Huge Entitlement Liabilities Calculated by GAO

Bryan R. Lawrence is the founder of an investment partnership in New York. He wrote an opinion piece for the Washington Post that was published December 28, 2011.

Lawrence notes that the Government Accountability Office issued a financial statement for the federal government on December 23, the Friday just before Christmas. It was released at a time when it was correctly calculated not to get much press, and it didn’t. Lawrence thinks it should be looked at closely.

Since 1997, the USA has been one of a very select group of countries that publishes a financial statement based on "accrual" basis accounting rather than mere "cash basis" accounting. [Accrual accounting is required for financial statements carrying the audit opinion of an American certified public accountant, as cash statements are correctly regarded as inherently misleading. Every single annual financial statement from every corporation in America that issues stock or has significant bonds is prepared using the accrual basis – the blog author]. GAO prepared the latest statement, and it has a reputation for fair and impartial work.

The GAO uses the professional technique, "net present value," to determine the amount of liability the government has for for future Social Security and Medicare promises. "Net present value" is the total value of streams of expenses in the future, discounted at a reasonable rate to the present time, something like figuring out the current value of a mortgage indebtedness by adding up and discounting all the future mortgage payments.

And here’s what Lawrence says about the calculation: "In fiscal 2011, the cost of the promises grew from $30.9 trillion to $33.8 trillion. To put that in context, consider that the total value of companies traded on U.S. stock markets is $13.1 trillion, based on the Wilshire 5000 index, and the value of the equity in U.S. taxpayers’ homes, according to Freddie Mac, is $6.2 trillion. Said another way, there is not enough wealth in America to meet those promises.

"If the government followed corporate accounting rules, that $2.9 trillion increase would be added to the $1.3 trillion cash deficit for fiscal 2011 that has been widely reported. And a $4.2 trillion deficit is something that Americans need to know about. "

The Treasury department, on the other hand, though acknowledging the importance of accrual accounting, only uses accrued figures in its "Citizen’s Guide" for benefits of government employees and veterans. The massive present value of promises to the American people at large are excluded.

The cost would have been a lot worse but for two assumptions that the GAO found questionable but did not apply estimates to improve the accuracy of the financial statements.

Lawrence notes that the annual increase in present value indebtedness for Social Security and Medicare is partly due to an ageing population in the USA. The Medicare numbers for the present value of the obligation are probably understated, because the GAO is following the actual text of the Medicare law, which requires cost controls on reimbursements to doctors – which legally should undergo an immediate 27 percent cut.
This drastic action, though part of current law, is "very unlikely" according to Lawrence.

The Medicare future estimates from the government assume that ObamaCare will reduce health cost growth by 1.1 percent per year, although the GAO has doubts about that and so do the trustees of the Medicare board.

What would happen if the doctors continue to be reimbursed as they are at present and the Obamacare cost reductions do not pan out? "The result is a $12.4 trillion increase in the cost of the promises, to more than $46 trillion. Given Congress’s history with the doc fix, and the general paralysis in Washington, it’s hard to argue with the GAO’s lack of confidence in Congress’s ability to honor its own cost controls."

http://www.washingtonpost.com/opinions/the-dirty-secret-in-uncle-sams-friday-trash-dump/2011/12/28/gIQArtWMNP_story_1.html

Blog Author’s Comments

Corporations and entities with significant publicly-traded bonds are required to provide audited annual financial statements that use net present value to calculate the liability for pensions (in accordance with FASB 86 of 1985) and to provide net present value liability figures for the net present value of future health benefits (FASB 106 of 1991).

Government organizations, finally, were encouraged to supply this information in accordance with government auditing standard GASB 45 (phased in beginning in 2007).

Lawrence’s article mistakenly attributes the requirement for accrual accounting to the government. It was the Financial Accounting Standards Board and the participating American Institute of Certified Public Accountants that wrote and enforced these standards. This is important because now, post-September 28, 2008, under TARP I, FASB pronouncements cannot be issued until reviewed and approved by the Securities and Exchange Commission, an enormous power grab indeed.  GASB 45 applies to state and local governments, but I have no knowledge that the federal government has agreed to accept these standards for its own financial reporting.

The trustees of Social Security and Medicare have their own board and, in early January of 2011, they issued a report showing, near the back in a chart, that the net present value of future Social Security and Medicare promises is already $45 trillion. Another report is due out in about ten days. This blog will report the latest figures when they are posted to the Internet by the government.

[Note: the blog author is a retired certified public accountant who for years prepared draft audited financial statements with nine-figure entries for FASB 86 retirement benefits as well as for FASB 106 retiree health benefits.]