Fiscal Shell Games, Government-Style

AUSTIN, Texas — President Bush warned American corporations recently that the days of “cooking the books” and “shading the truth” are over. Now he should deliver the same message to the country’s governors and mayors--even to members of his own administration.

The nation’s current economic funk has government at every level in a pickle. Revenues are down, nondiscretionary expenses are up: How to balance the budget?

It’s not all that hard, it seems. Current corporate accounting scandals notwithstanding, governments are still looking to balance their budgets the old-fashioned way--with accounting legerdemain. The results can be as pernicious as those of the bookkeeping abuses in the corporate world. Governments pile up off-the-balance-sheet debts that will have to be repaid by taxpayers of the future.

A classic example: On April Fools’ Day 1991, New York state announced the sale of Attica prison for some $200 million, an amount it counted as general revenues. Who was the buyer? The state of New York in the guise of a specially created state agency, which financed the acquisition by issuing bonds. The one problem with the scheme is that bonds need to be repaid, and prisons are not known for generating income. So to obtain the resources necessary to service its debt, the new agency leased Attica back to the state. The state operated the facility just as it did in the past. The rent payments were exactly the same as the required interest and principal payments on the debt. Not only that, the debt was guaranteed by the state. This, of course, was more than a decade before Enron engaged in similar asset sales, making “special purpose entities” a near-household phrase. Another year, New York generated “income” by selling the Cross-Westchester Expressway to itself.

The accounting practices of state and local governments are under the purview of the Governmental Accounting Standards Board (GASB), which is to governments what the Financial Accounting Standards Board is to corporations. But the board’s responsibility is only to establish the standards that governments must apply in annual financial statements. In governments, though, the key financial documents are not annual financial reports. They are budgets, and the GASB has no control over the accounting practices in government budgets. These are determined either by state statute or by local prerogative.

The budgeting practices of almost all governments preserve legal fictions. Thus, even though a state may have economic and political control over an agency that is technically a separate entity, it may treat transactions with such an agency as though they were with independent outsiders.

Most state and local governments budget on a cash or near-cash basis. Under the cash basis of accounting, governments recognize revenues when cash is received and expenditures when it is paid. But when preparing their annual financial statements, they must do so on an accrual basis of accounting. Under the accrual basis, they recognize revenues and expenses when transactions have a substantive economic effect--for example, when goods or services are received and used rather than when the check is drawn to pay for them.

Needless to say, New York has no monopoly on fiscal sleight of hand. In Texas, for example, state employees receive their paychecks on the first day of the month following that in which they are earned. State workers used to be paid a day earlier, on the last day of the previous month. The one-day change was made so that in the year of the shift the state was able to move one-month’s salary costs into the next year, thereby reducing compensation expenditures by one-twelfth.

Similar budgetary maneuvers that our elected officials have used in the past, and can look to in these hard times, include advancing the due date on taxes, licenses and other charges from one fiscal year to the prior year, and delaying the date on which the state makes its own payments to suppliers, contractors and welfare recipients.

Another well-proven budget-balancing technique is to reduce contributions to pension funds. Because government pension plans are typically “defined benefit,” the amounts that employees will receive upon retirement is set by the terms of the plan, not by the timing of employer cash contributions. So, any payments not made in a current year will have to be made in future years, plus interest.

The federal government, unlike state and local governments, is not required either by statute or constitutional mandate to balance its budget. But that doesn’t mean that its budget provides any more of a meaningful insight into its true revenues and expenses. Like state and local governments, the federal government budgets on a cash basis. For the fiscal year ending Sept. 30, 2001, the federal government reported a budgetary surplus of $127 billion. On an accrual basis, however, it had a deficit of $515 billion. Most of the difference can be attributed to pension and related benefits. Generally accepted accounting principles require pension costs to be recognized as expenses during employees’ working years--when the country gets the benefits of their services. The federal government budgets the costs only as the employees receive their retirement checks. The result is that the federal government is bequeathing more than $600 billion in obligations to the next generation of taxpayers.

Worse yet, the federal government’s accounting system is in disarray and therefore cannot be counted on to produce the numbers needed to make reliable budget projections. The problems, however, are not merely isolated in a few small departments. According to the government’s own independent auditor, the General Accounting Office, the weaknesses in internal controls and various operating and accounting practices are pervasive. Consequently the GAO is unable to issue the standard auditor’s opinion as to whether the government’s annual financial statements are fairly presented. Citing the Department of Defense as the most culpable agency, it says that overhauling the Defense financial management systems “represents a major ... challenge that goes far beyond financial accounting to the very fiber of the department’s business operations and management culture.” The Securities and Exchange Commission would reject out of hand the financial statements of any corporation that were accompanied by such a negative audit report.

As of last Wednesday, corporate CEOs had to certify to the accuracy of their firms’ financial statements. Imagine what would happen if Bush and the nation’s governors and mayors had to similarly affirm the veracity of their governments’ budgets.

All these stratagems are not only legal but in the past have been touted by politicians as creative revenue enhancements or cost savings. Were one to ask voters whether they would prefer these budget-balancing tactics or tax increases, they would undoubtedly opt for the former. However, citizen reaction might be quite different if one were to pose the question in what is perhaps the more honest form: Do you favor passing on to your children the cost of services that you benefit from today?