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What’s the real federal deficit?

by Den­nis Cau­chon

The fed­er­al gov­ern­ment keeps two sets of books.

The set the gov­ern­ment pro­motes to the pub­lic has a health­i­er bot­tom line: a $318 bil­lion deficit in 2005.

The set the gov­ern­ment does­n’t talk about is the audit­ed finan­cial state­ment pro­duced by the gov­ern­men­t’s accoun­tants fol­low­ing stan­dard account­ing rules. It reports a more omi­nous finan­cial pic­ture: a $760 bil­lion deficit for 2005. If Social Secu­ri­ty and Medicare were includ­ed — as the board that sets account­ing rules is con­sid­er­ing — the fed­er­al deficit would have been $3.5 tril­lion.

Con­gress has writ­ten its own account­ing rules — which would be ille­gal for a cor­po­ra­tion to use because they ignore impor­tant costs such as the grow­ing expense of retire­ment ben­e­fits for civ­il ser­vants and mil­i­tary per­son­nel.

Last year, the audit­ed state­ment pro­duced by the accoun­tants said the gov­ern­ment ran a deficit equal to $6,700 for every Amer­i­can house­hold. The num­ber giv­en to the pub­lic put the deficit at $2,800 per house­hold.

A grow­ing num­ber of Con­gress mem­bers and account­ing experts say it’s time for Con­gress to start using the audit­ed finan­cial state­ment when it makes bud­get deci­sions. They say accu­rate account­ing would force Con­gress to show more restraint before approv­ing pop­u­lar mea­sures to boost spend­ing or cut tax­es.

“We’re a bot­tom-line cul­ture, and we’ve been hid­ing the bot­tom line from the Amer­i­can peo­ple,” says Rep. Jim Coop­er, D‑Tenn., a for­mer invest­ment banker. “It’s not fair to them, and it’s delu­sion­al on our part.”

The House of Rep­re­sen­ta­tives sup­port­ed Coop­er’s pro­pos­al this year to ask the pres­i­dent to include the audit­ed num­bers in his bud­gets, but the Sen­ate did not con­sid­er the mea­sure.

Good account­ing is cru­cial at a time when the gov­ern­ment faces long-term chal­lenges in pay­ing ben­e­fits to tens of mil­lions of Amer­i­cans for Medicare, Social Secu­ri­ty and gov­ern­ment pen­sions, say advo­cates of stricter account­ing rules in fed­er­al bud­get­ing.

“Account­ing mat­ters,” says Har­vard Uni­ver­si­ty law pro­fes­sor How­ell Jack­son, who spe­cial­izes in busi­ness law. “The deficit num­ber affects how politi­cians act. We need a good num­ber so politi­cians can have a tar­get worth look­ing at.”

The audit­ed finan­cial state­ment — pre­pared by the Trea­sury Depart­ment — reveals a fed­er­al gov­ern­ment in far worse finan­cial shape than offi­cial bud­get reports indi­cate, a USA TODAY analy­sis found. The gov­ern­ment has run a deficit of $2.9 tril­lion since 1997, accord­ing to the audit­ed num­ber. The offi­cial deficit since then is just $729 bil­lion. The dif­fer­ence is equal to an entire year’s worth of fed­er­al spend­ing.

Sur­plus or deficit?

Con­gress and the pres­i­dent are able to report a low­er deficit most­ly because they don’t count the grow­ing bur­den of future pen­sions and med­ical care for fed­er­al retirees and mil­i­tary per­son­nel. These oblig­a­tions are so large and are grow­ing so fast that bud­get sur­plus­es of the late 1990s actu­al­ly were deficits when the costs are includ­ed.

The Clin­ton admin­is­tra­tion report­ed a sur­plus of $559 bil­lion in its final four bud­get years. The audit­ed num­bers showed a deficit of $484 bil­lion.

In addi­tion, nei­ther of these fig­ures counts the finan­cial dete­ri­o­ra­tion in Social Secu­ri­ty or Medicare. Includ­ing these retire­ment pro­grams in the bot­tom line, as pro­posed by a board that over­sees account­ing meth­ods used by the fed­er­al gov­ern­ment, would show the gov­ern­ment run­ning annu­al deficits of tril­lions of dol­lars.

The Bush admin­is­tra­tion oppos­es includ­ing Social Secu­ri­ty and Medicare in the audit­ed deficit. Its rea­son: Con­gress can can­cel or cut the retire­ment pro­grams at any time, so they should not be con­sid­ered a gov­ern­ment lia­bil­i­ty for account­ing pur­pos­es.

Polic­ing the num­bers

The gov­ern­men­t’s record-keep­ing was in such dis­ar­ray 15 years ago that both par­ties agreed dras­tic steps were need­ed. Con­gress and two pres­i­dents took a series of actions from 1990 to 1996 that:

• Cre­at­ed the Fed­er­al Account­ing Stan­dards Advi­so­ry Board to estab­lish account­ing rules, a role sim­i­lar to what the pow­er­ful Finan­cial Account­ing Stan­dards Board does for cor­po­ra­tions.

