Budget Impact of a Capital Budget Framework
Staff Paper Prepared for the President's Commission to Study Capital Budgeting

April 23, 1998
 
 
BUDGET IMPACT OF A CAPITAL BUDGET FRAMEWORK
 
This paper discusses the impact on the budget of shifting to a capital budget framework, in which investment spending appears in a separate capital budget and the operating budget is defined to exclude spending on investment and to include a charge for depreciation of existing capital. Relative to the present unified budget, such a redefinition would reduce outlays when new investment exceeded depreciation, but increase outlays when depreciation exceeded new investment.

Historical DataTable 1 shows gross investment and depreciation from 1975 to 1997 for two definitions of capital:

The table shows that gross investment in direct physical capital was about 7% of outlays from 1975 through 1981. The 1980s defense buildup raised this percentage, reaching a peak of 10% in 1987. Since then, gross investment has declined, to a level of around 5% in 1997. Gross investment in nondefense direct physical capital has been more stable, holding at between 1.0% and 1.6% of outlays over the entire period.

The magnitude of net investment in direct physical capital has been much smaller. Including defense, net investment was less than 2% of outlays until the 1980s defense buildup, rising to almost 4% during the buildup and more recently becoming negative as the depreciation on the buildup has exceeded new defense investment. Excluding defense, net investment in direct physical capital has fluctuated in a more narrow range, between 0.4% and 0.9% of outlays.

Budget Impact. If shifting to a capital budget were limited to redefining the calculation of the deficit, then the budget impact of the shift appears directly in Table 1.  Outlays and the deficit in each year would change by the amounts shown as net investment in the table. As noted in the preceding paragraph, the effect of this redefinition on outlays would be relatively small.

However, shifting to a capital budget could involve more than simply redefining the deficit. Many advocates of a capital budget framework argue that a capital budget would allow taxes to be set so that investment would be financed over time by those who enjoy the benefits of the investment, rather than by those who paid taxes in the year the investment was made. This would be accomplished by setting taxes to cover operating budget outlays, defined to exclude spending on new investment and to include depreciation on prior investment.

Compared to financing investments with current taxes, setting taxes to cover depreciation would allow a tax cut if net investment were positive, on the rationale that the addition to the capital stock should be financed by future taxpayers, not current ones. On the other hand, this basis of setting taxes would require a tax increase if net investment were negative, in order to charge current taxpayers for drawing down the capital stock.

Table 2 shows the hypothetical impact if the budget had shifted to setting taxes high enough to cover depreciation rather than investment outlays, starting in 1975. The analysis assumes that the unified budget financed all investment with taxes over this period (i.e. that all borrowing was to support current spending, rather than investment).(1) Thus, the impact of the shift would have been to change receipts in each year by the amount of net investment removed from the budget, plus the debt service from prior changes in receipts. The table shows that if capital is defined as total direct physical investment, receipts would have had to rise in 1975 and 1976 to pay for the negative net investment in those two years. Later, as the defense buildup rose, tax cuts would have been allowed. Eventually, the interest on those tax cuts would have grown about as large as net investment, however. By 1997, the required $33.5 billion increase in receipts would have been $17.7 billion to pay for that year's negative net investment and $15.8 billion to pay for the higher interest from previous tax cuts.

If the shift in policy was for capital defined as nondefense direct physical investment, the change in receipts would have been far smaller. Net investment would have been positive in all years, which would allow small tax cuts. However, the interest on these tax cuts would have grown steadily over time. In 1997, it would have exceeded the amount of net investment, requiring a small tax increase.

The results in Table 2 arbitrarily assume that a capital budget was implemented in 1975. The choice of starting point would affect interest, since interest depends on the cumulative changes in receipts since the start of the capital budget. For example, if the capital budget for nondefense direct physical investment had started in 1980, interest would not have exceeded net investment in 1997, allowing a continued tax cut for that year.

The accompanying chart shows the changes in receipts for this policy under the two definitions of capital, as a percent of actual unified budget receipts. During the peak of the defense buildup, setting taxes to cover the depreciation on direct physical capital would have allowed a tax cut peaking at a little more than 3% of receipts. In recent years, the capital budget would have required a tax increase of around 2%, since defense depreciation now significantly exceeds investment. If the definition of capital had excluded defense, it would have allowed a tax cut of a little more than 1% of receipts in the late seventies, and would have had a negligible impact since then.

Footnote:
1.  The extent to which historical borrowing financed investment versus non-investment spending is impossible to determine. An argument might be made that the large deficits in the 1980s were allowed in part because of the defense buildup. To the extent that one assumed that part of historical investment was financed by borrowing, the changes in receipts shown in Table 2 are overstated.

