Connecticut: Winning By Losing

Just four years ago, the Houston Astros of Major League Baseball was the worst team in the sport. But last week, the ‘Stros won the World Series. How did the organization progress from worst to first in merely four years?

By its own admission, the team won by losing. 2013 was the final year of a three year period when the organization leveraged its abysmal situation to clean house and reinvent itself. That clearance process set the stage for its subsequent success.

The State of Connecticut may be facing a similar opportunity today. Since 2016, two of the fifty largest business corporations in the nation moved their corporate headquarters out of state, with GE shifting to Boston and Aetna to New York City. And Alexion Pharmaceuticals, a firm that had received state funds to establish a New Haven headquarters, announced that it would follow Aetna to Boston.

Nevertheless, based on recent news about these corporations, Connecticut may not have been badly damaged by their departures after all. GE is now reacting to severe financial problems by implementing an immense operational retrenchment. Aetna is negotiating a potential merger into CVS, a much larger corporate entity. And Alexion is reported to have arranged its relocation to divert investor attention from a myriad of legal problems.

Meanwhile, earlier this year, Governor Malloy had been locked in battle with the Republicans and with his fellow Democrats in the Legislature over the state budget. Connecticut had been the only state in the nation to proceed into October without a fiscal blueprint.

But just last week, Republican and Democratic legislators finally resolved the situation by shutting out the Governor and working together to craft a budget. In other words, they simply placed the Governor’s proposals to the side, worked with each other, and passed legislation with a super-majority vote that was impervious to a gubernatorial veto.

So how far has Connecticut progressed this year? Not nearly as far as the Houston Astros have progressed since 2013, of course. No one in the Nutmeg State is declaring victory over its challenges just yet.

Nevertheless, just a few months ago, three ostensibly successful business corporations were preparing to depart the state, and the Governor was locked in a budget stalemate with the State legislators. And today? It appears that Connecticut’s economy may win by “losing” a trio of unstable employers, and its Legislature may likewise win by “losing” a stalemating gubernatorial negotiator.

So how long may the residents of Connecticut need to wait until they can truly celebrate? They may wish to take heart and recall that the Houston Astros merely needed four years to progress from cellar-dwelling losers to championship winners.

So perhaps, for Nutmeggers, 2021 may be a glorious year.

Shell Games And Fiscal Policy

For the past several years, Democratic Governor Dan Malloy of Connecticut and Republican Governor Chris Christie of New Jersey have engaged in a public war of words over fiscal policy. Despite the economic similarity of their northeastern states, the two men have repeatedly clashed on television over their strategies for restoring fiscal discipline in government.

Malloy, following traditional Democratic doctrine, has chosen to maintain government spending in the face of economic malaise by raising taxes in order to eliminate budget shortfalls. Meanwhile, Christie, adhering to classic Republican policies, has slashed spending and reduced taxes in pursuit of the same goal.

So which strategy has proven itself to be the successful one? Regrettably, neither one has done so. During the past month, in fact, both Governors have acknowledged failure.

The first failure occurred in Connecticut, where Governor Malloy had been accused by his political foes of generating $500 million in excess cash by over-borrowing on debt. He had announced plans to spend the cash by mailing $55 checks to Connecticut households as election year tax refunds.

But then the anticipated $500 million budget surplus suddenly vanished with the collapse of overly optimistic economic assumptions. Because the excess cash was needed to finance normal government operations, the proposed tax refund vanished as well.

Meanwhile, in New Jersey, a similar collapse of overly optimistic economic assumptions forced Governor Christie to slash required payments to the state’s employee pension plans. To compensate for unexpectedly low tax revenues, the Governor decided to redirect the funds to finance normal government operations.

Ironically, Governor Christie himself initially agreed to authorize pension plan contributions at levels that would help the state “catch up” for many previous years of fully or partially cancelled payments. His predecessors had often balanced their budgets by redirecting pension funds to meet current needs.

But when Christie found himself in the same situation that had plagued his predecessors, he opted for the same choice that they had made: to shift budgeted pension funds into current year expenditures.

And so the “shell game” of government fiscal policy continues on both sides of the political aisle. Whenever debt generated funds or pension plan funds are shifted to finance current government operations, future budgets become more difficult to balance while the size and scope of government remains unaffected.

