How government plays the budget game

Not so long ago, the toughest day of the year for a CEO usually came in the spring, when publicly traded companies typically hold their annual meetings. In most states, anyone owning a single share of a multibillion-dollar company can attend the meeting and question the CEO directly. Veteran public-relations executive Fraser Seitel, echoing how most CEOs view these yearly interrogations, calls them "a forum for a small band of lunatic dissidents to embarrass a red-faced, blood-boiling CEO."

But the annual meetings are nothing compared with the new star-chamber venue for corporate leaders-the congressional hearing room. After a decade in which CEOs were welcomed on the Hill as engineers of the economic boom, Congress has recently been skipping the hospitality. Invitations now come in the form of subpoenas, and instead of being greeted with back-slapping admiration, corporate leaders are being subjected to hours and sometimes days of uncomfortable questioning.

While the witnesses have represented only a few well-known companies, the indictment issued by Congress and the White House is much broader. Sen. Paul S. Sarbanes, D-Md., author of the recently enacted corporate accountability law, recites a litany of past accounting-related business scandals, including the savings and loan crisis of the 1980s-and says that the latest wave of corruption is worse than any of them.

"Today's difficulties, unfortunately, appear to be more widespread," Sarbanes said at one of several hearings on accounting practices. "And the fears they have generated are more widely shared, since more and more people are investing in our stock market than ever before."

Sarbanes isn't the only outraged politician. House Energy and Commerce Committee Chairman W.J. "Billy" Tauzin, R-La., had this to say about the Enron mess: "We have witnessed an incredible collection of not only miscreants and potential criminal behavior, but a series of accounting abuses [of] standards and practices, a series of abuses of the American public." Just after July 4, Rep. Michael G. Oxley, R-Ohio, chairman of the House Financial Services Committee, invoked both the American Revolution and the war on terrorism at his hearing looking into WorldCom's accounting practices. "We honored the ultimate sacrifice of our heroes who, long ago, and just last year, placed those virtues above self-interest and beyond the temptations of affluence and protecting others instead of themselves."

Democratic leaders were the first to insist that the accounting profession couldn't be trusted to regulate itself: "I really don't know that people are confident that with the industry watching the industry, you're going to get any real oversight," said Senate Majority Leader Thomas A. Daschle in June. "Who's watching out for the stockholders, and who's watching out for the taxpayers?" House Democratic Leader Richard A. Gephardt scoffed at President Bush's suggestion that accounting procedures were "not exactly black and white." Gephardt said, "Mr. President, with all due respect, accounting should be black and white: clear, precise, and easy for employees and investors to understand."

Let's see: arrogant misuse of the public's hard-earned money; self-preservation over the public good; clear and precise accounting rules blurred to hide the truth. And Daschle's bottom-line question: "Who's watching out for the taxpayers?"

By the way, isn't it budget time in Washington?

Sarbanes is right about one thing: Unlike the S&L crisis and other business scandals, this latest string of abuses involves a practice that Congress and the executive branch understand very well-cooking the books.

Sen. Phil Gramm, R-Texas, who has been at the center of every budget fight on Capitol Hill for 20 years, says if Congress was bound by the same accounting rules as business, "we'd all be in jail right now." He noted that the new Sarbanes law requires CEOs to certify, under threat of prison, that their financial books are honest. "Yeah, if we had to do that, we'd go to jail." In fact, Ernest F. Hollings, D-S.C., chairman of the Senate Commerce, Science, and Transportation Committee, puckishly asked the White House to certify to securities regulators that its budget reports are accurate. So far, Budget Director Mitchell E. Daniels Jr., hasn't responded.

Depending on how it is measured, the fraud committed by Enron and WorldCom executives amounted to between $10 billion and $20 billion. "That's nothing compared to what happens in the budget process," said Robert Bixby, executive director of the Concord Coalition, a budget watchdog group. As one senior congressional aide put it, "Traditionally, we've been able to shift much larger amounts." He paused. "By `shift,' I mean hide." Former House Speaker Newt Gingrich said it is "incredibly hypocritical" for Congress to impose accounting standards on business that it couldn't begin to meet in handling the government's year-to-year finances.

