The Balanced Budget and Interperiod equity: Implications for Financial Reporting

A critical issue in international financial management is that of "balancing the government's books" (The Economist 1994, p. 73). Since governmental commitments to maintaining or improving citizens' well-being are subject to resource constraints, the Governmental Accounting Standards Board (which is the accounting standard setting body for state and local governments in the U.S.) has noted the need for governments to "live within their means" and has espoused the notion of interperiod equity (IPE) as a performance measure (GASB 1987, para 59, 61).

According to Concepts Statement No. I (GASB 1987, para 60), interperiod equity has its roots in the various state and local government balanced budget statutes the intent of which is to obtain "intergenerational equity." However, since the term generation implies "approximately 30 years," the Board (para 60) believes that from a financial reporting perspective the appropriate concept is that of "yearly balance."

Concepts Statement No. I (GASB 1987) indicates that interperiod equity (IPE) can be assessed by "whether current-year revenues are sufficient to pay for the services provided that year" (para 61). More recently, the GASB (1995) has suggested that an interperiod equity-related result is "whether the government's financial position is better or worse as a result of the year's activities." To date, the GASB has not provided an operational definition of IPE and also has not identified the appropriate capital maintenance concept underlying IPE.

The objective of this paper is to benefit professionals in governmental financial management by increasing their common understanding of concepts such as the balanced budget, intergenerational equity, and the relevance of IPE information. Over the past decade, the GASB's attempts at reforming the financial reporting model have proved to be very contentious. The paper reviews briefly the ongoing attempts at reform and discusses the notion of a targeted level of service capacity as the appropriate capital maintenance concept for governments.

The Balanced Budget and IPE

In American politics, the balanced budget appears to have a symbolic value representing a particular vision of government (for example, bureaucratic professionalism, moral rectitude and restraint, prudent management) that transcends any accounting interpretation or measurement of the matter (Savage 1988). In fact, closer examination suggests considerable ambiguity as to exactly what is implied by a balanced budget. According to the General Accounting Office (GAO 1985), 49 of the 50 states have a balanced budget requirement. However, the requirement usually applies only to the general fund and excludes the multitude of other funds. The basis of accounting is typically the cash basis. Technically, a budget may be balanced by postponing capital expenditures, by borrowing, or by the sale (or sale and leaseback) of capital assets. Also, the requirement is generally ex ante or "before the fact," that is, the governor is required to submit and/or the legislature is required to pass a balanced budget, but actual results at the end of the year do not have to be in balance.

Although Concepts Statement No. 1 (GASB 1987) traces the roots of interperiod equity to the balanced budget, the governmental budget is basically a current financing plan (that is, a plan to finance current period expenditures for operations, debt service, and capital outlays) rather than an instrument for measuring interperiod equity. An "expenditure" occurs when goods and services (including capital assets) are received and either a liability is incurred (the accrual basis) or when cash is paid (the cash basis). In contrast, an "expense" occurs when goods and services (including capital assets) are consumed. "Cost" is a measure of the economic resources utilized for a particular purpose or in providing a particular service. Both expenses and costs incurred are measured on an accrual basis since accrual accounting better reflects underlying economic events.

As a current financing plan, the budget is concerned with current period expenditures not expenses or costs incurred. Expenditures are recognized in the budget only to the extent that claims will be paid-off by the end of the year (or shortly thereafter). Hence, it is possible to defer a portion of current labor costs to future taxpayers by not funding (or underfunding) pension obligations. Other fiscal practices aimed at balancing the budget (for example, borrowing, the sale or sale-leaseback of capital assets, deferral of maintenance) also have the effect of deferring costs to future taxpayers.1

In the context of current period transactions that have long-term financial implications (such as unfunded retiree health benefits or zero coupon bonds), it is possible to legally balance the budget and yet defer the burden of current period services to future taxpayers. Thus, while a balanced budget has symbolic value, it is neither synonymous with nor can it assure interperiod equity.

Intergenerational Equity, Taxpayer Mobility, and Generational Accounting

Intergenerational Equity

As indicated in Concepts Statement No. 1 (GASB 1987, para. 60), intergenerational equity implies that "the current generation of citizens should not be able to shift the burden of paying for current-year services to future-year taxpayers." However, the term "generation" is used in two distinctly different ways in the literature. Below, the two alternative definitions are discussed briefly and the definition appropriate for state/local government financial reporting is identified.

