Trevor Tombe says debt can be useful
Thomas Jefferson wrote over 200 years ago that “the principle of spending money to be paid by posterity is but swindling futurity on a large scale.” To Jefferson, accumulating public debt was a great danger; a choice, as he put it, between “profusion and servitude.”
Today, many share this sentiment. Opposition politicians in Alberta regularly describe the province’s $10.5-billion deficit as crippling. To quote MLA Derek Fildebrandt, the province’s growing debt is “suffocating what we once called the Alberta Advantage.” And there’s no shortage of equally sharp critiques of Trudeau’s fiscal policy choices federally.
But despite their long history, such exaggerated views neglect important benefits of debt that, at times, can outweigh its costs. Used wisely, government debt is an important tool—and neither the federal nor the Alberta government is on a fundamentally unsustainable path. A focus on debt also distracts from more fundamental questions about our budget that we should be asking. I’ll try to provide some perspective.
First, debt is a shock absorber. Uncertainty is an unavoidable fact of our lives. If something costly and expected arrives—say, a leaky roof—debt can cushion the blow today and be gradually repaid over time. The same is true for governments. Former Prime Minister Stephen Harper accumulated substantial debt to fund stimulus spending during the recent financial crisis. And Alberta and Saskatchewan, two provinces whose governments occupy opposite ends of the political spectrum, are both using debt to cushion the blow from low oil prices.
Second, debt transfers costs and benefits through time. Debt must be repaid in the future, but some projects to which borrowed funds are directed will have benefits in the future, too. Roads, schools, hospitals and other infrastructure projects often last for decades. The public largely understands this. A 2015 survey by the province found that over 60 per cent of Albertans agreed such borrowing for capital investment is useful because future generations will benefit and so should share in the cost.
The trick is not to accumulate too much. But how much is too much? The ability to sustainably manage debt is not fixed but depends on the strength of a region’s economy and the amount of other assets available. Government revenues, after all, tend to increase as economies grow, and assets (such as the Heritage Fund) can be liquidated if need be. So economists look to “net debt to GDP” ratios, and by this measure Alberta does very well. By 2020 the province’s net debt will be roughly 11 per cent of GDP, according to recent data from RBC. This is below every other province and hardly unsustainable for Canada’s strongest economy.
Even if interest rates increase to 5 per cent, total interest paid will be about 1 per cent of GDP, lower than any province east of Saskatchewan today.
But what about the future? Can deficits continue indefinitely? Under certain circumstances, yes. Let me illustrate. For an economy that grows at 5 per cent per year, even a permanent annual deficit of 1 per cent of GDP (equivalent to $3-billion for Alberta today) would maintain a debt to GDP ratio below 20 per cent. Behind the math is an important point: modest deficits—constrained by the rate of economic growth and an acceptable debt to GDP ratio—are sustainable.
Another important concern is the burden of interest payments. By 2020/21, Alberta may be on the hook for $2.3-billion in debt service payments per year—a large increase from the $200-million paid in 2008/09. It’s true that rising debt means higher interest payments. And it’s also true that higher interest payments mean either higher future taxes or lower spending on public goods than would otherwise be the case. But to balance the books today and avoid new debt also means either higher taxes or lower spending. Perhaps that’s a choice worth making, but it’s ultimately a question only of timing.
Let me end on a deeper point, and one that is unfortunately often lost in the debate: Accumulating debt and selling assets are fundamentally similar acts. Just as increased debt decreases our wealth, so too does selling assets. And just as debt involves interest payments, selling assets forgoes future returns. Sometimes it may make sense to sell assets instead of accumulating debt, but sometimes not. Would liquidating the $20-billion in Alberta’s savings fund to repay debt be a smart move? Probably not. The return on those assets is likely higher than the historically low interest rates governments can borrow at today.
This way of thinking leads to some interesting implications for how we think about government budgeting, especially in resource-rich provinces. For such jurisdictions, some important assets are not part of the budget. Alberta’s oil and gas resources, for example, are owned by Albertans through their government, and royalties levied on extraction are the public claiming its share of the asset’s value. (Currently, roughly two-thirds of so-called resource “rent” is captured.) That is, royalties are proceeds from an asset sale, not income in the regular sense.
