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Committee For A Responsible Federal Budget
June 4, 1998
Mr. Richard P. Emery, Jr.
Executive Director
Capital Budgeting Commission
Office of Management and Budget
17th Street & Pennsylvania Avenue, NW
Washington, DC 20503

Dear Dick:

I am enclosing comments, on behalf of the Committee for a Responsible Federal Budget, on the issue of capital budgeting. The Committee has spent an enormous amount of time, effort and money over the years to identify shortcomings in the current systems and design a better process. We are working closely with Members of Congress who share those goals. All of our views on capital budgets and other process changes are colored by that experience.

There are a series of questions we believe your commission should ask and answer. They are as follows:

  • Would a capital budget solve the problem it is intended to address. That is would it promote more Federal investment spending vis-a-vis the current system? Is that a desirable goal?
  • Would a capital budget enhance the ability of Congress and the Administration to weigh competing priorities? That is, would it make clearer the relative costs and benefits of investment vis-a-vis consumption spending?
  • What new problems would a capital budget create?
  • Is capital budgeting the most important change Congress and the President should be considering with regard to budget process?
  • If not, would focus on this change increase or diminish the chances for more important change?
  • If the Commission does not recommend that Congress and the Administration adopt a capital budget, what contribution can your report make toward solving the specific problems you are asked to address; and what contribution could you make toward better budget process in general?
The following statement is organized around those questions. We hope this is helpful. We would be happy to meet with Commission members or staff, if that would be useful.

Best regards,


Carol Cox Wait


Capital Budgeting: What Problem Would It Solve?

Some policy experts, concerned about the decline in national savings and investment rates, argue that the federal government should devote a greater share of its resources to investment. Budget rules limit overall discretionary spending, under which most federal investment and capital spending s funded. Entitlement spending is growing as a share of the budget and the economy.

Proponents of capital budgeting believe that budget accounting practices make matters worse. These practices require up-front allocation of budget authority representing the full cost of capital spending at the time an agency commits to capital project. Even though the expenditure of funds (outlays) spreads the project cost over the acquisition or construction period, they argue this makes investment look prohibitively expensive.

Capital budgeting proponents argue that this budgetary treatment of capital spending fails to distinguish between spending that provides long-term benefits to the economy (investment) and spending that provides immediate benefits (consumption). Decision makers weigh the immediate budgetary consequences of their funding decisions and shy away from capital investment. A capital budget(1), proponents argue, would eliminate this bias by matching costs with long-lived benefits.

There are three major assumptions underlying arguments in favor of capital budgeting:

1. The federal government under-invests and, therefore, more federal capital spending would be desirable policy.

2. Current budget accounting practices are at fault for federal capital under-investment.

3. Capital budgeting would correct that fault without creating further, and possibly even more egregious, budget problems.

Although we too are concerned about the need to increase national savings and investment, the Committee for a Responsible Federal Budget is not inclined to agree these assumptions.

Does government invest too little?

The budget is a political document that identifies the division between public and private responsibilities. Within the public area, the budget divides federal from state and local activities. And, within the federal budget, resources are allocated based upon political priorities. This is different from the private sector, where investment decisions are subject to market discipline and rates of return. Just as there is no analytically "right" level of government spending, there is no "right" level of federal investment or capital spending. Currently, Federal investment and non-defense capital spending represents 9­10 percent of total federal spending.

Some have argued that budget deficits and budget spending limits have hurt Federal investment and capital spending. According to the General Accounting Office, federal investment spending declined from 2.6 percent of GDP to 1.9 percent of GDP between 1981 and 1996, with the sharpest drop occurring between 1981 and 1984. (2) (GAO defines federal investment spending as "designed to enhance the private sector's long-term productivity.") Since 1984, spending for federal investment as a share of the budget and as a share of GDP has been relatively stable. When measured in constant dollars, federal investment spending declined from $124 billion in 1981 to $107 billion in 1982, but then actually rose to $137 billion in 1995. The trends for Federal non-defense capital spending (physical assets for government operations) are similar. The GAO finds that except a dip from 1981 to 1984, Federal capital spending has been stable since 1970.(3)

The simple fact is: Congressmen and Senators like to point to buildings, highways, bridges, etc., (literally) concrete examples of their ability to bring home benefits to constituents. In our judgment, that compulsion vastly outweighs any disadvantage that otherwise might accrue to the budget accounting treatment of big ticket expenditures.

