Federal Financial Management: Critical Accountability and Fiscal 
Stewardship Challenges Facing Our Nation (01-MAR-07,		 
GAO-07-542T).							 
                                                                 
The foundation laid by the Chief Financial Officers Act of 1990  
and other management reform legislation provided a much needed	 
statutory basis to improve the accountability of government	 
programs and operations. Such reforms were intended to produce	 
reliable, timely, and useful financial information to help manage
day-to- day operations and exercise oversight and promote fiscal 
stewardship. This testimony, based on GAO's prior work, addresses
(1) the progress made and challenges remaining to improve federal
financial management practices, and (2) the serious challenges	 
posed by the government's deteriorating long-range fiscal	 
condition and the Comptroller General's views on a possible way  
forward.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-542T					        
    ACCNO:   A66367						        
  TITLE:     Federal Financial Management: Critical Accountability and
Fiscal Stewardship Challenges Facing Our Nation 		 
     DATE:   03/01/2007 
  SUBJECT:   Accountability					 
	     Accounting procedures				 
	     Accounting standards				 
	     Budget deficit					 
	     Budget outlays					 
	     Erroneous payments 				 
	     Federal legislation				 
	     Financial management				 
	     Financial management systems			 
	     Financial records					 
	     Fiscal policies					 
	     Internal controls					 
	     Performance management				 
	     Policy evaluation					 
	     Reporting requirements				 
	     Financial reporting				 

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GAO-07-542T

   

     * [1]Summary
     * [2]Progress Made and the Key Challenges that Remain in Improvin

          * [3]Progress Made since Passage of Key Federal Financial Managem
          * [4]Financial Management Challenges Facing the Federal Governmen

               * [5]Transforming DOD's Financial and Business Management
                 Practic
               * [6]Improving Agency Financial and Performance Reporting
               * [7]Modernizing Financial Management Systems
               * [8]Addressing Long-standing Internal Control Weaknesses
               * [9]Building a Financial Management Workforce for the Future
               * [10]Strengthening Consolidated Financial Reporting

     * [11]Fiscal Stewardship Is an Increasingly Critical Challenge

          * [12]The Long-Term Fiscal Outlook
          * [13]A Possible Way Forward

     * [14]Concluding Remarks
     * [15]Contacts and Acknowledgments
     * [16]GAO's Mission
     * [17]Obtaining Copies of GAO Reports and Testimony

          * [18]Order by Mail or Phone

     * [19]To Report Fraud, Waste, and Abuse in Federal Programs
     * [20]Congressional Relations
     * [21]Public Affairs

United States Government Accountability Office

GAO

For Release on Delivery Expected at 3:00 p.m. EST

March 1, 2007

FEDERAL FINANCIAL MANAGEMENT

Critical Accountability and Fiscal Stewardship Challenges Facing Our
Nation

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

GAO-07-542T

Testimony

Before the Subcommittee on Federal Financial Management, Government
Information, Federal Services, and International Security, Committee on
Homeland Security and Governmental Affairs, U.S. Senate

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to testify on the progress made towards a
results-oriented, accountable, and relevant government and the challenges
that must be addressed to provide accountability and exercise stewardship.
The foundation laid by the Chief Financial Officers (CFO) Act of 1990^1
and other management reform legislation provides a basis to improve the
accountability of government programs and operations as well as to
routinely produce valuable cost and operating performance information.
While certain material weaknesses in internal control and in selected
accounting and financial reporting practices continue to prevent GAO from
being able to issue an opinion on the consolidated financial statements of
the U.S. government, the federal government has come a long way since
enactment of the CFO Act. At the same time, there is a continuing need to
address persistent, long-standing accountability problems and to take
financial management to the next level. This will be important as the
federal government faces difficult fiscal challenges that will require
reliable cost and performance information to support timely decisions on
spending and, at the same time, pressures to address fraud, waste, abuse,
and mismanagement will only intensify.

From a broad financial management perspective, the federal government's
deteriorating long-range financial condition and long-term fiscal
imbalance are matters of increasing concern. We face large and growing
structural deficits due primarily to known demographic trends and rising
health care costs. There is a need to engage in a fundamental review,
reprioritization, and reengineering of the base of government.
Understanding and addressing the federal government's financial condition
and long-term fiscal imbalance are critical to maintain fiscal flexibility
so that we can respond to emerging social, economic, and security
challenges.

Your decision to begin this Congress with a hearing on these important
issues demonstrates the seriousness with which this Subcommittee views the
financial management challenges facing the federal government and your
commitment to address them. Today I would like to:

           o outline progress made to date and the key challenges in
           improving federal financial management practices, and

           o highlight the challenges posed by the government's fiscal
           condition and my views on a possible way forward.

^1Pub. L. No. 101-576, 104 Stat. 2838 (Nov. 15, 1990).

Our prior work on which this testimony is based was performed in
accordance with generally accepted government auditing standards.

Summary

Since the enactment of key financial management reforms, the federal
government has made substantial progress in strengthening financial
management. Since passage of the CFO Act, all of the administrations have
made financial management reform a priority. Improving financial
management has been one of the cornerstones of the President's Management
Agenda from the outset of the current administration, and the Executive
Branch Management Scorecard, which tracks the status of progress at
agencies, has been an effective tool to drive improvement. We have seen a
cultural change in how financial management is viewed and carried out in
most agencies and a recognition of the value and need for good financial
management throughout government, which was not the case in 1990 when the
Congress passed the CFO Act. Financial management systems have been
improved. Internal control has been strengthened, and the Office of
Management and Budget (OMB) has increased emphasis on establishing,
assessing, correcting, and reporting on internal control. Generally
accepted government accounting standards have been developed. For fiscal
year 2006, 19 of 24 CFO Act agencies received clean audit opinions on
their financial statements, up from just 6 for fiscal year 1996. Audited
financial statements for federal agencies were issued just 1 1/2 months
after the close of this fiscal year as opposed to 5 months, which was the
case just a few years ago.

A number of challenges remain to fully realizing the world-class financial
management anticipated by the Congress through the enactment of financial
management reform legislation. It will be critical that the federal
government meet these challenges so that reliable, useful, and timely
financial information is available not only for day-to-day management,
decision making, and oversight, but also to provide the key cost and
performance data needed to help address our nation's looming fiscal
crisis. I see six principal challenges, which I will highlight in my
testimony today against the backdrop of our nation's deteriorating
long-range financial condition and long-term fiscal imbalance.

           o There is a need to transform financial management and business
           practices at the Department of Defense (DOD) that adversely affect
           the department's and the federal government's ability to control
           costs; ensure basic accountability; anticipate future costs and
           claims on the budget; measure performance; maintain funds control;
           prevent fraud, waste, and abuse; and address pressing and
           persistent management problems. Of the 27 areas on GAO's high-risk
           list, 15 relate wholly or partially to DOD. The problems at DOD
           are deeply rooted and I do not anticipate they will be resolved in
           the near future, but meaningful progress should be expected.
           Today, we see a commitment from top DOD management, and actions
           are under way, such as the Financial Improvement and Audit
           Readiness (FIAR) plan, to address serious problems. In our view,
           DOD needs to (1) develop and implement a viable strategic plan
           with goals, objectives, key milestones, and measures to monitor
           and report on progress in transforming its key business
           operations, and (2) establish a chief management officer to
           oversee its overall business transformation efforts.

           o Improvements in financial and performance reporting practices
           are needed so that for the remaining 23 CFO Act agencies,
           unqualified opinions on financial statements become routine. In
           particular, the Department of Homeland Security (DHS)--an agency
           whose implementation and transformation we have designated as high
           risk since its inception--faces significant challenges to achieve
           this milestone. Developing and implementing corrective action
           plans to improve the underlying financial management systems and
           internal control will be necessary to address financial reporting
           problems.

           o Financial management systems must be modernized to provide the
           complete range of information needed for accountability,
           performance reporting, and decision making. While the problems are
           much more severe at some agencies than others, overall, agencies'
           current financial systems do not meet basic statutory systems
           requirements and, more importantly, do not provide timely,
           reliable, and useful information for day-to-day management. Our
           work has shown that best practices in systems implementation that
           can reduce risk are not being consistently applied when agencies
           undertake a major financial management system modernization
           effort. Full adoption of these best practices is equally important
           as OMB moves forward on its initiative to migrate agencies to
           shared service providers.

           o The federal government continues to face a myriad of material
           weaknesses and reportable conditions in internal control related
           to property, plant, and equipment; inventories and related
           property; liabilities and commitments and contingencies; and
           disbursement activities, just to mention a few of the problem
           areas. Particularly problematic to the U.S. government's
           consolidated financial statements is the lack of internal control
           to adequately account for and reconcile intragovernmental activity
           and balances. Agencies need to tackle long-standing internal
           control weaknesses by fully embracing the assessment, reporting,
           and corrective action approach called for in OMB's revised
           Circular No. A-123 and following intragovernmental procedures
           developed by OMB and the Department of the Treasury (Treasury).
           Another key problem area is the tens of billions of dollars
           federal agencies waste on improper payments.^2 Adopting our
           specific recommendations to improve reporting under the Improper
           Payments Information Act of 2002^3 is important to fully
           understand the nature and extent of this problem.

           o The federal financial workforce that supports the business needs
           of today is not well positioned to support the needs of tomorrow.
           The lack of a sufficient number of staff with the requisite
           knowledge, skills, and experience has hampered financial
           management operations at key agencies such as DOD and DHS. At
           Treasury, during our work on the U.S. government consolidated
           financial statements, we found that there were not enough
           personnel with specialized financial reporting experience to help
           ensure reliable financial reporting by the reporting date.
           Building a sufficient and sustainable financial management
           workforce for the future to support program managers and decision
           makers will require a workforce transformation strategy developed
           in partnership between agency CFOs and Chief Human Capital
           Officers, working with OMB and the Office of Personnel Management
           (OPM). To sustain financial management reform given the leadership
           changes that occur at the end of any administration, establishing
           management accountability at an appropriate level with significant
           authority, experience, and tenure to provide sustained leadership
           is needed to achieve successful and sustainable transformation.
           Establishing such positions at selected agencies, such as DOD and
           DHS, will be a critical success factor.

           o Three major impediments--that have existed for the entire
           10-year period GAO has been required to perform this annual
           audit--continue to prevent us from rendering an opinion on the
           U.S. government's consolidated financial statements: (1) the
           deeply rooted, long-standing, and pervasive financial management
           problems in DOD; (2) the federal government's inability to
           adequately account for and reconcile significant amounts in
           intragovernmental activity and balances between federal agencies;
           and (3) the federal government's ineffective process for preparing
           the consolidated financial statements. As I previously discussed,
           addressing the first two impediments will be difficult challenges.
           Resolving the weaknesses in the systems, controls, and procedures
           for preparing the consolidated financial statements will require a
           strong commitment from Treasury and OMB. Notwithstanding the
           difficulties to overcome current challenges, we should consider
           the need for further revisions to the current federal financial
           reporting model to recognize the unique needs of the federal
           government, which would affect both consolidated and agency
           financial reporting. While the current reporting model recognizes
           some of these needs, a broad reconsideration of issues such as the
           kind of information that may be relevant and useful for a
           sovereign nation, could stimulate needed discussion and lead to
           reporting enhancements that might help the Congress deliberate
           strategies to address our growing long-term fiscal imbalance. In
           this regard, we support the current efforts of the Federal
           Accounting Standards Advisory Board (FASAB) to begin a project on
           fiscal sustainability reporting. We also support a Statement of
           Fiscal Sustainability that clearly shows the extent to which
           future revenues are sufficient to support the federal government's
           growing entitlement and other spending. We believe that such
           reporting needs to reflect the significant commitments associated
           with the Social Security and Medicare programs while recognizing a
           liability for the net assets (principally investments in special
           U.S. Treasury securities) of the "trust funds." We also believe
           that any such statements need to consider the intergenerational
           implications of our current fiscal path. Other areas to reconsider
           might include the reporting of key outcome-based performance
           information, as well as the role of a balance sheet in the federal
           government reporting model. In addition, we support the
           preparation and publication of an easily understandable summary
           annual report that includes in a clear, concise, and transparent
           manner, key financial and performance information embodied in the
           Financial Report of the United States Government.

