Pride and Prejudice (and Depreciation)
It is a truth universally acknowledged that a City with a balanced budget must be doing just fine.
And since Winnipeg has so far produced 143 consecutive balanced budgets, it must be doing REALLY fine. [Like Mr. Darcy fine.]
Except we all know that it’s not doing fine. Every year, we have to cut things we used to be able to afford. Every year, more infrastructure is left to crumble.
With the budget planning cycle starting again on Friday, I would say now’s a good time to go on an educational journey together. [Bring your passport, Bridget. And pants.]
[I realize that’s not strictly a Pride & Prejudice reference. But it is from the very popular adaptation, Bridget Jones’ Diary.]
[Or should I say… Budget Jones’ Diary? Too late, I already did!]
The first thing we need to realize is that, despite all the attention that The BudgetTM gets every year, it’s really only one part of what needs to be considered to keep our city financially healthy.
[If the budget was a Bennet sister, she’d be Jane. Or maybe Elizabeth. Or actually, probably both: the Operating Bennet and the Capital Bennet!]
But in reality, the answers we’re looking for live in a whole other place, on the Balance Sheet (or the Statement of Financial Position in municipal accounting-speak) of our annual financial reports. This tells us what we own, and what we owe, basically a Net Worth Statement for the City of Winnipeg.
[I know, totally the Mary!]
But the Balance Sheet can give us a LOT of insight into where we’re headed financially. It’s why you hear investors looking for a “healthy balance sheet” on potential business investments.
And the first place we’re going to look is the Net Financial Position (NFP).
Here it is on page 29. So what is it?
It’s basically a type of solvency ratio, a measure of our ability to pay for stuff. It measures how many financial assets we have (cash, basically) compared to our liabilities (debt).
So when I say that our City is insolvent, it’s not just hyperbole. It’s right there in our financial statements: at the end of 2019, our liabilities exceeded our financial assets, the very definition of insolvency, by about $841.8 million. That’s right, almost negative $1 Billion.
Now, this is only mildly interesting by itself (of course negative is bad, and nearly $1 Billion in the red in itself seems like cause for panic), but what we’re actually interested in is how it has changed over time. So I put the last 10 years on a graph for us:
I’m not an accountant, but something tells me this is not headed for a happy ending…
We’ve already talked about the relationships between the 4 different categories of numbers on the Balance Sheet, so I won’t repeat myself. Suffice it to say, based on those relationships, the only possible cause of the downward slope of doom is either:
- we’ve been taking on debt to pay for infrastructure, OR
- we’ve been spending more cash on infrastructure than we received in net revenue.
Surprise! The answer is both!
So that tells us the how, but it still doesn’t tell us the why.
After all, we added over 100,000 new taxpayers (page 2-3) over this period, our second largest decade of growth ever, yet we still continued to get poorer despite balancing our budgets every year. What are we missing?
For that, we need to look at how money flows on the Balance Sheet, where the budgets fit in, and where there might be something we haven’t been paying attention to. That looks like this:
Hmmm, I think we found a leak…
So let’s talk about infrastructure replacement. Basically, the cost is made up of two components: depreciation and increase in replacement cost.
Depreciation is always included in the financial statements, and its effect is basically to force us to put aside a small portion of the purchase price of our infrastructure every year over the length of its lifespan.
On the other hand, any increase to the replacement cost of a piece of infrastructure between the time we buy it and the time we replace it is not included in the financial statements. Like, at all. That’s just the rules of accounting, they don’t require it. And that’s the root of our problem.
Because while this usually works pretty well in a business setting, it’s a disaster for cities.
Many business assets don’t last much longer than a few years anyways, so the price you’ll pay to replace that laptop or delivery van won’t be that different than the price you originally paid 5 or 6 years ago.
