Budgeting for Mandatory Spending
Revised Draft: April 8, 2017
Marvin Phaup
Trachtenberg School of Public Policy and Public Administration
George Washington University
Contact: MPhaup@ gwu.edu
1
Marvin Phaup1
MPhaup@ gwu.edu
April 8, 2017
Budgeting for Mandatory Spending
“Traditional budgets [are] a flawed tool for decision making, but pretty good
for accountability and control.” John L. Mikesell
Abstract/Summary: Federal budgetary accounting for mandatory spending
contributes to overspending for social insurance relative to revenues and other
spending. Those effects result from a failure to recognize mandatory obligations
in the budget as they become irrevocable. Instead, annual mandatory costs
consist of payments to/for eligible beneficiaries, mostly retirees, less collections
from employees and non-federal employers. This measure mixes outlays for
legacy costs with receipts earmarked for future payment: a measure largely
irrelevant to current period costs. Alternative use of actuarial normal cost in the
budget would facilitate tradeoffs among mandatory spending, taxes, and other
resource uses. A remedial accounting is offered. (100 words).
I.
INTRODUCTION
Under current U.S. budget policy, federal debt/GDP is projected to rise
without limit.2 This path entails onerous future net tax burdens, risks debtdriven fiscal crises, limits the ability of the government to respond to future
1
I am especially indebted to Deborah Lucas and James J. Hearn for many discussions of this topic. (Lucas. 2003)
and (Hearn and Phaup. 2016) were fundamental to developing this analysis. I also thank Joe White and other
participants at the 2016 ABFM Conference in Seattle for useful comments and suggestions. I gratefully
acknowledge the contributions of Charles Blahous, Noah Meyerson, Eugene Steuerle, David Torregrosa, Dwitipriya
Sanyal, and Quiran Wang. However, the views expressed here are mine and are not necessarily shared by those
who contributed generously to their development.
2
Congressional Budget Office, The 2016 Long-Term Budget Outlook, Washington DC
https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/reports/51580-LTBO.pdf
2
shocks and priorities, reduces standards of living, and increases the chances
that government will rely more heavily on newly-created money to finance its
operations. These outcomes all threaten economic, political, and social
stability. (Minarik, 2011).
A primary driver of rising debt is the current and projected growth in
mandatory spending, which now constitutes two-thirds of total federal
outlays.3 Those payments are largely for Social Security, Medicare, Medicaid,
pensions, and other post-employment benefits.4 This growth not only imperils
stability, it crowds out discretionary spending for current priorities, including
research, education and other investments. Although the Congress and the
President are aware of the risks and forgone opportunities of current policy,
they procrastinate. The absence of a timely response is especially problematic
because adjusting fiscal course sooner rather than later would require a
smaller correction.
An important contributor to inaction is the failure of the current budgetary
accounting to recognize the cost of mandatory obligations when they are
incurred and controllable. Instead the budget recognizes the cost of
obligations as they are paid to retirees and other beneficiaries, when it is too
late, politically and ethically, to make significant reductions in benefits.
The key feature of budgetary accounting that delays recognition of costs is the
use of budgetary funding accounts for deferred payments. In combination
with cash-basis accounting and a narrow definition of government debt, the
use of on-budget funding accounts postpones the recognition of cost and
associated debt until cash flows out of the government to liquidate
obligations.
The current treatment of mandatory obligations and spending is defended on
grounds that budgetary accounting is based on the absence of a
constitutionally-protected right to benefits scheduled under current law. That
is, because elected policymakers could change the law at any time and revoke
authorized benefits, even for those who are currently receiving payments. In
that case, those who were previously eligible would have no legally
3
4
Discretionary and interest are the other two components of federal spending.
Social Security and Medicare dominate. Together they account for more that 40 percent of federal spending.
3
enforceable claim to benefits.5 Thus, the argument runs, because
government could revoke benefits, the budget should delay recognition of
mandatory obligations until government forgoes exercise of the option and
makes payment. Thus, the budget does not recognize any obligation, or debt,
to pay mandatory benefits beyond the current period.
This rationale is inconsistent with the assumption of a continuation of current
law used elsewhere in the budget process. Baseline projections, for example,
show the expected path of mandatory outlays based on current law benefits,
including authorized cost of living adjustments. As a rule, budget preparation
assumes the absence of new legislative action because this assumption is
useful in identifying the likely fiscal outcome of current policy and in forging
plans to improve those outcomes by changing the law.
However, simply assuming the continuation of current law for mandatory
spending does not reveal the rate at which additional benefits accrue in the
current period. It only recognizes the annual benefits to be paid in the future,
if the law remains unchanged. To develop a measure of the increment or
increase in total benefits this period, it is necessary to replace the arbitrary
and improbable assumption that no benefits will be paid in the future, with
another arbitrary, but more useful, assumption. One commonly-used such
assumption is that an equal pro-rata share of projected benefits is earned in
each year of covered employment. This latter assumption is more useful
because it provides a more timely, accurate, and salient measure of the
change in current period obligations. It thereby facilitates planning by
policymakers to assure the payer’s ability to make the payments it has
encouraged others to expect.
Current budgetary accounting practice also fails to recognize the effective
encumbrance of participants’ financial contributions to fund future payments.
