Fiscal Exposures: Improving the Budgetary Focus on Long-Term	 
Costs and Uncertainties (24-JAN-03, GAO-03-213).		 
                                                                 
GAO and other budget experts have discussed that the current time
horizons and content of the federal budget could be enhanced to  
more comprehensively reflect the government's commitments or	 
signal emerging problems. GAO was asked to (1) provide		 
information on the range and nature of responsibilities,	 
programs, and activities that may explicitly or implicitly expose
the government to future spending and (2) present and discuss	 
options for increasing the attention paid to these items in the  
budget and budget process. GAO recommends that OMB report	 
annually on fiscal exposures. Where possible, OMB should report  
the estimated costs-"exposure level"-of certain activities in the
Program and Financing schedules of the budget. In a few select	 
areas, the ultimate objective might be to include costs directly 
in the budget when doing so would enhance up-front control of	 
spending. Congress may wish to consider exploring options for	 
improving the budgetary information and the attention given to	 
fiscal exposures. If more explicit congressional consideration is
desired, as estimates improve, Congress may wish to develop	 
budget process mechanisms that prompt more deliberation.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-213 					        
    ACCNO:   A05946						        
  TITLE:     Fiscal Exposures: Improving the Budgetary Focus on       
Long-Term Costs and Uncertainties				 
     DATE:   01/24/2003 
  SUBJECT:   Budget authority					 
	     Budget obligations 				 
	     Congressional budgets				 
	     Cost analysis					 
	     Financial management				 
	     Fiscal policies					 
	     Future budget projections				 
	     Presidential budgets				 
	     Social security taxes				 
	     Medicaid Program					 
	     Medicare Program					 
	     Social Security Program				 

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GAO-03-213

a

GAO United States General Accounting Office

Report to the Chairman, Committee on the Budget, House of Representatives

January 2003 FISCAL EXPOSURES Improving the Budgetary Focus on Long- Term
Costs and Uncertainties

GAO- 03- 213

The federal government undertakes a wide range of responsibilities,
programs, and activities that may either obligate the government to future
spending or simply create an expectation for spending. GAO uses the
concept of *fiscal exposure* (risk) to provide a framework to consider
these long- term costs and uncertainties.

Fiscal exposures vary widely as to source, extent of the government*s
legal obligation, likelihood of occurrence, and magnitude. These exposures
include items such as retirement benefits, environmental cleanup costs,
and future social insurance benefits. Given this variety, it is useful to
think of a spectrum extending from explicit liabilities to implicit
promises embedded in current policy or public expectations.

Fiscal exposures warrant budgetary attention and oversight. Demographic
trends, in particular, argue for considering the long- term sustainability
and flexibility of the government*s fiscal position. Regardless of whether
the government is legally required or simply compelled by circumstances,
some exposures may encumber future budgets and constrain fiscal policy.
Not capturing the long- term costs of current decisions limits Congress*s
ability to control the government*s fiscal exposures at the time decisions
are made.

Current budget reporting, however, does not always fully capture or
require explicit consideration of some fiscal exposures. For some
exposures, such as environmental cleanup costs, the government*s
commitment occurs years before the cash consequences are reflected in the
budget. Other potential draws on future resources, such as life- cycle
costs for fixed assets and disaster assistance, may not flow from
commitments of a strictly legal nature but from public expectations.

Determining how to improve the budgetary attention to fiscal exposures is
complicated by difficulties in (1) determining the scope of items to be
considered and (2) estimating costs. The variety of fiscal exposures and
the difficulties in estimating their costs suggest that an across- the-
board approach may not be the best way to proceed. Improved supplemental
information may be helpful to increase transparency without introducing
additional uncertainty and complexities into the budget. In cases where
the extent of the government*s obligation or ultimate costs (or both) is
unclear, supplemental reporting may be the most appropriate approach.
Beyond increasing supplemental reporting, providing more opportunities to
consider fiscal exposures in the budget process may help facilitate
explicit consideration of certain exposures. Finally, in some cases where
there is an

explicit liability and accepted, reasonable cost estimates exist,
additional steps may be taken to directly incorporate costs in the budget
when doing so would enhance up- front control of spending.

FISCAL EXPOSURES

Improving the Budgetary Focus on LongTerm Costs and Uncertainties

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 213. To view the full report,
including the scope and methodology, click on the link above. For more
information, contact Paul Posner at (202) 512- 9573 or posnerp@ gao. gov.
Highlights of GAO- 03- 213, a report to the

Committee on the Budget, House of Representatives

January 2003

GAO and other budget experts have discussed that the current time horizons
and content of the federal budget could be enhanced to more
comprehensively reflect

the government*s commitments or signal emerging problems. GAO was asked to
(1) provide information on the range and nature of responsibilities,
programs, and activities that may explicitly or implicitly expose the
government to future spending and

(2) present and discuss options for increasing the attention paid to these
items in the budget and

budget process. GAO recommends that OMB report annually on fiscal
exposures. Where possible, OMB should report the estimated costs**
exposure level** of certain activities in the

Program and Financing schedules of the budget. In a few select areas, the
ultimate objective might be to include costs directly in the budget when
doing so would enhance up-

front control of spending. Congress may wish to consider exploring options
for improving the budgetary information and the attention given to fiscal
exposures. If more explicit congressional consideration is desired, as
estimates improve, Congress may wish to develop budget process mechanisms
that prompt more deliberation.

Page i GAO- 03- 213 Fiscal Exposures

Contents Letter 1

Results In Brief 1 Background 7 Objectives, Scope, and Methodology 9
Fiscal Exposure Could Be Considered on Several Levels 12 Fiscal Exposures
are Wide- Ranging and Varied 14 Fiscal Exposures Involve Complex
Measurement and Budgeting

Challenges 24 Diversity of Fiscal Exposures Suggests that Tailored
Approaches

Would Be More Feasible than an Across- the- Board Approach 27 Conclusion
41 Recommendations for Executive Action 43 Matters for Congressional
Consideration 43 Agency Comments and Our Evaluation 43

Figures Figure 1: Composition of Spending as a Share of GDP Assuming
Discretionary Spending Grows with GDP and the Tax

Cuts Do Not Sunset 8 Figure 2: Spectrum of Fiscal Exposures 15 Figure 3:
Social Security, Medicare, and Medicaid Spending as a

Percent of Gross Domestic Product 20 Figure 4: Overview of Possible
Approaches 27 Figure 5: Possible Options For Improving Supplemental
Reporting

29 Figure 6: Possible Options for Providing Opportunities For

Explicit Consideration of Fiscal Exposures 33 Figure 7: Possible Options
for Incorporating Costs Directly into the

Primary Budget Data 37

Abbreviations

CBO Congressional Budget Office DOD Department of Defense GDP gross
domestic product OMB Office of Management and Budget

Contents

Page ii GAO- 03- 213 Fiscal Exposures

This is a work of the U. S. Government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. It may contain
copyrighted graphics, images or other materials. Permission from the
copyright holder may be necessary should you wish to reproduce copyrighted
materials separately from GAO*s product.

Page 1 GAO- 03- 213 Fiscal Exposures United States General Accounting
Office

Washington, D. C. 20548 Page 1 GAO- 03- 213 Fiscal Exposures

A

January 24, 2003 Letter

The Honorable Jim Nussle Chairman Committee on the Budget House of
Representatives

Dear Mr. Chairman, As the central process by which the President and
Congress select among competing demands for federal funds, the budget
should provide complete cost information and adequate signals about
emerging problems. For many programs, the current budget does this. It
does not, however, always help policymakers consider the long- term costs
associated with some activities

that explicitly or implicitly commit the government to future spending or
otherwise affect the long- term fiscal outlook of the nation. This may
limit the attention given to the future sustainability and flexibility of
the government*s fiscal position and the cost effectiveness of existing
programs.

You requested that we: (1) provide information on the range and nature of
certain responsibilities, programs, and activities that may explicitly or
implicitly expose the government to future spending and (2) present and

discuss options for increasing attention paid to these items in the budget
and the budget process. As discussed with your staff, this report covers a
number of issues surrounding long- term costs and uncertainties that
present risk for the fiscal future, including

 the concept and different dimensions of fiscal exposures (risks)  the
range and nature of specific fiscal exposures facing the federal
government  the complexities and challenges surrounding cost measurement
and budgeting for fiscal exposures and

 approaches for increasing the attention given to fiscal exposures in the
budget and the budget process.

Results In Brief The federal government undertakes a wide range of
responsibilities, programs, and activities that may either obligate the
government to future

Page 2 GAO- 03- 213 Fiscal Exposures

spending or create an expectation for spending. In particular, demographic
trends facing the nation argue for considering the long- term
sustainability and flexibility of the government*s fiscal position.
Profound demographic changes, with the impending retirement of the baby
boom generation, will have significant implications not only for the
Social Security, Medicare, and Medicaid programs but also for the budget
and the economy as a whole.

The approaching demographic tidal wave also serves to reinforce the
importance of looking beyond short- term budgetary consequences. The
savings and loan crisis in the 1980s and the resulting multibillion dollar
bailout serve as a vivid reminder of the shortcomings and consequences
when the federal budget does not adequately signal emerging problems.
Current budget reporting, however, is not designed to promote the

recognition and explicit consideration of some of these exposures. For
some claims, such as environmental cleanup and disposal costs, the
government*s commitment occurs years before the cash consequences are
reflected in the budget. Other potential draws on future resources, such
as future social insurance benefits or disaster assistance, may not flow
from commitments of a strictly legal nature but from expectations that the
public holds about the government*s responsibilities. For example, while
the federal budget shows annual Social Security tax receipts exceeding
annual cash benefit payments, the fiscal year 2001 consolidated Financial
Report of the United States Government estimates the net present value of

Social Security*s negative cash flow over a 75- year period as $4.2
trillion. 1 Concerns have been raised that such potential draws on future
federal resources extending beyond current budget time frames may not be
readily apparent in current budget reporting and process.

Policy choices that may have significant implications for long- term
budget flexibility and for which future growth paths are uncertain can
affect either spending or revenue; thus, fiscal exposures could be thought
of on several levels. Aggregate projections of the cost of the
government*s current programs and policies provide important context for
decision making. This construct, however, may be too broad to highlight
specific areas for reform. To help address this concern, this report looks
below the aggregate level on

1 Net present value of the negative cash flow is the current amount of
funds needed to cover projected shortfalls, excluding trust fund balances,
over a 75- year period. The trust fund balance at the beginning of the
valuation period (January 1, 2001) was $1,049 billion. The net present
value of negative cash flows shown in this report is from the fiscal year
2001 consolidated Financial Report of the United States Government and is
a different measure from the actuarial balance in the Trustees* Report.

Page 3 GAO- 03- 213 Fiscal Exposures

the spending side to provide insights on the range and nature of specific
fiscal exposures.