How would you modify the budgetary practices of our government officials to ensure the long term fiscal solvency of our states?

Government Spending: A Matter Of Priorities

I’ll gladly pay you Tuesday for a hamburger today.

Who coined that famous phrase? It was J. Wellington Wimpy, the intellectual hobo in the classic Depression era comic strip Popeye. Wimpy loved to consume hamburgers, but he was perpetually short of funds, and so he would incur debts (in exchange for meals) that would never be repaid.

Oddly enough, Wimpy was always a well dressed hobo. He often wore a blue suit, white shirt, and red tie, with brown leather shoes on his feet and a sturdy hat on his head. Although the authors of the strip never explicitly identified his original profession, his name and attire served as an effective parody of the banking industry.

After all, a well dressed man like Wimpy likely could have financed his own meals; the fact that he chose to borrow from others was simply a matter of priorities. And though his comic strip peaked in popularity during the 1930s, his strategy of debt financed consumption survives to the current day.

Desperately Seeking Shovels

Consider, for instance, the operating practices of the state of Connecticut. Last week, the Land of Steady Habits was buried in a blizzard. The city of Hamden led the region with 40 inches of snow fall, and the metropolis of Milford was right behind it with 38 inches.

Regrettably, for the residents of Milford, its municipal leaders had not invested in sufficient snow removal equipment to clear the roads on a timely basis. Thus, its citizens were stranded in their homes for days after the storm. Mayor Ben Blake was eventually forced to hire sixteen payloader vehicles from privately owned construction firms to free his own town residents.

So what is the town doing now? Is it establishing a fund to purchase additional snow removal equipment? Well, no … priorities being priorities, the city has issued a call for brigades of citizen volunteers to carry their own shovels to the next calamitous blizzard.

And what are the tax expenditure priorities of the State of Connecticut? If not directed towards snow removal, where are the funds being spent?

$2 Billion And Counting …

Connecticut Governor Dan Malloy answered that question last month with the unveiling of a new investment initiative entitled Next Generation Connecticut. Originally introduced as a $1.5 billion series of investments in the academic programs of the University of Connecticut, the total tab for the initiative was revalued at more than $2.0 billion after its full scope was released to the public.

Ironically, State House Republican leader Larry Cafero predicts that $2.0 billion will also represent the size of the government’s annual budget deficit during the next two years. “We’ve got other problems, too,” protested Cafero when he learned about the initiative. “We have roads, we have bridges.”

Of course, they also have snow. Lots of snow. And an insufficient number of snow removal vehicles to clear it all away. That’s why Mayor Blake issued his call for a volunteer snow shovel brigade.

Investments vs. Expenditures

The Governor characterizes the Next Generation initiative as an investment in the future of the state, and not as a series of expenditures. The bioscience, digital media, and engineering programs at the University are all expected to receive significant funding increases.

The initiative is also expected to increase the size of the student body at the institution. The University’s total enrollment is expected to grow by 30%, or by 6,580 students, with many joining an expanding engineering program.

Other university systems, of course, are choosing far less expensive paths to growth. The university systems of Florida and Texas, for instance, are each focusing on the development of a $10,000 undergraduate degree, one partially based on online education technologies. And university systems from California to North Carolina to Pennsylvania are beginning to embrace the free or extremely low cost offerings of online-only courses that are offered by organizations like Coursera.

Unlike its rivals, the University of Connecticut will be growing in a more traditional manner. And if the institution manages to generate long term economic benefits in excess of $2 billion, it may yet demonstrate that it is the beneficiary of the wiser investment strategy.

Still Wimpy!

Nevertheless, even if the Nutmeg State’s initiative eventually generates a positive return on investment, its strategy will maintain a decidedly Wimpy perspective. That’s “Wimpy” as in “J. Wellington Wimpy,” of course.

After all, Wimpy managed to acquire stylish clothing and to satisfy his taste for hamburgers simultaneously. But he needed to become a debtor to do so, and he never actually paid his debts.

Likewise, the state of Connecticut is managing to build its university system and to (eventually) clear its roads of snow. But it is borrowing billions of dollars to finance its operating activities, and for the sake of the Next Generation initiative, it is about to go even deeper in debt.

