Accounting for Federal Retirement and Veterans' Benefits: Cash and Accrual Measures

How programs are accounted for in the federal budget can significantly affect the size and timing of their estimated effects on the deficit. Those effects in turn can influence lawmakers’ decisions about how to allocate the government’s budgetary resources.

For programs that provide pensions and health care benefits to retired federal civilian workers and retired military personnel—as well as various benefits to other veterans—the federal budget process uses cash-based accounting to track the programs’ effects on the deficit. Cash-based accounting records programs’ spending and receipts when they occur, rather than when the government makes the commitments that lead to those transactions. That approach means that the future costs of near-term decisions about such programs are not reflected in the current year’s budget totals. Estimates of the effects of proposed changes to those programs typically cover a 10-year period, but that time frame is usually much too short to show the full long-term impact of current policy decisions.

An alternative is for policymakers to use accounting measures that incorporate long-term effects, such as accrual-based estimates. An accrual estimate summarizes, in a single number, the total future net budgetary impact that is expected to result when a commitment is made. Through that summarizing, accrual measures can provide more complete information about federal programs, making it easier to compare the costs of programs or policy proposals that differ in the timing of their cash flows. However, accrual estimates are more complex and involve more uncertainty than cash-based estimates.

This report examines how cash and accrual measures differ for federal retirement and veterans’ benefits and highlights trade-offs between the types of information that those measures provide to policymakers. The report also discusses some ways to expand the use of accrual measures for such benefits. (It does not address the treatment of Social Security and Medicare benefits, which many federal retirees also receive.)

How Are Federal Retirement and Veterans’ Benefits Treated in the Budget?

Retired civilian employees of the federal government receive pensions through the Federal Employees Retirement System (FERS) or the older Civil Service Retirement System (CSRS), which is being phased out. They receive health insurance through the Federal Employees Health Benefits program. Military personnel who serve long enough to qualify for retirement benefits (typically 20 years) receive pensions from the Department of Defense. An array of other benefits are available to qualifying veterans (not just military retirees), including health care, disability compensation, and assistance with education costs or mortgages.

Federal budget totals reflect the cost of almost all benefit programs for federal retirees and veterans on a cash basis as the benefits are paid. Thus, the effect of those programs on the budget deficit is the difference between cash outflows for benefits and related cash inflows (mainly from federal workers’ contributions toward their future pensions) in a given year.

In many cases, however, the budgets of individual federal agencies record those benefits differently. Most agencies’ annual budgets are charged for some of the costs of future retirement benefits that their employees earn in the current year. Those charges are calculated on an accrual basis and are credited to the federal retirement funds that will pay the benefits when they become due. Although accrual charges attribute the long-term costs of those benefits to agencies’ current budgets, they are recorded as intragovernmental payments (made by one part of the government to another) and have no net effect on the deficit.

Currently, accrual charges and retirement funds are used to account for the cost of most pensions for federal civilian and military retirees but only a portion of those retirees’ health-related benefits. Accrual charges are rarely used for veterans’ benefits. Like the bulk of health care benefits for federal retirees, all veterans’ benefits except mortgage guarantees are recorded in the budget entirely on a cash basis.

How Does CBO Assess the Information Provided by Cash and Accrual Measures for Federal Retirement and Veterans’ Benefits?

In assessing whether accrual estimates offer more helpful information than 10-year cash-based estimates for projecting a program’s costs or analyzing proposed changes, the Congressional Budget Office considers the following questions:

• Do accrual measures convey more complete and relevant information about budgetary effects? A key factor is the extent to which 10-year cash and accrual estimates communicate different information, potentially affecting how policymakers view the trade-offs between alternatives in designing retirement systems and veterans’ benefits.
• Are accrual measures practical to develop and accurate enough to use in the federal budget process? An important concern is whether accrual measures are sufficiently reliable to use for enforcing rules and procedures related to Congressional and statutory budget requirements.
• Is the nature of the government’s commitment to provide future retirement and veterans’ benefits firm enough to justify recording future cash flows years before they occur? Accrual measures may be most appropriate for commitments that are legally binding or otherwise firm.