Under existing budgetary accounting, those collections—paid in during
5
In Flemming v. Nestor (1960), the U.S. Supreme Court voting 5-4, upheld the denial of Social Security benefits to
Ephram Nestor under a 1954 law which withdrew benefits for those deported for having been a member of the
Communist Party. Nestor had been receiving benefits when he was deported in 1956 for his membership in the
Party 20 years earlier when membership was not illegal. In that decision, the Court opined famously, perhaps
recalling the Great Depression origins of the program as an instrument of depression relief, that making Social
Security benefits an enforceable property right, “would deprive it of the flexibility and boldness in adjustment to
ever-changing conditions which it demands.”
4
participants’ working lives --are treated as general inflows of financial
resources to government. Thus, funds collected for deferred payment reduce
the current budget deficit and create fiscal space for additional current
spending and other uses, including tax reductions. This accounting overstates
resources available now and understates the current period loss of control
over future inflows of fiscal resources.6
Much of the information needed to inform federal budget decisions about
accruing mandatory obligations is already in the public domain. For example,
an actuarial measure of the present value of government’s obligation incurred
in the current period for federal pensions is disclosed in intragovernmental
transfers. Long-term budget projections, the Financial Report of the U. S.
Government and the Annual Reports of the Social Security and Medicare
Trustees also disclose information useful in measuring current period,
accruing costs.
However, as behavioral research has confirmed, disclosure of relevant
information is not enough to insure its use in decisions (Coronado et. al. 2008;
Thaler and Sunstein.2008; Hearn and Phaup.2016a, and additional references
therein). The frequency of choices consistent with the expressed preferences of
decision-makers is lower where significant search effort or analysis is required to
identify the cost of a considered alternative. Processes that make goal-consistent
decisions cognitively easier by rendering relevant information more easily
available and salient can improve choice and long-term well-being. Choices can
also be improved by framing forward-looking decisions to weaken a bias toward
present rather than future consumption, e.g. “Save More Tomorrow.”7 To be
used in decisions, information must be hard to ignore and easy to use. Including a
measure of the incremental periodic cost of mandatory obligations in budget
outlays and the deficit and in increases in debt owed to the public for existing and
proposed legislation would enhance the use of existing information.
6
The House Budget Committee’s proposed budget process reform, November 30, 2016 addresses in an ad hoc
manner many of the shortcomings of the budgetary treatment of mandatory spending for federal pensions and
insurance. It would prohibit some abusive scorekeeping practices, such as the use of increases in earmarked trust
fund revenues to pay for new spending for unrelated purposes or for tax cuts. It also requires discretionary
transfers from Treasury to the trust funds to be scored as new budget authority and budget outlays. For details
see: http://budget.house.gov/uploadedfiles/bpr-longsummary-30nov2016.pdf
7
http://www.savemoretomorrow.com/
5
In sum, current budgetary accounting for mandatory payments does little to
mitigate cognitive limitations, including present bias, excessive optimism,
distaste for analytical effort, and overreliance on heuristic shortcuts. More
specifically, it encourages policy makers to overspend relative to available
resources and discretionary spending by:
 Postponing recognition, i.e. reducing the salience, of current period
mandatory costs, until they are politically sunk, beyond feasible
recovery, and must be paid;
 Framing the implied fiscal imbalance of current law for mandatory
spending as a future rather than current on-going condition;
 Focusing on corrective policies that are inconsistent with political
incentives and self-interest, e.g. reducing currently payable benefits,
and
 Failing to distinguish accumulated legacy debt from new current
obligations.
The remainder of this paper which proposes to address some of these
failings is organized as follows: The next section describes current
budgetary accounting for three mandatory programs, which are
components of the Federal Employees Retirement System (FERS). Those
are: Basic Benefit defined benefit pension plan; Old-Age, Survivor, and
Disability Insurance (OASDI); and the Federal Employees Thrift Savings Plan
(TSP). The discussion highlights a fundamental accounting difference
between the Basic Benefit and OASDI programs on the one hand and the
Thrift Savings Plan on the other: the budgetary status of fund accounts.
The informational effects of the difference in budgetary classification of
Fund accounts combined with full, continuous funding of obligations
suggests an alternative accounting, not only for the Basic Benefit and
OASDI, but for other mandatory programs.
Second, the paper reviews and evaluates the major arguments advanced in
defense of the current budgetary accounting: that mandatory obligations
are conditional both on current law funding, which limits spending to trust
fund balances, and policymakers’ ever-changing and unpredictable
6
priorities; and short-lived because they do not become legally enforceable
until they are due to be paid under prevailing law.
A third section describes an alternative budgetary treatment for the Basic
Benefit and Social Security, that addresses many of the shortcomings of
the current accounting. It also considers some disadvantages of this
alternative.
A brief section concludes that the proposed alternative should be adopted
for budgeting, or at least piloted for federal pensions and insurance as
proposed by the House Budget Committee (2016), because it would enable
policymakers to gain control over the periodic costs of mandatory
spending, approximating their control of discretionary spending. It would
also distinguish clearly those programs with significant current deficits
from those close to operating balance by eliminating the distorting effect
of differences in legacy debt. The effectiveness of the new accounting in
improving decisions would likely be increased if it were accompanied by
other changes in the budget process, especially including a binding
intertemporal budget constraint. (Bhatti and Phaup. 2013)
II.