In this report, we use the term *fiscal exposure* to provide a conceptual
framework for considering the wide range of responsibilities, programs,
and activities that may explicitly or implicitly expose the federal
government to future spending. The budget treatment of items that could be
considered fiscal exposures varies* some have been captured in budget
obligations and some have not. Fiscal exposures include not only
liabilities, 2 contingencies, 3 and financial commitments 4 that are
identified on the balance sheet or in the accompanying notes, but also

responsibilities and expectations for government spending that do not meet
the recognition and disclosure requirements for that statement. We use the
term implicit exposures in this report to refer to exposures that

stem not from a legal obligation of the federal government but rather from
implied commitments embedded in the government*s current policies or in
the public*s expectations about the role of government. 5

Fiscal exposures vary widely as to source, extent of the government*s
legal obligation, likelihood of occurrence, and magnitude. Their ultimate
costs may or may not be measurable. Given this variety, it is useful to
think of fiscal exposures as falling on a spectrum extending from explicit
liabilities

2 For financial statement reporting, a liability represents a probable and
measurable future outflow of resources arising from past transactions or
events. A liability is recorded on the face of the balance sheet when an
item is identifiable, its occurrence is probable, and its cost can be
reasonably estimated.

3 For financial statement reporting, a contingency is an existing
condition, situation, or set of circumstances involving uncertainty as to
possible gains or losses. The uncertainty will ultimately be resolved when
one or more future events occur or fail to occur. Contingencies are
disclosed in the notes of the financial statements if any of the
conditions for liability recognition are not met and there is at least a
reasonable possibility that a loss may have been incurred. Contingencies
that are classified as remote are not required to be disclosed.

4 For financial statement reporting, financial commitments refer to
contractual obligations that require the future use of resources. For
example, although a liability generally is not recognized on the balance
sheet when a contract is signed because the contracted goods or services
have not been delivered, this transaction may be recognized as a
commitment in the notes. In contrast, budgetary accounting would record
obligations at the time the government enters into a contract and allows
for deobligation if the contract is not fulfilled. Budgetary accounting
records obligations when an order is placed, contract awarded,

service rendered, or similar transaction takes place that will require
payment. 5 Some of these implicit exposures, such as the costs of future
social insurance benefits, are discussed in the stewardship section of the
government*s consolidated financial statement.

Page 4 GAO- 03- 213 Fiscal Exposures

to the implicit promises embedded in current policy or public
expectations. Some, such as environmental cleanup and disposal costs and
postretirement benefits, are reported in the financial statements as
liabilities. Some are reported as financial commitments* such as
contracted goods or services that have not yet been delivered* or
contingencies* such as insurance* that depend on future events. Others,
such as future social insurance benefits, are not explicitly stated or
reported as liabilities but rather are implied by current decisions or
public

expectations about the role of government and shown as stewardship
responsibilities. The budgetary treatment of these items varies* some have
been included in the budget and some have not. Some liabilities reported
on the financial statements, such as accounts payable and loan guarantees,
are included in the budget because agencies must have budget authority to
cover them. Others, such as environmental and disposal liabilities, are
not included in

primary budget data 6 beyond the amount for current cleanup activities.
Some implicit exposures, such as the cost of future Social Security
benefits, are not included in primary budget data for the budget year but
are captured in long- range budget projections. Other implicit exposures,
such as the risk assumed by insurance programs, may not be captured in
either primary budget data or in long- range budget projections.

This variety increases the difficulty of determining how and to what
extent fiscal exposures should be handled in the budget and budget
process. Specifically, budgeting for fiscal exposures is complicated by
difficulties in (1) determining the scope of programs that should be
considered and (2) estimating costs. There is no technical definition of
fiscal exposures and no universal agreement on which and to what extent
specific activities should be considered fiscal exposures or how they
should be treated in the budget and budget process. Further, the
complexity and uncertainty surrounding some exposures creates significant
cost estimation challenges, which in turn raises concerns about using
these estimates as the sole basis of budget and other policy decisions.
These issues need to be considered carefully to avoid subjecting the
primary budget data to large

and volatile reestimates. Nevertheless, information on the existence and
estimated cost of fiscal exposures needs to be considered along with other
factors when making policy decisions. Not capturing the long- term costs
of 6 In this report, primary budget data refers to budget authority,
obligations, outlays, and the

deficit/ surplus.

Page 5 GAO- 03- 213 Fiscal Exposures

current decisions limits Congress*s ability to control the government*s
exposure at the time decisions are made. The variety of fiscal exposures,
the difficulties in estimating their costs, and the range of uncertainty
surrounding such cost estimates suggest that an across- the- board
approach may not be the best way to proceed and that approaches may evolve
over time. A framework organized around possible objectives can facilitate
consideration and analysis of various approaches to help improve the
attention given to fiscal exposures. The three possible objectives used to
structure this analysis are (1) improving transparency, (2) prompting more
deliberation, and (3) improving budget incentives. If the primary
objective is to improve the transparency of fiscal exposures,

then supplemental reporting would help promote this objective. One option
for increased supplemental reporting would be to require, on an annual
basis, a report on fiscal exposures. Another option would be to report,
where appropriate, the future estimated costs of certain exposures as a
new budget concept** exposure level** as a notational item in the Program
and Financing schedule of the President*s budget. If, however, the primary
objective is to prompt more explicit deliberation of exposures, then
budget process mechanisms could be designed to provide opportunities for
such consideration* especially as the amount and quality of cost
information is improved over time. For example, as more information on
costs is provided, the budget resolution could include limits on creating
new or expanding existing exposures, with points of order permitted
against legislation violating such limits. Another option would be to
establish triggers to signal when the costs of existing exposures exceed
some predetermined amount. Any process mechanisms* whether points of order
or triggers* would need to take into account the uncertainty inherent in
all long- range estimates and be designed accordingly. Finally, if the
primary objective is to change budgetary incentives, then estimates of the
future costs of exposures might be included directly into the primary
budget data. For example, accrual- based measurement could be used to
record estimated costs when doing so

would enhance obligations- based control by recognizing costs up front at
the time decisions are made that might encumber future resources. The
general approaches outlined and the various options for implementing them
achieve the three objectives to differing degrees and also vary in the

implementation challenges they present. We are recommending that the
Office of Management and Budget (OMB) report annually on fiscal exposures,
including a concise list and description

Page 6 GAO- 03- 213 Fiscal Exposures

of such exposures, cost estimates, where possible, and an assessment of
methodologies and data used to produce cost estimates for such exposures.
In addition, where possible, OMB should report the estimated costs
associated with certain exposures as a new budget concept* *exposure
level** as a notational item in the Program and Financing schedule of the
President*s budget. For select areas where an explicit liability exists
and there are accepted cost estimation methodologies, the ultimate
objective might be to include the accrual costs directly in the primary
budget data when doing so would enhance obligation- based control. These
steps should complement and support continued and improved reporting of
long- range projections and analysis of the budget as

a whole to assess fiscal sustainability and flexibility. If more explicit
congressional consideration of the potential costs of certain exposures is
desired, Congress may wish, as estimates improve over time, to develop
budget process mechanisms that prompt more deliberation about fiscal
exposures while recognizing the uncertainty inherent in estimating some
long- term costs.

Page 7 GAO- 03- 213 Fiscal Exposures

Background A primary focus of current federal budget reporting is the cash
implications of the government*s obligations over a period of 1 to 10
years. The federal budget is an obligation- based budget designed to
ensure that agencies do not incur legal obligations unless and until
Congress provides authority for

that purpose. Obligation- based budgeting involves three stages (1)
Congress must enact budget authority up front before government officials
can obligate the government to make outlays, (2) government officials
commit the government to make outlays by entering into legally binding
agreements, and (3) outlays (cash disbursements) are made to liquidate
obligations. However, with limited exceptions, 7 the amounts to be
obligated are measured on a cash or cash equivalent basis and the unified
budget deficit/ surplus 8 *a key focus of the policy debate* represents
the difference between cash receipts and cash outlays in a given year. As
a result, the U. S. budget is often referred to as cash- based as well as

obligation- based. For many programs, the cash- and obligation- based
budget provides sufficient information on and control over the
government*s spending commitments. However, this focus does not require
explicit consideration of some responsibilities, programs, or activities
that may result in future

spending. For some programs, obligations and cash outlays do not reflect
the magnitude of the government*s commitment of future resources at the
time decisions are being made. We and other federal budget experts have
raised concerns that, in these cases, the current budget may neither
adequately reflect the extent of the government*s commitment nor signal
emerging problems.

Demographic trends facing the United States argue for considering the
long- term sustainability and flexibility of the government*s fiscal
position. Profound demographic changes with the impending retirement of
the baby

7 The U. S. budget uses accrual measures to recognize the government*s
cost for certain programs. One example is the treatment of credit programs
for which budget authority, obligations, and outlays are measured on an
accrual basis. Interest on Treasury debt held by

the public is almost entirely on an accrual basis. 8 Under the budget
concepts set forth in the Report of the President*s Commission on Budget
Concepts, the unified budget is a comprehensive budget in which receipts
and outlays from federal and trust funds are consolidated. When these fund
groups are consolidated to display budget totals, transactions that are
outlays of one fund group for payment to another fund group (that is,
intrafund transactions) are deducted to avoid

double counting.

Page 8 GAO- 03- 213 Fiscal Exposures

boom generation will have significant implications not only for the Social
Security, Medicare, and Medicaid programs but also for the budget and the
economy as a whole. The share of the population that is age 65 or older is
climbing and is expected to surpass 20 percent by 2035. Our recent
simulations show that absent policy changes, social insurance and health
programs will encumber an increasing share of the government*s resources,
thus restricting fiscal flexibility to address other needs. As

shown in figure 1, our long- term budget simulations show that the aging
of the baby boom generation and rising per capita health care spending
will, absent meaningful reform, lead to massive fiscal challenges in
future years. Assuming, for example, that recent tax reductions are made
permanent and discretionary spending keeps pace with the economy, by
midcentury, federal revenues may only be adequate to pay Social Security
and interest on the federal debt. As a result, major spending reductions,
tax increases, or some combination of the two would be necessary to obtain
balance. Figure 1: Composition of Spending as a Share of GDP Assuming
Discretionary

Spending Grows with GDP and the Tax Cuts Do Not Sunset 0 10

20 30

40 2000 2015 2030 2050 Fiscal year Percent of GDP

Net interest Social Security

Medicare and Medicaid All other spending

Revenue

Source: GAO's August 2002 analysis.

