The Looming Crisis - The Fiscal Unsustainability of Western Governments

As the first practicing certified public accountant elected to the US Congress, I have been sounding the alarm for more than two decades about the inadequate accounting principles used in the US budget process to measure annual deficits and national debt. After leaving the US House of Representatives in 1989, I set up a foundation, Truth in Government, because I believe that America, along with every other country, needs an independent, oversight group to provide the real numbers when it comes to the financial results of government operations. Many' governments, including the United States, do not publicize their total debt and obligations for all to see. Thankfully, in this time of economic crisis, a genuine debate is starting in the US Congress about the unmanageable increases in the annual budget deficit as a percentage of Gross Domestic Product (GDP), and, as a result, America's financial unsustainability as a nation whose economy is built much more on debt, consumption, and imports than on investment, production, and exports. Because of the current concern that major bond rating agencies could downgrade the AAA rating of US Treasury securities (one well-known rating service has done so already), members of the House and Senate (and state comptrollers) are now recognizing that the government has to consider unfunded pension liabilities and obligations for other entitlements that, in the past, were not considered to be part of the national debt. Publicly traded companies have always been required by the Securities and Exchange Commission (SEC) to calculate and report all these obligations in order to protect corporate stockholders. The question today is: Will the US government do the same to protect American taxpayers, even those in future generations?

Unaccountable Congress: It Doesn’t Add Up

In 1992, I published Unaccountable Congress: It Doesn't Add Up to make the case that there: should be no double standard when it comes to federal (accounting, financial management, and financial reporting. I updated and republished the book in May 2010, and I chose an apocalyptic-looking cover for the new edition - one that includes "a national debt card" on the backs of young people and the Capitol of the United States in flames. I wanted to draw attention to the unsustainable fiscal picture that I see emerging in the next 10 years. A partisan, uncompromising political fight on whether to raise taxes or cut spending has been raging since then. (This continuing partisan conflict took us to the edge of a shutdown of the US government during the summer of 2011 when the statutory debt ceiling for the US bonded debt of $14.3 trillion was reached.) As we go into a presidential election year in 2012, we see no resolve to do anything but political posturing on both sides of the aisle.

President Barack Obama came to office with a message of hope and change. But many Americans, both Democrat and Republican, say that he has not delivered. Out of the eighty-seven new members of Congress, seventy are either identified with the Tea Party or are fiscally conservative. The Tea Party is a new movement calling for limited government and dramatic spending cuts without raising taxes at the federal level. In order to get elected in November 2010, they promised their constituents that they would shut down the government if deficit spending and the national debt were not dramatically reduced. No one wants to see the US government shut down. Nevertheless, the United States cannot continue with current debt levels and deficit spending. Much attention has been given to the European debt crisis, but the crisis that is now looming in the United States is not disconnected from what is going on with Greece, Portugal, Italy, Spain, Ireland, and France today, and may even be worse once the real numbers are known. (Alarmingly, the US government's deficit is currently reported to be $1 trillion 300 billion for the fiscal year ending 30 September 2011. This was the third year in a row that spending exceeded revenue by more than a trillion dollars, adding to an already bloated national "bonded" debt, which is now approaching 100 per cent of US GDP.)

The current problem will only grow because the US government must raise the debt ceiling limit again in 2012 in order to keep the government going. (Under us law, when the legal borrowing limit runs out, Congress cannot spend more money until it passes a law raising the statutory debt ceiling.) In the past, Congress has not been serious about' the consequences of raising the debt ceiling. Every time the government ran out of money, Congress automatically raised the debt ceiling in order to avoid any restraints on its spending and, in the process, increased the national debt without much reflection or resistance. To make matters worse, Congress only takes into consideration the bonded debt when raising the debt limit - not obligations for unfunded entitlements like Social Security and Medicare. This is also true in many other countries, and this is why we need to develop better global accounting standards for governmental entities. International accounting standards are emerging to ensure that publicly traded corporations protect the business assets of shareholders, but they have yet to emerge in the public sector. This remains a big challenge for the United States and the European Union in the future in order to gauge which countries are fiscally sustainable and can continue to borrow when funds are needed to cover a nation's annual operating budget deficit and to pay promised retirement and health care benefits, which are usually not officially recognized as part of the annual deficit or national debt.