OVERVIEW AND BUDGETARY ACCOUNTING FOR FEDERAL PENSIONS
FERS is the federal retirement plan for most civilian employees hired after
December 31, 1983.8 It replaced the Civil Service Retirement System
(CSRS), which was a defined benefit plan.9 FERS was adopted to make
federal benefits more competitive with private plans and to increase the
portability of earned benefits for employees moving between federal and
non-federal employment. New hires are automatically enrolled in FERS;
participation is a condition of employment.
8
The federal government also provides a variety of pension plans to meet special occupational needs of its
employees. Those include plans for the military, foreign service, law enforcement, firefighters, air traffic
controllers, members of Congress, and Congressional employees. Except for the military retirement system, most
of these are variations on the FERS model.
9
Defined benefit plans provide a specified benefit to employees, e.g. a fixed percent of the average of the highest
three years of pay for each year of service. Defined benefit plans may be contrasted with defined contribution
plans which provide a specified, (defined) annual contribution to an employee’s retirement account that may be
invested in securities of varying risk chosen by the employee. The value of the account at retirement varies with
realized returns and amounts contributed by the employee and employer.
7
FERS has three components with each expected to contribute about a third
of retirement income for federal employees.10 These are:
 Basic Benefit, a defined benefit plan that provides specified, monthly
pension payments to eligible beneficiaries, based on the employee’s
pay and years of covered employment;
 Social Security, or the federal Old-Age, Survivors and Disability
Insurance (OASDI) program; and
 Thrift Savings Plan (TSP), a defined contribution plan that offers
employees an option to save, invest, and defer taxes on a portion of
earnings with contributions and partial matches from their
employing agency. (For additional detail, see Appendix.)
Basic Benefit
The defined benefit component retained the budgetary accounting of its
CSRS predecessor, including the use of the Civil Service Retirement and
Disability Fund (CSRD). That budget account is credited with agency and
employee contributions and Treasury interest on fund balances. It is also
charged with payments to beneficiaries. Figure 1 shows the financial flows
recorded in the budget for this program.
The dotted horizontal line across the figure is the accounting boundary
between the federal budget entity and the rest of the world. The federal
side has three accounts: the employing agency, the Treasury and the CSRD
Fund. Federal employees and retirees are outside the budget.
Cash flows that cross the budget boundary are recognized in the budget
when they occur as either outlays or receipts and affect the budget deficit
accordingly. Flows between budget accounts, however, are intragovernmental; the outlays of one account are receipts of another. The two
cancel on consolidation of all budget accounts. Intra-governmental
transfers, therefore, have no effect on aggregate budget outlays, receipts,
10
https://www.opm.gov/retirement-services/fers-information/
8
or the deficit when they occur.
In most cases, agency contributions to the CSRD Fund are the actuarial
“normal costs” to the government, net of employee contributions. 11 Under
current policy, however, total annual costs of the FERS basic benefit is
estimated to be 14.2 percent of basic pay. Agencies contribute 11.1 percent
and employees pay 4.4 percent. The excess 1.3 percent of wages and salaries
is being used to pay down a previous deficit in the Basic Benefit plan. Because
the agency payment does not cross the budget boundary, it has no effect on
budget outlay costs or the deficit until benefits are paid.12 Employee
contributions, however, cross the budget boundary and are shown in the
budget as revenues.
CSRD balances from employing agencies’ and employees’ contributions to the
Fund are invested in notional assets made up of special issue, interest-bearing
Treasury securities. The interest earned provides a third source of funding for
the CSRD Fund. However, the Treasury securities held by the Fund are not
classified as debt held by--and owed to--the public. Rather the Fund’s claims
11
12
For details, see https://www.actuary.org/pdf/pension/fundamentals_0704.pdf
See (Torregrosa. 2003) for additional detail.
9
are reported as intra-governmental debt of Treasury owed to the Retirement
Fund, or more vividly as “money the government owes itself.” No
corresponding claim by employees is acknowledged. By this accounting, the
government avoids recognizing in the budget aggregates and in debt held by
the public, any obligation to pay defined benefit pensions.
Interest credited to the Fund corresponds to the time value of money on
account balances and is critical to actuaries’ estimates of the amount to be set
aside now to pay future benefits. As indicated in Figure 1, Treasury interest
payments to the Fund are intra-governmental and are not shown in the
budget aggregates until paid in retiree benefits.
The government’s budget cost of the FERS Basic Benefit for any fiscal year and
the program’s reported effect on the government’s fiscal position is:
 annuities and other distributions paid retirees this period
 minus contributions received from employees this period.
If the government’s labor force and compensation policies were static so that
annuities paid were equal to annuities earned this period, the budget
measure of costs would accurately depict the period’s change in financial net
position. But this appearance of accuracy is no better than that of a stopped
clock. The current accounting does not support informed budget choice or
policy decisions because the current measure is unaffected by those changes.
If, for example, the government considered a proposal to increase defined
benefit pensions for new hires, the reported budget effect in the year of
enactment (and the 10-year cost estimate for the enabling legislation) would
be approximately zero. The current measure fails to provide decision makers
with the current period, manageable cost of deferred compensation.
Social Security
Budgetary accounting for OASDI follows the FERS/CSRS defined benefit
model, with minor differences.13 A significant difference from the FERS Basic
13
Instead of a single on-budget Fund for accumulating balances and paying benefits, this program uses two
accounts, one each for OASI and Disability Insurance. In addition, the OASDI receives most of its funding from
10
Benefit, however, is that instead of actuarially-determined payments to the
Fund, government and private employer and employee contributions are
established in statute. The 2016 Annual Report of the Social Security Trustees
estimates the combined statutory OASDI rate of 12.4 percent of taxable
wages paid by covered employees falls short of full actuarial funding by an
average of 2.66 percent per year for the next 75 years.
