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On With the Budget Show

Smoke, Mirrors, & Shades Of Enron!

By Cheryl Block
Sunday, February 13, 2005; Page B01

Maybe it was a coincidence, but I can't think of a timelier one. Last week, as the White House released President Bush's budget for the coming fiscal year, there came the news that a former Boeing Co. executive who had pleaded guilty to ethics violations in the Pentagon's 2003 weapons procurement scandal would be sentenced this Friday.

The Boeing scandal, for those who don't recall, involved a deal in which the Air Force lobbied intensively to lease several Boeing tanker planes instead of purchasing them outright, even though one government estimate showed that leasing would cost taxpayers $5.7 billion more than buying. Why was the Pentagon so hot to lease? For no reason other than to avoid up-front budget reporting of the aircrafts' full cost -- and thereby help mask the true extent of the federal budget deficit.

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Ledger

President Bush's proposed budget for fiscal year 2006 is 38 percent larger than the budget the year he took office and 3.6 percent larger than the estimated expenditures for the current year.

Including $60 billion for military costs widely expected for Iraq and Afghanistan, Bush's proposed budget for FY2006 would be nearly 6 percent larger than the current year. (Figures are not adjusted for inflation.)

Proposed defense spending for fiscal year 2006 is 41 percent higher than the amount spent in 2001. (Figures are not adjusted for inflation, but also do not include FY2006 military costs for Iraq and Afghanistan.)

Federal tax revenue as a percent of GDP in 2000: 20.9

Federal tax revenue as a percent of GDP in 2004: 16.3 (lowest level since 1959)

Federal spending as a percentage of GDP in 2000: 18.4

Federal spending as a percentage of GDP in 2005: 20.3 (estimate, highest since 1996)

Percentage of total federal tax revenues that now comes from social insurance receipts: 39

-- Steven Mufson, Outlook staff

Seeing that news story in the midst of reports about Bush's proposed budget reminded me of just how little has changed. The president and Congress continue resorting to ever more smoke and mirrors to veil the truth about the costs and burdens that will be placed on American taxpayers. Moreover, they're using precisely the sorts of gimmicks and tricks that we wouldn't tolerate in the private sector.

The Boeing deal was eerily reminiscent of corporate deals using the same kinds of long-term leases for exactly the same reasons. I still carry images in my mind of that imposing Enron headquarters building in Houston that we saw on the nightly news as the Enron scandal unfolded about four years ago. Guess what? Enron acquired that building by creating a special entity solely for the purpose of purchasing the building and then leasing it back to the company. Its reasons were the same as the Air Force's in the Boeing deal -- to avoid recording the full cost of the building up front, effectively keeping the purchase "off the books."

You'd think the embarrassment of the Boeing deal, and the lessons of Enron et al., might have compelled the administration to cease and desist from the use of such accounting tricks. But in this new budget, they're everywhere.

Take, for instance, the administration's insistence on five-year rather than 10-year budgeting. Big tax cuts don't look nearly as expensive when you're projecting decreased revenues for only five years. Or take a look at Bush's proposals for new tax-favored savings accounts, which are marketed as an effort to simplify and encourage savings and are intended to replace existing IRA-type programs. Traditional IRAs give taxpayers a deduction for contributions and impose no tax until the money is withdrawn. The proposed new Lifetime Savings Account (LSA) and Retirement Savings Account (RSA) are modeled instead on the Roth IRA, which provides no deduction for contributions, but makes future distributions completely tax-free. The spin on this budget proposal is that it would reduce the current confusing plethora of tax-preferred savings accounts, each subject to different rules on eligibility, contributions and tax treatment.

Under the proposal, existing Roth IRAs would be renamed RSAs and taxpayers would be permitted to convert funds from traditional and nondeductible IRAs into these new accounts. What the spinners don't tell you, though, is that while these new accounts amount to huge tax cuts, they are actuallyrecorded in the budget as revenue increases in the first few years.

How is this budget magic achieved? For one thing, conversions from existing IRAs would be taxed now in exchange for tax savings later. In addition, since contributions to these new accounts would not be deductible, revenues are projected to increase in the first few years as taxpayers deposit funds into the new accounts rather than the old-style IRAs. Most of the revenue loss from these changes does not show up in the budget until savers withdraw their funds over decades into the future, well beyond a five-year or even a 10-year budget window.

The trick used here is similar to the smoke and mirrors used for the estate tax repeal provisions and the large tax cuts from 2001 and 2003. At the time those cuts were enacted, most people expected -- and Bush continues to promise -- that they would be made permanent, but the current budget numbers project a large revenue increase when the cuts expire in 2009-2010. There is no reason for this sunset on the tax cuts other than masking the true size of the deficit.

