Infrastructure Bonds

by Stubborn Mule on 17 August 2010 · 15 comments

With Australia’s Federal election looming, the opposition has today proudly announced a new policy to fund infrastructure without actually increasing Government debt! What are we to make of this?

It’s hard to determine the details from a media announcement, but based on the text posted by Peter Martin on his blog, it would seem that the idea is to provide tax incentives for entities other than the Federal Government to borrow to fund infrastructure:

Private infrastructure operators and State and Local Governments will be eligible to apply for the concessional treatment.

The way the scheme would seem to work is that eligible projects could issue bonds and investors would receive a tax rebate amounting to 10% of the interest on the bond. So, if you received a $100 interest payment and your earning put you in the top marginal tax bracket, you would pay $45 in tax. Under this scheme, you would only pay $35 in tax.

So, the cost to the Federal Government would simply be forgone tax revenue (and this would be capped at $150 million per annum) and the Opposition believes that the program could support up to $20 billion in infrastructure financing. Presumably, investors currently buying plasma TVs would rush to buy these bonds instead.

Seems like a neat trick, but I have a number of reservations about the scheme.

First, I have argued in the past that the near-hysterical concern about Government debt is overdone. For a start, Government debt in Australia is far lower than in other developed countries around the world. More importantly, the facile analogy that compares Government finance to that of a household budget does not stand up for one very important reason: unlike you or me, the Government is the monopoly issuer of Australian dollars. This changes the game and breaks the analogy utterly.

Second, the opposition’s policy would still involve raising significant amounts of debt, just not issued by the Federal Government. If that debt is all incurred instead by State Governments, should that really be a cause for celebration? After all, unlike the Commonwealth, State Governments do not control issuance of currency, so they really could go bankrupt and indeed, recent history has shown that many of the State Governments are loath to increase their debt levels too significantly for fear of having their credit rating downgraded. What if the borrowers are in the private sector? Well, that would be worse still! Back in March I updated my chart showing private and government sector debt. The debt level we should all be worried about in Australia is private sector debt, which is far higher than government sector debt.

History of Government and Private Sector Debt levels

Third, infrastructure bonds have form. Back in the 90s, the then Labor government introduced an infrastructure bond scheme which also featured tax incentives. Of course, it did not take long for clever investment bankers to work out how to surgically isolate the tax benefit so that wealthy individuals could take advantage of the concession without actually taking on any investment risk. In the end, the whole scheme was shut down, although some of the transactions that were done still survive today. I would expect exactly the same thing to happen with this policy. Any special tax treatment is always a red rag to the tax expert bull.

So, it may sound clever, but to me it does not seem to be sound policy.

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{ 14 comments… read them below or add one }

1 zebra August 17, 2010 at 5:56 pm

Re isolating tax deduction: I imagine it’s as simple as repoing the IB over a coupon date. Bond borrower receives coupon+tax deduction and then pays coupon (+spread) back to Bond lender and keeps tax deduction. It’s hard to see how this can be avoided. As to who would do this it could be a foreign owner of the bonds who can’t use the tax benefit.

The tax consultants must be dusting off all their old files from the 90s and can’t believe their luck.

2 Marco aka Cracticus August 17, 2010 at 9:41 pm

Stubborn,

Good post. The previous two blogs were quite beyond my technological illiteracy; this one, however, does make a lot more sense to my ears. :D

In principle, I believe a project should either be fully conducted by the government, or by the private sector. But this “mixed” ideas don’t quite make sense and they end up having all sorts of “unintended” consequences.

In particular, I tend to favor a private sector NBN, for many of the reasons given in the two previous blog.

The first “unintended” consequence I can imagine is that, in an environment where the Federal Govt (either Labor or Coalition) will be cutting government spending, chances to save will be reduced. So, where is the money needed to buy these bonds coming from? Leverage.

Who will be doing this leveraging? The usual suspects: upper middle-class and above. Who will be earning the interests on this leveraging? The usual suspects, as well: the banks.

That, to me, sounds like the Coalition has found yet another way to increase wealthfare spending.

By the way, in this limited sense, it’s a similar idea to the Abbott maternity leave scheme: as higher paid mothers will be paid more (because it’s not a social security benefit, but a work entitlement and, thus, proportional to their original pays), they will need government protection.

This way, employers and government will contribute to the pay, until the levy on employers is removed, when the government will be left to pay for this by itself. So, what is it that makes it different from a social security benefit, other that Mr. Abbott’s word, is a mystery to me.

3 JamesGlover August 18, 2010 at 7:15 am

An additional point: will the debt raised by IBs sit on the Govt’s balance sheet? I suspect that as with PPPs the answer is “no” and that this is a way for the Coalition to fulfill their promise to get the budget back in surplus more quickly while meeting election promises for infrastructure spending. Cynical?

4 Stubborn Mule August 18, 2010 at 7:51 am

Marco: like you, I think this policy would be fraught with unintended consequences.

James: as I understand it, none of the debt would be raised by the Federal Government. While it would be possible for the Government to guarantee the debt, I don’t think this is part of the plan. So there would be no liability for the Government and nothing on the balance sheet. The only role the Government would play is to provide tax incentives.

5 Andos August 18, 2010 at 10:51 am

It’s great to see someone acknowledging the fact that:

“unlike you or me, the Government is the monopoly issuer of Australian dollars.”

This significant fact, and its implications, never seems to make it into any mainstream articles about government debt. And it absolutely never comes into any political speeches about government debt.

