Capital Budgeting: A Two Part Series on Principles of Long-Term Investment
August 17, 2017:
On the 55th Anniversary of President Kennedy’s Speech at the Oahe Dam, Pierre, South Dakota
by John Ascher
New Orleans and Katrina, 2005; Minneapolis, 2007 and the I-35 Mississippi River Bridge Collapse; February 2017, Northern California, and the failure of the Oroville Dam spillway….
Tired of fixing things in our nation only after disaster strikes?
Wondering what has gone wrong in our thinking that nothing can be done in advance?
In this two part series, we will examine a very relevant aspect of national planning related to long-term investment in infrastructure – capital budgeting- why it is needed, and why we have never been able to make that happen on a national level.
First, after introducing the subject, we will examine how we got off track, and then, in the second part, introduce certain scientific principles of capital budgeting.
And in the first case, you may be surprised to find out, that we went in the wrong direction as a direct result of the aftermath of the assassination of JFK.
But first, some background.
The Scale and Prevalence of Stupidity on this Subject
As we write, large construction teams are on an emergency footing deployed in Northern California to repair aspects of the once famous California Water System by October, including levees which protect thousands of people. Over 180,000 people were evacuated earlier this year along the Feather River in the Sacramento Valley because of this disaster.
Yet, in March, President Donald Trump, who promises infrastructure for our nation, produced his proposed budget, which included a nearly 50% cut for the Army Corps of Engineers’ Construction budget. Even conservative Republican Members of Congress were upset.
Congress (not to be let off the hook) passed in 2014, the ”Water Resources Reform and Development Act”, a multi-billion dollar authorization bill to significantly improve water infrastructure in the US. It has never been funded.
Overall, the American Society of Civil Engineers has given America a D+ mark on its 2017 Report Card on infrastructure. Levees, as one example, received a D. The group called for 2 trillion in spending to meet this crisis, yet we have nothing growing except inertia.
So, what do we hear when spending money for big projects is raised?
‘We can’t afford infrastructure, because we already have too much debt, and too large a deficit. When we increase spending for the space program, we have to cut something else, first. Medicare for all? Simply another vast boondoggle we can’t pay for’… Etc, Etc.
What’s the fallacy? In general terms, we have mixed consideration of expenditures for large-scale and long-term investments, into the consideration of what can be afforded in annual operating budgets.
We have adopted as a matter of doctrine, the belief that budget balancing, deficit elimination, and the austerity measures needed to bring this about, are the nation’s top priority for economic health. This is reflected over decades, in the adopted practices of the Congress, such as PAYGO (“pay-as-you-go”), CBO scores, and off-sets. One new item can never be voted up, unless something else is cut.
What types of investment create improvement in the nation’s wealth, and therefore increase government revenue is no longer considered or understood. It all comes down to money–there is no concept of physical economic value. One big zero-sum game taking us down the drain.
We hope here, to stand people on their feet for a change, so that you can finally understand that accounting measures, while necessary, are not the fountainhead of growth. They simply provide an indispensable form of regulating spending, based upon agreed upon priorities and strategies for growth.
Therefore, let us shine a light upon Federal Capital Budgeting.
First, a Simple Definition
So why discuss a Federal Capital Budget?
Capital budgeting simply means a method by which an entity can separate operating expenses from long-term investment, and account for capital improvement based upon the life span of that investment. So for government it provides a necessary means for regulating large scale spending for major capital improvements.
This is a long-standing practice for corporations, as well as for states and localities.
The Federal Government has never adopted that approach, despite repeated efforts, but instead has incorporated such short-term vs long-term distinctions through segregated funds such as the Federal Highway Trust Fund, and others. These were always compromise solutions, although very effective.
Recent History of the Fight for a Federal Capital Budget
The most recent thorough public examination of Federal Capital Budgets was the President’s Commission to Study Capital Budgeting, established by President Clinton in 1997, which issued its final report in 1999. The Commission had several well-known figures on its board including Jon Corzine (co-chair), and Robert Rubin. The final findings of the commission, and its failure to propose capital budgeting, in this author’s view, was wholly consistent with another failure of the Clinton Administration in the same year, the repeal of Glass-Steagall via the Gramm- Leach- Bliley Act.
