In the furor over the size of the federal debt, rarely does anyone discuss good debt versus bad debt. Unfortunately, this failure is skewing the debate over the federal debt—to the potential detriment of the nation.

Household vs. Nation
  In discussing federal revenues and outlays, the comparison is often made to a household that must balance its budget. This comparison should be carefully limited in its application. What is true for an individual or household is not necessarily true for a nation. In introductory macroeconomics courses, this is referred to as the “fallacy of composition.” Not to go too deeply into this topic, but at its simplest level, there is one major difference:  Nations can print money; individuals cannot (at least not if they want to stay out of jail).

The analogy of good debt versus bad debt for the individual or the household can be extended to a country. We clearly delineate between debt acquired for long-lived assets, such as the purchase of a house or a car, versus a short-term consumption item, such as a vacation or a fabulous restaurant meal.  The first is considered good, or acceptable, debt; the second is bad, or unacceptable, debt. As with all things in life, there are gray areas. Debt to maintain a major asset, such as replacing a broken furnace or repairing the roof of the house, both of which would have a long useful life, is considered acceptable debt. Debt to acquire an asset that is largely for consumption purposes, although it might have a long useful life, such as a home entertainment system, is less clear. (We could throw into the questionable region the purchase of a refrigerator or dishwasher or repair of a car.)

Investing in Infrastructure
  Countries face similar decisions. Debt acquired to build or maintain long-lived assets,  such as highways, bridges, dams, ports, communications systems, and so forth,  which are investments in the country’s infrastructure, will be repaid with better economic growth, and at least some of the associated cost of construction will be recaptured in higher tax payments. In this sense, the analogy has shifted from a household to a business. Long-term debt acquired for short-term needs, such as meeting payrolls or paying for office supplies,  reflects poor management. If necessary, like a business, a country may use short-term borrowing (in the case of the United States, Treasury bills) to deal with the mismatch of short-term expenses (outlays) and receipts (revenues).

Businesses separate these expenses to differentiate between short-term expenses and long-term expenses associated with investment in plant and equipment. For the latter, a company has a capital account. That account will include an expense for depreciation, which recognizes that any asset will wear out over time or become technologically outdated and need to be replaced.

A National Capital Budget?
  The United States government, on the other hand, does not have a capital budget. There is a strong argument that the U.S. government should have a capital budget (see for example Federal Capital Budgeting). The argument is not as cut and dry as some would have it.  Charles Schultze, former Director of the U.S. Bureau of the Budget (1965-67)  and former Chairman of the President’s Council of Economic Advisors under President Carter (1977-80), laid out many of the pros and cons of a federal government capital budget in testimony to the President’s Commission to Study Capital Budgeting in 1998.

The chief danger of a government capital budget is political. Suddenly, virtually every new spending proposal would become a capital item not subject to what little control there is for current outlays. The equivalent would be arguing that an oil change for your car is necessary to maintain its long-term life and, therefore, should be funded through your home equity line rather than paid out of pocket.

Although a formal government capital budget might have significant risks from a political standpoint, the absence of such an account does not preclude voters and politicians from thinking along the lines of capital budgeting when discussing various proposals.

Using a capital budgeting approach is helpful in considering the current state of the economy and the recent partial resolution of the fiscal cliff issues. The federal deficit (outlays minus revenues) and debt (the accumulation of deficits over the life of the nation)  are issues that need to be kept in perspective. In the same way that a household or a business should be careful not to take on too heavy a debt burden, the U.S. government has to be cognizant of the dangers of too large a debt burden.

The Economic and Budget Challenge
  As previously noted, a nation is not a household or a business. Within reason, a nation can take on additional debt when its economy is struggling and its revenues are down. In addition, it must also reduce its deficits when economic times are good.

Although the United States economy has improved over the past few years, it continues to operate well below its potential. Unemployment remains too high. At the same time, there is a large need for investment in infrastructure. For too long the nation has underinvested in its highways, ports, and other facilities. It is estimated that Minnesota alone needs to spend over $10 billion to repair and improve its water and sewer systems. And if the need to repair and upgrade infrastructure doesn’t seem pressing, consider the 2007 I-35W bridge collapse in Minnesota, which resulted in 13 deaths and 145 people being injured.

Consider the following facts:

  • At present, large numbers of construction workers are out of work. The unemployment rate among construction workers in December was 13.5%, not counting workers who left the industry for jobs in other sectors or retired because of lack of work in construction over the past few years
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  • Building materials are relatively inexpensive and will only increase in price once the economy is on an even better footing
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  • Long-term interest rates are near historic lows

Given these facts, as well as the pressing need for investment and the economy’s underperformance, what better time to engage in revitalizing our infrastructure?

Making such an investment will not only help lift the economy in the short-run, but increase the nation’s potential growth, improving the government’s ability to pay the debt accumulated for these projects. Failure to invest in our national infrastructure will limit future growth, reducing our global competitiveness.

We should not let legitimate concerns about federal deficits keep us from investing in our future. Borrowing to invest in the nation’s infrastructure would be good for the economy and for the country. It would be good debt.