SEC Unprepared to Implement the Fiduciary Standard for Broker-Dealers

Broker-dealers will be subject to a fiduciary standard of care no earlier than the second half of 2012, predicts Richard Ketchum, Chairman and CEO of the Financial Industry Regulatory Authority (“FINRA”).  Mr. Ketchum’s remarks come a week after SEC chairman Mary Schapiro said that the SEC has “a lot of work to do” before putting “pen to paper” and writing the fiduciary standard rules.

Causes of the delay were hinted at by a pair of reports issued by the SEC last month, one of which concluded that broker-dealers and registered investment advisers (“RIA”) should be subject to the same fiduciary standard of care. The other report provided recommendations for improving the examination of investment advisors, concluding that a Self-Regulatory Organization (“SRO”) should be appointed to conduct examinations of investment advisors. An SRO is a private organization that is granted some regulatory authority over a particular industry. SROs are typically funded by member user fees.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the fiduciary standard in Advisor’s Journal, see SEC Fiduciary Standard Study Answers Few Questions (CC 11-25), Study Finds that Universal Fiduciary Standard Will Hurt Investors (CC 10-97) and What You Don’t Know Yet Might Hurt You: A Broker’s Duties under the Financial Reform Act (CC 10 40)

Your questions and comments are always welcome. Please post them below or call the Panel of Experts.

Why is this Topic Important to Wealth Managers?   A wealth manager should be able to present Advanced Market Intelligence on the long-term economic impact of government spending and its ability to raise revenues with clients.

The United States faces daunting economic and budgetary challenges. The economy has struggled to recover from the recent recession, which was triggered by a large decline in house prices and a financial crisis—events unlike anything this country has seen since the Great Depression.

For the federal government, the sharply lower revenues and elevated spending deriving from the financial turmoil and severe drop in economic activity—combined with the costs of various policies implemented in response to those conditions and an imbalance between revenues and spending that predated the recession—have caused budget deficits to surge in the past two years. The deficits of $1.4 trillion in 2009 and $1.3 trillion in 2010 are, when measured as a share of gross domestic product (GDP), the largest since 1945—representing 10.0 percent and  8.9 percent of the nation’s output, respectively. [1]

Also, the recovery in employment has been slowed not only by the moderate growth in output in the past year and a half but also by structural changes in the labor market, such as a mismatch between the requirements of available jobs and the skills of job seekers, that have hindered the employment of workers who have lost their job. Payroll employment, which declined by 7.3 million during the recent recession, gained a mere 70,000 jobs (or 0.06 percent), on net, between June 2009 and December 2010. [2]

However, under current law, CBO projects, budget deficits will drop markedly over the next few years—to $1.1 trillion in 2012, $704 billion in 2013, and $533 billion in 2014. Relative to the size of the economy, those deficits represent 7.0 percent of GDP in 2012, 4.3 percent in 2013, and 3.1 percent in 2014. From 2015 through 2021, the deficits in the baseline projections range from 2.9 percent to 3.4 percent of GDP. [3]

Nevertheless, the deficits that will accumulate under current law will push federal debt held by the public to significantly higher levels. Just two years ago, debt held by the public was less than $6 trillion, or about 40 percent of GDP; at the end of fiscal year 2010, such debt was roughly$9 trillion, or 62 percent of GDP, and by the end of 2021, it is projected to climb to $18 trillion, or 77 percent of GDP. [4]

With such a large increase in debt, plus an expected increase in interest rates as the economic recovery strengthens, interest payments on the debt are poised to skyrocket over the next decade. CBO projects that the government’s annual spending on net interest will more than double between 2011 and 2021 as a share of GDP, increasing from 1.5 percent to 3.3 percent.

Beyond the 10-year projection period (though 2012), further increases in federal debt relative to the nation’s output almost certainly lie ahead if current policies remain in place. The aging of the population and rising costs for health care will push federal spending as a percentage of GDP well above that in recent decades. Specifically, spending on the government’s major mandatory health care programs—Medicare, Medicaid, the Children’s Health Insurance Program, and health insurance subsidies to be provided through insurance exchanges—along with Social Security will increase from roughly 10 percent of GDP in 2011 to about 16 percent over the next 25 years. [5] If revenues stay close to their average share of GDP for the past 40 years, that rise in spending will lead to rapidly growing budget deficits and surging federal debt.

