Accrual accounting dodges a bullet, but …
Double-entry, accrual-based accounting systems can help secure accountability and financial stability in private and public organizations. Accrual accounting is an important bedrock, but not without defenders.
In recent years, the Governmental Accounting Standards Board (GASB) embarked on a fundamental reexamination of its financial reporting model. GASB’s proposals appeared likely to reinforce existing unreliable and misleading cash-basis-like principles for state and local governmental funds statements. But in recent months, GASB has at least pulled back from trying to claim that its proposals are grounded in accrual accounting principles.
School districts depend on the financial stability of relevant local and state governments, including public pension plans. Flimsy, misleading accounting standards for governmental funds accounts have long enabled many local and state governments to advertise balanced budgets, even as they accumulated massive on-and-off-balance-sheet debt undermining their financial sustainability.
For one example, in October 2014, prior to his last reelection as Mayor of the City of Chicago, Rahm Emanuel made an extraordinary claim. A city press release titled “Mayor Emanuel Presents Balanced 2015 Budget to the City Council” included the following:
“To balance our budget for the past three years without any increase in property, sales or gas taxes was only possible by changing the way Chicago does its business,” Mayor Emanuel said. “We have reduced our structural deficit by making city government smaller, smarter, and simpler.”
There are words, and there are deeds, the saying goes. For state and local governments, there are budget reports, and there are accrual-accounting-based results arriving in the government-wide Statement of Net Position and Statement of Activities. In each of the four years ended in 2014, amidst Emanuel’s ‘balanced budgets,’ the City of Chicago’s accrual-based revenue fell short of expenses by more than a billion dollars a year. The City’s unrestricted net position (akin to shareholders’ equity in corporate statements) fell from (negative) $7.2 billion in 2011 to (negative) $11.7 billion in 2014.
In 2015, at a public meeting, I went up to a member of the Finance Committee of the Chicago City Council, and asked how the city could claim to balance its budget according to state law when its revenues fell short of expenses by a billion dollars a year every year. He was almost proud in his response. “We borrow the money! We have access to the markets!”
Anticipated borrowing proceeds (planning to run up the credit card) isn’t the only way to deceptively ‘balance’ government budgets. Deliberately underfunding pension and other retirement obligations can also reduce short-term cash outflows, but long-term consequences.
Back in June 2020, GASB issued an optimistically titled exposure draft, “Financial Reporting Model Improvements.” A few days earlier, they issued another exposure draft, “Recognition of Elements of Financial Statements.” The former could lead to a new standard, and the latter to a new fundamental concept statement.
Together, however, the two exposure drafts would have tried not only to reinforce past practices leading to unreliable funds statements, but they also would have tried to claim the “improved” practices constitute accrual accounting, not the “modified accrual” practices from the past.
The GASB is now in its “redeliberations” phase on these projects, including over comment letters received on its exposure drafts. Those comment letters included the following from Martin Ives, former GASB member:
“I strongly disagree with the Board’s proposed concepts statement, primarily because it continues to exclude – in fund financial reporting – significant long-term liabilities arising from pension and OPEB transactions and events. The proposal refers to the MFBA as “short-term measurement focus and accrual basis of accounting.” As discussed in Comment 1, accrual basis accounting requires reporting of long-term liabilities arising from operating transactions such as pension benefits and OPEB. … Hence, what is accruable for government-wide reporting is not accrued for fund reporting. In my opinion, stating that the Board’s proposal regarding fund reporting results in the “accrual basis of accounting” is grossly misleading and must be dropped.”
Mr. Ives wasn’t alone.
The commenters appear to have made an impact. Reporting on developments from its latest meeting (November 2021) on the “Conceptual Framework: Recognition” project, GASB stated:
“The Board continued redeliberations of the Conceptual Framework—Recognition and the Financial Reporting Model projects by discussing the name of the measurement focus and basis of accounting for governmental fund financial statements. The Board discussed whether any modifications should be made to the name short-term financial resources measurement focus as proposed in the Exposure Drafts, Recognition of Elements of Financial Statements (Concepts ED), and Financial Reporting Model Improvements (Financial Reporting ED), and tentatively decided that the name of the measurement focus should be retained. The Board then discussed whether any changes should be made to the use of accrual to describe the basis of accounting proposed in the EDs and tentatively decided that the basis of accounting for governmental fund financial statements should be identified as the modified accrual basis of accounting.”
Full accrual accounting for “governmental funds” should be the benchmark, but at least they aren’t trying to stretch the meaning of accrual accounting anymore. School districts, citizens and taxpayers more generally should remain watchful, however, over government “budget-balancing.”