Page 9 GAO- 03- 213 Fiscal Exposures

One need not look only to implications of the demographic shift to see the
disconnection between how some exposures appear in the budget in the short
term and the long term. The savings and loan crisis and the resulting
bailout serve as a vivid reminder of the shortcomings of the federal
budget in signaling emerging problems. During the 1980s, as hundreds of
institutions became insolvent and the government*s liabilities mounted,
the federal budget failed to provide timely information on the rising
deposit insurance costs accruing to the government. Although we and some
industry analysts raised concerns about these rapidly increasing deposit
insurance costs, corrective action was delayed and the government*s total
costs increased. Since the federal budget did not record outlays until the
institutions were closed and depositors paid, it provided little incentive
to act promptly. Indeed, budget treatment may have created incentives to
delay closing insolvent institutions, which raised the government*s
ultimate costs. Delayed budget recognition obscured the program*s, as well
as the government*s, underlying financial condition and limited the
usefulness of the budget process as a means for Congress to assess the
problem.

Recent performance reforms also reinforce the need for full cost
information to assess and manage program performance. These reforms
emphasize the need for complete cost information* not just cash flows* to
assess and manage performance. However, for some activities, such as
deferred compensation, the current budgetary focus on annual cash flows

does not match full costs with the goods and services provided by the
government. By making it more difficult to assess and compare the costs
associated with a given level of performance, the failure to align
budgetary cost recognition with the consumption of resources may hamper
the government*s performance and accountability reform efforts.

Objectives, Scope, and Methodology

The Chairman of the House Committee on the Budget asked us to (1) provide
information on the range and nature of responsibilities, programs, and
activities that may explicitly or implicitly expose the government to
future spending and (2) present and discuss options for increasing
attention paid to these items in the budget and the budget process.
Although some tax preferences may have uncertain or accelerating future
growth paths that have significant implications for the long term, this
report deals only with spending.

Page 10 GAO- 03- 213 Fiscal Exposures

To identify examples of programs and activities that may either directly
obligate the government to future spending or simply create an expectation
for such spending, we reviewed the consolidated Financial Report of the
United States Government, relevant literature, the President*s budget
documents, and prior GAO work. To begin construction of the spectrum of
fiscal exposures, we reviewed the generally accepted federal accounting
standards, including the basis of conclusions for federal liabilities,
contingencies, and stewardship responsibilities. Data on estimated
exposures were drawn from the fiscal year 2001 consolidated Financial
Report of the United States Government, agency financial statements, and
the President*s budget. Although we used generally accepted federal

accounting standards as an initial framework in constructing the spectrum
of fiscal exposures outlined in the report, we also considered additional
items that may implicitly expose the government to future spending but may
not be fully captured in the financial statements or the budget. In order
to identify ideas and describe various approaches for improving the
budgetary attention given to fiscal exposures, we reviewed relevant
literature and our prior work, including discussions with budget experts.
We also drew upon our previous work looking at the experiences of other
nations with accrual budgeting 9 and the recognition of fiscal risks, such
as federal insurance. 10 9 U. S. General Accounting Office, Accrual
Budgeting: Experiences of Other Nations and Implications for the United
States, GAO/ AIMD- 00- 57 (Washington, D. C.: Feb. 18, 2000).

10 U. S. General Accounting Office, Budget Issues: Budgeting for Federal
Insurance Programs, GAO/ AIMD- 97- 16 (Washington, D. C.: Sept. 30, 1997).

Page 11 GAO- 03- 213 Fiscal Exposures

Our list of fiscal exposures is meant to be illustrative to provide
perspective on the range and nature of responsibilities, programs, and
activities that may explicitly or implicitly expose the government to
future spending. It should not be interpreted either as all- inclusive or
universally agreed upon. Further, although this report notes that the
concept of fiscal exposure can be thought of broadly, its main focus is
the long- term costs and uncertainties associated with certain items that
may expose the government to future spending. Rather than looking at the
broad fiscal outlook, it focuses only on certain parts of the spending
side of the budget. As such, it does not consider all federal spending and
general revenues that would need to be considered in order to assess long-
term fiscal sustainability. We have discussed long- term fiscal
sustainability issues in numerous reports and testimonies. 11 As part of
this work, our simulations of the long- term economic impact of federal
budget policy show that the nation*s economic future depends, in part,
upon today*s budget and fiscal policy choices. This report builds on this
previous work by looking below the aggregate level to the long- term costs
associated with certain specific spending items. Our work was done in
Washington, D. C., in accordance with generally

accepted government auditing standards. Comments on a draft of this report
from OMB staff are discussed and incorporated as appropriate.

The remainder of this report discusses a number of issues, including  the
concept and different dimensions of fiscal exposures (risks)  the range
and nature of specific fiscal exposures facing the federal

government  the complexities and challenges surrounding cost measurement
and budgeting for fiscal exposures and  approaches for increasing the
attention given to fiscal exposures in the

budget and the budget process. 11 For example, U. S. General Accounting
Office, Budget Issues: Long- Term Fiscal Challenges. Testimony before the
Committee on the Budget, U. S. Senate, GAO- 02- 467T (Washington, D. C.:
Feb. 27, 2002) and U. S. General Accounting Office, Long- Term Budget
Issues: Moving From Balancing the Budget to Balancing Fiscal Risk, GAO-
01- 385T (Washington, D. C.: Feb. 6, 2001).

Page 12 GAO- 03- 213 Fiscal Exposures

Fiscal Exposure Could Be Considered on Several Levels

We use the term fiscal exposure to provide a conceptual framework for
considering the wide range of responsibilities, programs, and activities
that may explicitly or implicitly expose the federal government to future
spending. The treatment of items that could be considered fiscal exposures
in the current cash- and obligation- based budget varies* some have been
captured in budget obligations and some have not. Fiscal exposures include
not only liabilities, contingencies, and financial commitments that are
identified on the balance sheet or accompanying notes, but also
responsibilities and expectations for government spending

that do not meet the recognition or disclosure requirements for that
statement. 12 By extending beyond conventional accounting and fiscal
analysis, the concept of fiscal exposure is meant to provide a broad
perspective on long- term costs and uncertainties. The aim is not to
provide strict definitional guidelines, but rather to improve
understanding of the exposures associated with certain activities.

It is possible to think about fiscal exposure on several levels. Aggregate
budget projections of the government*s current programs and policies
provide important context for considering the implications of specific
decisions. For example, long- range (approximately 75 year) current
service projections and simulations, such as those provided by our model
and in the Analytical Perspectives of the President*s budget, provide a
broad context for considering the sustainability and flexibility of the
government*s future fiscal position. However, such constructs are likely
to be too broad to highlight specific areas for reform. Further, the
aggregate outlook is driven largely by Social Security, Medicare, and
Medicaid. As a

result, it provides little or no information to guide choices* or even
signal growth* outside those areas. 12 In this report, the term implicit
exposures refers to exposures that stem not from a legal

obligation of the federal government but rather from implied commitments
embedded in the government*s current policies or in the public*s
expectations about the role of government. Some implicit exposures, such
as the costs of future social insurance benefits, are discussed in the
stewardship section of the government*s consolidated financial statement.

Page 13 GAO- 03- 213 Fiscal Exposures

While Social Security, Medicare, and Medicaid are large drivers, there are
other exposures and it is important for policymakers to have information
on their long- term costs. The budgetary treatment of these exposures
varies* some have been included in the budget and some have not. For some
federal programs, the government*s commitment or resource use occurs years
before the cash spending consequences are reflected in the budget. Even
though some of these exposures stem from liabilities and are reported in
the financial statements, their recognition in the cash- and obligation-
based budget may be delayed. Beyond explicit liabilities, there are
implicit and/ or contingent 13 exposures that may encumber future budgets
or reduce fiscal flexibility. Including this range provides a more
complete picture of the extent of exposure facing the government. For this
report, we discuss fiscal exposures in terms of the long- term costs
associated with certain spending items. 14 In addition to the fiscal
exposures from spending covered in this report,

certain tax expenditures 15 may have uncertain or accelerating future
growth paths that have significant implications for the long term.
According to OMB, the largest reported tax expenditures tend to be
associated with the individual income tax. For example, an exclusion is
provided for employer contributions for medical insurance. In its special
analysis on tax expenditures included in the Analytical Perspectives of
the President*s budget, OMB includes estimates of the revenue effects,
outlay equivalents, and present value of revenue effects, but states that
the

meaningfulness of tax expenditure estimates is uncertain. OMB notes that
estimates are uncertain because of the arbitrariness of the baseline and
the fact that each estimate is calculated assuming that all other parts of
the tax code remain unchanged.

13 In this report, the term contingent exposures refers to exposures that
are based on the occurrence or nonoccurrence of some future event. 14 For
a more in- depth look at the fiscal exposure associated with environmental
liabilities, see U. S. General Accounting Office, Long- Term Commitments:
Improving the Budgetary Focus on Environmental Liabilities, GAO- 03- 219
(Washington, D. C.: Jan. 24, 2003).

15 Tax expenditures are revenue losses attributable to a provision of the
federal tax laws that allows a special exclusion, exemption, or deduction
from gross income or that provides a special credit, preferential tax
rate, or deferral of tax liability.

Page 14 GAO- 03- 213 Fiscal Exposures

Fiscal Exposures are Wide- Ranging and Varied The federal government
undertakes a wide range of responsibilities, programs, and activities that
may either obligate the government to future

spending or create an expectation for such spending. Specific fiscal
exposures vary widely as to source, likelihood of occurrence, magnitude,
and strength of the government*s legal obligation. They may be explicit or
implicit; they may currently exist or be contingent on future events.
Their ultimate costs may or may not be reasonably measurable. Given this
breadth, it is useful to think of fiscal exposures as lying on a spectrum

extending from explicit liabilities to the implicit promises embedded in
current policy or public expectations. Figure 2 shows a spectrum of
responsibilities, programs, and activities that may be viewed as fiscal
exposures.

Page 15 GAO- 03- 213 Fiscal Exposures

Figure 2: Spectrum of Fiscal Exposures

a. A liability represents a probable and measurable future outflow of
resources arising from past transactions and events. A liability is
recorded on the face of the balance sheet only when an item is
identifiable, its occurrence is probable, and its cost can be reasonably
estimated. b. Commitments refer to contractual obligations that require
the future use of resources. For example, although a liability generally
is not recognized on the balance sheet when a contract is signed because

the contracted goods or services have not been delivered, this transaction
may be recognized as a commitment in the notes. In contrast, budgetary
accounting would record obligations at the time the government enters into
a contract and allows for deobligation if the contract is not fulfilled.
Budgetary accounting records obligations when an order is placed, contract
awarded, service rendered, or similar trnsaction takes place that will
require payment.