In the "overlapping generations" model, a generation is viewed as all individuals who were born at approximately the same time so that, in fact, a number of generations can coexist simultaneously (Rosen 1988, Chapter 18). The phrase "approximately the same time" refers to an undefined but flexible time window. Thus, the baby boom generation is defined as those born between 1946 and 1962 since birth rates were unusually high during that 17 year period.

In the overlapping generations approach, redistributional effects are examined by measuring the lifetime consumption of a group of individuals of approximately the same age. As an example, consider the redistribution effects of the social security program. Under this program (which until recently was subject to pay-as-you-go financing), those retiring until about 1980 received a windfall gain (that is, returns greater than what they would have received by saving privately the taxes they paid), because they were taxed for only a portion of their working years and/or at a very low rate. These windfall gains were or will be financed by the young (or unborn) who face the steeply higher taxes imposed since 1983. It is estimated that many retiring after 2000 will in fact receive a negative return on their payments (Browning and Browning 1987).

Alternatively, in the "Lerner" model a generation is viewed as consisting of all individuals who are alive during a given time period (Rosen 1988, Chapter 18). In the Lerner model, redistributional effects are examined by measuring the consumption of a group of individuals (residents) who are alive during a given time frame. In this model, the burden of current government services can be passed on to future residents by financing current services through borrowing with the debt issued to non-residents. Servicing that debt will require transfers from future residents (taxpayers) to non-resident bondholders without any reciprocal exchange. Hence, the overall consumption of those future residents will be reduced.

With its yearly orientation, interperiod equity is consistent with the Lerner model. This is clear from the fact that Concepts Statement No. 1 does not seek to measure burden shifting across residents of various age groups. Rather, the GASB seeks to measure burden shifting across residents of different fiscal time periods.

Why Taxpayer Mobility is Relevant

If taxpayers have zero mobility (that is, spend all their lives in the same state or local government), the burden of government spending (whether financed by taxes or by borrowing) will likely fall on the same group of taxpayers over their lifetime. However, taxpayers who are mobile can escape the burden of current period services (if financed by borrowing) by relocating elsewhere before the debt matures, although potentially they could face similar burdens in their new location. Current taxpayers can also avoid the burden of debt-financed government spending simply by dying before the debt matures and leaving an insufficient bequest to their offspring (Barro 1974). In the context of taxpayer mobility, the burden of deferred taxes will fall on those original taxpayers who remain and new residents who have moved in since the deferral.2

Taxpayers relocate for a variety of reasons (job transfers, children leaving home, retirement, etc.) and it has been estimated that in the U.S. on average approximately one urban household in five moves every year. Dye (1990, p. 16) notes that competitive federalism (that is, a system in which state and local governments compete for taxpayers) does not require that every taxpayer be mobile but only that a significant number of taxpayers be prepared to relocate in response to government policies. "The importance of ... (taxpayer) mobility for state-local government finance cannot be overemphasized (Fisher 1988, p. 3).

In the context of taxpayer mobility and a competitive political climate, Inman (1982) suggests that current taxpayers and public officials have an incentive to defer the cost of current services to future periods and a different set of taxpayers. Inman (1983) points out that the primary need of a politician seeking re-election is to satisfy current voters, and that this need generates a "what have you done for me lately" myopic mentality where only current services and short-run payoffs matter. Public officials face competing pressures from "hardpressed taxpayers, concerned investors, worried public employees, and needy residents" (Inman 1983, p. 17). Especially in the context of a stagnating or declining private economy and limited federal assistance, it can be very tempting to turn to future (and presumably different) taxpayers for aid by borrowing against future tax revenues through various strategies for deferring the cost of current period services.

By subsidizing the cost of current services, a deferral strategy can result in an overconsumption of government services and a misallocation of resources. In economic terms, current government spending will increase inefficiently in an allocative sense (beyond that consistent with social welfare).