Next week’s blogticles will discuss relevant topics for wealth managers in 2011.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts

 

NB: This work or parts thereof originated from previous official Federal Government publication available to the public.

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[1] See generally Congressional Budget Office. “The Budget and Economic Outlook: Fiscal Years 2011 to 2021”.  January 2010.  http://www.cbo.gov/ftpdocs/120xx/doc12039/SummaryforWeb.pdf.  Last Accessed 2/17/2010.

[2] Id.

[3] See generally Office of Management And Budget. “Budget of the U.S. Government Fiscal Year 2012”-Summary Tables.  http://www.whitehouse.gov/omb/budget/Overview.  Last Accessed 2/16/2011.

[4] Congressional Budget Office. “The Budget and Economic Outlook: Fiscal Years 2011 to 2021”.  January 2010

[5] See Congressional Budget Office, The Long-Term Budget Outlook (June 2010), revised August 2010.

Why is this Topic Important to Wealth Managers?  Increasing the IRS staffing budget in certain departments may be indicative of increasing scrutiny of client’s information and tax returns.  Increasing government scrutiny may lead to increased compliance costs in time and fees.  Consequently, a wealth manager may want to address with client the need for increasing diligence in preparation of their affairs.  Thus, Advanced Market Intelligence presents a discussion on the Internal Revenue Services’ allocations for fiscal year 2012, and contrasts 2010 data and figures.

The fiscal year 2012 proposed budget allocates $14 billion to the Department of the Treasury; a 4 percent increase above the 2010 enacted level. [1] The increase over 2010 levels is attributed to costs associated with implementation of legislation and new investments in IRS tax compliance activities that are aimed to help reduce the deficit.  Of the $14 billion appropriated to the Treasury operations, over $13.28 billion is encumbered for the Internal Revenue Service.[2]

The Internal Revenue Service has allocated its appropriations to the tune of $2.345 billion for “Taxpayer Services”; $5. 96 billion for “Enforcement” of which over $5 billion is apportioned to “Exam and Collections”; “Operations and Support” represent $4.62 billion; and “Business Systems Modernization” together with “Health Insurance Tax Credit Administration” represent approximately $351 million. [3]

The main function of the Internal Revenue Service is to collect he revenue that funds the government and administer the nation’s tax laws. [4] The IRS collected $2.345 trillion in taxes (gross receipts before tax refunds) in 2010, or 93 percent of all federal government receipts.

Total resources to support the IRS activities for fiscal year 2012 are estimated to be around $13.626 billion, including $13.283 billion from direct appropriations, an estimated $138 million from reimbursable programs, and an estimated $204 million user fees.  The direct federal budget appropriation is $1,137,784,000, 9.37 percent, more than the fiscal year 2010 enacted level of $12,146,123,000. [5]

The 2012 budget provides funding to implement enacted legislation; handle new information reporting requirements; increase compliance by addressing offshore tax evasion; expand enforcement efforts on noncompliance among corporate and high-wealth taxpayers; and enforce return preparer compliance.

The IRS estimates new enforcement personnel will generate more than $1.3 billion in additional annual enforcement revenue once the new hires reach full potential in fiscal year 2014.

Even the Department of the Treasury notes, the tax law is complex and that even sophisticated taxpayers can make honest mistakes on their tax returns.  To this end, the IRS states that it remains committed to a balanced program of assisting taxpayers to both understand the tax law and remit the proper amount of tax.

