The US is now suffering from a “contained” depression. It is visibly present in the social pathologies surrounding us, which are particularly pervasive in our disintegrating cities, and less visibly present in the decade-long decline of real incomes of all families, save those at the very top. At least 60 percent and as much as 70 percent of the increase in national wealth during the Reagan years went to the richest 1 percent of families; the incomes of the approximately 70 million families that make up the lower four fifths declined. The depression has been contained only because the economy has deposit insurance, social security, and unemployment benefits. Without these safeguards we would be in an uncontained fall similar to that of the 1930s—not simply worried over a rise in unemployment to 7.5 percent of the labor force, but in despair over a rise in unemployment to 25 percent.

All depressions are slowdowns in the momentum of growth. Except for its rising volume of exports, American business is contracting, not expanding. The manufacturing sector has been weak for two years. Construction is at a standstill because our cities are glutted with unrentable office space. Most important of all, we lack the technological or organizational stimulus to launch the “transformational” growth that took place previously when the railroads were being constructed, or the country was being electrified, or during the automobile boom that started in the 1920s. Unfortunately, when transformational growth runs out, there is little the private sector can do.

Along with many other economists, I have frequently urged that a plausible alternative exists, one that has long been ignored: we can revitalize the growth process by undertaking a program of investment in the public sector. Such a program would for the most part be carried out by private companies, large and small, but it has the advantage that it could be set in motion by specific federal programs, as a private boom could not. Moreover, a public investment program could also contribute to the larger changes that are badly needed: bullet trains to link major cities, major construction to restore the inner cities, a long overdue effort to upgrade our educational system. These could invigorate the economy as effectively as any technological or organizational revolution now in sight.

Indeed, the need to improve the nation’s roads, bridges, dams, water supply, airports, mass transport systems, and schools is now so urgent that even fiscal conservatives make an exception for infrastructure when they condemn “wasteful government spending.” Many economists have become convinced that investment in infrastructure could now produce more growth in the private sector than the same amount of direct investment in the private sector. The research of David Alan Aschauer has shown that because our infrastructure has been so neglected a dollar spent for public investment today can raise GNP between two and five times as much as a dollar spent for private investment.1

Unhappily, there is a hitch: it is the deficit. We cannot mount a public spending program because the United States is running an excess of expenditures over tax receipts estimated at $382 billion for fiscal 1992, $400 billion for fiscal 1993. In the face of such numbers, little can be done. The deficit is the impassable barrier that blocks any such bold public initiative. The assumption of recent political debate is that until we have got rid of the deficit by some combination of cost-cutting and tax increases, public investment must be postponed. If that view prevails, the contained depression will continue, no matter which party is in office.

Is there a way out of this impasse? I believe there is. The Gordian knot of the deficit must be cut, not untied. Moreover, the means to do so lies immediately at hand. It is to establish a capital budget, the economic equivalent of Alexander’s sword.

Capital budgets are accounting techniques used to separate receipts and expenditures involving investment projects from those of ordinary “current” activities. Suppose AT&T decides to build a $1 billion addition to its laser network. It will not bill this cost to you on your telephone bill. Your payments are used to cover regular operating costs, not capital projects. For the same reason, when AT&T wants to finance the laser project, it looks outside its normal sources of income. It pays for the project with funds taken from its reserves, or raised by floating AT&T stock or bonds, or borrowed from banks. These financial transactions are approved by management because of the future profits the project is expected to generate.

As a result, at the end of the year, AT&T has two quite separate budgets. Its current budget shows regular income and expenses: if the phone company makes $2 billion selling its telephone services and spends $1.5 billion on wages, raw materials, and other costs of doing business, it will show a profit of $500 million. But these costs do not include the $1 billion spent for the laser project, which appear on a separate, capital budget. The revenues in this budget derive from the resources used to finance the expenditure—the reserves that AT&T has drawn on and the money it has obtained from stock and bond issues or borrowing from banks. The expenditures are outlays for the laser project. Thus there is no profit or loss in this account. There is certainly no “deficit”; the word does not exist in business accounting.


Of course there are costs attached to raising money for capital purposes, most importantly the interest costs that will accompany any increase in debt, and the depreciation costs of the new equipment itself. These costs now become part of the current expenses of the enterprise, so that AT&T’s regular budget would be increased by the interest it pays out and the depreciation it accrues. If the government had a capital budget, whatever new interest costs or depreciation expenses resulted from its infrastructure projects would also become part of its normal operating expenses.

Why, then, does the federal government show a huge deficit? The answer must already be clear: the government does not have a capital account. All its expenditures, for current and capital purposes alike, are lumped into one category of “outlays,” and only its regular income—that is, tax revenues—is credited against these outlays. If AT&T did the same, it would, in our example, show total outlays of $2.5 billion—$1.5 billion for running the company plus $1 billion for building the laser project—and would report only its regular income, $1.5 billion in sales revenues. As a result, it would no longer show a profit of $500 million but a “deficit” of $1 billion.

Capital budgets exist, in other words, to clarify the differences between ordinary business operations and the extraordinary ones that involve investment in the facilities that make it possible for business to expand. This accounting procedure is followed by every large corporation, most states, many cities, and, so far as I know, by all industrial nations except our own. Walter Wriston, former chairman of Citicorp, has said that any business that kept its books the way our government does would be called up before the Securities and Exchange Commission for misrepresentation.

