Social Security: Is This Creative Accounting?

For much of the summer, America’s political leaders have argued about the impact of a failure to raise the federal government’s debt ceiling. Treasury Secretary Tim Geithner, Federal Reserve Bank Chair Ben Bernanke, and a host of others have warned that a default on the nation’s debt would lead to unimaginable economic catastrophe, although other representatives have questioned whether a default would do any significant damage at all.

Now that we’re actually arriving at the original August 2nd default date, it may be instructive to reflect back on one of the harshest exchanges between political leaders during this debate. It involved America’s national system of Social Security, and its ability to “make good” on financial guarantees that have been made to its senior citizens.

Three weeks ago, during an interview with CBS Evening News Anchor Scott Pelley, President Obama warned that he could not guarantee the issuance of monthly social security checks in early August if the nation defaults on its debt. The following day, though, former Republican Vice Presidential candidate Sarah Palin publicly retorted that Obama’s comment was “shameful.” Other critics noted that the Social Security system’s Trust Fund is fully solvent, and is expected to remain so for many years to come.

Which political leader was telling the truth? Surprising, they both were … which reveals quite a bit about the confused state of America’s federal budget system.

A Little History

The Social Security system was first instituted during the Great Depression in order to provide seniors with income at the ends of their natural lives. During that era, many Americans spent their lives working on farms and in factories, performing backbreaking manual labor for relatively low wages. By the time they reached the retirement age of 65, many were physically incapable of full-time work; furthermore, given that in 1930 only 54% of all 21 year old American males could expect to live more than 65 years, most citizens did not spend extended periods receiving Social Security payments.

Today, of course, most Americans spend their working lives in far more physically accommodating surroundings. They remain physically fit well into their 70s, and can live for decades beyond then. But the Social Security system’s retirement age has barely budged beyond 65, and has begun to exhibit actuarial stresses on its state of long term solvency.

During the era of Ronald Reagan’s presidency, America’s federal government reached an agreement to guarantee the solvency of the Social Security system well into the 21st century. It accomplished this task by a variety of means, one of which involved increasing the Social Security taxation rate to a level that was significantly above what was required to finance annual payments. The plan was to deposit those excess tax payments into a Trust Fund for two or three decades, and then — once the surging retiree population of the 21st century overwhelmed the annual tax receipts — to finance the shortfall by withdrawing funds from that same Trust Fund until it was liquidated.

Obama’s critics, and the Social Security Administration itself, have correctly noted that the Trust Fund will not be fully liquidated for many years. Nevertheless, President Obama was indeed speaking truthfully when he noted that the Trust Fund would hold no cash if the American government defaults on its debts.

A Little Creative Accounting

How can the President and his critics simultaneously be correct? Well, the Trust Fund has never truly held its deposited funds for significant periods of time. Instead, the United States Congress has always borrowed monies from the Trust Fund to pay for routine expenditures, and has deposited IOUs into the Trust Fund to serve as Congressional promises to repay those borrowings in the future.

How does the Congress actually intend to repay those borrowings and “make good” on those IOUs? By increasing taxes if necessary, and by issuing more federal government debt if needed to make up any shortfalls. But now the federal government is approaching its debt limit; thus, without issuing additional debt (and without increasing taxes), it will be unable to raise the cash to repay the IOUs.

In other words, the Trust Fund may not be technically insolvent at the moment, but only because America’s creative budget accountants have decided to treat those IOUs as fully valued investment assets. There are no other monies in the Trust Fund, and if the United States government defaults on its debts, those IOUs become worthless … or, at the very least, of highly uncertain value.  On the one hand, as long as the federal government remains solvent, the Trust Fund will remain fully funded with guaranteed government securities; however, as soon as the government defaults on its debts, America’s seniors will be transformed into unsecured creditors.

The long term fiscal health of the Social Security system will not be resolved in the near future, regardless of how the current budget battle plays out during the days and weeks ahead. Nevertheless, the process of transforming America’s opaque budget system into one that transparently characterizes levels of fiscal solvency can certainly begin today.

Connecticut Inauguration: Accountants Go Wild!

Whom would you include on a list of Connecticut’s most famous sons and daughters?