In fiscal year 2010, revenue from all enforcement sources at the IRS reached $57.6 billion, 18 percent more than in 2009.  The significant increase was attributable in part to:

• The examination of more than 1.58 million individual returns, an increase of 11 percent, reaching the highest rate in the past decade;
• Increased high-income/high-wealth audits on taxpayers with income greater than $200,000 by 5.5 percent and audits for those with income greater than $1 million by more than 8 percent;
• Increased automated underreporter contact closures by 19.8 percent, surpassing the four million mark for the first time, with more than 4.3 million;
• Increased collection case closures by 6.3 percent and criminal investigations by 12.4 percent;
• Increased large corporate audits by 8.1 percent, a significant achievement given the size (assets greater than $10 million) and complexity of these corporate entities and audits of foreign corporations by almost 48 percent; and
• Increased tax exempt and government entity compliance contacts by approximately 20 percent. [6]

Tomorrow’s blogticle will wrap-up this week’s discussion on the national budget.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts

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[1] See Office of Management And Budget. “Budget of the U.S. Government Fiscal Year 2012” at 127.  http://www.whitehouse.gov/omb/budget/Overview.  Last Accessed 2/16/2011.

[2] Id. At 130.

[3] See Department of the Treasury. “Budget-in-Brief”; Internal Revenue Service.    http://www.treasury.gov/about/budget-performance/budget-in-brief/Documents/FY2012_IRS_508.pdf.  Last Accessed 2/6/2011.

[4] See generally, Department of the Treasury.  “Duties & Functions of the U.S. Department of the Treasury”.  http://www.treasury.gov/about/role-of-treasury/Pages/default.aspx.  Last Updated 12/7/2010.  Last Accessed 2/16/2011.

[5] Department of the Treasury. “Budget-in-Brief”; Internal Revenue Service.

[6] Id.

Firms Selling Private Placements Face Increased Scrutiny

If you’re selling Reg D private placements or non-traded REITs, the proverbial Huns are on the hill. These illiquid, private investments are the top two items on FINRA’s (“Financial Regulatory Authority Inc.”) list of enforcement priorities.  FINRA is particularly interested in whether firms selling the investments are complying with “suitability, supervision and advertising rules,” and is also looking at cases of fraud and the unregistered sale of the securities.

Medical Capital Holdings Inc. and Provident Royalties, LLC.—both of which offerings brought in hundreds of millions of dollars through private placements sold by broker-dealers—were given as examples of private placements done wrong. Both were charged with fraud in 2009. At least 12 broker-dealers who sold Provident Royalties to their customers are now defunct as a result of the millions of dollars in arbitration claims and lawsuits related to the offering.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of FINRA regulatory action in Advisor’s Journal, see Broker Bonus Arbitration Bottleneck Forces FINRA to Reconsider Arbitrator Qualification Standards (CC 11-08), SEC Approves FINRA Suitability and Know-Your-Customer Rules (CC 11-17), and New FINRA Rule Restricts Brokers’ Outside Business Activities (CC 10-110).

For in-depth analysis of the taxation of REITs, see Advisor’s Main Library: D—REITs and Limited Partnerships.

Tax and insurance advisors looking for answers on how the new Tax Relief Act of 2010 will impact their clients are finding them in The National Underwriter Company’s just-published Selected Provisions and Analysis of the Tax Relief Act of 2010.  The proprietary analysis is the only practitioners’ guide in Q&A format that answers the most critical questions asked by clients on insurance, estate and gift tax law changes.

Copies of the 64-page report are available for only $12.95 plus shipping and handling here.  Producers and their companies can also license use of their logos and contact information directly on the cover of the guide for a marketing and client-management tool.

National Underwriter’s wealth management experts and report authors, Professor William H. Byrnes, Esq., LL.M, CWM and Robert Bloink, Esq., LL.M., noted, “While most media attention has focused on the Act’s retention of existing tax rates on the highest-earning Americans, tax, insurance and investment advisors are finding that the most important changes, from their perspective, are likely to be found in insurance, estate and gift tax provisions that will drive client decisions on investment strategy and wealth management priorities in 2011 and beyond.”

Rick Kravitz, Vice President & Managing Director of Summit Business Media’s Reference Division, said, “This proprietary analysis – compiled by leading experts in the field – demonstrates National Underwriter’s commitment to bringing timely and critical updates to advisors and financial planners so that they can successfully build their practices and better serve their clients.”

