Manual for Development Projects - Planning Commission

Chapter 5
and benefits would lead to under - estimation of costs or over-estimation of benefits or vice versa. The
identification of secondary costs and benefits is a difficult task. For example, most of the benefits from an
expanded irrigation project may be offset by a fall in fish production and reduce income for thousands of
fishermen. Increased benefits due to the construction of a new highway may be equally matched by a
reduction in the income of the railways due to decrease in passengers/goods. An important technique which
is followed for correct quantification of costs and benefits is "with and without project" comparison of costs
and benefits. Project analysis tries to identify and value costs and benefits that arise with the proposed
project and to compare them with the situation as it would be without the project. The difference is the
incremental net benefits arising from the project investment. This approach is not the same as comparing
the situation "before" and "after" the project. The "before" and "after" comparison fails to account for
changes in production over the life of the project that would occur without the project and thus leads to an
erroneous statement of benefits attributable to the project investment. A change in output can also occur
without the project if production would actually fall in the absence of new investment. In some cases, an
investment to avoid a loss might also lead to an increase in production so that the total benefits would arise
partly from the loss avoided and partly from increased production. Here are some special items which must
carefully be handled while identifying and quantifying costs and benefits for financial and economic
analyses:
i) Direct Transfer Payments
Some entries in financial accounts really represent shifts in claims of goods and services from one
entity in the society to another and do not reflect changes in the national income. The following
four kinds of transfer payments are important which are not included in economic analysis:
(a) Taxes (Direct and Indirect)
When a farmer pays a tax, his net benefit is reduced but it does not reduce national
income. It is a cost to the farmer and is not a cost from the stand-point of society as a
whole. Thus, unlike financial analysis, in economic analysis, we would not treat the
payment of taxes as a cost in project accounts. However, some taxes called user taxes
are exempted from this rule. Governments often include payments for road
improvements, water or power supply charges in property taxes and this element of
property tax does represent a real cost to society. Highway and bridges tolls, if
accurately set, also may be users taxes and represent real cost. But taxes on gasoline
and petrol do not represent users taxes.
(b) Subsidies
Subsidies are simply direct transfer payments, that flow in the opposite direction from
taxes. If a farmer is able to purchase fertilizer at a subsidized price, that will reduce his
costs and thereby increase his net benefit. But fertilizer used by the farmer is cost to
the economy and in economic analysis must enter the full cost of fertilizer. Another
form of subsidy is that which lowers the selling price of inputs below what otherwise
would be their market price. Market price may be maintained at a level higher than it
otherwise would be by, say, levying an import duty on competing imports or forbidding
competing imports altogether. The difference between the higher controlled price, set
by such measures, and lower price for competing imports, that would prevail without
such measures, does represent such indirect subsidy.
(c) Credit Transactions
Credit transactions are the other major form of direct transfer payment. Loan to a
farmer, for example, does not reduce the national income. It merely transfers the
control over resources from the lender to borrower. Same is the case when the farmer
repays the loan (interest + principal).
(d) Interest
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In determining the gross cost-stream for calculating discounted measures of project
worth, we do not include interest as a cost both in economic and financial analysis.
Expressing it in another way, we do not deduct interest from the benefit-stream on the
capital supplied by the entity for which we are doing the analysis, because in effect the
9/23/2010