February 28, 1985

February 28, 1985 | Backgrounder on Federal Budget

Putting Off-Budget Federal Spending Back on the Books

(Archived document, may contain errors)

406 January 30, 1985 PUTTING OFF- BUDGET FEDERAL SPENDING BACK ON THE BOOKS INTRODUCTION The Office .of Management and Budget (OMB) recently proposed putting all federal off-budget spending back on the books.

Federal off-budget spending is spending or lending th at, by law is not counted as part of the regular budget and thus does not appear in "the deficit Since 1973, off-budget spending has ballooned, having grown from $100 million in 1973 to $21 billion in 1981, a 21,000 percent increase. In fiscal year 1985, off budget spending, it is estimated, will be in the range of $15 billion, and there is now nearly $150 billion in off-budget debt outstanding.

Off-budget spending, in short, is a tool used to disguise the true cost of government programs. As a result, U.S . taxpayers OMB proposals to place off-budget spending back on the books would afford an important step toward fiscal responsibility. forfeit a degree of control over the process of government. The I I WHAT IS OFF-BUDGET SPENDING?

Off-budget spending is f ederal spending or lending that, by law, is not counted as part of.the regular federal budget, and as such, is isolated from the normal appropriations processes and public debate surrounding on-budget spending. Since 1973, Congress has enacted legislatio n to place various agencies off the books.

The U.S. Railway Association, the Rural Electrification and Telephone Revolving Fund, and the Rural Telephone Bank were For a detailed discussion of off-budget spending at the federal, state and local levels of go vernment, see James T. Bennett and Thomas J.

DiLorenzo, Underground Government: The Off-Budget Public Sector (Wash ington, D.C Cat0 Institute, 1983 2 placed off-budget in 19

73. The U.S. Postal Service Fund and the Pension Benefit Guaranty Corporation were placed off the books in 19

74. Off-budget spending seemingly is nonpartisan, for it was the Reagan Administration that in 1981 placed the Strategic Petroleum Reserve off-budget entity responsible for most off-budget spending is the Federal Financing Ba nk (FFB), which was created in 1974 as part of the Treasury Department agency debt from funds obtained by borrowing directly from the Treasury. By law, any federal agency can place some of its spending or lending off the books by dealing with the FFB, sin c e FFB borrowing is not included as part of the Treasury's outlays although interest payments from the FFB to the Treasury are counted as deductions from Treasury outlays Table 1 shows recent off-budget outlays by agency. The Its primary activity is the pu r chase of Table 1 Outlays of Off-Budget Federal Entities in billions of dollars 1984 1985 Off-budget Federal Entity 1983 estimate es t ima te Federal Financing Bank 10.4 12.7 10.2 Rural Electrification and Rural Telephone Bank Strategic Petroleum Reserve P ostal Service Fund U.S. Railway Association Synthetic Fuels Corporation Revolving Fund 0.1 1.6 0.3 0.2 2.2 1.2 Q 0.2 1.7 2.8 Total 12.4 16.3 14.8 SO million or less.

Source: Budget of the United States Government, FY 1985 (Washington, D.C c U.S. Government Printing Office, 1984 pp. 6-11 There are two ways in which the FFB serves as a conduit through which federal spending is placed off the books: FFB purchase of loan assets and its purchase of guaranteed loans issued by federal agencies. Outstanding FFB ho ldings in these three categories, from 1976 to 1983, are shown in Table

2. By 1983, there were $60.5 billion in loan assets and $46.3 billion in guaranteed loan purchases for a total of $106.8 billion in debt outstanding. 3 Table 2 Outstanding Federal Fin ancing Bank Holdings, Fiscal Years 1976-1983 billions of dollars Fiscal Year 1976 1977 1978 1979 1981 1982 1983 19!0 Loan Assets 9.2 16.0 23.3 32.7 40.4 51.8 57.2 60.5 Direct Loans 3.1 6.6 10.5 14.4 21.5 31.8 39.3 46.3 L That is, purchases of loans guaran teed by agencies.

Source: Special Analyses, Budget of the U.S. Government (Washington, D.C U.S. Government Printing Office, Fiscal Years 1978-1985 The most important source of off-budget FFB financing, how ever, is the purchase of loan assets. Federal agen cies are permitted'to llsellll their direct loan obligations to the FFB.