Prof. Byrnes, a former Coopers & Lybrand associate director in international tax and now Dean of the wealth management graduate program at Thomas Jefferson School of Law, noted that the 64-page analysis has answers to more than 100 important questions in these areas:

• Income Tax
• Estate and Gift Tax
• Generation Skipping Transfer Tax
• Deduction for State and Local Sales Taxes
• Alternative Minimum Tax
• Tax Credits
• Payroll Tax Holiday
• Wage Credit for Employees Who Are Active Duty Members of the Military
• Charitable Distributions from Retirement Accounts
• Bonus Depreciation and Section 179 Expensing
• Basis Reporting Requirements for Brokers and Mutual Funds
• Regulated Investment Company Modernization Act of 2010
• Health Care Act
• Form 1099 Reporting Requirement for Businesses
• American Jobs and Closing Tax Loopholes Act of 2010
• Requirements for Tax Return Preparers

“This is the only guide available on the market today that gives financial planners and producers issue-specific, time-critical information in Q&A format that addresses their most important technical questions with content that can also be used directly in client presentations,” Prof. Byrnes added.  “The unique combination of The National Underwriter Company’s editorial staff and the resources and professional experience of the wealth management faculty at Thomas Jefferson School of Law provides assurance that these are answers that can be counted on.”

About The National Underwriter Company

For over 110 years, The National Underwriter Company has been the first in line with the targeted tax, insurance, and financial planning information you need to make critical business decisions.  With respected resources available in print, on CD, and online, National Underwriter remains at the forefront of the evolving insurance industry, delivering the thorough and easy-to-use resources you rely on for success.  National Underwriter is a Summit Business Media company.

About Summit Business Media

Summit Business Media is the leading B2B media and information company serving the insurance, investment advisory, professional services and mining investment markets through a variety of channels, including print, online and live events.  Summit provides breaking news and analysis, in-depth practice management strategies, business-building techniques and actionable data to the markets it serves. Through its Media and Reference Divisions, Summit publishes 16 magazines, 20 websites and 150 reference titles. Summit’s Event Division hosts a dozen conferences across the spectrum of markets the company services.  Summit’s Data Division is the leading data provider of financial, marketing and benefits information on corporations, insurance companies and life, benefits and property-casualty agents.

Summit employs nearly 400 employees in ten offices across the United States.  For more information, please visit summitbusinessmedia.com.

In a recent case, the IRS denied an estate a fractional interest discount on the family ranch, resulting in a seven digit tax bill and the likely liquidation of the family homestead.  The father had numerous options for securing a valuation discount on, or excluding the value of, a significant tract of property from his gross estate, but hadn’t done any planning since 1965, resulting in total denial of a discount.  When he died in 2004, the property was worth $6,390,000.  Don’t let this be your client.

The dispute between the IRS and the father’s estate centered on whether the property’s value in the gross estate was: (1) the undiscounted value of a fee simple interest in the property or (2) the aggregated value of the children’s fractional interests in the property—valued separately with fractional interest discounts.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of valuation discounts in Advisor’s Journal, see IRS Rebuffed by Federal Court of Appeals in Valuation Discount Case (CC 11-21) and Valuation Discounts: Only for a Bona Fide Business (CC 10-60).

For in-depth analysis of valuation discounts, see Advisor’s Main Library: A—Family Limited Partnerships and Estate & Gift Tax Valuation Discounting.

Why is this Topic Important to Wealth Managers?  A producer should be able to present a perspective of the potential impact of current budget proposals upon investments that will be realized in the future.  Thus, Advanced Market Intelligence discusses certain features to the proposed federal budget that impact fiscal year 2012.

The President’s new budget proposal included many revenue raising measures.  However, below are two areas affecting the tax code that will actually increase the deficit, and also have a strong likelihood to have an impact on clients’ decisions made today.

Currently, the maximum rate of tax on the qualified dividends and net long-term capital gains of an individual is 15 percent. [1] In addition, any qualified dividends and capital gains that would otherwise be taxed at a 10- or 15-percent ordinary income tax rate are taxed at a zero percent rate.

