For Release on Delivery

Expected at

10:30 a.m.

Tuesday,

February 6, 2001

GAO-01-385T

LONG-TERM BUDGET

ISSUES

Moving From Balancing

the Budget to Balancing

Fiscal Risk

Statement of David M. Walker

Comptroller General of the United States

Testimony

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

United States General Accounting Office

GAO
Page 1 GAO-01-385T

Chairman Domenici, Ranking Member Conrad, and other Senators, I am

pleased to be here today to present GAO’s perspective on the long-range

fiscal policy challenges facing this Congress and our nation. In recent

testimony before this committee, Federal Reserve Chairman Alan

Greenspan observed that the new, larger surplus projections have

reshaped the choices and opportunities before us.1 That is true. As I have

noted before, this Administration and this Congress enter the 21st Century

facing new opportunities—and new challenges. You have the opportunity

to respond to many of today’s wants, but also the obligation to prepare for

the long term.

As you face budget choices in a time of projected surpluses, I’d like to hit a

few points:

ï First, as the Congressional Budget Office (CBO) notes these projections

are based on a set of assumptions that may or may not hold—no one

should design tax or spending policy pegged to the precise numbers in any

10-year forecast.

ï Higher 10-year surplus projections provide room to address pent-up

demands for some tax cuts and/or additional spending kept in abeyance

during years of fighting deficits. It is important to remember, however, that

while projections for the next 10-year period look better, the long-term

outlook looks worse. Without a change in entitlement programs,

demographics will overwhelm the surplus and drive us back into

escalating deficits and debt.

ï The rapid increase in surplus projections brings closer the time at which

the surplus is expected to generate cash above that needed to redeem debt

held by the public. Congress and the President face new challenges in

saving for the future as we approach a time when there will be almost no

publicly held debt.

ï Budget choices should be viewed in terms of a balanced portfolio of

options. In the aggregate, choices should be balanced across different

levels of fiscal risk to the long-term outlook by using a portfolio approach.

Attention must be paid not only to responding to current needs but also to

making choices that increase the capacity of future generations to make

their own choices by promoting long-term growth and reducing the

relative future burden of entitlement programs.

 1Alan Greenspan, Testimony before the Committee on the Budget, U.S. Senate (January 25, 2001).
Page 2 GAO-01-385T

Before looking ahead, I think it is useful to take a moment to remind

ourselves of how we got where we are today. We face burgeoning surplus

projections not only because of sustained strong economic growth but

also as a result of many difficult decisions made by earlier Congresses.

These decisions, taken at different times and maintained over time,

ultimately helped us to slay the deficit dragon. They included a budget

control regime that imposed caps on discretionary spending and a pay-asyou-go (PAYGO) process on mandatories and revenues. They included the

difficult spending and tax decisions that implemented this process. Fiscal

discipline was enforced. As these processes and measures took hold, little

by little deficits receded. As the unified budget went into surplus, a

bipartisan consensus emerged on saving the Social Security surpluses, and

this consensus has also played an important part in today’s favorable fiscal

outlook and reduced levels of debt held by the public.

Both the Office of Management and Budget (OMB) and CBO now show

not only Social Security surpluses but also increasing levels of non-Social

Security, or on-budget, surpluses over the next 10-year period. It is these

projected surpluses that have changed the budget landscape dramatically

from even a year ago. The surpluses offer a welcome opportunity to

address the legitimate pent-up demands held in abeyance during the era of

deficits. At the same time the surplus estimates imply that, absent policy

or economic change, debt held by the public could be virtually eliminated

before the end of this decade. As Chairman Greenspan recently

emphasized in testimony before this Committee, the possible elimination

of debt held by the public is an unexpected aspect of the new budgetary

environment. In modern times, it is unprecedented. As you know, Mr.

Chairman and Senator Conrad, GAO has done and is doing some work on

debt management, and later in this testimony I will discuss some of the

emerging issues in this area we have identified in our ongoing work.

The question before this Congress is how to balance today’s wants and

needs against our long-term challenges. The advent of actual and projected

surpluses provides a window to respond to a wide range of demands held

in abeyance during years of restraint. The surplus does not, however,

eliminate our obligation to be prudent in dealing with the taxpayers’ funds.

As we noted recently in the Performance and Accountability Series2 the

newfound budget surpluses provide an opportunity—to move from a focus

on annual budget deficits to a reexamination of what government does and

how the government does business.

 2Major Management Challenges and Program Risks: A Governmentwide Perspective (GAO-01-241,

January 2001).
Page 3 GAO-01-385T

Further, while we can rejoice in the prospect of burgeoning surpluses, at

the same time we need to proceed with a measure of caution. It is

important also to remember that only a few years ago OMB and CBO

projected deficits as far as the eye could see. I do not say this to question

the new projections but simply to remind us of their limitations and how

they are meant to be used. These new projections, like the ones before

them, are a “what-if”—not a precise prediction of the future. The

projections are useful because they quantify the likely future budgetary

consequences if we continue current federal policies without change. As

such, they serve as a reference point and are a key tool for policymakers in

choosing between alternative policy courses. At the same time they are

built on a complex set of assumptions, and I want to talk a little about

those later because we need to understand these assumptions if we are

appropriately to understand the baseline projections.

