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by Douglas Duncan

A chief way the federal government can get its fiscal house in order is through the adoption of a financial accounting process. By that I mean the way government conducts its financial business and represents it to the public. The current federal budget process is pitiful both in its structure and in the way it is developed. If the Congress and the Executive were a freshman accounting class, they would be expelled from school for cheating. This fact is not unrelated to the recent election results.

The predominant method of financial accounting used in the business world is called Generally Accepted Accounting Principles (GAAP). Constantly under review for adaptation to changes that emerge in dynamic markets, these principles have assisted in making the United States markets the best in the world in providing consumers and investors with indicators of financial health and prospects. There is no logical argument against the application of GAAP to structuring the federal budget. Rather, a variety of plaintive cries by elected representatives emerge which, upon scrutiny, reveal unwillingness to be honest about the assets and liabilities on the national balance sheet and about the collection and allocation (current and future) of tax revenues.

This failure to follow basic accounting principles at the federal level leads to all sorts of trickery. For example, in the business world, items are not "off budget" where they need not be considered on the financial statements of the firm. If they are a liability of the firm, they must show on the firm's balance sheet. If there are both revenues and expenses from an activity, both must be recognized, rather than just the revenue.

As noted above, the federal government has a variety of "off budget" items. Many of these were born when the Gramm-Rudman deficit reduction plan was put in place in the 1980s. Contrary to reports in the popular press, Gramm-Rudman was very effective and created a crisis for the Congress. They would either have to cut expenditures to control budget expenses or evade the law. They evaded the law through the "off budget" methodology until they got President Bush to assist in killing Gramm-Rudman. The term "off budget" should be read "requires too much courage or honesty to account for accurately."

Prior Congresses found that the American voter felt quite strongly that an important role for the federal government was providing for the common defense. This made it tough to cut the defense budget. The next best thing was to load overhead from other less popular departments and programs onto the Defense budget by calling them defense expenditures.

Because of its huge political and economic implications, Social Security spawns more creative accounting ploys than any other federal program. At present the government counts the taxes collected for Social Security as revenue and spends the bulk of this revenue on current benefits. There is no reserve fund. The Social Security surplus that we hear of is a result of the large size of the baby boomer generation and their current income earning level relative to the recipient population. When the "boomers" move to retirement, outflows will exceed inflows. Since surplus Social Security tax revenue must be invested in obligations of the federal government, we are financing the current budget deficit with revenues designed to fund future obligations of Social Security.

To summarize what needs to be done on the structure side of the budget:

• apply business accounting principles to the federal budget;

• eliminate "off budget" trickery;

• account for all contingent claims;

• stop perverting the Defense Department budget with nondefense overhead; and

• make every insurance program actuarially sound.

Of equal duplicity to the structure of the budget is the way it is developed. Here the words "budget reduction" do not mean "spending less than last year" but rather "spending less than we intended." The distinction is critical as one of them is actually an increase in spending.

When the budget planning process is put into motion, a "base-line scenario" is developed. This scenario automatically assumes spending will increase over the previous year. This is because of built-in accelerators in individual program spending. The baseline says, "If everything continues into next year with no alterations, spending on program X will increase 5 percent."

After looking at the baseline, the Congress or White House may see that there is political good will to be gained by announcing a spending cut. They return to program X and propose that its spending increase be held to 3 percent next year and grandly announce that spending on program X has been cut 2 percent (or better yet announce it in dollars since the dollar amount will be large). In fact, we now see it hasn't been cut at all. It just doesn't increase as fast.

The cure for this dishonest process is what is called "zero-based" budgeting. That means that every program in the budget begins with zero dollars to spend. The Congress and the White House then debate the merits of the program and its appropriate level of funding without assuming it need exist at all. Zero-based budgeting in combination with "Sunset Provisions" (automatic expiration of legislation) is anathema to spenders.

Finally, we need a formal way to account for the cost imposed on private individuals and companies from the imposition of federal regulations. (This also applies to mandates passed from the federal government to lower levels of government.) Such regulations include forced changes in business practices which are costly or the devaluation of private property through federal restriction in the use of private property (called "takings"). There should be standard procedures for assessment of these costs. The assessment should require private sector input and a formal budget for these costs.

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