The Government debt connundrum

The debate about government debt is getting louder as the United States rapidly approaches the so-called ‘fiscal cliff”. Burdened by deficits and a large debt of $16 trillion, the U.S has created a legal mechanism that will trim the 2013 deficit by automatically creating spending cuts and increase taxes. The repercussions of such a policy, if a political deal is not arrived at, are great for not only the U.S but world economies, including Canada.

In Canada the Finance Minister just announced that his government will now wipe out the deficit a year later than expected. In Alberta the government is proposing to increase its debt level. All of this under the cloud of more problems from Europe which has been in the economic doldrums for quite some time. It is too bad that we don’t seem to learn anything from failed socialist policies which have caused massive spending and large deficit which now overburden many economies

Debt is a financial tool. It makes sense to use long debt to finance long term assets. But too often governments have used debt to finance deficits caused by political expenditures motivated by the desire to give the electorate wants instead of needs.  Political parties who are not in power automatically oppose debt, until they get in government and then perpetuate the trend of paying for promises through deficits, and debt.

Those who do not trust policymakers with deficit spending propose a balance budget policy because in their view policymakers do not worry about the costs of their policies as the burden falls on future taxpayers.  However, talks of a balanced budget are cheap when not in power; but too often economic realities are ignored when doing so. Most economists oppose a strict balanced budget rule, as it would hinder the use of fiscal policy to stabilize output, smooth taxes, or redistribute the tax burden across generations. As Harvard Professor N. Gregory Mankiw correctly points out: “Fiscal policy is not made by angels…” And politicians are certainly no angels when it comes to managing other peoples’ money.

So what is the answer to managing debt?  In my view capital debt may be justified when it is used to provide needs. Spreading the burden of capital expenditure instead of using cash passes the burden on future generations who would benefit from long term assets. Using cash to finance capital expenditure will unduly penalize current taxpayers through increased taxes.

This means that responsible governments should cut their desire of financing ‘wants’ and also cutting operating costs. More specifically labour costs which cause enormous deficits.  The burden of financing public sector wages and benefits is growing rapidly and the growing unfunded pension liability is an additional burden. Governments, who legitimately increase their levels of debt for long term assets, should put in place policies which have caveats and sunset clauses. Debt should not exceed 20%-30% of GDP, and any tax increase used to pay for the debt should immediately be removed when the debt is fully paid for.

Instead of calling for expensive ‘referenda’ to survey the taxpayer, politicians should take a good look at their policies. They should sign an agreement with the public that they will not make promises that necessitate increasing the debt level. We should have a dialogue that clearly explains that the government cannot provide everything that the public wants without explaining the costs. Too often politicians pander to special interest groups who pass the burden of their desires to the taxpayer. Organizations who support better fiscal management with fewer taxes should also actively explain the public about the consequences of answering surveys which result in further government expenditure

As the levels of debt by governments and individuals become chronic, governments should lead by example and cut their debts. Politicians should also explain to the public that not all services should be provided by the government and stop politicizing privatization.  In the 21^st century there is virtually no service that cannot be put to tender and provided by the private sector or through managed competition.

Debt is not a four letter word that should be ostracized. The management of debt requires prudence, restraint, transparency, and accountability. It should not become a tool to finance  ‘wants’ and entitlements.

Marcel Latouche