Budget Issues: Long-Term Fiscal Challenges (27-FEB-02,		 
GAO-02-467T).							 
								 
Combating terrorism and ensuring the nation's homeland security  
have created urgent claims on our attention and on the federal	 
budget. Although there are indications that an economic recovery 
is underway, the recession that began last spring has had real	 
consequences for the budget. At the same time, the fiscal	 
pressures created by the retirement of the baby boom generation  
and rising health care costs remain the same. The surpluses also 
put the nation in a stronger position to respond to the events of
September 11 and to the economic slowdown than would otherwise	 
have been the case. The nation's commitment to surpluses will be 
tested. A return to surplus will require sustained discipline and
difficult choices. Because the longer-term outlook is driven in  
large part by known demographic trends the outlook 20 years from 
now is surer than the forecast for the next few years. The	 
message of GAO's updated simulations remains the same as last	 
year--absent structural changes in entitlement programs for the  
elderly, in the long term persistent deficits and escalating debt
will overwhelm the budget. Both longer-term and new commitments  
undertaken after September 11 sharpen the need for competing	 
claims and new priorities. A fundamental review of existing	 
programs and activities is necessary both to increase fiscal	 
flexibility and to make government fit the modern world. Stated  
differently, there is a need to consider the proper role of the  
federal government in the 21st century and how the government	 
should do business in the future. The fiscal benchmarks and rules
that moved the country from deficit to surplus expire this fiscal
year. Any successor system should include a debate about	 
reprioritization today and a better understanding of the	 
long-term implications of different policy choices. There are	 
many things that the nation may be able to afford today but may  
not be sustainable in the future.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-467T					        
    ACCNO:   A02822						        
  TITLE:     Budget Issues: Long-Term Fiscal Challenges 	      
     DATE:   02/27/2002 
  SUBJECT:   Budget administration				 
	     Financial management				 
	     Strategic planning 				 
	     Recession						 
	     Budget surplus					 
	     Entitlement programs				 
	     Economic stabilization				 
	     Fiscal policies					 
	     Coast Guard Deepwater Project			 
	     Hospital Insurance Trust Fund			 
	     Medicaid Program					 
	     Medicare Program					 
	     Social Security Program				 
	     Supplementary Medical Insurance Program		 
	     Old Age and Survivors Insurance Trust		 
	     Fund						 
								 
	     Social Security Disability Insurance		 
	     Trust Fund 					 
								 

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GAO-02-467T
     
United States General Accounting Office

GAO Testimony

Before the Committee on the Budget, U.S. Senate

For Release on Delivery

Expected at 10 a.m. BUDGET ISSUES

Wednesday, February 27, 2002

Long-Term Fiscal Challenges

Statement of David M. Walker Comptroller General of the United States

GAO-02-467T

Chairman Conrad, Ranking Member Domenici, and Members of the Committee:

I am pleased to return this year to present GAO's perspective on the
long-range fiscal policy challenges facing this Congress and our nation. We
meet today in a situation that seems very different from that of last
February. Today the challenges of combating terrorism and ensuring our
homeland security have come to the fore as urgent claims on our attention
and on the federal budget. While there are indications that an economic
recovery is underway, the recession that began last spring has had real
consequences for the budget. These are important changes in the last year.
At the same time, the known fiscal pressures created by the retirement of
the baby boom generation and rising health care costs remain the same.
Absent substantive reform of the entitlement programs, a rapid escalation of
federal spending for Social Security, Medicare, and Medicaid beginning less
than 10 years from now is virtually certain to overwhelm the rest of the
federal budget. Indeed, the slowing economy and tax and spending decisions,
including the increased spending levels necessary to respond to new security
challenges, have increased pressures on the budget. Correspondingly, the
ultimate task of addressing these needs without unduly exacerbating the
long-range fiscal challenge has become much more difficult.

In my testimony today I make the following points:

* The surpluses that many worked hard to achieve-with help from the
economy-not only strengthened the economy for the longer term but also put
us in a stronger position to respond to the events of September 11 and to
the economic slowdown than would otherwise have been the case.

* Going forward, the nation's commitment to surpluses will be tested: a
return to surplus will require sustained discipline and difficult choices.

* Because the longer-term outlook is driven in large part by known
demographic trends, in some ways we can be surer about the outlook 20 years
from now than the forecast for the next few years.