But for cities, the replacement cost of an asset we may have bought 30, 50 or 100 years ago, like roads, bridges and pipes, is most definitely VERY different than the original purchase price. For example, the Disraeli Bridge was originally built in 1960 for $5.5 million. In 2012, the cost to replace it was $195 million.
Even with $5 or 6 million set aside over 60 years through depreciation, we still needed almost $190 million more.
Multiply that kind of mistake by every piece of infrastructure we own, and you can see how we’d quickly start to get into trouble.
As of the end of 2019, we had a total of just under $12 Billion of infrastructure, tallying its original purchase cost, to which we have applied, over the years, just under $4.4 Billion in depreciation, for a net “book value” of about $7.6 Billion (pages 68- 69).
This is the number we use when calculating the depreciation to put aside for next year. Last year it was $266.6 million, or 3.8%, which works out to an average replacement cycle of about 26 years.
To put aside that kind of money over 26 years would mean depreciation of just over $1.3 Billion per year.
That’s an extra $1 Billion or so per year that we haven’t planned for, and that doesn’t even show up anywhere on our financial statements, or in our budgets. Until it’s time to spend it, that is. And that time will come.
And because that money isn’t there when we need it, say when a sewage treatment plant needs replacement, we will take it from our cash reserves, or we will borrow it. Or both.
And that, as we’ve seen, drags down our Net Financial Position. Again. And again. And again. Just like it has for at least the last decade.
Until eventually, we have no cash reserves left, and we’ve reached our borrowing limit. What happens then? Yeah, bankruptcy.
And last March we approved a 4-year budget that will spend $17 million of our Financial Stabilization Reserve, and borrow an extra $160 million.
And that was the plan before COVID hit.
I know. We may get to that bankruptcy sooner than we think…
Now, we could solve this on the income side by tripling our property taxes, but that’s obviously unrealistic.
We could also try solving this on the income side by bringing in more taxpayers. But we’ve had a decade of some of the biggest population growth we’ve ever had, and it hasn’t helped. In reality, the graph tells us it’s actually made things worse.
So that leaves the expense side. The more infrastructure we have, the higher the growth in replacement value, the bigger the leak.
We’ve already seen this table:
Each Winnipegger today is responsible for nearly 2.5 times more feet of pipe than Winnipeggers in the 1940s.
If we had 2.5x less infrastructure today, our $35 Billion replacement cost would only be $14 billion. And consequently, our leak would be a lot smaller.
So how do we reduce our infrastructure addiction? And what does this have to do with The BudgetTM?
Simply put, a lot of our spending choices determine how much infrastructure each person must use while going about their day. They can push us to use more, or enable us to use less.
When we “rationalize” pools, we force people to drive who used to walk. And even a few kilometers of 6-lane arterial roads is much more expensive than two pools people can walk to.
When we cut transit service, when we don’t clear snow from sidewalks, and when we choose not to build a network of protected bike lanes, we end up pushing more people to drive, which uses a lot more infrastructure than the alternatives of walking, biking and bussing.
When we neglect our urban forest, more rainwater ends up in our combined sewers, and our streets are no longer protected from the thermal stress provided by tree shade, accelerating the pace at which we need to replace both the streets and the sewers.
I could go on.
The numbers don’t lie. Simply having a balanced budget every year has not been enough to keep us solvent. It matters what we balance it with.
Granted, a lot of this is a product of City departments working, and making budget recommendations, in silos, completely oblivious to how their recommendations affect the big picture.
But seeing the big picture, that’s Council’s job. So why aren’t they doing it?
Look, I’m willing to accept the fact that I may be wrong here. But if so, I’d be interested in hearing Councillors Browaty, Mayes, Sharma, Eadie and Orlikow explain how the City became nearly $1 Billion poorer over their watch this past decade, despite some of the most robust growth we have ever seen, and despite balanced budgets every single year as required by law…
I’ll be waiting.
In the meantime, I’ve got my theory.
Love Actuarially, [Meh, Colin Firth was in it, and I just had to use it!]