Monday, January 09, 2006

You thought the 2005 federal budget deficit was $319 billion? How about more than $3 trillion, by the accounting rules the private sector uses.

[Update: The 2007 deficit. ]

The US government's budget deficit for 2005 was $319 billion, as officially reported by the Treasury. That's the number in the newspapers that everyone editorializes and op-eds about, representing the increase in the government's net liabilities, basically in the form of additional government debt issued during the year. And it's been reported as good news, being down from the $412 billion of 2004.

But wait ... the Treasury has published another analysis on its web site, in its 2005 Financial Report of the United States Government, that gives a very different number for the increase in its net liabilities, albeit one that receives very little publicity: more than $3 trillion.

How can two such hugely different numbers -- on ten times larger than the other -- be provided by the US Treasury for the same thing?

The answer lies in accounting methods: the difference between cash and accrual accounting.

Cash accounting is what individuals use and most people are familiar with. It counts the difference between cash in and cash out during a given time period. The difference is net income or loss. Done.

That's fine for the simple finances of most individuals, but in even moderately more complicated situations it can be highly misleading and is easily manipulated. This is because it ignores accruing legal rights to receive income, and legal obligations to make payments, in the future.

As a simple example, say a firm makes a deal in which it receives $1 million from another party today, in exchange for making a legally binding promise to pay $10 million to the other party five years from now. Obviously that's a loser. Accrual accounting -- which recognizes accruing future liabilities and rights to income -- reports this truth: $1 million receivable today minus the current value of $10 million to be paid five years from now (at a 5% discount rate, about $7.7 million) shows this transaction to have a net cost of about $6.7 million.

But under cash accounting it is a winner, for only the $1 million of income is counted. The attached $10 million liability is ignored. Sure it'll have to be paid someday (or the firm will go bankrupt due to it) -- but that will be somebody else's problem. In the meantime you've boosted the firm's profits by making this deal, so you get a raise and a bonus!

Well, that wouldn't be good. So to prevent such situations the government prohibits cash accounting and requires accrual accounting for all but the very smallest businesses and organizations.

If you use cash accounting anyhow to report income while keeping related liabilities off the books, you are Enron ... or you are the US government. For the government exempts itself from the accrual accounting rules imposed on everyone else, and uses cash accounting to figure its own deficit: that $319 billion for 2005.

OK -- so what is the US government's deficit under the accounting rules that everyone else in the country must use? The Treasury itself tells us. As a "good government" reform -- and in response to plenty of criticism about its accounting methods -- it began publishing these numbers as supplemental information to the official budget a few years back.

The official $319 billion cash basis deficit excludes a host of accrued liabilities, three of which are really big: Medicare, Social Security, and federal employee/military retirement benefits. Here are the numbers, from the 2005 Financial Report...

"Present value of future expenditures less future revenue [p.42] :"

That's $2.333 trillion dollars just for Medicare and Social Security.

Then add a $430 billion one-year increase in Federal employee/veteran benefits payable (to $4,492 billion in 2005 from $4,062 billion in 2004).

And then add the $319 billion official budget deficit.

The total so far is over $3.08 trillion, and we're still not counting lots of things. (The cost of federal employee retiree health benefits isn't computed. Smaller multi-billion dollar items like FEMA, the PBGC, etc., I haven't bothered to add.)

Interestingly, the official budget deficit is the smallest of all the above items ... and while so many people worry about paying future Social Security and Medicare costs, few ever mention the unfunded federal employee/military retiree costs that are as big or bigger.

Some more perspective:

[] All federal income taxes (personal and corporate) totaled $1.2 trillion in 2005. To cover the accruing deficit, income taxes would have to be increased to 3.6 times what they are today (with the increase "saved" somehow in an interest bearing account for future use).

[] All federal receipts (including payroll and excise taxes, tariffs, national park user fees, whatever) totaled $2.1 trillion in 2005. The accruing deficit is 50% larger than that -- so total revenue would have to be raised to 2.5 times its current level to cover it.

[] The total US national debt held by the public is $4.7 trillion -- but the government's unfunded debt to its own employees and military personnel for retirement benefits matches it, exceeding $4.5 trillion (remember, health benefits aren't included in this number) and is growing faster.

[] Total US national income (to individuals, businesses, everyone) in 2005 was $10.7 trillion. The accrued deficit was almost 30% of this. To close it, taxes would have take almost another 30% of national income -- in addition to the about 30% that currently goes to fund federal, state and local government combined.

(By the way, if you think a $3 trillion deficit is bad, the 2004 accrued deficit was $11.1 trillion, thanks to the $8 trillion accrued start-up cost of the Bush-Republican drug benefit plan, Medicare Part D. So much for Republican fiscal conservatism!)

These numbers are so big that when I mention them even to generally well informed people, they simply don't believe it. Yet they are published every year by the US Treasury itself.

Now, I'm very sorry folks -- but we can't increase the national debt by 30% of national income every year for a generation off the books to fund retiree entitlements, and then expect to be able to pay it off, any more than we'd be able to increase the debt on the books by $3 trillion a year and pay it off. It ain't going to happen.

That being the case, why don't Senators and Congressmen stand up and make an issue of these published numbers every day, demanding reform? Why didn't George W. Bush highlight them to educate the public to the urgent need for entitlement reform, starting with Social Security?

Well ... if Democrats suddenly admitted that the entitlement programs that cement the base of their party together are in fact driving a 30%-of-national income deficit, on course to bankrupting the nation, they could hardly defend those programs as being "sound" and untouchable, eh?

And if Republicans suddenly admitted that the real deficit is ten times larger than they've claimed, they could hardly make enacting more tax cuts to make such yawning deficits even worse their key issue. Much less claim to be fiscal conservatives while larding on new multi-trillion entitlements of their own.

Both parties want to keep their key issues working in the next election. So every year the politicians push another $2.7 trillion (and growing) of debt off the books and out of sight, the super-Enron of all time. Sure, these trillions will have to be dealt with some time in the future, or the nation will go broke ... but that will be years from now, and it will be somebody else's problem.

And when that day arrives, a lot of people aren't going to be getting a lot of the retirement benefits that they think they've been promised.

Prepare for it now.

I close with words from GAO as quoted in the Treasury report:

The federal government’s gross debt in the consolidated financial statements ... excludes such items as the gap between the present value of future promised and funded Social Security and Medicare benefits, veterans’ health care, and a range of other liabilities (e.g., federal employee and veteran benefits payable), commitments, and contingencies that the federal government has pledged to support.

Including these items, the federal government’s fiscal exposures now total more than $46 trillion, up from about $20 trillion in 2000. This translates into a burden of about $156,000 per American or approximately $375,000 per full-time worker, up from $72,000 and $165,000 respectively, in 2000...
All more than double in only five years. That's growing a lot faster than the economy. Things have not stabilized, they are getting worse, fast.

Continuing on this unsustainable path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security...

Given the size of the projected deficit, the U.S. government will not be able to grow its way out of this problem -- tough choices are required.

Traditional incremental approaches to budgeting will need to give way to more fundamental and comprehensive reexaminations of the base of government.
It's time to start such thinking now, folks.

And it might not hurt to supplement your own savings for retirement a little bit, just in case someday you might need more than you expect.