Attachments:
 

Table 1. GROSS INVESTMENT, DEPRECIATION, AND NET INVESTMENT
(In billions of dollars)
 
1975 1976 1977 1978 1979 1980 1981 1982
Direct physical capital:
     Gross investment..... 23.5 24.5 27.4 30.0 36.7 40.6 47.9 56.5
     Depreciation........... 28.3 28.4 26.9 28.1 31.2 34.3 38.4 42.7
          Net investment...... -4.7 -3.9 0.4 1.9 5.5 6.3 9.5 13.8
                Percent of outlays.. -1.4% -1.0% 0.1% 0.4% 1.1% 1.1% 1.4% 1.9%
Memo, gross investment as 
     a percent of outlays....
7.1% 6.6% 6.7% 6.5% 7.3% 6.9% 7.1% 7.6%
Nondefense direct physical capital:
     Gross investment..... 4.8 5.2 5.8 6.7 7.9 8.1 8.8 8.5
     Depreciation........... 2.4 2.7 2.8 3.0 3.4 3.8 4.3 4.9
          Net investment...... 2.4 2.6 3.0 3.7 4.6 4.2 4.5 3.7
                Percent of outlays.. 0.7% 0.7% 0.7% 0.8% 0.9% 0.7% 0.7% 0.5%
Memo, gross investment as 
     a percent of outlays....
1.5% 1.4% 1.4% 1.5% 1.6% 1.4% 1.3% 1.1%
  
1983 1984 1985 1986 1987 1988 1989 1990
Direct physical capital:
     Gross investment..... 67.5 78.3 90.0 96.3 102.6 100.7 105.0 105.3
     Depreciation........... 47.5 53.1 58.5 63.1 66.6 70.5 75.9 80.8
          Net investment...... 19.9 25.1 31.6 33.2 36.0 30.2 29.1 24.5
                Percent of outlays.. 2.5% 3.0% 3.3% 3.4% 3.6% 2.8% 2.5% 2.0%
Memo, gross investment as 
     a percent of outlays....
8.3% 9.2% 9.5% 9.7% 10.2% 9.5% 9.2% 8.4%
Nondefense direct physical capital:
     Gross investment..... 8.2 10.0 12.0 11.5 13.0 14.9 14.3 15.4
     Depreciation........... 5.2 5.4 6.0 6.5 7.1 7.9 8.8 9.4
          Net investment...... 3.0 4.6 6.0 5.0 5.9 7.0 5.6 6.0
                Percent of outlays.. 0.4% 0.5% 0.6% 0.5% 0.6% 0.7% 0.5% 0.5%
Memo, gross investment as 
     a percent of outlays....
1.0% 1.2% 1.3% 1.2% 1.3% 1.4% 1.3% 1.2%
 
 
1991 1992 1993 1994 1995 1996 1997
Direct physical capital:
     Gross investment..... 106.3 102.9 95.3 83.9 79.3 75.7 72.2
     Depreciation........... 86.1 89.2 90.9 92.4 91.9 90.9 89.8
          Net investment...... 20.2 13.7 4.4 -8.5 -12.5 -15.2 -17.7
                Percent of outlays.. 1.5% 1.0% 0.3% -0.6% -0.8% -1.0% -1.1%
Memo, gross investment as 
     a percent of outlays....
8.0% 7.4% 6.8% 5.7% 5.2% 4.9% 4.5%
Nondefense direct physical capital:
     Gross investment..... 17.0 20.3 19.1 17.2 19.5 20.7 19.7
     Depreciation........... 10.0 10.5 11.0 11.5 12.0 12.3 13.0
          Net investment...... 6.9 9.8 8.1 5.7 7.5 8.4 6.7
                Percent of outlays.. 0.5% 0.7% 0.6% 0.4% 0.5% 0.5% 0.4%
Memo, gross investment as 
     a percent of outlays....
1.3% 1.5% 1.4% 1.2% 1.3% 1.3% 1.2%
 
 
Table 2.  INCREMENTAL IMPACT OF A CAPITAL BUDGET FRAMEWORK
(In billions of dollars)
 
