Thursday, December 30, 2004

You thought the 2004 federal deficit was $412 billion? How about $11.1 trillion, by the accounting rules the private sector uses.

[Update: The 2008 deficit.]

The U.S. government's official budget deficit was $412 billion for fiscal 2004. That's the number reported in the newspapers that everyone editorializes and op-eds about. It represents the net increase in the government's liabilities -- the new debt it incurred during the year, basically by issuing bonds to borrow the cash it needed to pay its bills.

But wait ... the Treasury has just published on its web site, albeit with very little publicity, the 2004 Financial Report of the United States Government. And in it we find a very different number for the amount of increase of the government's net liabilities during 2004.

This number is $11.087 trillion ... with a "t". And, yes, that's just for one year.

So two numbers are published by the Treasury for the same thing -- the increase in the government's net liabilities during 2004 -- with a difference between them of $10.7 trillion. How can this be?

The difference is that of governmental accounting.

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.

The reason for this is obvious. Using cash-basis accounting a business could incur a legally binding obligation to pay $10,000 current value some time in the future in exchange for receiving a cash payment of $1,000 this year and book the transaction as generating $1,000 of income -- instead of a $9,000 net liability.

Thus, the Generally Accepted Accounting Principles (GAAP) used in the private sector require all public corporations and other entities that incur multi-year accruals in any significant way to use accrual-basis accounting.

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.

Looking at the "Overall Perspective" summary on page 11 (.pdf) we can see what this increase is composed of. The significant items:

Medicare: $9.609 trillion

Social Security: $0.812 trillion

Federal debt held by public: $0.385 trillion

Federal/veterans pensions: $0.182 trillion

(Note: Medicare and Social Security net liabilities are computed over 75-years -- not using an unlimited horizon under which they are much larger.)

To place these numbers in some scale, total US national income in 2004 was $10.3 trillion -- that was the total combined income of all individuals, businesses, everybody. So the 2004 increase in the accrued liabilities of the US government exceeded total national income.

Now I'll go far out on a limb here and make a prediction: Currently promised entitlements that increase the current-value liabilities of the US government by more than 100% of national income annually will prove to be unsustainable.

Promises will be broken, folks.

Where will they be broken?

Well, federal & veterans' pensions total only about 1.5% of the accruing liability, not enough to make a difference. And the bond debt owed to the public must be paid, because the Constitution mandates it.

That leaves all the promise-breaking coming in Social Security and Medicare. The 2004 growth in Social Security's current value liabilities of $812 billion by itself equaled 43% of total US government revenues in 2004 of $1.9 trillion. Pretty hefty!

But even that is dwarfed by the eleven times larger one-year increase in current value liabilities for Medicare: more than $9 trillion -- four times the budget of the entire United States government in 2004.

The unquestioned Big Daddy Mountain Gorilla of accruing budget-busting, government-bankrupting entitlement expenses is Medicare.

Spell it out: M_E_D_I_C_A_R_E. And remember it well whenever anybody mentions the words "budget deficit" to you. (Should anyone says "Bush tax cuts" in this regard, remember the difference in scale between perhaps $200 billion added to the public debt through bond issuances in 2004, and $9.8 trillion added in accruing Medicare and Social Security liabilities in just 2004. )

Now, the Treasury doesn't give page 11 of its Financial Report much publicity and politicians give it even less heed. The reason for this is evident -- the information it presents is rather awkward for everyone in Washington, in both parties.

In every election Democrats make hay by accusing the Republicans of planning to cut these entitlements, which are the Democrats' proud heritage and crowning achievement. (Just as if the Democrats will have any way to avoid cutting them if they are in power when all the promises come due).

Bush the Younger and the Republicans for their part have responded by flanking the Democrats on the left on the entitlement issue by creating their own mega-dollar totally unfunded addition to Medicare in the form of their prescription drug benefit. (Unfortunately, what the health of the national fisc needs is for the Democrats to get the idea of flanking the Republicans on the right here, but don't anybody hold your breath waiting for that.)

And, of course, if the government used accrual accounting there would never have been any surplus back in 1998-2001 for the Clinton people to claim they had created ... nor to release the bipartisan spending restraints that Congress imposed on itself during the post-Reagan deficit years -- which release resulted in the big surge of bipartisan vote-buying Congressional discretionary spending that started with the lead-up to the 1998 Congressional election, and over which both Clinton and Bush the Younger afterward presided very happily.

Then with the national debt clock spinning forward 20-odd times faster under accrual rules after 2001, Republican tax cuts would hardly have been so credible to the public ... so page 11 really is quite awkward for everyone in Washington.

But there it is nonetheless, in black and white, you can read it yourself.

If there is any good "less bad" news hidden in this financial statement, it is the new $6 trillion liability for the Medicare prescription drug benefit included in it. No, not that this new entitlement is good news for future national solvency (when you hear people criticize Bush for the mere $200 billion or so his tax cuts added to the public debt in 2004, feel free to correct them with the number for this.) Rather, it is that this $6 trillion is a one-time charge -- in the future only the growth in this number will accrue as a government liability.

So next year's annual increase in accrued government liabilities should be smaller less huge. Subtract $6 trillion from $11 trillion, then add growth on the resulting $5 trillion and on the cost of the prescription drug benefit too, and by "the back of the envelope" we drop back to an annual accural closer to only half of national income, or about twice the operating cost of today's entire federal government, and growing faster than national income. Only. And for anyone who thinks entitlement net liabilities accruing at that rate annually are much more sustainable ... well, I have some magic beans for sale. E-mail me.

Besides, who knows what new retiree entitlements our politicians will promise us all as they compete for votes in the next presidential election cycle? (Democrats were attacking Bush's drug benefit as being not nearly large enough even before it was enacted. Has any such new program ever not expanded rapidly?)

There's only one thing to be sure of: The government's existing promises of retiree entitlements will be broken -- you can bet your own retirement on it.

If you want to do something about it politically while there is still some (diminishing) time left to do so, before the great entitlement-funding fiscal crunch hits a decade or so from now, then accept this reality, consider the issues, make your own list of priorities among entitlements, and decide just how you want the promises to be broken. Choices here will make a difference.

Then get your opinion out in the world. That's why you have an Internet connection.

The retirement you save may be your own.