Those who defend the current regime for budgeting federal capital expenditure over an alternative with more privately financed capital investments that are leased back to the government cite several primary reasons for their position. In particular, and mentioned earlier, are the issues of transparency and flexibility. Fully funding a capital investment in the first year makes the cost of an investment clear. Further, this approach forces those making the investment decision to identify and set aside the resources to fund it, ensuring future flexibility for subsequent decision makers who will not inherit multiple streams of contractually obligated expenses. Although this structure breaks the "user pays" bond-in that prior generations will pay for the consumption of future ones-it seems like the lesser of two evils when decision makers are trying to manage or control near-term expenditures.
The more frequently cited reason for this approach to budgeting, though, is the issue of the relative cost of public versus private capital. More succinctly put, the U.S. government-as the largest and safest credit risk in the world-is able to borrow at the lowest interest rates available. As this argument goes, why would one commit to paying a higher cost of capital by allowing private financing of a public investment when the government could pay for that investment with much less expensive capital it borrows itself?
One problem with this logic is that through spending caps, sequestration, and continuing resolutions, the federal government has created two classes of public capital.
One is the least expensive capital available in the market, which is what the federal government uses to cover its current accounts balance-or put more starkly, fund its recurring deficit spending. The other class of capital has an undeterminable effective rate, in that it is not extractable from the budgeting process. That is to say, the unwillingness to fund reinvestment in federal real estate leaves agencies with two choices: (a) to allow the asset to continue to deteriorate, without adequate maintenance or reinvestment (a course that leads to an eventual cost that is five to seven times more than if the asset were maintained); or (b) to rent the asset from the private sector, with no ownership or equity participation by the federal government.
This latter scenario means the federal government will pay a market rate for the asset that includes the private cost of capital plus a premium associated with the risk of the government abandoning its tenancy, local taxes, and profit. In other words, to avoid paying the private cost of capital in a transaction, the federal government pays the private cost of capital plus a premium that includes the increased cost of dilapidation.
Another issue cited by those who support the current approach is private sector risk. The theory is that for the private sector to be eligible for the private cost of capital there has to be some inherent risk above that of inflation, which is essentially the public cost of capital. In theory, the government's inability to guarantee a tenancy that will recover more than 90 percent of the value of a leased building justifies a risk premium for paying the implied interest rate of an operating lease. However, this rationale ignores the fact that market-rate rents are adjusted to account for the likelihood of renewal, as well as the cost of capital renewal of a tenant, after the cost of capital is accounted for. In essence, this approach actually permits a risk premium to be charged twice in an operating lease-once for interest rates and once for the risk of renewal-when compared with the public cost of capital.
Although the Advisory Group first considered the inherent inconsistencies in these two principles underlying the current scoring regime as a reason to explore additional exceptions to the existing scoring structure, their position evolved. Instead, they recognized that these assumptions could be tested-rather than assumed-if a project evaluation and scoring regime was developed that allowed alternative approaches to be compared on a consistent, life-cycle, net present value basis.