Credit Reform: Speculative Savings Used to Offset Current Spending
Increase Budget Uncertainty (Letter Report, 03/18/94, GAO/AIMD-94-46).

Using the present valued based estimated future savings from a credit
program to offset expenditures of a noncredit program is consistent with
both the theory behind credit reform and the application of credit
reform requirements. However, the opportunity to use such savings to
offset current spending can create an incentive for overly optimistic,
if not unrealistic, savings estimates. The net present value of
estimated additional future collections on guaranteed student loans
resulting from the 1991 Emergency Unemployment Compensation Act was
scored as anticipated under the Budget Enforcement Act, the Omnibus
Budget Reconciliation Act of 1993, the Federal Credit Reform Act of
1990, and existing scorekeeping conventions governing cost estimation
and the budgetary effect of legislation. Estimates of the guaranteed
student loan program savings were speculative because the Education
Department has little historical data on which to base one of the
collection methods. This greatly increased budgetary uncertainty.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-94-46
     TITLE:  Credit Reform: Speculative Savings Used to Offset Current 
             Spending Increase Budget Uncertainty
      DATE:  03/18/94
   SUBJECT:  Government guaranteed loans
             Federal agency accounting systems
             Collection procedures
             Offsetting collections
             Accounting procedures
             Future budget projections
             Credit
             Budget administration
             Cost control
             Intragovernmental transactions
IDENTIFIER:  Guaranteed Student Loan Program
             Federal Family Education Loan Program
             
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Cover
================================================================ COVER


Report to the Chairman, Committee on the Budget, U.S.  Senate

March 1994

CREDIT REFORM - SPECULATIVE
SAVINGS USED TO OFFSET CURRENT
SPENDING INCREASE BUDGET
UNCERTAINTY

GAO/AIMD-94-46

Credit Reform Savings


Abbreviations
=============================================================== ABBREV

  CBO - Congressional Budget Office
  GAO - General Accounting Office
  GSL - guaranteed student loan
  IRS - Internal Revenue Service
  OMB - Office of Management and Budget

Letter
=============================================================== LETTER


B-251511

March 18, 1994

The Honorable Jim Sasser
Chairman, Committee on the Budget
United States Senate

Dear Mr.  Chairman: 

You requested that we review specific issues related to
implementation of the Federal Credit Reform Act of 1990 (Public Law
101-508).  The first part of our response was issued in January
1993.\1 A second report responding to your questions on modifications
and the use of the financing account was issued in September 1993.\2
This letter, responding to a third issue in your request, discusses
the use of present value based\3 estimated future credit savings to
offset expenditures of a noncredit program.  Specifically, you asked
us to address whether the use of present value based savings from
Federal Family Education Loan Program (commonly referred to as the
guaranteed student loan--GSL--program) to offset the cost of
unemployment benefits provided in the Emergency Unemployment
Compensation Act of 1991 (Public Law 102-164) was prohibited and
whether savings estimates were speculative.  We will report
separately on the other areas in your request. 

The pay-as-you-go procedures of the Budget Enforcement Act of 1990
required that, in the aggregate, mandatory spending or legislation
dealing with receipts enacted during a session of Congress (such as
the unemployment legislation) not increase the deficit in any fiscal
year through 1995.  The pay-as-you-go procedures were extended
through 1998 by enactment of the Omnibus Budget Reconciliation Act of
1993 (Public Law 103-66).  The present value based estimated future
credit savings resulting from two financing provisions of the
Emergency Unemployment Compensation Act were scored,\4 by both the
Office of Management and Budget (OMB) and the Congressional Budget
Office (CBO), as offsets to the cost of the unemployment legislation
under the pay-as-you-go procedures. 


--------------------
\1 Federal Credit Programs:  Agencies Had Serious Problems Meeting
Credit Reform Accounting Requirements (GAO/AFMD-93-17, Jan.  6,
1993). 

\2 Federal Credit Reform:  Information on Credit Modifications and
Financing Accounts (GAO/AIMD-93-26, Sept.  30, 1993). 

\3 Present value means the worth of future returns or costs in terms
of money paid today.  A dollar available now is worth more than one
available in the future because it could earn interest in the
interim.  The future sums are converted to present value using the
prevailing interest rate which, in the case of credit reform, is
defined as the average interest rate on marketable Treasury
securities of similar maturity to the direct loan or guaranteed loan
that is disbursed. 

\4 Scorekeeping is the process used by the Office of Management and
Budget and the Congressional Budget Office to estimate the budgetary
effects of pending and enacted legislation and compare them to limits
set in the budget resolution or legislation. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Using the present value based estimated future savings from a credit
program to offset expenditures of a noncredit program is consistent
with both the theory behind credit reform and the application of
credit reform requirements.  However, the opportunity to use such
savings to offset current spending can create an incentive for overly
optimistic, if not unrealistic, savings estimates. 

The net present value of estimated additional future collections on
guaranteed student loans resulting from provisions in the 1991
Emergency Unemployment Compensation Act was scored as anticipated
under the Budget Enforcement Act, the Omnibus Budget Reconciliation
Act of 1993, the Federal Credit Reform Act of 1990, and existing
scorekeeping conventions governing cost estimation and the budgetary
effect of legislation.  Estimates of the guaranteed student loan
program savings were speculative because the Department of Education
had little historical data on which to base estimates for one of the
collection methods.  This greatly increased budgetary uncertainty. 


   BACKGROUND
------------------------------------------------------------ Letter :2

The Federal Credit Reform Act of 1990 changed the budget treatment of
loans and loan guarantees made on or after October 1, 1991, to more
accurately reflect the cost to the government.  It requires that the
budget include budget authority in the amount of the full estimated
cost (calculated on a net present value basis for the entire life of
the credit instrument) in the year decisionmakers authorize an
initial credit commitment or make any changes to outstanding credit. 
Outlays are to be included in the budget in the year in which a
direct loan or a guaranteed loan is disbursed.  This permits
appropriate cost comparisons between credit and cash-based programs. 

When subsequent legislation changes an existing credit program, any
revised cost is termed a modification under the Credit Reform Act. 
The net present value of such a modification--whether it increases or
decreases the cost to the government over the life of the
credit--must be included in the budget when the legislation is
enacted. 

The GSL program was modified by the Emergency Unemployment
Compensation Act of 1991, enacted November 15, 1991.  This
legislation, authorizing a temporary program that provided extended
or additional benefits to unemployed workers, included two provisions
to increase collections from borrowers in default on guaranteed
student loans.  Lower default losses are expected to reduce the cost
to the government, thereby producing future credit savings. 

A more comprehensive discussion of the history and principles of
credit reform appears in appendix I. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3

We (1) reviewed relevant sections of the Federal Credit Reform Act of
1990, the Emergency Unemployment Compensation Act of 1991, the
Deficit Reduction Act of 1984, the Omnibus Budget Reconciliation Act
of 1993, 26 U.S.C.  (Internal Revenue Code), and OMB guidance and
scoring reports for the Emergency Unemployment Compensation Act, (2)
reviewed the accuracy of the estimates of future GSL program savings,
(3) interviewed Department of Education officials responsible for
budget execution and revenue collection, and (4) discussed and
confirmed the above information with OMB and CBO staff, obtaining and
analyzing their rationales for the scoring and revenue decisions. 

We performed our work in Washington, D.C., between October 1992 and
October 1993, in accordance with generally accepted government
auditing standards.  OMB provided written comments on a draft of this
report.  We have addressed these comments in the Agency Comments and
Our Evaluation section and they are reprinted in appendix II. 


   ESTIMATED GSL SAVINGS SCORED AS
   OFFSET TO UNEMPLOYMENT
   LEGISLATION COSTS
------------------------------------------------------------ Letter :4

The Emergency Unemployment Compensation Act authorized a temporary
program to provide additional weeks of federal assistance to
unemployed workers who had exhausted current benefits, as well as
additional unemployment benefits for former members of the armed
forces, railroad workers, and school employees.  These outlays were
to be paid over more than 1 fiscal year and were scored on a cash
basis like most programs in the budget.  The act also contained
several provisions to finance the extended benefits, including two
that applied to borrowers who had defaulted on guaranteed student
loans.  The first provision permanently extended the authority of
federal agencies to enter into agreements with the Internal Revenue
Service (IRS) to collect overdue non-tax debts by withholding income
tax refunds.  The second authorized the garnishment of an
individual's disposable pay.\5

