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March 18, 2005
Surpluses, Deficits and Government Accounting
How can Social Security be running surpluses every year and yet have unfunded liabilities in the trillions? And how can New Zealand turn a $7 billion surplus into a $1 billion surplus without spending a dollar? Both come down to a question of accounting.
Jim Glass over at his blog has a great summary of the difference between cash and accrual-basis accounting and how they can lead to vastly different pictures of the financial shape of corporations or the government. I'll quote him at length:
The government computes its $412 billion deficit number using cash-basis accounting.
Cash-basis accounting is what individuals use. "Cash in" measures income, "cash out" measures expense, and the difference is net income or loss, nothing or little else counts.
But cash-basis accounting is illegal for all publicly owned corporations, and even for private businesses that have inventory or which accrue in any significant amount either liabilities or rights-to-income that stretch over more than one year.
Accrual-basis accounting recognizes the full current value of all future income that one obtains a legal right to receive, and of all liabilities one becomes legally obligated to pay. So if one receives $1,000 cash in exchange for committing to pay $10,000 in the future, a $9,000 net cost is recognized, rather than $1,000 of income.
As noted, the government requires that GAAP rules be used by all public corporations and all but the very smallest of other entities that have inventories or accruals -- except itself. The government reserves for itself the right to use cash basis accounting.
And it is such cash-basis accounting, cash in minus cash out, that produces the government's reported deficit figure of $412 billion. (And a rather dubious version of cash-basis accounting at that -- as the Financial Report itself notes, a better measure is $615 billion.)
But what about the government's accruals? What about the currently accrued future cost of the already promised benefits of Medicare, Social Security, military pensions, government employee pensions, and so on, all measured net against the accrued value of the future income taxes, Social Security taxes, Medicare taxes, and so on that have been established to pay them?
Well, for the last few years, as per a legal requirement pushed through Congress by fiscal reformers, the Treasury has published within its financial report, for informational purposes, an annual Asset and Liability Statement for the government that does follow GAAP rules, using accrual accounting. And this statement shows the government's net liability increasing in 2004 by $11.087 trillion -- a good 27 times more than the official budget deficit.
Scary stuff isn't it? Hold the government to the same accounting standards that they require business to comply with and the country is drowning in red ink.
Bizarrely, as Rodney Hide points out on his blog and in this article in The New Zealand Herald, New Zealand has the exact opposite problem. Their government wants to switch it's accounting practices to cash-basis from accrual-basis. Why? To make the government's surpluses look smaller, making it easier for the government to resist calls for a tax cut. As Hide writes:
To [Finance Minister Dr. Michael Cullen], decades of accrual accounting and public sector financial reform were all misguided. The generally accepted accounting practice edicts, while legally required, are apparently misguiding in that they give people the wrong impression of the amount of money the Government has to play with.
Much easier to go back to cash, says Dr Cullen. That way he can deduct from the operating surplus all the capital items, all the student loans advanced, all the super fund contributions and spending on construction of new hospitals, schools, prisons and police stations.
This way, a $7 billion surplus can easily be transformed into a $1 billion surplus or even a deficit.
Just two examples of how governments will put politics ahead of sound accounting principles. That is not too surprising, but it's all the more reason that the public needs to educate itself about at least the basics of accounting.
Posted by Peter Mork at March 18, 2005 1:38 PM
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Economics with a Face explains how politicians like to use cash accounting to disguise the true state of the accounts. The two examples? The US's Social Security fund and Michael Cullen's disappearing surplus:Just two examples of how governments will... [Read More]
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