Super Accountant Michael Granof Looks at the U.S. Treasury Financial Report with Horror

“Immediate future generations will have no doubt as to where to place the blame.”

The following commentary was published on McCombs TODAY.

Michael Granof is the Ernst & Young Distinguished Centennial Professor in Accounting at McCombs. He is currently serving a five-year term on the Federal Accounting Standards Advisory Board. The views expressed herein are his own, not necessarily those of the Board.

If you listen to certain politicians and talking heads you might get the impression that the federal fiscal sky is falling.  Unfortunately, unlike Chicken Little, they may be right.

The Treasury Department recently issued the 2009 financial report of the United States government. Whereas there is lots of talk in Congress and in the press about the federal budget, the annual report was released to near silence. That’s too bad, not only because the annual report is untainted by creative accounting but also because its message is too important to ignore. And that message is that the sky is indeed falling.

No Creative Accounting

What is the difference between the budget and the financial report?

Most notably the federal budget is on what is essentially a cash basis.  Contrast that to the federal financial report which is on an “accrual” basis and thereby recognizes revenues and expenses when they have their true economic impact, not necessarily when cash is received or disbursed.  As but one example, whereas the federal budget delays recognition of military pension costs until personnel retire and receive their payments, the annual report recognizes them as they perform their service.   Similarly, the cash basis, but not the accrual basis permits the government to reduce expenses of a particular year merely by postponing payment of its bills from that year to the next.

These devilish machinations are possible in part because there are no established accounting rules for the budget or requirements that it be independently audited.. By contrast, the annual report is based on accounting principles established by the Federal Accounting Standards Advisory Board.  The FASAB is an independent body of nine members, two-thirds of whom have no direct connection with the federal government.  The report is subject to audit by the Government Accountability Office, an agency whose independence and integrity is almost never questioned.

To be sure, the accounting principles adopted by the FASAB are not beyond challenge.  However, for the most part the criticisms relate to the basic financial statements, those that report assets, liabilities, revenues and expenses, rather than to the report in its totality.  The complete report consists of scores of pages and notes, supplementary data and analyses.  Data that critics charge are absent from the basic financial statements are almost always conveyed elsewhere in the report.

The 2009 federal balance sheet indicates that the government’s net position (total assets less total liabilities) is a negative $11.5 trillion, 12.3 percent worse than the previous year.  But that’s just the tip of the iceberg. That negative balance excludes government obligations for social insurance programs, mainly Social Security and Medicare.

Whether social insurance should be booked as a liability has long been a controversial issue among government accountants.

On the one hand, it is argued that social insurance program are like pensions.  Participants pay into the plan and earn their eventual benefits while they are employed.  Hence, both the expense for the programs and a corresponding  actuarial liability, it is said, should be recognized during their working years.

On the other hand, some contend, social insurance programs are not – and were never intended to be – pension-like programs.  Rather, like other entitlement programs, they are a tax and spend program in which resources get redistributed from one group of citizens to another.  After all, when social security was initially established the first recipient, Ida May Fuller of Brattleboro Vermont contributed only $24.75 but received $22,888.92 in benefits.

Unable to reach agreement as to whether social insurance should be included as a balance sheet liability, the members of the FASAB compromised, and, thus, immediately following the balance sheet is a “Statement of Social Insurance.” In the 2009 annual report this indicates that the total present value of estimated social insurance expenditures over revenues is $45.9 trillion. Hence, simple addition indicates that the total net position of the government is a whopping negative $57.4 trillion.

Similarly, the potential losses from investments in Freddie Mac and Fannie Mae are not included among the government’s liabilities. That’s because these entities are government-sponsored enterprises, not part of the government itself.  Still, the report reveals that in an “extreme case scenario” the government could be on the hook for an additional $130 billion to satisfy existing loan guarantees – an amount that unfortunately  seems trivial compared to the social insurance obligation

We Have Been Warned

The message of the annual report is frighteningly candid. In a section of the report entitled Management’s Discussion and Analysis which is intended to put the basic numbers into perspective, a multi-colored chart is entitled  “Current Trends Are Not Sustainable Because Program Outlays Would Persistently Exceed Total Receipts.”

It shows that, in the absence of policy changes, total government costs excluding interest will increase gradually from 19 percent of gross domestic product in 2014 to 25 percent in 2040 and 29 percent in 2080. Not surprisingly, rising health care costs is the major culprit.  Even more telling, another chart shows that if current policies are left unchecked U.S. government debt held by the public will increase from approximately 80 percent of GDP today to 700 percent in 2080 (when, one hopes, your children or grandchildren will still be alive). Correspondingly, per still another chart, net interest could rise from 1.3 percent of GDP in 2009 to 10 percent in 2040 and to 35 percent in 2080.

The federal annual report is 234 pages in length and, though some of the data are technical in nature, much is readily understandable by a layperson. There is virtually nothing in the report that a reasonable person would consider to be politically partisan. Indeed, in key respects the report is not much different the annual reports issued by the Bush Administration.

The message of the report is resoundingly clear. The federal government’s course is dire. Therefore, if, when the history of the current decade is written, it reveals that the American people and its representatives in Congress and the Administration failed to respond to the report’s warnings, then immediate future generations will have no doubt as to where to place the blame.

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