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Annette Nellen
Transparency and the FY 2011 Budget

President Obama's FY2011 budget includes some tax proposals that challenge the Administration's goals for greater transparency.

February 11, 2010
by Annette Nellen, CPA, Esq.

A theme of President Obama's administration has been openness and transparency. The White House maintains many Web sites and blogs, which along with Web sites of the various government agencies, provide a wealth of information to the public. Transparency — ensuring that information is clear, is a difficult goal to fully achieve though, particularly given the complexities of the budget process and the tax law. This article reviews the Administration's transparency goal and points out six aspects of the recent budget proposals that challenge achievement of this goal.

Transparency

Soon after entering office, President Obama issued a Memorandum on Transparency and Open Government, noting his commitment to "creating an unprecedented level of openness in Government." He further stated: "We will work together to ensure the public trust and establish a system of transparency, public participation and collaboration. Openness will strengthen our democracy and promote efficiency and effectiveness in Government."

The Administration's FY2011 budget report further emphasizes the need for citizens to see how all government dollars are being spent. A chapter of the report states the following action to "further open up the government to the American people."

"Make It Easier to Track How Taxpayer Dollars Are Spent. For too long, Americans have been in the dark about how their tax dollars are spent. They pay their taxes, but have no clear, concise way to track how and where the money is spent and what it accomplishes. The Administration is committed to pulling back the curtain on Government spending and will launch a new tracking tool with daily updates that will provide citizens with the ability to see aggregate spending by agency and also by geographic area. A new search engine will allow the public to customize their information by location, by agency or by timeframe. This innovative development will allow people to have a greater understanding of how their Government works and hold officials accountable for responsible spending decisions." (FY2011 Budget, Restoring Responsibility (PDF), pages 43 to 44.)

Transparency is also a principle of good tax policy. AICPA statements on this topic define tax law transparency as taxpayers knowing "that a tax exists and how and when it is imposed upon them and others." (AICPA, Tax Policy Concept Statement #1, Guiding Principles of Good Tax Policy: A Framework for Evaluating Tax Proposals (PDF) (2001), page 13.) The AICPA's Tax Policy Concept Statement #3, Guiding Principles for Tax Law Transparency (PDF), further provides that improved transparency will bring "an end to the unnecessary mechanical complexity and backdoor revenue provisions that obscure taxpayers’ ability to identify the true cost of transactions, what their total tax liability is and which level of government is being paid the tax. Increased transparency will reduce the complexity and improve the perceived fairness of our tax system, benefiting all constituents of the tax system" (page 12).

FY2011 Budget and Tax Challenges

The FY2011 budget from the Administration includes roughly 100 tax changes that both reduce and increase government revenues (FY 2011 "Green book" (PDF)). Listed below are six examples of items or approaches in the FY 2011 budget that conflict with the transparency goal. Modifications that would overcome these problems are also noted. The details of the particular proposals can be found in the FY 2011 "Green book" (PDF).

Hiding the marginal tax rate: The FY 2011 budget proposals make clear that the Administration will keep some of the 2001/2003 tax cuts for individuals with income of $250,000 or less ($200,000 if single). The 36 percent and 39.6 percent tax rates will return for those above these income thresholds. In addition, the phase-outs for itemized deductions and personal exemptions will return to their original form for higher income individuals. In addition, a new limitation proposes to cap the benefit of itemized deductions to 28 percent even if the individual's marginal tax rate is higher.

Phase-outs and capping of deductions prevent the tax system from meeting the principle of transparency. These rules increase the marginal tax rate for individuals subject to them. The AICPA's Guiding Principles for Tax Law Transparency (PDF), recommends that phase-out’s be avoided because they "create difficulties in estimating a taxpayer’s marginal tax rate and in determining the ultimate tax cost or tax savings of any economic choice" (page 13). Further complicating the ability of a high-income individual to know the true cost of their transactions and their marginal tax rate is the alternate minimum tax (AMT), which remains under the Administration's tax proposals.

Transparent alternative: Avoid phase-outs by reducing the current amount of certain deductions or eliminating certain deductions or increasing the statutory tax rate; repeal the AMT.

Who pays? The Administration proposes a new "financial crisis responsibility fee" on financial institutions with consolidated assets of $50 billion or more. Ultimately, all taxes are paid by individuals rather than by businesses. Taxes represent a cost of doing business and will be borne by some combination of shareholders, customers and employees. This concept is not well known though among the public.

