United States: President Obama Releases Proposed Fiscal Year 2012 Budget: Outlines New Spending And Tax Measures, Deficit Reductions

Republicans Seek More Spending Cuts as Congress Debates Current Year Funding

On Monday, February 14, 2011, President Barack Obama released his Administration's proposed budget for Fiscal Year 2012 (October 1, 2011 - September 30, 2012) (the "President's FY 2012 Budget"). This release came as Congress, specifically the US House of Representatives, commenced a debate over the contours of federal spending for the balance of the current fiscal year that ends September 30, 2011. Occurring in the midst of campaign promises by Congressional Republicans to reduce federal spending by $100 billion this fiscal year, the consideration of the continuing resolution ("CR") and the politics surrounding the President's budget release will dominate the debate over the coming weeks.

Although the President's FY 2012 budget consists primarily of specific proposals, the budget as a whole presents a platform for the Administration to state its policy priorities, and its future direction with respect to spending initiatives and tax proposals. It also provides a valuable window into the willingness of the Administration to enact spending reductions. While the US Congress must ultimately pass any spending legislation, the President's FY 2012 budget will influence the debate, and it offers those who interact with government or who are involved in federal contracts or programs a sense of the fiscal landscape for the coming year.

The following provides an outline of some of the key priorities contained in the President's budget for several critical departments and agencies, as well as proposed tax changes and assumptions on which the budget proposal is based.

Overview

The President's FY 2012 Budget includes a variety of spending proposals, both decreases and increases compared to prior budgets. It also includes some familiar and previously proposed revenue provisions.

In its release, the Obama Administration highlighted the following features:

• A five-year spending freeze on most discretionary spending
• $1.1 trillion in deficit reduction over the next 10 years, with 2/3 of the reduction attributable to spending cuts
• A projected 2011 budget deficit of $1.645 trillion (10.9% of GDP), falling to $627 billion (3.0% of GDP) in 2017

Direct Agency Spending

The President's FY 2012 Budget provides for $3.73 trillion in spending. That spending package includes a number of key initiatives (as well as proposed programmatic cuts) across agencies, including:

Department of Defense - FY 2012 Request: $553 billion / FY 2010 Enacted: $530.8 billion

Spending

• Additional $2.2 billion for National Nuclear Security Administration (NNSA) in support of Nuclear Posture Review and START treaty implementation with Russia
• $172 billion for overall training and readiness; $52 billion for Military Health System
• 1.6% pay increase for service members
• $2.3 billion in new and ongoing cyber research; $119 million for U.S. Cyber Command operations

Cuts

• $13 billion cut from the elimination of three programs: Marine Corps Expeditionary Fighting Vehicle (EFV), the Army Surface Launched Advanced Medium Range air-to-air missile, and the Navy's SM-2 Block IIIB surface-to-air missile
• Acquisition reforms - reducing high-risk contracts and efficiently targeting high-priority needs to save DOD $78 billion through 2016

Department of Energy - FY 2012 Request: $29.5 billion / FY 2010 Enacted: $26.4 billion

Spending

• $6.3 billion for clean energy research, development, demonstration, and deployment
• $550 million for Advanced Research Projects Agency
• New $100 million "Race to Green" competition for states and municipalities; Buildings Challenge for private-sector initiatives; pilot program to increase financing for universities, schools, and hospitals
• Change from tax rebate for fuel efficient vehicle to a rebate at point of sale
• $7.6 billion for nuclear weapons stockpile protection in pursuit of new START Treaty; $2.5 billion in nuclear proliferation prevention

Cuts

• Elimination of coal subsidies - savings of $2.6 billion over 10 years
• Repeal of oil and natural gas research and development subsidies - savings of $43.6 billion over 10 years

Department of the Treasury - FY 2012 Request: $14 billion / FY 2010 Enacted: $13.3 billion

Spending

• $30 billion to Small Business Lending Fund intended to support community banks
• $1.5 billion to create the State Small Business Credit Initiative to boost state-sponsored small business loans
• Over $240 million for the IRS to improve customer service and modernize tax compliance activities

Cuts

• Reduce spending on Community Development Financial Institution by $20 million from the 2010 enacted level
• Save roughly $200 million in administrative and overhead reductions

Department of Housing and Urban Development - FY 2012 Request: $42 billion / FY 2010 Enacted: $47.5

Spending

• $250 million in additional spending to continue HUD's work in high-poverty neighborhoods
• $150 million of investments for sustainable community development
• $200 million expenditure to transform HUD-assisted public and privately-owned housing
• $35 billion to preserve rental housing assistance
• $2.5 billion spend towards ending chronic homelessness

Cuts

• 7.5% cut in funding for Community Development Block Grants, a $300 million reduction from current levels
• $172 million reduction (relative to the 2010 enacted level) in spending for new housing for seniors and person with disabilities

Government-Sponsored Enterprises - FY 2012 Request: $169 billion

Costs

• Fannie Mae and Freddie Mac will cost $73 billion (net of dividends) through 2012
• Spending from 2009 through 2012 will be $224 billion
• $150.8 billion has been spend on Fannie and Freddie since December 31st, 2010

Revenues and Offsets

• Continuation of the planned 10% per year reduction in investment portfolios of Fannie and Freddie
• Dividends from 2009 through 2012 are projected to be $55 billion
• Since December 31st, 2010 the Treasury has received a $20.2 billion quarterly dividend from Fannie and Freddie

Tax Proposals

Most of the tax proposals in the President's FY 2012 Budget are carryovers from last year's budget. Nonetheless, the budget contains a few new measures and some modifications of previous proposals.