^2The Improper Payments Information Act of 2002 (Public Law 107-300)
defines improper payments as any payment that should not have been made or
that was made in an incorrect amount (including overpayments and
underpayments) under statutory, contractual, administrative, or other
legally applicable requirements. It includes any payment to an ineligible
recipient, any payment for an ineligible service, any duplicate payment,
payments for services not received, and any payment that does not account
for credit for applicable discounts.

^3Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002).

Addressing the six principal financial management challenges I just
discussed will help ensure that the financial and performance data
provided to decision makers are reliable, useful, and timely. Having such
information will be critical to deal with our nation's significant
challenges regarding the long-term fiscal imbalance of the
government--that is, the sustainability of the federal government's
programs, commitments, and responsibilities in relation to the resources
expected to be available. I recently provided all members of the new
Congress with a package of materials to help them understand the facts,
why we should start sooner rather than later, and what types of changes
need to be considered.^4 More troubling than the persistent short-term
budget deficits, long-range fiscal simulations by GAO and others show that
over the long term, we face large and growing structural deficits in
future years due primarily to known demographic trends and rising health
care costs. The federal government's fiscal exposures now total over $50
trillion, representing close to four times gross domestic product (GDP) in
fiscal year 2006 and up from about $20 trillion or two times GDP in 2000.
We all know that it is hard to make sense of what "trillions" means. One
way to think about it is: if we wanted to put aside today enough to cover
these promises, it would take about $440,000 per American household, up
from $190,000 in 2000. Clearly, despite recent progress on our short-term
deficits, we have been moving in the wrong direction in connection with
our long-range imbalance in recent years.

As members of this Subcommittee know, continuing on our current fiscal
path would gradually erode, if not suddenly damage, our economy, our
standard of living, and ultimately even our domestic tranquility and
national security. Many of the federal government's current policies,
programs, functions, and activities are based on conditions that existed
decades ago, are not results-based, and are not well aligned with 21st
century realities. Our report, 21st Century Challenges: Reexamining the
Base of the Federal Government^5 provided a suggested list of specific
federal activities for reexamination, and perspectives on various
strategies, processes, and approaches for congressional consideration that
could be used in reexamining the federal base. I have proposed a number of
ideas for improving the transparency of long-term costs and the attention
paid to these costs before decisions are made. For example, in addition to
the Statement of Fiscal Sustainability I just described, a portfolio of
outcome-based key national indicators could also be a useful tool to help
measure progress, assess trends, and communicate complex issues. The
Congress should consider supporting a public/private partnership approach
to making key national indicators a reality.

^4GAO, Fiscal Stewardship: A Critical Challenge Facing Our Nation,
[22]GAO-07-362SP (Washington, D.C.: January 2007); The Nation's Long-Term
Fiscal Outlook: September 2006 Update, [23]GAO-06-1077R (Washington,
D.C.); Understanding the Similarities and Differences between Accrual and
Cash Deficits, [24]GAO-07-117SP (Washington, D.C.: December 2006) and its
supplement, Accrual and Cash Deficits: Update for Fiscal Year 2006,
[25]GAO-07-341SP (Washington, D.C.); Understanding the Primary Components
of the Annual Financial Report of the United States, [26]GAO-05-958SP
(Washington, D.C.: September 2005); and Statement of the Comptroller
General of the United States transmitting GAO's report on the U.S.
government's consolidated financial statements for fiscal years 2006 and
2005.

^5GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, [27]GAO-05-325SP (Washington, D.C.: February 2005).

Progress Made and the Key Challenges that Remain in Improving Federal Financial
Management Practices

The federal government has made substantial progress in financial
management. If I were to summarize in just a few words the environment in
2007 as compared to prior to enactment of key financial management laws,
financial management has gone from the backroom to the boardroom. There
has been a cultural change in how financial management is viewed and
carried out in the agencies and a recognition of the value and need for
good financial management throughout government, which was not the case in
1990 when the Congress passed the CFO Act. Financial management systems
and internal control have been strengthened. Generally accepted government
accounting standards have been developed. For fiscal year 2006, 19 of 24
CFO Act agencies received clean audit opinions on their financial
statements, up from just 6 for fiscal year 1996. While there has been
marked progress in federal financial management, a number of challenges
still remain, including transforming financial management and business
practices at DOD, modernizing financial management systems, and building a
financial management workforce for the future. Fully meeting these
challenges will enable the federal government to provide the world-class
financial management anticipated by the CFO Act and other management
reform legislation.

Progress Made since Passage of Key Federal Financial Management Legislation

First, I would like to briefly highlight the legislative framework that
governs federal financial management. The Congress has long recognized the
importance of the federal government implementing strong financial
management practices. Towards this end, the Congress has passed a series
of management reform legislation aimed at improving and providing a strong
foundation for federal financial management. This series of legislation
started with the Federal Managers' Financial Integrity Act of 1982
(FMFIA),^6 which the Congress passed to strengthen internal control and
accounting systems throughout the federal government, among other
purposes. In accordance with FMFIA, GAO has issued Standards for Internal
Control in the Federal Government,^7 which provides the standards that are
directed at helping agency managers implement effective internal control,
an integral part of improving financial management systems.

While agencies had achieved some early success in identifying and
correcting material internal control and accounting system weaknesses,
their efforts to implement FMFIA had not produced the intended results.
Therefore, the Congress passed additional management reform legislation to
improve the general and financial management of the federal government.
This legislation includes the (1) CFO Act of 1990, (2) Government
Performance and Results Act of 1993 (GPRA),^8 (3) Government Management
Reform Act of 1994 (GMRA),^9 (4) Federal Financial Management Improvement
Act of 1996 (FFMIA),^10 (5) Clinger-Cohen Act of 1996,^11 (6)
Accountability of Tax Dollars Act of 2002 (ATDA),^12 and (7) Improper
Payments Information Act of 2002 (IPIA).^13

The CFO Act is the most comprehensive and far-reaching financial
management improvement act since the Budget and Accounting Procedures Act
of 1950. The CFO Act established a leadership structure, provided for
long-range planning, required audited financial statements and modern
financial systems, and strengthened accountability reporting for certain
agencies. Three years later, the Congress enacted GPRA, which required
certain agencies to develop strategic plans, set performance goals, and
report annually on actual performance compared to goals. GPRA's emphasis
on performance management complements the concepts in the CFO Act. GPRA
was followed by GMRA, which made permanent the pilot program in the CFO
Act for annual audited agency-level financial statements, expanded this
requirement to all CFO Act agencies, and established a requirement for the
preparation and audit of governmentwide consolidated financial statements.
In 1996, FFMIA built on the foundation laid by the CFO Act by reflecting
the need for CFO Act agencies to have systems that can generate reliable,
useful, and timely information with which to make fully informed decisions
and to ensure accountability on an ongoing basis. The Clinger-Cohen Act of
1996 (also known as the Information Technology Management Reform Act of
1996) sets forth a variety of initiatives to support better decision
making for capital investments in information technology, which has led to
the development of the Federal Enterprise Architecture and better-informed
capital investment and control processes within agencies and across
government. ATDA required most executive agencies that were not otherwise
required by statute or exempted by OMB, to prepare annual audited
financial statements and to submit such statements to the Congress and the
Director of OMB. Finally, IPIA has increased visibility over improper
payments by requiring executive agency heads, based on guidance from the
OMB,^14 to identify programs and activities susceptible to significant
improper payments,^15 estimate amounts improperly paid, and report on the
amounts of improper payments and their actions to reduce them. The
combination of reforms ushered in by these laws, if successfully
implemented, provides a solid foundation to improve the accountability of
government programs and operations as well as to routinely produce
valuable cost and operating performance information.

^6FMFIA is codified at 31 U.S.C. S 3512(c), (d).

^7GAO, Standards for Internal Control in the Federal Government,
GAO/AIMD-00.21.3.1 (Washington, D.C.: November 1999).

^8Pub. L. No. 103-62, 107 Stat. 285 (Aug. 3, 1993).

^9Pub. L. No. 103-356, 108 Stat. 3410 (Oct. 13, 1994).

^10Pub. L. No. 104-208, div. A., sec. 101(f), title VIII, 110 Stat. 3009,
3009-389 (Sept. 30, 1996).

^11Pub. L. No. 104-106, div. E, 110 Stat. 186, 679 (Feb. 10, 1996).

^12Pub. L. No. 107-289, 116 Stat. 2049 (Nov. 7, 2002).

^13Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002).

The five key financial management improvements that we have noted from a
governmentwide perspective are as follows.

           o Achieving Cultural Change--We have seen true cultural change in
           how financial management is viewed. This has been accomplished
           through a lot of hard work by OMB and the agencies and continued
           strong support and oversight by the Congress. At the top level,
           federal financial management reform has gained momentum through
           the committed support of top federal leaders. For example,
           improved financial performance is one of the governmentwide
           initiatives in the President's Management Agenda (PMA). Under this
           initiative, agency CFOs share responsibility--both individually
           and through the efforts of the CFO Council--for improving the
           financial performance of the government. The Executive Branch
           Management Scorecard, developed as part of the PMA, has been an
           effective tool to monitor progress and help drive much needed
           improvements.

           o Establishing a Governmentwide Leadership Structure--The Joint
           Financial Management Improvement Program (JFMIP)^16
           Principals--the Secretary of the Treasury, the Director of OMB,
           the Director of OPM, and myself, the Comptroller General--have
           provided leadership by holding periodic meetings that have
           resulted in unprecedented substantive deliberations and agreements
           focused on key reform issues such as improving accounting for and
           reporting on social insurance, accelerating issuance of audited
           agency financial statements, and advocating audit committees. GAO
           has led by example in this regard, by establishing an audit
           advisory committee to help us in overseeing the effectiveness of
           our current financial reporting and audit processes.