Clearly, these new surplus projections present us with different—but not

necessarily easier—issues and trade-offs than was the case in the era of

large and persistent deficits. Indeed, in my view these surpluses present

both opportunity and obligation as well. While much of the discussion will

properly concern the opportunities the surpluses afford, I believe it is

important to remember that they bring with them a stewardship

obligation. By stewardship obligation, I mean that today’s budget decisions

need to be made with the future in mind. We must not only respond to the

legitimate needs of today but also take into account the longer term fiscal

pressures that loom ever larger in coming decades as the nation ages and

the baby-boom generation retires. Our long-term simulations, updated

using CBO’s new budgetary estimates, show that spending for federal

health and retirement programs eventually overwhelms even today’s

projected surpluses. This is true even assuming no additional spending for

defense, education, or a Medicare prescription drug benefit—i.e., even if

the entire unified surplus were saved. The aging of our nation, which will

truly begin to affect the budget just after the 10-year budget window ends,

is one key backdrop for the choices this Congress will make.

These long-term pressures which cast a shadow on today’s budgetary

deliberations are a kind of fiscal risk. Budget policy actions may be seen in

terms of their impact on the long term. Our work on budget choices in

states and other nations suggests an array of fiscal actions that may serve

as a framework for thinking about budget choices in a surplus

environment. No one factor is likely to dominate and the allocation of

these surpluses among debt reduction, new or increased spending, and tax

cuts is inherently a matter for political choice. However, these choices can

be made in the context not only of today’s needs but also of the future

realities. Policymakers might think in terms of a portfolio of actions in
Page 4 GAO-01-385T

which a balanced approach may spread and moderate any related fiscal

risk.

In using baseline budget projections, we need to understand what

assumptions they incorporate and how realistic these assumptions may be.

Intended as a neutral reference point for comparing alternative policies,

baseline projections make no assumptions about future policy change. The

overarching assumption is that current laws concerning tax policy and

spending continue unchanged. The conventions governing baseline

projections are appropriate and understandable in the context of budget

enforcement purposes. However, in using these projections as a basis for

policymaking, it is important to remember what they are and what are they

are not. The baseline is just that—a baseline from which to estimate the

impact of policy actions; one would expect the ultimate outcomes to be

different—particularly over a decade.

Some analysts have suggested that baseline projections may understate

likely future discretionary spending while overstating likely future

revenues. Where current law does not provide a determinative rule—as is

the case for discretionary spending after expiration of the caps—both

CBO and OMB must make some assumptions. CBO’s most commonly used

projection for discretionary spending—and the one we use for the first 10

years of our long-term simulations—is the baseline under which

discretionary spending grows with inflation. A number of observers of the

federal budget, including former CBO directors Robert Reischauer and

Rudolph Penner, have suggested that this inflated discretionary

assumption is unrealistic. One analysis has pointed out that a growth rate

no higher than inflation would mean that future per-capita discretionary

spending would decline in real terms during an era of budget surpluses.3 In

addition, projections based on current-law assumptions may overstate

likely future revenues. For example, the baseline projections assume

expiration of a set of about 20 tax credits—including the research and

experimentation tax credit—which have been routinely extended in the

past. The baseline projections also assume no change to the alternative

minimum tax, which is expected to affect an increasing number of middleclass taxpayers.

 3Robert Greenstein, “Can the New Surplus Projections Accommodate a Large Tax Cut?” Center on

Budget and Policy Priorities (January 2001). See also the Concord Coalition’s “The Surplus Field of

Dreams” (October 11, 2000), and Alan Auerbach and William G. Gale, “Perspectives on the Budget

Surplus,” NBER Working Paper 7837 (August 2000).

Current-Law Budget

Projections May

Understate Future

Spending and

Overstate Future

Revenues
Page 5 GAO-01-385T

All projections are surrounded by uncertainty. In using budget estimates,

we need to keep in mind that budget estimates are not—and are not meant

to be—a crystal ball. CBO itself has warned against attributing precision to

its projections, stating that actual budgetary outcomes will almost

certainly differ from the baseline projections—even absent any policy

changes.4CBO notes that its estimate of the 2006 surplus could vary by as

much as $400 billion in either direction. As CBO has said, the value of the

10-year estimates is that they allow Congress to consider the longer-term

implications of legislation rather than focus only on the short-term

effects.5 No policy should assume the exactness of baseline projections;

relatively small shifts can lead to large year-to-year differences.

While considerable uncertainty surrounds both short- and long-term

budget projections, we know two things for certain: the population is

aging and the baby boom generation is approaching retirement age. In

addition demographic trends are more certain than budget projections!

Although the 10-year horizon looks better in CBO’s January 31 projections

than it did in July 2000, the long-term fiscal outlook looks worse. In the

longer term—beyond the 10-year budget window of CBO’s projections—

the share of the population over 65 will begin to climb, and the federal

budget will increasingly be driven by demographic trends.