New Initiatives

• 3-year patch to the Alternative Minimum Tax (AMT)
• A proposal to restructure the existing deduction for energy-efficient commercial building property expenditures into a tax credit
• Designation of 20 "Growth Zones" with employment tax credits and expensing for qualifying property
• A package of "simplification measures" (generally dealing with technical parts of the tax code) that raises approximately $400 million over 10 years
• Some new reporting obligations

Modified Proposals

Although the budget explanations are very general, making it hard to identify modifications, several significant modifications are apparent. For example, the budget continues to call for a financial crisis responsibility fee, but at only 1/3 the size of last year's proposal because of the reduction in the projected final costs of the Troubled Asset Relief Program.

Similarly, the budget's proposed extension (and, in certain cases, modification) of provisions that expire in 2011 and 2012 necessarily takes into account the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. In other words, the budget generally proposes to extend the so-called "extenders" and the "Bush tax cuts" in the same manner as before, but reflecting the extensions and changes enacted last year. The budget's proposed extensions include some of the American Recovery and Reinvestment Act provisions that were not extended in 2010 (such as Build America Bonds and the qualified advanced energy manufacturing credit).

Repeats from Last Year's Budget

Significant revenue-losing provisions include:

• Permanent extension of the research and experimentation tax credit
• Permanent extension of the small business capital gains exemption
• Extension of certain expired or expiring provisions

Practically all revenue raisers from last year's budget that were not enacted are included in this year's budget. These include proposals to:

• "Reform" the treatment of financial institutions and products, including the financial crisis responsibility fee (or "bank tax"), albeit at a reduced level
• Reinstate Superfund taxes
• Increase Oil Spill Liability Trust Fund taxes
• Make the unemployment insurance surtax permanent
• Repeal the LIFO method of accounting
• Repeal gain limitation for dividends received in reorganization exchanges
• Adopt the remaining U.S. international tax "reforms" (with modifications to provisions dealing with transfer of intangibles and reinsurance premiums)
• "Reform" treatment of insurance companies and products
  Eliminate fossil fuel tax preferences
• Adopt a "carried interest" proposal
• Deny a deduction for punitive damages
• Repeal the lower-of-cost-or-market inventory accounting method
• Limit itemized deductions for upper-income individuals

Next Steps

Once the US Congress and the Administration reach final agreement on the FY 2011 spending package, they will turn to the FY 2012 budget process. As this week has illustrated, however, the budget process for both FY 2011 and FY 2012 will be an incredibly difficult and politically complex one. With the current CR expiring on March 4th and Congress recessing for the President's Day holiday, Congress will likely be forced to enact another short-term spending measure to give it time to finalize a funding plan for FY 2011. Debate on this measure is further complicated by the need for Congress to pass a statutory increase in the debt limit in the next several months. Because debate on these two measures and perhaps even the FY 2012 budget may eventually become linked, the path forward is not entirely clear.

Under the normal process, the House and Senate Budget Committees would each produce budget resolutions, which are the spending and tax blueprints for the fiscal year, with both the House and Senate adopting budget resolutions preferably in April. The Republican-controlled House and the Democratic-controlled Senate would then seek to agree to a compromise budget resolution. Being only blueprints, the budget resolutions lack the force and effect of law, and the President cannot veto a budget resolution.

Once a budget blueprint is established, the House and Senate Appropriations Committees will begin to develop appropriations bills that implement the spending levels in the budget resolution. The mandatory spending (i.e., entitlements, such as Medicare and Medicaid) changes identified in the budget resolution will be considered by the House and Senate committees of jurisdiction. Finally, the House Ways and Means Committee and the Senate Finance Committee will begin to develop the tax legislation outlined in the budget resolution.

So, the process begun on February 14th will continue for much of 2011. Close attention is critical, however. In recent years, the process for budgetary, spending, and tax legislation has been anything but normal, and, as mentioned above, there is every reason to think that the FY 2012 spending process will be a very bumpy ride. While agreement on a budget resolution would facilitate the FY 2012 spending process, given the deep-seated differences between Republicans and Democrats, passage of such a concurrent resolution cannot be assured. A real possibility exists that Congress will once again not pass most of the appropriations bills and instead be required to fund FY 2012 government operations through one or more continuing resolutions.

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