Posts Tagged ‘discretionary spending’

Decoding the Debt Debate

If you’re following the current debate on raising the debt ceiling, you’re probably frustrated.  Your angst may be triggered by, the partisan bickering, the lack of great leadership or the uncertainty of what may happen and what it all means.

Politicians from all political persuasions and affiliations have become very adept at obfuscation.  Knowing whatever they say or do can and will be used against them in a future election, politicians have become very proficient in deflecting and dodging direct answers.  They speak in vague terms and try to boil everything down to a 30 second sound bite.

Politicians and political commentators often use terminology that is confusing and often misleading.  You almost need a secret decoder to decipher what they are saying.  I don’t all of the secret codes, but I have a few.

As you listen to the debate, the following are a few terms to keep in mind.

  • The National Debt – The cumulative amount of money owed by the U.S. government. These are actual bonds held by various investors (including the Chinese government and your friendly bank).  The total outstanding debt is approximately $14.5 trillion.
  • The Debt Ceiling – The total amount of bonds the U.S. Treasury is authorized to issue.  The debt ceiling is currently equal to the National Debt.  A law must be passed to increase the debt limit.
  • Deficit – This is the amount of money the government is spending in excess of revenues it collects in one fiscal year (October 1 – September 30).  The deficit for fiscal 2011 is projected to be $1.4 trillion.
  • Credit Rating – Every bond traded on a public market is rated by an independent credit rating agency, which assesses the financial strength of the issuer and the likelihood of default.  The lower the rating, the higher the interest rate required.  For bonds already issued, a change in credit rating will often influence the price at which the bond is traded on the market.

Aside from these terms bantered about, I believe there are a few important factors you need to pay close attention to in any deal that is reached.  These will be the types of issues our  political leaders will attempt to obfuscate.

  • Time Horizon – The time horizon for the spending cuts and additional revenues will be calculated over the next 10 years.   If Congress and the President agree to cut $1 trillion in spending, it won’t all come in fiscal 2012.  They may sound like everything is happening this year, but any plan will be adopted over the next decade.  Raising the debt ceiling is the only thing to take effect immediately.
  •  Timing – Look at the timing for when additional revenue is received and spending cuts are enacted.  If history repeats itself, the revenues will start to be received soon, and the  bulk of the spending cuts will happen in the latter years.  In the world of pork barrel politics, elected officials use government spending to buy votes, and the termination of programs will frequently cost votes.  Thus, politicians have a real incentive to defer spending cuts to another day.
  • Details –It won’t be easy, but do your best to understand the details of the plan.  Congress is trying to make major changes to the tax code, Social Security, Medicare and  Medicaid, and they’re rushing to get it done in the next few days.  I don’t think you want a repeat of Nancy Pelosi’s famous quote, “We have to pass the bill so you can find out what is in it.”

I believe this is a serious issue, and how it is resolved could have far-reaching implications for the future.  No one knows what will happen if the government defaults on its debt, since it has never happened.  As I previously wrote, I think Congress will and should raise the debt ceiling, but it also needs to curtail government spending.  Racking up over $1 trillion of debt each year is just as perilous as defaulting on the current obligations by not raising the debt ceiling.

I also have serious reservations about our leaders’ability and willingness to cut spending.  The 2011 budget compromise is a good illustration of this.  Although they supposedly agreed to $38 billion in spending cuts, most of it was accounting gimmicks and money that wasn’t going to be spent anyway.  One analyst calculated the reduction in spending on specific programs to be less than $1 billion in comparison to fiscal 2010.

As the debate continues forward, follow closely.  Here’s why.  Last week, President Obama was pushing a plan to cut spending by $3.7 trillion and add $1 trillion of new revenue, for a net decrease of $2.7 trillion over the next decade.  Sound like a reasonable compromise?  Before deciding, you may want to consider this.  When the Administration presented their 2012 budget to Congress, they also provided a 10-year budget estimate.  The Administration projected total deficits over the next 10 years to be in excess of $9 trillion.  If the current deal cuts it by $2.7 trillion, that still means we’ll add over $6 trillion to the national debt, pushing out total debt close to $21 trillion by the end of the decade.  Still think it’s a good deal?

