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Background DOD is one of the largest and most complex organizations in the world. Overhauling its business operations will take many years to accomplish and represents a huge and possibly unprecedented management challenge. Execution of DOD’s operations spans a wide range of defense organizations, including the military services and their respective major commands and functional activities, numerous large defense agencies and field activities, and various combatant and joint operational commands that are responsible for military operations for specific geographic regions or theaters of operation. To support DOD’s operations, the department performs an assortment of interrelated and interdependent business functions—using thousands of business systems—related to major business areas such as weapon systems management, supply chain management, procurement, health care management, and financial management. The ability of these systems to operate as intended affects the lives of our warfighters both on and off the battlefield. To address long-standing management problems, we began our high-risk series in 1990 to identify and help resolve serious weaknesses in areas that involve substantial resources and provide critical services to the public. Historically, high-risk areas have been designated because of traditional vulnerabilities related to their greater susceptibility to fraud, waste, abuse, and mismanagement. As our high-risk program has evolved, we have increasingly used the high-risk designation to draw attention to areas associated with broad-based transformation needed to achieve greater economy, efficiency, effectiveness, accountability, and sustainability of selected key government programs and operations. DOD has continued to dominate the high-risk list, bearing responsibility, in whole or in part, for 15 of our 27 high-risk areas. Of the 15 high-risk areas, the 8 DOD-specific high-risk areas cut across all of DOD’s major business areas. Table 1 lists the 8 DOD-specific high-risk areas and the year in which each area was designated as high risk. In addition, DOD shares responsibility for 7 governmentwide high-risk areas. GAO designated DOD’s approach to business transformation as high risk in 2005 because (1) DOD’s improvement efforts were fragmented, (2) DOD lacked an enterprisewide and integrated business transformation plan, and (3) DOD had not appointed a senior official at the right level with an adequate amount of time and appropriate authority to be responsible for overall business transformation efforts. Collectively, these high-risk areas relate to DOD’s major business operations, which directly support the warfighter, including how servicemembers get paid, the benefits provided to their families, and the availability of and condition of the equipment they use both on and off the battlefield. DOD’s Pervasive and Long-standing Financial Management and Business Weaknesses Affect the Department’s Efficiency and Effectiveness and Ultimately Impact DOD’s Ability to Support the Warfighter The persistence and magnitude of DOD’s business transformation challenges underscore the fact that the status quo is unacceptable, and without focused and sustained leadership to guide business transformation, the department will continue to waste billions of dollars every year. Within DOD, business transformation is broad, encompassing people, planning, processes, organizational structures, and technology in all of DOD’s major business areas. DOD spends billions of dollars to sustain key business operations intended to support the warfighter. DOD’s pervasive and long-standing weaknesses in its financial management and business operations adversely affect the economy, efficiency, and effectiveness of DOD’s operations, and have resulted in a lack of adequate accountability across all the department’s major business areas. Every dollar that DOD could save through improved economy and efficiency of its operations is important to the fiscal well-being of our nation, and ultimately can be used to support the needs of the warfighter. DOD’s high- risk areas have real world implications for our men and women in uniform, including how the future needs of ongoing operations are estimated, the availability and condition of the equipment they use both on and off the battlefield, and the performance of contractors paid to provide logistical support to servicemembers in theater, as the following examples illustrate: Financial management. Continuing material weaknesses in DOD’s business processes, systems, and controls have adversely affected the reliability of the department’s reported financial information and the department’s ability to manage its operations. To its credit, the department initiated the “Check It” Campaign in July 2006 to raise awareness throughout the department on the importance of effective internal management controls. However, until the impact of this campaign and other efforts, including its financial improvement and audit readiness (FIAR) effort, begin to significantly transform and improve DOD’s business operations, the department will continue to suffer weaknesses in the reliability and usefulness of its management information as illustrated by the examples below. The lack of reliable asset information, including cost, location, and condition, necessary to effectively (1) safeguard assets from physical deterioration, theft, or loss; (2) account for the acquisition and disposal of these assets; (3) ensure that the assets are available for use when needed; (4) prevent unnecessary storage and maintenance costs, or purchase of assets already on hand; and (5) determine the full costs of programs that use these assets. DOD’s inability to estimate with assurance key components of its environmental and disposal liabilities and support a significant amount of its estimated military postretirement health benefits liabilities included in federal employee and veteran benefits payable. Problems in accounting for liabilities affect the determination of the full cost of DOD’s current operations and the extent of its liabilities. Also, improperly stated environmental and disposal liabilities and weak internal control supporting the process for their estimation affect the department’s ability to determine priorities for cleanup and disposal activities and to appropriately consider future budgetary resources needed to carry out these activities. Continuing weaknesses in DOD’s ability to properly record transactions and reconcile its disbursement activities have adversely impacted the reliability of DOD’s reported cost data. Unreliable cost information affects DOD’s ability to control and reduce costs, assess performance, evaluate programs, and set appropriate fees to recover costs where required. Improperly recorded disbursements could result in misstatements in the financial statements and in certain data provided by DOD for inclusion in The Budget of the United States Government concerning obligations and outlays. Further, inadequacies in DOD’s systems and processes for recording and reporting obligation data related to ongoing operations in support of the global war on terrorism have contributed to uncertainty regarding the reliability of reported costs. Our reviews found a number of problems, including long-standing deficiencies in DOD’s financial management and business systems, incorrectly categorized or omitted obligations, and the reporting of large amounts of obligations in miscellaneous “other” categories. Without transparent and accurate cost reporting, neither DOD nor Congress can reliably know how much the war is costing, examine details on how funds are spent, or have historical data useful in considering future needs. DOD has taken positive steps in response to our recommendations intended to improve the reliability and accuracy of its cost reports, and therefore cost reporting continues to evolve. These financial management problems continue to be exacerbated by the department’s inability to implement business systems with the desired capability. For example, the Army’s Logistics Modernization Program has been beset with problems virtually since its initial implementation in July 2003. For instance, as we reported in July 2007, the program cannot accurately recognize revenue and bill customers, and its inability to implement effective business processes has adversely affected the reliability of its financial reports. Weapon systems acquisition. DOD weapon system programs typically take longer to field and cost more to buy than planned, placing additional demands on available funding. For example, we reviewed 27 weapon programs that were in the research, development, test and evaluation phase and noted that since development began the costs had increased by almost $35 billion, or 33.5 percent, over the first full estimate. The same programs have also experienced an increase in the time needed to develop capabilities. The consequence of cost and acquisition cycle time growth is often manifested in a reduction of the buying power of the defense dollar. As costs rise and key schedule milestones are delayed, programs are sometimes forced to reduce quantities, resulting in a reduction in buying power and a reduction in capability delivered to the warfighter. It is a predictable and recurring phenomenon that can be remedied with more attention to separating wants from needs and better knowledge at key decision points. With a weapon investment portfolio of $1.5 trillion, DOD cannot settle for the same kind of outcomes it has gotten in the past. Supply chain management. Systemic deficiencies in DOD’s supply support for U.S. ground forces have led to critical supply shortages during war operations. At the outset of Operation Iraqi Freedom and periodically throughout the campaign, DOD has experienced difficulties in providing U.S. ground forces with critical items such as tires, body armor, and Meals- Ready-to-Eat. In addition, our review of the Air Force’s inventory management practices found problems that hindered its ability to efficiently and effectively maintain its spare parts inventory for military equipment. For example, we found that from fiscal years 2002 through 2005, an average of 52 percent ($1.3 billion) of the Air Force’s secondary on-order inventory was not needed to support on-order requirements. Furthermore, we also reported that the Army plans to invest about $5 billion over the next several years to develop and implement business systems to better track inventory items without a clear, integrated strategy, Armywide enterprise architecture, or concept of operations to guide this investment. Challenges remain in coordinating and consolidating distribution and supply support in theater, which could lead to similar types of supply problems experienced in Operation Iraqi Freedom in future military operations. Contract management. DOD has relied extensively on contractors to undertake major reconstruction and logistical support to its troops in Iraq. Service contracts have grown by nearly 80 percent in a decade, both at home and abroad. In some cases, contractors have begun work without the key terms and conditions of contracts, including projected costs, being defined within required time frames. Problems with poor planning, insufficient leadership and guidance, inadequate numbers of trained contracting personnel, and limited oversight contribute to ineffective contract management controls. For example, a program official for the Logistics Civil Augmentation Program (LOGCAP)—DOD’s largest support contract—noted that if adequate staffing had been in place, the Army could have realized substantial savings through more effective reviews of new requirements. Furthermore, we recently found that sole-source contracts for security contractors on installations were found to be 25 percent higher than past contracts awarded competitively. In addition, DOD does not have a sufficient number of oversight personnel, in deployed locations and elsewhere, which precludes its ability to obtain reasonable assurance that contractors are meeting contract requirements efficiently and effectively at each location where work is being performed. For example, officials responsible for contracting with the Multi-National Force—Iraq (MNF-I) stated that they did not have enough contract oversight personnel and quality assurance representatives to allow MNF-I to reduce the Army’s use of the LOGCAP contract by awarding more sustainment contracts for base operations support in Iraq. Further, a lack of training for military commanders hinders their ability to adequately plan for the use of contractor support and inhibits the ability of contract oversight personnel to manage and oversee contracts and contractors who support deployed forces. As these examples point out, weaknesses in DOD’s business operations span most of the department’s major business areas and negatively impact the department’s efficiency and effectiveness and affect its ability to support the warfighter. Overall, these long-standing weaknesses in DOD’s business areas have (1) resulted in a lack of reliable information needed to make sound decisions and report accurately on its operations; (2) hindered its operational efficiency; (3) adversely affected mission performance; and (4) left the department vulnerable to fraud, waste, abuse, and mismanagement. DOD Has Made Progress in Addressing Its Business Transformation Efforts, but Critical Actions are Needed to Provide Comprehensive, Integrated, and Strategic Planning and Focused and Sustained Leadership Due to the impact of the department’s business weaknesses on both the department and the warfighter, DOD’s leaders have demonstrated a commitment to making the department’s business transformation a priority and have made progress in establishing a management framework for these efforts. For example, the Deputy Secretary of Defense has overseen the establishment of various management entities and the creation of plans and tools to help guide business transformation at DOD. However, our analysis has shown that these efforts are largely focused on business systems modernization and that ongoing efforts across the department’s business areas are not adequately integrated. Furthermore, key characteristics of the management framework have yet to be institutionalized or defined in directives. In addition, DOD lacks two crucial features that are integral to successful organizational transformation—(1) a strategic planning process that results in a comprehensive, integrated, and enterprisewide plan or interconnected plans, and (2) a senior leader who is responsible and accountable for business transformation and who can provide full-time focus and sustained leadership. DOD Has Made Progress in Addressing Its Business Transformation Challenges DOD’s senior leadership has shown commitment to transforming the department’s business operations, and DOD has taken a number of positive steps to begin this effort. In fact, because of the impact of the department’s business operations on its warfighters, DOD recognizes the need to continue working toward transformation of its business operations and provide transparency in this process. The department has devoted substantial resources and made important progress toward establishing key management structures and processes to guide business systems investment activities, particularly at the departmentwide level, in response to congressional legislation that codified many of our prior recommendations related to DOD business systems modernization and financial management. Specifically, DOD has made progress in establishing a management framework for business transformation by creating various governance and management entities and developing plans and tools to help guide transformation. In the past few years, DOD has established the Defense Business Systems Management Committee, investment review boards, and the Business Transformation Agency to manage and guide business systems modernization. The Defense Business Systems Management Committee and investment review boards were statutorily required by the Ronald W. Reagan National Defense Authorization Act for Fiscal Year 2005 to review and approve the obligation of funds for defense business systems modernization, depending on the cost and scope of the system in review. The Business Transformation Agency was created to support the top-level management body, the Defense Business Systems Management Committee, and to advance DOD-wide business transformation efforts. Additionally, DOD has developed a number of tools and plans to enable these management entities to help guide business systems modernization efforts. The tools and plans include the business enterprise architecture and the enterprise transition plan. The business enterprise architecture is a tool or blueprint intended to guide and constrain investments in DOD organizations and systems as they relate to business operations. It provides a thin layer of corporate policies, capabilities, standards, and rules and focuses on providing tangible outcomes for a limited set of enterprise-level (DOD-wide) priorities. The enterprise transition plan is currently considered the highest level plan for DOD business transformation. According to DOD, the enterprise transition plan is intended to summarize all levels of transition planning information (milestones, metrics, resource needs, and system migrations) as an integrated product for communicating and monitoring progress, resulting in a consistent framework for setting priorities and evaluating plans, programs, and investments. Our analysis of these tools, plans, and meeting minutes of the various transformational management entities shows that these efforts are largely focused on business systems modernization, and that this framework has yet to be expanded to encompass all of the elements of the overall business transformation. Furthermore, DOD has not clearly defined or institutionalized in directives the interrelationships, roles and responsibilities, or accountability for the various entities that comprise its management framework for overall business transformation. For example, opinions differ within DOD as to which senior governance body will serve as the primary body responsible for overall business transformation. Some officials stated that the Defense Business Systems Management Committee would serve as the senior-most governance entity, while others stated that the Deputy’s Advisory Working Group, a group that provides departmentwide strategic direction on various issues, should function as the primary decision-making body for business transformation. Additionally, opinions differ between the two entities regarding the definition of DOD’s key business areas, with the Defense Business Systems Management Committee and the Business Transformation Agency using a broader definition of business processes than that of the Deputy Advisory Working Group and its supporting organizations. Until such differences are resolved and the department institutionalizes a management framework that spans all aspects of business transformation, DOD will not be able to integrate related initiatives into a sustainable, enterprisewide approach and to resolve weaknesses in business operations. Critical Actions Are Needed to Provide Comprehensive, Integrated, and Strategic Planning and Focused and Sustained Leadership for DOD’s Overall Business Transformation Efforts As we have testified and reported for years, a successful, integrated, departmentwide approach to addressing DOD’s overall business transformation requires two critical elements: a comprehensive, integrated, and enterprisewide plan and an individual capable of providing full-time focus and sustained leadership both within and across administrations, dedicated solely to the integration and execution of the overall business transformation effort. DOD Lacks a Strategic Planning Process That Results in a Comprehensive, Integrated, and Enterprisewide Plan or Set of Plans DOD continues to lack a comprehensive, integrated, and enterprisewide plan or set of linked plans for business transformation that is supported by a comprehensive planning process, and guides and unifies its business transformation efforts. Our prior work has shown that this type of plan should help set strategic direction for overall business transformation efforts and all key business functions; prioritize initiatives and resources; and monitor progress through the establishment of performance goals, objectives, and rewards. Furthermore, an integrated business transformation plan would be instrumental in establishing investment priorities and guiding the department’s key resource decisions. While various plans exist for different business areas, DOD’s various business-related plans are not yet integrated to include consistent reporting of goals, measures, and expectations across institutional, unit, and individual program levels. Our analysis shows that plan alignment and integration currently focuses on data consistency among plans, meaning that plans are reviewed for errors and inconsistencies in reported information, but there is a lack of consistency in goals and measurements among plans. For example, our analysis of the March 2007 enterprise transition plan showed that the goals and objectives in that plan were not clearly linked to the goals and objectives in the most recent Quadrennial Defense Review, which is DOD’s highest-level strategic plan. Additionally, the enterprise transition plan is not based on a strategic planning process. For example, it does not provide a complete assessment of DOD’s progress in overall transformation efforts aside from business systems modernization. The plan also does not contain results-oriented goals and measures that assess overall business transformation. Other entities such as the Institute for Defense Analyses, the Defense Science Board, and the Defense Business Board have similarly reported the need for DOD to develop an enterprisewide plan to link strategies across the department for transforming all business areas and thus report similar findings as our analysis. DOD officials recognize that the department does not have an integrated plan in place, although they have stated that their intention is to expand the scope of the enterprise transition plan to become a more robust enterprisewide planning document and to evolve this plan into the centerpiece strategic document. DOD updates the enterprise transition plan twice a year, once in March as part of DOD’s annual report to Congress and once in September, and DOD has stated the department’s goal is to evolve the plan to that of a comprehensive, top-level planning document for all business functions. DOD released the most recent enterprise transition plan update on September 28, 2007, and we will continue to monitor developments in this effort. DOD Lacks a Full-time and Term-based Senior Management Official to Provide Focus and Sustained Leadership for the Overall Business Transformation Effort DOD has not established a full-time and term-based leadership position dedicated solely to the business transformation effort. We have long advocated the importance of establishing CMO positions in government agencies, including DOD, and have previously reported and testified on the key characteristics of the position necessary for success. In our view, transforming DOD’s business operations is necessary for DOD to resolve its weaknesses in the designated high-risk areas, and to ensure the department has sustained leadership to guide its business transformation efforts. Specifically, because of the complexity and long-term nature of business transformation, DOD needs a CMO with significant authority, experience, and a term that would provide sustained leadership and the time to integrate its overall business transformation efforts. Without formally designating responsibility and accountability for results, reconciling competing priorities among various organizations and prioritizing investments will be difficult and could impede the department’s progress in addressing deficiencies in key business areas. Furthermore, a broad-based consensus exists among GAO and others that the status quo is unacceptable and that DOD needs a full-time and term- based senior management official to provide focused and sustained leadership for its overall business transformation efforts, although differing views exist concerning the specifics of the position, such as term limit and the level of the position within the department. Congress directed DOD to commission studies of the feasibility and advisability of establishing a deputy secretary of defense for management to oversee the department’s business transformation process. As part of this effort, the Defense Business Board and the Institute for Defense Analyses both supported the need for a senior executive to be responsible for DOD’s overall business transformation efforts. Additionally, this matter is now before Congress as it prepares to deliberate on pending legislation that calls for statutorily establishing a CMO at DOD. Both the current House and Senate versions of the Fiscal Year 2008 Defense Authorization legislation contain provisions for assigning responsibility for DOD’s business transformation efforts to a senior-level position within the department, although the versions differ in certain details. The Senate version calls for the Deputy Secretary of Defense to take on the additional duties of the CMO position while also establishing a Deputy CMO position at the Executive Level III; the House version would require the Secretary of Defense to assign CMO duties to a senior official at or above the under secretary level. DOD has recently taken action on the issue of establishing a CMO position at DOD; however, we believe this action does not go far enough to change the status quo and ensure sustainable success. We recognize the commitment and elevated attention that the Deputy Secretary of Defense and other senior leaders have clearly shown in addressing deficiencies in the department’s business operations. For example, the Deputy Secretary has overseen the creation of various business-related entities, such as the Defense Business Systems Management Committee and the Business Transformation Agency, and has been closely involved in monthly meetings of both the Defense Business Systems Management Committee and the Deputy’s Advisory Working Group, a group that provides departmentwide strategic direction on various issues. Most recently, DOD issued a directive on September 18, 2007, that assigned CMO responsibilities to the current Deputy Secretary of Defense. In our view, subsuming the duties within the responsibilities of the individual currently serving as the Deputy Secretary represents the status quo and will not provide full-time attention or continuity as administrations change. While the Deputy Secretary may be at the right level, the substantial demands of the position make it exceedingly difficult for the incumbent to maintain the focus, oversight, and momentum needed to resolve business operational weaknesses, including the high-risk areas. Furthermore, the assignment of CMO duties to an individual with a limited term in the position does not ensure continuity of effort or that sustained success will be ensured both within and across administrations. In the interest of the department and the American taxpayers, we maintain that the department needs a separate, full-time CMO position over the long term in order to devote the needed focus and continuity of effort to transform its key business operations and avoid billions more in waste each year. Therefore, we continue to believe that the CMO position at DOD should be: Codified in statute as a separate and full-time position. The CMO should be a separate position from the Deputy Secretary of Defense in order to provide full-time attention to business transformation. The CMO would be responsible and accountable for planning, integrating, and executing DOD’s overall business transformation effort. The CMO also would develop and implement a strategic plan for overall business transformation. It should become a permanent position to ensure continuity of business transformation efforts, with the specific duties authorized in statute. Designated as an Executive Level II appointment. The CMO should be at Executive Level II and report directly to the Secretary of Defense so that the individual in this position has the stature needed to successfully address integration challenges, adjudicate disputes, and monitor progress on overall business transformation across defense organizations. Subject to an extended term appointment. The CMO’s appointment could span administrations to ensure transformation efforts are sustained across administrations. Because business transformation is a long-term and complex process, a term of at least 5 to 7 years is recommended to provide sustained leadership and accountability. In the absence of a CMO with these characteristics to focus solely on the integration and execution of business transformation efforts, and an enterprisewide plan to guide these efforts, it is highly unlikely that DOD will ever resolve its pervasive weaknesses and get the most out of every dollar it invests in these times of growing fiscal constraint to better support the warfighter. Transforming DOD’s business operations is an absolute necessity in the context of an increasingly demanding security environment and the pressures of our nation’s long-term fiscal outlook. Further, the current deployment of tens of thousands of servicemembers, civilians, and contractor personnel to support ongoing operations provides an even greater sense of urgency for the department to aggressively address weaknesses in its business operations and achieve transformation goals in the near and long term. DOD-Specific High- Risk Areas Highlight the Need for Further Change and Transformation in the Department I would like to discuss the remaining seven programs and activities within DOD that have been designated as high risk. Some of these areas have remained on the high-risk list for nearly 20 years and have continued to be a challenge for DOD, while others have newly emerged as a challenge for the department in more recent years. The remaining high-risk areas include DOD’s financial management, business systems modernization, personnel security clearance program, support infrastructure management, supply chain management, weapon systems acquisition, and contract management. Each area was added to our high-risk list due to weaknesses that make DOD more vulnerable to waste, fraud, and abuse. DOD has made progress in addressing each of these areas, but serious challenges remain that will require continued attention and sustained leadership over a number of years to achieve success. DOD Financial Management DOD’s pervasive financial and related business management and system deficiencies adversely affect its ability to assess resource requirements; control costs; ensure basic accountability; anticipate future costs and claims on the budget; measure performance; maintain funds control; prevent and detect fraud, waste, and abuse; and address pressing management issues. Therefore, we first designated DOD financial management as high risk in 1995. A major component of DOD’s business transformation effort is the defense Financial Improvement and Audit Readiness (FIAR) Plan, initially issued in December 2005 and updated periodically pursuant to section 376 of the National Defense Authorization Act for Fiscal Year 2006. Section 376 limited DOD’s ability to obligate or expend funds for fiscal year 2006 on financial improvement activities until the department submitted a comprehensive and integrated financial management improvement plan to the congressional defense committees. Section 376 required the plan to (1) describe specific actions to be taken to correct deficiencies that impair the department’s ability to prepare timely, reliable, and complete financial management information and (2) systematically tie these actions to process and control improvements and business systems modernization efforts described in the business enterprise architecture and transition plan. The John Warner National Defense Authorization Act for Fiscal Year 2007 continued to limit DOD’s ability to obligate or expend funds for financial management improvement activities until the Secretary of Defense submits a determination to the committees that the activities are consistent with the plans required by section 376. DOD intends the FIAR Plan to provide DOD components with a framework for resolving problems affecting the accuracy, reliability, and timeliness of financial information, and obtaining clean financial statement audit opinions. In its June 2007 FIAR Plan update, DOD introduced a change in its audit strategy in which it moved from a line item approach to a segment approach for addressing its financial management weaknesses and achieving auditability. According to the limited information provided in the June update, DOD has loosely defined a segment as a business process (Civilian Pay), financial statement line item (Cash and Other Monetary Assets), group of related financial statement line items (Fund Balance with Treasury, Accounts Payable, and Accounts Receivable), or a sub-line (Military Equipment). According to DOD officials, the FIAR Plan and the enterprise transition plan are key efforts in improving financial information for decision makers and obtaining unqualified (clean) audit opinions on their annual financial statements. According to the DOD FIAR Director, the September 2007 FIAR Plan update, which the department intends to release by mid-October 2007, and the March 2008 update of the FIAR Plan, are expected to provide more details on DOD’s new audit strategy and respective changes in its business rules and oversight process for ensuring that its goals are achieved. We cannot comment on specific changes in DOD’s audit strategy until we have had an opportunity to review these more substantive updates of the FIAR Plan. We will continue to monitor DOD’s efforts to transform its business operations and address its financial management deficiencies as part of our continuing DOD business enterprise architecture work and our oversight of DOD’s financial statement audit. Furthermore, the department invests billions of dollars annually to operate, maintain, and modernize its over 2,900 business systems, including financial management systems. Despite this significant investment, the department is severely challenged in implementing business systems on time, within budget, and with the promised capability. As previously reported, many of the department’s business systems are nonintegrated, stovepiped, and not capable of providing department management and Congress with accurate and reliable information on DOD’s day-to-day operations. Effective process improvement and information technology investment management and oversight will be critical to the department’s success in transforming its business management systems and operations. Many of the problems related to DOD’s inability to effectively implement its business systems on time, within budget, and with the promised capability can be attributed to its failure to implement the disciplined processes necessary to reduce the risks associated with these projects to acceptable levels. Disciplined processes have been shown to reduce the risks associated with software development and acquisition efforts and are fundamental to successful systems acquisition. DOD Business Systems Modernization DOD is still not where it needs to be in managing its departmentwide business systems modernization. Until DOD fully defines and consistently implements the full range of business systems modernization management controls (institutional and program-specific), it will be not be positioned to effectively and efficiently ensure that its business systems and information technology services investments are the right solutions for addressing its business needs, that they are being managed to produce expected capabilities efficiently and cost effectively, and that business stakeholders are satisfied. For decades, DOD has been challenged in modernizing the thousands of timeworn business systems. We designated DOD’s business systems modernization program as high risk in 1995. Since then, we have made scores of recommendations aimed at strengthening DOD’s institutional approach to modernizing its business systems, and reducing the risks associated with key business system investments. In addition, in recent legislation, Congress included provisions that are consistent with our recommendations, such as in the Ronald W. Reagan National Defense Authorization Act for Fiscal Year 2005. In response, the department has taken, or is taking, actions to implement both our recommendations and the legislative requirements, and as a result has made progress in establishing corporate management controls, such as its evolving business enterprise architecture (BEA), corporate investment management structures and processes, increased business system life-cycle management discipline on its largest business system investments, and leveraging highly skilled staff on its largest business system investments. However, much more remains to be accomplished to address this high-risk area, particularly with respect to ensuring that effective corporate approaches and controls are extended to and employed within each of DOD’s component organizations (military departments and defense agencies). To this end, our recent work has highlighted challenges that the department still faces in “federating” (i.e., extending) its corporate BEA to its component organizations’ architectures, as well as in establishing institutional structures and processes for selecting, controlling, and evaluating business systems investments within each component organization. Beyond this, making sure that effective system acquisition management controls are actually implemented on each and every business system investment also remains a formidable challenge, as our recent reports on management weaknesses associated with individual programs have disclosed. Among other things, these reports have identified program-level weaknesses relative to architecture alignment, economic justification, and performance management. More specifically, we recently reported that DOD has continued to take steps to comply with legislative requirements and related guidance pertaining to its business systems modernization high-risk area, and that these steps addressed several of the missing elements that we previously identified relative to, for example, its BEA, enterprise transition plan, business system investment management, and business systems budgetary disclosure. However, we reported that additional steps were still needed to fully comply with legislative requirements and relevant guidance. The latest version of the BEA does a good job of defining DOD-wide corporate policies, capabilities, rules, and standards, which are essential to meeting the act’s requirements. However, this version had yet to be augmented by the DOD component organizations’ subsidiary architectures, which are also necessary to meeting statutory requirements and the department’s goal of having a federated family of architectures. Compounding this are our reports showing the military departments’ architecture programs were not mature and the strategy that the department had developed for federating its BEA needed more definition to be executable. To address these limitations, we made recommendations aimed at ensuring that DOD’s federated BEA provides a more sufficient frame of reference to optimally guide and constrain DOD- wide system investments. DOD agreed with these recommendations and has since taken some actions, such as developing an updated draft of its federation strategy, which according to DOD officials, addresses our recommendations but has yet to be released. The March 2007 enterprise transition plan continued to identify more systems and initiatives that are to fill business capability gaps and address DOD-wide and component business priorities, and it continues to provide a range of information for each system and initiative in the plan (e.g., budget information, performance metrics, and milestones). However, this version still does not include system investment information for all the defense agencies and combatant commands. Moreover, the plan does not sequence the planned investments based on a range of relevant factors, such as technology opportunities, marketplace trends, institutional system development and acquisition capabilities, legacy and new system dependencies and life expectancies, and the projected value of competing investments. According to DOD officials, they intend to address such limitations in future versions of the transition plan as part of their plans for addressing our prior recommendations. DOD recently released its September 2007 version of the plan which, according to DOD, continues to provide time-phased milestones, performance metrics, and statement of resource needs for new and existing systems that are part of the BEA and component architectures, and includes a schedule for terminating old systems and replacing them with newer, improved enterprise solutions. We have yet to review the updated transition plan. The department has established and has begun to implement legislatively directed investment review structures and processes. However, it has yet to do so in a manner that is fully consistent with relevant guidance. Specifically, the department has yet to fully define a range of policies and procedures needed to effectively execute both project-level and portfolio- based information technology investment management practices. For example, while DOD has established an enterprisewide information technology investment board that is responsible for defining and implementing its business systems investment governance process, it has not fully defined the policies and procedures needed for oversight of and visibility into operations and maintenance-focused investments. Accordingly, we made recommendations aimed at improving the department’s ability to better manage the billions of dollars it invests annually in its business systems. DOD largely agreed with these recommendations and has since undertaken several initiatives to strengthen business system investment management. For example, it has drafted and intends to shortly begin implementing a new Business Capability Lifecycle approach that is intended to consolidate management of business system requirements, acquisition, and compliance with architecture disciplines into a single governance process. Further, it has established an Enterprise Integration directorate in the Business Transformation Agency to support the implementation of Enterprise Resource Planning systems by ensuring that best practices are leveraged and BEA-related business rules and standards are adopted. The department has continued to review and approve business systems as directed in legislation. As of March 2007, the department reported that its senior investment review body had approved 285 such systems. However, the military departments reported that their review and approval processes were still evolving and that additional work was needed for them to mature. Because of the importance of the military departments’ investment management structures and processes, we have ongoing work to determine their maturity. Beyond having a well-defined federated architecture for the business mission area and business systems investment management policies and procedures across the department, the more formidable challenge facing DOD is how well it can implement these and other acquisition management controls for each and every business system investment and information technology services outsourcing program. In this regard, we have continued to identify program-specific weaknesses. Most recently, for example, we reported that the Army’s approach for investing about $5 billion over the next several years in its General Fund Enterprise Business System, Global Combat Support System-Army Field/Tactical, and Logistics Modernization Program did not include alignment with Army enterprise architecture or use of a portfolio-based business system investment review process. Moreover, we reported that the Army did not have reliable processes, such as an independent verification and validation function, or analyses, such as economic analyses, to support its management of these programs. We concluded that until the Army adopts a business system investment management approach that provides for reviewing groups of systems and making enterprise decisions on how these groups will collectively interoperate to provide a desired capability, it runs the risk of investing significant resources in business systems that do not provide the desired functionality and efficiency. We also reported that the Navy’s approach for investing in both system and information technology services, such as the Naval Tactical Command Support System (NTCSS) and Navy Marine Corps Intranet (NMCI), did not include effective program performance management. For NTCSS, we reported that, for example, earned value management, which is a means for determining and disclosing actual performance against budget and schedule estimates, and revising estimates based on performance to date, had not been implemented effectively. We also reported that complete and current reporting of NTCSS progress and problems in meeting cost, schedule, and performance goals had not occurred, leaving oversight entities without the information needed to mitigate risks, address problems, and take corrective action. We concluded that without this information, the Navy cannot determine whether NTCSS, as it was defined and was being developed, was the right solution to meet its strategic business and technological needs. For NMCI, we reported that performance management practices, to include measurement of progress against strategic program goals and reporting to key decision makers on performance against strategic goals and other important program aspects, such as examining service-level agreement satisfaction from multiple vantage points and ensuring customer satisfaction, had not been adequate. We concluded that without a full and accurate picture of program performance, the risk of inadequately informing important NMCI investment management decisions was increased. DOD Personnel Security Clearance Program We first designated DOD’s personnel security clearance program as a high- risk area in January 2005. The designation followed about 20 years of our reports documenting delays in determining clearance eligibility and other clearance-related challenges. The type of information accessed by individuals with clearances and the scope of DOD’s clearance program are two factors to consider in understanding the risk present in this area. For example, personnel with clearances can gain access to classified information that could cause damage to U.S. national defense and foreign relations through unauthorized disclosure. In our 1999 report, we noted that the damage had included intelligence personnel being killed, critical information being compromised, and U.S. military forces being put at risk. Furthermore, problems with DOD’s program have effects outside of the department. DOD is responsible for about 2.5 million security clearances issued to servicemembers, DOD civilians, and industry personnel who work on contracts for DOD and 23 other federal agencies. Our reports have documented a wide variety of problems present in DOD’s clearance program. Some of the problems that we noted in our 2007 high- risk report included (1) DOD’s consistently inaccurate projections of clearance requests and their negative effects on workload planning and funding, (2) incomplete and delayed investigative reports from the Office of Personnel Management (OPM)—DOD’s primary provider of clearance investigations, and (3) DOD personnel (namely, adjudicators) granting clearance eligibility despite data missing from the investigative reports used to make such determinations. While some of those findings were reported on data which are now over 1 ½ years old, our May 2007 testimony noted that problems continue to exist such as OPM not fully counting all of days required for investigations and limited information being provided to Congress on reinvestigations for clearance updating. Delays in determining initial clearance eligibility can increase the cost of performing classified work, and delays in updating clearances may increase the risk to national security. Additionally, incomplete investigative or adjudicative reports could undermine governmentwide efforts to achieve clearance reciprocity (e.g., an agency accepting a clearance awarded by another agency). High-level attention has been focused on improving the personnel security clearance processes in DOD and governmentwide. Since June 2005, the Office of Management and Budget’s (OMB) Deputy Director of Management has been responsible for improving the governmentwide processes. During that time, OMB has overseen, among other things, the issuance of reciprocity standards, the growth of OPM’s investigative workforce, and greater use of OPM’s automated clearance-application system. An August 9, 2007, memorandum from the Deputy Secretary of Defense indicates that DOD’s clearance program is drawing attention at the highest levels of the department. Specifically, streamlining security clearance processes is one of the 25 DOD transformation priorities identified in the memorandum. Another indication of high-level involvement in addressing clearance problems is a memorandum of agreement that seeks to develop, in phases, a reformed DOD and intelligence community security clearance process that allows granting high-assurance security clearances in the least time at the lowest reasonable cost. While the Office of Director of National Intelligence and the Office of the Under Secretary of Defense posted a request for information on the Federal Business Opportunities’ website for August 7 through September 4, 2007, the request indicated that they plan to deliver “a transformed, modernized, and reciprocal security clearance process that is universally applicable” to DOD, the intelligence community, and other U.S. government agencies no later than December 31, 2008. DOD Support Infrastructure Management Since 1997, we have identified DOD’s management of its support infrastructure as a high-risk area because infrastructure costs continue to consume a larger than necessary portion of its budget. We have frequently reported in recent years on the long-term challenges DOD faces in managing its portfolio of facilities, halting the degradation of facilities, and reducing unneeded infrastructure to free up funds to better maintain enduring facilities and meet other needs. DOD officials have likewise been concerned for several years that much of the department’s infrastructure is outdated, inadequately maintained, and that DOD has more infrastructure than needed, which affects its ability to devote more funds to weapon systems modernization and other needs the department deems critical. Inefficient management practices and outdated business processes also have contributed to the problem. While DOD has made progress and expects to continue making improvements in its support infrastructure management, DOD officials recognize they must achieve greater efficiencies. To its credit, the department has continued to give high-level emphasis to reforming its support operations and infrastructure, including continued efforts to reduce excess infrastructure, promote transformation, and foster jointness through the base realignment and closure (BRAC) process. Also, DOD is updating its Defense Installations Strategic Plan to better address infrastructure issues, and has revised its installations readiness reporting to better measure facility conditions, established core real property inventory data requirements to better support the needs of real property asset management, and continued to modify its suite of analytical tools to better forecast funding requirements for the sustainment and restoration of facilities. It also has achieved efficiencies through demolishing unneeded buildings at military installations and privatizing military family housing. Our work examining DOD’s management of its facilities infrastructure shows that much work remains for DOD to fully rationalize and transform its support infrastructure to improve operations, achieve efficiencies, and allow it to concentrate its resources on the most critical needs. For example, we have reported that the cleanup of environmental contamination on unneeded property resulting from prior BRAC rounds has been a key impediment to the transfer of these properties and could be an issue in the transfer and reuse of unneeded property resulting from the 2005 BRAC round. Impediments to transfer continue to be related primarily to a variety of interrelated environmental cleanup issues, including limited technology to address unexploded ordnance and protracted negotiations on compliance with environmental regulations. We have also recently reported that projected savings from past BRAC rounds have been significantly overstated. During recent visits to installations in the United States and overseas, service officials continue to report inadequate funding to provide base operations support and maintain their facilities. They express concern that unless this is addressed, future upkeep and repair of many new facilities to be constructed as a result of BRAC, overseas rebasing, and the Army’s move to the modular brigade structure will suffer and the facilities’ condition and base services will deteriorate. We have also found that DOD’s outline of its strategic plan for addressing this high-risk area had a number of weaknesses and warranted further clarification and specification. For example, DOD’s outline does not identify DOD’s short- and long-term goals or the desired end state for its facilities infrastructure—information critical for a meaningful plan. Instead, the outline focuses on completing administrative actions and producing paper products, and it does not describe how the completion of these actions and products will directly affect DOD infrastructure, including major support functions, and ultimately meet DOD’s short- and long-term goals. We will continue to meet with OMB and DOD officials to discuss the department’s efforts in addressing this high-risk area. Through future work examining DOD’s strategic plan for this area and through our monitoring of DOD base realignment and closures, overseas rebasing, and the sustainment and operations of military installations and facilities, we will be able to determine what other work needs to be done to assist DOD in its efforts to improve the management of its support infrastructure. As demands on the military continue to change and increase, organizations throughout DOD will need to continue reengineering their business processes and striving for greater operational effectiveness and efficiency. Having a comprehensive, long-range plan for its infrastructure that addresses facility requirements, recapitalization, and maintenance and repair will help DOD provide adequate resources to meet these requirements and improve facility conditions and base services. DOD Supply Chain Management The availability of spare parts and other critical supply items that are procured and delivered through DOD’s supply chain network affects the readiness and capabilities of U.S. military forces, and can affect the success of a mission. Moreover, the investment of resources in the supply chain is substantial, amounting to more than $150 billion a year according to DOD, and supply inventory levels have grown by 35 percent from $63.3 billion in fiscal year 2001 to $85.6 billion in fiscal year 2006. While DOD has taken a number of positive steps toward improving its supply chain management, it has continued to experience weaknesses in its ability to provide efficient and effective supply support to the warfighter. Consequently, the department has been unable to consistently meet its goal of delivering the “right items to the right place at the right time” to support the deployment and sustainment of military forces. As a result of weaknesses in DOD’s management of supply inventories and responsiveness to warfighter requirements, supply chain management has been on our high-risk list since 1990. Our prior work over the last several years has identified three focus areas that are critical to resolving supply chain management problems: requirements forecasting, asset visibility, and materiel distribution. Beginning in 2005, DOD developed a plan to address long-term systemic weaknesses in supply chain management. Since the January 2007 update of the high-risk series, DOD has made progress in developing and implementing supply chain management improvement initiatives in its supply chain management plan. However, the long-term time frames for many of these initiatives present challenges to the department in sustaining progress toward substantially completing their implementation. The plan also lacks outcome-focused performance measures for many individual initiatives as well as its three focus areas: requirements forecasting, asset visibility, and materiel distribution. Together, these weaknesses limit DOD’s ability to fully demonstrate the results it hopes to achieve through its plan. Our recent work has also identified problems related to the three focus areas in DOD’s plan. In the requirements area, for example, the military services are experiencing difficulties estimating acquisition lead times to acquire spare parts for equipment and weapon systems, hindering their ability to efficiently and effectively maintain spare parts inventories for military equipment. In March 2007, we reported that 44 percent of the services’ lead time estimates varied either earlier or later than the actual lead times by at least 90 days. Overestimates and underestimates of acquisition lead time contribute to inefficient use of funds and potential shortages or excesses of spare parts. Challenges in the asset visibility area include the lack of interoperability among information technology systems, problems with container management, and inconsistent application of radio frequency identification technology, all of which make it difficult to obtain timely and accurate information on assets in theater. In the materiel distribution area, challenges remain in coordinating and consolidating distribution and supply support within a theater. Furthermore, we recently reviewed DOD’s joint theater logistics initiative, which is aimed at improving the ability of a joint force commander to direct various logistics functions, including distribution and supply support activities. Our work raises concerns as to whether DOD can effectively implement this initiative without reexamining fundamental aspects of its logistics governance and strategy. In this respect, joint theater logistics may serve as a microcosm of some of the challenges DOD faces in resolving supply chain management problems. DOD Weapon Systems Acquisition For more than a decade, we have identified DOD’s acquisition of major weapon systems as high risk. The weapon acquisitions process continues to produce systems that are the best in the world but cost more than first promised, take longer to field than first promised, and do less than first promised. Weapon acquisitions are demanding a larger share of the DOD budget at a time when the nation’s fiscal imbalance is growing. DOD has doubled its planned investment in new weapon systems from approximately $750 billion in 2001 to almost $1.5 trillion in 2007. During the same period, the government’s total liabilities and unfunded commitments have increased from about $20 trillion to about $50 trillion. In this context, DOD simply must maximize its return on investment to provide needed capabilities to the warfighter and to provide the best value to the taxpayer. We have found that knowledge at key decision points is critical in the development of new weapon systems if they are to meet their promised costs, schedules, and capabilities—in other words, using a knowledge-based approach to acquisitions. The link between knowledge and cost is real and predictable. It provides three choices for decision makers: (1) accept the status quo, (2) require demonstrations of high knowledge levels before approving individual programs, or (3) increase cost estimates to accurately reflect consequences of insufficient knowledge. With over $880 billion remaining to invest in the current portfolio of major systems, the status quo is both unacceptable and unsustainable. The inability to deliver new weapon systems at promised times and costs has significant consequences for both the taxpayer and the warfighter. When time and costs increase, quantities often decrease to compensate. The result is the warfighter gets less capability than planned and the taxpayer’s dollar does not go as far. For example, table 2 depicts the following programs that experienced both cost increases and quantity decreases: DOD knows what to do to achieve more successful outcomes but finds it difficult to apply the necessary discipline and controls or assign much- needed accountability. DOD has written into policy an approach that emphasizes attaining a certain level of knowledge at critical junctures before managers agree to invest more money in the next phase of weapon system development. This knowledge-based approach should result in evolutionary—that is incremental, manageable, and predictable— development and inserts several controls to help managers gauge progress in meeting cost, schedule, and performance goals. However, as we reported in our March 2007 report on selected DOD weapon systems, DOD has not been employing the knowledge-based approach, proceeds with lower levels of knowledge at critical junctures, and attains key elements of product knowledge later in development than specified in DOD policy. In particular, the department accepts high levels of technology risk at the start of major acquisition programs. DOD’s acquisition community often takes on responsibility for technology development and product development concurrently. Without mature technologies at the outset, a program will almost certainly incur cost and schedule problems. Without mature technologies, it is difficult to know whether the product being designed and produced will deliver the desired capabilities or, alternatively, if the design allows enough space for technology integration. Our work has shown that very few DOD programs start with mature technologies. We continue to annually assess DOD’s weapon system acquisition programs, and the breadth of our work gives us insights into a broad range of programs as well as the overall direction of weapon system acquisitions. In examining our defense work, we have observed 15 systemic acquisition challenges facing DOD—which we have included as appendix I to my statement. DOD is depending on the weapons currently under development to transform military operations for the 21st century. As we have recently reported, the complexity of DOD’s transformational efforts is especially evident in the development of several megasystems or major weapon systems that depend on the integration of multiple systems— some of which are developed as separate programs—to achieve desired capabilities. This strategy often requires interdependent programs to be developed concurrently and to be closely synchronized and managed, as they may, for example, depend on integrated architectures and common standards as a foundation for interoperability. If dependent systems are not available when needed, then a program could face cost increases, schedule delays, or reduced capabilities. Furthermore, the larger scope of development associated with these megasystems produces a much greater fiscal impact when cost and schedule estimates increase. The current fiscal environment also presents challenges for DOD’s plans to transform military operations. As the nation begins to address long-term fiscal imbalances, DOD is likely to encounter considerable pressure to reduce its investment in new weapons. Within DOD’s own budget, investment in new weapon systems competes with funds needed to replace equipment and sustain military operations in Iraq and Afghanistan. The nation’s long-term fiscal imbalances also will likely place pressure on DOD’s planned investment in major weapon systems. As entitlement programs like Social Security, Medicare, and Medicaid consume a growing percentage of available resources, discretionary programs—including defense—face competition for the increasingly scarce remaining funds. Sustaining real, top-line budget increases in any discretionary program will be difficult in this constrained resource environment. DOD budget projections conform to this tightening framework by offsetting growth in procurement spending with reductions in research and development, personnel, and other accounts. The minimal real increases projected in defense spending through fiscal year 2011 depend on these offsets. However, these projections do not reflect recent experience, nor do they take into account higher than anticipated cost growth and schedule delays, which can compound the fiscal impact and affordability of DOD’s planned investment. Program approvals in DOD have also shown a decided lack of restraint. DOD’s requirements process generates more demand for new programs than fiscal resources can support. DOD compounds the problem by approving so many highly complex and interdependent programs. Once too many programs are approved, the budgeting process must broker trades to stay within realistic funding levels, Because programs are funded annually and departmentwide, cross-portfolio priorities have not been established, competition for funding continues over time, forcing programs to view success as the ability to secure the next funding increment rather than delivering capabilities when and as promised. DOD recognizes this dilemma and has embraced best practices in its policies, instilled more discipline in requirements setting, strengthened training for program managers, and reorganized offices that support and oversee programs. However, this intention has not been fully implemented and it has not had a material effect on weapon system programs. To translate policy into better programs, several additional elements are essential, including having a sound business case for each program that focuses on real needs and embodies best practices, sound business arrangements, and clear lines of responsibility and accountability. DOD Contract Management DOD’s management of its contracts has been on our high-risk list since 1992. Our work has found that DOD is unable to ensure that it is using sound business practices to acquire the goods and services needed to meet warfighters’ needs, creating unnecessary risks of paying higher prices than justified. DOD’s long-standing problems with contract management have become more prominent as DOD’s reliance on contractors to provide services continues to grow. Recently, I have been quite vocal about the large and growing long-range structural deficits the federal government faces. Given this fiscal reality, it is imperative that DOD gets the best return it can on not only major weapon systems, but also on its investments in goods and services. In our recent testimony we noted that within the federal government, DOD is the largest purchaser of a variety of goods and services. In fiscal year 2006 DOD spent about $297 billion, or 71 percent of the more than $400 billion spent by the federal government, on goods and services to equip and support the military forces, but is not able to ensure it is using sound business practices to acquire the goods and services needed to meet the warfighters’ needs. In November 2006, we reported that DOD’s approach to managing service acquisitions has tended to be reactive and has not fully addressed the key factors for success at either the strategic or transactional level. At the strategic level, DOD has yet to set the direction or vision for what it needs, determine how to go about meeting those needs, capture the knowledge to enable more informed decisions, or assess the resources it has to ensure departmentwide goals and objectives are achieved. Actions at the transactional level continue to focus primarily on awarding contracts and do not always ensure that user needs are translated into well-defined requirements or that postcontract award activities result in expected performance. In June 2007, we reported that DOD used time-and-materials contracts, one of the riskiest contract types for the government because they could be awarded quickly and labor hours or categories can be adjusted if requirements are unclear or funding uncertain. Even though these contracts call for appropriate government monitoring of contractor performance, there were wide discrepancies in the rigor with which monitoring was performed and most of the contract files we reviewed did not include documented monitoring plans. DOD also used undefinitized contract actions (UCA) to rapidly fill urgent needs. While this is permitted in a variety of circumstances, we reported in June 2007 that DOD did not meet the definitization time frame requirement of 180 days after award on 60 percent of the 77 UCAs we reviewed. Since DOD tends to obligate the maximum amount of funding permitted—up to 50 percent of the not-to- exceed amount—immediately at award of UCAs, contractors may have little incentive to quickly submit proposals. Lack of timely negotiations contributed significantly to DOD’s decision on how to address $221 million in questioned costs on the $2.5 billion Restore Iraqi Oil contract. All 10 task orders for this contract were negotiated more than 180 days after the work commenced. As a result, the contractor had incurred almost all its costs at the time of negotiations, which influenced DOD’s decision to pay nearly all of the questioned costs. Additionally, DOD management and oversight of contractors continues to be problematic for two reasons: inadequate numbers of trained contract oversight personnel and second, insufficient training for those officials responsible for contract oversight. On multiple occasions, we and others have reported on the challenges caused by DOD’s lack of contract management and oversight personnel. For example, in our June 2004 report on Iraq contract award procedures, we found that inadequate acquisition workforce resources presented challenges to several agencies involved in Iraq reconstruction efforts and, at times, resulted in inadequate oversight of contractor activities. Similarly, in 2004, we reported that administrative contracting officers from the Defense Contract Management Agency, who were responsible for monitoring the LOGCAP contract in Iraq, believe that they needed an increase in the number of qualified staff to fully meet their oversight mission. In an April 2005 report, we found that DOD, faced with an urgent need for interrogation and other services in support of military operations in Iraq, turned to the Department of the Interior for contract assistance. However, numerous breakdowns occurred in the issuance and administration of the orders for these services, including inadequate oversight of contractor performance. More recently, in December 2006 we reported that DOD does not have sufficient numbers of contractor oversight personnel at deployed locations, which limits its ability to obtain reasonable assurance that contractors are meeting contract requirements efficiently and effectively. For example, an Army official acknowledged that the Army is struggling to find the capacity and expertise to provide the contracting support needed in Iraq. In addition, officials responsible for contracting with MNF-I stated that they did not have enough contract oversight personnel and quality assurance representatives to allow MNF-I to reduce the Army’s use of the LOGCAP contract by awarding more sustainment contracts for base operations support in Iraq. Additionally, a Defense Contract Management Agency official responsible for overseeing the LOGCAP contractor’s performance at 27 installations in Iraq told us he was unable to personally visit all 27 locations himself during his 6-month tour in Iraq. As a result, he was unable to determine the extent to which the contractor was meeting the contract’s requirements at each of those 27 sites. Moreover, he only had one quality assurance representative to assist him. The official told us that in order to properly oversee this contract, he should have had at least three quality assurance representatives assisting him. The contracting officer’s representative for an intelligence support contract in Iraq told us he was also unable to visit all of the locations that he was responsible for overseeing. At the locations he did visit he was able to work with the contractor to improve its efficiency. However, because he was not able to visit all of the locations at which the contractor provided services in Iraq, he was unable to duplicate those efficiencies at all of the locations in Iraq where the contractor provided support. Since the mid-1990s, our work has shown the need for better pre- deployment training for military commanders and contract oversight personnel on the use of contractor support. Training is essential for military commanders because of their responsibility for identifying and validating requirements to be addressed by the contractor. In addition, commanders are responsible for evaluating the contractor’s performance and ensuring the contract is used economically and efficiently. Similarly, training is essential for DOD contract oversight personnel who monitor contractor performance for the contracting officer. As we reported in 2003, military commanders and contract management and oversight personnel we met in the Balkans and throughout Southwest Asia frequently cited the need for better preparatory training. Additionally, in our 2004 review of logistics support contracts, we reported that many individuals using logistics support contracts such as LOGCAP were unaware that they had any contract management or oversight roles. Army customers stated that they knew nothing about LOGCAP before their deployment and that they had received no pre-deployment training on their roles and responsibilities in ensuring that the contract was used economically and efficiently. In July 2005 and again in June 2006, we reported that military units did not receive any training on private security contractors in Iraq and the military’s roles and responsibilities regarding private security contractors. In our December 2006 report, we noted that many officials responsible for contract management and oversight in Iraq stated that they received little or no training on the use of contractors prior to their deployment, which led to confusion over their roles and responsibilities. For example, in several instances, military commanders attempted to direct (or ran the risk of directing) a contractor to perform work even though commanders are not authorized to do so. Such cases can result in increased costs to the government. Mr. Chairman and Members of the Subcommittee, this concludes my statement. I would be happy to answer any questions you may have at this time. GAO Contact For questions regarding this testimony, please contact Sharon L. Pickup at (202) 512-9619 or pickups@gao.gov. Appendix I: Systemic Acquisition Challenges at the Department of Defense 1. Service budgets are allocated largely according to top line historical percentages rather than Defense-wide strategic assessments and current and likely resource limitations. 2. Capabilities and requirements are based primarily on individual service wants versus collective Defense needs (i.e., based on current and expected future threats) that are both affordable and sustainable over time. 3. Defense consistently overpromises and underdelivers in connection with major weapons, information, and other systems (i.e., capabilities, costs, quantities, and schedule). 4. Defense often employs a “plug and pray approach” when costs escalate (i.e., divide total funding dollars by cost per copy, plug in the number that can be purchased, then pray that Congress will provide more funding to buy more quantities). 5. Congress sometimes forces the department to buy items (e.g., weapon systems) and provide services (e.g., additional health care for non- active beneficiaries, such as active duty members’ dependents and military retirees and their dependents) that the department does not want and we cannot afford. 6. DOD tries to develop high-risk technologies after programs start instead of setting up funding, organizations, and processes to conduct high-risk technology development activities in low-cost environments, (i.e., technology development is not separated from product development). Program decisions to move into design and production are made without adequate standards or knowledge. 7. Program requirements are often set at unrealistic levels, then changed frequently as recognition sets in that they cannot be achieved. As a result, too much time passes, threats may change, or members of the user and acquisition communities may simply change their mind. The resulting program instability causes cost escalation, schedule delays, smaller quantities, and reduced contractor accountability. 8. Contracts, especially service contracts, often do not have definitive or realistic requirements at the outset in order to control costs and facilitate accountability. 9. Contracts typically do not accurately reflect the complexity of projects or appropriately allocate risk between the contractors and the taxpayers (e.g., cost plus, cancellation charges). 10. Key program staff rotate too frequently, thus promoting myopia and reducing accountability (i.e., tours based on time versus key milestones). Additionally, the revolving door between industry and the department presents potential conflicts of interest. 11. The acquisition workforce faces serious challenges (e.g., size, skills, knowledge, and succession planning). 12. Incentive and award fees are often paid based on contractor attitudes and efforts versus positive results (i.e., cost, quality, and schedule). 13. Inadequate oversight is being conducted by both the department and Congress, which results in little to no accountability for recurring and systemic problems. 14. Some individual program and funding decisions made within the department and by Congress serve to undercut sound policies. 15. Lack of a professional, term-based Chief Management Officer at the department serves to slow progress on defense transformation and reduce the chance of success in the acquisitions/contracting and other key business areas. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. 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The Department of Defense (DOD) continues to face significant challenges in resolving its many long-standing business challenges. DOD is solely responsible for eight high-risk areas and shares responsibility for another seven governmentwide areas on GAO's high-risk list. GAO designated DOD's approach to business transformation as high risk in 2005 because (1) DOD's improvement efforts were fragmented, (2) DOD lacked an enterprisewide and integrated business transformation plan, and (3) DOD had not appointed a senior official at the right level with an adequate amount of time and appropriate authority to be responsible for overall business transformation efforts. A recent DOD directive designated the current Deputy Secretary of Defense as DOD's chief management officer (CMO). Successful overall business transformation, however, will require full-time leadership that is focused solely on the integration and execution of these efforts, over the long term, to resolve pervasive weaknesses that have left DOD vulnerable to waste, fraud, and abuse at a time of increasing fiscal constraint. This testimony is based on previous and ongoing GAO work and discusses (1) the impact of DOD's long-standing business challenges on DOD and the warfighter, and (2) the progress DOD has made and actions needed to achieve sustainable success in its business transformation efforts. This testimony also provides an update on DOD-specific high-risk areas. The persistence and magnitude of DOD's business transformation challenges highlight the fact that the status quo is unacceptable and that, without focused and sustained leadership to guide the overall business transformation effort, the department will continue to waste billions of dollars annually. Within DOD, business transformation is broad, encompassing people, planning, processes, organizational structures, and technology. DOD's pervasive and long-standing business weaknesses adversely affect the department's economy, efficiency, and effectiveness, and have resulted in a lack of adequate accountability across all of its major business areas. Ultimately, these weaknesses affect the department's ability to support the warfighter, including the availability of equipment and weapon systems, the cost and performance of contractors supporting the warfighter, and the assessment of resource requirements. DOD's senior leadership has shown a commitment to transforming the department's business operations. Two critical actions, among others, however, are still needed to change the status quo. DOD has yet to establish (1) a strategic planning process that results in a comprehensive, integrated, and enterprisewide plan or set of plans to help guide transformation, and (2) a senior official who can provide full-time attention and sustained leadership to transformation. Broad-based consensus exists among GAO and others that DOD needs a full-time and term-based senior management official to provide focused and sustained leadership over its overall business transformation efforts, both within and across administrations. Also, various legislative proposals call for senior-level attention to these efforts. While DOD recently assigned CMO duties to the current Deputy Secretary of Defense, this does not ensure full-time attention or continuity of leadership. GAO continues to believe a CMO position should be codified in statute as a separate position, at the right level, and with the appropriate term in office. In the absence of a CMO with these characteristics, and an enterprisewide plan to guide business transformation efforts, it is highly unlikely that DOD will ever get the most out of every taxpayer dollar it invests to better support the warfighter in times of growing fiscal constraint.

Background Under its Safeguards Agreement with IAEA, the United States submitted a list of civilian nuclear facilities—primarily civilian nuclear power reactors. The Additional Protocol, a separate agreement between the United States and IAEA, supplements the United States’ Safeguards Agreement with IAEA. Under the Additional Protocol, the United States must provide IAEA with a broader range of civilian nuclear and nuclear-related information than that required under the Safeguards Agreement, such as the manufacturing of key nuclear-related equipment; research and development activities related to the nuclear fuel cycle; the use and contents of buildings on a nuclear site; and exports of IAEA-specified, sensitive nuclear-related equipment. The United States must also provide IAEA with access, through on-site inspections, to resolve questions relating to the accuracy and completeness of the information. As a nuclear weapon state party to the Treaty on the Non-Proliferation of Nuclear Weapons, the United States is not obligated by the Treaty to accept IAEA safeguards or to implement an Additional Protocol. However, according to U.S. officials, voluntarily adopting the Additional Protocol underscores U.S support for IAEA’s strengthened safeguards system and makes efforts to encourage more countries to adopt the Additional Protocol more effective and credible. In its act implementing the Additional Protocol, Congress prohibited the inclusion of certain information: any classified information; any information that would be deemed restricted data under the Atomic Energy Act; and any information of direct national security significance regarding any location, site, or facility associated with activities of the Department of Defense or DOE. The act also provided that information collected for the purposes of the Additional Protocol would be exempt from disclosure under 5 U.S.C. § 552, which is the Freedom of Information Act. Figure 1 shows a timeline of the U.S. implementation of the Additional Protocol. The U.S. government classifies information that it determines could damage the national security of the United States if disclosed publicly. Beginning in 1940, classified national defense and foreign relations information has been created, handled, and safeguarded in accordance with a series of executive orders. Executive Order 12958, Classified National Security Information, as amended, is the most recent. It demarcates different security classification levels, the unauthorized disclosure of which could reasonably be expected to cause exceptionally grave damage (Top Secret), serious damage (Secret), or damage (Confidential). Federal agencies also place dissemination restrictions on certain unclassified information. Federal agencies use many different designations to identify this type of information. For example, DOE uses the designation OUO, while State uses SBU. According to a May 2009 presidential memorandum, there are more than 107 unique markings and over 130 different labeling or handling processes and procedures for documents that are unclassified, but are considered sensitive. For example, according to DOE officials, although OUO information is less sensitive than classified information, OUO information may be shared with people lacking security clearances provided that officials determine they have a “need to know.” These restrictions are used to indicate that the information, if disseminated to the public or persons who do not need such information to perform their jobs, may cause foreseeable harm to protected governmental, commercial, or privacy interests. Such information includes, for example, sensitive personnel information, such as Social Security numbers and the floor plans for some federal buildings. It may also include information exempted from disclosure under the Freedom of Information Act. Each of the Federal Agencies and Offices Involved in Preparing and Publishing the Draft Declaration Shares Some Responsibility for Its Release to the Public While no single U.S. government agency or office was entirely responsible for the public disclosure of the draft declaration, all of the agencies and offices involved in preparing and publishing the draft declaration share some responsibility for its public release. We identified several points during the life cycle of the draft document where problems occurred. Specifically, we found that opportunities to improve the secure handling of the document were missed because of the absence of clear interagency guidance, different procedures across the agencies governing the handling and marking of sensitive documents, poor decision making, and a lack of training and adequate security awareness. These missed opportunities occurred between February 2008 and May 2009. Several U.S. government agencies played key roles in preparing and making important decisions regarding the publication of the draft declaration: DOE, Commerce, State, NRC, the White House (the National Security Council and Executive Clerk’s Office), the U.S. House of Representatives (Office of the Parliamentarian, Office of Security, and the Clerk’s Office), and GPO. Figure 2 is a two-page summary of key dates and events that occurred during the life cycle of the draft declaration, leading up to its inadvertent public release on May 7, 2009. DOE, NRC, and Commerce Began Collecting Information on Civilian Nuclear Sites to Be Included in the Draft Declaration in Early 2008 After the President signed an executive order in February 2008 to implement the Additional Protocol, DOE, Commerce, and NRC began collecting information on nuclear sites, facilities, and activities to be included in the draft declaration. DOE collected information from national laboratories and nuclear weapons production facilities. NRC, which regulates the civilian use of nuclear materials, collected information from NRC-licensed nuclear facilities, including four civilian nuclear power plants previously selected by IAEA for the application of safeguards. DOE and NRC provided nuclear-related information to Commerce on January 15, 2009, and March 18, 2009, respectively. Commerce collected information from private nuclear-related industries not regulated by DOE or NRC, such as the location, operational status, and production capacity of conventional uranium mines. Commerce then consolidated all nuclear- related information from its offices, as well as from DOE and NRC, into a draft U.S. declaration for final interagency approval and transmittal to State. The process for collecting and consolidating this information from the three agencies took several months. Commerce, in consolidating and formatting the information in the draft declaration, did not mark the document with an official U.S. government security marking. The only marking on the draft declaration was IAEA’s designation on the top of the document—“Highly Confidential Safeguards Sensitive”—which has no legal significance in the United States. To consolidate and properly format the information, Commerce established and managed a central database, known as the U.S. Additional Protocol Reporting System (APRS). IAEA provided a software program for this database that standardizes the information sent to IAEA by each member state and helps IAEA assess the completeness of the information. Before transmitting data to Commerce or adding data to the APRS, each agency reviewed the information it collected for accuracy, data consistency, and national security concerns. Each agency also reviewed the information to ensure that no classified information was being disclosed. The agencies had agreed that the information in the U.S. declaration would not be classified, as required by the U.S. Additional Protocol Implementation Act; that an unclassified database could be used to process the information; and that the data were sensitive and would be restricted to authorized personnel only. When Commerce and NRC added information to APRS, IAEA-supplied software automatically marked the top of each page of the draft declaration as “Highly Confidential Safeguards Sensitive.” IAEA uses this designation to ensure the document’s appropriate handling and control. According to IAEA officials, Highly Confidential Safeguards Sensitive information is the agency’s highest classification level. This type of information, if released, could cause grave damage to IAEA interests. When IAEA receives a document from a country with this classification, it cannot publicly disclose the information in the document because, in some instances, its release could disclose confidential business information, create potential security issues, or identify reporting discrepancies between countries. Distribution of this information is limited and released on a need-to-know basis. Since this IAEA marking has no legal significance in the United States, DOE, Commerce, and NRC treated the information as OUO. These agencies use OUO markings to provide a warning that information in a document is sensitive and is generally only to be released to those with a need to know, regardless of their security clearance. DOE, NRC, and Commerce took steps to safeguard the information that each contributed to the draft declaration. Specifically, before DOE and NRC submitted data to Commerce in January and March 2009, respectively: DOE marked the top and bottom of each page it submitted to Commerce with nuclear information from the national laboratories and production facilities as OUO and added a statement that the information may be exempt from public release under the Freedom of Information Act. NRC officials hand carried a compact disc containing its nuclear-related information to Commerce, rather than electronically sending the information. Commerce officials also safeguarded the information by password protecting APRS and sending State the draft declaration through secure e- mail that included a transmittal letter explaining that the contents were considered OUO. In addition, they hand carried a compact disc to State that was marked with “For Official Use Only/Not For Public Release/IAEA Highly Confidential Safeguards Protected” hand written on the disc. Although each agency designated the information it contributed as OUO, the document—which was produced from each agency’s contributions— did not have any U.S. government security markings. The agencies reviewed the draft declaration multiple times, but no agency marked the pages containing information it had contributed to the full draft declaration as OUO. Once all the information was consolidated, the 266- page document was not marked OUO or any other security designation recognized in the United States that would have clearly indicated that the data were sensitive, restricted to authorized personnel only, and not releasable to the public. The only OUO markings were next to site diagrams of two DOE facilities found on two different pages of the draft declaration. According to Commerce officials, while the IAEA software template automatically adds the IAEA designation, it does not add a U.S. security designation to the top and bottom of each page and does not allow Commerce to modify the IAEA designation or add U.S. security markings. They stated that the only way to mark the draft document as OUO would have been to print out each page, stamp the U.S. designation by hand, and then scan the document back in as a new electronic file. Furthermore, according to DOE officials, the agencies wanted to submit a draft declaration to Congress that was identical to the final declaration submitted to IAEA. Providing Congress with a draft declaration that had both the IAEA and U.S. security markings would not have been an exact representation of the declaration sent to IAEA. However, there were no requirements in the U.S. Additional Protocol Implementation Act binding U.S. agencies to submit a declaration free of any additional U.S. security markings. Even after Commerce circulated the draft declaration to DOE, NRC, and the Department of Defense for a final interagency review in late March 2009 to ensure no information of national security significance was included in the draft before submission to State, agency officials did not raise any concerns about the draft declaration’s lack of a U.S. security designation. According to DOE, Commerce, and NRC officials, they assumed that the draft declaration would never be publicly released and that, once delivered to IAEA, it would be properly safeguarded. As a result, they saw no need to add an additional U.S. government security marking. In Mid-April 2009, Commerce Sent the Draft Declaration to State for Transmittal to the White House Commerce sent the consolidated draft declaration to State on April 17, 2009. State prepared the draft declaration for transmittal to the White House. In completing the draft declaration for transmittal, State prepared a letter to the National Security Council asking it to treat the contents of the draft declaration as SBU. Unlike DOE, Commerce, and NRC, State does not use the OUO designation, but rather the SBU designation. State’s guidance governing the use and handling of SBU documents is similar to that of the other agencies for handling OUO. State also prepared a draft message from the President to Congress that would accompany the draft declaration. In describing the purpose and contents of the document and the classification level of the information, State wrote in the draft presidential message, “the IAEA classification of the enclosed declaration is ‘Highly Confidential Safeguards Sensitive’; however, the United States regards this information as ‘Sensitive but Unclassified’.” The two-page transmittal letter described the contents of the draft declaration and the top and bottom was clearly marked SBU, accompanied by a footnote explaining that the draft declaration was exempt from disclosure under the Freedom of Information Act. State completed its review of the draft declaration and accompanying transmittal documentation in mid-April 2009 and sent the “package” to the Executive Secretary of the National Security Council on April 30, 2009. The White House’s National Security Council and Executive Clerk’s Office Did Not Provide Explicit and Clear Instructions on How to Safeguard the Draft Declaration When It Sent the Document to Congress In early May 2009, the National Security Council completed its review of the draft declaration and presidential message and provided the documents to the Executive Clerk of the White House for transmission to Congress. The National Security Council, which reviewed these documents on behalf of the White House, did not add explicit and clear instructions in the presidential message on how to handle the draft declaration, such as whether or not it should be published, when it sent the documents to the White House Clerk’s Office, which transmitted the documents to Congress. The National Security Council also did not include a transmittal letter, as other executive branch agencies had, with instructions on how to handle the draft declaration. Attorneys from the Office of the White House Counsel provided two reasons why the National Security Council did not feel it was necessary to take these additional measures to protect the document from disclosure. First, counsel stated that they did not think Congress would publish the report and the National Security Council and the Executive Clerk’s Office followed their standard practice for transmitting unclassified documents, which does not involve using a transmittal letter or modifying text in the presidential message. However, attorneys from the Office of the White House Counsel did not provide us with any written guidance on how these offices usually handle documents that are unclassified, but are considered sensitive, such as those marked SBU, and should not be publicly released. In addition, attorneys from the Office of the White House Counsel told us that the Executive Clerk’s Office does not have written guidance on how it transmits documents to Congress. Second, counsel pointed out that the draft declaration was an unusual and unique document because it was the first time that the United States had prepared a draft declaration and submitted it to Congress. “The IAEA classification of the enclosed declaration is ‘Highly Confidential Safeguards Sensitive;’ however, the United States regards this information as ‘Sensitive but Unclassified.’ Nonetheless, under Public Law 109-401, information reported to, or otherwise acquired by, the United States Government under this title or under the U.S.- IAEA Additional Protocol shall be exempt from disclosure under section 552 of title 5, United States Code.” The language in the presidential message prepared by State and used by the National Security Council did not clearly and explicitly state that the information was not to be published, and the additional legal citations did not clarify how to handle the document. According to attorneys from the Office of the White House Counsel, the White House clerks who transmitted the document to Congress read the presidential message and noticed its reference to the draft declaration as SBU. However, while the White House clerks have security clearances and have received training on how to handle unclassified, sensitive, and classified documents, they do not normally see SBU documents and did not have the authority or responsibility to determine whether Congress could print the document. Attorneys from the Office of the White House Counsel told us the draft declaration was an unusual and unique document because of the IAEA classification markings and the reference to the information as SBU. The White House clerks transmit only unclassified documents. The National Security Council does not transmit documents that cannot be printed, such as classified documents, to the White House clerks. Instead, the National Security Council transmits those documents directly to congressional committee staff with the appropriate clearances. Because the clerks received the draft declaration from the National Security Council, the clerks transmitted the presidential message and the draft declaration to Congress just as they had received it from the National Security Council—without a transmittal sheet or SBU markings on the top or bottom of any page. Congressional Offices That Reviewed and Transmitted the Draft Declaration Determined Incorrectly That the Document Could be Published Congressional offices that reviewed and then transmitted the draft declaration to GPO for publication—the House of Representatives’ Office of the Parliamentarian and Clerk’s Office—determined, incorrectly in our view, that the document could be published. The draft declaration passed through several congressional offices. First, on May 5, 2009, the Executive Clerk of the White House formally delivered the presidential message and draft declaration while the House was in session. The Parliamentarian read the presidential message and decided the message should be referred to the House Committee on Foreign Affairs and ordered it printed as a House of Representatives document. The Parliamentarian told us that while he received security training on classification issues, he did not recall ever seeing a presidential message that just mentioned the SBU designation and did not know how that type of information should be safeguarded. The Parliamentarian believed that the draft declaration could be published because it was unclassified. According to the Parliamentarian, sensitive and classified messages and documents are usually not delivered to the floor of the House, but rather are transmitted by secure courier and referred directly to the appropriate committee for handling and storage. In addition, while the Parliamentarian read the presidential message—the one-page message from the President to Congress that described the purpose and contents of the draft declaration—he did not read the draft declaration, which listed U.S. civilian nuclear sites and activities. Staff in the Office of the Parliamentarian do not routinely read enclosures accompanying a presidential message, according to the House Parliamentarian. Second, the Office of the Parliamentarian gave the document to the House of Representatives’ Clerk’s Office to process it for referral to the House Committee on Foreign Affairs and prepare it for transmission to and publication by GPO. After reading the President’s message and seeing the IAEA markings on the draft declaration, the Executive Communications Clerk, who works in the Clerk’s Office, told us she was confused about the classification level of the document and whether it could be published. As a result, the Clerk locked the document in a safe while she sought clarification and guidance from the following sources before sending the draft declaration to GPO for publication: The Journal Clerk in the House of Representatives’ Legislative Operations Office. On May 5, 2009, this clerk had received the documents from the Office of the Parliamentarian and stamped the documents acknowledging receipt from the White House before providing the documents to the Executive Communications Clerk. According to the Executive Communications Clerk, the Journal Clerk told her she could print the document because it was unclassified. The House of Representatives’ Security Office. The Security Office Director reviewed the document on May 5, 2009, but did not take custody of it or make inquiries on its proper handling and safeguarding. Instead, the Security Office Director told the Executive Communications Clerk to obtain clarification from IAEA—incorrectly assuming that IAEA was the classifier of the document—and the White House Clerk’s Office. The Security Office stated that it was not required to take custody of the document and the Executive Communications Clerk did not request that the Security Office store the document or help her in contacting the agencies and offices that transmitted the document. However, the Security Office did not raise concerns with the House Clerk’s Office about publicly releasing 266 pages of information on U.S. nuclear sites and activities and, in our view, missed an opportunity to be more directly involved in ensuring that the document was not publicly released without explicit authorization from the agencies that designated the information as SBU. An IAEA official located in New York. According to the Executive Communications Clerk, this official told her on May 5, 2009, that IAEA member states have discretion on how to treat information provided to IAEA and publication of the declaration is a decision left to each member state. In July 2009, we interviewed IAEA officials in the Department of Safeguards in Vienna, Austria. This department is responsible for reviewing all Additional Protocol agreements between the agency and member states. These officials told us that the Executive Communications Clerk received correct information from IAEA’s New York office, but the appropriate inquiry should have been directed to their office in Vienna. The White House Clerk’s Office. The White House Clerk’s Office and the Executive Communications Clerk disagreed in their recollections of the advice the White House clerk provided to the House of Representatives. According to attorneys from the Office of the White House Counsel, the White House Clerk’s office told the Executive Communications Clerk that the document was unclassified but did not make a legal judgment or provide any advice on whether the document should be printed. However, according to the Executive Communications Clerk, the White House Clerk’s office referred her to the penultimate paragraph in the presidential message stating that the United States regards the information as SBU as justification for printing the document. According to the Executive Communications Clerk, the White House Clerk’s justification for going forward with the printing was that the document was unclassified. On the basis of advice from these various offices, on May 6, 2009, the Executive Communications Clerk ordered GPO to print the presidential message and the draft declaration. GPO Did Not Raise Concerns about Publishing the Draft Declaration GPO, which edited and processed the document for publication, did not raise any concerns about the document’s sensitivity. On May 6, 2009, GPO received a request from the House of Representatives’ Executive Communications Clerk to print the presidential message and draft declaration by 7:00 a.m. on May 7, 2009. The transmittal page from the Clerk did not include any special handling instructions and ordered the documents to be printed. The presidential message, which contained the language that the contents of the draft declaration should be treated as SBU, was typeset and proofread twice by GPO production employees. According to an August 2009 GPO Inspector General’s report, GPO production employees are not required to read and proof for meaning, but merely to check for proper characters and format. The 266-page draft declaration was digitally scanned, rather than typed and proofread. While “Highly Confidential Safeguards Sensitive” was marked on nearly every page of the draft declaration, the GPO Inspector General found that no GPO employees raised any concerns during the processing of the document. According to the GPO Inspector General’s report, GPO employees who reviewed the scanned copy looked for page numbers and format, without proofreading or reviewing the document text or markings. GPO officials told us that GPO rarely prints sensitive or classified documents. They told us that GPO relies on its customers to identify sensitive documents and notify it of special instructions, given the high volume of print requests. However, the August 2009 GPO Inspector General’s report found that GPO does not have procedures for identifying potentially sensitive documents and safeguarding them. In addition, most employees had not received education or training for recognizing or identifying sensitive documents or information. Although the GPO Inspector General found no wrongdoing on the part of GPO or its employees, it made several recommendations to improve GPO’s process for handling sensitive information and preventing the inadvertent disclosure of such information in the future. These recommendations included establishing a protocol with customer agencies on clearly identifying sensitive information that may be published and developing written procedures for handling such information; establishing written procedures for verifying any requests for publishing documents that are clearly identified or marked as being of a sensitive or otherwise restricted nature; updating GPO guidance to define “sensitive information” and how to specifically recognize, mark, and safeguard such information; and developing and conducting ongoing training of GPO employees on how to recognize, handle, and safeguard sensitive information and documents. During the course of our review, officials from several of the federal agencies and offices told us that it would be helpful if there was a standardized marking system for documents that are sensitive but are unclassified. In fact, the term sensitive but unclassified was very confusing for several officials who handled the draft declaration. To help clarify, a May 2008 presidential memorandum had adopted the phrase “Controlled Unclassified Information” (CUI) as a single designation for all information previously labeled SBU or with another similar marking. This memorandum also charged the National Archives and Records Administration with implementing a framework for CUI terrorism-related information, which is not expected to be in place until 2013. Despite these efforts, a May 27, 2009, presidential memorandum found that there is still no uniformity across federal agencies on rules to implement safeguards for information that is deemed SBU. The memorandum noted that agencies use SBU as a designation for federal government documents and information that are sufficiently sensitive to warrant some level of protection, but that do not meet the standards for national security classification. With each agency implementing its own protections for categorizing and handling SBU material, the memorandum stated that there are more than 107 unique markings and over 130 different labeling or handling processes and procedures for SBU information. The 2009 memorandum directed the creation of a Task Force to review agencies’ current procedures for categorizing and sharing SBU information, to track the progress federal agencies are making to implement the framework for CUI terrorism-related information, and to recommend whether the CUI framework should be extended to apply to all SBU information. Public Release of Draft Declaration Does Not Appear to Have Harmed National Security, According to DOE, NRC, and Commerce Officials The inadvertent public release of the draft declaration of civilian nuclear sites and nuclear facilities does not appear to have damaged national security, according to officials from DOE, NRC, and Commerce. Information in the draft declaration was limited to civilian nuclear activities, and most nuclear-related information was publicly available on agency Web sites or in other published documents, according to officials from the three agencies. However, officials from all of the agencies that compiled this information told us the information—all of which was considered unclassified—was sensitive because it was consolidated into one document and should never have been posted to GPO’s Web site. Commerce, DOE, and NRC did not formally assess the impact of the public release of the information on U.S. national security. According to DOE, NRC, and Commerce officials, it was not necessary to do so because the agencies reviewed the list of civilian nuclear facilities and related activities on multiple occasions to ensure that no information of direct national security significance was included and that no classified information was contained in the declaration prior to transmitting it to the White House and Congress. Consolidated List of Civilian Nuclear Facilities and Activities Contained in the Draft Declaration Is Considered Sensitive and Was Never Meant to be Made Public According to U.S. government officials, the draft declaration in totality represents a consolidated list of hundreds of U.S. civilian nuclear facilities and activities that never should have been publicly released. These officials asserted that it could be potentially problematic if such a consolidated list of facilities and activities found its way into the hands of individuals who had malicious or malevolent intentions. For example, agency officials told us, in several instances, the draft declaration contained maps showing detailed diagrams of civilian reactor facilities or buildings storing nuclear materials at national laboratories. The draft declaration included 14 diagrams of buildings or facilities, 2 of which were marked OUO. For example, the declaration provided the building and vault numbers where highly enriched uranium is stored at the Y-12 nuclear production facility, as well as a diagram showing the layout of the part of the building where the material is stored. According to DOE officials, this information was sensitive because it identified the specific building and vault number, but no classified information was revealed because the diagram does not show a map of the entire Y-12 facility and the specific location of a vault at the Y-12 complex. Of the other 12 diagrams, 1 was of a plutonium oxide storage area at DOE’s Savannah River site and 11 were of civilian nuclear facilities. The pages containing these diagrams did not have any markings: Highly Confidential Safeguards Sensitive, OUO, or any other U.S. designation. The 11 diagrams of civilian nuclear facilities accompanied information on 8 NRC licensed commercial sites—4 reactors and 4 fuel fabrication facilities. For example, the draft declaration included a site map of the Turkey Point reactor in Florida and a diagram identifying the building where spent fuel is stored. According to NRC officials, the information and diagrams related to the facilities in the draft declaration are not classified because they do not specify the quantities and types of nuclear materials held at these facilities. However, the information is sensitive because it includes commercially sensitive data, such as the actual annual production, rather than the more general and publicly available information on how much material the facility is licensed to produce. According to DOE and State officials, the release of the information could be problematic for the United States because other countries could scrutinize the completeness and accuracy of the information and potentially pressure IAEA to do more rigorous inspections of the facilities listed. Inspections of nuclear facilities with nuclear materials and nuclear- related activities are the cornerstone of IAEA’s data collection efforts and provide the ability to independently verify information in countries’ Additional Protocol declarations. Potential pressure to conduct more comprehensive inspections of U.S. facilities could divert time and resources from more rigorous inspections in countries and facilities of proliferation concern, such as Iran or Syria. Agencies Did Not Assess National Security Implications of Disclosure of Draft Declaration Commerce, DOE, State, and NRC did not undertake any assessments after the draft declaration was released to determine its impact on U.S. national security. According to officials from these agencies, no such assessment was necessary because all of the agencies involved in the development of the draft declaration (as well as the Department of Defense) had fully reviewed the consolidated list of civilian nuclear facilities and related activities on multiple occasions to ensure that no information of direct national security significance was included and that no classified information was contained in the declaration prior to transmitting it to the White House and Congress. DOE, which provided most of the information in the draft declaration, had three separate levels of security review and approvals for the information it submitted for the document. First, the national laboratories’ counterintelligence, export controls, and security offices reviewed the information submitted for the declaration. Second, the national laboratories’ site managers reviewed the information, and each site manager certified to DOE that the national laboratory had completed vulnerability assessments on the national security impact of releasing the information to IAEA and that the facilities were ready for IAEA inspections. Finally, program managers and security officers at DOE headquarters reviewed the contents. According to DOE officials, at all levels of review, officials from the national laboratories and DOE concluded that no information detrimental to national security was included in the document. NRC and Commerce reported information about facilities’ activities and locations that was mostly, if not all, publicly available. State obtained additional confirmation from DOE, Commerce, NRC, and the Department of Defense that the draft declaration contained no classified or national security information before sending it to the White House. According to agency officials, there was no requirement to conduct a formal assessment of any possible security concerns arising from the declaration’s publication because classified information was not released. A formal assessment is required only if there is a release of information that could harm U.S. national security. DOE and NRC did seek assurances after the release of the draft declaration from officials at the national laboratories and civilian nuclear facilities that physical security at those locations was sufficient. DOE asked the national laboratories to review their security procedures and ensure that the facilities were secure. Based on these assessments, DOE officials told us they did not increase security at any site. NRC contacted every NRC licensee and agreement states with licensees included in the draft declaration to notify them of the disclosure of information. Agreement states notified their affected licensees. NRC and agreement states’ licensees reviewed their security procedures to make sure there were no vulnerabilities. According to NRC, the only NRC facility to express concern was Turkey Point in Florida because of its spent fuel pool. NRC officials told us that the location of this facility was already publicly disclosed, and satellite images show the building that houses the spent fuel pool. Turkey Point operators reviewed their security procedures and determined the procedures they had in place were sufficient, even with the release of the draft declaration. Conclusions The draft declaration listing civilian nuclear sites and activities under the terms of the Additional Protocol was the first of its kind prepared by the United States for IAEA and sent to Congress for review. However, the draft declaration contained sensitive civilian nuclear information that, when taken in its totality, needed to be properly handled and safeguarded. Protecting sensitive information from inadvertent public disclosure is a critical function of all federal entities that possess, handle, or transmit such information. Since the United States is required to submit a draft declaration to Congress and then send the declaration to IAEA every year, there is an opportunity to address the problems that occurred to ensure that this inadvertent disclosure does not occur again. A more systematic, well-coordinated approach by all of the agencies that handled the draft declaration would have reduced the chances of publicly releasing sensitive information—particularly if the document had been clearly identified as not for public release. We found several critical points where opportunities to improve safeguards over the document were missed due to: the absence of clear interagency guidance, different procedures across the agencies governing the handling and marking of sensitive documents, poor decision making, and the lack of training and adequate security awareness. No agency or office that was involved with the production or transmittal of the draft declaration ensured that the final document was marked with any U.S. security designation. DOE, NRC, and Commerce marked the information they submitted for the draft declaration as OUO. However, none of these agencies took the added precaution of ensuring that the consolidated draft declaration maintained the OUO designation on each page of the document once the IAEA marking was placed on the document. Further contributing to the subsequent confusion over how to handle the draft declaration was State’s use of the SBU marking. Many officials focused on the unclassified portion of the marking and determined, incorrectly in our view, that the document could be made public. We believe that it would have been a simple matter to clearly state in the presidential message that the draft declaration was not meant for public dissemination. Furthermore, the White House failed to take measures to ensure that the draft declaration was not published. Attorneys from the Office of the White House Counsel did not provide us with any written guidance on how the National Security Council and the Executive Clerk’s Office usually handle documents that are unclassified, but are considered sensitive, such as those marked SBU, that should not be publicly released. However, counsel did indicate that individuals with the National Security Council and White House Clerk’s office handled the draft declaration according to White House practices. In our view, these practices, as best as we understand them, are not sufficient to prevent similar problems from occurring in the future. In addition, legislative branch officials did not properly safeguard the draft declaration and did not properly handle the information. In particular, we believe that the House of Representatives Security Office Director should have been more directly involved in resolving conflicting and confusing information regarding the classification of the draft declaration. Conversely, the Executive Communications Clerk is to be commended for taking actions to do everything in her power—at her level of responsibility—to pursue the right course of action. Finally, in our view, GPO officials also share responsibility for the public disclosure of the draft declaration. Although the August 2009 GPO Inspector General’s report assigns no wrongdoing to either GPO or its employees, GPO officials should have had procedures in place to prevent such a release from occurring. Thus, we agree with the Inspector General’s proposed recommendations and we encourage GPO to implement them as expeditiously as possible. Recommendations for Executive Action To ensure that corrective actions are taken to prevent the inadvertent public disclosure of sensitive information in future draft declarations or other documents prepared for IAEA by multiple U.S. agencies, we are making the following four recommendations: The Secretaries of Commerce, Energy, and State, and the Chairman of the NRC should enter into an interagency agreement concerning the designation, marking, and handling of such information, and make any policy or regulatory changes necessary to reach such an agreement. This agreement should be revised, as necessary, to take into account future direction from the President or the Controlled Unclassified Information Council regarding standardization of the procedures for designating, marking, and handling documents that are unclassified but are not intended for public release. The Secretary of State should clearly indicate in the text whether the presidential message and attached documents, if any, should be printed and made publicly available when preparing presidential communications to Congress for documents to be presented to IAEA. The Executive Office of the President should consider revising any written guidance and/or practices it has and conduct staff training for handling and safeguarding sensitive information in future declarations or other documents between the United States and IAEA before it needs to issue its next declaration in May 2010. GPO’s public printer should implement, as expeditiously as possible, the recommendations from the agency’s August 2009 Inspector General report in order to improve the security culture and reduce the possibility of future postings of sensitive information to the GPO Web site. Agency Comments and Our Evaluation We provided a draft of this report to DOE, State, GPO, NRC, Commerce, Office of the White House Counsel, and the House of Representatives’ Sergeant at Arms and Offices of the Clerk and Parliamentarian for comment. DOE, State, GPO, NRC and the House of Representatives Sergeant at Arms provided written comments, which are presented in appendixes I, II, III, IV and V, respectively. State and the Office of the White House Counsel provided technical comments which we incorporated as appropriate. Commerce and the House Offices of the Clerk and Parliamentarian reviewed, but did not provide comments on our draft report. DOE, State, and GPO agreed with our recommendations. NRC neither agreed nor disagreed with our recommendations, but did provide technical comments which we incorporated as appropriate. In response to our recommendation involving an interagency agreement to designate, mark, and handle sensitive information provided to IAEA on U.S. nuclear sites and activities, DOE noted that the interagency agreement would specifically address the marking and handling of future draft declarations and other documents provided to IAEA under U.S. safeguards agreements. The interagency agreement will not address broader, governmentwide standards on how to mark and handle all unclassified, but sensitive information. These standards will be developed by the Controlled Unclassified Information Council or other entity designated by the President. This is consistent with our recommendation. As we state in our report, the interagency agreement should be a corrective action to prevent the inadvertent public disclosure of sensitive information in future draft declarations or other documents prepared for IAEA by multiple U.S. agencies, rather than addressing broader, governmentwide standards on how to mark and handle all unclassified but sensitive information. The House of Representatives’ Sergeant at Arms did not comment on our recommendations but provided three points of clarification regarding the Office of Security’s role in reviewing and transmitting the draft declaration. First, the House Sergeant at Arms stated that, contrary to what we stated in our draft report, the House Security Office made no determination as to whether the draft document could be published and did not provide the House Clerk’s office with any direction or legal advice regarding this matter. Second, according to the House Sergeant at Arms, the House Security Office properly advised the House Clerk’s office to contact IAEA regarding the handling of the draft document. Third, the House Sergeant at Arms stated that the House Security Office did not need to take control of the draft document, nor was the Security Office requested to take control of the document. In addition, the Security Office does not have the authority to order a House of Representatives office or entity to store a document with the Security Office. Regarding the first point, we believe that given the sensitive nature of the draft document—and commensurate with its role and responsibilities— the House Security Office should have, at a minimum, raised concerns with the House Clerk’s Office about publicly releasing 266 pages of information on U.S. nuclear sites and activities and advised the House Clerk not to print the document without explicit authorization from the agencies that designated the information SBU. While we do not dispute the statement that the House Security Office did not provide any advice or direction regarding the printing of the document, we believe that it would have been appropriate for this Office to play a more assertive role because the House Clerk sought advice and guidance in determining whether the document could be printed. However, based on these comments, we modified the text of the report to reflect the claims made by the House Security Office. Specifically, we removed reference to the Security Office on page 16 to avoid inferences that the Security Office provided direction or legal advice to the Clerk’s Office that it could print the document. Regarding the second point, the House Office of Security has misconstrued what we stated in the draft report. While there was nothing inherently wrong with the Office of Security suggesting that the Clerk’s Office contact IAEA about the document, IAEA did not prepare, transmit, or mark the document. As we noted in our report, the U.S. agencies that prepared the draft declaration placed the IAEA markings on the document. The presidential message explained that the draft declaration was prepared by the United States and would be submitted to IAEA. Because the IAEA markings on the document have no legal significance in the United States, the presidential message further explained that information in the document should be treated as SBU and was exempt from disclosure. IAEA was not the originating agency for the information. As a result, it continues to be our view that the Director of the House Office of Security did not provide the correct advice to the House Clerk on who she should contact to obtain authorization on releasing SBU information. Finally, regarding the matter of physical custody of the document, we do not dispute Security Office’s claim that it was not required—nor did it have the authority—to take control of the document. However, we believe that it would have been prudent for that office to take physical control of the document as a precautionary measure until a determination was made concerning whether or not the document could be published. The Director of the Office of Security missed opportunities to prevent the document’s release and should have been more directly involved in resolving conflicting and confusing information regarding the dissemination of the draft declaration. However, we modified the text on page 17 to include information about the Security Office’s physical custody requirements and the assistance the House Clerk requested from the Security Office. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution of it until eight days from date of this report. At that time, we will send copies of this report to the Secretaries of Commerce, Energy, and State; the Chairman of the Nuclear Regulatory Commission; the House of Representatives’ Parliamentarian, Clerk, and Sergeant at Arms; the Executive Clerk of the White House; the Public Printer of the Government Printing Office; and interested congressional committees. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-3841 or aloisee@gao.gov. Contact points for our Office of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix VI. Appendix I: Comments from the Department of Energy Appendix II: Comments from the Department of State Appendix III: Comments from the Government Printing Office The following are GAO’s comments to the Government Printing Office letter dated December 2, 2009. GAO Comments 1. We added GPO to the Highlights page as one of the agencies and offices we met with to discuss why the disclosure of the draft declaration occurred. 2. We modified the text on page 3 to include the most recent data on the status of the printed copies of the draft declaration, based on information contained in the technical appendix provided by GPO. Appendix IV: Comments from the Nuclear Regulatory Commission The following is GAO’s comment to the Nuclear Regulatory Commission letter dated December 2, 2009. GAO Comment 1. We modified the text on the bottom of page 4 in the Background section to clarify that under the Additional Protocol, the U.S. must declare exports of sensitive nuclear-related equipment specified by IAEA. Appendix V: Comments from the House of Representatives’ Sergeant at Arms The following are GAO’s comments to the House of Representatives Sergeant at Arms letter dated December 2, 2009. GAO Comments 1. We have modified the text on page 16 by removing a reference to the Security Office to clarify that it did not make a determination as to whether the document could be published. 2. The Sergeant at Arms is incorrect when he states that IAEA marked the document “Highly Confidential Safeguards Sensitive.” As we state in our report, U.S. agencies that prepared the declaration marked the document, not IAEA. U.S. agencies used an IAEA-supplied software to mark the document with the highest IAEA security marking to put IAEA on notice, once it received the document, that it should be properly safeguarded against disclosure. However, the draft declaration is a U.S. document and should not have been publicly disclosed. 3. We agree that U.S. agencies and offices that prepared and transmitted the document prior to sending it to the House of Representatives missed opportunities to better mark the document and avoid confusion about whether it should have been published. However, the presidential message that accompanied the draft declaration explained that the United States regarded the information as SBU. The presidential message also explained that the information was exempt from disclosure under FOIA. In our view, the information in the presidential message should have been sufficient to put the House Security Office on notice that the information should be treated as SBU and should not be published or publicly released without a more rigorous inquiry. 4. See comment 2. 5. See comment 1. 6. While there was nothing inherently wrong with the Office of Security suggesting that the Clerk’s Office contact IAEA about the document, IAEA did not prepare, transmit, or mark the document. IAEA was not the originating agency for the information. As a result, it continues to be our view that the Director of the House Office of Security did not provide the correct advice to the House Clerk on who she should have contacted to obtain authorization on releasing SBU information. 7. As we noted in our report, U.S. agencies that prepared the draft declaration placed the IAEA marking on the document. The presidential message explained that the draft declaration was prepared by the United States and would be submitted to IAEA. IAEA was not the originating agency for the information. 8. We have modified the text on page 17 to clarify that the Security Office was not required to take custody and control of the document. 9. See comment 8. 10. We have modified the text on page 17 to clarify that the Security Office was not required to take custody and control of the document. However, given the unfamiliar markings and 266 pages of detailed information on U.S. nuclear sites and activities, we believe that it would have been prudent to take positive physical control of the document as a precautionary measure until a determination was made concerning whether or not the document could be published. The Director of the Office of Security missed opportunities to prevent the document’s release and he should have been more directly involved in resolving conflicting and confusing information regarding the classification of the draft declaration. 11. See comment 8. 12. We have modified the text on page 17 to clarify that the Security Office was not required to take custody and control of the document and the Executive Communications Clerk did not request that the Security Office take custody of the document or assist her in contacting the agencies and offices that transmitted the document. 13. We have modified the text on page 17 to clarify the Security Office’s document custody requirements and what was asked of the Security Office by the House Clerk. However, we believe that given the sensitive nature of the draft document—and commensurate with its role—the House Security Office should have, at a minimum, raised concerns with the House Clerk’s Office about publicly releasing 266 pages of information on U.S. nuclear sites and activities and advised the House Clerk not to print the document without a more rigorous inquiry as to whether it should have been published. 14. We believe that the recommendation suggested by the Sergeant at Arms to require Member offices and other non-Committee House entities that are not equipped to properly store sensitive or classified data to relinquish custody of such material to the House Security Office would involve a change in House rules and procedures that is beyond the scope of our review. Appendix VI: GAO Contact and Staff Acknowledgments Gene Aloise (202) 512-3841 or aloisee@gao.gov. Staff Acknowledgments In addition to the contact named above, Glen Levis, Assistant Director, Antoinette Capaccio, Leland Cogliani; Ralph Dawn, Karen Keegan; Tim Persons; and Carol Herrnstadt Shulman made significant contributions to this report.

On May 7, 2009, the Government Printing Office (GPO) published a 266-page document on its Web site that provided detailed information on civilian nuclear sites, locations, facilities, and activities in the United States. At the request of the Speaker of the House, this report determines (1) which U.S. agencies were responsible for the public release of this information and why the disclosure occurred, and (2) what impact, if any, the release of the information has had on U.S. national security. In performing this work, the Government Accountability Office (GAO) analyzed policies, procedures, and guidance for safeguarding sensitive information and met with officials from four executive branch agencies involved in preparing the document, the White House, the House of Representatives, and GPO. While no single U.S. government agency or office was entirely responsible for the public disclosure of the draft declaration, all of the agencies and offices involved in preparing and publishing the draft declaration share some responsibility for its release. GAO identified several points during the life cycle of the draft document where problems in the process occurred. First, none of the agencies that prepared the draft declaration--the Departments of Energy (DOE) and Commerce, and the Nuclear Regulatory Commission (NRC)--took the added precaution of ensuring that the consolidated draft they helped prepare had a U.S. security designation on each page of the document. Rather, the final version of the document, which they all reviewed, was marked only with the International Atomic Energy Agency's (IAEA) designation--"Highly Confidential Safeguards Sensitive." This marking has no legal significance in the United States. Second, the Department of State, which prepared the draft declaration for transmittal to the White House, sent a transmittal letter to the National Security Council indicating that the contents of the draft declaration should be treated as Sensitive but Unclassified (SBU). Not all federal agencies use this particular marking and, therefore, the marking created confusion for other executive and legislative branch offices that subsequently received the draft declaration on whether the information could be published. Third, the National Security Council, which reviewed the draft declaration on behalf of the White House, did not provide explicit and clear instructions on how to handle the draft declaration to the White House Clerk's Office. Fourth, the legislative branch offices which reviewed and then transmitted the document to GPO for publication--the House of Representatives' Parliamentarian and Clerk's Office--determined incorrectly, in GAO's view, that the document could be published. Officials from these congressional offices were not familiar with the phrase "Sensitive but Unclassified" and did not know how to safeguard that information. Finally, GPO, which proofread and processed the document for publication, did not raise any concerns about the document's sensitivity. GAO believes it is important to correct these problems as soon as possible because the United States is required to submit a declaration to IAEA annually. The public release of the draft declaration of civilian nuclear sites and nuclear facilities does not appear to have damaged national security, according to officials from DOE, NRC, and Commerce. Commerce, DOE, and NRC did not assess the national security implications of the draft declaration's public release because these agencies--plus the Department of Defense--had reviewed the list of civilian nuclear facilities and related activities prior to transmitting it to the White House and Congress to ensure that information of direct national security significance was not included. Information in the draft declaration was limited to civilian nuclear activities, and most nuclear-related information was publicly available on agency Web sites or other publicly available documents. However, according to officials from all of the agencies responsible for compiling this information, the information consolidated in one document made it sensitive and, thus, it should never have been posted to GPO's Web site.

Background The mission of USTRANSCOM, which is DOD’s single manager of all defense transportation services, is to provide global air, land, and sea transportation to meet national security needs, both in time of peace and time of war. USTRANSCOM executes its mission through three component commands: (1) MTMC for land transportation and port operations (2) MSC for sea transport, and (3) the Air Force’s Air Mobility Command (AMC) for air transport. Within this report, defense transportation refers to common-user transportation, defined by DOD as transportation and transportation services provided on a common basis for two or more DOD agencies. USTRANSCOM’s responsibilities include financial management of all defense transportation. USTRANSCOM and its component commands operate under the Working Capital Fund system of financial management. Its budget, which includes the component commands, is submitted within the Air Force’s Working Capital Fund budget, separated and identified therein as the Transportation Working Capital Fund (TWCF). Under the TWCF concept, DOD customers place orders with the component commands, which then contract for the services and/or provide the services using their own resources. In turn, the component commands charge customers for their services. Customers predominantly use funds from their operations and maintenance appropriations to reimburse component commands, which use these reimbursements to pay their suppliers and to fund their operating costs. (See fig. 1.) USTRANSCOM’s operating costs were approximately $4.0 billion in fiscal year 1997, and in fiscal year 1998, its budget submission estimate is $4.2 billion. In fiscal year 1997, AMC accounted for about 60 percent of total TWCF operating costs, MSC was about 30 percent, and MTMC was about 10 percent. The congressional defense committees have raised concerns regarding USTRANSCOM’s infrastructure. Therefore, the fiscal year 1996 appropriation included a reduction of $52 million and the fiscal year 1997 appropriation included a reduction of $100 million due to these high infrastructure costs. The committees believed immediate action was necessary to consolidate and streamline transportation operations in a manner that reduced the amount of transportation overhead passed on to customers without adversely affecting mobilization capability. Consistent with working capital fund policy, component commands charge for services using rates that must cover costs USTRANSCOM and its component commands incur for the commercial services plus their other direct, indirect, and overhead costs. Each component command must develop a budget and determine how much to charge its customers for each service. MSC is responsible for negotiating the cargo rates and terms of carriage with the ocean carriers and paying carrier invoices. MTMC is responsible for booking service for individual shipments, preparing shipment documentation, clearing customs, and supporting MSC’s payment processes. AMC is responsible for booking cargo shipments and passenger moves, billing customers, and providing airlift. Multiple factors affect the ability to reduce rates charged to customers, including inflation, the way the rates are calculated, declining workload, and customer satisfaction. In addition, due to the budget process, there is a lag time of up to 18 months between when rates are first estimated and when they are effective. While most rates are supposed to recover actual cost of the operations, some rates do not. For example, the customer rates AMC charges for airlift are supposed to cover only those operating and maintenance costs directly related to providing the airlift service. However, training and readiness, which are not always directly related to providing airlift services and are AMC primary missions, make up much of AMC’s operating costs. In accordance with a DOD directive, the Air Force pays or subsidizes the costs of training and readiness, which are in addition to the portion of costs AMC recovers from its customers through the rates it charges for services directly related to providing airlift. This payment, generally referred to as the Air Force subsidy, was about $420 million in fiscal year 1997 and USTRANSCOM estimates it will be about $514 million in fiscal year 1998. Reducing costs that are covered by the subsidy would not reduce customer rates, rather, it would reduce the amount of the Air Force subsidy. Another factor impacting the ability to reduce rates charged to customers is declining workload. According to the Under Secretary of Defense (Comptroller), DOD has been unable to reduce infrastructure costs as fast as customer budgets have been reduced. Faced with a finite amount of funds, customers are consequently paying higher prices for needed goods and services while overall demand for work is decreasing. Customer satisfaction is another element that impacts the ability to reduce transportation costs. The less satisfied a customer is with the quality, timeliness, or cost of the service, the more likely they will seek alternate transportation resources outside the defense transportation system. For example, in USTRANSCOM’s fiscal year 1998 TWCF budget submission, AMC notes that it has been losing peacetime airlift customers to the commercial sector because the commercial sector provides a better service. Similarly, because the military exchanges and commissaries were concerned over high costs of ocean transportation, they received legislative authority to obtain transportation services outside MTMC and MSC in fiscal year 1996. In a May 17, 1997, policy memorandum, DOD stated that this authority may only be exercised to the extent that the military exchanges and commissaries can demonstrate that it would be more cost-effective to DOD to do so, and readiness would not negatively be impacted. The determination of the overall cost-effectiveness and impact on readiness would be made by the Under Secretary of Defense (Acquisition and Technology) in conjunction with the Under Secretary of Defense (Comptroller), the Under Secretary of Defense (Personnel and Readiness), and the Commander in Chief, USTRANSCOM. According to USTRANSCOM officials, this authority has not been exercised. Our Analysis of USTRANSCOM Reported Savings and Effect on Reducing Infrastructure and Operating Costs USTRANSCOM and the component commands have taken action to improve customer service, reduce costs, and improve operational efficiency. In March 1997, USTRANSCOM reported that nearly a $780-million savings occurring during the fiscal years 1993 through 1999 time period are expected to incrementally reduce customers’ rate charges for transportation through the rest of the decade. Specifically, USTRANSCOM reported that its budget submissions between fiscal years 1993 and 1999 reflect over $500 million in savings resulting from productivity and cost avoidance initiatives, over $200 million in cost reductions due to fewer flying hours, and over $70 million in streamlining-related savings. According to USTRANSCOM, about 65 percent of the reported savings has been achieved and about 35 percent are projected to occur through fiscal year 1999. Table 1 shows the savings USTRANSCOM reports by component command. The total savings reported by USTRANSCOM represent about 3 percent of the $27 billion in TWCF costs that it has incurred or expects to incur during the 6-year period covered by the savings. To the extent that these savings are expected to be realized, we found that most of the reported savings, over $400 million, would not reduce long-term operating costs, and that only a relatively small portion of the savings, about $260 million, was apt to result in reductions to transportation rates for users of the defense transportation system. Another $120 million actually involved improved revenue collections rather than efforts to reduce long-term operating costs. Table 2 summarizes our categorization of the reported savings. It should also be noted that for purposes of our analysis, we assumed that the cost reductions would be fully realized. However, in doing our analysis we found that many of the reported cost reductions were not well-documented and some will not materialize. The extent to which the savings are not well-documented is discussed in greater detail in the Scope and Methodology section of this report. Some Reported Savings Reduce Infrastructure and Long-Term Operating Costs About $149 million, or 19 percent, in reported savings result from USTRANSCOM initiatives to reduce infrastructure and operating costs. These efforts are a step in the right direction and should have a positive impact by lowering costs that are passed on to common user customers. Table 3 shows a breakdown of the savings resulting from initiatives to reduce infrastructure and operating costs by command. Some actions that the commands have taken, or are taking to reduce infrastructure and long-term operating costs and to achieve these savings follow. AMC has reduced the number of civilian personnel employed, improved operations by combining previously separated air traffic management functions into one Tanker Airlift Control Center, and implemented better airlift loading processes. MSC is in the process of reinvention, assessing its key business lines and establishing an organization that it believes will better meet the needs of its diverse customers. Its reinvention plans include a reduction in size and a relocation of its two largest area commands from Bayonne, New Jersey, and Oakland, California, to Norfolk, Virginia, and Pearl Harbor, Hawaii, respectively. MTMC is consolidating its Eastern and Western Area Command headquarters into one headquarters. In taking this action, MTMC is not only complying with the decision of the 1995 Base Closure and Realignment Commission to relocate its Eastern and Western Area Commands, but also is consolidating the two area command headquarters into a single MTMC Continental U.S. Command headquarters at Fort Eustis, Virginia. MTMC has closed or is planning to close port facilities at Baltimore, Maryland; Compton, California; New Orleans, Louisiana; Iskenderun, Turkey; and Lisbon, Portugal. The closure of its Bremerhaven, Germany, facility is under study. Other downsizing actions have been taken or are planned at Oakland, California; Bayonne, New Jersey; the Azores; Greece; Germany; and Panama. In addition, USTRANSCOM directed the establishment of the Joint Traffic Management Office at MTMC. This office combines cargo and passenger missions and consolidates separate MTMC and MSC traffic management staff. USTRANSCOM reduced the number of headquarters personnel in the Joint Transportation Corporate Information Management Center. The Center’s primary objective is to improve the efficiency and effectiveness of defense transportation information systems. Some Reported Savings Affect Primarily a Single Customer Reported savings of $109 million would reduce costs to programs that serve basically single customers and should reduce rates charged to them. About $44 million of the savings was achieved by changing maintenance procedures, shore support, and operating status, for example, in the Fast Sealift Ship program. The Fast Sealift Ship program consists of eight high-speed, roll-on/roll-off ships that are kept in reserve for surge capability and is funded almost entirely by one customer, the Navy. Another $33 million of the savings was achieved by changing delivery methods, numbers of ships employed for delivery of fuels, and types of ships employed, for example, in the sealift Tankership program. This program uses government and chartered ships to deliver petroleum around the world and is funded almost entirely by the Defense Logistics Agency’s Defense Fuel Supply Center. An additional $9 million was attributed to renegotiation of contracts for ships in the Maritime Prepositioning Ships program. This program consists of 13 prepositioned ships loaded with tanks, ammunition, fuel, and other materials for operations involving the U.S. Marine Corps and is funded by, and primarily benefits, the Navy through the Navy Working Capital Fund. Finally, $23 million of the savings was attributed to savings initiatives in the three programs mentioned above, but MSC did not provide data on the exact amount attributed to each specific program. Some Reported Savings Would Increase Revenues Not Reduce Long-Term Operating Costs Reported savings of $120 million is actually revenue increased by charging customers for services not billed to them in prior years. One example is an ongoing initiative to locate missing manifests and to charge customers for transportation services not previously billed, resulting in $55 million in additional revenue. Another is the inclusion of new charges to customers for unused space, resulting in an additional $65 million in revenue through fiscal year 1999. By collecting for services not previously billed and charging for unused space, USTRANSCOM will not have to raise rates or increase the amount of the Air Force subsidy in order to cover the losses it may have incurred because those costs had not been previously passed on to customers. At the same time, total customer charges for the same services may actually increase because customers will now pay for costs not previously billed to them. According to DOD, the process of charging customers for unused space should provide an incentive to the customer to reduce or eliminate some airlift requirements, which could also result in some cost savings. Large Portion of Reported Savings Offset by Related Cost Increases In two instances, we found that reported savings of $209 million were more than offset by directly related cost increases. AMC reported a total savings of nearly $173 million as a result of reduced flying hours and MSC reported over $36 million in savings from renegotiated container agreements. However, neither of these initiatives considered related cost increases. AMC, for example, attributed the $173 million savings primarily to the retirement of aging C-141 aircraft and a transfer of some C-141 training hours to flight simulators. However, AMC is replacing the C-141 with new C-17 airlift aircraft, and C-5 flying hour costs have been increasing. The reported flying hour cost savings do not reflect increased C-17 and C-5 flying hour costs. Since AMC’s estimate includes only reductions for three of the years between fiscal years 1993 and 1999, we recalculated the total C-141 flying hour costs, which actually decreased by $420 million during that period. However, the combined C-17 and C-5 cost increases were over $500 million during the same period, which more than offsets the cost decreases that USTRANSCOM projects will occur in the C-141 program. MSC’s reported savings showed that costs related to container rate agreements would be decreased by $36 million, mostly for fiscal years 1994 and 1995. This is an accurate statement; however, the statement does not give a complete analysis of rate changes through fiscal year 1999. For example, the same container agreements were renegotiated in fiscal year 1996. As a result, in many cases, rates in fiscal years 1997 and 1998 are higher. For example, the negotiated rate for moving a 40-foot dry cargo container from the Military Ocean Terminal, Oakland, California, to Seoul, Korea, dropped about 20 percent from June 1993 to June 1994 but increased by 40 percent in December 1996. The impact of the higher renegotiated rates was not considered in the savings calculation. Some Reported Savings Reduce Need for Appropriated Funds but Do Not Affect Customer Rates Reported savings of $114 million would reduce the subsidy the Air Force pays to TWCF but would not affect rates. As previously discussed, the purpose of the Air Force’s yearly subsidy to TWCF is to cover readiness and training costs that are not recovered by the rates AMC charges customers for services directly related to providing transportation services, such as airlift. AMC officials told us that the Air Force subsidy to TWCF, in effect, reimbursed the AMC portion of TWCF for the costs attributed to the closure of Norton Air Force Base ($55 million) and for the transfer of C-130 fixed-costs ($42 million). As a result, savings achieved by eliminating those costs would reduce the Air Force subsidy but would not lower customer rates. An additional $17 million in savings relate to costs that were reimbursed through the subsidy. This amount is calculated using the percentage of operating costs that were reimbursed by the Air Force subsidy between fiscal years 1994 and 1999 from approximately 10 to 44 percent of all AMC TWCF costs during that period. Thus, a total of $114 million reduces appropriated funds but not TWCF costs. Some Reported Savings Will Not Materialize According to AMC representatives, about $78 million in reported savings for AMC will not occur. Although AMC reported $23 million in savings was achieved in fiscal year 1996 by reducing the number of regularly scheduled C-5 and C-141 overhauls at depots, those reductions never materialized. Representatives of AMC told us that the Air Force decided it would be unsafe to decrease maintenance on those aircraft because of their age. The remaining savings—about $55 million in fiscal years 1998 and 1999—is associated with performing an intermediate level of maintenance for C-5 aircraft engines located at Dover Air Force Base being performed at the base instead of the depot level. However, these savings will not materialize because, according to AMC representatives, intermediate-level maintenance for Dover C-5 engines has never been done at the depot level. Many Transportation Rates Continue to Increase USTRANSCOM reported that the savings discussed previously will be passed on to peacetime customers in the form of lower rates for transportation through the rest of the decade. Therefore, to determine the extent that the savings are, or are projected to be, reflected in the form of lower rates to common user customers, we examined the trends in customer rates as reported by USTRANSCOM in its budget submissions. We also examined surcharges in two common user transportation areas to determine whether the difference we previously reported between underlying transportation costs and USTRANSCOM surcharges continues to occur. We found that USTRANSCOM and the component commands project increases in most common user transportation rates at or above the rate of inflation through fiscal year 1999, indicating that total customers’ charges are continuing to increase as well. While in total, the TWCF budget submission includes unit cost projections, workload assumptions, and rate changes for 10 separate transportation areas, 6 of the areas are for common user transportation. These common user areas provide more than 50 percent of USTRANSCOM’s revenue and include airlift channels for both passengers and cargo, special assignment airlift and joint exercise missions, sealift cargo for both breakbulk and containerized cargo, and port operations. The remaining four transportation areas are primarily single customer oriented programs and include MSC’s Fast Sealift, Tankership and Afloat Prepositioning Programs, and the Trained Crews Program, which serves the Air Force almost exclusively. USTRANSCOM projects that rates for the Fast Sealift Ships and Tankership programs will be below the projected rate of inflation. Those lower rates will affect rates for a few select customers but will have little effect, if any, on what most common user customers pay for defense transportation. See appendix I for figures showing rate changes as compared to inflation during the fiscal years 1995 through 1999 time period for each of the 10 transportation areas. Of the six common user transportation areas, half are projected to substantially increase above the rate of inflation and half will remain generally level with inflation during fiscal years 1995 through 1999. Specifically, USTRANSCOM projects rates for the combined area of special assignment and joint exercise airlift missions to increase 20 percent over the rate of inflation during that time period. According to USTRANSCOM officials, this increase is not due to price growth but rather to a DOD policy change that passes more of the operations costs to special assignment and exercise airlift users. Furthermore, according to the same officials, the rationale behind the policy decision was that, unlike channel cargo and passenger areas, special assignment mission and exercise services are often military-unique services that do not require a billing rate that approximates private industry. USTRANSCOM projects breakbulk and container cargo rates to increase about 40 percent during the same period. On the other hand, it projects that rates for both passenger and airlift channels during the same time period will remain about even with inflation because these rates are set at a commercially competitive level and any costs not recovered by rates in these areas are reimbursed through the Air Force subsidy. Even though USTRANSCOM projects the port operations rate to remain about even with inflation during this period, reflecting cost decreases affecting common user customers, those decreases are more than offset by increases noted for sealift cargo. As mentioned previously, various factors contribute to rate changes. Moreover, within each transportation rate area there are many rate categories and rates within categories. Separate categories often apply to specific types of service provided, types of cargo, and location. For example, the MTMC port handling rate area has separate rate categories for export and import cargo and within those categories are rates for each of 14 types of cargo and 6 locations. Thus, the actual change for any given category or any individual rate may vary significantly from the composite rate change. In addition, since rates are based on actual costs and are first estimated up to 18 months in advance of their effective date, some lag time will occur before the rates are changed to reflect actual cost changes. As previously mentioned, $258 million of reported savings are likely to impact customer rates. Of that amount, about $80 million of savings were actually achieved between fiscal year 1993 and 1995. Thus, the impact of those savings should be reflected in rates for fiscal years 1996, 1997, and 1998. The balance, about $180 million of the $258 million in savings, would not likely affect rates until fiscal year 1999 or beyond. Transportation composite rate changes in the February 1998 President’s Budget submission show significant reductions in some rate areas, differing from the 1999 rate estimates in the February 1997 President’s Budget submission and depicted in our rate trend analysis, which we submitted to DOD for comment on March 3, 1998. Although data was not available for us to review the 1999 composite rate changes released after our draft report, we are hopeful that these changes indicate that USTRANSCOM may be successful in reducing charges to its customers in fiscal year 1999 and beyond. USTRANSCOM Surcharges Continue to Be High In our February 1996 report, we examined charges to customers in two of the common user transportation areas: MSC cargo/container and MTMC port handling. We have updated those examples to identify changes in underlying (contractor) transportation costs and surcharges being passed on to USTRANSCOM customers. We acknowledge that some potential reductions in rates associated with expected savings are yet to occur. At the same time, the savings that will likely reduce rates in future years represents only a small portion of total USTRANSCOM operating costs. These savings represent less than 1 percent of USTRANSCOM’s estimate of $27 billion in total TWCF operating costs for fiscal years 1993 through 1999. Accordingly, this raises significant questions about the ability of these savings to substantively reduce charges. The updated examples identify changes in customer charges for the same service in fiscal year 1995 and in fiscal year 1997. The examples also show the costs USTRANSCOM incurred in contracting for commercial transportation, with remaining costs representing USTRANSCOM surcharges. The previous amounts charged customers were from 24 to 201 percent higher than the basic contractor transportation costs and the updated examples show that customers are now charged from 56 to 200 percent higher. In two examples, the actual contractor charges showed a decrease between fiscal year 1995 and 1997, indicating that USTRANSCOM negotiated more favorable container agreements. However, at the same time, the USTRANSCOM surcharge showed an increase between the two fiscal years in both examples. Table 4 cites changes in rates for four of these shipments. All 15 examples using updated data are shown in appendix II. The extent that TWCF rates, including the USTRANSCOM surcharge, can be reduced is directly related to the extent that long-term operating costs can be reduced. Although nearly $80 million in TWCF savings were reported as occurring by fiscal year 1995, about $180 million in savings expected in fiscal year 1996 through fiscal year 1999 may have a future impact on rates. Nevertheless, the USTRANSCOM surcharge continues to remain relatively high in the two fiscal years—1995 and 1997—we examined. Using MTMC data, we verified that these examples were representative using MTMC data by comparing the costs and charges of the same examples at the rates (fiscal year 1995) used in our February 1996 report with the more current rates (fiscal year 1997). To obtain additional information regarding the examples and to ensure all relevant factors were considered in our calculations, we presented the examples to MTMC, MSC, and USTRANSCOM in July 1997. USTRANSCOM responded that the examples “. . . describe the optimal situation of shipping port-to-port cargo,” and “. . . focused on shipping rates of the lowest cost carrier for ocean transportation only—not all the applicable charges.” We believe our examples demonstrate a variety of shipping points, give consideration to other than the lowest-cost carrier, and include all applicable charges. Only 5 of the 15 examples describe a port-to-port situation, and those examples, according to MTMC traffic data, indicate that they are illustrative of a significant number of containers handled in the defense transportation system. The other 10 examples represent port area-to-port area, port area-to-inland point, inland point-to-port, and inland point-to-inland point-type shipments. Each type encompasses large numbers of containers moving in the defense transportation system. Our examples include what MTMC charged its customers for shipment booking, cargo manifesting, customs clearance, and shipment receipt. MTMC could not provide us with any additional costs for any other services it may have provided. However, in many cases, defense customers perform their own shipment booking and have their own documentation and would not require MTMC to provide any additional services. As stated in our February 1996 report, the total USTRANSCOM surcharge for each shipment in our analysis was substantially higher than DOD’s carrier costs even though the charges for an individual component command may not always be higher than what the component command pays the carriers. Our examples highlight the USTRANSCOM surcharge, that is the difference between what USTRANSCOM pays commercial carriers for basic underlying transportation services and what it charges its customers, illustrating the costs customers pay for USTRANSCOM and component command operating costs. We continue to believe the USTRANSCOM surcharge as shown in our examples is excessively high. We did not attempt to determine what USTRANSCOM surcharge would be reasonable; we have reported, however, the surcharges passed on to customers in other defense business areas were generally much lower. For example, the Defense Logistics Agency’s surcharge for hardware items in fiscal year 1996 averaged about 39 percent, which covered the cost of the hardware item, plus supply center and distribution expenses, inflation, and material-related expenses such as inventory losses. The Agency also lowered the surcharge for medical supplies from 21.7 percent to 7.9 percent using best management practices. Conclusions USTRANSCOM has taken some positive steps attempting to reduce transportation rates that may be passed on to customers in the form of lower charges for transportation. However, overall only about one third of the reported savings would directly reduce long-term operating costs, which could affect transportation charges to defense customers. Even if all the reported savings directly affected long-term operating costs, the $780 million in savings represents only about 3 percent of $27 billion in estimated TWCF operating costs during the same period. Furthermore, the USTRANSCOM surcharge continues to remain high in the 2 fiscal years—1995 and 1997—we examined, most transportation rates have increased since fiscal year 1995, and USTRANSCOM projects that transportation rates will continue to increase through fiscal year 1999. Further measures to reduce long-term operating costs, such as additional infrastructure reductions, will likely be required to reduce customer charges. Otherwise, peacetime customers will likely continue to pay prices for some defense transportation services that are often two to three times higher than the cost USTRANSCOM pays for the underlying transportation service. Because we are continuing to review the overall issues related to streamlining and reengineering the defense transportation system, we are not making any recommendations at this time. Agency Comments and Our Evaluation In commenting on a draft of this report, DOD expressed concern with our conclusions because they believe our report minimizes the efficacy of overall savings to DOD and the taxpayer. Specifically, DOD disagreed with (1) our categorization of its reported savings, (2) the examples we used to show the impact of rate changes and our use of the term surcharge, and (3) the starting year of our rate trend analysis. Our evaluation of these points is discussed below. We noted that USTRANSCOM and component command actions to improve customer service, reduce costs, and improve operational efficiency are positive steps. We recognize that, as USTRANSCOM points out, some of the reported savings will, or have, reduced subsidies that customers pay, offset rate increases, and improved revenue collection efforts. As stated in our report, however, these savings will not directly impact customer rates because they do not reduce infrastructure and long-term operating costs. Even if all the reported savings directly affected long-term operating costs, the total dollar savings represent a very small portion of estimated TWCF operating costs during the time period in which the command expects the savings to occur. Further, only about one-third of the reported savings would result in reductions to transportation rates. As our categorization shows, nearly two-thirds of the reported savings would not reduce long-term operating and infrastructure costs and are not likely to affect rates over the long term. Consequently, we remain concerned that transportation charges to its military customers are unnecessarily high. DOD also stated that the examples in our draft report comparing TWCF to USTRANSCOM-negotiated commercial transportation costs do not portray the results of efforts to reduce costs and increase operating efficiency. As stated in our draft report, the examples are representative of what USTRANSCOM actually pays for commercial transportation compared with what it actually bills its customers. The examples are also representative of actual shipments in fiscal years 1995 and 1997 and payments for commercial carrier contracts USTRANSCOM was reimbursed at actual point-to-point billing rates. Since we were advised by MTMC that contract negotiations for fiscal year 1999 commercial carrier contract prices are still being negotiated and that reimbursement point-to-point rates will not be finalized and published until about August 1998, we used actual available data. Using projected or estimated prices and rates, based on composite rate changes, would be speculative and the results would be subject to change. Our analysis is based on the most current actual data available. As our work continues, we will assess new cost data as it becomes available. DOD also questioned our use of the term “surcharge”, which we defined as the difference between what USTRANSCOM pays commercial carriers for basic underlying transportation and what it charges its customers. DOD was concerned that we were indicating that the services provided for the surcharge are of little or no value. This was not our intent. We used the term surcharge and the amounts represented by it in each of our examples to show the differences between underlying commercial transportation charges, and the total amounts billed. We recognize, as DOD pointed out, that the amount shown as surcharge is for contract negotiation and administration, cargo booking, customs clearance, cargo receipt, automated in-transit visibility systems, port management, and surge and readiness programs. We have modified this report to clarify that point. Finally, DOD stated that fiscal year 1994 transportation composite rate changes should be included in our rate trend analysis as opposed to using fiscal year 1995. We acknowledge that had we used fiscal year 1994 as the baseline there would be less of an upward trend in some rates. However, we chose fiscal year 1995 because it was the first year that reflected USTRANSCOM-managed transportation rates. DOD stated that using fiscal year 1994 was more appropriate because that was the first year USTRANSCOM submitted rate changes for approval by the DOD Comptroller and was the first time a unique budget was developed for USTRANSCOM. However, Command officials told us that it was not until fiscal year 1995 that USTRANSCOM developed customer rates for defense transportation. Accordingly, we chose fiscal year 1995 as the baseline for our rate trend analysis. Also, 1995 rates were the basis for the examples comparing contractor charges with customer charges as we reported in February 1996. We agree that, due to the cyclical nature of rates, the selection of any particular fiscal year as a baseline would likely change the rate trend. In addition, it is important to note that comparing one’s rate with another and determining the reasons for the shift in rates is difficult because of the various factors that comprise the rate changes. DOD also provided several technical comments, which we incorporated into the text of our report as appropriate. DOD’s comments are reprinted in appendix III. Scope and Methodology To determine the extent to which USTRANSCOM expects to achieve long-term savings in its operating and infrastructure costs, we assessed the savings it reported to Congress in December 1996, including subsequent testimony that reported $780 million, cumulatively, in savings initiatives. We met with officials and obtained briefings and documents from USTRANSCOM on the reported savings initiatives, as well as supplemental information from the component commands—AMC, MSC, and MTMC. We also analyzed available data on reported productivity savings/cost avoidance initiatives and streamlining initiatives and assessed fiscal year 1993 through fiscal year 1999 TWCF budget estimates and submissions. We attempted to trace the savings to the affected budget accounts with the supporting documents and to validate the amount of the savings and their applicability to reducing transportation charges to defense customers. In most cases, USTRANSCOM or the component commands reconstructed information to show how they best recalled having calculated the amount of savings reported. However, supporting documentation was generally insufficient to track and validate the savings to source and budget documents. Also, because DOD’s accounting systems, like all accounting systems, are oriented to tracking expenses and disbursements, not savings, we could not validate or track savings reported to specific budget lines. According to USTRANSCOM officials, most of the reported savings were not traceable to corresponding reductions in specific budget lines because budget adjustments include several factors such as workload, pricing, program changes, and other adjustments that make it difficult to track discreet savings by budget line items. Additionally, USTRANSCOM officials said that many of these initiatives cross several line items. Nevertheless, since it was the only data available, we used the information USTRANSCOM and the component commands reconstructed as the basis for assessing whether the reported savings are likely to result in lower rates for defense customers. To assess changes in transportation rates and customer charges, we met with officials at USTRANSCOM, AMC, MSC, and MTMC; reviewed budget documents and other supporting documentation; estimated the extent that rates paid by defense transportation customers have changed and are likely to change; and recalculated the examples of customer charges used in our February 1996 report. We assessed the extent defense transportation rates changed between 1995 and 1999 by first obtaining approved rate changes shown in the fiscal years 1998 through 1999 TWCF budget submissions. For each rate category, we started with a base of 100 for fiscal year 1995, then made adjustments to that amount for each fiscal year with approved rate changes. We compared these changes in approved rates to the annual changes in the price index used to measure inflation, where we also used fiscal year 1995 as the base of 100. We used the same inflation factor shown for budget purposes by the component commands as our measure of inflation to compare the approved rate changes against. For fiscal years 1995 through 1999, the average yearly inflation is 2.56 percent for AMC, 2.48 percent for MSC, and 2.36 percent for MTMC. The changes in each rate category by fiscal year in appendix I use a baseline year of fiscal year 1995. Rates for fiscal year 1995 represent the first year in which USTRANSCOM established rates on behalf of its component commands. The fiscal year 1995 rates are also comparable to the baseline we used for comparisons of the shipment examples noted in appendix II. Specifically, rates for fiscal year 1995 were formulated by the component commands around January 1993, submitted by USTRANSCOM to the Assistant Secretary of Defense (Comptroller) in a budget document dated October 1993, approved by the Assistant Secretary of Defense (Comptroller) in a program budget decision in December 1993, and published in the President’s “Budget Estimates” support materials in February 1994. It is important to note that comparing one year’s rate with another and determining the reasons for the shift in rates is difficult because of the various factors that comprise the rate changes. For example, reasons for changes in the rates include changes in customers’ workloads, contractor prices, policy, and congressional directives to include, or not include prior years’ operating results, costs to maintain mobilization capability, military pay, and movement of programs into or out of TWCF. We also assessed changes in customer rates and charges for the examples cited in our February 1996 report by first obtaining the most current MTMC and MSC rates data available (using fiscal year 1997 published rates). We then recalculated our examples and compared the results with those developed in our 1996 report. We provided the recalculations to USTRANSCOM and its component commands to solicit their review and comment and addressed their concerns in this report. The examples used in table 4 and appendix II are based on charges for typical DOD shipments, each consisting of general (dry) cargo, 47 measurement tons each, transported in commercial carrier 40-foot containers, at rates for the low-cost carrier on each route. The examples reflect charges MSC and MTMC bill their customers for the costs they incur for negotiating rates with commercial carriers used to move DOD shipments, for contracting with the underlying carrier and paying its charges, and for the administrative expenses incurred to document the shipments and handle booking, manifesting, receiving and clearing customs. In every case, all applicable drayage and/or line-haul trucking costs to and from a ship’s side were included in our cost calculations. Cost comparisons are based on using the low-cost carrier because MSC advises us that it uses the low-cost carrier in most instances. However, we also examined the costs of other than low-cost carriers and in each example found the higher cost carrier was not significantly more expensive. The examples show a comparison of contractor charges with the costs to USTRANSCOM’s defense customers for containerized dry cargo shipments. Each example shows two points in time: (1) the first point is described in our February 1996 report and is based on fiscal year 1995 USTRANSCOM-negotiated prices and charges and (2) the second point is calculated based on fiscal year 1997 USTRANSCOM-negotiated prices and charges. We did not use projected prices and charges because the purpose of the analysis was to show what USTRANSCOM actually paid for contracted services and what it actually charged its defense customers for the service. We conducted our work between July 1997 and March 1998 in accordance with generally accepted government auditing standards. We are sending copies of this report to the Secretaries of Defense, the Army, the Navy, and the Air Force; the Commander in Chief, U.S. Transportation Command; the Director, Office of Management and Budget; and other interested congressional committees. Copies will also be made available to others upon request. Please contact me on (202) 512-8412 if you or your staff have any questions concerning this report. Major contributors to this report are listed in appendix IV. Changes in Rate Categories by Fiscal Year Compared to Inflation MSC: Cargo/Breakbulk MSC: Fast Sealift Ships Examples Comparing Contractor Charges With Cost to Customers A. Port-to-Port Shipment Cost Comparisons (no local drayage at origin or destination) Example A.3 From: U.S. West Coast (any port in range) To: Korea (any port in range) Percent cost exceeds contractor charges: (continued) Example A.5 From: U.S. West Coast (any port in range) To: Okinawa (any port in range) B. Port Area-to-Port Area Shipment Cost Comparisons (local drayage at origin and destination) C. Port Area-to-Inland Point Shipment Cost Comparisons (local drayage at origin and line-haul transportation at destination) Percent cost exceeds contractor charges: D. Inland Point-to-Port Shipment Cost Comparisons (line-haul transportation at origin and no drayage at destination) E. Inland Point-to-Inland Point Shipment Cost Comparisons (line-haul transportation at origin and destination) Comments From the Department of Defense Major Contributors to This Report National Security and International Affairs Division, Washington, D.C. Kansas City/St. Louis Field Office John G. Wiethop, Evaluator-in-Charge David J. Henry, Evaluator The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. Each day, GAO issues a list of newly available reports and testimony. To receive facsimile copies of the daily list or any list from the past 30 days, please call (202) 512-6000 using a touchtone phone. A recorded menu will provide information on how to obtain these lists.

Pursuant to a congressional request, GAO provided information on the U.S. Transportation Command's (USTRANSCOM) savings initiatives, focusing on the: (1) extent to which USTRANSCOM expects to achieve long-term savings in its operating and infrastructure costs; and (2) changes regarding transportation rates and customer charges. GAO noted that: (1) USTRANSCOM and its components have sought to reduce costs and improve operating efficiencies in the defense transportation system, while at the same time preserving its readiness capabilities and effectiveness; (2) GAO recognizes that reducing transportation charges to defense customers is complicated by multiple factors that impact the ability of USTRANSCOM to affect transportation charges; (3) the lag time, for example, between reducing operating costs and realizing reductions in customer charges means that the impact of some of USTRANSCOM's savings initiatives has yet to occur; (4) at this time, however, it appears that the savings initiatives identified by USTRANSCOM will not yield as great a result as initially reported; (5) the reported savings are not likely to have a significant impact on lowering infrastructure and long-term operating costs, which is the key to reducing customer charges; (6) available data indicate that many costs USTRANSCOM charges its customers are rising at a rate greater than inflation and that surcharges may remain high, even when underlying transportation charges have declined; (7) specifically, only about $260 million of the $780 million reported savings represents reductions to infrastructure and long-term operating costs--savings that could more readily result in lower charges over time to defense customers for transportation services; (8) a small portion of the reported savings actually involves improved revenue collections rather than efforts to reduce long-term operating costs; (9) the reported savings that are to occur between fiscal years 1993 and 1999 represent less than 3 percent of USTRANSCOM's $27-billion working capital fund operating costs during that time period; (10) thus, the extent to which total operating costs might be affected raises questions about the ability of these savings to substantively reduce customer transportation charges; (11) customer rates have been increasing and USTRANSCOM projects increases to continue through the end of the decade; (12) the increases are at or above the rate of inflation; (13) in addition, USTRANSCOM's surcharge continues to be substantially higher than the amount component commands pay commercial carriers; and (14) there where instances where surcharges were increasing significantly even when underlying transportation costs had declined.

Background The International Monetary Fund is a cooperative, intergovernmental, monetary and financial institution, and as of November 2000, it had 182 members. As part of the Fund’s mission to promote financial cooperation among its members, the Fund may provide financial assistance to countries facing actual or potential balance-of-payments difficulties that request such assistance. The Fund’s approach for providing financial assistance to its members has two main components—financing and conditionality—that are intended to address both the immediate crises as well as the underlying factors that contributed to the difficulties. The access to and disbursement of Fund financial assistance are conditioned upon the adoption and pursuit of economic and structural policy measures the Fund and recipient countries negotiate. This Fund “conditionality,” usually in the form of performance criteria and policy benchmarks, aims to alleviate the underlying economic difficulty that led to the country’s balance-of-payments problem and ensure repayment to the Fund. The Fund’s general framework for establishing a financial assistance arrangement is applied on a case-by-case basis that considers each country’s individual circumstances. The Fund and the recipient countries negotiate conditions for receiving Fund assistance that include a variety of changes in a country’s fiscal, monetary, and structural policies. Over the course of the arrangement, Fund staff and country officials periodically review the program’s status, and Fund staff determine whether or not the country has made satisfactory progress with respect to meeting the program’s conditions. In addition to providing financial assistance, the Fund conducts surveillance and provides policy advice regarding members’ economic policies as they relate to their overall external payments position. Article IV of the Fund’s charter provides that all members undergo a consultation process with the Fund as part of the surveillance effort; these reviews are usually conducted on an annual basis. Treasury Uses a Systematic Process to Promote Mandates Based on Countries’ Circumstances The Treasury has instituted a systematic process for applying legislative mandates concerning the Fund to individual countries, based on their economic circumstances. This process, adopted in 1999, uses a task force to facilitate coordination between Treasury and the U.S. Executive Director and to identify early opportunities to influence decisions regarding Fund members’ programs and economic reviews. Generally, Treasury and the U.S. Executive Director’s office pursue the mandates that are most relevant to the particular circumstances of a given country, because they believe that this is where they can have the greatest impact and success in influencing Fund members. Our case study analyses show that Treasury and the U.S. Executive Director have actively promoted U.S. policies related to sound banking principles, labor issues, and audits of military expenditures as required by the applicable legislative mandates, through their discussions with Fund and member country officials and formal statements to the Fund’s Executive Board. The Treasury Has a Systematic Process to Review Mandates In response to the growing number and complexity of legislative mandates concerning the Fund, Treasury has created a formal process to advance U.S. objectives at the Fund. Specifically, in March 1999 Treasury set up the Task Force on Implementation of U.S. Policy and Reforms in the International Monetary Fund. The task force was designed in part to increase awareness among Treasury officials of the importance of the mandates and identify opportunities to provide early input to the U.S. Executive Director to advance U.S. objectives toward the Fund. Treasury recognized the need to strengthen its efforts to routinely review and coordinate how mandates may apply to countries, because previously it had used an ad hoc approach of addressing mandates that relied heavily on Treasury officials’ own initiative to be cognizant of mandates. Under its new process, Treasury disseminates information on the mandates to all officials working on Fund matters and also makes reference material on the mandates easily accessible electronically. In addition, representatives from Treasury offices who work on Fund matters, and a representative from the U.S. Executive Director’s office, meet every 2 weeks as the task force to discuss how Treasury and the U.S. Executive Director can best apply mandates, given countries’ economic circumstances. In between these meetings, Treasury and U.S. Executive Director officials also coordinate to formulate and implement U.S. objectives at the Fund. (A detailed description of Treasury’s process for pursuing legislative mandates concerning the Fund is provided in app. II.) Treasury and U.S. Executive Director officials use a variety of means to pursue legislative mandates as part of their efforts to achieve U.S. policy objectives within the Fund. For example, on a regular basis the U.S. Executive Director makes oral and written statements to the Fund’s Executive Board to make Board members aware of U.S. policy objectives regarding requests from countries for new programs, Fund reviews of existing programs, and regular Fund reviews of all members’ economic policies. In addition, to build support for U.S. policy goals, U.S. officials also discuss U.S. policy objectives informally with other executive directors, Fund management and staff, and occasionally country authorities, particularly when the Fund is involved in negotiating with countries about financial arrangements. U.S. officials also attempt to build support within the broader political arena to achieve U.S. objectives at the Fund. According to the U.S. Executive Director, a large part of advancing any policy issue is to reach a “critical mass” of support among other countries for a particular policy. Therefore, for some policies the dialogue necessary to reach an international political consensus also takes place outside of the Fund in other international forums. Treasury’s Process Considers a Country’s Circumstances When Applying Mandates Since the legislative provisions direct Treasury to instruct the U.S. Executive Director to promote specific policies at the Fund, these policies are often referred to as “mandates.” However, to varying degrees U.S. officials have flexibility in determining how best to promote particular policies at the Fund. This flexibility generally allows Treasury and the U.S. Executive Director to take into account the individual circumstances of each country when promoting specific policies. This is especially true of mandates that do not involve directed votes, as is the case for most of the legislative mandates that concern the Fund. Treasury officials told us they promote such mandates for each country on a case-by-case basis, using their knowledge and judgment to decide whether an individual mandate is most relevant for a country and, moreover, whether a particular time is appropriate for advancing a mandate given a country’s economic circumstances. Countries that approach the Fund for financial assistance often face multiple economic problems, and Treasury prioritizes how best to address these problems. According to Treasury and U.S. Executive Director officials, the U.S. message can be made more compelling and effective when priorities are set based on country circumstances, taking into consideration the range of problems that can be manageably addressed at one time. However, some legislative mandates that pertain to the Fund are more prescriptive in nature. According to Treasury’s Office of the General Counsel, Treasury and the U.S. Executive Director are more constrained in the degree of flexibility they have to implement these mandates because they usually direct the U.S. Executive Director to oppose (which in practice means to vote against or abstain from voting on) a financial arrangement or Fund disbursement when a country meets or does not meet certain criteria. Examples include when a country has what is considered excessive external debt service payments or has been determined by the President to violate religious freedom. The directed nature of these mandates compels Treasury and the Executive Director to promote them regardless of whether they believe it is an appropriate time to do so given a country’s overall circumstances. Case Study Results Show U.S. Officials Promoted Policies as Required by Legislation From 1998 through 2000, Treasury and U.S. Executive Director officials actively promoted the policies we reviewed in our case studies—sound banking principles, labor standards, and audits of military expenditures— as required by the applicable legislative mandates, by identifying opportunities to influence Fund members’ program and economic reviews. For each policy, Treasury and U.S. Executive Director staff worked together to prioritize the issues that should be raised for each country. They then promoted those policies that they viewed as most relevant for the countries we reviewed, given the country’s economic and political circumstances. For example, in a 1999 statement to the Fund’s Executive Board in support of a new program for Kazakhstan, the U.S. Executive Director urged Kazakhstan both to ensure that any reforms to its labor code be consistent with internationally recognized labor standards and to consult with the International Labor Organization on this matter. Also, for a country that did not have a financial arrangement with the Fund, such as India, but where Treasury had prominent banking sector concerns, the U.S. Executive Director repeatedly highlighted U.S. concerns in statements to the Board during the Fund’s regular reviews of India’s economic policies. If Treasury determines through its analysis that a policy is not a major concern relative to other priorities for an individual country, it is not pursued at that time, unless it is a directed vote mandate. For example, until recently, Treasury determined that adherence to labor standards was not a major concern in Ghana relative to other problems Ghana faces as a poor country. According to a Treasury official, developing countries like Ghana typically lack an industrial base large enough for the protection of workers’ rights to be a major issue. In poor countries, labor issues, such as abusive child labor, are more likely to reflect human rights concerns than economic ones and thus are more difficult for the Fund to address. Difficult to Discern U.S. Unique Influence Over Fund Policies Our case study analysis indicates that while Treasury and the U.S. Executive Director have had some influence over Fund policies, it is difficult to attribute the adoption of a policy within the Fund solely to the influence and efforts of any one member, because the Fund generally operates on a consensus decision-making basis. Furthermore, the Fund’s willingness to adopt policy positions that are consistent with U.S. legislatively mandated policies is affected by whether a majority of Fund members perceive a given policy to be part of the Fund’s core mission to promote monetary cooperation and currency exchange rate stability and to provide resources to Fund members experiencing balance-of-payments problems. Moreover, mandated policies that constrain the U.S. Executive Director’s discretion may increase pressure on countries to implement specific U.S.-promoted reforms but may have a negative impact on the broader U.S. influence at the Fund by limiting the ability of U.S. policymakers to consider the overall circumstances confronting countries. Core Policies While Treasury and the U.S. Executive Director have actively promoted sound banking principles at the Fund, it is difficult to discern the unique influence of the United States because of the general agreement within the Fund that strengthening members’ banking sectors is part of the Fund’s core mission. Moreover, since the Fund’s Executive Board generally operates on a consensus basis in making decisions, it is hard to distinguish the U.S.’ influence within the Fund from that of other members. In recent years, partly in response to economic crises faced by Mexico in 1994-95 and several Asian countries in 1997-98, the Fund increased its emphasis on strengthening banking and banking supervision as part of members’ programs. Fund members now see a close interrelationship between weaknesses in a country’s banking system and the susceptibility of that country to financial shocks. Moreover, the Fund now realizes that encouraging countries to have a strong framework of financial regulatory policies and institutions is key to maintaining macroeconomic stability, according to Fund officials we interviewed. As a result, according to Treasury and Fund officials, strengthening a country’s banking sector has been promoted irrespective of any U.S. legislative mandate because it is now considered an important part of both Treasury and the Fund’s ongoing work. Treasury and the U.S. Executive Director have generally been in agreement with the Fund’s approach for pursuing these reforms, and the U.S. Executive Director has been viewed by Fund officials as a strong advocate among many supporters for the Fund’s involvement in this area. (For more information about Treasury and U.S. Executive Director efforts to promote sound banking principles with the Fund, see app. III.) The challenge to Treasury and the U.S. Executive Director, amid widespread member support for sound banking principles, has been in deciding how to influence what the Fund emphasizes within a country’s overall banking reform agenda. Given the complexity of banking issues and the difficulty in addressing banking reforms, especially reforms that require legal changes, there may occasionally be disagreement among the Board members on the pace of reform of the banking sector in a particular country, according to some executive directors. Nevertheless, we did not identify evidence of disagreement on the importance of pursuing sound banking policies for the five countries we reviewed, making it difficult to distinguish the U.S. Executive Director’s overall influence from those of other members in this area. Noncore Policies In contrast, Treasury and the U.S. Executive Director have found it more difficult to advance some mandated policies, such as those promoting the adherence to the five internationally recognized core labor standards or the adoption of environmental protection policies, because, according to Treasury and Fund officials, these policies do not directly relate to the Fund’s traditional mission. For example, some Fund officials believe that in individual country circumstances, core labor standards issues are not central to the economic problems causing the countries’ macroeconomic difficulties. Instead, the Fund views these policies as more closely related to the work of the International Labor Organization or the missions of other international financial institutions, such as the World Bank. The Fund views the mission of these institutions to be more focused on problems stemming from microeconomic, sector-specific concerns within countries. According to a labor policy specialist at Treasury, the Fund’s reluctance to consider labor standards within the scope of its work is due in part to conflicting academic literature on whether certain labor standards have beneficial or detrimental effects on economic growth. Conventional economic theory treats certain social policies, such as labor and environmental standards, as government interventions that can inhibit the efficient operation of the markets and, in turn, overall economic growth. According to this Treasury official, since most Fund staff and country representatives are trained as economists, they are reluctant to pursue policies that their training tells them could be counter to the Fund’s goal of encouraging economic growth. As one Executive Director at the Fund expressed, the implication of promoting stronger social standards in a country is higher unemployment. If the choice is between workers being employed under less than ideal labor conditions or not having them work at all, the Executive Director favored having the workers be employed and earning income. While Treasury and the U.S. Executive Director have made special efforts to advance U.S. policy on core labor standards at the Fund, they have found it challenging to convince other members that consideration of labor standards fits within the Fund’s work. Despite the resistance at the Fund to the labor standards policy, the U.S. Executive Director has tried to build support for this policy by discussing it with individual executive directors who may be receptive to including this issue in Fund programs. In addition, the U.S. Executive Director has noted in statements to the Executive Board the importance of labor concerns in particular countries. For example, on several occasions the U.S. Executive Director has expressed concern over inadequate attention given to protecting labor standards in reviews of Mexico’s Fund program. Specifically, these statements noted the need to protect the freedom of workers to associate and bargain collectively and to prevent gender discrimination while Mexico was undertaking reforms to modernize its labor market. Likewise, in commenting on Thailand’s program at the Executive Board, the U.S. Executive Director urged Thai authorities to bring their labor laws into compliance with international standards and address complaints concerning legal restrictions on the rights to unionize and bargain collectively for employees of state enterprises. Despite these and other statements by the U.S. Executive Director in support of labor standards, we did not find evidence that the Fund has sought to have the adherence of labor standards specifically incorporated as a structural benchmark or performance criterion within a program. (The Treasury’s and the U.S. Executive Director’s efforts to promote labor policies at the Fund are described in more detail in app. IV.) In certain circumstances, Treasury and the U.S. Executive Director have had difficulty reaching consensus on how adherence to core labor standards best fits into the Fund’s work and how to effectively advance U.S. policy on labor issues at the Fund. For example, in March 2000, a Treasury official recommended that the U.S. Executive Director ask the Fund to report on the state of collective bargaining, union organization, and labor and management relations in Argentina, especially in the context of the U.S. Executive Director’s and the Fund’s recommended labor reforms in that country. However, the U.S. Executive Director did not raise this point because concerns were advanced that such a review of the Argentine labor market was beyond the Fund’s expertise. To help address these ongoing challenges, Treasury has developed two documents since April 2000. One is a reference document outlining economic arguments for the relevance of labor standards to the Fund’s work for use by U.S. officials in their discussions with Fund members. The other is a document that sets out guidelines on how Treasury should advance U.S. policy on labor standards at the Fund through the U.S. Executive Director’s office. Treasury adopted these guidelines in November 2000, after several months of internal debate during which senior Treasury policy officials were consulted to settle differences of view among staff-level officials. According to Treasury officials, the guidelines clarify U.S. policy objectives and legislative obligations concerning labor standards to facilitate Treasury’s efforts to provide the U.S. Executive Director with timely and effective input. Directed Vote The impact of directed vote mandates on U.S. influence at the Fund is uncertain. By limiting the discretion of the U.S. Executive Director, such mandates may increase pressure for countries to implement U.S.-promoted reforms but may have had a negative impact on the broader U.S. influence at the Fund by limiting the ability of U.S. policymakers to consider the overall circumstances confronting countries. This tradeoff is demonstrated by the audits of military expenditures mandate. Specifically, this mandate directs the U.S. Executive Director to oppose (which in practice means to vote against or abstain from voting on) any loan or utilization of funds for countries that do not have a functioning system for conducting an audit of military spending and reporting the results to a civilian authority. On the one hand, U.S. efforts to advance the mandate have successfully increased pressure on countries to make their military audit systems conform to the mandate’s requirements. On the other hand, the constraints the mandate places on U.S. officials may negatively affect U.S. credibility at the Fund, according to Treasury, U.S. Executive Director, and Fund officials. For example, the mandate has required Treasury and U.S. Executive Director officials to raise military audit concerns when they otherwise may not have chosen to do so because of the overall circumstances confronting the country. As a result, other Board members expressed the view that the United States may at times promote the issue primarily because it is a legislative requirement and not because it is the most appropriate for the borrowing country at that time. U.S. efforts to promote audits of military expenditures and influence the Fund have met with some success. Several countries we examined improved their military audit systems, partly in response to the threat of U.S. opposition to their Fund programs. All of these countries had a financial arrangement with the Fund where the U.S. directed vote could be applied. Although U.S. opposition to a Fund arrangement does not, on its own, prevent a country from having access to Fund resources, countries strive to avoid having the Fund’s largest member register such opposition, according to an official in the U.S. Executive Director’s office. For example, following the threat of U.S. opposition to their receipt of resources under their Fund arrangement, both Burkina Faso and Rwanda took steps to improve their military audit processes or accelerated efforts to conform to the U.S. mandate. U.S. efforts to advance the mandate have been successful in four of the five countries we reviewed in part because the Fund has agreed that military audits are important for countries where military spending is not transparent or where there is suspicion that the country may have high levels of hidden, off-budget spending for the military. Prior to Treasury’s implementation of the mandate in 1999, the Fund already viewed excessive and unproductive spending by the military as having an adverse impact on individual countries’ overall macroeconomic stability. Generally, the Fund does not require countries to perform annual audits of military spending. Fund members we spoke with generally agreed that the auditing and transparency mechanisms promoted by the mandate could potentially bring important information regarding military spending to the attention of donors. The Fund’s agreement on the importance of audits of military expenditures is part of a broader campaign to improve the transparency and management of public finances. This has made it easier for the U.S. Executive Director to promote this mandate than, for example, the core labor standards mandate. Treasury and U.S. Executive Director officials are pleased with the progress that has been made in bringing several countries that are under a financial arrangement with the Fund into compliance with the mandate’s requirements. However, at the same time, several of these officials are concerned that the lack of discretion that the mandate gives the U.S. Executive Director can have negative consequences. For example, the mandate required Treasury and U.S. Executive Director officials to raise audits of military expenditures concerns with Indonesia, when they otherwise might not have chosen to do so, given the overall circumstances confronting the country. In their view, the economic and political turmoil that the country has faced in recent years has presented more pressing reform priorities than the improvement of the audit of its military expenditures. Nevertheless, Treasury and the U.S. Executive Director were compelled by the directive nature of the mandate to make this a high priority issue with the country. This lack of discretion could also result in U.S. opposition to a program that it believes should be endorsed. For example, the U.S. Executive Director was compelled to abstain from voting to make a financial disbursement for Rwanda’s program because Rwanda was not yet in full compliance with the standards set forth in the military audit mandate. This occurred despite Treasury’s knowledge that Rwanda would become compliant with the mandate shortly, and, in Treasury’s judgment, was making satisfactory progress in implementing economic reforms and improving fiscal transparency. Other Fund Board members questioned whether the U.S. Executive Director pursued military audit concerns because of the legislative requirements and not necessarily because it was most appropriate for these countries at the time. These Board members noted that limitations on an executive director’s discretion run counter to the consensus decision-making approach of the Fund. Therefore, while Treasury and U.S. Executive Director officials agree with the intent of the mandate, they see a risk to U.S. credibility when Treasury and the U.S. Executive Director must emphasize an issue over other pressing matters that a borrowing country may be confronting. (See also app. V for more information on Treasury and U.S. Executive Director officials’ efforts to advance this mandate.) Agency Comments and Our Evaluation We received written comments on a draft of this report from the Department of Treasury, which are reprinted in appendix VII. Treasury’s comments characterized the report as a thorough and balanced appraisal of the administration’s efforts to advance in the Fund policies set out in U.S. legislative mandates. Treasury said that the report helps illustrate the risk that legislative mandates can at times weaken its ability to promote in the Fund the very objectives that the mandates aim to achieve. Treasury also states that the continued expansion of legislative mandates by Congress, without consolidating the provisions already in effect, risks overloading and thereby weakening its policy message and influence at the Fund. Treasury and the International Monetary Fund separately provided technical comments that GAO discussed with relevant officials and included in the text of the report, where appropriate. We are sending copies of this report to other interested committees; the Honorable Paul H. O’Neill, Secretary of the Treasury; the Honorable Horst Köhler, Managing Director of the International Monetary Fund; and other interested parties. Copies will also be made available to others upon request. Please contact me at (202) 512-4128 if you or your staff have any questions concerning this report. Another GAO contact and staff acknowledgments are listed in appendix VIII. U.S. Legislative Policy Mandates Concerning the International Monetary Fund We identified 60 legislative mandates concerning U.S. policy objectives toward the International Monetary Fund (IMF) as of November 2000 through our own legal analysis supplemented with documentation obtained from the Department of the Treasury. We used two criteria as the basis for identifying the relevant laws for this review. These criteria were defined as (1) any current law that explicitly directs the U.S. Executive Director to the IMF to use its vote at the IMF to achieve a policy goal and (2) any current law that seeks to have the U.S. Executive Director use its voice at the IMF to promote a U.S. policy or make a policy change. Table 1 identifies the mandates and includes a brief description of the broad policy objective they address, as well as some of the actions they require on the part of the U.S. Treasury and the U.S. Executive Director. The mandates span more than 50 years, dating from as early as 1945 to as recently as 2000, with the majority being enacted in the last decade. Many mandates address multiple policy issues, sometimes overlapping with one another. Table 2 identifies some policies that are addressed in multiple laws. Many of the mandates direct the Secretary of the Treasury to instruct the U.S. Executive Director to use its “voice” and “vote” at the IMF to pursue certain policies. Other mandates are even more directive in that they require Treasury to instruct the U.S. Executive Director in certain circumstances to oppose a decision regarding a country’s use of IMF resources. (In practice, “oppose” means to vote against or abstain from voting.) We identified 21 such mandates that address a variety of issues, including combating terrorism, nuclear and chemical nonproliferation, religious persecution, and human rights abuses in other countries. Several of the directed vote mandates have primarily applied to countries that borrow from the World Bank, and the United States has implemented them there. Treasury’s Process for Pursuing IMF Legislative Mandates The Department of the Treasury uses a systematic process to discuss and formulate a strategy for pursuing U.S. policies toward the IMF, including policies set forth in legislative mandates. Treasury has the lead role within the executive branch for formulating U.S. policy toward the IMF, while the U.S. Executive Director represents the United States at the IMF and pursues U.S. policy objectives through its membership on the IMF’s Executive Board. In March 1999, Treasury created the Task Force on Implementation of U.S. Policy and Reforms in the IMF with the broad purpose of strengthening the process by which the United States pursues its objectives in the IMF. In particular, the task force was designed to improve the implementation of U.S. policy and reforms called for in legislative mandates by increasing awareness among Treasury staff about the mandates and identifying early opportunities to provide input to the U.S. Executive Director to influence decisions regarding IMF members’ programs and economic reviews. Treasury and the U.S. Executive Director Jointly Formulate U.S. Policy Positions Regarding Legislative Mandates Treasury’s Office of International Affairs along with the Office of the U.S. Executive Director of the IMF formulate, evaluate, and implement Treasury policy concerning U.S. participation in the IMF, including policies set forth in 60 legislative mandates (for more information on these mandates, see app. I). The Office of International Affairs has regional and functional offices staffed with country officers and policy specialists who monitor developments in individual countries and various policy matters. Over time, Treasury has hired or created specialist positions to monitor country developments concerning policies for which Treasury traditionally did not have expertise. For example, according to Treasury officials, Treasury began covering environmental issues in the late 1980s and began hiring environmental specialists in the early 1990s. In 1996, Treasury created a military audit specialist position to follow issues related to military audit concerns, and in 1998, Treasury created a similar position to monitor country developments concerning labor practices. According to Treasury officials, the environmental and military audit specialists initially focused primarily on pursuing U.S. policy and legislative mandates concerning the multilateral development banks. Beginning in 1998, these specialists also focused on IMF practices. The U.S. Executive Director, who represents the United States on the IMF’s Executive Board, pursues U.S. objectives, including legislative mandates, through various channels at the IMF. For example, on a regular basis the U.S. Executive Director makes oral or written statements to the Board to make Board members aware of U.S. policy objectives regarding requests from countries for new programs, Fund reviews of existing programs, and regular Fund reviews of all members’ economic policies. The U.S. Executive Director prefers to make oral statements but does provide written statements when the United States has a major policy pronouncement to make or when the topic being discussed is contentious. Written statements allow IMF staff and Board members to become familiar with the U.S. position prior to the Board’s discussion and serve as a reference point for the discussion. To build support for U.S. policy goals, the U.S. Executive Director also discusses U.S. policy objectives with IMF staff and management and other Board executive directors, outside Executive Board meetings. Treasury country officers, policy specialists, and U.S. Executive Director staff share the responsibility for applying to countries the standards set forth in the mandates, although their roles differ somewhat. Treasury country officers are responsible for being broadly aware of U.S. policy and legislative mandates and the topics these mandates cover; policy specialists are responsible for tracking specific U.S. policies. Country officers generally consult the policy specialists first when evaluating whether a mandate applies to a country’s circumstances. Like Treasury country officials, U.S. Executive Director staff must be mindful of legislative mandates as they monitor the status of the countries they cover. They are also responsible for assisting Treasury staff in the development of the U.S. policy position for IMF member countries. Specifically, they are tasked with (1) providing additional perspectives about country circumstances and whether mandates apply, (2) helping craft input to the U.S. Executive Director, (3) alerting Treasury officials about upcoming opportunities to pursue legislative mandates, and (4) sharing information about discussions among Executive Board members and IMF staff. U.S. Executive Director staff are in regular contact with Treasury staff about specific country matters. The ongoing collaborative approach Treasury and U.S. Executive Director officials use to formulate and implement U.S. objectives at the IMF, including legislative mandates, is illustrated in figure 1. It starts with Treasury and U.S. Executive Director officials identifying and sharing information with one another on upcoming opportunities to influence the Fund concerning U.S. objectives. According to Treasury officials, on a daily basis Treasury and U.S. Executive Director officials consult about when countries are coming before the IMF Executive Board for a program or economic review or when IMF missions to a country are planned as part of these reviews. Working together, Treasury and U.S. Executive Director staff determine whether legislative mandates are relevant to these countries and jointly develop input to the U.S. Executive Director on U.S. objectives to be used in oral or written statements to the Executive Board or other discussions with IMF officials. In addition to this ongoing contact, Treasury’s task force is used to coordinate and collaborate on developing and implementing the U.S. policy position toward IMF members. Composition of the Task Force Treasury’s task force is composed of staff-level representatives from the regional and functional offices within Treasury’s Office of International Affairs, Treasury’s Office of General Counsel and the U.S. Executive Director’s office and meets every 2 weeks to discuss how Treasury and the U.S. Executive Director can best apply legislative mandates given a country’s economic circumstances. Task force members seek to provide early input to the U.S. Executive Director as opportunities arise to influence the IMF, in part because Treasury and U.S. Executive Director officials believe the United States can have the most impact if it engages early with IMF officials prior to decisions regarding program and economic reviews. Task force meetings are conducted informally and are designed to address several goals: Ensure that Treasury staff are aware, as early as possible, of upcoming opportunities to provide input to the U.S. Executive Director, especially with respect to requests by IMF members for new programs, IMF reviews of existing programs, periodic IMF reviews of members’ economic policies, and general policy discussions. Exchange views at an early stage regarding which policy goals and legislative mandates are especially important for particular upcoming events. As needed, seek to resolve issues concerning particular policy goals or mandates. Encourage consistency of purpose across and coordinate U.S. strategy among the international financial institutions. Task Force Serves as Coordinating Mechanism but Not Final Arbiter of U.S. Policy Position According to Treasury officials, the task force serves an important role as a mechanism to systematically remind Treasury officials of the need to address legislative mandates. As shown in figure 1, prior to each task force meeting, a tentative schedule of the IMF Executive Board meetings for upcoming weeks is circulated to task force members. Also before the meeting, task force members review the schedule to keep abreast of what countries will be discussed by the Board and when Treasury should be ready to provide input to the U.S. Executive Director staff for the Board discussions. In addition, Treasury officials, through their ongoing contacts with U.S. Executive Director staff, may identify and come prepared to share information on other opportunities to attempt to influence the IMF, such as through discussions with Fund officials when an IMF mission is planned to a given country as part of negotiations for a new or existing program or an economic review. At their meetings, task force members informally discuss both what opportunities exist to implement mandates and whether there are mandates that may be potentially relevant for a given country. According to the Treasury official who generally chairs these meetings, the aim of the discussion is to identify the best opportunities to make a credible and convincing case for pursuing a mandate at a given time. If possible, members try to reach agreement in the meeting on two questions: (1) whether there are relevant mandates for the countries discussed and (2) whether the opportunity available is an appropriate one to pursue the mandate. According to Treasury officials, some mandates that are directive in nature must be applied in all cases, regardless of country circumstances. Once agreement is reached on whether to pursue a mandate, Treasury country officers collaborate with U.S. Executive Director staff and functional specialists where appropriate on drafting a policy position for the U.S. Executive Director. This can be in the form of input for a written statement or talking points for an oral statement to the Executive Board. The policy position may undergo several revisions until country officers, functional specialists, and U.S. Executive Director staff reach agreement. Although the task force helps facilitate coordination among Treasury officials and with the U.S. Executive Director, it is not the final arbiter for determining the U.S. policy position toward the IMF on any given issue. The task force is not a review or approval mechanism to give Treasury’s sanction to pursue individual mandates. Instead, it is a forum to discuss and debate the merits of how mandates fit into the macroeconomic focus of the IMF, whether certain mandates apply to individual countries, and what the best opportunities are to pursue various mandates. When members disagree on the best approach for pursuing a mandate and are not able to reach agreement in discussions that continue after a task force meeting, the matter is forwarded to Treasury’s senior management for a policy decision. U.S. Policy on Sound Banking Principles at the IMF In 1998, Congress passed legislation that encourages the U.S. Executive Director at the IMF to work to strengthen the financial systems of IMF member countries and encourage them to adopt sound banking principles and practices. Over the last 5 years, the promotion of sound banking practices have come to be regarded as a core mission of the IMF. As a result, there is general agreement in the IMF that it is appropriate for the IMF to advance sound banking policies and practices in member countries. In addition, IMF members generally agree on the steps that need to be taken to implement banking reform in member countries. For example, executive directors generally agree on the details of how to strengthen members’ banking systems when countries have financial arrangements with the IMF. They also agree on the need for members that do not have financial arrangements to adhere to international banking standards. The U.S. Executive Director has been a strong advocate of encouraging the IMF to increase its emphasis on the stability of the banking sector and pushing banking reforms in member countries. However, the general support of other IMF members for sound banking principles makes it hard to discern the U.S.’ unique influence within the IMF. Background The U.S. policy concerning sound banking principles and practices toward the IMF, as laid out in federal law, requires that Treasury instruct the U.S. Executive Director to vigorously promote policies to increase the effectiveness of the IMF in strengthening financial systems in developing countries and encouraging the adoption of sound banking principles and practices. This requirement includes encouraging the development of laws and regulations that will help to ensure that domestic financial institutions meet strong standards regarding capital reserves, regulatory oversight, and transparency. To assess whether Treasury and the U.S. Executive Director have been able to influence IMF operations and other members’ policy positions regarding the adoption of sound banking principles and practices, we reviewed the financial assistance arrangements and economic program reviews for five countries: India, Mexico, Romania, South Africa, and Thailand. We selected these countries, in part because of banking sector issues, geographic location, and type of IMF arrangement, where applicable. Sound Banking Practices Have Become Part of the IMF’s Core Mission Before the mandate was implemented, the international financial institutions, particularly the IMF, had already begun to focus their attention on what constitutes sound banking practices and how sound banking practices could be put in place in the banking systems of member countries. Focusing on sound banking systems has become more important in recent years because many financial crises in emerging markets have either been precipitated or exacerbated by problems in banking systems. The financial crises of the 1990s, specifically the 1994-95 Mexico and the 1997 Asia crises, led the IMF to intensify its focus on members’ banking sectors. In early 1996, the Executive Board of the IMF began to examine the relationship between banking system soundness and macroeconomic and structural policies, as well as the ways in which issues of bank soundness could be incorporated into the IMF’s periodic economic reviews, financial assistance programs, and technical assistance. The IMF’s efforts were focused on where there was a possibility that financial system problems could have systemic implications, not only domestically, but also by affecting the financial systems of other countries. According to Treasury and IMF officials, by the time the U.S. mandate was implemented, sound banking had come to be considered a core mission of the IMF. As such, the IMF’s and the U.S. Executive Director’s efforts to strengthen member countries’ banking systems and promote sound banking practices would have been pursued by the IMF irrespective of whether the U.S. sound banking mandate had come into being. IMF members and staff had already realized the importance of countries having and maintaining sound financial systems and had begun to increase their emphasis on the stability of members’ banking systems. IMF Staff and Executive Board Generally Agree on How to Implement Banking Reform in Member Countries As an accepted part of the IMF’s core mission, the IMF pursued sound banking practices and policies in both its financial assistance arrangements and its periodic economic reviews. Generally, the executive directors agree on the steps that countries need to take in order to make necessary reforms in their banking sectors. Executive directors told us that directors may disagree over the pace for implementing reforms, mostly due to concerns about countries’ abilities to implement reforms quickly. However, executive directors said that within the IMF’s Board there is general agreement on the content of a country’s financial arrangement regarding banking reform, including the diagnosis of the problem facing a country and the reforms needed to fix the problems. The same is generally true for suggestions the IMF Executive Board makes to member countries during the periodic economic review. In reviewing IMF financial assistance arrangements, executive directors focus on the specific banking situation of each country seeking financial assistance from the IMF. For example, when Thailand sought financial assistance from the IMF during its financial crisis in 1997, there were numerous banking sector problems that had to be addressed, such as weak licensing requirements, lax banking supervision, and no formal deposit insurance. The IMF’s financial assistance to Thailand was conditioned upon Thailand’s undertaking a set of actions that would address those and other issues that were specific to Thailand’s banking sector. The IMF has also sought ways to focus on sound banking practices in its economic reviews. The IMF holds annual consultations with most member countries as a part of its economic reviews to discuss, among other things, the country’s banking sector practices and policies. During the last few years, the IMF has implemented a number of voluntary assessments that member countries can undertake to help the IMF assess the stability of members’ financial systems and encourage members to implement internationally accepted banking standards. For example, IMF members can volunteer to participate in the Financial Sector Assessment Program. This joint World Bank-Fund program provides a diagnosis of financial sector vulnerabilities and development needs. It is used by the IMF as a basis for its Financial System Stability Assessments, which focus on examining the soundness and operation of a country’s financial sector and its link to the country’s macroeconomic performance. The IMF staff prepares Financial System Stability Assessment reports during the periodic economic review process, and these reports become a part of the IMF staff papers presented to the IMF Executive Board. In addition to the Financial System Stability Assessment program, the IMF, in cooperation with the Basel Committee on Banking Supervision, has been undertaking assessments of countries’ compliance with the Basel Core Principles for Effective Banking Supervision. In many instances, these assessments are published as Reports on the Observance of Standards and Codes modules. The IMF has used the Basel core principles assessments to identify specific gaps in a country’s regulatory or supervisory framework and to develop an appropriate focus for reforms. Similar to the Financial System Stability Assessments, the Basel core principle assessments are also to be included in the IMF’s economic reviews. We reviewed how the IMF and the U.S. Executive Director worked together in promoting sound banking principles in five countries—India, Mexico, Romania, South Africa, and Thailand (see table 3 for examples of IMF and U.S. Executive Director proposed banking reforms in these five countries). The U.S. Executive Director generally agreed with the focus of the IMF Executive Board in the three countries that had an IMF arrangement (Mexico, Romania, and Thailand) and in the two countries that were not under an IMF arrangement (India and South Africa). Table 3 provides an analysis of examples of reforms promoted by the U.S. Executive Director and the IMF in the five countries we reviewed. U.S. Executive Director Has Been a Strong Advocate of Banking Reform The U.S. Executive Director told us that the United States was already promoting the importance of the IMF’s focus on banking sector reform, prior to the implementation of the banking mandate. The U.S. Executive Director’s emphasis has been on two factors that the IMF should be concerned with regarding sound banking and financial system stability. The first factor was to determine the vulnerability of countries’ financial systems in order to prevent a financial crisis. The second factor was to focus greater attention on establishing efficient financial intermediation— the process of transferring funds from savers to borrowers. According to the U.S. Executive Director, the most critical piece in determining the vulnerability of members’ financial systems was assessing the health of each member’s banking system. In addition, the U.S. Executive Director stated that the IMF’s main role in the financial sector agenda was surveillance—the job of alerting members to the weaknesses in their banking systems and supervisory regimes, and monitoring a member’s progress to that end. Over the last 3 years, the U.S. Executive Director has supported the IMF’s efforts to incorporate Financial System Stability Assessment reports into the IMF’s surveillance efforts and has actively supported the adoption and monitoring of the Basel core principles by member countries and assessments of countries’ progress. Other executive directors have said that the U.S. Executive Director was a driving force in focusing the IMF’s attention on sound banking practices. However, it is difficult to discern the extent of the U.S. Executive Director’s influence in relation to other executive directors in promoting sound banking practices in member countries, because the IMF generally operates on a consensus decision-making basis. In addition, there is broad agreement among IMF members that pursuing sound banking principles and policies in member countries is an important part of the IMF’s work. U.S. Policy on Labor Issues at the IMF Since 1994, Congress has enacted two provisions of law that set forth U.S. policy on internationally recognized core labor standards and worker rights in the context of International Monetary Fund programs. However, the predominant view at the IMF is that a country’s adherence to those standards is usually not relevant to its macroeconomic condition and thus not directly relevant to the IMF’s mission. Therefore, although U.S. officials have taken several different approaches to actively promote U.S. policy on core labor standards in an effort to garner support for the inclusion of this policy within the IMF’s dialogue with borrowing countries, they have not had much success in influencing the IMF on this issue. Background Under U.S. mandates concerning labor issues at the IMF, the Secretary of the Treasury must instruct the U.S. Executive Director to urge the IMF, as an institution, to encourage countries to guarantee internationally recognized core labor standards and worker rights. The five internationally recognized core labor standards advanced by Treasury and the U.S. Executive Director are the freedom of workers to associate with one another, the right to organize and bargain collectively, the prohibition of exploitative child labor, the prohibition of forced or compulsory labor, and the prohibition against employment discrimination. Through the International Labor Organization (ILO), the international community has codified these core labor standards in eight international treaties, or conventions. At the ILO’s 1998 conference, ILO members adopted the “ILO Declaration on Fundamental Principles and Rights at Work,” which renewed all ILO members’ commitment to respect, promote, and realize these core labor standards. The Department of the Treasury and the U.S. Executive Director collaborate to formulate and actively advance their objectives concerning labor policies at the IMF. To advance U.S. policy on core labor standards, the U.S. Executive Director urges the IMF to consider the implications of its programs on borrowing countries’ adherence to these standards. To illustrate the influence that Treasury and the U.S. Executive Director have had on IMF policies and practices with respect to labor issues, we reviewed their efforts to affect IMF programs for Argentina, Ghana, Kazakhstan, Mexico, and Thailand. We selected these countries, in part, because of the range of labor issues in each country, especially as they related to the economic challenges the countries have faced. General information on the countries and a summary of our findings are presented in table 4. IMF Members Have Not Embraced U.S. Policy on Core Labor Standards The IMF does not regularly pursue adherence to core labor standards with borrowing countries. According to IMF officials, while the IMF supports core labor standards in principle, the IMF has not found that the degree to which a country has adhered to core labor standards is directly related to the country’s macroeconomic difficulties. Therefore, IMF members and staff do not consider the issue to be within the IMF’s core mandate and have not addressed this issue in the IMF’s country programs. Also, the IMF’s staff lacks expertise in this complex and sensitive policy area. Our analysis of five borrowing countries found no evidence that IMF staff had incorporated the countries’ adherence to core labor standards issues into the countries’ performance criteria or structural benchmarks. According to Treasury officials, the IMF’s reluctance to consider core labor standards within the scope of its work is due in part to conflicting academic literature on whether certain labor standards have beneficial or detrimental effects on economic growth. Conventional economic theory treats certain social policies, such as labor and environmental standards, as government interventions that can inhibit the efficient operation of markets and, in turn, overall economic growth. According to Treasury officials, since most IMF staff and country representatives are trained as economists, they are reluctant to pursue policies that their training tells them could be counter to the IMF’s goal of encouraging economic growth. As one Executive Director at the IMF expressed, the implication of promoting stronger social standards in a country is higher unemployment. If the choice is between workers being employed under less than ideal labor conditions or not having them work at all, this Executive Director favored having the workers be employed and earning income. Other IMF members are also reluctant to have the IMF include consideration of these standards because it is a policy area where the IMF does not currently have expertise or institutional knowledge. Some executive directors with whom we spoke noted that other institutions, particularly the ILO, are better placed to address labor standards. In addition, some executive directors noted that the World Bank also has some expertise and institutional knowledge to help countries address core labor standards. Executive directors also noted that they would be agreeable to IMF staff consulting with the ILO or the World Bank on labor issues in borrowing countries if the staff found that labor issues were relevant to the country’s program. Furthermore, one Executive Director noted that there is concern that a country’s adherence to core labor standards is primarily a political issue, and as such the IMF is prohibited from addressing them by its charter. As another Executive Director noted, the issues embodied in the core labor standards are complex and must be handled with careful regard for various cultural and political factors facing borrowing countries. Treasury and the U.S. Executive Director Actively Promote U.S. Policy on Core Labor Standards Since other IMF members and IMF staff have not widely embraced U.S. policy on the relevance of core labor standards to the IMF’s work, Treasury and the U.S. Executive Director have made special efforts to advance this policy at the IMF. Nevertheless, they have not had much success in influencing the IMF to consider core labor standards in its programs. In certain circumstances, Treasury and the U.S. Executive Director’s staff have had difficulty reaching consensus on how adherence to core labor standards best fits into the IMF’s work and how to effectively advance U.S. policy on labor issues at the Fund. As part of its efforts to reach consensus, Treasury, with input from the U.S. Executive Director, has completed two documents since April 2000. The first document circulated within Treasury presents economic arguments for the relevance of core labor standards to the macroeconomic focus of the IMF’s work. The second document, which was finalized in November 2000, sets out guidelines for Treasury officials as they pursue U.S. objectives on core labor standards and try to build support for U.S. policy among other IMF members. These guidelines clarify U.S. policy objectives and legislative obligations concerning labor standards to facilitate Treasury’s efforts to provide the U.S. Executive Director with timely and effective input. Engaging the IMF on the Relevance of Core Labor Standards Treasury and the U.S. Executive Director are simultaneously following two approaches to change the thinking of other IMF members, IMF staff, and IMF management on this issue. The first approach is to engage other executive directors and IMF staff on the relevance of core labor standards to the IMF’s mission. Treasury and the U.S. Executive Director have argued that the IMF should not develop programs that may negatively impact countries’ adherence to core labor standards without taking those impacts into consideration. Treasury officials have also taken advantage of other forums to promote U.S. policy on the relevance of core labor standards to the IMF’s mission. For example, Treasury officials have promoted U.S. policy at meetings with government officials of the Group of Eight, through personal contact with other countries’ officials, and at IMF annual meetings. In addition, Treasury and the U.S. Executive Director organized a seminar on core labor standards for the IMF and the World Bank’s 1999 annual meeting in cooperation with the IMF, the World Bank, and the American Federation of Labor-Congress of Industrial Organizations (AFL-CIO). Senior officials from these institutions, as well as a Minister of Finance from Chile and a noted academic, presented their views on the role of core labor standards at the IMF and the World Bank. Treasury and the U.S. Executive Director’s second approach has been to pursue the best examples of countries where they believe that adherence to core labor standards is deficient and that the IMF should consider core labor standards as relevant to their macroeconomic stability. Treasury and the U.S. Executive Director can then use these examples as successful precedents to urge the IMF to advance core labor standards in other countries and at the broader level. According to Treasury officials, countries that make the best cases are those where the conditions of its IMF program will clearly have implications for the labor market. For example, the IMF and the Argentine government agreed that to stimulate economic growth, Argentina would need to increase labor market flexibility through various reforms, including legally decentralizing union collective bargaining. While Treasury and the U.S. Executive Director agreed with Argentina’s need to increase labor market flexibility, they also recognized that some of the reforms discussed would have implications for Argentina’s adherence to the core labor standard concerning collective bargaining. Therefore, they monitored the progress of these reforms and asked IMF staff to clarify whether the reform proposed to decentralize union collective bargaining would be consistent with the ILO Right to Organize and Collective Bargaining Convention (no. 98). The U.S. Executive Director also tries to set precedents by pursuing labor policy with IMF management and staff in advance of an IMF mission to a member country as part of a program or general economic review. For example, Treasury and the U.S. Executive Director became aware that the IMF and the Mexican government were exploring a possible financial arrangement at the end of 1998. Officials from Treasury and the U.S. Executive Director’s office collaborated to determine whether the U.S. labor mandates were relevant to the proposed IMF program in Mexico. Based on their analysis, they became concerned that reforms the Mexican government was proposing to increase labor market flexibility and modernize the labor relations system could have negative implications for the rights of workers to organize and bargain collectively. The U.S. Executive Director therefore sent a memo to the Managing Director of the IMF, urging the IMF’s mission team to, among other things, (1) incorporate the discussion of core labor standards into their policy dialogue with Mexican authorities in the context of any discussion of broader labor market reforms and (2) survey labor market policies and practices in Mexico and recommend policy initiatives that will help ensure the maintenance or improvement of core labor standards. As part of another means for establishing precedents, the U.S. Executive Director encourages IMF staff and borrowing country governments to consult with the ILO when labor issues come up in a country or when a country’s program may have implications for the country’s adherence to core labor standards. For example, in commenting on Kazakhstan’s 1999 request for a new arrangement at an Executive Board meeting, the U.S. Executive Director encouraged the Kazakhstani government to consult with the ILO concerning proposed reforms to Kazakhstan’s labor code. In doing so, Kazahstan could ensure that these reforms were not only better suited to the market economy that it is trying to develop, but also consistent with core labor standards. Officials at Treasury and U.S. Executive Director’s office do not often advance core labor standards with two groups of countries—advanced industrial economies and the poorest countries—because they believe that these countries do not make good precedents. According to Treasury officials, they do not pursue these issues with advanced industrial economies, such as France, Germany, or Japan, because their adherence to core labor standards is generally high. In reviewing the poorest countries, Treasury officials have found that they also do not generally make good cases because they do not have a sufficiently large industrial base for the core labor standards of freedom of association and freedom to organize and bargain collectively to be important issues relative to the other challenges facing these countries. Moreover, although child labor can be a concern in these countries, Treasury officials noted that the root of the problem is in the high level of poverty, cultural and societal norms, and lack of opportunities for the children. In addition, concerns that Treasury might have about forced labor or gender inequality in these countries are more closely related to human rights issues than to core labor standards. Therefore, according to Treasury officials, they address these issues in that context. For example, according to Treasury officials, Ghana’s adherence to each of the core labor standards could be improved, but since Ghana has a pressing need to address poverty, and most of its labor force is engaged in agriculture, Treasury did not urge the U.S. Executive Director to comment on core labor standards in Ghana until recently. To enhance Treasury’s and the U.S. Executive Director’s efforts to advance U.S. policy on core labor standards, Treasury hired a labor policy specialist in 1998 to provide background information and policy guidance on core labor standards issues to other Treasury officials and the U.S. Executive Director. The labor specialist is responsible for reviewing the labor situation in each IMF member country as it comes before the IMF’s Executive Board as part of a program request, a review of an existing program, or the IMF’s periodic reviews of the country’s economic conditions. For each country, the specialist determines whether there are concerns for that country’s adherence to core labor standards and coordinates with Treasury’s country desk officers to provide the U.S. Executive Director with input for an oral or written statement to the IMF’s Executive Board. Although U.S. officials have been targeting their efforts to pursue core labor standards, two executive directors noted that some developing countries do not support U.S. policy on core labor standards because these countries do not believe that U.S. motives are altruistic. Rather, they view U.S. promotion of core labor standards as a trade protectionist measure meant to increase labor costs in developing countries, thereby potentially averting the relocation of U.S. firms and the loss of U.S. jobs. Despite this resistance, officials at Treasury and the U.S. Executive Director’s office note that they have seen signs that their efforts to advance U.S. policy are being heard. For example, in response to U.S. interest on labor issues in Mexico, IMF staff included an appendix concerning Mexico’s efforts to modernize labor markets and improve their efficiency in their 1999 report on Mexico’s request for an arrangement. In addition, during visits to Argentina to discuss its ongoing arrangement, IMF staff consulted with union officials on a variety of labor issues related to the flexibility of its labor markets. U.S. Policy on Audits of Military Expenditures at the IMF In 1996, Congress enacted the audits of military expenditures legislation, which includes a specific directed voting provision that requires the U.S. executive directors at international financial institutions to oppose nonbasic human needs assistance to countries that do not conduct and report regular audits of their military spending to civilian authorities. In the five cases we reviewed, we determined that the United States has achieved some success in advancing this mandate at the IMF and in convincing some borrowing countries to conduct audits of military spending. The U.S. Executive Director’s effectiveness in advancing this particular mandate at the IMF is due in part to a widespread view in the international community that good governance, transparency of budgets, unproductive spending, and military spending are economic issues that could impact the effectiveness of a country’s macroeconomic reform effort. Nevertheless, the pursuit of this mandate has had an uncertain impact on the broader U.S. influence at the IMF. While there is strong IMF support for the intent of the legislation, U.S. and IMF officials emphasized that the military audit mandate sometimes competes with countries’ priorities and that U.S. officials have limited discretion on when to advance the mandate for countries deemed out of compliance. As a result, U.S. and IMF officials believe that the limited discretion that U.S. officials have in advancing this mandate runs counter to the consensus decision-making approach of the Fund and could negatively impact U.S. influence at the IMF. Background Congress has been concerned that military expenditures by some developing countries are excessive and an unproductive drain on their limited resources. Congress was also concerned that public information on military expenditures for some countries is generally characterized by incompleteness, lack of transparency, and inaccuracy. Partly in response to these concerns, in 1996 Congress passed the audits of military expenditures legislation. The legislation states that the U.S. Executive Director is to use its voice and vote to oppose the use of funds, other than those to address basic human needs, for any government that does not have in place a functioning system for reporting audits of military expenditures to civilian authorities or has not provided such information to any institution that requests it. The U.S. Treasury was given a 3-year window to develop an implementation approach, with the voting requirement taking effect on October 1, 1999. After that date, the U.S. Executive Director was instructed to oppose approval of IMF arrangements for countries deemed not in compliance with the standards set forth in the mandate. On October 18, 1999, 22 countries were deemed noncompliant with the standards of the mandate, but by November 9, 2000, this number had declined to 17 countries. In 1999, Treasury formed an Interagency Policy Group to assess countries’ compliance with the military audit legislation. The group is comprised of the Treasury, the Department of State, the Department of Defense, the U.S. Agency for International Development, the National Security Council, and the Office of Management and Budget. The Policy Group developed the following interpretation and definitional guidance for the legislation: A country must be routinely conducting a post-expenditure examination, verification of accuracy, and reconciliation of irregularities of receipts that fund the military (annually, though a 2-year completion lag is acceptable). Results of the audit must be reported to a nonmilitary entity. Significant off-budget or commercial revenue (defined as greater than 5 percent of the total defense budget) that funds the military must also be audited and reported to a civilian authority. Treasury has taken several steps to advance the military audit mandate at the IMF, including working with the State Department to inform IMF member countries of the legislation through U.S. embassies and providing information to the U.S. Executive Director on the countries that are noncompliant with the mandate. The U.S. Executive Director’s office also informed IMF management and staff of the importance it attached to the mandate and the compliance requirements. The Process for Registering Opposition to IMF Programs When a country is found to be not in compliance by the Policy Group, the U.S. Executive Director is directed to oppose the use of IMF resources. The process for registering opposition to the use of IMF resources is as follows: The Policy Group recommends to the Secretary of the Treasury that the U.S. Executive Director oppose the use of Fund resources to that country. The Secretary of the Treasury then instructs the U.S. Executive Director to oppose the use of Fund resources to that country. The U.S. Executive Director then states in an oral or written statement to the Executive Board that the United States wants to record its opposition to that country’s program. The Secretary of the IMF’s Executive Board records U.S. opposition in the Board minutes. The Policy Group has determined that the reference in the legislation for the U.S. Executive Director to “oppose” provides flexibility to either abstain or vote no. The use of a “no” vote versus “abstain” would be the Secretary’s determination, based on interagency consultation on a case-by-case basis. The Policy Group has also determined that in cases where the only reason for opposing the use of IMF resources is a lack of compliance with the military audit legislation, the U.S. Executive Director should abstain. In addition, in cases where countries are actively engaged in making necessary changes to become compliant, the U.S. Executive Director would include strongly supportive comments in Board statements accompanying the directed vote. The U.S. Executive Director has never voted no under the military audit mandate but has abstained 3 times, as of September 30, 2000. Regardless of whether the United States chooses to abstain or vote no, its actions alone are not sufficient to veto a country’s access to IMF resources because approval of a country’s arrangement requires support from a majority of the Executive Board. Although the United States has the largest voting share of any member (17 percent), this is insufficient to unilaterally block access to IMF resources. The decision by the United States to record its opposition to a country’s program is considered by the Secretary to the Board to be a vote (and recorded as such in the minutes). However, other members do not have to formally vote in response. Formal votes are rarely taken at IMF Board meetings, but any executive director may require a formal vote to be held. According to an IMF official, Board decisions are expected to reflect the consensus of Board members, with the views expressed as part of the overall discussion. Over the course of the meeting, the Secretary keeps track of each executive director’s position. While directors in almost all cases support IMF programs on the whole, they may express differences of views with programmatic details or broader issues regarding the quality of the program. However, if there is evidence of widespread opposition, the Chairman or an individual member may request a poll of members’ views. Such a poll is not considered a “vote” by the Board but a tool for accurately gauging the views of Board members. An analysis of the U.S. Executive Director’s voting record for the period of October 1997 through September 2000, shows that the U.S. Executive Director voted against or abstained from voting a total of 21 times. Of these 21 votes, 3 were related to abstentions under the military audit mandate. U.S. Efforts to Advance the Military Audit Directed Vote Mandate Have Been Successful The United States has been actively advancing the military audit mandate and has been successful in the majority of the cases we analyzed. The U.S. Executive Director has emphasized issues of fiscal controls and budget transparency in U.S. country statements to the Board, in attempting to integrate the military audit mandate within the IMF’s own operating guidelines and institutional processes. According to the U.S. Executive Director, the military audit mandate is easier to advance than, for example, the labor mandate, because it fits well within the Fund’s efforts to promote good governance, fiscal transparency, and the control of unproductive spending. While the IMF does not generally require audits of military spending as a condition for the use of its resources, the IMF has asserted that its staff may need information about the level of and trend in military expenditures and related transactions in order to permit a full and internally consistent assessment of the member’s economic position and policies. In addition, IMF members we spoke with generally agreed that the auditing and transparency mechanisms promoted by the mandate could potentially bring important information regarding military spending to the attention of donors. We reviewed five countries that were included on the October 1999 list of 22 noncompliant countries established by the U.S. Treasury (Burkina Faso, Guinea-Bissau, Indonesia, Kazakhstan, and Rwanda). Of these five countries, as of November 9, 2000, only Guinea-Bissau is not in compliance with the military audit mandate (see table 5). According to the U.S. Executive Director, U.S. success in advancing the audits of military expenditures mandate was aided by two factors: acceptance by the IMF of the merits of the issue, and the possibility that the United States would oppose a country’s use of IMF resources. There is a widespread view in the international community, including at the IMF, that good governance, transparency of budgets, unproductive spending, and military spending are economic issues that could impact the effectiveness of a country’s macroeconomic reform effort. Therefore, IMF staff consider it appropriate to raise concerns about military expenditures in the context of their efforts to assist countries. As shown in table 5, IMF staff encouraged the countries’ authorities to audit government accounts, including military receipts and expenditures. In the case of Kazakhstan, IMF support was unnecessary because the country was already compliant. In these cases, the changes encouraged by the IMF also helped the country in its efforts to comply with the U.S. mandate. For example, in the case of Indonesia, IMF staff strongly encouraged Indonesian officials to include a commitment to audit off-budget military expenditures as part of its Letter of Intent to the IMF. The inclusion of this commitment within the Indonesian Letter of Intent was a contributing factor in the U.S. decision to remove Indonesia from the list of noncompliant countries. Based on our review of country documents and discussions with Treasury, U.S. Executive Director, and IMF officials, we have determined that the success of the mandate was also aided by countries’ desire to avoid having the United States oppose their receipt of resources under their IMF arrangements. As our military audit mandate case study revealed, certain countries have agreed to undertake military audits as a response to U.S. pressure. According to Treasury and U.S. Executive Director’s officials, because of the key role of the U.S. government in the IMF and the donor community, recipient countries do not like having the United States oppose their IMF program. Although U.S. opposition is not sufficient to veto a country’s access to IMF resources, according to U.S. and country officials, the U.S. position raised the priority of this issue and motivated some of the countries on the noncompliant list to become compliant more rapidly. For example, according to Treasury, because the United States was threatening to oppose debt relief to Burkina Faso, the authorities agreed to initiate an audit of military spending earlier than they otherwise would have. In the case of Guinea-Bissau and Rwanda, despite their efforts to become compliant with the audits of military expenditures mandate, the U.S. Executive Director opposed their receipt of IMF resources because at the time of the review of their IMF arrangement, they were not compliant with the criteria established by the Policy Group. Both countries continued to address U.S. concerns following their reviews; Rwanda became compliant in September 2000, and Treasury believes the government of Guinea-Bissau is beginning to take steps to audit government expenditures, including the military. According to a Treasury representative, the Treasury is working with U.S. embassy representatives to ensure that Guinea-Bissau understands U.S. legislative criteria requiring the reporting of its military audit to civilian authority. The Impact of the Military Audit Mandate on Broader U.S. Influence at the IMF The impact of pursuing the military audit mandate on the broader U.S. influence on IMF policy is uncertain. Based on our discussions with U.S. and IMF officials, we have determined that the directed nature of the mandate has worked to advance U.S. policy goals; nevertheless, it may also limit U.S. credibility with other IMF members. There is widespread support by IMF members with the intent of the legislation, meaning that countries should strive to control their level of military spending and have in place a system that provides accurate and reliable information to the public. As our military audit mandate case study revealed, certain countries have agreed to undertake military audits in response to U.S. pressure. However, other IMF members we spoke with questioned whether the United States may have promoted the military audit issue in certain countries simply because it is a legislatively mandated directed vote and not necessarily because it was in the best interest of the country at the time. Therefore, while U.S. officials are pleased with the progress realized through their pursuit of the mandate, they see a risk to U.S. credibility when they must emphasize one issue over other more pressing matters that a country may be confronting. The mandate does not give the U.S. Executive Director the discretion to determine when to pursue the military audit issue. As a result, the U.S. Executive Director is compelled to advance the mandate with country authorities and with IMF staff regardless of whether the U.S. Executive Director believes it is an appropriate time to pursue the mandate with a given country. Treasury staff and all of the executive directors we interviewed at the IMF expressed concern with the inflexibility of the law. The executive directors believe that the U.S. Executive Director has been very effective in advancing the military audit mandate but, due to the inflexibility of the mandate, has at times been too aggressive in this pursuit. The constraints imposed by the directed nature of the military audit mandate were evident in our case study analyses. For example, as a result of a severe economic crisis and the subsequent collapse of 30 years of military dictatorship, Indonesia has been faced with many competing priorities. Numerous Treasury and IMF documents and Board meeting agendas over the past 3 years indicate that the major priorities of the IMF Board for Indonesia centered on issues such as banking and corporate restructuring, bankruptcy law, and social safety net issues. Annual audits of off-budget revenues that fund the military were not one of these major priorities. According to IMF staff, while the new democratic government of Indonesia is receptive to the military audit mandate, discussions with authorities on this issue were highly complex. For example, according to IMF staff, the auditing capacity in Indonesia is limited, and it has been a challenge getting the overall fiscal accounts under control, especially when it requires the cooperation of the military. In addition, according to IMF staff, the time frame needed to achieve transparency in military expenditures is quite burdensome, and there are many immediate, more urgent issues to address. IMF staff also believe that the Letter of Intent commitment to audit off-budget sources that fund the military was ambitious and should be recognized as such. IMF staff expressed concern about having U.S. officials overemphasize this issue at this point. Similarly, Rwanda, as a post-conflict country, has several major priorities, including government and macroeconomic stability, building administrative capacity, and satisfying the requirements of the Heavily Indebted Poor Countries Initiative. Based on issues before the IMF Board, an audit of its military spending was only one of a large number of important priorities. According to the U.S. Executive Director, as of July 2000 Rwanda continued to face very difficult humanitarian and economic problems that require the utmost resolve and determination to effectively address. In addition, according to the U.S. Executive Director’s representative, when the United States abstained from voting on Rwanda’s program in July 2000, it required the U.S. Executive Director to raise as the first priority an issue that was just one of the necessary steps to address the country’s many problems. The U.S. Executive Director was compelled to abstain from voting to make a financial disbursement for Rwanda’s program because Rwanda was not yet in full compliance with the military audit mandate’s requirements. This occurred despite the administration’s knowledge that Rwanda would become compliant with the mandate shortly and, in its judgment, was making good progress in implementing economic reforms and improving fiscal transparency. IMF Board members understand that in certain cases the U.S. Executive Director advanced military audit concerns because of the legislative requirements and not necessarily because a focus on military audits was among the most important issues confronting that country. These Board members noted that the Executive Board generally makes decisions on a consensus basis and that limitations on an executive director’s discretion runs counter to this practice. Therefore, while U.S. officials agree with the intent of the mandate, they believe that there is a risk to U.S. credibility at the IMF when the U.S. Executive Director must emphasize an issue over other, more pressing priorities for a borrowing country. Objectives, Scope, and Methodology The Consolidated Appropriations Act for Fiscal Year 2000 (P.L. 106-113 sec. 504 (e)) requires GAO to report on the extent to which Fund practices are consistent with U.S. policies set forth in federal law. In order to address this requirement, we (1) identified how the U.S. Treasury and the U.S. Executive Director promote U.S. policies mandated by Congress for the Fund and (2) assessed whether Treasury and the Executive Director have been able to influence Fund operations and other members’ policy positions in a direction that would be consistent with U.S. policy as set forth in law. To help answer these objectives, we analyzed the process by which Treasury pursues its legislative mandates and conducted case studies of specific U.S. policies and Treasury’s efforts to promote them for individual countries’ Fund arrangements from 1998 through 2000. To identify how the U.S. Treasury and the U.S. Executive Director of the International Monetary Fund promote U.S. policies mandated by Congress for the Fund, we analyzed the process by which Treasury pursues legislative mandates. Specifically, we reviewed Treasury documents, including internal correspondence, concerning the creation in 1999 of Treasury’s Task Force on Implementation of U.S. Policy and Reforms in the International Monetary Fund, its operations, and the challenges that Treasury has faced in implementing its process for addressing legislative mandates. We also reviewed examples of Treasury officials’ draft policy position input to the U.S. Executive Director for oral and written statements to the Executive Board. In addition, we interviewed officials within all 10 Treasury offices who are responsible for developing the U.S. policy position toward the Fund, including members’ Fund arrangements. Further, in July 2000 we attended one task force meeting to observe Treasury’s efforts to address legislative mandates. We also reviewed U.S. statements to the Executive Board and internal U.S. Executive Director documents from 1998 to 2000 regarding U.S. Executive Director efforts to pursue legislative mandates. Finally, we interviewed the U.S. Executive Director and all of the staff in that office who monitor country and policy developments concerning the Fund, as well as numerous Fund staff and other Executive Board members. To assess whether Treasury and the U.S. Executive Director have been able to influence Fund operations and other members’ policy positions in a direction that would be consistent with U.S. policy as set forth in law, we conducted case studies of specific U.S. policies and Treasury’s efforts to pursue them for individual countries’ Fund arrangements. To select these case studies, we identified legislative mandates concerning U.S. policy objectives with respect to the Fund, using our own legal analysis supplemented with documentation obtained from Treasury. We used two criteria as the basis for identifying the relevant laws for this review. We defined these criteria as (1) any current law that explicitly directs the U.S. Executive Director to use the U.S. vote at the Fund to achieve a policy goal and (2) any current law that seeks to have the U.S. Executive Director use the U.S. voice at the Fund to promote a U.S. policy or make a policy change. We selected sound banking principles, labor policies, and audits of military expenditures as the U.S. policy focus for our case studies. We chose these policies because they represent a range of types of legislative provisions, or mandates, that are set forth in federal law, including both voice and directed vote provisions. We also chose these policies on the basis of our preliminary analysis, which suggested that the U.S.’ ability to impact Fund practice was related to whether policies encompassed issues that were viewed as central to the traditional focus of the Fund’s mission. For each policy issue, we reviewed Fund practices with respect to five member countries that we selected based on a number of factors, including geographic diversity, level of economic development, type of Fund arrangement, and range of issues connected to the policy concern. For the labor policies and audits of military expenditures case studies, we selected only countries that have a financial arrangement with the Fund because the language in their corresponding mandates is expressly directed at those countries. Specifically, we selected the following countries for each case study: (1) for sound banking principles, India, Mexico, Romania, South Africa, and Thailand; (2) for labor policies, Argentina, Ghana, Kazakhstan, Mexico, and Thailand; and (3) for audits of military expenditures, Burkina Faso, Guinea-Bissau, Indonesia, Kazakhstan, and Rwanda. We limited our review to the activities of the Treasury, the U.S. Executive Director, and the Fund for the last 3 years; that is, the period from January 1998 through November 2000. Since we focused primarily on the Fund rather than on country practices, we did not travel to any of these countries as part of this review. However, we interviewed Fund officials who monitor developments in these countries as well as seven other executive directors of the Fund’s Executive Board in Washington, D.C. Our basis for selecting these executive directors to speak with is discussed below. We reviewed numerous internal Treasury and U.S. Executive Director documents dating from 1998 to 2000 to answer our second objective. These documents included internal correspondence among officials within Treasury and the U.S. Executive Director’s office concerning their deliberations to develop U.S. policy positions with respect to both general mandate issues as well as the case study policies. We also reviewed Treasury’s policy position input to the U.S. Executive Director and all U.S. statements to the Fund’s Executive Board for each country covered for our case studies. In addition, we interviewed Treasury and U.S. Executive Director officials who monitor sound banking, labor, and military audit issues as well as those who monitor the country developments and are charged with formulating and implementing the U.S. policy position for each country with respect to the Fund. We also reviewed all Fund staff documents provided to the Executive Board concerning these countries for their program and economic policy reviews. These included Fund staff reports concerning countries’ requests for arrangements, reviews of ongoing arrangements, and countries’ periodic economic reviews, as well as staff summaries of Executive Board meetings. In addition, we interviewed numerous officials at the Fund to answer our second objective. Specifically, we interviewed staff at the Fund who monitor each of the countries under our review, except for Fund staff who monitor developments in Burkina Faso, who were not available to meet with us. For the other countries, we discussed with Fund staff how they set priorities in negotiating arrangements with these countries and how our case study policies fit into these priorities. We also met with officials from the Fund’s Policy Development and Review Department to discuss how the Fund pursues labor and military audit issues and we met with the Fund’s Monetary and Exchange Affairs Department to discuss how the Fund pursues strengthening sound banking principles in countries. In addition, we met with 7 of the 23 non-U.S. Executive Board directors and discussed their views of these policies and the impact of U.S. influence at the Fund. Specifically, we met with the appointed executive directors of France, Germany, Japan, and the United Kingdom, and the elected representative executive directors from Gabon, Mexico, and Thailand. We selected these executive directors to speak with because (1) they represent the largest donor countries and a mix of borrower countries at the Fund and (2) the elected executive directors represent several of the countries we reviewed in our case studies. Finally, we also interviewed the Assistant Secretary of the Fund’s Executive Board and the Deputy General Counsel of the Fund to obtain information on the Board’s process for voting and how often voting occurs. For comparison purposes, we interviewed an official within the U.S. Executive Director’s office at the World Bank about the voting process in that institution as well. We conducted our work from March through November 2000 in accordance with generally accepted government auditing standards. Comments From the Department of the Treasury GAO Contact and Staff Acknowledgments GAO Contact Acknowledgments In addition to the person named above, Carolyn Black-Bagdoyan, Tamara Cross, Barbara Shields, Valérie Leman Nowak, Rona Mendelsohn, Mark Speight, Mary Moutsos, and Mark Dowling made key contributions to this report. Ordering Information The first copy of each GAO report is free. Additional copies of reports are $2 each. A check or money order should be made out to the Superintendent of Documents. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. Orders by mail: U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Orders by visiting: Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders by phone: (202) 512-6000 fax: (202) 512-6061 TDD (202) 512-2537 Each day, GAO issues a list of newly available reports and testimony. 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The core mission of the International Monetary Fund (IMF) is to promote monetary cooperation and exchange rate stability and provide resources to IMF member countries that experience balance-of-payment difficulties. Because it is an international organization, IMF is generally exempt from US law; however, Congress can seek to influence IMF policy by passing laws that direct the Secretary of the Treasury to direct the Executive Director to vote on certain issues within the Board of the Fund. Through three case studies, GAO found that the Treasury and the U.S. Executive Director actively promoted U.S. policies related to (1) sound banking principles, (2) labor issues, and (3) audits of military expenditures. It is difficult to determine whether IMF's adoption of a policy is due solely to U.S. influence because other countries generally support the same policies.

Background Medicare and Medicaid Coverage for Disabled Dual-Eligible Beneficiaries Beneficiaries under age 65 may qualify for Medicare coverage on the basis of disability (such as a physical disability, developmental disability, or disabling mental health condition). Disabled individuals typically enroll in the federal Social Security Disability Insurance program and then have a 24-month waiting period before Medicare benefits begin. During the waiting period, low-income individuals who qualify for the Supplemental Security Income program (SSI) in their state can also qualify for Medicaid coverage. SSI is a means-tested income assistance program that provides cash benefits to individuals who meet certain disability criteria and have low levels of income and assets. After the Medicare waiting period ends, beneficiaries become dually enrolled in both programs. Medicare becomes the primary payer for most services, but Medicaid continues to cover benefits not offered by Medicare. Medicare coverage for dual-eligible beneficiaries includes hospitalizations, physician services, prescription drugs, skilled nursing facility care, home health visits, and hospice care. Under Medicaid, states are required to cover certain items and services for dual-eligible beneficiaries, including nursing facility services and home health services. Although states are required to cover certain populations and services, they have the option to expand coverage beyond these mandatory levels, and accordingly state Medicaid programs vary in scope. Characteristics of Disabled Dual-Eligible Beneficiaries Compared with Aged Dual-Eligible Beneficiaries Compared with aged dual-eligible beneficiaries, disabled dual-eligible beneficiaries in 2009 were more likely to be male and African-American, and they tended to have a much higher incidence of mental illness. However, they had a far lower incidence of three or more chronic conditions and were less likely to be institutionalized. In terms of relative spending, disabled dual-eligible beneficiaries had lower per capita Medicare spending but higher per capita Medicaid spending in 2009. However, among beneficiaries who did not use LTSS, per capita Medicare and Medicaid spending were both slightly higher for disabled dual-eligible beneficiaries. Disabled dual-eligible beneficiaries were less likely to live in an institution than aged dual eligible beneficiaries; however, among those that did, Medicaid spending was significantly higher than for aged dual-eligible beneficiaries in institutions. See table 1. Special Needs Plans In addition to requiring SNPs to meet all the requirements of other MA plans, CMS requires SNPs to provide specialized services targeted to the needs of their unique beneficiaries, including beneficiaries with certain severe and disabling chronic conditions, beneficiaries who live in institutions, or beneficiaries dually enrolled in both the Medicare and Medicaid programs. SNPs that provide specialized services, such as case management, for dual-eligible beneficiaries are referred to as D-SNPs. CMS pays D-SNPs the same way that it pays other MA plans, that is, a monthly amount determined by the plan bid—the plan’s estimated cost of providing Medicare Part A and Part B benefits—in relation to a benchmark, which is the maximum amount the Medicare program will pay MA plans in a given locality. CMS then adjusts the monthly payments to MA plans on the basis of beneficiaries’ risk scores. For MA plans that bid below the benchmark, CMS provides a rebate that is modified by an overall assessment of quality at the contract level using a 5-star rating scale based on measures of clinical quality and patients’ reported care experience for Medicare Part C and Part D. CMS designates certain D-SNPs as FIDE-SNPs, which is a designation for plans that integrate Medicare and Medicaid program benefits for dual- eligible beneficiaries through a single MCO. All FIDE-SNPs are financially at risk for enrollees’ nursing facility services for at least 6 months of the year. In 2013, CMS designated 35 FIDE-SNPs that enrolled about 98,000 beneficiaries across seven states. Beginning in contract year 2013, CMS may give certain D-SNPs that meet a high standard of integration and specified performance and quality-based standards the flexibility to offer supplemental benefits beyond those that CMS currently allows for other MA plans if the agency determines these benefits would better integrate care. This benefits flexibility is designed to assist dual-eligible beneficiaries who are at risk of institutionalization to remain in the community and may prevent health status decline and reduce the quantity and cost of health care services. As part of the qualifying criteria that CMS currently applies to benefits flexibility, the agency requires D-SNPs either to be in a contract with a 3 star (or higher) overall rating for the previous contract year or, if the D-SNP is part of a contract that does not have sufficient enrollment to generate a star rating, to score 75 percent or above on five of seven specific SNP plan-level HEDIS measures. For 2013, CMS approved 21 highly integrated D-SNPs for benefits flexibility that enrolled about 75,000 beneficiaries. CMS Financial Alignment Demonstration In 2011, CMS announced a financial alignment demonstration that is intended to align Medicare and Medicaid services and funding to reduce costs and improve the quality of care for dual-eligible beneficiaries. As of June 2014, 12 states have been approved to participate in the demonstration and 4 states have active proposals pending.demonstration is authorized for at least 3 years. Most states participating in the financial alignment demonstration plan to use a capitated model. Under the capitated model, CMS and states provide a single capitated payment to health plans to provide all Medicare and Medicaid benefits to enrolled dual-eligible beneficiaries. Payment rates to health plans will be reduced up front each year based on a predetermined combined Medicare and Medicaid savings estimate by CMS. In general, CMS and states expect the savings percentages to increase during the second and third years of the demonstration. Furthermore, to encourage quality of care improvements, CMS and states will withhold a portion of the payments—starting at 1 percent in the first year and up to 3 percent in the third year—that participating health plans can earn back by meeting a certain threshold of performance on quality measures. CMS expects that the capitated model will result in savings (1) to Medicare by reducing hospital admissions, emergency room visits, and skilled nursing care, and (2) to Medicaid by avoiding costly long-term nursing home care. At the same time, CMS expects that there may be increased use of primary care services, outpatient services, behavioral health services, and community-based LTSS, due to a greater emphasis on care coordination and maintaining beneficiaries in the community. Although CMS projects that approximately 61 to 75 percent of savings will come from reductions in costly Medicare-covered services, the agency requires that—as part of a more integrated approach—both the Medicare and Medicaid programs adjust their payment rates to plans based on aggregate savings percentages. In Massachusetts’s demonstration, only disabled dual-eligible beneficiaries between the ages of 21 and 64 are eligible for enrollment. Voluntary enrollment for the program began on October 1, 2013, and passive enrollment—whereby individuals are automatically enrolled in the program but can opt out—began January 1, 2014. Since 2004, Massachusetts has separately participated in a financial alignment program for dual-eligible beneficiaries age 65 and older known as Senior Care Options. This program provides all of the services covered by Medicare and MassHealth—the Massachusetts Medicaid program—and is funded by a combined capitated payment from both programs. Overall Spending for High-Expenditure Disabled Dual-Eligible Beneficiaries Driven Largely by Medicaid Spending Medicaid Spending— Particularly for Users of Community-based LTSS— Accounted for Nearly Two- Thirds of Overall Spending for High-Expenditure Beneficiaries High Medicaid spending for disabled dual-eligible beneficiaries drove high combined (Medicare and Medicaid) program spending for these beneficiaries. Beneficiaries ranked within the top 20 percent—or top quintile—of spending in their respective states accounted for more than 60 percent of national combined program spending for disabled dual- eligible beneficiaries. Furthermore, for these high-expenditure beneficiaries, nearly two-thirds (63 percent) of combined program spending was Medicaid spending and slightly over one-third (37 percent) was Medicare spending. (See fig. 1.) High-expenditure beneficiaries in the top combined spending quintile were also more likely to be in the top Medicaid spending quintile in their states than in the top Medicare spending quintile. Specifically, 72 percent of high-expenditure beneficiaries were in the top Medicaid spending quintile, while 54 percent of these beneficiaries were in the top Medicare spending quintile. Only 26 percent of high-expenditure beneficiaries were in both the top Medicare and the top Medicaid spending quintiles in their states. (See fig. 2.) Just over half (52 percent) of Medicaid spending for high-expenditure disabled dual-eligible beneficiaries was for those who used community- based LTSS, while for low-expenditure beneficiaries (those in the bottom combined spending quintile), community-based LTSS users accounted for only 4 percent of Medicaid spending. Inpatient stays accounted for the largest share (39 percent) of Medicare spending for high-expenditure beneficiaries but accounted for less than 1 percent of Medicare spending for low-expenditure beneficiaries. States with High Medicaid Spending Often Had Lower Medicare Spending but Greater Overall Spending for High- Expenditure Beneficiaries Because Medicaid benefits differ across states, per capita Medicaid spending for high-expenditure disabled dual-eligible beneficiaries varied more across states than per capita Medicare spending did. Per capita Medicaid spending for these beneficiaries ranged from about $27,000 in Michigan to about $188,000 in New York, while per capita Medicare spending ranged from about $18,000 in North Dakota to about $49,000 in Florida. Largely because of the variation in Medicaid spending, combined program spending ranged from about $68,000 in Alabama to about $220,000 in New York. Although states with greater per capita Medicaid spending for high- expenditure beneficiaries often had less per capita Medicare spending, they were usually among the states with the greatest per capita combined (See fig. 3.) For example, 5 of the 10 states with the greatest spending.per capita Medicaid spending had per capita Medicare spending that was less than the average across states. Nevertheless, all 10 states were among those with the greatest per capita combined spending. In fact, 17 of the 20 states with the greatest per capita Medicaid spending were also among those with the greatest per capita combined spending. Because the majority of spending for high-expenditure disabled dual- eligible beneficiaries was for beneficiaries who used community-based LTSS, and because CMS expects to see an increase in the use of these services under the financial alignment demonstration, we repeated this analysis for only beneficiaries who used community-based LTSS and found similar results. States that had greater per capita Medicaid spending for high-expenditure beneficiaries who used community-based LTSS tended to have less per capita Medicare spending but greater per capita combined spending for these beneficiaries. (See fig. 4.) In particular, 8 of the 10 states with the greatest per capita Medicaid spending for community-based LTSS users had per capita Medicare spending that was less than the average across states. Nevertheless, 9 of the 10 states with the greatest per capita Medicaid spending were among the 10 states with the greatest per capita combined spending. Service Use and Characteristics Differed Widely between High- Medicare-Expenditure and High-Medicaid- Expenditure Disabled Dual-Eligible Beneficiaries Beneficiaries with High Medicare Expenditures Were More Likely to Use Inpatient Services; Beneficiaries with High Medicaid Expenditures Were More Likely to Use LTSS The services most commonly used by disabled dual-eligible beneficiaries in the top Medicare-spending quintile and those in the top Medicaid- spending quintile often differed widely. As expected—because Medicare is the primary payer for acute hospital stays—beneficiaries with high Medicare expenditures were highly likely to use inpatient services. However, a relatively low percentage of beneficiaries with high Medicaid expenditures used these services. In contrast, beneficiaries with high Medicaid expenditures were much more likely than beneficiaries with high Medicare expenditures to use LTSS—particularly community-based LTSS. (See fig. 5.) Beneficiaries with high Medicaid expenditures were also more likely to use community-based LTSS and less likely to use inpatient services than most beneficiaries with lower Medicaid expenditures. Despite differences in service use, high-Medicare-expenditure and high- Medicaid-expenditure disabled dual-eligible beneficiaries had similar utilization levels of Medicare-covered primary care and mental health services. Nearly 80 percent of beneficiaries in each group received at least one primary care service, and approximately 40 percent of beneficiaries in each group received at least one mental health service. Both groups also were more likely to receive primary care or mental health services than beneficiaries with lower expenditures in their respective programs. (See app. I for more information on the use of selected Medicare and Medicaid services by disabled dual-eligible beneficiary expenditure levels.) Beneficiaries with High Medicare Expenditures Were Far More Likely than Those with High Medicaid Expenditures to Have Multiple Health Conditions Disabled dual-eligible beneficiaries with high Medicare expenditures were considerably more likely than beneficiaries with high Medicaid expenditures to have multiple chronic or mental health conditions. About 35 percent of beneficiaries with high Medicare expenditures had six or more chronic conditions, compared with 14 percent of beneficiaries with high Medicaid expenditures. In addition, 25 percent of beneficiaries with high Medicare expenditures had three or more mental health conditions, compared with 13 percent of beneficiaries with high Medicaid expenditures. The presence of multiple health conditions may drive the use of costly Medicare services among beneficiaries with high Medicare expenditures. As the number of chronic and mental health conditions increased among these beneficiaries, the average number of emergency room visits, inpatient stays, and readmissions also increased. The increase in the average number of emergency room visits was particularly dramatic as the number of mental health conditions increased. (See fig. 6.) Furthermore, as the number of chronic conditions increased, the percentage of beneficiaries with high Medicare expenditures who had at least one inpatient admission increased substantially, although as the number of mental health conditions increased, the percentage was relatively stable. Fully Integrated D-SNPs Often Provided High Quality Care, but Had Limited Experience Serving Disabled Dual-Eligible Beneficiaries or Demonstrating Medicare Savings Fully Integrated D-SNPs Often Met Criteria for High Quality, but Relatively Few of Those Plans Served Disabled Dual-Eligible Beneficiaries FIDE-SNPs in 2013 were far more likely than other D-SNPs to meet criteria for high quality. Among those that reported sufficient data to receive a quality score, 14 (56 percent) of the 25 FIDE-SNPs met criteria for high quality but only 24 (14 percent) of all other 169 D-SNPs met these criteria. While FIDE-SNPs often received an overall quality score within the top two quintiles, 7 FIDE-SNPs (28 percent) scored below this mark, including 6 FIDE-SNPs that scored below the 40th percentile and 3 FIDE-SNPs that scored below the 25th percentile. The 14 high quality FIDE-SNPs operated across four states under programs through which all D-SNPs fully integrated Medicare and Medicaid benefits. In contrast, all 6 FIDE-SNPs that operated outside of these four states received a quality score below the 60th percentile. While 207 (64 percent) of the 323 D-SNPs in 2013 served disabled dual- eligible beneficiaries, only 13 (37 percent) of the 35 FIDE-SNPs served this population (see fig. 7). The proportion of disabled dual- eligible beneficiaries in each of these 13 FIDE-SNPs ranged from 12 percent to nearly all of plan enrollment. These 13 D-SNPs operated across four states. Among the 22 FIDE-SNPs that did not serve disabled beneficiaries, most operated in state fully integrated programs that excluded this population from enrollment in those plans. Furthermore, only 2 FIDE-SNPs met criteria for high quality and served disabled beneficiaries. While 11 of the 21 highly integrated D-SNPs that CMS approved for 2013 benefits flexibility were high quality FIDE-SNPs, CMS’s quality requirements did not prevent some D-SNPs with relatively low quality from being approved for benefits flexibility. Although CMS approved 18 of the 21 D-SNPs for benefits flexibility through their contract star rating, only D-SNPs without a star rating are assessed for quality at the plan level. Just 3 of the 18 D-SNPs approved through their contract star rating would have met CMS’s plan-level quality requirements. Furthermore, 3 of the 18 D-SNPs approved for benefits flexibility through their star rating performed below the median quality score, including the only two D-SNPs approved with an overall star rating of 3.0. Relatively Few High Quality FIDE-SNPs Showed Potential for Medicare Savings, Regardless of Whether They Served Disabled Dual-Eligible Beneficiaries Only 8 of the 35 FIDE-SNPs—and 3 of the 14 with high quality—bid below Medicare FFS spending in 2013, an indication that these plans can provide standard Medicare Part A and B benefits at a lower cost than what Medicare would have likely spent for these beneficiaries in FFS. Also, only 3 FIDE-SNPs that served disabled dual-eligible beneficiaries bid below Medicare FFS spending, and none of these met criteria for high quality.Medicare FFS spending, only 2 bid within 3 percentage points of FFS spending. On average (weighted by July 2013 enrollment), the 35 FIDE- SNPs bid 6 percent above FFS spending, and the 14 high quality FIDE- Among the 11 high quality FIDE-SNPs that bid at or above SNPs bid 3 percent above FFS spending.FIDE designation bid 4 percent below FFS spending. In contrast, D-SNPs without a Prior GAO research found that MA plans in service areas with high Medicare FFS spending were more likely to bid below Medicare FFS spending than MA plans in service areas with low FFS spending; FIDE- SNPs in 2013 generally followed that pattern. that bid below FFS spending, five operated in the 70th percentile or higher of MA service area FFS spending, two operated between the 60th and 70th percentiles, and only one operated below the median. In addition, among the 10 FIDE-SNPs that bid below FFS spending or had high quality and bid within 3 percentage points above FFS spending, 5 operated in the same service area as D-SNPs that were not fully integrated. In each of these 5 cases, total bids as a percentage of FFS spending were lower for D-SNPs with less integration of Medicare and Medicaid benefits. Furthermore, FIDE-SNPs were not notably more likely to bid below FFS spending based on CMS approval for benefits flexibility, not-for-profit status, relatively smaller projected profit margin, or plan enrollment size above 1,000. See GAO, Medicare Advantage: Comparison of Plan Bids to Fee-for-Service Spending by Plan and Market Characteristics, GAO-11-247R (Washington, D.C.: Feb. 4, 2011). Moderately Better Health Outcomes for Disabled Dual-Eligible Beneficiaries in D-SNPs Relative to Those in Traditional MA Plans Did Not Translate into Lower Levels of Costly Medicare Services D-SNPs’ performance for disabled dual-eligible beneficiaries relative to traditional MA plans’ was similar on average for process measures, but was moderately better on health outcome measures. On average, D-SNPs’ relative performance on 23 process measures (including screening for certain diseases and annual monitoring for patients on certain prescriptions) was 1 percentage point higher both for all beneficiaries and for those with six or more chronic conditions. While D-SNPs performed better on approximately two-thirds of the process measures,from 6 percentage points lower to 9 percentage points higher for all beneficiaries, and by an even wider range for those with six or more chronic conditions. In contrast, on average, D-SNPs’ performance on seven health outcome measures (including maintaining healthy cholesterol, blood pressure, and blood sugar levels) was 5 percentage points higher for all beneficiaries and 7 percentage points higher for those with six or more chronic conditions. D-SNPs’ relative performance was consistently better on each health outcome measure—ranging from 3 to 6 percentage points higher for all beneficiaries and 2 to 16 percentage points higher for those with six or more chronic conditions. (See table 2.) Concluding Observations These results suggest that CMS’s expectations regarding the extent to which integration of benefits will produce savings through lower use of costly Medicare services may be optimistic. Whether CMS and participating states will be able to improve quality without increasing overall program spending for disabled dual-eligible beneficiaries is uncertain. While increasing the use of community-based LTSS may improve the quality of care for disabled dual-eligible beneficiaries who utilize those services, community-based LTSS users drove high combined program spending for disabled dual-eligible beneficiaries. Likewise, states with the highest per capita Medicaid spending for disabled dual-eligible beneficiaries were usually among the states with the highest overall program spending. In addition, the wide differences in health characteristics between disabled dual-eligible beneficiaries with the highest Medicare spending and those with the highest Medicaid spending may indicate the potential challenge of providing additional services without disproportionately impacting the costs of each program. Although most disabled dual-eligible beneficiaries with the highest Medicaid spending used community-based LTSS to assist them with activities of daily living, these beneficiaries generally did not have the numerous chronic conditions associated with those who had the highest Medicare spending. Furthermore, if the models of care in the financial alignment demonstrations or other integrated models build on fully integrated D-SNP models, these efforts may improve the care provided to dual- eligible beneficiaries but may not produce significant Medicare savings for dual-eligible beneficiaries. D-SNPs that fully integrated Medicare and Medicaid benefits were far more likely than other D-SNPs to meet criteria for high quality but usually operated under fully integrated state programs that excluded disabled dual-eligible beneficiaries from enrollment. Regardless of whether they served disabled beneficiaries, high quality fully integrated D-SNPs did not usually demonstrate the potential for Medicare savings. In addition, many fully integrated D-SNPs that demonstrated the potential for Medicare savings operated in service areas where D-SNPs with less integration of benefits demonstrated more potential for Medicare savings. Our findings also suggest that even if there is moderate improvement in the performance of health outcome measures, and if dual-eligible beneficiaries are enrolled in plans specifically designed for them, instead of enrolled in traditional MA plans, these conditions are not necessarily sufficient to reduce disabled dual-eligible beneficiaries’ use of costly Medicare services. Despite moderately better performance on health outcome measures for both disabled and aged dual-eligible beneficiaries, the fact that D-SNPs had similar levels of costly Medicare-covered services (i.e., inpatient admissions, readmissions, and emergency room visits) as traditional MA plans for this population has significant implications for program costs. Furthermore, for dual-eligible beneficiaries with six or more chronic conditions—a group that is at risk for high Medicare spending—although D-SNPs had better relative performance on health outcome measures, they still had similar, if not higher, levels of costly Medicare-covered services. Agency Comments We provided a draft of this report to CMS for comment. CMS did not have any general comments. The agency provided technical comments, which we incorporated as appropriate. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the Secretary of Health and Human Services, interested congressional committees, and others. The report also is available at no charge on GAO’s website at http://www.gao.gov. If you or your staffs have any questions regarding this report, please contact me at (202) 512-7114 or cosgrovej@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix II. Appendix I: Disabled Dual-Eligible Beneficiaries’ Service Use and Health Conditions by Expenditure Level, 2009 Any long-term services and supports (LTSS) Appendix II: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, individuals making key contributions to this report include Catina Bradley, Assistant Director; Phyllis Thorburn, Assistant Director; Alison Binkowski; Aubrey Naffis; and Luis Serna III. Todd Anderson, Emily Johnston, Elizabeth T. Morrison, and Hemi Tewarson also provided valuable assistance.

In 2009, the Medicare and Medicaid programs spent an estimated $103 billion on disabled dual-eligible beneficiaries—those individuals who are disabled, under age 65, and qualify for both Medicare and Medicaid benefits. Recently, Congress and CMS have emphasized benefit integration for all dual-eligible beneficiaries—both disabled and aged—including beginning a financial alignment demonstration, which CMS expects will improve care and reduce program spending. GAO was asked to provide insights for potentially improving the care provided to disabled dual-eligible beneficiaries while reducing spending. GAO examined (1) spending, utilization, and health status patterns for the portion of this population with the highest spending, (2) the extent to which integrated D-SNPs provided high quality of care for this population while controlling Medicare spending, and (3) D-SNPs' and traditional MA plans' performance in serving this population based on quality and resource use measures. To do this work, GAO analyzed Medicare and Medicaid 2009 claims and summary data—the most recent data available. GAO identified D-SNPs that met standards of quality and integration and compared their 2013 costs to expected Medicare FFS spending. GAO used 2011 data—the most recent data available when GAO began its analysis—from the Health Care Effectiveness Data and Information Set to evaluate D-SNPs' and traditional MA plans' performance. Overall spending for high-expenditure disabled dual-eligible beneficiaries—those in the top 20 percent of spending in their respective states—was driven largely by Medicaid spending, and the service use and health status often differed widely between those with high Medicare expenditures and high Medicaid expenditures. For these beneficiaries, Medicaid expenditures accounted for nearly two-thirds of overall spending. Also, states with high Medicaid spending often had lower Medicare spending but nearly always had greater overall spending for these beneficiaries. Furthermore, service use and health status often differed widely between high-Medicare-expenditure and high-Medicaid-expenditure disabled dual-eligible beneficiaries. Those with high Medicare expenditures were considerably more likely than those with high Medicaid expenditures to have multiple health conditions and use inpatient services but far less likely to use long-term services and supports. Dual-eligible special needs plans (D-SNP)—Medicare Advantage (MA) private plans designed to target the needs of dual-eligible beneficiaries—that fully integrated Medicare and Medicaid benefits often met criteria for high quality but had limited experience serving disabled dual-eligible beneficiaries or demonstrating Medicare savings. D-SNPs that the Centers for Medicare & Medicaid Services (CMS)—the agency that administers Medicare and oversees Medicaid—designated as Fully Integrated Dual-Eligible (FIDE) SNPs were far more likely to meet high quality criteria compared with other D-SNPs. However, relatively few FIDE-SNPs with high quality served disabled dual-eligible beneficiaries or reported lower costs for Medicare services than expected Medicare fee-for-service (FFS) spending in the same areas. Additionally, FIDE-SNPs that demonstrated the potential for Medicare savings often operated in service areas where D-SNPs with less integration of Medicaid benefits demonstrated more potential for Medicare savings (i.e., lower relative costs for Medicare services). Moderately better health outcomes for disabled dual-eligible beneficiaries in D-SNPs relative to those in traditional MA plans did not translate into lower levels of costly Medicare services (that is, inpatient stays, readmissions, and emergency room visits). These results were also similar whether dual-eligible beneficiaries were at risk for high Medicare spending (those with six or more chronic health conditions), aged (those age 65 and over), or aged and enrolled in FIDE-SNPs. These results suggest that CMS's expectations regarding the extent to which integration of benefits will produce savings through lower use of costly Medicare services may be optimistic. While operating specialized plans and integrating benefits could lead to improved care, GAO's results suggest that these conditions may not reduce dual-eligible beneficiaries' Medicare spending compared with Medicare spending in settings without integrated benefits. CMS reviewed a draft of the report and provided technical comments, which GAO incorporated as appropriate.

Background FHA is a wholly owned government corporation within HUD. It was established in 1934 under the National Housing Act to broaden homeownership, shore up and protect lending institutions, and stimulate employment in the building industry. FHA’s Single-Family Mortgage Insurance FHA’s single-family programs insure private lenders against losses from borrower defaults on mortgages that meet FHA criteria for properties with one to four housing units. FHA primarily insures forward mortgages for initial home purchases and refinancing, but also insures reverse mortgages that permit persons 62 years and older to convert their home equity into cash advances through its Home Equity Conversion Mortgages for Seniors (HECM) program. single-family mortgage insurance through programs supported by the Fund.Deputy Assistant Secretary for Single Family Housing, who reports to the Assistant Secretary for Housing-Federal Housing Commissioner. With forward mortgages, the borrower’s monthly loan payments to the lender add to the borrower’s home equity and decrease the loan balance. With reverse mortgages, the borrower receives payments from the lender. The lender adds the principal and interest to the loan balance, reducing the homeowner’s equity. FHA is a government mortgage insurer in a market that also includes private mortgage insurers. Private mortgage insurance policies provide lenders coverage on a portion (generally 20 to 30 percent) of the mortgage balance. However, borrowers who have difficulty meeting down-payment and credit score requirements for conventional loans may find it easier to qualify for a loan with FHA insurance, which covers 100 percent of the principal balance of the loan involved in a claim and other eligible costs. Generally, borrowers are required to purchase mortgage insurance when the loan-to-value (LTV) ratio (the amount of the mortgage loan divided by the value of the home multiplied by 100) exceeds 80 percent. FHA-insured borrowers are required to make minimum cash investments of 3.5 percent, which may come from the borrowers’ own funds or from certain third-party sources. Borrowers are also permitted to finance their mortgage insurance premiums, a practice that can create an effective LTV ratio of close to 100 percent. Congress has set limits on the size of the forward mortgages FHA may insure, which can vary by county. For the period from January 1, 2013, through December 31, 2013, the limits range from $271,050 to $729,750 for one-unit properties in the contiguous United States. FHA’s Role in Mortgage Financing FHA’s single-family mortgage programs have played a prominent role in mortgage financing in the wake of the 2007-2009 financial crisis and housing downturn. In 2012, FHA insured about $227 billion in single- family mortgages, and its overall insurance portfolio was about $1.1 trillion. The agency has played a particularly large role among minority, lower-income, and first-time homebuyers. In 2012, about 78 percent of FHA-insured loans went to first-time homebuyers, about 32 percent of whom were minorities. FHA is generally thought to promote stability in the market by ensuring the availability of mortgage credit in areas that may be underserved by the private sector or that are experiencing economic downturns. As the recent housing crisis and economic recession set in, the contraction of other segments of the mortgage market and legislated increases in the loan amounts eligible for FHA insurance resulted in higher demand for FHA-insured mortgages. FHA officials also noted that even if their volume had not increased, the agency’s share of the market would have increased because other segments of the market declined or were completely eliminated. According to HUD’s Housing Market Conditions, FHA’s share of the market for home purchase mortgages (in terms of loan originations) grew sharply, rising from approximately 4.5 percent in 2006 to approximately 26.1 percent in 2012.entire mortgage market (including refinance activity), FHA’s share of the market also rose dramatically, and stood at 14.6 percent in 2012 (see fig. 1). A number of other private-sector and government institutions participate in the mortgage market. Private lenders offer home purchase and refinance mortgages and often work with mortgage brokers, independent contractors that originate the loan products of multiple lenders. The Department of Veterans Affairs’ (VA) Loan Guaranty Service and the Department of Agriculture’s (USDA) Rural Housing Service (RHS) administer federal programs that insure or guarantee single-family mortgages made by private lenders. Private mortgage insurance companies offer mortgage insurance that protects private lenders against losses in the event the borrower defaults on the mortgage. Fannie Mae and Freddie Mac, two government-sponsored enterprises (the enterprises), purchase mortgages from lenders across the country, financing their purchases through borrowing or by issuing securities backed by the mortgages (mortgage-backed securities or MBS). The enterprises are currently under conservatorship. Ginnie Mae is another wholly owned government corporation in HUD. It guarantees the timely payment of principal and interest of MBS backed by pools of federally insured or guaranteed mortgage loans, such as FHA, VA, or RHS. FHA’s Mutual Mortgage Insurance Fund The Omnibus Budget Reconciliation Act of 1990 required HUD to take steps to ensure that the Fund attained a capital ratio of at least 2 percent by November 2000 and maintained at least that level thereafter. The capital ratio is the Fund’s economic value divided by the insurance-in- force (outstanding insurance obligations). The act also required an annual independent actuarial review of the Fund’s economic net worth and soundness. This actuarial review is now a requirement in the Housing and Economic Recovery Act of 2008, which also requires an annual report to Congress on the results of the review. The Fund’s capital ratio dropped sharply in 2008 and fell below the statutory minimum in 2009, when economic and market developments created conditions that simultaneously reduced the Fund’s economic value (the numerator of the ratio) and increased the insurance-in-force (the denominator of the ratio). According to annual actuarial reviews of the Fund, the capital ratio fell from about 7 percent in 2006 to 3 percent in 2008 and dropped to below 2 percent in 2009 (see fig. 2). In 2012, the ratio fell below zero to negative 1.44 percent. Under the Federal Credit Reform Act of 1990 (FCRA), FHA and other federal agencies must estimate the net lifetime costs—known as credit subsidy costs—of their loan insurance or guarantee programs and include the estimated costs to the government in their annual budgets. Credit subsidy costs represent the net present value of expected lifetime cash flows, excluding administrative costs. When estimated cash inflows (such as borrower insurance premiums) exceed expected cash outflows (such as insurance claims), a program is said to have a negative credit subsidy rate and generates offsetting receipts that reduce the federal budget deficit. When the opposite occurs, the program is said to have a positive credit subsidy rate and therefore requires appropriations. Generally, agencies must produce annual updates of their subsidy estimates—reestimates—on the basis of information about actual performance and estimated changes in future loan performance. FCRA recognized the difficulty of making credit subsidy estimates that mirrored actual loan performance and thus provided permanent and indefinite budget authority for reestimates that reflected increased program costs.Upward reestimates increase the federal budget deficit unless accompanied by reductions in other government spending or an increase in receipts. As the capital ratio declined, the Fund’s condition also worsened from the federal budgetary perspective. FHA annually estimates the subsidy costs of new activity for its loan insurance program and also reestimates, or annually updates, prior subsidy cost estimates. Historically, FHA estimated that its loan insurance program had a negative subsidy cost. On the basis of these estimates, FHA accumulated substantial balances in a capital reserve account, which represents amounts in excess of those needed for estimated claims or other costs and was used to cover reestimates reflecting unanticipated increases to those costs (such as higher-than-expected claims). In recent years, FHA has transferred billions of dollars annually from the capital reserve account to cover increases in estimated credit subsidy costs of the Fund (upward subsidy reestimates). As a result, balances in the capital reserve account fell dramatically, from $19.3 billion at the end of 2008 to an estimated $3.3 billion at the end of 2012 (see fig. 3). If the reserve account were to be depleted, FHA could draw on permanent and indefinite budget authority to cover reestimates indicating additional increases in estimated credit subsidy costs. The President’s budget for 2014 contained a $22.4 billion upward reestimate in FHA’s credit subsidy costs for the Fund. The budget indicated that the reestimate would be funded by depleting FHA’s capital reserve account in 2013, using premiums collected in 2013 from new endorsements, and potentially drawing on $943 million in permanent and indefinite budget authority. However, to the extent that such premiums collected in 2013 are different than FHA estimated, FHA may need to draw on more or less permanent and indefinite budget authority. Changes to Product Terms and Conditions Could Help Mitigate Risk and Increase Financial Viability but Could Also Limit Borrowers’ Access to Credit Mortgage industry observers have suggested changes to FHA’s product terms and conditions to lower its exposure to risk and improve its capital position. These proposed changes include tightening its underwriting standards and increasing down payments and premiums charged. However, implementing one or a combination of these options could affect borrowers’ access to credit, create an adverse selection problem for FHA, or affect the agency’s role in terms of the types of borrowers it serves. Proposed Changes to FHA’s Underwriting Standards Would Involve Trade-offs That Could Affect Target Populations Lenders must comply with FHA’s underwriting criteria when making FHA- insured loans. Underwriting is a risk analysis that uses information—such as a borrower’s credit history and cash assets, among other things— collected during the origination process to decide whether to approve a loan. In order to qualify for an FHA-insured loan, a borrower must have a decision credit score of at least 500. In addition, a borrower’s payment- to-income (PTI) ratio may exceed 31 percent and debt service-to-income (DTI) ratio may exceed 43 percent only if compensating factors are documented. With some exceptions, lenders are required to use FHA’s Technology Open to Approved Lenders (TOTAL)—a mortgage scorecard—to underwrite loans. TOTAL evaluates the overall creditworthiness of an applicant based on a number of credit variables and determines the associated risk level for an FHA-insured loan. FHA requires lenders to manually underwrite loans that are not accepted by TOTAL to determine if the loan should be accepted or rejected. Among other things, manual underwriting involves evaluating compensating factors to justify the approval of an FHA-insured mortgage. Table 1 describes the compensating factors lenders may consider when manually underwriting an FHA-insured loan for a borrower whose PTI ratio exceeds 31 percent or DTI ratio exceeds 43 percent. FHA recently revised TOTAL to tighten its underwriting standards. For example, according to FHA officials, the agency revised the cut points— the points of separation within a population of mortgage scores that divide applications that are accepted in TOTAL from those that are not—in order to set the lifetime claim rate of its highest-risk loans at about 13 percent. In addition, some mortgage industry observers we spoke to said that lenders may apply additional, more stringent underwriting requirements, known as credit overlays. For example, a lender could require that borrowers have a minimum credit score of 620 in order to qualify for an FHA-insured loan. Some of the literature we reviewed and those we spoke to suggested that FHA could further tighten its underwriting standards in order to reduce the risk to the Fund, as well as the agency’s high market share. However, as described in the following examples, tightening of FHA’s underwriting requirements may affect certain borrowers’ ability to obtain mortgage credit and FHA’s ability to serve families that are able to sustain a mortgage, but do not qualify for conventional financing. Some mortgage industry observers have suggested raising FHA’s minimum credit score requirement to, for example, 580 or 620. We previously found that lower credit scores were associated with a higher likelihood of default. FHA officials also told us that lower credit scores increase the likelihood of delinquency and default among borrowers. Accordingly, increasing the credit score requirement, all else being equal, could make FHA less subject to adverse selection based on its credit policy and help to reduce the level of risk in the overall portfolio. However, FHA data also show that the percentage of borrowers with FHA-guaranteed loans and credit scores below 620 was relatively small in 2009—approximately 10 percent of loans endorsed by FHA. Thus, implementing a credit score floor of 620—the conventional mortgage standard—likely would not significantly reduce FHA’s market share, absent any other changes to FHA’s underwriting standards, other program requirements, or the current lending volume. Some mortgage industry observers noted that increasing FHA’s credit score requirement would decrease access to mortgage credit and delay or prevent homeownership for borrowers with lower credit scores. One paper we reviewed noted that more restrictive credit score requirements excluded a larger share of borrowers from the market in relation to the percentage of defaults they prevented. One mortgage industry observer also said that a higher minimum credit score requirement likely would have a disparate impact on minority borrowers. In addition, in a 2007 paper, the Federal Reserve found that different demographic groups had substantially different credit scores. The study found that on average blacks and Hispanics have lower credit scores than non-Hispanic whites and Asians. Some mortgage industry observers also suggested that FHA implement a residual income requirement. Residual income is the amount of net income remaining after the deduction of payments for debts and obligations (including the mortgage), and is thus a measure of a borrower’s ability to make such payments without creating a substantial financial burden on the household. These observers pointed to VA’s mortgage insurance program, which requires that lenders calculate the balance available for family support and compare that figure to the residual income guidelines that are based on family size, loan amount, and geographic location. For example, the guideline for a family of two living in the midwest with a loan of $80,000 or more is a minimum of $738 in residual income. For the same family in the west, it is a minimum of $823. Lenders also consider the borrower’s DTI ratio, but according to VA, that is a secondary underwriting factor to the residual income. One industry observer we spoke to said that implementing a residual income test could be difficult, though not impossible, because determining whether borrowers were capable of paying for other expenses presented practical challenges. One paper we reviewed noted the lack of adequate empirical data and models documenting the relationship between residual income, DTI ratios, and loan performance. This paper concluded that without such information, it would be difficult to determine the residual income thresholds that would most effectively produce high-quality mortgages without excluding lower-income borrowers from access to credit. Increasing FHA’s Down- Payment Requirement and Reducing Seller Concessions Could Increase Borrowers’ Cash Contributions In addition to meeting the underwriting requirements outlined earlier, a borrower generally must make a cash investment (down payment) in the property to obtain an FHA-insured mortgage. The amount of the down payment required depends on the borrower’s credit score (see table 2). Down payment funds may come from the borrower’s own savings or from certain third-party sources. In addition, borrowers also must pay for related closing costs. Currently, FHA permits a seller to pay up to 6 percent of the lesser of the purchase price or the appraised value of a home on behalf of a buyer to help fund these closing costs. Such payments are referred to as “seller concessions.” In July 2010, FHA proposed reducing allowable seller concessions to 3 percent of the lesser of the purchase price or the appraised value of a home in order to align its policy with conventional mortgage lenders and reduce the risk exposure to the Fund. In announcing the change, FHA noted that the then current level exposed FHA to excess risk by creating incentives to inflate the appraised value of homes. In February 2012, FHA amended this plan in a proposed rule that permitted seller concessions in the amount of the lesser of 3 percent of the purchase price or the appraised value of a home, or $6,000, According to FHA officials, the agency is in the whichever was greater.process of addressing comments on the proposed rule. The officials said that they did not know when the rule would be finalized. Some of the literature we reviewed and mortgage industry observers we interviewed suggested increasing FHA’s requirement from 3.5 percent to, for example, 5 percent. Some said that increasing FHA’s down-payment requirements would help to decrease risk in its portfolio. A substantial amount of the research we reviewed for a 2005 report on risks associated with FHA products indicated that LTV ratios and credit scores were among the most important factors in estimating the risk level associated with individual mortgages. findings. We found that, in general, mortgages with higher LTV ratios (smaller down payments) and lower credit scores were riskier than mortgages with lower LTV ratios and higher credit scores. See GAO, Mortgage Financing: Actions Needed to Help FHA Manage Risks from New Mortgage Loan Products, GAO-05-194 (Washington, D.C.: Feb. 11, 2005). In addition, one mortgage information collected from loan applications.industry observer said that increased down-payment requirements could have a disparate impact on minorities. Some of those we spoke to and the literature we reviewed said that FHA should reduce seller concessions. According to FHA, about 21 percent of loan originations in 2009 and 2010 had seller concessions of more than 3 percent of the property value. Allowing higher seller concessions makes FHA-insured loans more accessible than conventional loans because borrowers do not have to invest as much cash at closing. For example, according to FHA, under current policy, concessions on higher-priced homes can reach almost $44,000. FHA and one mortgage industry observer suggested that reducing seller concessions could reduce the risk of exposure to the Fund from incentives that inflated the appraised value of homes. Our work on seller-funded down-payment assistance demonstrated that funds provided by seller-funded nonprofits had the effect of increasing the selling price of the home, leaving the borrower with less equity and FHA with more risk than they would have otherwise.could result in higher sales prices than would occur without seller concessions. This suggests that transactions involving seller concessions Conversely, some have highlighted the importance of providing assistance to those borrowers who have difficulty accumulating sufficient funds to become homeowners. For example, one mortgage industry observer we spoke with said that reducing allowable seller concessions would be like increasing the down-payment requirement. In commenting on FHA’s proposed rule, representatives of this group said that FHA must strike a balance between managing risks and ensuring that its product is offered as widely as possible to qualified borrowers. They said that the proposed changes in seller concessions would adversely impact homebuyers seeking FHA-insured mortgages. Because of similar concerns, FHA revised its original proposal for reducing seller concessions. In its revised proposed rule, FHA noted that an across-the- board reduction to 3 percent would have had a disproportionately negative impact on borrowers with low and moderate incomes who were purchasing modestly priced homes. Therefore, the agency revised its proposal to allow concessions of the greater of 3 percent or $6,000, so that borrowers purchasing homes valued at less than $200,000 could receive seller concessions of more than 3 percent. Pricing Changes Could Raise the Cost of Credit for Some Borrowers FHA has raised premiums several times in recent years, but such increases have not been risk-based. Most recently, FHA increased the annual insurance premiums most borrowers pay between 0.05 and 0.10 percentage points. FHA now charges the maximum allowable premium for loans of $625,500 or more, and although FHA also increased premiums for smaller-value loans, these premiums still remain below the maximum FHA is permitted to charge (see table 3). FHA can continue to raise up-front and annual premiums to the statutory maximums (generally 3 percent of the original insured principal mortgage amount for up-front premiums and between 1.5 and 1.55 percent of the remaining insured principal amount for annual premiums). In addition, since June 3, 2013, FHA has required most new borrowers to continue paying annual premiums, regardless of the value of their loans. Previously, premiums could be canceled after the first 5 years once the principal amount declined to 78 percent of the original value. According to FHA, the reversal of the premium cancelation policy and the increase in premiums would generate approximately $3 billion for the Fund for every $100 billion in new endorsements. Some mortgage industry observers said that FHA could raise its up-front and annual premiums. For example, FHA could raise premiums to the statutory maximums, as outlined in table 3 above. One mortgage industry observer we spoke to and some of the literature we reviewed indicated that increases in FHA’s premiums could result in more revenue for the Fund, provided that the increases did not reduce the volume of new FHA- insured mortgages enough to offset the increased revenue. However, we and others have noted that increases in the cost of mortgage insurance could increase the likelihood of adverse selection for That is, low-risk FHA if its pricing were far different from its competitors.borrowers with fewer down-payment constraints could choose less costly loans from other sources, effectively making private mortgage insurance more competitive with FHA insurance. This shift in borrowers potentially could result in an increase in the overall risk of FHA’s portfolio because FHA would be insuring relatively more high-risk borrowers. In this case, an increase in premiums can result in both lower premium revenue as low-risk borrowers no longer purchase FHA insurance, and an increased claim rate among the remaining higher-risk borrowers. Further, others have noted that increased premiums could price some borrowers out of the market. As previously discussed, some mortgage industry observers have noted that many FHA borrowers have limited cash assets to pay for down-payment and closing costs. According to FHA, nearly all FHA-insured borrowers finance the up-front premium, so the net effect of increasing it would likely be to raise the borrowers’ mortgage payments. FHA officials said that the agency was unlikely to implement further increases in annual premiums in the near future. They said that FHA loans could become unaffordable to some borrowers when interest rates increase. We also found that FHA’s recently announced policy lengthening the duration of premium assessments might have an adverse impact on borrowers. Mortgagee Letter 2013-04, implemented on June 3, 2013, mandates that the monthly mortgage insurance premium on FHA loans with LTV ratios exceeding 90 percent apply for the life of the loan, rather than terminating after the first 5 years once the principal amount declines to 78 percent LTV. FHA has acknowledged that this policy change will increase the annual percentage rate (APR) on FHA mortgages and may result in mortgages whose interest rates qualify them as higher-priced mortgage loans (HPML). Under Regulation Z, HPMLs must meet certain requirements, including those related to repayment After consulting with the ability, prepayment penalties, and escrows.Bureau of Consumer Financial Protection (also known as CFPB), FHA issued guidance to lenders that explained their responsibilities for meeting both HPML and FHA requirements. Some of the literature we reviewed and mortgage industry observers we spoke to suggested that FHA assess premiums using “risk-based pricing.” Risk-based pricing takes into account borrowers’ risk attributes such as credit score, DTI ratio, product type, and LTV ratio. As described earlier, FHA’s current premiums are based on the size and term of the loan and the LTV ratio and do not consider credit score and other risk factors, a practice FHA refers to as “average pricing.” Using this method, low-risk borrowers pay the same actual price for insurance coverage as high-risk borrowers. For example, all FHA borrowers with loans at or below $625,500, LTV ratios less than or equal to 95 percent, and terms of greater than 15 years pay the same premiums, even though other measures of risk, such as credit scores, indicate that they represent a variety of risks. Risk-based pricing could address the adverse selection problem that is a possibility under average pricing (that is, when premiums charged do not align with the actual risks of borrowers so that low-risk borrowers are charged too much for insurance and thus seek it elsewhere). One mortgage industry observer also noted that it would more accurately align FHA’s revenues with its potential claims. Conversely, others have argued that risk-based pricing would place FHA in the position of having to raise the mortgage financing costs of borrowers with weaker credit. To the extent that relatively low-risk borrowers might face lower premiums, they likely would not leave FHA. But other borrowers could face higher premiums, and those who could not qualify either for an FHA or conventional mortgage could be priced out of the market. For example, in 2007 we found that an FHA proposal to implement risk-based pricing would have affected the availability of FHA insurance for about 20 percent of the home purchase borrowers that FHA insured in 2005. This group would not have qualified for mortgage insurance under the parameters of the proposal because of high LTV ratios and low credit scores. FHA officials said that they are aware that the agency risks losing some lower-risk borrowers under its current pricing scheme. Therefore, they said that the agency has set pricing so that it covers the expected losses of the highest risk loans that its underwriting permits, with the idea that if FHA were to face increasing competition for its lower-risk borrowers, it would be charging a sufficiently high premium to cover expected losses on all newly insured loans. Proposed Changes That Restrict the Borrowers FHA Serves Would Affect the Agency’s Role in the Mortgage Market As noted earlier, FHA’s share of loan originations has increased in recent years. During 2006, FHA insured approximately 4.5 percent of purchase mortgages. At its peak in 2009, it insured 32.6 percent of purchase mortgages, and in 2012 still insured 26.1 percent of purchase mortgages originated that year. Mortgage industry observers have proposed options that would limit FHA’s market presence as a way of either reducing FHA’s liability or better ensuring that it serves a certain market—that is, low- or moderate-income borrowers and first-time homebuyers. These options include changes that would have a direct effect on FHA’s market share, such as reducing loan limits from current levels and determining borrower eligibility based on income. Options that could have an indirect effect on FHA’s market presence include reducing FHA’s insurance coverage to less than 100 percent of the value of the loan and entering into risk- sharing agreements with private partners. Concerns have been raised that options affecting FHA’s market presence might also affect its ability to serve its traditional countercyclical role to stabilize the housing market during times of increased stress or credit contraction. Reducing Loan Limits Could Focus FHA on Low- to Moderate-Income Borrowers and Reduce Its Market Share Congress raised the loan limits on FHA-backed forward mortgages following the recent housing crisis and has continued to extend the higher limits. Currently, the loan limits vary by county, ranging from $271,050 to $729,750 for one-unit properties in the contiguous United States. These limits are set to expire on December 31, 2013. Mortgage industry observers have recommended that FHA’s loan limits be lowered to reduce FHA’s market share. Some recommend reducing the loan limits to what they were prior to the crisis, while others propose reducing them further. FHA data show that large loans are a small portion of FHA’s loan pool. Loans that exceeded $450,000 (somewhat higher than the national conforming loan limit) comprised only 4 percent of active FHA loans as of October 31, 2011. As of this date, 82 percent of FHA’s active pool included loans with a balance of $271,050 or less. Because of the small number of high-value loans that FHA has endorsed, a reduction in loan limits might not have a large effect on its overall market share. However, for certain high-cost markets, a reduction in FHA’s loan limits would have a greater impact. For example, according to FHA, in fiscal year 2012 about 24 percent of the loans FHA insured in Hawaii and about 10 percent of those it insured in California exceeded $450,000. Further, more than half of the loans over $450,000 endorsed during this time period were for properties located in California. We previously found that a possible reduction in the conforming loan limit could result in certain homebuyers in high-cost markets such as California needing to either provide a larger down payment or seek alternate financing. Industry observers have proposed approaches to reducing the current loan limits. For example, one researcher suggests limiting loans to no more than 100 percent of county median house price. The Mortgage Bankers Association (MBA) testified that Congress should allow the current limits to expire at the end of 2013 and reduce the loan ceiling to match the enterprises’ conforming loan limits. FHA officials said that at the end of 2013 the loan limits would return to the levels established in HERA—limits that FHA has determined are appropriate for 2014. Further, a reduction in loan limits would allow FHA to focus on low- to moderate-income borrowers and first-time homebuyers, the groups that many industry observers see as FHA’s traditional market. In a February 2013 report, the Bipartisan Policy Center Housing Commission stated that a key objective for FHA should be to return to what it sees as FHA’s traditional mission of serving primarily first-time homebuyers—something that could be achieved in part through a gradual reduction in loan limits. A number of observers suggest that FHA is serving a population of borrowers far beyond those targeted by its traditional mission. For example, one observer noted that reducing FHA’s loan limits by approximately 50 percent would still enable the agency to reach its intended population of first-time, minority, and low-income borrowers. Observers also noted that loan limits act as a proxy for income, with lower limits focusing FHA’s efforts on low-wealth borrowers. As noted above, about 78 percent of FHA-insured loans went to first-time homebuyers in 2012. Bipartisan Policy Center Housing Commission, Housing America’s Future. serious delinquency rates among loans with the highest balances (6 percent and 4 percent, respectively, of all active loans over $625,000 as of October 31, 2011). In contrast, loans under $271,000 had a delinquency rate of 17 percent and a serious delinquency rate of 9 percent. Factors other than loan size could contribute to these delinquency rates. For example, FHA officials noted that many high-value loans were endorsed following the housing crisis when the economy had improved and may perform better as a result. FHA officials could not point to analysis that would support the argument that high-value loans, all else being equal, perform any differently than smaller loans in terms of default, or the severity of the resulting losses. Nonetheless, FHA officials stated that a broader pool of insurable loans helps to better manage portfolio risk. According to a number of industry observers, by reducing loan limits the agency would effectively step back from the high-wealth market, allowing private lenders to step back into the market during the recovery. Some industry observers have raised concerns about FHA crowding out private capital. They note that lower loan limits would not have a significant effect on FHA lending but would allow high-wealth buyers to be served in the conventional market, a shift they consider appropriate at this time. However, some industry observers have noted that the higher loan limits, which have been in effect since 2008, have allowed FHA to fulfill its countercyclical role of providing credit to borrowers when the private market was generally frozen. One organization stressed that the housing recovery was not complete, that lending remained constrained in many markets, and that Congress should be cautious about lowering loan limits. Industry observers also note that the elevated loan limit was particularly important in high-cost markets and that FHA continues to serve a significant role in these markets today. One observer argued that the relatively low FHA loan limits in effect prior to the crisis limited FHA’s presence in high-value areas that suffered a more severe contraction during the housing crisis, which helped mitigate FHA’s losses. Some said that FHA loan limits should be relatively constrained during most years, but raised when needed to provide stability in housing finance. Others noted that whatever loan limit FHA might use, it should be adjusted to allow for the variability in home prices across the country. FHA told us that it needs to have the flexibility to alter market-limiting policies—for example, by reinstating high loan limits quickly—to properly execute its countercyclical role. Eligibility Limits Based on Income Rather Than Loan Amount Would Target Lower-Income Borrowers, but Could Also Restrict Access to Credit Some mortgage industry observers have suggested that eligibility should be based on borrowers’ income in order to refocus FHA on its traditional role of providing mortgage credit to low- and moderate-income borrowers. FHA data show that 64 percent of its purchase loans and 47 percent of its refinance loans in fiscal year 2012 were made to low- and moderate-income borrowers. As shown in figure 4, the income levels of borrowers approved for purchase loans have varied over time. During the recent housing crisis, the proportion of FHA-insured mortgages made to low-income borrowers dropped substantially just as the proportion to high-income borrowers increased. Between 2005 and 2008, the share of FHA borrowers that had low incomes dropped about 16 percent, while the share that had high incomes increased about 14 percent. FHA has continued to endorse a larger proportion of high-income loans through 2012. These shifts are consistent with the increased loan limits in effect during the period. That is, loan limit increases expanded FHA’s portion of the market that would be sought after by households with relatively higher income. According to some of the literature, income limits would affect the market that FHA serves, targeting FHA’s guaranty to low- and moderate-income borrowers. In recent congressional hearings, industry observers encouraged a system of assessing borrowers according to area median income targets to determine program eligibility.on reforming the housing finance market that was developed by the U.S. Department of the Treasury (Treasury) and HUD, the administration presented one option for reform that would strictly limit FHA eligibility to In a 2011 white paper low- and moderate-income borrowers, leaving the risk for high-income borrowers to the private market. A change to income-based eligibility could restrict certain borrowers’ access to credit. In its white paper, the administration cautioned that some borrowers, who may be ineligible when their income exceeds a threshold, may find it difficult to afford the cost of a conventional 30-year fixed-rate mortgage. Observers point to the additional costs, such as higher premiums and interest rates, that some borrowers might face if they must seek conventional mortgage insurance. Multiple observers have noted that even borrowers with relatively strong incomes have difficulty accumulating sufficient savings for a down payment, especially in high-cost areas. Several industry observers and FHA said that a system of income verification to determine FHA eligibility would also be difficult to implement. For example, one observer we interviewed noted that FHA’s current loan application process required prospective borrowers to provide documentation of qualifying income, but said that additional sources of income were not considered. According to this observer, if maximum income levels were in place, lenders would have to gather documentation for all income sources and assess the borrower’s income against all liabilities and expenses, which could give borrowers an incentive to under report income. FHA officials told us that basing eligibility on income would create compliance risks for lenders and would be time consuming. Yet another industry observer added that income verification could also affect lenders’ behavior, making them fearful of increased liability under indemnification agreements if they failed to correctly identify all borrower income to verify a borrower’s eligibility. The FHA Commissioner noted that income verification was difficult to implement in other programs, such as the Low-Income Housing Tax Credit Program.limits, could help FHA focus the market it served. FHA officials told us that loan limits, rather than income Further, while income limits could be structured to vary by geographic area, as loan limits now do, implementation could be difficult. Some observers described to us the complexity of implementing and monitoring income limits that vary by geographic area, and one suggested that a national income ceiling rather than income limits set by area median income might be a more expedient policy. FHA officials and industry observers told us that determining program eligibility based on appropriate loan limits is an effective substitute for income limits in order to target the program to low- and moderate-income borrowers. Some observers have further argued that limiting eligibility based on income could affect FHA’s ability to manage credit risk. Some argue that FHA-insured loans made to borrowers with higher income perform better than loans to lower-income borrowers. However, we have not seen analysis that would support the argument that income alone is a predictor of credit risk. Limiting eligibility based on income may reduce the number of insured loans, which could constrain FHA’s ability to manage risk. An industry observer noted that FHA was intended to be more universally available than a program for only the lowest-risk borrowers might be. FHA officials noted the importance of maintaining a broad-based insurance pool. FHA officials also stated that they were not aware of studies concluding that serving only low-income borrowers would improve the agency’s financial condition. Finally, this option could limit FHA from serving its countercyclical role in the future. In its white paper, the administration warned that reducing FHA’s market share too much—for example, by serving only low- and moderate-income borrowers—could affect its ability to ensure access to capital during a crisis. The paper emphasized that without sufficient government support to mitigate a credit crisis, downturns could be more severe, increasing costs to the taxpayer. Reducing FHA’s Insurance Coverage Would Reduce Losses, but Might Not Protect Taxpayers and Could Increase Costs for Borrowers Currently, FHA insures 100 percent of the principal balance of the loan involved in a claim and other eligible costs. Some mortgage industry observers have suggested that FHA’s loan coverage be reduced in order to limit FHA’s risk and market share. VA’s guaranty program is often cited as a model, as it insures only 25 to 50 percent of the original principal in the case of a default. Various levels of reduced loan coverage have been suggested for FHA, ranging from 90 percent coverage, which some observers say would have little impact, down to 25 percent coverage. Industry observers proposing this change point to a reduction in taxpayer risk as a key benefit. They argue that a lower level of insurance coverage would reduce FHA’s liability for defaulted loans by reducing the severity of the agency’s loss. We have also found that a reduction in insurance coverage could have a beneficial effect on the Fund. In May 1997, we examined the potential effects of reducing FHA’s insurance coverage and found that lower coverage would reduce both the volume of FHA-insured loans and income from premiums but would also reduce FHA’s losses and ultimately have a beneficial effect on the Fund. Others have noted that a reduction in loan coverage could provide lenders an incentive to improve underwriting quality, thus reducing the risk of default. Some have cited the relatively superior delinquency and default rates in the VA program as evidence of careful origination by lenders that must assume some credit risk for VA-guaranteed loans. Nonetheless, it is important to note that VA limits its eligibility to veterans who have served in a branch of the armed services and received an honorable discharge, certain currently serving members of the Reserves or National Guard, and spouses of veterans under certain circumstances. It therefore starts with a universe of eligible borrowers that are different from the population that might seek an FHA-insured mortgage. Also, as mentioned in the previous section, VA underwriting differs somewhat from that of FHA, with greater attention given to the veteran’s residual income. Further, the VA program provides supplemental servicing to borrowers that face difficulty making mortgage payments. These and other differences need to be considered before it can be concluded that differences in insurance coverage explain the differences between VA and FHA default rates. Industry observers also discussed the impact of a reduction in insurance coverage on borrowers’ access to credit. Because lenders would be exposed to additional risk, they could increase fees and interest rates, which some industry observers noted in testimonies to Congress. Also, for some lenders the additional exposure might prompt the purchase of additional insurance coverage from third parties, the cost of which could be passed on to borrowers. We have reported that without the guaranty for FHA-endorsed mortgages, lenders would likely make fewer and more costly loans, making homeownership more expensive, limiting borrowers’ access to credit, and reducing FHA’s presence in underserved communities.underwriting criteria or increased fees and interest rates, high-risk borrowers would be disproportionately unable to access FHA-endorsed mortgages. We found that reducing insurance coverage would limit FHA’s ability to stabilize distressed communities and housing markets during regional economic downturns. Our analysis showed that if lenders imposed stricter Further, some industry observers testified to Congress or told us that reduced FHA insurance coverage could simply transfer taxpayer risk from FHA to Ginnie Mae. That is, any additional risk borne by the lender would pose additional risk to Ginnie Mae as the guarantor of the securities issued by that lender. This risk would require Ginnie Mae to provide more intense monitoring of its counterparties’ financial condition, potentially increasing the fees it required to provide its guarantee. FHA officials agreed that Ginnie Mae would assume additional counterparty risk with a reduction in coverage. Ginnie Mae officials noted that issuers would likely seek additional third-party assurance, most likely through additional mortgage insurance, to manage the additional risks they might face. As a result, borrowers could face further costs. Issuers could also take other steps, such as limiting the amount of FHA-insured lending they would permit or overlaying additional credit requirements, which would limit their participation in the program. In addition, MBA testified that this option would limit the ability of independent mortgage bankers and other small lenders to manage risk. It noted that small mortgage lenders were not structured to take on large amounts of credit risk and might restrict credit to borrowers, or leave the mortgage industry. Other observers note that reducing FHA’s loan coverage would facilitate the return of private capital. For example, one stated that the 100 percent coverage that FHA provides combined with its expanded market share created a barrier to the reentry of private capital to U.S. residential mortgage finance. The same observer noted that capital regulations and other requirements strongly favor obligations with a government guarantee over those supported by private capital. Proposals for Entering into Risk-Sharing Agreements with Private Partners Vary FHA does not currently engage in single-family risk sharing. To protect the taxpayer by sharing risk with the private market, various industry observers have suggested that the agency explore this option. In 2002, the Millennial Housing Commission recommended that Congress authorize FHA to initiate single-family risk-sharing demonstration programs, stating that FHA should have broader authority to choose its partners, loss position, and types of credit enhancements (including reinsurance as well as insurance or reinsurance on pooled loans). The report also stated that while FHA could absorb risk better than private lenders, potential partners could have superior risk assessment and management systems and might be able to provide access to new products and delivery systems targeting communities with underserved borrowers that FHA did not yet reach. In 2007, we found that a public- private risk-sharing arrangement would recognize the government’s ability to spread risk. We also found that private mortgage industry participants generally were more flexible and responsive to market pressures and better able to innovate and adopt new technologies quickly. Industry observers have continued to promote various forms of risk sharing to improve FHA’s financial condition. Two main approaches for risk sharing have been proposed by industry observers: Coinsurance. This approach would create agreements between FHA and private mortgage insurers. The private mortgage insurer would conduct an independent underwriting of the borrower and the mortgage being sought. If the borrower and the mortgage underwriting terms met the conditions that both FHA and the private insurer agreed on, the private insurer would take the first loss on the loan, and FHA would cover the remaining loss. One industry observer suggested that the agency should reduce taxpayer risk by assuming losses only after private partners absorbed first losses of 25 to 35 percent. Another risk-sharing arrangement between FHA and other partners could be a model similar to FHA’s Multifamily Risk-Sharing Programs through which the agency shares proportional risk at varying levels between 10 and 90 percent with Fannie Mae, Freddie Mac, and housing finance agencies among others. Reinsurance. Large portfolio lenders and the enterprises will at times enter into reinsurance contracts with approved counterparties to sell portions of credit risk in their loan portfolios. According to a private mortgage insurer testifying before a congressional committee, this approach has the benefit of minimizing impacts on lenders and the potential to be implemented more quickly than a coinsurance arrangement. The representative noted that FHA should have the flexibility to selectively test such arrangements. Risk sharing could affect taxpayers’ risk, according to industry observers. It could protect the taxpayer, not only because private partners would assume some of the risk but also because the quality of the underwriting might improve because private partners would want to minimize the likelihood of loss. However, to the extent that FHA would offer both full mortgage insurance and engage in risk sharing, it could be subject to adverse selection. That is, private partners could seek relatively low-risk borrowers for the shared-risk product, leaving FHA with the riskiest borrowers. One report notes that under risk-sharing agreements, private partners may act in other ways that are contrary to FHA’s interest. For example, according to this report, if FHA takes only a catastrophic loss position, the partner may have little incentive to minimize FHA’s losses once the partner’s maximum exposure level has been reached. Sharing risk on a pro rata basis, starting with the first dollar of loss and ending with the last dollar of loss, creates stronger incentives for FHA’s risk- sharing partners to use sound underwriting terms and service their loans diligently. We have found that this is particularly true when there is a more equal division of risk. If FHA agrees to assume the first portion of loss on default, the partner may not feel the need to protect against a high incidence of claims as long as the loss severity is not expected to reach its maximum level of exposure. The partner would also need to be sufficiently capitalized or otherwise protected to withstand its portion of the loss. Also, one observer warned that FHA would be at risk because it lacked the capacity to analyze risk-sharing proposals, which could place it in a weak position with partners. Consistent with this, FHA officials told us that FHA would need to increase its staff and analytic capacity to safely implement risk-sharing agreements. Risk sharing would also affect the role that Ginnie Mae plays in guaranteeing timely payment of principal and interest on mortgage- backed securities. That is, like reducing FHA’s loan guarantee coverage below 100 percent, risk sharing changes the nature of Ginnie Mae’s exposure to counterparty risk, according to observers. Ginnie Mae would need to undertake assessment of a new class of counterparties—the private partner providing the insurance coverage—while continuing to assess the counterparty risk of its issuers, one observer noted. Ginnie Mae officials confirmed that any FHA risk-sharing agreements would increase the agency’s counterparty risk and noted that they would probably require issuers to hold more capital to mitigate this risk. One paper emphasized that risk sharing would also require FHA to monitor counterparty risk and provided a number of approaches for doing so. Ultimately, any risk-sharing arrangement would need to carefully consider the structure of premiums and the way they were shared between parties. Identifying the type and level of premium needed by the federal government requires considering not only expected losses from loans that default and losses exceeding a predetermined level, but also unexpected losses from infrequent but costly adverse market conditions on both the national and regional level. Some argue that the federal government would still absorb catastrophic risk regardless of how risk sharing and premiums are structured. In this case, FHA would need to receive premiums across a broad spectrum of the market. In addition, like other options for improving FHA’s viability, risk sharing could impact other mortgage market participants and reduce borrowers’ access to credit, according to observers. Depending on how FHA structured risk sharing, including how widely it would be applied to FHA’s future endorsements, this option could reduce participation by smaller mortgage lenders, particularly community banks, which might have difficulty meeting the eligibility criteria for such a program, according to some industry observers. Others have expressed concern that risk sharing could raise the cost of the mortgage credit, as private investors would demand a market rate of return. While this trade-off might be viewed as acceptable in terms of improved underwriting, in times of market contraction risk sharing could significantly raise the cost and limit the availability of credit to borrowers, according to one observer. That is, FHA’s role in stabilizing mortgage markets could be affected by its partners’ willingness to continue underwriting during market contractions. This may limit FHA’s ability to serve as a countercyclical force during such national or regional housing downturns. Some of the literature we read stressed the importance of FHA serving a countercyclical role, as it has in the past, including by mitigating the effect of the 2007-2009 financial crisis on the housing market. One observer cautioned that broad changes, such as risk sharing, applied to FHA’s entire portfolio, or too quickly implemented without a full understanding of the potential effects of the change, could reduce its flexibility to adjust to larger housing market shifts. Others have stated that risk sharing might constrain the agency’s countercyclical flexibility because FHA and its private partners might not have the same incentives. During a downturn, private partners in risk-sharing arrangements would likely lack the incentive to serve deteriorating markets. Further, if FHA could endorse only loans that involved a private partner, a contraction of private credit could prevent it from expanding when such action was needed most. Another observer encouraged a small, discretionary or piloted approach to any risk-sharing program, suggesting that it was not necessary to make this option mandatory for each new endorsement. FHA officials cautioned that risk sharing should only be considered in the context of broad mortgage market reform, which has yet to be resolved. Greater Operational and Managerial Powers Could Give FHA Greater Flexibility but Could Limit Congressional Direction Although FHA is a wholly owned government corporation within HUD, it does not have the corporate powers other government corporations have. Some mortgage industry observers have suggested that making FHA an independent government corporation—more autonomous from HUD— could give it greater operational and managerial flexibility and the ability to be nimble when faced with changes in the housing market or problems in its programs. For example, FHA could have enhanced enforcement powers, greater authority to make changes to program requirements, and additional authorities to invest in technology and staff. Some of these authorities would bring FHA’s corporate powers more in line with other government corporations. However, FHA and others said that these flexibilities could be implemented within FHA’s existing organizational structure. But even within the existing structure, many of these options would require congressional action to implement. Further, these reform options are not mutually exclusive—that is, one or more options could be implemented—and implementation of these options would involve trade- offs between, for example, congressional direction and agency flexibility, or between efforts to minimize costs to borrowers and to make the program self-sustaining. Making FHA an Independent Government Corporation Could Provide It with More Flexibility Some mortgage industry observers have suggested that making FHA an independent government corporation could increase its flexibility to respond to changing market conditions and mitigate risks. FHA is a wholly owned government corporation within HUD but does not have some of the powers that other government corporations have. Specifically, Congress sometimes exempts government corporations from key management laws to provide them with greater flexibility than federal departments and agencies typically have in hiring employees, paying these employees competitive salaries/benefits, disclosing information publicly, and procuring goods and services. In 1995, we assessed the extent to which FHA and other government corporations had to comply with 15 selected federal statutes. FHA reported that it had to comply with 14 of the 15 federal statutes, while other government corporations reported greater flexibility. For example, Amtrak reported full adherence to two statutes. In addition, when FHA was moved within HUD in 1965, Congress assigned the corporate powers of FHA to the Secretary of HUD, who has delegated them to the Assistant Secretary for Housing/FHA Commissioner. Some observers have suggested that one way to give FHA increased flexibility would be to increase its corporate powers. For example, a 1994 National Academy of Public Administration study stated that FHA’s commissioner did not have the flexibility to adjust FHA products to respond to changing market conditions, such as fluctuating interest rates, and that the commissioner had to operate within the budgeting and administrative parameters of a traditional federal agency. The report recommended that Congress transfer the corporate powers of FHA from the HUD secretary to the corporation, permitting it to function with greater operational autonomy within HUD. It also recommended that Congress vest management of FHA in a single administrator appointed by the President, with Senate confirmation for a 6-year term of office. Under this proposal, the administrator would be compensated at the same level as the chief executive officer of comparable government corporations. In 2002, the Millennial Housing Commission made a similar proposal, but its proposal would combine FHA and Ginnie Mae and establish a corporate board of directors.structures. Recently, some observers have suggested similar Other observers have suggested moving FHA outside of HUD. For example, one paper suggested organizing FHA as an independent government agency, a government-sponsored enterprise, or even a privatized entity structured as an assigned risk pool that would spread risk for otherwise uninsurable borrowers across insurance carriers in proportion to the size of their portfolios. According to the author, any of these structures could make underwriting, pricing, and administration more efficient while achieving what he viewed as the agency’s social objectives of providing credit enhancements through insurance to serve otherwise marginal low-income, first-time, and often minority homebuyers. He further stated that the FHA commissioner should have an appointment independent of HUD and for a term that would extend beyond a single administration term. Another observer testified that setting up FHA outside of HUD would reduce incentives for future administrations to impose policies on FHA that limited its flexibility and increased risks. However, two observers we interviewed said that making FHA an independent corporation outside of HUD would make it more difficult for Congress to hold it accountable. FHA, which was created in 1934, operated outside of a cabinet department for decades before becoming part of HUD, which was created in 1965. In addition, some people we interviewed said that FHA should remain affiliated with HUD so that it could collaborate closely with other department offices on housing policy and remain part of a cabinet-level agency. According to the literature, making FHA more autonomous could provide it the flexibility to determine the best way to meet policy goals set by Congress or HUD and mitigate risk. For example, in a congressional testimony an observer suggested that FHA be provided the authority, without further congressional action, to create or alter specific insurance programs. Such authority, the observer argued, would enable FHA to react promptly to changes in market and other conditions. In addition, the observer stated that hiring, salaries, personnel management, and procurement could be freed from federal government constraints in order to be more consistent and competitive with the private sector. Some of the literature we reviewed noted that FHA had exercised greater control over its resources when it was independent of HUD. However in June 2007, we found that making FHA an independent government corporation could have budgetary and oversight implications that would need to be considered. For example, Congress would have to determine the extent to which (1) the corporation’s earnings in excess of those needed for operations and reserves would be available for other government activities and (2) the corporation would be subject to federal budget requirements. Also, if the corporation were created outside of HUD, Congress would have to consider whether oversight of the corporation would require a new institution or could be done by an existing organization. In addition, an observer said that making FHA an independent government corporation or providing it with certain flexibilities, such as powers to change its products, could make FHA loans more attractive to borrowers who should be served by the private sector. Although such autonomy would also permit FHA greater capacity to manage risk, two observers we interviewed suggested that any additional autonomy or flexibility should be accompanied by clear direction on FHA’s mission to serve borrowers not otherwise served by the private sector. FHA Could Gain Greater Flexibility without Changing Its Organizational Structure FHA and others have said that although making the agency an independent government corporation could increase the agency’s flexibility, the agency could be given increased flexibility without such changes. For example, mortgage industry observers have suggested giving FHA enhanced enforcement powers, greater authority to make changes to program requirements, and additional authorities to invest in technology and staff. Many of these options would require congressional action to implement. Notwithstanding the potential benefit and costs of these options, there are a number of steps that FHA could undertake under its existing authority, including actions we have previously recommended. In order to originate FHA-insured loans, lenders must be approved by FHA to participate in its mortgage insurance programs. Virtually all of the lending institutions approved to participate in FHA’s single-family mortgage insurance programs have direct endorsement authority, meaning that they can underwrite loans and determine their eligibility for FHA mortgage insurance without HUD’s prior review. Direct endorsement lenders can apply to participate in the Lender Insurance Program, which enables high-performing lenders to approve mortgages for FHA insurance without a pre-endorsement review by HUD. To hold lenders accountable for program violations or poor performance, FHA may (1) suspend their direct endorsement authority, (2) terminate their loan origination or underwriting authority through its Credit Watch program, or (3) take enforcement action through the Mortgagee Review Board. In its proposed budget for fiscal year 2014, FHA requested a number of additional enforcement powers. Specifically: Since 2010, FHA has asked for enhanced indemnification authority for direct endorsement lenders. Currently, FHA has authority to require indemnification only for lenders that participate in FHA’s Lender Insurance Program. According to FHA, granting the agency this authority would enable it to obtain indemnification from all of its approved lenders for loans that do not comply with its guidelines. Legislation proposed in March 2013 includes a provision intended to address this issue. HUD may terminate a lender’s approval to originate or underwrite FHA-insured loans in a specific geographical area if a lender’s branch office default and claim rate exceeds the established Credit Watch Termination thresholds. However, FHA is also seeking authority to terminate origination and underwriting approval on a broader geographic basis, stating that such authority would enhance its ability to review lender performance. If a lender was found to have an excessive rate of early defaults or claims, FHA would have greater flexibility in terminating the lender’s ability to originate or underwrite single-family mortgages for FHA insurance. FHA has been seeking this authority since 2010. Again, the 2013 proposed legislation includes such a provision. To help make loss mitigation more effective, FHA is seeking authority to, on a case-by-case basis, transfer servicing of loans to institutions better equipped to reduce losses.allow FHA to require any of the following actions when a servicer underutilized FHA’s loss-mitigation tools or the agency deemed the action necessary to protect the interests of the Fund: (1) transfer servicing from the current servicer to a specialty servicer designated by FHA; (2) require a servicer to enter into a subservicing arrangement with an entity identified by FHA; or (3) require a servicer to engage a third-party contractor to assist in some aspect of loss mitigation such as borrower outreach. According to FHA, such authority would permit the agency to better avoid losses from poor servicing of FHA-insured loans, yielding better results for borrowers and FHA. Specifically, this authority would Finally, FHA is seeking greater flexibility in establishing the metrics it uses to compare lender performance so that it can more effectively assess lender performance during all market conditions. As discussed previously, FHA is currently required by statute to compare lenders’ default and claim rates by geographic area. With enhanced authority to set alternative performance metrics, FHA said it would be able to compare a lender’s rate of early defaults and claims (for insured single-family mortgage loans) with the rates of other lenders on any basis determined appropriate. Examples of metrics include geographic area, varying underwriting standards, or populations served. The majority of the observers we interviewed said that FHA needed authority for enhanced enforcement actions. For example, some said that FHA needed these additional powers to more effectively manage risk and avoid unnecessary losses. Others suggested additional options—for example, requiring lenders to take back loans that defaulted within the first 6 months. However, one observer said that the prospect of tough administrative and legal actions already provided strong incentives for lenders to carefully follow FHA program guidelines. Two stakeholders we interviewed stated that increased scrutiny of lenders by FHA and others had increased concern among lenders about the risks of litigation. As a result, lenders have moved to further restrict credit in recent years. Many FHA lenders have taken the step of imposing additional requirements (known as credit overlays) on FHA loans, potentially making it more difficult for borrowers to obtain FHA loans. FHA and some mortgage industry observers have suggested that the agency should have more authority to make changes to program requirements, including emergency powers. Currently, FHA must go through the rulemaking process or seek legislative authority to make major changes to its programs. For example, after problems with loans with seller-funded down-payment assistance were identified, it was several years before these loans were disallowed. HUD’s latest annual report on the Fund noted that the effect of loans with seller-funded down- payment assistance on the Fund was expected to be more than $15 billion in losses. Problems associated with these loans are well documented. A March 2005 HUD contractor study found that property sellers who provided down-payment assistance through nonprofits often raised sale prices of the homes involved to recover the required payments that went to the organizations. As noted previously, in November 2005, we also found that loans with this type of assistance had inflated prices and defaulted more often than loans without such assistance.funded down-payment assistance. Subsequently, the rule was struck down by the courts on procedural grounds. Congress ultimately prohibited the use of this assistance in January 2009. In October 2007, FHA published a rule that prohibited seller- FHA is currently trying to address losses from its HECM program (reverse mortgages that permit persons 62 years and older to convert their home equity into cash advances), but has not been able to make programmatic changes that it has determined might stem them. In a testimony on HUD’s fiscal year 2014 proposed budget, the Secretary attributed the potential need for $943 million in permanent and indefinite budget authority for the Fund in fiscal year 2013 to losses in the HECM program. FHA has proposed a number of changes to the HECM program, such as mandating the use of escrow accounts to ensure continued and timely payment of property charges, including taxes and insurance. However, FHA officials said that the average time for a rulemaking of this type was about 18 months—a length of time that exposed the agency and the Fund to risks that could be avoided if, for example, it could make changes through a mortgagee letter. Recently, FHA was provided authority to establish through mortgagee letters any requirements that HUD “determines are necessary to improve the fiscal safety and soundness” of the HECM program. FHA officials told us that a mortgagee letter could be issued within 30 to 60 days. Another approach to dealing with the issue would be to limit the ability of borrowers to withdraw up-front the maximum amount allowable under the program. HUD noted that the vast majority of borrowers in the HECM program take out 80 percent or more of the maximum amount possible in one initial cash draw, and that this increases the likelihood that they have insufficient funds to pay items such as property taxes. In its November 2012 annual report to Congress, FHA announced that it would take immediate action to reduce the amount borrowers are permitted to draw out at the time of origination of their HECM loan. The report notes that the change would protect FHA from losses and reduce the likelihood of borrower default due to nonpayment of taxes and insurance. Although FHA points to other actions that will be needed to reform the HECM program, this example demonstrates the importance of FHA exercising the authority it already has. Several proposals have been put forward that would increase FHA’s ability to make changes to its programs. One observer has recommended that Congress give the HUD secretary special emergency powers to suspend FHA insurance programs or make emergency modifications to a program when the HUD secretary finds that current program terms expose the taxpayers to an elevated risk of loss and fail to serve the public interest. In addition, a paper that lays out the current administration’s plan to reform the nation’s housing finance market stated that the administration should work with Congress to give FHA more flexibility to respond to stress in the housing market and manage its risk more effectively. It added that doing so would mean giving FHA flexibility to adjust fees and programmatic parameters more quickly than it can today. Regardless, two observers pointed to the need for offsetting any additional flexibility that might be afforded to FHA with clear limits to this authority, such as limits on the duration of such changes absent a formal rulemaking process. Two observers we interviewed expressed concern about giving FHA greater authority to make significant program changes, stating that such authority should be reserved for Congress. One noted that during the recent housing crisis Congress showed that it was able to act quickly to change FHA program requirements when needed by increasing the loan limit requirements. Also, he told us that FHA did not need congressional action to change its programs. For instance, FHA could create an interim rule to quickly handle a problem while going through the official rulemaking process to make a permanent change. Similarly, the other observer said that FHA could make some changes through mortgagee letters and the rulemaking process. However, according to FHA, HUD’s Office of General Counsel has advised that not all procedures or policies may be changed by interim rule and interim rules can be particularly sensitive to litigation and a legal stay. Thus it is the General Counsel’s opinion that statutory authority is often the safest and fastest route to make changes. FHA has reported that the more than 40 information systems its single- family programs use are outdated, unable to sustain the increasing volume of insurance applications, and costly to maintain. In addition, recent increases in FHA’s business volume have exacerbated its information technology (IT) constraints. A consultant FHA hired to examine technology constraints and identify risks related to processing workloads (for single-family programs) reported in 2009 that critical elements of IT infrastructure were at capacity, causing work slowdowns and poor customer service. For example, network overloads slowed systems in the afternoon, when work hours overlapped at the homeownership centers (which are in different time zones). To partially address these issues, HUD upgraded the mainframe’s system capacity and made changes to certain applications to improve response time. Nevertheless, during a period in which transaction levels continued to increase, FHA had reached the limit of hardware and software capacity on IT systems. Moreover, the audit of FHA’s 2011 and 2012 financial statements identified a significant deficiency related to IT systems and stated that FHA management and the HUD Office of the Chief Information Officer should mitigate persistent IT control deficiencies. The audit report noted that expensive and manual compensating controls, including monthly reconciliations of data among the interfaced systems, were needed to manage the numerous systems and that security and access controls had weaknesses. We found in November 2011 that the large number of systems resulted in hundreds of interfaces, which meant that changing one system required extensive effort to maintain the interfaces across systems. The multiple systems and interfaces also presented challenges for maintaining appropriate accessibility levels, security controls, and privacy standards. To address system constraints, FHA has initiated the FHA Transformation Initiative to improve FHA’s management of insurance programs through the development and implementation of a modern financial services information technology environment that is expected to improve loan endorsement processes, collateral risk capabilities, and fraud prevention. For fiscal years 2010 and 2011, HUD reported that the Transformation Initiative funding made available was $58.5 million. According to FHA, the agency maintains an aggressive, robust, and varied project management and applications development portfolio aimed at deploying new and modernizing existing mortgage insurance capabilities and business processes. In June 2013, we found that HUD had not yet fully implemented key project management practices in executing and managing the IT projects associated with the FHA Transformation Initiative. Specifically, while the department had developed project management documents such as charters and requirements management plans, none of these documents included all of the key details that could facilitate effective management of its projects such as full descriptions of the work necessary to complete the projects, cost and schedule baselines, or prioritized requirements, among other things. A lack of project management expertise along with HUD’s inadequate development and use of a project management framework and governance structure contributed to these deficiencies. Therefore, we recommended that HUD establish a plan of action to fully implement best practices, provide needed project management expertise, and improve the development and use of its project management framework and governance structure. HUD agreed with our recommendations to improve its framework and governance, but did not agree with the entirety of the recommendation to develop a plan of action or the need for providing project management expertise. The department described actions it would take to improve its project management practices in order to address the deficiencies identified. However, some mortgage industry observers said FHA should be provided with additional funding to enhance its information technology. The congressionally appointed Millennial Housing Commission found that FHA’s dependence on the appropriations process for budgetary resources and competition for funds within HUD had led to underinvestment in technology, increasing the agency’s operational risk and making it difficult for FHA to work efficiently with lenders and other industry partners. Some observers we spoke with also cited competition for funds within HUD, and most supported providing FHA additional funding for these enhancements. One benefit of this option is that the technology enhancements could improve FHA’s operations. For example, an observer said that it supported the recent efforts that FHA had taken to improve its risk management and protect the safety and soundness of the agency, but added that these efforts could not be sustained without, among other things, state-of-the-art technology. FHA officials also told us that the agency’s limited resources meant implementing technology improvements using a piecemeal approach, although it would be better if FHA could upgrade and integrate all of its systems at the same time. Specifically, the agency stated that sustained and timely funding through using receipts or direct appropriation would enable FHA to budget and procure support and services more strategically, systematically, and consistently. In the current budget environment, funding for technology enhancement is limited. FHA technology investments must compete with other HUD technology investments. Some observers argue that FHA should be granted the authority to use a portion of its insurance premiums for technology enhancement. In a June 2007 report on FHA modernization, we found that Congress could grant FHA specific authority to invest a portion of the Fund’s current resources—that is, negative subsidies that accrue in the Fund’s reserves—in technology enhancement. However, FHA has not met its statutory capital ratio requirement since 2009 and using premium income for technology enhancement would further reduce the ratio. Even in more prosperous times, using the Fund’s current resources would have implications. Specifically, in our June 2007 report we found that using the Fund’s current resources for information technology would diminish its ability to withstand severe economic conditions and would also increase the federal government’s budget deficit, all other things being equal. Further, requiring FHA to use program revenue to pay for administrative costs could require it to increase the premiums charged to borrowers. To the extent that having greater control over resources might improve agency efficiency and effectiveness, FHA may limit any potential premium increases needed to cover administrative expenses. Congress also could consider allowing FHA to compensate its employees outside of federal pay scales. In November 2011, we reported that from 2006 to 2010, Single Family Housing field staffing levels remained relatively constant, while key workload items, such as volume-driven loan reviews and the management of foreclosed homes, grew considerably. As a result, it may be difficult for FHA staff to mitigate risk. Some federal agencies, such as the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, and FHFA, are permitted to pay salaries above normal federal pay scales in recognition of the special skills demanded by sophisticated financial market operations. FHA and some mortgage industry observers have suggested that FHA be given similar authority. FHA officials told us that in order to appropriately manage the Fund, FHA needs a mix of staff with industry expertise, including those with strong operations management, and that flexibility in compensation would help FHA accomplish the right balance. An observer suggested that giving the HUD secretary authority to hire risk management, analytic, and technological system staff on a more generous pay scale could close some of the gap between private market participants and those charged with protecting taxpayers from economic harm. In addition, another observer recommended that FHA have the ability to more broadly use retention allowances and recruitment bonuses. This option could help FHA to recruit experienced staff to help the agency adapt to changes. Some suggest that, as with investments in technological enhancements, enhancements in compensation could be funded with the Fund’s premium income. The effect would be to provide FHA greater flexibility, but also would require program participants to absorb administrative costs that are currently borne by direct federal appropriation or would reduce resources available to pay claims and reduce the capital ratio. Some mortgage industry observers have suggested that Congress give FHA authority to implement pilot programs. For example, one noted that too often the statutory and regulatory environment for FHA leads to “all or nothing” policy changes, although private mortgage industry participants frequently tested new strategies before applying them to an entire portfolio. She recommended that FHA be given authority to implement pilot programs quickly with the goal of better understanding, measuring, and mitigating risk. In addition, the Millennial Housing Commission found that the statutes and regulations to which FHA was subject dramatically increased the time necessary to develop and implement new products. It recommended that Congress expressly authorize FHA to introduce new products without requiring a new statute for each. In a June 2007 report, we found that such authority would offer FHA greater flexibility to keep pace with the rapidly changing mortgage market.determined that Congress would have less control over FHA’s product offerings and that in some cases it might take years before a new product’s risks were well understood. In a February 2005 report, we recommended that FHA consider using pilots for new products and for any planned significant changes to its existing products. Because FHA officials had questioned the circumstances under which they could use pilots when not required to do so by Congress, we also recommended that FHA seek the authority to offer new products on a limited basis, such as through pilots, if the agency determined that it lacked sufficient authority. In comments on the report, HUD did not specifically state whether it agreed with the recommendations. Rather, it stated that it was in basic agreement with GAO that all policy options, implications, and implementation methods should be evaluated when considering or proposing a new FHA product. For this review, however, FHA officials told us that FHA had the appropriate level of authority to pilot programs and had successfully piloted several. For example, FHA piloted a program that allowed lenders to sell foreclosure properties securing nonperforming FHA-insured loans to third parties at a reserve price slightly below the property value without conveying the properties to FHA. According to FHA, the agency plans to expand the program after finding that this method of disposing of properties yields lower losses for the Fund than FHA’s normal disposition process. Even with no changes to its existing organizational structure and authorities, FHA can do more to enhance program efficiency and effectiveness and protect taxpayers. We have made a number of recommendations aimed at improving FHA’s information technology, loss mitigation efforts, management of real-estate owned inventories, risk assessment, and human capital management. As previously mentioned, we recommended in June 2013 that HUD establish a plan of action to fully implement best practices in management of information technology, provide needed project management expertise, and improve the development and use of its project management framework and governance structure. In addition, in June 2012 we recommended that FHA periodically analyze the effectiveness and the long-term costs and benefits of its loss mitigation strategies and actions to more fully understand their strengths and risks and protect taxpayers from absorbing avoidable losses to the maximum extent possible. This report found that several agencies, including FHA, were not conducting analyses to determine the effectiveness of their loss mitigation actions. The experiences of Treasury, the enterprises, and our econometric analysis strongly suggested that such analyses could improve outcomes and cut program costs. In November 2012, FHA announced revisions that were designed to reduce the number of full claims against the Fund. Specifically, FHA changed the steps that loan servicers must take to assist home buyers in bringing their mortgage payments current. We requested and plan to assess the analysis HUD completed as the basis for this change in FHA’s loss mitigation strategies to determine whether it fully responds to our recommendation. And as noted previously, FHA has proposed additional revisions to its loss mitigation and foreclosure processes that would require congressional action. FHA could also mitigate losses on mortgages that it insures by improving its recovery rate for foreclosures by, for example, improving the foreclosure process itself and the process for selling its inventory of foreclosed properties. In 2002, we found that FHA’s existing procedures could delay the start of critical steps necessary to preserve the value of foreclosed properties and sell them quickly. We pointed to the fact that FHA divided custody of foreclosed properties between servicers and contractors, which could prevent the initiation of critical maintenance necessary to make properties attractive to potential buyers. We recommended that HUD make establishing unified property custody a priority. In 2012, FHA announced that it was expanding a pilot that would permit such unified custody. Under the expanded pilot, FHA permitted loan servicers to maintain custody of properties from foreclosure sales through final disposition, relieving FHA of the responsibility for managing and selling these properties. Because this program is a pilot, FHA continues to take into its inventory foreclosed properties. According to FHA, it has taken steps to improve recovery through techniques such as using best execution modeling to ensure an optimal asset disposition approach. In June 2013, we recommended a number of ways that FHA could improve on the performance of these properties—for instance, by ensuring that price reductions were based on an evaluation of market conditions rather than on standardized schedules. FHA agreed with these recommendations and identified actions that it had taken or planned to take in response to them. In a November 2011 report, we recommended specific improvements that FHA could make to its risk assessment processes and human capital management. We recommended that FHA (1) integrate two ongoing efforts to assess risk, (2) conduct an annual risk assessment, and (3) establish ongoing mechanisms to anticipate and address risks that might be caused by changing conditions. To improve human capital management, we recommended that FHA develop workforce and succession plans for the Office of Single Family Housing. Since our report, FHA has taken several actions, including developing a plan for conducting an inaugural risk assessment and a workforce analysis and succession plan. Finally, we previously reported on opportunities to increase collaboration among the agencies responsible for overlapping and fragmented housing programs and activities, including those that support homeownership, with the potential for realizing efficiencies. In 2000, we suggested that Congress consider requiring RHS and HUD to examine the benefits and costs of merging programs serving similar markets and providing similar products. In 2012, we found that the administration had formed a task force to evaluate the potential for coordinating or consolidating loan However, we found that the task programs at HUD, RHS, and VA.force’s efforts had not yet incorporated key collaborative practices. We therefore recommended that HUD, USDA, and VA, and the Director of the Office of Management and Budget (OMB) take steps to establish a more rigorous approach to collaboration. In addition, we recommended that officials from HUD, Treasury, USDA, and VA evaluate and report on the specific opportunities for consolidating similar housing programs, including those that would require statutory changes. HUD and OMB expressed concern about implementing the recommendations while HUD was focused on the ongoing housing recovery. As we stated in the report, in addition to focusing on the ongoing housing crisis and government support for the housing market, focusing on achieving efficiencies and cost savings and the delivery of government support for housing is important. Given its financial condition, now more than ever it is important that FHA optimize its effectiveness across all aspects of its operations. Broader Housing Market Reforms Could Impact FHA’s Role Following the collapse of the mortgage market, policymakers proposed a number of mortgage reforms that could impact FHA’s market share and role. These reforms could affect the willingness of the conventional market to serve future home buyers of varying credit risk profiles and the fees that lenders would charge for conventional loans. The administration has put forth several options for reforming the federal role in the mortgage market, including reforming the enterprises (Fannie Mae and Freddie Mac). Each of these options has potential implications for FHA. Some of our recent work—a 2009 report on options for resolving the enterprises and our 2013 high-risk series—discussed the trade-offs associated with options for resolving the enterprises, as well as how these efforts could affect FHA. Recent Statutory and Regulatory Changes Could Affect FHA’s Market Share Recent statutory and regulatory changes related to qualified mortgages (QM) and qualified residential mortgages (QRM) have the potential to affect FHA’s market share. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) required lenders to make a reasonable and good faith determination, based on verified and documented information, that borrowers seeking residential mortgages have a reasonable ability to repay the loan according to its terms. The Dodd-Frank Act also established a presumption of compliance with the ability-to-repay requirements for a certain category of mortgages called QM. The ability to repay provisions are similar to those implemented by the Board of Governors of the Federal Reserve System (Federal Reserve Board) in 2008 but cover all mortgages. The Dodd-Frank Act shifted rulemaking authority for these provisions and QM from the Federal Reserve Board to the CFPB. On January 30, 2013, CFPB published its final rule on ability to repay and QMs (effective January 10, 2014). Among other things, CFPB’s final rule establishes general underwriting criteria for QMs, including that the borrower have a DTI ratio of less than or equal to 43 percent. As previously discussed, FHA underwriting standards allow some borrowers to have DTI ratios that are greater than 43 percent. While acknowledging that many borrowers with high DTI ratios likely could afford mortgages, CFPB was concerned that lenders would not make loans to these consumers in light of the current economic conditions. As a result, CFPB expanded the definition of a QM to include any loan that is eligible to be purchased, guaranteed, or insured by various federal agencies, including FHA, VA, USDA, and USDA’s RHS, or by the enterprises while they are operating under conservatorship. This rule is temporary and in general will remain in effect until these agencies finalize their own QM regulations. According to FHA, the agency is currently developing its QM regulations. The Dodd-Frank Act also requires mortgage securitizers to retain a financial exposure of no less than 5 percent of the credit risk of any securitized residential mortgage that does not meet a separate set of criteria (to be defined by regulators) that are associated with a lower risk of default. Securitized mortgages that meet these criteria are exempt from this risk retention requirement and are considered QRM. All FHA- insured mortgages are exempt from the risk-retention requirement, and Fannie Mae and Freddie Mac mortgages are exempt as long as the agencies are in conservatorship. Federal regulators published a proposed QRM rule on April 29, 2011, that included a 20 percent down-payment requirement. However, federal regulators issued another proposed rule on August 28, 2013. The new proposed rule offers two approaches. The first approach would define a QRM to have the same meaning as the term QM defined by the CFPB and, thus, would not include a down- payment requirement. The alternative approach, which according to the regulators “was not selected as the preferred approach,” would require lenders to retain risk in any loan with a down payment of less than 30 percent. Because the QM and QRM regulations will affect whether and at what price the conventional market will be willing to serve higher-risk borrowers, some have suggested that they could push these borrowers to FHA. For example, a recent HUD paper outlined several factors that may make higher-risk borrowers migrate to FHA: (1) conventional lenders are unlikely to originate non-QM loans (which by definition are also non-QRM loans, as QRM is a subset of QM) because they will face significantly higher capital retention requirements; (2) lenders that are willing to originate non-QM loans will do so only at a higher cost to the borrower; and (3) the April 2011 QRM proposal is quite narrow, requiring for example, that borrowers make a 20 percent down payment, which may be a difficult threshold for first-time borrowers to meet. Another paper we reviewed concurred, positing that the April 2011 proposed QRM rule could make it extremely difficult to securitize high-LTV loans made to first- time home buyers and other borrowers who could prudently manage low down-payment mortgages, resulting in a flood of loans to the enterprises and FHA.most of these loans could flow to FHA. The Resolution of Fannie Mae and Freddie Mac Could Impact FHA’s Role On September 6, 2008, FHFA placed Fannie Mae and Freddie Mac into conservatorship because of concern that their deteriorating financial condition threatened the stability of the financial markets. According to FHFA, the two enterprises had a worldwide debt and other financial obligations totaling $5.4 trillion at the time they were placed in conservatorship. Defaulting on those obligations would have significantly disrupted the U.S. financial system. While the conservatorships can remain in place indefinitely as efforts are undertaken to stabilize Fannie Mae and Freddie Mac and restore confidence in financial markets, FHFA has said that the conservatorships were not intended to be permanent. Recent policy changes and proposals on how to restructure or wind down the two enterprises are likely to have an impact on FHA’s role in the mortgage market. In August 2012, FHFA directed the enterprises to increase their guarantee fees on single-family mortgages by an average of 10 basis points. According to FHFA, the increase represented a step toward encouraging greater participation in the mortgage market by private firms. One impact of this change could be to push business to FHA. In addition, in February 2011, Treasury and HUD jointly issued a proposal for reforming the federal role in housing finance. The proposal would make private markets the primary source of mortgage credit and would place the burden of losses on the private market. In addition, banks would be required to adhere to underwriting standards that were more conservative than those currently in place and that would require homeowners to hold more equity in their homes. The plan also includes proposals for reducing the roles of Fannie Mae and Freddie Mac, and ultimately winding down both institutions, while at the same time ensuring access to quality, affordable housing. To this end, the report presents several proposals for structuring the government’s long-term role in a housing finance system in which the private sector is the dominant provider of mortgage credit: Option 1. A privatized system of housing finance with the government insurance role limited to FHA, USDA, and VA assistance for narrowly targeted groups of borrowers. Option 2. A privatized system of housing finance with assistance from FHA, USDA, and VA for narrowly targeted groups of borrowers and a guarantee mechanism that could be scaled up during times of crisis. Option 3. A privatized system of housing finance with FHA, USDA, and VA assistance for low- and moderate-income borrowers and catastrophic reinsurance behind significant private capital. Under each of these options, FHA would continue to play a central role in providing mortgage credit to low- and moderate-income borrowers. In a 2009 report, we also identified several options for revising the structure of the enterprises and outlined a framework for identifying the trade-offs associated with them: reconstitute the enterprises as for-profit corporations with government sponsorship but place additional restrictions on them, establish the enterprises as government corporations or agencies, or privatize or terminate the enterprises. In evaluating the trade-offs associated with these options, we noted that the credit needs of certain groups no longer served by the enterprises could be met by FHA. However, we also pointed out that some have questioned FHA’s capacity to manage large increases in its business, which could raise taxpayer risks. In addition, we previously had identified “modernizing the U.S. financial regulatory system” as a high-risk area. Because of continuing uncertainty over the resolution of Fannie Mae and Freddie Mac, the potential impact of their resolution on FHA, and concerns about FHA’s financial condition, in February 2013 we included FHA in this high-risk area, now called “modernizing the U.S. financial regulatory system and the federal role in housing finance.” As of March 31, 2013, over 90 percent of new mortgage volume had federal backing, either through FHA and Ginnie Mae or the enterprises. The heightened federal role in mortgage lending and the increased reliance on FHA insurance highlights the need for policymakers to ensure that changes made to FHA and the enterprises recognize the interdependence of these entities and that changes to federal regulations governing the mortgage market consider the interaction between public and private capital and reflect the roles and capacities of the agencies. Ultimately, FHA’s place in the housing finance system will depend on how the private market reacts to new regulations and how the federal government resolves Fannie Mae and Freddie Mac. It will also depend on which, if any, of the options outlined in this report policymakers pursue and how they are implemented. Agency Comments We provided a draft report to HUD for review and comment, and HUD had no comments. As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the Secretary of Housing and Urban Development and other interested parties. In addition, the report will be available at no charge on GAO’s website at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-8678 or sciremj@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs are listed on the last page of this report. GAO staff who made major contributions to this report are listed in appendix II. Appendix I: Objectives, Scope, and Methodology Our objectives were to examine options that have been proposed for improving the long-term viability of the Federal Housing Administration (FHA) or reducing its market presence and the implications of these options. Specifically, we discuss the implications of options related to (1) changing FHA’s product terms and conditions for single-family mortgage insurance, (2) restricting FHA’s presence in the single-family housing market, and (3) enhancing FHA’s operations and powers within its single- family program. In addition, we discuss the possible effects of broader housing finance reform on FHA. To identify proposed options for improving the long-term viability of FHA or limiting its market presence, we obtained relevant academic and industry studies based on our past and ongoing work and conducted a literature search of relevant databases. We reviewed and summarized the literature identifying options for change at FHA, including congressional testimonies and other documents from mortgage market participants (such as the Mortgage Bankers Association) and researchers (such as the Urban Institute, Cato Institute, and others). As noted above, we sorted these options into three categories: changes related to product terms and conditions, changes that could affect the market FHA serves, and changes related to FHA’s organizational structure or powers. We also reviewed and summarized the literature for implications associated with the proposed options (including the effects on the cost or risk to the taxpayer, borrowers’ access to credit, FHA’s role and the market it serves, and other mortgage market participants). Finally, we reviewed these materials for information on broader housing refinance issues that may affect FHA, including mortgage reforms and proposals for reform of Fannie Mae and Freddie Mac, two government-sponsored enterprises. We assessed the reliability of the key studies we used and determined them to be reliable for our purposes. We also obtained and reviewed documentation from the Department of Housing and Urban Development, FHA, and Ginnie Mae. This documentation included FHA’s mortgagee letters, which we reviewed to determine existing program policies and procedures and recent changes. We obtained FHA data on (1) loans originated in 2009, including credit scores and down-payment percentages, (2) the effect of a potential increase in the down-payment requirement on loans for which applications were submitted in August 2010 through July 2011, (3) the percentage of loan originations in 2009 and 2010 that had seller concessions of more than 3 percent of the property value, (4) the percentage of loans that FHA insured in fiscal year 2012 that were above $450,000, by state, (5) the income distribution of FHA borrowers in fiscal years 2000-2013 (October through April), and (6) delinquency rates for all active loans as of October 31, 2011, by loan size. To determine the reliability of this information, we reviewed information on the data and queried FHA officials about how its data are collected, verified, and maintained to identify potential data limitations. The FHA officials agreed these data were generally accurate and complete. Based on this work, we concluded that the data we received from FHA were sufficiently reliable for our purposes. We also used data published by Inside Mortgage Finance on mortgage originations for the first quarter of 2013. To determine the reliability of these data, we reviewed information on the data source and queried a knowledgeable official about the accuracy of the data. We determine the data were sufficiently reliable for our purposes. Finally, we conducted interviews with mortgage industry participants, researchers, consumer groups, and three former FHA commissioners to discuss the proposed options and, in particular, their implications. Specifically, we interviewed representatives from the following organizations: American Enterprise Institute, Cato Institute, Center for American Progress, Center for Responsible Lending, Harvard Business School, Harvard University’s Joint Center for Housing Studies, Hudson Institute, Independent Community Bankers of America, Mortgage Bankers Association, Mortgage Insurance Companies of America, National Association of Home Builders, National Association of Realtors, National Community Reinvestment Coalition, National Council of State Housing Agencies, and Urban Institute. We also interviewed FHA and Ginnie Mae officials. At each interview, we sought to obtain any additional relevant studies or papers. We conducted this performance audit from April 2013 to September 2013 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the individual named above, Paige Smith, Assistant Director; Stephen Brown; Marcia Carlsen; Emily Chalmers; Cory Marzullo; John McGrail; Marc Molino; Josephine Pérez; Andrew Stavisky; Julie Trinder; and Heneng Yu made major contributions to this report.