 4CBO, The Budget and Economic Outlook: Fiscal Years 2002-2011 (January 2001).

5CBO, The Budget and Economic Outlook: An Update (July 2000), p. 22.

Despite Today’s

Outlook for Large and

Growing Surpluses, in

the Long Term

Deficits Will Reemerge
Page 6 GAO-01-385T

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

Grow

Note: Projections based on the Trustees’ intermediate assumptions.

Source: The 2000 Annual Report of the Board of Trustees of the Federal Old-Age and

Survivors Insurance and Disability Insurance Trust Funds.

As more and more of the baby boom generation enters retirement,

spending for Social Security, Medicare, and Medicaid will demand

correspondingly larger shares of federal revenues. Federal health and

retirement spending will also surge due to improvements in longevity.

People are likely to live longer than they did in the past, and spend more

time in retirement. Finally, advances in medical technology are likely to

keep pushing up the cost of providing health care. In contrast to the

improvement in the 10-year projections, our updated simulations—shown

in figure 2—show a worsening in the long-term fiscal outlook since July.

This worsening is largely due to a change in the assumptions about health

care costs over the longer term.

0%

5%

10%

15%

20%

25%

1950 1975 2000 2025 2050 2075

Percent of total population

Population aged 65 and over
Page 7 GAO-01-385T

Figure 2: Comparison of Unified Deficits as a Share of GDP Under the Save

the Social Security Surpluses Simulation, July 2000 Update and January

2001 Update

*Data end when deficits reach 20 percent of GDP.

Source: GAO’s January 2001 analysis.

In recent months there has been an emerging consensus that the long-term

cost growth assumption traditionally used in projecting Medicare and

Medicaid costs in the out-years is too low. A technical panel advising the

Medicare Trustees stated this conclusion in its final report. Charged with

reviewing the methods and assumptions used in the Trustees’ Medicare

projections, the panel found that the methods and assumptions were

generally reasonable with the exception of the long-term cost growth

assumption. Basing its finding on recent research and program experience,

the panel recommended that in the last 50 years of the 75-year projection

period, per-beneficiary program costs should be assumed to grow at a rate

one percentage point above per-capita gross domestic product (GDP)

growth.6 CBO made a similar change to its Medicare and Medicaid longterm cost growth assumptions its October 2000 report on the long term.7

Given this convergence of views, we have incorporated higher long-term

 6Technical Review Panel on the Medicare Trustees Reports, Review of Assumptions and Methods of

the Medicare Trustees’ Financial Projections (December 2000), p. 27. The panel stated that it believes

that the long-term forecasts should reflect the impact of changes in per-beneficiary spending in

addition to the impact of demographic change (p. 28). A more detailed rationale for the

recommendation can be found in chapter III of the final report (pp. 27-42).

7CBO, The Long-Term Budget Outlook (October 2000), pp. 3 and 19. See also the Medicare technical

panel’s discussion of CBO’s similar assumption (p. 38).

-5

0

5

10

15

20

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075

Percent of GDP

July 2000 Save the Social

Security Surpluses*

January 2001 Save the

Social Security Surpluses*
Page 8 GAO-01-385T

health care cost growth consistent with the Medicare technical panel’s

recommendation into our January update.8

The message from our long-term simulations, which incorporate CBO’s 10-

year estimates,9 remains the same as it was a year ago. Indeed, it is the

same as when we first published long-term simulations in 1992.10 Even if

all projected unified surpluses are saved and used for debt reduction,

deficits reappear in 2042. If only the Social Security surpluses are saved,

unified deficits emerge in 2019. (See figure 3.) In both scenarios deficits

would eventually grow to unsustainable levels absent policy changes.

 8It is not known at this time whether the panel’s recommendation on Medicare’s long-term cost growth

will be adopted by the Trustees and incorporated into the 2001 Hospital Insurance and Supplementary

Medical Insurance estimates.

9These simulations are based on the projections CBO released last week. As is our standard practice,

we use CBO’s estimates for the 10-year budget window. Beyond the 10-year window, we assume that

all current-law benefits in entitlement programs are paid in full (i.e., we assume that all promised

Social Security benefits are paid including after projected exhaustion of the OASDI Trust Funds in

2037) and that discretionary spending grows at the same rate as the economy.

10Budget Policy: Prompt Action Necessary to Avert Long-Term Damage to the Economy (GAO/

OCG-92-2, June 5, 1992), The Deficit and the Economy: An Update of Long-Term Simulations

(GAO/AIMD/OCE-95-119, April 26, 1995), Budget Issues: Deficit Reduction and the Long Term (GAO/TAIMD/96-66, March 13, 1996), Budget Issues: Analysis of Long-Term Fiscal Outlook (GAO/

AIMD/OCE-98-19, October 22, 1997), Budget Issues: Long-Term Fiscal Outlook (GAO/TAIMD/OCE-98-83, February 25, 1998), and Budget Issues: July 2000 Update of GAO’s Long-Term

Simulations (GAO/AIMD-00-272R, July 26, 2000).
Page 9 GAO-01-385T

Figure 3: Unified Deficits as a Share of GDP Under Alternative Fiscal Policy

Simulations

*

Data end when deficits reach 20 percent of GDP.