To me this is a good example of why we must watch this closely.  Despite the political rancor, everyone in Washington is looking for a deal which will make them look good.  Let’s just make sure the American people get as good of a deal as our politicians.

Raising the National Debt Ceiling

Within a matter of days, the U.S. Treasury is expected to hit the ceiling on its authority to borrow money on behalf of the U.S. Government.  Treasury Secretary Geithner has already made plans to extend this timeframe by a couple of months.  Most of it involves deferring payments and accounting gimmicks to buy the President and Congress more time.

I have no doubt that the debt ceiling will be raised.  With a projected budget deficit of nearly $1.5 trillion this year, there is no way our politicians will balance the budget any time soon.  Thus, the Treasury will need to continue to borrow more money to fund the government.  The real issue is how much more borrowing will be allowed and what spending cuts and fiscal reforms will be enacted.

For the most part, the debate over raising the debt ceiling is political theater and brinkmanship.  Sadly, it’s another example of the dysfunction in Washington.  If it wasn’t so serious, it would be funny.  A couple of years ago when George W. Bush was President, the Democrats resisted raising the debt ceiling and the Republicans argued that it was necessary.  Now that President Obama occupies the Oval Office, it’s exactly the opposite.  The Republicans are balking and the Democrats are calling them irresponsible.

Most of the Members in Congress would like to raise the debt limit by $2 trillion, which would fund the government until after the 2012 election.   At the current rate of overspending, the limit would be reached shortly after the 113th Congress is seated and the President is inaugurated in 2013.

Earlier this week, Speaker Boehner said that the Republicans want to cut spending by the same amount that the debt ceiling is raised.  Given the recent agreement on the 2011 budget, it’s doubtful the Republicans will come anywhere near this goal.  While campaigning in 2010, the Republicans promised to cut $100 billion from the 2011 budget.  The final  agreement was $38 billion. Of that amount, a substantial portion included accounting gimmicks and money that wasn’t going to be spent anyway. If they couldn’t agree to cut spending by $100 million, how in the world will they ever come close to eliminating a $1.5 trillion annual budget deficit?

If you believe the U.S. Government needs some significant changes in its fiscal policy, then you must pay very close attention to what happens, and you’ll need to do some digging to get to the truth.  It’s unfortunate, but you can’t take statements by our elected officials at face value.  Most of what they say is political posturing and spin.  Rarely do they tell the whole truth.  There is often more to the story.  The real truth of the $38 million of spending cuts in the latest budget deal is a prime example.

As much as I am troubled by the growing national debt, I think raising the debt ceiling is necessary.  To immediately cut $1.5 trillion of spending from a $3.5 trillion budget is too much too quickly. However, it doesn’t mean that significant changes can’t be made.  The President and Congress need to stop patting themselves on the back for cutting less than 1.5% of total spending.  It’s a pittance in relationship to the magnitude of the problem.

Raising the debt ceiling is necessary to avoid a current crisis, and making significant cuts to the current spending and fiscal policies is needed to evade a long-term catastrophe.

Spending Cuts and Accounting Gimmicks

Three weeks ago, President Obama and Congress reached an agreement on the 2011 Federal budget.  Keep in mind that the government’s fiscal year started on October 1, 2010.  Thus, we were already more than six months into the year before they could reach an agreement of how to spend money for the current year.  How they are able to do that is a different discussion.

After they reached an agreement on the 2011 budget, members of both sides of the aisle trumpeted their success in reducing Federal spending and moving towards more fiscal restraint.  Even for those who wanted greater cuts, they conceded that it was a good start.  According to the budget agreement, federal spending is will be reduced by $38 billion.  This may seem like a lot of money, but keep it in perspective.  This amount is approximately 1% of the total $3.5 trillion of federal spending for 2011 and less than 3% of the projected $1.4 trillion budget deficit.  It’s a good start, but certainly not what you might consider draconian cuts.

