Forty-Five State Are "Financial Sinkholes"

by Sheila Weinberg

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 has 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 following article 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.

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F.A.C.T.-Based Budgeting Provides Honest State Numbers

by Sheila Weinberg

To bring truth and greater transparency to state budget processes, the Institute for Truth in Accounting has developed a budgeting system called “Full Accrual Calculations and Techniques,” or F.A.C.T., which would require governors and legislatures to recognize expenses when incurred regardless of when they’re paid.

F.A.C.T.-Based Budgeting

F.A.C.T.-based budgeting is necessary because government has increasingly grown its role from funding and building infrastructure and operating the rather limited machinery of the state’s internal operations to being concerned with the health, welfare, and lifestyles of citizens and government employees. This expanded role involves committing new programs for citizens and employees not just for the current period but also for years to come.

F.A.C.T.-based budgeting would allow governments’ accounting and budgeting systems to evolve to provide a comprehensive indication of total activity and the long-term effects of current policies. It would record revenue in the budget year the activity revenue was generated. Expenses would be included in the budget year when the resources were consumed and the liability was incurred, regardless of when associated cash is actually received or paid.

By recording accounts payable and receivable, and thus the change in the value of assets and liabilities, F.A.C.T.-based accounting would keep a running tally of what a government owns and owes in economic terms. If a government promises pension benefits in the current year and must pay retirement claims in future years, the liability and expense is recorded when the event occurs. When the cash is actually paid, the liability is removed.

More Transparency

To increase transparency before a budget would come up for a vote, its financial effects would be summarized in easy-to-read, pro forma balance sheets, income statements, and cash flow statements. After the budget year, these statements could easily be compared to the state’s audited financial statements.

The calculation of the retirement liabilities on the pro forma balance sheet and the related costs included in the income statement would be based on the unfunded retirement liabilities determined by the states’ actuaries.

Particularly important for intergenerational equity, F.A.C.T.-based budgeting will limit elected officials’ ability to expand programs and services by deferring the payment of current costs.

The IFTA believes that if F.A.C.T.-based budgeting had been used by state governments over the past 50 years, they would not be in the situations of high financial risk they are in today.

Overseas Examples

Australia, New Zealand, and Canada have successfully adopted systems similar to F.A.C.T. These countries have experienced benefits in linking their budgeting and accounting systems.

The IFTA would like to educate legislators and other state officials on the Truth in Accounting Act, which would require the implementation of F.A.C.T.-based budgeting. Model legislation can be found at the end of the Financial State of the States report.

The IFTA staff is available to hold legislators’ workshops on budgeting processes and best practices for state government budgeting. The staff has testified at budget hearings throughout the country and can be scheduled in legislators’ states.

The American people have made it clear that putting our nation’s finances in order is a top priority. Effectively addressing this will require an accurate picture of our public finances and electing policymakers who are willing to make hard decisions.

To avoid what Europe now is facing, Congress, the White House, and the state and local governments must act soon, before their budget sinkhole collapses.

Sheila Weinberg (sweinberg@truthinaccounting.org) is founder and CEO of the Institute for Truth in Accounting.

Reprinted with permission from Sheila Weinberg, founder and CEO of the Institute for Truth in Accounting.

IOWA TRANSPARENCY NEWSLETTER is a monthly newsletter reporting on government transparency in our state.

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