These sales are treated as rep'ayments of the loans as far as the budget is concerned. Converting on-budget direct loans into off-budget loans in this way gives the taxpayer the erro neous impression that debts are being repaid. In addition, the agencies then can make even more loans since they have more funds available due to the sale. The net effect is a gross understatement of the amount of federal lending activity. For example, in 1981 the Farmers Home Administration FmHA) extended more than $9 billion in new loans, but the federal budget actually recorded a net reduction in loans outstanding to the tune of $900 million suggesting that loan repayments exceeded new loans impression was misleading because the FmHA simply had converted almost $7 billion in new on-budget loans to off-budget loans by selling them to the FFB. Accordingly, the recorded federal budget deficit was lfreduced,ll in an accounting sense, by that amount.

The seco nd way in which the FFB helps disguise federal spending is by purchasing loans (from the borrowers) guaranteed by other agencies, thereby converting the guaranteed on-budget loans into off-budget loans. For example, ,there are Department of Defense progra m s that guarantee the principal and interest on loans made before fiscal year 1985 to foreign governments to finance their purchases of military equipment. A foreign govern ment can take the loan guarantee to the FFB, which may purchase it for the full amo u nt of the guaranteed loan principal. Thus the borrower has received the funds, in the form of a direct loan, from the federal government. And since loan guarantees are But this 4 not considered to be budgetary outlays, none of the loan activity is charged to the budget of the Defense Department In 1984 Congress amended the law, such that new guarantees issued under these military programs will appear in the budget not included in the budget totals As shown in Table 2, the Bank's purchases of loan guarantee s have ballooned in recent years, more than doubling between 1980 and 1983, a period when on-budget spending programs grew much more slowly. The spending that has expanded because of this activity includes foreign military sales ($14.3 billion in debt outs t anding in 1983), Rural Electrification Administration programs ($18.9 billion), the Student Loan Marketing Association 5 billion), and, to a lesser degree, federal public housing programs, Department of Transpor tation railroad programs, and the Tennessee Valley Authority.2 Treasury Department that such a bank would reduce financing costs by pooling agency borrowing the borrowing costs to the government, because FFB borrowing from the Treasury increased the overall interest rate on federal debt.

This more than offset the minimal savings to federal agencies that take advantage of the.slightly lower Treasury borrowing rate approximately one-eighth of one percent to a different market than does Treasury debt, as the difference in interest rates attests. And w h en the Treasury issues more debt (to finance the FFB), it puts pressure on the market segment to which its issues appeal, and that forces rates up on Treasury debt. Indeed, this effect invalidates the entire economic--but The Federal Financing Bank' and o t her off-budget mechanisms Since the FFB is an off-budget agency, its direct loans are When the FFB was established, the argument was made by the But in reality the FFB increased Agency debt appeals unfortunately not the political--rationale for the FFB th e refore, are used to hide the true costs of federal spending programs from those who must ultimately pay for them--U.S.tax payers. Dozens of agencies participate in the I1launderingl1 of funds through the FFB, which enables their spending programs to conti nue growing outside the direct view of the taxpaying public.

OFF-BUDGET SPENDING AND THE POLITICAL PROCESS Off-budget spending is' the epitome of fiscal irresponsibility and governmental hypocrisy OMB's proposal to include off-budget outlays as'part of the budget should be welcomed by all those who are seriously co n cerned about budgetary control. The political role of off-budget spending is to allow politicians to preach fiscal responsibility and to practice political profligacy. It is a way of telling U.S. voters that they can have something for nothing--that the g o vernment can provide them with benefits at no Executive Offce of the President, Special Analyses: Budget of the United States Government (Washington; D.C U.S. Government Printing Office 1983 p. F-69 5 cost. A brief look at the origins of federal off-budge t spending makes this clear.

In 1974 U.S. News and World Report praised the Congressional Budget and Impoundment Control Act as Ira revolutionary budget reform intended to give Congress a tighter grip on the nation's purse string The Budget Act of 1974 eme rged from a recognition that existing budgetary procedures generated a bias toward over spending and budget deficits. Before 1974, the total amount of federal spending was the product of many individual appropriations decisions; no explicit limit was ever placed on the total amount of public expenditure. Every Congressman had then, as now, a strong incentive to maximize spending for his own constituency but no Congressman was required to take responsibility for the total amount of federal spending So for t h e first time in the history of Congress, lawmakers were required to stand up and be counted--they had to vote for a budget package. The ,Budget Act also created a budget committee in each House of Congress, responsi ble for setting overall targets for rev enues, expenditures, and deficits.