OMB and CBO scored these two provisions of the Emergency Unemployment
Compensation Act (authorizing seizure of income tax refunds and
garnishment of the pay of GSL borrowers in default) as modifications
that decreased the costs of pre-fiscal-year 1992 guaranteed student
loans, thereby creating an estimated future savings to the
government.  The anticipated future collections from GSL defaulters
resulting from the two provisions together are estimated to total
$2.7 billion.\6 The estimated collections from the seizure of income
tax refunds (so-called IRS offsets) are expected by OMB and the
Department of Education to total $1.9 billion over a 12-year period
beginning in 1994.  The additional collections resulting from the pay
garnishments are estimated to total $0.7 billion over a 14-year
period beginning in 1992.  In accordance with credit reform
requirements, the total estimated collections ($2.7 billion) were
discounted to present value at the time the Congress enacted the
legislation.  The $1.9 billion in present value based savings then
was scored as an offsetting receipt in fiscal year 1992 and used with
other financing provisions of the Emergency Unemployment Compensation
Act to offset expenditures for the additional unemployment benefits. 


--------------------
\5 Disposable pay is defined in the act as that part of the
compensation of any individual from an employer remaining after the
deduction of any amounts required by law to be withheld. 

\6 Estimated collections from pay garnishment ($0.7 billion) and the
IRS offset ($1.9 billion) do not add to this total due to rounding. 


   GSL SAVINGS ESTIMATES WERE
   SPECULATIVE
------------------------------------------------------------ Letter :5

Although use of the net present value of estimated future credit
collections to offset current expenditures is consistent with credit
reform requirements,\7 it creates an incentive to be optimistic in
estimating the future savings.  While that incentive exists for all
savings estimates, it is a particular problem for present value based
savings because such savings occur in future years and the spending
that it offsets occurs in the present.  In this case, by the time
estimates may be proven incorrect, the spending already would have
occurred. 

Any estimate carries a risk of inaccuracy, but this risk is increased
markedly when little relevant historical data exist.  According to
credit reform requirements, both costs and savings are estimated over
the entire life of the credit instrument and discounted to present
value.  This estimation period can range from as little as 6 months
for the Export-Import Bank's loan guarantee program to 50 years for
some rural housing loans.  In the case of the GSL program, a lack of
reliable historical data imparts a high degree of risk to the savings
estimates. 

The additional GSL collections, estimated to be $2.7 billion\8

over 14 years, would result from two collections actions.  More than
one-quarter of the estimated collections ($0.7 billion) was to come
from additional collections from individual pay garnishments.  This
1991 estimate was especially speculative because the Department of
Education had little implementation experience and no historical
collection data.  Although several of the 46 guaranty agencies did
use pay garnishment under state-granted authority, they did not
report the resulting collections separately to the Department of
Education.  In July 1993, the Department of Education first required
guaranty agencies to report separately the receipts from pay
garnishment. 

The $1.9 billion in additional estimated collections from the seizure
of income tax refunds is likely to be a more reliable figure,
primarily because the IRS offset program has been in place for a
number of years and because the Department of Education maintains an
historical database of information used to make current estimates. 


--------------------
\7 Credit reform requirements are embodied in the Federal Credit
Reform Act of 1990 and in related OMB and Treasury implementation
guidance. 

\8 See footnote 6. 


   CONCLUSIONS
------------------------------------------------------------ Letter :6

The use of present value based estimated future savings from a credit
program to offset expenditures of a noncredit program is consistent
with both the theory behind credit reform and the application of
credit reform requirements.  However, the opportunity to use such
savings to offset current spending can create an incentive for overly
optimistic, if not unrealistic, savings estimates. 

While the net present value of the estimated future collections from
guaranteed student loans resulting from provisions in the 1991
unemployment law was scored as anticipated under credit reform
requirements, the estimates were speculative.  Maintaining revenue
data by collection method would permit more accurate estimates in the
future and facilitate review and oversight. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :7

In commenting on a draft of this report, OMB agreed that the report
is factually accurate, aside from some suggested technical changes
which have been incorporated where appropriate.  OMB also raised
several concerns and one question relating to legal and estimating
issues. 

