Contracts and leases: Government Permits Brent R. Moulton (paper by John Pitzer) Fourth Meeting of the AEG, Frankfurt, Germany 30 January 2006

2 Possible Classifications of Permits  Tax  Purchase/sale of a service  Lease of a non-financial asset Operating lease Financial lease Rent  Purchase/sale of an existing asset  Creation of a non-produced, non-financial asset  Financial asset

3 Canberra II Concerns  Types of non-financial assets.  Treatment of assets once in the system.  Principles to distinguish permits that are non-financial assets or represent transactions in non-financial assets from other permits.  Definition of a tax necessary to separate taxes and assets.

4 Definition of a Tax 1.Compulsory 2.Unrequited 3.Received by a government unit  What is meant by “compulsory” A.A transaction occurs or a condition exists. B.Government learns about the transaction or condition. C.Payment becomes compulsory.

5 Conditional Taxes  Taxes become compulsory only if a specified event occurs or condition exists.  The specified event/conditions often are optional to some degree. Examples— owning property, purchasing a luxury good.  Decision to engage in taxable activity is based on total benefits and costs of activity.

6 Unrestricted Permits  In the current SNA, distinction between a tax and a service is based on: Whether the government produces a service that is delivered to the individual purchaser, and The cost of producing any such service relative to the price of the permit.  No reason to change.

7 Other Classifications of Permits  No guidance on permits that involve use of existing non-financial assets.  No guidance on prepayments creating financial assets.  No guidance on permits that are themselves intangible non-financial assets, produced or non-produced.

8 Asset-Related Permits  If a permit gives permanent control of an existing non-financial asset—treat as sale of an asset.  If a permit gives temporary use of an existing non-financial asset—treat as lease of an asset.  Prepayment of a tax or service—create a financial asset.

9 Restricted Permits: Tax or Non-produced Asset?  Permits and the definition of a tax: Permits allow a transaction or activity to occur. Can selling permission to engage in a transaction or an activity be “requited”? Only government permits are being considered, so payment is to government. Permits are compulsory if the transaction or activity is to occur. Permits are unrequited if no service or asset is received in exchange, or the price is out of all proportion to the value of the service or asset.

10 Permits versus Explicit Taxes  Explicit taxes are imposed by government units on non-government units, after a taxable transaction or activity takes place.  Permits are imposed by government units before the transaction or activity takes place.  Non-government units engage in taxable transactions or activities because they expect the benefits from the transaction or activity to be in excess of total costs (including the tax).  Non-government units purchase permits because they expect the benefits from the transaction or activity be in excess of total costs (including permit).

11 Similarities with Explicit Taxes  Payment is compulsory because of the sovereign power of government. No unit would pay an explicit tax or purchase a permit without government’s sovereign power.  Payment is made because expected benefits are greater than total cost (including explicit tax/permit).  Purchasing a permit is a cost of doing business that reduces the net return.  Granting permission is not something of value for which the unit is willing to pay.  Some units that otherwise would engage in the activity do not because of the cost of the permit.

12 Setting the Price of a Permit  Government is a monopoly seller.  Price can be set to maximize revenues, or to pursue other policy goals.  If price set and number of permits is not limited, then the number sold depends on price and demand.  Why might the government limit the number of permits?  Market may not clear; government lacks information on demand  Need to determine demand before setting price.

13 Auctions  An auction is a means to determine the market clearing price when the number of permits is limited.  Willingness of units to bid does not imply that services or assets are being obtained.  Government, using sovereign power, requires the permit.  Units willing to bid based on the expected benefits from engaging in the underlying activity.  Bidding to purchase permits is consistent economic behavior, even though the permits are fundamentally taxes.

14 Multi-Year Permits  Only the first year’s share of the cost is a tax.  Remainder is a financial asset.  Early returns to issuing government are transactions in financial assets.

15 Secondary Sales  Multi-year permits may be tradable.  If price can vary from recorded value, it is necessary to record the creation of a non-produced, non-financial asset. Value is zero when permit is issued. Thereafter, value varies with market price of permit.

16 Canberra II Recommendations 1.All government permits that rely on the exercise of sovereign powers and are issued on a restricted basis should be treated as taxes. 2.The method of setting the price of a restricted government permit is not relevant for its treatment as a tax or an asset.

17 Canberra II Recommendations 3.If permits are valid for several years, only the portion representing the current year is a tax. The remainder is a financial asset for the purchaser and a liability for the government. 4.Permits that are transferable or that can be returned to the issuing government for a refund of the unexpired portion are treated as financial assets/liabilities. If a multi-year permit is transferable, a non-produced, non-financial asset is deemed to be created, with a value that varies according to market conditions.