One reason it happens, of course, is that neither Congress nor the administration is directly beholden to anyone in putting together the federal budget. They are not even beholden to each other. Both sides "pretend like they are making a budget, and then they just blow through it," said Leon Panetta, who has seen the game from both ends of Pennsylvania Avenue-first as chairman of the House Budget Committee and later as President Clinton's budget director and chief of staff.

Bixby said, "The president and the [congressional] leaders can give speeches about controlling spending, but when the rules get in the way, they just change the rules."

With the help of Congress, the public has learned a lot this year about the many ways that some corporations hide their losses, boost their profits, and try to keep their chicanery from coming to light. As the budget season heats up in Washington, it's an appropriate time to look at how the government does the same. Outside critics, and even members of Congress themselves, commonly blame Capitol Hill for the budget shenanigans. But the executive branch has been just as active a player in this shell game. Some of these budget gimmicks are already notorious-classifying regular spending as an "emergency," for example. But some of the biggest and most abusive tricks are known only by the budget experts themselves. Here's a look at 10 ways the government plays the game.

1. Loading the Dice

Even before the government begins to make a budget, the process is skewed by official manipulation of forecasts for economic growth, revenue, and spending rates. This practice is akin to what badly run corporations do all the time-exaggerate their long-term growth projections and underestimate their long-term expenses. For the government, the most famous and still archetypal example was the Reagan administration's concoction of a "Rosy Scenario" to put forward a 1982 budget of tax cuts and spending increases that would be sustained by an unrealistic growth rate of 5 percent a year in the economy.

Most of the time, the techniques the White House and Congress use to spin their forecasts are fairly opaque. The bad faith behind the Reagan example is well-known only because then-Budget Director David Stockman decided to come clean in an interview with William Greider in The Atlantic Monthly.

The popular version of history has it that the Rosy Scenario was the product of "supply-side" economics-the discredited idea that tax cuts would produce enough economic growth, even in the short-term, to offset the loss of revenue. In fact, there were no supply-side assumptions in the Reagan budget, just an unrealistically high forecast for growth.

2. Assuming Virtue

One of the common ways the government distorts its budget forecasts is to assume it will behave in cautious, responsible and thoroughly unprecedented ways. For example, the Office of Management and Budget currently assumes that discretionary spending (the spending that has to be approved by Congress every year) will grow at about 2.5 percent a year-roughly the rate of inflation-when it has always grown at a much faster rate. And the pressures for higher spending are particularly strong now that the government is ramping up the war on terrorism.

Similarly, the economic forecast most often cited by budget makers assumes that many billions of dollars in popular tax breaks will expire when the law authorizing them runs out-even though Congress almost always extends such breaks. Barry Anderson, deputy director of the Congressional Budget Office, says that is why CBO and OMB use multiple forecasts in their budgets. But rather than clearing things up, this often only serves to confuse those who are not steeped in budget arcana. During the high-tech bubble, dot-com companies similarly avoided mentioning that they were losing money by dreaming up new, rosier measurements such as the rate at which their revenue was growing relative to losses.

Anderson says that government agencies regularly understate their costs by making unrealistic assumptions about multiyear projects that experience proves will cost much more than projected. He calls the Defense Department the biggest offender. With weapons systems that can take 10 years to develop and 20 years to deliver fully, low-ball cost estimates can be carried over from year to year, until they eventually show up on the budget ledger as government debt.

A related example, almost unknown except to budget insiders, is "spendout rates." Anderson says that government agencies often deliberately underestimate how quickly they will spend their budget authority (the amount Congress has authorized for a program), thus understating their expenses in the short term. In a sense, WorldCom was playing the same game when it claimed that billions of dollars in day-to-day expenses were actually capital expenditures, to be used (and depreciated under the tax laws) over a number of years.

The laws are fairly clear about what qualifies as a capital expenditure, and WorldCom has admitted that it was wrong. But the rules are not as clear for government agencies and their spendout rates, and disputes are common. In one recent example, CBO looked at $100 billion in defense spending authorized for fiscal 2003 and effectively found that the Pentagon was reaping a windfall of $3 billion by slowing down its spendout rate.

