Capital Budgeting and Fiscal Sustainability in British Columbia

The opening sentence of British Columbia’s Budget and Fiscal Plan 2014/15–2016/17 states: “Budget 2014 affirms government’s ability to balance its budget on an ongoing basis.” That statement refers to the operating budget. However, the province’s financial reporting is based on a capital budgeting approach, meaning when the government borrows to pay for capital expenditures it records only the annual cost of interest and amortization in the operating budget. As a result, taxpayers can overlook the accumulated debt when the government reports a balanced operating budget. In 2014/15, the BC government expects a surplus of $384 million in its operating budget ($184 million after accounting for the forecast allowance). Despite this surplus, provincial debt will grow by $1.9 billion.

The real bottom line for a government is public net debt and changes in this figure depend on both the operating budget’s deficit and the capital budget’s deficit. Given the recent increase in British Columbia’s public net debt from 12.2% of GDP in 2008/09 to 17.3% in 2012/13, this paper examines whether BC’s fiscal policy is on a sustainable path.

Fiscal sustainability measures the affordability of the government’s program spending, given the cost of servicing public debt. When public debt is large, over time the resulting high interest payments may force government to cut programs or hike taxes, or to finance the interest payments by borrowing even more. This leads to an upward debt spiral until financial markets become unwilling to lend to the government.

The paper tracks BC’s annual surpluses or deficits of the both operating budget and the capital budget over the period from 2005 to 2017 and uses two indicators of fiscal sustainability. The first indicator measures whether the size of public net debt in 2014 surpasses the level it would have attained had the government rolled over its debt each year since 2005. By this measure, fiscal policy has been unsustainable. Extending the period to the end of Budget 2014’s forecast horizon, 2017, the projected reduction in capital spending places fiscal policy at the cusp of sustainability. A second indicator, based on the size of the primary surpluses that are required to stabilize the debt-to-GDP ratio, passes the sustainability test.

On the whole, the prudent debt management exhibited from 2005 to 2008, together with the government’s commitment to reducing capital spending in Budget 2014, suggest that sustainable fiscal policy from 2005 to 2017 is achievable, but barely. Beyond 2017, sustainability will require restraint in program spending to generate not only balanced operating budgets, but also some years of substantial surpluses in the operating budget.