Explicit liabilities a Financial commitments b Financial contingencies c
Implicit exposures d Spectrum of fiscal exposures Explicit liabilities
Implicit exposures Civilian and military

pensions payable $1,821

Post retirement health benefits

$786 Veteran benefits

payable $692

Accounts payable $96

Loan guarantees $28

Other benefits due and payable e

$44 Social Security due

and payable e $42

Undelivered orders f $413

Long- term leases $49

Insurance programs i $18

Unadjudicated claims

$2 Environmental and

disposal liabilities $307 Publicly- held

debt $3,320

Net future benefit payments under Social Security g

$4,207 Net future benefitpayments underMedicare Part A $4,730 and Medicare
Par

t Bg $8,084

Life cycle costs for fixed assets (i. e., including, deferred/ future
maintenance and

operating costs) Unfunded portion of incrementally funded

capital projects Federal disaster relief Potential financial bailout of

significant public and private institutions

Net future benefit payments for other social

insurance programs h $15 Risk assumed by insurance

programs i Insurance programs i $33

Source: GAO. Cost data from the Financial Report of the United States
Government, fiscal year 2001.

Dollars in billions

Page 16 GAO- 03- 213 Fiscal Exposures

c. A contingency is an existing condition, situation, or set of
circumstances involving uncertainty as to possible gains or losses. The
uncertainty will ultimately be resolved when one or more future events
occur or fail to occur. Contingencies are disclosed in the notes of the
financial statements if any of the conditions for liability recognition
are not met and there is at least a reasonable possibility that a loss may
have been incurred. Contingencies that are classified as remote are not
required to be disclosed. d. In this report, the term implicit exposures
refers to exposures that stem not from a legal obligation of

the federal government but rather from implied commitments embedded in the
government*s current policies or in the public*s expectations about the
role of government. e. Due and payable amounts are the benefits owed to
program recipients as of the fiscal year end that have not yet been paid.

f. Undelivered orders represent the value of goods and services ordered
that have not yet been received. g. The term net future benefit payments
is used in this report to represent the net present value of negative
cashflow. Net present value of the negative cashflow is the current amount
of funds needed to cover projected shortfalls, excluding trust fund
balances, over a 75- year period. This estimate of cashflows is for an
open system, meaning that it includes births during the period and
individuals below the age of 15 as of January 1 of the valuation year. The
valuation date for the amount included in the figure was January 1, 2001.
The trust fund balances at the beginning of the valuation period that were
eliminated for this consolidation were: $1,049 billion for Social
Security, $177 billion for Medicare

Part A, and $44 billion for Medicare Part B. This is a different measure
from the actuarial balance in the Trustees* Report. h. Includes Railroad
Retirement and Black Lung (Part C). See footnote g. Trust fund balances at
the

beginning of the valuation period that were eliminated for consolidation
were: $19 billion for Railroad Retirement and a negative balance of $7. 2
billion for Black Lung. i. Federal insurance programs are listed three
times in figure 2. Under federal accounting standards, a liability is
recognized based on insured events that have been identified by the end of
the accounting period. The standard requires recognition of expected
unpaid net claims inherent in insured events that have already occurred,
including (1) reported claims, (2) claims incurred but not yet reported
and (3) any changes in contingent liabilities that meet criteria for
recognition. A contingency is an existing condition, situation, or set of
circumstances involving uncertainty as to a possible loss. Contingencies
that do not meet the conditions for liability recognition are disclosed in
the notes to the financial statements. Contingencies that are classified
as remote are not required to be disclosed. The risk assumed by federal
insurance programs represents the cost of claims inherent in the
government*s commitment. Estimation of the cost of the risk assumed by the
federal government can be thought of

as analogous to premium rate setting in that it would look at the long-
term expected costs of the insurance commitment at the time the insurance
commitment is extended. The risk assumed by the government is essentially
that portion of the full risk- based premium not charged to the insured.

While our list of fiscal exposures provides some perspective on the range
and magnitude of exposures facing the federal government, it is neither
meant to be comprehensive nor to represent a universally agreed- upon
list. The cost data should be viewed in a similar way. Although most of
the cost data in this figure were drawn from the consolidated Financial
Report of the United States Government for fiscal year 2001, they should
be used with caution. In auditing these statements, we were unable to
determine the reliability of significant portions of the government*s
assets, liabilities, and costs due to serious financial management
weaknesses. These weaknesses may affect the reliability of estimates
reported for certain exposures, such as military postretirement health
benefits and environmental cleanup and disposal costs.

Page 17 GAO- 03- 213 Fiscal Exposures

Along the spectrum of fiscal exposures there is great variation in the
extent and magnitude of a government*s legal obligation, the certainty of
expected costs, their treatment in the budget, and the recognition of
these items in the financial statements. Some, such as deferred employee
compensation or environmental cleanup and disposal costs, are reported as
liabilities on the balance sheet. For financial statement reporting
purposes, liabilities are viewed as representing probable and measurable
outflows of resources arising from past transactions and events. Others
that relate to a past event but are contingent on future events, such as
pending litigation, generally are disclosed as contingencies. Others, such
as undelivered goods or services previously contracted for, are disclosed
as financial commitments in the notes to the financial statements. Some,
such as future social insurance benefits and some disaster assistance, do
not flow from legal

obligations but are implied by current policies and/ or expectations about
the role of government and are shown as stewardship responsibilities. 16
In this report, we use the term implicit exposures to refer to the last

category of exposures that stem not from a legal obligation of the federal
government but rather from implied commitments embedded in the
government*s current policies or in the public*s expectations about the
role of government. While social insurance and health programs represent

significant implicit exposures, other activities may also create
expectations for future spending. For example, incrementally funded
capital projects 17 create an expectation for future spending since there
is an expectation that

partially funded capital projects will be completed. In general, the
decision to purchase a building or another fixed asset implicitly commits
the government to the life- cycle costs associated with its future
operation and maintenance. Further, the earmarking of taxes or the
establishment of trust funds creates an expectation of future spending for
the designated purpose. Even an activity that appears to decrease
government involvement, such as privatization, may carry with it an
implicit assumption that the government will step in if necessary to
provide the service or good. Clearly, the range and nature of activities
that may create an expectation

16 Some implicit exposures, such as the costs of future social insurance
benefits, are discussed in the stewardship section of the government*s
consolidated financial statement. 17 An incrementally funded capital
project is a project for which the budget authority provided is for only
part of the estimated cost of the capital acquisition or part of a usable
asset. For more information, see U. S. General Accounting Office, Budget
Issues: Incremental Funding of Capital Asset Acquisitions, GAO- 01- 432R
(Washington, D. C.: Feb. 26, 2001).

Page 18 GAO- 03- 213 Fiscal Exposures

for future spending increase the difficulty of determining the parameters
of what constitutes a fiscal exposure.

The budgetary treatment of these items varies* some have been included in
the budget and some have not. Some liabilities reported on the financial
statements, such as accounts payable and loan guarantees, are included in
the budget because agencies must have budget authority to cover them.
Changes in the debt level generally are reflected in the annual deficit or

surplus. Others, such as environmental and disposal liabilities, are not
included in primary budget data 18 beyond the amount for current cleanup
activities. Some implicit exposures, such as the cost of future Social
Security benefits, are not included in primary budget data for the budget
year but are captured in long- range budget projections. Other implicit

exposures, such as the risk assumed by insurance programs, may not be
captured in either primary budget data or in long- range budget
projections. Despite the challenges of determining what should be
considered a fiscal

exposure, efforts to improve the information on and incentives to consider
these exposures are important. Failure to understand and address fiscal
exposures can have significant consequences. Even those exposures that are
not legal obligations of the government may imply future government
spending* and that should be considered in making a program or budget
decision. Whether the government is legally required or simply compelled
by circumstances to provide funding, these exposures can encumber future
budgets and reduce fiscal flexibility. Understanding these items can also
be

important to efforts to improve government performance. For some items,
such as deferred compensation, the budgetary focus on annual cash flows
does not match the full costs of an employee with the services the
employee provides. For example, federal employees earn their pension while
they are working but receive pensions after they have stopped working. The
accruing cost of the pensions earned by current employees is really part
of the costs of the goods and services they provide, but the budget does
not capture the full extent of these costs and total budget outlays
include only the cash payments made to current retirees. By making it more
difficult to assess and compare the costs associated with a given level of
performance, the failure to align budgetary cost recognition with the
consumption of resources may hamper the government*s efforts to assess its
performance.

18 In this report, primary budget data refers to budget authority,
obligations, outlays, and the deficit/ surplus.

Page 19 GAO- 03- 213 Fiscal Exposures

Several exposures provide insight into challenges facing the government

A closer look at some fiscal exposures* although not necessarily
representative of all fiscal exposures* provides a sense of the issues
facing the government. For example, the government faces a large and
rapidly growing exposure for certain social insurance and health programs.
Social Security, Medicare, and the federal portion of Medicaid are
expected to grow considerably in the future due to the aging of the
population and

impending retirement of the large baby boom generation. Figure 3 shows the
total draw on the economy represented by federal spending on Social
Security, Medicare, and Medicaid. Taken together, they represent an
unsustainable burden on future generations. Although significant
information is available on the estimated future costs of Social Security
and Medicare, the annual budget is not currently structured to fully
capture these growing costs. Current reporting of annual budget data
focuses on cash to current beneficiaries and thus does not capture the
funding shortfall for future benefits. For example, fiscal year 2001
Social Security tax receipts exceeded cash benefit payments by more than
$94 billion and increased the unified federal surplus. The fiscal year
2001 consolidated Financial Report of the United States Government,
however, shows the

net present value of Social Security*s negative cash flow over a 75- year
period as $4.2 trillion. 19 Similarly, the budgetary treatment of Medicare
focuses on the annual cash paid to current beneficiaries and cash revenues
from current workers. As a result, Medicare's significant and growing
actuarial shortfalls are not reflected in the annual budget.

19 Net present value of the negative cash flow is the current amount of
funds needed to cover projected shortfalls, excluding trust fund balances,
over a 75- year period. The trust fund balance at the beginning of the
valuation period (January 1, 2001) was $1,049 billion. The net present
value of negative cash flows shown in this report is from the fiscal year
2001 consolidated Financial Report of the United States Government and is
a different measure from the actuarial balance in the Trustees* Report.

Page 20 GAO- 03- 213 Fiscal Exposures

Figure 3: Social Security, Medicare, and Medicaid Spending as a Percent of
Gross Domestic Product

Note: Projections based on intermediate assumptions of the 2002 Trustees*
Reports and Congressional Budget Office*s June 2002 long- term projections
under midrange assumptions. Spending includes only the federal portion of
Medicaid.

Pensions and retiree health care costs of civilian and military employees
of the federal government and veterans* benefits payable comprise another
large fiscal exposure. Together, these future benefits represent a
liability of nearly $3.4 trillion for fiscal year 2001. Changes in
benefits may result in long- term costs. For fiscal year 2001, a $293
billion increase in the military postretirement health benefits liability
is attributed to provisions of the fiscal year 2001 National Defense
Authorization Act (Public Law 106- 398) that expand certain benefits to
Medicare- eligible Department of Defense (DOD) retirees, their dependents,
and survivors.

