The federal budget used by Congress and the Administration should send shivers down the spines of accountants, economists and policy makers. Unlike state and local government budgets or those of private business, it contains no separate accounts for capital transactions.

Thus, in calculating the budget "deficit," or now surplus, all outlays are lumped together, whether for current expenses or for new bombers, highways, buildings, adding to the oil reserves or buying up the assets of savings and loan associations. Thus all add equally to the deficit, or reduce the surplus. Sales of assets are generally viewed as negative outlays, thus reducing the deficit or adding to the surplus.

During the long years of deficit I used to joke that I had a simple method of eliminating it, at least for a good number of years. Each year I would sell off whatever was necessary--say, $200 billion of government assets--taking it back on a leasing arrangement. This would reduce the deficit by the difference between the sale value and the obviously much lesser rental payment. We could begin with the White House, Capitol and Pentagon and go on to the interstate highway system, assuming the federal government could claim title to that, and perhaps continue by selling off all of our defense arsenal, hopefully at least at original cost. Of course, after a number of years we would run out of assets to sell, but perhaps then we could find another accounting gimmick to save the day.

All this is not that far-fetched. In fact, I understand, budgetary considerations have led to expensive renting of office space in Washington when purchase or construction of buildings would in the long run have been much more economical.

What private business does, by contrast, is sensible and illuminating. Profit and loss or income statements include as costs only current expenditures and a charge for the depreciation or using up of fixed capital. A profitable firm that makes large outlays for new plant and equipment does not report to its stockholders that it is therefore suffering a loss. Conversely, firms that let their capital run down, never replacing that which has worn out or become obsolete, are not able to report for long that their bottom line is really very good.

Actually, there is a good model to find within the federal government itself. That is the highly respected national income and product accounts (NIPAs) kept by the Bureau of Economic Analysis. As of a few years ago, following the internationally endorsed System of National Accounts, our BEA has set up separate capital accounts for all government--federal and state and local. The break-down of GDP (gross domestic product, in Table 1.1) ⁽²⁾ now includes a total, designated "Government consumption expenditures and gross investment." Then, in going from gross to net domestic product (Table 1.9), there is a subtraction not only for private consumption of fixed capital but also for government consumption of fixed capital (which came to $151 billion in 1997). This, in turn, is broken down into general government and government enterprises.

Section 3 of the NIPAs is then devoted to "Government Receipts, Current Expenditures and Gross Investment." A first table (3.1) ⁽³⁾ reports "Government Receipts and Current Expenditures," along with their difference, "Current surplus or deficit (-1), national income and product accounts." Unfortunately, it does not add a line for depreciation or capital consumption.

Tables 3.1 and 3.2 present separate current accounts for federal and for state and local government. Table 3.7 then shows "Government Consumption Expenditure and Gross Investment by Type" and does report consumption of general government fixed capital, broken down for the federal government into "National defense" and "Nondefense" categories. And here the consumption of fixed capital or depreciation is included in the totals of government consumption expenditures.

The NIPAs then contain a "Saving and Investment" section 5. Table 5.1, entitled "Gross Saving and Investment," includes both gross private saving and gross government saving, the latter broken down into federal and state and local. In each case, the total comprises consumption of fixed capital as well as the current surplus or deficit (-1).

We should have three sets of federal accounts: 1) a current account that includes depreciation or capital consumption as a cost; 2) a capital account that contains all investment outlays; and 3) a consolidated or truly "unified" account that puts the current and capital accounts together. ⁽⁴⁾ The consolidated account would tell us the total budget surplus or deficit, essentially the borrowing requirements of the government. The current account would tell us how much of the nation's resources the government is actually commanding or using up. And the capital account would give us the vital information of how much the government is providing for the future.

Lacking a set of accounts of this nature, policy makers are encouraged into uneconomic action. A major argument for eliminating budget deficits--much more dubious I have argued for years, than is usually recognized--has been that it will increase "national saving." This is the sum, as conventionally and currently measured, of private saving and government saving, the latter equal to budget surpluses. When we have deficits, these surpluses are negative, thus at least arithmetically implying a reduction in the total of national saving. ⁽⁵⁾ But suppose Congress and the Administration decide to reduce the deficit by cutting government investment, say to replace antiquated, run-down school buildings or bridges or to invest in more airport runways and terminals or in new computers. Even if private investment rises, the total of public and private investment may well fall. That would hardly be a way to provide more for the future, the ostensible aim of deficit reduction. Yet without a capital budget that may well be the path chosen.

Many of those opposed to developing and using a capital budget in our unified accounts, I fear, have an ulterior motive. They are, in some cases, "deficit hawks," who fear that the introduction of a capital budget will foster public acceptance of overall government budget deficits. Their reasoning is that attention will be focused on the current account, which may be in balance or even in surplus while there is extensive borrowing to finance capital expenditures.

As a matter of fact, the federal government has been starving investment so much in recent years that a correctly constructed set of accounts would show the current expense budget more in deficit than the consolidated budget, and the capital budget, if we restrict ourselves only to investment in tangible capital, in substantial surplus, as we do not have enough such public investment to match depreciation or capital consumption.

