The System of National Accounts

The role of government in the U.S. economy receives a great deal of public discussion and understandably so. Government actions affect the structure of the economy, its stability, its rate of growth, and its role in the world economy. Government actions also directly affect in myriad ways the economic well-being of households and individuals.

Understanding the economic impact of government actions and formulating effective government policies require reliable quantitative information about government taxing, spending, and borrowing. The accounting categories used to tabulate and present this information influence understanding of the size and structure of the government sector. The national income and product accounts (NIPAs) present information about the government sector in the context of a comprehensive accounting framework for the entire economy.

The Role of Government in the Economy and the U.S. Economic Accounts

The economic role of government and the composition of government spending have undergone profound changes over the years since the NIPAs were first introduced in the 1940s. For example, a greatly increased share of total government spending (federal, state, and local)—39 percent in 1992—consists of transfer payments to individuals. Grants to state and local governments have become an important component of federal government spending. Most direct purchasing of goods and services is done by state and local governments: In 1993, 62 percent of total government purchasing (84 percent of non-defense purchasing)



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--> The System of National Accounts The role of government in the U.S. economy receives a great deal of public discussion and understandably so. Government actions affect the structure of the economy, its stability, its rate of growth, and its role in the world economy. Government actions also directly affect in myriad ways the economic well-being of households and individuals. Understanding the economic impact of government actions and formulating effective government policies require reliable quantitative information about government taxing, spending, and borrowing. The accounting categories used to tabulate and present this information influence understanding of the size and structure of the government sector. The national income and product accounts (NIPAs) present information about the government sector in the context of a comprehensive accounting framework for the entire economy. The Role of Government in the Economy and the U.S. Economic Accounts The economic role of government and the composition of government spending have undergone profound changes over the years since the NIPAs were first introduced in the 1940s. For example, a greatly increased share of total government spending (federal, state, and local)—39 percent in 1992—consists of transfer payments to individuals. Grants to state and local governments have become an important component of federal government spending. Most direct purchasing of goods and services is done by state and local governments: In 1993, 62 percent of total government purchasing (84 percent of non-defense purchasing)

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--> was by state and local governments.1 State and local government employment has grown in recent years (although more slowly than employment in private service industries), while federal employment has remained approximately level: state and local government employment now makes up 85 percent of total civilian government employment. Governments now own and operate many large enterprises, such as hospitals, utilities, and transit services, that produce goods or services for sale to the public. Finally, governments have become vital participants in financial markets, not only as direct borrowers but also as lenders, guarantors of private loans, and purchasers and consolidators of private loans. The NIPAs and the financial accounts prepared by the Federal Reserve provide a wealth of information about the diverse economic roles of governments. However, the traditional structure of the accounts was not well designed for yielding information about some basic issues that have become more important in recent years: How much of government spending represents capital investment and what return does this investment yield? The accounts treat all government purchases as current consumption and offered no ready answer. Are government workers growing more or less productive? Because of the difficulty of obtaining output measures, the accounts arbitrarily assume that productivity in the government sector never changes. Do government enterprises—such as utilities, airports, transit services, and hospitals—operate efficiently? The information needed to answer this question is not readily available. How much saving occurs in the U.S. economy and how does government influence the amount saved? Estimates of national and personal saving are significantly affected by the way in which certain components of the national accounts are defined. The Revised System of National Accounts A comprehensive revision of the international System of National Accounts (SNA) guidelines has recently been completed by international working groups in which the United States played an active role. The Bureau of Economic Analysis (BEA) has for several years been involved in a major effort to modernize the NIPAs and move them toward conformity with the SNA.2 As part of this 1   The term "purchases" as used here includes the compensation of government employees. 2   The revised SNA, completed in 1993, provides the framework for much of BEA's ongoing effort to modernize the NIPAs. When BEA's work is completed, the NIPAs will be more comprehensive, will be better integrated with the Federal Reserve Board's flow of funds accounts, and will include a more complete set of balance sheets. In addition, the revised U.S. accounts will be more internationally comparable.

