Historical Costs of Capital - England

Following on from the recent ‘Brandy and Soda’ blog, in response to a question this note provides some additional information, all in the context of water and sanitation history in England demanding that 'everything' was supported by cost-reflective tariffs/local council rates for many many years. If the local councillors thought the local 'rates' (property taxes) could not fund the improvements …. they did not get done.

Any decisions to be made with respect to capex were therefore based on the likely borrowing costs, which were the responsibility of the local council, however small it was (until 1929 when costs were allowed to be shared within District Council areas).

Supporting much of the borrowing for water and sanitation was the Public Works Loans Board, a central government agency on-lending national government borrowing, which, over quite a long period, was lending at a 3.5% interest rate. With amortisation of loans over thirty years this meant a 5% annual charge on the rates for the interest and repayment of the principal. This figure of 5% became a useful ‘ready reckoner’, always being referred to in the parish/rural council meetings with respect to the cost any improvements. Every councillor (who initially all came from property owners) seemed to know the tax base of their community (total ‘rateable value’ of their council area) and therefore what any increase would mean to their own twice-yearly local tax payments. It became a straightforward calculation – time after time. And often led to the decision not to invest yet.

On occasions the PWLB rate went up to 3.75% (1906 example) sometimes down to 3.25% (1936 example); frustratingly for the municipal borrowers, the support from London came with supervision over planning and quality of engineering proposals. Some towns, Bedford for example, to avoid that unwanted oversight (‘infringement of local interests’ etc) were able to get relatively good rates from insurance companies, at 4.5% in 1869. However, for ‘Temporary Loans’ to complete works (after cost overruns – though these were unusual - or for extensions to mains or sewers when the town was expanding rapidly) they were able to borrow from local businessmen at 5% ‘but on the express condition that if any time the [lenders] should desire the repayment of the whole balance in one sum the board should comply with the same.’ Councillors on this occasion being reminded that ‘to obtain the sanction of the Secretary of State before the money could be borrowed from [PWLB] would entail a considerable expense’ (1869), therefore the interest in alternatives.

In the case of Ampthill, a small town with its own Urban District Council, the Councillors were complaining in 1906 about the cost of their proposed water supply scheme being overly increased by the Local Government Board (the 'Ministry' in London) with its demands for 'extras': "they [LGB] would not lend them money without they [LGB] did it in their way [conditionality!]. One Councillor commenting somewhat optimistically “unless they saw their way to make a private Company of it, and in that way the cost would have been very much reduced.” To which the rejoinder came: “Mr Abbis said the Company would want 8 per cent."  Privatisation always requires a higher cost of capital to manage risk as well as rewarding the private providers of capital? But 8%, double the rate available through PWLB?

Within a few months the Council’s application to the PWLB received a quote at 3 ¾ per cent (3.75% - 1906) with the question posed to the Clerk of the Council “whether they could get it cheaper elsewhere?”  The report came back (1906) that "None of the Insurance companies would lend money at less than 3 ⁷/₈ percent" (3.875%). Which was an impressively small margin of difference, but the Council went with the PWLB and accepted, in 2020 USD PPP prices, an additional $20,000 of costs to meet the higher standards. The Council constructed the system within that budget, and charged [large user] metered customers 1s 6d per 1,000 gallons – equivalent to $2.60 per m3 in 2020 prices. As often seen, large users being charged above full cost recovery (operating costs plus full cost of capital, interest and principal repayment) in order to cross-subsidise domestic users.

This 3 ¾ per cent can be compared with other figures given to the surrounding Rural District of Ampthill, or rather to some of its constituent ‘Parish’ [Village] Councils. In 1909, a quote for 4% was obtained from Prudential Assurance, a private insurance company, relative to PWLB's 3.5%.

Subsequently one village, Flitwick, in 1926, of maybe only two thousand people was anticipating the need to borrow between £40,000 to £50,000 [$6.3m-$7.9m 2020 prices] with an interest rate of 5 per cent – understood to be unaffordable. That scheme made no progress until 1936 when for a larger 'multi-village' scheme across the District the PWLB 'granted a sum' (provided a loan) at three and a quarter per cent’.

Not only were the taxes (and the operating expenses – these usually charged as a separate water tariff) cost-reflective there was also an extremely efficient system of collecting revenue – the local ‘Overseer’ or ‘Collector’ knowing his community well and being incentivised with his own percentage of the money collected by way of remuneration.

Bedford’s Mayor commenting in 1867 that “this was a most satisfactory account, and that the rate had never previously been so closely collected. The account is satisfactory also from the fact that so few summonses have been issued. Mr Trapp suggested that this was a more satisfactory testimonial to the collector than if he had collected the money in a compulsory manner.

The Mayor: We are perfectly satisfied with the statement; it reflects great credit on him. At this stage, a supplementary resolution was unanimously passed, adopting a recommendation of the Board that the collector should be paid at the rate of 2.5 per cent on the amount of the new rate”.

Two years later “For all houses assessed under £6 sterling the landlords pay instead of the tenants, which was a great advantage; and when they took into consideration that the late collector was perfectly willing to collect the rates at 2½%, he did not see why they should give another person 3½%.” A percentage which had been recommended for a new Collector because “the public generally were in favour of Mr. Robinson, and against Mr Joy.” Another Councillor commenting that “he considered he was on fairgrounds when he asked why they should give a higher percentage to one man for doing the work, when another, and a tried man, would do it for less?”

All of these discussions were based on the guarantee that every council would pay its borrowing costs, from whatever source, from local taxation. No write-offs, no excuses, no escape, it was paid. Hence the low rates of interest required, particularly when backed by Government borrowing through the Public Works Loans Board. ‘Institutional capital’, that is trust in repayment systems, as well as just about adequate national wealth enabled this process. Any transgressions had to be paid from the Councillor’s own pockets; one interesting example being when Ampthill Urban District Council had paid a 'water diviner' to find the required source for the new piped water supply – the diviner failed but was still paid. The auditors demanded that the Councillors had to pay themselves– and even though they appealed the ruling, they had to pay.

No write-offs that is until the 1989 nation-wide privatisation when any still outstanding borrowing was written off as part of what was called the 'green dowry' etc. This being a time when, as the figures in the 180 years of CapEx paper show, Government was desperate to get water sector borrowing off the government books (just as they remain today with Thames Water 🙂 – but that’s another story altogether).

Sources: The Bedfordshire Times and Independent (1864, 1867, 1869, 1906  & 1936) and the Bedfordshire Mercury (1868, 1869, 1906 & 1909) along with Luton News & Bedfordshire Advertiser (1926).