The 2009 unified budget deficit is estimated now at $490 billion. Some of that number is expected and fine – during a recession taxes fall and certain expenses like unemployment benefits rise.

It’s still a really big number – and it turns out that the real deficit is much, much higher.

First, the number doesn’t account for $80 billion in war costs.

Next, the number is for the “unified” budget deficit. “Unified” in federal budget speak means the cash in, cash out budget. This ignores serious obligations the government has taken on this year – veterans benefits to the hundreds of thousands of troups serving overseas, Medicare and Social Security payouts to the baby boomers etc etc.

The real government budget deficit is the number that takes into account all these future liabilities. It is *probably* $200 billion higher than the fictional unified budget deficit, but no one really knows.

Congress mandated that all the major departments of the Federal government start producing auditable financial statements in 1990. Many departments are now compliant but the behemoths – Defense, Homeland Security and State departments – are not.

I love this footnote in a recent report from the General Accounting Office (the government’s internal audit staff) on budget numbers:

Data reported in the Financial Report of the United States Government, hereafter referred to as the Financial Report, for fiscal years 2001 through 2007. GAO disclaimed an opinion on the U.S. government’s consolidated financial statements for these years, other than the 2007 Statement of Social Insurance. As such, the reported amounts may not be reliable.

Or how about this snippet from the same report:

Importantly, emphasis should not be placed on the precise numbers for either a single year accrual deficit or the change from year to year. For the 11th consecutive year, the government was unable to demonstrate the reliability of significant portions of the 2007 Financial Report, from which the data in this update were taken.

The cash on cash number, while in no way an accurate assessment of the government finances is still an important number – because it tells us how much the government needs to borrow every year to pay its bills.

We can project forward 20 and 30 years and the cash on cash number starts looking really, really ugly. All those deferred liabilities start coming due. Our best guess is that they will add $600 billion a year to the current deficit. That will either mean much higher interest rates or higher taxes (50% higher) or elimination of the entire government outside of defense or some combination.

Many of our client’s have written off social security being there for them in their retirement. They are surprised to hear our view that, while we think benefits will be clipped for the wealthy, Social Security will survive. A clear majority of retirees rely on Social Security and Medicare/Medicaid for their retirement and these programs will become even more important as the post- company retirement plan generation retires. These programs cannot and will not go anywhere. We may have an overhaul, eventually, of our health care system but don’t count Social Security or Medicare out.

The good news is that there will be Social Security benefits – the bad news is that tax rates will go up, a lot.

More reading on budget unsustainability

Congressional Budget Office’s report

The GAO’s report

Things I learned:

1) These decisions have a huge impact over how much money people and their heirs end up with and are important to think about.

2) The calculations required to make these decisions are really hard, even for the country’s top financial professionals, and not always intuitive.

3) There were people of all political persuasions in the room and EVERYONE thinks tax rates are going up, way up. As someone said, if taxes were a stock, they would be rated a long term “buy”.

4) The Roth IRA / 401(k) can be great for people of even very high incomes.

5) Congress will allow unlimited conversions to Roth IRAs from regular IRAs in 2010. Currently, you can only do this if you earn less than $100,000. This is a fabulous opportunity for our clients but will be very costly for our nation’s finances without any obvious public benefit.

When you convert to a Roth, you have to pay the taxes on all the income that was sheltered in an IRA, but you and even your grandchildren who inherit that money never pay tax again on any investment or dividend income. You pay $1 today to avoid $2-$30 of tax in the future.

Even though Congress gives up a huge amount of revenues in the future, it still loves this idea because all its budget calculations are done on a 10 year basis. They get all of the benefit from people writing checks to the IRS today without having to account for the taxes people will avoid paying 10-100 years from now. When they passed the provision, they were able to count it as a revenue raising measure.

According to this New York Times article, this one little obscure tax law could cost over $50 billion when all is said and done. I guess we can just add unlimited Roth conversions as reason #932 that tax rates will be headed north.

Anyway, if you are our client, and you got a notice from the HR department about a new Roth 401(k) option and shoved it into a desk drawer, pull it out and give us a call.

If you happen to be a member of Congress, you need to consider revisiting the Roth conversion idea.

As always, everyone’s financial situation differs and you need to consult your own advisor.

Private equity firms may be able to foist a lot of change on a company in a short period of time, force a focus on cashflow since most private equity owned firms take on a lot of debt and need to generate money to make interest payments, and offer enormous incentives for success to the management team.

If this is so – and I suspect the truth varies dramatically based on the private equity firm- we need to consider the implications for how most people in this country are saving for retirement.

At this point, there is about $16 trillion in pensions and retirement acounts. Half of that money is in IRAs, 401(k)s and the like. Virtually 100% of the equity allocation in that $8 trillion pool of money is in public equities.

When traditional pension plans were the norm, the pension plan manager had the option to invest in public or private equity and generally did both.

Currently, individuals in defined contribution plans have little choice. You can choose really really big and expensive mutual fund ABC or maybe if you are lucky index fund XYZ.

Laura Resnikoff, a business school professor who studies the kinds of changes that private equity makes, is quoted in the the article as saying,“A good management team at a public company could do all of this, of course. And yet, we don’t see management teams doing it.”

IF we don’t want drastic changes in the current system of retirement saving, we need to think very hard about why this is because as the system exists today, the outsized rewards of change largely go to private equity investors and the public equity investors (us) look like chumps.

This is a problem – my generation is largely reliant on the performance of the country’s largest couple hundred public companies to fund their retirement. And there is quite a lot of evidence that the current management and ownership structure of these companies is significantly less than optimal and an impediment to change.

Less than optimal is okay. Optimal is not realistic for many reasons but I think it’s likely we are further away from optimal than we need to be.

One way in which the current system falls short is that we make it really hard for motivated, qualified groups to make changes at a company without going to the extreme of taking it over.

You know those really irritating proxy forms you get, asking you to rubber stamp the board of directors the company’s management has handpicked? Well, they aren’t even binding in most cases.

I’d love to see a serious policy discussion start about how to improve corporate governance. We’ve spent a lot of time on Sarbanes-Oxley trying to avoid fraud. I’m quite confident that mediocrity is a lot more costly to American investors than a little pumping and dumping by corporate executives…