Sinkholes seem to appear without notice. The earth beneath may be eroding for years, but the surface usually stays intact until the land collapses suddenly.
That describes the dire fiscal situations of most of the states in 2012. For years the financial conditions of 45 states have been eroding to the point that the Institute for Truth in Accounting (IFTA) has labeled them “financial sinkholes.”
A pervasive lack of truthful accounting and transparency in government budget processes has made it so most citizens have little warning of the impending fiscal collapse. On the contrary, they have been made to believe balanced budget requirements are preventing their states from spending more than their resources allow.
More Than $1 Trillion Debt
According to the IFTA’s recent “Financial State of the States” study, that’s not the case. The IFTA has determined states have accumulated more than $1 trillion in debt.
In all but four states, a “taxpayer’s burden” now exists, representing the amount each taxpayer would have to send to their state treasury to fill its financial hole.
Put simply, responsibility for government spending in years past—including for government employees’ retirement benefits—has been shifted to future taxpayers.
If state budgets had truly been balanced, no taxpayer burden would have accumulated.
Connecticut’s Big Burden
The IFTA has identified the top five “Sinkhole” states, each with a per taxpayer burden exceeding $23,000. Connecticut’s taxpayer’s burden is $41,200; New Jersey’s is $34,600; Illinois’s is $26,800; Hawaii’s is $25,000, and; Kentucky’s is $23,800.
In contrast, the IFTA identified five “Sunshine” states. Nebraska, North Dakota, Utah, and Wyoming each have a per taxpayer surplus because they have more than adequate assets available to pay their obligations. Although taxpayers in South Dakota are burdened by past spending for which they will have to pay, South Dakota is included as a “Sunshine State” because it has the smallest deficit among the other states.
Due to the delay in states publishing their annual financial reports, data for the IFTA study are derived from states’ 2009 financial reports and related retirement plans’ actuarial reports. Now that all states have finally issued their 2010 financial reports, the IFTA is currently working to recalculate each state’s financial condition and taxpayers’ burdens.
These taxpayers’ burdens exist despite balanced budget requirements due to the deficient accounting policies used to calculate state budgets.
Overstated Revenues, Understated Expenses
States today use cash basis budgeting, which allows them to overestimate revenues and underestimate expenses in the following ways:
• Loan proceeds are considered revenue.
• Revenue is created by moving money from one fund to another.
• Long-term assets are sold to fill short-term budget holes.
• A current budget year cost is not included if the related check isn’t written.
• Current compensation costs are pushed into the future.
The largest annual cost incurred by states is employees’ compensation, which includes benefits, such as health care, life insurance, and pensions and other post-employment benefits (OPEB). These benefits are earned each day an employee works, meaning the cost accumulates every day. As these benefits are promised and earned, a liability is created that must be paid in the future.
Prudent management demands the value of this liability be estimated—and assets set aside—to make sure the payments can be made when they come due.
Because of the historical use of cash basis accounting and its focus on checks written today, the retirement benefit portion of current compensation costs have been ignored in budget calculations.
The IFTA also found most states’ unfunded pension liabilities are calculated assuming pension investments will earn 7 percent to 8.5 percent each year. These rates would be optimistic even in good economic times.
Missing Full Costs
The primary focus now, however, should be to get states to include in their budget calculations their full employee compensation costs, including the retirement benefits earned.
Current convoluted rules enable and encourage dishonesty in the budget process. It is practically impossible for legislators to independently determine whether the budget they are voting on is truly balanced.
A balanced budget is not just something to make citizens and politicians feel better. Every state but Vermont has a balanced budget requirement to help avert future financial difficulties and increase accountability. Because state governments can neither print money nor tax excessively, their ability to spend is finite, making truthful accounting crucial.
Truthful accounting also protects intergenerational equity, preventing the current generation of citizens from shifting the burden of paying for current-year services to future-year taxpayers—namely, our children and grandchildren.
IFTA’s Financial State of the States proves these good intentions have been circumvented.
Pleasure But No Pain
Former U.S. Treasury economist Francis X. Cavanaugh once said, “Politicians should not have the pleasure of spending (getting votes) without the pain of taxing (losing votes).”
Yet that is precisely what has happened.
Future taxpayers will be burdened with paying prior years’ costs without receiving any services for those tax dollars.
Put simply, balanced budget requirements without truthful accounting simply do not work.
In the article on the opposite page I outline a budgeting system called “Full Accrual Calculations and Techniques” or F.A.C.T., which would give taxpayers a realistic idea of the burdens being placed on them.
Sheila Weinberg ([email protected]) is founder and CEO of the Institute for Truth in Accounting.
The Financial State of the States report can be downloaded from the IFTA’s website: www.truthinaccounting.org.