3. Breaking the Rules

Every five years or so, the government has a budget crisis and ends up adopting new rules that are supposed to avert a recurrence. The most fundamental reason that the new rules eventually fail is that the government always ends up breaking them. The budget reform cycle usually lasts about five years because it usually takes that long for the rule-breaking to become so widespread that the budget becomes a sham. Now, says Panetta, the government is past even that point.

"The budget process has collapsed. The budget doesn't mean anything because of the lack of enforcement. Everybody involved knows it, but they are pretending to not notice because they are unprepared to stop" spending.

The best-known example of rule-breaking is the yearly debate over "emergency spending," a loophole created in the 1990 budget reforms that allows the government to add spending for emergencies, such as natural disasters, to the budget without breaking previously set budget limits. By the late 1990s, Congress and the Clinton administration had given up much pretense that "emergency spending" was really limited to emergencies. Perhaps the most notorious example was when extra spending needed to conduct the 2000 census was declared an emergency.

"How can something that is required under the Constitution be an emergency?" Bixby asked. Richard Kogan of the Center on Budget and Policy Priorities said the abuse of the emergency-spending loophole in supplemental appropriations bills reached its height in 1999 and 2000, when the caps on discretionary spending adopted in the 1997 budget accord were still in force but the government had an unexpected budget surplus.

Kogan cites Congress's deal in 2000 to reconcile differences in the House and Senate defense appropriations bills by throwing an additional $7.2 billion into the Labor-Health and Human Services appropriations bill. This classic logrolling was accomplished by classifying more of the Defense Department's funding as emergency spending, thus freeing up extra dollars for Labor-HHS.

Kogan says this sort of practice tapered off in 2001, but only because Congress and the administration agreed to the ultimate rule-breaking-raising the spending caps. Another feature of the 1990 budget deal-a requirement that new entitlement spending or tax cuts be offset by spending cuts or revenue increases-has also been flouted. This "pay-as-you-go" requirement is supposed to prevent runaway deficits, but the requirement has been waived so frequently, according to Panetta, that it is effectively useless.

4. Changing the Rules

When the loopholes in the rules aren't big enough, Congress and the administration sometimes change the rules. One way that the government has done this is by reclassifying certain expenditures as "entitlement" spending. (Entitlements are programs, such as Social Security, whose budgets aren't set every year by Congress. The programs spend as much as is required to pay benefits to those who are entitled to them.)

During the Clinton administration, OMB decided that it wanted to tap some of the funds held by the Federal Reserve System, which is supposedly self-financing and independent of the executive branch. The Fed, the central bank for the United States, buys and sells dollars and other currency, earning returns on its lending. Each year, it racks up a small (by its terms) profit of several billion dollars, which sits in a Fed account. Then the Clinton administration decided to count that profit as an asset of the executive branch. The independent Fed still controls the money, but by claiming it as an asset, the White House helps make the budget picture look a little brighter.

One change of the rules last summer was an example of a phenomenon that almost every member of Congress condemns but that large majorities nonetheless wholeheartedly support-"directed scoring." The Congressional Budget Office was created in 1974 to be an independent voice in the budget process, and in most cases, it has the last word on how to count things in the budget. On occasion, however, CBO's judgments get in the way of a popular bill in Congress, and the leaders take matters into their own hands.

In this case, it was a bill bailing out the retirement fund for railroad employees. The fund was facing serious problems because the retirees were living longer but the number of railroad workers supporting them was dropping. One idea was to boost the return of the plan by allowing its funds to be invested in the stock market. CBO's view was that since that money would be put at risk, the investment had to be scored in the budget as an expenditure, and a hefty one-$15.5 billion. Over the objections of some conservative Republicans, big majorities in the House and Senate voted to "direct" the CBO to declare that the shift in railroad money would cost nothing.

