Fiscal Gap Accounting
I have recently become aware of an effort to introduce legislation in congress that would required the U.S. Government to apply Fiscal Gap and generational accounting assessments annually and also when any major fiscal policy decisions are being considered. Let me say right up front that I fully support this effort as a proper action for Congress to take so that we can get more accurate and informative financial assessment and reporting. The legislation is called The INFORM ACT and can be explored on the following website: ( www.theinformact.org).
The INFORM ACT is a bipartisan bill introduced, in the Senate, by Senator Kaine (Democrat from Virginia) and Senator Thune (Republican from South Dakota) and cosponsored by Senator Coons (Democrat from Delaware) and Senator Portman (Republican from Ohio). Congressman Cooper (Democrat from Tennessee) and Congressman Shock (Republican from Illinois) have introduced the bill in the House.
The INFORM ACT requires the Congressional Budget Office (CBO), the General Accountability Office (GAO), and the Office of Management and Budget (OMB) to do fiscal gap and generational accounting on an annual basis to assess the sustainability of fiscal policy and measure, on a comprehensive basis, the fiscal obligations facing our children and future generations. The ACT also permits Congress to request fiscal gap accounting and generational accounting to evaluate major proposed changes to fiscal policy.
Dr. Laurence Kotlikoff, Professor of Economics at Boston University, is a leading advocate of this legislation and was instrumental in drafting the content of the legislation. This bill has been endorsed by over 1000 economists, including 15 Nobel Laureates in Economics.
I have held the position for some time, and still do, that the U.S. Government should be using GAAP-basis accounting for their budgeting, planning, and reporting of our fiscal condition but also feel we should extend the GAAP principles to included the "complete and comprehensive" concepts embodied in Fiscal Gap. These GAAP techniques (Generally Accepted Accounting Principles) have been time tested as the most appropriate "rules" for companies to use so that all interested stakeholders can get as consistent as possible comparisons of one entity to another. These "rules" are thoughtfully adjusted as necessary to provide improving quality of corporate financial conditions so that investors get an accurate assessment of stocks or bonds in which they might be interested in investing. These rules are established for commercial entities (both public and private) by FASB (Financial Accounting Standards Board).
That said, I also recognize that financial reporting for governments calls for somewhat different rules than those for commercial corporate entities. This need was recognized many years ago and the GASB (Government Accounting Standards Board www.gasb.org) was established in 1984 to provide a formal structure for adapting the FASB GAAP rules to government needs specifically for state and local governments. These rules are therefore sometimes referred to as "Government GAAP".
My concern is that the Federal Government is not applying GAAP-basis rules for the financial budgeting and reporting for the most important entity for the U.S. economy and for that matter the world economy that of course being the U. S. Federal Government itself. By using simple Cash Accounting, the Government is grossly misrepresenting the financial condition of the country and has created what will be a chaotic financial situation over the next few years.
This chaotic situation has been caused by the Government making financial commitments without adequate consideration for the financial consequences of these commitments. As a result, the U.S. Government has made massive commitments and promises that cannot possibly be kept. We know that this is a problem because even with our simple Cash Accounting we report $17.2 Trillion of debt with no reasonable possibility of being able to pay back that debt. We have been overspending our cash receipts for years and as a result have had to continually increase our borrowing. Further we have been essentially ignoring our accruing liabilities for our social benefits commitments. Applying GAAP rules would provide advance awareness of these coming liabilities in a formal way so that the key decision makers and the U.S. (and world) citizenry would clearly know how we stand financially. GAAP accounting would be a major step in the right direction to resolve these financial planning and reporting issues.
That said, while GAAP accounting is a huge step in the right direction, it does not totally reflect our "complete" financial liability. This brings us to an area where FASB GAAP and GASB GAAP have different assessment and reporting needs and priorities. That being "defined benefit" commitments for constituents. Corporations have this need as well since they have offered and to some extent still do offer pension plan and healthcare for retirees. But in the case of governments these defined benefit plans have become an Achilles heel and a dominant part of their budgets.
That brings me to Fiscal Gap accounting. To introduce this topic let me try to give a brief explanation of how these three accounting methodologies apply when assessing and reporting our social benefits financial commitments. These three methodologies are: Cash Accounting, GAAP Accounting, and Fiscal Gap Accounting.
Cash Accounting acknowledges a liability when the government pays each entitlement check so if the government does not have the funds it borrows (or prints) the money and at that point it becomes a debt on our books so our total liabilities, with Cash Accounting, now looks like we have a Federal Debt of $17.2 Trillion. This of course means that due to lack of funds we made the payment but had to borrow the funds to meet the obligation.
GAAP Accounting acknowledges a liability for social benefit payments when a new social benefit participant becomes eligible for a benefit and would expect that the present value of this benefit stream be collected or begin to be collected in tax revenue during the reporting period when the participant became eligible. These collected funds would be placed in a Trust Fund accruing interest to ensure that the benefit can be paid on the projected payment schedule. Any shortfall in meeting this funding requirement would be posted as an unfunded liability. In our case since we collect no funds in Trust Funds all of our future liabilities are unfunded. GAAP Accounting then routinely reports our total Federal Obligation as our Federal Debt of $17.2 Trillion plus the present value of our Unfunded Liabilities for all of our citizens that are currently eligible for social benefits. This Unfunded Liability now totals $74 Trillion for a total Federal Obligation of $91 Trillion.
Fiscal Gap Accounting
Fiscal Gap Accounting acknowledges a liability as soon as the President signs the bill for a new social benefit program for all future participants. Therefore our total financial commitment according to the Fiscal Gap accounting includes the Federal Debt and the present value of our GAAP-basis Unfunded Liabilities PLUS the present value of the social benefits for people that are alive and scheduled to become eligible for certain social benefits at some point in the future AND also for those not yet born that will become eligible for these social benefits any time between the signing of the law granting the benefit and an infinite horizon. Since this is a present value measure it does converge at the infinite horizon.
It should be noted that these accounting methodologies apply not just to the entitlement benefits but to all of our commitments including spending for defense, transportation, security, etc.
What "Fiscal Gap" accounting does is look at all projected inflows of funds (primarily tax revenues) and all outflows of funds for all current commitments and calculates the present value (with a current discount rate of 3%) of each of these items and sums these present values to determine the net present value of all of these inflows and outflows. This number than becomes the U.S. Fiscal Gap which was determined to be $205 Trillion as of the end of fiscal year 2013 i.e. September 30, 2013. (see Kotlikoff October 7, 2013 Article)
The following table shows a brief summary of how the three accounting methodologies assess and report the financial considerations for social benefits.
Liability As of Dec 2013 Liability recognized when Horizon
Cash Accounting Debt $17.2 Trillion Insufficient Funds Budget Year
GAAP Accounting Obligation $91 Trillion Participant becomes eligible 75 Years
Fiscal Gap Accounting Fiscal Gap $205 Trillion Benefit program approved Infinite
I feel that it is imperative that we begin to accurately assess and report the financial implications of our social benefit programs and therefore should immediately adopt GAAP accounting for the Federal Government and incorporate the Fiscal Gap accounting principles (complete and comprehensive acknowledgment of liabilities) into "Government GAAP" as defined by GASB.
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