The shortfall is an average of annual gaps between taxes paid and the cost of
benefits over the projection period. Those annual shortfalls increase, from
1.10 percent of taxable wages in 2016, to 2.92 percent in 2030 and to 4.35
percent at the end of the projection period in 2090.14
Social Security is primarily a government program for retired and disabled
persons and their dependents; it is only secondarily a component of the
retirement program for federal employees. Accordingly, the government’s
annually accruing costs for OASDI I s not only the employer’s 6.2 percent of
taxable wages for federal employees. It is also the 1.31 percent actuarial
shortfall between taxes paid and costs of benefits in 2015 for all public and
private employees.15 That shortfall is estimated to have been $80.4 billion.
Neither the government’s contribution for its own employees nor the shortfall
for all employees are included in the cash-basis budget cost of OASDI under
current accounting.
Thrift Savings Plan
Budgetary accounting for TSP is the simplest and most transparent of federal
retirement programs. Net budget outlays also align with the government’s
periodic costs which are recognized by cashing out obligations as they accrue.
This accounting consists of recording specified, defined payments from the
employing agency to non-budgetary Fund accounts. Four of those, the F, C, S,
and I Funds are classified as being on the non-federal side of the budget
outside the government in the form of employee and employer payroll tax contributions. This difference requires
the addition of non-federal employers to the EMP box on the non-federal side of the budget boundary in Figure 1.
14
Social Security Trustees’ Report 2016, Table VI. G2, p.208.
15
The estimated shortfall of 1.31 percent of taxable wages is from the 2015 Report of the Social Security Trustees,
Table VI, G2
11
boundary. The G fund is held and maintained by Treasury but is classified as a
non-budgetary “deposit account,” or funds held for others, pending
payment.16
Classifying the TSP Funds as “non-budgetary” has the following effects on key
budget measures:
 Agency contributions to the retirement accounts are included in budget
outlays as benefits are earned;
 Employee contributions to the non-budgetary retirement accounts are
not treated as net inflows of fiscal resources to the government;
 Treasury debt securities held by the investment funds are included in
Treasury debt held by (and owed to) the public;
 Interest on Treasury debt held by the Funds is scored as budget outlays
as it accrues; and
 Payments of benefits to retirees and survivors are not included in
budget outlays when paid; those costs are recognized in outlays as
accrued.
It would be possible, though undesirable, to convert the budgetary accounting
for TSP to the Basic Benefit/OASDI model. This could be accomplished by
creating on-budget TSP Funds. Balances in those Funds would vary just as they
do with non-budgetary invested funds, even though the government would
not buy market securities. Each pay period, agencies would contribute the
“defined” amount to the employee’s account. But the government would also
adjust the fund balance by direct transfer, to match the calculated change in
the value of the account as determined by the employee’s contributions,
allocation decisions and the performance of the respective fund’s indices.
Thus, employees could select an investment portfolio with their desired level
of volatility and realize the same returns, as if the account were invested in
market securities. The cost of retirement benefits to the government,
however, would not be recognized in budget outlays until the funds were paid
in a lump sum or as an annuity to retirees. Employee contributions would be
16
TSP also offers a life cycle option, or L fund, which automatically changes the distribution of employee balances
across the five basic funds to reduce volatility of principal as employees age.
12
scored as net inflows of budgetary resources to the government; Treasury
interest would not be recognized in outlays until benefits are paid to retirees.
Those changes in budgetary cost resulting from the reclassification of TSP
Funds warrant consideration of potential gains in relevance, timeliness, and
salience of information from reclassifying other deferred payment funds as
non-budgetary. Before doing so, however, we consider in more detail the
rationale used to justify the current budgetary accounting for federal defined
benefit pensions, Social Security, and other mandatory programs.
III.
A TRADITIONAL DEFENSE OF CURRENT BUDGETARY ACCOUNTING,
REASSESSED
Current budgetary accounting has it defenders, especially among staff and
appointed public officials. Those analysts dispute the claim that a substantial
lag exists between the government’s commitment to provide mandatory
benefits and liquidation of those obligation. They argue instead that
government’s obligations are short-lived and conditional. In their view,
obligations are incurred and liquidated monthly. Future benefits are
conditional on the ability under current law and willingness of government to
make those payments.
Defenders use the programs’ short-term financing cycles, often referred to as
“pay-as-you-go,” to support the view that mandatory commitments are shortterm. Pay-as-you-go in this case means that current period earmarked
collections are used, first, to pay current period benefits, and only second to
accumulate a buffer against financial shortfalls.17 Payable benefits are limited
by law to collections plus balances in the fund account. The OASI Fund holds
balances of Treasury securities of about $2.8 trillion, which would be
sufficient to pay less than four years of benefits in the absence of additional
collections.18
17
Pre-funding, or the accumulation of Fund balances, increased significantly in the 1980s. In earlier periods,
funding aimed at providing only amounts sufficient to pay current benefits.