* The message of GAO's updated simulations remains the same as last year:
absent structural changes in entitlement programs for the elderly, in the
long term persistent deficits and escalating debt will overwhelm the budget.

* Both longer-term pressures and the new commitments undertaken after
September 11 sharpen the need to look at competing claims and new
priorities. A fundamental review of existing programs and activities is
necessary both to increase fiscal flexibility and to make government fit the
modern world. Stated differently, there is a need to consider what is the

proper role of the federal government in the 21st century and how should

the government do business in the future. * The fiscal benchmarks and rules
that moved us from deficit to surplus

The Fiscal Backdrop
for Today's Choices

expire this fiscal year. Any successor system should facilitate both a
debate about reprioritization today and a better understanding of the
long-term implications of different policy choices. Simply stated, there are
many things that we may be able to afford to do today but we may not be able
to sustain in the future.

Today it is evident that recent surpluses were the result not only of hard
choices made earlier in the 1990s, but also of fortuitous economic,
demographic, and policy trends that are no longer working for us as we enter
the 21st century. In retrospect, the nation emerged from deficits of nearly
three decades only to find itself in what has been called "the eye of the
storm." The passage to surpluses was aided by a tailwind consisting of (1)
extraordinarily strong economic growth, (2) a slowing of health care cost
growth, (3) a demographic holiday stemming from low birth rates during the
Depression and World War II paired with a large workforce resulting from the
post-war baby boom-which together gave rise to a stable
worker-to-beneficiary ratio in Social Security, and (4) the fall of the
Soviet Union permitting a decline in defense spending as a share of the
economy.

The fiscal winds have now shifted-many of these fortunate trends have now
reversed course and are making the choices harder. Although it appears the
economy may have turned the corner, forecasters are not showing a return to
the extremely rapid growth the nation enjoyed during the last half of the
nineties. Health care costs have once again resumed growing at double-digit
rates. Reductions in defense spending can no longer be used as a means to
help fund other claims on the budget; indeed, spending on defense and
homeland security will grow as we seek to defeat terrorism worldwide.
Finally-and I know this is one of the reasons you invited me here today-the
nation's demographic holiday is ending. In 2008-only 6 years from
now-demographic storm clouds will begin to shadow the baseline as the first
wave of baby boomers become eligible to claim Social Security.

However one allocates credit across the events and decisions that led to
years of surpluses, we benefited from that achievement. These large
surpluses not only helped in the short term by reducing debt and interest
costs but also strengthened the budget and the economy for the longer term.
The budgetary surpluses of recent years put us in a stronger position

The Known Demographic Challenge

to respond both to the events of September 11 and to the economic slowdown
than would otherwise have been the case.

However, going forward, the nation's commitment to surpluses will truly be
tested. For the last few years surpluses were built in to the baseline so
that given a lack of policy action, there would be a surplus. Last year, the
Congressional Budget Office (CBO) baseline not only projected unified
surpluses for at least the 10-year window but also substantial surpluses in
the non-Social Security portion of the budget. Saving the Social Security
surplus became an achievable and compelling fiscal policy goal for the
nation in this context. This is no longer true. At least for the next
several years the baseline does not turn to unified surplus. A surplus in
the non-Social Security portion of the budget is not projected under the
baseline to emerge until 2010. As a result, explicit policy actions on
spending and/or revenue will be necessary to return to and maintain
surpluses over the next 10 years.

Although in important ways you begin the task of crafting a budget this year
in a very different place than you did last year, in other ways the
responsibilities remain the same. We still have a stewardship obligation to
future generations. By stewardship obligation I mean that in making budget
decisions today, it is important to be mindful of their impact on the
future. This means that in responding to the legitimate needs of today, we
should take into account the longer-term fiscal pressures we face. The
message of GAO's long-term simulations, updated using CBO's new budget
estimates, is consistent with previous simulations: absent change, spending
for federal health and retirement programs eventually overwhelms all other
federal spending.

As we look ahead we face an unprecedented demographic challenge. A nation
that has prided itself on its youth will become older. Between now and 2035,
the number of people who are 65 or over will double. As the share of the
population over 65 climbs, federal spending on the elderly will absorb
larger and ultimately unsustainable shares of the federal budget. Federal
health and retirement spending are expected to surge as people live longer
and spend more time in retirement. In addition, advances in medical
technology are likely to keep pushing up the cost of providing health care.
Moreover, the baby boomers will have left behind fewer workers to support
them in retirement, prompting a slower rate of economic growth from which to
finance these higher costs. Absent substantive change in related entitlement
programs, large deficits return, requiring a combination of unprecedented
spending cuts in other areas,

and/or unprecedented tax increases, and/or substantially increased borrowing
from the public (or correspondingly less debt reduction than would otherwise
have been the case). These trends have widespread implications for our
society, our culture, our economy, and-of most relevance here-our budget.