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--> effort, BEA in the 1996 comprehensive revision of the U.S. National Income and Product Accounts separated government purchases into investment and current consumption.3 In addition, changes in the treatment of the government sector are under study. The nature of the changes that would occur if the SNA were fully adopted are described and their quantitative impacts estimated in a paper prepared for the workshop by D. Timothy Dobbs (1993) of BEA. Some of the principal ways that the SNA differs from the traditional (pre-1996) NIPA treatment include a distinction between spending for current consumption and for fixed capital formation; a more inclusive definition of ''government enterprises'' and an accounting treatment that emphasizes their business nature by placing them entirely in the private sector; and classification of government pension plans as owned by households rather than by governments. The SNA also differs from current U.S. practice in its greater emphasis on balance sheets and the integration of financial with income and product accounts. Fixed Capital Formation of Government Prior to 1996, the NIPAs classified all government purchases of goods and services (federal, state, and local) as purchases for final consumption. This decision was initially based not on a failure to recognize that the government purchases capital goods, but on the difficulties associated with separately identifying these purchases, measuring their service lives, and making estimates of consumption of fixed capital (Dobbs, 1993). This treatment had several shortcomings, including understating total U.S. investment and saving; increasing the deficit when new investment occurs and reducing the deficit when investment is postponed and capital stock is allowed to deteriorate; and excluding from the NIPAs measures of government investment and depreciation of the existing government capital stock (although BEA provided supplementary measures for these items). BEA had for some time prepared regular historical estimates of the stock of government capital and of annual investment in equipment and structures (Bureau of Economic Analysis, 1993a). Using such data, the Dobbs paper estimated that government gross fixed capital formation in 1988 (including government enterprises) was $163 billion and that consumption of fixed capital was $112 billion, for net fixed capital formation of $51 billion; see Table 1. Using the SNA approach, the $163 billion would be shown in the gross domestic fixed capital formation sector of the gross domestic product (GDP) 3   The 1996 revisions also included changes in the way depreciation is measured. These changes apply to both the government and the private sector. A description of BEA's current methodology and a discussion of the theoretical and empirical literature that supports the change in methodology can be found in Fraumeni (1997).

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--> TABLE 1 SNA-Based Fixed Capital Formation of Government and Government Enterprises, 1988 (in billions of dollars) Government and Government Enterprises Gross Fixed Capital Formation Consumption of Fixed Capital Net Fixed Capital Formation Total 162.8 111.5 51.3 Government 127.6 91.1 36.4 Federal 64.1 46.2 17.9 Federal—military 53.3 34.7 18.5 Federal—nonmilitary 10.8 11.5 -0.7 State and local 63.5 44.9 18.6 Government Enterprises 35.2 20.4 14.8 Federal 3.4 1.9 1.6 State and local 31.8 18.5 13.3   SOURCE: Adapted from Dobbs (1993). rather than in the government sector, and $91 billion of consumption of fixed capital would be added to the government sector. (Twenty billion of consumption of fixed capital by government enterprises does not show up in final output.) This change in accounting concepts thus would have the effect, in this particular example, of raising GDP by $91 billion, or almost 2 percent; gross domestic fixed capital formation would be increased by about 21 percent; and final consumption by government reduced by about 8 percent; see Table 2. The SNA approach has the advantage of more completely portraying total national investment and saving and of including in the national accounts a measure of the extent to which government is consuming its existing stock of fixed capital. This approach has long had the support of many economists, and the SNA guidelines are a significant step toward improved presentation of government investment spending. At the same time, the SNA guidelines seem to fall short in some respects. For example, they do not incorporate into the accounts any measure of net return to government capital. In addition, military purchases of "destructive weapons" are distinguished from purchases of other military facilities (airfields, hospitals, etc.). Only the latter are included in fixed capital formation. These issues are discussed in the final section, "Going Beyond the System of National Accounts." Government Balance Sheets A major feature of the SNA is its emphasis on the integration of accounts measuring the stocks of assets and liabilities at a point in time (i.e., balance sheets) with accounts measuring flows over a period of time (i.e., income and product accounts). The accounting framework is designed to show explicitly