18
However, Executive branch budget documents caution beneficiaries not to rely on receiving benefits from either
accumulated fund balances or current period collections. Consider, for example, this description of federal trust
funds used to finance many mandatory programs: “In contrast [with private trust funds], the Federal Government
13
The FERS defined benefit program is in process of becoming “fully-funded,”
but—like Social Security -- that funding consists of intra-governmental
notional claims on Treasury.19 Honoring those claims requires the government
to increase taxes or borrowing or to reduce other spending. If those measures
prove insufficient, the government could create new money to pay benefits
owed under current law.
Advocates of the current accounting also argue that commitments are
necessarily tentative because of “legislative sovereignty.” This refers to the
doctrine that no sitting legislature can bind subsequent legislatures, or
otherwise prevent them from changing existing law. In the case of mandatory
spending this acknowledges that the legislation which authorizes payment,
defines eligibility, and specifies benefits could be amended or repealed.
Indeed, government could reduce mandatory benefits to any level that voters
demand.20
Reconsidering this Defense
The argument that obligations of the government to pay mandatory benefits
are short-lived, tentative, and revocable at any time constitutes a prima facie
case against proposals to recognize outstanding mandatory obligations and
the periodic increment to that total. However, the argument is not
dispositive, especially for budgetary accounting, which supports an internal
planning function. The use of “pay-as you go” financing as evidence of a
short-term commitment may be more easily explained by the desire to grant
benefits on enactment to those who were already retired or otherwise
eligible.21 The appeal to “legislative sovereignty” ignores the political
owns and manages the earnings of most trust funds and can unilaterally change the law to raise or lower future
trust fund collections and payments or change the purpose for which the collections are used.” Analytical
Perspectives, Budget of the US Government, FY 2017, p.382.
19
Isaacs (2015) correctly describes those balances as consisting of budget authority, or the authority to extend
obligations that will lead to outlays.
20
Defenders of the current accounting also rely selectively on the continuation of current law. They claim that
under current law, payments cannot exceed current income plus fund balances. They emphasize that no existing
authority permits drawing on the general fund of Treasury to pay benefits. [Reimbursement of OASDI for a
temporary payroll tax reduction required new enacted authority. See Note23.]. Legislated changes in benefit levels
and eligibility, however, are to be expected at any time in response to “ever-changing conditions.”
21
The phrase “pay-as-you-go” implies that current spending is financed by some means other than borrowing
from those who are currently working, i.e. an absence of implied obligation to pay benefits to current contributors.
14
imperative to “protect Social Security.” The argument also neglects the
enabling power of government planning and budgeting to deliver promised
benefits. In short, a constitutional authority to change the law and revoke
benefits does not provide a workable approach to managing fiscal balance; it
only acknowledges the possibility of fiscal failure by the sovereign. Nor does it
justify use of a budget accounting that increases that risk.
Use of “legislative sovereignty” to support the claim that mandatory
commitments are tentative is ironic. Mandatory programs as currently
structured demonstrate precisely how one Congress can tie the hands of
future Congresses. The continued growth of these programs is the result of
legislation enacted in decades past, with occasional expansions and marginal
reductions. Further, at least since the early 1980’s, Social Security--and later
Medicare- -have become the “third rail of American politics.”22 Attempts to
restrict benefits, or target eligibility, risks political death for the perpetrator.
This triumph of past legislatures inspired the title of Eugene Steurle’s 2014
analysis of the effects of mandatory spending growth on today’s budgets,
Dead Men Ruling.
While many mandatory programs were adopted in the 1930’s as a part of
Depression recovery and relief, they are now an enduring part of the social
and economic infrastructure. Any residual countercyclical role consists of their
contribution as automatic stabilizers and, occasionally, as candidates for tax
reduction.23 Temporal flexibility in the provision of benefits is no longer
consistent with their role.
Finally, for budgetary accounting, the arguments offered in defense of current
practice are largely irrelevant.24 Public budgeting is the process of planning
“Government borrowing occurs whenever the government foregoes control over some future flow of resources or
benefits in order to acquire resources for current use.” Bifulco et. al. (2012) p. 660. Also see Irwin (2015).
22
This use of the phrase to mean an untouchable political issue is commonly attributed to Thomas “Tip” O’ Neill in
1982 or to his aide, Kirk O’Donnell.
23
In response to the 2007-9 recession, Social Security payroll taxes for employees were reduced from 6.2 percent
to 4.2% during 2011-12. However, the enabling legislation also required that the reduction in Social Security
receipts to be replaced by transfers from the General fund of Treasury. Because replacement funds were invested
immediately in Treasury securities, the transfer was ostensibly of money that “the government owes itself” and
presumably of no value or cost to anyone.
24
They may have some relevance for financial accounting and reporting. Federal financial accounting differs for
FERS and OASDI. FERS obligations are recognized as a liability; OASDI commitments are disclosed off-balance
15
the fiscal affairs of government to maximize social benefits from scarce
resources (Schick. 1966). Pursuit of that objective requires budget decisions to
allocate resources across all desirable alternative uses and to smooth
consumption over time, by avoiding the feasts and famines of unsustainable
high levels of consumption (Phaup and Kirschner. 2010). Budgetary
accounting exists to provide relevant information in a manner that facilitates
informed decisions. In the present context, those objectives require: a)
mandatory spending-- 66 percent of all federal spending—to be brought into
the active decision process; and b) an accounting to facilitate decisions that
permit government to honor its commitments. Current accounting falls short
of these objectives for many mandatory programs. That failure is sufficient to
consider alternatives to current practice.
