How governments work around balanced budget requirements

There's structural balance and then there's 'balanced for now.'

Photo by Ehud Neuhaus on Unsplash

Confession time. In the more than 15 years that I have been writing about state and local government, I have avoided really trying to understand why a lot of people advocate for budgeting using Generally Accepted Accounting Principles, or GAAP. Currently, most governments rely on "modified cash" or cash-based techniques. 

This er, “gap,” is not for lack of people explaining it to me. It’s just that, like a lot of people, my eyes start to glaze over and my brain takes a mini-vacation when folks expound about the virtues of GAAP accounting. Even for someone like me who likes to spend time out in the weeds of public policy, this is way out in the hinterland.

But recently, I read a report that made me see this issue much more clearly and—more importantly—what this big push is really about.

You can’t spell ‘government transparency’ without GAAP

The argument for GAAP accounting on financial statements, as so aptly laid out by Matt Fabian and Lisa Washburn in this Volcker Alliance report, is that it provides a more accurate picture of a government’s overall fiscal health. Why? Because revenue is recorded when it is earned and is expected to be received within a set period of time. Expenses are recorded when they are incurred, not paid.

Cash basis, on the other hand, records revenues and expenses when they're received and paid. 

Here’s a very rudimentary real life comparison: Let’s say you’re deciding between an electric vehicle and a gas-powered one. 

• Under GAAP, you’d consider the full cost of the car over time (EVs are known to cost less over time than regular cars) along with your other financial commitments (like your mortgage debt payoff schedule, your kid’s future college bill, etc.) You’d look at your expected income and regular expenses and determine whether you can afford the higher cost now for the EV in exchange for lower costs later on when college tuition bills start coming in.

• On a cash basis, you’d look at your monthly income and expenses (which includes monthly debt payments), and then determine how much wiggle room you have in your budget to add another cost. Given that the monthly bill to pay off an EV would be higher than a traditional vehicle, the latter might seem like the more prudent choice.

This isn’t apples-to-apples but you get the point. Scenario #1 takes into account the full picture of your financial commitments and the full cost of the vehicle. It provides a wider, more transparent view of what you can ultimately afford. Maybe you still go for the gas guzzler but you lease one and plan to revisit the issue in a couple years. Either way, your investment decision is much more informed than it would be by just looking at your short-term commitments.

It’s not that different for governments.

"Annual cash budgeting allows governments to make short-term spending decisions without accounting for their medium-to-long-term implications, which opens the door for fiscally unsustainable tactics to achieve balance," Washburn and Fabian write. Meanwhile, “GAAP requires recognition of promised payments when liabilities are incurred and discourages many onetime maneuvers—such as borrowing—to balance budgets.” 

Sort of balanced budgets

Most states are constitutionally required to have a balanced budget and cities usually are by state statute. (This is something state and local officials love to point out to their congressional counterparts.)

But accounting practices allow governments to work around this requirement because 12 months of balanced inputs and outputs is not the same as structural balance. Perhaps nowhere in government budgeting has this boomeranged on lawmakers more than in pension funding.