Nasty financial weather is raining down on many state and local governments. Retirement benefits and related obligations have grown into thunderheads, seeded by decades of false financial reports masking the debt progressively foisted on taxpayers. Granted, some of the rules of the road have been moving in the right direction recently. Profound and valuable innovations are still possible, and necessary. Citizens deserve fundamental changes in the content and governance of government financial reporting.
Who Will Lead the Way?
Rulebreaking alone did not create this storm. The rules themselves—laws set by governments, as well as accounting standards set by “independent” standard setters under law—have led to this impending crisis. Government financial communication includes two basic “buckets” of reports—budgets and results. Budgets provide planning and control devices, in theory. Sadly, in many cases, they have been hijacked as tools of propaganda and deception. The deception has been facilitated by GAAP for decades, until the looming truth became too obvious to ignore.
Consider some egregious examples that highlight the urgency of the situation. In April 2015, Rahm Emanuel won a reelection bid to remain mayor of Chicago. The months before the election included claims like the following, in a press release from the city:
To balance our budget for the past three years without any increase in property, sales or gas taxes was only possible by changing the way Chicago does its business,” Mayor Emanuel said. “We have reduced our structural deficit by making city government smaller, smarter, and simpler.
Over those same three years, however, Chicago’s expenses ran about $1 billion per year more than general revenue, fees, and grants. The growth rate in the city’s reported liabilities doubled during Emanuel’s first administration—even before the massive hike in liabilities reported in the annual report for 2015, which included a “net pension liability” for the first time. Chicago was not getting smaller, smarter, and simpler. The surge in borrowing, despite the city’s claim, helped “balance the budget.”
What About New York City?
In an August 2015 NYC Budget Brief titled “Measuring New York City’s Budgetary Cushion: How Much is Needed to Weather the Next Fiscal Storm?” New York City Comptroller Scott Stringer claimed:
New York City is required to balance its operating budget according to generally accepted accounting principles (GAAP), which mandates that revenues in a given year must equal or exceed expenditures in the General Fund in that year. … While all governments in the country practice GAAP accounting, New York City is the only major government subject to GAAP budgeting” (http://on.nyc.gov/2mk7RHV).
This sounds good, but the question arises whether “GAAP budgeting” even exists. Meanwhile, like Chicago, New York City’s expenses ran billions of dollars ahead of incoming general revenue, fees, and grants for years.
In contrast to Chicago, New York City has been able to generate operating surpluses in recent years. But the long-term consequences of spending ahead of revenue, despite “balanced budgets,” have been considerable. In Truth in Accounting’s analytical framework, used by this author to evaluate public finances, New York City has fallen into the worst financial condition of any of the ten largest cities in the United States.
Budgets have words, but there are words, and there are deeds. Looking at many state and local governments, years of misdeeds are becoming more evident. Accounting standards are finally catching up to reality. This has led to a fundamental recasting of reported financial positions. To be relevant, financial statements must help inform users about trends on results. But getting a grip on trends for many state and local governments has become no small feat, given the changes in standards.
How to Weather the Storm?
In light of the federal government’s own financial reporting, leadership from that quarter on these issues looks unlikely. An enlightened and engaged citizen-ry could make a difference, but how helpful has that been in the past? Perhaps we shouldn’t be too pessimistic, however; citizens chose to trust the less-than-truthful information they were getting for decades. Things could change on this score.
Accounting should provide a vehicle for accountability. But American citizens have been hamstrung—the facts haven’t been saying what they should have said. A fundamentally new approach to government budget accounting and financial reporting is necessary. The time has also come for leadership from the accounting profession, leadership that includes owning up to past failures and living up to the ideals of the profession.
Budget methods and reporting standards need to be combined with better accrual accounting in audited financial statements. This will require significant further changes in GAAP, as well as in rulemaking in a variety of jurisdictions.
Rhetoric and practice vary significantly around the country, of course, and much can be learned from responsible governments. But better discipline in government financial management requires earnest efforts toward enforcing accrual-based budgeting, coupled with further movement towards reflecting reality in financial reporting models. This is not only true at the local and state government levels; massive fundamental advances in the substance, verification, and governance of federal government accounting and financial reporting are needed. Joseph Marren, President and CEO of KStone Partners, is not far from the mark when he decries the state of affairs in federal reporting as being so derelict that the government is failing to live up to the inherent intent of the Statement and Account Clause of the U.S. Constitution (“No Accounting for Government Cost,” Barron’s, Jan. 4, 2014, http://bit.ly/2mt6r2J).
A fundamentally new approach to government budget accounting and financial reporting is necessary.
Where to Begin?
Some immediate priorities at the federal level should emphasize enhancing independence and accountability in standards-setting, improving accounting for entitlement programs like Medicare and Social Security, fixing auditing issues in the Department of Defense and related programs, and combining budget reporting and financial accounting with a greater emphasis on accrual accounting principles.
A telling part of the federal government’s financial report, and good place to start with reform is the following statement, taken from the introduction to the balance sheet for the federal government (fiscal years ended Sept. 30, 2015 and 2016):
There are, however, other significant resources available to the Government that extend beyond the assets presented in these balance sheets. Those resources include Stewardship Land and Heritage Assets in addition to the Government’s sovereign powers to tax and set monetary policy. (http://bit.ly/2mQySTz, p. 48)
In other words, taxpayers shouldn’t worry that liabilities already outpace reported assets by some 20 trillion dollars, because the government possesses the sovereign powers to tax them and to inflate the value of the currency. Are these comforting words? Granted, the government has the power to tax us. But does it possess the sovereign power to tax, and to set monetary policy, as a reporting entity? The government is the servant of the people. And given that, in the area of accurately reporting its own financial status, it has been providing less-than-exemplary service, it is well past time for a change.