Finance minister Mike de Jong recently issued a flurry of press releases touting the high credit rating of the BC government by various rating agencies. In one release he said: “The judgment of the rating agencies is an objective confirmation that by balancing our budget and keeping our debt affordable for British Columbians, our finances are on the right track.” Statements like these can mislead British Columbians about the actual state of BC’s finances, which may not be as rosy as the minister lets on.

When de Jong refers to BC’s budget being balanced, he is referring to the government’s operating budget. However, government debt in BC is growing and the source is hidden in the province’s capital budget, unnoticed by many taxpayers. If not carefully managed, this debt could pose fiscal challenges.

High levels of capital debt could saddle future operating budgets with increased interest payments and amortization expenses. This in turn could derail balanced budget plans and prompt spending cuts, tax hikes, or more borrowing.

While de Jong’s focus on the state of the operating budget is politically understandable, the province bases its financial reporting on a capital budgeting approach. That means when the government borrows to pay for capital spending (such as roads, schools, and hospitals), it typically records only the annual interest payments and amortization expense in the operating budget.

Capital budgeting has the important merit of spreading the cost of capital spending over many years. But it also creates a situation where taxpayers can overlook the accumulated debt when the government reports a balanced operating budget. Consider that this year the BC government expects a surplus of $184 million in its operating budget. Despite this surplus, provincial debt will grow by $1.9 billion due to a capital budget deficit.

The real bottom line for a government is its net debt (gross debt minus financial assets) and changes in net debt depend on both the operating budget and the capital budget. This year BC’s net debt will reach $41.1 billion (or 17.6 percent of GDP), up from $24.9 billion (12.2 per cent of GDP) in 2008/09.

A new study published by the Fraser Institute examines how increasing debt can affect the sustainability of BC’s finances. Fiscal sustainability measures the government’s financial health based on its ability to meet future debt obligations without major changes to tax and spending plans.

When government debt is large, over time the resulting high interest payments may force program cuts or tax hikes. The unpopularity of such actions often induces governments to finance the interest payments by borrowing even more. This can lead to an upward debt spiral until financial markets become unwilling to lend to the government.

The study focuses on BC’s fiscal policy from 2005 to 2017 (the last three years incorporate the projected fiscal plan announced in February’s 2014 budget).

After a period of operating budget surpluses, the BC government turned to operating budget deficits in 2009. More startling, however, is the persistently large capital budget deficits throughout the entire period, especially the increase in 2011 and the general use of debt to finance infrastructure spending after the recession of 2008/09.

The findings suggest that the sustainability of fiscal policy over the period from 2005 to 2017 is achievable, but barely. Achieving it depends partly on the government’s ability to reduce capital spending in 2016 and 2017.

Beyond 2017, the government will have to restrain program spending to generate not only balanced operating budgets but also some years of substantial surpluses in the operating budget. This may prove difficult. But spending restraint will be important especially if interest payments on the debt increase in coming years.

No one knows exactly how fiscal policy will unfold. But if de Jong fails to deliver on his budget commitments, British Columbians could see government debt spiral out of control.