Bill Hulet Editor

Here's the thing. A lot of important local issues are really complex. And to understand them we need more than "sound bites" and knee-jerk ideology. The Guelph Back-Grounder is a place where people can read the background information that explains why things are the way they are, and, the complex issues that people have to negotiate if they want to make Guelph a better city. No anger, just the facts.


Saturday, November 4, 2017

Guelph Municipal Capital Investment

This post is really a case of "fools rush in", because I am writing about a very complex issue that I really know almost nothing about. But if I want to put a positive spin on this fact, I could say that in this case I'm starting from the same place as almost all voters. Let's just see if a guy with just a general education can wade through a mountain of information and find the most important points for voters to understand---. 

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The first thing to get a handle on is the scale of Guelph's capital budget. In the 2016 budget, the total revenue came to $483.7 million. Of that, $87.6 million was spent on capital investments, as opposed to operating costs, which came to $396.1 million. This means that 18% of the budget went to capital investments. The complexity for an outsider like me, is that when you read the budget document some confusing issues have to be remembered. For example, it is possible to present a budget in several different ways. You can split the money up in terms of which department uses the money (transit, versus water, versus police, etc.) Or, according to whether something is an operating cost (paying the wages of the water workers) or a capital investment (building a new water line) or a maintenance cost for a capital investment (repairing a water main that is worn out.) Also, there are a lot of different sources of revenue, such as taxes, operating fees, and, transfers from provincial and federal governments. Or, if something is a capital cost, the city can borrow the money---in which case you can record the money either as "debt" (what the city owes in principle), or as "interest" (the amount of money the city is paying just to pay for the borrowed money), or, as "interest plus principle" (the amount of money the city pays to both pay for borrowing money plus the actual amount of the borrowed money that is being paid off.)

To be totally honest, as a fairly well-educated generalist I find it very hard to understand all these distinctions. I simply do not expect the general citizenry to understand all of this. Nor do I expect a politician to understand it either. We simply have to accept the word of our paid staff because they have had the professional training and time to work through all this stuff. It's just the same thing as when I go see my doctor about an ache in my shoulder---if he says it's arthritis, that's pretty much what I have to accept.

Having said that, here's a table from the city that describes what staff say about the actual and projected costs of debt servicing for the city.


From the city of Guelph Website,
"Appendix 6: 2015 – 2017 Debt Report and Debt"

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There are even more complexities that people need to remember about capital debt. As I've mentioned before, it really doesn't do any good to just put a simple number in front of people and say that the city spent "X million dollars" on capital stuff last year, because unless you understand the context, it means nothing. That's why I try to express everything as a percentage when possible. In the above chart the cost of debt servicing is expressed in terms of percentage of net revenue. But it's also important to realize that there are two variables in this that can confuse people too.

First, you can lower the debt charges as a percent by either paying off the actual debt or by increasing the revenue. Think of this hypothetical example. If my business borrows some money in two equal loans that together cost me 10% of net revenue. I can cut that 10% in half, to only 5%, by paying off one of the loans. I can also cut the percentage in half, however, by using the money I borrowed to double my net revenue. (Let's say it both increases my sales and increases efficiency at the same time.)  This is a very important issue for Guelph, because it happens to be the one of the fastest growing cities in Canada. This means Guelph could cut the percentage of city costs due to debt servicing without paying off a penny of the principle---simply because the tax base increases.

Secondly, the percentage you pay in servicing debt can change as the interest rate increases or decreases over time. Sometimes existing debt needs to have the interest rate changed, and, sometimes you simply cannot avoid borrowing money---especially in a fast growing city where things like roads, waterlines, sewers, transit, simply have to be expanded because of increased demand. In actual fact, because the cost of borrowing money is so cheap now, this is actually a tremendously good time for the city to borrow money for capital investment.  See the following chart of the Canadian prime rate from a banking website (click on the image to get a easier to read image):

See that spike in the 1980s? Lots of people lost their homes then.

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I often hear people complaining about Council "borrowing money" to run the city. I also hear people retort that "it's against the law for the city to borrow money". Well, like a lot of things, there's a little truth and a fair amount of confusion in both statements. First of all, municipalities cannot run up a deficit for operating costs (like the province and federal government routinely do.)

Restriction
(2.1) A municipality may issue a debenture or other financial instrument for long-term borrowing only to provide financing for a capital work.  2009, c. 18, Sched. 18, s. 7 (1).
Term restriction
(3) The term of a debt of a municipality or any debenture or other financial instrument for long-term borrowing issued for it shall not extend beyond the lifetime of the capital work for which the debt was incurred and shall not exceed 40 years.  2006, c. 32, Sched. A, s. 176; 2009, c. 18, Sched. 18, s. 7 (2).
Ontario Municipal Act, 2001, Part XIII, "Debt and Investment", "Restrictions"

To understand this distinction, consider personal household debt. I'm a pretty tight-fisted guy and don't believe I have ever not paid off my credit card bill before I started getting charged interest. (In fact, I only stopped paying for everything with cash once I started having problems because I had no credit history at all.) But I have borrowed lots of money---to buy my house, to finance the boiler for my heating system, and so on. The difference is that when you borrow money to buy a house, this is "capital investment", whereas when you use your credit card, you are running a deficit on your operating costs. In effect, Ontario law allows the city to borrow for a mortgage but doesn't allow the city to run up credit card debt. (Actually, it allows the city to borrow against it's future tax revenue to be able to pay it's bills on a very short term---monthly---basis. But this is very tightly controlled.)

