How the government cooks the books; the budget deficit is bigger than you think.

• Author: Longman, Phillip

HOW THE GOVERNMENT COOKS THE BOOKS

In October, 1908, a landmark exhibit opened in a private gallery on lower Broadway in New York. According to the show's ebullient sponsors, 62,808 attended. "Pictures that Tell Stories of a City's Waste' was the draw. Everyone came to see the budget of the City of New York.

Even The New York Times was excited. "The idea of the exhibition is to show with striking tables and in graphic form what the city is doing, what it needs to so, and how it is day by day wasting a large part of its income,' it reported.

It was the Progressive movement at its peak, and literally millions of Americans--not just a few green eye-shade types--wanted to see what was in their public budgets. Two years later, another exhibit of New York's budget, blown up and pasted on boards drew a million spectators wanting to know where their tax dollars were going. "No voter, certainly no householder or housewife, can merely stroll through this exposition without receiving a certain understanding of the kind of men who ought to be selected to attend to the several branches of such an immense concern,' the Times opined. Held over by popular demand, the exhibit soon inspired similar displays throughout the country, fueling a genuinely popular movement.

We could stand to rekindle some of that curiosity. Today we debate the deficit ad nauseam, but we are evading a fundamental problem. The number we identify as the deficit--the $200 billion-ish figure we hear-- includes only a fraction of our actual debt. The additional debts will eventually come due. For instance, the government has promised to pay out trillions of dollars in Social Security payments, but none of that accumulating debt shows up in each year's budget deficit. Similarly, big Pentagon costs such as military pensions and weapons systems will cost us later, even if they aren't on this year's books. Rather than pay some of these costs now, Congress (and many states) impose these obligations on future taxpayers, hoping that somehow, the money will be there. We don't have to stand in line to see the budget. But we do need to see it clearly.

Bomb throwers

To really understand the budget, you have to understand the accounting on which it is based. Accounting is supposed to give an accurate and useful description of how an institution is taking in money and spending it. Its usefulness depends on the kind of questions one wants answered. If the questions are short-term--"How much money do we have now?,' "How much will we have at the end of the year?'--then the calculations are fairly straightforward. Just keep track of the cash-flow.

Back when the federal government did little more than guard the coasts and deliver the mail, annual cash-flow accounting could provide an adequate picture. But the expansion of government services has created a series of long term obligations extending years, even decades. Each day, entitlement programs, such as Social Security and Medicare, obligate the government to pay benefits far into the future, as workers build up claims by paying into them. Indeed, since the end of World War II, nearly all the growth in federal spending as a percentage of GNP, excluding interest costs, has been in programs that promise to pay future benefits. Today's budgets create tomorrow's liabilities.

So what about next year? What about ten or 20 years from now? To answer the fundamental question of whether an institution is living beyond its means, one has to know how fast capital assets are likely to wear out, what it will cost to replace them, and what big contracts will come due. For this reason, the federal government requires all publicly held companies to disclose their finances using an "accrual' basis rather than simply counting up annual receipts and expenses. For the same reason, 25 states use accrual systems, and ten are converting to them.

It makes sense. Under accrual accounting, liabilities are reported as they are accumulated, rather than when they are paid off. Of course, those big liabilities can be paid off over a period of years. So accountants using the accrual method take that into consideration by calculating how much should be set aside each year to help pay off those long-term expenditures. It's still bean counting, but it's bean counting with vision.

Governments that don't use accrual accounting can find themselves swamped by debt. During the first half of the seventies, the City of New York used simple cash-flow accounting to keep its books and each year proudly reported a balanced budget. Actually, it was slouching towards bankruptcy. For years, the city had been accruing enormous long-term liabilities--especially public-employee pensions--that went unreported in its annual budget. In 1961, 25 percent of the money the city collected from taxes was paid out to retired city workers. By 1975, that figure had jumped to 40 percent. Even when the comptroller's office did make...