Budget Crisis -- Do You Understand Gov't Accounting?

We hear about it everywhere: budget crisis, deficit spending, ballooning national debt. For the average citizen, it is all so confusing. Why can’t we live within our means? Not spend more than we have? Reduce our national debt?

In order to find the answers to these questions it is necessary to be able to think like a member of Congress. In addition, there are two parts to the problem: the income side and the spending side. This article will discuss problems with the income side. So, herewith I provide a Congressional Primer where I will clearly outline and define the necessary concepts on the income side of the problem so you can understand how we got where we are and why we’re not going to solve these problems very quickly.

Tax Expenditures – Believe it or not, this is an income problem, not an expenditure problem. Earlier this year President Obama said, “WE MUST CUT SPENDING IN THE TAX CODE BY THE ELIMINATION OF TAX EXPENDITURES.” This statement was confusing on several fronts.

What spending is there in the tax code? Isn’t the tax code what they use to get money out of us taxpayers? And what in the heck are tax expenditures? Understanding this concept will take you a long way towards understanding how Congress thinks.

The final report of the Deficit Commission released in December 2010 recommended to “…eliminate all income tax expenditures.” These expenditures represent $1.1 trillion of annual government “spending” or $8,000 of tax savings per tax return filed. Wow. Sounds like we had better jump on this.

Simply put, a “tax expenditure” is any provision of the tax code that allows you to keep some of your money. You see, the government can tax (take away) everything that we have. If government decides to let you keep something, and not take it away, that is defined as an “expenditure” by the government. Makes sense now, huh? Allow me to continue.

You’ve all heard of the term “tax shelter”. A “tax shelter” saves you taxes and keeps more of your money in your pocket, not the governments. We’ve also heard the term “corporate welfare”, which simply is a tax shelter for businesses. I’m sure you think that tax shelters are for the wealthy and for big business – not for the average schmuck like you and me. Actually that’s not true.

A few examples might help. The number one “tax shelter” in the tax code is for individuals and says that employer paid medical benefits (health insurance) are not taxable income to the employee. Remember the flap last year over putting the cost of employer paid medical insurance on the 2010 W-2? Everyone thought it would go in Box 1 (taxable income) but it was later explained it would go in Box 14 (information only). The reporting requirement was changed from starting in 2010 to W-2’s issued for 2011. Under Obamacare there is discussion of making it taxable to help fund the healthcare program, i.e. put it in box 1. If that was done then Congress will have eliminated this “tax expenditure”.

The number two “tax shelter” for individuals is the home mortgage interest deduction. You have probably heard Congress talking about limiting or eliminating this “tax expenditure”. Other “tax expenditures” for individuals include property tax deductions, charitable deductions, child credits, refundable child credits, education credits, etc. etc. These are all things that we consider automatic and would certainly hate to lose. In fact, the top 26 “tax expenditures” are for individuals. The 27th is the first one available for business, which is the deferral of controlled foreign corporation income – remember the story of GE paying no taxes? So how do you feel about having your ox gored?

Now that you understand about “tax expenditures” you can see how Congress thinks when they are debating tax policy. It really is all their money and they are simply deciding how much you get to keep and how to give it to you. P.S. – this is also why we will never have a “flat tax” – but that’s another story.

Government Income Defined -- The second concept you need to understand is Congress’ definition of “Income”. Let me illustrate this with a parable.

Image that your Uncle Harry called you up one day and told you he needed to borrow $10,000 so that some guys would not break his legs. It’s obviously a worthy emergency but you don’t have $10,000. You can however, draw $10,000 from your home equity line of credit. You do so after explaining to Harry that you really need to be paid back because this is borrowed money that you are on the hook for.

Amazingly, several months later Harry actually pays you back the $10,000. Now the big question is – what do you do with the money? Obviously, you, I and everyone else on the planet would take the $10,000 and pay back the home equity line of credit. But that is what separates us from thinking like Congress.

The U.S. Treasury just announced that it had recovered nearly $900 million during the first six months of this year in taxpayer money used to bail out the banking system (the TARP bailout). The Treasury said that this is “…positive news for taxpayers.” Since the creation of TARP in October 2008, the Treasury has recovered $314 billion of the $413 billion disbursed for the TARP program. (To-date we’ve only lost $100 billion) So, you say, since TARP money was all borrowed then the repayment of this $314 billion must mean that our National debt has gone down by the same amount, right? Because any sane person would use the repayment of borrowed money to pay back the money we borrowed, right?

Unfortunately, in government accounting this repaid money is actually treated as “Income” and therefore can be spent on any other government program just like the income tax they take from you. That’s like taking the $10,000 that Uncle Harry repaid to you and thinking that you can go out and buy a boat or take a nice family vacation with the money. Remember, you still owe $10,000 on the line of credit. Well, with Congress they are two unrelated transactions. Cool, huh?

This helps solve the mystery of why the National debt always goes up and never comes down.

Now that you understand the logic of “tax expenditures” and what constitutes “income” in government accounting it should be much easier for you to follow what is going on in Washington. If any of this still bothers you then maybe we should have a frank talk with our elected officials about whose money they are really dealing with. I personally think it’s ours.

Next, we’ll talk about the spending side.