The zero- and 15-percent rates for qualified dividends and capital gains are scheduled to expire for taxable years beginning after December 31, 2012. [2] In 2013, the maximum income tax rate on capital gains would increase to 20 percent (18 percent for assets purchased after December 31, 2000 and held longer than five years), while all dividends would be taxed at ordinary tax rates of up to 39.6 percent.

Taxing qualified dividends at the same low rate as capital gains for all taxpayers is said to reduce the tax bias against equity investment and promote a more efficient allocation of capital.  Eliminating the special 18-percent rate on gains from assets held for more than five years is thought to further simplify the tax code.

The Administration’s revenue baseline budget assumes that the current zero- and 15-percent tax rates for qualified dividends and net long-term net capital gains are permanently extended for middleclass taxpayers.   In addition, the proposed budget would apply a 20-percent tax rate on qualified dividends that would otherwise be taxed at a 36- or 39.6 percent ordinary income tax rate.  This is the same rate as will apply to net long-term capital gains for upper-income taxpayers under current law after 2012.  The reduced rates on gains from assets held over five years would be repealed.  The special rates applying to recapture of depreciation on certain real estate (Section 1250 recapture) and collectibles would be retained.

This proposal would be effective for taxable years beginning after December 31, 2012, and would increase the deficit by $9.582 billion in 2013.

Secondly, the President’s budget calls for the repeal of information reporting on payments to corporation and payments for property (an issue that has been the topic of much discussion lately).

Generally, a taxpayer making payments to a recipient aggregating to $600 or more for services or determinable gains in the course of a trade or business in a calendar year is required to send an information return to the Internal Revenue Service setting forth the amount, as well as name and address of the recipient of the payment (generally on Form 1099). [3] Under a longstanding regulatory regime, there were certain exceptions for payments to corporations, as well as tax-exempt and government entities.  Also, this information reporting requirement did not apply to payments for property.

Effective for payments made after December 31, 2011, the Affordable Care Act expanded the information reporting requirement to include payments to a corporation (except a tax-exempt corporation) and payments for property.  [4]

Generally, compliance increases significantly for payments that a third party reports to the IRS.  In the case of payments to tax-exempt or government entities that are generally not subject to income tax, information returns may not be necessary.  On the other hand, during the decades in which the regulatory exception for payments to corporations has become established, the number and complexity of corporate taxpayers have increased.  Moreover, the longstanding regulatory exception from information reporting for payments to corporations has created compliance issues.   In addition, the expanded information reporting requirements imposed by the Affordable Care Act is expected to put an undue burden on small businesses.

The proposed budget would repeal the additional information reporting requirements imposed by the Affordable Care Act.  Further, the proposal would require businesses to file an information return for payments for services or for determinable gains aggregating to $600 or more in a calendar year to a corporation (except a tax-exempt corporation).  Information returns would not be required for payments for property.

This proposal would be effective for payments made after December 31, 2011, and have a net increase of the deficit in 2012 of $475 million.

Tomorrow’s blogticle will continue with discussion on the national budget.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts

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[1] See generally, 26 U.S.C. § 1(h).

[2] See Section 102 of The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (HR. 4853).

[3] See Internal Revenue Code Section (IRC) 6041, Treasury Regulations (TR) 1.6041-1(a)(1)(i), TR 1.6041-1(a)(2).

[4] See Patient Protection and Affordable Care Act, 124 Stat. 1029.  §9006 (a).

Why is this Topic Important to Wealth Managers? Clients will often ask for your “take” on the annual federal budget.   It is important to show the client a command of the the facts and figures before addressing the political perspective of spending and revenue.  Any producer can “mime” someone else’s perspective.  Distinguish yourself with a command of the underlying numbers.  Thus, this week Advanced Market Intelligence presents the facts and figures of the proposed federal budget for fiscal year 2012. 

The new 2012 Federal Budget was released today by the President.  Below is a summary of the inflows and outflows concerning next year’s proposed budget (in billions of dollars).