When it comes to spending taxpayer dollars and borrowing money responsibly, most governments have a credit card mentality. Certainly, the United States does, and that is why, when I first published Unaccountable Congress: It Doesn't Add Up, I put what I called a "congressional credit card" on the front cover. (I felt strongly that it represented a congressman's or congresswoman's plastic voting card, which is inserted into a computer terminal at the end of each row of seats in the House of Representatives in· order to record a member's vote.) In one of my first speeches on the US House floor, I held up my voting card and called it "the most expensive credit card in the world" and said that every time we members use our cards in the computer terminal to vote on spending, we were raising the annual deficit and the national debt. I pointed out that a personal credit card has a limit - one that you cannot change unless you convince the bank to raise it based on objective criteria like increased personal income - while the "Congressional credit card" has no effective limit. Even in 1986, under Ronald Reagan, a president who called himself a staunch fiscal conservative, the United States had a $200 billion deficit. That is why Congress passed the "Gram Rudman" bill (H.R. 3520) in 1986, which was. a formulaic approach to reduce the deficit and balance the budget during four years. When Congress was failing to reach that target in four years, they changed it to five years, and then ultimately abandoned it altogether. And <luting the last 40 years, the US Congress has been changing the budget process to meet the desires of politicians who want to disguise deficit spending to get re-elected, not the needs of citizens who deserve a fiscally sound and economically sustainable government.

The fiscal crisis that America is facing today is the same one that the 17 eurozone countries are facing. Politicians are controlling. the budget process and under-reporting liabilities for pensions and other entitlements, passing them on to future generations. The US Congress uses what is called a "cash basis" accounting system for the budget - not generally accepted accounting principles (GAAP) that the SEC requires for· publicly traded corporations. The "cash basis" of accounting is easily manipulated because one does not need to record an expense until one writes a check, not when one gets the bill. (Under GAAP, an expense must be recorded as soon as a bill is received or a liability to pay is incurred.) In an economic sense, GAAP gives a sound picture of where a government stands financially. And yet, Congress is still using the cash basis for budgeting (raising the debt ceiling whenever it needs more money to spend) and passing a huge national debt on to the next generation, with interest.

Partisan Politics is Preventing Fiscal Responsibility

The Founding Fathers of the United States envisioned a limited federal government. Listening to the Obama administration today, one would think that the federal government created the states when, in fact, the states created the federal government. The biggest debate that the United States will face over the next ten years concerns the urgent need to reduce federal spending and to decide what the role of the federal government should be today and in the future. The United States is a democracy, but it is also a republic in which each state is sovereign. But through the years, the U.S. government has raised taxes from the states, and Washington has become the paymaster for many programs-such as healthcare, education, and retirement benefits. In the process, we have put government too far away from the people, creating an inefficient and uncontrollable bureaucracy. The question now is whether we will bring government closer to the people, so we can measure how effective or inefficient government expenditures are. As a fiscal conservative, I believe in the vision that the Founding Fathers had of a smaller government in Washington, leaving it to the states (and their localities) to decide how to serve the everyday needs of the people.

On 7 April 2011, Congressman Paul Ryan, chairman of the House Budget Committee, initiated an irnp01tant debate about the role of the federal government when he unveiled his budget proposal for cutting federal spending by $5.8 trillion during the next decade. Earlier, in December 2010, ·President Obama's Debt Commission, a bipartisan commission on fiscal responsibility and reform that was chaired by two highly regarded fo1mer senators - Alan Simpson, a Republican from Wyoming, and Erskine Bowles, a Democrat from North Carolina - put forward a plan that never even made it into the Obama administration's 2012 proposed budget. Now that Congressman Ryan, the Debt Commission, and most recently, the failed Congressional Super Committee on deficit reduction have sounded the alarm, the 2012 budget hopefully will be based on a bipartisan vision that results in a decreasing annual deficit and national debt for a fiscally sustainable America.

