One of the wonkier discussions that arise inside the Washington beltway from time to time is what accounting method to use for federal credit programs. In a new issue brief, CBO weighs in on the argument for and against using "fair value" accounting versus the current method. We provide a brief overview here, but be sure to check out the full report for more details.

Background on Federal Credit Programs

The federal government supports a number of private sector activities through a combination of direct loans to individuals and businesses and loan guarantees to private lending firms, the largest of which are loans and guarantees for residential properties and postsecondary education. The way that the federal costs, or subsidies, stemming from federal credit programs have been reflected in the budget has changed over time, and may continue to do so.

Prior to 1990, only the cash outlays and receipts for federal loans and guarantees were recorded in the budget. After lawmakers enacted the 1990 Federal Credit Reform Act (FCRA), however, this "cash accounting" system changed to an "accrual accounting" system to reflect the budgetary costs of a new loan or guarantee upfront. Cash accounting hides the true costs of new commitments: a $100 million loan made in a certain year doesn't reflect expected repayments in future years or the estimated total impact on the federal budget (see the table below). The system was changed to an accrual basis in order to reflect the expected future costs of loans, eliminating the incentive to favor loan guarantees (which receive premiums upfront and don't incur costs until later) under cash accounting over direct loans.

The 1990 reforms required credit programs to discount the future expected cash flows to a present value estimate, a process which requires an interest rate. Under those reforms, federal programs would use the interest rate on U.S. Treasuries.

Understanding the Current Debate

In recent years, some organizations and experts (including the Congressional Budget Office and our colleague Jason Delisle at the New America Foundation's Federal Education Budget Project) have argued that the rules under FCRA are not a comprehensive measure of the cost the government incurs when it enters into loans and loan guarantees. They argue that using the Treasury discount rate does not fully account for the market risk the government is taking on and does not accurately portray the costs to policymakers.

A "fair-value" approach to estimating the costs of federal credit programs would assign a "market risk premium" to bridge the gap between Treasury interest rates and the discount rate that private lending institutions would assign when assessing the costs of a loan. Some federal programs already incorporate fair-value accounting, including payments to the IMF and the financial and auto industry assistance under TARP, but it is not widespread practice.

The table below from the CBO report shows how the cost of credit programs would differ under both methods.

^{Note: See CBO's detailed version of this example in the report.}

But those arguing on the other side point out that these loans are funded through the issuance of Treasury debt, which means there is very little or no market risk, so it is appropriate to use the FCRA rules. They also argue that the additional cost that fair-value accounting records does not actually occur and that using this method would apply inconsistent budgetary treatment to credit programs versus other programs.

CBO dives into the details of what a switch to fair-value accounting would mean in practice, touching on the additional resources and time spent training staff on the new method, the judgment calls about what discount rates to use when there are no similar examples in the private sector, and the need to better communicate program costs under a more complicated estimating approach.

But CBO’s view is best expressed in a section on the cost of market risks to the government and taxpayers, concluding with this passage,

Thus, none of the differences between the federal government and private investors changes the fact that investments with returns that are correlated with the performance of the economy as a whole are risky in a way that other investments are not. Federal credit programs expose taxpayers to that market risk.

The valuation of federal credit programs can be a pretty arcane topic. But at the same time policymakers need to decide what is the best way to reflect the costs, or profits, of the operations of the federal government. Given that the total amount of such loans outstanding in 2011 stands at $2.7 trillion, it's an important debate to be having.

To continue and enlighten the debate, e21 will be holding an event in DC on March 19 about the optimal way to account for the cost of loan programs. To learn more than you ever wanted to know about accounting rules in the federal budget, register for the event here.

Deficit Secondary in Primary – The presidential primary campaign hits a key point this week as "Super Tuesday" contests in several states may go a long ways in determining who will face off against President Obama in November. Although voters constantly rank the economy and federal budget deficit as the top two issues, they seem to have taken a back seat to social issues in the campaign right now. However, CRFB’s U.S. Budget Watch project seeks to elevate fiscal policy in the election. It started with "The 12 Principles of Fiscal Policy for the 2012 Campaign" and recently featured the release of "Primary Numbers: The GOP Candidates and the National Debt" – which examined how the candidates' policy positions would affect the budget.

"Fiscal Cliff" Hanger Ending to the Year – Whether candidates want to discuss fiscal policy or not on the campaign trail, events seem destined to put the issue to the fore just after the election. The statutory debt ceiling will likely be reached soon after the election, the 2001/2003/2010 tax cuts will expire at the end of the calendar year, and the sequester cutting over $1 trillion in spending triggered by the failure of the Super Committee is scheduled to kick in at the beginning of next year. Federal Reserve Chair Ben Bernanke described the confluence of the tax cuts expiring and the sequester beginning as a "massive fiscal cliff" in congressional testimony last week. Bernanke said he hopes lawmakers will find a way to achieve long-term deficit reduction without such a shock to the system. CRFB has also called for a "Go Big" and a "Go Smart" approach.

