Sunday, March 04, 2018

On Government Finances and Debt

In Alberta Views this month, we have a debate column pair about government debt written by economist Trevor Tombe, and former PC finance minister Ted Morton.

There are a number of respects in which I find Morton's arguments are profoundly flawed, and I would like to take some time to address them in more depth than the relative brevity that the magazine format allows for.

Mr. Morton begins his argument as follows:

In 2005 the $23-billion debt inherited by Ralph Klein’s Progressive Conservatives in 1993 was officially paid off. Klein celebrated Alberta’s new “debt free” status, proudly declaring: “Never again will this government or the people of this province have to set aside another tax dollar on debt… If need be, we will put in place legislation to make sure that we never have a debt again.”
This is a common little bit of mythology in Alberta politics.  Supposedly the fiscal prudence of the Klein governments enabled us to wipe out our fiscal debts entirely.  Except that he didn't, and we never really erased our debts - we just kind of shuffled things around until the financial picture looked better.

For example, the Klein governments placed their entire focus on government indebtedness.  In order to erase that debt, they axed some 20% from the government's spending off the top, redirected royalty revenues that should have gone into the Heritage Savings Trust Fund to paying down the immediate debt.  Any time issues were raised like road maintenance, repairing school buildings (heaven forbid we might actually build a new school), the public was told quite bluntly that the government simply didn't have the money for it.  We'll come back to this issue in a little bit.

When oil and gas prices crashed in the wake of the 2008 financial crisis, so did government revenues. The PC governments of Stelmach and then Alison Redford began to run “temporary” budget deficits. By the time they were defeated in 2015, the Stelmach/Redford governments had run seven consecutive deficits and burned through over $16-billion in savings from the now defunct Sustainability Fund.
This is an interesting part of Morton's arguments, in part because it is directly connected to his own time as a minister in Alberta's government under Ed Stelmach. First, I'd like to draw your attention to his attempt to minimize the deficits run by the Stelmach government.  This is not a trivial point - it's actually quite significant.  He makes reference to the so-called "Sustainability Fund" that Klein created, and oblique reference to the economic crisis that took hold in 2008. It was obvious as far back as 2002-2003 that the the crisis was going to come sooner or later - subprime mortgages were becoming common in the US even when Klein was still in power.  By late 2007, it was painfully obvious that the bubble was collapsing.

However, one might want to ask Mr. Morton how he thinks a government can avoid going into debt when forces well beyond its control cause an overall economic drop worldwide?  However, by the time Stelmach took over from Klein, the provincial government was under increasing pressure to address the growing infrastructure deficit that they had created.  Parents were calling out for money to be spent building schools closer to where they lived (especially in Calgary and Edmonton which had both experienced major urban growth during the Klein years),  there were major roadworks needed, the pressure on hospitals caused by population growth meant that new beds were needed across the province.  The proverbial chickens were coming home to roost.

Morton goes on to argue as follows:

The NDP’s own budget projects Alberta’s debt to hit $71-billion by 2019. The comparable figure at the end of the Getty government’s deficit streak was $23-billion. In 1993 this meant that 24 cents of every tax dollar collected went to pay interest on the debt, leaving not nearly enough to pay for education, healthcare and social services. Today’s historically low interest rates have spared Alberta this calamity so far, but this will not last. Interest rates are going up, and Alberta’s credit rating is going down.
Not only is this kind of deficit spending unsustainable, it’s also unfair. It leaves the bill for today’s services to be paid by tomorrow’s taxpayers. But this is precisely what accumulated deficit/debt spending does. Every politician’s favourite tax is one that is paid by someone other than his constituents. Economists have a polite term for this—“intergenerational equity.” Informed members of the next generation have a more blunt term for it: “Generation screwed.” And they’re right. Why should our children and grandchildren be stuck paying bills run up by today’s vote-hungry politicians?
First of all,  Morton's argument at this point starts to slide into sleight of hand tactics.  He doesn't present us with numbers that are inflation adjusted, nor does it account for changes in overall government revenue (and expenditures) caused by a near doubling of the provincial population.  This is why Tombe's arguments which are based on a Debt-to-GDP ratio calculation are in fact more reasonable.  Raw numbers seldom tell the whole picture, and in this case really mean that he is comparing "apples to oranges".

The second part of this is the implicit assumption in Mr. Morton's argument that the costs associated with the big 3 government expenditures social services, education and health care, are simply expenses - money spent with no return.  This is a profoundly flawed way of looking at government expenditures in these areas.  It is well established across G-7 countries that these expenditures are actually investments in the population with overall net benefit to all.  Generally speaking, a secure, healthy and educated population is more productive.  Mr. Morton's approach here is typical of conservative political thought these days which tends to focus on the immediate costs today, and ignores the longer term consequences of decisions.