FHA has historically provided mortgage guarantees for home buyers, particularly first-time, minority, and lower-income borrowers. In 2012, FHA insured about $227 billion in single-family mortgages, and its overall insurance portfolio was about $1.1 trillion. Its market presence expanded during the recent housing crisis as the conventional market contracted and Congress increased the limit on the size of loans FHA may insure. But FHA's financial condition has weakened, and FHA has not met its 2 percent statutory minimum capital ratio since 2009. In its most recent budget, the agency stated that its capital reserve account might require an infusion of federal funds. FHA, industry participants, and researchers have suggested a number of options for improving FHA's long-term viability or for limiting FHA's market presence. These options have potential implications for taxpayers, borrowers, and others. This report discusses the options--which fall into three broad categories: (1) changes to product terms and conditions, (2) changes that would restrict FHA's market presence, and (3) changes to FHA's operations and powers--and their implications. It also describes the possible effects of broader housing finance reform on FHA. GAO interviewed a variety of industry stakeholders and researchers and reviewed studies and other documents to identify options for reforming FHA and their implications. GAO identified a number of proposed options for adjusting product terms and conditions to help improve the Federal Housing Administration's (FHA) long-term viability. FHA has raised the premiums that it charges borrowers several times in recent years and has taken steps to tighten its underwriting standards--for example, by setting a minimum required credit score. Some mortgage market observers have argued that further changes such as revising underwriting standards to focus on borrowers' residual income, requiring higher down payments, or reducing seller concessions (that is, funds sellers provide to buyers to help pay for closing costs) could help FHA better manage credit risk. However, such changes would entail trade-offs. For instance, some said that raising down-payment requirements would improve loan performance, but others said that this move would delay homeownership for many borrowers. Similarly, raising premiums could potentially increase revenue, but this potential would be constrained if it caused volume to decline. Further, low-risk borrowers with fewer down-payment constraints could choose less costly loans from other sources, leaving FHA with more high-risk borrowers. These changes could have a direct effect on the availability of credit for borrowers. GAO also identified options that could either directly or indirectly change FHA's market presence, which increased after the housing crisis, or address its financial viability. Among the proposals that would have a direct effect are those limiting FHA insurance to loans below a lowered ceiling or to borrowers who met new income guidelines. Many stakeholders and FHA itself view FHA's current loan limits, which range from $271,050 to $729,750 for one-unit properties in the contiguous United States, as too high. Some note that the agency may insure larger loans than the housing enterprises Fannie Mae and Freddie Mac. The current FHA limits were put in place in response to declines in mortgage lending during the housing crisis, when the private sector's role in financing mortgages shrank. However, as the market has improved, some have noted that lowering loan limits would allow private capital to return to the market and focus FHA on low- and moderate-income and first-time home buyers, a shift that many observers consider appropriate. Other proposed changes, such as reducing insurance coverage to less than 100 percent of the loan amount or entering into risk-sharing agreements with private partners, may indirectly reduce FHA's market presence. However, applying a partial coverage model would limit availability of credit to some borrowers. For some lenders, the additional exposure might prompt the purchase of additional insurance coverage from third parties, the cost of which would be passed on to borrowers. Some argue that under a risk-sharing structure private partners would assume and better manage credit risk. But creating such a structure would require careful consideration of how risks are borne, how pricing is determined, how incentives are aligned between FHA and its partners, and how FHA's role in stabilizing mortgage markets would be impacted. Others point to the additional counterparty risk posed by risk-sharing arrangements, which would necessitate greater federal oversight. Finally, these options might also affect FHA's ability to respond to changing market conditions. FHA and industry observers have also suggested changes to FHA’s structure and powers that could enhance its flexibility and capacity to manage risk. Some of these changes would bring FHA’s corporate powers more in line with those of other government corporations and increase its autonomy, providing it with enhanced enforcement powers and greater authority to change program requirements and invest in staff and technology. FHA has already requested additional enforcement authority. FHA and other observers have also argued that FHA needs greater power to change loan products or loan features without a lengthy rulemaking process and additional information technology resources—resources for which FHA must currently compete within HUD. Expanding FHA’s operational and managerial powers would give the agency more flexibility, and increasing its enforcement powers would allow it to more effectively oversee lenders. But any expansion of FHA’s authority may need to be limited and transparency requirements heightened, including for the rulemaking process. Even with no changes to its existing organizational structure and authorities, FHA can do more to enhance program efficiency and effectiveness and protect taxpayers. GAO has made a number of recommendations aimed at improving FHA’s loss mitigation efforts, management of real-estate owned inventories, risk assessment, human capital management, and information technology systems. In response to these recommendations, FHA has taken steps, such as developing a plan for conducting an inaugural risk assessment and a workforce analysis and succession plan. Finally, efforts to further regulate housing finance and the continuing uncertainty over resolution of Fannie Mae and Freddie Mac present challenges to any efforts to reform FHA. Following the collapse of the mortgage market, Congress passed a number of mortgage reforms that could impact FHA’s market share and role because they could affect the price at which the conventional market will be able to serve future home buyers of varying credit risk profiles. Similarly, the administration has put forth several options for reforming the federal role in the mortgage market, including reform of Fannie Mae and Freddie Mac. Each of these options could have an impact on FHA’s role in the mortgage market. Partly for this reason, GAO identified modernization of the federal role in housing finance as a high-risk area in early 2013. Any changes to the federal tools that support housing finance should be made in concert and with full recognition of the interdependence among FHA, the enterprises, and federal regulation.

Background Interoperability problems existed among public safety agencies for many years prior to the September 11 attacks on the Pentagon and New York City. Reports on incidents have documented a number of problems in public safety wireless communications. For example, the National Task Force on Interoperability (NTFI) documented interoperability problems in several states - including South Dakota, Indiana, and Minnesota--that had developed over a number of years. For over 15 years the federal government has been concerned about public safety spectrum issues, including communications interoperability issues. A variety of federal agencies have been involved in defining the problem and identifying potential solutions. In addition, Congress has taken several actions over the past two decades to address the availability and use of the public safety wireless spectrum. The events of September 11, 2001, have resulted in greater public and governmental focus on the role of first responders and their capacity to respond to emergencies, including those resulting from terrorist incidents. One result has been significantly increased federal funding for state and local first responders, including funding to improve interoperable communications among federal, state, and local first responders. In fiscal year 2003 , Congress appropriated at least $154 million for interoperability through a variety of grants administered by the Department of Homeland Security, the Department of Justice, and other agencies. In addition to appropriating more funds, the executive branch and Congress have attempted to consolidate federal efforts and coordinate federal grant programs. Within the executive branch, the Office of Management and Budget in 2001 created the Wireless Public SAFEty Interoperable COMmunications Program, or SAFECOM, to unify the federal government’s efforts to help coordinate the work at the federal, state, local and tribal levels, in order to provide reliable public safety communications and achieve national wireless communications interoperability. The First Challenge: Identifying and Defining the Interoperability Problem In discussing the issue of interoperable communications, it is important to recognize that interoperable communications is not merely a technological issue or an end in itself. It is rather a key means of achieving a desirable objective—the effective response to and mitigation of events or incidents that require the coordinated actions of emergency responders. These events could encompass a wide range of possibilities, such as multi- vehicle accidents, major floods or wildfires, or a terrorist attack that involved thousands of injuries. Interoperable communications is also but one component, although an important one, of an effective incident command planning and operations structure. As a standard practice, public safety agencies are to establish communications capabilities to support command and control of their operations at an incident scene. Determining the most appropriate means of achieving interoperable communications must flow from an effective planning and operations structure that identifies who is in charge and who must be able to communicate what information to whom under what circumstances. For example, there are likely to be both similarities and differences in the interoperable communications capacities, protocols, and participants associated with responding to seasonally predictable wildfires and terrorist attacks that involve biological agents. Defining the range of interoperability capacity needed requires identifying the types of events for which interoperable communications would be needed, the participants involved in responding to those events—by professional discipline and jurisdiction—and an operational definition of who is charge and who would need to communicate what types of information (e.g., voice, data, or both) with whom under what circumstances. These are not easy tasks, and they require both a multi- disciplinary and multi-jurisdictional perspective. But these tasks are a precursor to assessing the current problems—e.g., operational, technical, and fiscal—that exist in meeting interoperable communication needs and alternative means of achieving identified interoperable communications needs. But more importantly, interoperability is not a static issue--it is an issue that is affected by changes in technology and the changing events and threats for which first responders must be prepared. Thus, there is no single, long-term solution; the issue is one that must be periodically reassessed as needs and technology change. Interoperability Is Not a Static Issue The issues and problems in defining and scoping what is meant by “interoperability” are not static. They evolve over time in a fluid and ever- changing environment of evolving threats and events for which we need to be prepared to respond, new operational requirements, new spectrum bands for public safety use, and new technology. The Evolving Definition of First Responders Public safety officials generally recognize that interoperable communications is the ability to talk with whom they want, when they want, when authorized, but not the ability to talk with everyone all of the time. However, there is no standard definition of communications interoperability. Nor is there a “one size fits all” requirement for who needs to talk to whom. Traditionally, first responders have been considered to be fire, police and emergency medical service personnel. However, in a description of public safety challenges, a federal official noted that the attacks of September 11, 2001, have blurred the lines between public safety and national security. According to the Commission, effective preparedness for combating terrorism at the local level requires a network that includes public health departments, hospitals and other medical providers, and offices of emergency management, in addition to the traditional police, fire, and emergency medical services first responders. Furthermore, Congress recognized the expanded definition of first responder in the Homeland Security Act of 2002, which defined “emergency response providers” as “Federal, State, and local emergency public safety, law enforcement, emergency response, emergency medical (including hospital emergency facilities), and related personnel, agencies, and authorities.” Reexamining the Jurisdictional Boundaries of Interoperability The context of the communications also affects the definition of the problem. Two key studies in the late 1990s sponsored by the Department of Justice (DOJ) and the Public Safety Wireless Network (PSWN) program provide a nationwide picture of wireless interoperability issues among federal, state, and local police, fire, and emergency medical service agencies at that time. Both studies describe most local public safety agencies as interacting with other local agencies on a daily or weekly basis. As a result, most local agencies had more confidence in establishing radio links with one another than with state agencies, with whom they less frequently interact. Local public safety agencies interact with federal agencies least of all, with a smaller percentage of local agencies expressing confidence in their ability to establish radio links with federal agencies. The events of September 11, 2001, have resulted in a reexamination of the circumstances in which interoperable communications should extend across political jurisdictions and levels of government. Interoperable Needs Are Scenario Driven and Change Over Time Another issue is the broad range of scenarios in which interoperable communications are required. Public safety officials have pointed out that interoperability is situation specific, based on whether communications are needed for (1) “mutual-aid responses” or routine day-to-day coordination between two local agencies; (2) extended task force operations involving members of different agencies coming together to work on a common problem; or (3) a major event that requires response from a variety of local, state, and federal agencies. One official breaks the major event category into three separate types of events: planned events, such as the Olympics, for which plans can be made in recurring events, such as major wildfires and hurricanes, that can be expected every year and for which contingency plans can be prepared based on past experience, and unplanned events, such as the September 11th attacks, that can rapidly overwhelm the ability of local forces to handle the problem. Technological Changes Also Affect Interoperability As technology changes, it presents new problems and opportunities for achieving and maintaining effective interoperable communications. According to one official, in the 1980s, a method of voice transmission called “trunking” became available that allowed more efficient use of spectrum. However, three different and incompatible trunking technologies developed, and these systems are not interoperable. This official noted that as mobile data communications becomes more prevalent and new digital technologies are introduced, standards become more important. Technical standards for interoperable communications are still under development. Beginning in 1989, a partnership between industry and the public safety user community developed what is known as Project 25 (P- 25) standards. According to the PSWN program office, Project 25 standards remain the only user-defined set of standards in the United States for public safety communications. The Department of Homeland Security has recently decided to purchase radios that incorporate the P-25 standards for the each of the nation’s 28 urban search and rescue teams. PSWN believes P-25 is an important step toward achieving interoperability, but the standards do not mandate interoperability among all manufacturers’ systems. Standards development continues today as new technologies emerge that meet changing user needs and new policy requirements. In addition, new public safety mission requirements for video, imaging, and high speed data transfers, new and highly complex digital communications systems, and the use of commercial wireless systems, are potential sources of new interoperability problems. Availability of new spectrum can also result in new technologies and require further development of technical standards. For example, the FCC recently designated a new band of spectrum, the 4.9 Gigahertz (GHz) band, for public safety uses and sought comments on various issues, including licensing and service rules. The FCC provided this additional spectrum to public safety users to support new broadband applications, such as high- speed digital technologies and wireless local area networks for incident scene management. The Federal Communications (FCC) in particular requested comments on the implementation of technical standards for fixed and mobile operations on the band. The National Public Safety Telecommunications Council has established a task force that includes work on interoperability standards for the 4.9 GHz band. Second Challenge: Establishing National Goals and Requirements When the interoperability problem has been sufficiently defined and bounded, the next challenge will be to develop national interoperability performance goals and technical standards that balance consistency with the need for flexibility in adapting them to state and regional needs and circumstances. Lack of National Requirements One key barrier to development of a national interoperability strategy is the lack of a statement of national mission requirements for public safety—what set of communications capabilities should be built or acquired—and a strategy to get there. The report of the Independent Task Force sponsored by the Council on Foreign Relations on emergency responders said national standards of preparedness have not been defined and that the lack of a methodology to determine national requirements for emergency preparedness constitutes a national crisis. The report recommended these standards be prepared for federal, state, and local emergency responders in such areas as training, interoperable communications systems, and response equipment. SAFECOM officials have noted that no standard, guidance, or national strategy exists on interoperability. DOJ officials told us they are working with SAFECOM to develop a statement of requirements that should be ready for release by May 1, 2004. Need for an Interoperability Blueprint To guide the creation of interoperable communications, there must be an explicit and commonly understood and agreed-to blueprint, or architecture, for effectively and efficiently guiding modernization efforts. For a decade, GAO has promoted the use of architectures, recognizing them as a crucial means to a challenging goal: agency operational structures that are optimally defined in both business and technological environments. An enterprise architecture provides a clear and comprehensive picture of an entity, whether it is an organization (e.g., a federal department or agency) or a functional or mission area that cuts across more than one organization (e.g., financial management). In August 2003, DHS released its initial enterprise architecture that it described as conceptual in nature.. We are in the process of reviewing this architecture at the request of the Chairman, Subcommittee on Technology, Information Policy, Intergovernmental Relations and the Census, Committee on Government Reform. Need For Flexibility There is no single “silver bullet” solution to interoperability needs. Our ongoing work indicates that communications interoperability problems facing any given locality or state tend to be situation specific, with no universally applicable solution. For example, the Association of Public Safety Communications Officials (APCO) noted in its White Paper on Homeland Security that various methods are possible to achieve interoperability but planning is an essential first step to choosing a solution. APCO noted that interoperability does not involve a single product or system approach; rather it is accomplished with a variety of solutions with a focus on the first responder. APCO noted that what is an appropriate interoperability solution varies with the operation of the particular government agencies, their funding, their physical location, and other individual circumstances. In addition, the Public Safety Wireless Advisory Committee’s (PSWAC) final report noted that the public safety community has some common operational requirements, such as dispatch communications and transmission of operational and tactical instructions. However, the PSWAC report also describes agencies’ specialized requirements that are based on specific missions and operating environments. For example, the report notes forestry and state police have long distance requirements where foliage can be a problem for higher frequency systems. In contrast, a metropolitan police department may need highly reliable in-building coverage, which is not a requirement for state police mobile operations. Those state and local officials we have interviewed to date have stated that they want to retain flexibility when addressing communications issues. For example, Virginia state officials noted that geographical locations within the state present different interoperability requirements. They said interoperability problems differ from locality to locality, and that solutions must be developed that fit the specific circumstances of the individual geography and situation. Third Challenge: Need to Define Intergovernmental Roles As noted above, the federal government has a long history in addressing federal, state, and local government public safety issues–in particular interoperability issues. The Government Reform Committee has also recently contributed to the development of policies. In October 2002 the Committee issued a report entitled “How Can the Federal Government Better Assist State and Local Governments in Preparing for a Biological, Chemical, or Nuclear Attack “(Report 107-766). The Committee’s first finding was that incompatible communication systems impede intergovernmental coordination efforts. The Committee recommended that the federal government take a leadership role in resolving the communications interoperability problem. Federal Efforts to Establish A Leadership Role The federal role in addressing the interoperability of public safety wireless communications continues to evolve. Today, a combination of many federal agencies, programs, and associations are involved in coordinating emergency communications. In June 2003, SAFECOM partnered with the National Institute of Standards and Technology (NIST) and the National Institute of Justice (NIJ) to hold a summit that brought together over 60 entities involved with communications interoperability policy setting or programs. According to NIST, the summit familiarized key interoperability players with work being done by others and provided insight into where additional federal resources may be needed. The SAFECOM program was initially established within Justice in 2001 and was transferred to the Federal Emergency Management Agency (FEMA) in 2002 before being brought into DHS in early 2003. The current director said his program is responsible for outreach to local, state, and federal public safety agencies to assist in interoperability planning and implementation. In an August 2003 briefing, SAFECOM stated its role is to serve “as the umbrella program within the federal government to coordinate the efforts of local, tribal, state and federal public safety agencies working to improve public safety response through more effective, efficient, interoperable wireless communications.” In the briefing, SAFECOM officials said they have begun to implement this coordination role by setting objectives to develop a national public safety communications strategy, providing supporting standards and guidance; developing funding mechanisms and guidance, and creating a national training and technical assistance program. SAFECOM officials have also stated that SAFECOM has taken several other actions to implement its role as the umbrella program to coordinate actions of the federal government. For example, in coordination with officials of other agencies, it developed guidance for federal grants supporting public safety communications and interoperability. The guidance is designed to provide an outline of who is eligible for the grants, purposes for which grant funds can be used and eligibility specifications for applicants. The guidance requires that, at a minimum, applicants must” define the objectives of what the applicant is ultimately trying to accomplish and how the proposed project would fit into an overall effort to increase interoperability, as well as identify potential partnerships for agreements.” Additionally, the guidance recommends, but does not require, that applicants establish a governance group consisting of local, tribal, state, and federal entities from relevant public safety disciplines and purchase interoperable equipment that is compliant with phase one of Project-25 standards. Although SAFECOM is the umbrella program to coordinate actions of the federal government, it does not include all major federal efforts aimed at promoting wireless interoperability for first responders. Specifically, the Justice Department continues to play a major role in interoperability after the establishment of DHS. Key Justice programs–the Advanced Generation of Interoperability for Law Enforcement (AGILE) and the Community Oriented Policing Services–did not transition to the SAFECOM program in the new Department of Homeland Security. AGILE is the Department of Justice program to assist state and local law enforcement agencies to effectively and efficiently communicate with one another across agency and jurisdictional boundaries. It is dedicated to studying interoperability options and advising state and local law enforcement, fire fighters, and emergency technicians. The SAFECOM program director also said most of the federal research and development on prototypes is being conducted within the AGILE program. The Department of Justice said it is also creating a database for all federal grants to provide a single source of information for states and localities to access, and to allow federal agencies to coordinate federal funding awards to state and local agencies. SAFECOM and AGILE officials told us they have an informal, but close working relationship today, and that they are negotiating a memorandum of understanding between the two programs. Federal officials also told us that efforts are also under way by SAFECOM, AGILE, and other federal agencies to coordinate work on technical assistance to state and local governments and to develop and set interoperability standards. The SAFECOM program may continue to face challenges in assuming a leadership role for the federal government while these significant Justice programs remain outside its domain. SAFECOM officials will face complex issues when they address public safety spectrum management and coordination. The National Governors’ Guide to Emergency Management noted that extensive coordination will be required between the FCC and the National Telecomunications and Information Agency (NTIA) to provide adequate spectrum and to enhance shared local, state, and federal communications. However, the current legal framework for domestic spectrum management is divided between the NTIA within the Department of Commerce, which regulates federal government spectrum use, and the Federal Communications Commission, which regulates state, local, and other nonfederal spectrum use. In a September 2002 report on spectrum management and coordination, GAO found that FCC’s and NTIA’s efforts to manage their respective areas of responsibility were not guided by a national spectrum strategy. The FCC and the NTIA have conducted independent spectrum planning efforts and have recently taken steps to improve coordination, but they have not yet implemented long-standing congressional directives to conduct joint, national spectrum planning. We recommended that the FCC and the NTIA develop a strategy for establishing a clearly defined national spectrum plan and submit a report to the appropriate congressional committees. In a January 2003 report, we discussed several barriers to reforming spectrum management in the United States. State Role in Interoperability Issues Is Evolving The role that state and local governments will play in public safety communications is evolving. This role is being defined by states and local governments as they address problems they recognize exist in their communications systems and by the FCC and the NTIA. As noted by the National Governors Association (NGA), many states are establishing a foundation for cooperation and statewide planning through memorandums of understanding or similar agreements. Several states have or are taking executive and legislative actions to address communications planning and interoperability planning. For example, the Missouri State Interoperability Executive Committee was created by the Missouri Department of Public Safety to enhance communications interoperability among public safety entities in Missouri by promoting available tools and relationships. The Missouri State Interoperability Executive Committee established a Memorandum of Understanding (MOU) that instructs public safety agencies within the state to use the FCC designated interoperability channels under an Incident Command/Incident Management structure. The MOU also attempts to diminish operational interoperability barriers by creating common operating procedures for the agencies to use on the channels. Furthermore, in order to create a comprehensive approach to interoperability that addresses new homeland security concerns, the State of Missouri enacted the “Missouri Uniform Communications Act for Homeland Security”, which established the State’s “Public Safety Communications Committee.” This Committee is composed of representatives from the Department of Public Safety, Office of Homeland Security, Department of Conservation and Department of Transportation. The committee reviews all public safety agencies’ plans that request state or federal wireless communications funds and relies on the recommendations of the Missouri Interoperability Executive Committee to ensure that state decisions enhance interoperability. Another state that uses the State Interoperability Executive Committee structure to enhance communications interoperability is the State of Washington, whose committee was established by state legislation effective July 1, 2003. The Washington Committee was created under the Information Services Board within the Department of Information Services. The Committee’s members include representatives from the Military, Transportation, Information Services and Natural Resources departments; the Washington State Patrol; state and local fire chiefs; police chiefs; sheriffs; and state and local emergency managers. Washington legislation requires the Committee to submit to the State legislature an inventory of all public safety systems within the state and a plan to ensure the interoperability of those systems. The Committee was given the authority to develop policies and procedures for emergency communications systems across the state and to serve as the point of contact for the FCC in the allocation, use and licensing of radio spectrum for public safety and emergency communication systems. Federal actions to support state efforts that address wireless interoperability issues are still evolving. On the one hand, the Public Safety Wireless Network program has supported state efforts to improve multistate and individual statewide planning and coordination through a number of projects that emphasize a regional approach. However, two agencies of the federal government–the FCC and the NTIA–set rules and regulations for state and local governments and federal government wireless systems respectively. The Regional or Shared Approach State and local efforts to address interoperability issues are widespread. The National Governors Association said in its recent Guide to Emergency Management that interoperable equipment, procedures, and standards for emergency responders are key to improving the effectiveness of mutual aid agreements with other states and other jurisdictions. The NGA guide calls for governors and their state homeland security directors to: develop a statewide vision for interoperable communications; ensure adequate wireless spectrum is available to accommodate all users; invest in new communications infrastructure; develop standards for technology and equipment, and partner with government and private industry. Specifically, states are taking action to facilitate strategic planning and interoperability planning that emphasize a shared approach at the multistate, state, and local levels. The Public Safety Wireless Network report notes that although in the past public safety agencies have addressed interoperability on an individual basis, more recently, local, state, and federal agencies have come to realize that they cannot do it alone. The report also notes that officials at all levels of government are now taking action to improve coordination and facilitate multi- jurisdictional interoperability. We talked to officials from several states about their states’ efforts to address interoperability issues on a regional basis. For example; State officials from Kentucky, Indiana, Illinois, Ohio, and Michigan have combined efforts to form a Mid-west Consortium to promote interstate interoperability. They have taken actions to form an interstate committee to develop interoperability plans and solicit support from key players such as local public safety agencies. The governors of the states have agreed to sign an MOU to signify that each state is willing to be interoperable with the other states and will provide communication assistance and resources to the other states, to the extent that it does not harm their own state. In Florida, the governor of the state issued an executive order in 2001 to establish seven Regional Domestic Security Task Forces that make up the entire state. Each of the regional task forces has a committee on interoperable communications under Florida’s Executive Interoperable Technologies Committee. The Florida legislature supported that effort by establishing the Task Forces in law and formally designating the Florida Department of Law Enforcement and the Division of Emergency Management as the lead agencies. The Task Forces consist of agencies from Fire/Rescue, Emergency Management, and public health and hospitals, as well as law enforcement. In addition, it includes partnerships with education/schools, business and private industry. Statewide Interoperability Plans Public safety representatives have stressed the importance of planning in addressing communications interoperability issues. The Association of Public Safety Communications Officials (APCO) has emphasized the importance of planning in addressing communications interoperability problems. In its Homeland Security white paper, APCO said that a plan for responding to terrorist events should include a section on how to address interoperability requirements. The creation of state interoperability plans could help reduce the current fragmented public safety communications planning process. Public safety agencies have historically planned and acquired communications systems for their own jurisdictions without concern for interoperability. This meant that each local and state agency developed communications systems to meet their own requirements, without regard to interoperability requirements to talk to adjacent jurisdictions. For example, a PSWN anlaysis of Fire and EMS communications interoperability found a significant need for coordinated approaches, relationship building, and information sharing. However, the PSWN program office found that public safety agencies have traditionally developed or updated their radio systems independently to meet specific mission needs. Each agency developed a sense of “ownership”, leading to “turf issues” and resistance to change. The SAFECOM program has reached similar conclusions. According to SAFECOM, the priorities of local and state public safety communications systems are first, to provide reliable agency specific communications; second, to provide local interagency communications; and third, to provide reliable interagency local/state/federal communications. In a August 11, 2003, briefing document, SAFECOM noted that limited and fragmented planning and cooperation was one barrier to public safety wireless communications. SAFECOM noted a complex environment of over 2.5 million public safety first responders within more than 44,000 agencies and the fragmented command structure–where each Chief of Police sees himself as the Chairman of the Joint Staff in his jurisdiction– but the Fire Chief disagrees. The briefing also noted that a multitude of federal programs provide funding for interoperable communications with no coordination of requirements or guidance and that local funding was also stove-piped to meet individual agency needs. In a recent statement, we identified 10 separate grant programs that could be used for first responder equipment, including a number of these that can be used for interoperable communications equipment. We stated that the fragmented delivery of federal assistance can complicate coordination and integration of services and planning at state and local levels. The Fundamental Barrier to Success: The Absence of Effective Coordinated Planning and Collaboration The barriers to successfully addressing the three challenges we have outlined are multifaceted. Among the organizations we have contacted or whose reports we have reviewed, we found a variety of identified barriers, with a number of common barriers. For example, the SAFECOM project and a task force of 18 national associations representing state and local elected and appointed officials and public safety officials identified similar barriers: (1) incompatible and aging communications equipment, (2) limited and fragmented funding, (3) limited and fragmented planning and cooperation, (4) limited and fragmented radio spectrum, and (5) limited equipment standards. Of all these barriers, perhaps the most fundamental has been limited and fragmented planning and cooperation. The regional chairs of the Florida State Interoperability Committee have noted that non-technical barriers are the most important and difficult to solve. Police and fire departments often have different concepts and doctrines on how to operate an incident command post and use interoperable communications. Similarly, first responders, such as police and fire departments, may use different terminology to describe the same thing. Differences in terminology and operating procedures can lead to communications problems even where the participating public safety agencies share common communications equipment and spectrum. No one first responder group, jurisdiction, or level of government can successfully address the challenges posed by the current state of interoperable communications. Effectively addressing these challenges requires the partnership, leadership, and collaboration of all first responder disciplines, jurisdictions, and levels of government—local, state, federal, and tribal. In the absence of that partnership and collaboration, we risk spending funds ineffectively and creating new problems in our attempt to resolve existing ones. That concludes my statement, Mr. Chairmen, and I would be pleased to answer any questions you or other members of the Subcommittees may have. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

The inability of first responders--police officers, firemen, hazardous materials teams, emergency medical service personnel, and others--to communicate effectively with one another as needed during an emergency is a long-standing and widely recognized problem in many areas across the country. When first responders cannot communicate effectively as needed, it can literally cost lives--of both emergency responders and those they are trying to assist. At the request of the Chairman of the House Committee on Government Reform, we are examining the barriers to improved interoperability and the roles that federal, state, and local governments can play in improving wireless interoperability communications. Interoperability problems existed among public safety agencies for many years prior to the September 11, 2001 terrorist attacks. Reports on incidents have documented a number of problems in public safety wireless communications. For over 15 years the Federal Government has been concerned about public safety spectrum issues, including communications interoperability issues. A variety of federal agencies have been involved in defining the problem and identifying potential solutions. In addition, Congress has taken several actions over the past two decades to address the availability and use of public safety wireless spectrum. The events of September 11 have resulted in greater public and governmental focus on the role of first responders and their capacity to respond to emergencies, including those resulting from terrorist incidents. The interoperability issues that the nation faces today did not arise overnight and they will not be successfully addressed overnight. Federal, state, and local governments face several major challenges in addressing interoperability in their wireless communications. The first challenge is to clearly identify and define the problem. For example, it is important to recognize that interoperable communications is not an end in itself, but it is rather one component for achieving an important goal--the ability to respond effectively to and mitigate incidents that require the coordinated actions of first responders. The second challenge is whether and how to establish national interoperability performance goals and standards and balance them with the flexibility needed to address differences in state, regional and local needs and conditions. The third challenge is defining the roles of federal, state, and local governments and other entities in defining the problem, implementing any national goals and standards, and assessing alternative means of achieving those goals and standards. The fundamental barrier to successfully addressing these challenges has been the lack of effective, collaborative, interdisciplinary and intergovernmental planning. No one first responder group or governmental agency can successfully "fix" the interoperability problems that face our nation. It will require the partnership, leadership, and coordinated planning of everyone involved.

Background In 1975, the President established the interagency Committee on Foreign Investment in the United States to monitor the impact and coordinate U.S. policy on foreign investment in the United States. In 1988, the Congress enacted the Exon-Florio amendment to the Defense Production Act. Exon-Florio authorized the President to investigate the impact of foreign acquisitions of U.S. companies on national security and to suspend or prohibit an acquisition if it might threaten national security and no legislation, other than Exon-Florio and the International Emergency Economic Powers Act, could adequately protect national security. The President delegated the authority to investigate to the Committee. The Committee operates at two levels: staff representatives who perform initial reviews of companies’ notices and principals who are the decision makers on issues of national security. The Secretary of the Treasury serves as the Committee Chair and Treasury’s Office of International Investment coordinates the Committee’s activities. This office has the dual responsibility of monitoring foreign investment in the United States and advocating free trade and world markets open to foreign investment, i.e., the U.S. open investment policy. In implementing Exon-Florio, the Committee seeks to preserve the confidence of foreign investors that they will be treated fairly while implementing the intent of Exon-Florio. That is, to provide a mechanism to review, and if the President finds appropriate, to restrict foreign investment that threatens to impair the national security. Exon-Florio and implementing regulations provide the Committee with broad discretion to evaluate and make decisions about issues of potential national security risk. Neither the law nor its implementing regulations define “national security,” although the law provides guidance on factors to consider, such as U.S. technological leadership in national security areas. The Committee interprets its authority to conduct an investigation as providing the Committee the authority to negotiate measures to mitigate national security concerns when other regulatory regimes do not apply. In an uninterrupted process, the Committee and the President would have up to 90 calendar days to review, investigate, and determine what if any action the President would take concerning an acquisition. The companies can request withdrawal of their voluntary notice at any time up to the President’s decision. (See app. I for a detailed discussion of the Committee’s process.) Notifying the Committee of an acquisition is not mandatory. However, the Committee may review any acquisition it identifies that has not been notified. In June 2000, we recommended that the Secretaries of Commerce, Defense, Treasury, and State establish procedures for the Committee and member agencies to improve their ability to identify foreign acquisitions with potential national security implications. The Committee also may reopen a case if it learns that companies submitted false or misleading information in their notice. From 1997 through 2001, the Committee received 333 notices for 320 proposed or completed acquisitions. Table 1 provides summary data on notices filed with the Committee. In most instances, the Committee concluded its activities under Exon- Florio within 30 days of receiving notification because (1) the Committee did not identify any issues of national security, (2) the companies and the government agencies addressed potential national security concerns prior to filing, or (3) the companies and the government agreed on measures to mitigate national security concerns before the end of the 30-day review. About 96 percent (306 of 320 acquisitions) were concluded within 30 days. The Committee Investigates in Only Limited Circumstances The Committee has initiated investigations under only limited circumstances, namely, when it could not identify potential mitigation measures in the review period that would resolve national security issues arising from the acquisitions or when it needed more time than the 30-day review period to complete its work and the companies involved were not willing to request withdrawal of their notification. Since 1997, the Committee has initiated only four 45-day investigations. The Committee initiated investigations because of concerns about the potential for unauthorized transfers of technology and because it could not identify measures that would mitigate those concerns or needed extra time beyond the 30-day review to negotiate possible mitigation measures, but the companies were not willing to request withdrawal of their notifications. As a matter of practice, the Committee tries to avoid the use of investigations and presidential determinations. The Committee reviews foreign acquisitions to protect national security while seeking to maintain the U.S. open investment policy. For many companies, being the subject of an investigation has negative connotations. Avoiding an investigation helps to maintain the confidence of investors that the government does not view the acquisition as problematic. Also, a presidential determination could be politically sensitive. According to one Committee staff member, the Committee looks for the best way to work out national security concerns without an investigation. Since 1997, the Committee has allowed companies involved in 13 acquisitions (including 3 of the 4 for which an investigation was subsequently initiated) to withdraw their notifications and re-file at a later date rather than initiate an investigation. In some, the time was needed for other agencies to complete reviews of the acquisition under other laws and regulations. For example, the Committee allowed two shipping companies to withdraw the notification of their planned merger to provide time for the companies to request approval from the Maritime Administration. The companies re-filed so that Committee approval would coincide with the end of the Maritime Administration’s 90-day review. The Maritime Administration required the companies to transfer operations of ships that participated in the Maritime Security Program to a U.S.-owned operator to prevent foreign ownership of ships that the United States would rely on in wartime. According to a Committee official, based on the Maritime Administration’s approval, the Committee did not need to initiate an investigation. In others, the Committee used the extra time to clarify such issues as the nature of the foreign ownership, products and technologies that were subject to U.S. export control laws, relationships with countries or companies of concern, and future plans for the U.S. company. In three acquisitions, the companies chose not to request withdrawal and the Committee initiated investigations. In two of these cases, the companies had withdrawn their notification once to provide more time to negotiate agreements to protect sensitive information and to provide more information. The companies then re-filed with the Committee and began a new 30-day review period. However, by the end of the second 30-day review they had not reached agreement and the companies were unwilling to withdraw again, so the Committee initiated an investigation. In one case, the companies and the Committee agreed on mitigation measures after the investigation ended but prior to a presidential determination. The Committee allowed the companies to withdraw the notification again and re-file it as a new case to avoid the need for a presidential determination. In the second case, the companies were unable to reach agreement with the Defense Department and the investigation ended after the companies agreed to abandon the proposed acquisition. In the third case, Committee members had raised concerns about the potential for foreign government access to sensitive information and the ability of the foreign company to deny the U.S. government access to information. The Committee and the companies were unable to reach agreement on how to mitigate these national security concerns within the 30-day review period and the companies were unwilling to withdraw the notification, so the Committee initiated an investigation. By the end of the investigation, the Committee and the companies had concluded an agreement in time for the Committee to recommend that the President take no action. Accordingly, the President determined that no further action was necessary and the acquisition was reported to the Congress. In another case in which the acquisition had already occurred, the Committee was unwilling to allow a second withdrawal of the notification. The Committee had allowed the company to withdraw and re-file to allow time to address export control concerns. However, the Committee could not resolve concerns about unauthorized transfers of technology. As a result, it initiated an investigation. During the investigation, the company asked to withdraw its notification instead of waiting for a presidential determination. The Committee permitted the company to withdraw on the 45th day of the investigation, with the understanding that the foreign company would divest the U.S. company. The Committee’s Process for Implementing Exon-Florio May Limit Its Effectiveness Weaknesses in the Committee’s process for implementing Exon-Florio may in some cases have resulted in ineffective national security protections because the Committee allowed withdrawal of cases in which the acquisition had been completed without establishing interim protections, used nonspecific provisions or language in agreements it had concluded with companies to mitigate national security concerns, and did not identify the agency responsible for overseeing implementation and monitoring compliance with the agreement. Allowing Withdrawals of Completed Acquisitions Can Delay National Security Protections According to Committee officials, few of the acquisitions for which the Committee receives notification are completed prior to the Committee concluding its responsibilities under Exon-Florio. Therefore, the period before the companies re-file generally creates limited risk to national security because, until the acquisition is completed, the foreign company does not have full access to the U.S. company’s resources. Committee officials told us that the companies’ desire to conclude the acquisition provides an incentive for the companies to resolve issues and re-file as quickly as possible. However, this incentive does not exist when companies notify the Committee after concluding their acquisition. We identified two instances where long periods had elapsed between the companies concluding their acquisition and the Committee completing its work. One company that filed its notification almost 2 years after concluding the acquisition asked to withdraw its notification near the end of the 30-day review to provide additional information and to address export control issues the Committee had identified. The company waited over 9 months to re-file. After re-filing, the Committee determined that concerns about unauthorized transfers of technology could not be mitigated and the company agreed to divest the acquired company. However, the foreign company had the ability to access the technologies that prompted the Committee’s concern for almost 3 years, from the time the acquisition was concluded until the company agreed to divest the acquisition to address the Committee’s concerns. In the second case, the company filed with the Committee more than a year after completing the acquisition. The Committee allowed the company to withdraw the notification to provide more time to answer the Committee’s questions and provide assurances concerning export control matters. The company did not re-file for more than a year after withdrawing the original notification. The Committee allowed the company to withdraw its notification a second time because there were still unresolved issues. More than a year has passed since the second withdrawal and the company has yet to re-file. Nonspecific Language May Make Agreements Difficult to Implement In the two acquisitions that required the Committee to conclude agreements under the authority of Exon-Florio, the agreements contained provisions or language that may make them difficult to implement. In one instance, the Defense Department was concerned about the release of certain technologies to foreign parties and took the lead in negotiating an agreement. In the other instance involving a communications company, the Justice Department was concerned about access to subscriber information, among other matters, and took the lead in negotiating an agreement. The agreement negotiated by the Defense Department contained language that was open to interpretation. It required a “good faith effort” to divest a subsidiary to mitigate a concern about access to technology and provided an alternative if the company could not find a domestic purchaser to make a “reasonable” offer. The agreement did not include criteria defining what actions would constitute a “good faith effort” nor what would be a “reasonable” offer. Accordingly, when the company divested part, but not all, of the subsidiary and cited the lack of interested buyers as the rationale, the agreement contained no criteria that would allow government officials to determine whether the company’s efforts to sell the subsidiary were made in good faith. Likewise, without measurable criteria in the agreement, it was not possible to determine whether the sole bidder for the entire subsidiary made a reasonable offer. Further, although the divestiture or the alternative was considered necessary, there were no criteria for determining whether the partial divestiture served the same purpose. Without clear criteria, government officials could not effectively evaluate compliance with the agreement and could be faced with the need to litigate questions of this nature. The Justice Department modeled the agreement it negotiated on network security agreements it has used with some telecommunications companies. These agreements are attached as conditions to Federal Communications Commission licensing orders. While the agreement negotiated under the authority of Exon-Florio addressed many of the same issues as the network security agreements, the provisions were often less detailed. In discussions with Justice Department officials, they acknowledged that several provisions were less specific and less stringent than those in some network security agreements. They said that, in their opinion, Exon-Florio offers less bargaining power to the government than the Communications Act, which underlies the Federal Communications Commission licensing process. As a result, conditions negotiated under Exon-Florio may be less stringent than conditions they have negotiated with some telecommunications companies. Provisions on Monitoring Compliance Are Lacking Exon-Florio implementing regulations do not provide guidance on monitoring company compliance with agreements. Committee officials have stated that the Committee generally defers to various federal agencies for monitoring activities, even in cases in which the authority to negotiate mitigation measures was based on Exon-Florio. One Committee official noted that these agencies have the expertise that the Committee lacks. However, neither of the two agreements negotiated under the authority of Exon-Florio specified which agency would be responsible for monitoring implementation. Provisions to assist agencies in monitoring agreements were also lacking. One agreement contained no requirement for the company to demonstrate compliance and no time frames by which provisions were to be implemented. The other required the company to appoint a board member, subject to approval by the Secretaries of the Treasury and Defense, to oversee the implementation of the agreement and provide a semiannual status report to the Committee and the Defense Department. It provided time frames for certain actions to occur, but it contained no consequences for failure to comply with the time frames, thus providing no incentive for the company to act within the time frames. And in fact, the company failed to meet the terms of one provision within the agreed upon time frame. This approach is less stringent than the approach used in consent agreements by the Department of Justice and the Federal Trade Commission in resolving antitrust issues during reviews of mergers and acquisitions. Some consent agreements contain provisions to ensure that the government has access to documents and people to verify compliance with the terms of the agreement. Some also include provisions allowing the government some approval authority over the buyer of a company in the event that a divestiture is required and provide for the government to appoint trustees to monitor the divestiture. If the companies do not divest within the agreed time frame, some consent agreements also provide for a trustee to manage the divestiture. Conclusions For the most part, the Committee on Foreign Investment in the United States is able to fulfill its responsibility to ensure that foreign acquisitions of U.S. companies do not threaten national security without resorting to investigations. When the process could not be completed within the 30 days, the Committee has allowed companies to withdraw and re-file to avoid initiating an investigation. However, this approach can, in certain circumstances, negate the effectiveness of the Exon-Florio statute. Typically, the Committee reviews a proposed acquisition for national security concerns before the acquisition is concluded. However, when companies have completed an acquisition before filing with the Committee, the potential for harm already exists and any actions to prevent harm can only be after the fact. Allowing companies to withdraw notification to the Committee when an acquisition has already occurred without instituting interim protections risks the very harm to national security that Exon-Florio was enacted to prevent. Likewise, when agreements are concluded to mitigate national security concerns, the lack of specificity in actions called for by the agreements and the uncertain responsibility for implementing and monitoring make assuring compliance difficult. Recommendations for Executive Action In view of the need to assure that national security is protected during the period that withdrawal is allowed for companies that have completed or plan to complete the acquisition prior to the Committee completing its work, we recommend that the Secretary of the Treasury, in his capacity as Chair of the Committee on Foreign Investment in the United States, revise implementing regulations to require specific interim protections prior to allowing withdrawal for companies that have completed or plan to complete the acquisition before the Committee has completed its work. Further, to ensure compliance with agreements concluded under the authority of Exon-Florio, we recommend that the Secretary of the Treasury, in his capacity as Chair of the Committee on Foreign Investment in the United States, (1) increase the specificity of actions required by mitigation measures in future agreements negotiated under the authority of Exon-Florio and (2) designate in the agreement the agency responsible for overseeing implementation and monitoring compliance with mitigation measures. Agency Comments and Our Evaluation In commenting on a draft of our report, the Treasury Department stated that understanding the context in which the Committee implements Exon-Florio would aid in assessing the report’s conclusions and recommendations. Treasury explained in its comments that the Congress intended that Exon-Florio be invoked only in cases where other laws were not adequate or appropriate to protect national security. Further, Treasury noted that the United States has traditionally maintained an open investment policy because it benefits our economy. Both Treasury and Defense disagreed with our recommendations (1) for interim measures to protect national security when companies that have completed an acquisition are allowed to withdraw their notification and (2) that increased specificity of actions be required by mitigation measures in future agreements negotiated under the authority of Exon-Florio. The Treasury Department agreed to act on our recommendation to make the agency responsible for ensuring compliance with mitigation measures more explicit in future agreements. The Treasury Department stated that we focused on only a few cases and that it is unusual for agreements to be negotiated under the authority of Exon-Florio. We agree. As Treasury noted in its comments, the Congress intended that Exon-Florio be invoked only when other laws are not adequate or appropriate to protect national security, and thus acts as a safety net. However, the two cases in which we raise concerns about granting an extended withdrawal period were the universe of cases in which companies that have already completed the acquisition prior to notifying the Committee have requested and been granted withdrawal. Likewise, the two cases in which we believe greater specificity was needed in the agreements represent 100 percent of the cases in which Exon-Florio was the basis for an agreement. As a result, we believe that the current process is not an effective safety net. The Departments of Treasury and Defense stated that our recommendation for interim measures is not necessary. Further, the departments said that negotiating interim measures could take considerable time and effort, thus delaying a final review of the acquisition. Treasury also said that the Committee already has the authority to place conditions on withdrawals without amending the implementing regulations and that by striving to do so, it can conclude its cases more expeditiously without compromising national security or the U.S. open investment policy. We did not intend for the regulations to call for negotiating interim measures, but rather for the Committee to use its authority to impose them as a condition of withdrawal under certain circumstances. In one of the cases we identified, the company waited over 9 months to re-file with the Committee, and when the Committee could not mitigate its concerns about unauthorized transfers of technology, the company agreed to divest. In the other case, the company did not re-file for more than a year after withdrawing the original notification, and has yet to re-file more than a year after the second withdrawal. In these cases, the Committee did not use its authority to ensure that the companies re- filed and that the cases were concluded expeditiously. Therefore, for those cases in which the acquisitions occur prior to the Committee completing its work, we continue to believe revising the implementing regulations to require interim protections prior to granting withdrawal would ensure that cases involving completed acquisitions are concluded more expeditiously. The departments questioned whether greater specificity in the agreements we cited would have provided additional national security protections. In our opinion, greater specificity would provide greater protection by making it easier for agencies to effectively evaluate compliance with agreements. For example, in the instance we noted where an agreement called for a “good faith effort” to sell a subsidiary, the foreign company sold only part of the subsidiary and deemed it a “good faith effort,” even though at least one other company offered to buy the entire subsidiary. Further, the foreign company sold the subsidiary in exchange for stock in the acquiring company. The agreement also provided, if divestiture was not possible, for the foreign company to ensure that the subsidiary would be able to support government contracts, such as by continuing a certain level of investment in equipment and personnel. The foreign company maintains that those requirements do not apply to the part of the subsidiary that was not divested. The government officials monitoring the agreement would need to decide whether what the company did constituted a “good faith effort” and whether the partial divestiture was adequate to protect national security as called for by the agreement. In our view, mitigation measures that are open to interpretation increase the difficulty of determining compliance and thus provide the potential for harm to national security. The Treasury Department agreed to act on our recommendation to make explicit which agency has responsibility for reviewing compliance with mitigation measures. However, Treasury, along with the Defense Department, maintained that the accountability in the two cases we cited was clear because the agreements were signed by policy level officials. During our review, the agencies did not provide evidence to show that anyone was ensuring that the companies were complying with the agreements. Although the Justice Department stated in its comments that officials from the Federal Bureau of Investigation visited the offices of the U.S. company to assess its compliance with the agreement, Bureau officials told us that only one visit took place and that they have no additional plans to verify compliance. In addition, the Defense Department did not provide any documentation showing that it took action to ensure the companies were complying with the agreement beyond some initial meetings. Defense Department officials also had indicated that it was not their responsibility to monitor compliance. Therefore, we believe that it is necessary to be more specific in assigning responsibility to ensure company compliance with commitments to the Committee. Treasury, Defense, and Justice Department comments are reprinted in appendixes II through IV, respectively. Scope and Methodology We examined 17 acquisitions notified to the Committee on Foreign Investment in the United States between January 1, 1997, and December 31, 2001. They included the 4 acquisitions that were investigated, 12 of the acquisitions that were withdrawn and re-filed, and 1 acquisition suggested by Committee staff. The objective of the case reviews was to understand and document the Committee’s process for reviewing foreign acquisitions of U.S. companies. We did not attempt to validate the conclusions reached by the Committee on any of the cases we reviewed. We analyzed data on acquisitions from relevant Committee member agencies, including the Departments of Commerce, Defense, Justice (including the Federal Bureau of Investigation), State, and Treasury. We also discussed the Committee’s process with Committee staff officials. To determine under what circumstances the Committee formally investigates foreign acquisitions, we interviewed Committee staff level members. We reviewed all four cases that went to investigation since 1997. After reviewing these, we interviewed Committee members, documented their national security concerns, and discussed the measures needed to mitigate those concerns. To determine whether weaknesses exist in the Committee’s implementation of Exon-Florio, we analyzed and discussed with Committee staff members the laws and regulations that grant the Committee authority to identify, negotiate, and mitigate national security concerns. For the telecommunications cases, we interviewed Federal Communications Commission officials and discussed their regulatory processes related to license transfer. We also compared Exon-Florio agreements to consent agreements used by the Department of Justice and the Federal Trade Commission in antitrust actions. We performed our work from June 2001 through May 2002 in accordance with generally accepted government auditing standards. As we agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution of it until 30 days from the date of this letter. We will then send copies to the Chairman and Ranking Minority Member of the Senate Committee on Banking, Housing, and Urban Affairs and the Chairman and Ranking Minority Member of the House Committee on Financial Services and the Ranking Minority Member of the Subcommittee on National Security, Veterans Affairs, and International Relations of the House Committee on Government Reform. We will also send copies to the Secretaries of Commerce, Defense, Justice, State, and the Treasury; the Chairman, Council of Economic Advisors; the Director, National Economic Council; the Assistant to the President for National Security Affairs; the Director, Office of Management and Budget; the Director, Office of Science and Technology Policy; and the United States Trade Representative. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. Please contact me on (202) 512-4841 if you or your staff has any questions concerning this report. Major contributors to this report were Thomas J. Denomme, Paula J. Haurilesko, Monica Brym, Gregory K. Harmon, Anne W. Howe, John Van Schaik, and Michael C. Zola. Appendix I: The Committee on Foreign Investment in the United States and the Process for Implementing Exon-Florio In 1975, the President established the interagency Committee on Foreign Investment in the United States to monitor the impact of foreign investment in the United States and to coordinate the implementation of U.S. policy on foreign investment. In fulfilling this responsibility, the Committee was expected to (1) analyze trends and significant developments in foreign investment in the United States, (2) provide guidance on arrangements with foreign governments for advance consultation on their prospective major investments in the United States, (3) review investments that may have major implications for U.S. national interest, and (4) consider proposals for new legislation or regulations relating to foreign investment. In 1988, the Congress enacted the Exon-Florio amendment to the Defense Production Act. Exon-Florio authorized the President to investigate the impact of foreign acquisitions of U.S. companies on national security and to suspend or prohibit an acquisition if credible evidence exists that a foreign controlling interest may threaten national security and no legislation, other than Exon-Florio and the International Emergency Economic Powers Act, can adequately protect national security. The President delegated the authority to conduct investigations under Exon-Florio to the Committee on Foreign Investment in the United States. The Committee, chaired by the Secretary of the Treasury, is currently composed of representatives from the Departments of Commerce, Defense, Justice, and State; the Council of Economic Advisors; the National Economic Council; the National Security Council; the Office of Management and Budget; the Office of Science and Technology Policy; and the United States Trade Representative. Figure 1 shows how the Committee’s membership evolved from 1975 to the present. The Treasury Department’s Office of International Investment coordinates the Committee’s activities and is responsible for monitoring foreign investment in the United States while also advocating U.S. policy on open investment. In 1991, the Treasury Department issued regulations to implement Exon-Florio. As figure 2 shows, the Committee follows a four-step review process of proposed foreign acquisitions of U.S. companies: voluntary notice, 30-day review, investigation, and presidential determination. Voluntary Notification The Committee relies on companies to voluntarily report pending or completed acquisitions and Committee members to inform each other about known foreign acquisitions, although neither the companies nor the Committee members are required to do so. Treasury officials generally encourage agencies through their Committee representatives to bring foreign acquisitions to Treasury’s attention informally so that the officials may contact the companies involved and encourage them to notify voluntarily. If companies do not voluntarily submit a notification, any member of the Committee may do so. The Committee points out that companies have a strong incentive to notify and obtain approval because the President can order divestiture of unapproved acquisitions. Although the regulations do not require prior notification, in most instances, companies notify the Committee before the acquisition occurs, thus avoiding the risk and expense of forced divestiture. The implementing regulations require notices to contain detailed, accurate, and complete information about the nature of the acquisition, the name and address of the U.S. and foreign principals, the acquisition’s proposed or actual completion date, each contract with any U.S. government agency with national defense responsibilities active within the last 3 years, and each contract involving classified information active within the past 5 years. Further, the notice is required to state whether the acquired U.S. company is a Department of Defense supplier and whether it has products or technical data subject to export controls or international regulations. Thirty-day Review Period To begin the 30-day review, the Committee staff from Treasury notifies the member agencies of the acquisition and provides them with supporting documents. The Committee members then notify their appropriate internal offices to assist in reviewing the acquisition. During the 30-day review, the Committee considers such factors as whether (1) the acquisition may result in control by a foreign person of a U.S. company engaged in interstate commerce in the United States; (2) credible evidence exists to support a concern that the acquisition could impair national security; and (3) adequate authority to protect the national security is provided under provisions of laws other than the International Emergency Economic Powers Act (50 U.S.C. 1701-1706). The Committee may invite the parties to meet with the staff to discuss and clarify issues. Investigation When necessary, Committee members meet to determine whether any concerns raised are significant, thus requiring a 45-day investigation. If the Committee agrees to investigate, the Committee formally notifies the companies about the investigation and its time frame for completion. During the investigation, the Committee may analyze the acquisition in greater depth or attempt to mitigate the national security concerns raised. If national security concerns are not resolved, the Committee informs the companies that a report will go to the President with the Committee’s recommendation on the acquisition. If Committee members cannot agree on a recommendation, the report to the President includes the differing views of all Committee members. Presidential Determination The President has 15 days to decide once he has received the Committee’s recommendations. The decision is not subject to judicial review. The President can suspend or prohibit any proposed or completed acquisition. He may require the Attorney General to seek appropriate relief, including divestiture, in U.S. district courts. The President’s divestiture authority, however, cannot be exercised if (1) the Committee has informed the companies that their acquisition was not subject to Exon-Florio or had previously decided to forego investigation or (2) the President has decided not to act on that specific acquisition under Exon-Florio. However, if the Committee determines that the companies omitted or provided false or misleading information, the Committee may reopen its review or investigation or revise its recommendation to the President. The President has ordered divestiture in only one case, although other acquisitions have been canceled after Committee action without presidential intervention. The 1992 Byrd amendment to Exon-Florio requires the President to send a report to the Congress if the President makes a decision regarding a proposed foreign acquisition. This requirement was added in response to concerns about the lack of transparency in the Committee’s process. Under the original Exon-Florio law, the President was obligated to report only after prohibiting a proposed acquisition. Withdrawal Any party to the foreign acquisition may request in writing that the voluntary notice be withdrawn at any time before the President’s decision on a proposed acquisition. The request must be addressed to the Committee staff chairman and state the reasons for the request. The Committee decides whether to grant a withdrawal and notifies the requestor in writing of the Committee’s decision. After the Committee approves a withdrawal under these circumstances, any prior voluntary notices submitted no longer remain in effect. Also, any subsequent proposals by these parties must be considered as a new, voluntary notice and receive a new case number from the Committee. In some circumstances, companies have received a 5-day expedited review if the re-filed notice did not differ from the original voluntary notice. Appendix II: Comments from the Department of the Treasury Appendix III: Comments from the Department of Defense GAO Comments 1. We have revised the text to clarify that access to subscriber information is just one of the issues of concern. 2. We believe our draft report accurately reflected information Justice Department officials provided to us. In discussions with department officials about our findings, they concurred with our statement that the agreement was less stringent than other agreements and further stated that the terms were less specific in many provisions. Moreover, a Justice Department analysis provided specific examples of measures that were less stringent than measures the department required in other agreements with telecommunications companies. However, we have revised the text to clarify that the department enters into network security agreements with only some, but not all, telecommunications companies. 3. Text revised to clarify that provisions that assisted the agencies in monitoring agreements were also lacking, as demonstrated in the text following the sentence in question.

The Exon-Florio amendment to the Defense Production Act authorizes the President to suspend or prohibit foreign acquisitions, mergers, or takeovers of U.S. companies if (1) there is credible evidence that a foreign controlling interest might threaten national security and (2) legislation, other than Exon-Florio and the International Emergency Economic Powers Act, does not adequately or appropriately protect national security. The President delegated the authority to review foreign acquisitions of U.S. companies to an interagency group, the Committee on Foreign Investment in the United States. The Committee initiates investigations only when it cannot identify potential mitigation measures in the review period to resolve national security issues arising from the acquisitions or when it needs time beyond the 30-day review to negotiate potential mitigation measures and the companies involved are not willing to request withdrawal of their notification. The Committee's process for implementing Exon-Florio contains the following weaknesses that may have limited effectiveness: (1) the Committee has not established interim protections before allowing withdrawal when concerns were raised and the acquisition had already been completed (2) agreements between the Committee and companies contained nonspecific language that may make them difficult to implement and (3) agreements did not specify responsibility for overseeing implementation and contained few provisions to assist in monitoring compliance.

Summary of Findings A key reason for the difference between the 2003 total project cost estimate and the revised 2005 estimate to install in-line baggage screening systems at LAX and ONT was that the 2003 estimate was developed at an early stage in the design process and was therefore based on preliminary data and assumptions that were subject to change. Consequently, the estimate did not adequately foresee some of the costs of retrofitting new systems into existing buildings or allow for sufficient space for the EDS machines, baggage inspection rooms, and conveyor belts. LAWA officials stated that they were under a tight timeframe to apply for the LOI because TSA had told them that federal funding was limited and that 17 other airports were competing for the funding. The 2003 total project cost estimate used concepts and construction estimates developed in about 12 weeks by Boeing, TSA’s contractor. LAWA relied on designs and estimates developed by Boeing and its subcontractors to determine the total project cost estimate because the company had expertise in integrating EDS equipment into airports. According to TSA and LAWA officials, both TSA and Los Angeles signed the LOI/MOA knowing the preliminary nature of the cost estimate. According to construction industry guidance, an estimate’s accuracy depends on the quality of information known about the project at the time the estimate is prepared. The 2003 estimate was made at the “concept development” stage where the final project cost can be expected to range from 50 percent under to 100 percent over the estimated cost, according to this guidance. The 2005 revised estimate was made at the “design development” stage where the range of the final project cost estimate can be expected to be more accurate—from 20 percent under to 30 percent over the estimated cost. In December 2003, LAWA presented TSA with a summary of inadequacies it had found in the original Boeing concept and the associated potential cost and scheduling impacts. LAWA then began an engineering study to update the in-line system concepts at LAX and ONT, the results of which it presented to TSA in September 2004. TSA reviewed these updated concepts and determined that they would meet its performance requirements; however, TSA’s review did not address cost issues. LAWA used these updated concepts to develop its 2005 estimate, which was based on more definitive information about terminal design requirements than the 2003 estimate. According to LAWA, new construction and excavation included in the 2005 designs increased the estimated costs. Among the design changes, LAWA determined that the placement of EDS machines in the 2003 concepts was infeasible in five of nine of the LAX terminals and both ONT terminals. In addition, the 2005 estimate included 20 additional baggage inspection rooms, 9 rooms for on-screen resolution of EDS alarms, and 10 computer rooms at LAX and ONT terminals. The 2005 estimate also included over $11 million in computer networking costs and costs associated with on-screen resolution of EDS alarms, which the 2003 estimate did not foresee. TSA also highlighted two additional factors that caused differences between the two estimates—cost increases due to the delay in beginning construction of the project and the escalation of construction costs between 2003 and 2005. LAWA also determined that TSA’s contractor and subcontractor made a mathematical error in the 2003 concept development estimate: construction costs were only included for one of the two baggage screening facilities and neither of the connected tunnels at ONT. TSA officials told us in January 2007 they were not able to substantiate this error. Further, according to LAWA, system redesigns were required because TSA’s guidance on in-line baggage screening systems changed between the 2003 and 2005 estimates, leading to higher estimates. Because few in-line systems were in use at the time of the September 2003 LOI/MOA, only limited information on the capabilities of the in-line EDS machines, including actual bags screened per hour and false alarm rates, was available for modeling the systems. In June 2006, TSA produced the Recommended Security Guidelines for Airport Planning, Design and Construction to guide future construction of in-line checked baggage screening systems based on its past experiences. TSA also expects to release more detailed guidelines for in-line system planning and design in a few months. The LOI/MOA affords TSA flexibility to amend the agreement to account for changed circumstances. However, under the terms agreed to in the LOI/MOA, TSA has no obligation to amend the LOI/MOA or to reimburse the City of Los Angeles for any additional costs beyond those agreed to in the LOI/MOA, and TSA officials have stated that the agency does not have plans for such reimbursement. Scope and Methodology To review key factors that contributed to the differences between the 2003 and 2005 cost estimates, we reviewed TSA and LAWA documents used in developing the cost estimates, including design plans, reports, briefings, and emails. We interviewed officials from TSA and LAWA, as well as TSA contractors and other relevant officials who participated in the cost- estimation process to learn about the factors that contributed to the increased estimate of the cost of in-line checked baggage screening systems at LAX and ONT. We visited LAX and ONT to obtain a first-hand perspective of the modifications needed to install the in-line EDS systems at both airports. Additionally, we examined industry guidance on estimating costs for construction projects. We did not independently verify the 2003 or 2005 cost estimates. We conducted our work in accordance with generally accepted government auditing standards from October 2006 through March 2007. Agency Comments and Our Evaluation We provided a draft of this report to LAWA and the Department of Homeland Security (DHS) for review and comment. LAWA provided written comments which we have included in their entirety in appendix III. DHS provided no written comments. TSA provided e-mail comments. In addition, LAWA and TSA provided technical comments concerning facts in the report which we incorporated as appropriate. In its March 8, 2007, comments, LAWA wrote that it believes the draft did not paint an accurate or complete picture of the facts. In general, LAWA raised three points: (1) TSA has the authority to revise the LOI to reflect accurate cost figures and explicitly anticipated doing so during the LOI/MOA development process, (2) the report fails to assign specific responsibility for initial designs and any errors, as directed by the Report of the Senate Appropriations Committee, and (3) the report does not recognize that LAWA responded to TSA urgency in completing the agreements and, as a result, used preliminary design and cost estimates as the basis for entering into the LOI/MOA. We do not agree with LAWA’s comments. With respect to its first point, it is true that the LOI/MOA agreements afford TSA flexibility to amend the agreements to account for changed circumstances. As stated in our report, however, under the terms of the LOI/MOA and in accordance with the law, TSA is under no obligation to amend the LOI/MOA or to reimburse LAWA for any costs beyond those agreed upon in the LOI/MOA. To date, as noted in our report, TSA has not indicated any intent to amend the LOI/MOA agreements to provide LAWA with additional funding for this project. LAWA states that it did not believe it would be held financially responsible for increases in eligible and allowable costs due to reasons beyond its control. When subsequent estimates revealed that the project costs would exceed the LOI/MOA-estimated amount, LAWA requested an amendment to the LOI to receive a 75 percent federal reimbursement of the $485 million revised estimate. LAWA also commented that a senior TSA official provided written assurances that the agency “would have the opportunity to cover an increase in costs due to design changes” and referenced an April 2004 e-mail from a TSA official to LAWA in support of this assertion. LAWA noted that it relied on this and other assurances from TSA, “reinforced in various discussions,” at the time it concluded the LOI/MOA process. While the April 2004 e-mail cited above did note that LAWA would not “be held to estimates that do not prove to be right on the mark,” this particular statement was made at least seven months after TSA and LAWA had concluded the LOI/MOA process and entered into the agreements. Furthermore, the MOA clearly provides that the agreement signed by both parties constitutes the “complete integration of all understandings between the parties.” More generally, it provides that any prior, contemporaneous, or subsequent changes, whether written or oral, have no force or effect, and that any changes or modifications to the MOA must be in writing, signed by the TSA Contracting Officer, and duly executed by the City of Los Angeles to have such force or effect. Neither LAWA nor TSA presented any documentation suggesting that steps prescribed in the MOA had been (or were anticipated to be) taken to amend the LOI/MOA with respect to the reimbursable amount. LAWA also stated that the report does not reflect the extensive and protracted discussions LAWA had with TSA, leaving the impression that LAWA simply presented a new set of design concepts to TSA in September 2004. Our objective in this report, as agreed with congressional offices, was to identify the key factors that contributed to the differences between the 2003 and the 2005 cost estimates. As such, we reported that LAWA reported the findings of its engineering study in September 2004 and that TSA approved the concepts. We believe this statement sufficiently demonstrates the agreement between TSA and LAWA on the revised designs. In its second point, LAWA suggests that the GAO report avoids assigning responsibility to TSA or its contractors and, as a result, “failed to answer the Senate Committee’s direction to provide a detailed explanation of the reasons for any differences the original estimate, including identification of and the party responsible for any material mistakes, omissions, and infeasible design concepts in the original estimate.” The objective of the report, as agreed with the appropriate congressional offices in accordance with our Congressional Protocols, was to identify factors contributing to differences between the estimates. To the extent appropriate, we identified the roles and responsibilities of the various parties. Specifically, we noted that Boeing produced the conceptual designs that served as the basis for the 2003 estimate agreed to in the LOI/MOA. We noted that these designs had been developed at an early stage of the design process, which assumes costs that can differ greatly from final project costs. The report also states that LAWA had determined that Boeing had made a mathematical error in the Ontario estimate. Further, we determined that both TSA and LAWA had signed the LOI/MOA knowing of the preliminary nature of the cost estimate. Finally, as referenced in our scope and methodology and as agreed with the congressional offices, in identifying factors associated with the estimates, we did not independently verify the 2003 or 2005 cost estimates. In its third point, LAWA suggests the report does not recognize that LAWA responded to TSA urgency in completing the agreements and, as a result, used preliminary design and cost estimates as the basis for entering into the LOI/MOA. The report notes that “LAWA officials stated that they were under a tight timeframe because TSA had told them that federal funding was limited and 17 other airports were competing for the funding.” We identified this as a factor associated with the preliminary nature of the 2003 estimate. LAWA also commented that it was essentially required to accept the Boeing design and cost estimates. The report states that TSA and LAWA used the Boeing estimate to provide the basis for the estimate agreed to in the September 2003 LOI/MOA. Neither TSA nor LAWA provided evidence suggesting that TSA had required LAWA to accept the Boeing design and cost estimates. In its e-mail comments, TSA stated that concept development for in-line solutions at all of the airports with LOIs was a collaborative effort between TSA and the respective airport entity. TSA further stated that most of the LOI estimates were developed early in the concept development phase. We incorporated a comment into the report to acknowledge that TSA viewed the development of the concepts as a partnership; however, we did not review concept development at other airports. In its comments, TSA also states that there were only two changes in its guidance between 2003 and 2005. The first was the addition of the use of On-Screen Alarm Resolution Protocol during the alarm resolution process, which TSA acknowledged required redesign and associated cost increases. The second was the increase in the baggage throughput number per EDS which led to the deletion of 13 EDS machines from the quantity estimated in the 2003 concepts. According to TSA, this would have a significant impact on lowering the overall project cost, which would be supported by decreasing required space, baggage handling system infrastructure (generally up to $4 million per machine on average) and associated electrical, mechanical, data and other infrastructure. In its comments, TSA described two additional factors that caused differences between the two estimates— cost increases due to the delay in beginning construction of the project and the escalation of construction costs between 2003 and 2005. We incorporated this comment into the report. Finally, TSA stated in its comments that it had reviewed the mathematical error LAWA determined Boeing made in the 2003 concept for ONT, and had not been able to validate that the error had been made. In our report we acknowledge that TSA was not able to substantiate the error. We will send copies of this report to the Secretary of Homeland Security and the Assistant Secretary, Transportation Security Administration, and interested congressional committees. We will send a copy of the report to LAWA and will also make copies available to others upon request. In addition, the report will be available at no charge on GAO’s Web site at http://www.gao.gov. If you have any questions or need additional information, please contact me at (202) 512- 2757 or goldenkoffr@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are acknowledged in appendix I. Appendix I: GAO Contact and Staff Acknowledgments Acknowledgments In addition to the contact named above, Charles Bausell, Kevin Copping, Kimberly Cutright, Glenn Davis, Terrell Dorn, Maria Edelstein, Richard Hung, Julian King, Brian Lipman, Thomas Lombardi, Amanda Miller, and Linda Miller made key contributions to this report. Appendix II: Briefing Slides Review of Cost Estimates for Installing Introduction Objectives Senate Report 109-273 directs GAO to review the differences between the original 2003 cost estimate and LAWA’s revised 2005 cost estimate. As agreed with committee offices, GAO identified the key factors that contributed to the differences in the two estimates. To address the objective, we reviewed key TSA and LAWA documents used in developing the cost estimates, including design plans, reports, briefings, and emails; interviewed TSA, LAWA, and other officials who participated in the cost- estimation process; visited LAX and ONT to obtain a first hand perspective of the modifications needed to install the in-line EDS Systems at both airports; and reviewed industry guidance on estimating costs for construction projects. We did not independently verify the 2003 or 2005 cost estimates for installing the in-line EDS systems or the reasonableness/adequacy of the designs. We conducted our work in accordance with generally accepted government auditing standards from October 2006 through March 2007. Background In-line EDS systems are advantageous because they can: Increase the efficiency of airport, airline, and TSA operations. Lower costs by reducing the number of transportation security officers required to screen checked baggage. out of airport lobbies where it causes overcrowding, creating a potential target for terrorists. In-line EDS systems are integrated with airports’ baggage- handling conveyor systems. Background (cont.) TSA and LAWA initiated discussions about in-line solutions for LAX and ONT in January 2003 in order to replace stand-alone EDS machines in the airports’ lobbies. LAWA used concepts and construction estimates developed by TSA’s contractor, Boeing, for the LAX and ONT in-line baggage screening systems because of Boeing’s and its subcontractors’ expertise in integrating explosive detection systems into airports. TSA reported that concepts for LAX and ONT were developed through a partnership between LAWA and the agency. Boeing’s 2003 cost estimate consisted of $260 million for LAX and $24 million for ONT. LAWA and TSA agreed to add another $57 million (or 20 percent) for estimated administrative expenses for a total project cost of $341 million. Background (cont.) In December 2003, LAWA presented TSA with a summary of inadequacies it had found in the original concepts, and the associated potential cost and scheduling impacts. In April 2005, LAWA submitted a revised cost estimate to TSA based on TSA approved concepts from a September 2004 LAWA engineering study. This revised cost estimate included a request that TSA amend the LOI/MOA to increase the federal reimbursement by about $122 million, a sum that would raise the total federal reimbursement to about $378 million. As of February 2007, TSA has obligated $256 million in accordance with the schedule set forth in the LOI/MOA for Los Angeles. As of October 2006, TSA had reimbursed LAWA for about $26 million in expenses from the total amount obligated. LAWA officials stated that they were under a tight timeframe to apply for the LOI because TSA told them that federal funding was limited and that 17 other airports were competing for the funding. TSA’s Boeing contracting team spent about 12 weeks from January to April 2003 to develop initial drawings (known as concept development drawings) and construction cost estimates. Between April and September 2003, TSA and LAWA negotiated the addition of administrative and contingency costs to the estimate. TSA’s in-line system design guidance was evolving while the estimate was being developed, requiring frequent changes to the conceptual drawings. Accuracy of Cost Estimates Depends on Completeness and Maturity of Information The accuracy of an estimate depends on the quality of information known about the project at the time the estimate is being prepared. The 2003 estimate was made at the “concept development” stage where the final project cost can be expected to range from 50 percent under to 100 percent over the estimated cost based on construction industry guidance.5 The 2005 estimate was made at the “design development” stage where the final project cost can be expected to range from 20 percent under to 30 percent over the estimated cost. (See fig.1.) Construction Industry Institute, Improving Early Estimates Research Team, Improving Early Estimates: Best Practices Guide, (September 1998.) The Use of Preliminary Information Limited the Precision of the 2003 Estimate Due to the preliminary information on which it was based, the 2003 estimate did not foresee some of the challenges of retrofitting new systems into existing buildings and did not include space for various screening operations. LAWA determined that the 2003 concepts for each terminal did not allow for sufficient space for the EDS machines, conveyor belts, and the construction of baggage inspection rooms, rooms for computer monitors for on-screen resolution of EDS alarms and rooms for computer routers and servers. LAWA determined that the placement of EDS machines in the 2003 concepts needed to be changed in five of the nine terminals at LAX and both ONT terminals. The 2005 Estimate Was Based on More Definitive Information The revised 2005 estimate was based on concepts approved by TSA in 2004 which included more definitive information about terminal design requirements than the 2003 estimate. The 2005 estimate designs included new construction and excavation, leading to cost estimate increases. The 2005 estimate included the incorporation of 20 additional baggage inspection rooms, 9 on-screen resolution rooms and 10 computer rooms at LAX and ONT terminals. The 2005 estimate included over $11 million in networking costs and costs associated with on-screen resolution of EDS alarms. TSA also highlighted two additional factors that impacted the estimates—cost increases due to the delay in beginning construction of the project and the escalation of construction costs between 2003 and 2005. In 2004, LAWA determined that Boeing had made a mathematical error in the 2003 concept development estimate: construction costs were only included for one of the two baggage screening facilities and neither connecting tunnel at ONT. In January 2007, TSA officials told us that they were not able to substantiate the mathematical error in the 2003 concept development estimate. Changes in TSA Guidance and Evolving Technologies Contributed to Rise in Estimate According to LAWA, changes in TSA guidance on in-line system designs after the LOI/MOA was signed necessitated system redesigns. Because few in-line systems were in use at the time of the LOI/MOA, limited information on the capabilities of the in-line EDS machines, including actual bags screened per hour and false alarm rates, was available for modeling the systems. In June 2006, TSA produced Recommended Security Guidelines for Airport Planning, Design and Construction to guide future construction of in-line checked baggage screening systems. TSA also expects to release more detailed guidelines for in-line system planning and design in a few months. Concluding Observations The rise in the estimate between 2003 and 2005 was primarily related to the fact that the 2003 estimate was developed at an early stage in the design process and was therefore based on preliminary data and assumptions that were subject to change. According to TSA and LAWA officials, both TSA and Los Angeles signed the LOI/MOA knowing the preliminary nature of the cost estimate. The LOI/ MOA affords TSA flexibility to amend the agreements to account for changed circumstances. However, under the terms agreed to in the LOI/MOA, TSA has no obligation to amend the LOI/MOA or to reimburse Los Angeles for any additional costs beyond those agreed to in the LOI/MOA and does not have plans to do so. Time Line of Key Events from the 2003 and 2005 Cost Estimates LAWA presents TSA summary of inadequacies in 2003 estimate. TSA approves design assumptions for LAX and ONT. LAWA submits revised cost estimate to TSA and requests amendment to LOI/MOA for additional funding. LAWA requests TSA to amend the LOI/MOA for a time extension and additional funding. Appendix III: Comments from Los Angeles World Airports

To meet the mandate to screen all checked baggage for explosives by December 31, 2003, the Transportation Security Administration (TSA) placed minivan-sized explosive detection systems (EDS) and other screening equipment in airport lobbies. However, these interim lobby solutions have caused operational inefficiencies, in part because they require a large number of screeners. According to TSA, in-line baggage screening--where EDS machines are integrated with an airport's baggage conveyor system--can be a more cost-effective and efficient alternative to lobby-based, stand-alone equipment. For example, in-line systems can increase the efficiency of airport, airline, and TSA operations, and lower costs by reducing the number of screeners. Moreover, in-line explosive detection systems can enhance security because they reduce congestion in airport lobbies, thus removing a potential target for terrorists. However, installing in-line systems can have large up-front costs, related to the need for airport modifications. To help defray these costs, in 2003, Congress authorized TSA to reimburse airports up to 75 percent of the cost to install these systems by entering "letter of intent" (LOI) agreements. An LOI, though not a binding commitment of federal funding, represents TSA's intent to provide the agreed-upon funds in future years if the agency receives sufficient appropriations to cover the agreement. TSA has issued eight letters of intent to help defray the costs of installing in-line systems at nine airports as of February 2007, but none since February 2004. In September 2003, TSA and the City of Los Angeles signed an LOI and an attached memorandum of agreement (LOI/MOA) in which TSA agreed to pay an amount not to exceed 75 percent of the agreed upon estimated total project cost of $341 million (about $256 million) to install in-line checked baggage screening systems at both Los Angeles (LAX) and Ontario (ONT) International Airports. However, in December 2003, officials from the City of Los Angeles' airport authority--Los Angeles World Airports (LAWA)--informed TSA that aspects of the design concept were infeasible and that additional construction modifications would be needed. LAWA subsequently submitted a revised cost estimate to TSA in April 2005 and requested that TSA amend the LOI/MOA to increase the federal reimbursement by about $122 million. TSA has not amended the LOI to provide for additional reimbursements; however, as of February 2007, TSA had obligated the $256 million for the City of Los Angeles LOI/MOA in accordance with the schedule agreed to in the LOI and had reimbursed LAWA for about $26 million in expenses. Senate Report 109-273 directs us to review the reasons for the differences between the original 2003 cost estimate and the revised 2005 cost estimate submitted by LAWA. In response and as agreed with committee offices, we identified the key factors that contributed to the differences between the two cost estimates. On January 23, 2007, we briefed staff of the Senate Subcommittee on Homeland Security, Committee on Appropriations, on the results of our work. A key reason for the difference between the 2003 total project cost estimate and the revised 2005 estimate to install in-line baggage screening systems at LAX and ONT was that the 2003 estimate was developed at an early stage in the design process and was therefore based on preliminary data and assumptions that were subject to change. Consequently, the estimate did not adequately foresee some of the costs of retrofitting new systems into existing buildings or allow for sufficient space for the EDS machines, baggage inspection rooms, and conveyor belts. LAWA officials stated that they were under a tight timeframe to apply for the LOI because TSA had told them that federal funding was limited and that 17 other airports were competing for the funding. The 2003 total project cost estimate used concepts and construction estimates developed in about 12 weeks by Boeing, TSA's contractor. According to TSA and LAWA officials, both TSA and Los Angeles signed the LOI/MOA knowing the preliminary nature of the cost estimate. According to construction industry guidance, an estimate's accuracy depends on the quality of information known about the project at the time the estimate is prepared. The 2003 estimate was made at the "concept development" stage where the final project cost can be expected to range from 50 percent under to 100 percent over the estimated cost, according to this guidance. The 2005 revised estimate was made at the "design development" stage where the range of the final project cost estimate can be expected to be more accurate--from 20 percent under to 30 percent over the estimated cost. In December 2003, LAWA presented TSA with a summary of inadequacies it had found in the original Boeing concept and the associated potential cost and scheduling impacts. LAWA then began an engineering study to update the in-line system concepts at LAX and ONT, the results of which it presented to TSA in September 2004. TSA reviewed these updated concepts and determined that they would meet its performance requirements; however, TSA's review did not address cost issues. LAWA used these updated concepts to develop its 2005 estimate, which was based on more definitive information about terminal design requirements than the 2003 estimate. According to LAWA, new construction and excavation included in the 2005 designs increased the estimated costs. Among the design changes, LAWA determined that the placement of EDS machines in the 2003 concepts was infeasible in five of nine of the LAX terminals and both ONT terminals. In addition, the 2005 estimate included 20 additional baggage inspection rooms, 9 rooms for on-screen resolution of EDS alarms, and 10 computer rooms at LAX and ONT terminals. The 2005 estimate also included over $11 million in computer networking costs and costs associated with on-screen resolution of EDS alarms, which the 2003 estimate did not foresee. TSA also highlighted two additional factors that caused differences between the two estimates--cost increases due to the delay in beginning construction of the project and the escalation of construction costs between 2003 and 2005. LAWA also determined that TSA's contractor and subcontractor made a mathematical error in the 2003 concept development estimate: construction costs were only included for one of the two baggage screening facilities and neither of the connected tunnels at ONT. TSA officials told us in January 2007 they were not able to substantiate this error.

Background As election officials manage voter registration processes and voter lists, they must balance two competing goals. On the one hand, officials seek to minimize the burden on eligible people registering to vote. On the other hand, they also seek to ensure that the voter lists are accurate, a task that involves including the name of each eligible voter on the voter list, removing names of ineligible voters, and having safeguards in place so that names of voters are not removed in error from the list. Congress has passed legislation relating to the administration of both federal and state elections, pursuant to its various constitutional powers, including processes related to maintaining voter lists. The constitutional framework for elections contemplates both state and federal roles. States are responsible for the administration of both their own elections and federal elections. States regulate various aspects of the election process, including, for example, ballot access, registration procedures, absentee voting requirements, establishment of polling places, provision of election day workers, and counting and certifying the vote. The states in turn incur the costs associated with these activities. Although the states are responsible for running elections, Congress has authority to affect the administration of elections. Congress’ authority to regulate elections depends upon the type of election. With regard to federal elections, Congress has constitutional authority over both congressional and presidential elections. In addition, with respect to federal, state, and local elections, a number of constitutional amendments authorize Congress to enforce prohibitions against specific discriminatory acts. Most recently, HAVA was enacted in 2002, and among other things, mandated that each state establish a computerized statewide voter registration list to serve as the official voter registration list for conducting elections for federal office in each state. The voter registration list is to serve as a secure, centralized, and interactive database that is coordinated with other state agency databases and grants state and local election officials immediate electronic access to enter and update voter information. States and territories were to implement a computerized statewide voter registration database by January 1, 2004. States could apply to EAC by January 1, 2004, for a waiver of the effective date until January 1, 2006. Nine states and one territory—Alaska, Arizona, Georgia, Hawaii, Kentucky, Minnesota, South Carolina, South Dakota, West Virginia, and Guam—did not apply for a waiver. States subject to HAVA must also take steps to ensure that the statewide voter registration lists are accurate. Under HAVA, states are to perform list maintenance on a regular basis by removing ineligible voters from the statewide voter list. States are to coordinate the computerized list with their state agencies’ records on felony status and death to verify voters’ eligibility. For example, states must cross-reference the voter registration list with their state’s records on felons to remove the names of ineligible voters and records on death to remove deceased registrants. States are also required to remove duplicate registrants, that is, names of voters that appear more than once on the statewide voter list. HAVA, in general, leaves it to the states’ discretion to determine the type and frequency of actions to implement this list maintenance requirement. In addition to undertaking list maintenance, states are required under HAVA to verify voter registration application information. For federal elections, a voter registration application may not be processed or accepted by a state unless it contains the applicant’s driver’s license number or the last four digits of the Social Security number. If the voter has neither of these numbers, the state must assign the voter a voter identification number. Voter registration information is to be matched with motor vehicle agency (MVA) records or Social Security Administration (SSA) records, depending on the information provided by the applicant. Certain state laws require applicants to provide their full Social Security number on voter registration applications. HAVA provides that for those states requiring full Social Security numbers on such applications, in accordance with Section 7 of the Privacy Act of 1974, the HAVA voter registration verification requirements are optional. Of the nine states that did not receive waivers, four—Georgia, Hawaii, Kentucky, and South Carolina—collect the full Social Security number and, therefore, are not subject to this HAVA requirement, according to state officials. Under HAVA, the state MVA must enter into an agreement with SSA to verify the applicant information when applicants provide the last four digits of their Social Security number rather than a driver’s license number on voter registration applications. HAVA additionally requires SSA to develop methods to verify the accuracy of information on the voter registration applications by matching the name, date of birth, and the last four digits of the Social Security number provided on the voter registration application with SSA records. SSA is to determine whether SSA records indicate the individual is deceased. Figure 1 provides an example of how a computerized statewide voter registration list could verify voter eligibility through matching registration applications with MVA and SSA, matching the statewide list with state records on felons and death notices from the state courts and the state vital statistics agency, and identifying duplicate registrants in the statewide list. To assist states with implementing these federal mandates, HAVA authorizes funding to states for the creation and maintenance of the computerized statewide voter lists. In turn, HAVA requires states to provide such support as may be required to local jurisdictions to enable them to use the computerized voter list. HAVA also established EAC and charged it with, among other things, providing voluntary technical guidance on the administration of federal elections, serving as a national clearinghouse for information on election administration, and providing federal funding to the states to implement the HAVA provisions. Also, DOJ has enforcement authority with respect to the uniform and nondiscriminatory implementation of certain HAVA requirements such as those relating to the statewide voter registration list and verifying information on voter registration applications. According to DOJ officials, following the passage of HAVA, it was unnecessary to take enforcement actions against any of the nine nonwaiver states. DOJ officials also reported working with the states to address initial challenges and provide informal guidance while EAC awaited staff and resources. Appendix II discusses EAC’s and DOJ’s roles regarding computerized statewide voter registration lists in greater detail. Eight States Reported Taking Actions to Establish Computerized Statewide Voter Registration Lists, and the Ninth Reported Having Such a List Prior to HAVA Officials from eight of the nine states reported taking a variety of actions in order to implement the HAVA computerized voter registration list requirement; an official from one state, Kentucky, reported no actions were taken because the state had such a system in place prior to the enactment of HAVA. Officials from Alaska, Georgia, Hawaii, South Carolina, and South Dakota reported modifying their existing computerized statewide voter registration systems; officials from Minnesota said the existing computerized voter registration system was replaced; and officials from Arizona and West Virginia said their states created computerized statewide voter registration systems for the first time. Although these eight states reported taking different steps to establish computerized statewide voter registration systems, election officials reported that all of these systems met the HAVA provisions that called for computerized statewide voter registration lists. According to officials, these computerized lists served as centralized and interactive databases containing the names of all legally registered voters in the state and granted election officials immediate electronic access to query, update, and enter voter information. They also said these computerized lists were capable of generating official voter registration lists. Figure 2 summarizes the actions that eight of the nine states reported taking to establish computerized voter registration lists. Election officials from six states, Alaska, Georgia, Hawaii, Kentucky, South Carolina, and South Dakota, said their states’ existing computerized statewide voter registration systems, in place in some cases for many years prior to HAVA, allowed state and local election officials to share and maintain an interactive database of registered voters and generate official voter registration lists. As a result, officials from Kentucky reported they were required to make no change to their existing system to implement the HAVA requirements. Officials from these other states reported that they were required to only modify their existing systems, in some cases making only minor changes, in order to implement HAVA. For example, in Hawaii, election officials reported their state has operated a computerized statewide voter registration system since 1982 and only made minor technical changes as a result of HAVA, such as adding the ability to flag inactive voters. In addition, since Georgia, Hawaii, Kentucky, and South Carolina collect voters’ full Social Security numbers on voter registration applications, they are not subject to the HAVA provisions for verifying information on voter registration applications by matching it with MVA and SSA records, officials reported. Accordingly, officials said they did not have to modify their existing systems to provide this matching capability. Alaska and South Dakota are subject to HAVA’s data matching provisions. These states also had computerized statewide voter lists in place prior to HAVA, and their election officials said they modified them as a result of HAVA. Alaska election officials reported that they added new data fields to the computerized statewide voter registration system to capture the last four digits of the voters’ Social Security numbers and to identify first-time voters who registered by mail, which required little or no effort. South Dakota election officials reported making similar changes as well as adding the capability to match voter registration applications with MVA and SSA records, actions that required a moderate level of effort, they said. In the three remaining states, officials reported creating new systems in order to implement HAVA. Officials from Minnesota said their state operated a computerized statewide voter registration system prior to HAVA. Their state replaced rather than modified this system. Arizona and West Virginia election officials reported that their states did not have computerized statewide voter lists in place prior to HAVA and that they expended a significant level of effort to create such systems. Prior to HAVA, some counties and local jurisdictions in these states had computerized voter registration systems in place. However, the systems were not interconnected to create statewide databases of legally registered voters. Election officials in Arizona said that creating the computerized list was also complicated because state and county election officials lacked the legal authority to access state records they were to match with the statewide voter list. The state had to pass new statutes and amend others so that election officials could receive information from state agencies, such as felony records, according to a senior election official. Some officials told us that in addition to the capabilities required by HAVA their states’ computerized voter registration systems provide election management tools that help them prepare for and conduct elections. For example, West Virginia election officials told us their computerized voter registration list is also able to identify voters who wished to serve as poll workers and produce reports on absentee ballots, early voters, poll workers, and election data statistics. Minnesota state election officials said that their computerized voter registration list includes a module that centrally tracks absentee ballots provided to military personnel or other citizens residing overseas. Some state officials are planning to enhance their systems’ election management features. For example, Arizona plans to award a contract to implement an updated version of its current system, which is to include the ability to track out-of-state moves by voters and manage issues such as petitions, provisional ballots, poll workers, and poll locations. Kentucky election officials told us that they wish to upgrade their system to provide more election management tools to counties, including a new function to identify poll workers and complete absentee ballot forms. See appendixes III through XI for more information on each state’s current computerized statewide voter registration system and future plans. Federal funds are available to states to assist them as they implement the HAVA provisions. In turn, HAVA requires states to provide such support as may be required to local jurisdictions to help them use the computerized voter lists. Officials from six states we interviewed—Alaska, Arizona, Minnesota, South Carolina, South Dakota, and West Virginia— reported receiving federal funds to establish computerized voter lists; these states said they spent a combination of federal and state funds totaling about $8.4 million to establish their computerized lists. As required by HAVA, each of the nine states, except Alaska, where the state is solely responsible for entering and maintaining voter registration information, provided some type of support to local jurisdictions to help them operate the computerized statewide voter registration systems, according to officials. For example, South Carolina election officials told us that they provided personal computers and software to local jurisdictions, as well as training for staff. States Reported Taking Steps to Verify Information on Registration Applications and Maintain Lists, Improving the Accuracy of Some Lists State election officials reported taking required steps to verify information provided on voter registration applications and to maintain accurate computerized voter lists. Alaska, Arizona, Minnesota, South Dakota, and West Virginia—the states subject to the HAVA provisions to verify information provided on voter registration applications—took steps to do so by collecting the required unique identifying information from voters, officials told us. As of November 2005, Arizona and South Dakota were matching information on the applications with state MVA or SSA records, according to election officials. The remaining states were in various stages of implementing the matching requirement. All nine states conducted regular voter list maintenance activities to purge duplicates and remove names of persons ineligible to vote, such as deceased registrants, as required by HAVA, officials also reported. Officials from four of the nine states we reviewed said that implementing the HAVA requirements led to some or great improvement in the accuracy of their voter lists. While HAVA contains requirements that should help states maintain accurate voter registration lists, maintaining accurate voter lists will likely remain a challenge for election officials, in part because lists are dynamic and constantly changing as voters move, change names, or become ineligible to vote. States Reported Taking Steps to Verify Voter Registration Applications with MVAs and SSA Under HAVA, most states are to verify the accuracy of information on voter registration applications by matching information, such as the name and date of birth, with MVA or SSA records, depending on the information provided by the applicant. As noted earlier, HAVA also requires that voter registration applicants for federal elections provide or be assigned one of several types of unique identifying information that can be matched with other records for verification. For matching purposes, applicants are to be asked for their state driver’s license number or, if an applicant has not been issued a driver’s license, the last four digits of the voter’s Social Security number. An eligible applicant who has not been issued a state driver’s license or a Social Security number can still register to vote. In those cases, election officials are required to assign the registrant an identification number. Not all states are subject to the HAVA requirement to verify voter registration application information by comparing or matching the information with MVA or SSA records. In general, under HAVA, states requiring full Social Security numbers on voter registration applications prior to 1975 in order to verify the identity of a registrant are not subject to the HAVA requirement that application information be matched with MVA or SSA records. HAVA provides that for those states the voter registration verification requirement is optional. Four of the nine states we reviewed— Georgia, Hawaii, Kentucky, and South Carolina—collect the full Social Security number on voter registration applications and, therefore, according to state officials, are not subject to this provision. Five of the nine states we reviewed—Alaska, Arizona, Minnesota, South Dakota, and West Virginia—are subject to this HAVA provision to collect or assign a unique identifying numbers and then verify voter information by matching it with MVA or SSA information. Officials from all five of these states subject to this HAVA provision reported their systems collected or assigned the required unique identifying numbers for registered voters, as indicated in table 1. Officials from four of the five states also reported taking steps to match information on voter registration applications with state MVA records and provided the date by which MVA matching became available, as indicated in table 2. In West Virginia, officials said that their state was not yet conducting these required matches because they were still in the process of developing an agreement with the MVA to verify information on applications. They also reported difficulty conducting data matches because the MVA lacked the ability to interface with the statewide voter list. They expected this issue to be resolved by 2006. Although not required to do so, Hawaii voluntarily implemented this HAVA requirement, election officials said. In addition, officials from all five of these states subject to this HAVA provision reported taking steps to match information on voter registration applications with SSA records. As noted earlier, if voter registration applicants provide the last four digits of their Social Security number on the registration applications rather than their driver’s license numbers, states are to verify information on the application by matching it with SSA records. Officials from two states—Arizona and South Dakota—reported that their states were currently conducting the required matches. They were not able to conduct these matches by the January 1, 2004, deadline because SSA’s computer program to process these matches was not operational until 8 months after the deadline had passed, in August 2004. Election officials from three states—Alaska, Minnesota, and West Virginia—said their states were not yet conducting these required matches because they were still in the process of developing an agreement with SSA to verify information on applications. Minnesota officials also said they encountered technical difficulties electronically sharing data with SSA but anticipated the agreement and the technological issues would be resolved so that they could conduct matches by 2006. Alaska and West Virginia officials could not provide an estimated date by which the agreement would be completed and the required matches conducted. All States Reported Taking Steps to Perform Required List Maintenance on a Regular Basis In addition to requiring most states to verify information on voter registration applications, HAVA provides that all states, including the nine states discussed in this report, are to perform list maintenance on the HAVA-required statewide voter registration lists on a regular basis. In general, list maintenance activities include adding new voters to the voter list; updating voter information if a voter moves within the state; and removing the names of ineligible voters from the voter list, such as persons who are deceased or convicted of a felony that, under state law, makes them ineligible to be registered to vote. HAVA requires that the computerized list be coordinated with state agency records on felony status and death to remove the names of ineligible voters. Duplicate registrations, that is, names of voters that appear more than once on the statewide voter list, are also to be eliminated. Election officials in all nine states reported taking the required actions to perform list maintenance on a regular basis to identify and remove duplicates and names of registrants ineligible to vote. The sections below identify the type and frequency of actions states reported taking to implement the HAVA-required list maintenance activities in accordance with state and local procedures. These procedures for maintaining the statewide voter list varied from state to state, as detailed in appendixes III-XI. Identifying duplicate voter registrations. HAVA requires that states are to remove duplicate registrations, that is, names of voters that appear more than once, from the statewide voter list. Duplicate registrations may occur in the statewide lists when, for example, voters move within a state, reregister, and then fail to notify the county in which they were previously registered to vote. HAVA, in general, leaves it to the states’ discretion to determine the type and frequency of actions to implement this list maintenance requirement. Officials from all nine states reported that their systems check for duplicate registrants to ensure that voters are not listed in the statewide voter list more than once. When applications are entered into the statewide database of registered voters, some states’ systems automatically screen the applications on a real-time basis, that is, as the data are entered, to ensure that they do not duplicate an existing registration; other states screen the entire list on a regular basis. Table 3 shows the variation by state in the reported type and frequency of actions taken to identify duplicate registrations. Identifying names of deceased voters. HAVA requires that states are to coordinate the voter list with their state agencies’ death records to verify voters’ eligibility. HAVA, in general, leaves it to the states’ discretion to determine the type and frequency of actions to implement this list maintenance requirement. Officials from all nine states reported that they or local officials regularly matched state agency death records with the statewide voter lists to ensure that names of deceased registrants do not remain on the rolls. Most of these matches were based on electronic or paper records. Table 4 shows the variation by state in the reported type and frequency of actions taken to identify deceased registrations. Identifying persons convicted of a disqualifying felony. HAVA requires states to coordinate the voter list with their state agencies’ records on felony status to verify voters’ eligibility. HAVA, in general, leaves it to the states’ discretion to determine the type and frequency of actions to implement this list maintenance requirement. Officials from all nine states reported that their states matched state court records with the statewide lists to identify persons ineligible under state law to vote because of a disqualifying felony conviction. These matches were based on electronic or paper records. Table 5 shows the variation by state in the reported type and frequency of actions taken to identify voters ineligible to register because of a felony conviction. Identifying individuals ineligible to vote because of mental incompetence. The voter eligibility requirements in the nine states we reviewed provided that applicants declared mentally incompetent to vote are not eligible to register to vote. Officials in eight states reported they have procedures in place to identify registrants ineligible to vote because of court orders of mental incompetence. All reported that removing registrants for this reason was a rare occurrence. The ninth state, West Virginia, did not report such procedures are in place. Four States Reported That Voter List Accuracy Improved as a Result of HAVA, but Managing Inherent Risks to Voter List Accuracy Remains a Challenge Officials from four states—Arizona, Minnesota, South Dakota, and West Virginia—reported that implementing the HAVA requirements improved the accuracy of their voter lists somewhat or to a great extent. South Dakota officials reported that verifying applications has helped identify inaccurate information on applications and that matching applications with the MVA helped reduce the number of duplicate registrations. Officials from Minnesota, which replaced its existing computerized voter registration with a new one in order to implement HAVA, also reported that implementing the HAVA requirements reduced the incidence of duplicate registrations. And officials in the states of Arizona and West Virginia, which built entirely new systems to comply with HAVA, reported a great improvement in the accuracy of their voter rolls. Officials from the remaining states—Alaska, Georgia, Hawaii, Kentucky, and South Carolina—reported that HAVA had little or no effect on the accuracy of their voter lists. This result likely occurred, some of these officials said, because their states have had well-established computerized statewide lists, similar to those required by HAVA, in place for many years prior to HAVA. Officials from Georgia, Hawaii, and Kentucky also attributed this result to their states’ ability to require the full Social Security number on voter registration applications. Having this unique identifier provided a means to identify and remove duplicate registrants from voter lists, they stated. While HAVA contains requirements directed at maintaining accurate voter registration lists, even after such requirements are implemented, maintaining accurate computerized lists will likely remain a challenging task for state and local officials. In part this is because of the inherent risks of managing a dynamic body of information that is constantly changing as voters move, change names, come of age to vote, or become ineligible to vote. Managing these risks has challenged election officials across the country for some time, as we have documented in a series of past reports. In October 2001 we issued a report that described the operations and challenges associated with each stage of the election process, including list maintenance. We reported that, judging from our national survey of local election officials, officials were challenged by continually updating and deleting information from voter registration lists and had concerns related to obtaining accurate and timely information to keep voter lists accurate. In June 2005 we reported on the processes 14 local voting jurisdictions from seven states used to verify voter registration eligibility and the challenges officials faced in maintaining accurate voter lists. We reported that while some of these challenges, such as reducing duplicate registrations among jurisdictions within the state, may be resolved when HAVA is fully implemented, others may continue to be issues. Problems identifying voters who are registered concurrently in more than one state and problems using incomplete, untimely, or hard-to-decipher felony, death, and other information could also continue to hinder efforts to maintain accurate voter lists. In September 2005 we issued a report that described the experiences of selected local election officials in the same seven states as they processed voter registration applications. We reported that officials in these jurisdictions face a number of challenges, such as processing incomplete or inaccurate applications received from voter registration drives sponsored by nongovernmental organizations. Some of the concerns highlighted in our October 2001, June 2005, and September 2005 reports remain issues in states we discussed in this report, even after these nine states implemented the HAVA-required computerized lists. For example: Duplicate voter registrants. Echoing concerns reported in our previous work, the majority of state election officials interviewed for this report said that their states might not receive information about residents who leave the state and reregister to vote in another state. As a result, voters could be registered and vote in two states concurrently. One senior election official described this type of duplicate registration as a “universal” problem affecting all states. States are not required to share information that would allow them to identify persons registered in more than one state, although some states voluntarily notify other states when a voter relocates and reregisters in that state, officials said. Officials from Alaska, Arizona, Georgia, Hawaii, Minnesota, South Carolina, South Dakota, and West Virginia told us they notify other states of voters who relocate and then reregister. However, such notifications are possible only if voters disclose on their voter registration application they have relocated from another state, officials also told us. This issue, caused in part by a lack of consistently available information, poses an inherent risk to the accuracy of voter lists and may not be resolved solely by implementing the HAVA-required computerized list requirement. Deceased registrants. We previously reported that concerns regarding timeliness and completeness of vital statistics data on deceased persons used to match against voter lists may continue to be an issue, even after the HAVA requirements for a computerized list are implemented. However, the election officials we interviewed in most of the states did not share concerns about the timeliness of information their offices receive on deceased persons from the vital statistics office. One official observed that the vital statistics office may not receive timely information from coroners or funeral home directors. Officials in a majority of the states we reviewed observed that data on deceased persons may not be complete because states are not able consistently to identify and remove names of deceased registrants if the deaths occur out of state. According to an official in South Dakota, some states are prohibited by state laws from sharing information on deaths, a fact that has, in part, prevented this issue from being resolved. Even in states that share such information, unless officials are aware that the deceased was registered to vote in a certain state, officials are not able to pass the information to the appropriate election office. This issue, related in part to the unavailability of information, poses an inherent risk to the accuracy of voter lists and is not resolved by implementing the HAVA-required computerized list requirement. Felons. While HAVA requires coordinating the voter list with state information on persons convicted of a felony, election officials we interviewed in several of the states expressed concerns similar to those reported in our previous work that the criminal information they receive is incomplete, not timely, or difficult to decipher. This issue, similar to concerns related to the availability, timeliness, and quality of other types of voter registration information, poses an inherent risk to the accuracy of lists because it could limit the ability of officials to identify and remove names of felons ineligible to register to vote from the computerized voter lists. U.S. citizenship. In addition to having concerns regarding felony status, election officials from two states also expressed concerns regarding the willingness of registrants to self-attest that they were U.S. citizens and therefore eligible to vote under state eligibility requirements, concerns that are consistent with those documented in our previous work. The HAVA- required unique identifying numbers, such as driver’s license numbers or Social Security numbers, are not useful for this purpose because neither is generally accepted as evidence of U.S. citizenship. This lack of information poses an inherent risk to the accuracy of lists, as illustrated by an example from Minnesota. Officials told us that they discovered 30 noncitizens on the Minnesota voter list during the November 2004 general election despite having the HAVA-required computerized statewide voter list in place. Minnesota’s MVA has since added visa expiration dates to the driver’s licenses of noncitizens to indicate their citizenship status. South Dakota officials reported their MVA provides similar information on driver’s licenses. To address this concern, Arizona officials told us that their state no longer accepts the registration applicants’ self-attestation of citizenship; all voter registration applicants are now required to provide proof of citizenship. As we reported in our June 2005 report, federal jury administrators could identify possible noncitizens on the basis of information that potential jurors provide when identifying themselves as noncitizens on their jury service questionnaire. We recommended that the Administrative Office of the U.S. Courts determine the feasibility and steps necessary for U.S. district court jury administrators to provide notice to state election officials of potential jurors who identify themselves as noncitizens. Officials from Hawaii reported that their state periodically checks the voter list with this type of information and other citizenship indexes. Receiving voter registration applications. Officials from Georgia, South Carolina, and South Dakota said that their state received voter registration applications from registration drives that contained inaccuracies such as fictitious names, a problem that we had identified in past reports. South Carolina officials also said that only a small number of such applications are generally received. Officials from a majority of the nine states we reviewed reported that they received a small number of complaints from voters who said that they had registered through a registration drive but that their names did not appear on the voter list on Election Day. State Election Officials Reported Numerous Challenges and Lessons Learned while Implementing HAVA Requirements for Their Statewide Voter Registration Lists Creating statewide computerized lists required by HAVA presented a number of challenges and resulted in lessons learned, officials told us, as they developed their computerized statewide voter registration systems, made them operational, and later managed them. The challenges and lessons learned they shared are consistent with those that our past research has shown to be important to effectively acquiring, developing, and implementing information systems in public and private sector organizations. Officials shared their experiences as they developed their systems, for example: Election officials from Minnesota and West Virginia reported that meeting the time frames they established for developing their computerized lists was challenging, in part because of limited staff available to complete the work. Designing a system with the appropriate scope was an issue raised by Arizona, Hawaii, Kentucky, and Minnesota officials. This challenge involved determining the functional requirements of the system, for instance, the number of election management features the system should provide, if any, in addition to the capabilities required by HAVA. A senior Minnesota official reported Minnesota reduced the scope of its new system from what it had initially planned because of resource and time constraints, keeping the necessary elements but eliminating some election administration functions. Officials said this experience taught them that the functional requirements of the system should be prioritized as early as possible to differentiate features that are necessary from those that would be nice to have. Arizona officials addressed this design challenge by initially implementing a system that performed only the basic tasks required under the HAVA provisions, they reported. In the near term, they told us, local officials used the computerized statewide system to manage voter registration information while continuing to use their local computerized systems to manage elections. This decision minimized changes to the way counties historically managed elections, officials said. The state plans to expand the scope of its new statewide system in the future, providing counties with additional election management capabilities, an official told us. Their plan, officials said, is to draw upon local and state officials’ experiences with the statewide system to identify and prioritize what additional features to add to their system. The Kentucky official offered a lesson learned as well, suggesting that election officials, as they define the capabilities the system is to offer, should be mindful of selecting a system that the state can afford now and in the future. Converting data on registered voters from the old system to the new system was time-consuming and required processes to ensure that data were accurately entered into the new system, election officials from Arizona, Minnesota, and West Virginia observed. This work was complicated, in part, because of inaccurate information in existing records such as misspelled street addresses or duplicate registrations that needed to be resolved before inputting the corrected data into the new systems’ databases. Minnesota officials said that to help local officials with this work, they developed a tool that allowed them to compare old records of voter information with the new ones on a case-by-case basis. Officials from Arizona, Georgia, Hawaii, Kentucky, South Carolina, South Dakota, and West Virginia also said that as states develop their computerized systems, they should adopt a collaborative approach, working with local officials to design, develop, or implement the systems in order to obtain local officials’ cooperation. The state officials provided various reasons for emphasizing the importance of maintaining cooperative relationships with local officials. For example, West Virginia officials told us local officials resisted moving from their county-based systems to the statewide system, which made implementing the system more difficult. Local officials resisted in part because many of them viewed the new statewide system as an intrusion into a domain of election administration that had been a local—not a state—responsibility, state officials told us. Involving county officials in designing and implementing the system, the state officials said, might have addressed this issue and simplified implementation of the new system. Arizona and South Carolina officials said they involved local officials by convening a working group composed of both local and state officials that was responsible for developing the system. Hawaii state officials told us that frequent, regular communication helped their state maintain a cooperative relationship with local officials; for instance, this state holds quarterly meetings with county officials in order to coordinate activities such as completing list maintenance and data entry before poll books and voter lists are printed. Kentucky officials said the key to their success was the cooperative working relationship they cultivated with local officials by keeping them involved. Officials also shared challenges and lessons learned while making their systems operational. For example, West Virginia officials said that their system became operational in every county on the same day. However, it may have been beneficial for their state, they stated, to introduce the system incrementally county by county rather than bringing every election jurisdiction online the same day. They reasoned that such a staggered rollout schedule might have been easier on the state election officials, given their staffing constraints. Officials from some states also told us that prior to putting systems into service, it is important to train staff to use the new system. In order to provide local officials access to the most current information, Minnesota officials said they provide the user’s manual online. State election officials also shared their lessons learned from their experience managing computerized voter registration systems once they were operational. Officials from Hawaii and Kentucky, two states that have managed computerized voter registrations systems for some years, observed that as technology develops, officials may decide to enhance their systems, as both of their states have done over the years. These officials offered lessons to keep in mind as states contemplate system upgrades: be mindful that selecting upgrades to the system may require compromises among local jurisdictions that may have competing needs or different administrative or technical constraints and that changes to the system affect all local jurisdictions equally. Hawaii officials shared another issue they encountered while managing their system; they could not use the computerized system while updating voter information. To address this issue, officials from Hawaii said their staff created a shadow system so that the system could be updated and available at the same time. Hawaii officials also recommended that states establish uniform processing procedures among their jurisdictions so that all jurisdictions function as one. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days after the report date. At that time we will make copies available to others on request. In addition, the report will be available at no charge on GAO’s Web site at http://www.gao.gov. If you or your staff have any questions regarding this report, please contact me at (202) 512-8777 or jenkinswo@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors are listed in appendix XII. Appendix I: Objectives, Scope, and Methodology This report describes the experiences of election officials in Alaska, Arizona, Hawaii, Georgia, Kentucky, Minnesota, South Carolina, South Dakota, and West Virginia implementing the Help America Vote Act of 2002 (HAVA) requirements pertaining to the establishment of computerized statewide voter registration lists and steps to verify and maintain the accuracy of those lists. Specifically, our objectives were to describe the actions election officials from nine states reported taking to (1) establish computerized statewide voter registration lists and (2) verify information provided on voter registration applications and maintain the statewide voter lists. In addition, we describe what these state officials told us regarding (3) the challenges they faced and lessons they learned while implementing these requirements. Most states obtained a waiver from the Election Assistance Commission (EAC) to postpone implementation of this HAVA requirement until January 1, 2006. However, these nine states did not obtain a waiver and, therefore, were to implement these HAVA requirements by the original deadline, January 1, 2004. To meet our objectives, we reviewed HAVA provisions related to the establishment of statewide computerized voter registration list requirements. We then identified the proper points of contact within each state and conducted telephone interviews using a structured interview format. Among other things, we asked election officials in the nine states to describe when their computerized systems had been developed; the capabilities of their systems; what actions, if any, their states took to implement the HAVA requirements for a computerized list; what level of effort was required to make any HAVA-related modifications; what effect implementing these changes, if any, might have had on the accuracy of their statewide voter lists; and what challenges they faced and lessons they learned while implementing these HAVA requirements. We did not independently verify the accuracy of state election officials’ responses. However, state election officials were provided the opportunity to verify the accuracy of their responses for this report, and on the basis of the comments we received, we made technical changes where appropriate. As part of our interviews, we also asked state officials how much federal and state money was spent on their computerized statewide systems in order to implement the HAVA requirements. We did not independently verify the amounts they reported to us. However, we attempted to compare the amounts of money the states reported that they spent with data reported by them to EAC on the implementation of all HAVA requirements. Because of variations in the way these amounts were reported by the states, we could not identify the amounts spent solely on implementation of the computerized list requirement. Our work focused primarily on the states, since most of the responsibilities for implementing HAVA statewide computerized list provisions took place at the state level. We did, however, communicate with officials from the EAC and Department of Justice (DOJ) Civil Rights Division to obtain information about and documentation on their roles and responsibilities related to the HAVA statewide computerized list provisions. We also provided sections of the report discussing EAC and DOJ to officials with those organizations to verify the accuracy of the information they provided and, on the basis of their comments, made technical changes where appropriate. In addition, we reviewed prior GAO reports on elections, including voter registration issues. We conducted our work from January 2005 through December 2005 in accordance with generally accepted government auditing standards. Appendix II: EAC and DOJ Roles in Implementing HAVA Statewide Voter Registration List Provisions The Help America Vote Act (HAVA) provides that the Election Assistance Commission (EAC) and the Department of Justice (DOJ) are to have specific roles in states’ efforts to implement the Help America Vote Act’s statewide voter registration list provisions. HAVA established EAC to, among other things, serve as a national clearinghouse for information on election administration and provide information and guidance with respect to laws, procedures, and technologies affecting the administration of federal elections. On August 4, 2005, EAC released its final version of the Voluntary Guidance on Implementation of Statewide Voter Registration Lists. The purpose of the voluntary guidance was to assist states in their efforts to develop and maintain a statewide voter registration list pursuant to HAVA Section 303(a). The guidance describes a set of specifications and requirements states may use to implement the HAVA provisions, such as establishing real-time access to all registration data, securing the registration list, synchronizing the statewide list with local databases at least every 24 hours, and coordinating with other databases for the purpose of performing voter registration verification and list maintenance. EAC’s guidance also contains recommendations on dealing with outcomes that may result from the verification process, the type of voting history information states should track, and the type of system that is most closely aligned with HAVA requirements. In addition to the voluntary guidance, EAC has also created and posted on its Web site two best practices documents—“Best Practices in Administration, Management, and Security in Voting Systems and Provisional Voting” and “Best Practices for Facilitating Voting by U.S. Citizens Covered by the Uniformed and Overseas Citizens Absentee Voting Act”—and other information on election administration. According to EAC officials, EAC expects that the clearinghouse will be fully operational during 2006. HAVA also provides enforcement authority to DOJ with respect to the uniform and nondiscriminatory implementation of certain HAVA requirements such as those relating to the statewide voter registration list and voter eligibility verification provisions. Officials with DOJ’s Civil Rights Division told us that in addition to monitoring states’ compliance with HAVA, DOJ has promoted pre-enforcement compliance, which includes working with states to identify what actions are reasonable to expect them to take, educating state and local officials, and responding to states’ inquiries. According to DOJ officials, at the time of our review, DOJ had not taken enforcement actions against any of the nine nonwaiver states. DOJ officials also said that they worked with the states following the passage of HAVA to address initial challenges and provide informal guidance while EAC began operations and hired staff. Appendix III: Reported Experiences of Alaska Election Officials Implementing HAVA Voter Registration List Provisions This appendix describes steps Alaska election officials reported taking to implement selected provisions of the Help America Vote Act of 2002 (HAVA) and manage the election process with regard to establishing computerized statewide voter registration lists, verifying the accuracy of information provided on voter applications, and maintaining accurate statewide voter lists. In addition, this appendix summarizes challenges and lessons learned election officials reported with respect to implementing HAVA requirements. The statements in this appendix reflect the responses to our telephone interviews with Alaska election officials and were not independently verified by us. Steps Taken to Establish Computerized Statewide Voter Registration Lists Alaska had in place a computerized statewide voter registration system prior to the enactment of HAVA. The state created a mainframe-based system in 1985. To implement the provisions of HAVA, minor modifications were made to the system to allow election officials to record driver’s license numbers and the last four digits of the voter’s Social Security number. These modifications cost approximately $5,000 in state and federal funds to implement. Alaska state officials awarded a contract to upgrade its statewide voter registration system, in order to include additional election management capabilities, such as poll worker management and Internet voter registration, at a cost of $2.6 million. Verifying Accuracy of Information Provided on Voter Applications To implement the HAVA voter application verification requirements, the state’s four regional election supervisors, who function as state employees, verified application information by comparing voter eligibility information (full name; date of birth; and either a driver’s license number, full Social Security number, the last four digits of the Social Security number, or a unique identifier assigned by the state if the individual lacks a Social Security number and a driver’s license) with state motor vehicle agency records to verify identity, age, and duplicate registrations. At the time of our review, Alaska was not comparing information with the Social Security Administration (SSA) because the state did not have a signed memorandum of understanding with SSA. Maintenance of Accurate Statewide Voter Lists To implement HAVA, Alaska has taken steps to maintain the accuracy of its voter registration list by coordinating the list with other state agency records, as described below. Duplicate registrants. State officials perform an electronic check on the entire statewide voter registration list for duplicates once a year and on an as-needed basis. Deceased registrants. State officials conduct monthly electronic updates of vital statistics death records by checking name, date of birth and either the full Social Security number or the last four digits. Disqualified felons. State officials update court system records on a monthly basis. Specifically, court system records from the Department of Corrections and Bureau of Vital Statistics are checked against the voter registration list, comparing name, date of birth, and full Social Security number. Disqualification of those declared mentally incompetent. In the event of a court declaration of mental incompetence, the court would notify state officials of the judgment and the Division of Elections would inactivate the voter’s registration. Officials reported that disqualification because of mental incompetence does not occur often. To ensure that eligible voters are not inadvertently removed from the state voter registration list, election officials send letters notifying individuals of their pending removal from the statewide voter registration list. These letters are sent to those who have not voted in the most recent two federal elections and those who have disqualifying felony convictions, as allowed under state law. Alaska officials reported that they removed the names of ineligible voters in 2004. Challenges and Lessons Learned Election officials did not report any challenges or lessons learned while implementing these HAVA requirements. Appendix IV: Reported Experiences of Arizona Election Officials Implementing HAVA Voter Registration List Provisions This appendix describes steps Arizona election officials reported taking to implement selected provisions of the Help America Vote Act of 2002 (HAVA) and manage the election process with regard to establishing computerized statewide voter registration lists, verifying the accuracy of information provided on voter applications, and maintaining accurate statewide voter lists. In addition, this appendix summarizes challenges and lessons learned election officials reported with respect to implementing HAVA requirements. The statements in this appendix reflect the responses to our telephone interviews with Arizona election officials and were not independently verified by us. Steps Taken to Establish Computerized Statewide Voter Registration Lists Prior to HAVA, Arizona did not have a computerized statewide voter registration system in place, although several counties operated computerized voter registration systems. Arizona created an interconnected, statewide Web-based voter registration system called Voter Registration Arizona (VRAZ) to implement the requirements of HAVA. VRAZ became operational by the HAVA deadline of January 1, 2004. VRAZ had an initial development cost of $1 million and was jointly funded by state and federal sources. The system took approximately 6 months to develop. The state had to pass new statutes and amend others so that election officials could receive information from state agencies, such as felony records. In addition to carrying out the required functions of the voter registration system, election officials can query all state voter registration records on Election Day if their polling place has an Internet connection. A new version of VRAZ is under development and is expected to replace voter registration systems in 13 of 15 counties. The new version of VRAZ, called VRAZ II, is expected to reflect reciprocity agreements with other states whereby officials will be alerted when a voter moves from state to state and registers to vote in those states covered by the agreement. In addition, the new system is expected to contain additional election management capabilities beyond those required by HAVA, including the ability to retrieve data on election administration issues such as voter petitions, provisional ballots, training of poll workers, and polling locations. The estimated cost for VRAZ II is $10 million. At the time of our review, Arizona officials were anticipating that VRAZ II would go online in 2007. Verifying Accuracy of Information Provided on Voter Registration Applications To implement the HAVA voter application verification requirements, Arizona compared the applicant’s name, date of birth, driver’s license number, or the last four digits of the Social Security number with motor vehicle agency (MVA) records to identify potentially inaccurate applications. In addition, Arizona’s Web-based voter registration software, EZ Voter—which allows Arizona citizens to register to vote via the Internet—electronically verified the accuracy of the voter registration applications filed online by matching the applicant’s name, date of birth, driver’s license number, or last four digits of the Social Security number with MVA records. EZ Voter registrations were then entered at the county level daily and submitted to the statewide voter registration list. At the time of our review, Arizona had completed a memorandum of understanding with the Social Security Administration (SSA) and was verifying information on voter registration applications by matching it with SSA records as required by HAVA. Maintenance of Accurate Statewide Voter Registration Lists As state officials developed the VRAZ system, they identified and corrected inaccurate voter registration data prior to entering the data into the new system; through this process they were also able to eliminate duplicate registrants from the statewide list. Election officials also took steps to maintain the accuracy of the voter registration list by coordinating the list with other state agency records, as described below. Duplicate registrants. State officials electronically identify duplicate matches by checking name, address, driver’s license number, and the last four digits of the Social Security number on voter registration applications on a daily basis. The entire list is screened once a month to identify duplicate registrants. Deceased registrants. The Secretary of State’s office receives an electronic file of recent deaths from the Department of Health Services once a month. Officials identify any matches by checking name, date of birth, and the last four digits of the Social Security number. Disqualifying felons. State officials receive information on felony convictions from Arizona courts on a varying basis—weekly or monthly in the case of the state’s superior courts and on an ongoing basis from U.S. district courts. Once a felon’s sentence has been completed, voting rights are reinstated and the individual may register to vote by submitting a new voter registration application. Officials identify any matches by checking name, date of birth, and the last four digits of the Social Security number. This is a paper-based process in smaller courts and an electronic process in larger courts. Disqualification of those declared mentally incompetent. As with information on felons, courts submit information in an electronic or paper format to state officials on individuals declared mentally incompetent at different times for comparison with the statewide voter registration list. To ensure that eligible voters are not inadvertently removed from voter registration lists, local officials send a letter to voters to notify them of their impending removal from the statewide voter registration list. For example, letters are sent to individuals with a disqualifying felony conviction. Challenges and Lessons Learned One challenge Arizona election officials faced was designing a system with the appropriate scope. Election officials said they addressed this design challenge by initially implementing a system that performed only the basic tasks required under the HAVA provisions. To minimize changes to the way counties historically managed elections, local officials used the computerized statewide system to manage voter registration information while continuing to use their local computerized systems to manage elections. The state plans to expand the scope of its new statewide system in the future, providing counties with additional election management capabilities. Another challenge reported by Arizona election officials was the conversion of data on registered voters from the old system to the new system. Officials said it was time-consuming and required processes to ensure that data were accurately entered into the new system. Election officials also reported on the importance of collaboration among state and local officials. The state convened a working group composed of both local and state officials that was responsible for developing its statewide computerized system. Arizona officials stated that a communications plan that allows information about the voter list management process to be shared among state and county officials can help lessen political resistance and facilitate buy-in by state and county officials. The implementation of VRAZ in stages was another way state officials gained the trust of the counties. Appendix V: Reported Experiences of Georgia Election Officials Implementing HAVA Voter Registration List Provisions This appendix describes steps Georgia election officials reported taking to implement selected provisions of the Help America Vote Act of 2002 (HAVA) and manage the election process with regard to establishing computerized statewide voter registration lists, verifying the accuracy of information provided on voter applications, and maintaining accurate statewide voter lists. In addition, this appendix summarizes challenges and lessons learned election officials reported with respect to implementing HAVA requirements. The statements in this appendix reflect the responses to our telephone interviews with Georgia election officials and were not independently verified by us. Steps Taken to Establish Computerized Statewide Voter Registration Lists Georgia had in place a computerized statewide voter registration system prior to the enactment of HAVA. The state created this mainframe-based system in 1995. To implement HAVA, state officials made one minor modification to their voter registration system—adding the capability to identify whether a voter had registered for the first time by mail. Officials have plans to enhance the current system in order to provide election administration management capabilities, such as identifying potential poll workers and giving election officials on Election Day immediate electronic access to the voter list so they can verify where voters are registered to vote. At the time of our review, officials were planning to conduct a pilot program to test the enhanced system. Verifying Accuracy of Information Provided on Voter Registration Applications In Georgia, voter registration applicants were required to provide their full Social Security number on voter registration applications as a unique identifier. Since Georgia collected the full Social Security number, the state was not subject to the HAVA requirements to collect a unique identifying number or to verify information on voter registration applications with motor vehicle agency or Social Security Administration records. Georgia elected not to verify information with these agencies, as HAVA allows. However, the state had processes in place to conduct real- time checks of voter registration applications to ensure they did not duplicate an existing registration and that the application information did not match the records of deceased persons. The state procedures also provide for verifying voter eligibility by comparing voter registration applications with state court records on felony lists to identify persons ineligible to vote because of a disqualifying felony conviction. Maintenance of Accurate Statewide Voter Registration Lists Prior to and since the enactment of HAVA, Georgia has maintained the accuracy of its voter registration list by coordinating the list with other state agency records, as described below. Duplicate registrants. On a monthly basis, state officials check the statewide voter list to identify duplicate registrants and transmit the list of duplicates to the counties for updating. Deceased registrants. Every month, county officials receive electronic files on deceased persons from the Department of Vital Statistics. Officials identify any matches with the statewide voter registration list by checking name, date of birth, full Social Security number, and address. On a quarterly basis, the state receives an electronic report from the Department of Vital Statistics and verifies that the counties have made the changes and checks for errors. The information is compiled into a quarterly report that verifies that the counties have made the necessary changes and that an error report is generated showing the records that did not match. Disqualified felons. On a monthly basis, the state receives a paper list of felony convictions from state courts. The felony list is then sent to counties for updating. County officials identify any matches with the statewide voter registration list by checking name, date of birth, full Social Security number, and address. Disqualification of those declared mentally incompetent. In the case of mental incompetence, a court order must specify that a person is barred from voting; otherwise, the person may continue to vote. As with information on felons, on a monthly basis, the state receives from state courts a paper list of individuals declared mentally incompetent. The list is then sent to counties for updating. County officials identify any matches with the statewide voter registration list by checking name, date of birth, full Social Security number, and address. To ensure that eligible voters’ names are not inadvertently removed from the statewide voter registration list, county officials send a letter to voters to notify them of their impending removal from the voter registration rolls. These letters are sent to individuals who have requested to be removed, those with a disqualifying felony conviction, and those who have been declared mentally incompetent. Georgia officials reported that they removed the names of ineligible voters in 2004. Challenges and Lessons Learned Although Georgia has had a statewide computerized voter list in place for 10 years, officials reported that a challenge they continue to face is training employees on how to use the system. Officials said that one lesson learned is that states need to get buy-in from county officials early on in the process of developing a statewide voter registration system. They suggested that one way to accomplish this may be to form a task force, composed of state and local officials, to review system development issues and design. Appendix VI: Reported Experiences of Hawaii Election Officials Implementing HAVA Voter Registration List Provisions This appendix describes steps Hawaii election officials reported taking to implement selected provisions of the Help America Vote Act of 2002 (HAVA) and manage the election process with regard to establishing computerized statewide voter registration lists, verifying the accuracy of information provided on voter applications, and maintaining accurate statewide voter lists. In addition, this appendix summarizes challenges and lessons learned election officials reported with respect to implementing HAVA requirements. The statements in this appendix reflect the responses to our telephone interviews by Hawaii election officials and were not independently verified by us. Steps Taken to Establish Computerized Statewide Voter Registration Lists Hawaii has had a computerized voter registration system since the 1970s and developed a statewide interactive system in 1982. Hawaii’s system provides election officials with immediate access to the computerized statewide voter list whereby they can enter new or update existing voter registration information and query all state voter registration records. To implement HAVA, election officials made minor technical changes to the statewide voter registration system, such as adding the ability to flag inactive voters. At the time of our review, Hawaii was making additional arrangements to enhance its current computerized voter registration system by modifying the absentee voting component of the system. Verifying Accuracy of Information Provided on Voter Registration Applications In Hawaii, voter registration applicants were required to provide their full Social Security number on voter registration applications as a unique identifier. Since Hawaii collected the full Social Security number, the state was not subject to the HAVA requirements to collect a unique identifying number or to verify information on voter registration applications with motor vehicle agency (MVA) or Social Security Administration records. Hawaii voluntarily matched information on voter registration forms with MVA records, comparing information such as the individual’s name, driver’s license number, and full Social Security number. The computerized voter registration system conducted real-time checks for duplicate registrations and age requirements prior to accepting the new application into the statewide voter registration system. Maintenance of Accurate Statewide Voter Lists Prior to and since the enactment of HAVA, Hawaii officials have maintained the accuracy of Hawaii’s statewide voter registration list by coordinating the list with other state agency records, as described below. Duplicate registrants. The computerized statewide voter registration system automatically checks for duplicate registrations as soon as an application is processed. Deceased registrants. Twice a month, county officials check paper death records from the Department of Vital Statistics to identify deceased registrants by checking the name, date of birth, and the full Social Security number. Disqualified felons. Twice a month, county clerks receive paper records from circuit court officials. These records are then checked against the information in the statewide voter registration list by comparing name, date of birth, and the full Social Security number. Disqualification of those declared mentally incompetent. Officials reported that disqualification because of mental incompetence does not occur often in Hawaii. The courts are the only entity that can make a judgment regarding mental incompetence that would disqualify a person from being registered to vote. To ensure that eligible voters’ names are not inadvertently removed from the statewide voter registration list, local officials send a letter to every voter prior to the general election before removing voters’ names from the list, in accordance with the National Voter Registration Act provisions for removing voters’ names from lists. Challenges and Lessons Learned Although Hawaii had a statewide voter registration system in place prior to HAVA, officials shared their general perspectives on implementing voter registration systems. Hawaii election officials said that one of the biggest challenges can be coordinating with counties and developing a rapport with county officials. To assist in coordination efforts, the state holds quarterly meetings with county officials. In these meetings, state and local officials coordinate activities such as completing list maintenance and data entry prior to the printing of poll books and voter lists. Another issue raised by Hawaii officials was designing a system with the appropriate scope. These officials also shared lessons learned about managing a computerized voter registration system. They stated that technological developments will require compromise among local jurisdictions that have different administrative and technological constraints. Officials also recommended that states establish uniform processing procedures among their jurisdictions so that all jurisdictions function as one. Finally, Hawaii created a shadow system so that the system could be both updated and available for use at the same time. Appendix VII: Reported Experiences of Kentucky Election Officials Implementing HAVA Voter Registration List Provisions This appendix describes steps Kentucky election officials reported taking to implement selected provisions of the Help America Vote Act of 2002 (HAVA) and manage the election process with regard to establishing computerized statewide voter registration lists, verifying the accuracy of information provided on voter applications, and maintaining accurate statewide voter lists. In addition, this appendix summarizes challenges and lessons learned election officials reported with respect to implementing HAVA requirements. The statements in this appendix reflect the responses to our telephone interviews by Kentucky election officials and were not independently verified by us. Steps Taken to Establish Computerized Statewide Voter Registration Lists Kentucky had in place a computerized statewide voter registration system prior to the enactment of HAVA. The state created this mainframe-based system in 1973. Kentucky’s current system allows all local election officials immediate access to enter new or update existing voter registration information in their jurisdiction, and immediate access to query all state voter registration records. In addition, election officials provided a toll-free number for precinct officers to access an interactive voice response phone system to check voter eligibility. As a result, Kentucky did not have to take any additional steps to implement HAVA statewide computerized list requirements. Election officials planned to upgrade their computerized statewide voter registration system in the future to provide more election management tools to counties, such as including a function to track poll workers and complete absentee ballot forms. The state has developed the absentee ballot application and expects it to be used by its counties in the 2006 elections. Verifying Accuracy of Information Provided on Voter Registration Applications In Kentucky, voter registration applicants were required to provide their full Social Security number on voter registration applications as a unique identifier. Since Kentucky collected the full Social Security number, the state was not subject to the HAVA requirements to collect a unique identifying number or to verify information on voter registration applications with motor vehicle agency or Social Security Administration records. Kentucky elected not to verify information with these agencies, as HAVA allows. To verify information on voter registration applications, Kentucky’s computerized statewide voter registration automatically checked for duplicate registrations before new registrants were added to the statewide list. Maintenance of Accurate Statewide Voter Registration Lists Kentucky currently has processes in place to maintain the accuracy of the statewide voter registration list by comparing the statewide voter registration list with state agency records, as described below. Duplicate registrants. The computerized statewide voter registration system automatically checks for duplicate registrations as soon as a new application is entered into the system. Deceased registrants. On a monthly basis, election officials check the computerized statewide voter registration list against the records from the Department of Vital Statistics to identify deceased registrants by comparing name, date of birth, and full Social Security number. Disqualified felons. On a monthly basis, court records are electronically checked against the computerized statewide voter registration list to identify persons convicted of a disqualifying felony by comparing name, date of birth, and full Social Security number. Disqualification of those declared mentally incompetent. Officials use court records to identify voters ineligible because of mental incompetence by comparing applicant’s name, date of birth, and full Social Security number with the computerized statewide voter registration list. To ensure that the names of eligible voters are not inadvertently removed from the statewide voter registration list, state officials match voters’ identifying information with U.S. Postal Service, felony, mental competency, and death records. State officials also send letters to voters to notify them of pending removal based on a disqualifying felony conviction. Challenges and Lessons Learned Since Kentucky had a computerized statewide voter registration system in place prior to HAVA, election officials did not report any challenges. However, Kentucky election officials provided examples of lessons learned while maintaining their current computerized statewide voter registration system. They said it is important to develop a computerized statewide voter registration system that will be sustainable now and in the future. Officials suggested that as states contemplate system upgrades, they be mindful that changes to the system affect all jurisdictions, despite their differing needs and constraints. A key to their success has been the cooperative working relationship they cultivated with local officials by keeping them involved. Election officials also recommended that states “think outside the box” when designing ways to use the voter registration database. For example, they utilized their statewide computerized system to established voter information centers on Kentucky’s state Web site to assist applicants and staff in the voter registration process. Appendix VIII: Reported Experiences of Minnesota Election Officials Implementing HAVA Voter Registration List Provisions This appendix describes steps Minnesota election officials reported taking to implement selected provisions of the Help America Vote Act of 2002 (HAVA) and manage the election process with regard to establishing computerized statewide voter registration lists, verifying the accuracy of information provided on voter applications, and maintaining accurate statewide voter lists. In addition, this appendix summarizes challenges and lessons learned election officials reported with respect to implementing HAVA requirements. The statements in this appendix reflect the responses to our telephone interviews by Minnesota election officials and were not independently verified by us. Steps Taken to Establish Computerized Statewide Voter Registration Lists Minnesota is unique in the way election administration functions are structured and can vary by jurisdiction. In this state, the county auditor has certain election responsibilities and can choose to delegate other election responsibilities to minor civil division-level (MCD) government— townships and cities. For example, while counties manage voter registration, county auditors may delegate other functions, such as absentee voting to MCDs. There are some functions that MCDs are responsible for handling, such as polling place matters. Minnesota had a computerized statewide voter registration system in place prior to the enactment of HAVA. The state created this mainframe-based system in 1988. To comply with the provisions of HAVA, the state amended its election laws and replaced its existing computerized statewide voter registration system in 2004. The system included new election management capabilities, such as providing election officials with immediate access to enter and update applicant information and creating electronic matching capabilities with state agencies to verify voter eligibility. The system also centrally tracked absentee ballots provided to military personnel or other citizens residing overseas. The project was completed in 11 months at a reported cost of about $5.3 million. Verifying Accuracy of Information Provided on Voter Registration Applications To implement HAVA, Minnesota verifies voter registration application information by comparing name, date of birth, driver’s license number, or the last four digits of the voter’s Social Security number with motor vehicle agency records to identify potentially ineligible applications. Since Minnesota is a same-day registration state, checks for duplicates are automatically run on voter applications on a daily basis. In addition, the Department of Public Service tracks visas issued to ensure that noncitizens are unable to vote. At the time of our review, Minnesota was in the process of completing a memorandum of understanding with the Social Security Administration (SSA) to allow verification of information on voter registration applications by comparing it with SSA records. Officials anticipated that they would begin conducting matches by 2006. Maintenance of Accurate Statewide Voter Lists To implement HAVA, Minnesota election officials took steps to maintain the accuracy of the voter registration list by coordinating with other state agency records, as described below. Duplicate registrants. The statewide voter registration system produces maintenance reports to identify potential duplicates. In addition, checks for duplicates are run on an annual basis. Deceased registrants. On a monthly basis, county officials conduct manual checks of oral and paper death records from the Department of Vital Statistics by checking the name, date of birth, and the full Social Security number. Disqualified felons. On a monthly basis, officials receive paper records from the courts to check for those persons convicted of a disqualifying felony. Once the court computer system is in place, this process will have the capability to provide electronic matching by comparing the applicant’s name, date of birth, driver’s license, identification card, full Social Security number, and last four digits of the Social Security number. Disqualification of those declared mentally incompetent. On a monthly basis, officials receive paper records from the courts to check for those declared mentally incompetent. To ensure that the names of eligible voters are not inadvertently removed from the statewide voter registration list, state officials send notices to voters prior to removing their names from the list. Challenges and Lessons Learned Minnesota election officials reported that one of the major challenges they faced was replacing the existing voter registration system in an 11-month time frame. Also, officials told us that conducting elections while updating their voter registration system further complicated their efforts. Another challenge that election officials reported was converting data on registered voters from the old system database to the new system. Minnesota officials said that to help local officials with this work they developed a tool that allowed them to compare old records of voter information with the new ones on a case-by-case basis. In addition, Minnesota election officials discussed various lessons learned while implementing the HAVA requirements. The first lesson learned was the importance of identifying and prioritizing the functional requirements for the computerized statewide voter registration system. In order to manage the scope of replacing a computerized statewide voter registration system, election officials told us they had to separate the “nice to have” features from the features required by HAVA. This step assisted election officials in managing the scope and cost of their project. Second, Minnesota election officials reported using in-house resources to replace the existing computerized statewide voter registration system. According to election officials, it is best to use in-house resources to establish a computerized statewide voter registration system when there are sufficient in-house resources and staff expertise. Third, Minnesota election officials said that it was useful to create an online user’s manual for the computerized statewide voter registration system. Election officials reported that by having the user’s manual online, staff at all levels had immediate access to information on how to operate the computerized statewide voter registration system. Appendix IX: Reported Experiences of South Carolina Election Officials Implementing HAVA Voter Registration List Provisions This appendix describes steps South Carolina election officials reported taking to implement selected provisions of the Help America Vote Act of 2002 (HAVA) and manage the election process with regard to establishing computerized statewide voter registration lists, verifying the accuracy of information provided on voter applications, and maintaining accurate statewide voter lists. In addition, this appendix summarizes challenges and lessons learned election officials reported with respect to implementing HAVA requirements. The statements in this appendix reflect the responses to our telephone interviews by South Carolina election officials and were not independently verified by us. Steps Taken to Establish Computerized Statewide Voter Registration Lists South Carolina had an interactive computerized statewide voter registration system in place prior to the enactment of HAVA. The state created this mainframe-based system in the late 1960s and modified it in 1992. Election officials made minor modifications to its system by adding additional data fields in order to implement the provisions of HAVA. The system also has election management capabilities beyond HAVA, including the ability to track absentee voters and poll managers. The state reportedly spent about $67,000 in federal funds for the most current system modifications. Election officials began work on a new Web-based, menu-driven system in 2000. The system is expected to be more flexible and is to allow election officials to perform election administration tasks such as signature verification. The new system is also expected to have the capability to run checks with the motor vehicle agency database. Officials reported that the implementation of the new system will not take place until after the 2006 elections. Verifying Accuracy of Information Provided on Voter Applications South Carolina required voter registration applicants to provide their full Social Security number on voter registration applications as a unique identifier. Since South Carolina collects the full Social Security number, the state is not subject to the HAVA requirements to collect a unique identifying number or to verify information on voter registration applications with the motor vehicle agency or Social Security Administration. South Carolina elected not to verify information with these agencies, as HAVA allows. Prior to entering applicants into the statewide list, county officials check to ensure the application does not duplicate an existing registration. State officials compare voter registration applications with records on deceased persons and persons ineligible to register to vote because of a disqualifying felony conviction, as allowed under state law. Maintenance of Accurate Statewide Voter Lists Prior to and since the enactment of HAVA, South Carolina officials maintain the accuracy of the state’s voter registration list by coordinating the list with other state agency records, as described below. Duplicate registrants. South Carolina produces a report on duplicates quarterly. The voter registration system identifies duplicate registrants using the full Social Security number and date of birth. County officials make the necessary changes. Deceased registrants. State officials conduct monthly electronic comparisons with state agency death records. Officials identify any matches by checking name, date of birth, and full Social Security number and remove names of ineligible registrants. Disqualified felons. State officials conduct monthly electronic comparisons with state agency felony records. Officials identify any matches based on name, address, date of birth, and full Social Security number and remove names of ineligible registrants. Disqualification of those declared mentally incompetent. The counties maintain paper records on the mentally incompetent. Upon receipt of a written court order, county officials identify and remove ineligible voters. In order to ensure that eligible voters’ names are not inadvertently removed, state officials send a letter to voters to notify them of their impending removal from the statewide voter registration list. Letters are sent to individuals who have filed a change-of-address with the U.S. Postal Service, failed to appear in the most recent two federal elections, or have a disqualifying felony conviction. South Carolina officials reported that they removed the names of ineligible voters in 2004. Challenges and Lessons Learned Although South Carolina had a statewide voter registration system in place prior to HAVA, officials shared their general perspectives on implementing voter registration systems. Officials stated that forming a working group composed of state and local officials helped to ensure stakeholder buy-in. State officials also reported that the updated system that they are in the process of creating is proving challenging because they are developing it in-house instead of purchasing the system from a vendor. Officials reported that states should assess their available resources and skills before deciding to develop a system on their own. Appendix X: Reported Experiences of South Dakota Election Officials Implementing HAVA Voter Registration List Provisions This appendix describes steps South Dakota election officials reported taking to implement selected provisions of the Help America Vote Act of 2002 (HAVA) and manage the election process with regard to establishing computerized statewide voter registration lists, verifying the accuracy of information provided on voter applications, and maintaining accurate statewide voter lists. In addition, this appendix summarizes challenges and lessons learned election officials reported with respect to implementing HAVA requirements. The statements in this appendix reflect the responses to our telephone interviews by South Dakota election officials and were not independently verified by us. Steps Taken to Establish Computerized Statewide Voter Registration Lists South Dakota had a computerized statewide voter registration system in place prior to the enactment of HAVA. The state created the system in 2002. Election officials added new data fields and data matching capability to the existing computerized list in order to implement the provisions of HAVA. The modifications cost $302,004, of which $103,598 came from federal funds and $198,406 from state funds. Verifying Accuracy of Information Provided on Voter Registration Applications To implement HAVA, county election officials verified voter registration application information by comparing name, date of birth, and driver’s license number, or the last four digits of the voter’s Social Security number, with state motor vehicle agency records to identify potentially inaccurate applications. These officials also compared applications with records on the deceased and persons convicted of a disqualifying felony prior to adding them to the statewide voter list. South Dakota local election officials verified voter registration information by comparing it with the Social Security Administration’s records beginning in August 2005. Maintenance of Accurate Statewide Voter Lists As required to implement HAVA, election officials have taken steps to maintain the accuracy of South Dakota’s voter registration list by coordinating the list with other state agency records, as described below. Duplicate registrants. State officials check the statewide list for duplicates at least annually and more often during an election cycle. State officials identify duplicate registrants by checking for voters with the same name, driver’s license number, and the last four digits of the Social Security number and forward the names of ineligible registrants to county officials for processing. Deceased registrants. Local officials match name, date of birth, and the last four digits of the Social Security number on voter registration applications with the state vital statistics agency’s death records through weekly electronic batch comparisons. Disqualified felons. Local officials electronically compare voter registration applications with records of persons convicted of a disqualifying felony that makes them ineligible to register to vote. Officials identify persons ineligible to register to vote based on name, date of birth, driver’s license number, and last four digits of the Social Security number. Disqualification of those declared mentally incompetent. In the event that a court issues a declaration of mental incompetence, the court provides the written declaration to the county election official who removes the ineligible registrant from the voter list. In South Dakota, local officials are responsible for updating voter information and removing names from the voter registration list. To ensure that eligible voters are not inadvertently removed from the state voter registration list, local election officials send letters notifying individuals of their pending removal from the statewide voter registration list. Challenges and Lessons Learned State officials reported that working as a team and maintaining a positive working relationship with the counties enabled South Dakota to implement HAVA by the deadline. Appendix XI: Reported Experiences of West Virginia Election Officials Implementing HAVA Voter Registration List Provisions This appendix describes steps West Virginia election officials reported taking to implement selected provisions of the Help America Vote Act of 2002 (HAVA) and manage the election process with regard to establishing computerized statewide voter registration lists, verifying the accuracy of information provided on voter applications, and maintaining accurate statewide voter lists. In addition, this appendix summarizes challenges and lessons learned election officials reported with respect to implementing HAVA requirements. The statements in this appendix reflect the responses to our telephone interviews by West Virginia election officials and were not independently verified by us. Steps Taken to Establish Computerized Statewide Voter Registration Lists With regard to the HAVA statewide computerized list provisions, West Virginia created an interactive, computerized statewide voter registration system. According to state election officials, some counties had computerized voter registration systems prior to the enactment of HAVA, but they were not interconnected through a statewide computer system. Election officials hired a vendor to create the new statewide system, which went into service in January 2004 at a reported cost of approximately $1.9 million in federal funds. The new system also has election management capabilities beyond the requirements of HAVA, including the ability to produce reports on absentee ballots, early voters, poll workers, and election data statistics. It also provides a separate database to track poll workers. Verifying Accuracy of Information Provided on Voter Registration Applications To implement HAVA, West Virginia developed the capability to verify voter registration application information by comparing name, date of birth, and driver’s license number or the last four digits of the voter’s Social Security number with motor vehicle agency (MVA) records. However, officials reported that the state had difficulty conducting data matches with MVA because MVA lacked the ability to interface with the statewide voter list. Officials said that they expected this problem to be resolved by 2006. Since the enactment of HAVA, the state system checks new applications for duplicates, automatically flags duplicates, and notifies county officials to eliminate them. West Virginia is in the process of finalizing the agreement with the Social Security Administration (SSA) to allow a comparison between voter eligibility information and SSA data as required by HAVA. This agreement will enable state officials to compare the last four digits of a voter’s Social Security number with SSA records. Officials reported that they expected the agreement to be completed by December 2005. Maintenance of Accurate Statewide Voter Lists Prior to HAVA, county voter registration systems could only check for duplicates within the county, and local officials could only check felony and death lists using paper records. Since the enactment of HAVA, election officials have taken steps to maintain the accuracy of the statewide voter registration list by coordinating the list with other state agency records, as described below. Duplicate registrants. West Virginia checked the entire database for duplicates during the implementation of its new statewide system. The county clerks also periodically check the system for duplicate registrants. Deceased registrants. County officials maintain the voter registration list through a monthly comparison of the list with state death records. At the time of this report, officials rely on oral and paper records to identify any matches by checking name, address, date of birth, and the last four digits of the Social Security number. Officials said they expected in the future to conduct these comparisons electronically. Disqualified felons. County officials receive paper records from federal and state courts on disqualifying felony convictions. Disqualification of those declared mentally incompetent. The state does not conduct list maintenance based on this information. Local officials are responsible for updating voter information and for removing voter records; state officials said that they follow the National Voter Registration Act provisions for removing names from the list. In general, section 8 of NVRA provides that, in the administration of voter registration for federal elections, states may not remove names of registrants for non-voting and that names of registrants may be removed only for certain specified reasons. Challenges and Lessons Learned implementation of the new system. Other challenges reported by West Virginia officials included data conversion, obtaining timely approvals for purchases, changing necessary provisions of state law, and overcoming technology problems. Appendix XII: GAO Contact and Staff Acknowledgments Acknowledgments In addition to the contact person named above, John Mortin, Assistant Director; David Alexander; Leo Barbour; Amy Bernstein; Michelle Fejfar; Geoff Hamilton; E. Anne Laffoon; Jean Orland; Dan Rodriguez; Miquel Salas: Stephanie Sand; and Ashanta Williams made key contributions to this report.

The Help America Vote Act of 2002 (HAVA) was enacted in part to help ensure that only eligible persons are registered to vote. Under HAVA, as of January 1, 2004, states were to create computerized statewide voter registration lists to serve as official rosters of legally registered voters for elections for federal office. States, however, were given the option to seek a waiver to postpone implementation of HAVA provisions until 2006. All but nine states did so. This report discusses the experiences of the nine states that were subject to the original HAVA deadline--Alaska, Arizona, Georgia, Hawaii, Kentucky, Minnesota, South Carolina, South Dakota, and West Virginia. The report describes actions election officials in these states reported taking to meet specific HAVA requirements--as applicable to their states--for (1) establishing computerized statewide voter registration lists and (2) verifying the accuracy of information on voter registration applications and maintaining accurate computerized voter lists. GAO is also reporting what states said about challenges they faced and lessons learned implementing the requirements. Draft sections of this report were reviewed by the nine states; the Election Assistance Commission, which was responsible for coordinating HAVA waivers; and the Department of Justice. GAO incorporated technical comments, as appropriate. To establish the HAVA-required registration lists, five states modified existing computerized statewide voter registration systems; one state replaced an older system with a new one; and two states created statewide voter registration systems for the first time, according to election officials. Officials from the ninth state reported no actions were taken because the state had such a registration list in place prior to HAVA. State election officials reported they took steps to verify information provided on voter registration applications and maintain their voter lists as required by HAVA. States either completed or were in the process of completing the required matches of voter registration information with state motor vehicle agency (MVA) or Social Security Administration (SSA) records. Officials from all nine states reported conducting the list maintenance activities required by HAVA: eliminating duplicate registrations and coordinating the voter list with state agency records on felons and the deceased to identify and remove the names of ineligible registrants. According to officials from four states, implementing HAVA improved the accuracy of the voter lists, for example, by correcting errors in voter information before they were entered into the statewide list. Officials from the other five states reported little to no improvements to the accuracy of their lists in part, some said, because they had established systems similar to those required by HAVA prior to the enactment of the law. State election officials reported they faced challenges and learned lessons while implementing the HAVA requirements. For example, officials from seven states reported their experiences taught them that collaborating with local officials to develop the computerized statewide systems later helped them successfully implement the systems.

Background In carrying out its mission, VA conducts medical research to find new treatments for diseases and disabilities that affect veterans and the nation’s population as a whole. VA researchers have been involved in a variety of important advances in medical research, including development of the cardiac pacemaker, kidney transplant technology, prosthetic devices, and drug treatments for high blood pressure and schizophrenia. VA’s research programs include nine high-priority areas: acute and traumatic injuries, military and environmental exposures, special high-risk or underserved populations, sensory disorders and loss, aging, mental illness, substance abuse, chronic diseases, and health services and outcomes research. In fiscal year 2000, funding for VA research totaled almost $1.2 billion, supporting research projects conducted by more than 3,800 scientists at 115 VA medical centers across the country. These funds finance research projects and their supporting infrastructure, including capital expenditures for buildings, animal laboratories, and equipment. Funding made available for medical research through annual appropriations provided $666 million of VA’s fiscal year 2000 research dollars; the other $491 million was provided by other federal and nonfederal sources (see fig. 1). Federal funding comes from such sources as NIH and DOD, while nonfederal funding sources include private organizations, such as drug or biotechnology companies, or organizations such as the American Lung Association, the American Heart Association, and the American Diabetes Association. Of the $491 million, $174 million was administered by the nonprofit corporations, and the remaining $317 million was administered by VA medical centers or their affiliated universities. Nonprofit research corporations exist solely to support VA research and education, using their funds to support local VA medical centers’ research environments. They are collocated with VA facilities and usually do not pay VA for services such as rent, utilities, local telephone services, and janitorial services. Currently, there are 88 chartered nonprofit research corporations, of which 85 are actively conducting research. In 2000, the most recent year for which revenue data are available, VA’s nonprofit research corporations received about $174 million in revenues— almost a 140-percent increase over the last 5 years—and administered 4,651 VA-approved research projects. The largest source of funding for VA’s nonprofit research corporations has been private organizations, averaging more than 40 percent from fiscal years 1996 through 2000 (see table 1). NIH has been the largest government source of funding for the corporations. VA treats all funds administered by VA medical centers as appropriated funds, and medical centers are generally required to comply with statutory and other restrictions on the use of those funds, as well as with federal regulations governing procurement and the hiring of employees. Prior to the establishment of nonprofit corporations, VA administered research funding from external sources through special accounts at local medical centers—known as general post funds—or through its affiliated universities. Flexibility Allows Nonprofit Corporations to Enhance VA Research Nonprofit corporations provide a flexible funding mechanism to support the indirect cost of VA’s research environment. For example, nonprofit corporations’ funds can be used to renovate laboratory space and support start-up research to develop grant proposals. Nonprofit research corporations also have more flexibility with respect to personnel and procurement issues than VA medical centers because, as private corporations, they are not subject to federal personnel or procurement regulations. The five nonprofit corporations we visited typically obtained donated and grant funds of between 10 and 20 percent of direct project costs to apply to indirect costs. According to the nonprofit corporations’ executive directors we interviewed, these indirect cost rates are generally based on what other nonprofit organizations normally charge and not based on their actual indirect costs. These indirect costs include the costs for running the corporation, equipment purchases, facility upgrades, subscriptions to scientific journals, travel to research conferences, maintaining VA research libraries, and renovating and maintaining VA animal laboratories. Further, nonprofit corporations can use the funds they obtain for indirect costs to support research. For example, at one VA medical center, the nonprofit research corporation incurred $8,451,000 in expenses in 2001, with $7,693,000 spent on the direct costs of research projects; $413,000 spent on corporation operating expenses, such as grant administration and payroll processing for research staff; and $345,000 spent on activities and improvements to the medical center’s research environment. Some of these activities and improvements included maintaining a clinical studies center, paying the salaries of a research science officer and assistant, and providing the “seed” or project start-up money for scientists to perform initial research to generate data necessary to apply for research grants. According to VA’s Office of Research and Development, the funds used by the nonprofit corporations to purchase equipment and maintain and upgrade VA’s facilities allow VA to use more of its appropriated funds for conducting research. For example, at one facility we visited, the nonprofit corporation is renovating laboratory space necessary to conduct a VA- funded research project. While grants to affiliated universities can also be used to cover indirect costs of research conducted at VA facilities, VA officials told us that universities generally do not provide funding to help pay for VA’s indirect costs; instead, they use it to support the indirect costs of the universities and their own research facilities. At another medical center, VA’s Office of Inspector General suggested security improvements be made in research laboratories containing hazardous materials. About $56,000 was needed from either VA’s Office of Research and Development or the medical center to make these improvements. Instead, the nonprofit corporation provided the funding. This preserved the Office of Research and Development’s funds for research and the medical center’s funds for patient care. In addition to the improvements in equipment, facilities, and research- related services, nonprofit corporations bring other benefits to VA’s research environment. Because private nonprofit corporations are not subject to the regulations that govern federal agency hiring practices, they can hire and release employees more quickly than VA, which, according to researchers, can be more responsive to their individual project personnel and contracting needs. For example, at some of the VA nonprofit corporations we visited, the principal investigators stated that because funding for research is dependent on the number, length, and timing of grants received, they prefer to quickly hire research technicians and support staff after project funds are awarded and release them from the projects as soon as their work is completed. The principal investigators noted that if nonprofit corporations did not exist, it would take longer to begin the research because they would have to hire staff through VA. A medical center official reported that it usually took 6 weeks or more to hire a research employee through VA compared to less than a week through the nonprofit corporation. Nonprofit corporations can also contract for goods and services more quickly than VA can because they do not have to follow the federal acquisition process. For example, two of the nonprofit corporations we visited were able to quickly order highly specialized digital, computerized microscopes needed by several research teams. Officials told us that based on their past experiences, if those microscopes had been purchased through VA’s competitive process, it could have taken months to award a contract. Finally, VA’s research environment is key to attracting and retaining highly qualified physicians, according to officials at some of the medical centers we visited and in VA’s Office of Research and Development. Investigators we interviewed said their research directly related to and benefited the care they provided to their patients, such as administering experimental research drugs for cancer. Some of the researchers we interviewed also noted that the nonprofit corporation’s contribution to the local VA research facility was one of the main reasons they came to or remained at the facility. For example, at one nonprofit corporation we visited, the corporation renovated laboratory space needed to attract an investigator, who is also a physician. VA Has Processes in Place to Help Detect Conflicts of Interest Conflicts of interest can occur in connection with medical research when an individual or an institution has financial interests in the research. Conflicts of interest impair the conduct of objective, unbiased research and create the risk that an investigator will compromise a study’s integrity to gain financial rewards or recognition. Investigators may establish financial relationships with donors—for example as employees, consultants, board members, or stockholders—as long as these relationships do not compromise, or appear to compromise, their professional judgment and the independence of the research. For example, an investigator’s financial relationships must not bias or appear to bias the development of the study to ensure certain outcomes. A conflict of interest would also result if investigators reported only favorable research results or withheld certain study findings to maintain a competitive edge for the entities in which they have financial interests. Conflicts of interest have the potential to put study subjects and the general population at risk. Investigators on research projects administered by VA nonprofit corporations must follow federal statutes and regulations applicable to federal employees concerning conduct and conflicts of interest. They cover, for example, restrictions on gifts from outside sources, the use of non-public information, and employees’ financial interests. Because investigators design and control the research, they may also be subject to additional federal conflict of interest regulations. For example, principal investigators conducting research under NIH grants are subject to Public Health Service regulations, and investigators conducting pharmaceutical trials are subject to Food and Drug Administration regulations. These regulations require investigators to disclose their financial interests. There are other conflict of interest procedures that investigators in some locations must follow. For example, investigators at three of the five VA nonprofit corporations we visited were required by the VA medical center or its affiliated university to disclose their financial interests related to each research project they conducted. At one of these locations, the corporation, the university, and VA formed a conflicts of interest committee to review financial disclosures and identify and manage conflicts of interest. The results of these reviews are documented in the committee’s meeting minutes and forwarded for review to the VA medical center’s institutional review board (IRB). Additionally, to guard against potential conflicts of interest, nonprofit corporation board members, officers, and employees must sign a certification that they comply with federal statutes and regulations on conflicts of interest; however, they are not required to file financial disclosure forms. Certain nonprofit corporation board members and officers are required to file financial disclosure forms because of their positions at the medical center. For example, a VA medical center’s director and chief of staff, who also serve on the nonprofit corporation’s board of directors, are required to file financial disclosure statements because of the positions they hold at the medical center. A VA official told us that there is no routine comparison of these financial disclosure forms and ongoing research projects at a particular facility. While federal regulations govern the financial interests of individuals, no similar regulations apply to the financial interests of an institution. Institutional conflicts of interest occur when an entity’s financial interests conflict with its goals of conducting and fostering objective, unbiased research. Financial interests may color an entity’s review, approval, or monitoring of research conducted under its auspices or its allocation of equipment, facilities, and staff for research. Some institutions, such as universities, may obtain financial benefits from owning stock in a company that sponsors research or from owning patents that result from research. In contrast, VA nonprofit research corporations cannot own stock, have an equity interest in private companies, or own patents. Consequently, these types of institutional conflicts are unlikely to occur. VA nonprofit corporations may only invest in government-backed securities such as certificates of deposit or U.S. Treasury bonds. VA, not the nonprofit corporations, controls the rights to patents arising from research administered by nonprofit corporations. In addition, nonprofit corporations cannot accept funds to administer a research project unless the local VA medical center approves it. VA Headquarters Does Not Monitor or Oversee Nonprofit Corporations’ Financial Activities The Secretary of VA has delegated responsibility for overseeing and evaluating nonprofit corporations to the directors at local medical centers. This responsibility includes ensuring that deficiencies noted in audited financial statements and management letters are corrected. VA requires that nonprofit corporations submit their audited financial statements and management letters; tax forms; and supplemental information on donors, payees, and research projects to the medical center’s chief financial officer and the nonprofit corporation’s board of directors—which must, by statute, include the medical center’s director, chief of staff, and assistant chief of staff for research—for review prior to the issuance of VA’s annual report to the Congress. At all five sites we visited, the nonprofit corporations provided their 2000 and 2001 audited financial statements as required, and all five received unqualified opinions on their financial statements, indicating that none contained material misstatements. We also reviewed a sample of the five nonprofit corporations’ expenditures from their most recent annual financial statements— including those for travel, meetings, conferences, professional dues and memberships, publications, and office supplies—and generally found that the expenditures were related to research or to running the nonprofit corporation and were consistent with its internal control procedures. However, no standard body of rules exists that governs the type and amount of expenditures made by nonprofit corporations, although specific requirements may be established by the source of the funds. For example, if the nonprofit corporations receive funds from a federal agency, then the Office of Management and Budget Circular A-122 applies, which does not allow certain expenses, such as for entertainment or alcohol. Other donors may place specific restrictions on the use of their funds. We reviewed a sample of travel expenditures—including the travel of members of the board of directors and executive directors—and found that while nonprofit corporations are not eligible for government rates, the rates they paid were comparable to the federal government’s rates for meals and lodging. Of the 66 travel vouchers we reviewed, only one first- class airline rate was charged and for only one segment of the trip because no economy seats were available. In addition, we reviewed expenses related to meetings. They generally covered food and beverages provided at staff meetings, team building sessions, and dinners with potential recruits. The dollar amounts were typically a small portion of the nonprofit corporation’s total expenditures. For example, one nonprofit corporation with annual expenditures of almost $8.5 million spent $16,171 on these expenses. Another nonprofit corporation with expenditures of about $25 million spent $66,469 on these expenses. Two of the five locations we visited received management letters from their independent auditors in 2000 and 2001, citing areas for improvement in internal controls. We found that these nonprofit corporations had either corrected or were in the process of correcting problems cited in the previous years’ management letters. For example, at one nonprofit corporation, the external audit of its year 2000 financial records found that it did not reconcile its general ledgers at month end in accordance with generally accepted accounting practices. Although the nonprofit corporation’s 2001 management letter still identified some problems with month-end reconciliations, the auditor noted that improvements had been made. While each nonprofit corporation submits its financial statements and management letters to VA, VA headquarters does not use this information to oversee and monitor the nonprofits’ financial activities and ensure that identified deficiencies are corrected. According to VA, it relies in part on the VA Inspector General, IRS, GAO, and state and local authorities to identify fraud, waste, and abuse. However, officials at the five nonprofit corporations we visited stated that, for the last 5 years, their corporations have not been the subject of systematic review, although the VA Inspector General is currently investigating specific matters related to nonprofit corporations reported through its fraud hotline. The two largest corporations we visited stated that their state labor departments conducted reviews, but these reviews were limited to their personnel practices and records.

GAO reviewed the Department of Veterans Affairs' (VA) nonprofit research corporations, which receive funds primarily from non-VA sources to conduct medical research at VA facilities. Since VA's nonprofit corporations were first established, there has been limited oversight of their operations and contributions to VA research. Nonprofit corporations support VA's research environment by funding a portion of the department's research needs, such as laboratory equipment and improvements to infrastructure, and by providing flexible personnel and contracting arrangements to respond to investigators' needs. To detect conflict of interest, investigators on research projects administered by VA's nonprofit corporations are subject to federal statutes and regulations applicable to federal employees concerning conduct and conflicts of interest and may be required to disclose their financial interests. Institutional conflicts of interest are unlikely to occur in VA's nonprofit research corporations because they cannot own stock, have an equity interest in private companies, or obtain intellectual property rights. VA has delegated responsibility for monitoring and overseeing the activities of nonprofit corporations to the directors of VA medical centers; however, VA headquarters does not oversee and monitor corporations' financial activities and ensure that identified deficiencies are corrected.

Background In e-mail comments on a draft of this report, the Acting CIO stated that the report reflects both Treasury’s shortcomings as well as progress to date and recognized the need to take proactive steps to strengthen its investment board operations and oversight of information technology resources and programs. Treasury also agreed with the need for an executive investment review board that is actively engaged in the investment management process and noted that nonmajor investments have not been a priority because the major investments the department has chosen to devote its resources to represent the more significant portion of the portfolio in terms of dollar value, visibility to OMB and Congress, and importance to Treasury’s mission. Treasury also commented on the department’s authority to redirect funding from one Treasury bureau to another. We incorporated these comments into our report where appropriate. Treasury’s Mission and Organizational Structure The Department of the Treasury is the primary federal agency responsible for the economic and financial prosperity and security of the United States, and as such is responsible for a wide range of activities, including advising the President on economic and financial issues, promoting the President’s growth agenda, and enhancing corporate governance in financial institutions. To accomplish its mission, Treasury is organized into departmental offices and operating bureaus. The departmental offices are primarily responsible for the formulation of policy and management of the department as a whole, while the nine operating bureaus—including the Internal Revenue Service and the Bureau of Engraving and Printing—carry out the specific functions assigned to Treasury. Figure 1 shows the organizational structure of the department. Treasury’s Use of Information Technology Information technology plays a critical role in helping Treasury meet its mission. For example, the Internal Revenue Service relies on information systems to process tax returns, account for tax revenues collected, send bills for taxes owed, issue refunds, assist in the selection of tax returns for audit, and provide telecommunications services for business activities, including the public’s toll-free access to tax information. To modernize the systems it relies on to carry out these functions, Treasury is engaged in a Business Systems Modernization program. Treasury requested $11.4 billion in the President’s fiscal year 2007 budget. Of this amount, the department estimates it will spend approximately $2.8 billion for 235 IT investments—some $2.3 billion (about 80 percent) for 75 major investments and some $480 million (about 20 percent) for 160 nonmajor investments. Prior Reviews on IT Management Issues at Treasury Since mid-1999, we have been reviewing the Internal Revenue Service’s (IRS) progress in implementing its Business Systems Modernization program as part of our reviews of the service’s associated expenditure plans. Our reviews have identified a number of weaknesses in IRS’s modernization management controls and capabilities and, over the years, we have made numerous recommendations to address these weaknesses. IRS has addressed many of our recommendations; however, several weaknesses remain. In January 2004, we reported as part of a governmentwide review, that Treasury had significant weaknesses in investment management. We noted, for example, that the department had neither developed a capital planning and investment control guide nor developed work processes and procedures for the agency’s IT investment management board. In addition, Treasury had not documented the alignment and coordination of responsibilities of its various boards for decision making related to investments, including the criteria for which investments—including crosscutting investments—were to be reviewed by the executive investment review board. We also reported that Treasury did not have a department-level control process; instead, each bureau could conduct its own reviews that address the performance of its IT investments and corrective actions for underperforming projects. We made several recommendations to address the weaknesses we identified. Treasury concurred with our recommendations, stating that it recognized its shortcomings and was working to correct them. In July 2006, we reported on Treasury’s Financial Crimes Enforcement Network’s (FinCEN) BSA Direct Retrieval and Sharing project, a nonmajor investment, noting that FinCEN did not always apply effective investment management processes to oversee this project. We recommended that the director of FinCEN direct its CIO to develop a plan for improving the agency’s capabilities for overseeing this project. FinCEN officials concurred with our findings and recommendation. In January 2007, in an update to our high-risk series report on the Internal Revenue Service’s Business Systems Modernization, which we first designated as high-risk in 1995, we reported that while the Internal Revenue Service had made progress in reducing risk with systems modernization and financial management, improvements made have not been sustained long enough to provide confidence that the program is fully stable. We also reported that many challenges remain, including improving processes for designing, developing, and delivering modernized IT systems. Several of Treasury’s projects have been deemed to be poorly planned and managed by the Office of Management and Budget (OMB) and have warranted inclusion on OMB’s Management Watch and High Risk Lists. Role of Department CIO in Investment Management The Clinger-Cohen Act of 1996 requires agency heads to designate the CIO to lead reforms to help control system development risks; better manage technology spending; and achieve real, measurable improvements in agency performance through better management of information resources. The agency head, through the department-level CIO, is responsible for providing leadership and oversight for foundational critical processes by ensuring that written policies and procedures are established, repositories of information are created that support investment decision making, resources are allocated, responsibilities are assigned, and all of the activities are properly carried out where they may be most effectively executed. Treasury’s Approach to Investment Management Treasury’s IT investment management process is to provide the framework for decision making and accountability required to ensure IT investments meet the strategic and business objectives of the department in an efficient and effective manner. In carrying out this process, the department makes a distinction between its major and nonmajor investments, to determine the extent and scope of the department’s investment management oversight and the level of reporting requirements. An IT investment is classified as major if it meets at least one of the following criteria:requires special management attention because of its importance to the mission or function of the agency, a component of the agency or another organization; is for financial management and obligations of more than $500,000 annually; has significant program or policy implications; has high executive visibility; has high development, operating, or maintenance costs; has total life-cycle costs exceeding $50 million; has an annual budget of $5 million or more; or significantly impacts more than one bureau. Investments that do not meet at least one of these criteria are considered to be nonmajor investments. Several groups and individuals play a role in the department’s process to manage its IT investments at the department and bureau levels. They are involved in all aspects of the process, including reviewing and approving proposed investments, monitoring the investments through implementation, and evaluating the investments once they become operational. Table 1 identifies the groups and individuals that have a role in this process and shows their composition and responsibilities. Reviews by TIRB and the department’s executive investment review board focus on IT investments that are defined as major strategic investments for the department. To support this process, Treasury uses an automated portfolio management tool for collecting and maintaining data during the four phases of the process. Various forms in the tool are available for staff to enter new and updated data on Treasury’s IT investments. Process for Managing Investments In September 2005, the department issued a Capital Planning and Investment Control Policy Guide defining a four-phase process for managing its IT investments. These phases consist of preselect, select, control, and evaluate. Completing the requirements of one phase is necessary before moving on to the subsequent phase. Each phase is to be overseen by Treasury’s executive investment review board, which ultimately approves or rejects an investment’s advancement to the next phase. Preselect phase is the annual process by which potential new major investments seeking funding in the upcoming budget year are approved to move into the select phase and are considered for inclusion in the department’s budget request. Only major IT investments are promoted through the preselect process and reviewed at the departmental level. During this phase, an investment’s business owner is to document the business need for the investment and describe its anticipated alignment with bureau, Treasury, and e-government initiatives, and the President’s Management Agenda strategic goals. The CPIC team is then expected to review and validate the preselect data and pass on its assessment and recommendation to TIRB, which is to provide recommendations to the department’s executive investment review board. Once a major investment is approved by the executive investment review board, it moves forward to the select phase. The department’s bureaus have the exclusive responsibility for the preselection of nonmajor investments within their respective bureaus, and the bureaus’ executive leadership must approve a nonmajor investment in order for it to enter the select phase. Select phase is the process by which new and existing major IT investments seeking funding in the upcoming budget year are annually screened, scored, and selected for inclusion in Treasury’s IT investment portfolio. In this phase, Treasury is to ensure that only IT investments that best support its mission, investment principles, and approach to EA are chosen and that the investment owners have taken steps to be successful, such as having a qualified project manager and analyzing risks. As in the preselect phase, the CPIC team is expected to review and validate that all data is complete, score each investment based on Treasury’s investment principles, and submit its findings and recommendations to TIRB. TIRB, in turn, is to review the scoring results and provide its recommendations to Treasury’s executive investment review board, which is then to select which investments will be included in the department’s IT investment portfolio that is ultimately submitted to OMB for funding considerations. Investments do not technically exit the select phase until they are terminated, since they must be reviewed annually for reselection. The bureaus are responsible for conducting their own select process for nonmajor investments. Control Phase ensures, through timely oversight, quality control, and executive review, that IT investments are managed in a disciplined and consistent manner. This phase is characterized by Treasury’s Office of the CIO initiating quarterly control reviews, which focus on ensuring that an investment’s projected benefits are being realized; that cost, schedule, and performance goals are being met; that risks are minimized and managed; and that the investment continues to meet strategic goals. Through Office of the CIO quarterly data calls, bureau project managers are to update data as of the end of the previous quarter for cost and schedule, performance measures, and risk assessments for both major and nonmajor investments. This updated data is to be entered into the department’s automated IT portfolio management tool, which the bureau project managers and the bureau CIOs are to certify for accuracy using a certification form within the tool. Next, Treasury’s CPIC team is to evaluate the data and provide feedback to the bureaus through the bureaus’ CPIC coordinators, giving the bureaus an opportunity to remediate missing or erroneous data. For major investments, the CPIC team is then expected to summarize the results, including identifying corrective actions planned, for presentation to TIRB. TIRB is to review the results for potential risk factors, such as schedule or cost slippages or major technical problems, before forwarding its recommendation to Treasury’s executive investment review board. The executive investment review board is to review TIRB’s recommendations before making a decision to continue, accelerate, modify, suspend, or terminate investments. While control data are captured for nonmajor investments, the department leaves it to the bureaus to conduct their own oversight process for these investments. However, TIRB and the executive investment review board may choose to review these investments on a random sample basis. In July 2006, Treasury adopted procedures for establishing an Internal Watch List of major investments at risk of not meeting established goals. The criteria for placement on this list include 1. cost or schedule variances greater than plus or minus 10 percent for 2. lack of validation of project manager’s qualifications by the bureau CIO; 3. lack of a current certification and accreditation; or 4. duplication of another investment within the department or with any of the President’s e-government initiatives or lines of business. Treasury’s Office of the CIO is to make this determination, and investments on this list are subject to additional reporting requirements, including development of an action plan to remediate the noncompliant conditions. Bureau CIOs are to report monthly to the Treasury CIO on the status of these investments. Once all requirements have been met and the Treasury CIO concurs, the investment can be removed from the list. Evaluation phase involves an annual process to determine how well major investments are performing once they become operational. This process is to occur in the first quarter of the fiscal year and is composed of two subprocesses—the postimplementation review (PIR) and the operational analysis (OA). The age and the life cycle stage of the investment determine which of these two subprocesses is conducted on an investment. The purpose of the PIR is to assess the performance of an investment that has been fully developed and has moved into the operational and maintenance stage of its life cycle. An investment’s project manager is to initiate a PIR 6 to 18 months after an investment has moved into its operational and maintenance stage. During a PIR, an investment’s actual performance is compared to its expected performance to identify lessons learned for improving both the investment and Treasury’s CPIC process. The PIR is also intended to measure the strategic impact, user satisfaction, and whether the investment is meeting cost, schedule, and performance metrics. The results of the PIR are to be documented in Treasury’s portfolio management tool. Once the PIR is completed, Treasury’s CPIC team is to evaluate the results, provide feedback to the project manager and the respective bureau management, and provide summary information to TIRB. TIRB, in turn, is to report lessons learned from the PIRs conducted and any recommendations it may have to the department’s executive investment review board in order to promote the lessons learned across the department’s IT investment portfolio. The purpose of the OA is to identify those investments in operations and maintenance for which PIRs have been conducted that are likely to require modification, acceleration, replacement, or retirement, and to help determine the remaining useful life of an investment. However, because of the newness of Treasury’s PIR requirement and the age of certain investments that have been in the operations and maintenance stage of their life cycle, a PIR may not have been performed on these investments prior to the required OA. Similar to a PIR, in conducting the OA, Treasury focuses on two key areas: (1) program objectives, looking at alignment to cost, schedule, and strategic goals; and (2) meeting user needs. In determining how well the investment aligns to program objectives, data are to be captured on an annual basis---most likely from established sources, such as the quarterly control reviews and annual select phase process. To determine whether user needs are still being met by the investment, the investment’s project manager, in coordination with the investment’s business owner, is to solicit user input, using such means as a survey, focus groups, or regular user group meetings. The results of the OA are to be documented in Treasury’s portfolio management tool and can entail recommending the investment continue operations as is, be modified, or be terminated. Based on further analysis by the CPIC team, a review meeting may be scheduled to discuss the results and the recommendations. The results of these meetings are to be shared with TIRB and the executive investment review board, as appropriate. Prior to exiting the evaluation phase, the executive investment review board must approve the disposal, retirement, or replacement of major investments. Figure 2 shows the schedule of select, control, and evaluate activities that take place throughout the year. (Oct. - Dec.) (Jan. - Mar.) (Apr. - June) (July - Sept.) Bdget ye Exhiit 00/5ll nd initisubmission to Treasury (Apr. - Jne) Preliminry elect review for budget yer plnning (Mr.) Hold finelect review for budget yer (Jly) Hold control review Q1 (Mrch) Hold control review Q2 (Jne) Hold control review Q (Jly) Evuation review on tedy te invetment for budget yer; et pend pl (Decemer) ITIM Maturity Framework To provide a method for evaluating and assessing how well an agency is selecting and managing its IT resources, GAO developed the Information Technology Investment Management framework (ITIM). The ITIM is a maturity model composed of five progressive stages of maturity that an agency can achieve in its investment management capabilities. It was developed on the basis of our research into the IT investment management practices of leading private- and public-sector organizations. In each of the five stages, the framework identifies critical processes for making successful IT investments. The maturity stages are cumulative; that is, in order to attain a higher stage, the agency must have institutionalized all of the critical processes at the lower stages in addition to the higher stage critical processes. The framework can be used to assess the maturity of an agency’s investment management processes and as a tool for organizational improvement. The overriding purpose of the framework is to encourage investment processes that increase business value and mission performance, reduce risk, and increase accountability and transparency in the decision process. We have used the framework in several of our evaluations, and a number of agencies have adopted it. These agencies have used ITIM for purposes ranging from self-assessment to redesign of their IT investment management processes. ITIM’s five maturity stages represent the steps toward achieving stable and mature processes for managing IT investments. Each stage builds on the lower stages, and the successful attainment of each stage leads to improvement in the organization’s ability to manage its investments. With the exception of Stage 1, each maturity stage is composed of critical processes that must be implemented and institutionalized in order for the organization to achieve that stage. These critical processes are further broken down into key practices that describe the types of activities an organization should be performing to successfully implement each critical process. It is not unusual for an organization to be performing key practices from more than one maturity stage at the same time, but efforts to improve investment management capabilities should focus on implementing all lower stage practices before addressing higher stage practices. In the ITIM, Stage 2 critical processes lay the foundation for sound IT investment processes by helping the agency to attain successful, predictable, and repeatable investment control processes at the project level. Specifically, Stage 2 encompasses building a sound investment management foundation by establishing basic capabilities for selecting new IT projects. It involves developing the capability to control projects so that they finish predictably within established cost and schedule expectations and have the capability to identify potential exposures to risk and put in place strategies to mitigate that risk. It also involves instituting an IT investment board, which includes defining its membership, guidance policies, operations, roles, responsibilities, and authorities for one or, if applicable, more IT investment boards within the organization, and, if appropriate, each board’s support staff. The basic selection processes established in Stage 2 lay the foundation for more mature selection capabilities in Stage 3, which represents a major step forward in maturity. In this stage, the agency moves from project-centric processes to a portfolio approach, evaluating potential investments by how well they support the agency’s mission, strategies, and goals. Stage 3 requires that an organization continually assess both proposed and ongoing projects as parts of a complete investment portfolio—an integrated and competing set of investment options. It focuses on establishing a consistent, well-defined perspective on the IT investment portfolio and maintaining mature, integrated selection (and reselection), control, and evaluation processes, which are to be evaluated during PIRs. This portfolio perspective allows decision makers to consider the interaction among investments and the contributions to organizational mission goals and strategies that could be made by alternative portfolio selections, rather than focusing exclusively on the balance between the costs and benefits of individual investments. Stages 4 and 5 require the use of evaluation techniques to continuously improve both the investment portfolio and the investment processes in order to better achieve strategic outcomes. At Stage 4 maturity, an organization has the capacity to conduct IT succession activities and, therefore, can plan and implement the deselection of obsolete, high-risk, or low-value IT investments. An organization with Stage 5 maturity conducts proactive monitoring for breakthrough information technologies that will enable it to change and improve its business performance. Organizations that have implemented Stages 2 and 3 have in place capabilities that assist in establishing the selection, control, and evaluation processes that are required by the Clinger-Cohen Act of 1996. Stages 4 and 5 define key attributes that are associated with the most capable organizations. Figure 3 shows the five ITIM stages of maturity and the critical processes associated with each stage. As defined by the model, each critical process consists of key practices that must be executed to implement the critical process. Treasury Has Established Many Key Practices for Managing Its Investments, but Has Key Weaknesses with Its Board Operations and Investment Oversight In order to have the capabilities to effectively manage IT investments, an agency, at a minimum, should (1) build an investment foundation by putting basic, project-level control and selection practices in place (Stage 2 capabilities) and (2) manage its projects as a portfolio of investments, treating them as an integrated package of competing investment options and pursuing those that best meet the strategic goals, objectives, and mission of the agency (Stage 3 capabilities). These practices may be executed at various organizational levels of the agency, including at the component level. However, overall responsibility for their success remains at the department level. Therefore, at a minimum, the department should effectively oversee component agencies’ IT investment management processes. While Treasury has established many of the capabilities needed to select, control, and evaluate its IT investments, the department has significant weaknesses that hamper its ability to effectively manage its investments. Specifically, the department has executed 19 of the 38 key practices that the ITIM requires to build a foundation for IT investment management (Stage 2), including practices needed to ensure that projects support business needs and that a disciplined process exists for capturing investment information. In addition, the department has executed 11 of the 27 key practices required to manage investments as a portfolio (Stage 3), including documenting policies and procedures for conducting postimplementation reviews. However, Treasury does not have an executive investment review board— a group of executives from IT and business units that is intended to be the final decision-making authority—that is actively engaged in the investment management process. According to the Associate CIO for Capital Planning and Information Management, while efforts to establish an executive investment review board have been initiated, these efforts have been stymied by changes in executive leadership. In addition, the department does not have any processes in place for managing its nonmajor investments, although they represent about 70 percent of the total number of investments. According to officials, nonmajor investments have not been a priority because the department has instead chosen to devote its resources to major investments, which represent about 80 percent of its IT expenditures. While it is reasonable to focus attention on major investments, nonmajor investments represent a significant amount of funding (about $480 million) and constitute the bulk of most bureaus’ investment portfolio and therefore also require a certain level of oversight. Until the department addresses these weaknesses, it will not have the investment management structure needed to effectively assess and manage the risks associated with its multibillion-dollar portfolio. In addition, until the department addresses these weaknesses, it will not have assurance that key investment management decisions are benefiting from the contribution of executives who are in the best position to make the full range of decisions needed to enable the agency to meet its mission most effectively. In addition, the department will not be able to ensure that it is effectively assessing and managing the risks associated with nonmajor investments costing hundreds of millions of dollars. Treasury Has Established Many of the Foundational Practices Needed to Manage its Investments At the ITIM Stage 2 level of maturity, an organization has attained repeatable, successful IT project-level investment control and basic selection processes. Through these processes, the organization can identify expectation gaps early and take the appropriate steps to address them. According to ITIM, critical processes at Stage 2 include (1) defining IT investment board operations, (2) identifying the business needs for each IT investment, (3) developing a basic process for selecting new IT proposals and reselecting ongoing investments, (4) developing project- level investment control processes, and (5) collecting information about existing investments to inform investment management decisions. Table 2 describes the purpose of each of these Stage 2 critical processes. Because of management attention that has recently been given to IT investment management, Treasury has put in place half of the key practices needed to establish the investment foundation. These include all of the key practices associated with identifying and collecting information to support investment decisions and some of the key practices for ensuring that projects and systems support organizational needs and meet users’ needs as well as for selecting new proposals and reselecting ongoing investments. However, because no executive investment review board currently exists (see details in next section), the department has not executed many of the key practices for instituting the investment board. In addition, because of its limited involvement in managing nonmajor investments, the department has not executed many of the key practices related to providing investment oversight. Treasury officials stated that the management turnover present a challenge to establishing an executive investment review board. They also acknowledged the need for a process to oversee nonmajor investments, particularly in light of the recent failure of the BSA Direct project. Table 3 summarizes the status of Treasury’s Stage 2 critical processes, showing how many associated key practices the department has executed. The establishment of decision-making bodies or boards is a key component of the IT investment management process. At the Stage 2 level of maturity, organizations define one or more boards, provide resources to support the boards’ operations, and appoint members who have expertise in both operational and technical aspects of proposed investments. The boards should operate according to a written IT investment process guide that is tailored to the organization’s unique characteristics, thus ensuring that consistent and effective management practices are implemented across the organization. The organization selects board members to ensure they are knowledgeable about policies and procedures for managing investments. Organizations at the Stage 2 level of maturity also take steps to ensure that executives and line managers support and carry out the decisions of the investment board. According to ITIM, organizations should (1) establish an enterprisewide IT investment board composed of senior executives from IT and business units, (2) have a documented IT investment process directing each investment board’s operations, and (3) ensure that the enterprisewide investment board has oversight responsibilities for the development and maintenance of the organization’s documented IT investment process. (The complete list of key practices is provided in table 4.) Treasury has executed three of the eight key practices for this critical process. For example, the department has documented an IT investment process that directs investment board operations. In addition, adequate resources are provided to support board operations. However, Treasury currently does not have an executive investment review board composed of senior executives from IT and business units that is actively engaged in the investment management process. According to officials, such a board was established in 2005 but stopped functioning at the prompting of the assistant secretary for management because it was considered inefficient. In 2006, another executive investment review board structure was proposed under a new assistant secretary for management, but, according to the Associate CIO for Capital Planning and Information Management, it was not implemented, due to yet another change in executive leadership. Officials told us that one of the challenges in establishing the board has been the constant turnover in Treasury’s management. They noted that many of the management positions, including the assistant secretary for management position, are currently being filled by temporary or “acting” officials, who may be replaced soon. Until the department establishes an executive investment review board with senior executives from IT and business units, its investment management process will not benefit from the contribution of those executives who are in the best position to make the full range of decisions needed for the department to meet its mission most effectively. Table 4 shows the rating for each key practice required to implement the critical process for instituting the investment board at the Stage 2 level of maturity and summarizes the evidence that supports these ratings. Defining business needs for each IT project helps to ensure that projects and systems support an organization’s business needs and meet users’ needs. This critical process ensures that an organization’s business objectives and its IT management strategy are linked. According to ITIM, effectively meeting business needs requires, among other things, (1) documenting business needs with stated goals and objectives, (2) identifying specific users and other beneficiaries of IT projects and systems, (3) providing adequate resources to ensure that projects and systems support the organization’s business needs and meet users’ needs, and (4) periodically evaluating the alignment of IT projects and systems with the organization’s strategic goals and objectives. (The complete list of key practices is provided in table 5.) Treasury has executed two of the seven key practices for ensuring business needs are met. Specifically, Treasury has a documented business mission, with stated goals and objectives in its Treasury Strategic Plan for fiscal years 2003 through 2008. In addition, resources are devoted to ensuring that IT projects and systems support the organization’s business needs and meet users’ needs, including Treasury’s portfolio management tool, several subcouncils, an Exhibit 300 scoring guide to help develop major IT investments business cases, and training manuals on the use of the portfolio management tool contained in an online resource called the CPICResource Link. Treasury’s weaknesses in this area stem mostly from the fact that, while the department has delegated the management of nonmajors to the bureaus, it has no mechanism for ensuring that bureaus are effectively carrying out associated activities. In addition, while Treasury’s system development life-cycle methodology requires user involvement in projects’ life cycle, the investment management process does not have any steps for ensuring this is done. By not ensuring that bureaus are effectively aligning nonmajor investments with business needs, Treasury is incurring the risk that investments that make up approximately 20 percent of their IT budget and represent the majority of their investments may not be supporting the department’s priorities. In addition, without an executive investment review board actively involved in the process, Treasury cannot be assured it is making the best decisions regarding investments’ ability to support ongoing and future business needs. Table 5 shows the rating for each key practice required to implement the critical process for meeting business needs at the Stage 2 level of maturity and summarizes the evidence that supports these ratings. Selecting new IT proposals and reselecting ongoing investments requires a well-defined and disciplined process to provide the agency’s investment boards, business units, and developers with a common understanding of the process and the cost, benefit, schedule, and risk criteria that will be used both to select new projects and to reselect ongoing projects for continued funding. According to ITIM, this critical process requires, among other things, (1) providing adequate resources for investment selection activities; (2) making funding decisions for new proposals according to an established process; and (3) using a defined selection process to select new investments and reselect ongoing investments. (The complete list of key practices is provided in table 6.) Treasury has executed 6 of the 10 key practices associated with selecting an investment. Treasury’s portfolio management tool contains a form for entering select data and provides staff, such as project managers and CPIC desk officers, with information to help manage the select process. We verified that three of the systems we reviewed—TFIN, CADE, and SaBRe—did, in fact, use the select form in the portfolio management tool for entering select data. The department has aligned funding decisions with the budget process for new and ongoing investments through the department’s budget formulation process, which is used to select both enterprisewide and bureau investments. Treasury has also documented criteria for analyzing, prioritizing, selecting, and reselecting new and ongoing major investments that address its strategic goals and its IT strategic goals, value, and risk. The criteria are incorporated into the department’s portfolio management tool and adjusted within the tool to reflect organizational objectives. However, the executive investment review board that is supposed to make final selection and reselection decisions does not exist. Treasury officials state that, as part of the budget formulation process, the results of the select process are approved by executives and that the results of the fiscal year 2008 select process were approved by a group of executives, including the Treasury Assistant Secretary for Management and other department and bureau executives, prior to being forwarded to OMB. The officials recognized, however, that this group was convened only for that purpose and did not include business (i.e., mission) representation from the bureaus. In addition, Treasury has delegated the selection and reselection of the nonmajor systems to the bureaus; however, as previously noted, Treasury does not have a mechanism for ensuring that the bureaus are effectively carrying out these activities. Without such a mechanism, Treasury cannot have assurance that investments that make up approximately 20 percent of its budget and represent the majority of investments are being consistently and objectively selected and reselected. Table 6 shows the rating for each key practice required to implement the critical process for selecting an investment at the Stage 2 level of maturity and summarizes the evidence that supports these ratings. An organization should effectively oversee its IT projects throughout all phases of their life cycles. An investment board should observe each project’s performance and progress toward predefined cost and schedule expectations as well as each project’s anticipated benefits and risk exposure. This does not mean that a departmental board should micromanage each project to provide effective oversight; rather, it means that the departmental board should be actively involved in all IT investments and proposals that are high cost or high risk or have significant scope and duration and, at a minimum, should have a mechanism for maintaining visibility of all investments. The board should also use early warning systems that enable it to take corrective actions at the first sign of cost, schedule, and performance slippages. According to ITIM, effect project oversight requires, among other things, (1) having written policies and procedures for management oversight; (2) developing and maintaining an approved management plan for each IT project; (3) making up-to-date cost and schedule data for each project available to the oversight boards; (4) having regular reviews by each investment board of each project’s performance against stated expectations; and (5) ensuring that corrective actions for each underperforming project are documented, agreed to, implemented, and tracked until the desired outcome is achieved. (The complete list of key practices is provided in table 7.) Treasury has executed two of the seven key practices associated with effective project oversight. Treasury has adequate resources to support the executive investment review board for this critical process. The TIRB conducts quarterly control reviews of IT investments and can make recommendations to the executive investment review board based on these reviews. The department uses an automated portfolio management tool for the collection and maintenance of information to support the department’s quarterly control reviews. Treasury’s CPIC team, composed of Office of the Chief Information Officer (OCIO) personnel, assists the bureaus in compiling data on their respective IT portfolios, reviewing the data for accuracy and completeness prior to submission to TIRB for its quarterly control reviews. In addition, the bureaus have CPIC coordinators, each of which serve as a single point of quality control for their respective bureaus before information is released to OCIO’s CPIC team and provide assistance in addressing CPIC team comments received during the department’s quarterly control reviews. In addition, we verified that cost, schedule, benefits, and risk expectations were documented for the four projects we reviewed: CADE, SaBRe, TFIN, and TRACS. All four projects maintained project management plans or other documents that captured this information. However, although the department has written policies and procedures for management oversight of its investments, including its Capital Planning and Investment Control Policy Guide and its Earned Value Management Policy Guide, these policies and procedures are centered on the department’s major investments. Treasury leaves oversight of its nonmajor investments to the bureaus. According to Treasury officials, the department has thus far focused on the major investments because they represent about 80 percent of its IT expenditures. Until the department develops a mechanism for TIRB and its executive investment review board to periodically conduct nonmajor portfolio reviews, as indicated in its CPIC guide, or develops a mechanism for ensuring that the bureaus are doing so, the department risks not being able to identify investment problems when it is easier and less costly to resolve them. In addition, because the executive investment review board does not exist, Treasury is not executing any of the activities associated with providing investment oversight. Specifically, there is no executive investment review board to receive actual investment performance data, review the performance of projects and systems against expectations, and ensure that appropriate actions are taken to correct or terminate underperforming projects. The TIRB is currently carrying out these activities. However, without the involvement of an executive investment review board, these reviews are being performed without the corporate perspective that is useful in determining the impact individual project decisions may have on other projects and on the attainment of organizational goals and objectives. Table 7 shows the rating for each key practice required to provide investment oversight and summarizes the evidence that supports these ratings. To make good IT investment decisions, an organization must be able to acquire pertinent information about each investment and store that information in a retrievable format. During this critical process, an organization identifies its IT assets and creates a comprehensive repository of investment information. This repository provides information to investment decision makers to help them evaluate the potential impacts and opportunities created by proposed or continuing investments. It can provide insights into major IT cost and management drivers and trends. The repository can take many forms and need not be centrally located, but the collection method should, at a minimum, identify each IT investment and its associated components. This critical process may be satisfied by the information contained in the organization’s current enterprise architecture (EA), augmented by additional information—such as financial information and information on risk and benefits—that the investment board may require to ensure that informed decisions are being made. According to ITIM, effectively managing this repository requires, among other things, (1) developing written policies and procedures for identifying and collecting the information; (2) assigning responsibilities for ensuring that the information being collected meets the needs of the investment management process; (3) identifying IT projects and systems and collecting relevant information to support decisions about them; and (4) making the information easily accessible to decision makers and others. (The complete list of key practices is provided in table 8.) Treasury has in place all six key practices associated with capturing investment information. For example, the department’s Capital Planning and Investment Control Policy Guide and Earned Value Management Policy Guide define the policies and procedures for identifying and collecting information to support its investment management process and, according to Treasury officials, the Associate CIO for Capital Planning and Information Management is assigned responsibility for ensuring that the information collected meets the needs of the investment management process. Also, the department has adequate resources for supporting the process, including the Office of the CIO’s CPIC team, which is responsible for reviewing the information for accuracy and completeness before it is presented to TIRB for review prior to making its recommendations to the executive investment review board for final decisions. It also maintains an automated portfolio management tool for collecting and maintaining information on its IT investments. This tool is used by department and bureau components for updating information on their projects in response to data calls for the information required by TIRB to conduct its quarterly reviews. Table 8 shows the rating for each key practice required to implement this Stage 2 critical process and summarizes the evidence that supports these ratings. Treasury Lacks Key Capabilities Needed to Manage IT Investments as a Portfolio, and It Has Not Conducted Postimplementation Reviews Once an agency has attained Stage 2 maturity, it needs to implement critical processes for managing its investments as a portfolio (Stage 3). An IT investment portfolio is an integrated, agencywide collection of investments that are assessed and managed collectively based on common criteria. Managing investments as a portfolio is a conscious, continuous, and proactive approach to allocating limited resources among an organization’s competing initiatives in light of the relative benefits expected from these investments. Taking an agencywide perspective enables an organization to consider its investments comprehensively, so that collectively the investments optimally address the organization’s mission, strategic goals, and objectives. Managing IT investments as a portfolio also allows an organization to determine its priorities and make decisions about which projects to fund and continue to fund based on analyses of the relative organizational value and risks of all projects, including projects that are proposed, under development, and in operation. Although investments may initially be organized into subordinate portfolios—based on, for example, business lines or life cycle stages—and managed by subordinate investment boards, they should ultimately be aggregated into this enterprise-level portfolio. According to the ITIM, Stage 3 maturity includes (1) defining the portfolio criteria, (2) creating the portfolio, (3) evaluating the portfolio, and (4) conducting postimplementation reviews. Table 9 summarizes the purpose of each critical process in Stage 3. Treasury has executed 11 of the 27 key practices required by Stage 3. For example, the department has a working group in place that is responsible for managing the development and modification of the department’s IT portfolio selection criteria. In addition, it has documented criteria to regularly assess its portfolio performance expectations through its portfolio tool. However, many key practices still need to be executed before Treasury can effectively manage its IT investments from a portfolio perspective. For example, the department has only addressed 3 of the 7 practices for evaluating the portfolio and 2 of the 6 practices for conducting PIRs. Until Treasury fully implements the critical processes associated with managing its investments as a complete portfolio, it will not have the data it needs to make informed decisions about competing investments. Table 10 summarizes the status of Treasury’s Stage 3 critical processes and shows how many associated key practices the department has executed. To manage IT investments effectively, an organization needs to establish rules or portfolio selection criteria for determining how to allocate scarce funding to existing and proposed investments. Thus, developing an IT investment portfolio requires defining appropriate cost, benefit, schedule, and risk criteria with which to evaluate individual investments in the context of all other investments. To ensure that the organization’s strategic goals, objectives, and mission will be satisfied by its investments, the criteria should have an enterprisewide perspective. Further, if an organization’s mission or business needs and strategies change, criteria for selecting investments should be re-examined and modified as appropriate. Portfolio selection criteria should be disseminated throughout the organization to ensure that decisions concerning investments are made in a consistent manner and that this critical process is institutionalized. To achieve this result, project management personnel and others should be aware of the criteria and address the criteria in funding submissions for projects. Resources required for this critical process typically include the time and attention of executives involved in the process, adequate funding, and supporting tools. (The complete list of key practices is provided in table 11.) Treasury has executed four of the seven key practices associated with defining the portfolio selection criteria. For example, according to Treasury officials, the department has adequate resources for portfolio selection activities, including the Associate CIO for Capital Planning and Information Management, the CPIC team, the CPIC subcouncil, which is responsible for managing the development and modification of the IT portfolio selection criteria, as well as a portfolio management tool. In addition, project management personnel and other stakeholders are made aware of the portfolio selection criteria through Treasury’s CPIC team, and the department’s internal Web site. Despite these important steps in defining portfolio selection criteria, weaknesses remain. Specifically, the department has not developed policies or procedures for modifying the portfolio selection criteria to reflect changes to its strategic initiatives. In addition, because Treasury does not have an executive investment review board, the activities that call for this board to review and approve the portfolio selection criteria are not being performed. Reviews of the portfolio selection criteria are performed by the department’s CPIC subcouncil, which forwards its reviews to TIRB for approval of the criteria. Until Treasury fully defines and implements the practices required for defining the portfolio selection criteria, it will not have the tools it needs to effectively select the mix of investments that best meet the department’s mission needs considering resource and funding constraints. Table 11 shows the rating for each key practice required to create a portfolio and summarizes the evidence that supports these ratings. At Stage 3, organizations create a portfolio of IT investments to ensure that IT investments are analyzed according to the organization’s portfolio selection criteria and to ensure that an optimal IT investment portfolio with manageable risks and returns is selected and funded. According to ITIM, creating the portfolio requires organizations to, among other things, document policies and procedures for analyzing, selecting, and maintaining the portfolio; provide adequate resources, including people, funding, and tools for creating the portfolio; and capture the information used to select, control, and evaluate the portfolio and maintain it for future reference. In creating the portfolio, the investment board must also (1) examine the mix of new and ongoing investments and their respective data and analyses and select investments for funding and (2) approve or modify the performance expectations for the IT investments they have selected. (The complete list of key practices is provided in table 12.) Treasury has executed two of the seven key practices associated with creating the portfolio. For example, the department has adequate resources for creating its portfolio, including the CPIC subcouncil and the use of the department’s portfolio management tool. In addition, information is captured and maintained for future reference in the department’s portfolio management tool. The information in the tool is used to select, control, and evaluate all major IT portfolio investments. Nevertheless, Treasury has weaknesses in the way it creates a portfolio. First, it does not have a complete set of policies and procedures that address this critical process. Even though the department has policies and procedures for selecting the IT portfolio criteria, it lacks policies and procedures for using the criteria to analyze and maintain the department’s IT investment portfolio. Second, since the department does not have an executive investment review board, board members are not knowledgeable about creating a portfolio. In addition, information comparing the performance of IT investments against expectations is not currently being provided to the board because Treasury does not have one. Even though TIRB board selects IT investments based on data associated with the mix of new and ongoing major investments, this activity is not done for nonmajors, and there is not an executive investment review board to select the IT investments. Moreover, the executive investment board does not approve or modify the performance expectations of the selected IT investments. Unless Treasury defines and implements the practices for creating a comprehensive portfolio of IT, it will not be able to determine whether it has selected the mix of investments that best meets its needs and considers resource and funding constraints. Table 12 shows the rating for each key practice required to create a portfolio and summarizes the evidence that supports these ratings. This critical process builds on the Stage 2 critical process—Providing Investment Oversight—by adding the elements of portfolio performance to an organization’s investment control capacity. Compared with less mature organizations, Stage 3 organizations will have the foundation they need to control the risks faced by each investment and to deliver benefits that are linked to mission performance. In addition, a Stage 3 organization will have the benefit of performance data generated by Stage 2 processes. Executive-level oversight of risk management outcomes and incremental benefit accumulation provides the organization with increased assurance that each IT investment will achieve the desired results. (The complete list of key practices is provided in table 13.) Treasury is executing three of the seven key practices for this critical process by providing adequate resources for reviewing the portfolio, including the use of a portfolio tool that captures data on cost, schedule, and risk and is used to produce scorecards on a quarterly basis that summarizes portfolio data. The performance data are consolidated in the portfolio tool and used by TIRB. The CPIC staff is responsible for ensuring that the data are consistent with the portfolio performance criteria and that it is modified as needed. For example, based on OMB guidance, the department has added and modified criteria related to the Exhibit 300s, EA, and earned value management reporting requirements. In addition, Treasury uses the portfolio tool to collect portfolio performance data in a consistent manner that aligns with Treasury’s portfolio performance criteria. Despite these strengths, the department has yet to develop policies and procedures that address the review, evaluation, and improvement of its IT portfolio performance. In addition, TIRB members are not consistently provided with oversight review information for nonmajor IT investments by bureaus even though nonmajors make up about 70 percent of the department’s total number of projects. Also, while the department has a process in place for ensuring that adjustments are made to major investments in response to actual portfolio performance, it does not have a process in place to ensure that the bureaus make the necessary adjustments to their nonmajor investments on a consistent basis. Until Treasury executes all the key practices associated with this critical process, senior executives will not have the information they need to determine whether the investments they have selected are delivering mission value at the expected cost and risk. Table 13 shows the rating for each key practice required to implement the critical process for portfolio performance oversight at the Stage 3 level of maturity and summarizes the evidence that supports these ratings. The purpose of a PIR is to evaluate an investment after it has been completely developed (that is, after its transition from the implementation phase to the operations and maintenance phase) in order to validate actual investment results. This review is conducted to (1) examine differences between estimated and actual investment costs and benefits and possible ramifications for unplanned funding needs in the future and (2) extract “lessons learned” about the investment selection and control processes that can be used as the basis for management improvements. Similarly, PIRs should be conducted for investment projects that were terminated before completion, to readily identify potential management and process improvements. (The complete list of key practices is provided in table 14.) Treasury has executed two of the six key practices for conducting PIRs. According to officials, in fiscal year 2006, the department finished revising its PIR policies and procedures as part of the last phase of its CPIC process, the evaluate phase. The PIR guidance states that PIRs are to be conducted 6 to 18 months after the investment has been deployed (transitioned into the steady state life-cycle stage) or after the investment has rolled out major functionality. In addition, the department’s portfolio tool (PIR form) requires that reviews measure user satisfaction, achievement of strategic goals, and whether the investment met cost, schedule, and performance goals. The CPIC guidance also stipulates that project managers are responsible for conducting the reviews and collecting the information needed to document lessons learned, and who is responsible for approving the final PIR recommendations. Nevertheless, the department has not yet performed any PIRs since the CPIC policy was issued and therefore has not performed any of the activities associated with this critical process. Treasury officials stated that, since the issuance of their PIR policy, they have not conducted any PIRs because they have not had any investments transitioning from the development phase into the steady state phase. In 2005, the department conducted pilot PIRs on two major IT investments. Of the two, one review met its goals and the other review was recommended for a follow-up PIR because it was unable to provide information on customer satisfaction, benefits analysis, and systems performance due to schedule delays. Until PIRs are conducted on a regular basis with senior executive management involvement, Treasury will not be able to effectively evaluate the results of its IT investments to determine whether continuation, modification, or termination of an IT investment would be necessary in order to meet stated Treasury mission objectives. Table 14 shows the rating for each key practice required to conduct PIRs and summarizes the evidence that supports these ratings. Treasury Does Not Have a Comprehensive Plan to Guide Its Improvement Efforts We have previously reported that to effectively implement IT investments management processes, organizations need to be guided by a plan that (1) is based on an assessment of strengths and weaknesses; (2) specifies measurable goals, objectives, and milestones; (3) specifies needed resources; (4) assigns clear responsibility and accountability for accomplishing tasks; and (5) is approved by senior-level management. Such a plan is instrumental in helping agencies coordinate and guide improvement efforts. Treasury has initiated efforts to improve its investment management process. Treasury has contracted for a review of the CPIC governance process at each of its bureaus that entails performing portfolio investment validation and evaluation on the bureaus’ major investments. The reviews involve visiting the respective bureaus to verify key CPIC documentation, the health of their governance and investment processes, and their compliance with the department’s CPIC process. These reviews are to provide the department with a better understanding of the bureau’s processes and help the department identify opportunities for investment management improvements. The reviews also are to provide the department with greater confidence in the investment information being provided by the bureaus. In April 2007, Treasury issued an Internal Watch List that identifies major investments at risk of not meeting established goals. Among the criteria for placement on this list is cost or schedule variances greater than plus or minus 10 percent for two consecutive quarters. The department’s Office of the CIO is responsible for overseeing the Internal Watch List. Investments placed on this list are subject to additional reporting requirements, including development of an action plan to remediate the investment’s noncompliant conditions. Bureaus are to report on the status of their corrective actions to the CIO monthly. Once the corrective actions have been implemented and the CIO concurs, the investment may be removed from the list. According to officials, as of May 2007, bureaus were beginning to submit their corrective action plans to the CIO. The Internal Watch List process should improve project oversight by providing greater assurance that actions are taken to address deficiencies. Although Treasury has initiated these efforts, the department has not developed a comprehensive plan with the characteristics listed above that would help guide improvements to its investment management process. Treasury officials recognize the value of having a comprehensive plan and told us they plan to develop one once their new assistant secretary for management is confirmed; however, a time frame for completing the plan has not been established. Until Treasury develops this plan, the department risks not being able to put in place an effective management process that will provide appropriate executive-level oversight for minimizing risks and maximizing returns. Treasury CIO’s Role in Managing IT Investments Has Been Mixed The Clinger-Cohen Act, E-Government Act of 2002, and implementing guidance from OMB provide a number of investment management responsibilities to CIOs that generally entail working with the agency head and senior managers to define and implement processes for selecting, controlling, and evaluating investments. Our IT investment management framework defines practices that are consistent with these provisions. Because CIOs are to carry out their investment management functions with the support of an enterprisewide investment review board, many of the responsibilities we used to evaluate the Treasury CIO’s role relate to key practices discussed earlier in the report as part of our evaluation of the department’s investment management capabilities. The Treasury CIO’s role in managing the department’s IT investments has been mixed, although it has gradually increased since September 2005, when the department’s CPIC policy was issued. Many responsibilities have been fully performed, including responsibilities for establishing investment management policy, several associated with selecting investments, and some associated with controlling investments. Several responsibilities have been partially performed—including some associated with selecting investments, and others associated with controlling investments—either because the department has not extended them to nonmajor investments or because some activities have not yet been completed. A few responsibilities—most of them associated with controlling investments—have not yet been performed, primarily because they are just getting under way and have yet to produce results. Table 15 shows the CIO’s role in performing key investment management responsibilities. The CIO’s involvement in managing the department’s investments has strengthened the investment management process. For example, by regularly reviewing and modifying investment selection criteria, as appropriate, to reflect organizational objectives, the CIO, as Chair of the TIRB, has helped ensure investments supporting organizational goals are selected. However, several responsibilities have not been fully performed. For example, several responsibilities for selecting and controlling investments have not been performed for nonmajor investments. As discussed earlier in the report, Treasury officials stated they have not made the nonmajor investments a priority because they have instead chosen to devote their resources to the major investments, which represent about 80 percent of the department’s IT expenditures. As noted earlier, while it is reasonable to focus on the major investments, the nonmajor investments also require a certain level of oversight, given the significant amount of funding (about $480 million) and number of investments (160) involved. Because several responsibilities have not been fully performed, there is increased risk that investments will not be effectively managed. Conclusions Given the importance of IT to Treasury’s mission, it is vital that the department manage its investments effectively. To its credit, because of the attention that has recently been given to investment management, Treasury has established many of the practices needed to build the investment foundation and manage its projects as a portfolio and, as such, has made progress since we examined the department’s process as part of our governmentwide review 3 years ago. However, the absence of an executive investment review board actively engaged in the investment management process and the department’s limited involvement in the management of nonmajor investments are significant weaknesses that hamper the department’s ability to effectively manage its investments. As a result, the department cannot ensure that it is managing the mix of investments that will maximize returns to the organization, taking into account the appropriate level of risk. Critical to Treasury’s success going forward will be the development and implementation of a plan that (1) is based on the assessment of strengths and weaknesses identified in this report; (2) specifies measurable goals, objectives, and milestones; (3) specifies needed resources; (4) assigns clear responsibility and accountability for accomplishing tasks; and (5) is approved by senior management. Without such a plan and procedures for implementing it, it will be difficult for the department to maintain steady progress in improving its investment management process. As a result, Treasury will continue to be challenged in its ability to make informed and prudent investment decisions in managing its annual multibillion-dollar IT budget. By fully performing selected investment management responsibilities, the CIO has taken positive steps toward strengthening the department’s process for selecting, controlling, and evaluating investments. However, the department’s investments will continue to be at risk as long as there are responsibilities that are partially performed or not performed. Recommendations for Executive Action To strengthen Treasury’s investment management capability, we recommend that the Secretary of the Department of the Treasury direct the Assistant Secretary for Management, in collaboration with the CIO, to develop and implement a plan to address the following two actions: (1) Establish an executive investment review board, composed of executives representing IT and business units, that would be actively engaged in the investment management process. (2) Develop and implement policies and procedures to manage nonmajor investments. We also recommend that the plan include actions to address the weaknesses in eight critical processes identified in this report, beginning with those identified in our Stage 2 analysis and continuing with those identified in our Stage 3 analysis. The plan should, at a minimum, provide for fully implementing the following: instituting the investment board, selecting an investment, and providing investment oversight. defining the portfolio criteria, evaluating the portfolio, and conducting postimplementation reviews. In developing the plan, the Secretary of the Department of the Treasury should direct the Chief Information Officer to ensure that the plan draws together ongoing and additional efforts needed to address the weaknesses identified in this report, including those relating to the CIO’s role in performing investment management responsibilities. The plan should also (1) specify measurable goals, objectives, and milestones; (2) specify needed resources; (3) assign clear responsibility and accountability for accomplishing tasks; and (4) be approved by senior management. In implementing the plan, the Chief Information Officer should ensure that the resources are available to carry out the plan and that progress is measured and reported periodically to the Secretary of the Department of the Treasury. Agency Comments and Our Evaluation In e-mail comments on a draft of this report, the Acting CIO stated that the report reflects both Treasury’s shortcomings as well as progress to date and recognized the need to take proactive steps to strengthen its investment board operations and oversight of information technology resources and programs. Treasury also commented on the need for an executive review board, nonmajor investments, and the department’s authority to redirect funding from one Treasury bureau to another. Regarding the need for an executive investment review board, Treasury noted that, in addition to the Technical Investment Review Board chaired by the CIO, an E-Board consisting of Treasury executives previously existed. We acknowledge the establishment of these boards in our report but emphasize that there currently is no executive investment review board composed of executives from IT and business units that is actively engaged in the investment management process. The department recognizes this in its comments, stating that it agrees it needs to reconstitute its executive board such that it is actively engaged in the investment management process. Regarding nonmajor investments, Treasury commented that nonmajor investments have not been a priority because the major investments the department has chosen to devote its resources to represent the more significant portion of the portfolio in terms of dollar value, visibility to OMB and Congress, and importance to Treasury’s mission. We recognize the importance of the major investments in our report and acknowledge that it is reasonable to focus attention on these investments. Nevertheless, we maintain that nonmajor investments should require a certain level of oversight given the amount of funding involved (about $480 million in estimated expenditures for fiscal year 2007) and the fact that they represent the bulk of most bureaus investment portfolio. Treasury also stated that its CPIC guide contains guidance on managing nonmajor IT investments and that the department conducts quarterly control reviews of all IT investments, both major and nonmajor. While the guide requires all IT investments to comply with its provisions, it clearly states that the select phase described applies to major investments and that bureaus are responsible for conducting their own select process for nonmajor investments. In addition, while, as we note in the report, Treasury requires bureaus to report on the cost, schedule, and performance of its nonmajor investments on a quarterly basis, this information is not provided to TIRB for review. Treasury noted that it is currently developing guidance and reporting requirements for nonmajors that integrates enterprise architecture and capital planning. In its comments, Treasury also noted that the department’s ability to exercise effective management of its IT portfolio requires that the CIO (as chairman of the Technical Investment Review Board) be empowered to make recommendations to the executive board concerning IT budgetary requests across the department. Additionally, the executive board needs to be empowered to make decisions across organizational lines on behalf of the department. Treasury added that, currently, neither the Treasury Department, including the Acting CIO, nor the executive board has the prerogative (authority) to redirect IT funding from one Treasury bureau to another. While this particular authority was not the subject of our review, we agree that not having it could present a challenge to effectively managing the IT portfolio. Nevertheless, effective portfolio management requires the collective decisionmaking of executives from both IT and business units, which highlights the importance of having an executive investment review board that is actively engaged in the investment management process. We are sending copies of this report to the Chairmen and Ranking Minority Members of other Senate and House committees that have authorization and oversight responsibilities for Treasury and other interested congressional committees; the Director of the Office of Management and Budget; the Secretary of the Treasury; the Assistant Secretary for Management and Chief Financial Officer; and the Chief Information Officer. We also will make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-9286 or pownerd@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix II. Appendix I: Objectives, Scope, and Methodology The objectives of our review were to (1) assess the Department of the Treasury’s capabilities for managing its IT investments, (2) determine any plans Treasury might have for improving those capabilities, and (3) evaluate the CIO’s role in managing the department’s IT investments. To address our first objective, we reviewed the results of the department’s self-assessment of Stages 2 and 3 practices using our IT investment management framework and validated and updated the results of the self- assessment through document reviews and interviews with officials. We reviewed written policies, procedures, and guidance and other documentation providing evidence of executed practices, including Treasury’s Capital Planning and Investment Control Policy Guide, Earned Value Management Policy Guide, Exhibit 300 Scoring Guide, Alternative Analysis Policy Guide, FY06 IT Portfolio Alignment Summary, IT Modernization Blueprint Volume 2: IT Strategic Plan, portfolio management tool guidance, and various memorandums. We also reviewed TIRB and CIO Council meeting materials. In addition, we conducted interviews with officials from the Office of the CIO, whose main responsibility is to oversee and ensure that Treasury’s IT investment management process is implemented and followed. We compared the evidence collected from our document reviews and interviews to the key practices in ITIM. We rated the key practices as “executed” on the basis of whether the agency demonstrated (by providing evidence of performance) that it had met the criteria of the key practice. A key practice was rated as “not executed” when we found insufficient evidence of a practice during the review or when we determined that there were significant weaknesses in Treasury’s execution of the key practice. In addition, Treasury was provided with the opportunity to produce evidence for key practices rated as “not executed.” We did not assess progress in establishing the capabilities found in Stages 4 and 5 because the department acknowledged it had not executed the key practices in these higher maturity stages. To determine the level of guidance the department is providing to its bureaus, we interviewed officials and obtained written responses from the Bureau of the Public Debt, Financial Management Service, and the Internal Revenue Service (IRS) to determine the level of investment management guidance and oversight that is provided by the department. As part of our analysis, we selected one enterprisewide and three bureau-level IT projects as case studies to verify that the critical processes and key practices were being applied. The projects selected (1) are in different life- cycle phases, (2) represent a mix of headquarters and component bureau investments, (3) support different functional areas, and (4) required different levels of funding. The four projects are described as follows: 1. Customer Account Data Engine (CADE). The database initiative is the foundation for managing taxpayer accounts in IRS’s Business Systems Modernization effort. CADE is being incrementally designed, developed, and implemented to form the data foundation for a modernized IRS by replacing the Individual Master File and its related applications with new technology, new applications, and new databases. The system’s purpose is to enable IRS tax specialists to post transactions and update taxpayer account and return data using an online interface tool. Updates are to be available daily to authorized personnel who have access to this data, which provide a complete, timely, and accurate account of the individual taxpayer’s information. The project is a major investment and has an estimated life-cycle cost of over $1.3 billion. 2. Savings Bond Replacement System (SaBRe). SaBRe supports two of the President’s Management Agenda initiatives: financial performance and expanded e-government. It processes cash and security transactions that result when accrued savings bonds are sold or redeemed by Federal Reserve Bank processing sites or by financial institutions and corporate entities designated as fiscal agents. Federal Reserve Bank processing sites consolidate and report to SaBRe daily issue and retirement transactions generated by processing cash and security transactions. SaBRe processes the transactions, updates electronic records that are used for customer service, and reports daily financial transactions for inclusion in the Daily Treasury Statement. The project is a major investment and has an estimated life-cycle cost of over $57 million. 3. Treasury Receivable, Accounting, and Collection System (TRACS). TRACS is to provide Treasury’s Financial Management Service with a tool for supporting its Payment Business Line for the accounting, debt billing, collection, and reporting requirements associated with Treasury’s check claims business process. It is to aid in the processing of check claims accounting, authorization of payments, issuing of bills, debt collection, and funds transfers from and to federal program agencies. Currently all funding for TRACS will be used to maintain and enhance the system. The project is a nonmajor investment and has an estimated life-cycle cost of over $11 million through fiscal year 2012. 4. Treasury Foreign Intelligence Network (TFIN). TFIN exists to assist Treasury analysts in their ongoing efforts to provide meaningful intelligence to senior Treasury management as well as to other agencies within the intelligence community. It was originally built as a customized in-house network over 10 years ago. In early fiscal year 2005, Treasury identified a need to modernize TFIN due to the age of the system, outdated components, and performance issues, and to address Treasury’s expanding mission in the fight against terrorism. The system is currently listed as a major department-level development, modernization, and enhancement effort, with total estimated life-cycle costs of $43 million. For these projects, we reviewed project management documentation, such as project plans, and status reports. We also obtained investment information from the bureau officials responsible for managing the projects. To address our second objective, we obtained and evaluated documents showing what management actions had been taken and what initiatives had been planned by the agency. This documentation included the IT Modernization Blueprint Volume 2, IT Strategic Plan, The Department of the Treasury’s Strategic Plan, and a contractor work request for an independent validation and verification of Treasury’s capital planning program support process. We also interviewed officials from the Office of the CIO to determine efforts undertaken to improve IT investment management processes. To address our third objective, we reviewed legislation, including the Clinger-Cohen Act of 1996 and the E-Government Act of 2002, and OMB guidance to determine the roles and responsibilities of CIOs regarding investment management. We also reviewed the practices laid out in GAO’s IT investment management framework. We reviewed documentation and conducted interviews with Treasury officials, including the Associate CIO for Capital Planning and Information Management, to determine the extent of the CIO’s involvement in selecting, controlling, and evaluating the department’s IT investments. We conducted our work at Treasury headquarters in Washington, D.C., from August 2006 through July 2007 in accordance with generally accepted government auditing standards. Appendix II: GAO Contact and Staff Acknowledgments Staff Acknowledgments In addition to the contact named above, Sabine Paul, Assistant Director; William Barrick; Camille Chaires; Neil Doherty; Nancy Glover; and Tomas Ramirez; made key contributions to this report.

The Department of the Treasury relies extensively on information technology (IT) to carry out its mission. For fiscal year 2007, Treasury requested about $2.8 billion--the third largest planned IT expenditure among civilian agencies. GAO's objectives included (1) assessing Treasury's capabilities for managing its IT investments and (2) determining any plans the agency has for improving its capabilities. GAO used its IT investment management framework (ITIM) and associated methodology to address these objectives, focusing on the framework's stages related to the investment management provisions of the Clinger-Cohen Act of 1996. While Treasury has established many of the capabilities needed to select, control, and evaluate its IT investments, the department has significant weaknesses that hamper its ability to effectively manage its investments. Specifically, the department has executed 19 of the 38 key practices that the ITIM requires to build a foundation for IT investment management (Stage 2), including practices needed to ensure that projects support business needs and that a disciplined process exists for capturing investment information. In addition, the department has executed 11 of the 27 key practices required to manage investments as a portfolio (Stage 3), including documenting policies and procedures for conducting postimplementation reviews. However, Treasury does not have an executive investment review board--a group of executives from IT and business units that is intended to be the final decision-making authority--that is actively engaged in the investment management process. In addition, the department does not have any policies and procedures for managing its nonmajor investments, although they represent almost 70 percent of the total number of investments. Until the department addresses these weaknesses, it will not have the investment management structure needed to effectively assess and manage the risks associated with its multibillion-dollar portfolio. To its credit, Treasury has initiated efforts to improve its investment management process. For example, it has recently implemented a process for identifying major projects that should receive additional oversight. However, the department has not developed a comprehensive improvement plan that (1) is based on an assessment of strengths and weaknesses; (2) specifies measurable goals, objectives, and milestones; (3) specifies needed resources; (4) assigns clear responsibility and accountability for accomplishing tasks; and (5) is approved by senior-level management. GAO has previously reported that such a plan is instrumental in helping agencies coordinate and guide improvement efforts. Until Treasury develops this plan and the controls for implementing it, the department risks not being able to put in place an effective management process that will provide appropriate executive-level oversight for minimizing risks and maximizing returns.

Background In the 21st century the nation faces a growing fiscal imbalance. A demographic shift will begin to affect the federal budget in 2008 as the first baby boomers become eligible for Social Security benefits. This shift will increase as spending for federal health and retirement programs swells. Long-term commitments for these and other federal programs will drive a massive imbalance between spending and revenues that cannot be eliminated without tough choices and significant policy changes. Over the past several years, GAO has called attention to this problem. Long-term budget simulations by GAO, the Congressional Budget Office (CBO), and others illustrate the growing fiscal imbalance. (See fig. 1.) Continued economic growth is critical to addressing this challenge and will help to ease the burden, but the projected fiscal gap is so great that it is unrealistic to expect that the United States will grow its way out of the problem. Early action to change existing programs and policies would yield the highest fiscal dividends and provide a longer period for prospective beneficiaries to make adjustments in their own planning. One of the potential policy changes that could address both the demographic shift and the need for robust economic growth is assisting older workers who want to stay in the workforce past retirement age. These demographic problems are not unique to the United States. Other countries are also confronting the economic and labor force consequences of aging populations. In fact, the challenges arising from these demographic shifts alone will be less pronounced in the United States than in several other high-income nations. In prior work that we conducted for this committee, we found that Sweden, Japan, and the United Kingdom had enacted retirement policy reforms that included incentives for older workers to extend their working lives. At the same time, these countries were also seeking policies that would reduce barriers to employment for older workers. Economic and Demographic Trends Call For Policies Encouraging Longer Working Lives In the 21st century, older Americans are expected to represent a growing share of the population, have a longer life expectancy than previous generations and spend more years in retirement. The baby boom generation is fast approaching retirement age; the oldest baby boomers will start to turn 65 in 2011, just 6 years from now. In addition, life expectancy is increasing. The average life expectancy at age 65 for men has increased from just over 13 years in 1970 to 16 years in 2005, and is projected to increase to 17 years by 2020. Women have experienced a similar rise--from 17 years in 1970 to over 19 years in 2005. Women’s life expectancy at age 65 is projected to be 20 years by 2020. (See fig. 2.) As a consequence of life expectancy increases, individuals are generally spending more years in retirement. The average male worker spent 18 years in retirement in 2003, up from less than 12 years in 1950. A lower fertility rate is the other principal factor underlying the growth in the elderly’s share of the population. In the 1960s, the fertility rate was an average of three children per woman. Since the 1970s, the fertility rate has hovered around two children per woman. This decline in the fertility rate is a major factor in the slowing growth of the labor force over the last decade, a trend that is expected to continue. By 2025 labor force growth is expected to be less than a fifth of what it is today, as shown in figure 3. As a result of these trends, the share of the population aged 65 and older is projected to increase from 12 percent in 2000 to almost 20 percent in 2030. These developments will lead to significant changes in the elderly dependency ratio--the estimated proportion of people aged 65 and over to those of working age. In 1950, there was one elderly person for every 7 workers. The ratio increased to 1 to 5 in 2000 and is projected to rise to 1 to 3 by 2050. (See fig. 4.) These demographic developments have real implications for the nation’s economy. If labor force growth continues to decline as projected, relatively fewer workers will be available to produce goods and services. Without a major increase in productivity or higher than projected immigration, low labor force growth will lead to slower growth in the economy and to slower growth of federal revenues. This in turn will accentuate the overall pressure on the federal budget. Another concern is the possible loss of many experienced workers as the baby boomers retire. This could create gaps in skilled worker and managerial occupations, leading to further adverse effects on productivity and economic growth. Though long-term trends in labor force growth present significant challenges, there is some reason for optimism. In recent years, the labor force participation rate of men over age 55 has increased, and it is projected to continue to increase in the future. After hitting a low point of approximately 65 percent in 1994, the rate for this group rose to more than 69 percent in 2002, and the Bureau of Labor Statistics (BLS) projects it will be almost 70 percent in 2012. For men 65 and older, the rate also increased, to about 19 percent, and is projected to rise to nearly 21 percent by 2012. Similarly, the labor force participation rate of women over 55 has continued to increase. For women 55 to 64, the rate rose to more than 56 percent by 2004 and is projected to grow to over 60 percent by 2012. (See fig. 5.) These recent increases in labor force participation by older workers are encouraging. If Americans increase the number of years they work it could ease pressure on government retirement programs by increasing revenues to the Social Security and Medicare trust funds. In addition, individuals can significantly improve their standard of living in retirement. By remaining in the labor force, workers continue to earn income and delay drawing down assets such as pensions and personal savings, resulting in a shorter period over which they have to budget their resources. Some researchers have found that delaying retirement can substantially increase annual income in retirement. For example, they found that postponing retirement from age 55 to age 65 could nearly double real annual income at age 75. Many Factors Influence Workers’ Retirement and Employment Decisions Although some people can benefit by remaining in the labor force at later ages, others may be unable or unwilling to do so. For those who are able, there are many factors that influence their choices. These include the eligibility rules of both employer pension plans and Social Security, an individual’s health status, the need for health insurance, personal preference, and the employment status of a spouse. The availability of suitable employment, including part-time work or flexible work arrangements, may also affect the retirement and employment choices of older workers. Eligibility Rules Depending on the eligibility rules and schedule of benefits, it can sometimes be more advantageous for workers to retire than to continue employment. The eligibility age for full Social Security benefits is currently 65 years and 6 months and rising, with reduced benefits available at age 62. Data from 2002 show that a majority of people (56.1 percent) elect to start benefits at age 62. Another important retirement incentive is eligibility for employer-provided pension benefits. In the United States, less than half of the labor force has some type of employer-provided pension coverage. In some cases the rules governing these plans create incentives to retire, even for those who may prefer to continue working. Health Status Health status and occupation are other key factors that influence the decision to work at older ages. As people age, they tend to encounter more health problems that make it more difficult to continue working or to work full-time. Thus, jobs that are physically demanding, usually found in the blue-collar and service sectors of the economy, can be difficult for many people to perform at older ages. Moreover, health status and occupation are often interrelated since health can be affected by work environment. Although blue-collar and service sector workers may continue to face significant health problems, there is evidence that the health of older persons generally is improving. Research has shown that the majority of workers aged 62 to 67 do not appear to have health limitations that would prevent them from extending their careers, although some could face severe challenges in attempting to remain in the workforce. In general, however, today’s older population may have an increased capacity to work compared with that of previous generations. Health Insurance Rising health care costs have made the availability of health insurance and anticipated medical expenditures important factors in the decision to retire. As health care costs continue to rise, many employers have decided to discontinue their retiree health benefits. A recent study estimated that the percentage of after-tax income spent on health care will approximately double for older married couples and singles by 2030. People at the lower end of the income distribution will be the most adversely affected. The study projected that by 2030 those in the bottom 20 percent of the income distribution would spend more than 50 percent of their after-tax income on insurance premiums and health care expenses, an increase of 30 percentage points from 2000. Continued employment could provide older workers with more income to help finance health care and in some cases could provide them with employer-sponsored health insurance. However, those least able to work at older ages may also be those with higher health care expenses. Personal Preference Researchers have also found that some older workers choose to remain in the labor force for reasons of physical and mental well-being. In recent surveys by AARP, Watson Wyatt, and the Employee Benefit Research Institute (EBRI), older workers and retirees indicated that, in addition to financial considerations, enjoyment of work and a desire to stay active were important reasons to decide to work in retirement. For example, in the 2004 Retirement Confidence Survey done by EBRI, retirees most often said they worked for pay because they enjoyed working and wanted to stay involved (66 percent); yet a large majority also identify at least one financial reason for having worked (81 percent). Spouse In addition, the labor force status of a spouse affects the retirement decision of an older worker. A recent study found that older married couples tend to retire at the same time. Another study which analyzed the retirement behavior of married men and women separately found that men were more likely to retire if their wife was also retired, but women were not significantly affected by the labor force status of their husbands. Alternative Work Arrangements The labor force decisions of older persons are also influenced by the availability of alternatives to full-time employment. In the United States, there has been interest among older workers who wish to work longer in seeking employment arrangements that allow them to work part-time in retirement. We define partial retirement as a reduction in hours from full-time to part-time work. A partial retiree may have transitioned directly from full- to part-time work at either a current or a new job, or may have returned to work after full retirement. Although surveys indicate that many older workers would like to partially retire, prior GAO work found that offering such options is not a widespread practice among private employers and does not involve large numbers of workers at individual firms. Employment Opportunities Labor force participation is not solely the workers’ decision—there must also be an effective demand for their labor. Employers’ perceptions or biases against older workers may form potential barriers to older workers’ retaining their current jobs, finding new jobs, or reentering the work force after retiring. For example, employers may feel that it is more difficult to recoup the costs of hiring and training older workers. All other things being equal, older workers can also raise an employer’s cost of providing health insurance. Older workers may also face an obstacle because of a negative perception among employers about their productivity. Although the Age Discrimination in Employment Act protects those age 40 and over from age-based discrimination in the workplace, complaints to the Equal Employment Opportunity Commission suggest that such discrimination does still occur. Conclusions To the extent that people choose to work longer as they live longer, the increase in the amount of time spent in retirement could be diminished. By staying in the workforce, older workers could ease financial pressures on Social Security and Medicare, as well as mitigate the expected slowdown in labor force growth. The additional income from earnings also could provide older Americans with greater resources in retirement and improve their financial security. Many older Americans are both willing and able to continue working at older ages. As described above, increased labor force participation of older workers would benefit both the economy and individuals. Thus, it is important to (1) encourage more widespread availability of flexible employment arrangements, such as partial retirement, which would make it easier for older workers to continue working, and (2) remove incentives that may induce older workers, who would otherwise choose to continue working, to retire. For those older Americans who are able to work, policies, programs, and alternative employment arrangements that help to extend their working life can enhance future supplies of skilled workers, bolster economic growth, and help many people secure adequate retirement income. We at GAO look forward to continuing to work with this Committee and the Congress in addressing this and other important issues facing our nation. Mr. Chairman, Mr. Kohl, members of the Committee, that concludes my statement. I’d be happy to answer any questions you may have. GAO Contacts and Staff Acknowledgments For further information regarding this testimony, please contact Barbara D. Bovbjerg, Director,or Alicia Puente Cackley, Assistant Director, at (202) 512-7215. Other individuals making key contributions to this testimony included Mindy Bowman, Sharon Hermes, and Kristy Kennedy. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

In the 21st century our nation faces a growing fiscal imbalance. A demographic shift will begin to affect the federal budget in 2008 as the first baby boomers become eligible for Social Security benefits. This shift will increase as spending for federal health and retirement programs swells. Long-term commitments for these and other federal programs will drive a massive imbalance between spending and revenues that cannot be eliminated without tough choices and significant policy changes. Continued economic growth is critical and will help to ease the burden, but the projected fiscal gap is so great that it is unrealistic to expect that we will grow our way out of the problem. Early action to change existing programs and policies would yield the highest fiscal dividends and provide a longer period for prospective beneficiaries to make adjustments in their own planning. One of the potential policy changes is assisting older workers who want to stay in the workforce past retirement age. The Chairman and Ranking Member of the Senate Special Committee on Aging asked GAO to discuss demographic and labor force trends and the economic and fiscal need to increase labor force participation among older workers. This testimony will address those factors making it important to encourage those who want to work to continue doing so, as well as factors affecting older Americans' employment decisions. The aging of the baby boom generation (those born between 1946 and 1964), increased life expectancy, and falling fertility rates pose serious challenges for our nation. These trends will affect the size and productivity of the U.S. labor force and its output and will have real and important impacts on employers and the economy. With the impending retirement of the baby boom generation, employers face the loss of many experienced workers and possibly skill gaps in certain occupations. This could have adverse effects on productivity and economic growth. Furthermore, the expected increasing ratio of the elderly to those of working ages will place added pressure on Social Security and Medicare, both of which face long-term financial problems. Increasing the labor force by encouraging Americans to work longer may be one part of solutions to these problems. Although some people can benefit by remaining in the labor force at later ages, others may be unable or unwilling to do so. For those who are able, there are many factors that influence their choices. These include the eligibility rules of both employer pension plans and Social Security, an individual's health status, the need for health insurance, personal preference, and the employment status of a spouse. The availability of suitable employment, including part-time work or flexible work arrangements, may also affect the retirement and employment choices of older workers.

Declining Mail Volume and Growing Expenses Contribute to USPS’s Deteriorating Financial Condition After about 30 years of relatively steady growth, USPS’s expenses began consistently exceeding revenues in fiscal year 2007—a trend that has continued through fiscal year 2016 (see fig. 1). As a result, USPS has lost a total of $62.4 billion since fiscal year 2007. As we testified last year, the continued deterioration in USPS’s financial condition is due primarily to two factors. 1. Declining First-Class Mail volumes: The long-term decline of First- Class Mail volume, which USPS expects to continue for the foreseeable future, has fundamental implications for USPS’s business model because this remains USPS’s most profitable class of mail. Domestic First-Class Mail volume declined by 2 percent in fiscal year 2016 from the previous fiscal year to 61 billion pieces—a level 41 percent below its peak in fiscal year 2001, and the smallest level since fiscal year 1981 (see fig. 2). USPS recently reported that First-Class Mail volume is declining as major commercial mailers actively promote the use of online services, and although the rate of decline has slowed, will continue to decline in future years with the migration to electronic alternatives resulting from technological changes. In the long run, USPS also faces the possibility of a future economic downturn that could have an additional impact on First-Class Mail volume. 2. Growing Expenses: USPS expenses increased by $3.1 billion in fiscal year 2016 from the previous year, outpacing the $2.6 billion increase in revenues. Increasing compensation and benefits expenses were a key driver of expense growth. USPS reported that compensation and benefits for active employees increased by $1.2 billion, due to contractually obligated salary escalations and additional work hours associated in large part with growth in the more labor-intensive Shipping and Packages business. In this regard, USPS reported a 14 percent growth in Shipping and Packages volume in fiscal year 2016. However, to accommodate the surge in this volume and to minimize service disruptions during the holiday season, USPS reported increasing Sunday delivery service and adding non-career employees for the holiday season. This contributed to growth in USPS work hours in fiscal year 2016 from the previous year, when the number of USPS career employees increased by 17,000 and the number of non-career employees increased by 1,000. Over the past 3 years, the size of USPS’s total workforce has increased by about 22,000, including career and non-career employees; this growth contrasts with the trend from fiscal years 1999 through 2013, when the workforce decreased by more than 288,000 (see fig. 3). Compensation and benefits comprise close to 80 percent of total USPS expenses. Thus, expenses will continue to grow if increases in salaries and work hours continue. As previously discussed, USPS’s unfunded liabilities and debt have become a large financial burden, increasing from 99 percent of USPS revenues at the end of fiscal year 2007 to 169 percent of revenues at the end of fiscal year 2016. These unfunded liabilities and debt—totaling about $121 billion at the end of fiscal year 2016—consist mostly of retiree health and pension benefit obligations for which USPS has not set aside sufficient funds to cover. When the Postal Accountability and Enhancement Act (PAEA) established the Postal Service Retiree Health Benefits Fund, it required USPS to begin prefunding health benefits for its current and future postal retirees, with annual payments of $5.4 billion to $5.8 billion from fiscal years 2007 through 2016, followed by actuarially determined prefunding payments beginning in 2017 and every year thereafter. As of the end of fiscal year 2016, USPS’s liability for retiree health benefits was about $104.0 billion and the Postal Service Retiree Health Benefits Fund balance was $51.9 billion, with a resulting unfunded liability of $52.1 billion. USPS has missed a total of $33.9 billion in required prefunding payments, which represent about half of its total losses since fiscal year 2007. However, USPS would have still lost $10.6 billion during this time period even without the annual prefunding requirement. USPS Will Remain Unlikely to Fully Make Required Retiree Health and Pension Payments USPS will remain unlikely to fully make its required retiree health and pension payments in the near future. Beginning this fiscal year (2017), USPS is no longer required to make fixed prefunding payments. Instead, under the requirements established by PAEA, it is required to start making annual payments based on actuarial determinations of the following component costs: a 40-year amortization schedule to address the unfunded liabilities for postal retiree health benefits, the “normal costs” of retiree health benefits for current employees, and a 27-year amortization schedule to address the unfunded liabilities for postal pension benefits under the Civil Service Retirement System (CSRS). These payments are in addition to annual payments USPS is already required to make to finance its pension benefits under the Federal Employees Retirement System (FERS), which consists of a 30-year amortization schedule to address any unfunded liabilities, and the normal costs of FERS benefits for current employees. USPS will find it very difficult to make all of these required payments given its financial condition and outlook. As table 1 below shows, in fiscal year 2017, USPS will be required to make an estimated total of $10.3 billion in payments for retiree health and pension benefits under CSRS and FERS—about $3.3 billion more than what USPS paid in fiscal year 2016 for these benefit programs. In addition to declining mail volumes and increased expenses, USPS’s ability to make its required payments for these retirement programs will be further challenged due to: Expiration of a temporary rate surcharge: USPS has reported that the April 2016 expiration of a 4.3 percent “exigent” surcharge that began in January 2014 is reducing its revenues by almost $2 billion annually. No new major cost-savings initiatives planned: USPS has made efforts in recent years to right-size its operations to better adapt to declining mail volumes that are adversely affecting its financial position. For example, in fiscal year 2015, USPS reduced the hours of over 13,000 post offices to better match retail service with demand and reduced its physical footprint by consolidating 36 mail processing facilities, and instituted operational changes to better utilize resources. However, USPS has no current plans to initiate new major initiatives to achieve cost savings in its operations. According to USPS, it will continue to implement operational initiatives to contain costs and take actions to maintain liquidity, but as we testified last year, such actions will not be enough to stave off future losses and stabilize its finances. Although USPS has faced stakeholder resistance to its right- sizing efforts, in the absence of such efforts, USPS will continue to face challenges to appropriately match resources with mail volume and help address its compensation and benefits costs. USPS has reported that without structural change to its business model and legislative change, it expects continuing losses and liquidity challenges for the foreseeable future. According to USPS, it has maintained adequate liquidity only by not making required payments to prefund retiree health benefits and deferring needed capital investments. Looking forward, USPS has reported that, if circumstances leave it with insufficient cash, it may prioritize payments to its employees and suppliers ahead of some payments to the federal government, as it has done in the past. Large unfunded liabilities for postal retiree health and pension benefits— which were $73.4 billion at the end of fiscal year 2016—may ultimately place taxpayers, USPS employees, retirees and their beneficiaries, and USPS itself at risk. As we have previously reported, funded benefits protect the future viability of an enterprise such as USPS by not saddling it with bills after employees have retired. Further, since USPS retirees participate in the same health and pension benefit programs as other federal retirees, if USPS ultimately does not adequately fund these benefits and if Congress wants these benefits to be maintained at current levels, funding from the U.S. Treasury, and hence the taxpayer, would be needed to continue the benefit levels. According to USPS’s testimony last year, “absent fundamental legislative reform, we face the prospect of having to continue to default on these prefunding payments [for retiree health benefits] in order to continue paying our employees and suppliers and to provide postal services to the American public. This increases the risk that taxpayers may ultimately be called on to fund these benefits.” Alternatively, unfunded benefits could lead to pressure for reductions in benefits or in pay. Thus, the timely funding of benefits protects USPS employees, retirees and their beneficiaries, taxpayers, and the USPS enterprise. Congress Faces Difficult Choices to Address USPS’s Financial Condition USPS’s financial situation leaves Congress with difficult choices and trade-offs to achieve the broad-based restructuring that will be necessary for USPS to become financially sustainable. USPS’s ability to make its required retiree health and pension payments requires a decrease in expenses or increase in revenues, or both. Although USPS needs to take further action to reduce costs and increase revenues, USPS’s actions alone under its existing authority will be insufficient to achieve sustainable financial viability; comprehensive legislation will be needed. Congressional decisions about how to address the following issues will shape USPS’s future role, services, operations, networks, and ability to adapt to changes in mail volume. In making these decisions, Congress could consider, among other things, the following factors: The level of postal services and the affordability of those services: USPS’s growing financial difficulties combined with vast changes in how people communicate provide Congress with an opportunity to consider what postal services will be needed in the 21st century. Specifically, Congress could consider what postal services should be provided on a universal basis to meet customer needs and how these services should be provided. Congress also could consider trade-offs in reducing the level of postal services, such as providing USPS with the authority to reduce the frequency of letter mail delivery to enable USPS to reduce its expenses. A key factor in any consideration to reduce postal services would include potential effects on postal customers, mail volumes, and employees. In particular, Congress could consider the quality of postal service—such as the frequency and speed of mail delivery and the accessibility and scope of retail postal services—in considering any service reduction. For example, as part of its efforts to reduce excess capacity, in January 2015 USPS revised its standards for on-time mail delivery by increasing the number of days for some mail to be delivered and still be considered on time. Even with the revised standards, on-time delivery performance declined significantly, particularly for the second quarter of fiscal year 2015, a decline USPS attributed to operational changes implemented in January 2015 and adverse winter weather. Performance has rebounded since then, facilitated in part by increases in workforce and mail transportation capacity and costs. Compensation and benefits in an environment of revenue pressures: Key compensation and benefits costs for USPS employees have increased and continue to increase, while the volume for First-Class Mail—USPS’s most profitable product—has declined and continues to decline. To put USPS’s situation into context, many private sector companies (such as automobile companies, airlines, mail preparation and printing companies, and major newspapers) took far-reaching measures to cut costs (such as reducing or stabilizing workforce, salaries, and benefits) when demand for their central product and services declined. However, although USPS has taken some steps to improve its financial situation, USPS has stated that its strategies to increase efficiency and reduce costs are constrained by statutory, contractual, regulatory, and political restrictions. USPS is subject to requirements to maintain 6-day delivery, limit rate increases for most mail within an inflation-based price cap, and participate in federal benefit programs. Most USPS employees are covered by collective bargaining agreements with four major labor unions which have established salary increases, cost-of-living adjustments, and the percentage of health insurance premiums paid by employees and USPS. When USPS and its unions are unable to agree, the parties are required to enter into binding arbitration by a third-party panel. There is no statutory requirement for USPS’s financial condition to be considered in arbitration. Considering USPS’s unsustainable financial condition and the competitive environment, we continue to believe— as we reported in 2010—that Congress should consider revising the statutory framework for collective bargaining to ensure that USPS’s financial condition be considered in binding arbitration. USPS’s dual role of providing affordable universal service while remaining self-financing: As an independent establishment of the executive branch, USPS has long been expected to provide affordable, quality, and universal delivery service to all parts of the country while remaining self-financing. USPS and other stakeholders have considered a range of different business models to address USPS’s financial difficulties. For example, USPS’s 2002 Transformation Plan included a range of alternatives from a publicly supported model to a business model with a corporate structure supported by shareholders. Any alternative business model would need to address the level of any costs that would be transferred from USPS, which is financed by postal ratepayers, to the federal government, which is funded by taxpayers. In addition, if Congress requires eligible postal retirees to participate in Medicare, as USPS has previously proposed, it should consider the tradeoffs for the federal budget deficit and Medicare’s financial condition, as well as the implications for affected employees. Finally, a fully functioning USPS Board of Governors is needed to support USPS’s ability to carry out its critical responsibilities, as certain powers are reserved to the nine presidentially-appointed Governors who must be confirmed by the Senate. Because the last serving Governor left the Board in December 2016 due to term limits, the 11-member Board currently consists of only the Postmaster General and the Deputy Postmaster General. According to USPS, the critical responsibilities reserved to the Governors include setting postal prices, approving new products, and appointing or removing the Postmaster General and the Deputy Postmaster General. USPS stated last year that, in the event no Governors are in place, these critical duties may not be able to be executed, potentially leaving USPS without the ability to adjust its prices as needed, introduce new products, or appoint or replace its two most senior executive officers. Conclusion USPS management, unions, the public, community leaders, and Members of Congress need to take a hard look at what level of postal services residents and businesses need and can afford. The status quo is not sustainable. Chairman Chaffetz, Ranking Member Cummings, and Members of the Committee, this concludes my prepared statement. I would be pleased to answer any questions that you may have at this time. GAO Contact and Key Acknowledgments For further information about this statement, please contact Lori Rectanus, Director, Physical Infrastructure Issues, at (202) 512-2834 or rectanusl@gao.gov. Contact points for our Congressional Relations and Public Affairs offices may be found on the last page of this statement. In addition to the contact named above, Frank Todisco, Chief Actuary, FSA, MAAA, EA, Applied Research and Methods; Derrick Collins, Assistant Director, Physical Infrastructure Issues; Samer Abbas; Antoine Clark; Kenneth John; Josh Ormond; Crystal Wesco; and Chad Williams made important contributions to this statement. Mr. Todisco meets the qualification standards of the American Academy of Actuaries to render the actuarial opinions contained in this testimony. Appendix I: U.S. Postal Service (USPS) Financial Obligations and Related Information Selected USPS liabilities (included and Pension Funds (not fully on USPS balance sheet) included on USPS balance sheet) Funded status for FERS (unfunded) Funded status for retiree health benefits (unfunded) Funded status for CSRS (unfunded) Unfunded obligations, liabilities, and debt as percentage of revenue 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 (12.7) (55.0) (3.1) (12.5) (53.5) (9.0) (13.2) (52.0) (7.3) (13.6) (48.6) (14.2) (46.2) (17.8) (13.7) (47.8) (18.8) (12.5) (48.3) (17.8) (0.1) (12.5) (48.9) (19.4) (3.6) (12.5) (54.8) (16.7) (3.8) (12.3) (52.1) (17.5) (3.8) Total USPS liabilities, debt, and unfunded obligations (74.3) (83.7) (85.9) (74.3) (103.7) (112.1) (110.9) (117.8) (121.6) (120.7) attributed to past service; these liabilities reflect all such projected future costs for current retirees and beneficiaries and a portion of such projected future costs (in excess of worker contributions) for current workers. Unfunded obligations, liabilities, and debt are the sum of the unfunded actuarial liabilities (obligations), USPS liabilities, and debt shown in this table. Total USPS revenue consists of total USPS operating revenue plus interest and investment income for each fiscal year. Total assets consist of current assets including cash and noncurrent assets largely comprising property and equipment measured at historic purchase value after depreciation. This does not include assets funding the retiree health and pension benefits. 2007 2008 2009 2010 2011 2012 2013 2014 2015 Projected 2016 Net CSRS funded Status (unfunded) (3.1) Total pension funded status (unfunded) (9.0) (7.3) (17.8) (18.8) (17.8) (0.1) (19.4) (3.6) (16.7) (3.8) (17.5) (3.8) 5.3 (2.5) (0.4) 12.5 (15.2) (17.9) (17.9) (23.0) (20.5) (21.3) (52.0) (48.6) (46.2) (47.9) (48.3) (48.9) (54.8) (52.1) Total

USPS is a critical part of the nation's communication and commerce, delivering 154 billion pieces of mail in fiscal year 2016 to 156 million delivery points. However, USPS's mission of providing prompt, reliable and efficient universal services to the public is at risk due to its poor financial condition. USPS's net loss was $5.6 billion in fiscal year 2016, its tenth consecutive year of net losses. At the end of fiscal year 2016, USPS had $121 billion in unfunded liabilities, mostly for retiree health and pensions, and debt—an amount equal to 169 percent of USPS's revenues. In July 2009, GAO added USPS's financial condition to its list of high-risk areas needing attention by Congress and the executive branch. USPS's financial condition remains on GAO's High-Risk List. In previous reports, GAO has identified strategies and options for USPS to generate revenue, reduce costs, increase the efficiency of its delivery operations, and restructure the funding of USPS pension and retiree health benefits. GAO has also previously reported that a comprehensive package of actions is needed to improve USPS's financial viability. This testimony discusses (1) factors affecting USPS's deteriorating financial condition, (2) USPS's ability to make required retiree health and pension payments, and (3) considerations and choices Congress faces in addressing USPS's financial challenges. This testimony is based primarily on past GAO work that has examined USPS's financial condition—including its liabilities—and updated USPS financial information for fiscal years 2016 and 2017. The U.S. Postal Service's (USPS) deteriorating financial condition is unsustainable as a result of trends including: Declining mail volume : First-Class Mail—USPS's most profitable product—continues to decline in volume as communications and payments migrate to electronic alternatives. USPS expects this decline to continue for the foreseeable future. Growing expenses: Key USPS expenses such as salary increases and work hours continue to grow, due in part to growth in shipping and packages, which are more labor-intensive. Compensation and benefits comprise close to 80 percent of USPS's expenses. USPS's financial condition makes it unlikely it will be able to fully make its required retiree health and pension payments in the near future. In fiscal year 2016, when USPS was required to make $13.0 billion in retiree health and pension payments, it made $7.0 billion in payments—mainly due to not making a required retiree health payment of $5.8 billion. USPS's required payments have been restructured for fiscal year 2017 and are estimated to total $10.3 billion. USPS's ability to make these 2017 payments will be further challenged due to: Expiration of a temporary “exigent” rate surcharge: USPS has said the April 2016 surcharge expiration is reducing its revenues almost $2 billion annually. No new major cost savings initiatives planned: USPS made efforts in recent years to right-size its operations, but has no current plans to initiate major new initiatives to achieve cost savings in its operations. Large unfunded liabilities for postal retiree health and pension benefits—which were $73.4 billion at the end of fiscal year 2016—may ultimately place taxpayers, USPS employees, retirees and their beneficiaries, and USPS itself at risk. As GAO has previously reported, funded benefits protect the future viability of an enterprise such as USPS by not saddling it with bills after employees have retired. Further, with USPS retirees participating in the same health and pension benefit programs as other federal retirees, if USPS ultimately does not adequately fund these benefits and if Congress wants these benefits to be maintained at current levels, funding from the U.S. Treasury—and hence the taxpayer—would be needed to maintain the benefit levels. Alternatively, unfunded benefits could lead to pressure for reductions in USPS benefits or pay. Congress faces difficult choices and tradeoffs to address USPS's financial challenges. The status quo is not sustainable. Considerations for Congress include the (1) level of postal services provided to the public and the affordability of those services, (2) compensation and benefits for USPS employees and retirees in an environment of revenue pressures, and (3) tension between USPS's dual roles as an independent establishment of the executive branch required to provide universal delivery service and as a self-financing entity operating in a business-like manner.

