Government accounting standards

Back many years ago in the MBA program, I took a class on Accounting Policy. One day, the professor made an off-hand comment that has intrigued me ever since: If the Government used the same accounting standards as businesses do, it would, in fact, be running large surpluses rather than deficits.

Although the specifics of both government and industry accounting are complex, the basic difference is that government accounting is based largely on income and spending. In industry, in contrast, credit is given for money spent to buy or produce a long term asset. That is, when the government creates a highway or building, the money spent is ordinarily "expensed" when payment is made. In contrast, when a firm builds a new factory, the money spent is generally balanced on the books with an asset that reflects the long term value of the investment made. Over time, a factory is then "depreciated," recognizing that it has a finite lifespan and future income generating potential.

What does this mean? It does not mean that it is OK to run up unlimited budget deficits as a way to "invest" in the future. Even if the money is put to good use, large deficits result in the so-called "crowding out" phenomenon: As the government borrows more money and pays increasingly higher interest rates, it is more difficult for businesses to borrow money. When firms have to pay higher interest rates, that reduces investment since, with higher interest rates and less certainty of the availability of capital, many new investments--such as factory expansion and new product development--become less attractive or, in technical terms, have a lower "net present value." Consumers, too, will generally--all other things being equal--end up paying higher interest rates on credit cards, mortgages, and other loans.

What these Government accounting standards do suggest is that not all budget deficits are created equal. Money spent on projects that--worthy as they may be--do not generate lasting value are more serious than those which create a long term asset. One can question whether we need another freeway, but once it has been constructed, it will be around for a while. Similarly, investing in education can result--from a purely pragmatic point of view--in a more competent and productive work force.

It should also be noted that, if put off, the maintenance of certain infrastructure such as power grids, bridges, and water distribution can become a lot more expensive in the future. As such, then, investing in those facilities that are Government operated and providing tax incentives for upgrades to privately owned facilities may make good fiscal sense.