The Flawed Politics of Government Debt

So, election season is upon us, and one mayoral candidate, in a bid to secure himself as the candidate of fiscal restraint, released a choice quote that “Our annual and total interest on the current $2.9 billion debt will be almost $1 billion.”  While it may be true that over its amortisation period, current debt will cost the city $1B (I haven’t checked), the use of the word annual in this statement is used to imply something that is soundly incorrect: that Edmonton is paying 34% interest on its debt.

I also question the numbers, since this would suggest Edmonton has borrowed about $700 million since December 31, but that’s another story.  For the purpose of this post, I’ll use Diotte’s number without question.

Government isn’t a Household
Comparing government borrowing to household borrowing isn’t a great place to start.  While most households recognise that some debt is useful – buying a house, a post-secondary eduction – the idea that they may need to regularly buy more houses to accomodate their growing and changing family is simply not a reality for most people.  The government, on the other hand, constantly faces pressures to deal with growth and change in their population.

Additionally, the government doesn’t have a fixed time horizon.  You and I live in a world where we need to eventually pay off our debt and save some money to support ourselves once our health no longer supports working for a living. The government will continue to be able to generate revenue until some societal catastrophy destroys our current civilisation.

Government Isn’t Really a Business Either
Comparisons of governments to business are a bit more apt, but still kind of sketchy.  Certainly governments operate more like businesses, with employees and payroll, capital investments and revenues.  Municipal taxes are their return on their investments, earning money from creating a good environment to live and make money.  However, unlike a business, government’s goal in making investments is (or should be) the public good, not profit.

Also, and here’s where the biggest difference lies, businesses can raise money by selling equity stakes.  Governments can’t.  They either need to fund expansion through current revenues, or borrow.  Having only two options makes it much harder to avoid the borrowing option.

Still, if Edmonton were a business, it would be a moderately successful one, earning a 5% return on equity.  (8% budgeted for 2013)  Nothing to write home about, but worth coming out to play.  The extent to which Edmonton borrows money is to fund expansion of its “business.”

So Why Borrow
We have two choices, so we could just raise taxes.  The Walterdale bridge is a few years away from being structurally unsafe…we need an extra $120m this year.  And that Arena…well, that’ll be another $500m.  What? You’re moving to Vancouver next year?  Too bad…those folks who buy your house should thank you.

Interest on debt is the price we pay to smooth these hits out over time.  Bridges last a century or two, but when they need replacement they don’t come cheap.

What about Saving Up?
Well, there is technically a third option.  We could put off capital projects until we have the cash to build them.

There are lots of problems with this approach.  To name a few:

  • Inflation or interest…take your pick. Over the last 20 years, the increase in construction cost has averaged 3.8%.  Current borrowing rates for 20 years?  3.25%.    And since interest is paid every year, it doesn’t compound, while inflation does.
  • Replacement projects are easy.  Planning for growth projects is really hard.  From 1953 to 1983, Edmonton’s population tripled.  If you were preparing a 30 year savings plan in 1983, would you have accurately predicted that over the next 30 years, we’d only add 1.45 times the current popuation?  What if you were doing the 1923 savings plan…could you have predicted the costs of automobile infrastructure demanded over then next 30 years?
  • Government surpluses are almost as bad politically as borrowing.  Assuming that Edmonton’s $10B in capital assets need to be replaced roughly every 30 years, we’d need to dedicate $335m/year to the fund annually.  Not accounting for growth or inflation.  A few years without big capital projects and voters will think their taxes should be lower.
  • Withdrawing savings is almost as bad politically as borrowing.  We saw criticism of Alberta government deficits years before their stability fund ran out.  Why would withdrawals from this savings account be any different?

Why is this a problem?
I see three big problems with the current political optics of borrowing.

  1. Municipalities (and other governments) put off necessary projects to avoid borrowing money.  This has been less of a problem in recent years, but the current state of Edmonton’s roads and many public buildings is to a large extent a result of the “discount city” policies of the Reimer and Smith years.
  2. Governments obfuscate borrowing.  The big thing I’ve noticed is the use of public private partnerships to create long term contracts that “aren’t really borrowing,” often resulting in higher costs as payments to the private partner must cover interest at corporate debt rates and a return to their investors.
  3. Cities end up paying more for projects when it reaches the point when things just can’t be put off any longer.  If borrowing costs are lower than projected inflation, it’s fiscally irresponsible to delay a project that must eventually be built.

The bottom line:
A good argument to have is about whether an individual capital project is needed or not.  Should taxpayers subsidize professional hockey facilities?  Do we need the Walterdale Bridge to be a “signature” bridge, or will a cheaper truss bridge like the one that’s coming down be adequate.  These are good policy questions for discussion, and public involvement on what kind of city we want to live in.

But when it comes to financial matters, I don’t see how it’s practical to leave borrowing out the equation.  The alternative of highly variable taxes depending on the current needs of the city seems unappealing, and a long term savings plan seems impossible to set up with any accuracy, without actually solving the optics problems.