such as deficit and debt levels, or time series of total expenditure and revenue levels as
shown in Figure 3.1. The net result of such policies may be larger or smaller deficits and
debt levels over time, but also erosions or increases in national saving and capital
formation independent of the impact on short- and long-term deficits and debt levels.
Because Figure 3.1 does not fully reflect the impact of all policy changes, it remains a
poor guide for decision makers and should be complemented with additional information.
In the words of Auerbach and Kotlikoff, “...conventional deficit measures may cause
alarm when alarm is not warranted and, conversely, may calm observers when alarm is
most appropriate.”26
Accrual Accounting
As mentioned earlier, accrual accounting “books” obligations and assets based on
triggering events through the current period. Since the objective of accrual accounting for
the budget would be to characterize current policy, future benefits based on past births,
labor force participation, earnings, and tax payments (as is common in the case of public
pensions) should be counted among government obligations. Even in the case of health
care benefits, future payments based on projected cost growth may be included to get a
fuller estimate of the government’s financial obligations under current policies.
Proposals to adopt accrual accounting for measuring the government’s intertemporal
budget balance are generally motivated by the attractive symmetry of applying the same
accounting rules to the government as are applied to private companies when evaluating
their pension and other obligations. However, the government as an economic entity is
sufficiently different from private entities to warrant a different accounting standard. In
particular, private entities can potentially fail and terminate at any time, whereas the
government is infinitely lived, at least in principle. Moreover, unlike private entities,
governments possess the sovereign power to levy taxes.
The purpose of accrual accounting for private firms is to reveal the extent of funds that
must be set aside to meet contractual deferred liabilities - pensions and health coverage
for retired employees, etc. Most such liabilities are created from past employee
performance and are measurable because they are determined by applying explicit benefit
formulas. In contrast, the objective of long-term government budget accounting is to
evaluate the sustainability of current tax and spending rules - not to evaluate total
liabilities if the “government fails.” Given its power to levy taxes, the government need
not necessarily set funds aside each time it enacts laws that create additional future
payment obligations. Applying accrual accounting to government liabilities could,
therefore, create the impression that the government’s future obligations to pay pension,
health, and welfare benefits somehow are contractual obligations - or liabilities - that can
never be reduced.27
26
27
See Auerbach and Kotlikoff (1987). They make the case that deficits and national debt are not
theoretically well grounded fiscal concepts and that their values over time reflect little more than the
particular accounting conventions used for labeling different government transactions as taxes and
transfers versus loans and repayments of principal plus interest. These arguments are amplified in
Kotlikoff (1989).
Discussions about federal financial reporting standards in the United States go into great detail about
precisely defining liability recognition criteria and the nature of events that trigger a recognizable
federal liability. Such discussions are obviously driven by concerns that if the reporting standards
were to adopt broader definitions of triggering events and liability recognition criteria, the public
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