Ultimately, as this Committee and its counterpart in the House recommended
on October 4,1 the federal government should attempt to return to a position
of surplus as the economy returns to a higher growth path. Returning to
surpluses will take place against the backdrop of greater competition of
claims within the budget. Although budget balance may have been the desired
fiscal position in the past decade, surpluses would promote the level of
savings and investment necessary to help future generations better afford
the commitments of an aging society.

Early action is important. We all recognize that we have urgent matters to
address as a nation and our history shows we have been willing to run
deficits during wars and recessions. However, it remains important that to
get on with the task of addressing the long-term pressures sooner rather
than later. Some will suggest that early action may not be necessary-for
example, that faster economic growth may enable a smaller pool of workers to
more easily finance the baby boom retirement. While this might happen, the
best estimates of the actuaries suggest it is unlikely. CBO has also said
that the nation's long-term fiscal outlook will largely be determined by
federal spending for retirees, especially for health..

Although long-term projections are inherently more uncertain than short-term
forecasts, in some ways we can be surer about the outlook 20 years from now
since it is driven by known demographics. The swing in 1-, 5-, and 10-year
projections over the last 12 months has served to emphasize the extent to
which short-term projections are subject to uncertainty. And CBO notes that
this year the near-term projections are subject to unusual uncertainties as
the nation wages war on terrorism and recovers from a recession. CBO pointed
out that it is considered more difficult to forecast the economy when it is
entering or exiting a recession. This year there are additional
uncertainties in the near-term budget outlook. CBO's reference case-the
baseline-from which you begin your deliberations (and which in the first 10
years is the underpinning for our long-term model) is a

1House and Senate Budget Committees, The Revised Budgetary Outlook and
Principles for Economic Stimulus (Oct. 4, 2001).

representation of current laws and policies. Thus, by definition it does not
account for the effects of future legislation, including likely increases in
spending for defense and homeland security to which both parties have agreed
in principle. Nor, as CBO noted, does it make assumptions about a number of
issues, e.g., the extension of agriculture programs, Medicare prescription
drug coverage, changes in the Alternative Minimum Tax, or the extension of
various expiring tax provisions.

Given this extreme uncertainty around the next 1 to 5 years, why look out 20
or 30 years? Absent some draconian or unexpected dramatic event, the
long-term budget outlook is driven by factors already in motion-most notably
the aging of the population. In previous testimonies before you, I have
talked about a demographic tidal wave. Beginning about 2010, the share of
the population that is age 65 or older will begin to climb, surpassing 20
percent by 2035. (See fig. 1.)

Figure 1: Aged Population as a Share of Total U.S. Population Continues to
Grow

Percent of total population 25

20

15

10

5

0 1950 1975 2000 2025 2050 2075

Note: Projections based on intermediate assumptions of the 2001 Trustees'
reports.

Source: The 2001 Annual Report of the Board of Trustees of the Federal
Old-Age and Survivors Insurance and Disability Insurance Trust Funds.

GAO's Model Simulations Illustrate Long-Term Budget Challenges

Because of the coming demographic shift, the message from our simulations
remains the same as last year, indeed as since we first published results
from our long-term model in 1992: Absent policy change, in the long term,
persistent deficits and escalating debt driven by entitlement spending will
overwhelm the budget. This year we ran three different policy paths to
illustrate the implications of a range of budgetary choices. I'd like to
emphasize again that these simulations are not intended to endorse a
particular policy but rather to illustrate the long-term implications of
different scenarios.