           As established by the CFO Act, the Office of Federal Financial
           Management (OFFM), the OMB organization with governmentwide
           responsibility for federal financial management for executive
           agencies, has demonstrated leadership by undertaking a number of
           initiatives related to improving financial management capabilities
           ranging from requiring the use of commercial off-the-shelf
           financial systems to the promotion of cost accounting to improve
           the availability of management information for decision making. In
           addition to assessing the status of agencies' progress in
           improving financial performance for the PMA, OFFM has also issued
           bulletins, circulars, and other guidance to provide a broad-based
           foundation for transforming agencies' financial management
           operations.

           o Strengthening Internal Control--In December 2004, OMB revised
           its Circular No. A-123, Management's Responsibility for Internal
           Control, to provide guidance to federal managers on improving the
           accountability and effectiveness of federal programs and
           operations by establishing, assessing, correcting, and reporting
           on management controls. Requiring federal managers, at the
           executive level, to focus on internal control demonstrates a
           renewed emphasis on identifying and addressing internal control
           weaknesses. As we testified^17 in 2005, many internal control
           problems have been identified and fixed, especially at the lower
           levels where internal control assessments were performed and
           managers could take focused actions to fix relatively simple
           problems. As a recent case in point, based on our 2006 assessment
           of high-risk programs,^18 two programs previously designated as
           high risk, largely due to financial management weaknesses, were
           removed from the list.

           Agencies have also made progress in implementing processes and
           controls to identify, estimate, and reduce improper payments.
           After passage of IPIA, OMB established Eliminating Improper
           Payments in 2005 as a new program-specific initiative under the
           PMA. This separate PMA program initiative was established in this
           manner to ensure that agency managers are held accountable for
           meeting the goals of IPIA and are, therefore, dedicating the
           necessary attention and resources to meeting IPIA requirements.
           OMB also issued guidance in August 2006 to help clarify and update
           requirements to support governmentwide IPIA compliance.^19

           o Improving Financial Management Systems and Operations--Since
           enactment of financial management reform legislation, federal
           financial management systems requirements have been developed for
           the core financial system; managerial cost system; and other
           administrative and programmatic systems, such as grants, property,
           revenue, travel, and loans, which are part of an overall financial
           management system. After the realignment of the JFMIP Program
           Management Office, OFFM has continued the practice of issuing
           these requirements. Beginning in 1999, OMB required agencies to
           purchase commercial off-the-shelf software that had been tested
           and certified by the federal government against the systems
           requirements that I just mentioned. With these requirements, the
           federal government has better defined the functionality needed in
           its financial management systems, which has helped the vendor
           community understand federal agencies' needs.

           OMB continues to move forward on initiatives that support the PMA
           with the further development of the financial management line of
           business to promote leveraging shared service solutions to enhance
           the government's performance and services. The financial
           management line of business initiative is modeled after the
           consolidation of agencies processing payroll, which were
           dramatically reduced from 22 to 4 systems. OMB, in conjunction
           with an interagency task force, estimated that these efforts could
           save billions of taxpayer dollars. Ultimately, this initiative is
           expected to (1) reduce the number of systems that each individual
           agency must support, (2) promote standardization, and (3) reduce
           the duplication of efforts.

           o Preparing Auditable Financial Statements--Unqualified audit
           opinions for CFO Act agencies' financial statements have grown
           from 6 in fiscal year 1996 to 19 in fiscal year 2006. Improvements
           in timeliness have been even more dramatic over the years.
           Agencies were able to issue their audited financial statements
           within the accelerated reporting time frame--all 24 CFO Act
           agencies issued their audited financial statements by the November
           15, 2006, deadline,^20 set by OMB, just 45 days after the close of
           the fiscal year. Just a few years ago, most considered this
           accelerated time frame unrealistic and unachievable.

           Another definitive example of progress made to date is the
           establishment of the Federal Accounting Standards Advisory Board
           (FASAB). In conjunction with the passage of the CFO Act, the OMB
           Director, Secretary of the Treasury, and the Comptroller General
           established FASAB to develop accounting standards and principles
           for the newly required financial statements. The concepts and
           standards are the basis for OMB's guidance to agencies on the form
           and content of their financial statements and for the government's
           consolidated financial statements. FASAB is comprised of a
           10-member advisory board of 4 knowledgeable individuals from
           government and 6 nonfederal members selected from the general
           financial community, the accounting and auditing community, and
           academia to promulgate proposed accounting standards designed to
           meet the needs of federal agencies and other users of federal
           financial information. The mission of FASAB is to develop
           accounting standards after considering the financial and budgetary
           information needs of congressional oversight groups, executive
           agencies, and other users. These accounting and reporting
           standards are essential for public accountability and for an
           efficient and effective functioning of our democratic system of
           government. The standards developed by FASAB have been recognized
           by the American Institute of Certified Public Accountants as
           generally accepted accounting standards for federal entities.

^14OMB Memorandum M-03-13, "Improper Payments Information Act of 2002
(Public Law 107-300)" (May 21, 2003), and OMB Circular No. A-136,
Financial Reporting Requirements, S II.5.6 (July 24, 2006). OMB recently
issued revised guidance for fiscal year 2006 reporting in OMB Memorandum
M-06-23, "Issuance of Appendix C to OMB Circular No. A-123" (Aug. 10,
2006).

^15OMB's guidance defines significant improper payments as those in any
particular program that exceed both 2.5 percent of program payments and
$10 million annually.

^16JFMIP was originally formed under the authority of the Budget and
Accounting Procedures Act of 1950 and was a joint and cooperative
undertaking of the Government Accountability Office, the Department of the
Treasury, OMB, and OPM, working in cooperation with each other to improve
financial management practices in the federal government. A JFMIP Program
Management Office developed federal financial management systems
requirements, and tested core federal financial management systems. In a
December 2004 memorandum, OMB announced a realignment of JFMIP's
responsibilities for financial management policy and oversight in the
federal government.

^17GAO, Financial Management: Effective Internal Control is Key to
Accountability, [28]GAO-05-321T (Washington, D.C.: Feb. 16, 2005).

^18GAO, High-Risk Series: An Update, [29]GAO-07-310 (Washington, D.C.:
January 2007).

^19OMB, Issuance of Appendix C to OMB Circular A-123, M-06-23, August 10,
2006.

^20The independent auditors for the Department of State's fiscal year 2006
financial statements issued a disclaimer of opinion on November 14, 2006,
because the department could not provide evidential matter in a timely
manner to meet the November 15, 2006, reporting deadline. After receiving
adequate documentation to support the amounts on the financial statements,
the auditors issued an unqualified opinion on the Department of State's
fiscal year 2006 financial statements on December 12, 2006.

Financial Management Challenges Facing the Federal Government

While there has been marked progress in federal financial management, a
number of challenges still remain. The principal challenges remaining are
(1) transforming financial management and business practices at DOD, (2)
improving financial and performance reporting, (3) modernizing financial
management systems, (4) tackling long-standing internal control
weaknesses, (5) building a financial management workforce for the future,
and (6) strengthening consolidated financial reporting. Fully meeting
these challenges will enable the federal government to provide the
world-class financial management anticipated by the CFO Act and other
management reform legislation. While there continues to be much focus on
the agency and governmentwide audit opinions, getting a clean audit
opinion, though important in itself, is not the end goal. The end goal is
the establishment of a fully functioning CFO operation that includes (1)
modern financial management systems that provide reliable, timely, and
useful information to support day-to-day decision making and oversight,
and for the systematic measurement of performance; (2) sound internal
controls that safeguard assets and help ensure proper accountability; and
(3) a cadre of highly qualified CFOs and supporting staff.

  Transforming DOD's Financial and Business Management Practices

DOD's long-standing financial and business management difficulties are
pervasive, complex, and deeply rooted in virtually all business operations
throughout the department. Resolution of these serious problems is
essential to improving financial management governmentwide and achieving
an opinion on the U.S. government's consolidated financial statements. Of
the 27 areas on GAO's high-risk list,^21 DOD has 8 of its own high-risk
areas and shares responsibility for 7 governmentwide high-risk areas.
These weaknesses adversely affect the department's and the federal
government's ability to control costs; ensure basic accountability;
anticipate future costs and claims on the budget; measure performance;
maintain funds control; prevent fraud, waste, and abuse; and address
pressing management problems. Additionally, the department invests
billions of dollars each year to operate, maintain, and modernize its
business systems. But despite this significant annual investment, the
department has been continually confronted with the difficult task of
implementing business systems on time, within budget, and with the
promised capability.

We also have concerns about the reasonableness, reliability, and
transparency of DOD's budget requests, especially the supplemental budget
requests the department has submitted to the Congress in recent years.
Reasonableness and reliability are critical factors not only for financial
information, but also for budget data. As I testified^22 last year, our
prior work found numerous problems with DOD's processes for recording and
reporting costs for the Global War on Terrorism (GWOT), the funding for
which has been provided through regular appropriations as well as
supplemental appropriations. These problems included long-standing
deficiencies in DOD's financial management systems and business processes,
the use of estimates instead of actual cost data, and the lack of adequate
supporting documentation. As a result, neither DOD nor the Congress have
reliable information on GWOT costs or the use of appropriated funds and
also lack historical data useful in considering future funding needs.

The nature and severity of DOD's financial management, business
operations, and system deficiencies not only affect financial reporting,
but also impede the ability of DOD managers to receive the full range of
information needed to effectively manage day-to-day operations. Such
weaknesses have adversely affected the ability of DOD to control costs,
ensure basic accountability, and prevent fraud. The following examples
illustrate DOD's continuing problems.

^21 [30]GAO-07-310 .