Outlays:

Appropriated (“discretionary”) programs:   Security $ 884/Non-security 456; Subtotal—appropriated programs: 1,340

Mandatory programs: Social Security $ 761, Medicare 485, Medicaid 269, Troubled Asset Relief Program (TARP) 13, Other mandatory programs 612; Subtotal, mandatory programs 2,140, Net interest 242, Disaster costs 8

Total outlays 3,819

Receipts:

Individual income taxes $ 1,141, Corporation income taxes 329

Social insurance and retirement receipts: Social Security payroll taxes 659,Medicare payroll taxes 201, Unemployment insurance 57, Other retirement 8, Excise taxes 103, Estate and gift taxes 14, Customs duties 30, Deposits of earnings, Federal Reserve System 66,Other miscellaneous receipts 20

Total receipts 2,627

2012 Deficit $ 1,101

Here are some noted observations of the current budget: 

• By 2020 individual income taxes will more than double from their 2012 levels of 1,141 to 2,439 billion. 
• The Proposed corporate tax rates increased from 2011 to 2012 to over 60% from 198 billion to over 329 billion (the budget notes that The President is calling on the Congress to work with the Administration on corporate tax reform that would simplify the system, eliminate these special interest loopholes, level the playing field, and use the savings to lower the corporate tax rate for the first time in 25 years—and do so without adding a dime to our deficit.)
• By 2020 the annual interest owed will balloon to over $729 billion, or an increase of over 300% from the 242 billion 2012 levels. 
• The cost of Medicaid will more than double by 2020 as compared to 2012 levels. 
• The estimated deficit for 2020 is 735, which means the overall national debt by year end 2020 is estimated to be over 21.5 trillion dollars. 

The Department of Defense and Department of Homeland Security together make up the largest spending area in the budget.  Here’s a list of some of the highlights the security spending provides for. 

• The allocated amount reflects the continued investment in national security priorities such as cybersecurity, satellites, and nuclear security.
• Maintains ready forces and continues efforts to rebalance military forces to focus on both today’s wars as well as potential future conflicts.
• Enhances the Administration’s commitment to maintaining a reliable nuclear deterrent by increasing investments in the nuclear weapons complex and in weapon delivery technologies, and to nonproliferation by preventing the spread of nuclear materials around the world.
• Refocuses funding for border surveillance on technologies that have proven to work, allowing for a tailored approach in different border regions instead of the previous one-size-fits-all approach.
• Safeguards the Nation’s transportation systems with an $82 million increase to support deployment of up to 1,275 Advanced Imaging Technology screening machines at airport checkpoints, with robust, built-in privacy safeguards.

Tomorrow’s blogticle will continue with discussion on the national budget. 

We invite your opinions and comments by posting them below, or by calling the Panel of Experts

Do small- to medium-sized advisors represent a threat to the systemic integrity of the worldwide financial system? Probably not, but you’d think so based on the flood of advisor regulations flowing out of Washington.

The Dodd-Frank compliance maze expanded again last week as the SEC commissioners voted unanimously to release proposed reporting requirements that will complicate the compliance landscape for many advisors. Although affected advisors are not among the largest advisors overseen by the SEC, they are nevertheless categorized by the Commission as large enough to represent a systemic threat warranting increased SEC attention.

And while the SEC has assured affected advisors that their proprietary trading strategies won’t become part of the public record, recent events like the Wikileaks private banking releases should spook advisors.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of recent SEC rulemaking activity in Advisor’s Journal, see SEC’s Plain English Requirement Equals Expensive Client Disclosures(CC 10-44) and SEC Approves FINRA Suitability and Know-Your-Customer Rules (CC 11-17).

Why is this Topic Important to Wealth Managers? Presents discussion on the national debt and national future financial outlook.  A client wants to know what YOU think about Treasury Notes versus other types of government debt, even foreign government debt.  An understanding of the annual federal national deficit, and its impact on the federal national debt, will provide you a helpful starting point to educate your client, without providing investment advice.

