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CONTENTS
[X] Purpose
[X] Fiscal Year (FY) 2004
[X] Federal Unified Budget
. . [X] Deficits, Debts, Surplus(es), and Interest Costs
. . [X] Three Federal Business Functions
[X] Two Different Paradigms
. . [X] The Single-Fund Paradigm
. . [X] The Multi-Fund Paradigm
[X] Social Security Surplus
[X] Truth-In-Budgeting Reforms
. . [X] Modify the Federal Accounting System
. . [X] Better
Public Information
PURPOSE
The purpose of this essay is to help taxpayers understand the current unified-budget accounting/reporting system. To do this, several common terms are explained, include: budget deficit, surpluses, gross
public debt, increase in debt, public debt interest cost, and net interest.
Under the unified-budgeting accounting/reporting method, the following curious events have occurred:
In many situations, these apparent contradictions occur because analysts are using the same figures but thinking in two different paradigms---a "single-fund paradigm" and a "multi-fund paradigm". The logic behind each of these two paradigms is explained below. This essay closes with two budgeting/reporting reforms. One proposed reform would change the rules of the federal accounting system. Another would change the "Income and Outlays" display that is printed in the I.R.S. "1040 Forms and Instructions" booklet that goes to millions of taxpayers each year.
Because the basic concepts of the federal unified-budget accounting system do not change from year to year, the accounting figures used here are not up-dated annually in order to save time.
FISCAL YEAR (FY) 2004:
As background information, a few finance figures for fiscal year (FY) 2004 are listed below. These
figures were obtained from The Budget of the United State - FY 2006.
$1.9 trillion - Unified-budget receipts
$2.3 trillion - Unified-budget outlays
$0.4 trillion - Unified-budget deficit
$0.6 trillion - Gross public debt increase
. . . [Note: The $0.4 trillion deficit in FY 2004 is $200 billion
. . . smaller than the increase in the public debt of $0.6 trillion.]
$7.4 trillion - Gross public debt
$4.3 trillion - Debt held by "private" investors
. . $1.9
trillion - Debt held by foreign investors
$3.1 trillion - Debt held by Federal Government accounts
Debt held by three of the larger trust funds (government accounts):
. . Civil Service Retirement - $627 billion
. . Hospital Insurance - $264 billion
. . Social Security - $1,412 billion
FEDERAL UNIFIED BUDGET
The annual unified budget encompasses all of the money flowing into the Federal Government's coffers and all of the money
flowing back out into the world's economy. It does not include inter-agency money flows. The most obvious problem with the Federal unified-budget accounting system is its practice of reporting an annual budget surplus in the same years that it
records an increase in public debt. We start by defining several technical terms.
Deficits, Debts, Surplus(es), and Interest Costs
*** Deficits and Debts ***
In conventional accounting
systems, a "deficit" is usually an annual event. The associated "debt" is usually a sum total of previous deficits minus annual surpluses. Because unified-budget deficits do not count "internal borrowing", the annual deficits are almost always
much smaller than the annual increases in the gross public debt. Currently, most internal borrowing comes from annual new surpluses in the various trust funds. Back in FY 1998 for example, the unified budget showed a $69 billion budget surplus, and a
public debt increase of $109 billion. (From: The Budget of the United State, Historical Tables - FY 2007). The above FY 2004 rounded figures show the budget deficit was $400 billion ($0.4 trillion) while the public debt increase by $600 billion
($0.6 trillion).
*** Surplus(es) ***
The word "surplus" may mean either an "annual surplus" or a "total surplus" that is built up over many years. To be clear, an author must specify (or imply) which "surplus" is being discussed.
*** Interest Costs ***
The gross public debt may be divided into two parts:
(a) debt bonds held by the "public" (non-Federal-Government investors that include foreign, state and local governments and private investors) and
(b)
debt bonds held by Federal Government accounts, such as trust funds.