^22 GAO, Global War on Terrorism: Observations on Funding, Costs, and
Future Commitments, [31]GAO-06-885T (Washington, D.C.: July 18, 2006).

           o We found that hundreds of separated battle-injured soldiers were
           pursued for collection of military debts incurred through no fault
           of their own, including 74 soldiers whose debts had been reported
           to credit bureaus, private collection agencies, and the Treasury
           Offset Program at the time we initiated our audit.^23 Overpayment
           of pay and allowances (entitlements), pay calculation errors, and
           erroneous leave payments caused 73 percent of the reported debts.

           o Over the past several years, we have reported^24 on significant
           pay problems experienced by mobilized Army National Guard and Army
           Reserve (Army Guard and Reserve) soldiers in the wake of the
           September 11, 2001, terrorist attacks. These reports included
           examples of hundreds of soldiers receiving inaccurate and untimely
           payroll payments due to a paper-intensive, error-prone pay process
           and the lack of integrated pay and personnel systems. In response
           to our reports, DOD has taken some action to improve controls
           designed to pay Army Guard and Reserve soldiers accurately and on
           time, especially those who had become sick or injured in the line
           of duty.

           o In March 2006, we reported^25 that DOD's policies and procedures
           for determining, reporting, and documenting cost estimates
           associated with environmental cleanup or containment activities
           were not consistently followed. Further, none of the military
           services had adequate controls in place to help ensure that all
           identified contaminated sites were included in their environmental
           liability cost estimates. These weaknesses not only affected the
           reliability of DOD's environmental liability estimate, but also
           that of the federal government as a whole.

           o In May 2005, we reported^26 that DOD did not have management
           controls in place to assure that excess inventory was reutilized
           to the maximum extent possible. We found significant waste and
           inefficiency because new, unused, and excellent condition items
           were transferred and donated outside of DOD, sold for pennies on
           the dollar, or destroyed. Root causes for the waste and
           inefficiency included (1) unreliable excess property inventory
           data; (2) inadequate oversight and physical inventory control; and
           (3) outdated, nonintegrated excess inventory and supply management
           systems.

^23GAO, Military Pay: Hundreds of Battle-Injured GWOT Soldiers Have
Struggled to Resolve Military Debts, [32]GAO-06-494 (Washington, D.C.:
Apr. 27, 2006).

^24GAO, Military Pay: Inadequate Controls for Stopping Overpayments of
Hostile Fire and Hardship Duty Pay to Over 200 Sick or Injured Army
National Guard and Army Reserve Soldiers Assigned to Fort Bragg,
[33]GAO-06-384R (Washington, D.C.: Apr. 27, 2006); Military Pay: Gaps in
Pay and Benefits Create Financial Hardships for Injured Army National
Guard and Reserve Soldiers, [34]GAO-05-125 and [35]GAO-05-322T
(Washington, D.C.: Feb. 17, 2005); Army National Guard: Inefficient,
Error-Prone Process Results in Travel Reimbursement Problems for Mobilized
Soldiers, [36]GAO-05-79 (Washington, D.C.: Jan. 31, 2005) and
[37]GAO-05-400T (Washington, D.C.: Mar. 16, 2005); Military Pay: Army
Reserve Soldiers Mobilized to Active Duty Experienced Significant Pay
Problems, [38]GAO-04-911 (Washington, D.C.: Aug. 20, 2004) and
[39]GAO-04-990T (Washington, D.C.: July 20, 2004); and Military Pay: Army
National Guard Personnel Mobilized to Active Duty Experienced Significant
Pay Problems, [40]GAO-04-413T (Washington, D.C.: Jan. 28, 2004) and
[41]GAO-04-89 (Washington, D.C.: Nov. 13, 2003).

^25GAO, Environmental Liabilities: Long-Term Fiscal Planning Hampered by
Control Weaknesses and Uncertainties in the Federal Government's
Estimates, [42]GAO-06-427 (Washington, D.C.: Mar. 31, 2006).

The department is provided billions of dollars annually to operate,
maintain, and modernize its stovepiped, duplicative, legacy business
systems. Despite this significant investment, the department is severely
challenged in implementing business systems on time, within budget, and
with the promised capability. Many of the problems related to DOD's
inability to effectively implement its business systems can be attributed
to its failure to implement the disciplined processes^27 necessary to
reduce the risks associated with these projects to acceptable levels.^28
Disciplined processes have been shown to reduce the risks associated with
software development and acquisition efforts and are fundamental to
successful systems acquisition. The weaknesses that we found in DOD
business systems implementations such as the Defense Travel System,^29 the
Logistics Modernization Program,^30 and the Navy's Enterprise Resource
Planning (ERP) efforts^31 illustrate the types of system acquisition and
investment management controls that need to be effectively implemented in
order for a given investment to be successfully acquired and deployed.

^26 GAO, DOD Excess Property: Management Control Breakdowns Result in
Substantial Waste and Inefficiency, [43]GAO-05-277 (Washington, D.C.: May
13, 2005).

^27Disciplined processes include a wide range of activities, including
project planning and management, requirements management, risk management,
quality assurance, and testing.

^28Acceptable levels refer to the fact that any systems acquisition effort
will have risks and will suffer the adverse consequences associated with
defects in the processes. However, effective implementation of disciplined
processes reduces the possibility of the potential risks actually
occurring and prevents significant defects from materially affecting the
cost, timeliness, and performance of the project.

^29GAO, Defense Travel System: Reported Savings Questionable and
Implementation Challenges Remain, [44]GAO-06-980 (Washington, D.C.: Sept.
26, 2006).

^30GAO, Army Depot Maintenance: Ineffective Oversight of Depot Maintenance
Operations and System Implementation Efforts, [45]GAO-05-441 (Washington,
D.C.: June 30, 2005).

Meeting the Challenge of Transforming DOD Financial and Business
Management Practices. Successful reform of DOD's fundamentally flawed
financial and business management operations must simultaneously focus on
its systems, processes, and people. DOD's top management has demonstrated
a commitment to transforming the department and has launched key
initiatives to improve its financial management processes and related
business systems such as the Financial Improvement and Audit Readiness
(FIAR) Plan. However, DOD still lacks two key elements that are needed to
ensure a successful and sustainable transformation effort.

           o As we have previously recommended, DOD should develop and
           implement an integrated and strategic business transformation
           plan. Since 1999, we have recommended the need for a
           comprehensive, integrated strategy and action plan for reforming
           DOD's major business operations and support activities.^32
           Critical to the success of DOD's ongoing transformation efforts
           will be top management attention and structures that focus on
           transformation from a broad perspective and a clear,
           comprehensive, integrated, and enterprisewide plan that, at a
           summary level, addresses all of the department's major business
           areas.

           o Because of the complexity and long-term nature of DOD's business
           transformation efforts, we again reiterate the need for a chief
           management officer (CMO) to provide sustained leadership and
           maintain momentum, as we have previously testified.^33 The
           National Defense Authorization Act for Fiscal Year 2006^34 directs
           the department to study the feasibility of a CMO position in DOD.
           In this regard, the Institute for Defense Analysis issued its
           report in December 2006 and, among other things, called upon the
           Congress to establish a Deputy CMO (level III official) at the
           department. Further, in May 2006, the Defense Business Board
           recommended, among other things, the creation of a Principal Under
           Secretary of Defense, as a level II official with a 5-year term
           appointment, to serve as CMO. I strongly support a level II
           official and believe that someone at this level is needed to be
           successful given the magnitude of the challenge and the need to
           effect change across the department. It is important to note that
           a CMO would not assume the responsibilities of the
           undersecretaries of defense, the service secretaries, or other DOD
           officials for the day-to-day management of the department. Rather,
           the CMO would be responsible and accountable for planning,
           integrating, and executing the overall business transformation
           effort. The reason I am so passionate about the need for a CMO at
           DOD is that progress at DOD has historically been painfully slow.
           A host of well-intended past improvement initiatives has largely
           failed. I am concerned that without a CMO who is responsible and
           accountable for demonstrable results and sustained success,
           history will continue to repeat itself.

^31GAO, DOD Business Systems Modernization: Navy ERP Adherence to Best
Business Practices Critical to Avoid Past Failures, [46]GAO-05-858
(Washington, D.C.: Sept. 29, 2005).

^32GAO, Defense Reform Initiative: Organization, Status, and Challenges,
GAO/NSIAD-99-87 (Washington, D.C.: Apr. 21, 1999).

  Improving Agency Financial and Performance Reporting

In the area of agency financial and performance reporting, I see obtaining
unqualified opinions on financial statements at all CFO Act agencies as
the primary challenge. While significant progress has been made by many
CFO Act agencies to prepare timely annual financial statements that can
pass the scrutiny of a financial audit, several agencies continue to
struggle to reach this milestone. For fiscal year 2006, five CFO Act
agencies--DOD, DHS, ^35 National Aeronautics and Space Administration
(NASA), and the Departments of Energy^36 and Transportation--failed to
meet this basic requirement. Problems at NASA and the Department of Energy
stem from deficiencies in those agencies' implementation of new financial
management systems, among other things. The Department of Transportation
auditors cited significant problems with a key accounting practice at the
Federal Aviation Administration as the underlying cause for qualifying
their opinion on the department's financial statements. As I previously
discussed, the problems faced by DOD are so pervasive that in accordance
with section 1008 of the fiscal year 2002 National Defense Authorization
Act,^37 for the sixth year, DOD acknowledged that its systems could not
support material amounts on DOD's fiscal year 2006 financial statements
and accordingly, the auditors did not perform auditing procedures and
disclaimed an opinion. At DHS, the auditors recognized that the department
has not yet established the infrastructure and internal control necessary
and disclaimed an opinion on its financial statements. Problems at these
agencies also significantly impact our ability to provide an opinion on
the U.S. government's consolidated financial statements.

^33GAO, Department of Defense: Long-standing Problems Continue to Impede
Financial and Business Management Transformation, [47]GAO-04-907T
(Washington, D.C.: July 7, 2004); Department of Defense: Financial and
Business Management Transformation Hindered by Long-standing Problems,
[48]GAO-04-941T (Washington, D.C.: July 8, 2004); Department of Defense:
Further Actions Are Needed to Effectively Address Business Management
Problems and Overcome Key Business Transformation Challenges,
[49]GAO-05-140T (Washington, D.C.: Nov. 18, 2004); DOD's High-Risk Areas:
Successful Business Transformation Requires Sound Strategic Planning and
Sustained Leadership, [50]GAO-05-520T (Washington, D.C.: Apr. 13, 2005);
and Department of Defense: Sustained Leadership Is Critical to Effective
Financial and Business Management Transformation, [51]GAO-06-1006T
(Washington, D.C.: Aug. 3, 2006).

^34National Defense Authorization Act for Fiscal Year 2006, Pub. L. No.
109-163, S 907, 119 Stat. 3136, 3403 (Jan. 6, 2006).

