SF Chronicle: Playing accounting games puts red-ink budgets in the black

New Jersey Gov. Chris Christie is in the news lately for an action his staff took in 2013 to deliberately close lanes on a bridge to create a traffic jam. That action was costly to his constituents. Workers lost wages, students missed school, and emergency services were placed at risk. A few years before – and far less visibly – Christie took another action at great expense to his constituents. The action: gaming government accounting rules. The cost: $240 million.

Gaming accounting rules sounds like something more suited to Wall Street than state capitals, but because state and local governments are permitted to use a unique form of accounting, elected officials play all kinds of games.

For example, unlike a business, governments can avoid recognizing an expense simply by delaying payment. That’s because state and local governments get to use “cash-based” accounting, which recognizes expense only when cash changes hands. That’s how Christie “balanced” New Jersey’s budget in 2010 simply by pushing a $3 billion pension payment from one year into the next. Pushing the payment cost $240 million in interest, a hefty price for citizens to pay so their governor can look good. But hardly anyone knew.

New Jersey is not the only state to game government accounting rules.

According to the State Budget Crisis Task Force co-chaired by former Federal Reserve Board Chairman Paul Volcker and former New York Lt. Gov. Richard Ravitch, “cash-basis budgeting is a major enabler of budget gimmickry” by state and local governments. For example, last year California used accounting rules to avoid recognizing a $3 billion compensation expense.

As part of employee compensation, California promises “post-employment” benefits. One of those promises is to pay health care costs after retirement. The promises are supposed to be prefunded with cash when the promises are made. If not, no one knows about the expense when it’s created or the debt that is generated if the promise is not funded. In 2013, the state controller said California’s cost for retirement health care was $5 billion, but less than $2 billion showed up as an expense in the state budget. That’s because Gov. Jerry Brown and the Legislature chose not to fully fund the promises.

Because they did not, hardly anyone knew about a $3 billion expense that became $3 billion of new debt. Unfortunately, the budget for the next fiscal year recently proposed by Brown adopts the same maneuver. Brown could have chosen to recognize the cost, but that would reduce his ability to declare a “surplus” this year. As a result, the state will incur another $3 billion expense and create another $3 billion of new debt – again, largely invisibly. That will take the state’s debt for postretirement health care benefits, which accrues interest, to more than $65 billion.

This is how Detroit and Stockton built up billions in post-retirement health care debt before their bankruptcies. Citizens in those cities didn’t know about such debts, even though Detroit’s postretirement health care promises are nearly twice as large as its pension promises.

Likewise, few Californians know that more than $10 billion of new postretirement health care debt will be created during Brown’s four-year term alone. This is why the Volcker-Ravitch task force recommends that governments adopt “accrual-based” budgeting, which would force disclosure of such expenses and allow the public and legislators to “easily discern how revenues earned in the fiscal year relate to obligations incurred in the same year.” Until that is the case, unsuspecting citizens will pay the price because larger and larger shares of their budgets will go to paying off a debt they didn’t know about, leaving them with less money for their own services.

This is also why we should think of accrual-based budgeting as “next-generation budgeting.” Forced reporting of expenses is the only protection future generations have against theft of their financial resources.

Truthful accounting should not be a political issue. Fiscal conservatives should care because recognizing the cost of spending is the first step to controlling it, and liberals should hate the gradual erosion of social services caused by hidden expenses grabbing ever-larger shares of revenues.

To his credit, Brown has mentioned the state’s growing debt for retiree health care as one reason why the state shouldn’t spend its “surplus” this year. But that’s less effective than showing the expense in his budget by setting aside cash. By not doing so, he reports a surplus when there isn’t one, and he adds to a largely invisible debt that will greatly burden the next generation. Until governments adopt accrual-based budgeting, courageous elected officials are the only protection we have against the gaming of accounting rules.

Link to original article: http://www.sfgate.com/opinion/article/Playing-accounting-games-puts-red-ink-budgets-in-5215154.php