Will Connecticut be able to pay its debts, or will it eventually renege on them like Wimpy? The fate of the state hinges on this question, and only time will yield the answer.

The Republican Party’s European Tax Policy

When was the last time an American political leader of the Republican Party embraced a European economic policy? Or a European policy of any kind, for that matter?

It’s difficult to recall such an event, isn’t it? You might need to go all the way back to President Dwight Eisenhower’s support of the New Look strategy, a policy that marked the apex of Euro-American cooperation against the Soviet Union. Or perhaps you could point to the fall of the Soviet Union during the 1980s and early 1990s, an era when U.S. Republican Presidents Reagan and Bush collaborated closely with European leaders like Margaret Thatcher, Helmut Kohl, and Francois Mitterrand.

More recently, though, Republican Party politicians have expressed far less friendly sentiments towards their European colleagues. Presidential candidate Mitt Romney, for instance, sharply critiqued Greek economic policy throughout his campaign. And anti-European sentiment during George W. Bush’s invasion of Iraq peaked with the banishment of french fries from the cafeteria of the U.S. Capitol, and the introduction of “freedom fries” in their place.

So why are conservative Republican politicians now embracing a quintessential European tax policy? And what does their embrace tell us about today’s political climate in the United States?

From Kansas to Louisiana

The policy in question involves an increased reliance on sales taxes to finance government operations. Conservative governors Sam Brownback of Kansas and Bobby Jindal of Louisiana have both recently advocated for increases in sales taxes.

Republican politicians advocating for tax increases? At first glance, that would appear to contradict the traditional conservative orthodoxy against tax increases of any kind. Ever since Republican President George H.W. Bush famously abandoned his read my lips, no new taxes pledge over twenty years ago, Republican lobbyists have stood firm against any form of tax increase.

But today, Governors Brownback and Jindal are making a more subtle argument. They are not simply advocating for increases in sales taxes; they are concurrently advocating for reductions in (or even an outright elimination of) income taxes. Thus, they are defining their proposals as modifications of existing systems of taxation, as opposed to increases in rates of taxation.

A more balanced system of taxation, one that more equally distributes taxes across earnings (i.e. income) and consumption (i.e. sales), strikes Brownback and Jindal as an improvement over the status quo. Unsurprisingly, however, neither one has acknowledged that such a modification would bring the system of American taxation into far closer alignment with the existing European system.

Value Added Taxes

Strictly speaking, the European tax on sales transactions isn’t really a “sales tax” in the American sense of the phrase. Instead, it is a tax on the incremental value added by each party to the development and sale of a product or service.

Imagine that a European farmer sells a bucket of milk that is worth five euros to an artisanal cheese producer. Then imagine that the cheese producer transforms the milk into an eight euro package of cheese. If the cheese is then sold to a retail store for twelve euros, the European farmer would pay taxes on five euros of value, the producer on three euros of value, and the retailer on four euros of value.

Within an American system of sales taxation, the retailer would pay sales taxes on the entire twelve euro purchase. Under either system, though, taxes would be calculated on a basis of the value of sales, purchase, or transfer transactions, as opposed to a basis of income or profit levels.

But why is this debate emerging now? What trends are occurring in the American political climate that would empower conservative Republican politicians to embrace such policies?

Bowing To Reality

Reality … What A Concept! That was the title of a 1979 stand-up comedy album by the American actor Robin Williams. Nevertheless, it could just as easily serve as the description of the current state of affairs in American politics.

After all, the federal government’s cumulative budget deficit now stands at $16.5 trillion, and it continues to grow by more than $1 trillion each year. Such worrisome numbers, considered in tandem with President Obama’s resounding electoral victory, are persuading Republican lawmakers to seek compromise. That is why America avoided a federal government shut-down during the fiscal cliff negotiations on New Year’s Day, as well as during the subsequent debt ceiling debate of early 2013.

Some commentators believe that demographic trends in American society are pushing the political parties towards the center too. An agreement regarding America’s illegal immigrant population is expected to occur within the next six months, in contrast to the outcome of a similar but ill-fated bipartisan policy initiative by the Bush administration in 2006.