Meeting the Challenge of Improved Financial and Performance Reporting.
Addressing the financial and performance reporting weaknesses that impede
CFO Act agencies from obtaining unqualified or clean opinions on the
respective agency financial statements will vary depending upon the
circumstances at the agency. Developing and implementing corrective action
plans to address the identified problems are time-honored methods for
resolving such problems. For example, the DOD Comptroller launched the
FIAR Plan to guide improvements to address financial management
deficiencies and achieve clean financial statement audit opinions. This
plan incorporates our prior recommendations and ties planned improvement
activities at the component and department levels together with
accountable personnel, milestones, and required resources. We view the
incremental line item approach, integration plans, and oversight structure
outlined in the FIAR plan for examining DOD's operations and preparing for
an audit as a significant improvement over prior financial improvement
initiatives. However, we continue to stress that the effectiveness of
DOD's FIAR plan will ultimately be measured by the department's ability to
provide timely, reliable, and useful information for day-to-day management
and decision making.

^35 For fiscal year 2006, only the Consolidated Balance Sheet and
Statement of Custodial Activity were subjected to audit, and the auditor
was unable to express an opinion on these two financial statements.

^36 For fiscal year 2006, only the Consolidated Balance Sheet of the
Department of Energy was subjected to audit, and the auditor qualified its
opinion on this statement.

^37Pub. L. No. 107-107, 115 Stat. 1012, 1206 (Dec. 28, 2001).

  Modernizing Financial Management Systems

Since the passage of the CFO Act and FFMIA, there has been progress in
achieving the financial systems requirements of these landmark laws. While
improvements have been made throughout government, much work remains to
fulfill the underlying goals of the CFO Act and FFMIA. In fiscal year
1997, 20 agencies were reported as having systems that were not in
substantial compliance with at least one of the three FFMIA systems
requirements,^38 while in fiscal year 2006, auditors for 17 of the CFO Act
agencies reported that the agencies' financial management systems did not
substantially comply with at least one of the three FFMIA requirements.
The major barrier to achieving compliance with FFMIA continues to be the
inability of agencies to meet federal financial management systems
requirements, which involve not only core financial systems, but also
administrative and programmatic systems. While the problems are much more
severe at some agencies than at others and progress has been made in
addressing financial management systems' weaknesses, the lack of
substantial compliance with the three requirements of FFMIA, and the
associated deficiencies, indicates that the financial management systems
of many agencies are still not able to routinely produce reliable, useful,
and timely financial information. Consequently, the federal government's
access to relevant, timely, and reliable data to effectively manage and
oversee its major programs, which is the ultimate objective, was and
continues to be restricted.

What is most important is that the problem has been recognized. Across
government, agencies have efforts under way to implement new financial
management systems or to upgrade existing systems. Agencies expect that
the new systems will provide reliable, useful, and timely data to support
day-to-day managerial decision making and assist taxpayer and
congressional oversight. Whether in government or the private sector,
implementing and upgrading information systems is a difficult job and
brings a degree of new risk. Organizations that follow and effectively
implement accepted best practices in systems development and
implementation (commonly referred to as disciplined processes) can manage
and reduce these risks to acceptable levels. For example, as part of our
work at DOD,^39 NASA,^40 and other agencies that have experienced
significant problems in implementing new financial management systems, we
have consistently found that these agencies were not following the
necessary disciplined processes, human capital practices, and information
technology management practices for efficient and effective development
and implementation of such systems.

^38FFMIA requires CFO Act agencies financial management systems to comply
substantially with (1) federal financial management systems requirements,
(2) applicable federal accounting standards, and (3) the U.S. government
standard general ledger at the transaction level.

Challenges also exist in implementing OMB's financial management line of
business initiative that is aimed at significantly improving the financial
data government managers need to make timely and successful decisions and
reduce the cost of government operations. For example, as we reported in
March 2006,^41 the requirements for agencies and private sector firms to
become shared service providers and the services they must provide have
not been adequately documented or effectively communicated to agencies and
the private sector. We made several recommendations that focused on
reducing the risk of this important initiative. During 2006, OMB addressed
some of the weaknesses by issuing an initial version of migration planning
guidance and publishing competition guidance for shared service providers
and agencies. However, as OMB acknowledged in the Federal Financial
Management Report 2007, it has not yet developed several critical elements
needed to minimize risk, provide assurance, and develop understandings
with software vendors, shared service providers, and agencies on topics
such as standard business processes and common accounting codes. Further,
a governmentwide concept of operations has not been developed that would
identify interrelationships among federal financial systems and which
financial management systems should be operated at an agency level and
which should be operated at a governmentwide level and how those would
integrate. In addition, processes have not been put in place to facilitate
agency decisions on selecting a provider or focusing investment decisions
on the benefits of standard processes and shared service providers.

^39GAO, DOD Business Systems Modernization: Navy ERP Adherence to Best
Business Practices Critical to Avoid Past Failures, [52]GAO-05-858
(Washington, D.C.: Sept. 29, 2005); Army Depot Maintenance: Ineffective
Oversight of Depot Maintenance Operations and System Implementation
Efforts, [53]GAO-05-441 (Washington, D.C.: Jun. 30, 2005); and DOD Systems
Modernization: Management of Integrated Military Human Capital Program
Needs Additional Improvements, [54]GAO-05-189 (Washington, D.C.: Feb. 11,
2005).

^40GAO, Business Modernization: Some Progress Made toward Implementing GAO
Recommendations Related to NASA's Integrated Financial Management Program,
[55]GAO-05-799R (Washington, D.C.: Sept. 9, 2005); National Aeronautics
and Space Administration: Significant Actions Needed to Address
Long-standing Financial Management Problems, [56]GAO-04-754T (Washington,
D.C.: May 19, 2004); and Business Modernization: NASA's Challenges in
Managing Its Integrated Financial Management Program, [57]GAO-04-255
(Washington, D.C.: Nov. 21, 2003).

^41GAO, Financial Management Systems: Additional Efforts Needed to Address
Key Causes of Modernization Failures, [58]GAO-06-184 (Washington, D.C.:
Mar. 15, 2006).

Meeting the Challenge of Modernizing Financial Systems. As the federal
government moves forward with ambitious financial management system
modernization efforts that identify opportunities to eliminate redundant
systems and enhance information reliability and availability, adherence to
disciplined processes, sound human capital practices, and proven
information technology management practices is crucial to reduce risks to
acceptable levels.

           o To help address the underlying problems agencies face in
           implementing financial management systems that will help them
           adhere to the requirements of the CFO Act and FFMIA, we have made
           numerous specific recommendations to agencies to address the
           specific shortcomings we identified. For example, at NASA we made
           a total of 45 recommendations aimed at addressing weaknesses we
           identified in NASA's acquisition and implementation strategy for a
           new integrated financial management system.

           o The key to avoiding these long-standing problems is to provide
           specific guidance to agencies that incorporate the best practices
           identified by the Software Engineering Institute, the Institute of
           Electrical and Electronic Engineers, and other experts. Toward
           this end, we have recommended that OMB develop such guidance to
           help minimize the waste of scarce resources from modernization
           failures.

           o We have also made a number of recommendations to OMB to help it
           provide a solid foundation for the financial management line of
           business initiative. OMB has projects under way to develop
           standard business processes, a common accounting code, and
           specific measures to assess the performance of the shared service
           providers to help address some shortcomings we identified. While
           all of these projects are important, developing a concept of
           operations is an important step because it lays the foundation for
           many subsequent decisions.

  Addressing Long-standing Internal Control Weaknesses

While continuing progress has been made in strengthening internal control,
at the same time, the federal government faces numerous internal control
problems, some of which are long-standing and are well-documented at the
agency level and governmentwide. As we have reported for a number of years
in our audit reports on the U.S. government's consolidated financial
statements, the federal government continues to have material weaknesses
and reportable conditions in internal control related to property, plant,
and equipment; inventories and related property; liabilities and
commitments and contingencies; cost of government operations; and
disbursement activities, just to mention a few of the problem areas.
Particularly problematic to the U.S. government's consolidated financial
statements is the lack of internal controls to adequately account for and
reconcile intragovernmental activity and balances between federal
agencies. Although OMB and Treasury require the CFOs of 35 executive
departments and agencies to reconcile intragovernmental activity and
balances on a quarterly basis, and report annually to GAO and others on
reconciliation efforts at the end of the fiscal year, a substantial number
of agencies did not adequately perform these reconciliations. To help
address this problem, OMB worked with Treasury and the CFO Council to
revise the business rules for intragovernmental transactions. Because
these new rules became effective on October 1, 2006, it is too soon to
tell if they will have the desired effect of strengthening internal
controls. Resolving the intragovernmental transactions problem remains a
difficult challenge and will require a strong commitment by agencies to
fully implement the recently issued business rules and continued strong
leadership by OMB.

As we testified^42 in February 2005, we support OMB's efforts to
revitalize internal control assessments and reporting through the December
2004 revisions to Circular No. A-123. These revisions recognize that
effective internal control is critical to improving federal agencies'
effectiveness and accountability and to achieving the goals established by
the Congress. They also considered the internal control standards issued
by GAO,^43 which provide an overall framework for establishing and
maintaining internal control and for identifying and addressing major
performance and management challenges and areas at greatest risk of fraud,
waste, abuse, and mismanagement. OMB reported in its Federal Financial
Management Report 2007, that CFO Act agencies identified new financial
reporting material weaknesses under this revised guidance, which is an
important first step. As agencies expand their assessments and all
agencies complete a full-scope assessment of internal control over
financial reporting, they will develop a better understanding of the full
nature and extent of material weaknesses.

^42GAO, Financial Management: Effective Internal Control is Key to
Accountability, [59]GAO-05-321T (Washington, D.C.: Feb. 16, 2005).

^43GAO/AIMD-00-21.3.1.

Effective internal control, as envisioned in the revised Circular No.
A-123, inherently includes a successful strategy for addressing improper
payments. Attacking improper payment problems requires a strategy
appropriate to the organization involved and its particular risks. We have
found that entities using successful strategies to address their improper
payment problems shared a common focus of improving the internal control
system--the first line of defense in safeguarding assets and preventing
and detecting errors and fraud. The Congress acted strongly to address the
improper payment problem by passing IPIA and in fiscal year 2005, OMB
began to separately track the elimination of improper payments under the
PMA. As I pointed out in testimony^44 before this Subcommittee in December
2006, while agencies are making progress in reporting under IPIA, three
major challenges remain in meeting the goals of the act. First, the
existing reporting was incomplete because some agencies still had not
instituted systematic methods to review all programs and some program
estimates were not based on a valid statistical sampling methodology as
required. Second, 10 risk-susceptible programs with outlays totaling over
$234 billion in fiscal year 2005 had not provided improper payment
estimates. Finally, OMB's implementing guidance includes specific criteria
that limit the disclosure and transparency of agencies' improper payments.

