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Building America to last: a smarter investment strategy can end the recession and balance the budget.

A smatter investment strategy can end the recession and balance the budget

And so, my fellow Americans, to summarize my budget recommendations, I propose that we stick to the economic program that has gotten this great nation where it is today-borrowing and spending about $300 billion a year more than we take in.

We won't use that money for investments in transportation, schools, and research that might spur long-term economic growth and thus create enough wealth to repay our creditors. Instead, we'll go deeper into debt to meet current expenses, like subsidies for those who can buy the political influence to get them.

Oh, I can hear the naysayers now-whining that piling more debt onto our kids to pay these short-term bills is unfair. Or immoral. Or that it k anyone guess how they'll be able to dig themselves out without living less well than we do.

Well, my fellow Americans, I refuse to yield to those who doubt the pluck and ingenuity of America's children. God bless those children -and God bless these United States.

Okay, maybe these won't be the exact words we'll hear when the president unveils his fiscal 1993 budget this winter. And maybe George Mitchell and Tom Foley's Democratic response won't sound like this either. But strip away the window dressing and the partisan rhetoric and the facts are plain: This borrow-and-spend philosophy is indeed the bipartisan fiscal policy of the United States, and it has been for 10 years.

The fact that it's "borrow and spend" and not "borrow and invest" helps explain why our children and grandchildren will curse our stewardship. The record, after all, is grim. We've quadrupled the national debt from $900 billion in 1980 to $3.6 trillion today-with $5 trillion in sight by 1995 if we keep hustling. That means that, while real incomes have stagnated, every household's share of the debt tab has spiralled in the last decade from $1 1,000 to $39,000. This year, interest on the debt edged out defense as the federal government's biggest expense.

Debt is not always a bad thing, of course; it's what it's used for that determines whether it's been smart or stupid to borrow. Yet the federal budget process ignores, by design, the one distinction that businesses, states, and families all use to make sure they're thinking soundly about debt: the distinction between investment and consumption.

Investment is what builds wealth, either for individuals, businesses, or nations. Companies invest when they build a new plant to hike production; so do cities when they upgrade their airports to attract new business to town. This type of investment creates both short-term jobs and long-term economic benefits-a combination that can help jumpstart a sluggish economy. Investing in transportation, for example, pays off not only in smoother, safer roads somewhere down the line, but also in the short run to the tune of some 41,000 new jobs for every $1 billion spent.

Consumption expenditures, by contrast, are just what they sound like. Dollars spent now on, say, plane fares or pension payments or paper clips are gone forever. Lumping investment and consumption expenses together, as the federal budget does, is more than just an accounting no-no. It's as if Uncle Sam saw no difference between borrowing to go out to dinner and borrowing to buy a house.

Say you're a Department of Health and Human Services official, and your Medicaid watchdogs need new office space. You scout the market and come down to two options. You can rent the space you need on a 20-year lease at 1 million a year. Or you can buy a good building outright for $5 million. You don't need an MBA to know that buying the building is a better deal. But because it involves a bigger cash outlay this year, your boss tells you it's a no-go. He'd rather do the lease -which looks on his budget like a smaller expense-and use the $4 million "extra" for other agency needs.

Welcome to the world of "cash budgeting," where taxpayers fund such cockeyed choices because, in the government's "unified" budget, all outlays are created equal. That basic bookkeeping disincentive plays out in thousands of different, expensive ways, even in places where a small investment has a clear economic payoff. Consider: The energy efficiency of government buildings has remained flat over the decades (the Environmental Protection Agency and Department of Energy are among the least efficient), while the efficiency of private sector buildings has grown two- or threefold thanks to new technology. Getting the government up to par could start paying off this winter. Similarly, a relatively minor investment in an IRS computer system that could systematically pick out tax cheats would begin saving federal money immediately. So would a beefed-up investment in the government's Women, Infants, and Children Program for improving the nutrition of expectant mothers and young children, as money spent now on properly feeding these babies saves millions in health care costs later. But these days there's no budgetary compulsion to make those investments. All incentives point in the opposite direction.

In a period of budget restraint, this bias against capital investment adds an extra accounting hurdle to the huge political obstacles already facing long-term investments. With visionary bookkeeping like ours, it's no surprise that the share of national income devoted to investment has plummeted by one third since 1973. Or that, compared to investment juggernauts like Germany and Japan, we're spendthrifts. "Without sufficient investment in new factories, highways, research, education, and all of the other factors that determine the productivity of our labor force," Controller General Charles Bowsher told a Senate subcommittee last spring, "the United States will not be competitive in the future world economy." With federal spending now accounting for a full quarter of GNP, getting Uncle Sam serious about investment may begin lifting us out of the recession the right way. And in the long run it may also mean the difference between our kids' living through an era of national renewal or becoming a lost generation.