Some of the accruing costs of postretirement benefits are captured in the
budget authority and outlays for agencies. The full cost of pension
benefits was recognized in budget authority and outlays at the agency
level beginning in 1985 for military personnel and for civilian employees
hired since 1984. Beginning in 2003, DOD will budget on an accrual basis
for the retiree health care costs for Medicare- eligible military
retirees. In these

0 5

10 15

20 25

2000 2010 2020 2030 2040 2050 2060 2075 Percent of GDP

Social Security Medicare

Medicaid Source: Office of the Chief Actuary, Social Security
Administration, Office of the Actuary, Centers for Medicare and Medicaid
Services, and Congressional Budget Office.

Page 21 GAO- 03- 213 Fiscal Exposures

cases, payments are made between accounts within the budget so that
outlays are recorded as program costs but do not affect total budget
outlays and the deficit/ surplus. However, for most civilian employees
hired before 1984, less than half the government*s share of accruing
pension costs are recognized in the budget and none of the accruing costs
of retiree health benefits for civilian or military retirees under the age
of 65 are recognized in the budget as earned. In an effort to improve the
budgetary treatment of accruing employee benefits, the Administration
proposed that agencies be required to request budget authority for the
government*s full share of the accruing costs of all pension and retiree
health benefits for

their employees and pay it to the benefit paying funds. Environmental
cleanup costs resulting from federal operations represent another fiscal
exposure. These constitute an explicit liability since the federal
government is legally required to clean up hazardous wastes that result
from its operations. These costs, however, usually are not paid until many
years after the government has committed to the operation generating the
waste. As required under generally accepted federal accounting standards,
the fiscal year 2001 consolidated financial statement reported a liability
of $307 billion for estimated environmental cleanup and disposal costs. 20
Although a liability for future costs is reported on the financial
statements, current budget guidance requires agencies to request only the
budget authority expected to be obligated during the budget year for
cleanup activities. As a result, these future costs are not shown in the
budget and may not even be provided in backup materials to policymakers at
the time decisions are being made to undertake the operations that may
generate environmental cleanup costs. For example, when a weapon system
using nuclear materials is built, there would be no disposal costs shown
in the budget since the disposal would not occur until some time after
that budget period. 21 20 About 98 percent of the $307 billion in
environmental liabilities that were reported in fiscal

year 2001 were associated with the Department of Energy and DOD. The
Department of Energy, which received a clean opinion on its financial
statements, reported environmental liabilities of $238 billion. DOD
reported $63 billion in environmental liabilities. Auditors, however, were
unable to render an opinion on DOD*s fiscal year 2001 financial
statements, in part, because of DOD*s inability to comply with
requirements for environmental liabilities.

21 Unlike what is required in the budget, current federal accounting
standards require agencies to estimate and report the full liability of
cleanup costs for weapon systems when they are deemed probable and
measurable.

Page 22 GAO- 03- 213 Fiscal Exposures

Federal insurance is provided to individuals and businesses against a wide
variety of risks, ranging from natural disasters under the flood and crop
insurance programs to bank and employer bankruptcies under the deposit

and pension insurance programs. While the face value of insurance
overstates the likely cost to the government, these programs do expose the
government to future, and potentially significant, draws on resources that
may not be adequately reflected in the budget at the time the decision to
extend the insurance is being made. We have previously reported 22 that
current budget reporting may not signal policymakers to the risk assumed
by the government at the time the decision to extend the insurance is
made.

For example, at the time budget decisions were being made for fiscal year
2003, the budget showed a positive budget estimate (i. e., revenues) for
the Pension Benefit Guaranty Corporation of about $1.3 billion. The
financial statements available at the same time showed an estimated
liability for future benefits of $13.5 billion and a positive net position
of about $7.8 billion. At the same time, OMB estimated the future cost of
the risk assumed by the government for vested covered benefits as $51
billion. 23 Clearly, these different estimates provided significantly
different pictures

of the program*s health and its potential draw on future resources. 22 See
GAO/ AIMD- 97- 16. 23 According to OMB, this estimate is for the future
costs of vested covered benefits and does not assume future growth in such
benefits.

Page 23 GAO- 03- 213 Fiscal Exposures

The government*s purchase and ownership of government- owned facilities
and other assets may create an expectation for future spending. If budget
authority for a capital project is not fully funded at the time the
commitment to buy the asset is made, the government*s costs will likely be
understated. Future Congresses and administrations may be forced to choose
between having an incomplete and unusable asset and continuing to fund the
project. In cases where funding is provided for only part of a

project and that part by itself is not usable, then policymakers may feel
compelled to continue funding to complete the project. 24 Moreover, the
total life- cycle cost of an asset includes not only all initial direct
and indirect acquisition costs but also all periodic or continuing costs
of operation and maintenance over the asset*s expected useful life and any

costs to decommission or dispose of the asset. While OMB requires agencies
to develop capital asset plans for major acquisitions and encourages long-
term agency capital plans* both of which should include

life- cycle costs* these plans are not routinely provided to Congress.
Budget authority generally is provided only for the acquisition costs
associated with capital asset purchases, not for the life- cycle costs
necessary to operate, maintain, and dispose of the asset. While this may
be appropriate for budget control purposes, the result, in most cases, is
that the budgetary focus is on the initial cost of assets even if this
cost represents only a fraction of the total costs flowing from the
purchase decision. 24 As part of our prior work on incremental funding, we
reviewed selected agency budget justifications and other agency data to
identify the extent to which capital projects were

incrementally funded. The 2001 report identified civilian nondefense
capital projects with total estimated costs of $176 billion and determined
that about $76 billion (44 percent) of total costs were incrementally
funded* an amount that does not include high technology projects.
Incremental funding can be justified for such projects because funding
provided on an incremental basis can provide useful knowledge even if no
additional funding is

provided. This review also found that data supporting capital acquisitions
in general may be incomplete and/ or unclear, thus making it difficult to
determine future costs or whether the funding provided would produce a
usable asset. See GAO- 01- 432R.

Page 24 GAO- 03- 213 Fiscal Exposures

Other exposures facing the government also present significant
definitional and measurement challenges because (1) the existence and
scope of the government*s commitment prior to the occurrence of the
underlying event is unclear, (2) the occurrence and timing of the
underlying event is unknown, and (3) the ultimate costs are difficult to
predict. Examples include the bailout of large institutions or disaster
relief. 25 The extent of the government*s commitment to cover these costs
may not be explicitly stated before the event but rather may be implied by
the role of government. Not

only is the extent of the government*s commitment unknown before the
occurrence of the event, the timing and magnitude of these exposures are
contingent upon the occurrence or nonoccurrence of some future event. For
example, even in cases where it is not explicitly required by law, the
federal government may be expected to provide for the financial losses
that arise from catastrophes and major disasters such as earthquakes,
hurricanes, terrorist attacks, and epidemics, the timing and magnitude of
which are unknown until they occur. There may also be an expectation that
the federal government would intervene to bailout the losses of state and
local governments and large institutions of economic significance.

Fiscal Exposures Involve Complex Measurement and Budgeting Challenges

Determining the appropriate budgetary treatment for fiscal exposures is
complicated by uncertainties. First, there is definitional uncertainty i.
e., uncertainty about what constitutes an exposure certain enough to
include as a claim on budgetary resources. In addition, there are
difficulties in estimating future costs. The extent to which either or
both of these factors contribute to the uncertainty about future costs
varies among fiscal exposures. As a result, policymakers should consider
both the degree of certainty of the government*s obligation and the
availability of reasonable cost estimates when weighing the trade- offs
associated with various approaches to help increase the attention paid to
particular exposures

when making budget decisions. 25 Another issue associated with implicit,
contingent exposures, such as bailouts and disaster relief, is that
recognition of these potential costs may create moral hazards in that
private parties may make too little effort to diminish their risk.

Page 25 GAO- 03- 213 Fiscal Exposures

Whether an exposure is certain enough to be included as a claim on
budgetary resources is a key question. As noted earlier, the extent of the
government*s obligation varies along the spectrum of fiscal exposures.
Some fiscal exposures are reported as liabilities of the federal
government and represent legal obligations to make payments; others are
not. For example, the $3.3 billion in publicly held debt is a clear
financial liability. On the other hand, generally accepted federal
accounting standards do not

view future social insurance benefits as a liability, except for the
amount due and payable at fiscal year end. The standard, however, also
requires that supplementary stewardship information be reported to
facilitate an assessment of the program*s long- term sustainability and
the ability of the program and the nation to raise resources from future
program participants to pay for benefits. 26 The standard for social
insurance is a compromise between parties with widely divergent views
about the government*s obligation to make future benefit payments.
Proponents of the standard

point out that the underlying laws establishing a claim to payment can
(and have been) changed and there is no legal obligation by the government
to pay benefits once the trust funds that finance these programs have been
exhausted. Others, however, believe that a liability should be recognized
for the net benefits expected to be paid in future periods to current
participants. Any changes in budgetary treatment would require similar
discussion and compromises concerning which items should be recognized as
exposures. There may be further disagreement over which of these exposures
should be directly recognized in the primary budget data. 27 Finally, even
if agreement can be reached that an exposure theoretically should be
included in the primary budget data, reasonable cost estimates

may not be available. For some exposures, estimates could be generated
given time and attention; for others that are contingent on future events,
estimates are more problematic.

Several factors affect whether reasonable cost estimates are currently
available or can be generated. The generation of reasonable cost estimates
depends not only on the development of appropriate methodologies but

26 For example, stewardship information generally includes narrative and/
or graphic presentation of items including (1) long- range cashflow
projections, (2) long- range projections of the ratio of contributors to
beneficiaries and (3) actuarial present values of (a) future benefits for
and (b) contributions and tax income from or on behalf of current and
future program participants.

27 In this report, primary budget data refers to budget authority,
obligations, outlays, and the deficit/ surplus.

Page 26 GAO- 03- 213 Fiscal Exposures

also on the acceptance and quality of underlying assumptions and data.
Estimates for some exposures, such as pension benefits, are based on
accepted methodologies and are reported as liabilities in financial

statements. The future costs of some exposures are inherently more
difficult to estimate than others. For example, some exposures, such as
bank and pension insurance, are dependent on many economic and behavioral
variables. Since these are inherently uncertain, there will always be some
uncertainty surrounding the estimated future costs of such

programs. Lack of adequate data may also be a factor in the reliability of
cost estimates. For example, postretirement health benefits and
environmental cleanup and disposal costs are reported as liabilities on
the balance sheet because they are considered to meet the criteria of
probable and reasonably measurable, but audits have revealed weaknesses
that may affect the reliability of these reported amounts. The fiscal year
2000

liability for military postretirement health benefits could not be
accurately estimated because some of the underlying costs and demographic
and workload data used to develop the estimate were not reliable. The
estimate for environmental cleanup costs is uncertain, in part, because
the dimensions of the cleanup problem remain unclear and the technology to
address the problem is evolving.