The retirement fund case is the biggest example of directed scoring that CBO's Anderson can remember, but not the only one. Almost every year, Congress votes to reverse some CBO decisions on individual budget items. "I hate directed scoring. I think it corrupts the budget process," said Gramm, who was one of a handful of senators who fought against the shift of railroad funds. Anderson, who is an employee of Congress, demurs when asked how he feels about directed scoring. "Congress writes the rules," he said.

And rewrites them.

5. Ignoring the Rules

Sometimes, when you can't break the rules or change the rules, the easiest thing to do is to ignore the rules. Early in the Clinton administration, when negotiators were putting the finishing touches on the 1993 budget deal, Anderson (then at OMB) remembers, White House officials were stuck: They were $5 billion short in finding all the "pay-as-you-go" offsets to meet their often-stated goal of $500 billion in deficit reduction, but they were unwilling to cut spending or raise taxes to meet the shortfall. Instead, Anderson said, the administration, and the Democrats who controlled Congress, just pretended as though all the accounts were properly balanced. The $5 billion deficit should have triggered a special session of Congress to find the money. It was never clear, Anderson said, whether the Republicans didn't notice the discrepancy or didn't care.

6. Stopping the Clock

The imperative that drove the suspected fraud at WorldCom was meeting short-term profit goals. One method employed by officials there-and at other companies that have recently "restated" their earnings-was to book income from long-term contracts in the near-term, even though the income wouldn't really come in for years. Another technique was to slow down the recording of expenses that should have (and often were) paid promptly. In both cases, the trick was only temporary-in the end, profits would fall and expenses would add up, but CEOs were more interested in making it through the next quarterly earnings report than in fixing the long-term problem.

There is a kindred tradition in the federal budget process, primarily demonstrated by the many ways budget makers delay payments to help make the current picture look a little brighter. Former CBO Director Rudolph Penner said such timing gimmicks are now used routinely in almost every budget. "Pretty much any time that a pay period [for federal employees] falls close to the end of the fiscal year, you can bet that the costs will be kicked over to the new year," he said.

One of the largest timing shifts happened last year, when the Bush administration was scrambling to accommodate the first slice of its $1.3 trillion tax cut and simultaneously boost spending. With the support of Congress, the White House agreed to postpone the normal due date for about $23 billion in corporate taxes by two weeks. By thus shifting the due date into the next fiscal year, the government was able to make the revenue losses from the tax cut look smaller than they really were-at least temporarily.

Robert Reischauer, who headed the CBO from 1989 to 1995, said he viewed timing shifts as pretty harmless gimmicks, since they had to balance out in the end. "There's no economic impact, it is just cosmetics," he said. The example Reischauer said he found most amusing was when Congress came up with a way to slow down Medicare payments, thus postponing some expenses each year. In an illustration of the government's impulse for double-talk, lawmakers dubbed the slowdown "Prompt Pay."

But Kogan of the Center on Budget and Policy Priorities said that timing shifts are more than just temporary emollients. The Bush administration's decision last year to delay the corporate tax payments came before Sept. 11, at a time when the administration was having trouble lining up support for a large increase in defense spending. The shift also came before drastic budget revisions had foreclosed any prospect of a balanced budget. Government officials "temporarily" delayed the tax payments with the goal of facilitating a permanent increase in spending, Kogan said.

7. Making It Disappear

The accounting abuses at the heart of the Enron scandal involved energetic and creative bookkeeping that allowed top management to hide losses that the company incurred from reckless business moves and to conceal staggeringly large sums that executives diverted from shareholders. Most of the losses and the apparently stolen profits were hidden through the creation of shell companies that kept the illegal maneuvers off Enron's balance sheet.

In terms of sheer scale, the most effective way the government cooks the books is by using the similar ploy of declaring entire agencies and problems to be "off-budget." This slippery term generally means that the costs of certain ongoing government functions are excluded, as a bookkeeping matter, from the year-to-year budget tussle. In some cases, this is probably a good thing. The Postal Service, for example, operates largely independent of government control and is fiscally sound, and thus it is appropriate that it is not part of the federal budget-if only to stop the government from grabbing its profits.

