Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Accounting Hides True Costs
Transcript
- Lucas: Let’s start with a number that feels almost too clean to be real. The federal government recently reported a deficit of roughly one point six trillion dollars for the last fiscal year. It’s a big number, sure, but it’s also a specific, bounded figure that policymakers can point to in hearings. They treat it like a scorecard, something you can fix by cutting spending or raising taxes. Luna: But that scorecard only counts what actually left the Treasury account that year, right? It ignores all the promises made today that will cost us tomorrow. Lucas: Exactly. And that is where the illusion begins. The United States operates on what accountants call modified cash basis accounting. If I buy a house today but pay for it over thirty years, my household budget looks terrible if I count the whole price upfront, but manageable if I just track monthly mortgage payments. The government does the latter, but on a scale that distorts reality. Luna: So when they say they spent three hundred billion on defense, that’s only the checks written this year, not the equipment contracts signed for delivery next decade? Lucas: Precisely. And it gets worse with entitlements. When Social Security or Medicare pays out a benefit, it shows up as an immediate expense. But the obligation to pay those benefits for decades to come? That doesn’t hit the annual deficit line until the check is actually cut. This creates a lag so profound that the current budget snapshot is essentially a photograph of yesterday’s transactions, not today’s commitments. Luna: That sounds like a classic case of kicking the can down the road, except the road is infinite. Lucas: It is. Consider the Medicare Trust Fund. The annual budget might show a modest shortfall because premiums and payroll taxes cover most of the current payouts. But the Congressional Budget Office estimates unfunded obligations for Medicare alone exceed ten trillion dollars over the next seventy-five years. That number doesn’t appear in the yearly deficit because those payments haven’t happened yet. Luna: Ten trillion is basically the entire GDP of Germany. How do you convince voters that a ten trillion dollar ghost is a problem when their tax bill looks normal today? Lucas: You don’t, which is why the system persists. Full accrual accounting would force those future liabilities onto the balance sheet immediately. If we did that, the government’s net worth wouldn’t just be negative; it would be deeply, structurally insolvent. Politicians prefer a ledger that balances on the surface, even if the foundation is crumbling. Luna: Doesn’t the Government Accountability Office push back on this? They seem to advocate for accrual methods constantly. Lucas: They do, and they publish detailed reports highlighting the discrepancy. But these reports go straight into a drawer. The Office of Management and Budget controls the actual execution of the budget, and they have no incentive to switch. Accrual accounting makes borrowing look expensive instantly. Cash accounting lets you borrow against future revenue without admitting you’re already underwater. Luna: It’s like buying a car on credit but only counting the interest payment as your monthly expense, ignoring the principal entirely. Lucas: A perfect analogy. And here is the kicker: the private sector has largely abandoned cash basis for large-scale operations. Publicly traded companies must use accrual accounting under GAAP rules. Investors demand to see liabilities matched against revenues in the same period. Why should taxpayers accept a lower standard than shareholders? Luna: Because shareholders can sell their stock and leave. Taxpayers are stuck with the country. Lucas: True. But let’s look at a concrete example from the Department of Defense. Last year, they obligated two hundred billion dollars for new fighter jets. In cash terms, maybe eighty billion changed hands. The rest is a promise. Under accrual, the entire two hundred billion reduces your fiscal capacity immediately. Under cash, you only feel the pain in installments, diluting the urgency of the decision. Luna: So the government effectively subsidizes its own bad decisions by spreading the cost out indefinitely. That encourages overspending. Lucas: It absolutely does. It creates a moral hazard on a national scale. If I know I can sign a contract today and pay for it in twenty years, I’m likely to sign more contracts today. This is why infrastructure projects always blow past their initial estimates. The true cost isn’t reflected in the approval phase because the approval phase only looks at immediate outlays. Luna: What about the bond market? Do investors care about this accounting trick? Lucas: Smart investors do. They look beyond the headline deficit. They analyze the primary balance and the growth-adjusted deficit. They know that a one-point-six-trillion-dollar deficit is only half the story if unfunded