To the extent that a problem exists, we believe it lies at least as much in the allocation of investment and capital spending among competing priorities as it does with the allocation of all spending between long-live physical and human capital and other purposes.

For example, it seems to us quite clear that modernizing the nation's air traffic control system, acquiring modern financial systems, and addressing the Y-2K problem, all are more compelling capital needs than some of the road and mass transit projects contained in the surface transportation reauthorization bill Congress just passed. Just as benefit--cost ratios differ among capital spending projects, so do short-term political benefits. A capital budget would do little to address these discrepancies.

Some, but not all, of the high priority placed on highways undoubtedly can be traced to motor fuel taxes. Airline ticked taxes illustrate the potential disconnect and the attractiveness of spending for physical infrastructure. If the link between revenue sources and expenditure beneficiaries were compelling, one would expect the lion's share of airline ticket tax to be devoted to modernizing the air traffic control system. Instead, we spend billions to build and improve general aviation airports, which provide visible physical facilities in congressional districts and States, but no benefits to commercial airline passengers (who pay the ticket tax).

Does the budget process distort budget decision-making to the disadvantage of investments?

We do not believe that existing budget accounting rules substantially disadvantage capital expenditures compared to alternative capital budgeting arrangements.

Congress and the Administration tend to focus myopically on outlays. The single most important aggregate on the face of any year's budget is the deficit or surplus, and deficits or surpluses equal receipts minus outlays.

Under existing budget practices, federal agencies generally are required to allocate budget authority representing the full cost of the capital project in the year in which government commits to the capital project. Outlays are recorded year-by-year as funds are expended to construct or acquire the asset. These practices help provide Congress with fiscal control by earmarking sufficient resources up front at the time government makes the decision to acquire an asset.

Although capital budgeting proposals vary, most generally would separate capital costs from operating costs. The full costs of capital spending would be recognized in the capital budget, but only annual depreciation would be reflected in the operating budget. This way, the costs would be appropriated over the useful life of the asset. Capital budget supporters argue that this accrual approach would match costs and benefits more accurately than the current cash-based approach. Because agencies could avoid funding "spikes," they might achieve more success at obtaining resources for needed capital projects.

Although a capital budget might help agencies with only sporadic capital needs, agencies that regularly engage in capital spending eventually would find that a capital budget could make capital projects appear more expensive. Talk of budgetary advantage associated with capital budgeting ignores the fact that all budgets must balance, i.e., some stream of revenue would be needed to balance capital expenditures no matter how we budget. Because capital budgets generally reflect debt service (interest) costs, investment would become more costly. Current budget accounting does not allocate interest expenditures to specific budget functions, programs or activities. We show all interest costs in the net interest function of the budget.

Would a capital budget create more problems than it solves?

A capital budgeting approach probably would not fix very many problems and could create several new ones that would weaken overall fiscal control. These include:

  • Balkanization of the federal budget. Setting up a capital budget would separate capital spending from the rest of the budget. This would erode the unified budget and make it more difficult to evaluate the impact of overall federal policies.
  • Creation of a favored category of spending. If this new category promised more favorable budgetary treatment than the regular operating budget, constituent groups and their Congressional supporters would seek to be included under this more favorable category. Policy experts and accountants do not agree on what should be included in a capital or investment budget. Thus, lawmakers would face irresistible incentives for everything to be classified as "investment." As a consequence, it could become more, not less, difficult to allocate resources to "productive" investment needs.
  • Problems stemming from basing budgets on estimates of "useful" life. A capital budget would recognize annual benefits and cost based upon the estimated economic useful life of an asset. Because longer useful lives would produce lower annual costs, a capital budget would create an incentive towards optimistic estimates of benefit periods. What, for example, is the useful life of public spending for education or childhood immunizations? Similarly, budget analysts would have to make many assumptions to determine the estimated useful life and annual cost of a highway or bridge. As a result, budgets would become more subjective and prone to errors and a less reliable measurement of fiscal policy.
Although we believe the budget is far from perfect, we don't think it disadvantages capital spending. While we believe a capital budget would do little to address the perceived problem of too little Federal spending in productive capital, we are concerned that it would create serious budgeting problems.

However, we do think that the budget process could provide a much better mechanism for Congress and the President to weigh competing priorities and hold elected decision-makers accountable for the priorities they set. The remainder of this statement outlines our suggestions for improving the budget process.

What are the most important shortcomings in the current budget process? What changes best could remedy those problems? Does focus on capital budgeting enhance or diminish the likelihood that Congress and the President will address these issues?

