Discount Rate

Proposed Structure > Discount Rate 

Like all New Zealand Government Departments the New Zealand Defence Force pays the Government a capital charge for the capital it employs. This effectively ties the capital cost of operating the defence force back to its operating costs. 

This is particularly relevant when we consider the outcome of the analysis which found that the annual operating costs should be increased slightly to $1.490 billion per annum if the defence force were to consider all hazards but cut in half if it only considered military ones. 

In theory this means that the proposed Defence Force would be entitled to more capital or operational budget than has been allowed here. Furthermore there is a further technical argument why even more capital expenditure should be allowed. This is connected to the discount rate.

Capital charges are a perfectly sensible cost to impose on any agency which has large numbers of capital assets in order to ensure that the cost of capital is considered when acquiring new operational equipment. For example an ANZAC frigate is a concentration of capital in a very limited operational space. A capital charge effectively represents the costs of putting all one's eggs in one basket because it means that whenever the frigate is used it carries the cost of capital with it. That is partly why this Study prefers a wider spread of capital in time and space.

However this study does have concerns with the rate of this charge (termed the discount rate) which is set across all Government Departments at 10%. 

For a kick-off few other Governments have such a high rate. This is for two reasons: 1) it encourages short-term thinking (the higher the rate the fewer the number of years before the asset must pay for itself) and 2) there would be very few sovereign bond issues among first world nations with a coupon rate of 10%, so it is simply unfair to expect such a high rate of return from working capital.

The Australian Government uses an 8% rate.  By adopting a lower rate it aligns its own investment decisions for longer term decision-making and with realistic expectations of the value of its own money. A high rate encourages Governments to allocate resources to areas of greatest immediate need. While this may have made sense back in the 1980s when the Government was strapped for cash due to high levels of international debt New Zealand's sovereign debt is now at internationally low levels and it has large fiscal surpluses.  The task of Government spending is to look to the longer term.

Defence assets are peculiar by comparison say to medical assets. While both are prone to excessive cost escalation and high depreciation due to technological advance there is a distinct difference between medical assets and defence assets. Medical assets provide a service for taxpayers as a collective good. Defence assets not only should do this (the whole point of this Study)  but additionally to an extent they also define the capacity of the nation to assert its sovereign independence. The employment of Defence assets bend markets the way mass bends space-time.  They make some options more or less possible. This is not to say that Defence lives outside the economy but that the economy relies on defence to ensure order. Thus like infrastructure defence underpins the economy and therefore investments in it should be based on a longer term view of return than the 10% level implies.

This author believes there would be merit in New Zealand adopting the Australian rate of 8%, or even 7.5%.