Today’s release of the new federal budget has us at Advanced Markets excited.  We thought an introduction to the current economic condition would therefore be appropriate.  As of September 30, 2010, the federal debt managed by Bureau of the Public Debt totaled about $13,551 billion primarily for borrowings to fund the federal government’s operations.  A Government Accountability Office (GAO) Study recently showed the Federal Debt balances consisted of approximately (1) $9,023 billion as of September 30, 2010, of debt held by the public and (2) $4,528 billion as of September 30, 2010 of intragovernmental debt holdings. [1]

Debt held by the public primarily represents the amount the federal government has borrowed to finance cumulative cash deficits.  To finance a cash deficit, the federal government borrows from the public.  When a cash surplus occurs, the annual excess funds can then be used to reduce debt held by the public.  In other words, annual cash deficits or surpluses generally approximate the annual net change in the amount of federal government borrowing from the public.

Intragovernmental debt holdings represent balances of Treasury securities held by federal government accounts, primarily federal trust funds, that typically have an obligation to invest their excess annual receipts (including interest earnings) over disbursements in federal securities.

The federal debt has been audited since fiscal year 1997. Over this period, total federal debt has increased by 151 percent.  During the last 4 fiscal years, managing the federal debt has been a challenge, as evidenced by the growth of total federal debt by $5,058 billion, or 60 percent, from $8,493 billion as of September 30, 2006, to $13,551 billion as of September 30, 2010.

The increase to the federal debt became particularly acute with the onset of the recession in December 2007. Reduced federal revenues and federal government actions in response to both the financial market crisis and the economic downturn added significantly to the federal government’s borrowing needs.  And, due to the persistent effects of the recession, experts believe federal financing needs remain high.  As a result, the increases to total federal debt over the past three fiscal years represent the largest dollar increases over a three year period in history.  The largest annual dollar increase occurred in fiscal year 2009 when total federal debt increased by $1,887 billion.

During fiscal year 2010, total federal debt increased by $1,653 billion.  Of the fiscal year 2010 increase, about $1,471 billion was from the increase in debt held by the public and about $182 billion was from the increase in intragovernmental debt holdings.

During fiscal years 2008, 2009, and 2010, legislation was enacted to raise the statutory debt limit on five different occasions.  During this period, the statutory debt limit went from $9,815 billion to its current level of $14,294 billion, an increase of about 46 percent.

Recovery from the economic downturn is expected to be slow during the next few years and as a result, deficits are expected to remain high.  The Congressional Budget Office (CBO) estimates the annual federal deficit will be just over $1 trillion for fiscal year 2011, down from $1.3 trillion for fiscal year 2010.  Correspondingly, debt held by the public is expected to grow from an estimated 62.5 percent of gross domestic product (GDP) at the end of fiscal year 2010 to over 66 percent of GDP at the end of fiscal year 2011. The real challenge is not this year’s deficit or even next year’s; it is how best to address the nation’s unsustainable long-term fiscal path over the coming decades.

While considerable attention has been understandably given to the near- term fiscal position, the federal government faces even larger fiscal challenges that will persist long after the return to economic growth.  The budget and economic implications of the baby boom generation’s retirement have already become a factor in near-term budget projections and will only intensify as the baby boomers age.  Since fiscal year 2008, the Medicare Hospital Insurance program has paid more in benefits than it receives in cash from payroll taxes.

In addition, for the first time in over 25 years, the Social Security program, which has historically run large cash surpluses that helped reduce the need to borrow to finance other federal government activities, paid more in benefits than it received in tax income in fiscal year 2010 thereby contributing to borrowing needs.

GAO and CBO’s long-range fiscal policy simulations continue to show that, absent significant changes in policy, the federal government’s fiscal condition over the coming decades is on an unsustainable path.  The sooner action is taken to address this long-term fiscal challenge, the less disruptive and destabilizing the changes will be.  As a result, the nation’s leaders face the challenge of dealing with current economic and financial issues in the context of the need to address the long-term fiscal challenges.

Tomorrow’s Advanced Markets Intelligence blogticle will continue with discussion on the national budget in order to provide you intelligence talking points when asked about the national debt beyond the generic that you may glean from news media.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts

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[1] The full study may be obtained by linking to: http://www.gao.gov/new.items/d1152.pdf.  Last Accessed 2/13/2011.