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Our Accounting Deficit

By Donald E. Knebel on September 6, 2013 in Civic Blog

As Congress tries to pass a federal budget, there will be plenty of claims that the projected deficit, whatever its size, is too large and unsustainable.  But like the issue of the size of the accumulated federal debt I discussed recently, the government’s method of accounting makes it impossible for citizens and politicians to make intelligent decisions about the size of the annual budget deficit.

The reported deficit simply compares the amount of cash going out with the amount coming in.  So, whether the money is spent for a dam capable of producing electricity for 50 years or a toothpick, the money is all counted toward the deficit in the year in which it was spent.

No family looks at its budget that way.  When a couple earning $50,000 a year spends $100,000 for a new house, borrowing $80,000, they don’t believe they are $30,000 in the red for the year.  They recognize the debt is offset by the value of the house and spread the cost over the expected life of the house or at least over the length of their mortgage.  On the other hand, they know they could be in serious financial trouble if they borrowed the same $80,000 to take their family on an around the world cruise generating no offsetting asset.  Understanding the difference, prudent families borrow for homes but not for cruises.

Businesses similarly divide their expenditures between those that create assets of lasting value and those that do not and account for the costs of assets over their useful lives.  Suppose a small business having $25,000 in the bank has to decide between purchasing a machine costing $90,000 that will last six years and another costing $25,000 that will last one year.  If it buys the cheaper version, the cost each year will be $25,000.  If it buys the more expensive version, the cost, including simple interest at the rate of 10 percent on the $65,000 it has to borrow, will be $21,500 per year.

taxesA rational business will borrow the money to make the investment in the better machine.  Its accounting system will not show that it has engaged in deficit spending in the year it purchased the machine, even though it had to borrow $65,000.  It will spread the $65,000 over the life of the machine.  But under the government’s accounting system, the better machine would be seen as creating $65,000 more in “deficit spending” than the cheaper version and the cheaper version would be preferred even though considerably more expensive.

There is no shortage of people who say “investment” is nothing more than a code word for government spending and that all increased spending should be avoided  Under this view, there is no difference between investing $65,000 for an unemployed worker to build a bridge and paying that same amount for unemployment compensation because both lead to the same increase in the annual budget deficit.  Because of that attitude, we fail to upgrade our infrastructure when unemployment is high, so our infrastructure continues to decay and unemployment stays high.  Any rational accounting system would reflect the difference between creating an asset and simply spending money and encourage building the bridge, the cost of which could be spread over its expected life.

Politicians often say that the federal government should emulate families in budget matters.  They are right, but not for the reasons most of them think.  Until the government distinguishes among types of expenditures as families (and businesses) do, we will not be able make sound financial decisions.  Perhaps more important, we will not be able to evaluate the claims of our politicians about the size of our annual deficits.

Donald E. Knebel is a partner in Barnes & Thornburg LLP, resident in the Indianapolis, Indiana office. He is a member of the firm’s Intellectual Property Law Department. Mr. Knebel serves as adjunct professor and senior advisor to the Center for Intellectual Property Research at the Indiana University Maurer School of Law. He frequently posts his observations here at Civic Blog. The views expressed do not necessarily reflect the views of Barnes & Thornburg LLP or the IU Maurer School of Law.

Image courtesy of nuttakit and freedigitalphotos.net.