Issue:

How should capital spending be defined?

Discussion:

There is no commonly accepted definition of what constitutes capital spending. In a broad sense, capital spending is any outlay that provides long-term benefits.

Spending for capital is only one type of spending that provides long-term benefits. Spending for "capital" does not need to be measured differently from other spending with long-term benefits -- except to the extent that assets need to be accounted for, maintained, and used well.

Accounting standards do not define "capital" as such but do require that property, plant, and equipment owned by the entity be recognized on its balance sheet and, except for land, depreciated. Federal accounting standards treat different types of property, plant, and equipment differently and require supplementary stewardship reporting for the cost of physical property financed by the Federal government but owned by state and local governments, education and training, and research and development.

For businesses and state and local governments that have some form of a capital budget, there are significant variations in how the term is used. State and local capital budgets include some subset of physical capital owned by the state or locality and, in certain cases, state grants to localities to buy physical capital.

The Federal budget includes several ways of looking at capital spending, depending on the context.

The President's proposals. In presenting the President's budget proposals, different Administrations have discussed "investment spending" but defined it in different ways depending on their priorities.

For the Reagan Administration Budgets in 1982 -1989, the focus of investment was almost entirely for national defense. In addition, early in the Administration gasoline taxes were increased to finance highway grants to States.

All of the Bush budgets had major sections highlighting investment. With some variation from year to year, these sections included as investment research and development; human capital; the next generation (child immunizations and related programs); drugs; the environment; energy; transportation and other infrastructure; distressed communities; national security and America's interests abroad; and preserving America's heritage, which included the arts, humanities, museums, and related spending. The budgets also addressed private sector productivity growth, national saving, and related macroeconomic issues.

For the Clinton Administration there are three consistent themes in each budget: reducing the deficit to increase national saving and provide for increased private sector investment; investments to increase living standards; and reducing trade barriers to raise economic growth. These themes have prevailed in each of the Clinton budgets, but the definition of Federal investment has changed somewhat in each budget.

The first Clinton budget, A Vision of Change for America (February 1993), included a chapter, "Investing in the Future: Increasing Public Investment." It included as investment transportation; environment; rural development; energy; community development and defense conversion; revitalizing technology; housing; lifelong learning; rewarding work (including the earned income tax credit); justice; health care; and tax incentives.

Subsequent budgets retained these themes. The FY 1998 Budget summarized the entire budget in a section called, "Investing in the Common Good: the Major Functions of the Federal Government."

Technical budget chapter. A special analysis or budget chapter on Federal investment outlays has been published since 1950, currently in the Analytical Perspectives document of the Federal budget. As it has since the beginning, this chapter , includes a discussion of investment spending that incorporates federally owned public physical capital, Federal grants to state and local governments for public physical capital, the conduct of research and development, and the conduct of education and training. Historical data are published in a separate budget document, Historical Tables.

In a separate part of this chapter, recent budgets have presented alternative capital budgets that offer two alternative definitions emphasizing different purposes. One definition emphasizes the provision of government services to the public. A second definition emphasizes investment in capital that contributes more directly to the economic growth of the nation.

Capital Programming Guide. This new publication provides guidelines to Federal agencies on capital planning, budgeting, procurement, and management. It uses a subset of the stable Analytical Perspectives definition based on Federal physical capital that defines capital assets as land, structures, equipment, and intellectual property, including software, that are used by the Federal government and have an estimated useful life of two years or more. This definition is appropriate for issues relating to the planning, acquisition, and maintenance of Federal capital.

Establishing a fixed definition of capital spending is a crucial issue in the context of a recommendation to separate capital spending from other spending, either in some form of capital budget, or a separate category for capital under the BEA. Improvements in capital planning and budgeting that continue the current integrated framework for decisionmaking do not require a fixed definition of capital.

Options:

There is a working definition of capital spending in the Capital Programming Guide. However, depending on the goal desired, many other definitions might be used. The examples below provide some of the alternative definitions.

1. Use the Capital Programming Guide definition (capital assets as land, structures, equipment, and intellectual property, including software, that are used by the Federal government and have an estimated useful life of two years or more) but exclude defense.

2. Use the Capital Programming Guide definition.

3. Add Federal grants made to state and local governments for physical capital.

4. Add conduct of research and development.

5. Add conduct of education and training.

6. Add some health care, e.g., infant care.

7. Restrict the definition exclusively to capital with a favorable cost-benefit ratio over the life of the project. For example, only public physical capital that has a favorable cost-benefit ratio would be defined as capital spending. Projects that do not have a favorable cost-benefit ratio would be shown separately.