Business Columns & Blogs

Ed Lotterman: Government accounting promotes poor decisions

Government accounting is less complete than in the private sector. That hurts the level of information in public discourse on important issues and the legislative process at both state and federal levels.

That is not a new insight, but it was brought home to me in reading a local weekly newspaper story about a meeting of the county board where I grew up. The county engineer, in reporting to the board, noted that only $80,000 in state funding was available this year for repairs to county-state aid highways in this 466-square-mile area. At that level of annual expenditure, it would take 40 years to complete all the repairs needed.

This is congruent with a conversation with another rural county engineer last year who noted that when he started, the goal was to replace county culverts and bridges on a 35- to 50-year rotation, but at the pace reported last year, it would take more than a century.

Leaders in rural areas know we lag in maintaining infrastructure, but this is hard to quantify, in part because we don’t keep track of the value and depreciation of long-term assets the way a private business has to. This is as true for counties and states as it is for the federal government. Yet the failure to properly include such depreciation of assets in government accounts and the practice of listing long-term investments as simple “outlays” compounds the problem.

We don’t, for example, have a federal balance sheet that includes the value of assets such as the aircraft carrier USS Carl Vinson or Yellowstone Park or Interstate 84. We don’t tabulate the worth of the state highway a half-mile from my house or Ponderosa State Park. We don’t keep a compilation of these assets’ original cost or what we would have to pay to replace them or what we might get if we sold them.

Moreover, we don’t keep track of these assets’ depreciation, or annual decline in value due to age and use. We don’t even always distinguish between short-term expenses and longer-term investments in productive assets.

A private-sector example might be a warehouse that buys sweeping compound or pays for light and heat. These are clearly short-term expenses. They are things that are used up and have no residual value. But a new forklift or a set of pallet racking will provide service for many years. The business has converted one kind of asset, cash, into another kind of asset, equipment. For this second outlay, the expense in any given year is the amount by which this equipment declines in value, but not the total outlay to purchase it.

We spent many billions of dollars during World War II, including the carrier USS Essex, off of which my Uncle Jack flew. Government accounting treated the ship as an expense in Fiscal Year 1942 and the bombs he dropped as ones in 1944. But the ship continued in service until 1969. In reality, the ship’s economic “expense” stretched over 27 years, even though we accounted for it the same as a bomb that blew up a few months after its manufacture. This accounting exaggerated our defense spending during World War II itself and underestimated it for decades after.

Similarly, we spent many tens of billions constructing the interstate highway system over 25 years after authorizing legislation passed in the mid-1950s. But those highways continue to provide valuable service to businesses and households decades after the durable investment in land acquisition and earth-moving was listed as an annual expense in federal budget records. A private business that must use accrual accounting, including calculating depreciation, would have a much more accurate reflection of its financial state.

This omission obscures public understanding of how we use resources. Cut back on maintenance of roads or parks or government buildings and you reduce apparent “government spending.” But to the extent this means the infrastructure deteriorates, the “reduced spending” is illusory. It is a version of “smoke and mirrors” budget obscurity – perhaps historically practiced and highly accepted, but obscurity nevertheless.

This can lead to economically bad decisions. More fiscally prudent countries in Europe, including Germany, Switzerland and the Netherlands, tend to build roads with thicker and much stronger pavements. Over the life cycle of such highways, the cost per vehicle or ton-mile carried is lower than if less-strong roads are built. Society gets better transportation for roughly the same use of resources. That is precisely what economists mean by “efficiency.” But because the higher initial cost requires apparent immediate government spending, there is political motivation to go for inferior construction that costs more over the long run but doesn’t show up as “out of control government spending” this year. So that is what we do in many states and at the federal level.

Our grandparents and great-grandparents had far less comfortable lives than we do, but, from this limited income, were willing to put a higher proportion of resources into public infrastructure than we are. Many of our municipal water and sewer systems, city streets and country and township roads were constructed from 1875 to 1950. Now we are depreciating them out the way a South Bronx slumlord depreciates out a building before abandoning it. City and county officials, elected and appointed, know this is true, as do many citizens. But we don’t quantify it very well, and it is not well understood by either the general public or the media.

Yes, there are many difficulties in doing as comprehensive a job of accounting for government assets as does the private sector. What is the “market value” of the roads in the rural township, where my farm is located? What would it cost to “replace” Itasca, the crown jewel of my state’s park system?

Moreover, what if you view early childhood education as a true investment, an outlay now that provides a return, perhaps in the form of reduced costs, over decades? Our Democratic governor thinks this, as does my former boss, once research head at the Minneapolis Fed. Shouldn’t we then include such program outlays as an asset on a balance sheet? But if we do that, then won’t every group benefiting from some spending category perform logical and political acrobatics to get their largess also deemed “investment?”

Just because something useful isn’t easy does not mean one should shrink from it. And yes, there are some tentative efforts in this direction that already exist. But we won’t make sound economic decisions about public investment until we do a much better job at distinguishing annual outlays of cash from true annual spending.