The Partnerships BC analysis uses an unfinanced PSC for three key reasons that include: difficulty in identifying the precise source and associated cost of publicly raised funds; the cost of raising taxpayer supported public funds does not reflect the true cost of financing a project; and applying the risk adjusted, market-based discount rate to the PSC cash flows implicitly accounts for the project risk in the PSC model.
The public sector, regardless of whether it is at the municipal, provincial or federal level, has substantial ongoing cash receipts from its various revenue sources (duties, income taxes, capital taxes, user fees, etc). For any given infrastructure project, therefore, the public sector could fund the associated costs from existing cash receipts, newly issued debt or a combination of the two, and each funding source would have a different cost. More importantly, neither source of public funds would be an accurate estimator of the true cost of using public capital, as only the cost of issuing long-term government debt can be determined.
The public sector's long-term borrowing rate, therefore, is an inappropriate estimator of the true cost of capital essentially because it only reflects the cost of RAISING capital, which can be very different from the cost of USING that capital. The public cost of raising capital does not include the full cost implications of retained project risk, nor does it typically include the cost of amortizing the debt. For example, if the public sector's long-term cost of borrowing is five per cent, when the project risk implies that an Internal Rate of Return of seven per cent15 is required by the private sector, taxpayers are in effect subsidizing the traditionally procured project by covering the potential additional cost of the risks associated with the project16. Taxpayers are often not aware of this exposure to the true risks of a project, nor to the implied subsidy they are providing. It is usually only in the case of large cost overruns and project failure that taxpayers realize the cost implication of the public's exposure. For this reason, using the public sector long-term cost of borrowing (e.g. five per cent) based on a bullet-type bond17, and applying a discount rate of seven per cent, leads to an analysis that is unfairly biased in favour of the PSC.
In order for the taxpayer to avoid providing this subsidy, a financed PSC would need to assume a financing cost at a rate that reflects the risk inherent in a project, in the same way as the private sector cost of capital, and amortize the debt over the term of the contract18. When the true cost to the public sector of financing a project is reflected in the discount rate, the effect of financing is equal to discounting the unfinanced cashflows by the discount rate, and can therefore be ignored.
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15 As determined by the private sector cost of capital for the project
16 Uncertainty and the Evaluation of Public Investment Decisions, Arrow, Kenneth J and Lind, Robert C., 1970, American Economic Review.
17 Bullet Bonds typically are non-callable and repay the full principle in a single payment at maturity.
18 This approach was used on the Sea-to-Sky Value for Money Report at the request of the Office of the Auditor General.