The budget, taxation, and regulation - what's the outlook?

FEI's Committees on Government Liaison and Taxation joined with The Heritage Foundation on June 10 and 11 in Washington to discuss the intricacies of the federal budget, taxation, and regulation. Keynote speaker Lawrence Lindsey, a member of the Board of Governors of the Federal Reserve System, opened the meeting with an overview of the U.S. economy.

Listing what he terms "bottle-necks" that affect the economy, Lindsey declared that, "I am not surprised that we had a recession, but that we had a mild one." And he believes that the economy is more resilient than anyone thought. One bottleneck, in his opinion, is that the world banking system has torn up old ways of regulation, while a new system is still in transition.

Other bottlenecks Lindsey listed include a reduction in money growth aimed at bringing down the underlying rate of inflation, the Deficit Reduction Act of 1990, and the invasion of Kuwait. The war, said Lindsey, "had an adverse effect on world capital markets" and the U.S. had to "take large numbers of reservists out of their civilian jobs."

Budget panel chairman Scott A. Hodge of The Heritage Foundation declared that, "While business has been cutting dramatically, the federal government has increased staffing and spending. If business can survive the scalpel, so can government."

A rational allocation of resources 

CGL member Robert F. Hogan, Jr., treasurer of Associated Materials, outlined CGL's ideas dealing with the budget process. The committee believes its approach would accomplish a "rational allocation of spending on government programs that would allow the U.S. to reach some of the long-range goals, such as affordable housing, retirement security, and health care, that the country should be setting."

Hogan thinks the federal Chief Financial Officers Act will have an impact, because if "we get qualified CFOs and financial systems, it might tell us what we're actually spending." CGL's subcommittee on federal budgetary and fiscal matters supports either a full line item veto or a modified rescission line item veto that would require separate voting on selected appropriations. Both of these measures would deter attaching spending bills to unrelated issues. Hogan pointed out that most states have a line item veto and it works.

Hogan believes FEI members would approve of a spending freeze and the establishment of a program review committee. This committee would review federal programs and put together a package of deletions on which Congress could vote. "This would give Congress some protection as in the defense base closing bill," he says.

CGL endorses the use of dynamic accounting models for revenue estimation or for spending cuts. "Both the Administration and Congress now whichever model suits their purpose," Hogan stated, pointing to the luxury tax as an example of how the use of static models gave the wrong impression on how much revenue the tax would generate. The tax generated far less revenue than had been expected and severely damaged the industries involved. Similarly, the use of dynamic accounting would show that a tax reduction that stimulates growth and new business would bring in more revenue than what had been lost.

Gimmickry from a balanced budget amendment 

C. Eugene Steuerle of the Urban Institute also likes the line item veto but doesn't think it will pass. He strongly opposes a balanced budget amendment because "it would work against good financial statements and leads to all kinds of gimmickry." As example, Steuerle listed off-budget outlays, accelerating tax collections from business, shifting burdens to state and local governments, asset sales, failure to book or account for liabilities, and recording of expenditures such as those for health and education as capital expenditures. In addition, he believes it would give Congress an excuse to not even consider the line item veto. "Instead, Congress would sit around for five years and wait for the states to ratify the amendment."

Steurle told the financial executives to put the current problem. into historical perspective. "Congress doesn't enact deficits of x,y, or z. They enact expenditure laws and tax laws, and the deficit is the residual that is left over," he pointed out. "The deficit reflects a much more profound problem in both expenditure programs and tax writing programs. In treating the symptom, we may ignore the real cause of the problem--the failure of our institutions to adapt to the requirements of a new fiscal era.

"After World War II," Steuerle recalled, "there were four major sources of funding provided to the Administration and Congress that made it easy to enact both tax cuts and expenditure increases." First was the accelerating inflation rate, which imposes a penalty on holders of older bonds and which is really a hidden source of taxation. Second, bracket creep in the individual income tax increased revenues and in time led to tax cuts. Third, a constantly increasing rate of taxation--from 3 percent in 1950 to 12 percent in 1980--for Social Security provided billions to finance programs. Fourth was a constant decline in defense expenditures as a percent of GNP.

"All these sources are gone and Congress and the Administration haven't adapted their institutions," Steuerle continued. "The federal government still has an expanded number of committees, subcommittees, departments, and agencies which split power and do not allow tradeoffs to be made very easily."

Despite this major institutional problem, Steuerle believes that a simplistic balanced budget constitutional amendment trivializes the constitution and stops automatic fiscal policy which is balanced over the economic cycle.

A wish list on taxes

Moving from the budget to a discussion of tax policy, Albert E. Germain, vice president of taxes and tax counsel of Alcoa and former chairman of FEI's Committee on Taxation, presented his "wish list" for tax policy. He wants a clearly defined tax vision that would be enunciated in a mission statement. And he wants a modern tax system, which in his view would be a value added tax (VAT).

He also would like to see the removal of barriers to competitiveness in the present tax system. Calling U.S. foreign tax policy the "worst in the world," he considers the non-deferral system the "most punitive." The tax rules inhibit joint ventures with foreign firms, according to Germain, and unfairly burden U.S. firms with the alternative minimum tax. In addition, transfer pricing rules are confusing and uncertain. "Tax policy suffers from the runaway plant syndrome," he declared, while the cost of tax compliance is enormous, both for the government and business.

Daniel J. Mitchell of The Heritage Foundation, chairman of the taxation panel, questioned Germain's strong support of the value added tax, asking if there was any remote scenario that a value added tax would be anything other than an add-on tax. Germain stated that he would oppose an add-on value added tax. He suggests there be some sort of commission that would study the VAT to identify pluses and minuses and suggest solutions.

