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June 1999
Volume 17, Number 6

Cooking the Books
by Mark Brandly

For the last two years, the federal government has attempted to construct a Consolidated Financial Statement of its financial status for the previous fiscal year. This statement is an audit of the financial status of 24 cabinet level departments and agencies and is an attempt to account for the government's revenues, expenditures, and assets.

According to the General Accounting Office (GAO), the audit failed to meet acceptable accounting standards. Congress commands bureaucrats to submit annual audits of their agencies' economic performance. However, the agencies' accounting practices are so poor that the statements submitted provide little usable information.

In the current audit, seven of the 24 agencies were not even able to submit an accounting statement for fiscal year 1998, even though the fiscal year ended six months ago. The GAO graded five other agencies' audits with a disclaimer of opinion, roughly meaning that their statements were inauditable. House Government Management, Information and Technology Chairman Stephen Horn gave only two agencies a grade of A for submitting statements that met appropriate accounting standards.

Without an accurate accounting picture, federal agencies do not know the costs of their programs and do not have the financial information needed to make informed day-to-day decisions. The government's failure to maintain common accounting standards creates the possibility that billions of dollars have been stolen or wasted. Funds may have been siphoned off to programs not approved by Congress. Graft and theft could be rampant. Private businesses that were managed in this manner would risk the government's wrath. Their assets would be seized and their doors would be padlocked.

Federal agencies, of course, do not face the same penalties that private firms would, but the failure to live up to minimum accounting standards disturbs many. Horn believes that "once again, billions of taxpayer dollars were lost to waste, fraud, and mismanagement," and demands improvements in the system.

One reason that government agencies have difficulty providing reliable accounting statements, according to California Congressman Tom Davis, is that their financial managers are not paid enough. Davis calls for better compensation to improve this management problem.

Comptroller General David Walker agrees, citing the need for the "right employees" with the proper "incentives" to get the job done. This proposal overlooks the fact that bureaucrats lack the same incentives to maintain high accounting standards that private firms have. Profits enable and motivate private firms to accurately account for their revenues and costs. This accounting provides information needed to make rational financial decisions.

As Ludwig von Mises explained 80 years ago in Economic Calculation in the Socialist Commonwealth, private firms use monetary prices as a means to determine profitability. Prices allow decisionmakers to conduct rational economic calculation. Given market prices for inputs, managers can make decisions that make financial sense. The lack of market prices eliminates the possibility for rational economic calculation. Socialist economies lack market input prices and therefore cannot generate rational economic calculations.

A corollary to Mises's argument is that even if the prices are available, the government has little incentive to use those prices in their calculations. Private managers need to know their costs and revenues. They need to anticipate the marginal costs and benefits of their decisions and prices aid them in this pursuit. Without this information, their ability to generate profits would be limited. The profit incentive induces managers to account for their firms' financial activities.

Contrast this with the financial managers of government agencies. Their activities generate monetary costs and their funding can be measured in monetary revenues. However, private firms have an incentive to serve consumers in order to increase their revenues and to minimize their costs in order to generate profits.

Bureaucrats have an incentive to please the legislature that provides its funding, not their alleged consumers, and they have little incentive to minimize costs. Agencies that reduce their costs find that their budgets have been cut. This creates an incentive to spend every penny possible in order to justify higher future funding.

Since government decisions are not motivated by profits, there is no motivation to provide accurate accounting statements. In fact, bureaucrats have an incentive to hide the costs of their agencies. An accurate accounting of an agency's activities would generate demands for reform. Wasteful spending could be discerned more easily. Congress could spot politically acceptable spending cuts, given accurate information. It's in the bureaucrat's interest to distort his agency's financial picture. This allows him to demand greater funding. An accurate accounting would only lead to funding reductions. No bureaucrat wants this. Therefore, we should expect agencies to have unsatisfactory accounting practices.

The point of this is simple: it is the nature of the state to mislead its citizens. Muddled accounting practices are a part of this nature and giving bureaucrats higher pay will not change this fact. Taxpayers should realize that the agencies that are funded with their taxes are inclined to lie to them and to be inefficient and wasteful. The solution to this problem is not better accounting practices, but lower taxes and large spending cuts.


Mark Brandly teaches economics at Ball State University and is an adjunct scholar of the Mises Institute. Further reading: Ludwig von Mises, Human Action (Auburn, Ala.: The Ludwig von Mises Institute, 1999).


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