Take the period from fiscal 1984 through fiscal 1989. During these six years the US gross national debt grew by roughly $1 trillion. This means that deficits averaged about $200 billion per year. But suppose we had had a capital account for investment projects. The Office of Management and Budget publishes a yearly breakdown of government expenditures that enables us to get some idea of how large public investment was in those years. In round numbers, it averaged about $200 billion per year.2 Unfortunately, more than half of that $200 billion was spent for such items as tanks and planes, not for civilian R&D, railroads, and schools. In other words, if we had had a capital budget, and we had spent the money for infrastructure, we would have had no “deficit” during that period. We would have shown an increase in debt of $1 trillion which was matched by an increase in productive public capital of that amount.

The $1 trillion of new roads, schools, and the like would have imposed new costs on our regular budget. Interest payments would have risen to cover the interest cost of the new capital projects, and depreciation costs would have increased to cover its wear and tear. But just as with the case of AT&T, the yearly new costs of interest and depreciation would have been far less than the total costs of the undertakings themselves. It is probably not unrealistic to think that they would have come to something like 10 percent of that total cost.

Why do we not pursue this course? One reason is that setting up a capital budget poses a number of formidable problems, among them the difficulty of calculating government investment. The OMB counts expenditures for military equipment as investment, but not expenditures to retrain soldiers for postmilitary economic life. That strikes many economists, myself included, as entirely wrong. Moreover, depreciation is not always simple to calculate. At what rate does one depreciate expenditures on bullet trains? R&D? Education?

There are problems on the borrowing side, too. The estimated deficits for fiscal 1992 and 1993 are much larger than those for the preceding years. This happened because the Treasury issued $350 billion of new bonds to bail out the failed savings and loan industry. The government thereby converted a standby obligation to make whole any depositor whose account was in jeopardy into actual payments not only to depositors but to shore up banks that were short of funds. This cost us a great deal of new indebtedness. On the other hand, it bought us the financial stability that we would have sorely missed had there been a run on the S&Ls comparable to the one that took place in the Thirties when nine million bank accounts vanished without a trace.


Not least, a capital budget poses difficult problems of fiscal judgment and management. Unlike the standard used by AT&T’s management, the criterion for inclusion on a capital budget is not profits but growth in GNP. This is the source of the government’s income: a rising GNP increases tax revenues, without any increase in tax rates. Growth expenditures should obviously include improving the railroad tracks, but should they also include railroad trains? Should they include programs for training teachers as well as for building schools? Determining what goes into the capital budget, and on what terms, is inescapably difficult and controversial. Every member of Congress, not to mention every president, will want his or her projects rated as capital investment and thereby qualified to be paid for by borrowing.

There will also be disagreement over how fast the items on the capital budget should be depreciated: Should a billion-dollar outlay for high-tech R&D be written off over twenty years or ten? In the first case, $50 billion will have to be charged against the regular yearly operating budget to be paid for by taxes; in the second case, $100 billion. Finally, it is a virtual certainty that we will have to do some noncapital borrowing in the recession years when the economy needs a stimulus. How can such borrowing be controlled?

In other words, a capital budget will not make all our fiscal problems disappear. Government financing is necessarily complex. It can be irresponsible under any budgetary procedure. But a capital budget could deal with a very important problem: the panic-mongering word “deficit” would take on a new meaning and would be used less and less frequently. In its place we will have the word “borrowing,” which leads us to ask the right question: Borrowing for what? Under our present jumbled budget here is absolutely no way of matching borrowing and spending. It is just as correct to say that we have borrowed to pay interest on the national debt as to say that we have borrowed to build much needed public capital goods.

For the same reason, if the borrowing is in fact used to pay interest on the debt, it is entirely correct to call the resulting deficit a drain on savings. But we can see that if the same borrowing is used for building up infrastructure it takes on another, quite different aspect. It is now not a drain on our national saving, but a use of it—and furthermore a use that is today likely to produce more growth in GNP than the same amount borrowed for private use. Without a capital budget it is next to impossible to distinguish good borrowing from bad—as would be the case if AT&T did not separate its capital expenditures from its current ones.

The same considerations hold true with regard to the national debt—the Treasury bonds that constitute the legal obligation behind our borrowing. The debt now looks like a burden because there seems to be insufficient real wealth behind those bonds. In fact, the debt of the United States is backed by the immense physical and fiscal powers of our government, which dwarf those of all our corporations together. But if we had a capital budget, we could much more easily see the growth-producing infrastructure that our Treasury bonds had financed. Over the years, the greater part of our national debt would gradually become the financial counterpart of our public productive capital. We would then have the discipline of a capital budget to serve as a basic guideline for our borrowing, and our “deficit” would refer only to whatever borrowing, if any, we needed for economic or other emergencies.

Since capital budgeting, with all its difficulties, has become the accepted procedure for so many cities, states, and foreign governments, why have we not adopted this eminently sensible procedure? I can think of only one reason, larger and more forbidding than all the others combined. It lies in Americans’ deep distrust of using government investment as a source of economic growth. Worse, this distrust is expressed by government itself, and was made a central principle of the Reagan and Bush administrations. Hence, until recently, there has been little interest in, much less pressure for, a change that would open the way for a government-led boom.

This distrust was not always there. The government financed the transcontinental railway system, built the Panama Canal, the TVA dams, and the interstate highway system, all with strong public support. Only during the last decade has belief in the constructive economic use of government largely disappeared. That is the great obstacle to be overcome. It may turn out to be what the November election has been about.

October 22, 1992

This Issue

November 19, 1992