Crawl Across the Ocean

Thursday, February 17, 2005

Government is not a Business - Part 1

The Liberal party in B.C. brought in it's latest budget a couple of days ago. Here is the unsurprisingly negative reaction from the NDP party.

The budget itself was pretty unremarkable. Tax relief for lower income people was welcome but still pretty meagre when compared to the tax cuts at the upper end of the income scale which were made in 2001. The rest of the budget consisted primarily of restoring some of the spending to various areas which have been cut over the last few years and trying to sell it as new spending. Overall, I don't think the Liberals management has been terrible, but circumstances are still showing that their initial tax cut in 2001 was too deep and that it should probably be partially (say 20%) rescinded.

The thing about the budget that really bothered me, is the claim that the government is forecasting surpluses for the next few years - a claim which is made by excluding capital spending from the government's balance sheet. As you can see from the budget summary here, the province's debt, while falling as a % of GDP, is still climbing as an absolute number. So to claim future surpluses as the budget does, and which the media reported as fact, seems wrong to me.

The government says that, "Borrowing for capital projects finances the building of schools, hospitals, roads and other social and economic assets. As these investments provide essential services over several years, the government, like the private sector, borrows to fund these projects and amortizes the costs over the assets' useful life." - but to me, there's a big difference between the way the private sector operates and the way the government operates.

For a business, it makes sense to exclude capital spending (e.g. building a hospital) from the calculation of profit (surplus) because capital spending creates an asset and the whole purpose of a business is to use it's assets to both the cover the cost of the money used to buy them (interest, if the money was borrowed) and to generate a profit on top of that. Whether the business is doing a good job of this can be measured by comparing its profit to its assets, calculating what is sensibly called the Return On Assets (ROA). If the assets are not generating an adequate return, they should be sold (or the business plan should be modified).

But for a government, building a school or a hospital or a road isn't going to generate a return which can be tracked back to that investment. There's no way of knowing for sure if there will ever be any profit (increased tax revenue or decreased spending for the government) which can be attributed to this investment and there's not much chance that these investments can be sold if they're not performing well. And as far as I can tell, the budget does not even try to measure the depreciation of all the government's assets and count that as an expense (although I could be wrong here - it's hard to say just by looking at what they've posted online).

In short, the government is not a business and it doesn't have any of the cultural or financial tools necessary to limit it's borrowing only to those items which generate an adequate return on investment or to track whether it's investments are earning an adequate return or to change course if they are not.

We recognize this distinction between government and business by identifying those areas of government activity which are like a business and isolating them in crown corporations which follow different financial rules from the rest of government.

So, I'm no expert on what typical practice is for governments around the world, but if you ask me, capital spending should be included in the general budget for a government, and if the total debt is going up, you're not running a surplus.

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