The recently announced Defence Capability Plan reconfirmed new capital expenditure of around $20B on Defence out to 2030. This is subject to the government of the day having the money and desire to actually approve each business case. However, there is a hidden cost to this re-equipping which needs sorting out.
Due to the vagaries of our public finance system, all parts of Government pay a capital charge on assets. I have written previously on the negative effect this has on Defence funding. In the NZDF Annual Report 2018, the breakdown of its $2.574B funding was as follows:
The capital charge of 15% equates to $384,765,000. It reflects a 6% ‘tax’ by the government on itself to reflect the value of assets. As I’ve noted frequently, Defence has few choices about its assets. Unless Uber is planning to start up a Light Armoured Vehicle service, the NZDF is stuck with owning those vehicles and most of its other big ticket items. In the 2017-18 period, Defence real estate and buildings were revalued, requiring a cash injection of $21.973m from the government to offset the increased cost of capital charge. This defines churn!
The rate is set by Treasury and has resulted in some perverse incentives like not keeping a war contingency stock of major items. We are the only country in the world to apply this misguided policy to core government assets and I believe it should go.
In the wake of the Defence Capability Plan, I submitted an official information act request to the Minister of Defence, Hon Ron Mark, asking for the annualised estimated impact of the $20b spend on capital charge and therefore operating funding. Unsurprisingly, the answer came back that they hadn’t done the calculations and it was too hard to do so because they didn’t know exactly when they would submit a business case. Really?
Here’s a quick starting point for those who ‘kicked for touch’ on this estimate. Take 6% of $20b. That’s $1.2b. Divide that by 11 to represent the years between 2019 and 2030 (everything beyond 2030 is a ‘maybe’). That equates to roughly $110m per year. I accept that there will be some offset from the removal of assets like the P3s and C130s from the books but it will be negligible. Also, some capabilities in the DCP involve people – they don’t incur capital charge but are still the most expensive part of Vote: Defence Force.
This means that, in current dollar terms, the government would need to provide another $110m per year into the NZDF estimates to offset capital charge increases just to allow it to remain static. That’s without considering the impact of increased depreciation on newer, more valuable assets and the annual increase in personnel salaries and expenses. When you see all the ‘new money’ being talked about in each budget, don’t be fooled. Largely it’s just top-ups to allow the NZDF to not go backward in funding terms.
It’s time we ended this capital charge nonsense for the NZDF and all core state functions like schools, hospitals, police and emergency services.
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