USA Today Adopts Fuzzy Accrual Accounting
Dennis Cauchon dusts off accrual accounting to scare the readers of USA Today:
The set the government promotes to the public has a healthier bottom line: a $318 billion deficit in 2005. The set the government doesn’t talk about is the audited financial statement produced by the government’s accountants following standard accounting rules. It reports a more ominous financial picture: a $760 billion deficit for 2005. If Social Security and Medicare were included – as the board that sets accounting rules is considering – the federal deficit would have been $3.5 trillion.
Elizabeth Garrett provides a nice description of accrual accounting for the Federal government in her discussion of Howell E. Jackson’s Accounting for Social Security and Its Reform (2004):
Social Security, the largest entitlement program in the federal government, is now accounted for on a cash-flow basis; its financial reports subtract the amount of benefits paid to retirees from the annual cash receipts from payroll taxes paid by workers. In cash-flow terms, the system is in surplus because it currently takes in billions of dollars more each year than it pays out. But the cash-flow method obscures the serious challenges that Social Security faces in the future as the Baby Boom generation continues to retire and fewer workers pay the taxes necessary to sustain this pay-as-you-go system. As Professor Jackson reveals, the unfunded accrued liabilities in the Social Security trust funds at the end of fiscal year 2002 were $12.6 trillion, or 122% of the country’s gross domestic product (GDP).
Of course, the problem with this 122% of today’s GDP is that she is referring to the present value of expected future cash flows over a very long period of time. If one takes the present value of GDP over a similar period, it’s likely close to $1000 trillion so the alleged long-run shortfall is only 1.3% of the present value of future GDP.
Dean Baker read this USA Today story and writes:
Be warned – this is not a story about the evils of Bush’s tax cuts for the rich. These tax cuts are just a footnote. The real villain in the bankruptcy story is the projected explosion in the cost of Medicare and Medicaid. This cost explosion is not due to aging; Social Security costs inch up in these projections – just like they have been doing for the past seventy years. Medicare and Medicaid costs explode in this story because the U.S. health care system is broken and the projections assume that we never fix it.
Ah projections – the key to any present value or discounted cash flow model! Yes if we assume that Bush’s tax cuts are made permanent and we also assume an explosion in Federal funding of a bloated health care system, the Federal finances look bleak. But what would one expect from a model that assumes future President’s are as fiscally reckless as the current one?
Max Sawicky has more as he notes the role played by one’s assumption of the discount rate.