Disappearing Deficits

By Tim Irwin

Suppose a government must reduce its budget deficit. Perhaps it made a commitment to do so; perhaps investors are beginning to doubt its ability to repay debt. It could cut spending or raise taxes, but that is painful and unpopular. What can it do?

In our work at the IMF, we sometimes discover that governments choose to employ accounting devices that make the deficit smaller without actually causing any pain, and without actually improving public finances.

In ideal accounting, this would not be possible. In real accounting, it sometimes is.

How the devices work

Some governments, for example, have been able to reduce their reported deficits by taking over companies’ pensions schemes. The government’s obligation to make future pension payments has a real cost, but it doesn’t count as a liability in the accounting. So when the government receives a pension scheme’s assets from the company, it can treat the receipt of those assets as revenue that reduces its deficit.

Many other governments have been able to defer spending, without significantly reducing it in the long run, by entering into public-private partnerships. Under these contracts, a private company builds and maintains an asset like a road or a hospital. In return, the government agrees to pay the company for its costs over 20 or 30 years. In a sense, the government has bought the asset on an installment plan, but government accounting seldom counts this obligation as a liability.

In each of the above cases—and in others analyzed in my note, Accounting Devices and Fiscal Illusions—the government’s deficit is lower at first, but only at the expense of bigger future deficits.

Improving transparency

The problem with the use of accounting devices is that the pain of spending cuts and tax increases is not avoided; it’s postponed and perhaps made worse. Accounting devices can also make the deficit a less accurate fiscal indicator, making it harder for citizens, journalists, think tanks, investors, rating agencies—and the government itself—to understand the true state of public finances.

The use of accounting devices cannot be eliminated, but several things can be done to reduce their use or at least bring them quickly to light:

  • Governments can prepare audited financial statements—income statement, cash-flow statement, and balance sheet—according to international accounting standards.
  • Statisticians can be given the resources and independence to be both expert and impartial, as well as the authority to revise standards in the light of emerging problems.
  • A variety of different indicators of the state of public finances can be monitored, since a problem suppressed in one indicator is likely to show up in another.

The chart below illustrates the last point and, in particular, shows the value of having two different indicators of the deficit in the United States. One is a mainly cash-based measure; the other, the net operating surplus, is more like the bottom line of a private company’s income statement. One cause of the difference between the two indicators is that the cost of incurring obligations to pay future pensions to government employees shows up in the net operating surplus but not in the budget surplus.

These proposals do create more work for government accountants and statisticians, but the problems created by accounting devices cannot be solved with the stroke of a pen. Getting an accurate picture of government finances requires hard work, careful checks, and a willingness on the part of analysts to look at several different measures of the deficit.

7 Responses

  1. […] is  authors’ post on the  paper and interview of the […]

  2. Joke:

    What was the accountant’s response when asked by the CEO what is the net income for the company?

    The Accountant’s response: What would you like it to be?

    Accounting is like anything else created by men … it can be used for good as well as evil. That is why fiscal policy making is an art. There will always be individuals/governments trying to game the system. Therefore, it is critical for organizations to have in place proper controls, checks and balances. Great paper.

  3. If governments get involved then it’s classed as Socialism; if governments don’t get involved, it’s classed as extreme Capitalism!

    When governments cut spending and raise taxes, it is all on the majority, but for the business elites they still enjoy all the benefits of “dictating to the government” about tax cuts/subsidies and write-offs.

    There is no way to fix it because of the actual financial system we have. The only way to fix it is to change the system!

  4. Devices look nice, but what happens if a government is overthrown or not following the guidelines

  5. […] Deficits Read more: http://blog-imfdirect.imf.org/2012/03/28/disappearing-deficits/ Share this:TwitterFacebookLike this:LikeBe the first to like this post. […]

  6. This accounting ingenuity is supposedly initiated and operated by the central government departments: Ministries of Finance, Treasury, Exchequer etc. In many instances, the deployment of these accounting devices is done with full knowledge of their financial implications. Covert processes gradually become overt and may go undetected for many years.The real problem is to have preventive mechanisms before transitioning to the “ideal” accounting and financial reporting. The role of external oversight and surveillance institutions to stem the issues is not entirely clear.

  7. If you have a fake masterpiece painting on your wall that you believe authentic, what can you benefit by exiting from your blissful ignorance?

    Jest aside, it is clear that most of the governmental miss-accounting, were it to occur in the private sector, our prisons would be even more overcrowded.

    The real question though is how to correct for the errors without having the transition to full accuracy going too fast and killing you in the process? Somewhat alike to how fast should banks be made to replenish what capital regulators should have ordered them to have from the very start–as a reserve for many of the ex-antes turning out wrong ex-posts !

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