Arguing that taking on debt today is somehow "screwing" future generations is also faulty reasoning. If we take on debt today to continue operating our schools, do the students not benefit from that both immediately, and in the future?  Similarly, major infrastructure costs such as building roads, schools and hospitals all ultimately are long term investments which have lifespans well beyond the immediate costs.  Failing to acknowledge this makes it far too easy for politicians like Morton to argue for massive cuts to government spending because they ignore the longer term costs.

For example, in 1998 the Alberta government demolished the Calgary General Hospital (which is often held up as an example of short-sighted policy on the government's part), but over the Klein years the Colonel Belcher hospital was shut down, and the Holy Cross hospital was also decommissioned and sold off to private interests for pennies.  At the time, that essentially left the Calgary area with 3 hospitals:  The Foothills Medical Centre, the Rockyview and the Peter Lougheed Centre - serving a growing municipal region with a population that was well on its way to crossing the 1,000,000 residents mark.  The government would spend most of the next decade sitting on its hands, refusing to replace the hospital capacity it had literally demolished while Calgarians faced ever increasing wait times at the remaining hospitals, and longer and longer trips to access care.  The South Health Campus wouldn't open fully until 2017.  We may never know how many patients didn't survive this era, or experienced worsened symptoms because of the gaps the Klein government created.  Further, by refusing to invest to replace these facilities early, the government actually increased the overall cost of doing so.  Both labour and materials costs are subject to inflation, and where the South Health Campus facility would have cost < $1bn in 1998, by the time the project completion occurred in 2017, the final price tag would be considerably higher.  (even correcting for inflation, it would still be much higher)

So, one might ask if putting off a major set of repairs actually saved Albertans any money?
In effect, the NDP has decided to use Alberta’s triple-A rating to borrow $70-billion over the next five years to help them win the next election. Notley’s bet is that most of the voting public will not understand or care where this money came from or how it will ever be paid back.
Now, this is such an obviously partisan shot at the NDP government, it scarcely bears mention.  However, we shouldn't forget that PC governments have repeatedly made similar promises of new schools, repaired roads, or even new hospitals in the run-up to an election.  All too often, they would then turn around and plead poverty to justify kicking the can down the road.  Calgary (and southern Alberta) has desperately needed a replacement for the aging, over-capacity, Tom Baker Cancer Centre for years.  Klein initially promised that replacement, and then the PCs basically kept delaying the project every four years.  The budget has grown over the years, although the NDP starting it during a downturn may actually be to our overall benefit since that will reduce the overall costs somewhat.

As for the issue of "paying the debt back", I think it is important to acknowledge that all debt instruments carry a built-in means of paying it back - whether that is a blended payment model like a loan where capital and interest are combined, or it is a bond where the capital has to be paid off at maturity (usually managed through something like a bond sinking fund so you don't have to issue a new bond to replace the old one).  Whether our governments are effectively using this latter model of building a fund to pay off bonds as they mature is open to discussion.  They certainly should be in my opinion.

Lastly, Mr. Morton's approach also presupposes that the government always spends too much, and already has adequate fiscal resources at hand.  In Alberta in particular, this is arguably a nonsensical argument.  Yes, government spending has outpaced inflation.  But it has done so because government spending is not a function of inflation, but of the needs of the people.  Decades of parsimony on the part of the PC governments, combined with significant population growth, left Alberta with a gap between what was needed and the fiscal capacity of the government.  Schools were needed, hospitals were needed, as the Fort McMurray fire demonstrated, better emergency response infrastructure in rural Alberta is still needed and so on.

So, how can we address this gap between fiscal capacity and required expenditure?  There are two basic levers available.  One is for the government to borrow funds as it has been doing.  The second is to increase government revenues through taxation and royalties.  Having the lowest taxes in the land does us precious little good if the people are living in penury as a result of gaps in government support. Alberta has always argued that it can "balance its books without raising taxes".  The 2014 oil price collapse makes it painfully clear that this is a fantasy written in the same ink as Klein's eulogy.

In Alberta political circles, the idea of raising taxes - even minimally is anathema because our politicians have spent decades telling us how fantastically wealthy the oil patch is going to make us all.  It hasn't, and it won't. Alberta needs to grow up and accept the reality that government isn't free, and we need to align our government's income regime with that of other provinces in Canada.

If Mr. Morton and his allies wish to argue against government debt, then let them show us their model for how they propose to do this given their apparent allergy to taxes.  Don't let them deceive you with arm-waving arguments about "government waste" - insist that they show you exactly where all this waste really is, and how they would structure things to work better.

If Alberta wants to minimize its use of government debt, then the government must revisit the fundamentals of its fiscal context, and ensure that it has the cash flow from taxation sources that it needs.  Then, and only then, can we have an intelligent discussion about the needed structure of government to sustain the programs it delivers in a useful form.

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