Background The U.S. military has long used contractors to provide supplies and services to deployed U.S. forces, and more recently contractors have been involved in every major military operation since the 1991 Gulf War. However, the scale of contractor support DOD relies on today in Iraq and throughout Southwest Asia has increased considerably from what DOD relied on during previous military operations, such as Operations Desert Shield/Desert Storm and those in the Balkans. At the end of the first quarter of fiscal year 2010, DOD estimated the number of contractors in Iraq to be about 100,000 and the number in Afghanistan about 107,000. In both Iraq and Afghanistan, U.S. citizens constitute a minority of the total contractor workforce. In Iraq, approximately 72,000 contractors are third country or Iraqi nationals, and in Afghanistan approximately 81,000 contractors, or 75 percent, are Afghan nationals. However, these numbers do not reflect the thousands of contractors in Kuwait and elsewhere who support operations in Iraq and Afghanistan. By way of contrast, an estimated 9,200 contractor personnel supported military operations in the 1991 Gulf War. Factors that have contributed to the increase include reductions in the size of the military, an increase in the number of operations and missions undertaken, and DOD’s use of increasingly sophisticated weapons systems. DOD uses contractors to meet many of its logistical and operational support needs during combat operations, peacekeeping missions, and humanitarian assistance missions. Today, contractors located throughout the Middle East and Southwest Asia provide U.S. forces with such services as linguistic support, equipment maintenance, base operations support, and security support. In Iraq and Afghanistan, contractors provide deployed U.S. forces with communication services; interpreters who accompany military patrols; base operations support (e.g., food and housing); weapons systems maintenance; intelligence analysis; and a variety of other types of support. Contractors provide logistics support that includes parts and equipment distribution, ammunition accountability and control, port support activities, and support to weapons systems and tactical vehicles. For example, in Kuwait, Iraq, Qatar, and Afghanistan, the Army uses contractors to refurbish, repair, and return to the warfighters a variety of military vehicles. Oversight of contracts—which can refer to contract administration functions, quality assurance surveillance, corrective action, property administration, and past performance evaluation—ultimately rests with the contracting officer, who has the responsibility for ensuring that contractors meet the requirements as set forth in the contract. Frequently, however, contracting officers are not located in the contingency area or at the installations where the services are being provided. As a result, contracting officers appoint contract monitors, who are responsible for monitoring contractor performance. For some contracts, such as LOGCAP, AFCAP, or theater-wide service contracts like the Afghan trucking contract, contracting officers may delegate contract oversight to the Defense Contract Management Agency (DCMA) to monitor contractor performance. In Iraq and Afghanistan, these teams include administrative contracting officers, who direct the contractor to perform work, and quality assurance representatives, who ensure that the contractors perform work to the standards written in the contracts and oversee the Contracting Officer’s Representatives (CORs) assigned to DCMA- administered contracts. The DCMA team also includes property administrators and subject matter experts who advise the agency on technical issues such as food service, electrical engineering, and air traffic control procedures. These subject matter experts augment the DCMA staff and provide expertise not inherent to DCMA’s workforce and normally outside of DCMA’s core competency area of oversight responsibilities. Unless the contracting officer delegates the administrative contract management and oversight functions to DCMA, the contracting officer is responsible for the administrative oversight and management of the contract. Regardless of whether or not DCMA provides administrative oversight of a contract, contracting officers generally appoint CORs. These individuals provide much of the day-to-day oversight of a contract during a contingency operation. They are typically drawn from units receiving contractor-provided services, they are not normally contracting specialists, and often their service as contracting officer’s representatives is an additional duty. They cannot direct the contractor by making commitments or changes that affect price, quality, quantity, delivery, or other terms and conditions of the contract. Instead, they act as the eyes and ears of the contracting officer and serve as the liaison between the contractor and the contracting officer. In Iraq and Afghanistan, CORs who have been appointed as contracting officer’s representatives for contracts administered by DCMA report their oversight results to DCMA personnel. For contracts not administered by DCMA, CORs provide oversight information to the contracting officer, who may be located in Iraq, Afghanistan, or outside the theater of operations. DOD guidance requires that trained CORs be appointed prior to the award of a service contract. In Iraq and Afghanistan, the Joint Contracting Command requires that its contracting officers appoint CORs for all contracts valued at more than $2,500 and having significant technical requirements that require on-going advice and surveillance from technical/requirements personnel. The contracting officer may exempt service contracts from this requirement when the following three conditions are all met: 1. The contract is awarded using simplified acquisition procedures; 2. The requirement is not complex; and 3. The contracting officer documents the file, in writing, as to why the appointment of a COR is unnecessary. DOD Continues to Face Challenges in Providing Management and Oversight of Contractors in Ongoing Operations Based on preliminary observations from our ongoing work in Iraq and Afghanistan, we found that DOD continues to be faced with five challenges related to providing management and oversight of contractors in ongoing operations. First, DOD continues to be challenged in having an adequate number of personnel to provide oversight and management of contracts. While DOD has acknowledged shortages of personnel and has made some efforts to address them, these efforts are in the early stages of implementation. Second, training non-acquisition personnel such as CORs and unit commanders to work with contractors continues to be a problem. For example, we found some instances in which a lack of training raised concerns over the potential risk of military commanders directing contractors to perform work outside the scope of the contract—something commanders lack the authority to do. Third, DOD continues to face badging and screening challenges, particularly of local national and third- country national contractor personnel. Fourth, DOD lacks reliable tracking data on contractor personnel in Iraq and Afghanistan. Fifth, DOD faces challenges in identifying its operational contract support requirements for ongoing operations in Iraq and Afghanistan. For instance, officials from U.S. Forces-Afghanistan’s logistics staff appeared to be unaware of their responsibility as defined by DOD guidance to identify contractor requirements or develop the contract management and support plans required by guidance. Challenges in Providing an Adequate Number of Contract Oversight and Management Personnel in Deployed Locations Are Likely to Continue to Hinder DOD’s Oversight of Contractors As we noted in several of our previous reports, having the right people with the right skills to oversee contractor performance is crucial to ensuring that DOD receives the best value for the billions of dollars spent on contractor-provided services supporting contingency operations. Additionally, as our previous work has shown, poor contract oversight and the poor contractor performance that may result can negatively affect the military’s mission. Although we could find no DOD guidelines regarding the appropriate number of personnel needed to oversee and manage DOD contracts at a deployed location, several reviews by GAO and DOD organizations have consistently found significant deficiencies in DOD’s oversight of contractors due to having an inadequate number of personnel to carry out these duties. In 2004, 2006, and again in 2008, we reported on DOD’s inability to provide an adequate number of oversight personnel in CENTCOM’s theater of operation, and our ongoing work in Afghanistan and Iraq demonstrates that this problem has not been resolved. For example, During our December 2009 trip to Afghanistan, officials at a contracting command told us that their workload required them to devote all their efforts to awarding contracts, and as a result they could not provide contract oversight. During that same trip, the commander of a maintenance battalion in Afghanistan expressed concern over having an inadequate number of personnel available to provide oversight of a key maintenance contract used to support the increase of troops in Afghanistan. He noted that the lack of sufficient quality assurance personnel and technical experts was an identified problem they were working to correct, but that the additional civilian personnel were slow to arrive. Furthermore, he expressed concern that the expanding U.S. mission in Afghanistan would require additional technical experts and quality assurance personnel to oversee the increased number of contractors expected to be needed to support the increased vehicle maintenance and repair requirements. In preliminary findings concerning the drawdown of forces from Iraq, we noted that an Army unit in Kuwait that was responsible for ensuring the steady flow of equipment out of Kuwait and for conducting certain maintenance tasks had 32 government personnel to provide oversight for more than 3,000 contractor personnel. In January 2010, Army Materiel Command requested funding to double to approximately 800 the number of this unit’s contractor personnel assigned to conduct retrograde-specific tasks—for example, receiving, accounting for, sorting, and moving equipment— necessary to prevent equipment backlogs in Kuwait. In July 2009 this unit identified the lack of oversight personnel as a significant concern with respect to successfully moving equipment out of Kuwait. According to contracting officials, the unit had requested an increase in civilian oversight personnel. However, we have previously reported on the Army’s difficulties in filling civilian personnel vacancies in Kuwait. In a June 2009 report, the Commission on Wartime Contracting in Iraq and Afghanistan found that DOD had insufficient logistics subject matter experts in Iraq and Afghanistan. In the department’s response to the June 2009 report, DOD noted that DCMA had in March 2009 requested 57 subject matter experts for food, water, medical, fire, and petroleum services, but only 40 of the 57 positions had been filled. Furthermore, according to DCMA as of January 2010, only 19 of the 40 personnel had arrived in theater. During our December 2009 trip to Afghanistan, DCMA officials stressed to us the need for more subject matter experts, and they have requested an additional 47 subject matter experts, but officials do not know when these positions will be filled. To help mitigate the shortfall of subject matter experts, DCMA intends to use contractors to provide the needed expertise, according to DCMA officials. Since 2004, we and others have reported that DOD has a lack of contract oversight officials, including CORs, to provide contract oversight and management in contingency operations. During operations in Iraq and Afghanistan, the shortage of CORs has been particularly acute for DCMA- administered contracts. For example, in June 2009 DCMA had a requirement for 1,252 CORs in Iraq but had only 985 in place. Similarly, in June 2009 DCMA in Afghanistan had a COR requirement of 576 but had less than half (or 253) of the needed CORs in place. In October 2009 DCMA announced a new risk-based approach toward assigning CORs. According to DCMA officials, it had been DCMA’s policy that a COR would be designated for each contractor-provided service at the location of the service. According to DCMA officials and documentation, DCMA now recommends that units assign CORs only to key services—which they define as high- and medium-risk services that could put health, life, and safety at risk if not executed in a manner consistent with the contract. Examples of high- and medium-risk services include food service, power generation, and postal services. Services such as morale, welfare and recreation are considered low risk. Services that are not designated as “key services” do not require CORs, but are monitored on a quarterly basis by a quality assurance representative. Since implementing this policy, DCMA has reduced the requirement for CORs to oversee its contracts in Iraq from 1,100 in October 2009 to 580 in January 2010, and DCMA officials in Iraq anticipate that they will be able to reduce the COR requirement further as they continue to designate additional services as low-risk. In January 2010 DCMA reported that it had 88 percent of its required CORs in place in Afghanistan. We have not evaluated the effectiveness of this risk- based management program at this time. In an effort to build economic capacity within Iraq and Afghanistan, Congress has authorized and DOD has developed programs to encourage the use of local contractor firms. However, these programs, the Iraq First Program and the Afghan First Program, further strain the availability of personnel to provide contract management and oversight. According to officials from the Joint Contracting Command-Iraq/Afghanistan local national contractors frequently require more oversight than U.S. firms because they lack experience, have limited capacity, are frequently less capable then their U.S. counterparts, are unfamiliar with U.S. quality standards and expectations, and lack the quality control processes that U.S. firms have in place. For example, according to DOD officials, buildings constructed by Afghan contractors have had to be re-wired when the LOGCAP program assumed responsibility for them because the LOGCAP contractors responsible for maintenance lacked assurance that that the electrical work was done correctly. Other officials described receiving poor quality office furniture, while still others noted that trucking companies contracted to move U.S. goods often failed to meet delivery schedules. Without a sufficient number of contract oversight personnel in place, including subject matter experts, DOD may not be able to obtain reasonable assurance that contractors are meeting their contract requirements efficiently and effectively at each location, and that health and safety concerns have been addressed. Actions to Improve Availability of Oversight Personnel Several individual organizations or services within DOD have taken actions to help mitigate the problem of not having enough personnel to oversee and manage contractors in Afghanistan and Iraq. For example, the Army issued an Execution Order on CORs in December 2009. In the order, the Army Chief of Staff directed the commanders of deploying units to coordinate with the unit they will replace in theater to determine the number of CORs they will need to designate prior to deployment. The order states that if the commander is unable to determine specific COR requirements, each deploying brigade should designate and train 80 CORs prior to deployment. In addition, a deploying Marine Expeditionary Force has created an operational contracting support cell within the logistics element of its command headquarters. The members of the cell will assist subordinate units with contracting oversight and guidance on policy, and they will act as contracting liaisons to the Joint Contracting Command-Iraq/Afghanistan and as conduits to the regional contracting commands should any issue arise. The Marines were prompted to set up this cell by lessons learned from their deployment to Operation Iraqi Freedom, where problems arose as a result of a lack of expertise and personnel to help oversee and manage contractors. In addition, the Marine Expeditionary Force trained approximately 100 Marines as CORs prior to its deployment to Afghanistan this spring. While not all personnel have been designated as CORs for the upcoming deployment, all could be called upon to serve as CORs should the need arise. While we recognize the efforts DOD has under way to develop long-term plans intended to address its personnel shortages, the problems we have identified in the past continue. In previous reports we have recommended that DOD develop strategies to address its oversight problems, and noted that unless DOD takes steps to address its current shortages, the department will continue to be at risk with regard to its assurance that contractors are providing their required services in an effective and efficient manner. Training of CORs and Non- Acquisition Personnel, Such as Unit Commanders, to Provide Contract Oversight and Management Remains an Issue Equally important as having enough CORs is having CORs who are properly trained to provide contract oversight. According to the Army Chief of Staff’s Execution Order, the lack of personnel in theater who are sufficiently trained in COR responsibilities is hindering effective oversight and management of contracts in support of operations in Afghanistan and Iraq. In addition, a lack of CORs with the right skills can make it more difficult to resolve contractor performance issues. The Defense Federal Acquisition Regulation Supplement requires that CORs be qualified by training and experience commensurate with the responsibilities to be delegated to them. Specifically, DOD requires that potential CORs complete courses (which are available on line) that include training on specific COR duties, an awareness course on trafficking in persons to help combat this practice and ethics training. In 2006 we reported that individuals deployed without knowing that they would be assigned as CORs, thus precluding their ability to take the required training prior to deployment. Individuals we spoke with noted that it was difficult to set aside the time necessary to complete the training once they arrived in Iraq. During our recent visit to Afghanistan we found that units continue to deploy without nominating CORs beforehand, and as a result the personnel assigned to serve as CORs have to take the required training upon arrival in theater. Because training is offered through online courses, staff officers at a combined joint command as well as at an Army sustainment command in Afghanistan told us that technical limitations, including a lack of bandwidth, make it difficult to access the training from Afghanistan. In November 2009 DOD acknowledged concerns regarding web-based COR training due to connectivity issues. We also found that although CORs and other oversight personnel are responsible for evaluating the technical aspects of a contractor’s performance, these oversight personnel often lack the technical knowledge and training needed to effectively oversee certain contracts. For example, in Afghanistan, officials from various organizations expressed concern to us that there were not enough CORs trained in trades such as electrical wiring and plumbing to provide oversight over all the construction contracts, and that this problem will only worsen as the number of construction projects continues to grow. Also, in a November 2009 analysis, a DOD task force acknowledged the importance of having CORs with the right skills, noting that units nominating CORs should consider the technical aspects, monitoring frequency, and monetary value of the contract to ensure that CORs’ subject matter expertise and availability are commensurate with the requirement. An additional, long-standing training challenge hindering management and oversight of contractors supporting deployed forces is the lack of training for military commanders and other non-acquisition personnel, such as senior leaders who need contractors to execute their mission. As we testified in 2008, limited or no pre-deployment training on the use of contractor support can cause a variety of problems for military commanders in a deployed location, such as being unable to adequately plan for the use of those contractors, or confusion regarding the military commanders’ roles and responsibilities in managing and overseeing contractors. Currently, military commanders and other unit leaders are not required to complete operational contract support training prior to deployment. In Afghanistan we continued to find that some commanders had to be advised by contract oversight personnel that they had to provide certain support, such as housing, force protection, and meals to the contractors they were overseeing. In addition, having limited or no pre- deployment training for military commanders on the use of contractor support to deployed forces can result in confusion regarding their roles and responsibilities in managing and overseeing contractors. For example, we found some instances in which a lack of training raised concerns over the potential risk of military commanders directing contractors to perform work outside the scope of the contract—something commanders lack the authority to do. According to several contract oversight personnel, some commanders did not understand the command and control relationship between themselves and the contractor, and were unclear as to whether they could direct the contractor to perform work. Similarly, in a January 2010 acquisition conference, DCMA noted as a challenge the education of unit commanders on working with contractors. These challenges include educating the commanders on the value of contractors as a force multiplier, the unit’s role in providing oversight, and distinguishing between command and contractual authority. The commander of the operational contract support cell at a Marine Expeditionary Force headquarters noted that he considered educating commanders to be one of his key challenges as his unit prepared to deploy. Without a clear understanding of the command and control relationship for contractors, commanders and other key leaders run the risk of directing the contractor to perform work beyond what was called for in the contract. As Army guidance makes clear, when military commanders try to direct contractors to perform activities outside the scope of the contract, this can cause the government to incur additional charges because modifications would need to be made to the contract. In some cases, the direction may potentially result in a violation of competition requirements. While we continue to observe issues regarding training on the use of contractor support, initiatives have been taken to implement and emphasize enhanced training for contract management and oversight personnel. For example, the Army’s December 2009 Execution Order directs the Army’s Training and Doctrine Command to develop additional training, including training to familiarize CORs with LOGCAP. It also requires brigade commanders to identify and train individuals as CORs prior to deployment, and it requires that training scenarios for CORs be incorporated into mission rehearsal and mission readiness exercises. In an independent effort in Afghanistan, two sustainment units provided training that incorporated a set of contract-related scenarios prior to their deployment to Afghanistan. One of the units also sent an officer to the new 2-week Operational Contract Support course conducted by the Army Logistics Management College. Ninety soldiers from one of the units also attended COR training, either through the Defense Acquisition University or through equivalent training. In another example, one of the Marine Corps’ expeditionary forces preparing to deploy to Afghanistan identified Marines who may have contract oversight roles in Afghanistan and brought in an instructor from the Defense Acquisition University to provide three sessions of COR training prior to their deployment. In addition, DCMA has begun reaching out to deploying units to provide them with pre-deployment training on what to expect when they arrive in Afghanistan, particularly with regard to LOGCAP. Officials responsible for overseeing a contract for linguist services also stated that their CORs received contract-specific training prior to deployment. However, these efforts do not address the concerns about CORs lacking the technical skills required to provide oversight on more technical contracts, specifically construction-related contracts. While these training efforts are promising, they have been driven by individual services and units. We have been discussing the need for better pre-deployment training on the use of contractors to support deployed forces since the mid-1990s, and have accordingly made several recommendations that DOD improve its training. For example, in 2003 we recommended that DOD develop training courses for commanding officers and other senior leaders who are deploying to locations with contractor support, and in 2006 we expanded on our recommendation and recommended that operational contract support be included in professional military education and pre-deployment training. In both instances DOD agreed with our recommendations but has not fully implemented them. Furthermore, in 2008, Congress mandated that DOD policies provide for contingency contracting training for certain non-acquisition personnel, including operational commanders expected to have acquisition or contract oversight responsibilities. However, these policies have not yet been finalized, and consequently the training required has not been institutionalized throughout DOD. DOD Continues to Face Badging and Screening Challenges In Iraq and Afghanistan military commanders and other military officials have expressed concerns about the risks that contractor personnel, particularly third country and local nationals, pose to U.S. forces due to limitations in the background screening process. In 2006 we first reported on the challenges that DOD faced in ensuring that contractor personnel had been thoroughly screened and vetted. In July 2009 we reported that DOD had not developed department-wide procedures to screen local national and third-country national contractor personnel, in part because two offices within the department—–that of the Under Secretary of Defense for Intelligence and that of the Under Secretary of Defense for Acquisition, Technology, and Logistics—could not agree on the level of detail that should be included in background screening for third country and local national employees, and therefore lacked assurance that all contractor personnel were properly screened. To resolve this issue we recommended that the Secretary of Defense designate a focal point at a sufficiently senior level and possessing the necessary authority to ensure that the appropriate offices in DOD coordinate, develop, and implement policies and procedures to conduct and adjudicate background screenings in a timely manner. DOD has still not developed a department-wide policy on how to screen local national and third-country national contractor personnel, and as a result it continues to face challenges in conducting background screening of these personnel. As we reported in July 2009, absent a DOD-wide policy, commanders develop their own standards and processes to ensure that contractor personnel have been screened. In Iraq, U.S. Forces-Iraq, the U.S. led military organization responsible for conducting the war in Iraq, has developed a command-wide policy for screening and badging contractors. However, in Afghanistan, U.S. Forces-Afghanistan (USFOR- A) has not established a command-wide policy for screening and badging contractors. Instead, each base is responsible for developing its own background screening and base access procedures, resulting in a variety of different procedures. Moreover, requirements differ between U.S. bases and NATO bases. The lack of guidance also affects the ability of force protection officials to determine the sufficiency of their background screening procedures. For example, at one base, force protection officials told us that while they require contractor personnel to provide valid background screening from their home countries, they had not received guidance on how to interpret those screenings, and did not know whether the screenings they received were valid or not. Officials stated that they rely on a biometric system, also used in Iraq, to screen local national and third-country national contractor personnel. However, as we reported in July 2009, the name-checks and biometric data collection associated with issuing badges rely primarily upon U.S.-based databases of criminal and terrorist information. In 2006, we reported that background checks that are reliant upon U.S.-based databases, such as the biometric system used in Iraq and Afghanistan, may not be effective in screening foreign nationals who have not lived or traveled to the U.S. Further, some DOD contracts require contractors to conduct background screenings of their personnel. In July 2009 we reported that contracts for private security services often contained unrealistic background screening requirements. For example, the requirements directed contractors to use data sources to which private firms may not have access, such as databases maintained by the Federal Bureau of Investigation and the Central Intelligence Agency. We continue to find that some DOD contracts include unrealistic background screening requirements similar to those identified in our July 2009 report. As we concluded in July 2009, without a coordinated DOD-wide effort to develop and implement standardized policies and procedures to ensure that contractor personnel—particularly local nationals and third-country nationals—have been screened, DOD cannot be assured that it has taken all reasonable steps to thoroughly screen contractor personnel and minimize any risks to the military posed by these personnel. DOD Lacks Reliable Data on the Number of Contractor Personnel in Iraq and Afghanistan Since 2002, we have reported on the challenges faced by commanders and other leaders to obtain accurate information on the number of contractors and the services they are providing in contingencies and have made recommendations to improve DOD’s ability to obtain contractor information. For example, in December 2006 we reported that commanders had limited visibility of contractors because information on the number of contractors at deployed locations or the services they provide was incomplete, unreliable, and not aggregated within any one DOD organization, a limitation that can inhibit planning, increase costs, and introduce unnecessary risks. Although DOD has recognized the need for commanders and other leaders to have reliable data on the number of contractors and the services they provide, DOD continues to face challenges in tracking contracts and contractor personnel in Iraq and Afghanistan. Absent complete and accurate information on contractors supporting contingency operations, the agencies are limited in their ability to develop a complete picture of their reliance on contractors, the tasks being performed, and their associated costs. Reliable and meaningful data on contractors and the services they provide are a starting point for agency discussions about when and how to effectively use contractors; support contractors in terms of housing, security, and other services; and ensure that contractors are properly managed and overseen. In January 2007, DOD designated the Synchronized Pre-deployment and Operational Tracker (SPOT) as its primary system for collecting data on contractor personnel deployed with U.S. forces, and it directed contractor firms to enter personnel data for contracts performed in Iraq and Afghanistan. The SPOT database is designed to provide accountability of contractor personnel by name, a summary of the services being provided, and information on government-provided support. Our reviews of SPOT have highlighted shortcomings in DOD’s implementation of the system in Iraq and Afghanistan. Most important, we found that as a result of diverse interpretations as to which contractor personnel should be entered into the system, the information in SPOT does not present an accurate picture of the total number of contractor personnel in Iraq and Afghanistan. For example, in Iraq, DOD officials stated that the primary determinant of whether contractor personnel were entered into SPOT was a contractor’s need or lack of need for a SPOT- generated letter of authorization. Contractor personnel need SPOT- generated letters of authorization to, among other things, enter Iraq, receive military identification cards, travel on U.S. military aircraft, or, for security contractors, receive approval to carry weapons. However, not all contractor personnel in Iraq, and particularly local nationals, need letters of authorization, and agency officials informed us that such personnel were not being entered into SPOT. Similarly, officials with one contracting office in Afghanistan stated that the need for a letter of authorization determined whether someone was entered into SPOT, resulting in Afghans not being entered. However, officials from another office stated that that office was following DOD’s 2007 guidance on the use of SPOT and entering local nationals into the system. Because of the varying practices for entering personnel into SPOT, there are inconsistencies and gaps in the data generated by the system. For example, while DOD officials expressed confidence that the SPOT data were relatively complete for contractor personnel who need a letter of authorization, they acknowledged that SPOT does not fully reflect the number of local nationals working on contracts. Tracking local nationals in SPOT presents particular challenges because their numbers tend to fluctuate due to the use of day laborers, and because local firms do not always keep track of the individuals working on their projects. DOD officials also explained that they have had to develop workarounds to get around the SPOT requirement of a first and last name to be entered for each individual, along with a birth date and unique identification number. The officials noted that many Afghan laborers have only one name, do not know their birth dates, and lack identification numbers. Because of the short-comings of SPOT, DOD has conducted quarterly censuses to obtain information on the number of contractor personnel in Iraq and Afghanistan. DOD officials have regarded the census as the most complete source of contractor personnel data, but they acknowledged that the census numbers represent only a rough approximation of the actual number of contractor personnel working in either country. We found that census data were sometimes incomplete, while in other cases personnel were doubly counted. Because of these and related limitations, we determined that the census data should not be used to identify trends or draw conclusions about the number of contractor personnel in either Iraq or Afghanistan. Challenges in Identifying Operational Contract Support Requirements in Iraq and Afghanistan DOD guidance highlights the need to plan for operational contract support early in an operations planning process because of the challenges associated with using contractors in contingencies. These challenges include overseeing and managing contractors in contingency operations. In previous reports and testimonies we have noted that DOD has not followed long-standing guidance on planning for operational contract support. Specifically, joint guidance calls for DOD to identify contract support requirements as early as possible, to ensure that the military receives contract support at the right place, at the right time, and for the right price. Other guidance directs the combatant commander or joint task force commander to identify operational contract support requirements as well as develop plans to obtain and manage contract support and include them in operation plans, operation orders, or fragmentary orders. Our preliminary observations from ongoing work continue to show that DOD has not fully planned for the use of contractors in support of ongoing contingency operations in Iraq and Afghanistan. On December 1, 2009, the President announced that an additional 30,000 U.S. troops would be sent to Afghanistan to assist in the ongoing operations there, and the Congressional Research Service estimates that between 26,000 and 56,000 additional contractors may be needed to support the additional troops. However, during our December 2009 trip to Afghanistan, we found that only limited planning was being done with regard to contracts or contractors. Specifically, we found that with the exception of planning for the increased use of LOGCAP, USFOR-A had not begun to consider the full range of contractor services that might be needed to support the planned increase of U.S. forces. More important, officials from USFOR-A’s logistics staff appeared to be unaware of their responsibility as defined by DOD guidance to identify contractor requirements or develop the contract management and support plans required by guidance. However, we did find some planning being done by U.S. military officials at Regional Command–East. According to planners from Regional Command–East, the command had identified the types of units that are being deployed to their operational area of Afghanistan and was coordinating with similar units already in Afghanistan to determine what types of contract support the units relied on. Furthermore, according to operational contract support personnel associated with a Marine Expeditionary Force getting ready to deploy to Afghanistan, the staff offices within the Marine Expeditionary Force headquarters organization were directed to identify force structure gaps that could be filled by contractors prior to deployment and begin contracting for those services. For example, one section responsible for civil affairs identified the need to supplement its staff with contractors possessing engineering expertise because the needed engineers were not available from the Navy. In addition, although U.S. Forces-Iraq has taken steps to identify all the LOGCAP support they will need for the drawdown, they have not identified the other contracted support they may need. According to DOD joint doctrine and service guidance, personnel who plan, support, and execute military operations must also determine the contracted support needed to accomplish their missions. Such personnel include combat force commanders, base commanders, and logistics personnel. In particular, these personnel are responsible for determining the best approach to accomplish their assigned tasks and—if the approach includes contractors—identifying the types and levels of contracted support needed. Multi-National Force-Iraq’s (MNF-I) drawdown plan, however, delegated the responsibility for determining contract support requirements to contracting agencies, such as the Joint Contracting Command-Iraq/Afghanistan, rather than to operational personnel. Joint Contracting Command-Iraq/Afghanistan officials told us, however, that they could not determine the theater-wide levels of contracted services required, or plan for mandated reductions based on those needs, because they lack sufficient, relevant information on future requirements for contracted services—information that should have been provided by operational personnel. For example, according to MNF-I documentation, during an October 2009 meeting between operational personnel and contracting officials, MNF-I reiterated that the levels of contracted service ultimately needed in Iraq during the drawdown were unknown. This is consistent with an overarching weakness identified by a Joint Staff task force, which recognized limited, if any, visibility of contractor support and plans, and a lack of requirements definition. As a result, rather than relying on information based on operationally driven requirements for contracted services, MNF-I planned for, and U.S. Forces-Iraq (USFOR-I) is subsequently tracking, the reduction of contracted support in Iraq using historical ratios of contractor personnel to servicemembers in Iraq, which may not accurately reflect the actual levels of contracted support needed during the drawdown. Insufficient planning may also lead to shortages in contractor personnel available to perform key functions affecting contractor responsiveness. For instance, during our December visit to Afghanistan, multiple DOD officials, including the commander of a base, told us that the current LOGCAP contractor had pulled many of its skilled workers off the job, which led to issues such as electrical problems that remained unresolved for longer than desired periods of time. Furthermore, a maintenance battalion commander told us that without the assistance of soldiers and civilian mechanics from the Red River Army Depot, the contractor would not have had enough personnel to maintain and repair the vehicles and equipment necessary to meet the mission. Additionally, in December 2009, an official from USFOR-A-South told us that in Kandahar military personnel were called upon to augment the operations of a supply facility because the contractor had not fully staffed the operation. In response to a DCMA letter of concern regarding contractor personnel shortages, the contractor agreed to have a full complement of contractor personnel in place by the middle of February 2010. Timely planning is critical to avoiding potential waste and ensuring that critical services are available when needed as the United States increases troops in Afghanistan and withdraws them from Iraq. In a January 2008 statement before Congress we again highlighted the need for the department to follow its long-standing planning guidance regarding the use of contractors to support deployed forces. In that testimony we called upon DOD leadership to take steps to ensure compliance with existing guidance. Insufficient planning for requirements may lead to other poor outcomes, such as increased cost, lengthened schedules, underperformance, and delays in receiving services. We continue to believe that the department should take steps to ensure that it adheres to the guidance detailed in both joint and service publications. While DOD Has Taken Some Actions to Institutionalize Operational Contract Support, Much Remains to Be Done In response to congressional direction and GAO recommendations, DOD has taken some actions to institutionalize operational contract support, however much remains to be done. The department has appointed a focal point to lead in these efforts, has issued some new guidance, and has begun to determine its reliance on contractors, but it has yet to finalize the policies required by Congress in the National Defense Authorization Acts for Fiscal Years 2007 and 2008. In addition, the department needs to take additional actions to improve its planning for operational contract support for future operations. DOD Has Taken Some Department-wide Steps to Institutionalize Operational Contract Support In October 2006, the Deputy Under Secretary of Defense for Logistics and Materiel Readiness established the office of the Assistant Deputy Under Secretary of Defense (Program Support) to act as a focal point for leading DOD’s efforts to improve contract management and oversight at deployed locations. That office has, for example established a community of practice for operational contract support comprising subject matter experts from the Office of the Secretary of Defense, the Joint Staff, and the services, and this community may be called upon to work on a specific task or project. Additionally, the office has established a Council of Colonels, which serves as a “gatekeeper” for initiatives, issues, or concepts, as well as a Joint Policy Development General Officer Steering Committee, which includes senior commissioned officers or civilians designated by the services. The committee’s objective is to guide the development of Office of the Secretary of Defense, Joint Staff, and service policy, doctrine, and procedures to adequately reflect situational and legislative changes as they occur within operational contract support. The Program Support office is also developing an Operational Contract Support Concept of Operations, and it has provided the geographic combatant commanders with operational contract support planners to assist them in meeting contract planning requirements. To provide additional assistance to deployed forces, the department and the Army introduced several handbooks to improve contracting and contract management in deployed locations. For example, In 2007 the department introduced the Joint Contingency Contracting Handbook, which provides tools, templates, and training that enable a contingency contracting officer to be effective in any contracting environment. The handbook also contains resources for contracting officers to promote uniform contracting practices, including standardized contract forms and language for terms and conditions The handbook is currently being updated and the department expects it to be issued in July 2010. In 2008 the Army issued the Deployed Contracting Officer’s Representative Handbook. This handbook provides the basic tools and knowledge needed for use in conjunction with formal COR training. The handbook was designed to address the realities that CORs face when operating outside the United States in a contingency operation. Additionally in October 2008, the department issued Joint Publication 4-10, “Operational Contract Support,” which establishes doctrine and provides standardized guidance for planning, conducting, and assessing operational contract support integration, contractor management functions, and contracting command and control organizational options in support of joint operations. Finally, in 2008, the Joint Staff (J-4), at the direction of the Chairman, undertook a study to determine how reliant the department was on contractors in Iraq. The intent of the study was to (1) better understand contracted capabilities in Iraq, to determine areas of high reliance or dependence; (2) determine where the department is most reliant, and in some cases dependent, on contractor support, to inform longer-term force structure and potential “buy back” implications; and (3) guide the development of future contingency planning and force development. According to the Joint Staff their initial findings suggest that in Iraq the department was highly dependent on contractors in four of the nine joint capability areas, including Logistics. For example, the study showed that in the third quarter of fiscal year 2008, over 150,000 contractors were providing logistical support, while slightly more than 31,000 military personnel were providing similar support. Having determined the level of dependency and reliance on contractors in Iraq, the Joint Staff plans to examine ways to improve operational contract support planning, including the development of tools, rules, and refinements to the existing planning process. DOD Has Yet to Finalize Operational Contract Support Guidance to Meet Congressional Direction In 2006 Congress directed the Secretary of Defense, in consultation with the Chairman of the Joint Chiefs of Staff, to develop joint policies by April 2008 for requirements definition, contingency program management, and contingency contracting during combat and post-conflict operations. In 2008, Congress amended this requirement by directing that the joint policies also provide for the training of military personnel outside the acquisition workforce who are expected to have acquisition responsibilities, including oversight of contracts or contractors during combat operations, post-conflict operations, and contingency operations. It also directed that GAO review DOD’s joint policies and determine the extent to which those policies and the implementation of such policies comply with the statutory requirements. In November 2008 we reported that the department had yet to finalize several key documents designed to meet the requirements established by Congress. We also noted that DOD was developing an Expeditionary Contracting Policy to address the requirement to develop a joint policy on contingency contracting, and was revising the October 2005 version of DOD Instruction 3020.41, Contractor Personnel Authorized to Accompany the US Armed Forces, to meet the congressional direction to develop a joint policy on requirements definition; program management, including the oversight of contractor personnel supporting a contingency operation; and training. At the time of our 2008 report, the draft Instruction directed combatant commanders and service component commanders to conduct planning to identify military capability shortfalls that require acquisition solutions in commanders’ operational plans, and combatant commanders to integrate operational contract support issues into training simulations, mission rehearsals, and exercises. The draft Instruction also directed the service to include requirements of the Instruction in their training. As of March 2010, the department had yet to issue either of these documents. According to the Assistant Deputy Under Secretary of Defense (Program Support), the revisions to DOD Instruction 3020.41 have been held up in the review process. The current plan is to post the proposed revisions in the Federal Register and issue the revised instruction in the summer of 2010. Until the DOD instruction is revised and issued, the department’s overarching policy document will not reflect the department’s current approach to operational contract support. Furthermore, the provisions of the draft instruction that were intended to meet the congressional requirement for joint policy applicable to combatant commanders and the military services have not been established. Regarding the expeditionary contracting policy, the department has determined that it will not issue the expeditionary policy because the practitioners do not believe a joint policy is necessary. Plans for Future Operations Lack Information on Contractor Support Requirements DOD also faces challenges incorporating operational contract support issues in its operation plans for potential future contingencies. Since 2003, we have identified the need for the department to ensure that specific information on the use and roles of contract support to deployed forces is integrated into its plans for future contingency operations. DOD guidance has long recognized the need to include the role of contractors in operation plans and, since early 2006, this guidance has required planners to include an operational contract support annex—known as Annex W—in the combatant commands’ most detailed operation plans. Our ongoing work has found that the department has made some progress in both meeting this specific guidance and, more generally, in incorporating contract requirements in its operation plans. However, additional steps are needed to fully implement DOD guidance. First, we found that four operation plans with Annex Ws have been approved, and planners have drafted Annex Ws for an additional 30 plans. However, according to combatant command officials, most of the annexes drafted to date restate broad language from existing DOD guidance on the use of contractors to support deployed forces and included few details on the type of contractors needed to execute a given plan—despite guidance requiring Annex Ws to list contracts likely to be used in theater. This was due to several factors, including a lack of information within the operation plans on matters such as the size and capabilities of the military force involved. According to combatant command planners, this information is needed to enable them to identify the details on contracted services and capabilities needed to support an operation. In addition, shortcomings in guidance on how and when to develop these annexes have resulted in a mismatch in expectations between senior DOD leadership and combatant command planners regarding the degree to which Annex Ws will contain specific information on contract support requirements. We found that several senior DOD officials have the expectation that most combatant command plans should at least identify the capabilities that contractors may provide, regardless of the level of plan. However, the contract support planners and other officials responsible for developing the Annex Ws disagreed, stating that given the limited amount of information on military forces in most operation plans, the expected level of detail was difficult if not impossible to achieve. In most cases, we found that Annex Ws did not contain the level of detail expected by senior DOD leadership and envisioned in current guidance, thus limiting the utility of the Annex W as a planning tool to assess and address contract support requirements. Second, in discussion with combatant command officials responsible for developing operation plans, we found that detailed information on operational contract support requirements is generally not included in other sections or annexes of these plans. Although the Annex W is intended to be the focal point within an operation plan for discussing operational contract support, DOD guidance underscores the importance of addressing contractor requirements throughout an operation plan. However, we found that non-logistics personnel tend to assume that the logistics community will address the need to incorporate operational contract support throughout operation plans. For example, combatant command officials told us they were not aware of any assumptions specifically addressing the potential use or role of operational contract support in their base plans. Assumptions are used to focus attention of senior DOD leadership on factors that could present risks to mission success. Similarly, according to DOD planners, there is a lack of details on contract support in other parts of most base plans or in the non-logistics (e.g., communication or intelligence) annexes of operation plans. DOD guidance for these annexes directs planners to identify the means or capabilities necessary for meeting mission requirements. Although this guidance does not specifically mention contractors, contractors provide significant support in these areas. The lack of details on contract support requirements in Annex Ws, along with the limited discussion of contractors in other portions of operation plans, can hinder the ability of combatant commanders to understand the extent to which their plans are reliant on contractors. Moreover, senior decision makers may incorrectly assume that operation plans have adequately addressed contractor requirements. As a result, they risk not fully understanding the extent to which the combatant command will be relying on contractors to support combat operations, and being unprepared to provide the necessary management and oversight of deployed contractor personnel. Concluding Observations In closing, DOD has taken positive steps in recognizing its reliance on contractors to support operations both now and in the future, and it has emphasized the need for increased oversight and management over these contractors. However, more work is needed to address the long-standing challenges I have discussed today. Many of the challenges I have identified, particularly those related to contract management, oversight, and planning, stem from DOD’s inability to institutionalize operational contract support by accepting contractors as an integral part of the total force. Reforming the way DOD approaches operational contract support will require a fundamental cultural change for the department. As part of the effort to bring about such changes, DOD will need to continue to evaluate the role that contractors play in contingency operations to determine the appropriate balance of contractors and military forces and institutionalize operational contract support at all levels of professional military education as well as in predeployment training and exercises. Mr. Chairman, this concludes my statement. I would be happy to answer any questions. GAO Contacts and Acknowledgments For further information about this statement, please contact William Solis at (202) 512-8365 or solisw@gao.gov. In addition, contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. Individuals who made key contributions to this statement are Carole Coffey, Assistant Director; Vincent Balloon, Laura Czohara, Melissa Hermes, Guy LoFaro, Emily Norman, Jason Pogacnik, James Reynolds, and Cheryl Weissman. 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The Department of Defense (DOD) relies greatly on contractors to support its current operations and is likely to continue to depend on contractors in support of future operations. As of December 2009, DOD estimated that over 207,000 contractor personnel were supporting operations in Iraq and Afghanistan. DOD expects to increase the number of contractors as more troops deploy to Afghanistan. The use of contractors in contingencies has challenged DOD in overseeing and managing contractors. This testimony addresses (1) the challenges DOD faces when trying to provide management and oversight of contractors in Iraq and Afghanistan, and (2) the extent to which DOD has made progress in institutionalizing a department- wide approach to managing and overseeing operational contract support. Today's testimony is based on GAO's ongoing audit work in Iraq and Afghanistan, looking at planning for operational contract support and at DOD's efforts to manage and oversee contractors, as well as on recently published related GAO reports and testimonies. DOD continues to face a number of challenges overseeing and managing contractors in ongoing operations. These challenges include: (1) Providing an adequate number of personnel to conduct oversight and management of contractors. (2) Training personnel, including non-acquisition personnel such as unit commanders, on how to work effectively with contractors in operations. (3) Ensuring that local and third-country nationals have been properly screened, given the lack of standardized documents, the lack of national police agencies in many countries, and poor record keeping in many countries. (4) Compiling reliable data on the number of contractor personnel supporting U.S. forces in contingencies. (5) Identifying requirements for contractor support in ongoing operations, although GAO notes that some steps have been taken at the individual unit level.

Background In the early 1990s, federal agencies and Congress recognized that doing business electronically could save resources, streamline the procurement process, and improve the private sector’s access to federal contracting opportunities. NASA first used NAIS at its Marshall Space Flight Center in 1994 to post midrange procurement opportunities on the Internet. NAIS services and features expanded rapidly, and the system began to be used NASA-wide in 1995. It was the first agencywide procurement information system on the Internet. With some exceptions, federal agencies must publish notices of competitive contracting opportunities above $25,000 in the CBD. To accommodate timely delivery of notices through a paper-based mail delivery system, the law generally prescribes a 15-day minimum interval between publication of a notice in the CBD and the issuance of a solicitation by an agency. After a solicitation is issued, agencies generally must give contractors a minimum of 30 days to prepare and deliver bids or offers. In support of NASA’s test of alternatives to the use of paper documents for communicating business opportunities to prospective contractors, FASA authorized NASA to waive the CBD notice and waiting period requirements for 4 years (until Oct. 13, 1998) and for up to $100 million in procurement life-cycle costs. Congress has supported the use of federal electronic commerce and electronic access to procurement information. Under FASA, this capability was to be provided through the Federal Acquisition Computer Network (FACNET), a governmentwide systems architecture for acquisitions based on electronic data interchange, which is the computer-to-computer exchange of routine business documents using standardized data formats. FACNET implementation proved to be problematic, however, and in 1997, section 850 of the National Defense Authorization Act for Fiscal Year 1998 replaced the preference for FACNET with a more flexible policy that promotes the use of electronic commerce techniques whenever practicable or cost-effective. Section 850 also requires that in implementing electronic commerce, agencies apply standards consistent with nationally and internationally recognized standards that broaden interoperability and ease of use. Agency notices of procurement opportunities must be provided in a form that allows convenient and easy user access through a single governmentwide point of entry. While CBDNet satisfies the requirement with respect to notices, neither it nor other currently available electronic procurement posting systems satisfy the requirement for a single governmentwide point of entry for access to solicitations and other procurement information. The law also requires that the Administrator of the Office of Federal Procurement Policy (OFPP) submit to Congress yearly reports through 2003 on the progress being made in implementing section 850. The reports must include a strategic plan for implementation of governmentwide electronic commerce and an assessment of compliance with the requirement for a single point of entry. NAIS Is an Effective Information Service Since 1994, NAIS has evolved into a procurement information system with many operational features that are effective, easy to use, and beneficial to NASA and vendors. By eliminating many of the steps in the paper-based process of publicizing contract opportunities and issuing solicitations, NAIS has contributed to a more streamlined agency acquisition process. Feedback from NAIS users, particularly small businesses, has generally been positive. However, the lack of data makes it very difficult to quantify specific benefits of NAIS, such as the amount of time it actually saves. NASA exceeded the $100-million ceiling authorized by FASA for the test. After NAIS implementation, the number of offers per contract and small businesses’ share of contract actions and dollars showed some increases. NAIS Is User-Friendly and Works Since July 1994, NAIS has evolved to provide a broad range of procurement-related functions and information. For example, in November 1995, NASA added an on-line procurement reference library. In March 1997, NASA completed the NAIS Electronic Posting System (EPS), which enables procurement staff anywhere in the agency to prepare and post notices and place solicitation files directly onto the NAIS Internet site. In March 1997, NASA also added an e-mail notification service that automatically notifies subscribers of new procurement information available on NAIS. We found that the system’s operational features were easy to use and worked as described. Procurement staff demonstrated how they use the EPS to generate, edit, and post notices and place solicitation files directly onto the Internet. The EPS automatically formats each NAIS posting, inserts links to other relevant documents and external information, updates the business opportunities index library, and constructs and feeds messages to the NAIS e-mail notification service. Appendix I provides more information on the development and evolution of the EPS and the approach NASA used to design, develop, and operate the system. By going to the NAIS Internet site, users can identify, at one location, notices of and solicitations for competitive business opportunities and awards over $25,000 at all NASA centers; search for business opportunities by type of product and/or service, NASA center, or posting date; locate and download documents related to a specific procurement; and view summaries of NASA’s current contracts (with contractor name, value, obligations, and description) and search current contracts by state, congressional district, business type, or type of product and/or service. The e-mail notification service automatically transmits announcements to subscribers immediately after new procurement information is posted on NAIS. This allows subscribers to track developments in the solicitation cycle and learn of new releases. Subscribers can register free of charge by providing an e-mail address and selecting the types of contracting opportunities in which they have the greatest interest. Thus, instead of having to search for information, subscribers can have it selected and delivered to their desktop electronically. As of July 1998, there were over 7,100 subscribers to the e-mail notification service. According to NASA, user feedback showed that this service was the most popular feature of NAIS. NAIS Contributes to a Streamlined and Accessible Procurement System One of NASA’s goals in establishing NAIS was to streamline and standardize the agency’s procurement process by using the Internet as the gateway to contracting opportunities for businesses. NAIS streamlined or eliminated many of the steps required by the paper-based process for publicizing synopses of contracting opportunities and issuing solicitations. The NAIS process involves fewer steps for procurement staff than the paper process. The EPS, for example, automatically formats notices, performs edit checks, automatically posts notices on the Internet through the NAIS server, and transmits them to the Government Printing Office for publication in the CBD. Using the paper process, procurement staff have to perform analogous functions manually and must also respond to requests for copies of solicitations by preparing mailing labels and mailing the copies. With NAIS, the solicitation files are available for review and retrieval (“downloading”) through the Internet. We believe the NAIS process is also easier for contractors to use. Using the paper-based system, contractors must either scan the CBD or periodically call or visit each of NASA’s procurement offices to identify contracting opportunities. In contrast, using NAIS, contractors can search for and view as many synopses and solicitations as they wish on-line. They can search by specific commodity, service, or location; view and provide comments on draft solicitations; and access the Federal Acquisition Regulation, NASA procurement policies and procedures, and NASA procurement forms. NASA officials point to the absence of protests from contractors concerning NAIS and the lack of complaints about NAIS to the NASA Ombudsman Program as evidence that the contractor community approves of NAIS. User Feedback Was Positive Both businesses and NASA procurement staff have provided positive feedback about NAIS. Overall, industry responses to specific NAIS operational features were positive. In a tally of on-line comments from NAIS users, 87 percent of respondents said they found NAIS to be beneficial. The respondents identified themselves primarily as small, small disadvantaged, or women-owned businesses. For the most part, feedback from the procurement staff was positive, and comments were often similar to those made by businesses. Federal electronic commerce officials from other agencies and industry representatives told us that systems with the operational features of NAIS can benefit both industry and government, especially when all buying organizations are using the same system. An on-line NAIS feedback system was established in 1995 to obtain input, especially from businesses, about the system. The NAIS team also requests feedback from the procurement staff at NASA centers. This feedback was compiled in December 1997 and again in June 1998. The team compiles survey feedback data, develops a consolidated summary of industry suggestions, and uses the summary to determine which changes and enhancements should be made. Lack of Data Makes It Difficult to Quantify NAIS Benefits NASA’s evaluation plan for the Midrange Pilot Program did not include a separate NAIS evaluation plan. In May 1998, NASA published the NAIS Business Case, which provides details of current NAIS features, along with its history, benefits, and funding alternatives. However, NASA did not collect data on or evaluate individual procurements advertised through NAIS. The information needed to determine how much time NAIS actually saved or to quantify other NAIS benefits, such as cost avoidance for the procurement process, was not available. We did not find any evidence that NAIS had negative effects, and there is substantial qualitative evidence of the positive impact of NAIS. Appendix II provides more information on our assessment of the NAIS Business Case. NASA Exceeded Waiver Authority’s Dollar Ceiling Although FASA allowed NASA a 4-year test authority to waive CBD publication requirements and waiting periods up to a limit of $100 million in life-cycle costs, NASA did not establish a mechanism to track compliance with the waiver provision. NASA officials told us that when the waiver authority was originally requested, they anticipated that NAIS, though not yet developed, would be used primarily by the Marshall Space Flight Center, the focal point of the pilot test, and that the $100-million ceiling would be adequate to cover Marshall’s procurements. However, the Internet posting capability was rolled out to all NASA centers by April 1995 and was being used agencywide for all competitive procurements over $25,000 1 month before NASA began waiving the CBD notice requirements in October 1995. In early 1997, NASA officials realized that the $100-million ceiling authorized by FASA for the test would not cover agencywide use of NAIS. In May 1997, the Administration submitted a legislative proposal to increase the ceiling for NASA’s use of the waiver authority and extend the test period from 4 to 6 years. Congress did not act on the proposal. NASA used the CBD waiver authority through the end of the fiscal year–September 30, 1997. NASA calculated that it awarded approximately 1,585 contracts worth a total of about $177 million using the CBD waiver authority. No Significant Changes in Offers and Awards Reported After NAIS Implementation In an effort to determine the impact of NAIS on the amount of competition for awards, NASA compared the number of vendors’ proposals received before and after NAIS implementation. NASA compared the number of offers received per contract action in fiscal year 1994–the year prior to agencywide use of NAIS−to the number of offers per contract action in fiscal year 1997–a year in which all midrange procurements were only advertised through NAIS. As table 1 shows, the average number of offers received per acquisition increased from 6.1 to 7.2 after NAIS implementation. NASA said in the NAIS Business Case that the increase in the average number of offers received per acquisition was especially promising because the majority of these acquisitions were set aside for small businesses. We also calculated and compared the percentages of contract actions and dollars awarded to small businesses in fiscal years 1994 and 1997, respectively. Table 1 shows these calculations. The percentage share of awards to small businesses did not change significantly after NAIS implementation, but the percentage share of dollars awarded to small businesses increased substantially in 1997. A NASA official said this was due in large part to a drop in awards to large businesses and not to any substantial change in dollars awarded to small businesses. Efforts Are Underway to Establish a Governmentwide EPS Today most federal agencies use the Internet in some way to advertise their contracting opportunities. Vendors search all these various Internet sites for government procurement information. Recent legislation requires the government to provide direct access to notices of agencies’ requirements and solicitations through a single governmentwide electronic point of entry. NASA, GSA, and other agencies are testing a multiagency electronic posting system. Agency officials are concerned that the benefits of providing direct electronic access to contracting opportunities may be offset by existing statutory requirements for publication of procurement notices and minimum waiting periods. Status of Efforts to Develop a Governmentwide EPS According to the San Antonio Electronic Commerce Resource Center,more than 400 different Internet sites provide federal procurement information. This multitude of sites makes it difficult and time-consuming for contractors to obtain governmentwide information on contracting opportunities. The March 1998 report, Electronic Commerce for Buyers and Sellers, A Strategic Plan for Electronic Federal Purchasing and Payment, described planned enhancements to the electronic version of the CBD, CBDNet, which now provides a single point of entry only for procurement notices. GSA and NASA approached the Department of Commerce and the Government Printing Office to form an interagency team to implement an enhanced CBDNet and to make an Internet-based EPS with features comparable to those of the NAIS system available to the entire federal sector. However, the agencies could not reach agreement on an enhanced CBDNet implementation approach. Among unresolved issues were the source and level of funding needed for the project, the costs to develop and implement the system, and the potential financial impact on the operating and user agencies. NASA, GSA, and other members of the Interagency Acquisition Internet Council are developing and testing a pilot multiagency posting system derived from the NAIS EPS to enable agencies to post notices, solicitations, and other acquisition-related documentation directly onto the Internet, where it would be available through a single point of entry. GSA is leading this effort and spent over $400,000 in the past year developing this multiagency EPS software. In October 1998, GSA began using the pilot software as the agency’s single EPS. If testing demonstrates that the multiagency EPS is capable of providing effective access to notices and solicitations through a single point of entry, the Administrator of the Office of Federal Procurement Policy will consider designating it as the single governmentwide point of entry required by section 850. Challenges to Governmentwide Implementation The difficulty of establishing a single governmentwide electronic point of entry for federal procurement opportunities was emphasized by several agency officials, who said they were concerned about the costs involved in developing, operating, and maintaining such a system; cost sharing among different agencies; and the linkages that need to be established with existing agency systems through the Internet. They also questioned how and when decisions would be made concerning who would lead such a project, who would be responsible for operating and maintaining the system, and who would mandate its use by agencies. Agency officials also said that the benefits of a governmentwide electronic notice capability could be enhanced through changes to the current statutory minimum waiting periods for notices and solicitations, which were fashioned around a paper-based process. Acquisition officials noted, in particular, that the law requires a 15-day waiting period after publication of a notice before a solicitation can be issued, even though the Internet enables agencies to publicize notices and provide solicitation files simultaneously, giving contractors immediate access to these documents and saving time in the procurement process. Agency officials said that changing these requirements could increase the benefits of using electronic commerce. OFPP plans to study what type of legislative action may be needed to enhance the benefits of electronic publication of business opportunities. Conclusions NASA has shown that it can successfully use NAIS to effectively disseminate solicitations and other procurement information, giving contractors easy and immediate access to business opportunities at each of its geographically dispersed procurement offices. Feedback from users has been positive, and the system has allowed increased standardization of the procurement process agencywide. However, benefits such as the time savings obtained through use of the system cannot be readily quantified because of data limitations. While NASA believes that NAIS has had a positive impact on competition, this conclusion was based on only 2 years of data. NASA’s on-line electronic posting system was the model for the pilot multiagency EPS software that is being tested by GSA, NASA, and several other agencies. If successful, this EPS may be considered for governmentwide expansion and designation as the single governmentwide point of entry for both notices and solicitations. While the March 1998 report assessing electronic commerce initiatives discussed enhancements to the CBDNet, it did not discuss the multiagency EPS pilot program. If a governmentwide EPS is successfully implemented, its benefits potentially could be enhanced by changing the statutory notice and waiting periods. Recommendations We recommend that the Administrator of the Office of Federal Procurement Policy describe the current plan for implementation of a governmentwide single point of entry to procurement information in its next annual report to Congress. This plan should take into consideration the status of and lessons learned from the multiagency EPS pilot and its potential as the basis for a comprehensive governmentwide electronic posting system. We also recommend that the Administrator of the Office of Federal Procurement Policy determine whether the issues raised by agency officials concerning procurement notice requirements set forth in statute, including waiting periods, require legislative action and make recommendations to Congress on legislative changes, if necessary. Agency Comments In commenting on the draft of this report, NASA and OFPP generally agreed with our findings and recommendations. NASA stated that it was proud of the NAIS staff for pioneering the use of the Internet in federal procurement; and our review largely corroborated the agency’s assessment of the value of NAIS. OFPP stated that NAIS has created the foundation for the ongoing multiagency pilot of an electronic posting system. If successful, the EPS will provide easy access to procurement information across the government through a single point of entry. OFPP was encouraged by the promising findings identified in the report. OFPP also commented on our recognition that current statutory requirements for procurement notices and minimum waiting periods may limit the potential benefits of electronic commerce and indicated that the feasibility of legislative action would be studied. The comments from NASA and OFPP are reprinted in their entirety in appendix III and IV, respectively. Scope and Methodology To determine whether the NAIS electronic notice and publication system was an effective mechanism for disseminating procurement information, we obtained information about the system’s design, development, operation, costs, and benefits. We obtained documents from and interviewed officials at NASA Headquarters in Washington, D.C., and at the Marshall Space Flight Center (the lead center for NAIS project management) in Huntsville, Alabama. We also accessed NASA’s procurement Internet site (http://procurement.nasa.gov) and reviewed the on-line NAIS operational features available to both public users and NASA contracting staff to determine whether the system worked as NASA represented. To evaluate NASA’s claim that NAIS usage had a positive impact on competition and was beneficial to small businesses, we compared NASA procurement data for fiscal year 1994 (the year prior to agencywide use of NAIS) with data for fiscal year 1997. We did not independently verify the NASA procurement data obtained from the NASA acquisition management information system. We also reviewed NASA’s evaluation of the system contained in the May 1998 NAIS Business Case. We reviewed the data in the NAIS Business Case, including calculations of cost avoidance and other benefits attributed to NAIS. We examined on-line industry feedback and narrative responses from vendors and NASA buyers about NAIS. To determine the agency’s compliance with statutory requirements, we reviewed the goals, objectives, and time frames established by FASA for NASA’s test of electronic notice and publication. To assess the status of efforts to establish a governmentwide EPS based on the NAIS model, we asked electronic commerce coordinators from several federal agencies, federal Electronic Commerce Resource Centers, and two industry groups for their observations. We received responses from coordinators at five agencies, two resource centers, and one industry group. We also interviewed acquisition officials at GSA, the Department of Commerce, and OFPP to obtain information on interagency efforts to develop a governmentwide electronic procurement posting system. We also reviewed the goals, objectives, and milestones established for the governmentwide electronic commerce program by the National Defense Authorization Act for Fiscal Year 1998. We performed our work between January and December 1998 in accordance with generally accepted government auditing standards. We are sending copies of this report to the Administrator, NASA; the Administrator, OFPP; and the Director, Office of Management and Budget. We will also make copies available to others upon request. Please contact me at (202) 512-4841 if you or your staff have any questions concerning this report. Major contributors to this report are listed in appendix V. The NAIS Electronic Posting System Staff at the National Aeronautics and Space Administration (NASA) responsible for developing and implementing the NASA Acquisition Internet Service (NAIS) consisted of a small group of procurement and, in some cases, technical staff from each NASA center and headquarters. They adopted an incremental approach to system development and operations. This approach included the following steps: (1) general requirements were drawn up, (2) commercially available software options were researched, (3) a prototype was designed and developed if a commercial solution was not available, (4) a prototype for testing was installed, (5) requirements were refined and a small pilot initiated, and (6) the pilot was expanded and the software solution added to the NAIS system. NASA’s development of its Electronic Posting System (EPS) is characteristic of the way the NAIS team applied the concept of incremental design, development, and implementation of NAIS features. Prior to agencywide use of EPS, each NASA center had its own unique process for preparing and posting procurement notices and solicitations on the Internet. Some centers used word processors while others used some form of automated document generation system. The completed files were then provided to a Web curator at the center who would post them on an Internet server and manually update a readable index of files. Changes to the posting process occurred spontaneously at various centers with little central control or agreement. The 10 centers’ differing processes required 10 separate efforts to implement a single change that had to be agreed on by the larger NAIS team. These process differences also made it difficult to maintain a standard “look and feel” when searching out business opportunities. A vendor was faced with 10 different entry points to search. NAIS operated for a year in this fashion. Then an ad-hoc group of NAIS team members began to study ways to make the centers’ posting processes more uniform. The team concluded that the NAIS posting process should be centralized to a single server and that the application for posting and maintaining documents should be standardized by using on-line forms to be completed by users. NAIS technical team members then designed and developed the uniform Web posting tools that were first piloted and then deployed agencywide. According to NASA, implementation of the EPS eliminated much duplication among the centers, standardized posting practices across all NASA centers, and lowered NAIS maintenance costs. The EPS application provides a common look and feel of acquisition opportunities. The incremental, evolutionary approach to deploying an electronic posting system avoided the costs and delays often associated with attempting a single solution to standardize disparate, decentralized systems. Additionally, because much of the system is based on commercial standards, commercially available software, and standard hardware, it was easily adopted by each of the centers without major disruptions. All NAIS features have been built using commercial Internet standards and Web methodology so that even casual Internet users can easily use NAIS. For internal procurement staff using standard NASA computer hardware and software, NAIS tools may include user instructions. For example, the NAIS EPS has an on-line user’s manual linked directly to the application. For external users with a wide variety of hardware and software, NAIS features are based on widely accepted Internet protocols and standards, and the features are designed to be used without any formal training. NASA’s Business Case for NAIS In May 1998, NASA completed and published an evaluation of NAIS in a document called the NAIS Business Case. The document sought to justify continued funding for NAIS by showing that the system’s quantitative and qualitative benefits far exceed NASA’s investment. According to NASA’s assessment, the NAIS tools implemented to date had produced outstanding results. We found weaknesses in the evaluation’s methodology. For example, NASA claimed that the Midrange Pilot initiatives, including NAIS, reduced procurement leadtimes by 40 percent. We examined the data used by NASA to support this calculation. In a number of cases, the data showed that the official purchase requests arrived at NASA procurement offices after solicitations for the requested products or services had already been issued. Consequently, we could not verify NASA’s claimed 40-percent reduction in leadtime. However, it is obvious that the reduction in mail delays and in the manual steps and efforts needed to post a procurement notice should contribute to reduced leadtimes. We also found that the NAIS Business Case’s discussion of the resources used in developing and operating NAIS was incomplete. It described only the full-time equivalent (FTE) staff years of effort, both funded and unfunded, which were devoted to NAIS development and support in fiscal year 1997 and did not reflect the additional resources such as technical support, hardware, software, and communications services provided by various NASA centers. Because the evaluation only identified NAIS FTE staffing for 1 year and did not identify hardware, software, and other costs associated with NAIS, we asked NASA to provide fiscal year estimates of the total costs associated with NAIS development and ongoing operations. The table below depicts NASA’s estimates of the staffing, hardware, software, and miscellaneous costs associated with NAIS for fiscal years 1995 through 1998. Amounts for fiscal years 1995 through 1997 are estimates, while the amount for fiscal year 1998 is a projection. Hardware/ software/misc. User Feedback on NAIS Was Positive NASA reported in the NAIS Business Case that data from the NAIS on-line feedback system showed that over 85 percent of those who responded to the question, “Is NAIS, as a whole, beneficial?,” answered “yes.” We reviewed summary reports of responses tallied from the NAIS system and found that of the 2,310 persons answering this question, 2,007 answered yes (87 percent). The survey respondents identified themselves primarily as small, small disadvantaged, or women-owned businesses. Overall, we found both industry and NASA procurement staff comments about specific NAIS operational features were positive. We also reviewed feedback responses submitted from 1995 through June 1998 to an open-ended question about enhancements that would improve NAIS. As of June 30, 1998, the NAIS team had completed actions or had actions underway related to 42 of 89 suggestions. Federal officials and groups representing industry perspectives told us that the NAIS Business Case properly identified the areas in which both government and industry may experience time and cost savings through an effective agencywide EPS. They noted that electronic commerce systems with the functionality and user-friendly features of NAIS have clear potential to benefit both industry and government, particularly if all buying centers are using the same system. Comments From the National Aeronautics and Space Administration Comments From the Office of Federal Procurement Policy Major Contributors to This Report National Security and International Affairs Division, Washington, D.C. Office of General Counsel, Washington, D.C. John Carter The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. 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Pursuant to a legislative requirement, GAO reviewed the National Aeronautics and Space Administration's (NASA) Acquisition Internet Service (NAIS), focusing on: (1) whether NAIS is an effective mechanism for disseminating procurement information to industry, including small businesses; and (2) the status of efforts to develop a governmentwide electronic procurement information system similar to NAIS. GAO noted that: (1) NAIS is a simple, effective, and user-friendly system for disseminating information on contract opportunities; (2) NAIS has contributed to the development of a more standardized and streamlined acquisition process at NASA and provides a central electronic source of procurement information from NASA's decentralized facilities; (3) it allows businesses to obtain procurement information immediately, without waiting for mail delivery of printed information; (4) vendors especially like the electronic mail notification service that automatically sends announcements about procurements of interest to them; (5) vendor feedback about NAIS came primarily from small businesses and was generally positive; (6) procurement data showed that offers and awards to small businesses did not change significantly after NAIS implementation; (7) NASA noted that data limitations made it difficult to quantify other NAIS benefits; (8) NASA, the General Services Administration, and other federal agencies are working together to develop a single, governmentwide Internet entry point for information on federal procurement opportunities; (9) but a number of steps must still be taken and many obstacles remain; (10) even if the new system is successfully developed and implemented governmentwide, current statutory requirements for publication of procurement notices and minimum waiting periods for mail delivery may continue to limit the potential benefits of an electronic procurement information system; and (11) the same legislation that encouraged NASA and others to work together also requires the Office of Federal Procurement Policy to submit to Congress annual reports assessing compliance with the requirement to provide direct access to procurement information through a single governmentwide electronic point of entry.

Assisting Congress and the Nation GAO remains one of the best investments in the federal government, and our dedicated staff continues to deliver high quality results. In FY 2013 alone, GAO provided services that spanned the broad range of federal programs and activities. We received requests for our work from 95 percent of the standing committees of Congress and almost two-thirds of their subcommittees. We reviewed a wide range of government programs and operations including those that are at high risk for fraud, waste, abuse, and mismanagement. GAO also reviewed agencies’ budgets as requested to help support congressional decision-making. Last year, our work yielded significant results across the government, including $51.5 billion in financial benefits—a return of about $100 for every dollar invested in GAO. Also, in FY 2013, we issued 709 reports and made 1,430 new recommendations. The findings of our work were often cited in House and Senate deliberations and committee reports to support congressional action, including improving federal programs on our High Risk list; addressing overlap, duplication, and fragmentation; and assessing defense, border security and immigration issues. Our findings also supported the Bipartisan Budget Act of 2013, in areas such as aviation security fees, unemployment insurance, improper payments to inmates, the strategic petroleum reserve, and the contractor compensation cap. Senior GAO officials also provided testimony 114 times before 60 Committees or Subcommittees on a wide range of issues that touched virtually all major federal agencies. A list of selected topics addressed is included in Appendix I. Financial Benefits GAO’s findings and recommendations produce measurable financial benefits through Congressional action or agency implementation. Examples of FY 2013 financial benefits resulting from congressional or federal agency implementation of GAO recommendations include: $8.7 billion from reducing procurement quantities of the Joint Strike Fighter Program: DOD decreased near-term procurement quantities in three successive budget submissions to lessen concurrency and the associated cost risks in light of our numerous recommendations citing the F-35 Joint Strike Fighter program’s very aggressive and risky acquisition strategy, including substantial overlap among development, testing, and production activities. $2.6 billion from revising the approach for the Navy’s Next Generation Enterprise Network (NGEN) Acquisition: Our recommendations led Navy to revise its NGEN acquisition strategy— which was riskier and potentially costlier than other alternatives identified due to a higher number of contractual relationships—thus significantly reducing program costs between 2013 and 2017. $2.5 billion from eliminating seller-funded payment assistance for FHA-insured mortgages: The Department of Housing and Urban Development and Congress took steps to prohibit seller-funded down payment assistance, citing our findings that losses associated with those loans had substantially higher delinquency and insurance claim rates than similar loans without such assistance, and were contributing to the Federal Housing Administration’s deteriorating financial performance. $2.3 billion from consolidating U.S. Forces stationed in Europe: DOD removed two brigade combat teams and support units from Europe, allowing it to further consolidate and close facilities, based in part on our work showing significant costs related to maintaining permanent Army forces in Europe and our recommendations that DOD identify alternatives that might lead to savings. $1.3 billion through improved tax compliance: Our recommendations on the use of information reporting to reduce the tax gap contributed to legislation requiring banks and others to report income that merchants receive through credit cards, third-party networks, and other means to help IRS verify information reported on merchants’ income tax returns. The estimated increased revenue through improved tax compliance is expected over the provision’s first 3 fiscal years. GAO has generated recommendations that save resources, increase government revenue, improve the accountability, operations, and services of government agencies, increase the effectiveness of federal spending as well as provide other benefits. Since FY 2003, GAO’s work has resulted in substantial financial and other benefits for the American people, including: over ½ trillion dollars in financial benefits; about 14,500 program and operational benefits that helped to change laws, improve public services, and promote sound management throughout government; and about 12,000 reports, testimony, and other GAO products that included over 22,000 recommendations. Program and Operational Benefits In FY 2013, GAO also contributed to 1,314 program and operational benefits that helped to change laws, improve public services, and promote sound management throughout government. Thirty six percent of these benefits are related to business process and management, 31 percent are related to public safety and security, 17 percent are related to program efficiency and effectiveness, 8 percent are related to acquisition and contract management, 5 percent are related to public insurance and benefits, and 3 percent are related to tax law administration. Examples include: enhancing coordination between DOD and the Social Security Administration (SSA) on the more timely delivery of military medical records through electronic transfer; improving Veterans Affairs (VA) oversight of its medical equipment and supply purchasing; increasing collaboration between the Army and Veterans Affairs through a joint working group to improve management of military cemeteries and help eliminate burial errors and other past problems; updating Federal Emergency Management Administration (FEMA) National Flood Insurance Program contract monitoring policies to reduce the likelihood that contractor performance problems would go unnoticed; and establishing National Oceanic and Atmospheric Administration policies outlining the processes, roles and responsibilities for transitioning tsunami research into operations at tsunami warning centers. Overlap, Duplication, and Fragmentation In FY 2013 GAO issued its third annual report on overlap, duplication, and fragmentation. In it, we identified 31 new areas where agencies may be able to achieve greater efficiency or effectiveness. Within these 31 areas, we identified 81 actions that the executive branch and Congress could take to reduce fragmentation, overlap, and duplication, as well as other cost savings and revenue enhancement opportunities. This work identifies opportunities for the federal government to save billions of dollars. We also maintain a scorecard and action tracker on our external website where Congress, federal agencies, and the public can monitor progress in addressing our findings. Federal agencies and Congress have made some progress in addressing the 131 areas we identified and taking the 300 actions that we recommended in our 2011 and 2012 reports. High Risk Programs In February 2013 GAO issued the biennial update of our High Risk report, which focuses attention on government operations that are at high risk of fraud, waste, abuse, and mismanagement, or need transformation to address economy, efficiency, or effectiveness challenges. This report, which will be updated in 2015, offers solutions to 30 identified high-risk problems and the potential to save billions of dollars, improve service to the public, and strengthen the performance and accountability of the U.S. government. Our 2013 High Risk work produced 164 reports, 35 testimonies, $17 billion in financial benefits, and 411 program and operational benefits. The major cross-cutting High Risk program areas identified as of September 2013 range from transforming DOD program management and managing federal contracting more effectively, to assessing the efficiency and effectiveness of tax law administration and modernizing and safeguarding insurance and benefit programs. The complete list of high-risk areas is shown on Appendix II. Details on each high risk area can be found at http://www.gao.gov/highrisk/overview. Electronic Protest Docketing System GAO’s FY 2014 budget request sought statutory authority for a new electronic docketing system to be funded by a filing fee collected from companies filing bid protests. The sole purpose of the filing fee would be to offset the cost of developing, implementing, and maintaining the system. We appreciate that the Consolidated Appropriations Act, 2014, directed GAO to develop an electronic filing and document dissemination system under which persons may electronically file bid protests and documents may be electronically disseminated to the parties. GAO is making progress in establishing the electronic protest docketing system. We have convened an interdisciplinary team of experts within GAO to examine matters such as technical requirements, the potential for commercially available systems, fee structure, cost-benefit analysis, and outreach to stakeholders, including representatives from the small business community. GAO will be reporting regularly to the House and Senate Committees on Appropriations on its progress in implementing the system. Watchdog Website In September 2013, GAO launched the Watchdog website, which provides information exclusively to Members and congressional staff through the House and Senate intranets. The new site is designed to provide a more interactive interface for Members and their staff to request our assistance and to access our ongoing work. In addition, Watchdog can help users quickly find GAO’s issued reports and legal decisions as well as key contact information. Strategic Plan for Serving Congress In December 2013, Members and their staff were invited to comment on our draft Strategic Plan for Serving Congress in FYs 2014-2019. The draft plan was issued in February 2014 and outlines our proposed goals and strategies for supporting Congress’s top priorities. Our strategic plan framework (Appendix III) summarizes the global trends, as well as the strategic goals and objectives that guide our work. GAO’s strategic goals and objectives are shown in Figure 1. The draft strategic plan also summarizes the trends shaping the United States and its place in the world. The plan reflects the areas of work we plan to undertake, including science and technology, weapons systems, the environment, and energy. We also will increase collaboration with other national audit offices to get a better handle on global issues that directly affect the United States, including international financial markets; food safety; and medical and pharmaceutical products. These trends include: U.S. National Security Interests; Fiscal Sustainability and Challenges; Global Interdependence and Multinational Cooperation; Science and Technology; Communication Networks and Information Technology; Shifting Roles in Governance and Government; and Demographic and Societal Changes. In the upcoming decade, for example, the US will face demographic changes that will have significant fiscal impacts both on the federal budget and the economy. The number of baby boomers turning 65 is projected to grow from an average of about 7,600 per day in 2011, to more than 11,600 per day in 2025, driving spending for major health and retirement programs. To ensure the updated strategic plan reflects the needs of Congress and the nation, we have solicited comments from stakeholders in addition to Congress, including GAO advisory entities, the Congressional Budget Office, and the Congressional Research Service. Managing Workload by Focusing Resources on Congressional Priorities To manage our congressional workload, we continue to take steps to ensure our work supports congressional legislative and oversight priorities and focuses on areas where there is the greatest potential for results such as cost savings and improved government performance. Ways that we actively work with congressional committees in advance of include 1) identifying mandates real time as bills new statutory mandatesare introduced; 2) participating in ongoing discussions with congressional staff; and 3) collaborating to ensure that the work is properly scoped and is consistent with the committee’s highest priorities. In FY 2013, 35 percent of our audit resources were devoted to mandates and 61 percent to congressional requests. I have met with the chairs and ranking members of many of the standing committees and their subcommittees to hear firsthand feedback on our performance, as well as highlight the need to prioritize requests for our services to maximize the return on investment. Repeal or Revision of Mandates GAO also appreciates Congress’s assistance in repealing or revising statutory mandates that are either outdated or need to be revised. This helps streamline GAO’s workload and ensure we are better able to meet current congressional priorities. During the second session of the 112th Congress, based on our input, 16 of GAO’s mandated reporting requirements were revised or repealed because over time they had lost relevance or usefulness. In addition, GAO worked with responsible committees to have 6 more mandates repealed or revised as part of the 2014 National Defense Authorization Act. GAO has identified 11 additional mandates for revision or repeal and is currently working with the appropriate committees to implement these changes. For example, our request includes language to repeal a requirement for GAO to conduct bimonthly reviews of state and local use of Recovery Act funds. As the vast majority of Recovery Act funds have been spent, GAO’s reviews in this area are providing diminishing returns for Congress. Promoting Good Governance and Accountability GAO is seeking authority to establish a Center for Audit Excellence to improve domestic and international auditing capabilities. The Center also will provide an important tool for promoting good governance, transparency and accountability. There is a worldwide demand for an organization with GAO’s expertise and stature to assume a greater leadership role in developing institutional capacity in other audit offices and provide training and technical assistance throughout the domestic and international auditing communities. The proposed Center would operate on a fee-basis, generating revenue to sustain its ongoing operation, including the cost of personnel and instructors. The Center would be primarily staffed with retired GAO and other auditors, and thus, would not detract from or impact the service GAO provides to Congress. In a similar vein, to provide staff from other federal agencies with developmental experiences, GAO is requesting authority to accept staff from other agencies on a non-reimbursable basis, who can learn about GAO’s work. This would allow people to develop expertise and gain experience that will enhance their work at their own agencies. GAO Recognized as One of the “Best Places to Work” We take great pride in reporting that we continue to be recognized as an employer of choice, and have been consistently ranked near the top on “best places to work” lists. In 2013, we ranked third overall among mid- sized federal agencies on the Partnership for Public Service’s “Best Places to Work” list, and again ranked number one in our support of diversity. Also, in November 2013, Washingtonian Magazine named us as one of the “50 Great Places to Work” in the Washington, D.C. region among public or private entities. In addition, earlier this year, O.C. Tanner, a company that develops employee recognition programs, cited us in its article, “Top 10 Coolest Companies to Work for in Washington, D.C.” Our management continues to work with our union (IFPTE, Local 1921), the Employee Advisory Council, and the Diversity Advisory Council to make GAO a preferred place to work. Fiscal Year 2015 Requirements GAO’s FY 2015 budget request will preserve staff capacity and continue critical infrastructure investments. Offsetting receipts and reimbursements primarily from program and financial audits and rental income totaling $30.9 million are expected in FY 2015. The requested resources provide the funds necessary to ensure that GAO can meet the highest priority needs of Congress and produce results to help the federal government deal effectively with its serious fiscal and other challenges. A summary of GAO’s appropriations for our FY 2010 baseline and FYs 2013 to 2015 is shown in Figure 2. Staff Capacity The requested funding supports a staffing level of 2,945 FTEs, and provides funding for mandatory pay costs, staff recognition and benefits programs, and activities to support congressional engagements and operations. These funds are essential to ensure GAO can address succession planning challenges, provide staff meaningful benefits and appropriate resources, and compete with other agencies, nonprofit institutions, and private firms who offer these benefits to the talent GAO seeks. In order to address the priorities of Congress, GAO needs a talented, diverse, high-performing, knowledgeable workforce. However, a significant proportion of our employees are currently retirement eligible, including 34 percent of our executive leadership and 21 percent of our supervisory analysts. Therefore, workforce and succession planning remain a priority for GAO. Moreover, for the first time in several years our budget allows us to replenish the much needed pipeline of entry level and experienced analysts to meet future workload challenges. In FY 2014, through a targeted recruiting GAO plans to hire entry-level staff and student interns, boosting our staff capacity for the first time in 3 years to 2,945 FTE. This will allow GAO to reverse the downward trend in our FTEs and achieve some progress in reaching our optimal staffing level of 3,250 FTE, and develop a talent pool for the future. Our FY 2015 budget request seeks funding to maintain the 2,945 FTE level. In FY 2015, pending final OPM guidance, we also plan to implement a phased retirement program to incentivize potential retirement eligible staff to remain with GAO and assist in mentoring and sharing knowledge with staff. Improving Internal Operations Efforts to address challenges related to GAO’s internal operations primarily relate to our engagement efficiency, information technology and building infrastructure needs. To better serve Congress and the public, we expanded our presence in digital and social media, releasing GAO iPhone and Android applications, and launching streaming video web chats with the public. During the past year, 7,600 additional people began receiving our reports and legal decisions through our Twitter feed. More than 26,600 people now get our reports, testimonies, and legal decisions daily on Twitter. GAO remains focused on improving the efficiency of our engagements through streamlining or standardizing processes without sacrificing quality. In FYs 2012 and 2013, we continued our improvements in this area. For example, with active involvement from GAO’s managing directors, we identified changes to key steps and decision points in our engagement process and now have a revised engagement process that we began implementing on a pilot basis in January 2014. We also piloted and revised a tool to help teams better estimate expected staff days required for engagements. In FY 2014, we plan to implement a series of process changes that will transform the management of engagements, the use of resources, and message communication. More Efficient Content Creation, Review, and Publication GAO will strive to dramatically improve the efficiency of our content creation and management processes by standardizing, automating, and streamlining the currently cumbersome and manually intensive processes for creating, fact-checking, and publishing GAO products. In FY 2014, we plan to request proposals to acquire a technical solution and phase implementation in FYs 2014 and 2015. The proposed system will automate document routing and approvals, incorporate management and quality assurance steps, and generate required documentation. To ensure our message is available to both our clients and the public, the proposed system capability will also enable GAO to routinely publish content on GAO.gov, GAO’s mobile site, and various social media platforms. Greater Transparency of Engagement Information To promote transparency, increase management capabilities, and reduce duplicate data entry and costs, in FY 2014 GAO will begin implementing a modernized, one-stop engagement management system. This system automates key business rules and decision points, improves resource management, eliminates rework, and provides increased visibility for all participants. In FY 2015, we will retire legacy databases as the new system becomes fully operational. The FY 2015 budget also provides funds to maintain our information technology (IT) systems, which are a critical element in our goal to maintain efficient and effective business operations and to provide the data needed to inform timely management decisions. Improvements to our aging IT infrastructure will allow GAO to further streamline business operations, reduce redundant efforts, increase staff efficiency and productivity, improve access to information, and enhance our technology infrastructure to support an array of engagement management, human capital, and financial management systems. GAO also plans to continue upgrading aging building systems to ensure more efficient operations and security. To support these requirements our FY 2015 budget request includes resources to: begin upgrading the heating, ventilation, and air conditioning system to increase energy efficiency and reliability; repair items identified in our long-range asset management plan, such as the water heater, chiller plant, and cooling fans; enhance continuity planning and emergency preparedness address bomb blast impact mitigation efforts. Concluding Remarks In conclusion, GAO values the opportunity to provide Congress and the nation with timely, insightful analysis. The FY 2015 budget requests the resources to ensure that we can continue to address the highest priorities of Congress. Our request seeks an increase to maintain our staffing level and provide employees with the appropriate resources and support needed to effectively serve Congress. The funding level will also allow us to continue efforts to promote operational efficiency, and begin addressing long-deferred investments and maintenance. This concludes my prepared statement. I appreciate, as always, your continued support and careful consideration of our budget. I look forward to discussing our FY 2015 request with you. Appendix I: Selected Testimony Topics for FY 2013, by Strategic Goal Goal 1:Address Current and Emerging Challenges to the Well-being and financial Security of the American People • Water Infrastructure • Goal 2:Respond to Changing Security Threats and the Challenges of Global Interdependence Appendix II: GAO’s 2013 High Risk List Strengthening the Foundation for Efficiency and Effectiveness Limiting the Federal Government’s Fiscal Exposure by Better Managing Climate Change Risks (new) Management of Federal Oil and Gas Resources Modernizing the U.S. Financial Regulatory System and Federal Role in Housing Finance Restructuring the U.S. Postal Service to Achieve Sustainable Financial Viability Funding the Nation’s Surface Transportation System Strategic Human Capital Management Managing Federal Real Property Transforming DOD Program Management DOD Approach to Business Transformation DOD Business Systems Modernization DOD Support Infrastructure Management DOD Financial Management DOD Supply Chain Management DOD Weapon Systems Acquisition Ensuring Public Safety and Security Mitigating Gaps in Weather Satellite Data (new) Appendix III: GAO’s Strategic Plan Framework This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

GAO's fiscal year (FY) 2015 budget request of $525.1 million seeks an increase of 3.9 percent to maintain staff capacity as well as continue necessary maintenance and improvements to our information technology (IT) and building infrastructure. Additionally, receipts and reimbursements, primarily from program and financial audits, and rental income, totaling $30.9 million are expected in FY 2015. GAO recently issued our draft Strategic Plan for Serving Congress in FYs 2014-2019. The plan outlines our proposed goals and strategies for supporting Congress's top priority. I also have met with the Chairs and Ranking Members of many of the standing committees and their subcommittees to hear firsthand feedback on our performance, as well as prioritize requests for our services to maximize the return on investment. In order to address Congressional priorities, and fulfill GAO's mission, a talented, diverse, high-performing, knowledgeable workforce is essential. Workforce and succession planning remain a priority for GAO. A significant proportion of our employees are currently retirement eligible, including 34 percent of our executive leadership and 21 percent of our supervisory analysts. In 2014, through a targeted recruiting strategy to address critical skills gaps, GAO plans to boost our employment level for the first time in 3 years to 2,945 Full Time Equivalents (FTE). The requested FY 2015 funding level will preserve strides planned for FY 2014 to increase our staff capacity. In conjunction with the ongoing recruiting efforts and planning, we will revive our intern program and hire and train an increased number of entry level employees. This will reverse the downward staffing trajectory, develop a talented cadre of analyst and leaders for the future, achieve progress in reaching an optimal FTE level of 3,250 FTE, and assist GAO in meeting the high priority needs of Congress. We also take great pride in reporting that we continue to be recognized as an employer of choice, and have been consistently ranked near the top on "best places to work" lists. Improvements to our aging IT infrastructure will allow GAO to further streamline business operations, increase staff efficiency and productivity, as well as improve access to information. Planned investments in IT will address deferred upgrades and enhance our technology infrastructure to support an array of engagement management, human capital, and financial management systems. We also plan to continue upgrading aging building systems to ensure more efficient operations and security. Areas of focus include, increasing the energy efficiency and reliability of the heating, ventilation, and air conditioning system; enhancing continuity planning and emergency preparedness capabilities; and addressing bomb blast impact mitigation efforts.

Background JIEDDO was created by the Deputy Secretary of Defense in January 2006 and is responsible for leading, advocating, and coordinating all DOD efforts to defeat IEDs. Prior DOD efforts to defeat IEDs included various process teams and task forces. For example, DOD established the Joint IED Defeat Task Force in June 2005 for which the Army provided primary administrative support. This task force replaced the Army IED Task Force, the Joint IED Task Force, and the Under Secretary of Defense, Force Protection Working Group. To focus all of DOD’s efforts and minimize duplication, DOD published new IED policy in February 2006 through DOD Directive 2000.19E, which changed the name of the Joint IED Defeat Task Force to JIEDDO and established it as a joint entity and jointly manned organization within DOD, reporting to the Deputy Secretary of Defense. The directive states that JIEDDO shall “focus (lead, advocate, and coordinate) all Department of Defense actions in support of the Combatant Commanders’ and their respective Joint Task Forces’ efforts to defeat Improvised Explosive Devices as weapons of strategic influence.” The organization is directed to identify, assess, and fund initiatives that provide specific counter-IED solutions, and is granted the authority to approve joint IED defeat initiatives valued up to $25 million and make recommendations to the Deputy Secretary of Defense for initiatives valued over $25 million. Under the directive, the Army remains the organization’s executive agent and is responsible for providing primary administrative support to JIEDDO. JIEDDO’s primary role is to provide funding to the military services and DOD agencies to rapidly develop and field counter-IED solutions. Prior to fiscal year 2007, JIEDDO did this by working with the DOD Comptroller to transfer its appropriated funds into a standard DOD appropriation account, such as one for procurement or one for research, development, testing, and evaluation. JIEDDO would then send these transferred funds to the military service that is designated to sponsor the initiatives using a Military Interdepartmental Purchase Request (MIPR). Beginning in fiscal year 2007, Congress provided JIEDDO with its own separate direct appropriation, but it still must transfer funds to the military services using a duly authorized and signed MIPR, which the Defense Federal Acquisition Regulation Supplement (DFARS) Subpart 208.7004 (Procedures, Guidance, and Information (PGI) 208.7004) states is the acquiring department’s authority for acquiring the goods or services on the requiring department’s behalf. DFARS PGI 208.7004 also states that the acquiring department, or military service, is then authorized to create obligations against the funding without further referral to the requiring department—JIEDDO— and that the military service has no responsibility to determine the validity of an approved MIPR. Therefore, after JIEDDO provides funding authority to the military service and the designated program manager for a specific initiative, the service program manager, not JIEDDO, is responsible for managing the initiatives for which JIEDDO has provided funds. JIEDDO’s efforts to counter the use of IEDs and subsequent funding for those efforts are organized according to three primary lines of operation: (1) attack the network that enables the use of IEDs, (2) defeat the IED itself once emplaced, and (3) train the military forces in counter-IED techniques. JIEDDO assigns all funds used to one of these lines of operation—or to a fourth line of operation called staff and infrastructure for miscellaneous expenditures not directly related to the three lines of operation. When JIEDDO undertakes any effort requiring funds, it assigns the funds for the effort to one of the lines of operations. JIEDDO further breaks down its expenditures into more detailed subsets, which it designates as initiatives, assigning a name and a unique number to track expenditures related to each initiative. JIEDDO manages and reports on all funds expended by line of operation and by initiative. Office of Management and Budget (OMB) Circular A-123 specifies that federal agencies have a fundamental responsibility to develop and maintain effective internal control that ensures the prevention or detection of significant weaknesses—that is, weaknesses that could adversely affect the agency’s ability to meet its objectives. According to OMB, the importance of management controls is addressed in many statutes and executive documents. A memorandum from the OMB Director to the heads of the executive departments accompanying OMB Circular A-123 as an attachment requires agencies and individual federal managers to take systematic and proactive measures to develop and implement appropriate, cost-effective internal controls for results-oriented management. FMFIA establishes the overall requirements with regard to internal control. Accordingly, an agency head must establish controls that reasonably ensure that (1) obligations and costs are in compliance with applicable law; (2) funds, property, and other assets are safeguarded against waste, loss, unauthorized use, or misappropriation; and (3) revenues and expenditures applicable to agency operations are properly recorded and accounted for to permit the preparation of accounts and reliable financial and statistical reports and to maintain accountability over the assets. Specific internal control standards underlying the internal controls concept in the federal government are promulgated by GAO and are referred to as the Green Book. In March 2007, the Senate Appropriations Committee directed JIEDDO to identify and track all civilian, military, and contractor personnel in the organization. In addition, DOD Directive 1100.4, “Guidance for Manpower Management,” provides that DOD components shall designate an individual with the authority to establish and maintain a manpower data system that accounts for all manpower resources, to include active military, DOD civilian, reserve component, contract, and host-nation support. The Senate Appropriations Committee, in its report on emergency supplemental appropriations, expressed concern over JIEDDO’s exponential personnel growth and ability to track this growth. The report stated that the committee has limited visibility into current staffing and future staffing requirements and is concerned that JIEDDO is not accounting for certain contractor support properly. As a result of these concerns, the committee directed JIEDDO to provide a report to the congressional defense committees on current staffing levels and future staffing requirements, broken down by function, contractor, civilian, military, and detailed from other agencies, and should include all contractor support that is provided through various contracts. The committee further directed JIEDDO to update this report whenever JIEDDO personnel authorizations change. In response to the committee’s direction, JIEDDO officials developed the JIEDDO Manning Description in May 2007 identifying and accounting for civilian, military, and contractor personnel working for JIEDDO. JIEDDO Has Taken Steps to Improve Financial Management Processes but Lacks Effective Internal Controls to Provide Assurances That Its Financial Data Are Accurate and Provide Transparency over Its Operations JIEDDO has made progress in improving its financial management processes but has not yet reached a point where its processes contain a system of internal control that ensures the accuracy of its financial data related to resources it has used in its operations. According to federal standards, internal control comprises the plans, methods, and procedures used to meet missions, goals, and objectives of an organization and help it to achieve desired results through effective stewardship of public resources. In addition, our prior work has stated the importance of organizations addressing internal control weaknesses. Otherwise, organizations may not achieve their objectives or may not use their resources to best advantage in achieving their objectives. Before beginning fiscal year 2007 operations, JIEDDO took several steps to improve its processes for managing and controlling its financial resources, and JIEDDO has been proactive in responding to financial management issues we raised during this audit by pursuing additional financial management process improvements. Nonetheless, JIEDDO is lacking an effective system of internal control that will provide adequate assurances of financial data accuracy and operations transparency. Although JIEDDO added changes toward the end of our review that are expected to address internal control weaknesses, their implementation occurred too late for us to determine their effectiveness. Nonetheless, in the absence of an adequate system of internal controls, inaccurate financial data and reports may negatively affect the internal and external decision-making process. JIEDDO Has Taken Steps to Improve Its Financial Management Processes JIEDDO has taken several steps to improve its financial management processes. JIEDDO’s actions are divided into (1) those taken in preparation for the beginning of fiscal year 2007 operations and (2) those taken to develop and continually improve on its operations. JIEDDO’s approach for fiscal year 2007 included three changes aimed at streamlining and reducing data processing and analysis. The first of these changes was that JIEDDO took direct control of accounting functions previously performed by Army activities in support of JIEDDO. This allowed JIEDDO to directly execute and oversee funds budgeted and made available to JIEDDO. Second, JIEDDO requested and received a separate appropriation exclusively for its efforts, without having to obtain approval for funds through other DOD funding streams. Third, JIEDDO developed a procedure for assigning distinct numbers to specific initiatives because some initiatives were referred to by more than one name. The assignment of numbers eliminated confusion over the name of the initiative and facilitated the automated transfer of data, which was not possible using only a descriptive name. JIEDDO’s more recent actions were taken as part of its efforts to fully establish its organizational framework as the organization evolves and to continually improve its processes. These actions include issuing an internal written instruction describing the roles and responsibilities of JIEDDO subdivisions in greater detail; developing internal controls imbedded in a new automated document management and storage system; and establishing a new internal control audit function to be staffed by three persons, reporting directly to the JIEDDO Director. While these actions could address JIEDDO’s internal control weaknesses, they have not yet been fully implemented and occurred too late for us to determine their effectiveness. JIEDDO Lacks Effective Internal Controls to Provide Assurances That Its Financial Data Are Accurate, and JIEDDO Is Unable to Provide Transparency over Its Operations JIEDDO does not have an effective internal control system in place to ensure that its financial data are accurate, and without such assurances, JIEDDO is unable to provide adequate transparency over the cost of its operations. The ability of JIEDDO to provide accurate financial information for internal and external decision makers depends on management accountability and an effective system of internal control. Consistent with federal standards, JIEDDO would need to adequately document its financial management processes and procedures, including related internal controls, and the internal control system would contain basic elements providing assurance that proper authorization is obtained before using funds and that once a transaction occurs it is accurately and promptly recorded. Furthermore, developing adequate oversight mechanisms within JIEDDO is a key factor in developing the conscientious control environment required by federal standards. However, although our review was not designed to identify all significant deficiencies in internal control, we identified four weak control areas at JIEDDO, which individually and collectively precluded adequate assurances of accuracy and usefulness of financial data produced by JIEDDO’s financial management operations. JIEDDO does not have (1) comprehensive documentation of its internal controls, (2) adequate funds authorization controls, (3) sufficient controls to ensure accurate categorization of transactions, and (4) an adequate process to monitor and review its internal control program. First, JIEDDO’s internal control processes related to its financial management are not adequately documented as required by government internal control standards. Specifically, JIEDDO has not developed management directives, administrative policies, or operating manuals that comprehensively describe how JIEDDO financial management personnel should perform their duties and the internal control activities designed to assure management that those duties are timely and accurately performed. As a result, we found inconsistent financial management control processes among JIEDDO staff and managers. For example, while DOD’s JIEDDO directive divides approval authority for JIEDDO initiatives between the Deputy Secretary of Defense—initiatives valued at greater than $25 million—and JIEDDO itself—initiatives valued up to $25 million, DOD did not adequately define in its directive the terms initiative or value with respect to which initiatives measure over or below $25 million. Not defining terms would affect interpretation for both those with approval authority and those making processing and authorization control decisions. As a result, when determining whether an initiative should be forwarded to the Deputy Secretary of Defense for approval—a key external authorization control—or whether the authority rests within JIEDDO itself because the value does not exceed $25 million, various JIEDDO officials and contractors provided us with varying descriptions for value determination (see table 1 for a listing of varying descriptions). However, any of these approaches could significantly change an initiative’s value calculations and consequently affect JIEDDO’s approval control decision process. In November 2007, JIEDDO issued an instruction that included further guidance on how to determine what constitutes an initiative for the purposes of requiring approval by the Deputy Secretary of Defense. However, this instruction has not yet been incorporated into financial management operating procedures to ensure that staff understand the definition and apply it consistently when processing transactions. According to JIEDDO officials, the instruction, while better documenting the initiative determination and approval processes, does not provide adequate detail to constitute sufficient standard operating procedures for the components of JIEDDO. JIEDDO officials added that they have planned to form internal teams in the upcoming months to develop the more detailed operating procedures JIEDDO components need to implement this instruction. Second, JIEDDO’s internal control system does not have adequate funds authorization controls to ensure that transactions are properly authorized before committing funds, which is a fundamental control activity required by government internal control standards. We reviewed 24 initiatives of which 18 had funding transactions totaling $795 million that were not authorized in accordance with the process that JIEDDO officials said should take place in advance of the commitment of funds on initiatives valued at greater than $25 million. JIEDDO officials stated that approval of the Deputy Secretary of Defense had to be obtained before funds could be committed on initiatives valued at greater than $25 million. Fourteen of the 18 initiatives received the required Deputy Secretary of Defense authorization after JIEDDO financial management personnel committed funds by approving the MIPR to transfer funds from JIEDDO to the external program manager for the initiative. For example, JIEDDO spent about $8 million in the first quarter of fiscal year 2007 for an initiative that it expected would, overall, require $57 million for that fiscal year. Since that overall amount exceeded the $25 million value determination that requires the approval of the Deputy Secretary of Defense, JIEDDO acted before obtaining required authorization. JIEDDO did obtain Deputy Secretary of Defense approval for this initiative, but it was approximately 3 months after JIEDDO had committed funds for this initiative. In another case, the financial management division initially refused to commit funds for one initiative exceeding $25 million until JIEDDO management obtained approval from the Deputy Secretary of Defense. However, JIEDDO management’s response was to request funds for only one quarter’s expenses, thus reducing the amount to under $25 million. According to documentation in the file, the financial management division then agreed to fund the amount and commit the funds, even though it was aware that total program costs exceeded $25 million for the fiscal year. Subsequently, JIEDDO’s legal advisor determined that the project was not an initiative because it was considered part of JIEDDO’s infrastructure costs and thus did not require approval by the Deputy Secretary of Defense. Nevertheless, although JIEDDO eventually decided approval was not required, the process for approving funds for this project demonstrates a breakdown in the internal control structure necessary to ensure proper authorization before funds are spent, since JIEDDO officials avoided obtaining approval even though they thought prior approval was required. Additionally, it is not clear whether 4 of the 18 initiatives were authorized prior to commitment of funds because authorization letters were not dated, making the time of authorization unverifiable. It is clear, however, that inconsistent with JIEDDO processes, officials within JIEDDO made several funding commitments prior to obtaining the approvals required by JIEDDO processes. This underscores that JIEDDO’s system of internal control allowed funds to be committed without the scrutiny of authorizing agents. Furthermore, the system did not detect, correct, or address this control failure. Third, JIEDDO internal controls do not ensure that its transactions are properly categorized, in spite of federal internal control standards requiring that accurate transaction recording be ensured by an entity’s internal control system. For example, JIEDDO used about $216 million on an initiative titled “CREW — USMC - Program Management Support (Contractor Salaries, Travel & Infrastructure),” recording the expenditure as management and professional support services. However, the $216 million actually funded the purchase of tangible equipment—IED jammers—and therefore should have been recorded as procurement of equipment instead. Overall, of the $1.34 billion in fiscal year 2007 commitments we reviewed, JIEDDO inaccurately recorded at least 83 percent of the dollars committed—involving 15 of the 24 initiatives we reviewed—as management and professional support services, when other categorizations should have been applied by JIEDDO financial managers. JIEDDO’s system of internal control also does not ensure that all transactions are accurately recorded in the proper JIEDDO lines of operation, and this could distort reported expenditures on these lines of operation. A key part of JIEDDO’s overall strategy to manage operations is to code various initiatives to reflect one of four JIEDDO lines of operation to track success in achieving the overall goal of increased effort to attack the IED network. According to officials, JIEDDO policy is to assign a single line-of-operation code to each initiative even when operations overlap, which may result in the reported funding for a given line of operation being inaccurate. For example, JIEDDO’s initiative involving the testing of counter-IED devices (constituting $92 million in fiscal year 2007 funds) was coded as an attack-the-network effort, when our analysis indicates that the initiative more accurately represents JIEDDO’s defeat- the-device line of operation. When originally established, JIEDDO coded its testing efforts as staff and infrastructure, which reflects general overhead incurred by JIEDDO, and reported the initiative as such in its second quarter congressional report. However, subsequently JIEDDO recoded the initiative and reported it as an attack-the-network initiative in its third quarter congressional report. We found four other instances of JIEDDO recoding initiatives in the attack-the-network line of operations that also affected the third quarter report. JIEDDO officials explained that the recoding was based on a JIEDDO decision to code or recode any nondirect overhead staff and infrastructure initiatives as attack-the- network initiatives. They did not have supporting documentation reflecting JIEDDO’s decision to recode. Documented directions would serve to track the rationale for how this line of operation was coded and recoded. The blanket assignment of direct overhead costs to the attack- the-network line of operation, along with reassigning lines of operation after initial recording affects JIEDDO’s ability to accurately determine trends in the use of funds in conjunction with its attack the network objective. Further, in the case of the testing operations, funding for attack the network is overstated because, according to JIEDDO officials, the majority of testing operations can be attributed to other lines of operation. Fourth, JIEDDO’s internal process to monitor and review the efficacy of its internal controls is inadequate. The first federal government internal control standard, relating to an entity’s control environment, includes having oversight mechanisms present within the agency as a key factor in accomplishing a conscientious control environment. However, JIEDDO appeared to lack adequate mechanisms to monitor and review its internal control program during the period of our audit. In a May 2007 internal control report that JIEDDO prepared for the annual DOD internal controls assurance statement, JIEDDO described its process for assessing its controls and, based on that assessment, stated that it was able to provide an unqualified statement of reasonable assurance that its system of internal controls met federal internal control objectives. However, we found several inaccurate statements in the report that were used as the basis for this conclusion, raising questions about the adequacy of JIEDDO’s process for assessing its internal control system and determining reasonable assurance. For example, the financial management section of the report cited four final audit reports from the Air Force Audit Agency, DOD Program Analysis and Evaluation, the DOD Inspector General, and GAO. According to JIEDDO, these reports said the organizations reviewed JIEDDO financial management for activity beginning in fiscal year 2004 and did not have findings or recommendations. However, two of the reports cited do not exist (those for the Air Force Audit Agency and DOD Program Analysis and Evaluation), and the DOD Inspector General report focused on assessing controls over the Army’s purchases from other government activities, not on JIEDDO’s internal control system. Further, that report concluded that the Army did not have adequate internal controls over purchases from governmental sources, which included one JIEDDO fiscal year 2006 expenditure, because the Army did not ensure that expenditures were properly initiated, prepared, executed, and monitored. Lastly, the GAO report cited is the predecessor to this review, and it concluded that JIEDDO’s lack of a strategic plan limits JIEDDO’s ability to properly align its resource use and management to achieve JIEDDO-wide goals. The report, however, did not provide any assessment of JIEDDO’s internal control system. Another question about the adequacy of JIEDDO’s internal control assessment process and related assurance report concerns JIEDDO’s statement that training of its staff has improved internal controls. However, some of the individuals who actually prepared feeder sections of the report had not received any training on internal controls or how to assess them. Further, some of these individuals are not familiar with the internal control standards and the structured internal control risk assessment. We did not assess JIEDDO’s stated basis for reasonable assurance of its internal control standards in its entirety because of the inaccuracies found relating to resource management and training sections of the report and because JIEDDO’s report did not identify the significant control weaknesses we found, such as JIEDDO’s noncompliance with authorization controls and inaccurate classification of expenditures. As evidenced by these four weaknesses, in the absence of an adequate system of internal control the objectives of the agency may not be fully achieved and its use of resources may not be fully consistent with DOD priorities. Furthermore, decision makers may be basing their decisions on inaccurate financial data and reports. JIEDDO officials stated that their efforts to develop an effective financial management program have been significantly challenged by turnover in key financial positions and difficulties hiring adequate numbers of staff. In discussing these internal control findings at the end of our fieldwork, JIEDDO managers said that they have taken several actions to address and correct these weaknesses, which we noted previously. JIEDDO believes that these actions have already improved the internal control weaknesses found; however, the changes are still in the early implementation stages, and as such, we have not been able to evaluate their effectiveness in improving JIEDDO’s internal control system. JIEDDO Does Not Comprehensively Identify, Track, and Report All Government and Contractor Personnel as Described by DOD JIEDDO does not fully identify, track, and report all government and contractor personnel as provided for in DOD Directive 1100.4. Identifying all government and contractor personnel is important to JIEDDO’s management and oversight responsibilities and contributes to its ability to effectively plan for its future workforce needs. DOD Directive 1100.4 states that it is DOD policy that manpower requirements be established at the minimum levels necessary to accomplish mission and performance objectives. It follows that a manpower data system that accurately accounts for all personnel, to include contractors, enables manpower management that promotes efficient and effective use of manpower resources. While JIEDDO employs various DOD policies to manage civilian and military personnel, these policies do not include accurately accounting for all of its personnel, as described in DOD Directive 1100.4. According to JIEDDO personnel officials, JIEDDO applies existing DOD policies to address administrative issues, such as performance, pay, and leave. JIEDDO also refers to the Federal Acquisition Regulation that includes personnel policy and procedures that are specific to the acquisition and management of services by contract. Additionally, JIEDDO issues policy letters as needed to clarify personnel management issues. For example, JIEDDO issued policy letter #16A that directed the division chiefs to be aware of the number of hours all employees, including contractor personnel, were working, and directed all employees to report all hours worked and obtain approval for their schedules from their supervisors. Nonetheless, these approaches do not identify, track, and report all military, civilian, and contractor personnel. JIEDDO officials track civilian, military, and some contractor personnel on a daily basis to identify personnel currently staffed and determine positions remaining to be filled; however, this effort does not track all personnel performing work for JIEDDO. For example, JIEDDO does not include some or all of personnel in the following categories: contractors working as field service representatives, contractors engaged as interagency liaisons, contractors providing law enforcement training, contractors involved in JIEDDO’s interagency partnership team, civilians and contractors from JIEDDO’s Joint Test Board, and contractors maintaining infrastructure at the Counter-IED Operations Integration Center (COIC) facilities. Personnel officials said that these data are collected to identify changes in JIEDDO’s on-hand strength as personnel leave or are newly assigned and are not intended to be a comprehensive data collection. We reviewed JIEDDO’s daily report from October 9, 2007, which shows that JIEDDO had 321, including civilian, military, and some contractor personnel, out of 418 authorized positions. The Senate Appropriations Committee directed JIEDDO to provide a comprehensive report of all of its personnel by May 2007, and because JIEDDO does not have a comprehensive process to track all personnel, it relied on an ad hoc process to develop the report. The results identified a total of 1,466 personnel working for JIEDDO, as compared to the 321 personnel filling 418 positions routinely tracked by the organization in its daily snapshots. The figures in the report to Congress tripled the number of personnel overall and showed a ratio between contractor and government personnel of nearly 5 to 1 when compared with the figures in the daily snapshots. We were not assured of the accuracy of those figures in the congressional report given the lack of guidance or evidence of a process that would indicate reasonable accuracy in identifying and reporting all categories of government and contractor personnel. JIEDDO officials also said that the organization lacked procedures for identifying and tracking all of its personnel. When we reviewed the report, we discovered inaccuracies and inconsistencies in the data that led us to conclude that about 114 personnel had been omitted from the report: 25 civilian positions and about 30 contractor personnel with the Joint Test Board, all funded by JIEDDO since JIEDDO funds all of the board’s operations costs, including these positions, and 59 contractor personnel working as field service representatives who were not included for one initiative but were reported in JIEDDO’s funding documentation. In addition, we also found 67 personnel who were not reported in the body of the report but were reported in JIEDDO’s summary schedule of personnel, and 9 additional authorized intern positions that were included in the report but were not included in JIEDDO’s daily snapshots. When accounting for personnel, different divisions may have applied inconsistent criteria as they collected data for the May 2007 congressional report because JIEDDO officials did not provide formal guidance to the divisions on how to report some personnel. For example, JIEDDO officials said that they could not tell whether the 474 field service representatives reported reflected actual individuals or full-time equivalents, which could represent more than one individual. At the conclusion of our review, JIEDDO officials were still unable to clarify this issue. In addition to the fact that the figure could be higher or lower, JIEDDO officials further explained that the reported field service figure of 474 was inaccurate because JIEDDO subsequently determined that the number for one initiative included in the data contained a significant error. JIEDDO had no means to track and verify the accuracy of its figures presented in the May 2007 report because officials did not maintain adequate supporting documentation representing how they arrived at their figures. For example, when JIEDDO accounted for field service representatives, we asked JIEDDO officials for clarification on how they arrived at the number of contractors they reported. However, they could not explain adequately because they did not document the process and their recollections were admittedly incomplete. Without adequate supporting documentation, JIEDDO cannot provide assurance that the data it reports are accurate. Furthermore, with change of personnel, which is typical within JIEDDO, new personnel would have difficulty determining the accuracy of figures as well as what process to follow to prepare subsequent reports. Although JIEDDO has not routinely tracked all of its contractors, it has relied heavily on contractor support to accomplish its mission since its creation in February 2006. According to JIEDDO officials, this reliance on contractors was attributed to the lengthy and complex civilian hiring process, the inability of the military services to fill all of the services’ authorized positions, and the urgency of the organization’s mission. Contractors have performed a broad range of labor and services for JIEDDO. Examples of functions contractors have performed include evaluating initiative proposals from outside contractors, piloting unmanned aerial vehicles, managing a division’s efforts to develop useful metrics, conducting virtually all of the day-to-day management of the various functions at the COIC, and providing equipment maintenance and logistics support in theater for new initiatives. In addition to playing significant roles in accomplishing JIEDDO’s mission, contractors have also held critical positions within JIEDDO management and might have had a significant influence on its decision making. In the recent past, JIEDDO employed contractor personnel for positions the organization designated as inherently governmental. OMB defines an inherently governmental function as one involving the exercise of substantial discretion in applying government authority, making decisions for the government, or both. JIEDDO personnel documentation showed that the organization had staffed contract personnel in positions of key governmental responsibility, and officials stated that the organization is in the process of resolving this practice. In July 2007, JIEDDO officials began transitioning government personnel—primarily temporary military staff— into these positions that until recently were held by contractors. According to JIEDDO officials, the organization is moving toward filling these positions with permanent government personnel. JIEDDO officials said that they did not believe tracking all contractor personnel was necessary because they are not considered JIEDDO staff, and consequently, JIEDDO has not developed a comprehensive process to identify, track, and report all personnel in accordance with DOD policy. However, without a comprehensive process, JIEDDO is not in a position to readily provide accurate and reliable information to internal and external decision makers on its staffing levels. For example, when the Senate Appropriations Committee directed JIEDDO to identify and report on staffing levels of civilian, military, and contractor staff, JIEDDO officials used ad hoc data requests to divisions they receive information from in their daily reports and to activities that are not being captured by the current process in order to collect information on contractor personnel. Despite responding to the committee’s direction for a May 2007 report and its direction to update this report to reflect future personnel changes, JIEDDO officials have not developed a policy requiring the collection of data accounting for all categories of personnel or provided guidance for doing this accurately. Additionally, without a comprehensive process to track all government and contractor personnel, JIEDDO cannot be in a position to effectively plan for its future workforce needs. For example, according to a JIEDDO official, in the case of one initiative JIEDDO needed to compare unmanned aerial vehicle piloting alternatives, contracted versus in-house, and it was critical for JIEDDO to know the quantity of and functions of contractor staff employed under the existing contract. However, because JIEDDO’s manpower management system does not routinely capture contractor staff information, it would have been difficult for JIEDDO to determine whether to continue the contract without finding an alternative source for this information. For this initiative, JIEDDO was able to obtain the information needed through detailed contract information that happened to be available. However, according to the JIEDDO official, these details are not always routinely available, depending on the type and terms of the contract. Our prior work also highlights the importance of accounting for and providing effective oversight of contractors. A recent report concerning the management and oversight of contractor support for deployed forces addresses the issue of limited visibility over the number of contractors deployed with U.S. forces and potential problems with planning for security and logistics needs if the numbers of contractors are not known to military commanders in theater. JIEDDO deploys contractor personnel in the theater to assist with counter-IED solutions. JIEDDO does not track the number of contractors it employs, and yet its May 2007 report indicates that the number can significantly affect how JIEDDO uses its resources and plans for future needs. Conclusions As IEDs continue to pose a significant threat to U.S. forces in Iraq and Afghanistan, defeating the threat continues to be a high defense priority. This likely will require a continued significant investment in resources, both financial and human capital. The volume of resources required, coupled with the scale and span of JIEDDO’s mission to focus all DOD counter-IED efforts, creates a challenge to achieving efficient and best use of funding made available to JIEDDO. However, DOD and JIEDDO cannot adequately manage JIEDDO’s financial and human capital resources if it does not have an effective system of internal control to provide reliable data and insight into how these resources are invested, and external parties cannot be assured that the information JIEDDO reports is reasonably accurate, complete, and transparent. Consequently, because of the absence of adequate internal controls and of a comprehensive efficient method for identifying, tracking, and reporting JIEDDO’s human capital resources, JIEDDO’s systems currently cannot efficiently provide the data and insight needed for internal management. Further, Congress is limited in its oversight of JIEDDO’s current and future requirements, the organization’s substantial use of contractors, and the organization’s use of resources to support its mission because of the unreliable information JIEDDO has reported. JIEDDO officials are not fully aware of how their personnel resources are being spent, and cannot fully plan for future workforce needs if their baseline information on current funds use and workforce composition is inaccurate. Although JIEDDO has taken several actions to improve its internal control system, as we noted in this report, these actions have not yet been fully implemented. As such, it is important that JIEDDO evaluate its recent actions to ensure that they will address the control weaknesses we identified and provide for a system of internal control that fully meets federal standards. Improving JIEDDO’s internal controls and the quality of its financial and personnel data is critical to assuring Congress and the public that JIEDDO is focusing all of its resources and using them wisely to address the threat of IEDs to U.S. forces. Recommendations for Executive Action To comply with federal internal control standards as well as improve the quality of JIEDDO’s financial management and the reliability of resulting financial data and reports, we are recommending that the Secretary of Defense direct the Director of JIEDDO to develop and document a comprehensive system of internal control for its financial management processes. Actions to develop and implement JIEDDO’s system of internal control to address specific control weaknesses we identified should, at a minimum, include the following: Fully documenting all internal control processes and procedures related to its financial management through the development of management directives, administrative policies, standard operating procedures, or other documentation that describe how JIEDDO personnel should perform their duties. Establishing effective controls to ensure that transactions are properly authorized before funding is executed, related documentation supporting transactions is accurately dated, and exceptions are properly approved and documented. Establishing effective controls to ensure that all transactions are properly classified by lines of operation and other expenditure categories used by JIEDDO, and to promptly and properly correct misclassifications when identified. Developing an internal process, to include involvement of its internal audit staff, to routinely monitor and review the efficacy of JIEDDO’s system of internal control and promptly correct any weaknesses identified. We are also recommending that the Secretary of Defense direct the Director of JIEDDO to report to Congress on the status of its efforts to implement its comprehensive system of internal control 1 year from the date of this report. To improve JIEDDO personnel or manpower management and provide Congress with the information it needs to perform its oversight duties effectively, we are recommending that the Secretary of Defense direct the Director of JIEDDO to establish and document a method or system to comprehensively identify, track, and report on a routine basis all government and contractor personnel. Agency Comments and Our Evalutaion In written comments on a draft of this report, DOD concurred with our findings and the thrust of our six recommendations. However, DOD did not concur with our fifth recommendation as originally stated in our draft report, which was to report on JIEDDO’s efforts to implement internal control improvements as part of JIEDDO’s recurring quarterly congressional reports. In its response, DOD proposed an alternative means for providing this information to the Armed Services and Appropriations Committees. DOD said that the focus of its quarterly report to Congress is to describe the IED threat and associated counter-IED efforts, and that adding the additional information we recommended would blur the focus of the report. DOD stated that instead, JIEDDO can produce and provide a report to the oversight committees 1 year after the issuance of our report as to the steps JIEDDO has taken to address and correct the weaknesses we identified. We believe that this approach satisfies the intent of our original recommendation and consequently we modified our recommendation to reflect this change. In commenting on our four recommendations dealing with internal control and financial management, JIEDDO provided several details of the actions it plans or said it has already taken to address the recommendations. While we acknowledge that JIEDDO management recognizes the importance of addressing the weaknesses we identified in our report, we maintain that more needs to be done before the weaknesses are fully corrected. For example, regarding our recommendation to develop documented internal control processes and procedures that describe how JIEDDO personnel should perform their duties, JIEDDO responded that it has established and fully implemented an internal control system, identifying four specific efforts for illustration. However, the specific efforts listed do not fully support JIEDDO’s statement that needed controls and operating procedures are fully developed. One of the efforts cited was JIEDDO’s November 2007 Capability Approval and Acquisition Management Plan instruction. While we agree and reported that this instruction is an important step in developing documented processes, it does not contain operating procedures developed to the level we recommended because JIEDDO divisions had not developed and documented roles, responsibilities, and specific procedures for implementing the JIEDDO Capability Approval and Acquisition Management Plan. As of February 2008, JIEDDO was still developing and documenting these roles, responsibilities, and specific procedures for implementing the JIEDDO Capability Approval and Acquisition Management Plan. Consequently, the degree to which JIEDDO has implemented this recommendation is unclear and additional action on JIEDDO’s part may be needed. In commenting on our sixth recommendation regarding establishing and documenting a method to comprehensively identify, track, and report government and contractor personnel, JIEDDO included extensive background information on its existing personnel processes and improvement efforts it is undertaking. However, more remains to be done in order to fully implement our recommendation. For example, while JIEDDO stated that it is in the process of accounting for contractors maintaining COIC facilities, JIEDDO did not identify any additional efforts to account for the remainder of contractor personnel cited in our report or any specific steps it plans to take to establish and document a method or system to comprehensively identify and track all personnel. Instead, JIEDDO explained that it does not track certain classes of personnel working in direct support of JIEDDO because these persons are already accounted for by other organizations in DOD. Consequently, JIEDDO’s insight into its human capital is limited because it excludes tracking certain manpower funded by the JIEDDO appropriation, such as personnel directly working for the Joint IED Defeat Test Board, whose workload is performed exclusively in support of testing JIEDDO initiatives. We recognize JIEDDO’s comments regarding the responsibility of the military, DOD, and other government agencies in providing oversight and reporting of their staff who may be assigned to work in support of the JIEDDO mission. However, we believe that as an organization, JIEDDO has an interest and a responsibility to identify, track, and report all civilian, military, and contractor personnel working in support of JIEDDO as a matter of good resource stewardship and sound human capital management. Any overlapping manpower management interests or responsibilities between JIEDDO and other organizations could still be recognized and reported with the appropriate caveats to users of the information. In its comments related to this recommendation, DOD also cited ongoing efforts that do not directly address our recommendation as well as several new efforts that were not established at the time of our review, and therefore we could not validate or consider them for purposes of this audit. DOD’s comments and our specific responses to them are provided in appendix II. We are sending copies of this report to the appropriate congressional committees and the Secretary of Defense. We will also make copies available to others upon request. If you or your staff have any questions about this report, please contact me at (202) 512-8365 or solisw@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III. Appendix I: Scope and Methodology To assess the Joint Improvised Explosive Device Defeat Organization’s (JIEDDO) financial management processes, controls, and data, we collected data on the $1.9 billion in funds available to JIEDDO for the first half of fiscal year 2007 and analyzed associated financial management and counter-improvised explosive device (IED) initiative data available for management and external reporting of JIEDDO’s activities. We selected the initial fiscal year 2007 funding provided to JIEDDO because it was received after JIEDDO made significant changes in its resource management processes and therefore should reflect impacts and improvements resulting from those changes. We also identified required approval controls over use of funds, reviewed selected transactions for compliance with these controls, and assessed whether the data recorded in the accounting and managerial systems accurately reflected JIEDDO’s activities. However, we did not perform a comprehensive assessment of all of JIEDDO’s internal controls. We drew high-dollar initiatives during the scoping phase of the review to more efficiently assess the largest portion of JIEDDO’s funds use in the relatively limited phase. Because the items initially selected included little in the way of attack the network initiatives, we added items from this line of operations to do control testing. We also reviewed large-dollar initiatives approved by the Deputy Secretary of Defense that had no recorded commitments at the time our initial data were collected for the first half of fiscal year 2007. Because we identified weaknesses in the completeness and accuracy of JIEDDO’s documentation and controls, we did not review the full range of initiatives we had originally planned because it would have added no further value for purposes of addressing the objectives of this review. Our analysis included 47 funding actions totaling $1.34 billion for 24 of the 301 initiatives JIEDDO had approved at the time we collected our data. We selected initiatives to review that reflected the JIEDDO defeat the device and attack the network activities as well as some approved most recently by the Deputy Secretary of Defense. The 24 initiatives we selected were divided into three subsets: 10 counter-IED initiatives JIEDDO identified as defeat the device initiatives with the highest fund commitments recorded as of the time we collected financial data, 9 of the 10 counter-IED initiatives JIEDDO identified as attack the network initiatives with the highest fund commitments recorded as of the time we collected financial data, and 5 additional initiatives that received Deputy Secretary of Defense approval after the date we collected our comprehensive funding data to determine whether conditions had changed. We also met with officials from JIEDDO’s Counter-IED Operational Integration Center, the Joint Center of Excellence, the Navy Center of Excellence, the Air Force Center of Excellence, the Technology and Requirements Integration Division, and the Joint IED Defeat Test Board to gather information corroborating and explaining the financial activity and documentation related to JIEDDO initiatives we tested. To assess JIEDDO’s efforts to identify, record, track, and report numbers of all personnel, including contractors, we met with officials from JIEDDO’s Secretariat Division who are responsible for the organization’s personnel management to discuss and obtain information on the numbers of JIEDDO personnel, the composition of personnel, and JIEDDO’s processes for capturing this information. We collected information on the numbers of JIEDDO personnel from several personnel documents and reports from the Secretariat Division. We reviewed the information and selectively compared it with corroborating sources, such as interviews with JIEDDO officials and JIEDDO’s financial documentation, to determine whether the reported figures were comprehensive and accurate. We also met with officials from JIEDDO’s Counter-IED Operational Integration Center, the Joint Center of Excellence, the Navy Center of Excellence, the Air Force Center of Excellence, the Technology and Requirements Integration Division, and the Joint IED Defeat Test Board to gather information regarding the numbers of and composition of JIEDDO’s personnel. In addition, we met with officials in the Office of the Secretary of Defense’s Directorate for Organizational and Management Planning to discuss the origins of DOD Directive 2000.19E. We assessed the reliability of JIEDDO’s financial data we reviewed by (1) corroborating the data with supporting information and documentation from physical file records at JIEDDO headquarters and from initiative program offices to verify the accuracy of the data, (2) reviewing existing information about the data and the system that produced them, and (3) interviewing agency officials knowledgeable about the data. We found problems with the reliability of the data, which we discuss in the report and in part form the basis for our recommendations. We conducted this performance audit from April 2007 to December 2007 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Comments from the Department of Defense The following are our comments on the Department of Defense’s (DOD) letter dated February 14, 2008. GAO Comments 1. DOD states that before our audit commenced, JIEDDO had worked diligently to formalize and document its processes to ensure that internal controls were in place. Further, DOD asserts that “many of these processes were finalized during the audit timeframe,” and then lists details on four specific “samples” where JIEDDO has “finalized, documented and implemented processes and procedures.” While we recognize that JIEDDO has undertaken efforts to improve its operations and resource management, the specific efforts described in DOD’s comments overstate the status and degree of implementation regarding these four “samples.” Specifically, responses 2 through 5 summarize our conclusions regarding the status and potential effectiveness of JIEDDO “samples” contained in DOD’s comments. 2. Before our review began in May 2007, JIEDDO planned to spin off part of an existing division to form a new acquisition oversight division. JIEDDO did not identify the planned division as relevant to our audit objectives, and while we were aware of the plans for the new division, we did not see documented objectives, plans, or policies describing the division’s role or purpose. The first policy document JIEDDO issued outlining the oversight division’s responsibilities was a broad instruction issued in November 2007, which was too late for us to review in the conduct of our audit. Further, as of mid-February 2008, JIEDDO was still drafting a roles and procedures manual to implement the instruction’s requirements for the new division, and none of the five civil service positions planned for the division had been filled. Consequently, this particular “sample” cited in the DOD comments does not by itself support the statement that JIEDDO has “finalized, documented and implemented processes and procedures.” 3. JIEDDO issued this instruction to define and implement JIEDDO’s “rapid acquisition management responsibilities” established in its charter documents and presented to us when we met to close out our fieldwork. To follow up on the comprehensiveness of the instruction related to the internal control weaknesses we identified during our review, we had brief follow-up conversations with JIEDDO personnel involved in the development of the instruction. At that time, we determined that specific steps regarding addressing the control weaknesses identified were not fully developed because JIEDDO divisions had not yet documented or developed the specific roles, responsibilities, processes, and procedures at the division level. Further, JIEDDO had not yet identified the persons who would participate in developing and drafting proposed division-level instructions for coordination and approval. One official stated that to have done so before issuing the instruction would have delayed issuance by 1 to 2 months. As with the prior item cited in DOD’s comments on our recommendation, this instruction does not by itself support the statement that JIEDDO has “finalized, documented and implemented processes and procedures.” 4. While JIEDDO has established the Records Management Division in recognition of the importance of good documentation, it is still an effort in development and not fully implemented. The comments provided state that some elements of JIEDDO’s records management processes and procedures are still in draft and are not scheduled to be initially operational until March 2008 or fully operational until May 2008. Based on DOD’s comments, we again conclude that establishment efforts for this division do not support the summary statement that JIEDDO has “finalized, documented and implemented processes and procedures.” 5. JIEDDO is in the process of adopting a new financial management system, adapted from an existing system, and is expecting full implementation of the new system by March 2008. While JIEDDO has identified the objectives of the new system and lists expected improvements for the organization, the comments clearly indicate that all requirements for the new system have not yet been gathered, which makes full implementation by March 2008 uncertain. Further, given the tasks yet to be accomplished for full implementation, JIEDDO’s new system status does not support the summary statement that JIEDDO has “finalized, documented and implemented processes and procedures.” 6. DOD states emphatically that funding authorizations are always made and documented according to the criteria in JIEDDO’s charter directive. As we reported, this was not the case for the items we selected in our review. DOD identified a new resource management checklist in its comments, and while it constitutes a new control measure that is a positive step, we were not able to test compliance with the new control or assess its effectiveness. 7. JIEDDO’s reasons for initial assignment and change in its lines of operations accounting do not address the specific inconsistency and potential impact on the reliability of its financial reports that we reported when JIEDDO moved Joint IED Defeat Test Board expenses to its attack the network line of operation. Further, changes in controls over recording of fund use into expenditure categories or lines of operation are either still in development or were not sufficiently developed for us to evaluate their effectiveness in meeting our recommendation’s intent. 8. DOD’s statements acknowledge JIEDDO’s internal control weaknesses. The actions proposed and those already taken, if fully implemented, would substantially address the intent of our recommendation. 9. Expressing full agreement with the findings in our report, DOD proposed an alternative approach for communicating the status of its efforts to Congress. We agree that DOD’s approach for reporting its progress in implementing internal control measures satisfies the overall intent of our recommendation. Consequently, we modified our original recommendation to reflect this change. 10. JIEDDO outlines steps that it is taking toward identifying and tracking civilian, military, and contractor personnel and to improve its personnel management practices that we highlighted in our report. While a positive first step, other efforts are needed to comprehensively account for all personnel, as noted in comments 11 through 16. 11. JIEDDO introduces processes that do not directly address our recommendation. We were aware of the development of JIEDDO strategic human capital plan, and based on our review of JIEDDO’s working documents, we concluded that the strategic human capital plan would not directly address the extent to which JIEDDO would identify and track all of its personnel. Also, JIEDDO had not instituted prior to the conclusion of our audit its Manpower Staffing Request System within the JCAAMP program to formalize the management of new manpower requirements. While these steps may assist JIEDDO in improving its personnel management, they do not directly address our recommendation. 12. We recognize and understand DOD’s comments regarding accounting for JIEDDO personnel who staff programs under the control and direction of the military services and other DOD and government departments, including those funded wholly or in part by JIEDDO. However, we believe that as an organization, JIEDDO has an interest in accounting for all civilian, military, and contractor personnel working in any capacity for JIEDDO, as a matter of sound personnel management. This information can be collected and reported with caveats stating that the personnel are, in whole or part, funded by JIEDDO. 13. DOD noted that our report suggested that JIEDDO does not account for categories of contractor personnel, such as field service representatives, interagency liaisons, law enforcement training personnel, interagency partnership team members, and infrastructure contractors, and stated that the information was included in the Senate report. During our audit and as stated in our report, we recognized that this information with the associated charts was included in the Senate report, but we found that it was not included in any of JIEDDO’s personnel documentation or daily staffing reports prior to the development of the Senate report. As a result, we questioned why JIEDDO did not account for these categories of personnel in its daily staffing reports or in other personnel documentation. 14. DOD explained JIEDDO’s challenges in hiring staff and the steps it is taking to increase the number of military and civilian billets and to facilitate the hiring of civilian employees by working with the Army and the Office of the Secretary of Defense. While these steps appear to address our recommendation and other areas of concern, we cannot validate the information because these steps occurred after we completed our audit. 15. We disagree with DOD’s statement that JIEDDO provides some funding for the staff of the Joint Test Board. According to financial documentation we obtained and corroborated with interviews, the Joint Test Board’s primary mission is to provide support to JIEDDO as stated in JIEDDO’s charter, DOD Directive 2000.19E. 16. See comment 11. Appendix III: GAO Contact and Staff Acknowledgments GAO Contact Acknowledgments In addition to the contact named above, the following individuals made contributions to this report: Cary Russell, Assistant Director; Grace Coleman; Eric Essig; Paul Kinney; Ronald La Due Lake; Stephen Lipscomb; Lonnie McAllister; Paulina Reaves; James Reynolds; Brian Shiels; Glenn Slocum; Yong Song; and John Strong.

Improvised explosive devices (IED) have been and continue to be a significant threat to U.S. forces. The Department of Defense (DOD) expanded efforts to defeat IEDs with the establishment of the Joint Improvised Explosive Device Defeat Organization (JIEDDO) in January 2006. GAO was asked to review JIEDDO's management and operations. For this second report in its series, GAO determined (1) the extent to which JIEDDO's management processes provide adequate assurances that its financial information is accurate and provides transparency over its operations and (2) the extent to which JIEDDO identifies, records, tracks, and reports numbers of all personnel, including contractors. GAO analyzed data for the first half of fiscal year 2007, which included 47 funding transactions totaling $1.34 billion for 24 initiatives to address these objectives. JIEDDO's financial management processes do not provide adequate assurances that its financial information is accurate, and as a result, JIEDDO is unable to provide full transparency over the cost of its operations. While JIEDDO has improved its financial management processes, it has not yet reached a point where those processes contain an effective system of internal control. According to federal standards, internal control comprises the plans, methods, and procedures used to meet missions, goals, and objectives of an organization and help it to achieve desired results through effective stewardship of its resources. GAO identified four internal control weaknesses that affect JIEDDO's financial management processes. First, JIEDDO has not comprehensively documented its administrative policies and operating manuals, which affects the consistency of how its financial management personnel perform their duties. Second, JIEDDO does not have adequate funds authorization controls to ensure that transactions are properly authorized before funds are committed. In reviewing funding transactions totaling $795 million, 18 of 24 initiatives were not properly authorized in accordance with internal control standards. As a result, funds may be used without proper scrutiny and without a mechanism to detect, correct, or address this control failure. Third, JIEDDO does not have controls to ensure that transactions are properly categorized. For example, of the $1.34 billion in fiscal year 2007 commitments reviewed, JIEDDO inaccurately categorized at least 83 percent of these dollars under one category that should have been applied to others. This could distort information used in assessing trends and prioritizing funds. Fourth, JIEDDO does not have an adequate internal process to monitor and review the efficacy of its internal controls. In the absence of an adequate system of internal control, the agency may not achieve all of its objectives and its use of resources may not be consistent with DOD priorities. Furthermore, decision makers may be basing their decisions on inaccurate financial data and reports. At the end of this review, JIEDDO managers said that they had corrected these weaknesses; however, because these actions occurred after audit completion, GAO could not determine their effectiveness. JIEDDO does not fully identify, track, and report all government and contractor personnel as provided for in DOD Directive 1100.4. Identifying all government and contractor personnel is important to JIEDDO's management and oversight responsibilities and contributes to its ability to effectively plan for its future workforce needs. While JIEDDO has a system in place for routinely tracking and reporting numbers of personnel JIEDDO regards as staff, this system is limited because it does not track all government and contractor personnel performing work for JIEDDO. However, since its creation in February 2006, JIEDDO has relied heavily on contractor support to accomplish its mission, which is not fully reflected in JIEDDO's system. When the Senate Appropriations Committee directed that JIEDDO provide a comprehensive accounting of all of its personnel, including contractors, by May 2007, JIEDDO had to rely on an ad hoc process to develop the report, which resulted in several inaccuracies and inconsistencies.

Background According to the Congressional Research Service, Title III nutrition funds provide almost 3 million older persons with about 240 million meals each year. Forty-eight percent of the meals are provided in congregate settings, such as senior centers, and 52 percent are provided to frail older persons in their home. In fiscal year 1999, about $785 million in Title III nutrition and support services funds was distributed to 56 states. A total of about $486 million was allotted for congregate and home-delivered meals (Title III-C). Table 1 shows how these federal funds were distributed to the states. Fiscal year 2000 funding for the Older Americans Act increased about 3.5 percent above the level for fiscal 1999. Funds for the home-delivered meals program increased by $35 million—31 percent over the level for fiscal 1999. The Nationwide Level of Title III-C Carryover Funds Is Low, but Some States Have Relatively High Levels Nationwide, the funds carried over into fiscal year 1999 reported by the states represented a small percentage of the $486 million Title III-C allotment—about 5 percent, or $24.6 million. However, the level of carryover funds reported by the states varied considerably. Twenty-two states reported that they had no carryover at the beginning of fiscal year 1999. The remaining 34 states reported a carryover that ranged, as a percentage of their fiscal year 1999 nutrition allotment, from less than 1 percent in 6 states (Colorado, Kentucky, Maryland, Massachusetts, New Mexico, and Puerto Rico) to about 50 percent in Arizona. Seven states (Arizona, Delaware, Hawaii, Missouri, New York, Oregon, and South Dakota) had carryover funds that exceeded their nutrition allotment for fiscal year 1999 by at least 15 percent. Additionally, two-thirds of the carryover funds—$16.3 million—were reported by seven states (Alabama, Arizona, California, Missouri, New York, Ohio, and Texas) that had at least $1 million in carryover funds. Table 2 shows the distribution of these carryover funds and their respective percentage of the nutrition allotment for each of the latter seven states above at the beginning of fiscal year 1999. (See app. II for information on the amount of carryover funds available to each of the 56 states at the beginning of fiscal year 1999.) States may have substantial amounts of carryover funds for a variety of reasons. For example, a state official said that the annual allotment of Title III funds may not be received by the beginning of a state’s fiscal year because of differences between federal and state fiscal year periods (41 states begin their fiscal year 3 months earlier than the federal government) or delays in the federal appropriations process. States may then need to budget their spending on the basis of funding projections. According to the official, some states may develop more conservative spending estimates than others. As a result, some of these states may have substantial funds that cannot be fully spent by the end of the fiscal year. Because of this, funds may be carried over into the next federal fiscal year. The accumulation of carryover funds can occur at the state, area-agency, and/or local-service-provider level. In fiscal year 1999, about 25 percent of the nationwide carryover funds reported by the states were held at the state level and 75 percent were held at the area-agency and/or local- provider level. The states reported that 341, or about 52 percent, of all area agencies had some carryover funds available for their nutrition programs at the beginning of fiscal year 1999. The level of carryover at the area-agency level can vary dramatically. For example, of the 208 area agencies that responded to our survey and reported some carryover at the beginning of fiscal year 1999, the carryover ranged from less than 1 percent of the fiscal year 1999 Title III-C allotment at 20 area agencies to more than 50 percent at 3 area agencies. Most area agencies (132) reported a carryover of from 1 to 10 percent of their annual allotment. Half of the States Do Not Restrict Title III-C Carryover Funds, and Those That Do Use a Variety of Limits Half of the 56 states reported that they do not restrict the amount of Title III-C funds that their area agencies and/or local service providers may carry over from one year to another. Of the remaining 28 states, 15 reported that neither area agencies nor local service providers are allowed to carry over any funds, and 13 reported having limits on the amount that their area agencies and/or local service providers may carry over into the succeeding fiscal year. Eleven of the 13 states with carryover limits reported that their limits were based on a percentage of the area agencies’ and/or local service providers’ annual grant allotment. The percentage of annual grant limit varied from 2 to 10 percent. The average reported percentage limit was about 8 percent. The remaining two states did not specify how they limited the amount of area-agency and/or local-service-provider carryover. Information on each state’s policy regarding carryover by area agencies or directly funded local service providers is shown in appendix II. We also examined the types of limits, if any, that area agencies located in the 28 states with no carryover limits placed on their local providers. Of the 563 area agencies responding to our survey, 178 were located in states that did not have carryover limits and did provide elderly meal services primarily through local service providers. The carryover limits that the agencies placed on their providers varied; most (97) did not allow their providers to carry over any funds. Information on the number and percentage of these 178 area agencies is presented in table 3 by type of area agency carryover restriction, if any, placed on local providers. Carryover Funds Are Used to Expand Meal Services, but Few Major Impacts From Declines in Carryover Funds Were Identified While some area agencies have used carryover funds to expand their meal services, state and area agencies identified relatively few instances of major cutbacks in meal services that occurred in fiscal year 1999 because carryover funds were less than they were in prior years. Additionally, from our analysis of the state and area-agency survey data, we estimate that, nationwide, a very small percentage of area agencies and local providers would have to make major cutbacks in meal services in fiscal years 2000 or 2001 because of reductions in carryover funds. Our state survey information indicated that 37 states allowed their area agencies to carry over unspent Title III-C funds into fiscal year 1999. Seventeen of these states reported that 133 of their 234 area agencies had used carryover funds to expand the number of meals served that year. Only 9, or about 7 percent, of these agencies had to reduce the number of meals served by 10 percent or more in fiscal year 1999. We estimated from the states’ survey data that 23, or about 4 percent, of all area agencies nationwide may have to reduce their meal services by 10 percent or more in fiscal years 2000 or 2001. Of the 5 states that directly funded local service providers, 2 reported that 2 of their 8 providers used carryover funds to expand the number of meals served (neither of these providers had to reduce meals served by 10 percent or more), 2 reported that none of their 54 providers used funds to expand the meals served, and 1 state with 37 providers reported that comparable data on its providers were not available. We did not estimate how many directly funded local providers may have to reduce meal services by 10 percent or more in fiscal years 2000 or 2001. The results from our area-agency survey were similar. Of the 152 area agencies reporting that they allow local service providers to carry over funds, about one-third (47) did not provide information about their local service providers’ use of carryover funds to expand meal services. The 105 area agencies that reported such information identified a total of 287 local service providers that had used carryover funds to expand meal services in fiscal year 1999. These area agencies identified only 20 local providers that had reduced the number of meals served by 10 percent or more in fiscal year 1999 because of declines in carryover funds. Again, from our analysis of the area agencies’ survey data, we estimated that about 3 percent of the approximately 4,000 local service providers nationwide may need to reduce meals by that amount in fiscal years 2000 or 2001 because of declines in carryover funds. Most States Have Transferred Title III Funds and Allow Area Agencies Similar Flexibility Forty-seven of the states reported that they transferred a total of about $76 million in Title III nutrition and support services funds during fiscal year 1999. Although funds were transferred among the two nutrition allotments and the support services allotment, the bulk of the funds came out of the congregate meal allotment. The flexibility that area agencies and local providers have to transfer these funds varied. Most Transfers of Title III Funds Are Made Out of Congregate Meal Allotments As shown in table 4, the bulk of the Title III funds transferred—$71 million—came from congregate meal allotments and were reallocated to either the home-delivered meal or support services allotments. These transfers resulted in a decrease of about 19 percent from the level of funding originally allotted to the states for congregate meal services. According to the Congressional Research Service, states have increasingly transferred funds from the congregate meal allotment to the home- delivered meal allotment because of various factors. For example, the growth in the number of persons in the oldest age categories has created a greater demand for the delivery of home care services, including home- delivered meals. According to federal population projections, the number of persons who are 60 years and older will increase by 21 million, or 46 percent, over the next 16 years, while the number who are 85 years and older will increase by 2.2 million, or 51 percent, during the same time frame. In addition, many states, including Connecticut, have devoted resources to the creation of a home- and community-based long-term care system for older persons. Home-delivered meals represent a key component in these systems. As with carryover funds, states reported widely varying amounts of funds transferred. For example, in 43 states that reported transferring funds from their initial congregate meal allotment to their home-delivered meal allotment, the percentage of funds transferred ranged from about 1 percent (Wisconsin) to about 34 percent (West Virginia)—the average transfer being 12 percent. Twelve states reported no transfers from their congregate meal allotment to their home-delivered meal allotment, and one state did not provide transfer information. Area Agencies’ Flexibility to Transfer Funds Varies Nine states reported that they do not allow the transfer of Title III funds by their area agencies and/or local service providers. Other states have adopted policies that limit the transfer of funds by area agencies and/or local service providers. Table 5 shows the number of states that reported a limit on the transfer of Title III funds. Conclusion At the present time, the buildup and use of Title III-C carryover funds to support elderly nutrition services does not appear to be a widespread problem. However, AoA does not monitor the states’ buildup of carryover funds. As a result, the agency has little assurance that it could identify meal service problems that could emerge in the future. Recommendation for Executive Action Although the use of carryover funds to support nutrition services for the elderly does not currently appear to be creating a serious meal service problem nationwide, we recommend that the Secretary, Department of Health and Human Services, direct the Assistant Secretary for Aging, Administration on Aging, to monitor the levels of unspent Title III-C funds that states carry over to the succeeding fiscal year and work with the states that build up substantial amounts of carryover funds to develop a strategy to spend down such funds in a manner that minimizes the potential disruption of meal services for the elderly. Such monitoring could be performed with available resources if it is done as a part of the administration’s routine program-monitoring activities. Agency Comments We provided the U.S. Department of Health and Human Services with a draft of this report for review and comment. Department officials agreed with our recommendation. More specifically, the Assistant Secretary for Aging, stated that AoA will monitor those states having a history of difficulty in controlling carryover and provide enhanced technical assistance to ensure that these practices do not jeopardize the program’s goals. In addition, the Assistant Secretary noted that the Department will consider the promulgation of regulations to reinforce the grantees’ understanding of their responsibility in controlling and monitoring such funds. The Department made no other comments on the information contained in the draft report. As arranged with your office, unless you publicly announce its contents earlier, we plan no further distribution of this report until 10 days after the date of this letter. At that time, we will send copies to appropriate congressional committees; interested Members of Congress; the Honorable Donna E. Shalala, Secretary of Health and Human Services; the Honorable Jeanette C. Takamura, Assistant Secretary for Aging, Department of Health and Human Services; the Honorable Jacob J. Lew, Director, Office of Management and Budget; and other interested parties. We will also make copies available upon request. If you have any questions about this report, please contact me or Thomas E. Slomba, Assistant Director, at (202) 512-5138. Key contributors to this report were Carolyn M. Boyce, Senior Social Science Analyst; and Peter M. Bramble, Jr., Senior Food Assistance Analyst. Scope and Methodology To address the objectives of our review, we developed separate written mail-out surveys for state and area agencies that received Title III nutrition and support funds, respectively, in fiscal year 1999. We pretested the draft state survey at three states that manage senior services (Colorado, Louisiana, and Pennsylvania), and the draft area- agency survey at four area agencies in four states (Colorado, Louisiana, Virginia, and West Virginia). We visited these states and area agencies to conduct each pretest. During these visits, we attempted to simulate the actual survey experience by asking the state or area agency official to fill out the survey. We subsequently interviewed the officials to ensure that the (1) questions were readable and clear, (2) terms were precise, (3) survey did not place an undue burden on the survey recipients, and (4) survey appeared to be independent and unbiased. Administration on Aging (AoA) officials also reviewed and provided comments on each draft survey. In order to maximize the response to our surveys, we mailed a prenotification letter to all of the 56 states and 652 area agencies about 1 week before we mailed the surveys. We also sent a reminder letter to nonrespondents about 4 weeks after the initial survey mailing and a replacement survey for those who had not responded after about 8 weeks. After reviewing all of the survey responses, we contacted several states by telephone and E-mail to clarify their responses to various survey questions. Our survey data represent the responses from all of the 56 states and 563 of the 652 area agencies (an 86-percent response rate). We also collected Title III administrative and program information from AoA. We performed our work from March through December 2000 in accordance with generally accepted government auditing standards. Nationwide Title III-C Carryover Funds Available to the States at the Beginning of Fiscal Year 1999 Ordering Information The first copy of each GAO report is free. Additional copies of reports are $2 each. A check or money order should be made out to the Superintendent of Documents. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. Orders by mail: U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Orders by visiting: Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders by phone: (202) 512-6000 fax: (202) 512-6061 TDD (202) 512-2537 Each day, GAO issues a list of newly available reports and testimony. To receive facsimile copies of the daily list or any list from the past 30 days, please call (202) 512-6000 using a touchtone phone. A recorded menu will provide information on how to obtain these lists. To Report Fraud, Waste, or Abuse in Federal Programs Web site: http://www.gao.gov/fraudnet/fraudnet.htm e-mail: fraudnet@gao.gov 1-800-424-5454 (automated answering system)

Under Title III of the Older Americans Act, the Administration on Aging (AoA) distributes grants to states on the basis of their proportional share of the total elderly population in the United States. These grants are then disbursed to more than 600 area agencies nationwide, and are used to fund group and in-home meals, as well as support services, including transportation and housekeeping. The grants are further subdivided by these agencies to more than 4,000 local service providers. AoA requires that states obligate these funds by September 30 of the fiscal year in which they are awarded. Also, states must spend this money within two years after the fiscal year in which it is awarded. During this time AoA does not limit or monitor the amount of unspent funds that states may carry over to the succeeding fiscal year. GAO examined whether states were using Title III carryover funds to expand their meal service programs for the elderly beyond a level sustainable by their annual allotments alone. GAO found that the buildup and use of Title III carryover funds to support elderly nutrition services does not appear to be a widespread problem. However, AoA does not monitor the states' buildup of carryover funds. As a result, the agency has little assurance that it could identify meal service problems that could emerge in the future.

Background Overview of U.S. Assistance to Egypt Since 1979, when the Israel-Egypt peace treaty was signed, Egypt has been among the top recipients of U.S. bilateral assistance in the world. In the more than 30 years since the signing of the treaty, Egypt has been a key strategic partner of the United States in the Middle East. In fiscal years 2009 through 2014, the U.S. government allocated an average of approximately $1.5 billion annually in assistance for Egypt. The U.S. government provided the majority of this assistance to the Egyptian military through the Foreign Military Financing program, with annual allocations of approximately $1.3 billion during this period. The U.S. government also provided economic assistance to Egypt in fiscal years 2009 through 2014 that funded a range of economic development, health, education, and democracy and governance projects. The U.S. government funded the majority of its economic assistance to Egypt through the Economic Support Fund (ESF) account, with $200 million to $250 million allocated annually to Egypt during this period. U.S. Direct Funding of Democracy and Governance Assistance in Egypt Egypt’s progress toward greater democratization has been a longstanding objective of the U.S. government, but it became a greater priority after the January 2011 revolution. While the U.S. government has funded democracy and governance activities in Egypt for more than 10 years, some of which was through agreements with the Egyptian government, the United States increased its direct funding to NGOs for such activities after the 2011 revolution. USAID; State’s Bureau of Democracy, Human Rights, and Labor (DRL); and State’s Middle East Partnership Initiative (MEPI) all fund democracy and governance programming in Egypt. Generally, USAID funds its democracy and governance activities in Egypt with ESF funds, DRL uses funding from the Human Rights and Democracy Fund, and MEPI funds its activities with regional ESF funds. In total, USAID has awarded approximately $108 million between fiscal year 2009 and March 31, 2014, for democracy and governance assistance in Egypt, and State has awarded approximately $32 million for democracy and governance assistance in fiscal year 2009 through March 31, 2014. In February 2011, shortly after the revolution, USAID and State reprogrammed $50 million in prior year ESF funds and allocated an additional $15 million in democracy funding to provide additional democracy and governance assistance to support Egypt’s political transition. It awarded all of this funding directly to NGOs and other organizations to fund a variety of activities including political party strengthening, election monitoring, and independent media development. In 2004, the U.S. government began discussions with the Egyptian government regarding a program to directly fund NGOs and other organizations to implement democracy and governance activities in Egypt outside of the framework of an implementing assistance agreement. From September to November 2004, the two governments worked to outline a process by which the United States would directly fund such activities. Further information on this process can be found in the sensitive version of our report. Shortly thereafter, Congress approved an amendment to the Consolidated Appropriations Act of 2005 (the Brownback Amendment), which provided further direction regarding assistance for democracy and governance activities in Egypt. The Brownback Amendment stated, “That with respect to the provision of assistance for Egypt for democracy and governance activities, the organizations implementing such assistance and the specific nature of that assistance shall not be subject to the prior approval by the Government of Egypt.” In fiscal year 2005, USAID began using some democracy and governance assistance to directly fund NGOs and other types of organizations to implement democracy and governance activities, rather than working with the Egyptian government under the implementing assistance agreement. Soon after USAID started to directly fund NGOs and other types of organizations to implement democracy and governance activities in fiscal year 2005, the Egyptian government raised objections. Among other things, the Egyptian government stated that USAID was violating the terms of the process that the two governments had outlined in a 2004 exchange of letters. However, the U.S. government officials responded that they were interpreting their commitments based upon the conditions applied by the Brownback Amendment and agreement in diplomatic discussions on direct funding to NGOs. According to State officials, DRL and MEPI have never funded any democracy and governance activities in Egypt under an implementing assistance agreement and have always funded their activities directly. Views on Egyptian Law Governing Activities of NGOs Egypt’s Law 84, which was passed in 2002, governs the activities of foreign and Egyptian NGOs, according to documents we reviewed. Among other things, the law establishes requirements for NGOs to register with the Egyptian government before beginning operations, according to documents we reviewed. According to Egyptian government officials, Egyptian NGOs are required to obtain their registration from the Ministry of Social Solidarity, while foreign NGOs must first complete a standing agreement with the Ministry of Foreign Affairs and then register with the Ministry of Social Solidarity. Egyptian NGOs must also obtain approval from the Ministry of Social Solidarity to receive funding from foreign sources, according to Egyptian government officials. U.S. government and NGO officials and documents noted that Law 84 establishes registration requirements for NGOs, but also asserted that there are significant ambiguities in the law and that it is sometimes inconsistently applied by Egyptian government officials. U.S. government and NGO officials stated that these issues complicate NGOs’ attempts to register and obtain approval to receive foreign funding. For example, although USAID understands that Law 84 contains a provision that allows for automatic registration if an NGO does not hear back from the Egyptian government in 60 days after submitting its application, USAID noted that there is significant ambiguity over how this provision is applied, including whether or not it applies to foreign NGOs. According to a senior official from Egypt’s Ministry of Social Solidarity, the 60-day time frame applies only to Egyptian NGOs. In addition, State reported in its Egypt Report on Human Rights Practices for 2011 that the Egyptian government generally allowed unregistered NGOs to operate, but that such NGOs operated in violation of the law and faced the risk of government harassment and interference, or closure. Prosecution of NGOs in Egypt The Egyptian government strongly objected to some of the U.S. government’s planned assistance for democracy and governance after the January 2011 revolution, including the award of funding to unregistered NGOs. These concerns led to the Egyptian Ministry of Justice questioning officials from several NGOs about their activities in late 2011. Subsequently, in December 2011, the Egyptian police raided the offices of four U.S. NGOs that were implementing U.S.-funded democracy and governance activities—Freedom House, ICFJ, IRI, and NDI. In February 2012, the Egyptian government charged employees of these four organizations and a German organization, the Konrad Adenauer Foundation, with establishing and operating unauthorized international organizations, according to government documents. At the time of the charges, all four U.S. organizations reported that they had submitted registration applications to the Egyptian government. In June 2013, an Egyptian court convicted a total of 43 employees from the four U.S. NGOs and the Konrad Adenauer Foundation, of these charges and the NGOs had to close their operations in Egypt. Table 1 provides a summary of the grants the U.S. government awarded after the January 2011 revolution to the four U.S. NGOs that were prosecuted. All of the American staff from the NGOs were allowed to leave Egypt before the convictions. Egypt’s Political Transitions Since the January 2011 revolution that ended the almost 30-year rule of Hosni Mubarak, Egypt has continued to undergo a series of political transitions. After a transitional period of military rule following President Mubarak’s resignation, Mohamed Morsi of the Muslim Brotherhood became Egypt’s first democratically elected president in June 2012. However, in July 2013, the Egyptian military removed Morsi from power after widespread protests against his rule. After Morsi’s removal, the military appointed the Chief Justice of Egypt’s Supreme Constitutional Court, Adli Monsour, to serve as interim president. Former Field Marshal Abdelfattah al-Sisi was subsequently elected as president in May 2014. Figure 1 provides a timeline of key events in Egypt’s political transition and the NGO trial. The U.S. Government Identified Risks but Has Not incorporated Lessons Learned from Experience in Egypt Consistent with their agencies’ policies and internal control standards, State and USAID identified potential risks as far back as 2005 with directly funding democracy and governance assistance in Egypt, but noted that it was difficult to assess the extent and specific nature of these risks in the aftermath of the revolution, given the significant political changes that had just taken place. Also consistent with their agencies’ policies and internal control standards, State and USAID have taken some steps as far back as 2005 to plan for managing the risks of providing democratic and governance assistance, but they have not taken steps to incorporate lessons learned from the events leading up to and including the prosecution of U.S.-funded NGOs in Egypt into their risk management plans. We have previously reported on the importance of lessons learned in planning agencies’ activities. The U.S. Government Identified Potential Risks with Directly Funding Democracy and Governance Assistance in Egypt Consistent with its policies, as well as internal control standards, the U.S. government identified potential risks in providing democracy and governance assistance in Egypt. Both State’s Foreign Affairs Manual and USAID’s Automated Directives System emphasize the need for program managers to identify and assess potential risks to their programs. State and USAID’s requirements reflect and incorporate the Standards for Internal Control in the Federal Government, which states that internal control should provide for an assessment of the risks the agency faces from both external and internal sources. These internal control standards note that agency managers need to comprehensively identify risks and should consider all significant interactions between the agency and other parties. The U.S. government has identified potential risks in implementing its democracy and governance assistance in Egypt since it began directly funding organizations, including unregistered NGOs, in 2005. U.S. officials and documentation noted that such assistance has been an ongoing source of tension with the Egyptian government since then. For example, beginning in 2005, the Egyptian government made repeated requests for USAID to stop funding Egyptian organizations that were not registered with the Ministry of Social Solidarity as NGOs or U.S. organizations that did not have a standing agreement with the Ministry of Foreign Affairs. The Egyptian government claimed that such direct assistance was a violation of the agreement reached between the two countries prior to the passage of the Brownback Amendment. However, the U.S. government disagrees with this interpretation of the agreements between the two countries. For example, U.S. government officials repeatedly noted that the Egyptian Foreign Minister had acknowledged that the Egyptian government did not have veto power over U.S.-funded democracy and governance activities. However, according to documents we reviewed, the Foreign Minister had also stated that Egypt did not favor direct funding for democracy and governance activities and retained the right to be kept fully informed of these activities and that the entire process should be undertaken in full respect of the relevant Egyptian laws. The Egyptian Minister of International Cooperation said that direct funding of NGOs that had not completed the required registration procedures is a violation of Egyptian law. The U.S. government further identified the risks of directly funding democracy and governance assistance in 2009, when the Egyptian government threatened to not allow all USAID assistance in Egypt for fiscal year 2009 if USAID did not stop directly funding unregistered organizations. In planning for the implementation of the $65 million in funding for democracy and governance assistance after the January 2011 revolution, the U.S. government identified the potential risk that the Egyptian government would object to the planned assistance. According to State and USAID officials, after the revolution, U.S. government officials determined that USAID would once again directly fund organizations, including unregistered NGOs, as part of an expansion of its democracy and governance programming in Egypt. The U.S. government acknowledged potential risks with this approach. For example, in a March 14, 2011, memo approving the planned use of the $65 million in democracy and governance assistance funds, USAID noted that the Egyptian government would potentially object to USAID’s intention to fund organizations that had not been registered to operate in the country and specifically noted the possible risks of funding IRI and NDI. While the U.S. government acknowledged potential risks, State and USAID officials also noted that it was difficult to assess the extent and specific nature of these risks in the aftermath of the revolution, given the significant political changes that had just taken place. For example, USAID officials stated that given the nature of the revolution, some U.S. government officials believed that the Egyptian government would embrace democratic change and that it would be more inclusive in regulating NGOs and other civil society organizations. Additionally, State and USAID stated that ambiguities in Egyptian law and its inconsistent application also complicated assessments of risk. According to U.S. government and NGO officials, the Egyptian government provided conflicting information regarding the legal status of some NGOs receiving U.S. funds. For example, officials from two of the prosecuted NGOs stated that they had received assurances from the Egyptian Ministry of Foreign Affairs that their registration paperwork was in order and that their registration applications would be approved shortly, before the raids on their offices took place in December 2011. In addition, the Egyptian government accredited IRI and NDI to serve as monitors during the parliamentary elections in November and December 2011 and January 2012, which U.S. and NGO officials noted led many to interpret that the Egyptian government was supportive of the two organizations’ activities. The U.S. Government Has Taken Some Steps to Manage Risks, but Has Not Taken Steps to Incorporate Lessons Learned from Egypt State and USAID have taken some steps to plan for managing the risks of providing democratic and governance assistance, but have not taken steps to incorporate lessons learned from their experience in Egypt. Both State’s Foreign Affairs Manual and USAID’s Automated Directives System emphasize the need for agencies to not only assess risk, but also plan ways to manage those risks that are identified. In addition, Standards for Internal Control in the Federal Government states that once risks have been identified, they should be analyzed for their possible effect. The standards note that such risk analysis generally includes estimating the risk’s significance, assessing the likelihood of its occurrence, and deciding how to manage the risk and what actions should be taken. USAID’s Automated Directives System also notes that lessons learned should be incorporated in USAID’s planning efforts. State’s Foreign Affairs Manual does not address lessons learned specifically; however, we have previously reported on the importance of lessons learned in planning agencies’ activities. We have reported that the use of lessons learned is a principal component of an organizational culture committed to continuous improvement, which serves to communicate acquired knowledge more effectively and to ensure that beneficial information is factored into planning, work processes, and activities. Lessons learned provide a powerful method of sharing good ideas for improving work processes, quality, and cost-effectiveness. State and USAID have taken some steps to plan for managing the risks of providing democracy and governance assistance in Egypt. USAID officials stated that their actions to regularly notify the Egyptian government of activities that they were directly funding, as the two governments had agreed to, was a means of seeking to manage risks related to their democracy and governance assistance. In an effort to manage risks globally, State has worked with other international partners to create an assistance fund to support NGOs operating in high-risk environments around the world. State and its partners launched the fund in July 2011 with initial funding of $4 million donated by 13 countries, including the United States. The fund is designed to provide emergency financial assistance to NGOs, including for legal costs, and to support advocacy initiatives on behalf of NGOs operating in hostile environments. In addition, USAID, in conjunction with State, issued a global cable in April 2013 that identified increasing risks to NGOs and other civil society organizations around the world and provided missions operating in such environments with guidance on how they could work to counter such threats. The cable suggests that missions focus on three key areas: prevention, adaptation, and the development of innovative approaches. The cable recommends that USAID missions: make prevention a focus by monitoring legal restrictions on civil society, and by developing real-time responses to threats to civil society through diplomatic pressure and support for local civil society organization advocacy efforts; make adaptation a focus by helping organizations to continue fulfilling their missions in the face of new regulations and enhancing their flexibility to adapt quickly to changing conditions, and engage and enhance civil society organizations in all development; and make the development of innovative approaches a focus by working through intermediaries, third countries, or regional platforms with a focus on information security and technology to provide virtual assistance. However, the cable does not provide any guidance for specific countries, including Egypt. One of the USAID officials who led the effort to develop the cable noted that USAID would like to develop more specific guidance for individual countries to help missions better manage risk. While State and USAID have taken some steps to manage potential risks associated with democracy and governance assistance, they have not taken steps to document and incorporate lessons learned from the experience of attempting to directly fund democracy and governance assistance in Egypt, which could help guide future U.S. efforts in Egypt and other potentially challenging environments. Both State and USAID officials noted that their democracy and governance activities in Egypt will continue to face potential risks going forward if the current challenging environment in the country persists. USAID officials said that issues related to potential future risks will still need to be addressed. For example, USAID officials noted that since the NGO trial began, USAID has revised its Automated Directives System to require missions to conduct risk analysis as part of the development of their Country Development Cooperation Strategies. However, as of June 2014, USAID had not completed such a strategy for Egypt and USAID officials stated that they had set no specific date for work on the strategy to begin. As noted in agency policy documents, internal control standards, and previous GAO work, State and USAID would benefit from the further development of plans to manage future risks to their democracy and governance assistance in Egypt that incorporate lessons learned from their experiences in Egypt. The U.S. Government Provided the NGOs Prosecuted in Egypt with Diplomatic, Legal, Financial, and Grant Flexibility Support From the time after the December 2011 raids through the conviction of the NGO workers in June 2013, the U.S. government took a number of actions to support the four U.S. NGOs prosecuted in Egypt—Freedom House, ICFJ, IRI, and NDI. These actions included providing the NGOs with diplomatic, legal, financial, and grant flexibility support. Two prosecuted NGOs noted certain areas where they needed additional support from the U.S. government. The U.S. Government Provided Diplomatic Support to the Prosecuted U.S. NGOs The U.S. government undertook a range of diplomatic to defend the employees of the four U.S. NGOs. Both U.S. officials at the embassy and senior officials from Washington, D.C. met repeatedly with officials in the Egyptian government, including the Egyptian armed forces, and the Morsi administration in an attempt to reach a diplomatic resolution to the issue. For example, as part of its diplomatic efforts, the U.S. government held a series of ultimately successful negotiations with the Egyptian government to have the travel ban on the U.S. employees of the NGOs lifted to enable them to depart the country in advance of the trial. In the interim, before the travel ban was lifted, the U.S. government allowed American staff from the organizations that were in the country and were fearful of being arrested to be housed at the U.S. embassy in Cairo. The U.S. government also met regularly with officials from the four U.S. NGOs to help them devise strategies for dealing with the Egyptian government. The U.S. Government Provided Legal and Related Support to the Prosecuted U.S. NGOs The U.S. government also provided legal support to the four U.S. NGOs. State representatives attended various hearings during the course of the trial and State and Department of Justice lawyers worked with the NGOs’ attorneys to develop legal strategies. State and Department of Justice attorneys provided assistance by working to have Interpol “red notices” filed by the Egyptian government overruled. If these notices had been left to stand, the U.S. NGO employees would have been subject to arrest upon arrival at international ports of entry in countries that are Interpol members, according to State and NGO officials. In addition, State provided assistance to the convicted U.S. NGO employees by writing a letter that stated that the U.S. government did not consider the convictions valid, which was signed by the Deputy Assistant Secretary of State for Democracy, Human Rights, and Labor, according to State and NGO officials. The U.S. Government Provided Financial Support to the Prosecuted U.S. NGOs The U.S. government provided financial support to the four U.S. NGOs by allowing them to use funding from their grants to pay for legal fees, court costs, fines, and other associated costs related to their trial. State and USAID exercised their authority under Section 636(b) of the Foreign Assistance Act to allow for the organizations to use funding from their grants for such costs. USAID reported that NDI, IRI, and ICFJ used a total of $3.1 million in grant funds on legal costs associated with the trial. In addition, State DRL reported that NDI, IRI, and ICFJ used a total of $1.7 million, and MEPI reported that Freedom House used a total of $94,000 in grant funds on legal costs associated with the trial. According to State officials, the amount of grant money that each organization used for legal costs was based on the amount the organizations had requested from State and USAID and the organizations’ grant amounts. State and USAID officials noted that the organizations may use additional grant funds for legal costs in the future. Table 2 summarizes the amounts of U.S. funding from their grants used by the four organizations for their legal costs, as of June 2014. In addition, three of the NGOs reported that they were allowed to use funding from their grants to pay for other personnel-related costs of employees convicted in the case. State DRL officials also noted that the bureau used one of its rapid-response mechanisms to provide emergency support to an employee of one of the NGOs, who requested assistance out of fears for his safety and that of his family, given the hostility that the prosecuted NGO employees faced from many in the Egyptian public. The U.S. Government Provided Grant Flexibility Support to the Prosecuted U.S. NGOs by Approving Modifications to Their Grants The U.S. government also supported the four U.S. NGOs by approving various modifications to their grants that allowed them to adjust the planned activities under their projects, given the constraints the organizations were facing. State and USAID both approved extensions to the period of performance for the grants to allow the organizations to continue using grant funding for their operations during the duration of the trial. State and USAID also approved other grant modifications to allow the organizations to modify their programming when various planned activities became unfeasible because of the trials. For example, when Freedom House determined that it was no longer feasible to continue its work with civil society organizations in Egypt, MEPI allowed Freedom House to instead submit a report on challenges faced by civil society organizations in Egypt. In addition, when it became clear that NDI would not be able to develop a media center in Cairo for political groups to use, as it had originally planned to do as part of its grant, USAID allowed NDI to instead develop online tools for these political groups to use. Two of the Four NGOs Identified Areas Where They Needed Additional Support from the U.S. Government In general, the four prosecuted U.S. NGOs did not identify many areas where they required additional support from the U.S. government; however, officials from two NGOs did raise certain issues related to U.S. government support. Officials from one NGO noted that it had taken almost a year for State to provide the letters for that organization’s employees stating that the U.S. government did not recognize the convictions, but noted that the letters were eventually provided. In addition, an official from this organization noted that the NGO had requested that the U.S. government help one of its Egyptian employees, who is now living in exile, for help finding employment in the United States, but that the U.S. government had not provided assistance to date. Officials from a different NGO noted that they had requested that the U.S. government take the matter to an international dispute mechanism because the organization believed that the trial was essentially a dispute between the U.S. and Egyptian governments. The Prosecution of NGO Workers Affected U.S. Democracy and Governance Assistance in Egypt The trial of employees of four U.S. NGOs—Freedom House, ICFJ, IRI, and NDI—from 2012 to 2013 significantly affected U.S. democracy and governance assistance in Egypt. Specifically, the four organizations that were prosecuted by the Egyptian government are no longer conducting activities inside Egypt. The NGO trial exacerbated existing challenges for some of the other NGOs implementing U.S. democracy and governance programs. Since the start of the trial in February 2012 the amount of funding that State and USAID have awarded for new or ongoing democracy and governance projects in Egypt has significantly decreased, going from about $72 million in 2011 to about $6 million in 2013. The trial also made certain types of democracy and governance activities more challenging for the U.S. government to fund in Egypt. The Four Prosecuted U.S. NGOs Are No Longer Conducting Democracy and Governance Programming inside Egypt The trial of Freedom House, ICFJ, IRI, and NDI employees from February 2012 through June 2013 affected the ability of these organizations to conduct their democracy and governance activities in Egypt and resulted in funds being redirected for legal costs related to the trial. These four organizations made up a significant portion of USAID’s and State’s democracy and governance assistance after the 2011 revolution, accounting for about $32 million, or nearly half, of the approximately $65 million in democracy and governance initially awarded after the revolution. However, approximately $4.9 million of the State and USAID funding for these NGOs was spent on legal costs, rather than on program activities. As a result of the trial, the four prosecuted NGOs are no longer conducting democracy and governance programming inside Egypt, and three have moved to online and other methods of delivering trainings for Egypt. According to a Freedom House official, Freedom House continued some of its activities until the verdict, in June 2013. After the verdict, according to a Freedom House official, Freedom House stopped all of its programming in Egypt and has since received no U.S. government funding for programming in Egypt. According to ICFJ officials, ICFJ stopped all of its activities in Egypt after its offices were raided in December 2011. After the raids on their offices, IRI and NDI observed the Egyptian parliamentary elections in January 2012, but did not conduct any further activities in Egypt. ICFJ, IRI, and NDI continued some of their activities through on-line training modules and held some trainings using other methods, according to officials from these NGOs. In November 2012, NDI launched an online learning portal with training modules on long-term political party development, campaign planning, election monitoring, and civil society development, among others. The NGO trial adversely affected the results that the four prosecuted organizations could achieve with their Egypt programming. USAID’s 2012 review of democracy and governance assistance in Egypt found that the trial had an adverse effect on the results that IRI and NDI could achieve. Both organizations cancelled numerous activities as a result of the raids and the initiation of the trial. IRI and NDI cancelled election observation, voter education activities, and political party development trainings, among others. In addition, NDI closed civil society resource centers in Egypt and stopped plans to establish a media center for training political parties and candidates in Egypt. According to IRI officials, after the 2011 revolution, IRI’s democracy and governance activities were able to reach more than 24,000 direct beneficiaries in Egypt, but since the June 2013 verdict, IRI programs have reached fewer than 500. Before the raids in 2011, NDI conducted public opinion research through 43 focus groups on voter attitudes among women and youth and shared the results with 23 political parties participating in the 2011-2012 parliamentary elections. Because of the trial, however, NDI was unable to conduct any further focus group sessions. Similarly, Freedom House and ICFJ also canceled activities. According to State officials, Freedom House had been planning to build the capacity of Egyptian civil society organizations, but could not complete the task after the trial began and instead submitted a report on the challenges faced by civil society in Egypt. According to ICFJ officials, ICFJ’s activities were limited by the trial, as it could no longer carry out any trainings of citizen journalists in Egypt. ICFJ’s citizen journalist trainings are now done online or using other methods. The NGO Trial Exacerbated Existing Challenges for Some, but Not All, of the Other NGOs Implementing Democracy and Governance Assistance in Egypt For some, but not all, of the other NGOs conducting U.S.-funded democracy and governance programs in Egypt, the 2012 trial exacerbated challenges to their efforts. NGOs receiving foreign funding in Egypt reported that they had faced challenges in implementing their activities well before the 2011 revolution and 2012 trial. For example, some Egyptian NGOs reported experiencing delays in getting approval from the Ministry of Social Solidarity to receive foreign funding since at least 2009. In addition, some U.S.-based NGOs reported facing delays in the registration process prior to 2011. One U.S-based NGO applied for registration in 2005, but did not receive it until 2010, according to an official from that organization. However, after the revolution and raids on NGOs’ offices in 2011, some U.S.-funded NGOs were able to successfully implement their democracy and governance projects. For example, one U.S.-based NGO, which had obtained registration, was able to implement a project on election administration, electoral processes, and citizen participation after the revolution and raids. After the raids on a number of NGOs’ offices in December 2011, NGO officials reported that some groups were initially reluctant to accept U.S. government funding, to include U.S. government branding on their materials, and to participate in U.S.-funded projects. The trial exacerbated an already challenging environment for Egyptian civil society organizations. According to USAID reviews of its democracy and governance assistance in 2011 and 2012, negative press reports in the Egyptian media about civil society organizations affected the ability of civil society organizations to operate. Such organizations were portrayed by the Egyptian media as spies because they were receiving foreign funding, according to NGO officials with whom we spoke in Egypt. USAID grantees reported facing delays in getting Egyptian government approval for their activities several months before and during the time period of the trial. A 2012 report by the USAID Inspector General found that in March 2012, 12 of the 24 NGOs to which USAID had awarded grants after the 2011 revolution—with activities worth $28.5 million—were not on track to achieve their goals. According to the Inspector General’s report, although the program began in April 2011, at least 7 of the 16 Egyptian organizations had not received Egyptian government approval to receive foreign funding by March 2012, with 1 organization’s approval denied and other organizations’ activities delayed up to 11 months after USAID had awarded their grants. According to USAID officials, USAID eventually terminated three of its grants because the organizations implementing the grants determined that they were not able to meet their program objectives, which may have stemmed in part from delays or a lack of approval to receive foreign funding. State/MEPI officials noted that some of the NGOs that they funded in 2011 withdrew from their grants for similar reasons. The Amount of Funding and Number of Grants Awarded for Democracy and Governance Projects in Egypt Decreased after the NGO Trial Since the beginning of the NGO trial in 2012, the number and total dollar value of grants awarded for democracy and governance activities in Egypt has decreased. U.S. officials noted that the NGO trial and the hostile environment it created for democracy and governance assistance contributed to this decrease. In addition, they noted that other factors also contributed to the significant decrease in democracy and governance funding awarded in fiscal years after 2011. For example, due to changing circumstances in Egypt, USAID did not submit a notification to Congress of its intent to obligate fiscal year 2012 funds for democracy and governance assistance to Egypt until February 2014 and did not submit a notification to Congress of its intent to obligate fiscal year 2013 funds for democracy and governance assistance to Egypt until May 2014. According to our review of USAID and State data, between fiscal year 2009 and March 31, 2014, USAID has awarded about $108 million and State has awarded about $32 million for democracy and governance assistance to Egypt. With the use of $65 million in prior year ESF funding in 2011, State and USAID significantly increased the number of democracy and governance activities that they funded in Egypt. For example, USAID almost tripled the number of grants it awarded for democracy and governance from 10 grants in fiscal year 2010 to 27 grants in fiscal year 2011. In addition, MEPI awarded 53 grants for democracy and governance in Egypt in fiscal year 2011, compared with 24 grants in fiscal year 2010. However, as shown in figures 2 and 3 below, the amount of funding and number of grants awarded for democracy and governance assistance to Egypt have decreased significantly since fiscal year 2011. For example, the amount of funding that USAID awarded declined by nearly 60 percent from fiscal year 2011 to fiscal year 2012, going from about $52 million to about $21 million. It declined further to about $4 million in fiscal year 2013. The number of grants USAID awarded declined from 27 in fiscal year 2011, to 4 in fiscal year 2012, to 2 in fiscal year 2013 (see fig. 2). The amount of funding that State awarded for democracy and governance assistance declined approximately 84 percent, from about $20 million in fiscal year 2011 to approximately $3 million in fiscal year 2012. It declined further to about $2 million in fiscal year 2013. The number of grants that State awarded declined from 73 in fiscal year 2011, to 26 in fiscal year 2012, to 13 in fiscal year 2013, as shown in figure 3 below. As of March 31, 2014, USAID had disbursed about $75 million of the approximately $108 million it awarded for democracy and governance activities that began in fiscal year 2009 through March 31, 2014. USAID continued to manage 17 active democracy and governance awards in Egypt as of March 31, 2014. As of June 30, 2014, State had disbursed about $22 million of the approximately $32 million it awarded for democracy and governance activities in fiscal years 2009 through March 31, 2014. State continued to manage 37 active democracy and governance awards in Egypt as of March 31, 2014. The NGO Prosecutions Made Some Democracy and Governance Activities More Challenging for the U.S. Government to Fund in Egypt After the conclusion of the NGO trial, some democracy and governance activities have become more challenging for State and USAID to fund in Egypt. State and USAID are not funding new political party strengthening activities given the environment in Egypt after the NGO trial as of March 31, 2014. IRI and NDI had been conducting such activities in Egypt prior to the trial, but are no longer operating in Egypt. State officials noted that funding other NGOs to conduct this type of activity in Egypt is possible, but that it would be challenging to do so. According to USAID, as of February 2014, the U.S. government is focusing its democracy and governance assistance in areas that aim to support more transparent and participatory political processes, more responsive and accountable governance, and more effective civil society and human rights activities. For example, a USAID and MEPI-funded NGO observed the January 2014 constitutional referendum and May 2014 presidential election. Both State and USAID officials emphasized the need to be flexible in their programming to respond to any opportunities that may arise to fund democracy and governance activities in Egypt in the future. State officials noted that various issues have affected the ability of the U.S. government to implement its democracy and governance programming in Egypt beyond just the NGO prosecutions, including the U.S. government’s relationship with the government of Egypt, policy considerations regarding different types of programming, and the ability to safely implement programming in a highly complex and rapidly changing environment. Conclusions The United States and Egypt have been longstanding military and political allies over the past three decades. The United States has provided billions of dollars in military and economic assistance to Egypt and partnered with Egypt on a range of security efforts in the region. While much of the U.S. and Egyptian governments’ relationship is anchored in shared security interests, the United States has also sought to support Egypt’s progress toward democracy, particularly after the January 2011 revolution. There are certain inherent risks associated with the U.S. government’s provision of democracy and governance assistance around the world, as the ruling government or other powerful entities may view such assistance as running counter to their interests. However, the U.S. government may decide that it is willing to accept such risks if it determines that it has a clear foreign policy interest in supporting progress toward democracy in a country, as it did in Egypt. The U.S. government cannot ensure that there will be no unintended or adverse consequences in providing democracy and governance assistance, but it can take steps to identify and manage potential risks. In planning its significant expansion of democracy and governance assistance in Egypt after the 2011 revolution, the U.S. government identified potential risks, given the Egyptian government’s past objections to the direct funding of NGOs to promote democracy dating back to 2005. Subsequent Egyptian government actions, including the prosecution of the four U.S. NGOs, demonstrated the extent of the risk that the U.S. government faced in supporting such efforts in Egypt. As a result of these actions, a portion of U.S. democracy and governance assistance was not used for its original purpose. The U.S. government has stated its intent to continue to support Egypt’s and other countries’ progress toward democracy. The U.S. government will likely continue to face risks in implementing such assistance. Accordingly, it is vital that the U.S. government be able to apply lessons learned from past experience as it moves forward with funding future democracy and governance assistance efforts. Recommendation for Executive Action To help ensure that State and USAID are better positioned to respond to unintended or adverse consequences related to their future democracy and governance assistance in Egypt and other countries, we recommend that the Secretary of State and the USAID Administrator take steps to identify lessons learned from their experiences in Egypt and work to incorporate these lessons into plans for managing risks to their future democracy and governance assistance efforts. Agency Comments We provided State and USAID with a draft of this report for their review. Both agencies provided technical comments, which we incorporated as appropriate. State and USAID also provided written comments, which are reproduced in appendixes II and III, respectively. In their written comments, State and USAID concurred with our recommendation and noted certain steps they are already taking that they can build on in responding to our recommendation. We are sending copies of this report to the appropriate congressional committees, the Secretary of State, and the Administrator of USAID. In addition, the report will be available at no charge on the GAO website at http://www.gao.gov. If you or your staff members have any questions about this report, please contact me at (202) 512-7331 or johnsoncm@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made contributions to this report are listed in appendix IV. Appendix I: Scope and Methodology The objectives of this review were to examine (1) the extent to which the U.S. government identified and managed potential risks of providing U.S. democracy and governance assistance in Egypt; (2) what support, if any, the U.S. government provided to the nongovernmental organizations (NGO) prosecuted by the Egyptian government; and (3) the extent to which U.S. democracy and governance assistance in Egypt has been affected, if at all, by the prosecution of NGO workers. To address all three objectives, we interviewed officials at the Department of State (State) and the U.S. Agency for International Development (USAID) who manage or coordinate democracy and governance assistance in Egypt. In Washington, D.C., we interviewed officials at State’s Bureau of Near Eastern Affairs who coordinate foreign assistance for Egypt, including democracy and governance assistance; officials who manage democracy and governance assistance provided through the Middle East Partnership Initiative (MEPI), and officials from State’s Bureau of Democracy, Human Rights, and Labor who manage assistance for Egypt. We also interviewed officials at USAID’s Bureau for the Middle East who coordinate assistance for Egypt, including democracy and governance assistance. At the U.S. embassy in Cairo, we interviewed officials who manage democracy and governance assistance, including State and USAID officials who participate in the Democracy Working Group, a State official from the Public Affairs section, and State officials in the political section who manage MEPI’s local grants program for Egypt. At the USAID mission in Cairo, we interviewed officials in USAID’s Democracy and Governance Office. To examine the extent to which the U.S. government identified the potential risks of providing U.S. democracy and governance assistance in Egypt, we reviewed memos approving democracy and governance assistance for Egypt, letters between the U.S. and Egyptian governments discussing the provision of democracy and governance assistance, State cables describing Egyptian government concerns with U.S. assistance, and implementing assistance agreements between the United States and Egypt regarding democracy and governance assistance. We also applied the Standards for Internal Control in the Federal Government. To determine agency policies for conducting risk assessments, we reviewed State’s Foreign Affairs Manual and USAID’s Automated Directives System. We also reviewed a State cable dated April 18, 2013, that describes challenges and responses for supporting civil society organizations, including those that implement democracy and governance programs, in restrictive environments. We reviewed U.S. laws related to democracy and governance assistance. We also reviewed Egyptian Law 84 of 2002, which outlines the legal requirements for Egyptian and foreign NGOs to operate in Egypt and the requirements for Egyptian NGOs to receive foreign funding. The opinions on the requirements of Egyptian law expressed in this report reflect the views of entities and individuals we interviewed, not an official position on the part of GAO. We interviewed State and U.S. officials who manage or coordinate democracy and governance assistance for Egypt in Washington, D.C., and Cairo, Egypt. In addition, we interviewed a senior official at the Egyptian Ministry of International Cooperation responsible for coordinating U.S. assistance, including democracy and governance assistance. We also interviewed Egyptian government officials from the Ministries of Foreign Affairs, International Cooperation, and Social Solidarity—the three ministries that coordinate bilateral assistance with the United States or authorize the registration of organizations that implement U.S.-funded democracy and governance assistance. To examine what support, if any, the U.S. government provided to the NGOs prosecuted by the Egyptian government, we interviewed and obtained written responses from officials at the four U.S.-funded NGOs that were prosecuted—Freedom House, the International Center for Journalists (ICFJ), the International Republican Institute (IRI), and the National Democratic Institute (NDI). We reviewed quarterly and final progress reports for their U.S.-funded projects and modifications made to their grant agreements with State and USAID. We interviewed State and USAID officials in Washington, D.C., and Cairo, Egypt; reviewed State cables describing assistance provided to the prosecuted NGOs; and reviewed a State document providing legal advice to the NGOs. We also obtained information from State and USAID on the amounts of grant funding the agencies authorized to be used for legal and related costs associated with the prosecutions. To examine the extent to which U.S. democracy and governance assistance in Egypt may have been affected by the prosecution of NGO workers, we interviewed officials from State and USAID in Washington, D.C., and Cairo, Egypt, that manage or coordinate this assistance. We interviewed and obtained written responses from officials at the four U.S.- funded NGOs that were prosecuted—Freedom House, ICFJ, IRI, and NDI. We also conducted roundtable discussions in Cairo, Egypt, with 17 other organizations that had received U.S. funding to implement democracy and governance activities in Egypt from fiscal years 2009 through 2013, but were not prosecuted. We selected this nongeneralizable sample of organizations to ensure representation among the four democracy and governance program areas (civil society, good governance, rule of law and human rights, and political competition and consensus building); U.S., Egyptian, and international organizations; organizations that received small and large amounts of U.S. funding; organizations whose U.S.-funded projects had varying start and end dates; and organizations funded by State and USAID. We reviewed documentation from State and USAID that described challenges implementing democracy and governance in Egypt during fiscal years 2009 through 2013. This documentation included annual portfolio reviews of USAID’s democracy and governance assistance in Egypt, annual performance reports prepared by the U.S. embassy in Cairo, various State and USAID strategy documents and resource requests, and State cables. We also reviewed progress reports for projects implemented by the four NGOs that were prosecuted and the organizations that participated in our roundtable discussions. We obtained and analyzed data from State and USAID on all democracy and governance awards that the agencies funded from fiscal year 2009 through March 31, 2014. We determined that these data were sufficiently reliable for the purposes of reporting on the number and value of awards made by State and USAID for democracy and governance programming in Egypt from fiscal year 2009 through March 31, 2014. We conducted this performance audit from November 2013 to July 2014 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Comments from the Department of State Appendix III: Comments from the U.S. Agency for International Development Appendix IV: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Jeff Phillips (Assistant Director), Ryan Vaughan (Analyst-In-Charge), Drew Lindsey, Rachel Dunsmoor, Ashley Alley, Jeff Isaacs, Debbie Chung, Justin Fisher, Oziel Trevino, Tracy Harris, and Kaitlan Doying made major contributions to this report.

For over 30 years, Egypt has been a key strategic partner of the United States and the recipient of billions of dollars of U.S. assistance. Starting with its revolution in January 2011, Egypt has undergone a series of political transitions. Shortly after the revolution, the U.S. government allocated $65 million in assistance for a range of activities to support Egypt's progress toward democracy. However, the Egyptian government objected to the U.S. government providing this assistance directly to NGOs, including to some that it viewed not to be registered under Egyptian law. In June 2013, the Egyptian government convicted employees of four U.S. NGOs. This report examines (1) the extent to which the U.S. government identified and managed potential risks of providing U.S. democracy and governance assistance in Egypt; (2) what support, if any, the U.S. government provided to the NGOs prosecuted by the Egyptian government; and (3) the extent to which U.S. democracy and governance assistance in Egypt has been affected, if at all, by the prosecution of NGO workers. GAO analyzed U.S. government and NGO documents and interviewed U.S., Egyptian, and NGO officials in Washington, D.C., and Egypt. The U.S. government identified potential risks in providing democracy and governance assistance in Egypt, including the Egyptian government's likely objection to the U.S. plan to use $65 million to directly fund nongovernmental organizations (NGO) in 2011. The Egyptian government had repeatedly raised objections to such direct funding since the U.S. Agency for International Development (USAID) began it in 2005. USAID and Department of State (State) guidance calls for the development of risk management plans for their programs. State and USAID have taken some steps to manage the risks of providing democracy and governance assistance in Egypt, including the issuance of an April 2013 cable that provided guidance on how to counter increasing risks to NGOs globally. However, State and USAID have not documented lessons learned from the U.S. experience in Egypt or used these lessons to inform their risk management plans for future democracy and governance assistance. The U.S. government provided the four prosecuted U.S. NGOs with diplomatic, legal, financial, and grant flexibility support. The U.S. government's diplomatic efforts included holding multiple meetings with Egyptian officials to try to defend the NGO employees. U.S. legal support to the NGOs included working with the NGOs' lawyers to develop legal strategies for the case. U.S. financial support allowed the four U.S. NGOs to use a total of $4.9 million in funding from their grants to pay for various legal costs related to the trial. Finally, the U.S. government allowed the four NGOs to modify their grants to adjust their planned activities and time frames as a result of the trial. The Egyptian government's trial of the four U.S. NGOs significantly affected U.S. democracy and governance assistance in Egypt. The four prosecuted U.S. NGOs are no longer conducting activities inside Egypt and modified or stopped a number of their programs. Other NGOs implementing U.S. democracy and governance programs reported experiencing delays in obtaining Egyptian government approval to receive U.S. funds. Since the start of the trial, in 2012, the amount of funding and number of grants awarded for democracy and governance projects in Egypt decreased (see fig.) and some activities are now more challenging for the U.S. government to implement.

Background In the late 1980s, DOD decided to close excess military bases because changing national security requirements had resulted in a military base structure that was larger than needed. Consequently, the Congress enacted base realignment and closure (BRAC) legislation that instituted base closure rounds in 1988, 1991, 1993, and 1995. For the 1991, 1993, and 1995 rounds, the legislation required DOD to complete all closures and realignments within 6 years from the date the President sent the BRAC Commission’s recommendations and his approval to the Congress. Closure and realignment actions for the 1988 and 1991 rounds were required to be completed by September 30, 1995, and July 10, 1997, respectively. Actions for the 1993 and 1995 rounds are to be completed by July 3, 1999, and July 15, 2001, respectively. The Congress established two base closure accounts to fund the closure rounds. The first account, the DOD base closure account, funded BRAC activities for the 1988 round and the second account, the DOD base closure account 1990, funded BRAC activities for the 1991, 1993, and 1995 rounds. DOD’s authority to obligate 1988 base closure account funds to close or realign bases expired on September 30, 1995. After that date, funds in the 1988 account ceased to be available for new obligations and may only be used to adjust and liquidate obligations already charged to the account.Unobligated funds in the account must remain there until the Congress transfers them or the account is closed. According to DOD officials, the account will be closed on September 30, 2000. Appendix II discusses the status of funds in the 1988 account. A different set of rules applies, however, to the 1990 base closure account. Funds in that account are available for an indefinite period. New obligations may be incurred and old obligations liquidated against the account until the Secretary of the Defense closes it. As a consequence of the 6-year implementation period for the 1991, 1993, and 1995 rounds, the period provided to obligate appropriated funds differs by BRAC round. For example, after July 10, 1997, unobligated funds in the account were not available to incur new obligations for BRAC 1991 closure or realignment actions, except for (1) environmental restoration and mitigation, and property management and disposal activities at BRAC 1991 sites and (2) adjusting and liquidating obligations properly charged to the BRAC 1991 round. The Congress, in appropriating funds to the 1990 base closure account, gave DOD the flexibility to allocate funds by military service, budget function, and BRAC installation. The Congress recognized the complexities of realigning and closing bases and of providing for environmental restoration and mitigation. As a result, appropriations to the 1990 account are structured in a manner that permits the Secretary of Defense to redistribute unobligated balances as appropriate to avoid delays and complete realignments and closures, along with environmental actions. In March 1998, DOD requested more than $1.7 billion for the BRAC program in fiscal year 1999. As shown in table 1, the amount requested is getting smaller each year as more implementation actions are completed. In November 1997, the Office of the Under Secretary of Defense (OUSD) Comptroller reported that approximately 97 percent of the $15.8 billion made available for all four BRAC rounds was obligated. Funding Opportunities to Offset the 1999 BRAC Budget Request Our analysis of the base closure account and the fiscal year 1999 BRAC budget request raises questions about the need for $131.1 million included in the request. Our questions center on (1) whether the budget request could be offset by using unreported proceeds from BRAC actions, and funds in the 1990 account are still needed for the BRAC 1991 round and (2) why fiscal year 1998 appropriations were withheld from the BRAC program for other purposes but never used. Further, the 1999 BRAC budget request contains funds for two MILCON projects that may no longer be needed in fiscal year 1999. Unreported Proceeds From BRAC Activities Could Be Used to Offset the Request The military services collected $35.7 million more in proceeds from land sales and leases at closing or realigning bases than reported in the 1999 BRAC budget request (see table 2). Although estimated proceeds from land sales and leases are usually used to offset budget requests, the $35.7 million in unreported proceeds has not been used for the reasons that are discussed below. Statutes and DOD guidance state that proceeds from the transfer, lease, or disposal of property due to the BRAC process shall be deposited into the base closure account. Proceeds deposited by a particular military service will generally be allocated to that service’s BRAC program. However, according to an official from the OUSD Comptroller, Defense Finance and Accounting Service financial reports do not show that the $35.7 million in unreported proceeds was deposited into the account by the responsible military service. Air Force Proceeds The $21 million in proceeds collected by the Air Force was not reported in the 1999 budget request because procedures for fund use have only recently been finalized and, as a result, program officials did not have constructive receipts of those proceeds. Documents indicate that the Defense Finance and Accounting Service started developing specific disposition guidance in July 1992. While the guidance was being developed, the proceeds were held in a suspense (temporary holding) account. When the disposition guidance was finalized in 1998, Air Force officials initiated actions to transfer the funds from the suspense account to the 1990 base closure account. As of May 1998, only $9.6 million and $4.1 million from the Air Force’s land sales and leases, respectively, had been deposited into the 1990 account. Air Force officials plan to report those proceeds in the budget submission for fiscal year 2000. Further, Air Force officials said that they plan to use these proceeds to partially offset unbudgeted costs (about $107.4 million in fiscal year 1998) related to the closure and realignment of McClellan Air Force Base, California, and Kelly Air Force Base, Texas. Because the decisions and plans for these BRAC actions were not finalized until November 1997 and not approved until February 1998, the Air Force did not budget for them in the fiscal year 1998 BRAC budget submission. As a result, Air Force officials told us that they will have a funding shortfall for its BRAC program in fiscal year 1998. Army Proceeds According to an Army official responsible for the BRAC program, $3.9 million in unreported proceeds for the Army was collected after the fiscal year 1999 budget submission and no estimate was included in the submission because of the uncertainties in collecting revenues from BRAC land sales and leases. The Army had planned to use the $3.9 million to offset the budget submission for fiscal year 2000. Navy Proceeds According to Navy officials, $9.3 million of the $10.8 million in unreported proceeds was received after the Navy’s 1999 budget request was submitted to DOD in September 1997 and, as a result, that amount was not included in the submission. Further, these officials are reluctant to include estimated proceeds in the annual budget process because of the uncertainties in collecting BRAC revenues. For example, in the budget request for fiscal year 1997, the Navy estimated $243.9 million in land sales for the BRAC 1993 round. However, due primarily to less emphasis on selling surplus land and a greater emphasis on economic benefits of transferring the property to nearby communities, there were no proceeds. As a result, Navy officials had to restructure the Navy’s BRAC program to meet this shortfall. In addition, the Navy does not routinely include lease revenues in its budget submissions but budgets for these proceeds to pay for caretaking costs on closing installations. Funds Allocated for BRAC 1991 MILCON Requirements Could Be Used to Offset the Request During March and April of 1998, the military services had $12.5 million of unobligated and unliquidated funds that was no longer required to support previously valid BRAC 1991 MILCON projects (see table 3). We found no instances where these funds were initially allocated or obligated for unsupported MILCON requirements. Program requirements tend to change, and in some cases disappear, as base closure and realignment actions are implemented. Although the services have reprogrammed some funds to other BRAC requirements, the $12.5 million represents additional available funding that was not anticipated at the time the fiscal year 1999 budget request was submitted to the Congress. According to the Office of Management and Budget Circular No. A-34, Instructions on Budget Execution, recoveries of prior year obligations that have been deobligated are available for new obligations if their period of availability has not expired. An official from the OUSD Comptroller Office said that the military services should periodically review their unobligated balances and unliquidated obligations so that the funds can be used for unfunded requirements. Although the DOD Financial Management Regulation provides financial policy and procedures for base closure and realignment actions, the regulation does not specify procedures for reviewing (1) unobligated balances and promptly obligating funds to valid requirements when original requirements no longer exist and (2) unliquidated obligations and promptly deobligating excess obligations when final costs are known. Program officials from several major commands said that validating the need for their unliquidated obligations was not a priority until 1998. In February 1998, the Army initiated a review of its unliquidated balances for the BRAC MILCON program. The Chief of the Army BRAC Office said that, although BRAC execution significantly improved during fiscal year 1997, poor execution in the first half of the fiscal year continued to be a problem. A particular area of concern was the large carryover balance of unobligated funds appropriated prior to fiscal year 1998. During the review, program officials verified that execution of the 1998 program had started. Also in February 1998, the Air Force initiated a review of the unobligated balances and unliquidated obligations for its BRAC program. During the review, program officials verified the requirements for their unobligated balances and unliquidated obligations. As a result, Air Force officials identified funds that were no longer needed to support previously valid program requirements. The Air Force intends to realign these available funds, shown in tables 3, 4, and 5, to offset the 1998 funding shortfall resulting from the closure and realignment of McClellan and Kelly Air Force Bases. Funds Allocated for BRAC 1991 O&M Activities Could Be Used to Offset the Request During March and April 1998, the military services allocated $7.8 million from the 1990 base closure account to fund BRAC 1991 O&M requirements that no longer existed (see table 4). Similar to allocations for MILCON projects, we found no instances where funds were initially allocated or obligated for invalid O&M requirements. Although the services have reprogrammed some funds to other BRAC requirements, the $7.8 million represents additional available funding that was not anticipated at the time the fiscal year 1999 budget request was submitted to the Congress. The OUSD Comptroller Office has reduced unobligated O&M balances in the 1990 base closure acount. During the review of the services’ budget requests for fiscal year 1999, the OUSD Comptroller Office deferred $34.5 million (requested by the Army and the Air Force) to later years because of poor execution of O&M funds in fiscal years 1995, 1996, and 1997. The Comptroller Office concluded that requesting more funds than can be obligated during a year ties up valuable budget resources that could be used more effectively. Funds Allocated to BRAC 1991 Environmental Projects Could Be Used to Offset the Request During March and April 1998, the military services allocated $8.5 million from the 1990 base closure account for BRAC 1991 environmental requirements that no longer existed (see table 5). Similar to allocations for MILCON projects and O&M activities, we found no instances where these funds were initially allocated or obligated for invalid requirements. Although the services have reprogrammed some funds, this amount represents additional available funding that was not anticipated at the time the fiscal year 1999 budget request was submitted to the Congress. The Air Force Audit Agency has issued the following two reports expressing concern about the use of funds allocated to BRAC environmental projects. In September 1995, the audit agency reported that BRAC funding did not match requirements and obligation rates could be improved by streamlining procedures for environmental contracting and providing better guidance to the major commands. In April 1997, the agency reported that the Air Force had $20.8 million in excess to its BRAC environmental requirements. Neither the team leaders nor funding management personnel could accurately account for environmental restoration costs by project. In October 1997, the Army Assistant Chief of Staff for Installation Management expressed his concern about the poor financial performance of the Army BRAC environmental program. Although the Army had obligated over $1.1 billion for BRAC environmental restoration, over $339 million remained unliquidated. According to the Assistant Chief of Staff, the entire BRAC program was vulnerable to budget reductions and reprogramming actions if the Army’s major commands did not act quickly to reduce the unliquidated balance. He concluded that the balance should be reduced to use idle environmental funds productively. As a result of this effort, the Army reduced its unliquidated balance for its BRAC environmental projects. Funds Appropriated and Previously Withheld From BRAC Activities in Fiscal Year 1998 Could Be Used to Offset the Request DOD withheld $26 million appropriated in fiscal year 1998 from the BRAC program that could be used to offset the fiscal year 1999 BRAC budget request. In December 1997, based on the administration’s estimated savings from a lower than expected inflation rate, the OUSD Comptroller Office withheld these BRAC funds from the military services. Although the $26 million was put in a holding account for potential reprogramming for other higher priority programs, the money was never used for these programs. An official in the OUSD Comptroller Office said that withholding these funds did not adversely affect the BRAC program because the services were able to carry out their programs as budgeted due to a lower inflation rate. The OUSD Comptroller Office released the funds to the services for BRAC activities on March 24, 1998. Thus, the $26 million represents additional available funding that was not anticipated at the time the fiscal year 1999 budget request was submitted to the Congress. The 1999 Budget Request Contains Funds for Two MILCON Projects That Are No Longer Required The 1999 BRAC budget request contains $40.6 million for two MILCON projects for which requirements have not been determined or have already been funded. The two projects are an Army medical warehouse ($31 million) and an Army headquarters building for the Military Transportation Management Command (MTMC) ($9.6 million). $31 Million Requested for a Warehouse Before Requirements Have Been Determined The Defense Logistics Agency (DLA) requested $31 million that requested to build a Deployable Medical Systems warehouse for the Army, although the requirements for the warehouse had not been determined. Recently, DLA officials questioned the Army’s estimated requirements for the warehouse. In it’s June 1997 report, the DOD Inspector General recommended withholding the $31 million requested until officials decided where the warehouse should be located. Although DLA adequately justified the requirements for the BRAC 1995 project, the Army had not decided whether DLA should continue to provide the reimbursable support for the Deployable Medical Systems, or where it wanted the workload performed. In response to the DOD recommendation, DLA has agreed not to program MILCON funds until it has a commitment from the Army on where to locate the warehouse. Although the Army has decided that the warehouse and related operations should be located at Hill Air Force Base, Utah, the size of the warehouse still has not been determined. In March 1998, DLA officials expressed reservations about maintaining the full scope of the warehouse as requested in the 1999 BRAC budget request.According to Army planning documents provided to DLA, the $45.3 million programmed for the project in fiscal year 1998 is estimated to decrease to $6.1 million in fiscal year 2005. The two major causes for this decrease are the projected reduction in the Army force structure and the potential impact of a medical reengineering initiative. In addition, the Army has decided not to move two programs (the Associated Support Items of Equipment Repair Program and Reserve Component Hospital Decrement Program) of the Deployable Medical Systems mission to Hill Air Force Base as planned. Instead, these programs will be moved to the Sierra Army Depot, California. As of May 4, 1998, DLA officials were revalidating these requirements and resizing the project. According to one agency estimate, a 50-percent reduction in the Deployable Medical Systems mission equates to a 43-percent reduction in the project’s square footage. However, as of May 4, 1998, DLA officials were unable to provide a revised cost estimate that could be included in the 1999 budget request for this project. Historically, the OUSD Comptroller Office has withheld funds for MILCON projects when requirements are undecided. $9.6 Million Requested for Headquarters Building Has Already Been Funded In the 1999 budget request, the Army requested $9.6 million for a MTMC headquarters building that has already been funded. The Army needed the funds to renovate one building and construct an addition at Fort Eustis, Virginia, to support the relocation and consolidation of MTMC Oakland Army Base and the Bayonne Military Ocean Terminal, New Jersey. However, DOD and Army officials said that BRAC funds have already been awarded for the project and the reprogramming action should be completed by June 1998. As a result, it no longer needs the $9.6 million included in the 1999 budget request for the MTMC headquarters building. Conclusions DOD and the military services have reduced the previous high unobligated balance in the 1990 base closure account. However, our analysis of the 1990 account and the fiscal year 1999 BRAC budget request raises questions about the need for $131.1 million included in the request. Our questions center on the potential (1) use of unreported proceeds from BRAC actions, unused funds allocated to the BRAC 1991 round, and withheld BRAC appropriations from fiscal year 1998 to offset equivalent amounts of funding included in the 1999 budget request and (2) need for funding requested for two MILCON projects, where the requirements for one project have not been determined and the other has already been funded. Matters for Congressional Consideration As the Congress develops the budget authority for DOD’s base closure activities in fiscal year 1999, it may wish to consider appropriating up to $131.1 million less than DOD is requesting in its fiscal year 1999 BRAC budget submission because prior year funds are available to meet these requirements and the request to fund two MILCON projects could be eliminated. Agency Comments and Our Evaluation In commenting on a draft of this report, DOD did not concur that its request should be reduced by $131.1 million. Specifically, DOD stated that (1) $35.7 million in unreported proceeds generated by BRAC activities is unavailable to offset fiscal year 1999 requirements because the proceeds have been or will be reprogrammed to cover unfunded requirements, (2) $54.8 million in unobligated balances is unavailable as an offset since it has already been earmarked for other unfunded requirements, (3) $40.6 million for two separate MILCON projects is unavailable for offset because previously approved actions that were deferred until 1999 still need to be fully funded, and (4) reductions of this magnitude will eliminate the management flexibility envisioned by the Congress and, adversely impact DOD’s ability to close installations and speed the economic recovery of affected communities. We continue to believe the Congress may wish to consider appropriating up to $131.1 million less than DOD requested in its fiscal year 1999 BRAC budget because prior year funds are available to meet requirements and the request to fund two MILCON projects can be eliminated. DOD’s fiscal year 1999 budget request did not reflect $35.7 million in proceeds that was collected but not included in the request. Public law and DOD guidance provide that proceeds generated from BRAC actions be reported in DOD’s annual budget estimate request. Further, the military services have reprogrammed some funds to other BRAC requirements; however, $54.8 million in unobligated balances represents additional available funding that was not anticipated at the time the fiscal year 1999 budget request was submitted to the Congress. After the budget submission, the major commands and the Army Corp of Engineers found that the requirements for these funds no longer existed and could provide no evidence where they would use the unobligated balances. Also, the 1999 budget request contains $40.6 million for two MILCON projects that are no longer needed. DLA officials continue to question the Army’s $31 million in requirements for a medical warehouse and could not provide a revised cost estimate for inclusion in the 1999 budget request. In addition, DOD agreed that the $9.6 million requested for the MTMC headquarters building has already been funded. While DOD said this $40.6 million could be used to fund other actions that had been deferred, we found no evidence of deferred actions that still needed to be fully funded. Finally, regarding DOD’s concern that reductions of the magnitude suggested by our report would limit management flexibility envisioned by the Congress and adversely impact the Department’s ability to close installations, we agree that the Congress provided the Department with flexibility to reprogram funds. At the same time, the Congress approves funding and the OUSD Comptroller Office makes funds available to the DOD components based on their official, detailed budget justification and financial plan. At the time we completed our review, only the Air Force, indicated a specific need associated with the funds we identified as available to offset DOD’s fiscal year 1999 budget request. The Air Force told us they planned to use the funds to help reduce a shortfall in the money needed to close two bases. However, the OUSD Comptroller Office has not yet formally approved the reprogramming of these funds. We are sending copies of this report to the Secretaries of Defense, the Army, the Navy, and the Air Force; the Director, Office of Management and Budget; and other interested parties. We will also make copies available to others upon request. Please contact me at (202) 512-8412 if you or your staff have any questions concerning this report. Major contributors to this report are listed in appendix IV. Scope and Methodology During our review, we interviewed and obtained data from Department of Defense (DOD) officials, including those from the Defense Logistics Agency (DLA), Defense Finance and Accounting Service, the DOD Inspector General, Air Force, Army, and Navy. Within the Air Force, we met with officials of the Office of the Chief of Staff, the Office for Financial Management and Comptroller, the Air Force Base Conversion Agency, the Air Combat Command, the Air Education and Training Command, the Air Mobility Command, and the 11th Wing. Army officials we met with were the Assistant Chief of Staff for Installation Management, the Office of the Comptroller, the Corps of Engineers, the U.S. Army Forces Command, the Communications-Electronics Command, the Materiel Command, the Medical Command, the Military Traffic Management Command (MTMC), the Training and Doctrine Command, and the Army Military District of Washington. Within the Navy, we met with officials of the Naval Facilities Engineering Command, Office of the Comptroller, Naval Air Systems Command, Naval Sea Systems Command, and Naval Audit Service. To identify funding opportunities for offsetting DOD’s budget request, we focused on identifying prior year appropriations that had not been obligated or liquidated and that may be available to fund base realignment and closure (BRAC) activities during fiscal year 1999. Because BRAC actions for the 1988 and 1991 rounds were required to be completed by September 30, 1995, and July 10, 1997, respectively, we questioned the need for the unobligated funds and unliquidated obligations that were still allocated for these rounds. We examined a variety of DOD and military services budget and financial documents; analyzed implementation legislation for the base closure accounts; examined budget execution data for BRAC military construction (MILCON), operations and maintenance, and environmental funds; compared execution data with the Office of Management and Budget and DOD guidance and goals; assessed initiatives to improve financial performance; and reviewed guidance on the use of funds in the base closure accounts and recent audits that focused on unobligated balances and unliquidated obligations in the accounts. We discussed the need for the unobligated funds and unliquidated obligations (in the 1988 base closure account) for the 1988 round with officials from DOD, the military services, and several major commands to determine their availability to fund other BRAC requirements. Additionally, we discussed the need for the unobligated funds and unliquidated obligations (in the 1990 base closure account) for the 1991 round with officials from DOD, the military services, and several major commands to identify funding that may be available during fiscal year 1999 that was not anticipated at the time the BRAC budget request was submitted to the Congress. Our 1998 audit of the federal governments fiscal year 1997 consolidated financial statements identified billions of dollars in DOD unreconciled cash disbursement activity. As a result of these accounting problems, we reconciled the reported unliquidated obligations with the major commands to verify that all transactions had been recorded for those BRAC projects and activities with balances that could be deobligated. We also compared data on proceeds from land sales and leases with those reported in the 1999 budget request to identify BRAC revenues that had not been reported to the Congress and not used to offset DOD’s budget requests for fiscal year 1999 and prior years. To validate DOD’s budget request for fiscal year 1999, including the MILCON projects, we reviewed fiscal year 1999 and prior year budget requests and supporting justifications for DOD, DLA, Defense Information Systems Agency, and military services. We obtained and reviewed data on requirements to support the budget request for selected bases and subaccounts. We reviewed Office of Management and Budget and DOD guidance on the preparation and justification of budget requests, policy guidance and submission requirements for the fiscal year 1999 BRAC budget request and prior budget requests, internal review procedures for validating budget submissions from major commands, and DOD program budget decision documents. We compared data on recently completed BRAC actions with the 1999 budget request to verify that budgeted requirements were still valid. We also compared the amounts requested for operations and maintenance activities and environmental projects at installations in the 1999 budget request with their unobligated balances and unliquidated obligations. We discussed the results of this comparison with officials from DOD, the military services, and several major commands to verify that additional appropriations were needed to fund 1999 requirements for these installations. We reviewed recent audits that have focused on MILCON projects in the 1999 budget request and prior requests to determine the magnitude, scope, and results of the audits. To verify MILCON requirements we compared the audit results with the MILCON projects included in the 1999 budget request to determine whether the results were reflected in the budget request. We discussed our comparison with officials from DLA and the military services to determine whether the MILCON projects and requirements were still valid. In performing this review, we used the same accounting systems, reports, and statistics the military services use to monitor their BRAC programs. We did not independently determine the reliability of this information. We conducted our review from December 1997 to May 1998 in accordance with generally accepted government auditing standards. Status of Funds in the 1988 Base Closure Account On February 28, 1998, the 1988 base closure account contained $45.8 million in unobligated funds. As shown in figure II.1, this funding is up from $30.6 million in September 1996. According to program officials, this increase occurred because the military services deobligated funds from requirements that no longer exist. Program requirements tend to change, and in some cases disappear, as BRAC actions are implemented. As the services’ deobligation process continues, the unobligated balance in the 1988 account will increase. Program officials stated, pursuant to a DOD Office of General Counsel’s memorandum, the $45.8 million in unobligated funds in the 1988 account will be used only to adjust and liquidate obligations that have already been charged to the account. Although several officials believe this requirement is likely not to be significant, there is no DOD criteria for determining the amount to reserve in expired accounts for this potential requirement. An official in the Office of the Under Secretary of Defense (Comptroller) said that he would reserve $25.8 million in the 1988 account to make any future adjustments and liquidations. Comments From the Department of Defense The following are GAO’s comments on the letter from the Under Secretary of Defense (OUSD) Comptroller, dated June 18, 1998. GAO Comments 1. We continue to believe that the Congress may wish to consider offsetting DOD’s 1999 budget request by $35.7 million in unreported proceeds from land sales and leases that was not reflected in the DOD’s or the military services’ 1999 budget request submissions. Public law and DOD financial management regulations and guidance provide that proceeds received from the transfer, lease, or disposal of property due to the BRAC process shall be deposited into the 1990 base closure account and shall be reported in the annual DOD budget estimate request. At the time we completed our review, we found no evidence, nor had DOD provided supporting documentation to show the $35.7 million had been or would be reprogrammed to cover unanticipated fiscal year 1998 expenses or for the requirement to transfer proceeds to a reserve account associated with the transfer or disposal of a commissary or nonappropriated fund facility. 2. We agree that the military services have reprogrammed some funds to other BRAC requirements. We also recognize that program requirements tend to change, and in some cases disappear, as base closure and realignment actions are implemented. However, the $54.8 million in unobligated balances represents additional available funding that was not anticipated at the time the fiscal year 1999 budget request was submitted to the Congress in February 1998. The $54.8 million was identified during interviews in March and April 1998 with officials from the services’ major commands and the Army Corps of Engineers. As a result of reviews of their unobligated balances and unliquidated obligations during February, March, and April 1998, the major commands and the Army Corps of Engineers found that the requirements for these funds no longer existed. At the time of our review, DOD, the Army, and the Navy could not provide supporting documentation that showed where they would use the unobligated balances, nor did they identify plans to redesignate for other BRAC needs those funds we identified as potentially available to offset DOD’s fiscal year 1999 budget request. Only the Air Force, in May 1998 after DOD submitted its budget estimate, identified a need to use some of these funds to reduce a shortfall it identified for two closing bases. 3. We continue to believe that the 1999 BRAC budget request contains $40.6 million for two separate military construction projects that are no longer required. DOD requested $31 million for DLA to build a medical warehouse for the Army, even though the requirements for the warehouse have not been determined. As of May 4, 1998, DLA officials continued to question the Army’s requirements for the warehouse and were unable to provide a revised cost estimate for the project that could be included in the 1999 budget request. It has been the OUSD Comptroller’s policy to not fund MILCON projects where requirements are not determined. DOD agreed that the Army’s MTMC headquarters building request for $9.6 million had already been funded. DOD asserts that these funds are still needed to refund previously approved actions where the funds were reprogrammed to accommodate an accelerated construction schedule. However, at the time of our review, we found no evidence of deferred actions that still needed to be fully funded. Major Contributors to This Report National Security and International Affairs Division, Washington, D.C. Norfolk Field Office Related GAO Products Military Base Closures: Detailed Budget Requests Could Improve Visibility (GAO/NSIAD-97-170, July 14, 1997). Military Bases: Cost to Maintain Inactive Ammunition Plants and Closed Bases Could Be Reduced (GAO/NSIAD-97-56, Feb. 20, 1997). Military Base Closures: Reducing High Costs of Environmental Cleanup Requires Difficult Choices (GAO/NSIAD-96-172, Sept. 5, 1996). Military Bases: Update on the Status of Bases Closed in 1988, 1991, and 1993 (GAO/NSIAD-96-149, Aug. 6, 1996). Military Bases: Potential Reductions to the Fiscal Year 1997 Base Closure Budget (GAO/NSIAD-96-158, July 15, 1996). Military Bases: Closure and Realignment Savings Are Significant, but Not Easily Quantified (GAO/NSIAD-96-67, Apr. 8, 1996). Closing Maintenance Depots: Savings, Workload, and Redistribution Issues (GAO/NSIAD-96-29, Mar. 4, 1996). Military Bases: Case Studies on Selected Bases Closed in 1988 and 1991 (GAO/NSIAD-95-139, Aug. 15, 1995). Military Bases: Environmental Impact at Closing Installations (GAO/NSIAD-95-70, Feb. 23, 1995). Military Bases: Reuse Plans for Selected Bases Closed in 1988 and 1991 (GAO/NSIAD-95-3, Nov. 1, 1994). The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. 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Pursuant to a legislative requirement, GAO reviewed the Department of Defense's (DOD) base closure accounts and its budget request for base closure activities, focusing on opportunities for offsetting the budget request for fiscal year (FY) 1999, including the validity of two proposed military construction (MILCON) projects included in that request. GAO noted that: (1) DOD and the military services have reduced the previous high unobligated balances in the 1990 base closure account; (2) however, there are opportunities to offset the 1999 budget request; (3) GAO's analysis of the 1990 account and the FY 1999 base realignment and closure (BRAC) budget request raises questions about the need for $131.1 million included in the request; and (4) specifically: (a) from the 1990 base closure account, $35.7 million in proceeds generated by BRAC activities that has not been reported to Congress; $12.5 million previously allocated but not needed for BRAC 1991 MILCON projects; $7.8 million allocated but not needed for BRAC 1991 operation and maintenance activities; and $8.5 million previously allocated but not needed for BRAC 1991 environmental projects; (b) from the FY 1998 BRAC appropriations, $26 million previously withheld but ultimately was not needed for other higher priority programs; and (c) from 1999 BRAC budget request, $40.6 million requested for two separate MILCON projects may no longer be needed because the requirements for one project have not been determined and the other has already been funded.

Background In terms of land area, Alaska is the largest U.S. state—more than the combined area of the next three largest states: Texas, California, and Montana. However, according to the Census Bureau, Alaska is also one of the least populated states, with about 630,000 people—of which about 19 percent, or 120,000, are Alaska Native or American Indian. Over half of the state’s population is concentrated in the Kenai Peninsula, Anchorage, and the Matanuska-Susitna area in south central Alaska. Many Alaska Natives, however, live in rural areas of western, northern, and interior Alaska long inhabited by their ancestors. Alaska Natives are generally divided into six major groupings: Unangan (Aleuts), Alutiiq (Pacific Eskimos), Inupiat (Northern Eskimos), Yup’ik (Bering Sea Eskimos), Athabascan (Interior Indians), and Tlingit and Haida (Southeast Coastal Indians). A Variety of Entities Facilitates the Provision of Federal Assistance to Alaska Native Villages A variety of entities facilitates federal assistance to Alaska Native villages. For many years, the federal government generally funded and administered many of the programs that provided assistance to Alaska Natives. However, with the passage of several key pieces of legislation, Alaska Native villages and other tribal organizations began to take on more responsibility for directly administering programs to assist their communities, and began to receive direct funding to carry out these tasks. For example, in 1971, Congress passed ANCSA, which was intended to resolve Native claims to land in the state. Under ANCSA, the Secretary of the Interior divided the state into 12 geographic regions so that each would include Natives “having a common heritage and sharing common interests.” All Natives became shareholders in one of 12 regional corporations or in a 13th corporation for nonresident Natives. In addition, Natives who resided in one of more than 200 villages listed in ANCSA were also enrolled in Native village corporations. The Bureau of Indian Affairs currently recognizes 229 Alaska Native villages as eligible to receive federal funds. Appendix II contains a listing of Alaska Native villages and the number of American Indian and Alaska Native (AIAN) persons and enrolled Alaska Native members by ANCSA region.8, 9 Figure 1 shows the location of Alaska Native villages and the 12 ANCSA regions. AIAN includes persons who indicated their race as American Indian or Alaska Native on the 2000 Census questionnaire. AIAN persons reside within geographic village boundaries recognized by the Census Bureau. AIAN persons who reside within the region but not within a specific village boundary area are counted as at-large members of the regional for-profit corporation. Enrolled members are actual members of a tribe that may reside anywhere in the world. Throughout, we have included two federally recognized entities with the regional Native nonprofits. The Central Council of the Tlingit and Haida Indian Tribes, a regional tribe with delegates from 21 communities, is identified as a regional Native association in ANCSA. The Metlakatla Indian Community, Annette Island Reserve is the only federally recognized Indian reservation within the state, and it operates a regional health entity and regional housing authority. Ahtna Inc. Kawerak Inc. Cook Inlet Region Inc. Koniag Inc. NANA Regional Corporation Inc. Also, nearly all health care that is delivered to Alaska Natives is administered by 13 Alaska Native regional health organizations that were identified in Public Law 105-83. These entities operate under compacting arrangements, which are agreements the Indian Health Service (IHS) negotiates with Native villages and other Native entities. Under the 1975 Indian Self-Determination and Educational Assistance Act, as amended, and further through the Tribal Self-Governance Act of 1994 and the Tribal Self-Governance Amendments of 2000, tribes and tribal organizations were allowed to participate in and manage programs that for years had been administered on their behalf by the Departments of the Interior and of Health and Human Services. Also, prior to NAHASDA, Alaska Natives were served by 14 regional housing authorities that were authorized by previous federal housing laws to provide services for Alaska Natives. NAHASDA further expanded the ability of Native villages to directly receive federal funding for the purpose of providing services to eligible Alaska Natives. The regional housing authorities and Native villages engage in a variety of affordable housing activities, including construction, rehabilitation, and management. See appendix III for a list of the ANCSA regional nonprofits, the regional health corporations, and the regional housing authorities that operate within the 12 ANCSA-defined areas of Alaska. Recent legislation has limited the ability of Native villages to directly receive federal funding. Public Law 108-447 temporarily limits the ability of IHS from directly funding villages that are already located within the area of a Native Alaska regional health facility. This restriction was put in place due to congressional concerns about the efficiency of providing direct federal funding to Alaska Native villages. Also, 25 USC 13f prohibits the provision of certain BIA funding to villages with fewer than 25 members; and 25 USC 3651 (note) limits which entities can receive certain Department of Justice funds. In addition, HUD’s fiscal year 2004-2005 appropriations included a provision that restricted certain housing funding to only those Alaska villages or tribally designated housing entities that had received funds in the previous fiscal year. In addition to the aforementioned Native nonprofits, a variety of other nonprofits also facilitate the provision of federal assistance to Alaska Native villages. These nonprofits, many of which are also controlled by Alaska Natives, provide assistance related to a broad range of areas, including justice issues, cultural and environmental preservation, and educational and economic advancement. Some of these nonprofits operate in one or more regions or on a subregional basis. Appendix IV contains a listing of nonprofits other than those discussed previously that received federal funding for the purpose of assisting Alaska Native villages from 1998 through 2003. Alaska Native villages also receive federal assistance that is passed through by the state or local agencies. For example, federally recognized Native villages may be part of communities that are incorporated under state law as cities or boroughs. State of Alaska data show that 124 Native villages are located within incorporated cities. However, these cities provide government services, such as water and sanitation, to Native village members that live in their jurisdiction, which would otherwise most likely be provided by Native villages. Likewise, some villages are located in organized boroughs that provide services to villages and cities. In 1998, Congress established the Denali Commission to address crucial needs of rural Alaska communities, particularly isolated Alaska Native villages. The commission is composed of a federal and a state co-chair and representatives from local agencies, as well as Alaska Native public and private entities. To carry out its work, the commission receives an annual federal appropriation and funds that are transferred from other federal agencies. The purpose of the commission is to (1) deliver the services of the federal government in the most cost-effective manner practicable; (2) provide job training and other economic development services in rural communities; (3) and, promote rural development and provide infrastructure such as water, sewer, and communication systems. According to the commission’s 2004 annual report, rural Alaska communities often face serious challenges to maintaining a sufficient energy supply, especially during the state’s harsh winters. Improving rural Alaska’s energy infrastructure has been the commission’s primary focus since 1999. Research Shows Improvement in the Social and Economic Condition of Alaska Natives, but Some Problems Persist Although recent research shows improvement in the social and economic condition of Alaska Natives, many problems persist. A 1989 report by the University of Alaska’s Institute of Social and Economic Research documented that Alaska Natives were facing a number of social and economic crises, such as high incidences of alcohol abuse, suicide, homicide, and unemployment. The Alaska Natives Commission—a federal-state commission—reported similar findings in 1994. The commission stated that because of the high rate of unemployment and lack of economic opportunities for Alaska Natives, government programs for the poor had become the foundation of many village economies. More recently, a 2004 report found that conditions for Alaska Natives improved in some areas, but that Alaska Natives still faced continuing and new disparities. For example, the report indicated that Alaska Natives have experienced improvements in health, such as reductions in tuberculosis, due in part to improvement in water and sewer systems; however, Natives continue to face health problems related to alcohol abuse and other factors. Similarly, the report indicated that Alaska Natives are making economic improvements, but continue to have disproportionately high poverty rates compared with non-Native Alaskans. Alaska Native Villages and Regional Native Nonprofits Received Over $3 Billion in Federal Funding from 1998 through 2003 From 1998 through 2003, Alaska Native villages and regional Native nonprofits received more than $3 billion in funding from multiple federal agencies, with HHS providing the majority of the funding. Native villages received substantially less funding than regional Native nonprofits, although Native villages had slightly more diverse sources for funding. Additionally, a small number of programs accounted for the majority of funding to villages and regional Native nonprofits, and, similarly, a few villages and regional Native nonprofits received the majority of federal funding. Combined federal funding to Native villages and regional Native nonprofits increased from about $512 million in 1999 to about $662 million in 2003. Alaska Native villages also benefited from federal funding provided to nonprofit organizations that primarily provide assistance to Alaska Natives, incorporated cities and boroughs that contain Native villages, and the state of Alaska. Moreover, during state fiscal years 1998 through 2003, the state of Alaska passed through more than $105 million in federal funds to Native villages and regional Native nonprofits. Alaska Native Villages and Regional Native Nonprofits Received Over $3 Billion in Funding from Multiple Federal Agencies, with HHS the Largest Single Provider of Funding Based on our analysis of information from FAADS, 17 federal agencies provided about $3.5 billion in federal funding to Alaska Native villages and regional Native nonprofits—ANCSA regional nonprofits, regional health nonprofits, and regional housing authorities—from 1998 through 2003. As shown in figure 2, HHS provided 63 percent of the funding, and HUD, Interior, and the Environmental Protection Agency (EPA) provided slightly more than 30 percent; thus, four agencies accounted for more than 90 percent of all direct federal funding to villages and regional Native nonprofits. None of the other 13 agencies provided more than 1 percent of the total funding to villages and regional Native nonprofits. The federally established Denali Commission, through its federal appropriations, also provided assistance to rural Alaska communities, including Alaska Native villages. From 1999 through 2003, Denali obligated approximately $290 million, but Denali did not report the grant amounts to the Census Bureau so that the information could be included in FAADS. Denali officials said they were not aware of the FAADS reporting requirement until recently. Native Villages Received Substantially Less Funding Than Regional Native Nonprofits, but Native Villages Received Their Funding from More Sources Of the $3.5 billion provided to Alaska Native villages and regional Native nonprofits, as shown in figure 3, federal agencies provided more than $483 million (14 percent) in direct federal funding to 216 Alaska Native villages and $3 billion (86 percent) to 33 regional Native nonprofits from 1998 through 2003. Although regional Native nonprofits received more funding than Native villages, the sources of major funding for villages were slightly more diverse than for regional Native nonprofits. Specifically, Native villages received direct funding from 16 agencies, with HHS, Interior, EPA, and HUD providing about 84 percent. In comparison, regional Native nonprofits received funding from 14 federal agencies, with HHS accounting for 70 percent of the funding (see figs. 4 and 5). Regional Native nonprofits may receive more funding from HHS than villages because regional Native nonprofits include regional health organizations that receive funding from IHS to operate major medical facilities such as hospitals. Under existing law, some villages are restricted from receiving IHS funding in cases where they are located in areas that are already served by an Alaska Native regional health organization. In contrast, Native villages received more funding from certain agencies than regional Native nonprofits. The Departments of Commerce, Justice, and Transportation (DOT) and EPA all provided more funding to villages than to regional Native nonprofits. For example, EPA provided $72 million to villages over the period, or over six times the amount provided to regional Native nonprofits. A Small Number of Programs Accounted for the Majority of Funding and a Small Number of Both Native Villages and Regional Native Nonprofits Received the Majority of the Funding While Native villages and regional Native nonprofits received different amounts of funding, with different primary sources of funding, both received the majority of their funding from a few programs. For example, Native villages received funding from a total of 112 programs; however, as shown in table 2, the top programs from nine agencies providing the most funding accounted for about 64 percent of the funding to all Native villages. Similarly, while regional Native nonprofits received funding from 149 programs, about 87 percent of the funding came from the nine agencies that provided the largest funding (see table 3). Further, Native villages and regional Native nonprofits received funding from some of the same programs, but not always in similar amounts. For example, Native villages received about $10 million from the Department of Justice’s Public Safety Partnership and Community Policing Grants and about $6 million from the United States Department of Agriculture’s (USDA) Water and Waste Disposal Systems for Rural Communities program. Regional Native nonprofits received less than $500,000 from the same Justice program and about $1.4 million from the same USDA program. In addition to the concentration of funding among a small number of agencies, as shown in figures 5 and 6, relatively few Native villages and regional Native nonprofits received more than a third of the funding. For example, only 13 out of 216 Native villages received 38 percent of total federal funding to Native villages. Also, 10 of 33 regional Native nonprofits received 71 percent of total funding to these entities. Combined Federal Funding to Native Villages and Regional Native Nonprofits Increased 29 Percent between 1999 and 2003 In 2003 constant dollars, annual combined federal funding to Native villages and regional Native nonprofits increased 29 percent, from $512 million in 1999 to $662 million in 2003. Combined funding to Native villages and regional Native nonprofits increased every year, except 2003, peaking in 2002 at $737 million (see fig. 7). The large increase between 2001 and 2002, from $586 million to $737 million, is primarily attributable to increases in HHS funding to Native villages and regional Native nonprofits. HHS funding increased from $308 million in 2001 to $475 million in 2002. The decrease in funding between 2002 and 2003 is primarily attributable to decreases in funding from HHS and Interior. Finally, direct federal funding to Native villages grew 29 percent, from $64 million in 1999 to $83 million in 2003, and the number of Native villages receiving funds directly increased 32 percent from 148 in 1999 to 196 in 2003. Federal direct funding to the 33 regional Native nonprofits grew 29 percent from $448 million in 1999 to $579 million in 2003. Funding for 1998 is not included in the comparison because not all HHS and Interior funding was included in FAADS. According to HHS officials, FAADS does not capture the $139 million in federal funds expended by HHS in 1998 for it to operate the Alaska Native Medical Center and provide sanitation facilities projects. Also, according to Interior, the Bureau of Indian Affairs did not report 1998 funding data for inclusion in FAADS. Alaska Native Villages and Alaska Natives Also Benefited from Federal Funding to Other Nonprofit Organizations, Cities, Boroughs, and the State of Alaska Many Alaska Native villages also benefited from other nonprofits that primarily assist Alaska Natives. Also, Native villages located within incorporated cities benefited from municipal services, such as sewer and water services. In addition, Alaska Native villages and Alaska Natives benefited from federal funding to school districts, boroughs, and the state, for purposes such as education, transportation, and other community services. The state also passed through some federal funding it receives to Native villages, cities, and boroughs. Based on our analysis of FAADS data, 46 nonprofit organizations that primarily provide assistance and support to Alaska Natives received $224 million during 1998 through 2003. These organizations are a diverse group that include: statewide entities, such as the Alaska Federation of Natives, considered to be the largest advocacy group representing Alaska Natives; the Alaska Eskimo Whaling Commission, which supports subsistence activities; the Alaska Native Heritage Center, which seeks to promote awareness of Native culture and values; and the Council of Athabascan Tribal governments, a subregional Native nonprofit that provides health care services to six villages. See appendix IV for a list of the nonprofit organizations that primarily assist Alaska Natives and that received federal funding from 1998 through 2003. Our analysis of FAADS data indicated that 12 federal agencies provided incorporated cities that have Native villages within their borders with $167 million in federal funding during 1998 through 2003. Overall, 75 different incorporated cities received some form of federal funding, with an average of 32 cities receiving funds in any year. USDA provided the largest amount of funding to these cities—$88 million or about half of all funding provided to the cities. More specifically, its Water and Waste Disposal Systems for Rural Communities program, provided the largest share of this funding— $55 million. The Department of Energy provided the next largest share of funding to cities—about $26 million over the period. However, most of the Department of Energy’s funding was from one program—Renewable Energy Research and Development program—which accounted for $25 million to the incorporated cities. In addition, incorporated cities with Native villages within their borders received about $22 million from the DOT’s Airport Improvement Program. Our analysis of FAADS data also indicates that from 1998 through 2003, 18 federal agencies provided $161 million to borough governments. DOT contributed the largest share of the funding, $53 million. Its Airport Improvement Program provided $37 million to boroughs, making it the largest program overall. HUD provided the next largest amount of funding, $25 million. HUD’s Community Development Block Grants program provided $18 million to boroughs, making it the second largest program. Commerce, USDA, and Education each provided about $16 million to boroughs. Based on our analysis of FAADS data, independent school districts received about $674 million from 11 federal agencies. Fifty-six different school districts received federal funding, with an average of 52 school districts funded annually. Education was responsible for 98 percent of all funding to school districts, about $662 million. More specifically, the majority of these funds came from the department’s formula-based Impact Aid program. Impact Aid provided $481 million in financial assistance to school districts where school enrollments or availability of revenue are adversely affected by federal activities, or where a significant number of children reside on federal (including Indian) lands. Finally, our analysis of FAADS data also shows that the state of Alaska received about $7 billion in federal funding from 1998 through 2003. The state received about $3 billion from DOT, with about $2.3 billion coming from a formula-driven Federal Highway Administration program and $662 million from the Airport Improvement Program. USDA and Education each provided about $800 million to the state, with USDA providing $335 million from the Food Stamp program and $95 million from the Water and Waste Disposal Systems for Rural Communities program, and Education providing $122 million for Impact Aid program. EPA provided $401 million to the state, which included $216 million from its Surveys, Studies, Investigations and Special Purpose Grants program, which is used primarily to fund the state’s Village Safe Water program. In addition to using federal funds to provide general services throughout the state, the state of Alaska also passed through some of its federal funds to Native villages, regional Native nonprofits, cities, and boroughs. During the state fiscal period 1998 through 2003, the state passed through more than $105 million in federal funds to Native villages and regional Native nonprofits. This funding was provided by 15 federal agencies to Native villages and by 17 federal agencies to regional Native nonprofits to address health, environmental, economic, and other needs. In addition, the state passed through $82.5 million to incorporated cities and almost $253 million to boroughs with Native villages. See appendix V for more information on federal funds the state passed through to villages, regional Native nonprofits and other entities. Federal Funds Have Been Used to Provide an Array of Services to Alaska Native Villages Federal funds from the 13 programs we reviewed have been used to provide an array of services to Alaska Native villages. However, the extent of federal agency information on those uses varied widely by program. Specifically, funds from these programs were used to provide Alaska Natives with assistance in health care, housing, infrastructure, and other areas such as education and community development. In addition to providing funds for carrying out specific program activities, most of the programs we reviewed also covered at least a portion of grantees’ total administrative costs. The extent of readily available information on how funds from these programs were used varied, partly because of different reporting requirements and partly due to different efforts to summarize individual grantee data. Summaries of the 13 programs we reviewed are contained in appendixes VI through XVI. Alaska Native Villages and Regional Native Nonprofits, and Other State and Local Organizations, Used Federal Funding to Provide an Array of Services to Their Communities Alaska Native Villages, regional Native Nonprofits, and other state and local organizations used funds from the 13 programs we reviewed to provide an array of services to their communities. Specifically, they used funds from these programs to provide assistance related to health care, housing, infrastructure, and other areas (see table 4). Two programs we reviewed provided health care funding for Alaska Natives: the Department of Health and Human Services’ Tribal Self- Governance Program and the Denali Commission’s Health Care Program. HHS’s Indian Health Service (IHS) awards self-governance funding to 13 regional Native health care nonprofits, three Native villages, one statewide Native health care provider, and four groups of between two and seven Alaska Native villages, to provide health care services to Alaska Natives. Under the program, IHS negotiates self-governance compacts with these regional Native nonprofits, villages, and the statewide Alaska Native Tribal Health Consortium that allow those organizations to assume the management, design and implementation of their own health care programs. According to IHS officials and agency documentation, these organizations recently used HHS’s Tribal Self-Governance Program funding in several areas. These include the following: Clinical health services, including hospitals and health clinics, dental services, mental health services, and alcohol and substance abuse treatment. Collectively, these funds were used to operate 7 tribal hospitals, 28 tribal health centers, and 176 tribal community health aid clinics with about 500 community health aides. Contract health services (i.e., health services from private-sector providers where specialized health care services were not readily available at tribally operated providers). For example, the Alaska Native Medical Center in Anchorage—which generally provides treatment for serious illness and injury for Alaska Natives from all over Alaska—often uses contract health care funds to consult with specialists and to provide specialized care such as cardiac or neurological surgery. Preventive health services, such as public health nursing, health education, and immunization. For example, the Tanana Chiefs Conference used tribal self-governance funds to provide a community health representative program for patient education. Contract support costs (such as general administrative costs incurred by grantees). Health care facilities, including maintenance, improvement, and construction of health care and sanitation facilities. For example, in 2004, the Southeast Alaska Regional Health Consortium added a small, ground-floor room to accommodate a Magnetic Resonance Imaging service. The majority of the Denali Commission’s recent Health Care Program funding was used by the Alaska Department of Health and Social Services and the Alaska Native Tribal Health Consortium, a statewide Native health care provider, according to Denali Commission documentation. These groups used the funding primarily to construct new primary care clinics and repair and renovate existing ones, as well as to purchase health care equipment, for residents in rural Alaska, including Alaska Natives. According to the commission’s 2004 annual report, since 1999 it funded the construction of primary health clinics in 41 communities, while projects are under way in 59 other communities across the state. For example, in 2003, the Alaska Native Tribal Health Consortium used a total of $2.7 million from the commission’s health facilities program to build a health clinic in Toksook Bay (the location of the Nunakauyarmiut Tribe). The Denali Commission provides funding for other health care needs as well, such as a grant to the Alaska Department of Health and Social Services to cover half of the $400,000 needed to purchase an ultrasound machine for Sitka. Native Villages and Tribally Designated Housing Entities Used Federal Housing Funding to Construct, Rehabilitate, and Maintain Housing Stock HUD’s Indian Housing Block Grant program (IHBG) funds housing activities conducted by Alaska Native villages or Native regional housing nonprofits. This program has the stated intent of recognizing the right of tribal self-governance. HUD’s IHBG funds can be used in a variety of housing-related activities, including housing development, assistance to housing developed under the U.S. Housing Act of 1937, and planning and administration. According to HUD, between 1998 and 2003, 38 percent of the IHBG funds were used for housing development activities, 22 percent were used for modernizing and operating current assisted stock, 11 percent were used for planning and administration, and 29 percent were used for other housing activities, such as housing services, housing management services, crime prevention, model activities, and unspent funds. Figure 8 shows a new house built in Alaska by the Bristol Bay Housing Authority with IHBG and other funds. Three of the 13 programs we reviewed—USDA’s Water and Waste Disposal System for Rural Communities, DOT’s Airport Improvement Program, and the Denali Commission’s Energy Facilities Program—provided water, transportation, and energy infrastructure in Alaska Native communities. Funding under USDA’s Water and Waste Disposal System for Rural Communities is used primarily in conjunction with the state of Alaska’s Village Safe Water program. According to USDA officials and agency documentation, USDA funds are combined with EPA funds and 25 percent matching state funds to eliminate the “honey bucket”—a plastic 5-gallon bucket used as a toilet in some Alaska Native villages—and provide communities with water and sewer systems that function in Alaska’s harsh environment, such as the flush and haul system. From 2000 through 2003, USDA funded 86 Village Safe Water projects. In the Alaska Native village of Napaskiak, for example, USDA provided a $570,300 grant that, when matched with $190,200 from the state, is being used to replace all of the remaining single-family home honey buckets in the community with the flush and haul system. DOT’s Airport Improvement Program (AIP) was used to construct new airports and rehabilitate old ones, since many of the Alaska Native villages that are not accessible by roads contain an airport runway that provides the only year-round access to the village. Most of the program’s funding goes to Alaska’s Department of Transportation and Public Facilities, which administers most projects under the program. AIP officials said that many funds go to improving existing airports to bring all airports up to a minimum standard, and while airports in the lower 48 states are often on their second or third improvement plan, most airports in Alaska are being constructed or improved for the first time. Figure 9 below shows the 310 AIP projects, by type, for the 1999-2004 AIP grants that benefited Alaska Native villages. The Denali Commission’s energy program has been used to address issues affecting Alaska Natives by focusing on upgrades for bulk fuel tank farms and rural power system upgrades. Energy has been the commission’s primary infrastructure theme since 1999. The first challenge undertaken by the commission was the upgrade and consolidation of fuel tanks in 172 communities identified as health and environmental hazards by the U.S. Coast Guard and EPA. According to the commission’s 2004 Annual Report, the two major recipients of the commission’s energy facilities funds—the Alaska Energy Authority and Alaska Village Electric Cooperative—have upgraded bulk fuel tanks in 64 communities across the state, while projects are under way in 70 other communities. For example, in 2001, the commission provided about $2.9 million of the roughly $3.8 million used by the Alaska Energy Authority to upgrade a tank farm in the Alaska Native village of Kotlik (see fig. 10). The new tank farm replaced a system that had been cited for violations by the U.S. Coast Guard with one that was in full compliance with federal regulations. The commission’s 2004 annual report also stated that the commission has upgraded rural power systems in 13 communities, has started construction in 20 others, and is in the planning or design phase in an additional 18. These upgrades include adding backup power generators and increasing efficiency of existing generators. Eight of the 13 programs we reviewed assisted Alaska Natives in areas such as social services, capacity building, community development, job training, education, law enforcement, and economic development in Alaska Native communities. Interior’s Tribal Self-Governance Program: Twelve Alaska Native villages, eight regional Native nonprofits, one group consisting of multiple Alaska Native villages and one Indian reservation recently used Interior’s Tribal Self-Governance Program to fund a variety of activities. According to agency officials and documents, these activities included: tribal government programs, such as funding to allow grantees to plan, conduct, consolidate, and administer programs, services, functions, and activities for tribal citizens according to priorities established by their tribal governments; human services programs, such as welfare assistance, child abuse and neglect counseling, and disaster assistance programs; education programs, such as scholarship grants for Alaska Native students attending accredited postsecondary institutions and adult education programs; public safety and justice, such as using funding for tribal courts that enable tribes to establish and maintain their own civil and criminal codes in accordance with local tribal customs and traditions; community development, such as the Housing Improvement Program, which funds repairs and renovations of existing homes and construction of new homes, job training and placement programs, or road maintenance programs; and resource management, such as programs assisting Alaska Natives in managing their forest, mineral, oil, gas, and other land-based programs, including fire protection and sacred-site programs. EPA’s Indian Environmental General Assistance Program: In 2004, program funding went to 139 Alaska Native villages and 11 groups of two or more tribes that are currently building their capacity to implement environmental protection programs, including development of solid and hazardous waste programs. According to EPA officials and documentation, villages use this “capacity building” funding to hire and train staff and purchase office equipment, conduct a review of village programs to ensure compliance with federal regulations, develop a strategic environmental plan for the village, implement village recycling programs, and coordinate environmental efforts with other villages and federal and state officials, among other uses. For example, officials in Native Village of Goodnews Bay reported to EPA that they used program funding to provide the village with environmental education, awareness, increased capacity to apply for other grants, and jobs. HUD’s Indian Community Development Block Grant Program (ICDBG): Eighty ICDBG grants were awarded from 1998 through 2003, with all but one of those grants going to Alaska Native villages, and one going to a joint venture between a village and a regional Native health care nonprofit. The projects included 21 health-related facilities (e.g., clinics, mental health, and primary care facilities); 35 community centers; 17 infrastructure projects (e.g., fuel tanks and water and sewer systems); 6 housing-related projects (e.g., housing rehabilitation, new construction, and land acquisition for new housing) and one imminent threat grant. For example, the Native Villages of Ekuk and Curyung used ICDBG grant funds in fiscal year 2002 to construct a combined Head Start/Family Resource Center in Dillingham (see fig. 11). Each Native village received $500,000 in ICDBG funds and leveraged an additional $3.2 million from other sources, excluding the land that was donated by the Bristol Bay Native Association, according to program documentation. Opened to students in January 2003, the center provides Head Start and Early Learning programs and child care to parents transitioning from welfare to work. The new center serves 60 children, ranging from infants to 12-year-olds, and replaced an old center that served only 30 children. Labor’s Youth Opportunity Grant Program: From 2000-2004, one coalition of Alaska Native Villages and regional Native nonprofits used approximately $32 million in funding from this program to fund a variety of education, job training, and youth development activities. The coalition selected Cook Inlet Tribal Council as the lead agency to apply for the Youth Opportunity Grant; Cook Inlet provided oversight, monitoring, and technical assistance. Cook Inlet subcontracted out the operation of most of the program to 11 regional Native nonprofits and 4 Alaska Native villages. According to agency documentation, about 2,960 Alaska youth, the vast majority of whom were Alaska Natives, enrolled in the YO! Alaska Program’s 40 youth centers and participated in internships, sports and recreation activities, reading and math remediation, community service, high school graduate equivalency degree preparation, and other activities. Education’s Alaska Native Education Program: In 2003, 32 educational organizations with experience in developing educational programs for Alaska Natives used funds to address the educational needs of Alaska Native students, parents, and teachers. The program’s enabling legislation specifically directs that some funding be used for Alaska Native cultural education programs, including a cultural exchange program between urban and rural students, dropout prevention programs, and parenting programs. Other funds have been used for family literacy programs, home instruction for preschool-age Alaska Natives, and to increase the educational opportunities of Alaska Native students and teachers. For example, the University of Alaska Southeast used an approximately $1.6 million grant for four main goals, one of which was to recruit and actively mentor Alaska Native high school students for the university’s Bachelor of Science program. Justice’s Community Oriented Policing Services (COPS): Alaska Native villages have used Justice’s COPS program to address village law enforcement needs through hiring and training police officers and purchasing uniforms and police vehicles. For example, since 1999, the COPS Tribal Resources Grant Program was used to hire 35 police officers in Alaska Native villages, and provide training and equipment to Native villages. Commerce’s Economic Adjustment Assistance Program: Alaska Native villages and regional Native nonprofits have used Economic Adjustment Assistance to develop comprehensive economic development strategies tailored to villages’ specific economic problems and opportunities. Since 1999, the program has funded 29 projects. For example, in 2001, the Tanana Chiefs Conference was awarded $725,000 for the construction of a 20-room hotel with a combination restaurant, lounge, and meeting facilities on council-owned property located in the Village of Circle. Commerce’s Public Works and Economic Development Facilities Program: Alaska Native villages and other tribal organizations have used three grants from this program since 1999. For example, in 2001, a village used $2.3 million to assist with the construction of a complex to house a museum, visitor center, and retail and office space. Most of the Selected Programs Provide Funding for at Least a Portion of Grantees’ Administrative Fees Eleven of the 13 programs we reviewed provided some funding to pay for a portion of the total administrative costs associated with the programs. The majority of these 11 programs provided funding for administrative costs as part of the overall grant amount, rather than allowing for reimbursement for specific administrative costs that grantees incur. Most of these 11 programs had restrictions on the amount of administrative funds grantees can use. For example, HUD’s IHBG program allows grantees to use up to 20 percent of the grant amount for total administrative costs. In contrast, Labor’s Youth Opportunity Grant program does not specifically limit administrative costs. However, according to Labor officials, the department negotiates with grantees to keep administrative costs low. Available Information on How Grantees Used Funds from Selected Programs Varies, in Part Due to Different Reporting Requirements Information on how Alaska Native villages, regional Native nonprofits, and other grantees used funds from the 13 programs we reviewed varied widely, partially because different programs have different reporting requirements and also because agencies summarize program data differently. For example, the statute governing the Department of the Interior’s Tribal Self- Governance Program does not require that the grantee submit information on how they used program funds; however, they can submit such information voluntarily. Additionally, reporting requirements for the other programs we reviewed varied, ranging from general information on delivery of services paid for by grant funds to detailed information on the financial uses of funds and progress toward grant goals. For example, HHS’s Tribal Self-Governance Program requires that grantees report annually on health status and service delivery in their locations, but does not require specific financial reports on how funding was used. Conversely, DOT’s Airport Improvement Program requires that grantees send quarterly performance reports that include comparisons between the projects’ accomplishments and the goals established for the quarter, reasons for not accomplishing planned goals in specific cases, and an analysis and explanation of any cost overruns. Additionally, some agencies do more than others to summarize individual grantee data on a programwide basis. For example, EPA’s Indian Environmental General Assistance Program has information in project files on each individual grantee’s projects, but has not summarized the information to show how all program funds have been used. In contrast, the Denali Commission collects project information in a Web-based, publicly available database that provides detailed financial and progress information. The system includes all of the commission’s grants, and can be queried to produce information by attributes such as theme (the underlying subject area of the project, such as energy—bulk fuel), community involvement, recipient, and milestone (such as in the business plan or construction phase). Alaska Native Villages and Regional Housing Authorities Constructed More Than 800 and Rehabilitated Almost 3,000 Homes, and the Number and Costs of Completed Units Varied across Regions Results from our survey of Alaska Native villages and regional housing authorities indicated that, from calendar years 1998 through 2003, these entities constructed 874 single-family units and rehabilitated 2,990 single- family units. Most of the new units constructed were three- and four- bedroom homes, and most of the new construction and rehabilitation activity occurred in a few regions. In addition, housing authorities constructed more than three times and rehabilitated more than twice the number of units than responding villages. However, village production of new homes increased steadily, while production by regional housing authorities fluctuated. Our analysis of survey data also indicated that the average costs of units constructed varied by region and by who developed them. Survey results also showed that housing authorities had higher new construction costs than villages, although villages had higher rehabilitation costs for units that did not require acquisition. According to federal, state, and local officials, variation in the number and cost of units constructed and rehabilitated by region and between housing authorities and villages reflect various factors, such as differences in local housing goals and objectives and proximity to sources of building materials. Also, regional housing authorities modernized 5,211 single-family units previously developed under the U.S. Housing Act of 1937 and developed several multifamily properties. Villages, however, are ineligible to receive funding for modernization. Reproductions of our surveys are contained in appendixes XVII and XVIII. Villages and Regional Housing Authorities Completed Construction on 874 Units and Rehabilitated 2,990 Units from 1998 through 2003 Based on our survey of Alaska Native villages and regional housing authorities, from calendar years 1998 through 2003, villages and regional housing authorities completed construction on a total of 874 single-family units and rehabilitated 2,990 single-family units. As shown in table 5, the number of units these entities constructed ranged from 104 in 1998 to 199 in 2002. The most common size of newly constructed units was a three- bedroom home. Slightly more than half of all units constructed were of this type. The second most common units were four-bedroom homes, which represented about a third of all units. Also, the total number of units rehabilitated by regional housing authorities and villages increased, from 253 in 1998 to 628 in 2002. As shown in figure 12, most of the newly constructed units were located in only a few regions. Specifically, four of the 12 regions—the Association of Village Council Presidents (AVCP), Fairbanks Native Association, Central Council, and Bristol Bay Native Association—accounted for 590 units— about 68 percent of the new construction. Specifically, one region— AVCP— accounted for about 30 percent of the production. Three regions, Copper River Native Association, Aleutian Pribilof Islands Association, and Kodiak Area Native Association, produced few or no new units. Similarly, the majority of units that villages and housing authorities rehabilitated over the period were located in a few regions. As shown in figure 13, three regions—Central Council, Cook Inlet Tribal Council, and Bristol Bay Native Association—accounted for almost 60 percent of all rehabilitated units. In contrast, the Aleutian Pribilof Islands Association and Arctic Slope Native Association regions completed relatively few or no rehabilitation projects. The 2,990 rehabilitated units include 2,920 units that did not require purchase before rehabilitation began, and 70 units that housing authorities and villages acquired before they were rehabilitated. Housing authorities and villages in five regions—AVCP, Bristol Bay Native Association, Central Council, Chugachmiut, and Maniilaq Association—rehabilitated acquired units. Most of the rehabilitated units that required acquisition—47—were completed in the Central Council region. Housing Authorities Constructed More Than Three Times and Rehabilitated More Than Two Times the Number of Units Compared with Villages Based on our survey, housing authorities constructed more than three times the number of new units as villages did. As shown in table 6, regional housing authorities constructed 666 units, while villages completed 208 units. Both the AVCP housing authority and the 11 villages within this region completed the most units—173 and 90, respectively—compared with housing authorities and villages located in other regions. The regional housing authority in Copper River Native Association region as well as the responding villages in both the Kodiak Island Native Association and Chugachmiut regions completed no units. Housing authorities rehabilitated more than double the number of units compared with responding villages, for both units that did not and did require acquisition. As shown in table 7, for units that did not require acquisition, housing authorities rehabilitated 2,114 units compared with 806 rehabilitated by villages. Almost 70 percent of housing authority rehabilitations occurred in three regions—Bristol Bay Native Association, Central Council, and Cook Inlet Tribal Council. Similarly, villages in four regions—AVCP, Cook Inlet Tribal Council, Fairbanks Native Association, and Maniilaq Association—accounted for over 70 percent of the units rehabilitated by villages. The regional housing authorities rehabilitated more units in all regions except for the Arctic Slope Native Association, AVCP, Chugachmiut, and Maniilaq Association regions. Similarly, housing authorities rehabilitated more than double the number of the acquired units as villages. Three housing authorities—Bristol Bay Native Association, Central Council, and Chugachmiut—rehabilitated 50 units that required acquisition. The housing authorities in Central Council rehabilitated the most acquired units, 43. Responding villages in three regions—AVCP, Central Council, and Maniilaq Association—rehabilitated 20 units that required acquisition. Rehabilitations of this type were more evenly spread among the responding villages, with Central Council completing 4 units, AVCP completing 6 units, and Maniilaq Association completing 10. Over the period covered by our survey, villages annually increased unit construction, while regional housing authority production varied annually. Specifically, village production grew more than sevenfold, from 7 units in 1998 to 53 units in 2003. Regional housing authority production ranged from 97 in 1998 to 149 in 2002, but also fluctuated widely over the period (see fig. 14). Regional Housing Authorities Modernized 5,211 Single-Family Units Previously Developed under U.S. Housing Act of 1937 Based on our survey, 13 housing authorities modernized 5,211 single-family units previously developed under the U.S. Housing Act of 1937. Villages are ineligible to receive funds for modernization activities. AVCP modernized the most units, 1,287. In contrast, the housing authorities in the Copper River Native Association and the Fairbanks Native Association regions modernized few units over the period (see fig. 15). Regional Housing Authorities Constructed, Rehabilitated, and Modernized Multifamily Housing Properties Only housing authorities completed new construction, rehabilitation, and modernization of multifamily properties (i.e., properties with five or more units). From 1998 through 2003, responding regional housing authorities constructed six multifamily properties—two by the housing authority in the Cook Inlet Tribal Council region, two by the housing authority in the Copper River Native Association region, and one each in the Aleutian Pribilof Islands and Central Council regions. Average property sizes ranged from 6,470 square feet in the Aleutian Pribilof Islands Association region to 34,831 square feet in the Cook Inlet Tribal Council region. Housing authorities also rehabilitated four multifamily properties, two of which were acquired. The housing authorities in the Bristol Bay Native Association and Central Council regions acquired and rehabilitated one multifamily property each, and the regional housing authority in the Kawerak Inc. region rehabilitated two multifamily properties. In addition, seven housing authorities modernized 73 multifamily properties over the period. Responding housing authorities completed a low of 8 multifamily properties in 1999 and a high of 17 properties in 2003. Housing authorities in seven regions—Arctic Slope Native Association, Bristol Bay Native Association, Central Council, Chugachmiut, Cook Inlet Tribal Council, Copper River Native Association, Kodiak Area Native Association—modernized multifamily housing. The housing authority in Cook Inlet Tribal Council region modernized the most multifamily properties—30. New Construction and Housing Rehabilitation Costs Varied by Region and by Whether Units Were Completed by Villages or Housing Authorities Construction and rehabilitation costs varied widely by region, with more remote regions generally incurring higher costs. Additionally, regional housing authorities had higher construction costs than villages. In contrast, villages had higher rehabilitation costs for housing units that did not require acquisition. Regional housing authority single-family modernization costs also varied by region, and multifamily housing costs varied according to the type of housing development. In general, housing costs are influenced by factors such as transportation, local expertise, terrain, site preparation, and required building/energy standards. Overall, based on our survey results, from 1998 through 2003, the average construction cost for all units produced by 31 villages and 12 housing authorities, was $222,928 per unit or $183 per square foot (in 2003 dollars). The average unit size was 1,217 square feet. During the same time period, the average cost of units rehabilitated by villages and housing authorities that did not require acquisition was $46,866 for major rehabilitation (costing $20,000 or more per unit) and $7,070 for minor rehabilitation (costing less than $20,000 per unit). The average cost of units that were rehabilitated and acquired by villages and housing authorities was $87,324 or $79 per square foot. New construction housing costs showed wide variation in eleven regions, based on responding regional housing authorities and villages. As shown by figure 16, the average combined cost per square foot ranged from $122 in Chugachmiut (located in southern Alaska, near Anchorage) to $267 in the Arctic Slope (located in the northern most region in Alaska). The average size of the units in these two regions was similar—1,134 per square feet and 1,142 per square feet, respectively. Kodiak Area Native Association region (located southwest of Anchorage) had the second highest costs per square foot, and Cook Inlet (Anchorage is part of Cook Inlet) had the second lowest cost per unit. These two regions also had similar sized units. Seattle is a primary source of construction materials for housing in Alaska. The Arctic Slope Native Association is the furthest region from Seattle and incurs the highest costs for transporting building material and equipment. Chugachmiut has lower transportation costs because it is closer to Seattle. However, the Kodiak Area Native Association region exemplifies how a region relatively close to Seattle can nonetheless face unusually high construction costs. According to an official with the Kodiak Island Housing Authority, there are several factors that have increased the cost of construction on the island, such as remote villages along the coast often not having adequate docking facilities to offload construction material, requiring special, expensive barges. Also, since the Kodiak Area Native Association area is rocky, extensive drilling and blasting is required to excavate the housing foundation for each unit and for digging trenches for water and sewer lines to the housing site. Finally, villages that are close to Kodiak City—the largest city in the Kodiak Area Native Association region—have high land costs. As shown in table 8, responding regional housing authorities had higher average costs for all units constructed and built larger units than did villages. Regional housing authorities’ average cost for all units constructed was $236,229 per unit or $189 per square foot, compared with villages, which had an average cost per unit of $180,338 or $160 per square foot. However, housing authority square-foot costs remained stable over the 6- year period, while village square-foot costs fluctuated. For example, from 1999 through 2000, the per-square-foot costs for villages decreased by 25 percent from $183 to $138, but between 2002 and 2003, the average per- square-foot costs increased 47 percent from $144 to $212. Moreover, housing authorities built units that were on average 433 square feet larger than units villages built in 1999 and 246 square feet larger in 2003. However, in 2000, villages built slightly larger units than housing authorities. Similar to new construction costs, the combined average rehabilitation cost for units that did not require acquisition varied throughout Alaska’s regions (see fig. 17). The region that reported the highest cost for major rehabilitation was the Arctic Slope Native Association, which had an average cost per unit of $93,444, followed by Cook Inlet Tribal Council, with an average per unit cost of $66,368. The two lowest-cost regions for major rehabilitation were Bristol Bay Native Association (southwestern Alaska), with an average per unit cost of $30,154, and Kawerak Inc. (northern Alaska), with an average cost per unit of $31,056. The highest- cost regions for minor rehabilitation were Kawerak Inc., which reported an average per unit cost of $17,671, and Kodiak Area Native Association, which reported an average per unit cost of $14,471. The lowest-cost regions for minor rehabilitation were Copper River Native Association (northeast of Anchorage) and Chugachmiut, which reported average per unit costs of $4,239 and $5,278, respectively. Although villages had higher rehabilitation costs for units that did not require acquisition, housing authorities had higher costs for units that did require acquisition. For units that did not require acquisition, housing authorities had lower costs than villages for major and minor rehabilitation. Housing authorities’ average cost for major rehabilitation was $44,200 per unit, while the village cost was $60,516 per unit. However, the average difference between village and regional housing authority minor rehabilitation costs was minimal: $6,967 vs. $7,301. (See fig. 18.) Conversely, regional housing authorities had higher average costs for units that were rehabilitated and acquired than villages. Over the 6-year period, 70 of these units were completed by four housing authorities and five villages. The average per unit cost for regional housing authorities was $105,849, compared with the average village per unit cost of $41,010. One reason for this cost difference may be that the regional housing authorities acquired much larger units; they averaged 1,281 square feet per unit compared with villages, which acquired units about half the size that averaged 634 square feet. However, regional housing authority costs per square foot were also higher than villages: $82 for regional housing authorities versus $64 for villages. Regional Housing Authority Single-Family Modernization Costs Also Varied by Region The average modernization costs for regional housing authorities varied by region. The average per unit costs for major modernization ($20,000 or more per unit) for all housing authorities was $28,387 per unit and for minor modernization (less than $20,000), $10,002 per unit. Twelve regional housing authorities completed major modernizations over the period. The regional housing authorities in Cook Inlet Tribal Council and Kawerak Inc. region had the highest average costs for major modernizations, averaging $44,330 and $43,324 per unit, respectively. The housing authorities in Association of Village Council Presidents and Bristol Bay Native Association regions had the lowest average costs for major modernization, averaging $22,795 and $23,643 per unit, respectively. Thirteen regional housing authorities completed minor modernizations. The housing authority in Kawerak Inc. region had the highest average minor modernization costs—$12,425 per unit—and the housing authority in the Cook Inlet Tribal Council region had the lowest average cost—$2,575 per unit. Multifamily Housing Costs Varied by Region and Type of Housing Development As previously noted, only regional housing authorities undertook multifamily projects. Although the average multifamily new construction cost for the six properties was about $3.8 million per property or $196 per square foot, per-square-foot costs ranged from $171 for the housing authority in the Copper River Native Association region to $219 for the housing authority in the Aleutian Pribilof Islands Native Association region. Similarly, the only two properties that included rehabilitation with acquisition experienced very different costs. For example, one small property (5,760 square feet), located in the Bristol Bay Native Association region, had a total cost of about $880,270 or $152 per square foot, and a large property (54,323 square feet) located in the Central Council region, had a total cost of about $5.3 million or $97 per square foot. Additionally, the two properties that were rehabilitated without acquisition (both in the Kawerak Inc. region) averaged $50,272 per property. In contrast, the 73 multifamily properties that were modernized had an average per property cost of $118,082. The average costs ranged from $8,661 per property in the Copper River Native Association region to $354,730 per property in Kodiak Island Native Association region. Several Factors May Account for Differences in the Number and Cost of Units Constructed and Rehabilitated by Villages and Housing Authorities and by Region As previously discussed, the number of units constructed and rehabilitated over the period varied by whether they were completed by villages or housing authorities, and by region. According to federal and tribal officials and documentation, the following factors could account for these differences: Differences in housing goals and objectives. In order to receive NAHASDA funding, housing authorities and villages are required to submit to HUD a 1-year and 5-year Indian Housing Plan (IHP), which outlines the housing goals and objectives for their communities. To carry out their plans, housing authorities and villages can determine the extent to which they focus their resources on new construction, rehabilitation, or other affordable housing activities. For example, Bristol Bay Housing Authority outlined in its fiscal year 2003 IHP that it would allocate a fixed amount of funds for new construction in villages, based on an assessment of needs. Differences in the amount of NAHASDA funding. Regional housing authorities generally receive considerably larger amounts of annual funding compared with villages because regional housing authorities receive funding on behalf of villages that have designated them to receive their NAHASDA funds, as well as modernization and operating funds for units developed under the U.S. Housing Act of 1937. Lack of additional funding in some cases limits the affordable housing villages can construct or rehabilitate. For example, in fiscal year 2003, the housing authority in the Maniilaq Association region received about twice the amount of funds of the single-largest amount provided to a village in that region. In addition, the amount of funding housing authorities and villages receive from the HUD formula takes into account Native population of the service area. Some of the populations that regional housing authorities serve are considerably higher than that of villages, and some regions have higher populations than other regions. For example, the total Native population in the Cook Inlet Native Association region is more than 10 times that of the Aleutian Pribilof Islands Association region. Differences in the extent to which NAHASDA funds were leveraged. Variations in the number of units constructed and rehabilitated may reflect the extent to which NAHASDA funds were leveraged. For example, according to the Cook Inlet housing authority, it leveraged IHBG funds with other sources of funding to complete a recent housing development. Cook Inlet housing authority used NAHASDA funds for about 10 percent of project costs and leveraged the remaining costs with private mortgages and other funding. Similarly, federal and state housing officials informed us that several factors may account for differences in regional construction and rehabilitation costs, as well as differences in costs reported by villages and housing authorities. These factors include the following: Transportation costs: Many Alaska Native villages are in remote locations, requiring equipment and building supplies to be transported to the construction sites. In general, regions that are farthest from Seattle—a major source of building materials—incur higher costs for transporting building material and equipment than regions that are closer. Length of construction season: Villages that experience extremely cold weather, such as those in the north and the interior of Alaska, have short construction seasons. For example, the construction season in the Arctic Slope Native Association is usually 2 or 3 months long, depending on ice conditions in the Bering Strait and north of the Arctic Circle. A short construction season means higher costs due to limited barge access to remote communities (with barge access the only viable method for moving construction materials and equipment to remote villages), less time available for site preparation and actual construction, overtime pay for working longer hours each day, and climate changes that suddenly stop construction or excavation. Using outside expertise: Higher costs are associated with transporting, housing and feeding outside construction workers, engineers, and housing inspectors. This could be for both regional housing authorities and rural Native villages. Larger villages may be able to use local construction workers, but smaller, more isolated villages with a limited skilled labor pool to choose from may have to rely on outside workers with required technical skills (e.g., electricians, plumbers, etc.). Many housing authorities rely on outside contractors, who usually provide a core crew of their own construction workers—supplemented by the local workforce—to construct housing. Land costs: Generally, urban areas cost more than rural areas because they are closer to utilities and roads and are located in active real estate markets in high-density areas. Rural Native villages often donate land for housing development, though in many cases they have less access to infrastructure. Wage costs: The hourly wage rates for new construction and rehabilitation of housing vary across Alaska’s regions. Generally, labor costs are higher in the more remote areas of Alaska, such as the north, and lower in the southern areas. For example, under the Davis-Bacon Act, carpenters are required to be paid $15.83 (without fringe benefits) in the Anchorage area; $25.05 plus $7.80 for fringe benefits in the Northern area; and $17.68 (without fringe benefits) in the southern area. In 2000, NAHASDA was amended to allow Native villages to establish tribally determined wage rates for their IHBG construction projects instead of using Davis-Bacon wages rates. However, according to HUD officials, Davis-Bacon wage rates and tribally determined wage rates within the same region are frequently similar. Type of terrain: Many of the houses in Alaska Native communities, particularly in northern and central Alaska, were constructed on permafrost—land that is permanently frozen. It generally costs more to build on this type of terrain due to the need for specialized engineered foundation systems. It also generally costs more to build on hilly terrain or rocky soil, such as Kodiak Island in the Kodiak Area Native Association region. Site preparation: Building or extending roads and installing power, water, and sewer lines—both on-site and off-site, particularly in rural communities—can be costly. Also, the same type of terrain problems mentioned above apply to site preparation. Energy efficiency standards: The Alaska Housing Finance Corporation (AHFC) requires any recipient of its funds to follow the Building Energy Efficiency Standard (BEES). Each regional housing authority receives annual funding from AHFC, but the villages do not receive any such funds. Therefore, each regional housing authority is required to adhere to the BEES for each newly constructed unit whenever they use AHFC funding. According to an AHFC official responsible for administering the BEES program, there are additional costs associated with compliance with the BEES standards, although these costs will vary depending on several factors, such as whether an independent inspector is required to inspect the housing unit. Villages may also voluntarily choose to use some or all of the BEES standards. Building code standards: Alaska’s Construction Inspection Guidelines require each builder to retain an independent, licensed inspector to perform each of the inspections set forth in the guidelines. According an AHFC official, this could amount to between 5 to 12 inspector site visits during the construction period. Since only regional housing authorities receive AHFC funds, Native villages are not required to follow any state building codes, unless they are located in one of the 13 municipalities that have adopted building code standards. However, similar to the BEES, Native villages may voluntarily choose to use some or all of the building code standards. Agency Comments and Our Evaluation We provided a draft of this report for review and comment to the federal co-chair of the Denali Commission and the Secretaries of Agriculture, Commerce, Education, Health and Human Services, Housing and Urban Development, Justice, the Interior, Labor, and Transportation, and the Administrator of the Environmental Protection Agency, as well as the Governor of Alaska. We received technical comments from five federal agencies and the state of Alaska that we incorporated, as appropriate. The Departments of Commerce and the Interior generally agreed with the report and provided written comments that are reprinted in appendixes XIX and XXI, respectively. The Department of Health and Human Services also provided written comments, stating that the GAO draft report did not include its Health Resources and Services Administration’s Minority AIDS Initiative among the 13 programs we reviewed. Funding for the administration is included in our analysis as part of overall funding for the Department of Health and Human Services. In addition, as discussed in the report, the 13 programs we selected for review generally provided the largest amount of funding to Alaska Native villages and regional Native nonprofits during fiscal years 1998 through 2003 for their respective agencies. Based on our analysis, the Minority AIDS Initiative did not provide the largest amount of the department’s funding to Alaska Native villages and regional Native nonprofits during the period. The Department of Health and Human Services’ written comments are reprinted in appendix XX. We are sending copies of this report to the federal co-chair of the Denali Commission and the Secretaries of Agriculture, Commerce, Education, Health and Human Services, Housing and Urban Development, Justice, the Interior, Labor, and Transportation, and the Administrator of the Environmental Protection Agency, as well as the Governor of Alaska. If you have any questions regarding this report, please contact me at (202) 512-8678 or shearw@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix XXII. Scope and Methodology This study’s objectives were to (1) provide information on the amount of federal assistance to Alaska Native villages during federal fiscal years 1998 through 2003; (2) describe how selected federal funds have been used to assist Alaska Native villages; and (3) provide data on the number and average cost of houses built by villages and Alaska Native regional housing authorities. To address these objectives, we met with officials of various federal agencies, the state of Alaska, boroughs, and cities. In addition, we met with representatives of Native villages, regional Native nonprofit organizations, and other organizations that primarily focus on Alaska Natives. We also met with officials from advocacy groups that represent Alaska Natives, including the Alaska Federation of Natives, the Alaska Inter-Tribal Council, and the National Congress of American Indians. To report on the amount of federal funding that has been provided to assist Alaska Native villages, we examined data on both funding to over 200 federally recognized Alaska Native villages and regional Native nonprofits. We classified as regional Native nonprofits the Native associations that were identified in the Alaska Native Claims Settlement Act (ANCSA) and the organizations that succeeded them, which, throughout this report, we refer to as ANCSA Native nonprofits; Native health organizations identified in Public Law 105-83; and housing authorities identified by the Department of Housing and Urban Development (HUD). To provide information on federal funding to Alaska Native villages, we analyzed data from the Federal Assistance Award Data System (FAADS), which identifies recipients of federal awards, federal programs for which awards were made, and award amounts. The analysis sought to isolate funding provided to Alaska Native villages, regional Native nonprofits, other nonprofits that primarily focus on Alaska Natives, incorporated cities that have villages within their borders, boroughs, and the state of Alaska. In providing FAADS data to the Census Bureau, each federal agency codes recipients of its federal funds into 13 categories. Two of these categories apply to Native recipients: Indian tribes and other nonprofit agencies. During electronic testing, GAO identified reliability problems with these categories. Similar problems were identified by other researchers (e.g., University of Alaska Anchorage and the Alaska Legislature Legislative Research Service) that have used this data. For example, agencies did not consistently apply the recipient codes to the same recipients. Therefore, we conducted our own coding of the recipient type, and in some cases, recipients were recoded into a new category. Specifically, we classified entities as Alaska Native villages based on whether they were recognized as such by the Bureau of Indian Affairs (BIA). We classified entities as regional Native nonprofits based on whether there were (1) regional Native associations identified in ANCSA and the organizations that succeeded them, (2) regional Native health organizations identified in Public Law 105-83, or (3) Alaska regional housing authorities identified by the Department of Housing and Urban Development. We classified entities as other nonprofits that primarily focus on Alaska Natives based our review of published information and on consultations with the Denali Commission and the Alaska Federation of Natives. In addition, we classified entities as state entities based on whether they were state of Alaska agencies or subagencies; boroughs based on whether there were recognized Alaska borough governments; cities based on whether they were incorporated cities that contain Alaska Native villages within their borders; and Independent School Districts based on whether they are Alaska public school districts. Maintained by the Census Bureau, FAADS produces a quarterly file of standardized data records on all types of financial assistance awards made by federal agencies to all types of recipients during the indicated quarter. Each transaction record identifies, by the Catalog of Federal Domestic Assistance (CFDA) program code number and name, the type and amount of financial assistance, the type and location of the recipient, and the geographic place of performance. Also, GAO’s FAADS analyses uses constant 2003 dollars. We assessed the reliability of the FAADS data by (1) performing electronic testing of the required data elements for obvious errors in accuracy and completeness, (2) comparing program totals by fiscal year to similar data from the Single Audit Act database, (3) reviewing related documentation, (4) reviewing related studies that used FAADS data, and (5) interviewing Census Bureau officials knowledgeable about the data. In addition, for 10 federal agencies whose programs are focused on in this report, we provided agency officials with FAADS program dollar amount totals for all entities receiving funds in Alaska, by fiscal year, and asked agencies to verify that the totals were correct. In cases where there was a greater than 10 percent difference between our totals based on FAADS compared with data provided directly to us by the agencies, we identified the agency programs producing the largest dollar differences and the largest percentage differences, and discussed those differences with agency officials. If we determined that the agency data were reliable, we adjusted our data to reflect the verified agency data. We did this by obtaining the agency obligations provided to individual recipients in Alaska for agency programs from 1998 through 2003. The FAADS data was obtained from Census in March 2005. To provide information on the amount of federal funds passed through to Alaska Native villages and other entities by the state of Alaska to carry out federal programs, we analyzed information obtained from the state of Alaska’s Department of Administration, Division of Finance; and the University of Alaska. The Division of Finance coordinated our request for “pass through” data with 15 state departments and component units. The information we obtained from the Division of Finance and the University of Alaska included the amount of federal funds passed through to various entities for state fiscal years 1998 through 2003, including the specific federal program that provided the funds. We limited our review to Alaska Native villages, regional Native nonprofits, incorporated cities that have Native villages within their borders, and boroughs. To assess the reliability of the state data, we discussed the data system with Division of Finance officials and the University of Alaska. We also discussed the process they used to satisfy our request. We concluded that the data we obtained from the state of Alaska were sufficiently reliable for the purposes of this report. The state data were obtained from the Division of Finance and University of Alaska during February and March 2005. To describe how selected federal funds were used to assist Alaska Native communities, we judgmentally selected 13 major programs from 11 agencies—1 each from 9 agencies and 2 each from the remaining 2 agencies. We selected 1 program each from the Denali Commission, the Departments of Agriculture (USDA), Education, Health and Human Services (HHS), Justice, Interior, Labor, and Transportation (DOT), and the Environmental Protection Agency (EPA). We also selected two programs each from the Department of Housing and Urban Development and the Department of Commerce. Generally, the selected programs provided the largest amount of funding to Alaska Native villages and regional Native nonprofits during fiscal years 1998 through 2003 for their respective agencies, based on our analysis of FAADS. These programs also represented 84 percent of total federal funding to Alaska Native villages and regional native nonprofits during the period. For USDA, we selected CFDA 10.760—Water and Waste Disposal Systems for Rural Communities—even though it did not provide the most direct funding to Native villages and regional Native nonprofits, because it also provided significant funding to cities and to the state, through the state’s Village Safe Water program, which used funds to benefit Native villages and Alaska Natives. For Labor, we selected Youth Opportunity Grants (CFDA 17.263), which provided almost $16 million to regional Native nonprofits during the period. Our FAADS analysis identified Workforce Investment Act program (CFDA 17.255) as the program that provided the most funding, which was used to provide funding for youth opportunity activities and was subsequently replaced during the period with 6 new programs, including CFDA 17.263—Youth Opportunity Grants. For Education, we selected the Alaska Native Education Program (CFDA 84.356), which represented the largest program when combining amounts provided by 2 other programs that were consolidated into this program during the period—Alaska Native Home-Based Education for Preschool Children (CFDA 84.321) and Alaska Native Educational Planning, Curriculum Development, Teacher Training, and Recruitment Program (CFDA 84.320). For Commerce, FAADS indicated that the Economic Adjustment Assistance (EAA) program provided the largest amount of department funding to Alaska Native villages and regional Native nonprofits during 1998 through 2003. We also selected Commerce’s Public Works and Economic Development Facilities program for review after department officials informed us that EAA provided atypically high funding to Alaska Native villages in 2001 in response to an Alaska salmon-fishing disaster. Also, we selected 2 HUD programs: the Indian Housing Block Grant program, which provided the largest amount of department funding to Alaska Native villages and regional Native nonprofits, according to our FAADS analysis; and the Indian Community Development Block Grant program, because it also can be used to construct new housing in Alaska Native villages. For each of the 13 programs we reviewed, we met with federal officials and, where appropriate, state, local, and village officials, as well as other officials representing organizations that primarily serve Alaska Natives. We also reviewed program descriptions from the CFDA and reviewed agency documents on how recipients used program funds, including grantee reports, annual reports to Congress, and reports prepared in compliance with the Government Performance and Results Act of 1993. To better understand certain programs administered by the state of Alaska, we spoke with officials from the Alaska Department of Transportation and Public Facilities, Alaska Department of Environmental Conservation, and the Alaska Housing Finance Corporation. Where program data are reported, we interviewed agency officials and reviewed program documents to assure ourselves that data were sufficiently reliable for the purposes of this report. To better understand the need for and uses of the selected programs, we visited several Alaska Native villages. Based on our analysis of FAADS, each of the villages received funding from at least 1 of the 13 selected programs. During our visit, we interviewed representatives of Alaska Native villages, regional Native nonprofits, and incorporated cities with villages within their borders. We saw several examples of projects completed using the selected programs, including housing, water and waste treatment facilities, bulk fuel tank farms, and primary health care facilities. To provide information on the cost and number of houses built by Native villages and Alaska Native regional housing authorities, we surveyed Alaska Native villages and regional housing authorities (also known as tribally designated housing entities) that were identified as having received Indian Housing Block Grant (IHBG) funds for at least 1 year from fiscal year 1998 through 2003. We identified 78 Alaska Native villages and 15 regional housing authorities that have received IHBG funds. We provided each of the 93 villages and regional housing authorities with a questionnaire delivered by e-mail or by U.S. mail. Questionnaire items covered the number developed and the cost of new single-family units and multifamily properties, the number developed and the cost of rehabilitated single-family units and multifamily housing properties, and the number developed and the cost of modernized single-family units and multifamily housing properties. To prepare for the survey, we conducted interviews with HUD officials, Alaska state officials, and members of various Alaska Native villages and regional housing authorities. We had HUD Alaska field office officials review the survey for content, and we pretested the questionnaire with two regional housing authorities and five villages to determine whether respondents would understand questions the way we intended. Since the questionnaire was administered via e-mail as well as U.S. mail, usability tests also were conducted with all of the pretests to observe respondents answering the questionnaire as it would appear when opened and displayed on their computer screen. We took the following steps to increase the response rate for both village and housing authority participants. We sent two reminder notices via e-mail and conducted follow-up telephone calls to those offices that did not respond to our survey by the initial deadline. Collection of survey data ended on March 15, 2005. We received responses from 57 villages and 13 regional housing authorities, providing a response rate of 73.1 percent for villages and 86.7 percent for regional housing authorities. Table 9 details the responding regional housing authorities and villages that were constructing or rehabilitating single-family homes between calendar years 1998-2003. We did not attempt to verify the respondents’ answers against an independent source of information; however, questionnaire items were tested by probing pretest participants about their answers using in-depth interviewing techniques. Interviewers judged that all the respondents’ answers to the questions were correct. In addition, answers to the final questionnaire were compared with data in HUD’s Annual Performance Reports for 1998 through 2003. These data are not directly comparable with data obtained in the survey, but do indicate whether survey respondents’ answers were reasonable. We conducted follow-up phone calls to clarify responses where there appeared to be discrepancies. The practical difficulties of conducting any survey may introduce certain types of errors, commonly referred to as nonsampling errors. For example, differences in how a particular question is interpreted, the sources of information available to respondents, or the types of people who do not respond can introduce unwanted variability into the survey results. Steps such as pretesting and follow-up contacts to increase response rates serve to minimize nonresponse error. In addition, steps such as performing statistical analyses to identify inconsistencies and having a second independent reviewer for the data analysis can further minimize such error. Data from surveys returned via e-mail were entered electronically by participants and imported into an electronic data file. Data from all fax- returned or mail-returned surveys were edited for consistency before sending them for keypunching. These surveys were “double key entered” into our database (that is, the entries were 100 percent verified), and a random sample of the surveys was further verified for completeness and accuracy. Close-ended questionnaire items were analyzed using statistical software. We conducted our survey work from August 2004 through March 2005 in accordance with generally accepted government auditing standards. Alaska Native Population by Native Village and ANCSA Region or Indian Reservation Alaska Natives receive assistance from more than 200 villages that are recognized by the Bureau of Indian Affairs to receive federal funding. Table 10 contains: a listing of the 12 regional areas established by ANCSA identified by the regional for-profit name and the Metlakatla Indian Community, Annette Island Reserve; the villages within each region; and the corresponding number of American Indian/Alaska Native (AIAN) persons and enrolled tribal members. Listing of Alaska Regional Native Nonprofits Regional Native nonprofits also serve Alaska Natives. In this study, we include regional nonprofits that were: identified as regional Native associations in ANCSA or the organizations that succeeded them; identified as regional Native health organizations in P.L. 105-83; or that were identified as Alaska regional housing authorities by HUD. Table 11 provides a listing of Alaska Native regional health care and housing nonprofits, by ANCSA region. Other Nonprofits That Provided Assistance to Alaska Native Villages In addition to receiving assistance directly from the federal government and from regional Native nonprofit organizations, Alaska Native villages also receive assistance from other nonprofits funded by the federal government. According to our analysis of data from FAADS for the federal fiscal year period 1998 through 2003, 46 of these other nonprofits received federal funding for the purpose of assisting Alaska Native villages. The 46 nonprofits are Alaska Eskimo Whaling Commission, Alaska Federation of Natives, Alaska Native Arts Foundation, Alaska Native Harbor Seal Commission, Alaska Native Health Board Inc., Alaska Native Heritage Center, Alaska Native Heritage Park Inc., Alaska Native Justice Center Inc., Alaska Native Science Commission, Alaska Native Women’s Coalition, Alaska Sea Otter and Steller Sea Lion Commission, Bering Straits Foundation, Chugach Regional Resources Commission, Council of Athabascan Tribal Governments, Cultural Heritage And Educational Institute, Eastern Aleutian Tribes Inc., Institute of Alaska Native Arts Inc., Mount Sanford Tribal Consortium, Qutekcak Native Tribe (Seward), Robert Aqqaluk Newlin Sr. Memorial Trust, Rural Alaska Community Action Program Inc., Simon Paneak Memorial Museum, Southeast Alaska Indian Cultural Center, United Crow Band Inc., Valdez Native Tribe, and Yukon River Inter Tribal Watershed Council. The State of Alaska Passed Through Federal Funding to Native Villages, Regional Native Nonprofits, Cities, and Boroughs Based on our analysis of data from the state of Alaska, the state passed through more than $105 million in federal funds to Alaska Native villages and regional Native nonprofits for state fiscal years 1998 through 2003. However, Native villages received a smaller share of this funding. Also, the state of Alaska passed through over $335 million in federal funds to incorporated cities and boroughs that have villages located within their borders. State of Alaska Passed Through Over $105 Million in Federal Funds to Alaska Native Villages and Regional Native Nonprofits According to data provided by the state of Alaska Department of Administration, Division of Finance, the state passed through more than $105 million to Native villages and regional Native nonprofits for state fiscal years 1998 through 2003. As shown in figure 19, Native villages received $18.2 million (17 percent) compared with regional Native nonprofits, which received $87.3 million (83 percent). During this period, the state passed through federal funding to 99 different Native villages and 23 regional Native nonprofits. Over the period, Native villages received most of their funding from slightly more agencies than regional Native nonprofits. Native villages received state pass-through funding from 15 federal agencies, with about 67 percent of the funding provided by four federal departments—Commerce, EPA, HHS, and Transportation. Commerce provided more than 20 percent of the major funding, with EPA contributing 20 percent and HHS and Transportation contributing 14 and 12 percent, respectively. In comparison, regional Native nonprofits received state pass-through funding from 17 federal agencies, but about 85 percent of all funding was provided by two federal agencies—HHS and USDA. HHS contributed about 68 percent of the major funding, with another 17 percent provided by USDA (see figs. 20 and 21). Overall, both Native villages and regional Native nonprofits received the majority of their pass-through funding from a few programs. For example, over the period, the state of Alaska passed through federal funding for 64 different programs to Native villages. However, as shown in table 12, the top five programs accounted for over 70 percent of the funding to these entities. None of the remaining 59 programs contributed more than $1 million each in state pass-through funding over the period. Also, most agencies’ funding was provided by only one of their programs. For example, three different Commerce programs provided slightly more than $3.9 million in pass-through funding to Native villages, and almost all of this was provided by the Fisheries Disasters Relief program. Similarly, Native villages received funding from two EPA programs, and most of this was provided by the Surveys, Studies, Investigations, and Special Purpose grants program. Further, all of the General Services Administration’s (GSA) funding came from the Donation of Federal Surplus Personal Property program. Regional Native nonprofits received funding from a larger number of programs than Native villages. For example, over the period, the state of Alaska passed through federal funding for 102 different programs to regional Native nonprofits. As shown in table 13, the top 6 funding programs accounted for 76 percent of the funding to these entities. None of the remaining 96 programs contributed more than $2 million each in state pass-through funding over the period. Similar to Native villages, most agencies’ funding to regional Native nonprofits were provided by a relatively few number of those agencies’ programs. For example, 42 different HHS programs provided funding to regional Native nonprofits, but Temporary Assistance to Needy Families (TANF) provided 68 percent of all HHS funding. Similarly, 79 percent of all USDA funding was provided by the Special Supplemental Nutrition Program for Woman, Infants and Children. Table 14 shows that pass-through funding provided to Native villages by the state of Alaska increased between state fiscal years 1998 and 2003. Although the number of Native villages receiving pass-through funding stayed fairly constant over the period, increasing from 41 in 1998 to 46 in 2003, the annual amount of funding increased by 75 percent, from $1.6 million in 1998 to about $2.9 million in 2003. The Denali Commission accounted for 63 percent of the increase during the period, while GSA’s Donation of Federal Surplus Personal Property program accounted for 35 percent. Commerce pass-through funding reached its peak in 2000 and 2002, with about 65 percent of all Commerce funding provided in those 2 years alone under the Fisheries Disaster Relief program in response to a slump in the Alaska fishing industry. EPA funding reached its peak in 1999 and 2000, with about 85 percent of the agency’s total funding over the period being provided in those 2 years under the Surveys, Studies, Investigations, and Special Purpose grants program. The amount of federal funding passed through by the state to regional Native nonprofits grew steadily over the period—by 160 percent—from 18 entities receiving $8.3 million in 1998 to 19 entities receiving $21.6 million in 2003. Most of this growth was caused by an increase in HHS program funding, which accounted for 90 percent of the growth. As was the case with Native villages, EPA funding reached its peak in 2000, with about 56 percent of the agency’s total funding over the period being provided under the Surveys, Studies, Investigations, and Special Purpose grants program. HUD funding also reached its peak in 2000, with about 36 percent of the agency’s total funding provided under the HOME Investment Partnerships program. Moreover, pass-through funding provided by HHS programs to regional Native nonprofits outpaced the growth in funding to Native villages by almost 10 times. (See fig. 22.) The state of Alaska passed through federal funds totaling more than $335 million for state fiscal years 1998 through 2003 to incorporated cities and boroughs with Native villages. Specifically, 104 cities received $82.5 million and 16 boroughs received almost $253 million. The state passed through funding it received from 20 federal departments for programs such as HHS’s ChildCare Mandatory and Matching Funds of the ChildCare and Development Fund, and TANF; and EPA’s Clean Water State Revolving Fund, and its Surveys, Studies, Investigations, and Special Purpose grants program. Although these funds were not given to a Native village or regional Native nonprofit, Alaska Natives likely benefited from shared services and assistance provided by the cities and boroughs. For example, incorporated cities that have Native villages located within their borders provide municipal services, such as water, that benefit Alaska Natives. Denali Commission Program Summary Agency: Denali Commission. Program name: Denali Commission (emphasis on energy and health). Authorization: The Denali Commission Act, as amended, 42 U.S.C. 3121 note; 70 Fed. Reg. 28283 (May 17, 2005) (Five Year Strategic Plan (2005- 2009) and Fiscal Year 2006 Work Plan). Eligible program recipients: Awards are available to state and local governments, private, public, profit, nonprofit organizations and institutions or individuals eligible in Alaska. Beneficiaries must be the general public, particularly distressed communities. Program objectives: To deliver the services of the federal government in the most cost-effective manner practicable by reducing administrative and overhead costs; to provide job training and other economic development services in rural communities, particularly distressed communities; to promote rural development, provide power generation and transmission facilities, modern communication systems, water and sewer systems and other infrastructure needs. Another objective is to provide funding for the construction of new primary health care clinics. Application process: For bulk fuel and rural power grants (the vast majority of energy grants), there is not an application process. In 1999, the commission worked with the Alaska Energy Authority to assemble a priority ranking of the needs of all bulk fuel sites in the state. One hundred seventy-two rural Alaskan communities were ranked, based on deficiencies in fuel storage and power systems, and funding priority goes to those projects with higher scores. Each year, as some projects are completed, those with lower priorities get funded. For most of the commission’s other programs, generally a community must send the commission a letter requesting assistance, along with comprehensive community-based and approved development plans. The commission judges potential projects based on consistency with locally developed and regionally supported infrastructure development plans, long-term sustainability, relative impacts on reducing unemployment, raising the standard of living, reducing the cost of utilities, and cost sharing by others. In some cases, applicants can apply directly to state and local partners working with the commission. The time frame for grants is based on the projects and negotiated between the commission and the grantee, subject to the 5-year maximum time frame imposed by the Office of Management and Budget. Allowable Uses of Program Funds: Funds can be used for infrastructure or utility needs benefiting Alaskans. The commission has made rural energy its primary infrastructure theme since its inception in 1999, but has 12 program areas in total: washeterias (potable water and laundry facilities as well as showers and elder housing, domestic violence facilities. Examples of actual uses of program funds: The commission maintains a Web-based information system that includes detailed financial and progress information on projects. The system can be publicly queried, specifying project attributes such as community involved, recipient, theme (the underlying subject area of the project, such as energy (e.g., bulk fuel) or health care (e.g., hospitals), and milestone (where in the process the project is, such as business plan or construction). The Denali Commission’s energy program has been used to address energy issues that affect Alaska Natives by focusing on bulk fuel tank farm upgrades and rural power system upgrades. Energy has been the commission’s primary infrastructure theme since 1999. According to the commission’s 2004 annual report, the first challenge undertaken by the commission was the upgrade and consolidation of fuel tanks in 172 communities identified as health and environmental hazards by the U.S. Coast Guard and U.S. EPA. Since its inception, grantees of the commission’s energy facilities funds—usually the Alaska Energy Authority and Alaska Village Electric Cooperative—have upgraded bulk fuel tanks in 64 communities across the state, while projects are under way in 70 other communities, according to the 2004 annual report. That report also notes that the commission has upgraded rural power systems in 13 communities, has started construction in 20 others, and is in the planning or design phase in an additional 18. These upgrades include adding backup power generators and increasing efficiency of existing generators. The commission’s web site has information on specific energy projects, including the following: upgrading a tank farm in the Village of Kotlik. In 2001, the commission provided about $2.9 million of the roughly $3.8 million used by the Alaska Energy Authority to upgrade the tank farm, which had been cited for violations by the U.S. Coast Guard. moving a fuel tank farm in the Native Village of White Mountain. The commission partnered with the Alaska Energy Authority to use a $2,395,743 commission grant, along with $1,239,817 in state and local funds. The Alaska Energy Authority used the funds to move the fuel tank farm from the middle of the village’s business district, where the school and store are located, to an area still accessible but west of the village, and equipped the tanks with spill prevention. Construction on that project was completed in 2003. developing a new aircraft off-loading fuel pipeline in the Native Village of Ambler. The commission partnered with Alaska Village Electric Cooperative to use a $566,700 commission grant (with $31,000 in other funds) to develop the pipeline to provide year-round fuel deliveries. The pipeline system included modifications to local tank farms to connect to the new pipeline. Construction on that project was completed in 2002. The primary focus of the Denali Commission’s health facilities program— its second infrastructure priority—is to provide funding for the construction of new primary care clinics and repair and renovation of existing primary care facilities. From 1999 through 2004, the commission completed primary care facilities in 41 communities, and has 59 facilities in planning or design phases, according to its 2004 annual report. Some specific health care projects from Denali’s project database include the following: designing and constructing a rural primary care facility and community health center in the Native Village of Kiana. The commission partnered with the Alaska Native Tribal Health Consortium to use a commission grant of $716,000 (with $400,000 in other funding) for the facility and community health center, which replaced an existing village clinic. Construction on that project was completed in 2002. constructing a health clinic in the Native Village of Toksook Bay (the location of the Nunakauyarmiut Tribe). The commission partnered with the Alaska Native Tribal Health Consortium to use two grants totaling $2.7 million from the commission’s health facilities program to build a health clinic in Toksook Bay. Construction was completed in January, 2005. providing funding for other health care needs as well, such as a grant to the Alaska Department of Health and Social Services to cover half of the $400,000 needed to purchase an ultrasound machine in Sitka. Funding mechanism: The commission’s energy and other programs usually provide federal funds to grantees that the commission calls “partners” (i.e., state or federal agencies or nonprofits that administer numerous projects). For energy projects, for example, the Alaska Energy Authority and Alaska Village Electric Cooperative were the commission’s partner agency on over 95 percent of grants. For health projects, the Alaska Native Tribal Health Consortium and the state of Alaska’s Department of Health and Social Services were the commission’s partner on most projects. A few grantees are not partner agencies, such as Native villages or other local communities that administer just one program for their community. Restrictions on administrative costs: The commission does not have a standard limit on the amount of funding grantees can spend on total administrative costs. However, the commission negotiates with each grantee on the amount of indirect administrative costs that the commission will provide. According to agency officials, for energy partners the amount of indirect costs that the commission allows has generally ranged from 0 percent to 4 percent of total grant amounts, paid for from the overall grant amount. Program Summary for the Department of Agriculture Subagency: Rural Development. Program name: Water and Waste Disposal Systems for Rural Communities. Authorization: Consolidated Farm and Rural Development Act, as amended, 7 U.S.C. 1926; 7 C.F.R. §§ 1779.1 et seq.; 7 C.F.R. §§ 1780.1 et seq. Eligible program recipients: Municipalities, counties, and other political subdivisions of a state, such as districts and authorities, associations, cooperatives, corporations operated on a not-for-profit basis, Indian tribes on federal and state reservations, and other federally recognized Indian tribes. Facilities shall primarily serve rural residents and rural businesses. The service area shall not include any area in any city or town having a population in excess of 10,000 inhabitants, according to the latest decennial Census of the United States. Beneficiaries may be farmers, ranchers, rural residents, rural businesses, and other users in eligible applicant areas. Program objectives: To provide basic human amenities, alleviate health hazards and promote the orderly growth of the rural areas of the nation by meeting the need for new and improved rural water and waste disposal facilities. Application process: Over 80 percent of program funding in Alaska is appropriated by Congress to fund the state of Alaska’s Village Safe Water program, administered by the Alaska Department of Environmental Conservation. For those grants, applicants file an application on forms prescribed by the Department of Environmental Conservation that describes the community need, how the proposed project will address that need, and cost. A committee comprising representatives from USDA Rural Development (USDA RD), the Alaska Department of Environmental Conservation, and EPA (which also provides funds for the Village Safe Water program) scores each application to the Village Safe Water program. (The Alaska Native Tribal Health Consortium, which oversees many of the projects funded by the Village Safe Water program, does not have a representative on the committee, but does have the ability to advise informally on project selection.) The scoring depends on several variables, including whether the grant is requested for construction or planning. For construction projects, project need and impact are the most significant scoring factors, followed by operation and maintenance of the project (e.g., if the project will be operated by certified technicians), community planning, and application quality. Communities must have overall environmental plans to be approved for construction grants. For planning projects, the factors include planning need, existing level of service, previous planning efforts, and type of facilities to be planned. Also, according to agency officials, there are some projects that are specifically included by Congress in appropriations legislation, which requires USDA RD to contact certain entities to assist them in USDA RD’s application process if they choose to apply. Most of the other program funding goes to the Combination Water/Waste programs, which USDA RD administers directly. Under this program, villages and cities can apply to USDA RD for funding. Allowable uses of program funds: Funds may be used for the installation, repair, improvement, or expansion of a rural water facility, including distribution lines, well pumping facilities and costs related thereto; the installation, repair, improvement, or expansion of a rural waste disposal facility, including the collection, and treatment of sanitary, storm, and solid wastes; and indoor plumbing in certain cases where the residents are unable to afford the improvements on their own. Grant funds may not be used to pay interest on loans, operation and maintenance costs, or to acquire or refinance an existing system. Examples of actual uses of program funds: USDA RD’s Water and Waste Disposal System for Rural Communities has been used for new and improved rural water and waste disposal facilities. According to USDA RD officials and available documentation, USDA RD funds are combined with EPA funds and 25 percent matching state funds to eliminate the honey bucket—5-gallon buckets that serve as a toilet—and provide communities with water and sewer systems that function in Alaska’s harsh environment, such as the flush and haul system. According to agency documentation, from 2000 through 2003, USDA RD provided funding for 86 Village Safe Water grants. Over that same time period, USDA RD funded 17 other projects through USDA RD Combination Water/Waste projects, and also provided funding for the state-administered Remote Maintenance Worker program. USDA RD and state documentation show the following examples of Village Safe Water projects: In 2003, USDA RD provided a grant of $570,300 to benefit Napaskiak that, when matched with $190,200 in state funds, is being used to replace all of the remaining single-family home honey buckets in the community with the “flush haul” system, according to agency documentation. In 2000, USDA RD provided $633,800, in conjunction with $211,200 in Alaska Housing Finance funding, for water and sewer improvements in Nulato. Uses of the funds included the design and construction of a wastewater lagoon for the lower town site, maintenance upgrades for the new town site lagoon and landfill, and replacement of the water and sewer system for the lower town site teacher housing area. In 2000, USDA RD provided a $2,175,000 grant that, in conjunction with $725,000 in state funds, was used in Bethel for a new piped water distribution and sewer collection system, including circulating water mains and pressure sewer mains. One example of a Combination Water/Waste project is the project in Talkeetna. According to USDA RD, Alaska’s 2003 annual report and other agency documentation, in 2002, USDA RD provided the Mat-Su Borough with $1.3 million to help fund an upgrade for a sewage treatment facility in Talkeetna. The new system was the first of its type in Alaska and uses a collection of cells and aquatic plants to pretreat raw sewage from the community. The project converted an old percolation cell into a lagoon cell lined with a plastic layer, increasing treatment capacity by over 25 percent, according to the 2003 annual report. A wetland was also constructed to treat secondary effluent from the lagoons prior to discharge into the Talkeetna River. Funding mechanism: According to agency documentation, over 80 percent of USDA RD’s Alaska funding is appropriated by Congress specifically for the Alaska Village Safe Water program; that funding goes to the state of Alaska’s Department of Environmental Conservation, which administers the Village Safe Water projects in rural Alaska. Most of the other program funding goes from USDA RD directly to cities and villages. Restrictions on administrative costs: The program follows Office of Management and Budget (OMB) Circular A-87, a primary federal regulation that outlines the principles for determining which administrative costs can be recovered for programs administered under grants with the federal government; there are no other established limitations. Until fiscal year 2005, the state paid for administrative costs of the Village Safe Water program from state funds and from federal EPA funds, so 100 percent of USDA RD’s funds went to project costs, according to agency officials. Officials also stated that, in fiscal year 2005, USDA RD and the state began working toward providing some USDA RD funds for administrative costs. Funding for these administrative costs will come from the grant amount. Program Summaries for the Department of Commerce Subagency: Economic Development Administration. Program name: Economic Adjustment Assistance. Authorization: Public Works and Economic Development Act of 1965, as amended, 42 U.S.C. 3149; 13 C.F.R. § 308.1 et seq. Eligible program recipients: Eligible applicants include economic development districts; states, cities or other political subdivisions of a state or a consortium of political subdivisions; Indian tribes or a consortium of Indian tribes; institutions of higher learning or a consortium of such institutions; or public or nonprofit organizations or associations acting in cooperation with officials of a political subdivision of a state. Applicants using Economic Development Administration (EDA) supplemental disaster assistance will generally be restricted to disaster-impacted areas. Program objectives: To assist state and local interests to design and implement strategies to adjust or bring about change to an economy. Program focuses on areas that have experienced or are under threat of serious structural damage to the underlying economic base. Such economic change may occur suddenly or over time, and generally results from industrial or corporate restructuring, new federal laws or requirements, reduction in defense expenditures, depletion of natural resources, or natural disaster. EAA aids the long-range economic development of areas with severe unemployment and low family-income problems; aids in the development of public facilities and private enterprises to help create new, permanent jobs. Application process: EDA’s Economic Development Representative (EDR) or regional office representative will meet with the applicant to determine whether preparation of a project proposal is appropriate. If appropriate, applicants are requested to prepare a brief project proposal according to an outline provided by the EDR. Following a review by the EDR and regional office staff, the Regional Director will determine whether to invite a formal application. An environmental impact assessment is necessary, and an environmental impact statement may also be required. All proposals and applications for funding submitted to EDA are evaluated competitively for conformance to statutory and regulatory requirements and conformance with EDA’s Investment Policy Guidelines and funding priorities. Final decision on applications from eligible applicants is made by the Regional Office Director of the Economic Development Administration, Department of Commerce. Allowable uses of program funds: EAA funds can be used to provide grants for planning or construction of projects tailored to the community’s specific economic problems and opportunities. Specific activities may include creation or expansion of strategically targeted business development, market or industry research and analysis. Examples of actual uses of program funds: According to information GAO received from EDA, since 1999, EDA has funded 29 EAA projects in Native villages and Native nonprofits. Examples of specific projects include the following: In 2001, a total of $5.1 million was provided to five different entities, including the Native Villages of Savoonga, Wales, and Unalakleet, for the construction of five approximately 4,000-square-foot multipurpose community buildings to Alaskan native entities. These facilities included amenities such as a visitor center, lodging, meeting hall; office spaces; conference rooms, kitchens, restrooms, and storage. In 2001, the Tanana Chiefs Conference was awarded $725,000 for the construction of a 20-room hotel with a combination restaurant, lounge, and meeting facilities on council-owned property located midtown in the Village of Circle. Funding mechanism: The EDA provides funding directly to grantees, which could be Alaska Native entities. Generally, EDA funds 50 percent of a project’s cost. However, certain conditions of high economic distress or an applicant’s inability to provide all of the matching share may permit a higher grant rate. Restrictions on administrative costs: According to EDA officials, there is no specific dollar limitation on allowable administrative costs; however, under the EAA program, administrative costs typically do not constitute a significant portion of the total grant. For smaller or rural grantees such as Alaskan tribes, allowable administrative costs could include the cost of a Project Administrator because such entities may not hold the in-house expertise needed to manage large construction projects. Program name: Grants for Public Works and Economic Development Facilities. Authorization: Public Works and Economic Development Act of 1965, as amended, 42 U.S.C. 3141; 13 C.F.R. § 305.1 et seq. Eligible program recipients: States, cities, counties, an institution of higher education or a consortium of institutions of higher education, and other political subdivisions, Indian tribes, the Federated States of Micronesia, the Republic of the Marshall Islands, Commonwealths and territories of the U.S. flag, Economic Development Districts, and private or public nonprofit organizations or associations acting in cooperation with officials of a political subdivision of a state or Indian Tribe. Individuals, companies, corporations, and associations organized for profit are not eligible. Program objectives: To promote long-term economic development in areas experiencing substantial economic distress. EDA provides public works investments to support the construction of rehabilitation of essential public infrastructure and development facilities necessary to generate higher-skill, higher-wage jobs and private investment. Application process: The EDR or other appropriate EDA official will meet with the applicant and community leaders to explore the applicability of the proposed project. If deemed appropriate, a proposal will be requested. After reviewing the proposal, the EDR or the regional office will notify the applicant regarding the decision of whether to invite an application. If the project appears viable, a preapplication conference with regional office personnel may be arranged at EDA’s discretion. An environmental impact assessment is required for this program. The review of the environmental impact assessment may result in an environmental impact statement being required. Applications are approved by the Regional Director and announced by the Assistant Secretary of Commerce for Economic Development. Allowable uses of program funds: Public works investments may include investments in facilities such as water and sewer system improvements, industrial access roads, industrial and business parks, port facilities, railroad sidings, distance learning facilities, skill-training facilities, business incubator facilities, redevelopment of brownfields, eco- industrial facilities, and telecommunications infrastructure improvements needed for business retention and expansion; eligible activities such as the acquisition, rehabilitation, design and engineering, or improvement of public land or publicly owned and operated development facilities, including machinery and equipment; and infrastructure for broadband deployment and other types of telecommunications-enabling projects and other kinds of technology infrastructure. Examples of actual uses of program funds: According to information we received from EDA, since 1999, EDA has funded three public works projects totaling about $3.8 million in Native areas. Examples of specific projects include the following: In 2001, the Seldovia Village Tribe was provided $2.3 million to assist with the purchase of two lots and construction of a complex that will encompass a museum, visitor center, and retail/office space. In 1999, the Nenana Native Association was provided $480,000 for implementation of the entities’ economic development plan by renovating and upgrading its community hall and funding construction of other business infrastructure to continue development of tourism business. In 1999, the Shishmaref Village Council was provided about $1 million for a traditional tannery. Funding mechanism: The EDA provides funding directly to grantees, which could be Alaska Native entities. The basic grant rate may be up to 50 percent of the project cost. Severely depressed areas may receive supplementary grants to bring the federal contribution up to 80 percent of the project cost. Recognized Indian tribes may be eligible for up to 100 percent assistance. On average, EDA’s investment covers approximately 50 percent of project costs. Restrictions on administrative costs: According to EDA officials, there is no specific dollar limitation on allowable administrative costs; however, under the Public Works and Economic Development Facilities program, administrative costs typically do not constitute a significant portion of the total grant. For smaller or rural grantees such as Alaskan tribes, allowable administrative costs could include the cost of a project administrator because such entities may not have the in-house expertise needed to manage large construction projects. Program Summary for the Department of Education Subagency: Office of Elementary and Secondary Education. Program name: Alaska Native Educational Programs. Authorization: Elementary and Secondary Education Act, as amended, 20 U.S.C. 7541-7546; 34 C.F.R. §§ 74, 75, 77, 80, 81, 82, 84, 85, 86, 97, 98, and 99. Eligible program recipients: Alaska Native educational organizations or educational entities with experience in developing educational programs for Alaska Natives. Program objectives: To support projects that recognize and address the unique educational needs of Alaska Native students, parents, and teachers. Application process: Alaska Native Educational Programs are competitive grants, except for program funds that have been earmarked for specified recipients for specified purposes. For competitive grants, applicants submit proposals under which the Department of Education uses a peer review process where panels choose applications to determine which proposal best meets program objectives and the needs of Alaska Natives. The Department of Education selects panelists who are knowledgeable of Alaska Native educational needs, eligible activities, and project management and evaluation, and who are from outside the department. To avoid potential conflicts of interest, panelists are usually non-Alaska Natives. Specific selection criteria for the 2003 application included the magnitude of the need for and significance of the project, quality of project design, quality of project services, and the quality of the project evaluation to be conducted on the project. Approved grants are usually for 3-year funding periods. Allowable uses of program funds: Program funds can be used in a variety of areas, including increasing the education of Alaska Native teachers or those who teach home instruction for preschool Alaska Natives, math and science assistance. Additionally, the enabling legislation, the Alaska Native Educational Equity, Support, and Assistance Act, has five earmarks for specific programs: $1 million annually for the Alaska Native Heritage Center for cultural educational programs designed to share the Alaska Native culture with students; $1 million annually for Alaska Humanities Forum for a cultural exchange program designed to share Alaska Native culture with urban students in a rural setting; $2 million annually for a dropout prevention program operated by Cook $2 million annually for the Alaska Initiative for Community Engagement for continuation of that entity’s general programs; and $1 million annually to continue existing parenting educational programs, including parenting education provided through in-home visitation of new mothers. Examples of actual uses of program funds: Individual grant files maintained by the department contain the following examples of how grantees used funds. In 2000, the University of Alaska Southeast (UAS) received a grant of about $1.6 million for “Preparing Indigenous Teachers for Alaska Schools.” The 3- year grant had four main goals, one of which was to increase participation of Alaska Native students in bachelor of science programs at UAS. One way the program increased participation was by using mentors to recruit high school students for the UAS bachelor of science program. By the third year of the grant, program participants actively mentored 75 high school students and post-high-school candidates from 11 different communities. In the third year of the grant, the program provided 16 mentors a stipend of $1,000 each, and also provided scholarships for 15 students in the amount of $8,500 each. Another goal of the program was to develop a focused support system for Alaska Native students at UAS. One way the program used grant funds to accomplish this was to hire math tutors to assist Alaska Native students in individual and group tutoring sessions. The program also financially supported the UAS Native/Rural Resource Center for cultural activities such as lectures, storytelling series, and pot luck dinners. In 1999, the Alaska Native Heritage Center received a 3-year Alaska Native Education Program grant in the amount of about $570,000. The grant had seven objectives, including providing Alaska Native youth with cultural activities unavailable in the schools. The center’s activities addressing this objective included dance classes, youth leadership workshops, and art workshops. Over the 3 years of the grant, 157 students participated in programs offered by the center through the grant. Funding mechanism: The Department of Education provides funding directly to grantees, which could be Alaska Native educational organizations or educational entities with experience in developing educational programs for Alaska Natives. Restrictions on administrative costs: The program’s enabling legislation states that no more than 5 percent of funds provided to a grantee may be used for administrative purposes. No amount in addition to the grant is provided for reimbursement of administrative costs. Program Summary for the Department of Health and Human Services Subagency: Indian Health Service. Program name: Tribal Self-Governance. Authorization: Indian Self-Determination and Education Assistance Act, as amended, 25 U.S.C. 458aaa—458aaa-18; 42 C.F.R. § 137.1 et seq. Eligible program recipients: Any federally recognized tribe that (1) formally requests, through a governing body action, participation in the Tribal Self-Governance Program; (2) has furnished organizationwide single audit reports for the previous 3 years that contain no uncorrected significant and material audit exceptions in the audit of the tribe’s self- determination contracts or self-governance funding agreements with any federal agency; and (3) successfully completes a planning phase, to the satisfaction of the tribe, that includes legal and budgetary research and internal tribal government planning and organizational preparation relating to the administration of health care programs. Tribes may also authorize another eligible tribe to participate in the self-governance program on their behalf. Under current law, tribes not already in a compacting relationship with the Indian Health Service (IHS) may not receive funds for health care services if they are located in areas served by an Alaska Native regional health entity. Program objectives: The purpose of the program is to make financial assistance awards to Indian tribes to enable them to assume from IHS programs, services, functions, and activities with respect to which Indian tribes or Indians are primary or significant beneficiaries. Application process: If a tribe is eligible and interested in entering the self-governance program, it sends a letter of intent to either the Director of the Office of Tribal Self-Governance or to an IHS area director for a tribe’s area. health care facilities, including maintenance, improvement, and construction of health care and sanitation facilities. Examples of actual uses of program funds: IHS and the Alaska Native Tribal Health Consortium—a statewide Native health care provider— collect information on health status and services delivery and compile this information into several different reports, including Alaska-specific reports such as the Statistical Summary of Workload reports and Annual Performance Contract information. The 2003 Annual Performance Contract states that grant recipients used program funds during this period to operate 7 tribal hospitals, 28 tribal health centers, and 176 tribal community health aide clinics; and provide 4,093 homes with water facilities, and 3,004 homes with wastewater facilities. The 2002 Statistical Summary of Workload states the following: In the 7 hospitals in Alaska that receive tribal self-governance funding, there were 10,992 inpatient admissions (excluding newborns), an overall decrease of 802 admissions from fiscal year 2001; and there were 1,868 total newborn admissions (deliveries), a 6.65 percent decrease from 2001. In the tribally run hospitals, health centers, and community clinics, there were 970,146 ambulatory care visits, a 2.2 percent increase in 2001, the most recent year available, contract medical accounted for 1,939 hospital admissions, 7,181 hospital patient days, 128 hospital births, and 60,741 outpatient clinic visits; and during 2002, adjusted health aide visits totaled 263,947 encounters, which was a 1.9 percent decrease from 2001. Funding mechanism: IHS provides funding directly to the compacting entity—that is, the regional Native health care nonprofit, Alaska Native village, or group of villages administering the health program. Restrictions on administrative costs: IHS does not have a standard limit on the amount of funding compacting tribes can spend on total administrative costs. Pursuant to tribal funding agreements, IHS provides funding for contract support payments—payments to compacting tribes to pay for some of tribes’ administrative costs. Program Summaries for the Department of Housing and Urban Development Subagency: Public and Indian Housing. Program name: Indian Community Development Block Grant. Authorization: Housing and Community Development Act of 1974, as amended, 42 U.S.C. 5306; 24 C.F.R. § 1003.1 et seq. Eligible program recipients: Any Indian tribe, band, group, nation, or tribal organization, including Alaska Indians, Aleuts, and Eskimos, and any Alaska Native village that is eligible for assistance under the Indian Self- Determination and Education Assistance Act or that had been eligible under the State and Local Fiscal Assistance Act of 1972. Tribal organizations are permitted to submit applications on behalf of eligible tribes when one or more eligible tribes authorize the organization to do so under concurring resolutions. The tribal organization must be eligible under Title I of the Indian Self-Determination and Education Assistance Act. Program objectives: The objective of the Indian Community Development Block Grant (ICDBG) program is to provide assistance to Indian tribes and Alaska Native villages in the development of viable communities, including decent housing, a suitable living environment, and economic opportunities, principally for persons of low and moderate income. Application process: Applicants must file an application on forms prescribed by HUD that describes the community development need and how that need will be addressed by the proposed project. The applicant must provide sufficient information for the project to be rated against selection criteria. The rating criteria include the need of the project, soundness of approach, leveraging resources and comprehensiveness and coordination. The Office of Native American Programs (ONAP) Area Office is responsible for administering the program and for notifying applicants of the results, which are done annually. (e.g., fuel tanks and water and sewer systems); 6 housing-related projects (e.g., housing rehab, new construction and land acquisition for new housing), and one imminent threat grant. Funding mechanism: Funding goes directly from HUD to the grantees; from 1998 through 2003, according to HUD documentation, all but 1 of the 80 grants went to Alaska Native villages, and that grant went to a joint venture between a village and regional Native health care nonprofit. Restrictions on administrative costs: The program’s regulations state that no more than 20 percent of funds provided to a grantee may be used for administrative purposes. Program name: Indian Housing Block Grant. Authorization: Native American Housing Assistance and Self- Determination Act (NAHASDA) of 1996, 25 U.S.C. 4101 et seq.; 24 C.F.R. § 1000.1 et seq. Eligible program recipients: Indian tribes or tribally designated housing entities (referred to throughout this appendix as housing authorities). Program objectives: IHBG funds are used for affordable housing activities administered by tribes or housing authorities, while recognizing the right of tribal self-governance. Application process: An eligible recipient must submit to HUD an Indian Housing Plan (IHP) each year to receive funding. Allowable uses of program funds: Indian Housing Block Grants can be used for a variety of eligible affordable housing activities, including modernization and operating assistance for U.S. Housing Act of 1937 housing; new construction, acquisition or rehabilitation of renter- or owner- occupied housing; housing services, housing management, crime prevention and safety or model activities as described in the Indian Housing Plan. Actual uses of program funds: The actual uses of IHBG funds from 1998 through 2003 for Alaska Native recipients were as follows, according to HUD documentation: Funding mechanism: HUD provides IHBG formula grants directly to Alaska Native tribes or their tribally designated housing entity. The IHBG funding formula considers two factors: (1) the needs of the grantee, and (2) the housing previously developed by HUD funding. Tribes may annually choose to receive IHBG funds and provide services directly to their members or tribes may choose to designate a housing entity to receive their IHBG funds and provide services on their behalf. Appropriations for 2004- 2005 included a provision limiting IHBG recipients in Alaska to those tribes or tribally designated housing entities that received funds in the previous fiscal year. Grantees do not have a matching funds requirement to qualify for the IHBG grant. The minimum grant award is $25,000. Restrictions on administrative costs: The IHBG program allows grantees to use up to 20 percent of the total grant amount for administrative costs. Administrative costs are taken out of the grant amount. Program Summary for the Department of the Interior Subagency: Bureau of Indian Affairs. Program name: Tribal Self-Governance Program. Authorization: Indian Self-Determination and Education Assistance Act, as amended, 25 U.S.C. 458aa—458hh; 25 C.F.R. § 1000.1 et seq. Eligible program recipients: Any federally recognized tribe that (1) formally requests, through a governing body action, participation in the Tribal Self-Governance Program; (2) demonstrates, for the previous 3 fiscal years, financial stability and financial management capability by furnishing organizationwide single audit reports for those 3 years that contain no uncorrected significant and material audit exceptions in the audit of the tribe’s self-determination contracts; and (3) successfully completes a planning phase, to the satisfaction of the tribe, that includes legal and budgetary research and internal tribal government planning and organizational preparation. If each tribe requests, two or more otherwise eligible tribes may be treated as a single tribe for the purpose of participating in self-governance as a consortium. Program objectives: To further the goals of Indian self-determination by providing funds to Indian tribes to administer a wide range of programs with maximum administrative and programmatic flexibility. Application process: If a tribe is eligible and interested in entering the self-governance program, it sends a letter of intent to the Director of the Office of Tribal Self-Governance. The letter of intent must also include information about how self-governance will benefit the tribe. Awards are not competitive; if a tribe is eligible, it may generally participate in the program. An annual funding agreement is negotiated between the participating tribe and the Secretary of the Interior consistent with federal laws and the tribal relationship. A tribe may also negotiate a multiyear funding agreement. Tribal Self-Governance Annual Report to Congress. Tribal submission of information for the Secretary’s annual report is optional, although agency officials and documentation noted that tribal self-governance data collection is important to the program. Most grantees in Alaska do not send such information to Interior; for 2003, for example, only six of the program’s 22 Alaskan grantees provided such information to Interior. Starting in fiscal year 2005, according to Interior officials, Alaska’s 22 grantees agreed in their annual funding agreements to provide Interior with Government Performance and Results Act information, such as housing, environmental, training, technical assistance, and other uses of tribal self- governance funds. Allowable uses of program funds: Funds may be used by grantees to support programs previously administered by the Bureau of Indian Affairs, pursuant to the terms of annual funding agreements or for programs specifically authorized by federal statute, and may not be used for the operation of elementary and secondary schools or for community colleges. Under these agreements, grantees have the flexibility to redesign programs to meet local needs and priorities. Table 24 shows budget categories for tribal self-government allocations from Interior to program grantees. Many of the budget categories also contain more specific allocation areas. Examples of actual uses of program funds: Based on summaries submitted by grantees for Interior’s Tribal Self-Governance 2003 Annual Report to Congress, the following are examples of recent uses of tribal self- governance funds: In 2003, the Central Council of Tlingit and Haida used approximately $4.6 million for job placement and training for 2,084 tribal members through its various programs. The number of individuals receiving support services assistance totaled 1,472. Those services included direct employment, vocational rehabilitation, and employability assistance. The Central Council also provided transportation, work clothing, and tools to over 276 tribal members. One hundred seventy people received classroom training and 25 received on the job training. courts. Bristol Bay also used the funds to provide training for village administrators and village presidents and improve communications with the village. Funding mechanism: Interior provides funding directly to the grantee— that is, the Alaska Native village, regional Native nonprofit, or group of villages administering the Tribal Self-Governance Program. Twelve Alaska Native villages, eight regional Native nonprofits, one group consisting of several other Alaska Native villages and one Indian reservation received self-governance funding in 2003. Restrictions on administrative costs: There are no specific restrictions on administrative costs. Pursuant to tribal funding agreements, Interior provides for contract support payments, which offset indirect and direct administrative costs. Program Summary for the Department of Justice Subagency: Office of Community Oriented Policing Services. Program name: Community Oriented Policing Services. Authorization: Omnibus Crime Control and Safe Streets Act of 1968, as amended, 42 U.S.C. 3796dd—3796dd-8. Eligible program recipients: States, units of local government, federally recognized Indian tribal governments, U.S. territories or possessions (including the Commonwealth of Puerto Rico, the Virgin Islands, Guam, American Samoa, and the Mariana Islands), other public and private entities, and multijurisdictional or regional consortia thereof. engage in community policing in and around elementary and secondary schools. Application process: COPS grants are awarded on a competitive basis. Applications are submitted to COPS’s Grants Administration Division for approval and include a description of the proposed project and a priority ranking of specific needs requested in the grant proposal. In fiscal year 2004, COPS received more than $60 million in grant requests and awarded available funds of about $25 million, nationwide. Typically awards are made to successful applicants based on the applicants’ ranking of needs at the time the grant request is submitted. Applicants may be denied any level of funding if they are under investigation by the U.S. Attorneys Office, in noncompliance under another COPS program, or not correcting deficiencies in their current application. Allowable uses of program funds: Grants provide funding for a variety of activities, including 36 months of entry-level salaries and benefits; basic equipment, such as handguns, holsters, and body armor; technology items, such as computers, software, automated booking systems, fingerprint identification systems, and GPS systems; and police cars. Examples of actual uses of program funds: Since its inception in 1994, COPS program grants have been used to add community policing officers to the nation’s streets and schools, enhance crime-fighting technology, support crime prevention initiatives, and provide training and technical assistance to advance community policing. In the state of Alaska, COPS grants have been awarded to hire 324 additional police officers and sheriff’s deputies, including about 100 officers under the programs discussed below. COPS has created a series of programs to meet the needs of law enforcement in Native communities. The COPS Tribal Resources Grant Program is a broad, comprehensive program designed to meet law enforcement needs in Native communities. This program offers a variety of funding in areas such as hiring additional officers, law enforcement training, uniforms, basic-issue equipment, emerging technologies, and police vehicles. incorporated both of these previous initiatives into one centralized grant program. The COPS in Schools (CIS) grant program is designed to help law enforcement agencies hire additional school resource officers to engage in community policing in and around primary and secondary schools. CIS provides an incentive for law enforcement agencies to build collaborative partnerships with the school community and to use community policing efforts to combat school violence. The Alaska State Patrol received technology grants beginning in 1999 that benefited the Village Public Safety Officers of Alaska. Funding mechanism: COPS provides grants to tribal, state, and local law enforcement agencies up to 75 percent of the costs to hire and train community policing professionals, acquire and deploy cutting-edge crime- fighting technologies, and develop and test innovative policing strategies. The CIS and technology grants do not require the 25 percent local match. Funds can be accessed by grantees using a phone system or electronically. Restrictions on administrative costs: According to the Grants Administration Division, administrative costs are not allowable under most COPS programs. Program Summary for the Department of Labor Subagency: Employment and Training Administration. Program name: Youth Opportunity Grants. Authorization: Workforce Investment Act of 1998, as amended, 29 U.S.C. 2914; 20 C.F.R. § 664.800 et seq. Eligible program recipients: This program is no longer taking new applications for grants. The 5 years of funding for grantees, which began in 2000, has already been completed, but most Youth Opportunity Grant program sites have some funds remaining that will allow them to provide a reduced level of programming for at least part of a sixth year. Eligible recipients included Native American and Alaska Native entities. Alaska Native applicants were required to be a Workforce Investment Act Section 166 Native American Grantee, and the community the applicant served had to meet certain poverty rate criteria in the Internal Revenue Code and be an Alaska Native village as defined in section 3 of the Alaska Native Claims Settlement Act. Beneficiaries had to be youth between the ages of 14 and 21 at the time they joined the program, and had to reside in the target area, without regard to income. Program objectives: To increase the long-term employment of youth who live in empowerment zones, enterprise communities, and high poverty areas. Youth Opportunity Grants concentrate extensive resources in high- poverty areas in order to bring about communitywide impact on employment rates, high school completion rates, and college enrollment rates. Application process: The program was competitive, and there were not specific amounts of grants set aside for Native Americans. Proposals were reviewed by an independent panel, including both federal staff and peer reviewers; site visits were made to finalists. Panelists rated the proposals based on project design and service strategy, youth development and community services, dropout prevention, management and accountability, and need in the target area. Applications had to include both a technical proposal and a financial proposal, describing, for example, how the grantee would provide comprehensive services, where the services would be delivered, the staff numbers that would deliver the services, and the program’s activities. Grant awards were made for an initial period of 1 year, with up to 4 additional option years based on the availability of funds and satisfactory progress toward achieving the goals and objectives of the grant. employment, community service, sports, recreation, education, and life skills programs. Funding mechanism: Funding went directly from Labor to the grantees. In Alaska, the grantee was Cook Inlet Tribal Council, which was designated as the lead agency to apply for the grant by the Alaska Native Coalition on Employment and Training. This coalition was originally composed of 10 Alaska Native regional nonprofits, two Alaska Native villages, and one other Native organization. That coalition selected Cook Inlet Tribal Council as the lead agency to apply for the Youth Opportunity Grant. Restrictions on administrative costs: The program’s enabling legislation does not specifically limit administrative costs. However, Department of Labor officials informed us that they negotiated with grantees to keep administrative costs low. Grantees pay for administrative costs from the grant amount; no amount in addition to the grant is provided for reimbursement of administrative costs. Program Summary for the Department of Transportation Subagency: Federal Aviation Administration. Program name: Airport Improvement Program. Authorization: 49 U.S.C. 47101 - 47142. Eligible program recipients: States, counties (in Alaska, boroughs), municipalities, and other public agencies, including Indian tribes, are eligible for airport development grants if the airport is listed in the National Plan of Integrated Airport Systems, which identifies more than 3,300 airports nationally that are significant to national air transportation. Grants for projects under the Airport Improvement Program (AIP) are typically given only to publicly owned, public use airports, with a few exceptions. Recipients of grants are commonly called sponsors. Sponsors must meet basic qualifications set up by the Federal Aviation Administration to receive AIP grants. In addition, a sponsor must be legally, financially, and otherwise able to assume and carry out the assurances and obligations contained in the project application and grant agreement. Program objectives: The purpose of the AIP is to assist sponsors, owners, and operators of public-use airports in the development of a nationwide system of airports adequate to meet the needs of civil aeronautics. Application process: Applicants file an application on forms prescribed by DOT that describe the objective of the project, benefits of the project, and need for the project, among other things. The application also requires budget and financial information. The Alaska Department of Transportation and Public Facilities (DOTPF) selects projects on a competitive basis, and the Federal Aviation Administration oversees the Alaska DOTPF’s selection of projects for completion. The Alaska DOTPF awards AIP funding based on, among other criteria, safety improvements that the project would make, improving community access to basic necessities, economic benefits, and if the community has alternatives to air travel. This process takes place annually, and projects can take up to 3 to 4 years to design, engineer, and build. and certain roads within airport boundaries; (6) construction and installation of airfield lighting, navigational aids, and certain off-site work; (7) safety equipment required for certification of airport facility; (8) security equipment required by the Secretary of Transportation; (9) snow- removal equipment; (10) terminal development; (11) aviation-related weather reporting equipment; (12) equipment to measure runway surface friction; (13) burn area training structures and land for that purpose; (14) agency-approved burn area training structures and land for that purpose; (15) relocation of air traffic control towers and navigational aids if they impede other projects funded by AIP; (16) land, paving, drainage, aircraft deicing equipment and structures for centralized deicing areas; and (17) projects to comply with the Americans with Disabilities Act of 1990, Clean Air Act, and Federal Water Pollution Control. Examples of actual uses of program funds: In general terms, the AIP uses its funding for airport planning and development. The AIP tracks its spending by three categories: purpose of the project (the underlying objective of the project, such as airport reconstruction), the physical component of the project (e.g., a runway), and the type of the project (the work being done, such as a runway extension). Based on GAO analysis of agency data, from 1999 through 2004, DOT provided funding for 310 grants that benefited Alaska Native villages and villages that are located within the boundaries of incorporated cities. According to AIP documentation, some recent examples of grant uses: In 2002, Alaska’s Department of Transportation and Public Facilities used grants totaling $8.3 million for airport improvements in the Alaska Native village of Iliamna, including $6.4 million to strengthen the runway. In 2003, the Native Village of Venetie used grants totaling about $6 million to construct a new airport and a snow-removal equipment building. In 2004, Alaska’s Department of Transportation and Public Facilities used grants totaling $257,000 to rehabilitate the seaplane base in the Metlakatla Indian Community, Annette Island Reserve. was located in an Alaska Native village or village located within the boundaries of an incorporated city. Restrictions on administrative costs: According to agency officials, the AIP limits the amount of indirect administrative costs that Alaska’s DOTPF can recover to 4.8 percent of the total AIP grants to the state; in 2003, the actual rate for indirect costs was less than 3 percent. DOT’s Federal Highway Administration adjusts that limit each year. Administrative costs are paid for from the grant, rather than given by AIP in addition to the AIP grant. Program Summary for the Environmental Protection Agency Subagency: Office of Water, American Indian Environmental Office. Program name: Indian Environmental General Assistance Program. Authorization: Indian Environmental General Assistance Program Act of 1992, as amended, 42 U.S.C. 4368b; 40 C.F.R. Part 35, Subpart B. Eligible program recipients: Alaska Native or American Indian tribal government or intertribal consortium. Program objectives: The primary purpose of the Indian Environmental General Assistance Program (IGAP) is to support the development of a core tribal environmental protection program. IGAP is intended to help Alaska Native and American Indian tribes build their capacity to administer environmental programs and address environmental problems on Indian land. Application process: Tribes and consortia in Alaska submit applications to EPA’s Alaska Operations Office on forms prescribed by EPA. Each IGAP application must include a description of the tribe’s environmental needs and goals, a work plan to accomplish those goals, and identification of grant outputs and outcomes. IGAP applicants must specify how they will spend the IGAP funds prior to receiving the IGAP grant. EPA evaluates proposals based on the completeness of the application, demonstration of risks and benefits to human health and the environment, the nature and quality of activities intended to build tribal capacity to address long-term environmental risks and needs, and management capability and past performance, if applicable. IGAP grants are not competitive grants; funding is available to all eligible tribes that demonstrate the capability to successfully manage a grant. EPA bases award amounts on fund availability, the number of eligible tribes and consortia applying, and the amount of any funds remaining in existing IGAP grants. IGAP project periods cannot exceed 4 years. developing and implementing integrated and sustainable solid waste cleanup and closure of unregulated dumps; acquiring training in environmental program priority areas (e.g., water, waste, pollution prevention, alternative energy, environmental emergency response); training and working with tribally elected officials on EPA programs, environmental regulations, and effective intergovernmental coordination; identifying and performing baseline assessments of sources of pollution (water quality sampling, air quality emissions inventories, and waste stream analysis); establishing a tribal communications capability and technical expertise to work with federal, state, local, tribal, and other environmental officials; and increasing communities’ environmental awareness. Additionally, EPA provided GAO with “success stories” highlighting specific examples of how IGAP funds have been used. Following are some examples: In 2003, the Gwich’yaa Zhee (Fort Yukon) IGAP program participated in the household hazardous waste back haul with Yutana barge lines, and back hauled 93 lead-acid batteries, 63 drums of waste oil, eight old vehicles, and 318 pounds of aluminum cans to be recycled. In 2003, the Goodnews Bay IGAP program sent a person to a Solid Waste Workshop, completed feasibility studies on the local dump, and started the process of getting a permit and draft management plans approved by the Alaska Department of Environmental Conservation to get a new landfill. Goodnews Bay also said that the IGAP program provided the community with environmental education, awareness, increased capacity to apply for other grants, and jobs. with other villages in the region, such as forming the Ugashik Watershed Council. In 1999, The Aleut Community of St. Paul Island IGAP program developed a Village Environmental Planning Survey and in 2000 began working on a Specific Action Plan, focusing on addressing the community’s solid and hazardous waste issues and educating the community on a variety of environmental issues. The IGAP program reported its top three accomplishments as: (1) establishment of a department within the tribal government of St. Paul to address current and ongoing environmental issues in the community; (2) signing the Tribal Environmental Agreement with EPA in 2000, and (3) establishment and implantation of a recycling program. Funding mechanism: IGAP grants go directly from EPA to the Alaska Native tribes and tribal consortia that run the programs. Restrictions on administrative costs: Grantees use indirect cost rates approved by the Department of the Interior where a grantee has such a rate. Where a grantee does not have a rate, it typically includes all administrative costs as direct costs, negotiating with EPA the portion of overhead costs allocable to IGAP. There is no programwide limit on total administrative costs. Direct and indirect administrative costs are provided as part of the grant, rather than given by EPA in addition to the IGAP grant. Reproduction of NAHASDA Survey to Native Villages Consolidated Appropriations Act of 2004, the Government Accountability Office (GAO) is Please also retain a copy of the questionnaire for your records. James Vitarello (202-512-5119, used them to construct, acquire, or rehabilitate vitarelloj@gao.gov). single-family units or multi-family properties during that period. Native communities, including when NAHASDA number, click on the answer box (___) and begin grants were used in combination with other typing. Do not enter dollar signs or commas. Do sources of funding. Results of the survey will be used in our report to the Congress, and will help them understand the costs of providing affordable housing in Alaska Native communities. not use the enter key to end a line. To select a check box (), click or double-click on the center of the box. To change or deselect a response, click on the check box and the “” should disappear. Please complete the following sections on housing about a particular question(s), include the comment activities pertaining to: new construction of single- with the question number at the end of the family units, rehabilitation of existing single-family questionnaire. units with acquisition, rehabilitation of existing single-family units without acquisition, and completion of multi-family property development. While completing this survey, please save your document often as you work. Thank you very much for your time and and return it to this email address as an attachment. assistance! 1. Please provide the following information for the individual(s) completing this questionnaire, so that we may call to clarify information if necessary. The answer boxes will expand. (Area Code) Phone Number The following sections will ask you about: New construction of single-family units (Question #2) Rehabilitation of existing single-family units with acquisition (Question #3) Rehabilitation of existing single-family units without acquisition (Question #4) Completion of multi-family property development (Questions #5-#7) NEW CONSTRUCTION OF SINGLE-FAMILY UNITS 2. Single-family units are housing constructed in one to four unit buildings and may be either rented or owned homes. During calendar years 1998 through 2003, did your village complete any new construction of single-family units using NAHASDA funds exclusively or in combination with other funds? Please check your response. 2a. If yes, how many single-family units of the following sizes were completed, and what were the combined square footages and total development costs for all units for each calendar year? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) (Includes costs for administration, planning, site acquisition, demolition, construction, and/or equipment and financing (including payment of carrying charges) and other necessary costs, such as (A unit is completed shipping costs or the Alaska Building Energy Efficiency Standards (BEES) costs. Excludes off- for occupancy.) site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. REHABILITATION OF EXISTING SINGLE-FAMILY UNITS WITH ACQUISITION 3. Single-family units are housing constructed in one to four unit buildings and may be either rented or owned homes. During calendar years 1998 through 2003, did your village complete any rehabilitation of existing single-family units where the unit(s) was/were acquired using NAHASDA funds exclusively or in combination with other funds? Please check your response. 3a. If yes, how many single-family units of the following sizes were completed, and what were the combined square footages and total development costs for all units for each calendar year? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) (Includes costs for administration, planning, site acquisition, single-family unit acquisition, demolition, construction, and/or equipment and financing (including payment of carrying charges) (A unit is completed and other necessary costs, such as shipping costs or the Alaska Building Energy Efficiency Standards for occupancy.) (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. REHABILITATION OF EXISTING SINGLE-FAMILY UNITS WITHOUT ACQUISITION 4. Single-family units are housing constructed in one to four unit buildings and may be either rented or owned homes. During calendar years 1998 through 2003, did your village complete any rehabilitation of existing single-family units where the rehabilitation did not require the purchase of the unit(s) using NAHASDA funds exclusively or in combination with other funds? Please check your response. 4a. If yes, for each calendar year, how many single-family units were completed, and what were total development costs for all units? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) Alaska Building Energy Efficiency Standards occupancy.) December 31) (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) COMPLETION OF MULTI-FAMILY PROPERTY DEVELOPMENT 5. Multi-family properties are housing structures with 5 or more units that may be either rented or owned homes. During calendar years 1998 through 2003, did your village complete any new construction of multi-family properties using NAHASDA funds exclusively or in combination with other funds? Please check your response. Yes, Continue to Question 5a No, SKIP to Question 6 Don’t know, SKIP to Question 6 5a. If yes, for each calendar year, how many multi-family properties were completed, and what were the combined square footages and total development costs for all properties? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) December 31) available for occupancy.) Standards (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) 6. Multi-family properties are housing structures with 5 or more units that may be either rented or owned homes. During calendar years 1998 through 2003, did your village complete any rehabilitation of existing multi-family properties where property was acquired using NAHASDA funds either exclusively or in combination with other funds? Please check your response. Yes, Continue to Question 6a No, SKIP to Question 7 Don’t know, SKIP to Question 7 6a. If yes, for each calendar year, how many multi-family properties were completed, and what were the combined square footages and total development costs for all properties? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) December 31) available for occupancy.) Standards (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) 7. Multi-family properties are housing structures with 5 or more units that may be either rented or owned homes. During calendar years 1998 through 2003, did your village complete any rehabilitation of existing multi-family properties where the rehabilitation did not require the purchase of property using NAHASDA funds either exclusively or in combination with other funds? Please check your response. Yes, Continue to Question 7a No, SKIP to Question 8 Don’t know, SKIP to Question 8 7a. If yes, for each calendar year, how many multi-family properties were completed, and what were total development costs for all properties? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) Total Development Costs for All (Includes costs for administration, planning, site acquisition, demolition, construction, and/or equipment and financing (including payment of carrying charges) and other necessary (A multifamily property is completed costs, such as shipping costs or the when it is available for occupancy.) December 31) Standards (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) Did your village construct, acquire, or rehabilitate single-family units and/or multi-family properties in the geographic area(s) corresponding to the following ANCSA non-profit regions during calendar years 1998 through 2003? Please check all that apply. 10. Please provide any additional comments below. The answer box will expand. Reproduction of NAHASDA Survey to Tribally Designated Housing Entities In response to a mandate contained in the Housing Assistance and Self Determination Act of Please also retain a copy of the questionnaire for your records. If you have any questions please contact: Brodi properties during that period. The purpose of this survey is to determine the cost vitarelloj@gao.gov). NAHASDA grants were used in combination with other sources of funding. Results of the survey questionnaire by clicking on the gray-shaded answer box or check box that you wish to answer. To will be used in our report to the Congress, and will answer a question that requires you to write a help them understand the costs of providing number, click on the answer box (___) and begin affordable housing in Alaska Native communities. Please complete the following sections on housing not use the enter key to end a line. To select a check box (), click or double-click on the center of the box. To change or deselect a response, click on the check box and the “” should disappear. Do not “unlock” this document, because it will erase units with acquisition, rehabilitation of existing your answers. If you wish to include comments single-family units without acquisition, about a particular question(s), include the comment modernization of single-family units, and with the question number at the end of the completion of multi-family property development. questionnaire. While completing this survey, please save your document often as you work. and return it to this email address as an attachment. Thank you very much for your time and mail the questionnaire back to us at: assistance! 1. Please provide the following information for the individual(s) completing this questionnaire, so that we may call to clarify information if necessary. The answer boxes will expand. (Area Code) Phone Number The following sections will ask you about: New construction of single-family units (Question #2) Rehabilitation of existing single-family units with acquisition (Question #3) Rehabilitation of existing single-family units without acquisition (Question #4) Modernization of single-family units (Question #5) Completion of multi-family property development (Questions #6-#9) NEW CONSTRUCTION OF SINGLE-FAMILY UNITS 2. Single-family units are housing constructed in one to four unit buildings and may be either rented or owned homes. During calendar years 1998 through 2003, did your Tribally Designated Housing Entity (TDHE) complete any new construction of single-family units using NAHASDA funds exclusively or in combination with other funds? Please check your response. 2a. If yes, how many single-family units of the following sizes were completed, and what were the combined square footages and total development costs for all units for each calendar year? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) (Includes costs for administration, planning, site acquisition, demolition, construction, and/or equipment and financing (including payment of carrying charges) and other necessary costs, such as (A unit is completed shipping costs or the Alaska Building Energy Efficiency Standards (BEES) costs. Excludes off- for occupancy.) site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. REHABILITATION OF EXISTING SINGLE-FAMILY UNITS WITH ACQUISITION 3. Single-family units are housing constructed in one to four unit buildings and may be either rented or owned homes. During calendar years 1998 through 2003, did your Tribally Designated Housing Entity (TDHE) complete any rehabilitation of existing single-family units where the unit(s) was/were acquired using NAHASDA funds exclusively or in combination with other funds? Please check your response. 3a. If yes, how many single-family units of the following sizes were completed, and what were the combined square footages and total development costs for all units for each calendar year? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) (Includes costs for administration, planning, site acquisition, single-family unit acquisition, demolition, construction, and/or equipment and financing (including payment of carrying charges) (A unit is completed and other necessary costs, such as shipping costs or the Alaska Building Energy Efficiency Standards for occupancy.) (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. Calendar Year of Completion: (January 1 to December 31) Sq. Ft. Sq. Ft. Sq. Ft. Sq. Ft. REHABILITATION OF EXISTING SINGLE-FAMILY UNITS WITHOUT ACQUISITION 4. Single-family units are housing constructed in one to four unit buildings and may be either rented or owned homes. During calendar years 1998 through 2003, did your Tribally Designated Housing Entity (TDHE) complete any rehabilitation of existing single-family units where the rehabilitation did not require the purchase of the unit(s) using NAHASDA funds exclusively or in combination with other funds? (Do not include modernized U.S. Housing Act of 1937 single-family units.) Please check your response. 4a. If yes, for each calendar year, how many single-family units were completed, and what were the total development costs for all units? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) Alaska Building Energy Efficiency Standards occupancy.) December 31) (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) MODERNIZATION OF U.S. HOUSING ACT OF 1937 SINGLE-FAMILY UNITS 5. Single-family units are housing constructed in one to four unit buildings and may be either rented or owned homes. During calendar years 1998 through 2003, did your Tribally Designated Housing Entity (TDHE) complete any modernization of U.S. Housing Act of 1937 single-family units using NAHASDA funds exclusively or in combination with other funds? (Do not include rehabilitated single- family units.) Please check your response. 5a. If yes, for each calendar year, how many single-family units were completed, and what were the total development costs for all units? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) Alaska Building Energy Efficiency Standards occupancy.) December 31) (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) COMPLETION OF MULTI-FAMILY PROPERTY DEVELOPMENT 6. Multi-family properties are housing structures with 5 or more units that may be either rented or owned homes. During calendar years 1998 through 2003, did your Tribally Designated Housing Entity (TDHE) complete any new construction of multi-family properties using NAHASDA funds exclusively or in combination with other funds? Please check your response. Yes, Continue to Question 6a No, SKIP to Question 7 Don’t know, SKIP to Question 7 6a. If yes, for each calendar year, how many multi-family properties were completed, and what were the combined square footages and total development costs for all properties? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) December 31) available for occupancy.) Standards (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) 7. Multi-family properties are housing structures with 5 or more units that may be either rented or owned homes. During calendar years 1998 through 2003, did your Tribally Designated Housing Entity (TDHE) complete any rehabilitation of existing multi-family properties where property was acquired using NAHASDA funds either exclusively or in combination with other funds? Please check your response. Yes, Continue to Question 7a No, SKIP to Question 8 Don’t know, SKIP to Question 8 7a. If yes, for each calendar year, how many multi-family properties were completed, and what were the combined square footages and total development costs for all properties? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) December 31) available for occupancy.) Standards (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) 8. Multi-family properties are housing structures with 5 or more units that may be either rented or owned homes. During calendar years 1998 through 2003, did your Tribally Designated Housing Entity (TDHE) complete any rehabilitation of existing multi-family properties where the rehabilitation did not require the purchase of property using NAHASDA funds either exclusively or in combination with other funds? (Do not include modernized U.S. Housing Act of 1937 multi-family properties.) Please check your response. Yes, Continue to Question 8a No, SKIP to Question 9 Don’t know, SKIP to Question 9 8a. If yes, for each calendar year, how many multi-family properties were completed, and what were the total development costs for all properties? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) Total Development Costs for All (Includes costs for administration, planning, site acquisition, demolition, construction, and/or equipment and financing (including payment of carrying charges) and other necessary costs, such as shipping costs or the (A multifamily property is completed when it is available for occupancy.) December 31) Standards (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) 9. Multi-family properties are housing structures with 5 or more units that may be either rented or owned homes. During calendar years 1998 through 2003, did your Tribally Designated Housing Entity (TDHE) complete any modernization of U.S. Housing Act of 1937 multi-family properties using NAHASDA funds either exclusively or in combination with other funds? (Do not include rehabilitated multi-family properties.) Please check your response. Yes, Continue to Question 9a No, SKIP to Question 10 Don’t know, SKIP to Question 10 9a. If yes, for each calendar year, how many multi-family properties were completed, and what were the total development costs for all properties? (Please enter numbers in each box, including “0” if none. Please do not enter commas.) Total Development Costs for All (Includes costs for administration, planning, site acquisition, demolition, construction, and/or equipment and financing (including payment of carrying charges) and other necessary costs, such as shipping costs or the (A multifamily property is completed when it is available for occupancy.) December 31) Standards (BEES) costs. Excludes off-site costs for water, sewers, and roads. Include all costs associated with unit completion even if some costs were incurred in previous calendar years.) 10. Did your Tribally Designated Housing Entity (TDHE) construct, acquire, rehabilitate, or modernize single-family units and/or multi-family properties in the geographic area(s) corresponding to the following ANCSA non-profit regions during calendar years 1998 through 2003? Please check all that apply. 11. In what Annual Performance Report (APR) “Table II Activity” did your Tribally Designated Housing Entity (TDHE) include costs for your staff and administration for each of the following years? Please check one for each row 12. Please provide any additional comments below. The answer box will expand. Comments from the Department of Commerce Comments from the Department of Health and Human Services Comments from the Department of the Interior GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to those named above, Mark Egger, Brodi Fontenot, Curtis Groves, Cathy Hurley, May Lee, John Lord, Jeffery D. Malcolm, Grant Mallie, Alison Martin, John McGrail, Dan Meyer, Marc W. Molino, Andrew Nelson, David M. Pittman, Barbara M. Roesmann, James D. Vitarello, and Chuck Wilson also made key contributions to this report.