Divide and prosper

At the root of our wholesale capital neglect is an elementary political problem. While most Americans would surely agree that our physical and human infrastructure deserves far-sighted, sensible investment, those investments don't have anything like the organized, letter-writing constituencies that support pensions, Medicare, farm subsidies, or dozens of other consumption programs. In fact, many of the beneficiaries of investments haven't even been born. So when push comes to shove, it's easy to guess which outlays our leaders choose to defer. Politicians don't get punished at the polls for rusty bridges-and when the bridges finally collapse, it'll probably be on someone else's watch.

States have avoided this trap through a sensible bookkeeping strategy-capital budgeting. Typically, the budget is divided into two parts: an operating and a capital component. By law, most states are required to balance the revenues and expenses of their operating component each year. They can borrow, however, to fund capital expenses. Because the balanced operating budget includes the annual interest payment owed on the outstanding debt, there's a built-in discipline that requires planning for repayment even as debt is incurred.

And if the states don't watch themselves, Wall Street will. If the budget gets too far out of line, a state's bond rating drops, and funding for roads, buildings, and other bond-supported items dries up. While this duet of internal and external controls has proven effective, it is far from perfect. In Minnesota, for example, where a 60 percent legislative majority must approve bond issues, capital projects are routinely traded for votes. But putting these shenanigans aside, capital budgeting clearly helps governments to invest and borrow smart. Maybe that's why even Japan divides its overall General Account into similar pieces.

Buried in a recent budget document of the Office of Management and Budget (OMB) is a summary of what the federal budget would look like if it were recast using this capital vs. operating approach. The bottom line? Just a nickel of each federal dollar we spend now goes for investment. And, in the best tradition of third-world debtors, 70 percent of the money we borrow goes to pay interest on the debt we've already piled up.

Consider some of the whopping investment shortfalls we're about to pass on to future generations-along with huge debts that, instead of being spent on ourselves, might have been used to plug the gaps:

>Infrastructure: The Department of Transportation says 40 percent of interstate roads are in fair or poor condition. The General Accounting Office (GAO) says 5,200 bridges are "critically deficient." And the blue-ribbon National Council on Public Works Improvement, in its report, Fragile Foundations, warns, "We are drawing down past investments without making commensurate investments of our own."

That conclusion is not surprising when you consider that the share of federal dollars devoted to infrastructure spending has fallen by half since 1965. Even after the 41 percent boost provided in the recently passed transportation bill, our annual infrastructure investment will amount to approximately 1 percent of GNP, compared to Germany's 3 percent and Japan's 5 percent.

What will it cost our kids to fix the broken roads, bridges, airports, and sewers if we don't? Depending on whose numbers you prefer, an extra $20 to $50 billion a year.

>Research and Development: An advanced economy wins in international competition by translating scientific breakthroughs into new products and processes. And our R&D investment-about 3 percent of GNP-appears competitive at first glance. But the picture changes when you take out defense-related research, which can't be counted on these days to spin off commercial applications. While we gladly spend a million bucks on a prototype uniform for the Air Force or on tastier dehydrated field rations, the rate of federal spending on nondefense R&D has dropped by 50 percent since the mid-sixties.

The result? While Germany and Japan today devote nearly 3 percent of GNP to commercial R&D, the U.S. spends less than 2 percent. The tab to achieve parity with our leading competitors would be about $50 billion a year.

>-Education: Money may not be the answer to all that ails our education system-but for kids in poor districts, it could be one helluva help. Tennessee began investing in 1985 to lower the student-teacher ratio in some of its poorest school districts. It had to wait a few years for the results, but it was worth the wait: The kids in smaller classes registered significant increases in reading and math scores.

Investing in education matters in the short run, too. For example, if the administration fully funded Head Start-that is, provided the extra $2.2 billion Congress asked for-it would mean 70,000 more teaching jobs in the next 12 months, as well as smarter graduating classes 12 years down the road.

In Princeton, New Jersey, the public schools spend $8,300 per pupil yearly, double what down-and-out Camden can afford, Governor Jim Florio, whose days are numbered in part because he has tried to remedy this sort of inequity, can tell you that rich districts aren't interested in reforms that improve poor schools at the expense of their own. That means that equalizing opportunity will require new funds.

How much? One study suggests that at least .5 percent of GNP-or about $25 billion a year-is needed to bring U.S. spending on grades K through 12 up to the average of the other industrial nations.

To be sure, federal dollars alone can't fill all of these gaps-but neither can the feds shirk their essential leadership role. And in spite of the president's inaugural lament that we have "more will than wallet," there's plenty of money to invest if we're ready to shut down the unfair consumption and phony investment programs we bankroll today.

As the first step in doing that, we'll have to take the states' capital budgeting scheme one step further.

