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March 30, 2012

Disappearing Deficits

Posted by Tim Irwin and previously published on iMFdirect

Suppose a government must reduce its budget deficit. Perhaps it made a commitment to do so; perhaps investors are beginning to doubt its ability to repay debt. It could cut spending or raise taxes, but that is painful and unpopular. What can it do?

In our work at the IMF, we sometimes discover that governments choose to employ accounting devices that make the deficit smaller without actually causing any pain, and without actually improving public finances.

In ideal accounting, this would not be possible. In real accounting, it sometimes is.

How the devices work

Some governments, for example, have been able to reduce their reported deficits by taking over companies’ pensions schemes. The government’s obligation to make future pension payments has a real cost, but it doesn’t count as a liability in the accounting. So when the government receives a pension scheme’s assets from the company, it can treat the receipt of those assets as revenue that reduces its deficit.

Many other governments have been able to defer spending, without significantly reducing it in the long run, by entering into public-private partnerships. Under these contracts, a private company builds and maintains an asset like a road or a hospital. In return, the government agrees to pay the company for its costs over 20 or 30 years. In a sense, the government has bought the asset on an installment plan, but government accounting seldom counts this obligation as a liability.

In each of the above cases—and in others analyzed in my note, Accounting Devices and Fiscal Illusions—the government’s deficit is lower at first, but only at the expense of bigger future deficits.

Improving transparency

The problem with the use of accounting devices is that the pain of spending cuts and tax increases is not avoided; it’s postponed and perhaps made worse. Accounting devices can also make the deficit a less accurate fiscal indicator, making it harder for citizens, journalists, think tanks, investors, rating agencies—and the government itself—to understand the true state of public finances.

The use of accounting devices cannot be eliminated, but several things can be done to reduce their use or at least bring them quickly to light:

Governments can prepare audited financial statements—income statement, cash-flow statement, and balance sheet—according to international accounting standards.

Statisticians can be given the resources and independence to be both expert and impartial, as well as the authority to revise standards in the light of emerging problems.

A variety of different indicators of the state of public finances can be monitored, since a problem suppressed in one indicator is likely to show up in another.

The chart below illustrates the last point and, in particular, shows the value of having two different indicators of the deficit in the United States. One is a mainly cash-based measure; the other, the net operating surplus, is more like the bottom line of a private company’s income statement. One cause of the difference between the two indicators is that the cost of incurring obligations to pay future pensions to government employees shows up in the net operating surplus but not in the budget surplus.

Chart
These proposals do create more work for government accountants and statisticians, but the problems created by accounting devices cannot be solved with the stroke of a pen. Getting an accurate picture of government finances requires hard work, careful checks, and a willingness on the part of analysts to look at several different measures of the deficit.

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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Comments

The reverse is also true, many times! Governments park funds, at the end of year, with implementing agencies, sub-national tiers and the local bodies. Actually the money is not spent and is available for future use; but the government accounts include this money as spent and adds to 'artificial deficit':(

Governments have ingenious ways of circumventing deficits by camouflaging contingent liabilities. It is common practice to resort to market borrowing through private placement of bonds floated by the Government owned Special Purpose Vehicles (SPV)/ para-statal agencies by using the sovereign guarantee. While the guarantee keeps the coupon rates lower for the borrowing authorities, the liabilty of the Government is not captured in the accounts, thus helping the deficit to remain low. This can be curbed only through prudent legislation on Fiscal Responsibilities of the sovereign Government.

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