Barriers To Outsourcing In The Public Service

The present system of government accounting puts significant barriers in the way of achieving the optimum use of external service delivery.

One of the elements of the Public Service Reform Plan announced by Minister Brendan Howlin on 17 November 2011 relates to the external service delivery or outsourcing of non-critical functions.  The way the present system of government accounting operates, puts significant barriers in the way of achieving the optimum use of external service delivery .

A budget holder will only pursue the objective of buying services externally if the net impact on their budget is favourable. Even if the external provider is more efficient, there are at least two elements which fail to be included in the cost of bought-in services, which do not impact on services provided internally. These act as a wedge inhibiting outsourcing.  These are VAT and pension costs.

Most bought-in services will attract VAT at 23 %.  If it costs 100 to provide services internally, as far as the budget holder is concerned, the cost of the equivalent bought-in service cannot exceed 81 (plus VAT of €18.63) before the external provider will be competitive with the in house service.

But, in the buying-in case, the Exchequer will be better off by the amount of VAT paid. The solution is to give the budget holder a credit for the VAT due in the accounts used to determine their performance (management accounts).

The second distortionary element is that the pension costs of the public sector are unfunded and so are not reflected in the cost of the internally provided service. The cost charged by the private operator will include the cost of any pension benefit provided such as any employer pension contribution. To address this, management accounts in the public service need to include a charge for pension costs.

Implications

Unless these distortions are addressed, the level of external service delivery will be sub-optimal and it is very unlikely that the potential benefits which can arise from external service delivery will be realised.

Steps are being taken to address these issues. A Business Case Model is being distributed to Departments to allow them to consistently evaluate alternative delivery models. The rules prohibit Departments from including VAT in the external delivery price for comparison purposes. Departments are also required to include a loading for public sector pension, taken from a 2009 Comptroller and Auditor General report on Public Service Pensions so that the internal options better reflect their true cost.

Regardless of business case comparisons, departments will still be required to pay VAT at the prevailing rates on outsourced contracts and this could continue to cause perverse incentives at a local level. To address this, Departments need to be given a credit for VAT paid on outsourced services in their Vote accounts.

Note: management accounts are aimed at internal users of accounting information. They are used to send signals to management by including charges for items such as the cost of accommodation, which do not give rise to actual payments and do not appear in the financial accounts.

 

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6 Comments

  1. Peter Brennan 9 Jan 2013 at 10:25 am

    A more important barrier is that potential project promoters do not know what D/PER wants. Ideally, a workshop should be held to set out the parameters of Government policy and most importantly the Outsourcing Business Case Guide should be made available.

  2. Vincent 9 Jan 2013 at 10:40 pm

    Unless this is treated as commercial how can this be NPVed at all. It’s apples and oranges, if even that. Perhaps more apples and oysters.

  3. A Reader 10 Jan 2013 at 1:47 pm

    The focus of the article is presumably on outsourcing within Ireland. I have no sense of what proportion of current or potential outsourcing in the public sector would be to foreign service providers. But for such cases, the impact of outsoucing would also have to take account of a loss of income tax/USC to the Exchequer and PRSI to the Social Insurance Fund. There would also be a loss of broader economic benefits from labour earnings staying within Ireland and a partial impact on unemployment benefit costs. So the hurdle would be significantly higher in such cases.

  4. Donal O’Brolchain 17 Jan 2013 at 12:30 pm

    What problem is outsourcing trying to solve?

    While waiting for an answer, two others issues arise
    1. How are existing public services costed?
    2. What basis exists for comparison between the same service provided “internally” and “outsourced”

    1. Costs
    Government bodies are housed in buildings on which local taxes (rates) are not paid, as they are on buildings used to private sector service providers. Is this being ignored in the loadings in the Business Case Comparison model being distributed?

    2. Comparison
    “A budget holder will only pursue the objective of buying services externally if the net impact on their budget is favourable.”
    If the existing budget/manager holder cannot provide the service cost-effectively, what basis is for assuming that the same budget holder has the skills/competence/experience/knowledge needed to “buy it in” cost-effectively?
    There is anecdotal evidence suggests that work which is outsourced cannot not lead to the savings anticipated, simply because existing workers are not redeployed or made redundant. They continue on the payroll without having any work to do. Unless the budget holder continues to be responsible for the full costs (including eg. pensions, accommodation) of these workers, such outsourcing leaves a lot to be desired in terms of incentives and accountancy.

  5. Breandán Mac Séarraigh 7 Mar 2013 at 12:54 pm

    We are not allowed favour Irish service or product providers over non-Irish (EU providers at least, inclduing northern Irish companies). That is part of the single European market. Councillors may complain about northern companies getting works contracts but if they are cheaper so be it. The fact that they are replacing southern companies, with employees living in the south, paying taxes here and shopping locally, creating other jobs, has been given up for the competitive benefits of operating in a larger and presumably more competitive economic space.

  6. Breandán Mac Séarraigh 7 Mar 2013 at 1:09 pm

    A lot of what public authorities, especially local councils, do is purchasing goods and services on behalf of the public. Councils do not build large roads or Waste Water Treatment Works using their own staff. In practice only small, routine maintenance jobs are carried out by council employees (some of which could perhaps be privatised). Most of the time what the council employees do is hire in PRIVATE SECTOR commercial companies to do the job. We certainly do not have lots of redundant, formerly ‘direct labour’ people sitting around doing nothing. The public servants’ job is deciding what needs to be done, on behalf of the public and hiring in private contractors, who they pay with public money. I wonder what proportion of the money given to local government is actually spent in the private, commercial sector? In terms of the issues mentioned above, councils don’t pay VAT in the UK, including the North. This means that 21% of the funding provided by central government to local government does not flow instantly and uselessly back to central government. We could copy this. In terms of pension costs etc these are calculated and added to project costs for recoupments from central government agencies where these provide funding for specific projects.

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