Generally speaking, the more direct and explicit the fiscal exposure, and
thus the more certain the existence of a claim and its ultimate costs, the
greater the suitability of including estimated costs directly into the
primary budget data when doing so would enhance up- front control of
spending. Even when agreement can be reached that an explicit liability
exists, efforts may be needed to develop reasonable cost estimates. For
exposures that are implicit and/ or contingent on future events, cost
estimation challenges and underlying questions about the existence of a
government commitment raise substantial questions. Perhaps most
challenging are those exposures that are both implicit and contingent on
unknown events, such as bailouts or disaster relief. In these cases, the
government may not have any current legal obligation and the magnitude and
timing of the underlying event is unknown. These exposures are very
difficult to estimate and uncertain as to whether they really represent
claims to future resources.

Page 27 GAO- 03- 213 Fiscal Exposures

Diversity of Fiscal Exposures Suggests that Tailored Approaches Would Be
More Feasible than an Across- the- Board Approach

The variety of certainties (and uncertainties) associated with fiscal
exposures suggests that no single approach to increasing attention to
these future costs will work in all cases. Various approaches might be
considered in a framework organized around three possible objectives: (1)
improving the transparency of fiscal exposures, (2) prompting more
deliberation about fiscal exposures, and (3) improving budget incentives
to address fiscal exposures. Several broad approaches for helping to
achieve these objectives discussed here are (1) improving supplementary
reporting, (2) providing opportunities for explicit consideration in the
budget process, and (3) incorporating the costs of fiscal exposures into
the primary budget data. A number of options could be used to implement
each of these approaches. Figure 4 displays how different approaches

could be used to achieve a primary objective by providing illustrative
options for implementing each approach. These options are meant to
illustrate how different approaches may be used depending on the primary

objective to be achieved and what may be feasible to implement. Not only
do these approaches achieve the various objectives to differing degrees,
but they also vary in the implementation challenges involved.

Figure 4: Overview of Possible Approaches Primary objective: To improve
transparency of fiscal exposures

Primary objective:

To prompt more deliberation about fiscal exposures

Primary objective:

To improve budgetary incentives to address fiscal exposures

Approach I: Improve supplemental reporting

Approach II:

Provide opportunities for explicit consideration of fiscal exposures in
the budget process

Approach III: Incorporate cost estimates of fiscal exposures directly into
primary budget data

Option:

 Provide special analysis for select exposures in the Analytical
Perspectives of the President*s budget

 Report, for select exposures, the *exposure level* by budget account in
the Program and Financing schedule of the President*s budget  Require
report on fiscal exposures

Option:

 Permit a point of order to encourage explicit consideration of exposures

 Establish a trigger to signal when exposure level increases beyond a
specified amount

Option:

 Use accrual- based costs to measure budget authority and possibly budget
outlays for select exposures when doing so would enhance up- front control
of spending

Source: GAO.

Page 28 GAO- 03- 213 Fiscal Exposures

The diverse nature of exposures and the significant differences in the
strength of the government*s underlying obligation, combined with the
varying quality and amount of cost information available outside the
budget process, suggest that across- the- board changes in budget
reporting or process would not be appropriate. Instead, targeted
approaches for different types of fiscal exposures would be most useful
for incorporating a longer- term perspective into the budget. Changes in
the information provided, the budgetary process, or budgetary incentives
could be tailored selectively for different categories of fiscal exposures
to address specific budgetary objectives and implementation challenges. A
discussion of each of the three approaches and related options follows.

Approach I: Improve Supplemental Reporting

Improved supplemental reporting on fiscal exposures would make information
more accessible to decisionmakers without introducing additional
uncertainty and complexity directly into the budget. With this approach,
estimates of the government*s exposure would be reported in various budget
documents, but the current basis of reporting primary budget data* budget
authority, obligations, outlays, and the deficit/ surplus* would not be
changed. This type of supplemental information is currently available in
various places for some programs. For example, the stewardship section in
the Analytical Perspectives of the President*s budget has included long-
range (75 year) budget projections assuming continuation of current
policies as well as a discussion of the government*s balance sheet, which
includes some liabilities not yet included in the primary budget data. The
stewardship section of financial statements contains information to
facilitate the assessment of the longterm sustainability of social
insurance programs. In some cases, improving supplemental reporting may
simply be a matter of highlighting or expanding existing analytical work.
For example, long- range projections and simulations of the budget as a
whole could be continued and improved, including analysis to help assess
driving factors, such as demographics and economic changes, and to improve
understanding of the range and magnitude of alternatives. As outlined in
figure 5, improved supplemental reporting on fiscal exposures could be
achieved in a number of ways. In addition to the

continuation and further development of long- range projections of the
budget as a whole, three options to consider include (1) providing special
analyses for certain, significant fiscal exposures in the Analytical

Perspectives of the President*s budget, (2) reporting estimated costs of
certain fiscal exposures as a separate notational line** exposure level**
in

Page 29 GAO- 03- 213 Fiscal Exposures

the Program and Financing schedule of the President*s budget, or (3)
requiring a report on fiscal exposures.

Figure 5: Possible Options For Improving Supplemental Reporting Approach
I:

Improve supplemental reporting

Objective:

To improve transparency of fiscal exposures

Option:

Report the *exposure level* by budget account in the Program and Financing
schedule of the President*s budget

Advantages:

Discloses potential future costs Does not subject budget data to increased
estimation uncertainty

Allows time to develop, test, and improve estimation methodologies

Allows time to assess feasibility of further integration of cost estimates
into budget data

Disadvantages:

Does not directly affect budgetary incentives to address exposures Does
not require explicit consideration of exposures Does not provide strong
incentives to improve cost estimates Raises implementation issues:

- need criteria to determine which items should be included as *exposures*
for supplemental reporting - increases reporting burden - reporting by
account would require determining the alignment of *exposure level* to
specific budget accounts

Option:

Provide special analysis for select exposures in Analytical Perspectives
of the President*s budget

Option:

Require report on fiscal exposures Source: GAO.

Page 30 GAO- 03- 213 Fiscal Exposures

Federal government insurance programs provide a prime example of where
special analysis of a particular type of exposure may be appropriate. Our
previous work has shown that the current cash- and obligation- based
budget generally provides incomplete or misleading information on the
government*s cost of federal insurance programs. 28 One reform option
would be to require an estimate of the budget authority likely to be
needed

to cover an estimate of the cost of the risk assumed 29 by the government.
However, given the difficulties in estimating the cost of risk assumed, we
concluded that supplemental reporting of the cost of the risk assumed by
federal insurance programs had several attractive features. It would allow
time to (1) assess the reliability of cost estimates, (2) develop and
refine estimation methodologies, and (3) formulate cost- effective
reporting. As another example, supplemental analysis could be provided for
uncertain exposures, such as future operation and maintenance costs
associated with asset acquisitions.

28 See GAO/ AIMD- 97- 16. 29 The estimation of the cost of the risk
assumed by the federal government would be analogous to premium rate
setting in that it would look at the long- term expected costs of the
insurance commitment at the time the insurance commitment is extended. The
risk assumed by the government is essentially that portion of the full
risk- based premium not charged to the insured.

Page 31 GAO- 03- 213 Fiscal Exposures

While providing a special analysis in the Analytical Perspectives would
provide additional information, it is not as directly linked to specific
budget proposals as is possible. Another option would be to routinely
report the future estimated costs of certain exposures as a separate
notational line in the Program and Financing schedule of the President*s
budget. This would

move beyond the current budget practice of generally including only budget
authority, obligations, and outlays for initial acquisition costs of an
asset to adding a new measure that reports the *exposure level* as a
notational item in the Program and Financing schedule. For example, an
estimate of the future operating and maintenance costs associated with
capital acquisitions could be reported as the *exposure level* in the
Program and Financing schedule for capital accounts that include the
initial capital acquisition costs. Similarly, the future funding needs
associated with incrementally funded projects could be included in the
Program and Financing schedule of the budget account that includes the
capital acquisition. This type of notational approach in the Program and
Financing schedule could also be used for future environmental cleanup

costs associated with an asset acquisition. In these cases, the *exposure
level* could be used to capture the exposure associated with the capital
acquisitions in each year. 30 As opposed to cash, the *exposure level*
might be reported in present value terms. Including exposure levels as
part of the budget presentations at the account level directly in the
budget documents would make such information available along with the
initial acquisition costs, rather than in an additional document.
Specifying the estimated potential future costs associated with current
decisions would promote transparency.

Another approach, which could stand alone or be done along with including
exposure levels in the Program and Financing schedule, would be to require
a report on fiscal exposures. For example, such a report could provide a
concise list and description of fiscal exposures, cost estimates, where
possible, and an assessment of the methodologies and data used to

produce cost estimates. Explicitly and directly integrating the report on
specific fiscal exposures with long- range projections and analysis of the
budget as a whole would increase its usefulness for assessing the
potential implications for long- range fiscal sustainability and
flexibility. If this type

of report was issued as part of or near the time of the release of the
President*s budget, it could be used to help inform and provide long- term
context to budget deliberations.

30 See GAO- 03- 219.

Page 32 GAO- 03- 213 Fiscal Exposures

These types of supplemental reporting have the advantage of providing
policymakers with a long- term perspective when making current decisions
and enabling those concerned about exposures to raise questions and
challenges in the budget debate. However, they do not in themselves change
incentives or require explicit consideration of costs. This is because
estimates of future costs would not directly affect spending or the
overall budget totals. Since this information would be excluded from the
primary budget data, it may or may not be used in budget decisions. As a
result, there may be little incentive to improve cost estimates or to
fully consider these potential costs. However, the uncertainties around
such cost estimates may argue for proceeding gradually with efforts to
further incorporate them into the budget. Supplemental reporting would
allow time to improve cost estimation methodologies and increase users*
comfort levels with the estimates. Such reporting might then be seen as a
first step toward more explicit consideration in the budget. In addition,
because the

primary budget data are not affected, this type of supplemental reporting
would avoid increasing the gap between the deficit and borrowing needs.

Approach II: Provide Opportunities for Explicit Consideration of Fiscal
Exposures in the Budget Process

Further along the continuum from supplemental reporting to including costs
in the primary budget data are budget process changes. Budget process
mechanisms would go beyond simply providing more information on fiscal
exposures to establishing opportunities for explicit consideration of
these exposures. Two possible options to consider are shown in figure 6.
Congress could modify budget rules to provide for a point of order against
any proposed legislation that creates new exposures or increases the
estimated costs of existing exposures over some specified level.
Alternatively, revised rules could provide for a point of order against
any proposed legislation that does not include estimates of the potential
costs of fiscal exposures created by the legislation. A second budget
process option would be to establish triggers that require some action
when the estimated future costs of a given exposure rise above some
specified threshold.