The dirty little Washington secret is that a substantial portion of the $38 billion won’t actually reduce federal spending for programs or personnel. Check out this Washington Post article which reveals some of the maneuvers and gimmicks utilized to account for the cuts.   Granted, there will be real cuts and reductions, “But some of the worst-sounding trims are not quite what they seem, and officials said they would not necessarily result in lost jobs or service cutbacks.”  One example cited is the $4.9 billion for the Justice Department’s Crime Victims Fund.  The money was allocated to a reserve fund that wasn’t going to be spent anyway, yet Congress counted it as part of their “spending cuts.”

Although it may seem like a rather trivial matter, it’s a good indication of how Washington works and the way our political leaders think and act.  In  Washington World, money you wanted to spend, could have spent, or even thought of spending all count as “spending cuts.”

If this were true, then I have cut millions of dollars from my spending… but it’s not real.  It makes no difference to my bank account how much money I thought of spending or wanted to spend, but didn’t.  It only counts if I don’t spend it, and it stays in my account.  This is common sense to the rest of the world, but it seems elusive to Washington politicians.

Understanding Washington World and the political spin of politicians will be very important as Congress and the President wade into the battle over the 2012 budget, raising the debt ceiling and tackling the annual deficits and national debt.  It’s in vogue to talk about spending cuts and deficit reduction, but there is often more to the story than what is being said.

This is an issue you should care about whether you support the current spending by the U.S. government or believe it needs to be dramatically reduced.  To me, it’s an issue of honesty and integrity. Hopefully, this matters to you irrespective of your political affiliation or philosophy.

Bill Gates Rips Government Accounting Practices

I would encourage you to read this short article published by the Wall Street Journal.  Last week, Bill Gates, co-founder of Microsoft and one of the richest men in the world, called out state and local government on their dubious accounting practices.   

Mr. Gates claimed that states use “tricks” to balance their budgets and the reporting is “riddled with gimmicks.”  He also said that some of the governmental accounting practices are “so blatant and extreme,” that “Enron would blush.”  Several former Enron executives are serving prison sentences for their role in the collapse of the company.  Do you think any government leaders will be facing charges for accounting improprieties any time soon?

Having practiced public accounting for the past twenty years, I agree with Mr. Gates’ general premise.  Governmental entities have some of the most bizarre accounting practices and principles.  Of course, it helps when you get to write your own rules.  Like Enron, the government may be following the technical provisions, but they may be obscuring the real financial picture.  Private enterprise would not be able to get away with the same shenanigans that our state, local and federal government perpetrates on a continual basis.

The article mentions Mr. Gates’ concern about the way states are accounting for their pension liabilities.  If you’re watching the news, you know that public workers’ pensions are a hot political issue nationwide.  Although I don’t know specifically what Mr. Gates was referring to, I do have at least one idea of what it might be – the rate of return used to calculate the future pension obligations.

A friend and former colleague of mine recently asked a state treasurer in a public forum what rate of return they were using to calculate the state’s future pension obligations.  The treasurer nonchalantly replied that it was 8%.  Without being too antagonistic, my friend queried if this was a little aggressive given the current market conditions.  The state treasurer replied that is was a rate allowed by the Governmental Accounting Standards Board.  He further explained that the rate was acceptable for governmental accounting purposes since no state had ever gone bankrupt, unlike private companies.  He also made mention that every 0.25% decline in the assumed rate of return increased the state’s current pension contribution by $___ million.

Given the current market conditions, you must invest fairly aggressively to receive an 8% rate of return.  Being aggressive is not the investment strategy most government pension plans use, nor should they.  The bottom line… a lower rate of return could exponentially increase the future obligation, making a current budget crisis worse.  Although a lower rate might be more reflective of the current market conditions, states continue to use the same rate to minimize to help balance their budgets.

