Budget Process: Long-term Focus Is Critical (23-MAR-04, 	 
GAO-04-585T).							 
                                                                 
The structure of the budget process can help ensure that budget  
decision makers are presented with the information and choices	 
for timely and informed decisionmaking. GAO's long-term budget	 
simulations show that, absent substantive entitlement reform	 
and/or dramatic changes in tax and spending policies, we will	 
face large, escalating, and persistent deficits. A budget process
incorporating new metrics and mechanisms that better signal the  
long-term commitments and promises made by the government will	 
help concentrate decision makers' efforts on long-term		 
sustainability. 						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-585T					        
    ACCNO:   A09548						        
  TITLE:     Budget Process: Long-term Focus Is Critical	      
     DATE:   03/23/2004 
  SUBJECT:   Fiscal policies					 
	     Future budget projections				 
	     Strategic planning 				 
	     Budget functions					 
	     Budget administration				 

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GAO-04-585T

United States General Accounting Office

GAO Testimony

Before the Subcommittee on Legislative and Budget Process, Committee on
Rules, House of Representatives

For Release on Delivery

Expected at 11:00 a.m. EST BUDGET PROCESS

Tuesday, March 23, 2004

                          Long-term Focus Is Critical

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

GAO-04-585T

March 23, 2004

BUDGET PROCESS

Long-term Focus Is Critical

The long-term fiscal pressures created by the impending retirement of the
baby boom generation sharpen the need to look at competing claims on
existing federal budgetary resources and emerging new priorities. Truth
and transparency in government reporting are essential if the United
States is to effectively address these long-term fiscal challenges.
Current metrics and mechanisms do not fully inform policy makers about the
sustainability of existing federal programs or commitments they are
considering making. While Social Security and health programs are the
major drivers of the longterm spending outlook, they are not the only
promises the federal government has made to the future. The 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. It is useful to think of such fiscal
exposures as a spectrum extending from explicit liabilities to the
implicit promises embedded in current policy and/or public expectations.

Selected Fiscal Exposures (End of FY 2003)

Highlights of GAO-04-585T, a testimony before the Subcommittee on
Legislative and Budget Process, Committee on Rules, House of
Representatives

The structure of the budget process can help ensure that budget decision
makers are presented with the information and choices for timely and
informed decisionmaking. GAO's long-term budget simulations show that,
absent substantive entitlement reform and/or dramatic changes in tax and
spending policies, we will face large, escalating, and persistent
deficits. A budget process incorporating new metrics and mechanisms that
better signal the long-term commitments and promises made by the
government will help concentrate decision makers' efforts on long-term
sustainability.

Type Example (dollars in billions)

The reinstitution of realistic Explicit liabilities	Publicly held debt
($3,913) Military and civilian pension and post-retirement health ($2,857)

spending caps and PAYGO is Veterans benefits payable ($955) necessary to
deal with the near-Environmental and disposal liabilities ($250)

and medium-term deficit. Beyond Loan guarantees ($35) that, a fundamental
reexamination of existing programs and activities must be undertaken. To
enable budget decision makers to consider the full range of the
government's commitments, OMB should report annually on fiscal exposures,
including a concise list and cost estimates, where possible. To address
the nation's fiscal imbalance, we need to employ a three-pronged approach
to (1) restructure existing entitlement programs, (2) reexamine the base
of discretionary and other spending, and (3) review and revise the federal
government's tax policy and enforcement programs.

www.gao.gov/cgi-bin/getrpt?GAO-04-585T.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact Susan J. Irving at (202)
512-9142 or [email protected].

Explicit financial Undelivered orders ($596) commitments Long-term leases
($47)

Explicit financial Unadjudicated claims ($9)

contingencies	Pension Benefit Guaranty Corporation ($86) Other national
insurance programs ($7) Government corporations e.g., Ginnie Mae

Implicit exposures implied by Debt held by government accounts ($2,859)a
current policies or the public's Future Social Security benefit payments
($3,550)b expectations about the role of Future Medicare Part A benefit
payments ($5,931)b government Future Medicare Part B benefit payments
($9,619)b

Life cycle cost including deferred and future maintenance and operating
costs (amount unknown) Government Sponsored Enterprises e.g., Fannie Mae
and Freddie Mac

Source: GAO analysis.

