Provinces play ‘hide the deficits’

Jack M. Mintz: Provinces play ‘hide the deficits’

 

Jack M. Mintz, Financial Post, March 12, 2015

I was attending a recent meeting with a somewhat august group of individuals when someone referred to the recent British Columbia budget as being in surplus, praising the government’s prudent behaviour. Except for one thing. While the B.C. Minister of Finance forecasts the 2015-16 surplus to be $534 million, provincial debt is rising by $2.1 billion.

For the ordinary voter, how can this be? When a paycheque is less than household spending, the family must run down its bank account or take on more debt. If a government is therefore borrowing money, isn’t $2.1 billion the real deficit?

What B.C., Ontario, Quebec and several other provincial governments are doing is using some theoretically correct accounting measures to hide the walloping faced by taxpayers when debt must be eventually repaid.

Most provincial governments use so-called capital budgeting whereby infrastructure expenditures are not charged against the budget. Instead, an operating surplus or deficit is presented by subtracting the cost of replacing depreciating capital due to wear and tear. Capital depreciation is therefore treated as an expense like salaries and debt charges.

If money is spent on infrastructure such as roads and school buildings, such expenditures are not treated as a cost to the operating budget. Instead, a capital account shows the relationship between investments and financing sources, including debt.

For those people familiar with corporate financial reporting, this makes sense. Net income is calculated by deducting capital depreciation from profits. Capital spending is treated as a reduction in cash flow. If the company sells off financial assets, borrows money or issue new shares to corporate owners, cash flow increases. So to have enough cash on hand, a corporation has to earn enough profits on its capital expenditures to provide shareholders sustainable income over time.

‘Bridges to nowhere’ won’t be producing tax revenues

So a government’s operating surplus is akin to the “net income” used by corporations for financial reporting. But, governments are not corporations. So is capital budgeting a good practice for politicians to follow?

The best argument in favour of capital budgeting is that investments in infrastructure provide benefits to current and future voters. Without capital budgeting, governments tend to avoid infrastructure spending that is immediately charged to the budget, thereby making current deficits look larger, which is particularly important when legislation requires balanced budget or limitations on deficits. So if capital spending can be spread over the lifetime of assets, a better picture evolves as to budgets in the long run.

This seems sensible until politicians take hold of accounting practices to hide their debt. From a public policy perspective, capital budgeting is letting provincial governments confuse the voter, most of whom are far from being financially literate. Provinces look like they are doing well running small operating surpluses while piling up debt to fund parks, transit and other non-income producing capital projects.

In the corporate world, money is spent on income-generating assets unlike the public sector with a majority of investments producing no income and has little market value. For example, two-thirds of B.C.’s borrowing is related to tax-payer subsidized capital.

While capital spending might create more jobs and future tax revenues, there are no assurances it does so. Some projects, like white-elephant sport stadiums and “bridges to nowhere,” won’t be producing tax revenues. Further, the taxes raised to pay for infrastructure will take away resources from other profitable pursuits.

Further still, many provinces have “balanced budget” legislation, which typically apply to their operating surplus accounts. Limitations on the size of the surplus or deficits create an incentive for governments to label spending as capital to shift expenses out of operating accounts to enable more public borrowing.

In the U.K. and New Zealand, limits on debt were introduced so politicians couldn’t as easily shift expenses off the balance sheet to capital accounts to avoid deficit limitations.

B.C .is not the only government that paints a less disturbing budget while taking on more debt. Financially challenged Ontario reported last year a $12.5-billion operational deficit when it was running up its net debt by $20 billion. Seems the latter provides a truer picture of Ontario’s financial health.

Alberta reported recently a surplus of $465 million for 2014-15 even though its deficit, measured as the decline in net financial assets, is $2.4 billion.

I can think of no government in the world that calculates a deficit like Alberta. Unlike other provinces that only report an operating surplus, Alberta calculates a surplus as the change in all assets, including non-income producing capital. If Alberta reported its results similar to Ontario, the operating surplus would have been $2.2 billion even though the Province was massively borrowing money to fund infrastructure.

This fiscal messaging was of no help to Premier Prentice, who has been making the case for significant spending cuts or revenue increases. If the Premier emphasized the $2.4 billion decline in net financial assets as the true deficit, he would convey a truer picture of the Province’s situation.

The federal government, on the other hand, does not use capital budgeting to report financial results. Capital spending is charged to the budget just like salaries, transfers and other charges. A deficit really means that the federal government has to borrow money. At one time, I thought this was not the best practice, thinking that capital budgeting provides a truer picture of the benefits associated with infrastructure. However, with voter confusion over the meaning of a deficit under capital budgeting, I think the federal approach is more transparent as to what a deficit means in terms of borrowing.

With upcoming federal and provincial budgets, voters should beware. Public deficits are much worse if the taxman cometh to pick your pocket in later years when the chickens come home to roost.

Jack M. Mintz is the Palmer Chair, School of Public Policy, University of Calgary.

Correction:  The above column states that the federal government uses a modified accrual accounting, which was in place until the 2002-3 budget.  In fact, full accrual accounting including capital was adopted that year, although the difference between the operating deficit and changes in net financial debt are relatively little.  For 2013-14, the federal operating deficit was $5.2 billion and the change in net debt was $4.0 billion