OMB was concerned that our report, which said that the use of present
value based estimated credit savings to offset current expenditures
is not inconsistent with credit reform requirements, implied that OMB
and CBO did not follow the law when calculating costs and savings
from modifications.  We do not think that the draft report's wording
implied this but we revised the report to eliminate OMB's concern. 
As our report states elsewhere, the cost of the GSL modification was
discounted to present value in accordance with credit reform
requirements and the scoring of the unemployment legislation was as
anticipated under credit reform requirements. 

OMB said that the draft did not distinguish between the legal
requirement to measure costs on a present value basis and the quality
of the estimates.  We disagree.  Like OMB, we viewed these as
separate issues and structured our report to address each separately. 
The first section of the report discusses the legal requirement to
discount estimated collections to present value, and the second
section presents our view that these estimates were speculative. 
These issues also are addressed separately in the conclusion. 

Regarding the statement in our Results in Brief that using present
value estimates greatly increases budget uncertainty, OMB commented
that while present value estimates are based on cash flows over a
longer period of years, it is not clear whether they are more
speculative than cash-based estimates.  We clarified this section by
noting that the GSL savings estimates were speculative because they
were calculated on the basis of little historical data for one of the
collection methods. 

OMB also commented that the report does not distinguish between the
calculation of the savings from credit modifications and the use of
such savings to offset spending in a non-credit program.  We
disagree.  The first section of our report addresses the legal
requirements to measure costs of modifications on a present value
basis.  It separately discusses the use of the present value based
savings from a modification of the GSL program to offset unemployment
spending, a non-credit program.  The Conclusions section also
presents these issues separately. 

Finally, OMB asked whether GAO advocates an alternative method to
measuring savings on a present value basis to produce better
estimates.  We continue to support measuring the costs of and savings
from credit programs on a present value basis.  It is the speculative
nature of the GSL savings that concerns us.  As noted in our
Conclusions section, maintaining revenue data by collection method
would permit more accurate estimates and facilitate review and
oversight. 


---------------------------------------------------------- Letter :7.1

We are sending copies of this report to the Director, Office of
Management and Budget; the Director, Congressional Budget Office; the
Secretaries of Education and Labor; interested congressional
committees; and other interested parties.  Copies also will be made
available to others upon request. 

Please contact me at (202) 512-9142 if you or your staff have any
questions concerning the report.  Other major contributors to this
report are listed in appendix III. 

Sincerely yours,




Susan J.  Irving
Associate Director, Budget Issues


BACKGROUND:  CREDIT REFORM
=========================================================== Appendix I

This background appendix also will be a part of two other forthcoming
reports on credit reform implementation:  an evaluation of decisions
to include certain programs under the Federal Credit Reform Act and
an evaluation of the use of negative subsidy credit receipts. 


------------------------------------------------------- Appendix I:0.1

The federal government uses direct loans and loan guarantees as tools
to achieve numerous program objectives such as assistance to housing,
agriculture, education, small businesses, and foreign governments. 
At the end of fiscal year 1991, the government's direct loan and loan
guarantee portfolio totaled $855 billion, of which $202 billion was
in direct loans and $653 billion was in loan guarantees. 

After over 20 years of discussion about the shortcomings of using
cash accounting for credit programs and activities, the Federal
Credit Reform Act of 1990 was enacted on November 5, 1990, as Title
13B of the Omnibus Budget Reconciliation Act of 1990, Public Law
101-508.  The Credit Reform Act changed the budget treatment of
credit programs so that their costs can be compared more accurately
with each other and with the costs of other federal spending.  It
also was intended to ensure that the full cost of credit programs
over their entire lives would be reflected in the budget so that the
executive branch and the Congress might consider them when making
budget decisions. 

In addition, it was recognized that credit programs had different
economic effects than most budget outlays, such as purchases of goods
and services, income transfers, and grants.  In the case of direct
loans, for example, the fact that the loan recipient was obligated to
repay the government over time meant that the economic impact of a
direct loan disbursement could be much less than other budget
transactions of the same dollar amount. 

