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The Truth About the Balanced Budget

Truth In Accounting had an incredibly important 50 state study that needs to be broadcast far and wide. It shows the mess that every state in the union is in with the budget.

When the Institute for Truth in Accounting (the IFTA) began to design “The Truth about Balanced Budgets—A Fifty State Study” (the Study) in early 2008 our purpose was to widely examine the effect accounting principles and policies have on states’ budgeting and financial reporting practices. Experience in Illinois indicated to the IFTA that this state’s budgeting process used unsound accounting principles and evaded the intent of balanced budgets mandated by its constitutional and statutory requirements.

Now complete, the Study discovered that the budgeting and accounting problems first identified in Illinois are rampant in other states. The IFTA’s findings include:

  • Most state annual reports indicate their budgets are not balanced;
  • Despite this fact, states perpetuate the myth that their budgets are balanced;
  • Governors and legislatures intentionally circumvent balanced budget requirements for their own political expediency, endangering fiscal sustainability and evading public scrutiny;
  • Billions of dollars in retirement costs are incurred each year but not provided for in state budgets;
  • Information required to assess the long-term consequences of current policy decisions is not available;
  • Surpluses reported on state financial statements do not report true financial results; and
  • Many state annual reports are not published on time, resulting in legislators entering budget negotiations completely unaware on how the state performed in the previous fiscal year.

Back in early 2008 no one foresaw the financial distress that was to develop during the second half of the year. Since then, news of developing fiscal difficulties in several states shows why the creative accounting they use is not useful to understand their financial condition or to predict the future financial crisis. These developments concretely prove the IFTA’s finding that a complete overhaul of the budgetary requirements governing the states is critically needed. It is also time to improve the Generally Accepted Accounting Principles used by state and local governments, so pension and healthcare obligations are included as liabilities on the governments’ balance sheets.

Balanced Budget Requirements are Critical

Since state governments cannot infinitely expand their credit, issue currency, or tax excessively, their ability to spend is finite. To avert future financial difficulties and to enhance accountability, states have adopted balanced budget requirements in their constitutions and/or statutory schemes. The IFTA’s study found all states, except Vermont, have such requirements.

These balanced budget requirements have both short- and long-term objectives. In the short term, the requirements generally force governors and legislatures to determine the amount of taxes that must be raised to cover the costs of governmental policies and actions. In theory, these requirements foster governmental accountability because politicians should be allowed to spend only the amount taxpayers are willing to pay. Former U.S. Treasury economist, Francis X. Cavanaugh, said it best: “Politicians should not have the pleasure of spending (getting votes) without the pain of taxing (losing votes).” Mr. Cavanaugh highlighted that “we need that accountability to ensure that spending is justified and that the taxpayers are willing to pay for it.”

The Governmental Accounting Standards Board (GASB) believes that laws requiring balanced budgets prevent the current generation of citizens from shifting the burden of paying for current-year services to future-year taxpayers – namely, our children and grandchildren. The GASB deems this concept, known as “inter-period equity,” to be a significant part of accountability and fundamental to public administration. Inter-period equity is indeed a significant part of accountability because it reduces incumbents’ ability to promise voters future benefits without having to face the political cost of enacting ways to pay for those benefits today.

The IFTA reviewed each state’s Budgetary Comparison Schedule as reported within the Required Supplementary Information included in the financial section of each state’s CAFR. This review found the majority of states report their budgets are not balanced. The review of the state numbers revealed that during the fiscal years 2005-2007:

  • Twenty-six states reported budget deficits for each of the three years;
  • Another nine states reported budgetary basis deficits for one or more of the three years;
  • The annual budget bills adopted by California, Arizona and Arkansas do not include revenues; therefore, only expenditures are presented on the Budgetary Comparison Schedules. This makes it impossible to determine whether their budgets were balanced.

Balanced Budget Requirements are Circumvented

Balanced budget requirements are intended to maintain fiscal sustainability and public accountability. Our Study found that self-serving budget manipulations are used to circumvent these requirements.

The IFTA found governments circumvent the intent of balanced budget requirements by: