Sleight-of-Hand Math for the Budget Deficit

By Allan Sloan
Tuesday, September 4, 2007

Don't believe the hype: The deficit is much bigger than you think.

There will be lots of celebrating in Washington next month when the Treasury announces that the federal budget deficit for fiscal 2007, which ends Sept. 30, will have dropped to a mere $158 billion, give or take a few bucks. That will be $90 billion below the reported 2006 deficit, and will be toasted by the White House and Treasury as a great accomplishment.

But I have a nasty little secret for you, folks: If you use realistic numbers rather than what I call WAAP -- Washington accepted accounting principles -- the real federal deficit for this fiscal year is more than 2 1/2 times the stated deficit.

Why am I inflicting this information on you? Because there's been so much joyous noise about the budget emanating from Washington, despite the subprime mess and market meltdowns, which don't bode particularly well for future tax collections, that my natural contrarianism makes me feel like bombing the buzz machine. In addition, so many investors (and speculators) are fleeing to the supposed safe haven of Treasury securities lately that it's a good time to take a look at what's really going on with the federal budget.

If a publicly traded corporation tried keeping books the WAAP way rather than the GAAP (generally accepted accounting principles) way, its auditors would be on the phone to the Securities and Exchange Commission before you could say Sarbanes-Oxley. But this is the federal government, which operates its unique budget accounting system regardless of which party's running the show. Making the deficit look smaller than it really is helps whoever's in power, be it today's borrow-and-spend crew or yesteryear's tax-and-spenders.

Let me show you how this works, using numbers from the recent update issued by the nonpartisan Congressional Budget Office. (I'm giving you the simplified version to keep your eyes from glazing over. You can find a detailed version in the accompanying box.) We'll start with Social Security, which will take in about $78 billion more in payroll and income taxes than it shells out. The Treasury takes that cash, gives the trust fund IOUs for it, and spends it. That $78 billion isn't in the stated deficit.

Wait, there's more. The Treasury will fork over $108 billion of interest on the trust fund's $2.2 trillion of Treasury securities, but will give the trust fund IOUs, not cash. They won't count in the deficit either. Add that $186 billion to the stated budget deficit, and it more than doubles, to $344 billion. The stated deficit, you see, measures how much less cash Uncle Sam takes in than he spends. That's fine for gauging the deficit's impact on the economy, which is what budget experts generally do. But if you're trying to assess Uncle Sam's overall fiscal condition, as I am, you should count those IOUs in the deficit because they have to be paid someday.

Now, let's move on. We end up with a total deficit of more than $400 billion by undoing another piece of WAAP legerdemain: the $97 billion increase in Treasury securities held by "other government accounts" such as federal employee pension funds. Thanks to the magic of Washington math, that doesn't increase the deficit, even though it increases the government's overall debt. Don't you wish you could keep books this way at home?

I worry that the happy news may produce unhappy long-term results by making politicians even less inclined than usual to inflict pain on voters by raising taxes or trimming future benefits to keep entitlements from overwhelming the public fisc. Congressional Budget Office Director Peter Orszag warns that at their current growth rate, Medicare and Medicaid will devour 20 percent of our gross domestic product in 2050 -- more than today's entire federal budget. Yech!

So even though the deficit's smaller than it was and financial markets (for now) love Treasury securities, don't take next month's budget numbers at face value. If you do, you're setting yourself up to be WAAPed.

Allan Sloan is Fortune magazine's senior editor at large. His e-mail address is asloan@fortunemail.com.


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