CREDIT REFORM WAS DESIGNED TO
REMOVE DIFFICULTIES CAUSED BY CASH
TREATMENT

Before credit reform, it was difficult to make appropriate cost
comparisons between direct loan and loan guarantee programs and
between credit and noncredit programs.  Credit reform requirements
were formulated to address the factors that caused this problem.  Two
key principles of credit reform are (1) the definition of cost in
terms of the present value of cash flow over the life of a credit
instrument and (2) the inclusion in the budget of the costs of credit
programs in the year in which the budget authority is enacted and the
direct or guaranteed loans are disbursed. 

CREDIT REFORM WAS DESIGNED TO
ALLOW APPROPRIATE COST COMPARISONS

Before credit reform, credit programs--like other programs--were
reported in the budget on a cash basis.  This cash basis distorted
costs and, thus, the comparison of credit program costs with other
programs intended to achieve similar purposes, such as grants.  It
also created a bias in favor of loan guarantees over direct loans. 
Loan guarantees appeared to be free while direct loans appeared to be
very expensive because the budget did not recognize that at least
some of the loan guarantees would default and that some of the direct
loans were to be repaid. 

For direct loans, the budget showed budget authority and outlays in
the amount that loan disbursements exceeded repayments received in
that budget year.  This cash approach overstated direct loan costs in
the initial years of a program when loan disbursements were likely to
be greater than repayments.  Conversely, this treatment understated
costs in later years when loan repayments were more likely to be
greater than disbursements.  Cash-based budgeting did not recognize
that at least a portion of the loan outlays would be repaid in the
future.  In contrast, for loan guarantees, the budget did not record
any budget authority or outlays when the guarantees were made (except
the negative outlay resulting from any origination fees), even though
they were likely to entail future losses.  It showed budget authority
and outlays only when, and if, defaults occurred. 

Credit reform changed this treatment for direct loans and loan
guarantees made on or after October 1, 1991.  It required that budget
authority to cover the cost to the government of new loans and loan
guarantees (or modifications to existing credit instruments) be
provided before the loans, guarantees, or modifications are made. 
Credit reform requirements specified a net cost approach using
estimates for future loan repayments and defaults as elements of the
cost to be recorded in the budget.  This puts direct loans and loan
guarantees on an equal footing; it permits the costs of credit
programs to be compared with each other and with the costs of
noncredit programs when making budget decisions. 

CREDIT REFORM IDENTIFIES THE
GOVERNMENT'S COST OF CREDIT
ACTIVITIES

Credit reform requirements separate the government's cost of
extending or guaranteeing credit, called the subsidy cost, from
administrative and unsubsidized program costs.  Administrative
expenses receive separate appropriations.  They are treated on a cash
basis and reported separately in the budget.  The unsubsidized
portion of a direct loan is expected to be recovered from the
borrower. 

The Credit Reform Act defines the subsidy cost of direct loans as the
present value--over the loan's life--of disbursements by the
government (loan disbursements and other payments) minus estimated
payments to the government (repayments of principal, payments of
interest, and other payments) after adjusting for projected defaults,
prepayments, fees, penalties, and other recoveries.  It defines the
subsidy cost of loan guarantees as the present value of cash flows
from estimated payments by the government (for defaults and
delinquencies, interest rate subsidies, and other payments) minus
estimated payments to the government (for loan origination and other
fees, penalties, and recoveries). 

According to OMB guidance, credit programs have a positive subsidy,
that is, they lose money, when the present value of estimated
payments by the government exceeds the present value of estimated
receipts.  Conversely, negative subsidy programs are those in which
the present value of estimated collections is expected to exceed the
present value of estimated payments; in other words, the programs
make money (aside from administrative expenses). 

CREDIT PROGRAMS NOW USE THREE
BUDGETARY ACCOUNTS

The Credit Reform Act set up a special budget accounting system to
record the budget information necessary to implement credit reform. 
It provides for three types of accounts--program, financing, and
liquidating--to handle credit transactions. 

