From: Jurist/Sidebar Brief
Joseph Marren, President and Chief Executive Officer of KStone Partners LLC, in a continuance of a previous piece, reviews the history of financial reporting by the federal government.
In Citizens United v. Federal Election Commission, Justice John Paul Stevens, joined by Justices Ruth Bader Ginsburg, Stephen Breyer and Sonia Sotomayor, concurred in part and dissented in part, writing that Congress’s “‘careful legislative adjustment of the federal election laws … warrants considerable deference'” and that “we should instead start by acknowledging that ‘Congress surely has both wisdom and experience in these matters that is far superior to ours.'” However, “[t]his is not to say that deference would be appropriate if there was a solid basis for believing that a legislative action was motivated by the desire to protect incumbents or that it will degrade the competitiveness of the electoral process.” In Part II of this series, we will review the history of financial reporting by the federal government to appreciate the extent of Congress’s abdication of its constitutional responsibility and the unconstitutional takeover of financial reporting by the executive branch.
The Treasury Department (“the Treasury”) was created by an act of Congress on September 2, 1789. However, the federal financial infrastructure remained very small for more than 100 years. Other than during the few major wars, the government did not collect or spend very much money, and so the need to centralize or modernize its payment, collection or accounting systems did not exist.
The Taft Commission, created in June 1910, proposed that a budget for the US government be established. Subsequently, US President William Howard Taft submitted the first consolidated budget. While Congress ignored this budget, the commission’s recommendation ultimately led to the passage of the Budget and Accounting Act of 1921 [PDF] (“the 1921 Act”).
The Sixteenth Amendment was ratified in 1913. Shortly thereafter, Congress enacted a federal income tax law. Prior to World War I, tariffs and excise taxes supplied more than 90 percent of revenues. After the war-income taxes generated 58 percent. Not surprisingly, the first major financial management reform took place after the war.
Woodrow Wilson — who served as US president from 1913 to 1921 — had a profound impact on federal financial reporting as the 1921 Act was a direct result of his thinking. Wilson thought that separation of powers was the product of an outmoded theory of politics. In particular, he had no use for separated powers. He declared that “[n]o living thing can have its organs offset against each other as checks, and live.” Further, he opined that “[t]here can be no successful government without leadership or without the intimate, almost instinctive, coordination of the organs of life and action.” Wilson’s thinking has become financial reporting reality. His views stand in sharp contrast to the importance of separation of powers as described by James Madison in Federalist No. 51.
There was no unified executive budget prior to the 1921 Act. Agency requests were simply packaged by the Treasury and transmitted to Congress without change. Following ten years of political maneuvering and debate, President Warren Harding signed the 1921 Act. Thereafter, requests from executive agencies were funneled into the Bureau of the Budget (BOB), which functioned as a central clearinghouse.
The 1921 Act involved trade-offs between the legislature and the executive branches. The BOB was the forerunner of the Office of Management and Budget (OMB) and established presidential authority over the budget formulation process. As a counterweight to the enhancements of executive power in the budget process, Congress established the General Accountability Office (GAO). The statute transferred to GAO the auditing, accounting and claims functions previously carried out by the Treasury. The office was designed to be “independent of the executive departments,” which were placed under its audit and review powers.
A major feature of the 1921 Act was that it gave the GAO power to “prescribe the forms, systems and procedure for administrative appropriation and fund accounting in the several departments and establishments[.]” It directed the comptroller general to prescribe accounting principles and standards in executive agencies. To enforce access to information, the comptroller general was given the power to sue non-complying agencies. More federal agencies ignored [PDF] the GAO’s guidance than complied in the years immediately after the 1921 Act was passed.
In 1937, the Brownlow Committee called for a stronger BOB to help President Franklin Roosevelt centralize fiscal management. It recognized that effective fiscal management required a good accounting system to control spending. Since the president’s duty was to faithfully execute the law, including appropriations laws, the committee reasoned that accounting was an executive function. The committee therefore advocated separating the GAO’s accounting and audit functions. Specifically, it recommended the authority to prescribe and supervise accounting systems, forms and procedures in the federal establishments should be transferred to and vested in the Secretary of the Treasury. This would limit the GAO to post audit functions. The Brownlow Committee’s assertion of accounting as an exclusive executive function was unacceptable to Congress.
The BOB was moved from the Treasury into the executive office of the president pursuant to Roosevelt’s Executive Reorganization Plan of 1939. This further increased the executive’s power over the budget. The executive office of the president had originally been proposed by the Taft Commission and again by Harding.
