Conversion to GAAP means kicking bad fiscal habits

It’s the budgetary day of reckoning that state officials have avoided for nearly two decades.

But when Gov.-elect Dan Malloy attempts to convert state financing to generally accepted accounting principles starting next year, it’s likely to mean more than paying for over $1 billion in papered-over problems from the past.

For a legislature that initially mandated GAAP conversion in 1993–and has postponed it repeatedly since 1995–it will mean immediately swearing off an array of fiscal gimmicks that has enabled it to balance a series of budgets with hundreds of millions of dollars in phantom savings and creative accounting.

wyman, nancy, 11-22-10

Lt. Gov.-elect Nancy Wyman: ‘We might as well face the problems’ (Keith M. Phaneuf)

“The fact is that the gimmicks are gone,” said Lt. Gov.-elect Nancy Wyman, who has spearheaded the push to follow GAAP rules since she became comptroller in 1995. “While we’re facing our new problems, we might as well face the problems we avoided previously.”

According to the Government Accounting Standards Board, that means following a series of common financial guidelines–already imposed on Connecticut cities and towns–that emphasize transparency.

Unlike the modified cash basis currently used, under GAAP expenses must be promptly assigned to the year in which they were incurred. Similarly, revenues are counted in most situations in the year in which they were received.

In the context of the state budget, that means no more pushing the last monthly payment for nursing homes from June 30 to July 1–a move that artificially helps to balance the books by shifting state expenses from the last day of one fiscal year into the first day of the next.

Similarly, other Medicaid expenses incurred in one year and paid in the next can’t be recorded as part of a future budget.

And tax revenues accrued at summer’s end no longer can be drawn back into the prior fiscal year.

At first glance that appears harmless. If an extra payment to nursing homes was added in July, at the start of a given year, wasn’t it offset at year’s end, when the June 30th payment was similarly pushed into the future, and so on?

The problem with this never-ending shifting theory is inflation, which always leaves the future inheriting a somewhat higher cost.

GAAP chart

According to calculations by the comptroller’s office in the Comprehensive Annual Financial Report, these gimmicks have gradually amassed a sizable spread between the budget set under the modified cash system and a budget that adheres to GAAP.

Since 2003, that difference has risen annually by an average of $85 million. By the end of 2008-09 fiscal year it had grown beyond $1.35 billion.

Though Malloy pledged to sign an executive order directing all agencies to begin converting to GAAP rules immediately after he is sworn in on Jan. 5, untangling this fiscal mess could take some time.

Agencies traditionally work for three months or more preparing their budget requests, and the respective plans for 2011-12 from more than 60 departments, boards, commissions and offices already have been submitted.

That means Malloy’s first biennial budget proposal due in February, which will cover the 2011-12 and 2012-13 fiscal years, likely would have to wait until the second stage to operate under GAAP finances from start to finish.

The more immediate challenge for Malloy simply will be not making the GAAP margin worse as he tries to close a deficit which could run as high as $3.7 billion in 2011-12, equal to about one-fifth of current spending and one-half of all annual receipts from the state income tax.

Though the new governor’s first budget still is under development, Wyman said the incoming administration is committed to beginning the conversion and stopping the cumulative GAAP margin from getting any worse. That would mean Malloy, in addition to closing what effectively equals the largest deficit in state history, also would have to find about $85 million or more in offsetting spending reductions or new revenues.

“Dan understands this will be hard, but this whole budget will be hard,” Wyman said. “But this has got to be transparent. People have to understand what is going on. We call it honest budgeting.”

But what about the $1 billion-plus difference that ultimately must be addressed? A 1994 study by the Office of Policy and Management suggested closing a much-smaller GAAP margin at that time by making annual payments into a separate fund for 15 years, using that and the fund’s interest earnings to complete the conversion.

Wyman declined to speculate whether Malloy would expect state government to begin whittling that $1 billion-plus margin down right away, noting that the legislature’s plate already would be filled addressing a huge deficit and the first stage of GAAP conversion. But she did predict Malloy would propose a long-range strategy for finishing the job.

Malloy made the GAAP conversion one of the cornerstones of his platform, vowing to veto any budget that did not begin the changeover. His promise to adopt strict budgetary standards sparked considerable speculation over whether his fellow Democrats, who have controlled both chambers of the legislature since 1997, would be willing to give up their fiscal leeway.

Rep. John Geragosian, D-New Britain, co-chairman of the Appropriations Committee, predicted his fellow Democrats would adopt a GAAP conversion “in some form” in 2011.

“We’ve all heard about the deficit and we all know what the nature of the problem is,” he said. “I think it’s always good to know where you stand.”

But Rep. Craig A. Miner of Litchfield, ranking House Republican on the Appropriations Committee, noted that when outgoing Gov. M. Jodi Rell warned of a potential $46 million gap in federal funding for the winter heating assistance program, legislators opted neither to scale back the program nor appropriate additional funds.

“If that was any indication, it might be happen right away,” he said.