An immigration reform bill that offers a path to citizenship to individuals who have entered the United States illegally? And a system of taxation that emphasizes the very features that have been implemented throughout the European Union? These may appear to be highly unusual positions by Republican politicians, and yet they may have been necessitated by the unique realities of the contemporary era.

The Massachusetts Strategy: Medical Cost Budgets

As the American presidential contest barrels towards the Labor Day holiday weekend and the proverbial “home stretch” of the campaign, the candidates continue to fling charges at each other regarding the health care system.

Mitt Romney, of course, continues to refer to the President’s universal health care plan as a burden on American society and as an unnecessary tax on the middle class. And Barack Obama continues to riposte that his Affordable Care Act is actually modeled on the 2006 landmark Massachusetts law that Romney championed as Governor.

Lost in the squabbling, though, is the fact that the Massachusetts model of universal health care has now been in operation for six long years. So how is it doing? Is it achieving its goals?

Primary Goal: Mission Accomplished!

The primary goal of the Massachusetts law, of course, was to extend health insurance coverage to virtually all state residents. That mission has indeed been accomplished; over 98% of all residents are now enrolled in state-mandated and government approved health insurance plans.

The enrollment process for individual policy holders is managed through an online portal known as the Health Connector. Many industry specialists have praised the effectiveness of the portal; in fact, it has become a model for the state-based “exchanges” that are now being developed across the nation to comply with the provisions of the Affordable Care Act.

Regrettably, investigative reporters at the Boston Globe have noted thousands of cases of individuals who appear to be “gaming” the system by enrolling in health plans for brief periods of time in order to gain temporary coverage to receive medical services. Nevertheless, the vast majority of the 6.5 million residents of the Commonwealth of Massachusetts appear to be complying with the letter and the spirit of the 2006 insurance coverage law.

Secondary Goal: Yet To Be Achieved?

The secondary goal of the Massachusetts law was to reduce the cost of providing health care services to residents throughout the Commonwealth. And the actual results? Pragmatically speaking, the evidence is mixed at best that the costs of medical care are actually trending downwards.

In theory, as a result of the enrollment of all residents into insurance plans, the utilization rates (and thus the costs) of primary medical care and preventive care services should increase over time. Policy makers are hoping, though, that these increases will be offset by concomitant declines in the utilization rates (and thus the costs) of hospital emergency room services and preventable disease treatment regimens.

Many studies have confirmed that these utilization and cost trends are indeed occurring for certain clusters of individuals. But other studies have noted that the overall costs of providing medical services to the population may be increasing significantly.

Next Step: Government Cost Targets

So how do the current Governor Deval Patrick and the Massachusetts Legislature intend to address the challenge of controlling medical costs? Earlier this month, they signed a bill into law that establishes explicit cost reduction targets for levels of health spending throughout the state.

For the next five years, through 2017, the law is designed to limit inflationary increases in health spending to levels that are consistent with the growth of the Massachusetts economy. And thereafter, it is designed to reduce health inflation rates to annual levels that are one-half of one percent below the growth rates of the state’s gross domestic product.

According to government estimates, the aggregate costs of medical care will decline by up to $200 billion over the next fifteen years if the health system meets these targets. Whether or not the system will actually do so, though, is any one’s guess.

It May Take Years

Does the Massachusetts model of universal health care represent an approach that should be replicated across the nation? A successful Massachusetts initiative, of course, can serve as an effective model for the other 49 states.

On the one hand, government mandated universal cost budgets may distort the market for health care services. Let’s assume, for instance, that the Commonwealth experiences an outbreak of influenza in a year when its costs are budgeted to decline by one half of one percent. If it diverts funds from other initiatives to fight influenza, it may force itself to abandon health programs with significant long term benefits.

On the other hand, it is possible that the government of Massachusetts is the only entity that possesses the authority and the power to mandate cost reduction activities on a statewide basis. In other words, no other organization may be able to accomplish such broadly defined goals.

It is, regrettably, too early to assess whether the cost budgeting law will prove to be effective. That is not surprising; after all, it took years to conclude that the original 2006 law could succeed at enrolling most residents in insurance plans. It may likewise take years to assess whether medical cost inflation can be controlled through the use of budgetary targets.

