GAAP's Budget Gaps Will Surprise
The events of the past two weeks have shown us that it is easier for President Reagan to reach an agreement with the Communists in Moscow on nuclear missiles than it is for him to reach an agreement with the Democrats in Congress on the budget deficit. And so long as congressional Democrats insist that new taxes are the only way to reduce the gap, it is likely to remain that way.
It should be clear by now that real progress on reducing the deficit will come about only through a new way of thinking. Despite the fact that the growth rate of federal spending has been significantly reduced under the Reagan administration, the president has been tagged as the biggest deficit spender in history. But now. with the budget summit, the president has a golden opportunity to shake this label by radically reforming the budget process and demonstrating to the American public that deficit spending has in fact been reduced, not increased, during his administration.
He could bring about a meaningful budget process by requiring the government to use Generally Accepted Accounting Principles, the accrual-basis budgeting and accounting system that is required of every publicly owned company in order to prevent fraudulent and misleading financial reporting. Moreover, GAAP would show that Reagan administration deficits are lower than those compiled by Jimmy Carter.
The federal government currently uses a cash-basis budgeting and accounting system for measuring government spending. This cash-basis system is nothing more than a simple measure of how much money an entity takes in and how much it spends. While the cash-basis budget system provides us with important quantitative information concerning our government's cash flow, it tells us absolutely nothing about the qualitative nature of these expenditures.
Replacing the cash-basis system with. GAAP would radically alter the manner in which we construct our budgets and show us the real cost of government programs. GAAP records economic events as they occur. giving us credits for assets that we will have for years to come. and putting liabilities on the books at the time they are incurred. If Congress creates a new program that will require future federal funding, the cost under GAAP would be reflected in our current accounts Like-wise, if Congress makes an investment in a capital item that will have value for years to come, that value would be recognized.
Instead, Congress has used smoke and mirrors to achieve imaginary budget "savings." Last year, to reach Gramm-Rudman-Hollings deficit-reduction targets, congress shifted the pay date for military personnel to one fiscal year from another. While congress has made moves to prevent such abuse in the future, under GAAP it would never have been possible for congress to get away with this budget chicanery: The obligation to pay military personnel would still be recorded on the books. as part of the current budget regardless of when it was to be paid.
This brings us back to the Carter-Reagan budget comparison. In 1986, Arthur Andersen & CO. attempted to get a clearer picture of the true nature of our federal debt by estimating U.S. budget deficits under GAAP from 1974 to 1984 and comparing them with our regularly used cash-basis system. What we find from the years 1976 to 1984 reveals some interesting facts about just who really is responsible for our deficit and national debt.
The accompanying tables compare the Carter-Reagan cash-basis and GAAP budgets during those years using both nominal and 1984 dollars. (comparative figures in this article are in 1984 constant dollars.)
In 1980, the last full year that Mr. Carter controlled the budget, while the cash-basis deficit totaled $93.5 billion, the estimated GAAP deficit for that same year was a staggering $408.3 billion. Meanwhile, four years later, while Ronald Reagan was taking the heat for increasing the cash-basis deficit to $185.3 billion, the estimated GAAP deficit stood at $333.4 billion, a deficit reduction of nearly $75 billion from carter's 1980 level. Furthermore, Mr. Carter's total estimated GAAP deficits over the 1977-80 period were $56.5 billion higher than Mr. Reagan's total for 1981-84.
A significant portion of Mr. Reagan's cash-basis deficits is actually the liquidation of liabilities incurred by the Carter ad· ministration, but whose costs were not recorded at that time because of the cash-basis system. In addition, the GAAP deficits tell us that President Reagan has spent proportionately more in his budgets on capital items whose benefit should be amortized over future fiscal periods. conversely, President Carter spent proportionately more on items that were consumed immediately, providing no benefit to future periods. As a result, President Reagan, who has significantly reduced the growth of federal outlays as demonstrated by GAAP. is being blamed for a cash-basis debt that is largely the result of spending decisions made by Jimmy Carter.
The bottom line, however, is that GAAP shows us serious and dangerous flaws in the federal government's reliance on cash-basis budgets that will not be cured by line-item vetoes, a balanced-budget amendment or tax increases. Cash-basis budgeting is the same system that led to the financial collapse of New York City in 1974. The fatal flaws in the cash-basis system were so apparent to the federal government at that time that it required New York City to adopt GAAP accounting as one of the conditions for a federal bailout.
At long last, Congress is beginning to· recognize the danger of sloppy federal accounting and financial management practices. In August, I introduced bipartisan legislation with 56 co-sponsors to create the Office of a Chief Financial Officer of the United States. Among the duties of the CFO would be producing the budget for the U.S. using GAAP.
Even though GAAP budgeting shows that the president is making progress on deficit reduction, he has been reluctant to support the adoption of a budgeting system that would recognize a doubling of our debt through its more accurate reflection of all government liabilities. But that was before black Monday.
It is time for the president to help put economic reality on the books. If the president and Congress retreat to their caves and ignore the truth of the budget, the bears on Wall Street may come out of hibernation on a full-time basis.
This Article was Originally Published in The Wall Street Journal