The Budget: A Citizen’s Guide?

The Department of the Treasury recently released its “Citizen’s Guide to the 2012 Financial Report of the United States Government.” At 246 pages of relatively dense economic analysis I’m guessing not too many citizens have read it. It has all the earmarks of a government document: obfuscating language, an endless series of charts and graphs, and a capacity to hide ideological issues in references to the public weal. For all that, it bears reading.

The report has three main parts: Secretary Geithner’s overview and narrative of the relevant data; the presentation of the data prepared by the Comptroller General in the Government Accountability Office; and the Independent Auditor’s Report. The bulk of the report is the second part, and it is there where we find many of the important pieces of information that don’t get discussed in State of the Union addresses or committee hearings.

Secretary Geithner makes it clear that the economic policy of the United States must be to coordinate economic activities to insure growth. This has been, of course, the magic elixir of US economic thinking for decades. Current fiscal policy, however, has not only worked against growth but, as is repeated throughout the report, has created genuine problems of long-term sustainability.

Let’s begin with the report’s basic assumption: that a sustainable economic policy is one where debt-to-GDP is relatively stable or declining. The economic policy of the United States Government can control one of these factors – debt – but has far less control over GDP or other macroeconomic factors. Projecting into the future, then, requires a certain amount of economic modeling, and these models often overestimate annual growth or underestimate inflation or other factors. For example, the CBO’s 2010 estimates of the costs of the Affordable Care Act were predicated on the assumption of 4% annual growth, a number that even at the time seemed unduly optimistic. The economy has performed nowhere near that level. So when reading a report such as this it is worth paying as close attention to the projections, which are usually way too rosy, as to the hard data.

Furthermore, the report suffers from what the CG refers to as “material weaknesses” in their ability to collect data. The most significant material weakness involves the lack of auditable financial statements from the Department of Defense. In fact, the GAO is hoping to get auditable financial statements from DoD by 2017. So we’re talking here about 34% of the nation’s assets and 21% of its spending having no reliable or properly accountable financial information. The GAO also notes the material uncertainties concerning the large social insurance programs that make projections difficult. Indeed, the GAO notes that it had to change its projections “drastically” over the ones it made just last year.

Nonetheless, the report states time and again that our current economic path is catastrophically unsustainable (again, with debt-GDP as the measure). The report places our current debt at 73% of GDP. Of the $17.6 trillion of debt, $11.3 trillion is publicly held and $6.3 trillion is in employee and veterans payables. However, the government is also holding over $5 trillion in “intergovernmental debt,” – that is, where one unit of government essentially holds IOU’s from another. The most significant of these is the so-called Social Security Trust Fund, which amounts to $2.7 trillion in intergovernmental debt (and so counts as a liability, but an “off the books” one).

The GAO projections of publicly held debt are indeed alarming. First of all, the report assumes that the government will experience substantial savings both from the Budget Control Act and from the Affordable Care Act. Those “savings” (which is to say, we might not spend as much as we originally thought) are again based upon what are mostly unrealistic expectations. For example, the CBO stated that the ACA will spend $1.7 trillion over the next ten years on coverage expansion. The ACA claimed to be revenue neutral because it projected $716 billion in Medicare savings (even though the Medicare Actuary warned that these cuts were “unrealistic”), and $836 billion in new taxes. Conceding there is “uncertainty about the effectiveness of the ACA’s provisions designed to reduce health care cost growth,” the GAO’s best-case model still projects the debt-GDP ratio to be at 78% by 2022, 145% by 2042, and 395% by 2087. For the record, the Office of Management and Budget projects the publicly held debt-GDP ratio to be at 89.7% in 2022 (dangerously near the 90% tipping point wherein growth gets stunted).

One of the main problems with the ACA’s provision, the CG notes, is that the savings would require “fundamental change in the current delivery system” and for providers “to generate and sustain unprecedented levels of productivity gains.” The CG wryly observes that this is “a very challenging and uncertain prospect.” Indeed, the word “uncertain” is sprinkled liberally throughout the report. Nonetheless, most estimates continue to operate as if best case scenarios are certain. Even then, HHS has in the last year organized a panel to review their economic models.

