‘Good’ debt, ‘bad’ debt: changes to accounting treatment

Budget Review 2017–18 Index

Daniel Weight and Liz Wakerly

Prior to the 2017–18 Budget, the Treasurer began to emphasise the importance of identifying the purpose for which Commonwealth debt was being raised, asserting that the majority of growth in Commonwealth debt was the result of a need to fund ‘recurrent,’ rather than ‘capital,’ expenditure.[1] In the 2017–18 Budget, the Government has sought to draw a distinction between this ‘bad’ debt (for recurrent spending) and ‘good’ debt (for capital spending). To better reflect those Government payments which contribute to recurrent expenditure, the Government has also begun to report the ‘net operating balance’ (which excludes capital spending) alongside the underlying cash balance.

Good debt, bad debt and the ‘Golden Rule’ of public finance

In Statement 4 of Budget Strategy and Outlook: Budget Paper No. 1: 2017–18, the Government has, for the first time, provided a distinction between recurrent spending (ongoing expenses that occur on a regular basis, such as pension payments) and capital spending (such as the purchase of buildings which can potentially provide a future stream of benefits).[2] The capital budget includes Government spending on physical assets, Commonwealth grants to others (primarily the states and territories) for capital purposes, and Government spending on financial assets (a loan or equity contribution to a third party).

Several economic commentators have advocated establishing separate capital and recurrent budgets as a means of highlighting the difference between the need to borrow to fund recurrent spending (‘bad’ debt) versus the desirability of borrowing to fund productive investment (‘good’ debt).[3] Such views are informed by the ‘Golden Rule’ of public finance, which states that, over the economic cycle, a government should only borrow to invest and not to fund current spending.[4] In other words, over the business cycle, the recurrent budget must balance.

Although the Government’s current fiscal strategy does not refer to the Golden Rule[5] in its assessment of the ‘adequacy of current budget practices and rules in promoting efficient and effective government, disciplined expenditure, long-term fiscal sustainability and budget transparency’, the 2014 National Commission of Audit examined the appropriateness of introducing such a rule in Australia.[6] According to a 2015 IMF report, increasing capital spending, financed by borrowing, would:

support aggregate demand ... employ resources released by the mining sector, catalyze private investment, boost productivity, take advantage of record-low borrowing rates, and maintain the government’s net worth’.[7]

Furthermore, the desirability of restraining recurrent spending while undertaking ‘a more sustained public investment effort’ was highlighted in the latest IMF Staff Country Report on Australia.[8]

The Commonwealth can currently borrow at very low interest rates.[9] Research shows that, for economies with clearly identified infrastructure needs and efficient public investment processes, and where there is economic slack (slow growth) and monetary accommodation (low interest rates), there is a strong case for increasing debt-financed public infrastructure investment. The evidence suggests that this is particularly effective in boosting demand and expanding productive capacity in the long run, without raising the debt‑to-GDP ratio.[10]

Some potential concerns

There are some important caveats and clarifications to the above-outlined benefits of increasing debt‑financed public infrastructure investment. For example:

  • under the Golden Rule, governments may be inclined to borrow unlimited amounts so long as it is classified as investment[11]
  • when debts become ‘too high’ (over 90 per cent of GDP), the effectiveness of further spending is reduced and growth can end up being reduced[12]
  • to ensure sound choices about new investment, clear objectives, co-ordination between federal and state governments, and sound economic analysis of projects is required to ensure that the benefits of an investment exceed the costs[13]
  • public spending on infrastructure may crowd out private investment, resulting in less total spending on infrastructure[14] and
  • investment in physical capital may be prioritised over investment in human capital, innovation and knowledge which are recognised as key drivers of economic growth but are usually funded from recurrent spending.[15]

Furthermore, recurrent spending on social security and welfare—notionally allocated by the Government as accounting for 45 per cent of the increased borrowing since 2007–08[16]—has an important role to play in the working of the overall economy, smoothing incomes during business cycle fluctuations. In other words, shifting resources from some types of recurrent spending to capital spending could have unanticipated consequences.[17]