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--> TABLE 2 Impact of Differences Between NIPA and SNA Treatment of Government Formation and Consumption of Fixed Capital, 1988 Sector NIPA GDP (billions of dollars) SNA-Based GDP (billions of dollars) SNA less NIPA GDP (billions of dollars) Percent Total gross domestic product 4,900.4 4,991.5 91.1 1.8 Personal consumption expenditures 3,296.1 3,296.1 —   Gross domestic fixed capital formation 777.4 940.2 162.8 20.9 Private 777.4 777.4 —   Government and government enterprises — 162.8 162.8   Government enterprises — 35.2 35.2   Government — 127.6 127.6   Change in business inventories 16.2 16.2 —   Net exports -108.0 -108.0 —   Government final consumption 918.7 847.1 -71.6 -7.7 Purchases of fixed assets 162.8 — -162.8   Government enterprises 32.7 — -32.7   Government 130.1 — -130.1   All other purchases 755.9 847.1 91.1     SOURCE: Adapted from Dobbs (1993).

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--> how a national economy moves from an opening to a closing balance sheet position through a combination of investments, asset revaluations, and other net asset changes. Balance sheets for the U.S. economy and associated flow of funds accounts are published regularly by the Federal Reserve. Government sector balance sheets are not provided, however, nor are the balance sheet and flow of funds estimates presented along with the national income and product accounts as an integrated set of accounts. The gaps in the balance sheet data and the complexities of separate presentation by two different agencies contribute to the confusion and misunderstanding that surround important questions relating to the amount and nature of U.S. saving and investment. The need for a better integrated set of national accounts that would relate balance sheets to income and product flows has long been recognized (see, e.g., Ruggles and Ruggles, 1982; Eisner, 1986; Boskin, Robinson, and Huber, 1989; Bohn, 1992; and Anderson, 1993). Interest in this problem has intensified in recent years. In response to increased requests for balance sheet information, the Federal Reserve now publishes U.S. asset and liability data on a quarterly basis (Fogler, Holder, and Teplin, 1993). Balance sheets for the government sector continue to be a major data gap, however. Recently, the Office of Management and Budget (OMB), as well as the Federal Reserve and others, has shown increased interest in the problem. In early 1993 OMB published an illustrative set of balance sheet estimates as part of its background material for the President's Budget (Anderson, 1993). A major obstacle to producing government sector balance sheets consistent with the U.S. national income and product accounts has been the lack of a NIPA government investment account. While many difficult issues of definition and valuation will remain, the development of a government investment account as part of the 1996 NIPA revisions provides the essential building block that will allow further work on an integrated set of accounts for the government sector. Government Enterprises Government enterprises are government-owned entities that produce goods and services for sale to the public; that are organized and operated separately from the owning government; and that keep separate financial records. Most government enterprises produce or sell goods or services similar to those produced by private businesses. However, the government enterprises usually were created to serve a public policy goal, making a profit is not normally their primary objective, and they often receive government subsidies. Examples are the U.S. Postal Service, electric and gas utilities, water and sewerage treatment facilities, airports, public transit authorities, and liquor stores. The NIPAs provide for a mixed accounting treatment of government enterprises (Dobbs, 1993). They receive a "business-like" treatment in that they are