Page 33 GAO- 03- 213 Fiscal Exposures

Figure 6: Possible Options for Providing Opportunities For Explicit
Consideration of Fiscal Exposures Advantages:

Encourages explicit consideration of potential future costs Does not
subject primary budget data to increased estimation uncertainty

Allows time to assess feasibility of further integration of cost estimates
into primary budget data

or Approach II:

Provide opportunities for explicit consideration of fiscal exposures in
the budget process

Objective:

To prompt more deliberation about fiscal exposures

Option:

Establish a trigger to signal when exposure level increases beyond a
specified amount

Disadvantages:

Raises significant implementation issues:

- increases complexity of already complex process

- need accepted criteria to determine which items should be included as
*exposures* subject to point of order or trigger

- need to determine responsibility for developing estimates

- increases reporting burden

- need to agree on acceptable threshold Raises questions about
effectiveness:

- inherent uncertainty of estimates

- ability to waive point of order

Option:

Permit a point of order to encourage explicit consideration of exposures

Source: GAO.

Page 34 GAO- 03- 213 Fiscal Exposures

A key advantage of permitting points of order with respect to fiscal
exposures is that they could result in explicit consideration of these
potential costs without subjecting the primary budget data to increased
uncertainty from estimation difficulties. It would be similar to
procedural rules for Social Security that permit points of order against
the consideration of legislation that would weaken the program*s financial

condition. A different point of order method would be to permit a point of
order that could block legislation lacking appropriate cost information
about an exposure. This would be similar to unfunded mandates legislation

that permits a point of order to be raised against proposed legislation
that imposes mandates if a Congressional Budget Office mandates estimate
has not been published in the committee report or the Congressional
Record. 31 This alternative would provide a greater incentive to improve
cost

information than simply requiring supplemental information because it
presents congressional members with an opportunity to challenge the
creation of programs without sufficient information on long- term costs.
Despite the potential benefits of permitting some type of point of order,
such a budget process change is not without significant implementation
challenges. Criteria would have to be agreed on for determining which

activities and programs would be considered as fiscal exposures subject to
a point of order. Mechanisms also would need to be developed to deal with
the uncertainties and volatility inherent in cost estimates associated
with

fiscal exposures. Further, this type of budget process change would
increase the complexity of an already complicated process. Since many
activities* including most capital acquisitions* routinely would result in
exposures, such as life- cycle costs, a point of order may become
burdensome and potentially ignored. Points of order also are limited
because they apply only to new legislation and then only if raised.
Further, they can be waived or overruled by a vote of the Members.
Finally, a budget

process change establishing a point of order would require an amendment to
the Congressional Budget Act of 1974 or a change to committee rules.

31 Unfunded Mandate Reform Act of 1995, Pub. L. 104- 4, S:423.

Page 35 GAO- 03- 213 Fiscal Exposures

A different budget process approach would be to establish triggers that
address the growth in existing exposures. In this case, triggers would be
established to signal when the future costs of exposures rise above a
certain level. Reaching the trigger threshold would require some action.
32 One possible trigger could be the future costs of a specific exposure

exceeding a specified dollar amount, but other thresholds are also
possible. For example, for the Medicare program, these might be a
specified floor in the trust fund, such as the balance falling below 1-
year*s worth of payments, the percentage of gross domestic product devoted
to Medicare, or program spending per enrollee. The use of triggers would
require agreement not only on the limits but on what will happen when the
limits are reached. A trigger could be *hard** including specific
provisions that would automatically go into effect if the trigger is
reached* or *soft** requiring some action to be taken to address costs or
reaffirm acceptance of the increase in potential fiscal exposure. 33 For
example, reaching a trigger could require the policymakers to propose how
to deal with growth in the Medicare program. This type of *soft* trigger
would help ensure that Congress and the President periodically review and
decide how to address

exposures. Like a point of order, the key benefit of a trigger is that it
would require explicit consideration of exposures facing the government
without adding uncertainty to primary budget data. However, like points of
order, establishing triggers would increase the complexities of an already
complex budget process. Further, the implementation issues associated

with determining the trigger threshold and the type of action required
would have to be addressed. 34 A budget process change establishing a
trigger would require an amendment to the Congressional Budget Act of 1974
or a change to committee rules.

32 U. S. General Accounting Office, Medicare Reform: Issues Associated
With General Revenue Financing, GAO/ T- AIMD- 00- 126 (Washington, D. C.:
Mar. 27, 2000). 33 Rules established by the current Congress can be
changed by a subsequent Congress. 34 Such a procedure would require some
assurance of unbiased estimates.

Page 36 GAO- 03- 213 Fiscal Exposures

Approach III: Incorporate Cost Estimates of Fiscal Exposures Directly into
the Primary Budget Data

Incorporating the estimated future costs of fiscal exposures directly into
the budget would represent the greatest change outlined in our spectrum.
For example, as shown in figure 7, accrual- based costs could be used to
measure budget authority needed and possibly outlays for select programs

when doing so would enhance obligation- based control. Since estimated
costs would be incorporated directly into the primary budget data, these
options are most suitable for explicit exposures for which reasonable cost
estimates are available.

Page 37 GAO- 03- 213 Fiscal Exposures

Figure 7: Possible Options for Incorporating Costs Directly into the
Primary Budget Data

The budget*s measurement basis can greatly affect the timing of when a
program or activity appears in the budget. Accrual- based measurement
recognizes cost at the time the activity generating the revenue, consuming
the resources, or increasing the liability takes place regardless of when
the associated cash flows occur. Conversely, cash- based measurement
recognizes receipts and outlays at the time cash is received or paid
regardless of when the activity generating the revenue, consuming the
Disadvantages

Subjects primary budget data to estimation uncertainty

Raises potential oversight and implementation issues: - need criteria to
determine

which exposures should be accrued

- increases reporting burden - increases complexity of an

already complex process - for outlay approach,

increases difference between reported deficit/ surplus and government*s
borrowing needs

Advantages

Provides earlier cost recognition at time decisions are being made

Improves budgetary incentives to address costs/ risks

Approach III:

Incorporate cost estimates of fiscal exposures directly into the primary

budget data

Objective:

To improve budgetary incentives to address fiscal exposures

Option:

Use accrual- based costs to measure budget authority and possibly budget
outlays for select exposures when doing so would enhance up- front control
of spending

Source: GAO.

Page 38 GAO- 03- 213 Fiscal Exposures

resources, or increasing the liability occurs. The U. S. budget is neither
accrual nor pure cash; it is obligation based. Obligation- based budgeting
is designed to ensure that agencies do not incur legal obligations unless
and until Congress provides authority for agencies for that purpose.
However, with limited exceptions, the amounts to be obligated are measured
on a

cash or cash equivalent basis and the deficit/ surplus* a key focus of the
policy debate* represents the difference between cash receipts and cash
outlays in a given year. As a result, the U. S. budget is often referred
to as cash based as well as obligation based. Cash measurement for
budgeting has the advantage of being recognized as an accepted measure of
the government*s impact on the economy, which is an important gauge of
fiscal policy.

Although the current cash- and obligation- based budget has several
benefits, the United States has recognized the contribution accrual- based
measurement can make to budgeting. Since about 1955, interest has been
accrued in the budget for Treasury securities held by the public. Even
before 1955, a portion of the accruing costs for civilian employee
pensions had been recognized in the budget. We have advocated the
selective use of accrual measures in the budget to better reflect costs at
the time decisions were made. The budget has been modified gradually to
use accrual- based measurement for certain programs in areas where doing
so would enhance

up- front recognition of costs. For example, the accruing costs of
military pension benefits have been included in the budget at the program
level since 1985 and the Federal Credit Reform Act of 1990 changed the
method

of controlling and accounting for credit programs to an accrual basis to
provide more timely recognition of their costs.

Prior to credit reform, obligations measured on a cash basis for credit
programs sent the wrong signals about the government's exposure. The full
amount of direct loans was reported as an outlay, ignoring the fact that
many would be repaid. In contrast, for loan guarantees, initially no
outlays were reported, ignoring the fact that some guaranteed loans would
be defaulted upon and require budget outlays. Consequently, the use of
cashbased measurement overstated the cost of direct loans in the year they
were made and understated the costs of loan guarantees in the year they
were issued. This deficient reporting skewed cost comparisons between

credit and grant programs with similar purposes but different funding
approaches. The relative cost of credit programs and other federal
spending was misrepresented. Credit reform addressed the shortfalls of
cash- based measurement for credit programs by requiring the budget to
include the estimated cost to the federal government over the entire life
of

Page 39 GAO- 03- 213 Fiscal Exposures

the loan or loan guarantee, calculated on a net present value basis. By
incorporating accrual cost measures in the budget for credit programs,
credit reform improved cost comparisons and better reflected the
government*s ultimate costs at the time decisions to extend the credit
were being made.

Similar concerns about the shortcomings of cash- based measurements for
other programs that involve cash flows over many years, such as pensions
and insurance, stimulated interest in whether further incorporation of
accruals in the budget would be useful. We reviewed the experiences of six
countries that had adopted, or planned to adopt, accrual- based budgeting.
35 In this work, we noted that the use of accrual- based measurement

selectively within the obligation- based budget would result in earlier
cost recognition for some major exposures such as employee retirement
benefits, insurance, and environmental clean- up costs. In these cases, if

reasonable cost estimates are available, the use of accrual- based
measurement would help reinforce the up- front control focus of the
obligation- based budget.

However, we also noted some limitations and concerns. We pointed out that
relative to the obligation- based budget, accrual- based measurement would
delay cost recognition of capital assets by spreading the costs over the
life of the assets 36 and for some government activities, such as salaries

and grants, there generally would not be significant differences between
cash and accrual amounts. Further, the use of accrual measurement needs to
be considered carefully to avoid subjecting the primary budget data to
large and volatile reestimates. We also pointed out that accrual budgeting
based on current federal accounting standards would not recognize social
insurance benefits because those standards do not view social insurance as
a liability beyond the amount due and payable to current beneficiaries at
the end of the period. We suggested alternative budgetary approaches could
be used to recognize the future costs of Social Security benefits. For
example, Social Security outlays could be recorded in the same amount as
Social Security receipts to reflect the government*s commitment to spend
those amounts on benefits in the future. Such an approach may serve to
prompt earlier recognition of future claims supported by earmarked 35 See
GAO/ AIMD- 00- 57.

36 Accrual budgeting for capital assets based on depreciation matches
budget costs with the provision of goods and services but, without
compensating controls, raises issues about upfront cost recognition and
control over capital asset acquisitions.

Page 40 GAO- 03- 213 Fiscal Exposures

receipts. On the other hand, this approach would represent a significant
change in budgetary treatment and could reduce fiscal discipline for
spending in programs financed by earmarked receipts.