Labor Unions In Peril: From Wisconsin To The NFL

Last week, Republican Governor Scott Walker of Wisconsin and his colleagues in the state legislature finally launched what some political pundits called, a bit ominously, their nuclear option. The target of their assault? The state’s public sector labor unions.

By the time the smoke had cleared from an arcane legislative maneuver, one that enabled them to pass their law without a single Democratic vote, the devastation was complete. Wisconsin’s public unions were forbidden to negotiate collectively about any issue other than wage increases; furthermore, their annual wage increases were limited to the rate of inflation. They were also forbidden to collect annual dues through routine payroll processes, and they were ordered to submit to periodic referenda by the labor force, elections that will threaten the possibility of union decertification each year.

Such restrictions, in essence, downgrade the power and authority of the Wisconsin public sector unions to levels typically held by trade associations. Somewhat lost in last week’s political hullabaloo over these developments, though, was a story about another trade union that found itself similarly threatened.

Tom Brady, Quarterback … and Union Hero

Although Major League Baseball still refers to itself as America’s national pastime, the National Football League is undoubtedly the most successful and popular professional sporting association in the United States. Its 32 teams collectively earn $9.3 billion annually in revenue; its Super Bowl championship game alone brings hundreds of millions of dollars of economic benefits to each city that serves as its host.

Last week, though, negotiations between NFL management representatives and the player’s union over a new collective bargaining agreement collapsed. In an unusual legal maneuver, the players then chose to decertify their own union, which positioned them to file an anti-trust lawsuit that asks a court to issue an injunction to prevent management from locking them out of training camp. Without such an injunction, the team owners could simply cancel the 2011 season and “wait out” the players, or — even worse, from the perspective of the players — they could hire temporary “scab” replacement athletes to play regular season games as they successfully did in 1987.

The player’s lawsuit was filed by a number of superstar athletes, including current Most Valuable Player Tom Brady of the New England Patriots. Because the names of the athletes are listed by the court in alphabetical order on the legal docket, the case will go down in history as “Brady versus the NFL.”

Beginning of the End … or of a Renaissance?

It would be incongruous, of course, to compare Tom Brady’s reported $18 million annual salary to the far smaller compensation levels earned by Wisconsin’s public sector employees. Likewise, it would be misleading to ignore, in response to last week’s developments, the immense differences between the howls of outrage expressed by laborers in America’s Dairyland and the cool sense of confidence exuded by America’s football heroes.

Nevertheless, within the time span of a single day, the labor movement of the United States found itself confronting a pair of unprecedented challenges at opposite ends of the economic spectrum. With Governor Scott Walker signing Wisconsin’s labor bill into law last Saturday, coinciding with the decertification of the NFL union and the filing of “Brady v. NFL” on the same day, America’s union forces suddenly had reason to contemplate the end of their existence.

It’s possible, of course, that the American public will rally to the defense of its labor force, and that — as predicted somewhat optimistically by AFL-CIO leader Richard Trumka — what we are witnessing is actually the beginning of a labor renaissance. After all, polls have indeed found widespread public support for the continuation of collective bargaining activities by public sector unions. Nevertheless, with state fiscal budgets in tatters, and with NFL owners facing no shortage of ready and willing replacement players, it is not difficult to foresee a potentially catastrophic outcome for the labor movement.

China or Pakistan, Germany or Italy

Pro-management forces, of course, are hoping for just such a catastrophe, claiming that nations like China have become economic dynamos by avoiding unionization activities, and that nations like Italy have become economic laggards by surrendering to union demands. On the other hand, pro-union forces retort that nations like Germany have built export-oriented powerhouses on the foundations of union labor, and that nations like Pakistan are sinking economically despite maintaining few restrictions against low wages and child labor.

It is hard to imagine labor unions ever disappearing entirely from the American scene, just as it is hard to imagine Medicare, Medicaid, and Social Security (to say nothing of America’s system of free public education) ever vanishing from the national landscape. Nevertheless, at a time when Wisconsin laborers and all-star NFL quarterbacks find themselves facing similar existential threats in their respective labor disputes, it is reasonable to wonder whether a fundamental shift is now occurring in the American economy.

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!