liabilities are growing faster than nominal GDP. The yield spreads on long-term Treasuries reflect this anxiety, even if the annual budget report looks benign. Luna: So the market is pricing in the risk, but the public remains ignorant because the news just reports the headline number. Lucas: Exactly. And that ignorance is politically useful. A politician can claim they are balancing the budget while simultaneously expanding entitlements, because the expansion doesn’t hit the cash flow statement yet. It’s a sleight of hand that works because most people don’t understand accrual versus cash. Luna: Is there any movement toward changing this? Any bipartisan effort to adopt accrual accounting? Lucas: Very little. Both parties benefit from the opacity. Democrats want to expand social programs without showing the immediate cost. Republicans want to cut taxes without showing the resulting structural hole. Accrual accounting would expose both agendas simultaneously. It removes the flexibility to play political games with timing. Luna: It seems like the only way to force a change is a crisis. When the cash runs out, they’ll have to switch. Lucas: Maybe. But by then, the adjustment would be catastrophic. Imagine waking up one day and realizing the national debt is twice what you thought because you finally had to recognize the pension obligations. The shock to confidence could trigger a sovereign debt crisis. We are walking a tightrope, hoping the accounting fiction holds until we find a real solution. Luna: And in the meantime, we’re just paying interest on a lie. Lucas: Paying interest on a lie is generous. We’re paying interest on the consequences of that lie. Every dollar borrowed to cover the gap between cash outflows and actual obligations adds to the compounding burden. It’s a snowball effect that accelerates every time we ignore the true cost of governance. Luna: It makes me wonder if we should stop talking about deficits altogether and start talking about net worth. Lucas: I agree. Net worth is the only metric that matters for long-term sustainability. If your assets don’t cover your liabilities, no amount of clever cash management will save you. The US government’s assets are mostly infrastructure and human capital, which are hard to value. But its liabilities are clearly defined and rapidly growing. The math is ugly. Luna: So the next time you see a headline about a balanced budget, ask yourself what they aren’t counting. Lucas: Always. Because the headline is just the tip of the iceberg. The submerged part is where the ship sinks. Luna: Speaking of keeping things clear, if walking through the economy with us has made something click, we deliberately don't run ads on these episodes. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Lucas: It helps us keep the research deep and the commentary independent, so thank you for considering it. Now, back to the ledger. Luna: Right. Let’s look at how this accounting gap affects local governments, not just Washington. Lucas: Good point. Municipalities face the same issue. Many cities report healthy operating budgets while their pension funds remain massively underfunded. Like the federal government, they spread pension contributions over decades, masking the true annual cost of employing workers. Luna: Did we see any cities collapse because of this? Detroit comes to mind, but that was broader than just accounting. Lucas: Detroit was a mix of deindustrialization and mismanagement. But look at Springfield, Illinois, or Stockton, California. Their bankruptcies were heavily driven by unfunded pension liabilities that didn’t show up on the daily operating statements. They could balance the books today by ignoring tomorrow’s obligations. Luna: So the federal model is contagious. Local leaders copy the federal playbook because it offers short-term relief. Lucas: It is. And since states can’t print money, the crunch hits them harder and faster. When the cash dries up, they can’t roll over the debt as easily as Washington. The federal government has a unique privilege that insulates it from immediate liquidity crises, allowing the accounting fiction to persist longer. Luna: But that insulation isn’t infinite. Eventually, the lenders get nervous. Lucas: Eventually. Which brings us back to the core question. Is transparency a virtue or a vulnerability? If we switched to accrual tomorrow, markets might panic. But if we stay on cash, we’re gambling that growth will always outpace liability. History suggests that’s a losing bet. Luna: It’s a gamble we’ve been making for fifty years. Maybe it’s time to stop betting and start accounting. Lucas: Agreed. Until then, we’ll keep reading between the lines of every budget report we see. The truth is usually in the footnotes, not the headlines. Luna: And hopefully, one day, the footnotes will match the reality. Lucas: Here’s to hoping. For now, I’ll stick to checking the net worth column instead of the deficit line. Luna: Smart move. Keep digging deeper next time.