Costs of public funds in project cost-benefit analysis

Over the long term, sometimes on the scale of several centuries, transport investments will shape the fundamental character of the country, the quality of its environment and its ability to meet future challenges. This underscores the importance of making decisions in the most informed manner possible, making the best evaluation of the benefits they will provide and the costs they will engender, especially since their funding is largely based on public funds, a scarce resource in general and even more so today. Project cost-benefit analysis (CBA) often makes use of parameters related to the public finance system, which are designed to take into account imperfections in the tax structure and the shortfall of public resources. This paper discusses how to define, estimate and use for CBA the "opportunity cost of public funds", which measures the inefficiency in the structure of the tax system. It discusses also the methods for prioritising projects in times of limited budgets when, for a given tax structure, tax revenue does not provide sufficient resources for public spending on all projects that merit it. To take into account that constraint, it suggests the introduction of a "scarcity cost of public funds" coefficient, which applies to public spending, and which should be used together with the opportunity cost of public funds when public funds available are insufficient to carry out all worthwhile projects. The opportunity cost depends on the tax structure, regardless of its level: as the distortive effect of these taxes increases (reducing the incentive for economic activity), so does the opportunity cost. The scarcity cost depends on the level of public funding for investment: as the difference between the funds for investment and the volume of worthwhile investment increases, so does the scarcity cost. The opportunity cost applies to the project's expenditures and revenues; the scarcity cost only applies to public expenditures. Methodology : Refering to Beaud(2013) we analyse the main sources of public revenues and their distortive effects, deriving analytical formulas first. Then, using statistical data for France and introducing informed assumptions, we issues numerical estimations of distortion coefficients for each main source public revenue in France, and for each main type of public entity (each of these having its own sources of revenues), among those the French state. The scarcity cost depends more on the balance between a level of budget constraint and the list and costs of potential transport projects: an illustrative simulation is made so as to estimate an order of magnitude for the scarcity cost in France. The limits and extensions of these notions and methodologies are then discussed. Analyses on the practical use of OCPF and SCPF does lead to cross political economy considerations with normative economics, and compare methodologies used in several countries. Results : Numerical results indicate that the OCPF for the main sources of revenues range between 1,01 to 2,2, the combined OCFP for the French state being close to 1,2. The scarcity cost is estimated to be 0,05 when systemic risks are fully taken into account in project CBA, but comes out higher when risks are not fully taken into account in net present value estimations. The discussion drives to question other types of similar distortions, which do not necessarily relate to public funds, some of them leading to imperfect competition issues for instance. Practical advice for the use of OCPF and SCPF at the project level and for programming, and their limits, are given.