Members of the Commission, thank you for the opportunity to provide a written statement on capital budgeting. Let me be up front with you: I do not support capital budgeting as I believe it is being proposed by some today. Incorporating a capital budget would erase the fiscal discipline we have worked so hard to achieve. I also think a capital budget would muddy our ability to measure how the budget affects the economy and further complicate an already complex budget process. The Federal budget process is far from perfect. As an example, I support reforms to the process such as moving to a biennial budget cycle.
Most of you have private-sector experience with very successful companies or have held prestigious government positions. We can, and should, learn more from you on how we can improve our budgeting practices to make the government more efficient and to allocate Federal resources to the highest priorities.
With respect to the budgetary treatment of capital spending, I want
to address two issues in my testimony today. First, the budgeting practices
of a private company or a state are not necessarily appropriate for the
federal government because it is a much different entity with different
functions. Second, a close look at federal budgeting practices reveals
what I think is a sophisticated approach to match the unique needs of the
The Federal Government has a Unique Mission
First, unlike a business whose primary function is to make a profit, the mission of the Federal government is ultimately defined by our Constitution: to establish a system of justice, secure the freedom and rights of individuals, provide for the national defense, and promote the general welfare of the American people. The success of the federal government in meeting these basic needs can never be measured in the same way as the profits or losses of a business enterprise. Many activities, by their very nature, must be undertaken by the federal government without regard to their rate of return.
Second, the Federal government devotes significant spending to items it does not own. Most entitlement programs are transfer payments to states and individuals, and most infrastructure spending subsidizes state-owned projects. Moreover, the federal government has a more ambiguous definition of investment than the private sector. When public officials talk about "investments," they often are talking about education, health care, research or training. The government usually does not invest to make money, making it more difficult to pay borrowing costs. To the extent financial benefits from public investment are anticipated, they are usually hard to quantify and verify, or often emerge after long lags. The question of ownership, combined with the problem of defining investment and depreciation, makes implementing private-sector accounting an immense challenge at the federal level.
Any effort to incorporate the long-term benefits of public investment into the federal budget process should also examine the impact of tax policy on economic growth. Many economists believe that tax policy has a greater impact on economic growth as compared to public investment. For example, just this week, Federal Reserve Chairman Greenspan stated in testimony before the Budget Committee that a reduction in marginal tax rates and the elimination of the capital gains tax would enhance economic growth.
Even with the complexities of trying to assess federal assets and liabilities, the Federal government does produce a balance sheet to provide supplementary information. The Treasury Department's most recent effort shows liabilities of $6.1 trillion, assets of $1.7 trillion, and a net worth of a negative $4.3 trillion for fiscal year 1996. Should we be worried? Although we are transferring liabilities to the next generation, the government's negative bottom line does not mean we are bankrupt. Even with this bleak financial picture, the federal government still has the best borrowing rate in the world. When financial markets are troubled, such as with the recent Asian currency crisis, the "flight to quality" is to Treasury securities. Why?
The reason is that the Federal government has two extraordinary powers businesses and states do not have: the unique ability to both tax and print money. Backed by the strength of an $8.2 trillion economy, the U.S. government is unlikely to ever default on its obligations. As a result, a balance sheet at the federal level is not comparable to a business's or states's balance sheet.
It is also important to remember that capital budgeting is not synonymous
with private-sector accounting. Capital budgeting attempts to address perceived
weaknesses on the asset side of the ledger while ignoring the liability
side. The government's balance sheet, as well as generational-accounting
models and long-term budget projections, suggest that we do not capture
the full long-term costs of many programs. While I believe under-funding
public investment is worrisome, our unfunded liabilities is a much larger
problem. The retirement of the baby boomers early in the next century will
pose a weighty dilemma for policy makers. The estimated unfunded liability
of Social Security is $3.6 trillion, the estimated unfunded liability of
Medicare Part A is $1.8 trillion, and the current net federal debt held
by the public is $3.8 trillion. I do not believe we should encourage more
borrowing -- which a capital budget would encourage -- now when significant
deficits lie just over the budget horizon.
The Advantages of the "Unified" Cash-Based Budget
The unified budget is basically a cash-based budget in which we record receipts and outlays in the year they occur. It also records obligational authority, called budget authority, which is made available to federal agencies. Looking at budget authority and outlays together, elected officials make decisions on which priorities to fund among a myriad of federal programs and to assess the economic impact of their decisions.
The Federal cash-based budget is based on straight-forward concepts of receipts and outlays that cannot be easily manipulated. Our budget practices have evolved into a sophisticated system to measure and enforce the impact of federal budget decisions. We have modified the budgetary treatment of programs when appropriate and required supplemental information in order to complement the federal budget process.
The unified budget provides a transparent and comprehensive process for allocating resources. With an infinite amount of demands, the Congress needs timely easily-digestible information to evaluate policy tradeoffs. In the budget process, the President and Congress can weigh the relative priorities of spending for infrastructure, education, health care, science or welfare against the revenue resources that are available. The country's elected officials must respond to the voters on whether the priorities they set in the budget process are affordable and the people's priorities.
The President's and Congress' decision to devote more resources to entitlement programs rather than capital items is not entirely the fault of the budget process. Isolating spending for capital items through a capital budget is not going to change this fact and may have some adverse consequences. I fear that it will make the budget process more inflexible, more complicated, and less transparent and indeed could actually result in an increased debt burden to the detriment of future generations.