Change in preferred headline budget balance measure

In the 2017–18 Budget, the Government also began to emphasise a different measure of the Commonwealth budget balance. Under the Charter of Budget Honesty Act 1998 the Government must prepare its budget forecasts according to established accounting standards, but it enjoys discretion about which specific measure to use as its headline measure of the budget balance.[18] In the 2017–18 Budget, the Government’s preferred cash measure of the budget balance—the underlying cash balance—is retained, but it has substituted the accrual ‘fiscal balance’ with the ‘net operating balance’ measure. The net operating balance excludes direct capital investment by the Commonwealth, focusing on recurrent expenditure.[19] It thus provides a clearer picture of whether recurrent expenditure is being funded by recurrent revenues or additional debt.

[1].         S Morrison (Treasurer), ‘Interview Alan Kohler, 'Talking finance' podcast’, transcript, 29 October 2016.

[2].         Australian Government, Budget strategy and outlook: budget paper no. 1: 2017–18. Statement 4 is typically a discursive piece focused on a topical economic issue. It is not clear whether the Government will continue to provide such analysis in future.

[3].         See, for example, R Holden, ‘Vital Signs: it’s time to borrow to build’, The Conversation, 15 July 2016; J Greber, ‘We need infrastructure not rate cuts: McKibbin’, The Australian Financial Review, 12 May 2016, p. 8;  and C Emerson, ‘Reforming budget still possible’, The Australian Financial Review, 12 April 2016, p. 38.

[4].         Australian Government, Towards responsible government: appendix to the report of the National Commission of Audit: volume 1, February 2014, p. 101.

[5].         Budget strategy and outlook: budget paper no. 1: 2017–18, op. cit., Box 1, p. 3-7.

[6].         There is international precedent for such a rule. See, for example, V Lledo, S Yoon, X Fang, S Mbaye and Y Kim, Fiscal rules at a glance, International Monetary Fund (IMF), March 2017.

[7].         IMF, Australia: concluding statement of the 2015 Article IV Mission, 24 June 2015.

[8].         IMF, Australia: 2016 Article IV Consultation – press release; staff report; staff statement; and statement by the Executive Director for Australia, IMF Country Report, no. 17/42, February 2017, p. 21.

[9].         See the yield curve assumptions in Budget strategy and outlook: budget paper no. 1: 2017–18, op. cit., p. 7-14.

[10].      A Abiad, D Furceri and P Topalova, The macroeconomic effects of public investment: evidence from advanced economies, Working paper, WP/15/95, IMF, May 2015. The OECD also supports reallocating spending towards infrastructure, education and innovative activities, since these are likely to raise income in the long run (see, for example, Organisation for Economic Cooperation and Development (OECD), ‘Chapter 2: Using the fiscal levers to escape the low-growth trap’, OECD Economic Outlook, special chapter, November 2016.

[11].      Towards responsible government: appendix to the report of the National Commission of Audit: volume 1, op. cit. Other problems can also arise: in the UK, there was speculation that the then Chancellor manipulated the rules (in 2005) to permit further borrowing.

[12].      F Fall and J-M Fournier, ‘Macroeconomic uncertainties, prudent debt targets and fiscal rules’, OECD Economics Department Working Paper No. 1230, 29 June 2015.

[13].      OECD, Economic surveys: Australia 2014: assessment and recommendations, 16 December 2014.

[14].      F Carmignani, ‘Highlighting “good and bad” debt will make it harder to fund social programs’, The Conversation, 4 May 2017.

[15].      P Romer, ‘The origins of endogenous growth’, The Journal of Economic Perspectives, 8(1), Winter 1994, pp. 3–22.

[16].      Commonwealth of Australia, ‘Budget 2017–18: Ensuring that the Government lives within its means’, 2017.

[17].      See, for example, OECD, OECD economic surveys: Australia 2017, 2 March 2017, p. 50.

[18].      Charter of Budget Honesty Act 1998 (Cth), Schedule 1.

[19].      Budget strategy and outlook: budget paper no. 1: 2017–18, op. cit., p. 10-35.


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