• Added chief finan­cial offi­cers to all major gov­ern­ment depart­ments and agen­cies.

• Required annu­al audit­ed finan­cial reports of those depart­ments and agen­cies.

• Ordered the Trea­sury Depart­ment to pub­lish, for the first time, a com­pre­hen­sive annu­al finan­cial report for the fed­er­al gov­ern­ment — an audit­ed report like those pub­lished every year by cor­po­ra­tions.

These laws have dra­mat­i­cal­ly improved fed­er­al finan­cial report­ing. Today, 18 of 24 depart­ments and agen­cies pro­duce annu­al reports cer­ti­fied by audi­tors. (The oth­ers, includ­ing the Defense Depart­ment, still have record-keep­ing trou­bles so severe that audi­tors refuse to cer­ti­fy the reli­a­bil­i­ty of their books, accord­ing to the gov­ern­men­t’s annu­al report.)

The cul­mi­na­tion of improved record-keep­ing is the “Finan­cial Report of the U.S. Gov­ern­ment,” an annu­al report sim­i­lar to a cor­po­rate annu­al report. (The 158-page report for 2005 is avail­able online at fms.treas.gov/fr/index.html.)

The House Bud­get Com­mit­tee has tried to increase the promi­nence of the audit­ed finan­cial results. When the House passed its ver­sion of a bud­get this year, it includ­ed Coop­er’s pro­pos­al ask­ing Bush to add the audit­ed num­bers to the annu­al bud­get he sub­mits to Con­gress. The request died when the House and Sen­ate could­n’t agree on a bud­get. Coop­er has rein­tro­duced the pro­pos­al.

The Fed­er­al Account­ing Stan­dards Advi­so­ry Board, estab­lished under the first Pres­i­dent Bush in 1990 to set fed­er­al account­ing rules, is con­sid­er­ing adding Social Secu­ri­ty and Medicare to the gov­ern­men­t’s audit­ed bot­tom line.

Rec­og­niz­ing cost­ly pro­grams

Adding those costs would make fed­er­al account­ing sim­i­lar to that used by cor­po­ra­tions, state and local gov­ern­ments and large non-prof­it enti­ties such as uni­ver­si­ties and char­i­ties. It would show the gov­ern­ment record­ing enor­mous loss­es because the deficit would reflect the grow­ing short­falls in Social Secu­ri­ty and Medicare.

The gov­ern­ment would have report­ed near­ly $40 tril­lion in loss­es since 1997 if the dete­ri­o­ra­tion of Social Secu­ri­ty and Medicare had been includ­ed, accord­ing to a USA TODAY analy­sis of the pro­posed account­ing change. That’s because gen­er­al­ly accept­ed account­ing prin­ci­ples require report­ing finan­cial bur­dens when they are incurred, not when they come due.

For exam­ple: If Microsoft announced today that it would add a drug ben­e­fit for its retirees, the com­pa­ny would be required to count the future cost of the pro­gram, in today’s dol­lars, as a busi­ness expense. If the ben­e­fit cost $1 bil­lion in today’s dol­lars and retirees were expect­ed to pay $200 mil­lion of the cost, Microsoft would be required to report a reduc­tion in net income of $800 mil­lion.

This account­ing rule is a major rea­son cor­po­ra­tions have reduced and lim­it­ed retire­ment ben­e­fits over the last 15 years.

The fed­er­al gov­ern­men­t’s audit­ed finan­cial state­ment now accounts for the retire­ment costs of civ­il ser­vants and mil­i­tary per­son­nel — but not the cost of Social Secu­ri­ty and Medicare.

The new Medicare pre­scrip­tion-drug ben­e­fit alone would have added $8 tril­lion to the gov­ern­men­t’s audit­ed deficit. That’s the amount the gov­ern­ment would need today, set aside and earn­ing inter­est, to pay for the tens of tril­lions of dol­lars the ben­e­fit will cost in future years.

Stan­dard account­ing con­cepts say that $8 tril­lion should be report­ed as an expense. Com­bined with oth­er new lia­bil­i­ties and oper­at­ing loss­es, the gov­ern­ment would have report­ed an $11 tril­lion deficit in 2004 — about
the size of the nation’s entire econ­o­my.

The fed­er­al gov­ern­ment also would have had a $12.7 tril­lion deficit in 2000 because that was the first year that Social Secu­ri­ty and Medicare report­ed broad­er mea­sures of the pro­grams’ unfund­ed lia­bil­i­ties. That cre­at­ed a one-time expense.

The pro­pos­al to add Social Secu­ri­ty and Medicare to the bot­tom line has deeply divid­ed the fed­er­al account­ing board, com­posed of gov­ern­ment offi­cials and “pub­lic” mem­bers, who are account­ing experts from out­side gov­ern­ment.