A bipartisan debate and compromise on government spending is important because the fast-rising national debt curve must be bent downward. As of this writing, it is projected to go dramatically upward. during the next five years, further threatening the Triple-A Treasury bill and bond ratings of the United States. The projected increase in America's national debt will create such high interest expenditures that ail discretionary spending in the next five to ten years will be in jeopardy. (Interest paid on the public portion of the national debt has never been as low as it is now because the Federal Reserve Bank, "the Fed'', has · lowered the short-term interest rate to practically zero to keep the United States from plunging into a major recession.) As soon as interest rates rise - as they are expected to do because of inflation - there will be an immediate, negative impact on the budget of the United States.

Last year, the price of cotton· doubled to $1.90 a pound. The cost of food and other household staples in the United States rose steeply. The price of oil hit more than $100 a barrel, contributing to high gasoline prices at the pump. As a result, many believe that the Fed will have to increase interest rates gradually to keep inflation under control. This is what happened in the late 1970s, 'when President Jimmy Carter's "stagflation" (a stagnant economy with high inflation) resulted in a prime interest rate of 21 percent. The Fed will not go 'to this extreme, but it, nevertheless, will be forced to raise interest rates in the next five to ten years to, I believe, somewhere between 6 and I0 per cent in order to cope with the legally permitted national debt that is estimated by the Obama administration to be $20 trillion by 2017. (At the end of fiscal year 2011, the bonded debt subject to the statutory debt limit reached approximately $15 trillion.) If the interest is calculated on only the public portion of the projected national debt by 2017 (approximately 60 per cent of the total bonded debt of $20 trillion, equaling $12 trillion), the interest cost at 6 per cent would be more than $700 billion dollars and would wreak havoc on future discretionary spending for defense, education, and aid to the states. (It should be noted that the public portion of the debt does not include Treasury securities in the so-called trust funds for which interest is accrued for future payment and not paid out currently.)

A Global Perspective on Fiscal Sustainability

The 2012 edition of the Pocket World in Figures published by The Economist lists the world's gross domestic product (GDP) at about $63 trillion or approximately $11,000 per person in 2010. Since America's GDP should approximate $15 trillion by the end of 2011, this means that the United States is responsible for about one-quarter of the sum of economic activity in the world, or about $48,000 per American. The euro-zone, which now includes 17 European countries, is roughly equal to the United States in total and per person· GDP. China has a GDP of approximately $5 trillion, which is now in excess of Japan’s, Nevertheless, China's GDP per person is estimated at only $6,800 because of the enormity of its underutilized population.

Looking at the 10-year average annual growth rate by country through 2009, China is indexed at 10.3 per cent and India at 6.9 per cent, because both countries are trying to boost their domestic economies as well as their exports. The United States has a projected growth rate of only 2.5 per cent, although this rate is projected by many economists to increase as long as the county does not slide into a double dip recession. It should be noted that, when population growth is taken into consideration, Japan (and potentially some Western countries) has a big problem: Its population is aging and its birth rate is not increasing; thus, a smaller workforce will be required to supply the pension benefits for a growing retired and elderly majority. Japan has the world's oldest population according to the 2012 edition of The Economist's Pocket World in Figures, and this, together with high debt levels of 200 per cent of GDP in 2010 and a weak domestic economy showing no economic growth, could result in a deflationary spiral leading to a significant economic depression.

Against the backdrop of this global perspective, the US economy plays and will continue to play an important role in the future. In June 2003, I published an article, entitled "Cooking the Nation's Books'', in 171e National Law Journal. Because there are laws that affect the budget and accounting process in the United States, I wanted to have my opinions vetted by lawyers, not just by accountants. I especially wanted to make the legislative branches in the states and in Washington (where lawyers predominate) aware of the role that they have played in disguising the fiscal problems that America faces today and how they can fix them by· reforming the budget process. They especially need to review the accounting principles used in the budget process to make sure that all spending and commitments to spend in the future are recognized in the annual financial statements of the US government.