Unfortunately for the taxpayer, while federal politicians were congratulating themselves on becoming more fiscally respon sible, the lawmakers were simultaneously placing various agencies off budget. They also were busy e stablishing the Federal Financing Bank so that spending and borrowing by all agencies could be placed off b~dget In short, off-budget spending allowed poli ticians of all persuasions to continue to win the political support of special interests, at taxpay e rs' expense, .while denying to taxpayers that the subsidies were costing them anything. It has enabled Congress to suggest that there is such a thing as a free lunch after all. Examples: the Export-Import Bank can continue to subsidize big business with o f f-the-books loans; the Tennessee Valley Authority can subsidize the utility bills of businesses and residents of the southeastern states: the Farmers Home Administration and Rural Electrificazion Administration can continue to grant low-interest loans and other subsidies to Americans in rural areas; the Department of Defense can subsidize exports by weapons contractors; and students can receive low interest loans. Beginning in 1992, even the Social Security system will be placed off-budget. This will not, o f course restore the financial stability of the Social Security system but politicians hope it will make the federal deficit (and defi cit projections) look better, at least on paper Cited in James M. Buchanan and Richard E. Wagner, Democracy In Deficit T h e Political Legacy of Lord Keynes (New York: Academic Press 1977 p. 156 Bennett and DiLorenzo, in Underground Government, provide a more detailed analysis of the political economy of off-budget finance. For a discussion of local government off-budget fina n ce, see James T. Bennett and Thomas J DiLorenzo Off-Budget Activities of Local Government: The Bane of the Tax Revolt," Public Choice, Fall 1982, pp. 333-342. 6 There is one question that should be posed to those who favor off-budget spending: If all thes e programs are in the public interest, why then are they so well hidden from the public?

If these programs are part of government's legitimate function why not finance them on budget rather than off budget answer is that many of these programs could not su rvive politi cally, at least not at the levels at which they are currently funded, in the normal democratic process where voters can have a reasonably clear perception of the benefits and costs of federal programs.

Off-budget spending provides Congressmen with greater lati tude than is available with regular on-budget spending, since the latter is subject to various checks and balances, however imperfect.

When in 1979 the Chrysler. Corporation was granted its widely publicized loan guarantee by the federa l government, for instance the on-budget guarantee was criticized sharply by both conserva tives and liberals objecting to government bailouts of big business or "corporate welfare Similarly, on-budget loan guarantees to New York City in the late 1970s we r e vigorously debated. In each case, the on-budget status of the loan guarantees meant that they went through the normal appropriations process and received widespread public attention tees, however, pale in comparison to the billions of dollars of off-bud get loans administered by the FFB-loans that usually receive only minimal congressional debate and almost no public attention.

Subsidies to big business, defense contractors, affluent college students and professors, and even more affluent corporate farm b usinesses are partially hidden when granted in the form of on-budget guaranteed loans rather than direct cash grants.5 If these subsidies were in the form of cash grants, the voting public doubtless would balk at many of them, once they realized how much t hey cost. Keeping these programs off-budget, however hides them from public scrutiny and so enables their supporters to obtain more benefits than the taxpaying public would otherwise permit. This is bad politics and a bad way of setting priorities for use of the nation's resources. If the defense budget should be bigger (or smaller) than it is, the issue should be decided openly by the electoral and political process, which in a democracy includes the opinions of voter-taxpayers. Similarly, the issue of a l arger (or smaller) welfare state also should ultimately be The real These well-publicized loan guaran Guaranteed loans are loans to individuals or governments in which the federal government guarantees the principal and interest in case of de fault. The m a jor economic impact of guaranteed loans is not the dollar amount of defaulted loans, but rather the allocative effects. There were approximately 125 billion in new federal guaranteed loans issued in 1983 The effect is to allocate credit according to polit i cal rather than eco nomic criteria. Unsubsidized, nonguaranteed borrowers get crowded out of the market. See James T. Bennett and Thomas J. DiLorenzo Credit Allo cation and Capital Formation in Dwight Lee, ed Taxation and Capital Formation (San Francisco: The Pacific Institute 1985 The Political Economy of Indirect Taxation," 7 decided through the electoral and political process. The, problem with off-budget spending is that it encourages the excessive expansion of all types of spending by sidestepping the normal democratic process as it distorts budgetary priorities and dis guises the cost of governmental activity. Eliminating off-budget spending, as OMB has proposed, would be an important first step toward fiscal responsibility and an improved democratic process.