This report responds to section 112, Division B, of the Consolidated Appropriations Act of 2004, which directs GAO to review federal programs benefiting rural communities in Alaska. After discussions with congressional staff, GAO agreed to examine federal programs benefiting Alaska Native villages. Specifically, this report (1) provides information on the amount of federal assistance provided to Alaska Native villages during fiscal years 1998 through 2003, (2) describes how selected federal funds have been used to assist Alaska Native villages, and (3) provides data on the number and average cost of houses built by villages and Alaska Native regional housing authorities. GAO's analysis of available data indicates that Alaska Native villages and regional Native nonprofits--including Native associations, and regional health and housing nonprofits--received over $3 billion in federal assistance from fiscal years 1998 through 2003. Specifically, total federal funding included approximately $483 million to 216 Alaska Native villages and about $3 billion to 33 regional Native nonprofits. The Department of Health and Human Services (HHS) accounted for 63 percent of all funding over the period. According to federal and state officials, Alaska Native villages also likely benefited from federal funding to the state of Alaska and to cities and boroughs that contain villages, such as when federal funding is used by municipalities to provide water services. Based on data GAO obtained from the state of Alaska, during fiscal years 1998 through 2003, the state passed through more than $105 million in federal funding to Native villages and regional Native nonprofits. Based on available information for 13 programs GAO reviewed, federal funding was used to provide Alaska Natives with assistance in health care, housing, infrastructure, and other areas. For example, according to information from HHS, its Tribal Self-Governance Program was used by 13 regional Native nonprofits, three Native villages, four groups of Alaska Native villages, and one statewide Native health care provider to provide clinical services at tribally run hospitals and health clinics that had over 1 million total visits throughout Alaska in 2002. Another program, HUD's Indian Housing Block Grant, provided funds used by villages and regional housing authorities to build, rehabilitate, modernize, and operate single-family homes and multifamily housing properties. However, the extent of readily available information on how funds were used from the 13 programs GAO reviewed varied, in part due to different agency reporting requirements. Results from GAO's survey of Alaska Native villages and regional housing authorities indicated that, during calendar years 1998 through 2003, responding entities constructed a total of 874 single-family units. GAO's survey indicated that the average cost of units constructed by responding entities varied by region and by whether they were developed by villages or housing authorities. For example, the 6-year average regional cost (in 2003 dollars) of all units constructed ranged from a low of $138,944 per unit, or $122 per square foot, to a high of $305,634 per unit, or $267 per square foot. GAO also found that the cost of new housing units developed by housing authorities was slightly higher than units developed by Native villages, and that regional housing authorities constructed more than three times the number of units compared with villages. However, various factors could account for differences in the cost and number of units completed among regions or between villages and regional housing authorities.

Social Security’s Long-term Financing Problem Is More Urgent Than It May Seem Today, the Social Security program faces not an immediate crisis but rather a long-range financing problem driven primarily by known demographic trends. While the crisis is not immediate, the challenge is more urgent than it may appear since the program will experience increasing negative cash flow starting in 2018. Acting soon to address these problems reduces the likelihood that Congress will have to choose between imposing severe benefit cuts and unfairly burdening future generations with the program’s rising costs. Acting soon would also allow changes to be phased in so that the individuals who are most likely to be affected, namely younger and future workers, will have time to adjust their retirement planning while helping to avoid related “expectation gaps.” On the other hand, failure to take remedial action will, in combination with other entitlement spending, lead to a situation unsustainable both for the federal government and, ultimately, the economy. The Social Security system has required changes in the past to ensure its future solvency. Indeed, the Congress has always taken the actions necessary to do this when faced with an immediate solvency crisis. While such an immediate crisis will not occur for many years, waiting until it is imminent would not be prudent. I would like to spend some time describing the nature, timing, and extent of Social Security’s financing problem. The Nature of Social Security’s Long-Term Financing Problem As you all know, Social Security has always been a largely pay-as-you-go system. This means that the system’s financial condition is directly affected by the relative size of the populations of covered workers and beneficiaries. Historically, this relationship has been favorable to the system’s financial condition. Now, however, people are living longer, and spending more time in retirement. As shown in figure 1, the U.S. elderly dependency ratio is expected to continue to increase. The proportion of the elderly population relative to the working-age population in the U.S. rose from 13 percent in 1950 to 19 percent in 2000. By 2050, there is projected to be almost 1 elderly dependent for every 3 people of working age—a ratio of 32 percent. Additionally, the average life expectancy of males at birth has increased from 66.6 in 1960 to 74.3 in 2000, with females at birth experiencing a rise of 6.6 years from 73.1 to 79.7 over the same period. As general life expectancy has increased in the United States, there has also been an increase in the number of years spent in retirement. Improvements in life expectancy have extended the average amount of time spent by workers in retirement from 11.5 years in 1950 to 18 years for the average male worker as of 2003. A falling fertility rate is the other principal factor underlying the growth in the elderly’s share of the population. In the 1960s, the fertility rate, which is the average number of children that would be born to women during their childbearing years, was an average of 3 children per woman. Today it is a little over 2, and by 2030 it is expected to fall to 1.95—a rate that is below what it takes to maintain a stable population. Taken together, these trends threaten the financial solvency and sustainability of Social Security. The combination of these trends means that labor force growth will begin to slow after 2010 and by 2025 is expected to be less than a fifth of what it is today, as shown in figure 2. Relatively fewer U.S. workers will be available to produce the goods and services that all will consume. Without a major increase in productivity or immigration, low labor force growth will lead to slower growth in the economy and to slower growth of federal revenues. This in turn will only accentuate the overall pressure on the federal budget. This slowing labor force growth has important implications for the Social Security system. Social Security’s retirement eligibility dates are often the subject of discussion and debate and can have a direct effect on both labor force growth and the condition of the Social Security retirement program. It is also appropriate to consider whether and how changes in pension and/or other government policies could encourage longer workforce participation. To the extent that people choose to work longer as they live longer, the increase in the amount of time spent in retirement could be diminished. This could improve the finances of Social Security. The Social Security program’s situation is one symptom of this larger demographic trend that will have broad and profound effects on our nation’s future in other ways as well. The aging of the labor force and the reduced growth in the number of workers will have important implications for the size and composition of the labor force, as well as the characteristics of many jobs in our increasingly knowledge-based economy, throughout the 21st century. The U.S. workforce of the 21st century will be facing a very different set of opportunities and challenges than that of previous generations. The slowdown in labor force growth can have very negative effects on our nation’s economic future, as relatively fewer workers will be producing the goods and services that everyone will consume. If people do choose to work longer this may mitigate the expected slowdown in labor force growth, which could strengthen the nation’s economic prospects. Cash Flow Turns Negative in 2018 Today, the Social Security Trust Funds take in more in taxes than they spend. Largely because of the demographic trends I have described, this situation will change. Although the trustees’ 2004 intermediate estimates project that the combined Social Security Trust Funds will be solvent until 2042, within the next few years, Social Security spending will begin to put pressure on the rest of the federal budget. Under the trustees’ 2004 intermediate estimates, Social Security’s cash surplus—the difference between program tax income and the costs of paying scheduled benefits— will begin a permanent decline in 2008. By 2018, the program’s cash flow is projected to turn negative—its tax income will fall below benefit payments. At that time, Social Security will join Medicare’s Hospital Insurance Trust Fund, whose outlays exceeded cash income in 2004, as a net claimant on the rest of the federal budget. (See figure 3.) In 2018, the combined OASDI Trust Funds will begin drawing on its Treasury securities to cover the cash shortfall. At this point, Treasury will need to obtain cash for these redeemed securities either through increased taxes, spending cuts, and/or more borrowing from the public than would have been the case had Social Security’s cash flow remained positive. Whatever the means of financing, the shift from positive to negative cash flow will place increased pressure on the federal budget to raise the resources necessary to meet the program’s ongoing costs. Different Measures but Same Challenges and Same Conclusion There are different ways to describe the magnitude of Social Security’s long-term financing challenge, but they all illustrate a need for program reform sooner rather than later. A case can be made for a range of different measures, as well as different time horizons. For instance, the shortfall can be measured in present value, as a percentage of GDP, or as a percentage of taxable payroll. The Social Security Administration (SSA) has made projections of Social Security shortfall using different time horizons. (See table 1.) While the estimates vary due to different horizons, both identify the same long-term challenge: The Social Security system is unsustainable in its present form over the long run. Taking action soon on Social Security would not only make the necessary action less dramatic than if we wait but would also promote increased budgetary flexibility in the future and stronger economic growth. Some of the benefits of early action—and the costs of delay—can be seen in figure 4. This figure compares what it would take to keep Social Security solvent through 2078, if action were taken at three different points in time, by either raising payroll taxes or reducing benefits. If we did nothing until 2042—the year SSA estimates the Trust Funds will be exhausted—achieving actuarial balance would require changes in benefits of 30 percent or changes in taxes of 43 percent for the period 2042-2078. As figure 4 shows, earlier action shrinks the size of the necessary adjustment. However, these changes do not achieve sustainable solvency, they only achieve solvency through 2078. Social Security Reform is Part of a Broader Fiscal and Economic Challenge As I have already discussed, reducing the relative future burdens of Social Security and health programs is essential to a sustainable budget policy for the longer term. It is also critical if we are to avoid putting unsupportable financial pressures on Americans in the future. Reforming Social Security and health programs is essential to reclaiming our future fiscal flexibility to address other national priorities. Changes in the composition of federal spending over the past several decades have reduced budgetary flexibility, and our current fiscal path will reduce it even further. During this time, spending on mandatory programs has consumed an ever-increasing share of the federal budget. In 1964, prior to the creation of the Medicare and Medicaid programs, spending for mandatory programs plus net interest accounted for about 33 percent of total federal spending. By 2004, this share had almost doubled to approximately 61 percent of the budget. GAO’s long-term simulations illustrate the magnitude of the fiscal challenges associated with an aging society and the significance of the related challenges the government will be called upon to address. Figures 5 and 6 present these simulations under two different sets of assumptions. In figure 5, we begin with CBO’s January baseline – constructed according to the statutory requirements for that baseline. Consistent with these requirements, discretionary spending is assumed to grow with inflation for the first 10 years and tax cuts scheduled to expire are assumed to expire. After 2015, discretionary spending is assumed to grow with the economy, and revenue is held constant as a share of GDP at the 2015 level. In figure 6 two assumptions are changed: discretionary spending is assumed to grow with the economy after 2005 rather than merely with inflation and the tax cuts are extended. For both simulations Social Security and Medicare spending is based on the 2004 Trustees’ intermediate projections, and we assume that benefits continue to be paid in full after the trust funds are exhausted. Medicaid spending is based on CBO’s December 2003 long-term projections under mid-range assumptions. Both these simulations illustrate that, absent policy changes, the growth in spending on federal retirement and health entitlements will encumber an escalating share of the government’s resources. Indeed, when we assume that recent tax reductions are made permanent and discretionary spending keeps pace with the economy, our long-term simulations suggest that by 2040 federal revenues may be adequate to pay little more than interest on the federal debt. Neither slowing the growth in discretionary spending nor allowing the tax provisions to expire—nor both together—would eliminate the imbalance. Although revenues will be part of the debate about our fiscal future, the failure to reform Social Security, Medicare, Medicaid, and other drivers of the long term fiscal gap would require at least a doubling of taxes—and that seems implausible. Accordingly, substantive reform of Social Security and our major health programs remains critical to recapturing our future fiscal flexibility. Alternatively, taking action soon on Social Security would not only promote increased budgetary flexibility in the future and stronger economic growth but would also make the necessary action less dramatic than if we wait. Indeed, long-term budget flexibility is about more than Social Security and Medicare. While these programs dominate the long- term outlook, they are not the only federal programs or activities that bind the future. The federal government undertakes a wide range of programs, responsibilities, and activities that obligate it to future spending or create an expectation for spending. GAO has described the range and measurement of such fiscal exposures—from explicit liabilities such as environmental cleanup requirements to the more implicit obligations presented by life-cycle costs of capital acquisition or disaster assistance. Making government face and address the challenges of the future will require not only dealing with the drivers— entitlements for the elderly— but also looking at the range of federal activities. A fundamental review of what the federal government does, how it does it, and how it finances its operations is both needed and overdue. Also, at the same time it is important to look beyond the federal budget to the economy as a whole. Under the 2004 Trustees’ intermediate estimates and CBO’s long-term Medicaid estimates, spending for Social Security, Medicare, and Medicaid combined will grow to 15.6 percent of GDP in 2030 from today’s 8.5 percent. (See figure 7.) Taken together, Social Security, Medicare, and Medicaid represent an unsustainable burden on future generations of Americans. The government can help ease future fiscal burdens through spending or revenue actions that reduce debt held by the public, thereby saving for the future and enhancing the pool of economic resources available for private investment and long-term growth. Economic growth can help, but given the size of our projected fiscal gap we will not be able to simply grow our way out of the problem. Closing the current long-term fiscal gap would require sustained economic growth far beyond that experienced in U.S. economic history since World War II. Tough choices are inevitable, and the sooner we act, the better. Considerations in Assessing Reform Options As important as financial stability may be for Social Security, it cannot be the only consideration. As a former public trustee of Social Security and Medicare, I am well aware of the central role these programs play in the lives of millions of Americans. Social Security remains the foundation of the nation’s retirement system. It is also much more than just a retirement program; it pays benefits to disabled workers and their dependents, spouses and children of retired workers, and survivors of deceased workers. In 2004, Social Security paid almost $493 billion in benefits to more than 47 million people. Since its inception, the program has successfully reduced poverty among the elderly. In 1959, 35 percent of the elderly were poor. In 2000, about 8 percent of beneficiaries aged 65 or older were poor, and 48 percent would have been poor without Social Security. Because the program is so deeply woven into the fabric of our nation, any proposed reform must consider the program in its entirety, rather than one aspect alone. To assist policymakers, GAO has developed a broad framework for evaluating reform proposals that considers solvency as well as other aspects of the program. Our criteria aim to balance financial and economic considerations with benefit adequacy and equity issues and the administrative challenges associated with various proposals. GAO Framework For Evaluating Reform Proposals GAO developed an analytic framework to assess reform proposals using three basic criteria: Financing Sustainable Solvency -- the extent to which a proposal achieves sustainable solvency and how it would affect the economy, the federal budget, and national saving. Our sustainable solvency standard encompasses several different ways of looking at the Social Security program’s financing needs. While a 75-year actuarial balance has generally been used in evaluating the long-term financial outlook of the Social Security program and reform proposals, it is not sufficient in gauging the program’s solvency after the 75th year. For example, under the trustees’ intermediate assumptions, each year the 75-year actuarial period changes, and a year with a surplus is replaced by a new 75th year that has a significant deficit. As a result, changes made to restore trust fund solvency only for the 75-year period can result in future actuarial imbalances almost immediately. Reform plans that lead to sustainable solvency would be those that consider the broader issues of fiscal sustainability and affordability over the long term. Specifically, a standard of sustainable solvency also involves looking at (1) the balance between program income and costs beyond the 75th year and (2) the share of the budget and economy consumed by Social Security spending. Balancing Adequacy and Equity -- the relative balance struck between the goals of individual equity and income adequacy. The current Social Security system’s benefit structure attempts to strike a balance between these two goals. From the beginning, Social Security benefits were set in a way that focused especially on replacing some portion of workers’ preretirement earnings. Over time other changes were made that were intended to enhance the program’s role in helping ensure adequate incomes. Retirement income adequacy, therefore, is addressed in part through the program’s progressive benefit structure, providing proportionately larger benefits to lower earners and certain household types, such as those with dependents. Individual equity refers to the relationship between contributions made and benefits received. This can be thought of as the rate of return on individual contributions. Balancing these seemingly conflicting objectives through the political process has resulted in the design of the current Social Security program and should still be taken into account in any proposed reforms. Implementing and Administering Proposed Reforms -- how readily a proposal could be implemented, administered, and explained to the public. Program complexity makes implementation and administration both more difficult and harder to explain. Some degree of implementation and administrative complexity arises in virtually all proposed changes to Social Security, even those that make incremental changes in the already existing structure. While these issues may seem technical or routine on the surface, they are important. In particular, if these issues are not considered early enough for planning purposes, they could potential delay—if not derail—reform. Moreover, issues such as feasibility and cost can, and should, influence policy choices. Continued public acceptance of and confidence in the Social Security program require that any reforms and their implications for benefits be well understood. This means that the American people must understand why change is necessary, what the reforms are, why they are needed, how they are to be implemented and administered, and how they will affect their own retirement income. All reform proposals will require some additional outreach to the public so that future beneficiaries can adjust their retirement planning accordingly. The more transparent the implementation and administration of reform, and the more carefully such reform is phased in, the more likely it will be understood and accepted by the American people. The weight that different policymakers place on different criteria will vary, depending on how they value different attributes. For example, if offering individual choice and control is less important than maintaining replacement rates for low-income workers, then a reform proposal emphasizing adequacy considerations might be preferred. As they fashion a comprehensive proposal, however, policymakers will ultimately have to balance the relative importance they place on each of these criteria. As we have noted in the past, a comprehensive evaluation is needed that considers a range of effects together. Focusing on comprehensive packages of reforms will enable us to foster credibility and acceptance. This will help us avoid getting mired in the details and losing sight of important interactive effects. It will help build the bridges necessary to achieve consensus. One issue that often arises within the Social Security debate concerns the appropriate comparisons or benchmarks to be used when assessing a particular proposal. While this issue may seem to be somewhat abstract, it has critical implications, for depending on the comparisons chosen, a proposal can be made more or less attractive. Some analyses compare proposals to a single benchmark and as a result can lead to incomplete or misleading conclusions. For that reason, GAO has used several benchmarks in assessing reform proposals. Currently promised benefits are not fully financed, and so any analysis that seeks to fairly evaluate reform proposals should include comparisons to benchmarks that reflect a policy of an adequately financed system. Similarly, it is important to have benchmarks that are consistent with each other. Using one that relies on action relatively soon versus one that posits no action at all are not consistent and could also lead to misleading conclusions. Estimating future effects on Social Security benefits should reflect the fact that the program faces a long-term actuarial deficit and that conscious policies of benefit reduction and/or revenue increases will be necessary to restore solvency and sustain it over time. Reform’s Potential Effects on the Social Security Program A variety of proposals have been offered to address Social Security’s financial problems. Some of these proposals work within the current structure of Social Security and others would restructure the program. For instance, many proposals contain reforms that would alter benefits or revenues within the structure of the current defined benefits system. Also, a number of proposals seek to restructure the program through the creation of individual accounts. The discussion about examples of reform in this section are meant for illustrative purposes, and are by no means intended to be exhaustive of all the reform options proposed or the issues related to these approaches. Some proposals would reduce benefits relative to scheduled benefits by modifying the benefit formula. For example, increasing the number of years used to calculate benefits or using price-indexing instead of wage- indexing would reduce the benefits individuals receive. Since wages generally grow faster than prices, indexing earnings to prices rather than wages would reduce the measure of average lifetime earnings used in the formula—reducing benefits. Changing the number of working years used to calculate benefits to include more than the highest 35 years of earnings would reduce the average lifetime earnings; thus, reducing benefits as compared to current levels. Other proposals include options to reduce cost-of-living adjustments (COLA) by lowering the COLA to less than the CPI, limiting the COLA to a specified threshold, or delaying the COLA; to raise the normal and/or early retirement ages or to reduce benefits more for workers who retire before the full retirement age; and to revise dependent benefits. Some of the proposals also include measures or benefit changes that seek to strengthen progressivity (e.g., replacement rates) in an effort to mitigate the effect on low-income workers. Others have proposed options that would provide revenue increases. For example, raising the payroll tax or expanding the Social Security taxable wage base that finances the system would result in more revenue coming into the system. In 2005, earnings above $90,000 are not subject to payroll taxes. If the cap were raised and the benefit formula remained the same, workers with earnings above the old cap would ultimately receive somewhat higher benefits as well as pay more taxes. Other options to increase revenues include increasing the taxation of benefits or covering those few remaining workers not currently required to participate in Social Security, such as some state and local government employees, although such new participants would increase future spending commitments as well. In addition to these proposals, Social Security can obtain revenues from sources outside of the program, such as by increasing the investment returns on Social Security holdings or by earmarking revenue from estate taxes or other sources. A number of proposals also seek to restructure the program through the creation of individual accounts. Under a system of individual accounts, workers would manage a portion of their own Social Security contributions to varying degrees. This would expose workers to a greater degree of risk in return for both greater individual choice in retirement investments and the possibility of a higher rate of return on contributions than available under current law. There are many different ways that an individual account system could be set up. For example, contributions to individual accounts could be mandatory or they could be voluntary. Proposals also differ in the manner in which accounts would be financed, the extent of choice and flexibility concerning investment options, the way in which benefits are paid out, and the way the accounts would interact with the existing Social Security program—individual accounts could serve either as an addition to or as a replacement for part of the current benefit structure. In addition, the timing and impact of individual accounts on the solvency, sustainability, adequacy, equity, net savings, and rate of return associated with the Social Security system varies depending on the structure of the total reform package. Individual accounts by themselves will not lead the system to sustainable solvency—an increase in revenue, a decrease in benefits, or both will also be necessary. Furthermore, incorporating a system of individual accounts may involve significant transition costs. These costs come about because the Social Security system would have to continue paying out benefits to current and near-term retirees concurrently with establishing new individual accounts. Individual accounts can contribute to sustainability as they could provide a mechanism to prefund retirement benefits that would be immune to demographic booms and busts. However, if these accounts are financed through borrowing, prefunding will not be achieved until the additional debt has been repaid. An additional important consideration in adopting a reform package that contains individual accounts would be the level of benefit adequacy achieved by the reform. To the extent that benefits are not adequate, it may result in the government eventually providing additional resources to make up the difference. Some degree of implementation and administrative complexity arises in virtually all proposed changes to Social Security. However, the greatest potential implementation and administrative challenges are associated with proposals that would create individual accounts. These include, for example, issues concerning the management of the information and money flow needed to maintain such a system, the degree of choice and flexibility individuals would have over investment options and access to their accounts, investment education and transitional efforts, and the mechanisms that would be used to pay out benefits upon retirement. The federal Thrift Savings Plan (TSP) could serve as a model for providing a limited amount of options that reduce risk and administrative costs while still providing some degree of choice. However, a system of accounts that spans the entire national workforce and millions of employers would be significantly larger and more complex than TSP or any other system we have in place today. Harmonizing a system that includes individual accounts with the regulatory framework that governs our nation’s private pension system would also be a complicated endeavor. However, the complexity of meshing these systems should be weighed against the potential benefits of extending participation in individual accounts through payroll deductions to millions of workers who currently lack private pension coverage. Social Security Reform Should be Considered in the Context of Broader Challenges Other broader concerns for Social Security reform include evaluating a proposal’s effect on national saving and a proposal’s implications for other sources of retirement income, access to long-term care and retirement security generally. An important economic consideration is assessing a proposal’s effect on national saving. Individual account proposals designed as a carve-out that finance accounts through the redirection of payroll taxes or general revenue, do not increase national saving on a first order basis. The redirection of payroll taxes or general revenue reduces government saving by the same amount that the individual accounts increase private saving. Individual accounts that are structured as “add- ons” may increase saving. However, this will depend on how the accounts are financed and how they are structured i.e. do they target low income workers who currently may not have high saving rates. Individual accounts that achieve prefunding without borrowing might increase government and individual saving. The effect of individual accounts on national saving will also be affected by other elements, such as benefit cuts or tax increases, that are part of the overall reform package. Beyond these first order effects, the actual net effect of a proposal on national saving is difficult to estimate due to uncertainties in predicting changes in future spending and revenue policies of the government as well as changes in the saving behavior of private households and individuals. For example, the higher deficits that result from redirecting payroll taxes to individual accounts could prompt changes in fiscal policy that reduce spending or increase revenue thereby resulting in lower deficits that would otherwise have been the case and increase net national saving. On the other hand, households may respond by reducing their other saving in response to the creation of individual accounts. No expert consensus exists on how Social Security reform proposals would affect the saving behavior of private households and businesses. Besides the effect on savings, Social Security reform proposals may also have implications for retirement security in general. Economic security in retirement requires both adequate retirement income—Social Security, pensions, personal savings, and earnings from continued employment— and affordable health care—Medicare and retiree health care; and long- term care coverage. In addition to the issues I have discussed regarding the financing challenges that Social Security, Medicare and Medicaid face, the nation also faces serious challenges associated with the private pension system and long-term care financing. Only about half of the private sector workforce is covered by a pension plan. A number of large underfunded traditional defined benefit plans— plans where the employer bears the risk of investment—have been terminated by bankrupt firms, including household names like Bethlehem Steel, US Airways, and Polaroid. These terminations have resulted in thousands of workers losing promised benefits and have saddled the Pension Benefit Guaranty Corporation, the government corporation that partially insures certain defined benefit pension benefits, with billions of dollars in liabilities that threaten its long-term solvency. Meanwhile, the number of traditional defined benefit pension plans continues to decline as employers increasingly offer workers defined contribution plans like 401(k) plans where, like individual accounts, workers face the potential of both greater return and greater risk. These challenges serve to reinforce the imperative to place Social Security on a sound financial footing which provides a foundation of certain and secure retirement income. In 2002, GAO reported that the total number of disabled elderly could be as high as 12.1 million, by 2040. Long-term care includes an array of health, personal care, and supportive services provided to persons with physical or mental disabilities. It relies heavily on financing by public payers, especially Medicaid, and has significant implications for state budgets as well as the federal budget. Current problems with the provision and financing of long-term care could be exacerbated by the swelling numbers of the baby-boom generation needing care. These problems include whether individuals with disabilities receive adequate services, the potential for families to face financially catastrophic long-term care costs, and the burdens that heavy reliance on unpaid care from family members and other informal caregivers create coupled with possibly fewer caregivers available in coming generations. Given the broader fiscal challenges that our nation faces and the potential future changes to Social Security, Medicare, and Medicaid, as well as the state of private pensions and long-term care trends, it is even more important that individuals are educated about what to expect in retirement. In this respect, regardless of what type of Social Security reform package is adopted, continued confidence in the Social Security program is essential. This means that the American people must understand why change is necessary, what the reforms are, why they are needed, how they are to be implemented and administered, and how they will affect their own retirement income. All reform proposals will require some additional outreach to the public so that future beneficiaries can adjust their retirement planning accordingly. The more transparent the implementation and administration of reform, and the more carefully such reform is phased in, the more likely it will be understood and accepted by the American people. Conclusions Social Security does not face an immediate crisis but it does face a large and growing financial problem. In addition, our Social Security challenge is only part of a much broader fiscal challenge that includes, among other things, the need to reform Medicare, Medicaid, and our overall health care system. Many retirees and near retirees fear cuts that would affect them in the immediate future while young people believe they will get little or no Social Security benefits in the longer term. I believe that it is possible to reform Social Security in a way that will ensure the program’s solvency, sustainability, and security while exceeding the expectations of all generations of Americans. In my view, there is a window of opportunity to reform Social Security; however, this window of opportunity will begin to close as the baby boom generation begins to retire. We have an opportunity to address Social Security as a first step toward improving the nation’s long-term fiscal outlook. Furthermore, it would be prudent to move forward to address Social Security now because we have much larger challenges confronting us that will take years to resolve. The fact is, compared to addressing our long-range health care financing problem, reforming Social Security should be easy lifting. As I have said before, the future sustainability of programs is the key issue policy makers should address—i.e., the capacity of the economy and budget to afford the commitment over time. Absent substantive reform, these important federal programs will not be sustainable. Furthermore, absent reform, younger workers will face dramatic benefit reductions or tax increases that will grow over time. Irrespective of when Social Security reform may occur and what form it may take, other Social Security related issues also need to be explored. These include, but are not limited to, the current accounting/reporting and budget treatment of Social Security and the related trust funds; its current investment options and strategy, and the current composition of the Social Security Board of Trustees. We at GAO look forward to continuing to work with this Committee and the Congress in addressing this and other important issues facing our nation. In doing so, we will be true to our core values of accountability, integrity, and reliability. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

Social Security is the foundation of the nation's retirement income system, helping to protect the vast majority of American workers and their families from poverty in old age. However, it is much more than a retirement program, also providing millions of Americans with disability insurance and survivors' benefits. Over the long term, as the baby boom generation retires and as Americans continue to live longer and have fewer children, Social Security's financing shortfall presents a major program solvency and sustainability challenge that is widening as time passes. The House Committee on Ways and Means asked GAO to discuss the need for Social Security reform. This testimony addresses the nature of Social Security's long-term financing problem and why it would be prudent for Congress to take action sooner rather than later. This testimony also notes the broader context in which reform proposals should be considered and the criteria that GAO has recommended as a basis for analyzing any Social Security reform proposals. Although the Social Security system is not in crisis, it faces a serious solvency and sustainability challenge that is growing as time passes. If we do nothing until 2042, achieving actuarial balance would require a 30-percent reduction in benefits or a 43-percent increase in payroll taxes for the period 2042-2078. Furthermore, Social Security's problems are a subset of the grave fiscal challenge facing our nation. Absent changes in budget policy, the nation will ultimately have to choose among escalating federal deficits and debt, huge tax increases and/or dramatic budget cuts. As GAO's long-term budget simulations show, substantive reform of Social Security and our major federal health programs (e.g., Medicare and Medicaid) is critical to saving our nation's fiscal future. Taking action soon would serve to reduce the magnitude of changes needed to ensure that Social Security is solvent, sustainable, and secure for current and future generations. It would also allow time to phase in certain changes and time for individuals to adjust to any such changes. Acting sooner would also serve to improve the federal government's credibility with financial markets and bolster the confidence of the American people in our government's ability to address long-range financial challenges. However, financial solvency and sustainability should not be the only consideration when evaluating Social Security reform proposals. Other key objectives, such as balancing the adequacy and equity of the benefit structure and various administrative and operational issues need to be considered. Furthermore, any changes to Social Security should be considered in the context both of the whole program--including disability and survivors' benefits--and of the broader challenges facing our nation, such as the changing nature of the private pension system, long-term care needs, escalating health care costs, and the need to reform the Medicare and Medicaid programs.

Background USDA, HHS, and other federal agencies employ veterinarians under the veterinary medical science occupational series, as well as other occupational series. As of fiscal year 2014, federal agencies employed about 2,100 veterinarians under the veterinary medical science occupational series, according to data from OPM.were concentrated in three component agencies—FSIS, APHIS, and ARS. Veterinarians at HHS were also concentrated in three component agencies—FDA, NIH, and CDC. As shown in table 1, the specific missions of the veterinarians vary by agency. Besides the routine missions, APHIS is responsible for implementing an emergency Veterinarians at USDA response, including coordination of veterinary services, to an outbreak of an economically devastating or highly contagious animal disease. In 2001, we designated strategic human capital management, which includes workforce planning, as a high-risk area of government operations. In 2015, we retained the high-risk designation because current budget and long-term fiscal pressures, coupled with a potential wave of employee retirements that could produce gaps in leadership and institutional knowledge, threaten the government’s capacity to effectively address a wide range of national issues. OPM, individual agencies, and Congress have all taken important steps over the last few years that will better position the government to close current and emerging critical skills gaps that are undermining agencies’ abilities to meet their vital missions. However, the area remains high risk because more work is needed to implement specific corrective strategies for addressing critical skills gaps and evaluating the results of those strategies. In particular, in our 2015 update, we found that OPM and agencies had partially met the leadership criterion for removal from the High Risk List but need to sustain senior leadership’s focus—for example, on defining and implementing corrective actions to narrow skills gaps through talent management and other strategies. Strategic workforce planning addresses two critical needs: (1) aligning an organization’s human capital program with its current and emerging mission and programmatic goals and (2) developing long-term strategies for acquiring, developing, and retaining staff to achieve programmatic goals. We have recognized the following five key principles for strategic workforce planning to address these needs: involve top management, employees, and other stakeholders in developing, communicating, and implementing the strategic workforce plan; determine the critical skills and competencies that will be needed to achieve current and future programmatic results; develop strategies to address gaps in number, deployment, and alignment of human capital approaches for enabling and sustaining the contributions of all critical skills and competencies; build the capability needed to address administrative, educational, and other requirements important to support workforce planning strategies; and monitor and evaluate progress toward human capital goals and how human capital results have helped achieve program goals. In addition, OPM provides information and guidance on a wide range of strategies that departments and agencies can use to achieve and maintain a workforce sufficient to accomplish their missions. OPM can also authorize departments to use additional strategies to address workforce shortage situations if standard strategies prove insufficient. For example, OPM can approve agencies’ use of direct-hire authority when a critical hiring need or severe shortage of candidates exists. Direct-hire authority enables an agency to hire any qualified applicant without regard to certain federal hiring requirements, such as competitive rating and ranking and veterans’ preference. Since we issued our report on the federal veterinarian workforce in 2009, other organizations issued reports on the veterinarian workforce across employment sectors, including the federal government. In particular, according to a 2013 report by the National Research Council, the federal veterinarian workforce faced an impending mass retirement, making workforce planning in the federal government critically important. USDA and Some Component Agencies Conduct Workforce Planning for Veterinarians, but HHS Has Not Done So Department-Wide USDA has taken actions to ensure that component agencies include veterinarians in workforce planning efforts for meeting routine needs, but HHS has not done so. Direction and guidance from HHS could help integrate its component agencies’ workforce planning efforts for veterinarians. USDA Has Provided Direction and Guidance to Component Agencies for Conducting Workforce Planning for Veterinarians USDA has provided direction to ensure that its component agencies include veterinarians in workforce planning efforts for meeting routine needs. The efforts of USDA and its component agencies met the intent of our recommendation for a department-wide assessment of its veterinarian workforce. In addition, USDA human capital officials said they considered the workforce planning efforts of their component agencies sufficient to meet their commitment in 2009 to a Senate subcommittee to conduct a department-wide assessment. In particular, since our 2009 report, USDA has developed guidance on workforce planning for its component agencies that have veterinarians, and the department initiated a process to evaluate the component agencies’ workforce plans. According to an official from USDA’s Office of Human Resources Management, in December 2012, the Secretary of Agriculture directed component agencies to create human capital and workforce plans that would include veterinarians. USDA’s guidance specified workforce planning steps for component agencies to assess their workforces and develop workforce planning strategies, including for occupations considered critical to agencies’ missions, such as veterinarians. For example, the guidance called for agencies to analyze the workforce needed to meet future workloads, identify any gaps in the workforce to meet future needs, and develop human capital goals. Human resources officials said that 2014 was the first year they began reviewing component agencies’ workforce plans and that they will conduct more formal reviews of the plans in 2015 to examine, for example, whether agencies conduct workforce planning on a periodic basis and whether their plans consider changes in mission and technology. As described below, USDA component agencies that consider veterinarians to be critical to their missions—FSIS and APHIS—have assessed and developed varying strategies for their veterinarian workforces needed to meet routine needs. FSIS. Veterinarians are one of four mission-critical occupations at FSIS. The agency tracks short-term needs for veterinarians and vacancies at slaughter plants on an ongoing basis, and retirement eligibility is calculated over a 6-year time frame. For example, according to the agency’s Director of Field Operations, FSIS tracks the vacancy rate of veterinarians, which he estimated was about 10 percent in 2014. In addition, the agency’s recruitment plan for fiscal year 2014 projected that about 43 percent of FSIS veterinarians would be eligible to retire by fiscal year 2018. FSIS has developed multiple workforce planning strategies to address needs identified through its assessments. As a short-term strategy, the agency employs a group of relief veterinarians—mostly full-time employees—who travel to various plants to fill in when the veterinarian assigned to a plant is absent for personal or other reasons, such as a position vacancy. Other longer-term strategies include (1) recruitment incentives for difficult-to-staff duty locations, (2) use of direct-hire authority, and (3) agency attendance at veterinary conferences and career fairs to attract students. The agency’s recruitment plan also includes efforts to target veterinary students, such as visits to colleges of veterinary medicine. APHIS. Veterinarians are one of nine mission-critical occupations at APHIS. The agency tracks attrition among its veterinarians on a monthly basis and calculates retirement eligibility for a 5-year period. For example, Veterinary Services—the agency’s operational unit with the largest number of veterinarians—prepared a workforce plan for 2011 to 2015 suggesting that 45 percent of its veterinarians would be eligible to retire by fiscal year 2016. In addition, the plan stated that an expected national shortage of veterinary medical officers may impact the unit’s ability to effectively meet mission requirements and respond to animal health emergencies, and that the unit would need to enhance recruitment and retention efforts to maintain current levels of mission-critical occupations. In fiscal year 2014, the unit prepared a staffing plan with a target level of 550 to 575 veterinarians and began hiring veterinarians with the expectation that it would meet the target level in fiscal year 2015. Another operational unit within APHIS conducted a study and issued a draft report in April 2014 on its veterinarian workload and staffing levels, helping the agency to assess workforce needs. APHIS’ workforce planning strategies targeting veterinarians include an internship program and use of direct-hire authority granted by OPM. In addition, agency officials said they are planning to initiate a cadre of veterinarians similar to the FSIS group that can fill in temporarily when vacancies or other needs occur, but the officials did not provide a time frame for commencing this initiative. Veterinarians are not considered to be a mission-critical occupation at ARS. Instead, the agency’s draft human capital management plan grouped veterinary medical officers together with other scientific occupations at the agency. According to the plan, occupations within this group may be targeted for priority human capital activity in the future. The approach used by ARS is consistent with our key principles for effective strategic workforce planning, in which the scope of agencies’ efforts to identify the skills and competencies needed for their future workforces varies considerably, depending on the needs and interests of a particular agency. Agencies may elect to focus their analysis on only the skills and competencies most critical to achieving their goals. HHS Has Not Provided Direction or Guidance for Components Agencies’ Workforce Planning for Veterinarians HHS does not have an approach similar to USDA’s efforts to guide its component agencies’ workforce planning for veterinarians for meeting routine needs. In 2009, we recommended that HHS conduct a department-wide assessment of their veterinarian workforces based on assessments completed by their component agencies. Key principles for strategic workforce planning include involving top leadership to help provide stability as the workforce plan is being developed and implemented and ensure that planning strategies are thoroughly implemented and sustained over time. Top leadership involvement can also help integrate workforce planning efforts with other key management planning efforts, such as succession planning, to ensure that such initiatives work together to achieve the agency’s goals. HHS has not conducted a department-wide assessment of its veterinarian workforce even though HHS officials agreed to do so in response to a question from a Senate subcommittee shortly after our 2009 report. In addition, HHS officials did not provide department direction or guidance for the development of workforce planning for veterinarians at its component agencies. Furthermore, the department has not reviewed the results of its component agencies’ efforts. As described below, component agencies’ workforce planning efforts occur at the agency level in FDA, and at the level of individual centers, institutes, or offices within CDC and NIH. HHS leadership and direction could help integrate these component agencies’ workforce planning efforts for veterinarians at the department-wide level. For this reason, we believe our previous recommendation to HHS remains valid and should be fully implemented. FDA included veterinarians in its workforce plans, although HHS did not provide guidance or direction to FDA or other component agencies to do so. Within FDA, veterinarians are a mission-critical occupation together with other scientific occupations, such as biologists and chemists. Veterinarians within FDA are concentrated in the Center for Veterinary Medicine, which prepared a separate human capital plan for fiscal year 2012 to fiscal year 2016. According to the plan, the center’s workforce increased by about 30 percent since 2006, primarily due to a hiring surge initiative that targeted selected science and medical positions, including veterinarians. The increase supported the expansion of the center’s regulatory responsibilities. The plan stated that the center would conduct annual workforce planning to determine the workforce composition needed to meet future requirements. The center’s recruitment and retention strategies include use of direct-hire authority for veterinarians, as well as exit interviews with departing employees to identify the root causes of turnover and assist in the development of targeted retention solutions. In contrast, HHS component agencies that do not consider veterinarians to be a mission-critical occupation—NIH and CDC—have not assessed or developed agency-wide strategies specifically for their veterinarian workforces. As discussed above, this approach is consistent with our key principles for effective strategic workforce planning, in which the scope of agencies’ efforts to identify the skills and competencies needed for their future workforces depends on agencies’ needs. Accordingly, NIH and CDC have assessed veterinarians together with other occupations as part of the agencies’ overall workforce planning efforts. NIH and CDC officials told us that workforce planning for veterinarians would instead occur at the level of individual centers, institutes, or offices within their agencies. Officials from both agencies said they had not gathered information or evaluated whether their subcomponents had conducted workforce NIH and CDC officials stated planning for their veterinarian workforces.that not designating veterinarians as a mission-critical occupation did not mean that they were not vital to the agency’s mission; rather, they said that they only apply the mission-critical designation to professions or occupational series involving a larger segment of the organizations’ workforce. USDA Has Not Identified Reliable Estimates of Veterinarians Needed to Augment Its Workforce for Emergency Response to Animal Disease Outbreaks USDA’s APHIS has not developed reliable estimates of the number of veterinarians needed for emergency response to animal disease outbreaks of various types. Instead, APHIS participated in a study led by TMAC to determine the veterinarian workforce needed to respond to a regional and a large-scale disease outbreak. However, because of limitations in the study, the estimates of the number of veterinarians needed are not reliable for purposes of effective emergency planning and response. Moreover, APHIS’ plans for an emergency response do not include details on how it will augment its workforce to respond to a large- scale emergency. APHIS Has Not Developed Reliable Estimates of the Number of Veterinarians Needed for Emergency Response Under the National Response Framework, USDA is the lead agency for emergency response to significant incidents threatening the health of animals. USDA has delegated its authority to act in response to such incidents to APHIS. The National Response Framework stated that response planning should address detailed resourcing, personnel, and A key goal of APHIS is to ensure adequate sourcing requirements.personnel to achieve the objectives of an emergency response to an animal disease outbreak. APHIS’ plan for achieving this goal includes determining the expertise needed, such as veterinary expertise, and the number of personnel needed for each expertise type. However, APHIS has not developed reliable estimates of the number of veterinarians needed for emergency response to an animal disease outbreak, such as a large-scale outbreak of foot-and-mouth disease in livestock or a limited outbreak of Newcastle disease in poultry. Instead, APHIS participated in a study led by TMAC to determine the veterinarian workforce needed to respond to a foot-and-mouth disease outbreak of two different scales. Specifically, APHIS developed a model that TMAC used to estimate that an outbreak in a single region would require at least 880 veterinarians, and that a national-scale outbreak would require approximately 6,000 veterinarians. The model developed by APHIS provides information about how many individuals might be required to respond during each day of an outbreak, whether there are a sufficient number of qualified personnel, and when shortages may occur. The TMAC report, as well as APHIS and DHS officials involved in the TMAC study, cited various limitations in the study’s estimates of the number of veterinarians needed for emergency response, as discussed below. Because of these limitations, we determined that the estimates are not reliable for purposes of effective emergency response and response planning, as called for under the National Response Framework. Identifying expertise and other capabilities needed to prepare for an outbreak is complex because the capabilities required will change according to the outbreak scenario. Nevertheless, it is important to provide a benchmark for planning purposes, particularly in the face of uncertainty. According to DHS, such planning helps determine how prepared we are as a nation, how prepared we need to be, and how to prioritize efforts to effectively respond to an emergency. The limitations in the TMAC study included the following: The estimates were based on an early release of the APHIS model that had not been verified or validated. According to APHIS officials, the model would need to be further developed in order for the agency to develop estimates it would consider useful, but they did not provide any information on plans to further develop the model. The geographic scope of modeling for both national-scale and regional outbreaks was limited. For example, the national-scale scenario did not include dairy or swine intensive states that, if affected by an outbreak, would potentially increase the workload of a response. The estimates did not account for strategies APHIS may use during an emergency response, such as assigning veterinarians to oversee rather than directly perform vaccinations of livestock or other critical activities. According to APHIS officials, such a strategy would reduce the number of veterinarians needed for a response. Other than the TMAC study on responding to outbreaks such as a foot- and-mouth disease scenario, APHIS has not developed estimates of the number of veterinarians needed for an emergency response. APHIS officials said they did not develop estimates because there are many different scenarios an outbreak could take and many different responses. For example, APHIS officials said that they could rely on veterinary technicians and other personnel to a greater extent than contemplated in the TMAC study. APHIS officials also said that the agency had not made a greater effort to plan the number of veterinarians needed for an emergency response because the agency considers other aspects of planning for an outbreak, such as determining the supplies needed and ensuring the right incident command is in place, to be a higher priority. Such aspects are part of response planning, as discussed in the National Response Framework, but are to be integrated with the personnel needed to respond to incidents. Without reliable estimates of the veterinarians needed for an emergency, it will be difficult for APHIS to be prepared and have a sufficient number of veterinarians to respond to the most serious animal disease outbreaks. APHIS Plans Do Not Include Details on How to Augment Its Workforce for an Emergency Response According to APHIS officials, the agency’s target level for the number of veterinarians it employs—550 to 575 in fiscal year 2015—is based on the agency’s routine workload and not on the needs of an emergency response. As a result, even though it may ask or assign agency employees to participate in a large-scale emergency response, the agency may not have sufficient veterinarians to respond to an animal disease outbreak. Moreover, according to the APHIS Deputy Administrator for Veterinary Services, not all APHIS veterinarians could be spared from their routine duties in order to be deployed during an emergency. APHIS officials recognize that they may need to augment their veterinarian workforce during certain emergencies and have established various arrangements to help their agency do so. However, APHIS officials have not identified the number of veterinarians the agency expects to be available under these arrangements in order to fill any gap between the number of APHIS veterinarians onboard and the number that might be needed during an emergency. Specifically, National Animal Health Emergency Response Corps (NAHERC). Under NAHERC, APHIS maintains a list of preapproved veterinarians and veterinary technicians who are willing to become temporary federal employees in an emergency. According to information from APHIS, NAHERC had 971 veterinarians as of January 2015. A NAHERC member’s decision to participate in an emergency response when the corps is activated is voluntary, and APHIS officials said they do not expect all members to be available in any given response. For example, according to APHIS, about one-quarter of the veterinarians responded to a request for immediate activation in an exercise conducted in June 2012. In addition, an APHIS emergency response official told us that the agency stopped processing NAHERC applications in fiscal year 2013 because the agency’s human resources staff needed to focus on hiring full-time employees to replace positions lost due to reductions in the agency’s budget. Information provided by APHIS showed that, as of January 2015, the number of NAHERC veterinarians had not increased since the end of fiscal year 2013. Other federal agencies. Under an agreement with the Department of Defense (DOD) signed in June 2006, APHIS can request veterinarians—in particular, from the Army Veterinary Corps—for an emergency response to an animal disease outbreak. However, according to an APHIS emergency response official, DOD veterinarians would provide at most a support role and would not be available in numbers great enough to meet the potential need. For example, the Army Veterinary Corps’ mission to support the national military strategy could limit the number of Army Veterinary Corps veterinarians available to assist APHIS in an emergency response. In addition, as of March 2015, the agency had not finalized similar agreements with other federal agencies, such as HHS, although HHS officials said the Public Health Service Commissioned Corps veterinarians would be ready to participate under the National Response Framework without an agreement. According to APHIS officials, veterinarians at other agencies—including other USDA agencies—may not be available or have the training needed to participate in an emergency response. For example, the APHIS Deputy Administrator for Veterinary Services estimated that no more than 10 percent of veterinarians at FSIS—the largest single employer of federal veterinarians—would be available during an emergency. Other countries. In May 2014, APHIS entered into a multilateral arrangement with Australia, Canada, Ireland, New Zealand, and the United Kingdom that established a framework for one country to request veterinarians from another country to participate in an emergency response to an animal disease outbreak. According to an APHIS emergency response official, the veterinarians requested under this framework would not provide an initial rapid response but would instead provide a support role, although the agreement did not provide this level of detail. USDA and DHS officials said that, in addition to augmenting the APHIS veterinarian workforce for an emergency response, APHIS needs to ensure that responders are trained appropriately. According to the APHIS training and exercise plan for emergency preparedness and response, training provides the critical knowledge, skills, and abilities to respond to emerging or other animal diseases. NAHERC veterinarians may choose to take online training related to specific types of animal diseases and various aspects of emergency response, such as on personal protective equipment and vaccination. However, according to APHIS officials, the agency has limited funds to pay for NAHERC veterinarians to participate in exercises that could help them build skills and practice techniques before an actual incident occurs. In addition, APHIS’ training and exercise plan does not provide details on how the agency will ensure that veterinarians from NAHERC, other agencies, and other countries have adequate training and exercise opportunities for participation in an emergency response to an animal disease outbreak. For example, the plan does not indicate how APHIS will train NAHERC veterinarians—most of whom, according to APHIS officials, are private practitioners who deal primarily with small animals—to overcome a skills gap the agency has identified related to handling large farm animals in the field. APHIS officials said that they expect to obtain funding for training when an emergency occurs. However, without planning for the training needed for its veterinarian workforce and those that could augment its workforce, it will be difficult for APHIS to provide reasonable assurance that it has the workforce that is sufficiently equipped to handle an emergency response. OPM and Federal Agencies Have Taken Limited Steps to Achieve Government- Wide Goals for Veterinarians OPM and other federal agencies have taken steps toward achieving the three goals outlined in OPM’s strategic government-wide workforce plan for the federal veterinary workforce, primarily through their participation in TMAC. However, in each of the three goals, TMAC did not follow through on next steps and made limited progress in achieving its goals in part because the group did not consistently monitor and evaluate its progress toward achieving the goals. TMAC’s efforts in each of its three goals were as follows: Obtain a comprehensive understanding of the federal veterinary workforce. TMAC’s primary effort toward this goal was a government-wide survey of federal veterinarians administered in June 2012. The survey—the first of its kind for federal veterinarians, according to the TMAC report on the survey—was an effort to collect standardized data on the veterinarians employed at 13 federal agencies, including information on their education and certifications, their emergency response skills, and the challenges agencies face in recruiting and retaining them. The survey was intended to serve as a starting point for identifying workforce issues and opportunities to collaborate across agency lines. However, several factors limit the reliability and relevance of the survey results. In particular, officials who conducted the survey said they no longer retained any documentation about their methodology; therefore, we could not evaluate the reliability of its results. Also, according to the survey report, 69 percent of federal veterinarians did not respond to the survey, and TMAC did not assess the potential for nonresponse bias, thereby reducing TMAC’s ability to draw reliable conclusions about the workforce as a whole. In addition, the survey did not address the unique workforce planning needs of individual agencies, such as component agencies within USDA and HHS. For example, the survey identified recruitment and retention challenges for departments as a whole and did not identify particular challenges or strategies to address the challenges confronting component agencies, such as FSIS, which has faced a shortage in veterinarian positions at slaughter plants. Finally, as of February 2015, TMAC had not followed through on next steps identified in the survey report, such as obtaining data from senior agency leaders to validate the results of the assessment. Without following through on such steps, OPM and federal agencies will not know whether there are issues to be resolved, where they exist, and how government-wide approaches can be developed to resolve them. Improve recruiting and retention results for the federal veterinary workforce. OPM’s strategic plan identified several recruitment and retention challenges, such as a limited number of veterinary school graduates and competition for graduates from the private sector. To address this challenge, TMAC considered marketing efforts, such as using social media, to attract veterinary students and others to consider careers in the federal government and discussed strategies for improving recruitment and retention. TMAC did not follow through on these discussions, however, by identifying the agencies using these strategies or evaluating their success. Another initiative to boost federal recruiting efforts, government-wide direct-hire authority for veterinarians, has not been sufficiently monitored or evaluated to determine its effectiveness. In its February 2009 memo approving the authority, OPM cited various factors as justification for the authority, including a severe shortage of candidates despite agencies’ use of other recruitment initiatives, such as recruiting at veterinary colleges. The memo also stated that OPM would monitor use of the direct-hire authority, as well as the continued need for it, and that OPM would modify or terminate the authority as appropriate. Without a review of the use of the authority, OPM cannot determine the overall impact on recruitment or whether the authority should continue or be modified if shortages are limited to some agencies, as TMAC reported. For example, an APHIS official told us that the agency uses direct-hire authority to facilitate the hiring process, not because the agency faces a shortage of applicants, suggesting that OPM could modify the direct-hire authority by limiting it to agencies that face shortages. Otherwise, standard federal hiring requirements can be circumvented without just cause. Enhance efforts to identify the veterinary workforce needed during emergency events. TMAC’s primary effort toward this goal was the study to determine the veterinarian workforce needed to respond to an animal disease outbreak. As we discussed above, the study’s estimates of the number of veterinarians needed are not reliable for purposes of effective emergency response planning because of several limitations, such as being based on a model that had not been verified or validated. In addition, according to the TMAC report on the study, an emergency response will require veterinarians with varying skills, experience, and specialty training, but TMAC did not follow through to identify the response needed by each veterinary specialty, which the report had identified as an important next step. As another step toward this goal, TMAC’s government-wide survey of federal veterinarians included questions on federal veterinarians’ capability and willingness to respond to an emergency and their related experience and training. The report on the survey included a list of training needs; in a related effort, DHS initiated a project to create an online training framework for animal agriculture emergency responders, which is mainly aimed for the use of state officials. A key reason that OPM and federal agencies have taken limited steps to achieve these goals is that they did not consistently monitor and evaluate progress toward achieving the goals. One of our key principles for effective strategic workforce planning is monitoring and evaluating progress toward human capital goals.progress toward human capital goals provides information for effective oversight by identifying performance shortfalls and appropriate corrective actions. According to OPM officials, the group did not consistently monitor progress toward goals in part because the group’s membership did not have sufficient leadership support from participating agencies. Monitoring and evaluating the group’s efforts could better position OPM to ensure progress is being made or assist it in determining appropriate actions to take if progress is limited. Currently, the OPM system for classification of federal employees allows for identification of veterinarians in the veterinary medical science series (i.e., veterinarians in the 0701 occupational series), but not of veterinarians who fill other types of positions, such as managerial or interdisciplinary positions that are open to but not required to be filled by veterinarians. As a result, OPM and federal agencies cannot easily identify all federal veterinarians. require agencies to retroactively identify the veterinarians they employ outside of the veterinary medical science series. In a September 2014 TMAC meeting we observed, TMAC members recognized a need for a higher level of leadership and agreed on a plan to form an executive steering committee. The committee would include a senior executive with veterinary subject-matter expertise from a participating agency’s program office, as well as a human capital officer. As of March 2015, TMAC members had not yet identified agency officials to serve in this leadership capacity. OPM officials said that, given that USDA, and to a lesser extent HHS, employ most civilian veterinarians, the leadership support for TMAC should come from these departments. Leadership involvement is among the key principles we have identified for effective strategic workforce planning, and we have also found that leadership involvement facilitates collaboration within interagency Without leadership support from USDA and HHS, TMAC will groups.likely continue to have difficulty ensuring progress toward group goals, such as developing a way to identify all federal veterinarians. Conclusions USDA has taken steps to provide department-wide guidance and evaluation of its agencies’ veterinarian workforce planning; APHIS and FSIS in particular considered veterinarians as part of their workforce planning efforts for routine activities. However, HHS has not made similar efforts or conducted a department-wide assessment. In 2009, we recommended that HHS conduct department-wide assessments of their veterinarian workforces based on workforce assessments by their component agencies. Among the HHS component agencies, only FDA developed a strategic workforce plan that considered veterinarians. Department-wide guidance and evaluation and collaboration among all of the department’s affected agencies, including individual centers, institutes, and offices within CDC and NIH that conduct workforce planning for veterinarians, could better position HHS to integrate its component agencies’ workforce planning efforts, including efforts to identify and address any gaps in its veterinarian workforce. Accordingly, we continue to believe that our previous recommendation remains valid. APHIS—the lead agency at USDA for an emergency response to an animal disease outbreak—has made a limited effort to estimate the number of veterinarians needed to respond to a large-scale outbreak. As a result, APHIS does not know whether the number of veterinarians currently available to respond is sufficient. Consequently, it does not know if it needs to place a higher priority on increasing the number of veterinarians available to assist in an emergency response—for example, by resuming the processing of applications for veterinarians who can volunteer to serve as temporary federal employees. In addition, APHIS has not fully assessed the sources it can rely on in an emergency or how to train this supplemental veterinarian workforce to be effective in an animal disease outbreak. Without these assessments, APHIS may be limited in its ability to mount an effective emergency response to an animal disease outbreak, with potentially serious consequences for the nation’s agriculture sector. OPM and other federal agencies that participate in TMAC have taken steps toward OPM’s government-wide goals for veterinarians—a relatively small but important population of the federal workforce that is spread among multiple agencies. However, without consistent monitoring and evaluation of the group’s efforts, TMAC’s efforts to follow OPM’s 2010 government-wide strategic workforce plan for veterinarians have fallen short of OPM’s goals. For example, the veterinarian workforce assessment spearheaded by TMAC in 2012 was not detailed or rigorous enough to answer basic questions about the specific challenges agencies face, and TMAC did not follow through on next steps it identified, such as obtaining data from senior agency leaders to validate the results of the assessment. Similarly, in the absence of consistent monitoring and evaluation, OPM and other federal agencies may not be appropriately targeting their efforts, such as with government-wide direct-hire authority for veterinarians that OPM granted in 2009. In particular, since granting the authority, OPM has not evaluated how agencies are using it, and whether its continuation is warranted. Without leadership support from TMAC members—including USDA and HHS, the major federal employers of civilian veterinarians—OPM may have difficulty ensuring progress toward TMAC goals and taking appropriate actions if progress is limited. Recommendations for Executive Action We are making three recommendations to improve the ability of the federal veterinarian workforce to carry out its activities. To prepare for an emergency involving a large-scale animal disease outbreak, we recommend that the Secretary of Agriculture direct the Administrator of APHIS to assess the veterinarian workforce needs under possible scenarios for an emergency response to a large-scale animal disease outbreak. Building on TMAC’s efforts to determine the veterinarian workforce needed to respond to an animal disease outbreak, the assessment should include the number and types of veterinarians needed, the sources required to have a sufficient workforce to respond, and the training needed to carry out their roles. To improve government-wide veterinarian workforce planning efforts, we recommend that the Director of the Office of Personnel Management initiate efforts to monitor and evaluate TMAC’s progress toward government-wide goals for the federal veterinary workforce and work with TMAC members to obtain leadership support, particularly from USDA and HHS, for making progress toward the goals; and evaluate whether the need for government-wide direct-hire authority for veterinarians continues to exist and modify or terminate the authority as appropriate. Agency Comments and Our Evaluation We provided a draft of this report to USDA, OPM, HHS and DHS for their review and comment. USDA and OPM provided written comments, which appear in appendixes II and III, respectively. DHS and HHS provided technical comments, which we incorporated as appropriate. USDA partially agreed with our recommendation about having APHIS assess the veterinarian workforce needs under possible scenarios for an emergency response to a large-scale animal disease outbreak. In particular, USDA agreed that APHIS could do more to improve its estimates of veterinarian workforce needs for an emergency response to an animal disease outbreak, but believes that it has made efforts to assess its needs. For example, USDA stated that APHIS follows National Response Framework principles in planning for animal disease emergencies and described efforts APHIS has made to assess its veterinarian workforce needs for an emergency response. According to USDA, these efforts include using insights from real-world outbreaks to improve planning models for an emergency response and developing response strategies that can alter veterinarian workforce needs during a disease outbreak, such as use of vaccines or quarantine. We recognize that the efforts described by USDA are an important part of response planning under the National Response Framework. However, USDA did not provide documentation to demonstrate that it had assessed its veterinarian workforce needs for an emergency response. Moreover, as stated in our report, APHIS officials told us that the agency had not developed estimates of the number of veterinarians needed for an emergency response, other than one modeling effort for a TMAC study. APHIS officials explained that the agency considered other aspects of planning for an outbreak, such as ensuring the right incident command is in place, to be a higher priority. As a result, we believe that our work fairly and accurately describes what is known about the extent of the APHIS efforts and what needs to be done. Reliable estimates of the veterinarians needed for an emergency, combined with other aspects of planning for an outbreak, will help APHIS to be prepared to have a sufficient number of veterinarians to respond to the most serious animal disease outbreaks. OPM agreed with our recommendation about initiating efforts to monitor and evaluate TMAC’s progress toward government-wide goals for the federal veterinary workforce and working with TMAC members to obtain leadership support, particularly from USDA and HHS. OPM stated that it designed and will aid in establishing a Veterinary Medical Officer Executive Steering Committee for TMAC to, among other things, provide leadership and ensure progress toward stated goals. OPM also agreed to evaluate whether the need for government-wide direct-hire authority for veterinarians continues to exist. OPM further stated that it periodically reviews direct-hire authority for veterinarians, as specified under the regulation on termination, modification, and extension of direct-hire authority. Under the regulation, OPM is to review agency use of the authority on a periodic basis to ensure proper administration and to determine if continued use of the authority is supportable. To demonstrate that it has conducted such reviews, OPM provided us a list of the number of times the authority was used by various departments and agencies in recent years. However, OPM did not provide information showing whether or how it had determined that continued use of the authority is supportable. Moreover, an OPM official responsible for direct- hire authority told us in August 2014 that he was not aware of any systematic review to determine whether direct-hire authority was still needed for veterinarians. In our view, a determination that continued use of the authority is supportable requires an evaluation that includes an examination not only of the number of times the authority was used, but also of other factors, such as whether there is a severe shortage of candidates or a critical hiring need for veterinarians. We are sending copies of this report to the appropriate congressional committees, the Secretaries of Agriculture; Health and Human Services; and Homeland Security; the Director of the Office of Personnel Management; and other interested parties. In addition, the report is available at no charge on the GAO website at http://www.gao.gov. If you or your staff members have any questions about this report, please contact me at (202) 512-3841 or neumannj@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made key contributions to this report are listed in appendix IV. Appendix I: Departments, Agencies, and Other Entities That Have Participated in the Talent Management Advisory Council Appendix I: Departments, Agencies, and Other Entities That Have Participated in the Talent Management Advisory Council Department of Agriculture (USDA) Agricultural Research Service (ARS) Animal and Plant Health Inspection Service (APHIS) Food Safety and Inspection Service (FSIS) Department of Health and Human Services (HHS) Centers for Disease Control and Prevention (CDC) Food and Drug Administration (FDA) National Institutes of Health (NIH) Department of Defense (DOD) Department of Homeland Security (DHS) Office of Personnel Management (OPM) Nonfederal entities American Veterinary Medical Association Association of American Veterinary Medical Colleges National Association of Federal Veterinarians The Smithsonian is a trust entity of the United States with most funds coming from federal appropriations. Appendix II: Comments from the Department of Agriculture Appendix III: Comments from the Office of Personnel Management Appendix IV: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the individual named above, Joseph Cook (Assistant Director), Kevin Bray, Mary Denigan-Macauley, Patricia Donahue, Jessica Lemke, Cynthia Norris, Katherine Pfeiffer, Terry Richardson, Daniel Semick, Rebecca Shea, and Anika Van Eaton made key contributions to this report.

USDA and HHS veterinarians perform crucial work for public and animal health and for emergency response to an economically devastating or highly contagious animal disease—where USDA has a lead role. In 2009, USDA and HHS committed to department-wide efforts to address veterinarian workforce challenges, such as recruitment. In 2010, OPM issued a strategic plan for federal veterinarians to help improve recruiting initiatives and emergency response plans. GAO was asked to review workforce planning for federal veterinarians. This report examines (1) department-wide efforts USDA and HHS have made for their routine veterinarian workforces, (2) the extent to which USDA has identified the veterinarians needed for emergency response to an animal disease outbreak, and (3) the steps OPM and other federal agencies have taken to achieve the goals of the government-wide strategic plan for the veterinarian workforce. GAO reviewed USDA, HHS, and government-wide workforce plans and interviewed relevant officials. The U.S. Department of Agriculture (USDA) has taken actions to ensure that component agencies include veterinarians in workforce planning efforts for meeting routine needs, but the Department of Health and Human Services (HHS) has not done so. GAO has identified top leadership involvement as a key principle for workforce planning. For example, USDA provided guidance to its component agencies to assess and develop strategies for its workforce. In accordance with this guidance, USDA's Food Safety and Inspection Service (FSIS)—the agency that inspects slaughter plants—developed a workforce plan that included recruitment incentives and other strategies for veterinarians. HHS's Food and Drug Administration (FDA) also included veterinarians in its workforce plans, but HHS did not provide guidance or direction to FDA or other component agencies to do so. GAO recommended in 2009 that USDA and HHS conduct department-wide assessments of their veterinarian workforces. The efforts of USDA and its component agencies met the intent of the recommendation. GAO believes that the recommendation to HHS is still valid. Direction and guidance from HHS could help integrate its component agencies' workforce planning efforts for veterinarians into a department-wide assessment. USDA participated in a government-wide study to estimate the veterinarians needed to respond to animal disease outbreaks, but because of limitations in the study, the estimates are not reliable for purposes of effective emergency response planning. For example, the estimates were based on a USDA model that had not been verified or validated. Moreover, USDA has not developed a detailed plan to augment or train its workforce to respond to an economically devastating or highly contagious outbreak. Without reliable estimates of the veterinarians needed or how it will augment and train its workforce, USDA cannot ensure it will have enough veterinarians to adequately respond. The Office of Personnel Management (OPM) and other federal agencies have taken steps toward achieving the goals outlined in OPM's government-wide strategic plan for the veterinarian workforce, primarily through an interagency group OPM created. However, in each of the three goals, the interagency group did not follow through on next steps and made limited progress. For example, to improve recruiting, OPM granted government-wide direct-hire authority in 2009 to enable agencies to hire qualified veterinarians without regard to certain federal hiring requirements. However, OPM did not follow through on plans to review agencies' use of the authority. As a result, OPM cannot determine the overall impact on recruitment or whether the authority should continue or be modified. Monitoring and evaluating progress toward human capital goals is among the key principles GAO has identified for effective strategic workforce planning. According to OPM officials, the group did not consistently monitor progress toward goals in part because it did not have sufficient leadership support from participating agencies. OPM and group members, including USDA and HHS, recognize a need for a higher level of leadership but have not identified officials to serve in this capacity. Obtaining leadership support—including from USDA and HHS, the major federal employers of civilian veterinarians—and monitoring and evaluating progress could help emphasize the importance of completing work under these goals and better position OPM to ensure progress or take appropriate actions if progress is limited.

Background Railroad Retirement is a multiemployer defined benefit (DB) plan for railroad employees. It is sponsored by interstate and other types of railroads and their affiliates that are engaged in railroad-connected operations as well as employer associations and national labor organizations and their subordinate units. Although the program’s retirement benefits generally are determined through collective bargaining agreements, the program is governed by the Railroad Retirement Act of 1974, as amended, and administered by the Railroad Retirement Board (RRB), an independent agency of the federal government. The program is not subject to the Employee Retirement Income Security Act of 1974 (ERISA), as amended, and thus railroad employees are not covered by ERISA requirements designed to protect the pension benefits of most private sector employees. Railroad Retirement benefits are provided in the form of a pension that is based on two formulas—known as Tier I and Tier II. The first-tier formula, which takes into account both railroad service and nonrailroad service covered by Social Security, provides benefits that are equivalent to what would be provided by Social Security. The second-tier formula, which takes into account railroad service only, provides additional benefits and is comparable in design to other private sector DB plans, according to RRB. However, Railroad Retirement provides certain benefits not generally provided under pension systems, including Tier II benefits for spouses and survivor Tier II benefits without an offset in the employee’s benefit. Regarding post-retirement benefit increases, the Tier I portion is increased automatically in the same way that Social Security benefits are increased. The Tier II portion is normally increased annually at 32.5 percent of the increase in living costs owing to inflation as measured by the Consumer Price Index (CPI). Railroad Retirement benefits are financed primarily through payroll taxes, which are deposited in Railroad Retirement trust funds. Tier I payroll taxes are the same as those for Social Security; for 1998, employers and employees are assessed 6.2 percent of pay on wages up to a maximum annual wage ceiling of $68,400. Tier II payroll taxes in 1998 are 16.1 percent for employers and 4.9 percent for employees, and they are assessed on wages up to a maximum of $50,700. Both the Social Security and Tier II wage bases are adjusted annually for economywide increases in wages. Tier II tax rates are higher than employer and employee contributions to private sector DB plans. According to an official of the Employee Benefit Research Institute, private sector employers that sponsor DB plans contribute 3 percent of payroll, on average, and most employees make no contribution to fund plan benefits. Former railroad employees who secure federal civilian employment would most likely also be covered by FERS—the federal retirement program nearly all new civilian employees must join. FERS provides benefits from three sources: a basic pension (a DB plan), Social Security, and the Thrift Savings Plan (TSP)—a DC plan much like private sector 401(k) plans. Starting at age 62, FERS pensions are to be increased automatically each year according to the CPI, unless inflation is greater than 2 percent. When inflation is between 2 and 3 percent, the adjustment is limited to 2 percent; and if inflation is 3 percent or more, the adjustment is limited to the CPI minus 1 percent. FERS benefits are funded through various agency and employee contributions, which are deposited in the Civil Service Retirement and Disability Trust Fund (CSRDF) that is administered by the Office of Personnel Management (OPM). In 1996, agencies and employees contributed 11.4 and 0.8 percent of pay, respectively, to cover the cost of FERS pension benefits in addition to the 6.2 percent each paid in Social Security payroll taxes. FERS also requires that agencies make automatic contributions of 1 percent and matching contributions of up to 4 percent on voluntary employee contributions to employees’ TSP accounts. National trends toward increased workforce mobility and the aging of the baby boom generation have focused greater attention on retirement issues in recent years, including the portability of retirement benefits. In this regard, portability can be more easily achieved in DC than DB plans. For DC plans, employees own or are immediately vested in any contributions they make to their own retirement accounts, as well as any investment earnings or losses associated with those contributions. Employees also generally become vested in employer contributions to their accounts and any associated earnings or losses within 5 to 7 years. Thus, an employee who separates can either withdraw his or her vested account balance as a lump-sum payment or preserve the benefits by rolling the account over into an individual retirement account or a new employer’s plan, if allowed. For DB plans, portability depends on the way in which vesting and service credit provisions, if any, are designed and whether the vested benefits of separated employees are deferred. For DB plans other than Railroad Retirement, employees are immediately vested in their own plan contributions, plus interest, and become vested in employer-provided benefits within 5 to 7 years. When an employee separates, vested DB benefits can be withdrawn as a lump-sum payment; however, more commonly, plans require that these benefits be deferred until the point at which the separated employee would have become eligible to retire under the plan and begin receiving benefits. If payment of vested benefits is deferred for many years, the value of those benefits may be eroded by the effects of inflation during the pre-retirement period. Indexation to protect the value of such benefits by increasing the value of the employee’s final wages (i.e., wage indexation) is rare because it is expensive. DB plan benefits can also be made portable through the transfer of service credits, where service under one employer is counted by a subsequent employer in determining retirement benefits under the more recent employer’s retirement program. Although some private sector multiemployer plans and some state and local governments allow for the transfer of service credit, most do not because of concerns about differences in plan design and benefit levels and who would pay the potential increase in retirement costs. Scope and Methodology As described in more detail in appendix I, to respond to your request, we reviewed our prior work, analyzed retirement literature on portability, and interviewed railroad and federal civilian retirement specialists and other retirement experts. We worked with an OPM retirement benefits specialist, RRB actuaries, and a Congressional Research Service (CRS) specialist in social legislation to (1) identify changes to FERS and Railroad Retirement that might enhance portability and (2) gain an understanding of the cost and administrative implications of such changes. The examples of cost increases presented in this report illustrate increases that might occur if the portability changes that we examined were enacted. More precise estimates would require detailed information on the design of any particular policy change and the specific requirements for its implementation. We requested comments on a draft of this report from the Director of OPM and the Chair of RRB. These comments are discussed at the end of this letter. We did our review in Washington, D.C., from February 1998 to June 1998 in accordance with generally accepted government auditing standards. Railroad Retirement Benefits Are More Portable Within the Industry Than Outside It The portability of Railroad Retirement benefits depends on whether an employee changes employers within the industry or leaves the industry for nonrailroad employment. If the employee continues doing railroad work, then Tier I and Tier II benefits are fully portable, regardless of how many times the employee changes employers. Outside the industry, the employee’s Tier I benefits are portable into nonrailroad employment; however, the portability of Tier II benefits depends on the employee’s status concerning vesting and other factors specific to Railroad Retirement. Tier I and Tier II Benefits Are Portable Within the Industry Multiemployer plans such as Railroad Retirement are more portable than other types of DB plans because if an employee changes employers within the plan, any accumulated retirement benefits are transferred from the prior employer to the new employer—usually as credited service. The Railroad Retirement program has a service credit arrangement within the industry, and thus, a railroad employee who switches employers experiences no loss in retirement benefits as long as the employee eventually obtains the 10 years (120 months) or more of total railroad service that is required for vesting. Moreover, the 120 months need not be consecutive, and one full month is credited for each month in which any amount of service is compensated by a participating railroad employer. In practical terms, service crediting may have diminished in value owing to a decline in railroad employment opportunities. According to RRB, about 60 percent of employees who begin railroad service leave the railroad industry with less than 10 years of service. Moreover, railroad employment has declined from more than 1.2 million in 1955 to less than 260,000 in 1997. Although railroad employment trends may have stabilized in recent years, a smaller number of job opportunities remains an important indicator that an employee who loses one railroad job may not be able to find another or return to the railroads after a period outside the industry. Outside the Industry, Tier I Benefits Are Portable to Any Employment Covered by Social Security Outside the industry, Tier I benefits are portable to any employment covered by Social Security and vice versa. A combined total of at least 10 years (or 40 quarters or 120 months) of railroad employment or nonrailroad employment covered by Social Security, or both, is required to establish eligibility for either Tier I or Social Security benefits. Wage information and service credits that are used to compute retirement benefits are entirely transferable between the two programs, and the benefits that a retiring employee would receive are comparable under either program as well, other factors being equal. To illustrate, if a railroad worker retired from the railroads with at least 10 years of railroad service, any wage information and service credits earned under Social Security from prior nonrailroad employment would be transferred to RRB and used to compute the employee’s Tier I benefits. Similarly, if a railroad employee separated without accumulating 10 years of railroad service, RRB would transfer Tier I wage information and service credits to the Social Security Administration to be used in computing any future Social Security benefits. Tier II Benefits Are Less Portable Outside the Industry Outside the industry, Tier II benefits are less portable than Tier I benefits because of Railroad Retirement’s stringent vesting and forfeiture rules and the fact that Tier II service credits are not transferable to nonrailroad employers. As described earlier, private sector plan participants become fully vested in DB plan benefits within 5 to 7 years, while railroad employees must have 10 years of railroad service to vest in their Tier II benefits. Railroad employees who are not vested also forfeit their Tier II employee contributions at separation. ERISA, as amended, requires other private sector employers to return such employee contributions even for those employees who separate before they are vested. Similarly, federal employees who are covered by CSRS or FERS can withdraw their contributions upon separation other than retirement, regardless of their vesting status, as can many state and local government employees. Tier II benefits are also less portable because any vested Tier II benefits must be deferred upon separation. It is difficult to generalize about the financial consequences of deferring benefits because the impacts vary depending on the length of the pre-retirement period and the rate of inflation over that same period. However, the impacts could be substantial if inflation rates were high and/or many years passed before the separated employee began to draw benefits. According to a Hay/Huggins analysis of private sector plans, up to two-thirds of the average loss in the value of deferred retirement benefits could be eliminated if vested benefits were indexed for inflation. Railroad Retirement does have a wage indexation feature for certain Tier II deferred benefits. In particular, any former railroad employee who secures employment at one of five federal agencies—Department of Transportation (DOT), RRB, Surface Transportation Board (STB), National Mediation Board, and National Transportation Safety Board (NTSB)—would have his or her deferred Tier II pension benefits indexed for inflation in the same way that Social Security benefits are indexed for changes in wages. However, if that employee separated from the federal agency before retirement, then Tier II benefits would not be indexed. Crediting Railroad Service Into FERS Could Enhance Tier II Portability, but Could Increase FERS Costs Crediting railroad service as federal service under FERS could enhance the portability of Tier II benefits by allowing former railroad workers who secure federal employment to effectively convert their Tier II pension benefits into FERS pension benefits. However, adding a railroad employment service credit provision to FERS could increase FERS costs as well as raise policy and administrative issues. Crediting Railroad Service Into FERS Could Increase FERS Costs Although transferring service credits across DB plans can be complicated to implement, conceptually it involves little more than totaling the employee’s years of service under both a former and current plan when calculating the employee’s pension under the current plan. Following this logic, a provision could be added to FERS to allow railroad service to be credited when computing a FERS pension for former railroad employees who secure federal employment and become covered by FERS. Extending service credit for railroad employment in this way could increase FERS retirement costs. Any such increased costs would be borne by the federal government unless the added costs were not paid from the CSRDF. The amount of any increase would depend on how many former railroad employees would actually become FERS participants, the number of those who would elect the service credit, and the characteristics of these employees (e.g., their railroad salary and work histories). At our request, an OPM retirement specialist prepared cost estimates to illustrate the potential per-person lifetime cost increase for three hypothetical employees, using various assumptions about age, salary, and service that the Federal Railroad Administration (FRA) believed represented a realistic range of former railroad employee circumstances. The calculations were present-value calculations and assumed that all of the former railroad employees began their FERS-covered employment at a GS-12, step 1 federal pay grade and had a normal salary progression thereafter. The OPM specialist used this starting pay grade because FRA told us that virtually every former railroad employee who has been hired by FRA has started at that grade, including those who had earned substantially more from the railroads. The results varied depending on the employees’ salaries, length of service, and age at retirement. For example, according to OPM’s calculations, the cost of a FERS pension could increase by about $34,000 for a 35-year-old railroad employee who had a railroad salary of $40,000 and 6 years of railroad service, a beginning federal salary of $47,066, and retired at age 56 after reaching the FERS minimum retirement age. The cost could increase by about $53,000 if the same employee worked until he or she reached age 62 and became eligible to retire with unreduced benefits. The cost could increase considerably more for senior employees who received higher salaries during their railroad employment than during their federal employment. For example, the cost could increase by as much as $148,000 for a 50-year-old railroad employee who had a railroad salary of $60,000 and 15 years of railroad service, a beginning federal salary of $47,066, and retired at age 62. Although OPM’s illustrations suggest that per-person lifetime costs could be high, the aggregate cost probably would not be if the number of employees involved was small. On this point, more than 1.6 million employees are covered by FERS, but only about 2,600 employees in all work for the five federal agencies that would most likely attract former railroad employees. Moreover, these five agencies made very few new appointments in 1997, ranging from 6 at STB to 100 at NTSB. The number of former railroad employees involved might be even smaller than these statistics suggest. The OPM specialist with whom we worked said that if given the choice, former railroad employees who secure employment at any of the five agencies might decide not to transfer their railroad service into FERS. Because their Tier II pension benefits would be indexed at retirement, these employees might be better off by drawing separate Tier II and FERS pensions. However, as the specialist also noted, if extending FERS service credit for railroad employment was made available to former railroad employees who secured employment in any federal agency, the number of employees who elected the service credit might increase, and as a consequence, so might the costs. The only way that adding a railroad service credit provision would be cost-neutral to FERS would be if the increase in FERS retirement costs attributable to the change was not paid from the CSRDF. One arrangement that could serve as a cost-neutral model was applied to employees of non-appropriated fund instrumentalities (NAFI)—organizations that generally provide morale and welfare support services to the military, such as military exchanges. Under section 1043 of the National Defense Authorization Act of 1996, FERS and NAFI employees of the Department of Defense or Coast Guard who met certain conditions after December 31, 1965, and before August 10, 1996, were allowed to credit all of their federal civilian service—both as NAFI employees or employees covered by FERS—toward a single pension. In practice, the credit could be combined under either FERS or NAFI. The opportunity to elect the transfer of service credits into FERS expired August 11, 1997. The railroad industry and each employee who elected the credit could together be required to pay the full actuarial cost of that portion of his or her FERS pension benefits attributable to railroad employment, similar to the arrangement for NAFI employees. As the illustrative examples described earlier suggest, however, the costs that would need to be paid could be considered high, perhaps too high to be paid as a lump-sum by an individual employee. As an alternative, cost-neutrality could also be accomplished by requiring a transfer of the employee and employer retirement contributions, plus interest, from Railroad Retirement trust funds to the CSRDF. Similar to the NAFI approach, if the amount transferred was insufficient to cover the full cost of the increase in the employee’s FERS pension, the employee could be required to pay any remaining cost. Rather than having the employee make a cash deposit to meet such a shortfall, OPM could make up the difference by making an actuarial reduction in the amount of the employee’s monthly FERS pension equaling the present value of the difference. Policy and Administrative Issues Could Arise Because they would need to collect and verify the railroad service of each employee who elected the credit, OPM and the agencies that hire former railroad employees could experience some increase in administrative costs if a railroad service credit provision were added to FERS. In addition, OPM would need to determine the actuarial cost of crediting the employees’ railroad service into FERS. OPM officials told us that the increased administrative costs would be manageable, largely because they expect that the number of employees who would elect the credit would be small. OPM has consistently objected to proposals to extend service credit for work that was not covered by CSRS and FERS, especially if it was performed in the private sector. As far back as 1969, the Civil Service Commission opposed extending service credit to state employees who were involved in federal grant activities. Although federal funds might have been involved, the Commission asserted that the programs were state functions and that the employees engaged in their administration were selected, employed, and supervised by states or their instrumentalities. Accordingly, OPM concluded that CSRS’ effectiveness as a retirement system would be severely reduced if it was to become a pension plan for numerous types of nonfederal service and that allowing individuals with such service to credit that service into CSRS would inevitably generate pressures for extending credit for almost any type of nonfederal work. We prepared several letters on the same issue, the most recent one at the request of the Chairman of the House Committee on the Post Office and Civil Service. Our letters recognized that the proposed amendment involved a matter of policy for the determination of Congress; however, they also recognized certain problems. In particular, they noted that any amendment to existing law that would permit the crediting of nongovernment service for civilian retirement purposes appeared to be inconsistent with the concept that an employee’s retirement annuity will be based upon, and will vary in proportion to, the length of civilian government service rendered. The letters also concluded that the amendment would impose a financial burden upon the federal government not contemplated under basic retirement law and suggested that if credit was to be extended, action should be taken to prevent any increase in the unfunded liability of the retirement trust fund. In 1986, OPM criticized provisions of the proposed Railroad Service Retirement Credit Act that would have granted retroactive railroad service credit into the now-closed CSRS to former railroad employees who had secured employment at DOT, Interstate Commerce Commission, National Mediation Board, NTSB, or RRB. Under that proposal, an employee who elected service credits would have been required to deposit into the CSRDF an amount equal to the difference between his or her retirement contributions under Railroad Retirement and the amount the employee would have contributed under CSRS if he or she had been covered by that program during the years of railroad service. OPM opposed the legislation, in part because the deposit would be substantially less than other covered employees would have contributed to the CSRDF. OPM also asserted that there was no justification for granting civil service retirement credit for private sector work and expressed strong concern that once the threshold of extending coverage for nonfederal service was crossed, it would be difficult to exclude employment in other sectors having needed expertise or a special relationship with the government. In interviews for this report, OPM officials told us that OPM would strongly oppose adding a railroad employment service credit provision to FERS.OPM’s rationale continues to be that providing credit for railroad service would be inconsistent with the intent of FERS and would create a troublesome precedent. As OPM has stated, FERS was designed to be a staff retirement program, providing deferred compensation benefits to employees based on the service that they perform while federal employees. Under the basic FERS statute, only service that was performed while an employee was covered under FERS would be credited in computing a FERS pension. However, past amendments to the CSRS statute provided for certain service credits and have applied to employees covered by FERS under limited circumstances. Specifically, there were 16 types of service for which federal civilian retirement credit could be granted, including work performed while a VISTA (Volunteers in Service to America) or Peace Corps volunteer; Nurse Cadet; U.S. Capitol Guide; or NAFI employee. A review of the terms under which credit for these services has been provided shows that although the work is not federal employment because there was no appointment to the civil service by a federal official, in most cases the work served a federal purpose. These election opportunities were available for a limited time and applied retrospectively only to past service performed by an individual who had since become a federal employee covered by CSRS or FERS. Currently, the only creditable service not performed while under FERS is military service and service performed under the Foreign Service Pension System. In no case has service credit been allowed for private sector service. Changing Vesting and Contribution Forfeiture Rules Might Enhance Portability, but Railroad Retirement Costs Might Increase The overall portability of Railroad Retirement Tier II benefits outside the industry could be enhanced in several ways. First, Tier II vesting requirements are stringent compared with requirements under ERISA. By allowing a 5-year rather than 10-year vesting period, more separated employees might receive deferred Tier II retirement benefits. Second, as Railroad Retirement is currently designed, a separated employee who is not vested forfeits not only any accrued plan benefits but also his or her own contributions. If these contributions were returned, they could be reinvested to provide additional assets in retirement. Railroad Retirement costs could increase if the vesting and forfeiture changes were adopted, but the amount of the increase could be small. At our request, RRB actuaries prepared illustrative estimates of these costs. The results of their analysis showed that if the vesting requirement was reduced from 10 to 5 years, there would be little difference in trust fund assets, outlays, and receipts. Annual outlays for program benefits and administration would increase by about $14 million more (or 0.26 percent) by 2022—if 5-year rather than 10-year vesting was used. As for trust fund balances, at the end of 1998, the Tier II trust fund asset balance was projected to be $14.2 billion. Under both 5-year and 10-year vesting, this balance would grow to a high of $18.7 billion in 2009 and then decline to about $9 billion in 2022. Reducing the vesting requirements would have no effect on Tier II payroll taxes. Because Tier II benefits would increase, federal income taxes on these benefits would increase, and such taxes are paid to the Railroad Retirement Account. Finally, with or without the change in vesting rules, tax revenues into the account are projected to decline from 88 to 65 percent of Railroad Retirement benefits and administration costs between 1998 and 2022. Regarding the potential cost of forfeiture rule changes, the RRB analysis showed that if lump-sum payments equal to contributions plus interest had been paid to employees who separated in 1995 and who were not vested, program costs in that year would have increased by $31.7 million—$23.9 million for contributions and $7.8 million for interest. Excluding interest from these payments would reduce costs by about 25 percent. The annual cost of providing refunds to separating employees in future years would depend on how many employees would separate from the railroad industry and the amount employers contributed toward the Tier II benefit. According to RRB officials, if either or both of the potential changes were adopted, the Board’s administrative burdens would also increase but they would be manageable. The changes would require substantial software modifications in application processing, calculation, recordkeeping, and edits. Conclusions Our work has shown that it would be possible to enhance the portability of Railroad Retirement benefits; however, the changes that we considered might not be desirable for cost, administrative, and policy reasons. If a service credit provision was added to FERS, it would be cost-neutral from the federal government’s perspective only if the costs were paid in full by the former railroad employees or the railroad industry or a combination of the two. If the required vesting period under Railroad Retirement were reduced and/or the contributions of nonvested employees were provided to them in a lump-sum payment upon their separation, the costs would be borne by the railroad industry and/or other railroad employees. Under the assumption that the number of former railroad employees that federal agencies would hire is limited, the aggregate administrative costs for agencies that might be involved—including OPM, RRB, and the hiring agencies—would be manageable if one or all of the changes were adopted, according to the OPM and RRB officials with whom we talked. Although a change to FERS could be made cost-neutral from the perspective of the CSRDF and the administrative costs could be manageable, according to OPM officials, any change to existing law to permit the crediting of nongovernment service for civilian retirement purposes would be strongly opposed by OPM. And as we have said in the past, such a change would appear to be inconsistent with the fundamental concept of CSRS and FERS that an employee’s retirement benefits, exclusive of Social Security, will be based on the years of his or her CSRS or FERS government service. Such a change could set a precedent for other private sector employees to seek similar treatment. Agency Comments and Our Evaluation We requested comments on a draft of this report from OPM and RRB. We received oral comments from RRB’s Deputy General Counsel. RRB agreed with the contents of the draft report and offered several technical and clarifying comments, which we incorporated where appropriate. We received written comments from the Director of OPM, which stated that the report effectively evaluated the cost and policy implications if provisions governing CSRS or FERS were amended to allow crediting Railroad Retirement as a means of enhancing portability. The letter, which is reproduced in appendix II, reiterated OPM’s opposition to such a change. We are sending copies of this report to the Ranking Minority Member of your Committee, the Director of OPM, and the Chair of RRB. Copies of this report will also be sent to other parties interested in railroad retirement matters and will be made available to others upon request. Major contributors to this report are listed in appendix III. If you have any questions, please call me at (202) 512-8676. Objectives, Scope, and Methodology Objectives The Chairman, House Committee on Transportation and Infrastructure, asked us to provide information on the portability of Railroad Retirement Program benefits and the potential for enhancing that portability. This review was undertaken in response to that request. The objectives of our review were to determine which, if any, Railroad Retirement benefits are portable; what changes could be made to the Federal Employees’ Retirement System (FERS) that might enhance the portability of Railroad Retirement benefits into FERS for former railroad employees who obtain federal civilian employment and the cost and management implications of those changes for FERS and whether such changes could be made cost-neutral to FERS; and what changes could be made to Railroad Retirement that might enhance the portability of its retirement benefits and the cost and management implications of such program changes for Railroad Retirement. Portability refers to an employee’s ability to retain retirement benefits when leaving one job for another while maintaining the value of those benefits until retirement. Scope and Methodology To determine which, if any, Railroad Retirement program benefits are portable, we first reviewed our prior work and retirement literature and interviewed experts at the Employee Benefit Research Institute, Watson-Wyatt Worldwide, Office of Personnel Management (OPM), Congressional Research Service (CRS), Railroad Retirement Board (RRB), Association of American Railroads (AAR), and the United Transportation Union (UTU) to determine what portability means and how retirement program features can help to achieve it. We then reviewed RRB documents and provisions of the Railroad Retirement Act, as amended. We compared program features regarding eligibility for benefits to the ways in which such features could be designed to enhance portability as determined through our literature review and discussions with experts. We confirmed our understanding of what and how Railroad Retirement features enhance or limit portability with officials at RRB, CRS, and OPM. To identify changes to FERS that could enhance the portability of the Railroad Retirement program benefits into FERS and develop information on any associated costs and the policy and management implications of the changes, we worked with retirement policy specialists at OPM and CRS. In collaboration with these specialists, we used feasibility and cost-neutrality as our criteria for selecting changes to FERS. Using these criteria, we selected a transfer of service credit approach, which was similar to transfers of service credit commonly described in the literature on multiemployer defined benefit (DB) plans and could be cost-neutral to FERS. To understand the potential increase in retirement costs from a service credit arrangement, we developed illustrative examples for three hypothetical employees, using information provided by the Federal Railroad Administration that represented former railroad employees. To calculate what the full actuarial cost would be if those employees purchased service credits under FERS, OPM used different salary and service histories for each. We did not determine how or what funds might be transferred from the Railroad Retirement fund to the Civil Service Retirement and Disability Trust Fund to help fund the purchase. To identify changes to Railroad Retirement that might enhance the portability of its retirement benefits and the cost and management implications of the changes, we interviewed private sector, RRB, and CRS retirement experts to determine the most feasible changes. We focused on Tier II benefits because Tier I benefits are equivalent to what would be provided by Social Security if an employee left the railroad industry and thus are portable. First, we identified the Railroad Retirement provisions that affected portability. On the basis of our review, we selected changes in vesting and forfeiture rules, because these are the features that most limit the portability of Tier II benefits. We worked with the RRB actuary and a CRS specialist in social legislation to develop a methodology for estimating the potential cost of a shorter vesting period and more liberal forfeiture rules. The RRB actuary projected the cost of 5-year vesting on Railroad Retirement over 25 years and compared it to the projected cost under 10-year vesting required by current law. These projections allowed us to compare alternative trust balances, payouts, and income. We also worked with the RRB actuary to estimate the potential cost of requiring that employees who are not vested receive lump-sum payments of their own contributions, with and without interest, at the time of separation. We estimated the costs for 1995 because it was the most recent year for which data were available. The actuary estimated the cost of refunds by determining the number of employees and the aggregated amount of the employee contributions with and without interest in excess of Social Security for employees who (1) separated in 1995; (2) had not died or retired; (3) were not on the retirement rolls in 1996; and (4) had between 1 and 59 service months (0 to 5 years), between 60 and 119 service months (more than 5 but less than 10 years), and between 1 and 119 service months (0 to almost 10 years). He then calculated the average amount of forfeited contributions with and without interest for these groups of employees. The forfeited contributions for the group with between 0 and almost 10 years of service served as an estimate of the costs of immediate vesting of employee contributions. The average forfeiture of contributions in the other groups showed how the length of service affected the average amount forfeited per employee. As agreed with Committee staff, we developed information on portability primarily as it relates to DB plans, because Railroad Retirement is a DB plan. Also as agreed, we only examined portability changes prospectively. In the case of FERS, the term prospective means that the change would apply only for employees who obtained federal employment after the portability service credit change was adopted. We did not consider any changes to FERS that would be applied retroactively for former railroad employees who were already federal employees and covered by FERS as of the date the option would be adopted. In the case of changes to Railroad Retirement, the term prospective means that the option would generally apply for all railroad employees who were employed within the industry as of the date the option would be adopted. If any of the changes—whether to FERS or Railroad Retirement—would be applied retroactively, they potentially would be much more costly. The information that we developed on the potential costs of portability enhancements should be viewed as illustrative, because more precise estimates of costs would require detailed information on the design of the portability enhancement and how it would be required to be implemented. We did not independently verify any of the estimates made by OPM or RRB actuaries. Comments From the Office of Personnel Management Major Contributors to This Report General Government Division Margaret T. Wrightson, Assistant Director H. John Ripper, Evaluator-in-Charge The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. 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Pursuant to a congressional request, GAO reviewed the portability of Railroad Retirement Benefits, focusing on: (1) which, if any, Railroad Retirement benefits are portable; (2) what changes could be made to the Federal Employees' Retirement System (FERS) that might enhance the portability of Railroad Retirement benefits into FERS for former railroad employees who secure federal civilian employment and the cost and administrative implications of those changes for FERS and whether such changes could be made cost-neutral to FERS; and (3) what changes could be made to Railroad Retirement that might enhance the overall portability of its retirement benefits and what are the cost and administrative implications of these changes for Railroad Retirement. GAO noted that: (1) under the Railroad Retirement program, Tier I and Tier II benefits are fully portable within the railroad industry; the benefits that employees earn from one railroad employer can be carried to the next employer without any reduction in value; (2) Tier I benefits are also portable outside the industry; railroad employees can convert their Tier I benefits into social security benefits and vice versa; (3) Tier II benefits, however, are less portable outside the industry; railroad employees must have at least 10 years of railroad service to establish their right to Tier II benefits and the receipt of any benefits must be deferred until the time that the employee would have become eligible to retire under the plan; (4) although the Railroad Retirement program provides for indexing wages for inflation that occurred during the pre-retirement period, this provision applies only to former railroad workers who secure employment at selected federal agencies that are responsible for federal railroad policies; (5) for former railroad workers who secure federal civilian employment, the portability of Tier II benefits could be enhanced if they could be converted into FERS pension benefits; (6) the arrangement would be cost-neutral to the Civil Service Retirement and Disability Trust Fund only if any increased costs were paid in full by the railroad industry, the former railroad employees, or a combination of the two; (7) according to the Office of Personnel Management's (OPM) analysis, per-person lifetime costs could be high; (8) however, its analysis also suggests that the aggregate cost probably would not be high if the number of employees involved was small; (9) according to OPM, the agencies that hire former railroad employees and OPM would both experience modest increases in administrative costs; (10) although it believes the administrative burdens of adding a railroad service credit provision to FERS would be manageable, OPM has consistently objected to proposals that would extend service credit for work that was not covered by the Civil Service Retirement System or FERS; (11) the portability of Tier II benefits could also be enhanced by reducing the required vesting period for railroad employees; and (12) according to a Railroad Retirement Board, the impact on Railroad Retirement trust fund assets, outlays, and receipts would be less if the option applied only to benefits earned by current or future employees.

Background Marijuana refers to the dried leaves, flowers, stems, and seeds from the cannabis plant (shown in fig. 1), which contains the psychoactive or mind- altering chemical delta-9-tetrahydrocannabinol (THC), as well as other related compounds. Marijuana can be smoked or consumed in food or drinks, such as marijuana-infused brownies, cookies, peanut butter, candy, and soda. According to the Substance Abuse and Mental Health Services Administration, marijuana is the most widely used illicit drug in the United States. For example, according to the 2013 National Survey on Drug Use and Health, an estimated 44 percent of Americans aged 12 and older reported they had tried marijuana, and an estimated 7.6 percent of Americans aged 12 and older reported having used marijuana in the past month. Marijuana is a controlled substance under federal law and is classified in the most restrictive of categories of controlled substances by the federal government. The CSA places all federally controlled substances in one of five “schedules,” depending, among other things, on the drug’s likelihood for abuse or dependence, and whether the drug has an accepted medical use. Marijuana is classified under Schedule I, the classification reserved for drugs that have been found by the federal government to have a high potential for abuse, no currently accepted medical use in treatment in the United States, and a lack of accepted safety for use under medical supervision. In contrast, the other schedules are for drugs of varying addictive properties, but found by the federal government to have a currently accepted medical use. The CSA does not allow Schedule I drugs to be dispensed with a prescription, unlike drugs in the other schedules. Furthermore, the CSA provides federal sanctions for possession, manufacture, distribution, dispensing, or use of Schedule I substances, including marijuana, except in the context of a government- approved research project. Within DOJ, two components have primary responsibility for enforcing the CSA. DEA is the primary federal law enforcement agency responsible for conducting criminal investigations of potential violations of the CSA. U.S. Attorneys are the chief federal law enforcement officers in federal judicial districts responsible for, among other things, prosecution of criminal cases brought by the federal government and prosecution of civil cases in which the United States is a party. As part of their marijuana enforcement efforts, DEA and the U.S. Attorneys collaborate, often with state and local law enforcement, to conduct criminal investigations and prosecutions, civil and criminal forfeiture, seizures, and eradications of cannabis plants. An increasing number of states have adopted laws that legalize the use of marijuana under state law. As of June 2015, 24 states and the District of Columbia had passed legislation or voter initiatives legalizing the possession and distribution of marijuana for medical purposes under state or territorial law. In 1996, California became the first state to do so with its passage of the Compassionate Use Act, and an increasing number of states have passed ballot initiatives, propositions, or legislation under state law to legalize medical marijuana in recent years. For example, from 2007 through June 2015, 13 states and the District of Columbia passed some type of measure to legalize marijuana for medical purposes under state law. The laws these states have passed legalizing medical marijuana vary, as does the extent to which the states have established regulatory and enforcement systems to implement them. As of June 2015, 4 states and the District of Columbia had passed ballot initiatives legalizing marijuana for recreational purposes under state law. In 2012, Colorado and Washington became the first states to pass ballot initiatives legalizing the production, processing, and sale of marijuana for recreational use. In 2014, Alaska, Oregon, and the District of Columbia passed ballot initiatives legalizing marijuana for recreational use. DOJ’s Marijuana Enforcement Policy DOJ has updated its marijuana enforcement policy in recent years in response to the rising number of states that have legalized marijuana under state law. According to a series of memorandums ODAG issued to U.S. Attorneys beginning in 2009, DOJ is committed to enforcing the CSA for marijuana regardless of state law. However, DOJ has directed its field components to focus on the efficient and rational use of its investigative and prosecutorial resources to address the most significant threats to public health and safety. According to one of the memorandums, DOJ has not historically devoted resources to prosecuting individuals whose conduct is limited to possession of small amounts of marijuana for personal use on private property. Rather, DOJ has left such lower-level or localized marijuana activity to state and local law enforcement authorities through enforcement of their own drug laws. While reiterating the department’s approach to enforcing the CSA and focusing its resources to address the greatest public health and safety threats, each of the ODAG’s memorandums provided additional clarification with respect to the conditions that may trigger federal action, including criminal investigation and prosecution. For example, in October 2009, ODAG issued guidance stating that DOJ’s investigative and prosecutorial resources should be directed towards the prosecution of significant traffickers of illegal drugs, including marijuana, and the disruption of illegal drug manufacturing and trafficking networks. Moreover, the guidance stated as a general matter, pursuing those priorities should not result in a focus of federal resources on individuals whose actions were in clear and unambiguous compliance with state laws providing for the medical use of marijuana, including individuals with cancer or other serious illnesses who use marijuana as part of a recommended treatment regimen consistent with applicable state law or caregivers who provide such individuals with marijuana in compliance with existing state law. The memorandum identified various conduct that may indicate illegal drug-trafficking activity of federal interest, while reiterating that U.S. Attorneys maintained prosecutorial discretion in addressing criminal matters within their districts. In June 2011, ODAG issued guidance stating that the 2009 memorandum was not intended to shield commercial marijuana operations from federal enforcement actions. Among other things, the guidance also stated that while DOJ’s efficient use of limited federal resources had not changed, there had been an increase in the scope of commercial cultivation, sale, distribution, and use of marijuana for purported medical purposes, and that this activity remained of federal concern. Furthermore, the guidance stated that the term medical marijuana “caregiver” referred to individuals providing care to individuals with cancer or other serious illnesses, not commercial operations cultivating, selling, or distributing marijuana. In August 2013, ODAG issued its first public guidance on marijuana enforcement since Colorado and Washington passed state ballot initiatives legalizing marijuana for recreational purposes. The guidance provided additional clarification of DOJ’s priorities and certain circumstances that may warrant DOJ to challenge a state’s implementation of its marijuana legalization program. The guidance outlined eight enforcement priorities that were particularly important to the federal government. These priorities generally focused on preventing the conduct ODAG outlined in its 2009 guidance, but with some additional activities specified. For example, the guidance included preventing the diversion of marijuana from states where it is legal under state law in some form to other states, preventing the growing of marijuana on public lands, and preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use. Figure 2 lists the eight marijuana enforcement priorities outlined in the August 2013 DOJ guidance. The guidance also stated that outside of these priorities, the enforcement of state law by state and local law enforcement and regulatory bodies should remain the primary means of addressing marijuana-related activity. The guidance stated that in jurisdictions that have enacted laws legalizing marijuana in some form and that have implemented strong and effective regulatory and enforcement systems to control the cultivation, distribution, sale, and possession of marijuana, conduct in compliance with those laws and regulations is less likely to threaten the federal marijuana enforcement priorities. The guidance indicated DOJ’s expectation that state systems must not only contain robust controls and procedures on paper, but must also be effective in practice, with jurisdictions providing the necessary resources and demonstrating the willingness to enforce their laws and regulations in a manner that does not undermine federal enforcement priorities. The guidance further stated that if state enforcement efforts are not sufficiently robust to protect against certain harms outlined in the guidance, the federal government may seek to challenge the state regulatory structures themselves, in addition to continuing to bring individual enforcement actions, including criminal prosecutions, focused on the enforcement priorities. Figure 3 shows a timeline with the years in which states and the District of Columbia legalized medical and recreational marijuana and the years in which DOJ issued public guidance clarifying its marijuana enforcement policy. Features of Colorado’s and Washington’s Regulatory Systems for Recreational Marijuana In November 2012, Colorado and Washington passed state ballot measures that legalized recreational marijuana production, processing, sales, and possession and designated regulatory agencies to develop, implement, and enforce regulations governing the recreational marijuana industry. In 2014, these recreational marijuana regulatory agencies—the Colorado MED and the Washington State LCB—began to implement the new regulations. In general, the two state regulatory systems share similar features, including requirements for licensing, licensee and employee background checks, facility security measures, and product labeling and packaging. The following describes some of the features of the 2 states’ regulatory systems. Licensing. The Colorado MED and the Washington State LCB have established four types of recreational marijuana licenses that allow licensees (or accredited testing facilities) to conduct specific tasks, including producing, processing, or selling marijuana products, or testing marijuana products for potency and potential contaminants. Figure 4 shows the types of recreational marijuana licenses issued in Colorado and Washington. Table 1 shows the number of active recreational marijuana licenses by type as of August 2015, as reported by each of the 2 states’ recreational marijuana regulatory agencies. Background checks. Both Colorado and Washington conduct background checks to determine if applicants are eligible to obtain a license to operate a recreational marijuana facility. As part of the licensing process, both states’ regulations require applicants to submit documentation that may include biographical information, fingerprints, financial information and funding sources, and facility floor plans. The regulatory agencies review this documentation to determine whether applicants meet eligibility requirements including state residency, age, and criminal history requirements. In order to own, manage, or invest in a marijuana facility, both states’ regulations require applicants to be 21 or older and a state resident for at least 2 years in Colorado and 6 months in Washington. According to state officials, the states’ regulatory agencies are to conduct fingerprint-based criminal history record checks against the Federal Bureau of Investigation’s (FBI) criminal history records. State regulatory agency officials are to examine the criminal history record check results and compare that information against the list of potentially disqualifying criminal offenses identified in the regulations to determine if an applicant is eligible for a license. According to Colorado and Washington regulations, generally, applicants who have received a felony conviction for controlled substances within the past 10 years of their application are disqualified; however, the 2 states’ methods for making this determination differ. For example, in Colorado an applicant with a felony conviction during the past 5 years or a felony conviction for controlled substances during the past 10 years is disqualified. In contrast, Washington uses a point system for different types of convictions to consider an applicant’s eligibility, whereby an applicant with 8 or more points is normally disqualified. Under this system, a felony conviction during the past 10 years is worth 12 points, a gross misdemeanor or a misdemeanor conviction during the past 3 years is worth 5 or 4 points, respectively, and each failure to report a conviction is worth 4 points. Both states require licensees to inform the regulatory agency of new criminal convictions. Facility security measures. Colorado and Washington regulations require that recreational marijuana facilities have physical security measures installed to combat theft and diversion of marijuana. These generally include perimeter fencing at outdoor marijuana producer facilities; a security alarm system on all perimeter entry points and perimeter windows; as well as a video surveillance system with camera coverage of all points of entry and exit to the exterior of the licensed premises, point-of-sale areas, and other areas such as areas where marijuana is grown or manufactured. The regulations specify that licensees must store recordings with the time and date available for a minimum of 40 days in Colorado and 45 days in Washington. According to officials, the stored video records are used to verify information agency officials obtain from inspections as well as actions reported by licensees such as the destruction of a plant or shipping marijuana products to another marijuana licensee. For example, we observed an unannounced premises check of a Washington marijuana producer where there was a delay of approximately 10 minutes before the Washington State LCB officers were able to access the facility. The officers stated that in that type of situation they might examine the last 10 minutes of a facility’s recorded video to check for suspicious activity. Inventory-tracking systems. Both states’ regulations require licensees to use inventory-tracking systems that the regulatory agencies operate and monitor. According to state officials, the regulatory agencies have implemented electronic systems for inventory tracking and require that unique identifier tags be attached to marijuana plants and marijuana- infused products. For example, according to state officials, the Colorado MED uses radio frequency identification (RFID) tags, while the Washington State LCB uses tags with a 16-digit number and an optional bar code. Licensees must enter each identifier tag number and information about the marijuana plant or product into the electronic inventory-tracking systems. Licensees must document all inventory changes in the system, such as harvesting existing plants, transporting plants or products once they are sold to another licensee, destroying plant waste or unused plants and products, thefts, and sales to retail customers. Colorado MED and Washington State LCB officials stated that they are able to use the inventory-tracking systems to trace specific marijuana plants and products through each stage of the supply chain, including production, processing, delivery to a retail store, and sale to a consumer. For example, Colorado MED officials reported an instance where the agency used the state inventory-tracking system to identify the lot numbers of marijuana-infused products made with potentially mold- contaminated marijuana and the retail stores that received those products in order to prevent them from being sold to consumers. Colorado MED and Washington State LCB officials reported that inventory-tracking system data are actively monitored to identify possible irregularities and verify information from inspections. For example, Washington State LCB officials reported that their agency audited a retail licensee that reported significant sales in 1 month and zero sales in the subsequent month. Figure 5 shows a photo of marijuana plants with RFID and bar code tags at Colorado and Washington recreational marijuana facilities, respectively. Both states’ regulations require licensees to notify the Colorado MED or Washington State LCB about the transport of marijuana or marijuana- infused products to other licensed facilities. Licensees must generate a transport manifest from information entered into the inventory-tracking system, such as the type of product, amount or weight, destination, the driver, and the transport vehicle, as well as the departure time and expected delivery time. Colorado MED and Washington State LCB officials reported that transport manifests can be verified by state and local police if a marijuana delivery driver is stopped for traffic violations to confirm that drivers are legally transporting marijuana or marijuana products. Product quality assurance testing. The Colorado MED and Washington State LCB have established regulatory provisions for licensees to submit marijuana and marijuana-infused product samples to state-approved testing labs for quality assurance testing. According to the regulations, testing labs are to perform a number of tests on samples, including potency testing to determine the percentage of THC in the sample; screening for harmful microorganisms such as bacteria or fungus; and may include tests for certain contaminants. Colorado and Washington regulations state that if a sample fails quality assurance tests, the batch of marijuana or marijuana-infused products it was taken from cannot be sold and must either be destroyed or retested. Labeling and packaging. Both states’ regulations include labeling and packaging standards for recreational marijuana products. Marijuana product labels are required to state that the product contains marijuana and include warnings about the potential health impacts of consuming the product. In addition, for edible marijuana-infused products, labels must also include an ingredients list, serving size statement and the number of servings of marijuana in the product, among other things. The states’ regulations also prohibit the packaging and labeling of a marijuana product from being designed in ways that are appealing to children or other persons under 21 years of age. For example, Colorado requires that multiple-serving edible marijuana product packaging maintain its child- resistant effectiveness for repeated openings or that single-serving edible marijuana products bundled into a larger package contain individually wrapped servings in child-resistant packaging. Generally, Colorado regulations also require that multiple-serving edible retail marijuana products have single-serving amounts that are physically demarked and easily separated, while liquid edible multiple-serving retail marijuana products can either be marked on the container to show individual servings or include a measuring device. For example, a marijuana-infused chocolate bar may have scored pieces that each contain 10 milligrams of THC. Washington regulations require that marijuana-infused edible products in solid form that contain more than one serving in the package must be packaged individually in single servings in childproof packaging and marijuana-infused edible products in liquid form that contain more than one serving in the package must include a measuring device with the product. According to officials, the Washington State LCB has implemented a process for reviewing marijuana-infused products to determine if they may be sold by licensed retail facilities. For example, Washington marijuana processor licensees must obtain approval from the Washington LCB for all marijuana-infused edible products, labeling, and packaging prior to offering these items for sale to a marijuana retailer. The processor licensee must submit a photo of the product, label, and package to the Washington State LCB for approval. According to Washington State LCB officials, a four-person working group meets on a weekly basis to review submitted products and determine if they are appealing to children. For example, the officials reported that the working group had previously approved marijuana-infused peanut brittle for sale, but did not approve hot chocolate mix, animal cookies, or gummy bears because these products were deemed to be appealing to children. Figure 6 shows examples of marijuana-infused products that the Washington State LCB reviewed—one that was approved for sale and another that was not. Consumer restrictions. Both Colorado’s and Washington’s recreational marijuana regulations include restrictions on consumer use of marijuana, including limits on who may possess marijuana, how much may be possessed, and where it may be used. For example, both states prohibit marijuana retailers from selling to anyone under age 21. In addition, the 2 states restrict the amount of marijuana that a marijuana retailer is permitted to sell to an individual. For example, Colorado prohibits retail marijuana stores from selling more than 1 ounce of retail marijuana or its equivalent in retail marijuana product during a single transaction to a Colorado resident and more than a quarter ounce of retail marijuana or its equivalent in retail marijuana product during a single sales transaction to a nonresident. In Washington, a single transaction is limited to 1 ounce of usable marijuana, 16 ounces of solid marijuana-infused products meant to be eaten or swallowed, 7 grams of marijuana-infused extract or concentrates for inhalation, or 72 ounces of marijuana-infused products in liquid form meant to be eaten or swallowed. Neither state allows marijuana consumption in public or at marijuana retailer facilities. To address the risk of drugged driving, both states have established THC blood level limits that are similar to the blood alcohol limits used for determining alcohol impairment. Law enforcement can use roadside breath tests to test for alcohol impairment, but Colorado and Washington currently test for THC only using blood draws. According to state laws, generally, drivers suspected of being impaired by law enforcement officers can be required to undergo blood testing to determine if they are under the influence of drugs and if their blood contains 5 nanograms or more of THC per milliliter. Facility inspections. Both Colorado’s and Washington’s regulations generally require marijuana licensees to grant regulatory agencies access to their facilities to carry out inspections. Colorado MED and Washington State LCB officials stated that they conduct scheduled and unscheduled inspections to verify regulatory compliance by licensees, including final inspections of new facilities and inspections of existing facilities. Colorado MED and Washington State LCB officials stated that they planned to conduct ongoing facility compliance checks modeled on their agencies’ liquor enforcement procedures. For example, Colorado MED and Washington State LCB officials reported performing underage compliance checks at retail stores. Violations and penalties. In both states, regulatory violations are addressed through penalties that can include monetary fines, suspension or cancellation of a license, and criminal charges. The Colorado MED and Washington State LCB report using a system of progressive discipline with escalating penalties for repeated infractions. For example, in Colorado, the penalty for selling marijuana to a minor could include “license suspension, a fine per individual violation, a fine in lieu of suspension up to $100,000, and/or license revocation depending on the mitigating and aggravating circumstances.” Washington regulations state that the sale of marijuana to a minor by a licensed marijuana business will result in a 10-day suspension or $2,500 fine for the first offense, a 30-day license suspension on the second offense, and cancellation of the license on the third offense. Table 2 shows selected features of Colorado’s and Washington’s recreational marijuana regulations, as of July 2015. Regulatory development and revision. Officials from both states reported using information from commissioned studies and working groups, as well as DOJ’s marijuana enforcement guidance, to inform their recreational marijuana regulations and have continued to do so as they have adopted regulatory changes. For example, in Colorado, a state- commissioned task force developed recommendations for implementing Colorado’s recreational marijuana law, while Washington used a crime and drug policy consultant to inform its regulatory development. Moreover, since recreational marijuana sales began in Colorado in January 2014 and in Washington in July 2014, both states have made revisions to their regulations. For example, in June 2015, the Washington State LCB adopted rules relating to marijuana-infused edible products, while in May 2015, the Colorado MED adopted changes regarding the packaging of marijuana products. DOJ Reports Actions to Monitor the Effects of State Legalization of Marijuana, but Has Not Documented a Plan for Doing So DOJ Reports Taking Actions to Monitor Effects of State Marijuana Legalization As noted earlier, in August 2013, DOJ’s ODAG issued guidance stating DOJ’s expectation that state and local governments that have enacted laws authorizing marijuana-related conduct will implement strong and effective regulatory and enforcement systems to ensure that the laws do not undermine federal enforcement priorities. However, the guidance noted that if state enforcement efforts are not sufficiently robust to protect against threats to federal enforcement priorities, the federal government may seek to challenge the state regulatory structures themselves, in addition to conducting individual enforcement actions, including criminal prosecutions, focused on the priorities. According to ODAG officials and information DOJ has provided to Congress since issuing the August 2013 guidance, DOJ is taking actions to monitor the effects of state legalization of marijuana relative to DOJ’s marijuana enforcement policy generally in two ways. First, DOJ continues to enforce the CSA by conducting individual law enforcement actions targeting those marijuana cases that threaten any of the eight enforcement priorities outlined in the August 2013 ODAG guidance. ODAG officials reported that U.S. Attorneys, as the senior federal law enforcement officials in the states, were effectively monitoring whether cases were implicating DOJ’s marijuana enforcement priorities and prosecuting those cases that did. In addition to conducting federal prosecutions, officials from ODAG and the U.S. Attorneys for Colorado and Washington reported that U.S. Attorneys were actively engaged in consultation and discussion with state and local regulatory and law enforcement officials. Through these interactions, officials reported that U.S. Attorneys have been able to communicate federal enforcement priorities, assess the implications of legalization relative to the priorities, and identify specific areas of federal concern as state laws have been implemented. For example, officials reported that as state recreational marijuana legalization was being implemented in Colorado, the U.S. Attorney had consulted with state and local officials to identify concerns about edible marijuana products and the potential that their sale and use could threaten federal enforcement priorities. Second, ODAG officials reported that DOJ was using various sources of information to monitor the effects of marijuana legalization under state laws. ODAG officials stressed that DOJ’s focus was on monitoring the effects that legalization has had relative to DOJ’s enforcement priorities, rather than evaluating specific requirements within states’ legalization laws or regulatory systems. ODAG officials reported that DOJ as a whole shared responsibility for collecting information to inform DOJ’s monitoring of the effects of state marijuana legalization, while ODAG was responsible for assessing this information to guide DOJ’s response to state marijuana legalization—including whether DOJ might challenge the state laws or regulatory systems. ODAG officials reported that their most detailed description of the data sources DOJ used in its monitoring efforts could be found in information DOJ sent to Congress in early 2015 as part of testimony for confirmation hearings for the Attorney General and Deputy Attorney General. According to this information, DOJ possessed quantitative and qualitative data and used these data to inform its marijuana enforcement efforts. ODAG reported that, as it carried out its monitoring efforts, DOJ would continue to consider all types of data on the degree to which state systems regulating marijuana-related activity protect federal enforcement priorities and public safety and health, including existing federal surveys on drug use; state and local research; and feedback from federal, state, and local law enforcement. To this end, the ODAG officials said that they were reviewing information developed by DOJ components such as DEA and USAOs, and other relevant information developed or published by other federal agencies. From within DOJ, ODAG officials cited DEA, EOUSA, and the Organized Crime Drug Enforcement Task Forces Program (OCDETF) as their primary data sources for monitoring the effects of state marijuana legalization. In particular, ODAG officials reported that DEA’s National Drug Threat Assessments were a source for identifying the effects of marijuana legalization. The National Drug Threat Assessment, prepared annually by DEA, assesses the threat posed to the United States by the trafficking and abuse of illicit drugs based upon law enforcement, intelligence, and public health data available for the review period. For example, DEA’s 2014 National Drug Threat Assessment summarizes emerging developments related to drug trafficking and the use of illicit substances of abuse, including marijuana, and highlights concerns associated with the legalization of marijuana. Among other things, the report includes information regarding ingestion of marijuana edibles by children in states with medical marijuana availability, marijuana-related emergency department visits, and the increasing use of marijuana concentrates and the public safety threat posed by the process used to make these concentrates—noting that butane extraction has resulted in numerous explosions and injuries. ODAG officials also cited information that they were considering from DOJ components’ case management systems, including EOUSA’s Legal Information Online Network System (LIONS) and OCDETF’s Management Information System. According to DOJ, these systems include, among other things, information on cases opened or declined by the USAO, cases prosecuted, and their disposition. ODAG officials also reported relying on information from other federal agencies that conduct public health and safety studies, such as ONDCP’s HIDTA program and the National Institute on Drug Abuse. For example, ODAG officials stated that they had reviewed reports that the Rocky Mountain HIDTA had issued describing the impacts of marijuana legalization in Colorado. These reports included information from various sources regarding impaired driving, youth marijuana use, emergency room and hospital marijuana-related admissions, and the diversion of marijuana from Colorado to other states. Furthermore, ODAG officials reported that ODAG and other DOJ components were sharing information regarding federal marijuana enforcement efforts in states that have legalized marijuana. In particular, ODAG officials cited the USAOs’ establishment of a Marijuana Enforcement Working Group, composed of U.S. Attorneys with jurisdiction for states that have legalized some form of marijuana who meet on a monthly basis to share information and perspectives regarding marijuana enforcement. ODAG officials reported participating in these meetings to discuss issues associated with DOJ’s enforcement efforts. Officials also reported that DOJ is working with ONDCP to identify other mechanisms by which to collect and assess data on the effects of state marijuana legalization. For example, ODAG officials reported participating in ONDCP-led interagency working groups that have met periodically since August 2014 to discuss data collection and evaluation regarding the effects of state marijuana legalization. ODAG officials reported that, as part of their own monitoring efforts, they would consider any information regarding the effects of marijuana legalization on public health and safety that ONDCP developed and shared with them. Table 3 identifies and summarizes the various actions ODAG officials reported that DOJ was taking to monitor the effects of state legalization of marijuana on its federal enforcement priorities. DOJ Has Not Documented Its Plan for Monitoring the Effects of State Marijuana Legalization Notwithstanding these efforts, DOJ has provided limited specificity with respect to aspects of its plan for monitoring the effect of state marijuana legalization relative to ODAG’s August 2013 marijuana enforcement policy guidance. As we noted earlier, ODAG officials reported that they were considering various qualitative and quantitative data sources and identified some of the sources they were using, such as DEA’s National Drug Threat Assessments. However, ODAG officials did not state how they would make use of the various information from the sources they cited to monitor the effects of state marijuana legalization. For example, ODAG officials reported that the most detailed description of DOJ’s monitoring efforts is contained in responses to questions for the record that DOJ sent to Congress in early 2015. According to this information, DOJ identified LIONS and OCDETF data as information sources for its monitoring efforts, noting that these case management systems provided statistical information reflecting the efforts of DOJ in prosecuting violations of federal law. DOJ reported that these data collections systems collectively assist in informing the department’s counterdrug policy, establishing law enforcement priorities, and making resource allocations. However, ODAG officials did not make clear how ODAG would be using these data in its efforts to monitor the effects of state marijuana legalization. For example, officials from EOUSA—which maintains LIONS—reported that USAOs do not consistently enter information in LIONS specifying the primary drug type involved in a case. Thus, officials said that LIONS would not provide reliable information regarding the extent of marijuana-related cases in a USAO district. Similarly, while officials identified DEA and HIDTA reports and various public health studies as sources of data for their monitoring efforts, they did not identify how they would use the data from these various reports and studies to monitor the effects of marijuana legalization relative to each of the eight marijuana enforcement priorities. ODAG officials also did not state how DOJ would use the information to determine whether the effects of state marijuana legalization necessitated federal action to challenge a state’s regulatory system. Further, ODAG officials reported that they had not documented their monitoring process. These officials reported that they did not see a benefit in DOJ documenting how it would monitor the effects of state marijuana legalization relative to the August 2013 ODAG guidance. Rather, ODAG officials reported that they would continue to consider all sources of available data as part of their ongoing responsibilities and would be using these data to inform DOJ’s efforts to protect its marijuana enforcement priorities. ODAG officials said they would consider documenting their monitoring plan in the future if they determined the need; however, they did not identify the conditions that might lead them to do so. Standards for Internal Control in the Federal Government provides the overall framework for establishing and maintaining an effective internal control system. The standards specify the need for internal controls to be clearly documented, and the documentation to be readily available for review. Moreover, information should be recorded and communicated to management and others within the entity who need it and in a form and within a timeframe that enables them to carry out their internal control and other responsibilities. Documentation also provides a means to retain organizational knowledge and mitigate the risk of having that knowledge limited to a few personnel, as well as a means to communicate that knowledge as needed to external parties. Documenting a plan specifying its monitoring process would provide DOJ with greater assurance that control activities—such as the ways DOJ is monitoring the effect of state marijuana legalization relative to federal enforcement priorities—are occurring as intended. Moreover, leveraging existing mechanisms to make this plan available to appropriate officials from DOJ components that are providing the various data can provide ODAG with an opportunity to gain institutional knowledge with respect to its monitoring plan, including the utility of the data ODAG is using. For example, ODAG cited LIONS as a key source of information for monitoring, yet EOUSA reported limitations with LIONS in tracking marijuana enforcement cases, and there may be limitations with other sources of information that ODAG officials are using, or planning to use, to monitor the effects of marijuana legalization. Incorporating the feedback into its monitoring plan can help ODAG ensure it is using the most appropriate data and thus better position it to identify those state systems that are not effectively protecting federal enforcement priorities— so that DOJ can work with states to address concerns and, if necessary, take steps to challenge those systems, in accordance with its 2013 marijuana enforcement guidance. DOJ Field Officials Reported That Various Factors Have Affected Their Marijuana Enforcement Actions in Selected States That Have Legalized Marijuana for Medical Purposes We interviewed officials from six DEA field divisions and 10 USAOs with jurisdictions for 6 states that have legalized marijuana for medical purposes: Alaska, California, Colorado, Maine, Oregon, and Washington. Overall, officials from these DEA field divisions and USAOs reported that their marijuana enforcement efforts were focused on addressing DOJ’s marijuana enforcement priorities while ensuring they were effectively applying their limited resources. Officials reported their perspectives on factors that had affected their marijuana enforcement actions, including key public health and safety threats, local concerns regarding the commercial medical marijuana industry, and DOJ’s updated marijuana enforcement policy. Applying resources to target most significant public health and safety threats. Officials from all of the DEA divisions and USAOs we spoke with reported that they continued to apply their limited resources to address the most significant threats in their jurisdictions. In this way, officials generally reported that marijuana enforcement, while important, was nonetheless one of many competing priorities, along with investigating and prosecuting other types of drug crimes and, for USAOs, all federal crimes in their districts. For example: Officials from the USAO for the Northern District of California reported dealing with a wide variety of federal crimes, including non-drug crimes, such as health care fraud, investment fraud, and computer hacking. Officials reported that they needed to be selective in how they directed their resources—and that those resources they directed toward marijuana enforcement generally involved gangs and violent crime, which pose significant threats to public safety. Officials from the USAO for the Eastern District of California reported that their district is one of the largest sources of marijuana production in the country, and many of the district’s cases involve marijuana grown on public lands or interstate trafficking involving drug-trafficking organizations; however, the largest portion of the district’s drug cases involve methamphetamine cases. Officials attributed this to the district historically being one of the main domestic sources of methamphetamine production and transport, which officials said poses a more significant threat to public health and safety in the district than marijuana, including a high number of hospitalizations and involvement of violent Mexican drug-trafficking organizations. As a result, the USAO has used its prosecutorial discretion to direct greater resources to methamphetamine prosecutions rather than those for marijuana. Similarly, a senior official from the DEA Seattle Division reported that the division’s priorities are the investigation of crimes involving heroin, methamphetamine, and Mexican drug cartels. Officials from the DEA San Diego Division and the USAO for the Southern District of California reported that within their jurisdictions, large quantities of drugs are trafficked from Mexico through U.S. maritime and land borders. Accordingly, their top priority is addressing the major poly-drug-trafficking organizations involved in these drug operations and the violent crime that is typically associated with them. A senior official from the DEA Anchorage, Alaska, District office reported that the district has generally focused its investigative resources on drugs other than marijuana, including cocaine, heroin, and methamphetamine. This official reported that because most drug- trafficking organizations traffic more than one type of drug, marijuana is often a part of but not the focus of the district’s investigations. Officials from DEA field divisions and USAOs in 4 of 6 states— California, Colorado, Oregon, and Washington—reported taking actions to target individuals associated with the rising number of butane hash oil explosions in their jurisdictions. For example, according to the DEA San Diego Division, the presence of butane hash oil laboratories at indoor marijuana growing operations was a growing concern and resulted in approximately 20 explosions and fires in the San Diego County area during fiscal year 2014. Addressing concerns regarding the commercial medical marijuana industry. Officials from DEA field divisions and USAOs reported targeting commercial marijuana operations having the most significant impacts on local communities in their jurisdictions. For example, officials from DEA field divisions and USAOs in 4 of 6 selected states—California, Colorado, Oregon, and Washington—reported sending warning letters to about 1,900 owners and lien holders of medical marijuana dispensaries during fiscal years 2007 through 2013. Officials reported taking this action partly in response to requests from civic leaders, municipalities, and law enforcement officials concerned about the growth in the commercial medical marijuana industry. In general, the letters emphasized that DOJ has the authority to enforce the CSA even when certain activities may be permitted under state law. The letters also notified the recipients that they could be subject to federal civil and criminal penalties and advised them to discontinue the distribution of marijuana. Some letters, from officials in California, Oregon, and Washington, stated that while the dispensaries they targeted were illegal under the CSA, they were generally also illegal under the states’ own medical marijuana programs. Furthermore, some officials in California reported that the dispensaries they targeted were also illegal under local ordinances. DEA and USAO officials reported that sending warning letters was an efficient and effective way to close dispensaries and support local community concerns. For example, officials from the USAO for the Central District of California reported that most of the nearly 700 dispensaries to which they sent letters closed. In addition, the U.S. Attorney for the District of Colorado reported sending letters in fiscal year 2012 to dozens of medical marijuana dispensaries operating within 1,000 feet of schools to protect the health, safety, and welfare of Colorado youth—and that all of the dispensaries that received letters closed or moved. Officials in 3 states—California, Oregon, and Washington—also reported conducting criminal investigations and prosecutions or civil forfeiture suits in conjunction with their letter campaigns. For example, the four U.S. Attorneys in California reported that in October 2011, they began coordinated enforcement actions targeting the for-profit medical marijuana industry in California. According to officials from the USAOs, these actions included sending warning letters to owners and lien holders of medical marijuana dispensaries, conducting criminal investigations and prosecutions, and initiating civil forfeiture lawsuits. Officials from the USAOs in California reported that they initiated these efforts in part to address concerns raised by civic leaders, municipalities, and law enforcement officials regarding the growing numbers of marijuana dispensaries in their districts. Officials reported that the number of dispensaries in their districts rose considerably beginning in 2009, and through discussions with state and local law enforcement, they began efforts to reduce the numbers of these dispensaries. DOJ’s updated marijuana enforcement policy. Officials from DEA field locations and USAOs we spoke with reported that their implementation of the marijuana enforcement guidance ODAG has issued since 2009 had affected their marijuana enforcement actions to varying degrees. Officials from all DEA and USAO locations we spoke with reported that the series of marijuana enforcement guidance ODAG issued had not changed their enforcement focus, which continues to emphasize the most significant threats in their jurisdiction, and that they maintained active partnerships with state and local law enforcement officials. For example, the U.S. Attorney for the District of Colorado reported working closely with the state’s Attorney General and the state’s marijuana regulatory agency on various issues related to marijuana enforcement, including the sale of marijuana edibles and butane hash oil explosions. Some DEA and USAO field officials reported examining their existing caseloads following DOJ’s August 2013 marijuana enforcement guidance to determine whether the cases were implicating DOJ’s marijuana enforcement priorities, and some field officials reported closing a limited number of cases that did not threaten the priorities. For example: Officials from the USAO for the District of Oregon reported that shortly after the August 2013 guidance was issued, they reviewed their open marijuana cases from 2011 to 2013 and determined that all of the cases were in compliance with the updated guidance. Similarly, the U.S. Attorney for the Eastern District of Washington reported that he was not aware of any cases that the USAO prosecuted prior to the August 2013 guidance that the USAO would no longer consider for prosecution. Elsewhere, officials from the DEA Seattle Division and the USAO for the Central District of California reported reviewing their caseloads and closing a limited number of cases that did not threaten one of the eight marijuana enforcement priorities. For example, a senior official from the DEA Seattle Division reported closing seven investigations that did not threaten the priorities in the first several months after the guidance was issued, whereas officials from the USAO for the Central District of California reported closing some forfeiture cases. Officials from some DEA and USAO locations reported that the August 2013 DOJ guidance had led them to change their marijuana enforcement tactics, including scaling back their roles in targeting the commercial medical marijuana industry. For example: Officials from USAOs in Alaska, California, and Oregon, and from one DEA field division in California, reported that, in accordance with the 2013 guidance, they would decline to consider for investigation and prosecution some marijuana-growing cases that they may have investigated and prosecuted prior to the 2013 guidance because these cases did not threaten DOJ’s marijuana enforcement priorities. Officials from two DEA field divisions—Los Angeles and Seattle— reported that because they were now required to demonstrate that at least one marijuana enforcement priority was threatened in an investigation before the USAO would grant them a search warrant, it had become more difficult to gather the additional evidence that may have helped them do so. These officials expressed concern that the August 2013 marijuana enforcement policy guidance had made it more challenging for them to identify crimes that potentially affected DOJ’s enforcement priorities. Officials from DEA and USAOs in the 4 states that had reported sending warning letters to owners and lien holders of medical marijuana dispensaries—California, Colorado, Oregon, and Washington—reported that they had not sent warning letters since the August 2013 guidance was issued. Officials attributed this change in part to the fact that the guidance requires that they no longer consider the size or commercial nature of a dispensary alone in taking marijuana enforcement actions, but rather whether a dispensary is implicating one or more of the enforcement priorities listed in the August 2013 guidance. For example, officials from one DEA field division reported that they were not directing resources to investigate dispensaries unless there was clear evidence that these priorities were being threatened. Officials from the USAO for the District of Alaska reported that while they continued their strong partnerships with state and local law enforcement, they had reduced some marijuana enforcement support to the state. Specifically, officials reported that prior to the issuance of the August 2013 guidance, they had a general understanding with Alaska state and local law enforcement that the USAO would accept for federal prosecution marijuana cases involving recidivists that the state had prosecuted at least twice before. Officials said the USAO had since moved away from supporting the state in this way unless the suspects in the case were involved in activities that threatened DOJ’s marijuana enforcement priorities. Conclusions It has been over 2 years since DOJ’s ODAG issued guidance in August 2013 stating that in jurisdictions that have enacted laws legalizing marijuana in some form, if state enforcement efforts are not sufficiently robust to protect against threats to federal enforcement priorities, the federal government may seek to challenge the state regulatory structures themselves, in addition to continuing to bring individual enforcement actions, including criminal prosecutions. ODAG officials reported relying on U.S. Attorneys to monitor the effects of marijuana enforcement priorities through their individual enforcement actions and communication with state agencies about how state legalization may threaten these priorities. ODAG officials also reported using various information sources provided by DOJ components and other federal agencies to monitor the effects of marijuana legalization and the degree to which existing state systems regulating marijuana-related activity protect federal enforcement priorities and public health and safety. However, ODAG officials have not documented their monitoring process or provided specificity about key aspects of it, including potential limitations of the data they report using and how they will use the data to identify states that are not effectively protecting federal enforcement priorities. Given the growing number of states legalizing marijuana, it is important for DOJ to have a clear plan for how it will be monitoring the effects of state marijuana legalization relative to DOJ marijuana enforcement guidance. Documenting a plan that specifies its monitoring process, such as the various data ODAG is using for monitoring along with their potential limitations, the roles of U.S. Attorneys in the monitoring process, and how ODAG is using all these inputs to monitor the effects of state legalization can provide DOJ with greater assurance that its monitoring activities are occurring as intended. Sharing the plan with DOJ components responsible for providing information to ODAG can help ensure that ODAG has an opportunity to gain institutional knowledge with respect to whether its monitoring plan includes the most appropriate information. This will help place DOJ in the best position to identify state systems that are not effectively protecting federal enforcement priorities, and take steps to challenge those systems if necessary in accordance with its 2013 marijuana enforcement guidance. Recommendations for Executive Action We recommend that the Attorney General take the following actions: direct ODAG to document a plan specifying DOJ’s process for monitoring the effects of marijuana legalization under state law, in accordance with DOJ’s 2013 marijuana enforcement policy guidance, to include the identification of the various data ODAG will use and their potential limitations for monitoring the effects of state marijuana legalization, and how ODAG will use the information sources in its monitoring efforts to help inform decisions on whether state systems are effectively protecting federal marijuana enforcement priorities, and direct ODAG to use existing mechanisms to share DOJ’s monitoring plan with appropriate officials from DOJ components responsible for providing information DOJ reports using regarding the effects of state legalization to ODAG, obtain feedback, and incorporate the feedback into its plan. Agency Comments and Our Evaluation On September 28, 2015, we provided a draft of this report to DOJ and ONDCP for their review and comment. We also provided excerpts of the draft report for review and comment to the Colorado MED, Colorado Attorney General’s office, Washington State LCB, and Washington State Attorney General’s office. ONDCP, the Colorado MED, Colorado Attorney General’s office, Washington State LCB, and Washington State Attorney General’s office provided technical comments, which we incorporated as appropriate. In its written comments, reproduced in appendix II, DOJ concurred with both of our recommendations. DOJ stated that ODAG will document a plan to identify the various data sources that will assist DOJ and USAO’s in making enforcement decisions, including decisions in individual criminal prosecutions or civil enforcement actions, regarding marijuana- related crimes. DOJ stated that it will also monitor these data, as well as other sources of information, to determine whether states that have legalized recreational marijuana are effectively protecting DOJ’s federal enforcement priorities as articulated in DOJ’s guidance memorandum dated August 28, 2013. Lastly, DOJ stated that to the greatest extent possible DOJ will seek to publicly share the data it receives pursuant to this plan. DOJ also provided technical comments, which we have incorporated as appropriate. As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the Attorney General, the Director of National Drug Control Policy, the Director of the Colorado MED, the Director of the Washington State LCB, the attorney generals of Colorado and Washington, appropriate congressional committees and members, and other interested parties. In addition, the report will be available at no charge on the GAO website at http://www.gao.gov. If you or your staff have any questions, please contact me at (202) 512- 7141 or groverj@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made key contributions to this report are listed in appendix III. Appendix I: DOJ Field Components Contacted in Selected States To determine the factors Department of Justice (DOJ) field officials reported affecting their marijuana enforcement actions in selected states that have legalized marijuana for medical purposes, we selected 6 states for our review, to include (1) Colorado and Washington because, in addition to their recreational marijuana laws, they have long-standing medical marijuana legalization laws in place, and (2) 4 additional states— Alaska, California, Maine, and Oregon—that were the earliest states to pass laws legalizing marijuana for medical purposes. We interviewed officials from the six Drug Enforcement Administration (DEA) field divisions and 10 U.S. Attorneys’ offices (USAO) with jurisdiction for these selected states. These DEA field divisions and USAOs include the following. Appendix II: Comments from the Department of Justice Appendix III: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Tom Jessor (Assistant Director) and Jason Berman (Analyst-in-Charge) managed this assignment. David Alexander, David Bieler, Billy Commons, Dominick Dale, Alexandra Gonzalez, Eric Hauswirth, Susan Hsu, Stephen Komadina, Jan Montgomery, and Alexandra Rouse made key contributions to this report.

An increasing number of states have adopted laws that legalize marijuana for medical or recreational purposes under state law, yet federal penalties remain. In 2012, Colorado and Washington became the first states to legalize marijuana for recreational purposes. In 2013, DOJ updated its marijuana enforcement policy by issuing guidance clarifying federal marijuana enforcement priorities and stating that DOJ may challenge those state marijuana legalization systems that threaten these priorities. GAO was asked to review issues related to Colorado's and Washington's actions to regulate recreational marijuana and DOJ's mechanisms to monitor the effects of state legalization. This report examines, among other issues, (1) DOJ's efforts to monitor the effects of state marijuana legalization relative to DOJ's 2013 guidance and (2) factors DOJ field officials reported affecting their marijuana enforcement in selected states with medical marijuana laws. GAO analyzed DOJ marijuana enforcement guidance and drug threat assessments, and evaluated DOJ's monitoring efforts against internal control standards. GAO also interviewed cognizant DOJ officials, including U.S. Attorneys and DEA officials in six states. Officials from the Department of Justice's (DOJ) Office of the Deputy Attorney General (ODAG) reported monitoring the effects of state marijuana legalization relative to DOJ policy, generally in two ways. First, officials reported that U.S. Attorneys prosecute cases that threaten federal marijuana enforcement priorities (see fig. below) and consult with state officials about areas of federal concern, such as the potential impact on enforcement priorities of edible marijuana products. Second, officials reported they collaborate with DOJ components, including the Drug Enforcement Administration (DEA) and other federal agencies, including the Office of National Drug Control Policy, and assess various marijuana enforcement-related data these agencies provide. However, DOJ has not documented its monitoring process, as called for in Standards for Internal Control in the Federal Government . Documenting a plan specifying its monitoring process would provide DOJ with greater assurance that its monitoring activities relative to DOJ marijuana enforcement guidance are occurring as intended. Further, making this plan available to appropriate DOJ components can provide ODAG with an opportunity to gain institutional knowledge with respect to its monitoring plan, including the utility of the data ODAG is using. This can better position ODAG to identify state systems that are not effectively protecting federal enforcement priorities and, if necessary, take steps to challenge these systems in accordance with DOJ marijuana enforcement guidance. U.S. Attorneys and DEA officials in six states with medical marijuana laws reported their perspectives on various factors that had affected their marijuana enforcement actions. These include applying resources to target the most significant public health and safety threats, such as violence associated with drug-trafficking organizations; addressing local concerns regarding the growth of the commercial medical marijuana industry; and implementing DOJ's updated marijuana enforcement policy guidance.

Background For fiscal year 2010, Congress appropriated more than $52 billion to the Military Personnel, Army appropriation primarily for Army active duty military personnel costs.1-year appropriation available for the pay, benefits, incentives, allowances, housing, subsistence, travel, and training primarily for Army service members on active duty. According to the Defense Finance and Accounting Service in Indianapolis, Indiana (DFAS-IN), of the $52 billion in fiscal year 2010 military personnel appropriations, the Army’s nearly 680,000 service members received $46.1 billion in pay and allowances. Army Human Resources Command, unit commanders, and training certification officials, among others, are responsible for providing DFAS- IN with accurate and timely information regarding changes in individual military member status necessary to maintain accurate and timely payroll accounts. DFAS-IN is responsible for the accounting, disbursement, and reporting for the Army’s military personnel costs using the Defense Joint Military Pay System-Active Component (DJMS-AC). Process and System Weaknesses Hindered Army’s Ability to Identify a Valid Population of Military Payroll Transactions We found that the Army could not readily identify a complete population of Army payroll accounts for fiscal year 2010, given existing procedures and systems. The Army and DFAS-IN did not have an effective, repeatable process for identifying the population of active duty payroll accounts. In addition, the Defense Manpower Data Center (DMDC), DOD’s central source for personnel information, did not have an effective process for comparing military pay account files to military personnel files to identify a valid population of military payroll transactions. For example, it took 3 months and repeated attempts before DFAS-IN could provide a population of service members who received active duty Army military pay in fiscal year 2010. Similarly, it took DMDC over 2 months to compare the total number of fiscal year 2010 active duty payroll accounts to its database of personnel files. Standards for Internal Control in the Federal Government requires all transactions and other significant events to be clearly documented and the documentation readily available for examination. DOD’s Financial Improvement and Audit Readiness (FIAR) Guidance sets out key tasks essential to achieving audit readiness, including defining and identifying the population of transactions for audit purposes. The GAO/PCIE Financial Audit Manual provides guidance concerning typical control activities, such as independent checks on the validity, accuracy, and completeness of computer-processed data.Without effective processes for identifying a complete population of Army military pay records and comparing military pay accounts to personnel records, the Army will have difficulty meeting DOD’s 2014 Statement of Budgetary Resources audit readiness goal and its 2017 goal for a complete set of auditable financial statements. DFAS-IN Did Not Have an Effective Process for Identifying the Population of Army Military Payroll Records DFAS-IN made three attempts from November 2010 through early January 2011 to provide us a Defense Joint Military Pay System-Active Component (DJMS-AC) file extract of Army service members who received active duty pay in fiscal year 2010. The first attempt included 11,940 duplicate pay accounts, and the total number of pay accounts included in the second attempt increased by 28,035 records over the first attempt, necessitating a third attempt to establish the population of fiscal year 2010 active duty pay records. We requested that DMDC compare the results of DFAS-IN’s third attempt to identify the population of Army fiscal year 2010 payroll accounts against DMDC’s compilation of monthly active duty payroll data that it received from DFAS-IN. Of the 677,024 Army active duty pay accounts, per DJMS-AC, we were able to reconcile all but 1,025 pay accounts (less than 1 percent of the total active duty pay accounts to pay account data that DFAS-IN had previously provided to DMDC. However, as discussed later, we were unable to verify the validity of the records. Standards for Internal Control in the Federal Government requires all transactions and other significant events to be clearly documented and the documentation readily available for examination. In addition, DOD’s Financial Improvement and Audit Readiness (FIAR) Guidance states that being able to provide transaction-level detail for an account balance is a key task essential to achieve audit readiness. At the time we initiated our audit, Army officials told us that they had not yet focused on this area in their audit readiness efforts because the target date for Army military pay was not until the first quarter of fiscal year 2015. The inability to readily provide a population of military pay accounts impeded our efforts to accomplish our audit objectives and, if not effectively addressed, will impede the Army’s ability to meet DOD’s new Statement of Budgetary Resources audit readiness goal of September 30, 2014. System Weaknesses Hindered the Matching of Army Pay Accounts to Personnel Files The Army’s pay and personnel systems are not integrated, which can lead to differences between the systems and potential errors. Therefore, an audit of military pay would include comparisons of military payroll accounts to personnel records to identify discrepancies. However, we found that DMDC did not have an effective process for comparing military pay account files with military personnel files. While DMDC was ultimately able to confirm that all 677,024 service members who received fiscal year 2010 active duty Army military pay from the DJMS-AC had an active duty personnel file in one of the multiple personnel systems, the reconciliation process was labor intensive and took over 2 months to complete. For example, DMDC’s initial comparison of active duty Army military pay accounts to personnel records identified 67,243 pay accounts that did not have a corresponding active army personnel record on Labor-intensive research was necessary to September 30, 2010.reconcile the differences between DJMS-AC pay records and Army personnel files compiled by DMDC. According to DMDC, these differences related primarily to personnel who had either left or were scheduled to leave the service, were reserve component soldiers released from active duty, or were soldiers who had died during fiscal year 2010. DMDC attempted to complete our requested comparison of active duty Army pay accounts to military personnel records in January 2011, but was unable to complete the reconciliation until early March 2011. DMDC officials told us that the reasons for the delays included mainframe computer issues, staff illness and turnover, and management data quality reviews of the file comparison results, including additional file comparisons to resolve differences. We referred six duplicate Social Security numbers in personnel account records that we confirmed with the Social Security Administration to DMDC and the Army for further research and appropriate action. The absence of an effective process for confirming that the Army’s active duty payroll population reconciles to military personnel records increases the risk that the Army will not meet DOD’s Statement of Budgetary Resources auditability goal of September 30, 2014. The Army Was Unable to Provide Documentation to Support the Validity and Accuracy of a Sample of Payroll Transactions We identified deficiencies in DFAS-IN and Army processes and systems for readily identifying and providing documentation that supports payments for Army military payroll. First, DFAS-IN had difficulty retrieving and providing usable Leave and Earnings Statement files for our sample items. Second, the Army and DFAS-IN were able to provide complete documentation for 2 of our 250 military pay account sample items, partial support for 3 sample items, but no support for the remaining 245 sample items. Because the Army was unable to provide documents to support reported payroll amounts for our sample of 250 soldier pay accounts, we were unable to determine whether the Army’s payroll accounts were valid and we could not verify the accuracy of payments and reported active duty military payroll. Further, because military payroll is significant to the financial statements, the Army will not be able to pass an audit of its Statement of Budgetary Resources without resolving these control weaknesses. DFAS-IN Could Not Readily Provide Usable Leave and Earnings Statement Files for Sample Items DFAS-IN staff experienced difficulty and delays in providing usable Leave and Earnings Statement files to support our testing of Army military payroll. We selected a sample of 250 Army active duty soldier pay accounts and in April 2011 requested the relevant Leave and Earnings Statement files for fiscal year 2010. Standards for Internal Control in the Federal Government requires internal control and all transactions and other significant events to be clearly documented and the documentation readily available for examination. DOD Regulation 7000.14-R, Financial Management Regulation (FMR), requires the military components to maintain documentation supporting all data generated and input into finance and accounting systems or submitted to DFAS. After multiple discussions and requests, we ultimately obtained usable Leave and Earnings Statement files for our sample items—5 weeks after our initial request. DFAS-IN took over 2 weeks to provide the initial set of Leave and Earning Statement files because it needed to retrieve files from two areas of the Defense Joint Military Pay System-Active Component (DJMS-AC). The DJMS-AC database holds the current month plus the previous 12 months’ data. Data older than this are archived and need to be retrieved from the archived database. In addition, the first set of Leave and Earnings Statement files that DFAS-IN provided included statements outside the requested fiscal year 2010 timeframe of our audit. It took 1 week, including our data reliability review, to obtain the second set of DFAS-IN Leave and Earnings Statement files consisting of 445 separate files containing monthly statements for 250 service member pay accounts in our sample. We determined that the Leave and Earnings Statement files for an individual service member generally were in two or more of the files provided. Consequently, we had to combine these files into a format with each service member’s Leave and Earnings Statement files grouped together to include all of the pay and allowance information for the service members in our sample. This combining and formatting required 2 additional weeks. The Army Was Unable to Locate Supporting Documentation for Military Pay Account Sample Items We found that the Army’s inability to locate personnel documents to support its military payroll transactions was primarily the result of weaknesses in Army procedures. Standards for Internal Control in the Federal Government requires internal control and all transactions and other significant events to be clearly documented and the documentation readily available for examination. DOD Regulation 7000.14-R, Financial Management Regulation (FMR), requires the military components to maintain documentation supporting all data generated and input into finance and accounting systems or submitted to DFAS. This regulation also requires the components to ensure that audit trails are maintained in sufficient detail to permit tracing of transactions from their sources to their transmission to DFAS. Audit trails are necessary to demonstrate the accuracy, completeness, and timeliness of transactions as well as to provide documentary support for all data generated by the component and submitted to DFAS for recording in the accounting systems and use in financial reports. Further, DOD’s FIAR Guidance states that identifying and evaluating supporting documentation for individual transactions and balances, as well as the location and sources of supporting documentation and confirming that appropriate supporting documentation exists, is a key audit readiness step. Without the capability to readily locate and provide supporting documentation for military pay transactions, the Army’s ability to pass a financial statement audit will be impeded. As of the end of September 2011, 6 months after receiving our initial request, the Army and DFAS-IN were able to provide complete documentation for 2 of our 250 sample items, partial support for 3 sample items, and no support for the remaining 245 sample items. As shown in figure 1, our review of the partial documentation provided for 3 sample items showed that the Army was unable to provide supporting documentation for common elements of its military pay, including basic allowance for housing, cost of living allowance, hardship duty pay- location, and hostile fire/imminent danger pay. One of the factors impeding the Army’s ability to provide supporting documentation is that it does not have a centralized repository for pay- affecting documents. Army personnel and finance documentation supporting basic pay and allowances resides in numerous systems, and original hard copy documents are scattered across the country—at hundreds of Army units and National Archives and Records Administration (NARA) federal records centers. According to Army and DFAS-IN officials, there are at least 45 separate systems that the Army uses to perform personnel and pay functions with no single, overarching personnel system. Although these systems contain personnel data on Army active duty military members and their dependents and feed these data to DJMS-AC, the systems do not contain source documents. Further, we found that the Army had not established a mechanism for periodic monitoring, review, and accountability of the Interactive Personnel Management System (iPERMS) to ensure that personnel files are complete. Army Regulation No. 600-8-104, Military Personnel Information Management/Records, establishes requirements for the Army’s Official Military Personnel File. The Army deployed iPERMS in 2007 and designated it as the Army’s Official Military Personnel File. However, when we attempted to find supporting documents in iPERMS, we found that this system had not been consistently populated with the required service member documents, resulting in incomplete personnel records. For example, when testing our sampled transactions, we discovered that documents, such as orders to support a special duty assignment, permanent change of station orders, and release or discharge from active duty, that should have been in iPERMS were not. The Army has designated the Human Resources Command as the owner of iPERMS; however, local installation personnel offices across the country are responsible for entering most documents into individual service member iPERMS accounts. We found that documents needed to support pay transactions are not in iPERMS because (1) Army Regulation 600-8-104 does not require the specific personnel forms to be included and (2) some pay-supporting documents are finance documents and are not considered personnel documents.documents should also be maintained in the Army’s central repository of pay-supporting documentation. In addition, the Army’s efforts to achieve auditability are compounded by payroll system limitations. DJMS-AC, used to process Army active duty military pay, is an aging, Common Business Oriented Language (COBOL) mainframe-based system that has had minimum system maintenance because DOD planned to transition to the Forward Capability Pay System and then to the Defense Integrated Military Human Resources System.pay active duty Army service members. To address these functionality limitations, DFAS has developed approximately 70 workaround procedures that are currently being used to compensate for the lack of functionality in DJMS-AC. An audit of Army military pay would necessitate an evaluation of these procedures and related controls. DJMS-AC lacks key payroll computation abilities to Another factor in the Army’s inability to provide support for military payroll is that the Army has not adequately documented its personnel processes and controls related to military pay. During our audit, we spent considerable time attempting to identify the range of personnel and finance documents that would be needed to support basic military pay and allowances reported on service members’ Leave and Earnings Statements and the appropriate office responsible for providing the documentation. According to Internal Control Standards, written documentation should exist covering the agency’s internal control and all significant transactions and events.control includes identification of the agency’s activity-level functions and related objectives and control activities and should appear in management directives, administrative policies, accounting manuals, and other such guidance. Army Military Pay Audit Readiness Efforts Currently Under Way DOD’s November 2011 FIAR Status Report includes DOD’s goal of achieving audit readiness for its Statement of Budgetary Resources by the end of fiscal year 2014. DOD and the Army have established interim goals for meeting the fiscal year 2014 Statement of Budgetary Resources audit readiness goal. For example, the Army plans to assert audit readiness for its General Fund Statement of Budgetary Resources, including military pay, by March 31, 2013, and have its assertion tested and fully validated by June 30, 2014. Army officials stated that military pay audit readiness poses a significant challenge and acknowledged that the success of the Army’s efforts will be key to meeting DOD’s 2014 Statement of Budgetary Resources audit readiness goal. To meet this goal, the Army has several military pay audit readiness efforts planned or under way, such as developing a matrix of personnel documents that support military pay and allowances and developing the Integrated Personnel and Payroll System-Army.are in the early planning stages. However, many of these efforts In our report, we recommend that the Army document and implement a process for identifying and validating the population of payroll transactions and identify, centrally retain, and periodically review key finance and personnel (i.e., pay-affecting) documents that support military payroll transactions. The Army agreed with our recommendations to improve the controls and processes related to active duty military. Our report more fully describes the Army’s comments and our evaluation of them. Concluding Observations Active Army military payroll, reported at $46.1 billion for fiscal year 2010, is material to the Army’s financial statements and, as such, will be significant to DOD’s audit readiness goals for the Statement of Budgetary Resources. The Army has several military pay audit readiness efforts that are planned or under way. Timely and effective implementation of these efforts could help reduce the risk related to DOD’s ability to achieve its 2014 Statement of Budgetary Resources audit readiness goal. However, most of these actions are in the early planning stages. Moreover, these initiatives, while important, do not address (1) establishing effective processes and systems for identifying a valid population of military payroll records, (2) ensuring Leave and Earnings Statement files and supporting personnel documents are readily available for verifying the accuracy of payroll records, (3) ensuring key personnel and other pay-related documents that support military payroll transactions are centrally located, retained in service member Official Military Personnel Files, or otherwise readily accessible, and (4) requiring the Army’s Human Resources Command to periodically review and confirm that service member Official Military Personnel File records in iPERMS or other master personnel record systems are consistent and complete. These same issues, if not effectively resolved, could also jeopardize the 2017 goal for audit readiness on the complete set of DOD financial statements. In addition, the Army’s military pay auditability weaknesses have departmentwide implications for other military components, such as the Air Force and the Navy, that share some of the same military pay process and systems risks as the Army. Chairmen Carper and Platts, Ranking Members Brown and Towns, and Members of the Subcommittees, this completes my prepared statement. I would be pleased to respond to any questions that you or other members of the subcommittees may have. GAO Contact and Staff Acknowledgments If you or your staffs have any questions about this testimony, please contact me at (202) 512-9869 or khana@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this testimony. GAO staff who made key contributions to this testimony are Gayle L. Fischer, Assistant Director; Carl S. Barden; Lauren S. Fassler; Wilfred B. Holloway; Julia C. Matta, Assistant General Counsel; Sheila D. M. Miller, Auditor in Charge; Margaret A. Mills; Heather L. Rasmussen; James Ungvarsky; and Matt Zaun. This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

This testimony discusses our work on the significant challenges the Army faces in achieving audit readiness for its military pay. The Army’s military pay is material to the Army’s financial statements. The Chief Financial Officers Act of 1990, as amended, established requirements for 24 agencies, including the Department of Defense (DOD), to prepare annual financial statements and have them audited. Further, the National Defense Authorization Act (NDAA) for Fiscal Year 2010 mandated that DOD be prepared to validate (certify) that its consolidated financial statements are ready for audit by September 30, 2017. On October 13, 2011, the Secretary of Defense directed the department to achieve audit readiness for the Statement of Budgetary Resources, one of the principal financial statements, by the end of fiscal year 2014 as an interim milestone for DOD to meet the legal requirement in the NDAA for Fiscal Year 2010 to achieve full audit readiness for all DOD financial statements by 2017. The Army’s active duty military payroll, comprising about 20 percent of its reported $233.8 billion in fiscal year 2010 net outlays, is significant to both Army and DOD efforts to meet DOD’s 2014 Statement of Budgetary Resources auditability goal as well as the mandate to achieve full audit readiness for all DOD financial statements by 2017. For years, we and others have reported continuing deficiencies with the Army’s military payroll processes and controls. These reported continuing deficiencies in Army payroll processes and controls have called into question the extent to which the Army’s military payroll transactions are valid and accurate, and whether the Army’s military payroll is auditable. Further, other military components, such as the Air Force and the Navy, share some of the same process and system risks as the Army. Today's remarks are based on our report, "DOD Financial Management: The Army Faces Significant Challenges in Achieving Audit Readiness for Its Military Pay," which is being released today. The testimony focuses on problems that impede the Army’s ability to (1) identify a valid population of military payroll transactions and (2) provide documentation that supports the validity and accuracy of payments for Army military payroll. We found that the Army could not readily identify a complete population of Army payroll accounts for fiscal year 2010, given existing procedures and systems. The Army and DFAS-IN did not have an effective, repeatable process for identifying the population of active duty payroll accounts. In addition, the Defense Manpower Data Center (DMDC), DOD’s central source for personnel information, did not have an effective process for comparing military pay account files to military personnel files to identify a valid population of military payroll transactions. For example, it took 3 months and repeated attempts before DFAS-IN could provide a population of service members who received active duty Army military pay in fiscal year 2010. Similarly, it took DMDC over 2 months to compare the total number of fiscal year 2010 active duty payroll accounts to its database of personnel files. "Standards for Internal Control in the Federal Government" requires all transactions and other significant events to be clearly documented and the documentation readily available for examination. DOD’s "Financial Improvement and Audit Readiness (FIAR) Guidance" sets out key tasks essential to achieving audit readiness, including defining and identifying the population of transactions for audit purposes. The "GAO/PCIE Financial Audit Manual" provides guidance concerning typical control activities, such as independent checks on the validity, accuracy, and completeness of computer-processed data. Without effective processes for identifying a complete population of Army military pay records and comparing military pay accounts to personnel records, the Army will have difficulty meeting DOD’s 2014 Statement of Budgetary Resources audit readiness goal and its 2017 goal for a complete set of auditable financial statements. We identified deficiencies in DFAS-IN and Army processes and systems for readily identifying and providing documentation that supports payments for Army military payroll. First, DFAS-IN had difficulty retrieving and providing usable Leave and Earnings Statement files for our sample items. Second, the Army and DFAS-IN were able to provide complete documentation for 2 of our 250 military pay account sample items, partial support for 3 sample items, but no support for the remaining 245 sample items. Because the Army was unable to provide documents to support reported payroll amounts for our sample of 250 soldier pay accounts, we were unable to determine whether the Army’s payroll accounts were valid and we could not verify the accuracy of payments and reported active duty military payroll. Further, because military payroll is significant to the financial statements, the Army will not be able to pass an audit of its Statement of Budgetary Resources without resolving these control weaknesses.

Background Used by all U.S. military service members and DOD civilians in the area of operations, the IBA consists of an outer tactical vest with ballistic inserts or plates that cover the front, back, and sides. As the ballistic threat has evolved, ballistic requirements have also changed. The vest currently provides protection from 9mm rounds, while the inserts provide protection against 7.62mm armor-piercing rounds. Additional protection can also be provided for the shoulder, throat, and groin areas. Figure 1 details the body armor components. Concerns regarding the level of protection and amount of IBA needed to protect U.S. forces have been raised in recent years, prompted by a number of reports, newspaper articles, and recalls of issued body armor by both the Army and the Marine Corps. In May 2005, the Marine Corps recalled fielded body armor because it concluded that the body armor failed to meet contract specifications, and in November 2005, the Army and Marine Corps recalled 14 lots of body armor that failed original ballistic testing. Additionally, in April 2005, we reported on shortages of critical force protection items, including individual body armor. Specifically, we found that the shortages in body armor were due to material shortages, production limitations, and in-theater distribution problems. In the report, we did not make specific recommendations regarding body armor, but we did make several recommendations to improve the effectiveness of DOD’s supply system in supporting deployed forces for contingencies. DOD agreed with the intent of the recommendations and cited actions it had or was taking to eliminate supply chain deficiencies. Army and Marine Corps Body Army Meets Current Theater Requirements Army and Marine Corps body armor currently meets theater ballistic requirements and the required amount needed for personnel in theater, including the amounts needed for the surge of troops into Iraq. Used by all U.S. military service members and DOD civilians in the area of operations, the IBA consists of an outer tactical vest with ballistic inserts or plates that cover the front, back, and sides. The vest and inserts currently meet the theater ballistic requirements. The vest provides protection from 9mm rounds, while the inserts provide protection against 7.62mm armor- piercing rounds. Additional protection can also be provided for the shoulder, throat, and groin areas. The Army and Marine Corps body armor meets the required amounts needed for personnel in theater as well. Table 1 details Army and Marine Corps theater requirements and worldwide inventory quantities of the body armor as of February 2007. CENTCOM requires that all U.S. military forces and all DOD civilians in the area of operations receive the body armor system. Currently, service members receive all service-specific standard components of the body armor system prior to deploying. For example, the Army issues the shoulder protection equipment to all its forces; however, Marine Corps personnel receive this equipment item in theater on an as-needed basis. The Army and the Marine Corps provide the DOD civilians with components of the armor system. However, the time frame for receipt of these items varies as some receive the body armor prior to deploying and others upon arrival in theater. Army unit commanders only reported one body armor issue in their December 2006 to February 2007 classified readiness reports. This one issue did not raise a significant concern regarding the body armor. Moreover, Marine Corps commanders’ comments contained in the December 2006 and January 2007 readiness reports did not identify any body armor issues affecting their units’ readiness. In December 2006 and January 2007, the Army, in its critical equipment list did not identify body armor as a critical equipment item affecting its unit readiness. Controls in Place to Assure Body Armor Meets Requirements The Army and Marine Corps have controls in place during manufacturing and after fielding to assure that body armor meets requirements. Both services conduct quality and ballistic testing prior to fielding and lots are rejected if the standards are not met. They both also conduct formal testing on every lot of body armor (vests and protective inserts) prior to acceptance and issuance to troops. During production, which is done at several sites, the lots of body armor are sent to a National Institute of Justice-certified laboratory for ballistic testing and to the Defense Contract Management Agency for quality testing (size, weight, stitching) prior to issuance to troops. Figure 2 illustrates the lot acceptance process. Once approved, the body armor is issued to operating forces. Currently, both Army and Marine Corps personnel are issued body armor prior to deployment. The Army lot failure rate from January 2006 to January 2007 was 3.32 percent for the enhanced small arms inserts, and there were no failures for the outer tactical vests. From February 2006 to February 2007, the Marine Corps lot failure rate was 4.70 percent for the outer tactical vests. Although not required to do so, after the systems have been used in the field, the Army does limited ballistic testing of outer tactical vests and environmental testing of the outer tactical vests and the inserts. The Marine Corps visually inspects the vest and the plates for damage. According to Army officials, there has been no degradation of body armor based on ballistic and environmental testing results. Additionally, to determine future improvements, the Army and the Marine Corps body armor program offices monitor and assess the use of body armor in the field, including the review of medical reports from the Armed Forces Medical Examiner. For example, the Army and Marine Corps added side plates and throat protection based on body armor usage in the field. DOD has a standard methodology for ballistic testing of the hard body armor plates, but not for the soft body armor vest. Currently, DOD’s Director, Operational Test and Evaluation Office is developing a standard methodology for ballistic testing of the soft body armor to eliminate discrepancies in testing methodologies. The new standard is expected to be issued sometime in 2007. Army and Marine Corps Share Body Armor Information The Army and Marine Corps share information regarding ballistic requirements and testing, and the development of future body armor systems, although they are not required to do so. For example, in August 2006, the Marine Corps attended the Army’s test of next generation body armor types at Fort Benning, Georgia. Similarly, the Army sent representatives to attend the Marine Corps’s operational assessment of the new Modular Tactical Vest. DOD officials indicate that there is no requirement to share information. Title 10 of the U.S. Code allows each service to have separate programs, according to Army and Marine Corps officials. Nevertheless, the services are sharing information regarding ongoing research and development for the next generation of body armor. Contractors and Non- DOD Civilians Are Provided Body Armor Where Permitted Regarding contractors or non-DOD civilians, DOD Instruction 3020.41 allows DOD to provide body armor to contractors where permitted by applicable DOD instructions and military department regulations and where specified under the terms of the contract. It is CENTCOM’s position that body armor will be provided to contractors if it is part of the terms and conditions of the contract. According to CENTCOM officials, non- DOD government civilians such as State Department civilians are expected to make their own arrangements to obtain this protection. However, the officials said that commanders, at their discretion, can provide body armor to any personnel within their area of operation. Conclusion In conclusion, Mr. Chairman, the Army and Marine Corps have taken several actions to address concerns, including assuring that the body armor systems meet the current theater requirements and that the amounts needed in theater are available. However, ballistic theater threats can change, and the services will need to continue to monitor and evaluate the theater ballistic threats in order to develop and provide individual body armor that can counter these changing threats. The services also will need to monitor and evaluate new technologies that may counter emerging theater ballistic threats. Moreover, they will need to continue to assure that controls are in place during manufacturing and after fielding to assure that existing and future body armor systems meet theater ballistic requirements. Mr. Chairman, this concludes my statement. I would be pleased to respond to any questions you or other Members of the Committee may have. Contacts and Staff Acknowledgments For more information regarding this testimony, please call me at (202) 512- 8365. Individuals making key contributions to the testimony include: Grace Coleman, Alfonso Garcia, Lonnie McAllister, Lorelei St. James, and Leo Sullivan. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

In recent years, a number of reports and newspaper articles have cited concerns regarding the level of protection and the available amounts of body armor to protect deployed service members. As part of GAO's efforts to monitor the Department of Defense's (DOD) and the services' action to protect ground forces, GAO reviewed the Army and Marine Corps's actions to address these concerns. On April 26, 2007, GAO issued a report regarding the Army and the Marine Corps's individual body armor systems. Today's testimony summarizes the report's findings regarding the extent to which the Army and Marine Corps (1) have met the theater requirements for body armor, (2) have the controls in place to assure that the manufacturing and fielding of body armor meet requirements, and (3) have shared information regarding their efforts on body armor ballistic requirements and testing. The report also included additional information concerning whether contractors or non-DOD civilians obtain body armor in the same way as U.S. forces and DOD civilians given the number of contractors and non-DOD civilians in Central Command's (CENTCOM) area of operation. GAO did not make recommendations in the report. DOD officials did not provide written comments on the report but technical comments were incorporated as appropriate. Army and Marine Corps body armor currently meets theater ballistic requirements and the required amount needed for personnel in theater, including the amounts needed for the surge of troops into Iraq. The Interceptor Body Armor (IBA) consists of an outer tactical vest with ballistic inserts or plates that cover the front, back, and sides. The vest and inserts currently meet the theater ballistic requirements. The vest provides protection from 9mm rounds, while the inserts provide protection against 7.62mm armor-piercing rounds. CENTCOM requires that all U.S. military forces and all DOD civilians in the area of operations receive the body armor system. Currently, service members receive all service-specific standard components of the body armor system prior to deploying. The Army and the Marine Corps provide the DOD civilians with components of the armor system. The Army and Marine Corps have controls in place during manufacturing and after fielding to assure that body armor meets requirements. Both services conduct quality and ballistic testing prior to fielding, and lots (a grouping of items varying in number) are rejected if the standards are not met. They also conduct formal testing on every lot of body armor (vests and protective inserts) prior to acceptance and issuance to troops. During production, which is done at several sites, the lots of body armor are sent to a National Institute of Justice-certified laboratory for ballistic testing and to the Defense Contract Management Agency for quality testing (size, weight, stitching) prior to issuance to troops. Although not required to do so, after the systems have been used in the field, the Army does limited ballistic and environmental testing to determine future improvements. The Army and Marine Corps share information regarding ballistic requirements and testing although they are not required to do so. Title 10 of the U.S. Code allows each service to have separate programs, according to Army and Marine Corps officials. Nevertheless, the services are sharing information regarding ongoing research and development for the next generation of body armor. DOD Instruction 3020.41 allows DOD to provide body armor to contractors and non-DOD civilians where permitted by applicable DOD instructions and military department regulations and where specified under the terms of the contract. It is CENTCOM's position that body armor will be provided to contractors if it is part of the terms and conditions of the contract. However, the officials indicated that commanders, at their discretion, can provide body armor to any personnel within their area of operation.

Background The U.N. Security Council authorizes all peacekeeping operations as a means to further international peace and security. The U.N. Department of Peacekeeping Operations (DPKO) is responsible for the planning, management, and logistical support of U.N. peacekeeping operations worldwide. From 1948 through August 2003, the Security Council authorized 56 peacekeeping operations. Fourteen of these operations were ongoing as of August 2003. Most current U.N. peacekeeping operations have relatively narrow mandates that authorize peacekeepers to monitor or supervise cease-fires and peace agreements between formerly warring parties. Three ongoing operations—those in East Timor, Sierra Leone, and the Democratic Republic of the Congo—have broader, multidimensional mandates that address complex emergencies. Earlier multidimensional peacekeeping operations in Somalia, Cambodia, and Bosnia tried to address governance, human rights, and humanitarian affairs, but they initially lacked long-term transition strategies. For example, the peace operation in Somalia did not clearly link security with efforts to rebuild the country. In Bosnia, a coalition of nations led by the North Atlantic Treaty Organization formed an international force to provide security, which was initially planned to last 1 year. But 2 years later, troop withdrawal was linked to the achievement of broad objectives for the overall peace operation. In Cambodia, there was no clear plan for effectively developing the rule of law after the peacekeeping operation left. The Security Council recognized the shortcomings in these operations and began to consider better strategies to plan and manage operations for sustainable peace. In 1999, the need to address such shortcomings gained greater urgency as the Security Council mandated new U.N. operations to address complex emergencies in Sierra Leone, East Timor, and the Democratic Republic of the Congo. (App. III describes in more detail the crisis each of these countries faced and the United Nations’ response.) The council debated the need for a new approach to planning, conducting, and concluding multidimensional peacekeeping operations in countries with complex emergencies. The council examined the lessons learned from these past failures and the process for closing a peacekeeping operation. In 2000, the council requested that the Secretary General make recommendations about how to effectively launch, close, or significantly alter a U.N. peacekeeping operation. Figure 1 provides more information on each country and the U.N. operation there. U.N. Peacekeeping Transition Strategy Consists of Three Elements Since the late 1990s, the United Nations has developed a general strategy for peacekeeping transitions in complex emergency countries. The U.N. strategy consists of three elements: establishing the conditions for sustainable peace, including security, rule of law, and economic and social reform; coordinating and sustaining the efforts of international organizations and developing objectives and results-oriented measures of progress to manage the peace operation and make troop withdrawal decisions. The Security Council has stated that it is supportive of this strategy but also notes that it decides whether to authorize the troops and resources needed to carry it out on a case-by-case basis. The U.N. Secretariat, particularly DPKO, has strengthened its planning and management to help implement this strategy. Strategy Focuses on Achieving Security, Rule of Law, and Economic Reform In 2001, the U.N. Secretary General stated that the ultimate purpose of peacekeeping is to help countries achieve sustainable peace. To do this, the U.N. transition strategy for complex emergency countries guides the United Nations, other international organizations, and donor countries to (1) establish and maintain security, (2) develop institutions that provide rule of law and participatory governance, and (3) create conditions for economic and social recovery and reform. Establishing and maintaining security are priorities for U.N. peacekeeping operations. However, when armed interventions have been necessary, the United Nations generally has authorized alliances—such as the North Atlantic Treaty Organization—or coalitions of nations to undertake military operations to restore security. U.N. peacekeepers then have responsibility for maintaining secure conditions so that other aspects of the peace operation, including humanitarian efforts, can move forward. In the longer term, maintaining security may include demobilizing and reintegrating ex-combatants into society, training a fair and impartial police force, and building a professional army that is accountable to the national government. The transition strategy emphasizes that sustainable peace is most likely if the country establishes rule of law and participatory governance. To support this, the peacekeeping operation and many other partners undertake programs to reform a country’s justice system so that it is fair, transparent, and equitable. Other activities include strengthening or building government institutions to ensure transparency, equal access, and accountability to all citizens. Other efforts, when authorized by the Security Council, may include supporting broad-based political parties, overseeing or administering free and fair elections, and supporting efforts to combat corruption. Creating the conditions for economic and social recovery and reform is also important in the transition strategy. Efforts to create these conditions include reconstruction of infrastructure and utilities and activities to promote national reconciliation and human rights, such as supporting war crimes tribunals or truth and reconciliation panels. Other efforts in this area include support for resettlement of refugees and displaced persons. Several studies have similarly found that the earlier operations did not focus on obtaining comprehensive results needed for sustainable peace. For example, a Department of Defense-sponsored study determined that past failures in restoring peace were highly correlated with the failure to restore public security, political rights, and honest government and with the facilitation of economic reconstruction. A 2002 guide developed as a tool for U.S. policy makers reached similar conclusions. The guide noted that a peacekeeping operation must undertake a range of military and political tasks to achieve a sustainable outcome in a complex emergency situation. These tasks include demobilizing armed groups, reforming the police, establishing rule of law, and rehabilitating the economy. The guide concludes that assessment of progress toward restoring stability in the country should identify measures to be relied upon (such as disarming ex- combatants or holding elections) and/or transforming conditions on the ground (such as reducing the level of violence in the country and increasing confidence in elected officials). Our observations on lessons learned from our survey of 32 previous reports on peacekeeping operations in 16 countries came to similar conclusions about the need for comprehensive transition planning in complex emergency situations. The Security Council recognized the shortcomings in the earlier missions and began to consider better strategies to plan and manage operations for sustainable peace. In February 2001, the Security Council endorsed this broad approach for effective transitions. The council stated that achieving a sustainable peace requires a comprehensive approach that includes political, humanitarian, and human rights programs to foster sustainable development, eradication of poverty, and transparent and accountable government and rule of law. However, the council qualified this endorsement by noting that it decides on a case-by-case basis the extent to which to authorize the troops, funding, and other resources needed to carry out these activities. Strategy Emphasizes Coordination with Other Organizations and Donor States The transition strategy recognizes that U.N. peacekeeping operations cannot undertake all transition activities. Thus, transition efforts must be closely coordinated among U.N. peacekeeping offices; U.N. development, humanitarian, and human rights agencies; international financial institutions; bilateral agencies; host nation governments; and nongovernmental organizations. The Secretary General has observed that peacekeepers should establish close working relationships with these other stakeholders and begin transition planning during the operation’s earliest stages. The Security Council has also strongly encouraged cooperation among all stakeholders to monitor and develop an integrated response to the specific conditions in each country. As part of the transition strategy, other international organizations and individual donor countries are expected to lead some efforts. For example, the host government; international financial institutions, such as the World Bank; and bilateral development agencies have responsibility for economic recovery. These stakeholders continue efforts after the peace operation ends. Strategy Focuses on Developing Objectives and Results-Oriented Measures The U.N. transition strategy also calls for developing objectives, linked to the country conditions sought, and measures of progress toward achieving those conditions. The objectives and results-oriented measures are intended to help manage the peace operation and help make decisions about drawing down the numbers of peacekeepers based on objective data. The emphasis on using objectives and results-oriented measures is part of the U.N. decision to implement results-based budgeting. Approved by the General Assembly in 2000, results-based budgeting links program objectives, outputs (the final product or service delivered to the client or users), outcomes (the results of a program compared with its intended purpose), and measures of impact (the result from achieving the program’s objectives). According to the Secretary General, this approach is intended to ensure that U.N. programs are designed to achieve results and to ensure that the United Nations can measure performance. U.N. Reforms Support Implementation of Strategy The U.N. Secretariat has begun to reform its planning and management capabilities to more effectively carry out peacekeeping operations and transitions. These initiatives were adopted based on recommendations made by the Panel on United Nations Peace Operations, a group of experts convened by the Secretary General in 2000 to assess the shortcomings of the existing system for managing peace operations. Some key initiatives included the following: In 2002, the United Nations consolidated all peacekeeping responsibilities into DPKO. Previously, the Department of Political Affairs was responsible for developing and proposing the mandates of potential peace operations, and DPKO was responsible for planning and logistical support. In 2001, the U.N. General Assembly approved a 50 percent increase in staff for DPKO, allowing it to better plan and manage operations. By January 2003, DPKO had largely met its recruiting goals in key areas. For example, it had increased the military planning group from 7 to 18 and increased the civilian police division from 2 to 9 staff, which enabled it to provide useful input in planning individual operations. DPKO revised its overall process and guidance for planning peace operations. This revised guidance requires planners to clarify long-term aims in the country and develop plans that identify objectives, tasks to be undertaken, resources required, expected timetables, and criteria for measuring success. As recommended by the Panel on United Nations Peace Operations, DPKO has begun using integrated mission task teams to plan operations. The task force membership varies but should include core military and police planners from DPKO and representatives of all involved U.N. humanitarian and development agencies. Representatives of the World Bank and the International Monetary Fund would also be invited to participate as appropriate. In 2001, DPKO merged two existing analysis units to create a best practices unit and attached it directly to the Under Secretary General for Peacekeeping Operations. The new unit’s mission is to analyze past experiences and apply the results of that analysis to new operations. The unit is also supposed to help develop guidelines and recommendations for the conduct, management, and support of these operations. Unit officials stated that they are beginning to make recommendations on the implementation of the United Nations’ revised approach to transition planning. United Nations Is Trying to Apply the Transition Strategy The United Nations is trying to apply all the elements of the transition strategy to help move countries from conflict to sustainable peace. First, the United Nations and other stakeholders have provided thousands of peacekeeping troops and other international workers to establish and maintain secure environments in East Timor and Sierra Leone and to help develop rule of law. U.N. peacekeepers have also supported efforts by the World Bank and others to begin development planning and to address human rights issues. In the Democratic Republic of the Congo, U.N. efforts are more limited, but as of July 2003, the Security Council authorized more peacekeepers and approved other efforts. Second, the United Nations and international organizations have tried to coordinate transition efforts with each other, host country governments, and donor countries. Third, each U.N. peacekeeping operation has begun to identify objectives and results- oriented measures of progress and, to a limited extent, uses these to manage drawdowns of operations. The Security Council, however, makes the final decision on the drawdown and withdrawal of a peace operation. U.N. Peacekeeping Operations Seek to Establish Conditions for Sustainable Peace In countries with complex emergencies, U.N. peacekeeping operations and other stakeholders seek to establish basic conditions for sustainable peace by (1) providing and maintaining security, (2) developing institutions that provide rule of law and participatory governance, and (3) creating conditions for social and economic reforms. Table 1 illustrates the transition objectives associated with U.N. and other stakeholder efforts to achieve these conditions in Sierra Leone, East Timor, and the Democratic Republic of the Congo. The Security Council mandates for the U.N. peace operations in Sierra Leone, East Timor, and the Congo made establishing and maintaining security a priority to facilitate other mission objectives, such as reestablishing government authority. For example, to assist in carrying out provisions of the Lomé Peace Agreement, the initial mandate for the U.N. Assistance Mission in Sierra Leone authorized 6,000 military personnel to provide security at key locations, government buildings, and disarmament sites. The mission also facilitated the free flow of people, goods, and humanitarian assistance. In May 2000, the Security Council expanded the U.N. mission’s mandate in response to renewed violence and by March 2001 had increased the military force to 17,500 troops. According to the force commander, the operation’s priorities since the election of a new government in May 2002 have shifted from maintaining security to improving the capacity of the local police and government officials. The British government has also played a major role in achieving these objectives. It deployed 4,500 troops to the region in 2000 to support the government and U.N. peacekeepers and is helping to train Sierra Leone’s armed forces and police. The Security Council applied similar measures in East Timor. In September 1999, the council sanctioned the deployment of an international force led by 5,400 Australian troops to stop the widespread violence perpetrated by pro-Indonesian militias. According to members of the Australian parliament, the government led the coalition because it had a strong national interest in ensuring a stable East Timor. The Security Council subsequently authorized (1) the U.N. Transitional Administration in East Timor in October 1999, with an authorized force level of 9,150 troops and 1,640 international police, and (2) the U.N. Mission of Support in East Timor in May 2002, with a force level of 5,000 troops plus 1,250 police. According to the deputy force commander and other U.N. officials, these missions have suppressed sporadic violence and have continued to patrol along the boundary with Indonesian West Timor, begun training a local police force, and supported donor nation efforts to train a small East Timor military force (see fig. 2). The Security Council has not yet applied similar security measures in the Democratic Republic of the Congo. As of May 2003, the U.N. force had about 4,600 troops; the mission was mandated to monitor the cease-fire and oversee the disarmament and repatriation of foreign fighters. In May 2003, the council authorized the French government to lead a separate 1,500-strong force on a limited mission to protect U.N. peacekeeping troops and suppress violence between rival militias fighting in and around the city of Bunia in the northeastern district of Ituri. In July 2003, the council increased the strength of the U.N. force to 10,800 and for the first time authorized peacekeepers to use force to protect civilians in selected locations. U.N. Efforts to Develop Rule of Law and Participatory Governance U.N. peacekeeping operations in Sierra Leone and East Timor have undertaken tasks to begin establishing the rule of law and participatory governance. In Sierra Leone, the peacekeepers, in coordination with the U.N. Development Program, the World Bank, and others, have worked with the Sierra Leone government to reestablish the court system, rebuild courtrooms throughout the country, and develop projects to train judges and prosecutors. In 2002, the U.N. operation provided transportation, supplies, and security and monitored the conduct of national elections that observers characterized as “free and fair.” Mission officials also plan to provide security, logistics, and technical assistance for local government elections in 2004. Furthermore, according to U.N. plans and reports, the priority is to improve the work of government officials in structures throughout the country. In East Timor, U.N. efforts to develop the rule of law and participatory governance have been extensive. For example, in 1999, the Security Council empowered the peacekeeping operation to exercise all legislative and executive authority for the country, including the administration of justice. In this capacity, the operation established a national consultative council to help make decisions about the future government and set up a transitional judicial commission. According to U.N. officials, international staff and advisors also provided on-the-job training to allow the East Timorese to gradually assume more responsibility for running the government. The U.N. mission also supervised East Timor’s first popular election of members to the constituent assembly in 2001 and the presidential elections in 2002. Since East Timor attained independence and the end of the U.N. transitional administration in May 2002, the follow- on peace operation has focused on advising and training government officials and on extending a national system of justice to outlying districts. In the Democratic Republic of the Congo, the U.N. peacekeeping operation’s support for governance has been largely limited to supporting the intermittent peace negotiations between the warring parties to establish an interim government. A new government of National Unity and Transition was formed in June, and, on July 28, 2003, the Security Council expanded the peacekeeping operation’s mandate to help the government restore stability, including support for security sector reform, elections, and rule of law, in coordination with other international actors. U.N. Peacekeeping Operations Support Economic and Social Recovery Efforts U.N. peacekeeping operations assist other stakeholders in working toward conditions for economic and social recovery. For example, in 2002 in East Timor, the World Bank, the Asian Development Bank, the U.N. peacekeeping operation, and the U.N. Development Program helped the government develop a 20-year national development plan. The plan described short- and medium-term strategies for the country’s economic recovery and growth, and was used by the international community to determine their economic support programs. Although the U.N. peacekeeping operation provided funding for some projects, other donors provided major funding for programs to reduce poverty, increase power generation, and support private sector development. U.N. peacekeeping operations also support efforts to provide social reconciliation in both Sierra Leone and East Timor. In both countries, the government, United Nations, and donor countries decided that leaders of rival factions had to be held accountable for human rights violations. In Sierra Leone, the United States and other donors helped establish and fund an independent Sierra Leone international tribunal to prosecute those bearing “greatest responsibility” for violations of international humanitarian law during that country’s civil war. The U.N. operation assists the tribunal by providing security, transportation, and supplies. In East Timor, the U.N. operation established a unit to assist in the investigation of the most serious atrocities committed in 1999. The United Nations also provides technical support and other assistance to commissions in both countries investigating human rights violations and fostering reconciliation. Similarly, the U.N. High Commissioner for Refugees coordinates refugee repatriation and return efforts in Sierra Leone, East Timor, and the Congo. The peace operations assist these efforts by providing security and logistical support. U.N. Peacekeeping Operations Attempt to Coordinate and Sustain Assistance The U.N. peacekeeping operations have undertaken several efforts to try to coordinate with other international organizations and donor nations. These include early planning efforts, donor meetings and conferences, and the establishment of a high-level position in the mission to coordinate security and economic recovery efforts. In East Timor, attempts to coordinate efforts among donor countries and international organizations occurred before the peacekeeping operation deployed. A joint assessment mission began in the autumn of 1999, 8 months before the start of the peacekeeping operation. The assessment mission included members from five donor countries, four U.N. agencies, the European Commission, the Asian Development Bank, and the World Bank. The International Monetary Fund also conducted a concurrent mission to assess East Timor’s budgeting capabilities. DPKO used the core plans for reconstruction and budgeting from the joint assessments in its planning. The joint assessment mission was a response to experiences in other post-conflict countries, where lack of coordination had delayed efforts and caused inefficiencies and duplication in the use of external resources. The U.N. peacekeeping operations in Sierra Leone and East Timor also coordinated with other international organizations through regular donor meetings and conferences. For example, during 2002, the government of Sierra Leone, the World Bank, the U.N. Office for the Coordination of Humanitarian Affairs, and the peacekeeping mission completed revised strategic plans for that country. U.N. organizations working in Sierra Leone (including the peacekeeping mission and the World Bank) subsequently collaborated in preparing an overall strategy for their national recovery and peace-building efforts. At an international donors conference in November 2002, U.N. organizations and other donors agreed to work together to support the government’s comprehensive national recovery strategy, restructure the government unit responsible for national aid monitoring and coordination, and hold bimonthly coordination meetings. Several mechanisms are used in the field to increase coordination among U.N. agencies and other international organizations in carrying out peacekeeping transitions. The Secretary General created the position of Deputy Special Representative of the Secretary General, the second highest ranking position at each mission, to ensure coordination between security and economic reform efforts. According to the deputy representative in East Timor, his dual responsibilities for peacekeeping operations and U.N. development programs allow him to better manage the process of transitioning the mission’s emphasis from peacekeeping to longer term peace building. United Nations Is Beginning to Use Objectives and Results-Oriented Measures in Peacekeeping Operations DPKO has specified objectives for its peacekeeping operations and identified some results-oriented measures of progress. The operations in Sierra Leone and East Timor are using the measures to a limited extent to plan the drawdown of troops and other activities, but the Security Council makes the final transition decisions. Peace Operations Are Making Efforts to Specify Objectives and Measures The U.N. operations in Sierra Leone, East Timor, and the Democratic Republic of the Congo have specified their objectives, based on mandates from the Security Council, and have developed measures of progress, some of which are results oriented. (App. II lists the objectives and measures for the three missions.) For example, in Sierra Leone, one objective is to reduce poverty and encourage economic growth. Measures of progress include increasing (1) the percentage of households with access to safe drinking water, (2) the percentage of women who are AIDS aware, and (3) the growth in gross domestic product (to 6 percent annually). Another objective is to ensure security and freedom of movement. Measures of progress for this objective include minimizing and containing cease-fire violations and opening roads and removing roadblocks. Although some measures for the peacekeeping operations are quantifiable, the United Nations faces challenges in developing results- oriented measures about conditions in the country that the peace operations are supposed to improve. This issue will be discussed in the last section of this report. Peace Operations Use Measures of Progress to a Limited Extent in Planning Drawdown The Security Council weighs political and budgetary considerations as well as the conditions in each complex emergency country when making the final decision to draw down and withdraw peacekeeping forces. Nonetheless, the United Nations has to a limited extent used some measures to plan the withdrawal of peacekeepers in Sierra Leone and East Timor. (The operation in the Democratic Republic of the Congo is not at a stage to begin withdrawing.) U.N. officials in Sierra Leone developed and modified plans for withdrawing peacekeepers based on an evaluation of progress in strengthening the police and armed forces, reintegrating ex- combatants, and restoring government control over diamond mining. Mission staff used some of these measures when they reviewed the security risks and capabilities of Sierra Leone security forces in each region to ensure that peacekeeping troops were withdrawn from lower security risk areas first and retained longer in higher risk areas along the Liberian border. U.N. military staff acknowledged, however, that the force was being drawn down more quickly under the current plan because of the council’s budgetary and political pressure to end the peacekeeping mission and not because the mission’s measures pointed to a reduced threat to the country’s security and stability. In March 2003, the council requested that the Secretary General provide faster and slower options for the drawdown based on the security situation and the ability of Sierra Leone security forces to take responsibility for external and internal security functions. Figure 3 illustrates the proposed timetable for withdrawal that the Secretary General presented to the council in September 2002, as well as a revised drawdown option recommended by the Secretary General based on his review of these factors and adopted by the council in July 2003. In East Timor, the Secretary General and Security Council have used measures to plan the drawdown of its peacekeepers. However, although the United Nations is retaining greater numbers of peacekeepers and international police in response to unexpected security threats and lack of sufficient progress in developing the capabilities of the East Timor police service, the Security Council did not change the final withdrawal date of June 2004. (Fig. 4 illustrates the alterations in the drawdown schedule for the troops and police.) According to U.N., U.S., and Australian officials, this end date is a political compromise developed in consultation with the United States and key council members. Senior military officers in the peacekeeping mission said that the failure to meet objectives, such as having a judicial system in place by mid-2003, will not change the withdrawal date. Although objectives and measures of progress provide information to help manage the withdrawal of peacekeepers, other factors influence council decisions. According to U.N. officials, U.S. officials, and members of the council, the following factors are involved in these decisions: Peacekeeping missions are intended to provide a limited window for countries to resolve internal differences and take advantage of the opportunity to rebuild their country with broad international support. The United Nations must set deadlines to maintain pressure on the country’s leaders and political factions to take responsibility for their country and fulfill their commitments. Each peacekeeping mission must compete for the attention of the Security Council, which often must respond to new crises and emergencies as it devotes resources to ongoing operations. The cost and resources needed for peacekeeping operations are high. Security Council members face domestic pressures to limit their support, particularly if an operation is not a priority national interest. United Nations Confronts Significant Challenges to Implementing Transition Strategy The United Nations confronts significant challenges to implementing each element of the transition strategy. First, achieving the conditions for sustainable peace establishing the conditions necessary for sustainable peace is a challenge. Maintaining security is difficult because the rival factions in a country may oppose the peacekeepers or continue their internal disputes, regardless of the peacekeepers’ presence. Further, establishing rule of law and democratic governance is problematic in countries with little or no tradition of accountable government and democratic principles. In this regard, peacekeeping transitions have taken longer and have been more costly than initially expected. Second, the United Nations has not been able to coordinate its efforts and priorities with those of other independent international organizations and donor states to the extent necessary to meet transition objectives. Third, developing clear objectives and meaningful results-oriented measures of progress is difficult. DPKO acknowledges that it needs better measures by which to assess the progress that peacekeeping operations are making in attaining sustainable peace. However, the department has not made developing or using these measures a priority. Achieving Security, Rule of Law, and Economic and Social Reform Is Difficult Establishing security in war-torn countries is difficult because of uncertain and volatile environments. For example, despite peace agreements among opposing factions in Sierra Leone, peacekeepers were initially threatened by one of the rival groups in the country, which restricted their movements, took more than 400 peacekeepers hostage, and continued to commit human rights atrocities. The armed intervention of 4,500 British troops was needed to help establish security. Through June 2003, 49 peacekeepers had died through accidents or hostile acts. Similarly, in East Timor, despite a free and fair referendum rejecting integration with Indonesia in favor of independence, the pro-integration militia created widespread violence to stop East Timor from becoming independent. A military coalition of 8,000 troops led by Australia was necessary to restore security. Through June 2003, 19 peacekeepers had died. Establishing security in the Democratic Republic of the Congo has proven extremely difficult. Despite numerous cease-fire agreements, the two large rebel groups; five foreign governments with armed forces within the country; and numerous foreign and domestic armed groups, many aligned with neighboring states, did not cooperate with the U.N. peace operation. The operation has not maintained a secure environment, and cease-fires frequently have been violated. The government’s forces only have control over half of the country’s territory. After violations of several cease-fire agreements, France led a coalition force to help U.N. peacekeepers control large-scale violence in the northeastern city of Bunia in the Ituri region (see fig. 5). Maintaining security in war-torn countries is also a problem. In East Timor, pro-Indonesian militia groups conducted armed attacks from Indonesian West Timor in January and February 2003, even after U.N. military officials stated that the militia no longer posed a threat to East Timor. The Secretary General concluded that U.N. peacekeeping troops should be maintained along the border. In April 2003, Sierra Leone peacekeepers expressed concern about ongoing violence in Liberia, a state that recently supported Sierra Leone rebels. (Fig. 6 illustrates Sierra Leone soldiers on duty near the border with Liberia.) U.N. officials also noted that large concentrations of ex-combatants, unemployed youths, corruption, and illegal mining in Sierra Leone’s diamond mining areas continue to be ongoing threats to security. Developing rule of law and participatory governance is difficult because countries with complex emergencies may have little or no experience with transparent accountable governments or democratic traditions and institutions. For example, the U.N. strategy for restoring local government to Sierra Leone included reestablishing both hereditary chieftaincies and elected district councils. According to a British government analysis, however, Sierra Leone’s reliance on hereditary chieftains has always compromised transparency and accountability and provided a means for the central government to control local affairs. Moreover, this reliance limits democratic participation because only candidates meeting hereditary lineage requirements were eligible to run in recent elections to fill 61 tribal chieftaincies left vacant during the war. Additionally, local civic leaders in one district stated that the Speaker of the National Parliament arbitrarily replaced the locally selected candidate for chief. A 2002 U.K. study characterized the Sierra Leone justice system as unresponsive, unaccountable, and corrupt. Furthermore, the Anti- Corruption Commission, a body specifically created in 2000 to investigate corrupt practices among government officials, has been ineffective, according to U.S. and U.K. officials. In light of these serious deficiencies, the World Bank and the U.K. government are planning a 5-year effort to improve the justice system beginning in late 2003. In East Timor, U.N. and other international officials told us that years of mistrust of the Indonesian-imposed court system and the rural population’s isolation have created reliance on traditional laws and informal courts. These courts show little regard for the rights of women, according to U.N. and other international officials. These issues present a significant obstacle to applying Western norms of judicial conduct and respect for human rights. In addition, the East Timor government has not passed laws identifying the number of locations or the villages that will serve as political jurisdictions, nor has it extended authority and services beyond the capital. We saw limited evidence of government services or representation in villages beyond Dili, the national capital. In the Democratic Republic of the Congo, government and rule of law have almost completely collapsed after years of warfare, according to U.S. government and U.N. officials. In 1999, the Secretary General noted that the substitution of armed force for the rule of law in much of the territory was a key factor in making the Democratic Republic of the Congo a difficult environment for peacekeeping. In June 2003, the parties to the peace agreement formed a national unity government with the assistance of the U.N. peacekeeping operation. Economic Recovery Is a Long- Term Effort U.N., international agency, and host and donor government officials have noted that the time frames for peacekeeping operations are shorter than those for economic recovery programs. Australian officials estimated that developing the economy of East Timor and redressing its serious poverty will take 20 to 50 years. As of December 2002, a study by the U.N. Children’s Fund estimated that 25 percent of the East Timorese population is below the poverty level. The most recent U.N. health survey indicated that 30 percent of children below age 5 were malnourished. Economic stabilization objectives can be difficult to achieve. In Sierra Leone, for example, the government has made limited progress in regaining legal and regulatory control over the diamond trade, a vital sector in its economy. The value of legal exports of diamonds (as opposed to smuggling) has increased from just over $1 million in 1999 to $41 million in 2002. A January 2003 analysis commissioned by the British government estimated that the annual value of diamond exports could rise to as much as $180 million by 2006 if the industry was properly regulated and effective anticorruption measures were implemented. However, Sierra Leone government, U.N., and other international officials agree that government systems for regulating the diamond industry remain weak and impractical. Implementing Overall Transition Takes Longer and Is More Costly than Originally Planned Because of the difficulties in achieving conditions for sustainable peace, overall peace efforts in countries with complex emergencies take more time and are more costly than originally planned. In Sierra Leone, international efforts to restore stability have been under way since the early 1990s. Recent efforts have also taken longer than originally planned. Although signatories of the Sierra Leone peace accord (July 1999) anticipated holding an election in 2001, conditions for a free and fair election were not achieved until May 2002, and peacekeepers will not exit until the end of 2004. In East Timor, the United Nations approved a limited operation in June 1999 to oversee a referendum to determine whether the nation would become an autonomous but integrated part of Indonesia or an independent country. The U.N. mission of 325 civilian police and military observers was expected to last about 4 months, but following violence over the results of the vote in favor of independence, the United Nations sanctioned intervention by a multinational force and later deployed thousands of U.N. peacekeeping troops to oversee the transition to independence. The peace operation is now scheduled to end in 2004. In the Democratic Republic of the Congo, a U.N. observer and peace mission has been ongoing since 1999, but numerous cease-fire violations have occurred. Congolese parties to the conflict did not form the interim government called for in the 1999 peace agreement until June 2003. In July 2003, the Security Council expanded the mandate to support the new government and increased the authorized force level to 10,800 troops. Because of the difficulties in achieving conditions for sustainable peace, implementing the transition strategies in these countries has cost over $6 billion: The estimated total cost of the operations in Sierra Leone is over $2.6 billion through June 2004. Annual costs have risen from $263 million for the U.N. fiscal year ending June 2000 to $670 million for the U.N. fiscal year ending June 2003. This increase reflects the Security Council’s decision to almost triple the size of the peacekeeping force in response to continued fighting and other problems. The estimated cost for the current fiscal year is about $544 million. The estimated total cost of the operations in East Timor is about $1.8 billion through June 2004. The initial U.N. observer mission sent to organize and conduct the referendum in East Timor in 1999 was expected to cost about $53 million. The current operation’s annual cost is $292 million for the U.N. fiscal year ending June 2003, and the estimated cost for the current fiscal year is $193 million. The estimated annual cost for the operations in the Democratic Republic of the Congo is about $1.9 billion through June 2004. Annual costs have risen from $55 million for the U.N. fiscal year ending June 2000 to an estimated $608 million for the current fiscal year. However, the latter estimate does not include costs associated with the Security Council’s recent decision to expand the operation’s mandate and authorize a larger U.N. force. There are also costs above and beyond the peacekeeping operation that are needed to fund overall transition efforts. These costs are often not funded. For example, in 2002, the United Nations requested about $69 million for humanitarian assistance in Sierra Leone, including the reintegration of refugees and internally displaced people and improved access to health, water, and education services. International donors funded less than 50 percent of this request. Similarly, the peacekeeping operation in East Timor faced a significant shortfall in additional donor resources. In 2002, the East Timor government and the U.N. Development Program identified the need for 228 donor-funded international advisers to begin to help manage government and economic development programs once the U.N. operation withdraws. As of April 2003, donors had provided 48 advisers and promised another 83, leaving a shortfall of nearly 100 positions. Coordination among Multiple Organizations Is Sometimes Ineffective Despite the numerous efforts at coordination—early planning, donor conferences, and other field representation—the United Nations, international organizations, nongovernmental organizations, and donor nations face difficulties in effectively working together on the ground. Part of the problem results from the multiple independent agencies in the country, each with its own mandates, funding, and priorities. This can create a variety of problems on the ground. In Sierra Leone, for example, officials of several agencies commented that efforts to coordinate the work of numerous development and humanitarian agencies were not effective. One donor agency official described donor efforts to work together as chaotic. Donor officials and Sierra Leone government representatives stated that neither the government nor the United Nations has an adequate system to track the amount and the impact of external aid, especially aid provided through nongovernmental organizations. Nor did any organization have the overall authority to direct the work of donors and thereby avoid duplication or overlap in specific locations. In East Timor, early efforts to coordinate U.N. peacekeeping operations with donors did not address critical needs in the governance and security areas. According to World Bank officials and assessments, U.N. officials planned activities to rebuild East Timor’s governance and security sectors largely outside of the coordinated needs assessments conducted by the international community in 1999. This situation contributed to some conflicts and hindered overall efforts. For example, one of the first World Bank projects was to help villagers in outlying regions establish local governing councils using traditional law. However, according to the Deputy Special Representative, this effort complicated outreach efforts by the peace operation, as it began establishing central government authority and providing consistent regulations throughout East Timor. Developing Meaningful Results-Oriented Measures Poses Difficulties The United Nations has had difficulty in developing results-oriented measures to help manage and make decisions about its peacekeeping transitions. In addition, the United Nations has not fully staffed DPKO’s Best Practices Unit, which is charged with developing tools for peacekeeping transitions, such as meaningful and quantifiable results- oriented measures of progress. Measures of Progress Often Focus on Tasks Rather than Conditions Although U.N. missions are using measures of progress for their operations, most measures are tasks and outputs rather than measures of underlying conditions in the country that the peace operation is to improve. For example, a U.K.-led coalition of donor nations in Sierra Leone is working to strengthen the armed forces. Some measures of progress in this area are the number of troops trained, reorganization of the armed forces, and restructuring the Ministry of Defense. (Table 2 shows some objectives and measures for security in Sierra Leone.) According to U.K. military trainers in Sierra Leone, other measures, such as ensuring the sustainability of army deployments, are not clearly defined or taken into account. These military trainers also said that measures for this area do not provide meaningful indications of the capability of the Sierra Leone armed forces. For example, military trainers noted that while the U.N. operation focuses on such performance measures as the speed at which units can deploy, it overlooks such measures as troop discipline, loyalty to the government, and the effectiveness of unit leadership. Subsequent events revealed problems in troop discipline, loyalty, and effectiveness. The Secretary General reported in December 2002 that the armed forces were “much improved” and were effectively patrolling the country’s border. He also stated that U.N. troops were supporting army units deployed along the Liberian border. However, the Secretary General reported in March 2003 two incidents that took place in January 2003 that lowered public confidence in the security forces and exposed shortcomings in their capability and training. First, Sierra Leone army troops retreated and left behind some of their equipment when about 70 Liberian raiders attacked a village near the border. Second, a police investigation into an attack by former soldiers and civilians on an armory implicated several active-duty soldiers in a plan to destabilize the government and prevent the operation of the international tribunal. A key objective of the peacekeeping operations in Sierra Leone, East Timor, and the Democratic Republic of the Congo is the increased capacity of the national police force to provide internal security. However, these missions use output-oriented measures. For example, in East Timor, the peace operation originally intended to train 2,830 police by 2004. However, the operation established this target using a standard European police-to-population ratio and relied on outdated population estimates. Moreover, the number of police does not measure the quality of their training and whether they are improving security in the country. In December 2002, riots occurred in the capital city, Dili, but the fully staffed police force could not restore order. In the aftermath of the riots, the United Nations resumed direct control over crowd control units, lengthened and revised its training program to incorporate more human rights and crowd control training, and increased the number of East Timor police officers by 500. The missions also use output measures to measure progress in creating governance and restoring the economies. In Sierra Leone, the number of district officials and magistrates placed in office is a measure of progress toward consolidating state authority. In addition, U.N. analysts in Sierra Leone reported that the reestablishment of courts in many areas was having a positive impact on public attitudes toward the rule of law. However, these analysts did not indicate that evaluations of the operations of these institutions had applied any systematic measures or criteria, such as the ability of those filing suit to obtain satisfactory resolution of their cases within a reasonable period of time. In 2002, DPKO tried to use the missions’ objectives and measures to develop results-based budgets for peacekeeping but was unable to do so. U.N. officials said that the missions’ measures were process-oriented and did not measure changes in country conditions that the peacekeeping operations were working to improve. A U.N. report in late 2002 acknowledged that it was difficult to shift from inputs and outputs to objectives and measures. Our past reports have also noted the difficulties in developing results-oriented measures. An example drawn from a Department of Justice international assistance program could be useful, however. Justice’s framework for overseas prosecutorial training and development identifies an overall objective of strengthening judicial independence, lists several subobjectives such as decreasing corruption, lists tasks such as getting legislative approval for an anticorruption task force, and then identifies several measurable measures of progress. The measures include an output, funding for the corruption task force. They also include measures of actual results, including the percentage increases in convictions for corruption and percentage increases in public confidence in judicial honesty. Such measures help demonstrate that program objectives are being met (see table 3). Increased regard for human rights courses on corruption and surveillance in corruption complaints filed, investigated, and leading to convictions Output measure: A tabulation, calculation, or recording of activity or effort that can be expressed in a quantitative or qualitative manner. Outcome measure: An assessment of the results of a program compared with its objective. Impact measure: Measures of the net effect or consequences of achieving program objectives. United Nations Has Not Yet Developed Results-Oriented Measures of Progress U.N. officials stated that identifying measures of progress useful in past missions would be helpful in developing results-oriented measures for future missions. Moreover, the Under Secretary General for Peacekeeping Operations stated that to develop and apply the transition strategy, his department needed to develop better measures by which to assess the progress peacekeeping operations are making in attaining sustainable peace. He also stated that developing systematic measures of results was an important task. Despite the importance of developing results-based measures, the peacekeeping operations in East Timor; the Democratic Republic of the Congo; and, to a lesser extent, Sierra Leone have not developed these measures. Although DPKO’s revised planning process for peace operations would require mission planners to clarify long-term aims in the country and identify criteria for measuring success, the head of the DPKO military planning group stated that it would be up to the individual missions to develop results-oriented measures. Mission staff and DPKO desk officers for each of the three operations noted that they have received only general guidance on developing results-oriented measures. Moreover, they stated they lacked the staff resources necessary to develop such measures and collect the data. Status reports from the missions that we reviewed were largely narrative accounts of daily or weekly events and did not use results-oriented measures. Beginning in late 2002, DPKO and mission staff attempted to implement results-based budgeting for peacekeeping operations for fiscal year 2003-04. According to one DPKO official, however, this effort to did not succeed because peacekeeping operations staff had not made it a priority to develop results-oriented measures linked to their peacekeeping mission strategies. U.N. officials noted that DPKO and mission staff are working to develop results-oriented measures in order to implement results-based budgets for most peacekeeping operations by fiscal year 2004-05. They also indicated that the lessons learned and best practices from this planning and budget preparation process will be reflected in the 2005-06 budget. Nevertheless, DPKO has only recently begun to provide the resources necessary to develop these measures. In 2001, DPKO combined its units for policy and analysis and peacekeeping lessons learned and to create a best practices unit to systematically review the results of past U.N. peacekeeping operations and develop guidelines and general measures of progress to better plan and conduct future operations. DPKO did not provide a director for the unit until April 2003, however, nor had it fully staffed the unit as of August 2003. State Department officials in the Bureau of International Organization Affairs and at the U.S. Mission to the United Nations are responsible for providing oversight of peacekeeping operations and budgets. For example, they monitor the progress of the 14 U.N. peacekeeping missions and track the budgetary costs, of which the United States contributes 27 percent. They also brief Congress monthly on these peacekeeping missions. According to these State officials, they have not focused on U.N. efforts to develop results-based measures. However, they follow the progress of the missions through U.N. reports and U.S. intelligence. Nonetheless, they said more systematic measures of results would be useful to monitor the progress of peacekeeping operations and would help in deciding whether they were helping a country move toward sustainable peace. They cautioned, however, that results were difficult to quantify and that the United Nations was not responsible for all aspects of rebuilding a country and helping it move toward sustainable peace. Conclusions The United Nations and other international stakeholders face an enormous challenge in helping countries that have been recently involved in internal conflicts and that have no rule of law or experience of accountable government transition to sustainable peace. The development of a general transition strategy for U.N. peacekeeping operations is a positive step in overcoming this challenge. The strategy takes a comprehensive and long- term view and focuses on addressing the causes of the conflict. The strategy further recognizes that the peacekeeping operation must specify results-oriented measures of progress to effectively manage operations and the withdrawal of peacekeepers. However, the United Nations has not yet developed quantifiable results- oriented measures of progress to help the Security Council make peacekeeping transition decisions. Although the United Nations uses output measures to manage the drawdown of peacekeepers, these measures did not provide useful information about results, such as progress in improving security in Sierra Leone and East Timor. The U.N. Department of Peacekeeping Operations has not yet developed results- oriented measures. It created a best practices unit to systematically review the results of past U.N. peacekeeping operations and develop measures of progress to plan and conduct future operations, but the unit did not have the resources necessary to begin these tasks until recently. Agency Comments and Our Evaluation We provided a draft of this report to the Departments of Defense, Justice, and State; the U.S. Agency for International Development; and the United Nations. We received verbal comments from the State Department and the U.S. Agency for International Development, and written comments from the U.N. Department of Peacekeeping Operations (see app. IV). The remaining agencies did not provide comments. The State Department generally agreed with our findings and provided technical comments and clarifications, which we incorporated where appropriate. The U.S. Agency for International Development provided technical comments, which we also incorporated where appropriate. The United Nations also generally agreed that the report identified key issues facing peacekeeping operations. The United Nations was concerned, however, that the report (1) did not fully recognize its efforts to apply results-oriented performance measures for its operations, (2) did not acknowledge numerical measures of progress included in routine peacekeeping operations reports to headquarters, (3) did not fully explain the mandate of the peacekeeping operation in the Congo, and (4) did not reflect progress made in the Congo over the past year and a half. We have added information to the report about recent and proposed U.N. efforts to develop results-oriented performance measures. We describe in the report a number of instances where the peacekeeping operations have used numerical measures in their reporting, but these are largely measures of tasks or outputs rather than the measures of outcomes called for by the United Nations’ results-based budgeting system. The report provides an accurate portrayal of the comparatively narrow focus of mandate of the peacekeeping operation in the Congo as it pertains to U.N. efforts to develop rule of law and participatory governance. Nonetheless, the report fully explains the mandate for the operation in the Congo in table 1 and appendix II. The report also notes that in July 2003 the Security Council voted to expand the operation's mandate. However, this operation's limited focus is especially clear compared with the other two operations we examined in detail for this report. Our report discusses the progress attained in the Congo to date, but notes that it is very recent. The Congolese parties to the conflict only formed a government in late June 2003, for example, and as of September 2003, the United Nations had yet to fully execute its plans to disarm, demobilize, and repatriate Rwandan ex- combatants. We are sending this report to interested congressional committees, the Secretary of State, the Administrator for the Agency for International Development, and the U.N. Secretary General. We will also make copies available to other parties on request. In addition, this report will be made available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions concerning this report, please contact me at (202) 512-8979, or at christoffj@gao.gov. Other GAO contacts and staff acknowledgments are listed in appendix V. Appendix I: Scope and Methodology To identify the elements of the U.N. transition strategy, we obtained and examined documentation on Security Council deliberations on peacekeeping policies and reform initiatives, including relevant reports to the council from the United Nations’ Secretary General. To obtain additional detail, we interviewed and obtained documents on planning and operational management from officials of the U.N. Department of Peacekeeping Operations, as well as officials in the Department of Political Affairs who are responsible for contributing to planning peace operations. We also interviewed and obtained documents from officials from other U.N. bodies, such as the Office for the Coordination of Humanitarian Affairs and the U.N. Development Program, that contribute to overall U.N. efforts to restore stability in complex emergency countries. To obtain other perspectives on U.N. policies and initiatives and peacekeeping operations in general, we interviewed and/or obtained critical evaluations and analyses from government and nongovernment analysts, including officials from the U.S. mission to the United Nations; the Departments of State, Justice, and Defense; the U.S. Agency for International Development; the World Bank; the Organization for Economic Cooperation and Development; the Henry L. Stimson Center; and others. To assess the extent to which the United Nations is attempting to apply the strategy in Sierra Leone, East Timor, and the Democratic Republic of the Congo, we obtained information from the Department of Peacekeeping Operations on the substance and status of initiatives to strengthen its operations in these countries. We reviewed efforts by this department to implement the United Nations’ commitment to applying results-based budgeting principles as a management tool. We performed fieldwork in Sierra Leone and East Timor to examine peacekeeping operations in those countries. These trips included visits to U.N. and national government military and police posts, ex-combatant reintegration centers, justice institutions, and reconstruction projects. We interviewed and obtained documentation from U.N. and host government officials, bilateral and multilateral agencies and nongovernmental organizations supporting U.N. peace efforts, and local citizens participating in or observing internationally supported programs. In conjunction with these trips, we visited and interviewed government officials in the United Kingdom and Australia, the major bilateral supporters of the peace operations in Sierra Leone and East Timor, respectively. Our work in these two countries allowed us to assess overall transition planning and actual execution of initial troop reductions, since the operations in these countries have completed substantial portions of their work and are beginning to withdraw. In the Democratic Republic of the Congo, we interviewed U.N. peacekeeping officials about the demobilization and reintegration programs and their efforts to provide humanitarian assistance. However, due to unsettled security conditions and the early stage of the United Nations’ activities, our fieldwork in the Congo was not as extensive as it was in Sierra Leone and East Timor. To assess challenges faced in applying the U.N. strategy in these countries, we reviewed our own substantial body of work on peacekeeping operations over the last decade (including reviews of U.N. operations in Cambodia and the Balkans) and included discussion about relevant issues in our interviews with U.N. headquarters and field-level staff, U.S. government officials, and other experts in the United States and abroad, as previously described. Our findings regarding U.N. efforts to develop meaningful measures and criteria for assessing progress were informed by our prior work on U.S. government efforts to develop and apply similar frameworks, including efforts to apply the principles advanced by the Government Performance and Results Act. To examine whether consistent and quantifiable measures were used to assess progress, we examined progress reports sent from the U.N. missions in Sierra Leone, East Timor, and the Democratic Republic of the Congo to the Department of Peacekeeping Operations headquarters in New York between November 2002 and May 2003. We conducted our work from October 2002 through August 2003, in accordance with generally accepted government auditing standards. Appendix II: U.N. Objectives and Measures of Progress, by Mission Support the development of the East Timor Police Service (ETPS) Appendix III: Crises and International Response in Sierra Leone, East Timor, and the Democratic Republic of the Congo Sierra Leone From 1991 through 2000, Sierra Leone experienced a devastating series of armed conflicts between the government and rebel groups, brought on by decades of poor governance, economic mismanagement, and corruption. The conflict was exacerbated by external support for the rebels, primarily from Liberia. The international community attempted unsuccessfully to restore peace for nearly a decade. In 1999, the government and primary rebel groups signed a peace agreement, and the United Nations deployed a peacekeeping operation to support efforts to create a sustainable peace. In 2000, international efforts to restore the peace intensified after rebels took about 500 peacekeepers hostage. The United Kingdom intervened and ultimately deployed about 5,500 troops to protect and evacuate U.K. and other nationals and to support the government and international peacekeepers. The United Nations strengthened its mandate and by 2001 had nearly tripled the size of its military force to 17,500 troops. After the rebel leader was captured in May 2000, the hostages were released or rescued, and the rebel groups were largely disarmed and demobilized. In May 2002, the former rebels participated in national elections conducted with U.N. support and characterized by observers as free and fair. The U.N. peacekeeping force currently assists the government of Sierra Leone in its efforts to maintain security and restore law and order throughout the country. Sierra Leone, a small West African country with an estimated population in 2001 of approximately 6 million was founded as a refuge for freed slaves by the United Kingdom in the late 1800s. It has been an independent country since 1961 (see fig. 7). Although endowed with substantial mineral resources, most notably diamonds mined in the eastern portion of the country, over 80 percent of Sierra Leone’s prewar population lived in poverty. The conflict in Sierra Leone began in 1991 with a relatively small-scale revolt against the government by a group known as the Revolutionary United Front (RUF). With the help of Liberian faction leader (and later president) Charles Taylor, the rebels gained control of Sierra Leone’s diamond mining areas, enabling them to sustain prolonged and destructive struggle against relatively weak and divided government opposition. Independent militias and elements of the armed forces fought each other, the RUF, and West African forces deployed as peacekeepers in a series of conflicts. By the late 1990s, damage and disruption from the ongoing conflict had reduced Sierra Leone to the extent that the United Nations’ global Human Development Index ranked it last place in the world. Much of the nation’s infrastructure was destroyed, and about half of the population was displaced from their homes. Approximately 500,000 people fled the country, including an estimated 80 percent of Sierra Leone’s professionals. Throughout the 1990s, the United Nations and other elements of the international community made a number of unsuccessful attempts to end the conflict in Sierra Leone. The Economic Community of West African States, with the support of the United Nations and the Organization of African Unity, attempted to achieve settlements through negotiated agreements, sponsorship of democratic elections, and military intervention. These attempts failed because of weaknesses in Sierra Leone’s civilian and military institutions, continuing rebel resistance, limitations of the international military forces operating in the country, and competing international commitments to the region. The government was overthrown by a military coup in 1992. The military relinquished power to a new president and parliament elected in February 1996, but the RUF did not participate in the elections and did not recognize the results. In November 1996, the United Nations helped negotiate a peace agreement (known as the Abidjan Accord) between the government and the RUF. This agreement was derailed when the government was overthrown in 1997 by another military coup, and the army and the RUF formed a ruling junta. The government was restored in 1998 after West African forces drove the junta from power. In January 1999, an unsuccessful attempt to overthrow the government by the RUF resulted in massive loss of life and destruction in Freetown and the surrounding area. In July 1999, the parties to the conflict signed a peace agreement (known as the Lomé Agreement because it was signed in Lomé, Togo) negotiated with the assistance of the United Nations. Under the agreement, the RUF agreed to maintain a cease-fire, transform itself into a political party, and join a government of national unity. In return, the agreement granted pardon and amnesty to all combatants, including those from the RUF, for actions before the agreement was signed. In October 1999, the Security Council established the United Nations Mission in Sierra Leone to, among other things, assist in the implementation of the Lomé Agreement, assist in the disarmament demobilization and reintegration of former combatants, and monitor the cease-fire. The council’s resolution authorized the deployment of up to 6,000 military peacekeepers. Despite having signed the Lomé Agreement, RUF forces attacked population centers and engaged in a series of armed confrontations with African peacekeeping forces and, subsequently, with U.N. troops. In May 2000, the RUF took about 500 U.N. peacekeepers hostage. U.N. and other assessments concluded that insufficient military strength and other shortcomings contributed to the peacekeeping force’s inability to deter and repel RUF attacks and stabilize the country. The hostage-taking and other incidents prompted a significant change in the United Nations’ and the international community’s approach to the crisis in Sierra Leone. The international community applied greater military and diplomatic pressure, which succeeded in overcoming RUF resistance and restoring the peace. Beginning in May 2000, the United Kingdom deployed troops to protect and evacuate U.K. and other nationals and secure the area around Freetown and the airport. This deployment boosted confidence in the government and allowed the United Nations to redeploy peacekeepers to other areas. At the same time, the United Nations began increasing the strength of its peacekeeping force in a series of steps from 6,000 to 17,500 troops. The Security Council augmented the mission’s mandate to clarify its right to self-defense and tasked it to help extend government authority throughout the country, including areas controlled by the RUF and other armed groups. In addition, Guinean armed forces defeated RUF incursions into that country, and the United Nations imposed sanctions on Liberia to reduce that country’s support for the RUF. The arrest and imprisonment of RUF leader Foday Sankoh in mid-2000 enhanced RUF cooperation. The United Nations reported that, through May 2002, the U.N. peacekeeping operation supported the extension of government authority throughout the country, the disarmament and reintegration of ex- combatants, and the conduct of free and fair national elections. According to U.N. reports, by December 2001, U.N. troops had been deployed to all districts of Sierra Leone, and, by June 2002, government administrators and police had also been deployed to all districts with the support of the U.N. forces, the U.N. Development Program, and international groups. In January 2002, the Government of Sierra Leone, the RUF, and the United Nations declared the disarmament process complete. Having disarmed, the RUF participated as a political party in national presidential and parliamentary elections in May 2002. The U.N. operation played an important role in supporting these elections, which international and local observers characterized as free, transparent, and generally free of violence. In the spring and summer of 2002, having achieved these basic milestones, U.N. officials began to develop plans to gradually reduce the size of the mission. In accordance with Security Council guidance, U.N. officials identified and articulated strategic goals for key areas where progress would affect the security threat facing Sierra Leone and its ability to maintain security and stability without substantial assistance from U.N. peacekeepers. East Timor A former Portuguese colony, East Timor experienced years of intermittent conflict following its 1975 occupation by Indonesia. Low-level international efforts to resolve this conflict were unsuccessful until 1998, when Indonesian-Portuguese negotiations finally produced agreement on a referendum to decide the territory’s political future. The ensuing vote for independence in August 1999 provoked a violent response from militias favoring integration with Indonesia. The international community intervened to end the fighting and established a U.N. transitional administration in 2000 to run the country and oversee international assistance efforts until a new national authority was elected and independence declared in May 2002. A U.N. peacekeeping operation remains in East Timor in support of the government and ongoing international efforts to create sustainable peace in the new country. East Timor is a small country with a population ranging between 800,000 and about 1 million occupying the eastern portion of the island of Timor (see fig. 8). First colonized by Portugal in the 1500s, Timor was divided between the Netherlands and Portugal in 1859. While the Dutch side became part of Indonesia after World War II, East Timor remained under Portuguese rule. In 1975, Portugal finally withdrew and East Timor declared independence. However, armed conflict among domestic factions provided Indonesia with a pretext for occupation. For the ensuing quarter century, Indonesia conducted an unsuccessful campaign to incorporate East Timor, with intermittent warfare claiming 100,000 to 250,000 lives. By 1999, years of violence and disruption had reduced East Timor to last place among Asian countries on the United Nations’ Human Development Index. Although the United Nations refused to recognize Indonesia’s annexation and called for self-determination for East Timor, these calls did not achieve results until the government of Indonesia changed hands in 1998 and the new administration decided to enter U.N.-mediated discussions with Portugal about the territory’s political future. In 1999, these talks resulted in agreement to hold a popular vote on whether East Timor would accept or reject a proposal to remain affiliated with Indonesia as an autonomous entity. To ensure a free and fair referendum, the Security Council created a small observer mission, the U.N. Mission in East Timor, to monitor campaigning and voting and to oversee the result of the vote. However, Indonesia retained responsibility for maintaining peace and security. On August 30, 1999, the population voted overwhelmingly against the proposal, voting in effect for U.N. administration and eventual transition to full independence. In response, militias favoring integration with Indonesia went on a rampage with the support of elements of the Indonesian security forces, killing hundreds of people, displacing 500,000 more—many of whom fled or were forcibly removed to West Timor—and destroying much of the country’s already damaged infrastructure and housing. Those leaving included most of the country’s professional class, who were predominantly Indonesian in origin. Despite diplomatic pressure from the Secretary General and others, Indonesian authorities did little to end the violence; Indonesian security forces in fact provided considerable support to pro-union militias. In 1999, the Secretary General noted that the potential for post-vote discord was widely acknowledged and Indonesian authorities had not done an effective job of quelling prereferendum violence. The U.N. mission then in the country, however, had not been provided with the means for taking effective action to restore stability. In the aftermath of the violence, the United Nations authorized a series of interventions in East Timor that were intended to end the violence, create a national government, and consolidate a stable environment that would permit devolution of all responsibilities to the new national government and withdrawal of U.N. forces. In September 1999, the Security Council authorized an Australian-led international force of approximately 8,000 military personnel to intervene in East Timor, end the violence, and facilitate humanitarian operations. With Indonesian consent, this force quickly entered East Timor and restored order. About 500,000 East Timorese were displaced from their homes. About half of the displaced went to West Timor, in some cases forced to go by fleeing pro-Indonesia militiamen. The following month, the council authorized creation of the U.N. Transitional Administration in East Timor that would assume responsibility for maintaining security from the Australian-led force, administer an interim government, and work to develop East Timor’s capacity for self-government. In the ensuing months, the mission oversaw development of a national consultative council, began training a police force, assisted with the return of most of the refugees, helped other international organizations create the conditions for economic development, and patrolled the boundary with Indonesia. Between August 2001 and April 2002, the people of East Timor elected a constituent assembly, adopted a constitution, and elected a president. On May 20, 2002, East Timor became an independent country, and the U.N. transitional administration turned over responsibility for governance to Timorese authorities. Recognizing this change in circumstances, the Security Council created a U.N. Mission in Support of East Timor to pursue a mandate that supports the new government as it works to establish stability and security in the country. The mission has developed implementation plans for its activities, identified security and governance “milestones” to be achieved, and developed a proposed timetable for reducing its presence in East Timor over a 2-year period, with the final withdrawal of the peacekeepers to be completed by mid-2004. Democratic Republic of the Congo Since suffering foreign invasion and overthrow of the government in 1996- 97 and again in 1998-99, the Democratic Republic of the Congo (DRC) has been divided by conflict among shifting alliances of foreign and domestic armed groups, including troops from seven other countries sent to support or oppose the government. International initiatives aimed at restoring peace, including a U.N. peacekeeping operation, have made some progress since 1999, but violence continues to occur. The Security Council established a peacekeeping operation, the U.N. Organization Mission in the Democratic Republic of Congo, in support of a 1999 peace agreement signed in Lusaka, Zambia. The parties to the agreement largely failed to meet their commitments until late 2002, making it difficult for the U.N. mission to plan a comprehensive approach to restoring stability. Foreign troops were withdrawn by May 2003, and the Congolese factions formed a transitional government in June 2003. In July 2003, the council expanded the peacekeeping operation’s mandate to assist the new government’s efforts to provide security and rule of law. In addition, the council authorized a substantial increase in the size of the peacekeeping force. The DRC occupies the core of central Africa. Approximately equivalent in size to the United States east of the Mississippi River, the country shares borders with nine other nations and has a population of about 55 million. The country is rich in natural resources, with substantial deposits of gold, diamonds, coltan, and other minerals; ample timber; and enormous potential for hydroelectric power generation. A colony of Belgium until 1960, the new country dissolved into a multisided war shortly after declaring independence. The government of dictator Mobutu Sese Seko, in power from 1965 to 1997, eventually restored order but failed to channel the country’s considerable wealth into economic and social development. Corrupt government officials became wealthy while the population remained poor, politically disenfranchised, and willing to support opposition groups and coup attempts. The economy suffered a near-total collapse during the early 1990s. By 1997, the central government could do little to resist rebels and outside forces. The political and economic tensions in the DRC were exacerbated by the 1994 conflict and associated genocide in neighboring Rwanda. More than 1 million ethnic Hutus fleeing Tutsi reprisals inside Rwanda became refugees in eastern DRC. Ethnic tension and fighting involving Congolese Tutsis, the army, and exiled Rwandan Hutu militias ensued, leading eventually to a 1997 uprising by domestic rebel groups that succeeded in deposing Mobutu with support from Rwanda, Uganda, and Angola. The successor government under rebel leader Laurent Kabila was challenged in 1998 by a new coalition of internal rebels and Rwandan and Ugandan troops. With support from Angola, Zimbabwe, Namibia, Sudan, and Chad, the Kabila government pushed its challengers back to eastern DRC before losing the initiative. Rwandan and Ugandan troops and their respective rebel client groups remained in control of large portions of the country (see fig. 9). According to International Rescue Committee estimates, the continuing conflict has cost more than 3 million lives since 1998. In July 1999, the main parties to the DRC conflict agreed to honor a cease- fire and begin a national dialogue to lead to the creation of a transitional government and national elections. The Security Council authorized a U.N. peacekeeping operation to support the cessation of hostilities, oversee the withdrawal of foreign forces, and encourage talks sponsored by the United Nations and the African Union to create a new national government that included the current government and foreign-supported rebel groups in eastern DRC. The peacekeeping operation would then support the new government’s efforts to restore peace, including a timetable calling for agreement on the formation of a unified transitional government within 3 months, withdrawal of all foreign forces within 6 months, and reestablishment of state administration throughout the DRC within 9 months, that is, by April 2000. The parties were slow to meet their commitments and were unable to implement a comprehensive plan to restore peace. The formation of a national government was also substantially delayed. The parties committed numerous violations of the cease-fire, and it was not until December 2002 that the Kinshasa government and major rebel groups from eastern Congo signed a power-sharing agreement that would permit the creation of the transitional government. Foreign troops have been slow to withdraw in part because they want to retain control of mineral resources. Rwanda withdrew its troops in late 2002, while Uganda removed the last of its units in May 2003. As of August 2003, fighting has continued among rebel militias seeking to control Ituri and other northeastern regions. In Ituri, local, ethnic militias began fighting after foreign troops vacated the area. Since 1999, the Security Council has gradually increased the strength and mandate of the U.N. peacekeeping operation that supported the peace process. In 2001, the council authorized the mission to train police for the eastern rebel-occupied city of Kisangani and help reopen the Congo River to commercial traffic. In 2002, it inaugurated a program to disarm and repatriate ethnic Hutu militiamen and their families from the DRC to Rwanda. The council approved a number of increases in the size of the peacekeeping force, raising its authorized strength from 90 military liaisons in August 1999 to 8,700 troops by December 2002. The actual forces provided by member states to the operation have been significantly below the ceiling because the country’s unstable political environment, great size, and poor transportation network make it costly to deploy troops. Consequently, the number of U.N. troops actually deployed to the DRC totaled about 6,200 soldiers and 76 police as of June 2003. In May 2003, the council also authorized the deployment of a separate French-led force of about 1,500 international troops to the Ituri region to end fighting and restore order in the city of Bunia. The Congolese parties to the peace agreement formed the National Unity and Transition government in June 2003. On July 28, 2003, the Security Council expanded the peacekeeping operation’s mandate to assist the government in developing a more comprehensive approach to restoring stability, including efforts to support security sector reform, elections, and the establishment of the rule of law, in coordination with other international actors. The council also authorized the mission to use force to stabilize Ituri and other northeastern regions and expanded its force level to 10,800 troops. The U.N. operation will also assume control over international forces in the Ituri region in September 2003. The new resolution extended the mission for 1 year but did not set a date for elections. However, the Secretary General suggested in May 2003 that the holding of free and fair national elections might serve as an appropriate time to end the current peacekeeping operation. Appendix IV: Comments from the U.N. Department of Peacekeeping Operations Appendix V: GAO Contacts and Staff Acknowledgments GAO Contacts Staff Acknowledgments In addition to those named above, Ann Baker, Lynn Cothern, Martin De Alteriis, Michael McAtee, and Claire van der Lee made major contributions to this report.

The United Nations responded to the failure of some past peacekeeping operations by developing a strategy to help peacekeeping operations move a country from conflict to sustainable peace. It has attempted to apply this strategy to the large and costly peacekeeping operations in Sierra Leone, East Timor, and the Democratic Republic of the Congo since 2001. As a contributor of over 25 percent of the cost of U.N. operations, the United States has a stake in the successful application of this strategy. The strategy also has implications for the conduct of international peace operations in other post-conflict countries. GAO was asked to (1) identify the elements of the U.N. transition strategy; (2) assess the extent to which the United Nations has applied the strategy to operations; and (3) assess the challenges to implementing the strategy in these three countries. The United Nations has developed a transition strategy for its peacekeeping operations that takes a comprehensive and long-term view and focuses on the causes of the conflict. The U.N. strategy for making effective peacekeeping transitions has three elements: (1) establishing conditions for sustainable peace, (2) coordinating efforts among the United Nations and other international organizations to establish these conditions and sustain assistance after peacekeepers withdraw, and (3) developing objectives and results-oriented measures of progress to help manage and decide when a country's conditions warrant the withdrawal of peacekeepers. The United Nations is attempting to apply the elements of this strategy to help Sierra Leone, East Timor, and the Democratic Republic of the Congo transition from conflict to sustainable peace, but it faces enormous challenges. Establishing security often takes longer and can be more expensive than originally planned in countries where rival factions may continue to fight. Developing participatory governance is also difficult in countries with little experience of accountable government. Coordinating with independent international organizations and donor nations with different priorities is also a challenge. The United Nations has not yet developed results-oriented measures of progress for the three peacekeeping operations. Although the United Nations uses some indicators to manage the withdrawal of peacekeeping troops, they did not have results-oriented measures to assess the security situations in Sierra Leone and East Timor and subsequent events in each country showed that the situation was not as secure as available measures indicated. The U.N. Department of Peacekeeping Operations acknowledges that it needs better indicators by which to measure the progress peacekeeping operations are making in attaining sustainable peace. However, the department has not yet developed these indicators.

Background Present and evolving threats highlight the need to design, operate, and defend military communication networks to ensure continuity of joint operations. However, current systems lack the connectivity, capacity, interoperability, control, adaptability, availability, and coverage to support military action. To address these shortcomings, DOD is moving toward network-centric communication systems to facilitate critical communication. A key system in this concept is TSAT—one of DOD’s most complex and expensive space programs involving the integration of multiple, complex technologies never before integrated in a single space system. As early as 2001, DOD had developed a new Transformation Communications Architecture (TCA) to guide the implementation of emerging communications technologies. The TCA is an element of a broader global information network or grid, DOD’s overarching vision to provide authorized users with a secure and interconnected information environment. The performance parameters for the GIG define the fundamental requirements for the systems to be interconnected through the TCA. The TCA is designed to realize the benefits of an Internet protocol (IP) environment, as it will provide instant accessibility to the military and intelligence communities. The goal of the TCA is to provide accessibility to all users while removing communications constraints related to capacity, control, and responsiveness. It is composed of elements in ground stations, aboard tactical vehicles, and in space. TSAT is the space-based network component of the TCA that is expected to provide survivable, jam-resistant, global, secure, and general purpose radio frequency and laser cross-links with air and other space systems. Some of the satellite technologies TSAT will employ have been evolving for over 25 years. TSAT is building on these heritage technologies in three primary areas: onboard signal processing for protection and connectivity, networking, and space laser communication. Through these advanced technologies, TSAT will improve communications to DOD, intelligence community, and homeland defense users by transmitting large amounts of data at a faster rate. Further, TSAT is designed to vastly improve satellite communications by extending the GIG to users without ground connections and making it possible for users to travel with small terminals and communicate while on the move. The TSAT system will consist of a five-satellite constellation (with a sixth satellite for backup), the TSAT satellite operations element (TSOE) which includes a primary TSAT satellite operations center (TSOC) for on-orbit satellite control, a backup TSOC, and a set of transportable units, a TSAT Mission Operations System (TMOS) to provide network management, and ground gateways (see fig. 1). DOD has awarded four TSAT contracts through separate bidding processes. In 2003 DOD awarded a contract to Booz Allen Hamilton for overall systems engineering and integration. DOD also awarded two separate contracts to competing contractor teams—Lockheed Martin Space Systems/Northrop Grumman Space Technology and Boeing Satellite Systems—to conduct risk reduction efforts and present development plans for the TSAT satellites. DOD expects to award a contract to one of these contractor teams in 2007 to design and build the satellites. Finally, in January 2006 DOD awarded a $2 billion contract to Lockheed Martin Integrated Systems and Solutions to develop TMOS and the overall network architecture. This network development contractor is responsible for negotiating the interfaces between the TSAT network and the space segment, user terminals, and other external networks. Recently, DOD changed the TSAT acquisition strategy to an incremental development approach. This approach establishes time-phased development of new products in increments. The first increment incorporates technology that is already mature or can be matured quickly. As new technologies become mature, they are incorporated into subsequent increments so that the product’s capability evolves over time. This approach also reduces risks by introducing less new content and technology into a design and development effort, an approach intended to enable developers to deliver a series of interim capabilities to the customer more quickly. As such, incremental development is considered a best practice for successful DOD and commercial development programs because it allows these programs to make cost and schedule estimates that are based on mature technologies. Recognizing the benefits of evolving space systems, DOD included the incremental development of space systems in its revised National Security Space acquisition policy. DOD Not Meeting Original TSAT Goals DOD is not meeting its original cost, schedule, and performance goals for the TSAT program. TSAT’s cost has increased by over $420 million, the planned launch date for the first satellite has slipped more than 3 years, and the satellites will be less capable than originally planned. Since DOD established initial goals for the program, Congress has twice reduced the program’s annual budget and directed DOD to spend more time developing and proving critical technologies. DOD developed the initial goals with limited knowledge, when almost all of the critical technologies had yet to be proven to work as intended. As a result, the goals were developed without a high level of reliability. Initial Goals for TSAT Were Based on Limited Knowledge When DOD started the TSAT program in January 2004, it estimated the total acquisition cost to be about $15.5 billion. TSAT’s acquisition cost had increased to nearly $16 billion by the end of 2004. DOD also originally scheduled critical design review (CDR) for April 2008 and the first TSAT satellite launch in April 2011. CDR is now scheduled for September 2010 and the first launch in September 2014—delays of approximately 29 and 41 months, respectively. In addition, DOD recently changed its TSAT acquisition strategy to an incremental approach by deciding to build the first two satellites with fewer capabilities and delaying the more advanced capabilities for the later satellites in the program. While the initial two satellites will not perform as originally planned, the full five-satellite system will still meet the original user requirements, according to program officials. According to program officials, the original goals for TSAT have been revised several times as a result of reductions in program funding. After DOD set its initial goals for TSAT, Congress twice funded the program at levels below DOD’s request (in fiscal years 2005 and 2006) because of concerns about the state of technical maturity for key subsystems and an aggressive schedule for acquisition. During this time, Congress also directed the program to focus on the challenges of integrating the technologies needed for the system. Figure 2 shows the changes to key milestones dates in TSAT’s acquisition schedules. The program recently was directed to develop a new total acquisition cost estimate at a higher level of confidence—which could further increase the amount of funding requested in the near term for the program. However, as of April 2006, DOD had yet to develop this new estimate. When DOD established initial goals for the TSAT program, it lacked sufficient knowledge about key critical technologies. Our past work has shown that a knowledge-based model leads to better acquisition outcomes. This model can be broken down into three cumulative knowledge points for technology maturity, design maturity, and production maturity. At the first knowledge point, a match is made between a customer’s requirements and the product developer’s available resources in terms of technical knowledge, time, money, and capacity. We have also reported that starting a complex program like TSAT with immature technologies can lead to poor program performance and outcomes. In early December 2003, we reported that the Air Force would have difficulty establishing goals when starting the TSAT program because critical technologies were underdeveloped and early design studies had not been started. At that time, we recommended that the Air Force delay the start of the TSAT program until technologies had been demonstrated to be at an acceptable level of maturity and to consider alternative investments to TSAT. One month later DOD started the program with only one of the seven critical technologies mature, and could not have known with any certainty what resources would be needed to eventually meet users’ requirements, despite having confidence in its technology development schedule. For the TSAT program, the Next Generation Processor Router (NGPR) and laser communications are the highest-risk areas. Program officials reported that three of the critical technologies in the NGPR are involved with the transmission of data: (1) packet processing payloads, (2) dynamic bandwidth and resource allocation (DBRA), and (3) protected bandwidth efficient modulation using high data rates. The use of these Internet-like processes will provide unprecedented connectivity for all TSAT users by moving from an older circuit-based network (similar to telephone) to the newer IP-based network (similar to the Internet). Additionally, DOD continues to develop the technologies that are needed for laser communications. Table 1 identifies the level of maturity of TSAT critical technologies at program start and their expected maturity dates. To minimize the potential for technology development problems after the start of product development, DOD uses an analytical tool to assess technology maturity. This tool associates technology readiness levels (TRL) with different levels of demonstrated performance, ranging from paper studies to actual application of the technology in its final form. For TSAT, the space segment contractors are using a series of events to demonstrate and integrate the critical technologies into subsystems and then testing to determine the extent the components function properly together. The maturity levels of the critical technologies for TSAT currently range from TRL 5 to 6, with the remaining technologies needing integration testing to demonstrate maturity. (See app. VI for a description of the TRL levels.) According to program officials, these technologies will be demonstrated at TRL 6 when key integration tests are completed in fiscal year 2007. The two main tests facing the program are the second series of integration testing on the Next Generation Processor Router and Optical Standards Validation Suite (NGPR-2 and OSVS-2). Program officials said that the program is using these independent tests to reduce risk by uncovering technical problems before awarding the space segment contract for the design and assembly of the satellites. The results of the tests are to be assessed at the second interim program review before DOD makes a decision to enter the product development phase of the program. At the time of this report, results from the first series of integration tests were unavailable. DOD Taking Steps to Lower Program Risk but Additional Knowledge Needed Before Product Development DOD is taking positive steps to lower TSAT program risk, but additional knowledge is needed before entering product development. DOD is separating its technology development efforts from product development, continuing to conduct program reviews before making key decisions, reducing program complexity by staggering the awards on its ground and space segment contracts, and incorporating knowledge-based metrics in software development. Additionally, DOD is reducing risks in technology development efforts by leveraging decades of knowledge on heritage systems and using independent integration tests to demonstrate the maturity of critical technologies. Despite these efforts, DOD faces gaps in knowledge that could hamper successful outcomes. As DOD implements an incremental approach for the TSAT program, it has yet to justify the TSAT investment in light of other DOD investments using the knowledge it has now gained. Efforts Under-Way Reduce Program Risk DOD is reducing TSAT program risk in the following ways: Separating technology and product development—DOD is separating technology development from product development and plans to prove that all critical technologies will work as intended before the TSAT program enters product development in 2007. In the past, DOD has not successfully implemented acquisition best practices in its space programs to reduce risks and increase the likelihood of better outcomes, particularly in some of its larger and more complex programs. We previously reported that DOD could curb its tendency to over-promise the capabilities of a new system and to rely on immature technologies in part by separating technology development from product development (system integration and system demonstration).According to program officials, the TSAT program will not start building the TSAT system until all critical technologies needed for the system to satisfy user requirements are mature, ensuring a clear demarcation between the two phases of system development. This approach better enables decision makers to determine if a match exists between TSAT requirements and available resources (time, technology, capacity, and funding). Conducting program reviews—DOD plans to continue conducting reviews of the TSAT program at key milestones to reduce program risk. DOD’s space acquisition policy requires that program managers hold milestone reviews or independent program assessments as a program is nearing key decision points. Following this guidance, the TSAT program’s acquisition schedule requires the program manager to assess program knowledge at specific points. The next major milestone is scheduled for the fourth quarter of fiscal year 2007, when the program will hold an interim program review to assess the program’s readiness to proceed into the product development phase. Importantly, this review will include an assessment of the maturity levels of the critical technologies. Part of this review will involve the use of independent cost estimators as a way to develop an unbiased, consistent, and objective total cost estimate for the program. Reducing ground and space segment complexity—DOD has lessened the likelihood of problems in development by reducing the complexity of the program. Specifically, according to program officials, the contract for ground-based network operations was awarded before the space segment contract so that the competing space segment contractors could work toward a stable and more mature network design. In January 2006, DOD awarded a TMOS contract worth $2 billion to Lockheed Martin Integrated Systems and Solutions to start developing the overall network architecture and TMOS. Awarding this contract first will allow the competing space contractors to focus their satellite designs on a single architecture and mission operations system, thereby reducing program complexity. Incorporating software best-practices—Our review of the development plans for the software-intensive TMOS segment that is to interface with other networks like the GIG shows that DOD is also incorporating best practices in this area to mitigate program risks. Our previous work has identified and reported on three fundamental management strategies that are best practices for software development: (1) implementing an evolutionary approach, (2) following disciplined development processes, and (3) collecting and analyzing meaningful metrics to measure progress. First, the evolutionary approach includes setting requirements, establishing a stable design, writing code, and testing. Second, successful acquisitions require that developers demonstrate they have acquired the right knowledge before proceeding to the next development phase. Finally, metrics such as costs, schedule, size of a project, performance requirements, testing, defects, and quality provide evidence that the developer has acquired appropriate knowledge in moving from one phase to another. Although DOD’s software acquisition plans may incorporate these best practices, the potential for cost and schedule increases because of unforeseen software complexity is inherent in the development of a large quantity of software, as is needed for TSAT. To manage this risk, program officials stated that extensive and fully funded mitigation plans are in place and that the network contractor will be held to the best practices through program oversight and reporting. Heritage Technologies and Independent Tests Reduce Program Risk To reduce risk while developing the critical technologies for TSAT, DOD is leveraging decades of existing knowledge from heritage systems. For TSAT to be successful, DOD will have to integrate technologies that have been proven to work in other space systems, but now must be integrated into a single communication system. Officials at MIT’s Lincoln Laboratory, who are responsible for the independent testing and verification of TSAT technologies, stated that there are no fundamental discoveries or breakthroughs involved with developing TSAT. Rather, the enabling technologies build upon architectures and technologies developed across decades of space programs or experiments. However, officials at the Aerospace Corporation who are working closely with the TSAT program stated that there are risks involved in using heritage technologies— primarily integration risks—because the technologies must still be tested and evaluated to determine if they will work together as intended. The three main TSAT enabling technologies are onboard signal processing, networking, and laser communications. See table 2 below for a list of the critical technologies and a description of their purposes. TSAT is building upon the onboard signal processing developments in military satellite communications that started in the mid-1970s. These developments initially focused on providing highly robust communications, but over time have evolved to increased capacity and bandwidth, as well as enhanced efficiency. For example, the Lincoln Experimental Satellites (LES) 8 and 9, Milstar I and II, and Advanced Extremely High Frequency (AEHF) system have verified the onboard processing capabilities that will be used in TSAT. According to officials at the Lincoln Laboratory, much of the required technology for the network services for TSAT comes directly from the ground-based Internet. Further, TSAT is building on the successful achievements of previous space programs like DOD’s Milstar and AEHF satellites, the National Aeronautics and Space Administration’s (NASA) Advanced Communications Technology Satellite (ACTS), and the Spaceway and Astrolink satellites from the commercial sector. In addition to space-based signal processing, the TSAT satellites will use packet routing in space, faster data transmission, and Internet-like data transmission formats to produce the networking capability to extend worldwide network services to the user. TSAT will use high-rate laser communications to connect TSAT satellites into a global network and to provide readout from other space- and air- borne intelligence, surveillance, and reconnaissance (SISR/AISR) assets. According to Lincoln Laboratory officials, many of the needed components for TSAT’s laser communications are versions from commercial optical networking. A series of three systems developed by Lincoln Laboratory (Lincoln Experimental Satellites (LES) 8 and 9, Laser Intersatellite Transmission Experiment (LITE) and LITE-2, and GeoLITE) have and continue to demonstrate laser capabilities needed for TSAT. Moreover, recent programs like Lincoln Laboratory’s Airborne Lasercom Experiment (ALEX) are providing knowledge about how TSAT’s laser communications can be used to support AISR assets, and DOD’s Airborne Laser (ABL) is helping scientist to characterize certain limits of laser capabilities in atmospheric conditions, according to the officials. Appendixes III through V further highlight the history of the technology heritage being applied to TSAT. Remaining Gaps in Knowledge Could Hamper Successful Outcomes Despite these positive steps to lower program risks, DOD faces gaps in knowledge, as it begins to implement its new development approach, that could impede TSAT’s success. In 2006, DOD directed the program to follow an incremental development approach, changing the contents of the program. Under this approach, the program will deliver less capability in the first two satellites, and then more advanced capabilities as technologies mature and are incorporated into the remaining satellites. DOD has not fully assessed the value of the TSAT investment in light of major changes to the program. Historically, many new development programs in DOD have sought to quickly gain the latest capabilities, but because the technologies were not mature enough to make such leaps, programs were often in development for years while engineers continued to develop and mature the needed technologies. This increased both the time and cost required to develop the systems. An incremental approach, on the other hand, reduces risks by introducing less new content and technology into a design and development effort. The incremental approach for TSAT allows more time for the development of higher-performing capabilities, thereby potentially increasing the level of confidence in the launch date of the first satellite, planned for 2014. High-level DOD officials have agreed to these reduced capabilities up front, so the TSAT program now plans to deliver satellites that meet user requirements in an evolutionary manner. Notwithstanding the approval for the revised TSAT program from senior DOD officials, DOD has yet to justify the TSAT investment in light of other DOD investments using the knowledge it has now gained on cost, schedule, and initial capabilities to be delivered. For example, TSAT’s cost estimate has increased and the initial satellites will be less capable than originally expected. Furthermore, it is imperative, given the recent changes to the program, that DOD work with the TSAT user community to update requirements to ensure the timely delivery of promised capabilities. Finally, it does not appear that DOD has completely addressed all the unknowns concerning the relationship between TSAT and two of DOD’s other expensive and complex systems, namely the GIG and Space Radar. For example, work still remains in finalizing the requirements for these systems and understanding how the incrementally developed TSAT will satisfy the needs. Conclusions DOD has taken action to put itself in position to prove out critical technologies before initiating satellite development—an approach not typically seen in DOD’s space programs. DOD has taken further action to reduce program risk by changing to an incremental development approach. While this approach will reduce the capability of the first two satellites, it is a positive step in reducing program risk because the program will gain additional technical knowledge before integrating the more advanced technologies into the satellites. Even though DOD is taking such positive steps, TSAT is still expected to be one of the most ambitious, expensive, and complex space systems ever built. TSAT is being designed to transform military communication using Internet-like and laser capabilities—key integrations risks. Other weapon systems are to interface with it and will be highly dependent on it for their own success. While DOD is planning to undertake new systems, such as TSAT, broader analyses of the nation’s fiscal future indicate that spending for weapon systems may need to be reduced, rather than increased, given the constrained fiscal environment. Given these challenges and fiscal realities, it is prudent for DOD to reexamine the value and progress of TSAT before committing to building the full constellation of communication satellites. Recommendations for Executive Action To improve DOD’s transition to transformational communications by gaining the additional knowledge it needs before TSAT enters product development, we recommend that the Secretary of Defense direct the Under Secretary of the Air Force to take the following four actions: Reassess the value of TSAT in the broader context of other DOD investments, using updated knowledge on likely cost, schedule, technology, and initial capability; Update requirements in coordination with the TSAT user community; Prove that all critical technologies will work as intended; and Establish new cost, schedule, and performance goals for the program once the above knowledge has been gained. Agency Comments We provided a draft of this report to DOD for review and comment. DOD concurred with our recommendations and provided detail comments, which we have incorporated where appropriate. DOD’s letter is reprinted as appendix II. We plan to provide copies of this report to the Secretary of Defense, the Secretary of the Air Force, and interested congressional committees. We will also provide copies to others on request. In addition, the report will be available on the GAO website at http://www.gao.gov. If you or your staff has any questions concerning this report, please contact me at (202) 512-4841 or sullivanm@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to the report are Arthur Gallegos, Assistant Director, Tony Beckham, Noah B. Bleicher, G. Martin Campbell, Sharron Candon, Claire Cyrnak, Maria Durant, and Hai V. Tran. Appendix I: Scope and Methodology To assess the Department of Defense’s (DOD) progress toward achieving cost, schedule and performance goals for the Transformational Satellite Communications System (TSAT), we collected and reviewed (1) budget and expenditure plans, (2) acquisition planning documents, and (3) technology and readiness information to determine if the program was meeting its original goals. We compared changes in cost and schedule to original estimates and evaluated DOD’s plans for maturing the critical technologies against best practice standards to determine if they will sufficiently mature when DOD plans to start product development. We discussed this information with DOD officials in the Office of the Secretary of Defense, Program Analysis and Evaluation, Crystal City, Virginia; National Security Space Office, Chantilly, Virginia; Space and Missiles Systems Center, Los Angeles Air Force Base, California; and with officials at the Massachusetts Institute of Technology (MIT) Lincoln Laboratory, Boston, Massachusetts; and the Aerospace Corporation, El Segundo, California. To determine if the TSAT program is using an acquisition approach that will provide the knowledge it needs to proceed to product development, we collected and reviewed documents that described the TSAT program’s plans to build knowledge and to mitigate risks. We reviewed detailed documents related to capabilities, schedule, funding, and technology development for the revised acquisition strategy. We considered DOD’s current knowledge-building activities against DOD and GAO studies that discuss acquisition problems and associated challenges with acquisition programs—including work on best practices in weapon system development that we have conducted over the past decade. We analyzed the extent to which the TSAT program is using a knowledge-based approach to technology and product development. To do this, we focused on the whether the new acquisition approach will meet user requirements and match those needs to resources. We discussed DOD plans and efforts to meet user’s needs with DOD officials in the Military Satellite Communication Joint Program Office, Los Angeles Air Force Base, California; Directorate of Space Acquisition, Office of the Under Secretary of the Air Force, Arlington, Virginia; and Office of the Assistant Secretary of Defense (Networks and Information Integration), Arlington, Virginia. We performed our work from August 2005 through March 2006 in accordance with generally accepted government auditing standards. Appendix II: Comments from the Department of Defense Appendix III: Onboard Signal Processing Technology Heritage Lincoln Experimental Satellites (LES) 8 and 9 First satellites to use onboard signal processing, spread spectrum techniques (frequency hopping) to demonstrate protected military satellite communications, and radio frequency (RF) crosslink capability. Onboard signal processing; spread spectrum satellite communications; and satellite-to- satellite crosslinks. Built by MIT Lincoln Laboratory and hosted on the operational FLTSATCOM satellites 7 and 8 (built by TRW). These packages provided the first satellite communications at extremely high frequency (EHF) on the uplink and super high frequency (SHF) on the downlink. Multichannel onboard signal processing; EHF/SHF spread spectrum satellite communications; and onboard control for circuit switching. Satellites provided the first strategic/tactical operational satellite using the EHF/SHF. Satellites also provided narrower spot beam coverage and electronically agile beam coverage to provide enhanced service to small, dispersed user terminals. Combined strategic/tactical service at EHF, narrow beam antenna coverage, electronically steered antenna coverage; and intersatellite crosslinks. Satellites provided enhanced capacity and protection through the addition of a medium data rate (MDR) payload through narrow spot beam antennas. Satellite capacity was more than 10 times greater than Milstar I. Extension of EHF waveform to higher rates. improved protection via active antenna discrimination (nulling). Advanced EHF (AEHF) The Advanced EHF (AEHF) system provides a further increase in the capability of EHF satellite communications by increasing both the total satellite throughput by another factor of 10 and by increasing the data rate available to individual terminals. The extended data rate (XDR) waveform supports data rates from 75 to 8,192,000 bytes per second for individual terminals. Binary bandwidth efficient waveforms for EHF, improved support for small terminals, and onboard processing technologies for increased satellite throughput. Appendix IV: Networking Technology Heritage The Milstar satellites were the first satellite payloads to use onboard processing and onboard switching of user signals. The AEHF system further developed space-based signal processing technology, providing more capacity and higher data rates. NASA Advanced Communications Technology Satellite (ACTS) This satellite produced many important studies of networking protocol behavior (such as Transmission Control Protocol/Internet Protocol: TCP/IP) in a combined space and terrestrial environment. Provided performance measurements for IP, and increased the class payload processing rate to more than 100 megabytes per second. These are the first satellites designed to perform packet switching in space. The Astrolink system was never launched because of a sudden market downturn in the telecommunications industry. However, the first payload was essentially completed before market conditions caused cancellation of the deployment. The first Spaceway satellite is now onorbit and operational, and launch of the second is planned in the near future. Lessons include how to build packet processing and routing hardware and software for use in space in the gigabytes per second data rate class. Appendix V: Lasercom Technology Heritage Lincoln Experimental Satellites (LES) 8 and 9 The LES-8/9 satellites built by Lincoln Laboratory in the mid-1970’s were originally slated to use lasercom crosslinks. The development of these crosslinks was impaired by the lack of an industry base for the necessary optical components and was abandoned in favor of RF links. Development of a fiber-based architecture, and use of space- qualified commercial fiber-optic components. The LITE lasercom terminal developed by Lincoln Laboratory was able to capitalize on commercial parts to leverage its large-scale production processes. In the early 1990s, as commercial fiber optic components became available, the LITE-2 terminal was developed. It used a new fiber-based architecture with remote optics. The ability to remote the telescope and other free space optics from the High Power Optical Amplifier and modem dramatically simplifies spacecraft integration. Telescope, optical module, fiber- based high power optical amplifier, modem, and high-rate lasercom. Built in the late 1990’s by Lincoln Laboratory and flown aboard a Northrop-Grumman (TRW) satellite. The GeoLITE experiment (launched in 2001) used the fiber-based architecture developed under the LITE-2 program. The lasercom payload continues to send telemetry from critical subsystems that provide insight into the lifetime of optical components in space. Same as in LITE and LITE-2, demonstrating all of the capabilities needed for the TSAT mission. Airborne Lasercom Experiment (ALEX) ALEX, built by Lincoln Laboratory, successfully demonstrated the capabilities necessary for air- space lasercom. While ALEX focused on the airborne terminal, it demonstrated an understanding of the channel that is relevant to TSAT lasercom AISR support. Airborne Laser (ABL) program The ABL program has performed numerous experiments characterizing the propagation of optical wavefronts through various airborne environments. These data are relevant to the TSAT Air-Space link. Atmospheric and airborne platform boundary characterizations. Appendix VI: Technology Readiness Levels Appendix VI: Technology Readiness Levels Lowest level of technology readiness. Scientific research begins to be translated into applied research and development. Examples might include paper studies of a technology’s basic properties. None (Paper studies and analysis) Invention begins. Once basic principles are observed, practical applications can be invented. The application is speculative and there is no proof or detailed analysis to support the assumption. Examples are still limited to paper studies. None (Paper studies and analysis) Active research and development is initiated. This includes analytical studies and laboratory studies to physically validate analytical predictions of separate elements of the technology. Examples include components that are not yet integrated or representative. Analytical studies and demonstration of nonscale individual components (pieces of subsystem). Basic technological components are integrated to establish that the pieces will work together. This is relatively “low fidelity” compared to the eventual system. Examples include integration of “ad hoc” hardware in a laboratory. Low fidelity breadboard. Integration of nonscale components to show pieces will work together. Not fully functional or form or fit but representative of technically feasible approach suitable for flight articles. Fidelity of breadboard technology increases significantly. The basic Technological components are integrated with reasonably realistic supporting elements so that the technology can be tested in a simulated environment. Examples include “high fidelity” laboratory integration of components. High fidelity breadboard. Functionally equivalent but not necessarily form and/or fit (size weight, materials, etc.). Should be approaching appropriate scale. May include integration of several components with reasonably realistic support elements/ subsystems to demonstrate functionality. Lab demonstrating functionality but not form and fit. May include flight demonstrating breadboard in surrogate aircraft. Technology ready for detailed design studies. Prototype—Should be very close to form, fit and function. Probably includes the integration of many new components and demonstration or limited/ restricted flight demonstration for a relevant environment. environment. needed to demonstrate full functionality of the subsystem. well defined. Prototype near or at planned operational system. Represents a major step up from TRL 6, requiring the demonstration of an actual system prototype in an operational environment, such as in an aircraft, vehicle or space. Examples include testing the prototype in a test bed aircraft. Prototype. Should be form, fit and function integrated with other key supporting elements/ subsystems to demonstrate full functionality of subsystem. Flight demonstration in representative operational environment such as flying test bed or demonstrator aircraft. Technology is well substantiated with test data. Technology has been proven to work in its final form and under expected conditions. In almost all cases, this TRL represents the end of true system development. Examples include developmental test and evaluation of the system in its intended weapon system to determine if it meets design specifications. Actual application of the technology in its final form and under mission conditions, such as those encountered in operational test and evaluation. In almost all cases, this is the end of the last “bug fixing” aspects of true system development. Examples include using the system under operational mission conditions.

The Department of Defense (DOD) wants to create a networked force where soldiers and systems are able to operate together seamlessly. To help facilitate this transformation, DOD began the Transformational Satellite Communications System (TSAT) program in January 2004. We reported in 2003 that TSAT was about to begin without sufficiently mature technology. In this report, at your request, we followed up with an assessment of (1) how the TSAT program is progressing, and (2) whether the program is using an acquisition approach that will provide the knowledge needed to enter product development. The Department of Defense is not meeting original cost, schedule, and performance goals established for the TSAT program. When the program was initiated in 2004, DOD estimated TSAT's total acquisition cost to be $15.5 billion and that it would launch the first satellite in April 2011. TSAT's current formal cost estimate is nearly $16 billion and the initial launch date has slipped to September 2014--a delay of over three years. Furthermore, while the performance goal of the full five-satellite constellation has not changed, the initial delivery of capability will be less than what DOD originally planned. After DOD established initial goals for TSAT, Congress twice reduced the program's funding due to concerns about technology maturity and the aggressiveness of the acquisition schedule. DOD developed the initial goals before it had sufficient knowledge about critical TSAT technologies. DOD is taking positive steps to lower risk in the TSAT program so it can enter the product development phase with greater chance of success. However, as DOD prepares to implement a new incremental development approach for the program, it faces gaps in knowledge that could hamper its success. An incremental development will mean reduced capabilities in the initial satellites and more advanced capabilities in the remaining satellites. Given this change, it will be important for DOD to update requirements in coordination with the TSAT user community. While senior DOD officials have agreed to these reduced capabilities to get the first satellite launched in 2014, DOD has yet to reevaluate its investment in TSAT in light of other DOD investments using the knowledge it has now gained. Using this new knowledge, DOD could be in a better position to set more realistic goals, before entering product development.

Project Schedules Have Been Revised but Not Fully Evaluated While work in several areas has moved forward since the Subcommittee’s September 15 CVC hearing, additional delays have been encountered, and project schedules have been revised but not fully reviewed or evaluated. Construction work has continued on the CVC, the East Front, the plaza, the House and Senate expansion spaces, and the utility tunnel since the Subcommittee’s September 15 hearing. For example, wall stone installation work has continued in the great hall, the orientation theaters, and the auditorium, and the number of stone masons working in the interior of the CVC has increased since mid August. Some stone masons worked on weekends between mid August and mid September. In addition, excavation, concrete, and piping work in the utility tunnel has been proceeding, as has mechanical, electrical, and plumbing work in the CVC. On the other hand, between the Subcommittee’s September 15 hearing and October 12, the sequence 2 contractor completed work on only 3 of the 11 activities we and AOC have been tracking for the Subcommittee. None of these activities had been completed by the target dates shown in the contractor’s April 2005 baseline schedule, although one was completed by the date shown in the contractor’s June 2005 schedule. (See app. I.) Furthermore, additional delays have occurred on interior and exterior stonework installation, the East Front, the utility tunnel, and the House connector tunnel. For example, according to AOC’s construction management contractor, during September, the sequence 2 contractor gained only 12 workdays on critical interior stonework and 10 workdays on the utility tunnel out of a possible 21 days of work. According to the construction management contractor, stonework has been delayed due a shortage of stone masons, a lack of critical pieces of stone, the need to do remedial concrete work in the orientation theaters and along the exterior concrete walls and interior concrete floors of the auditorium, and delays in getting shop drawings for stonework on the East Front. According to AOC’s construction management contractor, excavation work on First Street for the utility tunnel has been delayed due to unforeseen conditions and the need to stop work for the former Chief Justice’s funeral at the Supreme Court, and unforeseen conditions have also delayed work on the House connector tunnel. During September, the sequence 2 contractor changed the manner in which the HVAC and Fire Protection system’s commissioning work and acceptance testing would be done, with the potential result of a time savings. The changes largely involved re-sequencing work and doing work concurrently that the August schedule showed would be done sequentially. According to the contractor’s revised schedule, these changes will result in an improvement of over 60 workdays and bring the scheduled completion date for this work to December 11, 2006, compared to the February 26, 2007, date shown in the August schedule. However, these changes have not yet been fully evaluated. AOC and its construction management contractor are reviewing the changes, as is AOC’s Chief Fire Marshal. AOC and its construction management contractor believe it will take about 30 to 60 days to complete their assessments, and AOC’s Chief Fire Marshal believes that he may have his evaluation done before the end of October. Altogether, the construction management contractor has identified a total of 11 critical activity paths in the September schedule that will extend the base project’s completion date beyond AOC’s September 15, 2006, target date if expected lost time cannot be recovered or further delays cannot be prevented. In addition to the critical paths related to the HVAC system and the fire alarm system that are discussed above, examples of other base project critical path activities included in the contractor’s September schedule are utility tunnel and piping, stonework in the East Front, interior wall stone in such areas as the orientation theaters and atria, stonework in the auditorium and exhibit gallery, millwork and casework installation in the orientation theaters and atria, fabrication and installation of bronze doors, and penthouse mechanical work. Of the 11 critical activity paths in the September schedule, completion dates for 4 paths improved compared to the August schedule, but completion dates for the other 7 paths, including all of the stonework paths, slipped. For example, according to the construction management contractor, the September schedule shows all of the work associated with the fire alarm testing critical path being completed by November 22, 2006, an improvement over the August schedule’s date of February 26, 2007; the September schedule also shows all of the work associated with the interior auditorium wall stone critical path being completed by December 12, 2005, more than a month later than the August schedule’s date of November 2, 2005. The sequence 2 contractor’s September 2005 schedule indicates that construction work on the base CVC will be essentially complete by September 15, 2006, and that remaining work between that date and December 11, 2006, will largely consist of testing, balancing, and commissioning the HVAC system; testing and inspecting the fire protection system; punch-list work; and preparing for operations. Most of the activities discussed above are among the activities we previously identified as likely having optimistic durations, suggesting that it could take even longer to complete them than shown in the project schedule. These activities served as the basis for the recommendation we made to AOC during the Subcommittee’s September 15 hearing that AOC rigorously evaluate the durations for the activities shown in the project schedule. According to AOC, it has not yet completed this evaluation. Moreover, we continue to believe that having such a large number of critical activity paths complicates project management and makes on-time completion more difficult. AOC’s construction management contractor has continued to integrate various component schedules into the CVC construction and summary schedules as they have been completed, and the integrated schedule contains about 6,500 activities. Consequently, AOC now has a summary schedule that integrates the completion of CVC and House and Senate expansion space construction with preparations necessary for opening the CVC to the public. This integrated summary schedule shows CVC construction as well as the activities necessary for opening the CVC to the public being completed by mid December 2006, the time AOC proposed last month for opening the CVC to the public. That is, AOC expects construction work on the base CVC project to be substantially completed by September 15, 2006, but expects such work as HVAC commissioning, fire protection system testing and inspection, punch-list work, and operations preparations work to be ongoing until December 15, 2006. According to AOC’s sequence 2 and construction management contractors, it is not yet clear whether expansion space construction will have progressed to the point where temporary work for fire safety once believed to be necessary to open the CVC to the public will no longer have to be done. They said that they are still analyzing the work associated with those areas where the base project interfaces with the expansion spaces and whether and how the need for temporary work for fire safety can be minimized or eliminated. Although the sequence 2 contractor has taken, plans to take, and is considering various actions to recover lost time and prevent or mitigate further delays, we continue to believe that the contractor will have difficulty completing construction before early to mid 2007. Our reasons for concern include the uncertainty associated with the September changes in the HVAC commissioning and fire protection system schedules that have not yet been fully reviewed, the schedule slippages to date, optimistic durations for a number of activities based on the views of CVC team members, the large number of activity paths that are critical, and risks and uncertainties that continue to face the project. AOC’s construction management contractor also points out that further delays could result from congressional requests to stop work due to high noise levels in the East Front and delays in completing CVC ceiling work necessary for the HVAC and fire protection systems, although the CVC team is considering ways to mitigate these risks. We also note that the Chief Fire Marshal has not yet approved the construction drawings for the fire protection system or the schedule for the system’s commissioning and testing. In addition to our views on the project’s September schedule changes and progress, we would also like to briefly discuss several schedule-related issues about which we have previously raised questions or issues or made recommendations to AOC. We have been recommending for some time that AOC improve schedule management and analyze and document delays and the reasons and responsibilities for them on an ongoing basis—at least monthly. We have noted considerable improvements in the CVC team’s schedule analysis and management since the arrival of the construction management contractor’s project control engineer several months ago. Shortly after his arrival, the scope and depth of schedule analysis and management improved significantly, and AOC’s construction management contractor modified its monitoring process to capture information on delays. However, we continue to be concerned about AOC’s not having adequate information systematically compiled and analyzed to fully evaluate the causes and potential responsibilities for delays on an ongoing basis. In our view, not having this type of information on an ongoing basis is likely to create problems later on should disputes arise and knowledgeable staff leave. Also, in this regard, we have previously expressed concerns about the need for the project schedule to show resources to be applied to meet schedule dates. While the sequence 2 contractor has shown proposed resource levels for many activities, proposed resource levels have not been included for many of the new activities added to the project schedule. The lack of such information can complicate the analysis of delays, including their causes and costs. AOC agreed that these issues are important and said it would discuss them with its construction management contractor. We have previously recommended that AOC develop risk mitigation plans to address risks and uncertainties facing the project. In July, AOC asked one of its consultants—MBP—to assist it in identifying risks and developing plans to address those risks. AOC has identified over 50 risks facing the project and established a process for addressing them. AOC has begun to develop and implement plans for managing these risks. As of October 11, AOC had developed plans for addressing 12 risks, such as unforeseen conditions associated with constructing the House connector tunnel, and fabrication and installation of custom bronze doors and windows. AOC said that it will continue to develop plans for the remaining risks. It also plans to discuss the risks at a weekly meeting and add new risks to its list and develop mitigation plans for them as they are identified. The September schedule shows utility tunnel construction being completed in February 2006 and CVC’s air handlers beginning to operate at that time, assuming that they can get steam and chilled water from the Capitol Power Plant. During our September 15 testimony, we noted several problems associated with CPP that could adversely affect the CVC as well as other congressional buildings if not corrected or addressed. These problems included, for example, potential delays in completing the West Refrigeration Plant Expansion Project, which is necessary to provide chilled water to the CVC; the removal from service of two chillers in the East Refrigeration Plant because of refrigerant gas leaks; fire damage to a steam boiler; and staffing and training issues associated with operating the new plant and the absence of a CPP director. Since the Subcommittee’s September 15 CVC hearing, the fire damage to the boiler has been repaired, and the two coal-burning boilers that were taken off line for maintenance had been put back on line; however, another maintenance problem occurred with one of the boilers and it had to be turned off for repairs, which AOC expects to have completed by the end of this week. Also, over the Columbus Day weekend, heavy rains caused damage to electrical equipment that resulted in a power outage affecting the entire plant. Power was restored within a few hours; however, because of damage to the electrical equipment, power is not available at certain locations within the plant. In particular, one of the chillers in the East Plant is inoperable because power cannot be provided to it. This incident prompted AOC to make a change that affects the West Refrigeration Plant Expansion Project. Specifically, AOC has decided to reconfigure the chilled water piping system to allow the West Plant to operate in isolation of West Plant Expansion. This change, which could result in an increase to the contract cost, will decrease CPP’s reliance on the older East Plant and will enhance its capacity to reliably provide chilled water to the CVC and other congressional buildings. Finally, AOC recently advertised the vacant director’s position. At this time, GAO has an active engagement to assess certain CPP issues, such as staffing and training for, and the estimated cost to complete, the West Refrigeration Plant Expansion Project. This engagement is being conducted as part of a separate review for the Subcommittee. Although AOC determined that the sequence 1 work was substantially complete in November 2004, the sequence 1 contractor has continued to work on punch-list items. Since the Subcommittee’s September 15 CVC hearing, AOC’s construction management contractor added about 15 additional work items to this list, such as chipping concrete interfering with wall stone installation and repairing drains. According to AOC’s construction management contractor, the sequence 1 contractor has been making satisfactory progress in completing the punch-list work. Fire Protection System Issues Are in the Process of Being Resolved The CVC’s fire protection system is complicated, interfaces with security and other building systems, and encompasses a variety of subsystems and components, such as smoke and heat detectors, an alarm system, a sprinkler system, a smoke evacuation system, door locks that will open in the event of a fire, monitoring and control systems, emergency signage, lighting, communication, and a system for preventing smoke from entering stairwells—referred to as stair pressurization—to allow occupants to get out of the building. We have identified three issues related to the fire protection system, each of which we would like to briefly discuss. 1. Evolving design: The CVC’s fire protection system has undergone a number of design changes and has been the subject of debate among relevant stakeholders for a number of reasons, largely due to conflicts between security and life and fire safety requirements. According to AOC, the building codes governing the design of the CVC often conflict with security requirements, do not recognize the unique security needs of the Capitol, and are particularly silent when it comes to the integration of new air filtration technologies. In addition, AOC said that security requirements and the decision to add state-of-the art air filtration technology to the project when the construction documents were almost complete forced the project team to redesign all of the air handling systems in a compressed timeframe in order to maintain the overall schedule. It also forced the project team to devise a complex design solution with AOC’s Chief Fire Marshal and USCP while sequence 2 was out for bid as well as after the contract had been awarded. On October 5, we attended meetings of representatives from the CVC project team, AOC’s Fire Marshal Division, and USCP where issues surrounding the CVC’s fire protection system were discussed. Based on those discussions and information subsequently provided by AOC and USCP, it appears to us that the design of the CVC’s fire protection system is now essentially complete and agreed to by all of the relevant stakeholders. The CVC project team and the Chief Fire Marshal note, however, that not all of the shop drawings related to the fire protection system have been submitted or approved, and some issues could arise during the review process. 2. Increased cost: As of September 30, executed contract modifications and anticipated changes related to CVC’s fire protection system totaled about $5.3 million, with most of this amount, about $4.4 million, being estimated costs for anticipated changes that have not been fully evaluated or approved. Changes to the system’s design and scope already made have resulted in about $900,000 in cost increases. Costs for changes that have been made or that are anticipated have increased or are expected to increase for several reasons, but the bulk of the increases stems largely from two factors—changes requested by AOC’s Chief Fire Marshal aimed at ensuring that the system meets fire safety standards based on his interpretation of code requirements (an area where conflict existed between fire safety and security requirements) and a disagreement between AOC and a contractor on contract requirements regarding certain detection devices. The most costly change involving the security/fire safety conflict that the CVC team has agreed to relates to the manner in which fresh air will be brought into the building to pressurize stairwells to prevent smoke infiltration in the event of a fire. The estimated costs for this change (including the expansion space) amount to about $2.2 million, or over 40 percent of the estimated increased costs for the fire protection system. Differences of opinion among CVC team members exist on the magnitude of the estimated costs for this change. We have discussed this issue with AOC, and it has agreed to fully evaluate the cost before it executes additional contract modifications relating to stair pressurization. The final costs for the stair pressurization and detection devices in question as well as the other anticipated changes could change significantly from the estimated amounts once any open issues regarding costs are resolved. It is also possible that some of the proposed change orders include work items that are not related to the CVC’s fire protection system, and to the extent this situation exists, costs for such work items would not be attributable to the fire protection system. 3. Coordination problems: The CVC project team and AOC’ s Fire Marshal Division have been experiencing difficulties arranging for timely inspections of completed work due to coordination problems involving the amount of notice and documentation needed before inspections can occur. To improve coordination, the CVC project team has been working with its construction management contractor and the Chief Fire Marshal to develop a systematic process for arranging for and documenting fire safety inspections and is considering hiring a consultant to help facilitate the coordination process. The Chief Fire Marshal has increased staffing devoted to the CVC and is planning to obtain contract support to help perform CVC inspections. The Chief Fire Marshal is also reviewing the sequence 2 contractor’s September 2005 schedule to determine whether the sequencing of work and the time allotted for fire safety and occupancy inspections are acceptable. Our Project Cost Estimate Update Awaits Assessment of Consultant Estimate and Schedule Stabilization; Funding Provided Has Not Changed Since September 2005 AOC’s consultant—MBP—finished its work last week to update the estimated cost to complete the project. We have not yet had time to evaluate MBP’s report. Also, as we said during the Subcommittee’s September 15 CVC hearing, we are waiting for the project schedule to stabilize before we begin our work to comprehensively update our November 2004 estimate of the cost to complete the project. Thus, we are not revising our interim updated estimated cost to complete the project of between $525.6 million and about $559 million that we discussed at the Subcommittee’s September 15 CVC hearing. As soon as we evaluate MBP’s report and the project schedule stabilizes, we will begin our work to assess the reasonableness of the scheduled completion dates for the CVC and the House and Senate expansion spaces and comprehensively update our estimate of the cost to complete the project. No additional funding beyond the $527.9 million for construction and the $7.8 million that was available for CVC construction or operations has been provided for the project since the Subcommittee’s September 15 hearing. As you may recall, Mr. Chairman, at your last CVC hearing, we expressed concern about possible duplication of work and costs in areas where the responsibilities of AOC’s CVC construction and operations contractors overlap, such as in designing wayfinding signage and the gift shops. AOC agreed to work with its operations planning contractor to clarify the contractor’s scope of work, eliminate any duplication, and adjust the operations contract’s funding accordingly. AOC told us that it has discussed these issues with its contractor and concluded that while no duplication of work or funding exists, it needs to clarify the contract’s scope of work on wayfinding signage because it included more work than the contractor would actually do. Mr. Chairman, this concludes our statement. We would be pleased to answer any questions that you or Members of the Subcommittee may have. Contacts and Acknowledgments For further information about this testimony, please contact Bernard Ungar at (202) 512-4232 or Terrell Dorn at (202) 512-6923. Other key contributors to this testimony include Shirley Abel, Michael Armes, John Craig, George Depaoli, Maria Edelstein, Brett Fallavollita, Jeanette Franzel, Jackie Hamilton, Bradley James, Scott Riback, Kris Trueblood, and Alwynne Wilbur. Appendix I: Capitol Visitor Center Critical Construction Target Dates September 16 – October 18, 2005 June 2005 Scheduled Finish Date *This activity was not noted listed in the April schedule. All other activities were critical in the April schedule or became critical in subsequent schedules. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

GAO testified before Congress on the progress on the Capitol Visitor Center (CVC) project. Our remarks will focus on (1) the Architect of the Capitol's (AOC) progress in managing the project's schedule since Congress's September 15 hearing on the project, (2) issues associated with the CVC's fire protection system, and (3) the project's costs and funding. Our ability to fully address these issues is limited by two important factors. First, AOC's sequence 2 construction contractor's--Manhattan Construction Company--September 2005 schedule reflects a number of significant changes, and AOC has not yet had the opportunity to fully evaluate these changes. Second, neither AOC nor its construction management contractor--Gilbane Building Company--has completed the evaluation of elements of the project schedule that we recommended during Congress's September 15 hearing. Thus, while we will discuss the schedule's status, we will not be able to provide specific estimated completion dates until AOC and its construction management contractor complete their assessments and we have the opportunity to evaluate them. Similarly, while we will discuss the status of the project's costs and funding, we will wait until the project schedule is fully reviewed and stabilized and we have had an opportunity to evaluate AOC's consultant's, McDonough Bolyard Peck (MBP), cost-estimation work before we comprehensively update our November 2004 estimate of the cost to complete the project. AOC and its construction contractors have made progress in managing the schedule and accomplishing work since Congress's September 15 CVC hearing, but additional delays have been encountered. Work on all interior levels of the CVC, various sections of the House and Senate expansion spaces, the plaza, and the utility tunnel has continued. However, additional delays have occurred in a number of areas. For example, despite an increase in the number of stone masons working on the project in September, the project lost about 2 weeks on interior stone work installation and a similar amount of time on the utility tunnel. The design of the CVC's fire protection system has undergone a number of changes--largely to reconcile conflicts between security and life and fire safety requirements--and in a number of instances has been the focus of considerable debate among stakeholders (e.g. CVC project team members, AOC's Chief Fire Marshal and AOC fire protection engineers, and USCP representatives). Changes to the system's design and scope have resulted in about $900,000 in cost increases so far and could result in additional increased costs of about $4.4 million based on anticipated changes as of September 30, 2005. The bulk of the potential $5.3 million cost increase stems from two factors--a change in the manner smoke will be kept from egress stairwells that was requested by AOC's Chief Fire Marshal and agreed to by the stakeholders and which resolves a conflict between security and life and fire safety requirements, and a disagreement between AOC and a contractor over contract requirements for certain detection devices. The increased cost figure could change significantly, however, because some CVC project team members believe that the estimated costs for these changes are too high, costs for all proposed or anticipated changes have not yet been fully evaluated, and negotiations relative to the estimated $4.4 million in anticipated changes have not been completed. We have discussed the costs associated with the stairwell change with AOC, and it has agreed to fully evaluate the situation before it executes any additional contract modifications for this change. Based on our discussions with the CVC project team, AOC's Chief Fire Marshal, and USCP representatives, it appears that the fire protection system design is now essentially complete and agreed to by all the stakeholders. Finally, coordination problems have existed between the CVC project team and AOC's Chief Fire Marshall in arranging for inspections of completed work, but steps are being taken to resolve the problems. We have not updated our interim estimate of a cost of between $525.6 million and about $559 million to complete the project, which we reported at Congress's September 15 CVC hearing, because AOC's consultant just completed its updated cost estimate and we have not yet had the opportunity to evaluate it, and because the project schedule has not yet stabilized. As soon as we evaluate MBP's report and the project schedule stabilizes, we will begin our work to reassess the reasonableness of project completion dates and comprehensively update our cost-tocomplete estimate. No additional funding beyond the $527.9 million for CVC construction and the $7.8 million that remained available for CVC operations or construction that we reported at Congerss's last CVC hearing has been provided for the CVC.

Background Child pornography is prohibited by federal statutes, which provide for civil and criminal penalties for its production, advertising, possession, receipt, distribution, and sale. Defined by statute as the visual depiction of a minor—a person under 18 years of age—engaged in sexually explicit conduct, child pornography is unprotected by the First Amendment, as it is intrinsically related to the sexual abuse of children. In the Child Pornography Prevention Act of 1996, Congress sought to prohibit images that are or appear to be “of a minor engaging in sexually explicit conduct” or are “advertised, promoted, presented, described, or distributed in such a manner that conveys the impression that the material is or contains a visual depiction of a minor engaging in sexually explicit conduct.” In 2002, the Supreme Court struck down this legislative attempt to ban “virtual” child pornography in Ashcroft v. The Free Speech Coalition, ruling that the expansion of the act to material that did not involve and thus harm actual children in its creation is an unconstitutional violation of free speech rights. According to government officials, this ruling may increase the difficulty of prosecuting those who produce and possess child pornography. Defendants may claim that pornographic images are of “virtual” children, thus requiring the government to establish that the children shown in these digital images are real. The Internet Has Emerged as the Principal Tool for Exchanging Child Pornography Historically, pornography, including child pornography, tended to be found mainly in photographs, magazines, and videos. With the advent of the Internet, however, both the volume and the nature of available child pornography have changed significantly. The rapid expansion of the Internet and its technologies, the increased availability of broadband Internet services, advances in digital imaging technologies, and the availability of powerful digital graphic programs have led to a proliferation of child pornography on the Internet. According to experts, pornographers have traditionally exploited—and sometimes pioneered—emerging communication technologies—from the dial-in bulletin board systems of the 1970s to the World Wide Web—to access, trade, and distribute pornography, including child pornography. Today, child pornography is available through virtually every Internet technology (see table 1). Among the principal channels for the distribution of child pornography are commercial Web sites, Usenet newsgroups, and peer-to-peer networks. Web sites. According to recent estimates, there are about 400,000 commercial pornography Web sites worldwide, with some of the sites selling pornographic images of children. The child pornography trade on the Internet is not only profitable, it has a worldwide reach: recently a child pornography ring was uncovered that included a Texas-based firm providing credit card billing and password access services for one Russian and two Indonesian child pornography Web sites. According to the U.S. Postal Inspection Service, the ring grossed as much as $1.4 million in just 1 month selling child pornography to paying customers. Usenet. Usenet newsgroups also provide access to pornography, with several of the image-oriented newsgroups being focused on child erotica and child pornography. These newsgroups are frequently used by commercial pornographers who post “free” images to advertise adult and child pornography available for a fee from their Web sites. Peer-to-peer networks. Although peer-to-peer file-sharing programs are largely known for the extensive sharing of copyrighted digital music, they are emerging as a conduit for the sharing of pornographic images and videos, including child pornography. In a recent study by congressional staff, a single search for the term “porn” using a file-sharing program yielded over 25,000 files. In another study, focused on the availability of pornographic video files on peer-to-peer sharing networks, a sample of 507 pornographic video files retrieved with a file-sharing program included about 3.7 percent child pornography videos. Several Agencies Have Law Enforcement Responsibilities Regarding Child Pornography on Peer-to-Peer Networks Table 2 shows the key national organizations and agencies that are currently involved in efforts to combat child pornography on peer-to-peer networks. The National Center for Missing and Exploited Children (NCMEC), a federally funded nonprofit organization, serves as a national resource center for information related to crimes against children. Its mission is to find missing children and prevent child victimization. The center’s Exploited Child Unit operates the CyberTipline, which receives child pornography tips provided by the public; its CyberTipline II also receives tips from Internet service providers. The Exploited Child Unit investigates and processes tips to determine if the images in question constitute a violation of child pornography laws. The CyberTipline provides investigative leads to the Federal Bureau of Investigation (FBI), U.S. Customs, the Postal Inspection Service, and state and local law enforcement agencies. The FBI and the U.S. Customs also investigate leads from Internet service providers via the Exploited Child Unit’s CyberTipline II. The FBI, Customs Service, Postal Inspection Service, and Secret Service have staff assigned directly to NCMEC as analysts. Two organizations in the Department of Justice have responsibilities regarding child pornography: the FBI and the Justice Criminal Division’s Child Exploitation and Obscenity Section (CEOS). The FBI investigates various crimes against children, including federal child pornography crimes involving interstate or foreign commerce. It deals with violations of child pornography laws related to the production of child pornography; selling or buying children for use in child pornography; and the transportation, shipment, or distribution of child pornography by any means, including by computer. CEOS prosecutes child sex offenses and trafficking in women and children for sexual exploitation. Its mission includes prosecution of individuals who possess, manufacture, produce, or distribute child pornography; use the Internet to lure children to engage in prohibited sexual conduct; or traffic in women and children interstate or internationally to engage in sexually explicit conduct. Two other organizations have responsibilities regarding child pornography: the Customs Service (now part of the Department of Homeland Security) and the Secret Service in the Department of the Treasury. The Customs Service targets illegal importation and trafficking in child pornography and is the country’s front line of defense in combating child pornography distributed through various channels, including the Internet. Customs is involved in cases with international links, focusing on pornography that enters the United States from foreign countries. The Customs CyberSmuggling Center has the lead in the investigation of international and domestic criminal activities conducted on or facilitated by the Internet, including the sharing and distribution of child pornography on peer-to-peer networks. Customs maintains a reporting link with NCMEC, and it acts on tips received via the CyberTipline from callers reporting instances of child pornography on Web sites, Usenet newsgroups, chat rooms, or the computers of users of peer-to-peer networks. The center also investigates leads from Internet service providers via the Exploited Child Unit’s CyberTipline II. The U.S. Secret Service does not investigate child pornography cases on peer-to-peer networks; however, it does provide forensic and technical support to NCMEC, as well as to state and local agencies involved in cases of missing and exploited children. Peer-to-Peer Applications Provide Easy Access to Child Pornography Child pornography is easily shared and accessed through peer-to-peer file- sharing programs. Our analysis of 1,286 titles and file names identified through KaZaA searches on 12 keywords showed that 543 (about 42 percent) of the images had titles and file names associated with child pornography images. Of the remaining files, 34 percent were classified as adult pornography, and 24 percent as nonpornographic (see fig. 1). No files were downloaded for this analysis. The ease of access to child pornography files was further documented by retrieval and analysis of image files, performed on our behalf by the Customs CyberSmuggling Center. Using 3 of the 12 keywords that we used to document the availability of child pornography files, a CyberSmuggling Center analyst used KaZaA to search, identify, and download 305 files, including files containing multiple images and duplicates. The analyst was able to download 341 images from the 305 files identified through the KaZaA search. The CyberSmuggling Center analysis of the 341 downloaded images showed that 149 (about 44 percent) of the downloaded images contained child pornography (see fig. 2). The center classified the remaining images as child erotica (13 percent), adult pornography (29 percent), or nonpornographic (14 percent). These results are consistent with the observations of NCMEC, which has stated that peer-to-peer technology is increasingly popular for the dissemination of child pornography. However, it is not the most prominent source for child pornography. As shown in table 3, since 1998, most of the child pornography referred by the public to the CyberTipline was found on Internet Web sites. Since 1998, the center has received over 76,000 reports of child pornography, of which 77 percent concerned Web sites, and only 1 percent concerned peer-to-peer networks. Web site referrals have grown from about 1,400 in 1998 to over 26,000 in 2002—or about a nineteenfold increase. NCMEC did not track peer-to-peer referrals until 2001. In 2002, peer-to-peer referrals increased more than fourfold, from 156 to 757, reflecting the increased popularity of file-sharing programs. Juvenile Users of Peer-to-Peer Applications May Be Inadvertently Exposed to Pornography Juvenile users of peer-to-peer networks face a significant risk of inadvertent exposure to pornography when searching and downloading images. In a search using innocuous keywords likely to be used by juveniles searching peer-to-peer networks (such as names of popular singers, actors, and cartoon characters), almost half the images downloaded were classified as adult or cartoon pornography. Juvenile users may also be inadvertently exposed to child pornography through such searches, but the risk of such exposure is smaller than that of exposure to pornography in general. To document the risk of inadvertent exposure of juvenile users to pornography, the Customs CyberSmuggling Center performed KaZaA searches using innocuous keywords likely to be used by juveniles. The center image searches used three keywords representing the names of a popular female singer, child actors, and a cartoon character. A center analyst performed the search, retrieval, and analysis of the images. These searches produced 157 files, some of which were duplicates. From these 157 files, the analyst was able to download 177 images. Figure 3 shows our analysis of the CyberSmuggling Center’s classification of the 177 downloaded images. We determined that 61 images contained adult pornography (34 percent), 24 images consisted of cartoon pornography (14 percent), 13 images contained child erotica (7 percent), and 2 images (1 percent) contained child pornography. The remaining 77 images (44 percent) were classified as nonpornographic. Federal Law Enforcement Agencies Are Beginning to Focus Resources on Child Pornography on Peer- to-Peer Networks Because law enforcement agencies do not track the resources dedicated to specific technologies used to access and download child pornography on the Internet, we were unable to quantify the resources devoted to investigations concerning peer-to-peer networks. These agencies (including the FBI, CEOS, and Customs) do devote significant resources to combating child exploitation and child pornography in general. Law enforcement officials told us, however, that as tips concerning child pornography on the peer-to-peer networks increase, they are beginning to focus more law enforcement resources on this issue. Table 4 shows the levels of funding related to child pornography issues that the primary organizations reported for fiscal year 2002, as well as a description of their efforts regarding peer-to-peer networks in particular. An important new resource to facilitate the identification of the victims of child pornographers is the National Child Victim Identification Program, run by the CyberSmuggling Center. This resource is a consolidated information system containing seized images that is designed to allow law enforcement officials to quickly identify and combat the current abuse of children associated with the production of child pornography. The system’s database is being populated with all known and unique child pornographic images obtained from national and international law enforcement sources and from CyberTipline reports filed with NCMEC. It will initially hold over 100,000 images collected by federal law enforcement agencies from various sources, including old child pornography magazines. According to Customs officials, this information will help, among other things, to determine whether actual children were used to produce child pornography images by matching them with images of children from magazines published before modern imaging technology was invented. Such evidence can be used to counter the assertion that only virtual children appear in certain images. The system, which became operational in January 2003, is housed at the Customs CyberSmuggling Center and can be accessed remotely in “read only” format by the FBI, CEOS, the U.S. Postal Inspection Service, and NCMEC. In summary, Mr. Chairman, our work shows that child pornography as well as adult pornography is widely available and accessible on peer-to- peer networks. Even more disturbing, we found that peer-to-peer searches using seemingly innocent terms that clearly would be of interest to children produced a high proportion of pornographic material, including some child pornography. The increase in reports of child pornography on peer-to-peer networks suggests that this problem is increasing. As a result, it will be important for law enforcement agencies to follow through on their plans to devote more resources to this technology and continue their efforts to develop effective strategies for addressing this problem. Mr. Chairman, this concludes my statement. I would be pleased to answer any questions that you or other Members of the Committee may have at this time. Contact and Acknowledgments If you should have any questions about this testimony, please contact me at (202) 512-6240 or by E-mail at koontzl@gao.gov. Key contributors to this testimony were Barbara S. Collier, Mirko Dolak, James M. Lager, Neelaxi V. Lakhmani, James R. Sweetman, Jr., and Jessie Thomas. Attachment: How File Sharing Works on Peer-to-Peer Networks Peer-to-peer file-sharing programs represent a major change in the way Internet users find and exchange information. Under the traditional Internet client/server model, access to information and services is accomplished by interaction between clients—users who request services—and servers—providers of services, usually Web sites or portals. Unlike this traditional model, the peer-to-peer model enables consenting users—or peers—to directly interact and share information with each other, without the intervention of a server. A common characteristic of peer-to-peer programs is that they build virtual networks with their own mechanisms for routing message traffic. The ability of peer-to-peer networks to provide services and connect users directly has resulted in a large number of powerful applications built around this model. These range from the SETI@home network (where users share the computing power of their computers to search for extraterrestrial life) to the popular KaZaA file-sharing program (used to share music and other files). As shown in figure 4, there are two main models of peer-to-peer networks: (1) the centralized model, in which a central server or broker directs traffic between individual registered users, and (2) the decentralized model, based on the Gnutella network, in which individuals find each other and interact directly. As shown in figure 4, in the centralized model, a central server/broker maintains directories of shared files stored on the computers of registered users. When Bob submits a request for a particular file, the server/broker creates a list of files matching the search request by checking it against its database of files belonging to users currently connected to the network. The broker then displays that list to Bob, who can then select the desired file from the list and open a direct link with Alice’s computer, which currently has the file. The download of the actual file takes place directly from Alice to Bob. This broker model was used by Napster, the original peer-to-peer network, facilitating mass sharing of material by combining the file names held by thousands of users into a searchable directory that enabled users to connect with each other and download MP3 encoded music files. Because much of this material was copyrighted, Napster as the broker of these exchanges was vulnerable to legal challenges, which eventually led to its demise in September 2002. In contrast to Napster, most current-generation peer-to-peer networks are decentralized. Because they do not depend on the server/broker that was the central feature of the Napster service, these networks are less vulnerable to litigation from copyright owners, as pointed out by Gartner. In the decentralized model, no brokers keep track of users and their files. To share files using the decentralized model, Ted starts with a networked computer equipped with a Gnutella file-sharing program such KaZaA or BearShare. Ted connects to Carol, Carol to Bob, Bob to Alice, and so on. Once Ted’s computer has announced that it is “alive” to the various members of the peer network, it can search the contents of the shared directories of the peer network members. The search request is sent to all members of the network, starting with Carol; members will in turn send the request to the computers to which they are connected, and so forth. If one of the computers in the peer network (say, for example, Alice’s) has a file that matches the request, it transmits the file information (name, size, type, etc.) back through all the computers in the pathway towards Ted, where a list of files matching the search request appears on Ted’s computer through the file-sharing program. Ted can then open a connection with Alice and download the file directly from Alice’s computer. The file-sharing networks that result from the use of peer-to-peer technology are both extensive and complex. Figure 5 shows a map or topology of a Gnutella network whose connections were mapped by a network visualization tool. The map, created in December 2000, shows 1,026 nodes (computers connected to more than one computer) and 3,752 edges (computers on the edge of the network connected to a single computer). This map is a snapshot showing a network in existence at a given moment; these networks change constantly as users join and depart them.

The availability of child pornography has dramatically increased in recent years as it has migrated from printed material to the World Wide Web, becoming accessible through Web sites, chat rooms, newsgroups, and now the increasingly popular peer-to-peer file-sharing programs. These programs enable direct communication between users, allowing users to access each other's files and share digital music, images, and video. GAO was requested to determine the ease of access to child pornography on peer-to-peer networks; the risk of inadvertent exposure of juvenile users of peer-to-peer networks to pornography, including child pornography; and the extent of federal law enforcement resources available for combating child pornography on peer-to-peer networks. GAO's report on the results of this work (GAO-03-351) is being released today along with this testimony. Because child pornography cannot be accessed legally other than by law enforcement agencies, GAO worked with the Customs Cyber-Smuggling Center in performing searches: Customs downloaded and analyzed image files, and GAO performed analyses based on keywords and file names only. Child pornography is easily found and downloaded from peer-to-peer networks. In one search, using 12 keywords known to be associated with child pornography on the Internet, GAO identified 1,286 titles and file names, determining that 543 (about 42 percent) were associated with child pornography images. Of the remaining, 34 percent were classified as adult pornography and 24 percent as nonpornographic. In another search using three keywords, a Customs analyst downloaded 341 images, of which 149 (about 44 percent) contained child pornography. These results are consistent with increased reports of child pornography on peer-to-peer networks; since it began tracking these in 2001, the National Center for Missing and Exploited Children has seen a fourfold increase--from 156 reports in 2001 to 757 in 2002. Although the numbers are as yet small by comparison to those for other sources (26,759 reports of child pornography on Web sites in 2002), the increase is significant. Juvenile users of peer-to-peer networks are at significant risk of inadvertent exposure to pornography, including child pornography. Searches on innocuous keywords likely to be used by juveniles (such as names of cartoon characters or celebrities) produced a high proportion of pornographic images: in our searches, the retrieved images included adult pornography (34 percent), cartoon pornography (14 percent), child erotica (7 percent), and child pornography (1 percent). While federal law enforcement agencies--including the FBI, Justice's Child Exploitation and Obscenity Section, and Customs--are devoting resources to combating child exploitation and child pornography in general, these agencies do not track the resources dedicated to specific technologies used to access and download child pornography on the Internet. Therefore, GAO was unable to quantify the resources devoted to investigating cases on peer-to-peer networks. According to law enforcement officials, however, as tips concerning child pornography on peer-to-peer networks escalate, law enforcement resources are increasingly being focused on this area.

Background General and Flag Officer Ranks Congress has established four military ranks above the rank of colonel (for the Army, the Air Force, and the Marine Corps) and captain (for the Navy). Table 1 displays the pay grade designation, title of rank, and insignia worn by officers at general and flag officer ranks. Title 10 of the U.S. Code establishes service-specific ceilings for active duty general and flag officers that total 877. Title 10 also authorizes 12 general and flag officer positions to be allocated by the Chairman of the Joint Chiefs of Staff to the services for joint duty positions. These authorizations do not count against the service ceilings. Title 10 establishes maximum limits on the percentage of general and flag officers that may serve in certain pay grades. Specifically, no more than 50 percent of all general or flag officers in each service may serve in a pay grade above O-7. Between 15.7 and 16.2 percent of a service’s general or flag officers may serve in pay grades O-9 and O-10. Finally, of a service’s general or flag officers in grade O-9 and O-10, a maximum of 25 percent may be in grade O-10. DOD’s Fiscal Year 2005 Legislative Proposals The National Defense Authorization Act for Fiscal Year 2003 directed DOD to review legislative limitations affecting the management of general and flag officers and directed DOD to submit a report to Congress. DOD submitted a report in March 2003. In its report, DOD stated that its review pointed to the merit of additional general and flag officer management flexibilities that would increase the department’s ability to respond to ever-changing events. The report also recommended changes in legislation to improve general and flag officer management. In April 2003, DOD submitted a legislative package to Congress—the Defense Transformation for the 21st Century Act of 2003—that included several proposals aimed at enhancing the department’s flexibility in managing general and flag officers. Congress did not enact these proposals. In March 2004, DOD resubmitted many of the same proposals to Congress for consideration as part of the National Defense Authorization Act for Fiscal Year 2005. DOD’s fiscal year 2005 legislative proposals are aimed at eliminating or amending statutory provisions that the department believes restrict its flexibility in managing general and flag officers. Career Length and Retirement Compensation One group of the fiscal year 2005 legislative proposals would make changes affecting general and flag officer career length as well as retirement compensation. A proposal to increase the maximum retirement age from 62 to 68. Currently, commissioned officers generally must retire upon reaching age 62. The President may defer the retirement of an officer serving in a grade above O-8 to age 64. No more than 10 such deferments may be in effect at any one time. DOD’s proposal would extend the maximum retirement age to 68 for general and flag officers and would allow the Secretary of Defense to defer retirement of a general and flag officer to age 72. There would be no limit on the number of deferments to age 72. A proposal to eliminate limits on the total allowable years of military service and time in grade. Currently, general and flag officers must retire upon reaching specified limits on the total years of active commissioned service or time in grade. These limits vary by pay grade. DOD’s proposal would set no limit on the total allowable years of active commissioned service and time in grade. A proposal to eliminate a requirement that general and flag officers spend at least 3 years time in grade in order to retire in that grade. In addition to the 3-year time-in-grade requirement, existing law mandates that a general or flag officer in pay grade O-9 or O-10 may retire in that grade only after the Secretary of Defense or his designee certifies to the President and Congress that the officer served on active duty satisfactorily in that grade. Under DOD’s proposal, a general or flag officer at any pay grade may retire in their current grade as long as the officer has served satisfactorily. The proposal also would eliminate the certification requirement for officers retiring in grade O-9 and O-10 and instead would require the approval of the military department concerned and concurrence by the Secretary of Defense or his designee. Proposals to remove limitations on retirement pay. Currently, basic pay— the pay used to calculate retirement pay—is capped at the rate of pay for level III of the federal civilian Executive Schedule, and retirement pay is capped at a maximum of 75 percent of base pay. Under one DOD proposal, the basic pay cap would be removed for the purposes of calculating retirement pay. The pay cap would remain in place while the officer is serving on active duty. A second DOD proposal would allow general and flag officers who stay in military service longer than 30 years to receive retirement pay that exceeds the current limit of 75 percent of base pay. Term Limits and Lateral Reassignment A second group of legislative proposals would change restrictions on the term limits for officers holding specified senior positions and on the lateral reassignment of officers. A proposal to eliminate existing restrictions on the length of terms of the service chiefs of staff. The service chiefs are appointed to a 4-year term by the President, by and with the advice and consent of the Senate. They serve at the pleasure of the President. In time of war or during a national emergency declared by Congress, a service chief may be reappointed for a term of not more than 4 years. Under DOD’s proposal, after the service chief’s initial 4-year term, the President may extend the service chief’s term as he determines necessary, without congressional involvement. A proposal to eliminate statutory 4-year terms of office for officers holding specified senior positions. These positions include the Army’s branch chiefs, deputy and assistant branch chiefs, Judge Advocate General and Assistant Judge Advocate General, Chief of Army Nurse Corps, and Chief of the Army Medical Specialist Corps; the Navy’s Chief of the Bureau of Medicine and Surgery, Chief of the Bureau of Naval Personnel, Chief of Chaplains, Judge Advocate General, and Director of the Nurse Corps or Director of the Medical Service Corps; and the Air Force’s Judge Advocate General and Deputy Judge Advocate General. A proposal to eliminate existing restrictions on the number of terms of the Chairman and Vice Chairman of the Joint Chiefs of Staff. Currently, the Chairman and Vice Chairman are appointed by the President, by and with the advice and consent of the Senate. They serve at the pleasure of the President for a 2-year term and may be reappointed in the same manner for two additional terms, for a total of 6 years. In time of war, there is no limit on the number of reappointments. An officer may not serve as Chairman and Vice Chairman if the combined service exceeds 6 years, except that the President may extend this period to 8 years if he determines such action is in the national interest. This limitation also does not apply in the time of war. Under DOD’s proposal, the President may reappoint the Chairman and Vice Chairman for additional 2-year terms as he determines necessary, without congressional involvement. The provision limiting total combined service as Chairman and Vice Chairman would be eliminated under DOD’s proposal. A proposal to eliminate existing restrictions on the length of terms of the two Assistants to the Chairman of the Joint Chiefs of Staff for National Guard and Reserve Matters. Each Assistant serves at the pleasure of the Chairman for a 2-year term and may be continued in that assignment in the same manner for 1 additional term. In time of war there is no limit on the number of terms. Under DOD’s proposal, no terms would be specified for these two positions. A proposal to permit the President or the Secretary of Defense to laterally reassign general and flag officers in grades O-9 and O-10 to positions at the same grade without congressional approval. Currently, the President may designate positions of importance to carry the grade of O-9 or O-10. An officer assigned to any such position has the grade specified for that position if he is appointed to that grade by the President, by and with the advice and consent of the Senate. If the officer is subsequently reassigned to a position at the same grade, that new assignment must be confirmed by the Senate. Under DOD’s proposal, the President or the Secretary of Defense may reassign such an officer to another position at the same grade without the advice and consent of the Senate. DOD’s proposed change would not apply to positions established by law; appointment of officers to these positions would continue to require the advice and consent of the Senate. Distribution Among Pay Grades One of DOD’s proposals addresses the distribution of officers among the general and flag officer pay grades. A proposal to eliminate a provision limiting the number of active officers who may serve above the pay grade of O-7 to no more than 50 percent of the total number of general and flag officers in a service. Under DOD’s proposal, the military services could have a higher proportion of officers in pay grade O-8 than allowed under existing law. The proposal does not affect existing caps on the percentage of general and flag officers in grades O-9 and O-10. Legislative Framework for General and Flag Officer Management Has Evolved Over Time DOD’s fiscal year 2005 legislative proposals represent the latest in a long series of discussions between Congress and DOD concerning general and flag officer management. These discussions, which reflect a history of congressional interest in maintaining oversight and accountability of general and flag officers, have addressed such issues as the appropriate number of general and flag officers to lead the armed forces, their education and qualifications, and their age and experience level. A legislative framework has evolved that shapes the careers of general and flag officers and the management of these officers. The Defense Officer Personnel Management Act of 1980 established key aspects of the current legislative framework. The act codified in Title 10 many of the legislative provisions DOD is seeking to change. Some provisions have roots in earlier legislation such as the Officer Personnel Act of 1947. Career Patterns of General and Flag Officers The career profile data we developed show that general and flag officers who retired between fiscal years 1997 and 2002 typically retired at age 56, ranging from an average age of 53 for officers in pay grade O-7 to 57 for officers in pay grade O-10. These retired general and flag officers averaged 33 years of active commissioned service, ranging from 30 years for an O-7 to 35 years for an O-10. The retirees spent an average of 3-1/2 years in their last pay grade. Table 2 summarizes this data by pay grade. Compared with the retirees, general and flag officers who remained on active duty during these years were typically younger and had fewer years of active commissioned service. Table 3 summarizes this data by pay grade. General and flag officers who retired between fiscal years 1997 and 2002 were promoted to pay grade O-7, on average, at age 49. At this promotion point, they averaged 26 years of active commissioned service. Individuals who retired at the higher pay grades were generally younger and had fewer years of service when promoted to pay grade O-7 compared with those who retired at the lower pay grades. General and flag officers who retired during this time period served an average of 6 years as a general or flag officer, with individuals in higher pay grades serving longer. Table 4 summarizes this data by pay grade. Promotion data for fiscal years 1998 to 2003 shows that of officers at the rank of colonel and Navy captain (pay grade O-6) who were considered for promotion to pay grade O-7, 2.5 percent were selected. Of officers in pay grade O-7 who were considered for promotion to pay grade O-8, 43 percent were selected. Table 5 provides promotion data by service. Additional career data for general and flag officers is provided in appendix I. DOD Did Not Provide Evidence That the Current Legislative Framework Hinders General and Flag Officer Management or Agency Performance Although DOD provided various rationales for its fiscal year 2005 legislative proposals and sponsored a study on issues related to general and flag officer management, DOD did not provide evidence showing that the current legislative framework has hindered DOD’s management of general and flag officers or degraded the department’s performance. In addition, the fiscal year 2005 legislative proposals (1) would reduce congressional oversight and provide broad latitude to the Executive Branch in managing general and flag officers, (2) could impede the upward flow of officers, and (3) would likely increase federal retirement outlays. Finally, the Executive Branch has not made frequent use of existing legislative authority that provides some flexibility to extend the careers of general and flag officers on a case-by-case basis beyond the statutory limits. DOD Did Not Provide Data to Support the Need for Its Legislative Proposals DOD did not provide data to support the need for its fiscal year 2005 legislative proposals to eliminate or amend current provisions governing general and flag officer management. Our prior work has shown that one of the critical success factors for strategic human capital management is the use of reliable data to make human capital decisions. A fact-based, performance-oriented approach to human capital management is crucial for maximizing the value of human capital as well as managing related risks. DOD has asserted that the proposals would enhance its ability to manage general and flag officers and has provided various rationales in favor of the proposals. However, we did not find evidence that the existing legislative framework has hindered DOD’s management of general and flag officers or the agency’s ability to perform its mission. As one example, DOD stated that its proposals to extend the statutory retirement age from age 62 to 68 would allow officers to serve longer careers and spend more time in assignments. DOD further stated that two reasons for adopting this proposal are to improve organizational stability and improve the execution of long-term initiatives under consistent leadership. However, DOD did not provide data showing that there are existing problems with organizational instability or inconsistent leadership, that the current retirement limits are a cause of these problems, or that the proposals would be effective in addressing these problems. DOD also did not provide data to explain why the pros it identified outweigh the cons. Regarding the retirement age proposal, for example, DOD stated that two cons were a reduction in opportunities for organizational change that naturally occur with new leadership and a reduction in opportunities for promotion to general and flag officer. Moreover, a data-driven analysis also would have given DOD an opportunity to consider other options for achieving its goal of extending general and flag officer careers. For instance, it could have analyzed options for extending military service of more general and flag officers to the current statutory retirement age, raising the retirement age by 1 or 2 years versus 6 years, raising the deferment age above age 64, or increasing the number of authorized age deferments beyond the 10 that are currently allowed. The career profile data we developed show that large numbers of general and flag officers are retiring several years before the statutory retirement limits on age and years of active commissioned service. Of the 172 general and flag officers who retired in pay grades O-9 and O-10 between fiscal years 1997 and 2002, 151 (88 percent) retired at least 3 years before age 62. Of these 151 officers, 133 (88 percent) also had 3 years remaining before reaching their statutory retirement limit on years of active commissioned service. Altogether, these 133 officers represent 77 percent of the 172 general and flag officers who retired in these pay grades. The data suggests that large numbers of senior officers could serve at least one more assignment prior to retirement under the existing legislative framework. Factors other than the statutory retirement limits may affect the career length of general and flag officers. Some of the retired general and flag officers we interviewed noted that many general and flag officers in their 50s explore their employment options outside the military to increase stability for their family and earn higher salaries. Some noted a “burnout” factor associated with their work as a general and flag officer. Another factor is a military culture, as expressed in service policies and practices, that encourages general and flag officers to move aside and make way for others coming up through the ranks. These policies and practices are discussed further elsewhere in this letter. DOD sponsored a study by the RAND Corporation that addressed general and flag officer management issues. DOD officials said this study served as the primary analytical support for its fiscal year 2005 legislative proposals. The RAND study, using the private sector as a model, identified strategies for managing general and flag officers that would increase the time they spend in assignments, the time spent in grade, and total career length. RAND recommended that the services categorize their general and flag officer positions as either “developing” or “using” positions and determine the desired tenure for each, with a general goal of 2 years for developing positions and 4 years for using positions. However, RAND was not specifically tasked in its study to include an analysis of the legislative proposals, and such an analysis was not included. RAND concluded that the management changes it suggested could be implemented largely within DOD’s current legislative authority. Title 10 authority permitting 40-year careers for officers in pay grade O-10 and 38 years for O-9s coupled with a statutory retirement age of 62 generally is sufficient, the RAND study stated. RAND added that changes in law could give the services more flexibility to implement its recommended management changes. For example, allowing officers to retire with less than 3 years time in grade would allow them to leave as needed. Also, RAND saw no reason the military retirement age should not increase from age 62. Finally, RAND supported retirement compensation changes similar to those proposed by DOD. Proposals Would Reduce Congressional Oversight and Provide the Executive Branch Broad Latitude in Managing General and Flag Officers Some of DOD’s legislative proposals would reduce congressional oversight of senior officer appointments. Specifically, the President could extend indefinitely the terms of sitting service chiefs, with no fixed term length, after they have completed their initial 4-year appointment. The President also could extend indefinitely the number of 2-year terms served by the Chairman and Vice Chairman of the Joint Chiefs of Staff, after their initial 2-year appointment. In none of these cases would Senate confirmation be required. In addition, senior officers appointed to O-9 and O-10 positions could be reassigned to other O-9 and O-10 positions (except for those positions established by law) without going through the confirmation process. DOD’s proposals to permit reappointment of officers to senior positions and make lateral appointments without going through the Senate confirmation process would remove a check and balance in the current system. The current legislative framework establishes congressional oversight of officer management through several provisions of Title 10 that require the President to seek the advice and consent of the Senate in order to promote or appoint military officers. For example, Title 10 states that appointments made to grades above O-3 by the President require the advice and consent of the Senate. Prior to such codifications in Title 10, the Officer Personnel Act of 1947 contained Senate confirmation requirements, stating that officers were entitled to the rank, title, pay, and allowances of a general or lieutenant general only when appointed in such positions by the President, by and with the advice and consent of the Senate. The confirmation process also is designed to disclose any important adverse information about the nominated officer and provides an opportunity for discussion between nominees and Members of Congress. By placing a hold on individual nominations, Senators may also use the confirmation process as leverage on military issues. The proposed new authorities for managing general and flag officers would give DOD broad latitude in determining how extensively they are applied and for what purposes. DOD officials have stated that the proposals, if approved, would be used sparingly in cases where their use is deemed appropriate. For instance, DOD could use its proposed new authorities to extend the career of an officer who holds a key policy-making, operational, or acquisition position if maintaining continuity in that position is deemed to be in DOD’s best interests. However, DOD did not present a plan showing how it would institute the proposed new authorities if approved. The proposed new authorities could be applied extensively and for purposes other than those currently intended by DOD. For example, although DOD has stated that one of its goals is to increase the length of assignments, DOD could use the authorities to extend the careers of senior officers while continuing to shift them from assignment to assignment with the same frequency as today. DOD could also choose to lengthen the time it takes for an officer to be promoted to general and flag officer rank with the knowledge that extra time could be gained at the end of the officer’s career. In addition, the proposed new authorities would not preclude DOD from extending the careers of numerous general and flag officers rather than a selected few as DOD has stated is its intent. Currently, the maximum number of age deferments authorized at any one time is 10 officers above pay grade O-8; DOD has proposed eliminating this limit. In addition, DOD has proposed eliminating existing provisions that require most general and flag officers to serve at least 3 years time in grade in order to retire in that grade. Under its proposed new authorities, DOD could retire numerous general and flag officers in their current pay grade after they have served satisfactorily for a few months, weeks, or even days. On the other hand, he should not remain indefinitely as the head of that service. Each service requires, and indeed, is entitled, to a new service chief every 4 years so that new ideas can be tested; but after 4 years he should step aside for a new appointee. Proposals Could Impede Upward Flow of General and Flag Officers DOD’s proposals, by enhancing its flexibility to extend the careers of general and flag officers, could impede the upward flow of general and flag officers. Because DOD is authorized a fixed number of general and flag officers, vacancies must open up in the general and flag officer pay grades in order to allow for promotions of lower-grade officers. Therefore, upward flow could be impeded if some general and flag officers are retained longer on active duty. Promotion of a steady and predictable upward flow of officers from junior to more senior positions is a long-standing precept of military officer management that is grounded in the legislative framework. The “up-or-out” promotion system, created by the Officer Personnel Act of 1947, requires most commissioned officers at or below pay grade O-4 who have twice been passed over for promotion to leave military service. The up-or-out system, among other things, creates promotion opportunities for lower level officers, limits stagnation, and maintains youth and vigor in the officer corps. As instituted under the Defense Officer Personnel Management Act of 1980, expectations are built into the officer management system concerning the points in an officer’s career when promotions should occur from one pay grade to the next higher level. In hearings preceding adoption of the Defense Officer Personnel Management Act, DOD affirmed the value of the up-and-out system in fostering a combat ready military. A DOD official also stated that the up-or-out system eliminated the turbulence and errors associated with replacing an aged senior leadership and provided a regularized way of replacing people that maintains a proper age and experience balance. Service policies on general and flag officer management also promote upward flow by encouraging general and flag officers to retire prior to the statutory limits. According to a 2002 Navy policy issued by the Chief of Naval Operations, a steady process of both promotions and retirements goes hand-in-hand in the flag community. Since the Navy operates with fixed authorizations, flag officers promote to vacancies and vacancies come from retirements. The policy states that to maintain upward flow, there will come a time when all flag officers must acknowledge the need to step aside and make room for the youth, vigor, and vitality of those more junior flag officers. The Navy policy establishes specific retirement expectations for flag officers in grades O-7 and O-8 and reinforces the Navy’s practice of not relying on statutory retirements. In 2004, the Marine Corps reiterated its general and flag officer retirement policy to support the service’s goal of maintaining a steady promotion flow. The policy states that general officers in pay grade O-7 who twice have been passed over for promotion should voluntarily retire after 30 years of service and general officers in pay grade O-8 who have not been nominated for appointment to a higher position should plan to voluntarily retire after 3 years time in grade. The same policy applies to general officers in pay grade O-9 who have not been nominated for another O-9 or O-10 position. An Army policy, which was rescinded in 2004, stated that general officers in pay grades O-7 and O-8 who had not reached their maximum limit for years of service were expected to request voluntary retirement at age 59. According to an Army official, the Army rescinded this policy because Title 10 restrictions were deemed to be sufficient. Air Force officials told us they did not currently have a written policy on the timing of general officer retirements. A former senior official we interviewed who was familiar with Air Force policy told us that while the Air Force did not have a written policy, general officers were orally briefed that they were expected to retire after 3 years in grade if they were not selected for promotion. The potential effects of impeding the upward flow of general and flag officers are reduced promotion opportunities, stagnation, and aging of the general and flag officer population. However, the impact would depend on the extent that DOD uses its proposed authority to extend general and flag officer careers. Some of the former senior officials we interviewed thought that youth and vigor should be maintained and that aging the general and flag officer population would therefore be a mistake. Concern was also expressed about the creation of promotion bottlenecks and the possibility that older general and flag officers may become out of touch with current technology, training, and other aspects of the military. Others were not concerned about aging this population, stating that individuals are different and their vigor should not be judged based solely on age. Life expectancy in the United States increased by about 10 years (16 percent) since the Officer Personnel Act of 1947 and about 3 years (5 percent) since the Defense Officer Personnel Management Act of 1980. Upward flow could be retained under DOD’s proposal to eliminate the statutory requirement that an officer must serve 3 years time in grade in order to retire in that grade. Currently, other statutory provisions allow for a small number of individuals to retire with less than 3 years time in grade. Eliminating the time-in-grade requirement would theoretically enable the services to balance the extensions of some general and flag officer careers with the earlier retirement of other officers in order to continue the upward flow of officers. The 3-year rule was instituted under the Defense Officer Personnel Management Act. The former senior officials we interviewed generally favored some time-in-grade requirement rather than eliminating the requirement altogether. They stated that at least a year or two is needed for newly promoted individuals to learn their new job, make an impact on the organization, and recover from any early mistakes. A time-in-grade requirement also gives the service time to assess the performance and future potential of these officers. Another DOD proposal that could affect the upward flow of general and flag officers is the elimination of the statutory limit requiring that no more than 50 percent of a service’s general or flag officers serve in a pay grade above O-7. Eliminating this limit could result in an increase in the number of positions at pay grade O-8 and a decrease in the number of positions at pay grade O-7. Consequently, the services may have to be less selective in promoting general and flag officers from pay grade O-7 to O-8. For instance, the Marine Corps already promotes, on average, 71 percent of its general and flag officers from pay grade O-7 to O-8. If its pool of O-8 positions increases relative to the O-7 pool, the Marine Corps would have to promote an even larger percentage of officers from pay grade O-7, thereby decreasing selectivity. Service officials said that the job structure for their general and flag officers is based on the current 50-percent distribution limit. DOD reviewed its general and flag officer positions in 2003 and validated requirements for 1,039 active duty general and flag officer positions, including 524 (50 percent) at the O-7 pay grade. Some of the former senior officials we interviewed expressed concerns about removing the distribution limit. The current limit creates a pyramid-shaped general and flag officer corps, with a large pool of O-7s at the base and fewer numbers at each higher rank. This pyramid shape enables the services to manage their general and flag officers in a way that allows for predictability and selectivity. Proposed Compensation Changes Would Increase Federal Retirement Outlays Our analysis of DOD’s retirement compensation proposals to remove the basic pay cap and the 75-percent cap shows that, if implemented, they would likely result in an increase in federal retirement outlays. Based on a cost estimate we developed, federal retirement outlays would increase by a total of approximately $55 million in fiscal year 2004 dollars over a 10-year period. Outlays over the longer term would continue to grow as more general and flag officers retire under the revised formulas and continue to receive higher retirement pay over their lifetime. Information on how we calculated this cost estimate, including the limitations of our methodology, is provided in the scope and methodology section at the end of this letter. We did not calculate the annual amount that would have to be appropriated for the military retirement fund if the proposals were implemented. DOD did not develop a cost estimate for its general and flag officer proposals. DOD officials, however, stated that the costs of its proposals taken together would be minimal because a smaller number of officers would serve longer in senior positions than is currently the case. A Congressional Budget Office analysis of legislative provisions to allow certain senior officers to remain on active duty longer and others to retire with less time in grade would have an insignificant impact on direct spending. According to the Congressional Budget Office analysis, the costs and benefits of these adjustments would offset each other. The Congressional Budget Office analysis did not include the retirement compensation proposals. DOD stated that its proposals to improve retirement pay would provide greater incentive for general and flag officers to remain on active duty and would provide more appropriate compensation for general and flag officers who serve longer careers. Our interviews with retired general and flag officers indicated that retirement pay was not a driving factor in their decision about when to retire. Some expressed the opinion that retirement pay was adequate, while others stated that retirement pay should be improved to recognize and reward longer military service. Retirement pay for general and flag officers, as well as other servicemembers, is based on a servicemember’s basic pay while on active duty times a multiplier. The multiplier is equal to 2.5 percent times their years of service. At this rate, retirement pay rises from 50 percent of basic pay with 20 years of service until reaching 75 percent of basic pay with 30 years of service. At that point, retirement pay is capped at 75 percent of basic pay. Based on basic pay rates effective January 1, 2004, the maximum basic pay for a general or flag officer (for an officer in pay grade O-10 with more than 26 years of service) is $13,304 per month, or $159,654 per year. However, a legislative cap on basic pay limits basic pay to the rate of pay for level III of the Executive Schedule, which for 2004 equals the rate of $12,050 per month, or $144,600 per year. Our analysis of DOD’s retirement compensation proposals shows that DOD’s proposal to eliminate the basic pay cap would increase retirement pay for officers in pay grade O-10, although general and flag officers at lower pay grades could be affected in later years if basic pay increases at a faster rate than the cap. DOD’s proposal to eliminate the 75-percent retirement pay cap would increase retirement pay for general and flag officers at any pay grade who retire with more than 30 years of service. Table 6 shows the estimated impact of eliminating one or both of these caps on a general or flag officer’s retirement pay. The table provides notional examples for an officer in each of the four general and flag officers pay grades retiring at either 30 or 37 years of service. The estimates are based on basic pay rates effective as of January 1, 2004. Executive Branch Has Not Made Frequent Use of Existing Legislative Authority to Extend General and Flag Officer Careers The Executive Branch currently has legislative authority to extend the careers of general and flag officers on a case-by-case basis without congressional approval. Title 10 grants the President authority to extend the careers of as many as 10 general and flag officers to age 64, or 2 years beyond the standard retirement age. In addition, service Secretaries may defer the retirement of officers in the health professions and the chaplain corps until age 68 if such a deferral is deemed to be in the best interest of the military service. Title 10 also authorizes a service Secretary, based on the needs of the service, to defer the retirement of officers in the grades of O-7 and O-8 for up to 5 years beyond their years of service limit. Deferment for any officer in a grade above O-8 requires Presidential approval. The Executive Branch has not made frequent use of its existing authority to extend the careers of general and flag officers. Although DOD does not track the extent that this authority is used, DOD officials told us it has been used rarely. For instance, they stated that just one age deferment was currently in effect. Our analysis showed that few general and flag officers have exceeded the statutory retirement limits. Only three general and flag officers who retired between fiscal years 1997 and 2002 exceeded the age 62 limit, and eight general and flag officers exceeded the years of service limits. According to an official in the Office of the Under Secretary of Defense (Personnel and Readiness), Officer and Enlisted Personnel Management, the existing authority to extend general and flag officer careers is seldom used because DOD prefers not to sanction routine exceptions to the normal retirement limits. The official also characterized the department’s process for gaining approval of these exceptions as onerous and time-consuming. DOD’s procedures call for six individuals to approve a deferment—the service chief, the service secretary, the Chairman of the Joint Chiefs of Staff, the Under Secretary of Defense (Personnel and Readiness), the Secretary of Defense, and the President. Some deferments, however, do not have a statutory requirement for approval beyond the service secretary. In addition, deferments have been included as part of the Presidential nomination process rather than treated as separate actions. In such cases, the nomination package from the Secretary of Defense to the President requesting appointment of an officer to a general and flag officer position simultaneously requests Presidential approval of a retirement deferment if a deferment is determined to be required for the officer to serve in the position. While DOD expressed misgivings about using its existing legislative authority to exceed statutory retirement limits, DOD could make greater use of this authority in order to extend the careers of general and flag officers on a case-by-case basis. DOD has used existing authority to allow a small number of general and flag officers to retire in their current pay grade with less than 3 years time in grade. A policy decision to make greater use of its existing authority to extend general and flag officer careers could also provide an incentive for DOD to achieve greater efficiency in the deferment process. Conclusions DOD has not presented a sound business case to support the need for changing existing legislative provisions to better manage general and flag officers. DOD, for example, has not provided data showing that the existing legislative provisions have hindered general and flag officer management or led to agency performance problems such as organizational instability. Furthermore, some of the proposed changes would reduce congressional oversight of general and flag officers and could impede the upward flow of general and flag officers. DOD may have options for extending the careers and assignments of general and flag officers without raising the statutory retirement age or the limit on total years of active commissioned service. Efforts to extend general and flag officer careers, however, would have to account for factors other than the statutory limits that have a role in the timing of general and flag officer retirements—factors including personal considerations and a military culture that encourages senior leaders to step aside and make way for others to move up. DOD also has the authority, on a case-by-case basis, to extend general and flag officer careers beyond the statutory retirement limits. We see no reason for DOD not to use this authority to the fullest extent allowable under the law. If DOD makes full use of its existing legislative authority but finds that it is inadequate to achieve its goal of retaining experienced leaders, then it may be in a better position to argue for changes to this authority. Finally, DOD has not determined the long- term cost implications of its proposals pertaining to retirement compensation. Recommendation for Executive Action To help achieve DOD’s goal of retaining experienced leaders, we recommend that the Secretary of Defense direct the Under Secretary of Defense (Personnel and Readiness) to evaluate options for extending general and flag officer careers within the existing legislative framework. This evaluation should include an assessment of (1) factors that contribute to the retirement of senior general and flag officers prior to the statutory retirement limits, (2) the need for changes in DOD policy or procedure to make greater use of existing authority to extend general and flag officers careers on a case-by-case basis beyond the statutory retirement limits, and (3) the long-term cost implications of proposals to change retirement compensation. Agency Comments and Our Evaluation DOD provided written comments on a draft of this report. In its comments, DOD did not concur with our recommendation and stated that it opposed the premise that the desired flexibility can be achieved within the current statutory framework. We recognize that the national security mission, including the Global War on Terrorism and transformation of the force, presents increasing complexities for military leaders, and we do not take issue with the department’s position that it needs experienced and agile senior leaders. The question is whether the current legislative framework has hindered DOD’s ability to manage general and flag officers effectively or the agency’s performance. We continue to believe that DOD has not presented a sound business case to support the need for changing the existing legislative framework. This is not to say that changes are not needed for the future, but that DOD has not provided data to make a determination either way. Unless and until a business case for change is made, we believe our recommendation will help DOD maximize the use of its current legislative authorities in order to retain experienced leaders. In addition, DOD already has the authority to extend the careers of some general and flag officers beyond the statutory retirement limits but has rarely used this authority. For example, as noted in our report, just one age deferment was in effect at the time of our review. DOD stated that options for extending general and flag officer careers within the existing legislative framework were considered by the RAND study and found wanting. However, the statement of work for the study established a broad objective to assess the management and policy implications of potential changes in military officer management and policy. The statement of work did not address specifically DOD’s legislative proposals for general and flag officer management. The main thrust of the RAND study was to assess options for varying the length and number of general and flag officer assignments rather than a review of the existing legislative framework. RAND advocated that the military services establish goals on the desired length of assignments based on the nature of the positions. RAND concluded that the changes it suggested to improve the management of general and flag officer careers could be implemented largely within DOD’s current legislative framework, although changes in law (such as extending the statutory retirement age) could give the services more flexibility to implement RAND’s recommendations. In its comments, DOD stated that it should not have to justify its legislative proposals by identifying failures in the current general and flag officer management system. Our report does not imply that this is the standard for seeking management improvements. However, DOD did not provide data to support its assertions that there were existing problems with the current system—such as organizational instability and inconsistent leadership—that the current statutory framework was a cause of these problems, or that the proposals would be effective in addressing these problems. In the absence of data, it is difficult to judge DOD’s assertions that the proposed authorities are needed. Moreover, a data-driven analysis may have identified other options for achieving DOD’s goal of extending general and flag officer careers. Our report provides examples of such options. DOD, in its comments, further stated that retaining senior, experienced leaders requires a systemic change to the management of general and flag officers. Making greater use of its existing authorities to extend general and flag officer careers on a case-by-case basis would, according to DOD, provide only marginal opportunities for improvement and would be less preferable than a set of statutes designed to encourage retention of experienced officers. The issue of whether DOD should make more extensive use of existing authorities in lieu of the systemic changes it seeks depends in part on DOD’s intentions for extending the careers of general and flag officers. During our review, we were told the legislative proposals, if approved, would be used sparingly in cases where their use is deemed appropriate. If that is still the case, then making greater use of the existing authorities could be sufficient for achieving this goal. If DOD makes greater use of these authorities and ultimately finds them to be inadequate, then the department may be in a better position to argue for changes to the existing statutes. As we noted in our report, however, DOD had not presented an implementation plan, and the proposed new authorities could be applied more extensively or for purposes other than those currently intended by DOD. DOD also stated that our report did not adequately address the relationship between service policy and culture and the existing statutory authorities. DOD stated that the services have had to adopt more stringent criteria than the law allows to ensure an orderly transition of senior officers as they approach their statutory age and tenure limits and to avoid organizational turmoil and personal hardship. Our report states, however, that a steady upward flow of officers is grounded in the legislative framework and reinforced by service policies on general and flag officer management. Because DOD is authorized a fixed number of general and flag officers, vacancies must open up in the general and flag officer pay grades in order to allow for promotions of lower-grade officers. The service policies cited in our report appear to be aimed primarily at ensuring that general and flag officers will retire when their services are no longer needed rather than on avoiding problems with the current statutory retirement limits. In addition, the Army’s decision to rescind its policy is inconsistent with DOD’s comment that the services have needed to adopt more stringent criteria than the law allows. As our report states, many general and flag officers are retiring several years before reaching their statutory limits on age and years of commissioned service. For example, more than three-fourths of general and flag officers who retired in grades O-9 and O-10 between fiscal years 1997 and 2002 could have served 3 or more years before reaching the current statutory retirement limits. Factors other than the statutory limits, such as personal considerations and military service culture, may account for early retirements of general and flag officers. As part of our recommendation, we state that DOD should assess these factors as part of its evaluation of options for extending general and flag officer careers within the current legislative framework. Finally, in its comments, DOD stated that the costs associated with the retirement compensation proposals would be offset by a reduction in the number of O-10 retirees and the fact that longer service means fewer years of actual retirement per retiree. DOD added that a detailed discussion of this point is provided in the RAND study. DOD, however, has not analyzed the long-term cost implications of its retirement compensation proposals. In addition, while the RAND study contains a discussion of retirement compensation and recommends that DOD consider changes in this area, it does not provide an analysis of long-term cost implications. RAND officials told us that they developed some rough cost estimates but that a cost analysis was not part of their study objectives. We continue to believe that a full assessment of the retirement compensation proposals should include a cost analysis. In addition, it should be noted that the proposal to remove the 75-percent cap would increase retirement pay for general and flag officers at any pay grade—not just O-10s—who retire with more than 30 years of service. DOD’s comments are reprinted in appendix II of this letter. Scope and Methodology To develop a career profile of general and flag officers, we obtained data from the Defense Manpower Data Center covering fiscal years 1997 to 2002. Of the 1,535 general and flag officers in the database, 635 had retirement dates and 900 were still on active duty as of the end of fiscal year 2002. We used the general and flag officer data to build an overall general and flag officer career profile by analyzing salient characteristics of that population. For example, we identified such things as the mean- averages of years in service, years in grade, and years of age at retirement. We assessed the reliability of the data by (1) performing electronic testing of required data elements, (2) reviewing existing information about the data and the system that produced them, and (3) interviewing agency officials knowledgeable about the data. As a further check on data reliability, we independently obtained general and flag officer data from each of the military services. We concluded from our review that the data were sufficiently reliable for the purposes of this report. We also obtained data from the military services concerning promotion opportunity for officers selected for promotion to pay grades O-7 and O-8. This data covered fiscal years 1998 to 2003. To assess DOD’s justification for its fiscal year 2005 legislative proposals, we reviewed DOD’s rationale and supporting evidence for the proposals, including a section-by-section analysis of the legislative proposals developed by the Office of the Secretary of Defense (OSD) and statements made by senior DOD officials in congressional testimony. We reviewed the 2004 RAND study on general and flag officer management, met with the principal authors of the study, and obtained related information, including the statement of work and the database RAND developed of general and flag officer assignments. We discussed with RAND officials the methodology used to compile this database. We did not assess the models RAND used in its analysis. We reviewed the legislative histories of existing provisions that DOD seeks to change. We also met with OSD and service officials to discuss the legislative proposals and the management of general and flag officers under the current legislative framework. We obtained DOD and service policies and other documents and data regarding general and flag officer management. We met with 11 retired senior general and flag officers and other officials with experience in general and flag officer policies and management to obtain their views on the legislative proposals. We identified these officials through information obtained from DOD as well as referrals from the individuals interviewed. In selecting the individuals, we sought to obtain a variety of perspectives based on their previous experiences. As a group, these individuals spanned the four military services and OSD and included senior leadership in the military services, the Joint Staff, and operational commands. Some of these individuals had worked extensively on military personnel matters and general and flag officer issues within both DOD and Congress. Since the individuals were selected judgmentally, their views are not representative of a larger population. For our analysis of DOD’s retirement pay proposals, we used the data from the Defense Manpower Data Center to determine the pay grade and years of service for general and flag officers who retired between fiscal years 1997 to 2002. We then calculated, based on the basic pay table effective as of January 1, 2004, what their retirement pay would be under the existing retirement pay formula and under the proposed changes. We calculated the annual average federal government outlay in fiscal year 2004 dollars for retirement pay and total outlays over a 10-year period. The assumptions we used for our analysis have limitations. We did not calculate annual increases either in basic pay or in retirement pay cost-of- living adjustments. We also assumed that all new beneficiaries would continue to receive retirement pay over the 10-year period; we did not include actuarial projections to account for expected life expectancy. Our calculations were based on the final pay retirement formula, although there will be future growth in the number of general and flag officers who retire under the “high-3” formula. We assumed that future general and flag officer retirees would have a similar profile in terms of number of retirees, pay grade, and years of service to those who retired between fiscal years 1997 to 2002. We are sending copies of this report to the Secretary of Defense and the Director, Office of Management and Budget. In addition, the report will be available at no charge on GAO’s Web site at http://www.gao.gov. If you or your staff have any questions regarding this report, please contact me at (202) 512-5559 (stewartd@gao.gov) or Brenda S. Farrell at (202) 512-3604 (farrellb@gao.gov). Major contributors to this report were James Driggins, Thomas W. Gosling, David Mayfield, J. Paul Newton, Jennifer R. Popovic, and Bethann E. Ritter. Appendix I: Career Profile Data for Retired General and Flag Officers This appendix presents data showing the age and years of service distributions for general and flag officers who retired between fiscal years 1997 and 2002. Appendix II: Comments from the Department of Defense GAO’s Mission The Government Accountability Office, the audit, evaluation and investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO’s commitment to good government is reflected in its core values of accountability, integrity, and reliability. 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Congress has established a legislative framework that shapes the careers and the management of general and flag officers. The Department of Defense (DOD) has proposed eliminating or amending a number of legislative provisions, such as revising existing statutory retirement limits based on age and years of service, to provide greater flexibility in managing its senior officers in order to retain experienced leaders. GAO is issuing this report in response to a mandate in the National Defense Authorization Act for Fiscal Year 2003. GAO's objectives were to (1) develop a profile of general and flag officer careers and (2) assess DOD's justification for its general and flag officer legislative proposals. General and flag officers who have retired over the past several years typically retired at age 56 after having served an average of 33 years of active commissioned service and 3-1/2 years in their last pay grade. On average, retired general and flag officers were first promoted to general and flag officer at age 49, upon reaching 26 years of active commissioned service, and served 6 years as a general or flag officer before retiring. DOD did not present evidence that the legislative provisions it seeks to change hinder the management of general and flag officers or the agency's ability to perform its mission. DOD presented various rationales for its proposals and sponsored a study of general and flag officer management but did not provide data to support the need for these proposals. GAO found that DOD can achieve its goal of extending some general and flag officers' careers and assignments within the parameters of the current legislative framework since many general and flag officers retire several years before reaching the statutory retirement limits. More specifically, the career profile data show that more than three-fourths of general and flag officers who retired in grades O-9 and O-10 between fiscal years 1997 and 2002 could have served at least 3 more years before reaching the current statutory retirement limits. Existing legislative authority provides some flexibility in managing general and flag officers, but the Executive Branch has not made frequent use of this authority. In particular, the Executive Branch has rarely used its existing authority to defer the retirement of general and flag officers on a case-by-case basis beyond the statutory limits on age and years of service. Additionally, factors other than the statutory limits, such as personal considerations and military service culture, may account for early retirements of general and flag officers. GAO also found that the proposals (1) would reduce congressional oversight and provide broad latitude to the Executive Branch in managing general and flag officers, (2) could impede the upward flow of officers by limiting promotion opportunities due to the extension of general and flag officer careers, and (3) would likely increase federal retirement outlays for retirement compensation, based on a cost estimate developed by GAO.

Background An increasing number of states have chosen to offer MLTSS programs. As of October 2016, 21 states had MLTSS programs and 8 additional states had plans to implement MLTSS programs. (See fig. 1.) The most recent enrollment data available at the time of our study, from July 2014, showed that MLTSS programs in 17 states collectively served at least 500,000 beneficiaries, and 5 of those states served over 50,000 beneficiaries each. In fiscal year 2014, Medicaid spent an estimated $22.5 billion on MLTSS. The characteristics of states’ MLTSS programs vary due to the flexibility, within federal parameters, that Medicaid allows states in establishing their programs. Flexibility in determining the included populations. In their MLTSS programs, states may include older adults, individuals with physical disabilities, and individuals with intellectual or developmental disabilities. States may limit some of these populations to adults or may include both children and adults. Flexibility in determining whether enrollment will be mandatory or voluntary. Generally, states with mandatory enrollment can require beneficiaries to be in the MLTSS program, whereas states with voluntary enrollment offer beneficiaries a choice between the MLTSS program and receiving similar services through fee-for-service (FFS). Flexibility in the services included and the extent to which MLTSS is part of a comprehensive managed care program. States can cover a variety of services, including community-based care and institutional care. In addition, some states choose to have MLTSS as part of a broader, comprehensive managed care program that also includes physical and behavioral health, while others have MLTSS as a separate managed care program. To be eligible for MLTSS, beneficiaries must meet income and asset requirements, and also meet state-established criteria on the level of care needed, such as needing an institutional level of care. Once a person is determined eligible by the state Medicaid agency, they can be enrolled in an MCO. The MCO then develops a service plan, which includes determining the types and amount of services expected to be needed by the beneficiary. (See fig. 2.) For example, for a beneficiary receiving care in the home, the MCO determines if personal care services are needed and, if so, the amount of services, such as the number of hours, needed per week. Federal Approval of MLTSS Programs States are required to seek CMS approval for their MLTSS programs, including their payment structures, which they can implement through several different authorities. Among the most commonly used authorities are section 1115 demonstrations and section 1915(b) waivers. In CMS’s 2013 guidance on its expectations for states’ MLTSS programs using either of those two authorities, the guidance noted that states’ programs should enhance the provision of community-based care. In addition, the guidance noted that, consistent with the intent of the Americans with Disabilities Act and the Olmstead decision, rate structures must encourage the delivery of community-based care, and other payments and penalties linked to performance must also support MLTSS program goals. Other program goals could include provision of supports to aid beneficiaries in achieving competitive employment, provision of services in the most integrated setting, and consumer satisfaction. Before approving an MLTSS program under one of these authorities, CMS engages with states to shape the structure of the program, including alignment with CMS’s 2013 guidance. For example, a state generally goes through a design phase during which the state engages in discussions with CMS. The state then submits a formal application to CMS, and the subsequent federal review process may include negotiations, including on the design of the payment structures. States with approved MLTSS programs are subject to reporting requirements, which could include financial reporting and quarterly and annual reports that provide CMS with information on the state’s progress, but the exact reporting requirements may vary by state. For example, CMS may require some states to report on the number of beneficiaries served, expenditure data, information on grievances and appeals, or other requirements specific to the state. Development and Approval of MLTSS Payment Structures States take various approaches to designing their MLTSS payment structures—the structure of rates and of incentive payments and penalties—which can influence the financial incentives being set for MCOs. For the rate structures, for example, some states choose to set one rate for beneficiaries in the community and a different rate for beneficiaries in institutions. Other states may choose to set a single rate regardless of the beneficiary’s setting of care, which is known as a blended rate. States that use a blended rate intend for it to set a financial incentive for MCOs to provide community-based care, because of the generally lower cost of such care. (See fig. 3.) In addition, states can also set incentives for MCOs’ performance by linking it to certain payments or penalties. For example, states can make a portion of payments conditional on achieving specified benchmarks. States can also impose financial penalties on MCOs for not fulfilling requirements in the contract, which may include requirements that relate to the quality of and access to care. By law, states must develop and get CMS approval of rates that are actuarially sound. Actuarially sound rates are projected as providing for all reasonable, appropriate, and attainable costs required of the MCO to fulfill the terms of its contract with the state, and must be developed in accordance with requirements for CMS’s review and approval of rates. In order to project costs, states rely on various data, such as data on demographic, health, and functional factors; the setting of care; and the scope of benefits. The sources and extent of these data, referred to as base data, vary by state. States require MCOs to provide encounter data (which are the primary record of services provided to beneficiaries in managed care), and states may also use financial data from the MCOs and claims data from the Medicaid FFS population. States and their actuaries project costs and set rates based on these data with adjustments and assumptions to account for missing, incomplete, or anomalous data; the extent to which covered populations and services are reflected in the data; changes in benefits and policies; and trends in utilization and prices of services. When setting or amending rates, states must submit an actuarial rate certification that explains how the rates were developed. CMS expects the rate certification to provide sufficient detail, documentation, and transparency to enable another actuary to assess the reasonableness of the methodology and the assumptions supporting the development of the final rate. CMS reviews the rate certification for compliance with agency requirements, including the rate guide for that year. CMS may ask questions of the state until CMS can assess that the data, assumptions, and rate development were reasonable and meet generally accepted actuarial principles and practices, at which point CMS approves the rates for the state to pay to the MCOs. The different steps of the process undertaken by states to develop rates, and by CMS to approve rates, are illustrated in figure 4. CMS has made several changes to its review process in recent years. Beginning in January 2015, CMS added its Office of the Actuary as a reviewer of all rate certifications from states. In addition, CMS has made changes to its annually issued rate setting guidance, or rate guide, which is guidance issued to states on information that must be included in rate certifications. Specifically, the rate guide issued in 2015 for rates starting on or after January 2016 included a new section with additional considerations for setting MLTSS rates. In May 2016, CMS issued a final rule that was the first major change to Medicaid managed care regulations since 2002, including the requirements around rate setting. The rate-setting requirements, such as CMS’s revised definition of actuarial soundness, became effective in July 2016, although certain provisions, such as those related to improving data reliability, apply on or after July 2017 or July 2018. Most Selected States Set Incentives for Community-Based Care, but Did Not Link Payment to Performance on MLTSS Goals Five of our six selected states set financial incentives in their rate structures for providing community-based care, which is a CMS expectation for MLTSS programs. However, we also found that most of the six states did not opt to link payments to MCO performance on MLTSS program goals, such as enhancing the provision of community- based care. Five of Six Selected States Set Financial Incentives for Providing Community-Based Care Five of our six selected states set clear financial incentives in their rate structures for MCOs to provide community-based care. Specifically, for all or part of 2015, four of the states—Arizona, Delaware, Florida, and Kansas—used blended rates, where the state pays MCOs the same rate per beneficiary regardless of the setting of care. Blended rates are intended to set an incentive for community-based care, which generally has lower costs. The fifth state—Minnesota—used a modified version of a blended rate. The four states with blended rates made different assumptions about the percentage of beneficiaries in community-based care when setting rates. These assumptions affected the strength of the financial incentive for community-based care. For example, for its rates ending in 2015, Florida assumed each MCO’s percentage of beneficiaries receiving community-based care was 2 percentage points higher than the MCO’s actual distribution in the previous year. Thus, Florida’s rate was slightly lower than if the state used the MCO’s actual distribution. The aggregate effect of that lower rate can be significant. For example, for one MCO with approximately 5,500 enrollees in Florida, we calculated that the difference of 2 percentage points in calculating the blended rate would result in approximately $475,000 less per month. The other three states with blended rates did not use a fixed percentage increase in setting the assumptions for the blended rates. For example, Arizona officials said they tailored their assumptions to each MCO’s past experience and the state’s expectations about the MCO’s capacity, and the assumptions could include making no increase. For our sixth selected state—Texas—it was unclear if the rate structure set a financial incentive for community-based care. The state paid MCOs higher rates for beneficiaries receiving institutional care than for beneficiaries receiving community-based care. The higher institutional rates could set an incentive for MCOs to move higher-cost beneficiaries from the community to an institution. Texas officials said that MCOs’ greater ability to control community-based utilization and payments to providers gave them a financial incentive for community-based care. For example, whereas Texas MCOs must pay nursing facilities a specified rate, the MCOs may be able to negotiate lower rates with community- based providers, potentially lowering their costs compared to the rate received for community-based care. CMS required the state to regularly report to CMS on the proportion of beneficiaries in community-based care to show whether or not there are changes in the proportion of such beneficiaries. The selected states varied in their methods to account for the costs of beneficiaries with particularly high costs. These methods may have enhanced or reduced the incentives in the rate structure for community- based care. Beneficiaries with high-cost institutional care. In two of our selected states, the state (and not the MCOs) was responsible for covering certain costs of these beneficiaries. For example, Kansas excluded from MCO responsibility the cost for beneficiaries with intellectual or developmental disabilities in one of the state’s public institutions. Minnesota excluded from MCO responsibility the cost of institutional care after 180 days. Instead, the states covered those costs through FFS, which could weaken the incentive for MCOs to manage those beneficiaries’ care in such a way that keeps them from reaching those points. Beneficiaries with high-cost community-based care. Three of our selected states differed in how to cover certain costs of these beneficiaries. For example, Florida reimbursed MCOs for a percentage of costs of beneficiaries whose cost of community-based care exceeded the cost of equivalent institutional care. Minnesota paid higher rates for beneficiaries who needed more assistance with activities of daily living and who were receiving community-based care. These provisions could counter incentives for MCOs to shift beneficiaries with a high cost of community-based care to institutions. Conversely, for example, Arizona required that if a beneficiary was projected to receive community-based care that exceeded the cost of equivalent institutional care, the beneficiary had to agree to move to institutional care or personally cover the additional costs of the community-based care. This could weaken the incentive for MCOs to manage care in such a way to reduce costs for beneficiaries at risk of hitting the cost ceiling, because those beneficiaries’ costs are likely exceeding the rate paid to the MCO. Data from four of our selected states—all of which had rate structures that set incentives for community-based care—indicated that the proportion of beneficiaries receiving such care increased between 2013 and 2015. As shown in table 1, state-reported data indicate that the percentage of community-based beneficiaries in Arizona, Delaware, Kansas, and Minnesota increased between 0.3 and 5.9 percentage points from 2013 to 2015. The two states with smaller increases included both an established program (Arizona, increase of 1.2 percentage points) and a newer program (Kansas, increase of 0.3 percentage points). The remaining two of our six selected states, Florida and Texas, had increases in the number of beneficiaries in community-based care, but, because of significant changes to their programs between 2013 and 2015, there were not comparable data to assess the difference in the percentage of beneficiaries receiving community-based care. Most Selected States Did Not Link Payments to Performance on MLTSS Goals Most of our six selected states did not opt to link payments to MCOs’ performance on MLTSS program goals, such as enhancing the provision of community-based care and aiding beneficiaries in achieving employment. In the contracts we reviewed, only one of our selected states (Kansas) linked payments to measures of outcomes on its MLTSS program goals. These measures included the rate of employment for certain beneficiaries receiving community-based care and the number of days of institutional care. In 2015, the state made 2 percent of the MCOs’ payments—$57.9 million for the three MCOs—conditional on the MCOs’ performance on these and other measures, but, as of June 2016, the state had not yet determined the amounts to be returned to the MCOs based on their performance in that year. The remaining five selected states had no links between payments and MCOs’ performance to measures of outcomes on MLTSS program goals. Instead, they mostly linked payments to measures of the outcomes or quality of care for beneficiaries’ physical and behavioral health, but not the outcomes of the long-term services and supports provided. Officials from one state told us that they do not link payment to performance on MLTSS goals, because standardized measures for long-term services and supports are not available. In addition, federally led efforts to develop outcome measures for long-term services and supports are in the early stages. In addition, most of our selected states had limited links between financial penalties and MCOs’ performance. Although the contracts in all six of our selected states required MCOs to report on performance measures specific to MLTSS, among other areas, only Delaware’s, Florida’s, and Texas’ contracts specified the amount of financial penalties, such as sanctions or damages, for MCOs that did not meet those performance measures. (See table 2.) For example, Florida could assess damages of $500 per beneficiary dissatisfied with care management if the MCO failed to achieve a satisfaction rate of 90 percent or higher. As another example, Texas could assess damages of up to $500 per beneficiary per day for late, inaccurate, or incomplete documentation of the MCOs’ assessments of beneficiaries’ needs. Data reported by our selected states indicated that the frequency of states issuing financial penalties varied, and when done were relatively small. In particular, three of our selected states issued no financial penalties or sanctions in 2015 for any reason. Our selected states also had different practices to monitor performance, particularly MCO decisions for beneficiaries’ service plans that detail the level and type of care to be provided. For example, officials from two states told us that they review and approve changes proposed by MCOs for beneficiaries’ service plans, such as reductions, suspensions, or terminations of services; and officials from four states told us that they required MCOs to submit data to the state on changes in the service plans. In addition, officials from five states told us they conduct audits or other types of reviews of the service plans. However, depending on the state, these reviews may use a sample of records or be targeted to a certain subset of beneficiaries. Officials in some states also told us that they track trends in grievances and appeals to assess beneficiaries’ satisfaction with MCO performance. CMS’s Oversight of MLTSS Payment Structures Is Limited We found weaknesses in CMS’s oversight of states’ payment structures. First, CMS has not consistently required states to report on progress toward MLTSS program goals, such as enhancing the provision of community-based care, and therefore cannot assess the effectiveness of states’ payment structures. Second, it is unclear whether new CMS requirements will sufficiently address issues with the appropriateness and reliability of the data used by states to set MLTSS rates. CMS Does Little to Monitor State Progress toward MLTSS Program Goals, and the Effectiveness of CMS’s Planned Efforts Is Unclear CMS has not consistently required states to report data on whether their MLTSS payment structures are achieving MLTSS program goals, such as enhancing the provision of community-based care. For three of our selected states—Texas, Arizona, and Delaware—CMS required reporting on the provision of community-based care. For example, CMS required Texas to report regularly on the proportion of beneficiaries in community- based care as a way of monitoring whether the state’s program set sufficient incentives for community-based care, since the state’s rates were not clearly structured to encourage such care. CMS required Arizona to annually report on placements and activities for expanding community-based care. CMS required Delaware to assess rebalancing, i.e., the proportional shift from institutional to community-based care, as part of a long-term evaluation of the program. For the three remaining states, CMS did not require reporting on progress toward goals to increase the use of community-based care. Discussions with CMS officials confirmed that the agency has not consistently required states to report on progress toward MLTSS program goals. Provisions in CMS’s new managed care rule could provide an opportunity for more regular and standardized MLTSS data from states. The final rule requires states to submit annual reports on their managed care programs, including their MLTSS programs. The reports have to cover at least nine topic areas, such as the availability and accessibility of covered services and the evaluation of MCO performance on quality measures. The report must address MLTSS in covering these areas, but CMS did not require separate reporting of information related to MLTSS, unless there are factors in the delivery of MLTSS not addressed in the other areas. The deadline for the first report is contingent on CMS issuing guidance on the format and content of the reports. CMS officials said that they did not anticipate that this guidance would direct states to include additional MLTSS information, such as progress toward program goals. CMS officials told us that they do not plan to do so because the requirements should allow for state flexibility in reporting since these programs vary among states. However, CMS could require reporting while still allowing flexibility. For example, CMS could leverage performance measurement information that it is requiring all states to identify for MCOs providing MLTSS. Specifically, beginning in 2017, states must identify performance measures for MCOs on quality of life, rebalancing, and community integration activities, among other things. States must require MCOs to measure and report on performance annually and submit the underlying data that would allow the state to assess performance on the measures. CMS officials told us that standardized MLTSS quality measures remain in the early stages of development; despite this, CMS could use preliminary information from states to inform potential concerns with program design within and across states. CMS has two additional efforts that may provide it with new information from some states, but the information would be limited in scope and reliability, as shown below: Expenditure data broken out by setting of care. CMS officials told us that, beginning in April 2016, they began requiring states to break out managed care expenditures by setting of care in quarterly expenditure reports. This will allow CMS to calculate the proportion of MLTSS expenditures on community-based care versus institutional care, which could serve as a proxy for assessing whether MLTSS programs are affecting the proportion of beneficiaries in each setting of care. CMS officials said that data limitations exist if using the data on a state-by-state basis, in part, because states are not required to certify the accuracy of the specific break out amounts of community- based care versus institutional care. Standardized performance information from states with section 1115 demonstrations. According to CMS officials, the agency plans to have states implementing MLTSS programs using section 1115 demonstrations report on certain standardized outcome measures, which as of November 2015, would include 12 of the 21 states with MLTSS programs. While some states are reporting some outcome information, CMS officials told us the agency wants to standardize the content and format of reporting requirements and data obtained. As of September 2016, CMS officials said that they have not yet determined the measures that might be included in this effort or whether reporting will be mandatory or voluntary for states, and that CMS did not have target timeframes for beginning to collect the information. According to federal internal control standards, federal agencies should use quality information to achieve their objectives. Without consistently requiring information on state progress toward MLTSS goals, CMS will continue to approve programs and pay billions of dollars to states without knowing whether the payment structures are providing sufficient incentives for MCOs to provide community-based care. CMS Has Established New Rate-Setting Requirements, but Risks Remain Regarding the Use of Appropriate and Reliable Data CMS has established several new rate-setting requirements for states related to the data used to set rates, including MLTSS rates. (See table 3.) These requirements focus on the appropriateness and reliability of the data states use in rate setting, which are critical to whether the rates are reasonable and adequate. In its annual rate development guide for 2016, CMS increased the information it required states to provide during rate review on the quality of the data used to set rates. CMS required states to describe the steps taken by their actuary and others to validate the data used to set rates. CMS specified that the information submitted needed to address the completeness, accuracy, and consistency of the data. CMS also specified that the state’s actuary include their assessment of the quality of the data. In addition, under the final rule, the agency will begin to require states to meet additional standards for the appropriateness of the data used to set rates beginning in July 2017. The rule requires that states use base data that are no older than the three most recent and complete years prior to the rate year. These new regulations also require states to validate encounter data, which are the primary record of managed care services and a key source of data for setting managed care rates, and periodically audit those data, as well as financial data, which states also may use in rate setting. It is unclear, however, whether CMS’s implementation of the new requirements will sufficiently minimize the risk of states using inappropriate and unreliable data to set MLTSS rates. Under federal regulations, in order to be actuarially sound, rates must be, among other things, appropriate for the population to be covered and services to be provided under a state’s contract with an MCO, and adequate for the MCO to meet requirements to ensure timely access to services, adequate networks, and coordination and continuity of care. To the extent that states are using data that are not appropriate or reliable, the data may not be a good predictor of expected costs, which could result in rates that are too high or too low. Rates that are too high have implications for MCOs receiving more federal funding to care for beneficiaries than is necessary. Rates that are too low may create incentives for MCOs to reduce the level of care provided, affect the ability to attract providers, and affect the stability of the market. We found evidence of concerns with the appropriateness of data that states used to set rates and the reliability of such data. Appropriateness of Data In the rate certifications we reviewed and our interviews with state officials, we found evidence of concerns with the appropriateness of data used to set rates in two of our selected states: State did not use recent data to set rates. CMS approved rates for calendar year 2015 for one of our selected states, Delaware, which were developed using FFS data from 2010 and 2011. When reviewing the state’s rate methodology, CMS questioned why the state did not use more recent data or a different type of data. The state explained that credible data from a more recent time period were not available at the time that the state developed its rates for calendar year 2015. Delaware’s MLTSS program—established in 2012—was relatively new. In contrast, the other five states included 2013 or 2012 encounter data, as well as previous years of data in a couple of cases, to set their rates for all or part of 2015. State did not rebase rates when newer data were available. Officials in Arizona, a state with an MLTSS program that has been in place for over 20 years, told us that the state used the same years of base data to set the rates paid to MCOs within the 5-year contract period. Thus, by the fifth year, the base data used to set the rates would be over 5 years old. CMS officials told us that they were aware of Arizona’s policy and that it was a concern that this state was not rebasing—using updated data to set rates—more frequently. They also said that they are aware of other states that rebase their rates infrequently, which officials attributed to the states lacking more recent, sufficiently reliable data for rate setting. CMS has not determined the extent to which it will allow these two examples to continue under the new requirement that the data used to set rates be no older than the three most recent and complete years. Under the new rule, a state that cannot fulfill this requirement would need to request from CMS an exception from the new data requirement. CMS officials told us that there can be circumstances where it is acceptable for states to use older data to set rates, such as during the first few years of implementing MLTSS programs and when the state has limited managed care experience. Similarly, CMS officials told us there may be instances in which a state would not rebase every year and states are not required to rebase annually. As of July 2016, CMS officials told us that they had not determined what situations would warrant exceptions from the new data requirements and did not know if they would issue guidance on the requirement. Without specifying its criteria for what situations would warrant exceptions, CMS may not be able to sufficiently minimize the number of states using data of questionable appropriateness to set rates. Reliability of Data We also found evidence of reliability issues with encounter data and of variation in state validation procedures. We and the HHS Office of Inspector General (OIG) have found evidence of reliability concerns with state encounter data. For example, in 2015, the OIG reported that 8 of 38 states reviewed did not report any encounter data for part of fiscal year 2011 to CMS by the required deadline. The OIG also found that 11 states did not report required encounter data for all of their MCOs or other managed care entities, indicating a lack of completeness. Similarly, in 2015, we reported reliability issues with the encounter data, from calendar year 2010, reported by 6 states. Rate setting documents indicated variation in data validation efforts among our selected states. In the rate certifications we reviewed, one of our selected states (Arizona) described steps taken by the state Medicaid agency to validate the data used to set rates. Specifically, the rate certification for Arizona stated that the state Medicaid agency used encounter data validation studies, which included reviewing and auditing the data for accuracy, timeliness, and completeness, and compared the data to MCO financial statements. In the other five states, the rate certifications did not describe any validation procedures taken by the state Medicaid agency, which, under the actuarial standards of practice, is responsible for the accuracy and completeness of the data as the supplier of the data. Instead, the rate certifications described other steps taken by the actuary to check other aspects of the data, including reasonableness and consistency. In three of these states, the rate certifications also described steps taken by the actuary to compare the encounter data to other data sources. While the new rule requires states to validate the completeness and accuracy of encounter data, CMS has not issued guidance with minimum standards for state data validation procedures and does not plan to do so. CMS officials noted that they had previously issued information to states on validation procedures, including a toolkit for states to use when establishing their encounter data systems and a data validation protocol that could be used as part of required external quality reviews (EQR). CMS issued the encounter data toolkit, in part, because the agency recognized the importance of encounter data for setting rates, and that encounter data are only useful to the extent that they are complete and accurate. In the toolkit, CMS suggested that states need to check the data by conducting front-end edits of the data, as well as validating data through reports and setting benchmarks. Similarly, the EQR protocol on validating encounter data included detailed steps for a state to determine the validity—completeness and accuracy—of encounter data reported by MCOs. This protocol, however, is optional, and it is unclear whether it is being used by states. Further, CMS may not receive complete information from states on their validation efforts, and, therefore, would not be able to assess whether state efforts are sufficient. CMS has required states to submit a description of validation efforts for 2016 rates, and its guidance indicates that this should include steps taken by the actuary and others, including the state, MCOs, and external quality reviewers. However, CMS officials said that they expect that the information provided will likely focus on the work performed by the actuary, and may not include information on steps the state performed to validate the data submitted by MCOs. The new rule states that CMS will assess state encounter data submissions to ensure that the data meet criteria for accuracy and completeness, which may be another means for identifying certain weaknesses in states’ validation efforts. States’ validation procedures are a critical check of the reliability of data for, among other purposes, setting rates. CMS has required states to set certain standards for enrollee encounter data in the states’ contracts with their MCOs. However, required state validation checks are needed to ensure that these are consistently implemented by MCOs. Without minimum standards for such state validation efforts, it is unclear that those efforts will be sufficient to minimize the risk of encounter data being incomplete or inaccurate. Conclusions Using managed care to deliver long-term services and supports offers state Medicaid programs an important strategy that can encourage and enhance the provision of community-based care. Both states and CMS have the goal of enhancing the provision of community-based care, which many beneficiaries may prefer, and which can result in savings for states and the federal government. Achieving these goals depends, in part, on states establishing payment structures that align financial incentives for MCOs with those goals, and setting rates that are adequate and appropriate. CMS plays an important role in overseeing states’ payment structures, both by monitoring whether states’ payment structures are achieving Medicaid program goals, including enhancing the provision of community-based care, and assessing whether states’ rates comply with actuarial soundness requirements. CMS’s new requirements under the May 2016 rule have created an opportunity for enhanced federal visibility over the effectiveness of MLTSS programs, which serve some of the most vulnerable Medicaid beneficiaries. For example, the requirements for annual reports on states’ managed care programs and for states to identify MLTSS measures and require MCOs to report on them, if connected during implementation, could provide CMS with timely information on progress toward program goals within a given state and nationally. Federal oversight is critical given our findings that states were often not linking payment to MCO performance on MLTSS goals. Without requiring all states to report on progress toward program goals, CMS will continue to pay billions of dollars for state programs without knowing whether they provide sufficient financial incentives for providing community-based care, which has implications both for beneficiaries and on federal costs. CMS has taken a number of important steps to improve state rate-setting practices, including rates for MLTSS programs. Requirements under the new 2016 managed care rule, particularly the new data standards and validation requirements for encounter data, have the potential to better ensure that states are using appropriate and reliable data to set the rates paid to MCOs. However, CMS has not established criteria for what situations would warrant exceptions to the data standards, and has no plans to do so. Without clear criteria, states may continue to seek approval for rates that are based on data of questionable appropriateness, as was the case in Arizona and Delaware. With regard to encounter data validation requirements, CMS does not plan to issue any guidance or require minimum standards for state procedures, despite a history of data reliability concerns and lack of state compliance with reporting requirements. Without strong data, states and the federal government risk paying rates that are too low, which could result in quality and access concerns for beneficiaries, or rates that are too high, which diverts limited Medicaid dollars to MCO profit and away from needed care. Recommendations To improve oversight of states’ payment structures for MLTSS, we recommend that the Administrator of CMS take the following three actions: 1. Require all states to collect and report on progress toward achieving MLTSS program goals, such as whether the program enhances the provision of community-based care. 2. Establish criteria for what situations would warrant exceptions to the federal standards that the data used to set rates be no older than the three most recent and complete years. 3. Provide states with guidance that includes minimum standards for encounter data validation procedures. Agency Comments and Our Evaluation We provided a draft of this product to HHS for comment. In its written comments, reproduced in appendix II, HHS concurred with our three recommendations and indicated steps HHS would consider taking in response. In response to our first recommendation to require all states to collect and report on progress toward achieving MLTSS program goals, HHS said it intends to release guidance clarifying the format of the annual reports on states’ managed care programs so that it includes the results of the states’ review of performance measures on quality of life, rebalancing, and community integration activities, among other things. In response to our second recommendation to establish criteria for what situations would warrant exceptions to the federal standards that the data used to set rates be no older than the three most recent and complete years, HHS said it will consider whether additional clarifying guidance is needed. In response to our third recommendation to provide states with guidance that includes minimum standards for encounter data validation procedures, HHS said it will work toward developing additional guidance on standards as it relates to encounter data validation procedures. HHS also provided technical comments, which we incorporated as appropriate. As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the appropriate congressional committees, the Secretary of Health and Human Services, and the Administrator of the Centers for Medicare & Medicaid Services. In addition, the report will be available at no charge on the GAO website at http://www.gao.gov. If you or your staffs have any questions about this report, please contact me at (202) 512-7114 or yocomc@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III. Appendix I: Characteristics of States’ MLTSS Programs Selected for Our Review Our six selected states (Arizona, Delaware, Florida, Kansas, Minnesota, and Texas) have managed long-term services and supports (MLTSS) programs that varied in terms of cost and enrollment. In 2015, total capitated payments to managed care organizations (MCO) for MLTSS reported by the six states ranged from $438.9 million for Delaware to $3.7 billion for Florida. (See table 4.) The number of beneficiaries reported by each state also varied, ranging from 6,340 in Delaware to almost 98,000 in Texas. In all of the selected states, these beneficiaries included seniors and adults with physical disabilities. In some of the selected states, these beneficiaries also included adults with intellectual and developmental disabilities and children with disabilities. The number of beneficiaries in some programs has changed in recent years. Specifically, between 2013 and 2015, two states—Florida and Texas—increased the number of beneficiaries by nearly 90 percent and over 145 percent, respectively, due to expansions in the scope of their MLTSS programs. Florida’s program became statewide in 2014, while Texas’ program expanded to rural areas in 2014 and began including beneficiaries receiving institutional care in its program in 2015. The MLTSS programs in our selected states also varied across a number of other characteristics, such as age, number of MCOs participating, and length of contract period. (See table 5.) Appendix II: Comments from the Department of Health and Human Services Appendix III: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Susan Barnidge (Assistant Director), Corissa Kiyan-Fukumoto (Analyst-in-Charge), and Jessica L. Preston made key contributions to this report. Also contributing were Emei Li, Drew Long, Vikki Porter, and Jennifer Whitworth.

The provision of long-term services and supports in Medicaid is a significant challenge, because of the vulnerability and service needs of beneficiaries, as well as the high cost of care. An increasing number of states have MLTSS programs, which can be used to expand community-based care and lower costs. However, whether these programs are an effective strategy depends, in part, on the design of the payment structures. GAO was asked to review states' MLTSS payment structures and CMS's oversight. This report examines (1) how selected states structured their financial incentives, and (2) CMS policies and procedures for overseeing states' payment structures. GAO reviewed relevant federal regulations, guidance, and internal control standards. For six states selected for variation in location and experience (AZ, DE, FL, KS, MN, and TX), GAO reviewed the contracts and rate certifications most recently approved by CMS, the terms and conditions set by CMS for the programs, and other payment documentation. GAO also interviewed CMS officials and Medicaid officials from the selected states. Out of six states with Medicaid managed long-term services and supports (MLTSS) programs that GAO selected for review, five set clear financial incentives in their payment rates for managed care organizations (MCO) to provide care in the community versus in an institution. However, most of the selected states did not opt to link payments or penalties to MCO performance on MLTSS goals. These goals, which include enhancing the provision of community-based care, are developed by states and the Centers for Medicare & Medicaid Services (CMS), the agency in the Department of Health and Human Services (HHS) responsible for overseeing Medicaid. GAO found that CMS's oversight of state payment structures was limited. CMS expects states' MLTSS programs to enhance the provision of community-based care. However, GAO found CMS does not consistently require states to report on whether the payment structures—including payment rates, incentive payments, and penalties—are achieving MLTSS goals. For example, CMS required three of the selected states to report on the provision of community-based care, but did not require any such reporting from the other three states. According to federal internal control standards, federal agencies should use quality information to achieve agency objectives. Without requiring information on states' progress toward MLTSS goals, CMS will continue to pay billions of dollars to states without knowing if states have sufficient incentives for community-based care. In addition, GAO identified risks with CMS's oversight of the data used to set MLTSS rates, specifically the appropriateness and reliability of those data. Under federal regulations, MLTSS rates must be appropriate and adequate. To the extent that states use data that are not appropriate and reliable to set rates, the resulting rates could be too low, which could provide an incentive for MCOs to reduce care, or too high, which results in more federal spending than necessary. Appropriateness concerns: GAO found issues with the appropriateness of data used by two of the selected states. For example, one state used data from 2010 and 2011 to set rates for 2015. Beginning in July 2017, CMS will require rates to be based on the three most recent and complete years of data. Although CMS will allow exceptions, it has not specified criteria for what situations would warrant exceptions. Without specifying criteria, CMS's requirements may not sufficiently minimize the number of states using data of questionable appropriateness to set MLTSS rates. Reliability concerns: GAO and the HHS Office of Inspector General previously found evidence of reliability issues with managed care encounter data, which are the primary record of managed care services and a key source of data used to set MLTSS rates. In addition, GAO's review of state documentation indicated variation in selected states' procedures for validating the reliability of their encounter data, specifically the completeness and accuracy of the data. Beginning in July 2017, CMS will require states to validate encounter data, but CMS has not issued guidance with minimum standards for state procedures. Without minimum standards for state validation efforts, it is unclear that CMS's efforts will sufficiently minimize the risk of encounter data being incomplete or inaccurate .

Background PBGC was created by the Employee Retirement Income Security Act of 1974 (ERISA) to pay benefits to participants in private defined benefit pension plans in the event that an employer could not. PBGC may pay benefits up to specified limits, if a plan does not have sufficient assets to pay promised benefits and the sponsoring company is in financial distress. As of September 2010, PBGC was paying monthly retirement benefits to more than 800,000 retirees in about 4,200 terminated pension plans. PBGC receives no funds from general tax revenues. Instead, the corporation finances its activities from three main sources of funds: (1) insurance premiums in amounts set by Congress and paid by defined benefit plan sponsors, (2) assets acquired from plans that have been terminated and trusteed by PBGC, and (3) investment income earned on these assets. Under current law, the corporation has no substantial source of funds available to it if it were to exhaust its assets, except for the ability to borrow up to $100 million from the Department of the Treasury. The United States government is not liable for any obligation or liability incurred by the corporation. PBGC’s deficit fluctuates due to various factors, including changes in interest rates, investment performance, and losses from completed and probable plan terminations. PBGC’s deficit improved during fiscal year 2008, but then worsened the next year with the severe market downturn. As of September 2010, PBGC held approximately $79.5 billion in assets and approximately $102.5 billion in liabilities—for an accumulated deficit of $23.0 billion, more than double the deficit from 2 years earlier (see fig. 1). This growth in its deficit was due largely to an increase in plan terminations and a decline in interest rates used to value PBGC’s liabilities. As a result of these plan terminations, PBGC became directly responsible for the pensions of more than 200,000 additional participants in fiscal year 2009, the third highest annual total of new participants in PBGC’s history. During this time, the corporation trusteed plans of companies such as Lehman Brothers, IndyMac Bank, Circuit City, Nortel, and Delphi Corporation. In addition, as of September 2010, PBGC estimated future losses from underfunded multiemployer plans that are unable to repay financial assistance provided by PBGC at about $3.0 billion—up from $1.8 billion 2 years earlier. PBGC currently has sufficient assets to make scheduled benefit payments for a number of years, given that benefits are paid monthly and spread over participants’ and beneficiaries’ lifetimes. However, in the long term, PBGC is likely to remain at financial risk due, in part, to several structural challenges that limit PBGC’s ability to manage its risk. For example, statutorily prescribed pension funding requirements specify how much a sponsor must contribute to its defined benefit plans each year. However, these funding rules are based on assumptions about future liabilities that may differ from a plan’s actual payouts of benefits over time. Similarly, PBGC’s premium structure is specified in law for both single- and multiemployer defined benefit plans. This structure limits the corporation’s ability to manage its financial risk because, unlike private insurers, PBGC cannot decline to provide insurance coverage or adjust premiums in response to actual or expected claims exposure. Meanwhile, PBGC’s premium base has been shrinking as the number of defined benefit pension plans and active plan participants has been declining rapidly. In fiscal year 2010, PBGC insured about half the number of plans it insured 15 years earlier. Legislation enacted over the past 5 years has taken steps to address these concerns, but the extent to which these steps may reduce PBGC’s risk of future losses is still unknown. For example, the Deficit Reduction Act of 2005 included provisions to raise flat-rate premiums and create a new, temporary premium for certain terminated single-employer plans. In addition, the Pension Protection Act of 2006 (PPA) included a number of provisions aimed at improving plan funding and PBGC finances through such measures as raising the funding targets defined benefit pension plans must meet, reducing the period over which sponsors can “smooth” reported plan assets and liabilities, and restricting sponsors’ ability to substitute “credit balances” for cash contributions. However, in response to the recession, Congress enacted legislation in 2008 to help companies better weather the economic downturn by granting funding relief to certain sponsors and delaying implementation of certain PPA provisions. Thus, the overall impact of PPA remains unclear. PBGC’s insurance programs are in need of urgent congressional attention and agency action. We first designated the single-employer insurance program as “high risk” in 2003 after it moved from a $9.7 billion accumulated surplus in fiscal year 2000 to a $3.6 billion accumulated deficit in fiscal year 2002. Since that time, the net financial position of PBGC has significantly worsened due, in part, to the declines in certain industries that led to PBGC having to assume responsibility for several large underfunded plans, and to the steep downturn in the financial markets. We added the high risk designation to the multiemployer program in 2009 in light of the increased risk of future losses in that program as well. As of September 2010, PBGC’s estimated financial deficit for both programs combined was $23.0 billion—more than double its deficit from 2 years earlier. PBGC’s Board Structure Needs Strengthening PBGC needs strong policy direction and oversight in the face of its current financial condition and long-term structural challenges, yet the board’s structure as established by law limits the board’s ability to provide such policy direction and oversight. ERISA specified that PBGC is to have a three-member board of directors consisting of the Secretaries of the Treasury, Commerce, and Labor. The Secretary of Labor serves as the Chairman of the Board. The board is required to direct and oversee the corporation, in part, by approving all policy decisions affecting American employers and workers as well as reviewing and approving its budget, strategic plans, and financial performance. Each board member can designate an official to serve on his or her behalf in most instances. This designee is referred to as the board member’s “representative.” In addition, ERISA established an Advisory Committee, whose seven members are appointed by the President to represent the interests of labor, employers, and the general public. The committee has an advisory role but has no statutory authority to set PBGC policy or conduct formal oversight. Our prior work has highlighted a number of limitations with this statutory governance structure, starting with the size and composition of the board. According to corporate governance guidelines published by The Conference Board, corporate boards should be structured so that the composition and skill set of a board is linked to the corporation’s particular challenges and strategic vision, and should include a mix of knowledge and expertise targeted to the needs of the corporation. We found that other government corporations’ boards averaged about 7 members, with one having as many as 15 (see table 1). None had a board as small as PBGC’s. In addition, the size of PBGC’s board also prevents the members from establishing standing oversight committees, which are commonly used by both government corporations and private corporate boards. For example, other government corporations, such as the Overseas Private Investment Corporation (OPIC) and the Federal Deposit Insurance Corporation have established standing committees to conduct oversight of certain functions, such as audits and case file reviews. PBGC’s governance structure is also vulnerable to disruptive transitions with each administration change. The board, its representatives, and the director typically change with each presidential transition, thus limiting the board’s institutional knowledge of the challenges facing the corporation. Other government corporations have board structures with staggered terms for their directors, which arguably avoid gaps in their organization’s institutional knowledge. For instance, OPIC’s directors may be appointed for a term of no more than 3 years, and the terms of no more than 3 of the 15 directors can expire in any given year. Our prior work has also found that PBGC’s board members often have limited time and resources to dedicate to PBGC matters given their numerous other responsibilities in their roles as cabinet secretaries. According to corporate governance guidelines, boards should meet regularly and focus principally on broader issues, such as corporate philosophy and mission, broad policy, strategic management, oversight and monitoring of management, and company performance against business plans. However, we found that since PBGC’s inception, the board has met infrequently, even when pressing strategic and operational issues were at play. In 2003, after several high-profile pension plan terminations, PBGC’s board began meeting twice a year (see fig. 2). But PBGC officials have told us that it is a challenge to find a time when all three cabinet secretaries are able to meet, and when they do meet, the meetings generally only last about an hour. The current board has recently begun to meet more frequently, meeting three times since February 2010. However, prior to that time, the board had not met since February 2008, despite pending terminations of several pension plans sponsored by large automakers and congressional investigations into certain procurement practices. Because PBGC’s board members have generally been unable to dedicate consistent attention to PBGC, they have relied on their board representatives to conduct much of the work on their behalf. The board also relies on PBGC’s Inspector General and management oversight committees to ensure that PBGC is operating effectively. However, we have found that the communications between these entities and the board may be limited and the board may not always be sufficiently aware of PBGC’s activities. For example, PBGC’s bylaws require the board to review any reports that the Inspector General deems appropriate, and the Inspector General reports to the board through the Chair. However, there is no formal protocol requiring the Inspector General to routinely meet with the board of directors or their representatives. Moreover, PBGC’s oversight committees are not independent of the PBGC director nor required to formally report all matters to the board. Under this structure, it remains unclear if the board members would be aware of the Inspector’s General findings or of significant actions taken by PBGC management. We have also noted that the PBGC Advisory Committee does not have formal access to the board members, potentially limiting the board members’ knowledge of the committees’ concerns and recommendations. PBGC’s Advisory Committee typically reports only to the director, although officials said that the committee can submit concerns to the board if it believes it is warranted. In contrast, the advisory boards or committees of other government corporations—such as the Federal Deposit Insurance Corporation and Export-Import Bank—are required to submit formal reports to their board chair and directors. To address these weaknesses in PBGC’s governance structure, we believe that Congress should consider expanding the board of directors to include additional members with diverse backgrounds who possess knowledge and expertise useful to PBGC’s mission. PBGC hired a consulting firm to review governance models and provide a background report to assist the board in its review of alternative corporate governance structures. While the report did not advocate any particular governance option, the consulting firm’s final report corroborated our findings and described the advantages and disadvantages of governance practices of other government corporations and selected private sector companies. The report concluded that there are several viable alternatives for strengthening PBGC’s governance structure and practices, some of which are now being put forth in pending legislation. PBGC Needs More Strategic Management of Its Contract Workforce and Benefit Determination Process Although PBGC management has taken steps in recent years to strengthen its operations, our prior work has identified ways that the corporation could be more strategic in its management of its contract workforce and the benefit determination process. The need for a strategic approach in these areas is essential to ensure that PBGC is operating as efficiently and effectively as possible to manage its increasing workload. Contract Workforce Management Since the mid-1980s, PBGC has had contracts covering a wide range of services, including the administration of terminated plans, payment of benefits, customer communication, legal assistance, document management, and information technology. As PBGC’s workload grew in response to the significant number of large pension plan terminations, PBGC has come to rely on contractors to supplement its workforce. About two-thirds of PBGC’s workforce consists of contract workers (see fig. 3). Over the years, PBGC has taken steps to improve its workforce management. For example, in response to a recommendation we made in 2000, PBGC agreed to conduct a comprehensive review of its future human capital needs and to use this review to better link contracting decisions to PBGC’s long-term strategic planning process. After commissioning this review, PBGC developed a human capital strategic plan that called for aligning human capital programs with the corporations’ strategic goals and mission. However, in 2008, we found that the corporation still lacked a strategic approach to identifying the optimal mix of federal versus contract workers and ensuring that the performance of its contract workforce contributes to the corporation’s mission. As a matter of general best practice, our 2008 work noted that a strategic plan should incorporate an understanding of how acquisitions will be used to assist an agency in achieving its mission. This is especially true of PBGC with its large contract workforce. Yet, our 2008 work found that although PBGC had made efforts to improve its acquisition infrastructure, it had not developed a strategic approach to its contracting process as envisioned in our 2000 report. Moreover, PBGC’s human capital strategic plan focused almost exclusively on its federal workforce. We recommended that the plan do more to reflect the importance of contracting and to link staffing and contracting decisions at the corporate level. While PBGC agreed that contracting should be part of its strategic planning process, it maintained that this is already being achieved by its current process. Since our 2008 report, PBGC has implemented new guidance and policies in a number of areas to improve its management of the contracting process and contractor oversight. In August 2009, PBGC issued guidelines for determining whether to use contractors or government employees. While useful, these procedures do not include any specific steps to ensure that such decisions are linked to the strategic planning process. Subsequently, PBGC issued its new human capital strategic plan for fiscal years 2010-2014. In this plan, PBGC acknowledges the importance of contracting and the challenges of balancing their workforce between federal and contract workers, but the plan does not provide specific actions to address such challenges and appears to continue to focus primarily on PBGC’s federal workers. Our previous reports also found weaknesses in PBGC’s efforts to ensure that the performance of its contract workforce contributes to the corporation’s mission. In 2000, and again in 2008, we found that most of PBGC’s contracts lacked performance incentives and methods to hold contractors accountable for performance outcomes linked to the corporation’s strategic goals. In 2000, we recommended that, where appropriate, PBGC should utilize more fixed-price contracts and fewer labor-hour payment arrangements, consistent with best practices in performance-based contracting. In 2008, we recommended that to improve implementation of a performance-based approach to contracting, PBGC should ensure that future contracts measure performance in terms of outcomes, provide incentives for the accomplishment of desired outcomes, and ensure payment of award fees only for excellent performance. We also recommended that PBGC should provide comprehensive training on performance-based contracting for PBGC’s procurement staff, managers, and acquisition-related workforce. PBGC agreed with our previous recommendations to enhance implementation of performance-based contracting, and stated that the actions recommended were already under way, including: incorporating performance-based measures into its future contracts and providing comprehensive training for PBGC staff. Further, PBGC noted that the use of labor-hour contracts had been restricted. However, the move to performance-based contracting has been difficult. For example, officials attempted to use performance-based contracts when making new awards for contracts with the field benefit administration offices, but these efforts were abandoned because, according to PBGC officials, the proposals were too complicated to evaluate and more costly than expected. We are examining these issues in a study currently under way to assess how well PBGC is managing its contracting activities and the steps it is taking to ensure the integrity of its contract process. We anticipate completing this work next summer. Although we commend PBGC for its improvements to contract management, we continue to believe that more should be done to include procurement decision-making in corporate-level strategic planning and to link contractor performance measures with the corporation’s mission. Without a more inclusive strategic planning process that looks at the contract workforce and federal workforce together, PBGC cannot be assured that it has the optimal mix of contractor staff and federal employees and that it is holding its contract workforce accountable for helping meet its strategic goals. Benefit Determination Process Management Finally, our prior work has also found that PBGC needs a more strategic approach for determining the benefits for participants in large, complex plans that have been terminated. In our August 2009 report, we reviewed plans terminated with insufficient funds and trusteed by PBGC during fiscal years 2000 through 2008. We found that a small number of complex plans—especially those with large numbers of participants affected by limits on guaranteed benefit amounts—accounted for most cases with lengthy delays and overpayments. For example, PBGC completed most participants’ benefit determinations in less than 3 years, but required more time—up to 9 years—to process determinations for complex plans and plans with missing data. In addition, while only a small percentage of participants receive overpayments of their estimated benefits while their final benefit amounts are being determined, we found that nearly two- thirds of cases with overpayments involved participants in just 10 large, complex plans. Given these findings, we recommended that PBGC develop a better strategy for processing benefit determinations for complex plans in order to reduce delays and minimize overpayments, and that PBGC set goals for timeliness and monitor the progress made in finalizing benefit determinations for large, complex plans separately from other plans. In response, PBGC has taken a number of steps to improve its procedures for communicating with participants in large, complex plans and to reduce overpayments. In addition, officials indicated that formal process improvement efforts were under way to tailor plan processing to plan size and streamline other aspects of work in an effort to reduce process times in the future. At the same time, officials noted that they had no plans to set any performance goals separately for large, complex plans as a group. Due to the complexities and variations with each of these plans, PBGC prefers to set schedules only on an individual plan basis. However, we continue to believe that reporting performance measures that reflect averages across all plans does not provide adequate weight to large versus small plans and does not provide sufficient incentive to improve the processing times for large, complex plans. Concluding Observations In these challenging economic times, PBGC has become even more essential as millions of American workers and retirees have come to rely on the corporation for protection of their retirement income. PBGC is now one of the largest federal government corporations with nearly $80 billion in assets, yet it continues to face a future of financial instability. Its premium base has been eroding over time as fewer sponsors are paying premiums for fewer participants. In addition, as a result of the recession, PBGC is still at risk from the increased underfunding of some large defined benefit plans. To the extent that companies are more at risk of bankruptcy, the plans that they sponsor are more at risk of termination. The fact that PBGC’s board of directors has only recently begun to meet to discuss these problems is less than reassuring. Moreover, even with the increased attentiveness of the current board, the lack of staggered terms for board membership means that consistency in both policy direction and oversight is not guaranteed in the future. PBGC needs a board that can offer long-term, strategic sophistication to keep the corporation as solvent as possible for as long as possible. Improvements to PBGC’s governance and to its strategic management cannot correct the structural weaknesses of its financial design, but it can put PBGC in a better position to confront the challenges that lie ahead. It is untenable to rest the management of nearly $80 billion in assets on a corporate board architecture that can fail to meet and provide strategic direction for years at a time, and that is vulnerable to a lack of leadership during transitions to new administrations. Companies that pay annual premiums to PBGC and the millions of employees whose retirement benefits are under PBGC’s protection are owed greater stewardship of the corporation and its funds. Chairman Harkin and Members of the Committee, this concludes my prepared statement. I would be happy to respond to any questions. Contacts and Staff Acknowledgments For further questions on this testimony, please contact me at (202) 512- 7215. Individuals who made key contributions to this testimony include Blake L. Ainsworth, Joseph A. Applebaum, Susan C. Bernstein, Jason S. Holsclaw, Charles A. Jeszeck, Kristen W. Jones, Lara L. Laufer, Sheila R. McCoy, Margie K. Shields, Craig H. Winslow, and William T. Woods. Related GAO Products Private Pensions: Changes Needed to Better Protect Multiemployer Pension Plans. GAO-11-79. Washington, D.C.: October 18, 2010. Private Pensions: Long-standing Challenges Remain for Multiemployer Pension Plans. GAO-10-708T. Washington, D.C.: May 27, 2010. Pension Benefit Guaranty Corporation: Workers and Retirees Experience Delays and Uncertainty when Underfunded Plans Are Terminated. GAO-10-181T. Washington, D.C.: October 29, 2009. Pension Benefit Guaranty Corporation: More Strategic Approach Needed for Processing Complex Plans Prone to Delays and Overpayments. GAO-09-716. Washington, D.C.: August 17, 2009. Pension Benefit Guaranty Corporation: Financial Challenges Highlight Need for Improved Governance and Management. GAO-09-702T Washington, D.C.: May 20, 2009. High-Risk Series: An Update. GAO-09-271. Washington, D.C.: January 2009. Pension Benefit Guaranty Corporation: Improvements Needed to Address Financial and Management Challenges. GAO-08-1162T. Washington, D.C.: September 24, 2008. Pension Benefit Guaranty Corporation: Need for Improved Oversight Persists. GAO-08-1062. Washington, D.C.: September 10, 2008. Pension Benefit Guaranty Corporation: Some Steps Have Been Taken to Improve Contracting, but a More Strategic Approach Is Needed. GAO-08-871. Washington, D.C.: August 18, 2008. PBGC Assets: Implementation of New Investment Policy Will Need Stronger Board Oversight. GAO-08-667. Washington, D.C.: July 17, 2008. Pension Benefit Guaranty Corporation: A More Strategic Approach Could Improve Human Capital Management. GAO-08-624. Washington, D.C.: June 12, 2008. Pension Benefit Guaranty Corporation: Governance Structure Needs Improvements to Ensure Policy Direction and Oversight. GAO-07-808 Washington, D.C.: July 6, 2007. PBGC’s Legal Support: Improvement Needed to Eliminate Confusion and Ensure Provision of Consistent Advice. GAO-07-757R. Washington, D.C.: May 18, 2007. High-Risk Series: An Update. GAO-07-310. Washington, D.C.: January 2007. Private Pensions: Questions Concerning the Pension Benefit Guaranty Corporation’s Practices Regarding Single-Employer Probable Claims. GAO-05-991R. Washington, D.C.: September 9, 2005. Private Pensions: The Pension Benefit Guaranty Corporation and Long- Term Budgetary Challenges. GAO-05-772T. Washington, D.C.: June 9, 2005. Private Pensions: Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules. GAO-05-294. Washington, D.C.: May 31, 2005. This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

The Pension Benefit Guaranty Corporation (PBGC) is a self-financing government corporation that insures the pensions of 44 million workers in more than 27,000 private sector defined benefit pension plans. Yet, PBGC faces financial instability that could pose a future threat to this source of protection for Americans' retirement income. As fewer sponsors pay premiums for fewer participants in defined benefit plans, and as the underfunding of large defined benefit plans increases, the risks to PBGC's financial future also increase. As of September 2010, PBGC's net accumulated financial deficit was $23 billion. GAO has designated PBGC and the pension insurance programs it administers as "high risk" areas in need of urgent attention and transformation to address economy, efficiency, or effectiveness changes. In this testimony, GAO discusses its recent work regarding PBGC. Specifically, this statement focuses on needed improvements to PBGC's governance structure and strategic management based on GAO's prior work in these areas. GAO is making no new recommendations in this statement, but continues to believe that Congress should consider expanding PBGC's board of directors and that PBGC should implement recommendations from prior reports that have not yet been implemented, such as those concerning strategic workforce management and benefit determination process performance measures for large, complex plans. PBGC requires a strong governance structure and strategic management to ensure that it can meet its future financial challenges. Companies who pay annual premiums to PBGC and the millions of employees whose retirement benefits are under PBGC's protection are owed greater stewardship of the corporation and its funds. By law, PBGC is governed by a three-member board of directors composed of the Secretaries of the Treasury, Commerce, and Labor. Because of their numerous responsibilities in their roles as cabinet-level secretaries, the board members have historically been unable to dedicate consistent attention to PBGC matters. In fact, since 1980, the board has met only 23 times. During a critical 2-year period between February 2008 and February 2010, amid turbulent economic times and congressional investigations of certain procurement practices, the board did not meet at all. While the current PBGC board is meeting more frequently than in prior years, its members still have little time to devote to PBGC governance and the board remains vulnerable to disruptive transitions during future changes of administration. In addition, although PBGC management has taken steps in recent years to strengthen its operations, recommendations from GAO's prior work concerning how the corporation could improve its strategic workforce management and the benefit determination process have yet to be fully implemented. PBGC's contract workers comprise about two-thirds of its workforce, yet GAO found that workforce management lacked a strategic approach for determining the mix of contract and federal workers, and PBGC did not include procurement decision making in corporate-level strategic planning. Also, GAO found that management of PBGC's benefit determination process did not provide for separate reporting of performance measures for large, complex plans, yet these plans are responsible for most long delays in processing and most cases with overpayments. Measures that reflect averages across all plans do not provide sufficient incentive to improve the processing of these plans. The need for a more strategic approach in managing both the contract workforce and the benefit determination process is essential to ensure that PBGC is operating efficiently and effectively. Improvements to PBGC's governance and strategic management cannot correct structural weaknesses in its financial design, but it can better position PBGC for the challenges that lie ahead.

Contract Costs Have Risen and Schedule Has Been Extended following State’s Incomplete Risk Assessment; Further Cost Increases Are Likely As part of recent construction of Kabul facilities, in fiscal years 2009 and 2010, State awarded two contracts originally worth $625.4 million to meet growing facility requirements at the U.S. embassy in Kabul. Table 1 details the original scope of each contract. Figure 1 depicts the compound upon completion of current construction. State’s plans called for sequencing construction under the two contracts and also entailed acquiring the Afghan Ministry of Public Health site adjacent to the compound to build parking facilities for approximately 400 embassy vehicles. In September 2011, after State determined that the planned transfer of the Afghan Ministry of Public Health site would not happen, State removed the parking and vehicle maintenance facilities from the project. State also partially terminated elements of the first contract in September 2011—specifically one of the permanent office annexes and one of the staff apartment buildings—for the convenience of the U.S. government, in part, due to concerns about contractor performance and schedule delays. The 2009 contractor completed the temporary offices and housing units, but State transferred contract requirements for those permanent facilities not begun by this contractor to the 2010 contract, which increased cost and extended schedule. The cost for the 2009 and 2010 contracts has increased by about 27 percent, from $625.4 million to $792.9 million (see table 2). As of March 2015, OBO and the 2010 contractor were negotiating the value of several potential contract changes that will likely result in increased costs. For example, the contractor has asserted that site areas it needed were not available to start construction as planned. With regard to schedule, projected completion has been delayed over 3 years to fall 2017, although the 2010 contract had not yet been revised to reflect that date as of May 2015. We found that State did not follow its cost containment and risk assessment policies, resulting in lost opportunities to mitigate risks. The U.S. Office of Management and Budget (OMB) requires value engineering (referred to here as cost containment) for certain construction projects. In addition, OBO’s standard operating procedures require risk assessment studies to reduce and manage risks to a project. For the 2009 contract, State confirmed that it did not conduct either type of assessment. For the 2010 contract, State did complete a cost containment study and a risk assessment in March 2010. The 2010 cost containment study made 31 recommendations to streamline construction and improve the project. State accepted 18, rejected 12, and partially accepted 1 of these recommendations. The risk assessment identified over 30 risks to the project. In particular, it identified the interface between the 2009 and 2010 contracts as a major source of risk. The study raised concerns about how State could best coordinate the 2010 contract with the 2009 contract without sufficient information about the first contractor’s design plans, which were under development. Examples of other major risks identified included (1) that adjacent Afghan Ministries of Public Health and Defense sites that State planned to acquire might not be available in time, or at all, to enable construction to proceed as planned, and (2) that there might be insufficient space for two contractors to stage construction concurrently. The consultant responsible for the risk assessment recommended risk mitigation actions, which State did not act on, that aligned with the cost containment recommendations. For example, two of the recommendations were that State (1) facilitate greater project coordination between the two contracts, and (2) divide the 2010 contract into two separate contracts so that if the 2009 contract was delayed, the 2010 contract would not also be delayed. One State official indicated that, given concerns about security in Kabul and pressure to get permanent, hardened facilities built as soon as possible, State was not going to act on any recommendation that would delay getting the contracts awarded and the facilities built. A senior State management official acknowledged that State did not fully follow its cost and risk policies, and said that had State more fully considered the cost containment and risk assessment study recommendations, there might have been a decision to delay award of the 2010 contract, which would have slowed efforts to provide facilities as quickly as possible. Several risks noted by that study eventually materialized, such as the loss of the Afghan Ministry of Health site and insufficient space that interfered with the sequencing of construction. These factors contributed to increased cost and extended schedule. Thus, in our May 2015 report, we recommended that State ensure existing cost containment and risk assessment policies are followed in future Kabul construction projects. State concurred. State to Continue Use of Temporary Facilities but Lacks Specific Security Standards for Them, Contributing to Increased Costs and Extended Schedules Since 2002, State has spent over $100 million to construct temporary facilities on the embassy compound to accommodate evolving staffing needs and provide temporary office and housing space as permanent facilities are built. OBO building guidance from 2009 states that “temporary facilities” are facilities that will be occupied for no more than 5 years or until a permanent building is constructed, whichever is sooner. The guidance also indicates that temporary facilities include, but are not limited to, containerized housing/office units, modular units, modified shipping containers, and trailers. On completing the project in 2017, all temporary facilities on-compound will be nearly 5 years old or more, and a smaller subset will be more than 10 years old. Based on numbers provided by State, those temporary facilities will likely consist of over a third of available desks and beds. State officials indicated that continued use of these temporary facilities is likely, as some may be used by contractors that will provide support services following the U.S. military’s drawdown. For more information, see appendix 1. The lack of security standards for temporary facilities contributed to insufficient and differing levels of protection, increased costs, and extended schedule. Prior to building additional temporary facilities under the 2009 contract, State informed Congress in its fiscal year 2008 Supplemental Appropriations Justification of its concerns about threats posed from potential incoming weapons fire—amid increasing attacks around Kabul—and indicated that overhead protection was required to protect staff in existing temporary facilities on compound. Also, State security standards in 2009 indicated that housing constructed as an integral part of or adjoining the chancery (i.e., office building) should be constructed to meet chancery physical security standards. State has physical security standards governing construction of offices and housing that State seeks to meet regardless of whether a facility is permanent or temporary. However, according to DS officials, State does not have security standards specifically tailored to temporary facility construction. For practical purposes, DS officials said that State’s physical security standards governing new construction—regardless of whether a facility is permanent or temporary—are standards that only permanent construction can meet. Where newly constructed temporary facilities— unlike newly constructed permanent facilities—cannot be constructed to meet all State’s security standards, State has the discretion to grant exceptions from those standards and to specify mitigating alternative security measures that will be provided. In the absence of minimal security standards (or guidance) to guide planning for temporary facility construction, State inconsistently applied alternative security measures, resulting in insufficient and different levels of security between the temporary offices and housing. When awarding the 2009 contract, State did not specify that overhead protection was required for either the temporary housing or offices, even though State had previously expressed to Congress concerns about the threat posed from incoming weapons fire in 2008. Furthermore, the only security protection measure specified in the 2009 contract for the temporary housing was shatter-resistant window film. By comparison, temporary offices were to receive forced entry and ballistic protection. State subsequently took corrective action through modifications on the 2009 contract that increased cost and extended schedule. State likely paid more than it would have had the security requirements been included in the original contract requirements. Thus, to address this issue, in our May 2015 report, we recommended that State consider establishing minimum security standards or other guidance for the construction of temporary structures, especially those used in conflict environments. State partially concurred. State does not support separate standards for temporary structures, reiterating that it aims to meet Overseas Security Policy Board security standards in all environments. Where this is not possible, State asserts it works to meet the intent of these standards through alternative security mitigation measures via its “waivers and exceptions” process. However, State commented that it does believe that there is value in documenting standard operating procedures and best practices associated with the deployment and protection of temporary structures in high-threat and conflict environments. State noted that while such documentation would not constitute security standards and would not circumvent risk management integral to its waivers and exceptions process, it would provide templates from which to base the design of future projects in exigent environments. Should State produce such documentation, we believe that this could meet the intent of our recommendation. Lack of Strategic Facilities Planning and Policy Has Led to Coordination Challenges in Addressing Future Needs in Kabul As discussed in our May 2015 report, since the U.S. embassy in Kabul reopened in 2002, the unpredictable operating environment of Afghanistan has produced changing facility needs that have continually outpaced the post’s existing capabilities. This has been due to various factors such as policy and program changes, staffing fluctuations, and changes in the security environment. To meet these needs, State has made or plans to make approximately $2.17 billion in infrastructure investments in Kabul. During this time, the embassy has used a variety of off-compound facilities to meet some needs that could not be met on-compound. Key off-compound facilities include Camp Sullivan, a 20.9-acre property near Kabul International Airport; Camp Seitz, a 7-acre facility southwest of the embassy that serves as housing and office space for security contractors; and Camp Eggers, a 16.8-acre former Department of Defense (DOD) facility southwest of the embassy planned to serve as a contractor camp. In addition, State is upgrading Camp Alvarado, a property located near the airport that serves as the main aviation hub for the embassy’s air transport and counternarcotics operations. As of March 2015, these off- compound properties represented a total State investment of almost $731.4 million. The relative locations of these properties are shown in figure 2. State plans to use $394.9 million to address unmet facility needs on- and off-compound in fiscal year 2015. State is also seeking future funding for additional facility investments, such as upgrading the remaining temporary facilities and constructing the parking facilities that State had to remove from the current project. The post’s current facility needs stem primarily from changing circumstances inherent to the operating environment in Kabul. For example, when the Afghan Ministry of Public Health site became unavailable for construction, OBO was forced to remove the parking garage, vehicle maintenance facility, and fuel point from the current project. Although the post has a temporary vehicle maintenance facility and fuel point, it is located where apartment buildings 2 and 3 will be built and must be demolished. State has explored interim solutions to provide a temporary vehicle maintenance facility at off-compound sites, but a permanent location had not been identified as of May 2015. Changes in the security environment in Kabul, including attacks against the compound in September 2011, have also affected post needs. For example, security concerns were a primary factor in DS and the post’s acquisition of the Camp Seitz and Camp Eggers, as this would allow, for example, the relocation of the Kabul Embassy Guard Force closer to the embassy. The withdrawal of the U.S. military has also produced new needs for the post. For example, this has driven recent post requests for a medical trauma facility and helicopter landing zone, as well as past and future planned upgrades at Camp Alvarado. In addition, as of March 2015, State continued to develop a contract to replace support services such as food, fuel, medical, and fire protection previously provided by DOD. According to State, this transition will also require further infrastructure upgrades on- compound. State officials at the post noted that the future embassy needs will likely exceed the available space on-compound and will require prioritization of needs as well as high-level policy and management decisions on staffing presence. State stakeholders in Washington and at the post are working to identify, prioritize, and address these facility needs through various coordination meetings and working groups. However, State does not have a strategic facilities plan for Kabul that documents current and future embassy needs, comprehensively outlines existing facilities, analyzes gaps, provides projected costs, and documents decisions made. Lack of such a plan has inhibited coordination and undermined the continuity necessary to address the embassy’s emergent needs. International Facility Management Association (IFMA), GAO, and OMB guidance recommend that an organization view all real property asset investments as a single portfolio with strategic linkages when determining the right mix of projects to undertake. IFMA describes a strategic facility plan as a 2- to 5-year facilities plan that contains a needs statement (i.e., mission need), analysis of all real property assets and their condition, analysis of gaps between needs and current capabilities, recommendations for new spaces or buildings, and facility cost projections. IFMA also indicates the plan should document findings to include expected timelines for implementation but allow for updates, as appropriate. Similarly, GAO and OMB capital planning guidance emphasize the importance of identifying current capabilities of real property assets, determining gaps between current assets and needed capabilities, deciding how best to meet the gap by identifying and evaluating alternative approaches, documenting decisions, and making updates as needed. State officials responsible for embassy management, facilities, security, and construction all cited the lack of an overarching plan as an obstacle to coordination intended to address emergent post needs. According to State officials in Kabul and Washington, coordination to address the embassy’s future needs is particularly difficult due to the large number of stakeholders in Kabul and in Washington. Additionally, the constant personnel turnover caused by the typical 1-year duty tours results in lack of continuity in decision making. Without a comprehensive plan that provides a strategic framework, the competing proposals of the post’s many stakeholders are difficult to manage, prioritize, and reconcile. Consequently, State has been challenged to efficiently address changing embassy needs in several instances on- and off-compound. Examples of those challenges include issues related to: (1) proposed projects conflicting with on-compound construction, (2) implementation of on-compound physical security upgrades, and (3) ineffective coordination of off-compound construction projects. When asked about strategic facilities planning, State officials provided a series of planning coordination tools as alternatives. These included OBO’s 2010 site master plan for the embassy compound and a 2014 draft update of that master plan. Although these tools did perform some coordination functions, they do not substitute for a strategic facilities plan. OBO’s use of the term “master plan” created some false expectations among non-OBO stakeholders in Kabul and Washington. For example, officials from post and DS believed the 2014 master plan update would comprehensively identify the post’s needs and take into account all facilities—to include off-compound projects—when determining capabilities and alternatives for meeting those needs; instead, the update was limited to the compound. When OBO presented the 2014 Master Plan Update to the post in September 2014, post officials told OBO that the site plan did not address all of the embassy’s needs. In addition, they told us that limited space on-compound requires the continued use of off- compound facilities. OBO continues to work with stakeholders in Kabul and Washington to find ways to incorporate as many post needs on- compound as possible. While the 2014 Master Plan Update may eventually be used to inform a series of new construction projects, it remains a compound-specific document and does not address how embassy needs will be met at off-compound facilities in the interim. Thus, in our May 2015 report, we recommended that State develop a Kabul strategic facilities plan. State concurred. From April 1990 through December 2013, OBO had a policy and procedures directive that required strategic facility planning (termed long- range facilities plans) for posts meeting certain criteria. State documentation shows that between 2004 and 2008, OBO prepared 16 long-range facilities plans (strategic facility plans) for selected posts with challenging real property issues. In 2008, OBO’s then director also reported to State’s Undersecretary for Management that long-range facilities plans were essential precursors to the development of individual projects. However, OBO produced no long-range facilities plans after 2008. In December 2013, OBO rescinded its long-range facilities plans policy and procedures directive based on an explanation that the office responsible for that function no longer existed and that the function had been replaced by master planning. However, the action did not indicate what master planning entailed within OBO, nor did it explain and justify how master planning could substitute for strategic facilities planning. OBO was unable to provide any current policy governing either post strategic facilities planning or site master planning. Without policies that clearly define strategic facilities planning and master planning, as well as outline the content and methods to conduct such planning, it will be difficult for OBO to fulfill these responsibilities. Therefore, in our May 2015 report, we recommended that State establish policy and procedure directives governing the definition, content, and conduct of post-wide strategic facilities planning and master planning. State concurred. Chairman Chaffetz, Ranking Member Cummings, Members of the Committee, this completes my prepared statement. I would be pleased to respond to any questions that you may have at this time. GAO Contact and Staff Acknowledgments For further information about this testimony, please contact Michael J. Courts, Director, International Affairs and Trade at (202) 512-8980 or at courtsm@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. GAO staff who made key contributions to this testimony are Leslie Holen (Assistant Director, International Affairs and Trade), Michael Armes (Assistant Director, Physical Infrastructure), David Hancock, John Bauckman, Eugene Beye, Mark Dowling, and David Dayton. Appendix I: Temporary Facilities in Kabul, Afghanistan Based on numbers provided by State, as of February 2015, temporary facilities on the embassy compound provided nearly 1,100 desks and 760 beds. Figure 3 shows some of the temporary facilities that the post has used to meet interim space needs. Temporary office facilities that are to remain can provide space for 875 desks. By comparison, permanent office facilities (existing and newly constructed) in fall 2017 will provide 1,487 desks. The number of temporary housing facilities that are to remain has not been finalized. The number of beds likely to remain within the temporary housing facilities will range from approximately 472 to 640 beds. By comparison, 819 permanent beds will be provided within permanent apartment facilities (existing and newly constructed) upon construction completion. This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

Since re-opening in 2002, the U.S. embassy in Kabul has experienced a dramatic increase in staffing, followed by a gradual drawdown. State has invested or plans to invest a total of $2.17 billion in its facilities in Kabul to address current and projected space needs in a difficult environment with constantly evolving security threats. State awarded two contracts in 2009 and 2010 to construct additional on-compound housing and office facilities. This statement summarizes GAO’s May 2015 report on the status of construction at the U.S. embassy in Kabul (GAO-15-410). Like its May 2015 report, this testimony discusses (1) the extent to which construction cost and schedule have changed and why, (2) State’s use of temporary facilities on-compound, and (3) State’s planning for projected embassy facility needs. For its May 2015 report, GAO examined agency planning, funding, and reporting documents and interviewed officials from State’s Bureau of Overseas Buildings Operations, Bureau of Diplomatic Security, and other offices. The review included fieldwork and associated follow-up in Kabul, Afghanistan throughout 2014. Cost and schedule have increased for the Kabul embassy construction project, in part due to incomplete cost and risk assessment. Cost for the 2009 and 2010 contracts has increased by about 27 percent, from $625.4 million to $792.9 million, and is likely to increase further. Projected completion has been delayed over 3 years to fall 2017. The Department of State (State) did not follow its cost containment and risk assessment policies, resulting in lost opportunities to mitigate risks. These risks, such as delays in the sequencing of the two contracts, eventually materialized, increasing cost and extending schedule. Unless State follows its policy, it may be unable to avoid or mitigate risks to cost and schedule on future projects. Since 2002, State has built over $100 million in temporary buildings (intended for no more than 5 years' use) to meet space needs on-compound but has no security standards tailored to those facilities. On completing the project in 2017, all temporary facilities will be nearly 5 to 10 years old, and their continued use is likely. Without security standards or other guidance to guide temporary facility construction in conflict environments, State inconsistently applied alternative security measures that resulted in insufficient and different levels of security for temporary offices and housing, as well as increased cost and extended schedules. Without temporary facility security standards or guidance, future construction in conflict environments could encounter similar problems. State's lack of a strategic facilities plan and policies governing such planning has led to coordination challenges in addressing the embassy's future facility needs. Industry standards cite the value of plans that comprehensively assess existing facilities, identify needs, and document decisions on meeting those needs. Additionally, State formally assigns responsibility for strategic facilities planning but lacks policy that governs implementation of such planning. State intends to make additional facility investments to address future facility needs. Without a strategic facilities plan and policy to guide its development, coordination to address these needs will continue to be difficult.

Background FMCSA establishes regulations for the physical and medical qualifications of CDL holders, develops standards to test and license commercial motor vehicle drivers, and enforces commercial motor vehicle safety regulations. Commercial drivers must be 21 years old to operate in interstate commerce, read English, have successfully completed a driver’s road test, be physically qualified to drive if operating in nonexcepted interstate commerce, and hold a current and valid CDL. Commercial drivers in intrastate commerce may operate commercial vehicles at 18 years old, if permitted by state law. They must also have no mental disease or psychiatric disorder that would interfere with their ability to safely drive a commercial vehicle, not use a controlled substance or habit-forming drug, and have no current clinical diagnosis of alcoholism. A commercial driver may use a legal non-Schedule I drug or substance if the drug or substance is prescribed by a licensed medical practitioner who is familiar with the driver’s medical history, and has advised the driver that the prescribed substance or drug will not adversely affect the driver’s ability to safely operate a commercial motor vehicle. Violations for impaired drivers can result in a range of penalties against CDL holders. For example, a first conviction of driving under the influence of alcohol or a controlled substance, regardless of whether it occurs in a commercial or personal vehicle, results in immediate CDL suspension by the issuing state for 12 months. A second results in permanent suspension. Licensing states are required to maintain driver records showing convictions for disqualifying federal violations and are to disqualify commercial drivers convicted of those violations while driving a commercial vehicle. Information on CDL holders must be exchanged among states through a nationwide system. The CDLIS is a nationwide computer system that, among other things, enables state driver-licensing agencies to ensure that each commercial driver has only one driver’s license and one complete driver record. State driver-licensing agencies use CDLIS to complete various procedures, including transmitting out-of- state convictions and transferring the driver record when a commercial driver’s license holder moves to another state. FMCSA Controls for Commercial Drivers Include Medical Exams, Drug and Alcohol Testing, and Roadside Inspections FMCSA has established a number of key controls that are designed to prevent CDL holders from operating commercial vehicles while impaired that generally cover three areas. First, drivers are required to undergo regular medical exams by a certified medical examiner to determine if a driver is physically qualified to operate a commercial vehicle. Second, employers are responsible for drug testing employees at various points of employment. Independent self-employed commercial vehicle operators are required to meet drug testing requirements by being enrolled in a random testing pool that includes other drivers and is managed by a consortium or third-party administrator that provides drug or alcohol testing services to DOT-regulated employers. Third, state and federal roadside-inspection programs are intended to identify impaired drivers and perform other safety checks. While our review did not evaluate whether these controls were working as intended, in prior work we have found that these controls were vulnerable to abuse or manipulation. With the enhanced statutory authority and direction provided by the MAP-21 Act, DOT may be able to address some of these vulnerabilities. DOT is required to issue implementing regulations by July 2014. Medical Exams Are Used to Determine Drivers’ Physical Fitness to Operate a Commercial Motor Vehicle FMCSA has established regulatory standards that require interstate commercial drivers to be examined and certified by a licensed medical examiner. The exams assess whether a driver meets minimum physical qualifications before obtaining a CDL. The exams are generally repeated at least every 2 years. Medical examiners must review the driver’s medical history; perform vision, hearing, blood pressure, and other such tests; and conduct a physical exam. The medical examiner must also determine that the driver does not use any drugs or controlled substances identified as a Schedule I drug. A CDL driver cannot use any non- Schedule I drug or controlled substance except when the drug or substance has been prescribed by a licensed medical provider who is familiar with the driver’s medical history and has determined that its use would not adversely affect the driver’s ability to operate a commercial vehicle. According to DOT, medical examiners do not give drivers drug or alcohol tests and largely base determinations on the physical examination and driver identification of prescribed medications, alcohol, or illegal drug use information included in the examination form. If a medical examiner deems a driver fit to drive, the examiner must sign and date a medical certificate. The medical examiner also keeps a paper copy of the signed certificate and may provide another copy to the driver’s employer if requested. As of January 30, 2012, individuals renewing or applying for a CDL must submit a copy of their current medical certificate to their state licensing agency, making state licensing agencies responsible for ensuring that drivers have current medical certificates on file. FMCSA does not maintain a copy or record of the medical certificates. GAO, Certification Process for Drivers with Serious Medical Conditions, GAO-08-826 (Washington, D.C.: June 30, 2008). the medical certification information on the electronic driving record. The medical certificate information could then be reviewed during a roadside inspection via a check of the driving record, such as through the CDLIS. In the instance of a driver who fails to renew his medical certificate on time, the States are required to downgrade the individual’s CDL so that he must not operate a commercial motor vehicle until a valid medical certificate has been submitted to the State licensing agency. In April 2012, FMCSA published a final rule establishing a National Registry of Certified Medical Examiners. The 2012 final rule provides requirements for all healthcare professionals responsible for issuing medical certificates for interstate truck and bus drivers to complete a training course on the Federal physical qualifications rules and to pass an examination to assess the examiners ability to apply the rules, and advisory criteria in a consistent manner when making the determination whether a driver meets the qualification standards. FMCSA has announced its plans to initiate a new rulemaking that would enable the agency to require medical examiners on the National Registry to submit to the agency the medical certificate information on each individual who applies for a medical certificate. The agency would then have the ability to transmit to the state driver licensing agency the medical certificate. This process will significantly decrease the likelihood of drivers being able to falsify medical certificates. When implemented, these requirements could help improve the control vulnerabilities identified in our prior work by ensuring that proper medical reviews are conducted and medical certificates are prepared by qualified medical examiners. However, additional work would need to be conducted to assess their effectiveness. Drug and Alcohol Testing by Employers Is Designed to Identify Unqualified Drivers FMCSA regulations also require CDL holders to undergo periodic drug and alcohol testing to identify unqualified drivers. Employers must test all CDL holders during preemployment screening; upon reasonable suspicion; randomly on a specific percentage; after a serious accident in which the driver was issued a traffic citation; and for all fatal accidents. In addition, according to DOT, employers must request a wide range of information from drivers’ previous employers as disclosed by the driver on his or her application for employment and pertaining to the driver’s history in the DOT drug and alcohol testing program. Each year, employers are also required to conduct random alcohol tests for at least 10 percent of their average number of driver positions, and random controlled substance or drug testing for at least 50 percent of their average number of driver positions. According to DOT, FMCSA may increase or decrease these percentages on the basis of self-reported drug and alcohol testing information from a sample of 2,000 employers. FMCSA regulations follow Department of Health and Human Services (HHS) employee drug testing requirements according to the Omnibus They use urine tests Transportation Employee Testing Act of 1991.covering five categories of drugs: marijuana, cocaine, amphetamines (dexadrine, adderall), opiates (heroin, morphine, codeine), and phencyclidine (PCP). Each year, employers must conduct alcohol tests equal to at least 10 percent of the average number of CDL drivers. Alcohol tests of either the driver’s breath or saliva must be performed immediately before, during, or after the driver’s performance of safety- sensitive duties such as operating a commercial vehicle. Drug tests are required to be analyzed by HHS-certified labs. All test results must be reviewed by a board-certified medical review officer (MRO) before being reported to the driver’s employer. The MRO will interview the driver to determine if there is a medical explanation for the driver’s use of the prohibited substance. If the driver provides appropriate documentation and the MRO determines that the driver has a legitimate medical reason for using the prohibited substance, the result is reported as negative to his or her employer. The MRO is required to report any safety concerns to the driver’s employer with regard to drug abuse and discuss the driver’s use of any prohibited substances with the prescribing physician. According to FMCSA regulations, the driver must be removed from safety-sensitive duty if the MRO reports a positive drug or alcohol test result to the driver’s employer. The driver cannot return to a safety- sensitive function, such as operating a commercial vehicle, until he or she has completed the return-to-duty process, which includes being evaluated by a substance-abuse professional, successfully complying with prescribed education or treatment, and passing a return-to-duty alcohol or drug test. FMCSA officials stated that follow-up testing to monitor the driver’s continued abstinence from drug use is also required. FMCSA regulations state that any driver, including independent self-employed operators who refuse to submit to a drug or alcohol test are not permitted to perform safety-sensitive functions until they complete a return-to-duty process. FMCSA officials stated that the results of drug tests are not directly reported to FMCSA, but rather processed and maintained by the current employers. Officials noted that FMCSA audits CDL employers for compliance with FMCSA testing regulations. In 2008, we reported examples of job hopping by commercial drivers who failed a drug test. After losing employment for a positive test, job- hoppers then test negative on a preemployment test for another carrier and return to duty. In each of the 19 cases of job hopping we reported in our 2008 report, the second employer stated that knowledge of a previous positive drug test would have disqualified the driver. Some of the19 drivers operated trucks carrying hazardous materials for periods of a month to over a year. These 19 cases were not generalizable to the population of CDL holders. The MAP-21 Act could help improve the control vulnerabilities identified by our prior work. Specifically, the law requires DOT to establish, operate, and maintain a national clearinghouse with records relating to the results of positive drug and alcohol tests of commercial drivers or instances of refused tests. Once the clearinghouse has been established, employers must request and review their CDL drivers’ records from the clearinghouse annually. The MAP-21 Act also requires DOT to develop a method to electronically notify an employer of each additional positive test result or other noncompliance. States and FMCSA Conduct Roadside Inspections to Identify Impaired Drivers and Perform Safety Checks FMCSA also conducts commercial vehicle and driver inspections as part of its roadside vehicle-inspection program. States can apply for Motor Carrier Safety Assistance Program grant funds for financial assistance in reducing the number and severity of crashes, injuries, and fatalities involving commercial vehicles. According to DOT, as a condition of receiving these funds, states must conduct these types of inspections. A software program is made available by FMCSA to identify which drivers or vehicles are recommended for inspection. During an inspection, a FMCSA or state officer will generally examine the vehicle and its equipment, as well as the driver’s license, medical certificate, and whether the driver is under the influence of alcohol or a prohibited drug. According to DOT, enforcement officials may demand to see a driver’s medical certificate; however, they would not be able to make an independent assessment of the driver’s medical condition absent any obvious indications of a problem. The roadside inspector would also only be able to address epilepsy or drugs and alcohol if the driver exhibited certain signs. FMCSA officials stated that drivers found to be using or possessing drugs or alcohol are reported into the MCMIS system, and additional actions (such as arrests or “out of service” indications in which the driver is immediately placed out of service and prohibited from operating the vehicle) may occur. In fiscal year 2011, over 3.5 million roadside inspections were conducted in which over 7 million violations were recorded, and of those violations, approximately 14 percent resulted in an out-of-service violation in which the driver, motor vehicle, or motor carrier was placed out of service because of safety issues. In addition to the roadside-inspection program, FMCSA conducts annual drug and alcohol strike-force sweeps. During the 2012 2-week sweep, FMCSA identified 287 commercial drivers who did not adhere to federal drug and alcohol regulations and who now face possible monetary fines and disqualification from operating a commercial vehicle. FMCSA also identified 128 truck and bus companies who now face possible enforcement actions for violations such as hiring drivers who had tested positive for illegal drugs and not implementing a drug and alcohol testing program. By conducting these sweeps, FMCSA has taken positive steps to help remove drivers that pose a risk to public safety from the road. Examples of Commercial Drivers with Disqualifying Impairments Related to Epilepsy, Drugs, or Alcohol We identified instances of drivers who operated—and sometimes crashed—commercial vehicles despite having medical conditions such as epilepsy. Epilepsy is a chronic disease characterized by seizures, loss of bodily control, and unconsciousness. We also found instances of state licensing agencies issuing or reissuing CDLs to commercial drivers with epilepsy or drug or alcohol dependence noted in their medical histories. FMCSA recommendations state that a person with an established history or clinical diagnosis of epilepsy is not physically qualified to drive a commercial vehicle for interstate commerce if he or she is taking antiseizure medication or has had a history of epilepsy or seizures within the past 10 years. These recommendations also state that individuals who use a controlled substance or habit-forming drug or who have a clinical diagnosis of alcoholism are not physically qualified to drive a commercial vehicle. The MAP-21 Act requires medical-certificate information to be transmitted to DOT on a monthly basis and mandates that states establish and maintain the capability to receive an electronic copy of a medical examiner’s certificate for each CDL holder licensed in that state. Drivers Operated Commercial Vehicles Despite Medical Impairments Related to Epilepsy Out of millions of CDL holders, we identified 230 individuals who were in an accident or had a roadside inspection in a commercial motor vehicle at some point between 2008 and 2011, after they started receiving SSA disability benefits for epilepsy. Thirty-one of the 230 individuals we identified were involved in accidents while driving a commercial vehicle during this time. However, because DOT’s database of crashes does not identify whether the driver’s medical condition may have contributed to the accident, we could not determine the extent to which the epilepsy impairment actually caused the accident. We plan to refer these 230 individuals to DOT for appropriate action as warranted. We randomly selected for further investigation 5 of the individuals involved in commercial vehicle accidents and 4 of the 199 drivers selected for an FMCSA roadside inspection to confirm that they were driving commercial vehicles. Eight of these 9 drivers selected for further investigation obtained CDLs after their epilepsy impairment date, with at least 6 of the 8 drivers obtaining their license within 10 years of having a seizure, a physical disqualification for obtaining a CDL.entitled to SSA benefits for epilepsy because SSA continued to determine that they could not work due to their impairment. In two of the cases that resulted in an accident, a health-care professional had noted in SSA documentation that the individual should not be driving. Because state driver’s license agencies nationwide only began requiring applicants’ presentation of a medical certificate after January 30, 2012, we were unable to obtain medical examination reports from all states or drivers and do not know whether their medical examiners were aware of their conditions. We plan to refer these 9 individuals to their state driver’s licensing agency for appropriate action as warranted. Eight of the drivers were still Examples of individuals who were driving commercial vehicles after being diagnosed with epilepsy include the following: Crash after epilepsy impairment. According to SSA documentation, this individual suffered from epilepsy, seizures, blackouts, memory loss, vision problems, substance abuse, and affective mood disorder. Holding an active CDL, he was approved for SSA disability benefits in December 2007. He informed SSA that he had been involved in an auto accident but had no idea how it occurred, and that he could no longer drive due to his condition. He added that he had been a truck driver since 1977, but due to his confusion, his employer had sent drivers after him on three different occasions. We did not receive a medical examination form or certificate for this individual from the state that issued his CDL and thus were unable to determine whether a medical examiner considered or was aware of the driver’s condition or whether a medical examination occurred. According to medical records contained in SSA documentation, medical professionals informed this individual in 2009 that he should not be driving and that it was unsafe to hold a job. However, he successfully renewed his CDL in August 2010. DOT records show that he was involved in a crash with a commercial vehicle 4 months later in December 2010. Because DOT’s database did not identify whether the driver’s medical condition may have contributed to the accident, we could not determine the extent to which the epilepsy impairment actually caused the accident. Numerous accidents after epilepsy impairment. A Washington state agency noted in 1989 that this driver’s seizure disorder made it unsafe for him to drive any vehicle, commercial or otherwise. In 1990, SSA determined this individual was disabled due to epilepsy and organic brain syndrome, which is a decreased mental function due to a medical disease other than a psychiatric illness. According to a medical evaluation in this driver’s SSA disability file, he began suffering from seizures and blackouts after an auto accident in 1976 but did not report them so he could continue driving tractor trailers. In 2000, the driver reported to SSA that medication did not prevent his weekly seizures. Despite this, Washington state issued him a CDL in 2002, 2005, and 2007. Washington state driving records reveal that he was involved in collisions in his commercial vehicle in 2005, 2006, and 2009. In 2009, a representative from this driver’s employer informed SSA that the individual had been driving a truck for 4 years, but was fired for being involved in too many accidents. SSA suspended this individual’s disability benefits from 2006 to 2009 while he was earning employment income. This individual surrendered his CDL in January 2012. Because DOT’s database did not identify whether the driver’s medical condition may have contributed to the accident, we could not determine the extent to which the epilepsy impairment actually caused the accidents. CDLs Were Issued or Reissued to Drivers with Impairments Related to Epilepsy, Drugs, and Alcohol From our random selection of 100 CDL holders, we identified 22 CDL holders who received SSA disability benefits where epilepsy, alcohol addiction, or drug dependence was a listed medical impairment and had CDLs issued or renewed after becoming eligible for those benefits. Specifically, according to SSA’s disability database, 10 of the 22 individuals had epilepsy or a seizure disorder identified as a medical impairment in their disability records. The remaining 12 had alcohol or drug dependence noted in their disability records. According to DOT, FMCSA and the states do not obtain complete information on whether individuals are driving on the road, and we were not able to determine whether all of these individuals were actually driving a commercial vehicle after their CDLs were issued or renewed. We are referring any cases where an individual had a disqualifying impairment yet still had an active CDL to the state driver’s licensing agency for appropriate action as warranted. Examples of individuals who obtained or renewed a CDL license after SSA determined they were eligible for disability benefits include the following: CDL issued despite epilepsy impairment. This driver reported to SSA that he suffered from sudden seizures, sometimes daily, beginning in 1999. The driver reported having seizures as often as three times a week, taking 20 minutes to 2 hours to recover from each episode. According to medical documentation in the claimant’s SSA disability file, he was also resistant to antiseizure medication. According to SSA documentation, the driver reported suffering from seizures as recent as 2008. The driver stated that he was unable to stand, walk, or sit for extended periods and that he suffered from memory loss, fatigue, and difficulty breathing. The driver was issued a new CDL by the state in November 2011 with endorsements allowing him to operate, among other things, school buses and passenger vehicles. To obtain this CDL, the driver certified to the state driver’s licensing agency that he did not have a physical condition preventing him for exercising reasonable and ordinary control of a motor vehicle. This individual continues to receive SSA disability benefits for epilepsy while holding an active CDL. We did not receive a medical examination form or certificate for this individual from the state that issued his CDL and thus were unable to determine whether a medical examiner considered or was aware of the driver’s condition or whether a medical examination occurred. CDL issued and renewed despite epilepsy impairment. According to SSA documentation, this individual began receiving disability benefits for a seizure disorder in 2001 and informed SSA that he stopped driving when his seizures began in 1999. He suffered from seizures and unconsciousness. For example, according to SSA documentation he passed out while driving a truck and awoke while walking in the street with no recollection of what had occurred. SSA documents included a physician’s note stating that the driver was medically disabled from any form of gainful occupation due to a diagnosis of intractable seizure disorder. Despite his medical history, he was issued a first-time CDL in 2005, which was renewed in 2009. When applying for his CDL, he certified to the state driver’s licensing agency that he did not have a condition that could cause a loss of consciousness. He continues to receive SSA disability benefits for seizures. We did not receive a medical examination form or certificate for this individual from the state that issued his CDL and thus were unable to determine whether a medical examiner considered or was aware of the driver’s condition or whether a medical examination occurred. CDL issued despite drug dependence. In 2005, this individual’s personal driver’s license was suspended for 12 months after a Driving While Intoxicated (DWI) conviction. According to SSA documentation, in 2007 he was diagnosed with psychosis, a history of alcohol abuse, and cannabis abuse following a mental-health hospitalization. He stated that his illness began to interfere with his work in 2006 and that he became unable to work in 2009. He began receiving SSA disability benefits the following year for functional psychiatric disorders. Drug dependency was also noted in his file. SSA documentation states that in January 2009, a physician noted that this individual was unable to participate in employment or training activities in any capacity due to paranoid schizophrenia. However, this individual obtained a CDL from Virginia in June 2010. We did not receive a medical examination form or certificate for this individual from the state that issued his CDL and thus were unable to determine whether a medical examiner considered or was aware of the driver’s condition or whether a medical examination occurred. In October 2010, he refused to submit to an alcohol test while operating a commercial motor vehicle. This refusal led to a DWI conviction and permanent CDL suspension in February 2011. States Could Not Provide Medical Examination Certificates Since most state driver’s licensing agencies do not require a medical examination report to be presented to them, according to DOT, they were unable to provide these reports or medical certificates that we requested for 29 of the 30 individuals who had CDLs issued or renewed after becoming eligible for SSA benefits. We were therefore unable to determine whether medical examiners considered or were aware of each driver’s conditions or whether a medical examination occurred for these individuals. While FMCSA regulations are meant to prevent an individual with these conditions from receiving or renewing a CDL, states were not required to obtain and maintain medical certifications or medical examination reports at the time of our review. According to DOT, only a few states on their own authority required CDL holders to provide either a medical examination report or medical certificate. As mentioned earlier, as of January 30, 2012, FMCSA requires states to electronically store medical certificates for new and renewing CDL applicants and are required to electronically post this information for all CDL holders to the state’s CDLIS driver records. States will also be required to report the date of the medical certification to the state’s CDLIS driver record. In addition, the MAP-21 Act requires medical certificate information to be transmitted to DOT on a monthly basis and mandates that states establish and maintain the capability to receive an electronic copy of a medical examiner’s certificate for each CDL holder licensed in that state who operates or intends to operate in interstate commerce. If these requirements are properly implemented and followed, they should help to prevent situations similar to these case studies from recurring. Agency Comments and Our Evaluation We provided a draft copy of this report to SSA and DOT. SSA did not have any comments. DOT’s Director of Audit Relations, Office of the Secretary of Transportation, provided technical comments on the report, which have been incorporated as appropriate. We are sending copies of this report to interested congressional committees, the Secretary of Transportation, the Commissioner of the Social Security Administration and other interested parties. In addition, this report is also available at no charge on the GAO website at http://www.gao.gov. If you have any questions concerning this report, please contact me at (202) 512-6722 or BerrickC@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report.

Commercial vehicles such as tractor trailers and school buses must be operated by skilled drivers who are mentally and physically capable of performing their jobs safely. Prior GAO work has shown weaknesses in DOT’s oversight of CDLs, such as inadequate medical certifications for commercial drivers, potentially putting the public at risk. GAO was asked to update its work on impaired commercial drivers. This report describes (1) key controls designed to prevent medically unfit or impaired commercial drivers from operating commercial vehicles and (2) examples of commercial drivers with potentially disqualifying impairments related to epilepsy, drugs, or alcohol. To identify key controls, GAO reviewed FMCSA policies and regulations, and interviewed officials. Cases were identified on the basis of FMCSA roadside-inspection data, DOT’s Commercial Driver License Information System (CDLIS), a national database of all commercial drivers, and SSA disability insurance files. From this analysis, GAO identified commercial drivers who were driving with an epilepsy diagnosis. GAO also randomly selected 100 individuals to determine whether the driver was receiving SSA disability benefits when the state issued or renewed the driver’s CDL. These cases cannot be generalized beyond those presented. GAO provided a draft of this report to SSA and DOT. SSA did not have any comments. DOT provided technical comments, which have been addressed in the report, as appropriate. The Federal Motor Carrier Safety Administration (FMCSA), part of the Department of Transportation (DOT), has established a number of key controls designed to prevent commercial driver’s license (CDL) holders from operating commercial vehicles while impaired. First, drivers are required to undergo regular medical exams by a certified medical examiner. Second, employers are responsible for drug testing employees at various points of employment. Third, state and federal roadside-inspection programs are in place to identify impaired drivers and perform other safety checks. If these key controls are operating effectively, they will help identify commercial drivers who are not capable of driving safely. However, GAO’s prior work has found that these controls were vulnerable to abuse or manipulation. The Moving Ahead for Progress in the 21st Century Act, enacted in July 2012, will require additional measures to ensure that disqualified drivers do not operate commercial vehicles, and could help address some of these vulnerabilities. For example, the law requires DOT to implement a national clearinghouse of commercial-driver controlled-substance and alcohol test results by July 2014. DOT has also taken some actions, and now requires CDL holders to provide a copy of their medical certificates to the State licensing agency. Matching CDL holders with Social Security Administration (SSA) disability files produced 204 commercial drivers who drove a commercial vehicle as recently as 2011 despite having epilepsy, a disqualifying medical condition characterized by sudden seizures and unconsciousness. Thirty-one of these drivers were involved in accidents, demonstrating the threat to public safety posed by medically impaired drivers. GAO also identified 23 cases where state licensing agencies issued or renewed CDLs for drivers after they were, according to SSA records, diagnosed with epilepsy or had drug or alcohol dependence noted, which could also disqualify them from driving under DOT regulations. However, because DOT did not require state licensing agencies to maintain drivers’ medical certifications at the time of GAO’s review, it is unlikely that states knew of the drivers’ conditions. In fact, they were unable to provide medical certifications for any of the 23 individuals. States are now required to electronically store medical certificates for new and renewing CDL applicants and will be required to electronically maintain this information for all CDL holders by January 2014. Doing so could help prevent ineligible drivers from obtaining or renewing CDLs in the future.

Background SBA’s standard operating procedures on outreach activities establish the agency’s policy on cosponsored activities and are governed by the cosponsorship authority provided to the agency under Section 4(h) of the act, SBA’s regulations implementing cosponsorship authority, and Office of Government Ethics regulations. SBA’s procedures define, among other things, the entities SBA may enter into a cosponsorship agreement with, certain activities that may and may not be performed as cosponsored activities, and how cosponsored activities may be funded. For example, SBA may enter into a cosponsorship agreement with any eligible entity with whom such partnership would not create a conflict of interest with the agency. Eligible entities can include for-profit or nonprofit entities, or any federal, state, or local government official or entity. SBA’s procedures on outreach activities also define certain activities that may be performed as cosponsored activities, described by the following examples: Training: Activity must include delivery of an instructional program— either in person or on-line—that provides information on or experiences with SBA programs or services or a business-related subject. Matchmaking: Activity (generally government contracting or financing initiatives) that brings together government and private-sector resources and small business owners. Matchmaking events are permissible so long as the activities are not exclusive to any one group or do not benefit only one entity. No business transactions (e.g., signing of contracts) can take place during the cosponsored activity. Counseling: One-to-one counseling may be a part of an activity only if the counseling is performed by an SBA employee or by an SBA grantee that provides counseling services as part of its SBA-funded activity. Web pages or websites: A cosponsored web page or website can refer to a variety of activities including (1) the actual cosponsored activity itself; (2) a means to host the cosponsored activity (i.e., online training, digital publication or podcast); or (3) a means to advertise or register participants for the cosponsored activity. The web page or website must include information or links to SBA programs and services and cannot include commercial activity. Recognition: Activity that celebrates the contributions of small business, small business owners, or small business advocates. In addition, SBA’s procedures define activities that may not be performed as cosponsored activities, including political and fundraising activities, and activities that are solely or primarily a networking or social reception and do not provide a formal opportunity for SBA to make a presentation on SBA programs and services. Further, SBA’s procedures define the various ways cosponsored activities may be funded. Cosponsors may provide cash or an in-kind contribution, a cosponsor may charge a participant fee to cover the direct costs of providing the cosponsored activity, or SBA may accept a gift under its gift acceptance authority to support cosponsored activities. SBA also may use appropriated funds to support a cosponsored activity. However SBA must purchase the product or service directly (following the appropriate procurement process) and provide that product or service to the cosponsored activity as an in-kind contribution. Additionally, SBA’s procedures note that funds to support a cosponsored activity may be used for nearly any expense so long as that type of expense is approved as part of the proposed cosponsorship budget, is a direct cost of the activity, and is necessary and integral to the activity. SBA district office officials and staff we spoke to said that they consider various factors when making a decision to provide assistance to small businesses under a cosponsorship agreement, including whether a potential cosponsor has expertise in a particular area such as lending or exporting, has resources necessary to conduct an event such as space, or could provide funding to cover these and other event costs. SBA and Cosponsors Jointly Plan, Fund, and Conduct Cosponsored Activities SBA and cosponsors share responsibilities for planning, funding, and conducting cosponsored activities. SBA’s procedures on outreach activities generally describe the roles and responsibilities of the various offices within SBA. In addition, cosponsorship agreements between SBA and cosponsors describe each party’s specific responsibilities; the division of responsibilities and the extent to which SBA and cosponsors share responsibilities differed in the agreements we reviewed. Figure 1 illustrates the key responsibilities of SBA and cosponsors before, during, and after cosponsored activities. Before a cosponsored activity takes place, SBA and cosponsors have several key responsibilities, as the following examples illustrate. Determining type and subject of activity. SBA field and program offices are responsible for originating cosponsored activities. As previously stated, our analysis of the information SBA maintains on cosponsorship agreements showed that the agency executed 132 cosponsorship agreements in fiscal year 2012. In addition, our review of the official file for these agreements and other related materials showed that more than 80 percent of them included training activities, about 20 percent included recognition activities, and about 17 percent included matchmaking activities. Further, the subject matter of the activities conducted under these agreements varied and included business planning and marketing, social media, e-commerce, technology, franchising, employment practices and employee benefits, tax planning and other legal issues, and government contracting. Making conflict-of-interest determinations. SBA field or program offices that originate cosponsored activities are responsible for vetting nonprofit and governmental entities; SBA’s Office of Strategic Alliances is responsible for vetting for-profit entities and upon request may assist originating offices in vetting nonprofit and government entities. Vetting is the process of gathering information to determine whether potential cosponsors have an actual or apparent conflict of interest with SBA that would preclude them from cosponsoring an activity. The information gathered during the vetting process is submitted to SBA’s General Counsel or designee to determine whether any conflicts of interest exist. The SBA Form 1615 documents the conflict-of-interest determination. Preparing cosponsorship agreement, agenda and budget. Initially, SBA will prepare a draft cosponsorship agreement and, with the assistance of potential cosponsors as necessary, drafts an agenda and budget. Cosponsorship agreements, among other things, describe the purpose of the activity or event, provide the dates and locations of the event and estimated number of attendees, and include, as applicable, a draft agenda and budget for the activity or event. After SBA’s General Counsel or their designee determines that no conflicts of interest exist with potential cosponsors and reviews the draft cosponsorship agreement for legal sufficiency, SBA field and program offices— with assistance from cosponsors—will work to finalize the agreement and develop a proposed budget for the activity that lists the sources of income, such as cash and in-kind contributions from cosponsors, in-kind contributions from SBA, and fees paid by participants, and the estimated cost of conducting the cosponsored activity. Some SBA district office officials told us that, beyond available human resources and the district office’s own space, they do not have an abundance of discretionary funds to spend on cosponsored activities and they leverage the resources of cosponsors because of this. SBA is responsible for designating a cosponsor as fiscal agent when the cosponsored activity expects to receive cash contributions from cosponsors or fees from participants. The fiscal agent is responsible for collecting, managing, and disbursing cosponsorship funds and establishing a separate mechanism to account for all cosponsorship funds that prevents commingling of cosponsorship funds with the fiscal agent’s own funds. Our review of the proposed budgets for all fiscal year 2012 cosponsorship agreements showed that SBA funded direct costs in less than half of the agreements, and when it did it generally funded costs for course materials and instructors, printing, postage, marketing activities, and awards. Table 1 provides information on the budgets for cosponsorship agreements SBA executed in fiscal year 2012. The largest direct cost SBA funded in fiscal year 2012 was $810,475 for the course materials and instructors for the Emerging Leaders Initiative, a 7-month training program provided to small business executives in more than 20 cities (under separate cosponsorship agreements) across the country. Collecting Feedback from Participants Would Help SBA Evaluate Cosponsored Activities and Its Use of Cosponsorship Authority SBA does not systematically collect feedback on the benefits that cosponsored activities provide to small businesses. However, participants in all eight focus groups that GAO held described various benefits they received from attending specific cosponsored activities. In addition, according to SBA officials, cosponsored activities enable the agency to combine public and private resources and provide assistance to small businesses at little or no cost. SBA officials and cosponsors also said that cosponsored activities provided participants with convenient access to services and resources from multiple organizations in a single location and often included counseling and training. Some SBA district office staff we met with told us that they collected feedback from participants at cosponsored activities—for instance, through a survey, evaluation, or informal follow-up—and as previously noted some fiscal year 2012 cosponsorship agreements we reviewed included specific responsibilities for SBA or cosponsors to collect participant feedback. However, SBA officials told us that the agency did not have a formal policy that required the collection of such information. Focus Group Participants, SBA, and Cosponsors Generally Reported That Cosponsored Activities Benefited Small Businesses Our focus groups participants identified benefits they received from attending cosponsored activities and also noted that they obtained information on topics useful to their small business (see fig. 2). For example, participants from all eight focus groups commented positively on the quality of the presentations and nearly all of the focus group participants said that the opportunity to network was beneficial. In addition, the focus group participants most often cited topics that provided information on how to develop and implement a business expansion plan (growth management) and information about the federal contracting process as being useful to their business. Further, the benefits reported were directly related to the type of cosponsored activity. For example, those attending the Emerging Leaders Initiative, which emphasized business management skills, reported obtaining information on topics such as financial management, strategic planning, and marketing as being useful. Likewise, those attending cosponsored activities focused on federal contracting, such as the Doing Business with Federal Procuring Agencies and the Small Business Talk series, reported obtaining information on understanding the federal contracting process as being useful. Focus group participants also described their reasons for attending certain cosponsored activities (see fig. 3). For example, focus group participants told us that networking and partnering opportunities and improved federal contracting opportunities were among the primary reasons why they attended the cosponsored activity. In addition, the participants noted in 6 of 8 focus groups that growth management, business administration, and the federal contracting process were topics of interest that led them to attend the cosponsored activity. We also noted that the number of focus groups citing certain benefits received from attending the cosponsored activity was higher than the number of groups citing this benefit as a primary reason for attending the cosponsored activity. For example, participants in all eight focus groups cited the quality of the curriculum as a benefit received from attending the cosponsored activity (see fig. 2); participants in four focus groups had mentioned obtaining access to the training curriculum as a reason for attending (see fig. 3). Similarly, participants in seven of eight focus groups cited networking or relationship building as a benefit received from attending the cosponsored activity, while participants in five focus groups said that the possibility of identifying such opportunities had helped motivate them to attend. SBA officials told us that having cosponsorship authority allowed the agency to benefit small businesses by combining public and private resources to offer activities and that the events offered benefits that SBA or the cosponsors alone could not provide. Both SBA officials and cosponsors told us that the activities provided attendees with “one-stop shopping,” including access to services and resources from multiple organizations, counseling, and referrals. SBA officials added that when multiple entities acted as cosponsors, small businesses gained a better understanding of the services each entity offered and the way the entities worked together to service small businesses. For example, a district office official said that one Emerging Leaders Initiative cosponsor specialized in business development and another in financing, allowing participants to learn about both opportunities for expanding their businesses. Further, many cosponsored events are offered for free, which an SBA official noted was an important benefit to small businesses that might not be able to spare money for attendance fees. Cosponsors generally shared SBA’s views, with one cosponsor citing one-stop shopping as a benefit. Some SBA District Offices Informally Collect Participant Feedback on Cosponsored Activities Although the act specifies that SBA cosponsored activities provide benefits to small businesses, it does not specify how SBA should identify and measure benefits. Some SBA district office staff we met with told us that they sought to obtain feedback from attendees at cosponsored activities through various means, including surveys, evaluations, and informal follow-up with participants and cosponsors. However, SBA officials told us that the agency did not have a formal policy requiring the collection and use of participant feedback on cosponsored activities. An SBA official told us that the agency had at one time obtained feedback from participants using an Office of Management and Budget approved survey instrument, but added that SBA did not seek to renew the survey instrument once it had expired. As previously noted, some fiscal year 2012 cosponsorship agreements we reviewed included specific responsibilities for SBA or cosponsors to obtain feedback from participants. SBA officials told us that obtaining participant feedback was not a responsibility that cosponsorship agreements were required to include. Although not required by the cosponsorship agreements, obtaining periodic participant feedback is an integral part of the Emerging Leaders Initiative course. The contractor that provides the curriculum and instructors for the course summarize the participant feedback and provide it to SBA. Further, SBA has reported that the Initiative has shown significant employment growth among participating companies and access to new financing since participants graduated from the program. Cosponsors we met with noted the importance of obtaining participant feedback. For example, three cosponsors told us that having a mechanism to follow up after an activity would help assess its impact— that is, how the activity ultimately benefited participants. Further, small businesses attending focus groups that we held provided us with feedback on ways in which the cosponsored activity could have been improved. As figure 4 shows, participants in seven of the eight focus groups we held commented that they wanted additional follow-up after attending a cosponsored activity. In addition, participants in five of the eight focus groups commented that more time was need for the activity. Standards for Internal Control in the Federal Government state that federal agencies should have appropriate policies, procedures, techniques, and mechanisms for each of their activities, including those to ensure compliance with key requirements. Obtaining feedback on cosponsored events could provide SBA with direct information from small business participants that could be used to help ensure that the events benefited small businesses. In addition, we found that participants had suggestions for improving the events that could help SBA in designing future activities. Further, evaluating participant feedback could help SBA evaluate its use of cosponsorship authority—that is, whether SBA is most effectively implementing the statutory authority to conduct cosponsored events for the benefit of small businesses. Conclusion Cosponsored activities can allow the agency to leverage public and private resources to benefit small businesses—generally in the form of training, education, or dissemination of information. Various offices within SBA and cosponsors have a shared responsibility for planning, funding, and conducting cosponsored activities as required under SBA policies and procedures and defined in cosponsorship agreements. Some cosponsorship agreements we reviewed included an additional responsibility for SBA or cosponsors to obtain the views of participants at cosponsored events, but SBA does not have formal policies or procedures for obtaining participant feedback. Federal internal control standards state that federal agencies should have, among other things, appropriate policies and mechanisms for each of their activities, including those to ensure compliance with key requirements. Obtaining feedback on cosponsored events would provide SBA with direct information from small business participants that could be used to help ensure that events are providing benefits to small businesses. Such information could also provide another way for SBA to evaluate the use of its cosponsorship authority. Recommendation for Executive Action To ensure that SBA most effectively implements the statutory authority to conduct cosponsored events for the benefit of small businesses and to enhance SBA’s ability to evaluate the use of its cosponsorship authority, the Administrator of the SBA should develop a mechanism to consistently obtain participant feedback on cosponsored activities. Agency Comments We requested comments from SBA on a draft of this report, and the agency provided written comments that are presented in appendix V. SBA generally agreed with our recommendation to develop a mechanism to consistently obtain participant feedback on cosponsored activities. SBA stated that it will evaluate the best means to obtain consistent feedback from participants during cosponsored activities in a manner that is not overly burdensome to the participant. In addition, SBA stated that it thinks there are many ways to obtain feedback on events and activities and it will look to provide a range of options for SBA program and district offices to employ. SBA also provided technical comments, which we incorporated as appropriate. We will send copies of this report to SBA and interested congressional committees. The report will also be available at no charge on the GAO website at http://www.gao.gov. If you or your staff have any questions about this report, please contact William B. Shear at (202) 512-8678 or shearw@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix VI. Appendix I: Objectives, Scope, and Methodology The objectives of this report are to (1) describe the roles and responsibilities of SBA and cosponsors in planning, funding, and conducting cosponsored activities; and (2) examine the benefits cosponsored activities provide to small businesses. To describe the roles and responsibilities of SBA and cosponsors in planning, funding, and conducting cosponsored activities, we reviewed Section 4(h) of the Small Business Act, implementing regulations, and SBA’s standard operating procedures and guidance related to the use of cosponsorship authority. In addition, we identified the specific roles and responsibilities of SBA and cosponsors for a nonprobability sample of 27 cosponsorship agreements SBA executed in fiscal year 2012. The results of our analyses of the specific roles and responsibilities described in these agreements cannot be generalized to all cosponsorship agreements SBA executed in fiscal year 2012, but the agreements represent a variety of eligible entities, eligible activities, expected number of businesses assisted, direct costs, and locations and dates. We interviewed officials and staff from SBA’s Office of Strategic Alliances and Office of General Counsel, and officials from six district offices and staff from five of those district offices to gain an understanding of the roles and responsibilities of SBA and cosponsors related to planning, funding, and conducting cosponsored activities. We selected four of the district offices based primarily on the frequency with which the office conducted cosponsored activities in fiscal years 2010 to 2012 and interviewed officials and staff from the remaining two district offices that originated the cosponsored activities we selected for our focus groups. The district offices were located in California, Florida, Georgia, Michigan, North Dakota, and New York. We also interviewed representatives from 10 entities that cosponsored an activity with SBA during calendar years 2012 or 2013 to understand their roles and responsibilities for the activities they cosponsored and how and why they cosponsored them. Seven of these entities had cosponsored the activities selected for our focus groups and the other three entities had cosponsored National Small Business Week activities in 2012 and 2013. Further, we attended two cosponsored events and observed how information was delivered to and received by participants. We also reviewed SBA’s Office of Inspector General (OIG) report on its audit of SBA’s controls over cosponsored activities, which assessed the adequacy of those controls, and discussed the audit with the OIG. In addition, we requested the official file for the more than 132 cosponsorship agreements SBA executed in fiscal year 2012 as listed in a spreadsheet the agency maintains on the status of these agreements. Two analysts reviewed the cosponsorship documentation contained in the files and other materials, including cosponsorship agreements, draft and final agendas, marketing materials and final cosponsorship reports (SBA form 2299). As a part of this review, the analysts independently coded the documentation to identify the type of activity and subject matter. The analysts also recorded the type of budgeted direct costs, whether each agreement included a responsibility for SBA or the cosponsor to obtain participant feedback, and compared the budgeted amount to that listed in the spreadsheet data SBA maintains. Any disagreement between the analysts on the coding of the cosponsorship documentation was resolved through discussion. We assessed the reliability of the spreadsheet data SBA maintains on the status of cosponsorship agreements by reviewing it for obvious errors and comparing the data for selected agreements to SBA’s official files. We clarified any discrepancies with SBA and corrected the data accordingly. We determined that the data were sufficiently reliable for the purposes of determining the number of executed cosponsorship agreements and the associated date of execution and budgeted direct cost for these agreements. To examine the benefits cosponsored activities provide to small businesses, we conducted eight focus groups in three cities (Atlanta, GA; Detroit, MI; and Kalamazoo, MI) with 48 entrepreneurs that had attended one of three SBA cosponsored activities conducted in 2012 and 2013— the Emerging Leaders Initiative, Doing Business with Federal Procuring Agencies series, and Small Business Talk Series. We considered a number of factors in selecting the three activities. For example, we selected the Emerging Leaders Initiative because of the large amount of direct costs SBA funded for the initiative. We selected the Doing Business with Federal Procuring Agencies and Small Business Talk series because the activities (1) took place in the same or nearby location where an Emerging Leaders Initiative was taking place (2) included a significant training component, (3) had a sizable number of expected attendees from which to solicit 8 to12 people for a focus group, (4) had lists of preregistered participants or attendee lists with contact information, and (5) occurred within 12 months preceding the focus groups. We also considered geographic diversity for the three activities we selected to conduct focus groups. We sought to ensure that the activities we selected to conduct focus groups took place in different regions of the country with differing economic profiles. We determined that these activities would provide us with sufficient information from participants on the benefits participants received or expected to receive in the future from having attended different types of cosponsored activities in different parts of the country. The entrepreneurs who participated in our focus groups included mostly small business owners, but also individuals who were interested in starting up their own small business and those who worked for a small business. We limited our focus group participation to entrepreneurs with recent experience attending a cosponsored activity to minimize recall bias and to ensure that the most accurate account of participants’ experiences could be obtained. To recruit volunteers to our focus groups, we obtained from SBA a list of persons who attended the three activities in locations we selected. We contacted each person by email, soliciting them to participate in our focus groups and took the first volunteers for up to 12 persons per focus group. Our focus groups ranged in size from 3 to 11. Attendees at our focus groups included women-owned and veteran- owned small businesses in a variety of industries including construction, janitorial services, and health care (see app. IV, figs. 5 through 8, for additional information about participant characteristics and focus group responses on various themes). The focus groups were structured small group discussions designed to generate information on the participants’ experiences with SBA cosponsored training, education, and counseling events. Methodologically, information gathered from focus groups cannot be used to make generalizations about a population or to demonstrate the extent of an issue. Thus, while the information we gathered is not generalizable to all participants in SBA cosponsored activities, it provides valuable context regarding their perceptions of the benefits and challenges they experienced when attending these events and this information is more in- depth than is possible using numerous individual interviews. Small business owners and other participants who did not attend our focus groups may have had different experiences. A GAO facilitator guided the focus group participants using a structured set of questions. In addition to the GAO facilitator, another team member recorded notes of the proceedings. At the start of each discussion session, ground rules were established encouraging participants to limit their comments to their own personal experiences with the SBA cosponsored event attended unless explicitly asked to respond more broadly. The facilitator encouraged all participants to share their views and react to the views of others. Using a GAO-developed discussion guide, the facilitator asked the participants to give their perspectives on (1) their decision to attend the SBA cosponsored event, (2) the perceived benefits, (3) the challenges associated with their experience or suggestions for improvements, (4) expectations about future uses of what they learned, and (5) events they attended within 12 months preceding the focus groups. We conducted the analysis of the focus group results in three steps. First, two analysts developed a codebook to identify common themes in the focus group notes and worked together to ensure agreement. Second, two GAO analysts independently coded the transcripts and then resolved any coding discrepancies. Third, the coders noted how often a theme was expressed across each focus group and focused on those that were mentioned frequently across the majority of focus groups. The focus group results discussed in this report reflect the range of views and perceptions expressed in a larger number of the focus groups. We also interviewed key officials at SBA headquarters in Washington, D.C., including representatives from the agency’s Office of Strategic Alliances and Office of General Counsel and six SBA district offices and staff from five of those district offices to obtain testimonial information about district office involvement and experiences with their use of SBA’s cosponsorship authority, including how they evaluate the results of the events. Finally, we interviewed representatives from 10 entities that cosponsored an activity with SBA during calendar years 2012 or 2013 to obtain their perspectives on benefits to small business arising from cosponsored events. We analyzed the information obtained from the interviews to determine what perceived benefits small businesses received from attending or were expected to gain from the cosponsored events, what would have improved the cosponsored event experience, whether cosponsors sought feedback about a cosponsored event, and whether SBA had any consistent practices for obtaining participant feedback on cosponsored events. We conducted this performance audit from November 2012 to May 2014 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Factors SBA Considers in Deciding Whether to Utilize Cosponsorship Authority SBA district office officials and staff we spoke to identified the following factors that they consider in deciding whether to utilize cosponsorship authority to conduct outreach activities: 1. Whether a proposed activity would better meet the needs of small businesses, and more of them, if conducted with other entities under a cosponsorship agreement. 2. Whether a potential cosponsor has expertise in a particular area, such as lending or exporting, or has resources necessary to conduct an event, such as space, or could provide funding to cover these and other event costs. 3. How much control SBA wants to have over the various aspects of an event’s planning, content, and delivery, including setting the agenda, identifying speakers, and selecting a suitable location, or whether it would be helpful to share these responsibilities. 4. Whether potential cosponsors could provide SBA with access to groups that it does not have a well-established relationship with or that might not be familiar with SBA or its programs and services. 5. Whether cosponsorship authority provides SBA with an opportunity to develop and strengthen long-term relationships with groups that represent minority small businesses or those in particular geographic areas that could help identify and target those businesses that might benefit most from a particular event. 6. Whether co-branding of a cosponsored activity—displaying SBA and cosponsor logos on all marketing and event material—could attract greater small business attendance, in part because of the appeal of having multiple small business resources at a single event. 7. What the costs would be in terms of time and SBA’s own resources. 8. Whether potential cosponsors would be able to fulfill their responsibilities under an agreement, including handling cosponsorship funds while serving as a fiscal agent. Appendix III: Summary of SBA Office of Inspector General Findings and Recommendations and SBA Required Procedures The SBA Office of Inspector General issued Advisory Memorandum Report No. 13-21, SBA Enterprise-wide Controls over Cosponsored Activities, dated September 26, 2013, which presented the results of its work on the adequacy of controls over SBA’s cosponsored activities. The table below summarizes the findings and recommendations from that report and the required procedures that the Office of Inspector General found SBA had not complied with. SBA agreed with some but not all of the OIG’s findings and recommendations. SBA stated that the OIG’s findings about the failings of SBA’s cosponsorship program as a whole are too broadly stated, considering that the five agreements the OIG tested represent less than 1 percent of all the cosponsored activities that took place during the fiscal years covered by their audit. SBA also responded to each specific recommendation. For example, SBA agreed that vetting is important, but disagreed with the recommendation because it believed that the OIG’s audit did not demonstrate a deficiency with the vetting process, adding that only one cosponsorship file did not contain the requisite vetting information. Also, SBA agreed with the intent of the OIG’s recommendation to modify the cosponsorship agreement template to include the specific roles and responsibilities of fiscal agents but did not agree with the recommendation itself, as SBA believes that providing staff with supplemental guidance and more instruction would be a better approach. Appendix IV: Additional Focus Group Characteristics and Information As discussed in this report, we conducted eight focus groups with 48 participants and obtained a variety of information about their experience at certain cosponsored events. This appendix provides additional information on the results of the focus groups including selected characteristics of the participants, as shown in the following figures. Figure 5 presents information on how the focus group participants thought they might use the information and skills learned at the cosponsored activity attended to improve their business management activities and approaches. As part of the focus group discussions, we asked participants whether they owned a small business or what role they held in the small business activity represented. Figure 6 describes the self-reported responses. This report notes that SBA helps entrepreneurs start, build, and grow businesses by, among other things, providing counseling and training as well as actions to increase federal contracting and subcontracting opportunities. As part of discussions, we asked the participants to describe the ownership of the business they represented, including ownership types that SBA has targeted for assistance. The responses received are noted in figure 7. Finally, the participants in the focus group discussions provided information on the industry in which their businesses or planned businesses operated (see fig. 8). Appendix V: Comments from the Small Business Administration Appendix VI: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Marshall Hamlett (Assistant Director), Emily Chalmers, Pamela Davidson, Alexandra Martin- Arseneau, John McGrail, Scott E. McNulty, and Jena Sinkfield made key contributions to this report.

Section 4(h) of the Small Business Act authorizes SBA to provide assistance for the benefit of small businesses through activities the agency cosponsors with eligible for-profit and nonprofit entities, as well as federal, state, and local government entities. Cosponsored activities can provide information on SBA programs and services or on subjects of interest to small businesses, bring together government and private sector resources and small business owners (generally for government contracting or financing initiatives), or celebrate the contributions of small business owners. GAO was asked to study SBA's use of its cosponsorship authority. This report (1) describes the roles and responsibilities of SBA and cosponsors in planning, funding, and conducting cosponsored activities, and (2) examines the benefits cosponsored activities provide to small businesses. GAO reviewed relevant laws and regulations and SBA procedures, guidance, and official cosponsorship files. GAO conducted eight focus groups with a total of 48 small business entrepreneurs in three cities to obtain feedback on their experiences with cosponsored activities. GAO also interviewed cosponsors and SBA officials. The Small Business Administration (SBA) and cosponsors share responsibilities for planning, funding, and conducting cosponsored activities. Before cosponsored activities take place, SBA field and program offices decide on the type and subject of the activity, solicit potential cosponsors, draft an agreement, agenda and budget, and designate a cosponsor as fiscal agent to collect, manage, and disburse any funds received. SBA's General Counsel or designee is responsible for reviewing draft cosponsorship agreements for legal sufficiency and determining whether any conflicts of interest exist with potential cosponsors. GAO's analysis of the official files for 132 cosponsored agreements SBA executed in fiscal year 2012 and other related materials showed that the activities were intended to provide training on a variety of topics, such as business planning and marketing, social media, and government contracting. SBA and cosponsors are both responsible for conducting the activity in accordance with the agreement. Following cosponsored activities, SBA field and program offices must submit a final cosponsorship report to SBA's Office of Strategic Alliances, which is responsible for maintaining the official files on these activities. SBA does not consistently collect feedback related to the benefits that cosponsored activities provide to small businesses. Participants in focus groups that GAO held commented positively on the quality of the presentations and opportunities to network, among other things, offered by cosponsored activities. Participants also noted that they obtained information on topics useful to their small businesses, including financial management and the federal contracting process. SBA officials and representatives of cosponsors told GAO that the events provided attendees with access to services and resources from multiple organizations in a single venue and often included counseling and referrals to other resources. Although the Small Business Act specifies that SBA cosponsored activities provide benefits to small businesses, it does not specify how SBA should identify and measure benefits. Some SBA district office staff told GAO that they solicited participant feedback on cosponsored events through a survey, evaluation, or questionnaire. GAO also found that obtaining periodic participant feedback is an integral part of a 7-month training initiative, called the Emerging Leaders Initiative, conducted using cosponsorship authority. However, SBA officials told us that obtaining formal feedback was not required and that the agency did not have a policy on soliciting and using it. Cosponsors GAO met with noted the importance of obtaining participant feedback and entrepreneurs GAO spoke to also identified ways in which the cosponsored activities could have been improved. Federal internal control standards state that federal agencies should have appropriate policies, procedures, techniques, and mechanisms for each of their activities, including those to ensure compliance with key requirements. Obtaining feedback on cosponsored events would provide SBA with direct information from small business participants that could be used to help ensure that events are providing benefits to small businesses. Such information could also provide another way for SBA to evaluate the use of its cosponsorship authority.

Background To help students pay for college, several forms of financial aid are available through federal, state, institutional, and private sources, as shown in table 1. In academic year 2011-12, about 70 percent of the undergraduate students attending college borrowed money from federal or private lenders. Before 2010, federal Stafford Loans and PLUS Loans were part of the Federal Family Education Loan (FFEL) Program as well as the William D. Ford Federal Direct Loan (Direct Loan) Program. Under the FFEL Program, private lenders made federally-guaranteed student loans to parents and students. The Student Aid and Fiscal Responsibility Act of 2009, enacted as a part of the Health Care and Education Reconciliation Act of 2010, terminated the authority to make or insure new FFEL loans after June 30, 2010. At the time, there was concern that paying banks to act as middlemen for student lending was adding to the cost of student borrowing. A Congressional Budget Office study estimated that the government would save over $85 billion over 10 years if it did the direct lending itself. Starting July 1, 2010 all Stafford and PLUS loans are originated and disbursed directly from the Department of Education under the Federal Direct Loan Program. FFEL Program loans disbursed before July 1, 2010 continue to be serviced according to the terms and conditions of the FFEL Program master promissory note the borrowers signed when they obtained the loan. The Stafford Loan program is the largest source of federal financial aid available to postsecondary students. In academic year 2011-12, 35 percent of undergraduate students participated in the program, which provided an estimated $89.6 billion to eligible students through subsidized and unsubsidized loans. The federal government pays the interest on subsidized loans while students are in school, and students must have a financial need as determined under federal law to qualify for this type of loan. Each student’s financial aid need is determined by subtracting the student’s expected family contribution (EFC) and certain other estimated financial assistance from the total price of attendance. Regardless of their financial need, students can borrow unsubsidized loans to pay for educational expenses and are responsible for paying back any interest that accrues on the loan. A student may be eligible to receive both subsidized and unsubsidized loans, which are generally referred to as a combined loan. To help students and their families pay for the rising cost of college, Congress first passed a law that raised Stafford loan limits for first-and second-year undergraduate students as well as for graduate and professional students in academic year 2007-08, and subsequently for all qualified undergraduate students receiving unsubsidized or combined Stafford loans in academic year 2008-09 (see table 2). Students whose financial need is not fully met by federal assistance and the school’s own resources (school grants and loans, called institutional aid) may turn to private lenders for college funding. While the private student loan market is dominated by traditional financial institutions such as banks, a variety of other private student lenders exist. Specifically, in addition to the traditional banks, nonprofit lenders, many of which are affiliated with states and certain schools, have elected to fund or effectively guarantee loans. Any Impact of Increases in Loan Limits on Rising College Prices Is Difficult to Discern For more than a decade, college prices have been rising consistently across most types of institutions of higher education and continued to rise after the Stafford loan limits increased, but it is difficult to establish if a direct relationship exists. Numerous events that affected the economy likely influenced rising prices, which generally followed a consistent upward pattern across three commonly-used measures of college prices (see fig. 1). As figure 2 shows, the tuition and required fees that a typical student would incur rose at an average annual rate of about 2 to 5 percent from academic years 2007-08 through 2011-12, following a decade-long trend of steady, consistent increases. The one exception to this pattern was at for-profit 2-and 4-year institutions, where prices decreased across all three measures during that time (see fig. 1). That is, for academic years 2007-08 through 2011-12, the tuition and required fees decreased at an annual average rate of 3 percent (see fig. 2). This pattern of gradual increases in tuition and fees has generally persisted across different regions of the United States, with higher overall annual rate increases from academic years 2007-08 through 2011-12 in the Far West region (average annual rate increase of 14 percent), and lower increases in the Great Lakes and Plains regions at 1 and 2 percent, respectively. Enrollment, which can be sensitive to college prices, was unaffected by increases in college prices, and continued an upward trend as shown in figure 3, rising to about 18 million students in academic year 2011-12, with variations by region, student characteristics, and higher education sector. Further, over the last decade, the cohort of college students who are 18-24 has grown substantially, with this population comprising about 42 percent of all college students in 2011. See Appendix III for additional data on college prices and enrollment. Although college prices went up, we were unable to determine whether or not these increases resulted from the loan limit increases because of the interference of various economic factors occurring around the same time these loan limit increases went into effect. Specifically, when the loan limit increases went into effect, the nation was in a recession which created one of the most tumultuous and complex economic environments in recent history, affecting families’ employment, income, and net worth (see fig. 4). As shown earlier, the availability and types of federal and institutional financial aid available to students increased around the time the new loan limits went into effect (see table 1), also making it difficult to discern any effect those loan limits may have had. For example, the dollar amounts of Federal PLUS loans, federal tax benefits, Pell grants, and federal veterans grants all increased. Further, the amounts of state and institutional grants and loans also increased, while the amounts of state appropriations for colleges and college endowments decreased. Further, colleges appear to have responded to the economic crisis in ways that are difficult to capture in a model. We found some evidence of this in our discussion with selected college officials, who responded to the economic crisis in different ways. For example, officials at a private nonprofit 4-year institution said that despite declines in their endowments, they used their general operating and annual giving funds to provide more aid to students. In contrast, officials at one public 4-year college said that they set their tuition so that their students, the majority of whom qualified for federal Pell grants, could cover the price of tuition with their grant aid. In addition, officials at one public 2-year college described how their state board of education would not allow them to increase their tuition more than 5 percent each year, while officials at a public 4-year college said that any public school in their state that increased their designated tuition by a certain percentage had to set aside more money for financial aid to their students. Finally, Stafford student loan borrowing that occurred after the loan limit increases presented a mixed picture. The proportion of students taking out the maximum in Stafford student loans continued to decline between academic years 2007-08 and 2011-12 for unsubsidized (24 to 20 percent) and combined loans (61 to 58 percent) but not for subsidized loans, which increased from 54 to 57 percent in the number of students borrowing the maximum loan amount (see figure 5). Private Student Loan Borrowing Declined After the Loan Limits Increased The landscape of private education borrowing has changed since the loan limit increases took effect. Before the loan limit increases, the total number of students borrowing private student loans had been increasing, rising by 188 percent from 961,356 to 2,764,469 students between academic years 2003-04 and 2007-08 (see fig. 6). After the loan limit increases went into effect, the number of students taking out private student loans dropped overall by 52 percent, down to 1,325,997 students between academic years 2007-08 and 2011-12. This pattern persisted across all types of institutions of higher education, with the steepest declines at public 2-year (61 percent) and for-profit 2-and 4-year institutions (58 percent) over this time period, according to Education data. While it is unclear why there were steeper declines among these types of institutions, increases in the availability of other types of aid may have been a contributing factor. For example, officials at one for-profit 4- year institution participating in our study told us they increased the amount of scholarship assistance available to students. Similarly, the financial aid administrator at a public 2-year school told us the school was able to increase institutional aid to students because its foundation aggressively sought grants to fund scholarships. Students also borrowed less private student loan money after the loan limit increases, on average about $1,179 less in academic year 2011-12 than in academic year 2007-08– approximately a 17 percent decrease (see table 3). While the decline in the amount students borrowed occurred across all higher education institution types, amounts borrowed by students attending public 2-year schools (28 percent) and private nonprofit 4-year schools (22 percent) dropped the most. In terms of average amounts borrowed in dollars, student borrowing at private nonprofit 4-year schools showed the largest dollar decline: about $2,178. The decrease in the average private loan amount borrowed by students at public 2-year schools may have resulted in part from the effort by school officials to rein in student borrowing and the increased availability of other aid. For example, the financial aid administrator at a public 2-year school said they encourage students to pursue federal loans first and private loans as a last resort. Officials at a private nonprofit 4-year institution said they adopted an “interventionist” approach toward students who were considering private student loans. These officials said they reached out to students who were considering private student loans and, in some instances, increased the amount of institutional aid to students so that they would not need to take out private loans. Private lenders we interviewed also said that they had to rein in student borrowing to reduce the risk of loan defaults. One lender said that some lenders decreased loans to students at for-profit schools because of low graduation rates and high default rates. The decline in the number of students borrowing private student loans paralleled other declines in the private education market. According to a study by the CFPB—the agency that supervises large banks and nonbanks that make private student loans—new loans for nine major lenders steadily increased from 2005, peaking in 2008 at $10.1 billion. However, in 2009, the calendar year the second loan limit increase took effect, new loans decreased 31 percent (dropping from $10.1 billion in 2008 to $7 billion in 2009). From 2009 to 2010, new loans dropped another 20 percent to $5.6 billion (See fig. 7). As the average amount of private student loans borrowed by students dropped, the average amount of federal education loans at all institutions increased (see fig. 8). For example, between academic years 2007-08 and 2011-12, the average amount of private loans borrowed by students at public 2-year institutions dropped by 28 percent while the average amount of federal loans increased by 16 percent. At for-profit 2- and 4- year institutions, there was about an 11 percent decrease in the average amount of private student loans borrowed and a 22 percent increase in the amount of federal student loans. The trend of less reliance on private student loans and more on federal student loans to fund education persisted across all types of institutions. Factors Contributing to Private Loan Declines Overall, the turmoil in the nation’s financial markets and the resulting recession set the stage for the declines in private loan borrowing and lending, but there were other contributing factors, too. Lender exit. In response to the turmoil in the financial markets, some lenders exited the student loan industry altogether, according to a study by CFPB. These actions changed the market from one with many lenders to a smaller market dominated by a few large lenders. More stringent lending criteria. Lenders responded to the crisis by tightening their lending criteria, making it more difficult for some students to obtain these loans, according to a study by the CFPB which was echoed by lenders and subject matter specialists we interviewed. The CFPB study found that in the years leading up to the 2007-2009 recession when private student lending was increasing, lenders were making a higher percentage of loans to borrowers with weaker credit qualifications. This trend reversed during the recession. In the aftermath of the credit crisis and recession, private lenders changed their criteria for making student loans. For example, the CFPB study found that lenders began to rely more heavily on criteria that had been traditionally used to determine a borrower’s creditworthiness, such as the borrower’s ability to repay the loan and individual repayment history as reflected by a borrower’s Fair Isaac Corporation credit score (FICO). Many lenders also required or strongly encouraged students to have a co-signer for their private student loans. While students could still obtain loans without a co- signer, lenders said student borrowers with a co-signer are more likely to secure a lower interest rate and more favorable loan terms. New consumer protections. In addition, the fallout from the turmoil in the national financial markets in 2008 increased scrutiny of the private student loan market, and subsequent statutory changes increased consumer protections (see table 4). Enacted in 2008, the Higher Education Opportunity Act (HEOA) amended the Truth in Lending Act (TILA) and the Higher Education Act of 1965 to add new disclosure requirements related to private student loan rates, terms, and the availability of federal student loans. For example, it provided for a 3-day period after consummation of the loan during which a borrower may cancel a loan without penalty and also provided that a borrower has 30 days after a loan is approved to accept the loan, during which time the lender generally cannot change the loan rates or terms. The new disclosures were accompanied by new borrower responsibilities. In an effort to prevent over-borrowing, applicants for private student loans must now complete a self-certification form that includes a calculation of how much the student needs to borrow, and attest that they are aware of the federal loan options available to them. See Appendix IV for a sample self-certification template. Several of the officials we interviewed noted that the self-certification forms helped to keep students from borrowing more funds than they actually need for educational costs. Furthermore, the HEOA amended the TILA to prohibit certain practices by private lenders, including revenue sharing between creditors and educational institutions. (See table 4 for more information). Proactive school initiatives. Officials at all of the schools in our study described a wide range of activities they implemented to raise student awareness and understanding of the various types of financial aid available to them. Some school officials also described efforts aimed at providing students with alternatives to private student loans. While most of the schools provided personal counseling to help students understand the obligations that come with borrowing private student loans, financial literacy training, and a wide range of online tools to help students calculate their college costs and financial need, they also told us about efforts that were unique to their own institutions. For example, officials at one public 4-year university described how 80 to 90 percent of their students are eligible for Pell grants, which cover much of their costs, and that many students do not have the credit scores to qualify for private student loans. Officials told us that they kept tuition at a level that would enable students’ Pell grants to cover the full cost of tuition. Rather than raise tuition, school officials said the school made modest increases to room and board prices for students who chose to live on campus. Officials at another public 4-year university said that they were able to hold tuition steady by increasing enrollment. They said that they have a multi-year plan to increase enrollment, especially for students served through their online education programs. These officials also described how they now offer a $10,000 degree to students who pursue a Bachelor’s degree in the specific field of organizational leadership. The program is competency-based rather than semester credit-hour based, and features a combination of traditional classroom instruction and credit for life learning. The $10,000 cost of the degree covers tuition and fees but not room and board, transit, or other miscellaneous costs. In addition, officials at both public 4-year institutions said that their state boards of education require them to keep college prices below a certain designated threshold, and if they go above it, they must then increase the amount of institutional aid to students. Their states put this policy in place, they said, to make college more affordable and reduce the need for students to seek private student loans to finance their education. Officials at a private nonprofit 4-year institution described an aggressive strategy for helping students pay for their education without private or federal student loans. According to these financial aid administrators, the university has adopted a policy of fully meeting each student’s financial aid need and that for all students in general, they have a no loan policy. To carry out this policy, the administrators said the university does not include loans when determining a student’s financial aid award and has increased institutional funding for students through grants and scholarships. According to university officials, during the recession they tapped into the university’s operating funds to ensure sufficient levels of grant aid for students. In addition, they said the university has changed the way it calculates a student’s financial need for purposes of institutional aid by eliminating home equity as a factor when considering a student’s eligibility for institutional aid. The elimination of home equity as an asset, school officials said, resulted in more students from middle income families qualifying for financial aid. Officials at all three for-profit institutions we interviewed said that keeping costs down is a significant part of their effort to reduce students’ reliance on loans, similar to the efforts that public institutions reported. Officials at one of the for-profit institutions participating in our study said they are focusing on reducing costs for academically gifted students by increasing merit-based financial aid. Students with higher admission test scores and GPAs receive more aid than other students. The same institution also recently announced that it is offering students in its honors program full tuition for their fourth year of school. Officials at another for-profit institution told us that the number of its students using private student loans had decreased to 11 percent in 2009 and has remained at that level. School officials saw this as particularly notable because students’ private loan usage had been as high as 30 percent in some years preceding 2009. School officials told us that students who are considering private student loans must participate in an interview at the school so that they fully understand the terms and conditions of their private loan. During the interview, the student is given information about private loan interest rates, and information about federal loans. School officials told us they encourage students considering loans to exhaust their federal loans before they take out private loans. Agency Comments and our Evaluation We provided a draft of this report to the Department of Education and Consumer Financial Protection Bureau for review and comment. The Department of Education and the Consumer Financial Protection Bureau had no comments. We are sending copies of this report to appropriate congressional committees, the Secretary of Education, the Director of the Consumer Financial Protection Bureau, and other interested parties. In addition, this report will be available at no charge on GAO’s website at http://www.gao.gov. If you or your staff members have any questions about this report, please contact me at (617) 788-0580 or nowickij@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made key contributions to this report are listed in appendix V. Appendix I: Objectives, Scope, and Methodology This appendix discusses our methodology for the study, which was framed around two objectives: (1) the extent, if any, that Stafford loan limit increases affected tuition, fees, and room and board prices at institutions of higher education; and (2) the trends in private student loan borrowing since the loan limits took effect. For our first objective, we developed a panel regression model—a statistical method where data are collected over time from the same panel to explore possible relationships among events—to examine the impact of Stafford loan limit increases on tuition, fees, and room and board prices at higher education institutions. This model is described in Appendix II. We conducted supplemental analyses of Department of Education (Education) data to determine patterns in college prices, enrollment, and students’ use of federal student loans before and after the loan limits took effect. For this objective, we also interviewed college officials to better understand the extent to which, if any, loan limit increases influenced how they set prices, such as tuition, fees, and room and board. For our second objective, we analyzed Education data on private student loans, reviewed results of a private student lenders survey conducted in a study by the Consumer Financial Protection Bureau (CFPB), the agency that supervises large banks and nonbanks that make private student loans. We also interviewed college officials about private student loan borrowing. For both objectives, we reviewed relevant federal laws, reports, and other information relevant to these issues. We assessed the reliability of the Education data we used by testing it for accuracy and completeness and reviewing documentation about systems used to produce the data. We found the data we reviewed reliable for the purposes of our analyses. Similarly, we assessed the reliability of the CFPB study’s private student lender survey data by reviewing documentation about systems used to produce the data and reviewing the survey methodology. We conducted this performance audit from December 2012 to February 2014 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence we obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Analysis of Education Data on Trends in College Prices, Enrollment, and Federal Student Loan Borrowing Patterns To determine trends in college prices since the loan limits took effect, we examined 13 years of trend data (academic years 1999-2000 through 2011-12) for all Title IV-eligible, degree-granting institutions of higher education from Education’s Integrated Postsecondary Education Data System (IPEDS), and from the three most recent National Postsecondary Student Aid Study (NPSAS) results (academic years 2003-04, 2007-08, and 2011-12). We examined this data for undergraduate students—the majority of college students—across four institutional sectors (nonprofit, for-profit, public 2-year, and public 4-year colleges) and geographic regions. For public 2-year and public 4-year colleges, we also reviewed the annual tuition for both in-state and out-of-state students. We analyzed three descriptors of price: 1. Tuition and fees: the amount of tuition and required fees covering a full academic year charged to students. These values represent what a typical student would be charged and may not be the same for all students at an institution. Tuition and fees data are weighted by undergraduate enrollment. We analyzed these data by sector and by region. 2. Total price of attendance: what a typical student would pay for tuition and required fees, books and supplies, room and board, and other personal expenses. We analyzed these data by sector. 3. Net price after grants: the total price of attendance minus all grant aid received by a typical student. We analyzed these data by sector. To determine patterns in undergraduate student enrollment, we used IPEDS to analyze enrollment trends from academic years 1999-2000 through 2011-12. To determine the characteristics of enrolled students, we also analyzed IPEDS data on institutional characteristics (geographic region and sector) and student characteristics (attendance status and race and ethnicity). To determine the extent to which students borrowed Stafford loans at their maximum levels in academic year 2011-12, we used NPSAS data. For each loan type, we analyzed and compared the proportion of eligible borrowers who received their maximum Stafford loan amount in academic years 2003-04, 2007-08, and 2011-12. Because NPSAS data are based on probability samples, estimates are formed using the appropriate estimation weights provided with each survey’s data. Because each of these samples follows a probability procedure based on random selection, they represent only one of a large number of samples that could have been drawn. Since each sample could have provided different estimates, we express our confidence in the precision of our particular sample’s results as a 95 percent confidence interval (e.g., plus or minus 2.5 percentage points). This is the interval that would contain the actual population value for 95 percent of the samples we could have drawn. Unless otherwise noted, all percentage estimates from NPSAS have 95 percent confidence intervals that are within 8 percent of the estimate itself. All NPSAS dollar estimates have 95 percent confidence intervals that are within 8 percentage points of the estimate itself. Analysis of Data on Private Student Loan Borrowing To determine trends in private student loan borrowing since the loan limits took effect, we reviewed aggregate trend data from nine major private student lenders compiled in a CFPB study from calendar years 2005-11. CFPB officials told us that the portfolios of these nine major lenders represent about 90 percent of the private student loan market. The lenders’ participation in the data collection was voluntary, and the information was provided to CFPB and Education under a non-disclosure agreement and is protected under various federal laws as proprietary and confidential business information. These private lender data consists of: 1. Sample loan-level data: records from all private student loans originated from calendar years 2005 to 2011 of nine major lenders were pooled and analyzed in the CFPB study. The data do not identify the specific lender for each loan. 2. Lender portfolio-level data: quarterly performance data on private student loans originated and/or purchased by the nine major student loan lenders who provided the loan-level data, aggregated across lenders. In addition, the CFPB study queried the nine lenders about current loan terms and conditions. We reviewed the CFPB study, including data appendices that described these data sources and methodology. To obtain additional information about trends after the loan limit increases, we supplemented the CFPB study data with analyses of Education’s IPEDS data (academic years 1999-2000 through 2011-12) and NPSAS data (academic years 1999-2000, 2007-08, and 2011-12) about private loan usage and undergraduate borrowing. We also examined these data by institutional sector and for undergraduate students only. Interviews with College Officials, Private Student Lenders and Other Experts To provide the schools’ perspectives about the role of loan limit increases on college prices and federal and private borrowing trends, we supplemented our data analysis with interviews with college officials at eight institutions. We selected a nonprobability sample of institutions to represent each major sector of higher education and different regions, amounts of federal aid received, enrollment sizes, admission selectivity levels, and prices of tuition and related fees (see table 5). During these interviews, we spoke with the financial aid directors and other school officials with knowledge of how tuition, fees, and other prices are set, asking a series of questions related to the setting of tuition and other prices and the role of loan limit increases in setting tuition and other prices. We also asked them a series of questions about private student loans, including trends in private student borrowing among their students and the type of information they provide students to help inform their decision about whether to borrow private student loans. We also interviewed officials for three of the largest private student lenders, who also participated in the CFPB study’s lender survey. We asked them a series of questions, including questions about the trends in private student lending, how they disclose the terms of their loans and the loan certification process, how private student lending has changed over time, and whether they expected to see resurgence in the private student loan market. In addition, we interviewed representatives from relevant professional associations, federal officials, and subject matter specialists, including academic researchers. Total price of attendance (living on campus) Total price of attendance (living on campus) Total price of attendance (living on campus) Appendix II: Analysis of the Relationship between Student Loan Limit Increases and Tuition This appendix provides the methodology we used to develop a panel regression model to analyze the relationship between Stafford student loan limit increases and college prices, and the results of that analysis. Our panel regression model is a statistical method where data are collected over a series of years for the same colleges to estimate possible relationships among certain variables, controlling for the effects of other variables; in this study, the relationship was between increases in loan limits and increases in college prices. Methodology Our analysis of the relationship between loan limit increases and college prices used a panel regression model, which allows one to compare the same group of institutions over multiple years. Our panel dataset consists of all Title IV-eligible colleges in the United States over an 8-year time span that covers years before and after the change in loan limits, which occurred in academic years 2007-08 and 2008-09. The dataset is divided by the type of institution and the control variables used in the regression include college fixed effects, economic variables, and college characteristics. We examined the following sectors: public 4-year colleges; private nonprofit 4-year colleges; private for-profit 4-year colleges; public 2-year colleges; private for-profit 2-year colleges; and private for-profit less-than-2-year colleges. The main source of data is IPEDS, an annual survey of colleges conducted by the Department of Education (Education) that collects financial characteristics of the institutions and is maintained by Education. Model The base specification of our model is given by the equation: 1. CollegePrices(i,t) = B0(i) + B1*LoanLimit(t) + B2*CollegeVars(i,t) + B3*EconVars(t) + B4*Pre-LoanLimitTrend(t) + B5*Post-LoanLimitTrend(t) + e(i,t) where the notation means the following: The subscript i represents college “i” The subscript t represents year “t” CollegePrices are the prices for a college in a certain year. We used undergraduate tuition and fees and price of attendance (i.e., tuition plus fees, room and board, books and supplies, and other expenses). We used in-state tuition for public institutions, out-of-state tuition for private 2- and 4-year colleges, and trade tuition for private, less-than- 2-year colleges. LoanLimit identifies the period following the increase in the Stafford student loan limit. The starting period for the increase in limits for both the subsidized and unsubsidized loans was academic year 2007-08 (when the limit was increased from $2,625 to $3,500 for dependent students), and academic year 2008-09 (when the loan limit was increased from $3,500 to $5,500) for unsubsidized or combined loans. We used dummy variables that are zero in the years before the change in loan limit and one in the years thereafter. The dummy variables for the loan limits in academic years 2007-08 and 2008-09 are used, respectively, in separate equations because the dummy variables overlap. The loan limit increases are one-time events. In addition to the loan limit increases, these variables also capture the effects on college prices of other events that occurred at the same time, such as the onset of the 2007-2009 financial crises and recession. B0 is a college fixed effect. The fixed effect allows us to control for characteristics of the college, which do not vary over time and may affect the college prices, but are not observed in our data. For example, the college may be located in an expensive region of the country. CollegeVars are variables that describe characteristics of a college in a certain year. The key variables we used involve revenue, and include state appropriations and endowment income. We also included the number of undergraduates (in full-time equivalents). EconVars are control variables that vary by year, but not by college. These variables reflect general economic conditions and include state-level unemployment, housing prices, and a stock market index. Pre-LoanLimitTrend and Post-LoanLimitTrend: To capture trends in college prices during the periods before and after the loan limit increases, two different time trends were used. For regressions analyzing the effect of the academic year 2007-08 loan limit increase on college prices: 2. Pre-LoanLimitTrend = (t – 2008)*(1 – LoanLimit), and 3. Post-LoanLimitTrend = (t – 2008 + 1)*LoanLimit. In Equations (2) and (3), 2008 will be replaced with 2009 for regressions analyzing the effect of the academic year 2008-09 loan limit increase on college prices. The post-loan limit trend is implicitly an interaction term between the loan limit variable and a time trend. These variables control for trends in college prices that are common to all colleges in our sample. Including both variables in our regressions allows trends in college prices after the loan limit increase to differ from trends in college prices before the loan limit increase. However, these variables also reflect changes in other unobservable factors, such as economic or political conditions, that may cause trends in college prices to differ before and after the loan limit increases. e is the error term, which captures potential model misspecification, measurement errors, and unobserved variables. We divided the sample into sectors based on the control (e.g. public, private, and nonprofit, for profit) and level (e.g. 2-year, 4-year) of the institution. Specifically, we examined the six sectors where there were sufficient observations for meaningful analysis and excluded the remaining three sectors because there were too few observations. Thus we included public 4-year colleges; private nonprofit 4-year colleges; private for-profit 4-year colleges; public 2-year colleges; private for-profit 2-year colleges; and private for-profit less-than-2-year colleges and excluded private nonprofit less than two-year colleges. The analysis was done separately by institutional sector for two reasons. First, different institution types may not necessarily compete for the same types of students. For example, students with lower household incomes are less likely to attend private colleges than public colleges. Thus, different sectors may use different strategies for the college prices they charge. Second, different institution types are likely to be affected by different variables. For example, state appropriations are likely to be more important to public colleges than for-profit private colleges. This implies that the model specification could be different for different sectors. Data The main source of data is the IPEDS dataset, maintained by Education. IPEDS is an annual survey of colleges conducted by Education which focuses on financial characteristics of the institutions. We merged the academic year data across years and colleges to form a panel that runs from the 2003-04 to the 2010-11 academic year. For certain income variables, we used definitions based on work by the Delta Cost Project. Now part of the American Institutes for Research, the Delta Cost Project published a data map with the goal of standardizing and simplifying some of the variables within IPEDS. Both IPEDS and the Delta Cost Project definitions have been used in prior GAO work and deemed reliable for our purposes. We further refined our IPEDS data by excluding certain colleges for various reasons. The major exclusion was institutions that did not have complete data for all 8 years that we examined. Further, responding to the IPEDS survey is required only for colleges that participate in the Title IV aid programs. We also excluded colleges that were outside the 50 states and the District of Columbia, did not participate in Title IV, were not open to the public, or were not predominantly postsecondary. We also excluded colleges that were not active, were primarily administrative units, or did not have undergraduate programs. This resulted in approximately 600 public 4-year colleges; 1200 private nonprofit 4-year colleges; 400 private for-profit 4-year colleges; 1000 public 2-year colleges; 400 private for-profit 2-year colleges; and 900 private for-profit less-than-2-year colleges. We also added data from outside IPEDS to control for the potential impact of household wealth on college prices. Specifically, we added a state-level unemployment rate from the Bureau of Labor Statistics. In some versions, we added the Case-Schiller composite housing price index, which came from Standard and Poor’s (S&P), and the S&P 500 stock index, which we got from Federal Reserve Economic Data (FRED) of the Federal Reserve Bank of St. Louis. Results We ran several versions of our model, the results of which are presented in tables 6 and 7. Table 6 shows results for the first loan limit increase in academic year 2007-08, and table 7 shows results for the second loan limit increase in academic year 2008-09—both best represent the various models we estimated. Overall, the estimated models are statistically significant as indicated by the models’ statistics (p-values). Table 6 shows the results for the academic year 2007-08 Stafford loan limit increase for both subsidized and unsubsidized loans on tuition and fees (college prices). In each estimated model, the average academic year change in college prices for years prior to the loan limit increase is given by B4 (the coefficient on Pre-LoanLimitTrend); the average academic year change in college prices in the year in which the loan limits increased relative to the prior year is given by the sum of B1 (the coefficient on LoanLimit), B4, and B5 (the coefficient on Post- LoanLimitTrend); and the average academic year change in college prices in years after the loan limit increase is given by B5, all else being equal. Thus, in the year the loan limit increases, the change in college prices resulting from the loan limit and the trend effects is the sum of B1 and B5; we could not obtain the effects of the loan limit by itself because B5 captures that effect as well as the trend effects. As shown in table 7, for example, for private, nonprofit 4-year colleges (B1 = – $698, B4 = $661, and B5 = $683), the average academic year change in college prices for years prior to the academic year 2007-08 loan limit increase is $661, the average change in college prices in the 2007-08 academic year compared to the prior year is $646, the average academic year change in college prices in years following the academic year 2007-08 loan limit increase is $683, and the average academic year change in college prices related to the loan limit increase is -$15 in the 2007-08 academic year. Estimates from the regressions analyzing the academic year 2008- 09 Stafford loan limit increases for only unsubsidized loans are shown in table 8. Table 7 presents the average academic year changes in college prices by different institutions in the periods before the academic year 2007-08 Stafford loan limit increase, the changes in college prices between the loan limit year and the prior year, the change college prices in the years after the loan limit increase, and the change in college prices in the loan limit year attributable to only the events that occurred in that academic year. The results show that average academic year college prices generally increased across all types of colleges before the increase in the Stafford loan limits. In the academic year of the 2007-08 Stafford loan limit increase, college prices increased for some colleges and decreased for others. The decrease in college prices by some colleges is consistent with the opinion that the rapid change in economic conditions may have led state legislatures to put political pressure on colleges in their states to keep tuition low, a sentiment that was echoed in some of our interviews with college officials. Furthermore, some of the college officials we spoke with said that they held down tuition increases because of the economic downturn and financial crises. In the years following the academic year 2007-08 loan limit increase, college prices generally increased. Although the results appear to suggest that the loan limit increase tended to weaken the rising trend in college prices, we cannot determine which portion of the change in college prices in the academic year of the 2007- 08 loan limit increase is attributable to the loan limit alone because it is confounded by other events in that year as well as the ongoing rising prices. The results in table 9 show the average academic year changes in college prices before, during, and after the academic year 2008-09 Stafford loan limit increases. There were generally increases in college prices in the academic year of the 2008-09 loan limit increase, before and afterwards (although there were few cases of decreases). Similar to the academic year 2007-08 loan limit increase, while the results seem to suggest that the loan limit increase in academic year 2008-09 tended to boost the rising trend in college prices we could not determine the portion of the increase due solely to the loan limit increase because of other confounding effects. Also, we could not separate out the effects of the academic year 2007-08 and 2008-09 Stafford loan limit increases from each other after they occurred since the two events overlapped. Our results suggest that average academic year college prices generally increased across all types of colleges prior to the increases in the Stafford loan limits in academic years 2007-08 and 2008-09, and after the loan limit increases. In the academic year of the 2007-08 Stafford loan limit increase college prices increased for some colleges while they decreased for others. And in the academic year of the 2008-09 Stafford loan limit increase, college prices generally increased. But, in the effective years of the loan limit increases we could not identify the changes in college prices that were due solely to the increases in the Stafford loan limit increases because of other events that happened during that time, including the financial crisis and the economic recession, as well as the upward trend in college prices. We took multiple steps to verify our methodology. First, we consulted with GAO experts on statistics, econometric modeling, and higher education issues. Based on their comments, we made modifications to our model where appropriate. Second, we consulted academic literature on student financial aid and tuition. Third, we consulted academic experts who reviewed our methodology and offered feedback. Fourth, we recognize that our analysis has some limitations, including the difficulty in isolating the effects of the Stafford loan limits themselves, the relatively small number of years used, and our inability to include other types of colleges. The results should therefore be interpreted with caution. Appendix III: Additional Data on College Prices and Student Enrollment Appendix IV: Sample Self-Certification Form for Private Loan Applicant Appendix V: GAO Contact and Staff Acknowledgements GAO Contact Jacqueline M. Nowicki, (617) 788-0580 or nowickij@gao.gov. Staff Acknowledgements In addition to the contact named above, Sherri Doughty, Assistant Director, Kristy Kennedy, Sandra Baxter, Patrick Dudley, John Karikari, and John W. Mingus made significant contributions to this report. Also contributing to this report were Jessica Botsford, Melissa H. Emrey Arras, Lorraine Ettaro, Mimi Nguyen, and Kathleen L. Van Gelder.

A college education can increase the choices and opportunities available to individuals, but high college tuition rates have prompted concerns that a college education may be an unattainable goal for some. To help students finance their education, Congress passed a law that raised the ceiling on the amount students can borrow under the federal Stafford Loan Program (referred to in the law as "loan limits"). The Ensuring Continued Access to Student Loans Act of 2008 mandated a series of GAO reports over a 5 year period assessing the impact of these increases in the loan limits on tuition and other expenses and on private student loan borrowing. For this final report, GAO examined: (1) the extent to which, if any, the Stafford loan limit increases affected tuition, fees and room and board prices at institutions of higher education; and (2) the trends in private student loan borrowing since the loan limits took effect. GAO developed a statistical model to explore whether the loan limit increases in academic years 2007-08 and 2008-09 had an impact on college prices in subsequent years. GAO analyzed data from the Department of Education (Education) and the Consumer Financial Protection Bureau (CFPB), and interviewed officials from eight higher education institutions that represented a mix of college sectors in different regions of the country, three of the largest private student lenders, federal officials, and subject matter specialists. For more than a decade, college prices have been rising consistently and have continued to rise at a gradual pace after the Stafford loan limit increases were enacted in 2008 and 2009. However, it is difficult to determine if a direct relationship exists between increases in college prices and the Stafford loan limit increases because of the confluence of many other factors that occurred around the time the loan limit increases took effect. Specifically, when the loan limit increases took effect, the nation was in a recession, which created one of the most tumultuous and complex economic environments in recent history. GAO's analysis found that the economic effects of the recession, which affected families' employment, income, and net worth make it difficult to isolate the impact the recession had on students' decisions to borrow money to finance college expenses versus the impact of the loan limit increases. Further, federal, state, and institutional aid available to students also increased significantly around the same time the loan limit increases went into effect. It is difficult to determine the extent to which the increased availability of this financial aid influenced the decisions of students on whether and how much money they should borrow versus the availability of increased loan limits. Conversely, GAO's analysis shows that even though college prices continued to increase at a gradual pace over the last decade as well as after the loan limits increased, enrollment, which can be sensitive to price increases, also generally continued to grow across both public and private institutions and in all regions of the country. Around the time that the loan limit increases took effect, the number of students taking out private education loans decreased across all types of institutions; lenders were making fewer loans and students borrowed less. Specifically, before the loan limit increases, the number of students borrowing private loans for academic year 2007-08 was about 2.8 million; after the limits went into effect the number dropped by over 50 percent to about 1.3 million for academic year 2011-12. Similarly, the average amount of money that students borrowed from private student loans decreased by about 17 percent after the loan limits went into effect. For example, for academic year 2007-08 students' private student loans averaged about $7,048 and for academic year 2011-12 this had dropped to about $5,870. According to the federal and institutional officials as well as financial lending experts that GAO spoke with, many factors may explain the changed private loan landscape. For example, these officials and experts noted that: lenders tightened lending criteria—such as requiring higher credit scores and co-signers—making it more difficult to obtain these loans; Congress enacted new protections to raise students' awareness about private loans, including disclosures of loan rates and terms; and colleges took steps to help students find alternatives to private borrowing and reduce reliance on private loans, such as increasing institutional aid and providing financial literacy counseling to help inform students about their federal assistance options.

Background In fiscal year 1994, VA medical care cost over $15.6 billion. VA facilities served about 2.4 million veterans nationwide. VA services included 925,000 inpatient hospital stays and about 25 million outpatient visits. The VA health care system was established primarily to treat war-related injuries and help rehabilitate veterans with disabilities incurred or aggravated as a result of military service; such service-connected disabilities include blindness, paralysis, and loss of limb. Subsequently, the Congress expanded the system so that hospital services could be provided, to the extent space and resources were available, to veterans who did not have service-connected disabilities and who lacked the resources to pay. Today, all veterans are eligible for treatment at VA medical facilities, but few are entitled to the full range of services under the existing complex eligibility requirements. For example, veterans with service-connected disabilities are eligible for cost-free hospital care, while high-income veterans without such disabilities are eligible for such care but may receive it only if space and resources are available. Such high-income veterans are also subject to co-payments and, if insured, their insurers must be billed for services provided by VA facilities. When the VA health care system was established, there were no health insurance programs to help veterans pay for needed care. Private insurance began to emerge in the 1930s and expanded rapidly in the 1950s. In the 1960s, the Congress established the Medicare and Medicaid programs—public insurance programs that help the elderly and selected low-income individuals pay for health care. By 1990, 9 out of 10 veterans had one or more alternatives to VA health care for standard benefits (excluding such special services as psychiatric care and prescription drugs): about 81 percent had private health insurance, almost 26 percent were eligible for Medicare, and 1.6 percent had Medicaid coverage. The VA health care system is fundamentally different from private or public health insurance programs. VA generally delivers health care to patients directly using salaried physicians, nurses, and other professionals in VA facilities. Insurance programs, on the other hand, provide services on a fee-for-service basis or through contracts with private providers. VA does not charge veterans for services provided to treat service-connected disabilities, although veterans may be required to make co-payments for nonservice-connected conditions if their income exceeds prescribed thresholds. Insurance programs typically charge premiums to, impose deductibles on, and require co-payments from all enrollees. In addition, VA provides some services that insurance programs typically do not provide. For example, VA covers outpatient prescription drugs and dental care that are not covered by Medicare. Similarly, while Medicare and most private insurance programs provide short-term nursing home care following hospitalization, VA may, in some instances, offer more extensive, longer-term nursing home and domiciliary care. If cost and service differences between VA and insurance programs diminish, the importance of accessibility as a factor in veterans’ decisions on where to obtain health care could increase. VA surveyed the status of veterans in 1987 and found that distance to VA facilities was one of the reasons most frequently cited by veterans for not using VA facilities. VA’s survey of the status of veterans in 1992 also showed that about one-third of the responding veterans who received inpatient care did not choose a VA hospital because they were too far from the VA location. Similarly, over one-fourth of the veteran respondents to VA’s health care reform customer satisfaction survey said that, given a choice of health programs and assuming no difference in cost, they would choose private providers, in part, because the private providers were more accessible. In October 1995, VA began a major reorganization that will replace its four regional offices with 22 integrated service networks. Each network will include from 5 to 11 medical centers. The service networks will be the basic budgetary and planning units for delivering veterans’ health care. VA officials envision greater emphasis on integrated delivery systems of care and on outpatient and primary care services as a result of the reorganization. Profile of VA Facility Users While many veterans received medical care during the early 1990s, relatively few obtained their care from VA facilities. Veterans who used VA facilities generally had lower incomes and were less likely to have private insurance than veterans who used non-VA facilities. Also, almost half the veterans who used VA facilities had service-connected disabilities. Most veterans lived over 25 miles from VA facilities, but veterans who lived within 5 miles of such facilities made greater use of the facilities. Most Veterans Used Non-VA Facilities VA’s survey of the status of veterans in 1992 showed that 54.8 percent of the 27 million veterans nationwide received medical care in 1992 but few received care in VA facilities. About 90 percent of the veterans who received either inpatient or outpatient care got it from non-VA sources, as did over 80 percent of the veterans who received both types of care. The survey also showed that of the 10 percent of veterans who received care in VA facilities, 5.6 percent received VA care exclusively and 4.4 percent received both VA and non-VA care. VA officials said that, while only 10 percent of all veterans used VA facilities in 1992, a larger percentage of veterans used VA facilities over a 3-year period; the reason for this is that many veterans do not require medical services every year. The officials also said that some veterans who received both VA and non-VA care needed resource-intensive care and had been transferred for that purpose to VA facilities. VA Facility Users Generally Had Lower Incomes Than Users of Non-VA Facilities Using VA patient treatment records and Internal Revenue Service information, we examined the incomes of the 2.2 million veterans who used VA medical facilities in 1991 and found that two-thirds had incomes under $20,000, and about one-third of these had incomes under $5,000.However, VA’s survey of veterans in 1992 showed that only about 32 percent of all veterans had gross family incomes below $20,000. This suggests that most VA facility users had lower incomes than non-VA facility users. VA’s survey also showed that veterans’ use of VA facilities decreased as incomes increased. For example, over 44 percent of veterans with incomes under $10,000 received inpatient care from VA facilities, compared with 2.5 percent of those with incomes over $50,000; and 32 percent of veterans with incomes under $10,000 received outpatient care in VA facilities, compared with 1.7 percent with incomes over $50,000. Moreover, cost was the reason most frequently cited by veterans who participated in VA’s survey for choosing a VA hospital for inpatient care: over 19 percent cited cost as a reason for choosing a VA hospital, while less than 1 percent cited cost as a reason for choosing private or public hospitals. VA Facility Users Were Less Likely to Have Insurance Veterans who used VA facilities were also less likely than users of non-VA facilities to have insurance. VA’s survey of veterans in 1992 showed that about 49 percent of all veterans had private insurance alone, 12 percent had public insurance alone, 29 percent had both, and 9 percent had no insurance. The survey also showed that the availability of insurance increased as income increased. For example, about 27 percent of veterans with income under $10,000 had no insurance, compared with 1.3 percent with income over $50,000. Conversely, about 14 percent of veterans with income under $10,000 had private insurance, compared with over 76 percent with income over $50,000. Veterans With Service-Connected Disabilities Were More Likely to Use VA Facilities Many veterans who used VA facilities had service-connected disabilities. In 1994, we reported that 1 million of the 2.2 million veterans who received care in VA facilities in 1991 had service-connected disabilities. In addition, VA’s survey of veterans in 1992 showed that veterans with service-connected disabilities were more likely than those without them to use VA facilities. Almost 72 percent of the veterans who reported they had a service-connected disability used medical facilities, compared with 53 percent who did not have such disabilities. About 24 percent of veterans with service-connected disabilities received inpatient care exclusively in VA facilities, compared with less than 7 percent who did not have such disabilities. Similarly, about 16 percent of veterans with service-connected disabilities received outpatient care exclusively in VA, compared with slightly over 3 percent who did not have such disabilities. VA Facility Users Often Traveled Long Distances Veterans’ use of VA facilities was influenced by the distances they had to travel to the facilities. Our analysis of 1990 census data showed that about 50 percent of all veterans lived over 25 miles from a VA hospital, including 6 percent who lived over 100 miles away, and 34 percent lived over 25 miles from a VA clinic. Many of those veterans traveled long distances to use VA facilities. For example, 44 percent of VA facility users lived over 25 miles from VA hospitals providing acute medical and surgical care, and 32 percent lived over 25 miles from outpatient clinics that provided such services. Living closer to a VA facility significantly increases the likelihood that a veteran will use VA health care and VA officials told us that some veterans move to be closer to VA medical facilities. For example, about 11 percent of all veterans lived within 5 miles of a VA hospital, and they accounted for 22 percent of the facility users. Similarly, 17 percent of veterans lived within 5 miles of a VA outpatient clinic and accounted for 26 percent of the clinic users. The likelihood and frequency of VA use decline significantly among veterans living more than 5 miles away. Veterans with service-connected disabilities and low-income veterans, however, are less sensitive to distance. VA Medical Facilities Are Less Accessible Than Private Facilities VA medical facilities are located throughout the country and are outnumbered by private-sector facilities. Consequently, private-sector health care is usually more convenient to veterans than VA health care. In some urban areas, for example, VA operates one or two hospitals, while the private sector may have a dozen or more hospitals and hundreds of locations that provide primary and specialty care. While private-sector hospital and outpatient providers are less plentiful in rural areas than in urban areas, they still generally outnumber VA providers. VA Health Care Facilities Are Scattered VA hospital and outpatient clinics are often located hundreds of miles from each other, as shown in figure 1. Some areas of the United States have more extensive VA medical coverage than others. Of VA’s 158 medical centers, 124, or 78 percent, are located in urban areas and 33 are in rural areas. Similarly, of VA’s 187 freestanding outpatient clinics, 123, or almost 66 percent, are located in urban areas and 58 are in rural areas. VA has no medical facilities in 147, or about 46 percent, of the country’s 323 urban areas. Private-sector medical facilities also significantly outnumber VA facilities. For example, in contrast to VA’s 173 hospitals, there are over 6,000 public and private hospitals nationwide. Moreover, private-sector health care programs generally target specific geographic markets and place a priority on developing extensive networks of providers. They typically strive to provide primary care within a few miles or minutes of their enrollees in urban markets and within a reasonable distance or time, albeit somewhat longer and farther, in rural areas. Further, while they realize that enrollees are willing to travel longer distances for specialty care, they also realize that such services must be “convenient” to attract enrollees and remain competitive with other private programs. Comparison of Veterans’ Access to VA and Private Facilities in Selected Markets Veterans generally have less access to VA medical facilities than to private facilities, as the following market examples show. Nevertheless, VA officials said that veterans often have better access through VA facilities than through private facilities to such specialty services as mental health care, rehabilitation for the blind, and post-traumatic stress disorder care. An Urban Area With a VA Medical Center Veterans living in urban areas with one or more VA medical centers, such as Chicago, Illinois, may not have to travel long distances for care in VA facilities but may have to endure long travel times. Moreover, private facilities are generally more accessible. VA operates four medical centers in the Chicago primary metropolitan statistical area, which encompasses nine counties with almost 700,000 veterans. Together, the four medical centers provide services ranging from primary care to highly specialized services, such as psychiatric inpatient care and treatment for spinal cord injuries. The centers provide 2,600 acute-, psychiatric-, and extended-care beds. In 1993, almost 17,000 veterans in the Chicago metropolitan area received VA inpatient services, and almost 70,000 received VA outpatient services. While over 77 percent of the veterans in the Chicago metropolitan area live within 20 miles of a medical center, traffic congestion makes these centers difficult and time-consuming to reach. When public transportation is used, travel times may exceed 1-1/2 hours. Private facilities are often more convenient. Over 100 hospitals and thousands of primary care and specialist physicians are located in the Chicago primary metropolitan statistical area. In addition, insurance companies and managed care programs have formed networks of hospitals and physicians to offer enrollees a wide range of services located near their homes. Patients enrolled in one of Aetna’s managed care plans, for example, have a choice of 45 hospitals and more than 450 sites where they can obtain primary care within the Chicago metropolitan area. (See fig. 2.) An executive from another major managed care plan serving the same area told us that the plan’s goal is to provide two primary care physicians within 5 miles of every enrollee. Veterans living in urban areas with only a freestanding VA outpatient clinic, such as Rockford, Illinois, often travel long distances to other VA facilities to obtain needed inpatient and specialty care. Such care is often available from nearby private providers. VA operates one outpatient clinic in the Rockford metropolitan statistical area, which encompasses three counties with about 40,000 veterans. The VA clinic provides a broad range of primary care and some specialty services. In 1993, about 400 veterans in the Rockford metropolitan area received VA inpatient services, and about 2,200 received VA outpatient services. While almost 74 percent of these veterans lived within 10 miles of the clinic, they had to travel about 70 miles to obtain inpatient care or outpatient specialty services not available at the Rockford clinic. The nearest VA medical centers are in Madison, Wisconsin, and North Chicago, Illinois. According to local health care officials, private-sector care is generally available within minutes of most of the Rockford population. Rockford has three general medical and surgical hospitals that, together, have almost 1,000 hospital beds. Each has developed a network of providers. For example, the SwedishAmerican Health Alliance System includes 3 hospitals and 22 primary care sites in the Rockford metropolitan area and operates or is affiliated with many retail pharmacies, acute-care centers, and home-care and long-term care facilities in the Rockford area. (See fig. 3.) Veterans living in urban areas with no VA medical facilities, such as Salem, Oregon, often travel long distances to obtain VA health care. Private providers are often nearby. VA operates no hospital or outpatient clinic in the Salem primary metropolitan statistical area, which encompasses two counties with about 46,000 veterans. The Salem metropolitan area, situated in VA’s Portland, Oregon, service area, covers 27 counties in northwest Oregon and southwest Washington. In 1993, about 600 veterans from the Salem metropolitan area received VA inpatient services, and about 2,700 received VA outpatient services. These veterans had to travel from 20 to over 70 miles to get to the Portland facility. Many private medical facilities are located in the Salem metropolitan area, typically, according to officials of these facilities, within 20 minutes of Salem residents. One of Oregon’s largest hospitals—a 454-bed facility that serves as a referral point for smaller hospitals in surrounding communities—is located within the Salem city limits, and there are three smaller hospitals in the metropolitan area as well. Physicians are widely distributed and within easy reach of most residents. In addition, the area has several private-sector managed care plans that have developed networks of providers to make care convenient for their enrollees. ODS Health Plans, for example, offers its enrollees a choice of 4 hospitals and 56 primary care sites in Salem. (See fig. 4.) A Rural Area With a VA Medical Center Veterans living in rural areas served by a single VA medical center, such as central Georgia, often travel long distances to obtain care in VA facilities because such facilities often serve large geographic areas. Private facilities scattered throughout the rural areas may be more convenient. VA operates a medical center in Dublin, Georgia, a rural community about 135 miles southeast of Atlanta. The medical center is the only VA medical facility in a 52-county area with about 130,000 veterans. The facility provides primary and secondary medical, surgical, and psychiatric care, as well as extended-care services. In 1993, about 3,700 veterans in the Dublin service area received VA inpatient services, and about 14,000 received VA outpatient services. The veterans came from as far away as 70 miles to the north, 150 miles to the east, 100 miles to the south, and 140 miles to the west. Moreover, veterans needing highly specialized care are referred to the VA medical center in Augusta, Georgia, about a 2-1/2-hour drive from Dublin. Private medical facilities are also scattered throughout the Dublin VA medical center service area and are more accessible to veterans, with the exception of veterans living in Dublin, than is VA’s medical center. In 1993, there were more than 40 medical and surgical hospitals and almost 1,400 physicians in the area. In addition, Blue Cross/Blue Shield of Georgia, which operates a preferred provider network throughout the state, offers its enrollees a choice of 10 hospitals and 79 primary care sites in the 52-county area. (See fig. 5.) Options VA Might Explore for Improving Accessibility of VA Health Care In February 1995, VA issued an interim policy that encouraged its field offices to employ all means at their disposal, consistent with funding availability and federal law, to improve veterans’ access to VA health care. VA also authorized its offices to establish VA-operated clinics as well as VA-funded or VA-reimbursed private clinics, group practices, or individual practitioners. The directors of VA’s newly created 22 networks are exploring ways to better integrate service delivery. In developing plans for improving veterans’ access to VA health care, the directors face two basic decisions: where to locate new facilities and how to operate them. Each decision involves the assessment of a variety of key factors. Target Population Is Key Factor in Deciding Where to Locate New Facilities A key factor that could influence VA’s decisions about where to locate new medical facilities is the population to be targeted. VA has several options: (1) improve convenience for current users, (2) attract new users by improving access for all veterans, or (3) improve access for specific groups of veterans, such as those in selected eligibility categories or those residing in medically underserved areas. Improving Access for Current Users In improving convenience for existing users by making VA medical facilities more accessible, VA could decide, for example, to help veterans traveling great distances or times to receive care or to help the largest number of veterans, without regard to travel distances or times. To improve convenience for current users with long travel distances or times, VA would have to establish criteria for determining reasonable travel distances or times and then assess the number of current users residing in areas beyond those distances or times. These criteria could vary depending on whether the area targeted is urban or rural. Facilities could be located so they could provide the maximum number of existing users with improved access, as illustrated in the following examples. In a densely populated urban area like Chicago, Illinois, one-quarter of a medical center’s current users might live 10 to 20 miles from the facility. However, traffic congestion and transportation barriers might cause these veterans to travel an hour or more one way to obtain care, especially if they needed to use public transportation. A medical center could decide to make outpatient care available within 30 minutes’ average travel time. That is, the center could establish facilities nearer to large numbers of current users who now have to travel significantly longer than 30 minutes. In a largely rural area, such as the one served by the VA medical center in Dublin, Georgia, many veterans must travel extensive distances to obtain VA care. In fiscal year 1994, over 23 percent of the outpatient visits at Dublin were by veterans living in or around Macon and Albany, Georgia, which are located approximately 50 and 100 miles away, or about 1 to 2 hours, respectively, from the medical center. A rural VA medical center like Dublin could significantly reduce the time veterans needed to travel for outpatient care by adding access points in key population centers, such as Macon or Albany. To establish delivery sites that improve access for the largest number of current users, VA could identify large concentrations of veterans currently served. These concentrations would be likely to be within close proximity of existing medical centers. For example, a medical center in an urban area could elect to establish a nearby clinic because over one-third of its current users resided in that area. Providing a new facility in a nearby location could help alleviate overcrowding at the medical center. Attracting New Users Medical facilities could also be located to attract new users. VA could identify areas that have a large number of veterans who do not now receive VA care. The target population could be based on the total number of veterans in an area, as shown in the following examples. Officials from the Dublin, Georgia, VA medical center told us their goal was to improve the accessibility of VA health care services for new and current users. Consequently, Dublin targeted population centers in its service area, such as Macon and Albany, as possible locations for new outpatient clinics. Portland, Oregon, VA medical center officials told us their plans were designed to retain existing users and attract new veterans. As a result, Portland officials planned on adding access points in major urban areas of their service area, such as Salem, from which they would be likely to draw the most veterans. VA also could target a population on the basis of a predetermined percentage of nonusers, regardless of how many veterans resided in the area. For example, a VA medical center could choose to establish a delivery site in a remote area where less than a prescribed percentage of veterans, such as 5 percent, obtained care at the medical center. By providing an access point closer to where the veterans lived, the medical center could encourage more veterans to use its health care services. Improving Access for Selected Eligibility or Other Groups VA’s assessment of areas in which to locate new medical facilities could also consider differences in veterans’ eligibility status and other factors. In general, veterans with service-connected disabilities, low-income veterans, and certain other “mandatory care” veterans, such as World War I veterans and veterans exposed to toxic substances, have the highest priority for receiving VA health care. High-income veterans without service-connected disabilities have the lowest priority. VA could improve access for one or more of the high-priority groups. For example, a medical center could target veterans with service-connected disabilities. The center could establish medical facilities in areas with high concentrations of such veterans, providing more convenient access. Moreover, the size of the facility could be based on the estimated number of such veterans residing in the targeted area. VA medical centers also could choose to provide better health care access for veterans living in areas where community providers are unavailable. For example, although many veterans have public or private health insurance, those that live in underserved areas may not be able to obtain care because of shortages of private providers. To improve access for such veterans, a VA medical center could identify veterans living in areas designated Health Professional Shortage Areas and establish a medical facility in the area. Resources, Market Conditions, and Private Provider Willingness to Contract With VA Are Key Factors in Deciding How to Deliver Care VA has identified two alternative approaches for expanding access. First, it could establish VA-operated facilities, using either VA-owned or VA-leased space. Second, it could contract with non-VA providers to provide care.VA’s decisions in this regard are likely to be primarily influenced by three factors—resources, market conditions, and the willingness of private providers to contract with VA. Resources The availability of resources is a key factor affecting VA’s decisions whether to operate new VA medical facilities or contract for care. In general, VA could assess the cost implications on a short- and long-term basis, taking into account start-up and operating costs. VA could also consider the potential for fraud, waste, and abuse. VA-operated facilities typically require a substantial capital investment, which increases VA’s costs over the short term. For example, VA would have to build, purchase, or lease a facility. It would also have to staff and equip the facility. VA-operated medical facilities could be more costly to operate than contracting for care. Although performing valid cost comparisons is complicated, one VA medical center concluded that certain types of health care could be more expensive when delivered in a VA medical center. The medical center contracted with a community provider to furnish certain health care services to veterans at a capitation rate of $178. A medical center official estimated that the cost to provide the same services in the VA facility would be substantially more. Similarly, in their Fiscal Year 1995 Independent Budget for the Department of Veterans Affairs, veterans’ service organizations estimated that adding 132 VA-operated leased clinics to VA’s direct delivery system over a 4-year period could cost $346 million—$137 million more than the $209 million the veterans’ service organizations estimated it would cost to provide comparable services through contracts with the private sector. VA-operated medical facilities would also be likely to result in less accessibility for veterans than could be achieved through contracting, because of high start-up and operating costs. VA could operate its own facility in an area or, for the same dollar expenditures, could contract for care at multiple locations, significantly enhancing the geographic accessibility of services to veterans living in the area. Managed care plans in the areas we visited typically contracted for care with geographically dispersed networks of physicians rather than operating their own facilities at only a few locations. In Salem, for example, most managed care plans contracted with an independent practice association that represented virtually all physicians practicing in the area. Thus, the plans were able to offer their enrollees numerous locations where they could obtain care. On the positive side, VA-operated facilities could give VA more control over resources, potentially lessening the risk of fraud, waste, and abuse. VA has had problems in administering contracts and sharing agreements. For example, in a 1987 audit of scarce medical specialist contracts, VA’s Inspector General reported that VA medical centers had paid for services they had not received and had not established controls to ensure that contractor performance and billing complied with contract terms. Our July 1992 follow-up to the Inspector General’s report found that VA lacked assurance that these problems were identified and corrected. In addition, contracting has sometimes led to less VA control over the utilization of health care services to veterans because VA has had difficulty controlling practice patterns of private physicians. Chicago VA officials told us this was a major factor in their decision to replace a contract clinic that was reimbursed on a fee-for-service basis with a VA-operated clinic in Rockford, Illinois, in 1994. According to VA officials, reviews of the contract clinic’s medical records indicated that many veterans continued to receive treatment at the clinic after their conditions had stabilized. Moreover, attempts to convince contractor physicians to discharge stable patients were unsuccessful, they said, because VA lacked direct administrative control over the physicians. While this problem could be avoided if VA contracted on a capitation basis, VA officials said that capitation contracts could lead to other problems, such as diminished services. Market Conditions The stability of market conditions and the competitive environment in which VA operates could affect its health care delivery decisions. In general, VA would need to ensure that its decisions included sufficient flexibility, since market conditions vary over time. Also, VA would need to ensure that its decisions considered the availability of existing providers in a particular market. Operating its own facilities could limit VA’s ability to expand or relocate operations promptly in response to changing market conditions. Expanding or relocating services could be more time consuming and difficult than modifying or renegotiating a contractual arrangement with a private provider because clinics would need to be constructed or leased, equipped, and staffed. Moreover, VA may be at a disadvantage in recruiting primary care physicians to operate its facilities. Only about 20 percent of VA’s physicians are primary care physicians, while about 60 percent of managed care plans’ physicians are typically primary care physicians. Private-sector officials we spoke with believed that VA would have difficulty increasing the number of primary care physicians to staff its facilities because of the shortage of such physicians and because VA currently is unable to match the salaries and benefits offered by managed care plans. Further, VA-operated facilities might duplicate private-sector services in areas where the private sector has sufficient capacity, requiring VA to compete for existing patients. Several private-sector officials we spoke with questioned the need to open new VA outpatient facilities, especially in urban areas where the private sector already provides sufficient access. In these cases, contracting with existing providers might be a more viable option for improving access. Conversely, VA-operated facilities might be a more viable option in areas that are underserved by the private sector. Some rural and inner-city areas, for example, suffer from a shortage of physicians. In other areas, physicians may have full practices and, as a result, be unlikely to take on additional patients. Thus, if VA wanted to improve access for veterans in such areas it might be able to do so only by establishing its own facility. Willingness of Private Providers to Contract With VA Finally, even if VA chose to do so, it could have difficulty contracting for veterans’ health care. Several private-sector officials indicated that providers would be cautious about entering into capitation arrangements with VA because the risk of financial loss would be too high. They said that the VA patient population is perceived as being sicker and, therefore, more expensive to care for than the general population. At the same time, they questioned the willingness of VA to provide an adequate level of reimbursement, particularly under a capitation arrangement. A medical center in Chicago recently encountered such an obstacle. The VA medical center proposed establishing a VA-operated outpatient clinic in its service area after failing to interest three local health maintenance organizations (HMO) in providing services on a capitation basis. The HMOs were not interested because they believed the medical histories of the medical center’s patients represented too high an underwriting risk. The HMOs, according to medical center officials, were unwilling to develop a rate for patients outside their normal risk definition. In addition, officials at two managed care plans expressed concern about contracting with VA because doing so could adversely affect veteran patients’ care. Non-VA physicians who lacked admitting rights in VA hospitals would be required to relinquish control of patients needing inpatient care to VA physicians. Officials at one managed care plan said that their physicians would not be likely to be receptive to such an arrangement because they would lose the ability to ensure continuity of care for their patients. Similarly, officials from another plan said that contracting only for primary care would result in veterans’ seeing physicians from two different systems—their plan and VA. This, they said, would make tracking their patients difficult. Finally, some private-sector officials believed that many providers would be reluctant to contract with VA because of their unwillingness to deal with excessive government contracting requirements and regulations. Conclusions Veterans’ access to VA health care could improve significantly if medical centers employed all means at their disposal to expand access, as VA’s February 1995 interim policy encourages centers to do. While medical centers have numerous options in locating new facilities, selecting a target population, such as current or new users, poses a difficult policy choice. Also, medical centers’ decisions on how to operate new facilities—directly or by contracting—require the evaluation of several key factors on a facility-specific basis to ensure care is delivered in the most appropriate manner. Overall, medical centers will be likely to use a variety of options tailored specifically to the variabilities of local conditions. Agency Comments and Our Evaluation We obtained comments on a draft of this report from VA officials, including the Deputy Secretary for Health. The officials agreed with the basic concepts in our report. They cautioned, however, that evaluating veterans’ access to health care and improving access may be more complex, in reality, than the report appears to suggest. For example, they said that the availability of a large number of private-sector medical facilities does not ensure that veterans can receive needed care from such facilities, noting that veterans often need such special services as psychiatric care and rehabilitation for blindness. We revised the report to show that we focused on veterans’ access to standard health care benefits. VA officials also suggested some technical changes, primarily for clarification. We incorporated the suggestions as appropriate. Copies of this letter are being sent to the Chairmen and Ranking Minority Members of the House and Senate Committees on Veterans’ Affairs and the Secretary of Veterans Affairs. Copies will be made available to others upon request. Please call me at (202) 512-7101 if you have any questions or need additional assistance. Other GAO contacts and contributors to this report are listed in appendix II. Scope and Methodology To obtain information on users of VA medical facilities, we reviewed VA’s studies of the status of veterans in 1987 and 1992 and previous GAO VA health care reports. To compare the accessibility of VA and private-sector facilities, we categorized VA’s existing facilities into four general markets: urban and rural areas with medical centers and urban and rural areas with freestanding outpatient clinics. We also identified urban areas where VA operates no medical facilities. We visited the following locations: Chicago, Illinois—an urban area where VA operates a medical center, Rockford, Illinois—an urban area where VA operates a freestanding Salem, Oregon—an urban area where VA has no medical facilities, and Dublin, Georgia—a rural area where VA operates a medical center. For purposes of this report, we considered metropolitan statistical areas and primary metropolitan statistical areas as urban areas. The Office of Management and Budget defines a metropolitan statistical area as either (1) an area that includes at least one city with a population of at least 50,000 or (2) a Census Bureau-defined urbanized area of at least 50,000 inhabitants and a total metropolitan population of 100,000 (75,000 in New England). Metropolitan statistical areas with populations of 1 million or more are called consolidated metropolitan statistical areas if separate component areas, or primary metropolitan statistical areas, can be identified in the areas. We used the primary metropolitan statistical area rather than the consolidated metropolitan statistical area to determine whether VA had medical facilities in urban areas. For example, both Portland and Salem, Oregon, are part of the same consolidated metropolitan statistical area but are separate primary metropolitan statistical areas. VA has a medical center located in Portland, and we classified the Portland primary metropolitan statistical area as an urban area with a VA medical center. The Salem primary metropolitan statistical area has no VA facility, and we classified it as an urban area with no VA medical facilities. The four study locations were selected as a nonrandom judgmental sample representing VA’s typical market categories and a diversity of geographic areas. In Chicago and Dublin, we met with local VA officials to discuss the accessibility of VA’s health care facilities and options for improving access. For Rockford, we met with local and North Chicago VA Medical Center (the parent facility) officials. For Salem, we met with officials from the VA medical center in Portland, Oregon, the closest VA medical facility. In each location, we also met with private-sector hospital and managed care plan officials to obtain information about the local health care market and the accessibility of their health care services. In each market area, we used the provider directory of one managed care plan to determine the number of primary care sites and hospitals available to the plan’s enrollees. A provider directory is a listing of the hospitals, physicians, and other health care providers affiliated with the managed care plan. We graphically depicted these facilities and VA’s facilities on maps of the four locations. The list of organizations contacted follows. Chicago, Illinois Private Sector Rockford, Illinois Salem, Oregon Private Sector Dublin, Georgia Private Sector Fairview Park Hospital Blue Cross/Blue Shield of Georgia (Macon, Georgia) To determine how far veterans in our study areas lived from a VA medical facility, we computed the distance from zip codes where the veterans lived to the closest VA medical facility in the area (that is, the Chicago primary metropolitan statistical area; the Rockford metropolitan statistical area; the Salem primary metropolitan statistical area; and Dublin service areas, as defined by VA). If VA had no facilities in the area, we computed the distance to the nearest VA facility. For example, in the Chicago, Illinois, primary metropolitan statistical area, we computed the distance from the zip codes where veterans lived to the closest of VA’s four medical facilities in the area; in the Salem, Oregon, area, which had no VA facility, we computed the distance from where the veterans lived to the VA facility in Portland, Oregon, the VA facility closest to Salem. We also used these zip codes to determine the number of veterans living and receiving services in the study areas. We applied 1990 U.S. census data to these zip codes to determine the number of veterans living in each study area. We applied data from VA’s fiscal year 1993 Outpatient and Patient Treatment databases to these zip codes to determine the number of veterans who received VA outpatient and inpatient services in each study area. To identify the factors VA considers in deciding where to locate new medical facilities and whether to add new VA-operated facilities or contract with private providers, we reviewed VA policy directives and other guidance and interviewed VA central office and selected medical center officials. We also reviewed prior GAO reports and other studies. In addition, we met with VA Office of General Counsel officials to discuss VA’s contracting authority. We also discussed contracting and expanding VA’s direct delivery system with officials from the private-sector organizations we visited. GAO Contacts and Staff Acknowledgments GAO Contacts Staff Acknowledgments In addition to those named above, the following individuals made important contributions to this report: Abigail Ohl provided assistance with data gathering and analysis, and Ann McDermott, Angela Pun, and Joan Vogel prepared the graphics. The first copy of each GAO report and testimony is free. Additional copies are $2 each. 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Pursuant to a congressional request, GAO provided information on veterans' use of Department of Veterans Affairs' (VA) medical facilities, focusing on: (1) users' characteristics; (2) the geographic accessibility of VA and private medical facilities that provide standard benefits; and (3) options to improve accessibility of VA health care. GAO found that: (1) in the early 1990s, over 80 percent of veterans who received health care services obtained them from non-VA sources; (2) veterans who used VA medical facilities generally had lower incomes and were less likely to have private health insurance than veterans who obtained health care from non-VA facilities: (3) veterans with service-connected disabilities utilized VA facilities more often than other veterans; (4) about 50 percent of all veterans lived over 25 miles from a VA facility and 11 percent of veterans lived within 5 miles of a VA hospital; (5) although VA hospitals and outpatient clinics were geographically less accessible to veterans than private medical facilities, veterans had better access to certain specialty services through VA facilities; (6) options to improve veterans' access to VA health care include determining whether to improve access for current users, all veterans, or selected veterans groups, and comparing the costs of VA-provided services and contractor-provided services; and (7) although VA facilities are more costly to operate, they lessen the chances of program abuse by giving VA more control over resources.

Background DHS began testing next-generation RPMs with a preliminary small-scale study performed in July 2004 by DOE’s Pacific Northwest National Laboratory (PNNL). (See fig. 3.) Specifically, PNNL performed small- scale, side-by-side comparisons of next-generation RPMs and the RPMs used by CBP. This study found that in some situations, the performance of the next-generation RPMs was better than that of CBP’s RPMs, and that in other situations, the performance of the two was equal. In a follow- up, small-scale study conducted for DHS in July 2005, PNNL found that the next-generation RPMs performed no better than CBP’s currently deployed RPMs but did produce fewer alarms for benign materials. In October 2005, DNDO conducted a number of tests on next-generation RPMs that DHS had commissioned from different manufacturers and used the test results to help evaluate proposals for the ASP program. In July 2006, DNDO awarded contracts for development and production of ASPs. Among other things, according to DNDO officials, the design specifications for ASP stated that it should operate on trucks traveling at 5 miles per hour during primary screening and 2 miles per hour during secondary screening. DNDO began testing these ASPs at DOE’s Nevada National Security Site in February 2007. As we have previously reported, we identified a number of weaknesses in the methods used for these tests that impaired the significance and validity of the test results. Concerned about the performance and cost of ASP, Congress required the Secretary of Homeland Security to certify that ASP would provide a “significant increase in operational effectiveness” before DNDO obligated funds for full-scale procurement of ASPs. In response, DNDO, CBP, and DHS jointly issued criteria in July 2008 for determining whether ASP provided a significant increase in operational effectiveness compared with existing equipment. The criteria generally compare ASP with the RPMs used by CBP under CBP’s standard operating procedure. Specifically, as shown in table 1, there were four criteria for primary screening and two criteria for secondary screening. In addition to these overarching criteria, each phase of testing also had criteria that needed to be met to complete that phase. The final ASP testing campaign began in July 2008 and was concluded in November 2010. DNDO started the campaign with performance testing at DOE’s Nevada National Security Site. The performance tests determined the probability of detection and identification of radiation sources, including special nuclear material that could be used to make a nuclear weapon. CBP then began field validation testing in 2009. Field validation tests are the first step in determining the suitability of fully operational equipment in the actual environment where the equipment is intended to be used. The ASP field validation tests were performed at land border crossings in Detroit, Michigan, and Laredo, Texas, and at seaports in Long Beach, California, and in New York City, New York. CBP made three attempts to complete this testing—in January and February 2009, July and August 2009, and October and November 2010. This testing, which we reviewed for this report, evaluated the compatibility of ASP with CBP’s interdiction system on the basis of 10 additional criteria CBP had specified for completion of this phase of testing. Among other things, these criteria included whether, under normal field operating conditions, ASP improved detection to the required degree compared with the currently deployed CBP equipment. To pass the field validation testing phase, ASP had to meet all 10 criteria. In addition, DNDO’s ASP program manager specified that ASP could not have any major unresolved issues that might render it ineffective or unsuitable for use by CBP. Test Results Show That ASP Did Not Meet Criteria to Pass Field Validation Testing, Leading DHS to Cancel the Program Because of unsatisfactory test results, ASP did not pass field validation testing, which led DHS to cancel the program. Specifically, in CBP’s first and second attempts to pass field validation testing in 2009, ASP did not meet 1 of the 4 criteria for demonstrating a significant increase in operational effectiveness during primary screening–that is, it did not refer at least 80 percent fewer trucks for secondary screening than CBP’s currently deployed RPMs. When CBP began the first field validation test in late January 2009, CBP found ASP produced a higher number of referrals to secondary screening than CBP’s currently deployed RPMs. CBP suspended the test about 2 weeks later in mid-February; CBP officials reported that the problem with referrals required significant corrective actions before testing could resume. DNDO, working with Johns Hopkins University’s Applied Physics Laboratory, determined that the problem could be addressed by revising ASP’s software to raise the thresholds for triggering alarms. CBP conducted a second field validation test of ASP in July and August 2009 using the revised ASP software. CBP and DNDO documents indicate that, with the revised software, ASP was able to reduce referrals to secondary screening by about 70 percent but not by the 80 percent required to demonstrate a significant increase in operational effectiveness. Significantly, according to these documents, the majority of the ASP referrals to secondary screening were for alarms that falsely indicated the presence of special nuclear material that could be used to make a nuclear weapon. CBP officials told us these types of false alarms were very disruptive in a port environment because they caused CBP officers to take enhanced security precautions—specifically, CBP officers had to conduct a thorough inspection to ensure no special nuclear material was present before permitting the cargo to enter the country. Moreover, repeated false alarms for such nuclear materials could cause CBP officers to be skeptical about future alarms. In the course of the second field validation test, ASP also experienced a “critical failure,” which caused it to shut down. Importantly, during this critical failure, ASP did not emit a signal to alert the CBP officer that it was no longer screening cargo. Had this failure not occurred in a controlled testing environment, in which CBP was using its RPMs in tandem with ASP, the CBP officer would have permitted cargo to enter the country unscreened for radiological material. Testing is performed so that issues like this can be discovered and fixed prior to full-scale production and deployment. Following the second field validation test, DNDO’s Acting Director stated that the ASP program would be scaled back to secondary screening only. According to the Acting Director, DNDO’s decision was based on ASP’s performance and cost. Specifically, the Acting Director stated that DHS decided to not pursue ASP for primary screening because ASP did not meet DHS’s criteria for a significant increase in operational effectiveness. However, the Acting Director stated that results to date had shown that ASP met secondary screening criteria by wide margins. The Acting Director also stated that the cost to replace current RPMs with ASP for secondary screening was relatively low—approximately $350 million—compared with the original total program cost of $2 billion to $3 billion to use ASP for primary and secondary screening. This is because the original program called for many more ASPs to be deployed in CBP primary screening than secondary screening. In November 2010, ASP could not pass the third and final field validation test for use in secondary screening because ASP did not meet 6 of the 10 criteria needed to complete the field validation testing phase, according to our review of CBP test documents. According to these documents, 2 of the 6 criteria that ASP did not meet involved issues that would significantly affect operations unless they could be mitigated or resolved. ASP did not meet these criteria in part because of its inability to turn on at the beginning of each day and to continue operating long enough to complete a full day of testing. In addition, when ASP was operating, it produced an excessive number of alarms that incorrectly indicated naturally occurring radioactive material in the cargo might be masking special nuclear material. In some cases, testing of the ASP had to be suspended because the high number of these alarms was backing up traffic for secondary screening, delaying the flow of commerce. According to the CBP documents, the remaining 4 of the 6 criteria that ASP did not meet involved issues that could affect or delay port operations, although not as significantly. For example, ASP did not meet one of these criteria because of difficulty in integrating ASP into a CBP information network. In addition to the 6 criteria that the ASP did not meet, DNDO test documents identified several major unresolved issues that would have needed to be resolved for successful completion of field validation testing. In explaining these issues, DNDO and CBP officials told us that, for example, at certain times of the day, direct sunlight impaired the ability of the ASP to operate properly. See table 2 for a summary of the results for the three field validation tests. In addition to the issues identified during testing, our review identified analytical weaknesses before and after the third field validation test. For example, DNDO was inconsistent in its analysis of how to properly set up the ASP for secondary screening. Specifically, ASPs have separate settings (modes) for primary and secondary screening, and before the third field validation test, DNDO performed an analysis that indicated ASP would perform best during secondary screening if the machines were set in primary screening mode. However, after the third field validation test, DNDO officials analyzed the test results and concluded that ASP would have performed better for secondary screening had the machines been set in secondary screening mode. Furthermore, the analytical basis for a key decision regarding the ASP program is unclear. Specifically, DNDO could not provide us with any supporting analysis on a principal factor that led to the decision to cancel the program. According to DNDO officials, for ASP to work in secondary screening, truck speeds would need to average 2 miles per hour, as indicated in the design specifications. On the basis of these specifications, the ASP Governance Board concluded in February 2011 that ASP was not operationally suitable for secondary screening and should not be deployed because, according to CBP officials, it was not possible to control truck speed to an average of 2 miles per hour. However, when we asked DNDO officials for the data or analysis supporting this conclusion, these officials could not provide such support. Moreover, during congressional testimony in July 2012, the Acting Director of DNDO said that it is possible to control truck speed to 2 miles per hour at state-operated truck weigh stations. Accordingly, it is unclear why such speeds cannot be achieved at CBP land border crossings and seaports but can be achieved at truck weigh stations. Lessons Learned Reviews Improve Future Acquisition Efforts, but DHS Does Not Have Processes Ensuring Such Reviews Conducting lessons learned reviews when programs are cancelled benefits organizations by identifying things that worked well and did not work well in order to improve future acquisitions programs, according to experts we consulted; however, DHS does not have processes in place to ensure such reviews are conducted and reports documenting the results of the review are disseminated. To determine the key benefits of conducting lessons learned reviews, we consulted seven experts in large- scale engineering and acquisitions programs who were identified at our request by the National Academies. (See app. I for a list of the experts we interviewed.) When we asked these experts for their views on lessons learned reviews and reports for cancelled acquisition programs, they generally agreed on the following observations: Lessons learned reviews help to determine the reasons why programs were cancelled including problems with the technology, management, or setting requirements. By identifying problematic practices and causes for program failure, lessons learned reports allow an organization to improve future efforts. Lessons learned reports should be prepared promptly because otherwise, knowledgeable personnel may not be available to contribute to the reports, important details may not be recalled accurately, and dissemination of lessons learned will be delayed. Lessons learned reports should not be optional for an organization. A requirement for lessons learned reports should be institutionalized— lessons learned reports should be required for programs administered by the organization rather than being an ad hoc requirement. However, an appropriate acquisitions executive should have the authority to tailor or waive the lessons learned report based on factors such as the size or cost of a program, its perceived importance and effects, or the perceived causes for failure. Lessons learned reports must be submitted to an appropriate acquisitions executive to be useful. The acquisitions executive should disseminate the lessons learned reports to other appropriate acquisition officials. Lessons learned reports should be disseminated widely; however, they should be edited to preserve the lessons learned while minimizing potential damage to the reputations of people and organizations that were involved with the program. DHS interim acquisition guidance, issued in 2010, also recognizes the benefits of timely lessons learned reviews for cancelled programs, although as guidance it does not constitute a requirement. Similar to the views of the experts identified by the National Academies, the DHS acquisition guidance states that (1) the objective of the reviews is to share lessons learned throughout the department to increase the probability of success for future acquisition programs and (2) the reviews are to take place immediately after programs are cancelled. In addition, an official from the DHS’s Office of Program Accountability and Risk Management (PARM)—DHS’s policy office for acquisitions—told us that it is important to conduct these reviews immediately so that key people remain available and do not forget the factors that contributed to programs being cancelled. Under DHS acquisition guidance, upon completion of the lessons learned review, a report documenting the lessons learned is to be submitted to PARM. DHS acquisition guidance on lessons learned provides general direction on what is to happen when programs are cancelled, but it does not specify processes to follow. PARM officials stated that there were no documented processes in place for (1) conducting timely lessons learned reviews, (2) preparing lessons learned reports, or (3) disseminating lessons learned reports throughout the department. Under the federal standards of internal control, agencies are to clearly document internal controls (i.e., in management directives, administrative policies, or operating manuals), and this documentation should be readily available for examination. PARM officials told us they generally rely on DHS component agencies, such as DNDO, to self-monitor many aspects of their programs including conducting lessons learned reviews, preparing lessons learned reports, and submitting lessons learned reports. In the case of the ASP program, a lessons learned review was conducted, and a lessons learned report was submitted to PARM and disseminated within CBP and DNDO in November 2012 at the explicit direction of DHS’s Under Secretary for Management. The lessons learned report states that the program was cancelled by the Secretary in October 2011. However, before the Under Secretary’s directive, there was confusion about whether such a review should be conducted for cancelled programs, as well as uncertainty about whether the program had been cancelled. DNDO officials told us in March 2012 that, even though they considered the program to have been cancelled by the Secretary in October 2011, they did not intend to conduct a lessons learned review because such reviews were not needed for cancelled programs. Furthermore, there was uncertainty between DNDO and PARM about whether and when the program had been cancelled. In this regard, while DNDO relied on the Secretary’s October 2011 letter, PARM officials told us that the program was not cancelled and would not be cancelled until DNDO and CBP completed certain additional actions such as gathering data to support a future acquisition program. These actions were started but not completed, however, the uncertainty over the program’s status was eventually resolved in July 2012 with a memorandum from the Under Secretary for Management which stated that, in accordance with the Secretary’s October 2011 letter, the program was considered cancelled. In discussing this with DNDO, and DHS officials, they acknowledged that the DHS acquisition guidance is confusing on when programs are considered cancelled and when to begin conducting a lessons learned review. DHS officials stated that they are in the process of revising the guidance to provide greater clarity on these issues. To determine whether the confusion and uncertainty that affected the ASP program were unique to that program, we asked PARM officials to provide us with examples of previous lessons learned reports from any cancelled programs across DHS, including several programs cancelled in 2011 that we had previously reported upon. The PARM officials told us that they did not have any lessons learned reports for these programs or any others in the department. Furthermore, there was confusion within the department about the need to disseminate lessons learned reports. Before the Under Secretary’s memorandum of July 2012 directing DNDO and CBP to prepare and disseminate an ASP lessons learned report, PARM officials had told us there was no requirement to disseminate lessons learned outside individual component agencies. Subsequent to the memorandum, PARM officials told us that they are developing plans to disseminate lessons learned reports through department-wide Centers of Excellence. The lessons that can be learned from such reviews and reports can be extensive and informative. In the case of the ASP program, DNDO and CBP’s lessons learned report identified 32 lessons learned in the following six categories: documentation of planning; structuring and staffing of the program office; coordination between stakeholders and end users regarding technical and operational requirements, as well as costs. (See app. II for a copy of the lessons learned report.) For example, concerning acquisition strategy, the lessons learned report states the government should consider a “commercial first” approach— meaning consider whether commercially available equipment can meet programmatic needs before developing new technologies. Such an approach can reduce costs and risks to the program. Another lesson learned from the ASP program is that the acquisition officials and the end users must work closely together to ensure the needed capability meets operational requirements. An additional lesson learned was to manage the schedule of the acquisition program by events—not the calendar. In other words, the program should not proceed to the next major phase until all the criteria are met for completing the current phase. Furthermore, the report stated that acquisition programs should be flexible enough to respond to major issues that may be discovered after program initiation. Specifically, management should take care not to believe in the program so strongly that early signs of trouble are ignored, or cannot be detected and acted upon in a timely manner. At this point, however, PARM has no assurance that that lessons learned reviews have been or will be conducted for other cancelled programs, as called for in DHS acquisition guidance. Until DHS puts processes in place to ensure component agencies conduct lessons learned reviews and prepare lessons learned reports, and PARM implements its plans for disseminating the reports, DHS risks limiting the probability of success for the department’s future acquisition programs. Success in such acquisition programs is important given the scale of DHS’s planned investments, which DHS has estimated to be many billions of dollars during the next few years. DHS Is Part of International Tests of Next-Generation RPMs and Is Working with States to Gather ASP Data DHS is participating in international tests of next-generation RPMs, including commercially available RPMs that have characteristics similar to ASP, and is working with states to gather data using ASPs at five truck weigh stations. For the international tests, DNDO is working with its European Union (EU) counterparts in the Illicit Trafficking Radiation Assessment Program (ITRAP); this program is currently known as ITRAP+10 because it is being revisited about 10 years after testing was originally conducted. According to the test planning documents, the final report is scheduled for issuance in August 2013. The documents further indicate that DNDO has the following objectives for the ITRAP+10 tests: Provide scientific and technical data on radiological and nuclear detection equipment to policy makers. Identify the best technologies based on results from repeatable testing. Promote harmonization of national and international standards and guidelines. Improve international exchange of information. Provide manufacturers with feedback on how well their equipment performed against standards. Promote new research and development efforts. The commercially available next-generation RPMs that DNDO and the EU are testing come from a variety of vendors and are being tested along with several other categories of radiation detection equipment. This testing is being performed to national and international standards for radiation detection set by the American National Standards Institute (ANSI) and the International Electrotechnical Commission (IEC). DNDO officials told us these tests are not part of any planned acquisition. According to the test plan, Oak Ridge National Laboratory (ORNL) will perform ITRAP+10 tests for DNDO on these next-generation RPMs. The primary planning documents for the testing of the next-generation RPMs were submitted by the National Institute of Standards and Technology and were approved by DNDO and the European Commission’s Joint Research Centre. These documents indicate that, in addition to testing to the standards, ORNL will test to determine the outer limits of what the next-generation commercial RPMs can detect. In addition to participating in the ITRAP+10 tests, DNDO is working with state agencies to gather data using five existing ASPs and installed at state-operated truck weigh stations in five states. According to a DNDO official, data collected will include information on the trucks and cargo passing through the ASPs, as well as any radiation detected by ASP. According to a DNDO official, data collected by the five ASPs will be sent to DNDO’s Joint Analysis Center Collaborative Information System, which informs DNDO about nuclear detection and coordinates responses to nuclear detection alarms. This official told us the data will be analyzed to determine the types of cargo transported and any trends that may be apparent. Conclusions To its credit, DHS has cancelled the ASP program, and DNDO conducted a lessons learned review about the cancelled program and prepared a lessons learned report. However, DNDO prepared the lessons learned report and disseminated it 2 years after the final ASP testing, and about a year after the Secretary of Homeland Security notified Congress of her decision to cancel the program. Moreover, the report was not prepared until there was a specific directive from the DHS Under Secretary for Management. For cancelled programs, DHS’s acquisition guidance calls for a lessons learned review immediately after cancellation of a program, preparation of a lessons learned report, and dissemination of such a report. However, the acquisition guidance does not constitute an institutional requirement, which the experts we consulted said it should be. Moreover, DHS does not have documented processes for component agencies to follow in (1) conducting timely lessons learned reviews, (2) preparing lessons learned reports, or (3) disseminating lessons learned reports throughout the department, instead relying on such agencies to self-monitor. The amount of time between the final field validation testing of the ASP, the program’s cancellation, and the conducting of a lessons learned review and dissemination of a lessons learned report suggests that timely identification of lessons learned was not a DHS priority. While our review focused on the ASP program, the inability of PARM to identify any lessons learned reports from cancelled DHS programs suggests that the problem is broader than this one program. PARM is developing plans for disseminating future lessons learned reports department-wide. However, until DHS makes lessons learned reviews an institutional requirement, puts processes in place to ensure component agencies conduct such reviews and prepare lessons learned reports, and implements plans for disseminating the reports, DHS may be missing opportunities to improve its chances of success for billions of dollars in future acquisitions. Recommendations for Executive Action To increase the probability of success for future acquisition programs, we recommend that the Secretary of Homeland Security take the following four actions for cancelled acquisition programs: Make lessons learned reviews an institutional requirement, such as through an agency directive or order or other appropriate means. Put documented processes in place to ensure that component agencies conduct timely lessons learned reviews, and prepare and submit lessons learned reports. Complete and implement plans to disseminate lessons learned reports throughout the department. Agency Comments and Our Evaluation We provided a draft of this report to DHS for review and comment. In its written response, reproduced in appendix III, DHS agreed with all four of our recommendations. DHS asked us to consider two of the recommendations resolved and closed on the basis of existing guidance and processes that were discussed in the body of this report. DHS outlined steps that it intends to take to address the other two recommendations. We are encouraged by some of the actions planned. However, we do not consider two of the recommendations resolved and closed because, as discussed below, we believe that DHS should take steps to address these recommendations. In DHS’s response to our recommendation to make lessons learned reviews an institutional requirement, DHS commented that it has institutionalized this requirement through existing departmental acquisitions guidance that was discussed in the body of this report. However, as discussed in this report and confirmed by PARM officials during the course of our review, this guidance does not constitute a requirement. DHS’s comments also refer to additional guidance called the Department of Homeland Security (DHS) Capital Planning and Investment Control (CPIC) Guide. However, officials from both PARM and the DHS Office of the Chief Information Officer told us that CPIC applies only to information technology programs, not to other programs such as ASP. In our view, the existing guidance referenced in DHS’s comments contributed to the confusion and uncertainty we discussed in the body of this report, including confusion about whether lessons learned were required for cancelled programs. Accordingly, we continue to believe that DHS needs to take action to address the problem. Similarly, in commenting on our recommendation to put processes in place to ensure that component agencies conduct timely lessons learned reviews, DHS stated that our recommendation is addressed by its existing acquisition oversight process, as evidenced by the completion of a lessons learned report for ASP. However, according to DNDO and CBP’s lessons learned report, the Secretary of DHS cancelled the program in October 2011, but the lessons learned report for this program was not issued until more than a year later. Furthermore, as noted in this report, the ASP lessons learned report is the only example PARM officials could identify of such a report having been completed. In our view, relying on this existing process seems unlikely to ensure that component agencies conduct timely lessons learned reviews. With regard to our final two recommendations—to put documented processes in place to ensure that component agencies prepare and submit lessons learned reports, and to complete and implement plans to disseminate lessons learned reports throughout the department—DHS stated that it is taking several actions. Specifically, DHS is revising and clarifying its acquisitions guidance with respect to lessons learned; it expects to complete these revisions by June 2014. In its comments, DHS stated that it has developed an online forum and library for DHS acquisition professionals that includes an area dedicated to lessons learned and best practices. Furthermore, DHS has designated a lead Center of Excellence and established a time frame of September 2013 for collecting and posting information on lessons learned for cancelled programs. In our view, as DHS completes more lessons learned reports, an online forum and library could become a useful means of disseminating these reports throughout the department. DHS also provided technical comments that we incorporated in the report, as appropriate. As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the Secretary of Homeland Security, the Director of DNDO, the Commissioner of CBP, the Executive Director of PARM, the appropriate congressional committees, and other interested parties. In addition, the report will be available at no charge on the GAO website at http://www.gao.gov. If you or your staff members have any questions about this report, please contact David C. Trimble at (202) 512-3841 or trimbled@gao.gov or Dr. Timothy M. Persons at (202) 512-6412 or personst@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made key contributions to this report are listed in appendix IV. Appendix I: Experts Identified by the National Academies Who Described Leading Practices for Reviewing Cancelled Acquisition Programs At our request, the National Academies identified experts who could highlight leading practices for reviewing cancelled acquisition programs. These experts were identified on the basis on their knowledge of leading practices in large-scale engineering and acquisition programs. The National Academies provided us a list of 10 experts, 7 of whom were available to participate in this effort. Six of the 7 experts who were available were members of the National Academy of Engineering. We conducted a group telephone conference with 6 of the experts. We drafted conclusions from the conference and circulated them to all 7 of the experts for their review and comment. With one exception, the experts reached consensus on all of the observations. One expert felt that lessons learned reports were so important that acquisitions executives should have less authority to tailor or waive the requirements for such reports. Appendix II: DNDO-CBP ASP Lessons Learned Report The following DNDO-CBP ASP lessons learned report was redacted on December 4, 2012, from the November 5, 2012, For Official Use Only version by DNDO. Appendix IV: GAO Contacts and Staff Acknowledgments GAO Contacts Staff Acknowledgments In addition to the individuals named above, Ned Woodward, Assistant Director; Gene Aloise; Cheryl R. Arvidson; Antoinette C. Capaccio; Frederick K. Childers; R. Scott Fletcher; Cindy K. Gilbert; David C. Maurer; Cynthia Norris; Katrina E. Pekar-Carpenter; Kiki Theodoropoulos; and Nathan A. Tranquilli made key contributions to this report. Related GAO Products Combating Nuclear Smuggling: DHS has Developed Plans for Its Global Nuclear Detection Architecture, but Challenges Remain in Deploying Equipment. GAO-12-941T. Washington, D.C.: July 26, 2012. Combating Nuclear Smuggling: DHS Has Made Some Progress but Not Yet Completed a Strategic Plan for Its Global Nuclear Detection Efforts or Closed Identified Gaps. GAO-10-883T. Washington, D.C.: June 30, 2010. Combating Nuclear Smuggling: Recent Testing Raises Issues About the Potential Effectiveness of Advanced Radiation Detection Portal Monitors. GAO-10-252T. Washington, D.C.: November 17, 2009. Combating Nuclear Smuggling: Lessons Learned from DHS Testing of Advanced Radiation Detection Portal Monitors. GAO-09-804T. Washington, D.C.: June 25, 2009. Combating Nuclear Smuggling: DHS Improved Testing of Advanced Radiation Detection Portal Monitors, but Preliminary Results Show Limits of the New Technology. GAO-09-655. Washington, D.C.: May 21, 2009. Nuclear Detection: Domestic Nuclear Detection Office Should Improve Planning to Better Address Gaps and Vulnerabilities. GAO-09-257. Washington, D.C.: January 29, 2009. Department of Homeland Security: Billions Invested in Major Programs Lack Appropriate Oversight. GAO-09-29. Washington, D.C.: November 18, 2008. Combating Nuclear Smuggling: DHS’s Phase 3 Test Report on Advanced Portal Monitors Does Not Fully Disclose the Limitations of the Test Results. GAO-08-979. Washington, D.C.: September 30, 2008. Combating Nuclear Smuggling: DHS Needs to Consider the Full Costs and Complete All Tests Prior to Making a Decision on Whether to Purchase Advanced Portal Monitors. GAO-08-1178T. Washington, D.C.: September 25, 2008. Combating Nuclear Smuggling: DHS’s Program to Procure and Deploy Advanced Radiation Detection Portal Monitors Is Likely to Exceed the Department’s Previous Cost Estimates. GAO-08-1108R. Washington, D.C.: September 22, 2008. Combating Nuclear Smuggling: DHS’s Decision to Procure and Deploy the Next Generation of Radiation Detection Equipment Is Not Supported by Its Cost-Benefit Analysis. GAO-07-581T. Washington, D.C.: March 14, 2007. Combating Nuclear Smuggling: DNDO Has Not Yet Collected Most of the National Laboratories’ Test Results on Radiation Portal Monitors in Support of DNDO’s Testing and Development Program. GAO-07-347R. Washington, D. C.: March 9, 2007. Combating Nuclear Smuggling: DHS’s Cost-Benefit Analysis to Support the Purchase of New Radiation Detection Portal Monitors Was Not Based on Available Performance Data and Did Not Fully Evaluate All the Monitors’ Costs and Benefits. GAO-07-133R. Washington, D.C.: October 17, 2006. Combating Nuclear Smuggling: Additional Actions Needed to Ensure Adequate Testing of Next Generation Radiation Detection Equipment. GAO-07-1247T. Washington, D.C.: September 18, 2007. Combating Nuclear Smuggling: DHS Has Made Progress Deploying Radiation Detection Equipment at U.S. Ports-of-Entry, but Concerns Remain. GAO-06-389. Washington, D.C.: March 22, 2006.

Preventing terrorists from smuggling radiological or nuclear material into the United States to carry out an attack is a national priority. DHS's DNDO develops and deploys radiation detection equipment to assist other federal agencies, such as CBP, in intercepting illicit radiological or nuclear materials that could be used to make a radiological dispersive device (dirty bomb) or a crude nuclear bomb. CBP uses RPMs at nearly all land border crossings and seaports to detect radiation in trucks and cargo. DHS recently cancelled acquisition of ASPs, which was originally envisioned as costing from $2 billion to $3 billion. GAO was asked to provide updated information on the ASP program. This report examines, among other things, (1) the results of ASP testing conducted in 2009 and 2010 that led to DHS's decision to cancel the ASP program and (2) the benefits of lessons learned reviews and how DHS captures any lessons learned when programs are cancelled. GAO reviewed testing and acquisition documents and interviewed key agency officials, as well as seven experts the National Academies identified for their knowledge of leading practices in large-scale engineering and acquisition programs. The advanced spectroscopic portal monitor (ASP)--a next-generation radiation portal monitor (RPM) for screening trucks and cargo containers--did not pass field validation tests conducted in 2009 and 2010. The Department of Homeland Security's (DHS) Domestic Nuclear Detection Office (DNDO) intended to replace many currently deployed RPMs and handheld radiation detectors used by U.S. Customs and Border Protection (CBP) with ASPs. However, in the tests, ASP did not meet key requirements to detect radiation and identify its source. For example, ASP triggered too many false alarms from benign, naturally occurring radioactive material in common items such as kitty litter and granite, and it sometimes would not turn on or continue operating long enough to complete a day of testing. In addition, GAO's review identified analytical weaknesses related to the testing and program cancellation, including inconsistencies in DNDO's analysis of the settings used for testing the ASP. The final field validation test was conducted in November 2010, and the Secretary of Homeland Security notified Congress of her decision to cancel the program in October 2011. Conducting lessons learned reviews when programs are cancelled benefits organizations by identifying things that worked well and did not work well in order to improve future acquisitions programs, according to experts GAO consulted. However, DHS does not have processes in place to ensure such reviews are conducted or that the results are disseminated. Experts identified by the National Academies told GAO that lessons learned reviews help identify reasons why programs were cancelled. The experts also said lessons learned reviews should be required and conducted promptly, and the results should be disseminated. At the direction of DHS management, DNDO reviewed the ASP program and submitted and disseminated a lessons learned report in November 2012. This report cited 32 lessons learned including having program officials work closely with end users to ensure equipment meets operational requirements. DHS guidance calls for lessons learned reviews immediately after programs are cancelled and states that the lessons learned are to be shared throughout the department, but this guidance is not a requirement. Before DHS's directive, there was confusion about whether a lessons learned review was needed for the ASP program, and DNDO officials did not intend to conduct such a review. Moreover, DHS officials were unable to provide examples of previous lessons learned reports from other cancelled programs. DHS officials also said they have no process for disseminating such reports but are planning one.

Background CMS has become the largest purchaser of health care in the United States, serving nearly 83 million Medicare and Medicaid beneficiaries. The agency administers the Medicare program, enacted in 1965, which provides health insurance to people who are aged 65 years and over and to some people with disabilities who are under aged 65 years. The agency also works with the states to administer the Medicaid program, enacted in 1965 as a jointly funded program in which the federal government matches state spending according to a formula to provide medical and health-related services to low-income Americans. In fiscal year 2005, CMS will reportedly spend about $519 billion: 63 percent for Medicare, 35 percent for Medicaid and Medicaid administration, and the remaining 2 percent for the State Children’s Health Insurance Program and other administrative costs. CMS estimates that its total budget in fiscal year 2006 will be $622 billion. The agency carries out its responsibilities from its national headquarters located in Baltimore, Maryland, and its 10 regional offices located throughout the nation. It is organized around three centers (to support its key functions): the Center for Medicare Management, the Center for Beneficiary Choices, and the Center for Medicaid and State Operations. Numerous other offices throughout the agency support these centers. CMS’s Use of Information Technology IT systems play a vital role in helping CMS to fulfill its responsibilities in carrying out the Medicare and Medicaid programs. These systems help to maintain Medicare information on the millions of beneficiaries, providers, and medical services provided. For example, CMS’s Medicare Fee-for- Service claims processing systems process more than 1 billion claims annually and make benefit payments for the 41 million elderly and disabled beneficiaries. In fiscal year 2004, the Medicare program had estimated outlays of $297 billion in health care benefits. Similarly, IT systems are relied on to manage the Medicaid program. In fiscal year 2003, this program provided benefits totaling about $261 billion to nearly 54 million people. Of this amount, the federal share was about $153 billion. To assist the states in developing and operating MMISs used to process Medicaid claims and administer the program, CMS provides funding assistance through grants. In fiscal year 2005, about $1.79 billion, or 70 percent, of CMS’s nearly $2.55 billion total appropriations for IT went to support Medicaid state investments. The remaining approximately $0.76 billion, or 30 percent, was used for CMS’s internal investments. Figure 1 shows the breakdown of this funding between CMS’s internal IT investments and Medicaid state IT investments. Weaknesses Previously Identified in CMS’s IT Investment Management Processes In September 2001, we reported that CMS’s processes for managing its IT investments omitted key review, approval, and evaluation steps. We recognized that the agency was making efforts to strengthen its IT planning and had developed guidance for an improved management process, but stated that it would need to make considerable progress in implementing these changes to ensure that its ongoing modernization efforts stayed on track. To improve its investment management processes, we made several recommendations to the CMS Administrator, including establishing sufficient and written criteria to ensure a consistent process for funding IT projects agencywide, and establishing a systematic process for evaluating completed IT projects that included cost, milestone, and performance data. CMS’s Approach to Investment Management Several groups and individuals play a role in CMS’s process to manage its internal IT investments, including an investment board for establishing the IT investment governance principles. However, a different process is used to oversee the Medicaid IT systems that the agency jointly funds with the states. This process is carried out by CMS’s Center for Medicaid and State Operations and 10 regional offices. Both of these processes, along with the roles and responsibilities of the groups and individuals involved, are described below. Process for Managing Internal Investments The groups and individuals who play a role in CMS’s internal IT investment management process include the Information Technology Investment Review Board, Executive Steering Committees, Enterprise Architecture Group, and Component Leads. Information Technology Investment Review Board (ITIRB). This board was established in January of 2004 to provide a corporate perspective in evaluating IT investments against CMS’s business priorities. Its members consist of senior leadership from CMS centers, offices, and regional offices, and it is chaired by the agency’s Chief Information Officer (CIO). Initially, the primary ITIRB responsibility was overseeing investments associated with the Medicare Presciption Drug, Improvement, and Modernization Act of 2003 (MMA) and with CMS’s revitalization initiative. These investments made up about one-third of CMS’s fiscal year 2005 Operating Plan for internal systems. In the spring of 2005, the role of the board was expanded to include all internal IT investments. To assist the ITIRB in its activities, CMS staff from the Office of Information Services and the Office of Financial Management provide administrative support. According to its charter, the board is responsible for establishing the criteria for the selection, control, and evaluation of CMS’s portfolio of IT projects; developing the agency’s IT operation plan and responding to the President’s budget request; reviewing the performance of IT investments using the criteria and checkpoints in meeting cost, schedule, risk, and benefit expectations and taking corrective actions when expectations are not being met; ensuring that IT investments in operation are periodically evaluated to determine whether they should be retained, modified, replaced, or terminated; and comparing the results of implemented investments with the expectations that were set for them and developing a set of lessons learned for future process improvement. Executive Steering Committees (ESC). The ESCs were established to support the ITIRB in carrying out its responsibilities. Each ESC is responsible for managing IT projects (or investments) that are grouped together into a portfolio for each of CMS’s business components. This responsibility includes maintaining the appropriate mix of IT investments in its portfolio, managing the investments in its portfolio, and providing funding recommendations to the ITIRB for these investments. The membership of each ESC depends on the IT investments contained in the portfolio, but, at a minimum, every CMS component that sponsors a project is to have a representative on the ESC. Enterprise Architecture Group. This group, formally known as the IT Architecture Planning Staff, supports the IT investment management process, by, among other things, reviewing business case analyses for new investments and major enhancements to ensure that they are consistent with the enterprise architecture, by making recommendations based upon that review that are aimed at the optimal leveraging of assets. Component Leads. These individuals provide support in the IT investment management process by serving as liaisons between the Office of Information Services and individual project managers. Component Leads are to assist project managers in understanding CMS’s investment management process and other operational policies and processes. They can also provide project managers with key contacts for various IT services that project owners may require during implementation of a project. In the spring of 2005, CMS implemented a new budget formulation process and used it to select its IT investments. This process begins with an information request from the CIO asking that each component submit information on all of its investments, both new and ongoing. This information is to include (1) a score sheet for each investment that shows how it compared with prescribed criteria, such as alignment with business drivers and IT strategic goals, and (2) a prioritized list of all investments for the component. For new investments, the components also are to submit an IT Fact Sheet (an investment proposal) that the ITIRB support staff; the Enterprise Architecture Group; and, ultimately, the board review to determine if the need for the new investment is justified. If the need is found to be justified, project managers receive funding to develop a Business Case Analysis (smaller projects may not require such a document), which goes through the same review process as the IT Fact Sheet. The ITIRB support staff review all information submitted in response to the information request and prepare it for the ESCs’ review. The ESCs reevaluate the investments against the criteria, making adjustments to the scoring if necessary, and make funding recommendations to the board. The ITIRB makes strategic and funding recommendations regarding CMS’s IT capital investment portfolio to CMS’s Chief Operating Officer who, in turn, provides recommendations to the CMS’s Office of Financial Management for integration into the agency’s overall budget. Figure 2 illustrates CMS’s process for selecting its internal IT investments. To date, the ITIRB’s role in controlling (overseeing) IT investments has been primarily limited to those associated with the MMA and revitalization initiatives. According to CMS officials, efforts to define procedures for the board to control all internal investments, in accordance with the responsibilities described in its charter, are currently under way. Process for Approving and Monitoring State Medicaid IT Investments The ITIRB plays no role in approving and monitoring state Medicaid IT investments. Instead, the process for approving states’ requests for matching funds for MMIS activities—including the design, development, and installation of new MMISs, and the operations, maintenance, and enhancement of existing MMISs—is the shared responsibility of CMS’s Center for Medicaid and State Operations (hereafter referred to as the central office) and its 10 regional offices. According to regulations, the State Medicaid Manual, and officials we interviewed at CMS’s central office and 5 regional offices, CMS’s process for approving states’ requests generally consists of the activities discussed below: To request federal funds for state MMIS activities, states must prepare an advance planning document (APD), which identifies, among other things, the purpose, scope, benefits, and preliminary cost estimates for the activities they want to undertake. States submit this document to the regional office, which reviews the APD for completeness and technical content. Regional office staff generally ensure that requests support the Medicaid program, are in compliance with federal requirements, and represent cost-effective solutions. Also, the regional office may have suggestions for the states to improve their APDs. Some of the officials we interviewed told us that they work with the states to complete the APDs to expedite the review and approval process. Once regional office staff determine that an APD adequately justifies the request for funding and the request is approved by that regional office’s Associate Regional Administrator for Medicaid, the CMS central office and HHS are notified of the approval through a process referred to as the Office of the Secretary Notice process. Once the central office concurs, the regional office can send an approval letter to the state. The states typically hire contractors to perform the MMIS activities. With the approval of an APD, a state is given the clearance to develop the request-for-proposals for soliciting contractor proposals. While the APD is a high-level justification for funding, the request-for-proposals is to contain the more detailed requirements of the MMIS activities. Before it is issued, the request-for-proposals must be approved by the CMS regional office through a process similar to that used for the APD. The states review the proposals received and evaluate them in order to make the final selection. While regional office staff do not formally approve a state’s evaluation process, they do review the process to ensure that it allows for open and free competition, to the maximum extent practicable. The states draft a contract for the MMIS activities. Prior to its award, the contract is reviewed by regional office staff and approved by the Associate Regional Administrator for Medicaid. The state then makes an award to the contractor whose bid or offer is responsive to the solicitation and most advantageous to the state—considering price, quality, and other factors. When the contracted MMIS activities start, regional office staff begin monitoring the status of these activities through a variety of mechanisms, including reviews of status reports; on-site visits; and meetings with external groups, such as industry associations, provider groups, and vendors. Once MMISs are built and become operational, CMS establishes a team consisting of headquarters and regional office staff with expertise in relevant areas to do on-site reviews, referred to as certification reviews. During these reviews, which are to be conducted about 6 months after a system has been in operation, the team makes sure that the system satisfies the terms of the state’s APD, meets minimal federal requirements, and complies with current regulations and policy. CMS has written guidance for conducting these reviews, which it is in the process of revising. Regional office staff are to continue monitoring MMIS activities through the previously mentioned mechanisms. Information Technology Investment Management Maturity Framework The Information Technology Investment Management (ITIM) framework is a maturity model comprising five progressive stages of maturity that an agency can achieve in its investment management capabilities. The ITIM framework was developed on the basis of our research into the IT investment management practices of leading private- and public-sector organizations. It identifies critical processes for making successful IT investments, organized into the five increasingly mature stages. These maturity stages are cumulative; that is, in order to attain a higher stage of maturity, the agency must have institutionalized all of the requirements for all of the lower stages in addition to the higher stage. The ITIM framework can be used to assess the maturity of an agency’s investment management processes and as a tool for organizational improvement. The overriding purpose of the framework is to encourage investment processes that increase business value and mission performance, reduce risk, and increase accountability and transparency in the decision process. We have used the framework in several of our evaluations, and a number of agencies have adopted it. These agencies have used ITIM for purposes ranging from self-assessment to the redesign of their IT investment management processes. The ITIM framework’s five maturity stages represent steps toward achieving stable and mature processes for managing IT investments. Each stage builds on the lower stages; the successful attainment of each stage leads to improvement in the organization’s ability to manage its investments. With the exception of the first stage, each maturity stage is composed of “critical processes” that must be implemented and institutionalized in order for the organization to achieve that stage. These critical processes are further broken down into key practices that describe the types of activities that an organization should be performing to successfully implement each critical process. An organization may be performing key practices from more than one maturity stage at the same time. This is not unusual, but efforts to improve investment management capabilities should focus on becoming compliant with lower-stage practices before addressing higher-stage practices. Stage 2 of the ITIM framework encompasses building a sound investment management process by establishing basic capabilities for selecting new IT projects. It also involves developing the capability to control projects so that they finish predictably within established cost and schedule expectations and the capability to identify potential exposures to risk and put in place strategies to mitigate that risk. The basic selection processes established in Stage 2 lays the foundation for more mature selection capabilities in Stage 3. Stage 3 requires that an organization continually assess both proposed and ongoing projects as parts of a complete investment portfolio—an integrated and competing set of investment options. It focuses on establishing a consistent, well-defined perspective on the IT investment portfolio and maintaining mature, integrated selection (and reselection), control, and evaluation processes that can be evaluated during postimplementation reviews. This portfolio perspective allows decision makers to consider the interaction among investments and the contributions to organizational mission goals and strategies that could be made by alternative portfolio selections, rather than focusing exclusively on the balance between the costs and benefits of individual investments. Organizations implementing Stages 2 and 3 have in place the selection, control, and evaluation processes that are required by the Clinger-Cohen Act of 1996. Stages 4 and 5 require the use of evaluation techniques to continuously improve both the investment portfolio and the investment processes in order to better achieve strategic outcomes. At Stage 4 maturity, an organization has the capacity to conduct IT succession activities and, therefore, can plan and implement the deselection of obsolete, high-risk, or low-value IT investments. An organization with Stage 5 maturity conducts proactive monitoring for breakthrough information technologies that will enable it to change and improve its business performance. Stages 4 and 5 define key attributes that are associated with the most capable organizations. Figure 3 shows the five ITIM stages of maturity and the critical processes associated with each stage. As defined by the model, each critical process consists of “key practices” that must be executed to implement the critical process. CMS’s Capabilities to Manage Its Internal Investments Are Limited In order to have the capabilities to effectively manage IT investments, an agency, at a minimum, should (1) build an investment foundation by putting basic, project-level control and selection practices in place (Stage 2 capabilities) and (2) manage its projects as a portfolio of investments, treating them as an integrated package of competing investment options and pursuing those that best meet the strategic goals, objectives, and mission of the agency (Stage 3 capabilities). CMS has executed 20 of the 38 key practices that are required to build a foundation for IT investment management. In addition, because CMS has focused primarily on establishing the Stage 2 practices, it has executed only 2 of the 27 Stage 3 key practices. Until CMS implements all of the key practices associated with building the investment foundation and managing its investments as a portfolio, the agency will not have much assurance that it has selected the mix of investments that best supports its strategic goals, or that it will be able to manage the investments to successful completion. CMS Has Established about Half of the Foundational Practices for Investment Management At the ITIM Stage 2 level of maturity, an organization has attained repeatable, successful IT project-level investment control processes and basic selection processes. Through these processes, the organization can identify expectation gaps early and take the appropriate steps to address them. According to the ITIM framework, critical processes at Stage 2 include (1) defining IT investment board operations, (2) identifying the business needs for each IT investment, (3) developing a basic process for selecting new IT proposals and reselecting ongoing investments, (4) developing project-level investment control processes, and (5) collecting information about existing investments to inform investment management decisions. Table 1 describes the purpose of each of these Stage 2 critical processes. Because IT investment management has only recently become an area of management attention, CMS has put in place 20 of the 38 Stage 2 key practices required for basic project-level selection and control. The agency has satisfied the majority of the key practices associated with establishing an IT investment review board, capturing investment information, and meeting business needs. CMS also has recently established a process for selecting investments, but it has not yet established a process for the IT investment review board to provide investment oversight. Figure 4 summarizes the status of CMS’s critical processes for Stage 2, showing how many key practices CMS has executed in managing its internal IT investments. The creation of decision-making bodies or boards is central to the IT investment management process. At the Stage 2 level of maturity, organizations define one or more boards, provide resources to support their operations, and appoint members who have expertise in both operational and technical aspects of the proposed investments. The boards operate according to a written IT investment process guide that is tailored to the organization’s unique characteristics, thus ensuring that consistent and effective management practices are implemented across the organization. Once board members are selected, the organization ensures that they are knowledgeable about policies and procedures for managing investments. Organizations at the Stage 2 level of maturity also take steps to ensure that executives and line managers support and carry out the decisions of the investment board. According to the ITIM framework, an IT investment management process guide should (1) be a key authoritative document that the organization uses to initiate and manage IT investment processes and (2) provide a comprehensive foundation for policies and procedures developed for all other related processes. (The complete list of key practices is provided in table 2.) CMS has executed 5 of the 8 key practices for this critical process. For example, in January 2004, the agency established the ITIRB to manage internal investments and provide business-driven leadership to its operations and development. While the ITIRB was initially only responsible for overseeing MMA and revitalization initiatives, its responsibilities were expanded this past spring to include management and oversight responsibilities for all internal investments. ITIRB members are senior- level officials from both business and IT areas who understand board policies and procedures. The ITIRB is adequately resourced to maintain its operations. For example, the Program Management and Support Group within the Office of Information Services assists the board in such ways as coordinating and integrating the investment management process. This group serves as the principal contact and entry point for all new and proposed IT projects. In addition, nine Executive Steering Committees were recently established to support the work of the ITIRB by managing a subset of investments grouped together according to business function. Their responsibilities include, among other things, scoring and ranking IT investments, and recommending investments to the ITIRB for funding. Notwithstanding these strengths, CMS does not have an IT investment process guide that reflects the agency’s current investment management practices. For example, the agency uses ESCs to work with the board on specific areas of IT investments, but its process guide does not identify this critical group. Moreover, the process guide does not mention the agency’s move to classify its IT investments in line with the department’s classification scheme. (The new classification scheme consists of three levels in which projects are rated as major, supporting, or tactical.) Instead, the process guide outlines a four-level classification scheme that identifies investments as A, B, C, or D, depending on the nature and sensitivity of the project. According to CMS officials, the guide has not yet been updated because the agency has made a priority of fully defining its processes before documenting them. Documenting the process, however, does not preclude it from future revisions or improvements, but does provide a basis for consistent implementation across the agency. Until CMS’s documented IT investment process guidance is updated, executives are at risk of inconsistently performing key investment decision-making activities and inaccurately communicating management practices. Such updated guidance would also provide a process that could lead to greater accountability about future IT investment outcomes, which would be helpful to new members joining the board. Another key weakness is that CMS’s ITIRB has not operated in accordance with its assigned roles and responsibilities. For example, the ITIRB has not yet been involved in systematically controlling investments nor has it actively maintained the documented investment management process. Until the ITIRB fully carries out its assigned roles and responsibilities, executives will not have assurance that the whole IT investment management process is functioning smoothly and effectively as intended. Table 2 shows the rating for each key practice required to implement the critical process for instituting the investment board at the Stage 2 level of maturity. Each of the “executed” ratings shown below represents instances where, on the basis of the evidence provided by CMS officials, we concluded that the specific key practices were executed by the agency. Defining business needs for each IT project helps to ensure that projects and systems support the organization’s business needs and meet users’ needs. This critical process ensures that a link exists between the organization’s business objectives and its IT management strategy. According to the ITIM, effectively meeting business needs requires, among other things, (1) documenting business needs with stated goals and objectives, (2) identifying specific users and other beneficiaries of IT projects and systems, (3) providing adequate resources to ensure that projects and systems support the organization’s business needs and meet users’ needs, and (4) periodically evaluating the alignment of IT projects and systems with the organization’s strategic goals and objectives. (The complete list of key practices is provided in table 3.) CMS has in place 5 of the 7 key practices for meeting business needs. The agency’s IT Investment Management Process Guide and Business Case Analysis Development Guide require business needs for both proposed and ongoing IT projects and systems to be identified in an IT fact sheet and, in some instances, a business case analysis document. The agency also has detailed procedures for developing these documents that call for identifying users. We verified that the four projects we reviewed identified specific users and also documented how the projects linked back to CMS business needs. Resources for ensuring that IT projects and systems support the organization’s business needs and meet users’ needs include Component Leads, the Enterprise Architecture Group, and detailed procedures and associated templates for developing the IT fact sheet and business case analysis document. Although CMS has performed most of the key practices associated with meeting business needs, a few weaknesses remain. Specifically, officials told us they rely on the HHS strategic plan to guide their efforts because CMS’s strategic plan documenting the agency’s business mission, goals, and objectives is outdated. However, the primary tool used to justify funding for investments does not tie into the HHS plan but provides high-level business drivers for aligning these investments with business needs. While, according to agency officials, these business drivers reflect a common understanding of the agency’s goals and objectives, they are not descriptive enough to drive IT investments. Until CMS develops a current strategic plan or other detailed statement of business mission with supporting goals and objectives, the agency is at risk of not being able to thoroughly communicate critical information on its goals and objectives or to provide clear and transparent direction for its IT investment management process. Finally, CMS’s budget formulation process serves as a mechanism to reevaluate the alignment of projects and systems with the organization’s goals and objectives. However, the ITIRB selected investments for the first time this past spring and, therefore, has not yet had to reevaluate projects’ and systems’ alignment with organizational goals and objectives. When CMS executes all key practices associated with this critical process, it will have greater assurance that its projects effectively meet the agency’s business needs. Table 3 shows the rating for each key practice required to implement the critical process for meeting business needs at the Stage 2 level of maturity and summarizes the evidence that supports these ratings. Selecting new IT proposals and reselecting ongoing investments require a well-defined and disciplined process to provide the agency’s investment board, business units, and developers with a common understanding of the process and the cost, benefit, schedule, and risk criteria that will be used both to select new projects and to reselect ongoing projects for continued funding. According to the ITIM, this critical process requires, among other things, (1) making funding decisions for new proposals according to an established process; (2) providing adequate resources for investment selection activities; (3) using a defined selection process to select new investments and reselect ongoing investments; (4) establishing criteria for analyzing, prioritizing, and selecting new IT investments and for reselecting ongoing investments; and (5) creating a process for ensuring that the criteria change as organizational objectives change. (The complete list of key practices is provided in table 4.) CMS has executed 4 of the 10 key practices associated with selecting an investment. Specifically, CMS used a process it defined in February 2005—its budget formulation process—to select new investments and reselect existing investments using a set of limited criteria. We confirmed that the four projects we reviewed were reselected using this new process. In addition, by using the budget formulation process to select investments, executives had assurance that funding decisions were aligned with selection decisions. Officials indicated that adequate resources were provided for identifying and selecting investments. However, weaknesses remain in the selection area. Although CMS has a number of documents that address investment selection and reselection, these documents are not linked to provide a clear understanding of the selection and reselection process. In addition, they do not define (1) the roles and responsibilities for each participating unit involved in the project selection process and (2) the decision-making procedures. CMS officials told us they chose to first implement the selection process and then go back to document it. Another key weakness in the selection area is that, although selection and reselection criteria have been defined, they do not include cost, benefit, schedule, and risk factors. Officials indicated that because the Executive Steering Committees and the ITIRB had a short amount of time to perform selection activities this year, they defined a limited set of criteria to evaluate projects. Further, CMS does not have a mechanism to ensure that its selection criteria continue to reflect organizational objectives. Until CMS implements all of the key practices associated with selecting investments, executives will not be adequately assured that they are consistently and objectively selecting projects that meet the needs and priorities of the agency in a cost-effective and risk-insured manner. Table 4 shows the rating for each key practice required to implement the critical process for selecting an investment at the Stage 2 level of maturity and summarizes the evidence that supports these ratings. An organization should provide effective oversight for its IT projects throughout all phases of their life cycles. Its investment board should maintain adequate oversight and observe each project’s performance and progress toward predefined cost and schedule expectations as well as each project’s anticipated benefits and risk exposure. The investment board should also employ early warning systems that enable it to take corrective action at the first sign of cost, schedule, or performance slippages. This board has ultimate responsibility for the activities within this critical process. According to the ITIM framework, effective project oversight requires, among other things, (1) having written policies and procedures for management oversight; (2) developing and maintaining an approved management plan for each IT project; (3) making up-to-date cost and schedule data for each project available to the oversight boards; (4) having regular reviews by each investment board of each project’s performance against stated expectations; and (5) ensuring that corrective actions for each underperforming project are documented, agreed to, implemented, and tracked until the desired outcome is achieved. (The complete list of key practices is provided in table 5.) CMS has only executed 1 of the 7 key practices associated with effective project oversight. While CMS’s IT Investment Management Process Guide addresses management oversight of IT projects and systems, it does not include specific procedures for the ITIRB’s oversight of IT projects and systems. In addition, while the board is receiving performance data for some investments, including revitalization investments, it is not yet performing oversight of projects on a systematic basis. CMS officials indicated that the ITIRB’s involvement in overseeing investments to date has been limited because the board was first focusing on selecting investments. However, CMS recognizes the importance of the ITIRB’s involvement in oversight of IT investments, and, according to officials, the agency is currently developing an approach to address this issue. While CMS is in the process of developing a structured process for the ITIRB to oversee investments, other entities are involved in the oversight of projects. For example, performance information for one of the projects we reviewed was not provided to CMS’s ITIRB, but instead was provided to senior-level management, such as the Chief Technology Officer and directors from some CMS components. Until the ITIRB systematically oversees CMS’s investments, the oversight process will not benefit from the corporate perspective that is gained by having an enterprisewide board. As a result, executives may not be able to easily determine the impact individual project decisions may have on other projects and on the attainment of organizational goals and objectives. Table 5 shows the rating for each key practice that is required to implement the critical process for project oversight at the Stage 2 level of maturity and summarizes the evidence that supports these ratings. To make good IT investment decisions, an organization must be able to acquire pertinent information about each investment and store that information in a retrievable format. During this critical process, an organization identifies its IT assets and creates a comprehensive repository of investment information. This repository provides information to investment decision makers to help them evaluate the impacts and opportunities that would be created by proposed or continuing investments. It can provide insights and trends about major IT cost and management drivers. The repository can take many forms and does not have to be centrally located, but the collection method should identify each IT investment and its associated components. This critical process may be satisfied by the information contained in the organization’s current enterprise architecture, augmented by additional information—such as financial information and information on risk and benefits—that the investment board may require to ensure that informed decisions are being made. According to the ITIM framework, effectively managing this repository requires, among other things, (1) developing written policies and procedures for identifying and collecting the information, (2) assigning responsibility for ensuring that the information being collected meets the needs of the investment management process, (3) identifying IT projects and systems and collecting relevant information to support decisions about them, and (4) making the information easily accessible to decision makers and others. (The complete list of key practices is provided in table 6.) CMS has in place 5 of the 6 key practices associated with capturing investment information. For example, CMS’s IT Investment Management Process Guide identifies specific information that is needed in the investment management process, such as how each IT project relates to the business needs of CMS. According to officials, adequate resources are provided to support the collection of investment information, such as the agency’s IT Investment Tracking Database, and an individual assigned responsibility for ensuring that the necessary information is collected to meet the needs of the investment management process. CMS is collecting specific information about IT investments to support decisions about these investments, including projects’ scores against selection criteria and earned value management information. We verified that this information was collected for the four projects we reviewed. However, although the ITIRB has used investment information to support selection decisions, it has not yet used it to systematically oversee projects. According to CMS officials, specific procedures for the ITIRB’s oversight of IT projects and systems are currently being defined. Table 6 shows the rating for each key practice required to implement the critical process for capturing investment information at the Stage 2 level of maturity and summarizes the evidence that supports these ratings. CMS Lacks the Key Capabilities Needed to Manage Its Investments as a Portfolio During Stage 3, the investment board enhances the investment management process by developing a complete investment portfolio. An investment portfolio is an integrated, agencywide collection of investments that are assessed and managed collectively on the basis of common criteria. Managing investments within the context of such a portfolio is a conscious, continuous, and proactive approach to expending limited resources on an organization’s competing initiatives in light of the relative benefits expected from these investments. Taking an agencywide perspective enables an organization to consider its investments comprehensively, so that, collectively, the investments optimally address the organization’s missions, strategic goals, and objectives. Managing investments with a portfolio approach also allows an organization to determine priorities and make decisions about which projects to fund, and continue to fund, on the basis of analyses of the relative organizational value and risks of all projects, including projects that are proposed, under development, and in operation. For an organization to reap the full benefits of the portfolio process, it should collect all of its investments into an enterprise-level portfolio that is overseen by its senior investment board. Although investments may initially be selected into subordinate portfolios—on the basis of, for example, the lines of business or life-cycle stages-—and managed by subordinate investment boards, they should ultimately be aggregated into this enterprise-level portfolio. According to our ITIM framework, critical processes performed by Stage 3 organizations include (1) defining the portfolio criteria, (2) creating the portfolio, (3) evaluating the portfolio, and (4) conducting postimplementation reviews. Table 7 shows the purpose of each critical process in Stage 3. CMS has executed very few key practices—2 of 27—associated with Stage 3 critical processes. Specifically, under the critical process for defining the portfolio criteria, CMS provided evidence that it had designated a working group to be responsible for developing and modifying portfolio selection criteria. Under the critical process for creating the portfolio, CMS provided evidence that it was capturing and maintaining investment information for future reference. In its self-assessment, the agency stated that it was not executing any other Stage 3 key practices. According to officials, CMS has not concentrated on implementing Stage 3 key practices because the agency is first focusing its resources on establishing the practices associated with Stage 2. Until CMS fully implements the critical processes associated with managing its investments as a complete portfolio, it will not have the data or enterprisewide perspective it needs to make informed decisions about its collection of investments. CMS Does Not Have a Comprehensive Plan to Coordinate and Guide Its Improvement Efforts CMS has initiated efforts to improve its investment management process. While these efforts do not fully address any of the weaknesses we identify in this report, they enhance the agency’s ability to perform key activities. Specifically: CMS has begun to implement a tool for capturing project information. According to officials, the tool will bring together investment information currently residing in various locations, including project description information captured in its IT Investment Tracking Database, information such as project scores collected to support project selection activities, and earned value management data. Although information to support investment decisions does not have to be in one location, doing so will improve accessibility and facilitate its use by decision makers. CMS recently established Executive Steering Committees to support the ITIRB in carrying out its investment management responsibilities. These groups played a key role in selecting investments for the fiscal year 2007 budget by reviewing investment information and making recommendations for funding to the investment board. They are currently determining procedures for overseeing investments. According to officials, once procedures for the Executive Steering Committee oversight have been determined, CMS plans to focus on defining procedures for determining how and when to involve the investment board in oversight—a key weakness identified in this report. Although CMS has initiated these improvement efforts, it has not coordinated them with the additional efforts needed to address the weaknesses identified in this report in a comprehensive plan that (1) specifies measurable goals, objectives, and milestones; (2) specifies needed resources; (3) assigns clear responsibility and accountability for accomplishing tasks; and (4) is approved by senior-level management. We have previously reported that such a plan is instrumental in helping agencies coordinate and guide improvement efforts. CMS officials recognize the value of having a comprehensive plan and told us they have begun to develop one; however, a time frame for completing the plan has not been established. Until CMS develops this plan, the agency risks not being able to put in place an effective management process that will provide appropriate executive-level oversight for minimizing risks and maximizing returns. Process for Monitoring MMISs Could Benefit from Standard Procedures, Guidance, and Reporting Requirements As we previously noted, the responsibility for approving and monitoring MMISs that CMS funds jointly with the states falls to CMS’s central office and its 10 regional offices, with the bulk of the activities being performed by the regional offices. Although the process for approving states’ funding requests for MMIS activities is characterized by (1) standard procedures performed consistently across the regional offices, (2) guidance that staff can rely on in carrying out their duties, and (3) requirements for reporting information to the central office, the process for monitoring MMIS activities is not. Standard Procedures, Guidance, and Reporting Requirements Exist for the Approval Process The process for approving states’ requests for federal funding of MMISs is characterized by a defined set of activities that are performed consistently across the regional offices. These activities include regional office staff review and approval of the standard documentation (i.e., the APDs, request-for-proposals, and contracts) that the states prepare to justify their requests. Specifically, as we previously described: States prepare an APD to request funding for MMISs. Regional office staff review the document to ensure that states’ requests support the Medicaid program, are in compliance with federal requirements, and represent cost-effective solutions. Once regional office staff determine that the APD adequately justifies the request, they issue a formal approval letter to the states (with concurrence from CMS’s central office). The request-for-proposals that the states prepare to solicit contractor bids for MMIS activities, including development and operations, is reviewed and approved by regional office staff through a process similar to that used to approve the APDs. Regional office staff review the states’ process for reviewing contractors’ proposed bids. Regional office staff review and approve the contract, after which the state makes an award to the contractor whose bid or offer is responsive to the solicitation and is most advantageous to the state—considering price, quality, and other factors. Regional office staff told us that they rely on the State Medicaid Manual and the Code of Federal Regulation for guidance in performing activities for approving states’ requests for federal funding. Regional staff are also required to inform the CMS central office of all approval actions through the Office of the Secretary Notice process previously mentioned. Process for Monitoring State MMISs Lacks Standard Procedures, Guidance, and Reporting Requirements In contrast to the approval process, the process for monitoring MMIS activities lacks (1) standard procedures regional office staff must perform to carry out their responsibilities, (2) guidance for staff to rely on, and (3) requirements for staff to report on the results of their monitoring efforts to the central office. First, regional office staff use a variety of mechanisms to monitor MMIS activities. These mechanisms include reviews of project status reports; site visits; telephone calls; and meetings with external groups, such as industry associations, provider groups, and vendors. In addition, regional office staff determine if and when to use these mechanisms. Table 8 shows the different mechanisms used by the regional office staff we interviewed and the number of regional offices who used them. Second, CMS has no guidance for regional office staff to use in monitoring MMIS activities. While CMS has a Regional Office Manual that includes guidance for monitoring MMIS activities, this manual is not used by regional office staff because, according to officials, it has not been maintained throughout the years, and it no longer reflects current processes. Third, there are no requirements for regional office staff to report to CMS’s central office on their monitoring of states’ federally funded MMISs activities. Monthly teleconferences are conducted between the central office and regional offices to discuss activities performed by these offices, including activities to monitor state MMISs. According to CMS officials, there is some communication outside of the scheduled teleconferences to discuss any issues that might arise regarding the status of state MMISs. In addition, according to officials, the certification reviews performed about 6 months after the MMISs have become operational provide opportunities to determine firsthand how systems are performing. Despite these mechanisms, the central office has no requirements for regional office staff to regularly report on the results of their efforts to monitor MMIS activities. According to CMS officials, the central office has traditionally placed greater emphasis on the front-end approval of requests for federal funding. The central office, however, now recognizes the need for and value of adopting an approach for maintaining the visibility of MMISs from beginning to end. To address this need, central office staff told us that they plan to ask the regional offices to provide them with quarterly reports on the status of MMIS activities in their states as part of a broader effort that is currently under way to improve the administration of the Medicaid program. Central office staff stated this effort would also result in standard procedures and guidance to support regional office staff’s monitoring efforts. While these activities would strengthen the monitoring process, during our review central office staff did not yet have specific plans or time frames for implementing them. Until CMS defines standard procedures for monitoring MMIS activities, guidance for staff to rely on, and reporting requirements, CMS’s central office may not be able to easily determine whether state MMISs are facilitating the delivery of Medicaid benefits in the most effective and beneficial manner. Conclusions Because IT investment management has only recently become an area of management focus, CMS capabilities to manage its internal investments are limited. Specifically, the agency has established about half of the practices for building the investment foundation, but few practices to manage its investments as a portfolio. Although the foundational practices have equipped CMS with the capabilities it needs to improve its management of individual investments, the agency is hampered in its ability to manage them as a portfolio because it has not implemented the practices for doing so. Until CMS fully establishes the key practices required to build the investment foundation and manage its investments as a portfolio, it will not have the capabilities it needs to ensure that investments supporting its multibillion-dollar Medicare and Medicaid programs are being managed to minimize risks and maximize returns. Critical to CMS’s success in going forward will be the development of an implementation plan that (1) is based on an assessment of strengths and weaknesses; (2) specifies measurable goals, objectives, and milestones; (3) specifies needed resources; (4) assigns clear responsibility and accountability for accomplishing tasks; and (5) is approved by senior-level management. Although the agency has initiated improvement efforts, it has not developed a comprehensive plan to guide these and other efforts needed to improve its investment management process. Without such a plan and procedures for implementing it, CMS will be challenged in sustaining the commitment it needs to fully establish its investment management process. Finally, the process for approving states’ funding requests for MMIS activities is characterized by standard procedures that are performed consistently across the regional offices, guidance, and requirements for informing the central office of regional office staff activities. The process for monitoring the development and operations of state MMIS, on the other hand, has no standard procedures for regional office staff, no guidance, and no requirement to report information to the central office. Without these elements for monitoring MMIS activities, CMS’s central office may not be able to easily determine whether state MMISs are facilitating the delivery of Medicaid benefits in the most effective and beneficial manner. Recommendations for Executive Action To strengthen CMS’s capability to manage its internal IT investments and address the related weaknesses addressed in this report, we recommend that the Secretary of the Department of Health and Human Services direct the CMS Administrator to develop and implement a plan for improving CMS’s IT investment management processes. The plan should address the weaknesses described in this report. The plan should (1) first focus on correcting the weaknesses in Stage 2 critical processes, and next focus on the Stage 3 critical processes, and (2) at a minimum, provide for accomplishing the following 12 actions: Update the agency’s investment management guide to reflect current investment management processes. Establish a process for the board to actively maintain the agency’s documented investment management process. Use an updated strategic plan or other detailed statement of business mission with supporting goals and objectives to align investments with business needs. Ensure that the board periodically evaluates the alignment of IT projects and systems with strategic goals and objectives and take corrective actions when misalignment occurs. Fully document procedures that address investment selection and reselection and (1) provide a clear understanding of the selection and reselection process, (2) define the roles and responsibilities for each participating unit involved in the project reselection process, and (3) define the decision-making procedures. Document procedures for integrating funding with investment selection. Revise the ITIRB’s selection and reselection criteria to include cost, benefit, schedule, and risk factors, and establish a mechanism to ensure these criteria continue to reflect organizational objectives. Define, document, and implement procedures for the ITIRB’s oversight of projects and systems. Implement processes to use investment information to fully support investment management decisions. Implement the Stage 3 critical processes for defining portfolio criteria, creating the portfolio, evaluating the portfolio, and conducting postimplementation reviews, which are necessary for portfolio management. We also recommend that the Secretary for Health and Human Services direct the CMS Administrator to ensure that the plan draw together ongoing efforts and additional efforts that are needed to address the weaknesses identified in this report. The plan should also (1) specify measurable goals, objectives, and milestones; (2) specify needed resources; (3) assign clear responsibility and accountability for accomplishing tasks; and (4) be approved by senior-level management. In implementing the plan, the Administrator should ensure that progress is measured and reported periodically to the Secretary of Health and Human Services. To improve CMS’s process for monitoring states’ progress in developing and maintaining Medicaid management information systems, we are recommending that the Secretary of the Department of Health and Human Services direct the CMS Administrator to take the following two actions: Define standard procedures and supporting guidance for regional offices to monitor MMIS activities. Require regional offices to regularly report on their MMIS monitoring activities to CMS’s central office. Agency Comments and Our Evaluation The Administrator of CMS provided written comments on a draft of this report (reprinted in app. II). In these comments, CMS identified actions it is taking or plans to take to address our recommendations and stated that effective management of IT investments is a critical priority at the agency. CMS contended that many of the agency’s improvements to its IT investment management process were not fully reflected in the report, and took exception with the need for up-to-date, documented processes to ensure consistency. Concerning our description of progress in implementing investment management processes, CMS commented that the report indicates that the agency has only established 2 out of 27 key practices needed to manage investments as a portfolio. CMS stated that this is misleading since the report also indicates that the agency has accomplished 20 of 38 foundational IT investment management practices. CMS also provided examples of the practices it has implemented, such as establishing an investment review board. In our report, we make a distinction between foundational practices, which are the Stage 2 key practices for establishing basic project-level selection and control capabilities, and portfolio-level practices, which are the Stage 3 key practices for managing investments as an integrated set of competing options. We also note that both of these sets of key practices are needed to implement the processes required by the Clinger-Cohen Act of 1996. On the basis of this, we state that CMS does not have the full suite of capabilities to manage its internal investments because it has only established a little over half of the foundational practices and 2 of 27 portfolio-level key practices, and we reiterate the need to fully establish both sets of practices to increase assurance that executives are selecting and managing the mix of investments that best meets the agency’s needs and priorities. In our report, the sections in which we discuss the implementation of specific key practices associated with critical processes from our IT investment management framework each describe CMS’s efforts and accomplishments to improve its IT investment management processes. These include all of the examples of accomplishments CMS provided in its comments. In its comments, CMS took issue with our reporting that its IT investment management guide did not reflect the current process, and that its procedures for selecting and reselecting IT investments were not fully documented. Although the agency fully agreed that an up-to-date guide would constitute a piece of an effective process, it commented that the emphasis should be on strengthening the process first and updating documentation later. CMS made three points: (1) it is not practical to publish an updated guide without having the effective and repeatable underlying process in place and noted that it is not provided the latitude to do this; (2) in the section of the report discussing instituting the investment board, the noted successful execution of key practices appears to be negated by the statement that the investment management processes are not documented; and (3) in the same section of the report, we are implying that an updated guide would improve rather than explain the process. We disagree with CMS that the process needs to be repeatable and strengthened before it can be documented. Documented procedures could actually serve to strengthen and improve the process by ensuring it is performed consistently. Finally, we are not negating the successful implementation of key practices to institute the investment board. We are simply emphasizing the importance of having documentation to drive the investment management process. In its comments, CMS also noted actions it is taking to (1) develop a plan to implement key practices in Stages 2 and 3; (2) revise existing documentation to reflect processes in place that are not formally documented; and (3) develop a plan that will be approved by senior management that will incorporate goals, objectives, and milestones required to further close the gaps between existing processes and our ITIM framework. Regarding our recommendation to improve its process for monitoring state MMIS activities and reporting to the central office, CMS stated that it is developing standard procedures and supporting guidance for the regional office(s) for monitoring these systems activities and reporting to the central office. We agree with CMS that these actions would address many of the weaknesses we identify in this report. CMS also provided some technical comments, which we have incorporated into the report as appropriate. As agreed with your offices, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days from the date of this letter. At that time, we will send copies to other interested congressional committees, the Secretary of Health and Human Services, the CMS Administrator, the CMS Chief Information Officer, and other interested parties. Copies will also be made available at no charge on our Web site at www.gao.gov. If you have any questions on matters discussed in this report, please contact David A. Powner at (202) 512-9286, or at pownerd@gao.gov, or Leslie G. Aronovitz at (312) 220-7600, or at aronovitzl@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III. Objectives, Scope, and Methodology The objectives of our review were to (1) evaluate Centers for Medicare & Medicaid Services (CMS) capabilities for managing its internal information technology (IT) investments, (2) determine any plans the agency might have for improving these capabilities, and (3) examine CMS’s process for approving and monitoring the state Medicaid management systems it funds. To address our first objective, we reviewed the results of the agency’s self- assessment of Stages 2 and 3 practices using our Information Technology Investment Management framework (ITIM) and validated and updated the results of the self-assessment through document reviews and interviews with officials. We reviewed written policies, procedures, and guidance and other documentation providing evidence of executed practices, including CMS’s IT Investment Management Process Guide, CMS’s Policy for IT Investment Management, and CMS’s fiscal year 2006/2007 budget process. We also reviewed the CMS Information Technology Investment Review Board (ITIRB) meeting minutes. We did not assess CMS’s progress in establishing the capabilities found in Stages 4 and 5 of the ITIM framework because CMS acknowledged that it had not executed any of the key practices in these higher maturity stages. In addition, we conducted interviews with officials from the Office of Information Services who have responsibility for the development and implementation of CMS’s IT investment management process. We compared the evidence collected from our document reviews and interviews with the key practices in our ITIM framework. We rated the key practices as “executed” on the basis of whether the agency demonstrated (by providing evidence of performance) that it had met the criteria of the key practice. A key practice was rated as “not executed” when we found insufficient evidence of a practice being executed or when we determined that there were significant weaknesses in CMS’s execution of the key practice. In addition, CMS was provided with the opportunity to produce evidence for key practices rated as “not executed.” As part of our analysis, we selected four CMS IT projects as case studies to verify that the critical processes and key practices were being applied. The projects were selected because they (1) supported different functional areas, (2) were in various life-cycle phases, and (3) required different levels of funding. The four projects are described below: Healthcare Integrated General Ledger Accounting System—The project is intended to standardize the collection, recording, and reporting of Medicare financial information by contractors. It is to replace the cumbersome ad hoc spreadsheets and “cuff” systems being used by Medicare contractors to accumulate and report financial information to CMS. The project’s life-cycle cost is estimated at about $567 million. Medicare Claims Processing Redesign—This project is intended to integrate and modernize the Common Working File system and Redesign and the Medicare Shared Systems enterprise claims processing applications and data systems. The modernization and unification of these systems is to allow CMS to significantly enhance program capabilities, integrity, performance, efficiencies, and maintainability; reduce program change implementation time frames; improve accuracy, timeliness, and quality of Medicare transaction processing; reduce system exposure to security risks; and facilitate use of the Internet. The project’s life-cycle cost is estimated at nearly $494 million. Medicare Managed Care System—This project is intended to cover the redesign of CMS’s managed care family of systems, including the legacy Group Health Plan system. It is to provide the platform for implementing requirements under the MMA. The project is intended to replace aging operations and to continue to support the agency’s managed care business needs until all functions are migrated to a new system. Its life- cycle cost is estimated at about $111 million. National Plan and Provider Enumeration System—The project is intended to implement a Health Insurance Portability and Accountability Act requirement to issue a unique identifier to each covered health care provider in the United States. It is expected to result in administrative savings by simplifying a complicated, multifaceted enumeration scheme, whereby a provider is issued different identifiers for electronic transactions by each health plan with which it does business, and sometimes multiple identifiers from a single plan. It will impact several million providers and health plans in the nation. The project’s life-cycle cost is estimated at about $38 million. For these projects, we reviewed project management documentation, such as project plans, business cases, status reports, and documentation on how these projects were selected by the ITIRB. We also interviewed the project managers for these projects. To address our second objective, we examined documentation on what management actions had been taken and what initiatives had been planned by the agency. This documentation included a requirements document for a tool CMS is currently implementing that is to help the agency with IT investment management, among other things. We also interviewed officials from the Office of Information Services to determine what efforts CMS had undertaken to improve IT investment management processes. To address our third objective, we reviewed documentation supporting CMS’s implementation of processes for (1) approving states’ requests for funding their Medicaid Management Information Systems (MMIS) and (2) monitoring these MMISs, including related legislation, policy, and implementing guidance. We also interviewed officials at CMS headquarters and at the 5 CMS regional offices with the highest fiscal year 2004 expenditures for administrative services, which includes MMISs. We conducted our work at CMS headquarters in Washington, D.C., and at 5 CMS regional offices located in New York, New York; Philadelphia, Pennsylvania; Chicago, Illinois; San Francisco, California; and Atlanta, Georgia, from January 2005 through September 2005 in accordance with generally accepted government auditing standards. Comments from the Centers for Medicare & Medicaid Services GAO Contacts and Staff Acknowledgments GAO Contacts Staff Acknowledgments In addition to the persons named above, William G. Barrick, Shaunessye Curry, Mary Beth McClanahan, Sabine R. Paul, and Amos Tevelow made key contributions to this report.

To carry out its mission of ensuring health care security for beneficiaries, the Centers for Medicare & Medicaid Services (CMS) relies heavily on information technology (IT) systems. In fiscal year 2005, CMS's total IT appropriations was about $2.55 billion, of which about $760 million, or 30 percent, was to support internal investments, and $1.79 billion was to fund the Medicaid Management Information Systems (MMIS) that states use to support their Medicaid programs. (GAO is using the term "internal" to refer to all of CMS' IT investments excluding state MMISs.) In light of the size and significance of these investments, GAO's objectives were to (1) evaluate CMS's capabilities for managing its internal investments, (2) determine any plans the agency might have for improving these capabilities, and (3) examine CMS's process for approving and monitoring state MMISs. Judged against GAO's framework for IT investment management, which measures the maturity of an organization's investment management process, CMS's capabilities for effectively managing its internal investments are limited. Specifically, the agency has established a little over half of the foundational practices it needs to manage individual investments and has executed 2 of the 27 key practices needed to manage investments as a portfolio. Until CMS fully establishes foundational and portfolio-level practices, executives will lack the assurance that they are managing the agency's collection of investments in a manner that minimizes risks and maximizes returns. CMS has initiated steps to improve its investment management process; however, these steps do not fully address the weaknesses GAO identifies in this report, nor are they coordinated with other needed improvement efforts into a plan that (1) is based on an assessment of strengths and weaknesses; (2) specifies measurable goals, objectives, and milestones; (3) specifies needed resources; (4) assigns clear responsibility and accountability for accomplishing tasks; and (5) is approved by senior-level management. Without such a plan and procedures for implementing it, CMS will be challenged in sustaining the commitment it needs to fully establish its investment management process. The process for approving requests for federal funding of MMIS activities (including development, operations, and maintenance activities) is characterized by standard procedures, guidance, and reported information to CMS's Center for Medicaid and State Operations. In contrast, the process for monitoring MMIS activities lacks standard procedures, guidance, and reporting requirements. Without these elements for monitoring MMIS activities, CMS may not be able to easily determine whether the state MMISs in which CMS invests close to $1.7 billion annually are facilitating the delivery of Medicaid benefits in the most effective and beneficial manner.

Background The Clean Air Act, a comprehensive federal law that regulates air pollution from stationary and mobile sources, was passed in 1963 to improve and protect the quality of the nation’s air. The act was substantially overhauled in 1970 when the Congress required EPA to establish national ambient air quality standards for pollutants at levels that are necessary to protect public health with an adequate margin of safety and to protect public welfare from adverse effects. EPA has set such standards for ozone, carbon monoxide, particulate matter, sulfur oxides, nitrogen dioxide, and lead. In addition, the act directed the states to specify how they would achieve and maintain compliance with the national standard for each pollutant. The Congress amended the act again in 1977 and 1990. The 1977 amendments were passed primarily to set new goals and dates for attaining the standards because many areas of the country had failed to meet the deadlines set previously. The act was amended again in 1990 when several new themes were incorporated into it, including encouraging the use of market-based approaches to reduce emissions, such as cap-and-trade programs. The major provisions of the 1990 amendments are contained in the first six titles. As requested, this report addresses EPA’s actions related to Titles I, III, and IV: Title I establishes a detailed and graduated program for the attainment and maintenance of the national ambient air quality standards; Title III expands and modifies regulations of hazardous air pollutant emissions and establishes a list of 189 hazardous air pollutants to be regulated; Title IV establishes the acid deposition control program to reduce the adverse effects of acid rain by reducing the annual emissions of pollutants that contribute to it. Although the Clean Air Act is a federal law, states and local governments are responsible for carrying out certain portions of the statute. For example, states are responsible for developing implementation plans that describe how they will come into compliance with national standards set by EPA. EPA must approve each state’s plan, and if an implementation plan is not acceptable, EPA may assume enforcement of the Clean Air Act in that state. Once EPA sets a national standard, it is generally up to state and local air pollution control agencies to enforce the standard, with oversight from EPA. For example, state air pollution control agencies may hold hearings on permit applications by power or chemical plants. States may also fine companies for violating air pollution limits. According to EPA, by many measures, the quality of the nation’s air has improved in recent years. Each year EPA estimates emissions that impact the ambient concentrations of the six major air pollutants for which EPA sets national ambient air quality standards. EPA uses these annual emissions estimates as one indicator of the effectiveness of its air programs. As figure 1 shows, according to EPA, between 1970 and 2004, gross domestic product, vehicle miles traveled, energy consumption, and U.S. population all grew; during the same time period, however, total emissions of the six principal air pollutants dropped by 54 percent. Despite this progress, large numbers of Americans continue to live in communities where pollution sometimes exceeds federal air quality standards for one or more of the six principal air pollutants. For example, EPA reported in April 2004 that 159 million people lived in areas of the United States where air pollution sometimes exceeds federal air quality standards for ground-level ozone. According to EPA, exposure to ozone has been linked to a number of adverse health effects, including significant decreases in lung function; inflammation of the airways; and increased respiratory symptoms, such as cough and pain when taking a deep breath. Moreover, in 2003, 62 million people lived in counties where monitors showed particle pollution levels higher than national particulate matter standards, according to a December 2004 EPA report. Long-term exposure to particle pollution is associated with problems such as decreased lung function, chronic bronchitis, and premature death. Even short-term exposure to particle pollution—measured in hours or days—is associated with such effects as cardiac arrhythmias (heartbeat irregularities), heart attacks, hospital admissions or emergency room visits for heart or lung disease, and premature death. EPA Has Implemented Almost All Required Actions, but Many Were Implemented Late EPA identified 452 actions required to meet the objectives of Titles I, III, and IV of the Clean Air Act Amendments of 1990. About half of these required actions were included under Title III, which also included the largest number of requirements with statutory deadlines. As shown in table 1, the 1990 amendments specified statutory deadlines for 338 of the Title I-, III-, and IV-related requirements. The numerous actions required to meet the objectives of Titles I, III, and IV of the 1990 amendments vary in scope and complexity. For example, Title I of the Clean Air Act requires EPA to periodically review and revise, as appropriate, the national health- and welfare-based standards for air quality. After EPA revises any one of these standards, states are responsible for developing plans that detail how they will achieve the revised standard. EPA then must review the individual state plans for each standard and decide whether to approve them. While EPA must review and approve all individual state plans submitted, each set of reviews is only counted as one action. Other Title I requirements, on the other hand, only require EPA to publish reports on air quality and emission trends. While the reports may represent a significant amount of effort, the steps required to implement national ambient air quality standards are inherently more difficult to accomplish and often require parties independent of EPA, such as state and local agencies, to pass legislation and issue, adopt, and implement rules. Comparing the requirements among titles also shows how they vary in complexity. For example, Title IV required EPA to develop a new market-based cap and trade program to reduce emissions of sulfur dioxide and a rate-based program to reduce emissions of nitrogen oxides from power plants. While developing the cap and trade program was a large undertaking on EPA’s part, it involved regulating a specified number of stationary sources in a single industry. In contrast, under Title III, EPA is required to implement technology-based standards for 174 separate categories of sources of hazardous air pollutants, involving many industries. As shown in table 2, a large portion of the requirements with statutory deadlines related to Titles I, III, and IV were met late. That is, 256 of the 338 requirements with statutory deadlines have been completed but were late. Of the 114 requirements without statutory deadlines, all but 3 of the requirements have been completed. On average, EPA met the requirements related to Titles I, III, and IV about 24, 25, and 15 months after their statutory deadlines, respectively. Of the 256 requirements that EPA met late, 162 were met within 2 years of their statutory deadline and 94 were completed more than 2 years after their deadlines (see table 3). Consequently, improvements in air quality associated with some of these requirements may have been delayed. EPA officials cited several factors to explain why the agency missed deadlines for so many requirements. Among these factors was an emphasis on stakeholders’ review and involvement during regulatory development, which added to the time needed to issue regulations. For example, according to an EPA official, the process to develop an early technology rule under Title III involved protracted negotiations among EPA, industry groups, a labor union, and environmental groups. The rule was finalized in October 1993, 10 months after its statutory deadline. In addition, EPA officials mentioned the need to set priorities among the tremendous number of new requirements for EPA resulting from the 1990 amendments, which meant that some of these actions had to be delayed. Moreover, competing demands caused by the workload associated with EPA’s responses to lawsuits challenging some of its rules caused additional delays. For example, the time needed to respond to litigation of previous rules impinged on EPA staff’s ability to develop new rules, according to agency officials. In addition, at the time of our 2000 report, EPA officials also attributed delays to the emergence of new scientific information that led to major Clean Air Act activities unforeseen by the 1990 amendments. For example, the emergence of new scientific information regarding the importance of regional ozone transport led to an extensive collaborative process between states in the eastern half of the country to evaluate and address the transport of ozone and its precursors. As of April 2005, 45 of the requirements related to Titles I, III, and IV with statutory deadlines that had passed have not been met. Thus, any improvements in air quality that would result from EPA meeting these requirements remain unrealized. The majority of the unmet requirements related to Title I are activities involving promulgating regulations that limit the emissions of volatile organic compounds from different groups of consumer and commercial products. According to EPA officials, these rules were never completed because EPA shifted its priorities toward issuing the Title III technology-based standards. Additionally, EPA officials noted that many states have implemented their own rules limiting emissions of volatile organic compounds from these products, and these state rules are achieving the level of emissions reductions that would be achieved by a national rule passed by EPA. However, EPA is currently being sued because it did not implement these rules by their statutory deadlines. According to an EPA official, the agency and the litigant have agreed on the actions to be taken to address the requirements, but they could not reach agreement on completion dates. As a result, EPA is currently awaiting court-issued compliance dates. In addition, 21 Title III requirements have yet to be met. Most of these are “residual risk” reviews of technology-based standards with deadlines prior to April 2005. That is, within 8 years of setting each technology-based standard, EPA is required to assess the remaining health risks (the residual risk) from each source category to determine whether the standard appropriately protects public health. Applying this “risk-based” approach, EPA must revise the standards to make them more protective of health, if necessary. EPA completed its first review and issued the first set of these risk-based amendments in March 2005. Two actions required by Title IV have not been met, but, according to EPA, the agency has decided not to pursue these actions further. The requirements were to (1) promulgate an opt-in regulation for process sources and (2) conduct a sulfur dioxide/nitrogen oxides inter-pollutant trading study. According to EPA officials, the agency decided not to promulgate the opt-in regulation because it determined that the federal resources needed to develop the rule would be well in excess of those available and the implementation of this provision would not reduce overall emissions. EPA officials also said that the rule would not be cost-effective due to these factors and the limited number of sources expected to use the opt-in option. EPA officials said that the agency decided not to pursue the sulfur dioxide/nitrogen oxides inter-pollutant study because of the lack of a trading ratio that would capture the complex environmental relationship between sulfur dioxide and nitrogen oxides and because an inter-pollutant trading program would be complex and unlikely to result in environmental benefits. The list of specific actions EPA is required to take to meet the objectives of Titles I and III of the Clean Air Act Amendments of 1990 includes requirements for periodic assessments of some of the standards related to these titles. Under the Clean Air Act, EPA is required every 5 years to review the levels at which it has set national ambient air quality standards to ensure that they are sufficiently protective of public health and welfare. If EPA determines it is necessary to revise the standard, the agency undertakes a rulemaking to do so. Each new national ambient air quality standard, in turn, will trigger a number of subsequent EPA actions under Title I, such as setting the boundaries of areas that do not attain the standards and approving state plans to correct nonattainment. As a result, the set of required actions related to Title I tends to repeat over time. Title III also includes requirements for periodic assessments of its technology-based standards. In addition to the residual risk assessments discussed above, the Clean Air Act requires that EPA review the technology-based standards every 8 years, and, if necessary, revise them to account for improvements in air pollution controls and prevention. The first round of these recurring reviews will occur concurrently with the first round of residual risk assessments, according to an EPA official. Moreover, EPA’s workload related to its air programs may increase as a result of recommendations for regulatory reform compiled by the Office of Management and Budget. For example, in response to a recommendation to permit the use of new technology to monitor leaks of volatile air pollutants, EPA plans to propose a rule or guidance in March 2006. Observations The Clean Air Act Amendments of 1990 constituted a significant overhaul of the Clean Air Act, and notable reductions in emissions of air pollutants have been attained as a result of the many actions these amendments required of EPA, states, and other parties. Currently, EPA has completed most of the 452 actions required by the 1990 amendments related to Titles I, III, and IV. The number, scope, and complexity of the required actions under each of these titles varied widely, and these differences, along with other challenges EPA faced, led to varying timeliness in implementing these requirements. Although EPA did not meet the statutory deadlines in many cases, we believe that the deadlines played an important role in EPA’s implementation of the myriad and diverse actions mandated in the 1990 amendments by providing a structure to guide and support the agency’s efforts to complete them. As EPA and the Congress now move on to addressing the remaining air pollution problems that pose health threats to our citizens, some points from our 2000 report on the implementation of the 1990 amendments bear repeating. First, some of the stakeholders we interviewed representing environmental groups and state and local government agencies expressed a preference for legislation and regulations that describe specific amounts of emissions to be reduced, provide specific deadlines to be met, and identify the sources to be regulated. Second, we, along with many of these stakeholders, concluded in that report that the acid rain program under Title IV could offer a worthwhile model for some other air quality problems because it set emission-reduction goals and encouraged market-based approaches, such as cap-and-trade programs, to attain these goals. While EPA officials noted that emissions-trading programs may not be suitable for all air pollutants, the agency has applied this approach to several pollutants since 2000. Specifically, EPA has issued final rules using cap-and-trade programs to achieve further reductions in sulfur dioxide and nitrogen oxides and to require reductions of mercury emissions for the first time. However, whether EPA can apply the cap-and-trade model to hazardous air pollutants such as mercury in the absence of express statutory authority to do so is unclear, particularly in light of the lawsuit that has been filed challenging EPA’s March 2005 rule on mercury emissions. Agency Comments and Our Evaluation We provided EPA with a draft of this report for its review and comment. EPA generally agreed with the findings presented in the report and provided supplemental information about the air quality, public health, and environmental benefits associated with implementation of the Clean Air Act Amendments of 1990 and comments related to its future challenges. The agency also provided technical comments, which we incorporated where appropriate. Appendix V contains the full text of the agency’s comments and our responses. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the date of this letter. At that time, we will send copies of this report to the appropriate congressional committees; the Administrator, EPA; and other interested parties. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions, please call me at (202) 512-3841. Key contributors to this report are listed in appendix VI. Title I The Clean Air Act requires that all areas of the country meet national ambient air quality standards (NAAQS), which are set by EPA at levels that are expected to be protective of human health and the environment. NAAQS have been established for six “criteria” pollutants: ozone, carbon monoxide, nitrogen dioxide, sulfur oxides, particulate matter, and lead. The act further specifies that EPA must assess the level at which the standards are set every five years and revise them, if necessary. To accomplish the objectives of Title I of the Clean Air Act Amendments of 1990, EPA identified 171 requirements. The specific requirements contained in Title I direct EPA to perform a variety of activities, many of which are related to implementing the NAAQS. Implementation of the standards involves several stages, many requiring efforts by both EPA and states. For example, once EPA has determined the appropriate air quality level at which to set a standard, the agency then goes through a designation process during which it identifies the areas of the country that fail to meet the standard. After the nonattainment areas are identified, states have primary responsibility for attaining and maintaining the NAAQS. To do this, states develop state implementation plans (SIPs) that specify the programs that states will develop to achieve and maintain compliance with the standards. Once a state submits a SIP to EPA, EPA is responsible for reviewing it and either approving or disapproving the plan. To assist states in developing their plans, EPA develops guidance documents that help states interpret the standards and provide information on how to comply. For example, EPA established several alternative control techniques documents for various sources that emit nitrogen oxides. These documents provide suggestions for states and industry on different techniques that can be used to reduce nitrogen oxides emissions. In some circumstances, EPA may provide guidance to the state and local air pollution control agencies through the issuance of EPA guidance and/or policy memos. For example, although designating areas as nonattainment or attainment is a complex and time-consuming process, EPA issued guidance through policy memos on the factors and criteria EPA used to make decisions for designating areas of the country as nonattainment. As of April 2005, EPA had completed 146 of the requirements that the agency must implement to meet the objectives of Title I. Sixty-one requirements that EPA had met by April 2005 had statutory deadlines. As table 4 shows, EPA met 16 of these requirements on time and missed the deadlines for 45 of them. EPA also completed 85 of the 88 requirements that did not have statutory deadlines. On average, Title I-related requirements that were met late were completed 24 months after their statutory deadline. As table 5 shows, the length of time by which requirements were met late for Title I varied. For example, 24 of the late requirements were met within 1 year of their statutory deadline while 8 requirements were completed more than 3 years late. According to EPA, the agency missed deadlines for Title I-related requirements for a number of reasons, such as (1) having to review a larger quantity of scientific information than was available in the past; (2) competing demands placed on agency staff who had to work concurrently on more than one major rulemaking; and (3) engaging in longer, more involved interagency review processes. According to agency officials, many of the requirements that EPA completed late arose due to issues beyond EPA’s control. For example, in implementing the ozone and particulate matter NAAQS, the emergence of new scientific information regarding the importance of regional ozone transport led to an extensive collaborative process between states in the eastern half of the country to evaluate and address the transport of ozone and its precursors. This information was then taken into account in the review and subsequent revision of the ozone NAAQS in 1997. In addition, EPA was sued on both the 1997 ozone and particulate matter standards, which delayed EPA’s action to designate areas as nonattainment. Moreover, the ongoing review of the particulate matter NAAQS has been significantly extended as a consequence of the unprecedented amount of new scientific research that has become available since the last review, according to EPA. Currently, EPA has not completed 22 requirements related to Title I with statutory deadlines (see table 6). Fifteen of these requirements call for rules involving different groups of consumer and commercial products, six involve reviewing the NAAQS for the criteria pollutants, and one requires EPA to finalize approving the state implementation plans for ozone and carbon monoxide. The outstanding rules involving the consumer and commercial products are to limit volatile organic compound emissions from various products, such as cleaning products, personal care products, and a variety of insecticides. The 1990 amendments specified that the rules be promulgated in four groups, based on a priority ranking established by EPA that includes a number of factors, such as the quantity of emissions from certain products. While EPA completed the first group of rules by September 1998, the agency had not done anything further to implement the remaining three groups of rules. According to EPA officials, no further work had been done to implement the rules because EPA shifted its priorities toward issuing the Title III technology-based standards. Additionally, EPA officials noted that many states have implemented their own rules limiting emissions of volatile organic compounds from these products, and these state rules are achieving the level of emissions reductions that would be achieved by a national rule passed by EPA. An EPA official stated that a national rule would not provide much of an additional benefit in the areas where emissions of volatile organic compounds are a problem and that a national rule would be fought by industry in states where emissions of volatile organic compounds are not a problem. However, promulgating these rules is a requirement under the 1990 amendments, and according to EPA officials, the agency is currently being sued by the Sierra Club, an environmental advocacy group, for not promulgating them by their statutory deadline. EPA and the litigant have agreed on the actions to be taken to address the requirements, however, they could not reach agreement on the completion dates and are currently awaiting court-issued compliance dates. In addition, the other six unmet requirements related to Title I involve potentially revising the NAAQS for the criteria pollutants. While EPA has been involved in litigation regarding four of these standards, litigation is still ongoing only regarding the lead NAAQS. EPA is being sued for not reviewing since 1991 the lead NAAQS that was originally issued in October 1978. According to EPA officials, the agency did not undertake this review because it shifted its focus to controlling other sources of lead, such as drinking water and hazardous waste facilities. As shown in table 6, EPA expects to complete the required reviews for four of the criteria pollutants by 2009. In addition to the unmet requirements discussed above, EPA has three requirements related to Title I without statutory deadlines that have not yet been completed. The first is to develop a proposed particulate matter implementation rule, which EPA expects to complete in summer 2005. The second is the promulgation of methods for measurement of visible emissions; EPA has not yet set a completion date for this action. The third is the promulgation of phase II of the 8-hour ozone implementation rule, expected in summer 2005. Title III Title III of the Clean Air Act Amendments of 1990 established a new regulatory program to reduce the emissions of hazardous air pollutants, specifying 189 air toxics whose emissions would be controlled under its provisions. The list includes organic and inorganic chemicals, compounds of various elements, and numerous other toxic substances that are frequently emitted into the air. Title III was intended to reduce the population’s exposures to these pollutants, which can cause serious adverse health effects such as cancer and reproductive dysfunction. After identifying the pollutants to be regulated, Title III directs EPA to impose technology-based standards, or Maximum Achievable Control Technology (MACT) standards, on industry to reduce emissions. These technology- based standards require the maximum degree of reduction in emissions that EPA determines achievable for new and existing sources, taking into consideration the cost of achieving such reduction, health and environmental impacts, and energy requirements. The process for developing each MACT standard may include surveying impacted industries, visiting sites, testing emissions, and conducting public hearings. As a second step, within 8 years after completing each technology-based standard, EPA is to review the remaining risks to the public and, if necessary, issue health-based amendments to each of the MACT rules to address such risks. The first set of these “residual risk” standards was finalized in March 2005; residual risk standards for the remaining MACT rules have not been completed. Finally, the Clean Air Act requires that EPA review and, if necessary, revise the technology-based standards at least every 8 years, to account for improvements in air pollution controls and prevention. The first round of these recurring reviews will occur concurrently with the first round of residual risk assessments, according to an EPA official. EPA identified 237 requirements—either with statutory deadlines prior to April 2005 or without statutory deadlines—that accomplish the objectives of Title III of the Clean Air Act Amendments of 1990. Most of the specific requirements under Title III direct EPA to promulgate MACT standards for various sources of hazardous air pollutants, such as dry cleaning facilities, petroleum refineries, and the printing and publishing industry. Title III also requires EPA to issue a variety of studies and reports to the Congress. For example, EPA has issued a series of studies on the deposition of air pollutants to the Great Lakes and other bodies of water. In addition, Title III also directs EPA to issue guidance on a number of subjects, including, for example, guidance regarding state air toxics programs. As of April 2005, EPA had met almost all of the requirements it identified to fully implement the objectives of Title III of the Clean Air Act Amendments of 1990, as shown in table 7. EPA’s most recent data show that it has taken the required action to meet 216 of the 237 Title III requirements, although 195 of these were met late, as shown in table 7. As shown above, the vast majority of Title III requirements were met late. On average, Title III requirements met late were completed 25 months after their statutory deadline. However, the length of time by which requirements were met late varied. As shown in table 8, 116 of the 195 requirements met late were completed within the first 2 years after the statutory deadline, while 29 were not completed until more than 3 years after the deadline. In explaining why requirements under Title III were met late, an EPA official discussed several factors. For example, the official said that the vast majority of the requirements involved the development of the MACT standards, which requires a significant amount of time and effort. The official also confirmed the reasons that requirements were met late provided by EPA officials at the time of our 2000 report, which included the need to prioritize, given resource limitations, the time needed to develop the policy framework and infrastructure of the MACT program, and the need for stakeholder participation in the rulemaking processes for certain MACT standards. In addition, the EPA official pointed out that in the past, litigation on issued rules has imposed additional demands on EPA staff working to meet outstanding requirements, leading to delays. There are 21 requirements under Title III that EPA had not met as of April 2005, most of which involve the residual risk reviews required after EPA has set technology-based standards (see table 9). Specifically, EPA has not yet reviewed residual risk for 19 MACT standards with deadlines prior to April 2005. EPA completed its first review and issued the first set of these risk-based amendments, for the coke oven batteries MACT standard, on March 31, 2005. In addition to the residual risk reviews, EPA has not yet completed its urban area source standards. The other unmet requirement under Title III calls for EPA to promulgate standards for solid waste incinerators not previously regulated under the title. According to an EPA official, the agency has focused its resources on regulating major solid waste incinerators, while this requirement consists of a “catch-all” to pick up remaining sources. Part of the challenge to completing this action has involved identifying what these other sources might be, according to the official. In addition to the unmet requirements above, EPA has not yet completed residual risk reviews for 76 MACT standards whose deadlines fall later than April 2005. Because these residual risk reviews are not due until 8 years after the completion of each technology standard, some of these residual risk reviews are not due until 2012. Title IV Title IV of the Clean Air Act Amendments of 1990 established the acid deposition control program. This program was designed to provide environmental and public health benefits through reductions in emissions of sulfur dioxide and nitrogen oxides, the primary causes of acid rain. The program provides an alternative to traditional “command and control” regulatory approaches by using a market-based trading program that allocates sulfur dioxide emission allowances to affected electric utilities. The program creates a cost-effective way for utilities to achieve their required sulfur dioxide emission reductions in the manner that is most suitable to them. Utilities can choose to buy, sell, or bank their allowances, as long as their annual emissions do not exceed the amount of allowances (whether originally allocated to them or purchased) that they hold at the end of the year. The nitrogen oxides program, on the other hand, does not cap emissions of nitrogen oxides, nor does it utilize an allowance trading system. Rather, this program, which focuses on emissions of nitrogen oxides from coal-fired electric utility boilers, provides flexibility for utilities in meeting emission limits by focusing on the emission rate to be achieved and providing options for compliance. To accomplish the objectives of Title IV of the Clean Air Act Amendments of 1990, EPA identified 44 requirements. Many of the required activities had to do with setting up the acid rain program—for example, conducting allowance auctions, issuing allowances to utilities, and establishing an allowance trading system. Additionally, EPA developed requirements for utilities to continuously monitor their emission levels to properly account for allowances. As of April 2005, EPA had completed 42 of the 44 requirements to meet the objectives of Title IV. There were 26 requirements in Title IV with statutory deadlines—EPA met 8 of them on time and missed 16; 2 others were unmet. There were 18 requirements that did not have statutory deadlines, and EPA has completed all of them. (See table 10.) On average, for the 16 requirements EPA met late, they were completed within approximately 15 months of their deadlines. As shown in table 11, 10 were met within 1 year of their deadline and 1 was met more than 3 years late. According to EPA officials, the agency was late with some of the requirements because interagency review and consultation with the Acid Rain Advisory Committee added time to the process. Officials consider this time spent worthwhile because it allowed for more stakeholder input into the rulemaking process, which may have made the rules less controversial. In fact, EPA officials stated that Title IV has been subjected to less litigation than other titles. According to the officials, litigation, however, did cause a delay in the effective date of the first phase of the acid rain nitrogen oxides reduction program by 1 year. EPA officials said the second phase of this program affected approximately three times more units and was implemented on schedule. EPA officials stated that since implementation of the acid rain program, changes have been necessary to keep the program up to date and successful. For example, EPA revised the continuous emission-monitoring rule in 1999 and 2002. According to EPA, these updates were necessary because of changes in the industry, such as technological advances and growth in the number of sources. Two Title IV requirements that EPA has not completed have statutory deadlines that have passed. The two requirements are (1) promulgating the opt-in regulation for process sources and (2) conducting a sulfur dioxide/nitrogen oxides inter-pollutant trading study. After conducting preliminary work for the first action, which was to have been completed by May 1992, EPA determined that the federal resources required to accomplish it were well in excess of those available. Additionally, according to an EPA official, there was evidence of very limited use of the opt-in election for other sources. Given these two factors, and EPA’s view that implementation of this provision would not reduce overall emissions, the agency determined that it would not be cost-effective to promulgate the regulation. Finally, EPA officials said that the agency decided not to pursue the second action, which was to have been completed by January 1994, for three reasons. Specifically, according to EPA officials, (1) they lacked a trading ratio that would capture the complex environmental relationship between sulfur dioxide and nitrogen oxides; (2) if the ratio issue could be resolved, an annual allowance system for nitrogen oxides would need to be created with which to trade sulfur dioxide allowances; and (3) it was not clear that implementing inter-pollutant trading would result in a net environmental benefit as there are multiple and complex health and environmental impacts of both sulfur dioxide and nitrogen oxides requiring a comprehensive analysis of impacts and cost-effectiveness beyond available resources. Objective, Scope, and Methodology The objective of this review was to determine the extent to which the Environmental Protection Agency (EPA) has completed the various actions required to meet the objectives of Titles I, III, and IV of the Clean Air Act Amendments of 1990. These titles, which respectively address national ambient air quality standards, hazardous air pollutants, and acid deposition control, are the most relevant to proposed legislation and recently finalized regulations that address emissions of air pollutants by power plants. To obtain information on the status of EPA’s implementation of requirements related to Titles I, III, and IV of the Clean Air Act Amendments of 1990—both those with and without statutory deadlines— we obtained lists of these requirements used for GAO’s 2000 report, Air Pollution: Status of Implementation and Issues of the Clean Air Act Amendments of 1990 (GAO/RCED-00-72) and held discussions with EPA officials knowledgeable about EPA’s workload required to meet the objectives of these titles. EPA officials verified the list of requirements related to each of the three titles for accuracy and completeness and provided documentation for any changes and additions made to the list. To determine how late the requirements were met, we compared the statutory deadline for each requirement to the month in which the requirement was met. For regulations that appeared in the Federal Register, for example, we considered the date the Federal Register issue was published to be the date the requirement was met, as agreed with EPA officials. In addition, we obtained explanations for why a large number of requirements were met after their statutory deadlines from two sources—our 2000 report and through discussions with EPA officials. For requirements that had not been met as of April 2005, we obtained additional information from EPA officials, including actions taken to date. To ensure the reliability of the information provided by EPA, we requested documentation for any changes EPA made to the list of requirements developed for our previous report and checked the documentation to ensure it matched the description of the requirement. In addition, we reviewed the information EPA submitted to ensure there were no duplicate entries or apparent inconsistencies; for any entries that appeared questionable, we followed up with EPA officials and usually obtained additional documentation. In certain cases, in particular with regard to Title III requirements, we also independently verified the status of the requirements. In all cases, EPA provided confirmation for the conclusions we reached as well as, in some cases, additional documentation. We determined that the data we obtained about the status of EPA’s implementation of required actions were sufficiently reliable for the purposes of this report. We also reviewed the methodology of two EPA studies that contained information about areas of the United States impacted by ground-level ozone and particulate matter. We determined that these studies were sufficiently methodologically sound to present their results in this report as background information. While this report addresses the extent to which EPA has met its requirements related to Titles I, III, and IV of the 1990 amendments, it does not address the status of requirements under other titles of the amendments or show the extent to which states have implemented applicable requirements. We conducted our work from January 2005 to May 2005 in accordance with generally accepted government auditing standards. Comments from the Environmental Protection Agency The following are GAO’s comments on EPA’s letter dated May 18, 2005. GAO Comments 1. As background, our report states that while air quality in the United States has steadily improved over the last few decades, more than a hundred million Americans continue to live in communities where pollution causes the air to be unhealthy at times, according to EPA. EPA has apparently interpreted this statement as implying that missed deadlines described in the report are responsible for the scope of the current particulate matter and ozone nonattainment problems. However, our report does not make that link. 2. EPA provided us several examples of cases in which a delay in the implementation of certain specific requirements did not lead to a delay in improvements in air quality. While our draft report indicated that requirements met late delayed improvements in air quality, we did not mean to suggest that all late requirements delayed improvements in air quality. Therefore, we revised the report to say that delays in implementation of some of the requirements may have led to delays in improvements in air quality. 3. During the course of our work, we discussed our proposed methodology with EPA officials and they agreed with our plan to use the Federal Register publication date as the completion date for relevant requirements. In commenting on the draft report, however, the agency stated that its Office of Air and Radiation generally considers that it has met its statutory obligation to issue a rule on the date on which a final rule is signed and disseminated to the public, which is likely to be earlier than the publication of that rule in the Federal Register. Although we agree with EPA’s assessment that using the signature date, rather than the Federal Register publication date, would not change the report’s conclusions, we revised the report to include EPA’s comment. 4. We revised report language throughout to reflect the fact that certain actions originally included as requirements of Title I of the Clean Air Act Amendments of 1990 were established earlier but are related to these amendments. GAO Contacts and Staff Acknowledgments GAO Contacts John B. Stephenson, (202) 512-3841 (stephensonj@gao.gov) Christine Fishkin, (202) 512-6895 (fishkinc@gao.gov) Staff Acknowledgments In addition to the individuals named above, Nancy Crothers, Christine Houle, Karen Keegan, Judy Pagano, and Nico Sloss made key contributions to this report.

While air quality in the United States has steadily improved over the last few decades, more than a hundred million Americans continue to live in communities where pollution causes the air to be unhealthy at times, according to the Environmental Protection Agency (EPA). The Clean Air Act, first passed in 1963, was last reauthorized and amended in 1990, when new programs were created and changes were made to the ways in which air pollution is controlled. The 1990 amendments included hundreds of requirements for EPA, as well as other parties, to take steps that will ultimately reduce air pollution. The amendments also established deadlines for many of these requirements. Since the 1990 amendments, various actions have been proposed to either amend the Clean Air Act or implement its provisions in new ways. GAO was asked to report on the current status of EPA's implementation of requirements under Titles I, III, and IV of the 1990 amendments. These titles, which address national ambient air quality standards, hazardous air pollutants, and acid deposition control, respectively, are the most relevant to proposed legislation and recently finalized regulations addressing emissions of air pollutants by power plants. As of April 2005, EPA had completed 404 of the 452 actions required to meet the objectives of Titles I, III, and IV of the Clean Air Act Amendments of 1990. Of the 338 requirements that had statutory deadlines prior to April 2005, EPA completed 256 late: many (162) 2 years or less after the required date, but others (94) more than 2 years after their deadlines. Consequently, improvements in air quality associated with some of these requirements may have been delayed. The numerous actions required to implement these titles varied in scope and complexity. For example, these actions included reviewing numerous state plans to comply with national health- and welfare-based air quality standards for six major pollutants, setting technology-based standards to reduce emissions from sources of hazardous air pollutants, and developing a new program to reduce acid rain. EPA officials cited several reasons for the missed deadlines, including the emphasis on stakeholders' involvement during regulatory development, which added to the time needed to issue regulations; the need to set priorities among the tremendous number of new responsibilities EPA assumed as a result of the 1990 amendments, which meant that some actions had to be delayed; and competing demands caused by the workload associated with EPA's response to lawsuits challenging some of its rules. Of the 48 requirements EPA had not met as of April 2005, 45 had associated deadlines, and 3 did not. The unmet requirements include 15 Title I requirements to promulgate regulations to limit the emissions of volatile organic compounds from a number of consumer and commercial products, such as household cleaners and pesticides. According to EPA officials, these rules were not completed because EPA shifted its priorities toward issuing standards related to the emissions of hazardous air pollutants regulated under Title III. However, the unmet requirements also include actions under Title III to periodically assess whether EPA's emissions standards for sources that emit significant amounts of hazardous air pollutants appropriately protect public health. These "residual risk" assessments are to be made within 8 years of the setting of each of the emissions standards, and 19 of these assessments are now past the 8-year mark. EPA completed the first of these residual risk assessments in March 2005. Any improvements in air quality that would result from EPA meeting these requirements remain unrealized. In commenting on a draft of this report, EPA generally agreed with our findings and provided supplemental information, primarily on the benefits of the Clean Air Act Amendments of 1990 and the reasons for implementation delays.

Background In 1980, the Congress passed the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), commonly known as Superfund, to clean up highly contaminated hazardous waste sites. The act gave EPA the authority to clean up the sites and to compel the parties responsible for the contamination to perform or pay for the cleanups. As of September 30, 1997, there were 1,353 sites on the NPL, and another 52 had been proposed for listing; 159 of the currently listed sites are federal sites. As of the end of fiscal year 1997, EPA had begun constructing cleanup remedies at 477 sites. It has completed constructing cleanup remedies at 504 sites. EPA’s goal is to complete the construction of remedies at 650 sites by the end of the year 2000, assuming level funding. Cleanup actions fall into two broad categories: removal actions and remedial actions. Removal actions are usually short-term actions designed to stabilize or clean up a hazardous site that poses an immediate threat to human health or the environment. Remedial actions are usually longer-term and more costly actions aimed at a permanent remedy. The sites that are referred to EPA for Superfund consideration are screened in a number of evaluations leading to a decision on whether to list the site on the NPL. Once listed, the sites are further studied for risks, and cleanup remedies are chosen, designed, and constructed. (See app. I for a more detailed description of the steps to place a site on the NPL and the time taken to accomplish those steps. See app. II for a similar discussion of the steps to clean up a site.) The Superfund Amendments and Reauthorization Act of 1986 (SARA) provided that facilities discovered after the act was passed should be evaluated for placement on the NPL within 4 years of the site’s discovery if EPA determines on the basis of a site inspection or preliminary assessment that such an evaluation is warranted. In 1992, EPA developed techniques to speed up the evaluation and cleanup of sites. These techniques included the expanded use of removal actions and the merging of certain site evaluations. EPA pilot-tested these techniques in 1992 and declared them operational in 1994. In 1995, EPA initiated its final round of administrative reforms, intended to make the program faster and achieve other improvements. In planning its Superfund activities in 1993, EPA set an expectation that sites would be cleaned up within 5 years from listing. More recently however, EPA has estimated that newly listed sites will be cleaned up within 8 years. For our reviews, we asked EPA to provide us with data on the length of time taken (l) to evaluate sites for possible placement on the NPL and (2) to complete cleanups of listed sites. The source of the data was EPA’s Comprehensive Environmental Response, Compensation, and Liability Information System (CERCLIS), which is the official repository of Superfund data. To measure the time taken to evaluate sites for listing, we identified sites that were added to the NPL each year and calculated the time between their listing and their “discovery,” i.e., their entry into CERCLIS. To measure the time for the cleanup process following listing, we identified the “operable units” at which remedial actions had been completed each year and calculated the time between the end of the remedial action and the date the site was added to the NPL. We also measured the time it had taken operable units to complete various phases of the Superfund process. For example, we calculated how long it took for cleanup remedies to be selected and designed. Sites Have Taken Longer to Be Listed on the NPL Generally, the average time between discovering a site and placing it on the NPL has increased over the life of the Superfund program. (See fig. 1.) As indicated by figure 1, sites listed in fiscal year 1996 had been discovered an average of 9.4 years earlier, down from 11.4 years in fiscal year 1995. The average site listing time has not met SARA’s 4-year goal since 1986. Although average listing times have generally lengthened, it should be understood that EPA can move quickly to list some sites if circumstances warrant. For example, in 1996, it listed three sites within 9 to 12 months after discovery when the Public Health Service’s Agency for Toxic Substances and Disease Registry issued a public health advisory concerning the sites. EPA used an expedited process that bypassed its normal evaluation process to list these sites. In addition, EPA may undertake removal actions at sites to deal with imminent threats before they are listed. However, listing is necessary before the full range of problems presented by many sites can be addressed under Superfund. The increase in the time to complete site listing is primarily a result of delays in processing sites in the end stage of the listing process, that is, after the sites have been inspected and the final analysis needed to evaluate their eligibility is done. (See app. I for a description of the Superfund process for evaluating sites for listing.) The time to complete this end stage for sites that were listed on the NPL rose from about 2 years in fiscal year 1986 to about 6 years in fiscal year 1996. A substantial portion of this time is accounted for by periods in which sites were in backlogs awaiting processing. Cleanup Completion Times Have Lengthened For sites with completed cleanups, the average time between the sites’ placement on the NPL and the completion of the cleanup increased in 1986 to 1996. Figure 2 shows the average time between listing a site on the NPL and the completion of cleanup at the operable units at the site. As the figure shows, completion times for cleanups of operable units have become progressively longer. In 1996, cleanup completions averaged 10.6 years for nonfederal operable units. As mentioned earlier, in 1993 EPA set an expectation for its regions to complete a cleanup within 5 years of a site’s listing. More recently, EPA said it expected that the sites listed in fiscal years 1993 through 1996 would be cleaned up in an average of 8 years. The increase in overall cleanup times was accompanied by a marked increase in the time to select cleanup remedies—the study phase of the cleanup process and the time during which attempts are made to reach settlements with the parties responsible for site contamination. This study phase was completed on average in about 2-1/2 years in 1986 but took an average of about 8 years in 1996. (See app. II for data on times to complete the remedy selection and design phases of the Superfund cleanup process.) Average Cleanup Times for Sites Listed in Fiscal Years 1986 Through 1994 Will Exceed 8 Years Our September 1997 report compared EPA’s estimate of future cleanup times with the program’s historical performance. We calculated, for the sites that began the cleanup process in fiscal years 1986 through 1994, (1) how long it took to clean up completed sites and (2) how long the uncompleted sites have been in the cleanup process. We found that, as of July 1, 1997, remedial action had been completed at 13 percent (95) of the 752 sites placed on the NPL in fiscal years 1986 through 1994. These remedial actions were completed in an average of 6.3 years after the sites were listed. As of the same date, remedial action had not been completed at 87 percent (657) of the sites listed in fiscal years 1986 through 1994. These uncompleted sites had been in the cleanup process an average of 8.1 years, that is, they had been listed on the NPL an average of 8.1 years earlier. Assuming that all remedial actions at these “in process” sites had been completed on July 1, 1997, the average cleanup duration for all sites listed on the NPL during the 9-year period would have been 7.9 years, almost as long as EPA’s 8-year estimate of the cleanup time for recently listed sites. But because such a large proportion of the sites are still in process, the average cleanup time for these sites will exceed 8 years, possibly by a substantial margin. EPA can reach its 8-year cleanup estimate for recently listed sites only through much faster cleanup times than have been achieved in the past. Factors Influencing the Sites’ Listing and Cleanup Times The Superfund database, which was the primary source for the data presented in this statement, does not contain all the information needed to fully explain the reasons for the changes in study and cleanup completion times over the history of the program. However, our past reviews and discussions with EPA officials have identified some of the factors that have lengthened listing and cleanup times. The time from discovery to listing has increased over the years for a number of reasons. A major factor was that the Superfund program started with a backlog of sites awaiting evaluation. In addition, program changes caused other delays. These changes included revisions to eligibility standards requiring the reevaluation of many sites, the need to seek states’ concurrence for site listings, and reductions in the annual number of sites that EPA added to Superfund. Furthermore, between 1994 through 1996, EPA’s budget for assessing sites was cut by some 50 percent and, according to EPA officials, EPA’s current priority is to finish cleaning up sites that have already been listed. The probability of long time frames for future site listings is indicated by the large number of sites that are awaiting a listing decision (about 3,000) and the small number of sites that have been admitted to the Superfund program in recent years (an average of 16 per year in fiscal years 1992 through 1996). EPA officials said that the upward trend in cleanup times for completed sites might be linked to the completion of more difficult cleanups. Our work supports this explanation. In September 1994, we reported that EPA’s data revealed longer average cleanup times for ongoing projects than for those already completed. In that report, we said that despite EPA’s efforts to expedite cleanups, cleanup times might grow longer because of the greater complexity of these ongoing projects. Also, EPA officials said that the effort to find the parties responsible for contaminating sites and reach cleanup settlements with them can increase cleanup times. They also thought that funding had affected the pace of cleanup. For example, they said that because of budget constraints, EPA was not able to fund $200 million to $300 million in cleanup projects in fiscal year 1996. In addition, EPA has shifted funding away from selecting remedies and toward the design and construction phases of the cleanup process. As indicated, remedy selection times have increased greatly over the years. EPA’s Reaction to Our Findings In responding to a draft of our March 1997 report and in a December letter to GAO, EPA objected to our portrayal of the program’s completion times. EPA challenged the fairness of our methodology, said that our report was inconsistent with earlier GAO reports, and said that it had recently accelerated the cleanup process. We have responded to these objections in our final March 1997 report and in a letter to the Administrator of EPA.We would like at this time to reemphasize a few of the points we made in our response to EPA’s comments: Our methodology accurately and fairly presents information on various trends in the Superfund program. This methodology shows increasing cleanup times for sites completing the Superfund cleanup process, not because it was “programmed” to produce this result, as EPA claimed, but because these times have, in fact, increased. Our reports and testimony over the last several years that have discussed the slow progress of site cleanups in the Superfund program are entirely consistent with our March 1997 report. For example, in 1994 we reported that EPA’s data indicated a trend toward longer cleanup times for projects still under way, even though the agency had initiated several major efforts to expedite the process. In fact, some of these “in process” sites are now reaching the end of cleanup and are reflected in the March 1997 report’s data on recent longer cleanup completion times. The data we presented in our March 1997 report are most relevant for judging the program’s performance for those sites that have completed the entire assessment and cleanup process or the segments of it—such as remedy selection—that we measured. Our work does not foreclose the possibility that process times have recently improved. EPA claims that such improvement has occurred, but in its comments to GAO, the agency has not provided data to adequately support its claim. Observations Increasing completion times for listing and cleanup are important because the Superfund program still has to deal with a large number of hazardous waste sites. While EPA has made progress at many NPL sites—completing the construction of remedies at more than 500 sites and starting construction at close to another 500 sites—construction has not yet been completed for most sites currently on the NPL, and thousands of additional sites remain in EPA’s inventory of potentially hazardous waste sites. Shortening the time required for future listings and cleanups will require (1) EPA and the states to come to grips with the large number of sites awaiting an NPL decision and (2) EPA to expedite the remedy selection process. Mr. Chairman, this concludes my prepared statement. I will be happy to respond to your questions or the questions of committee members. Time Taken to Accomplish the Principal Steps in the Process of Placing Sites on the NPL We examined the time taken to accomplish the principal steps in the process of placing a site on the National Priorities List (NPL)—the preliminary assessment, the site inspection, and the proposal to list the site as a national priority. Steps in the Process of Listing a Site The Environmental Protection Agency’s (EPA) regulation implementing the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) outlines a formal process for placing hazardous waste sites on the NPL (see fig. I.1). The listing process starts when EPA receives a report of a potentially hazardous waste site. A state government or private citizen most often reports a nonfederal site. EPA enters a potentially contaminated site into a database known as the Comprehensive Environmental Response, Compensation, and Liability Information System (CERCLIS). EPA or the state in which the potentially contaminated nonfederal site is located then conducts a preliminary assessment to decide whether the site poses a potential threat to human health and the environment. If the site presents a serious, imminent threat, EPA may take immediate action—called a removal action—to deal with the acute problems. If the preliminary assessment shows that the site warrants further study, EPA may proceed to the next step of the evaluation process, the site inspection, which takes a more detailed look at possible contamination. If at any point the site is found not to pose a potential threat serious enough to warrant federal attention, the site can be eliminated from further consideration under CERCLA. If warranted by the results of the site inspection, EPA applies the hazard ranking system to evaluate the site’s potential risk to public health and the environment. The hazard ranking system is a numerically based scoring system that uses information from the preliminary assessment and the site inspection to assign each site a score ranging from 0 to 100. This score is used as a screening tool to determine whether a site should be considered for further action under CERCLA. A site with a score of 28.5 or higher is considered for placement on the NPL. EPA first proposes a site for placement on the NPL and then, after receiving public comments, either places it on the NPL or removes it from further consideration. The hazardous waste sites on the NPL represent the highest priorities for cleanup nationwide. Preliminary Assessments Figure I.2 shows, for nonfederal sites, the average time taken to complete a preliminary assessment of conditions at a site following its discovery. Figure I.2 shows that in 1987 through 1989, EPA sharply reduced the average time between the discovery of a site and the completion of the preliminary assessment at nonfederal sites. EPA officials attributed this decrease to EPA’s effort to reduce the time for completing preliminary assessments following the passage of the Superfund Amendments and Reauthorization Act of 1986 (SARA). After SARA’s passage, EPA adopted a policy of completing a preliminary assessment within 1 year of a site’s discovery. The preliminary assessment was completed within a year of discovery at about two-thirds of the sites that were discovered after fiscal year 1987 and were preliminarily assessed by the end of fiscal year 1995. The officials said that EPA’s efforts to complete assessments within 1 year had reduced the backlog of sites needing assessments and shortened the time required for the assessments. However, since 1989, the time from the discovery of a site to the completion of the preliminary assessment has gradually increased. Site Inspections Figure I.3 shows, for nonfederal sites, the average time between discovery of the site and completion of the site inspection. As figure I.3 shows, the average time from the discovery of the site to the completion of the site inspection has declined in recent years. EPA has made progress over the past 5 years in reducing the time from discovery to completion of the site inspection for nonfederal sites. In 1991, EPA took an average of 6.6 years to complete the site inspection, whereas in 1996, it brought this average down to 4.1 years. EPA officials told us that the time for completing site inspections increased until 1991 because EPA concentrated its resources on completing preliminary assessments within 12 months, an effort that created a backlog of site inspections. They said that after reducing the backlog of preliminary assessments, EPA focused on reducing the backlog of site inspections, bringing about the recent improvement in the time for completing site inspections. Proposing a Site as a National Priority Figure I.4 shows, for nonfederal sites, the average time between completing the site inspection and proposing to place the site on the NPL. As figure I.4 shows, the average time required to propose a site for placement on the NPL generally increased for nonfederal sites in 1986 through 1996. For nonfederal sites proposed for listing in 1986, the proposal took 20 months from the completion of the site inspection, compared with 6 years in 1996. According to EPA officials, the increases in the time required to propose sites for listing are partly attributable to revisions in the hazard ranking system mandated by SARA. SARA directed EPA to obtain additional data so that the system could more accurately assess the relative risk to human health and the environment posed by sites and facilities nominated to the NPL. EPA officials said that the agency decided to limit listings while it was revising the hazard ranking system. EPA announced in April 1987 that it was considering revisions to the system, and in December 1988 it requested comments on proposed revisions. In December 1990, EPA promulgated final revisions to the hazard ranking system. EPA officials said that the revisions to the hazard ranking system led EPA to seek additional data on 5,275 nonfederal sites in 1992 through 1996. For these sites, EPA developed a temporary intermediate step—referred to as a site inspection prioritization—to gather the additional information needed on the sites’ risks to human health. EPA officials also said that the time taken to assess sites has grown because of the large backlog of sites at the start of the Superfund program, enforcement activities, and the need to seek a state’s concurrence for listing a site. In addition, the number of sites placed on the NPL has declined in recent years. Duration of Evaluation Steps We attempted to obtain data from CERCLIS showing the duration of some of the major steps in the process of evaluating sites for placement on the NPL: the preliminary assessment, the site inspection, and the site inspection prioritization. However, the starting date for many of these steps is not recorded in the database. For example, the beginning and ending dates are available for only 27 percent (4,693 of 17,469) of the site inspections completed at nonfederal sites through fiscal year 1995. Time Taken to Accomplish the Principal Steps in the Process of Cleaning Up Sites In addition to measuring the total time taken from the placement of a site on the National Priorities List (NPL) to the completion of its cleanup, we examined the time taken to complete two of the principal intermediate steps: (1) the preparation of the record of decision, which documents the final remedy selected after the completion of the remedial investigation and feasibility study (RI/FS), and (2) the preparation of the remedial design, which includes the technical drawings and specifications for the selected remedy. We also obtained data on the duration of the RI/FS, the remedial design, and the remedial action. Steps in the Process of Cleaning Up a Site The Environmental Protection Agency’s (EPA) regulation implementing the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) outlines the remedial process for cleaning up sites on the NPL (see fig. II.1). The remedial responses to an NPL site consist of several phases. If a site is divided into discrete cleanup projects, known as operable units, each of the operable units may pass through these phases. First, through the RI/FS, the conditions at a site are studied, problems are identified, and alternative methods to clean up the site are evaluated. Then, a final remedy is selected, and the decision is documented in a record of decision. Next, during an engineering phase called the remedial design, technical drawings and specifications are developed for the selected remedy. Finally, in the remedial action phase, a cleanup contractor begins constructing the remedy according to the remedial design. Once EPA, in consultation with the state in which the site is located, determines that the work at a site has achieved all of the desired cleanup goals, the site can be removed (deleted) from the NPL. Selecting a Remedy Figure II.2 shows, the average time taken from the placement of a nonfederal site on the NPL to the selection of a remedy for cleanup of its operable units. Figure II.2 shows that the average time taken to select a remedy at nonfederal sites has steadily increased over the years. In 1986, selecting a remedy after a site was listed took an average of 2.6 years, compared with an average of 8.1 years in 1996. The cleanup phase that ends with the selection of a remedy comprises two periods: the time between listing and the start of the RI/FS and the time for the RI/FS. Both of these periods add significantly to the total time taken to complete cleanups. For nonfederal sites at which RI/FSs were begun from 1991 through 1996, an average of 4.5 years had elapsed since the sites were proposed for listing. For the nonfederal sites at which RI/FSs were completed in 1995 (the last year for which complete data were available), the RI/FS took an average of 4.4 years to complete, or about 2 years more than in 1986. Designing a Remedy Figure II.3 shows the average time taken to develop the remedial design—the technical drawings and specifications for the selected remedy—for nonfederal operable units. The elapsed time is measured from the date of a nonfederal site’s placement on the NPL. Duration of Cleanup Steps EPA’s records indicate that the actual time taken recently to complete the latter phases of the cleanup process—the remedial design and the remedial action—is less than one-half of the total time taken, from listing, to complete recent remedial actions. Nonfederal remedial designs took 2.3 years to complete in 1996, up from 1.6 years in 1991. Nonfederal remedial actions took about 2 years in 1996, essentially as long as they took in 1991. The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. Each day, GAO issues a list of newly available reports and testimony. To receive facsimile copies of the daily list or any list from the past 30 days, please call (202) 512-6000 using a touchtone phone. A recorded menu will provide information on how to obtain these lists.

GAO discussed two of its recent reports on the pace of cleanup in the Superfund program, focusing on the: (1) time taken to evaluate hazardous waste sites for possible placement on the National Priorities List (NPL) and the time to clean them up after the listing; and (2) status of cleanup for sites listed from 1986 to 1994. GAO noted that: (1) GAO's March 1997 report stated that the Environmental Protection Agency (EPA) took an average of 9.4 years--calculated from the date of each site's discovery--to evaluate and process the nonfederal sites it added to the NPL in 1996; (2) this evaluation and processing time was generally longer than for prior years; (3) the 1986 Superfund Amendments and Reauthorization Act (SARA) requires EPA to evaluate nonfederal sites for listing, when warranted, within 4 years of their discovery; (4) listing decisions were made within 4 years of their discovery for 43 percent of the 8,931 nonfederal sites discovered in 1987 through 1991--the last year for which an analysis could be done at the time of GAO's review; (5) a number of factors contributed to the increased time to list a site, including a backlog of sites awaiting evaluation and a reduction in the annual number of sites being added to the NPL; (6) GAO's March report also stated that cleanup times have also lengthened for completed projects; (7) nonfederal cleanup projects completed in 1986 through 1989 were finished, on average, 3.9 years after the sites were placed on the NPL; (8) by 1996, however, nonfederal cleanup completions averaged 10.6 years; (9) although SARA did not set deadlines for completing cleanups within a certain number of years, EPA set an expectation for 1993 for its regions to complete a cleanup within 5 years of a site's listing; (10) much of the time to complete cleanups is attributable to the early planning phases of the cleanup process when the decision is made on the selection of cleanup remedies; (11) actual construction work at sites is being done quicker than the selection of cleanup remedies; (12) EPA officials attributed the increased completion times for cleanups to the growing complexity of sites, efforts to reach settlements with parties responsible for site contamination, and resource constraints; (13) GAO's September report stated that because a large portion--87 percent--of the sites listed on the NPL in fiscal years 1986 through 1994 were still in the Superfund cleanup process as of July 1, 1997, the average cleanup time for this group of listed sites will exceed 8 years, possibly by a substantial margin; (14) EPA stated that the methodology used in GAO's March 1997 report was biased in favor of showing increasing completion times and that the report was inconsistent with GAO's earlier Superfund reports; (15) it claimed to have recently speeded up the Superfund process; and (16) GAO believes that its March 1997 report fairly portrays trends in the program and is consistent with its earlier reports.

FAA Depends on Information Processing to Fulfill Its Mission In ensuring a safe, secure, and efficient airspace system that contributes to national security and the promotion of U.S. airspace, FAA administers a wide range of aviation-related programs, such as those to certify the airworthiness of new commercial aircraft designs, inspect airline operations, maintain airport security, and control commercial and general aviation flights. Integral to executing each of FAA’s programs are extensive information processing and communications technologies. For example, each of FAA’s 20 en route air traffic control facilities, which control aircraft at the higher altitudes between airports, depends on about 50 interrelated computer systems to safely guide and direct aircraft. Similarly, each of FAA’s almost 100 flight standards offices, responsible for inspecting and certifying various sectors of the aviation industry, is supported by over 30 mission-related safety database and analysis systems. Because of the complexity of these systems supporting FAA’s mission, many of them are unique to FAA, not off-the-shelf systems that could be readily maintained by vendors. FAA also has numerous, complex information processing exchanges with various external organizations, including airlines, aircraft manufacturers, general aviation pilots, and other government agencies, such as the National Weather Service (NWS) and the Department of Defense. Over the years, these organizations and FAA have built vast networks of interrelated systems. For example, airlines’ flight planning systems are linked to FAA’s Enhanced Traffic Management System, which monitors flight plans nationwide, controls high-traffic situations, and alerts airlines and airports to bring in more staff during busy periods. As another example, FAA facilities rely on weather information from NWS ground sensors, radars, and satellites to control and route aircraft. It is easy to see, then, that should FAA systems not be Year 2000 compliant, the domino effect would be far-reaching. In fact, representatives of major airlines are concerned that even if their own systems are ready for the millennium, they could not fly until FAA’s systems were Year 2000 compliant. FAA’s Year 2000 Awareness, Assessment Work Incomplete; Extent of Problem Unknown To assist agencies in resolving the Year 2000 problem, we have prepared a guide that discusses the scope of the challenge and offers a structured, step-by-step approach for reviewing and assessing an agency’s readiness to handle this challenge. The guide describes in detail five phases, each of which represents a major Year 2000 program activity or segment. The first phase, awareness, entails gaining executive-level support and sponsorship and ensuring that everyone in the organization is fully aware of the issue. During this phase a Year 2000 program team is also established, and an overall strategy developed. The second phase, assessment, entails assessing the likely Year 2000 impact on the enterprise, identifying core business areas, inventorying and analyzing the systems supporting those areas, and prioritizing their conversion or replacement. Contingency planning is also initiated, and the necessary resources identified and secured. FAA recognizes that the upcoming change of century poses significant challenges. It began Year 2000 problem awareness activities in May 1996, and within 3 months had established a Year 2000 product team and designated it the focal point for Year 2000 within FAA. A Year 2000 steering committee was also established. Since then, the product team and steering committee have conducted various awareness activities and have briefed FAA management. In September 1996 the product team issued the FAA Guidance Document for Year 2000 Date Conversion. Yet FAA was late in designating a Year 2000 program manager and its initial program manager recently retired. FAA has not yet selected a permanent replacement and needs to fill this position as soon as possible. Further, its strategic plan—defining program management responsibilities and providing an approach to addressing the millennium challenge—has yet to be made final. A draft of this plan was provided to the Administrator on December 1, 1997, and we understand that it is now being revised. Until an official agencywide strategy is available, FAA’s executive management will not have the approved road map they need for achieving Year 2000 compliance. The lack of a formal agencywide strategy also means that FAA’s program manager position lacks the authority to enforce Year 2000 policies. As a result, each line of business within the agency will have to decide if, when, and how to address its Year 2000 conversion, irrespective of agency priorities and standards. Additionally, FAA’s inventory of all information systems and their components is still evolving. According to a Year 2000 program official, FAA’s inventory of 741 systems was completed on December 29, 1997. However, we have found that the inventory changed on at least three occasions since then and, by January 23, 1998, had reached 769 systems. Other crucial tasks include an assessment of the criticality of the systems in the inventory, and deciding whether they should be converted, replaced, retired, or left as is. On January 30, 1998, we were told by a Year 2000 program official that all outstanding systems assessments were to be received that day, but that review and validation of these assessments would continue during February. Assessing the likely severity of systems failures is crucial as well, yet FAA only recently began to examine the likely impact of Year 2000-induced failures; this assessment is due to be presented to FAA management this month, February 1998. Without the thorough definition of a program’s scope and requirements that only such inventorying and assessment can provide, cost estimates are uncertain at best, as the agency acknowledges. FAA’s current Year 2000 program cost estimate of $246 million will likely change once the agency more accurately identifies its inventory and determines how it will go about making its systems Year 2000 compliant. On the basis of our discussions with FAA personnel, it is clear that FAA’s ability to ensure the safety of the National Airspace System and to avoid the grounding of planes could be compromised if systems are not changed. FAA’s organization responsible for air traffic control reported that 34 of the 100 mission-critical systems it initially assessed were likely to result in catastrophic failure if they were not renovated. FAA plans to renovate all of these systems. As of January 30, 1998, assessments of another 140 mission-critical air traffic control systems were continuing. The Host Computer System: Critical Information Processing Link As FAA completes its systems assessments, it faces difficult decisions about how to renovate, retire, or replace its date-dependent systems. One of the most significant examples is FAA’s Host Computer System—the centerpiece information processing system in FAA’s en route centers—which runs on IBM mainframe computers. Key components of the Host include its operating system, application software, and microcode—low-level machine instructions used to service the main computer. While FAA officials expressed confidence that they have resolved any date dependencies in the Host’s operating system and application software, IBM reported that it has no confidence in the ability of its microcode to survive the millennium date change because it no longer has the skills or tools to properly assess this code. IBM has therefore recommended that FAA purchase new hardware. Given these concerns, FAA—in an attempt to help ensure success and minimize risk—is considering moving in two directions simultaneously: It is continuing its assessment of the microcode with a plan to resolve and test any identified date issues, while at the same time preparing to purchase and implement new hardware, called Interim Host, at each of its 20 en route centers before January 1, 2000. Yet the purchase of new hardware carries its own set of risks—risks that FAA must mitigate in a short period of time. These are at least fourfold. First, Lockheed Martin, currently the Host software support contractor, will be responsible for porting the existing Host operating system and application software to the new hardware. This software conversion requires extensive testing to ensure that air traffic control operations are not affected. Unexpected problems in testing and certifying the new system for use in real-time operations may also become apparent. Second, the Interim Host will have to be deployed concurrently with FAA’s new Display System Replacement (DSR), compounding the risk of delays and problems. When upgrading parts of a safety-critical system such as the Host and DSR, it is simpler and safer to upgrade one part at a time. Third, deploying the Interim Host to 20 en route centers in less than 2 years will be very difficult. As a point of reference, FAA’s Display Channel Complex Rehost took almost 2 years to deploy to just five centers. Fourth, by moving quickly to purchase the Interim Host, FAA may not be purchasing a system that best meets its long-term needs. For example, alternative mainframe systems may provide more communications channels—something the Host currently depends on peripheral systems to provide. External Organizations Also Concerned About FAA Year 2000 Compliance External organizations are also concerned about the impact of FAA’s Year 2000 status on their operations. FAA recently met with representatives of airlines, aircraft manufacturers, airports, fuel suppliers, telecommunications providers, and industry associations to discuss the Year 2000 issue. At this meeting participants raised the concern that their own Year 2000 compliance would be irrelevant if FAA were not compliant because of the many system interdependencies. Airline representatives further explained that flights could not even get off the ground on January 1, 2000, unless FAA was substantially Year 2000 compliant—and that extended delays would be an economic disaster. Because of these types of concerns, FAA has now agreed to meet regularly with industry representatives to coordinate the safety and technical implications of shared data and interfaces. Little Time Remains for Critical Renovation, Validation, and Implementation Activities, Placing January 1, 2000, Readiness at Risk One result of delayed awareness and assessment activities is that the time remaining for renovation, validation, and implementation can become dangerously compressed. Renovation, validation, and implementation activities are the three critical final phases in correcting Year 2000 vulnerabilities. Renovation involves converting, replacing, or eliminating selected systems and applications. Validation entails testing, verifying, and validating all converted or replaced systems and applications, and ensuring that they perform as expected. Implementation involves deploying, operating, and maintaining Year 2000-compliant systems and components. Contingency plans are also implemented, if necessary. FAA has started to renovate some of the systems it has already assessed. However, because of the agency’s delays in completing its awareness and assessment activities, time is running out for FAA to renovate all of its systems, validate these conversions or replacements, and implement its converted or replaced alternatives. FAA’s delays are further magnified by the agency’s poor history in delivering promised system capabilities on time and within budget, which we have reported on in the past. FAA’s weaknesses in managing software acquisition will also hamper its renovation, validation, and implementation efforts. Given the many hurdles that FAA faces and the limited amount of time left, planning for operational continuity through the turn of the century becomes ever more urgent. To ensure the ability to carry out core functions, such planning defines assumptions and risk scenarios, operational objectives, time frames, priorities, tasks, activities, procedures, resources, and responsibilities. Such planning also lays out the specific steps and detailed actions that would be required to reestablish functional capability for mission-critical operations in the event of prolonged disruption, failure, or disaster. We plan to issue a guide later this month, in exposure draft form, to assist agencies in ensuring business continuity by performing necessary contingency planning for the Year 2000 crisis. Structured, Rigorous Approach Can Reduce Level of Risk, but Urgent Action Essential FAA’s delays to date put the agency at great risk. The coming millennium cannot be postponed, and FAA will continue to be hamstrung until all inventorying and assessments have been completed. Once the degree of vulnerability has been determined, a structured, five-phase approach with rigorous program management—such as that outlined in our assessment guide—can offer a road map to the effective use of available resources, both human and financial. But time is short. Should the pace at which FAA addresses its Year 2000 issues not quicken, and critical FAA systems not be Year 2000 compliant and therefore not be ready for reliable operation on January 1 of that year, the agency’s capability in several essential areas—including the monitoring and controlling of air traffic—could be severely compromised. This could result in the temporary grounding of flights until safe aircraft control can be assured. Avoiding such emergency measures will require stronger, more active oversight than FAA has demonstrated in the past. Our report being released today makes a number of specific recommendations to increase the likelihood that FAA systems will be Year 2000 compliant on January 1 of that year. In summary, we recommend that the Secretary of Transportation direct that the Administrator, FAA, take whatever action is necessary to expedite overdue awareness and assessment activities. At a minimum, this would include issuing a final FAA Year 2000 plan providing the Year 2000 program manager with the authority to enforce Year 2000 policies and outlining FAA’s strategy for addressing the date change; assessing how its major business lines and the aviation industry would be affected if the Year 2000 problem were not corrected in time and using these results to help rank the agency’s Year 2000 activities; completing inventories of all information systems and their components, completing assessments of all inventoried systems to determine criticality and whether the system will be converted, replaced, or retired; determining priorities for system conversion and replacement based on establishing plans for addressing identified date dependencies; developing plans for validating and testing all converted or replaced crafting realistic contingency plans for all business lines to ensure the continuity of critical operations; and developing a reliable cost estimate based on a comprehensive inventory and completed assessments of the various systems’ criticality, and how their needs for modification will be addressed. Officials of both FAA and the Department of Transportation generally agreed with our findings, conclusions, and recommendations. FAA’s CIO stated that FAA recognizes the importance of addressing the Year 2000 problem and plans to implement our recommendations. This concludes my statement, and I would be pleased to respond to any questions that you or other Members of the Subcommittees may have at this time. The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. Each day, GAO issues a list of newly available reports and testimony. To receive facsimile copies of the daily list or any list from the past 30 days, please call (202) 512-6000 using a touchtone phone. A recorded menu will provide information on how to obtain these lists.

Pursuant to a congressional request, GAO discussed the Federal Aviation Administration's (FAA) efforts to address the year 2000 problem, focusing on: (1) FAA's reliance on information processing; (2) where the agency stands today; (3) what remains at risk; and (4) what GAO recommends must be done to increase the likelihood that FAA systems will be year 2000 compliant by January 1 of that year. GAO noted that: (1) many of FAA's systems could fail to perform as needed when using dates after 1999, unless proper date-related calculations can be assured; (2) the implications of FAA's not meeting this immovable deadline are enormous and could effect hundreds of thousands of people through customer inconvenience, increased airline costs, grounded or delayed flights, or degraded levels of safety; (3) FAA's progress in making its systems ready for the year 2000 has been too slow; (4) at its current pace, it will not make it in time; (5) the agency has been severely behind schedule in completing basic awareness activities, including establishing a program manager with responsibility or its year 2000 program and issuing a final, overall year 2000 strategy; (6) further, FAA does not know the extent of its year 2000 problem because it has not completed key assessment activities; (7) specifically, it has yet to analyze the impact of its systems' not being year 2000 compliant, inventory and assess all of its systems for date dependencies, make final its plans for addressing any identified date dependencies, or develop plans for continued operations in case systems are not corrected in time; (8) until these activities are completed, FAA cannot know the extent to which it can trust its systems to operate safely using dates beyond 1999; (9) delays in completing awareness and assessment activities also leave FAA little time for critical renovation, validation, and implementation activities--the final three phases in an effective year 2000 program; and (10) with under 2 years left, FAA is quickly running out of time, making contingency planning even more critical.

VA Justifies Leasing to Open Facilities More Quickly and to Obtain Flexibility to Relocate but Does Not Provide Information to Decision Makers Demonstrating the Benefits of This Flexibility VA prioritizes all proposed capital projects using six major-decision criteria (see table 1), which focus on addressing needs that (1) can demand quick solutions, such as the need to replace an expiring lease that cannot be renewed, and (2) often change, such as demands for veterans’ access to care options. As such, according to VA officials, leasing is often VA’s preferred alternative for major medical facilities because project implementation times are often shorter than the time for constructing a federally-owned facility and leasing can provide flexibility to relocate in the future to meet changes in VA’s needs. VA cited a shorter project time frame and flexibility to relocate in all 51 of its prospectuses for major medical facilities’ leases submitted to Congress since fiscal year 2015. For example, in the fiscal year 2015 submission, VA cited a shorter implementation time frame and flexibility to relocate as justifications for a new lease in Johnson County, Kansas, to address growing demand and overcrowding at the Kansas City Veterans Medical Center and to reduce the drive time for a high concentration of veterans in the area to within VA’s 30-minute drive-time target. VA also generally identified leasing as the lowest cost alternative in its prospectuses, but in some cases preferred leasing for the two previously cited reasons when other options may have been less costly. For example, in fiscal year 2015, VA proposed a new lease in Lafayette, Louisiana, to replace a facility that the VA determined was too small and estimated leased space would have a total life-cycle cost of approximately $259 million, compared to $201 million for construction of a new federally-owned facility. According to VA, an owned facility would require a longer time frame to open than a leased facility and limit VA’s flexibility to adapt to potential changes in the veterans population, demand for services, new technologies, or health care delivery. Leasing may offer VA greater efficiencies and flexibilities when major medical-facility projects are compared to construction. Specifically, VA’s use of GSA delegated leasing authority to execute its major medical facility leases requires that VA’s lease terms not exceed 20 years. This period provides some of the flexibility that VA values in terms of relocating to facilities that align with VA’s changing needs. Construction of federally- owned facilities may not offer this flexibility given the challenges that we have previously identified with renovating and disposing of some federal properties, including VA’s, due to issues such as competing stakeholder interests that can make renovating or closing facilities difficult. Further, construction of a federally-owned facility requires a full upfront funding commitment that can be difficult to secure in the current budgetary environment. VA officials added that although VA’s major medical facility lease projects also generally require a lessor to construct a new facility to VA’s specifications, leasing tends to have a shorter project timeframe because it does not require VA to acquire the land on which the facility will be constructed, which can require additional time and resources. Although VA has justified leasing its major medical facilities to its department leadership and congressional decision makers based on the flexibility that leasing offers compared to other alternatives, VA has not provided these stakeholders with information on the extent to which it has benefited from that flexibility, nor does VA regularly assess information that would help it do so. In particular, while VA regularly cited future “flexibility,” such as ability to move when needs change, as a justification for the leases included in its annual capital plans, the benefits that VA has experienced from this flexibility with major medical facility leases are not presented to VA stakeholders responsible for selecting projects to present to Congress or to congressional decision makers. VA officials told us that VA’s data systems do not provide VA staff responsible for planning new leases with information on the use of flexibilities with existing major medical facilities’ leases, such as how far VA has moved from a previously occupied medical facility and why it has moved to new leased locations. We and OMB have previously identified the importance of assessing the results of capital decisions and incorporating lessons learned from those assessments into capital decisions. Without transparency on the actual benefits VA has experienced from leasing its major medical facilities, VA and congressional decision-makers may lack information to make informed decisions about the need for VA’s major medical facility leases. Further, greater transparency could help decision- makers and taxpayers understand the value of leasing in cases in which VA proposes leasing major medical facilities when other alternatives, such as construction of a federally-owned facility, may have a lower cost. In our issued report, we recommended that the Secretary of Veterans Affairs annually assess how VA has benefited from flexibilities afforded by leasing its major medical facilities and use information from these assessments in its annual capital plans in order to enhance transparency and allow for more informed decision making related to VA’s major medical facility leases. VA agreed with our recommendation, noting that assessing and explaining the benefits and flexibilities of leasing major medical facilities could improve transparency. VA agreed to add this information to future annual budget submissions. VA’s Cost Estimating Process for Major Medical Facility Leases Aligns with Most of Our Best Practice Steps and Recent Changes May Improve VA’s Estimates for These Leases VA’s cost-estimating procedures for major medical facilities’ leases generally align with 9 of the 12 best practice steps for cost-estimating that we have previously identified, and recent changes may improve the quality of VA’s cost-estimating process for these leases. (See fig. 1.) For a cost-estimating process to support the creation of reliable cost estimates, it should substantially or fully meet each of the four characteristics in GAO’s Cost Guide—comprehensive, well-documented, accurate, and credible—based on the extent to which the procedures incorporate the underlying best practice steps for each characteristic. We found that VA’s cost-estimating procedures for major medical leases fully met the comprehensive characteristic, substantially met the well- documented characteristic, and partially met the accurate and credible characteristics. Our finding that VA’s cost-estimating process partially met the characteristics for producing reliable cost estimates is based on the following: Comprehensive: VA’s cost-estimating process fully met the comprehensive characteristic because its procedures include both the best practice steps of developing an estimating plan and determining the estimating structure. Well-documented: VA’s process substantially met the well- documented characteristic because its procedures incorporate a large number of related best-practice steps, such as defining the estimate’s purpose and presenting the estimate for approval. Accurate: VA’s process partially met the accurate characteristic because the procedures incorporate some elements of the two associated best practice steps. Specifically, VA’s process includes the best practice step of developing a point estimate and comparing it to an independent estimate, which is based on the market rental rate determined by a market survey that VA conducts and the cost of specific improvements required for VA’s intended medical purposes. VA applies several standard and variable adjustments to the market rental rate to determine the rental portion of the estimated first-year lease cost to include in the VA’s prospectuses to Congress. (See Table 2.) This best practice step normally includes comparing the estimate to an independent cost estimate, which VA does not obtain. Because of the standardized nature of the adjustments to the rent rate and pricing for improvements for major-medical facilities’ lease cost estimates, obtaining an independent cost estimate for these inputs would likely yield little new information; accordingly, we consider the rating for this best practice step to be substantially met. The procedures also include updating the estimate, another best practice step supporting this characteristic, but VA does not update it with actual costs as the best practice step requires. Estimates are updated during the development process to calculate whether actual costs are likely to rise more than 10 percent above the prospectus-estimated cost. For leases executed under GSA authority, the estimated maximum cost provided in a prospectus may be increased for construction or alterations but may not exceed 10 percent. After leases are executed VA does not update the estimate with actual costs. Updating the estimate with actual costs is a best practice step because it enables a “lessons learned” analysis, which can strengthen estimates going forward. Credible: VA’s process partially met the credible characteristic because VA’s procedures incorporate some elements of the three associated best practice steps. For example, the best practice step of conducting a sensitivity analysis on the lease’s cost estimate is not directly included in VA’s procedures, but some procedures do address uncertainty and risk. A sensitivity analysis reveals how to assess the potential variability in the estimate by calculating how the estimate is affected by a change in any single underlying assumption. These calculations identify the cost elements that represent the most risk to an estimate. Instead, VA officials said that VA applies an annual escalation rate to adjust for increases in market rental rate and inflationary increases in the cost for tenant improvements over time, two key assumptions supporting the estimate that could cause actual first-year lease costs to fluctuate from the prospectus estimated costs. We found that VA’s use of an escalation rate often did not fully account for variation in lease costs. Specifically, our review of cost data provided by VA for 18 of the 23 most recently completed major medical-facility leases activated by the end of fiscal year 2015 shows that actual costs for 15 of the 18 leases varied substantially from adjusted prospectus costs, including 7 leases that were more than 15 percent above VA’s adjusted estimates and 8 that were more than 15 percent below the VA’s adjusted estimates. For example, actual first-year lease costs increased about 26 percent over the adjusted estimate for VA’s San Francisco, California, medical facility’s lease and decreased about 44 percent for the VA’s Montgomery, Alabama, facility. VA recently issued a new standard design guide to increase the reliability of its prospectus estimates for major medical facilities and plans to conduct a “lessons learned” study that could further improve how VA estimates its costs. The standard design guide, issued in January 2016, covers the different types of outpatient clinic facilities and provides guidance on VA activities, such as site selection, and delineates minimum federal-facility requirements for security, sustainability, and seismic standards. VA officials told us that the new guide was developed to reduce the risk of facility changes and consequent cost changes for lease projects, and that moving forward all authorized major medical facility leases would use this guide. Reducing the potential for design changes— which we have previously found to be a main driver of increases in facility costs—after a prospectus is submitted may enable VA to better estimate facility costs. Second, VA officials told us that the department is planning a “lessons-learned” review that would involve updating data used for planning major medical facilities’ leases with actual cost data after the facility is accepted. This type of review can improve cost- estimating processes over time by exposing the precise reasons why actual costs differed from the estimate, such as faulty project ground rules and assumptions, and previously unrecognized risks. The new design guide and the lessons-learned study are in the early stages, and their success will depend on how quickly and successfully VA implements them. In conclusion, the recent changes in VA’s leasing program show promise for improving cost estimates for VA’s major medical facility leases. In particular, VA’s new guidance could introduce more discipline into the process and VA’s “lessons learned” study could identify factors that lead to cost variance from what is proposed to Congress. Further, VA’s commitment to assess and provide information to Congress on the benefits and flexibilities of leasing major medical facilities could provide much needed transparency to VA’s decisions to pursue leasing versus other alternatives. We will continue to monitor how VA proceeds with these changes. Chairman Barletta, Ranking Member Carson, and Members of the Subcommittee, this completes my prepared statement. I would be pleased to respond to any questions that you may have at this time. GAO Contact and Staff Acknowledgments If you or your staff members have any questions concerning this testimony, please contact Rebecca Shea, (202) 512-2834; shear@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. GAO staff who made key contributions include Heather MacLeod, Assistant Director; Jennifer Echard, Delwen Jones, James Leonard, and Crystal Wesco. This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

VA operates the largest health care network in the United States, with over 2,700 health care sites, including hospitals and outpatient facilities. However, many facilities are outdated, and VA estimates that its capital needs will require up to $63 billion over the next 10 years. In recent years, VA has increasingly leased its facilities, including major medical facilities. This testimony discusses (1) the factors that account for VA’s decisions to lease major medical facilities and (2) the extent to which VA’s cost-estimating process for leasing these facilities reflects best practices. This testimony is based on GAO’s June 2016 report (GAO-16-619). For that report, GAO analyzed agency documents, VA data on major medical facilities’ leases, compared VA’s cost-estimating procedures to best practices in GAO’s Cost Guide, and interviewed VA officials. VA’s cost-estimating procedures for leasing major medical facilities generally align with GAO’s 12 cost-estimating best practice steps and recent changes in VA’s approach may improve the quality of VA’s estimates. GAO’s review of cost data for these leases since 2006 found that actual costs often varied more than 15 percent above or below the estimates included in VA’s proposals for these leases, often due to project design changes. In 2016, VA introduced a design guide for leased medical facilities that delineates VA and federal requirements, such as security and sustainability standards, that may reduce the risk that a project, and its cost, change from what the VA proposed. VA also initiated a lessons-learned effort to evaluate the factors that contribute to differences between actual lease costs and those included in proposals. The success of these steps will depend on how quickly and effectively VA implements them.

Background In 1964, the National Capital Planning Commission (NCPC) approved the design concept for FBI headquarters. Construction started in 1967, and in 1974, FBI personnel began moving into the new building, which was named for the FBI’s first director, J. Edgar Hoover (see fig. 1). Situated on one entire city block in downtown Washington, D.C., and containing approximately 2.4 million gross square feet of space, the building is bounded by four major city streets—9th, 10th, and E Streets and Pennsylvania Avenue—all of which are open to public traffic (see fig. 2). The building is a concrete structure, 7 stories high on its Pennsylvania Avenue side and 11 stories high on its E Street side. A dry moat protects the building in addition to numerous antivehicular barriers. When the FBI first occupied the Hoover Building, it was primarily a law enforcement organization. Since then, its mission has grown in response to evolving threats and now includes counterterrorism, counterintelligence, weapons of mass destruction deterrence, and cyber security. Accordingly, use of the Hoover Building has changed to support new programs in these areas. For example, the Hoover Building originally housed a crime laboratory, and more space was dedicated to records storage. These functions have since been transferred to off-site locations, making space available for new programs in the Hoover Building. The FBI’s headquarters workforce has grown as the agency has assumed new mission responsibilities. In 2001, the FBI had 9,700 headquarters staff, working in 7 locations. Today, the FBI has 17,300 headquarters staff, including those housed in more than 40 annexes, the majority of which are located within the National Capital Region. According to the FBI, programs in 21 of these off-site locations and in the Hoover Building should be colocated to meet the agency’s mission requirements. In projecting its staffing levels from fiscal year 2010 through fiscal year 2018, the FBI estimated that its headquarters workforce will grow by a total of 7 percent during that period. The FBI’s headquarters facilities, like all facilities in the United States occupied by federal employees for nonmilitary activities, are subject to the Interagency Security Committee’s (ISC) baseline facility security standards. The ISC, chaired by the Department of Homeland Security (DHS) and composed of representatives from all major federal departments and agencies, is tasked with coordinating federal agencies’ facility protection efforts, developing security standards, and overseeing the implementation of security measures. In 2004, the ISC issued security criteria for federally owned facilities and space leased by agencies (hereafter referred to as the 2004 ISC standards), establishing facility security standards for space owned or leased by the federal government. In 2010, the ISC issued new standards that superseded the 2004 standards. The new security criteria (hereafter referred to as the 2010 ISC standards) were intended to make security an integral part of the operations, planning, design, construction, renovation, or acquisition of federal facilities—whether in owned or leased space. The 2010 ISC standards establish a baseline set of protective measures (countermeasures) to be applied at each facility according to its security level and outline a risk management process for agencies to follow as they assess the security of their facilities. To determine the security level of a federal facility, the ISC uses criteria that it issued in 2008. Factors considered in determining the facility security level (FSL) include the criticality of an agency’s mission, the symbolism of the facility, and the building’s size and population. The Hoover Building is categorized at the same FSL applied to the headquarters facilities of other agencies with national security missions, such as the Central Intelligence Agency and the Department of Defense. The FSLs of the FBI’s annexes in the National Capital Region vary. In meeting its needs for office space, the FBI generally works through GSA, although it has received direct appropriations to construct specialized facilities, such as the FBI laboratory and academy training facilities, and has entered into leases on its own. GSA can use government-owned or leased facilities to meet an agency’s space needs. If a facility is not available to meet the agency’s needs and the estimated cost of a new facility exceeds a defined dollar threshold, GSA can request congressional authorization to construct or lease a new facility by submitting a project prospectus. GSA typically funds new federal construction and the acquisition of leased space from the Federal Buildings Fund (FBF). Agencies occupying GSA-controlled space (owned or leased) pay rent to GSA, which GSA deposits into the FBF. GSA then pays the landlord from the FBF for those buildings it leases. In addition to federal construction or leasing, GSA has the authority to enter into a sale-leaseback or a ground lease and leaseback arrangement through which GSA sells or leases federal land to a developer that builds a facility on the site and leases it back to GSA. We have previously reported that the FBF is not large enough to meet GSA’s construction and major repair needs and that alternative financing strategies may be viable options for GSA to meet agencies’ facilities needs. GSA has generally provided space in leased facilities for the FBI’s expanded headquarters staff. We have also reported that GSA has used operating leases extensively to meet agencies’ long-term space needs, even though building ownership is generally less costly. Both GSA and the FBI have generally concluded that the FBI has long-term space needs and that its operations should be consolidated to achieve greater security and efficiency. Working with GSA, the FBI has studied a number of alternatives for consolidation. FBI Headquarters Facilities Present Security, Space, and Condition Challenges The Hoover Building Does Not Meet the FBI’s Long- Term Security Requirements According to FBI officials, the Hoover Building does not meet the FBI’s long-term security requirements. We found that planning for the FBI’s headquarters security requirements has evolved over time. A 2005 GSA study and a 2009 FBI study cited different planning assumptions about the security requirements for a new FBI headquarters. The 2010 ISC standards do not prescribe security requirements for federal facilities like the Hoover Building or new facilities that an agency proposes to construct or lease. Instead, the 2010 standards indicate that, in establishing requirements for existing or new facilities, agencies should determine what combination of countermeasures would provide an appropriate level of protection against identified threat scenarios that the ISC refers to as the “design-basis threat.” Furthermore, the 2010 ISC standards indicate that whenever an agency-determined threat level deviates from the ISC design-basis threat baseline, the factors that influenced the agency’s threat assessment must be documented and fully supported by detailed information as part of the assessment. In addition to the Hoover Building not meeting the FBI’s long-term security requirements, FBI security officials told us on our site visits that they have some security concerns—to varying degrees—about some of the headquarters annexes, including the following:  Proximity of non-FBI tenants to FBI employees performing sensitive operations. At least nine annexes are located in multitenant buildings, where some space is leased by the FBI and other space is leased by nonfederal tenants. While this arrangement does not automatically put FBI operations at risk, it heightens security concerns.  Lack of control over common areas. FBI security officials also cited a lack of control over common areas in multitenant buildings. For example, at one annex we visited, FBI officials told us that the building’s landlord denied the FBI’s request to implement some recommended countermeasures made in 2007 and in 2009 by DHS’s Federal Protective Service (FPS), which conducts security assessments of facilities under the control or custody of GSA. The landlord chose not to implement the countermeasures, citing costs and concerns about inconveniencing nonfederal tenants in the building.  FBI Police response. According to FBI officials, security at the annexes is primarily handled by contract guards, local police, or the FBI’s internal police force, the FBI Police, depending on the location and circumstances. The FBI Police does not physically station its personnel at the annexes; rather, it periodically conducts patrols of annexes. FBI Has Implemented Several Countermeasures to Improve the Security of the Hoover Building Over the past several years, the FBI has implemented countermeasures at the Hoover Building to improve security, including  upgrading the building’s exterior windows;  moving and upgrading the security of the FBI business visitor center so that it now provides internal queuing for identification checks, an X- ray screening area, a badge office, and a secure waiting area; strengthening barriers to prevent unauthorized access; installing new doors to the building to meet the FBI’s requirements for protection against forced entry; securing air intakes to keep airborne contaminants out of the building; and  paying the District of Columbia government to restrict public metered parking along one side of the building in order to prevent unscreened vehicles from parking or idling near the building. Although the FBI has implemented these countermeasures, others have yet to be implemented, and FBI officials did not provide historical documentation of the agency’s rationale for not implementing them. FBI security officials we spoke with were not part of the earlier decision making, but suggested that some past recommendations were not implemented because of their high cost and potential impact on operations. A 2005 GSA study concluded that some of the recommendations would have been costly and disruptive to the FBI’s operations within the building. Because FBI officials did not provide historical documentation of the FBI’s rationale for not implementing some recommendations, it is difficult for us to determine why the FBI and GSA did not pursue them. More recently, in 2008, the FBI received approval from NCPC for one security project at the Hoover Building, but FBI officials reported they were unsuccessful in obtaining funding for the project before NCPC’s approval expired. The FBI said it intends to resubmit its request for NCPC approval at the end of fiscal year 2011, and if the request is approved, it may attempt to obtain funding in fiscal year 2012. While implementing recommended countermeasures may not always be feasible—because of physical limitations or budgetary restrictions, for example—the 2010 ISC standards require agencies to document any decision to reject or defer the countermeasures’ implementation, including whether the agency is willing to accept risk and whether there are any alternative strategies to meet the agency’s required level of protection. This ISC standard is consistent with a component of our risk management framework that calls for agencies to identify and evaluate alternatives to mitigate risk, taking into account the alternatives’ likely effect on risk and their cost. FBI Recently Performed a Comprehensive Security Assessment of the Hoover Building and Intends to Have the Security of Its Annexes Assessed against the 2010 ISC Standards FBI officials performed a comprehensive security assessment of the Hoover Building in 2011 using the 2010 ISC facility security standards. This assessment, which the FBI provided to us after we issued our law enforcement sensitive version of this report in July 2011, was the FBI’s first comprehensive review of the building’s security since 2002, although FBI officials told us they had assessed the security of selected portions of the building during the interim. For federal buildings under the control or custody of GSA, such as the Hoover Building, FPS normally conducts periodic security assessments unless the tenant agency waives the requirement for FPS to do so. The FBI waived the requirement for FPS to conduct security assessments of the Hoover Building, acknowledging that it would assume responsibility for conducting the assessments itself. However, the FBI did not conduct a comprehensive assessment of the Hoover Building from 2002 until 2011 because, according to FBI officials, the FBI had concluded that an updated assessment would be unlikely to yield new information. Under the current ISC standards, agencies are to conduct security assessments of their facilities at regular intervals, depending on the building’s FSL. The requirement for the Hoover Building is every 3 years. The ISC also requires agencies to document their security assessment findings in a report, including the threats and vulnerabilities they have identified and the specific countermeasures they have recommended based on their building’s FSL. Conducting regular security assessments is also an important component of one of our key practices in protecting federal facilities—allocating resources using a risk management approach. This practice emphasizes the need to identify threats and assess vulnerabilities in order to develop countermeasures and to prioritize the allocation of resources as conditions change. In July 2011, we reported that an updated security assessment would allow the FBI to fully assess the building against the 2010 ISC standards, evaluate if additional security technologies could be implemented, and document decisions about whether to implement certain recommendations or accept risk going forward. We also noted that an updated security assessment would provide the FBI with current information to help prioritize its allocation of security-related resources across all of its facilities. We recommended that the FBI update the Hoover Building’s security assessment using the 2010 ISC standards, including (1) documenting threats, (2) analyzing the building security requirements, and (3) indicating whether recommendations would be implemented. Subsequent to our July 2011 law enforcement sensitive report, the FBI completed a security assessment of the Hoover Building. This security assessment was conducted by the FBI’s Physical Security Unit and coordinated with the FBI Police and the FBI’s Facilities and Logistics Services Division. FBI security staff evaluated security conditions against specific criteria outlined in the 2010 ISC standards. According to our analysis, the assessment covered some areas that were not covered in the 2002 assessment. Moreover, the assessment documented both the security posture of the Hoover Building and the FBI’s building security requirements in relation to baseline ISC requirements. Where appropriate, the assessment included recommendations, and those recommendations were recently forwarded to the FBI’s executive management for consideration. Currently, the FBI is in the process of determining its response to these recommendations, some of which would require capital investments in the building. FBI needs time to make final decisions on some recommendations and may need to reach agreement with GSA as the federal steward for the building. As the FBI determines its response to the recommendations, it is important that it document decisions because of their budget implications and effect on the planning for its long-term facility needs. According to FBI security officials, they were not aware of any countermeasures that needed to be implemented at the annexes. Although they indicated that they do have security concerns about headquarters annexes, such as lack of control over building common areas, the officials told us the annexes generally meet the 2004 ISC standards for leased space. We received security assessments or other security-related information— from both FPS and the FBI—for most, but not all, of the 21 annexes. According to the FBI, it intends to request that FPS assess the annexes’ compliance with the 2010 ISC standards when the new standards are fully implemented and then evaluate the need for any additional countermeasures. Tracking the implementation status of all countermeasures recommended in FPS or FBI security assessments will provide the FBI with complete, current information on any security vulnerabilities at its annexes, and help it determine the extent to which the annexes meet the 2010 ISC standards and the FBI’s security requirements. The Hoover Building’s Design Limits Space Efficiencies and Hampers Collaboration; Dispersion of Staff Causes Operational and Logistical Challenges Although the Hoover Building is large, occupying an entire city block, much of its approximately 2.4 million gross square feet of space is unusable, and the remaining usable space—according to a 2007 study conducted for GSA and the FBI—is not designed to meet the needs of today’s FBI. According to a 2008 GSA market appraisal of the building, its design is inefficient and functionally obsolete. According to the FBI, the space is laid out as efficiently as possible, but the original design of the building’s floor plates is inefficient. For example, the building provides a lower percentage of usable square footage for office and mission functions than a federal office building built to current design standards. In its 2010 facilities standards, GSA established a space efficiency target of 75 percent for new federal office buildings, based on the ratio of usable to gross square footage. The Hoover Building’s efficiency ratio is 53 percent. Figure 3 illustrates some of the features that limit the building’s efficiency. To accommodate additional staff at the Hoover Building, the FBI has reconfigured parts of the building’s interior, including converting about 200,000 square feet of basement, cafeteria, and storage space to offices. Renovations were implemented reactively as the agency’s mission grew. Some areas could not be renovated as open spaces, as desired, because the building’s original design hampered such changes. While converting building support space has provided the FBI with some additional offices in the Hoover Building, GSA’s facility condition assessment indicates that those offices may not be adequately ventilated and cooled. As a result, some space may provide an uncomfortable working environment for staff. GSA has a project planned to address ventilation requirements. While the project was proposed as early as 2004, we found that GSA has been unable to get the design approvals needed to implement the project. FBI officials we spoke with also indicated that the building lost some functionality—for example, they said less space was available for meetings—after those spaces were converted to offices to accommodate the agency’s rapid growth. The FBI and GSA have concluded that the Hoover Building’s interior design remains a significant barrier to staff collaboration and information sharing across teams. Furthermore, GSA has concluded that the building’s structure constrains further increases in its efficiency. For example, a 2007 study for GSA and the FBI found that the Hoover Building’s long corridors and closed office suites result in significant fragmentation among working groups that hampers communication and collaboration and that the building’s inflexible design is incompatible with changing mission needs. FBI officials told us that whereas newer office buildings with modular designs can be quickly and cost-efficiently reconfigured to accommodate new missions or staff growth, the Hoover Building would likely require months of modernization work to achieve similar results. According to senior FBI and GSA officials, space restrictions at the Hoover Building limit the FBI’s ability to meet two GSA workplace goals for the next decade—to improve collaboration and communication and to make more efficient use of space. Because the Hoover Building cannot readily be modified to accommodate new mission needs and staff growth, and because core headquarters staff are therefore dispersed among multiple annexes, the FBI now faces several operational and logistical challenges. According to FBI officials, space constraints at the Hoover Building and the resulting dispersion of staff sometimes prevent the FBI from physically locating certain types of analysts and specialists together. For example, according to an FBI report, one FBI division within the Hoover Building is not able to embed analysts within other offices—to facilitate greater collaboration—because of the lack of available space. During our site visits, FBI officials reported logistical challenges as well, including a lack of facilities at a few annexes for discussing some classified information, known as sensitive compartmented information facilities (SCIF). As a result, some FBI personnel told us they have to travel to meetings in different locations across the National Capital Region, resulting in inefficient use of their time and the FBI’s transportation resources. Furthermore, FBI officials at three annexes we visited reported that the private landlords responsible for building maintenance at their sites were often slow to respond to maintenance requests from the FBI, such as requests for repairs to malfunctioning heating and cooling systems. To mitigate the operational and logistical challenges of dispersion and to avoid further complications as its workforce continues to grow, the FBI has centralized its real property management functions for headquarters and has begun to take a more focused approach to managing its space needs. In 2005, the FBI established a central Space Management Unit and started assessing its headquarters space needs twice a year. In addition, it initiated an interim phased plan to consolidate some leases into fewer facilities based on the lease expiration dates until it can obtain a facility designed to consolidate operations in the Hoover Building and in the 21 annexes it has determined should be colocated. The Hoover Building Is Aging and Showing Signs of Deterioration, but Needed Repairs and Recapitalization Projects Have Been Deferred Although the Hoover Building is nearing its life-cycle age and exhibiting signs of deterioration, GSA has decided to limit major repair and recapitalization investments to those systems or components that affect life safety and building functionality until it is determined whether the FBI will remain a long-term occupant of the building. According to GSA, its investments have been appropriate to ensure that FBI operations are not at risk. For example, since 2004, GSA has spent approximately $22 million to upgrade components and systems in the Hoover Building. Nevertheless, a 2009 GSA physical condition survey estimated that the building requires about $80.5 million in further repairs and upgrades. The condition survey identifies repair needs to the building’s air-handling distribution systems and ductwork ($44.2 million), electrical switchgear ($23.3 million), and elevators ($2.3 million), among other systems. GSA officials told us these repairs have been deferred. GSA also has plans to repair the building’s concrete façade ($8.9 million) and to replace the entire fire alarm system ($22 million), but has not yet obtained funding for either project. GSA officials indicated that the fire alarm system replacement would most likely be included in any future renovation of the Hoover Building. During a tour of the Hoover Building given by FBI officials, we observed several signs of exterior and interior deterioration. One FBI official stated that some areas of the upper-level exterior façade have deteriorated over time, heightening the risk that pieces of concrete could fall and strike pedestrians below. As a precautionary measure, GSA and the FBI have installed netting around the upper level of the building to catch any falling debris. In addition, water infiltration from the courtyard has corroded parts of the parking garage ceiling. The basement is also prone to flooding from the interior courtyard during periods of rain. Figure 4 depicts conditions we observed during our tour. At the time of our review, the Hoover Building was categorized as a “core asset” in GSA’s asset business plan. However, this categorization was inconsistent with GSA’s decision to limit major repair and recapitalization investments in the building. GSA core assets generally have a long-term holding period of at least 15 years. For buildings with a long-term holding period, GSA policy states that reinvestment will be funded to ensure maintenance of the building’s quality and condition at levels appropriate to meet continuing mission and customer needs. This includes all preventative maintenance, necessary upgrades, and enhancements to the building and its systems to maintain the asset in appropriate condition. GSA’s near-term maintenance policy for the Hoover Building is more consistent with GSA’s policy for a “transition asset.” A transition asset typically has a 6- to 15-year holding period as its tenant prepares for relocation to a new federal building or a leased building. For such an asset, GSA funds projects that meet basic needs in transition, but avoids any major reinvestment. In its technical comments on our draft law enforcement sensitive report, GSA reported that it has recently recategorized the Hoover Building as a transition asset to reflect the FBI’s concerns about the building’s security, condition, and efficiency, as well as GSA’s own decision to limit investments in the building. GSA further reported that its categorization of the building may change again if the FBI moves or further study of the asset points to a change. Regardless of how the building is categorized, it will likely be used for several more years, and its large backlog of deferred maintenance, major repairs, and recapitalization requirements increases the potential for systems or components to fail and potentially disrupt FBI operations. Consistent with Leading Practices Thus Far, the FBI and GSA Have Identified Alternatives for Better Meeting the FBI’s Facility Needs and Are Developing an Approach for Moving Forward FBI and GSA Planning Actions Have Been Generally Consistent with Applicable Leading Practices in Capital Decision Making Over the past decade, the FBI and GSA have conducted a number of studies (see fig. 5) to assess the FBI headquarters facilities’ strategic and mission needs. Through these studies, they have determined the condition of the FBI’s current assets and identified gaps between current and needed capabilities, as well as studied a range of alternatives to meet the FBI’s requirements. (See app. II for more detail on the studies undertaken by the FBI and GSA.) These activities are consistent with applicable GAO leading practices in capital decision making. Consistent with our first two leading practices in capital decision making— to conduct a comprehensive assessment of needs to meet an agency’s mission goals and objectives and to identify the current capabilities and condition of existing assets (i.e., facilities) to meet those needs—the FBI and GSA conducted facility condition and security assessments of the Hoover Building in 2001 and 2002 and identified recommendations in both areas. For example, the poor condition of the Hoover Building was identified as a gap in the FBI’s need for a functional headquarters. In addition, as noted, the FBI’s 2005 Asset Management Plan identified the need for a new headquarters facility to safeguard personnel and information within efficient and cost-effective workspace, and the FBI has worked with GSA to identify its strategic facility and space requirements. Also in 2005, the FBI Director and a Deputy FBI Director—with input from assistant directors—decided which FBI programs should be colocated in a headquarters facility to meet the agency’s strategic and mission requirements. According to their analysis, the FBI Director; the National Security Branch, including its counterterrorism and intelligence divisions; the Criminal, Cyber, Response, and Services Branch; and other FBI headquarters functions, such as the Information Technologies Branch, would need to be colocated. Throughout the decision-making process, FBI senior officials have consulted with senior GSA regional and national officials to discuss the FBI’s requirements and the range of alternatives to meet the FBI’s needs. In 2007, GSA and the FBI found that the need to colocate certain FBI programs—to better enable collaboration and facilitate information sharing—could not be met in the Hoover Building and the annexes and that the FBI’s operations in the Hoover Building and 21 of its annexes in the National Capital Region should be consolidated. This decision to consolidate is also consistent with a 2010 presidential memorandum directing federal agencies to eliminate lease arrangements that are not cost-effective, pursue consolidation opportunities, and identify reductions when new space is acquired, as the FBI pointed out in its 2010 consolidation report. In the studies they conducted from 2005 through 2009, the FBI and GSA identified security requirements for a consolidated FBI headquarters facility. Our previously issued law enforcement sensitive report describes these security requirements. The 2005 through 2009 planning studies also identified space requirements for an FBI headquarters facility. For example, a formal space programming study performed by the FBI’s architectural consultant established space requirements for approximately 11,600 personnel and for support headquarters spaces, such as conference rooms and SCIF space. This personnel figure was based on current staffing levels for the functions that the FBI had determined should be colocated in a headquarters facility, adjusted to allow for limited future growth. To further identify the FBI’s headquarters space requirements, the architectural consultant and staff from the FBI’s Facilities and Logistics Services Division met with representatives from the FBI’s branches and their divisions to assess their operational needs, such as access to SCIF space or proximity to another organization or function. In addition, the FBI Facilities and Logistics Services Division established space standards for staff after reviewing GSA and industry benchmarks. According to the FBI, it requires modern, open-plan office space for its operations and shared team spaces to promote collaboration and information sharing across mission teams and to permit easy reconfiguration to meet changing needs, such as space for newly formed internal and interagency task forces. The FBI also identified requirements for large SCIFs to fully support its divisions’ classified discussion and processing needs. Consistent with our third leading practice in capital decision making— decide how best to meet a gap by identifying and evaluating alternative approaches—the FBI and GSA, in their 2005 through 2009 planning studies, identified and analyzed a range of alternatives, together with their estimated costs and benefits, for meeting the gap between the FBI’s current and needed space. These alternatives fall into three categories: (1) modernizing the Hoover Building; (2) demolishing the building and constructing a new facility on the existing site; and (3) acquiring a new consolidated headquarters facility—through federal construction or lease— on a new site. Figures 6 and 7 provide summary information about these three alternatives and the status quo, which we include because the Office of Management and Budget (OMB) requires agencies to submit baseline information when they propose a major capital acquisition. The cost estimates in figures 6 and 7 cannot be compared because the studies and estimates were completed at different times, for different purposes, by different consultants, using different methodologies and facility specifications. As the FBI and GSA continue to advance through the capital planning process, our leading practices in capital decision making can help guide their efforts, as well as inform decision makers’ evaluations of any preferred alternative and other alternatives considered. Our fourth leading practice—establish a review and approval framework that is supported by analyses—encourages management reviews and approvals, supported by the proper financial, technical, and risk analyses that are critical in making sound capital investment decisions. OMB’s guidance, together with GSA’s Capital Planning Program Guide, provides a capital asset review framework such as our fourth leading practice describes. OMB’s guidance requires GSA—if GSA constructs or leases a headquarters facility for the FBI’s use—to submit a capital asset business case in support of the project. According to OMB’s guidance, the FBI and GSA need to partner to develop the business case— providing input on the estimated project costs and financing strategies— but the design and construction budget request would be part of GSA’s annual budget submission to OMB if the construction is to be funded through the FBF. (See app. III for information on the FBF.) This business case should include the total estimated life-cycle costs—for the preferred alternative and the other alternatives the agencies considered— including the costs of acquisition, operations, maintenance, and disposal. In addition, GSA’s guide directs GSA to conduct a variety of reviews, such as site feasibility studies and environmental analyses, designed to ensure that projects are feasible and in compliance with all federal construction requirements. As GSA develops a capital asset business case for OMB with input from the FBI, it will have to rank the alternatives the agencies considered and select a preferred alternative. This ranking, when weighed against other relative priorities that the FBI and GSA will have to evaluate, would be consistent with our fifth capital decision-making practice—rank and select projects based on established criteria. FBI officials have preliminarily concluded that their security and space requirements can be met only through the construction of a new headquarters facility on a new site. GSA officials have thus far generally concluded that the FBI has long- term space needs and that FBI operations should be consolidated to achieve greater security and efficiency, but have not finalized their construction cost estimates. According to GSA officials, the FBI and GSA will discuss the FBI’s needs with OMB, and a final decision will be based on the results of a more comprehensive analysis that GSA will complete with FBI input for OMB. For the preferred alternative, GSA officials said they will need to undertake a final due diligence process to revalidate the FBI’s program requirements, update costs, and initiate feasibility studies—such as an assessment of the likelihood that sites are available in the National Capital Region—so as to develop a detailed prospectus for formal OMB approval and congressional consideration. Our leading practices state that prudent decision makers also should consider various funding options available to them. In the case of real property, that means considering other funding alternatives in comparison to funding new construction or a modernization through the FBF. In separate interviews, both GSA’s Deputy Administrator and Director of the Office of Real Property Asset Management indicated that GSA will undertake a thorough analysis of a range of financing strategies as part its due diligence. (See app. III for a description of some of the financing strategies that GSA may consider.) According to GSA, it almost always recommends federal construction using the FBF because this is usually the lowest cost alternative. However, GSA reports that in the current budgetary environment, it believes that alternative strategies such as the ground lease and leaseback arrangement—providing for eventual ownership of the building by the government—may need to be considered. After GSA and the FBI identify a preferred alternative and financing strategy, and if the alternative entails constructing a new federal facility through the FBF, GSA will have to rank the need for any FBI headquarters capital project against other FBI and governmentwide facility needs. GSA ranks projects from all agencies that have identified requirements—first by GSA region and then nationally. The GSA Administrator decides which major prospectus projects to propose within GSA’s budget based on recommendations and input from the Commissioner of the Public Buildings Service, among others. While GSA has general criteria for prioritizing capital construction and major modernization needs, it does not specifically include security among its ranking criteria. Instead, according to a GSA official, the agency relies on its customers to convey their mission-critical needs in a way that reflects which issues, such as security, are critical to them. At this time, GSA officials could not indicate how a new FBI headquarters facility—or a major modernization of the Hoover Building—might be ranked in relation to other competing federal asset needs. FBI staff we spoke with indicated that a new headquarters project has the support of the FBI Director, but it is unclear whether a new headquarters is the most important facility need for the FBI or whether regional field office facility needs may be more important. The FBI and GSA plan to continue working together to reach a decision with OMB on how best to meet the FBI’s needs. GSA reports that fiscal year 2014 is likely the earliest that any budget request and prospectus might be put forth for congressional consideration. Based on that insight and our review of preliminary FBI and GSA schedules, we estimate that the earliest that any project could be completed would be fiscal year 2020. Conclusions With its employees dispersed throughout the National Capital Region and many of them housed in the aging and inefficient Hoover Building—a facility constructed prior to current ISC standards governing security countermeasures—the FBI is under pressure to find an alternative that will meet its security, space, and building condition requirements. Any alternative will take years to implement and is likely to cost over a billion dollars. It is therefore important that the choice of an alternative be based on up-to-date assessments of the FBI’s security, space, and building condition needs. In the interim, the FBI and GSA may have opportunities to further enhance security and address condition deficiencies at the FBI’s current facilities. For the next several years or more, the FBI’s headquarters workforce will be dispersed between the Hoover Building and the headquarters annexes. During this time, it is important that the FBI and FPS conduct security assessments of the annexes, as required by the 2010 ISC standards, and that the FBI track the implementation status of recommended countermeasures for all its headquarters facilities. For the FBI, documentation of decisions to implement recommendations— whether made in its 2011 security assessment of the Hoover Building or in future assessments of its headquarters annexes against the 2010 ISC standards—could inform decisions on how best to meet the FBI’s long- term headquarters facility needs. Complete, current information on security needs and the status of recommended countermeasures—some that have budget implications—at both the Hoover Building and the annexes could indicate to the FBI whether it is allocating its security resources as efficiently as possible to mitigate risks. Such information could also help the FBI and GSA evaluate alternatives to the FBI’s current dispersed headquarters structure and develop a business case to support a budget request for the alternative that they determine would best meet the FBI’s security needs. Given the likelihood that FBI employees will be housed in the Hoover Building for several more years no matter which alternative is ultimately selected, and that the building may remain in GSA’s portfolio whether it is occupied by the FBI or another federal tenant, it is important to ensure that GSA’s current strategy for maintaining the facility is appropriate. The deferred maintenance, repairs, and recapitalization projects that have accumulated under this strategy could lead to system or component failures and potentially disrupt FBI operations. Allowing the building to deteriorate further could also make it difficult to house another agency in the Hoover Building if the FBI moves to a different location. Ultimately, decisions about the future of the FBI’s headquarters facilities will require careful consideration of policy matters related to the FBI’s mission and security needs and competing budget priorities, as well as other factors, such as the availability of a suitably sized site in the National Capital Region where the FBI’s headquarters operations could be colocated. Currently, planning for a new FBI headquarters is ongoing, and GSA has yet to submit a business case for a preferred alternative to OMB, which is essential in the decision as to which specific alternative and financing strategy to pursue. Recommendations for Executive Action To ensure that complete, current security information is being used to minimize risks to FBI facilities, operations, and personnel and to inform a final decision on how best to meet the FBI’s long-term facility requirements, we recommend that the Attorney General direct the FBI Director to take the following two actions:  Document whether any recommendations from the FBI’s 2011 security assessment will be implemented at the Hoover Building.  Track the implementation status of all recommendations made in FPS or FBI security assessments—of both the Hoover Building and the FBI’s headquarters annexes—using the 2010 ISC standards. Where recommendations are not implemented, document the rationale for accepting risk, including any alternate strategies that are considered. Given that the FBI will likely remain in the Hoover Building for at least the next several years, we also recommend that the GSA Administrator direct the Commissioner of the Public Buildings Service to take the following action:  Evaluate GSA’s current strategy to minimize major repair and recapitalization investments and take action to address any facility condition issues that could put FBI operations at risk and lead to further deterioration of the building, potentially affecting continued use of the Hoover Building by the FBI or any future tenant. Agency Comments and Our Evaluation We provided a draft of the law enforcement sensitive version of this report to the Department of Justice, GSA, and DHS for review and comment. In that law enforcement sensitive report we also recommended that the Attorney General direct the FBI Director to update the Hoover Building’s security assessment using the 2010 ISC standards—to include undertaking an analysis of its building security requirements, documenting if threat scenarios exceed the ISC design-basis threat, and indicating whether recommendations would be implemented. Given that the FBI took action to address part of the recommendation—subsequent to our July 2011 law enforcement sensitive report but prior to this public version—we modified the recommendation to reflect the FBI’s recent security assessment. Specifically, the security assessment documents threats and analyzes building security requirements consistent with ISC security standards, but does not indicate whether recommended actions will be implemented. This is reasonable given the short period of time since our report and the FBI’s ensuing analysis. We therefore revised the first recommendation above to focus on the need for the FBI to document decisions on the 2011 security assessment’s recommendations. Our July 2011 law enforcement sensitive report also recommended that the FBI track the implementation status of all recommendations in FPS or FBI security assessments. We will continue to monitor the FBI’s decisions and actions related to its security assessment of the Hoover Building— and the security assessments of the FBI headquarters annexes—as indicated in the recommendations above. For security reasons and for clarity, we made additional modifications to the language used in the above recommendations to the Attorney General compared to the language we used in our July 2011 law enforcement sensitive report. We received written comments from the FBI on our law enforcement sensitive report on behalf of the Department of Justice. We also received written comments from GSA and DHS on that report. The FBI concurred with our recommendations and said that its primary concern in finding a long-term solution for its headquarters facility needs is to mitigate the operational impact of a fragmented workforce located at multiple sites across a wide geographic area. The FBI also cited concerns that its current headquarters housing is inefficient and expensive, and stated that a new, consolidated headquarters facility is one of the FBI’s highest priorities. GSA indicated that it is currently taking appropriate action to implement our recommendation and remains committed to making all necessary investments in the Hoover Building to ensure ongoing operations until a long-term solution for the FBI can be developed. Written comments—on our law enforcement sensitive report—from the FBI, GSA, and DHS are reprinted with sensitive information redacted in appendixes IV through VI, respectively. The FBI, GSA, and DHS provided additional clarifying and technical comments, which we incorporated throughout the report as appropriate in consideration of sensitivity concerns. In addition, we provided a draft of this public report to the FBI, GSA, and DHS for review. Those agencies provided no additional comments. We are providing copies of this report to appropriate congressional committees, the Attorney General, the Director of the Federal Bureau of Investigation, the Administrator of the General Services Administration, the Secretary of Homeland Security, and other interested parties. In addition, this report will also be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staffs have any questions about this report, please contact David C. Maurer at (202) 512-9627, maurerd@gao.gov, or David J. Wise at (202) 512-2834, wised@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made key contributions to this report are listed in appendix VII. Appendix I: Objectives, Scope, and Methodology Congress directed us, in the explanatory statement accompanying the 2009 Omnibus Appropriations Act, to review the J. Edgar Hoover Building (Hoover Building)—the main headquarters building for the Federal Bureau of Investigation (FBI)—and the FBI’s off-site locations (annexes), which support headquarters and are dispersed throughout the National Capital Region. We conducted our review to examine (1) the extent to which the Hoover Building and annexes support the FBI’s operational requirements for security, space, and building condition and (2) the extent to which the FBI and the General Services Administration (GSA) have followed leading capital decision-making practices in identifying alternatives for meeting the FBI’s operational requirements and the extent to which each alternative would address these requirements. To determine the extent to which the Hoover Building and annexes support the FBI’s operational requirements for security, space, and building condition, we visited the Hoover Building and five annexes. We selected the five annexes to represent different facility security levels (FSL); different FBI divisions, such as Cyber and Counterterrorism; and varying degrees of staff fragmentation. While visiting these annexes, we examined security, space, and building condition issues firsthand and interviewed on-site program and security officials about the FBI’s operational requirements and the extent to which the annexes do, or do not, meet those needs. For security-related issues at the five annexes, we reviewed site-specific facility security assessments (security assessments) that were conducted by either FBI security officials or the Department of Homeland Security’s Federal Protective Service (FPS) in relation to Interagency Security Committee (ISC) security standards that are applicable to owned and leased federal buildings. We also discussed with FBI officials the extent to which countermeasures recommended in those security assessments had been implemented. In our July 2011 law enforcement sensitive report, we recommended that the FBI conduct a new security assessment in accordance with updated security standards issued in 2010. In response to our recommendation, the FBI conducted such an assessment, which we also reviewed. During our site visits, we interviewed FBI security officials about the security assessments, security risks and challenges, and actual security incidents or breaches at each facility. We also asked FBI officials whether any security challenges at the annexes were a direct result of operations not being colocated at the Hoover Building. To learn more about security issues at the Hoover Building, we toured the building while FBI officials reported on security vulnerabilities and some countermeasure improvements that had been implemented, and we interviewed FBI security, police, and facilities officials with knowledge of these improvements. In addition, we interviewed FBI security and facility officials about outstanding security projects to determine why they had not been implemented. To identify these projects, we reviewed FBI, FPS, GSA, and National Capital Planning Commission documents, including the FBI’s 2002 security assessment of the Hoover Building, as well as numerous FBI and GSA planning studies that identified security requirements for the building. We interviewed FPS security officials about the security standards for federal facilities, both past and present, and the FSL determination process. We reviewed FPS’s 2000 Policy Handbook and the ISC standards from 2004 and 2010. Furthermore, we reviewed and analyzed GSA’s design standards related to security. In addition, we relied on internal security experts from GAO’s Office of Security and Forensic Audits and Investigative Service to verify security assumptions and requirements. For space-related issues, we reviewed the size and location of current facilities and programs; reviewed FBI and GSA reports that tracked annex leases, space use, and the Hoover Building’s efficiency (how much of its space is usable for mission needs) and how the existing space does, or does not, meet the FBI’s operational needs; and interviewed FBI program officials to understand the effects on operations of having different programs housed in several annexes. We reviewed FBI and GSA planning studies that identified which FBI programs or functions should be colocated. We compared attributes of the Hoover Building, such as its efficiency, to GSA standards and compared the Hoover Building to other agency headquarters in the National Capital Region. We asked FBI officials about the systems they use to manage their real property data and how frequently they update their leasing and space planning data. We used GSA’s asset business plans to cross check the real property data reported to us by the FBI to ensure reasonable consistency in the facility data, such as the ownership status and size (i.e., square footage) of facilities. Furthermore, we reviewed and analyzed GSA’s design standards related to building efficiency and space planning. For building condition issues, we analyzed assessments of the Hoover Building’s physical condition and compared this information to GSA policies for building condition. We also asked GSA how often it conducts facility condition assessments of owned buildings. We examined GSA’s asset business plan and other studies of the Hoover Building to identify completed maintenance projects, deferred maintenance, and planned major repair and recapitalization projects. We also asked FBI and GSA officials about their assessments of the Hoover Building’s condition. To determine the extent to which the FBI and GSA have followed leading capital decision-making practices in identifying alternatives for meeting the FBI’s operational requirements, we compared the FBI’s and GSA’s planning actions against leading practices we have reported on in this area. In addition, we reviewed FBI and GSA studies of the FBI’s facilities and operational requirements, identified the alternatives discussed in these studies for meeting the requirements, and reviewed relevant laws relating to real property. We determined that the alternatives fell into three broad categories, each of which included a number of variations. For our analysis, we focused on the categories, since the appropriateness of the variations could not be determined without further study and would depend on site-specific conditions. We then assessed the extent to which each alternative would address the FBI’s security, space, and building condition requirements. We did not independently analyze the FBI’s requirements for security, which are based on its assessments of the threats it faces and their probability of occurrence; its requirements for space, which are based on its projections of each FBI program’s future staffing and space needs; or the FBI’s process for deciding which programs need to be colocated at a single location. In our view, such analyses were outside the scope of our review and would require extensive reviews of classified intelligence on threats and hostile groups, as well as of programmatic mission justifications for FBI branches and their associated staffing levels. We did, however, determine that the FBI senior leadership was involved in deciding which FBI programs should be colocated. Furthermore, because the FBI and GSA are still in the early stages of the facility planning process and have not yet prepared final cost estimates for the Office of Management and Budget (OMB), we did not validate preliminary cost estimates for new construction or past cost estimates for modernizing or redeveloping the Hoover Building and site. We conducted this performance audit from July 2010 to November 2011 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: FBI and GSA Studies Related to FBI Headquarters Planning This appendix provides summary information about eight studies that provide information on the condition of the Hoover Building and the FBI’s facility needs. The studies, issued from 2001 through 2010, are presented in chronological order. 1. Condition assessment, 2001 In 2001, a facility engineering consultant conducted a facility condition assessment for GSA of the Hoover Building and identified numerous building deficiencies including deferred maintenance and life-cycle replacement projects. The study concluded the building was in poor condition. The contractor prepared three funding scenarios to provide GSA with insight into how the condition of the building would be affected based on various investment assumptions over 20 years. One scenario included improving the building condition to an industry-acceptable level. 2. Security assessment, 2002 In 2002, the FBI conducted a security assessment of the building, and with the assistance of two consultants, identified recommendations to further improve the building’s security. 3. Headquarters housing strategy, 2005 In 2005, a real estate services consultant contracted by GSA studied the FBI’s facility needs. According to the consultant, the FBI’s mission was impaired by a fragmented headquarters organization that caused staff to be dispersed across the Hoover Building and 16 annexes at that time in the National Capital Region. In addition, the consultant documented space inefficiencies in the Hoover Building. To address these deficiencies, the consultant developed a strategic housing plan and facility requirements for FBI headquarters. These requirements included  meeting ISC security standards,  making maximum use of open-plan office space,  providing enough secure space for handling classified information,  planning building systems to support current and future information  providing extensive emergency backup power as well as state-of-the- art air filtration systems. The consultant developed three consolidation alternatives for addressing identified deficiencies and meeting the FBI’s headquarters facility needs based on projected 2011 staffing levels:  one-site consolidation with both headquarters national security and law enforcement located together; two-site consolidation (option A) with national security functions at one site and law enforcement functions at a second site; and two-site consolidation (option B) with a more even distribution of FBI headquarters elements (compared to option A) and no split between national security and law enforcement functions. A preliminary financial analysis, which estimated the net present value of savings for each alternative over 30 years, showed that each alternative was more economically beneficial than the status quo. The savings were largely due to the planned consolidation of 3.1 million rentable square feet into 2.3 million rentable square feet. According to a draft timeline, it would take nearly 3 years for GSA to complete its analysis, develop a project prospectus for congressional authorization, and identify a site. Another 3 years was estimated for design, construction, and move-in. Citing detailed cost estimates for a project of similar size for another intelligence agency, the consultant predicted a total project cost of over $1.5 billion. 4. Site study, 2006 In 2006, another real estate services consultant hired by GSA studied a range of scenarios for use of the Hoover Building and site. This study was intended to inform GSA management decisions on optimizing the value of the Hoover Building as a GSA real property asset and was not necessarily performed to identify alternatives for meeting the FBI’s headquarters facility needs. The study did, however, consider the impact on operations if the FBI remained as the building tenant. The consultant identified five scenarios:  maintain and operate the building “as is,” vacate the building and sell the asset,  modernize the building, vacate and demolish the building and redevelop the site, and  partially demolish the building to redevelop the front side facing Pennsylvania Avenue and renovate the back portion that faces E Street. Estimated costs to modernize the Hoover Building ranged from $850 million to $1.1 billion. Estimated costs to demolish the Hoover Building and redevelop the site ranged from $853 million to $1.4 billion. The study concluded that no alternative was a definite best option for GSA. The study reported that a modernization, in general, would not improve the building’s gross and rentable square footage. In addition, this alternative would create a demand for swing space and could adversely affect the FBI’s operations if the FBI remained as the building’s tenant during the modernization. According to the study, the modernization would be least costly if the FBI vacated the entire building to give the construction contractor unrestricted access. According to the study, redeveloping the site with a new building or buildings would not meet GSA’s required rate of return on investment, and constructing a new secure facility would sacrifice tremendous value associated with a highly marketable location. 5. Space study, 2007 In 2007, GSA hired an architectural design and planning consultant to assess the condition of the Hoover Building and determine the extent to which it supports the FBI’s mission. The consultant assessed the Hoover Building’s design and use of space against industry standards and compared the Hoover Building to facilities used by other intelligence agencies. According to the report, the FBI’s work process is dynamic, requiring intelligence gathered by one team to be shared with multiple teams for whom the intelligence may also be relevant. To respond to the FBI’s work process and mission, the consultant determined that the FBI’s workplace should promote collaboration and communication among staff and be easily reconfigured. The study found that the Hoover Building does not generally meet these criteria because of its structural characteristics and inherent inefficiencies. For example, the study found that aspects of the building—including the location of structural elements and hard wall partitions—result in an inherently inefficient use of space. According to the consultant, these characteristics limit the degree to which the FBI can reconfigure space to optimize its operations and respond to mission changes. The consultant concluded that the Hoover Building is a significant barrier to the FBI’s performance and operational effectiveness and no longer effectively supports the FBI’s mission. The consultant also indicated that the renovations necessary to make the Hoover Building viable, feasible, and desirable may be unjustifiable given the costs and disruption they would entail. The consultant concluded that relocating the FBI to a new facility would likely lead to a significant improvement in performance at a lower cost. 6. Real estate appraisal, 2008 In 2008, GSA hired a real estate appraisal firm to develop a market-value opinion of the Hoover Building and site to inform GSA’s asset management strategy. The appraisal firm considered three valuation approaches: (1) a cost approach; (2) a sales comparison approach; and (3) an income capitalization approach. The appraisal firm described the construction quality of the existing building as average and the condition of the building as below average. It also found the building inferior to other office buildings constructed during the same period. In particular, the consultant reported the building windows are very small compared to modern office building windows and that larger windows are generally required to attract tenants to higher- priced leased space. The firm reported that GSA had estimated a cost of over $200 million to modify the structure and replace its windows. GSA provided the appraisal firm with a list of planned recapitalization projects totaling over $460 million, to be implemented over 10 years; however, the appraiser reported that GSA’s Property Manager had indicated that, for lack of funds, none of the planned capital expenditures would likely be made. Therefore, the appraiser did not consider the value of any planned recapitalization projects in the estimated value. However, the appraiser reported that even if the planned capital expenditures were made, the Hoover Building would not be considered a Class A office building. The appraiser reported that the site was zoned to permit retail, office, housing, mixed, and public uses, and the appraiser concluded that no reasonably probable use of the site would be likely to generate a higher value than office use. Accordingly, the appraiser identified office use, developed to the level permitted by the zoning, as the highest and best use of the property. The appraiser reported that the site, if redeveloped, could accommodate a building area of approximately 2.5 million gross square feet based on the current zoning regulations. The appraiser also noted that the existing Hoover Building is 2.4 million gross square feet and therefore a building on the redevelopment site would likely be similar in size. The appraiser noted that the existing building is set back farther from Pennsylvania Avenue greater than is typical for a commercial office building downtown but not far enough where demolishing the building to capture the space would be cost-effective. Redevelopment would enable a developer to construct a new Class A office building. 7. Relocation study, 2009 In 2009, the FBI contracted with an architectural and planning firm to develop a housing plan, space requirements program, and conceptual site plans for consolidating its headquarters in a new facility onto a single site. While the 2005 GSA study examined space requirements at a macro level, it did not provide a detailed housing plan and space requirements program. Thus, to more fully define its requirements, the FBI established goals for the 2009 study. These goals were to  develop a housing plan that identified the FBI branches and divisions to be located on-site; summarize staffing levels by branch and division, including both FBI personnel and contractors; summarize future staffing growth factors;  develop space-planning standards and workspace types;  develop a space requirements program for branches and divisions based on those staffing and space standards;  outline common shared support spaces and special space requirements; recommend an ideal floor plate size for a new building that would maximize future flexibility; identify circulation factors for the building; calculate total gross and usable square footage of a new facility;  develop conceptual site plans; and identify design criteria, including Leadership in Energy and Environmental Design, security, and building code requirements. The consultant collected data by walking through the FBI’s headquarters spaces, using a space requirements questionnaire, and interviewing FBI personnel in the facilities, security, and information technology groups to verify information from the questionnaire. Each FBI branch and division reviewed the consultant’s data. Using FBI personnel counts from 2008 with projections for future growth through 2013 and 2018, the consultant derived overall square footage tabulations. FBI’s Resource Planning Office provided the personnel counts and growth projections. Based on the space and security requirements for the main headquarters building, the consultant developed planning estimates for the site acreage required. The consultant developed two site concepts: (1) a suburban office campus and (2) a more urban site located near the Washington beltway. Preliminary cost estimates for a new headquarters were developed based on the consultant’s analyses of space and security requirements. FBI costs for special security equipment, communications and information systems, modular systems furniture, and moving were not included in the construction-related costs but were separately estimated and are not considered GSA project costs. Land costs were estimated on the basis of comparable land sales over the past several years in a variety of locations inside and outside the beltway. The suburban and beltway property costs were each averaged to determine average expected prices. The land costs were added to the GSA project cost summary and increased by 10 percent to reflect potential increases in land value, which may occur before a property is acquired. The study identified a need for a headquarters facility containing an estimated 2.6 million gross square feet—including 2.1 million useable square feet—to house nearly 11,600 personnel. Required site sizes were estimated at between 55 and 65 acres based on zoning assumptions for suburban and more urban locations. 8. Consolidation report (Final Draft), 2010 In 2010, the FBI’s Facilities and Logistic Services Division prepared an executive-level report to summarize past FBI and GSA findings and conclusions about the Hoover Building and both agencies’ studies of the need for a new headquarters facility. The report was intended to update FBI leadership on the current headquarters planning, costs, and recommendations prior to discussions with GSA and OMB. The report outlines a range of acquisition strategies that GSA and the FBI could use to acquire a new consolidated headquarters and identifies the FBI’s preferred strategy. According to the report, the FBI’s mission-critical headquarters operations are dispersed in 22 separate locations including the Hoover Building, up from 17 when GSA first studied the issue in 2005. Citing space and staffing requirements, the report identifies the need for a facility with 2.5 million gross square feet, 2.2 million rentable square feet, and 1.9 million usable square feet to house an estimated 11,500 personnel. The report further anticipates a reduction of approximately 873,400 rentable square feet when the 22 current locations are consolidated, as well as an estimated annual savings of at least $30 million in leased housing costs. Appendix III: Financing Strategies Available for Capital Projects This appendix describes potential financing strategies that may be considered in acquiring a new headquarters for the FBI. Federal Construction Using the Federal Buildings Fund  Construction or modernization is funded through GSA’s Federal Buildings Fund (FBF).  We have previously reported that although ownership through federal construction is often the most cost-effective option, pursuant to budget scoring rules, the full cost of construction of a capital project is recorded up front in the budget.  The FBF is the primary means of financing the operating and capital costs associated with federal space owned or managed by GSA. GSA’s Public Buildings Service charges federal agencies rent, the receipts of which are deposited in the FBF. Congress exercises control over the FBF through the annual appropriations process, setting annual limits on how much of the fund can be used for various activities. In addition, Congress may appropriate additional amounts for the FBF. Among the activities the FBF is used for are new construction, building repairs and alterations, building operations, and rental of space. Lease of Federal Site to a Developer Who Constructs a Facility On-site and Leases It Back to the Government (i.e., Ground Lease and Leaseback)  GSA officials report that lease construction by a developer could be pursued using GSA real property authorities in 40 U.S.C. § 585(c) or Section 412 of Public Law 108-447 (hereafter referred to as Section 412).  40 U.S.C. § 585(c) authorizes GSA to lease federal property—for not more than 30 years—to a developer who would build a facility on a site owned by the government and lease it back to GSA. The title to the parcel never leaves government ownership, and at the expiration of the lease, the title to the building passes to the United States.  Section 412 provides GSA with new, additional authorities to dispose of and use its real property inventory by sale, lease, exchange, and leaseback arrangements. Section 412 does not specify any limit on the term of the lease.  According to GSA, it has attempted to use 40 U.S.C. § 585(c) only once as a development authority, and it ultimately did not complete the project using this authority. GSA has never used Section 412 as a development authority.  Section 412 also authorizes GSA to retain the net proceeds from its real property disposals. Section 412 might enable GSA to use the proceeds of a sale—if the existing Hoover Building or site were sold— to pay for some of a new project’s costs.  How a leaseback is structured will determine how it is scored, and it may be treated as a capital lease with the amount equal to the asset cost recorded up front in the budget.  Given the current budgetary environment, this type of arrangement may be more feasible now than in the past. Furthermore, even though GSA told us that it almost always recommends the traditional funding strategy—federal construction—it has said that in the current budgetary environment, it believes that alternative strategies such as a ground lease and leaseback arrangement may need to be considered.  FBI officials believe that if a ground lease and leaseback arrangement were to be pursued, the agency may be able to move into a new consolidated facility 2 or 3 years earlier than it could with a direct federal appropriation for design and construction, given the demands on the FBF. Lease Construction (i.e., Leasing)  The government acquires space through an operating lease.  The government has no ownership of the land or the facility at any time.  We have previously reported that operating leases tend to be the most expensive approach to meeting long-term federal space needs and that over the last decade, GSA has relied heavily on operating leases to meet new long-term needs because it lacks funds to pursue ownership. GSA currently leases more space than it owns. Use of this approach has grown because only the annual lease payment needs to be recorded in GSA’s budget request, reducing the up-front funding commitment but generally costing the federal government more over time. Appendix IV: Comments from the Federal Bureau of Investigation Appendix V: Comments from the General Services Administration Appendix VI: Comments from the Department of Homeland Security Appendix VII: GAO Contacts and Staff Acknowledgments GAO Contacts Staff Acknowledgments In addition to the individuals named above, Michael Armes, Assistant Director; Sandra Burrell, Assistant Director; John Bauckman, Analyst-in- Charge; Kevin Craw; Daniel Hoy; Bess Eisenstadt; Susan Michal-Smith; Linda Miller; Sara Ann Moessbauer; Joshua Ormond; Thomas Predmore; and Janet Temko made key contributions to this report.

Since September 11, 2001, the Federal Bureau of Investigation's (FBI) mission and workforce have expanded, and the FBI has outgrown its aging headquarters, the J. Edgar Hoover Building (Hoover Building). As a result, the FBI also operates in over 40 annexes, the majority located in the National Capital Region. In the explanatory statement accompanying the 2009 Omnibus Appropriations Act, GAO was directed to examine the FBI's headquarters facilities. In response, GAO examined the extent to which (1) these facilities support the FBI's security, space, and building condition requirements and (2) the FBI and the General Services Administration (GSA)--the real property steward for the Hoover Building--have followed leading capital decision-making practices in identifying alternatives for meeting the FBI's facility needs. GAO reviewed security, space, and condition assessments and planning studies; visited FBI facilities; and interviewed FBI and GSA officials. According to FBI and GSA assessments, the FBI's headquarters facilities--the Hoover Building and the headquarters annexes--do not fully support the FBI's long-term security, space, and building condition requirements. The FBI has addressed many security concerns at the Hoover Building by implementing protective measures. Furthermore, in response to a recommendation GAO made in a law enforcement sensitive version of this report issued in July 2011, the FBI has updated its security assessment of the Hoover Building in accordance with security standards issued in 2010. The assessment includes recommendations but does not indicate whether recommended actions will be implemented. While this is reasonable given the short period of time since GAO's July 2011 report, documentation of decisions on the recommendations and tracking implementation is important because of facility planning and budget implications--for both the Hoover Building and a new headquarters--and time needed to coordinate with GSA. FBI officials told GAO that the annexes will be assessed against the 2010 security standards. The officials noted, though, that the dispersion of staff in annexes creates security challenges. The Hoover Building's original design is inefficient, according to GSA assessments, making it difficult to reconfigure space to promote staff collaboration. Staff dispersion across annexes likewise hampers collaboration and the performance of some classified work. Furthermore, the condition of the Hoover Building is deteriorating, and GSA assessments have identified significant recapitalization needs. However, GSA has decided to limit investments in the Hoover Building to those necessary to protect health and safety and keep building systems functioning while GSA assesses the FBI's facility needs. This decision increases the potential for building system failures and disruption to the FBI's operations. Through studies conducted over the past decade, the FBI and GSA have considered three broad alternatives, each with variations, to try to meet the FBI's facility needs--(1) modernize the Hoover Building, (2) demolish the Hoover Building and construct a new headquarters on the existing site, and (3) acquire a new headquarters on a new site. In doing so, the FBI and GSA thus far have generally followed leading practices for capital decision making. To varying degrees, these alternatives would improve security, space, and building conditions, but each would take several years to implement. Estimates of the alternatives' costs, developed in the studies, are not comparable because they were prepared at different times and for different purposes. The FBI and GSA plan to discuss the FBI's facility needs with the Office of Management and Budget, and GSA and the FBI will need to present a business case, including current, comparable cost estimates, to support the choice of a preferred alternative and financing strategy. The FBI's 2011 security assessment of the Hoover Building, as well as information on any security improvements that may be needed at the annexes, could inform the agencies' decisions and help ensure that limited budgetary resources are allocated effectively. This is a public version of a law enforcement sensitive report that GAO issued in July 2011, which has been updated, including a modification to a recommendation, to reflect recent FBI actions. Information that the FBI and the Department of Homeland Security deemed sensitive has been omitted. The FBI should document decisions about, and track its implementation of, all security recommendations for the Hoover Building and the FBI's headquarters annexes. GSA should reassess its decision to limit recapitalization investments in the Hoover Building, since the FBI is likely to stay in it for several more years while its long-term facility needs are being planned. The FBI agreed with these recommendations. GSA indicated it is working to implement GAO's recommendation.

Background The United States health care system is a large sector of the economy comprised of clinicians, health care delivery organizations, insurers, consumers, and government health agencies. According to the Medicare Payment Advisory Commission, the health care industry generally uses less IT than other industries, and the extent and types of IT deployed vary by setting and institution. The health care industry has recognized that IT can improve the quality of care, promote patient safety, reduce costs of both care and administrative functions, and expedite response to public health emergencies. Public health officials are increasingly concerned about our exposure and susceptibility to infectious disease and food-borne illness because of global travel, increased volume of food imports, and the evolution of antibiotic-resistant pathogens. Public health experts maintain that a strong infrastructure could provide the capacity to prepare for and respond to both acute and chronic threats to the nation’s health, whether they are bioterrorism attacks, emerging infections, disparities in health status, or increases in chronic disease and injury rates. IT can play an essential role in supporting federal, state, local, and tribal governments in public health activities and clinical care delivery. For public health emergencies in particular, the ability to quickly exchange data from provider to public health agency—or from provider to provider—is crucial in detecting and responding to naturally occurring or intentional disease outbreaks. It allows physicians to share individually identifiable information with public health agencies for use in performing public health activities. The Centers for Disease Control and Prevention (CDC) has previously acknowledged several IT limitations in the public health infrastructure. For example, basic capability for disease surveillance systems to detect and analyze disease outbreaks is lacking for several reasons. First, health care providers have traditionally used paper- or telephone-based systems to report disease outbreaks to approximately 3,000 public health agencies. This is a labor-intensive, burdensome process for local health care providers and public health officials, often resulting in incomplete and untimely data. Second, not all public health agencies have access to the Internet or to secure channels for electronically transmitting sensitive data. Several types of systems can play vital roles in identifying and responding to public health emergencies, including acts of bioterrorism. These types of systems—described in a technology assessment for the Department of Health and Human Services (HHS) that was completed by the University of California San Francisco-Stanford Evidence-based Practice Center—serve different but related functions and include the following: Detection—systems that consist of devices for the collection and identification of potential biological agents from environmental samples, making use of IT to record and send data to a network. Surveillance—systems that facilitate the performance of ongoing collection, analysis, and interpretation of disease-related data to plan, implement, and evaluate public health actions. Diagnostic and clinical management—systems with potential utility for enhancing the likelihood that clinicians will consider the possibility of bioterrorism-related illness. These systems are generally designed to assist clinicians in developing a differential diagnosis for a patient who has an unusual clinical presentation. Communications—systems that facilitate the secure and timely delivery of information to the relevant responders and decision makers so that appropriate action can be taken. In April of this year, the President issued an Executive Order, which recognizes the importance of IT to the improvement of the health care system to address problems with high costs, medical errors, and administrative inefficiencies. The order establishes the position of a National Health Information Technology Coordinator. This new position has been tasked with providing leadership for the development and nationwide implementation of interoperable health IT in both the public and private health care sectors. The President also announced a goal of having EMRs available for most Americans within the next 10 years. Information Technology Can Provide Benefits for Delivery of Care IT can provide significant benefits in providing clinical health care and in the administrative functions associated with health care delivery. Last October, we identified 20 examples of reported cost savings or other benefits at 14 health care organizations that had implemented IT solutions in their clinical care environments. The rapidly rising costs of health care, along with an increasing concern for the quality of care and the safety of patients, are driving health care organizations to use IT to automate clinical care operations and their associated administrative functions. IT is now being used for, among other things, EMRs, order management, Internet access for patient and provider communications, and automated billing and financial management. Health care delivery organizations identified instances that resulted in cost savings from the use of IT as a result of reductions in costs associated with medication errors, communication and documentation of clinical care and test results, staffing and paper storage, and processing of information. Specific examples included: A teaching hospital reported that it realized about $8.6 million in annual savings by replacing paper medical charts with EMRs for outpatients. It also reported saving over $2.8 million annually by replacing its manual process for handling medical records with electronic access to laboratory results and reports. A teaching hospital reported that it saved $5 million annually on drug substitutions, based on automated prompts that recommended alternatives resulting in increased quality and decreased cost. A community hospital prevented the administration of over 1,200 wrong drugs or dosages and almost 2,000 early or extra doses by using bar code technology and wireless scanners to verify both the identities of patients and their correct medications. The reported monetary value of the errors prevented was almost $850,000. An integrated health care delivery organization reduced the overall number of daily chart pulls, estimating that about $5.7 million in medical record staffing costs were avoided or saved annually. IT also contributed to other benefits, such as shorter hospital stays, faster communication of test results, improved management of chronic disease, and improved accuracy in capturing charges associated with diagnostic and procedure codes. For example, A teaching hospital reported a decrease in average length of stay from 7.3 to 5 days when it implemented an integrated EMR system that resulted in improvements in health care efficiency and practice changes. A teaching hospital reported improved patient scheduling using a rules-based electronic scheduling system that accommodated travel time to the appointment, fasting requirements, and providers’ availability. An integrated health care delivery organization reported improvements in diabetes control for members with the disease, decreases in upper gastrointestinal studies ordered, and increases in the number of Pap smears performed by using alerts and reminders, automated patient care guidelines, and data warehouse reports. A teaching hospital reported that 4 percent of radiology orders that had been entered into the order entry system were cancelled and 55 percent were changed when an embedded alert warned that an order was inappropriate for specified clinical reasons. Health care organizations also told us that EMRs could also improve the delivery of care because, among other reasons, more complete medical documentation was available to support the provider’s diagnosis. In addition, EMRs greatly facilitate the reporting of public health information associated with the early detection of and response to disease outbreaks. The lessons learned that were reported to us by health care organizations that have successfully implemented IT may prove useful for other organizations as they implement solutions—such as recognizing the importance of reengineering business processes, gaining users’ acceptance, providing adequate training, and making systems available and secure. For example, organizations reported that business process changes were key in effectively implementing the technology and that users, including physicians, should be involved in systems design and implementation. Many IT Initiatives Address the Public Health Infrastructure, Although Standards Implementation Challenges Remain In May 2003, we reported that six federal agencies involved in bioterrorism preparedness and response had a large number of existing and planned information systems associated with supporting a public health emergency. Specifically, these agencies identified 72 information systems and supporting technologies. Of the 72 systems, 34 are surveillance systems, 18 are supporting technologies, 10 are communications systems, and 10 are detection systems. In spite of these many initiatives, the key ones that are intended to facilitate greater information sharing are still being developed and implemented. For example, CDC is currently implementing its Public Health Information Network, which consists of a number of disease surveillance and communications systems, including the Health Alert Network. This network is an early warning and response system intended to provide federal, state, and local agencies with better communications during public health emergencies. The Department of Defense is using its Electronic Surveillance System for the Early Notification of Community-based Epidemics (ESSENSE) to support early identification of infectious disease outbreaks in the military by comparing analyses of data collected daily with historical trends. We also found that agencies varied in the extent to which they interacted and coordinated with other agencies in planning and operating each of these initiatives. The October 2001 anthrax attacks and the subsequent emergence of new infectious diseases have highlighted the importance of data standards for real-time data exchange across the public health infrastructure. During the anthrax attack, participants accumulated dissimilar data and principally exchanged it manually. Since 1993, we have called for federal leadership to expedite the standards development process in order to accelerate the use of EMRs. Most recently, in May 2003, we again reported that the identification and implementation of health care data, communications, and security standards—which are necessary to support the compatibility and interoperability of agencies’ various IT systems—remains incomplete across the health care industry. We also identified other standards setting initiatives (e.g., CHI and HIPPA) and raised concerns about coordinating these initiatives. To address the challenges of coordinating the many IT initiatives and implementing a consistent set of standards, we recommended that the Secretary of Health and Human Services (HHS), in coordination with other key stakeholders, establish a national IT strategy for public health preparedness and response, including specific steps toward improving the nation’s ability to use IT in support of the public health infrastructure. Specifically, we recommended, among other things, that the Secretary set priorities for information systems, supporting technologies, and other IT initiatives; define activities for ensuring that the various standards-setting organizations coordinate their efforts and reach further consensus on the definition and use of standards; establish milestones for defining and implementing all standards; create a mechanism—consistent with HIPAA requirements—to monitor the implementation of standards throughout the health care industry. Since our May 2003 report, HHS has continued its efforts to identify applicable standards throughout the health care industry and across federal health care programs. For example, in May 2004, the CHI initiative—one of OMB’s e-government projects—announced fifteen additional standards that build on the initial five announced in March 2003. Federal agencies are expected to include the standards in their architectures and when they build, acquire, or modify systems. Current plans for the CHI initiative call for it to be incorporated into HHS’s Federal Health Architecture by September 2004. This architecture is still evolving, and many issues—such as coordination of the various standards setting efforts and implementation of the standards that have been identified—are still works in progress. Until these standards are more fully implemented, federal agencies and others associated with the public health infrastructure cannot ensure that their systems will be capable of exchanging data with other systems when needed and consequently cannot ensure effective preparation for and response to public health emergencies, including acts of bioterrorism. In addition, in April of this year, the President issued an Executive Order, which calls for the establishment of a National Health Information Technology Coordinator and the issuance of a broader strategic plan to guide the nationwide implementation of interoperable health care information systems. The coordinator is also specifically tasked with creating incentives for the use of health IT and accelerating the adoption of EMRs, among other things. The Coordinator plans to present the strategic plan next week. Such a plan, if properly crafted, should help to move the health care industry towards interoperable information systems. As health IT initiatives are pursued, it will be essential to have continued leadership, clear direction, measurable goals, and mechanisms to monitor progress. In summary, there are many opportunities and challenges associated with the implementation of IT for clinical care delivery and public health. The federal government, namely HHS, has taken a leadership role in establishing a strategy and identifying data and communications standards, which are critical for sharing data across the health care industry—both to improve the quality of patient care in the United States and to strengthen the public health infrastructure. However, much more work remains to more fully utilize IT for the delivery of care and to identify and respond to public health emergencies. HHS needs to provide continued leadership, sustained and focused attention, clear direction, and mechanisms to monitor progress in order to bring about measurable improvements and achieve the President’s goals. Mr. Chairman, this concludes my statement. I would be happy to answer any questions that you or members of the subcommittee may have at this time. If you should have any questions about this testimony, please contact me at (202) 512-9286 or M. Yvonne Sanchez, Assistant Director, at (202) 512-6274. We can also be reached by e-mail at pownerd@gao.gov and sanchezm@gao.gov, respectively. Other individuals who made key contributions to this testimony include Joanne Fiorino, M. Saad Khan, and Mary Beth McClanahan. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

Health care is an information-intensive industry that remains highly fragmented and inefficient. Hence, the uses of information technology (IT)--in delivering clinical care, performing administrative functions, and supporting the public health infrastructure--have the potential to yield both cost savings and improvements in the care itself. In 2003, GAO reported on benefits to health care that could result from using IT--both cost savings and measurable improvements in the delivery and quality of care. GAO also reported on federal agencies' existing and planned information systems intended to support our nation's preparedness for and ability to respond to public health emergencies and the status of health care standards setting initiatives. Congress has asked GAO to summarize our work on reported benefits of the use of IT for health care delivery and on IT initiatives supporting public health preparedness and response. The use of IT can yield benefits in clinical care and associated administrative functions as well as in public health. Health care organizations reported that electronic medical records (EMR) improved the delivery of care because, among other reasons, more complete medical documentation was available to support the provider's diagnosis. In addition, EMRs could greatly facilitate the reporting of public health information associated with the early detection of and response to disease outbreaks. One hospital replaced outpatients' paper medical charts with EMRs, realizing about $8.6 million in annual savings. This hospital also established electronic access to laboratory results and reports, replacing its manual process for handling medical records and saving another $2.8 million a year. In addition, the lessons learned that were reported to us by health care organizations that have successfully implemented solutions could be used by other organizations to accelerate the adoption of health IT. These lessons recognize the importance of reengineering business processes, gaining users' acceptance of IT, providing adequate training, and making systems secure. Regarding public health, federal agencies identified 72 existing and planned information systems--34 surveillance systems, 18 supporting technologies, 10 communications systems, and 10 detection systems. For example, the Centers for Disease Control and Prevention is currently implementing its Public Health Information Network comprised of a number of disease surveillance and communications systems, including the Health Alert Network. This network is an early warning and response system that is intended to facilitate communication among federal, state, and local agencies during public health emergencies. GAO also reported that identification and implementation of health care data, communications, and security standards--which are necessary to support compatibility and interoperability of agencies' various IT systems--remained incomplete across the health care sector. To address the challenges of coordinating the many IT initiatives and implementing a consistent set of standards, GAO recommended last year that the Secretary of Health and Human Services develop a strategy for public health preparedness and response, to include setting priorities for IT initiatives and establishing mechanisms to monitor the implementation of standards throughout the health care industry. Since that time, progress has been made in identifying standards. The Office of Management and Budget's e-government initiative, the Consolidated Health Informatics initiative, has identified a number of standards to be applied to new federal development efforts and modifications of existing systems. This initiative is intended to promote the interoperability of information systems. However, implementing these standards across the federal government is still a work in progress. Until these standards are implemented, information-sharing challenges will remain. In April of this year, Executive Order 13335 established a National Health IT Coordinator and called for a strategic plan to guide the nationwide implementation of interoperable health IT. As this plan moves forward, it will be essential to have continued leadership, clear direction, measurable goals, and mechanisms to monitor progress.

Background For purposes of this report, we define the Control environment—positive and supportive attitude toward internal controls, conscientious management, and ethics standards. Risk assessment—identification and assessment of risks from internal and external sources and establishment of controls to mitigate them. Control activities—policies, procedures, techniques, and mechanisms that ensure management’s directives to mitigate risk are carried out. Information and communication systems—assurance that information is recorded and communicated to management and others in a form and within a time frame that enables them to carry out internal controls and operational responsibilities. Monitoring—activities that assess the quality of performance over time and ensure that audit and review findings are promptly resolved. As part of their overall governance and control, many companies establish internal audit departments to monitor adherence to management policies and controls, report exceptions to policies and procedures, and track corrective actions. One of the principal authorities on the standards and practices of internal auditing is the Institute of Internal Auditors (the Institute). The Institute is a non-profit professional organization that provides guidance on assessing, maintaining, and improving the quality of internal auditing within the profession. Importantly, the Institute provides guidance for the profession through its International Standards for the Professional Practice of Internal Auditing. These standards include requirements at the organizational level such as independence and objectivity, as well as for conducting audits, including planning, performing fieldwork, communicating results, and following up on corrective actions. The Institute also conducts training and administers the Certified Internal Auditor (CIA) testing and certification program. The CIA certification is acknowledged by auditing professionals as a standard by which individuals demonstrate their competence in internal auditing. In addition to a company’s own internal audit department, companies that provide goods and services to DOD may be audited by DCAA. As required by the Federal Acquisition Regulation (FAR) and the Defense Federal Acquisition Regulation Supplement (DFARS), DCAA’s audits examine internal controls, incurred costs, and business systems used in the execution of government contracts. DCAA’s contract audit services are intended to be a key control that helps ensure that prices paid by the government are fair and reasonable and that companies are charging the government in accordance with applicable laws, regulations, cost accounting standards, and contract terms. At the completion of an audit, DCAA provides the contracting officer with a report to assist in negotiations or in assessing contract costs, as well as in determining compliance with regulations and contractual requirements. DCAA, which employs approximately 4,000 auditors, consists of a headquarters office at Ft. Belvoir, Virginia and six major organizational components—five regional offices across the United States that direct and administer audits for assigned geographical areas and a field detachment office that audits classified contracting activity. The five regional offices manage about 300 field audit offices. Field audit offices can be categorized as branch offices, resident offices, or suboffices. Branch offices are located within each region and have responsibility for all contract audit services within the assigned geographical area. Resident offices are established at company locations where the audit workload justifies assignment of a permanent staff of auditors. Suboffices are established by regional directors as extensions of branch or resident offices when required to furnish audit services. A suboffice depends on its parent field office for release of reports. For larger companies with operations at multiple locations, DCAA assigns a Contract Audit Coordinator (CAC) who serves as a central point of communication between DCAA auditors and company representatives. DCAA audits are governed by generally accepted government auditing standards (GAGAS). These standards require evaluation and testing of the overall internal controls including the work of the contractor’s internal audit activity, specific controls, and business systems. These standards and associated principles govern the audit planning and evidence required to conduct a GAGAS-compliant audit. DCAA’s procedures for adhering to GAGAS in conducting different types of audits, such as audits of internal controls or company business systems, are contained in its Contract Audit Manual (CAM). According to the CAM, DCAA is required periodically to examine the contractor’s internal controls, as well as contractor policies and procedures. It also states that in the process of planning an audit, auditors should consider the company’s self governance programs when assessing the adequacy of the internal controls to determine the scope of their audit. Further, the CAM states that audits of individual business systems are to include an evaluation of the internal control activities applicable to that system.guidance for audit procedures states that auditors should consider a company’s internal audit activities to determine the adequacy of its internal controls when performing an audit of the company’s control environment and accounting system. Lastly, DCAA To conduct its audits, DCAA relies on the examination of contractor financial, accounting, and other data. DCAA’s authority to access and audit contractor records in support of DOD contracting and contract payment functions is described in sections 2313 and 2306a of title 10 of the United States Code (U.S.C.) and in the FAR. DCAA’s use of its authority has been addressed in two court decisions involving Newport News Shipbuilding and Dry Dock Company. The decisions are generally known as Newport News I and Newport News II, both decided in 1988. In the first case (Newport News I), the court held that DCAA’s statutory subpoena power could not be used to access internal audits not tied to a specific contract or proposal. In the second case, (Newport News II), the court held that DCAA could subpoena company tax returns and other materials, which were directly relevant to an audit and would allow DCAA to corroborate the company’s computation of direct and indirect costs.For additional information on DCAA’s access authorities and the Newport News cases, see appendix IV. Internal Audit Departments We Reviewed Generally Adhered to Institute Standards All of the companies we reviewed generally followed the Institute’s standards for organizing their internal audit departments. These organizational standards include maintaining independence and objectivity, constructing a risk-based audit plan, employing and maintaining a skilled, professional audit staff, and completing an external assessment. Similarly, based on our examination of internal audit reports and audit documentation (generally referred to as workpapers), we found that the majority of companies followed the standards for performing individual audits. These standards include assessing risks during audit planning, including the risk of fraud, obtaining evidence for findings to include testing and documenting evidence, and following up on audit issues. However, some companies did not provide sufficient information on how they conduct individual audits for us to determine if the standards for performance were met. Figure 1 shows the applicable Institute standards and the number of companies in our review that followed them. Our analysis indicates that five of the seven companies we evaluated generally conformed to five Institute standards for internal audit organizations. The remaining two companies did not provide for an external quality assurance review as required under the Institute’s standards. The five standards are: Independence and objectivity—According to the organizational charts of the seven selected companies, their Vice Presidents of Internal Audit, also called the Chief Audit Executives (CAE), report directly to the Audit Committees of the Board of Directors for matters related to internal audits. For administrative matters such as payroll and office space, the internal audit departments can be linked to the Chief Financial Officer or another department. This organizational feature allows the internal audit activity to be independent of company management, as called for under the Institute’s standards. To further ensure independence and objectivity, most audit executives we met with stated that they encourage an attitude of objectivity in their staff. For example, one CAE said that if staff from other divisions of the company are assigned to the internal audit department, those staff do not audit their former division’s activities to mitigate conflict of interest risks. Risk-based audit plan—All seven companies we reviewed developed audit plans using risk-based assessments consistent with the Institute’s standards. Audit plans are used by companies’ internal audit departments to schedule their audits throughout the year so that the highest risk issues the company is facing are covered. According to the Institute’s standards, internal audit departments should base audit plans on an annual evaluation of multiple risk factors, prioritized to ensure coverage of the highest risk areas. In reviewing how the companies develop their audit plans, we found that they receive input from management and the board of directors and consider a variety of factors such as changes in government regulations, review of high- risk areas identified in previous risk assessments, the potential for financial misstatement, and external factors facing the company. Once the information is compiled, the seven internal audit departments plan specific audits across company businesses and product lines, taking into account the likelihood of the risk materializing and the damage to the company should the risk materialize. Sometimes companies conduct a follow-up audit for high- risk issues highlighted in a previous year. Follow-up audits allow the internal audit department to track high-risk findings to ensure they are corrected. Proficiency—The Institute’s standards require that internal auditors have sufficient expertise. We found that although internal audit departments’ staff varies in number, the staff are comparable in professional qualifications. Six of the company internal audit departments are staffed by company employees, while the seventh company contracts with an accounting firm to conduct its audits. Based on information provided by the companies, we found that the staff from six companies have a wide range of professional credentials including certified public accountants, certified fraud examiners, certified internal auditors, and certified information systems auditors. In addition, more than half of the staff members have advanced degrees, such as a masters of business administration. Table 1 shows the audit staff experience and the average number of auditors with certifications for six companies. For the seventh company that retains an outside accounting firm to perform its internal audits, the audit directors and the staff of the accounting firm combined have a range of professional certifications and advanced degrees comparable to the other companies. Company officials informed us that their practice enhances the audit function’s independence since the audit staff is not employed by the company and ensures the availability of specialists, if needed. Another company in our review previously outsourced its internal audit function but stopped doing so, according to a senior internal audit official, to save money, provide an in-house talent pool, and enhance the connection between the auditors and the company. Continuing professional development—The Institute’s standards require certified internal auditors to complete 80 hours of continuing professional education (CPE) every 2 years to ensure that they maintain and update their knowledge and skills. We found that the companies take a variety of measures to enhance auditors’ knowledge and skills. For example, one company provides 100 hours of annual training, covers the cost of professional certifications, provides financial incentives for their completion, and expects auditors to obtain an additional 100 hours of training on their own. In addition to CPE requirements and professional certifications, officials at three companies stated they have training programs that allow staff from other departments or business units to rotate through the internal audit department for a limited time. External assessments—Institute standards require that internal audit departments must be subjected to external assessments at least once every 5 years. Five of the selected companies have had external quality assurance reviews of their organization and audit performance within the previous 5 years. These assessments review a company’s conformity with the Institute’s standards and provide comments on the performance of the internal audit function. All five companies received the highest possible rating of “generally conforms.” Officials from the other two companies in our review stated that they do not have an external assessment of their internal audit departments. Internal Audits We Reviewed Followed Institute Standards Our analysis found that five of the companies met the standards for individual audits (see figure 1), including engagement planning, conducting fieldwork and testing, reporting findings, and tracking corrective actions. We were unable to completely assess two companies’ compliance with the standards because the companies did not provide the information needed to do so. Specifically, we found that the 470 audit reports provided by six companies and 25 sets of supporting workpapers provided by five companies followed the Institute’s standards. Planning the audit including assessing the risk of fraud—Workpapers we examined from the five companies that provided them contained documents showing planning steps for each objective consistent with the Institute’s standards. Some companies completed an additional step by noting in the workpapers the evidence associated with each planning step. We also found that some workpapers contained assessments of the fraud risks specific to the audit’s scope. For example, one workpaper set we reviewed reported that the audit team met with the legal department about fraud risks and ethics considerations for that particular audit. Another set of workpapers showed that a risk assessment chart was used to identify areas to be included in the audit’s scope along with a rationale for its inclusion. Conducting fieldwork including testing—The Institute’s standards require internal auditors to conduct sufficient analysis and document information to support the audit. The workpapers we reviewed contained extensive documentation of the fieldwork, such as interviews with company officials, and testing, such as comparing company actions to policies and procedures to determine the extent of compliance. The audit reports we reviewed from the six companies showed evidence of substantive testing and provided analysis of the testing showing the level of compliance with company policies, procedures, business systems, and defense contracts. When testing was conducted, it was cited in the reports as support for reportable issues. Some testing relied on judgmental samples, but for certain audits, such as audits of purchase card transactions, all of the transactions were examined. In addition, we traced identified findings through the workpapers to track the testing and the inclusion of the work in the audit planning. By tracing the findings back to their origin in the audit objectives, we verified that the findings reported were supported by sufficient audit work. Reporting findings—The audit reports we reviewed followed the Institute’s standards for reporting results of the audit work by providing reports to upper management and the audited party. The audit reports provided the objectives and scope of the audit work and the findings or issues discovered through the audit work. While the companies do not follow GAGAS standards, the reports, although brief, contained a clear explanation of the findings often citing criteria, condition, cause, and effect as defined in GAGAS. Audit officials at one company stated that they include only those findings they consider to be the most important in their reports because that is what company management has indicated has the most value to them. Officials said that highlighting the most important issues allows them to prioritize their resources and take appropriate actions to correct them. In contrast, some companies include nearly every finding discovered during the audit work. Illustrative of these different approaches, the company that only reports on the highest risk issues routinely had 2 to 4 findings per report, while other companies had multiple reports with more than 10 findings per report. Tracking corrective actions—The Institute’s standards require that the CAE establish a process for the internal audit department to track corrective actions to ensure they have been implemented or that management has accepted the risk of not taking the corrective action. We found that five companies documented the corrective actions they had taken or intended to take to fix the problems identified in the audit reports. Usually, the responsibility and accountability for implementing the corrective actions were assigned to specific individuals and were generally required to be implemented within a certain time period. According to officials at one company, if corrective actions are not taken or completed in a timely manner internal audit management and company management are notified. In addition to findings that require corrective actions, some companies’ audit reports include suggestions for process enhancements for improving operations, comments that are notable business practices, and observed areas of excellence that are exceptional practices that would benefit other business units within the company. Internal Audit Reports Contain Information Relevant to DCAA Audits The internal audits conducted by the seven selected defense companies cover a broad spectrum of policies, business systems, and programs. The seven companies conducted 1,125 internal audits from January 1, 2008, through December 31, 2009, with 520—slightly less than half—of these audits relevant to the internal control for defense contracts.defense-related internal audit reports fell into one or more of the following categories: All 520 audits examined some aspect of the companies’ overall control environment. 338 audits related to one or more of the six business systems that DOD audits. 97 audits pertained to a specific DOD program and could include reviews of an entire business system, such as the earned value management system, or one component of a business system, such as purchasing. 96 audits were associated with a company’s compliance with federal laws and regulations, or company policies related to its management and oversight of its defense contracts. Of the 338 audits related to the business systems audited by DOD, we found that most concerned some aspect of the company’s accounting system. In addition, the audits reviewed a wide range of subjects, including purchase cards or earned value management systems to determine if they are compliant with FAR and DFARS standards, and internal controls over accounts payable. For example, an audit from one company assessed a division’s purchase card program and found several issues of non-compliance with policies and procedures and identified control weaknesses related to the administration of the purchase card program. Another company’s audit reviewed the general controls, including the accounting system, for a division within a company and found that controls were not operating effectively to ensure consistent classification of accounting transactions. Figure 2 shows the distribution of internal audits among the six business systems. DCAA’s Access to and Use of Company Internal Audits Are Limited DCAA’s access to and use of internal audit information were generally limited at the companies we reviewed. Company policies on providing DCAA access to such information varied at the seven companies—from allowing full access on a case-by-case basis to denying access. The extent to which DCAA has requested or been denied access to internal audits is difficult to determine because DCAA does not track its requests or denials. Based on information provided to us by the seven companies, we estimate that DCAA requested access to 115 of the 520 audits we identified as being relevant to internal controls and oversight of defense contracting. We identified a number of factors that affect how frequently DCAA auditors request internal audits, including interpretations of prior legal decisions on DCAA’s access and the limited details DCAA receives from the companies about the contents of the internal audit reports. However, GAGAS and DCAA’s audit manual require an evaluation of internal control, which includes internal audits, to provide a basis for efficiently and effectively planning an audit. DCAA Obtains Limited Access to Internal Audit Reports and Workpapers The seven companies that we reviewed do not have uniform policies about providing DCAA with access to internal audit reports and workpapers. Of the seven companies: Six companies have policies that provide for DCAA access to at least some internal audits reports upon request. Four of the six, however, provide that access on a “view-only” or “read-only” basis, meaning that DCAA auditors may not have physical or electronic copies of the reports but may view them and take notes in the presence of company staff. Company officials explained to us that they adopted this policy because the reports are sensitive and proprietary. One company provides copies only of the sections of the reports and workpapers that company officials consider relevant to DCAA’s work. Of those six, four companies have policies that provide for DCAA access to the supporting workpapers for their internal audits upon request. Again, one company’s policy is to provide only workpapers for the sections of internal audit reports the company deems relevant to DCAA’s work. The other two companies have policies to not provide DCAA with access to supporting workpapers. One company adopted a policy of not providing DCAA with access to its internal audits or workpapers. Each of the six companies that have policies for providing access to their internal audit reports require approval for specific requests for access on a case-by-case basis, and most require that the requested internal audit information directly relate to a DCAA audit of a specific contract or proposal. When companies determined that such a request is not relevant, the companies have denied DCAA’s requests. For example, one company denied DCAA access to two requested audits because company officials determined that the audits were related to commercial or other activities the company believed were not subject to DCAA’s review. Another company official said that the company would not provide DCAA with access to internal audits related to internal controls for information technology due to the potential threat of unauthorized individuals getting access to networks, critical applications, and confidential company or client data. For the company with the policy of not providing DCAA with access to internal audit reports, DCAA has cited the lack of access as preventing it from obtaining an understanding of the company’s internal controls and reported this as a deficiency in the audit of the company’s overall accounting system. DCAA concluded that without access to the company’s internal audit reports, DCAA could not determine if the company’s monitoring function was operating effectively and whether deficiencies were corrected. The company’s response cited the Newport News I decision to support its position that contractors are not required to provide DCAA with access to internal audit reports that are not tied to a specific DCAA audit. While the company provided DCAA with lists of planned audits as requested by DCAA and a summary of the three requested audits, DCAA noted in its 2010 report that this was not enough information to establish that the company’s internal controls were effective. In another instance, DCAA reported a deficiency in another company’s control environment, citing the company’s policy of limiting access to sections of internal audit reports the company deemed relevant to contract oversight and not providing adequate and timely disclosure of audit reports that identified unallowable costs. The company changed its policy and agreed to provide DCAA with access to all audit reports the company determines to include findings related to government costs. However, auditors at one DCAA office who have requested internal audit reports from the company said that the company has not adhered to the revised policy and has continued to deny DCAA access to reports. Another company we reviewed also changed its policy in recent years in response to discussions with DCAA officials or as the result of DCAA reporting the lack of access as contributing to a control environment deficiency. The company previously had a policy of providing DCAA with no access to internal audit reports, citing the Newport News I court case as support for restricting DCAA’s access. After the CAC sent a letter in 2009 challenging this access policy and discussed the access issue with company officials, the company changed its policy to provide DCAA with read-only access to internal audit reports. DCAA Does Not Generally Track Requests and Company Responses Related to Internal Audits DCAA audit teams generally do not coordinate their requests for audit reports among their field audit offices, which limits DCAA’s insight into the extent to which audit teams are requesting or are being denied access to internal audit reports. Within DCAA, one of the responsibilities of the CAC assigned to a company is to serve as a contact point for discussions related to access to contractor information, such as internal audit reports. However, we found only one DCAA audit team that has implemented a system in which the CAC serves as a focal point for all internal audit report requests by all the field offices. For the other companies, the corporate and field offices submit requests directly to the company. As a result, the CAC does not necessarily know how frequently or what type of internal audit information field audit offices are requesting. One of these CACs noted that the CAC is informed when DCAA teams are denied access, but otherwise the CAC does not track requests or company responses. In the case of the one company that has multiple locations but does not have a CAC, the DCAA audit team does not coordinate internal audit requests to the company. As a result, the audit team does not know how many requests for internal audit information are made to company, what type of information is being requested, or whether the requests are fulfilled or denied. Although DCAA does not generally track requests or denials for internal audit reports and, therefore, cannot say how many audit reports it asks for or receives, the companies we reviewed maintain such information with varying degrees of specificity. Based primarily on information from these companies, we determined that for the most part, DCAA audit teams request a small number of company internal audits, even though a significant number of internal audits pertain to internal controls and systems that are subject to DCAA audits. The companies provided us with estimates or specific counts of how many internal audits were requested by DCAA since 2008. In most cases, the number of reports requested was significantly fewer than the number of reports we determined were related to DOD contract oversight. The companies estimated that DCAA requested 115 audit reports over the 2-year period while we determined that 520 audit reports were related to some aspect of oversight of DOD contracts. Information on the number of reports requested from each of the companies and the number of reports we determined to be related to oversight of government contracts is summarized in table 2. DCAA auditors we spoke with identified several factors that could affect the number of internal audits they request. Auditors from four DCAA audit teams told us they have difficulty determining which internal audit reports are relevant to their own audit work because descriptions of internal audits they receive from the companies are often too brief to assess the relevancy to ongoing or planned DCAA audits. Our review of the lists of audits provided to DCAA confirmed that five of the companies provide only brief titles of audits, while two provide more detailed summaries that included the purpose, potential risks, and scope. DCAA auditors stated when they request an internal audit report, the company usually requires them to justify their request by linking it to a planned or ongoing DCAA audit of a particular contract or proposal. As a result, DCAA auditors believe they are limited to requesting only those reports related to a specific planned or ongoing DCAA audit, even if the company has other internal audit reports related to another system or program that DCAA is responsible for auditing. Auditors from three DCAA audit teams stated that they did not believe that access to contractor internal audit information is critical to their own audit work and that the internal audit reports do not have enough detail to be helpful. They also stated that they are restricted by auditing standards in relying on the work of others. However, auditing standards do not restrict auditors from relying on the work of other auditors, including internal audit functions. While not reducing the level of work to be performed by DCAA auditors, consideration of relevant internal audit reports in planning related DCAA audits and performing risk assessments can provide useful information for planning DCAA’s scope of work and audit procedures. DCAA has issued significantly fewer audit reports since 2008. The annual number of DCAA audits of the seven companies selected for this review decreased by almost 50 percent from 2008 to 2010. The number of internal control audits DCAA performed on the companies decreased from 128 to 62 in the same period. A DCAA policy official noted that DCAA decreased its number of control environment audits because it was waiting for a regulatory change that would redefine critical business systems for contractors. As a result of this decrease, the number of internal audits necessary to supplement DCAA’s audit work also decreased during this time period. Auditors from the DCAA audit teams we spoke with confirmed that while they request relatively few internal audits, when they are provided access to the audit reports, they use them primarily to help assess the companies’ internal controls and to determine whether companies took corrective action to address reported issues. Other uses of internal audits that DCAA auditors identified included: assessing the risk associated with a given DCAA audit, identifying the amount of testing needed for a given area, and determining whether company audit report findings identify unallowable costs that affect government contracts. DCAA officials have acknowledged that getting access to internal audit information has been an issue with some of the major defense contractors and, at best, they have access on a case-by-case basis. They also acknowledge that they have not used their subpoena authority to get access to internal audits or other company documents since the Newport News decisions were issued in 1988 in part because the Fourth Circuit Court of Appeals held that the language in the statutes did not generally include internal audit reports unrelated to a specific contract or proposal.They also stated that the court’s decisions may have resulted in some DCAA auditors limiting their requests for internal audit information. A DCAA official noted that they have implemented a pilot program with one major defense contractor that could be a model for how the agency disseminates and coordinates internal information. The pilot program consolidates authority and communication among various field offices throughout the country that are responsible for auditing the contractor into one regional audit team. DCAA auditors and company representatives told us that the pilot provided enhanced communications and efficiency between DCAA and the company. While the pilot does not specifically address requests for internal audits, a senior DCAA official suggested that the model could be applied to the process of requesting and distributing company internal audit information as well. Conclusions The internal audits conducted by the seven companies we reviewed generally were conducted in accordance with recognized professional organizational standards. For individual company audits, the audit reports and workpapers from five companies demonstrate that they likewise adhere to recognized professional standards. The audit reports assess the controls and systems for managing defense contracts that DCAA is charged with auditing and contain information and analysis that DCAA could find useful as it conducts its own work. However, DCAA is not making full use of internal audits to help accomplish its critical oversight role. This is attributable, in part, to company limits on access to internal audit information based on their interpretations of DCAA’s access authority and related court cases. While the courts have held that DCAA does not have unlimited power to demand access to all internal company materials, the courts have also made it clear that DCAA may demand access to materials that are relevant to carrying out its audit responsibilities. There are other issues that also account for DCAA’s limited use of internal audit reports. Specifically, DCAA auditors do not routinely request access to the reports due to limited visibility into the scope and objectives of internal audits and uncertainty as to how relevant internal audits can be used. DCAA management lacks insight into the limited access and use of internal audits because DCAA does not centrally track requests and denials for access to documents that could improve its ability to carry out its mission. When companies do not provide DCAA with access to internal audits or DCAA auditors do not request them, DCAA auditors do not have information that may be relevant for audit planning and risk assessment. Conversely, greater access to internal audit information could improve DCAA’s efficiency. DCAA auditors could either conduct a full audit of all components of internal control, or in instances in which internal auditors have conducted related work, DCAA auditors could examine the audit reports and workpapers, if needed, and adjust their planning accordingly. Moreover, we believe that by not routinely obtaining access to relevant company internal audits that can inform their audits of the companies’ control environments, as well as audits of specific business systems and contracts, DCAA auditors are hindered in their ability to meet the GAGAS requirement for assessing internal controls. The work of the internal auditors by no means replaces the work of DCAA auditors, but it could provide DCAA auditors with a basis for making a judgment about a company’s internal controls and help inform their audit planning, thereby making more effective and efficient use of DCAA audits. Recommendations for Executive Action To increase DCAA’s access to and use of internal audits, we recommend that the Secretary of Defense direct that the Director of DCAA take the following three actions: Ensure that DCAA’s central point of contact for each company coordinates issues pertaining to internal audits. For some companies, this would be the Contract Audit Coordinator. For companies without a Contract Audit Coordinator, a point of contact would need to be designated except when DCAA officials have determined that a company does not have an internal audit function that produces reports that may be relevant to DCAA’s audit responsibilities. Coordination responsibilities should include obtaining sufficient information from the companies on their internal audit reports so DCAA auditors can better identify and request relevant audit reports and workpapers and tracking DCAA auditors’ requests for access to internal audit reports and workpapers and the companies’ disposition of those requests. Periodically assess information compiled by the central points of contact regarding the number of requests for internal audits and their disposition to determine whether additional actions are needed. Such additional actions could include senior level engagement with company officials to change company access policies or, as warranted, the issuance of subpoenas. Reaffirm with DCAA staff through guidance and training how and under what circumstances company internal audit reports can be accessed and used to improve the efficiency of audit planning and execution. Agency and Third- Party Comments and Our Evaluation We requested comments on a draft of this report from DOD. In its written comments, reproduced in appendix II, DOD concurred with two of the recommendations and partially concurred with the recommendation regarding DCAA central points of contact for issues pertaining to internal audits. In its partial concurrence, DOD explained that DCAA would implement the recommendation to establish central points of contact for larger companies to attempt to obtain internal audit information from them and establish processes for tracking auditor’s requests for internal audit reports and workpapers. DOD stated, however, that doing so for smaller companies may not be feasible or beneficial, as some smaller contractors may not have sophisticated internal audit functions. DOD further expressed skepticism that implementing the recommended actions alone would fully ensure that DCAA would have complete and full access to contractor internal audits, citing the limits that companies have placed on DCAA’s access to internal audits and prior legal precedence. We agree that for companies without internal audit functions that produce reports that may be relevant to DCAA’s audit responsibilities, designated coordinators would not be necessary. We, therefore, revised our original recommendation to provide for such an exception. We agree that implementing these recommendations alone may not be sufficient to provide DCAA with full and complete access to internal audit reports in all instances. However, implementation of the recommendations is a necessary step for DCAA to obtain the information needed to determine the extent to which DCAA is or is not getting access and how that is affecting DCAA’s ability to fulfill efficiently its oversight responsibilities. After taking such steps, DOD may be in a better position to identify and pursue other remedies for ensuring DCAA’s access to internal audit reports. We also provided a draft of the report to the Chief Audit Executives of the seven selected companies for their review and comment. In its written comments on the draft, which are reproduced in appendix III, Lockheed Martin Corporation expressed support for providing DCAA with internal audit reports to the extent they can be used by DCAA to satisfy internal control reviews. Lockheed Martin also noted, with regard to the recommendation for DCAA central points of contact, that all DCAA audit requests are already centrally coordinated through the DCAA CAC, which has allowed the company to be responsive to DCAA request for internal audit reports. The other six companies declined to provide official comments, but two provided technical comments, which we incorporated into the final report as appropriate. We are sending copies of this report to the Secretary of Defense, the Director of the Defense Contract Audit Agency, the Director of the Office of Management and Budget, appropriate congressional committees, and other interested parties. We will make this report available to the public at no charge on the GAO website at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-4841 or at woodsw@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix V. Appendix I: Scope and Methodology In response to a congressional request to assess the role of defense companies’ internal audit departments and their ability to provide the Defense Contract Audit Agency (DCAA) with information on their control environments, business systems, and policies affecting government contracts, we examined (1) the adherence of selected major defense companies to internal auditing standards for organizations and individual audits, (2) the extent to which the internal audit reports of those companies address internal controls for the management of defense contracts and associated business systems, and (3) DCAA’s ability to examine and use those reports in carrying out its oversight responsibilities. Our review focused on seven selected major defense companies. For purposes of our review we defined a major defense company as having at least $500 million in contracts with the Department of Defense (DOD) and at least $100 million in cost reimbursable contracts. The companies we selected had at least $1 billion in DOD contracts and derived at least 25 percent of their revenue from DOD contracts in fiscal year 2009. We selected the top five major defense companies based on fiscal year 2009 DOD contract obligations—The Boeing Company, Lockheed Martin Corporation, Raytheon Company, Northrop Grumman Corporation, and General Dynamics Corporation. We then judgmentally selected URS Corporation and KBR, Incorporated to obtain insights on how smaller major defense companies carry out their internal audit functions. Collectively these seven companies represent about $106.7 billion (57 percent) of the value of all contracts awarded by DOD to all major defense companies in fiscal year 2009. The results of our review cannot be generalized across major defense companies; instead, they provide insights into how companies have organized their internal audit function, conduct audits, and interact with DCAA. To provide a framework for our assessment of the seven companies’ internal audit organization and engagement performance, we interviewed officials with the Institute of Internal Auditors and reviewed standards promulgated by the Institute for characteristics used in their peer review assessment of internal audit organizations as well as the standards for engagement performance. We also interviewed officials and reviewed documentation pertaining to the Institute’s Certified Internal Auditor examination and its training programs and conferences available to the auditing profession. To develop information on companies’ organizational characteristics, we reviewed documents related to the organization and reporting structure of companies’ internal audit departments. We conducted an initial interview and obtained documents from officials from all seven companies to determine the internal audit department’s organizational standards, including its reporting structure, qualifications of staff, and whether the company participated in a peer review of its organization and engagement performance. We compared company policies, standards, and practices to standards set by the Institute regarding the organization and activities of company internal audit departments and to the standards for engagements. Our work in examining the audit reports was conducted in two phases. First, we requested a list of all audit reports completed by the companies from January 1, 2008, through December 31, 2009—the latest audits completed when we began our assessment. We asked that the lists contain the titles, objectives, and scope of the audits. In total, the seven companies provided information on 1,125 audits. Second, we analyzed the information provided on the 1,125 audits and identified reports that pertained to the oversight of government contracts. We categorized the report as defense-related if the audit report’s scope and objectives identified one or more of the following aspects of company operations that are related to execution of government contracts: The audit’s scope and objectives included review of some aspect of the overall internal control system. The audit’s scope and objectives included review of one of the six business systems DOD is charged with reviewing—accounting system, earned value management system, estimating system, purchasing system, material management and accounting system, and property management system. The audit’s scope and objectives covered one or more DOD programs. The audit’s scope and objectives covered some aspect of the Federal Acquisition Regulation (FAR), Defense Federal Acquisition Regulation Supplement (DFARS), or company policies related to defense contract oversight. In total, we identified 520 audit reports as defense-related and requested those reports from the companies. We also selected a nongeneralizable random sample of five sets of workpapers from each company’s audit reports in order to assess how individual audits adhere to the Institute’s standards for conducting audits. The companies provided us with 470 audit reports and 25 sets of workpapers. Lockheed Martin Corporation, Northrop Grumman Corporation, The Boeing Company, Raytheon Company, and URS Corporation provided us with both audit reports and workpapers for review. General Dynamics Corporation provided only audit reports for review. KBR, Incorporated did not provide audit reports or workpapers for our review. When companies did not provide us with requested audit reports or workpapers, we obtained the rationale for not providing the materials from company officials for documenting purposes. These rationales included the limitations on access to company internal documents discussed in two court cases and ownership of the workpapers by a third party. We do not regard the company decisions as a limitation of our scope since we examined the vast majority of the documents we requested and were fully able to address our audit objectives. To assess how internal auditors applied the standards in conducting their audits, we reviewed 470 audit reports and 25 sets of workpapers. For the audit reports we determined the issues raised by the auditors, distribution of audit findings as well as evidence in the reports of testing conducted and follow-up of corrective actions. For our examination of the workpapers, we looked for evidence of planning for the engagement, risk assessments to include the risk of fraud, testing of company policies and procedures to determine if they are being followed, and whether the work performed supported the findings. For the workpaper reviews, we traced a finding from the conclusion back through the evidentiary materials including testing to the planning and risk evaluation to ascertain whether the finding was supported by the audit evidence and planning. To determine whether the audit finding was followed until it was corrected, we examined documentation in the audit workpapers to identify the person responsible for taking the action, what action was taken, and the date corrective action was completed. To assess DCAA’s access and use of company internal audits, we reviewed DCAA’s audit manual and its audit programs for control environment audits as well as for audits of business systems and incurred costs. We interviewed DCAA officials responsible for audit policy. At the seven companies we selected, we also interviewed the DCAA audit staff to determine their experience in examining internal audit reports. We obtained DCAA documents requesting audit reports and copies of material provided by the companies in response to requests. We discussed actions taken by DCAA to gain material requested and reviewed reports of internal control deficiencies citing a lack of access to company audit reports. We interviewed staff to review their rationale for requesting company audit reports as well as the materiality of those reports to DCAA’s work. We reviewed sections 2313 and 2306a of title 10 of the United States Code concerning DCAA access to records and FAR and DFARS provisions governing DCAA’s responsibilities. We also reviewed two key court decisions regarding DCAA’s ability to enforce a subpoena for company records including internal audits. We conducted this performance audit from September 2010 through December 2011 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Comments from the Department of Defense Appendix III: Comments from Lockheed Martin Corporation Appendix IV: DCAA Access Authority and Associated Court Cases The Defense Contract Audit Agency’s (DCAA) authority to access and audit contractor records in support of Department of Defense (DOD) contracting and contract payment functions is described in sections 2313 and 2306a of title 10 of the United States Code (U.S. Code) and in the Federal Acquisition Regulation (FAR). Section 2313 of title 10 of the U.S. Code gives the head of an agency, acting through DCAA as its authorized representative, the authority to inspect the plant and audit the records of a contractor performing a cost-reimbursement, incentive, time and materials, labor hour, or price redeterminable contract for agency. Records are defined as including both documents and data (among other things) whether written or in electronic form. The statute also provides that records may be subpoenaed if not provided by the contractor. Section 2313(i) of title 10 of the U.S. Code defines records to include books, documents, accounting procedures and practices, and other data, regardless of type and regardless of whether such items are in written form, in the form of computer data, or in any other form. Section 2306a of title 10 of the U.S. Code gives the head of an agency, acting through the contracting officer, the authority to require offerors, contractors, and subcontractors to make available cost or pricing data to the government. It also provides the head of an agency, acting through the contracting officer and DCAA, with the authority to review the records provided by the offerors, contractors, and subcontractors for the purpose of evaluating its accuracy, completeness, and currency. The FAR describes the auditor’s contract audit responsibilities such as submitting information and advice to the requesting activity based on the auditor’s analysis of contractor’s financial and accounting records or other related data as to the acceptability of the contractor’s incurred and estimated costs. In addition, the auditor is responsible for reviewing the financial and accounting aspects of contractor cost control systems and performing other analyses and reviews that require access to contractor financial and accounting records supporting proposed and incurred costs. The FAR also provides specific language regarding DCAA role as the responsible government audit agency. DCAA’s use of its access authority has been addressed in at least two court decisions, generally known as Newport News I and Newport News II, both decided in 1988. In both cases, DCAA sought to enforce subpoenas for access to internal documents of Newport News Shipbuilding and Dry Dock Company. In the first case (Newport News I), Newport News challenged the scope of DCAA’s subpoena power as it related to Newport News’ internal audits. The court held that the statutory subpoena power of DCAA extends to cost information related to government contracts but that DCAA does not have unlimited power to demand access to all internal corporate materials of companies performing cost type contracts for the government. Because the materials sought by DCAA were not within the scope of its statutory authority, the court affirmed the district court’s order denying enforcement of the subpoena. In the second case (Newport News II), DCAA subpoenaed the company’s tax returns, financial statements, and supporting schedules.decided to uphold enforcement of the subpoena, concluding that the requested material was relevant to an audit and provided evidence of the consistency of costing methods and the reconciliation of costs claimed for tax purposes. Further, the court decided that access to the documents would allow DCAA to corroborate the company’s computation of direct and indirect costs. The court contrasted the two cases, stating that the subpoena at issue in the first case did not extend to internal audits, which contain the subjective assessments of Newport News’ internal audit staff. In the second case, DCAA requested production of objective financial and cost data and summaries, not the subjective work product of Newport News’ internal auditors. To the extent that the materials subpoenaed would assist DCAA in verifying and evaluating the cost claims of the contractor, the court determined they were within DCAA’s statutory subpoena authority. Appendix V: GAO Contact and Acknowledgments GAO Contact Acknowledgments Principal contributors to this report were Johana R. Ayers, Assistant Director; James Ashley; Lisa M. Brownson; John W. Crawford; Gayle L. Fischer; Laura S. Greifner; Carolyn R. Kirby; John Krump; Jean L. McSween; Carol T. Mebane; John Needham; Matthew M. Shaffer; Robert A. Sharpe; and Roxanna T. Sun.

The Defense Contract Audit Agency (DCAA) has a critical role in contract oversight. DCAA audits are intended to help provide reasonable assurance that defense company policies for safeguarding assets and complying with contractual requirements are fulfilled. Defense companies also maintain their own internal audit departments to monitor policies, procedures, and business systems related to their government contracts. GAO was asked to assess the role of defense companies' internal audit departments and their ability to provide DCAA with information on their internal controls. GAO assessed (1) selected defense companies' adherence to standards for internal audits, (2) the extent to which those companies' internal audit reports address defense contract management internal controls, and (3) DCAA's ability to examine internal audits and use information from these audits. GAO reviewed a nongeneralizable sample of seven major defense companies including the five largest defense contractors and two smaller contractors; analyzed information on their 2008 and 2009 internal audits, which were the latest available when GAO began its assessment; and reviewed DCAA's ability to examine and use the audits in carrying out its oversight. The seven internal audit departments GAO reviewed generally adhered to Institute of Internal Auditors standards for organizing their internal audit departments. These standards include maintaining independence and having a proficient workforce. For example, all seven companies are organized so that the internal audit department is independent of company management. For performing individual audits, the majority of the companies followed the standards in areas such as planning the audit work and obtaining evidence. In its examination of evidentiary workpapers, GAO found documentation of the internal auditors' testing to show the level of compliance with company policies. The selected companies' internal audit reports cover a broad spectrum of policies, business systems, and programs that are relevant to DCAA audits. Each company performs audits with scope and objectives specific to that company and its individual businesses, such as audits about defense programs or audits that review a company's accounting system. In addition, some audits are common across companies, such as reviews of purchase card transactions or controls over information technology. In 2008 and 2009, the seven companies conducted 1,125 internal audits. GAO determined that of these, 520 were related to the defense contract control environment and one or more areas reviewed by DCAA, such as overall internal control functions and specific business systems. DCAA's access to and use of internal audit information from reports and workpapers is limited, in part, because of company interpretations of court decisions concerning DCAA's access to documents. Consequently, the seven companies GAO reviewed have developed differing policies and procedures for providing internal audit information to DCAA but ultimately provide DCAA access to internal audit reports and workpapers on a case-by-case basis. (1) Six of the companies have policies that provide for DCAA access to at least some internal audits reports upon request. Of the six, four have policies for providing access to supporting workpapers for their internal audits upon request. The other two companies have policies of not providing DCAA with access to supporting workpapers. (2) One company has a policy of not providing DCAA with access to internal audits or workpapers. DCAA's use of its access authority has been addressed in two court decisions. The courts held that DCAA does not have unlimited power to demand access to all internal company materials, but they also held that DCAA may demand access to materials relevant to its audit responsibilities. However, DCAA does not generally track its requests or denials for internal audit reports. GAO found that the number of DCAA requests for internal audit reports is small relative to the number of internal audits GAO identified as relevant to defense contract oversight. In explaining why few reports are requested, DCAA auditors noted obstacles such as not being able to identify internal audits relevant to their work and uncertainty as to how useful those reports could be. By not routinely obtaining access to relevant company internal audits, DCAA auditors are hindered in their ability to effectively plan work and meet auditing standards for evaluating internal controls.

Work Remains to Be Done Regarding the Justification and the Affordability of the Deepwater Replacement Project In October 1998, we issued a report that raised concerns about the justification and the affordability of the Deepwater Replacement Project. Our major findings are summarized as follows: We found that the Coast Guard had understated the remaining useful life of its aircraft, and to a lesser extent, its ships. For example, the Coast Guard’s justification that was prepared in late 1995 estimated that its aircraft would need to be phased out starting in 1998. However, last year, the Coast Guard issued a study showing that its aircraft, with appropriate maintenance and upgrades, would be capable of operating until at least 2010 and likely beyond. The study’s findings suggest that in upgrading or replacing its deepwater ships and aircraft, the Coast Guard should give a relatively low priority to modernizing or replacing its aircraft. Also, since our report was issued, the Coast Guard has taken additional steps to assess the condition and the remaining useful life of its ships, including hiring naval architects to evaluate the condition of its deepwater ships and completing studies on two 378-foot cutters. According to a Deepwater Project official, contractors have also conducted their own evaluations of the condition of deepwater ships and aircraft to validate their condition. We found that the Coast Guard had not conducted a rigorous analysis comparing the current capabilities of its aircraft and ships with current and future requirements, as required by DOT’s and the Coast Guard’s own guidance. Although, the Coast Guard asserted that its current deepwater ships and aircraft were incapable of effectively performing future missions or meeting the future demand for its services, we were unable to validate these assertions. The Coast Guard had originally planned to complete a comparative assessment of the current capabilities and the functional needs of the future deepwater system by November 1998, but work on that assessment has slipped. The Coast Guard now plans to complete a baseline study of the capabilities of its existing fleet of ships and aircraft later this month; a comparative assessment is planned for completion in April 1999. We found that the Coast Guard lacked support for its estimates of the resource hours needed for its deepwater ships and aircraft to perform required missions. We attempted to verify the Coast Guard’s estimates of surface and aviation hours needed for deepwater law enforcement missions, which constitute over 95 percent of the total estimated mission-related hours for its ships and about 90 percent of the total estimated mission-related hours for its aircraft. We could not verify the reasonableness of these estimates because the sources for the data were not documented or available. An independent Presidential Roles and Missions Commission will study the Coast Guard’s roles and missions. The Commission plans to issue a report by October 1999 that will be used to gauge the demand for the Coast Guard’s services. The Coast Guard plans to use this study to recalculate the operating levels needed to meet the requirements of its missions when it issues a revised mission analysis that is scheduled for completion in January 2000. In our report on the Deepwater Project, we acknowledged that the Coast Guard is correct in starting now to explore alternative ways to modernize its deepwater ships and aircraft. However, we expressed concerns about proceeding with the project without a clear understanding of the current condition of its ships and aircraft and whether they are deficient in their capabilities and service demands. We recommended that the Coast Guard expedite the development and issuance of updated information from internal studies to the contractors involved in developing proposals for the project. The Coast Guard agreed with our recommendation and has made progress in developing data on the condition of its ships and aircraft; however, other data on its roles and missions and any shortfalls in its performance capabilities will not be available until later this year or early next year. Contractors, however, are now evaluating deepwater alternatives without such data, and they are scheduled to provide the Coast Guard with an analysis of alternatives for the Deepwater Project in March 1999 and conceptual designs for the system in December 1999. Without basic data on the needs of its deepwater ships and aircraft, there is increased risk that the contractors could develop alternatives or designs that would not be the most cost-effective to meet the Coast Guard’s needs for the Deepwater Project. The Coast Guard agreed with the importance of providing contractors with accurate and complete data as soon as possible; however, it also noted the importance of starting now due to the long lead times associated with a project of this magnitude. The agency has plans to provide the contractors with data on its roles and missions and performance shortfalls as soon as the information becomes available. Coast Guard officials believe that they will have data in enough time so as not to adversely affect the contractors’ proposals. We believe that this is a concern that requires close oversight. Our report also raised concerns about the project’s affordability. The estimated cost of the Deepwater Project could consume nearly all of the agency’s projected spending for its capital projects. By fiscal year 2002, when capital spending for the project could reach as much as $500 million a year, the project could consume 97 percent of the Coast Guard’s total projected capital budget, leaving little for other capital projects and expenditures. Unless the Congress grants additional funds, which under current budget laws could mean reducing funding for other agencies or programs, the Coast Guard’s other capital projects could be severely affected. In January 1999, Coast Guard officials told us that they plan to address the Deepwater Project’s affordability issue in two ways. First, they believe that competition among three teams of contractors to develop alternative deepwater systems will help minimize the project’s life-cycle costs because the proposed costs will be one key factor in the selection of the winning proposal. Second, they said that the agency’s independent evaluation group will analyze various funding alternatives to determine what impact they would have on the project. The group will examine the most cost-effective funding amounts for the project as well as the minimum amount that is needed each year. However, until the Coast Guard develops its revised mission analysis in early 2000 and the contractors provide their cost estimates for various alternatives, it will not be known whether the affordability issue has been adequately addressed. The Coast Guard’s draft Agency Capital Plan, issued in January 1999, also identifies strategies for dealing with the affordability of the Deepwater Project. The plan describes the agency’s long-term capital requirements and identifies strategies for dealing with affordability issues, such as extending the service life of the Coast Guard’s ships and aircraft and replacing equipment with fewer, more capable assets. As an example, extending the service life of its aircraft could result in significant cost savings. A Coast Guard study estimates that between $257 million and $297 million in upgrades and maintenance could extend the service lives of current deepwater aircraft by 11 to 28 years longer than the Coast Guard’s initial estimate of when these aircraft would need to be phased out.However, the estimated cost to upgrade does not include the increased cost of operating older aircraft. The Coast Guard estimates that a one-for-one replacement would cost $3.8 billion to replace the same aircraft, or about $3.5 billion more than the option to extend the aircraft’s service life. In addition, the Coast Guard’s Director of Resources told us that, as part of the capital planning process, the agency will prioritize projects rather than give them the equal priority that it had previously done. This strategy would involve making trade-offs between projects. For example, the Coast Guard could concentrate its resources on buying more ships over 2 to 3 years and buying fewer aircraft or other equipment. After the ships have been bought, the agency could then focus its resources on buying the aircraft or other equipment and reducing the amount of resources used to buy ships. The Coast Guard believes that this approach could help it deal with “spikes” in the agency’s capital needs during a period of fiscal constraint. While these strategies will help the Coast Guard deal with affordability issues, it is uncertain whether they will fully address the affordability issues raised by the Deepwater Project. Most of the Emergency Funds Will Be Spent in Fiscal Year 1999 The Coast Guard received about $377 million in emergency funds for fiscal year 1999, most of which are aimed at reducing the use of illegal drugs in the United States. The Congress directed that these funds be used in the following ways: About $271.7 million was provided for expanding the Coast Guard’s anti-drug program. The Congress directed the Coast Guard to use $217.4 million to buy new equipment; $44.3 million to operate the new equipment and expand drug interdiction activities; and $10 million for training Coast Guard reservists and for research, development, test, and evaluation. The Coast Guard plans to obligate about $195 million of these funds in fiscal year 1999, with the balance to be obligated in fiscal year 2000. Another $72 million was provided for maintaining the overall military readiness of the Coast Guard. According to a Coast Guard official, the funds will allow the agency to carry out its basic missions and responsibilities, such as law enforcement and search and rescue activities. All of these funds will be expended in fiscal year 1999. Another $12.6 million was provided for repairing damage to equipment and facilities caused by Hurricane Georges. The Coast Guard plans to spend about $7.5 million of these funds in fiscal year 1999 and the remaining $5.1 million the following year. Finally, $20.5 million was provided for ensuring that the Coast Guard’s computer systems do not have Year 2000 computer problems. The agency intends to expend all of these funds in fiscal year 1999. Spending for Anti-Drug Efforts The Coast Guard plans to acquire a variety of new equipment to help expand its anti-drug program. For example, it plans to purchase 15 new 87-foot patrol boats at a cost of $66.1 million. This purchase will allow it to deploy some of its larger 110-foot patrol boats in the Caribbean for counter-narcotics operations. The Coast Guard also plans to spend $29.3 million to purchase new sensors and communications systems for its cutters and patrol boats, and it plans to reactivate two ships for $20 million to provide command and control and logistics support for its drug-fighting efforts. In addition, the Coast Guard plans to spend $3.5 million to purchase eight high-speed boats to help it pursue the high-speed boats used by drug smugglers. The Coast Guard also plans to upgrade and expand its drug interdiction efforts by spending about $52 million to reactivate six HU-25 jet aircraft used for surveillance and to buy other aircraft equipment. It will also spend about $44 million to buy sensors for its aircraft, which will improve its ability to detect and classify suspected drug smugglers at sea, and to upgrade engines for its C-130 surveillance aircraft. (See the appendix for more details on the status of the Coast Guard’s acquisition of equipment from emergency funding.) The Office of National Drug Control Policy has set a national goal of reducing the flow of drugs entering the United States from maritime routes by 10 percent by 2002 and 20 percent by 2007. The Coast Guard and other federal agencies will be involved in achieving this goal. The additional emergency funds should aid the Coast Guard in its anti-drug efforts; however, currently, there is no effective way of knowing the true impact of increased funding provided to the Coast Guard or any other law enforcement agencies. Similar to what we found 2 years ago, it is difficult for the Coast Guard or any other agency to effectively measure the results of its anti-drug program. For example, it is inherently difficult to develop accurate data on the quantity of illegal drugs entering the country. Moreover, it is difficult to distinguish the impact that the Coast Guard’s anti-drug actions are having from those of other agencies. However, progress is being made—the Office of National Drug Control Policy’s Interagency Assessment of Cocaine Movement has developed estimates of the amount of cocaine shipped from foreign countries. If reasonably accurate, this information could aid the Coast Guard in measuring the results of its cocaine interdiction program. The Coast Guard plans to use the entire $44.3 million appropriated for operating expenses by the end of this year to operate new equipment and continue intensified anti-drug initiatives begun last year in the Caribbean. In fiscal year 1999, the Coast Guard also plans to use $5 million to train reservists in counter-narcotics operations, hire more reservists and recruiters, and buy new law enforcement equipment. Also, the Coast Guard plans to spend $4 million of the $5 million it received for research, development, test, and evaluation of counter-narcotics strategies by the end of fiscal year 1999. The Deepwater Project and the Expansion of Anti-Drug Efforts Heighten the Challenges for Addressing Budget Constraints While the Coast Guard received a sizable emergency appropriation for fiscal year 1999, which was largely to expand its anti-drug efforts, the agency will need additional funding to sustain these higher operating levels in future years. Last month, legislation was introduced in the Senate to authorize additional funding for the Coast Guard for anti-drug operations in fiscal years 2000 and 2001; however, there is no guarantee that these funds will ultimately be appropriated. In addition, if the Deepwater Project moves forward as planned, the Coast Guard would likely need hundreds of millions of dollars each year for the next 20 years to complete the project. In our May 1997 report to this Subcommittee, we discussed the challenges the Coast Guard faces as it operates within a constrained fiscal environment. While the Coast Guard had taken a number of steps to reduce its costs, we suggested that the Coast Guard look toward several budget strategies to further cut costs. Given the continuing budget pressures that currently exist for the Coast Guard, much of the message of our 1997 report is still relevant today. Our report concluded that the agency could renew efforts to improve its operating efficiency by delivering services at a lower cost. For example, in our earlier report, we identified cost-cutting options that had been identified by a number of studies on the Coast Guard that have been conducted since 1981. The agency has not implemented many of these options. For example, past studies by groups outside the Coast Guard have pointed out that lengthening periods between assignment rotations for military personnel could substantially reduce transfer costs, which now amount to more than $60 million a year. The Coast Guard thinks its current rotation policies are best and does not plan to study the issue further. In addition, using civilian personnel rather than military personnel in administrative support positions could achieve significant cost savings. Soon, we will be reporting to this Subcommittee on other administrative and support functions that have potential for cost savings. Achieving some of these cost-cutting measures will be controversial and difficult, either because they involve a change in the agency’s organizational culture or they are not popular with the public. Consolidating functions or closing facilities have been identified by previous studies as another option to reduce expenditures. For example, several years ago, the Coast Guard identified a cost-cutting option involving the consolidation of its training facilities, a move that would have resulted in annual savings of $15 million by closing the facility at Petaluma, California. Fearing a public outcry by the local community, especially because of the numerous recent closures of military bases in California, the Coast Guard postponed taking this step. To address situations like this, we recommended that the Congress may wish to consider a facility closure approach for the Coast Guard that is similar to the one the Department of Defense has used to evaluate base closures. Under this approach, an independent commission would be established and given authority to recommend the closure of some of the Coast Guard’s facilities. To date, such a commission has not been established. Even if the Coast Guard is successful in achieving significant cost savings by improving its operating efficiency, the adequacy of this approach alone to meet budget challenges is highly uncertain. As we pointed out in our 1997 report, the agency may have to look beyond efficiency measures for cost-cutting options. Our past work examining a cross section of private-sector and public organizations that have faced fiscal constraints similar to the Coast Guard’s has shown that a much broader approach for evaluating potential cost-cutting options is often needed. Frequently, these broader assessments have involved a fundamental rethinking of the missions and services performed by the organizations and the sources of their funding. Driven largely by the potential magnitude and the impact of the Deepwater Project on future budgets, the administration has renewed efforts to evaluate the roles and the missions of the Coast Guard and to push for additional user fees. The independent Presidential Commission, which is about to begin studying the agency’s roles and missions, could identify areas or functions that could be (1) added or enhanced, (2) maintained at current levels of performance, or (3) reduced or eliminated. Also, in its fiscal year 2000 budget request, the Coast Guard is proposing a user fee on commercial cargo and cruise vessels for navigation services provided by the Coast Guard that could add revenues of $41 million each year if it is fully implemented. The administration favors earmarking the proposed user fees as a means of giving agencies an incentive to collect fees. Earmarking would allow the agency to keep all or significant portions of the fees collected to pay for providing the services rather than the current practice of returning the bulk of the revenues to the Treasury. We are not taking a position on whether such fees, including the proposed fees on navigation services, should be established or on whether such fees should be earmarked for the Coast Guard rather than returned to the Treasury’s general fund. This is a policy question that the Congress must ultimately decide after considering a number of issues and trade-offs. Mr. Chairman, this concludes my testimony. I will be happy to respond to any questions you or other Members may have. The Coast Guard’s Acquisition of Equipment From Emergency Funding to Expand Its Drug Interdiction Activities, Fiscal Years 1999 and 2000 Cost Applicability to anti-drug program These boats will allow the Coast Guard to deploy larger 110-foot patrol boats to the Caribbean for counter-narcotics operations, resulting in 1,440 more operating hours to support its anti-drug program per patrol boat. Have two of these boats in operation and obligate $66.1 million by the end of the fiscal year. The Coast Guard plans to have four more boats in operation by the end of fiscal year 2000. The sensors will improve the Coast Guard’s ability to detect and classify targets. The communications equipment will improve interagency communications and communications capabilities on cutters, boats, and shore facilities. Begin to receive much of this equipment and obligate $20 million this fiscal year. These ships will provide command and control and logistical support for ships and fast-pursuit boats. The ships will provide 3,600 operating hours per ship for anti-drug activities. Pay the Military Sealift Command to operate and maintain the platforms. Coast Guard personnel will be on the ships to carry out law enforcement responsibilities. The first vessel will be available in the last quarter of fiscal year 1999 and the second in the second quarter of fiscal year 2000. The Coast Guard plans to obligate all funds this fiscal year. These boats will provide the capability to interdict high-speed boats used by smugglers. Four will be deployed to the reactivated command and control platforms and four will be deployed to shore-based units. Operate at least two boats by the fourth quarter of fiscal year 1999 and obligate all funds in this fiscal year. The Coast Guard anticipates all eight boats will be in operation in fiscal year 2000. The jets will increase surveillance and will provide 600 hours per aircraft to support the anti-drug effort. The use of unmanned airborne vehicles to help classify and detect targets at sea will also be examined. Deploy three aircraft by the last quarter of this fiscal year and obligate $21 million this year. The remaining three aircraft will be available by the last quarter of fiscal year 2000 and the Coast Guard plans to obligate the balance in fiscal year 2000. The aircraft will help the Coast Guard evaluate the potential use of force from aircraft to interdict smugglers at sea. Lease aircraft to develop and test tactics that include the use of force. The Coast Guard plans to obligate all funds and complete the testing this fiscal year. This equipment will improve the Coast Guard’s ability to detect and classify targets at sea. In addition, the C-130 upgrade will provide maintenance and fuel savings in future years. Complete the engine upgrades in fiscal year 1999 and install the sensors starting in the third quarter of fiscal year 1999. The Coast Guard plans to obligate $9.3 million this fiscal year. The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. Each day, GAO issues a list of newly available reports and testimony. 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Pursuant to a congressional request, GAO discussed the Coast Guard's budgets for fiscal years 1999 and 2000, focusing on the: (1) Coast Guard's progress in justifying the Deepwater Replacement Project and addressing GAO's concerns about its affordability; (2) Coast Guard's plans for spending its fiscal year (FY) 1999 emergency funds; and (3) budget strategies the agency may have to consider in the future to address continuing budget constraints. GAO noted that: (1) while the Coast Guard has made progress in addressing GAO's concerns about the justification and the affordability of the Deepwater Project, additional work is needed; (2) the Coast Guard had not sufficiently justified the project in that it lacked accurate and complete information on the condition and the performance shortcomings of its ships and aircraft and the resource hours needed to fulfill its missions; (3) the Coast Guard and its contractors are currently developing this information, but some of it will not be available until later this year; (4) in the meantime, contractors working on the conceptual design for the project will be assessing alternatives without the benefit of current data on the performance shortcomings of the agency's ships and aircraft and the resource hours needed to fulfill its missions; (5) the Coast Guard plans to have performance data on its current ships and aircraft by April 1999, and the agency plans to provide that information to contractors at that time; (6) GAO reported that if the cost of the Deepwater Project approaches the agency's planning estimate of $500 million dollars annually, it would consume more than the agency now spends for all capital projects and leave little funding for other critical capital needs; (7) Coast Guard officials said that competition among contractors would cut costs and more closely align the potential cost of the project with probable funding levels; (8) however, until the Coast Guard develops its new justification for the Deepwater Project in early 2000 and contractors provide their cost estimates for various alternatives, neither GAO nor the Coast Guard can tell whether the affordability issue has been adequately addressed; (9) by the end of FY 1999, the Coast Guard plans to spend about 78 percent of the $377 million in emergency funds that it received, primarily to expand its anti-drug efforts; (10) as directed by Congress, it has begun buying more patrol boats, reactivating its surveillance aircraft and ships, and obtaining additional equipment to improve its ability to detect drug smugglers and to coordinate its anti-drug activities; (11) in the future, the agency might have to develop different budget strategies and approaches to live within its budget; (12) typically, the Coast Guard has adopted a budget strategy that relies heavily on cost-cutting initiatives to improve efficiency; and (13) GAO's work has shown that additional cost-cutting measures to improve efficiency are possible, and the Coast Guard should renew its efforts in this area.

Background BLM, a bureau of the Department of the Interior, administers millions of acres of public land for a variety of uses, including mineral resources development. BLM’s mining law program is responsible for managing the environmentally responsible exploration and development of locatable minerals on public land under the General Mining Law of 1872 and the Federal Land Policy and Management Act of 1976. The General Mining Law allows individuals and corporations to prospect for mineral deposits on public lands and locate a claim on the deposits discovered. Since 1993, claimants have been required to pay an annual maintenance fee for each mining claim and site in lieu of performing assessment work as previously required under the General Mining Law. Mining claimants locating new claims or sites must pay a onetime location fee, processing fee, and initial maintenance fee. Thereafter, the maintenance fee is paid annually. Currently, the annual per-claim maintenance fee is $155, the per-claim location fee is $37, and the processing fee is $20. BLM has authority to use receipts from mining claim fees for mining law program operations, although the use of these fees cannot exceed the limits prescribed in BLM’s annual Management of Land and Resources appropriation. BLM headquarters in Washington, D.C., and its 12 state offices manage and oversee mining law program operations. BLM headquarters provides guidance and oversight for the program. Specifically, within headquarters, the Energy, Minerals, and Realty Management group, Division of Solid Minerals, is responsible for overseeing the program. Each state office is headed by a state director who reports to the Director of BLM at headquarters. The state offices manage BLM programs and land in the geographic areas that generally conform to the boundary of one or more states. The state offices are Alaska, Arizona, California, Colorado, Idaho, Montana, Nevada, New Mexico, Oregon, Utah, Wyoming, and Eastern States. The state offices also provide oversight and program guidance to the district and field offices. Each BLM state office, with the exception of Eastern States, has several district offices and many field offices. The state offices also record and adjudicate mining claims. The district and field offices perform program fieldwork, such as reviewing and approving plans and notices of mining operations, conducting inspections and mineral examinations, and taking enforcement actions. In addition to the state offices, BLM also operates its National Training Center, National Operations Center, and National Interagency Fire Center to provide support to all BLM programs. See figure 1 for a map of BLM state offices and their administrative jurisdictions. The mining law program includes the following activities: processing notices for exploration, processing and approving plans of operations for exploration and recording and adjudicating mining claims, collecting location and annual maintenance fees, production, inspecting notices and plans of operations to ensure compliance with their terms and conditions, taking enforcement actions when terms and conditions have been violated, identifying and eliminating cases of unauthorized occupancy of mining claims, reviewing reclamation plans and financial guarantees, and conducting mineral examinations to determine valid existing rights under the mining laws. BLM is responsible under applicable appropriations laws to ensure that funds appropriated for a specified purpose—such as those funds that BLM’s annual appropriations provide for mining law program operations— are used for that purpose only and are not augmented with funds appropriated for different purposes. As such, BLM issues annual budget directions for all programs, including the mining law program, to outline the importance of proper budget coding and accounting. BLM records all mining law program costs of activities under one subactivity code. BLM’s policy recognizes the importance of accountability for program funds. Specifically, its Fund Coding Handbook states the following: “harging work tasks, employee salaries, procurement items, or equipment purchases to any subactivity other than the benefitting subactivity violates the terms of the Appropriation Act. Similarly, when procurements are charged to a given subactivity simply because ‘money is available there’ but have no direct relationship to that subactivity’s program accomplishment, is a violation of the integrity of managers’ financial management responsibility and both the specific policy decisions and the direction of proper authorities in setting those requirements. Future year program needs and requirements are based in part on the record of past years’ costs and accomplishments. Therefore, records of actual costs and accomplishments must be accurate as possible.” Importance of Internal Controls To reasonably assure that designated funds are spent only on mining law program operations, BLM is responsible for designing and implementing an effective system of internal control. Internal control is an integral component of an organization’s management that when properly designed, implemented, and operating effectively, provides reasonable assurance that the following objectives are being achieved: (1) effectiveness and efficiency of operations, (2) reliability of financial reporting, and (3) compliance with laws and regulations. Internal control represents an agency’s plans, methods, and procedures used to meet its mission, goals, and objectives and serves as the first line of defense in safeguarding assets and preventing and detecting errors, fraud, waste, abuse, and mismanagement. BLM’s Mining Law Program Was Appropriated and Expended Almost $40 Million Annually in Fiscal Years 2011 through 2013 According to our review of BLM’s data, reports, and relevant appropriations laws, BLM was appropriated for its mining law program approximately $37 million, $40 million, and $38 million for fiscal years 2011 through 2013, respectively. These appropriated funds are available until expended, meaning that BLM may also carry over any unused amounts to subsequent years. Table 1 summarizes the resources available to the program for fiscal years 2011 through 2013. Interior’s appropriation laws require that amounts appropriated to BLM for its mining law program be reduced (i.e., repaid) using mining claim fees that BLM collects. In recent years, BLM has collected funds through its claim fees that more than fully repay its appropriated amounts. For example, according to BLM’s budget documents, it reported mining claim fee collections of approximately $64 million each in fiscal years 2011 and 2012 and $66 million in fiscal year 2013. At the end of the fiscal year, BLM deposits the amount of fees collected into the Department of the Treasury’s General Fund. BLM recorded mining law program expenditures of about $38 million annually for fiscal years 2011, 2012, and 2013. The program’s largest expenditure was for personnel compensation and benefits, ranging from 76 to 80 percent of the program’s total expenditures, over the 3 fiscal years. Its second largest expenditure was for contractual services and supplies, ranging from 17 to 20 percent of the program’s total expenditures. This category includes many types of expenditures, such as travel, communications, utilities, and training. Overall, total reported expenditure trends appeared consistent from year to year. Table 2 summarizes BLM’s reported expenditure amounts for its mining law program by major budget category. BLM’s Deficiencies in the Design and Implementation of Internal Controls over Mining Law Program Expenditures Weaken Accountability for Program Resources BLM has designed internal controls, including policies and procedures, over mining law program funds. However, some of BLM’s policies and procedures are outdated, inconsistent, and not effectively communicated. Our review of transactions also showed that BLM did not effectively implement controls to reasonably assure that mining law program expenditures were properly recorded and supported. Furthermore, our interviews with employees indicated that some employees were not recording hours worked consistent with BLM policy. Selected BLM Policies and Procedures on Mining Law Program Expenditures Are Outdated, Inconsistent, and Not Effectively Communicated BLM has a directives system that includes permanent and temporary policies and procedures. Permanent BLM policies and detailed instructions needed to carry out those policies are contained in BLM’s manuals and handbooks and have continuing application to BLM programs. These include the Fund Coding Handbook and the Charge Cards and Convenience Checks for Travel, Purchase, Fleet, and Uniforms section of the BLM Manual, which provide policies related to charging the mining law program as well as other BLM programs. To update its policies, BLM issues instruction memorandums, which are intended to be temporary new policy or instructions that must reach BLM employees quickly. In addition to instruction memorandums, BLM may transmit supplemental information through information bulletins.has policies and procedures that have been updated or revised through BLM these temporary directives. They contain specific policies and procedures for the use and coding of mining law program expenditures and other financial and business processes. However, some of these policies and procedures are outdated, inconsistent, and not effectively communicated. Two instruction memorandums that alert employees to the importance of appropriately charging expenditures to the mining law program include important coding information and provide guidance about charging operational expenditures to the correct account or subactivity. However, these instruction memorandums exclude key information and have not been updated. Instruction Memorandum 2001-144, Obligations from the Mining Law Administration Program, is intended to convey coding policies for charging expenditures to mining law program-related activities, but it does not include updated coding instructions for charges related to reviewing reclamation plans and financial guarantees or an updated expiration date. BLM amended regulations in 2001 to require all mining operations to provide bonds or other financial assurances before beginning exploration or mining operations on BLM land. This is an important mining law program activity because having adequate financial guarantees to pay reclamation costs is critical to ensuring that the land is reclaimed if the mining operators fail to do so. The memorandum was reissued in March 2003, but was not updated to include coding instructions for charging expenditures related to this activity. In addition, Instruction Memorandum 2001-144 also contained inconsistencies in its expiration date information, which could be confusing to users of this guidance. Specifically, the memorandum was reissued in fiscal year 2003 but showed a fiscal year 2002 expiration date. Instruction Memorandum 2004-047, Proper Coding within the Solid Minerals Subactivities, was issued to provide additional guidance on proper coding but lists a priority program element code that is no longer used by BLM for the mining law program.fiscal year 2012, BLM changed the code that was used to capture the cost for mining law program work activity related to trespass and unauthorized occupancy cases. The memorandum shows an expiration date of fiscal year-end 2005. In addition to the deficiencies identified in these mining law program instruction memorandums, policies and procedures used for the review and approval of charge card purchases are also inconsistent. BLM issues government charge cards to its employees for travel and purchases of supplies and services. Many of the mining law program expenditures were paid using charge cards as they are required for travel transactions In 2008, Interior issued its Integrated and preferred for micro-purchases. Charge Card Program Policy Manual, which states that within 30 calendar days of the charge card statement, the approving official must review, sign, and date the statements and supporting documentation. Micro-purchases are purchases of up to $3,000 for supplies and $2,500 for services. Bureau of Land Management, Integrated Charge Card Program Management – Purchase Business Line, Information Bulletin No. 2011-073 (June 23, 2011). review.Internal Control in the Federal Government states that internal control and all transactions and other significant events need to be clearly documented, and that all documentation and records should be properly managed and maintained. This inconsistency can create further confusion. Standards for Further, issues in communicating BLM policies and procedures on properly coding mining law program funds also contributed to employees not following such procedures. For example, while instruction memorandums clarifying the proper coding of BLM activities can be accessed through BLM’s intranet, BLM officials said that these memorandums, which are over 10 years old, may be difficult to locate because they are stored in reverse chronological order by issuance date, and BLM’s online repository does not include an effective search function. During our interviews at the Arizona and Nevada state offices, we spoke with BLM employees who charged the mining law program, and some employees stated that they were not aware of program-specific policies for use of mining law program funds. BLM officials told us that instruction memorandums on properly coding mining law program funds were not updated because BLM determined it was more advantageous to use directives included in its annual budget process to communicate updates on the coding of costs to subactivities and program elements rather than incorporate these interim policies into formal policy. However, such directives, which are mainly used by budget and managerial employees, may not be reviewed closely by specialists in the field who carry out BLM activities and charge the related codes. Standards for Internal Control in the Federal Government states that information should be recorded and communicated to management and others within the entity who need it and in a form and within a time frame that enables them to carry out their internal control and other responsibilities. Without consistent and up-to-date policies and procedures on the use of mining law program funds that are readily accessible and communicated to all employees, BLM lacks adequate controls to reasonably assure that expenditures are properly recorded to the mining law program. BLM officials said that they plan to (1) issue a new instruction memorandum that incorporates the policies set forth in both instruction memorandums on the importance of appropriately charging the mining law program and properly coding labor and operational expenditures, (2) clarify information about the 14-day time frame for the charge cardholder to ensure timely reviews of the reconciliation, and (3) improve BLM’s capabilities to enable employees to effectively search policies and guidance on its intranet. In addition, BLM officials told us that officials from the mining law program will work with BLM’s Division of Budget to determine how to best update the Fund Coding Handbook to include the mining law program policies. BLM plans to issue the revised handbook by December 31, 2015. BLM Did Not Effectively Implement Controls to Reasonably Assure That Mining Law Program Nonpayroll Expenditures Were Properly Recorded and Supported BLM did not effectively implement key control activities to reasonably assure that mining law program expenditures were properly recorded and supported. Specifically, we tested a random probability sample of 100 nonpayroll expenditure transactions for fiscal year 2013 for evidence that each expenditure (1) was accurately recorded to the correct fund, subactivity, fiscal year, and budget category; (2) was related to or was reasonably allocated to the mining law program; (3) was authorized; and (4) underwent supervisory review and approval of supporting documentation. We found exceptions during each test. We also found control deficiencies through testing of a nonprobability sample of 30 accounting adjustment transactions for fiscal year 2013, including (1) lack of timely supervisory review and therefore delayed recording of adjustments and (2) inadequate documentation to support the adjustments. Figure 2 summarizes the estimated percentages of control deficiencies found in our nonpayroll expenditures testing. On the basis of our testing of controls for the random probability sample of 100 nonpayroll mining law program expenditure transactions, an estimated 13 percent of the 15,829 fiscal year 2013 mining law program nonpayroll expenditure transactions were either not recorded accurately or did not have sufficient documentation for determining whether each expenditure was accurately recorded to the correct fund, subactivity, fiscal year, or budget category.consideration whether (1) supporting documentation or BLM officials’ explanations clearly showed another subactivity should have been charged or (2) BLM did not provide any documentation or the documentation provided was insufficient. Specifically, in the instances where evidence or documentation was provided by BLM, the information showed that the transaction was intended to be recorded to another subactivity outside of the mining law program. The majority of these were charge card transactions in which recording errors may have occurred because the mining law program code was assigned as the default code to the charge card account, and BLM did not reallocate or adjust the For these exceptions, we took into charge to the correct benefitting subactivity. The following examples illustrate the problems we found. BLM-provided electronic travel data showed that an employee’s travel was conducted under the subactivity code for oil and gas management activities. However, travel costs of $1,069 were erroneously recorded to the mining law program. An expenditure for $348 under a contract for mail services was recorded to the mining law program. However, the contract order did not contain the mining law program as the chargeable subactivity. An expenditure for $460 was recorded as office supplies and materials to the mining law program. BLM provided screenshots from its financial management system but was unable to provide any supporting documentation, such as invoices or receipts for the items purchased. BLM’s policy is that procurement items, including travel, and equipment purchases should be charged to the benefiting subactivity. In addition, for charge card transactions, the cardholder is required to reconcile charge card statements, annotate the correct accounting code on the charge card statement, and include supporting documentation. Supervisors are required to review and approve the charge card statements. BLM also requires that supporting documentation for transactions be retained. We identified the lack of training to reinforce policies as a contributing factor in the implementation issues found in our control tests. BLM officials told us that they developed a general online course for managers in January 2013 to provide an overview of the BLM budget process. Among other objectives, the course was created to help managers plan and execute the BLM budget and provide guidance on spending operating funds correctly and using appropriate cost structures and funding codes. According to BLM officials, the training is not mandatory but is encouraged for managers and is available to all employees. However, this course does not address procedures and related controls specific to the coding and supervision of mining law program expenditure charges. Additionally, BLM training records showed that only 14 of 128 BLM employees who enrolled in the course had completed it as of March 10, 2015. Transactions Lacked Evidence That Expenditures Were Related to or Reasonably Allocated to the Mining Law Program An estimated 14 percent of fiscal year 2013 mining law program nonpayroll expenditure transactions either (1) lacked evidence to demonstrate that an expenditure was related to or reasonably allocated to the mining law program or (2) contained evidence suggesting that other subactivities should have been charged. The following examples illustrate the charges to mining law program that were not related to or reasonably allocated to the program. An expenditure of $6,525 for patrolling services on all BLM lands was charged to the mining law program. While reviewing this item, we noted that the entire $25,000 contract was fully obligated to the mining law program although it included specific nonmining locations, such as campgrounds and recreational areas. An employee who did not perform work for the mining law program and is employed at a BLM office that does not conduct any mining law program activities charged the program for travel expenses in the amount of $260. The purpose of travel was to attend nonmining training on producing educational exhibits related to environmental sustainability. An employee charged the mining law program $539 for a vehicle rental during the employee’s travel to conduct land surveys in support of the BLM Legacy Well Program. This program encompasses the plugging of oil and gas wells in Alaska that are currently not operational and is not related to the mining law program. Legal services of $673 were charged to the mining law program. These services were for legal mediation of administrative grievances from BLM employees who did not perform work on the mining law program. BLM’s policy, in accordance with applicable appropriations laws, is to assure that mining law program funds are properly expended and that any costs charged to the program directly relate to or benefit the mining law program. Also, its Instruction Memorandum 2001-144 states that overhead support costs and shared service costs must be shared equitably among benefitting subactivities. Therefore, costs of shared services that include the mining law program must be equitably allocated to the mining law program along with other subactivities. As previously mentioned, BLM did not offer training that addressed procedures and related controls specific to the coding and supervision of mining law program expenditure charges. Transactions Lacked Authorization We estimate that 16 percent of fiscal year 2013 mining law program nonpayroll expenditure transactions lacked evidence that a supervisor or other approving official authorized the transactions in accordance with prescribed BLM policies.lacking evidence of authorization were travel transactions recorded using GovTrip, BLM’s travel system in fiscal year 2013. The following examples illustrate mining law program nonpayroll transactions that lacked proper authorization. The majority of the expenditure transactions For 11 travel transactions, authorization was not approved by a supervisor or approving official before travel commenced. These included 5 instances where travel was completed before the authorization was approved. The Federal Travel Regulation requires that an authorization be obtained prior to travel unless it is not practicable or possible to obtain such authorization. trips appeared to have been for nonemergency activities, such as training and site visits. A transaction for lodging costs totaling $161 was incurred, but the costs were not included in the trip authorization to provide evidence of prior approval. 41 C.F.R. § 301-2.1. BLM did not provide supporting documentation for one of the selected travel transactions to demonstrate that the travel was authorized. Standards for Internal Control in the Federal Government states that qualified and continued supervision should be provided to ensure that internal control objectives are achieved. In its May 2013 audit report, Interior’s Office of Inspector General also reported similar findings with travel transactions recorded in GovTrip. In fiscal year 2014, Interior implemented a new electronic travel system and also issued new travel guidance, which BLM officials said they expected would improve its processes for the approval, processing, and payment of authorized travel expenditures. However, as noted in the next section, BLM did not have a monitoring process to evaluate employee and supervisory compliance with mining law program policies. Transactions Lacked Evidence of Timely and Adequate Supervisory Review of Supporting Documentation We found that an estimated 31 percent of fiscal year 2013 mining law program nonpayroll expenditure transactions lacked evidence that a supervisor or approving official timely and adequately reviewed required Examples follow: transaction support in accordance with BLM’s policy. In four sampled transactions, supervisory review of charge card transactions’ supporting documentation was inadequate. For example, supporting documentation lacked a description of goods purchased, and in one instance, the charge card statement was not signed by the cardholder or the supervisor, as required by BLM policy. We found six instances of charge card statements that were not approved in a timely manner. For example, one charge card statement was not approved until 3 months after the statement date. Our travel sample included eight travel vouchers that were not submitted for review promptly after the traveler’s return. In two such cases, vouchers were submitted 57 and 76 business days, respectively, following trip completion. The Federal Travel Regulation, which BLM follows, requires that a travel voucher be submitted within 5 working days after completion of trip or period of travel. For eight transactions, we could not verify whether there was adequate supervisory review of supporting documentation because BLM could not locate the supporting documentation, such as receipts, credit card statements, and travel vouchers, that should be maintained for these transactions, as required by its policies and procedures. BLM’s charge card policies require that cardholders (1) verify that all transactions are valid and correct by matching each transaction to receipts and invoices; (2) reconcile their statements and include a concise, detailed description for each transaction; (3) annotate the applicable accounting code if the code associated with the cardholder’s account (default code) is not applicable for the transaction; and (4) sign and date the statement and include supporting documentation in the package. Policies also state that supervisors must review and certify reconciled statements. However, while BLM’s policies include controls for documenting and reviewing purchase card transactions, these policies are not consistent on the required deadline for statement reconciliation by the cardholder. In addition, updates to charge card policies were transmitted to BLM headquarters, state office, and district office officials rather than to all BLM employees who are cardholders. Since charge card purchases are paid automatically, it is critical that all cardholders and approving officials promptly reconcile and review charge card transactions so that erroneous charges can be quickly disputed with the vendor, and fraudulent, improper, or wasteful purchases can be quickly detected and acted upon. These reviews are also critical to ensuring that the correct program codes have been charged if the code assigned to the cardholder’s account differs from the code benefiting from the expenditure. Standards for Internal Control in the Federal Government states that (1) internal control and all transactions and other significant events need to be clearly documented and the documentation should be readily available for examination and (2) all documentation and records should be properly managed and maintained. These standards also state that qualified and continued supervision should be provided to ensure that internal control objectives are achieved. Supervisors are a key control in approving and reviewing transactions to reasonably assure that the transactions are properly supported and that appropriate codes are used. However, BLM did not have a monitoring process to evaluate employee and supervisory compliance with mining law program policies. While BLM has procedures in place to periodically review purchase card transactions and check for charge card reconciliations, these reviews are not intended to identify expenditures that do not relate to the mining law program. BLM officials told us that they performed a review of contracts charged to the mining law program in 2000, but they have not since performed any other similar reviews. Given the significant percentage of transactions that we estimated (1) lacked evidence of adequate supervisory review of supporting documentation, (2) were erroneously charged to the program, and (3) lacked supporting documentation, monitoring compliance with policies is especially important. Selected Adjustments to Mining Law Program Nonpayroll Expenditure Transactions Were Not Supported or Promptly Recorded Our review of the mining law program’s fiscal year 2013 total nonpayroll expenditures showed that approximately 24 percent of these transactions were adjustments to the expenditure accounts. Given the large number of adjustments to expenditures coupled with the large number of transactions lacking adequate supervisory reviews, as previously discussed, we randomly selected a nonprobability sample of 30 accounting adjustments and examined supporting documentation to determine the nature and appropriateness of these adjustments. The adjustments consisted of reductions to the expenditures charged to the program. Many adjustments to mining law program expenditures are caused by the reallocation of charge card purchases, which occurs when a BLM employee makes a purchase for the benefit of a program other than the program to which his or her charge card account was assigned (i.e., the default program code to the charge card account). Per BLM policies, BLM employees are required to reconcile their charge card statements each month and annotate the correct accounting code for each item. Supervisors are required to review supporting documentation and approve the individual transactions and the statement reconciliations. We found issues with 12 of the 30 adjustment transactions selected. These problems largely involved (1) failure to record the adjustment in a timely manner because of delays in supervisory review and (2) inadequate documentation to support the adjustment. Examples follow: A charge card statement with charges totaling over $1,100 was not reconciled by the cardholder and reviewed by the approving official until 7 months after the statement date. BLM did not provide documentation to support an adjustment for $2,257 recorded as supplies transferred out of mining law program expenditures. Therefore, it was unclear what the charge was for and what subactivity the expenditure benefited. Although one non-mining law program expenditure for freight costs was correctly adjusted, our review of the transaction data showed that it was charged to the mining law program twice and only adjusted once, resulting in the freight cost of about $3,000 being paid by the mining law program. Standards for Internal Control in the Federal Government states that internal control activities help ensure that management directives are carried out and that control activities, which include management and supervisory reviews, proper documentation, and recording of transactions, are effective and efficient in accomplishing the agency’s objectives. Given the large number of accounting adjustments recorded, effective supervisory review of transactions is key to reasonably assuring proper accounting of mining law program funds. As discussed previously, the lack of monitoring was a contributing factor in the issues we found with the adjustments. Interviews Indicate Hours Worked Were Not Recorded Consistent with BLM Policy Our interviews of a nonprobability sample of 43 employees from two BLM state office jurisdictions—Arizona and Nevada—indicated that some employees were not accurately charging their hours to the mining law program. These two BLM state offices had the highest amounts of personnel compensation charged to the mining law program in fiscal year 2013, totaling about $9.3 million, or 32 percent of total personnel compensation charges. BLM’s policy, in accordance with applicable appropriations law, states that transactions should be charged to the benefitting subactivity. BLM’s Instruction Memorandum 2001-144 also emphasizes the importance of charging the mining law program only for mining law-related transactions. It assigns supervisors the responsibility to ensure that employee charges to the mining law program are the result of work that is directly related to program activities. However, over half of the employees interviewed indicated that they were not aware of the BLM mining law program policy for recording work hours. In particular, 18 of the 43 employees interviewed stated that they were charging time to the mining law program on their time cards based on work plans developed for budgetary purposes or supervisor instructions rather than work as it was actually performed. time was also confirmed at another state office we interviewed. Work plans are designed to aid the funding allocation process for personnel compensation and are based on factors such as (1) the funds appropriated and allocated to each BLM state office and (2) an estimate of the work needed to accomplish program objectives. Although these plans provide an amount budgeted for labor to each subactivity, the amounts are estimates of hours to be worked and are likely to be different from hours actually worked. Examples follow: Eleven direct-labor employees stated that they charged their hours to the mining law program based on the work plans provided or instructions from their supervisors and not in accordance with work actually performed. Seven of these employees also stated that they were not familiar with the instruction memorandums that discuss mining law program charges and coding or did not know the correct codes for charging certain mining law activities. The work plans are developed to plan costs based on available budgeted amounts and provide guidance to employees on codes to charge. Labor data for one BLM employee in which she self-identified that she was not working on the mining law program showed over 100 hours charged to the program in fiscal year 2013. The employee stated that she did not know the mining law program codes and did not remember charging them. One BLM employee noted that managers have instructed employees to charge one of the codes listed on the work plan first until it is exhausted. This employee discussed relying on the plan to charge work hours even though program codes charged do not always align with the work actually performed. A temporary BLM employee, who subsequently became a permanent employee and whose work directly benefitted the mining law program, stated that he did not charge time to the program in fiscal year 2013 because funds were not allocated for his position. The employee was instructed to charge hours to another subactivity. The employee stated that mining law program funds were allocated for his position in fiscal year 2015 after he brought this situation to the attention of management. Although these examples cannot be generalized to all BLM employees, they illustrate control deficiencies that increase the risk that BLM employees are not charging their hours to the programs for which they actually performed work. These findings are similar to the findings in our March 2001 report. Of the 18 employees who stated that they were charging the mining law program based on work plans developed for budgetary purposes or supervisor instructions rather than work as it was actually performed, 11 conducted work directly related to the mining law program, which included positions such as environmental coordinator, land law examiner, surface specialist, and cartographic technician. For employees who perform direct work for the mining law program, accurate recording of actual hours is especially important to BLM ensuring that its records are as accurate as possible and that it is able to use past year records as a basis for estimating future program needs. The other 7 employees performed support functions, such as office personnel, information technology, and finance, which provided services across multiple BLM programs. BLM allocates the costs of employees who perform support functions across several subactivities using either of two alternative methods to assess support costs: (1) actual labor expenditures or (2) base funding. However, because the actual labor expenditures method relies on actual charges, it is also important for support employees to properly charge their time to the activities they supported. As noted previously for the issues we identified in our tests of nonpayroll expenditures, our interviews with sampled employees also indicated that the lack of training to reinforce policies may have contributed to the errors in charging the mining law program. For example, over half of the 43 employees interviewed at the two largest BLM state offices said that they were not aware of the policies and procedures related to BLM’s guidance In addition, the for charging expenditures to the mining law program. BLM Nevada state office conducted a budget review of the mining law program in 2012 and recommended training on budget use and coding to address issues related to mining law program charges identified through its budget review. However, this training was not conducted for the state office. Personnel compensation expenditures represent the majority of the mining law program recorded expenditures—about 76 percent in fiscal year 2013. Therefore, improperly charging work to the mining law program or not recording work to the mining law program could result in program cost information that is inaccurate for making program management decisions and for accountability of public resources. Conclusions BLM has policies and procedures for the use and coding of mining law program charges and other financial and business processes that apply to all programs. Its policies recognize the importance of accurate cost records to reasonably assure compliance with applicable appropriations law and to enable informed decision making and program planning. However, our review showed that deficiencies in the design and implementation of BLM’s internal controls resulted in costs erroneously charged to the mining law program or other programs. Until BLM updates its policies and procedures and properly implements them through effective communication, training, and monitoring, there is increased risk that the mining law program may be charged for future transactions that do not benefit the program and that its reported information will not accurately reflect the actual costs of the program or reasonably assure accountability of program funds. Recommendations for Executive Action To strengthen BLM’s controls and reasonably assure accountability over mining law program expenditures, both payroll and nonpayroll, we recommend that the Secretary of the Interior direct the Director of the Bureau of Land Management to take the following four actions: Perform a comprehensive review of applicable temporary directives, including instruction memorandums, related to mining law program expenditures and update or incorporate them into permanent policies in BLM’s Fund Coding Handbook or relevant manuals, as appropriate. Establish procedures for regular and timely communication to all BLM employees on policy and procedural changes affecting the mining law program’s expenditure-related processes. Develop and implement a training program that provides all BLM employees with an understanding of the use of the mining law program funds to reasonably assure uniform application and effective execution of BLM policies and procedures. This training, to be successful, should be provided to all BLM employees who charge the program and communicate clear instructions on how employees should charge, document, and review transactions related to mining law program expenditures. Develop and implement internal control activities for regularly monitoring compliance with expenditure-related policies and procedures in the mining law program. These activities should, at a minimum, (1) determine whether transactions were recorded to the correct subactivity and verified by an approving official and (2) assure that documentary evidence of review is maintained, as required in BLM’s policies and procedures. Agency Comments We provided Interior with a draft of this report for review and comment. In written comments, reprinted in appendix II, Interior generally agreed with our findings, concurred with our recommendations, and described actions taken or planned to address each recommendation. Interior also provided technical comments, which we incorporated as appropriate. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until seven days from the report date. At that time, we will send copies to the Secretary of the Interior, the Director of the Bureau of Land Management, appropriate congressional committees, and other interested parties. In addition, the report is available at no charge on the GAO website at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-2623 or davisbh@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff members who made key contributions to this report are listed in appendix III. Appendix I: Objectives, Scope, and Methodology Our objectives were to determine (1) the funding amounts appropriated to and expended for the Mining Law Administration Program (mining law program) during fiscal years 2011, 2012, and 2013 and (2) the extent to which the Bureau of Land Management (BLM) has designed and implemented internal controls to reasonably assure that designated funds are spent only on mining law program operations. To determine the amounts appropriated to and expended for the mining law program, we reviewed pertinent appropriations laws, Office of Management and Budget reports, BLM financial reports, and BLM’s calculation and explanation of the program’s fiscal year 2013 appropriated amount after sequestration. We also obtained detailed expenditure data for fiscal years 2011 through 2013 from BLM’s financial management system, the Financial and Business Management System We analyzed expenditures by major budget object categories. (FBMS).To assess the reliability of the data extracted from FBMS, we reviewed available documentation and interviewed Department of the Interior and BLM officials on the procedures used to enter and verify information entered into FBMS. We also performed data reliability checks that included conducting electronic testing for obvious errors, such as duplicate entries and missing values. We found the FBMS data elements that we used to create our summaries to be sufficiently reliable for the purpose of reporting mining law program expenditures for fiscal years 2011, 2012, and 2013. To assess the design of controls related to the use of mining law program funds, we obtained, reviewed, and assessed relevant policies and procedures, using Standards for Internal Control in the Federal Government as criteria.and procedures for the use of mining law program funds. We also interviewed officials from 8 of the 12 BLM state offices to obtain an understanding of controls over employee time and attendance and how funds are allocated to the BLM state offices. The BLM state offices where we interviewed officials were Alaska, Arizona, California, Idaho, Nevada, Oregon, Utah, and Wyoming. We also reviewed documents from the BLM state offices to gather information about BLM’s policies and procedures We interviewed BLM officials to clarify policies and controls over mining law program spending. We conducted site visits at two BLM state offices—Arizona and Nevada—to interview officials and examine documents on BLM’s processes and controls related to mining law program spending. We selected transactions at BLM’s Arizona and Nevada state offices to obtain an understanding of how controls were implemented and reviewed relevant supporting documentation. These two BLM state offices had large amounts of total expenditures charged to the mining law program in fiscal year 2013. The BLM Nevada state office, including its district and field offices, had $8.2 million, or 22 percent, of the total mining law program expenditures in fiscal year 2013. The BLM Arizona state office, including its district and field offices, had about $3.6 million, or 9 percent, of the total mining law program expenditures in fiscal year 2013. To test the implementation of controls over the use of mining law program funds, we conducted tests on a random probability sample of 100 nonpayroll transactions from the mining law program’s fiscal year 2013 expenditures. With this probability sample, each record in the population had a nonzero probability of being included, and that probability could be computed for any record. To select the expenditures for review, we used BLM’s detailed listing of fiscal year 2013 mining law program expenditures as discussed for our first objective. The total nonpayroll expenditures population from which we sampled contained 15,829 records totaling $11.6 million in credits (expenditures) and 5,133 records totaling $2.6 million in debits (adjustments). Since the adjustments constituted about 24 percent of the records, we also selected a nonprobability random sample of 30 adjustment transactions to examine documentation and determine the nature and appropriateness of the adjustments. To assess the reliability of the information, we reviewed available documentation and interviewed knowledgeable Department of the Interior and BLM officials about the data. We also conducted electronic testing, for example, looking for duplicate entries and missing values. We found that the data elements we used were sufficiently reliable for selecting samples of mining law program nonpayroll expenditures for review. Because we followed a probability procedure based on random selections, our sample of 100 nonpayroll expenditures is only one of a large number of samples that we might have drawn. Since each sample could have provided different estimates, we express our confidence in the precision of our particular sample’s results as a 95 percent confidence interval (e.g., plus or minus 9 percentage points). This is the interval that would contain the actual population value for 95 percent of the samples we could have drawn. Confidence intervals are provided along with each sample estimate in the report. We used a tolerable error rate of 5 percent to test internal controls. If the lower bound of the 95 percent confidence interval was greater than 5 percent, then we considered the control to not be implemented effectively. The results from our sample apply to the universe of nonpayroll mining law program expenditures recorded from October 1, 2012, to September 30, 2013. With regard to implementation of controls over labor charges, we selected for interview a nonprobability sample of employees from the two BLM state offices with the highest amounts of personnel compensation charged to the mining law program in fiscal year 2013. These two BLM state offices—Arizona and Nevada, including district offices and field offices within their jurisdictions—had personnel compensation costs totaling about $9.3 million, or 32 percent, of the total personnel compensation costs in fiscal year 2013. We interviewed employees from the following BLM offices: Arizona and Nevada state offices; Phoenix and Carson City district offices; and Hassayampa, Lower Sonoran, Sierra Front, and Stillwater field offices. We obtained BLM data on hours charged to the mining law program for fiscal years 2011, 2012, and 2013. We performed analyses of the labor data, including comparing hours from year to year and by state office. We used the fiscal year 2013 data to select employees to interview from the selected offices. We selected the employees based on several factors, including (1) large total number of hours charged to the program, (2) high average hours charged per pay period, (3) different grade levels, (4) varying job titles, and (5) varying suboffices. We conducted face-to-face interviews with 43 BLM employees to determine how time and attendance controls were operating at these state offices using a standard set of questions that were developed based on GAO’s internal control guide, Maintaining Effective Control over Employee Time and Attendance Reporting. We conducted this performance audit from March 2014 to July 2015 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Comments from the Department of the Interior Appendix III: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Elizabeth Martinez (Assistant Director), Mai Nguyen (Auditor-in-Charge), Laura Bednar, Carl Barden, Maxine Hattery, Jason Kelly, Diana Lee, Jerome Sandau, and Sam Slater made key contributions to this report.

BLM's mining law program is responsible for managing the exploration and development of minerals, such as gold, silver, and copper, on federal land. The program is funded through fees collected from holders of mining claims and sites, subject to limits in annual appropriations acts, and is appropriated funds from the Department of the Treasury to the extent that the actual fees collected fall short of such limits. GAO was asked to review the funding and spending of the mining law program. This report discusses (1) the amounts appropriated and expended for the program and (2) the extent to which BLM designed and implemented internal controls to reasonably assure that designated funds are spent only on mining law program operations. To address these objectives, GAO (1) reviewed relevant BLM policies and procedures and financial data, (2) conducted tests on a statistical random sample of fiscal year 2013 nonpayroll expenditures, and (3) interviewed BLM officials and employees. The Department of the Interior's (Interior) Bureau of Land Management's (BLM) Mining Law Administration Program (mining law program) was appropriated and expended almost $40 million annually from fiscal years 2011 through 2013. Funds are to be used for mining law program activities such as administering mining claims and processing notices for mineral exploration. The mining law program's largest expenditures include personnel compensation and contractual services and supplies, which account for over 96 percent of its expenditures. BLM has designed internal controls, including policies and procedures over mining law program funds, but some of them are inconsistent, outdated, and not effectively communicated. GAO's statistical tests of fiscal year 2013 nonpayroll mining law program expenditures showed that BLM did not effectively implement controls to reasonably assure that such mining law program transactions were properly recorded and supported. In addition, in interviews conducted at selected BLM offices, GAO found that some employees were charging hours of work to the mining law program based on funding allocations or supervisor instructions rather than the actual work performed, as required by BLM policies. While these examples cannot be generalized to all BLM employees, they illustrate control deficiencies that increase the risk that BLM employees are not charging the program correctly. GAO found that internal control implementation deficiencies were the result of design flaws in BLM's policies and procedures as well as the lack of training and monitoring to reinforce them. Because of these deficiencies, BLM does not have reasonable assurance that mining law program expenditures relate to or are reasonably allocated to the program. As a result, the information in BLM's financial records may be at risk of not reflecting the actual cost of the mining law program.

Background Risk management has been widely practiced for years in areas such as insurance, construction, and finance. By comparison, its application in homeland security is relatively new—much of it coming in the wake of the terrorist attacks of September 11—and it is a difficult task with little precedent. The goals for using it in homeland security include informing decisions on ways to reduce the likelihood that an adverse event will occur, and mitigate the negative impact of and ensure a speedy recovery from those that do. Achieving these goals involves making decisions about what the nation’s homeland security priorities should be—for example, what the relative security priorities should be among seaports, airports, and rail—and basing spending decisions on where scarce resources will do the most good at narrowing gaps in security. Homeland security is a broad term with connotations resulting from the September 11 attacks and other connotations resonating from the disaster created by Hurricane Katrina in August 2005. Risk management has applications for deliberate attacks of terror and natural disasters, such as hurricanes and earthquakes. My statement today examines the approach used by DHS to deal with both of these areas. Risk management has received widespread support as a tool that can help inform decisions on how to protect the homeland. The Homeland Security Act of 2002 requires DHS to carry out a comprehensive assessment of risk related to vulnerabilities of critical infrastructure and key resources, notably (1) the risk posed by different forms of terrorist attacks, (2) the probability that different forms of an attack might succeed, and (3) the feasibility and efficacy of countermeasures to deter or prevent such attacks. Two congressionally chartered commissions—the 9/11 Commission and the Gilmore Commission—support the use of data on risks to help inform resource allocation decisions. The President has issued policies directing the heads of seven major departments or agencies to assess risks. These policies have made DHS responsible for the national effort at protecting critical infrastructure and they call on DHS to establish uniform policies, approaches, guidelines, and methodologies for integrating risk management within and across federal departments and agencies. In addition, risk management is one of the target capabilities DHS has established to measure state and local emergency preparedness and make homeland security investments in achieving the National Preparedness Goal. DHS's “Target Capabilities List” identifies risk management as one of four common capabilities for incident management—prevention, protection, response and recovery—for major events. While there is widespread support for the use of risk management in homeland security programs, doing so is a complex task that has few precedents and until recently, little specific guidance. To provide a basis for examining efforts at carrying out risk management, we developed a framework for risk management based on best practices and other criteria. The framework is divided into five phases: (1) setting strategic goals and objectives, and determining constraints; (2) assessing the risks; (3) evaluating alternatives for addressing these risks; (4) selecting the appropriate alternatives; and (5) implementing the alternatives and monitoring the progress made and the results achieved (see figure 1). We used this framework to examine many of the programs that I discuss later in this statement. The application of risk management to homeland security is relatively new and the framework will likely evolve as processes mature and lessons are learned. Guidance is also important when agencies integrate a concern for risk into the annual cycle of program and budget review. Doing so within an agency is a difficult task in that traditional ways of reviewing budgets and programs often rely on program data that call for continuing or expanding a program without examining the relative risks that are addressed with the funds that are expended. Shifting organizations toward this nexus of using risk-based data as part of annual management review cycles will take time, attention, and leadership. Even in agencies where much progress has been made in developing risk management techniques, integrating disparate systems such as risk management with budget and program management remains a long-term challenge. Risk management approaches have been applied to DHS’s investments in state and local homeland security through the Homeland Security Grant Program (HSGP). The HSGP includes the Urban Area Security Initiative (UASI), the State Homeland Security Program, Law Enforcement Terrorism Prevention Program, and Citizen Corps Program. In fiscal year 2007, DHS has been appropriated funds to provide over $1.6 billion in federal funding to states, localities, and territories through the HSGP to prevent, protect against, respond to, and recover from acts of terrorism or other catastrophic events. DHS components also use risk management principles to varying degrees to allocate funding to implement their homeland security missions. Key homeland security missions and the associated departmental agencies and organizations include Emergency preparedness and response: The Federal Emergency Management Agency (FEMA) prepares the nation for all hazards and coordinates the federal response and recovery efforts following any incident that requires federal support to state and local emergency responders. Under the statutorily mandated FEMA reorganization that is to take effect by March 31, 2007, FEMA is to include the Office of Grants and Training, which is responsible for allocating homeland security grants to states and localities, including the UASI and State Homeland Security grants. In addition, FEMA will be the responsible for implementing the National Preparedness Goal and other programs that are designed to enhance the nation’s prevention, protection, response and recovery capabilities. Transportation Security: The Transportation Security Administration (TSA) is responsible for security for all modes of transportation and, while TSA’s efforts have historically focused on aviation security due to the events of 9/11, increasing attention has been paid to surface transportation security as a result of more recent international terrorist attacks. Maritime security: The United States Coast Guard (USCG) is the lead federal agency for maritime homeland security. Key objectives of the nation’s maritime security strategy are to prevent terrorist attacks and criminal or hostile acts, protect maritime-related population centers and critical infrastructures, minimize damage and expedite recovery, and safeguard the ocean and its resources. Border Security: U.S. Customs and Border Protection (CBP) was created to protect the nation’s borders in order to prevent terrorists and terrorist weapons from entering or exiting the United States while facilitating the flow of legitimate trade and travel. Immigration Enforcement: Immigration and Customs Enforcement (ICE) was established to enforce immigration and customs laws and to protect the United States against terrorist attacks. Immigration Services: U.S. Citizenship and Immigration Services (USCIS) is responsible for the administration of immigration and naturalization adjudication functions and establishing immigration services policies and priorities. USCIS provides immigration benefits to people who are entitled to stay in the United States on a temporary or permanent basis. Critical infrastructure and key assets protection: The Directorate for Preparedness is responsible for establishing uniform policies, approaches, guidelines, and methodologies to help ensure that critical infrastructure is protected, and using a risk management approach to coordinate protection efforts. The Directorate works with state, local, and private-sector partners to identify threats, determine vulnerabilities, and target resources where risk is greatest, thereby safeguarding our borders, seaports, bridges and highways, and critical information systems. The National Cyber Security Division is charged with identifying, analyzing, and reducing cyber threats and vulnerabilities, disseminating threat warning information, coordinating incident response, and providing technical assistance in continuity of operations and recovery planning. Science and Technology: The Directorate for Science and Technology (S&T Directorate) is the primary research and development arm of DHS. Its mission is to provide federal, state and local officials with the technology and capabilities to protect the homeland. Since 2004, Congress has appropriated over $100 billion for DHS’s homeland security efforts. For example, Congress has appropriated more than $30 billion in fiscal years 2006 and 2007 for some of the key components and agencies GAO has reviewed, as shown in table 1. As the Comptroller General has repeatedly stated, our nation’s fiscal policy is on an unsustainable course. Long-term budget simulations by GAO, the Congressional Budget Office (CBO), and others show that, over the long term, we face a large and growing structural deficit due primarily to known demographic trends and rising health care costs. Continuing on this unsustainable fiscal path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security. DHS is responsible for ensuring that the nation’s annual investments of billions of dollars are targeted to the most efficient and effective uses using a sound, comprehensive risk management approach. DHS’s Use of a Risk Management Approach to Guide Investments through the Homeland Security Grant Allocation Process Is Evolving DHS Uses a Risk-Based Approach in Distributing Urban Area Security Initiative Grants Today, we issued a report on DHS’s use of risk management in distributing the Urban Area Security Initiative (UASI) grants. For fiscal years 2006 and 2007, DHS has used risk assessments to identify urban areas that faced the greatest potential risk, and were therefore eligible to apply for the UASI grant, and based the amount of awards to all eligible areas primarily on the outcomes of the risk assessment and a new effectiveness assessment. Starting in fiscal year 2006, DHS made several changes to the grant allocation process, including modifying its risk assessment methodology, and introducing an assessment of the anticipated effectiveness of investments. DHS combined the outcomes of these two assessments to make funding decisions (see fig. 2.) DHS used different risk assessment methodologies for the 2006 and 2007 UASI grant process, reflecting the evolving nature of its risk assessment approach. It is important to note that our understanding of the process is based principally on DHS officials' description of their process, including briefings, and limited documentation on the details on the actual data used and the methodology's application. Fiscal Year 2006 Grant Process For fiscal year 2006, DHS’s risk assessment included the three components we have identified as essential elements of an effective risk management approach—threat, vulnerability, and consequences—to estimate the relative risk of successful terrorist attacks to urban areas. DHS assessed risk from two perspectives, based on specific locations (asset-based) and based on areas of the country (geographic risk). To estimate asset risk, DHS assessed the intent and capabilities of an adversary to successfully attack an asset type, such as a chemical plant, dam, or commercial airport, using different attack scenarios (e.g., nuclear explosion or vehicle-borne improvised explosive device). DHS assessed geographic risk by approximating the threat, vulnerability, and consequences considering general geographic characteristics—mostly independent of the area’s assets—using counts of data, such as reports of suspicious incidents, the number of visitors from countries of interest, and population. In DHS’s view, the estimates of asset-based risk and geographic risk are complementary and provided a “micro- and macro-” perspective of risk, respectively. Because of data limitations and the inherent uncertainties in risk assessment, DHS officials had to apply policy and analytic judgments. For example, DHS made judgments about how to weight asset and geographic risk, how to identify the urban boundaries it used to estimate risk, and what data were sufficient to use in its risk estimates. DHS used this risk assessment to identify the eligibility cut point, which determined the number of urban areas that could apply for UASI funding in fiscal year 2006 and defined high-risk urban areas. According to DHS officials, the DHS Secretary selected a point that resulted in 35 eligible urban areas, which accounted for 85 percent of total related risk. DHS also implemented a competitive process to evaluate the anticipated effectiveness of proposed homeland security investments by using peer reviewers--homeland security professionals from fields such as law enforcement and fire service. The peer reviewers scored the investments using criteria, such as regionalization, sustainability, and impact. For fiscal year 2006, DHS required urban areas to submit investment justifications as part of their grant application to assess the anticipated effectiveness of the various risk mitigation investments urban areas proposed. Reviewers on each panel assigned scores for six investment justifications, which were averaged to determine a final effectiveness score for each urban area. The criteria reviewers used to score the investment justifications included: relevance to the interim National Preparedness Goal, relevance to state and local homeland security plans, anticipated impact, sustainability, and regionalism. The risk and effectiveness scores did not automatically translate into funding amounts, but rather, the scores were used in conjunction with final decisions on allocation amounts made by the Secretary of Homeland Security. To prioritize the allocation of funds DHS used the combined scores to assign eligible urban areas into four categories: Category I— higher risk, higher effectiveness; Category II—higher risk, lower effectiveness; Category III—lower risk, higher effectiveness; and Category IV—lower risk, lower effectiveness. DHS officials gave Category I the highest funding priority and Category IV the lowest funding priority. For fiscal year 2006, once the amounts for each category were decided, DHS used a formula to determine the grant award for each urban area, giving the risk score a weight of 2/3 and the effectiveness score a weight of 1/3. The final funding decision resulted in 70 percent of UASI funding going to “higher risk” candidates in Categories I and II. DHS extended eligibility to an additional 11 “sustainment” urban areas that participated in the program in fiscal year 2005, but did not make the eligibility threshold in the 2006 risk assessment process. One concern we identified during our review was that DHS had limited knowledge of how changes to its risk assessment methods, such as adding asset types and using additional or different data sources, affected its risk estimates. As a result, DHS had a limited understanding of the effects of the judgments made in estimating risk that influenced eligibility and allocation outcomes in fiscal year 2006. DHS leadership could make more informed policy decisions if provided with alternative risk estimates and funding allocations resulting from analyses of varying data, judgments, and assumptions. The Office of Management and Budget (OMB) offers guidelines for treatment of uncertainty in a number of applications, including the analysis of government investments and programs. These guidelines call for the use of sensitivity analysis to gauge what effects key sources of uncertainty have on outcomes. According to OMB, assumptions should be varied and outcomes recomputed to determine how sensitive analytical results are to such changes. By applying these guidelines decisionmakers are better informed about how sensitive outcomes are to key sources of uncertainty. While DHS has indicated that it has performed some analyses, at this date it has not provided us with details on the extent of these analyses, how they were used, or how much they cost. Fiscal Year 2007 Process The fiscal year 2007 process, as described by DHS officials, represents a continuing evolution in DHS's approach to its risk methodology for grant allocation. DHS officials said they will to continue to use the risk and effectiveness assessments to inform final funding decisions. For fiscal year 2007, DHS officials described changes that simplified the risk methodology, integrated the separate analyses for asset-based and geographic-based risk, and included more sensitivity analysis in determining what the final results of its risk analysis should be. DHS officials said the primary goal was to make the process more transparent and more easily understood, focusing on key variables and incorporating comments from a variety of stakeholders regarding the fiscal year 2006 process. For the 2007 grant cycle, DHS no longer estimated asset-based and geographic risk separately, considered most areas of the country equally vulnerable to a terrorist attack, given freedom of movement within the nation, and focused on the seriousness of the consequences of a successful terrorist attack. As shown in figure 3, the maximum risk score possible for a given area was 100. Threat to people and places accounted for a maximum 20 points, and vulnerability and consequences for a maximum 80 points. In the fiscal year 2007 process the intelligence community for the first time assessed threat information for multiple years (generally, from September 11, 2001, forward) for all candidate urban areas and gave the Office of Grants and Training a list that grouped these areas into one of four tiers. Tier I included those at highest threat, relative to the other areas, and tier IV included those at lowest threat relative to the others. According to DHS officials, the greatest concern was the impact of an attack on people, including the economic and health impacts of an attack. Also of concern was the quantity and nature of nationally critical infrastructure within each of the 168 urban areas assessed. In assessing threat, vulnerability and consequences, DHS specifically wanted to capture key land and sea points of entry into the United States, and the location of defense industrial base facilities and nationally critical infrastructure facilities. The approximately 2,100 critical infrastructure assets included in the risk assessment were selected on the basis of analysis by DHS infrastructure protection analysts, sector specific agencies, and the states. These assets included some 129 defense industrial base assets. Assets were grouped into two tiers: (1) those that if attacked could cause major national or regional impacts similar to those from Hurricane Katrina or 9/11, and (2) highly consequential assets with potential national or regional impacts if attacked. Tier II included about 660 assets identified by state partners and validated by sector specific agencies. On the basis of Office of Infrastructure Protection analysis, Tier I assets were weighted using an average value three times as great as Tier II assets. Throughout this process, a number of policy judgments were necessary, including what variables to include in the assessment, the points to be assigned to each major variable (e.g., threat, the population index, economic index, national infrastructure index, and the national security index) with an eye toward how these judgments affected outcomes. DHS officials noted that such judgments were the subject of extensive discussions, including among high-level officials. In addition, DHS officials said that they conducted more sensitivity analyses than was possible in the fiscal year 2006 process. DHS officials noted that because expert judgment was applied to the data and fewer variables were used in the current model, it was possible to track the effect of different assumptions and values on the ranking of individual urban areas. However, we have limited understanding of the sensitivity analyses that DHS conducted for the fiscal year 2006 and 2007 risk assessments because DHS has not provided us documentation on what analyses were conducted, how they were conducted, how they were used, and how they affected the final risk assessment scores and relative rankings. Finally, DHS officials said that the effectiveness assessment process will be consistent with last year's process, although enhancements will be made based on feedback received; however, no final decision has been made on the weights to be given to risk and effectiveness for the allocation of the fiscal year 2007 grants. One modification to the effectiveness assessment will provide urban areas the opportunity to include investments that involve multiple regions. This can potentially earn an extra 5 percent to 8 percent on their final score. In addition, DHS may convene separate peer review panels to assess proposed investments for these multi-regional investments. DHS has also offered applicants a mid- year review where applicants can submit their draft applications to DHS to obtain comments, guidance, or address questions that the grant may pose (such as little or unclear information on the anticipated impact of the investment on preparedness). As in the 2006 process, DHS officials have said that they cannot assess how effective these investments, once made, are in mitigating risk. DHS’s Use of a Risk Management Approach for Transportation Security Investments Can Be Strengthened Our past work examining TSA found that this DHS component has undertaken numerous initiatives to strengthen transportation security, particularly in aviation, and their efforts should be commended. However, we found that TSA could strengthen its risk-based efforts to include conducting systematic analysis to prioritize its security investments. Although TSA has implemented risk-based efforts with many of its programs and initiatives, we have found—because of circumstances beyond TSA’s control and a lack of planning—that TSA has not always conducted the systematic analysis needed to inform its decision-making processes and to prioritize security enhancements. For example, we found that TSA has not always conducted needed assessments of threats, vulnerabilities, and criticality in allocating its resources, and has not fully assessed alternatives that could be pursued to achieve efficiencies and potentially enhance security. Such planning could guide TSA in moving forward in its allocation of transportation resources both within aviation and across all transportation modes. Much of our work in the area of transportation security has focused on aviation and rail security, and our reviews have identified the need for a greater focus on, and application of, a risk management approach to guide investments in enhancing air cargo, general aviation, commercial airport, and passenger rail transportation security. Air Cargo Security: In October 2005, we reported that TSA had taken initial steps toward applying a risk-based management approach to address air cargo security. In that report, we noted that, in November 2003, TSA completed an air cargo strategic plan that outlined a threat-based, risk management approach to secure the air cargo system by, among other things, targeting elevated risk cargo for inspection. TSA also completed an updated threat assessment in April 2005. However, we found that TSA had not yet established a methodology and schedule for completing assessments of air cargo vulnerabilities and critical assets—two crucial elements of a risk-based management approach without which TSA may not be able to appropriately focus its resources on the most critical security needs. General Aviation Security: In reporting on efforts to enhance general aviation security in 2004, we found that TSA had not conducted an overall systematic assessment of threats to, or vulnerabilities of, general aviation to determine how to better prepare against terrorist threats. TSA had conducted limited vulnerability assessments at selected general aviation airports based on specific security concerns or requests by airport officials. TSA reported its intentions to implement a risk management approach to better assess threats and vulnerabilities of general aviation aircraft and airports and, as part of this approach, was developing an outline vulnerability self-assessment tool to be completed by individual airport managers. However, we noted limitations to the use of the self-assessment tool, and TSA had not yet developed a plan with specific milestones to implement the assessment, thereby making it difficult to monitor the progress of its efforts. Commercial Airport Access Control and Perimeter Security: In June 2004, we reported that TSA had not yet developed a plan to prioritize expenditures to ensure that funds provided have the greatest impact in improving the security of the commercial airport system. Through funding of a limited number of security enhancements, TSA had helped to improve perimeter and access control security at some airports. However, we concluded that, without a plan to consider airports’ security needs systematically, TSA could not ensure that the most critical security needs of the commercial airport system were identified and addressed in a priority order. We will initiate work later this year to assess the steps TSA has taken to better prioritize its homeland security investments in this area. Surface Transportation Security: As we reported last month, DHS’s Office of Grants and Training has developed and conducted risk assessments of passenger rail systems to identify and protect rail assets that are vulnerable to attack, such as stations and bridges. TSA has also begun to conduct risk assessments, including a threat assessment of mass transit and passenger rail and assessments of individual critical rail assets. While TSA has begun to establish a methodology for determining how to analyze and characterize the risks identified, the agency has not completed a comprehensive risk assessment of the U.S. passenger rail system. Until TSA completes this effort, the agency will be limited in its ability to prioritize passenger rail assets and help guide security investment decisions about protecting them. Similarly, TSA has not yet conducted threat and vulnerability assessments of other surface transportation assets, which may adversely affect its ability to adopt a risk-based approach for prioritizing security initiatives within and across all transportation modes. DHS’s Progress in Using a Risk Management Approach in Making Port Security Investments Can Be Linked to Each of Three Component’s Organizational Maturity and Task Complexity In December 2005, we reported that three DHS components responsible for port security or infrastructure protection varied considerably in their progress in developing a sound risk management framework for homeland security. Our work reviewed the risk management approaches used by three DHS components prior to DHS’s Second Stage Review and departmental reorganization: the Coast Guard, the lead federal agency for the security of the nation’s ports; Office of Domestic Preparedness (ODP), the former DHS component responsible for administering federal homeland security assistance programs for states and localities, including the port security grant program, and the Information Analysis and Infrastructure Protection Directorate (IAIP), the former DHS component responsible for, among other things, identifying and assessing current and future threats to the homeland, mapping those threats against known vulnerabilities, and offering advice on preventive and protective action. This DHS component was responsible for cataloging key critical infrastructure, then analyzing various characteristics to prioritize this infrastructure, including those located at ports, for the entire nation. We found at that time that the varied progress reflected, among other things, each component’s organizational maturity and the complexity of its task (see table 2). The Coast Guard, which was furthest along, is the component of longest standing, being created in 1915, while IAIP had came into being with the creation of the Department of Homeland Security in 2003. We found that IAIP had made the least progress. This DHS component was not only a new component but also has the most complex task: addressing not just ports but all types of infrastructure. Those DHS components that had a relatively robust methodology in place for assessing risks at ports were the Coast Guard and, what was at the time the Office for Domestic Preparedness (ODP), who awarded grants for port security projects. IAIP was still developing its methodology and had several setbacks in completing the task. We found that all three components had much left to do. In particular, each component was limited in its ability to compare and prioritize risks. The Coast Guard and ODP were able to do so within a port but not between ports, and at that time, IAIP did not demonstrate that it could compare and prioritize risks either within or between all infrastructure sectors. Coast Guard Progress Reflects Historical Focus on Risk Management Efforts The Coast Guard was furthest along among the three components, reflecting in part where it stood in relationship to all three of these factors. It had been at the task the longest of the three components, having begun work on implementing risk management in its port security efforts immediately after the September 11 attacks. The Coast Guard implemented a port security risk assessment tool in November 2001, and by August 2002 (prior to the creation of DHS and the port security framework called for under the Maritime Transportation Security Act of 2002), it had begun security assessments at major U.S. ports. To a degree, these early efforts were learning experiences that required changes, but the Coast Guard was able to build on its early start. The Coast Guard also had the greatest organizational stability of the three components. It moved into DHS as an already established entity with an organizational culture spanning decades, and its organization and mission were not significantly altered by moving into DHS. Finally, with regard to the scope of its risk management activities, the Coast Guard’s work is specific to port locations, where it has direct and primary responsibility for carrying out security responsibilities. With its focus on ports, the Coast Guard does not have to address a number of the critical infrastructure sectors laid out in national preparedness policy, such as banking and finance, information and technology, and public health. Even so, the Coast Guard’s experience to date shows that as the scope of activity widens, even within a single sector, complexities develop. For example, the Coast Guard has prioritized risks within individual ports, and it has actions under way to assess risks across ports, but using this information to strategically inform the annual program review and budget process will require further attention. ODP’s Progress in Risk Management Reflected Its More Recent Initiation of Efforts and Organizational Role At the time of our review, ODP had made somewhat less progress than the Coast Guard. Relative to the Coast Guard’s progress, its progress reflected a later start, an organization with much less institutional maturity, and a different role from the Coast Guard’s in that ODP provided grant money rather than directly setting security policy. ODP was transferred from the Department of Justice to the Department of Homeland Security in 2003. While ODP’s early grant approval efforts had some risk management features in place, its main strides in risk management had come in the procedures recently adopted for the fiscal year 2005 grants. In moving toward risk management, ODP had found ways to allow information from the Coast Guard and IAIP to inform its decision making. This is an encouraging and important sign, because the success of risk management efforts depends in part on the ability of agencies with security responsibilities to share and use each others’ data and expertise. Although both the Coast Guard and the port security grant program administered by ODP had port security as their focus, ODP’s more limited scope of responsibility also had an effect on its risk management efforts. First, because ODP’s role was to award grants that support federal priorities in port security, its progress in risk management depended to a degree on the progress made by other federal agencies in determining what their own port security performance measures should be. Second, ODP’s funding priorities were subject to criteria other than risk, as the fiscal year 2004 grant awards demonstrated. That year, after creating an initial list of awardees based in part on risk, and without regard to ability to pay, ODP extensively revised the list and awarded grants to entities considered to have fewer funding alternatives. Lack of IAIP Progress in Risk Management Reflects In Part Its Broader Focus Of the three components, IAIP was the least far along in its risk management efforts. All three factors have had an effect on this progress: IAIP had been at its task for a relatively short time; it was a new component; and relative to the Coast Guard and ODP, the scope of its efforts was much broader and more difficult. IAIP was created under the Homeland Security Act of 2002, giving the directorate little time to acquire institutional maturity. In addition to taking on difficult tasks like risk management, IAIP faced other institutional challenges, such as establishing new management systems, developing sound human capital practices, and integrating its efforts with those of the rest of DHS. Further, the scope of its risk management activities extended well beyond the port- focused activities of the Coast Guard or ODP. (At the time, IAIP was responsible for conducting risk assessments for every critical infrastructure segment in the nation.) As demonstrated by the experience of its Risk Analysis and Management for Critical Asset Protection (RAMCAP) methodology for comparing risk across sectors, IAIP remained challenged in meeting that responsibility. Its lack of progress reflected the same lesson that emerges from the Coast Guard’s experience in trying to expand the focus of risk assessments beyond a single port: the complexity of risk management appears to grow exponentially as the focus expands beyond a single location or single type of infrastructure. This complexity may help explain IAIP’s lack of progress, but IAIP was unable at that time to provide adequate assurance to Congress or the country that the federal government was in a position to effectively manage risk in national security efforts. Steps have been small; by far, the biggest work is still yet to come. DHS Use of Risk Management in Making Investments in Other Mission Areas Varies by Degree and Application We have assessed DHS’s risk management efforts across a number of other mission areas in the 4 years since the department was established-- including border security, immigration enforcement, immigration services, critical infrastructure protection, and science and technology—and found varying degrees of consideration and application of risk management principles in DHS’s investments in homeland security. Border Security: In 2006, as part of our work on border security, we issued a report assessing how DHS manages the risks of the Visa Waiver Program. The Visa Waiver Program enables citizens of 27 countries to travel to the United States for tourism or business for 90 days or less without obtaining a visa. While there are benefits to the program in terms of facilitating travel for millions of people, inherent risks include barriers to border inspectors conducting in-depth interviews of travelers and the use of stolen passports from visa waiver countries. DHS had taken some action to mitigate the program’s risks. For example, it had established a unit to conduct biennial reviews of the Visa Waiver Program as mandated by Congress in 2002. Yet stakeholders were not consulted during portions of the process, preparation for in-country site visits was not consistent, and the final reports were untimely. Further, the department had not established time frames and operating procedures regarding timely stolen passport reporting—a program requirement since 2002. DHS also had not issued clear reporting guidelines to the program’s participating countries about reporting lost and stolen passport data. Immigration Enforcement: In the area of immigration enforcement, we reported in 2006 that, while ICE had taken some initial steps to introduce principles of risk management into its operations, it had not conducted a comprehensive risk assessment of the customs and immigration systems to determine the greatest risks for exploitation, nor analyzed all relevant data to inform the evaluation of alternatives and allow officials to make risk-based resource allocation decisions. We recommended that ICE conduct comprehensive risk assessments, including consideration of threats, vulnerabilities, and consequences, of the customs and immigration systems to identify the types of violations with the highest probability of occurrence and most significant consequences in order to guide resource allocation. Immigration Services: In 2006, we reported that USCIS had not yet developed a comprehensive risk management approach to identify the types of immigration benefits that are most vulnerable to fraud and the consequences of their exploitation, monitored ongoing efforts to determine needed policy and procedural changes to reduce immigration benefit fraud, or sanctioned those who commit immigration benefit fraud to help deter them from committing future fraudulent acts. We recommended that USCIS implement additional internal controls and best practices to strengthen its fraud control environment and that DHS develop a strategy for implementing a sanctions program. Critical Infrastructure: As we reported in October 2006, DHS issued a National Infrastructure Protection Plan in June 2006 to serve as a road map for how DHS and other relevant stakeholders should use risk management principles to prioritize protection activities within and across sectors in an integrated, coordinated fashion. However, we concluded that DHS guidance does not require the plans to address how the sectors are actually assessing risk and protecting their most critical assets. In September 2006, we reported that DHS had initiated efforts to address its responsibilities for enhancing the cybersecurity of information systems that are a part of the nation’s critical infrastructure but had not fully addressed all 13 of its key responsibilities. For example, while DHS had begun a variety of initiatives to fulfill its responsibility to develop an integrated public/private plan for Internet recovery, these efforts were not complete or comprehensive. Many of DHS’s efforts lacked time frames for completion and the relationships among its various initiatives were not evident. We recommended that DHS (1) conduct threat and vulnerability assessments, (2) develop a strategic analysis and warning capability for identifying potential cyber attacks, (3) protect infrastructure control systems, (4) enhance public/private information sharing, and (5) facilitate recovery planning, including recovery of the Internet in case of a major disruption. Science and Technology: In the area of science and technology, we reported in 2004 that DHS had not yet completed a strategic plan to identify priorities, goals, objectives, and policies for the research and development (R&D) of homeland security technologies. We recommended that DHS complete a strategic R&D plan and ensure that this plan is integrated with homeland security R&D efforts of other federal agencies; complete strategic plans for transportation security research; and develop programs and conduct risks assessments for all modes of transportation to guide research and development investment decisions. DHS Has Not Provided Guidance for a Coordinated Risk Management Approach and More Work Remains to be done in Carrying Out Such an Approach DHS Has Identified the Need for a Risk-based Approach, but Efforts to Develop Guidance to Coordinate Such an Approach Have Been Hampered by Organizational Restructuring The need for and difficulties associated with creating a coordinated, coherent risk management approach to the nation’s homeland security have been widely acknowledged since the events of September 11, 2001, and the creation of DHS. Yet, this general acknowledgment has not been accompanied by the guidance necessary to make consistent use of risk management across DHS. The National Strategy for Homeland Security and DHS’s strategic plan called for the use of risk-based decisions to prioritize DHS’s resource investments regarding homeland security related programs. Although the Homeland Security Act and subsequent strategies call for the use of risk management to protect the nation’s critical infrastructure and key resources, they did not define how this was to be accomplished. In addition, Homeland Security Presidential Directive 7 (HSPD-7) directed the Secretary of the Department of Homeland Security (DHS) to establish uniform policies, approaches, guidelines, and methodologies integrating federal infrastructure protection and risk management activities. However, no further direction or guidance as to the course of action has been forthcoming. As our 2006 report on risk management at ports and other critical infrastructure concluded, as DHS’s individual components begin to mature in their risk management efforts, the need for consistency and coherence becomes even greater. Without it, the prospects increase for efforts to fragment, clash, and work at cross purposes. Efforts to establish guidance to coordinate a risk-based approach across DHS components has been hampered by organizational restructuring. At the time we conducted our 2005 review of risk management for ports and other critical infrastructure, risk management was the responsibility of the Infrastructure Protection Office. The Infrastructure Protection Office’s risk management efforts were focused mainly on assessing and reducing the vulnerabilities that exist in and around specific facilities or assets. But DHS’s responsibility is broader than this: besides assessing and reducing vulnerabilities at specific facilities, it also includes preventing attacks from occurring (and in the process protecting people and critical infrastructure) and responding to and recovering from natural disasters and acts of terrorism. This initial focus on vulnerabilities at specific assets had the potential of limiting DHS’s ability to achieve the broader goal of using risk- based data as a tool to inform management decisions on all aspects of its missions. In July 2005, the Secretary of DHS announced the department’s Second Stage Review and reorganization, which had moved risk management to a new Preparedness Directorate. At the time of our work, we determined it was unclear how such a move could affect DHS’s ability to carry out its risk management responsibilities, and were concerned that the new focus on preparedness could result in an emphasis that may go too far the other way—that is an emphasis on protection of specific assets and response and recovery at the expense of prevention. To comply with certain requirements in the fiscal year 2007 DHS appropriation act, particularly with regard to FEMA, DHS is reorganizing, with some of the responsibilities of the Preparedness Directorate moving to FEMA. The Undersecretary for Preparedness is to become the Undersecretary for National Protection and Programs, retaining responsibility for risk management and analysis. The new structure is to take effect by March 31, 2007. As we noted in our past work, the office responsible for risk management should have a broad perspective across the department’s entire mission as well as the necessary authority to hold DHS component agencies responsible for carrying out risk management activities in a coordinated and consistent manner. Over the Long-Term, More Work Remains to Be Done in Carrying Out a Risk- Based Approach DHS has centered much attention on implementing risk management, but much more work remains to be done than has been accomplished so far. As discussed in the preceding sections, DHS components have made progress in applying risk management to varying degrees in guiding homeland security investments in state and local capabilities and in implementing their homeland security missions. The challenges that remain, however, are substantial and will take time, leadership, and attention to resolve. This is particularly true when risk management is viewed strategically—that is with a view that goes beyond what assessing the risks are and integrating a consideration for risk into annual budget and program review cycles. In this way, DHS faces challenges in the following areas: Developing a way to compare and set priorities across different types of key infrastructure the Department is responsible for overseeing. While DHS components, such as TSA and the Coast Guard, have made progress in applying risk management to airports and seaports, challenges remain in making comparisons across assets and infrastructure within the transportation sector and in setting relative priorities. DHS has been challenged in establishing uniform policies, approaches, guidelines, and methodologies for integrating federal infrastructure protection within the department, including metrics and criteria. While coordination occurs among the various components in the department, our work shows that components apply risk management in ways that are neither consistent nor comparable. The degree to which DHS uses common metrics, criteria, and approaches remains a management challenge. Coordinating efforts across the federal government. DHS plays a central role in guiding risk management activities across the federal government and much more work remains in offering policies, guidelines, and methodologies, including metrics and criteria, for the array of programs covered by Homeland Security Presidential Directives. Seven major departments or agencies are covered by the Directives, including the Departments of Defense, Energy, and Agriculture. DHS is developing a methodology to do this, but in the absence of this, these departments will use approaches that may not be compatible or may not be able to inform one another. Until such a methodology is in place, it will be impossible for DHS to make a determination of relative risks that could inform spending decisions. Integrating a concern for risk into other management systems, such as the annual cycle of budget and program review. A key aim of risk management is to inform decisions on setting relative priorities and on spending and ultimately to improve the quality of decisions made. Doing so, however, is difficult in that the traditional ways of reviewing budgets and programs often rely on program data that call for continuing or expanding a program without examining the relative risks that are addressed. Additionally, DHS is challenged because it must depend on others to follow risk management principles at other federal departments or agencies that have also been called on to implement risk management. Translating the concept of risk management into applications that are consistent and useful represents a major challenge for DHS as it moves from an organization that is in its early stages to one that is more organizationally mature. The Secretary of DHS has said that operations and budgets of its agencies will be reviewed through the prism of risk, but doing this is made difficult by the level of guidance and coordination that has been provided so far. Failure to address the strategic challenges in risk management could have serious consequences for homeland security. Until it does so, DHS is unable to provide adequate assurance to the Congress or the country that the federal government is in a position to effectively manage risk in national security efforts. Concluding Observations Fully integrating a risk management approach into decision-making processes is challenging for any organization, and is particularly challenging for DHS, with its diverse set of responsibilities. But the basic goal across DHS homeland security programs is similar—to identify, prevent where possible, and protect the nation from risks of all types to people, property, and the economy. DHS has taken the first step in confronting this challenge by acknowledging the need for such an approach. It has taken further steps by incorporating risk management principles to at least some degree into making homeland security grant allocations, funding transportation and port security enhancements, and targeting federal funding across other DHS mission areas. However, much work remains to be done to implement a comprehensive risk management approach across DHS. We do not underestimate the challenge involved. Nevertheless, such a comprehensive implementation would place DHS in a better position to identify the threats that can and should be offset by limited resources. So that policymakers can make informed spending decisions, it is essential that policymakers fully understand the the assumptions and policy judgments that inform the risk analyses used for these decisions. A more comprehensive approach to risk management would also help the DHS components responsible for emergency preparedness, transportation, port security, and other mission areas to better protect our nation’s assets. Without further attempts to address this incomplete work, DHS cannot assure the Congress or the public that federal funding is targeting the most critical risks. Mr. Chairman and Members of the Committee, this concludes my prepared statement. I would be pleased to respond to any questions you and the Committee Members may have. Contact and Staff Acknowledgments For further information about this statement, please contact William O. Jenkins Jr., Director, Homeland Security and Justice Issues, on (202) 512-8777 or jenkinswo@gao.gov. Major contributors to this testimony included Chris Keisling, Assistant Director; John Vocino, Analyst-in-Charge; and Katherine Davis, Communications Analyst. Appendix I: Related GAO Products Homeland Security Grants: Observations on Process DHS Used to Allocate Funds to Selected Urban Areas. GAO-07-381. Washington, D.C.: February 7, 2006. Homeland Security: Progress Has Been Made to Address the Vulnerabilities Exposed by 9/11, but Continued Federal Action Is Needed to Further Mitigate Security Risks. GAO-07-375. Washington, D.C.: January 24, 2007. Passenger Rail Security: Enhanced Federal Leadership Needed to Prioritize and Guide Security Efforts. GAO-07-225T. Washington, D.C.: January 18, 2007. Border Security: Stronger Actions Needed to Assess and Mitigate Risks of the Visa Waiver Program. GAO-06-1090T. Washington, D.C.: September 7, 2006. Interagency Contracting: Improved Guidance, Planning, and Oversight Would Enable the Department of Homeland Security to Address Risks. GAO-06-996. Washington, D.C.: September 27, 2006. Aviation Security: TSA Oversight of Checked Baggage Screening Procedures Could Be Strengthened. GAO-06-869. Washington, D.C.: July 28, 2006. Border Security: Stronger Actions Needed to Assess and Mitigate Risks of the Visa Waiver Program. GAO-06-854. Washington, D.C.: July 28, 2006. Passenger Rail Security: Evaluating Foreign Security Practices and Risk Can Help Guide Security Efforts. GAO-06-557T. Washington, D.C.: March 29, 2006. Hurricane Katrina: GAO’s Preliminary Observations Regarding Preparedness, Response, and Recovery. GAO-06-442T. Washington, D.C.: March 8, 2006. Risk Management: Further Refinements Needed to Assess Risks and Prioritize Protective Measures at Ports and Other Critical Infrastructure. GAO-06-91. Washington, D.C.: December 15, 2005. Strategic Budgeting: Risk Management Principles Can Help DHS Allocate Resources to Highest Priorities. GAO-05-824T. Washington, D.C.: June 29, 2005. Protection of Chemical and Water Infrastructure: Federal Requirements, Actions of Selected Facilities, and Remaining Challenges. GAO-05-327. Washington, D.C.: March 28, 2005. Transportation Security: Systematic Planning Needed to Optimize Resources. GAO-05-357T. Washington, D.C.: February 15, 2005. Homeland Security: Observations on the National Strategies Related to Terrorism. GAO-04-1075T. Washington, D.C.: September 22, 2004. 9/11 Commission Report: Reorganization, Transformation, and Information Sharing. GAO-04-1033T. Washington, D.C.: August 3, 2004. Critical Infrastructure Protection: Improving Information Sharing with Infrastructure Sectors. GAO-04-780. Washington, D.C.: July 9, 2004. Homeland Security: Communication Protocols and Risk Communication Principles Can Assist in Refining the Advisory System. GAO-04-682. Washington, D.C.: June 25, 2004. Critical Infrastructure Protection: Establishing Effective Information Sharing with Infrastructure Sectors. GAO-04-699T. Washington, D.C.: April 21, 2004. Homeland Security: Summary of Challenges Faced in Targeting Oceangoing Cargo Containers for Inspections. GAO-04-557T. Washington, D.C.: March 31, 2004. Rail Security: Some Actions Taken to Enhance Passenger and Freight Rail Security, but Significant Challenges Remain. GAO-04-598T. Washington, D.C.: March 23, 2004. Homeland Security: Risk Communication Principles May Assist in Refinement of the Homeland Security Advisory System. GAO-04-538T. Washington, D.C.: March 16, 2004. Combating Terrorism: Evaluation of Selected Characteristics in National Strategies Related to Terrorism. GAO-04-408T. Washington, D.C.: February 3, 2004. Homeland Security: Information Sharing Responsibilities, Challenges, and Key Management Issues. GAO-03-1165T. Washington, D.C.: September 17, 2003. Homeland Security: Efforts to Improve Information Sharing Need to Be Strengthened. GAO-03-760. Washington, D.C.: August 27, 2003. Homeland Security: Information Sharing Responsibilities, Challenges, and Key Management Issues. GAO-03-715T. Washington, D.C.: May 8, 2003. Transportation Security Research: Coordination Needed in Selecting and Implementing Infrastructure Vulnerability Assessments. GAO-03-502. Washington, D.C.: May 1, 2003. Information Technology: Terrorist Watch Lists Should Be Consolidated to Promote Better Integration and Sharing. GAO-03-322. Washington, D.C.: April 15, 2003. Homeland Security: Voluntary Initiatives Are Under Way at Chemical Facilities, but the Extent of Security Preparedness Is Unknown. GAO-03-439. Washington, D.C.: March 14, 2003. Critical Infrastructure Protection: Challenges for Selected Agencies and Industry Sectors. GAO-03-233. Washington, D.C.: February 28, 2003. Critical Infrastructure Protection: Efforts of the Financial Services Sector to Address Cyber Threats. GAO-03-173. Washington, D.C.: January 30, 2003. Major Management Challenges and Program Risks: Department of Homeland Security. GAO-03-103. Washington, D.C.: January 30, 2003. Homeland Security: A Risk Management Approach Can Guide Preparedness Efforts. GAO-02-208T. Washington, D.C.: October 31, 2001. Homeland Security: Key Elements of a Risk Management Approach. GAO-02-150T. Washington, D.C.: October 12, 2001. Homeland Security: A Framework for Addressing the Nation’s Issues. GAO-01-1158T. Washington, D.C.: September 21, 2001. Combating Terrorism: Selected Challenges and Related Recommendations. GAO-01-822. Washington, D.C.: September 20, 2001. Critical Infrastructure Protection: Significant Challenges in Developing National Capabilities. GAO-01-323. Washington, D.C.: April 25, 2001. Combating Terrorism: Linking Threats to Strategies and Resources. GAO-00-218. Washington, D.C.: July 26, 2000. Combating Terrorism: Threat and Risk Assessments Can Help Prioritize and Target Program Investments. GAO-03-173. Washington, D.C.: April 9, 1998. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

Since the terrorist attacks of September 11, 2001, and the subsequent creation of the Department of Homeland Security (DHS), the federal government has provided DHS with more than $130 billion in budget authority to make investments in homeland security. However, as GAO has reported, this federal financial assistance has not been guided by a clear risk-based strategic plan that fully applies risk management principles. This testimony discusses the extent to which DHS has taken steps to apply risk management principles to target federal funding for homeland security investments (1) in making grant allocations, (2) in funding transportation and port security enhancements, (3) in other DHS mission areas, and (4) at a strategic level across DHS. This testimony summarizes previous GAO work in these areas. Risk management, a strategy for helping policymakers make decisions about assessing risk, allocating resources, and taking actions under conditions of uncertainty, has been endorsed by Congress, the President, and the Secretary of DHS as a way to strengthen the nation against possible terrorist attacks. DHS has used risk management principles to invest millions of dollars at the state and local level as part of its Urban Area Security Initiative (UASI) grants. For fiscal year 2006, DHS adopted a risk management approach to determine which UASI areas were eligible for funding. For the fiscal year 2007 grant process, DHS made substantial changes to its 2006 risk assessment model, simplifying its structure, reducing the number of variables considered, and incorporating the intelligence community's assessment of threats in candidate urban areas. The fiscal year 2007 model considers most areas of the country equally vulnerable to attack; its analysis focuses on the expected impact and consequences of successful attacks occurring in specific areas. DHS and the components of DHS responsible for transportation and port security have taken steps to apply risk management principles with varying degrees of progress. The Transportation Security Administration has not completed a methodology for assessing risk, and until the overall risk to the entire transportation sector is identified, it will be difficult to determine where and how to target limited resources to achieve the greatest security gains. The progress of each of DHS's three components responsible for port security varies according to organizational maturity and the complexity of its risk management task. The Coast Guard, created in 1915, was the most advanced in implementing a risk-based approach. Meanwhile, the Office for Domestic Preparedness (responsible for grants) and the Information Analysis and Infrastructure Protection Directorate (responsible for all sectors of the nation's critical infrastructure) were brought to or established with DHS in 2003 and lagged behind the Coast Guard in applying risk management to port security. Other DHS mission areas GAO has assessed include border security, immigration enforcement, immigration services, critical infrastructure protection, and science and technology; the extent to which a risk management approach has been implemented in each area varies. While DHS has called for using risk-based approaches to prioritize its resource investments, and for developing plans and allocating resources in a way that balances security and freedom, DHS has not comprehensively implemented a risk management approach--a difficult task. However, adoption of a comprehensive risk management framework is essential for DHS to assess risk by determining which elements of risk should be addressed in what ways within available resources.

Background The Homeland Security Act of 2002 created DHS and consolidated most of the federal programs and agencies with responsibilities for emergency management into that agency. DHS serves as a federal partner to state and local governments in emergency management. DHS provides technical assistance and homeland security grant funding to states and local governments to enhance their emergency management efforts. States and local governments have the responsibility for spending DHS grant funds in accordance with DHS guidelines to meet local emergency management needs. In fiscal year 2006, DHS awarded $1.7 billion to states, urban areas, and territories to prepare for and respond to terrorist attacks and other disasters. States and local governments may then provide a portion of this funding to a range of entities, as specified in DHS’s program guidance. As we have noted in prior reports, emergency management requires coordinated planning and implementation by a variety of participants. Effective emergency management requires identifying the hazards for which it is necessary to be prepared (risk assessments); establishing clear roles and responsibilities that are effectively communicated and well understood; and developing, maintaining, and mobilizing needed capabilities, such as people, skills, and equipment. The plans and capabilities should be tested and assessed through realistic exercises that identify strengths and areas that need improvement, with any needed changes made to both plans and capabilities. The hazards that school districts may face will vary across the country depending upon the natural hazards to which their particular areas are prone and an assessment of other risks for which they need to be prepared, such as pandemic influenza or the discharge of hazardous substances from nearby chemical or nuclear plants. Similarly, who should be involved in emergency planning and response for schools, and the roles of the various participants will vary by type and size of the emergency incident. For large-scale emergencies, effective response is likely to involve all levels of government—federal, state, and local— nongovernment entities, such as the Red Cross, and the private sector. Federal and State Governments Provide Resources to School Districts for Emergency Management Planning, While Only States Have Laws that Require School Emergency Management Planning Although no federal laws exist requiring school districts to have emergency management plans, most states reported having requirements for school emergency management planning; however, the federal government, along with states, provides financial and other resources for such planning. Education, DHS, and state governments provide funding for emergency management planning in schools. However, DHS program guidance does not clearly identify school districts as entities to which states and local governments may disburse grant funds. Not all states receiving DHS funding are aware that such funding could be disbursed to school districts. In addition to providing funding, the federal government assists school districts and schools in emergency management planning by providing other resources such as guidance, training, and equipment. Although No Federal Laws Exist Requiring School District Emergency Management Planning, the Majority of States Have Requirements Although there are no federal laws requiring school districts to have emergency management plans, many states reported having laws or other policies that do so. Congress has not enacted any broadly applicable laws requiring all school districts to have emergency management plans. While the No Child Left Behind Act of 2001 provides that local education agencies (LEAs or school districts) applying for subgrants under the Safe and Drug Free Schools and Communities Program include in their grant applications an assurance that either they or their schools have “a plan for keeping schools safe and drug-free that includes...a crisis management plan for responding to violent or traumatic incidents on school grounds”, Education has not issued any regulations imposing such a requirement on all school districts. However, 32 of the states responding to our survey of state administering agencies and state education agencies reported having laws or other policies requiring school districts or schools to have a written emergency management plan (see fig. 1). Several state laws identify a broad range of specific emergencies that schools or districts are required to address in their plans, while many other states do not identify particular kinds of crises or use more general language to refer to the kinds of emergencies that plans must incorporate. Federal Agencies and States Provide Funding for School Districts’ Emergency Management Planning Education and DHS provided some funding to school districts for emergency management. Education provides funding to some school districts specifically for emergency management planning through its Emergency Response and Crisis Management (ERCM) Grant Program. Since fiscal year 2003, Education dispersed $130 million in such grants to over 400 of the over 17,000 school districts in the United States. These grant awards ranged from $68,875 to $1,365,087. DHS provides funding to states and local jurisdictions for emergency management planning, some of which can be provided to school districts or schools for emergency management planning. DHS officials told us that such funds are available through the State Homeland Security Program, Urban Areas Security Initiative, and Citizen Corps grants. Five states— Florida, Hawaii, Michigan, Mississippi, and Wyoming—reported that they provided approximately $14 million in DHS funding directly to school districts in these states during fiscal years 2003–2006. In addition, eight states and the District of Columbia reported that they provided DHS funding to local jurisdictions that then provided a portion of these funds to school districts or schools for emergency management planning. Although DHS officials told us that these three grant programs allow for the use of funds at the district or school level, the department’s program guidance does not clearly specify that school districts are among the entities to which state and local governments may disburse funds. As a result, some states may not be aware of their availability. State governments also provide state funds to school districts. Eleven of the 49 states responding to surveys we sent to state education and state administering agencies reported providing state funding to school districts for emergency management planning. Federal Agencies and States Provide Guidance, Training, and Equipment for Emergency Management in School Districts The federal government also provides guidance, training, and equipment to school districts to assist in emergency management planning (see table 1). Education, DHS, and HHS have collaborated and developed recommended practices to assist in preparing for emergencies that can be applied to school districts. Some of these practices are shown in table 2. The type of guidance available from the federal government on topics related to these recommended practices varies significantly; in some instances, federal agencies provide detailed instructions on how to implement recommended practices while, in other instances, guidance is less detailed. We have also recognized the importance of certain of these practices in our prior reports on emergency management. We have noted the importance of realistic training exercises followed by a careful assessment of those exercises. Those with whom the school districts should coordinate and train will vary by the type and size of the emergency. For example, for a potential pandemic flu or other major infectious outbreak, planning and working with local health authorities is critical. In addition to the federal government, states provide guidance and training to school districts. Based on our survey of state administrative agencies and state education agencies, 47 states reported providing guidance and 37 states reported providing training. Some states also reported providing online resources that include guidance and training. Most Districts Have Taken Steps to Prepare for Emergencies, but Some Plans and Activities Do Not Address Recommended Practices Almost all school districts have taken steps to prepare for emergencies, including developing written plans, but some plans do not address federally recommended practices such as establishing procedures for special needs students and procedures for continued student education in the event of an extended closure. Additionally, many school districts do not have procedures for training regularly with first responders and community partners. Most School Districts Have Undertaken Some Emergency Management Activities Many school districts, those with and without emergency management plans, have undertaken activities to prepare for emergencies. Based on our survey of school districts, we estimate that 93 percent of all school districts conduct inspections of their school buildings and grounds to identify possible vulnerabilities in accordance with recommended practices. Of those school districts, 87 percent made security enhancements to their school facilities and grounds as a result of these inspections. Security enhancements included adding or enhancing equipment to communicate with school employees, strengthening the perimeter security of the school, and enhancing access controls. In addition to conducting vulnerability assessments, many school districts carry out a number of other activities to prepare for emergencies such as conducting some type of school drill or exercise and maintaining a storage location for and replenishing emergency supplies such as food, water, and first-aid supplies, as recommended. Additionally, school districts took responsibility for a number of activities to prepare for emergencies at the district level such as negotiating the use of school buildings as community shelters and identifying security needs in schools. These activities can vary by locality depending on community needs and include oversight, coordination with other entities, and training. Most Districts Have Emergency Management Plans That Address Multiple Hazards, but the Content of Plans Varies Significantly Most school districts have developed written emergency management plans that address multiple hazards. Based on our survey of school districts, we estimate that 95 percent of all school districts have written emergency management plans with no statistical difference between urban and rural districts. Of those school districts that have written emergency plans, nearly all (99.6 percent) address multiple hazards in accordance with recommended practices to prepare for emergencies. However, the specific hazards addressed by plans vary. (See fig. 2.) In some instances, the hazards included in emergency plans are specific to local conditions, which is to be expected. The extent to which school districts’ emergency management plans and planning activities are consistent with other recommended practices varies: Develop Roles and Responsibilities for School Community Members. Based on our survey of school districts, most districts have written roles and responsibilities in their plans for staff such as superintendents, building engineers or custodians, principals, teachers, and nurses. Develop Roles and Responsibilities for First Responders and Community Partners. Based on our survey, we estimate that 43 percent of school districts use the Incident Command System (ICS)—established by DHS as part of the National Incident Management System (NIMS)— to establish the roles and responsibilities of school district officials, local first responders, and community partners during an emergency, in accordance with recommended practices. Develop Procedures for Communicating with Key Stakeholders. Central to district emergency plans is the inclusion of procedures for communicating with key stakeholders such as staff, parents, and students, including those who are Limited-English Proficient. Our survey finds that roughly three-quarters of all school districts have not included written procedures in their plans for communicating with Limited-English Proficient parents and students, in accordance with federally recommended practices. Develop Procedures for Special Needs Students. Although the number of special needs students in the schools is growing, our survey finds that an estimated 28 percent of school districts with emergency management plans do not have specific provisions for them in their emergency management plans. Education officials told us that because there is no agreement among disability groups on what the best practices are for special needs students in an emergency, districts usually devise their own procedures. According to these officials, some of these procedures such as keeping special needs students in their classrooms during some emergencies may not ensure the students’ safety in an emergency. Develop Procedures for Recovering from an Incident. Over half of all school districts with written emergency plans include procedures in their plans to assist with recovering from an incident, in accordance with recommended practices. School districts’ plans include such procedures as providing on-site trauma teams, restoring district administrative functions, and conducting assessments of damage to school buildings and grounds. Develop Procedures for the Continuation of Student Education. Few school districts’ emergency plans contain procedures for continuing student education in the event of an extended school closure, such as a pandemic outbreak, although it is a federally recommended practice. Based on our survey, we estimate that 56 percent of school districts do not include any of the following procedures (see table 3) in their plans for the continuation of student education during an extended school closure. Without such procedures school districts may not be able to educate students during a school closure that could last from several days to a year or longer. Determine Lessons Learned. Based on our survey of school districts, we estimate that 38 percent of districts have emergency management plans that contain procedures for reviewing lessons learned to analyze how well the plans worked in responding to a drill or emergency. Of the remaining school districts, 53 percent indicated they have procedures but those procedures are not included in their plans and 7 percent have no such procedures. Develop Multi-Purpose Manuals. Some school districts have multi- purpose manuals that contain various types of information such as roles and responsibilities for staff, descriptions of how to respond to different types of emergencies, as well as site specific information for individual schools to complete in order to tailor their plan. In contrast, other districts provide less information. For example, one district’s plan consisted of a flipchart with contact information on whom to call during an emergency. Involve Local Government and Public Heath Agencies in Developing and Updating Plans. School districts differed in the extent to which they involve community partners in the development and updating of their plans. Fewer than half of school districts with emergency management plans involve community partners such as the local head of government (43 percent) or the local public health agency (42 percent) when developing and updating their emergency management plans, as recommended by HHS. According to written guidance provided by Education, those school districts that do not include community partners in the development and updating of their plans may limit their opportunity to exchange information with local officials, take advantage of local resources, and identify gaps in their plan. More than half (52 percent) of all school districts with emergency management plans report regularly (i.e., at least once a year) updating their emergency management plans in accordance with recommended practices. However, 10 percent of all school districts had never updated their plans. Train with First Responders. Based on our survey, we estimate that 27 percent of all school districts with emergency management plans have never trained with any first responders on how to implement the plans, in accordance with federally recommended practices. The reasons why school districts are not training with first responders are not readily apparent. As we have previously reported, involving first responder groups in training and exercise programs can better familiarize first responders with and prepare first responders for their roles in an emergency as well as assess the effectiveness of a school or district emergency plan. Train with Community Partners. School districts report training with community partners—such as local government and local public health entities—on activities to prepare for an emergency with similar frequency. Specifically, we estimate that 29 percent of all school districts train with community partners. As with first responders, the reasons for the lack of training with community partners are not readily apparent. In our work on Hurricane Katrina, we reported that involving local community partners in exercise programs and training could help prepare community partners and enhance their understanding of their roles in an emergency as well as help assess the effectiveness of a school district’s emergency plan. Without such training, school districts and their community partners may not fully understand their roles and responsibilities and could be at risk of not responding effectively during a school emergency. School Districts Report Challenges in Planning for Emergencies and Difficulties in Communicating with First Responders and Parents In planning for emergencies, many school districts face challenges resulting from competing priorities, a lack of equipment, and limited expertise; some school districts experience difficulties in communicating and coordinating with first responders and parents, but most do not have such challenges with students. Competing Priorities, Lack of Equipment, and Limited Expertise Are Obstacles to Incorporating Recommended Practices in Emergency Management Planning School district officials who responded to our survey reported difficulty in following the recommended practice of allocating time to emergency management planning, given the higher priority and competing demand on their time for educating students and carrying out other administrative responsibilities. Based on our survey of school districts, we estimate that in 70 percent of all districts, officials consider competing priorities to be a challenge to planning for emergencies. In an estimated 62 percent of districts, officials cited a lack of equipment and expertise as impediments to emergency planning. For example, officials in one Massachusetts school district we visited reported that they do not have adequate locks on some of the doors to school buildings to implement a lockdown procedure. In a North Carolina district we visited, officials said a lack of two-way radios for staff in the elementary schools hinders their ability to communicate with one another and with first responders during an emergency. As demonstrated in these school districts, the lack of equipment would prevent districts from implementing the procedures in their plans and hinder communication among district staff and with first responders during emergencies. In addition to not having sufficient equipment, school district officials we spoke with described a shortage of expertise in both planning for and managing emergencies. These officials said their districts lacked specialized personnel and training with which to develop needed expertise. For example, district officials in 5 of the 27 districts we interviewed noted that they do not have sufficient funding to hire full-time emergency management staff to provide such training or take responsibility for updating their district plans. These officials noted that the lack of expertise makes it difficult to adequately plan for responding to emergencies. Some School Districts Reported Difficulty in Communicating and Coordinating with First Responders Based on our survey of school districts, an estimated 39 percent of districts with emergency plans experience challenges in communicating and coordinating with local first responders. Specifically, these school districts experience a lack of partnerships with all or specific first responders, limited time or funding to collaborate with first responders on plans for emergencies, or a lack of interoperability between the equipment used by the school district and equipment used by first responders. For example, the superintendent of a Washington school district we visited said that law enforcement has not been responsive to the district’s requests to participate in emergency drills, and, in addition to never having had a districtwide drill with first responders, competition among city, county, and private first responders has made it difficult for the school district to know with which first responder entity it should coordinate. According to guidance provided by Education, the lack of partnerships, as demonstrated in these school districts, can lead to an absence of training that prevents schools and first responders from understanding their roles and responsibilities during emergencies. Additionally, in 8 of the 27 districts we interviewed, officials said that the two-way radios or other equipment used in their school districts lacked interoperability with the radios used by first responders. School Districts Have Methods to Communicate With Parents, but Face Challenges in Ensuring Parents Receive Consistent Information during Incidents In keeping with recommended practices that call for school districts to have a way to contact parents of students enrolled in the district, all of the 27 school districts we interviewed had ways of communicating emergency procedures to parents prior to (e.g., newsletters), during (e.g., media, telephone), and after an incident (e.g., letters). Eleven of these districts have a system that can send instant electronic and telephone messages to parents of students in the district. Despite having these methods, 16 of the 27 districts we interviewed experience difficulties in implementing the recommended practice that school districts communicate clear, consistent, and appropriate information to parents regarding an emergency. For example, officials in a Florida school district said that with students’ increased access to cellular telephones, parents often arrive on school grounds during an incident to pick up their children before the district has an opportunity to provide parents with information. Thus, according to these officials, the district experiences challenges in simultaneously maintaining control of both the emergency situation and access to school grounds by parents and others. Representatives of three education associations also noted that school districts have much to do to ensure that their emergency management efforts diffuse confusion during emergencies and provide parents with consistent information. Based on our survey of school districts, an estimated 39 percent of all school districts provide translators to communicate with Limited-English Proficient parents during emergencies, but fewer—an estimated 23 percent of all districts—provide translations of emergency management materials. Officials in eight of the 27 districts we interviewed discussed challenges in retaining bilingual staff to conduct translations of the districts’ messages or in reaching parents who do not speak the languages or dialects the district translates. Our findings, are consistent with the observations of some national education groups that have indicated that districts, in part due to limited funding, struggle to effectively communicate emergency-related information to this population of parents. Officials in all but one of the districts in which we conducted interviews said that the district did not have problems communicating emergency procedures to students. While some of these officials did not provide reasons; as we previously discussed, most districts regularly practice their emergency management plans with their students and staff. Concluding Observations The federal government plays a critical role in assisting school districts to prepare for emergencies by providing funding, giving states flexibility to target federal funding for emergency management to areas of greatest need, disseminating information on best practices and other guidance, and providing training and equipment. School districts have taken a number of important steps to plan for a range of emergencies, most notably developing emergency management plans; however, in many districts these plans or their implementation do not align with federally recommended practices. Given the challenges many school districts face due to a lack of necessary equipment and expertise, they do not have the tools to support the plans they have in place and, therefore, school districts are left with gaps in their ability to fully prepare for emergencies. Additional clarity regarding access to federal resources and improved guidance may enhance the ability of school districts to plan and prepare for emergencies. We are currently considering recommendations to address these issues. GAO Contacts For further information regarding this testimony, please contact me on (202) 512-8403 or William O. Jenkins, Jr. on (202) 512-8757. Individuals making contributions to this testimony include Kathryn Larin, Debra Sebastian, Tahra Nichols, and Kris Trueblood. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

Events such as the recent shootings by armed intruders in schools across the nation, natural disasters, the terrorist attacks of September 11, 2001, and potential pandemics have heightened awareness for the need for school districts to be prepared to address a range of emergencies within and outside of schools buildings. Congress has raised concerns over school preparedness, with a particular interest in how federal agencies provide assistance to school districts. This testimony discusses preliminary findings related to GAO's review of emergency management in school districts, including (1) the roles of federal and state governments in establishing requirements and providing resources to school districts for emergency management planning, (2) what school districts have done to plan and prepare for emergencies, and (3) the challenges school districts have experienced in planning for emergencies, and communicating and coordinating with first responders, parents, and students. To obtain this information, GAO interviewed federal officials, surveyed a stratified random sample of all public school districts, surveyed state agencies that administer federal grants that can be used for school emergency management planning, conducted site visits to school districts, and reviewed relevant documents. Federal and state governments have a role in supporting emergency management in school districts. While no federal laws require school districts to have emergency management plans, 32 states reported having laws or policies requiring school districts to have such plans. The Departments of Education and Homeland Security (DHS) provide funding for emergency management planning in schools. However, some DHS program guidance, for specific grants, does not clearly identify school districts as entities to which state and local governments may disburse grant funds. Thus, states receiving this funding may be uncertain as to whether such funding can be allocated to school districts or schools and therefore may not have the opportunity to benefit from this funding. States also provide funding and other resources to school districts to assist them in planning for emergencies. School districts have taken steps to plan for a range of emergencies, as most have developed multi-hazard emergency management plans; however some plans and activities do not address federally recommended practices. For example, based on GAO's survey of a sample of public school districts, an estimated 56 percent of all school districts have not employed any procedures in their plans for continuing student education in the event of an extended school closure, such as might occur during a pandemic, and many do not include procedures for special needs students. Fewer than half of districts with emergency plans involve community partners when developing and updating these plans. Finally, school districts are generally not training with first responders or community partners on how to implement their school district emergency plans. Many school district officials said that they experience challenges in planning for emergencies and some school districts face difficulties in communicating and coordinating with first responders and parents, but most said that they do not experience challenges in communicating with students. For example, in an estimated 62 percent of districts, officials identified challenges stemming from a lack of equipment, training for staff, and personnel with expertise in the area of emergency planning as obstacles to implementing recommended practices.

Background High-speed ground transportation, which includes rail or magnetic levitation (maglev) systems capable of speeds of 90 miles per hour (mph) or more, could be developed in a number of ways. System developers can (1) make incremental improvements to existing tracks, signaling systems, and grade crossings and purchase modern trains that could permit speeds between 90 and 150 mph on existing rights-of-way; (2) build completely new rail infrastructures to support very-high-speed operations of 200 mph or more; or (3) build maglev systems that could permit speeds around 300 mph. Typically, the cost to implement these options grows as the sophistication of the technology and speed increase. Since 1975, most federal funding for high-speed rail development in the United States has been focused on making infrastructure improvements to Amtrak’s Northeast corridor. However, high-speed rail corridors across the United States may have access to federal funds through the High-Speed Rail program, the Magnetic Levitation Transportation Technology Deployment program, the Railroad Rehabilitation and Improvement Financing program, and the finance provisions under the Transportation Infrastructure Finance and Innovation Act of 1998 (TIFIA) program. The TIFIA program is designed to help large infrastructure projects—those costing at least $100 million or 50 percent of a state’s federal-aid highway apportionment for the preceding fiscal year—access capital by using federal funds to leverage substantial private investment.TIFIA authorizes the Secretary of Transportation to make secured loans, loan guarantees, and lines of credit available to eligible projects that will repay the assistance, in whole or in part, from dedicated revenue streams, such as tolls or passenger fares. TIFIA requires the Secretary of Transportation to establish criteria for selecting projects and includes general selection criteria such as whether a project is creditworthy and nationally or regionally significant and whether the use of federal funds would expedite implementing the project. The three credit instruments under TIFIA—secured loans, loan guarantees, and lines of credit—can be used to fund up to one-third of the costs of a project. A secured loan would typically provide the project’s sponsors with an infusion of capital needed to help pay for construction costs. The loan would have to be payable, in whole or in part, from some form of dedicated revenue and would typically be subordinate to other project debt. In general, TIFIA loans are contingent on the receipt of an investment-grade rating for a project’s senior debt. This measure helps ensure that the project is creditworthy. The second type of instrument, loan guarantees, involves a pledge by the Secretary to pay all or part of the principal of and interest on a loan or other debt obligation of the project. A loan guarantee would help a project obtain capital by providing added security to the debt. Finally, a line of credit is an agreement made by the Secretary to provide a project with a secured loan, if needed, during a project’s initial 10-year operating period. One project that plans to use very-high-speed French train a grande vitesse (TGV) technology and obtain TIFIA funding is FOX. The FOX system would link Miami, Orlando, and Tampa, cover 320 miles, and have seven stops along the route. Proponents of the system believe high-speed rail is needed to alleviate the future highway and airport congestion that will be caused by the anticipated growth in Florida’s population and tourism. Trains could reach speeds of up to 200 mph, and the system would have no ground-level pedestrian or vehicle crossings. To help design, construct, and operate the system, the Florida Department of Transportation (FDOT) entered into a system franchise agreement in 1996 with the FOX consortium. The FOX members include Fluor Daniel, a U.S.-based engineering and construction firm; Alstom, the manufacturer of French TGV trains; and Bombardier, a manufacturer of rail passenger cars. The franchise agreement between FDOT and FOX (collectively referred to as the project’s sponsors) calls for a public-private partnership to plan, design, build, operate, and finance the system. The FOX Project Faces Several Challenges The FOX project is in the early phases of development and faces several uncertainties regarding its cost, financing, ridership, and schedule. The project’s sponsors are developing the detailed information needed to assess whether the high-speed rail project is viable. It will be at least 2 more years before sufficient information is available to comprehensively assess the project. Preliminary Cost Estimates Range From $6 Billion to $8 Billion FOX’s engineer responsible for developing the cost estimate stated that the capital cost to construct the project may range from $6 billion to $8 billion (in 1997 dollars). This range reflects up to 54 potential route options for the new track under study in the environmental review process. Both FDOT and FOX officials stated that the estimates are preliminary because they are based on only a 5-percent level of design. These officials noted that by the end of 2000, the project will be at a 35-percent level of design, and therefore the cost estimate available at that time will be more precise. The project’s sponsors were unable to provide us with a detailed line-item breakout of the project’s high and low cost estimates, nor were they able to provide detailed documentation explaining the $2 billion difference between the estimates. However, according to FOX’s engineer, the $2 billion range reflects whether track for the various alignments must be elevated to cross roads and rivers and the degree to which the alignments can use existing rights-of-way. In general, the $8 billion estimate assumes an alignment from Miami to Orlando that traverses urban areas on the east coast, using a significant amount of elevated track to avoid over 100 grade crossings and cross several rivers. In contrast, the $6 billion estimate assumes a more westerly alignment that requires less elevated track and uses more state-owned rights-of-way along interstate highway corridors. To develop more precise estimates over the next 2 years, FOX engineers will take field measurements to either validate or adjust the earlier conceptual estimates, according to FOX’s engineer. Engineers will perform such tasks as taking instrument surveys to get actual measurements of potential alignments, calculate the alignments’ grades and curvatures, determine soil conditions, and determine the exact nature of any bridge clearance problems. When completed by the end of 2000, this detailed engineering work will provide FOX with a 35-percent level of design—a level that will give FOX sufficient information to agree with FDOT on a fixed-price construction contract for building the system. To help ensure the accuracy of the FOX estimates, FDOT officials have hired an independent engineering consultant to review the estimates. The initial review is focusing on the methods that FOX used to develop the current cost estimates. The review will report on whether FOX used industry-accepted estimation techniques and whether the estimates cover all capital cost components. It will also include spot audits of FOX’s estimates for quantities and unit prices. FDOT officials said that they would continue to use independent engineering reviews throughout the cost estimation process. The Project’s Financing Is Incomplete In developing their finance plan, the project’s sponsors have assumed that the FOX system will cost $6.3 billion (in 1997 dollars) to build. The project’s sponsors are seeking federal, state, and private funds to finance these capital costs. As of December 1998, they had secured only $436 million in financing and faced significant challenges in securing the remaining funds needed to build the project. As figure 1 shows, the project’s sponsors expect to use state infrastructure bonds and system infrastructure bonds—bonds backed by the state and future system revenues, respectively—and a $2 billion federal loan to pay for about 81 percent of the project’s financing needs. State cash contributions prior to issuing the bonds, contributions from the FOX consortium, private debt financing for the train equipment, and other income sources make up the rest of the project’s financing. System infrastructure bonds ($3.346 billion) Federal loan ($2.0 billion) The project’s sponsors would rely on four sources of debt financing to raise most of the needed funding. One source of debt financing would be state infrastructure bonds. These bonds would be tax-exempt and backed by a dedicated state committment of $70 million per year for 40 years, adjusted for inflation at 4 percent per year, beginning in 2001. The project’s sponsors anticipate that the bonds will have a 30- to 35-year maturity, with an interest rate of 6.67 percent. A second source of debt financing would be system infrastructure bonds. These bonds would be tax-exempt and secured by a senior lien on net system revenues. A senior lien means that bondholders would have the first claim on available revenues after the payment of annual operating costs, principal, and interest payments on train equipment debt and a portion of FOX’s return on equity. The project’s sponsors anticipate that the bonds will have a 30- to 35-year maturity, with an interest rate of 6.67 percent. A third source of debt financing would be private-sector financing for most of the train equipment. Sponsors are considering using either a lease or private bonds. The train equipment would secure the debt, and repayment of the debt would have the first claim on system revenues available after the project pays its annual operating costs. Finally, the fourth source of debt financing would be a $2 billion federal loan secured by a junior lien on the net system revenues. A junior lien means that the federal government would have the last claim on revenues and would be repaid after the project pays the annual operating costs, train equipment debt service, a portion of FOX’s return on equity, and system infrastructure bondholders. The remaining funds will come from equity contributions made by the state and FOX, project balances, and interest earned on those balances. State equity consists of state contributions made before the state infrastructure bonds are issued. The FOX equity contributions include $58 million to pay for project development and $291 million to pay for some of the trains. The project’s funding balances and interest earnings amount to $588 million. In total, the sponsors must secure nearly $9.3 billion to finance the $6.3 billion in initial capital costs. According to the project’s sponsors, the financing needs exceed the estimated capital costs by about $3 billion because the project must account for inflation, pay interest on state and system infrastructure bonds during the construction period, establish reserve funds required by bondholders, and cover the costs of issuing the bonds. As of December 1998, the project’s sponsors had secured commitments for about $436 million—$349 million from the FOX consortium and about $87 million from the state of Florida. Over the next 2 years, the project’s sponsors will have to secure the remaining funding—about $8.8 billion. Should the cost estimates increase as the sponsors complete more detailed engineering, FDOT’s financial manager for the project stated that the sponsors would likely issue more bonds or work with bond issuers to lower reserve funding requirements. The Project Must Meet Several Financing Challenges The project’s sponsors face several challenges in obtaining the nearly $8.8 billion in estimated additional funding needed for the project. The major challenges include issuing two sets of bonds on favorable terms and obtaining the federal loan. To issue about $5.4 billion in state and system infrastructure bonds, sponsors must convince the bond market that the project will have sufficient state and operating revenues to repay the bonds. To do this, sponsors must demonstrate that the state legislature will support a $70 million yearly funding commitment for 40 years and that the ridership estimates and revenue projections are valid. To obtain the $2 billion federal loan, the sponsors must also show that the project meets the criteria for assistance under TIFIA and deserves funding. Challenges in Issuing State and System Infrastructure Bonds The project’s sponsors must convince the bond market that the state and system infrastructure bonds are a good investment. Potential investors will be more likely to buy the bonds if the bonds provide competitive returns on investment and if the project has a reliable source of revenue to pay back the principal and interest. According to FDOT officials, the state will provide $70 million each year for the next 40 years to secure the $2.1 billion in state infrastructure bonds. In addition, future operating revenues will secure the $3.3 billion in system infrastructure bonds. FDOT’s lead attorney for the project stated that in early 2000, FDOT will seek the state legislature’s commitment to provide the $70 million in annual funding. The state’s commitment is uncertain, however, because several members of the legislature have raised concerns about the project and the state’s new governor has indicated skepticism about the project. In addition, should the legislature approve the 40-year funding commitment, FDOT must still obtain an annual appropriation. FDOT’s lead attorney for the project stated that the legislature has appropriated funds for other transportation projects that were previously authorized and that he viewed the risk of not obtaining the appropriation as minimal. In contrast to the state infrastructure bonds, the system infrastructure bonds will not be backed by a known amount of revenue. Instead, these bonds will be backed by operating revenues, which can fluctuate each year depending on the success of the system. On the basis of a 1998 FOX ridership study, the project’s sponsors forecast that system revenues will be sufficient to repay the principal and interest on $3.3 billion in system infrastructure bonds. The sponsors are confident that bond-rating agencies will accept the revenue estimates and are planning to provide them with the cost, ridership, and revenue information needed to assess the bonds’ creditworthiness and to thereafter issue a bond rating. FDOT’s financial manager for the project does not anticipate issuing state or system infrastructure bonds until cost estimates are more precise and the amount of bonds needed is better known. The current plan is for the project’s sponsors to receive a preliminary opinion from rating agencies in 1999 and obtain a final rating and issue the bonds in 2001. Our discussions with officials from three bond-rating agencies—Moody’s Investors Service, Standard and Poor’s, and Fitch IBCA—revealed that these agencies have little detailed information about the FOX project. Of the three, Fitch’s officials had the most knowledge of the project. Fitch officials told us that, in general, bond-rating agencies have little or no experience reviewing high-speed rail projects, but when asked to rate the project’s proposed bonds, they will focus on the reliability of the ridership estimates and other important factors in assessing the project’s revenue projections. On the basis of preliminary observations, one Fitch official stated that some of the assumptions used in the ridership study were optimistic and that the overall ridership estimate could be high. However, Fitch officials said it was too early to make any definitive statement about potential bond ratings for the project. In addition to the ridership estimates, another factor that may affect the rating for the system infrastructure bonds is the order in which the project will pay its obligations. According to the November 1996 agreement between FOX and FDOT, the project must first cover its operating costs, principal and interest payments for the debt-financed train equipment and pay the FOX consortium a partial return on its investment before it pays back system infrastructure bond investors. This agreement subordinates the system infrastructure bondholders’ claims on revenues and thereby makes the bonds less secure. FDOT’s financial manager for the project stated that this agreement may make the system infrastructure bonds riskier to potential investors and therefore more difficult to sell. Our discussions with Fitch officials also revealed that potential bondholders would consider the structure of the FDOT and FOX agreement as something that adds risks to the bonds. Challenges in Obtaining a Federal Loan The project’s sponsors intend to seek a $2 billion federal loan from the U.S. Department of Transportation under the new TIFIA program. The sponsors cited language in the Transportation Equity Act for the 21st Century (TEA-21) conference report as evidence of federal support for the project. The conference report noted the national significance of the FOX project and suggested that the Department favorably review the project’s request for TIFIA funds as long as it meets the program’s criteria. The project’s sponsors intend to apply for a TIFIA loan as soon as the Department begins soliciting project applications. The sponsors anticipate a favorable preliminary decision by the Department by fall 1999. However, unanswered questions regarding the TIFIA program, the bond market’s views of the project, and the impact of a single $2 billion loan on the TIFIA program could have an impact on the timing and outcome of the Department’s funding decisions. As of January 1999, the Department was developing regulations to implement the TIFIA program, including the criteria it will use to select projects. The regulations and selection criteria will affect the FOX project. For example, during a September 1998 outreach session on the TIFIA program, an official from the Department said that TIFIA funds may not be forthcoming for projects that have not completed the environmental review process. If this criterion is part of the Department’s TIFIA regulations, the FOX project would be unable to receive a commitment for TIFIA capital assistance until it completes its environmental review, projected for the end of 2000. In addition, TIFIA requires that a project’s sponsors provide a preliminary rating letter from at least one bond-rating agency indicating that the project’s senior obligations have the potential to achieve an investment-grade rating. An investment-grade rating indicates a relatively low probability of default. Until the project develops firmer cost and financing estimates for bond-rating agencies to review, a preliminary rating for the FOX project may not be forthcoming. Furthermore, TIFIA requires that, when selecting projects, the Department consider the amount it must obligate to fund the credit assistance. As discussed later in this report, providing the FOX project with the full $2 billion loan would require the Department to obligate a significant amount of the program’s available funding and would limit the funds that the Department has available to fund other projects through TIFIA. Lower Ridership May Affect the Project’s Financing The FOX project’s sponsors forecast that the system will carry 8.26 million passengers in 2010. From our analyses of the ridership study data, an independent review of the ridership forecast, and other data we found that the ridership forecast for the project may be overstated by 30 percent or more because it relies on optimistic assumptions. Using more conservative assumptions could reduce the ridership forecast to 5.59 million passengers or fewer in 2010. Because lower ridership would reduce the amount of fare revenues that the system is expected to generate, revising the forecast could affect the debt rating needed to obtain private capital and the federal loan. Project’s Sponsors Forecast 8.26 Million Passengers in 2010 Official forecasts prepared for the proposed FOX system have estimated that the project’s ridership could range from 8.01 million to 8.50 million; a consensus average is 8.26 million passengers in 2010. Table 1 shows the estimated number of annual FOX high-speed rail riders in 2010, categorized by the sources of the riders. As table 1 shows, the project’s sponsors expect that over 50 percent of the high-speed rail riders will be people who would otherwise use automobiles to travel along the Tampa-Orlando-Miami corridor. The next largest source of riders is from the air transfer market, that is, those travelers who fly for one portion of their trip, but through a code-share agreement between FOX and an airline, are expected to transfer to or from FOX to reach their destination. The project’s sponsors also forecast that the new high-speed rail service will induce 1.3 million new trips in the corridor that otherwise would not have been taken if high-speed rail were not available. The remaining 1.2 million riders would be diverted from the local air market—those air trips that have their origins and destinations within the high-speed rail corridor. Alternative Assumptions Could Produce a Significantly Lower Ridership Forecast Experts in travel demand forecasting acknowledge that forecasting ridership for high-speed rail is difficult and that the results depend upon future assumptions that may or may not become reality. The ridership forecast is extremely important because it provides the basis for determining the expected revenues of a system and whether a system can be financially viable. On the basis of our review of an independent report on the ridership forecasts, actual average airfare data from the Department, the Federal Railroad Administration’s (FRA) estimates of induced travel—new travel made solely because a transportation system exists—and our interviews of airline industry officials, we concluded that the FOX ridership forecast is too high because some of the assumptions used to prepare the ridership studies were optimistic. Using alternative scenarios based on less optimistic assumptions could produce a ridership estimate of 5.59 million or lower in 2010. Table 2 summarizes the results of our analysis of how less optimistic assumptions about the air transfer market, lower airfares, and induced or new travel could reduce total ridership estimates for the FOX system. First, the ridership forecasts for the FOX project assume that nearly 1.5 million passengers will be supplied to the FOX system by airlines operating in Florida markets. The assumption is that some airlines with hubs in Miami and Orlando will establish code-share agreements with FOX, thereby transferring short-haul intrastate air passengers to FOX so the airlines can maximize revenues on long-haul flights. For example, the ridership forecasts assume that through a code-share agreement, passengers flying to Miami or Orlando could transfer to the FOX system to reach another Florida destination in the high-speed rail corridor. An independent review of the ridership forecasts completed by Wilbur Smith Associates found that this assumption was unverified, and questioned the entire forecast of passengers transferring through airline agreements. In addition, officials from American Airlines, Delta Airlines, the Air Transport Association, and the Miami International Airport told us that airlines would not be interested in establishing a code-share agreement with a competitor such as high-speed rail. Accordingly, they contended that the forecast for passenger transfers through code-share agreements was unsupported. Without passengers from the air connect market, the FOX ridership forecast is reduced by about 1.47 million passengers. (See table 2.) Second, the FOX ridership forecasts assume that some air passengers will choose FOX instead of air travel in local air markets. To divert these passengers, FOX’s fares must be comparable with airfares. However, average 1997 airfares actually charged were generally lower than the fares assumed by the FOX ridership forecasts. This assumption could lead to an overestimate of the number of travelers who would use FOX instead of flying. The actual airfares charged by airlines in 1997 were, in some cases, 21 percent less than the airfares assumed in the ridership forecasts. For example, in the Fort Lauderdale-to-Orlando market, the ridership forecasts assumed an average one-way airfare of between $62 and $66, while the actual average airfare according to the Department’s data, was $52. In addition, FOX’s forecast assumed that airfares would remain constant in real terms from 1997 through 2010. However, officials from one major airline stated that they would likely reduce fares in response to the introduction of high-speed rail service. Furthermore, the Department has found that over the past few years, established airlines have responded to the entry of a new competitor by selling large numbers of seats at low fares. In preparing their ridership estimates, both KPMG Peat Marwick and SYSTRA developed alternative scenarios that were based on lower airfares. KPMG Peat Marwick found that a 20-percent decrease in assumed airfares would reduce total high-speed rail ridership by 60,000 passengers, while SYSTRA found a 20-percent reduction in airfares would lead to 761,000 fewer high-speed rail passengers. We used these numbers to reflect the effect of more conservative assumptions on ridership. (See table 2.) Third, the forecasts of passengers using the FOX system because of induced or new demand may also be optimistic. KPMG Peat Marwick’s and SYSTRA’s estimates for induced demand represent 11 and 21 percent of total forecast ridership on the FOX system, respectively. The consensus estimate—an average of the two forecasts—projects that 16 percent of the total riders will be induced travelers. However, Wilbur Smith Associates expressed concern about the amount of induced travel that the FOX system will actually produce. In addition, a 1997 FRA report noted that estimates of new demand are controversial because little historical information exists; defining and quantifying such demand is methodologically difficult. The FRA study assumed that the new or induced demand generated by high-speed rail service would equal 10 percent of the traffic diverted from local air and automobile travel. Using FRA’s assumption for induced traffic, KPMG Peat Marwick’s estimate would be reduced by 298,000 passengers, while SYSTRA’s estimate would be reduced by 1.26 million passengers. (See table 2.) Finally, the consensus ridership forecast also predicts that over 4.2 million passengers—52 percent of the total FOX ridership—will use the FOX system instead of automobiles. In its independent review report, Wilbur Smith Associates stated that the ability of a new high-speed rail system to cause travelers to choose it rather than to travel by automobile has not yet been proven in the United States. The report stated that while the level of diversion forecast by FOX could occur, lesser rates of diversion from private automobiles are also possible, which would result in lower ridership. Although we did not attempt to quantify the impact of a more conservative assumption regarding diversion from automobiles on the overall ridership forecast, reductions in this rate of diversion could reduce ridership below the 5.59-million-passenger forecast resulting from the analyses shown in table 2. The Uncertainty in Ridership Estimates Increases Risks to the Project’s Financial Viability Lower ridership would reduce the fare revenues the FOX system generates. Lower fare revenues, in turn, would affect the project’s ability to repay its infrastructure bonds and the federal loan. On the basis of their current ridership estimate of 8.26 million passengers in 2010, the project’s sponsors predict that fare revenues will be sufficient to pay all operating costs and to repay bondholders and the federal government. However, if a lower ridership estimate, such as 5.59 million, is used, it is not clear whether the project can meet all of its obligations, given the lower fare revenues that would result. On the basis of the 8.26-million-passenger estimate, sponsors anticipate that revenues will be 1.5 times the principal and interest requirements for the system infrastructure bonds and 1.3 to 1.4 times the principal and interest requirements for the federal loan. The FOX project’s sponsors are in the process of analyzing financial scenarios and preparing updated cash flow statements. If the updated cash flow statements indicate that debt service payments are potentially in jeopardy, the bond-rating agencies have indicated that they will be less inclined to provide the project’s senior debt obligations with the investment-grade debt rating that is necessary for participation in the TIFIA program. In addition, a lower rating for project debt would increase future interest costs for the project. The Project’s Schedule Is Ambitious The FOX project is currently in the preliminary engineering stage of development; therefore, many tasks must be completed before construction can begin in 2001. Staying on schedule will require completing an extensive environmental review process, securing needed financing, passing several pieces of state legislation, and finalizing federal high-speed rail safety standards in a timely manner. The project’s sponsors do not have direct control over these matters, and staying on schedule will be challenging. An August 1996 agreement between FDOT and the FOX consortium sets out three phases for developing the FOX system prior to construction—the preliminary phase, the certification phase, and the final design phase. The preliminary phase runs through January 31, 1999. During this phase, the project’s sponsors will refine the project’s concept, identify proposed alignments, refine capital cost estimates, and develop finance plans. Prior to January 31, 1999, FDOT and FOX must jointly assess the prospects for successful system development and decide whether they should continue the project and enter the certification phase. If they decide to terminate the project, a November 1996 agreement requires FDOT to reimburse FOX for eligible costs incurred through the preliminary phase, or about $5.59 million. If the sponsors choose to proceed beyond the preliminary phase and complete remaining tasks on schedule, construction could begin in 2001. According to the current schedule, the construction of the Miami-to-Orlando segment would take about 4 years, and revenue operations on that segment would begin in 2005. Revenue operations on the Orlando-to-Tampa segment would begin in 2006. The project’s sponsors face many challenges in keeping the project on schedule. The environmental review could pose a significant challenge to the FOX project’s schedule. According to the Federal Highway Administration’s (FHWA) Florida Assistant Division Administrator, whose office has overall responsibility for this federal environmental review process, the environmental impact statement for this project will be among the largest in scope and the most complex the office has undertaken. The 320-mile FOX system could have an impact on wetlands, encroach on the habitats of threatened and endangered species, cause noise pollution, and adversely affect the region’s water quality. The project’s sponsors must study these and other impacts and, where necessary, develop plans to mitigate them. For example, if the project has a significant impact on wetlands, the project’s sponsors will have to create new or improve existing wetlands. Depending on the proposed alignment, preliminary estimates by FOX show that mitigation plans may be needed for over 700 acres of wetlands affected by the project’s construction. Construction cannot proceed until sponsors obtain a wetlands permit from the U.S. Army Corps of Engineers. To resolve these issues, FDOT must coordinate efforts among at least 15 state and federal agencies. Both FHWA and FDOT officials stated that the project is on schedule, and they are confident that they will complete the entire environmental review process in 2.6 years—by January 2001. Our previous work has found that the average time for completing complex FHWA-led environmental reviews for projects affecting wetlands was over 5 years. The availability of TIFIA funding could also affect the FOX project’s schedule. FDOT officials have stated that they cannot build the project, as currently proposed, without the federal loan. The project’s sponsors plan to obtain a preliminary TIFIA funding decision in the fall of 1999—about 2 years prior to construction. However, as of January 1999, the Department had not issued the regulations for implementing the TIFIA program. According to a Department official, TIFIA’s regulations could preclude the Department from making construction funding commitments to projects that have not completed the environmental review process. If the FOX project cannot secure a TIFIA funding commitment until its environmental review is completed, the project’s ability to secure bond financing could also be delayed. These financing delays could delay the construction schedule. The project’s sponsors must also secure the state legislature’s timely approval of several pieces of legislation needed to begin construction. FDOT expects to introduce the legislation in spring 2000, when it will also request that the legislature approve the $70 million per year, 40-year funding commitment for the project. If approved, the proposed legislation would provide FOX with an exclusive right to develop high-speed rail in Florida, limit the project sponsors’ liability in the event of an accident, and streamline and clarify the project certification process. FDOT expects the legislation to pass easily. However, should the legislation encounter difficulties or be held up by opponents to the project, the project could be delayed. Finally, FOX officials stated that a delay in the issuance of new federal high-speed rail safety standards could affect the project’s schedule. In February 1997, FOX petitioned FRA to develop a rule establishing safety standards for the FOX system. The project’s sponsors requested the rule because FRA’s safety regulations did not address a system with trains traveling at speeds of up to 200 mph. In December 1997, FRA issued a proposed rule containing a draft of the new safety standards for the FOX system. Having received public comments, FRA is now drafting the final rule. FRA officials stated that they are strongly committed to completing the final rule for the FOX system in a timely manner. However, they also stated that they have a large workload of other pressing safety issues to address, including some required by the Congress, and therefore have no timetable for issuing the final rule. Since the final rule may affect the design and cost of the trains, track, and other infrastructure, the project’s sponsors believe they need a final rule before they can arrange financing for the project. FRA officials disagree and believe the proposed rule serves as an excellent basis for financing the project because it addresses key elements of FOX’s petition. Funding FOX Would Constrain the Department’s New Financing Program Enacted in June 1998, the Transportation Infrastructure Finance and Innovation Act established a new transportation infrastructure financing program. The program is designed to help large infrastructure projects access capital by providing federal credit assistance. The FOX project’s sponsors intend to seek a $2 billion loan through the program to help finance their high-speed rail project. The result of providing the full $2 billion to the FOX project may be that the Department dedicates over one-half of the funds available for subsidy costs under TIFIA to one project, thereby constraining the program’s ability to fund other projects. The Department Is Developing Regulations for the TIFIA Program The Department has created a multiagency Credit Program Steering Committee and Working Group to coordinate and monitor all policy decisions and implementation actions associated with the Department’s credit programs, including TIFIA. The Steering Committee and Working Group are composed of representatives from the Department’s Office of Budget and Programs, Office of Intermodalism, FHWA, FRA, Federal Transit Administration, as well as other departmental agencies and offices. As of January 1999, the Department and the Office of Management and Budget (OMB) were reviewing a draft notice of proposed rulemaking (NPRM) for TIFIA. The current timetable calls for the NPRM to be published in January 1999. After receiving public comments and making necessary revisions, the Department plans to submit final regulations to OMB for review and clearance by April 1999. Both the final regulations and general policy guidelines should be published in April 1999. Once the regulations and guidelines are issued, the Department will begin accepting applications for TIFIA funds. Before the Department can issue the regulations, an FHWA official stated that the Department must address a number of issues that will influence the program’s structure. First, the Department must develop a clear and objective process, including criteria for selecting projects. Second, the Department must determine whether it should establish one deadline for applications or allow multiple deadlines since some projects may not be ready to apply at a particular time. Third, the Department must develop a methodology for comparing the relative merits of different types of projects (e.g., highway, rail, and port projects, e.g.). Fourth, the Department must determine whether a project should be at a certain stage of development before it is eligible for assistance under TIFIA. For example, an FHWA official said that the Department might require that a project complete the environmental review process before the Department can provide a commitment for TIFIA construction funding. Fifth, the Department must decide what level of input from financial markets is necessary for the Department to determine whether a project is creditworthy and at what point in the process financial markets should become involved. Furthermore, the Department must determine how long it will take to review applications. OMB is working with the Department to complete the TIFIA regulations. OMB officials told us that TIFIA funding decisions should be based on fair, objective, and transparent analyses. To ensure that this goal is met, they stressed that the process would benefit from having detailed information on all projects applying for TIFIA funds, such as a completed environmental impact statement, a cost estimate based on detailed engineering plans, and a finance plan with well defined and secured nonfederal funding commitments. The officials said that having this type of detailed information will enhance the Department’s ability to make sound decisions on the financial viability of projects applying for TIFIA funds. In addition to working with OMB, the Department is holding outreach sessions with stakeholders such as bond market rating agencies and state highway agencies to help develop the regulations. An FHWA official stated that a number of issues remain undecided, including what appropriate criteria the Department should use to make decisions; what level of information is needed to assess projects; and whether the Department can make funding commitments prior to and contingent on the resolution of certain events, such as completing an environmental review. He stated that the Department’s legal counsel needed to address many of these issues, and no decisions had been made. The Department Must Determine the Risk Level of Credit for Projects Funded Through TIFIA Under the Federal Credit Reform Act of 1990, the Department has to obligate funds to cover the cost of the credit provided through TIFIA. The amount obligated, which is known as a subsidy amount, covers the expected long-term cost of the credit in case of default. The Department, in consultation with OMB and the applicable rating agency, will calculate the subsidy amount associated with the assistance to be provided for each project. The subsidy amount is based on the risk level of the credit—the more risky the credit, the greater the potential long-term cost and the greater the subsidy amount. TIFIA, as amended by the TEA-21 Restoration Act, provides $530 million over fiscal years 1999 through 2003 to cover the cost of up to $10.6 billion in credit. The annual amounts provided and the credit limits are shown in table 3. As table 3 shows, the yearly authorized funding levels are equal to 5 percent of the annual maximum credit limit. Therefore, in order for the Department to issue the maximum amount of credit—$10.6 billion—the average subsidy amount must be 5 percent. However, if the Department and OMB determine that credit for a particular project is more risky than this assumed average, they will require a greater risk subsidy percentage for the project. This means that to still provide the maximum amount of credit, the Department would have to fund other, less risky projects that require lower risk subsidies. Ultimately, whether the Department will be able to provide the full $10.6 billion in credit will depend on the risk level of the projects it chooses to fund. The FOX Project Could Require Over Half of TIFIA’s Funds The FOX project’s sponsors intend to seek a $2 billion loan through the TIFIA program. In connection with this loan, the Department, in consultation with OMB and the applicable rating agency, will have to prepare a risk analysis of the project and determine the subsidy amount associated with the loan. While it is too early to tell exactly what the subsidy amount will be, the subsidy amount for a $2 billion loan could require a significant amount of TIFIA’s total authorized funding. Table 4 shows a range of potential subsidy levels for a $2 billion loan. As table 4 shows, the FOX project could require a substantial portion of TIFIA’s total 5-year funding. In comparison, on the Alameda Corridor project, the Department and OMB determined that a subsidy amount of $59 million would cover the long-term cost of a $400 million federal loan—a risk subsidy of about 14.75 percent. If it uses the same subsidy rate for the FOX project, the Department would have to obligate $295 million to support the $2 billion loan, which would be 56 percent of TIFIA’s $530 million in total authorized funds. Bond market and OMB officials we contacted stated that in their opinion, a loan to the FOX project appears to be more risky than the loan to the Alameda Corridor and that the subsidy rate for FOX could be higher. They regarded the FOX project’s risk as higher because it will depend on unproven high-speed rail passenger revenues to secure the federal loan, while the Alameda Corridor project used cargo revenues from one of the nation’s largest established port complexes. With a higher subsidy rate, the Department would have to obligate more than $295 million. The Department has not developed a list of projects that may apply for TIFIA funding. However, in 1997, FHWA identified 31 projects nationwide, including FOX, that could be candidates for federal credit assistance. These projects include bridge, highway, and other types of projects, as well as high-speed rail. Our review of the report indicates that these projects’ estimated capital costs range from $100 million to over $16 billion and that 10 of the projects are estimated to cost $1 billion or more. (App. I contains a list of these projects and their estimated costs.) It is uncertain whether these projects will request TIFIA assistance or how much they might request. Given the large costs and scope of some of these projects, any one of several could require most of TIFIA’s authorized funds if it applied for a large secured loan. However, limited TIFIA funds would be available for these projects if the Department decides to provide FOX with a $2 billion loan. Most Corridors Will Use the Incremental Approach to High-Speed Rail In addition to the FOX project, we have identified 11 corridors in the United States that are either planning or implementing forms of high-speed rail (see table 5). Most of the corridors are in the early stages of project planning, but officials in Amtrak’s Northeast corridor—between Washington, D.C., and Boston—have been upgrading Amtrak’s system for several years, and officials in the Pacific Northwest corridor, between Vancouver, British Columbia, and Eugene, Oregon, have bought high-speed rail trains and secured funding to upgrade its track. Appendix II shows the locations of these corridors. Ten of the corridors will use an incremental approach to high-speed rail, which provides gradual speed increases by making incremental improvements to existing rail infrastructure or equipment. In contrast, the California corridor is considering the development of a new high-speed rail system that may use technologies similar to those of FOX or even more advanced technology capable of reaching speeds up to 310 mph. The preliminary cost estimates of these systems range from $315 million to $29 billion. Like FOX, most of these corridors are developing their finance plans. Unlike FOX, however, most of the corridors have not determined their funding sources. Two corridors have expressed interest in applying to the TIFIA program for funding, but none besides FOX have approached the Department about doing so. Some corridors are beyond the preliminary stages and have already begun to implement aspects of high-speed rail. The 10 corridors that are concentrating on the incremental approach will upgrade current rail lines to accommodate higher-speed passenger rail traffic, as shown in table 5. Under this approach, the projects’ sponsors would improve track, signals, and safety systems along existing rail lines. Improving track often involves modernizing switches, replacing wooden ties with concrete ties, and creating additional track capacity. More sophisticated signal and collision avoidance systems are also needed to handle the higher train speeds and the higher traffic density that accompanies high-speed rail. The lengths of the corridors currently considering high-speed rail range from 85 miles on the Chicago-to-Milwaukee corridor to 719 miles on the Gulf Coast corridor. Costs range from $315 million on the Empire corridor in New York to between $21 billion and $29 billion on the California corridor. Some corridors, such as the Wisconsin-Illinois-Minnesota and Gulf Coast corridors, are still in the process of developing feasibility studies for their proposed high-speed rail lines. As of December 1998, other corridors were implementing some high-speed rail improvements. For example, the Empire corridor was running trains at speeds approaching 110 mph. Also, the Pacific Northwest corridor had purchased two high-speed rail trains that will operate initially at about 79 mph but can operate at higher speeds (125 mph) once the corridor is prepared for high-speed traffic. Appendixes III through XIV provide status reports on the 11 corridors with active high-speed rail plans and on the Texas Triangle corridor, where high-speed rail is not now under active consideration. Conclusions With TIFIA funds soon to be available to support large transportation projects nationwide, proposed high-speed rail systems and other types of transportation projects in the United States will have an important source of federal financing to further their development. The Florida Overland Express (FOX) project’s sponsors will ask the Department of Transportation to provide the project with a $2 billion loan in the near future. As a result of making this loan, the Department could provide at least one-half of the funding available for subsidy costs under TIFIA to this one project. However, the project’s sponsors are at least 2 years from developing the information needed to determine whether the project is economically viable. Currently, there is great uncertainty about whether (1) the project can be built for the $6.3 billion that the project’s most recent finance plan assumes; (2) the project’s sponsors can secure the needed funds to complete the project’s financing; (3) the estimated ridership levels are accurate and, thus, whether the project will be able to generate sufficient revenues to repay the bonds and federal loan; and (4) the sponsors can complete the complex environmental review and mitigation process in time for construction to begin by 2001. Similar to the FOX project, other large transportation projects applying for TIFIA funding will face challenges in developing accurate capital cost estimates, securing financing for those costs, generating sufficient revenues needed to repay project debt, and minimizing impacts on the environment. Some of these projects also have the potential to require most of TIFIA’s funds, which would constrain the TIFIA funding available to other projects. Therefore, the Department must make informed decisions on each project’s technical merits and must obtain and evaluate detailed information on the projects’ costs, financing plans, revenue projections, and environmental impacts. As of January 1999, the Department was still developing regulations for the TIFIA program; therefore, the extent to which the Department will require this type of information is unclear. Without this important information, the Department cannot ensure that TIFIA funds are targeted to financially viable transportation infrastructure projects. Recommendations In implementing the Transportation Infrastructure Finance and Innovation Act program, we recommend that the Secretary of Transportation direct appropriate Department officials to evaluate the economic feasibility of projects applying for the program’s funds. Before providing a substantial amount of federal dollars to projects, such as the Florida Overland Express project, the Secretary should obtain and independently evaluate information including (1) a capital cost estimate based on detailed engineering plans, (2) a finance plan that is based on the detailed cost estimate and that specifies the source and security of all public and private-sector financial commitments, and (3) an operating plan that enumerates the project’s future revenues and assesses the risks to the federal credit instrument should revenues be lower than projected. The Department’s regulations or general policy guidelines on the program should indicate that the Department will conduct this evaluation. The Secretary should also ensure that the environmental review process has been completed before it makes substantial Transportation Infrastructure Finance and Innovation Act program funding commitments. Agency Comments and Our Evaluation We provided the Department, OMB, and FDOT with a draft of this report for review and comment. We also discussed the report with officials from the Department and FDOT—including the Associate Administrator for Railroad Development, FRA; the Director of Financial Management and Budgeting, FHWA; and the Manager, High-Speed Rail program, FDOT—to discuss their comments on the report. Overall, the Department’s officials generally agreed with the report’s findings and conclusions, while officials from Florida stated that the report was thorough. Officials from the Department and FDOT had specific comments on the report’s (1) analyses of the FOX project’s ridership forecast, (2) recommendations, (3) discussion of the impacts of a loan to the FOX project through the Transportation Infrastructure Finance and Innovation Act program, and (4) discussion of the time frames for completing the FOX project’s environmental review. With regard to our analysis of the FOX project’s ridership forecast, FRA officials stated that we should adopt a less pessimistic stance on certain aspects of the project’s ridership forecast. Specifically, the FRA officials stated that it was too early to expect the airlines to enter into code-sharing agreements with the FOX system; therefore, our ridership analysis should not entirely dismiss the forecast number of passengers that these agreements could generate. The FDOT officials also affirmed their forecast’s assumption that airlines will establish code-sharing agreements with FOX and therefore transfer a substantial number of air passengers to the FOX rail system. As a result, they stated that our ridership analysis should include these passengers. The FDOT officials also disagreed with our assertion that the airfares used in their ridership forecast overstated the cost of air travel within Florida. They noted that their forecast accurately reflected the fares paid by passengers and cited first quarter 1998 airfare statistics that airlines reported to the Department as evidence. Accordingly, they contend that we should not reduce our ridership estimate on the basis of the assumption of lower airfares. The FDOT officials further stated that our estimate of new, or induced, ridership was too low. They stated that their estimate was based on the state’s intercity travel surveys, surveys that they contend are more precise than FRA’s estimates used in our report. As a final point on ridership, FRA officials stated that our report implied that FOX’s fares must always be lower than the airlines’ fares in order to remain competitive. The officials stated that this assumption was too simplistic because FOX’s ridership would not solely be based on ticket prices. They noted that the FOX system could also attract passengers because it will have a higher quality of service and shorter trip times. The FRA officials further questioned whether the airlines could maintain low airfares over the long term and thereby remain competitive with FOX. In responding to these comments on ridership, we recognize that making estimates of how many people will use a high-speed rail system, where none previously existed, is more an art than a science. The assumptions used can significantly affect the forecast level of ridership. We have developed a ridership forecast that is based on alternative scenarios that use less optimistic—but still quite plausible— assumptions. Our first alternative scenario evaluates whether the airlines, in a highly competitive Florida air market, would willingly give up their passengers to a new competitor—FOX. We acknowledge that FOX and some airlines might establish code-sharing agreements in the future and that FOX officials have cited positive statements made to them by at least one major airline to this effect. However, FOX officials could not provide us with any documentation showing that such agreements were likely. In addition, our discussions with two major airlines, the Air Transport Association, and the Miami airport found little, if any, airline interest in establishing code-sharing agreements with FOX. Wilbur Smith Associates also questioned the viability of these potential agreements. On the basis of this evidence, we made no changes to our ridership analysis with regard to the possibility of ridership resulting from code-share agreements. Our second alternative scenario evaluates whether the FOX ridership forecast assumed airfares consistent with what the major airlines reported to the Department. Using data from the first quarter of 1998, the FDOT officials stated that Florida airfares are comparable to proposed FOX fares, thus potentially enhancing FOX’s competitive position with the airlines. This contrasts with our use of 1997 average reported airfares that are, in some cases, 21 percent lower than the ones FOX used in its ridership forecast. We used the average airfares for all of 1997 in reviewing the FOX forecast because (1) it is the same year as that for other data used throughout the FOX forecast and (2) a yearly average provides a more constant picture of the air market than a single quarter. Accordingly, we made no changes to our ridership analysis with regard to the level of airfares. Our third alternative scenario assessed the project’s assumptions regarding induced demand. The FDOT officials’ suggestion that we use their assumption regarding induced demand rather than FRA’s assumption highlights the uncertainty in making estimates of induced demand. Forecasting induced ridership is a subject of great uncertainty and controversy, since induced demand attempts to predict how many people will use a system simply because it provides a new service. The FDOT officials said that their assumption was more accurate than FRA’s. However, FRA has reported that because of the uncertainty in forecasting induced demand, high-speed rail proponents should use caution when preparing such estimates. We agree and therefore have not revised our analysis to reflect the higher FOX assumption. In addition, the FRA officials presented no evidence to support their assertion that the airlines may not be able to sustain lower airfares over the long term in competition with FOX. The experience of Southwest Airlines supports just the opposite conclusion. Southwest Airlines has established significant market shares in new markets while charging low fares and has sustained these markets in the long term. Nonetheless, we agree with the FRA officials’ comment that FOX could have a competitive advantage over the airlines because it may provide better service and faster trip times in some markets. Since the FOX forecast already assumed this service differential in its ridership assumptions and we did not question them, no change to our ridership analysis is needed. Regarding our recommendations, officials from the Department stated they did not plan to independently verify information on the costs, financing, revenue estimates, and environmental impacts of projects applying for TIFIA program funds. They said that the Department would rely on the financial markets in the private sector to analyze these factors rather than on the Department to conduct its own independent analysis. They also stated that since the Department is responsible for completing the environmental review process, it did not need to independently validate the results of environmental reviews. In regard to these comments, we agree that the Department cannot independently evaluate its own environmental document. As a result, we have changed our recommendation to reflect the importance of having the environmental review process completed before the Department provides substantial TIFIA funds to a project. However, we disagree with the assertion that the financial markets’ assessment of a project’s costs, financing, and revenue estimates will provide the independent evaluation that we call for in our recommendation. The financial markets’ input, generally in the form of a bond rating, is important information that the Department can use to supplement its equally important engineering, financial, and transportation planning expertise. However, the Department must produce an independent assessment of the merits of projects seeking TIFIA funds. This is particularly important because the Department has the expertise to compare, for example, a highway project to a rail or transit project that might apply for TIFIA funds. As of January 1999, the Department had not yet determined which of its agencies will have the lead responsibility for performing such evaluations. Therefore, our recommendation is targeted to the Secretary of Transportation, who can ensure that the Department uses its analytical expertise as a basis for awarding federal funds. Regarding a potential federal loan to the FOX project, the FDOT officials disagreed with our assertion that by funding the FOX project, the TIFIA program would use over half of its available funding. The officials stated that the subsidy rate that the Department used for the Alameda Corridor project—a freight rail improvement project in Southern California—was conservative and we should not use it to estimate the subsidy cost of a federal loan to the FOX project. The FDOT officials believe that the subsidy rates for TIFIA-funded projects would be less than 10 percent rather than the 14.7 percent used for the Alameda Corridor. The FDOT officials’ questioning our use of the subsidy level for the Alameda Corridor project’s loan as a model for TIFIA-funded projects is not based on evidence from OMB or the bond rating agencies we contacted. These groups will play critical roles in determining FOX’s loan subsidy amount. OMB officials believe that the 14.7-percent subsidy cost for the Alameda Corridor was accurate. In addition, both OMB and bond-rating agency officials we contacted stated that a federal loan to FOX is riskier than the loan to the Alameda Corridor because the loan repayment is premised on unproven revenues from future ridership. In contrast, the loan repayment for the Alameda Corridor comes from proven cargo revenues from one of the nation’s largest ports. In terms of the environmental review process, officials from both FHWA and Florida expressed confidence that the project will complete the environmental review process on schedule. The Florida officials stated that our skepticism of their projected date for completing the environmental review process is unwarranted. Because they have worked early and closely with environmental review agencies to identify impacts, they expect to meet their timetable for completing the environmental review. We have added language in the report to reflect the agencies’ confidence in meeting their schedule. However, to accomplish this over the next 2 years, the project’s sponsors must assess the 320-mile-long project’s impact on wetlands (over 700 acres), endangered and threatened species, and water quality; seek and incorporate public comments; develop mitigation plans acceptable to at least 15 state and federal agencies; and obtain wetlands permits from the Army Corps of Engineers. An FHWA official characterized the environmental review for the FOX project as one of the largest and most complex ever undertaken by the office. The complexity and amount of work remaining to be done continue to suggest that it might take longer than planned to complete the required environmental reviews. Finally, officials from FRA, FHWA, the Department’s Office of the Secretary, OMB, and the Florida High-Speed Rail program offered additional technical comments that we incorporated throughout the report, where appropriate. Scope and Methodology To identify the status of the FOX project’s costs, financing, ridership estimates, and schedule, we reviewed project documents, including the engineering cost report, the finance agreement, the ridership studies, and project status reports. To learn more about the status of the project, we also interviewed officials from FDOT’s High-Speed Rail Office and the FOX consortium. To identify challenges facing the project, we reviewed independent analyses of the project and contacted numerous officials with knowledge of the project. For example, to identify issues surrounding the ridership forecast and the potential for the airlines to agree to transfer passengers to the FOX project, we reviewed Wilbur Smith Associates’ independent review of the ridership forecast and interviewed officials from the U.S. airline industry, including officials from the Miami and Orlando airports, several U.S. airlines serving Florida, and the Air Transport Association. In addition, to identify issues surrounding the finance plan and the environmental mitigation for the project, we contacted bond-rating agencies and state and federal environmental review agencies. To obtain information about the TIFIA program, we reviewed the act as established in the Transportation Equity Act for the 21st Century, and as amended by the TEA-21 Restoration Act. To learn more about the goals and objectives of the program, we discussed the program with FHWA’s credit program manager, attended a TIFIA outreach session in New York City in September 1998, and reviewed FHWA documentation regarding the TIFIA program. We also contacted OMB and bond-rating agency officials to obtain their views on the potential risks to the federal government of providing a $2 billion loan to the FOX project. To obtain information on the current status of other high-speed rail corridors, we reviewed information published by FRA and the High-Speed Ground Transportation Association. To obtain further information on the specifics of other high-speed rail projects, we contacted officials in states responsible for planning and developing the projects and reviewed the status reports they provided. We performed our work from July 1998 through January 1999 in accordance with generally accepted government auditing standards. We will send copies of this report to cognizant congressional committees; the Secretary of Transportation; the Administrator, FHWA; the Administrator, FRA; the Director, OMB; the state of Florida’s Governor and Secretary of Transportation; and other interested parties. We will make copies available to others upon request. Please call me at (202) 512-2834 if you or your staff have any questions. Major contributors to this report are listed in appendix XV. Candidates for Federal Credit Assistance In November 1997, the Federal Highway Administration (FHWA) issued a draft report entitled Federal Credit for Surface Transportation: Exploring Concepts and Issues. In that report, FHWA identified 30 projects besides the Florida Overland Express that could be candidates for federal credit assistance. The projects are listed in table I.1. Arkansas, Louisiana, Missouri Los Angeles, Calif. to San Francisco, Calif. Orange County, Calif. Oakland, Calif. San Diego, Calif. Denver, Colo. New Haven, Conn. Miami, Fla. Atlanta, Ga. High-Priority Corridor 18 (I-69 Extension) Indiana, Kentucky, Tennessee, Mississippi, Arkansas, Louisiana, and Texas Detroit, Mich. Greenville, Miss. East Rutherford, N.J. New York, N.Y. New York, N.Y. South-North Light Rail Transit Project (continued) Charleston, S.C. Salt Lake City, Utah Seattle, Wash. Seattle-Tacoma, Wash. High-Speed Rail Corridors in the United States Washington, D.C. California Intercity High-Speed Rail Corridor Background The California Intercity High-Speed Rail Commission was created in 1993 to study the feasibility of implementing a high-speed ground transportation system in California. In 1996, the Commission issued its study, which found that high-speed rail offered California an environmentally and physically feasible alternative to highway and air transportation for accommodating future growth in intercity travel. The report also found that revenues from the high-speed rail system would be able to cover its operating costs but not all construction costs. The report concluded that construction of the system would rely on substantial public investments. In 1996, the state legislature created the High-Speed Rail Authority, which now is responsible for implementing the system. Proposed Technology A new high-speed rail or magnetic levitation (maglev) system. Project’s Goals/Scope To build a high-speed ground transportation system to link northern and southern California. The proposed system covers 676 miles and would link Sacramento, the San Francisco Bay Area, the Central Valley, Los Angeles, and San Diego. The project’s sponsors are considering using either a new high-speed rail system with speeds reaching up to 220 mph or a maglev system with speeds up to 310 mph. A new high-speed rail system could carry up to 19.8 million passengers per year in 2015, while a maglev system could carry 26.4 million passengers. Cost Estimates The current cost estimates range from $21 billion for the new high-speed rail system to $29 billion for a maglev system. Status The Commission is continuing to study the feasibility of the system and is trying to secure financing. The current schedule calls for a statewide vote on the proposal by 2000. Chicago-St. Louis High-Speed Rail Corridor Background Under the Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA), the Secretary designated the Chicago-to-St. Louis corridor as a high-speed rail corridor. In May 1994, the State of Illinois published a feasibility study on the financial potential of implementing high-speed passenger rail service in the corridor. The study found that revenues from projected ridership would cover all the operating and maintenance costs and a portion of the capital improvement costs for the project. The state hopes to cover the remainder of the capital costs with federal or state government assistance. Proposed Technology Incremental improvements. Project’s Goals/Scope To create a high-speed rail system connecting Chicago and St. Louis. The proposed system covers 282 miles and would also link Springfield, Illinois and Bloomington-Normal, Illinois to Chicago and St. Louis. The Illinois Department of Transportation (IDOT) plans to improve grade crossings across the state, rebuild track in the East St. Louis area, and develop a new signal system on an existing rail line between Chicago and St. Louis. Currently, trains in the corridor travel at a top speed of 79 mph, with the proposed improvements increasing speed up to 110 mph. Cost Estimate IDOT estimates the cost of the project to be $350 million. Status IDOT is currently working on a draft environmental impact statement for the corridor and developing a grade crossing arrestor net that will block the road when trains approach to prevent train-vehicle collisions. Also, IDOT is working with the Association of American Railroads and the Federal Railroad Administration to develop a train control system that will increase safety along the line by overriding certain engineer actions. For example, the control system would automatically stop a train if the engineer runs a red signal or exceeds the speed limit. Once these tasks are complete, IDOT will seek a private sector partner for the project. IDOT hopes high-speed service could begin in 2003. Chicago-Detroit High-Speed Rail Corridor Background Since 1981, the State of Michigan has been exploring high-speed rail technology. Under ISTEA, the Secretary designated the Chicago-to-Detroit corridor as a high-speed rail corridor. The State of Michigan has developed a plan of incremental improvements for the corridor. Proposed Technology Incremental improvements. Project’s Goals/Scope To create a high-speed rail system connecting Chicago and Detroit. The system would run approximately 279 miles and also link Ann Arbor, Michigan and Kalamazoo, Michigan with Chicago and Detroit. The Michigan Department of Transportation (MDOT) and Amtrak plan to rebuild stations and improve signals on an existing rail line between Chicago and Detroit to accommodate trains traveling at speeds up to 110 mph. Trains would also need to be refurbished. MDOT estimates that if the line is fully upgraded, 3.5 million passengers will ride the corridor’s trains annually by 2010. Cost Estimate MDOT estimates the cost for the improvements to be $800 million. Status MDOT and Amtrak are working on an automatic control system that would help avoid collisions by using a computer to alert train engineers to hazards out of their line of sight. It has also closed a number of grade crossings and is constructing new stations and renovating existing stations. MDOT and Amtrak plan on beginning high-speed service along a portion of the corridor sometime in 1999 and along the full corridor by 2006. Chicago-Milwaukee High-Speed Rail Corridor Background The states of Illinois and Wisconsin completed a feasibility study for the Chicago-to-Milwaukee high-speed rail corridor in 1994. The study identified the existing Amtrak route between Chicago and Milwaukee as the preferred route for high-speed service. The study also concluded that operating revenues from a system with trains operating at 110 mph or 125 mph would cover operating costs and some capital costs. The study also mapped out a comprehensive plan to allow the right-of-way to be shared by high-speed rail, Amtrak, freight lines, and Metra, a Chicago area commuter rail service. Proposed Technology Incremental improvements. Project’s Goals/Scope To create a high-speed rail system between Chicago and Milwaukee. The system would run approximately 85 miles, most likely along an existing Amtrak route. The Wisconsin Department of Transportation (WisDOT) plans to improve track and stations along an existing rail line between Chicago and Milwaukee to accommodate trains traveling up to 110 mph. Cost Estimates WisDOT’s cost estimate for the project is $471 million. Status WisDOT is currently working with a nine-state coalition to determine funding sources for high-speed rail. WisDOT has no construction planned at this time and has not set a date for the start of revenue service, although it hopes to have some high-speed service running by 2006. Wisconsin-Illinois-Minnesota High-Speed Rail Corridor Background In 1991, the Minnesota Department of Transportation (MN/DOT), along with the Illinois and Wisconsin transportation departments, completed a feasibility study for a Chicago-Milwaukee-Twin Cities high-speed rail system. The study looked at the engineering, environmental, financial, and economic impacts of a high-speed rail system and concluded that such a system might be economically viable. The Minnesota legislature provided $500,000 for a more detailed feasibility study that is in progress. The second study will deal with the engineering and environmental issues associated with a high-speed rail system, while also determining ridership and revenue projections, as well as other issues. Proposed Technology Incremental improvements. Project’s Goals/Scope To create a high-speed rail system between Chicago and Minneapolis-St. Paul. The system would run approximately 418 miles and link Chicago and Minneapolis with Milwaukee and perhaps Madison, Wisconsin and Wisconsin Dells. The project’s sponsors plan on incrementally improving an existing rail line between the two end points to accommodate high-speed trains. The exact speed of trains and form of improvements along the corridor are still to be determined. Cost Estimate The project’s sponsors have not released any cost estimates at this time. Status The second, more detailed feasibility study is under way and should be completed in early 1999. Future actions are uncertain and depend on MN/DOT identifying sources of funding. Empire High-Speed Rail Corridor Background The Transportation Equity Act for the 21st Century (TEA-21) designated the Empire corridor as a federally recognized high-speed rail corridor. On September 29, 1998, the state of New York and Amtrak announced a plan to split $185 million in rail line improvements to the Empire corridor. Proposed Technology Incremental improvements. Project’s Goals/Scope To increase the maximum speed on portions of the existing high-speed rail line between New York City and Buffalo to 125 mph. The line would link Rochester, Syracuse, and Albany with New York City and Buffalo. The project’s sponsors plan to embark on a capital investment plan to improve the condition and technology of the existing rail service between these cities. Currently, the trains’ top speed is 110 mph, although only a portion of the corridor is capable of handling trains at that speed. The line will be approximately 431 miles long. The New York Department of Transportation (NYDOT) estimates that once the corridor is finished, annual ridership will be approximately 3 million. Cost Estimate The funding for the current round of improvements is set at $185 million. Future planned improvements would bring the total cost of upgrading the corridor to $315 million. Status Amtrak and NYDOT have acquired funding and will soon begin work on adding a second track for a portion of the corridor, improving curves so trains can negotiate them at faster speeds, and upgrading seven trains to travel at speeds of up to 125 mph. The work should be completed by 2004. Pacific Northwest High-Speed Rail Corridor Background In 1993, the states of Washington and Oregon began funding additional train service along Amtrak’s Pacific Northwest line. Since then, ridership on the line has nearly doubled. The Washington State Department of Transportation (WSDOT) leased two Talgo trains for the line. Talgo trains are made in Spain, have tilt technology that allows them to travel around curves faster than a conventional train, and have a top speed of 125 mph. However, in the Pacific Northwest corridor they are limited to 79 mph because of track conditions. WSDOT and Amtrak have purchased three new Talgo trains to replace the leased ones. Proposed Technology Incremental improvements. Project Goals/Scope To create a high-speed rail corridor between Vancouver, British Columbia, and Eugene, Oregon. The line would run approximately 466 miles and link Portland and Seattle with Vancouver and Eugene. The project’s sponsors plan to install a new signal and monitoring system using global positioning satellites, renovate stations and improve grade crossings along the current rail line between these cities. Also, new sidings and track will be added in some places to add capacity to the line, which will serve freight, commuter, and high-speed trains. Cost Estimate WSDOT estimates the total cost for bringing 125 mph service to the corridor at $1.865 billion. Status The State of Washington and Amtrak have purchased three Talgo trains capable of traveling 125 mph. These trains were scheduled for service on the existing Amtrak line in late 1998. The new trains will reduce the travel times along the route because of their speed around curves. Also, WSDOT and the Oregon Department of Transportation are currently preparing an environmental impact statement and a 20-year investment plan for the corridor. The project’s sponsors have not announced any schedule for the start of high-speed rail service. Southeast High-Speed Rail Corridor Background Under ISTEA, the Secretary designated the Washington-to-Charlotte corridor as a high-speed rail corridor. The states of North Carolina and Virginia are working together to develop the corridor. The Virginia Department of Rail and Public Transportation (VDRPT) and the North Carolina Department of Transportation have done a preliminary engineering study. Currently, the project’s sponsors are performing an environmental impact study of the corridor. Proposed Technology Incremental improvements. Project’s Goals/Scope To create a high-speed rail line between Washington, D.C., and Charlotte, North Carolina. The line would run approximately 390 miles and link Richmond, Virginia; Raleigh, North Carolina; and Greensboro, North Carolina; with Washington, D.C. and Charlotte, North Carolina. The project’s sponsors plan to straighten curves, add track, and improve signals along an existing right-of-way between the end points, and eventually run rail service at speeds up to 110 mph. Cost Estimate No cost estimates have been released for the corridor. However, VDRPT has estimated the cost of adding another track on the corridor at $350 million. Status The State of Virginia has approved a six-stage high-speed rail plan for the Washington-to-Richmond corridor. The plan allocates funding to straighten curves, improve signals, and eliminate speed restrictions along this corridor. This work should be completed in 2002 and allow the maximum train speed in the corridor to rise to 90 mph. Future improvements on the corridor have not yet been determined. The project’s sponsors are negotiating with CSX Transportation Corporation to purchase some rights-of-way. The project’s sponsors have not set a starting date for 110 mph service. Keystone High-Speed Rail Corridor Background In 1995, Amtrak sought help from the Pennsylvania Department of Transportation (PennDOT) to save the deteriorating rights-of-way between Philadelphia and Harrisburg. PennDOT began giving Amtrak $2.6 million per year to help operate service along the corridor. TEA-21 designated this corridor as a high-speed rail corridor. The corridor is already electrified, although few electric trains now serve the corridor. A few sections of track along the corridor are capable of handling 90 mph service. Proposed Technology Incremental improvements. Project’s Goals/Scope To create a high-speed rail line between Harrisburg and Philadelphia. The line would run 104 miles. PennDOT hopes to improve track, overhead wiring, and stations along existing, electrified rights-of-way to reduce travel times between Harrisburg and Philadelphia. Cost Estimates The project’s sponsors have not released any cost estimates for the project. Status FRA, PennDOT, and Amtrak are working on identifying the corridor’s investment needs. PennDOT is negotiating the purchase of trains capable of traveling 110 mph. PennDOT has not set a starting date for high-speed rail service. Texas Triangle High-Speed Rail Corridor Background In 1989, the Texas state legislature created the Texas High-Speed Rail Authority to award a franchise to build a high-speed rail system in Texas. The Texas TGV Corporation eventually won this franchise but could not arrange financing for the project. In early 1994, the Authority determined that Texas TGV had not fulfilled the terms of the franchise agreement and terminated the franchise. Proposed Technology Texas TGV was planning on building a new high-speed rail system using French train a grande vitesse (TGV) technology. Project’s Goals/Scope The franchise intended to link Dallas, Houston, and San Antonio, a distance of 436 miles. Cost Estimate The final cost estimate for the project was $4 billion. Status Plans for a new high-speed rail system are dormant. As of December 1998, the Texas Department of Transportation was in discussions with private investors and a major railroad about taking an incremental improvement approach to high-speed rail in Texas, but the proposal remains in the planning stage. Northeast High-Speed Rail Corridor Background With the introduction of the Metroliner in 1969, the Northeast corridor between Washington, D.C., and Boston became the first high-speed rail corridor in the United States. In fiscal year 1997, the Northeast corridor carried over 9 million of Amtrak’s passengers, making it the most highly utilized Amtrak route. In 1990, the Congress directed Amtrak to upgrade service on the corridor. Proposed Technology Incremental improvements. Project’s Goals/Scope To improve the existing high-speed rail line between Washington, D.C., and Boston by electrifying the corridor north of New Haven, Connecticut, installing continuous welded rail and concrete ties, rebuilding bridges, and making numerous other improvements. The line is 457 miles long and links Washington and Boston with New York, Baltimore, Philadelphia, and New Haven. High-speed trains will operate at up to 150 mph. Cost Estimate The total cost for the improvement project will be approximately $4 billion. Status Work is under way to mitigate environmental impacts, straighten curves to allow higher speeds, install concrete ties for a smoother ride, and improve the existing signal system. This work is to be completed by 2001. Electrification of the section of track between New Haven and Boston will be completed by 1999. Amtrak is buying 20 new electric trains capable of traveling 150 mph. New trains are set to begin service in fall 1999, with higher speed operation beginning sometime in 2000. Gulf Coast High-Speed Rail Corridor Background Under TEA-21, the Secretary designated the Houston-to-Birmingham corridor as a high-speed rail corridor. The states of Mississippi, Alabama and Louisiana are working together to obtain funding for the Gulf Coast corridor. Proposed Technology Incremental improvements. Project’s Goals/Scope To create a high-speed rail system linking Houston, New Orleans, and Birmingham. The line would be approximately 719 miles. No further plans have been created. Cost Estimate The project’s sponsors have not released any cost estimates. Status A ridership and feasibility study is under way. Major Contributors to This Report Joseph Christoff Helen DeSaulniers Lewison Lem David Lichtenfeld Ray Sendejas The first copy of each GAO report and testimony is free. 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Pursuant to a congressional request, GAO reviewed the status of high-speed rail development in the United States, focusing on: (1) project plans for the Florida corridor for which detailed studies on building a new high-speed rail system between Miami, Orlando, and Tampa have begun; (2) the estimated cost, financing, ridership, and schedule for the Florida Overland Express (FOX) rail project; (3) the status of a new federal transportation infrastructure financing program and how federal funding decisions for the FOX project might affect the new program; and (4) the status of other planned high-speed rail corridors in the United States. GAO noted that: (1) because the Florida project is in the early phases of development, it faces uncertainties; (2) overall, it will be at least 2 more years before sufficient information is available to comprehensively assess the project's cost, financing, ridership, and schedule; (3) the project's current estimated cost ranges from $6 billion to $8 billion, however, the accuracy of the estimate is uncertain because the project is only at a 5-percent level of engineering design; (4) the finance plan, which relies heavily on debt, is incomplete, and the project's sponsors have secured only 5 percent of the estimated needed funding for the project; (5) the ridership forecast for the project relies on optimistic assumptions and could be overstated by 30 percent or more; (6) adjusting the forecast to reflect more conservative assumptions would reduce expected future system revenues and increase risks to the project's financial viability; (7) the project's ambitious schedule calls for the train to begin operating over a 320-mile route in 2005, but several factors will make it difficult to meet this schedule; (8) to help pay for the Florida project's capital costs, the project's sponsors will seek a $2 billion federal loan under the Department of Transportation's new Transportation Infrastructure Finance and Innovation Act program; (9) the Department anticipates issuing regulations and guidance for this program in April 1999 and has not yet funded any projects under the program; (10) under the Federal Credit Reform Act of 1990, the Department must consider a project's risk of default and estimate the cost to the federal government of the credit provided for each project funded through the program; (11) the Transportation Infrastructure Finance and Innovation Act provided a total of $530 million for fiscal years 1999 through 2003 to cover the costs of providing all selected projects with credit; (12) in order to cover the cost associated with a $2-billion loan to the Florida project, the Department may need to obligate over one-half of the program's $530 million; (13) providing the Florida project with a $2-billion federal loan would constrain the Department's ability to fund other projects that are potential candidates for credit assistance; (14) at least 11 other corridors in the United States are in various stages of developing high-speed rail projects; (15) unlike the Florida project, most of the other corridors have not determined their funding sources; and (16) these 10 projects have preliminary cost estimates ranging from $315 million to $4 billion.

Background Head Start was designed to help break the cycle of poverty by providing comprehensive educational, social, health, nutritional, and psychological services to low-income children. Head Start is authorized to serve children at any age prior to compulsory school attendance. Originally, the program was aimed at 3- to 5-year-olds. A companion program begun in 1994, Early Head Start, made these services available to children from birth to 3 years of age as well as to pregnant women. Head Start and Early Head Start programs are administered by ACF, which funds and monitors more than 1,500 grantees through its 10 regional and 2 branch offices. (See fig. 1) ACF’s national office has responsibility for overseeing and providing guidance to the regional offices, as well as for administering and collecting annual survey data from grantees. Head Start grantees include community action agencies, school systems, for-profit and nonprofit organizations, other government agencies, and tribal governments or associations. Also, many Head Start grantees provide services by subcontracting with other organizations, known as delegate agencies. In fiscal year 2002, Head Start grantees served more than 912,000 children, a 69 percent increase over the number of children served in 1990. Head Start has traditionally been a part-day, part-year program, but currently serves more children on a full-day basis, which is defined as 6 hours or more a day, than on a part-day basis. Approximately 47 percent of children served by Head Start were enrolled in a center- based full-day program for 6 hours or more a day. Less than 20 percent of children enrolled in Head Start receive 8 hours or more of center-based services a day. As of 2001-02, about 44 percent of Head Start children were enrolled in a part-day center-based program. Figure 2 shows the percentages of Head Start services provided on a full-day or part-day basis. Head Start funds are allotted among the states based on their 1998 allocation and, for funds exceeding that amount, by formula based on the number of children in each state under the age of 5 from families whose income is below the federal poverty level. Head Start grantees are required to provide at least 20 percent of annual program funding, which can include in-kind contributions, such as facilities for holding classes. During the award process, Head Start grantees receive from ACF regional officials their level of funded enrollment—the number of children the grantee is to serve. Head Start regulations require that at least 90 percent of the children enrolled in Head Start come from families with incomes at or below the federal poverty guidelines, from families receiving public assistance, or from families caring for a foster child. While the poverty guidelines are firm, grantees have some flexibility in determining income eligibility. For example, grantees can use the 12 months prior to the month the family applied to Head Start or the previous calendar year as a basis for determining income eligibility. Also, once a family is determined to be eligible in 1 program year, it is considered eligible for the subsequent program year, for a total of 2 years. Additionally, families that participate in the Temporary Assistance for Needy Families program (TANF) or the Supplemental Security Income program (SSI) or that care for a foster child are eligible for Head Start services even when family income exceeds the poverty guidelines. Grantees may fill up to 10 percent of their slots with children from families that exceed the low-income guidelines. An enrollment occurs when a Head Start program officially accepts a child and completes all necessary steps to begin providing services. If a child is chronically absent and the grantee cannot serve the child in another way, the child’s slot is considered vacant. Once a slot is vacant, the grantee generally must fill it within 30 days to be considered fully enrolled. Consequently, actual enrollments can fluctuate somewhat throughout funding periods. Head Start regulations require grantees to track program attendance on a daily basis. However, grantees are asked to annually report enrollment levels for any 2 months they choose as part of ACF’s annual Program Information Report (PIR) survey. ACF regions may require grantees to report enrollment data more frequently. Head Start regulations require grantees to maintain enrollment at 100 percent of the funded level and regional offices have primary responsibility for identifying and addressing underenrollment. However, as a practical matter, not all grantees are able to continually sustain enrollment at the fully funded level. Underenrollment can occur for a variety of reasons and can vary from month to month in a given program. Therefore, before deciding that underenrollment is unacceptable and taking action, the regions take into consideration a variety of factors about underenrollment, including its level and duration, its causes, and the actions taken by grantees to address it. The number of children eligible for Head Start services on the basis of being below the poverty line has decreased over the last decade, falling from over 6 million children in 1992 to just over 4 million in 2000. By 2002, the number of children under age 6 living in poverty had increased to nearly 4.3 million. Over the same period, Head Start enrollment has increased to over 910,000 children—a level that is significantly below the number of children living in poverty. (See fig. 3.) However, it should be noted that Head Start predominately serves children ages 3 and 4, who make up only a portion of all children under 6 living in poverty. In addition, during the 1990s, the number of other federal and state programs offering services to low-income children increased substantially. For example, welfare reform in 1996 greatly expanded the Child Care Development Fund (CCDF) and also allowed TANF funds to be used for child care. For fiscal years 1997 through 2002, these programs increased their investment in children; CCDF spending increased from $2.5 billion to $6.4 billion and TANF spending on child care increased from $13 million to $1.6 billion. (See fig. 4.) On the state level, one study cited by the Congressional Research Service (CRS) found that state spending on prekindergarten programs increased from about $700 million in 1991-92 to about $1.7 billion in 1998-99. Over the same period, the number of children served by these programs has increased from 290,000 to 725,000. Expanding federal and state early childhood programs has increased the need for coordination to better ensure that services are provided in a complementary fashion. One way that Head Start encourages coordination is by requiring all grantees to periodically prepare community assessments that analyze trends in the number of eligible children in their jurisdictions and assess the other early childhood services provided in the area. While grantees are not required to coordinate with other service providers, ACF has issued guidance encouraging grantees to coordinate with other providers in order to provide more full-day services. Also, in recent years, ACF has used some Head Start expansion money to build partnerships with child care providers to deliver full-day, full-year services. As another way to increase coordination, HHS has been authorized since 1998 to provide additional funds to states to encourage such collaboration. The Extent to Which Head Start Programs Are Underenrolled is Not Known The extent to which Head Start programs are underenrolled is unknown because ACF does not collect accurate national data and it does not monitor grantee enrollment in a uniform or timely way. Specifically, national enrollment data contain many inaccuracies and regional offices use a variety of thresholds to define “unacceptable” levels of underenrollment. Additional approaches used by the regions to identify underenrollment do not systematically address underenrollment or provide timely information. Using varying thresholds, the regional offices identified 170 grantees as unacceptably underenrolled in program year 2001-02, or about 7 percent of all grantees. By contrast, the agency’s annual survey data indicated that as many as half or more of the grantees were enrolled at less than 100 percent—the enrollment level grantees are required to maintain under Head Start regulations. Overall, regions’ use of different thresholds for unacceptable underenrollment suggests that regions may treat grantees with similar enrollment ratios differently. ACF Annual Grantee Surveys Contain Inaccurate Enrollment Data ACF’s annual survey of grantees—the only source of nationwide information on grantee enrollment rates—contained many inaccuracies. The PIR survey, as it is known, requests actual enrollment figures for any 2 months that grantees choose to report. When we attempted to verify 2001-02 PIR enrollment data for 19 of the grantees, we found that 8 had reported erroneously. For 6 underenrolled grantees, we found they underreported their enrollment ratio by an average of 25 percent. We also found that 2 overenrolled grantees had erroneously reported enrollment ratios that were over 200 percent. A similar review by ACF of 75 grantees and delegate agencies that had reported particularly high or low enrollment levels found that approximately half had erroneously reported their actual numbers. GAO and ACF found a variety of causes that grantees cited for misreported enrollments, including typographical errors, failure to report children who were enrolled in the home-based or after- school programs, and reporting on 2 months in which enrollment was not their highest. Regional Monitoring Efforts Employed Varied Criteria and Lacked Timely Data We found that ACF regional offices employed different criteria and used a variety of data sources and approaches to determine if a grantee is underenrolled. Given that regional offices are responsible for identifying and monitoring underenrollment, we asked regional offices to identify their operational criterion for an unacceptable level of underenrollment. Of 11 regional offices we surveyed, we found that 3 did not utilize a specific threshold to distinguish between acceptable and unacceptable underenrollment, while the other 8 offices used different thresholds. Each of the 3 regions that did not have a set threshold for “unacceptable” underenrollment indicated that underenrollment was treated on a case-by- case basis that would take into consideration the degree of underenrollment and other factors, including the grantee’s efforts to increase enrollment. For the regions that specified thresholds of “unacceptable” underenrollment, these thresholds ranged from any enrollment ratio below 100 percent in 3 regions to below 74 percent in one region (See table 1.) ACF regional offices reported that they identify unacceptable underenrollment primarily by visiting grantees every 3 years and also by engaging grantees in periodic dialogue. More than half of the regions also said that they relied heavily on PIR data and on their review of grant- refunding applications. Finally, 5 regions indicated that they rely to a great extent on their reviews of annual audits of grantees. Table 2 presents the extent to which regional offices rely on various approaches to identify underenrollment. Each of the approaches used by regional offices to monitor enrollment is lacking in timeliness or accuracy, or is not used systematically to monitor underenrollment. For example, in 3 regions we visited, ACF officials commented that while the on-site visits are designed to systematically assess underenrollment, the visits do not provide timely information because they are only conducted every 3 years. Conversely, while most regional officials we surveyed said that they rely on periodic discussions with grantees to identify underenrolled grantees, regional officials we visited said that they do not systematically discuss enrollment levels with grantees during this process. Officials from one region we interviewed also said that enrollment data included in grant re-funding applications are not informative because the data are based on forecasts. Also, while surveyed officials listed the PIR data as a key resource, those we spoke with said it was not necessarily accurate or timely due to the fact that data arrive after the subsequent program year has begun. Finally, regarding the use of annual audits, regional officials we spoke with said they did not always receive them for all grantees and that the audits they did receive do not necessarily comment on grantee enrollments. National Data on the Extent of Underenrollment Differs from Regionally Reported Data on Number of Unacceptably Underenrolled Grantees Applying a range of underenrollment thresholds to national data indicates that a higher percentage of grantees may be underenrolled than what was reported to us by regional offices. Regional offices, using a range of enrollment thresholds, reported to us that about 7 percent of grantees were unacceptably underenrolled. Comparatively, PIR survey data indicated that more than 50 percent of Head Start grantees had enrollment ratios below 100 percent—the regulatory definition of fully enrolled. PIR data also showed a significantly higher proportion of grantees—33 percent—reported enrollment ratios below 95 percent than the 7 percent of grantees reported as unacceptably underenrolled by the regional offices. Finally, PIR data showed that a similar proportion of grantees— about 9 percent—reported an enrollment ratio below 80 percent as the 7 percent of unacceptably underenrolled grantees reported to us by the regions. (See fig. 5.) The portion of grantees that regions reported as unacceptably underenrolled differed from what would have been identified by applying the regional threshold to national PIR data. When compared with the percentage of unacceptably underenrolled grantees reported by regions, PIR data show larger percentages of grantees below these thresholds for each region that specified a threshold. This was true even in regions that indicated they relied on PIR data to a great or very great extent. (See table 3). For example, region V, using a threshold of 100 percent for unacceptable underenrollment, reported to us that slightly less than 2 percent of its grantees were unacceptably underenrolled in 2001-02. PIR data from that same year indicate that about 62 percent of region V grantees had enrollment ratios less than 100 percent—a difference of 60 percentage points from what was reported to us. In fact, only regions III and VII, of the 7 regions in table 3 with clearly defined thresholds for unacceptable underenrollment, reported to us a percentage of unacceptably underenrolled grantees that was within 10 percentage points of what PIR data show using the same threshold. While we do not think that PIR data are reliable for reporting national enrollment figures, the regional offices based what they reported to us in part on their review of PIR data. Differing Definitions of Underenrollment Create Potential for Uneven Treatment of Grantees across Regions As a result of differences in regional definitions of what constitutes an unacceptable level of underenrollment, grantees with similar levels of underenrollment may be treated differently across regions, particularly in areas without a defined threshold. Regional offices reported to us that they take a variety of actions to address unacceptable underenrollment, including increased monitoring, technical assistance, and, occasionally, enforcement actions, including recouping funds and reducing future grant awards. To the extent that differing thresholds affect the identification of deficiencies that would lead to these actions, regions may subject grantees to different treatment. For example, as shown in table 4, although a higher percentage of grantees in region II have enrollment levels below 95 percent than in region III, according to PIR data (44 percent versus 18 percent), region II considers only 3 percent of its grantees unacceptably underenrolled, while region III considers 14 percent of its grantees unacceptably underenrolled. This discrepancy may be attributable to the fact that region II lacks a threshold for defining unacceptable enrollment, while region III has set a threshold of 97 percent. As a result, more grantees in region III have been subject to monitoring and enforcement actions. Regional and Grantee Officials Often Cited Combinations of Factors as Responsible for Underenrollment ACF regional officials and officials of underenrolled Head Start grantees often cited a mixture of factors that made it difficult to achieve full enrollment, including increased parental demand for full-day child care and a decrease in the number of eligible children. Many said welfare reform has increased the number of working parents, increasing demand for full-day child care and reducing the number of eligible children. Also, more than one-half of the grantees we interviewed reported they were having difficulty acquiring and developing adequate facilities. Meanwhile, underenrolled grantees and ACF regional officials also said that underenrollment was occurring because more parents were seeking services with other early education and child care programs, some of which subsidized care with relatives. Other contributing factors, such as eligible families moving from the service area, language, and cultural differences between children’s families and program staff, and weak or inadequate recruiting efforts by the grantees, were less frequently cited. Multiple Factors Often Linked to Underenrollment Many grantees indicated that the combination of multiple factors had fostered underenrollment for their program. Nearly two-thirds of the underenrolled grantees we spoke with cited two or more contributing factors. For example, one northern California grantee believed that underenrollment was caused by a decrease in income-eligible children in its area, because the high cost of living and a shortage of affordable housing in the area, and also by the number of families moving from welfare to work. In addition to citing the decrease in eligible children, this grantee expressed a need for more full-day slots, and reported facing increasing competition from day care programs that reimbursed relatives or friends to provide full-time child care. Similarly, one New Jersey grantee experiencing problems acquiring a new facility was also affected by a state supreme court decision requiring free preschool for poor children. Additionally, this grantee felt that it was losing eligible children as a result of families on welfare finding jobs and needing more full-day slots. A commonly cited combination of factors—cited by 8 of the 25 grantees we interviewed—was the simultaneous shortage of full-day slots and the movement of families out of welfare and into the workforce. Increased Demand for Full-day Care, Facilities Problems, and Increased Availability of Other Programs Most Frequently Cited as Affecting Underenrollment Regional and grantee officials most frequently cited the increased demand for full-day child care, construction delays and inadequate facilities, and the increased availability of early education and child care programs as the factors causing underenrollment. Other factors, such as high turnover rates and income eligibility criteria were also cited, but less frequently. Each of the factors affecting underenrollment that grantees and regions cited is described in more detail in the following sections. Appendix II lists the factors identified by regions as contributing to grantee underenrollment, and appendix III lists factors identified by grantees. Grantees and Regions Said Movement of Families from Welfare to Work Affected Enrollment and Increased Demand for Full-day Care Both regional and grantee officials said that the movement of low-income families from welfare to work had contributed to underenrollment. Seven of 11 regions cited the movement of low-income families from welfare to work as either a major or a moderate reason for grantees’ underenrollments. Similarly, of the 25 grantees we contacted, 11 cited this factor. Regional officials and grantees suggested the movement from welfare to work affected enrollments in two ways. First, as many parents began to work full-time, they increasingly needed full-day care. When Head Start grantees could not meet this need, some eligible families secured child care elsewhere. Second, some families entered work and earned income that disqualified their children from Head Start programs. A number of grantees related specific examples of how the movement from welfare to work affected enrollments. For example, A large grantee in Illinois said that many former welfare recipients who need full-day child care services no longer qualify for Head Start because they earn wages just above the Head Start income guidelines or work rotating schedules to avoid using formal child care services. A grantee in California said that the cost associated with switching to full- day care sometimes is a barrier to meeting families’ needs. Construction Delays and Inadequate Facilities Affected Enrollments Of the 25 underenrolled grantees we surveyed, 14 reported that difficulty acquiring and developing adequate facilities contributed to underenrollment. Similarly, over half of the 11 regions reported that underenrollment was linked to a major or moderate extent to facilities being completed more slowly than expected. For example, an Eastern grantee was unable to serve children in need of full-day care because it lacked classrooms and found it difficult to acquire more space. In the Midwest, 2 grantees reported that their inadequate facilities kept them from filling about 1,800 funded slots—43 percent of their funded slots— even though many eligible families desired Head Start services for their children. The grantees said that they had difficulty acquiring alternate facilities: some potential sites were environmentally unsuitable, while others faced neighborhood opposition. In another case, an American Indian grantee that had 25 unfilled Early Head Start slots expects to achieve 100 percent enrollment in the fall of 2003 when a new facility is scheduled to open. Other Early Education and Child Care Programs Can Affect Enrollments Regional and grantee officials often indicated that competition from other early education or child care centers serving low-income preschool children contributed to Head Start underenrollment. Seven of 11 regions cited this factor as a major or moderate contributor to underenrollment, and 8 of 25 grantees we interviewed identified this factor. In addition, 5 grantees said that a closely related factor also reduced families’ use of Head Start—the availability of state subsidies to pay relatives or friends for child care. Officials in 2 regions provided specific examples of increased availability of other programs having a negative impact on Head Start enrollment. According to region V officials, the availability of other programs had a major impact on a large grantee in Michigan when the public school system increased its preschool programming and as a result increased the options available to Head Start-eligible children. As a result, the grantee sustained a shortfall of almost 2,000 children. Grantees also reported specific examples of increased availability of other programs having a negative impact on Head Start enrollment: A large underenrolled grantee on the East Coast said that availability of prekindergarten programs at public and charter schools is the most important reason its delegate agencies are underenrolled. A medium-sized grantee in Oklahoma with 454 funded slots indicated that in the 2001-02 school year, the local public school started a preschool program for 4-year-old children that resulted in a slight decline in Head Start enrollments at some of its service centers. Officials representing a smaller grantee in Georgia with 161 funded slots said that their program was affected in 2001-02 when the state funded a prekindergarten program in public schools. Specifically, the grantee said that some children who had been pre-enrolled for Head Start switched to the state-funded program. Regional and grantee officials also indicated that state subsidies for unlicensed child care caused some grantees to be underenrolled. Officials of region IX (Arizona, California, Hawaii, Nevada, and Pacific Insular Areas) said that increasingly, low-income parents make use of state child care subsidies to pay for child-care exempt from licensing standards, such as care provided by friends or nonresident relatives. Region IX officials believed this had a significant impact on reducing Head Start program enrollments. In another example, a grantee in Pennsylvania saw its enrollments drop after the state allowed parents to use state child care subsidies to pay nonlicensed child care providers such as relatives and friends. In another instance, a grantee in California said that since its program primarily offers part-day/part-year services, many families chose to use subsidized, license-exempt care by relatives or friends who can provide full-day or part-day care. Other Factors Affected Enrollments, but Were Cited Less Frequently Less frequently, regions and grantees also cited other factors as negatively influencing Head Start enrollment. Eight grantees indicated that eligible families had moved from their service areas, often because of the high cost of living, increasing underenrollment. Three regions also reported that high turnover rates among enrolled children contributed moderately to underenrollment. Five grantees indicated that the income-eligibility criterion for Head Start was too low in their high-cost areas. For example, 4 underenrolled California grantees said that even relatively poor families were disqualified from Head Start participation because their incomes, though inadequate to meet the basic costs in the local area, were above the federal poverty guidelines. Officials of an underenrolled grantee in Oakland indicated that during the 2002-03 program year they had denied Head Start services to over 100 families because their incomes exceeded the current poverty guidelines. The other three California grantees said that they were also turning families away because they were slightly over the income guidelines. Grantees said that families just over the federal poverty guideline cannot afford to send their children to education and child care programs equivalent in quality to Head Start programs. Four regions cited inadequate program management factors, such as weak recruitment efforts, as a major or moderate contributor to underenrollment. Five grantees also cited such factors as inhibiting Head Start enrollments. Inadequate program management was characterized by weak recruitment efforts, not developing or using waiting lists of Head Start-eligible children, and planning enrollment expansions poorly. For example, a grantee in Pennsylvania agreed to expand enrollment by 144 slots, and although the grantee received increased funding in the 2000-2001 program year, grantee officials said they had difficulty filling the additional slots because of inadequate planning by the previous management team. Three grantees in California noted that language and cultural differences between eligible Head Start families and program staff complicated outreach and consequently reduced enrollments from some minority groups. One grantee indicated that families in its service area spoke over 25 languages at home. Another grantee said it was difficult to find staff that spoke the same languages as the families needing service. ACF and Grantees Use a Variety of Approaches to Address Underenrollment ACF national and regional offices and grantees all report taking action to address underenrollment, such as issuing guidance, increasing monitoring, and attempting to conduct broader outreach efforts. The ACF national office issued a memorandum instructing regional offices to address underenrollment, and all ACF regions we surveyed said that they have increased their monitoring efforts. Some ACF regions have also taken action to reduce grantees’ funding and recoup federal funds. Many grantees we spoke with have increased outreach efforts, sought partners to help provide more full-day services, and increased the capacity of physical facilities. While 18 of the 25 grantees we contacted had made progress toward achieving full enrollment, others cited continuing challenges. ACF-Issued Guidance for Managing Underenrollment Lacks Specific Criteria for Priority Review and Corrective Action In April 2003, ACF headquarters issued policy guidance to its regional offices instructing them to take specific actions with underenrolled grantees, although it provided no particular instructions for the review process or any criteria for prioritizing grantees for corrective action. The guidance instructs regional officials to address underenrollment depending on four possible causes. For example, if the grantee can demonstrate that an inappropriate program option is causing underenrollment, the guidance instructs regions to carefully consider grantee requests to make changes to their services, such as converting current part-day slots to full-day slots. The four causes identified in the guidance and the recommended actions are summarized in table 5. The April guidance does not suggest any systematic process for identifying underenrolled grantees, nor does it specify criteria for prioritizing when grantees should be subject to corrective action based on their level of underenrollment. One regional official said that the lack of a threshold offered no gauge for establishing priorities and intensifying monitoring efforts. Regional Officials Reported Intervening with Underenrolled Grantees to Correct Underenrollment The ACF regions we surveyed reported taking a variety of actions to address underenrollment ranging from providing assistance to recouping federal funds in some cases. Officials in all 11 regions responded that they had taken at least one action to ensure that grantees address underenrollment. The interventions taken most often were to monitor enrollment levels (55 grantees), track improvement efforts (43), and provide training and technical assistance (30). Notably, 4 regions provided additional funds to a total of 18 underenrolled grantees to purchase or renovate facilities. Somewhat less often, regions took action to reduce funded enrollment levels or recoup funds. Specifically, only 2 regions reported that they recouped funds from a total of 6 underenrolled grantees. (See table 6.) As noted earlier, many regions and grantees said the need for full-day services was a major factor fostering underenrollment. As part of their efforts to assist grantees in providing more full-day services, some ACF regional officials told us they had encouraged grantees to collaborate with other programs or had provided additional funds to purchase or renovate facilities. However, such efforts can be costly. For example, region V officials told us that it costs more to provide full-day care than part-day care because full-day care requires more facility space and staff per child. Underenrolled Grantees Report Taking Some Remedial Actions Grantees we interviewed took a variety of actions to address underenrollment, including more aggressive recruiting efforts, collaborating with other preschool and child care programs, and increasing slots in selected program options such as home-based services. Most grantees we contacted said that they had taken one or more actions. The most frequently mentioned was more aggressive recruiting followed by collaboration with other programs. For example, a large grantee in New York State that faced increased demand for full-day care since welfare reform collaborated increasingly with other child care providers to piece together a package of full-day services. Nine grantees also reported trying to increase physical facilities capacity. (See table 7.) Other actions taken to address underenrollment, which were cited by 3 or fewer grantees, included improving the tracking or monitoring of enrollment opportunities, hiring multilingual staff, reducing the number of funded slots, and providing contractual incentives for delegate agencies to maintain full enrollment. Grantees Cite Obstacles to Providing Additional Full- Day Care The costs of transitioning part-day, double sessions, to full-day services have never been fully understood and no national process has emerged to assist grantees and regional offices to address this problem. The major costs often include facilities and additional staffing (where only two and one-half staff are needed for a double session, four to six are needed to staff a full-day session, depending on the number of hours the option operates). Such fixed costs would require a reduction in the number of slots (children enrolled) or an increase in funding in order to transition from part-day double sessions to two full-day sessions. While these two grantees expressed concern over a lack of guidance, it should be noted that there is national guidance on budgeting for partnerships between child care and Head Start and on financial management issues in Head Start programs utilizing other funding sources. Furthermore, grantees told us of their concern to maintain total funded enrollment levels, even as they were converting unfilled part-day openings to full-day. According to region V officials, this concern to maintain enrollment levels may be in keeping with national efforts to serve a greater number of needy children. For example, one underenrolled grantee said that ACF suggested several alternatives to address underenrollment, including converting part-day to full-day slots, but would not permit the grantee to reduce funded slots as a way to address underenrollment. Consequently, while converting part-day slots to full-day slots, the grantee would have had to expand its facilities or find other child care partners in order to serve the same number of children. Grantees Reported Mixed Results Resolving Underenrollments Some grantees reported success addressing underlying factors contributing to underenrollment, while others did not. Of the 25 underenrolled grantees that we contacted, 18 (72 percent) indicated that their underenrollment had either been corrected (10 grantees) or would be corrected shortly (8 grantees). These 18 grantees overcame a variety of factors that they said affected underenrollment. For example, 6 of these 18 grantees overcame a shortage of available full-day slots and 8 managed to fill slots lost due to a decline in eligible children attributed to declining TANF rolls. The 7 grantees that had not made progress addressing underenrollment often cited similar issues. For example, 3 of these 7 grantees said they had faced challenges resulting from decreasing TANF caseloads and were unable to respond to the increased demand for full- day services. On the basis of our limited number of interviews, we could not determine why some grantees reported they were able to successfully address problems that other grantees could not. Conclusions Because ACF has no reliable nationwide data on enrollment, it is not possible for the agency to identify and track underenrollment trends and to develop strategies to ensure that federally funded Head Start slots are filled. While we could not determine with any precision the extent to which there is underenrollment, our survey work and analysis indicate it is possible that underenrollment is more widespread than ACF has acknowledged. The complexity of factors buffeting Head Start grantees underscores the need for ACF to accurately identify underenrollment and its causes on a timely basis. Even if ACF corrects national survey data issues, there is no guarantee that its regions will know of underenrollment in a timely manner because the main national data source is not available until the following program year. Furthermore, because ACF regions vary in how they define unacceptable levels of underenrollment and because they rely on approaches to identify grantees that are not timely or consistent, there is some indication that Head Start grantees with similar levels of underenrollment are treated differently across regions. ACF guidance to the regions on how to address different types of underenrollment is a good first step toward a more systematic approach to underenrollment. However, until ACF issues guidance that more clearly explains how to prioritize grantees with varying levels of underenrollment for purposes of corrective action, regions are likely to continue using varied criteria or none at all. Also, until more timely and systematic approaches are developed for regions to identify underenrolled grantees, it is possible that low enrollment will go undetected and federal dollars will not be fully utilized for low-income children who could benefit from Head Start’s program goals. Finally, it appears that there may be a perceived incentive for underenrolled grantees to maintain or increase enrollments due, in part, to ACF’s emphasis on counting the total number of children served irrespective of whether they are enrolled part-day or full-day. Measuring Head Start enrollments without capturing the difference in level of service provided by full-day or part-day programs adds to the difficulty of meeting local needs and adjusting to changes in those needs. Until ACF can get a better grasp of the nature and size of underenrollment and align program incentives with family needs, it may be a challenge for Head Start to best meet the needs of some families it could serve. Recommendations for Executive Action We recommend that the Secretary of HHS direct ACF to (1) take steps to ensure the accuracy of enrollment data reported in its annual nationwide survey of grantees, (2) develop a standard criterion for regional offices to use in identifying grantees whose underenrollment merits monitoring or corrective actions, (3) develop an additional measure of aggregate services other than total enrollment that takes into consideration the different levels of service provided by full-day and part-day programs, and (4) work with regional offices to develop a more systematic process for them to collect reliable enrollment data during the program year so that they can address underenrollment more quickly. Agency Comments We provided a draft of this report to the Department of Health and Human Services for review and comment. In its written response, included as appendix IV of this report, HHS agreed with our recommendations and indicated that it will take action to address each recommendation. We are sending copies of this report to the Secretary of Health and Human Services and other interested parties. In addition, the report will be available at no charge on GAO’s Web site at http://www.gao.gov. If you or your staffs have any further questions about this report, please call me on (202) 512-7215. Other GAO contacts and staff acknowledgments are listed in appendix V. Appendix I: Scope And Methodology To determine what is known about the extent to which Head Start programs are underenrolled, we assessed the reliability of PIR enrollment data, conducted interviews, reviewed program documentation, and surveyed ACF regional offices. Specifically, we assessed the reliability of the PIR data on grantee enrollment by (1) performing electronic testing of key data elements for obvious errors in completeness and accuracy, (2) reviewing existing information about the data and the system that produces it, and (3) contacting 19 underenrolled and overenrolled grantees selected across a range of reported enrollment ratios. We did not assess the reliability of other PIR data used in the report. We also interviewed ACF headquarters officials, reviewed federal guidance and regulations on enrollment, surveyed the regions and a branch office, and interviewed regional officials in regions III, V, and IX. The 3 regions were selected for site visits on the basis of geographical representation and the number of underenrolled grantees they reported to us. Since ACF oversight of Head Start grantees is primarily accomplished through its regions and program branches, we designed a survey instrument in which these entities could provide written responses to our specific requests for such information as: the methods the regions used to oversee grantee and delegate agency enrollment levels; the threshold, if any, they had established for determining the point at which a grantee or delegate agency’s level of underenrollment is considered to be unacceptable; a list of all grantees and delegate agencies that they believed had unacceptable levels of underenrollment for both the 2001-02 and 2002-03 program years; the reasons that they believed unacceptable levels of underenrollment had occurred and the extent (major, moderate, minor, or none) that they believed each identified reason had contributed to underenrollment; the actions they had taken to address the unacceptable level of underenrollment for their grantees and delegate agencies. We surveyed all 10 ACF regional offices and the American Indian-Alaska Native Program Branch. The Migrant and Seasonal Program Branch was excluded from our review because of its lack of comparability with the other branch and regions caused by anticipated enrollment fluctuations resulting from the seasonal movement of migrant families. To determine ACF officials’ and Head Start grantees’ views on the factors that contribute to underenrollment and to identify actions they took to address underenrollment, we relied on our survey of the ACF regional offices and the American Indian-Alaska Native Program Branch office as well as a interviews with 27 grantees (1 of which was actually a delegate agency) that had been identified by the regions as underenrolled. Twenty grantees were contacted by telephone and 7 were interviewed face-to-face. Two of the 27 grantees said that they had not experienced any underenrollment; therefore, our grantee survey results were based on the responses of 25 grantees that agreed with the regions’ designation of their underenrolled status. Using a standard set of questions, we interviewed at least 1 identified grantee from each region or branch. In selecting grantees to be interviewed, we chose 7 from the metropolitan areas of the 3 regions that we visited so that we could conduct some of the interviews in person. The other 20 grantees we interviewed were primarily selected from each region based on having been identified as being underenrolled for 2 program years (2001-02 and 2002-03). We also attempted to interview both grantees that were funded for more than 500 slots and grantees that were funded for fewer. The grantee interview requested that grantee officials describe the factors they believed contributed to the grantee’s identify the actions the grantee had taken to address underenrollment, and indicate whether they believed that the grantee’s underenrollment had been corrected. Because of the lack of reliable enrollment data, the information we collected regarding underenrollment was primarily testimonial. Apart from assessing the basic consistency of interviewees’ responses with known program characteristics, we did not independently test the information they provided, such as reasons for underenrollment. Appendix II: Factors That the ACF Regions Believed Contributed to Underenrollment to a Major or Moderate Extent Appendix III: Factors that Grantees Believed Contributed to Their Head Start Programs’ Underenrollment Appendix IV: Comments from the U.S. Department of Health and Human Services Appendix V: GAO Contacts and Staff Acknowledgments GAO Contacts Acknowledgments In addition to those named above, Daniel Jacobsen, Lesley Woodburn, Luann Moy, Barbara Johnson, James Rebbe, Susan Bernstein, and Amy Buck made key contributions to the report. Related GAO Products Education and Care: Head Start Key Among Array of Early Childhood Programs, but National Research on Effectiveness Not Completed. GAO- 03-840T. Washington, D.C.: July 22, 2003. Head Start and Even Start: Greater Collaboration Needed on Measures of Adult Education and Literacy. GAO-02-348. Washington, D.C.: March 29, 2002. Early Childhood Programs: The Use of Impact Evaluations to Assess Program Effects. GAO-01-542. Washington, D.C.: April 16, 2001. Title I Preschool Education: More Children Served, but Gauging Effect on School Readiness Difficult. GAO/HEHS-00-171. Washington, D.C.: September 20, 2000. Early Education and Care: Overlap Indicates Need to Assess Crosscutting Programs. GAO/HEHS-00-78. Washington, D.C.: April 28, 2000. Early Childhood Programs: Characteristics Affect the Availability of School Readiness Information. GAO/HEHS-00-38. Washington, D.C.: February 28, 2000. Education and Care: Early Childhood Programs and Services for Low- Income Families. GAO/HEHS-00-11. Washington, D.C.: November 15, 1999. Head Start: Challenges in Monitoring Program Quality and Demonstrating Results. GAO/HEHS-98-186. Washington, D.C.: June 30, 1998. Head Start Programs: Participant Characteristics, Services, and Funding. GAO/HEHS-98-65. Washington, D.C.: March 31, 1998.

Head Start, created in 1965, is designed to prepare low-income preschool children for school by providing a comprehensive set of early child development services primarily through communitybased organizations. Over the last decade there have been a number of changes in Head Start's operating environment, including a decrease in the number of poor children; an increase in the number, size, and scope of other federal and state early childhood programs; and an expansion in Head Start spending and enrollment. Given this environment, GAO was asked to determine (1) what is known about the extent to which Head Start programs are underenrolled, (2) ACF regional officials' and Head Start grantees' views on what factors contribute to underenrollment, and (3) what actions ACF and grantees have taken to address underenrollment. The extent to which Head Start programs have enrolled fewer children than they are funded to serve is unknown because the Administration for Children and Families (ACF) does not collect accurate national data and does not monitor underenrollment in a uniform or timely manner. While some modest fluctuations in enrollment are to be expected, regional offices had differing definitions of unacceptable underenrollment, and the approaches they used to identify it were either not timely or not systematic. The regional offices identified a total of about 7 percent of grantees as unacceptably underenrolled in 2001-02, significantly less than the percentage of grantees reporting enrollment ratios below 100 and 95 percent on ACF's survey of grantees. As a result of differences in regional definitions of what constitutes an unacceptable level of underenrollment, grantees with similar levels of underenrollment may be treated differently across regions. ACF regional officials and officials of underenrolled Head Start grantees often cited a mixture of factors that made it difficult to achieve full enrollment, including increased parental demand for full-day child care, a decrease in the number of eligible children, facilities-related problems, and more parents seeking openings with other sponsors of early education and care. ACF national and regional offices and grantees all report taking action to address underenrollment through the issuance of guidance, increased monitoring by regional offices, and more aggressive outreach attempts by grantees. The ACF national office issued a memo in April 2003 that instructed regional offices to address underenrollment with a variety of measures depending on its causes. While this guidance was clear on the actions to be taken, it lacked clear criteria for prioritizing grantees for corrective actions. Also, while many grantees we spoke with had taken steps to address underenrollment, some told us of their concern to maintain total funded enrollment levels, even as they were converting unfilled part-day openings to full-day. While 18 of the 25 grantees we contacted had made progress toward full enrollment, others cited continuing problems.

Background To carry out its missions, Energy relies on contractors for the management, operation, maintenance, and support of its facilities. Since the end of the Cold War, the agency’s mission at its defense nuclear facilities has changed from weapons production to cleanup and environmental restoration, thus necessitating a change in employees’ skills. Energy’s facilities have also had to reduce their workforce in response to overall cuts in the federal budget. At the end of fiscal year 1996, total employment by contractors at the facilities was estimated at about 110,000, down from a high of nearly 149,000 at the end of fiscal year 1992. Section 3161 of the National Defense Authorization Act for Fiscal Year 1993 requires that when a change in the workforce at a defense nuclear facility is necessary, Energy must develop a plan for restructuring the contractor workforce. These plans are to be developed in consultation with the appropriate national and local stakeholders, including labor, government, education, and community groups. According to the act, changes in the workforce should be accomplished to minimize social and economic impacts, should be made only after 120 days’ notice, and should be accomplished, when possible, through the use of retraining, early retirement, attrition, and other options to minimize layoffs; the Secretary shall submit to the Congress a plan for a defense nuclear facility within 90 days after the date of the 120-day notice, or 90 days after the enactment of the act, whichever is later; employees shall, to the extent practicable, be retrained for work in environmental restoration and waste management activities; employees whose employment is terminated shall, to the extent practicable, receive preference in hiring; and Energy should provide relocation assistance to transferred employees and should assist terminated employees in obtaining appropriate retraining, education, and reemployment. In addition to the act’s specific requirements, Energy’s guidelines provided that extended medical insurance should be offered to all separated contractor employees. Moreover, although the act refers only to defense nuclear facilities, the Secretary of Energy determined that in the interest of fairness, the workforce restructuring planning process would be applied at both defense nuclear facilities and nondefense facilities. Although Energy provided guidelines to the field offices, these guidelines were intended to be general and not prescriptive. In order to allow for consultation with local stakeholders and to incorporate the unique needs at each facility, field offices were responsible for developing workforce restructuring plans. Energy’s Office of Worker and Community Transition is responsible for coordinating restructuring efforts, reviewing and approving workforce restructuring plans, and reporting on the status of the plans. As of November 1996, a total of 35 workforce restructuring plans either had been approved or were in draft form. While restructuring occurred at 32 of Energy’s facilities, some facilities had multiple restructuring plans; others had none because few employees were affected, and plans were not required if fewer than 100 employees would be involved. (App. I contains a list of the 32 facilities that reported costs associated with the restructuring.) Similar Types of Benefits Offered, but Amounts Varied Among Locations The workforce restructuring plans generally included similar types of separation payments and other benefits. Since 1993, the costs associated with these benefits have totaled about $609 million. The value of separation payments varied among facilities due to such factors as differences in the method used to calculate severance pay. Other benefits, including extended medical insurance, educational/training assistance, relocation assistance, and outplacement assistance, were offered at most facilities, and the value of these benefits also varied. These differences in the value of benefits among facilities reflect the nonprescriptive nature of Energy’s guidelines and the emphasis on developing plans at the local level. Types and Amounts of Benefits Provided The workforce restructuring plans included three types of separation programs: enhanced retirement, voluntary separations, and involuntary separations. Energy’s goal in workforce restructuring was to encourage employees to leave through enhanced retirement or voluntary separation programs and to use involuntary separations only when necessary. The enhanced retirement programs typically added 3 years to age and service for the purpose of calculating pension benefits. Some enhanced retirement programs included an additional incentive payment. The voluntary and involuntary separation programs usually consisted of a severance payment based on length of service and base salary. In all, nearly 75 percent of the employees leaving under the three separation programs accepted enhanced retirement or voluntary separations (see fig. 1). Voluntary separation (12,576) Employees leaving under most voluntary and involuntary separation programs were eligible for additional benefits. These additional benefits included extended medical insurance, educational/training assistance, relocation assistance, and outplacement assistance. However, separation payments accounted for most of the total funds spent on workforce restructuring. Figure 2 shows that 88 percent of the $609 million in workforce restructuring costs consisted of separation and enhanced retirement payments. As shown in table 1, the total average cost of benefits provided to the 23,782 separated employees was $25,619. Average separation payments ranged from about $37,400 for enhanced retirement to about $15,800 for involuntary separation. Value of Benefits Varied Among Facilities Although most facilities included similar benefits in their workforce restructuring plans, the value of these benefits varied considerably for several reasons. For separation payments, the variance was generally due to two factors: differences in the severance pay formula used and the characteristics of the workforce at a given facility. For example, the Fernald facility provided severance pay based on service up to a maximum of 24 weeks’ pay, while Lawrence Livermore National Laboratory provided 2 weeks of pay per year of service to a maximum of 52 weeks. In addition, the value of severance payments at a location varied due to average salaries, length of employment, and the age of the workforce. For example, the average severance payment for voluntary separations ranged from $10,172 at Grand Junction to $42,855 at Portsmouth; for involuntary separations, the average payment ranged from $4,076 at Morgantown to $51,409 at the Naval Petroleum Reserve; and for enhanced retirement, the average benefit ranged from $10,000 at Grand Junction to $78,783 at Pinellas. Similarly, the value of benefits other than separation payments generally varied for two reasons—either because Energy’s guidelines specified a maximum amount for the benefit but allowed discretion in determining the appropriate amount for each facility or because of local variances in the costs of those benefits. For example, almost all plans provided educational and training assistance; the maximum benefit ranged from $2,500 to $10,000. In addition, relocation assistance was offered at most facilities; the maximum reimbursement ranged from $2,000 to $5,000. For extended medical coverage, Energy’s costs included the contractors’ full share of health insurance premiums for the first year following separation. The differences in the value of this benefit were due to the costs of coverage at different locations. For example, the average value of the extended medical coverage ranged from $194 at Grand Junction to $16,084 at Pinellas (the Pinellas costs included coverage for retired workers under the plant-closing provisions of the contract). Appendix II summarizes the benefits provided in the 29 workforce restructuring plans at defense nuclear facilities, and appendix III summarizes the benefits provided in 6 workforce restructuring plans at nondefense facilities. Both tables show some of the differences in how these benefits were calculated. Benefits Exceeded Amounts That Would Have Been Awarded Under Existing Contracts Section 3161 of the National Defense Authorization Act for Fiscal Year 1993 authorized benefits such as educational and relocation assistance that exceeded those that would have been provided under existing contracts at the facilities. In addition, the agency determined that all contractor employees, whether voluntarily or involuntarily separated, should be eligible for extended medical coverage (as shown in table 1, the cost of providing this benefit totaled $35.2 million). The contracts at Energy’s facilities usually provide only severance payments and outplacement assistance; no other benefits are offered. As we reported in March 1995, these limited benefits are consistent with both federal and private practices. Our review of downsizing efforts at 22 private companies and state organizations and 3 foreign governments concluded that many of these organizations offered separation incentives more generous than those generally included in federal “buyout” legislation to encourage employees to resign or retire. The only other benefit frequently offered by these organizations was outplacement assistance. However, most of Energy’s workforce restructuring plans included benefits, such as extended medical coverage and educational assistance, in addition to severance pay and outplacement assistance. In contrast, federal employees who are involuntarily terminated through a reduction in force receive only severance pay based on years of service and an additional 10 percent of basic severance for each year an employee is over age 40; the maximum lifetime benefit is 1 year’s annual salary. Under the federal buyout legislation for voluntary separations, the maximum severance pay allowed was $25,000. Although the act was silent on the issue of severance pay, Energy’s guidance allowed the use of enhanced severance payments to encourage voluntary separations. The plans varied as to whether they provided severance payments in accordance with the existing contracts. Of the 35 plans reviewed, 9 conformed to existing contracts, 8 were unclear as to how severance payments compared to normal contract provisions, and 18 provided severance payments that exceeded those normally provided for in the contracts. For example, at Rocky Flats, the existing contractor policy allowed for a maximum of 15 weeks severance pay, while the plan provided a maximum of 52 weeks. At Elk Hills Naval Petroleum Reserve, the enhanced severance pay amounts exceeded the normal severance pay by 41 percent. Similar Benefits Were Generally Provided to Cold War and Post-Cold War Workers at Defense and Nondefense Facilities Although the act referred only to workforce restructuring at defense nuclear facilities, the Secretary of Energy determined that in the interests of fairness, the planning process included in the act would apply to all workforce restructuring. Therefore, the agency generally extended the same benefits to contractor employees at both defense nuclear and nondefense facilities. Workforce restructuring costs were reported for 15 nondefense facilities. However, the cost of benefits provided at these facilities accounted for about 7 percent of the total workforce restructuring costs reported for fiscal years 1995 and 1996 and primarily included severance payments and medical coverage. The act does not specifically mention employees who worked during the Cold War. However, in its March 1994 guidelines, the Office of Worker and Community Transition established a “job attachment test” that was to be used to determine whether an employee qualified as a Cold War worker and stated that only Cold War workers should be eligible for all benefits. In practice, most plans made little or no distinction in the benefits offered to those employees who worked during and after the Cold War. The largest benefit cost—for severance pay—depended on length of service and base salary rather than on whether the employee worked during the Cold War. The two facilities that did make a distinction—Hanford and Savannah River—provided a lump-sum payment option for voluntary separations, with larger payments for Cold War workers. For other benefits, most plans offered the same benefits to all workers regardless of when they were employed. Although Energy does not routinely collect data separating costs between Cold War and post-Cold War workers, four facilities—Hanford, Savannah River, Oak Ridge, and Rocky Flats—did provide this breakdown of costs. However, since these data are not normally collected, the contractors at the facilities were not able in all cases to identify or separate all costs. According to the data available at these four locations, about 7 percent of the costs went to post-Cold War workers. Table 2 shows the number of employees and cost of benefits provided at the four facilities. Efforts to Retain Critical Skills Have Improved The limited data available for the early years of restructuring showed problems in retaining workers with critically needed skills. While Energy did not collect comprehensive information about rehiring rates during the early years, audits at three facilities indicated difficulties in maintaining the workforce necessary to accomplish the mission at the facilities. For example, the agency’s Office of Inspector General reported that during the first restructuring at Fernald, of the 255 separations in fiscal year 1994, all but 14 of the positions had been refilled within 1 year by either the previous employees or ones with similar skills, representing a 95-percent rehire/backfill rate. The report concluded that Energy did not (1) require the contractor to perform the skills analysis necessary to identify which employees were needed to perform the current mission and (2) effectively monitor the contractor’s restructuring efforts. In addition, the report stated that continuing to separate and replace employees with critical skills was deemed a material internal control weakness. In response, Energy acknowledged that this restructuring did not accomplish its objectives. Since these early efforts, Energy has taken steps to improve its ability to retain critically needed skills. The agency acknowledged in its report on the restructuring efforts in fiscal years 1993 and 1994 that it was essential for facilities to do more effective workforce planning to identify the critical skills necessary to carry out the new mission. After Energy revised its guidance to emphasize workforce planning, the facilities targeted voluntary separations to retain critical skills and established controls to restrict the rehiring of employees taking voluntary separations. For example, during the fiscal year 1995 restructuring at the Hanford facility, the employees with critical skills were excluded from the voluntary separation program. According to preliminary data reported for all facilities for fiscal years 1995 and 1996, about 2 percent of separated employees have had to be rehired or have their positions backfilled by someone with similar skills. In the explanations accompanying these data, many of these rehires were either employees who had been involuntarily separated and qualified for preferential hiring or collective bargaining employees who had recall rights. However, Energy normally does not track contractor employees below the level of principal contractor and has no data available on hires at most subcontractors. Therefore, separated employees with critical skills could be rehired by subcontractors at the same facility and would not be reflected in the 2-percent rehire/backfill rate. Energy Provides Limited Oversight of Plan Implementation After Energy approves the workforce restructuring plans, it provides little oversight or monitoring of how contractors implement those plans. According to the Director of the Office of Worker and Community Transition, agency field offices are responsible for monitoring workforce restructuring efforts and for determining if benefits are applied appropriately. However, field offices at the four facilities we visited do little monitoring or oversight of the implementation of the facilities’ plans. When monitoring has been done by either Energy’s Office of Inspector General or internal audit personnel at field offices, their investigations have identified instances of excessive costs or inappropriate benefits. The Office of Worker and Community Transition reviews all restructuring plans to ensure that they conform to Energy’s policy before submitting the approved plans to the Congress. This Office also gathers data from the facilities on the costs of restructuring for annual reporting to the Congress. In addition, the office has revised program guidelines to incorporate lessons learned in early restructuring efforts. At the four facilities we visited, field office personnel told us that the contractor was primarily responsible for implementing the workforce restructuring plan. However, agency personnel do review the contractors’ separation programs to ensure consistency with the plan and respond to the contractors’ questions about specific benefit determinations. At one facility, the rehiring of the individuals who accepted enhanced retirement requires approval by the field office manager. However, according to the agency officials responsible for workforce restructuring at the four facilities, they do no detailed review of the costs submitted by the contractors for workforce restructuring. Independent reviews of early restructuring efforts by Energy audit staff have raised questions about the impact of limited monitoring. The Inspector General has issued four reports on workforce restructuring problems and has two ongoing reviews. For example, an August 1995 report at Oak Ridge found that the contractor established training programs and an outplacement center that provided few benefits to separated employees, yet cost Energy $8.2 million in fiscal years 1993 and 1994 and would cost an additional $15.6 million through fiscal year 1997. The report recommended that Energy officials at Oak Ridge evaluate and monitor the implementation of the plan to preclude unnecessary expenditures. In addition, the reviews by an internal audit organization at one facility have identified problems and excessive costs associated with workforce restructuring. The reviews of restructurings at Rocky Flats that occurred in fiscal years 1993 through 1995 identified problems with both separation payments and educational and training assistance. For example, one review noted that the contractor paid out $0.8 million for voluntary separations and then hired workers to fill the vacated positions. In addition, another review found voluntary separation payments made to ineligible employees that totaled over $93,000. Internal audits also found that retained employees were reimbursed for training courses that were not relevant to the skills needed at the facility; $200,000 in questionable expenses were identified, including $25,000 for helicopter pilot training for a retained employee. We discussed these concerns with the Director of Energy’s Office of Worker and Community Transition. According to the Director, the agency shares these concerns and acknowledges that early restructuring efforts could have been more effective. The Director added that the Office has learned from these experiences and has a two-part strategy in place to address these issues. First, to increase the effectiveness of workforce restructuring efforts, the Office revises the guidelines annually to reflect lessons learned and holds annual meetings to share experiences with field office personnel responsible for workforce restructuring plans. In addition, although the agency provides limited oversight of the implementation of the plans, the Director believes that contract reform efforts, including the change to performance-based contracts, will provide the appropriate incentives for the contractors to implement the workforce plans more effectively. Conclusions Energy has exercised wide discretion in restructuring its contractor workforce, defining the types and amounts of benefits and who should receive those benefits at its defense nuclear facilities and nondefense facilities. Through improved guidance and emphasis on workforce planning, the agency has taken steps to improve its ability to conduct restructuring while meeting critical skill needs at its facilities. However, given the lack of tracking of employees below the level of principal contractor, it is difficult to determine how effective these steps have been. In addition, given Energy’s limited oversight of the implementation of restructuring plans, problems with excessive costs or inappropriate benefits, such as those identified by audit organizations, could occur in future restructurings. To address these concerns, Energy has developed a strategy to incorporate lessons learned and to provide incentives for contractors to implement the plans in a cost-effective manner. Since workforce restructuring will continue, the agency needs to ensure that this strategy will be effective in preventing similar problems in the future. Agency Comments We sent a draft of this report to the Department of Energy for its review and comment. (Energy’s comments appear in app. IV.) Energy generally agreed with the report’s findings and conclusions; however, the agency had two concerns. First, Energy did not agree with the characterization of its workforce restructuring program in the title of the report, stating that similar types of benefits were offered at most facilities. While similar types of benefits were offered at most facilities, the formulas used to calculate severance pay combined with the differences in length of service and base salaries among the facilities resulted in a wide range for the value of these benefits. Second, in connection with the rehiring of separated employees, Energy acknowledged that it does not normally track employees below the level of principal contractor. Furthermore, the agency believes that the reduction in both its overall budget and the number of principal contractor employees would not have occurred if subcontractors were hiring employees separated under the programs. However, reductions in budgets and employment levels are not necessarily good indicators. While reductions in budgets and employment levels have occurred, hiring has continued at most facilities. In addition, Energy forwarded a copy of our draft report to the four sites that we visited. The Richland and Savannah River Operations Offices said that our characterization of Energy’s limited oversight of the implementation of restructuring plans did not apply to them. Both offices believe that they are involved in providing direction to the contractors and then monitoring the results. For example, Savannah River indicated that they closely monitor the cost reports and other data submitted by the contractors. However, as noted in our draft report, the activities performed by these offices did not include detailed reviews of the costs submitted by contractors. The other two facilities had only clarifying comments that we incorporated as appropriate. Scope and Methodology To determine the types and amounts of benefits provided to separated employees as well as to determine what distinctions Energy made in determining who should receive these benefits, we relied primarily on data provided by the agency’s Office of Worker and Community Transition. The data provided by this office relating to the detailed results of workforce restructuring at Energy’s facilities for fiscal years 1995 and 1996 were preliminary and subject to change, and we did not independently verify the data’s accuracy. The data for fiscal years 1993 and 1994 were obtained from the first report on workforce restructuring efforts. We reviewed section 3161 of the National Defense Authorization Act for Fiscal Year 1993 and Energy’s guidelines for implementing this legislation. We also discussed policies, procedures, and data with officials from the Office of Worker and Community Transition. We reviewed 35 final and draft workforce restructuring plans covering the restructuring activities at 32 of Energy’s facilities. Our summaries of these plans are included in apps. II and III and are based on our understanding of the language included in the plans; we did not contact the Energy field offices for clarification. At the four facilities we visited—Hanford, Oak Ridge, Rocky Flats, and Savannah River—contractors provided a breakdown of costs between Cold War and post-Cold War workers. To determine the extent to which the contractors at Energy’s facilities had to rehire or replace workers, and to determine the steps that the agency has taken to oversee the implementation of the plans, we interviewed the officials responsible for restructuring at the four facilities we visited and officials in the Office of Worker and Community Transition. We also reviewed narrative explanations accompanying the fiscal years 1995 and 1996 data provided by that Office, which identified the extent of rehires and backfills. We also reviewed reports by Energy’s Office of Inspector General and the results of reviews by the Chief Financial Officer at the Rocky Flats facility. Our review was performed from August through December 1996 in accordance with generally accepted government auditing standards. As arranged with your office, unless you publicly announce its contents earlier, we plan no further distribution of this report for 7 days after the date of this letter. At that time, we will send copies to the Secretary of Energy. We will also make copies available to others on request. Please call me at (202) 512-3600 if you or your staff have any further questions. Major contributors to this report were Jeffrey E. Heil, Carole J. Blackwell, Gene M. Barnes, William K. Garber, Robert E. Sanchez, Stan G. Stenersen, and Carrie M. Stevens. Energy Facilities Reporting Workforce Restructuring Costs Defense Facilities Nondefense Facilities Facilities with one or more workforce restructuring plans. Summary of Benefits Provided Under Section 3161 in 29 Workforce Restructuring Plans for Defense Nuclear Facilities Examples of range of benefit Typical enhanced retirement programs added 3 years to age and pension credited service for calculating pension benefits. None. Oak Ridge allowed the addition of only 2 years to both age and pension credited service. Most enhanced retirement offerings would not be available to employees hired after 9/27/91 because of minimum years of service requirements. The Mound plan allowed an employee, if at least age 49, to retire with an unreduced pension if age and years of service totaled 80. In addition, there was a one-time payment of 3 months of current base pay plus 1.25 percent of base pay for each year of service. Severance pay calculations were usually based on length of service and base salary. A limited number of plans provided payments in addition to severance pay. Examples include 60 days’ notice pay (Kansas City), $3,500 termination bonus (Idaho Protection Technology), and transition assistance equal to 3 months base salary (Mound). Three plans had lump-sum payment options that varied on the basis of whether employees were hired before or after 9/27/91. For example, two plans provided employees hired prior to this date with the option of a $15,000 payment, while employees hired after this date received $7,500. The remaining plans made no distinction. Fernald’s fiscal year (FY) 1994 plan provided severance pay up to a maximum of 24 weeks of pay for employees with 15 or more years of service. Fernald’s FY 1995 plan provided separation pay based on length of service up to 50 weeks of pay for employees with 35 or more years of service. Employees also received a lump-sum payment of $15,000. Lawrence Livermore National Laboratory provided 2 weeks of pay for each year of service up to a maximum of 52 weeks pay. (continued) Examples of range of benefit Most severance pay calculations were based on years of service and base salary. In one plan, employees hired after 9/27/91 were not eligible to receive separation payments. In 10 plans, severance pay was the same as for voluntary separations. The remaining plans made no distinction. Ross Aviation allowed only 2 weeks of pay in lieu of notice for involuntary separations. Los Alamos National Laboratory used two severance schedules, depending on overall length of service. One provided from 1 week of pay for employees with less than 1.5 years of service up to a maximum of 52 weeks of pay. The other provided from 2 weeks of pay for employees with less than 2 years of service up to a maximum of 39 weeks. All plans that included extended medical coverage used the Displaced Workers Medical Benefits program. For the first year, the company continues to pay its normal contribution to health insurance; for the second year, the separated worker pays one-half the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) rate and for the third and subsequent years, the full COBRA rate. The COBRA rate is equal to the full premium for group insurance plus an administrative surcharge. In six of the plans, employees hired after 9/27/91 were not eligible for extended medical coverage. The remaining plans made no distinction. All but one plan provided this coverage to both voluntary and involuntary separations, provided the employee had no alternate coverage through other employment or a spouse’s medical plan. Two plans—Pinellas and Kansas City—provided coverage for up to a year at no cost, in accordance with existing agreements. (continued) Examples of range of benefit Most of the plans provided for up to $10,000 in educational assistance over a period of 4 years for both voluntary and involuntary separations. Mound provided the maximum for degree programs and up to $5,000 for job- specific programs. In five of the plans, employees hired after 9/27/91 were not eligible for educational assistance. In three additional plans, employees who were involuntarily separated and hired after 9/27/91 were not eligible for this benefit. Fernald provided different benefits for voluntary and involuntary separations— $10,000 for voluntary and $5,000 for involuntary. In addition, Lawrence Livermore National Laboratory restricted these benefits to voluntary separations only. All but one plan (Los Alamos Cafeteria) provided relocation assistance. The amount provided ranged from $2,000 to $5,000; the Kansas City plan provided reimbursement for “reasonable and actual” relocation expenses. Four plans provided relocation assistance only to employees hired before 9/27/91. Three additional plans provided relocation assistance for involuntary separations only to employees hired before 9/27/91. The remaining plans made no distinction. All of the plans included a provision for outplacement assistance, which was available for both voluntary and involuntary separations. At most sites, an outplacement resource center was established to provide assistance to workers of all contractors on the site. One plan restricted outplacement assistance to those employed as of 9/27/91, and one plan restricted this benefit for involuntary separations of those employed as of 9/27/91. The remaining plans made no distinction. Summary of Benefits Provided in Six Workforce Restructuring Plans for Nondefense Facilities Examples of range of benefit Princeton Plasma Physics Laboratory provided, for those eligible for retirement (age 55 with at least 10 years service), a one-time incentive payment based on length of service up to 11 months of pay—no years were added to age and service for pension calculation. Severance pay normally calculated on the basis of base pay and length of service. Strategic Petroleum Reserve offered 2 weeks of base pay per year of service with a maximum payment of $25,000. Princeton Plasma Physics Laboratory included severance pay for nonexempt employees from 2 to 30 weeks for 25 years; exempt employees received from 1 to 15 months of pay for 25 years. Severance pay normally calculated on the basis of base pay and length of service. National Institute for Petroleum and Energy Research allowed 20 percent of base salary with all benefits or 25 percent of base salary with medical coverage only. Princeton Plasma Physics Laboratory included severance pay for nonexempt employees of 2 to 30 weeks for 25 years; exempt employees received from 1 to 15 months of pay for 25 years. All plans that offered extended medical coverage did so using Displaced Workers Medical Benefits: employee pays share of premium as if active employee for first year; one-half Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) rate for second year; and full COBRA rate for third and subsequent years. Maximum benefit ranges from $3,000 to $10,000 over maximum of 4 years. Maximum of $5,000, if relocation costs not reimbursed by receiving employer. Resource center established to provide outplacement assistance to all separated employees. 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Pursuant to a congressional request, GAO reviewed the Department of Energy's (DOE) workforce restructuring plans, focusing on the: (1) types and amounts of benefits provided to separated employees; (2) distinctions DOE made in determining who should receive these benefits; (3) extent to which the contractors at DOE's facilities have to rehire workers or replace them with others having similar skills, because the downsizing was not targeted sufficiently to retain critically needed skills; and (4) steps DOE has taken to oversee the implementation of the plans. GAO found that: (1) the 23,800 contractor employees separated since 1993 under DOE's workforce restructuring plans have received an average of $25,600 in benefits; (2) about 88 percent of the costs were for enhanced retirement incentives or severance pay; (3) although similar benefits were offered at most facilities, the value of these benefits varied considerably among locations, reflecting the considerable discretion given to each facility in determining how best to reduce its workforce; (4) more than half of the workforce restructuring plans provided more generous severance pay than would have normally been provided by the contractors under existing contracts, and almost all plans provided other benefits not normally provided by the contractors, such as extended medical insurance; (5) the benefits provided under the plans exceeded those that would have been provided to federal employees in a reduction in force; (6) DOE's guidelines provide that the consideration of specific benefits for contractor employees should take into account both available funding and whether the employee was hired prior to the end of the Cold War, but most plans made no distinction in the benefits provided to employees hired during the Cold War and those hired after the Cold War ended; (7) the preliminary data for fiscal years (FY) 1995 and 1996 suggest that DOE's facilities have improved their ability to retain critically needed skills during downsizing; (8) early restructuring at some facilities resulted in subsequent hiring to fill vacated critical skill positions; (9) while data are not available on the number of critical skill positions that were refilled during FY 1993 and 1994, DOE's preliminary data for FY 1995 and 1996 indicate that about 2 percent of the positions vacated had to be refilled; (10) DOE provides limited oversight over how contractors implement workforce restructuring plans; (11) according to DOE officials, once the workforce restructuring plans are approved, the responsibility for implementation is left with the contractors and little monitoring is done by DOE program personnel; and (12) reviews by DOE's Office of Inspector General and others of DOE's early restructuring efforts have identified problems with the awarding of benefits.

Background States regulate the insurance products that many employers and individuals purchase. Each state’s insurance department enforces the state’s insurance statutes and rules. Among the functions state insurance departments typically perform are licensing insurance companies, managed care plans, and the agents who sell their products; regulating insurers’ financial operations to ensure that funds are adequate to pay policyholders’ claims; reviewing premium rates; reviewing and approving policies and marketing materials to ensure that they are not vague and misleading; and implementing various consumer protections, such as assisting people who do not receive health benefits that are covered through insurance products or by providing an appeals process for denied claims. The federal government regulates most private employer-sponsored pension and welfare benefit plans (including health benefit plans) as required by the Employee Retirement Income Security Act of 1974 (ERISA). These plans include those provided by an employer, an employee organization (such as a union), or multiple employers through a multiple employer welfare arrangement (MEWA). DOL is primarily responsible for administering Title I of ERISA. Among other requirements, ERISA establishes plan reporting and disclosure requirements and sets fiduciary standards for the persons who manage and administer the plans. These requirements generally apply to all ERISA-covered employer sponsored health plans, but certain requirements vary depending on the size of the employer or whether the coverage provided is through an insurance policy or a self-funded plan where the employer assumes the risk associated with paying directly for at least some of their employees’ health care costs. In addition, ERISA generally preempts states from directly regulating employer-sponsored health plans (although maintaining states’ authority to regulate insurers and insurance policies). Therefore, under ERISA, self-funded employer group health plans generally are not subject to the state oversight that applies to insurance companies and health insurance policies. The federal and state governments coordinate their regulation of MEWAs, with states having the primary responsibility to regulate the fiscal soundness of MEWAs and to license their operators, and DOL enforcing ERISA’s requirements. DOL and States Identified 144 Unique Unauthorized Entities Operating from 2000 through 2002 That Left More Than $250 Million in Unpaid Claims DOL and the states identified 144 unauthorized entities from 2000 through 2002. This likely represents the minimum number of unauthorized entities operating during this period because some states did not report on entities that they were still investigating. The number of unauthorized entities newly identified by DOL and the states each year almost doubled from 2000, when 31 were newly identified, through 2002, when 60 were newly identified. DOL and the states found that every state had at least 5 entities operating in it. Specifically, the number of entities per state ranged from 5 in Delaware and Vermont to 31 in Texas. (See fig. 1.) Many entities marketed their products in more than one state, and some operated under more than one name or with more than one affiliated entity. These entities were concentrated in certain states and regions. Seven states had 25 or more entities that operated during this period; 5 of these states were located in the South. In addition to the 31 entities in Texas, 30 were in Florida, 29 each in Illinois and North Carolina, 28 in New Jersey, 27 in Alabama, and 25 in Georgia. At least 15,000 employers purchased coverage from unauthorized entities, affecting more than 200,000 policyholders from 2000 through 2002. The number of individuals covered by unauthorized entities was even greater than the more than 200,000 policyholders covered because the policyholder could be an employer that purchased coverage on behalf of its employees or the policyholder could be an individual with dependents. Therefore, any one policyholder could represent more than one individual. The states reported that more than half of the entities they identified frequently targeted their health benefits to small employers. At the time of our 2003 survey, DOL and states reported that the 144 entities had not paid at least $252 million in medical claims. This represents the minimum amount of unpaid claims associated with these entities identified from 2000 through 2002 because in some cases DOL and the states did not have complete information on unpaid claims for the entities they reported to us. Federal and state governments reported that about 21 percent of unpaid claims had been recovered from entities identified from 2000 through 2002—$52 million of $252 million. These recoveries could include assets seized from unauthorized entities that have been shut down or frozen from other uses. Licensed insurance agents who have marketed products offered by these entities have also reimbursed unpaid claims either voluntarily or through state or court action. Additional assets may be recovered from the entities identified from 2000 through 2002 because investigations and federal and state actions remain ongoing. However, it is likely that many of the assets will remain unrecovered because federal and state investigators report that the entities often are nearing bankruptcy when detected or otherwise have few remaining assets with which to pay claims. A few entities were responsible for a large share of the affected employers and policyholders and the resulting unpaid claims. Of the 144 unique entities, 10 alone covered about 64 percent of the employers and about 56 percent of the policyholders. They also accounted for 46 percent of the unpaid claims. In addition to the unauthorized entities selling health benefits, 14 states reported that discount plans were inappropriately marketed as health insurance products in some manner. Unlike legitimate insurance, discount plans do not assume any financial risk nor do they pay any health care claims. Instead, for a fee they provide a list of health care providers that have agreed to provide their services at a discounted rate to participants. In response to our survey, 40 states reported that they were aware that discount plans were marketed in their state. While discount plans are not problematic as long as purchasers clearly understand them, 14 of these states reported that some discount plans were misrepresented as health insurance. For example, some discount plans were marketed with terms or phrases such as “medical plan,” “health benefits,” or “pre-existing conditions immediately accepted.” However, state insurance departments do not regulate discount plans because they are not considered to be health insurance. Thus, while state insurance departments might be aware that discount plans operated within their borders, they would not necessarily be able to quantify the extent to which they exist. Most Unauthorized Entities Characterized Themselves as One of Several Types of Arrangements and Some Had Other Approaches in Common The 144 entities that federal and state governments identified from 2000 through 2002 varied in size and specific characteristics, but most were variations of one of four types of arrangements and some had other approaches in common that enhanced their appearance of legitimacy and attractiveness to prospective purchasers. For example, about 80 percent of the entities characterized themselves as one of four arrangements— associations, professional employer organizations, unions, or single- employer ERISA plans—or some combination of these arrangements. According to DOL and the states, specifically: 27 percent of the entities characterized themselves as association arrangements through which employers or individuals bought health benefits through existing legitimate associations or through newly created associations established by the unauthorized entities. Although some of these entities claimed that this structure would shield them from oversight by federal or state governments, these associations would be subject to federal and state oversight if they were determined to be MEWAs. 26 percent of the entities were identified as professional employer organizations, also known as employee leasing firms, which contracted with employers to administer employee benefits and perform other administrative services for contract employees. However, professional employee organizations could be subject to federal and state requirements if, in addition to providing administrative services, they managed assets or controlled benefits for multiple employers. 9 percent of the entities identified claimed to be union arrangements that would be exempt from state regulation. However, they lacked legitimate collective bargaining agreements and were therefore subject to state oversight. 8 percent of the entities identified characterized themselves as single- employer ERISA plans and claimed to be administering a self-funded plan for a single employer. Such plans, when administered with funds from one employer for the benefit of one employer’s workers, are exempt from state insurance regulation under ERISA. However, assets for several employers were commingled in these entities, making them MEWAs subject to state regulation. 10 percent of the entities were reported as a combination of one of these or other types of arrangements. The operators of these entities often characterized the entities as one of these common types to give the appearance of being exempt from state regulation, but often states found that they actually were subject to state regulation as insurance arrangements or MEWAs. These entities sometimes took other steps to enhance their appearance of legitimacy and make their products attractive to prospective purchasers. For example, some entities adopted names that were familiar to consumers or similar to those of marketed their products through licensed agents; established relationships with networks of health care providers and with companies that provide administrative services for employers offering health benefits; set premiums below market rates; marketed to employers or individuals that were particularly likely to be seeking affordable insurance alternatives, such as small employers, workers in industries such as construction or transportation who are disproportionately more likely to be uninsured, and self-employed individuals; and paid initial claims while collecting additional premiums before ceasing claims payments. One of the most widespread entities during the period we examined that illustrates some of these approaches was Employers Mutual, incorporated in Nevada in July 2000. According to court documents and DOL, four individuals (“the principals”) operated Employers Mutual and, during a 10-month period from January through October 2001, collected a total of approximately $16 million in premiums in every state from over 22,000 people. Today, more than $24 million in medical claims against Employers Mutual remain unpaid. The name Employers Mutual is similar to the name of a long-established Iowa-based insurance company marketed throughout the United States, Employers Mutual Casualty Company, which had no affiliation with Employers Mutual. Notably, both in 1998 and in 2000, one of the Employers Mutual principals was found to have engaged in the health care insurance business in California without a license and was barred from engaging in any insurance business in that state. Two of the principals formed 16 associations having names relating to workers in a wide array of industries and professions, such as farmers, construction workers, mechanics, and food service employees. Principals were named as the “managing members” of all 16 associations and created an employee health benefit plan for each association. The principals contracted with legitimate firms to process claims and to market the plans to employers nationwide. Employers Mutual claimed that it was exempt from DOL regulation. One of the principals, who was not a licensed actuary and had no formal training, set the premiums for the 16 plans after he calculated the average of sample rates posted by insurance companies on the Internet and reduced them to ensure that Employers Mutual offered low prices. The principals also formed two companies, Columbia Health Network and Western Health Network, that purported to provide networks of health care providers for people insured by Employers Mutual. Additionally, the principals formed two other companies, Graf Investments and WRK Investments, which purported to provide investment services. However, these companies were found to be vehicles for the illegal diversion of over $1.3 million of plan assets. When Nevada insurance regulators became aware of Employers Mutual, they found that it was transacting insurance business without a certificate of authority as required by Nevada law and issued a cease and desist order against Employers Mutual in June 2001. Subsequently, other states also issued cease and desist orders against Employers Mutual. In December 2001, based on a petition from DOL, the U.S. District Court for the District of Nevada granted a temporary restraining order against Employers Mutual and its four principals. The restraining order temporarily froze the assets of all the principals and prohibited them from conducting further activities related to the business. It also appointed an independent fiduciary to administer Employers Mutual and associated entities and, if necessary, implement their orderly termination. On September 10, 2003, the district court issued a default judgment granting a permanent injunction against the principals and ordered them to pay $7.3 million in losses suffered as a result of their breach of fiduciary obligations to beneficiaries. The fiduciary has also sued and sought settlements from insurance agents who marketed or sold Employers Mutual’s plan for damages and relief from unpaid or unreimbursed claims. Employers Mutual is also under investigation by law enforcement authorities. Appendix I includes a chronology of events from Employers Mutual’s establishment to state and federal actions to shut it down. States and DOL Share Responsibility for Identifying, Stopping, and Preventing the Establishment of Unauthorized Entities Both federal and state governments have responsibility for identifying unauthorized entities and stopping and preventing them from exploiting businesses and individuals. DOL’s EBSA conducts civil and criminal investigations of employer-based health benefits plans that are alleged to violate federal law as part of its responsibilities for enforcing ERISA. For example, EBSA may identify entities whose operators have breached their ERISA fiduciary responsibilities, which generally require managing benefit plans and assets in the interest of participants. State insurance departments investigate entities and individuals that violate state insurance or MEWA requirements, such as selling insurance without a license. Because some entities may violate both federal ERISA requirements and state insurance requirements, both EBSA and states may investigate the same entities or coordinate investigations. Of the 144 unique entities DOL and states identified, the states identified 77 entities that DOL did not, DOL identified 40 that the states did not, and both the states and DOL identified another 27. States and DOL often relied on the same method to learn of the entities’ operations—through consumer complaints. States also received complaints about these entities from several other sources, such as agents, employers, and providers. In addition, NAIC played an important role in the identification process by helping to coordinate and distribute state and federal information on these entities, and states and DOL also reported that they coordinated directly. For example, DOL submitted quarterly reports to NAIC that identified all open civil investigations, the individuals being investigated, and the EBSA office conducting the investigations. NAIC shared this and other information from EBSA regional offices with state investigators throughout the country. After identifying the unauthorized entities, the primary mechanism states used to stop them from continuing to operate was the issuance of a cease and desist order. Generally, a state cease and desist order tells the operator of the entity, and affiliated parties, to stop marketing and selling health insurance in that state and in some cases explicitly establishes their continuing responsibility for the payment of claims and other obligations previously incurred. Such an order, however, only applies to the activity in the issuing state. Thirty states reported that they issued a total of 108 cease and desist orders that affected 41 of the 144 unique entities. About 58 percent of policyholders and nearly half of the total unpaid claims were associated with these 41 entities. States also took other actions against some entities, sometimes in conjunction with issuing cease and desist orders. For example, in 48 instances, states responding to our survey reported that they took actions against or sought relief from the agents who sold the entities’ products, including fining them, revoking their licenses, or ordering them to pay outstanding claims. States also reported that they took actions against the entity operators in 25 instances and filed cases in court in 14 instances to pursue civil or criminal penalties. DOL often relied on states to stop unauthorized entities through cease and desist orders while it conducted investigations, usually in multiple states, to obtain the evidence needed to stop these entities’ activities nationwide through the federal courts—that is, by seeking injunctive relief and, in some cases, pursuing civil and criminal penalties. DOL’s enforcement actions apply to all states. To obtain a temporary restraining order or injunction, DOL must offer sufficient evidence to support its claim that an ERISA violation has occurred and that the government will likely prevail on the merits of the case. As of December 2003, DOL had obtained temporary restraining orders against three entities for which investigations were opened from 2000 through 2002. In two of these cases, DOL also obtained preliminary injunctions and in one case ultimately issued a permanent injunction. Each of these actions affected people in at least 41 states. (See table 1.) These three entities combined affected an estimated 25,000 policyholders and accounted for about $39 million in unpaid claims. Documenting that a fiduciary breach took place can be difficult, time- consuming, and labor-intensive because DOL investigators often must work with poor or nonexistent records, uncooperative parties, and multiple trusts and third-party administrators. As of August 2003, EBSA was continuing to investigate 51 of the 69 entities it had investigated from 2000 through 2002. As a result, further federal actions remain possible. To help prevent unauthorized entities from continuing to operate, the four states we reviewed—Colorado, Florida, Georgia, and Texas—and DOL alerted the public and used other methods. These states, which were among the states with a moderate or high number of entities, and DOL emphasized the need for consumers and employers to check the legitimacy of health insurers before purchasing coverage, thus helping to prevent unauthorized entities from continuing to operate. To help states increase public awareness, NAIC developed a model consumer alert in the fall of 2001, which it distributed to all the states and has available on its Web site. Insurance departments in the four states took various actions to prevent unauthorized entities from continuing to operate. Each of these states issued news releases to alert the public about these entities in general and to publicize the enforcement actions they took against specific entities. The four states’ insurance departments also maintained Web sites that allow the public to search for those companies authorized to conduct insurance business within their borders, and some states also released public service announcements via radio, television, or billboards. In addition to increasing public awareness, the four state insurance departments warned insurance agents through bulletins, newsletters, and other methods about these entities, the implications associated with selling their products, and the need to verify the legitimacy of all entities. DOL primarily targeted its prevention efforts to employer groups and small employers. For example, to help increase public awareness about these entities, on August 6, 2002, the Secretary of Labor notified over 70 business leaders and associations, including the U.S. Chamber of Commerce and the National Federation of Independent Business, about insurance tips that the department had developed and asked them to distribute the tips to small employers. Also, the EBSA regional offices initiated various activities within the states in their regions. For example, EBSA’s Atlanta regional office sponsored conferences that representatives from 10 states and NAIC attended. Concluding Observations Recent double-digit premium increases for health coverage have encouraged employers, particularly small employers, and individuals to search for affordable coverage. At the same time, however, these premium increases have created an environment that makes them vulnerable to being exploited by unauthorized or bogus entities. This has been reflected by the increasing number of these entities identified by federal and state governments in recent years. As a result, tens of thousands of employers and hundreds of thousands of individuals have paid premiums for essentially nonexistent coverage. As many employers and individuals continue to seek affordable health coverage alternatives in this environment of rising premiums, it is especially important that federal and state governments remain vigilant in identifying, stopping, and preventing the establishment of these entities and continue to caution individuals, employers, and their agents to verify the legitimacy of entities offering coverage. Mr. Chairman, this completes our prepared statement. We would be happy to respond to any questions you or other Members of the Committee may have at this time. Contacts and Acknowledgments For future contacts regarding this testimony, please call Kathryn G. Allen at (202) 512-7118 or Robert J. Cramer at (202) 512-7455. Other individuals who made key contributions include John Dicken, Joseph Petko, Matthew Puglisi, Andrew O’Connell, and Paul Desaulniers. Appendix I: Chronology of Key Events Regarding Employers Mutual, LLC Figure 2 summarizes key events regarding Employers Mutual, one of the most widespread unauthorized entities operating in recent years. Employers Mutual collected approximately $16 million in premiums from over 22,000 people in 2001, and left more than $24 million in unpaid medical claims. January - October 2001 Employers Mutual collects approximately $16 million in premiums from over 22,000 policyholders. January 2002 U.S. District Court holds hearing. February 1, 2002 U.S. District Court issues preliminary injunction. March 3, 2003 Independent fiduciary files civil complaint against Employers Mutual's principals and insurance agents and brokers that marketed the 16 plans. January - October 2001 Employers Mutual pays principals' investment firms. April 30, 2002 U.S. District Court issues quasi-bankruptcy order. May 2001 Principals establish two provider networks. September 10, 2003 U.S. District Court issues a default judgment granting a permanent injuction against Employers Mutual. Principals ordered to pay $7.3 million. June 14, 2001 Nevada issues cease and desist order against Employers Mutual. October 20, 2003 U.S. District Court orders the civil suit to mediation in February 2004. August - November 2001 Alabama, Colorado, Florida, Oklahoma, Texas, and Washington take action against Employers Mutual. October 3, 2001 Claims processing firm terminates contract with Employers Mutual. November 21, 2001 Nevada seizes Employers Mutual's assets held in Nevada banks. December 13, 2001 U.S. District Court for the District of Nevada grants a temporary restraining order against Employers Mutual and appoints an independent fiduciary. December 20, 2001 Nevada surrenders to independent fiduciary the Employers Mutual assets it seized. 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As health insurance premiums have risen at double-digit rates in recent years, employers and individuals who have sought to purchase more affordable coverage have fallen prey to certain entities that may offer attractively priced premiums but do not fulfill the expectations of those buying health insurance. These unauthorized entities--also known as bogus entities or scams--may not meet the financial and benefit requirements typically associated with health insurance products or other arrangements that are authorized, licensed, and regulated by the states. This testimony is based on GAO's recent report Private Health Insurance: Employers and Individuals Are Vulnerable to Unauthorized or Bogus Entities Selling Coverage, GAO-04-312 (Feb. 27, 2004). In this testimony, GAO was asked to identify the number of entities that operated from 2000 through 2002 and the number of employers and policyholders affected, approaches and characteristics of these entities' operations, and the actions federal and state governments took against these entities. GAO analyzed information obtained from the Department of Labor (DOL) and from a survey of insurance departments in the states; interviewed officials at DOL and at insurance departments in Colorado, Florida, Georgia, and Texas; and examined the operations of one of the largest entities--Employers Mutual, LLC. DOL and the states identified 144 unique entities not authorized to sell health benefits coverage from 2000 through 2002. Although every state was affected by at least 5 of these entities, these entities were most often identified in southern states. These unauthorized entities covered at least 15,000 employers and more than 200,000 policyholders. The entities also left at least $252 million in unpaid medical claims, only about 21 percent of which had been recovered at the time of GAO's 2003 survey. In most cases, the operators characterized their entities as one of several types to give the appearance of being exempt from state regulation, but states found that they actually were subject to state regulation. Other characteristics that were common among at least some of these entities included (1) adopting names that were familiar to consumers or similar to legitimate firms, (2) marketing their products through licensed agents and with other health care or administrative service companies, (3) setting premiums below market rates, (4) marketing to employers or individuals that were particularly likely to be seeking affordable insurance alternatives, and (5) paying initial claims while collecting additional premiums before ceasing claims payments. Employers Mutual adopted many of these characteristics as it collected approximately $16 million in premiums from over 22,000 people in 2001, leaving more than $24 million in medical claims unpaid. Both federal and state governments--individually and collaboratively--took action against these entities and sought to increase public awareness. For example, state insurance departments issued cease and desist orders against 41 of the 144 entities, and DOL obtained court orders against three large entities from 2000 through 2002. States also took other actions against some entities' operators and agents that received commissions for marketing these entities. Further state or federal actions remain possible as many investigations remain ongoing. States and DOL primarily focused their prevention efforts on improving public awareness, including the need for consumers, employers, and insurance agents to verify an entity's legitimacy with insurance departments.

