Federal agencies sometimes use long-term leases and special-purpose public/ private ventures to acquire capital assets without having to obtain Congressional appropriations for the full costs up front. Depending on their budgetary treatment, such leases and public/private ventures can allow an agency to pay for an asset over time. In the case of a lease, the asset is paid for incrementally, through annual lease payments. In the case of a public/private venture, the asset is paid for over time through the prices the agency pays for the goods and services that it agrees to purchase from the venture or through a lower return on the equity or other valuable considerations that the agency contributes to the venture. In both cases, the financing technique obscures the full costs of the asset. In contrast, if the agency purchased the asset directly, the full costs would appear up front in its budget.

This paper examines recent trends in federal agencies' use of leases and public/private ventures and includes recent examples. It also describes how the Congressional Budget Office (CBO) scores budget authority and outlays for legislation providing authority for leases or public/private ventures and how the Office of Management and Budget (OMB) records the obligations and outlays associated with leases and public/private ventures.⁽¹⁾

This analysis finds that in many instances, long-term leases and public/ private ventures used by federal agencies to finance the acquisition of capital assets are treated in the budget in a manner that is inconsistent with two fundamental principles of federal budgeting:

• First, that federal financial commitments should be recognized up front in the budget, at the time those commitments are made; and



• Second, that the budget should be comprehensive, capturing all financial activities of the federal government.⁽²⁾

A budgetary treatment inconsistent with those principles could deny the Congress and the Administration the information needed to oversee federal spending. Moreover, unless the costs of asset purchases financed through leases and public/private ventures appear up front in the federal budget, in the same way as the costs of assets purchased directly by the government, federal managers will be more likely to rely on such financing techniques even though they are inherently more costly.

Efforts to increase the transparency of the budget in regard to capital acquisitions could take many forms. One approach would be to develop new budgetary guidelines or modify existing ones. Another would be to reinterpret the current guidelines and apply them in a more consistent, inclusive manner. In addition, improvements in the processes that agencies use to plan, budget for, and manage their capital acquisitions could help reduce the incentive that managers now have to try to obtain assets without recognizing the costs up front.
 

The Budgetary Treatment of Leases

The current guidelines for the budgetary treatment of leases, which were first implemented in 1991, were developed jointly by the House and Senate Budget Committees, OMB, and CBO. Under those guidelines, a long-term lease that--in effect--provides the government with ownership of an asset is scored up front with budget authority equal to the present value of all future lease payments. Such leases include both capital leases (leases in which the government consumes almost all of the services produced by an asset over its useful life) and lease-purchases (leases in which the government purchases the asset at the end of the lease term). That up-front scoring puts such leases on a more equal budgetary footing, that is, on a level playing field, with direct purchases of assets. In contrast, the budget authority for operating leases (leases that are not tantamount to purchases, but which provide the government with access to the services of a commercial asset only for a limited portion of its useful life) can be recorded annually over the life of the lease as lease payments are made.

The Origins and Intent of Current Lease Guidelines
Prior to 1991, budgetary guidelines allowed many long-term leases that were the equivalent of purchases to be scored in the budget on an annual basis, as the lease payments were made. In the 1980s, that practice, together with budgetary pressures and tax laws that favored leasing, encouraged many agencies to increase their use of such leases. During that decade, the Department of Defense (DoD) relied on lease-purchases to acquire assets ranging from support ships to on-base housing. By 1990, the Department of Energy had proposed--albeit unsuccessfully--leasing oil for the Strategic Petroleum Reserve.

In 1991, the introduction of the new budgetary guidelines for leases reflected a number of concerns about the growing use of long-term leases to finance asset purchases. Such leases could:

• Reduce the budget's ability to fully depict the federal government's financial commitments;



• Undermine fiscal policy by circumventing controls such as limits on deficits and caps on discretionary spending;



• Allow an agency to avoid facing the full costs of purchasing an asset at the time it decides to buy it, thus making acquisitions that are not cost-effective more likely; and



• Raise the costs of some investments because a lease-purchase is, over the life of an asset, inherently more costly to the government than a direct purchase.

