“A valid comparison [of public and private costs] must count the cost of central administration, of buildings and insurance, of recruitment and training, and of fringe benefits. Even more important, it must count the cost of capital. These calculations, routine in private businesses, are by no means the norm in
public activity.”156 Full-cost accounting (FCA) provides the basis for comparing costs of government agencies with costs in the private sector. An important feature of FCA is its ability to capture overhead costs. These are the management and support costs of programs, such as accounting, auditing, executive leadership, legal services, insurance, utilities, and cross-subsidizing.
As the table below shows, the state of the art in determining overhead rates is less than perfect. The overhead rates vary widely (53 percent to 307 percent), even when based on similar definitions.
Overhead costs are the indirect costs of completing a project. Indirect costs include staff benefits, recruiting, rent, insurance, utilities, etc. An example of a direct cost is the actual time spent designing or constructing a project. The most difficult aspect of comparisons is establishing equitable, accurate overhead rates.
For cost accounting purposes, in a $2 million project with a 100 percent overhead rate, $1 million is said to be attributed to indirect costs and $1 million to direct costs. If the same project with direct costs of $1 million was undertaken at a 150 percent overhead rate, the indirect costs would escalate to $1.5 million, raising the total cost to $2.5 million.
Another issue is whether to use full costs or avoidable costs in calculating overhead. Avoidable costs a r e “ t h o s e i n - h o s e c o s t s t h a t w i l l n o t b e i n c u r r e d i f a t a r g e t s e r v i c e , o r p o r t i o n t h e r e o f , i s c o n t r a c t e d Avoidable costs set a baseline of what can be saved, given no other changes besides the out.”157
outsourcing. But officials can decide to trim support agencies and programs commensurate with reduced demand on their services due to outsourcing. For example, outsourcing highway design would reduce design staff, but not directly reduce the cost of agency or government-wide personnel management, legal, and similar costs, so they would not be considered avoidable. A full-cost approach aims to calculate the unit cost of services delivery, and allows officials to calculate how outsourcing the design work reduces demand for overhead services and reduce staff and funding for support agencies accordingly.
Table 3: Literature Review of Overhead Rates
Study Caltrans (Berkeley) Caltrans (PECG: Reply on Berkeley Study)
Texas State Department of Highways and Public Transportation (Ernst & Whinney)
Texas State Department of Highways and Public Transportation (CTR)
Texas State Department of Highways and Public Transportation (TTI) Wisconsin Legislative Audit Bureau
Louisiana Transportation Research Center
Overhead Rate Used 145%, 155%, 175% 118% In-house 147% Consultant 75%–93%
194%–212% In-house 286%–307% Consultant
% (“avoidable rate”)
% (full absorption rate)
Madsen Pirie, Privatization: Theory, Practice, and Choice (London: Wildwood House, 1998), p. 21.
Lawrence Martin, How to Compare Cost Between In-house and Contracted Services, Reason Foundation How-to Guide No. 4, (Los Angeles: Reason Foudnation, 1993), p. 10.