GOVERNMENT BUDGETS, ‘DEFICITS’ AND ‘GOOD’ AND ‘BAD’ INVESTMENTS

‘The government budget deficit’ is a phrase that has become embedded in our mind, as a ‘bad’ thing. You can’t spend more than you earn.  But we have a completely illogical way of looking at government spending.  some government spending is ‘good’ and some is ‘bad’.  And the stated ‘deficit’ which results from the total is a figment of someone’s imagination, designed to communicate a perception, but not the truth.  Let me explain, in non-economic language!

‘Good’ and ‘Bad’ Investments

Any government in any country receives money (income) and spends money (expenditure). The difference is either a ‘surplus’ (income is greater than expenditure) or a ‘deficit’ (vice versa).

Sounds simple. Ah, but government ‘expenditure’ is not all the same.  For instance, for a given expenditure (say $10m), would you prefer the government built a new public asset (such as an extension of public transport, a school, a hospital), or would you prefer the government provided services (such as more police, border security, legal assistance)?

I know it’s not that simple, but here’s the principle: assets last a long period but services disappear as soon as they are provided.  So, at the end of a year – a budget period – we still have the asset, but we have to spend the same amount again each year to provide the same services.  Yet the ‘budget’ treats these items as equivalent, even though one is much more valuable than the other.

Of course, governments need to spend on lots of different types of activities, but the more you can spend on investing for the future (‘good’ investment), creating future benefits and not just current ones, the more chance the society has to improve itself. Should we spend money on preventative medicine programs, so people don’t get sick so much, or on hospital services to cater for them as they become sick?

And vice versa for ‘bad’ investments. Imagine if we didn’t spend on defence, police, border security, all of which have an ephemeral short term value and could instead spend that money on schools, hospitals, universities.

So governments make choices between ‘good’ and ‘bad’ investments on our behalf, but don’t distinguish between them when discussing the ‘budget deficit’.

Government Budget ‘Deficits’

The second issue that causes much of economic and political discussion to be useless is because of the calculation of the ‘budget’. What actually goes into, or is reported as, government income and expenditure and the resulting bottom line ‘deficit’?  (It is possible for governments to have ‘surpluses’.  The Howard government ran a series of surpluses that reduced Australian government debt to virtually zero, enabling subsequent governments to incur deficits and get Australia through the GFC.)

Calculating the budget has many issues. Different choices on each issue lead to different reported ‘deficits’.  First, some government income and spending is counted and some isn’t!  If governments can create autonomous bodies (eg NBN, CSIRO, Australia Post, joint ventures), the spending (and income) of those organisations is not counted in the reported ‘deficit’.  Only the contribution – if any – which the government makes to those organisations is included.

Second, governments count some expenditure on a ‘cash’ basis (record it when it is spent) and some on an ‘accrual’ basis (record at the times the money is used).  That’s why public officials often rush to spend their own department budget within the budget year because, if they don’t spend it, any surplus gets taken away!  On the other hand, a government may wish to present a better picture for this budget year, so it defers spending announced expenditure till the following financial year (eg delaying the cash payments from June to July will do it), even though the benefits may well have already started to be received.

Third, the budget is extremely complex, so manipulation of what is included and what isn’t and where it is shown is pretty easy, especially in these days where media have less time to investigate difficult or long-term issues.  That’s why the government often makes (bad outcome) announcements on Friday nights, holiday periods, or at year end.  People and the media are focussed on other areas, so government announcements are often missed at those times, or cursorily reported.

Fourth, the ‘deficit’ is often announced now as a single figure, not just for the current year or the next year, but for some arbitrary period eg “The budget deficit will be $25 billion for the next four years.”   Sounds clear but let’s think about this.  What we concentrate on is ‘$25 billion’.  What we don’t concentrate on is ‘How does each year contribute to that?’  The answer is often that the government has rigged the figures, either by front-ending the income or back-ending the expenditure to give a better picture than might be shown by the true current year’s ‘deficit’.

And there are many other ways to manipulate the reported ‘deficit’. So much so that’deficit’ really has limited real meaning, except perhaps for the trend line – which way are the figures going over time? (And in Australia, unfortunately, they are all headed in the wrong way, regardless of which definition or set of figures you are given and which government is in power.)

So what does all this mean?

It means that the system provides little idea about the amounts of ‘good’ or ‘bad’ spending, or the true deficit, because governments mix up spending on items which have completely different value to the community. The system counts some expenditure but not others and arbitrarily adds years together for reporting.  Coupling that with deliberate manipulation by (all) government of how and when they report deficits and reduction in the power of mainstream media to investigate the complexities, we are almost bound to come to the wrong conclusions about the nature and importance of the size of government and the deficit.

What should we do?

Be aware, when government spending is being proposed or discussed: is this ‘good’ spending (ie expected to have long term benefits for the society) or ‘bad’ spending (ie expected to be completed within the year for services which will have to be repeated again next year)?  This is doable.  This changes the way you read and think?

Develop a new system of government reporting which classifies spending differently, so we can distinguish more easily between these types. This is very difficult, but possible, but not by you!

Demand that governments are more honest in their reporting. Kick governments out (whatever their political persuasion) if they are found to deliberately produce misleading information.  Unfortunately, I think this is almost impossible…but we can try!

