Mismeasurement of Federal Spending, Investment and Saving

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform - Why We Need It and What It Will Take.”

Much of the motivation for deficit reduction, a goal shared by policy makers across the political spectrum, is the belief that deficits consume the nation’s seed corn. That is, deficits represent negative saving. Because saving is presumed to be the key determinant of long-term real economic growth, deficits deplete the supply of saving and thus reduce growth.

There are many problems withthis analysis. One is that it assumes that all government spending is consumption. In fact, much of it consists of investment. According to the 2013 budget (see Section 21, Page 356), the federal government will invest $550 billion this year in physical capital (buildings, equipment), research and development and human capital (education). This includes grants to state and local governments for these purposes.

It is perfectly reasonable to finance long-lived capital projects with borrowing. Because the benefits will accrue over many years, it would be silly to treat things like highways as if they were consumed within a single year for budget purposes. Virtually all homeowners know this and borrow to buy homes. They understand that the flow of housing services they receive on an annual basis compensates for the interest that is paid.

Unfortunately, the federal budget is silly in this respect. I! t treats investment spending the same way every other budgetary item is treated - as if it were consumption with no long-lasting benefits for the nation.

An unfortunate consequence of this budgetary convention is that reducing federal investment is viewed as beneficial if it reduces the deficit. Moreover, it is often easier to cut investment spending than consumption, just as homeowners suffering from an income loss may find that deferring maintenance or planned improvements is the easiest way to conserve cash.

But just as deferred maintenance on our homes, like putting off repairs to the roof, can be very costly in the long run, reducing the value and hence the net worth of our principal asset, the same is true of government investment. Maintenance that is deferred too long may require assets that would have lasted many more years to be replaced prematurely at much higher cost.

According to the American Societ of Civil Engineers, the nation is already in a net deficit position as far as building and maintaining its basic public infrastructure. The society estimates that the added costs to people and businesses from this underinvestment will reduce the aggregate gross domestic product by $3 trillion over the next decade. The group recommends an additional $1.1 trillion of public investment through 2020 to what is currently planned, $157 billion per year.

Of course, the federal government is not going to spend that much more because it would make the goal of balancing the budget more difficult, based on the way deficits are calculated, making no allowance for capital outlays. Indeed, it will be difficult to prevent cuts in investment outlays that will reduce such spending below current projections.

One solution to this problem would be to have a capital budget that segregates government investment spending from consumption spending. Virtually all the states do this already. Conservatives who! routinel! y defend a balanced-budget amendment to the Constitution, on the grounds that the states must balance their budgets annually, appear to be unaware that such requirements apply only to operating budgets, excluding capital outlays.

If households were required to balance their budgets the way balanced-budget amendment supporters want the federal government to operate, they would almost never be able to buy homes or cars. Such outlays almost always exceed their annual incomes over and above consumption and would thus constitute deficit spending.

Of course, families could draw down savings to buy homes and cars. But that’s an option not available to the government because it has no savings, only a large debt. Treating it and private individuals the same way, as balanced-budget supporters propose, would require the entire national debt to be paid off and a surplus accumulated before it would be permitted to make new investmens in roads, bridges, buildings and other long-lived assets.

Of course, no one actually believes that. But it follows logically from arguments one often hears about why the government should balance its cash income and outlays annually, because that is supposedly how families and the states are said to operate. In fact, they don’t.

The distinction between capital spending and consumption spending also affects the way economists interpret the rate of saving. The standard measure, produced by the Commerce Department, calculates personal income and personal outlays. The difference between these two figures is assumed to be personal saving. Thus saving is not calculated directly, but is merely a residual between income and spending.

An alternative measure of saving that treats consumer durables, like autos, as investments would raise the measured rate of saving considerably. Alternatively, one could measure savi! ng direct! ly from financial institutions and other sources, as the Federal Reserve does (see Page 17). This yields a much higher measure of saving. In 2011, the last full year available, the Commerce Department estimated the personal saving rate at 4.2 percent, while the Fed put it at 10.3 percent.

Periodically, administrations have suggested creating a capital budget, both to give clearer picture of the economic effects of federal spending and to shield investments from budget cuts that should be limited to consumption outlays. The Reagan administration floated the idea in 1986, and the Clinton administration created a commission to study it.

A common criticism has always been that the definition of “capitl” is too slippery and could too easily become a loophole through which consumption spending could escape. The obvious answer is to assign some entity, like the Government Accountability Office, to audit investment spending and ensure that it truly represents investment and not consumption.

Many economists say they believe that the best thing the federal government can do to raise the long-term economic growth rate is increase infrastructure spending. It would have the double benefit of mobilizing idle resources, especially unemployed workers, while low interest rates permit capital projects to be financed very cheaply.

One main barrier to achieving this double benefit is the confusion between investment spending and consumption spending, which is distorted by the way the budget is presented and the way we calculate saving.