Budgets get lots of ink.
By Bill Bergman. March 28, 2022
President Biden will be presenting his Fiscal 2023 budget today. The budget has already received a lot of attention. But its worth a quick note that budgets always get lots of attention, and to contrast their popularity with the deafening silence that accompanied the federal government’s issuance of audited financial statements for Fiscal 2021 about a month ago. Unfortunately, budgets are where the action (and eyeballls) are, because people care more about spending money than accounting for it.
Bob Laurent: Selected ‘Thank Yous’ from his economics PhD dissertation at the University of Chicago
From March 22, by Bill Bergman, includes “Bob was my best professional friend and mentor at the Federal Reserve of Chicago. A longer story. Here are some relevant sentences from his opening ‘Acknowledgments’ page from his economics PhD dissertation for the University of Chicago. ‘A particular debt of gratitude is owed to Professors Milton Friedman and Lester Telser for their aid and guidance in the course of this work. The work was completed while I was at the Federal Reserve Bank of Chicago. The entire staff of the bank was helpful at every juncture but I am particularly indebted to George Kaufman. The library staff and publications section also rendered invaluable aid. …’ I’m especially fond of Bob’s genuine appreciation for the librarians — and for his fearlessness. And I’m reminded of how I met with Lester Telser after leaving the Chicago Fed, after Bob was pushed out of there too, and how Telser said simply and firmly ‘That place is mismanaged.’ …”
Paul Douglas: Economics professor, Chicago alderman, and U.S. Senator
By Bill Bergman. March 18, 2022
There’s a new book coming out about the ‘Chicago School’ of economics. I contributed a chapter about Paul Douglas, an enigmatic member of the legendary University of Chicago economics department. Douglas was a socialist leader in his younger years, but over time he developed a strong backbone for fiscal conservatism, and he was writing insightful and inspirational ‘public choice school of economics’ material before people talked about a ‘public choice school of economics.’ His 1952 book Economy in the National Government is valuable reading today. It included a closing chapter titled “The Budget Must Be Balanced!”
Below I simply transcribe some of the material for you.
Have a nice weekend.
Bill
Paul H. Douglas, Economy in the National Government; The University of Chicago Press (1952)
Chapter 10 -- “The Budget Must Be Balanced”
"… In the first place, the public interest in economy is diffused. Any one appropriation means very little to an individual taxpayer. … He is interested in economy, but it is a diffused interest, not a concentrated one. The public interest is weak as Congress makes its decisions, as it must, on individual items.
On the other hand, those who benefit from given piece of waste or from a subsidy or from an unnecessary public works project have a vested, concentrated and powerful interest to maintain or increase their gain. In the struggle between the concentrated private interest and the diffused general interest, the former usually wins.
… Even strong advocates of reduced government spending fight hard for their own special benefits. Local chambers of commerce, for example, provide one of the most vehement voices in favor of general economy. Yet many of these chambers of commerce are also powerful promoters for rivers and harbors improvements and public works in their particular localities.
… Government employees resent having their numbers diminished and want expanding opportunities for employment. This is true not only of the government employees themselves but of their friends.
… The individual groups, in order to achieve their ends and to protect their particular interests, tacitly combine with one another. … The total result is that each particular group tends to get what it wants: and there are more and more expenditures for more and more groups.
The further result is a fine paradox. Everybody is for economy as a general principle; but no one can get his special privilege unless he consents to special privileges for others. As groups win their battle for special expenditures, they lose the more important war for general economy. They cannot have both victories, and they sacrifice the general need for economy in favor of their own special interest. They are like drunkards who shout for temperance in the intervals between cocktails.
… If we are to trim waste out of the budget, the cuts will primarily have to come from the people and from the legislative branch. They will not come from the executive branch.
… We need a citizens’ committee to help eliminate waste from the federal government. … A continuing citizens’ committee on economy would be a big help to Congress in pushing through economy measures just as the citizens’ committee for the Hoover Report was helpful in pushing for administrative reorganization.
… We have a very important agent in the Comptroller-General of the United States. He is responsible to Congress, not to the executive.
… The very life of our nation is in danger. We can come through this difficult time only if we all resolutely put the interests of the nation ahead of the interests of our particular group. We can prevent inflation only if members of Congress, civil administrators, the military leaders, and the various groups in the country subordinate their individual selfish interest to the national welfare."
