Summary: Honest Government Accounting Act

S. 1915 (Lieberman, Nov. 11, 2003)

Baby Boom Entitlements

· It will not be possible for the Federal Government to honor its commitment to deliver retirement security to the Baby Boom generation without first honestly accounting for the financial status of Social Security and Medicare. 

· It is not possible for the government to set spending priorities on social insurance entitlements, national defense, homeland security etc. if the size and timing of these commitments under current policies are not made transparent. 

· The current backward looking, cash flow accounting system used to make federal policies is completely inadequate for these tasks.

Need to Account for Both Explicit Liabilities and Implicit Commitments

· The Honest Government Accounting Act of 2003 will ensure that the Government fully accounts for both its explicit liabilities (the debt held by the public) and implicit commitments (social insurance entitlements) – in relation to the funding available under current policies.  This is necessary to design fiscal reforms that will enable the federal government to finance and better manage its liabilities and commitments.

Explicit Liabilities Are Dwarfed by Implicit Commitments

            · The national debt (debt held by the public) stands at $4.2 trillion, but the present value of our implicit commitments is calculated to be $10.4 trillion for Social Security and $61.6 trillion and for Medicare, Parts A, B, and D (Part C is subsumed under Parts A and B).

            · The present value is the amount that needs to be set aside now earning interest to fund future shortfalls that are projected to arise in these programs under current tax and spending policies.  If we postpone funding these commitments, the funds needed will increase substantially with each passing year. 

            · This $72.0 trillion imbalance for our implicit commitments is over 17 times the debt held by the public, 6 times the Gross Domestic Product, and 1.7 times the total net worth of the 112 million United States households ($42.4 trillion).

Demographics of the Baby Boom Generation

· The staggering size of this fiscal imbalance may be attributable to the social insurance entitlement commitments to the Baby Boom generation that is fast approaching retirement.  Payroll tax receipts projected from the following generations and dedicated to these programs are not sufficient to cover those commitments. There are 77 million individuals in the Baby Boom generation, Including 8 million immigrants that America has absorbed in that age group. It is by far the largest retiring generation in United States history.

· On September 2, 2011, the first Baby Boomers, defined as those born after the

end of World War II through 1964, will turn 66 and begin to draw full Social Security benefits--just 8 years from today. Baby Boomers can begin drawing full Medicare benefits in 2010 at age 65.

Realistic Accounting Necessary to Government Decisions

· The Government and public need to face these realities and can do so only if they understand the scope and magnitude of all of the Government’s long-term liabilities and commitments.

· The Government and the public must prepare and adopt realistic long-term financial plans, not aggravate the challenge by adding to the debt held by the public, and take decisive steps to prepare for the retirements of the Baby Boomers and subsequent generations. 

· The Government needs to ensure that its liabilities can be met, its commitments to beneficiaries are realistic, and that the impact of these liabilities and commitments does not undermine the ability of the Government to fund other critical priorities.

Present Value Calculations Used in Business Sector

            · Comparing the present value of receipts and expenditures is standard operating procedure in household financial planning, mortgage lending, and investment banking. This legislation applies this methodology to government accounts. 

            · The most appropriate way to assess Government finances is to calculate its net assets under current policies: the net present value of all prospective receipts minus the net present value of all prospective outlays and minus outstanding debt held by the public. 

Present Value Calculations Needed to Measure Sustainability of Government Programs

· A net present value calculation measures the sustainability of government fiscal policy and programs.  It is the sum of the debt held by the public and the net present value of the government's future outlays subtracted from the net present value of the government's future revenues. 

· This measure shows the amount of funds the government needs to have on hand today invested and earning interest in order to never have to change current fiscal policies and programs. 

· If the government does not have this amount set aside today, today's fiscal policy and programs are not sustainable and either outlays must be reduced or revenues increased so that the present value of the government's liabilities and commitments net of the present value of available assets and revenues is zero or negative. 

· This is a powerful way to assess the consequences of current and proposed policies.

Widespread Use of Present Value Calculations in Federal Government

· OMB already utilizes net present value analysis under OMB Circular A-94 and every agency of the government is already experienced in utilizing these analyses as an integral element of their decision making. The legislation mandates that these analyses be utilized in fiscal policy and legislative policy debates.

· The Circular applies this type of analysis broadly to "any analysis to support Government decisions to initiate, renew, or expand programs or projects which would result in a series of measurable benefits or costs extending for three or more years into the future."  This includes any analysis of the "benefit-cost or cost-effectiveness of Federal programs or policies," "regulatory impact analysis," "analysis of decisions to lease or purchase," and "asset valuation and sale analysis."

· The use of this methodology is found to "promote efficient resource allocation through well-informed decision-making by the Federal Government."

· The Circular finds that the "standard criterion for deciding whether a government program can be justified on economic principles is net present value -- the discounted monetized value of expected net benefits (i.e., benefits minus costs)."  It specifies, "Net present value is computed by assigning monetary values to benefits and costs, discounting future benefits and costs using an appropriate discount rate, and subtracting the sum total of discounted costs from the sum total of discounted benefits. Discounting benefits and costs transforms gains and losses occurring in different time periods to a common unit of measurement."

· It concludes, "Programs with positive net present value increase social resources and are generally preferred. Programs with negative net present value should generally be avoided."

Federal Government Already Mandates Present Value Analyses for the Private Sector

· Under the Internal Revenue Code and the Employee Retirement Income Security Act (ERISA), the Federal government requires private companies to calculate the present values of their accrued pension liabilities to determine the sustainability and integrity of their private defined-benefit pension and other benefit plans.  This calculation adds together the current year's benefit payout and the increase in the present value of the firm's accrued benefits discounted at a pre-specified interest rate. The estimate of accrued benefits uses information on the age profile and expected mortality of the company's workforce and the company's benefit formulae for determining expected future payouts.  The present value of current plus accrued future benefits is then compared to the balance in the company's pension fund dedicated to paying pension benefits to determine the plan's financial adequacy. 

· If the pension-fund is underfunded (it's balance covers less than 90 percent of the firm's current plus accrued future liabilities), the firm is required to make additional "deficit reduction contributions" intended to returning the fund to financial adequacy over time.

· The federal government currently does not require any similar accounting or funding requirement for its public pension and health-care systems, including Social Security and Medicare.

Difference Between Present Value and Accrual Accounting

· Net present value accounting differs from accrual accounting.  Although appropriate for private sector entities whose operations can potentially terminate in the future, accrual accounting is potentially misleading and incomplete for an entity such as the Federal Government that is expected to continue operating indefinitely.  For Government social insurance programs such as Social Security and Medicare accrual accounting would count only the liabilities accrued to date.  Moreover, these liabilities are calculated in such a way as to assume that these programs are immediately terminated and that the Government must pay off existing obligations according to a particular method of evaluating their size. 

· By contrast, a focus on net present values includes liabilities and income we know will accrue in the future for future beneficiaries (e.g. the Baby Boomers and all future generations).  These values focus squarely on the extent to which current programs such as entitlements are sustainable into the future. 

· The legislation redresses the short sightedness and potentially misleading focus we find in the current Budget Act and Budget resolutions and public discourse about cash flow measures of Government finances, deficits, and public debt.

Relationship of Present Value Calculations to Entitlement Reform and Tax Cuts

            · The legislation sets up a process that will ensure that when entitlement reform is considered, it is premised on an accurate assessment of the fiscal standing of the entitlement programs. 

· It does not support or discourage any specific entitlement reform proposal. 

· The legislation sets up a process that will ensure that when tax cuts or spending programs are considered, they are premised on an accurate assessment of the government's long-term liabilities and commitments.