So yes, the city does borrow money, but only for capital investment. And yes again, the city is forbidden by law from running up a deficit, but only for operating costs. 

Moreover, the province has set a limit for how much of a city's budget can be devoted to servicing the debt on capital investments. As a general rule, most cities are only allowed to spend 25% of the money they raise through taxes on paying off incurred debt.  This is called the "Annual Repayment Limit" (ARL). In actual fact, the city of Guelph policy is that they will not go beyond an ARL of 10%, not the 25% set by the province. 

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One more thing that the Guelph citizenry should understand is that there are more than one type of "deficit". The city can borrow money to pay for stuff and run up a fiscal deficit. Or, it can "kick the can down the road", not borrow the money, and, let future generations pay for fixing stuff.

I bought my house off an absentee landlord who used to rent it out to students. When I had it inspected prior to purchase, I asked the guy I'd hired to explain why there was a line of white discolouration in the bricks a couple feet below the roof overhang. He told me that what had happened was the previous owner had let the roof go to the point where water was seeping into the walls, migrating to the outside, and, evaporating into the air. In doing so, it pulled out the lime in the mortar and that was what was discolouring the red bricks. He also pointed out that if I looked carefully there was the odd bump in the wall where a brick had been inserted length-ways into the wall. He said that the water had been in the wall for so long that the original iron clamps that held the two courses of bricks together had rusted out, and a bricklayer had been hired to painstakingly tuckpoint the rotten mortar and insert bricks at 90 degrees to the others to hold the wall together. In effect, the previous owner had let her roof go to the point that it significantly damaged the walls of the house---to the point where she had had to not only put a new roof on, but also pay a mason A LOT OF MONEY to repair the damage caused by the leaky roof.

The same sort of principle happens with public institutions. Politicians get elected that say that they can cut taxes by "eliminating the gravy train" and "cutting waste", but generally all they really do is defer necessary capital investments. Sadly, kicking the can down the road has become a key electoral strategy in our society.

It's important to understand this point, because a huge part of what it means to be a modern, civilized human being depends on the infrastructure in our cities. The roads, transit, library, hospitals, schools, etc, are not only what allow us to function as a community, they are also crucial to our economy and advancement as a civilization. Moreover, it turns out that the lion's share of this infrastructure comes from the level of government with the most limited means for paying for it.


From "The Canadian Infrastructure Report Card: 2016"
That's right, 57% of the built support for modern civilization comes from 18% of your city taxes. 

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By this point some readers have no doubt been asking themselves, "Just how much money does the city of Guelph owe? and what did Council spend this borrowed money on?" Thanks to the increased openness of our local government, it's easy to see, both in absolute terms:

From the City of Guelph Website,
"2015 – 2017 Debt Report and Debt Continuity Schedule


and, as a percentage of the budget:

"2015-2017 Debt Report and Debt Continuity Schedule"

The provincial government limits the amount of debt a community takes on according to a complex formula that is outlined in the Ontario Municipal Act as "O. Reg. 403/02: DEBT AND FINANCIAL OBLIGATION LIMITS". I couldn't find out what the province says is the absolute maximum debt that the city can take on under it's laws, but the Guelph policy statement on indebtedness says that the city has set it's own maximum limit at 55% of the yearly revenue (the red line in the above graph.)

Of course, $124 million dollars (in 2014) is a lot of money. But with a total city budget of $483.7 million (in 2016), that would only come out to 26% of the yearly revenue. (Please note the discrepancy with the chart. It lists the debt as percentage of revenue in 2014 as a little under 40%. I can only assume that the difference between this percentage and the one I just calculated is because of the growth in city revenues---both from increased taxation rates and also because of the increase in the number of people being taxed. Guelph is one of the fastest growing cities in Canada, and, as I mentioned before, this has an impact on percentage of debt to revenue.) 

Now put this into a context. I have mentioned before that it is not a good idea to make analogies between government and business or personal finance. But in this case I think it might be useful to consider the amount of debt that individuals and businesses routinely take on. My own personal economics guru, E. F. Schumacher, suggested that it is not a good idea to buy a house that costs more than twice your annual income. He also said that no business should purchase tools that cost more than twice the cost of the yearly salary of the person who uses them. Many people nowadays would find these "rules of thumb" far too conservative. But if we followed Schumacher's suggestion, the city of Guelph would be allowed a debt load of 200% instead of 55%, which would come out to a potential debt of $967.4 million---or just a shade below one billion dollars!

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Now I am not suggesting that Guelph take on a debt load of a billion dollars. It is really not a good idea to think of the city budget as either a business or as a household---it is substantially different. But I do think that it is important to understand what the debt load of the city really is as compared to many other sectors of society. It might just be that 55% is a either too low or too high---I just don't know. I do think that is something that, like me, very few people have an informed opinion about. But unfortunately, this doesn't stop some people from making very strong statements on the subject.

Please note, I haven't written a word about the levy fees that the city has introduced to deal specifically with the backlog of capital investment that many people in the city believe it needs to get working on. That's more of a topical story, and if you are interested in learning about the details of that issue, I'd suggest you follow Adam Donaldson at Guelph Politico. But if you don't know the back-ground that I've tried to outline above, it is very hard to understand the importance of the discussions between Council and staff.

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Thought you might get through this story without seeing any blue type?  No such luck!

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