Sticking a Thumb in the IPAB – It may sound like the latest tech gadget, but IPAB (short for Independent Payment Advisory Board) is actually a mechanism in the Affordable Care Act to control Medicare spending, which is projected to grow substantially if left unchecked. While IPAB’s operations will not begin until 2014 and it will have a rather limited mandate, it has become a target for some lawmakers. A subcommittee of the House Energy and Commerce Committee approved of legislation last week to repeal the body and the full committee will mark up the bill starting Monday. The House Ways and Means Committee will conduct a hearing on IPAB Tuesday. Lawmakers complain that the body will infringe on their authority because it will be able to make cost-cutting recommendations that will automatically go into effect unless Congress acts, but legislators can override the recommendations. One may be inclined to suggest that a compromise would be to have the panel simply make recommendations to Congress to act on. Well, that is exactly the system we have in place now. The Medicare Payment Advisory Commission (MedPAC) routinely makes recommendations to Congress that are consistently ignored. Indeed, we pointed out that Congress has been much more active in opposing IPAB than it has been in seeking solutions to bend down the health care cost curve. IPAB represents one of the few serious attempts to control Medicare spending, which is essential as federal health care spending will be the main driver of the national debt moving forward.

GAO Highlights Government Duplication; GAO Highlights Government Duplication – Last week the Government Accountability Office (GAO) issued its second annual report to Congress identifying duplicative efforts within the federal government, along with recommendations for savings. A few examples of recommendations include better information-sharing among various agencies involved with health research and consolidation of Pentagon unmanned aircraft acquisition programs.

Tax Reform Storm Brewing – Limiting tax expenditures received lots of attention at a Thursday Senate hearing on tax reform that promotes growth, fairness and deficit reduction. Sen. Pat Toomey (R-PA) mentioned the proposal to cap individual tax expenditures put forth by Martin Feldstein, Daniel Feenberg, and CRFB’s Maya MacGuineas. The Simpson-Bowles tax reform proposal that involves eliminating most tax expenditures was also held up as a good model to follow. Meanwhile, Treasury Secretary Tim Geithner last week met with leaders of the tax-writing congressional committees on the subject of tax reform. 

EU Agrees on Fiscal Pact...Now Comes Hard Part – On Friday, 25 European Union leaders signed a new fiscal pact that will give the EU more power to enforce budget discipline among member countries. Among other things, the compact sets deficit targets for countries to follow and provides punishments for non-compliance. National legislatures must still ratify the agreement, but doubts already are surfacing regarding the arrangement that is intended to prevent further crises like the debt crisis that has been dogging the continent. Countries such as Spain and Hungary are projected to fail to meet their deficit targets, which will test the enforcement mechanisms of the treaty and the will of EU leaders to carry it out. See our budget reform resources for more on ideas like fiscal rules and targets.

Mobilizing a Sound Strategy to Confront the Debt – In congressional testimony last week, Defense Secretary Leon Panetta testified that a smart approach can reduce the deficit significantly without hurting national defense. He said everything had to be on the table, including discretionary spending, mandatory spending and revenues. He also said that "the leaders of both the legislative and executive branches of government have a duty to protect both our national and fiscal security." Panetta speaks from a unique perspective as not only the Pentagon chief, but also as a former OMB director (and former CRFB co-chair).

Key Upcoming Dates (all times ET)

March 6-10

• Wyoming Caucus

March 6

• Super Tuesday - presidential contests in Alaska, Georgia, Idaho, Massachusetts, North Dakota, Ohio, Oklahoma, Tennessee, Vermont and Virginia.
• House Appropriations hearing on the FY 2013 budget request for the US Agency for International Development at 9 am.
• House Appropriations hearing on the FY 2013 budget request for the Bureau of Land Management at 9:30 am.
• House Energy & Commerce Committee continues markup of legislation to repeal the Independent Payment Advisory Board (IPAB) at 10 am.
• House Ways and Means Committee hearing on the Independent Payment Advisory Board (IPAB) at 10 am.
• Senate Budget Committee hearing on perspectives on the FY 2013 Defense budget request at 10 am.
• Senate Finance Committee hearing on "Tax Reform Options: Incentives for Capital Investment and Manufacturing" at 10 am.
• Senate Energy & Natural Resources Committee hearing on the FY 2013 budget request for the Forest Service at 10 am.
• House Appropriations hearing on the FY 2013 budget request for the Air Force at 10 am.
• House Appropriations hearing on the FY 2013 budget request for the Securities and Exchange Commission at 10 am.
• House Appropriations hearing on the FY 2013 budget request for the National Science Foundation at 10 am.
• House Appropriations hearing on the FY 2013 budget request for the Dept. of Health and Human Services with HHS Secretary Kathleen Sebelius at 2:30 pm.
• Senate Foreign Relations Committee hearing on international development priorities in the FY 2013 budget at 2:30 pm.