Want ‘skin in the game?’ End income tax withholding
By Bill Bergman. March 12, 2022
Florida Senator Rick Scott recently kicked over a beehive when he included an income tax increase for most Americans in his 11-point plan to ‘Rescue America.’ The fifth point of that plan, titled ‘Economy/Growth,’ included ‘All Americans should pay some income tax to have skin in the game, even if a small amount. Currently over half of Americans pay no income tax.’
How does this happen? Many low-to-moderate income households have standard deductions and child tax credits that effectively eliminate their federal income tax liability.
Why should they have ‘skin in the game?’ There’s a good argument that many taxpayers – and voters – would be significantly less likely to vote for politicians supporting expensive government programs if they had to pay a price for them.
However, if a federal income tax has to exist (it doesn’t have to, of course), there is a better way to sensitize Americans to the cost of government. It could be pursued of its own accord, or in conjunction with a minimum income tax for all.
In World War II, the federal government laid the modern framework for income tax collection in the “Current Tax Payment Act of 1943.” The federal government forced employers to set aside a portion of the paychecks for their employees and send it to the government, adding income tax collection services to employers’ legal responsibilities.
The practice didn’t expire with the end of World War II, given its attractiveness to government and special interest groups benefitting from government spending and other policies.
Income tax withholding dramatically improved the government’s ability to raise revenue, but it also desensitized taxpayers to the cost of taxes.
Consider an alternative – a law forbidding the federal government from skimming paychecks like this. Instead, individual income taxpayers would calculate their income tax liability like they do now, but they would have to pay any tax liability after it was calculated.
This isn’t just about ‘skin in the game.’ Ending income tax withholding would improve the transparency and integrity of the tax system, period.
But income tax withholding has been an attractive, powerful tool in the government’s toolbox. It remains firmly entrenched. Republicans and Democrats alike don’t want to touch it. It didn’t find its way into Gov. Scott’s 11-point plan, even as he expressed a desire for all Americans to have some ‘skin in the game.’
One possible downside to ending income tax withholding could be that government would borrow more money if extracting taxes proved more politically problematic. But that would be a challenge for another day.
Speaking of challenges for another day, consider whether Social Security and Medicare withholding should be part of this.
But ending income tax withholding, today, could be a great step forward. Who in Congress will step forward?
What, exactly, would ‘repealing the income tax’ involve?
By Bill Bergman. March 13, 2022
Section 2.0 of the Libertarian Party Platform calls for “the repeal of the income tax.” This provision refers to “income tax” in singular, which might imply it is referring only to the federal income tax. If so, this may leave open a question whether the Libertarian Party also calls for repealing income taxes levied by state and local governments.
Focusing on the federal income tax, for now, how would the income tax be repealed?
Repealing something means getting rid of something. But “repeal” has a specific legal meaning, relating to laws, specifically. The Legal Information Institute has developed “Wex,” an open dictionary/encyclopedia of legal terms. The Wex definition for repeal notes that there are two ways to repeal a law – enactment of a new law, or passage of a constitutional amendment.
Repeals can also be explicit or implicit. When a new legislative act is inconsistent with a previous law, it may implicitly repeal the earlier law, depending on interpretation by the court system. Laws are more certainly “repealed” when a new law or amendment explicitly identifies the law or laws at issue.
So, how could the income tax be repealed? Again, “repeal” does not refer to getting rid of a practice, or an organization, but laws. In this case, the relevant laws would certainly include much of Title 26, “Income Taxes,” of the United States Code. Congress could pass a law explicitly repealing the income tax provisions in this section of the federal code – for individuals as well as corporations and other organizations. Alternatively, the U.S. Constitution might be amended, with an amendment provision explicitly repealing the relevant sections of Title 26.
What would happen once federal income tax laws were repealed? Federal income taxes constituted nearly 90% of federal government revenue last year, so this would immediately threaten massive amounts of government spending. Pressures would build on Congress to borrow more money, raising the prospect of higher future taxes outside of income taxes -- including inflation.
Any repeal of the federal income tax would most valuably be joined at the altar by a commitment to dramatically reduce government spending – and radically revising or eliminating Social Security and Medicare. By definition, repeal of the federal income tax would also eliminate income tax withholding, including withholding “dedicated” (ha!) to Social Security and Medicare.
These implications are consistent with two other elements of the Libertarian Party Platform. Section 2.4 of the platform includes “We oppose any legal requirements forcing employers to serve as tax collectors.” And Section 2.14 includes “Retirement planning is the responsibility of the individual, not the government. Libertarians would phase out the current government-sponsored Social Security system and transition to a private voluntary system.”
