The “net debt” sleight-of-hand

The Vancouver Sun’s Harvey Enchin comments on Finance Minister Jim Flaherty’s net debt elimination plan, pointing out some nuances in changed accounting practice around the concept of “net debt”:

 

When Finance Minister Jim Flaherty vowed to wipe out Canada’s net debt by 2021, many people heard something else. They thought he had made a pledge to pay off the federal debt.

As it became clear that he intended nothing of the sort, the government was accused of everything from deceit to dishonesty.

But, contrary to Liberal MP John McCallum’s charge that only a handful of economist are aware of it, net debt is a widely recognized term that has been used in government accounts, and in the corporate world, for many years.

In business, net debt — though not a measure under generally accepted accounting principles (GAAP) measure — is typically defined as long-term debt plus current maturities minus cash and equivalents, and is one of the components in a number of ratios used to determine compliance with debt covenants.

The Organization for Economic Development and Cooperation uses net debt as an international comparator because it is a standard measure most countries have adopted. In calculating net debt, the OECD excludes government employee pension liabilities, and Canada has followed that practice.

In Canada’s public accounts, net debt used to be the same as the accumulated deficit, but a move to full accrual accounting in 2002, a change fully supported by the Public Sector Accounting Board of the Canadian Institute of Chartered Accountants, altered the way it was presented. By removing unfunded pension liabilities for public servants, Canada is on comparable footing with its G-7 counterparts.

… The winds of change could derail the zero net debt program, which is based on a broad range of assumptions about economic growth, inflation, interest rates, investment returns and actuarial forecasts.And the plan depends to some degree on the provinces’ buy-in, since they’ll have to apply at least some of their surpluses, estimated at $13 billion this year, to debt repayment.

Despite these uncertainties, the federal government’s goal, which will make Canada the first G-7 country to bring its debt in line with assets, seems achievable and worthwhile.

No matter how you measure it, paying down debt is good public policy.

What is with that throwaway line at the end? Nothing in the article above makes that case. If anything, Enchin should take that editorial space to point out that the large drop in debt-to-GDP has been largely due to GDP growth, and only a small portion from annual surpluses After deftly weaving down the ice, Enchin blows the shot way wide of the open net.

While many people are warm to the idea of debt reduction, as they are to reducing their mortgage, there are substantial opportunity costs. The rate of return on debt reduction is the average rate of return on government bonds, around 5% give or take. Maintaining debt at that financing cost is a good bet if you have alternative investments that pay back a higher return.

Investing that money in early childhood education, heck, almost all education, would generate much higher returns than that. Investing money in creating supportive housing the homeless and affordable housing for the working poor would also have a tremendous payback (we currently spend more on the homeless through the health care, criminal justice and social services than we would if we were to provide them with supportive housing, according to a study done for the BC government). And as the Stern Review points out, there is net gain if we were to invest in mitigating global warming.