The Effects of the 1991 Guidelines
Overall, the new guidelines made the costs of federal activities more visible and contributed to a more disciplined fiscal policy. In 1991, when the guidelines were implemented, the rush toward lease-purchases stopped. In some cases, agencies decided not to undertake investments that--when scored up front with their full budgetary costs--did not appear worth the expense. In other cases, less costly direct purchases replaced lease-purchases. In the early 1990s, for example, DoD abandoned its plan to replace 40 percent of its housing stock using a type of lease-purchase known as Section 801 housing. Instead, it limited its spending on military housing to what could be financed using appropriations.

The guidelines did, however, have an unintended and undesirable effect: some managers turned to other, even less cost-effective approaches. For example, federal managers sometimes chose to rely on a series of operating leases to obtain access to assets for which they had a long-term need--a strategy that is generally less cost-effective than a lease-purchase.⁽³⁾ In some cases, managers designed operating leases for specialized federal assets that, while achieving the effect of a lease-purchase over the long term, were written to avoid triggering the guidelines' requirement for up-front scoring. In other cases, to acquire assets, agencies turned to more-complex financing arrangements, including special-purpose public/private ventures.
 

The Budgetary Treatment of Public/Private Ventures

In this paper, a special-purpose public/private venture refers to a business entity (such as a corporation, partnership, limited liability company, grantor trust, or other trust) that is created by public and private parties for a single specified purpose and whose activities are predetermined by the contracts and other arrangements between the parties involved. A public/private venture differs from an arm's-length lease or purchase contract in that the government plays a significant role in creating and controlling the venture and the government's claims are subordinate to those of the venture's other creditors.⁽⁴⁾ An example of such a venture would be a limited partnership created by the Army and a private developer for the sole purpose of financing and building housing for military personnel in a particular location.

Supporters of special-purpose public/private ventures argue that such ventures serve a legitimate economic purpose by providing the government with expertise and flexibility available in the private sector. This paper does not examine the validity of that claim; instead, the paper focuses on the budgetary treatment of such ventures. Displaying the nature and full extent of the federal government's financial commitments can help inform decisions about whether the benefits of such arrangements justify the federal costs. The public/private ventures reviewed in this paper--including DoD's housing privatization projects at Fort Hood, Texas, and Elmendorf, Alaska, as well as the Department of Veterans Affairs' (VA's) enhanced-use leasing projects at Mountain Home, Tennessee, and the West Side in Chicago--finance the acquisition of federal assets outside the budget, raising issues about the budgetary treatment that they have received.

Public/private ventures are often complex business arrangements in which explicit lease payments by the government may not be involved or may play a minor role. Instead, the government may contribute to the venture by offering low-cost leases of government property, making commitments to purchase goods or services from the venture, or conveying assets to the venture. Few precedents exist for scoring or recording the budgetary implications of those new arrangements. Although recording commitments up front in the budget is a fundamental principle, the precise level of the federal government's financial commitment and control in such a venture may be unclear.

Agencies often enter into public/private ventures using broad legal authorities, such as those provided to DoD and the VA for, respectively, the privatization of family housing and enhanced-use leasing. At the time the Congress grants such broad authorities, it may be uncertain whether and to what extent agencies will use them to enter into financial commitments. Moreover, under such authorities, agencies need not seek subsequent authorization from the Congress for individual projects. Those factors can limit the role that the Congress plays in determining the budgetary treatment of public/private ventures.

OMB has an opportunity to review individual public/private ventures as the budget is executed, but it may choose not to record obligations and outlays up front if the budgetary precedents are not extremely clear. In some cases, OMB has allowed agencies, including DoD and the VA, to record the obligations associated with contracts with public/private ventures as if each provision in the contracts was an independent transaction between a federal and nonfederal entity. That approach generally keeps ventures' spending on assets, and borrowing to finance that spending, out of the federal budget.