Transparent alternative: Be open about the incidence of business taxes and provide the public with an analysis of the possible economic incidence of this fee.

Unclear tax policy: Several international tax changes are included in the FY2011 budget proposal under the heading "Reform the U.S. International Tax System." However, there is no description of what the reform objective is and how the 10 proposals help achieve any objective. In addition, the proposals are not identical to those included in the Administration's FY2010 budget. In the past several years, there have been various discussions on the need to modernize international tax rules to improve the competitiveness of US firms and to recognize a more global economy than existed when most of these rules were written decades ago. (See Nellen, Groundwork for Modernizing International Tax Rules in the U.S., AICPA Corporate Taxation Insider, November 13, 2008.)

Transparent alternative: Explain the rationale for the proposals for international tax reform and how they will improve competitiveness for U.S. firms. Such explanation should also note why the FY 2011 reforms differ from those of FY 2010, how these changes tie to suggestions to reduce the corporate tax rate and why they are better than alternative tax proposals.

Baseline confusion: Tax cuts enacted in 2001 and 2003 automatically expire after 2010. Thus, if any are to be retained, specific legislation is needed. We should expect to see these changes included in the budget as reductions in revenue because the "baseline" should be the law as it exists for a particular year. The Administration's FY 2011 budget takes a different approach (noted in the report), which assumes that the cuts proposed to be reinstated are part of the baseline. The budget report refers to this as an "honest baseline" because it reflects policies of today. That is a questionable approach because it masks the reality of the need to enact legislation to retain such policies and the affect of such law changes on government revenues. (See FY2011 Budget Tables (PDF) and Analytic Perspectives, at pages 169 to 170 (PDF)).

Transparent alternative: Make it clear to the public that the tax cuts expire after 2010 and to be retained, have to be enacted into law. The baseline should reflect the law without assumptions of future, possible tax law changes.

Hidden spending in the tax law: The FY2011 budget calls for a three-year freeze in non-security discretionary funding (Restoring Responsibility (PDF), page 39). Not all spending, however, is in the form of line items in the budget. Some of the spending is in the tax law in the form of special deductions, exclusions and credits. The freeze ignores the reality that the cost to fix many of these tax breaks will increase over time. For example, the Joint Committee on Taxation projects that the five-year "cost" of the deduction for mortgage interest is $444 billion for fiscal years 2008 to 2012 (JCS-2-08, page 51), increasing to $573 billion for fiscal years 2009 to 2013
(JCS-1-10, page 33). Similarly, the American Opportunity Tax Credit proposed in the FY2011 budget is projected to "cost" $6.9 billion for FY 2012, increasing to $8.4 billion in FY 2015 (FY 2011 "Green book" (PDF), page 150).

Transparent alternative: Find a way to also impose a freeze on spending what exists in the tax law or be more explicit that despite the freeze on some direct spending, tax expenditures are not frozen and are likely to increase over time.

Nonunified budget: Government spending exists in two key forms: direct spending listed in agency budgets and tax expenditures in the form of special tax rules, such as an R&D credit. Tax expenditures are hidden because they are not included in agency budgets and typically do not have to be reviewed annually. Also, tax expenditures are not capped as is an annual budget allocation to an agency or program. Thus, it is difficult to see how much the government is spending on various programs. For example, the U.S. Department of Education budget shows how much is spent on Pell Grants and various other programs for higher education. However, the tax expenditures for the Hope Scholarship and Lifetime Learning credits, as well as other tax provisions for higher education expenses, are not included in the Department of Education budget.

Transparent alternative: For greater transparency, accountability and openness, the federal government should prepare a "unified" budget that shows both direct spending and tax expenditures for all programs.

Conclusion

Greater transparency and openness of government operations is a laudable goal. The Administration has made progress in achieving this goal, but more is needed. Improvements can be made, as indicated in this article, but will likely require greater effort by the public to note where transparency is missing and what additional information or approaches are desired.

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Annette Nellen, CPA, Esq., is a tax professor and director of the MST Program at San José State University. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA’s Individual Income Taxation Technical Resource Panel and chairs the California Bar Tax Section’s Tax Policy Committee. She has several reports on tax reform and a blog.