Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Accounting Rules Make a Trillion-Dollar Deficit Look Small
Transcript
- Lucas: The official federal budget deficit for fiscal year 2026 is projected around one point five trillion dollars — a number that gets cited in every policy debate. But that number is built on accounting rules that would get a private company's CFO fired. Luna: Which specific rule are we talking about? Because there are a lot of candidates here. Lucas: Let's focus on one that has an outsized effect this year: how the government accounts for its student loan portfolio. Under the Credit Reform Act of 1990, when the government issues a new student loan, it books the expected net present value of future repayments as revenue — immediately. So in the year the loan is made, the budget shows a profit, even if history suggests a large share will default. Luna: Wait — so the government treats the face value of the loan as an asset, subtracts the estimated subsidy cost, and if the subsidy cost is low enough, loan issuance actually reduces the deficit? Lucas: Exactly. And the subsidy cost estimate is based on the government's own cost of borrowing — the Treasury rate — not the risk-adjusted rate a private lender would use. That makes the estimated subsidy cost artificially low, because the government's borrowing rate is lower than what a private bank would charge for the same risk. Luna: So the cheaper the government can borrow, the smaller the expected loss on loans looks, and the more loan issuance looks like a money-maker on the books. Lucas: Right. In fiscal year 2025, the Congressional Budget Office estimated that new student loans would actually produce a net positive return for the government under that methodology — meaning the budget showed loan issuance reducing the deficit by about four billion dollars. If you used private-sector fair-value accounting, which discounts expected cash flows at a market rate that reflects actual default risk, those same loans would show a net cost of roughly twenty billion dollars. Luna: That's a swing of twenty-four billion dollars in one year, just from changing the discount rate. And nobody in Congress has to vote on that — it's embedded in the accounting rule. Lucas: And it's not just student loans. The same kind of gimmick affects the Highway Trust Fund. The fund is legally required to maintain a positive balance, but the government accounts for it on a cash basis — so when the trust fund runs low, Congress can simply transfer general revenue into it and call it a loan, even if the loan will never be repaid. The Office of Management and Budget then books the transfer as an asset, not a cost. Luna: So you get this weird situation where the government lends itself money, calls it an asset, and the official deficit stays lower than the real cash shortfall. Lucas: Exactly. Some analysts, like the Peterson Foundation, estimate that if you adjusted the federal budget to use accrual accounting — similar to what public companies use — the deficit for 2025 would have been about two hundred billion dollars larger than the official number. That's a twelve percent increase. Luna: And that's without even touching the big one: unfunded pension liabilities for Social Security and Medicare, which are off-budget entirely. Lucas: Right. Those show up in the 'long-term projections' but not in the annual deficit. So the one-point-five-trillion figure is already an undercount by several hundred billion, and that's before you consider the implicit liabilities that aren't counted at all. Luna: It makes you wonder why there's so much focus on the exact deficit number when the definition of the number is so malleable. Lucas: The politics of it is that the official deficit is what triggers budget enforcement rules — PAYGO, sequestration, debt-limit debates. If you redefined the deficit to include all the off-budget stuff, those triggers would fire constantly, and Congress doesn't want that. So the accounting system is designed to keep the number manageable. Luna: And the Credit Reform Act was originally sold as a way to make loan programs more transparent — to force the government to recognize the cost of subsidies upfront instead of hiding them in future defaults. Lucas: That was the intent, and it did improve transparency relative to the old cash-based system where the cost of a loan only appeared when the borrower defaulted years later. But the choice of discount rate — using the Treasury rate instead of a market rate — means the upfront cost is systematically understated. Every scholar who has studied this, from Deborah Lucas at MIT to the Government Accountability Office, has recommended switching to fair-value accounting. And Congress hasn't done it. Luna: Because adopting fair-value accounting would instantly make the deficit look bigger, and no one wants to vote for that. Lucas: Exactly. There have been bills — Senator Corker introduced one years ago — but they never got traction. The CBO itself publishes a fair-value estimate every year in its budget options volume, so the information exists. It's just not the official number. Luna: So when we hear that the deficit is one point five trillion, what's the real number we should have in our heads? Lucas: If you use fair-value accounting for credit programs, adjust for the Highway Trust Fund gimmick, and include the annual change in the present value of Social Security and Medicare's unfunded obligations, you're probably looking at something closer to two point two to two point five trillion for fiscal 2026. Meaning the true deficit is roughly fifty to sixty percent larger than what's reported. Luna: That's a staggering gap. And it's not a partisan issue — both parties have an interest in keeping the official number low because it gives them more room to pass spending or tax cuts. Lucas: Right. So the next time you see a headline about the deficit shrinking or growing, it's worth asking: which deficit? Because the answer can change by trillions depending on the accounting rulebook you're using. Luna: And if you're someone who likes to dig into these numbers and understand how the government actually spends money, this show has probably saved you hours of reading through arcane budget documents. Lucas: It definitely has for me. And look, putting these episodes together takes real work — research, fact-checking, scripting. If you've gotten something out of walking through the economy with us, a couple of dollars a month at buymeacoffee dot com slash fexingo genuinely makes a difference. No pressure, just know it's appreciated. Luna: Yeah, it keeps the show ad-free and independent. And if that's not your thing, no worries — we're glad you're listening either way. Lucas: Back to the numbers — one concrete example from this year's budget: the Department of Education's budget request for 2026 included a line item that showed a net negative subsidy rate for new direct loans, meaning the government expects to make money on them. That's a direct consequence of using the Treasury rate. If you applied a private-sector discount rate, that line item would flip to a positive cost. Luna: So the government is literally booking profit on loans that, under any realistic risk assessment, will lose money. That's the kind of detail that makes you question every official budget number you see. Lucas: It should. And the fix is simple on paper: Congress could amend the Credit Reform Act to require fair-value discounting. It would make the deficit look worse in the short term, but it would give policymakers and the public a much more honest picture of the government's financial position. Whether that ever happens is a political question — but at least now you know what to look for.