“A government which robs Peter to pay Paul can always depend on the support of Paul.” – George Bernard Shaw

One of the biggest lies we’ve been told by government lately — and this comes from both Democrats and Republicans alike — is that the federal budget is in surplus. Almost everyone I know believes this, and that’s a shame — because it is resulting in baseless ideas and foolish policies.

The truth is that the government is running deficits higher than at any time in history. But through a machination of standardized accounting, the politicians have managed to create the illusion that they desire.

Here’s how it works: Instead of reporting its numbers on an accrual basis, the government uses a cash system of accounting. A cash system reports cash in and cash out but doesn’t account for payables or receivables.

If you are running a strictly cash business, like a candy store, this is a perfectly good system. But if you are running a big operation with credits and debits, you need a way to account for them. Standard accounting practice has developed accrual accounting just for that purpose. Accrual accounting forces you to put all your expenses and all your income together when you are trying to figure out your income.

For example, let’s say you are selling jewelry by mail. You place an ad in the local newspaper and sell $10,000 worth of bracelets from it. If the cost of the ad was $6,000 and the cost of the jewelry and fulfillment was another $6,000, a fair system of accounting would show that you lost $2,000 on this venture. That’s how it works in accrual accounting.

With cash accounting, you could recognize all the income in one period of time but put off paying the bills until later. This would show you as being $10,000 in the black — a very impressive situation — when, in reality, you were solidly in the red.

That’s why the government and professional organizations require accrual accounting for tax and business purposes.

At least, they require accrual accounting for private businesses. Public enterprises — notably the federal government — are not so constrained. By using the cash system of accounting, the US government shows a substantial surplus when it should be showing a substantial loss. Why would it do that? If you can’t guess, nothing I can say will make you a believer.

In 1975, Arthur Andersen & Company published a lengthy report titled “Sound Financial Reporting in the Public Sector.” The report reviewed the US federal budgets for the fiscal years ending 1973 and came up with some shocking figures. Using the cash basis of accounting, the government had reported a federal deficit of $14.3 billion. Recalculated according to the accrual method, the 1973 budget deficit jumped to $86.6 billion.

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