Note: Updated February 27, 2004.

aThis amount includes $774 billion in securities held by military and
civilian pension funds that would offset the explicit liabilities reported
by those funds.

bFigures for Social Security and Medicare are as of January 1, 2003, and
are estimated over a 75year period. These amounts represent net present
value and are net of debt held by the trust funds ($1,378 billion for
Social Security, $235 billion for Medicare Part A, and $34 billion for
Medicare Part B). The estimate for Social Security over an infinite
horizon would be $10.5 trillion according to the Social Security Trustees'
2003 annual report. There is no infinite horizon estimate for Medicare
included in the Medicare Trustees' 2003 annual report. Medicare Part D was
enacted after the end of FY 2003.

Madam Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss budget process reform ideas that
can help the Congress deal with the long-range fiscal challenges facing
our nation. I want to thank the Subcommittee for its role in beginning the
discussion and debate on what the nation needs to do to address our large
and growing fiscal challenges. As part of that discussion, today we are
focused on how best to structure a budget process to help ensure that
decision makers are presented with the information and choices for timely
and informed decision-making. While former Congressional Budget Office
(CBO) Director Rudy Penner was correct when he said, "The problem is not
the process, the problem is the problem," process is important. A lack of
process and discipline can certainly work against attempts to make the
difficult decisions that will be required to address our large and growing
fiscal imbalance. And, a process that illuminates the looming fiscal
pressures and provides appropriate incentives can at least help decision
makers focus on the right questions.

As you look at the challenge of updating the budget process, you face a
two-pronged challenge: first, the need to reinstitute controls to deal
with the near-and medium-term deficit; and second, the need to design a
process that helps the Congress tackle the formidable long-term fiscal
challenges facing this nation. With regard to deficit reduction in the
nearand medium term, changes on both sides of the ledger affect the bottom
line. I endorse what many budget experts have suggested here and
elsewhere-namely, the restoration of realistic caps and of pay-as-you-go
(PAYGO) discipline. Today, however, I want to focus more on the role the
budget process can play in dealing with the longer-term budget and fiscal
challenges facing this nation. Indeed, since at its heart the budget
debate is about the allocation of limited resources, it is understandable
and appropriate for the budget process to play a key role in helping to
address our broader challenge of modernizing government for the 21st
century.

The long-term fiscal pressures created by the impending retirement of the
baby boom generation, rising health care costs and increased homeland
security and defense commitments sharpen the need to look at competing
claims on existing federal budgetary resources and emerging new
priorities. As we look ahead, our nation faces an unprecedented
demographic challenge. Between now and 2035, the number of people who are
65 years old or over is expected to double, driving federal spending on
the elderly to a larger and ultimately unsustainable share of the federal
budget. Absent substantive entitlement reform and/or dramatic

  The Long-term Budget Challenge

changes in tax and spending policies, we will face large, escalating, and
persistent deficits.

For over ten years, the GAO has periodically prepared various long-term
budget simulations that seek to illustrate the likely fiscal consequences
of our coming demographic challenges and rising health care costs. Our
latest long-term budget simulations reinforce the need for change in the
major long-range cost drivers-Social Security and health care programs. As
shown in figure 1, by 2040, assuming no changes to currently projected
benefits or revenues, projected federal revenues may be adequate to pay
little beyond interest on the debt.

Figure 1:Composition of Spending as a Share of GDP Assuming Discretionary
Spending Grows with GDP after 2004 and All Expiring Tax Provisions Are
Extended

Percent of GDP 50

40

30

20

10

0 2003 2015 2030 2040

Fiscal year

All other spending

Medicare and Medicaid

Social Security

Net interest

Source: GAO's January 2004 analysis.

