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September 20, 2012

Government Accounting Tricks Designed to Conceal Rather Than Reveal

Posted by Tim Irwin

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It’s well known that governments sometimes use accounting devices to make their reported deficits smaller than, in some sense, they really are. But how do these devices work? And how can they be revealed?  A new IMF working paper by FAD’s Tim Irwin—Some Algebra of Fiscal Transparency: How Accounting Devices Work and How to Reveal Them—discusses these issues.  

One way to answer the questions is to consider future deficits. Deficit devices, unlike genuine changes in fiscal policy, reduce this year’s deficit only at the expense of future ones. And their use can therefore be revealed if governments also produce good fiscal forecasts.

This paper takes a different approach. It starts by defining the deficit as the decline in the government’s net worth and then shows how deficit devices can be analyzed as transactions involving assets and liabilities that are not recognized on the government’s balance sheet. For example, many governments do not include nonfinancial assets such as land and buildings on their balance sheets, so they can reduce their reported deficit by selling these assets, even though this doesn’t really improve their finances. It would seem, then, that accounting devices can be prevented by ensuring that all assets and liabilities are recognized on the balance sheet.

Unfortunately, it’s not so simple. Assets and liabilities come in different kinds. Cash, for example, is liquid and presents no valuation problems, while land can be hard to value and hard to sell. Sometimes it’s not clear whether a set of rights or obligations constitutes any kind of asset or liability. So working out which assets and liabilities should be counted in measuring the deficit is not easy. Moreover, the broadest possible measure is probably not the best measure to use in setting deficit targets. That makes it impossible to prevent all deficit devices, but it does leave open the possibility of revealing the devices by ensuring that broader measures of the deficit are presented alongside the targeted measure. Deficit devices reduce the targeted measure, but not the broader measures.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy. 

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supplying PDF version would come handy

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