Caution! Showers may be dangerous to your health!

Did you know that taking a shower may be dangerous to your health? When the Environmental Protection Agency found that a small amount of chlorine is released in the spray, the agency considered regulating shower activity. Heading off such unnecessary regulation is one of the activities of the President's Council on Competitiveness, according to David M. McIntosh, the Council's executive director.

Both McIntosh and Edward L. Hudgins, director of The Heritage Foundation's Center for International Economic Growth, cited examples of costly and thoughtless regulations that impede U.S. competitiveness, including "All drive-through tellers should be accessible to the blind" and a directive, dubbed "The EPA vs. the Tooth Fairy," sent to dentists stating that baby teeth could not be given to parents because they were considered toxic waste.

Hudgins believes that to determine if any policy advances U.S. competitiveness, three questions must be asked: Does the policy increase the nation's living standard and economic growth? Does it increase consumer choice and reduce the cost of goods and services? Does it expand employment opportunities?

An important issue for the Competitiveness Council, says McIntosh, is the protection of property rights. The Constitution, he explains, provides that just compensation be paid for the taking of property for public purposes. "With the rise of the regulatory state, government hasn't physically taken property," he says, but frequently substantially restricts its use, either wholly or in part, without compensation. "The courts agree that the land owner should be compensated for that kind of taking," McIntosh points out. In its activities, the Council is working to ensure respect for the principle of property rights.

The Competitiveness Council has been reviewing all in place regulations. However, McIntosh laments, the Council has learned that to reduce the regulatory burden, it is necessary to issue a new regulation, which requires public notice and comment and can take several years. "Some people in government do nothing but write regulations and would be out of a job. We need to create some incentives to create recognition for people who have reduced regulation," McIntosh concludes.

"A BAG OF EMPTY PROMISES"?

When Secretary of Labor Lynn Martin spoke to CFOs of FEI's New York City Chapter recently, she explained that the Pension Benefit Guaranty Corporation reforms put forth in President Bush's economic growth package would strengthen the pension safety net and give a truer picture of the PBGC's financial situation.

Martin stressed the need to change the budgetary treatment of PBGC's accounting from a cash to an accrual basis, citing the Pan Am example: "When PBGC lost over $600 million because of the termination of Pan Am's pension plans, it was reported in the federal budget for that year as a $10 million cost."

But Thomas M. McMahon, vice president of finance and administration at the San Francisco-based Pacific Maritime Association and chairman of FEI's Committee on Employee Benefits, believes it would be senseless to switch the PBGC's accounting to an accrual basis at a time when its financial reporting systems are "in disarray."

"There's a great deal of frustration with the PBGC saying this is the next S&L problem, when nothing could be further from the fact," says McMahon. "This puts a very bad light on the corporate pension plans that have done an incredible job of keeping their promises. We all get tarred by the same brush." He contends that the underfunded, potentially dangerous plans are a small minority of the total pension plans system.

The Washington, D.C.-based Employee Benefit Research Institute supports McMahon's concern about comparing PBGC problems to the S&L fiasco. In its May 1992 Issue Brief, the EBRI explains: "The most important difference between the two guarantee funds is that the likelihood that a plan insured by PBGC will fail is diversified across several key industries, whereas S&L guarantee funds were exposed exclusively to the risks of a single industry that was extremely vulnerable to fraud and events beyond its control."

Secretary of Labor Martin acknowledges some may view the PBGC's efforts to switch to accrual accounting as a "gimmick," but finds it "a rather strange way to describe the proper accounting required of all insurance companies."

Martin also claims the real financial situation the PBGC faces is a $19-billion deficit by the end of 1997. She proposed three long-term reforms that would turn that deficit into a small surplus. These reforms deal with bankruptcy, minimum pension funding, and PBGC guarantees for future benefits.

Martin would like to see the PBGC's bankruptcy claims receive higher priority in bankruptcy court. "Only about 20 percent of PBGC's claims receive priority consideration and are treated seriously. But even in these instances PBGC's interests are subject to challenge because its claims priority stems from the Employee Retirement Income Security Act (ERISA) and the Tax Code, but it is not spelled out in the Bankruptcy Code."

McMahon agrees: "Case in point: Continental Airlines is trying to come out of bankruptcy and can't afford to give its people raises, so it may offer to improve their pension payments. If Continental ultimately throws its plan onto the PBGC, then every other company in America has to pay for that promise, not Continental. If that's going to be the case, every other company wants the PBGC, who's representing them, to be number one in line, so irresponsible employers can't make promises they can't keep."

Martin also proposes that minimum funding requirements be increased, but McMahon counters that mandating funding levels may push some companies into bankruptcy, because the mandate may occur in a bad year.

The PBGC's final proposal calls for the Guaranty Corporation to guarantee future benefit increases only in plans that are or become fully funded. "Too often employers and unions negotiate new benefits before old ones are funded," explains Martin. "The result is chronically under-funded plans that in many cases leave the PBGC and workers holding a bag of empty promises.

"I don't want to give the impression that the PBGC and the defined benefit system that PBGC insures are falling apart," Martin continues. "They're not. Defined pension plans are still the pension of choice for most American workers and the backbone of American savings. We are working to keep it that way by creating a program based on sound market-based insurance principles." Martin stresses that these changes will not be effective until 1994 and that transition rules and caps will prevent undue burden on companies.

According to the EBRI, the overall defined benefit pension system currently has $1.3 trillion in assets to cover $900 billion in liabilities. The Research Institute concludes that, "There are currently sufficient liquid assets within the aggregate defined benefit system itself to cover the pockets of underfunding within individual plans."