Recognizing Cost of Capital just Good Government

Commentary, Crown Corporations, Frontier Centre, Uncategorized

Manitoba's Finance Minister Greg Selinger is entertaining the idea of having Crown corporations pay part of their profits into government coffers as dividends. Since the public puts money into these organizations, he suggests, it's legitimate to ask for a return on their investment.

The Minister's musings suggest there are glimmers of new thinking in the Doer government despite recent "old NDP" policy decisions that ended workfare and reversed the trend towards performance measurement in public schools.

Good public policy views the government as a steward of assets for the citizen and taxpayer. Holdings and investments should generate a minimum rate of return, just as they do in private markets. Capital has a value, whether it's invested in a company, bonds, or hard assets like land or a house. Even cash in the bank earns a return. If Sally Q. Public sells a $100,000 piece of land, at a minimum she can realize 5% on it — $5,000 a year — by placing the money in a risk-free term deposit. No one would expect her to put it in the bank for free.

Sophisticated governments realize this. New Zealand's Labour administration, for example, led the way in the 1980s by requiring an adequate return on all departmental and Crown corporation assets. This policy concentrated administrators' minds wonderfully. Departments sitting on vacant lots in city centres quickly sold them to avoid paying the capital charge involved with holding on to them. This not only generated revenue, but also usually freed the assets for more valued uses like development into taxpaying commercial or residential property.

Requiring a return on the capital invested in Crown corporations resolves a difficult public policy question: Is the government being a responsible manager of the taxpayer's resources? A multiplicity of studies from the OECD, IMF and World Bank has demonstrated that governments husband capital assets poorly. They show that state-owned enterprises frequently lose money or generate paltry profits that fail to cover their capital costs. The prospect of cutting losses and releasing resources for better uses has provided countries from Austria to Zambia a bulletproof reason to sell their under-performing state-owned enterprises.

Governments need to recognize there's no such thing as "free" capital. When they ignore that fact, they distort the marketplace and reduce the community's overall welfare. In effect, "free capital" gives the public sector a subsidy that competitors from the market sector cannot match. We have all heard the well-intentioned arguments that government ownership allows us to have lower cost services. In Manitoba, the favourites are "cheap" electric power and auto insurance.

It is more accurate to say "subsidized" low prices for power and insurance, since these enterprises don't have to pay income tax or yield a rate of return commensurate with the cost of capital in the marketplace. Imagine an entrepreneur with heavy political connections who moves to town. He's given free money to build a bakery and, to top it off; his business is exempted from paying income tax. Guess where the cheapest bagels in town are to be had?

Which brings us back to the issue of expecting Crown corporations to pay dividends. Requiring a minimum return on capital invested in all aspects of government operations and payment of the same taxes levied on normal enterprises would create a level, measurable playing field. If, in fact, a public operation can produce a more cost-effective product at prices that include all costs, including capital and taxes, then there is a clear case (ideological arguments aside) for keeping it in the public sector.

In a neutral framework, we would pay power and insurance prices that included all the true costs involved in bringing them to market. This would eliminate the illusion that public ownership "creates" lower prices. The cost of the products produced by these business organizations would rise without the subsidies of cheap capital and the income tax exemption. But, it would also effectively lower the tax burden on the entire community as these companies paid market rates for capital and their fair share of taxation.

Would unsubsidized prices necessarily be higher? Not necessarily if you removed the monopoly privilege that shelters these organizations from the competitive pressure to innovate and strive for efficiency. They might even fall. Simultaneously, the government would expand the tax base. If the returns on capital were not adequate, it would have a good reason to sell the assets, pay down debt, reduce debt-service payments and cut taxes.

Greg Selinger's thoughts about Crown corporations should receive serious consideration. They advance the concept of neutrality, a crucial paving stone on the road to good government.