With taxpayer mobility, it is not meaningful in state and local government finance to track the lifetime consumption of residents since current taxpayers may not remain to become future taxpayers. Hence, the Lerner model (discussed previously) is appropriate for analyzing state/local government intergenerational equity issues. Conceptually, the focus on a limited time frame (for example, a fiscal year, without consideration of the age distribution of current residents) implicit in the GASB notion of interperiod equity is the preferred approach.3

Generational Accounting

In recent years, Auerbach et al. (1991) and Kotlikoff (1992) have developed an analytic tool which they call "generational accounting" for addressing intergenerational equity issues primarily at the federal level. The purpose of the analysis is to estimate the distributive effects of government fiscal policy across different age groups. The outcome of the analysis is an estimated lifetime net tax rate for each age group defined as "the present value at birth of net taxes paid over a lifetime as a percentage of the present value at birth of labor income earned over a lifetime" (Congressional Budget Office 1995, p. xi). Thus, for those born in 1930 the lifetime net tax rate is estimated to be 31 percent while for those born in the future (after1992) the rate is estimated to be (an extraordinarily high) 82 percent. However, as pointed out by Baker (1995) and the Congressional Budget Office (CBO 1995), due to a number of omissions the analysis fails to provide a reasonable measure of the tax burden or the economic well being of future generations. For example, the analysis includes only labor income but not capital income such as dividends, capital gains, and interest in the lifetime income of future generations. Also, the analysis fails to distinguish between operating expenditures and capital expenditures for governments. Thus, while future taxes required to service government debt is considered, the benefits to future generations from current capital spending are ignored in the analysis. The analysis is also very sensitive to assumptions such as the discount rate used in computing present values of future taxes and labor income. For these reasons, the CBO (1995, p. ix,18) notes that generational accounting cannot serve as an official statement although it may be useful as an "abstract indicator."

By focusing on the lifetime taxes and income of different age groups, generational accounting is unambiguously based on the overlapping generations model. As noted previously, given taxpayer mobility, it is the Lerner model (rather the overlapping generations model) which is appropriate for addressing state and local government intergenerational equity issues and IPE. Thus, "generational accounting" as articulated by Auerbach et al. (1991) and Kotlikoff (1992) is not a useful analytic tool from a state and local government financial reporting perspective.

The Stewardship/Value-Revelance of IPE Information

From a stewardship (accountability) perspective, Gjesdal (1981, p. 214) notes that the demand for information is "about a variable of choice for the purpose of controlling it." Since public officials have the choice (and possibly the incentive) to defer current period costs to future periods, legislative and oversight bodies need IPE information to be able to control deferral behavior. Although financial statements provide only historical information, the mere existence of a periodic (and timely) measurement and disclosure system can have a deterrent effect. Potentially, timely financial reporting may help constrain (deter) professional politicians from simultaneously supporting new programs (especially ones with deferred payments) and opposing tax increases. Hence, IPE information would be relevant as an instrument for controlling the pursuit of deferral strategies by public officials. In the words of Justice Brandeis, sunshine (timely measurement and disclosure) may be the best disinfectant.

IPE information would also be relevant from a valuation perspective. Value-relevance refers to the usefulness of information in pricing assets. Prior research (Raman and Wilson 1990; Lin and Raman 1996) suggests that governmental accounting information is useful in pricing municipal (state and local government) bonds and residential real estate. Burdens assumed by future taxpayers for services previously provided basically represent a potential claim on the future tax revenues and cash flows of the governmental unit, and should be reflected (priced) in lower asset values. From a valuation perspective, IPE reporting would potentially reduce "information costs" (that is, the costs to potential bondholders and homeowners of searching for and obtaining value-relevant information) by measuring and disclosing the extent to which the cost of current services is being deferred.

Lev (1988) notes that the purpose of financial reporting regulation is to promote ex ante or "before the fact" equity (equality of opportunity) in obtaining access to information. The role of financial reporting is to reduce "information asymmetry" or the unequal distribution of information which would otherwise exist. Lev (1988) notes that the last two U.S. administrations were characterized by the deregulation of various industries (e.g., airlines, trucking, financial institutions, and telephone utilities). However, the fact that disclosure regulation (for businesses) withstood these changes can be potentially explained by the equity justification that underlies reporting regulation. This equity orientation provides the basic rationale for regulating and mandating financial disclosure. From this perspective, IPE reporting can be viewed as promoting equity by reducing the unequal distribution (asymmetry) of information between current and future bondholders and taxpayers.