Meeting the Challenge of Addressing Internal Control Weaknesses. Actions
can be taken on several fronts to help resolve internal control
weaknesses.

           o As pointed out in our February 2005 testimony on internal
           controls,^45 there are six issues critical to effectively
           implementing the changes to Circular No. A-123--specifically, the
           need for: (1) development of supplemental guidance and
           implementation tools to help ensure that agency efforts are
           properly focused and meaningful; (2) vigilance over the broader
           range of controls covering program objectives; (3) strong support
           from managers throughout the agency, and at all levels; (4)
           risk-based assessments and an appropriate balance between the
           costs and benefits of controls; (5) management testing of controls
           in operation to assess if they are designed adequately and
           operating effectively, and to assist in formulating corrective
           actions; and (6) management accountability for control breakdowns.

           o Addressing the multitude of problems in financial reporting
           internal controls, including reconciling intragovernmental
           activity and balances, that have been identified to date will
           require a significant effort over a long time. Many of these
           problems have been around for years and have proven resistant to
           actions to resolve them. Continuous monitoring by top agency
           management and OMB along with oversight by the Congress will be
           critical to successfully resolving these material weaknesses and
           enhancing financial management.

           o The ultimate success of efforts to reduce improper payments
           depends, in part, on each agency's continuing diligence and
           commitment to meeting the requirements of IPIA and the related OMB
           guidance. Full and reasonable disclosure of the extent of the
           problems could be enhanced by modifying the act's underlying
           criteria used to identify which programs and activities are
           susceptible to significant improper payments and we asked^46 the
           Congress to consider amending IPIA to do so. We also recommended
           that OMB's implementing guidance be strengthened in several areas.

^44GAO, Improper Payments: Incomplete Reporting under the Improper
Payments Information Act Masks the Extent of the Problem, [60]GAO-07-254T
(Washington, D.C.: Dec. 5, 2006).

^45 [61]GAO-05-321T .

  Building a Financial Management Workforce for the Future

The financial management workforce plays a critical role in government
because the scale and complexity of federal activities requiring financial
management and control are monumental. The federal government has always
faced the challenge of sustaining the momentum of transformation because
of the limited tenure of key administration officials. The current
administration's PMA has served as a driver for governmentwide financial
management improvements. It has been clear from the outset that the
current administration is serious about improved financial management. We
have been fortunate that, since the passage of the CFO Act, all three
administrations have been supportive of financial management reform
initiatives. And, as I discussed earlier, we have seen a positive cultural
shift in the way the federal government conducts business. Given the
long-term nature of the comprehensive changes needed and challenges still
remaining to fully realize the goals of the CFO Act, it is unlikely they
will all occur before the end of the current administration's term.
Therefore, sustaining a commitment to transformation in future
administrations will be critical to ensure that key management reforms,
such as the CFO Act, are fully attained.

^46GAO, Improper Payments: Agencies' Fiscal Year 2005 Reporting under the
Improper Payments Information Act Remains Incomplete, [62]GAO-07-92
(Washington, D.C.: Nov. 14, 2006).

Changing the way business is done in a large, diverse, and complex
organization like the federal government is not an easy undertaking.
According to a survey of federal CFOs,^47 federal finance organizations of
the future will have fewer people, with a greater percentage of analysts,
as opposed to accounting technicians. However, today most functions within
federal finance organizations are focused primarily on (1) establishing
and administering financial management policy; (2) tracking, monitoring,
and reconciling account balances; and (3) ensuring compliance with laws
and regulations. While they recognize the need for change, according to
the CFOs surveyed, many questions remain unanswered regarding how best to
facilitate such changes.

When it comes to world-class financial management, our study^48 of nine
leading private and public sector financial organizations found that
leading financial organizations often had the same or similar core
functions (i.e., budgeting, treasury management, general accounting, and
payroll) as the federal government. However, the way these functions were
put into operation varied depending on individual entity needs. Leading
organizations reduced the number of resources required to perform routine
financial management activities by (1) consolidating activities at a
shared service center and (2) eliminating or streamlining duplicative or
inefficient processes. Their goal was not only to reduce the cost of
finance but also to organize finance to add value by reallocating finance
resources to more productive and results-oriented activities like
measuring financial performance, developing managerial cost information,
and integrating financial systems.

^47Grant Thornton LLP and the Association of Government Accountants, CFO
Survey: Preparing for Tomorrow's Way of Doing Business (Alexandria, Va.:
March 1998).

^48GAO, Executive Guide: Creating Value Through World-class Financial
Management, GAO/AIMD-00-134 (Washington, D.C.: April 2000). Appendix II
includes a synopsis of the key concepts discussed in the study.

The federal financial workforce that supports the business needs of today
is not well-positioned to support the needs of tomorrow. A JFMIP study^49
indicated that a significant majority of the federal financial management
workforce performs transaction support functions of a clerical and
technical nature. These skills do not support the vision of tomorrow's
business which will depend on an analytic financial management workforce
providing decision support. A 2005 survey of senior level federal CFO
executives^50 noted that the respondents still believed that mid- and
lower-level personnel lack the skills needed for modern financial
management. The 2005 survey indicated that the federal CFO community
thought that overly complex civil service rules made it difficult to
recruit entry-level talent and nearly impossible to hire middle managers
from outside the government. Our work has shown that staffing shortages,
particularly at key agencies such as DOD, DHS, and Treasury can adversely
impact financial management operations. For example, as part of our work
on the U.S. government's consolidated financial statements, we found that
personnel at Treasury's Financial Management Service had excessive
workloads that required an extraordinary amount of effort and dedication
to compile the consolidated financial statements and that there were not
enough personnel with specialized financial reporting experience to help
ensure reliable financial reporting by the reporting date.^51

Meeting the Challenge of Building the Financial Management Workforce. We
have previously identified several factors that are critical to resolving
financial management human capital issues.

           o Part of the commitment to transformation is the establishment of
           skilled and sustained leadership through the creation of a chief
           management officer (CMO) at selected federal agencies. The CMO
           would serve as the strategic, enterprisewide integrator of efforts
           to transform agency business operations, including financial
           management. While we have called for the creation of such a
           position specifically at DOD and DHS, in July 2006, a major global
           consulting firm recommended that the concept of a chief operating
           officer be instituted in many federal agencies as the means to
           help achieve the transformation that many agencies have
           undertaken.^52

           o Building a world-class financial workforce will require a
           workforce transformation strategy devised in partnership between
           CFOs and agency human resource departments, now established in law
           as Chief Human Capital Officers, working with OMB and OPM. Agency
           financial management leadership must identify current and future
           required competencies and compare them to an inventory of skills,
           knowledge, and current abilities of current employees. Then they
           must strategically manage to fill gaps and minimize overages
           through informed hiring, development, and separation strategies.
           This is similar to the approach that we identified when we
           designated strategic human capital management as a high-risk area
           in 2001.^53 Achieving a successful financial management vision of
           the future will be directly determined by the workforce that
           supports it. In our view, adequate succession planning to ensure
           these positions and other key senior-level financial management
           positions are promptly filled with highly qualified staff will be
           a key success factor to help transform federal financial
           management.

^49JFMIP, Building a World Class Financial Workforce, The Federal
Financial Management Workforce of the Future (Washington, D.C.: September
2003).

^50Grant Thornton LLP and the Association of Government Accountants, CFO
Survey: Integrating Internal Control with Performance Management
(Alexandria, Va.: 2005).

^51See GAO's audit report on its audit of the federal government's fiscal
year 2006 financial statements that was incorporated in the 2006 Financial
Report of the U.S. Government published by Treasury.

  Strengthening Consolidated Financial Reporting

As you know, GAO is responsible for auditing the consolidated financial
statements included in the Financial Report of the United States
Government (Financial Report), but we have been unable to express an
opinion on them for the 10th year in a row because the federal government
could not demonstrate the reliability of significant portions of the
financial statements, especially in connection with major financial
management challenges that I discussed earlier regarding DOD. The lack of
effective internal controls to adequately account for and reconcile
intragovernmental activity and balances is another primary challenge that
impedes our ability to provide an opinion on the consolidated financial
statements. The third major impediment that prevents us from rendering an
opinion on the consolidated financial statements is the federal
government's ineffective process for preparing the consolidated financial
statements. As I previously discussed, addressing the first two
impediments will be difficult challenges. Resolving the weaknesses in the
systems, controls, and procedures for preparing the consolidated financial
statements is also a formidable challenge.

^52T. Danker, T. Dohrmann, N. Killefer, and L. Mendonca, How can American
government meet its productivity challenge? (Washington, D.C.: McKinsey &
Company, 2006).

^53 [63]GAO-05-207 .

While further progress was demonstrated in fiscal year 2006, the federal
government continued to have inadequate systems, controls, and procedures
to ensure that the consolidated financial statements are consistent with
the underlying audited agency financial statements, balanced, and in
conformity with U.S. generally accepted accounting principles. Most of the
issues we identified in fiscal year 2006 existed in fiscal year 2005, and
many have existed for a number of years. In addition, Treasury could not
provide the final fiscal year 2006 consolidated financial statements and
supporting documentation in time for us to complete all of our planned
auditing procedures. During our fiscal year 2006 audit, we found the
following:

           o Treasury showed progress by demonstrating that amounts in the
           Statement of Social Insurance were consistent with the underlying
           federal agencies' audited financial statements and that the
           Balance Sheet and the Statement of Net Cost were consistent with
           federal agencies' financial statements prior to eliminating
           intragovernmental activity and balances. However, Treasury's
           process for compiling the consolidated financial statements did
           not ensure that the information in the remaining three 2006
           principal financial statements and notes were fully consistent
           with the underlying information in federal agencies' audited
           financial statements and other financial data.

           o To make the fiscal years 2006 and 2005 consolidated financial
           statements balance, Treasury recorded net decreases of $11 billion
           and $4.1 billion, respectively, to net operating cost on the
           Statement of Operations and Changes in Net Position, which it
           labeled "Other - Unmatched transactions and balances."^54 An
           additional net $10.4 billion and $3.2 billion of unmatched
           transactions were recorded in the Statement of Net Cost for fiscal
           years 2006 and 2005, respectively. Treasury is unable to fully
           identify and quantify all components of these unreconciled
           activities.

           o The federal government did not have an adequate process to fully
           identify and report items needed to reconcile the operating
           results, which for fiscal year 2006 showed a net operating cost of
           $449.5 billion, to the budget results, which for the same period
           showed a unified budget deficit of $247.7 billion.

^54Although Treasury was unable to determine how much of the unmatched
transactions and balances, if any, relate to operations, it reported this
amount as a component of net operating cost in the accompanying
consolidated financial statements.

We also noted other deficiencies related to the adequacy of required
disclosures and whether amounts reported are complete. Treasury continued
to make progress in addressing certain other internal control weaknesses
in its process for preparing the consolidated financial statements.
However, internal control weaknesses continued to exist involving a lack
of (1) appropriate documentation of certain policies and procedures for
preparing the consolidated financial statements, (2) adequate supporting
documentation for certain adjustments made to the consolidated financial
statements, and (3) effective management reviews.