California Bankruptcy: IOUs from the Terminator!

Last week was a mighty depressing one for any American living in one of the seven states that failed to pass an annual budget. Californians, for instance, were treated to the sad spectacle of Governor Arnold Schwarzenegger vowing to issue IOUs instead of cash payments to any one expecting cash payments from the Golden State.

The Governor once rose to fame on the strength of his Terminator character’s famous film vow “I’ll be back.” But in his current role, he is forbidden by law from seeking another term, and his lame duck status has drained him of any real power in state politics.

But what was it about last week that brought so many states to the brink of financial catastrophe? The answer, it seems, can be found in the arcane field of governmental accounting principles.

GASB vs. FASB

There are all sorts of oddities that exist in the realm of governmental accounting practices in the United States. For instance, did you know that the Financial Accounting Standards Board (FASB) does not establish Generally Accepted Accounting Principles (GAAP) for state and local governments?

That’s right; the FASB establishes GAAP for all American entities except state and local governments. A different quasi-regulatory body, one called the Governmental Accounting Standards Board (GASB), establishes GAAP for those entities.

By the way, the GASB offices aren’t located in or near Washington DC, the capitol of our national government. They’re actually located in the same building as the FASB; in fact, the two bodies even share visitor parking spots with each other!

Same parking spots, same office development … heck, even the same mission: establishing GAAP. Then why is the GASB necessary? Why can’t the FASB handle GAAP for state and local governments, as they do for all other sectors of American society?

GASB itself explains that “governments are fundamentally different” than other sectors, and that “the information needs of the users of government financial statements are different” as well. But why is this true? And why did it lead seven states to the brink of fiscal suicide last week?

The Perils of State Budgeting

Before we plunge into the bizarre aspects of state budgeting, let’s remind ourselves of a few universal accounting and legal principles that apply to most other organizations.

To begin with, most organizations are permitted to earn profits. Even “nonprofits” can earn profits, as long as they reinvest their surpluses in the future development of their charitable activities.

And how do most organizations earn funds to pay their obligations? They sell products and services to customers, and they collect payments from them. If demand for their products and services decline, then revenues and cash collections decline as well, and organizations cut back on operations to reduce their expenditures accordingly. The only ways to avoid such cutbacks are to borrow money from banks, to seek new funding from investors or donors, to sell existing assets, and/or to dip into cash stockpiles.

State governments, though, don’t adhere to these universal principles at all. To begin with, states generally don’t earn profits. Although some try to maintain rainy day funds, most state legislators will opt for tax cuts and new spending programs whenever taxation revenues exceed expenditures.

Furthermore, with the exception of a few user fees for services like automobile registrations and state park admission tickets, states generally do not collect revenues for services rendered. Instead, states generally collect most of their revenues from real estate, sales, and income taxes, and then spend these proceeds on public education, transportation, police, fire, sanitation, and other essential services.

So what happens when large numbers of citizens lose their jobs? Well, state revenues tend to decrease, but the demand for state services tend to increase. So cutbacks become extremely difficult because the demand for government services actually soars at the very time when the revenues required to pay for them decline. That’s a sure fire prescription for financial Armageddon!

But Why Last Week?

Those are pretty unusual conditions, aren’t they? In fact, it’s not surprising that state and local governments, as well as the users of their financial statements, feel more comfortable with their own unique Board for establishing GAAP!

There’s still one question, though, that begs for an explanation. Namely, why last week? What was it about the week leading up to Independence Day that caused dramatic budget crises in seven states?

The answer to that question is a simple one. Virtually all states require themselves to balance their budgets every year.

Let’s think about that for a moment. We all know that state governments cannot easily cut services when their revenues decline because the demands of their citizens increase in times of economic recession. And states can’t seek funding from investors or donors, or sell critically needed state assets.

So one would think that the only available alternative to balancing budgets would be to finance deficits by issuing debt in times of recession, and then repaying those long term liabilities in times of prosperity. But by requiring themselves to balance their budgets every year, state legislators make it impossible to run annual deficits.

Thus, in recessionary times, many states hit a proverbial wall at the annual deadline for passing the following year’s budget. And for most states, that deadline is the final day of the current fiscal year, i.e. June 30.