The interest cost on the gross public debt may also be divided into two parts. The term "net interest" refers only to the annual interest paid to non-Federal-Government investors (the public). The other part of total interest cost is the interest paid to government accounts.
Three Federal Business Functions
From a business perspective, Federal institutions may be operated as
either an "enterprise", a "trust fund", a "general-operating-fund-supported agency", or a combination. Medicare is an example of a program that is funded with all three methods---user-paid fees, ear-marked taxes, and an appropriation from the general
operating fund.
*** 1. Enterprises ***
Federal enterprises are fee-supported agencies. Enterprises include the Post Office, the Government Printing Office, the National Technical Information Service, and others. These
agencies sell a product or service and, in the long run, try to maintain a balanced budget. As a result, Government enterprises do not make significant contributions to the gross public debt or annual budget deficits/surpluses.
*** 2.
Trust Funds ***
Trust funds obtain ear-marked tax money from a specific segment of the population and then spend it for pre-determined purposes. For example, part of the tax on gasoline goes into the Highway Trust Fund and is earmarked for
highway construction and maintenance. The Social Security tax is collected from employees and employers and is paid out mostly to retirees. The Federal Government operates over 100 trust funds. Almost all trust funds are well managed and do not
contribute to the public debt. In fact, all together, trust funds and other special-purpose funds had accumulated a total surplus of about $3.1 trillion by the closed of fiscal year (FY) 2004. As listed above, that same year, the total gross public debt
was $7.4 trillion. Thus, the public debt held by non-federal investors was $4.3 trillion. (These are rounded numbers.)
*** 3. General Operating Fund ***
The general operating fund is the source of money that pays the
salaries of the President and his staff, legislators and their staffs, the Department of Justice, the Department of Defense, Medicaid, farm subsidies, etc. The general operating fund receives its revenue from personal income tax, excise tax, business tax,
and borrowing. In FY 2004 the operating fund received $1,150 billion in taxes. Also in FY 2004, Congress over-spent the fund by $600 billion. This drove the public debt up by a like amount. As a result, it was necessary for the Treasury to borrow $600
billion. At the close of FY 2004, almost all of the $7.4 trillion gross public debt had been caused by Congress's over-spending in the general operating fund. And each year, the growing interest payments on the existing public debt helps to cause another cycle of overspending by Congress. In 2004, the interest cost was $322 billion.
TWO DIFFERENT PARADIGMS
Most of the current confusion over budget deficits reported in the news and the associated public debt
stems from two different viewpoints of the federal accounting system. Some observers see the Government as one large single-fund accounting unit. In this essay, this viewpoint is called the "single-fund paradigm". Others view the Federal Government as
many interacting agencies, each with its own individual budget. This viewpoint is called the "multi-fund paradigm". First we look at the single-fund paradigm.
The Single-Fund Paradigm
The Federal Government has
hundreds of departments, agencies, funds, bureaus, etc. that receive income from the general-operating fund, ear-marked taxes, fines, fees (including inter-agency transfers), and/or gifts. Those who think in the single-fund paradigm consider only money
from non-governmental entities as income to the federal accounting system. The outlays from the single-fund system are moneys flowing out of the Treasury in the form of purchases, benefits, interest cost, services, and wages to the world's economy,
including government employees. The unified-budget accounting system is based on this same reasoning.
The single-fund paradigm is commonly used by lawyers, economists, and legislators. The lawyers are on firm legal ground because years ago the Supreme Court held that one secession of Congress could not pass a law restricting Constitutionally-correct actions of a future Congress.
Legally, this means Social Security could be discontinued overnight by an Act of Congress. As it now stands, past Congresses have established a Social Security Trust Fund which has build a large surplus. In the future, any given Congress could legally shut down the fund and transfer the surplus to a retirement program for ex-senators and ex-representatives. While such an action would be Constitutional, it is very likely to cause a political response that leads to many new faces in the next Congress. The new faces would be those who ran on a platform of returning the confiscated funds back into the Social Security Trust Fund. Because most federal legislators understand the political risk, the Social Security surplus is fairly safe.