Source: GAO’s January 2001 analysis.

To move into the future with no changes in federal health and retirement

programs is to envision a very different role for the federal government.

Assuming, for example, that Congress and the President adhere to the

often-stated goal of saving the Social Security surpluses our long-term

model shows a world by 2030 in which Social Security, Medicare, and

Medicaid increasingly absorb available revenues within the federal budget.

Under this scenario, these programs would require more than threequarters of total federal revenue. (See figure 4.)

-5

0

5

10

15

20

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075

Percent of GDP

Save Unified

 Surpluses*

Save the Social Security

Surpluses*
Page 10 GAO-01-385T

Figure 4: Composition of Federal Spending as a Share of GDP Under the

Save the Social Security Surpluses Simulation

Notes: (1) Revenue as a share of GDP declines from its 2000 level of 20.6 percent due to

unspecified permanent policy actions that reduce revenue and increase spending to

eliminate the non-Social Security surpluses. (2) The “Save the Social Security Surpluses” simulation can only be run through 2055 due to the elimination of the capital stock.

Source: GAO’s January 2001 analysis.

Little room would be left for other federal spending priorities such as

national defense, education, and law enforcement. Absent changes in the

structure of Social Security and Medicare, some time during the 2040s

government would do nothing but mail checks to the elderly and their

healthcare providers. Accordingly, substantive reform of Social Security

and health programs remains critical to recapturing our future fiscal

flexibility.

Since these simulations assume current-law entitlement benefits, they

both overstate and understate the challenge. They overstate it because

they assume Congress and the President would take no action to change

the cost structure of these programs. However, they understate it because

they also assume no benefit enhancements such as the addition of

coverage for prescription drugs. In addition, these simulations—like the

budget—do not recognize the long-term cost implications of insurance

programs, environmental cleanup liabilities and other long-term

commitments. In other words, in some ways this could be seen as an

optimistic scenario!

The government undertakes other activities and programs that directly

obligate it to spend in the future. While some steps have been taken to

0

10

20

30

40

50

2000 2030 2050

Percent of GDP

Social Security Medicare & Medicaid Net interest All other spending

Revenue
Page 11 GAO-01-385T

improve financial statement reporting of a number of these commitments,

more needs to be done. In addition, many future costs are not reflected in

either budget projections or long-term simulations. Explicit liabilities not

reflected in the budget can be sizable. For example, estimates indicate that

environmental cleanup of government-caused waste is expected to cost

the federal government at least $300 billion. Other future financial

commitments and contingencies are also important considerations.

The future costs of other activities are often difficult to estimate, but

nonetheless can add to future fiscal stress. Some, such as credit subsidy

costs, are in the budget and thus in the baseline; others, like the risk

assumed by federal insurance programs, are not. All of these as well as

demands for increased federal support in areas ranging from health

insurance to national defense will compete for a share of the fiscal pie in

the future—a pie that will already be increasingly encumbered by higher

costs for the elderly. This highlights the government’s stewardship

responsibility to provide future generations with sufficient budgetary

flexibility to make their own choices and an economic base sufficient to

finance current commitments as well as future needs.

Today Congress and the President face a very different set of budget

choices than did your recent predecessors. For over 15 years fiscal policy

has been seen in the context of the need to reduce the deficit. The policies

and procedures put in place to achieve a balanced budget do not provide

guidance for fiscal policy in a time of surplus. At the same time, as

Chairman Greenspan warned last month, we “need to resist those policies

that could readily resurrect the deficits of the past and the fiscal

imbalances that followed in their wake.”

As you know, we have looked at a number of other countries that have

already faced this challenge.11 Like the United States, these nations

achieved budget surpluses largely as the result of improving economies

and sustained deficit reduction efforts. After years of restraint, there are

pent-up demands—for tax cuts and/or for spending. In several notable

cases, these countries met current demands while retaining surpluses for

longer-term economic goals. How do countries meet these demands

without abandoning restraint? The countries we reviewed articulated a

compelling case for sustaining surpluses and developed a fiscal policy

 11Budget Surpluses: Experiences of Other Nations and Implications for the United States (GAO/

AIMD-00-23, November 2, 1999). In the report we looked at Australia, Canada, New Zealand, Norway,

Sweden, and the United Kingdom.

Budget Policy in a

Time of Surplus
Page 12 GAO-01-385T

framework that addressed current needs within the context of broader

economic targets or goals. Some adopted fiscal targets such as debt-toGDP ratios as a guide for decision-making while others such as Australia

attempted to focus on the impact of fiscal policy on national saving and

economic growth.

Achieving consensus on a long-term fiscal policy goal this year may seem

unlikely. Nevertheless, I believe it is important that Congress and the

President look at budget choices today in the context not only of today’s

needs and demands but also of the long-term pressures we know loom on

the horizon. Today’s surpluses create, in effect, a unique window of

opportunity to better position the government and the nation to address

both current needs as well as the longer-term budget and economy we will

hand to succeeding generations. Our long-term model illustrates how

important it is for us to use our newfound fiscal good fortune to promote a

more sustainable longer-term budget and economic outlook so that future

generations can more readily afford the commitments of an aging society.

