In November 2014, a Michigan bankruptcy judge confirmed a plan that allowed Detroit’s government to shed $7 billion in liabilities, averting a total financial collapse. One year later, however, many in Detroit are still dealing with the fallout of the massive debt reorganization.
Among the many shortchanged by the city’s bankruptcy, Detroit’s retired municipal workers have gotten a particularly raw deal. The plan imposed deep cuts in future pension and health-care benefits. Perhaps more galling, it also required retirees to pay back a decade of interest they earned on city-sponsored retirement savings accounts. These so-called clawbacks averaged nearly $50,000 per retiree. In one circumstance, a retiree returned $96,000.
These losses for retirees seem unusual, but many more like them could follow. The same accounting strategy that led Detroit to make unfulfilled promises is widely used by state and city legislators throughout the country. By using an accounting method known as cash-basis accounting, legislators project future spending without having to consider billions of dollars of long-term financial commitments, leaving many budgets balanced in name only.
It may be easiest to think in terms of personal finance. Imagine you purchase a car for $20,000 in 2015, but under a special promotion no payments are due on your bill until 2018. In what year did you incur the $20,000 bill? Most people would say 2015, the year you acquired the car. That’s the answer mandated under accrual accounting, a method of financial reporting required of all public companies by the Financial Accounting Standards Board. But many state and city legislatures disagree. They operate with the conviction that a bill is not incurred until the money leaves your bank account to pay it. So if you choose not to pay the bill for your car until 2018, for accounting purposes the bill will only appear that year.