Keep in mind these accusations are not coming from some uneducated, right-wing radical with a political axe to grind.  This is coming from one of the richest men in the world, who knows a little about money and financial principles.

Although it’s wonderful that Mr. Gates is raising this issue, I doubt much will change.  Accounting theory and principles can be esoteric and hard for people to understand en masse.  However, common sense is fairly simple, and the more these issues are raised, the more people will realize that this is another examples of politicians who live by a different set of rules than the rest of the world. 

We can only hope things change before it’s too late.

Spinning the 2012 Budget

President Obama delivered his proposed 2012 budget earlier this week.   The budget is for 2012, but also projects spending though 2021.

Here are a few highlights of his spending plan.

  • The budget deficit is expected to be $1.6 trillion for fiscal 2011 and will decrease to $1.1 trillion for 2012
  • The deficit is projected to decrease to $607 billion by 2015 and gradually increase in subsequent years to reach $771 billion by 2021
  • The annual interest cost on the national debt is expected to be $205 billion in 2011 and grow to $884 billion in 2021
  • The total national debt will rise to $26.3 trillion by 2021

Here are some of the statements made by the President and top administration officials regarding this budget.

  • “What my budget does is to put forward some tough choices, some significant spending cuts so that by the middle of this decade our annual spending will match our annual revenues. We will not be adding more to the national debt.” President Obama
  • “The budget that he laid out on Monday, which is actually quite an extraordinary document, it proposes $400 billion in cuts through a freeze on non-defense discretionary spending.” Jay Carney, White House Press Secretary
  • “You’re absolutely right that with the president’s plan, even if Congress were to enact it, and even if Congress were to hold to it and reduce those deficits to three percent of GDP over the next five years, we would still be left with a very large interest burden and unsustainable obligations over time,” Timothy Geithner, Treasury Secretary

President Obama has said that spending will match revenue by the middle of the decade, but the annual deficit is never projected to drop below $607 billion.  He also said that we won’t be adding anything more to the national debt, yet the debt will nearly double over the next 10 years.  The truth about the budget is that he expects to spend more than the government takes in every year, and the national debt will continue to grow.

In making his statement, the President has conveniently ignored the interest cost to the debt.  He’s not counting that as part of the annual spending.  He has tried to make some lame argument that the debt is a different issue and needs to be handled separately.  He made an analogy that it’s like racking up a huge credit card debt, but not charging anything more against it.  In making this comparison, he conveniently ignored the interest payments on the balance due as a required expenditure.

If you follow his line of thinking you could take out a huge mortgage on a house, buy a fully financed car and go on a shopping spree with your credit card, without impacting your budget.   Effectively, you could exclude all of these payments in determining if your expenses exceed your income because those payments are “a consequence of a series of [prior] decisions that were made.” 

You know that this is ridiculous.  One of the consequences of your prior decisions is that you must pay off your debts.  The same goes for the government.  It may sound academic and profound to try to isolate the interest on the national debt, but it is real money and real cash needs to be paid every year to U.S. bondholders.

Politicians are masters of “spinning” the truth to accomplish their objectives, but there is a difference between political spin and dishonesty.  In presenting his 2012 budget, the President is flirting with being dishonest with the American people.  Some might argue he is flat-out lying.

Don’t believe it when you hear that the budget is balanced, and national debt is not going to rise.  It’s simply not true.  Probably the most truthful statement was that made by Secretary Geithner when he said that we’re creating “unsustainable obligations over time.”  That I believe.

More Government Regulators

President Obama has rolled out his proposed 2012 budget earlier this week.  Of course, Congress has yet to pass the 2011 budget, but that is a separate matter.  As expected, there is a tremendous amount of scrutiny regarding this budget.  People are looking for the specifics of how the President and Congress are going to tackle federal spending, the deficit and total debt.