As in previous years, Treasury did not have adequate systems and personnel
to address the magnitude of the fiscal year 2006 financial reporting
challenges it faced, such as (1) the Governmentwide Financial Report
System (GFRS) undergoing further development^55 and not yet being fully
operational, and (2) weaknesses in Treasury's process for preparing the
consolidated financial statements noted above. One of the underlying
causes of these weaknesses, as I discussed earlier, is the lack of
sufficient personnel with specialized financial reporting experience to
help ensure reliable financial reporting by the reporting date.

Meeting the Challenge of Strengthening Consolidated Financial Reporting.
During fiscal year 2006, Treasury, in coordination with OMB, developed and
began implementing corrective action plans and milestones for short-term
and long-range solutions for certain internal control weaknesses we have
previously reported regarding the process for preparing the consolidated
financial statements. In April 2006, we reported^56 in greater detail on
these issues and provided recommendations to OMB and Treasury. Resolving
some of these internal control weaknesses will require a strong commitment
from Treasury and OMB as they execute and implement their corrective
action plans.

^55GFRS uses a closing package methodology that has been developed to
capture each federal agency's information and link the agencies' audited
financial statements to the governmentwide consolidated financial
statements. See GAO, Financial Management Systems: Lack of Disciplined
Processes Puts Effective Implementation of Treasury's Governmentwide
Financial Report System at Risk, [64]GAO-06-413 (Washington, D.C.: Apr.
21, 2006).

^56GAO, Financial Audit: Significant Internal Control Weaknesses Remain in
Preparing the Consolidated Financial Statements of the U.S. Government,
[65]GAO-06-415 (Washington, D.C.: Apr. 21, 2006).

Overcoming current challenges will be difficult, but after a decade of
reporting at the governmentwide level perhaps now is an appropriate time
to step back and consider the need for further revisions to the current
federal financial reporting model, which would affect both consolidated
and agency financial reporting. While the current reporting model
recognizes some of the unique needs of the federal government, a broad
reconsideration of the federal financial reporting model could address the
following types of questions.

           o What kind of information is most relevant and useful for a
           sovereign nation?

           o Do traditional financial statements convey information in a
           transparent manner?

           o What is the role of the balance sheet in the federal government
           reporting model?

           o How should items that are unique to the federal government, such
           as social insurance commitments and the power to tax, be reported?

Engaging in a reevaluation of this nature could stimulate discussion that
would bring about a new way of thinking about the federal government's
financial and performance reporting needs. To understand various
perceptions and needs of stakeholders for federal financial reporting, a
wide variety of stakeholders from the public and private sector should be
consulted. Ultimately, the goal of such a reevaluation would be reporting
enhancements that can help the Congress deliberate strategies to address
the federal government's challenges, including those of our growing
long-term fiscal imbalance.

More specifically, we continue to support several specific improvements to
federal financial reporting. For example, the federal government's
financial reporting should be expanded to disclose the reasons for
significant changes during the year in scheduled social insurance benefits
and funding. It should also include a Statement of Fiscal
Sustainability--providing a long-term look at the sustainability of
current federal fiscal policy in the context of all major federal spending
programs and tax policies. The reporting on fiscal sustainability should
include additional information that will assist in understanding the
sustainability of current social insurance and other federal programs,
including key measures of fiscal sustainability and intergenerational
equity,^57 projected annual cash flows, and changes in fiscal
sustainability during the reporting period. We believe that such reporting
needs to reflect the significant commitments associated with the Social
Security and Medicare programs while recognizing a liability for the net
assets (principally investments in special U.S. Treasury securities) of
the "trust funds." We support the current efforts of the Federal
Accounting Standards Advisory Board (FASAB) to begin a project on fiscal
sustainability reporting. In addition, an easily understandable summary
annual report should be prepared and published that includes in a clear,
concise, and transparent manner, key financial and performance information
embodied in the Financial Report. Later in this statement, I offer other
suggestions for improved reporting that will help in this regard.

Fiscal Stewardship Is an Increasingly Critical Challenge

Successfully addressing the six primary challenges I just described will
undoubtedly help strengthen the federal government's financial and
performance reporting and resolve many accountability and stewardship
challenges. This will become increasingly important, because as I stated
in our audit report included in the Financial Report, testified before the
Congress, and emphasized in numerous speeches, the nation's current fiscal
path is unsustainable and tough choices by the President and the Congress
are necessary to address the nation's large and growing long-term fiscal
imbalance.

The federal government's financial condition and fiscal outlook are worse
than many may understand. We are currently experiencing strong economic
growth and yet running large on-budget (operating) deficits that are
largely unrelated to the Global War on Terrorism. Despite an increase in
revenues in fiscal year 2006 of about $255 billion, the federal government
reported that its costs exceeded its revenues by $450 billion (i.e., net
operating cost) and that its cash outlays exceeded its cash receipts by
$248 billion (i.e., unified budget deficit). Further, as of September 30,
2006, the U.S. government reported that it owed (i.e., liabilities) more
than it owned (i.e., assets) by almost $9 trillion. In addition, the
present value of the federal government's major reported long-term "fiscal
exposures"--liabilities (e.g., debt), contingencies (e.g., insurance), and
social insurance and other commitments and promises (e.g., Social
Security, Medicare)--rose from about $20 trillion to over $50 trillion in
the last 6 years.

^57Intergenerational equity assesses the extent to which different age
groups may be required to assume financial burdens to sustain federal
responsibilities.

The federal government faces large and growing structural deficits in the
future due primarily to known demographic trends and rising health care
costs. These structural deficits--which are virtually certain given the
design of our current programs and policies--will mean escalating and
ultimately unsustainable federal deficits and debt levels. Based on
various measures--and using reasonable assumptions--the federal
government's current fiscal policy is unsustainable.

The Long-Term Fiscal Outlook

In addition to considering the federal government's current financial
condition, it is critical to look at other measures of the long-term
fiscal outlook of the federal government. An evaluation of the nation's
long-term fiscal outlook should include not only liabilities included in
the Financial Report but also the implicit promises embedded in current
policy and the timing of these longer-term obligations and commitments in
relation to the resources available under various assumptions.

Over the next few decades, the nation's fiscal outlook will be shaped
largely by known demographic trends and rising health care costs. As the
baby-boom generation retires, federal spending on current retirement and
health care programs--Social Security, Medicare, and Medicaid--will grow
dramatically. A range of other federal fiscal commitments, some explicit
and some representing implicit public expectations, also bind the nation's
fiscal future. Absent policy changes, a growing imbalance between expected
federal spending and tax revenues will mean escalating and ultimately
unsustainable federal deficits and debt levels.

There are various ways to consider and assess the long-term fiscal
outlook, including

           o the Statement of Social Insurance,

           o major reported long-term fiscal exposures, and

           o long-term fiscal simulations.

Statement of Social Insurance. The Statement of Social Insurance in the
Financial Report displays the present value of projected revenues and
expenditures for scheduled benefits of certain benefit programs that are
referred to as social insurance (e.g., Social Security, Medicare). For
Social Security and Medicare alone, projected expenditures for scheduled
benefits for the next 75 years exceed earmarked revenues (e.g., dedicated
payroll taxes, premiums, and existing government bonds in the trust funds)
for the same period by approximately $39 trillion in present value terms.
Stated differently, one would need approximately $39 trillion invested
today to deliver on the currently promised benefits for the next 75 years.
Table 1 shows a simplified version of the Statement of Social Insurance by
its primary components.

Table 1: Simplified Statement of Social Insurance as of January 1, 2006

aThese amounts include administrative expenses for the programs.

bUnder current law, Social Security and Federal Hospital Insurance
(Medicare Part A) payments are limited to amounts available to the
respective trust funds.

Note: Data are from the fiscal year 2006 Financial Report.

Major Reported Long-Term Fiscal Exposures. GAO developed the concept of
"fiscal exposures" to provide a framework for considering the wide range
of responsibilities, programs, and activities that explicitly or
implicitly expose the federal government to future spending.

The concept of fiscal exposures is meant to provide a broader perspective
on long-term costs. Major reported long-term fiscal exposures in fiscal
year 2006 with a present value totaling over $50 trillion consisted of $10
trillion of liabilities reported on the Balance Sheet, $1 trillion of
other commitments and contingencies, and the $39 trillion of social
insurance responsibilities, the last two of which are reported elsewhere
in the Financial Report. This $50 trillion compares to about $20 trillion
in fiscal year 2000.

These large numbers are difficult to comprehend. Table 2 seeks to
translate them into several figures and ratios that are more
understandable.

Table 2: Understanding the Size of Major Reported Fiscal Exposures

Note: Percentage increases reflect actual data and may differ from
calculation of rounded numbers presented in table.

Long-Term Fiscal Simulations. Another way to assess the U.S. government's
long-term fiscal outlook and the sustainability of federal programs is to
run simulations of future revenues and costs for all federal programs,
based on a continuation of current or proposed policy. The simulations GAO
has published since 1992 are designed to do that. As shown in figure 1,
GAO's long-term simulations--which are neither forecasts nor
predictions--continue to show ever-increasing long-term deficits resulting
in a federal debt level that ultimately spirals out of control. The timing
of deficits and the resulting debt buildup varies depending on the
assumptions used, but under either optimistic ("Baseline extended") or
more realistic assumptions, the federal government's current fiscal policy
is unsustainable.

Figure 1: Unified Surpluses and Deficits as a Share of GDP under
Alternative Fiscal Policy Simulations

Over the long term, the nation's growing fiscal imbalance stems primarily
from the aging of the population and rising health care costs. Absent
significant changes on the spending or revenue sides of the budget or
both, these long-term deficits will encumber a growing share of federal
resources and test the capacity of current and future generations to
afford both today's and tomorrow's commitments. Continuing on this
unsustainable path will gradually erode, if not suddenly damage, our
economy, our standard of living, and ultimately our domestic tranquility
and national security.

If, for example, as shown in figure 2, it is assumed that recent tax
reductions are made permanent and discretionary spending keeps pace with
the growth of our economy, our long-term simulations suggest that by 2040
federal revenues may be adequate to pay little more than interest on debt
held by the public and some Social Security benefits. Neither slowing the
growth in discretionary spending nor allowing the tax provisions,
including the tax cuts enacted in 2001 and 2003, to expire--nor both
together--would eliminate the imbalance.

Figure 2: Potential Fiscal Outcomes under Alternative Simulation:
Discretionary Spending Grows with GDP after 2007 and All Expiring Tax
Provisions Are Extended

Note: Alternative Minimum Tax (AMT) exemption amount is retained at the
2006 level through 2017 and expiring tax provisions are extended. After
2017, revenue as a share of GDP is held constant--implicitly assuming that
action is taken to offset increased revenue from real bracket creep, the
AMT, and tax-deferred retirement accounts.

