JURIST Guest Columnist Joseph Marren, President and Chief Executive Officer of KStone Partners LLC, says that the recent health care reform act may be unconstitutional due to inaccurate financial reporting to the states and the public at large…

This spring the Supreme Court will hear arguments related to the Patient Protection and Affordable Care Act (PPACA). One of the key questions being asked is whether the PPACA’s requirement that states expand Medicaid eligibility or risk losing federal funds is unduly coercive. The PPACA substantially expanded Medicaid eligibility with the federal government agreeing to pay nearly the entire cost.

Federal financial reporting is coercive as it relates to Medicaid because it significantly overstates the federal government’s ability to continue providing funding. The Comptroller General recently stated “The comprehensive long-term fiscal projections presented in the 2011 Financial Report of the United States Government show that — absent policy changes — the federal government continues to face an unsustainable fiscal path.” The Citizens Guide to the 2011 Financial Report [PDF] states “The Nation must bring social insurance expenses and resources into balance before the deficit and debt reach unprecedented heights. Delays will only increase the magnitude of the reforms needed and will place more of the burden on future generations.”

The Supreme Court has indicated that legislation enacted pursuant to the spending power is much in the nature of a contract: in return for federal funds, the states agree to comply with federally imposed conditions. However, the states cannot knowingly accept the full terms of the contract if a fundamental assumption or condition on which they rely is materially in error. The ability to continue to provide financing for the Medicaid program is a key determinant whether a state wants to continue taking the money.

The failure of the federal government to advise the states of their ability to continue providing funding through the publication of a truthful and accurate statement and account required by Article I, Section 9, Clause 7 of the US Constitution renders any state acceptance of the Medicaid “contract” null and void. The clause, typically referred to as the Statement and Account Clause, states that “a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time.”

Although the Supreme Court has never opined on the meaning of the Statement and Account Clause, it would appear that there can be no other meaning that one can ascribe to the text than it creates a right for the public to receive accurate, truthful and complete financial information and that it imposes a concurrent duty for the government to publish financials that reflect its economic reality. The publication recognized by the government as the official Statement and Account is the Combined Statement of Receipts, Outlays, and Balances, which is largely derived from the president’s budget. This publication is not widely known or used by the public (including the media), not central to any discussion of the nation’s finances, and is not viewed as a major publication by any recent Congress or administration.

Social Security, Medicare and Medicaid have either permanent appropriations or mandatory authorizing legislation. A distinctive feature of authorizing legislation for mandatory spending is that they provide agencies the authority or requirement to spend money without first requiring appropriations committees to enact funding.

Congress’s power of the purse is governed by two principles: the Principle of the Public Fisc, which states that all funds belonging to the US received from whatever source and regardless of form are public monies, subject to public control and accountability; and the Principle of Appropriations Control, which states that all expenditures from the public fisc must be made pursuant to congressional appropriation. Several commentators have made the point that Congress renders meaningless the principles of the public fisc and of appropriations control if it creates spending authority without amount or time limitations and fails to subject such authority to periodic legislative review. When permanent appropriations and/or mandatory authorizing legislation are coupled with inadequate financial disclosure, accountability disappears altogether. The Supreme Court has never ruled on the impact that such legislation has on reporting requirements. Presumably such legislation raises the bar with respect to disclosure in the statement and account.

Currently it is impossible to determine the truth about the government’s financial results and financial position, as the government maintains two sets of books which individually and in the aggregate are grossly misleading. The most well-known is the budget, which is cash-based. Unfortunately, the budget and the budget deficit have little to do with the government’s economic reality. Under budget accounting rules, outlays are recorded only when bills are paid. Americans know that real expense is incurred when one makes spending commitments. This is the primary reason why every publicly traded company in the US today is required to use accrual accounting. The little-known alternative set of books is the Financial Report of the United States Government.

The simplest way to think about our government’s recent financial results is to add up all the expenditures and revenues over the last decade and divide the total expenditures by total revenues. This produces a “dollar spent per dollar of revenue” figure which everyone that manages a household can understand. Using budget accounting, the federal government has spent $1.28 for every $1 of revenue it has received; per the Financial Reports it has spent $1.38 for every $1 of revenue. The Financial Report has two serious flaws. It does not consolidate numerous material government controlled entities including the Federal Reserve System, Fannie Mae and Freddie Mac, and it does not include the costs of our social insurance programs that are payable in the future. If one adds the increase in the present value of the Medicare and Social Security obligations to the Financial Report’s results over the last decade, this raises spending to $2.71 for every $1 of revenue. This is roughly double the reported government spending. However, a strong argument can be made that this figure still significantly understates government spending.

It is inconceivable that the practices described comply with the all-public money requirement of the Statement and Account Clause. The failure to report social insurance costs in the Financial Report violates the intent of the Statement and Account Clause to require publication of financial results that reflect the federal government’s economic reality.

When one looks at the federal government’s balance sheet as of September 30, 2011, it indicates that there is a net liability of $14.8 trillion. When you add the $46 trillion of obligations for Medicare and Social Security and the understated $24 trillion Medicaid obligation, the total US obligations rise to approximately $85 trillion. A good argument can be made that the $70 trillion of social insurance obligations are substantially understated as they only reflect a 75-year time horizon.

Most of us were taught growing up that it is always best to tell the truth and that not telling the truth can lead to some very bad outcomes. The federal government’s lack of truthfulness in financial reporting may soon have dire consequences.

Joseph Marren is the President and Chief Executive Officer of KStone Partners, an SEC registered investment advisor that specializes in managing funds of hedge funds. Previously he was Head of Business Development in the mergers and acquisitions departments at several firms including Sagent Advisors, Citigroup, Credit-Suisse and DLJ. He is the author of two books on mergers and acquisitions, taught at New York University Stern School of Business and is a graduate of Fordham University School of Law.

Suggested citation: Joseph Marren, Financial Reporting Renders Health Care Reform Unconstitutional, JURIST – Hotline, Mar. 10, 2012, http://jurist.org/hotline/2012/03/joseph-marren-government-finance.php.