In this article, I'll reveal the fourth of the seven sins that I introduced in "Seven Deadly Sins of the Government Debt Debate - #1" (sin #1) and continued here and here (sins #2 and #3). And in case you missed the first three installments, the diagram below shows how the articles tie together. Seven sins are listed in the column on the right, seven topics in the column on the left, and we're playing word match with the two columns. Because I'd like to establish trust, we're using the honor system. If you'd like, you could skip to the end of the article to see my answer. But you'd feel bad about yourself afterwards. Not to mention missing out on all the wisdom I've embedded in the middle. The discussion covers topic #4: Entitlement Program Accounting.
Entitlement program accounting
Early in each calendar year, the Social Security Administration creates personalized statements for all working Americans. You may recall that your statement begins with this suggestion:
This Social Security Statement can help you plan for your financial future. It provides estimates of your Social Security benefits under current law and updates your latest reported earnings.
If your interpretation is the same as mine, you've concluded you should use your Social Security Statement for financial planning purposes. That seems to be the message in the words "help you plan for your financial future." And it's reinforced by a steady drumbeat of promises from our political leaders. Politicians' well-practiced attempts at empathy and sincerity are perhaps most apparent when they're swearing to protect our entitlement benefits. It's one of the easiest and most popular promises they can make. To exploit our entitlement programs to the fullest, a senatorial candidate in Pennsylvania has gone so far as to make his elderly mother the star of his commercials. His message: "My own mother receives these benefits, and no son would jeopardize that, right Mom?" After all, how could we not trust a son's promise to his dear mom?
To get from political promises to the word match category "entitlement program accounting," consider that promises of future payments need to be, well, accounted for. And entitlement promises are, of course, accounted for in the government's financial reports. No professional accounting organization would accept otherwise, and the Federal Accounting Standards Advisory Board is no exception. But wait, where exactly are they on these reports? Presumably, we should be able to find the effects of entitlement promises on the government's income statement and balance sheet. This is where any analyst would focus their attention. Income statements contain the bottom line, after all, and balance sheets are meant to report all of an entity's assets and liabilities. Where on these reports should we look?
The answer is: the costs of entitlement promises are relegated to separate sections that don't touch the primary reports. They don't appear in the Statement of Net Cost or in the Statement of Operating Cost and Changes in Net Position (equivalent to an income statement for a private company). Nor do they appear in the balance sheet. They're excluded from our principal financials on the flimsy excuse that entitlement laws could be altered in the future. Even as we're told to plan on them in our professional-looking and reassuring annual statements. And even as our elected representatives want us to believe that the sanctity of these benefits ranks somewhere alongside that of God and country. Oh, and mom, too.
You may argue that the information is still available for those willing to dig through 250 pages of financial results to find it. And that's partly true. Some of it appears after the primary statements in the Financial Report of the United States Government, under the headings "Statement of Social Insurance" and "Changes in Social Insurance Amounts." The problem is that the information is both ring-fenced from the key results and incomplete. The Financial Report only allows us to guess at the government's true net worth - this figure isn't explicitly reported. (And by the way, private estimates generally place it somewhere between -$50 and -$150 trillion.) The reported deficit is particularly vexing for anyone familiar with accounting principles. This should include the additional entitlement credits that we earn each year, according to the basic principle that expenses are recognized as they're incurred. Yet, the calculation appears nowhere in the Financial Report.
Jane Q. Public's perspective
For a program recipient's perspective, let's look at the retirement savings of Jane Q. Public, federal employee. She has a pension that's directly linked to her government service and also participates in Social Security and Medicare like any working American. Therefore, she earns two sets of retirement benefits from the same source - the U.S. government. Each type of benefit is accrued over time, meaning that it's earned as her service time grows. But the pension isn't visible on her paycheck, while Social Security and Medicare are clearly marked. These are the FICA and FICM deductions that remind her that she's sacrificing pay today in return for benefits tomorrow. And yet, from an accounting perspective, the government only recognizes its commitment to deliver the "invisible" pension benefits. It doesn't recognize the entitlement benefits, even though she funded them herself.
Imagine reviewing your bank's financial statements and finding that your banker doesn't consider your savings account to be quite real enough to recognize as a liability. The government's accounting methods for entitlement promises are no different. To make another comparison to the private sector, they're a lot like the unscrupulous practices of corporations who skirt the rules. When companies unexpectedly collapse, we usually find that they used accounting tricks to sustain the fiction of financial strength. Their tricks typically involve off-balance sheet structures that conceal large risks from anyone who reads their financials. In other words, our government's off-balance sheet accounting practices place it in the same category as Enron, Worldcom, Lehman Brothers, and so on. In each case, you can think of accounting shenanigans as a well-hidden time bomb that's easily overlooked until its eventual detonation. The difference is that the government's fuse is much longer.
But unfortunately, the length of the fuse is an indication of the size of the bomb. Our entitlement bomb has reached tremendous proportions - think Manhattan Project versus the weapons that came before - and it's still growing. And the accounting practices that disguise this growth are best described as subterfuge.
Check back next week for the next word match topic - net government debt.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.