ECONOMIC IMPLICATIONS OF OFF-BUDGET SPENDING The problems associated with off-budget spending are not solely political Off-budget spending is an accounting gimmick used to reduce the perceived cost of government programs. When the Federal Financin g Bank receives funds from the U.S. Treasury the funds may not show up in the federal budget, but the economic costs of these expenditures are nonetheless real. The Treasury must either tax or borrow to obtain the funds eo that ultimately they come from e ither taxpayers or at the expense of those who otherwise would have borrowed those funds to finance cars, homes and businesses. The cost of off-budget spending, like all govern ment spending, is the sacrifice of private sector spending.

Since much off-budg et activity is in the form of credit marketing activity, such as subsidized loans and loan guarantees, the credit markets are distorted to the extent that government allo cates credit to economically inefficient (albeit politically popular uses. In 1980, f or instance, a 20 percent prime rate and 16 percent consumer loan rate contributed to the bankruptcy of scores of small businesses, yet the Rural Electrification Administration began a new program to provide 35-year loans at 5 percent to finance rural cab levision stations; rural home mortgages were available at 3.3 percent; and student loans went for 7 percent.6 In each case, resources were diverted from one-use to another, simply because certain groups enjoyed federally subsidized credit facilities.

OMB's proposal to put off-budget spending into the regular budget has been criticized by some as increasing the federal deficit. But this objection is a red herring. Off-budget spending is a problem because it hides the true cost of government programs and the r efore allows government spending to be higher than it otherwise would be. The true cost to society of higher spending is foregone private sector economic activity, regardless of whether the spending is on budget or off budget. If the federal sentially the same effect on the nation's resources whether all I of it appears on the official budget accounts or not. But because off-budget credit reduces the perceived cost of governmental therefore increases the demand for them.7 Such deficit financing I 1 I gover nment spends $900 billion, for example, it will have es- I programs-since the costs are passed on to future generations--it I Bennett and DiLorenzo, Underground Government, p. 144.

James T. Bennett and Thomas J. DiLorenzo The Ricardian Equivalence Theorem Finances Publique, vol. 2, 1983, pp. 309-316.

Evidence From the Off-Budget Public Sector ,I1 Public Finance/ 8 the mainstay of off-budget spending, causes total government spending to be higher than it otherwise would be. This leads to greater crowding ou t of private sector economic activity. By disguising the true costs of government, off-budget spending encourages deficit and allows government to take a larger propor tionate share of national income at the expense of private sector production, consumpti on, and employment.

What many who object to the OMB proposals are really saying is that they prefer a relatively larger governmental sector and a smaller private sector. To object to the proposals on grounds of fiscal responsibility, stemming from an alleg ed concern over the deficit, is economic nonsense. The published deficit may well go up in the short run, as hidden spending is put on the books. But Congress then would be held more fully responsible for its actions and increased public scrutiny would fo ster greater incentives for genuine budgetary restraint and deficit reduction.

CONCLUSION unified budget totals should be repealed by Congress. An alter native would be for Congress to revise the budgetary treatment of loan assets and direct loans to guaranteed borrowers. Redefining loan asset sales as agency borrowing, for instance, would keep on-budget loans from being given off-budget status A similar approach could be applied to FFB purchases of loan guarantees made by on-budget agencies. By treating these as loans made by the agency issuing the guarantee and redefining the FFB trans action as agency borrowing, agency budgets would accurately reflect outlays associated with FFB-financed loans and enable the public to see exactly what these loans cost.

Eliminating federal off-budget spending would be a long overdue reform. The implicit subsidies embodied in off-budget spending and loan programs are not only economically inefficient they are also' inequitable since they are comprised almost entirely of subsidies to those in the middle- and upper-income brackets.

Perhaps this is why they are so well hidden from the public.

Opposition to off-budg et spending spans the political spectrum for regardless of their political persuasion, most Americans prefer a government that is aboveboard and open, not under ground and off the books The legal provisions that exclude off-budget entities from Prepared f or The Heritage Foundation by Thomas J. DiLorenzo Department of Economics George Mason University

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