Bruce Bartlett: Beware of Budget Gimmickry Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of "The Benefit and the Burden: Tax Reform - Why We Need It and What It Will Take." It's clear that the United States is entering a long period of budgetary confrontation. Sooner or later, meaningful action on the budget deficit will be necessary. And despite the best hopes of budget hawks, the likelihood of a grand bargain that will solve our problem once and for all is extremely remote. Because all of the options for meaningful deficit reduction - tax increases, in particular - are extremely unpopular, it is inevitable that accounting gimmicks will be called upon to give the illusion of progress. Budgetary gimmickry is at the heart of Europe's continuing debt problem. According to a 2010 article in The New York Times, Wall Street firms arranged for countries like Greece to borrow funds in ways that circumvented European Union budgetary rules by using financial derivatives that were hidden off-budget. Often, borrowing was disguised as an asset sale so that the borrowing receipts were classified as revenues rather than debt. The International Monetary Fund has long been concerned about such budgetary gimmickry. Last week, it published a staff discussion note detailing some ways that governments may be tempted to use gimmickry to give the illusion of fiscal improvement. The note begins by explaining the nature of fiscal gimmicks, which it calls "accounting devices." Their essence "is to improve headline indicators without actually improving public finances." Such a device usually involves measures that appear to improve the current-year deficit, but by increasing future years" deficits. They may take place on either side of the ledger - by appearing to reduce current spending in return for higher spending later or increasing current revenues in return for lower future revenues, or some combination of the two. One classic form in which accounting devices operate is through "hidden borrowing." In Europe, governments sometimes took over the pension plans of private companies or public enterprises. In the short term, the government gained assets that appeared to reduce borrowing; but in the process it incurred a liability for future pension payments that was not immediately apparent on the government's books. This technique has been used in the United States as well. States have been known to sell state assets and then lease them back in order to improve their near-term fiscal condition. Revenue from the sale is booked as revenue, while the long-term lease payments are pushed off to the future and may not be visible in budget documents. Another instance of hidden borrowing involves currency swaps. The trickery involves cases where a nation specifies borrowing and repayments in foreign currencies at different exchange rates. Something like this got Italy into financial trouble some years ago and Greece more recently, according to the article in The Times. The I.M.F. calls a second type of accounting device "disinvestment," which increases revenues in the near term while reducing future revenues. A common method of doing this involves the sale by governments of certain rights to future cash flows - such as air-traffic-control fees or lottery process - through securitization. The trickery is that the government often guaranteed the cash flows, effectively making the transactions loans rather than sales. Examples in the paper include selling the rights to lottery proceeds, >air traffic control fees and tax receivables. See page 8. >http://www.imf.org/external/pubs/cat/longres.aspx?sk=25795 xx A third device is called "deferred spending." The United States is a guilty party to this sort of trickery. According to an Associated Press report published in The New York Times in 1987, the military payday was moved forward by a single day, which pushed $3 billion in spending from fiscal year 1987 into fiscal year 1988. There was no real saving, but on paper the budget deficit for 1987 was reduced by $3 billion. Another type of deferred spending is where governments postpone maintenance on roads and public buildings. This classic penny-wise/pound-foolish behavior often costs more in the long run. The I.M.F. also classifies some leasing arrangements as deferred spending, in cases where governments would typically purchase assets outright. It cites a 2003 proposal in which the Air Force would have leased 100 refueling planes from Boeing at a long-term cost 10 percent to 15 percent more than the cost of buying them, but in a way that reduced near-term spending. Pensions are another classic form of deferred spending. Government workers may trade increases in pay for higher pensions in the distant future. The future pension liabilities may not appear in the budget but impose large future costs on taxpayers. The I.M.F. study includes the following table showing just how large future civil service pension liabilities can be. A fourth type of budget trickery is called "forgone investment," which reduces near-term spending at the expense of lower future revenues. An example of this would be government concessions to private companies for airports and toll roads. Spending is lower by the amount that governments would otherwise spend for public works, but they lose the future tolls and other revenues that would have been collected. Finally, there is a device called "disappearing government," in which national government costs are shifted to lower-level governments or off-budget agencies. The report cites the debts owed by Fannie Mae and Freddie Mac as falling into this category. A 2005 study by the Organization for Economic Cooperation and Development sought to catalog cases of fiscal gimmickry in Europe over a 10-year period. Virtually every country was found to have engaged in cases of "one-off measures," "creative accounting" and budgetary reclassifications to improve the appearance of the debt or fiscal balance. Not surprisingly, Greece was the worst offender, engaging in such activities annually, averaging 2 percent of G.D.P. a year. A great deal of gimmickry is already embedded in American budgetary practices. The Government Accountability Office routinely calls attention to them, but Congress has never shown any willingness to consider reforms that would make the debt or the deficit appear larger. The pressure to reduce deficits will undoubtedly increase the incentive to engage in further trickery.