After a thorough-going analysis of the current state of local capital budgeting, the inadequacies of spending on infrastructure, post-WWII declines in productivity, and the inadequacies of the Federal budget process, the Commission rejects the idea of Federal Capital Budgets on one primary ground: There can be no agreement of the definition of “capital”. (Page 22)
A more recent (2008) paper on the matter, issued by the Congressional Budget Office (CBO) under then Director Peter Orzag, reached a similar conclusion (with similar specious “reasoning”) in the following way:
“Moving to a budget that is more reliant on accrual-based Accounting (used in Capital Budgeting-ed.) could increase complexity, diminish transparency, and make the federal budget process more sensitive to small changes in assumed parameters, such as depreciation rates. (Indeed, other nations have considered adopting capital budgets, but generally decided against it for those same reasons.) Adopting an accrual approach to only one aspect of the budget could raise concerns as to whether the budgeting system would provide a fair basis for allocating the government’s resources among competing priorities. In addition, providing special treatment to certain areas of the budget, such as capital spending, could make the process more prone to manipulation. Furthermore, simply arriving at a definition of capital for budgeting purposes could be a significant challenge. (Emphasis added) Concerns about such issues largely explain why previous groups charged with exploring budgetary concept issues—including the 1967 President’s Commission on Budget Concepts and the 1999 President’s Commission to Study Capital Budgeting—have rejected the idea of a separate capital budget for the federal government.”.
Let’s translate that into English, and out of bureaucratic double-talk.
Note that in addition to the claim that capital cannot be defined, we see here two other common concoctions used to summarily dismiss capital budgeting and related spending for great infrastructure projects. The first charge is, of course, “corruption”. If a federal project–let’s say a new dam, for example–is allowed to be considered separate and not in the budget, without having its full cost accounted for immediately (as opposed to over the life of the investment), who is to stop everybody from using such a terrible approach? Spending money leads to abuse. (This is the same argument as that Medicare is bad because it leads to so much Medicare fraud.)
More revealing is the second claim that separate accounting for long-term expenditures and investments unfairly undermines urgent short term requirements. This is the same stupidity of those who have always claimed we cannot spend money on space, because “what about all of the poor people and what they need now”.
Concerning the failure to “define” capital, this is not some issue of semantics. This cuts to the core of the catastrophic gutting of U.S. productive powers, which growth would have been sustained by an appropriate level of long-term investment, coupled with scientific and technological progress. (This will be the subject of part two of this series.)
And, the inability to define capital is a sure sign of the impact of decades of brainwashing in monetarism, where the brainwash victim seems to lose the capacity to see productive value in an economy.
Of course, said failure was never in a vacuum. As the budget process in the U.S. has become obsessed with deficit reduction, Wall Street has emerged as a major beneficiary of this general austerity approach on a Federal, State, and local level.. Various forms of derivatives typify how forms of basic infrastructure investment have been leveraged for Wall Street gain, including the case of Jefferson County, Alabama, and interest rate swaps. One can also look at various privatization swindles, or energy deregulation, both of which redefined previously government connected infrastructure activity as the playground of private interests which have used various means to loot the public.
Furthermore, the remaining parts of federal spending which have managed to segregate their budgets under a similar approach to capital budgeting, like Social Security and the Federal Highway Trust Fund, have been for a long time, the focus of the budget cutters, as well as Wall Street vultures.
A Basic Introduction
States and local jurisdictions widely practice capital budgeting for core public services and related infrastructure, such as education, sewers, water, power, etc. The separate capital expenditures allow for longer-term planning on larger items, while the source of funding for these projects can come from a variety of sources, including bonded debt, dedicated income streams, Federal funding, and more. Generally, what is considered a capital expenditure is based upon a designated threshold dollar amount, while the life span of such investments are multiple years, and therefore separated from annual operating budgets. Annual budgets will include the upkeep and repairs for these buildings, and other capital investments.
There is no standard practice for local government capital budgeting, and these practices are different from those used by private corporations. Private corporations, for instance, will calculate depreciation of fixed assets (partly for tax reasons), while government bodies instead may calculate the value over the lifespan of the asset through different means.
Executive Intelligence Review recently reprinted a 2007 article by Lyndon LaRouche entitled “The Lost Art of the Capital Budget”, which will be referred to more extensively in the second part of this article.
In that groundbreaking piece, LaRouche indicates that capital budgeting was a commonplace type of thinking in the United States in the 1950s and 60s. This author has found that such knowledge even persisted into the 1990s.
What Happened to Federal Capital Budgeting?
With the construction of the Federal Highway System, one of the great achievements of President Eisenhower, there was a major fight over the means to finance the gap, some $50 billion, between budgeted expenditures and the total cost of construction. General Lucius Clay’s proposal included the issuance of long-term bonds, as well as a dedicated gas tax. Led by the originator of PAYGO, Senator Harry Byrd of Virginia, who believed in building roads through the approach of “pay as you go, the only way to go”, Congress defeated any government bond issuance. The compromise is what we still have today, which utilizes separate accounting, and therefore is a form of capital budgeting.
The drive for such an approach did not stop there, and what came next is today entirely unknown.
What was clearly needed was a means to pre-calculate the effects of capital investments, to differentiate which would contribute to long-term economic growth.
Without any doubt, the most advanced thinking is contained in a June 1964 study created at the behest of President John Kennedy, entitled “Policies, Standards, and Procedures in the Formulation, Evaluation, and Review of Plans for Use and Development of Water and Related Land Resources.” This document, also known as Senate Document no. 97, of the 87th Congress, was prepared under the President’s Water Resources Council.
While that document may not be well known, JFK’s commitment to the idea of science-driven investment, was not only implicit in his drive to put man on the moon, but also was made very clear by the projects he supported in the western part of the United States.
JFK went on an extraordinary Western States trip in August of 1962, which included his inspection of the Oahe Dam site in South Dakota, and the groundbreaking for the San Luis Dam, in California.
The content of both of these speeches, but in particular that in South Dakota, leaves no doubt of Kennedy’s thinking concerning the role of infrastructure investment in the development of national productivity and growth. That speech also makes explicit that wealth can only be understood as creating long-term potential for the entire nation, and the commitment for adequate resources for the future.These are the core ideas of the American System, of both the General Welfare principle, and the idea of posterity.
“We take for granted these miracles of engineering, and too often we see no connection between this dam right out here and our Nation’s prosperity and our Nation’s security, and our leadership all around the world. The facts of the matter are that this dam, and many more like it, are as essential to the expansion and growth of the American economy as any measure that the Congress is now considering. And this dam and others like it are as essential to our national strength and security as any military alliance or missile complex.
When we are inclined to take these wonders for granted, let us remember that only a generation or two ago all the great rivers of America, the Missouri, the Columbia, the Mississippi, the Tennessee, ran to the sea unharnessed and unchecked. Their power potential was wasted. Their economic benefits were sparse. And their flooding caused an appalling destruction of life and of property. Then the vision of Theodore Roosevelt was fulfilled by Franklin Roosevelt, and to demonstrate how important this is as a national issue, two distinguished American Presidents from New York State saw how essential it was to the Nation and New York State to develop the resources of the West. And as a result this Nation began to develop its rivers systematically, to conserve its soil and its water, and to channel the destructive force of these great rivers into light and peace. And today, as a result of this, the face of this Nation has been changed. Forests are growing where there was once dirt and waste. Now there is prosperity where our poorest citizens once lived. If there is one outstanding story among all this which indicates the kind of progress we can make working together, it’s the story of the REA [Rural Electrification Administration], and of Sam Rayburn of Texas, and Franklin Roosevelt of New York, and George Norris of Nebraska.
Less than 30 years ago, in the lifetime of most of us here, as you know, fewer than 10 percent of all our rural homes in this country had electric power. Whenever I read about the statistics of desolation, in the underdeveloped world, Latin America, and all the rest, we should realize that less than 30 years ago only 10 percent of our rural homes had electricity. That’s how quickly the face of a nation can be changed by determination and by cooperative action by all the people.
Then, a farmer had no opportunity to participate in the mainstream of American life, to use labor-saving machinery, nor did his wife; nor did they have light, or a telephone, or a radio. Today, more than 95 percent of rural homes have electric power. The lives of these farmers and their families and their children have been enriched by living in the closest communion with the rest of our country.”
Later, he states:
“This is not a choice between spending and saving, for REA is a form of saving, as is this dam, hours and lives, saving farms and saving and returning to our Nation’s Government every dollar loaned, with interest, in taxes on new appliances and new equipment, and new farm income. This program and so many like it have returned to the public treasuries many times the entire cost of the program. “(Emphasis added)
Kennedy also spells out in the speech, his vision of nuclear energy, the anticipated growth of population, and where America (and the world) needed to be by the turn of the next century.
Clearly, much of that work has yet to be done.
(to be continued)
 Richard Freeman, “Capital Budgeting for Economic Growth; Eisenhower’s National Defense Highway Act”, EIR, February 3, 2006