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November 02, 2008

The Real United States Federal Deficit

During the Bush administration's reign, we've constantly heard the drumbeat about the ballooning federal budget deficit.  While deficits of $400+ billion dollars may sound like a lot, do they tell the entire story?  They don't.  The Federal Government has been manipulating the deficit numbers for the past 40 years in order to make itself appear healthier than it really is.  Is a Federal default likely?  It's a strong possibility with the impending retirement of the baby boomers.  While I hate to be pessimistic, realism is necessary and the stars are not aligned well for the Federal Government, and governments are not immune to default - remember Russia in 1998?

The Federal Government's deficit calculations are based-on the cash method of accounting, in conjunction with the unified method.  In the cash method, revenue is only recognized when cash is received and expenses recognized when cash is paid.  While it is very important to understand the cash flow of any entity, the cash method represents a dramatically distorted picture when it comes to the Federal Government's finances.

In 1968, Democratic President Lyndon B. Johnson had the Federal Government adopt a method of accounting known as "unified" budget accounting in order to allow his administration to use the Social Security surplus revenues to go against the then ballooning budget deficit caused by the Vietnam War.  Would a for-profit company be able to use surplus gains from its pension system and other obligations in order to show excess profits but not take a hit when those liabilities ballooned?  No, they wouldn't be able to.  These gimmicks would bring about an accounting scandal reminiscent of what happened with accounting manipulation at Enron and Worldcom.  So why does the government get to get away with it?  Good question.  Are the politicians in DC afraid the truth would be too great for the public to bear?

So what do the numbers really look like?  If you think a $400 billion deficit is big, you'll pass out from these.  

Federal Budget Deficit

Note - 2004's huge increase is mostly due to the creation of the Medicare part D (Prescription Drug Benefit) plan

As you can see the Federal Government has been running an actual budget deficit of approximately $3 trillion a year for the last 10 years, with only one year of an actual surplus, which is about 20-30% of US GDP.  Sustainable? No, it's not.  Runaway spending has completely destroyed the Federal Government's financial position.  Currently the Federal Government is carrying $51 trillion in debt - $41 trillion from entitlements and $10 trillion in other liabilities.  If the Federal Government were a public corporation it would have a negative net worth and would be deemed insolvent.

So how can we make the Federal Government more accountable with this knowledge?
  1. Replace use of the Unified Method with GAAP-based accrual accounting for Federal Government reporting (including taking into account the entitlement programs).
  2. Modify the annual financial statements to show a Consolidated Income Statement, Balance Sheet, and Statement of Cash Flows, and put them at the beginning of the report to make them easily accessible.
  3. Distribute financial statements to all registered voters in the country.  If shareholders of corporations are required to be sent this information, then the voters should receive it every year in the mail as well.
  4. Require a balanced budget using GAAP-based accrual accounting. 
  5. Reform the Entitlement System. 
Other Resources:
Accounting Insolvency - From Bloomberg
Fudging the Budget - From the NY Times
Federal Deficit Reality - From Shadow Stats

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