Luca Pacioli – the Father of double-entry accounting – was onto something when he contributed his wisdom in the 15th century to create what we know today.  Out of his principles, the basic accounting equation was born:  assets = liabilities + equity.

Assets represent the resources owned by a business.  Liabilities represent the financial obligations owed to others.  Equity represents the owner’s or shareholders’ interest in the business such as accumulated historical earnings of the business net of owner distributions plus amounts received for issuance of stock.  The accounting equation ensures that every financial transaction maintains balance in an organization’s books.

For example, if a business acquires an asset, it must be financed either by increasing liabilities (e.g., taking a loan) or equity (using retained earnings and / or issuing shares). Governments must use other assets (perhaps by selling those assets or converting such assets to cash), fund out of current net revenues or issue debt since there is no such thing as equity in the traditional sense with governments.

Centuries later, generally accepted accounting principles (“GAAP”) were “born”. Each country has slightly different principles and reporting requirements that encompass GAAP but for the most part, GAAP is GAAP around the world.  In other words, accounting principles have not changed much over the centuries since the foundational accounting equation has not changed.  It’s a core and foundational principle.

However, accounting principles can be malleable and “flexible”.  One of the most common manipulations of accounting is the classification of assets versus expenses.  The general rule of thumb is if an economic outlay has a lingering benefit – usually longer than one reporting period which is commonly a year – then such an outlay is likely an asset / capital outlay.  Such assets are then usually amortized over their useful life with the annual amount being expensed in the current year.  Some assets, like land, never depreciate in value and therefore are not amortized.

Accordingly, there is often gamesmanship with capital vs expense since if it is capital then the income statement is not as adversely affected.  When preparing budgets for organizations, a budget for revenues and expenses is always a good starting point to gauge expected performance for future years.  If expenses exceed revenues, that is usually not a good thing since ultimately the resulting loss / deficit will need to be financed by borrowings or equity.  In a government context, it means borrowings.

But what if the budgeted income statement is manipulated to reduce expenses and instead characterize such outlays as assets?  Well, that means the budgeted income statement appears better than the actual since the expenses are reduced.  While GAAP does provide general guidance on what capital amounts are versus expenditures, there is a lot of flexibility in the determination of such.

Given this background, when the Liberal leadership “appointed one”, Mark Carney announced a proposed new approach to government budgeting, my ears perked up.  This is what he announced on his website:

“…a government led by Mark Carney will separate the federal government’s operating and capital budgets, and make major changes to each. It will balance the federal operating budget over the next three years, creating room for personal tax cuts so that Canadians can keep more of their hard-earned money.”

While the statement lacks further details, one can easily see the trick being attempted here.  Mr. Carney and his cohorts will attempt to classify otherwise expense spending (which would increase the government deficit) into capital items so as to remove such spending from the “operational” deficit calculation.  What counts as ‘capital’? Good question.  Without details, it’s a blank cheque to reclassify spending—say, public sector wages, pet projects or “green energy” subsidies – as assets / “investments”, sparing the operational budget. The result? A rosy deficit picture that hides borrowing reality.

In an excellent article in the National Post on this topic, the author reminds readers that the Alberta Provincial government, led by then disastrous Premier Allison Redford, attempted this kind of budgeting exercise in 2013 and got thoroughly and rightfully roasted for this lame attempt to make the numbers look better.

There are other examples in recent history of this kind of political trick.  The UK Chancellor (and later PM), Gordon Brown deployed this trick with his version of the “Golden Rule” from 1997 to 2009 hiding massive overspending and debt accumulation by keeping such amounts away from the “operational budget”.  The same occurred in Greece before the 2008 financial crisis. History shows that when politicians use this approach, it often leads to debt spiralling out of control.

So, what about Mr. Carney’s claims that such an approach will lead to personal tax cuts?  Well, keep dreaming Mr. Carney.  Any Canadian who falls for this promise should do themselves a favour and take a basic accounting course.  Again, if you move expenditures off the budget into a “capital budget”, that does not reduce cash outlays.  For governments, it means piling up debt.

And if the spending gets too out of control (like it has in Canada), it leads to inflation, a stealth tax that slams the poor hardest. Governments can only pay for spending increases by increasing taxes and / or significantly reducing expenditures – operational and capital.  Reduced personal taxes?  I’ll believe that when Luca Pacioli comes back from the dead and develops a new accounting equation.

The famous US economist, William A. Niskanen, stated in his 1971 book, Bureaucracy and Representative Government, the following:

“The separation of current and capital budgets permits the executive and legislative branches to present a partial picture of fiscal policy that conceals the aggregate growth of public expenditure”.

Niskanen’s warning from over 50 years ago rings truer than ever given Mr. Carney’s proposal. By separating budgets, governments aren’t balancing finances—they’re hiding spending in plain sight.

The bastardization of Luca Pacioli’s basic principles is usually ridiculous and debatable. With Mr. Carney’s proposals, they are simply nutty with a long history of others trying this trick.

Canadians need to reject this kind of manipulation.  It certainly won’t help them pay less tax.