State governments have a surefire strategy for hoodwinking the public and the news media, and nowhere does it work more perfectly than in California. Journalists can't stop lauding Governor Jerry Brown for turning a fiscal crisis into a "surplus," even though that surplus was achieved by ignoring more than $6 billion in costs.
It's not just because they love Brown. The same thing happened in 2000 and 2007, when California's previous two governors, Democrat Gray Davis and Republican Arnold Schwarzenegger, respectively, also reported rosy budgets. Both were praised for responsible governance. Davis was considered presidential material, and there were calls to amend the Constitution to allow Schwarzenegger (for whom I worked) to run for president.
Then, within just a few years, California's budget turned south again because neither governor had addressed the state's core budget issues.
They avoided scrutiny thanks to an accounting method known as "cash-based budgeting," which recognizes expenses only when cash changes hands and treats any cash received, even borrowed cash, as revenue. That's how New Jersey Governor Chris Christie "balanced" New Jersey's budget in 2010: by simply pushing a $3 billion pension payment from one year into the next.
Similarly, Brown is using cash-based budgeting to underreport the cost of an employee benefit -- retiree health care -- by $3 billion. The governor could have chosen to report the expense at its full size, but to do that under cash-based budgeting, he would have had to actually contribute $3 billion in cash to a retiree health-care trust fund.
That's exactly what governors are supposed to do. Retiree health-care expenses, like pensions, are supposed to be pre-funded in order to protect future generations from having to pick up an earlier generation's costs. But Brown chose not to do so, making his budget look rosier than it is. This shortchanges future generations, which will have less money for their own services because they will have to pay off the skipped costs.
Businesses aren't permitted to use cash-based budgeting. Instead, they must accrue expenses whether paid or not. During Brown's current term in office, his budgets will ignore more than $12 billion in retiree health-care costs.
According to the State Budget Crisis Task Force, led by former Federal Reserve Board Chairman Paul Volcker and former New York Lieutenant Governor Richard Ravitch, "cash-basis budgeting is a major enabler of budget gimmickry" by state and local governments. This is why they recommend that governments adopt accrual-based budgeting, which would force disclosure of such expenses and allow the public and legislators to "easily discern how revenues earned in the fiscal year relate to obligations incurred in the same year." (Disclosure: I was on the task force.)
Brown's budget this year also ignores more than $3 billion in required contributions to the state teacher pension fund. It's the largest "skipped" pension contribution in the country and continues a pattern that has led the fund to build up an $80 billion deficit accruing zero-coupon interest at 7.5 percent a year. Even though California teacher pensions -- and therefore that debt -- are guaranteed by the state, for accounting purposes the state treats that obligation as off its balance sheet, as if it's not on the hook. When the trust fund runs out of money, the debt will total more than $600 billion.
You really can't blame Brown (another disclosure: I donated to his campaign and voted for him). Governors regularly game cash-based budgeting for their short-term advantage.
Just as California's budget wasn't fixed in 2000 or 2007, it isn't fixed in 2014. In fact, even though revenue, taxes and fees are higher now than they were the last time California reported a balanced budget, in 2007, state spending on most state services is lower. Spending on welfare, universities, courts and parks is down more than 20 percent because spending on employee salaries, pensions, retiree health care, debt service and Medicaid is up more than 20 percent.
In short, California is able to report a balanced budget only by ignoring more than $6 billion in costs, cutting services to the state's most defenseless people, and imposing temporary taxes that will go away when Brown leaves office in 2018 (assuming he is re-elected). No core issue has been solved. But cash-based budgeting obscures those realities.
For journalists and citizens to get to the truth about state budgets, states will have to adopt truth-based budgeting. Until then, everyone will have to dig deeper.
(David Crane, a former financial-services executive, is a lecturer at Stanford University and president of Govern for California, a nonpartisan government-reform group. He was an economic adviser to California Governor Arnold Schwarzenegger from 2004 to 2011. Follow him on Twitter at @DavidGCrane.)
--Editors: Katy Roberts, Brooke Sample.
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