Capital crimes

In 1957, the Ford Motor Company, after a quarter billion-dollar investment, unveiled its newest, state-of-the-art automobile-the Edsel-and promptly lost $350 million when consumers stayed away in droves. Despite the red ink, the Edsel was an "asset" on the books-an asset that nearly sank the entire company.

In all account books, "capital" can be a pretty misleading term. A truly effective capital budgeting plan would do what states and companies still quiver to do: aggressively make distinctions between things that truly contribute to the nation's resources-like lowering class size to help disadvantaged kids learn to read-and those whose value ends on the ledger.

Take our current "capital investment" in the B-2 "stealth" bomber, whose $700-million-a-copy cost is as high-flying as its mission is obscure. After playing bait-and-switch with this mission for years, the Pentagon now tells us that the B-2's real purpose is to find and attack Soviet mobile missiles. Forget for the moment that 1) our difficulty in finding Scud launchers in Iraq suggests that this may not be feasible; 2) the Pentagon admits the technologies don't exist to let the B-2 even try; and 3) much cheaper planes are likely to be as effective. With the collapse of the Soviet Union and with arms-reduction initiatives in the air, the B-2's secret mission-as a bargaining chip-may not be worth a cent.

It's time we owned up to the Edsel on our hands and wrote off the $35 billion we've sunk in the B-2. According to Congressional Budget Office estimates, halting this dubious investment at the 15 planes already authorized (and scrapping the 60 more now planned) would free up $4 billion a year through 1997. That's enough to fully fund bona fide long-term investments like Head Start, whose lack of cash today closes the door on a shameful 73 percent of eligible kids.

Meanwhile, on the consumption front, why don't we means-test old-age "entitlements" and invest the savings in our schools? Almost $30 billion in social security, Medicare benefits, and federal pensions go each year to households with incomes of more than $100,000. This money is being redistributed by Uncle Sam from households whose average yearly income is just $30,000. Wouldn't we be better off investing this $30 billion in the education of tomorrow's work force? With this kind of money, we could lower the student-teacher ratio in poor districts and equip them with the textbooks, computers, and safe buildings their well-heeled neighbors take for granted, and we'd still have money left to offer scholarships to college students who'll commit to serving as math and science teachers.

Options like these suggest the possibilities if we get serious about the stakes. With an urgent investment agenda, and capital budgeting as a proven tool for managing it, the inevitable question follows: What keeps us from getting on with the j ob?

A delicate balance

Like most good ideas in Washington, capital budgeting has been kicked around for years-to no avail. Support for it "doesn't break down by party," says Controller General Bowsher, a long-time capital budgeting advocate. "It breaks down by the background of the individual." Not surprisingly, Republicans tend to bring more business types into office who wonder why government doesn't handle its books more sensibly. But through the seventies and eighties, even supporters of capital budgeting tended to concede that it has two fatal flaws: It will be used as an excuse to justify new spending, and the classification of expenses as "capital investment" will be abused to make this possible. In these deficit nightmares, liberal Democrats will cook up measures like "The Conscientious Objector Investment Act" to give truckloads of cash to able-bodied people who, on principle, just don't feel like working.

This isn't a groundless fear. "Every time it comes up," says budget expert Stan Collander, a former Hill staffer now at Price Waterhouse, "it's always by people who want to spend more." Carol Cox, president of the watchdog Committee for a Responsible Federal Budget, warns, "You can't have a separate class of expenditures that we pretend is costless." New York City learned that the hard way in the mid-seventies, when it went broke after shifting millions of dollars of police salaries and vocational education costs into its capital budget and then borrowed to fund them.

This prospect-of-abuse argument is laughable to anyone who's stepped within 100 miles of today's budget circus. After all, the government now functions under a scheme that for years has declared deficits to be under control when in fact they've skyrocketed.

Sure, there will be classification disputes if capital budgeting is implemented. For example, no state currently treats investments in education and training as "human capital" that will bring long-term returns.

But making distinctions between true and false capital is obviously vital to sensible investment. We can't go into debt to pad bloated board of education bureaucracies. That's not capital; that's waste. But to the extent that we do borrow, why borrow to pay windfall pensions when we could be underwriting a school year as long as Japan's? Why borrow to subsidize profitable megafarms when we could instead provide seed money for a school-to-work apprenticeship program like Germany's?

The trick is to identify real capital-an exercise in definition that most states conduct using strict accounting rules. In New York state, for example, the salary of an architect who designs bridge repairs comes out of the capital budget, while the salaries of people who operate the bridge-the budget manager or toll collectors-come out of the operating side of the budget. At the federal level, similar standards could be enforced by a bipartisan board of accounting wizards, whose assignment would be to stand watch over the definition of "capital." But the bigger point is that this very debate about investment is precisely the kind of dialogue our consumption-crazy country needs. If every annual budget presentation, by virtue of its capital vs. operating layout, forced a discussion of whether the government's plan is meeting our nation s investment needs, we might begin doing right by our kids.

