Flood prevention schemes: guidance for local authorities

ANNEX A: TRANSFER PAYMENTS

Transfer payments

When does a change result only in a transfer payment?

A1 Benefit-cost analysis is concerned with national economic efficiency where efficiency is, in effect, the ratio of the value of outputs (consumption) to inputs (resources). These inputs are yielded both from stock (eg engineering plant, buildings ) and from flows (eg electricity, labour).

A2 A transfer payment occurs when a change simply affects either who gets the consumption or who provides the resources, but there is no change in the national total of either all the consumption, or all the resources required to generate that consumption.

Test for a transfer payment

A3 Will there be any change either or both in the total value of UK consumption, or in the resources required to provide that consumption? If not, then only a transfer payment is involved.

A4 When a physical object is damaged or destroyed by a flood, a transfer payment is not involved since maintaining current levels of consumption will require the replacement of that object. There will be distributional consequences as well (eg builders will get more work) but the test is whether there will be a change in the total level of consumption or the resources required, including the need to repair or replace stocks which have been damaged or destroyed.

Examples of a transfer payment

A5 Examples are:

• VAT and excise duties are always transfer payments and must be netted out of the analysis. If less petrol is sold, then the Exchequer will simply find different ways of raising taxes.
• If a hotel or pub were lost, the trade would simply transfer to other outlets, the value of any such 'goodwill' element in the market price must therefore be netted out of the analysis.
• Losses of trade to commercial or retail outlets will be a transfer payment except in the circumstances given below.

Examples of changes which are not a transfer payment

A6 In some cases, a levy is made in respect of negative externalities, a 'green tax', which is intended to reflect a real economic cost, although otherwise it appears identical to other forms of taxation such as VAT. If, for example, a charge were to be levied on aggregates which reflected the real environmental damage caused by aggregate extraction, this would reflect the additional economic loss resulting from mineral workings. Therefore, an increase in aggregate extraction would result in additional economic losses to the country, in addition to the resource costs of extraction and transportation. Landfill taxes are also a 'green tax' and represent a real economic cost. Ideally, where appropriate, these additional economic losses should be quantified and included in the analysis. However, this is unlikely to be practical for most flood prevention schemes and it will normally be reasonable to use the tax rates as a surrogate for the real economic loss in any analysis.

A7 Losses of trade to commerce and retail outlets result in real losses if consumers cannot obtain equivalent goods at the same time and at the same cost. If all 3 conditions do not hold, an economic loss is involved. However, the normal expectation is that consumers will be able to obtain equivalent goods at no extra cost and therefore any differences will not be worth evaluating.

A8 The test can also be applied to non-priced goods, such as visits to a riverside park. If consumers can go somewhere else and get the same amount of enjoyment at no extra cost, the change in visiting results in no real economic cost. If they cannot, the net value of the loss in enjoyment, plus any increase in cost to the visitor measures the economic loss.