Today’s budget decisions have important consequences for the living

standards of future generations. The financial burdens facing the smaller

cohort of future workers in an aging society would most certainly be

ameliorated if the economic pie were enlarged. This is no easy challenge,

but in a very real sense, our fiscal decisions affect the longer-term

economy through their effects on national saving. Recent research

estimated that increasing saving as a share of GDP by one percentage

point each year would boost GDP enough to cover 95 percent of the

increase in elderly costs between now and 2050.

Simply put, we are not saving enough as a nation. Personal saving is at a

40-year low. As shown in figure 5, the reduction of federal deficits and the

emergence of budget surpluses in recent years have slowed the long-term

decline in national saving. While investment needed to promote growth

has been supported by foreign capital in recent years, the profits due to

foreign investment go abroad. What would happen if in the future foreign

investors found more attractive opportunities elsewhere? The most viable

strategy for expanded growth in the long run is to increase saving from our

own economy. Since expanding the nation’s productive capacity through

saving and investment is a long-term process, increasing saving now is

vital since labor force growth is expected to slow significantly over the

next 20 years.

Deficits, Debt, and

National Saving
Page 13 GAO-01-385T

Figure 5: Composition of Net National Saving (1960-1999)

*“Other net saving” consists of net saving by businesses and state and local governments.

Source: Department of Commerce, Bureau of Economic Analysis.

Traditionally, the most direct way for the federal government to increase

saving has been to reduce the deficit or—more recently—to run a surplus.

Although the government may try to increase personal saving, results of

these efforts have been mixed. As a general rule the surest way for the

federal government to affect national saving has been through its fiscal

policy.

In general, saving involves trading off consumption today for greater

consumption tomorrow. When the government saves by reducing debt by

the public, it helps lift future fiscal burdens by freeing up budgetary

resources encumbered for interest payments—which currently represent

more than 12 cents of every federal dollar spent—and by enhancing the

pool of economic resources available for private investment and long-term

economic growth. This is especially important since—as I noted a year and

a half ago—we enter this period of surplus with a large overhang of debt

held by the public. Indeed, we should be a little more subdued in

congratulating ourselves on the decline in debt held by the public—we are

still significantly above the debt/GDP ratio of the late 1970s. Given the

-5

0

5

10

15

1960-1969 1970-1979 1980-1989 1990-1999

Percent of gross domestic product

Federal surplus/deficit Personal saving Other net saving* N et national saving 

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Page 14 GAO-01-385T

demographic pressures looming, today’s level of publicly held debt is not a

good benchmark.

However, current projections show that—depending on the budget

policies adopted—the United States could reach a point in this decade at

which annual budget surpluses could not be fully used to reduce debt.

Although estimates of exactly when this might occur vary, most put it

between 2004 and 2011. If the entire unified surplus is saved, this point is

likely to be reached in sometime in the next 5 years; if only the Social

Security surplus is saved, this point will be delayed until the second half of

the decade.

This would raise a number of issues: whether and if so how the

government should hold nonfederal assets; whether and if so how a

market for debt held by the public should be maintained; how do we as a

nation raise the level of national saving if reducing federal debt held by the

public is not an option.

The issues Chairman Greenspan raised concerning government ownership

of nonfederal assets deserve careful consideration. I note that while

Chairman Greenspan opposed such a step, he also said that if the

government were to acquire nonfederal assets, he would prefer that they

be allocated to the Social Security Trust Funds. At GAO we have looked

both at the experiences of other countries during times of declining debt

and at the question of trust fund investments in equities. We believe this

work can assist you in your deliberations.

For example, in our ongoing work looking at other nations’ experiences

with declining debt, we found that some have decided to hold some

nonfederal assets as part of their efforts to deal with long-term pressures.

With the advent of surpluses, Norway established a goal of sustained

surpluses in order to build up savings to address long-term fiscal and

economic concerns resulting primarily from an aging population and

declining petroleum reserves. As a vehicle for accumulating assets, the

government created the Government Petroleum Fund in 1991 to help

manage Norway’s petroleum wealth over the long term. The Fund serves

several important fiscal and economic functions. By investing surpluses,

the Fund is an instrument for saving part of Norway’s petroleum revenues

for the next generation. During the 1990s, Canada modified its pension

system to invest in nonfederal assets as one way to improve the system’s

sustainability. Sweden also invests a portion of its pension funds in

nonfederal assets. Management of Norway’s Petroleum Fund is the

responsibility of the Ministry of Finance, which has delegated the task of

operational management of the Fund to Norway’s central bank. Both
Page 15 GAO-01-385T

Canada and Sweden have established separate boards to oversee the

investment of their fund assets. In the near future, we plan to conduct a

study of other nations that invest in nonfederal assets in order to learn

more about how they deal with governance issues.

In 1998, we reported on the implications of allowing the Social Security

Trust Funds to invest in nonfederal assets, specifically equities.12One of

the implementation issues we looked at was that of governance—at the

concern that there would be tremendous political pressures to steer the

trust funds’ investments to achieve economic, social, or political purposes.

