a result. However, some aspects of accrual appropriations are also viewed as major drawbacks and have resulted in increased scepticism regarding the relative merits of an accrual budgeting system.
One major downside of accruals relates to the practice of appropriating cash for non-cash items. This relates primarily to depreciation and to a lesser extent, employee superannuation entitlements. Agencies receive cash appropriations on the understanding that they will build-up cash balances until the need for the money arises. However some agencies, given flexibility in how the appropriation is used, have been using these funds for short term operating expenses. A prime example, underpinning the questionable nature of such appropriations relates to the National Archives which were assessed to have assets of $800 million and were being depreciated over 100 years. In order to avoid an annual $20 million 'loss' appearing in their accrual financial statements, the Archives receive an equivalent cash appropriation although there is no operational need for the funds. This lack of transparency between appropriations and use of funds has led to criticism that provision of cash in excess of immediate needs provides a pool of funds which can be used for other purposes
Another major dispute with accrual accounting in the public sector relates to the lack of uniformity in valuing and depreciating assets, which, it is argued are rubbery and subject to manipulation. Accurate valuations are intended to enhance ability to capture the full cost of service provision and proponents of accrual budgeting argue that unless a government knows the total value of public assets it will not have the capacity to effectively manage them. However given the theoretical and practical difficulties in valuing public assets such as art collections, roads, Crown land, coastline etc, described earlier, the usefulness of such information is highly contentious. Critics maintain that in practical terms asset management under accrual budgeting is more dependent on assumptions and estimations leading to: arbitrary decisions about selling assets in favour of leasing arrangements; distorting decisions between in-house and outsourced provision; or to manipulate and entity's net worth on their balance sheet. For example, some heavily indebted local governments have sought to exploit asset valuation and depreciation methods to influence their debt-to-equity ratio in order to improve their credit rating and interest rate on borrowings. A lack of historical data on an accrual basis also adds to the confusion of users of budgetary information, particularly cabinet ministers.
One reason why the Commonwealth Treasury prefers cash-based to accrual balances is that at the Commonwealth level there is little material difference between the two sets of numbers. A relatively small proportion of the national budget relates capital investment and of that investment most is associated with defence equipment. The vast majority of capital spending, including infrastructure occurs at the state or local level. Additionally, at the Commonwealth level superannuation is fully funded and the general government sector has little or no interest expenditure to account for. Furthermore, the vast bulk of general government sector transactions are completed within a month or two of the accrual. This means that the timing of the recording of these transactions provides little if any strategic benefit in terms of their management.
Another reason relates to the conceptual difficulties and interpretation problems associated with accrual reporting, in particular the Statement of assets and liabilities (or balance sheet). Simple comparisons with private sector accounts are misleading, for example, a negative net asset position would indicate insolvency for a business, whereas for government this is not the case given its sovereign powers to raise taxes. This capacity to collect future revenues via taxation is arguably one of the government's primary assets yet is not included in the balance sheet. Similarly, the government is committed to providing pensions and other welfare benefits to the wider community yet these future liabilities are not treated the same under the accruals framework as other future liabilities such as employee superannuation.
A final consideration from a Commonwealth treasury perspective is that accrual reports provide little assistance in assessing the effectiveness of the macro-economic impacts of its policies. For example, stimulus spending in the form of capital expenditure, under the accrual approach needs to be apportioned over the life of the capital asset making this approach less useful than cash reporting for measuring the short term fiscal response.
10. While Australia, New Zealand and Iceland pioneered the introduction of full accrual accounting and budgeting in their respective jurisdictions, other nations been more reluctant to embrace these accounting reforms. Why is this? What reasons might explain the why some nations have followed this path while others have not? Why is the Commonwealth going back to a modified accruals system?
One explanation as to why some nations and not others have embraced accrual budgeting relates to the philosophical and ideological leanings of national governments. Accrual budgeting must be seen within the context of a larger reform process where the effort to refocus government activity and reduce the cost of providing services has its origins in neo-liberal economics.
The broader New Public Management (NPM) reforms include the adoption of price-output reforms, use of market prices and contestability to drive behaviours. In this context accrual methods to define and value assets are necessary to shows the extent to which the full costs of government services are being matched or funded by the taxing effort of government and to permit comparisons with potential alternate private sector provision. Social democracies with stronger attachment to the notion of universal provision of government services are unlikely to perceive any benefit from such accrual methods.
Despite pursuing a similar reform agenda (Reinvented Government) to the NPM reforms, neither the US nor Canada have as yet adopted accrual budgeting. It has however been adopted at the state and province level in a handful of jurisdictions in both countries, rejected in some states and put on hold in others. Other countries have adopted modified accrual adjustments for some components of their budgets (eg, Denmark, Japan, the Netherlands and the UK).
One reason the US has not pursued accrual budgeting is due to the different institutional arrangements that exist in that country. The US budget is neither accrual nor pure cash; it is obligation-based. Obligation-based budgeting focuses on controlling the legal obligations or commitments entered during a period. It records financial transactions, primarily when orders are placed, contracts are awarded and other similar transactions are made that will require payment during the same or a future period. Legally binding agreements entered into commit the government to make outlays which are primarily measured on a cash basis.
While several countries have demonstrated considerable interest in the potential for using accrual budgeting, particularly with regards to better understanding of intergenerational equity implications of an aging economy, the costs of moving to accrual accounting are accepted as being substantial. The valuation of assets has considerable theoretical, technical and practical difficulties which are onerous on agencies to undertake and maintain, and the benefits of accruals are uncertain in the public sphere.
This is consistent with the view that after a decade of accrual budgeting and reporting in Australia, the results and learnings still do not provide a reliable basis from which other countries can analyse Australia's experience with any confidence. That several leading OECD countries are still not convinced of the overall benefits of moving to full accrual accounting and budgeting is evident from a recent cross-country assessment by the US General Accountability Office which concluded that "accrual budgeting is useful in certain areas but does not provide sufficient information for reporting on our nation's longer-term fiscal challenge". This reinforces growing recent scepticism on the value of a full transition to accrual accounting and budgeting.
Additionally, there is a strong view that there is no real need for accrual budgeting in the general government sector. The perceived benefits of commercial business accounting are simply not relevant since the purpose of government departments does not require making a profit and solvency is not a relevant measure of vulnerability since governments can raise taxes.
Other shortcomings of the accruals approach evident in Australia relate to a lack of transparency between appropriations and use of funds, for example where cash is appropriated for depreciation of assets but used by agencies for other short-term operational needs. As a result the Australian government intends to move to a modified accruals system where depreciation will be calculated centrally and cash system for agency appropriations to meet actual requirements such that cash in excess of immediate needs can be pooled and used for other purposes.