The country does not have a budget, i.e., the two policy branches never agree on one fiscal policy plan, much less agree to adhere to such a plan until and unless they adopt a new budget.

The President sends a budget to Congress every year. Congress rarely votes on the President's budget. Congress has not adopted any President's budget in modern memory.

Congressional budgets take the form of concurrent resolutions, which Presidents do not sign and cannot veto.

The President and Congress each compare results to their own version of the budget. Sometimes, the House and Senate each compare results to their own versions of the Congressional budget. In the absence of agreement on one budget, there is no basis for enforcement. Given different starting points, the Administration and Congress even describe similar policy changes differently.

The last point is illustrated by the 1995 Medicare debate. The President proposed to spend about $60 billion more over five years than the Republican Congress' balanced budget bill (less than 5% of total Medicare estimates over the same period of time). However, OMB projected Medicare spending would be much lower than the CBO told Congress it would be, given no change in law. Thus, the Administration was able to claim that their budget cut Medicare much less than Congress proposed to do.

Beginning with the 1990 Budget Agreement, nominal dollar caps for discretionary spending subject to annual appropriations have become a fixture of Federal budget law and process. The caps were amended and extended in 1993 and 1997. They extend into the "out years"--in the most recent instance through 2002. If discretionary spending exceeds or is projected to exceed the caps, sequestration is triggered to cut the total back down to the statutory limit(s). In FY 91-FY 93, there were separate caps for defense, international and domestic discretionary spending. In FY 98-FY2000, there are separate caps for defense and non-defense discretionary spending. When Congress passed and the President signed into law budget bills containing caps, they agreed to a budget for discretionary spending. But spending subject to the caps is declining. It was 40% of total outlays in FY 91; it will be about one-third this year; and unless the caps are amended or budget totals vary significantly from current projections, amounts subject to the caps will be 30% of total outlays in FY 2002.

Even within discretionary spending, Congress and the Administration left themselves a loophole. It is called "emergency" spending. This year, so called emergencies include such unanticipated costs as peacekeeping in Bosnia and a series of natural disasters. Of course, our troops were in Bosnia when Congress and the President wrote the discretionary caps into law last year, and we experience natural disasters every year. But those expenses don't count against the caps, if the President and Congress agree to label them emergencies.

The first item on our agenda for budget process is one budget, passed by Congress and signed into law by the President--and agreement to enforce expenditure limits contained in the budget (except for interest outlays). We would extend the cap concept to include mandatory spending. We would include so-called emergency spending in the budget. And we would establish special rules to limit expenditures from emergency reserves.

We fear that focus on capital budgeting diverts attention from issues such as these that are far more important to fiscal discipline and political accountability.

Budget Concepts Commission

Whether or not this Commission recommends a capital budget, you are serving an important objective. Your work will collect and organize a great deal of thought and information around budget process and budget process reform. The data will be better and better organized as a result, and that is no small contribution.

We only regret that the subject of your inquiry has been restricted to capital budgeting. There are a number of process and scorekeeping issues which bear serious study. The world and the Federal budget has changed dramatically since the last budget concepts commission in 1967, which made the recommendations which form the basis of our budget rules today. Our Committee believes that it is time for a new Budget Concepts Commission. That recommendation was supported by the vast majority of participants in a meeting we convened in December 1996 to discuss scorekeeping issues. We are transmitting a copy of the report on that meeting on scorekeeping with this. It is illustrative of issues, beyond the budget process changes discussed so briefly above, which we believe argue for a new concepts commission.

It may sound strange, but we sincerely recommend that your commission recommend setting up another commission--or ask Congress and the President to give you more time and assign you a broader task. As with so much else, we believe that the issue of capital budgeting better is understood and debated in a broader context. Having said that, it should be clear from the comments above: taken in a broader context we do not think capital budgeting is necessary--and we certainly don't think it is a priority.

1 Capital budget proposals vary. In this document, we refer to generic proposals that would separate the cash flows associated with the acquisition or construction of the long-lived asset from the operating budget. These costs would be given the same "off-budget" treatment provided direct and guaranteed loans transactions. Resources would have to be provided in the operating budget to fund annual payments reflecting a year's benefits (i.e., depreciation of physical assets).

2 General Accounting Office, Federal Investment Outlays, Fiscal Years 1981-2002 (GAO/AIMD 97-88). May 1997..

3 General Accounting Office Budgeting for Federal Capital (GAO/AIMD 97-5). November 1996

President's Commission to Study Capital Budgeting

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