Credit obligations and commitments made on or after October 1,
1991--the effective date of credit reform--use only the program and
financing accounts.  The program account receives separate
appropriations for administrative and subsidy costs of a credit
activity and is included in budget totals.  When a direct or
guaranteed loan is disbursed, the program account pays the associated
subsidy cost for that loan to the financing account.  The financing
account, which is nonbudgetary,\1 is used to record the cash flow
associated with direct loans or loan guarantees over their lives.  It
finances loan disbursements and the payments for loan guarantee
defaults with (1) the subsidy cost payment from the program account,
(2) borrowing from the Treasury, and (3) collections received by the
government.  Figure I.1 diagrams this cash flow. 

   Figure I.1:  Credit Reform Cash
   Flow Simplified

   (See figure in printed
   edition.)

If subsidy cost calculations are accurate, the financing account will
break even over time as it uses its collections to repay its Treasury
borrowing. 

Direct loans and loan guarantees made before October 1, 1991, are
reported on a cash basis in the liquidating account.  This account
continues the cash budgetary treatment used before credit reform.  It
has permanent, indefinite budget authority\2 to cover any losses. 
Excess balances are transferred periodically--at least annually--to
the Treasury. 

In addition to the three accounts specified in the Credit Reform Act,
OMB has directed that credit programs or activities with negative
subsidies must have special fund receipt accounts to hold receipts
generated when the program or activity shows a profit.  OMB guidance
provides that these funds cannot be used unless appropriated. 

OMB AND TREASURY PROVIDE
IMPLEMENTATION GUIDANCE

OMB and the Department of the Treasury provide guidance on
implementing credit reform.  OMB's written guidance is contained
primarily in OMB Circulars A-11, A-34, and A-129.\3 OMB also has
issued memoranda to provide additional implementation guidance
addressing specific situations.  The Treasury's guidance is provided
in materials such as Basic Transactions Relating to Guaranteed Loans
and Subsidies (Apr.  30, 1992) which contains a number of
illustrative cases developed by its Financial Management Service and
distributed to agencies as examples of how to account for credit
reform transactions. 

INDIVIDUAL PROGRAM CHARACTERISTICS
RAISE CREDIT IMPLEMENTATION
QUESTIONS

Fiscal year 1994 is the third year that credit programs have been
required to comply with credit reform.  Both agencies that operate
credit programs and those that provide implementation guidance--OMB
and Treasury--have had to address a variety of situations for which
the Credit Reform Act does not provide explicit direction.  Questions
have arisen and continue to arise as the agencies implement credit
reform.  Several groups have been created, such as the Federal Credit
Policy Working Group and the Credit Reform Steering Committee, to
address these implementation issues and questions. 



(See figure in printed edition.)Appendix II

--------------------
\1 Nonbudgetary accounts may appear in the budget document for
information purposes but are not included in the budget totals for
budget authority or outlays.  They do not belong in the budget
because they show only how something is financed, and do not
represent the use of resources. 

\2 Permanent budgetary authority is available as a result of
permanent legislation and does not require annual appropriation. 
Indefinite budget authority is budget authority of an unspecified
amount of money. 

\3 OMB Circular No.  A-11 is entitled Preparation and Submission of
Budget Estimates; Circular No.  A-34 is entitled Instructions on
Budget Execution; Circular No.  A-129 is entitled Managing Federal
Credit Programs. 


COMMENTS FROM THE OFFICE OF
MANAGEMENT AND BUDGET
=========================================================== Appendix I



(See figure in printed edition.)


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III

ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION, WASHINGTON,
D.C. 

Christine Bonham, Assistant Director
Carolyn Litsinger, Evaluator-in-Charge
Trina Lewis, Senior Evaluator

OFFICE OF THE GENERAL COUNSEL,
WASHINGTON, D.C. 

Bertram Berlin, Assistant General Counsel
Carlos Diz, Attorney Adviser

RELATED GAO PRODUCTS

Federal Credit Reform:  Information on Credit Modifications and
Financing Accounts (GAO/AIMD-93-26, Sept.  30, 1993). 

Federal Credit Programs:  Agencies Had Serious Problems Meeting
Credit Reform Accounting Requirements (GAO/AFMD-93-17, Jan.  6,
1993). 

