Chronically large federal budget deficits:The American experience

(This policy bulletin is extracted from FMF monograph published 1998 written by Roger W Garrison.)

The unified budget

One issue relevant for gauging the current fiscal excesses – but also of a more general relevance in understanding the nature of government debt – is the issue of what debt counts in assessing fiscal responsibility. There is a popular argument currently coming from both sides of the political spectrum according to which only a particular portion of the deficit is a legitimate cause for concern. The government’s budget, in this view, should be divided into a capital budget and an operating budget. Debt associated with the capital budget, which finances real assets whose value wholly offsets this part of the debt, is nothing to worry about. Just like a homeowner who finances his home with a mortgage or a businessperson who borrows to establish or expand his business, the government borrows to finance projects, such as highways, waterways, and parks, that will benefit taxpayers for years to come. Here, government debt – so the argument goes – is simply a means of creating a pay-as-you-go basis for using the government-provided facilities. It serves to avoid burdening the current taxpayers at the outset for the entire cost of long-lived public assets. The other component of the budget, the operating budget, is a different matter. Expenditures associated with entitlements programs and for other current benefits should be funded by-and-large with current tax revenues. Spreading the costs of these publically provided benefits over a prolonged financing period has no economic justification.

However, the technical, political, and even theoretical difficulties in separating the government’s capital budget from its operating budget suggests the inadvisability of even attempting to do so. The government’s use of a unified budget (with the capital component and the operating component simply added together) reflects a fundamental difference between the public sector and the private sector. Assets in the private sector that justify a separate capital budget can be valued on the basis of market prices. There is a market for the homeowner’s home and for the capital assets of a business firm. The housing market and the stock market provide timely and independent verification of the values that borrowing helped to bring forth. But there is no market for the highways and other capital projects of government. Significant in this respect is the government’s convention for attributing value to publically provided assets: The actual expenditures made as taken to be a proxy for value created. The millions of dollars borrowed and spent on a waterway project, for example, show up on both sides of the government’s capital budget. This supposed value which exactly offsets the debt, though, is more accurately described as sunk costs. There is no independent means of establishing that the actual value is anywhere close to the costs – or even that it is greater than zero. The taxpayers may have to service this part of the debt while receiving little or nothing in the way of benefits. Further, with no market for the shares of Government and Co., Ltd., there would be no check on the government’s decision to include all manner of spending programs (medical, educational, environmental) in the capital budget in order to minimise the imbalance in the reported operating budget.

The deficit in the unified budget, together with the accumulating debt does provide some indication of the fiscal excesses of government even if it provides no actual incentives for the government to do something about it. Separating out the capital budget from the operating budget would only create the illusion of a difference and would suggest that government is somehow being run on business principles, when in fact it is not and cannot be so run. In the absence of effective constraints on its authority to tax and to print money, the government is simply not subject to the market’s discipline of profit and loss and cannot conduct its affairs as if it were.

Closing the loopholes

Any deviation from measuring the debt and deficit in terms of the unified budget should be in the direction of incorporating the many off-budget items, which currently provide the government an escape valve from accountability, and banning all further use of off-budget budgeting. Although the distinction between on- and off-budget spending has become much more a matter of politics than of economics, some government operations that actually collect fees for services rendered, such as the Tennessee Valley Authority and the United States Postal System, have their own separate budgets. Also, the “special” bond issues of the early 1990s used to financed the governmental bailout of the Savings and Loan industry were “special” in their being off-budget. (The revenues from the increased deposit insurance premiums were not similarly “special,” which meant that the reported unified deficit was actually reduced as a result of the debt-financed bailout.) The deficits in these off-budget operations do not show up in the government’s unified budget. Incentives for the government to balance its budget, then, can easily get perverted into renewed efforts to de-budget the budget, that is, to finance government spending on an off-budget basis to avoid increasing the deficit in the unified budget. Clearly, this loophole, which now allows the government to hide part of the deficit, should be closed as an essential prerequisite to reform in the direction of fiscal responsibility.

Concerns about our grandchildren

Finally, we can note that the chronic fiscal irresponsibility provides no basis for a sermon about imposing a burden on our grandchildren. We have all heard that lop-sided argument too many times before. The long-established practice of double-entry bookkeeping suggests that there are strict limits to pushing the net burden of borrowing into the future. At death, we tend to leave behind our assets as well as our liabilities. Some grandchildren will inherit interest-bearing government securities – if not directly, then indirectly through banks or other financial intermediaries. Others will inherit the tax liabilities for paying that interest. What we are leaving to our grandchildren, then, is a fiscally unbalanced playing field – one that pre-ordains that some will pay and some will receive.

Source:This policy bulletin may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author's and are not necessarily shared by the members of the Foundation.  

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