One must recognize that the political patties represent very different philosophies in Washington. Liberal Democrats will say that the federal government should keep spending money in order to keep the unemployment rate down. While that may be a good thing to do initially, at what point does the nation focus' on the fact that the national debt is becoming so large that just spending more and paying the interest on that debt can soon bankrupt America?

Europe is also facing a debt crisis of enormous proportions. Greece, Iceland, Ireland, and Portugal have technically defaulted on their debts. The extent of the problem was made clear when we learned in the spring of 2011 that Greece's debt equaled 150 per cent of its GDP. Meanwhile~ although the United States has a recognized national debt of approximately $15 trillion, amounting to approximately 100 per cent of its GDP, the real debt is much larger. In addition, actuaries have computed unfunded pension and entitlement liabilities for the United States as follows: $8 trillion for Social Security and $37 trillion for Medicare 52 Joseph J. DioGuardi Parts A, B, and D. When this $45 trillion total is added to $15 trillion, the national debt of the United States is approximately $60 trillion, which is an amazing 400 per cent of America's GDP.

Whether we are talking about the European debt crisis or the US national debt, the key word is "sustainability". Are Europe and America economically sustainable? Is a country able to sustain a certain level of debt based on its economic activity? In response to these questions, Stanford University sponsored a research project that came up with a sovereign fiscal responsibility index. Compared to 34 other countries, the United States was ranked low at 28. But if the budget reforms that Congressman Ryan. and President Obama's Debt Commission have recommended were implemented, the United States would be ranked at 16, as stated in the Sovereign Fiscal Responsibility Index 2011 produced by Stanford University's Public Policy and International Studies Program (see Table 1).

According to the Stanford study, there are several factors that go into determining a country's sovereign fiscal responsibility index. There is a "fiscal path'', which describes how a country's debt level is managed through time. "Fiscal status" concerns the level of a nation's debt and how it is determined. And, finally, "fiscal governance" describes the financial structure of a government and its budgeting and accounting processes in order to ascertain whether a country is fiscally responsible and transparent. Australia and New Zealand, for example, are ranked number 1 and 2, respectively, because they use GAAP accounting and have financial management systems and controls that restrain unnecessary spending and borrowing. By contrast; Greece has a zero "sovereign fiscal responsibility index'', and it is ranked last at 34 because it is technically in default and in need of a massive bailout. In short, Greece cannot borrow from others, is completely unsustainable as a nation, and is in dire need of massive external help and significant internal fiscal reforms.

Preserving the "Promise of America"

The debate that is taking place in America about the fiscal crisis and the national debt needs to take place in every country. The United States is spending money that it does not have and borrowing from foreign countries that do not share its commitment to democracy and human rights. (Major European countries like Spain, France, and Italy are heading down the same economically disastrous path.) As a result, the United States is threatening the very foundation of its democracy and the prospects of the next generation to achieve the American dream of self-development and prosperity. That dream motivated my father to immigrate to the United States in 1929 at the age. of 15 from a poor farming village in Italy. As his oldest child, I have benefited from the opportunity America offered my father and mother. The challenge that Americans face today is keeping the promise of America alive. That will not only be good for the future economic, political, and social sustainability of the United States but will serve as a shining example to other developed and less-developed countries around the world. I believe that this can be done only if the politicians tell the truth about what they are spending and if people learn to live within their means, work hard, and create a self-sustaining economy currently and for the future.

References

Augustine, T.J. et al., under the guidance of David M. Walker (2010). Sovereign Fiscal Responsibility Index 2011. Stanford: Stanford University and the Comeback America Initiative. www.tcaii.org/pefs/SFRI_Final_Report_ Executive_ Summary.pdf.

DioGuardi, Joseph J. (2003). "Cooking the Nation's Books", The National Law Journal. 23-30 June.

DioGuardi, Joseph J. (2010). Unaccountable Congress, It Doesn't Add Up. Revised edition. New York: Amazon.

The Economist (2012). Pocket World in Figures 2012 Edition. London: Profile Books, Ltd.