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6 thoughts on “GOVERNMENT BUDGETS, ‘DEFICITS’ AND ‘GOOD’ AND ‘BAD’ INVESTMENTS

  1. So where does the govt account for ongoing (bad) expenditure to cover the cost of perks that politicians, but not ordinary people, get after they cease working in their job as an elected MHR or senator?
    Periodically the extent and cost (for an individual leaving parliament) of such ‘entitlements’ gets published in the media. I’m always astounded by the cost which, in total for all past pollies, must be enormous. Voters will never see these excesses addressed because, no matter who they vote for, pollies will never agree in sufficient numbers that their own ‘entitlements’ are excessive and vote to bring them more into line with what ordinary working people get when they leave their jobs.
    If the govt attempts to bring superannuation into its mix of proposed tax reforms, I’ll be very interested to see whether the changes will have the same impact on politicians as other workers/retirees.

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  2. Thanks for the comment David. This is a classic example of a service with no future benefit. However it should be accounted for as an (accrual) expenditure at the time of service (using actuarial provisions to estimate future costs), but it is probably accounted for as a cash cost in the year it is incurred.

    Australian politicians have in fact reduced their entitlements to some extent in the last 10 years and new pollies get much less than those who were in before. Eventually, if enough pressure – and light – is brought to bear on this element, it will change. But right now, there are much bigger fish for the government to fry.

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  3. Your comments beg the question as to why governments do not follow more conventional accounting procedures of separating capex from opex, and include only asset depreciation as the opex in the p&l to determine whether the budget is in surplus or deficit.
    And a second comment (do I have too much time on my hands?) is that nothing annoys me more than a government (particularly those facing near certain defeat) announcing some initiative that does not have a material impact on the budget until well beyond the current electoral cycle, thereby locking a future government into either capex or opex.

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  4. Good vs Bad:
    Yes, it’s absolutely true that there’s good and there’s bad expenditure. However, this is a very subjective area, and it would probably be inappropriate for the Budget Papers to comment on this. Instead they focus on the aggregate position. It’s up to analysts, journalists, experts and the public to determine whether this is good expenditure or bad expenditure. Ultimately, voters give their take on what they thought of the quality of expenditure through who they vote for.

    Headline figures:
    The methodology underpinning the headline budget figures is well established, and in line with international accounting standards.
    The numbers are by no means meaningless. They give an indication of the actual, and estimated, position of the budget. This is critical information for government’s to underpin their current and future decision making.
    Budgets are prepared for the current year, and the forward estimates (3 years) and projections (2 years). The quoted headline figure is often the biggest number. It typically includes all of the forward estimates. This doesn’t mean it’s unreasonable. The issue is about how the information is presented. In general, so long as you’re consistently comparing the same figures for consistent time frames the numbers used are fine. Deficits/surpluses for individual years are available and can be quoted. Not everyone wants to know the position for every individual year, but if they do want to know this, the information is available to them.

    Cash vs Accrual:
    The Commonwealth Government Budget (and I believe State) papers include both cash and accrual figures.

    Australian politicians pay:
    The base salary of an Australian politicians in 2014 was around 195,000. These are individuals that deal with extremely important issues and have very stressful jobs. They work 7 days a week for the most part, and much more than 8 hour days, every day. They could all earn substantially more, for substantially less effort if they pursued a career in the private sector. If anything, I think they are vastly underpaid.
    http://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/rp/rp1415/ParlBaseSal2014

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  5. Wow! this blog certainly generated some interest! Thanks so much for the detailed responses and sorry for the slow response. I have been otherwise occupied this week unfortunately.

    On your comments, Mike, I wouldn’t expect the government to comment on ‘good’ or ‘bad’ investments, but I think this is a way for us (all) to think about expenditure. The problem with the way journalists and analysts look at it is that they get mired in the detail, not the bigger picture. So they focus on whether buying a submarine from the Japanese, the French or the Germans is better, when the real question is, ‘What future benefit do we really get from buying a submarine of any sort in the first place?’.

    Regarding the figures which the government releases, while I agree there is a ‘methodology’ and a ‘standard approach’, the reality is that governments and oppositions – and then journalists and analysts – pick a number often without saying what period it refers to. the public picks the figure as ‘fact’. The figure has in fact been picked to give a good or bad impression, depending on the viewpoint of the promulgator and this then anchors the debate, often in the wrong place. When the good or bad effects of a policy or investment are hidden in either the front or end of the period, the choice of the period of analysis has a huge impact on the perception which the public – even an informed public – will get about the issue.

    And if you complicate this with cash or accrual accounting, which most people don’t even know exists, the errors are compounded, so that the debate can be totally misled or misleading. The introduction of accrual accounting was supposed to overcome this problem (large businesses don’t have a choice and must use accrual accounting), but it seems the government likes to use cash accounting, which is often a very misleading indicator of the benefits or costs eg the granting of $3bn cash by the Federal government to the Vic Liberal government for East West Link which they could show as income when the road hadn’t even been started!

    You raise the issue of parliamentarian’s salaries. But I don’t think I raised this as an issue at all. All I argue for is good decisionmaking, based on expectations about real benefits to be gained, particularly if those benefits are longer term benefits and not just for the short term.

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    • Graham, and Mike, I raised the isse of politicians salaries and ongoing benefits post their time as an elected MHR or senator. Graham clarified the current status in his response. Apparently benefits have been pruned back. Mike, I’m all for paying them much more while they are in the job to reflect the time commitment and responsibility, as would happen in private enterprise. What I object to is the ongoing recurring (bad) expenditure to pay benefits that ordinary people don’t get once they cease their employment as a politician.

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