Avoiding debt by selling assets is the core budget challenge Alberta repeatedly fails to confront. Alberta last balanced its budget without royalty revenues in 1949. Peter Lougheed, for example, averaged surpluses of about 0.5 per cent of GDP over his tenure. But remove royalties, and deficits would have been 7 per cent of GDP—roughly equivalent to $23-billion per year today. Past governments sold assets to balance the books, but this is no longer an option. Today, Alberta’s growing debt merely makes transparent the same steady decline in the province’s wealth that has existed for many, many years.
Alberta has neither a “spending problem” nor a “revenue problem,” as the debate is often framed; it has a budget problem, one that all sides aren’t taking seriously. Reasonable people will surely disagree over appropriate spending levels, over the merits of sales taxes, or over a host of other issues, but these are the conversations we ought to be having in a calm and rational way. Overheated political rhetoric that avoids tough but concrete solutions are the true threats to the Alberta Advantage.
Ted Morton says debt should be illegal
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.”
True to his word, Klein did enact balanced-budget legislation. But within four years the law prohibiting deficits was repealed, and Alberta has not had a balanced budget since. Rather than being debt free, Alberta is now projected to have a debt of $71-billion by the next provincial election in 2019. The net financial assets of $35-billion left at the end of the Klein era are gone.
Ed Stelmach succeeded Klein as premier in 2006. In the 18 months leading up to the next provincial election—Stelmach’s first (and last!)—virtually every resource dollar was being spent. 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.
Rachel Notley did not invent the art of spending money the government does not have. During the last decade of PC governments (2004–2015), program spending doubled from $24-billion per year to $48-billion, increasing almost two times faster than the combined growth rate of population plus inflation (PPI). Indeed, if the PCs had limited annual spending increases to PPI, there would have been no deficits during their last decade of governing. Unfortunately the Notley government is continuing the mistakes of its predecessors with an annual spending increase of 7.5 per cent, double PPI. What’s novel about the Notley budgets is how they’re going to be financed: over $70-billion of borrowing over five years, all on the back of the triple-A credit rating she inherited from her PC predecessors.
In the last decade of PC governments, spending doubled from $24-billion per year to $48-billion, increasing two times faster than PPI.
Since winning power in 2015, the NDP government has posted deficits of $6.4-billion, $10.8-billion, and now $10.3-billion (projected). Those are the official numbers. The Dominion Bond Rating Service (DBRS) recently reported that real numbers for 2016 and 2017 budgets are $12.8-billion and $13.6-billion, respectively. When measured as a percentage of provincial GDP, the 2017 deficit is 4.2 per cent, which makes it the largest deficit in Canada. DBRS concluded that “Alberta is continuing to erode its low-debt advantage through sustained deficit spending” and downgraded the province’s long-term debt from “stable” to “negative,” meaning it will cost us more to borrow.
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?
This is not just an Alberta problem, but one facing all democratically elected governments. No government pursues a policy of long-term public good—such as a balanced budget—if the short-term effect is to increase the risk of imminent electoral defeat. In democratic politics, short-term electoral self-interest almost always trumps longer-term public interest.
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. They’ll see the new schools, hospitals and roads in their communities and reward the NDP with another majority.
PC governments’ failure to constitutionally protect the fiscal policies that created the “Alberta Advantage” effectively handed the NDP the political equivalent of a platinum credit card to spend and borrow their way to winning the next election.
Alberta’s experience proves that statutory rules are not sufficient to protect a positive fiscal legacy. Klein’s balanced budget law was removed by a simple majority vote in the legislature. Any meaningful reinstatement of a balanced budget rule will require that it be put beyond the reach of a simple majority by future governments of whatever party. To withstand the inevitable instinct of politicians to borrow and spend to win the next election, any sustainable balanced budget rule must require a super-majority vote to amend or repeal it; that is, it must be constitutionally entrenched.
Tombe responds to Morton:
In his argument against government borrowing, former Alberta Finance Minister Ted Morton raised many important points worth considering carefully. I’ll respond to some and provide perspective—starting with Ralph Klein.
On July 12, 2004, the then premier famously held high a “Paid in Full” sign in celebration of a debt-free Alberta. The trouble is, Alberta still had roughly $18-billion in debt—including $5-billion in direct borrowings, over $4-billion in Alberta Capital Finance Authority debt (loans to hospitals, universities, schools etc.), pension liabilities and more. “Paid in Full” meant enough cash was earmarked to eventually repay $5-billion in maturing bonds, not all debt. Klein’s Budget 2004 also included new capital debt not covered by the balanced budget law—$151-million by March 2005, rising to $702-million within two years. Klein used debt, and that’s okay.
Of course, today’s borrowing is larger. Is spending the problem? It’s true that spending has grown faster than population and prices since 2004. Had it kept pace there would be no deficit today. But the new spending was either worth it or not. If benefits exceed the costs, then there’s no problem; if not, then cut spending. That’s the debate, not the deficit itself.
Will rising interest rates lead to calamity? No. Not even close. If the budget balances over the next five to six years—a goal shared by government and opposition alike—direct debt may reach $90-billion to $100-billion. Even if interest rates on that debt increase to, say, 5 per cent, total interest paid will be about 1 per cent of GDP. Lower than any province east of Saskatchewan today.
The ultimate problem is reliance on royalties. Past governments had it easy, even in difficult times. Budget 2010 delivered by Ted Morton after the financial crisis, for example, featured an “official” deficit of $4.75-billion (or $7.3-billion on a cash basis, which Mr. Morton suggests is the “real” measure) with royalties at 21 per cent of revenues. Today, if we were similarly flush with royalties, the deficit would be only $3-billion.
My argument doesn’t absolve the government of its responsibility to fix Alberta’s finances, nor does it ignore prior governments’ failure to do so. Instead, it’s a call for Albertans to think beyond the buzzwords, beyond the sound bites, and to move past politics. The collapse in oil prices has forced difficult decisions upon us. We must rise to the occasion.
Morton responds to Tombe:
Everything Trevor Tombe writes is true… in theory. But budgets aren’t made by economists on blackboards with the goal of serving the public interest. In the real world, budgets are made by politicians who want to win the next election. And the recipe is pretty simple: spend now, pay later. Or better yet, let someone else pay later.
This is a recipe for failure in our personal finances, and it won’t work for governments either. But it does work for politicians, because they’re typically long gone when it comes time to pay the bill. That’s why Churchill called democracy the worst form of government except for all the others.
As long as we stick with democracy, we need a solution to this problem—an entrenched balanced budget law (BBL). A BBL isn’t economic theory. A BBL is a legally binding fence around politicians.
Tombe concedes that Notley government deficits will mean interest payments of $2.3-billion a year by 2021. And that this will “mean either higher future taxes or lower spending on public goods.” But, he continues, “to balance the books today and avoid new debt means either higher taxes or lower spending. …It’s ultimately a question only of timing.” True, but in politics, timing is everything. Given the choice, the government of the day will always leave the bill for some future government and future taxpayers/voters.
Tombe correctly points out that during a recession, debt can be a “shock absorber” to cushion a government’s drop in tax revenues and ability to pay for social services and programs. But a BBL needn’t have a one-year timeframe. Similar US laws allow a state government to run deficits for a year or two, but require a final, net balance at the end of a four-year term; i.e., before the next election.
What about the future benefits of capital spending and “spreading the costs” across decades of taxpayers? Again, true in theory, but a dangerous loophole. How far into the future do you allow today’s politicians to “spread the costs”? Suffice it to say that periods of population growth are also times of economic growth, which translate into increased government revenues. Better that governments build and pay for public works when the economy is growing. Future governments can always apply the brakes when the economy cools.
Tombe writes, “Used wisely, government debt is an important tool.” Politicians’ obsession with elections virtually ensures debt will be used unwisely. Tombe concludes by warning against “overheated political rhetoric” in favour of “tough but concrete solutions.” An entrenched BBL is just such a solution.
Trevor Tombe is an associate professor of economics at the University of Calgary. Ted Morton is a senior fellow at the Manning Centre and former Alberta finance minister.