Katharine Hepburn, of course. William F. Buckley, too. Martha Stewart as well. And how about the first President Bush?

Indeed, the self-proclaimed Land of Steady Habits has been home to a wide array of starchy and patrician characters. And whenever residents of the Nutmeg State attempt to break free of their button-down demeanors, they risk being ridiculed for their efforts. The Daily Show’s Jon Stewart, for instance, once ravaged Senator Chris Dodd for attempting to write what Stewart called a racy blog for his constituents.

Thus, it was no surprise when the state elected the slender, bespectacled, conservatively dressed lawyer Dan Malloy to serve as its next Governor. Imagine Malloy’s surprise, though, when it appeared that the state’s Certified Public Accountants (CPAs) had stormed the Capitol last week to raucously interrupt his inauguration speech!

C-Span Captures The Moment

According to the official state transcript of the Governor’s Inaugural Message to the Connecticut General Assembly, Malloy asserted that the Nutmeg State must “adopt a responsible tell-it-like-it-is approach to balancing and managing our budget, and treat it just like any company treats a budget, with Generally Accepted Accounting Principles commonly referred to as GAAP.”

However, the official transcript fails to describe what transpired immediately after Malloy delivered this line. To his astonishment, an obligatory smattering of applause suddenly erupted into a throaty standing ovation. The nonplussed Governor blurted out “Honestly, I didn’t know there were that many accountants serving in the legislature!”

This ad hoc quip fails to appear in any of the major official transcripts that purport to reprint the inaugural address, but it was clearly captured by C-Span’s video of the speech. Viewers who web surf to the 17 minute, 40 second mark of the 28 minute, 13 second video clip can witness the moment.

Most likely, of course, few or none of those state legislators in the audience were actually CPAs. But why would legislators of the Constitution State become so boisterous at the very mention of accounting principles?

Broke? Or Earning A Surplus?

One cause of their excitement might involve the location of the organizations that establish GAAP, the formal standards that define responsible accounting practices. GAAP is promulgated by the Financial Accounting Standards Board and its sister entity, the Governmental Accounting Standards Board; both are located in the same office complex in Norwalk, Connecticut.

So whenever a Nutmegger hears about accounting principles, he might understandably feel compelled to give a cheer for the home team. And yet that still doesn’t explain why the Connecticut Society of CPAs (CSCPA) would establish an entire web site to declaring that “Connecticut is broke,” and urging that legislators “fix our future.”

Broke? How can the state be broke when its budget reportedly earned a surplus last year? It all depends on how accountants calculate budgets; hence the excitement over accounting principles!

Abuse of Credit

Accounting standards are universal in nature; generally speaking, the same policies and procedures that make sense for a single family likewise make sense for an entire state government.

Let’s consider an individual’s abuse of credit, for instance. Is it wise for an individual to use a credit card at a grocery store if he doesn’t know how he will find the money to pay off the debt in the future? Of course not; sooner or later, the debt will inevitably become due and the individual will go broke.

But if “obtaining funds through a credit card” is accounted for as “incoming cash,” and if “payment for groceries” is accounted for as “outgoing cash,” then such an individual might account for himself as “breaking even” on the day that he purchases his groceries. Heck, if he asks his grocer to add an extra $100 to his bill in order to receive $100 in cash-back pocket money, he might even claim that he has earned $100 in profit by purchasing his food on credit!

These are the types of accounting tricks that the state of Connecticut (and many other states as well) have played for years, tricks that permit legislators to claim that cash surpluses are being earned while long term debt levels build and build. The legislators who cheered during Malloy’s speech, though, were clearly determined to change their state’s profligate ways.

Travel to Connecticut!

Are you curious about the financial predicament facing our states, and the stark choices that confront us? If you live in Connecticut, or if you simply admire the lively dispositions of their boisterous legislators, you can track the state’s budgetary developments at the CSCPA’s flagship blog site.

Don’t forget to follow the news about other states and cities as well, ranging from California’s creative accounting gimmicks to Chicago’s parking meter lease transactions. Nevertheless, if you’d like to visit a state where the legislators actually interrupted an inaugural address to cheer about GAAP …

… travel to Connecticut!