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--> classified as noncorporate business, their sales are recorded in the business production account, their outlays for intermediate goods and services are excluded from final business product, and their labor costs are charges against business product. However, their interest payments, their fixed capital formation, and their inventory change are combined with those of general government and included in the government sector. The SNA definition of government enterprises is more inclusive than that used in the NIPAs (see below, "Implementing the System of National Accounts"), and the SNA provides for an accounting treatment more fully comparable to that of similar private businesses. The SNA places government enterprises entirely in the private sector and provides for an accounting treatment fully paralleling that for corporations. This treatment provides a clearer picture of the economic role of these enterprises and a more explicit statement of the amount of subsidy paid by government to government enterprises. The issue of what types of entities to classify as government enterprises is very much open. For those that are so classified, however, the more business-like SNA treatment facilitates analysis of their operating characteristics and provide a better starting point for weighing the costs to government of subsidizing government enterprises against the public benefits obtained. Government Employee Pension Plans In both the NIPAs and the SNA, funded private pension plans are treated as financial institutions that sell financial services to households.4 Employees covered by the plans are considered to own financial assets equal to the net equity of the funds. Personal income includes the pension plan contributions of employers and the property income (mainly dividends, interest, and rental income) earned on pension fund assets. Increases in the net equity of the pension plans resulting from the receipt of property income and contributions are included in personal saving. Pension plan benefits paid to individuals are not added to personal income. The SNA treats funded government employee pension plans in the same way it treats funded private plans. In the NIPAs, these government plans are treated as government-operated social insurance funds. Employer and employee contributions are social insurance contributions to the government sector, the net equity is 4   In an unfunded pension plan, the employer promises to pay specified benefits to an employee under certain conditions but has no procedures in place to guarantee payment of the benefits. The same measure of saving is recorded with the SNA and NIPAs treatment of the unfunded plans; thus, they are not discussed at length in this report. Funded plans, which may be managed by the employer or by a contractor, are held in accounts that are completely separate from the employer's accounts. The employer has limited, if any, access to the accounts.

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--> considered to be owned by government, and the saving is government saving. Personal income includes only the pension benefits paid to individuals. Using the Dobbs estimates, the differing classification of government pension plans accounts for the largest dollar difference between the SNA and the NIPA measures of the government deficit. In 1988, net equity of funded government pension plans increased by $90 billion (Dobbs, 1993). In the NIPAs this is government saving; in the SNA it is household saving. The change to the SNA treatment thus enlarges the government deficit and increases personal saving by this amount. The move to the SNA would bring treatment of government pension plans into line with that of private pension plans, providing more consistent and analytically useful measures of personal income and personal saving. In general, the SNA treatment is preferred for the pension plans of state and local governments. State and local plans invest largely in private and federal securities and typically operate with a large degree of independence from the sponsoring government. Federal pension plans invest exclusively in federal securities but operate with less degree independence, and some experts have reservations regarding the change in their treatment. Adoption of the SNA treatment for state and local government pension plans would reduce government saving and increase household saving by $54 billion; extension of the SNA treatment to the federal government would increase the impact by another $36 billion. Recommendation This section has described four important benefits of adoption of the SNA for the government sector: identification of government investment in plant and equipment; development of government sector balance sheets; use of an accounting treatment for government enterprises that parallels that for private corporations; and recognition of the household saving invested in government pension plans. Another benefit is a full set of accounts for government social insurance funds, showing transactions of these funds with other government funds. Adoption of these major changes in accounting procedures is not without costs. Substantial resources will need to be devoted to the effort. The SNA treatments will in some ways be less suited to use in macroeconomic analysis and forecasting—which uses information on all government purchases, including those for plant and equipment. For this and other reasons (see below), changes in the accounts must be well documented so that users will be able to reconstruct the traditional presentation. In general, we are persuaded that the benefits of the SNA treatment, especially those of international comparability, better measurement of national saving, and recognition of the investment component of government spending substantially outweigh the costs of transition.

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--> RECOMMENDATION 1. The Bureau of Economic Analysis (BEA) should continue to move toward adoption of the major features of the international System of National Accounts (SNA) accounting framework for the government sector of the U.S. income and product accounts. The Federal Reserve, working closely with BEA, should develop and regularly publish balance sheets for the government sector. Other agencies that provide source data or that are major users of the national accounts should support these efforts. The Administration and the Congress should provide the resources needed to accomplish the transition to the SNA in a timely way.