There is one consistent message you can glean from the proposed budget, President Obama wants to increase the number of government regulators, especially for the Departments dealing with money and finances.  The following is a snapshot of the number of the proposed new government hires:

Some of the funding will come from a direct allocation of taxpayer dollars (or additional federal borrowing), and the remaining portion will come from user fees charged by the various agencies.  For instance, the total 2012 cost to implement the financial regulations from the Dodd-Frank Act will be $6.5 billion. Of that amount, $4.8 billion is part of the federal budget’s discretionary spending, and the remaining $1.7 billion will come from user fees assessed to financial institutions.

Bloomberg has estimated that the new $6.5 billion of spending to implement Dodd-Frank is the equivalent of creating a new agency equal in size to the Army Corps of Engineers.  I can’t want to see how many people will need to be added to implement, operate and regulate the provisions of the health care bill.

There is no guarantee that all of these positions will be filled.  The budget has to make it through Congress, which will likely make some alterations, and cuts.  These new positions may serve a valuable purpose, but there is a cost to adding nearly 10,000 new employees to the government payroll.  Congress will have to decide if the cost is worth it.

The President’s 2012 budget shows just how hard it’s going to be to trim federal spending.  Even while talking about deficit reduction and getting government debt under control, the Administration wants to create thousands of new government positions.  They may believe in less government spending, but their budget certainly indicates they believe in more enforcement of government regulations.

Can Congress Cut Spending?

As part of their Pledge to America, Republicans promised to cut $100 billion of federal spending in the first year they were in office.  With the Republicans regaining majority control in the House of Representatives, the pressure is on for them to act.

Let’s take a little look beyond the political rhetoric and consider some of the facts.

  • Congress has yet to pass the 2011 budget, so the government continues operating based upon the 2010 budget.
  • Total federal spending for FY 2010 (October 1, 2009 – September 30, 2010) was $3.55 trillion.
  • Mandatory spending (i.e., Social Security, Medicare, debt service) was $2.184 trillion, defense spending was $664 billion and all other discretionary spending was $702 billion.
  • The deficit for fiscal 2010 was $1.42 trillion.

When you look at federal spending of $3.55 trillion, $100 billion is approximately 2.8% of the total.  It’s hard to argue that a 2.8% reduction in expenditures is a draconian cut.  However, opponents of the cuts have a valid reason to be concerned. 

When Congress talks about cutting spending, they usually are referring to non-defense discretionary spending, which is only about 20% of all federal outlays.  When you look to trim $100 billion from $702 billion of spending, the cuts are far more dramatic, so it’s understandable why the recipients of these funds are concerned.  Furthermore, this is the area of the budget that directly impacts the various constituents of a particular Member of Congress, which is one of the reasons it’s so difficult to enact spending cuts.  Everyone is trying to protect their turf.

Irrespective of these issues, I believe that Congress has to cut spending.  When you look at the numbers, there is simply no way that the government can raise sufficient revenue to balance the budget, nor can it continue to overspend in excess of $1 trillion each year.  At the current rate of spending, the total federal debt is projected to be near $20 trillion by the end of 2015, and will continue climbing ad infinitum.  It doesn’t take a genius to realize it is unsustainable.

I’m also of the opinion that this is a test of Congress’ true mettle and ability to deal with our fiscal crisis (yes… I’ll call it a crisis).  On the big picture, if Congress can’t trim $100 billion from nearly $3.6 trillion of spending, something is wrong.  That’s less than 3% of the total pie.  It’s also less than 10% of what would be needed to balance the budget.

Given the political dynamics of Washington, the burden doesn’t rest solely with the Republicans. President Obama and the Democratically controlled Senate also need to be part of the process.  Both parties contributed to the debt and excess spending, and both need to be part of the solution.

Without doubt, it’s going to be a difficult and painful process.  Just like your personal finances, it’s easier to increase spending than reduce it, but if necessary, you do it.  For me, a $100 billion spending cut is the beginning and not the end.  They will need to reduce spending by much more to solve our fiscal crisis, but you have to start somewhere.  Time will tell if Congress really can reduce spending.