Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / Why Government Budgets Use Accrual Accounting
Transcript
- Lucas: So here's a question that sounds like an accounting nerd trap but actually gets at something fundamental: when the government says it's spending $500 million on a new bridge, does that $500 million represent the full cost of that bridge? Luna: I'm guessing the answer is no, but I want to hear why. Lucas: Right — because the government budgets on a cash basis. It records the cash that goes out the door in the year it goes out. So year one, you spend $500 million on construction. That's the budget line. But the bridge will need maintenance for fifty years — repaving, structural repairs, snow removal. Those costs might total another $2 billion over the bridge's life. None of that appears on the budget when the bridge is approved. Luna: So the decision to build the bridge is based on a fraction of the real cost. That seems like a pretty big blind spot. Lucas: It's the standard way governments have done it for centuries. Every dollar that leaves the treasury shows up in the year it leaves. But it means the government's budget is essentially a checkbook register — not a full picture of what it owes or what its assets are worth. In the private sector, companies are required to use accrual accounting. When you sell a product on credit, you record the revenue even before the cash arrives. When you sign a lease for a warehouse, you record the liability for the full lease term, not just this year's payment. Luna: And that gives investors a much clearer picture of the company's financial health. So why don't governments do the same? Lucas: It's partly tradition, partly politics, and partly genuine complexity. But a few governments have tried. New Zealand was the pioneer — in the early 1990s, it became the first national government to adopt full accrual accounting for its budget and financial statements. The Treasury of New Zealand publishes a balance sheet that includes things like the value of the country's roads and bridges as assets, and the expected cost of future pension payments as liabilities. Luna: Did it change how they made decisions? Lucas: In some cases, yes. When you see the full lifecycle cost of an asset, you start asking different questions. For example, New Zealand's defense ministry had to account for the future cost of maintaining a piece of military equipment before buying it. That led to some purchases being reconsidered. But it's not a silver bullet — you still have political incentives to spend today and push costs to tomorrow. Luna: And in the United States, we have a sort of split system. The federal budget is cash-based, but the government also produces accrual-based financial statements every year. Lucas: Exactly. The Department of the Treasury and the Office of Management and Budget publish something called the Financial Report of the United States Government. It's prepared on an accrual basis, and it includes a balance sheet. The most recent report — for fiscal year 2025 — showed total federal liabilities of about $45 trillion, including $27 trillion in Social Security and Medicare obligations over the next 75 years. But the official budget, which Congress debates, doesn't show those numbers. Luna: So the financial report tells you the government is $45 trillion in the hole, but the budget debate is about whether to spend an extra $50 billion on a program next year. Those two things exist in different universes. Lucas: That's exactly the problem. And it's not just the federal level. States and cities also budget on a cash basis for the most part. But many of them have huge future liabilities — especially for public employee pensions. A city might have a balanced budget this year while its pension fund is underfunded by hundreds of millions. Under cash accounting, that underfunding doesn't show up until the city actually has to write a bigger check to the pension fund decades later. Luna: And by then, the politicians who made the decisions are long gone. Lucas: Right. So the question is: would accrual budgeting actually change behavior? The evidence is mixed. New Zealand's experience suggests it can improve cost awareness for capital projects. But it doesn't eliminate the basic political incentive to defer costs. If voters reward you for cutting taxes today and don't punish you for the future liability, you'll still cut taxes. Luna: It's almost like the accounting method is a technology, and the political system is the user. You can give them better information, but if they don't want to act on it, it doesn't matter. Lucas: That's a really good framing. And it points to a deeper issue: the budget itself is a political document, not just a financial one. The cash basis lets policymakers tell a story: 'We spent X on roads this year.' Accrual accounting forces them to tell a different story: 'We committed future taxpayers to Y in maintenance.' That second story is harder to sell. Luna: And it's also harder to measure. How do you estimate the maintenance cost of a bridge fifty years from now? That's a lot of assumptions. Lucas: Absolutely. Accrual accounting requires estimates — for depreciation, for future obligations, for contingent liabilities. Those estimates can be wrong. In the private sector, auditors check them. For governments, there's less external oversight, and the numbers can be politicized. When New Zealand's defense ministry tried to estimate future maintenance costs for a new naval frigate, the numbers were hotly contested. Luna: So accrual accounting isn't a perfect fix. But it seems like a step toward transparency. The question is whether voters and politicians want that transparency. Lucas: Speaking of transparency and the kind of conversations we try to have on this show — if walking through the economy with us has made something click, we'd love for you to consider supporting the show. We keep it ad-free, and listener support is what makes that possible. You can find us at buy me a coffee dot com slash fexingo. No pressure, just putting it out there. Luna: Yeah, it's a small way to help keep these conversations going. And it really does make a difference. Lucas: So back to the accounting question. There is one area where the U.S. government actually uses a form of accrual accounting in its budget process, and that's for federal credit programs — things like student loans and mortgage guarantees. The Credit Reform Act of 1990 requires the budget to record the estimated subsidy cost of a loan in the year the loan is made, not when the cash flows happen. Luna: That's interesting. So if the government makes a $10,000 student loan that it expects to lose $1,000 on, it has to budget $1,000 in the year it makes the loan, not the $10,000 cash outflow. Lucas: Exactly. That was a big reform. Before 1990, the budget showed the full $10,000 as spending in the year the loan was disbursed, even though the government expected to get most of it back. That made loan programs look much more expensive than they actually were. The reform gave policymakers a more accurate picture. But it's one of the only areas where accrual thinking has penetrated the U.S. budget. Luna: So there is precedent. It's not like accrual budgeting is impossible. It's just politically difficult to expand. Lucas: Right. And there are genuine technical challenges. The federal government is so large and complex that producing accrual-based financial statements is a massive undertaking. The Financial Report I mentioned often comes out months late, and the Government Accountability Office has not been able to give it a clean audit opinion — partly because of the Department of Defense's accounting systems. Luna: The Pentagon's books. That's a whole other can of worms. Lucas: It is. But the fact that the financial statements exist at all shows it's possible. The gap is between what the executive branch reports and what Congress budgets. Congress still operates on a cash basis, and that's where the power lies. So any move to accrual budgeting would require Congress to change its own rules. Luna: And that's a heavy lift. But there are some small steps. I know a few states have experimented with accrual-based capital budgeting. For example, Virginia requires a 'life-cycle cost analysis' for major capital projects over a certain size. Lucas: That's a good example. Virginia's approach doesn't go all the way to full accrual budgeting, but it forces agencies to estimate the total cost of owning an asset — not just building it. That kind of partial reform might be the most politically feasible path. You don't have to overhaul the entire budget system. You just add a few lines that show the future costs. Luna: And then voters and journalists can start paying attention to those lines. That's where transparency really comes from — not just the accounting method, but people using the information. Lucas: Exactly. The accounting method is a tool. It's not the whole solution. But if you don't have the tool, you can't even start the conversation. And right now, for most government spending, we're having the conversation without the tool. Luna: It's like trying to manage a household budget by only looking at your checking account balance and ignoring your credit card debt. You might think you're fine until the bill comes due. Lucas: That's the analogy that always works. And it's the reason why, at the end of the day, accrual accounting matters. It's not about being more 'correct' in some abstract sense. It's about giving decision-makers — and the public — a fuller picture of the trade-offs they're making. Luna: So the next time you hear a politician say a project is 'fully funded,' you might ask: fully funded for construction, or fully funded for the next fifty years? Lucas: That's exactly the question. And the answer, nine times out of ten, is the first one.