6 Brendan August 21, 2010 at 2:26 am

“unlike you or me, the Government is the monopoly issuer of Australian dollars.”

So debt is okay, because they can print more money, slugging us all with an invisible tax, eroding our savings?

Somethings got to give, if it’s not the value of our currency; it will be out quality of life in retirement.

Mmme, thanks but no thanks.

7 Stubborn Mule August 21, 2010 at 4:16 am

Brendan: you may dislike fiat money systems and pine for the days of the gold standard, but this statement reflects the simple reality that Australia today does in fact have a fiat money system.

8 Brendan August 22, 2010 at 1:08 pm

Fair enough Mr Mule, fair enough.

This whole article appears to be about financing infrastructure investment and the oppositions aversion to debt of any kind.

Everyone accepts that infrastructure investment can result in good debt; be it in income producing assets or something that contributes to our long term to quality of life.

However, the current ALP governments fiscal performance has gotten a lot of peoples ‘backs up’. At a time like this, talk of monopoly power over currency makes people such as myself very, very nervous.

I concede that this bond scheme is designed to cash in on this fear.

Can this scheme be described as ‘off balance sheet financing’?

9 Stubborn Mule August 22, 2010 at 1:38 pm

Brendan: There’s no doubt that fear of Government debt has been whipped up quite successfully. I find it ironic that this is often pitched in contrast to households and businessses which have supposedly got their debt under control (this was the subject of the Chaser skit in my last post and Andrew Robb said the same thing today on Insiders). Yet, the numbers show the opposite: if anything is out of control, it is private sector debt!

As for the question about, “off balance sheet debt”, this policy would not fit that label. The term usually refers to debt which uses derivatives or some kind of special purpose vehicle so that borrowing doesn’t have to be treated as a standard liability on the borrower’s balance sheet (or anyone else’s), even though it’s really ultimately their borrowing. In this policy, their is a loan but it would be a corporation or State Government doing the borrowing and the debt would appear on this borrower’s balance sheet. So the debt would in fact be “on balance sheet”, just not on the Federal Government’s balance sheet.

10 Brendan August 22, 2010 at 6:29 pm

I don’t want to quibble over the definition of off balance sheet financing, as you seem to know what you are on about. But, you seem to acknowledge that this scheme does achieve the objective of shifting the liability off the Federal governments balance sheet.

I’m not saying it’s a good thing to sweep debt under someone else’s rug. The definition of off balance sheet financing is said in the same breath as Enron.

As for private sector debt. I can’t and won’t presume to speak for everyone else. I can only speak for myself.

I will say, that I have a very significant mortgage. Thankfully, the value of my home more than offsets this. I also have government funded HELP debt, which I’m grateful for. In addition to that, I admit to having a small credit card debt; which only helps the banks.

A lot of my borrowing is good, some of it great and some of it is crap.

This is all my prerogative.

Government on the other-hand is a fundamentally coercive institution, and so; I expect, hope and pray that they take a great deal of care.

Now, the previous Liberal government set a very interesting precedent. One that is in stark contrast to the ALP government that succeeded them. A government that has spent the last three years taking the fiscal piss out of us.

11 Stubborn Mule August 23, 2010 at 5:17 pm

Brendan: I certainly agree that there’s debt and there’s debt. Some can be good, some bad. However, I’m not sure I can agree that Governments are fundamentally coercive. There have been plenty of coercive Governments (nominally democratic ones included), but I don’t know that it’s an inevitable state of Government. Plenty of developed economies have Governments that can be misguided and inefficient, but I wouldn’t consider too many of them to be particularly coercive.

12 Brendan August 23, 2010 at 6:25 pm

This is largely a matter perspective. I concede that most people would agree with you.

Is government fundamentally coercive?

In any other western country, I would laugh and jokingly dare you not to pay your taxes.

In Australia, I laugh and jokingly dare you to not vote.

It’s a simple thing really. They force us to give them a mandate.

At the end of the day. If you don’t want to play ball, push come to shove; you are going to get manhandled and have your possessions stripped of you.

I’m not proposing that we change the arrangement. I like modern life just the way it is.

The fact that government spends more on me, than what I give them in return; is not lost on me. I’m grateful for all the wonderful services and protection that I receive.

I will however say this. That money, though it may not be entirely mine, or yours; was collected in our name, on our behalf! We have every right to demand fiscal accountability from government.

It would appear, as if the people have spoken …

13 Stubborn Mule August 23, 2010 at 6:44 pm

Brendan: Fair enough. In the sense that we trade off various rights in being a part of society and the government (including its apparatus of police, judiciary etc) enforces some of these trade-offs, then yes all governments are coercive. In this sense I would say that all societies are coercive, even down to a simple village without anything that you would consider elaborate enough to warrant the label “government”. I also agree that we rightly demand accountability in matters fiscal and indeed all areas in which the government acts. The challenge, of course, is that as with fiscal policy, not everyone in the society agrees as to what is or is not responsible when it comes to government policy.

14 Brendan August 23, 2010 at 6:57 pm

And that’s what’s so great about a hung parliament. In some ways, it’s the ultimate liberal victory (not absence of the big-L).

Whoever forms government won’t be in a position to railroad legislation through. They will have to negotiate with all sides and they will be more accountable than they have ever been.

For once, no single group will be in a position to inflict their grand design or ‘vision’ upon us.

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