At some point, action will need to be taken to change the nation's fiscal
course. The sooner appropriate actions are taken, the sooner the miracle
of compounding will begin to work for the federal budget rather than
against it. Conversely, the longer that action to deal with the nation's
long-term fiscal outlook is delayed, the greater the risk that the
eventual changes will be disruptive and destabilizing. Acting sooner
rather than later will give us more time to phase in gradual changes,
while also providing more time for those likely to be most affected to
make compensatory changes.

The "fiscal gap" is a quantitative measure of long-term fiscal imbalance.
Under GAO's more realistic simulation, assuming debt held by the public
remains at the current share of the economy (i.e., GDP), closing the
fiscal gap would require spending cuts or tax increases equal to 8 percent
of the entire economy each year over the next 75 years, or a total of
about $61 trillion in present value terms. To put this in perspective,
closing the gap would require an immediate and permanent increase in
federal tax revenues of more than 40 percent or an equivalent reduction in
federal program spending (i.e., in all spending except for interest on the
debt held by the public, which cannot be directly controlled).

A Possible Way Forward

Although the long-term fiscal outlook is driven primarily by rising health
care costs and known demographics, we cannot ignore other government
programs and activities. There is a need to engage in a fundamental
review, reprioritization, and reengineering of the base of government.
Aligning the federal government to meet the challenges and capitalize on
the opportunities of the 21st century will require a fundamental review of
what the federal government does, how it does it, and how it is financed.
Many of the federal government's current policies, programs, functions,
and activities are based on conditions that existed decades ago, are not
results-based, and are not well aligned with 21st century realities. We
need to address the growing costs of the major entitlement programs and
also review and reexamine all other major programs, policies, and
activities on both the spending and the revenue side of the budget.
Programs that run through the tax code--sometimes referred to as tax
expenditures^58--must be reexamined along with those that run through the
spending side. As we move forward, the federal government needs to start
making tough choices in setting priorities and linking resources and
activities to results. Meeting our nation's large, growing, and structural
fiscal imbalance will require a multipronged approach:

^58In addition to the reported net cost, the federal government foregoes
tax revenues as a result of preferential provisions, such as tax
exclusions, credits, and deductions. These revenue losses are referred to
as tax expenditures.

           o increasing transparency and enhancing the relevancy of key
           financial, performance, and budget reporting and estimates to
           highlight our long-term fiscal challenges;

           o reinstituting and strengthening budget controls for both
           spending and tax policies to deal with both near-term and
           longer-term deficits;
           o strengthening oversight of programs and activities, including
           creating approaches to better facilitate the discussion of
           integrated solutions to crosscutting issues; and

           o reengineering and reprioritizing the federal government's
           existing programs, policies, and activities to address 21st
           century challenges and capitalize on related opportunities.

In my January 2007 testimony,^59 I proposed a number of ideas for
consideration to improve the transparency of long-term costs. In November
2006, I provided the congressional leadership with recommendations, based
on the work of GAO, for consideration for the agenda of the 110th
Congress.^60 These recommendations focused on three areas: (1) targets for
near-term oversight, (2) policies and programs that are in need of
fundamental reform and reengineering, and (3) governance issues. One of
the areas I pointed out that warranted congressional attention was the
development of a portfolio of outcome-based key national indicators (e.g.,
economic, security, social, environmental) to help measure progress toward
national outcomes, assess conditions and trends, and help communicate
complex issues. The Congress could take a leadership role in highlighting
the need for a U.S. national indicator system to inform strategic
planning, enhance performance and accountability reporting, inform
congressional oversight and decision making, and stimulate greater citizen
engagement. In my view, this should include consideration of a
public/private partnership to help make this key concept a reality sooner
rather than later.

^59GAO, Long-term Budget Outlook: Saving Our Future Requires Tough Choices
Today, [66]GAO-07-342T (Washington, D.C.: Jan. 11, 2007).

^60GAO, Suggested Areas for Oversight for the 110th Congress,
[67]GAO-07-235R (Washington, D.C.: Nov. 17, 2006).

In order to effectively address our long-term fiscal imbalance,
fundamental reform of existing entitlement programs is essential. However,
entitlement reform alone will not get the job done. We also need to
reprioritize and constrain other federal government spending and generate
more revenues--hopefully through a reformed tax system. GAO's 21st Century
Challenges: Reexamining the Base of the Federal Government^61  contains a
suggested list of specific federal activities for reexamination,
illustrative reexamination questions, and perspectives on various
strategies, processes, and approaches for congressional consideration
stemming from our audit and evaluation work that can be used in
reexamining the federal base. Answers to these questions may draw on the
work of GAO and others; however, only elected officials can and should
decide which issues to address as well as how and when to address them.
Addressing these problems will require tough choices, and our fiscal clock
is ticking. As a result, the time to start is now, to help save our
future.

Concluding Remarks

In closing, given the federal government's current financial condition and
growing long-term fiscal imbalance, the need for the Congress and the
President to have timely, reliable, and useful financial and performance
information is greater than ever. Sound decisions on the current results
and future direction of vital federal government programs and policies are
more difficult without such information. Until the problems discussed in
this testimony are effectively addressed, they will continue to have
adverse implications for the federal government and the taxpayers.

Since enactment of federal financial management reform legislation, we
have seen continuous movement toward the ultimate goals of accountability
laid out in the different financial management statutes. While early on
some were skeptical, these laws have dramatically changed how financial
management is carried out and the value placed on good financial
management across government. Across government, financial management
improvement initiatives are underway, and if effectively implemented, have
the potential to greatly improve the quality of financial management
information as well as the efficiency and effectiveness of agency
operations. By the end of my term as Comptroller General, I would like to
see the civilian CFO Act agencies routinely producing not only annual
financial statements that can pass the scrutiny of a financial audit, but
also quarterly financial statements and other meaningful financial and
performance data to help guide decision makers on a day-to-day basis. For
DOD, my expectations are not as high given the current status of DOD's
financial management practices, yet it is realistic for at least major
portions of DOD's financial information to become auditable by the end of
my term. Moreover, progress on developing meaningful financial and
performance reporting on the federal government will be a key area that I
will continue to champion. I am determined to do whatever I can to help
ensure that we are not the first generation to leave our children and
grandchildren a legacy of failed fiscal stewardship and the hardships that
would bring.

^61GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, [68]GAO-05-325SP , (Washington, D.C.: February 2005).

Finally, I want to emphasize the value of sustained congressional interest
in these issues, as demonstrated by this Subcommittee's leadership. It
will be key that going forward, the appropriations, budget, authorizing,
and oversight committees hold agency top leadership accountable for
resolving the remaining problems and that they support improvement efforts
that address the challenges for the future I highlighted today. The
federal government has made tremendous progress, and sustained
congressional attention has been and will continue to be a critical factor
to ensuring achievement of the goals and objectives of management reform
legislation.

Mr. Chairman, this completes my prepared statement and I want to thank you
for the opportunity to participate in this hearing and for the strong
support of this Subcommittee in addressing the need for financial
management reform and accountability. I would be happy to respond to any
questions you or other members of the Subcommittee may have at this time.

Contacts and Acknowledgments

For information about this statement, please contact Jeffrey C. Steinhoff,
Managing Director, Financial Management and Assurance, at (202) 512-2600
or McCoy Williams, Director, Financial Management and Assurance, at (202)
512-9095 or [email protected] . Individuals who made key
contributions to this testimony include Felicia Brooks, Robert Dacey, Kay
Daly, Francine DelVecchio, Gary Engel, Susan Irving, Jay McTigue, Diane
Morris, and Paula Rascona. Numerous other individuals made contributions
to the GAO reports cited in this testimony.

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www.gao.gov/cgi-bin/getrpt?GAO-07-542T .

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Highlights of [77]GAO-07-542T , a testimony before the Subcommittee on
Federal Financial Management, Government Information, Federal Services,
and International Security, Committee on Homeland Security and
Governmental Affairs, U.S. Senate

March 1, 2007

FEDERAL FINANCIAL MANAGEMENT

Critical Accountability and Fiscal Stewardship Challenges Facing Our
Nation

The foundation laid by the Chief Financial Officers Act of 1990 and other
management reform legislation provided a much needed statutory basis to
improve the accountability of government programs and operations. Such
reforms were intended to produce reliable, timely, and useful financial
information to help manage day-to- day operations and exercise oversight
and promote fiscal stewardship.

This testimony, based on GAO's prior work, addresses (1) the progress made
and challenges remaining to improve federal financial management
practices, and (2) the serious challenges posed by the government's
deteriorating long-range fiscal condition and my views on a possible way
forward.

[78]What GAO Recommends

GAO has made numerous recommendations over the years to federal agencies
aimed at addressing financial management weaknesses. Regarding the
government's fiscal imbalance, this testimony reiterates a possible way
forward based on a multipronged approach of increased financial reporting
transparency; reinstituted budget controls; strengthened oversight; and
reprioritized programs, policies, and activities.

Since the enactment of key financial management reforms, the federal
government has made substantial progress in improving financial management
activities and practices. Federal financial systems requirements have been
developed, and internal control has been strengthened. Nonetheless, the
federal government still has a long way to go to address the six principal
challenges to fully realizing strong federal financial management: (1)
transforming financial management and business practices at DOD, (2)
improving agency financial and performance reporting, (3) modernizing
financial management systems, (4) addressing key remaining internal
control weaknesses, (5) building a financial management workforce for the
future, and (6) strengthening consolidated financial reporting.

From a broad financial management perspective, the federal government's
financial condition and fiscal outlook are worse than many understand. We
are currently experiencing strong economic growth and yet running large
on-budget (operating) deficits that are largely unrelated to the Global
War on Terrorism. The federal government faces large and growing
structural deficits in future years due primarily to known demographic
trends and rising health care costs. As shown in the chart below, if it is
assumed that recent tax reductions are made permanent and discretionary
spending keeps pace with the growth of our economy, GAO's long-term
simulations suggest that by 2040, federal revenues may be adequate to pay
little more than interest on debt held by the public and some Social
Security benefits. Neither slowing the discretionary spending growth nor
allowing certain tax provisions to expire--nor both together--would
eliminate the imbalance.

Potential Fiscal Outcomes under Alternative Simulation: Discretionary
Spending Grows with GDP after 2007 and All Expiring Tax Provisions Are
Extended

Note: The Alternative Minimum Tax (AMT) exemption amount is retained at
the 2006 level through 2017 and expiring tax provisions are extended.
After 2017, revenue as a share of GDP is held constant--implicitly
assuming that action is taken to offset increased revenue from real
bracket creep, the AMT, and tax-deferred retirement accounts.

References

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