Reform and the GASB Due Process

Why Current Accounting Standards Don't Work

Under current accounting standards, the basic tax-supported services provided by governments are accounted for in the governmental funds. The measurement focus in the governmental funds (that is, what the fund is attempting to measure in the operating statement) is the flow of current financial resources on a modified accrual basis. Hence, current period revenues as well as proceeds from the sale of bonds or capital assets are reported as increases in financial resources. Similarly, currrent services spending as well as bond redemptions and capital asset purchases are reported as decreases in financial resources. The current financial resources measurement focus is consistent with the traditional role of the governmental budget as a current financing plan and that of the governmental funds as short-term financing vehicles. However, by focusing on what is available for spending, the governmental funds ignore the long-term financial implications of current transactions and events and are unable to demonstrate consistency (or lack thereof) with interperiod equity (IPE).

Also, under current standards, financial data are not aggregated beyond the fund-type level. Data from one governmental fund-type (such as the general fund) are not combined with data from other governmental fund-types (such as the special revenue funds) to provide an aggregated single column operating statement for the government-wide entity. Under current standards, there is no aggregation and it is not possible to obtain a view of the governmental entity's overall financial picture including consistency (or lack thereof) with interperiod equity (IPE).

The 1995 Preliminary Views

Over the past decade, the GASB (1985, 1990, 1992, 1994, 1995) has explored a number of alternative reporting models in its effort to reform state and local government financial reporting. The issues are very contentious and relatively little progress appears to have been made. Miller (1995) notes that the GASB's constituents appear to be split between those who are resistant to change and those who are insistent on change.

For the sake of brevity, we focus on the GASB's most recent proposal Ñ the 1995 Preliminary Views document. This document proposes two sets of financial statements based on a "dual perspective"Ña fund perspective and an entityÐwide perspective. The two sets of statements would use different measurement focuses and would not have to be reconciled. From a fund perspective, the individual governmental funds would continue to use the flow of current financial resources measurement focus. However, from an entity-wide perspective all governmental activities would be reported using the flow of economic resources measurement focus and include a "capital use charge" (depreciation expense) based on the historical cost of general fixed assets including infrastructure assets (GASB 1995, p. 33). The entity-wide operating statement would provide information about IPE by reporting an overall excess or deficiency for the period.

Measuring IPE Within a Flow of Financial Resources Framework

By recommending a flow of economic resources measurement focus (including depreciation calculations based on the historical cost of general fixed assets), the Board's most recent proposal (GASB 1995) essentially adopts the business reporting model. This represents a radical departure from the traditional measurement focus in the governmental funds (and in the governmental budget) which is the flow of financial (not economic) resources. Truth be said, the business reporting model has severe problems of its own and offers no panacea (AICPA 1994; Elliott and Jacobson 1991). Understandably, the latest proposal (GASB 1995), like its earlier predecessors, has met with widespread disapproval and may not be finally adopted (Miller 1995). Below, the measurement of IPE within a flow of total financial resources framework is examined.

Alternative Capital Maintenance Concepts

As noted previously, Concepts Statement No. 1 (GASB 1987) discusses IPE without identifying the appropriate capital maintenance concept for governments. Alternative capital maintenance concepts will lead to different measures of capital use (and IPE), and are discussed below.

The total financial resources measurement focus (GASB 1990) is intended to permit the recognition of the effects of transactions or events on financial resources in the period they occur regardless of when cash is paid. Thus, the long-term financial implications of current period transactions and events would be captured in the current period within a flows of financial resources framework. In measuring IPE within this framework, current period revenues would exclude the proceeds of bond issues and the sale of capital assets. Similarly, current services spending (operating expenditures) would exclude capital expenditures and debt redemptions. However, in measuring IPE, it would not be enough to match revenues with operating expenditures only since an important element of the cost of current services is the use of general fixed assets. To measure IPE, revenues would have to be matched with operating expenditures as well as a capital use charge (including necessary maintenance, as discussed below). A capital use charge based on traditional depreciation calculations would be a non-cash item and would be irrelevant from a budgetary (current financing plan) perspective. Alternatively, as discussed below, a capital use (and maintenance) charge could be estimated within a flow of financial resources framework based on the maintenance of a targeted level of service capacity as the appropriate capital maintenance concept underlying IPE.

With a system of infrastructure assets (defined as the system of assets behind basic services such as transportation, waste disposal, water resources, electricity generation, etc.), timely maintenance and renewal (replacement of elements of the system) will likely extend the service life of these assets indefinitely. Currie (1987, p. 8) notes that with these fixed assets management's accountability is "not to maintain any specific asset, but to maintain the operating capability of the system." With others, such as equipment, the asset will eventually need replacement even with regular maintenance.