Indeed, Table 6-11, prepared by the Office of Management and Budget (OMB) ⁽⁶⁾ confirms this in estimates for fiscal 1999. What is called there the "Operating Budget" includes $85 billion in depreciation and, with total expenses of $1,752 billion, is $10 billion in deficit. The capital budget, by contrast, is $19 billion in surplus, reflecting $85 billion of depreciation and only $66 billion in capital expenditures. The unified budget is thus $10 billion in surplus, which lead some to assert that we are contributing to more national saving. In fact, the separate capital budget makes clear that we are eating our seed corn.

But this is only part of the story. A proper set of national accounts should include not only investment in fixed or tangible capital. It should recognize the much greater--and as seen now by many economists, more vital-- investment in human and other intangible capital. Unfortunately, neither public nor private business accounting handle this appropriately. Thus, investment in research and development other than facilities is expensed, not capitalized. Similarly, while computer hardware expenditures are capitalized, our vast outlays for software are not.

In estimates I prepared some years ago ⁽⁷⁾ I reported that, as against conventionally measured business investment of $344 billion in 1981, there was $68 billion to be credited to research and development and all of $640 billion to education and training. There was thus a total of $708 billion of intangible investment that was not included in BEA's measure of gross private domestic investment, which came to only $475 billion. Adding in this intangible investment would have increased the total by 149 percent!

Office of Management and Budget (OMB) estimates for fiscal 1999 for the federal government are in line with this. As shown ⁽⁸⁾ in Table 6-1, "direct major public physical capital investment" was put at $68.8 billion, of which $50.3 billion was for national defense and only $18.5 billion for nondefense. In addition, grants to state and local governments for physical investment were calculated at $44.4 billion, bringing the total to $113.2 billion. But federal investment in research and development amounts to $73.7 billion and investment in education and training, including $29.8 billion in grants to state and local governments, totals $50.0 billion. "Major Federal investment outlays" for fiscal 1999 are thus put at $236.9 billion, 109 percent more than the total of physical investment alone. And, it should be noted, the OMB does not include here "tax expenditures" entailing subsidies for private investment in education and training or health. Indeed, no investment in health, except for facilities and research, is included.

It should be clear that comprehensive, consistent accounts including separate consumption (or "current" or "operating") and capital or investment accounts can be presented within the unified budget. It is of enormous importance that this be done if we are to have the benefit of proper information on which to analyze the state of the economy and the impact of government. And it is of enormous importance as well if we are make enlightened, correct decisions affecting the lives of our children and grandchildren, as well as our own.

Appendix: Illustrative Accounts for Saving and Investment and Government Expenditures and Receipts With Separate Current and Capital Budgets. ⁽⁹⁾
 

Source: Survey of Current Business, August 1993, p. 55, Table A.--Summary National Income and Product Accounts, 1992, Account 5.--Gross Saving and Investment Account.

Sources: National Income and Product Accounts, Survey of Current Business, September 1993, p. 12, Tables 3.2 and 3.3, Federal and State and Local Government Receipts and Expenditures, respectively; pp. 30, 32, 34, Tables 3.15, 3.16 and 3.17, "Government Expenditures by Function," "Federal Government Expenditures by Type and Function," and "State and Local Government Expenditures by Type and Function"; Bureau of Economic Analysis, from John Musgrave, "Fixed Government Capital (including residential) historical-cost valuation, gross investment, depreciation and net investment," total; National Science Foundation/SRS, National Patterns of R&D Resources: 1992, pp. 47,48, Tables B-2 and B-3, and data and estimates from Carol Evans of Bureau of Economic Analysis; consumption of intangible capital assumed equal to two-thirds of gross intangible capital expenditures.

Sources: Table 3.2, above, and Survey of Current Business, August 1993, p. 55, Table A.--Summary National Income and Product Accounts, 1992, Account 5.--Gross Saving and Investment Account.

Footnotes:
1. William R. Kenan Professor Emeritus of Economics, Northwestern University.

2. See, for example, Survey of Current Business, Volume 78, Number 3, March 1998, p. D-2.

3. Ibid., p. D-7.

4. An illustrative set of such accounts, which I have calculated from 1992 data, is presented in the Appendix.

5. Whether reducing public deficits actually increases national saving, I have pointed out, depends on private saving not going down by as much or more than public saving increases. But total saving must equal total investment, the sum of gross domestic investment and net foreign investment. If government deficits are decreased, for example, by an increase in taxes, can we be sure that the consequences may not include a fall in private domestic investment as well as consumption? I like to pose the question, "If an increase in taxes--or a cut in Social Security payments or other income received from government--leads us to buy fewer new cars, is that going to lead the automobile industry to invest more--or less?"

6. Budget of United States Government, Analytical Perspectives, Fiscal Year 1999, U.S. Government Printing Office, 1998, p. 151.

7. In The Total Incomes System of Accounts, Chicago: University of Chicago Press, 1989, Table 1, pp. 156 and 157.

8. Budget of United States Government, Analytical Perspectives, Fiscal Year 1999, U.S. Government Printing Office, 1998, p.125.

9. From Robert Eisner, The Misunderstood Economy, Boston: Harvard Business School Press, 1994, pp.37, 53, and 55.