Notes: Although expiring tax provisions are extended, revenue as a share
of GDP increases through 2014 due to (1) real bracket creep, (2) more
taxpayers becoming subject to the AMT, and (3) increased revenue from
tax-deferred retirement accounts. After 2014, revenue as a share of GDP is
held constant.

Reducing the relative future burdens of Social Security and federal health
programs is critical to promoting a sustainable budget policy over the
longer term. Absent reform, the impact of federal health and retirement
programs on budget choices will be increasingly felt as the baby boom
generation retires. While much of the public debate concerning the Social
Security and Medicare programs focuses on trust fund balances-that is, on
the programs' solvency-the larger challenge facing these programs is how
to assure their longer-term security and sustainability.

The Social Security and Medicare Health Insurance (HI) programs are
currently running surpluses that are invested in U.S. Treasury securities,
resulting in an accumulated balance of Treasury assets that can be drawn
upon to pay future benefits. According to the 2003 Trustees' projections,
these trust funds would be considered insolvent in 20421 for Social
Security and in 2026 for Medicare HI.

The information on insolvency provides one signal to policy makers that
claims will exceed trust fund balances, but this measure alone can provide
a false sense of security regarding these important federal programs. If
we rely solely on trust fund insolvency to trigger actions to reform these
programs, we will have delayed action far past the point when these two
programs have become a significant and unsustainable fiscal burden on the
federal government as a whole. Based on the 2003 Trustees Reports, the
cash flows for Social Security will shift to a deficit in 2018 and for
Medicare HI in 2013-at these points, both programs will then have to draw
on their accumulated IOUs from the Treasury to pay a portion of benefits.
The only way that Treasury can pay off these IOUs is by increased taxes,
spending cuts, or increased borrowing from the public, or some combination
of the three. Moreover, the trust funds' balances do not reflect the full
future cost of existing government commitments. In addition, the HI trust
fund reflects only a portion of the Medicare program, which is financed
primarily through payroll taxes. Other parts of the Medicare program
include the Part B Supplementary Medical Insurance component and the new
Part D drug benefit, both of which are financed through general revenues
and beneficiary premiums. Taken as a whole, the Medicare program is
fiscally unsustainable in its present form as program expenditures are
expected to exceed program revenues dramatically in the future. From a
macro perspective the critical question is not how much a trust fund has
in assets, but whether the government as a whole has the economic capacity
to finance the benefits promised by these programs both now and in the
future and, if so, at what cost, and with what implications.

As a result, we need to incorporate new metrics and mechanisms into the
budget process that better signal the long-term commitments and implicit
promises made by the government-its fiscal exposures-so that decision

1 The year 2042 is when the combined Social Security trust fund-the Old
Age and Survivors Insurance and Disability Insurance trust funds-is
projected to become insolvent.

  Fiscal Exposures Are Wide-ranging and Varied

makers' attention and efforts can be more concentrated on their long-term
sustainability. The difficulty of developing meaningful measures of
sustainability is exacerbated by the length of time covered by our
longterm commitments. The longer the span of time between the collection
and the expenditure of funds, the greater the uncertainty involved in
forecasting future needs. Since trust fund balances do not fully inform
policymakers and the public about the long-term sustainability of the
programs financed by earmarked funds, consideration is warranted of other
ways to make the long-term implications of spending and tax proposals and
policies more apparent when making budget decisions. The future
sustainability of programs is the key issue policymakers should
address-that is, the capacity of the economy and budget to afford the
proposed actions.

