On track with the deficit

Wriston, Walter B.

1989-01-06

On track with the deficit

On track with the deficit

 

It is always useful to have a simple answer to complex problems, and the budget deficit has served that purpose admirably. It is blamed for everything from America's supposed lack of competitiveness, to a low saving rate, to contributing to -- or even causing -- the trade deficit.

While there is disagreement over the effects of the budget deficit, and even its causes, most people would agree we have a problem and that the first step in solving it is to get the facts -- in this case, not as easy as it seems. The government is incapable even of telling us what the last quarter's GNP growth was with any precision; final figures are not issued until three years after the quarter's close and vary widely from initial reports -- yet all projections of future deficits are based on someone's estimate of the GNP.

To understand the dimensions of the problem we should look at the deficit in three ways: By what rules were the numbers assembled and do these rules produce meaningful data on which to base policy decisions? How does the U.S. compare with other members of the Organization for Economic Cooperation and Development? And, what is the economic impact of deficits of the size we have seen?

If the accounting principles used to determine the size of the deficit were adopted by your business, the SEC would doubtless bring criminal charges of misrepresentation of fact. There are off-budget entities such as the Social Security Trust Funds and some other federal operations whose transactions are excluded from the budget totals by law. This law produces an on-budget surplus or deficit number. The Gramm-Rudman-Hollings Act, however, at present includes two out of three Social Security Trust Funds and other off-budget items for the purpose of computing that deficit or surplus. Differences between the two numbers are estimated in the $40 billion range for 1988.

The new element in the economic equation is the Social Security system -- currently in surplus, and building at the rate of $76,000 a minute. Gramm-Rudman recognizes that in the real world it is a fact that a separate tax stream funds the Social Security Trust Fund, and that the cash thus accumulated is lent to the U.S. Treasury. This is a new situation, since for 50 years there were no trust funds -- benefits were paid out to retirees about as fast as taxes were collected from workers.

Whatever the future holds, it is a fact that part of our outstanding national debt is now funded by direct taxes on workers and much more of it will be in the future. The Social Security tax is now the biggest tax bite felt by most Americans, and it is scheduled to go up again in January 1990. If projections hold, no government bonds will be sold to the public in the mid-1990s -- the Trust Funds will take them all.

The second anomaly in the deficit numbers is that everything the federal government buys is "expensed" -- from the space shuttle to a 10-cent pencil. By contrast, a family buys a home with the help of a mortgage, since it is a capital asset, and balances its budget not against a one-time capital cost, but on a cash-flow debt-service basis. The familiar refrain that every family must balance its budget, so why can't the federal government, has a nice ring to it, but no family I know of expenses its home.

All businesses are run on the same principles. In 1987 business capital expenditures exceeded the before-tax business profits of all U.S. corporations by more than $100 billion. At the state level, this vital distinction between capital assets and operating costs is recognized, and some 37 states have a distinct capital budget with current operations reported separately.

Office of Management and Budget data show that in fiscal 1986, federal outlays for physical investments ranged from $84 billion for acquiring federally owned assets to $107 billion if one includes grants to states and local entities for their capital projects. In addition, federal direct loans, loan guarantees and government-sponsored loans amounted to about $42 billion. All in all, capital expenditures totaled 13.2% of total outlays, a not inconsiderable amount to expense, and if funded in a capital budget would produce near balance in the operating budget.

The reason the federal government has not brought its accounting into the 20th century is political, not economic. Everyone remembers that New York City got in deep trouble partly by classifying operating expenses as capital and thus "balancing its budget." The principal reason against instituting a capital budget is that many do not trust the national political process to maintain the discipline needed to distinguish between capital expenditures and operating costs.

Another anomaly in the way we keep our books is that we are perhaps the only country in the world that does not include the deficits or surpluses of the nation's political subdivisions, in our case the 50 states, in computing the national deficit. This is akin to a business failing to include the results of some of its divisions when reporting its earnings. Recent experience with the Financial Accounting Standards Board has taught us to pay attention to how accounting rules affect reported results; we should do the same with the federal accounting system.

The second way to look at the budget deficit is on a comparative basis with our neighbors. Exact comparisons are difficult, because foreign countries keep their books differently than we do. Even so, the U.S. budget deficit as percentage of GNP is smaller than that of France, for example, and falls in the middle of the range for all OECD countries. Today our ratio of net government debt (federal, state and local) as computed by the OECD is about 30% of GNP, about the same general range as Japan, Canada and West Germany, and much lower than Italy or Britain. Levels of saving appear lower in the U.S., and this is thought to make public deficits less tolerable here, but in an age of global capital markets, capital goes where it's wanted and stays where it's well-treated.

That brings us to the third perspective on the budget deficit -- its effect on the economy. While the deficit, as currently computed, has been blamed for all of society's ills, there is little hard evidence on which to form such a judgment. Not long ago, we were warned by experts that government borrowing would crowd out private financing and thus cripple our economic expansion. The crowding-out theory was all the rage, but it did not happen. As a historical note, most people have forgotten that when we emerged from World War II, the gross federal debt was in excess of 100% of GNP.

Much of the rhetoric regarding the presumed effects on our economy is based on the concept of closed national economies. While this view once had some validity and, indeed, is the framework surrounding much economic theory from Adam Smith to modern times, the world can no longer be understood as a collection of national economies managed in isolation from the rest of the world.

Borders that were once the cause of wars are now becoming porous. Money moves over, around and through them with the speed of light. The flows of capital are now in the range of 30 to 50 times greater than world trade. The world's capital that moves along this electronic highway goes where it is wanted and it stays where it is well-treated. This is why there was no crowding out, this is why foreign capital comes and stays in the U.S. As long as our free-market system permits and delivers an acceptable rate of return on investment in an environment of political stability that is competitive with other areas of investment, the capital will keep coming.

Large budget deficits are often said to cause high interest rates, but nominal rates on long-term Treasurys have fallen from more than 17% to about 9%. Real interest rates remain in the high end of the historical range. There are good economists who say the real interest rates are higher today than they would have been had we not had these deficits, but there are other scholars with equal credentials who believe that is really an assertion and not a documented fact. Both points of view are supported by reams of statistics.

Today the world looks at America and sees our GNP moving toward $5 trillion; it sees a huge creation of jobs; it sees manufacturing productivity rising at an annual rate of 4.3% since 1982, with unit cost falling, making the U.S. the lowest-cost producer in the G-7 according to recent IMF data. It sees our deficit, as measured, falling both in absolute terms and as a percentage of GNP.

While we are on the right track, we will always have problems to deal with. The real worry in the economy has been a trend that has been going on for decades: the growth of government spending on the federal, state and local level. In 1951, federal expenditures were 14.4% of GNP; by 1987 they had grown to 22.8% of GNP. State and local expenditures rose from 6.1% to 9.3% during the same period.

The good news is that the growth rate of federal spending reached a peak of 19% in fiscal 1980 and fell to 2% in fiscal 1987, a dramatic improvement largely ignored by commentators. Measured as a ratio of GNP, spending has fallen from a peak of 25% in 1983 to about 23% now. All in all, this adds up to real progress.

In the great American tradition, Gramm-Rudman is proving to be an effective compromise. As Lawrence Kudlow of Bear Stearns put it: "Budget experts don't like it because it puts the budget on automatic pilot. Conservatives don't like it because it prohibits heavy spending in the military defense area. And liberals don't like it because it cuts into spending on domestic social services and entitlements." But it is clearly working.

Mr. Wriston is former chairman of Citicorp. This article is condensed from a recent speech to U.S. executives.

 
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