The federal government is also the watchman of the national economy. Unlike an individual business or state, the actions of the federal government significantly impact the economy. Each year the Federal government must determine the size of government, the level of taxes and debt needed to support it, and the economic impact of its actions.
The unified cash based budget provides us with a comprehensive measure of the economic impact of the Federal budget. With a projected balanced budget this upcoming year, Federal spending and taxes each will represent about 20 percent of our gross domestic product (GDP) and our debt will represent 45 percent of our GDP. There is a great deal of dispute about what the appropriate levels of spending, taxes, and debt among economists and policy makers, but there is little doubt that these levels have a dramatic impact on our economy. For example, changing the relative size of the Federal deficit will affect private investment, the trade deficit, and the short-term performance of the economy.
Estimating Future Costs
Federal budgeting also relies heavily on estimates. Where a business usually agrees to pay a specific amount for a service, the federal government often undertakes responsibilities without knowing the exact cost. For example, it is very difficult to quantify on an accrual basis the long-term cost of the Medicare or deposit insurance programs. A cash-based system makes it relatively simple to project costs, often in an extremely short time span.
The cash-based system also leaves less room than a capital budget to manipulate estimates. The federal government is always under enormous pressure to increase spending and cut taxes, encouraging some policy makers to search for short-cuts. Under the current system there has been little dispute about what constitutes a "receipt" or an "outlay." Moving to a capital budget could include a protected spending category outside the budget caps or the application of depreciation that would be even more sensitive to the vagaries of economic forecasting. Such complications could further open the budget process to manipulation or gimmickery.
A Sophisticated, Long-Term View
Because a cash-based budget does not always account for the long-term impact of budgeting decisions, we have extended the time-frame of our budget enforcement mechanism and our budget forecasts. The 1990 Budget Enforcement Act lengthened the time-frame of budgeting decisions from one year to five years. In 1993, the Senate instituted a "pay-as-you-go" rule to measure the budgetary impact of legislation over ten years. This rule sets a higher hurdle than a simple majority to pass legislation that increases the deficit. If Senators want to increase spending or reduce revenues over a ten-year period, they must fully offset the deficit effect or gain sixty votes for their legislation.
We devote a great deal of resources and effort to measuring Federal budgetary levels and the impact of legislation over the long-run. The Office of Management and Budget (OMB) and the Congressional Budget Office (CBO) make ten-year budget projections semiannually. I doubt many private-sector firms project spending and revenue this far into the future. During the debate on health care reform, CBO conducted an in-depth analysis of competing proposals over a decade. In order to provide some perspective on the impact of the baby boomers' retirement, CBO began producing reports projecting budgetary trends over the next 50 years. The actuaries at the Social Security Administration go even farther, making 75-year projections to assess the program's solvency.
Applying Accrual Concepts to Federal Credit Activities
Where cash-based budgeting has not worked well to reflect the budget impact of programs, we have made modifications. The 1967 Commission on Budget Concepts recommended the cash-based budget, but recognized that federal-credit activities deserved different treatment. In 1990, we amended the budget treatment of federal credit programs to essentially place them on an accrual basis.
After over 20 years of study and 7 years of implementation, we still struggle with credit reform. The objective of credit reform was to require the Federal government to base decisions on whether to make a direct loan or insure private loans based on the long-term cost of the obligation. In order to make these determinations, the Congress must rely on the Office of Management (OMB) to make good faith estimates on interest rate and default rate assumptions. The General Accounting Office is reviewing the implementation of credit reform and there appears to be a pattern in which OMB has under-estimated the cost of these programs under credit reform. More recently, House Budget Committee Chairman Kasich and I have written OMB to raise concerns about their methodology with respect to estimating the cost of certain international lending activities. While on balance it appears credit reform has been a success, it has made the budget process more complex and may have inadvertently opened it to abuse.
In addition to modifications to the existing process, the Congress has moved to provide supplemental requirements to improve performance and budgeting decisions. During this decade, we have implemented a number of ambitious reforms to supplement the budget process, including the Chief Financial Officers Act, the Government Management Reform Act, and the Government Performance and Results Act. As directed by the first two laws, experts have created federal accounting standards and agencies are producing audited financial statements and unit-cost information for the first time.
Under the Results Act, agencies must create outcome goals and measure
their actual performance for every activity. Instead of asking how much
we spend, we are beginning to ask whether the government is achieving results.
Much of the motivation for capital budgeting is that we do not spend sufficient
sums on public investment. By focusing on the outcomes of federal spending,
the Results Act should put a much higher priority on productive capital
The issue of how to measure the Federal budget is not new. The one thing I am certain you will learn is that federal budgeting is unique and complex. Capital budgeting is one option that may deserve consideration, but other methods must also be examined. During your review, you should keep in mind the extraordinary responsibilities, mission, size and complexity of the Federal government. The Federal government will spend $1.7 trillion this year on an array of programs beyond your imagination. The Federal government spends money on almost every facet of the American economy from agriculture support payments to the National Zoo. Our current practices are not perfect. But given the enormity of the task, they work reasonably well.
As you delve into capital budgeting and federal budgeting concepts,
I urge you to take the time to understand what the Federal government does
and how it affects the economy. Avoid looking at any recommendation in
a vacuum of just how an "investment" or "capital item" is displayed. Instead,
I advise you to review these recommendations in the context of how such
a change might affect the Federal resource-allocation process and the government's
economic policy-making role.
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