While Social Security, Medicare, and Medicaid are the major drivers of the
long-term spending outlook in the aggregate, they are not the only
promises the federal government has made to the future.2 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 obligations. 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 a spectrum extending from explicit
liabilities to the implicit promises embedded in current policy and/or
public expectations. Figure 2 shows some selected fiscal exposures. These
liabilities, commitments, and implicit exposures have created a fiscal
imbalance that will put unprecedented strains on the nation's spending and
tax policies. In addition, certain tax expenditures3 may have uncertain or
accelerating future growth paths that have significant implications for
the long term. Although economic growth can help, our projected fiscal

2 While interest is a large and growing share of the budget, it does not
directly drive the fiscal outlook in that interest is the result of other
decisions affecting spending and tax policy.

3 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.

gap is now so large that we will not be able to simply grow our way out of
the problem. Tough choices are inevitable.

              Figure 2: Selected Fiscal Exposures (End of FY 2003)

Type Example (dollars in billions)

Explicit liabilities	Publicly held debt ($3,913) Military and civilian
pension and post-retirement health ($2,857) Veterans benefits payable
($955) Environmental and disposal liabilities ($250) Loan guarantees ($35)
Explicit financial Undelivered orders ($596) commitments Long-term leases
($47)

Explicit financial Unadjudicated claims ($9)

contingencies	Pension Benefit Guaranty Corporation ($86) Other national
insurance programs ($7) Government corporations e.g., Ginnie Mae

Implicit exposures implied by Debt held by government accounts ($2,859)a
current policies or the public's Future Social Security benefit payments
($3,550)b expectations about the role of Future Medicare Part A benefit
payments ($5,931)b government Future Medicare Part B benefit payments
($9,619)b

Life cycle cost including deferred and future maintenance and operating
costs (amount unknown) Government Sponsored Enterprises e.g., Fannie Mae
and Freddie Mac

Source: GAO analysis.

Note: Updated February 27, 2004.

aThis amount includes $774 billion in securities held by military and
civilian pension funds that would offset the explicit liabilities reported
by those funds.

bFigures for Social Security and Medicare are as of January 1, 2003, and
are estimated over a 75year period. These amounts represent net present
value and are net of debt held by the trust funds ($1,378 billion for
Social Security, $235 billion for Medicare Part A, and $34 billion for
Medicare Part B). The estimate for Social Security over an infinite
horizon would be $10.5 trillion according to the Social Security Trustees'
2003 annual report. There is no infinite horizon estimate for Medicare
included in the Medicare Trustees' 2003 annual report. Medicare Part D was
enacted after the end of FY 2003.

Particularly troubling are the many existing "big-ticket" items that
taxpayers will eventually have to deal with. The federal government has
pledged its support to a long list of programs and activities, including
pension and health care benefits for senior citizens, veterans' medical
care, and, implicitly, various government-sponsored entities, whose
potential claims on future spending total tens of trillions of dollars.
Despite their serious implications for future budgets, tax burdens, and
spending flexibilities, these fiscal exposures often get short shrift in

reporting on the government's current financial condition and in budgetary
deliberations. Even though some fiscal exposures stem from liabilities and
are reported in the financial statements, their recognition in the current
cash- and obligation-based budget process is wholly inadequate. And beyond
explicit liabilities and contingencies, there are implicit
exposures-implied commitments embedded in the government's current
policies or in the public's expectations about the role of government-that
may encumber future budgets or reduce fiscal flexibility. One example is
the life cycle cost of fixed assets, including deferred and future
maintenance and operating costs.

An exposure recognized in the financial statements is the federal
government's gross debt which, as of September 2003, was about $7
trillion, or about $24,000 for every man, woman, and child in this country
today. But that number excludes items such as the gap between promised and
funded Social Security and Medicare commitments. If these items are
factored in, the burden for every American rises to well over $100,000. In
addition, the new Medicare prescription drug benefit will add thousands
more to that tab.

