A payback culture

By Gérard Bérubé

At a time when governments are juggling budget imperatives, they are often reminded about the size of the public debt. After zero deficits, economists and analysts are now exhorting the provincial governments to set up a systematic debt repayment policy. Basically, they are being advised to imitate Ottawa and set up a contingency reserve that, if unused, would be allocated to debt reduction. But should this really be a priority? And is it the best thing to do?

Those partisans of paying down the debt — building their case on intergenerational equity, an aging population and the pressures that demographic changes are bound to put on the cost of public services — are urging the debt-ridden governments to give themselves more flexibility. They also argue that current upward pressure on interest rates will rebound on debt servicing.

Then they cast a glance at the federal government. Budget after budget, Ottawa annually uses at least $3 billion  of its contingency reserve to reduce its debt. Between 1996-1997 and 2002-2003, the government managed to repay $47.5 billion, almost 8% of the federal debt. In the meantime, the debt-to-GDP ratio fell to 48.8% from 74.4%. While this may be a telling example, it is nonetheless very limited. In a report published by the Institute for Research on Public Policy, economists Marcelin Joanis and Claude Montmarquette argued for a systematic debt-reduction policy and pointed out that the debt was growing despite the zero-deficit goal and that the reduced debt-servicing burden on budgetary revenue was mainly due to lower interest rates and increased tax revenue from a protracted period of economic expansion. Above all, they insisted, “an increasing debt pushes the costs of current government spending onto future gen- erations, who will derive little benefit.” If this is the case, what can we do?

First, it is a mistake to say that any debt contracted today will not benefit future generations. Just look at infrastructure investments, for one thing. However, Joanis and Montmarquette are the first to admit that paying down the debt is not a cure-all. “In the case of the federal government, annually repaying a small fraction of the public debt had a minor impact on the debt-to-GDP ratio compared to that of the increasing denominator,” they wrote. Further, 80% of the decrease in the debt-to-GDP ratio is due to the combined effects of economic growth and inflation.

This is a much more realistic interpretation of the scope of a systematic public-debt repayment policy that has wider implications. You also have to consider the long-term effect of a policy like this. It could be 15 years before methodically paying down the debt gives a government more flexibility, and a party in power is seldom so farsighted.

Another factor also narrows the scope of a comparison between federal and provincial budgets and stems from different kinds of pressure on provincial government finances. Because most of their actions are geared to meeting primary needs, provincial governments are faced with a higher level of expenses that cannot be cut. This means provinces do not have the same flexibility as the federal government in terms of discretionary expenditures. On top of which Ottawa’s finances, fattened by excess employment insurance premiums, still show generous surpluses from a lengthy period of economic expansion that began after the 1990-1992 recession — and let us not forget the famous debate on the fiscal imbalance between Ottawa and the provinces. Lastly, more and more authors tend to understate the impact of the aging population, claiming this demographic trend will not have the anticipated catastrophic effect on public finances.

As you can see, while the systematic debt repayment policy is supported by a contingent of ministers, politicians and economists, it is not so clear cut. However, although less applicable to the provinces than to the federal government, let us recognize that the policy at least has the merit of imposing some discipline on governments that tend to focus only on the short term and their own re-election.

Even more so, debt has start- ed looking good again ever since Quebec and then Ottawa adopted new accounting rules. The ensuing reform reintroduced accounting depreciation, whereas before, the cost of capital assets were expensed in full during the year. From this perspective, a payback culture definitely seems better than a debt culture.

Gérard Bérubé is editor of the Économie et finance section of Le Devoir in Montreal