The decline in state and local government service capacity as a result of inadequate maintenance or replacement has been noted in a number of studies (Peterson 1978; Choate and Walter 1981). Moreover, delayed maintenance can mean, ultimately, higher repair and replacement expenditures in future periods (Peterson 1978, p. 49).4

If capital assets are not maintained or replaced, the deterioration or loss of service capacity can pass on to future taxpayers a portion of the burden or cost of services provided in the current periodÑas effectively as an increase in liabilities for unfunded pension obligationsÑand thus violate interperiod equity. The comparison with underfunded pensions is apt, since the deferral of essential maintenance and replacement is similar to the deferral of a portion of current labor costs in the form of unfunded pensions. In a competitive political environment, both allow public officials an opportunity to provide a higher level of services to current taxpayers without having to raise current taxes.5

Financial Capital Maintenance

Business reporting is based on the concept of maintaining "financial" capital and capital use (depreciation) is computed based on the historical cost of capital assets. Implicitly, it is this very same capital maintenance concept that is being proposed for governments (GASB 1995). However, a capital use charge based on historical cost is unlikely to maintain the service capacity of governmental general fixed assets. In business accounting, historical cost depreciation came into vogue only after the income tax laws allowed for cost recovery (the deductibility of the original cost of a capital asset over its estimated life) in computing taxable income (Hendricksen 1982, pp. 30-31). Beyond the recovery of original cost for tax purposes, historical cost depreciation appears to have few uses. As noted by Anthony (1989, p. 68), historical cost depreciation cannot be used for cost comparisons since differences in depreciation methods, estimated service lives, and the cost of similar assets acquired at different time periods would render such comparisons "dubious." Anthony provides examples of business cost comparison studies which basically omit depreciation as an expense on grounds of non-comparability. He acknowledges that depreciated net book values do not indicate remaining service potential, do not facilitate planning for capital budgets, and do not indicate whether fixed assets have been properly maintained or their replacement cost. Hence, the maintenance of financial capital (a largely irrelevant objective in the government context) would be the sole reason for recording depreciation based on the historical cost of general fixed assets.

Physical Capital Maintenance

An alternative to historical cost depreciation is depreciation based on the replacement cost of capital assets. Replacement cost depreciation is designed to maintain "physical" capital in the context of rising prices.6 However, a capital use charge based on replacement costs would have adverse implications for the "pricing" of (that is, taxes raised to pay for) government services. Pricing in the regulatory and government contexts has to take "fairness" into account. As in the context of utility regulation, it would be considered unfair to "bill" consumers (current taxpayers) for current period services based on higher replacement costs when old capital assets are currently still in service (Zajac 1978).

Moreover, for governments, the maintenance of physical capital may not be an appropriate objective if the population is decreasing or if there is a change in taxpayer preferences for public services as reflected in the so-called tax revolt since the late 1970s. It would be unrealistic for the GASB to require that the operating statement include a sufficient capital use charge for maintaining physical capital when citizens would rather spend their income on other things besides the stock of public capital.

There is perhaps a more important and fundamental reason for shying away from depreciation calculations of any kind in computing capital use charges on general fixed assets. Depreciation is a non-cash charge, is not meant to suggest that capital assets are actually replaced as used, and have no implications for cash flows. In the government environment, "pricing" (that is, taxing) decisions are made within a budgetary (current financing plan) framework. As noted by the GASB (1987), the governmental budget is a device for obtaining resources since it establishes the amount of tax revenues (such as property taxes) to be raised for financing proposed spending. If IPE reporting is to have an impact, it must have a visible connection to the budget and affect current period taxing and spending decisions. IPE reporting is more likely to have an impact if actors in the budgetary drama (taxpayers, legislators, special interest groups, and others) perceive the capital use charge as representing or implying a claim on financial resources. In contrast, IPE reporting based on depreciation calculations could be viewed as irrelevant because of the absence of a visible connection with the current need for financial resources.

