Accounting Principles and National Budgets

Governments, unlike companies, do not prepare financial statements on an accrual basis in line with generally accepted accounting principles. They generally use a crude cash-based method of accounting to measure their budget deficits, under which revenue and expenditure are recorded when the cash is received or paid out. Accrual accounting, by contrast, records spending and taxes when they are incurred, regardless of when the money actually changes hands.

Cash-based accounting gives a false sense of security about the sustainability of government policies. It takes no account of the cost to future generations of current policies. For example, failing to maintain roads and water mains, or the growing unfunded pension liabilities which accrue for every week that workers belong to a national pension scheme.

Accrual accounting or balance-sheet budgeting should provide a more accurate picture of a government's financial position because it keeps track of the changing value of assets and liabilities. Capital investment would be depreciated over the life of the asset rather than being written off in the year when the money is spent, as is done under cash accounting. Also, future pension obligations would count as liabilities. Over time, this type of reporting system should provide a clearer picture of whether it is maintaining or running down its assets, such as roads and bridges, and the water and sewerage infrastructure.

We should be better able to monitor whether government is ignoring spending on development projects or borrowing to finance recurrent expenditure, such as public sector wages. The pursuit of such policies would provide a clear indication that the nation was becoming poorer, since the result would be a decrease in net worth - the public sector's stock of fixed capital minus its debts.

Negative net worth, where debts exceed assets, is possible for a government. However, it does not mean that the government will go bankrupt. Governments have the power to tax and so eliminate deficit. Therefore, in the final analysis, what such policies mean is that taxpayers are consuming more today at the expense of future generations who will face a heavier tax burden.

Under such a system, government departments would have to produce accounts on commercial accounting principles, including full balance sheets of assets and liabilities and operating statements which charge depreciation on assets. This should make departmental managers more conscious of costs and the value of their assets and reduce the incidence of indiscriminate year- end spending in order to use up allocations based on a system of cash budgets which are in turn, based on the principle that if you don't use it, you lose it.

If governments adopt such a system and keep their accounts like companies do, it should give them the information they need to make better long-term decisions. The information provided by such a system should make it harder for governments to ignore the future consequences of short-sighted policies.