State debt through an accounting lens

 

A narrative form of a presentation given to Economic Society of Australia (Tasmania) Tasmanian Economic Forum 2026 on 21^st August 2026 titled  State Debt: Blessing or Curse?

Good morning, and thank you for the invitation. I want to offer a different way of understanding government debt — one that begins not with slogans about discipline or burdening future generations, but with the actual accounting structure of the Commonwealth’s balance sheet. Once you see that structure clearly, Tasmania’s fiscal challenges look very different from how they are usually portrayed. What appears to be a behavioural problem — “spend less” — is, in large part, a structural one.

The only place where you can see the Commonwealth’s full balance sheet is in the Consolidated Financial Statements, released each December. The Budget papers focus almost entirely on the General Government Sector. They provide only partial information about the Public Non‑Financial Corporations (PNFCs) and Public Financial Corporations (PFCs), and they do not consolidate the whole Commonwealth. The consolidated statements do. And they reveal features of the Commonwealth’s liability structure that simply do not exist at the State level.

Those differences matter. They shape the fiscal capacity of each level of government. They determine what kinds of liabilities each can issue, how those liabilities behave, and how much refinancing risk each must carry. If we ignore those differences, we misdiagnose Tasmania’s problem as one of discipline rather than structure.

At June 2025, the Commonwealth’s consolidated liabilities arising from deficit spending — which incidentally comprise most of the liabilities on the Commonwealth’s balance sheet — totalled $994 billion. These liabilities fall into two broad groups.

The first group is what I call policy‑controllable liabilities:

• settlement balances of $212 billion, and
• currency on issue of $103 billion.

Together, that is $315 billion, roughly one‑third of the Commonwealth’s total liabilities.

These liabilities do not mature. They do not require refinancing. Their cost is set by policy, not markets. They are extinguished through taxation. They behave more like perpetual claims on the Commonwealth than like market debt. They are liabilities, but without repayment obligations. They have equity‑like features.

Settlement balances are created when the Commonwealth spends. They are then used when economic players settle amongst themselves. Currency on issue arises when settlement balances are swapped for cash. Both are simply different forms of the same underlying liability.

These settlement balances exist only because private banks have been granted a privileged position as intermediaries in the settlement system. If private banks were not intermediaries — if every Australian simply had a deposit account at the RBA — those deposit accounts would still appear on the Commonwealth’s balance sheet, but they would look even more like equity: non‑redeemable preference shares, to use a corporate analogy.

The second group of Commonwealth liabilities arising from deficit spending is market‑linked liabilities — Commonwealth bonds, totalling $679 billion. These liabilities behave like debt. They mature, must be refinanced, and are priced by markets. They expose the issuer to rollover risk and interest rate cycles.

This distinction — between equity‑like liabilities and market‑linked liabilities — is fundamental. It is the foundation of Tasmania’s structural constraint. The Commonwealth can issue liabilities with no refinancing risk and with pricing determined by policy. States cannot.

The RBA’s post‑COVID operations made this asymmetry visible. The RBA bought Commonwealth — and State — bonds, mainly from banks. As bonds were swapped, bank settlement balances rose. The RBA’s bond holdings rose. The Commonwealth’s consolidated net bond liabilities fell — by almost $200 billion overnight. The intent was monetary policy: to influence interest rates across the yield curve. But the effect was a dramatic shift in the Commonwealth’s liability mix. Settlement balances rose; bonds fell.

The RBA’s $186 billion Term Funding Facility had a similar effect. Banks delivered bonds to the RBA as collateral. The RBA issued loans at 0.1% and credited their settlement balances. When the cash rate rose, banks earned 4% on their settlement balances but paid only 0.1% on the loans that created them. It was a loss‑making exercise for the RBA. The RBA is still in negative equity. But it was a windfall for banks.

States would have loved to be treated the way private banks were. I am not suggesting States be lent money at 0.1%. I am only saying the system is flexible. It can be used in different ways. And the Commonwealth has tools that States simply do not.

This brings me to capital grants. Commonwealth capital grants — $24 billion in 2024–25 — are expenses for the Commonwealth and revenue for States. Over half of the Commonwealth’s $41 billion deficit that year resulted from capital grants to States. This treatment is required by accounting standards, but it can mislead. It can make it appear that Commonwealth deficits arise from service delivery rather than from capital transfers to States. Over the years, capital grants have been a major contributor to the Commonwealth’s accumulated liabilities.

States also borrow to fund infrastructure — more than ever. Total State borrowings are now approaching the level of Commonwealth borrowings. A large share of Australia’s public sector borrowing is driven by State capital programs and the capital needs of State‑owned businesses.

Conceptually, capital grants could be treated as loans and written off once spent. That would avoid inflating State revenue and better reflect the substance of the transaction — which is more like an equity contribution from a parent to a subsidiary. But isn’t that just shifting debt from States to the Commonwealth? Yes. But the Commonwealth has a better toolkit. It can issue equity‑like liabilities. States cannot.

One fundamental thing missing from the “pay down debt to avoid burdening our children” mantra is that if government liabilities fall, assets must also fall. A balance sheet with less debt has fewer public assets. Removing the so‑called burden of debt removes the benefit of assets. When we say “reduce debt”, we are also saying “reduce assets”, even if we don’t say it out loud. A balance sheet cannot shrink on one side without shrinking on the other.

We talk endlessly about annual deficits and surpluses, but almost never about what they mean for the balance sheet over time. Surpluses accumulate. They shrink the asset base. They mean a decade of selling assets, deferring maintenance, shrinking capital programs, or pushing ownership offshore. Deficits accumulate too — but they accumulate into things: roads, hospitals, water systems, transmission lines, schools. The annual number is not the story. The long‑term balance sheet is the story.

We need to be clearer about what a government balance sheet represents. When we say the government is “in debt”, we are taking an inside‑out view — as if the government were a private company facing negative equity. But from the outside‑in view, which is the only view that makes sense for a public institution, those liabilities are the community’s equity. Government debt is our equity. It is the financial expression of the public assets we collectively own.

Sectoral balances matter too. Public sector surpluses require private sector deficits. Most people overlook that. Ask around and you will find most people think it best if households save for a rainy day and the government at least breaks even. But households are already highly leveraged. Paying down government debt would require either more private borrowing, reduced private saving, or increased foreign ownership of Australian assets.

And what public assets do we stop acquiring? Which renewals do we defer? Which upgrades do we abandon? Which water systems don’t get replaced? Which hospitals don’t get rebuilt? Less debt means less infrastructure. Less debt means fewer public assets. Less debt means a smaller State. No one talks about that.

Financialisation has made this harder. Competitive neutrality has made it harder still. Government businesses are expected to behave like private firms — paying Income Tax Equivalents, funding capital renewal from operating cash flows, and borrowing at market rates. To make it worse, the Tasmanian Government drains 90% of after‑tax profits as dividends. The Government has become dependent on government businesses filling the gap in its own‑source revenue.

But government businesses cannot raise prices enough to service the loans required for modern infrastructure. They are capital‑intensive businesses trapped in a revenue‑constrained environment. The model worked when capital needs were modest. It does not work now. We have reached the endgame of that model. When most underlying profits are drained, government businesses cannot renew assets. They cannot expand. They cannot modernise. They cannot meet regulatory standards without external support. If they cannot renew assets, the State cannot renew assets. The balance sheet shrinks — not because anyone chose to shrink it, but because the financial architecture forces it.

Tasmania faces fiscal pressures on several fronts. Operating expenses — especially health — grow faster than revenue. Past liabilities are eating up more of the pie: unfunded defined benefit obligations, historical sexual abuse compensation, risk management claims, and liabilities for services yet to be delivered. Some of these have cash set aside, but they are still netted off to produce a “net debt” figure that masks the true position. Similar distortions appear in the broader State sector.

Capital spending needs to exceed depreciation. Break‑even profits will not be enough to fund new capital needs. Operating cash will never be enough. A fiscal balance in the General Government Sector is not enough. A fiscal balance in the overall Public Non‑Financial Sector is the minimum required to stop debt growing — and even that is unlikely.

Tasmania’s debt challenge is structural, not behavioural. Restraint matters, but it is not enough. The solution is to work more cooperatively as a federation and make better use of the Commonwealth’s broader liability toolkit. Part of that involves recognising that not all Commonwealth liabilities are “debt” in the usual sense. Some are more like equity — perpetual, policy‑priced claims. We could mandate more be held by super funds, as was the case forty years ago, and integrate them more with our retirement system. If we can identify which liabilities have equity‑like characteristics, we can think differently about how the nation shares the cost of public investment.

In that regard, interest paid on those equity‑like claims becomes part of an agreed national policy for dividing up the pie — a deliberate choice about how we fund services and infrastructure across the federation. Interest need not be a burden. It can be a way to split the pie.

There needs to be more Commonwealth lending to States and subsequent writing‑off of those loans. These would appear on the Commonwealth’s balance sheet as assets and on State balance sheets as liabilities — and the write‑off would derecognise both. The economic substance is identical to a capital grant, but the presentation is clearer: it looks like equity‑like support from the Commonwealth to the States. The Grants Commission can assess or quarantine the write‑off. The choice determines whether GST shares change.

When the Commonwealth spends, it creates a liability on its own balance sheet. If every Australian had an account at the RBA, that liability would simply be the deposit the government placed in your account. Is that a debt? Not in any meaningful sense. The government cannot repay you with anything other than another deposit. There is no redemption obligation, no maturity date, no refinancing risk. It is a perpetual, policy‑priced claim — more like equity than debt.

Introduce the States. If the Commonwealth spends and places money into a State’s account, that appears as a liability of the State. Whether it is truly debt depends entirely on the Commonwealth’s intention. If the Commonwealth later writes it off, the liability disappears. The economic substance is identical to a capital grant — but clearer, cleaner, and more honest.

The key point is this: the Commonwealth can issue liabilities that behave like equity. States cannot. That asymmetry shapes everything. If we want a functional federation, we must let the level of government with equity‑like liability powers support the level of government that cannot issue them — the level of government that does the bulk of capital spending.

It will not solve all our problems. But it will help.

Thank you.