U.S. Financial Report Reveals "Deep Trouble"

 

Takeaway

  • 2010 financial report released by Treasury reveals net operating cost ($2.1 trillion) to be higher than reported budget deficit ($1.3 trillion).
  • Government obligations for social insurance programs cause negative net position to balloon to $44 trillion.
  • U.S. budget challenges encompass interrelated issues, which must be addressed holistically, says Prof. Michael Granof.

U.S. Budget Deficit & Net Operating Cost (Source: U.S. Treasury Department)

In Michael Granof’s post about the 2009 U.S. Treasury Financial Report, he explained why the sky was, in fact, falling. A year later, the news is no better despite numbers that seem to be going in the right direction. Just when you thought the debt ceiling was the nation’s biggest problem, Granof, the Ernst & Young Distinguished Centennial Professor in Accounting at the McCombs School of Business, offers an updated accounting of the government’s financial challenges.

At $1.3 trillion, the federal budget deficit seems pretty disastrous. But the federal financial statements, based on a more realistic accounting, reveal an even worse reality — a 2010 negative net operating cost of $2.1 trillion.

Professor Michael GranofThe difference between these two debt amounts, as Granof noted last year, is explained by a difference in accounting techniques — accrual vs. cash, or recognizing “revenues and expenses when they have their true economic impact, not necessarily when cash is received or disbursed,” he wrote.

“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,” explained Granof, who is serving a five-year term on the Federal Accounting Standards Advisory Board.

Further, Granof noted, the reported net position of the government is a whopping negative $13.5 trillion. But that is only a fraction of the real story. Add to that number government obligations for social insurance programs, mainly Social Security and Medicare, and the negative net position balloons to close to $44 trillion.

Interestingly, the $44 trillion figure is actually less than last year’s negative $57.4 trillion net position whopper. This is due in large part to the passage of the Affordable Care Act and a projected decrease in Medicare spending as a result. Good news, right? Not according to Granof.

“These [projections] are based on current policy, but nobody believes that current policy will remain future policy,” Granof said in June to an audience of McCombs School alumni. By “nobody,” Granof includes the trustees of Medicare, as well as the Government Accountability Office, both of which have issued caveats with their financial reports.

Social insurance, the broad category that includes Social Security and Medicare, is only part of the problem. Defense, the Department of the Treasury, Veterans Affairs and interest on Treasury securities held by the public along with social insurance make up 80 percent of government spending, according to Granof.

“You can eliminate the entire rest of the government and you’re not going to solve the problem,” he said. “If you’re not focusing on Medicare and Social Security and Defense, you’re not going to solve the problem.”

But here’s the worse news: this covers just the federal government. State and local governments are in no better shape, and the 30 percent of their budgets that comes from the federal government will surely remain flat or shrink, Granof said. This comes at a time when most states are striving to cover historic budget gaps and declining revenues.

“Since 2007 [state and local] governments have lost 236,000 jobs. In 2012 and 2013 that’s going to be even worse,” he said. Lost jobs mean a bigger strain on Medicaid and other state programs. And if federal support for these programs decreases, the responsibility for medical costs simply shifts downward to states, local governments and, ultimately, emergency rooms.

“Medicare cannot be solved alone. You have to reduce medical costs,” he said.

Pension liability and other post-employment benefits (i.e., health care, again) are additional weights on states. “When a state and local government is in trouble, what do they do? They cut back on maintenance, so the infrastructure is falling apart,” Granof said, as his audience sank further into their seats.

After sizing up the challenges, Granof put forth what is, to his mind, the crux of the problem: our “hamstrung” political system.

“Social Security should be a relatively easy problem to solve,” he suggested. “You raise the retirement age from 65 to 67, you raise the cap a bit from $106,000 to something higher than that, you’re going to eliminate the deficit like that,” he said with a snap. But acknowledging the lack of political will to move forward in that direction, Granof outlined two sets of steps: What Not to Do and What To Do.

What Not to Do

  • Don’t make meaningless gestures, such as a federal pay freeze. “It may be good theater, but it doesn’t solve the problem.”
  • Don’t make across-the-board government pension cuts. “Pensions are one element of compensation. We should be examining the pay scales and getting a reasonable pay scale” that compares public sector compensation schemes to those in the private sector, rather than slashing across the board.
  • Don’t rely on accounting gimmicks. “Delaying payments by one day … advancing revenues by one day … moving money from a rainy day fund into the general fund … taking money from the left hand pocket and putting it into the right hand pocket — I’m not saying we should or we shouldn’t dip into our savings , but it’s not solving the long-term problem.”
  • Don’t focus on “issues of no financial consequence.” Regardless of your feelings about National Public Radio, oil companies, rich people, or abortion, changing policies related to these doesn’t address fiscal problems.
  • Don’t make short-sighted cuts that will increase costs or reduce revenues in the future. Cutting funding for prenatal care leads to “paying millions of dollars to keep babies alive in premature baby units.” Cutting elementary school education may result in “paying for that in prisons and the like,” he said. “That’s not going to solve your problem; that’s just making it worse in the future.”
  • States should not follow the trend toward offering defined contribution plans over defined benefit plans. This strategy, “in the long run, is not going to solve the problem” because defined benefit plans are much more efficient, dollar for dollar.

What To Do

  • “Reform our political system” through changes in campaign financing and genuine competition for positions in Congress.
  • Reform health care, starting with eliminating Medicare abuse, reducing administrative costs, enacting tort reform to help doctors stop practicing defensive medicine. “The main thing we have to do is think about changing our system where there are inefficiencies because we pay for services. As long as 18 percent of our economy goes to health care, we’re not going to be competitive. [It’s] built into every product we produce,” he said.
  • Make changes to state and local pension plans, such as increasing unreasonably low retirement ages and eliminating “spiking,” which enables employees to put in an extraordinary number of hours in their last few years of employment and thereby boost their pension benefits to ridiculously high amounts.
  • Review our tax codes, eliminating tax expenditures or loopholes; increase tax rates when the impact on investment or consumer demand may be negligible; provide real incentives for research, investment and hiring.
  • Develop targeted short-term stimuli that focus on infrastructure projects.
  • Reduce defense expenditures.

“Like it or not, we’re going to have to make some very critical choices,” Granof said. “Which is worth more to you, a big-screen television or a transportation system that works? How important is education? How important is it that we express certain values like everyone gets health care? We are not going to solve the problem easily.”

 

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Faculty in this Article

Michael Granof

Professor of Accounting McCombs School of Business

Michael Granof received an A.B from Hamilton College, an MBA from Columbia University, and a Ph.D. from the University of Michigan. His research...

About The Author

Cory Leahy

Assistant Director of Communications, McCombs School of Business

Cory is the editor of Texas Enterprise, the McCombs TODAY news site and OPEN, the alumni magazine for the McCombs School of Business. She's been...

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