We concluded that passively investing in a broad-based index would

reduce, but not eliminate, the possibility of political influence over the

government’s stock selections. The question of how to handle stock voting

rights, however, seemed likely to be more difficult to resolve. To blunt

concerns about potential federal meddling, the government’s stock voting

rights could be restricted by statute or delegated to investment managers.

The issue of how to select stock investments also emerged when the

federal employees’ Thrift Savings Plan (TSP) was created. To eliminate

political influence in TSP’s stock investment decisions, the Congress

restricted TSP investments to widely recognized broad-based market

indexes; thus the portfolio composition is automatically determined by the

market index chosen and consideration of nonfinancial objectives is

precluded. TSP board members and employees are subject to strict

fiduciary rules, and breaching their fiduciary duty would expose them to

civil and criminal liabilities. The fiduciary rules require board members

and employees to invest the money and manage the funds solely for the

benefit of the owners of the individual accounts—the participating federal

employees and their beneficiaries. TSP board members and employees are

prohibited from exercising stock voting rights, and voting instead is

delegated to investment managers according to their own guidelines.

Obviously, the design and management of any federally owned assets will

be critical to mitigate the risks of political interference. Since TSP assets

are owned by federal employees, it cannot be seen as directly analogous to

government investment. Nevertheless, it can be helpful in considering

these issues.

Government ownership of nonfederal assets is obviously complicated and

would carry certain risks. Although the governance issues may not be

insurmountable, another possible concern is the magnitude of federal

 12Social Security Financing: Implications of Government Stock Investing for the Trust Fund, the

Federal Budget, and the Economy (GAO/AIMD/HEHS-98-74, April 22, 1998).
Page 16 GAO-01-385T

involvement in the financial markets. Although the federal government

would become the largest single investor, the amounts invested might not

seem disproportionately large in terms of the size of the U.S. financial

markets. Under our Save the Social Security Surpluses simulation, the

federal government would buy nonfederal assets for about a decade and

cumulative federal holdings would peak at about 2 percent of GDP

assuming that a federal debt market is not maintained. This would

represent about 1 percent of the stock market or 4 percent of the

corporate bond market today. Any price effects associated with the federal

government acquiring and then selling these assets are uncertain.

However, the government would not necessarily be selling its nonfederal

assets in this window.

If nonfederal assets are to be held by the government, the question arises

whether they could be used to prefund a portion of federal commitments

and liabilities. Since a successful stock investment strategy should be

grounded in a long-term outlook, the idea of investing in nonfederal assets

could be considered appropriate for federal programs with a long time

horizon. For example, federal civilian and military retirement programs

could buy and hold assets that match the expected timing of their

liabilities.

As I have already noted, there is a growing body of experience in other

nations that might help us understand this new landscape better. It is

worth noting that investing in the financial markets is a standard practice

for state and local governments, and the experiences of public pension

funds may yield some insights into the implications of the federal

government investing on behalf of Social Security or other federal

retirement programs. Other nations have decided that the potential risks

of political interference with markets can be managed and are outweighed

by what they perceive as a risk of failing to save for the future or providing

a cushion for contingencies. These trade-offs are inherently political

decisions—and although we can look to others for insights, we will have

to resolve these issues in our own way.

If the governance, control and size issues loom so large that there is a

consensus the federal government should not hold nonfederal assets, we

face a new set of issues: should we avoid eliminating debt held by the

public, and if so, how? How then would we accumulate sufficient national

saving to promote the level of economic growth needed to finance the

baby boom retirement? The surest way for the federal government to raise

national saving has been by raising government saving. How to raise

national saving in an environment of zero federal debt is a complex

question. The government could aim for a balanced budget once the
Page 17 GAO-01-385T

federal debt held by the public is eliminated. In such a case, all national

saving would have to be achieved through increased private saving.

Whether existing federal incentives for people to save have been effective

in increasing private saving and ultimately national saving is open to

question. Even with preferential tax treatment granted since the 1970s to

encourage retirement saving, the personal saving rate has steadily

declined, as shown in figure 6.

Figure 6: Personal Saving Rate (1960-1999)

Note: This rate as measured in the National Income and Product Accounts (NIPA) is

personal saving as a percentage of disposable personal income.

Source: Department of Commerce, Bureau of Economic Analysis, Survey of Current

Business, Tables 5.1 and 2.1.

Some have suggested that one option would be using the surpluses to

finance individual saving accounts. Various proposals have been advanced

that would create a new system of individual accounts as part of

comprehensive Social Security reform, while other proposals would create

new accounts outside of Social Security. Individual account proposals also

differ as to whether individuals’ participation would be mandatory or

voluntary. If the goal of individual account proposals is to increase

national saving, careful consideration must be given to the specifics of

design.13 Matching provisions may affect how much such accounts

 13Social Security: Capital Markets and Educational Issues Associated With Individual Accounts

(GAO/GGD-99-115, June 28, 1999).

0

2

4

6

8

10

12

1960 1965 1970 1975 1980 1985 1990 1995

Percent of disposable personal income

NIP A personal saving rate
Page 18 GAO-01-385T

increase national saving. On another dimension, allowing early access to

these accounts increases people’s willingness to put money in them-but

reduces their usefulness as retirement accounts. One possible approach

might be to use part of any realized surplus as a kind of surplus dividend

that could be returned in the form of an individual saving account. Again,

design features including targeting and limitations on access would be

important.

As I discussed earlier, reducing the relative future burdens of Social

Security and health programs is critical to promoting a sustainable budget

policy for the longer term. Moreover, absent reform, the impact of federal

health and retirement programs on budget choices will be felt as the baby

boom generation begins to retire. While much of the public debate

concerning the Social Security and Medicare programs focuses on trust

fund balances—that is, on the programs’ solvency—the larger issue

concerns sustainability. Absent reform, the impact of federal health and

retirement programs on budget choices will be felt long before projected

trust fund insolvency dates when the cash needs of these programs begin

to seriously constrain overall budgetary flexibility.

The 2000 Trustees Reports estimate that the Old-Age and Survivors

Insurance and Disability Insurance (OASDI) Trust Funds will remain

solvent through 2037 and the Hospital Insurance (HI) Trust Fund through

2025. This date does not incorporate either the technical panel’s suggested

higher cost growth assumption or any benefit expansions such as

prescription drug coverage. Furthermore, because of the nature of federal

trust funds, HI and OASDI Trust Fund balances do not provide meaningful

information about program sustainability—that is, the government’s fiscal

capacity to pay benefits when the program’s cash inflows fall below

benefit expenses. From this perspective, the net cash impact of the trust

funds on the government as a whole—not trust fund solvency—is the

important measure. Under the Trustees’ intermediate assumptions, the

OASDI Trust Funds are projected to have a cash deficit beginning in 2015

and the HI Trust Fund a deficit beginning in 2009 (see figure 7). At that

point, the programs become net claimants on the Treasury. In addition, as

we have noted in other testimony,14 a focus on HI solvency presents an

incomplete picture of the Medicare program’s expected future fiscal

claims; the Supplementary Medical Insurance (SMI) portion of Medicare,

 14Medicare Reform: Issues Associated with General Revenue Financing (GAO/T-AIMD-00-126,

March 27, 2000).

Entitlement Reform
Page 19 GAO-01-385T

which is not reflected in the HI solvency measure, is projected to grow

even faster than HI in the future.

Figure 7: Social Security and Medicare’s Hospital Insurance Trust Funds Face Cash Deficits as Baby Boomers

Begin to Retire

Note: Projections based on the Trustees’ 2000 intermediate assumptions.

Source: GAO analysis of data from the Office of the Actuary, Social Security

Administration and the Office of the Actuary, Health Care Financing Administration.

To finance these cash deficits, Social Security and the Hospital Insurance

portion of Medicare will need to draw on their special issue Treasury

securities acquired during the years when these programs generated cash

surpluses. In essence, for OASDI or HI to “redeem” their securities, the

government must raise taxes, cut spending for other programs, or reduce

projected surpluses.

Our long-term simulations illustrate the magnitude of the fiscal challenges

associated with our aging society and the significance of the related

-600

-500

-400

-300

-200

-100

0

100

200

2000 2005 2010 2015 2020 2025 2030 2035 2040

Billions of 2000 dollars

Medicare HI cash flow Social Security cash flow

Medicare HI

cash deficit

2009

Social Security cash

deficit 2015
Page 20 GAO-01-385T

challenges that government will be called upon to address. As we have

stated elsewhere,15 early action to change these programs would yield the

highest fiscal dividends for the federal budget and would provide a longer

period for prospective beneficiaries to make adjustments in their own

planning. This message is not changed by the new surplus numbers. It

remains true that the longer we wait to take action on the programs

driving long-term deficits, the more painful and difficult the choices will

become.

While these new surplus projections offer an opportunity to address

today’s needs and the many pent-up demands held in abeyance during

years of fighting deficits, they do not eliminate our obligation to prepare

for the future. Today’s choices must be seen not only in terms of how they

respond to today’s needs, but also how they affect the future capacity of

the nation and our ability to meet our looming demographic challenge.

When we looked at how other nations responded to budget surpluses, we

discovered that most found a way to respond to pressing national needs

while also promoting future fiscal flexibility and saving. Their actions

could be seen as constituting a range of actions across a continuum by the

degree of long-term fiscal risk they present. Figure 8 illustrates this array

along one dimension. At one end debt reduction and entitlement reform

actually increase future fiscal flexibility by freeing up resources. One-time

actions—either on the tax or spending side of the budget—may neither

increase nor decrease future flexibility—although here many would

distinguish between types of actions; devoting funds to previously

underfunded liabilities or to one-time capital investments may be seen as

different than actions that increase consumption. Permanent or openended tax cuts and/or spending increases may reduce future fiscal

flexibility—although that is likely to depend on their structure and

implementation. For example, many would argue that certain permanent

changes in the tax structure and/or funding for well-chosen investments

can enhance economic growth and build for the future.