Economists, commonly use the single-fund paradigm when making economic studies and forecasts. Present-day practical politics or ethical standards are not usually a consideration. Here, the focus is on the macro-economic impact of this or that government policy of the national economy. For example, an economic forecast might show that Medicare, Medicaid, and veteran-health programs will be facing serious deficits by the year 2025. From this study, an economist might suggested a public policy of folding these government health-care programs (and others) into a national universal health-care program. Just because transferring the present Medicare surplus into a universal health-care program makes mathematic sense, doesn't mean the old folks will go along.
The economists' position on the single-fund paradigm is defined in Chapter 16, Federal Borrowing and Debt, in the Budget of the United States - FY 2008, Analytical Perspectives, pages 224-226 in the printed version---see subsection "Debt Held by the Public, Gross Federal Debt, and Liabilities Other Than Debt". Starting in about the fourth paragraph, "...issuing debt to Government accounts does not have any of the credit market effects of borrowing from the public." An expanded explanation is also given.
Counter points from the taxpayers' point of view are:
(1) The Treasury
bonds were purchased in good faith by a federal agency.
(2) The lender is entitled to receive annual interest payments and repayment of the principal when a bond is cashed in.
(3) The credit market effects are not an issue in terms of the taxpayers'
financial obligations.
The single-fund paradigm of not including "internal borrowing" in the annual deficit figures is favored by most legislators because it is currently easier to eliminate the unified-budget deficit than to stop the growth of the gross public debt. However, for the average taxpayer who is trying to follow the money, the multi-fund paradigm is better suited.
The Multi-Fund Paradigm
In the multi-fund paradigm, each of many Federal Government
agencies, departments, commissions, etc. has its own accounting books which tracks its financial interactions with both (a) other Federal Government entities and (b) non-government entities. As mentioned above:
For FY 2004--$7.4 trillion - Gross
public debt
($322 billion - annual interest cost)
. . $4.3 trillion - Debt held by "private" investors
. . .($160 billion - annual net interest)
. . $3.1 trillion - Debt held by Federal Government accounts.
. . .($162 billion - annual
interest for government accounts)
The multi-fund paradigm sees the full public debt ($7.4 trillion) held by all investors as the most important figure to track. In FY 2004, the interest cost incurred on this $7.4 trillion public debt was $322 billion. In the single-fund paradigm, the annual "net interest" cost ($160 billion) is considered more important than the interest cost on the full debt ($322 billion). In FY 2004, the annual interest on the full public debt was about twice that of the "net-interest" cost.
Another difference -- a dramatic difference -- between the single-fund and multi-fund paradigms is found in the percentage of income devoted to debt interest cost. Using the single-fund paradigm, the percent of budget devoted to "net interest" in FY 2004 is recorded as 7%. This was displayed in the I.R.S. 1040A Forms and Instructions booklet that was mailed to taxpayers in early 2005. The display carried two pie-charts that were titled Income and Outlays for 2004. The Outlays pie-chart showed "net interest" on the debt to be 7%. That is, net interest ($160 billion) is divided by the full budget outlays of the Federal Government in FY 2004 ($2,292 billion). [160/2292 X 100 = 7%] In the multi-fund paradigm, the full interest ($322 billion) is divided by only the income to the general operating fund ($1,150 billion). [322/1150 X 100 = 28%] Clearly, the multi-fund paradigm's 28% spent on interest is four times larger than the single-fund paradigm's 7% spent on interest.
The point here is: REASONABLE PEOPLE, THINKING IN TWO DIFFERENT PARADIGMS, CAN HAVE STRONG DIFFERENCES OF OPINION ON BUDGET ISSUES WHILE USING THE SAME SET OF FIGURES.