Budget director Richard Darman is making encouraging noises. At his behest, a task force from OMB, GAO, and the budget committees recently began exploring budget process reforms, including the use of capital budgeting. But Democrats, perhaps wanting to snub a Darman initiative, haven't joined the Republicans in detailing their highest-ranking staffers to the team.

Meanwhile, as the task force talks, the government will borrow another $400 billion dollars before the November election, create few of the jobs necessary to end the recession, and invest astonishingly little. The year after, the interest on that borrowing will eat up an additional $30 billion, as our biggest federal program-interest payments-crowds out every investment priority in its way. And a generation of children, unaware of the grim inheritance being prepared for them, will laugh as kids always laugh. And their parents, who have the power to change things, will do ... what?

Speaking of high-stakes accounting, capital budgeting isn't the only bright idea we need. Along with a mammoth investment shortfall, today's twenty-somethings are inheriting some crushing but little-discussed liabilities, courtesy of the government's generous retirement programs. Unreformed, these entitlements" amount to an astounding $14 trillion in today's dollars-with only a few pennies currently set aside.

Here's where the costliest liabilities lie: Social security. As it turns out, the Greenspan Commission's 1983 "fix" was just a band-aid. The "surpluses" you hear about today-which in any event are being spent to cover the rest of the government-will be totally inadequate for tomorrow's inexorable demographics. In the fifties, nearly 10 workers paid payroll taxes for every retiree drawing a check; today the ratio is three to one and narrowing.

While you won't hear a peep from them until the next crisis looms, our politicians know what this math means. Only massive new tax increases on today's young folks will prevent the system from going bankrupt when the postwar baby boomers hit the rocking chairs early in the next century. Can this be fair?

Contrary to popular myth, today's retirees get back from the system between two and five times what they put in. This windfall-which is only partially taxed and fully indexed against inflation-is funded by regressive and ever-increasing payroll taxes on workers who've seen their own real wages stagnate for two decades and who have no assurance the system will be there for them.

How will today's twentysomethings react when our politically powerful parents try to tax the pants off us in a few years to keep the checks rolling? Did somebody say "generational war".1

Federal pensions. The $60 billion the federal government spent last year on retirement programs for its employees was more than it spent on higher education, consumer safety, AIDS research and treatment, Aid to Families with Dependent Children, food stamps, and low-income housing combined.

What's more, these pensions are by any standard the most generous in the nation. Consider: Two out of five civil servants retire before age 55, and at a percentage of preretirement pay that dwarfs that of programs in the private sector. Disability criteria are so lax that more than one quarter of federal pensioners collect extra for being "disabled."

Sound cushy? Well, the median age for military retirement is only 41. After 20 to 30 years on the job, the serviceman, who makes no contribution to his pension, retires on 50 to 75 percent of his highest pay. He's also free to collect social security and pursue a second career to achieve the armed forces' famed "triple dip" pension.

If the government had to act like a business and put money in reserve each year against these and other "unfunded liabilities" (Medicare's the other huge one), the budget deficit-officially projected at a record $362 billion in fiscal 1992-would double.

But what's worse is that the "official" annual deficit wildly understates the increase in the national debt during the year. If you think that's wrong, you're right.

Here's the anatomy of the fraud. In the fiscal year that ended September 30, 1991, the "official" deficit was $269 billion. But the increase in the national debt for the year turned out to be $408 billion. How? Most of the difference occurs because our government prefers not to count money it borrows from its own retirement trust funds as debt," or interest it pays to these trust funds for past borrowings as an expense,

But while the "official" deficit figures don't count such intergovernmental debts, today's young adults will one day have to honor them. Otherwise, the trust funds (like social security) will be holding only worthless IOUs by the time we hit old age.

The bottom line? Since 1985, our published deficits have added up to almost $1.4 trillion; but our debt-for which today's kids are going to be on the hook-has gone up by more than $2 trillion. What Senator Terry Sanford of North Carolina calls a "cover up" amounts to more than $650 billion since 1985. But what's $95 billion a year between friends-or between generations'?

Some fiscal hairsplitters make the case that the official number, excluding intergovernmental borrowing, is actually the better measure of Uncle Sam's impact on the private credit markets. Maybe. But isn't it about time we began to measure the impact on the next generation-publicizing the real increase in our debt? Senator Sanford thinks so, and for three years has been peddling a bill that would do that.

Facing the true debt will be a start. As for fixing it-well, don't just sit there. Rally your friends. March on Washington. And, if you're in the media, spotlight the stakes every chance you get. Because clearly our politicians won't. M. M.
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Title Annotation:includes related article on deficit financing
Author:Miller, Matthew
Publication:Washington Monthly
Date:Jan 1, 1992
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