But government budget experts still grumble about the sleight of hand when the Postal Service was taken off-budget a decade ago. OMB, scrambling to decrease the deficit, had the Postal Service write a check to the U.S. Treasury for $50 million, which showed up as new revenue, even though it was just an accounting trick. "There's a lot of room for this stuff when you start taking things off-budget," Gramm said.

In the current fiscal year, CBO considers $358 billion off-budget, about 18 percent of the federal government's $2 trillion total spending.

One of the most notorious off-budget gambits came at the end of the Reagan administration, when Budget Director Richard Darman and others needed a cost-free way to begin paying for the savings and loan bailout. Instead of recording the $30 billion bailout as spending, and thus adding to it the growing budget deficit, the government created the Resolution Funding Corp., which issued bonds that Uncle Sam will have to pay off in 2009. To make matters worse, since those S&L bonds carried a higher interest rate than regular Treasury bonds, taxpayers will end up paying more in the long run.

8. Ransoming the Future

The federal government's biggest budget dodge, by far, is classifying Social Security and parts of Medicare as off-budget programs. The Concord Coalition's Bixby dismisses timing shifts and directed scoring as "low-grade gimmicks," but he calls the off-budget treatment of Social Security and Medicare "the kind of [accounting] abuse that will consume the federal budget if something drastic isn't done." According to the President's Commission to Strengthen Social Security, in 2016 the Social Security program will pay out more in benefits than it collects in payroll taxes, requiring the government to start borrowing money.

Richard Kogan argues that the accounting treatment of Social Security captures the conflict inherent when budget makers have to decide between budgeting for the short term or the long term. Counting Social Security tax receipts outside of the normal budget process makes it a little harder for the government to use the Social Security surplus to paper over a short-term budget deficit, he said. On the other hand, walling off Social Security has allowed the government to project healthy budget surpluses in the years ahead-when, everyone knows, the Social Security shortfall will be eating up revenues. According to the Commission to Strengthen Social Security, without tax hikes, benefit cuts, or borrowing, the Social Security deficit will be nearly as big a burden as the defense budget by 2035.

Although politicians often talk of a Social Security "trust fund," as if its balances were safeguarded, Bixby points out that there is no real prohibition on dipping into Social Security to help reduce a deficit. Furthermore, because the "trust fund" incurs obligations to workers who will retire later, while simultaneously collecting payroll taxes, nothing prevents Social Security from issuing more IOUs than it will be able to cover. "There is no trust fund, just a promise the government won't be able to keep," he said.

9. Passing the Buck

The Constitution provides for a government of limited, enumerated powers, with the rest left to the states, but it is safe to say that the Framers never anticipated the concept of "burden-sharing" for Medicaid and other programs. Thanks to a campaign by Republicans in the mid-1990s, Congress has rules against enacting "unfunded mandates," which are laws that impose costs on local government but provide no federal money to pay for them. But that prohibition does not apply to many existing mandates that, through regulatory changes, can end up shifting significant costs to local governments.

The most expensive are environmental programs, such as local air pollution standards. Then there are the occasional changes in the burden-sharing formulas for federal-state programs such as Medicaid, or for transportation spending, which can shift more costs to the states. While participation in the state-funded aspects of Medicaid is optional, other responsibilities are not. States must pay 50 percent of the cost of distributing food stamps to the poor, for example, and state and local governments must fund 85 percent of the cost of a federal law benefiting disabled children, according to Kogan.

But the government has even more ways to pass the buck. Barry Anderson said the method that bothers him the most is what could be called "proxy taxation." An example is the Universal Service Fund, money that the phone companies collect on every phone bill and use to fulfill various federal mandates, such as the fund's original purpose: extending basic phone service to rural areas. That goal was achieved long ago, but the tax lives on. Anderson said he was at OMB when Vice President Al Gore hit on the idea of diverting that money to help extend Internet access to public school classrooms. "Treasury never touches the money, but this is a huge program, billions and billions," he said.

Another proposal that would have imposed huge costs on consumers in this indirect fashion was the never-enacted Clinton health care plan, which would have effectively forced millions of people to buy insurance from a government-sponsored health cooperative. Other such "proxy taxes" abound, most of them imposed on business. These fees and surcharges help finance a larger government without showing up in the federal ledger.