1975 1976 1977 1978 1979 1980 1981 1982
Actual unified budget:
Receipts....... 279.1 298.1 355.6 399.6 463.3 517.1 599.3 617.8
Outlays....... 332.3 371.8 409.2 458.7 504.0 590.9 678.2 745.8
     Surplus/deficit(-)....... -53.2 -73.7 -53.7 -59.2 -40.7 -73.8 -79.0 -128.0
Average interest rate on debt 
     held by the public.......
6.3% 6.1% 5.8% 6.1% 6.8% 7.8% 9.2% 10.0%
Capital budget with same deficit (direct physical capital):
Receipts:
     Actual....... 279.1 298.1 355.6 399.6 463.3 517.1 599.3 617.8
     Change in taxes....... 4.6 3.5 -0.9 -2.4 -5.7 -6.1 -8.6 -11.7
          Total....... 283.7 301.6 354.6 397.2 457.6 511.0 590.7 606.0
Outlays:
     Actual....... 332.3 371.8 409.2 458.7 504.0 590.9 678.2 745.8
     Less net investment....... 4.7 3.9 -0.4 -1.9 -5.5 -6.3 -9.5 -13.8
     Change in net interest... -0.1 -0.4 -0.5 -0.4 -0.2 0.2 0.9 2.1
          Total....... 336.9 375.3 408.3 456.4 498.3 584.9 669.6 734.0
Surplus/deficit(-)....... -53.2 -73.7 -53.7 -59.2 -40.7 -73.8 -79.0 -128.0
Cumulative change in debt:
     Start of year....... 0.0 -4.7 -8.6 -8.2 -6.3 -0.8 5.5 15.0
     End of year....... -4.7 -8.6 -8.2 -6.3 -0.8 5.5 15.0 28.8
Memorandum, change in 
     taxes as % of total receipts...
1.6% 1.2% -0.3% -0.6% -1.2% -1.2% -1.4% -1.9%
Capital budget with same deficit (nondefense direct physical capital):
Receipts:
     Actual....... 279.1 298.1 355.6 399.6 463.3 517.1 599.3 617.8
     Change in taxes....... -2.3 -2.3 -2.6 -3.1 -3.7 -2.9 -2.5 -1.1
          Total....... 276.8 295.7 353.0 396.4 459.6 514.3 596.8 616.6
Outlays:
     Actual....... 332.3 371.8 409.2 458.7 504.0 590.9 678.2 745.8
     Less net investment....... -2.4 -2.6 -3.0 -3.7 -4.6 -4.2 -4.5 -3.7
     Change in net interest... 0.1 0.2 0.4 0.6 0.9 1.4 2.0 2.5
          Total....... 330.0 369.5 406.6 455.6 500.4 588.1 675.8 744.6
Surplus/deficit(-)....... -53.2 -73.7 -53.7 -59.2 -40.7 -73.8 -79.0 -128.0
Cumulative change in debt:
     Start of year....... 0.0 2.4 5.0 7.9 11.6 16.2 20.4 24.9
     End of year....... 2.4 5.0 7.9 11.6 16.2 20.4 24.9 28.6
Memorandum, change in 
     taxes as % of total receipts...
-0.8% -0.8% -0.7% -0.8% -0.8% -0.6% -0.4% -0.2%
 
 
1983 1984 1985 1986 1987 1988 1989 1990
Actual unified budget:
Receipts....... 600.6 666.5 734.1 769.2 854.4 909.3 991.2 1032.0
Outlays....... 808.4 851.9 946.4 990.5 1004.1 1064.5 1143.7 1253.2
     Surplus/deficit(-)....... -207.8 -185.4 -212.3 -221.2 -149.8 -155.2 -152.5 -221.2
Average interest rate on debt 
     held by the public.......
8.8% 9.1% 9.2% 8.4% 7.7% 7.7% 8.0% 8.0%
Capital budget with same deficit (direct physical capital):
Receipts:
     Actual....... 600.6 666.5 734.1 769.2 854.4 909.3 991.2 1032.0
     Change in taxes....... -16.7 -19.8 -23.6 -23.4 -24.5 -16.1 -12.2 -5.5
          Total....... 583.9 646.7 710.5 745.9 829.9 893.2 979.0 1026.4
Outlays:
     Actual....... 808.4 851.9 946.4 990.5 1004.1 1064.5 1143.7 1253.2
     Less net investment....... -19.9 -25.1 -31.6 -33.2 -36.0 -30.2 -29.1 -24.5
     Change in net interest... 3.3 5.4 7.9 9.8 11.5 14.1 16.8 19.0
          Total....... 791.7 832.1 922.8 967.1 979.6 1048.4 1131.4 1247.6
Surplus/deficit(-)....... -207.8 -185.4 -212.3 -221.2 -149.8 -155.2 -152.5 -221.2
Cumulative change in debt:
     Start of year....... 28.8 48.8 73.9 105.5 138.7 174.7 204.9 234.0
     End of year....... 48.8 73.9 105.5 138.7 174.7 204.9 234.0 258.4
Memorandum, change in 
     taxes as % of total receipts...
-2.8% -3.0% -3.2% -3.0% -2.9% -1.8% -1.2% -0.5%
Capital budget with same deficit (nondefense direct physical capital):
Receipts:
     Actual....... 600.6 666.5 734.1 769.2 854.4 909.3 991.2 1032.0
     Change in taxes....... -0.5 -1.6 -2.6 -1.4 -2.2 -2.8 -0.7 -0.7
          Total....... 600.1 664.9 731.5 767.8 852.2 906.5 990.5 1031.3
Outlays:
     Actual....... 808.4 851.9 946.4 990.5 1004.1 1064.5 1143.7 1253.2
     Less net investment....... -3.0 -4.6 -6.0 -5.0 -5.9 -7.0 -5.6 -6.0
     Change in net interest... 2.5 3.0 3.5 3.6 3.7 4.2 4.8 5.3
          Total....... 807.9 850.3 943.9 989.1 1001.9 1061.7 1142.9 1252.5
Surplus/deficit(-)....... -207.8 -185.4 -212.3 -221.2 -149.8 -155.2 -152.5 -221.2
Cumulative change in debt:
     Start of year....... 28.6 31.6 36.2 42.2 47.2 53.1 60.1 65.7
     End of year....... 31.6 36.2 42.2 47.2 53.1 60.1 65.7 71.7
Memorandum, change in 
     taxes as % of total receipts...
-0.1% -0.2% -0.3% -0.2% -0.3% -0.3% -0.1% -0.1%
 
