Capital Budget Nixed for Now

Capital budgeting has meant different things to different people. For some, capital budgeting for the public sector justifies borrowing for long-term assets. For others, it is a way to favor, or at least highlight the need for, major public investments to spur economic growth. Still others see it as a management tool to make government operations more efficient, advocating the adoption of private-sector accounting practices. Therefore, it is not surprising that the commission was unable to find a clear set of rules for the federal budget that would meet all of these concerns.

The debate over a federal capital budget dates back to the 1945 Hoover Commission and the 1967 Budget Concepts Commission under which the comprehensive "unified budget" was established. Both explicitly rejected a capital budget. The subject was considered by the Committee for Economic Development in a study on budget concepts under the direction of former Comptroller General Elmer Staats and has been the subject of several General Accounting Office reports. The issue precipitated a major battle within the Reagan administration when Treasury Secretary Donald Regan (former chief executive officer of Merrill Lynch) tried to get the administration to back a capital budget. Then-budget director David Stockman strongly opposed the idea, and Regan lost the fight. From time to time, Congress members and governors have passionately supported capital budgeting.

However, the report says "a majority of the members of the commission does not support, at this time, adopting a budget procedure that would impose a separate cap on capital spending." Three commissioners rejected a capital budget of any kind. In fact, the commission failed to even settle on or endorse a single definition of capital.

While falling short of endorsing a capital budget per se, the commission did agree on 11 recommendations designed to improve budgeting practices for capital expenditures in particular and more generally for setting priorities among all programs. The commission developed extensive materials on issues related to capital budgeting, which are available on the White House Web site (www.whitehouse.gov/ pcscb).

National Economic Council Director Gene Sperling told the commission he hoped that its report would be the definitive work on capital budgeting. Commission co-chair Kathleen Brown said that she would like to see a document that would be a touchstone on this issue.

Both Sides Weigh In

The most common arguments in support of a federal capital budget are "the states do it" and "the private sector does it." In some cases advocates say "other countries do it." The standard answers by federal budgeteers are that "we are not a state" and "we are not a private-sector firm" and "other countries don't do it." Federal budgeteers point to the unique role of the federal government and macro-economic policy. As the commission's report reiterates, capital projects may provide tangible benefits many years into the future, but they compete for current resources in the economy. Skeptics are concerned that capital investment would receive special status in the budget process, as it has with the states, and would be treated more favorably than general borrowing for federal government.

Those with a substantial amount of experience with the federal budget in its entirety have unanimously opposed adoption of a capital budget, regardless of their political affiliation. Among them are Treasury Secretary Robert Rubin; Senate Budget Committee chair Pete Domenici, R-N.M.; Paul Posner, director of budget issues for the General Accounting Office; and Edward Gramlich, former CBO acting director and member of the Federal Reserve Board.

In contrast, a number of the witnesses who supported a capital budget during commission hearings represented special interests, such as the American Road and Transportation Builders Association, the Construction Industry Roundtable, and Airport Council International. These affiliations tend to reinforce the cynicism of those who oppose a capital budget, even though there was no shortage of witnesses who favored some form of a capital budgeting on the grounds that it is good government or that the current system results in underfunding of public infrastructure.

The commission challenges the assertion that other countries have routinely used capital budgeting by pointing out that although Sweden, Denmark and the Netherlands once did so they have all abandoned it. On the other hand in 1998, New Zealand's government introduced a capital budget for government-owned fixed assets as part of a major set of public management reforms that went well beyond budgeting and financial management. More recently, the United Kingdom has introduced an initiative that established for a three-year period a separate budget for all physical investments and grants in support of capital spending.

The Economy vs. Government

Since the commission never settled on a single definition of capital, witnesses at the hearings talked about different concepts in presenting their positions. The commission does, however, make the distinction between federal government capital and national capital. National capital, which the Office of Management and Budget labels "federal investment outlays," represents federally financed capital, whether the federal government owns it or not. OMB's definition includes not only physical capital (including defense spending) but also research and development and education and training. In contrast, federal government capital includes the land structures and equipment the federal government uses.