10. Postponing the Pain

This is the phrase that Barry Anderson uses to define budget gimmicks large and small. "Anything that postpones the pain qualifies," he said. Under that definition, the Pentagon's effort to lease 100 Boeing 767 fuel tankers is a gimmick, no matter what the Air Force claims. "It is just like leasing a car," Anderson said. "Deep down, you know it is going to cost you more." In the case of the planes, the incentive for budget planners is that the leasing cost in the early years of the contract will be only about 1 percent of the cost of buying the planes. It is surely no coincidence that the Air Force is considering a 10-year lease for the tankers, putting the decision on whether to buy the planes just beyond the reach of the House's 10-year budget rules.

Another innovative and increasingly popular technique for postponing the pain is "advance appropriations," where Congress commits to spending money in future years. Before 1995, the only consistent advance appropriation was the $200 million to $300 put aside for the Corporation for Public Broadcasting, which operates on a biennial budget that is supposed to insulate it from political pressure. By 1996, the total in advances for different programs rose to $1.9 billion; in 1998, it was $3.9 billion; in 2000, it jumped to $11 billion; and in the current fiscal year, the grand total is $23.5 billion.

What triggered this exponential increase in advance appropriations? Much of it has come in five education programs. Senate Budget Committee Chairman Kent Conrad, D-N.D., has explained that the advance appropriations have something to do with the academic year running differently from the fiscal year. But this argument is pretty well eviscerated by the committee's minority staff director, Bill Hoagland: "Congress must have finally realized that after 30 years of funding education the old-fashioned way, it suddenly had to adopt advanced appropriations," he writes in the acerbic Budget Bulletin newsletter. "Instead, the real reason ... was because they could (there was no limit), because they wanted to get around the discretionary spending caps, and because ... beneficiaries did not care."

Now What?

The government's resourcefulness in evading budget discipline might seem funny if so much was not at stake. Based on the latest estimates from Treasury, the United States will go from a $91 billion surplus in 2001 to a deficit of about $165 billion in the fiscal year that ends on September 30, 2002. That $256 billion swing is by far the largest in history,

Some congressional leaders are demanding that the rules on spending caps and pay-as-you-go spending, which expire on Sept. 30, be renewed this fall. But most lawmakers eagerly abandoned that discipline a year and a half ago, when it became standard practice to waive the budget rules and ignore the fact that new spending was not being paid for in tax hikes or offsetting cuts. At last count, the pay-as-you-go deficit stood at $127 billion, and sometime before adjourning, Congress will have to vote to waive the rule again.

President Bush grumbled recently about Congress's plan to add $5 billion to his supplemental spending request, but he has otherwise shown little discomfort with Washington's freewheeling budget environment. Bush's tendency to focus on a single objective like the war might mean that the looming problems with the budget could get far worse before he is forced to confront them.

"You either govern by leadership or crisis," said Panetta, who now heads a public policy school at California State University. "It looks like this is going to be crisis."

Gingrich, who used to blame most budget problems on Democrats, offers a more philosophical explanation nowadays. "I think it gets back to divided government and the narrowness of the majorities in Congress," he said. "When there is this tension between two competing ideologies, there's a natural tendency to try to find common ground-and that's increased spending."

In addition to setting a poor example with its own budget shenanigans, the federal government has always lent a sympathetic ear when business sought to bend accounting principles to serve shortsighted goals. A year ago, just before the deluge of business failures, one of the most popular tax bills in Congress would have allowed business to immediately write off the cost of computers and telecommunications gear. Breaking from the usual practice of depreciating computers over their useful lives, businesses would be able to treat them on their books as if they were paper cups or some other disposable item.

The change wouldn't have hurt tax receipts in the long run, but the real goals were to promote computer sales and to let companies pad their bottom line in the short term by declaring a capital purchase as an operating expense and thus deduct it in full from their taxes. It was exactly the kind of accounting gimmick, in other words, that many corporations used to spit shine their next quarterly report.

If government wants to change the values that led business astray in the past decade, perhaps it should start with its own.