SOCIAL SECURITY SURPLUS
The
single-fund/multi-fund paradigm shift is sometimes the cause of differences of opinion on the long-term stability of the Social Security Trust Fund. For example, in FY 2004, the Social Security (Old-Age and Survivor Insurance - OASI) total surplus
increased by $145 billion. Of this, $79 billion came from interest income and $66 billion came from surplus tax income. Some forecasts indicate that surplus tax income will drop to zero in 2018. In the single-fund paradigm, one reasons that 2018 is a
turning-point year because from here on the Trust Fund surplus will start shrinking. In the multi-fund paradigm, one reasons that 2018 is just a typical year because the Trust Fund surplus is forecasted to grow by about $200 billion due to interest income
paid by the general operating fund. And, the Trust Fund would be solvent until the year 2042. (These forecasts are given by the FY 2004 report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance trust funds.)
The pages linked by [X] THE SOCIAL SECURITY DEBATE: SELECTED TOPICS provides more information on this topic.
TRUTH-IN-BUDGETING REFORMS
Modify the Federal Accounting System
Over 15 years ago, the General Accounting Office proposed a reform that would improve the "readability" of the annual federal budget. Annual summaries would show the deficits, surpluses, and debts residing in the general operating fund, the
enterprises, and the trust funds as well as the associated interest costs. It would also distinguish between operating funds and capital improvements. This possible reform is described in the report: Managing the Cost of Government: Proposals for
Reforming Federal Budgeting Practices, GAO/AFMD-90-1/October 1989. These proposals are consistent with the multi-fund paradigm.
Better Public Information
One way to enhance public understanding of Congressional
over-spending is to improve the clarity of budget-related information. As mentioned above, the annual I.R.S. 1040A Forms and Instructions booklet is mailed to millions of taxpayers. For example, the 2005 booklets carried two pie-charts that were titled,
"Income and Outlays for 2004". The Outlays pie-chart showed "net interest" on the debt to be 7% of budget. This pie-chart display is required by law and it is very misleading. (26 USC 7523- "Graphic Presentation of Major Categories of Federal Outlays
and Income") In FY 2004, the full interest cost on the gross public debt was 28% of the tax income to the general operating fund, not 7%.
There are at least three arguments for changing the I.R.S's interest-cost display method. They are:
- First, because our personal income tax goes into the general operating fund (Federal funds), a chart describing how personal income tax is used should focus only on the money flow into and out of the general operating fund. To use
an analogy: If the Social Security Administration published a display showing that agency's income and outlays, the display would not logically include unrelated data on income and outlays of the general operating fund, the Highway Trust Fund, or some
other government activity.
- Second, it is deceiving for the right-hand pie chart to show "Net interest on the debt - 7%" (FY 2004 figure). That is, 7% of total income to the Federal Government. Very few taxpayers know that "net interest" is just part of the total interest cost incurred by the gross public debt---only interest paid to non-government investors. A reasonable person would assume the pie chart refers to the interest cost on the full public debt as a percent of one's personal-income tax. As mentioned above, in FY 2004, 28% of personal income tax went to paying interest on the gross public debt, not just 7%.
- Third, when 7% of one's personal income goes to interest cost, this is looked upon by many home owners as a very manageable burden. They may be paying even more of their own income to a house mortgage. Thus, the I.R.S. is, in effect, telling the nation's taxpayers (and voters) that the interest cost on our large public debt is really nothing to worry about. As a consequence, legislators are not getting the public support they need as they try to head off the long-range problems and the year-to-year interest costs resulting from a monstrous public debt.
* * Pie Charts? The pie-chart format currently used by the IRS to show Income and Outlays will not be suitable for explaining activity in the general operating fund. The use of bar charts (technically speaking, stacked column charts) would make a more informative display. This arrangement would allow a taxpayer to visually note the relative size of the annual general-fund income in relation to the debt interest obligation.
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Updated: June 17, 2007