Nonetheless it is necessary to concede the merit of a practical objection to an
accounting change that would increase a salient measure of government’s
reported debt by trillions of dollars. Accounting changes of that magnitude
may be too big to contemplate. Although the argument may sound illogical, it
makes sense in terms of what the political process judges to be reasonable
and feasible.25 Fortunately, taking account of both expected current law
revenues and current law obligations, reduces some of the sticker shock. In
addition, precedent exists for phasing in accounting changes and smoothing
the recognition of changes in debt over time.
IV.
PROPOSED BUDGETARY ACCOUNTING CHANGE: Reclassify Fund
Accounts as Non-Budgetary with Continuous Full Federal Funding
To significantly improve budgeting for and financial management of
mandatory spending, changes are required in the annual flow measure of new
obligations to make mandatory payment and in the stock measure of
government obligations to the public. Specifically, increasing the salience and
relevance of the flow of periodic budget cost entails replacing legacy
mandatory payments with the cost of new commitments. Similarly, the headsheet. Efforts to eliminate this difference, however, threatened the existence of the Federal Accounting Standards
Board and raised doubts about the Board’s independence. (Patton and Mosso. 2009).
25
Similar arguments were advanced against bringing Fannie Mae and Freddie Mac on budget as federal credit
agencies when they were taken into the Federal government in 2008.See also note 22.
16
line public debt measure should be broadened to include legacy costs. These
changes could be accomplished in several steps:
 Adopt, for budgetary accounting, rules for recognizing accruing
mandatory obligations substantially in advance of payment. Based
on current practice and recent proposals, it appears that
policymakers and the public might accept a retirement benefits
system that used total annual actuarial normal cost as the accrual
rate, subject to a safe harbor condition that beneficiaries within five
or ten years of eligibility would be exempt from reductions in the
benefit accrual rate. Thus, for example, assuming a 40-year working
life, after 20 years of covered employment, an employee would be
entitled to 50 percent of current law benefits at the age of full
retirement benefits. Legislated changes in benefits or taxes would
affect only prospective future accruals for those outside the safe
harbor band preceding retirement. Such a rule would identify both
total legacy debt and budget year increments in that debt.26
 Fully fund accrued obligations by intra-governmental transfer(s)
from Treasury to the Fund accounts. Fully funded balances would be
included in the new debt category, “debt owed the public” on
grounds that a sovereign’s debt is fungible and cannot be
meaningfully distinguished by the program for which it was issued
 Reclassify the Funding accounts as non-budgetary.27 With this
change formerly intragovernmental transfers to the funding
accounts from budgetary accounts would be scored as budget
outlays. Also, payments to and from entities outside the federal
26
The distinction between legacy debt and current period costs is critical to the Social Security reform proposal of
Diamond and Orszag (2003). They define legacy costs as benefits paid to early generations of beneficiaries
(including many of those retired today) in excess of their contributions plus a market rate of interest and payments
to be made to those 55 and older at the enactment of their proposal. They note the similarity of legacy debt to
Treasury’s public debt, notably that it is beyond recovery and can only be borne by others. As a part of their
reform, they propose that this debt be retired, in part by a legacy tax on earnings above the maximum earnings tax
base.
27
In some cases, e.g. Federal Employee Retirement health care, mandatory spending is financed from an annually
appropriated account. For these programs, it would be necessary also to create a Funding account.
17
entity would not be scored as affecting budget outlays, receipts or
the deficit.28 For purposes of reporting budget aggregates, the
Funding accounts would appear in the receivables/payables section
of the budget.29
 Rebalance the Funding accounts annually following annual reestimates.30 If re-estimated obligations exceed fund balances,
permanent and indefinite budget authority would be used to
rebalance the account; if balances exceed obligations, the excess
would be transferred to a Treasury receipt account. Similarly,
legislation changing the cost of previously accrued mandatory
benefits would be scored against the legislation as outlays for the
full amount of the change in legacy costs. All balancing transfers
would be recognized as outlays or offsetting collections (depending
on the direction of the flow) in budget outlays and the deficit.
The accounting effects of those changes are illustrated in Figure 2. As noted,
the major differences between Figures 1 and 2, is that in the latter, the
Funding accounts have been reclassified as non-budgetary and the Fund
accounts are rebalanced annually. To maintain accountability and oversight,
the Funds have been retained within the budget, in a section not shown in
Figure 1, accounts payable and receivable. One use of this budget
classification is to permit cash-basis budgetary accounting to accommodate
accelerated recognition of costs and revenues using accounts payable and
receivable. (For details see Bhatti and Phaup. 2015)
28
Earmarked taxes would be scored as tax receipts and simultaneously as outlays to the non-budgetary funding
account. This double-entry approach maintains the comprehensiveness of the budget coverage of taxes, but
prevents earmarked taxes from appearing to provide resources for other uses. Inflows from sources other than the
exercise of the sovereign power to tax would be credited to the funding account without affecting the budget
aggregates. For an example of this “double-entry” treatment as receipts and outlays, see Burman and Phaup, 2012.
29
Technically, this is “means of financing the deficit, other than borrowing from the public.” One such means is
drawing down the government’s cash balances. Another is the increased balance in the account to which accrued
Treasury interest has been credited but not yet paid to debt holders.
