TO: THE PRESIDENT'S COMMISSION TO STUDY CAPITAL BUDGETING
DATE: JUNE 5, 1998
BY: MARTIN A. REGALIA, Ph.D.
The U.S. Chamber of Commerce is the world's largest business federation, representing more than three million businesses and organizations of every size, sector, and region.
More than 96 percent of the Chamber's members are small businesses with 100 or fewer employees, 71 percent of which have 10 or fewer employees. Yet, virtually all of the nation's largest companies are also active members. We are particularly cognizant of the problems of smaller businesses, as well as issues facing the business community at large.
Besides representing a cross-section of the American business community in terms of number of employees, the Chamber represents a wide management spectrum by type of business and location. Each major classification of American business -- manufacturing, retailing, services, construction, wholesaling, and finance -- numbers more than 10,000 members. Also, the Chamber has substantial membership in all 50 states.
The Chamber's international reach is substantial as well. It believes that global interdependence provides an opportunity, not a threat. In addition to the U.S. Chamber of Commerce's 83 American Chambers of Commerce abroad, an increasing number of members are engaged in the export and import of both goods and services and have ongoing investment activities. The Chamber favors strengthened international competitiveness and opposes artificial U.S. and foreign barriers to international business.
Positions on national issues are developed by a cross-section
of Chamber members serving on committees, subcommittees, and task forces.
Currently, some 1,800 business people participate in this process.
The U.S. Chamber of Commerce -- the world's largest business federation, representing more than three million businesses and organizations of every size, sector and region -- appreciates this opportunity to comment on the issue of capital budgeting.
A crucial function of the federal government is the provision of public goods and services, such as national defense, public infrastructure, and education. The Chamber recognizes that public goods are not free and that such public spending ultimately gives rise to the need to tax. Because of the burden taxes place on society, we believe that the federal government should prioritize its spending to ensure the greatest benefit to society at the least cost. To facilitate this process, the government should use accounting methods and concepts designed to foster good decision-making. Exactly what such an accounting framework would look like is a more difficult question. Clearly, highlighting expenditures that are intended to increase the capital stock would seem like a good idea, however, even such a simple change raises questions of how one defines capital, how one measures depreciation and how to budget for replacement cost.
These problems notwithstanding, the Chamber supports
your effort to encourage sound investment in public capital by the federal
government. There is one area, however, that causes us grave concern. Some
have suggested that federal capital investment should be facilitated by
splitting the federal budget into an operating budget, financed with tax
revenues, and a capital budget, financed with borrowing. The Chamber believes
that deficit financing is, inappropriate for any part of the federal budget.
Instead of providing additional investment, such an arrangement is far
more likely to lower long-term productivity growth, retard future economic
growth, and limit increases in our standard of living.
Deficit-Financing of Capital Projects Is Inappropriate
During the debates on the Balanced Budget Amendment, one often heard the argument that the federal government should only be required to balance its operating budget while allowing borrowing for capital expenditures. The claim was made that this was in keeping with the budgeting practices of most corporations and households. We strongly disagree with these arguments. We believe that the suggestion for deficit financing of capital goods ignores fundamental differences between private sector entities and the federal government -- namely, the latter's virtually unlimited access to the credit markets, its sovereign ability to tax, and the ability to create inflation to reduce the real obligation of borrowing.
When a corporation decides to undertake a capital project, it must finance that project from current corporate income or borrow from the capital markets. Because the current income stream is often insufficient to finance a capital project, corporations opt to borrow. The investment that is financed with this borrowing is expected to generate sufficient income to service and retire the debt and provide a reasonable return to shareholders. If the future income stream from a project is insufficient to cover these costs and provide a profit (i.e., if the investment was not a good one), then the corporation's net worth is eroded and stockholders and creditors suffer. Obviously, a firm cannot last long should it continually make poor investment decisions. For these reasons, shareholders and creditors have a financial incentive to accurately evaluate the prospective projects and chose accordingly. Market discipline acts to allocate funds to the most worthwhile ends.
The situation is far different for the federal government. If we focus on the domestic economy and ignore the foreign sector for the moment, all federal expenditures, whether for consumption or investment, must be financed out of the economy's current income. Furthermore, there are two vehicles for extracting the public funds from the current income stream -- namely taxes or issuance of government debt. If the government chooses to tax, the tax reduces available income. However, because taxes are paid before the private sector makes its consumption/savings decision, the burden of the tax falls on both private consumption and private savings.
Contrast this with the process of deficit financing. When the government borrows, the private sector has already paid its taxes and made its consumption/saving decision. As a result, the government must borrow from the pool of private saving. Both the government and the private sector must then compete for the available pool of private saving. Because the government can outbid the private sector, government borrowing "crowds out" private borrowing. Unless government investment is a perfect substitute for private sector investment that were "crowded-out," the economy ends up with a lower capital stock and misallocation of resources.
It is important to note that whether the government borrows or taxes, it is drawing the funds from the current income stream of the economy. The only question is whether the burden is borne by both saving and consumption or just saving.
When we move to an open economy, the government has the additional option to borrow from abroad. Borrowing from foreigners can increase the available resources beyond the current income stream of the domestic economy, but at a significant cost. Excessive borrowing from foreigners can increase interest rates, cause unwanted currency appreciation and reduce exports. Moreover, increased indebtedness to foreigners requires a subsequent transfer of wealth to foreigners to service and retire the debt. If the federal spending financed by foreign borrowing fails to promote sufficient future economic growth, the debt servicing and repayment can lower our future standard of living.
It is true that during the formative years in our country, we borrowed heavily from abroad. However, this borrowing was channeled into highly productive private investment, not government consumption. The private investment ultimately produced sufficient income to service and retire the debt. Unfortunately, current government spending is heavily weighted toward consumption and appears unlikely to generate future income sufficient to retire debt issued to finance it.
The use of deficit financing causes other problems as well. Deficit financing tends to be less noticeable than taxation. This disconnection of the government spending decision and the ultimate need for taxation can foster a lack of discipline by the government. Because much of the voting population does not see the direct connection between the spending decision and the financing decision when debt financing is used, the voting public fails to control the Congress's spending appetite. This, in turn, tends to reduce the government's incentive to prioritize federal spending. The benefits of specific projects are not weighed or measured against each other, with the result that many substandard projects are undertaken. Tying government capital spending decisions to the taxation that they ultimately create produces a higher level of public scrutiny and better choices in public spending.
There is a common misconception that without borrowing, the government will be unable to finance the necessary public investment. This is simply not the case. In FY 1997, the government raised about $1.6 trillion. The ratio of federal government revenues to Gross Domestic Product stood at 19.8%, the highest level since World War II. Surely this amount of tax revenue is sufficient to cover government operating expenses, as well as to fund the worthy public investments and current expenditures that should be made.
The U.S. Chamber believes sound capital investment,
both by private and public entities, is the cornerstone to our nation's
future prosperity, and that it is critically important for the federal
government to properly measure and account for investment spending. However,
cloaking federal government deficit spending in the guise of "investment
for the future" language only serves to erode our hard-won fiscal discipline.
Deficit spending will not deliver the sound public investment our nation
needs. Making deficit spending respectable again would give our politicians
the license and opportunity to siphon away even more funds from private
investment. We thank you for this opportunity to testify on this important
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