Balancing Act



  • The federal government's budgeting and accounting systems are complex and use sometimes arbitrary rules and conventions
  • Reconciling these in the way a balanced budget amendment would require complex implementation legislation and likely would lead to "fiscal wizardry"

The balanced budget amendment failed to receive the required two thirds vote when, as required by last summer's debt ceiling agreement, it was taken up by the House on November 18. But this is not the end of the debate on this issue. A sizable House majority (261 versus 165) did, in fact, support it, and each of the leading Republican presidential candidates had endorsed it.

However, from an accounting perspective there is so much wrong with such an amendment that it cannot be seen as anything but a prop for political theater.

The bill that failed to pass the House provided that actual total outlays may not exceed actual total receipts without the approval of three-fifths of each house of Congress, and that the limit on federal debt held by the public may not increase without a corresponding three-fifths vote. In addition, it prescribed that total budgeted outlays in the President’s budget as submitted to Congress may not exceed total budgeted receipts.  Exceptions can be made only in the event of a declaration of war or other military threat to national security.

There are many reasons not to love a constitutional balanced budget amendment.  Keynesian economists contend that such an amendment will hamstring the government in the event of economic downturns.  Just as federal tax revenues are decreasing and the economy most needs a jolt, the government will have to match the decreases with spending cuts, thereby preventing or at least slowing a recovery. Political scientists assert that a balanced budget amendment will restrict Congress from exercising its constitutional responsibility and power to levy and collect taxes, to borrow money, and to provide for the common defense and general welfare. 

But there’s another group — accountants — who can make the case that, leaving aside the legitimacy of the economic and political arguments, a balanced budget amendment is simply unworkable.

Two Statements, Each Prepared a Different Way

The federal government prepares two sets of year-end financial statements.  The first, known as the “Combined Statement of Receipts, Outlays, and Balances,” is prepared on primarily a “cash” basis. The other, called the “Financial Report of the United States Government,” reports on an “accrual” basis. The differences between the two can be significant. On a cash basis, receipts and outlays are measured as cash is received and disbursed. On an accrual basis, receipts and outlays are measured when the underlying event occurs; that is when they have their key economic impact. 

For example, on a cash basis employee compensation is recorded as an outlay in the year in which the employees are paid. On an accrual basis, it is recorded as an expense in the period in which the employees actually work. On a cash basis, the cost of an aircraft carrier is recognized as payments are made to the contractor.  On an accrual basis, it will be expensed over the 50 years the asset is expected to provide its services. In 2010, the deficit was $1.29 trillion, per the cash-based Combined Statement of Receipts, Outlays, and Balances. But per the accrual-based Financial Report, the deficit was $2.08 trillion — $790 billion or 61 percent greater. 

The federal budget, by contrast, largely mirrors the accounting cash-oriented principles of the Combined Statement of Receipts, Outlays, and Balances. However, inasmuch as it is governed by a complex set of rules and conventions, receipts and outlays on a budget basis may differ from those in the Combined Statement of Receipts, Outlays, and Balances by hundreds of billions of dollars.

Although not specified in the amendment as currently written, the Combined Statement of Receipts, Outlays, and Balances will presumably determine whether outlays exceed receipts and the similarly cash-oriented budget will be used to determine whether the President’s required submission achieves the mandated balance. One does not have to imagine the type of fiscal wizardry that the federal government can employ to seemingly, but not actually, reduce the costs of government or increase its revenues.  One need look only to what governments (state and local as well as the federal) have done in the past.  

For example, the government can advance the date at which certain revenues are due and collected from say, October 15 (early in a following fiscal year) to September 15 (the end of a current fiscal year).  It can delay making payments to suppliers by a few days, thereby moving the cost into a future year.  It can negotiate lucrative compensation packages with employees that call for generous pensions and post-employment health benefits (which will be paid in the distant future) in exchange for lower current wages — exactly the types of arrangements that have caused fiscal headaches for the Postal Service, state and local governments, and U.S. automobile manufacturers. 

State and Federal Goverments Budget Differently

In endorsing a balanced budget amendment, supporters routinely point out that every state, with the exception of Vermont, has some form of similar constraints on spending, and that these provisions have presumably ensured fiscal responsibility (an arguable proposition given that several states are within sight of bankruptcy).  However, the comparison with states is invalid. The budget and accounting systems of states are notably different from those of the federal government. 

States, unlike the federal government, have at least two separate budgets and sets of accounts. One is for operating purposes — their everyday revenues and expenses — and the other is for capital expenditures, such as for infrastructure.  Only the operating budget needs to be balanced, not the capital budget. States routinely borrow for projects that will provide benefits for years to come. In this regard states are no different than prudent families who borrow for houses or automobiles.   

The federal government, by contrast, does not distinguish between operating and capital expenditures. Accordingly, the balanced budget amendment would prevent the government from borrowing for long-term projects, thereby requiring that taxpayers of the present to pay for assets that will be enjoyed mainly by taxpayers of the future.

Anything Goes

As for the requirement that the President submit a balanced budget to Congress, that will constrain spending about as much posted 55 miles-per-hour speed limits would slow traffic on West Texas highways.  The federal budget is a plan and a forecast, based on any number of estimates and assumptions. The budget, unlike the Financial Report of the U.S. Government, is not subject to independent audit, so when it comes to estimates and assumptions, virtually anything goes.  Revenue estimates can reflect dreams rather than reality and expenditure projections can assume a future of calm and tranquility. 

Thus, for example, in 2008 the budget assumed that war, at least in Iraq and Afghanistan, would be no more and that the nation would be free of natural catastrophes. This resulted in the need for a mid-year “supplemental” (off-budget) defense appropriation of over $100 billion and an additional $22.8 billion for disaster relief. 

Both the budget and the federal accounting system are a tangle of nonstatutory, and often arbitrary, rules and conventions. Were a balanced budget amendment enacted it would inevitably have to be supported by implementation legislation that would make the recently enacted health care bill look like a model of brevity and simplicity.

Moreover, the government’s financial statements are insufficiently reliable to provide the level of control that a balanced budget amendment would require. Although the Government Accountability Office audits the federal financial report each year, it has yet to be able to express an “unqualified opinion” — that is, the auditors’ standard stamp of approval. Accordingly, any effort to enforce the amendment’s provisions would almost certainly wind up in the courts (thereby doing some good by reducing the unemployment rate among lawyers). 

Whenever the issue of the balanced budget amendment arises again, the political and economic arguments are certain to dominate the debate. Ultimately, however, it is the nuts and bolts of accounting that renders the amendment infeasible. Reducing the nation’s debt and deficit will require our legislators to make the tough choices as to which taxes to increase and which expenditures to cut. The balanced budget amendment, however, will likely lead more to fiscal deception than fiscal discipline. 


The views expressed are those of the author and not necessarily The University of Texas at Austin.

About The Author

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...

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