The distinction between the two definitions "is of more than academic interest." Those interested in national capital are concerned with raising the long-term output of the economy. The commission cited a 1993 GAO study, which defined national capital as public investments that promise "to raise the private sector's long-run productivity." GAO and OMB include education and training and research and development because they can contribute to long-term economic growth as much as, or even more than, physical capital.

The difference between the ideas of federal government capital and national capital were reflected in the different points a few expressed at the hearings. An institution like the National Science Foundation illustrates the point. Under the concept of federal government capital, NSF's budget would be divided into expenditures that have a long-run return to the foundation (i.e. buildings, computers and other physical assets) and current expenditures for salaries, travel and supplies. Under the definition of national capital, however, all expenditures-including salaries and expenses for conferences-could be classified as capital because they are designed to improve the long-term productivity of the economy. Under the federal government capital definition, the Social Security Administration would define its physical infrastructure as capital, distinct from its salaries and other current expenditures. In terms of national capital, however, none of its expenditures would fit this definition, since the agency's sole purpose is to distribute money to increase the current income and resources of elderly and disabled citizens.

Commission witnesses supporting capital budgeting to enhance the economic strength of the country said the definition should be limited to physical capital, especially non-defense investments in infrastructure. This definition is substantially narrower than those favored by GAO and OMB. Had witnesses included people from the research and education communities, they would surely have pointed out that these, too, are long-term investments in future growth.

Unfortunately, none of the witnesses or commission members, for that matter, have experience in managing a major direct federal government operation. Having made the distinction between government capital and national capital, the commission never researched how the budget system affects operational managers. The commission categorized its recommendations under "strategy and planning, decision-making, reporting and the evaluation." Management, operations, execution or implementation are not part of the vocabulary.

Falling Short

The commission did not function under ideal circumstances. It was set up by executive order, with the Treasury Department providing funding within its appropriations. The commission hired Robert E. Litan of the Brookings Institution to write the report but had no other outside staff. The responsibility for staffing the commission quickly shifted to OMB, which provided a large part of the analysis. The executive director was OMB's senior career budget official, an arrangement that was both positive and negative. OMB has a cadre of career professionals, knowledgeable in many, if not most, of the commission's technical issues. OMB works in the tradition of objectivity and neutral competence. However, the executive director already had a full-time day job and a political boss who is likely to have more than a passing interest in the outcome of the commission's work. In terms of the technical quality of the final product, taking into account the extensive background materials available on the Web site, the positives clearly outweighed the negatives.

The commission, having made the important distinction between "national" and "government" capital, devoted most of its discussion to national capital issues but most of its recommendations to government capital issues. The 900-pound gorilla of the national capital issue is whether the budget system restricts the nation's long-term economic growth potential with inadequate allocations for physical infrastructure, research and development, education, or some combination of these. The report begins to address the subject but gets bogged down in discussion of the 1990 budget caps. It fails to notice the gorilla.

Government capital is the target of the majority of the recommendations, the most interesting of which addresses capital acquisition funds. Others call for additional analysis and reporting, which in theory could improve resource allocation for investment projects. For example, the commission recommends a federal report card, which would require agencies to assess existing investment projects in terms of returns against "some benchmark cost of capital." It adds that "where benefits and costs cannot be expressed in monetary terms, the evaluations should identify project objectives and assess outcomes qualitatively" under OMB guidance. Similarly, it recommends strengthening agency five-year strategic planning under the Government Performance and Results Act, proposes improvements in financial statement reporting, and supports plans for the development of standardized methods for estimating deferred maintenance.

The commission strongly advocated benefit-cost assessments. It would have been encouraging if there was some indication that the commission had exercised this form of discipline on its own recommendations.

By focusing on resource allocation, the report has little to offer in the way of suggestions aimed at improving the day-to-day management, efficiency and productivity of government operations. The problems of the federal manager did not seem to weigh heavily on the minds of the commissioners.

David Mathiasen has worked at the White House Budget Office, the General Accounting Office, the Agency for International Development, and was Executive Director of the National Economic Commission.