The six pub­lic mem­bers sup­port the change. “Our job is to give peo­ple a clear pic­ture of the finan­cial con­di­tion of the gov­ern­ment,” board Chair­man David Mosso says. “Whether those num­bers are good or bad and what you do about them is up to Con­gress and the admin­is­tra­tion.”

The four gov­ern­ment mem­bers, who rep­re­sent the pres­i­dent, Con­gress and the Gov­ern­ment Account­abil­i­ty Office, oppose the change. The retire­ment pro­grams do “not rep­re­sent a legal oblig­a­tion because Con­gress has the author­i­ty to increase or reduce social insur­ance ben­e­fits at any time,” wrote Clay John­son III, then act­ing direc­tor of the pres­i­den­t’s Office of Man­age­ment Bud­get, in a let­ter to the board in May.

Ways of account­ing

Why the big dif­fer­ence between the offi­cial gov­ern­ment deficit and the audit­ed one?

The offi­cial num­ber is based on “cash account­ing,” sim­i­lar to the way you track what comes into your check­ing account and what goes out. That works fine for pay­ing today’s bills, but it’s a poor way to mea­sure a finan­cial con­di­tion that could include cred­it card debt, car loans, a mort­gage and an over­due elec­tric bill.

The audit­ed num­ber is based on accru­al account­ing. This method does­n’t care about your check­ing account. It mea­sures income and expens­es when they occur, or accrue. If you buy a vel­vet Elvis paint­ing online, the cost goes on the books imme­di­ate­ly, regard­less of when the check clears or your eBay pur­chase arrives.

Cash account­ing lets income and expens­es land in dif­fer­ent report­ing peri­ods. Accru­al account­ing links them. Under cash account­ing, a $25,000 cash advance on a cred­it card to pay for a vaca­tion makes the books look great. You are $25,000 rich­er! Repay­ing the cred­it card debt? No wor­ries today. That will show up in the future.

Under accru­al account­ing, the $25,000 cash from your cred­it card is off­set imme­di­ate­ly by the $25,000 you now owe. Your bot­tom line has­n’t changed. An accoun­tant might even make you report a loss on the trans­ac­tion because of the inter­est you’re going to pay.

“The prob­lem with cash account­ing is that there’s a tremen­dous oppor­tu­ni­ty for manip­u­la­tion,” says Uni­ver­si­ty of Texas account­ing pro­fes­sor Michael Gra­nof. “It’s not just that you fool oth­ers. You end up fool­ing your­self, too.”

Fed­er­al law requires that com­pa­nies and insti­tu­tions that have rev­enue of $1 mil­lion or more use accru­al account­ing. Microsoft used accru­al account­ing when it report­ed $12 bil­lion in net income last year. The Amer­i­can Red Cross used accru­al account­ing when it report­ed a $445 mil­lion net gain.

Con­gress used cash account­ing when it report­ed the $318 bil­lion deficit last year.

Social Secu­ri­ty chief actu­ary Stephen Goss says it would be a mis­take to apply accru­al account­ing to Social Secu­ri­ty and Medicare. These pro­grams are not pen­sions or legal­ly bind­ing fed­er­al oblig­a­tions, although many peo­ple view them that way, he says.

Social Secu­ri­ty and Medicare are pay-as-you go pro­grams and should be treat­ed like food stamps and fight­er jets, not like a Trea­sury bond that must be repaid in the future, he adds. “A coun­try does­n’t record a lia­bil­i­ty every time a kid is born to reflect the cost of pro­vid­ing that baby with a K‑12 edu­ca­tion one day,” Goss says.

Tom Allen, who will become the chair­man of the fed­er­al account­ing board in Decem­ber, says sound account­ing prin­ci­ples require that finan­cial state­ments reflect the eco­nom­ic val­ue of an oblig­a­tion.

“It’s hard to argue that there’s no eco­nom­ic sub­stance to the promis­es made for Social Secu­ri­ty and Medicare,” he says.

Social Secu­ri­ty and Medicare should be reflect­ed in the bot­tom line because that’s the most impor­tant num­ber in any finan­cial report, Allen says.

“The point of the num­ber is to tell the pub­lic: Did the gov­ern­men­t’s finan­cial con­di­tion improve or dete­ri­o­rate over the last year?” he says.

If you count Social Secu­ri­ty and Medicare, the fed­er­al gov­ern­men­t’s finan­cial health got $3.5 tril­lion worse last year.

Rep. Mike Conaway, R‑Texas, a cer­ti­fied pub­lic accoun­tant, says the num­bers report­ed under accru­al account­ing give an accu­rate pic­ture of the gov­ern­men­t’s con­di­tion. “An old pho­tog­ra­pher’s adage says, ‘If you want a pret­ti­er pic­ture, bring me a pret­ti­er face,’ ” he says.


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