Government accounting is peculiar, to say the least. It confuses people about spending on new roads, bridges and navy ships. It also distorts citizen perceptions of the state of government finances.
The problem is that while various levels of government do publish rudimentary income statements, they really don’t keep track of assets and don’t tabulate balance sheets.
An income statement shows how much money comes in and how much is spent. The federal government, states and local government units do this, in a fashion. That is how we know what the federal budget deficit was for some year or a state’s surplus in another.
But accountants consider these accounts crude and misleading. They don’t take into account depreciation of public property over time or other changes in the value of government assets. Spending on new projects with long lives – bridges, schools, nuclear subs – is written off completely in the year the contractor gets paid.
Virtually all private entities, for-profit and not-for-profit, use accrual accounting. If you spend $1 million on a new facility, you can’t write it all off as an expense in the year you wrote the check. Instead, you list the fraction of the $1 million that the facility declines in value or “depreciates” each year as the relevant expense.
Why is government practice misleading? Consider the U.S. Navy. At the end of World War II it had over 2,000 ships and thousands of smaller vessels. Most had been constructed during the war. There were dozens of aircraft carriers and cruisers and hundreds of destroyers and submarines. They represented the expenditure of tens of billions of dollars, a big chunk of total national output for four years.
Their cost already was written off. Yet the ships continued to provide defense service to the nation for decades.
From 1940 to 1945, our tabulated defense spending overstated what our military was costing us because it ignored the fact that some funds expended went into ships that would serve for years.
From 1945 to 1975 or later, our budget outlays understated true defense spending because it ignored the fact that ships were depreciating. We were getting more defense than we were paying for each year.
Navy ships are particularly sharp example of “block obsolescence,” in which a whole group of machines or facilities built during some era all wear out or become outdated during a short span of time.
After 1945, we never built as many ships as were wearing out, so the total number of ships fell steadily. When the Reagan administration came into office, there was much hoopla about maintaining a 600-ship Navy. Spending on construction did increase dramatically, but not enough to offset ongoing scrapping of older vessels.
That was not necessarily bad. Technology has changed. A modern ship can do more than several ones built 60 years ago. Moreover, the threats we face changed dramatically.
The same phenomenon applies to roads and schools. These are more relevant to current problems.
At the impetus of President Dwight Eisenhower, we spent large amounts constructing the Interstate Highway System between 1955 and 1975. We continue to add to the system. We do some maintenance. But in most recent years, the loss in value of what wears out exceeds new spending.
From 1948 through 1968, we constructed many local schools and college buildings. This was in response to the baby boom, the G.I. Bill that opened college education to the masses and National Defense Education Act spending motivated by fear of the Soviets.
After this spurt of construction, however, some states and school districts rested on their laurels. For years they spent less than the amount their buildings depreciated. They enjoyed more educational services than they really were paying for because they were depreciating out their earlier investments.
As attitudes toward taxes and government spending changed in the 1980s and as “no new taxes” became a common campaign slogan, most states reduced spending on both transportation and buildings below amounts necessary to offset depreciation.
Cutting infrastructure spending is seductive for political leaders. You can boast of having held the line on government spending and of having cut taxes without important consequences being obvious. What others spent on roads, bridges, schools and hospitals before you came into office continues to serve the public – at least for a time.
As long as the lag time is enough for that official’s term to end or for him to move to a higher post, willful shortsightedness never hurts his career. But it eventually does bite citizens in the rear.
Realize that such cut-spending-and-let-the-property-depreciate strategies are exactly what slumlords in the South Bronx followed for years. The result was a wasteland.
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.