Take for example the chart on page 135 of the report. This compares Medicare’s present values (incomes and expenditures) through 2034. The report’s official number is that Medicare runs about a $27 trillion deficit over that time period.  However, right next to this number the GAO runs its “Illustrative Alternative Scenario” measures, which have Medicare running at a $37 trillion deficit. That’s a fairly substantial difference, and it’s not as if the latter number is presented as a “worst case” scenario. The second scenario is based purely on phasing out productivity adjustments and assuming physician fee reductions will be overridden. In other words, The ACA assumes certain cuts will go into operation, even though Congress and the President have been unwilling to make those cuts, causing actuaries to have to adjust the estimates annually. And of course, all these scenarios assume interest rates will continue to remain at record lows (p. 165)

Even with the increase in spending and debt, interest payments servicing the debt have remained relatively stable at about 2% of GDP. This is a result of the Fed’s efforts to keep interest rates at historic lows, the main mechanism for doing so being the $85 billion a month the Fed is spending in purchasing troubled assets, leading to its own portfolio now topping $3 trillion. Five Fed staff economists recently expressed concern that the Fed will have to sell those bonds back at a loss, particularly if interest rates begin to rise. Last year the Fed sent $89 billion in profits to the Treasury. If the Fed starts operating at a loss it would have significant budgetary consequences for the government as well as for taxpayers. An average household would have to pay an extra $774 a year to make up what Fed profits alone are currently putting into the treasury.

The longer the government delays addressing the budgetary gaps, the worse the problems become. (See page 161) “Relative to a policy that beings immediately, it is estimated that the magnitude of reforms necessary to close the 75-year fiscal gap increases nearly 20 percent if action is delayed by 10-years and for more than 50 percent if action is delayed 20 years.” Or, put more forcefully, “Future generations are harmed by policy delay because delay necessitates higher primary surpluses during their lifetimes, and those higher primary surpluses must be achieved through some combination of lower government benefits and higher taxes.” And mind you, the GAO is using 73% of debt-GDP as its new baseline in these analyses, even though that is an historically high number.

One gets a better idea of how unsustainable this all is when looking at the CBO’s 5 June 2012 Long-Term Budget Outlook report that projected publicly held debt to be at $57.1 trillion and GDP to be at $28.7 trillion by 2037. In other words, the government would need the economy to grow at a rate no lower than 2.5% annually, and would also need the rate of spending to stay under 5%, which in historical terms seems unlikely. I should note, by the way, that according to the CBO the rate of increase in government spending has been significantly lower for President Obama than any of his predecessors going as far back as Reagan, even if spending as a percent of GDP has been at record highs.

Where is the money going? The biggest growth has been in Health and Human Services, which now operates 23% of the federal budget. The Social Security Adminstration comes in next at 22% and Defense at 21%. Veterans Affairs operates as a separate budget entity at 9%, so one might argue that military spending still tops out at roughly 30%.

Numbers such as this are difficult to process. Perhaps it’s best to simply repeat the OMB’s numbers that while median household income has increased 24.2% since 1970, federal spending has increased 287.5% over that same time. This can only mean an increased burden on the taxpayer that would have to quickly outpace the ability of most households to absorb the costs. Indeed, when one tallies up Social Security and Medicare taxes; federal, state and local income taxes; property taxes; sales taxes; corporate taxes rolled into consumer costs; capital gains taxes; estate taxes – here a little dip, there a little touch – the average American household has a heavy burden to bear.

Perhaps the most interesting part of the Citizen’s Guide is the Independent Auditor’s Report, found on page 223. Noting the plethora of “material weaknesses” in reporting and the “significant uncertainties” in projecting, the IA noted his own limitations in being able to do his job because of “the federal government’s inability to demonstrate the reliability of significant portions of the U.S. government’s…financial statements.” “As a result,” the IA continues, “ readers are cautioned that amounts reported…may not be reliable.”

These material weaknesses continued to (1) hamper the federal government’s ability to reliably report a significant portion of its assets, liabilities, costs, and other related information; (2) affect the federal government’s ability to reliably measure the full cost as well as the financial and nonfinancial performance of certain programs and activities; (3) impair the federal government’s ability to adequately safeguard significant assets and properly record various transactions; and (4) hinder the federal government from having reliable financial information to operate in an efficient and effective manner. Due to these material weaknesses and to other limitations on the scope of our work discussed below, additional issues may exist that could affect the accrual based consolidated financial statements that were not identified. Appendix II describes these material weaknesses in more detail and highlights the primary effects of these material weaknesses on the accompanying accrual-based consolidated financial statements and on the management of federal government operations.

The report presents a government that is so large and complex that it can’t even report on itself to itself. As a result, there is “a formidable management challenge in providing accountability to the nation’s taxpayers.” Even the advocates of big government ought to be chastened by the report and realize that the issue isn’t simply about reform or efficiencies. Any large-scale centralized government by its nature is going to have serious accountability problems. Perhaps the Treasury ought to have called it “A Subject’s Guide” rather than “A Citizen’s Guide.”