December 28, 2011

Bryan R. Lawrence is founder of Oakcliff Capital, a New York-based investment partnership.

Releasing information on the Friday before a big holiday is a time-tested way to bury bad news. So when the Government Accountability Office’s fiscal 2011 financial statements for the federal government were released on the Friday before Christmas, it made sense to read them closely.

Since 1997, the United States has been a rare example of a government willing to publish financial statements using accrual accounting, which counts the cost of promises made as well as cash paid out. And the GAO’s professionalism over the years has won it a reputation for impartiality and effectiveness.

That professionalism is evident in the GAO analysis of the net present value of the Social Security and Medicare promises Washington has made to Americans. “Net present value” means the total that would have to be set aside today to pay the costs of these programs in the future. The government puts these numbers in appendices, rather than in headlines. But the costs are real.

In fiscal 2011, the cost of the promises grew from $30.9 trillion to $33.8 trillion. To put that in context, consider that the total value of companies traded on U.S. stock markets is $13.1 trillion, based on the Wilshire 5000 index, and the value of the equity in U.S. taxpayers’ homes, according to Freddie Mac, is $6.2 trillion. Said another way, there is not enough wealth in America to meet those promises.

If the government followed corporate accounting rules, that $2.9 trillion increase would be added to the $1.3 trillion cash deficit for fiscal 2011 that has been widely reported. And a $4.2 trillion deficit is something that Americans need to know about.

The Treasury acknowledges the need to show an accrual-based deficit, but the only retirement accruals it includes in its “Citizen’s Guide” to the GAO numbers are for promises to direct government employees and veterans. Promises to the rest of Americans are excluded, even though they are multiples larger than the $10.2 trillion of government debt held by the public.

The latest GAO numbers are particularly interesting because of a change in accounting standards that requires the government to explain why the cost grew by $2.9 trillion. Fully $1.5 trillion of that reflects the aging of all 312 million Americans by one year. In the GAO report from fiscal 2001, the cost of promises was $17 trillion. The growth in the cost from $17 trillion to $33.8 trillion averages about $1.7 trillion per year. The GAO doesn’t specify numbers for the other nine years, but one suspects that aging has driven most of the growth in the cost of the promises.

The cost would have been a lot worse but for two assumptions that the GAO found questionable.

First, Medicare’s cost projections assume legally required decreases in reimbursement rates to doctors that Congress has ignored for years — the so-called doc fix. For these projections to be realized, Congress would have to abide by its own cost controls and allow an immediate 27 percent cut to doctors’ rates, which is very unlikely.

Second, the Medicare projections assume that the 2010 Affordable Care Act (ACA) will reduce health-care cost growth by 1.1 percent per year, despite doubts voiced by the GAO and a panel appointed by the Medicare board of trustees.

The panel and the GAO recommended including an alternate scenario in the year-end figures, in which the doc fix continues and the ACA cost reductions do not materialize. The result is a $12.4 trillion increase in the cost of the promises, to more than $46 trillion. Given Congress’s history with the doc fix, and the general paralysis in Washington, it’s hard to argue with the GAO’s lack of confidence in Congress’s ability to honor its own cost controls.

If the government were a company, its huge and growing off-balance-sheet liabilities would set off alarm bells. But investor confidence has not been lost — Treasurys can still be sold at very attractive yields.

Confidence has been shaken, though, among the American people. Congress’s approval ratings are at record lows. Anger is flaring across the political spectrum, reflecting a sense that something has broken in our country.

In such an environment, is it right to release critical financial information the Friday before Christmas? Is it acceptable that politicians are not required to describe the cost of the promises they have made?

In 1990, the government required that companies begin to account for the net present value of retirement promises, not just current-year cash flows. General Motors began complying in 1992; and it recorded a $33.1 billion (pretax) charge to reflect the value of its promises up to that point, which led to what was then the largest annual loss in U.S. corporate history. Seventeen years later, the “free until accounted for” promises were a major factor in GM’s bankruptcy.

The United States is stronger than General Motors. And the good news is that small changes in health-care cost trends have a large impact on the government’s long-term promises. Our system is fixable. But our politics are toxic, and each side is dug into an ideological trench. In such an environment, when hard choices need to be made about promises and taxes, why should information be buried in an appendix?

Americans deserve better. One way for Washington to start earning back our trust is by giving us all the information, even if it is unpleasant.