March 7

• House Appropriations hearing on the FY 2013 budget request for the FBI at 9 am.
• Senate Appropriations hearing on the FY 2013 budget request for the Dept. of Health and Human Services with HHS Secretary Kathleen Sebelius at 10 am.
• House Appropriations hearing on the FY 2013 budget request for the US Army at 10 am.
• House Appropriations hearing on the FY 2013 budget request for the Federal Emergency Management Agency at 10 am.
• Senate Appropriations hearing on the FY 2013 budget request for the Dept. of Navy at 10:30 am.
• House Appropriations hearing on the FY 2013 budget request for the US Army Corps of Engineers at 2 pm.
• Senate Commerce, Science & Transportation Committee hearing on the FY 2013 budget request for the Coast Guard and the National Oceanic and Atmospheric Administration at 2:30 pm.

March 8

• House Appropriations hearing on the FY 2013 budget request for the Dept. of Transportation with Transportation Secretary Ray LaHood at 9:30 am.
• House Appropriations hearing on the FY 2013 budget request for the National Park Service at 9:30 am.
• House Appropriations hearing on the FY 2013 budget request for the Defense Health Program at 10 am.
• Senate Appropriations hearing on the FY 2013 budget request for the Dept. of Justice with Attorney General Eric Holder at 10 am.
• Senate Appropriations hearing on the FY 2013 budget request for the Dept. of Homeland Security with Homeland Security Secretary Janet Napolitano at 10 am.
• House Appropriations hearing on the FY 2013 budget request for Immigration and Customs Enforcement at 1 pm.
• Senate Indian Affairs Committee hearing on the FY 2013 budget request for native programs at 2:15 pm.

March 9

• Dept. of Labor's Bureau of Labor Statistics releases February 2012 employment data.

March 10

• Presidential contests in Kansas and the Virgin Islands

March 13

• Presidential contests in Alabama, Mississippi, and Hawaii

March 16

• Dept. of Labor's Bureau of Labor Statistics releases February 2012 Consumer Price Index (CPI) data.

March 17

• Missouri Caucus

March 18

• Puerto Rico Primary

March 19

• Oregon GOP Debate sponsored by PBS at 9 pm.

March 20

• Illinois Primary

March 21

• House Appropriations hearing on the budget, Military Construction, Veterans Affairs and Related Agencies, with Eric Shinseki, Secretary of Veterans Affairs. 

March 24

• Louisiana Primary

March 29

• US Dept. of Commerce's Bureau of Economic Analysis releases its third and final estimate of 2011 fourth quarter GDP.

April 3

• Presidential contests in DC, Maryland, Wisconsin, and Texas

April 6

• Dept. of Labor's Bureau of Labor Statistics releases March 2012 employment data.

April 13

• Dept. of Labor's Bureau of Labor Statistics releases March 2012 Consumer Price Index (CPI) data. 

April 17

• Tax Day! Federal income tax returns are due.

The Tax Reform Act of 1986 is often hailed as a major bipartisan achievement, a reform that simplified the tax code and lowered marginal tax rates. Of course, more holes were opened up, more tax brackets were added, and significant complexity was introduced to the tax code thereafter. 

Third Way's recent paper on tax reform shows some of the changes made to the code in the 1986 reform and what has been added on since. The carveouts they mention that were eliminated or limited in the reform are:

• Elimination of the deduction for credit card and other loan interest
• Elimination of the second earner deduction
• Elimination of income averaging
• Elimination of the unemployment benefits exclusion
• Elimination of the state and local sales tax deduction
• Limiting of the business meals and entertainment deduction to 80 percent (now at 50 percent)
• Elimination of the investment tax credit

Notably, many of these tax expenditures have returned in some form or another. The second earner deduction's purpose was to reduce marriage penalties, which is now done through other parts of the tax code. Income averaging, which allows people with volatile income levels to smooth out their tax burden over a period of time, returned permanently in 2004 for farmers and fishermen only. The unemployment benefits exclusion returned for 2009, although it has now expired. The state and local sales tax deduction returned in 2004 legislation as a temporary "tax extender" (although it can only be used in lieu of the companion income tax deduction). The investment tax credit returned in 2005 legislation for renewable energy companies as a tax extender as well.