 15Major Management Challenges and Program Risk: A Governmentwide Perspective (GAO-01-2421,

January 2001), p. 45.

Moving From

Balancing the Budget

to Balancing Fiscal

Risk
Page 21 GAO-01-385T

Figure 8: Array of Fiscal Choices

The decision on how to allocate surpluses is by its very nature inherently a

political one—and I am not here to advocate any particular tax or

spending proposal. Rather, my point is that since surplus projections are

more uncertain than demographic trends, prudence would argue for

seeking to balance risk. You might think about the budget choices you face

today as a portfolio of fiscal actions balancing today’s unmet needs with

tomorrow’s fiscal challenges. If the experience of other nations and the

states is any guide, we will most likely choose actions across an array of

choices. In thinking about balanced risk, it is not the merits of any

individual proposal that are key but the impact of these decisions in the

aggregate or from a portfolio perspective.

This suggests that whatever the fiscal choices made in allocating the

surplus among debt reduction, tax cuts, and spending increases,

approaches should be explored to mitigate risk to the long term. For

example, provisions with plausible expiration dates—on the spending and

the tax side—may prompt re-examination taking into account any changes

in fiscal circumstances. A mix of temporary and permanent actions may

also reduce risk. In our recent Performance and Accountability series, we

also suggested that, given the inherent uncertainty of surplus projections,

consideration be given to linking a portion of new fiscal commitments to

the actual levels of surpluses achieved. As I mentioned earlier, one

possible approach could be a kind of “surplus dividend” that had to be

saved. Whatever the form, linking new commitments to actual results can

be seen as a kind of contingency planning. Others have suggested

considering a portion of the surplus as a kind of contingency fund.

Some states have developed approaches to limiting fiscal risk by linking

temporary tax cuts or spending to actual fiscal results. In Ohio, an Income

Reduce

debt

Capital

investments

One-time

tax refunds

Permanent

tax cut

Reserve

funds

Address

underfunded

liabilities

One-time

spending

Permanent

spending

increase

Invest

surpluses
Page 22 GAO-01-385T

Tax Reduction Fund was established as a mechanism to return surplus

revenues to taxpayers based on the size of the actual surplus in excess of

the amount required to maintain the budget stabilization fund. Minnesota

has refunded surplus revenues beginning in 1997 and has since instituted a

requirement that a revenue surplus exceeding 0.5 percent be designated

for a tax rebate. Arizona developed triggers which designate the use of

surplus revenues for specific tax reductions, or new appropriations based

on the amount of actual surpluses achieved. Arizona also has increased

the balances in the Budget Stabilization Fund. The excess surplus funds

triggered reductions in vehicle license and corporate taxes as well as

increased education funding.

Surpluses challenge our nation to move beyond a focus on reducing

annual deficits to a broader agenda. They offer us an opportunity to look

more closely at what government does and how it does business. With the

advent of surpluses in the near-term, the nation needs to develop a new

fiscal paradigm–one that will prompt greater attention to the long-term

implications of current programs and policy choices and help to better

balance today’s wants against tomorrow’s needs.

For more than a decade, budget processes have been designed with the

goal of reaching a zero deficit. Now that goal has been reached—indeed

passed. Clearly, the limits imposed to achieve a balanced budget are not

working in the world of surplus. At the same time eliminating all controls

would be a mistake. You face the need not only to make choices about tax

and spending policy, but also to design a process for the future.

Now that the goal of “Zero Deficit” is gone, what should replace it?

Whatever measure you select, we believe that the budget and the budget

process must pay more attention to the long-term cost implications of

today’s budget and program decisions. We have recommended, for

example, budgeting for the fully accrued costs for insurance and pensions

in current budgets to reflect the future commitments made in current

programs.16 Ultimately, the federal government needs a decision-making

framework that permits it to evaluate fiscal good fortune and choices

against both today’s needs and the longer-term fiscal future we wish to

hand to future generations.

 16Accrual Budgeting: Experiences of Other Nations and Implications for the United States

(GAO/AIMD-00-57, February 18, 2000) and Budget Issues: Budgeting for Federal Insurance Programs

(GAO/AIMD-97-16, September 30, 1997).

Conclusion
Page 23 GAO-01-385T

I have suggested here today that budget choices can be seen as a fiscal

portfolio—and as such the ideal set would balance different types of fiscal

risks. Not only should policy choices be examined individually, but also

their aggregate impact on the nation’s long-term economic health should

be considered. The budget surpluses before us offer policymakers the

opportunity to strike a balance between addressing today’s needs and the

obligation to hand a strong economy and sustainable fiscal policies on to

our children, our grandchildren, and future generations.

(450041)
Orders by Internet

For information on how to access GAO reports on the Internet, send

an e-mail message with “info” in the body to:

Info@www.gao.gov

or visit GAO’s World Wide Web home page at:

http://www.gao.gov

Contact one:

Web site: http://www.gao.gov/fraudnet/fraudnet.htm

E-mail: fraudnet@gao.gov

1-800-424-5454 (automated answering system)

Ordering Information

To Report Fraud,

Waste, and Abuse in

Federal Programs