Chapter 27: Funding

Investment

Article XIII: Public services, Section 3: Funding constraints states:

Each material financial risk and any compensation for accepting it shall be identified in the service contract. Risks arising from an operator's efficiency or operational choices shall not be transferred to taxpayers after the event.

Public services are only funded using credit to the extent that their operators in the private sector use credit. The potential profit versus risk of lending is entirely borne by the private sector. For investors, these operators can be attractive opportunities. Lending money, providing capital, or buying equity may look ideal, because the services they run are subsidised by tax revenue.

Tax budget

The constitution states:

Each public service shall have a defined tax budget for each tax allocation period, representing the maximum tax revenue allocable to that service during that period.

Every registered public service operates with a defined tax budget. This budget is set in the service contract with the operator. It represents the price taxpayers collectively pay for the service's tax-funded obligations during the period and caps the tax revenue the service may receive for those obligations. The service may also receive revenue directly from its patrons. In many cases, the budget is tied directly to usage. For example, public transport may be free for passengers, yet the operator is funded through tax revenue based on the number of rides taken. This ensures services remain accessible to the public, while operators are compensated fairly according to demand.

Passing on costs to patrons

Some services carry costs that depend directly on the individual who uses them. For example, connecting electricity to a remote home may involve higher expenses. In other cases, supply may be limited by scarce resources, or use of the service may cause harmful effects on the environment.

The Non‑Discrimination Principle prevents a public service from deciding arbitrarily which patrons will receive costly provision. Taxpayers must instead fund the service on universal terms or define an objective tax-funded entitlement that applies equally to everyone. Because an unlimited universal guarantee could impose enormous costs, particularly for services delivered to remote locations, public-service contracts will tend to require patrons to bear some or all of the costs attributable to their own use beyond the universal tax-funded entitlement.

Avoiding markup on costs

Article XIII: Public services, Section 3: Funding constraints states:

An operator's profit shall not increase merely because the operator increases its expenditure or reimbursable costs.

Accurately known or retrospectively verified costs shall be reimbursed without a markup. Payments for operating the service, providing capital, achieving defined outcomes, or assuming identifiable risk shall be stated separately.

Profit should reward the provision of a useful service and the assumption of risk. It should not arise merely because an operator spends more money. A contract which pays an operator a percentage markup on every cost gives the operator an incentive to increase those costs. If a ten per cent markup applies to a cost of one million Runes, the operator receives one hundred thousand Runes. If the cost rises to two million Runes, its payment rises to two hundred thousand Runes even though the service has not improved. The interests of the operator and taxpayers are then opposed.

Accurately known costs

Where a cost can be determined accurately, the service contract should add that cost to the tax budget without a markup. This may apply to a fixed charge, a specified quantity of a standard Product with an observable market price, or an independently invoiced cost which can be verified. The operator passes the cost through to the service but does not earn a larger profit merely because the cost is larger.

The operator's compensation should be specified separately. It may receive a fixed operating payment, an agreed price for each unit of service, or a reward for achieving defined outcomes. Separating compensation from pass-through costs removes the incentive to increase expenditure in order to increase profit.

Cost reimbursement nevertheless requires safeguards. An operator must not be able to purchase from an associated business at an inflated price, classify its ordinary overhead as a pass-through cost, select an unnecessarily expensive supplier, or move costs from a fixed-price obligation into a reimbursable category. Contracts may require open records, competitive purchasing, independent invoices, market-price comparisons, and clear definitions of which costs qualify for reimbursement.

Inaccurately known costs

Where a cost cannot be estimated accurately in advance, a margin may be justified because the private operator assumes the risk that the actual cost will be higher than expected. If the contract provides ten million Runes for work which might cost eight million or twelve million, the operator requires compensation for accepting the possibility of loss. It retains the benefit if it performs the work for less than the agreed amount and bears the loss if the cost is greater.

This margin is not a reward for spending money. It is the market price of transferring uncertainty from taxpayers to the operator. The contract should make the distinction explicit:

\[ \text{payment} = \text{estimated cost} + \text{risk margin} + \text{payment for operating the service}. \]

The risk margin should correspond to identifiable uncertainty rather than being concealed as a percentage markup on every expense. Risks arising from the operator's efficiency and operational choices should ordinarily remain with the operator. A genuinely external cost which neither the operator nor taxpayers can control may justify a different allocation of risk in the contract.

Funding costs after they are incurred

A cost incurred in one tax-allocation period may be funded from tax allocated during a later period. Once the cost has been incurred and verified, its amount is known. Later tax allocations can therefore repay that exact prior cost without a markup. The operator is no longer assuming the risk that the cost itself will be greater than the estimate.

