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This version 20 August 1996

 

The environmental trust fund and sustainable environmental spending

 

Submission to Senate Environment, Recreation, Communications and the Arts Reference Committe inquiry into the Natural Heritage of Australia Trust Fund Bill 1996

 

John Quiggin

Professor of Economics

James Cook University

 

 

 

 

 

EMAIL jquiggin@postbox.anu.edu.au

FAX + 61 77 814149

Phone + 61 77 81 5387

+ 61 77 251269


The environmental trust fund and sustainable environmental spending

I have been invited to make a further supplementary submission to the Inquiry into the Proposed Dilution of Telstra, which will also serve as a submission to the Inquiry into the Natural Heritage of Australia Trust Fund Bill. The purpose of this submission is to evaluate the sustainable level of environmental spending that can be financed using the proposed trust fund, and particularly the estimate by Senator Carr that the sustainable level would be $10 million per year.

Under the Natural Heritage of Australia Trust Fund Bill, a trust fund is to be established with initial funding of $1 billion sourced from the proposed partial privatisation of Telstra. $700 million of this sum will be applied to five projects to be conducted over the period 1996-97 to 2000-01. It is stated in the explanatory memorandum that 'at the end of this period $300 million will remain in the Reserve as a capital base' that 'interest from the Reserve will be devoted to a range of environmental and natural resource management projects' and that 'the base amount in the Reserve at 1 July 2001 will be indexed annually in accordance with an indexation factor determined by the Minister of Finance. This will ensure that the real value of the capital base in the Reserve is maintained.

There are a number of ambiguities here. Most importantly, it is unclear what will happen to interest accrued on the unallocated sum of $300 million between now and 2001. There are four possibilities

(i) The interest will go into consolidated revenue

(ii) Part of the interest will be used to maintain the real value of the $300 million, and the remainder will go to consolidated revenue

(iii) All of the interest will remain in the fund

(iv) All of the interest, and interest accrued on the $700 million capital sum as it is drawn down will remain in the fund

For purposes of analysis I will assume an inflation rate of 3.5 per cent and a real interest rate of 4 per cent, implying a nominal interest rate of 7.5 per cent. This yields the following results:

Under (i), the real value of the base amount, expressed in 1996-97 dollars. will be around $263 million. Under (ii), the real value of the base amount, expressed in 1996-97 dollars. will be exactly $300 million. Under (iii), the real value of the base amount, expressed in 1996-97 dollars, will be around $365 million. The real value under (iv) is a little harder to assess, since it depends on the pattern of spending, but would probably be around $450 million.

In each case, the proportion of the base amount that can be spent while maintaining the real value of the sum invested is equal to the real interest rate, here assumed to be 4 per cent. The corresponding annual flows for assumptions (i), (ii), (iii) and (iv) are approximately $10 million, $12 million, $14.5 million and $18 million respectively (all sums in 1996 dollars). The statement by Senator Carr was presumably based on assumption (i).

Although the information available to me is insufficient to determine which assumption is correct, this information must be available to the government. It would be useful if the explanatory memorandum could be expanded to clarify this point.

Also I have assumed that the real value of the Trust fund will be maintained using the inflation component of interest earnings. The memorandum could be read to imply that this component will be spent on environmental projects and that the loss in real value will be made up by an annual infusion of funds from Consolidated Revenue. This seems unlikely, and I have disregarded the possibility. However, clarification would be useful.

A digression on discount rates

A point of controversy in the debate over the sale of Telstra has been the appropriate discount rate for the analysis of public assets and public investments. Real discount rates of 8 per cent and even more have been advocated by the Department of Finance, In the present context, a real discount rate of 8 per cent would imply that a project with an initial capital outlay of $300 million should be rejected unless its annual flow of benefits was at least $24 billion. In the context of the proposed Natural Heritage of Australia Trust Fund Bill, the Department of Finance approach would imply rejecting the Trust Fund unless each dollar spent yielded benefits of at least two dollars. This is a nonsensical policy framework which would lead to the rejection of many beneficial investment opportunities. The appropriate approach is to set the real discount rate equal to the real bond rate faced by the government. This argument has been rejected on ideological grounds in the past and will presumably continue to be rejected by the Department of Finance and others.

However, the arithmetic set out in the preceding paragraphs is entirely straightforward. Given the base amount, any attempt to undertake expenditure in excess of the flow of real interest payments must lead to the exhaustion of the fund. Hence the real interest rate is the relevant discount rate. It is up to the Department of Finance to reconcile this obvious fact with the use of other discount rates to evaluate publicly owned assets.



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