This appendix examines the conceptual basis for differences between the cost of an outright purchase and the cost of a pure lease-purchase. A pure lease-purchase is one in which the government takes full responsibility for an asset and its maintenance and is firmly committed to paying for the asset over time and owning it at the end of the lease. (This appendix does not examine the costs of leases in which the government is not committed to owning the asset. Such leases can be a cost-effective approach in situations in which the government is uncertain about its long-term need for an asset or lacks the expertise and flexibility to manage the asset as effectively as a private lessor would.)

As discussed in more detail later, the government finances a pure lease-purchase by issuing a specialized form of debt promising future lease payments. It would be possible to convert payments on such leases into standard, negotiable instruments backed by the full faith and credit of the United States. A central agency could then serve as a clearinghouse for government leases, consolidating and packaging the payments into notes equivalent to those issued by the Treasury. Although never less costly than an outright purchase, a lease-purchase financed in that way might cost only a little more than an outright purchase. Thus, the fundamental disadvantage of pure lease-purchases is not simply that they are intrinsically more costly than outright purchases--although in practice large cost differentials have often arisen--but rather that the only benefit they can provide is the questionable one of not recording up front all of the costs associated with them.

A pure lease-purchase is invariably more costly than a direct purchase for a number of reasons, but how much more costly it is--as well as the specific reasons for the difference--varies, depending on whether budgetary costs or economic resource costs are being focused on. One standard explanation for the lease-purchase's higher cost, regardless of the type of cost being considered, is that the private sector's risky borrowing rate is higher than the Treasury's risk-free rate. That rationale, however, is misleading.

From a budgetary perspective, the cost to the federal government of a pure lease-purchase is invariably greater than the cost of an outright purchase.⁽¹⁾ One reason is that lease-purchases are often negotiated in a sole-source environment in which the lack of competition sometimes allows the lessor to earn excess profits--for example, if the government agency negotiating the deal is willing to share the benefits of reduced taxes with the lessor rather than claiming them all for the government. Also increasing the cost of pure lease-purchases are the higher transaction costs associated with that more-complex method of financing. Higher budgetary costs can arise as well if--despite the government's commitments--the lessor still bears some residual ownership risk for which he must be compensated.

A further contributor to the higher budgetary costs of lease-purchases is the provision, which is standard in many long-term lease agreements, that the obligation of the United States to make the lease payments in future years is subject to the availability of appropriations for that purpose. Under the scorekeeping practices of the 1980s, that provision allowed the Congress to authorize long-term leases without recording their budgetary costs up front. In addition, it protected the agency signing the lease from violating the letter of the Anti-Deficiency Act (see Box 2 for a discussion of that law).

Yet because the provision gave the arguably incorrect impression that the government was not fully committed to making future lease payments, lenders were uncertain and tended to require a rate of return that included a risk premium for what was essentially risk-free agency debt. That premium can raise the budgetary cost of the pure lease-purchase above that of an outright purchase.

However, not all of these differences in budgetary costs reflect differences in resource costs. For example, the lack of competition for a lease-purchase raises its budgetary costs, but to the extent that the government's loss is the lessor's gain, it does not necessarily raise the total economic resource costs. Similarly, if the lessor bears some of the ownership risk of the asset, the government bears less--the total ownership risk is unchanged. In contrast, the cost of the transactions needed to set up, execute, and monitor a lease-purchase is both a budgetary and a resource cost.

A pure lease-purchase is invariably less efficient (involves higher economic costs) than a direct purchase. But it is incorrect to attribute, as many do, the inefficiency associated with a lease-purchase to the difference between the government's risk-free borrowing rate and higher borrowing rates in the private sector. In both a pure lease-purchase and an outright purchase, the government obtains an asset in exchange for a stream of future payments. However, in an outright purchase, the promise of future payments takes the form of a negotiable Treasury instrument; in a lease-purchase, it is the promise of future lease payments, which takes the form of a specialized note. The economic costs and benefits associated with the actual investment project--that is, the opportunity costs of the resources used to produce the asset and the uncertain returns that the asset will generate--are the same for both a lease-purchase and an outright purchase.

The additional economic costs associated with a lease-purchase are attributable to the difference between the two kinds of government borrowing and not to the difference between the government's borrowing rate and the rate demanded for financing risky private-sector projects. Factors that will tend to make financing with a specialized note more costly than Treasury financing include any expected costs of litigation over the terms of the lease, the lack of liquidity associated with a specialized debt instrument, and any additional administrative costs that might be expected.⁽²⁾ The more similar a lease-purchase contract is to a direct purchase, the greater the justification for the lease-purchase rule--which requires them to be treated similarly in the budget--but the smaller the likely difference in the economic costs will be. Nonetheless, because the transaction costs associated with agency debt will inevitably be greater than those associated with Treasury debt, there is never an economic rationale for a pure lease-purchase.