The new drug benefit is one of the largest unfunded commitments ever
undertaken by the federal government. The Trustees of the Social Security
and Medicare trust funds will include an official estimate of the
discounted present value cost of this new benefit over the next 75 years
in their annual report, which is scheduled for issuance today. Preliminary
estimates of its long-term cost range up to $7-8 trillion in discounted
present value terms over a 75-year period. To put that number in
perspective, it is as much or more than the total amount of the federal
government's gross debt outstanding as of September 30, 2003. Even before
the drug benefit was enacted, our long-term simulations showed that by
2040, the federal government may have to cut federal spending in half or
double taxes to pay for the mounting cost of the government's unfunded
commitments. Either would have devastating consequences on the nation's
future economy and the quality of life for Americans in the future.

Where Do We Go 	Truth and transparency in government reporting are
essential if the United States is to effectively address its long-term
fiscal challenges. The fiscal

from Here? 	exposures just mentioned can be managed only if they are
properly accounted for and publicly disclosed. A crucial first step will
be to face facts and identify the many significant commitments already
facing the federal government. If citizens and government officials come
to

understand various fiscal exposures and their potential claims on future
budgets, they are more likely to insist on prudent policy choices today
and sensible levels of fiscal risk in the future.

So how do we start this hard process? Today you are focusing on budget
process improvements, so I will start there. We need a process that does
two things better than the processes we have used in the past. The budget
process needs (1) better transparency and controls about the fiscal
exposures/commitments that the federal government is considering making
and (2) better signals and incentives to address the fiscal
exposures/commitments the federal government has already made. GAO has
encouraged reforms that would help move forward on both fronts.

Transparency of existing commitments would be improved by requiring that
the Office of Management and Budget (OMB) report annually on fiscal
exposures, including a concise list, description, and cost estimates,
where possible. OMB should also ensure that agencies focus on improving
cost estimates for fiscal exposures. This 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.

Others have also embraced this idea for better reporting of fiscal
exposures. Last year Senator Voinovich proposed that the President report
each January on the fiscal exposures of the federal government and their
implications for long-term financial health. The President's fiscal year
2005 budget proposes that future Presidents' budgets report on any enacted
legislation in the past year that worsens the unfunded obligations of
programs with long-term actuarial projections, with CBO being required to
make a similar report. Senator Voinovich's bill would require GAO to
review the President's report on fiscal exposures for completeness,
quality and the long-range fiscal outlook. Senator Lieberman has also
introduced legislation to require better information on liabilities and
commitments over both a 75-year and indefinite time horizon. Such
reporting would be a good starting point. Senator Lieberman's bill
provides for a point of order against bills that adversely affect the net
present value of overall liabilities and commitments by more that a
specified amount.

Better information on existing commitments and promises must be coupled
with estimates of the long-term discounted net present value cost of any
new proposed commitments. Ten-year budget projections have been available
to decision makers for many years. We must build on that regime but also
incorporate longer-term estimates of net present value costs for spending
and tax commitments comprising longer-term

exposures for the federal budget beyond the 10-year window. Better
reporting is just a starting point, however.

While Social Security and Medicare drive the long-term spending outlook,
decisions are made about a whole host of other programs with long-term
implications too small to drive the long-term outlook. A budget is all
about how to allocate available resources. Budget decisions reflect a
number of factors including beliefs about the appropriate role of
government in various areas, judgment about the likely success of a
program in achieving certain goals, and the cost of a program. It is
important that Members of the Congress and the President-and citizens-be
able to compare the full costs of programs on a consistent basis. In the
past, GAO has suggested that the budget numbers should themselves reflect
long-term cost commitments for programs such as credit, federal pension
and retiree health benefits, and insurance programs. The Federal Credit
Reform Act of 1990 put credit programs on a comparable basis with grants
and other assistance programs. This reform enabled decision makers to
budget for credit based on the net present value of the federal subsidies
over the life of the loan or guarantee. We have suggested that a similar
treatment be applied to insurance programs in which the cost of the
program in the budget would, in effect, be the missing premium-the subsidy
provided by the government to the insured. This approach was included in
legislation sponsored by Congressmen Nussle and Cardin several years ago.
They recognized, as did GAO, that the budget's current cash treatment of
insurance programs could misstate the cost of the commitments that have
been made. Some improvements have been made in budgeting for federal
pension and retiree health benefits, but they have not been applied to all
employees.