Two methods could be used to incorporate accrual- based costs directly
into the budget for fiscal exposures. One method (the aggregate outlay
method) would be to use accrual- based measurement to recognize costs in
both budget authority needed and net outlays. Under this method, the
accrued cost of the fiscal exposure would be included in the budget totals
and therefore in the budget deficit/ surplus. This method is similar to
that used for credit programs under credit reform. Another method (the
aggregate budget authority method) would use accrual- based measurement to
recognize costs in budget authority at the account level and in the
aggregate budget totals. Accrued costs would also be reflected

in net outlays at the account level but then would be offset by a transfer
within the budget to another account. Aggregate net outlays and thus the
deficit/ surplus would continue to be reported on a cash basis. This is
similar to the method currently used for some employee pension costs.

A key advantage of budgeting for the accruing costs of exposures is the
recognition of the government's costs at the time decisions are being made
to commit the government. This earlier recognition of costs improves the
information available to policymakers about the costs associated with
current decisions and may improve the incentives to manage these costs.
However, this benefit is dependent on reasonable, unbiased estimates of
the government's costs. For some programs, such as life insurance,
reasonable cost estimates may be available, but for other programs such as
deposit insurance, health care costs, or social insurance benefits,
estimates are less certain. Because the future costs of some exposures are
dependent upon many economic and technical variables that cannot be known
in advance, there will always be uncertainty in cost estimates. Such
uncertainty makes using accrual- based measurement directly in the budget
more difficult. Budgeting for accruing costs may make sense for some
exposures but not for others because the certainty of the government*s
commitment and the availability of reasonable, unbiased estimates varies

across the different fiscal exposures.

Page 41 GAO- 03- 213 Fiscal Exposures

Using accrual- based measurement in the budget has the potential to
increase the complexity of the budget in several ways. Complexity may be
increased through the use of (1) sophisticated estimation models, (2)
multiple budget accounts and/ or presentations to reflect cash flows and
program reserves, and (3) procedures to handle reestimates of costs
reported as budget authority and/ or outlays. Although recognition of
costs may be improved, general understanding of budget data and the budget
process may decline. Further, if estimates are seen as short- term gaming
or overly erratic, credibility is eroded. Stopping short of using accrual-
based measurement for aggregate outlays and measuring only budget
authority and agency outlays on an accrual basis would mitigate some of
the potential problems associated with accrual budgeting while providing
information on future costs. For example, if aggregate outlays remain on a
cash basis and only budget authority and agency outlays are accrual based,

there would be no need for nonbudgetary accounts 37 that are necessary to
hold reserves under an aggregate outlay approach. This aggregate budget
authority option also would avoid introducing estimation uncertainty into
the budget deficit/ surplus that with limited exception is calculated as
net cash outlays. However, since the accrual- based cost would not be
reflected in the budget deficit/ surplus, it is unclear how much this
approach would

affect the budget decision- making process. Conclusion Today*s budget
decisions, in part, shape the choices and resources available to future
decisionmakers and taxpayers. Accordingly, today*s budget decisions
involve tradeoffs between satisfying current needs and fulfilling
stewardship responsibilities to future generations* budget and economy.
The federal government undertakes a wide range of responsibilities,
programs, and activities that may obligate the government to future
spending or simply create an expectation for such spending. Current budget
reporting, however, is not always designed to promote the

recognition and explicit consideration of some of these *fiscal
exposures.* These exposures range from explicit liabilities to the
implicit promises embedded in current policy or public expectations.
Failure to understand and address these exposures can have significant
consequences. Regardless of whether the government is legally required or
simply

37 Nonbudgetary accounts appear in the budget document for information
purposes but are not included in the budget totals for budget authority or
outlays. They account for transactions of the government that do not
belong within the budget because they are a means of financing and do not
represent a cost to the government.

Page 42 GAO- 03- 213 Fiscal Exposures

compelled by circumstances to provide funding in the future, these
exposures may encumber future budgets and constrain fiscal policy. Not
capturing the long- term costs of current decisions limits Congress*s
ability to control the government*s fiscal exposures at the time decisions
are made. The diversity of items that could be considered fiscal exposures
increases

the difficulty of determining which items should be considered and how and
to what extent they should be handled in the budget process. Specifically,
budgeting for fiscal exposures is complicated by difficulties in (1)
determining which items should be considered fiscal exposures and (2)
estimating their costs. Despite these challenges, the potentially
significant effects of these items on the nation*s future fiscal condition

warrant efforts to improve disclosure and oversight. The diversity of
fiscal exposures suggests that across- the- board changes in budget
reporting or process would not be the most appropriate way to proceed.
Instead, it would be more useful to look at different types of fiscal
exposures and tailor changes to address specific budgetary objectives and
implementation challenges. Improved supplemental reporting would be
helpful in increasing awareness without introducing uncertainty and
complexity into the primary budget data. In cases where the extent of the
government*s obligation or ultimate costs (or both) is unclear,
supplemental reporting may be the most appropriate approach. Beyond simply
increasing awareness, adapting the budget process to facilitate

explicit consideration of fiscal exposures might be possible. Finally, for
exposures where the government*s obligation is explicit and reasonable
cost estimates are available, additional steps could be taken to directly
incorporate costs in some primary budget data when doing so would enhance
up- front control of spending. The direct incorporation of accrualbased

measures in the budget may be appropriate for selected exposures where
such treatment would enhance obligation- based control by prompting the
recognition of expected future costs of decisions when they are made. With
complete and highly visible reporting of fiscal exposures,

decisionmakers are better positioned to address future costs and to help
prevent unexpected changes in fiscal policy. Since today*s decisions
affect the choices and resources available for the future, improvements in
budgeting for fiscal exposures are critically important.

Page 43 GAO- 03- 213 Fiscal Exposures

Recommendations for Executive Action

OMB should report annually on fiscal exposures, including a concise list
and description of such exposures, cost estimates, where possible, and an
assessment of methodologies and data used to produce cost estimates for
such exposures. In addition, where possible, OMB should report the
estimated costs associated with certain exposures as a new budget
concept** exposure level** as a notational item in the Program and
Financing schedule of the President*s budget. For select areas where an
explicit liability exists and there are accepted cost- estimation
methodologies, the ultimate objective might be to include the costs
directly in the budget when doing so would enhance obligation- based
control. OMB also should ensure that agencies focus on improving cost
estimates

for fiscal exposures. These steps should complement and support continued
and improved reporting of long- range projections and analysis of the
budget as a whole to assess fiscal sustainability and flexibility.

Matters for Congressional Consideration

Congress may wish to consider exploring options for improving the
information available and the attention given to fiscal exposures in the
budget and budget process. If more explicit congressional consideration is
desired, as estimates improve, Congress may wish to develop budget process
mechanisms that prompt more deliberation about fiscal exposures while
recognizing the uncertainty inherent in estimating some long- term costs.

Agency Comments and Our Evaluation

We provided a draft of this report to the Office of Management and Budget
for comment. In consultation with OMB staff, they commended GAO for
tackling the important problem of the government*s exposure to future
fiscal demands. OMB staff agreed that our concept of *fiscal exposure* is
a valuable one, noting that it focuses attention on the fact that 1-
year*s surplus or deficit is not the only, or even the best, measure of
the

government*s fiscal condition. They noted that the Administration endorses
the view that long- range fiscal exposures should be more prominently
highlighted in the budget documents and in the budget process, and noted
that some of the specific recommendations are more or less consistent with
legislation the Administration has proposed to Congress (accruals for
pensions and retiree health care). OMB staff, however, raised two general
concerns that are discussed below. First, they questioned whether the
broad conceptual framework used to describe fiscal exposures had been
fully developed to sufficiently cover all future spending. Secondly, they
argued that the analysis of ideas for improving the recognition of fiscal

Page 44 GAO- 03- 213 Fiscal Exposures

exposures in the budget could be improved by more fully considering the
various purposes of the federal budget, such as resource allocation and
controlling spending. In addition, they provided specific comments that we
have incorporated in the report as appropriate. OMB staff stated that the
term *exposure* is particularly laudable because

it captures the contingent nature of some future budgetary requirements,
which are critical to distinguish from the more definite, legally binding
requirements that are categorized as *liabilities* on the financial

statements. OMB staff also noted that the draft appropriately emphasizes
that fiscal exposures lie along a continuum and recognized that this
heterogeneity requires that different fiscal exposures be addressed in
different ways for the budget documents. They, however, commented that the
discussion of fiscal exposures could be improved by explicitly recognizing
that in concept all, or virtually all, future spending appears on the
continuum of fiscal exposure. For example, OMB staff pointed out that the
Constitution establishes a responsibility to *provide for the common
defense* and the authority for an Army and a Navy, and more than two
centuries of experience have created an expectation that this
responsibility

will be met and the cost will be high. They stated that while the future
costs of these functions do not appear in the financial statements, they
are no less basic expectations of government than others that do appear
there. We agree that it is important to model the long- term outlook for
the budget

as a whole at the macro level. Indeed, we have been doing such long- term
modeling since 1992 and we commend OMB*s efforts to present long- term
scenarios in the Analytical Perspectives of the President*s budget. While
long- term modeling simulates the long- term implications of all current
spending and revenue policies, the fiscal exposure concept is intended to
highlight a discrete subset of programs and activities whose long- term
costs and uncertainties warrant greater attention in current budgetary
deliberations.

OMB staff also stated that a number of the ideas and recommendations in
the draft are very good, and point to improvements that should be made in
the budget. OMB staff, however, argued that the analysis of
recommendations should more explicitly consider their effects on the main
purposes of budgetingto allocate resources, control agency spending, and
set aggregate fiscal policy. We agree that the various purposes of the
budget should be considered in assessing the merits of approaches and
options for improving the budget treatment of fiscal exposures. We did, in

fact, structure our discussion of potential approaches for improving the
budget treatment of fiscal exposures around objectives of budget reforms.

Page 45 GAO- 03- 213 Fiscal Exposures

As part of our illustrative examples, we provided insights into the
potential issues for the multiple, and sometimes conflicting, purposes of
the federal budget. We agree, however, that these issues warrant further
investigation if specific reforms are pursued.

As agreed with your office, unless you release this report earlier, we
will not distribute it until 30 days from the date of this letter. At that
time we will send copies to the Ranking Minority Member of the House
Committee on the Budget and the chairmen and ranking minority members of
the Senate Committee on the Budget. We are also sending copies to the
Directors of the Office of Management and Budget and the Congressional
Budget Office. Copies will also be made available to others upon request.
In addition, the report is available at no charge on GAO*s Web site at
http:// www. gao. gov.

This report was prepared under the direction of Christine Bonham,
Assistant Director, Strategic Issues, who may be reached at (202) 512-
9576. Elizabeth McClarin was a major contributor to this report. Please
contact me at (202) 512- 9573 if you or your staff have any questions
concerning this report.

Sincerely yours, Paul L. Posner Managing Director, Strategic Issues
Federal Budget Analysis

(450021)

United States General Accounting Office Washington, D. C. 20548- 0001

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