All three scenarios begin with CBO's baseline estimates. The first starts
with the baseline where for the first 10 years tax and entitlement laws are
unchanged-including sunset provisions-and discretionary spending grows with
inflation. After the first 10 years, we hold discretionary spending and
revenues constant as a share of gross domestic product (GDP) and allow
Social Security and Medicare to grow based on the actuaries' intermediate
estimates.2 In this path, the unified surpluses that emerge in 2004 are
saved. Nevertheless, deficits return in 2036. At the other end is an
alternative policy path in which discretionary spending grows with the
economy in the first 10 years and in which last year's tax cuts are
extended. This yields a smaller period of surpluses with deficits returning
in 2011. In both of these paths taxes remain constant as a share of GDP
after 2012; this is, of course, a policy decision. To illustrate something
in between these two paths, we simulated a third that tracks the CBO
baseline until 2010. After 2010 we assume that the full Social Security
surplus is saved through 20243-this requires some combination of tax and
spending policy actions. In this simulation deficits reemerge in 2025. (See
fig. 2.)

2We also assume that all current-law benefits in entitlement programs are
paid in full (i.e., we assume that all promised Social Security and Medicare
benefits are paid including after the projected exhaustion of the respective
trust funds).

3The last year of projected Social Security surpluses (including interest
income) under the 2001 trustees' intermediate estimates. As discussed later
in this testimony, program expenses exceed non-interest income beginning in
2016.

Figure 2: Unified Surpluses and Deficits as a Share of GDP Under Alternative
Fiscal Policy Simulations

Percent of GDP 5

0

-5

-10

-15

-20

2000 2010 2020 2030 2040 2050 2060 2075

Source: GAO's January 2002 analysis.

In all three paths, surpluses eventually give way to large and persistent
deficits. These simulations show that there is a benefit to fiscal
discipline-it delays the return to deficits-but that even the most demanding
path we simulated-a path that does not provide for funding Presidential or
many Congressional initiatives-is structurally imbalanced over the long
term. Although savings from higher surpluses are important, they must be
coupled with action to slow the long-term drivers of projected deficits,
i.e. Social Security and health programs. Surpluses can help-they could, for
example, facilitate the needed reforms by providing resources to ease
transition costs-but, by themselves, surpluses will not be sufficient.

In the long term, under all three paths federal budgetary flexibility
becomes increasingly constrained and eventually disappears. To move into the
future with no changes in federal health and retirement programs is to
envision a very different role for the federal government. Assuming, for
example, that last year's tax reductions are made permanent and
discretionary spending keeps pace with the economy, spending for net
interest, Social Security, Medicare, and Medicaid consumes nearly
three-quarters of federal revenue by 2030, leaving little room for other
federal priorities including defense and education. By 2050, total federal
revenue

is  insufficient  to fund  entitlement  spending  and interest  payments-and
deficits are escalating out of control.4 (See fig. 3.)

Figure 3:  Composition of Spending as a Share  of GDP Assuming Discretionary
Spending Grows with GDP and the Tax Cuts Do Not Sunset

                               Percent of GDP

40

30

20

10 0

                               2000 2030 2050

    Net interest Social Security Medicare & Medicaid All other spending

Source: GAO's January 2002 analysis.

Reducing the relative future burdens of Social Security and federal health
programs is critical to promoting a sustainable budget policy for the longer
term. Absent reform, the impact of federal health and retirement programs on
budget choices will be felt as the baby boom generation begins to retire.
While much of the public debate concerning the Social Security and Medicare
programs focuses on trust fund balances-that is on the programs'
solvency-the larger issue concerns sustainability.

The 2001 Trustees Reports estimate that the Old-Age Survivors Insurance and
Disability Insurance (OASDI) Trust Funds will remain solvent through 2038
and the Hospital Insurance (HI) Trust Fund through 2029.5

4Due to recent changes in methodology as well as updates to underlying
assumptions, simulations presented in this testimony are not comparable to
previously published simulations.

5In the FY 2000 Financial Report of the United States Government, issued in
March 2001, the net present value of the estimated expenditures in excess of
income as of January 1, 2000, was $3.8 trillion for Social Security and $2.7
trillion for Medicare Part A. The 2001 figures will be available at the end
of next month.

Furthermore, because of the nature of federal trust funds, HI and OASDI
Trust Fund balances do not provide meaningful information about program
sustainability-that is, the government's fiscal capacity to pay benefits
when the program's cash income falls below benefit expenses. From this
perspective, the net cash impact of the trust funds on the government as a
whole-not trust fund solvency-is the important measure. Under the trustees'
intermediate assumptions, the OASDI Trust Funds are projected to have a cash
deficit beginning in 2016 and the HI Trust Fund a deficit also beginning in
2016. (See fig. 4.) At that point, the programs become net claimants on the
Treasury. In addition, as we have noted in other testimony,6 a focus on HI
solvency presents an incomplete picture of the Medicare program's expected
future fiscal claims. The Supplementary Medical Insurance (SMI) portion of
Medicare, which is not reflected in the HI solvency measure, is projected to
grow even faster than HI in the near future. According to the best estimates
of the Medicare trustees, Medicare HI and SMI together will double as a
share of GDP between 2000 and 2030 (from 2.2 percent to 4.5 percent) and
reach 8.5 percent of GDP in 2075. Under the trustees' best estimates, Social
Security spending will grow as a share of GDP from 4.2 to 6.5 percent
between 2000 and 2030, reaching 6.7 percent in 2075.

6Medicare: New Spending  Estimates Underscore Need for Reform (GAO-01-1010T,
July 25, 2001).

Figure 4: Social Security and Medicare's Hospital Insurance Trust Funds Face
Cash Deficits as Baby Boomers Retire

                          Billions of 2000 dollars

                               Social Security

200

100 0 -100

-200

-300

-400

-500

-600

2000  2005  2010 2015  2020  2025  2030 2035  2040   Medicare HI  cash flow

Note: Projections based on intermediate assumptions of the 2001 OASDI and HI
reports.

Source: GAO analysis of data from the Office of the Chief Actuary, Social
Security Administration and the Office of the Actuary, Health Care Financing
Administration.

To finance these cash deficits, Social Security and the Hospital Insurance
portion of Medicare will need to draw on their special issue Treasury
securities acquired during the years when these programs generated cash
surpluses. This negative cash flow will placed increased pressure on the
federal budget to raise the resources necessary to meet the program's
ongoing costs. In essence, for OASDI or HI to "redeem" their securities, the
government will need to obtain cash through increased taxes, and/or spending
cuts, and/or increased borrowing from the public (or correspondingly less
debt reduction than would have been the case had cash flow remained
positive).

Our long-term simulations illustrate the magnitude of the fiscal challenges
associated with an aging society and the significance of the related
challenges the government will be called upon to address. As we have stated
elsewhere,7 early action to change these programs would yield the

7Major Management Challenges and Program Risks: A Governmentwide Perspective
(GAO-01-241, January 2001), p. 45.

The Need to Reexamine Government Activities and Programs

highest fiscal dividends for the federal budget and would provide a longer
period for prospective beneficiaries to make adjustments in their own
planning. Waiting to build economic resources and reform future claims
entails risks. First, we lose an important window where today's relatively
large workforce can increase saving and enhance productivity, two elements
critical to growing the future economy. We lose the opportunity to reduce
the burden of interest in the federal budget, thereby creating a legacy of
higher debt as well as elderly entitlement spending for the relatively
smaller workforce of the future. Most critically, we risk losing the
opportunity to phase in changes gradually so that all can make the
adjustments needed in private and public plans to accommodate this historic
shift. Unfortunately, the long-range challenge has become more difficult,
and the window of opportunity to address the entitlement challenge is
narrowing. It remains more important than ever to return to these issues
over the next several years. Ultimately, the critical question is not how
much a trust fund has in assets, but whether the government as a whole can
afford the promised benefits now and in the future and at what cost to other
claims on scarce resources.

One of the reasons to address these longer-term pressures is their potential
to crowd out the capacity to support other important priorities throughout
the rest of the budget. The tragedy of September 11 made us all realize the
benefits fiscal flexibility provides to our nation's capacity to respond to
urgent and newly emergent needs. Obviously we will allocate whatever
resources are necessary to protect the nation. However, these new
commitments will compete with and increase the pressure on other priorities
within the budget. Financing these compelling new claims within an overall
fiscal framework that eventually returns the budget to surplus is a tall
order indeed.

The budget process is the one place where we as a nation can conduct a
healthy debate about competing claims and new priorities. However, such a
debate will be needlessly constrained if only new proposals and activities
are on the table. A fundamental review of existing programs and operations
can create much-needed fiscal flexibility to address emerging needs by
weeding out programs that have proven to be outdated, poorly targeted, or
inefficient in their design and management. It is always easier to subject
proposals for new activities or programs to greater scrutiny than that given
to existing ones. It is easy to treat existing activities as "given" and
force new proposals to compete only with each other. Such an approach would
move us further, rather than nearer, to budgetary surpluses.