The Hoover Commission was appointed in 1947 by President Harry Truman. It took its name from former president Herbert Hoover, who was appointed by Truman to chair it. In 1949, it made 273 recommendations of which over 100 were implemented in legislation over ensuing years. Specifically, it recommended the use of accrual accounting by the federal government.
The Joint Financial Management Improvement Program is a program authorized by the Budget and Accounting Procedures Act of 1950 (the 1950 Act) to improve financial management practices. It was originally set-up in 1948 by the comptroller general, the director of the OMB and the secretary of the Treasury. It is a joint and cooperative action undertaken by the Treasury, GAO, OMB and the Office of Personnel Management.
The recommendations of the first Hoover Commission led to the passage of the Accounting and Auditing Act of 1950 (“the Auditing Act”). The Auditing Act directed the comptroller general to prescribe the principles, standards and related requirements for accounting to be observed by executive agencies after consulting with the secretary of the Treasury and the president. The use of accrual accounting and cost-based budgeting was required to establish and maintain adequate systems of accounting and internal control. Furthermore, accrual accounting enhances the ability of agencies to execute the required cost-based budgeting. In response to the Auditing Act, the GAO issued accounting standards. Throughout the 1950s and 1960s the GAO reported to Congress that federal agencies responded poorly to their guidance.
The Auditing Act governed the way all government agencies submitted and maintained financial information, including the executive branch. This brought up a constitutional question as to whether Congress could pass a piece of legislation that governed the executive branch. Some OMB officials asserted that the GAO standard setting provision was unconstitutional because it authorized a legislative agency to define accounting standards for executive agencies. As a result the GAO, OMB and the Treasury never reached agreement.
The second Hoover Commission was created by Congress during President Dwight Eisenhower’s administration and sent its report to Congress in 1955. It recommended the continued use of performance budgeting, in addition to agencies formulating and administering their budgets on a cost basis. Amendments [PDF] to the 1921 Act and the 1950 Act were passed in 1956. The 1921 Act was amended to require that requests for appropriations be developed from cost-based budgets. The 1950 Act was amended to require each executive agency to keep its accounts on an accrual basis, in accordance with principles and standards prescribed by the comptroller general, with a view to facilitating the preparation of cost-based budgets described in the 1921 Act.
The President’s Commission on Budget Concepts was established by President Lyndon B. Johnson. Its 1967 report recommended accrual accounting and that the annual budget be presented on an accrued expenditure basis. This was endorsed by two administrations but not implemented.
Under President Richard Nixon, the Executive Reorganization Plan of 1970 was passed. The BOB was renamed OMB. All executive departments, agencies and other bureaucratic units had to funnel their budget requests through OMB and the president. If these had to depend on OMB and the president, they would more likely follow the president’s wishes. This further strengthened the executive’s control over the budget. Meanwhile in Congress, the budget was not treated as a single entity but as thirteen separate bills. Its budgetary process remained uncoordinated and confusing. The Congressional Budget and Impoundment Control Act of 1974 [PDF] created House and Senate budget committees and established the Congressional Budget Office (CBO).
During the 1970s, Arthur Andersen (AA) completed a study of the government’s financial reporting and issued a report proposing that the government prepare consolidated financial statements on an accrual basis for all entities and programs. AA reasoned that both Hoover Commissions had recommended accrual accounting, and this had led to the passage of Public Law 84-863 [PDF]. This law, supplemented by related regulations from the Treasury, specifies that government agencies must prepare business-type, accrual-basis financial reports. These laws and regulations were in existence since 1956 but had only been partially implemented. The first prototype financial report was produced by AA for 1973 and 1974. In 1975, the Treasury began issuing annual prototype government-wide financial statements on an accrual basis. In response to the AA study, the CBO argued that if its recommendations were implemented the unified budget would be useless. It described [PDF] accrual accounting as undefined in the law and that Congress had left that responsibility to the comptroller general.
In 1984, GAO required audited agency statements prepared on an accrual basis and required federal agencies to prepare consolidated financial statements using the accrual basis of accounting. In February 1985, then-Comptroller General Chuck Bowsher put forth a detailed recommendation [PDF] for a completely revised integrated approach for financial reporting for the federal government. The GAO called for accrual-based consolidated financial statements and recording social insurance obligations in all budgeting and financial reports. AA supported the GAO’s stance. OMB budget officials reacted very negatively.
In Part III, we will continue reviewing the history of financial reporting by the federal government.