Service Capacity Maintenance

For these reasons, this section explores a method for measuring capital consumption costs within a flow of total financial resources framework. As discussed by Riordan et al. (1987), a pre-requisite to assessing existing service capacity for governments is to have adequate (auditable) fixed asset reporting systems. In the context of changing demographics and taxpayer preferences, it would be necessary for governments to identify a targeted level of service capacity. If the city population is declining, for example, targeted service capacity may be below existing service capacity.7 On the other hand, if the population is increasing, the targeted service capacity may exceed existing capacity. Although not explicitly identified, a targeted level of service capacity is implicit in the article by Riordan et al. (1987) which discusses the multi-year capital budgeting process in Dayton, Ohio. As outlined by Riordan et al., a government will need to prepare an inventory and condition assessment of its capital assets. Such an assessment is the starting point for preparing an annual engineering-based estimated maintenance and replacement schedule as part of a city's multi-year capital budgeting process. The objective of the process is to estimate the annual expenditures necessary to provide for adequate maintenance and orderly replacement of capital assets and to minimize future maintenance and replacement costs. According to Riordan et al. (1987, p. 47), such a comprehensive multi-year capital plan for maintenance, repair, and replacement has been implemented by the city of Dayton, Ohio, and the entire process is "easily transferable" to other cities.

In measuring interperiod equity, capital use charges can be proxied by the engineering-based estimate of necessary maintenance, repair, and replacement expenditures each period.8 The estimate of necessary maintenance, repair, and replacement costs each period would clearly be a subjective "soft" number. Riordan et al. suggest that the engineering-based estimates could be determined by consensus as part of the capital budgeting process. It is relevant to note that there are other examples of the use of "soft," subjective numbers in both governmental and business reporting, for example, pension expense estimates. As pointed out by Wallman (1995, 1996) and Burton (1981, p. 55), it is characteristic of financial reporting numbers to be "uncertain, interpretive and subjective."

To summarize, the maintenance of a targeted level of service capacity (implicitly incorporating estimates of changing demographics and taxpayer preferences for public services) would be appropriate as the capital maintenance concept for governments. The maintenance, repair, and replacement expenditures estimated to be necessary each period (as part of a comprehensive engineering-based multi-year capital budgeting process) would be usable as a capital use charge in measuring IPE. Although the notion of a targeted service capacity would be perceived as a "soft" concept, it would be more meaningful and relevant for governments than the maintenance of financial (or physical) capital implicit in depreciation calculations.

Conclusions

Interperiod equity (IPE) is potentially an important concept from both a stewardship as well as a value-relevance perspective. However, since the governmental budget is a current financing plan rather than an instrument for measuring IPE, a balanced budget is no guarantee of interperiod equity. As yet, the GASB has not operationally defined IPE and also has not identified the capital maintenance concept underlying IPE. Implicitly, the measurement of IPE rests on a concept of capital that must be maintained before interperiod equity can be said to have been achieved.

In this paper, the maintenance of a targeted level of service capacity was identified as the appropriate capital maintenance concept for governments. Although historical cost depreciation is consistent with the maintenance of financial capital, it is not consistent with maintaining service capacity. Albeit a "soft" number when compared with historical cost depreciation, an annual estimate of necessary maintenance, repair, and replacement capital spending based on a comprehensive engineering-based multi-year capital plan would be appropriate for governments as a measure of capital use. This particular approach will permit capital use (and IPE) to be measured within a flow of total financial resources framework.

In the business context, Anthony (1976) suggests that prices are targeted to allow for cost recovery (including historical cost depreciation of capital assets) and a reasonable return on the financial capital employed by the firm. However, in the government context, the budget is a device for obtaining resources and revenues (such as property taxes) are targeted based not on cost recovery but on estimated expenditures for the current period. When spending needs exceed available revenues (as is typically the case), it would be very hard to convince taxpayers, legislators, special interests, and others about the need to set aside (or raise additional) revenues simply to cover non-cash depreciation charges. During budgetary hearings, capital use charges based on depreciation calculations are likely to be viewed as irrelevant (and consequently ignored) by legislators and others because of the absence of a visible connection with the need for current spending.

Traditional governmental budgeting has been much maligned but also has shown endurance and persistence.9 The truth of the matter is that the traditional government budget is not about to disappear. If IPE reporting is to make a difference, it must influence the budgetary process. To be able to influence the budgetary process, IPE reporting will need to measure capital use within a flow of financial resources framework.