Moreover, it is healthy for the nation periodically to review and update its
programs, activities and priorities. As we have discussed previously,8 many
programs were designed years ago to respond to earlier challenges. In the
early years of a new century, we have been reminded how much things have
changed. For perspective, students who started college this past fall were 9
years old when the Soviet Union broke apart and have no memory of the Cold
War; their lifetimes have always known microcomputers and AIDS. In previous
testimony,9 both before this Committee and elsewhere, I noted that it should
be the norm to reconsider the relevance or "fit" of any federal program or
activity in today's world and for the future. Such a review might weed out
programs that have proven to be outdated or persistently ineffective, or
alternatively could prompt us to update and modernize activities through
such actions as improving program targeting and efficiency, consolidation,
or reengineering of processes and operations. Ultimately, we should strive
to hand to the next generations the legacy of a government that is effective
and relevant to a changing society-a government that is as free as possible
of outmoded commitments and operations that can inappropriately encumber the
future. We need to think about what government should do in the 21st century
and how it should do business.

The events of last fall have provided an impetus for some agencies to
rethink approaches to long-standing problems and concerns. In particular,
agencies will need to reassess their strategic goals and priorities to
enable them to better target available resources to address urgent national
preparedness needs. For instance, the threat to air travel has already
prompted attention to chronic problems with airport security that we and
others have been pointing to for years. Moreover, the crisis might prompt a
healthy reassessment of the broader transportation policy framework with an
eye to improving the integration of air, rail, and highway systems to better
move people and goods.

Other long-standing problems also take on increased relevance in today's
world. Take, for example, food safety. Problems such as overlapping and

8Budget Issues: Effective Oversight and Budget Discipline are Essential-Even
in a Time of Surplus (GAO/T-AIMD-00-73, Feb. 1, 2000).

9Homeland Security: Challenges and Strategies in Addressing Short- and
Long-Term National Needs (GAO-02-160T, Nov. 7, 2001) and Budget Issues:
Effective Oversight and Budget Discipline are Essential-Even in a Time of
Surplus (GAO/T-AIMD-00-73, Feb. 1, 2000).

duplicative inspections across many federal agencies, poor coordination, and
inefficient allocations of resources are not new and have hampered
productivity and safety for years. However, they take on new meaning and
urgency given the potential threat from bioterrorism. We have argued for a
consolidated food safety initiative merging the separate programs of the
multiple federal agencies involved. Such a consolidated approach can
facilitate a concerted and effective response to the new threats.

The federal role in law enforcement is another area that is ripe for
reexamination following the events of September 11. In the past 20 years,
the federal government has taken on a larger role in financing criminal
justice activities that have traditionally been viewed as the province of
the state and local sector. This is reflected in the growth of the federal
share of financing-from 12 percent in 1982 to nearly 20 percent in 1999.

Given the new daunting new law enforcement responsibilities in the wake of
September 11 and limited budgetary resources at all levels, the question is
whether these additional responsibilities should prompt us to rethink the
priorities and roles of federal, state, and local levels of government in
the criminal justice area and ultimately whether some activities are
affordable in this new setting. The Federal Bureau of Investigation has
already begun thinking about reprioritization and how its investigative
resources will shift, given the new challenges posed by the terrorism
threat.

With the Coast Guard's focus on homeland security, it has de-emphasized some
of its other critical missions in the short term, most notably fisheries
enforcement and drug and migrant interdiction. The Coast Guard is currently
developing a longer-term mission strategy, although it has no plans at
present to revise the schedule or asset mix for its Deepwater Project (which
will be awarded mid-2002).

In rethinking federal missions and strategies, it is important to examine
not only spending programs but the wide range of other more indirect tools
of governance the federal government uses to address national objectives.
These tools include loans and loan guarantees, tax expenditures, and
regulations. For instance, in fiscal year 2000, the federal health care and
Medicare budget functions include $37 billion in discretionary budget
authority, $319 billion in entitlement outlays, $5 million in loan
guarantees, and $91 billion in tax expenditures.

The outcomes achieved by these various tools are in a very real sense highly
interdependent and are predicated on the response by a wide range

of third parties, such as states and localities and private employers, whose
involvement has become more critical to the implementation of these federal
initiatives. The choice and design of these tools is critical in determining
whether and how federal objectives will be addressed by these third parties.
Any review of the base of existing policy should address this broader
picture of federal involvement.

GAO has also identified a number of areas warranting reconsideration based
on program performance, targeting, and costs. Every year, we issue a report
identifying specific options, many scored by CBO, for congressional
consideration stemming from our audit and evaluation work.10 This report
provides opportunities for (1) reassessing objectives of specific federal
programs, (2) improved targeting of benefits, and (3) improving the
efficiency and management of federal initiatives.

Just as long-standing areas of federal involvement need re-examination, so
proposed new initiatives designed to address the new terrorism threat need
appropriate review. With the focus on counterterrorism, you will undoubtedly
face many proposals redefined as counterterrorism activities. The Congress
will need to watch for the redefinition of many claims into counterterrorism
activities. It will be especially important to seek to distinguish among
these claims.

In sorting through these proposals, we might apply investment criteria in
making choices. Well-chosen enhancements to the nation's infrastructure are
an important part of our national preparedness strategy. Investments in
human capital for certain areas such as public health or airport security
will also be necessary as well to foster and maintain the skill sets needed
to respond to the threats facing us. A variety of governmental tools will be
proposed to address these challenges-grants, loans, tax expenditures, and/or
direct federal administration. The involvement of a wide range of third
parties-state and local governments, nonprofits, private corporations, and
even other nations-will be a vital part of the national response as well.

In the short term, we will do whatever is necessary to get this nation back
on its feet and compassionately deal with the human tragedies left in its
wake. However, as we think about our longer-term preparedness and

10Supporting  Congressional Oversight:  Framework for Considering  Budgetary
Implications of Selected GAO Work (GAO-01-447, March 9, 2001).

Budget Process Should Facilitate Discipline and Awareness of Long-Term
Implications of Decisions

develop a comprehensive homeland security strategy, we can and should select
those programs and tools that promise to provide the most cost-effective
approaches to achieve our goals.

Today the Congress faces the challenge of sorting out these many claims on
the federal budget without the fiscal benchmarks and rules that served as
guides through the years of deficit reduction. Going forward, new rules and
goals will be important both to ensure fiscal discipline as we sort through
these new and compelling claims and to prompt policymakers to focus on the
longer-term implications of current policies and programs. For more than a
decade, budget process adaptations have been designed to reach a zero
deficit. With the advent of surpluses, a new framework was needed-one that
would permit accommodating pent-up demands but not eliminate all controls. A
broad consensus seemed to develop to use saving the Social Security surplus
or maintaining on-budget balance as a kind of benchmark. However, the
combination of the economic slowdown and the need to respond to the events
of September 11 has overtaken that measure.

Once again, Congress faces the challenge of designing a budget control
mechanism. Last October, Mr. Chairman, you and your colleague Senator
Domenici and your House counterparts called for a return to budget surplus
as a fiscal goal. This remains an important fiscal goal, but achieving it
will not be easy. In the near term, limits on discretionary spending may be
necessary to prompt the kind of reexamination of the base I discussed above.
There are no easy choices. There will be disagreements about the merits of a
given activity-reasonable people can disagree about federal priorities.
There may also be disagreements about the appropriate response to program
failure: Should the program be modified or terminated? Would the program
work better with more money or should funding be cut? Spending limits can be
used to force choices; they are more likely to do so, however, if they are
set at levels viewed as reasonable by those who must comply with them.

Spending limits alone cannot force a reexamination of existing programs and
activities. However, the recognition that for most agencies the new
responsibilities acquired since September 11 cannot merely be added to
existing duties requires that decisions be made about priorities. In the
last decade Congress and the Administration put in place a set of laws
designed to improve information about cost and performance. This information
can help inform the debate about what the federal government should do. In
addition, the budget debate can benefit from the

kind of framework I discussed above. In previous testimony before this
committee, I suggested that Congress might equip itself to engage in this
debate by developing a congressional performance resolution to target its
oversight on certain governmentwide performance issues cutting across
agencies and programs.11 Along with caps, this and other measures might help
ensure that Congress becomes part of the debate over reprioritization and
government performance.

