In Under the Rug: The Pitfalls of an “Operating Balance” Approach for Reporting Federal Employee Pension Obligations authors Alexandre Laurin (right) and William B.P. Robson (below) examine a proposed revamp of the federal statement of operations that would highlight an “operating balance” in addition to the annual surplus or deficit and the resulting change in the government’s accumulated deficit. The authors argue that the proposed presentation would move costs of federal employee pensions that were underreported in the past and are now coming to light “below the line.” Presenting an operating balance that does not include these costs, they say, could bias federal budgets toward larger deficits.
Laurin and Robson argue that changes in pension valuations resulting from changes in bond yields might merit separate reporting. The revaluations at issue, however, are the result of the federal government’s systematically under-recording the costs of its pensions. The federal government records the costs of employees in its major funded pension plans using a discount rate that understates today’s value of the benefits they will receive tomorrow. Over time, it adjusts this discount rate downward, which reveals the costs of federal employees to be higher than initially reported – and adds to its annual deficit and the net federal debt.
An “operating balance” that excludes these pension expenses will present a misleadingly positive picture. The government’s annual operating expenses will look smaller than they should, and the operating balance line more positive than it should.
Before it adopts the proposed operational balance concept, the authors recommend Ottawa should record the value of its obligations in its funded pension plans using discount rates based on yields on other federal government debt – as is already done for unfunded obligations. Only then could the operating balance improve the transparency and usefulness of the federal government’s budgets and financial statements.
“The federal government has been calculating, and continues to calculate, a major portion of its pension obligations using discount rates that are unrealistically high, and produce valuations of these obligations that are unrealistically low,” write Laurin and Robson. “Presenting the negative impact of periodic upward revaluations of its pension obligations below the operating balance line will understate the federal government’s actual employment costs, and relegate the negative impact on its net worth to a category of expenses that appear to be outside its control – in effect, sweeping it under the rug.”
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