Along with better reporting, budget process mechanisms could establish
opportunities for the explicit consideration of important fiscal
exposures-both new and existing. When considering the creation of new
exposures, Congress could modify budget rules to provide for a point of
order against any proposed legislation that creates new spending or tax
exposures over some specified level or trigger. This would encourage the
explicit consideration of potential future costs. To make sure the cost
estimates are made available, rules could also provide for a point of
order against any proposed legislation that does not include estimates of
the potential costs of fiscal exposures it would create.

A different budget process approach would be to establish triggers that
address the growth in existing exposures. Triggers would signal when the
future costs of exposures rise above a certain level. Reaching the trigger

  Looking More Broadly

would require some action to address costs or reaffirm acceptance of the
increase in potential fiscal exposure. There are many different ways to
construct a trigger. Possible triggers include future costs of a specific
exposure exceeding a specified dollar amount, or expected program growth
beyond a specified share of the federal budget or the gross domestic
product. Congress already adopted an approach similar to this for the
Medicare program last year. Under this process, the program as a whole
would trigger a requirement for presidential and congressional
consideration when the general revenue share of Medicare funding is
projected in two consecutive years to exceed 45 percent during a 7-year
period. The design of triggers is important and has implications for the
mix of financing to be provided for covered programs. My staff would be
happy to work with you if you choose this approach.

We must look through a wide-angle lens when deciding what to do about the
nation's fiscal imbalance. Based on realistic assumptions, our future
fiscal gap is simply too great to grow our way out of the problem. As a
result, we need to employ a three-pronged approach to (1) restructure
existing entitlement programs, (2) reexamine the base of discretionary and
other spending, and (3) review and revise the federal government's tax
policy and enforcement programs. Fundamentally, we need to undertake a
top-to-bottom review of government activities to ensure their relevance
and fit for the 21st century and their relative priority. The
understanding and support of the American people will be critical in
providing a foundation for action. The fiscal risks I have discussed,
however, are a long-term problem whose full impact will not be felt for
some time. At the same time they are very real and time is currently
working against us.

While I agree with others that realistic spending caps and the restoration
of PAYGO are necessary, additional actions are needed to prompt a
reexamination of existing programs and activities. In the 1990s, the
Congress and the Administration put in place a set of laws designed to
improve information about cost and performance. More performance
information has become available thanks to 10 years of experience under
the Government Performance and Results Act (GPRA) and better financial and
cost information has been produced as a result of legislative actions,
including the Chief Financial Officers (CFO) Act of 1990. This information
can clearly help inform the debate about what the federal government
should do and how it should do business.

Congress now has the challenge to use new information and data to engage
in a process to systematically reexamine the base of federal

programs across the entire budget. In previous testimonies and reports, we
have suggested that Congress might equip itself to engage in this debate
by (1) establishing a vehicle for communicating performance goals and
measures for key congressional priorities; (2) developing a more
structured oversight agenda to permit a more coordinated congressional
perspective on crosscutting programs and policies; and (3) using such an
agenda to inform its authorization, oversight and appropriations
processes. Some have suggested a commission to jump-start this process
while others have suggested periodic sunsetting of major programs. We at
GAO stand ready to provide assistance to whatever process Congress chooses
for this important work.

Such a process can be supported by a national education campaign and
outreach effort to help the public understand the nature and magnitude of
the long-term financial challenge facing this nation. After all, an
informed electorate is essential for a sound democracy. Members of
Generation X and Y especially need to become active in this discussion
because they and their children will bear the heaviest burden if policy
makers fail to act in a timely and responsible manner. The difficult but
necessary choices we face will be facilitated if the public has the facts
and comes to support serious and sustained action to address the nation's
fiscal challenges.

In closing, Madam Chairman, I want to reiterate the value of sustained
congressional interest in these issues, as demonstrated by this
Subcommittee's hearing.

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