Advancing the money may create a separate financing cost or risk. If repayment is certain and prompt, no risk margin is justified. If payment is delayed, a financing charge may compensate for the use of capital. If repayment depends upon the service attracting enough future tax, the operator or lender bears a risk of non-payment and may require compensation for that risk. Any such compensation should be separately identified and related to the duration and probability of non-payment, rather than calculated as a profit markup on the underlying cost.

The general principle is that accurately known or retrospectively verified costs should be funded at cost. Additional compensation is justified only for operating the service, providing capital, achieving defined outcomes, or assuming identifiable risk. This aligns the operator's profit with the value it provides and the risks it bears, rather than with the amount of taxpayer money it spends.

Scaling funding with demand

Article XIII: Public services, Section 3: Funding constraints states:

Public-service funding shall be calculated according to objective and independently verifiable costs, usage, quality, outputs, or outcomes specified in the service contract.

Demand for some public services varies over time. The number of people using public transport, for example, may change with the time of day, the season, population growth, and the quality of the service. A contract based on a fixed level of provision may leave too little capacity when demand grows and waste resources when demand falls. It is therefore better for the contract to contain usage scales which allow funding and provision to respond to measured demand.

A usage scale specifies the payment associated with each unit of service, such as a passenger journey, occupied place, treatment, or hour of care. That payment may include the cost of providing the additional unit and a margin for the operator. Unlike a markup on expenditure, this margin does not reward the operator for increasing its costs. It rewards the operator for providing more of a service which people choose to use:

\[ \text{usage payment} = \text{cost of additional usage} + \text{usage margin}. \]

The operator's profit can consequently grow with usage. This gives it an incentive to provide a reliable, convenient, and attractive service which generates high demand, and to expand capacity so that additional demand can be served. The operator profits by serving more people rather than by making each unit unnecessarily expensive.

Scaling also reduces the demand risk borne by the operator. Under a fixed payment, unexpectedly high usage may increase staffing, maintenance, energy, supplies, and capacity costs without increasing revenue. A successful service could then become less profitable precisely because more people use it. That would create a perverse incentive to discourage use, tolerate poor quality, or avoid improvements which would attract additional users. A well-designed usage scale increases payment as demand increases, covering the additional cost and preserving a margin for the operator. High usage then strengthens rather than threatens the service's financial position.

The usage scale applies regardless of how its payment is divided between customers and taxpayers. A public transport journey, for example, may be paid for entirely by a passenger fare, entirely from allocated tax, or by a combination of the two. In every case it is one journey under the usage scale and should produce the same total payment to the operator. The source of the money does not change the amount of useful service provided or the incentive created by the margin.

Fixed costs and capacity

Not every cost varies with usage. Vehicles, depots, software, administration, and a minimum level of staffing may need to be funded before the first person uses the service. The contract should distinguish these fixed costs from costs which grow with demand. It may fund the fixed capacity separately and use the usage scale to fund additional operation and expansion. This prevents a useful service from becoming unviable during a temporary period of low demand while retaining the incentive to attract users.

The usage scale need not pay the same amount for every additional unit. Where economies of scale make later units cheaper, the margin or payment may decline as usage rises. Where serving more users requires a discrete increase in capacity, the scale may provide funding when the relevant threshold is reached. The scale should be designed so that the operator can add capacity before congestion or declining quality drives users away.

Measuring useful usage

The constitution further requires:

Funding shall not reward unnecessary use, duplicate or operator-generated activity that provides no useful service, reduced quality, avoidable harm, or deliberate restriction of capacity.

A payment based on usage shall apply only to independently verifiable useful use and shall account for associated quality requirements.

Payment should be tied to independently verifiable use of the service. The selected unit must represent useful service rather than activity which the operator can generate without producing value. A transport operator should not be able to increase its payment by running empty vehicles, for example, if the purpose of the usage scale is to reward passenger journeys. Nor should it profit by recording the same use more than once or encouraging needless use merely to increase its payment.

Usage alone is not sufficient if quality can be sacrificed to increase volume. The contract may therefore combine the usage scale with requirements for safety, reliability, waiting times, available capacity, and other relevant outcomes. An operator should not receive a greater profit by overcrowding vehicles or allowing the standard of the service to deteriorate.

A usage margin is distinct from both reimbursement of costs and compensation for risk. Reimbursement pays a known cost, a risk margin compensates the operator for accepting uncertainty, and a usage margin rewards the provision of more service in response to demand. Identifying each separately makes the incentives in the contract transparent and allows taxpayers to decide whether the resulting scale offers good value.