Reasonable minds may differ on whether tax cuts or new tax-free savings accounts are a good or bad idea as a matter of economic or tax policy. For me, the problem is that they are structured in a way that misleads and deceives American taxpayers as to their real impact on the ever-burgeoning deficit.

Add to this the fact that increased spending for military operations in Iraq and Afghanistan and the war on terrorism have been omitted from the budget numbers, and you get budget projections that are wildly out of touch with reality. How is this off-budget device any different from what corporations do when they use offshore tax shelters to keep expenses off their books?

You might be wondering how such gimmicks could survive the labyrinth of extensive federal budget procedures, many of which were specifically designed to prevent them. One simple answer is that the potential games and gimmicks are so numerous and varied that budget process rules never were, and perhaps never could be, up to the monumental challenge of keeping them in check.

Another explanation is that Congress is now at budget sea without a rudder. Until Congress permitted them to expire in 2003, the budget process included mandatory spending caps and a so-called "paygo" requirement, under which any new legislation calling for an increase in direct spending or tax cuts had to be offset by other provisions that decreased direct spending or increased taxes. Failure to comply with these constraints resulted in mandatory across-the-board cuts in federal programs.

To be sure, Congress found ways to bypass these rules. But by most accounts, the spending cap and paygo requirements, instituted in 1990, were moderately successful over the last decade in reining in a Congress that had been speeding dangerously toward a deficit train wreck. A substantial part of the blame for the ongoing deadlock over this year's congressional budget resolution lies with political disagreements over whether, and in what form, paygo should be revived.

In last year's budget, the president proposed an extension of paygo that would apply only to new mandatory spending legislation and not to tax legislation. Under this model, Congress could slice tax rates freely without providing any reduction in spending elsewhere to compensate for the lost revenue. But it would only be permitted to increase spending on one entitlement program if it found a way to pay for the additional cost by decreasing spending on another. So, for example, if Congress wanted to increase spending for Medicare programs, it might have to reduce expenditures for food stamps in order to pay for it. Congress would not be able to raise taxes to pay for expanded Medicare programs. The immediate reaction of Democrats and even many Republicans was that this was simply ludicrous. I thought the question had been laid to rest. Yet the same proposal appears in this year's proposal.

Of course, the White House is not alone in its use of gimmicks; after all, they only work if Congress goes along. There's more than enough blame to go around here. Bear in mind that the budget that Congress ultimately adopts may accept or reject the president's proposals.

But one concern is that neither the president's nor Congress's budget is subject to the same generally accepted accounting standards that the government demands of contractors with whom it does business, and that the Securities and Exchange Commission demands of the private sector generally.

For example, much of the budget uses a cash method of accounting under which receipts are reflected in the budget as they come in and expenses reflected when they are paid. The result is that Congress can authorize a new program with substantial long-term costs, but not reflect those costs in the budget until payments are later made.

Private sector firms with government contracts and, more generally, those regulated by the SEC, are not permitted to use this method of accounting because it is thought to distort the firm's income. Doesn't it stand to reason that, absent some strong policy reason to the contrary, the government should be required to use accounting methods that are consistent and that best reflect the true financial picture?

These accounting issues really reflect a general concern with the budget process itself, though. Virtually every presidential budget sent to Congress in recent memory includes a section entitled "Budget Reform Proposals." I think it disingenuous to refer to many of the proposed changes in this year's budget as "reform." Now more than ever, we need a bipartisan effort to achieve true budget process reform.

Enron, WorldCom and other corporate scandals aren't ancient history yet. In fact, they're still on the front pages, but our budget drafters seem to have forgotten every lesson they imparted. After the scandals came to light, federal prosecutors and members of Congress responded to public outrage and whipped into action to convict the offenders, curtail the abuse, and reform accounting standards and the tax code to close the loopholes. During the 2002 congressional debate on the Sarbanes-Oxley Act, which was designed to impose stricter accountability and transparency rules on an accounting industry thought to have run amok, Sen. Christopher Dodd (D-Conn.) complained that WorldCom accountants hadn't been just "cooking the books, but marinating, sauteing and garnishing them."

Now, our government seems to be doing the same. Taxpayers have the right to demand the same accountability and responsibility from our president and the Congress that it expects from corporate executives.

Author's e-mail: cblock@law.gwu.edu

Cheryl Block, a tax specialist who has written extensively on tax and budget policy, is a professor of law at the George Washington University Law School.


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