Last year I did a quick piece on the revenue aspects of Local Government Funding - specifically the process for calculating council tax after subtracting central government funding (national non-domestic rates & revenue support grants) from planned spending.
Today I've been tuning in to the web cast of Bristol Council's Physical Environment Scrutiny Commission. Lots of great stuff for bloggers today - waste management, incinerators, buses, parks and green spaces and of course budgets. And the usual procedural fights, naturally.
One particular theme in today's discussion prompted me to dig out the draft of the next part in this irregular series and cobble the following post together.
Das Kapital or 'dis Capital?
Regardless of the size of an organisation - from the biggest public departments or corporations to the smallest economic units such as families, households and individuals - one can divide their expenditure into two categories: Operating Costs and Capital Expenditure.
Let's say you buy your weekly shopping. Chances are you pay for it with cash or a debit card, out of your monthly salary. On the other hand, if you want to buy a new car, you might consider dipping into your savings or taking out a loan.
The former - purchase of a small quantity of perishable goods using cash at hand - is an example of an operational cost. The latter - purchase of a fixed asset with a long life from reserves or borrowed funds - is an example of a capital expenditure.
These are just examples, though. The debate over when a particular transaction is an operational cost and when it is capital expenditure is a virtual battlefield, on which the tax lawyers and the Revenuers wage eternal war.
Further complications ensue when considering public bodies, since local government may wish to undertake capital projects that require borrowing funds, and yet central government - for reasons of sound economics - wishes to limit the scope of public borrowing and thus has developed a complex system of rules to bend local government to their will.
Since 1997, the Labour government (prop. G Brown) developed a cunning wheeze called the Private Finance Initiative (PFI) from an original idea conceived by Ken Clarke of the Conservatives.
PFI is not as complex as you might think. A local body decides it wishes to undertake a capital project, for which it needs what is known in these parts as a "gurt ginormous wodge of cash." The local body finds a supplier who will provide the asset they require but - and this is the clever bit - the supplier is asked to design, build, finance and operate (DBFO) the asset and supply it to the local body as a service. The local body then pays a charge to the supplier for use of the asset for an agreed period. In this fashion, the local body can insulate themselves from the risks associated with large capital project and lock-in predictable operational costs.
To use an example - instead of Bogshire Council having to spend £20 million building a new school, they can do it all on t PFI and spend £1 million a year for twenty five years to purchase "educational services". The observant amongst you may have noticed that Bogshire ends up paying much more for their school, and at the end of the contract they don't actually own any of the assets. But this is simply a recognition of the transfer of risk from the local body to the supplier. Think of it as a "tip".ick
Whitehall loves PFI, and is even willing to give local government PFI Credits to part-finance such projects (over and above other grants) to encourage them to engage in a bit of advanced financial engineering. Whitehall loves PFI because as far as they are concerned, the borrowed money isn't on their books so they can continue to report that the economy is all fine and dandy, being as how everyone is a Monetarist these days. (Except the socialists, obviously, but what have they ever been right about?).
The funny thing is that the borrowed money isn't always on the books of the companies that are doing the Design, Build, Finance and Operation (DBFO) of the assets either. No doubt at some point this aggressive accounting will be resolved to someone's disadvantage, and a quick look at the current state of Northern Rock suggests it'll be you and me picking up the pieces.
Baiting the Hook
Beyond the dodgy accounting, one of the primary problems with PFI is that is incentivises risky capital expenditure. Hold on, James, you might be thinking: didn't you just say something about "a transfer of risk from the local body to the supplier"?
Well it's all a matter of your point of view. Is it better to "own" a large percentage of the risk in a small CAPEX project, or to "own" a small percentage of the risk in a large CAPEX project?
A good example from today's Scrutiny Committee relates to Waste Management, specifically a proposal to build an large incinerator at Avonmouth. Ignoring for a moment the voodoo economics of recycling, the current situation for Bristol is that we are likely to face a large bill for Landfill Tax if we, as a city, choose to reject demands to reduce the amount of residual waste we send to be buried.
A public consultation on the subject identified local support for a number of small waste management plants around the city. But currently £2 billion worth of PFI Credits are on offer from Whitehall for projects that will reduce Landfill usage, and they are unlikely to be awarded to projects that don't implement big-ticket solutions processing 250,000 tonnes of waste or more.
All the proposed solutions are ultimately big vessels into which one shovels waste, after which some burn it, others gassify it, and others mince it up and digest it with bacteria. The really clever ones generate some power from this process.
There are a lot of risks associated with all of these waste management technologies. One of the key variables is getting a predictable feedstock; the waste being shovelled in must have a degree of homogeneity. Chucking in one load of Evian bottles, followed by a load of banana skins, and finally bales of cardboard leads to a very lumpy mix which doesn't burn, gassify or digest well. Learning how to build the right feedstock from the unique mix of waste in this City might take some time. And if it's wrong, then the collected waste goes off to landfill anyway.
This is one example of a risk which is amplified by selecting a single high capacity waste plant. Building a single, smaller plant as a prototype and trying things out for 6 months or so would remove this risk, although it might mean paying some Landfill Tax. This is a straightforward trade-off between operational capability and costs. Add in the temptation of scaling the project up and reaching for the PFI Credits, though, and suddenly those pessimists start to sound like a bunch of whiners with an absence of "can-do" spirit.
The promise of "free money" from London is the bait on the hook. Because there is a deadline for registering interest in centrally disbursed funds - in this case PFI Credits - there is an impetus to go for a project profile that can earn the most money - "to get our fair share" and opt for the flashiest, highest profile, riskiest approach to solving the underlying problem.
A similar example is evident in the Leisure & Culture Sector. Bristol was offered a £10,000,000 grant by the Heritage and Lottery Fund toward the Museum of Bristol. To ensure we got our "fair share" the City put in a bid with all the bells and whistles, and while we won the grant money, we ended up needing another £4,000,000 of local funding to shore up holes in the plan, and after it's built we've got to pay annual operating costs of over £1,000,000.00. The grant was the bait on the hook, and we took the whole thing, with line and sinker attached. We might be about to do the same with our Waste Management systems.
Conclusion
Pick your cliché. You can have:
There's no such thing as a free lunch.
or
If you've dug yourself into a hole, you can't dig your way out
Postscript: Rubbish or Resource?
The guys at the West of England Waste and Planning Partnership are asking the following question at the eponymous web site:
"It it rubbish? Or could it be a valuable resource?"
Here's a quick way of finding out:
- If you have to pay people to take it away, it's rubbish.
- If people will pay you to let them take it away, it's a resource.
I hope that's cleared things up for you.