An alternative approach, used by CBO in several of its cost estimates for legislation considered in the 107th Congress, is to consider each public/private venture as a whole to determine whether and to what extent its financial commitments should be reflected in the federal budget. In CBO's view, the factors generally associated with the government's control of an entity--such as cash or in-kind equity investments by the government and, depending on their terms, commitments for purchases, leases of property, and credit assistance--determine whether all or part of many ventures are sufficiently governmental to be included in the federal budget.

The differences between OMB's and CBO's approach to public/private ventures is illustrated by their perspectives on DoD's family housing privatization ventures. In CBO's view, housing privatization ventures that result in the construction of family housing on military bases should be reflected in the budget as if they were investments by the government because, in effect, it controls the ventures and ultimately will own the housing. OMB takes a different position, emphasizing that DoD may have little if any equity ownership, DoD may not be legally liable for the ventures' debts, and the rental payments are made by individual service members--even though such payments are funded by annual appropriations.

CBO's approach is consistent with the recommendation of the 1967 Report of the President's Commission on Budget Concepts, which called for a unified, comprehensive federal budget that encompasses the full range of federal activities. In addition, it is consistent with changes in private-sector accounting practices mandated by the Federal Accounting Standards Board (FASB) in the wake of recent concerns about the lack of transparency and integrity in private firms' financial reports.⁽⁵⁾ Under those new standards, a firm may be deemed to have a controlling financial interest in a special-purpose entity--and be required to include that entity in its own financial statements--even if it does not control the entity through legal ownership or voting rights and even if it is not legally responsible for the entity's debts.⁽⁶⁾ Instead, the firm's controlling financial interest in the entity may arise from contractual rights and obligations such as those that result from loans or debt securities, guarantees, management contracts, service contracts, residual interests in transferred assets, and leases. If a similar concept was used in federal budgeting, it would imply that many of DoD's family housing ventures and the VA's enhanced-use leasing ventures should be included in the federal budget. Their financial commitments and spending would then be recorded as federal obligations and outlays, respectively.
 

Meeting the Challenges Posed by Leases and Public/Private Ventures

The 1991 guidelines made the budgetary treatment of assets financed through lease-purchases consistent with that for assets purchased directly by the government, thus limiting the ability of agencies to use lease-purchases to avoid recording the costs of investments up front. In response, however, agencies have sought new ways--including the use of public/private ventures--to acquire assets without recording the costs that way.

In some cases, those methods have reduced the ability of the budget to facilitate cost-effective decisions and make agencies' commitments visible to the Congress and the public. That situation is exemplified by DoD's plans for public/ private ventures to build or rehabilitate more than 120,000 military housing units by 2006. If DoD achieves that goal using its current budgetary treatment of the projects, the department could record approximately $1.2 billion in federal spending up front while committing to projects that would, if the full costs were recorded up front, require more than $11 billion in appropriations.

Some analysts argue that the current budgetary guidelines and precedents are adequate to ensure transparency in the budget, provided that they are interpreted broadly and applied consistently. Others argue that changes in the guidelines for leases and new guidelines for public/private ventures are needed to make costs more visible and to facilitate more cost-effective decisionmaking. Still another approach might be to require Congressional authorization of and scoring for individual leases or public/private ventures that involve private-sector financing above a certain threshold.

In addition, some analysts suggest that focusing on how agencies plan, budget for, and manage their real property could improve the transparency of the budget in regard to capital acquisitions. Better long-term planning might reduce the pressure that managers feel to keep the costs of constructing and rehabilitating facilities outside of their budgets. Capital acquisition funds, such as those proposed by the current Administration, might be used to keep capital costs up front in the agencies' overall budget while spreading those costs out over time in program managers' budgets.

All of those approaches merit consideration. However, the purpose of this paper is not to recommend a specific solution but to identify the challenges that financing federal projects through leases and public/private ventures poses for Congressional control over federal spending as well as for the transparency of the budget and its ability to facilitate cost-effective investment decisions.