The dramatic shift in budget projections since last year has prompted
discussion of shortening the budget window. This may well be a sensible
approach to reducing uncertainty. However, such a change should be coupled
with steps to provide a broader and longer-term fiscal horizon: goals and
metrics to address the longer-term implications of today's choices. This
does not mean that we should budget for a 20-or 30-year period. It does mean
considering establishing indicators and targets that bring a long-term
perspective to budget deliberations and a process that prompts attention to
the long-term implications of today's decisions. Periodic simulations along
the lines we and CBO have developed can and should become a regular feature
of budget debate. We would be the first to say that the simulations are not
predictions of the future or point estimates, rather they serve as
indicators-or warning lights-about the magnitude and direction of different
policy profiles. These scenarios are particularly helpful in comparing
long-term consequences of different fiscal paths or major reforms of
entitlements using the same assumptions. As I said earlier, the demographic
tidal wave that drives the long-term budget challenge is a known element
with predictable consequences.

Some kind of fiscal targets may be helpful. As a way to frame the debate,
targets can remind us that today's decisions are not only about current
needs but also about how fiscal policy affects the choices over the longer
term. Other nations have found it useful to embrace broader targets such as
debt-to-GDP ratios, or surpluses equal to a percent of GDP over the business
cycle. To work over time targets should not be rigid-it is in the nature of
things that they will sometimes be missed. It should be possible to make
some sort of compelling argument for the target-and it should be relatively
simple to explain. Reaching a target is not a straight line but an iterative
process. The other nations we have studied have found that targets prompted
them to take advantage of windows of opportunity to

11  Budget  Issues:   Effective   Oversight  and   Budget  Discipline   Are
Essential-Even in a Time of Surplus (GAO/T-AIMD-00-73, Feb. 1, 2000).

save for the future and that decisionmakers must have flexibility each year
to weigh pressing short-term needs and adjust the fiscal path without
abandoning the longer-term framework.

In re-examining what I have called the "drivers" of the long-term budget, we
need to think about new metrics. We have been locked into the artifacts of
the trust funds, which do not serve as appropriate signals for timely action
to address the growth in these programs. As I mentioned earlier, trust fund
solvency does not answer the question of whether a program is sustainable.

Although aggregate simulations are driven by these programs, the need for a
longer-term focus is about more than Social Security and Medicare. In recent
years there has been an increased recognition of the long-term costs of
Social Security and Medicare. While these are the largest and most important
long-term commitments-and the ones that drive the long-term outlook-they are
not the only ones in the budget that affect future fiscal flexibility. For
Congress, the President, and the public to make informed decisions about
these other programs, it is important to understand their long-term cost
implications. A longer time horizon is useful not only at the macro level
but also at the micro-policy level. I am not suggesting that detailed budget
estimates could be made for all programs with long-term cost implications.
However, better information on the long-term costs of commitments like
employee pension and health benefits and environmental cleanup could be made
available. Here again, new concepts and metrics may be useful. We have been
developing the concept of "fiscal exposures" to represent a range of federal
commitments-from explicit liabilities to implicit commitments. Exactly how
such information would be incorporated into the budget debate would need to
be worked out-but it is worth serious examination.

Conclusion In one sense much has changed in the budget world since last
February. There are even more compelling needs and demands on the federal
budget than a year ago-and policymakers must deal with them absent the
surpluses that were projected then. However, the demographic trends that
drive the long-term outlook have not changed. The baby boom generation is
still getting older and closer to retirement. Because of the coming
demographic shift, the message from our simulations remains the same as last
year, indeed as since we first published results from our long-term model in
1992: Absent changes in Social Security and health programs, in the long
term, persistent deficits and escalating debt driven by entitlement spending
will overwhelm the budget.

The events of September 11 highlighted the benefits of fiscal flexibility.
Addressing the long-term drivers in the budget is essential to preserving
any flexibility in the long term. In the nearer term a fundamental review of
existing programs and operations can create much-needed fiscal flexibility
to address emerging needs by weeding out programs that have proven to be
outdated, poorly targeted, or inefficient in their design and management.

Congress and the President stand at a point where current needs and wants
must be balanced against known long-term pressures. And you face the
challenge of sorting out these many claims on the federal budget without the
fiscal benchmarks and rules that guided us through the years of deficit
reduction into surplus. Going forward, new rules and goals will be important
both to ensure fiscal discipline and to prompt a focus on the longer-term
implications of decisions. It is still the case that the federal government
needs a decision-making framework that permits it to evaluate choices
against both today's needs and the longer-term fiscal future that will be
handed to future generations. As stewards of our nation's future, we must
begin to prepare for tomorrow. In this regard, we must determine how best to
address these structural challenges in a reasonably timely manner in order
to identify specific actions that need to be taken.

None of this is easy. We at GAO stand ready to assist you.
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