A multi-year capital plan for maintenance, repair, and replacement spending should have a positive effect on the budgetary process by encouraging greater attention to the future. In this sense, engineering-based multi-year capital plans should do for capital use charges what actuarial funding plans have accomplished for pension costs. Without an actuarial study and funding plan, current spending needs for pensions are likely to be perceived by taxpayers and legislators as being the same amount as what is currently payable to retirees (pay-as-you-go funding). With an actuarial funding plan, it is much easier for taxpayers and others to understand the need for current spending in excess of current retiree benefits in order to provide for the delayed costs of current period services. Like actuarial funding plans, engineering-based multi-year maintenance, repair, and capital replacement plans are likely to produce "soft" and arguable estimates. Nonetheless, these plans are likely to add the necessary multi-period perspective to budgetary current financing plans and promote IPE.

Footnotes

1. An article in Business Week (1991) notes that the State of New York reduced the deficit in its general fund (for fiscal year 1991) by the sale or sale-leaseback of various state assets (e.g., portions of state highways, Attica prison) to off-budget state agencies. The state agencies, in turn, obtained the necessary resources to make the purchases by issuing new long-term regular or zero-coupon bonds. Also, Massachusetts reduced its 1991 budget deficit by issuing $1.2 billion of long-term bonds. The article observes that zero-coupon bonds are an attractive means of borrowing for governments since the budgetary impact of both interest and principal payments can be postponed many years into the future. It quotes New York State Comptroller Regan as stating that the effect of these budget balancing fiscal practices is to "... shift the cost to tomorrow's taxpayers."

2. If a state or local government is losing population (as many in the U.S. currently are), the remaining residents are likely to face a disproportionately larger deferred burden per capita. The burden of deferred taxes may also be expected to fall disproportionately on those who are least mobile such as the poor.

3. Although the GASB (1987, para 60) speaks of "yearly balance," Marks and Raman (1996) provide empirical evidence which suggests that public officials have a multi-year budgeting horizon and that IPE may not be achievable each and every year. Still, reported yearly IPE would be useful as a measure of whether a government has lived within its means that year.

4. Leonard (1986) notes that preventive maintenance, although essential, has a low profile and therefore tends to be neglected. Moreover, during a financial bind maintenance is likely to be the first target for a budget cut. A city mayor is quoted as saying that "In the choice between laying off police and maintaining sewers, the sewers always lose" (Leonard 1986, p. 170).

5. Recent research (Aschauer 1989; Munnell 1990; Eberts 1990) indicates that there is more to public sector service capacity than simply the level of government services. It is suggested that public infrastructure enters the production function not only for government services but also for private sector outputs. Moreover, the public capital stock can impact private investment and location decisions as well as the productivity of private inputs. Both Aschauer and Munnell suggest an empirical association between the decrease in the growth rate of U.S. productivity since the 1970s and the decrease in the rate of investments in public capital stock. Hence, a deterioration or loss of service capacity can pass on to future residents a double burden: a reduced level of government services and a diminished level of private sector productivity.

6. There is extensive discussion in the business literature on the pros and cons of financial vs. physical capital maintenance in the context of changing prices. For brevity, that literature is not reviewed here.

7. Hulten and Peterson (1984) suggest that many older cities with declining populations have capital stock that is probably more extensive than what they need.

8. Anthony (1989) suggests that annual debt service (principal repayments and interest on bonds) could be used as a proxy for capital use. However, governments vary greatly in the extent to which they use debt to finance capital expenditures (Gordon and Slemrod 1986). Also, it would be to difficult to distinguish between debt repayments on borrowings used for capital outlays and repayments on borrowings used to finance operating deficits. Further, there is likely to be little or no association between annual debt service and the necessary expenditure on maintenance and repair of service capacity. For these reasons, annual debt service is likely to be a very poor proxy for capital use. In general, borrowings and repayments are financing transactions that should not be allowed to affect the measurement of operating results and IPE.

9. Despite its many defects (for example, the cash basis of accounting, focus on inputs instead of outputs, a built-in short-term or current focus), the traditional budget endures primarily because it is effective as a device for controlling the spending of taxpayers' dollars. Cash is simple, straightforward, and tangible. In contrast, accrual accounting can be abstract and relatively complex and may be perceived as a device for manipulating the budget. Taxpayers, legislators, special interests, and other participants in the budgetary process are concerned first and foremost with holding public officials accountable for appropriations of taxpayers' cash. Despite many real or alleged faults "the traditional budget reigns supreme virtually everywhere ..." (Wildavsky 1978, p. 501).

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This paper was funded by the ICGFM through a research grant and received an award as the best paper produced under the program by Dr. Adolf J.H. Enthoven, Consortium Vice-President and Chaiman of the Research and Education Committee in September 1996.