Capital Budget: Good in Theory, Bad in Practice

I agree with Bruce that underinvestment in federal capital is a problem, but I agree with Stan that Congress is bound to make a mess of capital budgeting and of an infrastructure bank. In my Capitol Hill experience, creating special treatment for anything puts a lot of smart people on K Street to work figuring out how to capture that benefit. It would be nice to think that “infrastructure” could be defined once and for all, but that will never happen. As Stan describes, the definition will be expanded at every opportunity until everything is capital. Try telling a senior that Medicare is consumption or a farmer that crop insurance is consumption. Economists have strong ideas that physical and human capital produces future returns, but political leaders see capital as another way to pay off their supporters.

 

Take a look at what happened to the short-lived Treasury Depreciation Analysis Division, created by the Tax Reform Act of 1986 to study depreciation lives, a key element of capital budgeting. Treasury had always had the authority to set those lives, but Congress increasingly usurped that authority through the 1970s and 1980s, resulting in a complicated, inequitable, and uneconomic system of winners and losers. It only took the winners two years to shut that Division down and take away Treasury’s authority to set depreciation lives in the last year of Ronald Reagan’s presidency. As I recall, the Gallo Brothers objected to the possibility of having to depreciate their grapevines over a longer life.

 

Here’s the history from Treasury’s report to Congress of July 28, 2000:

 

In September 1987, Treasury established the Depreciation Analysis Division (DAD) within the Office of Tax Analysis. That division, established in accordance with the mandates of the 1986 Act was created to monitor and analyze actual depreciation and to recommend asset class lives for assets that did not have ADR guideline lives or to replace existing ADR guideline lives. Over the next several months, DAD announced its intention to study four classes of assets (and, over time, an additional eleven classes of assets) and held public meetings with industry representatives to discuss the nature of the information needed for its studies and how that information might be obtained. In general, the information was to be obtained through special surveys of owners and operators of the assets whose depreciation was being examined. The scope of each study, the nature of the survey instruments, the potential survey recipients, the timetable for conducting the survey and other related issues were negotiated with industry representatives in a series of public meetings.358

 

Two of the asset classes initially chosen for study - clothing held for rental (tuxedos) and scientific instruments - were mandated by the 1986 Act. Studies of two other asset classes – cars and light trucks - were mandated by the Omnibus Budget Reconciliation Act of 1989. Three of the asset classes chosen for study - horses (primarily racehorses), fruit and nut trees, and cropbearing vines (such as grapevines) - were chosen because these assets did not have class lives, and in the legislative history to the 1986 Act Congress indicated that such assets were to be given priority of study.359 The other depreciation studies initiated - assets used in the electronics industry, assets used in television and radio broadcasting, assets used in the cable television industry, assets used in the manufacture of fabricated metal products, assets used in the manufacture of motor vehicles, assets used in the chemical industry, assets used in the telecommunications industry, and aircraft and air transport assets - were chosen because of their importance in the economy, the apparent disparity between their existing class lives and their implied class lives based on the 1981 Hulten-Wykoff geometric depreciation rates, their relationship to other assets under examination, or because they presented methodological issues (such as how to deal with the issue of technological obsolescence) that needed to be addressed.

 

Although Treasury always had the authority to administratively change depreciation classes and class lives, and initially retained that authority after enactment of the 1986 Act, not long after DAD announced its intention to study the depreciation of aircraft and air transport assets, the Congress repealed that authority in the Technical and Miscellaneous Revenue Act of

 

 

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1988. Henceforth, although Treasury was still required to study asset depreciation, it could only report the results of its studies to the Congress.

As might be expected, owners of assets who felt that the existing class lives assigned to their assets were too long sought DAD’s assistance in documenting such evidence. Conversely, owners of assets who were comfortable with the existing assignment of class lives to their assets

suggested reasons why DAD should not give priority to an examination of their assets. For most assets, the data required to establish the appropriate class life for an asset class could only be obtained from owners and operators of those assets. However, as discussed below, it frequently was the case that the determination of the actual depreciation of an industry’s assets on the basis of the information provided by the business community was problematic.