Gov't financial planning with inaccurate financial information
Accountants assist clients with financial plans based upon the information their clients provide. Some clients might tell their accountants that they made money last year and have a large reserve. Other clients might be deep in debt and need a new financial plan. But even the best-designed plan will not work if the accountants are not given accurate information.
Unfortunately, the largest businesses in our country are not giving their accountants, boards and shareholders accurate information about their finances. These businesses are our governments. A government’s budget is its annual financial plan, but it is often made by elected officials based upon inaccurate financial information.
To ensure sound financial planning, all the states (except Vermont) have balanced budget requirements. Yet 40 states — and 63 of the 75 most populous U.S. cities — are deep in debt. These requirements are supposed to prevent unsustainable debt and promote accountability by requiring current costs to be funded by current taxpayers. Former U.S. Treasury official Frank Cavanaugh said it best: “The politicians shouldn’t have the pleasure of spending (getting votes) without the pain of taxing (losing votes).”
Unfortunately, the good intentions behind balanced budget requirements have been circumvented by the shoddy accounting practices used in the budget process. Historically, public entities have used cash-basis accounting to calculate their budgets and financial reports. Under this short-sighted accounting method, governments establish separate funds to track and pay for various governmental functions. This allows the money in the designated fund to be used for a specified purpose or project. When the money in the designated fund runs out, no more money can be spent without legislative approval.
But some elected officials have developed their own version of cash-basis accounting that allows them to inflate revenues and understate expenses. For example, some governments include loan proceeds as revenues or inflows, and include only the checks written in the budget calculations.
Governments also do not include all of their activities in their budgets. Illinois, for example, has more than 600 funds and only has six “budgeted” funds. The budgeted funds can be “balanced” by moving money from non-budgeted funds or hiding costs in non-budgeted funds.
Cash-based budget calculations also do not take into account the fact that governments have expanded their missions beyond providing for current services and benefits. For the last few decades, elected officials have increasingly made long-term commitments, such as pension and retiree health care promises to their employees. While current employee compensation costs include salaries and retirement benefits earned, most government budget calculations do not include all of the earned and incurred retirement benefits.
Since only the checks written during the budget period need to be included, only the amounts elected officials choose to put in the pension and retiree health care funds get counted in the budget calculations. The result is elected officials claiming “balanced” budgets or even “surpluses,” while their government’s unfunded pension and retiree health care debt increases. Truth in Accounting’s research found that the 50 states and 75 most populous cities have amassed unfunded pension debt of $824 billion and $176.2 billion, respectively, and unfunded retiree health care debt of $664.6 billion and $149.8 billion, respectively.
To make matters worse, GAAP for governments adds credence to these balanced budget claims. While governments’ consolidated statements are prepared on an accrual basis, the general and other budgeted funds statements are prepared using the “modified accrual basis,” which loosely resembles the cash basis. These two sets of books lead to misleading and contradictory financial information.
Of course, government officials often point to the financial data from the fund statements — leaving out long-term liabilities and all the expenses incurred — because these statements make their financial conditions and budgets look better. Unfortunately, government officials don’t use the comprehensive, accrual basis numbers presented in the consolidated statements for financial planning and budgeting.
For example, California’s officials claim a $7 billion surplus and are considering increasing ongoing expenses and adding new health care spending and housing construction. Meanwhile the state's pension and retiree health care plans are $221 billion underfunded.
For fiscal year 2018, New York City claimed a $4.6 billion surplus, but that was achieved by not including $4.9 billion of earned and incurred compensation costs related to retiree health care benefits. New York City used some of its $4.6 billion “surplus” for additional spending, even though its pension plans were unfunded by $51 billion and the city needs $106 billion to pay for retiree health care benefits that have already been earned.
When Chicago Public Schools issued their Comprehensive Annual Financial Report, the Chicago Sun-Times headline said, “CPS finishes year with budget surplus — just in time for [the Chicago Teachers Union] contract talks.” The story highlighted that CPS had a surplus of almost $600 million and quotes a union leader saying this means the school district has “more money and more resources.” Based upon the belief that CPS had a $600 million surplus, the school board negotiated a new contract with the unions that will increase spending by $1.5 billion over the next five years. The Sun-Times article failed to mention that the $600 million surplus was only reported in the general fund and was derived using cash-basis accounting. The consolidated Statement of Activities for CPS reported a loss of almost $751 million and the district has more than $14 billion of liabilities in excess of its assets.
These governments are not alone. Tax and spending policy decisions have been made by elected officials and taxpayers in cities and states throughout the country using the wrong financial information. But beyond the numbers, citizens throughout the country have been lulled into a false sense of security by claims their governments’ budgets have been balanced, while millions, if not billions, of dollars of debt have been accumulated. Even worse, our representative forms of government are being harmed because voters are making decisions on who to vote for based upon claims that their elected officials have been living within their means, when they have not been.
Many governments are in financial trouble and need good financial plans. Accountants throughout the country could help elected officials, who usually don’t have financial expertise, with developing financial plans. The first step for accountants would be to work with elected officials to understand their governments’ true financial conditions and help to create budgets that include accurate revenue estimates and all incurred costs.