In addition to reinstating some of the pre-1986 loopholes that were closed, many new tax expenditures have been created as well. Third Way cites the following as some examples:

• Exclusion of small business capital gains
• Preferential rates for gains from self-created musical works
• Health Savings Accounts
• Tax credit for maintaining railroad tracks
• Deduction for film and TV production costs
• Tax credit for taxes paid on inventoried distilled spirits
• Tax credit for securing agricultural chemicals

As Ezra Klein notes, tax expenditures are much less transparent than government programs and are, as a whole, regressive. Their costs are less tangible to citizens who must pay for these subsidies with either higher tax rates or reduced spending elsewhere in government. While there may be a case for running some benefits through the tax code (like the EITC) since the IRS may better track income data than other agencies, the sheer size and number of tax expenditures makes for poor tax policy. And their presence has exploded over the last 25 years.

Further deterioration of the tax code since 1986 comes from the fact that much of it is now temporary, a trend that has dramatically accelerated in the past decade. The paper notes that the number of temporary tax provisions increased from 25 in 1985 to over 140 in 2010. This number includes not only the tax extenders, which have grown significantly in number and size (especially in the past decade), but also central features of the tax code, like the income tax rate schedules, the estate tax parameters, and the expansions of the Earned Income and Child Tax Credits.  

Third Way's paper concludes what many already know: our tax code needs fixing. With so many provisions expiring at the end of this year and so many provisions that expired last year that Congress will look to extend retroactively, we hope that lawmakers will find it more pleasant to re-write the code rather than patch another temporary one together for the next few years. The Modified Zero plan from the Fiscal Commission is certainly a good place to start to comprehensively re-work the tax system.

Update: CBO has estimated that the IPAB repeal bill (HR 452) would increase spending and deficits by $3 billion from 2013-2022.

On Wednesday, the Energy and Commerce Health Subcommittee voted by a wide margin to repeal the Independent Payment Advisory Board (IPAB), the 15-member panel tasked by the Affordable Care Act with making recommendations starting in 2014 to hold down Medicare spending when it grows faster than GDP per capita plus 1 percent. H.R. 452 was approved by the panel by a 17-5 vote with some bipartisan support. 

The biggest knock against IPAB from lawmakers is that it usurps Congressional authority over Medicare and puts decisions involving the program in the hands of an unaccountable panel instead of with elected representatives. However, a closer examination of how IPAB would function suggests that these concerns are overblown. For example, Congress has the ability to override IPAB recommendations with a majority vote if they are replacing them with equal savings or with a three-fifths vote if they are simply preventing them from going into effect. If Congress does not act at all, the recommendations go into effect automatically. Furthermore, IPAB has a rather limited mandate -- it cannot make changes to benefits, cost-sharing, or eligibility.

The most disconcerting thing about this vote, and about broader efforts in general to dismantle or repeal IPAB, is that while the IPAB repeal bill has bipartisan support, there is no bipartisan Congressional plan for controlling Medicare costs. Medicare spending will be the single largest contributor to rising debt in the future, and the reason IPAB was viewed as necessary in the first place is because Congress has been unable to take steps to rein in Medicare costs. CBO's estimate of repealing of the Affordable Care Act last year estimated IPAB's effect on spending through 2021 would be $14 billion, although the magnitude of the cuts could grow substantially over the long-term depending on Medicare cost growth.

IPAB is intended to be action-forcing because the politics of Medicare have been toxic and there has been no agreement on a plan that goes beyond provider and physician payment reductions. Ironically, the vote to repeal IPAB without any passable plan to replace it shows the need for it in the first place.

IPAB may also be necessary because of the board's ability to make smarter changes than blunt reductions in physician and provider payments. We know that scheduled reductions to Medicare payments to physicians are unlikely to take place given that "doc fixes" have routinely passed, but the status of provider payment reductions from the health care reform legislation -- specifically, the productivity adjustments that lower payments by about 1.1 percent annually -- is more uncertain. If those reductions prove to be too blunt a tool over the long-term, IPAB could be utilized to make smarter reductions in payments -- areas where, say, the Medicare Payment Advisory Commission believes that reimbursements are too high -- as we have argued in the past. Additionally, to address the concern of leaning too heavily on providers, IPAB's mandate could be broadened to make other changes to Medicare.

Controlling the growth of health care spending will be one of the most important tasks in putting our long-term debt on a sustainable path. There are plans out there, such as Ryan-Wyden or Lieberman-Coburn (or our ideas), which could control costs or at least take a big step in the right direction. IPAB has to remain in place, at least as a backstop, until we know that lawmakers have accomplished that goal.