What Are the Advantages and Disadvantages of Accrual Measures for Federal Retirement and Veterans’ Benefits?

Although cash-based measures are transparent and readily verifiable, accrual measures can improve decision-making and give a clearer picture of the annual change in the long-term sustainability of the government’s retirement and veterans’ programs, for several reasons:

• Accrual measures recognize the cost of retirement and veterans’ benefits when they are incurred and therefore are most controllable, whereas cash-based measures recognize the cost of those benefits when they are paid, which may be decades after they were earned.
• Accrual measures facilitate direct comparisons between all forms of current and deferred compensation (such as wages and pensions), making the cost of alternatives clearer to policymakers.
• By summarizing long-term budgetary effects up front, accrual measures more accurately indicate whether proposed changes to retirement and veterans’ benefits would increase or decrease programs’ costs over the long run.
• Accrual measures make it harder to change budgetary outcomes simply by shifting the timing of a program’s cash flows (say, from one fiscal year to another) without materially changing the underlying value of those cash flows.

Accrual measures also pose disadvantages compared with cash-based measures:

• Accrual estimates are more methodologically complex and potentially harder to understand.
• Accrual estimates involve additional uncertainty because they rely on projections of variables such as future salaries, health care costs, length of employment, and life expectancy over long horizons. They are also highly sensitive to changes in the technical assumptions used to translate future dollars into present values, and they can be volatile if those assumptions change from year to year. More broadly, the need to reconcile accrual estimates with actual cash flows periodically requires revisions to estimates and accounting adjustments that can add instability to the budget.
• Using accrual measures in the budget would pose significant challenges of transition and implementation, including the need for new account structures and decisions about how to address the cost of retirement and veterans’ benefits that have been earned but not yet paid.
• Incorporating accrual estimates into measures of the deficit would significantly widen the gap that typically exists between the annual budget deficit and the increase in the amount of outstanding federal debt held by the public.

In the context of enforcing statutory and Congressional budget targets, using accrual measures to account for transactions that affect the deficit could be confusing, and permitting lawmakers to budget differently for similar policies might create mixed incentives. On the one hand, accrual accounting would allow a piece of legislation to be credited with long-term savings (or charged with long-term costs) if it altered retirement or veterans’ benefits in ways that would affect net costs beyond the 10-year budget window. Thus, accrual measures would give lawmakers a stronger incentive to enact legislation that would constrain or reduce the expected costs of those benefits over the long term.

On the other hand, using accrual estimates for some programs within a broader budget enforcement framework that is based mainly on 10-year cash estimates could encourage lawmakers to use the expected long-term savings from such legislation (measured on an accrual basis) to finance short-term priorities, such as near-term spending increases or tax cuts. The long-term changes to retirement or veterans’ benefits might prove difficult to sustain, however. If future lawmakers curtailed those changes rather than letting them take full effect, the projected savings would not occur.

What Are Potential Approaches to Expand the Use of Accrual Measures for Federal Retirement and Veterans’ Benefits?

To improve decision-making about the allocation of resources among and within federal retirement and veterans’ programs, policymakers have options for including information about the long-term effects of those programs in the federal budget process. Those options would affect the budget deficit in various ways:

• Adopting an accrual-based treatment for all federal retirement and veterans’ programs in the budget as a whole—akin to the current treatment for federal credit programs—would change those programs’ impact on the deficit and probably do the most to incorporate long-term budgetary effects into the decision-making process.
• Expanding federal agencies’ intragovernmental accrual payments, to recognize the future cost of a broader range of retirement and veterans’ benefits than they do now, would affect the budgets of individual agencies. That change could affect the overall deficit, depending on the extent to which making more accrual payments would require agencies to curb other programmatic spending.
• Using accrual estimates only to enforce Congressional budget rules—but not in the budget itself—would change cost estimates for legislation and might affect decision-making. But that option would create a potentially confusing inconsistency between the estimates used by the Congress and those used by the Administration.
• Providing policymakers with supplemental information—whether accrual estimates or long-term cash estimates—would allow them to judge the value of such estimates in illuminating long-term effects without changing the budget numbers or budget enforcement. However, that option would do the least to incorporate long-term budgetary effects into legislative procedures.