30
The House Budget Committee’s November 30, 2016 Reform Proposal includes a similar mandatory appropriation
process to maintain fund balance in federal pension and insurance programs. See:
http://budget.house.gov/uploadedfiles/bpr-longsummary-30nov2016.pdf
18
The re-classification and rebalancing of the Funding accounts produces
significant changes in timing of budget costs of mandatory spending. Most
importantly, the budget outlay cost of mandatory spending would correspond
to the annual net actuarial costs to the government of the program under
existing law.
Potential Disadvantages of Proposal. In addition to the major objection—that
mandatory spending policies create no significant long term obligations
because they may be revoked at any time—several arguments have been
raised against proposals to use accruals to change the recognition of
mandatory costs in the budget. Those include that doing so would widen the
scope for political manipulation of budget estimates, increase the volatility
and uncertainty of budget costs, make reductions in benefits more difficult to
enact, and change the nature of Social Security from an “earned benefit” to a
“welfare program.”
Restraining the impulse to understate the cost of favored actions is an
unending, universal necessity. But in this case that goal could be facilitated by
the established practice of using professional actuaries to estimate the cost of
19
long-term, accruing obligations.31 (For an alternative method, see Biggs.
2011.) Requiring annual re-estimates and rebalancing is also useful in this
regard, as demonstrated by experience in budgeting for direct loans and loan
guarantees under the Federal Credit Reform Act of 1990.
Policy makers and the media sometimes evaluate budget processes by the
accuracy of budgets, meaning the closeness of actual numbers to those in the
budget. When used as an indicator of fiscal discipline, this criterion is
appropriate. But it is less appropriate when applied to spending for
mandatory programs which, by design, depend on the number who qualify for
benefit and, whose costs likely vary. In this case, budget framers have little
choice but to estimate relevant costs with due care and a readiness to revise
those estimates as new information arrives. Uncertainty and volatility of
budget estimates is inescapable. Using irrelevant but more predictable
alternative measures is not an effective solution.
Enactment of the proposed accounting changes could make it more difficult
to reduce benefits that constituents have been encouraged to expect.32
Indeed, one goal of the change proposed here is to reduce the chances that
government will reduce legacy benefits either by choice or fiscal necessity,
especially for the least financially able. On the other hand, the change should
facilitate enactment of modifications to slow the rate of accruing benefits.
Just as policymakers seek to reduce, or at least stabilize, the national debt,
through means other than default, similar reductions could be achieved in
legacy debt for mandatory programs. For example, a technological advance
that significantly reduced the cost of treating heart disease would trigger a reestimate of the cost of Medicare obligations and subsequent rebalancing
31
A related objection is that the new accounting would exceed the analytical capabilities of budget staff. However,
in this case, staff is already accustomed to using actuarial estimates for inter-account transfers, dealing with reestimates of costs, and working with non-budgetary accounts. This proposal would only extend the scope of
established practice.
32
My Social Security Statement for 2016 provided notice of my estimated monthly benefit, if I were to retire now.
It also tells me I am eligible to enroll in Medicare. An asterisk leads to a notice: “Your estimated benefits are based
on current law. Congress [sic] has made changes to the law in the past and can do it at any time. The law governing
benefit amounts may change because, by 2034, the payroll taxes collected will be enough to pay only about 79
percent of scheduled benefits.” The notice of possible change in law appears inconsistent with the rationale for the
current budgetary treatment because it suggests that a change in law may maintain (or increase) my benefits,
rather than reduce them.
20
flows that would reduce both current period outlays and debt owed the
public.
The public framing of Social Security benefits as “earned, not given” has
increased the reliability of benefits, a desirable feature for a program that
people count on in retirement. Some observers are concerned that this
perception might be lost, if the federal government were to recognize, by
governmental transfer, OASDI’s annual actuarial deficit. It is somewhat
reassuring, however, to note the prevailing view has survived the transfer of
federal tax revenues on Social Security benefits to the OASDI Fund and the
use of general fund transfers to replace Fund revenues lost during the payroll
tax holiday. It is also unlikely that maintaining this perception would be worth
the large economic distortions that would result from attempting to rebalance
all mandatory programs, including Social Security, using a narrow tax base,
such as the payroll tax, rather than supplementing it with a broader based
levy, such as the income tax.
Partial Effects of Change in Accounting on Debt Owed the Public, Interest,
Budget Deficits and Program Outlay Costs
Precise estimates of the effects of changing the budgetary treatment of
mandatory programs are not easily extracted from published cash-basis
budget and financial data. This paper offers only FY 2015 estimates for CSRD
and OASDI based on the Appendix to the President’s 2017 Budget, the 2016
Social Security Trustees’ Reports and the 2015 Financial Report of the US
Government. These estimates suggest that adopting the proposed change in
budgetary accounting for mandatory programs would result in large, order of
magnitude increases in reported debt owed the public but more modest
changes in annual programs outlays.
Estimate of increase in debt owed the public and net interest, EOY 2015.
Under current accounting practice, publicly-held debt outstanding is $13.2
trillion. That number is often contrasted with the gross debt of $18.2 trillion,
which includes $5 trillion in debt held by federal accounts, with more than 70
percent held by the OASDI and CSRD funds.