 
1991 1992 1993 1994 1995 1996 1997
Actual unified budget:
Receipts....... 1055.0 1091.3 1154.4 1258.6 1351.8 1453.1 1579.3
Outlays....... 1324.4 1381.7 1409.4 1461.7 1515.7 1560.5 1601.2
     Surplus/deficit(-)....... -269.4 -290.4 -255.0 -203.1 -163.9 -107.5 -21.9
Average interest rate on debt 
     held by the public.......
7.6% 7.0% 6.4% 6.1% 6.6% 6.6% 6.5%
Capital budget with same deficit (direct physical capital):
Receipts:
     Actual....... 1055.0 1091.3 1154.4 1258.6 1351.8 1453.1 1579.3
     Change in taxes....... -0.4 5.7 13.8 25.8 30.5 32.3 33.5
          Total....... 1054.6 1096.9 1168.2 1284.4 1382.3 1485.4 1612.8
Outlays:
     Actual....... 1324.4 1381.7 1409.4 1461.7 1515.7 1560.5 1601.2
     Less net investment....... -20.2 -13.7 -4.4 8.5 12.5 15.2 17.7
     Change in net interest... 19.7 19.3 18.2 17.2 18.0 17.1 15.8
          Total....... 1324.0 1387.3 1423.2 1487.5 1546.2 1592.8 1634.8
Surplus/deficit(-)....... -269.4 -290.4 -255.0 -203.1 -163.9 -107.4 -21.9
Cumulative change in debt:
     Start of year....... 258.4 278.6 292.3 296.7 288.2 275.6 260.4
     End of year....... 278.6 292.3 296.7 288.2 275.6 260.4 242.7
Memorandum, change in 
     taxes as % of total receipts...
-0.0% 0.5% 1.2% 2.0% 2.3% 2.2% 2.1%
Capital budget with same deficit (nondefense direct physical capital):
Receipts:
     Actual....... 1055.0 1091.3 1154.4 1258.6 1351.8 1453.1 1579.3
     Change in taxes....... -1.4 -4.1 -2.4 0.2 -0.8 -1.2 0.9
          Total....... 1053.6 1087.2 1152.0 1258.8 1351.1 1451.9 1580.2
Outlays:
     Actual....... 1324.4 1381.7 1409.4 1461.7 1515.7 1560.5 1601.2
     Less net investment....... -6.9 -9.8 -8.1 -5.7 -7.5 -8.4 -6.7
     Change in net interest... 5.5 5.7 5.7 5.9 6.8 7.2 7.6
          Total....... 1323.0 1377.6 1407.0 1461.9 1515.0 1559.3 1602.2
Surplus/deficit(-)....... -269.4 -290.4 -255.0 -203.1 -163.9 -107.4 -21.9
Cumulative change in debt:
     Start of year....... 71.7 78.6 88.4 96.4 102.1 109.6 118.0
     End of year....... 78.6 88.4 96.4 102.1 109.6 118.0 124.8
Memorandum, change in 
     taxes as % of total receipts...
-0.1% -0.4% -0.2% 0.0% -0.1% -0.1% 0.1%



President's Commission to Study Capital Budgeting


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