Imagine a governor in the last year of office proposing the following budget:
- Taxes will be reduced to zero for one year.
- The state will sell enough assets to fund state operations for one year.
- The state will be required to repurchase the assets the following year.
Would that governor be allowed to claim a balanced budget?
Believe it or not, the answer is yes. That’s because governments are permitted to use “cash-based” budgeting, which treats cash received from any source as revenue and recognizes expenditures only when cash is disbursed and regardless of commitments made that year to pay cash in the future.
Common sense tells you that such a budget is not balanced. Also, no business or nonprofit would be allowed to claim such a budget as balanced. That’s because they are required to report on an “accrual” basis, which allows observers to easily discern how revenues earned in the fiscal year relate to obligations incurred in the same year. But governments aren’t required to follow any budgeting standards. Not surprisingly, most elect the route that allows politicians to look best.
Even individuals are held to a tougher standard. When applying for credit, individuals are asked to provide evidence that income exceeds expenses. If an applicant claimed expenses were less than income but failed to disclose that this was achieved by ignoring some expenses, that action would constitute fraud.
Yet that’s exactly what some governors are doing to claim balanced budgets. Gov. Andrew Cuomo of New York moved some expenses off the books by paying them with promissory notes. Gov. Jerry Brown of California proposed a budget ignoring billions in expenses. Gov. Chris Christie of New Jersey skipped a payment to that state’s underfunded pension plans.
Under accrual methods, all those expenses would be recorded this year whether or not paid with cash. But under cash-based budgeting, those governors get to ignore them and to report balanced budgets to boot. In doing so, they are making involuntary debtors of unsuspecting young people to pay for current services. But because of cash-based budgeting, no one is the wiser. Needless to say, those three governors are by no means the only state executives gaming accounting rules.
To journalists who cover only governments this seems normal because to them it’s always been this way, but the same is not true of the nongovernment world.
In that world government budgeting techniques would be laughable. Imagine the CEO of this newspaper taking the exact same steps listed above. Accounting rules would require the newspaper to report a major loss. But change “newspaper” to “state government” and, voilà, it would be a balanced budget.
This esoteric accounting issue matters a great deal, especially to the next generation. Let’s use California as an example. Gov. Brown is proposing a budget providing billions of dollars of services this year but committing others down the road to involuntarily pay the costs of those services, plus interest.
By not using cash to pay those costs now, cash-basis budgeting allows him to ignore them and claim a surplus while those unpaid expenses are silently added to debt. That passes the cost of today’s services, plus interest, to tomorrow’s taxpayers, allowing us to enjoy more today than we are willing to pay for and leaving them with less money for their own services.
Cash-based budgeting obscures those truths. Accrual-based budgeting exposes them.
There is a role for cash-basis reports, which are useful for reporting liquidity. But they are deceptive when it comes to measuring, disclosing or allocating costs.
That deception favors the current generation over future generations. That’s why the State Budget Crisis Task Force co-chaired by Richard Ravitch and Paul Volcker characterizes cash-basis budgeting as “a major enabler of budget gimmickry” that should be replaced with a responsible system of accrual budgeting.
As with most accounting changes, the replacement of cash-basis budgeting with accrual-basis budgeting will take time because certain vested interests benefit from the status quo. But until then, nothing stops governors from voluntarily telling the truth regardless of what they are allowed to hide.