21
Under the proposed accounting, a new debt measure “debt owed to the
public“ would be the sum of“ debt held by the public” and outstanding
mandatory obligations.33 That sum would include the $6.7 trillion existing
liability for post-employment benefits now owed federal employees and
veterans (from the Federal balance sheet, 2016 Financial Statements of the
US Government).34
In addition, the present value of the OASDI benefits, net of payroll taxes,
expected to be paid to those who have already attained the eligibility age of
63 is estimated to be $11.7 trillion.35 By most standards of political feasibility,
nearly all those costs are irrevocable.36 Similarly, the estimated present value
of net benefits to be paid current participants who are not yet eligible is $17.5
trillion. Assuming one-third, or $5.8 trillion, is beyond recovery then the total
legacy cost of the OASDI Fund is $17.5 trillion.
Debt owed the public would increase from the full funding of CSRD, retiree
health benefits, and OASDI, and thus as a lower bound, by ($6.7 + 17.5 =)
$24.2 trillion from $13.2 trillion to $37.4 trillion. Treasury interest payments
would also increase (at the 3.4 percent average paid to OASDI in 2015) both
outlays and the deficit by $1.2 trillion. However, interest on Treasury debt
held by the Funds is interest on legacy costs, which by logical extension is also
beyond recovery. By this reasoning, interest paid to mandatory deferred
payment programs by Treasury should be shown in the budget, as unallocated
net interest, rather than as a cost assigned to federal labor compensation
(Lucas, 2003.) Lucas also has argued that counting current period interest in
budget outlays on dollars scored as outlays in previous budget periods is a
form of double counting. That is, interest serves only to maintain a time
adjusted value of the initial sum over time. This potential distortion might be
33
The new measure might also reasonably exclude US Treasury debt held by the Federal Reserve, which is
currently included in debt held by the public.
34
Treasury debt now held by CSRD (intra-governmental) plus new balances from the full funding transfer for
pensions and health benefits.
35
Statement of Social Insurance, Financial Report of the US Government 2015. Diamond and Orszag’s 2003
estimate of Social Security legacy debt was $11.5 trillion.
36
A recent proposal from Congressman Sam Johnson, Chair of the Social Security Subcommittee, House Ways and
Means to stabilize OASDI by reducing net benefits to high income retirees and extending the normal retirement
age would apply only to those who become initially eligible in 2023 or later. COLA adjustments would begin in
2020. For details, see https://www.ssa.gov/OACT/solvency/SJohnson_20161208.pdf
22
avoided by focusing policymakers on the primary budget deficit, which
excludes interest on the debt.
Nonetheless, a jump of more than $1 trillion in the unified budget deficit from
recognizing the annual interest on sunk costs is likely a bridge too far for
political feasibility. This may require scaling back the proposed accounting to
pilot cases, e.g. FERS and federal insurance as proposed by the House Budget
Committee. 2016, or shifting the fiscal focus to the primary deficit.
Estimates of effect on program outlays and deficit FY 2015: CSRD and OASDI
CSRD. Following Isaacs (2015)—and due to the difficulty of separating the
cash flows for the FERS Basic Benefit from those of the old CSRS—I estimate
the major effects on budget outlays and the deficit of moving the entire multiplan CSRD Fund to non-budget status for 2015. This involves replacing
payments to annuitants ($81.5 billion) in outlays with agency actuarial net
cost payments ($24.3 billion) and Treasury interest on fully funded balances
($56.0 billion) for a net increase of less than $2 billion in annual program
outlay cost.
OASDI.
The major budget effects of the proposed accounting change for OASDI in
2015 include:
 Replacing program outlays for benefits (-$881.2 billion) with
 Outlays from Treasury to the OASDI Fund for
o FICA/SECA taxes ($770.4 billion);
o Interest on Fully Funded balance: ($595.8 billion)
o Receipts from taxing Social Security benefits and Payroll Tax
holiday ($30.9 billion);
o Agency payments of employers’ share of tax (16.0);
o Gap between cost of benefits and payroll taxes ($80.4 billion)
The net effect would be to increase 2015 budget outlays for OASDI by $612.3,
with about $500 billion on the increase accounted for by the increase in
interest payments to the OASDI fund.
23
The proposed accounting has significantly different effects on the annual
budget cost of CSRD and OASDI; it makes salient the on-going annual shortfall
for OASDI and the current actuarial balance for FERS.
V. Concluding Comment
Current budgetary accounting for mandatory programs has become more
damaging to the objectives of fiscal and social stability and economic
efficiency as mandatory spending has risen as a share of total federal outlays
from 26 percent in 1962 to 66 percent in 2016.37 Arguably, this growth has
been aided by the current accounting.
An accounting that recognizes in a salient and timely form the current cost of
deferred payment obligations could facilitate the legislative management of
mandatory spending, increase the reliability and credibility of government’s
commitments, while reducing the risks of social and economic turmoil from a
significant cutback in irrevocable commitments. It would also reduce costly
uncertainty about the reliability of accrued benefits, which the government
has given every indication that it intends to honor. It thereby provides an
efficiency gain by dispelling a cultivated, but overstated, uncertainty.
The proposal also has desirable features for both progressives and fiscal
conservatives. For the former, it strongly signals policymakers’ intent to honor
past commitments and mitigates constituents contrived anxiety about the
current law “requirement” that benefits must be reduced to the level of
receipts when Fund balances are exhausted. For the latter, it provides a
salient measure of current period costs that are equivalent to the cost of new
discretionary spending and a routine opportunity to exercise legislative
control of those incremental costs. (Penner and Steuerle.2016)
37
Office of Management and Budget, Budget of the US Government for Fiscal 2017, Historical Tables.
https://www.whitehouse.gov/omb/budget/Historicals
24
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