All utilize “cash basis” budget accounting, an accounting method by which revenue and expense are recorded only when cash is received and paid out. Cash basis budgeting can allow a state to record more revenue than really earned and less expense than really incurred.
A stark example took place in New Jersey last year when it “balanced” its budget simply by not paying a $3 billion bill – no different than leaving a credit card bill unpaid. The unpaid bill accrues interest, which means a larger payment down the road. But through the magic of cash basis budgeting, New Jersey was able to report a balanced budget.
Few states take such blatant steps, but virtually all make use of other techniques. For example, in its proposed budget this year, California projects health care for retired employees to cost $1.5 billion. But the true cost is $4 billion, as reported by the state controller. The $1.5 billion is the equivalent of a minimum payment on a credit card, while $4 billion is the amount required to stop the card balance from growing. By paying just the minimum, the state’s debt for retirement health care, already $52 billion, will grow.
Other methods include what former New York Lt. Gov. Richard Ravitch calls “offloads and sweeps.” An “offload” transfers spending obligations from a state’s general fund, which captures all the public’s attention, to special funds, which capture little attention even though they too are funded by the public (e.g., via motor vehicle taxes and fees) and this year will account for $34 billion of spending.
A “sweep” boosts general fund revenue by borrowing money from special funds. This year, California’s general fund will offload $13 billion of spending onto special funds and sweep almost $2 billion of special funds.
States also understate their debt obligations. For example, the California treasurer publishes an annual “Debt Affordability Report,” but that report lists only debt owed to bond investors and not debt owed to current and future retirees. The state’s debt to retirees is as real as bonded debt (and equal if not higher in priority) and larger in size, and this year the state will spend $7 billion to service that debt, 30 percent more than the state will spend on bonded debt. Yet it doesn’t make the state debt report.
Who should care most about budget accounting? The answer is not bondholders, retirees or others with contractual rights, all of whom have priority claim to the first dollars after the state meets its obligations to K-14 education. Under almost any scenario, they will be paid. Instead it’s programs such as higher education, health, corrections and parks that must fight for annual appropriations out of the residual.
Needless to say, current budgetary practice by states is inadequate, which is why Ravitch, former Federal Reserve Chairman Paul Volcker and I are forming a task force on that subject. Citizens would be well advised to look closely at what’s reported to them.
David Crane was an adviser to Gov. Arnold Schwarzenegger and now lectures on public policy at Stanford University. He serves on the UC Board of Regents and California High Speed Rail Authority.