Background History of the UN Headquarters Complex The original UN headquarters complex in New York City was considered among the most modern facilities when construction was completed in 1952; however, it no longer conforms to current safety, fire, and building codes and does not meet UN technology or security requirements. Although originally designed to hold 70 member states, the complex currently accommodates the needs of 192 member states and approximately 4,700 UN staff and also hosts nearly 1 million visitors per year from around the world. The United States financed construction of the original complex—the General Assembly, Secretariat, and Conference Building—by providing the UN with a no-interest loan. The rest of the present-day complex—the Dag Hammarskjöld Library, the underground North Lawn Extension, South Annex, and Unitar Building—was built between 1960 and 1982 and was funded through the UN regular budget or private donations. Under the CMP, the UN intends to renovate the complex to make it conform to current safety, fire, and building codes and meet UN technology and security requirements (see fig. 1). This process will involve upgrading or replacing all major building systems, including electrical, plumbing, fire suppression, heating and air conditioning, as well as reinforcing structural integrity and removing asbestos from the entire complex. As shown in figure 2, the General Assembly first proposed a comprehensive renovation in June 2000. Under the current schedule, work associated with the renovation will begin in early 2007 with an estimated completion date of 2014. The Renovation Process In June 2001 and May 2003, we reported that the UN’s early renovation planning was reasonable and consistent with leading industry practices. By 2003, the UN had completed the first stage of a five-stage renovation process—conceptual planning. In December 2002, the General Assembly authorized the Secretary-General to proceed with the second stage, design. According to CMP officials, as of July 2006, the project was about 60 percent through this stage (see fig. 3). The five stages of a renovation project are summarized as follows: Stage 1: Conceptual Planning—Feasibility studies are conducted to determine scope of work and alternative design solutions incorporating requirements for performance, quality, cost, and schedule. Several alternative design solutions are identified, and one approach is generally selected. Stage 2: Design—The preferred design solution is further developed, culminating in the development of final construction documents from which construction services can be solicited. Stage 3: Procurement—Owner procures construction services and long lead-time equipment, such as unique or large electrical or mechanical equipment. Stage 4: Construction—Contractors and consultants are employed to execute the renovation based on the construction documents. Stage 5: Start-up—Building is occupied and tests are conducted on individual and systems components to ensure that they are operating correctly. In its December 2002 authorization, the General Assembly decided to implement the CMP and execute the design phase. In developing design documents for the renovation, the General Assembly instructed the CMP office to include options that the General Assembly has not yet decided whether to include in the renovation. The options were divided into three categories: security, system redundancies, and sustainability and include additional blast protection, backup equipment for building communications systems, increased coverage and reliability for emergency power, higher efficiency equipment, and on-site alternative energy sources. These options could enhance operational and working conditions but were not considered integral to the project at the time. Because of difficulties in securing off-site space to temporarily relocate UN staff and activities, the UN has changed its renovation approach. In May 2003, we reported that the UN had decided on a single-phased approach to the renovation, in which most UN staff and activities would be temporarily relocated so that the buildings could be renovated concurrently. The U.N. Development Corporation would have built a new building, referred to as UNDC-5, adjacent to the UN headquarters where UN activities could continue during the renovation. However, the UN determined that this option was no longer viable when the corporation could not secure approval for the new building from the New York State legislature in time for the beginning of construction. In June 2006, the General Assembly approved proceeding with the renovation project using a multiphased approach. This approach consists of renovating the Secretariat building, 10 floors at a time, and moving UN staff and functions displaced by the renovation to rented commercial office space and a temporary building to be constructed on the North Lawn above the existing North Lawn extension. The CMP office has modified its design documents to reflect this multiphased renovation approach and moved forward with completing the required design details. This information will be used in the procurement process to solicit construction services. Renovation Process Continues to Follow Leading Industry Practices but Faces Challenges Going Forward Consistent with our 2001 and 2003 reviews of the early planning for the renovations, we found that UN officials continue to follow leading industry practices in the development of the UN headquarters renovation project. These include involving those impacted by the project, using a competitive procurement process, and using a team to review the design. However, reliance on existing procurement processes and the vacancy of the leadership post could create challenges as the project proceeds. Those Affected by the Project Involved in its Development The CMP office has continued to consult with UN managers and other affected entities, such as the city of New York, in the various aspects of planning and designing the renovation to help ensure that the project meets their needs. The CMP office has solicited input from officials in various UN departments during the design review process. In addition, while not required, it is UN policy to follow city and state codes. To facilitate the implementation of the project, the CMP office continues to coordinate and meet with the city and state of New York to discuss the UN’s renovation plans. The CMP office has also taken steps to ensure that information about the renovation is readily available to stakeholders and the public. It has established a Web site, www.un.org/cmp, which explains the renovation project and provides related UN documents and opportunities to direct comments to the CMP office. Competitive Procurement Used but UN Procurement Process Has Weaknesses The CMP office has continued to use a competitive process to procure program management, planning, and design services for the renovation project. Competition among multiple firms is important for obtaining a quality product at a reasonable price. As part of the competitive process, the CMP office and UN officials issued requests for proposals, obtained proposals from multiple firms, evaluated the proposals based on established criteria, and selected firms to perform the work. OIOS reviewed the CMP procurements and reported that the process was fair and transparent. To increase visibility of the procurements related to the CMP, the procurement division has created a page on its Web site, www.un.org/depts/ptd/, for CMP awards that lists information such as the contractor, subject of the contract, and award amount. The CMP office is also exploring the possibility of posting copies of the awarded contracts on this Web site. Although the CMP office has used a competitive process to date, we reported in April 2006 that the UN’s procurement process has numerous weaknesses. For example, the UN has yet to incorporate guidance for construction procurement into its procurement manual, and the chairman of the UN procurement contract review committee has stated that his committee did not have the resources to keep up with its expanding workload. In addition, the UN had not established an independent process to consider vendor protests that could alert senior UN officials of procurement staff’s failures to comply with stated procedures. The UN is currently in the process of hiring a construction manager to oversee the day-to-day project activities and the subcontractors performing the construction work. CMP officials stated that as the project progresses, the CMP office will continue to be responsible for the daily oversight and administration of the CMP contracts. In addition, according to a UN procurement official the UN procurement division will be involved in processing contract amendments and ensuring compliance with UN procurement rules and procedures. According to CMP officials, to address resource shortfalls in the UN procurement division, funding has been made available from the CMP budget to hire three new staff with construction-related experience. Experienced Team in Place to Review Renovation Design, but Vacancy in Leadership Post Exists Within the UN, the CMP office manages the development and execution of the renovation project, including the review of the ongoing renovation design. The CMP office has supplemented its in-house staff with a consultant to assist with design review and cost estimate development. While the UN was considering different renovation approaches, the CMP office instructed its contractors to incorporate flexibility in the design so it could be tailored to work with any of the approaches being considered. This ensured that when the UN selected a multiphased approach in August 2006, there was little need for redesign. Although the CMP office has continued moving the renovation project forward, it has often lacked an executive director. The executive director provides leadership, support, and direction to the project, and acts as the primary representative of the CMP to the General Assembly and UN stakeholders. In February 2003, the Secretary-General appointed the first executive director for the CMP, but he left after about a year. The position remained vacant until September 2005 when the UN hired a CMP executive director with experience working on large construction and renovation projects in New York City. However, he left in June 2006 and the position is currently vacant. The current staff are now performing the executive director’s duties as well as their own. UN officials have stated that they recognize the importance of having a CMP executive director and are working to fill the position. Cost Estimate Increased; Industry Practices Followed but Estimate Likely to Change The estimated total cost of the CMP increased from about $1.19 billion to almost $1.75 billion—an almost $560 million increase—between 2002 and 2005 to reflect inflation arising from a later start date, refinements to the design, and a multiphased renovation approach. In developing the 2005 estimate, the CMP office followed industry practices such as defining the work required and reviewing the estimate. In November 2006, the Secretary-General released a progress report on the CMP that included an updated cost estimate of $1.88 billion. This estimate was developed before the design phase was completed; therefore, it is still preliminary and likely to change. Cost Estimate Increased Due to Changes in Schedule, Refinements to the Design Project, and Approach As shown in table 1, the estimated total cost of the CMP including the scope options increased from about $1.19 billion to about $1.75 billion between 2002 and 2005. The change in the scheduled start date and project duration increased estimated costs due to inflation. In August 2002, the CMP office projected that the renovation project would begin in 2005 and be completed in less than 5 years. By December 2005, the CMP office had adjusted the schedule to a 7-year multiphased approach. The CMP office’s cost estimator determined that the New York City construction industry for projects similar to the UN renovation experienced about 11 percent inflation between 2002 and 2004, which accounts for almost $103 million of the estimated cost increase. In addition, the escalation costs in the estimate increased by $185 million to account for the expected inflation over the duration of the project, including the additional 2 years that were added to the project schedule for the multiphased approach. Any future changes that extend the start date or duration of the renovation would be expected to further increase the cost of the project. We have previously reported that changes in the cost estimate should be expected as the design progresses and more project details become known. The 2002 estimate is based on a broad conceptual design, whereas the 2005 estimate was based on a more detailed project design. For example, the 2005 estimate was based on the actual number and size of the systems needed, rather than an overall cost estimate for the heating and air conditioning systems, as in the 2002 estimate. These types of design refinements increased the cost estimate by about $80 million. The Secretary-General’s third annual progress report on the CMP noted that the process of controlling the scope and cost of the CMP would continue to be part of the project management process during design development and contract document preparation. According to CMP officials, efforts are under way to reduce the construction cost through value engineering and detailed scope review. The change to using a multiphased renovation approach, in which parts of the buildings will be renovated while other parts remain in operation, increased the project’s complexity and required the CMP office to make numerous adjustments to the estimate. For example, 20 percent was added to the expected cost of replacing the window structure on the outside of the Secretariat building because it will have to be done in more than one stage and additional waterproofing will be required. There was also a cost associated with isolating those floors being renovated from those that will be occupied by UN staff during the renovation. In addition, the source of temporary space needed for UN complex occupants during the renovation changed after the 2002 estimate was completed. In the 2002 estimate, the UN had expected to lease about 800,000 square feet of office and conference space in the new UNDC-5 building at below market rates. Since the proposed UNDC-5 building will not be built and the rental rates in New York City have increased considerably, the 2005 estimate reflects the UN’s revised plan to (1) lease about 228,000 square feet of office space and 80,000 square feet of library space at market rates for displaced staff and functions and (2) construct a 100,000 square foot temporary building on the UN complex to meet the conference needs of the UN during the renovation. While the projected amount of necessary office space has decreased since the last estimate, it will be needed for a longer period of time, and the projected rental rates have increased substantially. The CMP office estimated that the change to a multiphased renovation approach added about $188 million to the 2005 estimated CMP cost. In November 2006, the Secretary-General’s fourth annual progress report on the CMP updated the total project cost estimate from about $1.75 billion to about $1.88 billion, an increase of approximately $128 million. According to the report, this increase is due primarily to increases in the cost of swing space ($50 million) and further development of the scope options ($69 million). The report also identifies some areas where the project cost is at risk of increasing further. For example, the UN would need to add a visitor screening area to the renovation project, if the proposed visitors’ center, which includes a visitor screening area, is not constructed. Cost Estimate Updated Following Industry Practices The CMP office continues to follow leading industry practices in updating the project cost estimate. In 2003, we reported that the UN had defined the work to be done, developed a standardized format for the cost estimate, had the estimate reviewed, and reported the estimate including its range of accuracy. Using the same leading industry practices, the CMP office updated the previous cost estimate to reflect the multiphased approach. The 2005 cost estimate includes relevant cost elements such as design, construction, overhead, management, contingency and escalation. Although the cost of new furniture and equipment is not included in the cost estimate for the CMP, the UN plans to purchase them for the renovated space through its regular budget. The CMP office is working with the various UN departments to estimate these costs for inclusion in the departments’ future budget submittals. Cost Estimate Still Preliminary and Likely to Change Following leading industry practices, the CMP office is continuing to update the total project cost estimate at major milestones in the project. According to the Construction Industry Institute, the final cost of any project at this stage of design may vary from plus or minus 20 to 30 percent of the estimate. The CMP office recently updated the project cost estimate on the basis of the ongoing design work. In accordance with industry practice, the CMP office will again update the cost estimate after the completion of the construction documents. This estimate will be based on actual quantities of materials that have been identified and the range of accuracy of this estimate is expected to increase to plus or minus 15 to 20 percent. In addition, CMP officials stated that they are planning to have this estimate independently reviewed. Several uncertainties outside the UN or CMP office’s control could also have a significant impact on the final cost of the project. The decreased availability of office space in mid-town Manhattan has driven up rental rates, which could make it difficult to procure the space necessary to relocate staff during the renovation at the 2005 estimated cost. In addition, construction costs could increase if the impending redevelopment of the World Trade Center site limits construction resources. The General Assembly Has Not Decided How to Finance Remaining Renovation Project Costs While the General Assembly has passed a resolution expressing a preference for cash assessments, it has yet to decide how to finance the bulk of the renovation. Under the cash assessment approach, each member state would likely be assessed the cost of the renovation based on the rate of its annual regular budget contributions to the UN. In addition, to assure the UN’s contractors that it can pay them for their work, the UN may obtain a commercial letter of credit. If the General Assembly decides to finance the renovation using direct assessments, the United States could explore the viability of renewing a prior loan offer to the UN to act as a line of credit, which could decrease the cost of any commercial borrowing. The General Assembly plans to revisit the issue of financing the CMP by the end of 2006. The General Assembly Has Not Decided on a Financing Arrangement for Its Remaining Renovation Project Costs While the General Assembly has passed a resolution stating that cash assessments would be the simplest and most cost-effective approach for funding the CMP, it has yet to decide how to finance the remaining $1.43 billion, which excludes scope options. The UN has already assessed member states for $152 million of the estimated renovation cost and obtained $8 million from the UN regular budget. In June 2006, the General Assembly decided to defer the issue of funding the CMP to the 61st General Assembly session, which began in September 2006. The UN appropriated a total of $160 million between 2000 and 2006 for various prerenovation activities (see table 2). Member States Considering Cash Assessments to Finance Renovation In June 2006, the General Assembly passed a resolution stating that a cash payment option, based on single- or multiyear assessments, would be the simplest and most cost-effective approach to funding the CMP. Under this approach, member states would pay their portion of the renovation in single- or multiyear payments. According to the CMP office, this could lower member states’ total assessments because the UN could invest these funds and earn interest on them, if received in advance of use. For example, member states would need to pay the UN $1.24 billion in 2007 to fund the remaining $1.43 billion renovation cost if the project was funded with one lump-sum assessment. As table 3 shows, the total amount member states would be assessed increases as the number of assessment periods increases, since there is less time for interest to accrue and offset costs. If the United States paid for its portion of the renovation in one lump sum, Table 4 shows that it would owe the UN approximately $274 million in 2007 under the 2005 cost estimate. If the United States paid over five years, it would pay a total of $302 million. If the General Assembly decides to finance the renovation through multiyear assessments, the UN may use a commercial letter of credit to demonstrate to its construction contractors that it has funding available for the project before construction begins and to meet short-term financing needs. Consistent with U.S. industry practice, construction contractors are not expected to agree to begin work without proof that the UN can pay the entire cost of the renovation work. To purchase a letter of credit, the UN would pay a fee based on the total amount of the letter of credit and the degree of risk the lender estimates the UN represents as a borrower. According to UN officials, the transaction fee associated with a letter of credit could range from $3 to $21 million, depending on whether or not a member state loan is available to back up the letter of credit. The cost of these fees has not been included in the UN’s cost estimate for the renovation. If the UN decides to purchase a letter of credit, these fees would represent an additional yearly cost to the member states. According to the CMP office, the fees would decrease over time as the UN pays for portions of the project, thus decreasing the amount it would need to have covered by a letter of credit. In addition, the Secretary-General has noted that the UN would need a working capital reserve if the General Assembly agreed to multiyear assessments. In the event of delays in member state payments, the UN periodically may not have sufficient funds to pay contractors. A working capital reserve of $45 million could be used to cover temporary cash flow shortages. Subsequently, the letter of credit could also supplement short- term cash flow needs in the event of delays in member state payments. Under such circumstances, the UN could rely on the commercial letter of credit as a source of short-term borrowing to pay its contractors and then repay the lender with interest when member states pay their assessments. A Renewed U.S. Loan Offer Could Reduce Cost of UN Commercial Borrowing If the UN decides to finance the renovation using cash assessments, the United States could explore the viability of renewing a prior loan offer to the UN, which could decrease the cost of a commercial letter of credit or short-term borrowing. In March 2005, the U.S. offered the UN a $1.2 billion loan at 5.54 percent interest that could act as a line of credit or a loan guarantee. The UN had anticipated receiving a noninterest-bearing loan from the United States, and the General Assembly did not accept the U.S. offer. Although member states are no longer considering a U.S. loan to finance the renovation, if the UN were to accept a renewed loan offer, the UN could use it to reduce the cost of commercial borrowing needed under a multiyear cash assessment plan. The UN would represent a lower credit risk, and commercial lenders would likely charge the UN less to purchase a letter of credit. In addition, the UN would likely pay less to arrange short-term borrowing if it needed to borrow funds to pay its construction contractors. The United States could explore renewing its loan offer because Congress appropriated $6 million to cover the cost of the loan and directed that the funds remain available until spent. However, under current U.S. law, U.S. assessments cannot go toward interest payments on UN external borrowing, including a loan from the United States. While Congress passed a statute for fiscal year 2005 specifically exempting U.S. assessments for the renovation from this provision, State Department officials stated that this is an annual provision that was not renewed for fiscal year 2006. Decisions Needed by December 2006 to Maintain the Current Start Date and Avoid Increased Costs The CMP’s current schedule could be delayed and costs could increase if the General Assembly does not make certain decisions by the end of 2006. Specifically, the UN would need a decision by the General Assembly on a financing arrangement and a total CMP budget to ensure that funds could be available by December 2007 so that the UN can procure construction services. Without a General Assembly decision on a financing arrangement and approval of a total CMP budget by the end of 2006, the CMP office may not be able to determine a start date for renovation work. The CMP office plans to temporarily move UN staff and activities to off-site office space during the renovation. However, without a start date, it may be more difficult for the CMP office to lease and prepare this space in an efficient and timely manner, which could delay the start date and increase project costs. According to the current CMP schedule, the UN would sign leases for temporary space by the end of 2006, begin preparing that space in early 2007, and relocate no later than early 2008. The start of renovation work could also be delayed if the General Assembly does not decide on a financing arrangement that ensures funds are available for the CMP by December 2007. To remain on the current schedule, the CMP office would need the first assessment paid by the end of 2007. A delay in the beginning of renovation work is likely to increase the project’s cost due to future inflation and overhead costs. As previously discussed, a significant portion of the increase in the 2005 cost estimate was due to moving the start date of the renovation from 2005 to 2008. The UN’s most 2005 cost estimate applies an inflation rate of 4 percent for 2007. UN Entities Have Continued Oversight of the CMP and State Has Monitored CMP Progress OIOS and the UN Board of Auditors have continued their oversight of the CMP since 2003. However, the extent to which OIOS must negotiate with the UN Office of Program Planning, Budget, and Accounts (OPPBA) for future funding could affect OIOS’s ability to conduct effective oversight of the CMP. In addition, State has continued to monitor the CMP and inform U.S. policy on the renovation. OIOS Has Conducted Oversight of the CMP Office OIOS has been conducting oversight of the CMP office since 2003 and has not found any material weaknesses in its work. Specifically, OIOS has reviewed draft procurement documents and participated in regular meetings with CMP, UN Procurement Services, and Office of Legal Affairs officials concerning the contracting of design and consulting services. OIOS found that the draft procurement documents needed to be modified to reflect the project’s complexity and size. OIOS also found that the CMP office’s process for procuring consulting services, such as a real estate broker to find temporary space for UN activities, was fair. Further, OIOS concluded that the CMP office had generally used its resources in accordance with UN financial rules. Currently, OIOS is developing an audit plan to guide its oversight during the construction phase, according to OIOS officials. OIOS will need additional staff with expertise in construction oversight as the work becomes more technical and complex and is considering hiring an outside consulting firm to assist with its oversight responsibilities as the renovation proceeds. OIOS’s Oversight Impaired by Its Funding Arrangement OIOS relies on funds from the CMP budget to conduct effective oversight of the CMP, which may impair its ability to secure sufficient funds. Generally, OIOS derives its funding through its regular budget and through extrabudgetary resources that come from the budgets for a variety of specific projects and activities, including the CMP office. To oversee the CMP, OIOS submitted work plans to the OPPBA and requested extrabudgetary funds from the CMP budget. OIOS noted in October 2004 and August 2005 that it required two full-time auditors to provide adequate audit coverage of the CMP. However, OPPBA determined that only one auditor was needed to complete the oversight activities that OIOS proposed, given the early stage of the CMP, according to an OPPBA official. We previously reported that OIOS’s reliance on extrabudgetary funds and limitations on how OIOS may spend its funds constrains its ability to conduct effective oversight. When relying on extrabudgetary funds, OIOS must obtain permission to perform audits or investigations from the managers of funds and programs, and negotiate the terms and funds for its oversight work. In addition, UN rules and regulations severely limit OIOS’s ability to reallocate resources from different sources. Therefore, OIOS cannot always direct resources to oversight of high-risk areas as they arise. The extent to which OIOS must negotiate for future funding during the construction phase of the renovation will affect OIOS’s ability to conduct effective oversight. Indeed, in a June 2006 resolution, the General Assembly noted that the CMP office will provide OIOS with resources to conduct an appropriate construction audit of the CMP. UN Board of Auditors has Conducted Oversight of CMP The UN Board of Auditors, an external oversight entity that reports to the General Assembly, has conducted yearly audits of the CMP financial statements since 2003. The board’s four objectives have been to evaluate the CMP office’s project accounting, payment and reporting ascertain the CMP office’s compliance with UN regulations and rules on determine whether CMP contractors have adhered to the terms of contract, such as deliverables, time, and materials provisions; and review the CMP office’s controls and processes established to properly manage the project. In reports on the CMP office released in September 2004 and August 2005, the board found that delays in the planning process had impacted the schedule for the completion of design development. The board also found that an advisory board for the Secretary-General had not been formed. The board did not note any instances of fraud or presumptive fraud within the CMP office. As the renovation proceeds with construction, the UN Board of Auditors will develop a new audit plan. The board will likely consider the CMP office’s new cost system for tracking funds and expenditures an important issue to address when the construction phase begins, according to board officials. The board will conduct a risk assessment of the CMP office’s general controls and accounting system in fall 2006. Based on the audit plan and risk assessment, the board will determine the financial resources it will need to conduct future audits of the CMP office. State Has Continued Its Monitoring Activities Since 2003, State has maintained a working group to monitor the CMP planning process and inform U.S. policy on the CMP. This task force is composed of officials from multiple departments within State and the Office of Management and Budget that meet at least once every 3 months. State has also engaged a part-time consultant with building construction and security experience to review security enhancements and advise the task force. The task force mission includes coordinating all U.S. government participation in the CMP process, evaluating the feasibility of the renovation project, and performing technical reviews. For example, officials from State’s Bureau of Overseas Buildings Operations (OBO) reviewed design documents and the 2005 cost estimate and found that they were developed in a manner consistent with industry practices. OBO’s assessment was included in a decision memorandum encouraging U.S. support for a decision to go forward with the renovation in June 2006. Based on its monitoring work, State has not identified any significant concerns with the renovation planning process, according to State officials. Conclusion Since 2000, the UN has been developing its CMP, a comprehensive renovation of its headquarters complex. Because the complex does not meet current fire, life safety, and other building codes and does not meet UN technology or security requirements, it is a potentially hazardous environment for UN employees and visitors. Much of the design work has been done and the UN has funded completion of design and leasing of temporary space to relocate UN staff and activities for the duration of the renovation. The UN has also begun the process of procuring a construction management firm to undertake the renovation work. The UN could spend more than an additional $1.4 billion to complete the renovation. These funds could be at risk if the UN does not ensure that CMP procurements are protected from weaknesses in the current procurement system. In addition, OIOS will need sufficient funds to oversee compliance with UN financial rules and regulations, as applied to the CMP project. Recommendations We recommend that the Secretary of State and the U.S. Permanent Representative to the United Nations work with other member states to ensure that the Secretariat identifies a procurement strategy for the CMP to mitigate the impact of weaknesses in UN procurement processes and ensure that OIOS receives sufficient funding for its oversight of the CMP. Agency Comments The Department of State, the UN, and OIOS provided written comments on a draft of this report, which are reproduced in appendixes II through IV. State agreed with our conclusions and endorsed our recommendations, stating that they were consistent with State’s policy goals for CMP procurement and OIOS funding. The UN found our report to be a valuable and accurate assessment of the current state of planning for the UN renovation project and generally concurred with our findings and recommendations. Furthermore, in response to our recommendation concerning CMP procurement, the UN noted that an independent bid protest mechanism has been designed for a major CMP procurement. The UN also noted that the Secretary-General’s fourth annual progress report on the CMP has been prepared and contains updated information on the CMP. OIOS also agreed with our conclusions and recommendations and noted that OIOS’s current resources do not allow it to provide adequate audit coverage. State and the UN also provided us with a number of technical suggestions and clarifications that we have addressed in this report, as appropriate. As agreed with your offices, we will make copies of this report available to interested members of Congress, the Secretary of State, and the U.S. Permanent Representative to the United Nations. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact Thomas Melito at (202) 512-9601 or melitot@gao.gov or Terrell Dorn at (202) 512-6923 or dornt@gao.gov. Contact points for our Office of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix V. Appendix I: Scope and Methodology To determine whether the continued development of the UN’s renovation project was consistent with leading industry practices, we reviewed UN records, including reports and designs developed by the architect- engineering firms. We also researched industry practices related to construction project planning, development, and design. We compared the Secretariat’s efforts in project planning and design with industry practices, as identified by the Federal Facilities Council and the Construction Industry Institute. We discussed various aspects of the project, including management and the design process for the Capital Master Plan (CMP) with UN renovation project staff and consultants. To examine the factors that contributed to the increase in the 2005 cost estimate and determine whether the cost estimate was updated using industry practices, we researched industry practices related to construction project cost estimating. We compared the Secretariat’s efforts in cost estimating with industry practices, as identified by the Construction Industry Institute. We also reviewed the 2005 cost estimate and identified the factors that were used to update the cost estimate. To assess the reliability of the UN’s cost estimate data, we interviewed UN officials responsible for compiling the estimate and reviewed how the cost estimate was complied but we did not verify the accuracy of the figures. We determined that the data were sufficiently reliable for the purposes of our report. We received the Secretary-General’s fourth annual progress report on the CMP with an updated cost estimate as our report was going to press. Although we did not have sufficient time to analyze the cost estimate, we included information from the Secretary-General’s report to the extent possible. To describe the financing options being discussed, we reviewed UN data concerning the yearly cash assessments under consideration. To report on the total amount of a 1-year assessment, we calculated the net present value of the total funds needed for the renovation. To calculate the estimated interest income, we subtracted the total assessments from the total amount of funds needed for the renovation. To determine the U.S. share of cash assessments, we calculated 22 percent of the total cash assessments. To assess the reliability of the UN data, we interviewed UN officials to determine how the data was derived and determined that the data were sufficiently reliable for the purposes of our report. To identify key decisions to be made and their impact, we reviewed the CMP office’s estimated schedules for leasing swing space, hiring a construction management firm, and the beginning of renovation work. We identified remaining decisions that require General Assembly approval and that are needed for the renovation to proceed. We then reviewed the schedules to determine if the timing of these decisions could substantially impact the beginning of the renovation. To review UN oversight efforts and State monitoring activities, we reviewed UN documents such as the Office of Internal Oversight Services (OIOS) and Board of Auditor reports submitted to the General Assembly, OIOS management letters to the CMP office, UN resolutions pertaining to the oversight of the CMP, and the mission statements of OIOS, the Board of Auditors, and State’s working group on the CMP. We also interviewed officials from OIOS, the Board of Auditors, and the Department of State to clarify information in these documents. In conducting our review, we received full cooperation from the UN and the Department of State. We conducted our work at the UN in New York City and at State in Washington, D.C., from August 2005 to September 2006 in accordance with generally accepted government auditing standards. Appendix II: Comments from the Department of State Appendix III: Comments from the United Nations Appendix IV: Comments from OIOS Appendix V: GAO Contact and Staff Acknowledgments Staff Acknowledgments In addition to the persons named above, Phyllis Anderson and Maria Edelstein, Assistant Directors; Michaela Brown; Debbie J. Chung; Bruce Kutnick; Valérie L. Nowak; and J.J. Marzullo made key contributions to this report. Mark Dowling provided technical assistance.

The United Nations (UN) estimated in 2005 that renovating its headquarters will cost up to $1.75 billion. As the UN's host country and largest contributor, the United States has a substantial interest in the project's success. In this report, we (1) determine whether the development of the Capital Master Plan (CMP) has been consistent with leading industry practices, (2) examine factors that led to changes in the cost estimate and determine whether the 2005 estimate was updated using industry practices, (3) review the status of financing of the renovation, (4) identify decisions needed for the renovation to proceed, and (5) review UN oversight and State monitoring efforts. To address these objectives, we reviewed UN design and planning documents, including the latest cost estimate, to compare them with industry standards. To assess oversight, we reviewed Office of Internal Oversight Services (OIOS) and UN Board of Auditors reports and met with UN officials. UN officials continue to use leading industry practices in developing the UN headquarters renovation project, but reliance on existing UN procurement practices could impact the effective implementation of the renovation in the future. Since the CMP office relies on current UN procurement practices, implementation of future CMP procurements could become vulnerable to numerous UN procurement weaknesses that GAO previously reported in April 2006 (GAO-06-577), such as the lack of guidance for construction procurement in the procurement manual. The estimated total cost of the CMP increased from about $1.19 billion to almost $1.75 billion between 2002 and 2005 to reflect inflation arising from a later start date, refinements to the design, and a change in the renovation approach. The UN continued to follow construction industry practices to develop the 2005 cost estimate and has included expected elements. However, the cost estimate is still preliminary and will likely change. While the UN has passed a resolution expressing a preference for cash assessments, it has yet to decide how to finance the remaining renovation costs. In June 2006, the General Assembly passed a resolution stating that a cash payment option would be the simplest and most cost-effective approach for funding the CMP. Under this approach, the UN would assess member states for the cost of the renovation through single- or multiyear payments. The amount the UN assessed member states would be likely based on each country's rate for its annual regular budget contributions. The General Assembly plans to revisit the financing issue by the end of 2006. Without certain General Assembly decisions by the end of 2006, the renovation's current schedule could be delayed and costs could increase. Specifically, a General Assembly decision on a financing arrangement for the total CMP budget would be needed to ensure that funds could be available by December 2007. Without these decisions, the CMP office cannot finalize a start date for the renovation. UN oversight entities have continued to oversee the CMP while the Department of State has monitored its progress. OIOS has conducted audits on CMP procurements and has issued several reports of its findings and recommendations. However, OIOS relies on funds from the CMP budget and must negotiate for those funds with the UN budget office, which may impair its ability to secure sufficient funds. The UN Board of Auditors has also conducted oversight of the CMP office by reviewing its financial records and internal controls and has found no material weaknesses in its review. Similarly, State's monitoring efforts have not identified any significant concerns, according to State officials.

Background June 2010 Presidential Memorandum In June 2010, the President directed agencies to review their preaward and prepayment procedures and ensure that a thorough review of applicable databases occurs before the release of any federal funds to help verify eligibility and prevent certain improper payments. The Presidential Memorandum listed five databases for review and directed OMB to develop a plan for integrating these databases so that agencies could access them through a single point of entry. In response to the memorandum, OMB and Treasury established the DNP working system in 2011. In April 2012, OMB issued guidance on the DNP working system through OMB Memorandum M-12-11 (M-12-11), which required the chief financial officer of each agency to submit to OMB a plan for using the DNP working system. Improper Payments Elimination and Recovery Improvement Act of 2012 The Improper Payments Elimination and Recovery Improvement Act of 2012 (IPERIA), as amended by the Bipartisan Budget Act of 2013 and the Federal Improper Payments Coordination Act of 2015 (FIPCA), enacted into law elements of the Presidential Memorandum by requiring agencies to ensure that a thorough review of available databases occurs prior to the release of federal funds. IPERIA, as amended, requires (1) the DNP working system to include six databases, as well as other databases designated by the Director of OMB in consultation with agencies, and (2) agencies to review—at a minimum—those six databases as appropriate before issuing any payment or award to help verify eligibility. The required databases are listed in table 2. The DNP Initiative and the DNP Working System In August 2013, OMB issued guidance through OMB Memorandum M-13- 20 (M-13-20) to help agencies protect privacy while reducing improper payments with the DNP Initiative. According to OMB, the DNP Initiative encompasses multiple databases and analytics resources to support agencies as they verify entity eligibility for awards or payment. This includes centralized data portals (such as the DNP working system) and agency-specific initiatives that serve particular program needs (such as the Centers for Medicare & Medicaid Services’ (CMS) Fraud Prevention System). According to OMB, the DNP working system is one element of the DNP Initiative that agencies can use to meet the requirements set out in IPERIA. The DNP working system offers user agencies four different functionalities by which they can perform searches of databases at various times during the award or payment process. The payment integration functionality matches agency payment files that are sent to Treasury at the time of payment. The payment files are matched against two databases—the Death Master File (DMF) and the System for Award Management (SAM) exclusion records— and matching results are sent back to the agencies. When agencies receive matches through the payment integration functionality, they are required to adjudicate each match (i.e., verify the match to determine whether the corresponding payment is improper) and record the results in the DNP working system. The other three functionalities are online single search, batch matching, and continuous monitoring. Through online single search, an agency can match a single entity against the authorized and available databases for that agency in the DNP working system. Batch matching is a similar process in which an agency can match multiple entities against the authorized and available databases at one time. Online single search and batch matching can be conducted either before or after a payment is made, as decided by the agency. Continuous monitoring matches an agency’s file of entities against the authorized and available data sources on an ongoing basis whenever the data are updated. For these three functionalities, an agency receives matches through the DNP working system but does not record adjudication results for these matches in the system. Responsibilities Related to the DNP Initiative and Working System M-13-20 splits responsibilities related to the DNP Initiative—and the DNP working system—among four entities: (1) OMB, (2) Treasury, (3) original- source agencies, and (4) payment-issuing agencies. These entities’ responsibilities include the following. OMB is responsible for implementing the DNP Initiative—including establishing a working system for prepayment and preaward review—and providing guidance, oversight, and assistance to agencies. IPERIA requires OMB to submit annual reports to Congress regarding the operation of the DNP Initiative. These reports should include an evaluation of whether it has reduced improper payments or improper awards and provide the frequency of data corrections or identification of incorrect information. Treasury OMB directed Treasury to host the DNP working system. In doing so, Treasury is responsible for developing memorandums of understanding (MOU) with original-source agencies and entering into computer matching agreements with payment-issuing agencies, as appropriate. OMB guidance states that Treasury must also periodically reassess whether all of the data in the DNP working system are relevant and necessary and delete any data that are not. Additionally, Treasury is responsible for preparing and submitting to OMB a written assessment documenting the suitability of any commercial databases that could be designated for use in the DNP working system. Further, Treasury is responsible for taking steps to ensure that records in the DNP working system are sufficiently accurate, complete, and up-to-date; coordinating with original-source agencies to allow individuals to request data corrections; and submitting periodic reports to OMB. Original-Source Agencies Original-source agencies provide records (e.g., databases) to Treasury for the DNP working system. These agencies are responsible for entering into MOUs with Treasury that describe how Treasury may use the records and provide rules for protecting and correcting the information and for retaining and destroying the records. Additionally, original-source agencies are responsible for ensuring that they have sufficient legal authority and specific designation from OMB (except as provided by law) to share the records and that Treasury has the appropriate level of security controls before providing records to the DNP working system. Payment-Issuing Agencies Payment-issuing agencies are responsible for making determinations about the disbursement of payments or awards, consistent with legal authority. In using the DNP working system, these agencies are responsible for ensuring that they only match against data sources that are relevant and necessary for the specific matching purpose. Payment- issuing agencies are responsible for ensuring that they have sufficient legal authority to engage in a matching program and, when appropriate, entering into computer matching agreements with Treasury. Treasury’s Do Not Pay User Guide states that each agency should verify match results received from the DNP working system against a secondary data source to ensure that match information received from the DNP working system is accurate. M-13-20 states that payment-issuing agencies should comply with all applicable requirements in the Privacy Act, which may include verifying match results and providing individuals an opportunity to contest match results prior to taking adverse action. OMB and Treasury Have Developed the DNP Working System, but Access to Certain Data Is Limited Although OMB and Treasury have developed the DNP working system, the system does not offer full access to three of the six databases required by law. For example, the DNP working system offers access to the more limited DMF, but access to SSA’s full death file is not available. OMB has not formally evaluated user-agency suggestions for additional databases for the DNP working system, in part because it has not developed a formal process for obtaining the suggestions. The DNP Working System Offers Either Partial or No Access to Three of the Six Databases Required by Law The DNP working system offers full access to three of the databases required by IPERIA: the System for Award Management exclusion records, the Debt Check database, and the List of Excluded Individuals and Entities (LEIE). However, it offers either partial or no access to the remaining three: the Credit Alert Interactive Voice Response System, SSA’s prisoner data, and SSA’s death records. Availability of data through the DNP working system is shown in table 3. According to Treasury officials, the process for obtaining access to databases for the DNP working system is extensive and requires coordination with original-source agencies to establish MOUs and to revise system of records notices (SORN) to include routine uses that allow disclosure of the data through the DNP working system. Treasury officials stated that Credit Alert Interactive Voice Response System (CAIVRS) data inputs from the Departments of Agriculture (USDA) and Education (Education) are not currently available through the DNP working system because of delays in negotiating MOUs with these agencies and revising SORNs. As efforts to finalize these documents continue, Treasury officials stated that they estimate that the DNP working system will offer access to CAIVRS data from USDA by the end of fiscal year 2016 and from Education in early fiscal year 2017. Additionally, the DNP working system does not offer access to SSA’s prisoner data. According to agency officials, Treasury and SSA have negotiated a permanent MOU to allow (1) the Internal Revenue Service (IRS) access to SSA’s prisoner data for tax administration through the DNP working system and (2) Treasury access to the data for planning and analysis purposes related to the DNP working system. The MOU allows Treasury to evaluate the prisoner data and determine whether it will be useful in the DNP working system, although SSA officials noted that disclosure of the prisoner data to other agencies for matching purposes through the DNP working system will be limited until the relevant SORN is revised to include this matching as a routine use of the prisoner data. Although Treasury continues to work with relevant agencies, until access to all of the required databases is offered, agencies may face a higher risk of not preventing or identifying improper payments, particularly those to prisoners and individuals that are delinquent on federal nontax debt. Further, Treasury has not obtained SSA’s more complete death records for the DNP working system. SSA shares two sets of death data: its full death file and DMF. DMF is a subset of the full death file, as it contains about 10 percent fewer death records than the full death file and does not include state-reported death data. Initially, IPERIA listed DMF as a required database for the DNP working system. FIPCA amended IPERIA by replacing the reference to DMF with “death records maintained by the Commissioner of Social Security.” SSA officials stated that the Social Security Act limits sharing of SSA’s full death file to federal benefit-paying agencies, which does not include the DNP working system. These officials stated that the Social Security Act would need to be amended to allow the agency to share its full death file with Treasury for the DNP working system. The President’s Budget for fiscal year 2017 included a proposal for such an amendment, but no amendment providing this authority has been enacted. Consequently, the DNP working system offers access to only DMF and not the full death file. In November 2013, we reported that SSA’s processes for collecting and maintaining death reports could result in untimely or erroneous death information, such as including living individuals or not including deceased individuals. For example, we identified about 500 instances in which death reports submitted to SSA in early 2013 listed dates of death in 2011 or earlier. This is of concern because—if the dates of death are accurate—SSA and other agencies may have been at risk of paying benefits to these individuals for long periods after they died. We also reported that SSA’s Office of Inspector General found that data for about 182,000 deceased Supplemental Security Income recipients and about 1.2 million deceased Old Age and Survivors Insurance beneficiaries were not included in SSA’s death data. To help improve the accuracy of its death data, we recommended that SSA conduct a risk assessment and assess the feasibility and cost-effectiveness of addressing various types of errors given the risk they pose. We found that since fiscal year 2014, SSA has been taking steps to redesign how the agency processes death reports and compiles data for dissemination. As part of that redesign, SSA completed a risk assessment and a data quality assessment in June 2014. SSA has completed the first two phases of its redesign project and developed a business process description for the third phase. According to SSA, the agency is taking care to ensure that improvements made to the death data processing system are cost-effective. Although we have not assessed the extent to which SSA’s efforts have improved the quality of its death data, we are encouraged that SSA plans to continue the redesign project in future years. SSA’s efforts will be critical to addressing the risk of errors in its death data. However, it is important to note that SSA does not guarantee the accuracy of the death information it provides to agencies. SSA reported that users of its death data must agree to independently verify the information before taking action based on an individual’s death report. Such verification—if completed—should help reduce the effect of erroneous death data. While there is a continued need for SSA to address the risk of errors in its death data, sharing the full death file through the DNP working system would provide agencies with additional information and enhance efforts to identify and prevent improper payments to deceased individuals. As we previously reported, because the deaths reported by states are generally more accurate, and these reports are included in the full death file, it is likely that agencies using SSA’s full death file would encounter fewer errors than agencies using the DMF. OMB Has Not Designated Additional Databases for Inclusion in the DNP Working System IPERIA provides the Director of OMB, in consultation with agencies, the authority to designate additional databases that substantially assist in preventing improper payments. However, OMB has not formally evaluated user agencies’ suggestions for additional databases or designated any additional databases to be included in the DNP working system. OMB staff stated that they consulted with data analytic centers regarding potential databases and services, and the President’s Budget for fiscal year 2017 included proposals to obtain access to additional databases. Nevertheless, certain user agencies we reviewed identified additional databases that could be beneficial if included in the DNP working system. OMB has not developed a formal process for user agencies to suggest additional databases to be included in the DNP working system. OMB staff stated that they expect user agencies to suggest additional databases to be included in the DNP working system through their AFRs. However, neither M-13-20 nor OMB Circular No. A-136 financial reporting requirements communicate these expectations. Further, OMB staff acknowledged that some user agencies made suggestions for additional databases through their AFRs but stated that the suggestions were not communicated through “formal requests.” OMB guidance does not clarify how agencies should formally suggest additional databases for inclusion in the DNP working system or how OMB should communicate its decisions to agencies. Because a formal process for obtaining suggestions for additional databases—whether from the AFRs or other means—has not been fully developed and communicated, OMB may not be identifying or considering additional relevant databases that could improve the effectiveness of the DNP working system. Selected Agencies Have Used the DNP Working System in Limited Ways in Part Because of a Lack of Clear Strategy and Guidance Nine of the 10 agencies we reviewed used the DNP working system’s payment integration functionality, despite limitations in its effectiveness and the lack of OMB and Treasury guidance for key aspects of the payment integration process. For example, this process matches against only two databases, and agencies generally receive results after payments are made. Further, certain agencies reported confusion regarding whether they were required to use the payment integration process, especially those agencies with other—and potentially duplicative—data matching processes. Aside from the payment integration process, 6 of the 10 agencies we reviewed used the DNP working system in limited ways, and 9 of the 10 agencies accessed the databases through means other than the DNP working system. OMB staff stated that they expect agencies to leverage the DNP working system to complement existing, non-DNP data matching processes, but OMB guidance does not reflect this approach, and OMB has not developed a strategy for how this should be carried out. The policies and procedures for using the DNP working system at the agencies that we reviewed generally lacked specific processes for (1) determining whether DNP matches were actually improper payments and (2) verifying matches against a secondary data source. These shortcomings were due in part to unclear and inconsistent guidance from OMB and Treasury. OMB and Treasury Guidance Does Not Address Key Aspects of the Payment Integration Process Nine of the 10 agencies we reviewed used DNP’s payment integration functionality—despite limitations in its effectiveness—because it is built into Treasury’s payment process. In part because OMB and Treasury guidance does not address key aspects of the payment integration process, understanding of the process varied across selected agencies, and in some cases, the process was potentially duplicative of existing agency procedures. Guidance Does Not Fully Address Limitations of DNP’s Payment Integration Process DNP’s payment integration functionality is limited because of the timing of the matching performed and the scope of databases and payments reviewed. Moreover, certain limitations are not fully communicated through existing guidance. Timing of matching. The payment integration process is not consistent with the requirement in IPERIA to review databases prior to award or payment. While matching is conducted at the time of payment, agencies generally receive the results after payments have been made. As such, use of the payment integration process does not assist agencies in preventing improper payments before they occur. While Treasury’s Do Not Pay Agency Implementation Guide states that payment integration matching happens at the time of payment, the agencies we reviewed reported inconsistent interpretations of the timing of the process. Because the guide is not clear that the results are generally received after payments have been made, about half of the agencies we reviewed considered the payment integration process to be a prepayment function, whereas others considered it to be a postpayment activity. Further, OMB guidance does not specifically reference the payment integration functionality or its timing. Databases used in matching. The payment integration process matches against only two databases, DMF and SAM exclusion records. Any other database available through the DNP working system must be accessed outside of the payment integration process. Some agencies we reviewed did not know which databases were included in the payment integration process, which may be a result of unclear guidance. While agency officials confirmed that it was their understanding that the objective of the process is to match against only DMF and SAM exclusion records, Treasury’s Do Not Pay Agency Implementation Guide states that the objective of the payment integration process is to match all payment files against the data sources identified in IPERIA. The guide does not acknowledge that the process matches payments against only two of the data sources identified in IPERIA, DMF and SAM exclusion records. Payments reviewed. Because the payment integration functionality is part of Treasury’s payment issuance process, payments that are made through other means—such as non-Treasury disbursing offices or contractors—are not automatically matched. Examples of these types of payments include Department of Defense payments disbursed through the Defense Finance and Accounting Service ($477 billion in fiscal year 2015) and Medicare Fee-for-Service payments ($351 billion in calendar year 2014). Further, certain federal payments flow through various entities—such as state or local governments—before ultimately being spent for their intended purposes. For example, benefits for USDA’s Supplemental Nutrition Assistance Program are funded by the federal government, but states are responsible for determining individual and household eligibility for the program, calculating the amount of monthly benefits, and issuing benefits on an electric benefit transfer card. In these cases, only the payment from the federal agency to the first recipient is matched against DMF and SAM exclusion records, and subsequent payments—those to the ultimate recipients, for example—are not matched through DNP’s payment integration process, though they may go through other agency-specific reviews. Figure 1 illustrates the payments reviewed through the payment integration process. Standards for Internal Control in the Federal Government states that management should externally communicate the necessary quality information to achieve the entity’s objectives. Without clear guidance on the limitations of the payment integration functionality, there is an increased risk that agencies will not use the DNP working system effectively to reduce improper payments. Guidance Unclear as to Whether Use of the Payment Integration Process Is Required Eight of the 10 agencies we reviewed considered use of the payment integration functionality required because it is built into Treasury’s payment process, though neither OMB nor Treasury guidance sets out this requirement. OMB staff stated that they do not consider use of the process to be a requirement. However, OMB’s actions (as noted below) could give the opposite impression. Two agencies we reviewed—SSA and IRS—requested and received permission exempting them from using the payment integration functionality for at least some of their payments. For example, OMB specifically determined that SSA is not required to use the payment integration functionality because it is the source agency for two relevant databases (death and prisoner data) and has access to SAM exclusion data and the Department of Health and Human Services’ Office of Inspector General’s LEIE outside of the DNP working system. Similarly, IRS officials stated that they worked with OMB to receive permission exempting IRS from using the payment integration process for its tax refunds given its existing data matching processes and confidentiality restrictions. Had the payment integration functionality been clearly optional, explicit OMB exemptions would not be necessary. Two other agencies we reviewed—the Railroad Retirement Board (RRB) and the Department of Veterans Affairs’ (VA) Veterans Benefits Administration (VBA)—had procedures to review SSA’s full death file for certain programs prior to implementation of the DNP working system. Officials at these agencies stated that they requested an exemption from OMB from the payment integration process—which they considered duplicative of their existing procedures—but were denied. OMB staff stated that they did not recall these agencies’ requests but that they would be willing to work with them to avoid duplication. Standards for Internal Control in the Federal Government states that management should externally communicate the necessary quality information to achieve the entity’s objectives. Given the limitations of the payment integration functionality, clear guidance is critical to help ensure that agencies fully understand the process and whether its use is required. Without clear guidance on whether the payment integration process is required, there is an increased risk that agencies may not effectively or efficiently use the DNP working system to reduce improper payments. Aside from Payment Integration, Use of the DNP Working System at Selected Agencies Is Limited Only 6 of the 10 agencies we reviewed used the DNP working system for purposes outside of payment integration, and their uses of the system were limited to certain programs or databases and often were not part of payment or award eligibility determinations. Two of the agencies we reviewed—the National Science Foundation and USDA—used the DNP working system on a preaward or prepayment basis for certain types of payments. Officials at the National Science Foundation stated that the agency uses the DNP working system to review grant proposals against SAM (both exclusion records and entity registration records) and LEIE simultaneously, streamlining and automating a process that was previously performed manually for one application at a time. USDA officials stated that the Commodity Credit Corporation and Risk Management Agency use the DNP working system on a preaward or prepayment basis for certain payments. According to officials, the Commodity Credit Corporation uses the DNP working system to review secure payments against DMF and SAM exclusion records. Similarly, the Risk Management Agency uses the DNP working system to review payments for reinsurance funds to entities other than approved insurance providers against DMF. The other four agencies use the DNP working system to periodically review certain of their databases, though the reviews are not necessarily tied to a payment or award. For example: CMS officials reported using the working system to review provider enrollment information from its Provider Enrollment, Chain and Ownership System against SAM exclusion records on a monthly basis. Officials at the General Services Administration reported using the DNP working system to review its vendor database against SAM exclusion records on a monthly basis. While some of the agencies we reviewed used the DNP working system for purposes beyond payment integration, 9 of the 10 agencies we reviewed accessed certain IPERIA-specified databases outside of the DNP working system. For example: Most agencies reported that they use SAM exclusion records when awarding contracts, as required by the Federal Acquisition Regulation. These agencies generally accessed SAM exclusion records through SAM.gov or by using systems integrated with SAM data. As previously noted, RRB and VBA reported that they use SSA’s full death file outside of the DNP working system. For example, VBA reported matching its Compensation and Pension programs’ master records against SSA’s full death file on a weekly basis, while RRB reported matching its master benefit payment file against SSA’s full death file on a monthly basis. Officials at the Veterans Health Administration reported that it reviews LEIE outside of the DNP working system when adding non-VA medical providers to its vendor database. Agencies are using the DNP working system in limited ways in part because of a lack of OMB strategy and guidance. OMB has not developed or documented a strategy for how it expects agencies to use the DNP working system. Instead, OMB staff informed us that OMB expects agencies to determine how best to use the DNP working system to complement existing data matching processes. According to M-13-20, OMB is responsible for providing agencies guidance on the DNP Initiative, but key aspects of OMB’s stated approach are not addressed by its existing guidance. Specifically, the memorandum does not indicate that agencies should determine how to use the DNP working system or whether agencies should consider using the system to streamline existing data matching processes. Because the DNP working system offers a single point of access to multiple databases, agencies may be able to streamline existing processes by using the DNP working system rather than accessing these databases separately. While it required agencies to develop plans for using the DNP working system through M-12-11 in 2012, OMB has not followed up with agencies to determine whether the plans were implemented or updated as the capabilities of the DNP working system evolved. Further, OMB guidance does not address other key aspects of the program, including how agencies should demonstrate that their data matching processes meet the requirements of IPERIA, whether agencies can decide on their own which specific databases to use, or how agencies should use the specific data matching functionalities offered through the DNP working system. Standards for Internal Control in the Federal Government states that management should externally communicate the necessary quality information to achieve the entity’s objectives. Without a strategy communicated through guidance, agencies may not effectively use the DNP working system to help prevent improper payments and, when possible, streamline data matching processes. Selected Agencies Had Limited Policies and Procedures for Using the DNP Working System Most of the agencies we reviewed did not have documented policies and procedures for determining whether a DNP match represented an improper payment (i.e., the adjudication process), including verifying a DNP match against a secondary data source and providing individuals an opportunity to contest the matching results prior to taking adverse action. OMB and Treasury guidance is inconsistent and unclear regarding agencies’ responsibilities for verifying DNP matches. M-13-20 provides requirements for agencies conducting matching programs under the Privacy Act, which include verifying matches and providing individuals an opportunity to contest. However, agencies we reviewed did not consider the majority of their matching through the DNP working system to meet the definition of a matching program per the Privacy Act, and M-13-20 does not state what is required if an agency concludes that its use of the DNP working system does not constitute a matching program. In contrast to OMB guidance, Treasury’s Do Not Pay User Guide states that agencies should verify all DNP matches against a secondary source. However, aside from Treasury’s Quick Reference Card for SAM, neither OMB nor Treasury guidance explains how an agency should verify a DNP match, including the use of a secondary source. Standards for Internal Control in the Federal Government states that management should externally communicate the necessary quality information to achieve the entity’s objectives. Without clear and consistent guidance, agencies may not effectively develop and document processes to help ensure that DNP matches are accurate and that, when appropriate, individuals are given an opportunity to contest adverse actions. Further, if agencies do not verify DNP matches, they face an increased risk that they may not effectively use the DNP working system to reduce improper payments. OMB Does Not Sufficiently Monitor Agency Use of the DNP Working System OMB Has Not Evaluated Agency Use of the DNP Working System Although OMB collects relevant information, it has not evaluated agency use of the DNP working system. OMB has not established specific goals or performance measures by which to evaluate agency use of the DNP working system, in part because it has not developed a strategy for how agencies should use the system. In its first annual report to Congress on the overall DNP Initiative, OMB reported that the DNP Initiative prevented $2 billion in improper payments in fiscal year 2014. While the report highlighted the DNP working system and four other agency-specific efforts, all of the reported $2 billion in prevented improper payments resulted from use of the agency-specific efforts, not the DNP working system. Further, several agencies we reviewed reported little benefit from their use of the DNP working system. The 10 agencies under our review reported in their AFRs a total of only $725 in improper payments that were prevented through use of the DNP working system during fiscal year 2015, although concerns regarding the reliability of these data are discussed later in this report. The 24 Chief Financial Officers Act agencies collectively reported in their AFRs about $680,000 in improper payments prevented through use of the DNP working system in fiscal year 2015. Although OMB considers it to be one part of the overall DNP Initiative, it is important for OMB to specifically monitor agency use of the DNP working system—as part of its responsibility to oversee the DNP Initiative—to determine whether its use is effective. Standards for Internal Control in the Federal Government states that management should establish and operate monitoring activities, evaluate the results, and remediate identified deficiencies on a timely basis. To do so, management can establish baselines or benchmarks against which to measure program performance. Without monitoring mechanisms, OMB may not effectively evaluate the DNP working system or identify performance issues. Further, OMB may be unable to provide complete information on the DNP working system to Congress as part of its annual report on the overall DNP Initiative. OMB Did Not Identify Inconsistencies in Agency- Reported Data While OMB staff stated that they collect and review agency-reported data on use of the DNP working system, the information may be limited and unreliable. Specifically, OMB staff stated that they use information in agencies’ AFRs to monitor the DNP Initiative, which includes agencies’ use of the DNP working system. OMB staff stated that they reviewed draft AFRs for fiscal year 2015 against OMB guidance in OMB Circular No. A-136 and found no issues with the information. However, among the 10 agencies we reviewed, we identified instances in which certain reporting in the fiscal year 2015 AFRs was inconsistent with OMB guidance or monthly adjudication reports generated by the DNP working system, calling into question the reliability of the information. Inconsistency with OMB Guidance Certain agencies we reviewed did not include all required elements in the AFR narrative or complete the results summary table in accordance with OMB guidance, resulting in potentially inaccurate data. For example: One agency overstated its false positives in its results table by reporting the payments reviewed that did not receive matches, instead of payments with matches that were reviewed and the payment determined to be proper (i.e., false positives). One agency did not use the most up-to-date template for its results table, leading it to report results of its matching inconsistent with the reporting of other agencies. Specifically, the agency reported on matches identified as improper payments instead of false positives. One agency reported on its use of the DNP working system for fiscal year 2014 instead of fiscal year 2015 in its fiscal year 2015 AFR. Inconsistency with DNP Working System Reports In addition, certain agencies we reviewed included information in the AFR results summary table that conflicted with reports generated by the DNP working system. For example: One agency reported no false positives in its summary table, but its DNP working system adjudication reports indicated over 60 false positives for fiscal year 2015. One agency reported identical information as both payments stopped and false positives in its summary table, calling into question the accuracy of these data. Further, these results did not agree with the agency’s DNP working system adjudication reports and were inconsistent with the agency’s AFR narrative, which stated that reviews were conducted after payments had been made. Because reviews were performed on a postpayment basis, the payments could not have been stopped. Given the issues we identified, OMB’s process for reviewing information on agency use of the DNP working system reported in AFRs may not be effective. Further, OMB Circular No. A-136 notes that Treasury will provide OMB summary information on use of the DNP working system on behalf of user agencies. However, this information is limited to results of the payment integration functionality. Although the DNP working system offers agencies four different methods for conducting data matching, the system only tracks results for the payment integration process. Treasury officials stated that the decision to track only payment integration results was made for ease of use by agencies. Agencies using the other three functionalities—online single search, batch matching, and continuous monitoring that can be used for prepayment reviews, such as eligibility determinations—must track their results manually, which may be more inefficient and susceptible to human error. Additionally, OMB guidance does not indicate whether agencies should report on all uses of the DNP working system, including those outside payment integration that the DNP working system does not track. Standards for Internal Control in the Federal Government states that management should use quality information to achieve the entity’s objectives. Without complete and reliable data and clear guidance on what information agencies should report, OMB cannot effectively monitor and evaluate the use of the DNP working system. Conclusions Improper payments are a significant problem in the federal government, and the DNP working system is one tool that agencies can use to help reduce them. However, the lack of certain data limits the effectiveness of the DNP working system. For example, SSA’s more complete set of death data is not offered through the DNP working system, and OMB has not developed a formal process to obtain suggestions of additional databases from user agencies for data matching. While the most common use of the DNP working system is its payment integration process, OMB guidance is unclear as to whether use of the process is required, and Treasury’s Do Not Pay Agency Implementation Guide does not clearly describe the limitations of the process, including the data sources used and the timing of matching. Further, the agencies we reviewed used the DNP working system in limited ways in part because OMB has not developed a strategy for how agencies should use it. Without a strategy that is communicated through guidance, agencies may not use the DNP working system to effectively and efficiently reduce improper payments. Finally, OMB does not sufficiently monitor use of the DNP working system. OMB has not developed performance measures or other monitoring mechanisms, in part because it lacks a strategy for use of the system, and the information OMB collects on agencies’ use of the DNP working system may be unreliable. Because the DNP working system does not track matches obtained through all of the available functionalities, the information OMB collects may also be incomplete. Without monitoring mechanisms and reliable and complete data, OMB will not be able to effectively evaluate agencies’ use of the DNP working system or remediate any issues identified. Matter for Congressional Consideration To provide agencies access to SSA’s more complete set of death data, Congress should consider amending the Social Security Act to explicitly allow SSA to share its full death file with Treasury for use through the DNP working system. Recommendations for Executive Action We recommend that the Director of OMB take the following seven actions. To reasonably assure that additional relevant databases are identified and evaluated for inclusion in the DNP working system, the Director of OMB should develop, document, and communicate a formal process that user agencies can use to identify, suggest, and receive feedback on additional databases to be evaluated for inclusion in the DNP working system. To reasonably assure that the DNP working system is used effectively and consistently, the Director of OMB should develop guidance that clarifies whether the use of DNP’s payment integration functionality is required and—if required—the circumstances and process in which agencies may obtain an exemption from this requirement. To reasonably assure that agencies use the DNP working system effectively, the Director of OMB should develop a strategy—and communicate its strategy through guidance—for how agencies should use the DNP working system to complement existing data matching processes and whether and how agencies should consider using the DNP working system to streamline existing data matching. Such guidance may cover how agencies should demonstrate that their data matching processes meet the requirements in IPERIA, whether agencies can decide on their own which specific databases to use, and how agencies should use the functionalities available through the DNP working system. To reasonably assure that agencies develop consistent policies and procedures to verify DNP matches, the Director of OMB should provide additional guidance that outlines when and how agencies should verify DNP matches against a secondary source and provide individuals an opportunity to contest before taking adverse actions as a result of DNP matches. To better monitor agency use of the DNP working system once a strategy has been developed, the Director of OMB should develop and implement monitoring mechanisms—such as goals, benchmarks, and performance measures—to evaluate agency use of the DNP working system. To reasonably assure that agency-reported information on use of the DNP working system is reliable, the Director of OMB should develop a process for comparing agency reporting on the use of the DNP working system to available sources, such as OMB guidance and DNP working system adjudication reports. To reasonably assure that agency-reported information on use of the DNP working system is complete, the Director of OMB should revise its guidance to clarify whether agencies should report on their uses of all of the functionalities of the DNP working system in their AFRs. In addition, we recommend that the Secretary of the Treasury take the following two actions: revise Treasury’s Do Not Pay Agency Implementation Guide to clearly describe the limitations of the payment integration process, including the data sources used and the timing of matching, and modify the DNP working system to track adjudication of matches obtained through all functionalities. Agency Comments and Our Evaluation We provided a draft of this report to each of the agencies we reviewed for comment. OMB, Treasury, and SSA provided written comments, which are reprinted in appendixes II through IV, respectively. USDA, HHS, Department of the Interior, Department of Labor, VA, GSA, National Science Foundation, and RRB had no formal comments on the draft report. In addition, Treasury, HHS, Department of Labor, SSA, and National Science Foundation provided technical comments, which we have incorporated as appropriate. In its written comments, OMB stated that it agreed with our first two recommendations and cited plans to consider or implement them. OMB stated that it agreed or generally agreed with the concepts behind the remaining five recommendations, as discussed below, but did not state whether it agreed with the recommendations themselves or planned to implement them. In response to our third recommendation, OMB stated that it generally agreed with the concept of developing a strategy for how agencies should use the DNP working system to complement existing data matching processes and will explore the concept further. In response to our fourth recommendation, OMB stated that it agreed with the concept of consistent policies and procedures and will work with agencies so that their policies and procedures for verifying DNP matches are developed consistently. In response to our fifth recommendation, OMB stated that it agreed with the concept of monitoring mechanisms and will continue to work with agencies to reduce improper payments and encourage agencies to establish goals to improve payment accuracy that will be monitored and evaluated by OMB. In response to our sixth recommendation, OMB stated that it agreed with the concept of ensuring that data are reliable and will consider the feasibility of a process to compare agency submissions to available sources to reasonably assure that agency-reported information on use of the DNP working system is reliable. In response to our seventh recommendation, OMB stated that it agreed with ensuring the completeness of data and will continue to work with agencies and the Chief Financial Officer community to ensure that agency-reported information on use of the DNP working system is complete. While OMB stated that it agreed or generally agreed with the concepts behind the recommendations and in some cases identified steps it would take in response, it is too soon to determine whether OMB’s approach will fully address these recommendations. We continue to believe that implementing the recommendations would help ensure that agencies use the DNP working system as intended. In its written comments, Treasury agreed with our two recommendations to it and stated that it plans to take action to implement them. Although there were no recommendations made to SSA, the agency noted in its written comments that it appreciates the matter for congressional consideration regarding amending the Social Security Act to explicitly allow the sharing of SSA’s full death file through the DNP working system, stating that it aligns with a similar proposal in the President’s Budget for fiscal year 2017. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies of this report to relevant congressional committees; the Director of the Office of Management and Budget; the Secretaries of Agriculture, Health and Human Services; the Interior; Labor, the Treasury; and Veterans Affairs; the Administrator of the General Services Administration; the Director of the National Science Foundation; the Railroad Retirement Board; the Commissioner of the Social Security Administration; and other interested parties. In addition, this report will be available at no charge on the GAO website at http://www.gao.gov. If you or your staff have any questions on matters discussed in this report, please contact me at (202) 512-2623 or davisbh@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix V. Appendix I: Objectives, Scope, and Methodology This review examines the extent to which (1) the Office of Management and Budget (OMB) and the Department of the Treasury (Treasury) developed the Do Not Pay (DNP) working system and obtained access to relevant databases, (2) selected agencies used the DNP working system to help review eligibility, and (3) OMB monitored the use of the DNP working system. Agencies Selected for Review In addition to OMB and Treasury’s DNP Business Center, we selected 10 agencies and relevant components for review. To do so, we reviewed budgetary outlays, net cost information, and improper payment estimates from fiscal year 2014 (the most recent information available at the time of the review), as well as information about agencies’ use of the DNP working system obtained from the DNP Business Center. We determined that these data were sufficiently reliable for the purposes of selecting agencies and components for review. The agencies and relevant components selected for review are included in table 4. To select the 10 agencies for review, we first split agencies into two groups (large and small agencies) based on fiscal year 2014 budgetary outlays. Within these groups, we analyzed fiscal year 2014 improper payment estimates to select agencies with high improper payment estimates and information on agencies’ use of the DNP Business Center to select agencies capable of using the different functionalities offered by the DNP working system. We also selected the Social Security Administration because, while it is the source of certain data in the DNP working system, the agency does not use the system. Five of the selected agencies delegated use of the DNP working system to agency components. For 4 of these agencies, we selected relevant components for review based on analysis of information on net costs by components in agencies’ fiscal year 2014 agency financial reports and fiscal year 2014 improper payment estimates. We used this information to identify large components and those with high reported improper payment estimates. Because net cost information does not capture Treasury’s custodial activities relating to tax administration (i.e., tax collections and refunds/tax credits), we used improper payment estimates and interviews with agency officials to select relevant Treasury components for review. Methodology To address our first objective, we obtained documentation from OMB and Treasury regarding the availability of required databases and other relevant databases through the DNP working system. We compared this documentation to relevant laws and guidance. We also interviewed officials at Treasury’s DNP Business Center, OMB, and the 10 user agencies selected for review regarding database availability and suggestions for additional databases for inclusion in the DNP working system. To address our second objective, we interviewed officials at the selected agencies regarding their use of the DNP working system. Additionally, we met with officials at shared service providers used by certain of our selected agencies and components as these shared service providers may use the DNP working system on behalf of the selected agencies. We analyzed OMB and Treasury guidance on the DNP working system. We also reviewed the 10 selected agencies’ policies and procedures for using the DNP working system to determine if they were effectively designed to meet requirements in relevant laws, guidance, and federal internal control standards. Our review focused on the design of internal controls, and as such, we did not test the implementation of the agencies’ policies and procedures. To address our third objective, we analyzed agency reporting on the use of the DNP working system in the 10 selected agencies’ fiscal year 2015 agency financial reports and OMB’s first annual report on the DNP Initiative; obtained relevant documentation regarding OMB’s monitoring of the DNP working system; and compared this information to relevant laws, guidance, and federal internal control standards. We also interviewed officials at Treasury’s DNP Business Center and OMB. We conducted this performance audit from April 2015 to October 2016 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Comments from the Office of Management and Budget Appendix III: Comments from the Department of the Treasury Appendix IV: Comments from the Social Security Administration Appendix V: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Phillip McIntyre (Assistant Director), James M. Healy (Auditor in Charge), Stephanie Adams, Daniel Flavin, Maxine Hattery, Christopher R. Klemmer, Diana Lee, Kevin McAloon, David Plocher, and Coleman Williams made key contributions to this report.

Improper payments are a long-standing, significant problem in the federal government, estimated at nearly $137 billion in fiscal year 2015. GAO previously reported that one strategy to help prevent improper payments is up-front verification of eligibility through data sharing and matching. Established by OMB in 2011 and hosted by Treasury, the DNP working system is a web-based, centralized data matching service. GAO was asked to review the DNP working system. This report examines the extent to which (1) OMB and Treasury developed the DNP working system and obtained access to relevant databases, (2) selected agencies used the DNP working system to help review eligibility, and (3) OMB monitored the use of the system. GAO reviewed relevant laws and guidance; interviewed officials at OMB, Treasury, and 10 user agencies selected in part based on size and reported improper payment estimates, including those with the largest reported estimates; and analyzed DNP working system documentation. The Office of Management and Budget (OMB), in coordination with the Department of the Treasury (Treasury), developed the Do Not Pay (DNP) working system as a data matching service for agencies to use in preventing improper payments, but GAO found that the DNP working system offers either partial or no access to three of the six databases required by the Improper Payments Elimination and Recovery Improvement Act of 2012, as amended. Specifically, the DNP working system offers no access to the Social Security Administration's (SSA) prisoner records and partial access to the Credit Alert Interactive Voice Response System and SSA's death records. The death records offered through the DNP working system do not include state-reported death data. SSA officials stated that sharing its full death file—which includes state-reported death data—would require an amendment to the Social Security Act. Sharing the full death file through the DNP working system would enhance efforts to identify and prevent improper payments. The 10 agencies GAO reviewed have used the DNP working system in limited ways, in part because of a lack of clear OMB strategy and guidance. The most common way these agencies used the DNP working system is through its payment integration process, whereby Treasury compares disbursements it makes with DNP databases. However, Treasury matches against only two databases, and because the matching is performed simultaneously with disbursement, agencies generally do not receive the results in time to prevent improper payments. Further, because the payment integration process is built into Treasury's payment process, it does not compare payments disbursed through other means, such as payments made by the Defense Finance and Accounting Service ($477 billion in fiscal year 2015). OMB and Treasury guidance do not fully address the limitations of the payment integration process or whether its use is required. Aside from payment integration, 6 of the 10 agencies GAO reviewed used the DNP working system in limited ways, and 9 of the 10 agencies used some of the databases outside the DNP working system. OMB has not developed a strategy or communicated through guidance how it expects agencies to use the DNP working system. As a result, agencies may not effectively and efficiently use the system to help reduce improper payments. Although OMB collects certain information about the use of the DNP working system, it has not developed monitoring mechanisms, such as goals or performance measures. Reported savings from use of the DNP working system have been minimal. OMB reported that the overall DNP Initiative (which encompasses the DNP working system and other agency-specific efforts) prevented over $2 billion in improper payments in fiscal year 2014, but none of these savings resulted from use of the DNP working system. Further, while OMB has not reported on fiscal year 2015 results, the 24 Chief Financial Officers Act agencies reported about $680,000 in improper payments prevented through use of the system in fiscal year 2015. However, GAO identified instances in which such agency-reported information was not consistent with reports generated by the system. Without monitoring mechanisms and reliable data, OMB cannot effectively evaluate the DNP working system or identify and address performance issues.

Background VA dramatically transformed its health care delivery system over the last decade. A central goal of this transformation has been to reduce the need for, and the length of, inpatient hospital stays by providing primary care in outpatient settings and taking advantage of technological advances that reduce the need for hospitalization. VA developed a continuum of care grounded in outpatient settings; made available a broader array of services, including preventive care; and opened hundreds of community-based outpatient clinics. As a result, VA reduced the length of inpatient stays while providing health care to a growing number of veterans. From fiscal year 1996 through fiscal year 2004, VA’s national acute inpatient daily census fell by nearly 40 percent while the number of veterans who received health care from VA increased by about 76 percent (2 million). As VA increased its emphasis on outpatient care rather than inpatient care, VA was left with an increasingly obsolete infrastructure, including many hospitals built or acquired more than 50 years ago in locations that are sometimes far from where veterans live. To address its obsolete infrastructure, VA initiated its CARES process— the first comprehensive, long-range assessment of its health care system’s capital asset requirements since 1981. Since its inception in 1999, VA’s CARES process has reached several major milestones (see table 1). The remaining steps in the CARES process include completing alignment decisions for inpatient services, implementing decisions that have been completed, and institutionalizing CARES. Institutionalizing CARES will involve integrating the CARES process—a systematic, data-driven framework for evaluating VA’s capital assets in light of projected demand for VA health care services—into VA’s ongoing strategic planning efforts. In the announcement of CARES decisions in May 2004, the Secretary of Veterans Affairs stated that through the CARES process VA had developed more complete information about the demand for VA health care and a more comprehensive assessment of its capital assets than it ever had before. The Secretary noted that this information, along with the experience gained through conducting CARES, positioned VA to continue to expand the accuracy and scope of its planning efforts. The Secretary stressed that VA would focus on integrating the CARES process into its annual strategic and capital planning efforts in order to ensure that VA uses the best information available when making plans to meet the health care needs of current and future veterans. VA Faces a Challenge in Developing Information Needed to Complete Decisions on the Alignment of Inpatient Services VA faces a key challenge in developing sufficient information to complete inpatient service alignment decisions. VA did not complete all its inpatient alignment decisions in the CARES process because it concluded that it lacked sufficient information to do so. VA did not complete inpatient alignment decisions across VA for long-term care (including nursing home care) and mental health services (including acute and long-term psychiatry, residential rehabilitation, and domiciliary care). VA also lacked sufficient information to complete its inpatient alignment decisions for services at 12 facilities. Developing Information Needed to Complete Inpatient Alignment Decisions for Long-Term Care and Mental Health Will Be Challenging Developing information needed to complete inpatient alignment decisions for long-term care and mental health services across VA will be difficult for three reasons. First, it is unclear whether VA has adequate information on the number of veterans who will need and seek inpatient long-term care and mental health services from VA on a daily basis because VA has not finalized models for projecting future demand for these services. In VA’s May 2004 announcement of CARES decision, VA concluded that its models were inadequate to forecast demand. As a result, VA did not complete its inpatient alignment decisions for these services across VA. While VA officials told us that they have subsequently revised models and forecasts of demand for care from VA, these models and forecasts are not finalized. Second, VA has not made the policy determinations that would allow it to generate information concerning which veterans it will serve in the future among those seeking long-term care—including nursing home care—and the nursing home care services it will offer. Completing inpatient alignment decisions for nursing home care requires having a technical forecast of how many veterans will need and seek care from VA, and requires information generated from policy decisions concerning which veterans VA will serve and which nursing home services VA will provide. VA lacks this information because it has not determined criteria to be used to identify which veterans it will serve as a matter of policy, in addition to those required by law, criteria such as a veteran’s level of service- connected disability or income. In addition, VA lacks information on which services will be provided, such as specifying to whom it will provide nursing home care for short-stay care rehabilitation of post-acute conditions such as hip replacement and to whom it will provide long-stay support and supervision for chronic conditions such as dementia. VA officials told us that such policy decisions have not been made and, as a result, VA’s long-term care model cannot provide the forecasts of workload demand that are needed to make inpatient alignment decisions. Third, VA has not finalized its strategic plan for long-term care, which would provide information for determining where VA needs to provide these services and the types of services needed. Developing adequate models for forecasting likely demand and resolving policy issues for inpatient long-term care would provide key information needed to develop a long-term care strategic plan. According to the Secretary’s May 2004 summary of CARES decisions, an important element of the strategic plan for long-term care will be the goal of ensuring that veterans’ access to an appropriate range of these services is equitable. This plan would help VA decide whether its current facilities and inpatient services are in the best locations to meet future demand or whether changes are needed to better align these facilities and services with demand. Developing Information Needed to Complete Inpatient Alignment Decisions at 12 Facilities Will Be Challenging Developing information needed to complete inpatient alignment decisions at 12 of VA’s 172 facilities will be challenging because VA does not have sufficiently precise information to evaluate tradeoffs between the costs and benefits of various alignment options. (See table 2 for a list of these facilities and their corresponding networks.) In some cases, these alignment decisions include inpatient long-term and mental health services. In general, VA concluded in its May 2004 announcement of CARES decisions that it does not have sufficient information to determine whether to maintain inpatient services as currently aligned at these facilities or to realign the services. For example, in the Boston area, VA provides inpatient care in 4 outdated facilities. VA concluded that it did not have sufficient information about the cost-effectiveness and benefits of building a replacement hospital in the area. VA also lacked sufficient information about how to preserve veterans’ access to nursing home services if such services in the Boston area are realigned. Similarly, VA faces a challenge developing sufficient information about the costs and benefits of options to make alignment decisions for inpatient services at its medical facility in Waco, Texas. In October 2003, network officials estimated that in the absence of a realignment of services at the Waco facility, which is primarily a psychiatric care hospital, VA will need about $1.5 million a year to maintain unused space at the facility, and that through 2022 the facility will require an additional $61 million for nonrecurring capital costs such as renovation. Options for realigning inpatient services at the Waco facility include moving some services, such as acute inpatient psychiatry, to other locations, such as VA’s medical facility in Temple, Texas. VA faces a challenge weighing these options and completing its alignment decision because VA has concluded that it lacks sufficient information on the possible savings it would achieve through realignment and the likely costs of construction at the Temple facility if services are added there. VA also concluded that it lacked sufficient information on access to inpatient services and continuity of care for veterans who currently receive health care services at the Waco facility. This information could help VA weigh options for the alignment of inpatient services at the Waco facility. This could also help VA address the concerns of stakeholders—including veterans’ service organizations, elected officials, and employee representatives—who will be affected by changes at the Waco facility. A group of stakeholders with concerns has asked to work with VA to develop alternatives for the facility and to assist in finding ways to lease the facility’s unused buildings and excess property. VA could use information on the costs and benefits of various alignment options not only to complete its inpatient alignment decisions for the 12 facilities, but also to address the concerns of stakeholders and others. Stakeholders—including veterans’ service organizations, affiliated medical schools, employee unions, and communities—as well as decision makers and veterans are more likely to have confidence in decisions at specific VA medical facilities when VA can present sufficient information about the key costs and benefits of alternative options for the alignment of inpatient services. Costs and benefits to be considered are the impacts these alternatives would have on the quality of and access to care; the cost to the government; VA’s other strategic goals, such as the medical education of health care providers and research; and the local community’s economy. If VA had this kind of information, it would be better positioned to make decisions and address concerns raised by veterans and stakeholders. In the past, some stakeholders have opposed proposed changes to VA’s health care system that they felt were not in the best interests of their members, even when those changes could have benefited veterans. For example, medical schools’ reluctance to change long- standing relationships with VA medical facilities has sometimes been a major factor inhibiting VA’s asset management. Similarly, unions have been reluctant to support decisions that involve restructuring services when doing so could result in staffing reductions. VA Has Taken Steps to Develop Information Needed to Complete Inpatient Alignment Decisions VA has taken several steps to address the challenge of developing sufficient information to complete its remaining inpatient alignment decisions. These steps include developing information for completing inpatient alignment decisions for long-term care and mental health across VA and information for completing decisions for inpatient services at the 12 facilities. For long-term care and mental health, VA officials told us that VA has developed more adequate models to forecast the number of veterans who will need and seek these services from VA on a daily basis in the future than the models considered for use in the CARES process. However, VA officials have not finalized the long-term care and mental health models or forecasts and said that they will continue to refine these models. Regarding the policy determinations to generate information for inpatient long-term care, VA has included a proposal in its current appropriations request to revise its policy on which veterans it will provide nursing home services to and the extent to which it will provide short-stay and long-stay care beginning in fiscal year 2006. However, the proposal has not yet been made policy. VA officials told us that they are trying to address whether they can develop the information needed to incorporate into VA’s nursing home model and projected demands for services before these policy issues are resolved. VA has taken several steps to develop the information it needs to complete decisions on the alignment of inpatient services at the 12 medical facilities where alignment decisions are not complete. VA hired a contractor in January 2005 who will be responsible for developing information on the costs and benefits of specific options for aligning inpatient services at these 12 facilities. To ensure stakeholder involvement in developing this information, VA gave notice of the establishment of the Advisory Committee for CARES Business Plan Studies in October 2004, under the Federal Advisory Committee Act, which includes an advisory subcommittee for each location. These committees include both network staff and local stakeholders and will help develop information about the concerns of veterans, employees, and other stakeholders or interest groups, for example, by holding public meetings. To further assist the contractor and carry out other responsibilities, in June 2004, VA established a new headquarters office, the Office of Strategic Initiatives, which will oversee the completion of these studies. VA Faces a Challenge in Improving Management of Excess Property Improving the management of VA’s large inventory of excess real property—including 8.5 million square feet of vacant space—poses another key challenge to VA. This challenge results, in part, from the disincentives associated with the administrative complexity and costs of disposing of federal property. In addition, the lengthy process required to establish leases, along with some local managers’ lack of expertise needed to negotiate these leases, adds to VA’s challenge. VA has taken steps to address some of these difficulties. Managing excess property is challenging for VA in part because of the disincentives associated with the administrative complexity and costs involved in the disposal of federal property. Like all federal agencies that own facility space or other forms of real property, VA must comply with federal requirements governing property disposal that are intended to protect subsequent users of the property from environmental hazards and preserve historically significant sites. For example, federal agencies are required to assess and pay for environmental cleanup that may be needed before disposing of property—a process that can require years of study and result in significant costs. Moreover, federal agencies that own buildings designated as historic structures must comply with provisions of the National Historic Preservation Act, which requires agencies to manage historic properties under their control and consider the effects of their actions on historic preservation. About 30 percent of VA’s buildings have been designated as historically significant. In addition, like other federal agencies, VA must generally make excess federal facilities available to other federal agencies and programs for the homeless when disposing of property. As valuable as these legal requirements are, their administrative complexity and the associated costs of complying with them create disincentives to the disposal of excess property. VA officials told us these requirements have contributed to some managers’ decisions to retain excess property rather than pursue disposal. In general, disposal of VA property, until November 2004, was controlled by the General Services Administration (GSA). Since 1990, VA disposed of no properties through this process and few properties through other means. In November 2004, Congress gave VA greater discretion in managing the disposal of excess property. VA had requested changes in its disposal authority to address disincentives that VA managers believed impeded their progress in disposing of excess property. The disincentives included administrative complexity and a limitation that allowed use of disposal proceeds only for nursing home construction and renovation. Changes in VA’s disposal authority included permitting VA to directly manage the disposal of excess property instead of using the disposal process managed by GSA. In addition, VA was granted the authority—to the extent specified in appropriations acts—to use proceeds from disposal not only for nursing home construction and renovation but for use in construction or renovation of other VA patient facilities or to defray expenses associated with their disposal requirements. VA officials acknowledge that direct management of the disposal process gives VA managers more flexibility in managing the disposal of excess buildings and land. However, they maintain that to dispose of excess property VA managers still face disincentives associated with legal requirements to address potential environmental hazards and the preservation of significant historical sites prior to disposal. In addition, VA officials acknowledge that even though VA may now use disposal proceeds for improving or disposing of other VA buildings, they believe the use of the funds for specific projects is subject to congressional approval in the appropriations process each year. VA officials also told us they believe that VA effectively derives no new funds from this authority because, in practice, funds obtained from the disposal process would be deducted each year from the amount that Congress appropriates. Unlike most federal agencies, VA has authority to enter into leases with other organizations, called enhanced-use leases, but VA managers face difficulties in leasing excess property to non-VA organizations under this authority. Specifically, the length of time needed to review and approve leases poses a challenge to VA in leasing excess property. For example, to establish leases, VA has had to negotiate with entities in the community that are interested in leasing VA property and obtain public comment and perform multiple rounds of review and approval by VA network and headquarters officials. The leases VA has established include, for example, partnerships for parking garages, child development centers, and senior housing. Contributing to the length of the leasing process is a requirement that VA quantify the benefits that veterans will likely derive from a lease— a task that officials say can be difficult and time consuming. For example, if VA establishes a lease for a child development center that may help in the recruitment and retention of VA staff to provide health care, VA is required to quantify the benefits to veterans of the child development center. Another difficulty that has hindered VA’s leasing activities has been that some local managers lacked the expertise needed to develop, negotiate, and finalize leases. Such expertise includes legal, real estate, marketing, and financial skills. The CARES Commission found that the lack of expertise made it difficult for VA to attract potential investors and navigate local zoning and land use requirements. Although the Commission noted that some VA networks had been successful in arranging leases for excess property, relatively few leases have been established since 1991, when VA was given authorization to lease excess property. VA has taken steps to address the difficulties associated with the disposal of excess property. For example, VA created a new position—the capital asset manager—in each of its networks to strengthen its management of excess property. These managers will be responsible for a number of tasks involving capital assets, including facilitating the disposal of excess property. The capital asset managers will also be responsible for ensuring that VA has current data on the condition and the use of its buildings and land. VA officials reported that they sought capital asset manager candidates with experience in the disposal of federal real property as a means to improve VA’s ability to manage its own disposal process. In addition, VA is developing an agencywide capital asset disposal policy that is designed to guide managers’ efforts to reduce VA’s inventory of unneeded property. VA is also taking steps to address the difficulties it faces in developing enhanced-use leases of its excess property. To streamline VA’s preparation of leasing proposals, VA recently granted authority to its capital asset managers to make some enhanced-use leasing decisions, such as conducting feasibility studies, creating enhanced-use lease business plans, and writing leases and memoranda of understanding. VA expects this will expedite its leasing process. The new capital asset managers will also be responsible for identifying leasing opportunities and negotiating leases. To facilitate leasing activities, including some that were identified in CARES, VA is making real estate, legal, marketing, financial, and other types of expertise available to network managers through a contract awarded in April 2005. According to VA officials, this expertise will help network managers develop key information, such as the potential market value of VA’s excess property. VA Faces a Challenge in Determining Priorities for the Purchase of Inpatient Services from Non-VA Providers to Improve Access to Care VA faces another key challenge in determining priorities for the purchase of inpatient services from non-VA providers to improve access to care by making these services available closer to where veterans live. While VA determined that in 25 markets purchasing acute and tertiary inpatient services from non-VA providers would be a reasonable option for providing these services closer to where veterans live, VA’s network managers, who are responsible for making such decisions, have to balance these efforts against competing priorities. Improving veterans’ access to inpatient acute and tertiary care through purchased care is one of many priorities that VA managers may support with their available resources. As a result, VA managers have to weigh the costs and benefits of various uses of their resources to determine whether, when, and to what extent they should purchase acute and tertiary care services from non-VA providers and to what extent resources should be spent instead, for example, on improving access to long-term care, mental health, and primary care services. VA determined that in 25 markets a large number of enrolled veterans face driving times that exceed VA standards in order to obtain inpatient acute and tertiary care services at the nearest VA-owned or VA-affiliated medical facility. VA also determined that in these 25 markets the number of veterans facing lengthy driving times was not sufficient to justify building a new VA facility and that a reasonable option for reducing these driving times would be to purchase inpatient services from non-VA providers. (See app. I for a list of the 25 markets and a description of the geographic areas that each market covers.) About 800,000 enrolled veterans could potentially benefit from the purchase of these inpatient services, according to our estimate using VA data for fiscal year 2001. The number of enrolled veterans potentially affected in any one of the 25 markets ranged from about 13,000 to 76,000. The number of these enrolled veterans who would actually need inpatient services in a given year would be substantially less than the total number of enrollees and would depend on a variety of factors such as age, gender, and health status. VA’s experience in Chattanooga, Tennessee, although not located in one of the 25 markets, illustrates the challenge network managers face in balancing competing priorities. VA does not have an inpatient facility in Chattanooga, and most veterans in the Chattanooga area face drives of 2 or more hours to obtain inpatient care at VA’s medical centers in Murfreesboro and Nashville, Tennessee. To reduce these driving times, VA contracted for acute inpatient services with a non-VA medical center in Chattanooga from September 2000 through August 2002. This arrangement did not, however, substantially improve veterans’ access to inpatient care because network managers restricted referrals to the non-VA facility to veterans with relatively less severe medical conditions, such as veterans who did not require surgery or hospital stays longer than 5 days. Although network managers purchased inpatient services from non-VA providers in Chattanooga, the managers had to reconcile this effort with other needs. For example, network managers told us that the restrictions they placed on referrals to the non-VA facility were necessary to manage resources effectively as well as to ensure that patient workload at VA’s Murfreesboro facility remained sufficient to support another priority—graduate medical education. As a result of the restrictions placed on the referrals, less than 5 percent of Chattanooga veterans’ inpatient workload was provided in Chattanooga in fiscal year 2002. VA provided most of its inpatient hospital workload for Chattanooga-area veterans in its medical facilities in Murfreesboro and Nashville. VA is developing guidance to address the challenge VA’s network managers face in determining priorities for purchasing inpatient care. This guidance specifies information that networks are to provide to headquarters when seeking approval of contracts with non-VA providers, including the inpatient services the network will purchase, the amount of resources needed to purchase these services, a timetable for when the services will be available, and the source of funding for these services. The guidance also requires network managers to provide evidence of the cost effectiveness of the proposed contract as well as a discussion of the potential impact of contracting on other health care services in the network. Concluding Observations Through the CARES process, VA has undertaken a critically important effort to address long-standing problems with the management of its capital assets. If it completes and successfully implements CARES decisions, VA may be able to enhance veterans’ health care by reinvesting resources now spent on excess property. Achieving this will depend on VA’s success in dealing with the challenges of developing sufficient information to complete inpatient alignment decisions, improving the management of excess property, and determining priorities for the purchase of inpatient services from non-VA providers to improve access to care. It is too early to know whether the steps VA is taking to address these challenges will be successful. VA’s ability to meet the goal of providing high-quality, accessible, cost- effective health care to the nation’s veterans will depend largely on the extent to which VA is successful in institutionalizing the CARES process into its ongoing strategic and capital planning efforts. In the short term, institutionalizing the capacity to assess VA services and real property would provide a framework for making decisions about the alignment of long-term care and mental health services as VA develops and refines models for these services. An essential step in completing alignment decisions is finalizing the models and demand forecasts for long-term care and mental health services as well as finalizing the long-term care strategic plan. In the longer term, institutionalizing the CARES process would help ensure that VA has a systematic, data-driven framework for evaluating options for managing its real property in order to better meet the future health care needs of veterans. Such a framework could contribute to VA’s effectiveness as a steward of national resources and provider of health care services for our nation’s veterans. Agency Comments In written comments on a draft of this report, VA concurred with our findings and conclusions and provided a technical correction and additional information on the CARES process, which we incorporated where appropriate. VA comments are reprinted in appendix II. We are sending copies of this report to the Secretary of Veterans Affairs, appropriate congressional committees, and other interested parties. We will also make copies available to others upon request. This report will be available at no charge on GAO’s Web site at http://www.gao.gov. If you or your staff have any questions, please contact me at (202) 512-7101 or bascettac@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III. Appendix I: 25 Markets Where VA Identified the Purchase of Inpatient Care as an Option to Improve Access This market includes most of Alabama and part of western Georgia. VA owns four inpatient medical facilities in this market, located in Birmingham, Montgomery, Tuscaloosa, and Tuskegee, Ala. 7—South Carolina This market includes most of South Carolina and part of Georgia. VA owns two inpatient medical facilities in this market, located in Charleston and Columbia, S.C. This market includes part of southwestern Florida. VA owns one inpatient medical facility in this market, located in Bay Pines, Fla. This market includes most of northern Florida and part of southern Georgia. VA owns two inpatient medical facilities in this market, located in Gainesville and Lake City, Fla. This market includes the southern central portion of Ohio. VA owns one inpatient medical facility in this market, located in Chillicothe, Ohio. This market includes northeastern Ohio. VA owns two inpatient medical facilities in this market, located in Cleveland, Ohio (Brecksville and Wade Park). This market includes the eastern central portion of Illinois and part of western Indiana. VA owns one inpatient medical facility in this market, located in Danville, Ill. This market includes parts of southern Alabama and western Florida. VA does not own any inpatient medical facilities in this market. This market includes the central portion of Texas. VA owns two inpatient medical facilities in this market, located in Temple and Waco, Tex. This market includes southern Texas. VA does not own any inpatient medical facilities in this market. This market includes New Mexico, western Texas, and parts of southern Colorado and western Oklahoma. VA owns three inpatient medical facilities in this market, located in Albuquerque, N. Mex., and Amarillo and Big Spring, Tex. This market includes eastern Colorado, southeastern Wyoming, and parts of both Kansas and Nebraska. VA owns two inpatient medical facilities in this market, located in Denver, Colo., and Cheyenne, Wyo. This market includes most of Montana and part of western North Dakota. VA owns two inpatient medical facilities in this market, located in Fort Harrison and Miles City, Mont. This market includes Alaska. VA owns one inpatient medical facility in this market, located in Anchorage, Alaska. Geographic area covered by market and the VA inpatient medical facilities within it 20—Inland North This market includes eastern Washington, northern Idaho, northeastern Oregon, and part of northwest Montana. VA owns two inpatient medical facilities in this market, located in Spokane and Walla Walla, Wash. 20—Inland South This market includes parts of eastern Oregon and southern Idaho. VA owns one inpatient medical facility in this market, located in Boise, Idaho. This market includes western Oregon, southwestern Washington, and part of northwestern California. VA owns four inpatient medical facilities in this market, located in Portland, Roseburg, and White City, Oreg., and Vancouver, Wash. This market includes northeastern California and western Nevada. VA owns one inpatient medical facility in this market, located in Reno, Nev. 21—South Coast This market includes part of central California. VA owns three inpatient medical facilities in this market, located in Livermore, Menlo Park, and Palo Alto, Calif. This market includes most of Iowa and parts of Illinois and Missouri. VA owns three inpatient medical facilities in this market, located in Des Moines, Iowa City, and Knoxville, Iowa. This market includes most of Minnesota and part of northwestern Wisconsin. VA owns two inpatient medical facilities in this market, located in Minneapolis and St. Cloud, Minn. 23—North Dakota This market includes most of North Dakota and parts of both Minnesota and South Dakota. VA owns one inpatient medical facility in this market, located in Fargo, N. Dak. 23—South Dakota This market includes most of South Dakota and parts of five other states: Iowa, Minnesota, Nebraska, North Dakota, and Wyoming. VA owns three inpatient medical facilities in this market, located in Fort Meade, Hot Springs, and Sioux Falls, S. Dak. VA health care facilities are organized into 21 regional networks, known as Veterans Integrated Service Networks, that are to coordinate the activities of and allocate resources to VA health care facilities. VA had 22 networks until January 2002, when it merged Networks 13 and 14 to form a new network, Network 23. VA defines a health care market as a geographic area having a sufficient population and geographic size to benefit from the coordination and planning of health care services and to support a full health care delivery system. Each VA network includes from 2 to 6 markets; nationwide, VA has 77 markets. Appendix II: Comments from the Department of Veterans Affairs Appendix III: GAO Contact and Acknowledgments GAO Contact Acknowledgments In addition to the contact named above, James C. Musselwhite, Assistant Director; Kristen Joan Anderson; Frederick Caison; Krister Friday; Clare Mamerow; and Paul Reynolds made key contributions to this report. Related GAO Products Federal Real Property: Further Actions Needed to Address Long-standing and Complex Problems. GAO-05-848T. Washington, D.C.: June 22, 2005. VA Health Care: Important Steps Taken to Enhance Veterans’ Care by Aligning Inpatient Services with Projected Needs. GAO-05-160. Washington, D.C.: March 2, 2005. High-Risk Series: An Update.GAO-05-207. Washington, D.C.: January 2005. VA Health Care: Access for Chattanooga-Area Veterans Needs Improvements. GAO-04-162. Washington, D.C.: January 30, 2004. Budget Issues: Agency Implementation of Capital Planning Principles Is Mixed. GAO-04-138. Washington, D.C.: January 16, 2004. Federal Real Property: Vacant and Underutilized Properties at GSA, VA, and USPS. GAO-03-747. Washington, D.C.: August 19, 2003. VA Health Care: Framework for Analyzing Capital Asset Realignment for Enhanced Services Decisions. GAO-03-1103R. Washington, D.C.: August 18, 2003. Department Of Veterans Affairs: Key Management Challenges in Health and Disability Programs. GAO-03-756T. Washington, D.C.: May 8, 2003. VA Health Care: Improved Planning Needed for Management of Excess Real Property. GAO-03-326. Washington, D.C.: January 29, 2003. Major Management Challenges and Program Risks: Department of Veterans Affairs. GAO-03-110. Washington, D.C.: January 2003. High-Risk Series: Federal Real Property. GAO-03-122. Washington, D.C.: January 2003. VA Health Care: VA Is Struggling to Address Asset Realignment Challenges. GAO/T-HEHS-00-88. Washington, D.C.: April 5, 2000. VA Health Care: Improvements Needed in Capital Asset Planning and Budgeting. GAO/HEHS-99-145. Washington, D.C.: August 13, 1999. VA Health Care: Challenges Facing VA in Developing an Asset Realignment Process. GAO/T-HEHS-99-173. Washington, D.C.: July 22, 1999. VA Health Care: Capital Asset Planning and Budgeting Need Improvement. GAO/T-HEHS-99-83. Washington, D.C.: March 10, 1999.

The Department of Veterans Affairs (VA) operates one of the nation's largest health care systems. In 1999, GAO reported on VA's aged, obsolete capital assets, noting that better management of these assets could significantly reduce VA's operating costs. GAO also noted that VA could reinvest the savings to enhance veterans' health care. In response, VA initiated its Capital Asset Realignment for Enhanced Services (CARES) process to identify what health care services it should provide in which locations through fiscal year 2022. CARES resulted in decisions to realign inpatient services at some VA facilities and to leave services as currently aligned at others. VA did not complete inpatient alignment decisions across VA for long-term care and mental health services and for inpatient services at some facilities because VA lacked sufficient information on demand for such care and other factors. GAO was asked to examine key challenges VA will face in completing and implementing CARES. This report discusses three key challenges: (1) developing information to complete inpatient alignment decisions, (2) improving management of excess property, and (3) determining priorities for purchasing care to improve access. GAO's analysis is based on its prior CARES work, review of CARES documents, and interviews with VA officials. VA faces a key challenge in developing sufficient information to complete inpatient service alignment decisions. VA concluded that it did not have sufficient information to complete such decisions across VA for long-term care (including nursing home care) and mental health services (including acute psychiatric care). VA also concluded that it did not have sufficient information to complete alignment decisions for inpatient services at 12 facilities. VA faces this challenge for several reasons. For example, it is unclear whether VA has adequate information on the number of veterans who will seek nursing home care and inpatient mental health services from VA on a daily basis because it concluded that its models were inadequate to forecast demand and it has not finalized revised models. VA has taken steps to address the challenge of developing the information needed such as working to develop improved models of demand for these services. Improving the management of VA's large inventory of excess property--including 8.5 million square feet of vacant space--poses another key challenge. This challenge results from disincentives associated with administrative complexity and costs of the disposal of federal property. Like all federal agencies, VA must comply with federal requirements governing property disposal that are intended, for example, to protect subsequent users of the property from environmental hazards. Some VA managers have retained excess property because the complexity and costs of complying with these requirements were disincentives to disposal. Congress has given VA authority to use disposal proceeds for construction and renovation of VA patient facilities and disposal activities, to the extent specified in appropriations acts. VA is taking steps to address this challenge, including hiring network-level capital asset managers to facilitate disposal. VA faces another key challenge in determining priorities for the purchase of inpatient services to improve access to care. While VA determined that purchasing inpatient services from non-VA health care providers in 25 health care markets would be a reasonable option for providing care closer to where veterans live, VA's network managers have to balance the costs and benefits of purchasing care against competing priorities. VA has taken steps to facilitate managers' development of information they need to decide among priorities, including information on the cost effectiveness of proposed contracts and their impact on other health care priorities. To improve its management of capital assets and enhance veterans' health care by reinvesting resources now spent on excess property, VA must overcome challenges in completing and implementing decisions reached through CARES. Furthermore, institutionalizing the CARES process into its ongoing strategic planning will be crucial to VA's effectiveness as a steward of national resources and a health care provider for the nation's veterans. VA concurred with GAO's findings and conclusions.

Background The disposal of LLRW is only the end of the radioactive material life cycle that spans its production, use, processing, interim storage, and disposal. In general the cycle starts with procurement of the radioisotopes that have medical, industrial, agricultural, and research applications. The isotopes come in either sealed or unsealed sources. While a metal container shields a sealed source, unsealed sources remain accessible in a glass vial or other type of container. Common uses of this radioactive material are in radiotherapy, radiography, smoke detectors, irradiation and sterilization of food and materials, gauging, and illumination of emergency exit signs. In the course of working with these materials, other material, such as protective clothing and gloves, pipes, filters, and concrete that come in contact with them will become contaminated. The nuclear utility industry generates the bulk of this LLRW through the normal operation and maintenance of nuclear power plants, and when these plants are decommissioned. Once these materials have served their purpose, they are recycled or become LLRW. LLRW can be processed by those licensed to use these materials or by specialized companies to reduce the volume and sometimes the radioactivity level of the waste before it is either put into a licensed interim storage or a disposal facility. After a period of storage, some LLRW can decay to the point that it is safe for disposal in regulated landfill sites. During the life cycle, there will also be some loss of radioactive materials. Figure 1 diagrams the life-cycle process for radioactive materials. Back in the 1960s, the Atomic Energy Commission (AEC) began to encourage the development of commercial LLRW disposal facilities, as a substitute for ocean disposal, to accommodate the increased volume of commercial waste that was being generated. Six such disposal facilities were licensed, two of which, the facility in Richland, Washington, licensed in 1965, and in Barnwell, South Carolina, licensed in 1971, remain open today to accept class A, B and C wastes. Each of these facilities is located within the boundaries of or adjacent to a much larger site owned by DOE. The third facility, operated by Envirocare of Utah, is about 80 miles west of Salt Lake City. The state initially licensed the Envirocare facility in 1988 to accept naturally occurring radioactive waste. In 1991, Utah amended the license to permit the disposal of some LLRW and the Northwest Compact agreed to allow Envirocare to accept these wastes from noncompact states. By 2001, the facility was allowed to accept all types of class A waste. Despite estimates by a nuclear industry association that expenditures may now have reached approximately $1 billion on various facility development efforts, no new commercial LLRW disposal facility has been developed since passage of the Act, except for the Envirocare facility, which was not developed at the instigation of the compact in which it exists. In our 1999 report, we found that the impetus to develop new disposal facilities was dampened by a combination of factors that included significant decreases in LLRW generation, available capacity at the three existing facilities to meet national disposal needs, and rising costs of developing disposal facilities. Development costs were a concern because these costs and operating costs would need to be covered by the disposal fees placed on uncertain and perhaps limited LLRW generated within a compact. Developing new LLRW disposal facilities also encountered public and political resistance in states designated to host these facilities. There are presently 10 compacts comprised of 43 states; the Appalachian, Atlantic, Central, Central Midwest, Northwest, Midwest, Rocky Mountain, Southeast, Southwestern, and Texas compacts. There are also 7 unaffiliated states, as well as the District of Columbia and Puerto Rico. A graphic of the state LLRW compacts and unaffiliated states is provided in figure 2. Since 1999 LLRW Disposal Availability and Federal Oversight Have Changed We identified a number of important changes that have occurred since our 1999 report that have had or might have significant effects on future disposal availability for these wastes and federal oversight of LLRW management by the states. The following changes that might have implications for long-term disposal availability include: In 2001, South Carolina legislation restricted the use of the Barnwell disposal facility to only generators in the three-member Atlantic compact after mid-2008. Presently, this facility is the only disposal option for the class B and C wastes generated in 36 other states and the District of Columbia and Puerto Rico. Approaching the threshold of capacity at Barnwell is not a new concern. In the past, the state legislature has changed its position on restricting access to this facility, both closing and reopening the facility to noncompact member states over the years. In 2001, Envirocare received a license from the state regulatory authority to accept class B and C wastes pending approval by the Utah legislature and governor. Currently, the state has imposed a moratorium on approving the use of this license until February 2005, after a review of the recommendations of a hazardous waste regulation and policy task force. The legislative task force was set up to conduct a two-year study of how facilities in Utah that accept radioactive waste or radioactive materials for processing or reprocessing compare to other facilities in terms of competitive fees and tax structure. The task force is expected to issue its final report by November 2004. Granting approval for Envirocare to use its class B and C wastes license to accept these wastes nationally might eliminate any shortfall in disposal availability for class B and C wastes resulting from restricted access to the Barnwell disposal facility. In 2003, Texas legislation designated a geographic area in the state as acceptable for a new LLRW disposal facility, and the state regulator developed a license application process for this facility. If a facility license is granted, the facility operator will be allowed to accept all classes of LLRW, as well as DOE site cleanup wastes. It has taken Texas two decades to garner the political support to move forward with developing a new disposal facility that would be privately operated instead of through a public entity. Access, however, may be granted only to generators in selected states outside of the Texas Compact. On the other hand, if access is granted nationally, the Texas disposal facility might eliminate any shortfall in disposal availability for class B and C wastes resulting from restricting access to the Barnwell disposal facility. In 2004, a federal appellate court ruling has renewed discussions in Nebraska about building a disposal facility for the 5-member state Central Compact. The Court of Appeals for the 8th Circuit affirmed a federal district court decision that Nebraska, as a designated host state, is liable for $151 million in damages for reneging on its obligations to the Central Compact to build a disposal facility by denying a license application for reasons not related to the merits of the application. While Nebraska may appeal this decision to the U.S. Supreme Court, the appeals court decision might encourage Nebraska to reconsider building a disposal facility and affect the decisions of other states that have prior obligations to build new disposal facilities for their respective compacts. The remaining changes affect federal agency guidance and oversight of LLRW management by the states. In 2001, DOE significantly diminished its involvement in guiding and overseeing LLRW management by the states. DOE’s reporting requirement on LLRW management, as originally required by the Act, terminated effective May 2000. The department’s last report to the Congress covered the 1998 LLRW management situation. DOE’s technical assistance activities under the Act have also essentially ended after a period of shifting emphasis and decline. According to a DOE Inspector General’s report, starting in 1996, the department shifted its technical assistance to states and compact regions from developing LLRW disposal facilities to providing assistance on, among other things, tracking and storing waste. The report found that the department’s shift in technical assistance was a reaction to the states’ inability to overcome barriers to disposal site selection. The funding level for the program in the late 1990s was about $4 million annually. In fiscal year 2000, the Congress did not appropriate funds for DOE’s National Low-Level Waste Management Program, with the exception of about $600,000 to maintain the online LLRW national database, known as the Manifest Information Management System (MIMS), that was a component of this program. Since then, DOE has not received appropriated funds specifically to support a National Low-Level Waste Management Program. Instead, according to DOE, it has requested and has been appropriated funds each fiscal year to purchase and maintain the MIMS database, although not as an identifiable line item in its budget. Since the late 1990s, NRC has decreased its direct involvement in LLRW management by the states because no new disposal sites were being developed and Agreement States have taken on more of these responsibilities. However, the perceived security risks of stored LLRW have heightened since 2001 because of the potential to use some of this material in radioactive dispersal devices, sometimes known as “dirty bombs.” While NRC has set no time limits on the storage of LLRW, as long as it is safe, it prefers disposal. Agency officials told us that implementation of the Act has not resulted in reliable and cost effective disposal options for generators. They added that while storage is presently safe, they are concerned about the future safety and security of the increasing volumes of LLRW stored by thousands of licensees who have decided not to pay high disposal fees today, and who might not have disposal options for class B and C wastes in the future. NRC is in the process of conducting vulnerability studies of both reactor and radioactive materials licensees, including those with LLRW storage and disposal. According to agency officials, the result of these assessments will include recommendations for graded approaches to security enforcement based on the overall risk of particular facilities. In addition, NRC has surveyed the states to determine if new regulations should be developed for assured isolation facilities. The Commission decided to defer further rulemaking in this area and to review the need for future action annually, including the potential need for rulemaking and or regulatory guidance for long-term storage of LLRW. The Commission also directed NRC staff to participate, as resources allow, in the Conference of Radiation Control Program Directors’ development of a suggested State regulation for control of radiation in assured isolation facilities. Notwithstanding these actions, NRC officials told us that the agency does not centrally track disposal availability or the volume and duration of stored LLRW. Annual LLRW Disposal Volumes Have Increased, but Future Volumes Are Uncertain Annual LLRW disposal volumes have increased significantly in recent years, primarily the result of cleaning up of DOE sites and decommissioning nuclear power plants. We chose to rely on disposal volume data from the three commercial disposal facility operators because the MIMS database does not include DOE waste volumes sent to commercial disposal, it is not as up to date, and it has other deficiencies. Future disposal volumes remain uncertain and will depend largely on waste disposal decisions by DOE and nuclear utility companies. LLRW Disposal Volumes Increased Significantly since 1999 Since the beginning of 1999, disposal volumes have steadily increased to over 12 million cubic feet in 2003, an increase of over 200 percent. Class A waste accounted for 99 percent of this volume. Data from disposal facility operators indicate that annual disposal volumes for class A waste tripled, going from about 4 million cubic feet in 1999 to nearly 12 million cubic feet by 2003. The class A waste disposed of at Envirocare represented 99 percent of the total volume in 2003, and about 78 percent of this waste came from DOE. According to the disposal facility operator, DOE has increased its shipment of waste to the facility from initially about 36,000 cubic feet in 1994 (6.6 percent of the class A waste disposed) to almost 9.3 million cubic feet in 2003 (77.8 percent of the class A waste disposed). In contrast, disposal volumes of class B waste declined 47 percent, from about 23,500 cubic feet in 1999, to about 12,400 cubic feet in 2003. Class C waste disposal volumes were more volatile, changing as much as 107 percent in a single year. The total annual disposal volume of class C waste alternately rose and fell between 1999 and 2003, with the annual total reaching over 20,000 cubic feet in 1999, falling as low as about 11,000 cubic feet in 2002, then rising over 23,000 cubic feet in 2003. Of the total class B and C wastes disposed of in 2003, 99 percent went to Barnwell. Overall annual changes in disposal volume were driven by shipments of class A wastes, which are generated primarily by cleanup of DOE sites. Class B and C waste disposal volumes were affected by commercial nuclear power plant decommissioning activities, but these classes of waste represented slightly less than 0.5 percent of total volume of disposed waste between 1999 and 2003. Concerns about Usefulness and Reliability of National LLRW Database We chose not to use MIMS, which DOE maintains and operates for the LLRW community and public, to determine recent disposal volumes or to use other information in this database to analyze sources of LLRW by state, compact, and generator type because of shortcomings in its usefulness and reliability. Instead, we relied on data supplied to us by the three commercial disposal operators for our analysis because it includes DOE waste volumes sent for commercial disposal, it is more up to date, and because it is the primary source data input into the national LLRW database. Even though DOE ships large quantities of LLRW to a commercial disposal facility, this useful information is not captured in MIMS. Other types of useful information, such as storage of waste and volume of waste reduction, are also not collected in this database. The consensus among the compact and unaffiliated state officials we surveyed was that they could more effectively regulate and monitor LLRW in their compacts and states if MIMS offered more comprehensive and reliable data. Despite these shortcomings, these officials have sometimes used MIMS data as a convenient source of information for public, media, and stakeholder inquiries, as a means of monitoring LLRW within their compact or region, and as an external check on the LLRW interstate shipment data reported to compact and state regulators by the disposal operators. We also identified shortcomings in the reliability of the MIMS database. We identified inconsistencies between what the disposal facility operators claimed had been disposed of at their facilities and what was recorded in this database. For example, the volumes of LLRW reported to us by Envirocare for 1999 to 2003 totaled 10.4 million cubic feet, compared to the 15.7 million cubic feet that was reported in MIMS. There were also problems with other kinds of data in MIMS. States and compacts have identified discrepancies that undermine the data’s usefulness, particularly regarding the state-specific information on the origins of waste. For example, Tennessee, which is the base of operations for companies that transport and process the waste from generators in other states prior to disposal, reports that it is erroneously recorded in MIMS as the state of origin of this waste. The data DOE puts into MIMS comes from the three commercial LLRW disposal facility operators in electronic format. DOE pays each operator varying amounts of money to extract data from the records accompanying shipments of LLRW that provide information on the volume, radioactivity level, source, and other information about the waste. These records are called manifests and NRC requires their use to track shipment of radioactive materials. The disposal operator then transmits some of this information to DOE for entry into MIMS. Each disposal facility operator is responsible for ensuring the validity of these data, but DOE’s contracts with these operators leave to them what steps, if any, should be taken to validate the data. DOE takes no responsibility for verifying the accuracy of the data supplied by the disposal facility operators. Furthermore, while DOE takes some steps to ensure that it accurately uploads operator- supplied data into MIMS, it does not perform other systematic quality checks on the data, such as “reasonableness” checks, cross tabulations, or exceptions reports. As a result, we determined that the lack of consistent and comprehensive internal controls, such as controls over information processing, undermine our confidence in the data output in MIMS for several types of information, including sources of waste coming from states, compacts, and generator types. Uncertainties Surround Projecting Future LLRW Disposal Volumes Notwithstanding problems obtaining reliable and complete LLRW disposal data, uncertainties remain concerning the timing and volume of LLRW needing disposal in the future, which largely will depend on the disposal decisions made by nuclear utility companies and DOE, as well as on possible changes in regulatory standards for what constitutes LLRW. The pace of nuclear power plant decommissioning has been slower than expected. Nuclear utility industry officials and federal officials told us that beyond the few nuclear power plants now being decommissioned, only a small number of plants are expected to be decommissioned in the next 20 years or more. The economics of electricity generation make it desirable for most utilities to keep their existing nuclear power plants running, in some cases even making investments to upgrade and extend the operating life of the reactors. Moreover, the nuclear power industry has aggressively minimized the amount of LLRW it produces, both in absolute volume and in decreasing the amount of the more radioactive class B and C wastes by, for example, changing some kinds of filters more often before radioactivity concentrates at higher levels. Recent DOE experiences cleaning up its sites underscore how difficult making useful projections can be. Officials at DOE told us that such projections for sites now being cleaned up have not proven very accurate, and have tended to significantly overestimate waste volumes that would require disposal as LLRW. There are several reasons cited for this difficulty: records from “legacy” sites—former nuclear weapons production sites that DOE is cleaning up—have not proven to be reliable; the decay rate of known buried radioactive wastes have often been higher than expected so wastes that were expected to need disposal as LLRW can instead be legally classified as radioactive waste mixed with nonradioactive but hazardous wastes and sent to less expensive disposal facilities; contractors have become more innovative and skilled in sorting and segregating hazardous and mixed wastes from LLRW so that a higher percentage of wastes can be disposed of as hazardous or mixed wastes rather than LLRW; and some debris and material from site cleanup projected to be LLRW has no appreciable radioactivity when generated and can therefore be disposed in sanitary landfills or other non-LLRW disposal facilities. Moreover, there are some indications that the volume of DOE cleanup waste likely to be sent to commercial LLRW disposal facilities is currently at or near a peak and will soon rapidly decline as cleanup at some DOE sites winds down and as cleanup activity shifts to other DOE sites that have considerable on-site disposal capacity. As a result, DOE officials expect the use of commercial LLRW disposal facilities to start declining after 2006 and to stay comparatively low until another anticipated spike in 2014. DOE officials stressed, however, that “high confidence numbers” are not yet available because the department is still in the process of reorganizing and developing new baselines for its accelerated cleanup projects, and it does not have a management system in place to develop corresponding waste projections. Potential changes to the threshold at which waste is classified as LLRW that is currently under consideration could also affect the amount of waste needing disposal in the future. The National Research Council and the Environmental Protection Agency (EPA) are separately studying this issue and considering possible changes that might affect the future management of LLRW. The National Research Council is studying the issue because members of its Board on Radioactive Waste Management are concerned that the statutes and regulations that govern LLRW management may be overly restrictive; in some cases, leading to excessive costs and other burdens on the waste generator and, in other cases, possibly leading to an exaggeration of the potential risks posed by these materials. EPA is examining its existing waste regulations and has begun the process of soliciting public comment as it considers new rulemaking in this area. Specifically, EPA is exploring an option with NRC to establish a regulatory framework that allows some of the lower activity radioactive waste to be disposed of at non-LLRW disposal facilities. Finally, and in a similar vein, there has been discussion by government and industry LLRW stakeholders of harmonizing U.S. standards with prevailing international standards for LLRW under consideration by the International Atomic Energy Agency. Such a change could prompt consideration by U.S. regulators to raise the threshold at which the radioactivity of waste would trigger regulation as LLRW, and would allow for lower activity LLRW to be disposed of under other regulatory regimes. LLRW Disposal Availability Appears Adequate Until Mid- 2008 There appears to be enough disposal availability to serve the nation’s needs at least until mid-2008, when many states might lose disposal access for their class B and C wastes. Disposal availability for class A waste does not pose a problem under current conditions. According to Envirocare representatives, their disposal site, which accepted over 99 percent of the nation’s class A waste in 2003, has enough capacity to accept this waste at the current volume levels for more than 20 years. The Richland facility has about 21 million cubic feet of capacity remaining for all classes of waste, which is more than enough to accommodate the LLRW coming from the 11 states in the Northwest and Rocky Mountain compacts until the expected closure of this facility in 2056. The Barnwell disposal facility has about 2.7 million cubic feet of remaining capacity, most of which has been set aside for waste from generators in the Atlantic Compact until 2050. Barnwell also appears to have enough disposal capacity to continue accepting class B and C wastes from other states until mid-2008, when it is scheduled to close to all but the three Atlantic compact states. According to the Director of Disposal Services at Chem-Nuclear Systems, the operator of the Barnwell facility, there should be enough space at the facility to accommodate the typical 20,000 to 25,000 cubic feet of class B and C wastes accepted at this facility in recent years. This representative told us that many generators have already contracted to dispose of their B and C wastes in the short term, and any generator outside of the Atlantic Compact anticipating a need to dispose of these wastes could still contract for the necessary space until mid-2008. A number of factors support the likelihood that disposal space for class B and C wastes will be available at Barnwell until mid-2008, if disposal volumes do not exceed anticipated levels. Based on current space commitments at this disposal facility under conditions of the volume caps set by the South Carolina legislature, there remains a range of 24,500 to 44,500 cubic feet of uncommitted space until 2008. The amount of space available depends on whether Atlantic Compact generators use all of their set-aside space through 2008. In addition, utilities are likely to take more aggressive efforts to ensure sufficient space for class B and C wastes at Barnwell. Industry officials said utilities might consider several initiatives and conditions that could alleviate the diminishing disposal availability for class B and C wastes. For example, utilities could send class A waste to Envirocare rather than Barnwell to save the remaining space at Barnwell for class B and C wastes. In addition, utilities might increase waste reduction efforts and storage. After 2008, disposal availability for the class B and C wastes generated in the 36 states outside the Northwest, Rocky Mountain, and Atlantic compacts is more uncertain. Disposal availability for these states will depend on a number of possibilities including extending access to Barnwell beyond mid-2008, or creating new disposal options for these classes of waste. The Barnwell facility has opened and closed to noncompact member states before and it could happen again. Given the difficulties of attracting class A waste to Barnwell because of the high disposal fees, and the fairly consistent level of class B and C wastes shipped to this site each year, the facility might not even reach its volume cap of 35,000 cubic feet per year after 2008. In addition, the set-aside of 2.2 million cubic feet for Atlantic Compact generators through 2050 may be negotiated downward, freeing up additional space at this disposal facility. There is also some possibility that new disposal options will become available in the future that could alleviate any disposal crisis for class B and C wastes. We mentioned these disposal options in the previous section on changes since 1999 in LLRW disposal availability and federal oversight. Finally, regardless of the outcome, representatives of the Nuclear Energy Institute, the policy organization of the nuclear energy industry, said that utilities, the greatest generator of class B and C wastes, have the ability to store these wastes on site if they have no disposal option. Any LLRW Disposal Shortfall After Mid- 2008 Unlikely to Pose Immediate Problem If after mid-2008, there are no new disposal options for class B and C wastes, licensed users of radioactive materials can continue to minimize waste generation, process waste into safer forms, and store waste pending the development of additional disposal options. These approaches, however, can be costly, with a higher financial burden on some licensees than others. Notwithstanding these business costs, we did not detect other effects of any shortfalls in disposal availability that might have wider implications. LLRW Minimization and Storage Can Lessen Effects of any Disposal Shortfall The licensed users of radioactive materials that must eventually dispose of their LLRW have employed a variety of techniques to both minimize and process this waste to reduce its volume prior to storage and eventual disposal. These techniques include substitution of nonradioactive materials for radioactive materials, separation of radioactive materials from nonradioactive materials, recycling, compaction, dilution, and incineration. For example, it is reported that most large research institutions make concerted efforts to find suitable and appropriate alternatives to the use of radioactive materials. One university official told us that such efforts have reduced LLRW generation at his institution by 30 percent in the last 5 years. The Electric Power Research Institute is encouraging nuclear utilities to use vendor volume reduction programs for resins, the single largest component of class B and C wastes, to reduce volume. Some licensees have used processors to super-compact class A waste to achieve up to a 5,000 percent reduction in volume, or to reduce this waste to ash through incineration, albeit increasing the concentration of radioisotopes. In addition to minimization of LLRW, licensees can decide to store this waste when no disposal option is available to them. In order to obtain a license to possess radioactive materials, entities must demonstrate the technical capability to safely manage them. Various reasons are given for storing waste, including allowing short-lived radioactive materials to decay to innocuous levels to avoid the need for disposal in a more expensive LLRW facility, the prohibitively high cost of disposal for some licensees, and concerns about the potential liability of sending the waste to a disposal site. Universities and biomedical companies generally rely on storage for decay for their LLRW, although finding space within large research institutions in urban settings is more difficult. The high cost of LLRW disposal can also pose financial problems for some licensees. Over the last 25 years, disposal costs have risen from $1 per cubic foot of LLRW to over $400 per cubic foot, with projections of well over $1,000 per cubic foot in the future. For some LLRW, the Barnwell disposal facility now charges $1,625 per cubic foot. These disposal costs can reach hundreds of millions of dollars for utility companies that are decommissioning their nuclear power plants. NRC reported to us that the cost to fully decommission a plant can run as high as $675 million. Finally, some licensees will not send their LLRW to disposal facilities because they are concerned that the mixing of their waste with other waste might draw them into litigation if the disposal site should ever require cleanup under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (commonly referred to as Superfund). While NRC policy favors disposal rather than storage over the long-term, since the mid-1990’s, the Commission has allowed on-site storage of LLRW without a specified time limit as long as it is safe. The Commission took this approach in part because LLRW can be stored and the states were not developing any new disposal facilities. According to the agency, NRC and Agreement State license and inspection programs help ensure the safe management of stored LLRW. However, some licensees are concerned that a fire, flood, or an earthquake might cause an unintended radioactive release. If an emergency ever should arise from stored LLRW, NRC has authority under the Act to override any compact restrictions to allow shipment of LLRW to a regional or other nonfederal disposal facility, if necessary under narrowly defined conditions, to eliminate an immediate and serious threat to the public health and safety or to the common defense and security. Since September 11, 2001, the perception of the risks posed by potential use of stored LLRW by terrorists has increased. A recent report found that at least a few radioisotopes of greatest security concern are classified as LLRW. According to the report, while radiological dispersal devices, such as a dirty bomb, are not weapons of mass destruction, they could cause mass disruption, dislocation, and adverse financial consequences associated with decontamination and rebuilding. NRC officials told us that as the volume and duration of stored LLRW increases so might the safety and security risks. LLRW Minimization and Storage Can Be Costly While waste minimization and storage can alleviate the need for disposal, they can be costly. The licensees that we interviewed provided many examples of the high cost of managing LLRW. For example, one university recently built a $12 million combined hazardous and radioactive waste management facility of which two-thirds is devoted to the processing and temporary storage of class A waste. And, a medical center official took us to a small (12’ x12’) LLRW interim storage and processing room that cost the institution about $150,000 to construct to meet stringent health and environmental standards. There are also costs associated with operating storage facilities. Representatives from one university system told us that about $100,000 is spent annually to maintain its interim storage building in a remote area of the state. Added to the cost of building and operating a storage facility is the cost of securing it. Such costs have been accounted for in higher utility rates, university overhead charges, drug prices, and medical treatments. These costs of doing business are more difficult for some entities to absorb than others. For example, representatives from several biotechnology companies told us that the industry, particularly the smaller start-up companies, are not prepared for the financial cost of storing and securing LLRW. No Other Widespread Effects Detected of Shortfall in LLRW Disposal Availability Notwithstanding the cost of minimizing and storing LLRW, we did not detect widespread national impacts on LLRW generators that have resulted or might result from any disposal shortfalls. In an effort to identify any such effects, we initially asked some questions on our survey of compact and unaffiliated state LLRW officials regarding documented effects on LLRW generators of any restricted disposal availability. Virtually no citations were provided or current concerns raised. We then sought information from a broader constituency in a further attempt to find evidence of such effects. We collaborated with medical researchers at the University of Texas to seek information from two overlapping groups involved in LLRW management: the approximately 2,000 subscribers of the RadSafe Listserv, a listserv for radiation safety officers, and the approximately 6,000 members of the Health Physics Society, a scientific and professional organization whose members specialize in occupational and environmental radiation safety. We sought information on any known cases where there have been or might be adverse effects on research activities and clinical practice stemming from costs or difficulties related to the storage and disposal of LLRW. Specifically, we e-mailed questionnaires asking if these factors have caused or might cause a discontinuance or disapproval of any research or clinical endeavors to RadSafe Listserv subscribers and placed a notice in the Health Physics Society’s newsletter asking for volunteers to answer the same questions we sent to the listserv subscribers. We obtained an extremely low response rate to these questions—14 responses from listserv subscribers and 6 from Health Physics Society members. Because these were nonprobability sample surveys the results are not generalizable and can only be used for anecdotal purposes. Of these respondents, only two said that the difficulties associated with LLRW had adversely affected research or clinical practice. Several respondents cited the challenges of dealing with LLRW, but also noted that they work around the difficulties through waste minimization, including substituting nonradioactive materials for radioactive materials when possible, and on-site storage as needed. The survey results provided no evidence of any widespread effects on research activities and clinical practice stemming from costs or difficulties related to the storage and disposal of LLRW in the last 5 years. We also had limited success in identifying published reports on the possible effects that lack of LLRW disposal options might have on waste generators. We identified a report supported by DOE that surveyed LLRW generators in Michigan during a period when they had no disposal alternative from 1990 to 1995. The survey found that storage costs were actually a small cost for most businesses, and that few broader socioeconomic effects were noted. Another report reviewed the potential impact of LLRW management policies on biomedical research in the United States. The 2001 National Research Council report concluded that the central issue was the cost of managing LLRW, and not access to disposal facilities. The report found that it would take 10 to 20 years before a lack of LLRW disposal options might have an adverse effect on biomedical research or medical care. However, the report cautioned that if use of radioisotopes increases or the use of longer half-life radioisotopes increases in the future, the system of LLRW storage, monitoring, inspection, and disposal might not be adequate to meet the needs of this expansion. Conclusions Although no shortfall in disposal availability appears imminent, uncertainties remain about future access to disposal facilities. Even with the prospect of new disposal options, there is no guarantee that they will be developed or be available to meet national needs for class B and C wastes disposal. While LLRW generators have options available to mitigate any future disposal shortfall, including storing waste, storage is costly and it can lead to increased safety and security risks. Therefore, continued federal oversight of disposal availability and the conditions of stored waste is warranted. Federal oversight is necessary to oversee disposal availability and the conditions of stored waste. However, DOE and NRC have reduced their oversight of LLRW management by the states. DOE’s involvement is now limited to maintaining its online national LLRW database, which has internal control weaknesses and other shortcomings. At the same time, DOE has become the largest LLRW generator shipping to commercial disposal facilities and thus has become a part of the system on which it was initially supposed to report. NRC’s involvement with LLRW management has similarly decreased because no new disposal facilities were being developed, and an increasing number of Agreement State agencies have taken over many responsibilities for overseeing radioactive material use, storage, and disposal. As a result of this decreased federal oversight and a national LLRW database with known deficiencies, there is no central collection of information to monitor disposal availability and the conditions of stored LLRW. Given that NRC is the federal agency responsible for overseeing the use, storage, and disposal of radioactive materials, and DOE’s changed role in LLRW management, we believe that NRC is now the most appropriate agency to report to the Congress on LLRW conditions. Recommendations for Executive Action We recommend that the Secretary of Energy halt dissemination of information contained in the online national LLRW database as long as the database has internal control weaknesses and shortcomings in its usefulness and reliability. Matters for Congressional Consideration The Congress may wish to consider directing NRC to report to it if LLRW disposal and storage conditions should change enough to warrant congressional evaluation of alternatives to ensure safe, reliable and cost effectiveness of disposal availability. Agency Comments and Our Evaluation We provided a draft of this report to DOE and NRC for their review and comment. DOE’s written comments are reproduced in appendix IV. DOE agreed with our assessment that disposal availability is adequate for the near future. DOE disagreed with our recommendation to halt dissemination of information in its national LLRW database. DOE stated that our report did not adequately characterize the usefulness of MIMS, and that removal of the national LLRW database without an alternative would evoke criticism from states and regional compacts and would not fulfill the requirement in the Act to maintain such a database. Our recommendation did not call for removal of this database. Instead, we recommended halting dissemination of information in this database as long as the database has internal control weaknesses and shortcomings in its usefulness and reliability. This action might only temporarily restrict access to the online national LLRW database. DOE did this for about 2 months in late 2003 and early 2004 to correct system problems with MIMS. With regard to the usefulness of MIMS, our report noted that state and compact officials use MIMS to respond to public inquiries and to monitor LLRW; however, the consensus among the officials we surveyed was that they could more effectively regulate and monitor LLRW if MIMS offered more comprehensive and reliable data. DOE did not address our concerns about internal control weaknesses and other shortcomings in the database. We stand by our recommendation to DOE because we believe that it is inappropriate to disseminate information that is known to be incomplete and unreliable. NRC’s written comments are reproduced in appendix V. NRC commented that we provided an accurate summary of current LLRW disposal conditions and potential issues that may be encountered in the future. NRC disagreed with our suggestion that the Congress consider directing it to gather information necessary to monitor the adequacy of LLRW disposal availability and the safety and security of stored waste, and to report to the Congress on significant changes in LLRW disposal and storage conditions. In commenting on our draft report, NRC provided information on data gathering actions already in place or planned that it contends would adequately ensure the safety and security of radioactive materials, including stored LLRW, which is an alternative to disposal. Given these actions and the concerns of NRC with the regulatory cost, such as new rulemaking, associated with gather information on LLRW disposal and storage conditions, we eliminated this suggested congressional directive. In regard to our reporting suggestion, NRC commented that it believes that such monitoring and reporting, if necessary, would fall within the responsibility of DOE as was previously recognized by the Act. However, as our report noted, the Congress eliminated DOE’s reporting responsibilities under the Act and no longer specifically appropriates funds to support a National Low-Level Waste Management Program. Given the need for continued federal oversight of LLRW conditions, we maintain that NRC is now the most appropriate agency to report to the Congress if LLRW disposal and storage conditions should change enough to warrant congressional intervention. We incorporated technical changes in this report where appropriate based on detailed comments provided by the agencies. As agreed with your office, we will make copies of this report available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-3841 or Dan Feehan, Assistant Director, at (303) 572-7352. Major contributors to this report include Doreen Feldman, Curtis Groves, Alan Kasdan, Thomas Laetz, Cynthia Norris, Daniel Semick, Richard Shargots, and Kevin Tarmann. Appendix I: Overview of Existing Commercial LLRW Disposal Facilities There are currently three commercial disposal facilities operating in the country, two of which were part of the group of six facilities established back in the 1960s. The facilities in Barnwell, South Carolina, and Richland, Washington, are the only ones that remain open today. Each of these facilities is located adjacent to or within the boundaries of a much larger site owned by DOE. The third facility is located outside of Salt Lake City, Utah. Figure 3 shows the location of three commercial disposal facilities. Barnwell Disposal Facility The Barnwell disposal facility was opened in 1969, but the actual license to use about 17 acres of land for shallow burial of LLRW in Barnwell County, South Carolina, was issued in 1971. This commercial site is located near the much larger Savannah River Site owned by DOE. In 1976, the site was expanded to its present size of 235 acres with an original capacity to hold 30.6 million cubic feet of all classes of radioactive waste and some other types of waste. Compact Affiliation South Carolina is the current host state for the Atlantic Compact; the compact comprises South Carolina, Connecticut, and New Jersey. South Carolina was originally in the 8-member Southeast Compact that was ratified by the Congress in 1985. However, in 1995, the state withdrew from this compact to become an unaffiliated state primarily because another member of the compact, North Carolina, had failed to develop a new disposal facility as planned by 1992. In 2000, the state joined the Northeast Compact. The name of the Northeast Compact was later changed to the Atlantic Compact to better characterize the geographic affiliation of the three member states. During the history of South Carolina as a compact state and an unaffiliated state, the state legislature has only restricted national access to the Barnwell disposal facility for one year, between July 1994 and June 1995, excluding some temporary access restrictions placed on Michigan between 1990 and 1995, and North Carolina between 1995 and 2000. State Regulators Three state regulatory entities have roles and responsibilities associated with the operation of the Barnwell disposal facility. The South Carolina Budget and Control Board owns the land that is set aside for the LLRW disposal, and it will assume responsibility for the site after it closes. Among other responsibilities, this board approves the disposal rates and authorizes the import of out-of-compact waste to Barnwell. In conjunction with the South Carolina Public Service Commission, the board determines allowable operating costs that can be charged by the operator. The operator is reimbursed for these operating costs and is allowed a 29 percent margin above most of these costs. As South Carolina is an Agreement State, the Department of Health and Environmental Control has licensing and technical regulatory authority over Barnwell. Disposal Operator Chem-Nuclear Systems has operated the Barnwell disposal facility continuously since it opened. In 2000, this company became a subsidiary of Duratek, Incorporated, which had purchased the owner of Chem- Nuclear Systems, Waste Management Nuclear Services. According to company officials, there are about 100 Duratek employees at the Barnwell facility, of which 60 to 70 deal with the disposal operations and retain the Chem-Nuclear Systems name. About 10 years ago there were about 350 employees at Barnwell, when disposal intake was higher. Current Conditions The Barnwell disposal facility is reaching its capacity. About 102 acres of the 235-acre site has been filled, with about 13 acres left for disposal. According to company officials, there is about 2.7 million cubic feet of space remaining. The vast majority of this remaining space, about 2.2 million cubic feet, has been set aside for the decommissioning of the 12 nuclear power plants in the three state compact region. The decommissioning waste is anticipated at about 12,000 cubic feet per facility annually, beginning around 2031 and lasting for about 20 years. Each facility is expected to produce much more LLRW, but much of this waste will likely be shipped to Envirocare of Utah. The Barnwell disposal facility is planned for closure to out-of-compact waste by mid- 2008. In 2001, the South Carolina legislature imposed volume caps on the amount of waste that could be accepted at Barnwell. Between 2001 and 2008, the facility is allowed to accept decreasing levels of waste until it reaches a steady state level of 35,000 cubic feet in 2008. State officials told us that the legislature set the cap at 35,000 cubic feet to provide revenues sufficient to cover operating costs and all other obligations; however, at current disposal rates, the breakeven volume intake might be as low as 20,000 cubic feet annually. These caps were based on an earlier task force report that provided a “road map’” for discontinuing South Carolina’s national role in providing disposal and ensuring that capacity would remain to serve the future needs of South Carolina generators. Barnwell has the highest disposal rates among the three commercial disposal facilities. In part, the rates have increased over the years with the additions of special fees, taxes, and surcharges. Noncompact generators have increasingly paid far more to dispose their waste than generators within the compact states, especially South Carolina generators, that receive a 33 percent rebate on their disposal fees. The 2003 rate for compact generators does not exceed about $400 per cubic foot for any class of waste, whereas for noncompact waste coming from processors with importation agreements, it is set at $1,625 per cubic foot. The most sizeable increase in disposal fees came in 1995, when South Carolina imposed a $235 per cubic foot tax on the LLRW accepted by Barnwell. In fiscal year 2002, of the approximately $34 million in gross disposal receipts from waste coming to Barnwell, about $11.6 million went to the operator, and most of the remaining 66 percent went to the state, primarily to support education programs. Notwithstanding the existing caps on the volume of waste that can be accepted at Barnwell through mid-2008, there are some indications that the legislature may reconsider its position on these caps. First, there has been a shortfall in the volume of waste that has actually come to Barnwell in the last 3 years. Company officials told us that this shortfall is 60,592 cubic feet. Negotiations are taking place to determine if this shortfall can be added to the cap levels over the next several years to make up the difference. Second, two utilities that had committed space at Barnwell have decided not to send a reactor vessel and several steam generators to this facility. This would free up even more space, if it were made available. Finally, other space might become available if prior allocation commitments to the 12 nuclear power plants in the Atlantic Compact are revised downward, given changes in how to manage the decommissioning of nuclear power plants. The Electric Power Research Institute is working with utilities on reducing their space needs at Barnwell. Figure 4 shows the delivery of a large reactor vessel to the LLRW trench at the Barnwell disposal facility. Envirocare Disposal Facility Since 1988, Envirocare has operated a 540-acre disposal facility 80 miles west of Salt Lake City. The facility is located in Tooele County within a 100-square mile hazardous waste zone that includes two hazardous waste incinerators, the Army’s nerve gas storage site, and the Army’s Dugway Proving Grounds. Prior to the low-level waste disposal site, DOE used the area for the disposal of uranium mill tailings. Much of the waste disposed at Envirocare comes from cleanup of commercial and government facilities. Also, Envirocare is the only commercial disposal facility to accept mixed waste, which is a combination of radioactive and hazardous waste. In 2003, Envirocare took about 99 percent of the nation’s class A waste. Compact Affiliation While Utah is part of the Northwest Compact, which includes seven other states, it is not the host state for the compact’s LLRW disposal facility. Originally, Utah approved Envirocare’s operation for accepting naturally occurring radioactive material—large volume, low activity low-level radioactive wastes. In 1991, recognizing that the Northwest Compact planned to exercise its exclusionary authority at the beginning of 1993, Utah and Envirocare sought a resolution from the Compact that would allow this disposal facility to continue to accept these specific types of low-level waste once the compact exercised its exclusionary authority. Realizing that proposed disposal facilities in other states and compacts were not designed to take wastes of such large volume, the Northwest Compact adopted a resolution and order that allowed continued access to Envirocare by those states that met the milestone requirements of the Act. In 1995, the resolution and order were amended to include a provision that states and compacts in which low-level waste is generated, including the Northwest Compact, must authorize any shipment of this waste to Envirocare. This was done to ensure that states and compacts maintain control over the disposition of LLRW generated within their state or compact. The resolution and order was also amended to delete the provision regarding the statutory milestone requirements since those milestones were no longer relevant. According to the executive director of the Northwest Compact, the compact retains the right to modify or rescind this authorization at any time. In 1998, Utah issued a license amendment for Envirocare to accept all types of class A low-level waste. To date, the Northwest Compact has not approved sending LLRW generated within the compact states, including Utah, to the Envirocare disposal facility. State Regulators The Utah Department of Environmental Quality has licensing and regulatory authority for the Envirocare facility. Envirocare’s license has been amended at least 10 times to allow more types of radioactive waste including in 1991 when the state permitted disposal of low-level waste, in 1995 when Envirocare became the only commercial disposal facility licensed for mixed waste, and in 2001 when Utah approved an amendment for Envirocare to accept all types of class A waste. On July 9, 2001, the Utah Department of Environmental Quality approved Envirocare’s license application to accept class B and C wastes. Appeals were filed and on February 10, 2002, the department affirmed the approval. In March 2003, the Governor of Utah signed a bill placing a moratorium on any acceptance of class B or C wastes through February 15, 2005, and requiring legislative and gubernatorial approval for acceptance of these wastes. Enactment of the bill also created a task force composed of 16 state legislators to study radioactive waste, hazardous waste, and commercial solid waste issues in the state, including state policy and an evaluation of fees and taxes imposed on these wastes. The task force will issue a report with specific recommendations by November 30, 2004, on, among other things, whether the state should accept class B and C wastes. Disposal Operator Envirocare, a privately owned company, has operated the disposal facility since its inception in 1988. The company said it has about 400 employees and about 250 employees are directly involved with low-level radioactive waste operations. Unlike the Barnwell and Richland sites, Envirocare owns the disposal site land. NRC normally requires institutional ownership of disposal sites in post-closure. However, at the inception of a license for the disposal facility in Utah the state’s Department of Environmental Quality established a national precedent when it exempted the site from rules requiring institutional ownership. At the time, Utah regulations contained a section compatible with NRC’s rule that disposal from other persons would be permitted only on land owned by the federal or state government. Nevertheless, Utah did not have legislative authority to own land used for disposal of LLRW. While the private entity is allowed to own the land indefinitely, the state requires that Envirocare carry a surety fund, currently about $40 million for low level and other wastes, for eventual site closure, decommissioning, and long-term stewardship. Utah will receive the funds if Envirocare should become unable to perform site closure and decommissioning. Current Conditions The disposal site has the capacity for more than 20 years of disposal under its current license. According to Envirocare officials, at the beginning of March 2004 the disposal facility had 58.9 million cubic feet of class A waste. The officials anticipate that the disposal facility will accommodate more than 20 years of waste for several reasons, such as a reduction in the annual disposal of waste at Envirocare. Envirocare typically has a contract condition requiring that its commercial disposal rates not be disclosed. While disposal rates are available for DOE waste, they are not reflective of disposal rates for other LLRW generators. According DOE officials, DOE receives a more favorable disposal rate than generally available to other LLRW generators because DOE can obtain discounted rates from Envirocare given the large volumes of waste it has for disposal and that it can use its own disposal facilities. DOE represents more than half of Envirocare’s business. DOE’s contract with Envirocare, which expires June 29, 2004, includes disposal rates ranging from a minimum of about $5.25 per cubic foot for soil to a minimum of about $14.80 per cubic foot for debris. Most DOE waste is shipped to Envirocare in bulk containers. According to DOE officials, Envirocare’s rail access and closer proximity to DOE sites east of Utah provide a disposal cost advantage over using DOE disposal facilities. Envirocare is subject to fees and taxes on waste disposal. The legislature raised fees and taxes in 2003 after a citizens’ initiative to substantially increase the fee and tax structure failed. The state levies a fee of 15 cents per cubic feet of waste and $1 per curie for radioactive waste. These funds are used to offset program costs for oversight. In addition, each generator pays a fee to the state ranging from $500 to $1,300 for a generator site access permit. These funds as well as a $5,000 fee paid by each broker are for state oversight of the disposal facility. In addition, the state imposes a fee ranging from 5 percent to 12 percent of gross receipts of the disposal operator as general tax revenue to be used in a manner determined by the state legislature. The amount is based on the type of waste and whether the source is from a government or nongovernmental generator. In addition, as of 2002, Envirocare is required to pay the state a perpetual care fee of $400,000 per year. Also, Tooele County imposes a 5 percent fee on the operator’s gross receipts. In recent years the operator has provided the county about $4 million annually. Those funds are general tax revenue for the county. According to the disposal operator, on average, Envirocare provides 25 percent of the county’s budget. Figure 5 shows the rail unloading facility for disposal of class A bulk waste at the Envirocare facility. Richland Disposal Facility The Richland disposal facility was opened in July 1965. It is situated in Benton County, Washington, approximately 23 miles northwest of the city of Richland, near the center of DOE’s 560 square mile Hanford reservation on 100 of the 1,000 acres of land leased by the State of Washington from the federal government in 1964 for 100 years. The state had hoped to attract other nuclear-related businesses to the site as part of an economic development strategy for the Richland-Kennewick-Pasco region. In 1993, DOE exercised its right under the terms of the lease to reclaim the 900 acres that remained unutilized. Compact Affiliation Washington is the current host state for the Northwest Interstate Compact on Low-Level Radioactive Waste Management. Besides Washington, the original members of the compact are Alaska, Hawaii, Idaho, Montana, Oregon, and Utah. The Northwest Compact was established in 1981 and ratified by the Congress in 1985. An eighth state, Wyoming, joined the compact in 1992. Also in 1992, the Rocky Mountain Compact, comprised of Colorado, Nevada, and New Mexico, reached agreement with the Northwest Compact and the state of Washington to send up to 6,000 cubic feet of LLRW to the Richland disposal facility annually, plus a 3 percent per annum growth factor. The Northwest Compact did so because the Rocky Mountain Compact expected generation of only a relatively small volume of LLRW once the decommissioning of its only nuclear power plant (Fort St. Vrain in Colorado) was completed. Since 1993, the Richland disposal facility has been open to LLRW only from generators in the 11 states of the Northwest and Rocky Mountain compacts. Regardless of the state of origin, Richland may accept naturally-occurring and accelerator- produced radioactive material, which is not addressed by the compact. The Richland facility accepted nonradioactive hazardous and mixed wastes until 1985. State Regulators Three state regulatory bodies have roles and responsibilities associated with the operation of the Richland disposal facility: the Department of Health, the Department of Ecology, and the Washington Utilities and Transportation Commission. The Department of Health exercises primary regulatory responsibility over the disposal facility. It issues licenses to the facility operator and regulates radioactive materials. A Department of Health inspector examines each shipment of waste prior to disposal to ensure compliance with the requirements of the U.S. Department of Transportation, the NRC, and the State of Washington. The Department of Ecology has primary program responsibility. It issues individual permits for radioactive waste disposal to generators, serves as the site landlord, and monitors the activities of the Northwest Compact. The Washington Utilities and Transportation Commission approves the disposal fees on an annual basis. Fees are set at a rate estimated by the facility operator, US Ecology, to produce enough revenue to cover all costs of operating the facility and provide a 29 percent profit. As an integral part of the fee setting process, the operator polls site users to obtain their projections for how much waste they plan to ship in the coming year. These estimates are the basis on which fees are set. Disposal Operator The private, for-profit contractor, US Ecology Incorporated, a subsidiary of Boise, Idaho-based American Ecology Corporation, and its corporate antecedents, has operated the Richland disposal facility since it opened. According to company officials, there are currently 18 US Ecology employees working at the Richland facility, in addition to 4 administrative staff. Current Conditions The Richland facility has much unused capacity to accept LLRW. According to state regulators and company officials, the remaining capacity at Richland is approximately 21 million cubic feet. To date the facility has disposed of approximately 13.9 million cubic feet of LLRW in 20 trenches. About 95 percent of the waste received is class A. There has been a significant decline in disposal volumes since 1993, when the Northwest Compact placed restrictions on the origin of the waste that the Richland disposal facility could accept. In the 5 years preceding these restrictions, the average annual amount of LLRW waste disposed was 395,000 cubic feet. In the 11 years since Richland began excluding waste from outside the Northwest and Rocky Mountain Compacts, the average amount of waste disposed annually is about 142,000 cubic feet, though individual years have been as high as 282,000 and as low as 61,000. At the current rates of disposal, fewer than 10 more trenches will be filled, or approximately 60 percent of the total available disposal capacity, when the facility is expected to close in 2056, 7 years before the state lease on the land expires. Disposal fees and other assorted fees for LLRW or naturally-occurring and accelerator-produced radioactive material waste at Richland are lower than the Barnwell disposal facility, but generally higher than those charged by Envirocare of Utah. Unit costs for disposal are calculated on a declining volume scale. That is, the lower the volume of waste disposed in a given year the higher the unit costs of disposal must be in order to reach the annual, state-approved revenue requirement. Generators pay a number of fees and surcharges to the State of Washington and US Ecology on each cubic foot they dispose at Richland. The state charges a site use permit fee that varies according to volume. For example, fees for waste disposed between March 1, 2004, and February 28, 2005, range from $425 for up to 50 cubic feet to $14,840 for 2,500 cubic feet and more. Nuclear utilities and brokers pay flat annual site use permit fees of $42,400 and $1,000, respectively. The state also imposes other fees and taxes to support local economic development, state agency expenses directly related to the regulation and operation of the facility, and for the Perpetual Care and Maintenance Fund. Unlike the other two commercial LLRW disposal facilities, none of these fees or taxes go directly to the state’s general revenue fund. The facility also pays a business and occupation tax. In addition to the state fees, generators also pay US Ecology’s disposal charges, which are based on an annual revenue requirement authorized by the Washington Utilities and Transportation Commission. All LLRW disposed at Richland is assessed charges based on access, volume, shipment(s), container(s), and exposure. For example, based on a projected disposal volume of 50,000 cubic feet of LLRW in 2004 and an annual revenue requirement of approximately $5.4 million, the site operator charges average approximately $108 per cubic foot. The surcharges assessed by the state on disposed waste would generate another $325,000 for local government ($6.50 per cubic foot), $450,000 to cover the regulatory costs of the Washington Department of Health ($9.00 per cubic foot), and at least $230,000 in site use permit fees to cover the regulatory costs of the Washington Department of Ecology and the administrative expenses of the Northwest Compact. The sum of these fees, charges, and surcharges paid by generators to the state and US Ecology in 2004 is expected to total approximately $6.4 million. These associated fees increase the average cost of disposal of LLRW to approximately $128 per cubic foot. This average is calculated based on the expectation that 95 percent of the waste disposed will be class A; typical class B and C waste disposal costs per cubic foot would be higher than this average as activity and other surcharges, which could be considerable, would apply. There is a strong desire to control the origin, and therefore the volume and nature of the waste disposed at Richland. The State of Washington was a lobbying force behind passage of the Act that allowed compacts to restrict access to disposal facilities. The state and US Ecology have agreed in concept to a new clause in the sublease agreement, which is expected to be renewed in 2005, providing for termination of the sublease if federal law eliminates the Northwest Compact’s restrictive authority on waste importation. This policy is also reflected in the host state agreements with the Northwest Compact and indirectly with the Rocky Mountain Compact. Terminating the sublease would effectively shut down the disposal facility. Figure 6 shows the LLRW disposal trench at the Richland disposal facility. Appendix II: LLRW Legislative Options The inability of states to develop any new regional disposal facilities since passage of the Low-Level Waste Policy Act (the Act) and occasional shortfalls in disposal availability have perpetuated debate about the need for further congressional intervention. GAO reported on the status of commercial LLRW disposal in 1995 and 1999. In our last report, we assessed three management options to address concerns about limited or no disposal access for generators of LLRW. While we acknowledged that LLRW could be stored for decades or even longer in assured isolation facilities, we noted that storage would only postpone, not replace, the need for disposal. The three options were (1) allowing the compact system under existing federal legislation to adapt to the changing LLRW situation, (2) repealing the existing federal legislation to allow market forces to respond to the changing LLRW situation, and (3) using DOE disposal facilities for commercial waste. The changes that occurred since our 1999 report affect the viability of these options in various ways, particularly the status quo option to maintain the existing compact system if no disposal options are available for class B and C wastes after mid-2008. Retain the Compact Approach Proponents of retaining the compact approach cite the degree of control that states exercise over LLRW management and flexibility in meeting changing circumstances. For example, facing declining waste volumes and satisfactory access to existing disposal facilities, states and compacts were able to avoid building expensive facilities that were not needed. In addition, an existing non-LLRW disposal facility was allowed to accept high volume, low-activity radioactive wastes nationally, even though it was located in a state that already had access to a licensed LLRW disposal facility. Further, under the compact system states were allowed to move from one compact to another or to become unaffiliated, and two compacts decided to share one disposal facility. And, most recently, the state regulator in Texas will begin accepting license applications to develop a new disposal facility that might be open in early 2008. Opponents of the compact approach point out that, despite all of this flexibility, not one compact has successfully developed a new disposal facility for LLRW despite spending millions to do so. Even the proposed disposal facility in Texas is moving through the approval process having never formed a Texas LLRW disposal compact commission. In 1999, we estimated that collectively, the states and compacts had spent about $600 million in trying to develop these facilities. Nuclear industry association officials estimate that expenditures may now have reached approximately $1 billion. Some of these additional costs are associated with ongoing litigation in California, Nebraska, and North Carolina regarding the failure of these states to fulfill their host state obligations to build LLRW disposal facilities after expenditures had been made to do so. In addition, there are certainly opportunity costs associated with this expenditure, and there may be an incalculable loss of advancement in nuclear research and medicine because the cost of disposal or lack of options may have diminished the desire to use radioactive materials. This option to maintain the status quo, as discussed in our 1999 report, may no longer be tenable if there are no assured safe, reliable, and cost-effective disposal options put forward to address a potential shortfall in disposal availability for class B and C wastes after mid-2008. Repeal the Compact Legislation Opponents of the compact system have called for repealing the LLRW Policy Act because of the unsuccessful attempts to develop new regional LLRW disposal facilities, coupled with authority under the Act to restrict access to existing commercial facilities that otherwise have disposal capacity. Eliminating access restrictions would allow commercial disposal operators to better adapt and respond to changing market conditions. And, repeal of the legislation could create a national LLRW disposal market that might lead to more competition and lower disposal fees. It would probably be difficult to build enough political support to repeal the LLRW Policy Act, however, given no imminent national crisis in the short term, and some states would likely resist opening their disposal facilities nationally. Even if the Congress repealed the Act, it would not necessarily affect the existence of each compact consented to prior to repeal. This would mean that a compact provision prohibiting the acceptance of waste for disposal from outside the compact region would continue in effect. However, under the Act, each compact must provide that the Congress may withdraw its consent every 5 years after the compact has taken effect. Apart from congressional action, states with privately managed disposal facilities could decide not to renew the disposal operators’ leases located on state-owned land. In addition, states that are concerned about the extent to which they would be able to restrict access to a commercial disposal facility within their borders might erect administrative barriers to developing such a facility. Use DOE Disposal Facilities for Commercial Waste The capping of disposal volumes through mid-2008 at Barnwell and restrictions on access to only Atlantic Compact member states after this time have heightened interest in having DOE open its disposal facilities to at least some commercial LLRW. Access might be allowed on an interim basis, as requested in the past by California generators, or permanently. According to NRC officials, the Act established a compact system that has not provided reliable and cost-effective disposal options to generators of LLRW, forcing many of them to store their waste. Establishing federal responsibility for disposal of at least the class B and C wastes would be similar to federal responsibilities for greater-than-class C waste, transuranic, and high-level waste. This approach would also be consistent with the management approaches taken by some European countries. Similar to the commercial disposal facilities in Richland and Barnwell that are operated by private companies on state-leased land, contractors manage and operate the two principal DOE disposal facilities on federal land. These two DOE disposal facilities in Nevada and Washington accept waste that exists on site, as well as from other department sites across the country. Each of these facilities has enormous capacity to accept LLRW. In 1999, about 171 million cubic feet of space was available at these two sites, with DOE estimating that it would only use less than 30 million cubic feet for its cleanup waste. This estimate may even be lower given the increasing volume of DOE waste that is being sent to a commercial disposal facility. In the past, DOE disposal facilities have not been considered appropriate repositories for commercial waste, but commercial facilities were viewed as appropriate for receiving DOE waste. The federal government has encouraged the development of private LLRW disposal facilities since the early 1960s when the volumes of waste were increasing at the same time as the cost of disposal in the ocean. As an interim measure, the AEC allowed such waste to be disposed of at its own facilities at the Idaho National Engineering Laboratory and at the Oak Ridge National Laboratory until commercial disposal facilities became available. As an incentive, in 1963, the AEC instructed its sites without disposal facilities to use commercial facilities for unclassified waste disposal. The proposed use of DOE facilities for commercial waste disposal would require resolution of a number of issues and may require legislation. These issues include whether DOE is presently authorized to accept commercially generated LLRW waste at its disposal sites. While previous AEC sites accepted commercial waste for a short time, it is not clear whether DOE currently has such authority. Another issue to be resolved is who (for example, generators, states, or DOE) would be responsible for paying the additional cost for disposing of commercial waste at DOE facilities and whether DOE would be allowed to keep any funds it receives. (Funds received by an agency normally must be paid into the U.S. Treasury, unless federal legislation authorizes the agency to retain the funds.) An additional issue concerns the potential licensing and regulation of a DOE facility that accepts commercial waste. The NRC and Agreement State regulations that govern commercial facilities do not apply to DOE disposal facilities or the wastes that are shipped to these facilities. Shifting waste to DOE facilities might also have the adverse effect of eliminating the financial viability of commercial disposal facilities and possibly putting DOE disposal facilities in competition with private facilities. However, one option might be to commercialize the DOE facility in Nevada by leasing at least some of the existing disposal site to the state, as is done in Washington for the commercial facility on DOE’s Hanford site. Nevertheless, given the significant excess capacity at DOE disposal facilities, there might not be any incentive to develop new commercial disposal facilities. Without any new disposal facilities, most waste would be shipped to Nevada and Washington, which have objected in the past to having to accept a disproportionate burden of LLRW disposal. Appendix III: Scope and Methodology To obtain information on changes in LLRW management conditions since our 1999 report, we interviewed regulators and disposal operators in states that have commercial disposal facilities or are considering opening one. We visited the Barnwell disposal facility and met with disposal site operators and state and Southeast Compact officials. In Texas, we met with state regulators and legislative staff. We interviewed DOE and NRC officials, and representatives of the nuclear power industry, the Department of Defense executive agent for LLRW, and several environmental groups. We also interviewed generators and waste processors in California, Texas, Maryland, and Tennessee that were suggested to us by various LLRW stakeholders in the course of this review. In addition, we met several times with members and officers from an independent nonprofit association of LLRW stakeholders, including obtaining feedback from this association on our preliminary findings during a March 2004 meeting. Finally, we reviewed applicable laws and regulations, including the Atomic Energy Act, as amended, and the LLRW Policy Act, as amended. In gathering information on recent annual disposal volumes, we relied on data provided to us by the three commercial disposal facility operators because, in contrast to MIMS data, these data included DOE waste and they were current through 2003. We also determined that MIMS data had other shortcomings in its reliability that hindered its usefulness for other types of analysis, such as sources of waste by state and generator type. These and other concerns prompted us to more closely examine the department’s internal controls over this database. In doing so, we reviewed DOE documents and written and oral DOE responses to our questions about the structure, development, and management of these data. We also interviewed, and in some cases surveyed, users of MIMS regarding their assessment of the database’s reliability. While we did not independently verify the reliability of the data obtained from the disposal facility operators, we relied on these data for our analysis for the reasons stated and because they are the primary source data input into the national LLRW database. To gather available data and analysis on projected future disposal volumes, we interviewed a spectrum of LLRW stakeholders, including state regulators, disposal facility operators, waste processors, compact officials, and DOE officials. We also reviewed documents from the EPA, the National Research Council, and the International Atomic Energy Agency to obtain information relating to the current management of LLRW. To obtain information on any current or anticipated shortfalls in LLRW disposal availability, we interviewed state regulators, compact officials, and disposal site operators in South Carolina, Utah, and Washington, and reviewed the planning documents they provided to us. This review allowed us to estimate how much disposal capacity remains at each of the commercial disposal facilities given current disposal volumes accepted at each facility and other factors, such as licensing agreements and compact restrictions on disposal access to these facilities. We also reviewed relevant state legislation and other activities pertaining to the regulation of the disposal facilities in these states, monitored activities in Texas, which is accepting applications for a new disposal facility, and tracked the effects of LLRW disposal litigation between the Central Compact and Nebraska. To determine the effects, if any, on LLRW generators of any shortfalls or other difficulties associated with the disposal of this waste, we initially relied on the interviews that we had with representatives from biotechnology companies, environmental groups, hospitals, LLRW processors, and nuclear power plants. We also used our survey of compact and unaffiliated state officials to identify any documented adverse effects when generators had limited or no disposal option for their LLRW. This research led us to collaborate with the University of Texas Health Science Center in Houston on two nonscientific sample surveys of radiation safety officers and Health Physics Society members to identify any actual (since 1999) or potential adverse effects on biomedical research and clinical practice resulting from costs or difficulties related to the storage and disposal of LLRW. The E-mail survey of radiation safety officers was conducted through the approximately 2,000 subscribers to the Radsafe Listserv. The approximately 6,000 members of the Health Physics Society, a scientific and professional organization whose members specialize in occupational and environmental radiation safety, were invited to participate in a survey through a notice in the Society’s monthly newsletter, Health Physics News. These surveys are considered nonscientific sample surveys of self-selected respondents from a nonprobabilistic sample of a largely unknown list of people, and there is overlap in affiliation between the samples. Our work was conducted between August 2003 and May 2004 in conformance with generally accepted government auditing standards. Appendix IV: Comments from the Department of Energy The following is GAO’s comment on the Department of Energy’s letter dated May 20, 2004. GAO Comment 1. DOE disagreed with our recommendation to halt dissemination of information in its national LLRW database. DOE stated that our report did not adequately characterize the usefulness of MIMS, and that removal of the national LLRW database without an alternative would evoke criticism from states and regional compacts and would not fulfill the requirement in the Act to maintain such a database. Our recommendation did not call for removal of this database. Instead, we recommended halting dissemination of information in this database as long as the database has internal control weaknesses and shortcomings in its usefulness and reliability. This action would prevent user access to DOE’s online database. With regard to the usefulness of MIMS, our report noted that state and compact officials use MIMS for various purposes; however, the consensus among the officials we surveyed was that they could more effectively regulate and monitor LLRW if MIMS offered more comprehensive and reliable data. DOE did not address our concerns about internal control weaknesses and other shortcomings in the database. We stand by our recommendation to DOE because we believe that it is inappropriate to disseminate information that is known to be unreliable and incomplete. Appendix V: Comments from the Nuclear Regulatory Commission The following are GAO’s comments on the Nuclear Regulatory Commission’s letter dated May 25, 2004. GAO Comments 1. We disagree with NRC’s suggestion that GAO commence a study to explore alternative options to the current LLRW management system. Given current disposal availability through mid-2008, and uncertainties about future disposal availability, we believe that such an evaluation by us is not needed at this time. As long as NRC places no time limits on LLRW storage and provides assurance that it is safe and secure, any shortfalls in disposal capacity would be manageable in the short-term. 2. We disagree with NRC’s position that it would be outside its mission to report to the Congress on changes in disposal availability and the conditions of stored waste. As the federal agency with statutory responsibility to protect public health and safety and promote the common defense and security, NRC is responsible for overseeing the use, storage, and disposal of radioactive materials. NRC and Agreement State agencies already have license and inspection programs in place to monitor the safety and security of stored waste. NRC is the agency that developed the manifest that is the only mechanism available to track LLRW nationally. According to NRC, it has also begun to establish an interim database for sealed sources, some of which become LLRW, that may lead to establishing a National Source Tracking System. As such, we believe that NRC is the most appropriate agency to determine when the safety and security of stored LLRW are approaching a level of risk that might warrant congressional assessment of legislative options to ensure disposal availability for all LLRW, and to consider disposal costs as a factor behind storing LLRW even if disposal options are available. In our opinion, DOE is no longer the most appropriate agency to oversee states’ management of LLRW given that it has become the major user of commercial disposal facilities since establishment of the Act, as amended, and that the Congress eliminated its reporting responsibilities under the Act. 3. We agree with NRC that there is no need for a congressional directive to require that NRC gather additional information necessary to monitor disposal availability and the safety and security of stored waste. In commenting on our draft report, NRC provided information on data gathering actions already in place at or planned by NRC to adequately ensure the safety and security of radioactive materials, including stored LLRW. Given these actions and the concerns of NRC with the regulatory cost of complying with our suggested actions, such as additional rulemaking, we eliminated our suggested congressional action in this regard. 4. We are not in a position to independently judge if LLRW is or is not an attractive target for terrorists. We do point out in our report that one study found that a few radioisotopes of greatest security concern are classified as LLRW. More importantly, this cited study noted that while use of these materials in radiological dispersal devices, such as a dirty bomb, are not weapons of mass destruction, they could cause mass disruption, dislocation, and adverse financial consequences associated with decontamination and rebuilding. Interviews we conducted with generators of LLRW also identified other threats posed by the unintentional dispersal of radiological materials that could be caused by fires, floods, and earthquakes that have raised public concerns and the perception of risk.

Low-level radioactive waste (LLRW) management concerns persist despite enactment of the LLRW Policy Act of 1980, as amended, which made states responsible for providing for disposal of most LLRW. It also enumerated guidance and oversight responsibilities for DOE and NRC. When GAO last reported on LLRW disposal, in 1999, the only existing facility accepting the more highly radioactive types of LLRW (known as class B and C waste) from most states was expected to be full within 10 years. In this context, GAO examined (1) changes in LLRW conditions since 1999, (2) recent annual LLRW disposal volumes and potential future volumes, (3) any current or anticipated shortfalls in disposal availability, and (4) potential effects of any such shortfall. GAO identified several changes in LLRW disposal availability and federal agency oversight since its 1999 report that have had or might have significant impacts on LLRW management by the states. For example, while one disposal facility plans to close to most states and new options are evolving that may counteract this shortfall, federal guidance and oversight of LLRW management has virtually ended. Annual LLRW disposal volumes increased 200 percent between 1999 and 2003, primarily due to LLRW shipped to commercial disposal by DOE. GAO identified this increase using data from the three commercial disposal facility operators because GAO determined that data from the national LLRW database, maintained by DOE to assist the LLRW community in managing LLRW, were unreliable. The uncertain timing and volume of future waste shipments from DOE and nuclear utilities make it difficult to forecast disposal needs for all classes of LLRW. At current LLRW disposal volumes, disposal availability appears adequate until at least mid-2008 for class B and C wastes. There are no expected shortfalls in disposal availability for class A waste. If disposal conditions do not change, however, most states will not have a place to dispose of their class B and C wastes after 2008. Nevertheless, any disposal shortfall that might arise is unlikely to pose an immediate problem because generators can minimize, process, and safely store waste. While these approaches are costly, GAO did not detect other immediate widespread effects. NRC places no limit on stored waste and presently does not centrally track it. However, as LLRW storage volume and duration increase in the absence of reliable and cost-effective disposal options, so might the safety and security risks.

Background When acquiring goods or services by contract, U.S. government policy is generally to pay only for completed work. The purpose of this policy is to reduce the government’s risk of financial exposure in the event a contractor fails to perform. In the case of payments at the time of conditional acceptance, this would generally mean withholding sufficient funds to cover the estimated cost and profit associated with completing the work. This policy of only paying for completed work is grounded in the prohibition against advance payments contained in title 31, section 3324 of the United States Code, which states that “a payment under a contract to provide a service or deliver an article for the United States Government may not be more than the value of the service already provided or the article already delivered.” This policy is also evident in the provisions governing progress payments, which state that agencies “shall ensure that any payment for work in progress . . . is commensurate with the work accomplished. . . .” The statutory exceptions to this policy apply conditions or restrictions to the transaction. For example, a written determination is required from the head of an agency, or his or her designee, that the use of advance payments is in the public interest. These policies are implemented in the Federal Acquisition Regulations System. This system consists of the Federal Acquisition Regulation (FAR), which is the primary authority, and agency acquisition regulations that implement and supplement the FAR. The Department of Defense’s (DOD) implementing regulation is the Defense Federal Acquisition Regulation Supplement (DFARS). In addition, each of the military services’ acquisition organizations has issued supplemental guidelines for use in implementing policies and procedures in the FAR and the DFARS. According to the FAR, contracting officers normally should reject supplies and services that do not conform to contract specifications. However, FAR section 46.407 (Nonconforming Supplies or Services) provides exceptions for those circumstances (such as for reasons of economy or urgency) in which accepting such supplies or services may be in the government’s best interest. This section addresses only situations when the government has decided to accept items with permanent nonconformances and not require a contractor to correct the deficiencies after delivery. In these situations, the FAR recommends that the contract be modified to reduce the price or provide other consideration to reflect that the items are less than were specified in the contract. Guidance on Conditional Acceptance of Items Is Not Adequate The FAR and the DFARS do not provide guidance for withholding payment for work to be performed after delivery in situations where the government conditionally accepts nonconforming or incomplete work. Moreover, within the military acquisition community, no consistent way has been developed for determining whether payments should be withheld or how to determine the amount to withhold. The DOD Director of Defense Procurement told us that a contracting officer should withhold from payment the estimated cost and profit for work to be done by the contractor after delivery. However, Air Force and Army acquisition officials told us that while the cost and profit of the remaining work should be a consideration, the amount withheld, if any, should be left to the discretion of the contracting officer. Air Force supplemental guidance includes a standard contract clause allowing contracting officers to use their discretion in determining the amount to be withheld. The Army provides no supplemental guidance to the FAR for use in conditionally accepting items and establishing a withhold amount. At the Naval Sea Systems Command and the Naval Air System Command (NAVAIR) procurement and contracting officials agreed that amounts withheld should directly relate to the anticipated cost of work to be performed by a contractor after delivery. However, contract clauses that the two commands use give a contracting officer authority to withhold a lesser amount. From 1981 through 1992, the Air Force Materiel Command’s (AFMC) Aeronautical Systems Division supplements provided for a standard contract clause entitled “Correction of Supplies Accepted With Deficiencies,” which called for withholding 10 percent of the price when conditionally accepting items. The clause allowed a contracting officer to use a higher or lower percentage as conditions warranted. In July 1997, AFMC revised this clause and left the determination of the amount withheld to the contracting officer’s discretion. The revised clause provides a list of factors to consider when deciding on a withhold amount, including (1) the cost to correct the deficiencies; (2) any loss of value to the government due to reduced reliability, increased life-cycle costs, or reduced availability; and (3) any other factors that may affect government use or cost of ownership. In ship construction and conversion contracts, the Naval Sea Systems Command uses a standard payment clause that requires a contracting officer to withhold a percentage of the contract price when a ship is conditionally accepted. The clause provides for withholding, as a performance reserve, the greater of either 1.5 percent of the contract price or $100,000. This clause also provides that a contracting officer may withhold more than the 1.5 percent if he or she finds that the standard withhold amount is insufficient to cover the cost to correct deficiencies or complete unfinished work. The NAVAIR standard clause entitled “Acceptance Under Fixed-Price Contracts” allows a contracting officer, under certain conditions, to accept nonconforming items and to withhold an amount, as he or she determines appropriate. A policy that would require the withholding of at least the estimated cost and profit in this circumstance or require written justification for an exception would protect the government’s interests and be consistent with the treatment accorded payments for work that has not been completed in other instances. For example, FAR, subpart 32.4, which implements the advanced payment statutes, requires that approval of a contracting officer’s recommendation for an advance payment be based on a written determination by an approving official that such advance payment is in the public interest or facilitates the national defense. Inadequate Withholds Result in Contractors Being Paid for Work Not Completed Our review of four selected acquisition programs indicated that each of the services conditionally accepted nonconforming items, with the expectation that the contractors would correct known deficiencies and complete unfinished work. When conditionally accepting nonconforming items, each of the services paid contractors the billing prices, assuming 100-percent completion, less some amount that was withheld for nonconforming or unfinished work. The services differed in how they determined the withhold amounts, but in each case, the amounts were less than the estimated costs to correct known deficiencies and complete unfinished work. As a result, the contractors were paid for work not yet done. Air Force’s C-17 Program To meet the need for additional long-range airlift, the Air Force contracted with the McDonnell Douglas Corporation, which later merged with the Boeing Company, to develop and produce 120 C-17 aircraft. As of October 1997, the contractor had delivered 34 production aircraft, all of which were conditionally accepted by the Air Force with a number of waivers and deviations that required corrective action by the contractor. We reviewed the adequacy of amounts withheld for eight aircraft conditionally accepted under two contracts for fiscal years 1990 and 1992, production lots III and IV, respectively. At the time of last aircraft delivery for each lot, the Air Force had withheld a net amount of about $47 million for problems with such things as computer software and assembly workmanship and for certain components on which qualification testing had not been completed. However, the amount withheld was significantly less than the estimated cost to correct known deficiencies and finish other incomplete work. Both contracts stipulated that the contracting officer should withhold a minimum of 10 percent of the contract price when conditionally accepting aircraft until the contractor completed the corrective actions. The lot IV contract, however, allowed the contracting officer to deviate from this requirement and withhold a lesser amount. C-17 program officials stated that they did not believe 10 percent was reasonable given the aircraft’s high price. Therefore, starting with lot III, instead of withholding 10 percent of an aircraft’s billing price, the program office and the contractor agreed to categorize waivers and deviations and establish standard withhold amounts for each category. In addition, they agreed to negotiate specific amounts for unique nonconformances. However, the program office did not modify the C-17 contracts to incorporate this withhold policy. Program officials told us that the withhold policy implemented in the C-17 program was not intended to cover the estimated cost and profit of the work remaining to be done by the contractor after conditional acceptance. They said that withholds were intended only to be an incentive to the contractor to correct deficiencies and finish other incomplete work. Table 1.1 compares our estimate of what should have been withheld after the delivery of the last aircraft in each lot with the amounts actually withheld. Our review indicated that the cost and profit to correct deficiencies and complete unfinished work for production lots III and IV exceeded the $47 million withheld by about $61 million, based on the contractor’s estimates of the cost of the aircraft at completion, or about $127 million, based on DCMC’s estimates of the cost of aircraft at completion. The final aircraft of lots III and IV were accepted in February and August 1994, respectively. At the time of our review, the contractor was correcting deficiencies and completing unfinished work. Army’s Tactical Vehicles Program The Army established the Family of Medium Tactical Vehicles (FMTV) program to replace its aging fleet of 2.5-ton and 5-ton trucks and vans. The Army plans to purchase about 85,000 FMTV vehicles over a 30-year period. In October 1991, the program office awarded a $1.2-billion contract to Stewart and Stevenson Services, Inc., for the initial production of 10,843 trucks and vans over 5 years. In August 1996, the program office revised the contract to procure these vehicles over a 7-year period. As of June 1997, the contract price to produce 11,197 trucks and vans was $1.36 billion. The contractor produced 3,040 vehicles during the program’s low-rate initial production phase. Nearly all of these vehicles (2,936) required a retrofit after production to resolve problems. These problems had been identified prior to acceptance during early testing. The government conditionally accepted 1,941 of these vehicles prior to retrofitting them. Many of these vehicles required an extensive retrofit effort, dismantling them down to the frame. The program office applied three different payment withholds, related to retrofit requirements, against the 1,941 vehicles. One withhold was for parts that were missing when the trucks were conditionally accepted. A second was imposed on vehicles accepted before the completion of first article testing, and a third involved deficiencies in the contractor’s quality control system. These withholds were released to the contractor after each vehicle had been retrofitted and accepted by the government. The second withhold was required by the contract’s conditional acceptance clause. This clause required that 10 percent of the billing price be withheld for those vehicles conditionally accepted prior to completion and approval of first article testing. The 10-percent figure was negotiated between the program office and the contractor. It did not bear any relationship to a projected cost estimate for retrofitting delivered trucks after testing was completed. A contracting officer with the U.S. Army Tank-Automotive and Armaments Command (TACOM) said that this clause was included in the FMTV contract based on experience with the previous M939A2 5-ton truck program. The third withhold was implemented later in the program because of government concerns that the vehicles did not conform to contract specifications because of inadequate contractor quality control. In July 1995, the program office modified the contract’s conditional acceptance clause to require an additional withhold amount on program year 1 and 2 vehicles. It involved withholding $2,000 for each vehicle built prior to April 11, 1994, and $1,000 for each vehicle built on or after this date. FMTV program officials were unable to provide an analytical basis for the two withhold amounts. Contracting files indicated that this withhold was implemented as an incentive to the contractor to improve his quality control system, thereby reducing the government’s risk in conditionally accepting vehicles. DCMC had estimated that the cost could be as high as $24 million to retrofit vehicles but had not developed a detailed estimate that we could use to evaluate the reasonableness of the amounts withheld. However, on the basis of the actual costs to retrofit these vehicles, we estimated the cost to retrofit the 1,941 vehicles conditionally accepted and compared that estimate to the amounts withheld related to the retrofit. As shown in table 1.2, we estimated the cost to retrofit the 1,941 vehicles exceeded the amounts withheld by about $2 million. At the time of our review, the retrofit required at the time of conditional acceptance had been accomplished. Navy’s Conversion of Commercial Container Ships To improve the Military Sealift Command’s prepositioning and surge sealift programs, the Navy is converting commercial container ships into roll-on roll-off sealift ships. Three ships are being converted under a contract with the National Steel and Shipbuilding Company. We reviewed the adequacy of the payment withholds for one of these ships, the USNS Shughart, which the Navy conditionally accepted on May 7, 1996. The contract for these ships contained the standard Naval Sea Systems Command clause that provides for a 1.5-percent performance reserve at the time of conditional acceptance but allows for a greater withhold as determined necessary by the contracting officer. At the time of the USNS Shughart’s conditional acceptance, the Navy project officer recommended withholding about $10.3 million for critical incomplete work and other deficiencies. However, there was only about $9.5 million available to withhold from the ship’s $289.7 million billing price because the Naval Sea Systems Command, with appropriate higher approval, had already released $5 million in prior progress payment retentions to the contractor. Accordingly, the project officer recommended and the contracting officer withheld the $9.5 million. At the time of our review, the contractor had generally completed work and corrected deficiencies identified at the time of conditional acceptance. Joint Tactical Unmanned Aerial Vehicle Program - Hunter System The Hunter Unmanned Aerial Vehicle (UAV) is a small, fixed-wing aircraft piloted remotely from a ground control station. The Hunter system, a part of the Joint Tactical UAV program, began in 1989 as a joint service effort to provide short-range UAVs for use by the Army, the Navy, and the Marine Corps. The Hunter system contract is administered by NAVAIR. In February 1993, this command exercised contract options with TRW, Incorporated, for the low-rate initial production of seven Hunter systems. In January 1996, DOD decided to end the Hunter Program at the end of the low-rate initial production contract. Between April and August 1995, the government conditionally accepted five Hunter systems, and it has since accepted, on an incremental basis, the remaining two systems. The cumulative billing price for the five complete systems was about $128.5 million. From this, the government withheld about $1.6 million for missing parts, nonconforming items, and other incomplete work. Although the contracting officer withheld payment for the above noted work, he did not withhold for other deficiencies. The contracting officer had issued 34 separate contractual waivers to prevent acceptance delays because the systems did not conform to contract specifications. Six of these waivers were temporary in nature and were approved on the condition that corrective action would be taken after delivery. These waivers involved hardware and software problems, subcontractor workmanship deficiencies, and incomplete work. The contracting officer did not withhold from the billing price the estimated cost to correct these deficiencies because program officials believed that the contractor was committed to correcting the deficiencies. However, not withholding funds based on the belief that the contractor will perform requires the government to assume a major risk in the event of nonperformance and is not consistent with a policy that requires paying only for completed work. Because the system had been terminated, we were unable to readily determine the status of the unfinished work. In commenting on a draft of this report, DOD stated that the contractor has since corrected the six deficiencies and the government has accepted, on a final basis, all of the systems. Conclusion and Recommendations When the government chooses to conditionally accept nonconforming items, the FAR, the DFARS, and supplementary service regulations do not require that an amount sufficient to cover the remaining work be withheld from the contract payment. As a result, the services’ withholding practices are inconsistent and contractors are being paid for work not completed at the time of delivery. We recommend that the Secretary of Defense amend the DFARS to require that, when conditionally accepting nonconforming items, amounts withheld be at least sufficient to cover the cost and related profit to correct deficiencies and complete other unfinished work. If the contracting officer determines that withholding a lesser amount is in the best interests of the government, such a determination should be properly documented and justified in the contract files. Agency Comments and Our Evaluation DOD generally concurred with the report’s findings, however, it only partially concurred with our recommendation. DOD agreed that the DFARS should be changed to include a requirement that when conditionally accepting nonconforming items, amounts to be withheld should at least cover the cost and related profit to correct deficiencies and complete unfinished work. DOD did not agree that the contracting officer should be required to obtain higher level approval before deviating from this general policy. DOD’s comments are reprinted in appendix I. Technical comments have been addressed in the report as appropriate. While we continue to believe that certain safeguards would help ensure adherence to the policy of only paying for work that is completed, revising the DFARS to specifically include the requirement is a good first step toward achieving this goal. DOD assumes that departure from the prescribed standard would be rare. We do not have information on a sufficient number of programs to address DOD’s assumption. Accordingly, we have modified our recommendation to delete the requirement for higher level approval of decisions to depart from the prescribed standard. We continue to believe, however, that requiring such departures to be justified and documented in the contract file will facilitate further oversight of this issue as needed. Scope and Methodology We reviewed the FAR, the DFARS, and supplementary service regulations regarding conditional acceptance of nonconforming items. We also spoke with the DOD Director of Defense Procurement and with acquisition and contracting officials from the Departments of the Air Force, the Army, and the Navy and the Defense Logistics Agency located in Washington, D.C., to determine their policies and procedures for accepting temporarily nonconforming items. We selected four acquisition programs that had entered low- or full-rate production to obtain coverage of Air Force, Army, Navy, and joint service programs. In addition, our selections were based on the size of the programs and the availability of documentation on the acceptance process. We reviewed contract files, billing and delivery documentation, and cost data. To gain an understanding of how conditional acceptance was implemented in each of the services, we interviewed contracting and procuring officials with the (1) C-17 program office in Dayton, Ohio; (2) FMTV program office located at the Army’s Tank-Automotive and Armaments Command in Warren Michigan; (3) Supervisor of Shipbuilding and Conversion in San Diego, California; and (4) Joint Tactical UAV project office at Redstone Arsenal, Alabama. We also discussed management of the various contracts with contracting personnel at the DCMC offices located at the Boeing Company in Long Beach, California; TRW Avionics and Surveillance Group in San Diego, California; and Stewart and Stevenson Services, Inc., in Sealy, Texas. Because we confined our review to defense programs, we have limited our recommendation to the DFARS. However, we will provide copies of this report to the FAR Council, the group responsible for approving changes to the FAR, for their consideration. Please contact me at (202) 512-4841 if you or your staff have any questions concerning this report. Major contributors to this report are listed in appendix II. Comments From the Department of Defense Major Contributors to This Report National Security and International Affairs Division, Washington, D.C. Thomas J. Denomme Noel J. Lance Carlos M. Garcia Dorian R. Dunbar John A. Carter The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. 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GAO reviewed the Air Force's procedures for payment to contractors for work not completed at the time of delivery, focusing on whether: (1) this situation occurred in other programs; and (2) additional guidance was needed to avoid paying contractors for work not done at the time of delivery. GAO noted that: (1) its review of four selected Air Force, Army, and Navy acquisition programs showed that each of the services accept items conditionally; (2) however, federal and Department of Defense (DOD) regulations do not provide guidance to contracting officers for determining amounts to be withheld from payments in these cases; (3) there is no consensus among Office of the Secretary of Defense and service officials as to what policy should govern payments at the time of conditional acceptance; (4) some officials agreed that the amount withheld should reflect the estimated cost and profit associated with the work to be done by a contractor after delivery while others indicated that contracting officers should have discretion to withhold whatever amount they determine appropriate; (5) the extent of service guidance ranged from the Army providing no guidance to standard Air Force and Navy contract clauses that leave determining the amount to be withheld to the contracting officer's discretion; (6) such guidance does not ensure that the amount withheld reflects the estimated cost and profit to correct known deficiencies and perform other incomplete work; (7) as a result, it lacks the safeguards necessary to reduce the government's risk of financial exposure and is inconsistent with the policy of paying only for completed work; (8) GAO's review of the four selected acquisition programs showed that when items were conditionally accepted, each of the services paid contractors the billing price, assuming 100-percent completion, less some amount for nonconforming or unfinished work; (9) in general, the amounts withheld were less than the costs to correct known deficiencies and complete unfinished work and resulted in contractors being paid for work that had not been performed at the time of conditional acceptance; (10) for example, the estimated price to correct known deficiencies and complete unfinished work on two C-17 production contracts exceeded the amounts withheld by about $61 million, based on the contractor's cost estimates, or $127 million based on the cost estimates used by the Defense Contract Management Command in administering the contract; (11) the Hunter Unmanned Aerial Vehicle program accepted five systems with six conditional waivers for which no money was withheld; (12) program officials told GAO that they believed the contractor would correct the deficiencies; and (13) the program office was not able to provide an estimate of the potential cost of this work.

Background The federal government has long played an important role in promoting the economic vitality of rural America—from supporting agriculture to building rural infrastructure, such as the electrification of rural America in the 1930s. More recently, since 1983, the federal government has funneled over $15.5 billion to rural areas for such activities as small business assistance, industrial development, and economic planning. In addition, rural areas receive federal funds that are not specifically targeted to economic development but that nevertheless influence rural economic development, such as agricultural payments, infrastructure assistance, and job training. The U.S. Department of Agriculture (USDA) has primary federal responsibility for rural development and provides leadership within the executive branch for coordinating federal programs, services, and actions affecting rural areas. Other federal agencies, such as the Department of Commerce’s Economic Development Administration (EDA) and the Department of Housing and Urban Development, also provide assistance for economic and other types of development to rural communities. Finally, independent federal agencies—such as the Appalachian Regional Commission, Small Business Administration, and the Tennessee Valley Authority—provide assistance in rural areas. To facilitate the delivery of assistance through the programs that these agencies administer, USDA has promoted the development of the National Rural Development Partnership (NRDP), whose objective is to promote collaboration, innovation, and strategic approaches among federal and state agencies involved in rural development. NRDP’s members include the National Rural Development Council and State Rural Development Councils. The national council is composed of senior program managers from over 40 federal agencies and representatives of public interest, community, and private organizations. State councils, which have been established in 39 states, are composed of representatives from federal, state, and local governments, tribal councils, and the private sector. Despite the range of federal assistance, many rural areas continue to face distinct barriers to social and economic development. One of these barriers, remoteness from population centers, means that rural areas may find it difficult to attract many services—such as access to advanced medical care and higher education—that are available in or near population centers and may offer fewer job opportunities than urban areas. Increasingly, telecommunications technologies are seen as a way to overcome the problems posed by distance, according to rural development experts. For example, some communities are using interactive videoconferencing to provide medical consultations. Some colleges and schools are offering classes, and even degree programs, to students on-line in remote locations. Large businesses have found it cost-effective to establish or maintain branch offices in rural areas by using videoconferencing or on-line access to hold meetings and conduct business. In February 1996, the Congress enacted the Telecommunications Act of 1996 (P.L. 104-104, Feb. 8, 1996), the first major overhaul of telecommunications law in over 60 years. The new law, which includes important provisions promoting the use of advanced telecommunications in rural America, seeks to preserve and advance the concept of universal service, defined generally as an evolving level of telecommunications service. The preservation and advancement of universal service is to be based on seven principles, including the availability of advanced services in all regions of the nation and access to services in rural and high-cost areas. The act also establishes the Telecommunications Development Fund, which, among other things, is to support universal service and promote the delivery of telecommunications services to underserved rural and urban areas. Multiple Federal Programs Directly or Indirectly Provide Telecommunications Assistance At least 28 federal programs in 15 agencies provide funding for telecommunications programs. Of the 28 programs, 13 are specifically designed to support telecommunications projects, although not necessarily for rural areas. The remaining 15 programs have more general economic development purposes but can be used for telecommunications efforts. In fiscal year 1995, the 13 telecommunications programs provided about $715.8 million for about 540 projects. Programs ranged from the Rural Utilities Service’s rural telephone loan programs ($585 million combined), which are designed to ensure that rural areas have telephone service comparable with urban areas’, to the Department of Health and Human Service’s (HHS) Health Care Financing Administration’s Research, Demonstration, and Evaluation Program ($0.5 million), which funds, among other things, innovative projects that use telecommunications technologies to improve medical access and care. Table 1 lists the 13 telecommunications-related programs, their funding levels, and the other types of activities they support. The other 15 programs we identified that can be used for telecommunications projects are intended to support a range of community assistance projects. For example, the Department of Housing and Urban Development provides Community Development Block Grants to communities for development purposes, while the EDA provides grants to communities for public works and infrastructure development. In addition, HHS’ Office of Rural Health Policy supports the Rural Health Services Outreach Program, which, among other things, can be used to provide better access to health care through telecommunications technology. (See app. I for more detailed information on all 28 programs.) Communities Identified Three Steps for Developing a Telecommunications Project Officials in five rural communities that have obtained federal funds for telecommunications projects identified three key actions for putting telecommunications projects into place: (1) developing a basic understanding of the potential benefits of telecommunications technologies; (2) engaging in long-term planning to determine the need for, and ensure the technical and financial feasibility of, their project; and (3) building partnerships among the key players who would be needed to support and/or benefit from the project. The representatives of the State Rural Development Councils and representatives of rural associations, such as the National Association of Development Organizations (NADO) and National Association of Regional Councils, confirmed the importance of these actions. Developing a Basic Understanding In examining options to address a particular problem in their rural communities, officials at all of the projects we visited identified telecommunications as a possible solution. They all agreed, however, that they had to develop a basic understanding of telecommunications technologies before they could evaluate their usefulness in solving their problem. For example, a consortium of mental health officials in eastern Oregon were seeking ways to reduce the risk, expense, and time involved in transporting individuals who might be committed to mental health facilities to and from various types of court hearings and psychiatric evaluations. Once they learned about various telecommunications technologies and the ways in which the technologies could help them deliver mental health services, these officials identified video teleconferencing as a alternative to repeatedly transporting patients across long distances. They developed the RODEONET project, which has 14 sites in eastern and southern Oregon. Similarly, in Kentucky, the Chief Executive Officer and Chairman of the Greater Paducah Economic Development Council told us that he first became interested in the potential of an information age park to bring economic opportunities to his community when he attended a telecommunications conference in 1989 that was sponsored by a telephone company. An information age park is an office park that, by concentrating state-of-the-art telecommunications—such as videoconferencing, high-speed data transfer, and computer networking—could attract a host of new industries, such as credit card centers and telemarketers. After studying the technology, he and the Greater Paducah Economic Development Council asked for assistance from the local carrier to determine the feasibility of a project. Most representatives of the 15 State Rural Development Councils, NADO, and many other experts on rural development underscored the importance of gaining a basic understanding of telecommunications technologies as a first step in using them. Furthermore, NADO, as well as others, reported that rural communities need reliable, centralized information on the use of telecommunications. Engaging in Long-Term Planning for the Project Officials for all of the projects we visited developed long-term plans to ensure the technical and financial feasibility of their project. For example, the director of the Paducah Information Age Park, told us that, in 1990, the Greater Paducah Economic Development Council formally requested a carrier’s assistance to identify and quantify the potential economic benefits of developing such a park for use as a resource in recruiting information-intensive, high-technology industries. In March 1991, project officials and their partners conducted a study to determine if information age business parks might be economically feasible in nonmetropolitan areas, such as Paducah, Kentucky. The study concluded that the proposed site would be a suitable location to develop a “micropolitan” information park. Planning for the project’s funding involved multiple participants. Total funds of $21 million were secured through investments from individuals and private businesses as well as state and federal loans and grants from the state of Kentucky and the Tennessee Valley Authority. In addition, the city government granted certain zoning concessions. Building Partnerships Among Key Players According to officials of all of the projects we visited and the 15 State Rural Development Councils we spoke with, partnership building is critical to the successful creation and continued operations of telecommunications projects. Partnership building involves bringing together the key players, such as telephone companies, anticipated users, and government officials at all levels. For example, the Spokane, Washington, STEP/Star Network, which develops, produces, and broadcasts education programs for credit, primarily at the high school level, relies on its relationships with the school districts, teachers, students, states, private businesses, and government. Further demonstrating the value of a strong partnership, in fiscal year 1994, the project received about $2 million from users and other local sources. In January 1994, the STEP/Star Network joined forces with other education broadcasters to create a new, much larger network. With the new network, the STEP/Star Network and other providers share programming, which greatly increases the course offerings to their subscribers. In commenting on a draft of this report, USDA officials reemphasized the importance of partnership building in developing telecommunications capabilities. They further explained that USDA actively encourages partnership building by those rural communities seeking the Rural Utilities Service’s assistance, but any rural community interested in using telecommunications as a rural development tool should include its local carrier in its partnership. Experts Reported That Changes in Telecommunications Programs Could Make Them More Useful to Rural Areas Rural development experts and public officials we interviewed suggested three ways to improve federal programs providing telecommunications assistance: (1) educating rural communities on the potential benefits of telecommunications technologies, (2) building in requirements for considering telecommunications technologies in long-range planning, and (3) making the multiple federal programs easier to use. Educating Rural Communities About Telecommunications Although at least 28 federal programs are available to help communities improve their telecommunications capabilities, these programs offer only limited outreach aimed at educating rural communities about the potential of advanced telecommunications for development, according to most of the program and rural development officials we spoke with. Instead, the programs generally offer technical assistance to communities that have already received approval and funding for a particular project. All of the experts we spoke with and the studies we reviewed pointed out that many rural areas do not have a full understanding of the development opportunities that the new technologies offer. For example, the Executive Director of the Missouri Rural Opportunities Council told us that her experience with residents and business people in rural midwestern communities showed that they have had limited exposure to telecommunications technologies and do not understand their potential benefits. She believes that better education, training, and overall exposure to these technologies are needed by rural areas. Most of the federal telecommunications program officials agreed that all rural areas should receive information and training in the uses of telecommunications technologies. They also agreed that providing this information and training was a valid federal role but that they lacked the staff and resources to provide such outreach. Building Telecommunications Into Long-Range Planning The federal programs that provide telecommunications assistance require plans for the projects they fund, but most of the officials again reported a lack of resources to actively encourage all rural areas to consider telecommunications infrastructure as a component in their comprehensive, locally based economic development plans. According to a number of rural development officials we spoke with, many rural areas have not considered telecommunications in their long-term strategic planning. Telecommunications technologies should at least be considered in communities’ long-range plans, according to the federal officials and rural development experts we spoke to. In some instances, requiring such consideration is being contemplated. For example, the Director of the EDA’s Planning Division confirmed that although the agency recognizes telecommunications as a high-priority item, the agency’s current guidelines for producing an economic development plan do not require including telecommunications. As we pointed out to the Director, these guidelines were last updated in 1992, and he agreed it is time for them to be updated again, and to include telecommunications issues. If such a change were implemented, 315 economic development districts across the nation, each encompassing multiple counties, would be coached to consider telecommunications technologies in their long-term strategic planning. The National Association of Regional Councils informed us that communities have economic development plans that do not include consideration of telecommunications technologies because the plans were developed before these technologies were fully recognized as a potentially important tool for rural areas. The Federal Agriculture Improvement and Reform Act of 1996 may also encourage rural communities to consider telecommunications technologies, depending on how the act is implemented. The act requires the Secretary of Agriculture to direct all of the Directors of Rural Economic and Community Development State Offices to prepare a 5-year strategic plan for their states. They are to work closely with state, local, private, and public persons, State Rural Development Councils, Indian tribes, and community-based organizations in preparing the plan. Once the plan is established, financial assistance for rural development is to be provided only for orderly community development that is consistent with the state’s strategic plan. The Deputy Under Secretary for Rural Development told us that USDA will encourage all rural areas to consider including telecommunications projects in their long-term strategic plan, which will be included in the state plan. He also stressed that others involved in the plan development process, including the State Rural Development Councils, are very strong advocates of using telecommunications technologies as a rural development tool and will encourage rural areas to consider these technologies in their plan. Making Federal Programs Easier to Use As we previously reported, federal programs providing assistance to rural areas are difficult to identify, understand, and use. This is also the case for telecommunications programs, according to all of the officials of the State Rural Development Councils we spoke with. For example, the Director of the Montana State Rural Development Council told us that with the exception of grants given by the Rural Utilities Service to telephone companies, most of that state’s rural planners do not have the expertise to obtain access to federal grants. In Montana, the applications submitted typically come from grant writers located at universities and other centers of expertise. Similarly, the Executive Director of the Iowa Rural Development Council told us that assistance programs tend to go to organizations like the universities. While the universities have some good project ideas, Council officials said, they do not always consider the local needs of rural America. Better coordination of federal programs would also help rural communities, according to officials we spoke with. For example, the Executive Director of the Colorado Rural Development Council told us that rural communities would benefit if the plethora of federal telecommunications programs could be coordinated because currently a full-time grant writer must spend much of his time tracking all the programs. She also said that given the extremely limited capacity of most small rural communities to access this type of technical assistance, most are effectively eliminated from applying for any of the grant programs. However, these are the same communities that would benefit the most from such assistance. Similarly, the National Association of Regional Councils told us that the federal government needs to pull these programs together to ensure consistent, readily understandable, and accessible assistance. The Federal Agriculture Improvement and Reform Act of 1996 emphasizes the need to better coordinate federal programs, requiring the Secretary of Agriculture to provide leadership within the executive branch and establish an interagency working group to be chaired by the Secretary. The working group is to establish policy for, coordinate with, make recommendations with respect to, and evaluate the performance of all federal rural development efforts. The conference report for the act noted that the NRDP should continue its role in monitoring and reporting on policies and programs that address the needs of rural America. The State Rural Development Councils, which are members of the NRDP, are to continue to act as the conduit of information to the partnership. Agency Comments We provided USDA a draft copy of this report for its review and comment because USDA is responsible for the federal involvement in rural development. For all other agencies and organizations that provided input to this report, we provided relevant sections of the draft report that either dealt with information they had provided to us or that we synthesized from data obtained both from them and other respondents. We met with USDA officials to obtain their comments, both on the programs discussed in this report and on policies relating to rural development. These officials included the Deputy Administrator of the Rural Utilities Service and representatives of the Office of the Under Secretary for Rural Development. The officials agreed with the report and provided several additional clarifying comments, which we have incorporated into this report as appropriate. In commenting on the draft report, the USDA officials also said that it was important to recognize the recent changes to rural telecommunications programs made by the Federal Agriculture Improvement and Reform Act. Specifically, they noted that the Act authorized $100 million for loans under the Distance Learning and Telemedicine Loan Program. They said this will result in a real cost to the government of $1 million, representing interest-rate subsidies, some general and administrative expenses, and allowance for bad debt. The officials also stressed that many rural areas lack the basic infrastructure needed for advanced telecommunications and that the Rural Utilities Service will continue its mission of meeting the needs of rural America. Officials from the other agencies and organizations that responded to our request for comments agreed with the facts presented in the report and, in some cases, provided clarifying information that we considered and incorporated as appropriate in preparing our final report. Scope and Methodology In developing information for this report, we identified the federal agencies and programs offering telecommunications assistance to rural areas by searching the June 1995 Catalog of Federal Domestic Assistance. Our search covered all programs that offer grants, loans, or technical assistance to rural areas for planning, constructing, expanding, demonstrating, and/or operating advanced telecommunications projects for rural development. We reviewed documents describing these programs and met with program officials at their headquarters offices in Washington, D.C., and in Knoxville, Tennessee, to learn about the programs’ operations. We obtained fiscal year 1995 funding amounts from agency officials. We did not independently verify this information. We judgmentally selected for site visits five telecommunications projects that received federal funds. We met with project officials and reviewed documents to learn how these projects were developed and are currently operating and what lessons officials had learned from these projects. For each project selected, we developed a description and identified the source of funds for the project. These projects are the Ringgold, Georgia, Telephone Company; the Mayfield, Kentucky, Rural Telecommunications Resource Center; the Eastern Oregon RODEONET Project; the Paducah, Kentucky, Information Age Park; and the Spokane, Washington, STEP/Star Network. These projects are discussed in greater detail in appendix II. To gain further insight into the lessons learned by other rural areas using the federal programs and to identify any changes needed, we reviewed relevant studies by the Aspen Institute, the National Governors Association, the National Association of Development Organizations, the Organization for the Protection and Advancement of Small Telephone Companies, the National Association of Regional Councils, the American Academy of Political and Social Science, USDA’s Economic Research Service, the Rural Policy Research Institute, and the Office of Technology Assessment. To obtain the state perspective on telecommunications technologies in rural communities, we spoke with a group of officials from 15 State Rural Development Councils through a conference call arranged by the National Rural Development Partnership Office at our request. These officials were in Alaska, Colorado, Florida, Idaho, Iowa, Massachusetts, Minnesota, Missouri, Montana, Nebraska, Ohio, Texas, Washington, Wisconsin, and Wyoming. To obtain a grassroots perspective, we requested NADO, the National Association of Regional Councils, and the Organization for the Protection and Advancement of Small Telephone Companies to solicit the views of their members on the same issues discussed with state officials. (See app. III for a brief description of these organizations.) We conducted our review from August 1995 through May 1996 in accordance with generally accepted government auditing standards. We are sending copies of this report to the House Committee on Agriculture; other appropriate congressional committees; the Secretary of Agriculture; and federal and state agencies with responsibility for telecommunications technologies in rural areas. If you or your staff have any questions about this report, I can be reached at (202) 512-5138. Major contributors to this report are listed in appendix IV. Federal Programs That Can Be Used for Telecommunications Projects This appendix presents detailed information on the 28 federal programs we identified that are either designed to support telecommunications projects or that can be used for that purpose. This information was principally obtained from the June 1995 Catalog of Federal Domestic Assistance. We confirmed the budget information with appropriate program officials but did not independently verify the information. Programs That Are Designed to Support Telecommunications Projects Thirteen programs we identified are designed to provide funding for telecommunications projects. The Department has four programs that directly support telecommunications projects. The Agricultural Telecommunications Program, supported by the Cooperative State Research Education and Extension Service, awards grants to eligible institutions to assist in the development and utilization of an agricultural communications network to facilitate and strengthen agricultural extension, residents’ education, and research, and domestic and international marketing of U.S. commodities and products through a partnership between eligible institutions and the Department. The network employs satellite and other telecommunications technologies to disseminate and share academic instruction, cooperative extension programming, agriculture research, and marketing information. Types of assistance. Project grants. Funding levels. This program was initially funded in fiscal year 1992. Funding levels remained constant at $1.22 million through fiscal year 1995. Eligibility criteria. Applicants must demonstrate that they will (1) make optimal use of available resources for agricultural extension, residents’ education, and research by sharing resources between participating institutions; (2) improve the competitive position of U.S. agriculture in international markets by disseminating information to producers, processors, and researchers; (3) train students for careers in agriculture and food industries; (4) facilitate interaction among leading agricultural scientists; (5) enhance the ability of U.S. agriculture to respond to environmental and food safety concerns; and (6) identify new uses for farm commodities and increase the demand for U.S. agricultural products in both domestic and foreign markets. Proposals are invited from accredited institutions of higher education. Intended beneficiaries. Institutions of higher education, state and local governments, private organizations or corporations, and individuals. Examples of funded projects. One project is to develop and deliver a model program for staff and faculty training in agricultural distance learning at 13 land grant universities. In another project, six land grant universities will develop a network training concept to improve the dissemination and sharing of academic instruction, extension programming, and research activities. Rural Telephone Loan and Loan Guarantees, in the Rural Utilities Service (RUS), has as its objective ensuring that people in eligible rural areas have access to telecommunications services comparable in reliability and quality with the rest of the nation. Types of assistance. Direct loans. Funding levels. Cost-of-money loans totaled $186.4 million in fiscal year 1991, rose to $311.03 million in fiscal year 1993, and fell to $242.35 in fiscal year 1995. The total loans guaranteed remained fairly constant at $120 million, from fiscal year 1991 to fiscal year 1995. Funding for hardship loans became a distinct funding category in fiscal year 1994. Fiscal year 1994 funding was $70.34 million and fiscal year 1995, $69.5 million. While the funding levels varied from year to year, this reflects the amount of funding (budget authority) provided by the Congress, not the number of applications received; in each year, more applications were received than could be funded. Eligibility criteria. Telephone companies or cooperatives, nonprofit associations, limited dividend associations, mutual associations or public bodies, including those located in the U.S. territories, are eligible for this program. Intended Beneficiaries. Residents of rural areas and others who may also receive telephone service as a result of service provided to a rural area. Examples of funded projects. Since 1992, loans have been made to RUS borrowers to finance over $368 million in projects for fiber optic cable, over $350 million for digital switching equipment, $70 million for advanced telecommunications features, and $14 million for distance learning. Rural Telephone Bank Loans (Rural Telephone Bank), under RUS, is designed to provide supplemental financing to extend and improve telecommunications services in rural areas. Types of assistance. Direct loans. Funding levels. The program made loans totaling $177.0 million in fiscal year 1991, $199.85 million in fiscal year 1994, and $175 million in fiscal year 1995. Eligibility criteria. Eligible recipients are borrowers, including those located in the U.S. territories, or possessions that have received a loan or loan commitment under section 201 of the Rural Electrification Act or that have been certified by the Administrator as qualified to receive such a loan. Intended beneficiaries. Residents of rural areas and others who receive telecommunications service resulting from service provided to rural areas. Examples of funded projects. Since 1992, loans have been made to RUS telephone borrowers to finance over $368 million for fiber optic cable, over $350 million for digital switching, $70 million for advanced telecommunications features, and $14 million for distance learning equipment. Distance Learning and Medical Link Grants, provided by RUS, are intended to encourage and improve the use of telecommunications, computer networks, and related advanced technologies to provide educational and medical benefits to people living in rural areas. Types of assistance. Project grants. Funding levels. Funding for fiscal years 1993 and 1994, the first 2 years that grants were awarded, was $10.0 million each year. The program’s funding level was reduced to $7.50 million in fiscal year 1995. Eligibility criteria. Eligible recipients include organizations such as schools, libraries, hospitals, medical centers, or similar organizations that will be users of a telecommunications, computer network, or related advanced technology system to provide educational and/or medical benefits to rural residents. The applicant must not be delinquent on any federal debt. Intended beneficiaries. Rural communities will benefit, particularly in the areas of health care and education. Examples of funded projects. The program has supported a network to link rural hospitals and health care clinics with urban tertiary care centers to provide rural residents with continuous access to trauma and emergency care. It has also sponsored a system to provide 37,000 rural residents—including students, patients, and other residents—with access to the Iowa Communications Network for educational and medical services. The Department has three programs that directly support telecommunications projects. The Star Schools Program encourages improved instruction in mathematics, science, and foreign languages, as well as other subjects, such as literacy skills and vocational education. Grants are made to eligible telecommunications partnerships to enable them to (1) develop, construct, acquire, maintain, and operate telecommunications audio and video facilities and equipment; (2) develop and acquire educational and instructional programming; and (3) obtain technical assistance for the use of such facilities and instructional programming. Type of assistance. Project grants. Funding levels. The program’s funding has increased from $14.4 million in fiscal year 1991 to $25 million in fiscal year 1995. Eligibility criteria. Eligible telecommunications partnerships must be organized on a statewide or multistate basis. Two types of partnerships are eligible. One type is a public agency or corporation established to develop and operate telecommunications networks to enhance educational opportunities provided by educational institutions, teacher training centers, and other entities. The agency or corporation must represent the interests of elementary and secondary schools eligible to participate under title 1 of the Elementary and Secondary Education Act of 1965, as amended. The second type is a partnership of three or more agencies, such as a state educational agency, a local educational agency that serves certain types of students, an institution of higher education or a state higher education agency, a teacher training center, an adult or family education program, a public or private elementary or secondary school, a telecommunications entity, or a public broadcasting entity. At least one of the partners must be an eligible local educational agency or state educational agency. Intended beneficiaries. The program serves underserved populations, including those who are disadvantaged or illiterate, as well as those who have disabilities or limited proficiency in English. Examples of funded projects. In fiscal years 1994 and 1995, Star Schools funded 13 projects totaling approximately $50.9 million. For example, the College of Eastern Utah received grants totaling $4.4 million to develop state-of-the-art studios and linked classrooms to improve the delivery of education services to the Four Corners area of the Southwest. The project is aimed at rural and Native American populations. The Pacific Mountain Network received $741,000 to develop eight 30-minute video modules focusing on distance learning and education reform, to screen distance learning resources, and to provide background information on technology’s role in education. Challenge Grants for Technology in Education provide support to consortia that are using new applications of technology to strengthen the school reform effort, improve the content of the curriculum, increase student achievement, and provide sustained professional development for teachers and others who are employing new applications of technology to improve education. Types of assistance. Project grants (discretionary). Funding levels. The program was originally appropriated $27 million for fiscal year 1995, its first year of operation. However, the Congress later reduced the appropriated amount to $9.5 million for the year. Challenge grants are for 5-year projects. Each project will receive an initial 15-month budget from combined fiscal year 1995-96 appropriations. Eligibility criteria. Consortia must include at least one local educational agency (LEA) with a high percentage or number of children living below the poverty line and may include other LEAs, state educational agencies, institutions of higher education, businesses, academic content experts, software designers, museums, libraries, or other appropriate entities. Intended beneficiaries. Elementary and secondary education students, teachers, administrators, and school library media personnel benefit from the program. Examples of funded projects. The program funded 19 projects in its first year. For example, the program provided funds to Westside Community Schools and the Nebraska Consortium for Discipline-Based Art Education to use telecommunications and digital technology to link urban and rural schools to the art collections of five major museums across the country. The program also funded the state of Utah Resource Web to use telecommunications to provide quality educational opportunities in low-income, rural, and culturally disenfranchised communities. Telecommunications Demonstration Project for Mathematics carries out a national telecommunications-based demonstration project to improve the teaching of mathematics. Types of assistance. Project grants. Funding levels. In fiscal year 1995, the first year of the program, $1.1 million was appropriated. Eligibility criteria. State educational agencies (SEA), LEAs, nonprofit telecommunications entities, or partnerships with these entities may apply. Intended beneficiaries. Those benefiting from the program include elementary and secondary school teachers of mathematics and schools of LEAs having a high percentage of children who are counted for the purpose of part A, title 1, of the Elementary and Secondary Education Act of 1965, as amended. Examples of funded projects. One grant was awarded in fiscal year 1995 to the Public Broadcasting Service for an elementary component of PBS Mathline. The project will provide video modules and on-line resources for teachers of mathematics in more than 30 states across the country. Department of Health and Human Services The Department has two programs that support telecommunications projects. Health Care Financing Administration’s (HCFA) Research, Demonstration, and Evaluation projects are designed to support analyses, experiments, demonstrations, and pilot projects aimed at resolving major health care financing issues or developing innovative methods for the administration of Medicare and Medicaid. In 1994, HCFA identified a number of areas in which specific information or experience was needed to improve programs’ effectiveness or guide decisions. These priority areas for discretionary cooperative agreements and/or grants were to be HCFA’s guide for project selection in fiscal years 1994, 1995, and 1996, and included (1) access and quality of care; (2) managed care systems; (3) provider payments; (4) health care systems reform and financing; (5) program evaluation and analyses; (6) service delivery systems; and (7) subacute and long-term care. However, substantial cutbacks in discretionary funding for HCFA in fiscal years 1995 and 1996 resulted in only a few new awards in these areas in 1995 and none in 1996. Types of assistance. Project grants or cooperative agreements. Eligibility criteria. Grants or cooperative agreements may be made to private or public agencies or organizations, including state agencies that administer the Medicaid program. Private for-profit organizations may apply. Awards cannot be made directly to individuals. Intended beneficiaries. Contributing retirees or specially entitled beneficiaries, which include those with disabilities, end-stage renal disease, and families receiving Medicaid benefits. Funding levels. HCFA funded five telemedicine demonstration projects totaling $858,000 in fiscal year 1993, $4 million in fiscal year 1994, and $524,000 in fiscal year 1995. New telemedicine projects have not been funded since fiscal year 1994. The fiscal year 1995 funding was to begin a comprehensive evaluation of HCFA’s previously awarded telemedicine demonstration projects. Examples of funded projects. The program funded five telemedicine demonstration projects in 1993 and 1994. For example, in fiscal year 1993, the program provided about $700,000 to the Iowa Methodist Health System for its telemedicine services in cardiology and pathology consultations. In fiscal year 1994, the program provided about $272,000 to East Carolina University to test a system of Medicare payments for telemedicine services involving two rural hospitals and a medical school affiliate. Rural Telemedicine Grants support projects to demonstrate and collect information on the feasibility, costs, appropriateness, and acceptability of telemedicine for improving access to health services for rural residents and reducing the isolation of rural practitioners. Types of assistance. Project grants. Eligibility criteria. The grant recipient can be a public (nonfederal) or private nonprofit or for-profit entity, located in either a rural or urban area. The entity must be a health care provider and a member of a telemedicine network or a consortium of providers that are members of a telemedicine network. Intended beneficiaries. Rural health care providers, patients, and rural communities benefit from this grant program. Funding levels. The program received $4.6 million in fiscal year 1994, its first year, and $5 million in fiscal year 1995. Examples of funded projects. For fiscal year 1994, the program granted 11 new awards. No new grants were made in fiscal year 1995 because of budget constraints. One project is the High Plains Rural Health Network in Fort Morgan, Colorado. This project is a consortium of hospitals, clinics, and physician practices in Colorado, Nebraska, and Kansas. Its telemedicine network will have two hub facilities serving two rural hospitals, two community health centers, and a long-term care facility. The network will have a videoconferencing system and an electronic bulletin board for ongoing communications among all network practitioners. Another project is the University of Kentucky’s Medical Center’s plan to provide specialty consultations to Berea Hospital (with 42 acute-care beds) and several clinics in rural Kentucky. The university hospital also will be linked with the Saint Claire Medical Center in Morehead, Kentucky, which will serve as a second hub site. The Department sponsors two telecommunications projects under its National Telecommunications and Information Administration. Public Telecommunications Facilities Planning and Construction Grants can be used to assist in the planning, acquisition, installation, and modernization of public telecommunications facilities, through planning grants and matching construction grants, in order to (1) extend the delivery of public telecommunications services to as many citizens of the United States and its territories as possible by the most efficient and economical means, including the use of broadcast and nonbroadcast technologies; (2) increase public telecommunications services and facilities available to, operated by, and owned by minorities and women; and (3) strengthen the capability of existing public television and radio stations to provide public telecommunications services to the public. Types of Assistance. Project grants. Funding levels. This program’s funding was increased from $19.7 million in fiscal year 1991 to $27.7 million in fiscal year 1995. Eligibility criteria. Several types of entities are eligible for these grants: (1) public or noncommercial educational broadcast stations; (2) noncommercial telecommunications entities; (3) systems of public telecommunications entities; (4) public or private nonprofit foundations, corporations, institutions, or associations organized primarily for educational or cultural purposes; and (5) state or local governments or agencies, including U.S. territories, federally recognized Indian tribal governments, or political or special purpose subdivisions of a state. Intended beneficiaries. The general public and students benefit from the program. Examples of funded projects. One project funded under this program is the construction of a new noncommercial radio station in Ada, Oklahoma, to provide the first public radio signal to 40,000 residents in southeastern Oklahoma. Another is the replacement of the transmission system, the remote control, and associated dissemination equipment for a public television station in Austin, Texas. The Telecommunications and Information Infrastructure Assistance Program promotes the widespread use of advanced telecommunications and information technologies in the public and nonprofit sectors. Types of assistance. Project grants. Funding levels. This program was initially funded in 1994. The program funded projects totaling $24.4 million in fiscal year 1994 and $36.0 million in fiscal year 1995. Eligibility criteria. State and local governments, nonprofit health care providers, school districts, libraries, universities and colleges, public safety services, and other nonprofit entities. Intended beneficiaries. The general public benefits from the program. Examples of funded projects. One project involves a rural educational system in Washington State, serving a predominantly Native American population, that will build a systemwide voice, data, and video instructional network. This system will be connected to statewide educational and national information services. Another project is the Kansas State Corporation Commission’s effort to develop a comprehensive, statewide telecommunications infrastructure plan that addresses the needs of business, health care, education, government, and the public. The National Science Foundation (NSF) has two programs that support telecommunications projects. Connections to the Internet is intended to encourage U.S. research and educational institutions to connect to the Internet. In March 1996, this program extended the Connections to the NSFNET program, which has been in place since 1990. Types of assistance. Project grants. Funding levels. The program’s funding was $1.6 million in fiscal year 1991. Funding rose to $8.3 million in fiscal year 1993 and fell to $5.8 million in fiscal year 1995. Eligibility criteria. Proposals may be submitted by any U.S. research or educational institution or consortium of such organizations as appropriate for connections categories: (1) connections utilizing innovative technologies for Internet access; (2) connections for institutions of higher education; and (3) connections for research and education institutions and facilities that have meritorious applications requiring high network bandwidth or other novel network attributes not readily available from commodity network service providers. Intended beneficiaries. Students, faculty, and researchers at the connected schools. Examples of funded projects. One example of a Connection to the Internet project is an NSF-funded connection of five community colleges in eastern New Mexico. Networking Infrastructure for Education has as its goal building synergy between technology and education researchers and developers and implementers so that they can explore networking costs and benefits, test self-sustaining strategies, and develop a flexible educational networking infrastructure that will be instrumental in the dissemination, integration, and application of technologies to speed the pace of educational innovation and reform. Types of assistance. Project grants or cooperative agreements. Funding levels. NSF allocated $8.7 million to the program in fiscal year 1994, its first year, and $11.7 million in fiscal year 1995. Eligibility criteria. Individual institutions or groups of institutions within the United States. Alliances of 2- and 4-year degree-granting academic institutions, school districts, professional societies, state agencies, public libraries, museums, and others concerned with educational reform. Business and industry participation, with cost-sharing consistent with their role, is required for demonstration, model site, testbed and infrastructure projects and encouraged for policy studies and research and development projects. Intended beneficiaries. Elementary, secondary, and undergraduate science, mathematics, and engineering teachers and faculty; secondary, undergraduate students; public and private colleges (2-year and 4-year) and universities; state and local educational agencies; nonprofit and private organizations; professional societies; science academies and centers; science museums and zoological parks; research laboratories; and other institutions with an educational mission. Examples of funded projects. One project funded under this program is a Montana statewide coalition featuring partners from all public and private stakeholders, including the Statewide Systemic Initiative, to plan for the development of a lasting infrastructure that will support a variety of educational telecommunications services, paying particular attention to the special conditions in this largely rural state. Another project is a regional data network to connect schools, libraries, and community centers to individual households, the network itself, and the Internet. Programs With Objectives Not Specific to Telecommunications We also identified 15 multipurpose programs that do not have telecommunications projects as a specific objective but can fund such projects. While these programs have similar objectives—such as economic development, education, and health outreach—they do not specifically cite telecommunications as the means to accomplish their objectives. Table I.2 lists these programs. Although these programs may fund many different kinds of projects, some have emphasized telecommunications technologies. For example, the Appalachian Regional Commission views telecommunications as crucial to Appalachia’s economic development. Telecommunications technologies is one of three initiatives ARC has targeted for the region, along with civic development and preparing Appalachia for the global economy. The ARC Co-Chairman has pledged to ensure that “the ’information superhighway’ not bypass Appalachia as the national highway system did some four decades ago.” The Department has one program in its Rural Business and Cooperative Development Service that, while not specifically designed for telecommunications technologies, can be used for them. Rural Economic Development Loans and Grants are designed to promote rural economic development and help create jobs, including funding for project feasibility studies, startup costs, incubator projects, and other reasonable expenses for the purpose of fostering rural development. Types of assistance. Direct loans; project grants. Funding levels. The program received $13.5 million in fiscal year 1994. Eligibility criteria. Electric and telephone utilities that have current Rural Electrification Administration or Rural Telephone Bank loans or guarantees outstanding and are not delinquent on any federal debt or in bankruptcy proceedings may apply. Intended beneficiaries. Rural communities and the general public benefit from this program. Examples of funded projects. Program officials say the program has not funded telecommunications projects. The Commission currently offers two programs that can be used for telecommunications projects. ARC receives only one appropriation each year for its assistance activities. All projects are funded from this “Area Development” allocation. Area Development funding has ranged from $39.5 million in fiscal year 1991 to $102.0 million in fiscal year 1995; only a small amount of this funding is used for telecommunications under the two programs discussed below. Special ARC Initiatives have been funded during fiscal years 1995 and 1996 and are planned to be funded again in fiscal year 1997. The three special initiatives provide assistance for telecommunications, internationalization of the Appalachian region’s economy, and local leadership and civic development. (Approximately $5 million to $6 million was set aside from the Area Development allocation for these three initiatives in fiscal years 1995 and 1996, and a similar amount is anticipated for fiscal year 1997.) Types of assistance. Project grants. Funding levels. See description of Area Development funding, above. Eligibility criteria. Multicounty organizations, state universities, community colleges, high schools, nonprofit organizations, and school boards. Intended beneficiaries. Residents of the Appalachian region. Examples of funded projects. Assisted with the strategic plan for the Multiregional Telecommunications Improvement Project in New York and the Western Maryland WMDNet Equipment Project, which connected universities, junior colleges, libraries, county governments, and health facilities. Appalachian Area Development provides assistance for a variety of needs, including telecommunications projects. (See Special ARC Initiatives described above). On average, across the region, about $2.5 million to $3 million is annually provided for telecommunications-related projects from the overall Area Development funding allocation. Types of assistance. Project grants. Funding levels. See description of Area Development funding, above. Eligibility criteria. Multicounty organizations, state universities, community colleges, high schools, nonprofit organizations, and school boards. Intended beneficiaries. Residents of the Appalachian region. Examples of funded projects. Assisted with the Elmore County (Alabama) Telecommunications Network Project (connecting high schools, junior colleges, businesses, and government offices) and the Greenville (South Carolina) Hospital Home Health Project. The Department has four programs that can be used to support development of telecommunications projects. Economic Development Grants for Public Works and Infrastructure Development, administered by the Economic Development Administration, are used to promote long-term economic development and assist in the construction of public works and development facilities needed to initiate and encourage the creation or retention of permanent jobs in the private sector in areas experiencing severe economic distress. Types of assistance. Project grants. Funding levels. The program’s funding has ranged from $140.8 million in fiscal year 1991 to $195.0 million in fiscal year 1995. Eligibility criteria. States, cities, counties, other political subdivisions, Indian tribes, the Federated States of Micronesia, the Republic of the Marshall Islands, commonwealths and territories of the U.S. flag, and private or public nonprofit organizations or associations representing a redevelopment area or a designated Economic Development Center are eligible to receive grants. Corporations and associations organized for profit are not eligible. Intended beneficiaries. Local economies, unemployed and underemployed persons, and/or members of low-income families benefit from the program. Examples of funded projects. These grants have supported infrastructure necessary for economic development (e.g., water/sewer facilities), the construction of incubator facilities, and port development and expansion. With respect to telecommunications, two rural community colleges in North Carolina received grant assistance to install two-way interactive telecommunications equipment that is used to provide training for underemployed and unemployed youths and adults. Economic Development Technical Assistance, administered by the Economic Development Administration, provides funding to promote economic development and alleviate underemployment and unemployment in distressed areas. The program provides funds to enlist the resources of designated university centers in promoting economic development, support demonstration projects, disseminate information and studies of economic development issues of national significance, and finance feasibility studies and other projects leading to local economic development. Types of assistance. Project grants. Funding levels. The program’s funding increased from $6.6 million in fiscal year 1991 to $10.9 million in fiscal year 1995. Eligibility criteria. Private or public nonprofit organizations, educational institutions, federally recognized Indian tribal governments, municipal, county or state governments, and U.S. territories or entities thereof. Intended beneficiaries. Projects are intended to assist in solving economic development problems, respond to economic development opportunities, and expand organizational capacity for economic development. Examples of funded projects. Management and technical assistance services to communities, counties, districts, nonprofit development groups; technology transfer assistance to firms; studies to determine the economic feasibility of various local development projects. An example of a recent telecommunications-related project involved providing grant assistance to rural communities in Colorado to improve the competitive stance of existing, emerging, and prospective businesses through Internet-based services. Planning Program for States and Urban Areas, administered by the Economic Development Administration, is designed to assist economically distressed states, substate planning regions, cities, and urban counties to undertake significant new economic development planning, policymaking, and implementation efforts. (Rural areas are included in this program). Types of assistance. Project grants. Funding levels. The program’s funding has remained fairly stable over the past 5 years, ranging from $4.7 million in fiscal year 1991 to $4.5 million in fiscal year 1995. Eligibility criteria. Eligible applicants include states, substate planning units, cities, urban counties within metropolitan statistical areas, and combinations of these entities. Intended beneficiaries. Residents of eligible areas. Examples of funded projects. The state of Alabama received a grant in 1994 that drew on computer technology to assist high school students in rural areas, as well as the unemployed and underemployed, in getting job training that would enhance their ability to obtain employment. The New River Valley Planning Development Council, in Radford, Virginia, received a grant in 1994 that uses telecommunications technology to link Southwest Virginia to areas that are more industrially developed. Advanced Technology Program, administered by the National Institute of Standards and Technology, is designed to promote “commercializing new scientific discoveries and technologies rapidly” and “refining manufacturing practices” through supporting high-risk civilian technologies that are in the nation’s economic interest. Types of assistance. Project grants (cooperative agreements). Funding levels. The program’s funding increased steadily between fiscal years 1991 and 1995, from $35.9 million to $341.0 million. Eligibility criteria. Recipients must be U.S. businesses or joint research and development ventures. Foreign-owned businesses are eligible, if they meet the requirements of the American Technology Preeminence Act of 1991 (P.L. 102-245, Feb. 2, 1992). Intended beneficiaries. U.S. businesses and U.S. joint research and development ventures. Foreign-owned businesses, if they meet the requirements of P.L. 102-245. Examples of funded projects. Printed wiring board manufacturing technology, flat panel display manufacturing, magnetoresistive random access memories, and ultra-high-density magnetic recording heads. The Department has two programs that can be used to support telecommunications projects. The Library Research and Demonstrations Program has as its objective the awarding of grants and contracts for research and/or demonstration projects in areas of specialized services intended to improve library and information science practices. Among other things, the program may fund the use of new technologies to enhance library services. Types of assistance. Project grants. Funding levels. Funds increased from $325,000 in fiscal year 1991 to $6.5 million in fiscal year 1995. Eligibility criteria. Institutions of higher learning or public or private agencies, institutions, or organizations are eligible. Intended beneficiaries. Institutions of higher learning or public or private agencies, institutions, or organizations are the beneficiaries. Examples of funded projects. Since fiscal year 1993, funds have been used to establish statewide multitype library networks. For example, in fiscal year 1993, Louisiana State University and Agricultural and Mechanical College was awarded a $2.5 million grant to expand its electronic library network to connect libraries around the state. Other grant recipients for the same purpose are the Colorado Department of Education’s State Library and Adult Education Office (fiscal year 1994, $2.5 million); State Library of Iowa (fiscal year 1995, $2.5 million); and West Virginia Library Commission, Department of Education and the Arts (fiscal year 1995, $2.5 million). Each project is making its databases available to all types of libraries throughout the state. In Iowa, the State University Extension Service is also participating in the project to coordinate information resources. The Eisenhower Professional Development Program is designed to give teachers, administrators, and other school personnel access to high-quality, sustained, and intensive professional development activities in the core academic subjects aligned to challenging state content and student performance standards. Types of assistance. Formula grants. Funding levels. $251.3 million in fiscal year 1995. Eligibility criteria. Funds are distributed to the states on a formula basis. Of the total state allocation, the SEA receives 84 percent and the state agency for higher education, 16 percent. The SEA distributes, by formula, at least 90 percent of the funds that it receives to LEAs within the state. The state agency for higher education distributes at least 95 percent of its allocation in the form of competitive subgrants to institutions of higher education and nonprofit organizations. Intended beneficiaries. Teachers, administrators, and other school personnel are direct beneficiaries, and as a result of these populations’ participating in professional development, students are indirect beneficiaries. Examples of funded projects. One project supported through this program is “Geometry Enhancement Models Institute: Meeting the Challenge of Mathematics Education,” funded through the University of Memphis, which is to be conducted during the summer of 1996. The Institute is planned for 20 middle school in-service teachers to acquaint participants with the van Hiele theory of geometry through interactive, hands-on participation drawing on a number of instructional methods. Department of Health and Human Services The Department has one program that can be used for telecommunications projects. Rural Health Services Outreach is intended to provide health services to rural populations that are not receiving them and to help rural communities and health care providers coordinate their services and enhance linkages, integration, and cooperation among rural providers of health services. Types of assistance. Project grants. Funding levels. Funds for telemedicine projects have increased from $220,000 in fiscal year 1991 to $1.7 million in fiscal year 1995. Eligibility criteria. Nonprofit public or private entities located in nonmetropolitan statistical areas or a rural area within a larger metropolitan statistical area may apply. Intended beneficiaries. Medically underserved populations in rural areas will receive expanded services. Examples of funded projects. The program funded eight new telemedicine projects in fiscal years 1994 and 1995. For example, the program provided assistance to Douglas County Hospital in Alexandria, Minnesota, to develop an advanced telemedicine network to serve eight rural communities in central Minnesota. The network’s goal is to reduce the isolation of rural health care providers and to enhance access to specialized medical services. For another project, the program provided a total of $306,000 to Big Bend Regional Medical Center of Alpine, Texas, over 3 years to use telemedicine to offer primary care and health education services to the underserved population of Presidio, Texas. A telecommunications system is being set up in the town to link it with Big Bend Medical Center in Alpine and the Texas Tech Health Sciences Center. Department of Housing and Urban Development The Department administers one program that can be used to support telecommunications projects. Community Development Block Grants/State’s Program has as its primary objective the development of viable communities by providing decent housing, and a suitable living environment and expanding economic opportunities, principally for persons of low and moderate income. Types of assistance. Formula grants. Funding levels. Total funding levels for the program were $1.0 billion in fiscal year 1992, $1.2 billion in fiscal year 1993, $1.3 billion in fiscal year 1994, and $1.3 billion in fiscal year 1995. Eligibility criteria. State governments receive funding according to a formula; funds are then provided through the state to eligible units of general local government. Eligible units of general local government are generally cities with populations of 50,000 or less that are not designated central cities of metropolitan statistical areas, and counties with populations of 200,000 or less. Forty-eight states and Puerto Rico participate in the state Community Development Block Grant program. Intended beneficiaries. Low- to moderate-income persons. Examples of funded projects. No telecommunications-related projects have as yet been completed by this program, according to program officials. One project—a telemedicine project linking 45 rural clinics to larger hospitals in Oklahoma—is being pursued at this time. We identified one program that can be used for telecommunications projects. Small Business Loans (7(a) Loans) are guaranteed loans to small businesses that are unable to obtain financing in the private credit marketplace but that can demonstrate the ability to repay the loans granted. This program can also provide guaranteed loan assistance to low-income business owners or businesses located in areas of high unemployment or to specific types of businesses, such as those owned by handicapped individuals. Types of assistance. Guaranteed/insured loans. Funding levels. In fiscal year 1992, loans totaling $6.0 billion were guaranteed. In fiscal year 1995, guaranteed loans totaled $8.3 billion. Eligibility criteria. Small businesses that are independently owned and operated and not dominant in their field are eligible; businesses must also meet specific criteria for size, depending on the industry. Intended beneficiaries. Small businesses, including those owned by low-income and handicapped individuals, or located in high unemployment areas benefit from the program. Examples of funded projects. With respect to telecommunications-related loans, the Small Business Administration has assisted small businesses that provide telecommunications-related services such as paging services and cellular telephone services. The Tennessee Valley Authority (TVA) has three programs to support telecommunications. The Economic Development Loan Fund was established to stimulate industrial development and leverage capital investment in TVA’s power service area. Specifically, the fund is used to promote economic expansion, encourage job creation, and foster the increased sale of electricity by TVA and its power distributors. Types of assistance. Direct loans. Funding levels. This revolving loan fund was initially funded in fiscal year 1995 with $20 million from power revenues. Eligibility criteria. Projects are sponsored by a local government, power distributor, or established economic development organization. Loans are made to TVA power customers, communities or nonprofit economic development corporations to support approved projects. Intended beneficiaries. The ultimate beneficiaries are the people of the Tennessee Valley region. Examples of funded projects. As of November 1995, this program had not funded any telecommunications projects. The Special Opportunity Counties Revolving Loan Fund is designed to stimulate economic development and private sector job growth in the most economically disadvantaged counties in the Tennessee Valley. Types of assistance. Direct loans. Funding levels. This revolving loan fund was funded with a $14 million allocation from TVA’s appropriations for fiscal years 1981 through 1987. Eligibility criteria. Per capita personal income and percent of persons below the poverty level were the two variables used to determine which of the 201 Tennessee Valley counties were eligible for the program. First, the 100 counties with the lowest per capita personal income were chosen. Then, the 50 counties with the highest percent of persons below the poverty level were considered to be eligible for the program. Intended beneficiaries. The ultimate beneficiaries are the people of the Tennessee Valley region. Examples of funded projects. One project is an interactive television network, a two-way interactive television network, in the Upper Cumberland area of Tennessee. The network provides full motion, multisite, multichannel simultaneous two-way interactive communication capabilities. The Technical Assistance Program invests in economic development to increase the production of goods and services and generate a higher standard of living for all citizens of the Tennessee Valley Region. Types of assistance. Advisory services, counseling, architectural and engineering studies, and the dissemination of economic information. Investments in the research, development, and implementation of a regional small business incubator network. Funding levels. Funding for this program includes salaries and expenses. Fiscal year 1991 funding was $21.2 million. Funding dropped to $18 million in fiscal year 1994, but rose to $22.5 million in fiscal year 1995. Eligibility criteria. Within the Tennessee Valley, officers and agencies of state, county, and municipal governments; quasi-public agencies; and private organizations, individuals, and business firms and associations may seek technical advice and assistance in community resource development. Intended beneficiaries. The ultimate beneficiaries are the people of the Tennessee Valley region. Examples of funded projects. TVA’s technical services include architectural/engineering, economic research and forecasting, information services support, environmental coordination, and project management. Detailed Description of Five Telecommunications Projects in Rural Areas We visited five telecommunications projects—two economic development projects, one distance learning project, and one medical link project. These projects are funded in part with federal moneys. In addition, we visited a borrower of the Rural Utilities Service’s Telephone Bank Loan program. The results of those visits are summarized below. The Paducah Information Age Park The Paducah Information Age Park, located in Paducah, Kentucky, includes 650 acres, with 360 acres planned for development. The park is designed for companies that heavily utilize telecommunications and telecommunications-related research and development. Typically, such companies move volumes of information: data processing companies, reservation businesses, credit card companies, payroll centers, and catalog companies. The park provides a fiber optic system that supports high-quality video conferencing, Lan-to-Lan internetworking, and multimedia communications. The park also includes an on-site digital switching center, which provides a network-based Automatic Call Distributor and Integrated Services Digital Network as well as other state-of-the-art capabilities. The mission of the park is to create economic growth for the region. The Chief Executive Officer and Chairman of the Greater Paducah Economic Development Council (GPEDC) said that, by the early 1980s, the Paducah area’s economy had stagnated. Community leaders recognized that new development opportunities were needed. Toward this end, they created GPEDC in 1989. GPEDC first became interested in the feasibility of an information age park in Paducah after an official attended a telecommunications conference in 1989 that was sponsored by a carrier. In 1990, GPEDC formally requested the carrier to identify and quantify the potential economic benefits of “developing an information age park for use as a resource in recruiting information-intensive, high-technology industries.” In March 1991, the carrier contracted for a study to help determine whether information age business parks might be economically feasible in nonmetropolitan areas such as Paducah, Kentucky. The contractor subsequently determined that Paducah/McCracken County would be a suitable location for such a park. The park officially opened in May 1994. According to GPEDC officials, it will be 12 to 15 years before it is fully developed. The contractor determined that the park could have an economic impact on the area of $100 million to $300 million, an estimate based on adding between 2,500 to 7,500 jobs in two information age parks and the multiplier effects of that employment. As of November 1995, four sites were sold, options to buy were held on three more, and one 12,000- to 15,000-square-foot speculative building is planned. GPEDC officials said that local government entities set aside jurisdictional questions to commit themselves to the park’s ability to provide high-quality services at the lowest possible cost. The city of Paducah has annexed the park because the city can most economically extend public services like water, sewer, and police and fire protection. Officials of McCracken County, in which the project is located, agreed to forgo the tax revenues from the park itself, confident that countywide growth will more than compensate for any short-term revenue losses. Paducah community leaders see the park’s creation as validating their commitment to the “partnering” of various private, public, local and state organizations. The Chief Executive Officer and Chairman of GPEDC is not aware of any case in which an organization that was asked to be a partner in the project declined to participate. According to GPEDC officials, the park has benefits beyond new jobs for the region. Residents have a positive attitude about the economic potential of the community, and new ways of approaching economic development are being considered, such as development involving advanced telecommunications technologies. GPEDC officials said that the total cost of the project is just over $21 million. According to GPEDC officials, a carrier invested $6 million in the project, including building a central office in the park. Additionally, TVA provided over $1.8 million in financial and technical assistance towards the development of the park. GPEDC officials said the Commonwealth of Kentucky created a $6.2 million package of combined grants/loans for infrastructure, the conversion of a wetlands area into a lake, and the partial construction of the Resource Center. Public and private local investments total almost $6.7 million and GPEDC officials said the council itself provided $300,000. The Mayfield Rural Telecommunications Resource Center The Purchase Area Development District (PADD), an economic development district serving eight western Kentucky counties, created the Rural Telecommunications Resource Center to serve both public agencies and businesses in its service area in an effort to promote economic development using advanced telecommunications. The resource center is located in Mayfield, Kentucky, in Graves County, and has two conference rooms, encompassing 4,000 square feet of the 15,000-square-foot PADD office complex. The resource center, which officially began operations in October 1995 has advanced teleconferencing capability, including equipment to make live interactive presentations. Additionally, the resource center has a satellite downlink and a graphical information system, a data tool for analyzing and displaying geographically related information. PADD officials said that the resource center has access to other Kentucky networks and that, ultimately, the center will have direct Internet access. PADD officials expect several benefits, including (1) increased training opportunities for employees of area businesses because of reduced travel costs and time, (2) improved communications between plant managers and their company headquarters and reduced travel costs for these executives, (3) improved business access to customers and suppliers, and (4) improved communication with state regulators and other officials in Frankfort, Kentucky. PADD officials believe that these benefits will enable businesses in their area to become more productive and therefore more competitive in the global economy. Furthermore, PADD officials expect the resource center to be a demonstration project that spawns additional interest in the economic development potential of telecommunications in the PADD area. PADD officials became interested in telecommunications as a tool for business and economic development in 1989. In October 1990, the Development District held the region’s first seminar on the telecommunications technology available for all types and sizes of businesses. Over the years, PADD has worked with groups such as South Central Bell, the West Kentucky Private Industry Council, and the University of Louisville Telecommunications Research Center to assist area businesses and industries to become better informed about the changing trends in communications and information technology. In 1994, PADD asked over 450 regional businesses and industries about their need for advanced telecommunications capability. To obtain funding for the resource center, PADD officials contacted the Economic Development Administration (EDA) in January 1992. PADD officials said that in February 1992, their agent, the Jackson Purchase Local Officials Organization, in partnership with Murray State, applied for an EDA public works grant. According to PADD officials, that application requested funding for the Rural Telecommunications Resource Center, as well as for linkages between each county and a districtwide economic and information database that PADD maintains. The total cost of the project was estimated at $572,679, with EDA providing a grant of $343,362, Murray State providing “in-kind” equipment valued at $168,907, and the Jackson Purchase Local Officials Organization providing $60,000. However, PADD officials said that EDA turned down the request in the spring of 1992 because it was not the type of project EDA normally funded. According to an EDA representative in Washington, D.C., as well as EDA’s Kentucky state representative, when the application was submitted, EDA generally was unfamiliar with the economic development potential of telecommunications projects. Traditionally, projects funded under the public works program have been for infrastructure items such as water or sewer systems for industrial parks. PADD officials said that EDA subsequently reconsidered the application, and following the visit of an EDA representative from Washington, D.C., in March 1993, PADD officials reworked and resubmitted the application. It was approved in September 1994. The approved project totaled $658,158. EDA supplied a grant of $451,236, Murray State provided $191,922 in “in-kind” equipment, and the Jackson Purchase Local Officials Organization contributed $15,000 in cash. Also, district officials said that they received a $25,000 technical assistance grant from EDA in September 1994 to help fund a full-time PADD position to assist in facilities operation. RODEONET, which began operations in 1992, is a mental health telemedicine project using advanced telecommunications technologies, such as two-way video teleconferencing, to provide selected mental health services and professional development opportunities to consumers and mental health professionals in 13 rural counties in eastern Oregon, an area of about 45,000 square miles. In 1995, the service was expanded to include one site in southern Oregon and three sites on the northwest Oregon coast. RODEONET’s services include consultation/evaluation, preadmission and predischarge interviews, medication management, and staff training and demonstrations. The Eastern Oregon Human Services Consortium, a consortium of community mental health programs, operates RODEONET, using the telecommunications facilities of Oregon’s educational network (ED-NET). The size of the eastern Oregon service area, the location of the state’s two public psychiatric hospitals, and Oregon’s laws regarding hearings and admissions to state mental health facilities make a project such as RODEONET a practical way of providing some mental health services to residents and training for mental health professionals in Eastern Oregon. The precommitment service, for example, operates in the following manner. If a mental health professional believes that a patient is a danger to himself or others, the mental health professional can have the patient transported to a mental health hospital and held. Oregon has two public psychiatric hospitals—one in northeast Oregon and one in western Oregon. For many rural communities in the extreme eastern and southern parts of Oregon, this often means a trip of hundreds of miles. During periods of inclement weather, the trip can be dangerous. Furthermore, consortium officials said that Oregon law requires that the patient be given a precommitment hearing within 72 hours or released, and the hearing must be presided over by a judge in the county in which the patient lives. If the patient is committed, a total of three long, costly, and frequently hazardous trips to court and to a psychiatric hospital will be made within a few days. When appropriate, two of the three trips can be avoided if video teleconferencing is used in lieu of face-to-face meetings. Recognizing the potential for reducing training and travel costs and the scarcity of mental health services in many rural communities, the consortium began planning a telemedicine project. In May 1991, it applied for funding from the Department of Health and Human Service’s Office of Rural Health Policy and was subsequently awarded a 3-year Rural Health Outreach demonstration grant. From October 1991 to September 1994, the grant provided over $800,000 of the project’s estimated $1.3 million cost for that 3-year period. RODEONET has been self sustaining since September 1994, and users are now required to pay their own satellite and access charges. RODEONET member institutions or agencies are now charged $145 per hour for video teleconferencing, with another $20 per hour for each additional site. All of the officials with whom we spoke, including officials from the Office of Rural Health Policy, consider the project a success and believe that there is increased potential for using advanced telecommunications to provide mental health services. RODEONET officials told us that a major factor contributing to the success of the project was that the 13 eastern Oregon counties that are partners in RODEONET had a long history of collaboration on providing mental health services in their nearly 45,000-square-mile service area. Officials stressed that without this long history of collaboration, successful completion of the project would not have been possible. The Spokane, Washington, STEP/Star Network The Satellite Telecommunications Educational Programming/Pacific Star Schools Partnership (STEP/StarNetwork) is a satellite-based K-12 distance learning network. Educational Service District (ESD) 101, a state-chartered regional agency located in Spokane, Washington, operates the STEP/Star Network. STEP/Star Network offerings include full-credit traditional courses in subjects such as foreign languages, mathematics, science, and vocational education. The network also offers innovative courses such as Young Astronauts, a course for fourth to sixth graders using space themes to teach math and science. The courses ESD 101 broadcasts over the STEP/Star Network include those developed by or for the district as well as those developed by other distance education providers. Through the STEP/Star Network, ESD 101 also offers a variety of other services for educators, school administrators, parents, and community leaders, including in-service workshops for college credit, teleconferencing, and parenting classes. ESD 101’s programming serves 31,500 students and 43,000 teachers located in 31 states and six time zones. Nearly 90 percent of the participating schools are in rural areas, and the average Star school is about 80 miles from the nearest university or college. The network’s principal customers are the remote or rural school districts in Alaska, Hawaii, Idaho, Montana, Oregon, and Washington State, and the Colorado and the Central Indiana educational service districts. The network is now expanding into the Pacific territories. The programming is broadcast live from ESD 101’s television studios via satellite uplink. Student and teacher interaction is achieved through a combination of two-way audio, one-way video, and two-way data transmission. Where possible, students’ papers and tests are submitted to instructors electronically. According to district officials, some instructors are developing tests that their students will be able to take on-line. Participating school districts pay an annual membership fee of $2,950 for basic services for a single site. Each additional site is $150. The membership fee includes the startup equipment needed to interface with the network (e.g., satellite dishes, computers, modems, and scanners). Some courses require the students to use computers. The participating school district is responsible for providing this equipment. The equipment ESD 101 provides for interface with the STEP/StarNetwork remains the property of ESD 101 and is retrieved from a district that discontinues its participation. Participating school districts are charged varying fees for the K-12 courses they use. For example, Elementary Spanish for grades 1 and 2 costs a flat $500 per site, but Advanced Placement English costs $490 for a maximum of seven students, with each additional student costing $175. ESD 101 officials said that the original STEP distance education network, which began operating in the district’s service area in 1986, was started because some farsighted school and community officials saw a need to provide educational offerings that the district’s schools would be unable to provide otherwise. They also said that the formation of the first Star program in the five original northwestern states was greatly assisted by the fact that these states had a long history of collaboration and partnerships on regional projects, and that partnership and collaboration has been key to the STEP/Star Network’s subsequent expansion. Since 1990, ESD 101, on behalf of its STEP/Star partners, has been awarded three successive 2-year Star Schools grants totaling $21.3 million from the Department of Education. These grants have enabled ESD 101 to (1) expand course offerings beyond those initially offered in STEP/Star and (2) expand the area it serves. The first grant totaled about $9.9 million for September 1990 to September 1992. The second grant totaled about $5.2 million for October 1992 to September 1994. The third grant totaled about $6.2 million for October 1994 through September 1996. As significant as ESD 101’s funding from the Star Schools Program has been, it does not represent all of the District’s funding. According to the District’s superintendent and the District’s annual financial report for the fiscal year ending August 1994, the agency’s total annual operating budget is about $40 million, with about $13.1 million in revenues coming from all sources. Of that amount, only about $3.6 million was from federal sources, and the balance was from local, state, and cooperative programs; payments for other programs; and investment earnings. Amounts from local sources included $1.7 million in tuition and fees and about $331,000 from sales of goods, supplies, and other services. Funds received from the state included an ESD allotment of about $685,000 and $100,700 for traffic safety education. Amounts from federal sources other than STEP/Star Schools included $420,400 for the Job Training Partnership’s payments for a program it operates for the city of Spokane. The Ringgold, Georgia, Telephone Company The Ringgold Telephone Company began operations in 1912 in Ringgold, Georgia, to serve the citizens of Catoosa County, located in extreme north Georgia. In 1958, Ringgold applied for and received a loan from the Rural Electrification Administration (subsequently organized as a part of RUS). The loan was needed for capital improvements and expansion to keep up with the growth in demand. Today, Ringgold services 11,000 lines, and its equipment includes digital switching gear and 100 miles of fiber-optic lines. According to the company’s executive vice president, if telecommunications is inadequate in any rural area, development of that area will suffer. He said that businesses usually ask about the transmission speed and band width capabilities of the phone system before deciding to locate in the area. He also said that his company works closely with its customers, the Catoosa County Chamber of Commerce, and the Economic Development Commission, which assists rural areas in north Georgia with development planning. He said that forming such partnerships and establishing such plans is an integral part of achieving projects’ success. The executive vice president told us that although he works actively on long-term county planning, he is aware of only two federal programs for telecommunications. He said that the RUS loans have made it possible for the company to provide its customers with advanced technologies. He considers RUS’ requirement that its borrowers maintain a 5-year telecommunications plan a very positive factor. Organizations Representing Rural Areas National Rural Development Partnership The National Rural Development Partnership, created in 1991, has as its objective the promotion of (1) innovative and strategic approaches to rural development and (2) collaboration among federal and state agencies involved in rural development. It also helps identify and resolve intergovernmental and interagency impediments. The partnership’s members are drawn from federal agencies involved in rural development, the 39 State Rural Development Councils, and national rural organizations. National Association of Development Organizations The goals of the National Association of Development Organizations are to (1) promote economic development, focusing primarily on rural areas and small towns; (2) serve as a forum for communication and education; and (3) provide technical assistance to its members. Founded in 1967, the organization has more than 300 members drawn primarily from multicounty planning and development agencies. Organization for the Protection and Advancement of Small Telephone Companies The Organization for the Protection and Advancement of Small Telephone Companies is a national trade association of nearly 450 small independently owned and operated local exchange carriers serving more than 2 million subscribers in the rural United States. Founded in 1963, the organization represents small independent telephone companies before the Congress and provides a forum for the exchange of ideas and a discussion of mutual problems. National Association of Regional Councils The National Association of Regional Councils has as its members regional planning agencies, councils of government, and development districts. The association was founded in 1967 and has about 230 members. It provides legislative representation in Washington, D.C., and technical assistance to its members through workshops and training programs. National Governors Association The National Governors Association represents governors at the national level to inform the federal government of the needs and views of the states. The association also provides technical assistance to the governors and serves as a vehicle for sharing information. Founded in 1908, the association has 55 members, including the governors of the 50 states and representatives from Guam, American Samoa, the U.S. Virgin Islands, the Northern Mariana Islands, and the Commonwealth of Puerto Rico. Major Contributors to This Report Robert C. Summers, Assistant Director John K. Boyle, Project Leader Sara Bingham Clifford J. Diehl Natalie H. Herzog Carol Herrnstadt Shulman Frank C. Smith The first copy of each GAO report and testimony is free. Additional copies are $2 each. 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Pursuant to a congressional request, GAO reviewed rural communities' efforts to develop advanced telecommunications technologies, focusing on: (1) federal programs that fund rural telecommunications projects; (2) lessons learned for developing such projects; and (3) whether changes to these programs are needed. GAO found that: (1) as of December 1995, there were at least 28 programs that provided discretionary development funds for rural telecommunications projects; (2) 13 designated programs provided about $715.8 million for 540 telecommunications projects; (3) program users and rural development experts believe that rural communities need a basic understanding of telecommunications technologies and their potential benefits, strategic plans to determine the technical and financial feasibility of telecommunications development, and partnerships among key players involved in constructing, financing, and using telecommunications networks; (4) rural development experts and public officials believe that telecommunications programs could be improved by educating rural communities on the potential benefits of telecommunications technologies, building in requirements for considering telecommunications technologies in long-range planning, and making multiple federal programs easier to use; (5) most federal agencies lack the resources required for educational outreach programs; and (6) 1996 legislation emphasizes the need for rural communities to include telecommunications projects in their long-term planning and coordination of multiple federal programs.

Background RWTMA reauthorized CARE Act programs for fiscal years 2007 through 2009. Part D grants—one of the types of grants under the act—are for entities that provide HIV/AIDS services to women, infants, children, and youth. In fiscal year 2007, HRSA provided $68,500,000 in Part D grants to 90 grantees, ranging from about $230,000 to over $2 million per grant. This represented about 3 percent of all CARE Act funding. CARE Act Part D Grantees Part D grantees compete for grant funding to provide a range of services— both medical and support—to women, infants, children, and youth in a variety of settings. Medical services are those outpatient and ambulatory care services that are part of essential medical care. They can include, for example, primary medical care and HIV/AIDS drug assistance. Support services are nonmedical services necessary to use the medical services. They can include, for example, client transportation to medical appointments, child care, or food assistance services. Applicants generally submit applications to HRSA for 5-year project periods. Grantees receive funding for the first year and then submit annual noncompeting applications to HRSA to receive the remaining funding and to update HRSA on their projects’ spending and services. Although the grant applications and federal funds are released by fiscal year, HRSA refers to grantee spending in each of the 5 years constituting a project period as budget years. Within Part D, there are two types of grants, each of which has a slightly different budget year. For example, in 2007, one Part D budget year ran from August 1, 2007, until July 31, 2008, and another budget year ran from September 1, 2007, until August 31, 2008. Because the Part D grants discussed in this report are from fiscal year 2007 funds and the grant applications and accompanying guidances use the term fiscal year, we use the term throughout this report. Part D grantees include state and local government entities, CBOs—which may or may not be specifically focused on HIV/AIDS—hospitals and medical centers, university/college hospitals and medical centers, and universities/colleges. (See app. I for additional information.) Part D grantees can (1) operate a network of Part D subgrantees that provide services, (2) directly provide the services, or, as most do, (3) both operate a network of subgrantee service providers as well as directly provide services. Administrative Expenses and Indirect Costs In addition to spending Part D funds on medical and support services for clients, Part D grantees may also use their Part D grant funds to pay for certain administrative expenses and indirect costs. Indirect costs differ from administrative expenses in that indirect cost rates for specific activities are typically negotiated with the federal agency from which the grantee receives the greatest amount of federal awards and that rate then applies to all relevant federal award programs that permit indirect costs, unless it conflicts with a legislative indirect cost cap. The Office of Management and Budget (OMB) cost principles provide guidance as to the expenses that can be included in indirect costs to the cognizant agencies and grantees according to entity type. Within HHS, the Division of Cost Allocation performs this role. HRSA, following OMB cost principles, defines indirect costs as costs “incurred for common or joint objectives, which cannot be readily identified but are necessary to the operations of the organization.” HRSA defines administrative expenses as “funds that are to be used by grantees for grant management and monitoring activities, including costs related to any staff or activity unrelated to services or indirect costs.” Some expenses can be considered to be either administrative or indirect. For example, rent and utilities could be considered either administrative expenses or indirect costs. However, for a grantee to claim any expenses as indirect costs, it must have an approved indirect cost rate. Smaller organizations or ones that receive only one federal grant may not have approved indirect cost rates, but organizations that receive multiple federal grants would need to have approved rates. For example, a university that receives multiple federal grants would have an indirect cost rate to cover different grants’ shares of costs such as rent, utilities, as well as library expenses. However, a small organization that receives only one federal grant might not have an indirect cost rate since it may be able to account for all of those expenses for the single federal grant it receives. If a grantee does not have an approved indirect cost rate agreement, the grantee must charge (account for) expenses such as rent and utilities as administrative expenses in order to pay for those expenses with grant funds. This means that grantees with approved indirect cost rates have greater latitude than those without such rates to pay for expenses that might otherwise be considered administrative expenses as they can spend more than 10 percent of their Part D grant on expenses such as rent and utilities. The CARE Act now caps at 10 percent the amount of the Part D grant awards that grantees can spend on administrative expenses. HRSA reports that the purpose of this cap is to maximize the amount of federal funds spent on services for Part D clients. HRSA reports that the cap only applies to grantees’ administrative expenses; there is no cap on indirect costs. Prior to RWTMA, there was no cap on administrative expenses for Part D grantees. Oversight of CARE Act Part D Grantees HRSA project officers are responsible for overseeing the Part D program by reviewing grant applications; writing and revising grant application guidance; responding to grantees’ questions; providing technical assistance and training to grantees; monitoring grantees’ performance and compliance with grant guidance, program expectations, and legislative requirements; and recommending approval on program budget submissions. Project officers are Part D grantees’ primary contact with HRSA, and they are expected to contact their assigned grantees at least once every 3 months. Required audits assist HRSA in providing financial oversight of some Part D grantees’ spending. Organizations that receive Part D grants are generally subject to the requirements of the Single Audit Act, as amended, and the implementing OMB guidance. These provisions require grantees that expend $500,000 or more in federal awards in a year to have either single or program-specific audits for that year conducted by an independent auditor. Single audits are organizationwide audits, not intended to focus specifically on an individual grant awarded by a particular agency. They include a review of the grantee’s financial statements, schedule of federal expenditures, internal controls, and compliance with laws and regulations pertaining to major programs that affect all federal funding, including grants—defined with reference to dollar thresholds—for which the grantee expends federal funds. Generally, grantees that expend federal funds under only one federal program may choose to have a program-specific audit. Among other things, such an audit includes a review of compliance with laws and regulations that affect that program. Part D Grantees Reported Providing a Range of Services, and Most Reported That the Administrative Expense Cap Did Not Change These but Had a Negative Effect on Programs Grantees reported providing a range of medical and support services to women, infants, children, and youth infected with HIV/AIDS, as well as support services for affected family members. The majority of survey respondents reported that they have not made any changes to the services they provide to their clients in response to the cap, which, according to HRSA, was meant to maximize the amount of federal funds spent on services for Part D clients. However, four grantees reported increasing services and three grantees reported reducing client services. While most grantees reported not making changes to client services, the majority reported that the administrative expense cap, by reducing administrative services, has had a negative effect on their programs. Some grantees, however, reported experiencing positive effects on their programs as a result of the cap. Part D Grantees Reported Providing Both Support and Medical Services to Women, Infants, Children, and Youth with HIV/AIDS and Their Families Grantees reported providing a range of medical and support services to women, infants, children, and youth infected with HIV/AIDS, as well as their families (see table 1). Survey respondents reported providing medical services such as outpatient and ambulatory health services, medical case management—including treatment adherence services—mental health services, and HIV counseling and testing. They also reported providing support services such as referrals to health care and supportive services, outreach services, transportation, family advocacy, case management services, and child care. Grantees reported in our survey that they spent an average of 53 percent of their fiscal year 2007 Part D grants on medical services for clients, ranging from 0 percent to 95 percent. They also reported spending an average of about 33 percent of their fiscal year 2007 Part D grants on support services for their clients, ranging from 1 percent to 90 percent. Grant money not spent on medical and support services was used to pay for administrative expenses, indirect costs, and other services not directly related to clients. Grantees reported serving a range of clients with their Part D funds, including affected family members of HIV-infected individuals. Grantees reported serving varying numbers of clients ranging from 75 to over 10,000 clients. Of those clients, grantees reported serving an average of 37 infants less than 24 months of age; an average of 59 children from 2 to 12 years old; an average of 194 youths from 13 to 24 years old; and an average of 443 adults over 25 years of age. The number of clients served varied by type of grantee, with CBOs and universities/colleges serving fewer clients on average (667 and 554, respectively) and government entities, hospital/medical centers, and university/college hospital/medical centers serving more clients on average (1,047, 1,471, and 1,125, respectively). In addition, grantees varied in the types of clients they served. For example, several grantees had no infant or child clients, while one grantee served over 300 infants and another served over 1,100 children. Representatives of Part D grantees, including the AIDS Alliance for Children, Youth & Families, stated that providing both HIV-infected individuals and their uninfected family members with medical and support services makes grantees of the Part D program unique compared to other CARE Act programs. Some grantees stated that this family-centered care can include educating the family members of HIV-infected individuals and providing prevention information, medical care, and HIV counseling and testing to family members. These grantees told us that by providing medical and support services to uninfected family members, Part D programs help to keep the infected family member’s support system intact and help to eliminate barriers to the infected family member receiving care. Grantees Generally Reported That the Administrative Expense Cap Has Not Changed the Services They Provide but Has Created a Negative Effect on Their Programs The majority of survey respondents (63 of the 83) reported that they have not altered the amount or type of services that they provide to their clients in response to the administrative expense cap. In addition, all eight of the HRSA project officers we interviewed reported that they were aware of only minor or no changes to the services that their Part D grantees provided in response to the administrative expense cap. Of the 19 grantees that said they made changes to their services in response to the cap (1 grantee did not respond to this question), 4 described spending more on client services, such as oral health care. However, 3 described reducing client services. For example, 1 grantee reported that, because of the cap, the grantee has been unable to upgrade older computers, causing delays in services, and reducing staff time spent on client services. Grantees also reported effects that the administrative expense cap had on their programs other than changes to services. In our survey, 57 of the 83 respondents reported that the administrative expense cap has had a negative effect on their programs that did not involve reducing client services. Fifty-two of the 57 provided specific examples of how the cap has had a negative effect at a time when some commented they are seeing more clients. For example, one grantee commented that the cap has reduced its ability to fund necessary administrative services, such as data tracking and program management, and another commented that clinical staff must now perform administrative duties. However, 19 grantees reported that the administrative expense cap has had positive effects on their programs, while not necessarily changing their services. These survey respondents reported that the administrative expense cap has led them to review how they spend their Part D funds or take steps to save money or change staff roles. Some grantees reported that they were unable to pay for all of their Part D programs’ administrative expenses with their Part D grants because of the administrative expense cap. Almost all grantees charged administrative expenses to their Part D grants (82 of the 83 survey respondents). However, about half (41 of the 83) of the grantees that responded to the survey reported that not all of their administrative expenses for the Part D program were covered by the 10 percent allowance. Grantees that needed additional funding to cover their Part D administrative expenses reported using money from their organizations’ general operating budgets (26 of the 41 grantees), funds from other government grants (17 of the 41), and in- kind donations (14 of the 41). HRSA officials told us that Part D funding is not intended to cover all of a program’s expenses and that the agency encourages Part D grantees to seek other sources of funding to pay for any administrative expenses that are not covered by the 10 percent allowance. Part D Grantees Report Planned Administrative Expenses and Indirect Costs Part D grantees report their planned administrative expenses and indirect costs in their grant applications, budget revisions, and other documents they submit to HRSA. HRSA officials review that information to ensure that grantees adhere to their spending plans. Starting in fiscal year 2009, Part D grantees will complete standardized budget forms that will provide information to HRSA on the grantees’ final spending on administrative expenses and indirect costs. Documents submitted to HRSA by grantees indicated that grantees complied with the administrative expense cap. However, responses to our survey indicate that the amount grantees spent on the types of items that would generally be covered by the administrative expense cap if a grantee did not have an approved indirect cost rate was up to 36 percent of their grants in fiscal year 2007, with grantees with approved indirect cost rates spending more on those expenses. Part D Grantees Report Planned Administrative Expenses and Indirect Costs to HRSA but Will Provide Additional Information in Fiscal Year 2009 Part D grantees report planned administrative expenses and indirect costs to HRSA in their grant applications, which the agency uses to oversee grantees’ compliance with the Part D program. Part D grantees submit grant applications to HRSA that include planned expenses in line-item budgets and budget justifications. Grantees are required to include in the grant applications explanations of how they plan to spend their Part D grant funds. They do this using line-item budgets, in which each expense is shown on one line. They also provide budget justifications, which are narratives of how the grantee plans to spend its grant money. These budgets and justifications show a range of expenses, such as the grantee’s estimated expenses for medical services and support services, as well as the grantee’s estimated indirect costs and—starting in fiscal year 2007, the first year of the administrative expense cap—administrative expenses for the year. HRSA uses the budget information grantees submit to oversee their spending. Grantees must report to HRSA any changes to the budgets they submitted in their grant applications and HRSA must review and approve those changes before a grantee can change how it spends its Part D grant funds. HRSA also receives the annual audits of Part D grantees conducted under the Single Audit Act. Among other things, these audits examine grantees’ Part D spending, which may include whether the grantees comply with the administrative expense cap. HRSA officials reported that the project officers and other HRSA staff review all of the grantees’ budget information to ensure that the grantees are meeting the obligations of the Part D program. Starting in fiscal year 2009, HRSA will require Part D grantees to report more detailed information, including administrative expenses, at the beginning and end of each fiscal year. HRSA officials stated that, starting in fiscal year 2009, Part D grantees will be required to complete forms at both the beginning (planned allocation report) and end (final expenditure report) of the fiscal year. In the planned allocation reports, grantees will be required to report their expected administrative expenses and indirect costs at the beginning of the fiscal year. In the final expenditure reports, grantees will be required to report the actual administrative expenses and indirect costs they incurred by the end of the fiscal year. Both reports note that administrative expenses cannot exceed 10 percent of the Part D grant award. The reports will also require grantees to provide detailed information about the services they provide with their Part D funding. The reports include a list of possible Part D medical and support services— such as outpatient services, mental health services, case management, and child care—and the grantees will be required to note what amount, if any, they spent on each of those. The reports also state that HRSA will use the information from the allocation and expenditure reports to prepare an annual report to Congress on the use of Part D funds. Grantees Reported Complying with the Administrative Expense Cap Grantees reported to HRSA that they spent 10 percent or less of their Part D grants on administrative expenses, but those with approved indirect cost rates were able to spend more on the types of expenses that could otherwise be considered administrative expenses. In the fiscal year 2007 grant applications, grantees reported administrative expense estimates that ranged from 0 to the maximum allowed 10 percent. However, 60 of the 83 grantees reported in our survey that they had federally approved indirect cost rates and that, with these rates, they charged to their Part D grants an average of 10 percent for indirect costs in addition to the 10 percent allowed for administrative expenses. In our survey, the highest rate grantees reported charging to the Part D grant was 26 percent, although the maximum approved indirect cost rate was 66 percent. Taking into account the maximum approved indirect cost rate in our survey, as well as the 10 percent that all grantees are allowed for administrative expenses, some grantees could use as much as 76 percent of their Part D grants to pay for items that could qualify as indirect costs or administrative expenses, such as rent, utilities, and photocopying. In our survey, while most of the grantees reported using their full rate for the Part D program (46 of the 60), the highest reported combined percentage of a Part D grant spent on administrative expenses and indirect costs was 36 percent. The primary reason grantees reported for not charging their full indirect cost rate was because they chose to use a greater portion of their grant award to pay for medical and support services for clients, rather than for indirect costs. HRSA Took Multiple Steps to Implement the Administrative Expense Cap, but Grantees’ Experiences Implementing the Cap Varied To implement the fiscal year 2007 administrative expense cap, HRSA reported revising its grant application guidance, approving grants with the condition that the grantee comply with the cap, and developing training for both its staff and grantees to implement the administrative expense cap. While 33 of the 83 grantees reported that the new guidance was helpful, others suggested that their project officers could have been more helpful in assisting them to meet the new administrative expense cap and some grantees expressed interest in receiving additional guidance. HRSA Took Multiple Steps to Implement the Administrative Expense Cap To implement the administrative expense cap, HRSA revised and issued new written grant application guidance, approved grants with the condition that the grantee comply with the cap, and developed training for both its staff and grantees. HRSA Revised the Part D Grant Guidance to Reflect the Administrative Expense Cap To implement the administrative expense cap, HRSA revised its Part D grant application guidance. In 2007, the first year of the administrative expense cap, HRSA issued grant guidance for Part D grantees that included guidance on how to define and calculate administrative expenses. Prior to RWTMA, there was no cap on Part D grantees’ administrative expenses so there was no guidance on administrative expenses specific to Part D grantees. The fiscal year 2007 grant application guidance stated that “a grantee may not use more than 10 percent of amounts received under a grant award under Part D for administrative expenses.” That guidance also defined administrative expenses as the CARE Act does as “funds that are to be used by grantees for grant management and monitoring activities, including costs related to any staff or activity unrelated to services and indirect costs.” HRSA included additional revisions related to the administrative expense cap in the fiscal year 2008 grant application guidance and plans to provide grantees with further guidance in the fiscal year 2009 application. In fiscal year 2008, HRSA added the following sentences to its definition of administrative expenses in its Part D grant application guidance: “Administrative costs also include rent, utilities and telephone services, as well as other costs not directly related to patient care. Administrative expenses are separate from those of indirect costs.” HRSA officials reported that the fiscal year 2009 grant guidance will be further revised to include more detail about how grantees should categorize their expenses, including administrative expenses. HRSA officials stated that the fiscal year 2009 grant guidance will be available to grantees in January 2009. In addition to the revised grant application guidance, HRSA issued a letter to all Part D grantees in May 2008 clarifying the definition of administrative expenses that appeared in the fiscal year 2008 guidance. The letter stated that the following are administrative expenses that are subject to the administrative expense cap: routine grant administration and monitoring activities, contracts for services awarded as part of the grant, and “costs which could qualify as either indirect or direct costs but are charged as direct costs,” such as rent, utilities, and telecommunications. The letter also described activities that are not subject to the administrative expense cap, such as indirect costs. HRSA Conditionally Approved Fiscal Year 2007 Part D Grants to Ensure Compliance with the Administrative Expense Cap HRSA officials reported that they placed conditions on all fiscal year 2007 Part D grant awards to ensure that all grantees met certain new requirements mandated in RWTMA, including the administrative expense cap, in order to avoid having their grant funds restricted. Some grantees reported that HRSA’s conditions required them to revise multiple documents, such as their budgets and work plans, in order to comply with the Part D program requirements. HRSA officials reported that, before they awarded the fiscal year 2008 grants, they had removed the conditions on all fiscal year 2007 Part D grant awards because the grantees had met all of the necessary requirements for the Part D grant awards, including the administrative expense cap. The amount of time grantees reported having conditions on their awards varied. In their survey responses, grantees reported that it took from over 2 weeks to almost 11 months to have the conditions removed. HRSA Trained Project Officers and Grantees about the Administrative Expense Cap Following the enactment of RWTMA, HRSA provided its project officers and grantees with training on the changes resulting from the law. The training for project officers included briefing slides, a handout highlighting changes due to RWTMA, the creation of a model budget form, and additional guidance for responding to grantee questions about the administrative expense cap. The eight project officers we interviewed reported receiving the training, consistently defining administrative expenses as they are defined by HRSA, and rarely requiring their supervisors to provide additional guidance to their grantees on administrative expenses. In addition to training the project officers, HRSA provided training for grantees. HRSA officials reported conducting multiple telephone and Internet technical assistance training sessions with grantees. Grantees’ Experiences with the HRSA Guidance Implementing the Administrative Expense Cap Varied In our survey, grantees reported both positive and negative reviews of the guidance HRSA provided related to the administrative expense cap. In addition, some grantees indicated the need for additional guidance from HRSA on the administrative expense cap. Grantees Reported Both Positive and Negative Reactions to HRSA’s Grant Guidance Grantees reported receiving various types of guidance from HRSA on the administrative expense cap. In addition to the grant application guidance that is included in the grant application that all grantees must complete, grantees that responded to our survey reported receiving verbal (63 of 83) and written (43 of 83) guidance from their project officers on the administrative expense cap. Fewer reported receiving technical assistance (6 of 83) and verbal (13 of 83) and written (19 of 83) guidance from other HRSA officials. Some grantees reported that HRSA’s guidance was helpful when implementing the administrative expense cap. Specifically, 33 of 83 grantees reported that the guidance on administrative expenses was very or somewhat helpful. In written comments on the survey, grantees that reported that HRSA’s guidance was helpful commented that the guidance made clear how to categorize expenses, their project officers could answer any questions, and what was required of the grantees to comply with the cap was clear. We also heard similar comments during our interviews. For example, one grantee reported that its project officer provided specific advice and was very helpful and explicit, speaking with the grantee daily when necessary. Another grantee stated that its project officer was “knowledgeable and helpful.” Some grantees, however, reported that HRSA’s guidance was not helpful when implementing the administrative expense cap. Thirty of the 83 survey respondents reported that they found the guidance not at all helpful or somewhat unhelpful. In written comments on the survey, grantees that reported that HRSA’s guidance was unhelpful commented that the guidance did not provide clear definitions of allowable expenses and that the guidance was unclear or poorly written. Twelve of the 30 commented that they had received conflicting guidance from HRSA. Five of the grantees commented that the project officers could not answer questions or provide explanations regarding the grant application guidance or that the project officers provided different information to different grantees. A poll of the group interview participants showed that none thought that either the formal guidance or the informal guidance, such as guidance from project officers, was adequate. Some Grantees Indicated a Need for Additional Guidance on the Administrative Expense Cap, and HRSA Officials Reported Revising the Guidance in Response to Feedback Some grantees reported seeking more detailed guidance about what should be considered an administrative expense. For example, during the group interviews, an official from one grantee stated that she would like to receive a list of approved administrative expenses from HRSA. In an interview with an official of a grantee, the official reported that there are “several gray areas” between what is considered an administrative expense and an indirect cost and HRSA had provided few definitions of those expenses. In addition, 16 of the 83 survey respondents sought guidance from sources other than HRSA on administrative expenses and the cap, such as from the AIDS Alliance for Children, Youth & Families. HRSA officials reported that the agency has received feedback from grantees about the grant application guidance and has worked to improve the guidance each year. These officials explained that the agency’s latitude is somewhat limited when revising the grant guidance. One official explained that the agency does not have complete control over the Part D guidance because all HRSA grant applications and guidance must follow a standard template. Moreover, one official stated that grantees often do not carefully read the guidance. Officials stated that in response to questions about the grant application guidance, project officers will often refer grantees back to the grant application guidance and might not provide additional clarification to ensure fairness in the application process by not providing existing grantees with information unavailable to new applicants. Agency Comments HHS provided technical comments on a draft of the report, which we incorporated as appropriate. We are sending copies of this report to the Secretary of Health and Human Services and the Administrator of HRSA. This report also is available at no charge on GAO’s Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact me on (202) 512-7114 or crossem@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs can be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix II. Appendix I: Scope and Methodology We examined the administrative expense cap, which took effect in fiscal year 2007, placed on grants for family-centered medical and support services for women, infants, children, and youth with HIV/AIDS and their families (Part D grants) under the Ryan White Comprehensive AIDS Resources Emergency Act of 1990 (CARE Act). Specifically, we examined (1) the services that Part D grantees provide and what effect, if any, the administrative expense cap has had on those services and on grantee programs; (2) how Part D grantees report on administrative expenses, indirect costs, and compliance with the administrative expense cap; and (3) how the Department of Health and Human Services’ Health Resources and Services Administration (HRSA) implemented the Part D administrative expense cap and grantees’ views on that implementation. To determine what services Part D grantees provide and what effect the administrative expense cap has had on those services; how Part D grantees report on administrative expenses, indirect costs, and compliance with the administrative expense cap; and how HRSA has implemented the Part D administrative expense cap, we analyzed data from our Web-based survey sent to all 90 Part D grantees. We obtained the e-mail addresses and the names of grantee contacts from HRSA. The survey contained questions on grantees’ services and clients, administrative expenses and indirect costs, and HRSA’s implementation of the administrative expense cap. The questions focused on changes that occurred in fiscal year 2007, the first year the administrative expense cap was in effect. Fiscal year 2007 was the only full year of information we were able to obtain from grantees. Because the Part D grants are generally awarded in August of each year— the beginning of what HRSA officials refer to as the budget year—a full year of information was not available for fiscal year 2008. Of the 90 Part D grantees, 83 completed the survey for a 92 percent response rate (see table 2). During the development of our survey, we pretested it with three Part D grantees from New York, Washington, D.C., and Maryland. We opened the survey on May 14, 2008. During the course of the survey, we sent two follow-up e-mails to each nonrespondent and then made telephone follow- up calls to remaining nonrespondents to address any problems they had and to encourage them to complete the survey. We closed the survey on July 10, 2008. Because this survey was conducted with all of the Part D grantees, it is not subject to sampling error. However, the practical difficulties of conducting any survey may introduce other errors. For example, difficulties in interpreting a particular question or sources of information available to respondents can introduce unwanted variability or bias into the survey results. We took steps to minimize such nonsampling errors in developing the questionnaire and collecting and analyzing the data. While the response rate of 92 percent is high, if those not responding differed materially from those responding on any particular question we analyzed, our analysis may not accurately represent the group surveyed. Our results therefore best represent only those responding to our survey. However, given our analysis of the nonresponders, we determined that we could generalize our findings to all Part D grantees. To obtain information on grantees’ fiscal year 2007 spending, including administrative expenses and indirect costs, we reviewed the grantees’ 2007 Part D grant applications that contain their proposed budgets. Because the Part D grant applications did not contain standardized spending information that met our reporting objectives, we also included questions in the survey on grantees’ fiscal year 2007 Part D spending. To gain further information on Part D grantees and the administrative expense cap, we visited two Part D grantees and one Part D subgrantee in the Washington, D.C., metropolitan area and conducted telephone interviews with officials from six Part D grantees. We selected the grantees for visits and interviews through a nongeneralizable sample based on their size, location, and organizational structure. We also conducted two group interviews held at the AIDS Alliance for Children, Youth & Families conference in May 2008. The 18 grantees that participated were self-selected volunteers representing universities, hospitals, community-based organizations, and government entities. To determine how HRSA has implemented the Part D administrative expense cap, we interviewed HRSA officials and reviewed relevant documents. We interviewed HRSA officials responsible for overseeing the Part D program. We also conducted one-on-one interviews with 8 of the approximately 30 project officers who oversee at least one Part D grant. These project officers write program guidance that defines the grant program objectives, monitor grantees’ performance, and evaluate grantee achievements. We selected the 8 project officers based on unbiased selection criteria by project officers’ service areas. We excluded project officers who were hired in 2008 because those officers did not oversee grantees during the entire first year of the administrative expense cap. Finally, we reviewed HRSA’s technical assistance tools and training provided to grantee staff and project officers, including fiscal years 2007 and 2008 grant application guidance, and reviewed Part D fiscal year 2007 grant applications. We did not consider how HRSA’s treatment of administrative expenses differed from other programs. We conducted this performance audit from January 2008 through November 2008 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: GAO Contact and Staff Acknowledgments Acknowledgments In addition to the contact named above, Tom Conahan, Assistant Director; Stefanie A. Bzdusek; Shaunessye Curry; Kelly L. DeMots; Cathy Hamann; Christopher Howard; Martha Kelly; and Eden Savino made key contributions to this report.

The Ryan White Comprehensive AIDS Resources Emergency Act of 1990 (CARE Act) makes federal funds available to assist those infected and affected by HIV/AIDS. Through the CARE Act, the Health Resources and Services Administration (HRSA), part of the Department of Health and Human Services (HHS), awards grants (known as Part D grants) to provide services to women, infants, children, and youth with HIV/AIDS and their families. These grantees incur administrative expenses and indirect costs, such as rent and utilities. The Ryan White HIV/AIDS Treatment and Modernization Act of 2006 (RWTMA), which took effect in fiscal year 2007, capped at 10 percent the amount that Part D grantees could spend on administrative expenses. According to HRSA, there is no cap on indirect costs, but grantees must have an indirect cost rate to use funds for indirect costs. RWTMA directed GAO to examine Part D spending. In this report GAO describes (1) the services that Part D grantees provide and what effect, if any, the administrative expense cap has had on those services and on grantee programs; (2) how Part D grantees report on administrative expenses, indirect costs, and compliance with the cap; and (3) how HRSA implemented the cap and grantees' views on that implementation. GAO surveyed all Part D grantees, interviewed selected grantees, reviewed Part D grant applications and guidance, and interviewed HRSA officials. Part D grantees reported in our survey that they provide a range of services to clients, and the majority of these grantees reported that they have not made changes to services in response to the administrative expense cap implemented in fiscal year 2007. These services included both medical services, such as outpatient health services, as well as support services, such as child care. The majority of the 83 grantees that responded to our survey reported that the cap has not affected the services they provide. However, 4 grantees reported increasing services and 3 grantees reported reducing client services in response to the cap. In addition, the majority of grantees also reported that the cap has had a negative effect on their Part D programs, even if it has not changed client services, because it has, for example, made it necessary for clinical staff to perform administrative tasks. In addition, about half of the grantees reported that not all of their Part D administrative expenses were covered by the 10 percent allowance. Part D grantees report planned administrative expenses and indirect costs to HRSA and, starting in fiscal year 2009, HRSA will require additional reporting. In their grant applications, Part D grantees provide HRSA with budgets that include administrative expenses and indirect costs. Grantees must then update HRSA on any changes to that information, and some provide the results of independent financial audits. Starting in fiscal year 2009, HRSA will require all Part D grantees to report more detailed budget information at both the beginning and end of each year. In fiscal year 2007, the first year of the administrative expense cap, grantees reported to HRSA that they were in compliance with the cap. Grantees with approved indirect cost rates could include expenses such as rent and utilities in their indirect costs rather than in their administrative expenses and so were able to spend more than 10 percent of their Part D grants on such expenses. Beginning in fiscal year 2007, HRSA took multiple steps to implement the administrative expense cap but, while some grantees reported that HRSA's guidance on how to implement the cap was helpful, others reported difficulties in implementing the cap due to unclear guidance from HRSA. HRSA reported revising its grant application guidance and developing training for both its staff and grantees in response to the cap. HRSA also included additional revisions related to the administrative expense cap in the fiscal year 2008 grant application guidance and plans to provide grantees with further guidance in the fiscal year 2009 application. While some grantees reported that HRSA's guidance was helpful, others reported receiving conflicting information. In the first year of the cap, some grantees also indicated a need for additional guidance on the administrative expense cap and reported that they sought such guidance from sources other than HRSA. HHS provided technical comments on a draft of the report, which GAO incorporated as appropriate.

Background The Paducah uranium enrichment plant, shown in figure 1, is located in western Kentucky, just south of the Ohio River and about 10 miles west of the city of Paducah. The plant—formerly operated by DOE and now operated by USEC—enriches uranium for commercial nuclear power reactors. Since it began operations in 1952, the Paducah plant has processed, or enriched, more than a million tons of uranium. Plant operations over time have introduced to the site radioactive and hazardous chemical wastes, including technetium-99, PCBs, uranium, and volatile organic compounds such as TCE. In past years, a cleaning solvent containing TCE—much like that previously used by dry cleaners—was used to degrease parts and equipment. In the plant’s more than half a century of operations, these various waste materials have contaminated the area’s groundwater, surface water, soils, and air. The Paducah site cleanup is funded primarily through the Uranium Enrichment Decontamination and Decommissioning Fund, which was established by the Energy Policy Act of 1992. The fund receives money from both annual federal appropriations and assessments on commercial utilities. Through fiscal year 2003, the Paducah site had received from the fund annual cleanup amounts ranging from $35.9 million to $97.2 million. The Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (CERCLA), governs the cleanup of sites placed on the National Priorities List—EPA’s list of contaminated sites designated as highest priority for cleanup. Paducah was placed on the list in 1994. CERCLA provides broad federal authority to respond directly to releases or threatened releases of hazardous substances that may endanger public health or the environment. It stresses the importance of permanent cleanup remedies and innovative treatment technologies, and it encourages citizen participation in deciding on how sites should be cleaned up. The Resource Conservation and Recovery Act of 1976, as amended, also comes into play in governing the Paducah cleanup. While CERCLA generally deals with cleaning up inactive and abandoned hazardous waste sites, this act generally governs the safe management and disposal of the huge amounts of hazardous or other solid wastes that are generated nationwide and are currently destined for disposal or recycling. The act permits states, rather than EPA, to assume primary responsibility for implementing its requirements. At Paducah, the key documents governing the cleanup are a federal facility agreement, the site management plan, and the life cycle baseline. The federal facility agreement—among DOE, EPA, and Kentucky—coordinates the requirements of both CERCLA and the Resource Conservation and Recovery Act for cleanup activities at Paducah and governs the cleanup. Under this agreement, the parties developed a site management plan that lays out DOE’s approach for the cleanup and includes near- and long-term milestones and projected activities for the site. This plan is updated annually by DOE and approved by EPA and Kentucky. DOE also uses a life cycle baseline to manage the cleanup. The life cycle baseline contains detailed information on cleanup projects, cost estimates, and time frames for completion and is updated frequently by DOE’s contractor to reflect the evolving nature of the cleanup process. For this report, we examined the May 2003 and November 2003 versions of the site management plan and the September 2002 version of the life cycle baseline. DOE’s Office of Environmental Management is responsible for the cleanup at Paducah, including characterizing, treating, and disposing of waste and contamination identified during site cleanup. Prior to January 2001, the Office of Nuclear Energy acted as the “landlord” at the site with responsibilities for maintaining roads, grounds, facilities not leased to USEC, and DOE material storage areas (DMSAs), which have since been transferred to the Office of Environmental Management. Currently, the role of the Office of Nuclear Energy is limited to administering USEC’s lease. DOE’s cleanup strategy for the Paducah site divides the cleanup into seven major categories as follows: Groundwater—About 10 billion gallons of groundwater are contaminated with radioactive and hazardous materials. Surface water—Contaminated sediments have been discovered in ditches and creeks leaving the site. One of the main sources of this contamination is rain runoff from thousands of tons of contaminated scrap metal stored at the site. Surface soils—Soils and sediments at the site have been contaminated by water runoff, spills, and buried waste. Legacy waste—Low-level radioactive or hazardous waste generated at the site before 2001 from DOE cleanup or site maintenance activities remains stored at the site. DOE material storage areas—160 indoor and outdoor storage areas contain a variety of radioactive, hazardous, and other materials. These areas have been added to the cleanup scope since our 2000 report. Burial grounds—Twelve burial grounds contain a variety of waste, including barrels of materials with low levels of radioactivity and hazardous chemicals. Decontamination and decommissioning of 17 unused buildings and other structures—These facilities were contaminated during earlier operations; 15 have been added to the cleanup scope since our 2000 report. DOE’s draft fiscal year 2004 site management plan, submitted to the regulators for approval in November of 2003, would commit DOE, EPA, and Kentucky to an accelerated cleanup of the site. Specifically, the plan establishes a two-phased cleanup approach for five of the seven categories—DMSAs and legacy waste are not included but are covered under DOE’s life cycle baseline and an October 2003 settlement between DOE and Kentucky. The two-phase approach consists of a series of early cleanup actions and studies while the uranium enrichment plant is in operation and a second series of actions to be implemented after the plant ceases operations. The primary objectives of the first phase are to prevent on- and off-site human exposure—including exposure of plant workers—to unacceptable risks, and to complete cleanup actions that provide the greatest opportunity for reducing risks. The second phase will include final decontamination and decommissioning of the plant and associated infrastructure, and an evaluation of the entire site to (1) determine the effectiveness of cleanup actions taken in phase I; (2) assess residual risks; and (3) determine what, if any, additional cleanup actions are needed. DOE Has Spent $823 Million at the Paducah Site; However, Billions of Dollars Will Be Required to Complete DOE Activities at the Site From fiscal year 1988 through fiscal year 2003, DOE has spent $823 million (in 2002 dollars) for cleanup and related activities at Paducah. DOE’s expenditures fall into three major categories: (1) base operations— including activities to maintain the site, such as security, waste storage, and environmental monitoring, and some administrative and legal costs; (2) removal and remedial actions—activities such as treatment and disposal of waste, and projects to clean up contamination at the site; and (3) assessments—studies done to investigate and characterize, or determine the qualities of, contamination and waste so that DOE’s contractor can determine what remedial or removal actions are necessary. As figure 2 shows, 45 percent was spent on base operations, 36 percent on actions taken to clean up contamination and remove waste, and 19 percent on assessments. However, for the past three fiscal years, the percentage of expenditures on remedial and removal actions has increased to about half of all funds expended. This increase can be attributed to increased overall funding for the cleanup and a smaller percentage of funds being spent on assessments. Nevertheless, the percentages spent on cleanup and related activities at Paducah through fiscal year 2003 are similar to those DOE’s Office of Environmental Management found for all of its cleanup programs: only about one-third of the environmental management program budget goes toward actual cleanup and risk reduction work, with the remainder going to maintenance, fixed costs, and miscellaneous activities, contributing to a lack of risk reduction and raising costs for DOE’s cleanups. As a result, DOE has since begun to implement accelerated cleanup plans at Paducah and other sites. DOE’s current estimate for completing the cleanup at Paducah is almost $1.6 billion—a $300 million increase over its 2000 estimate—and the completion date has moved from 2010 to 2019. The cost increase is due in part to an expanded project scope since 2000—for example, the inclusion of DMSAs not previously considered part of the cleanup—as well as millions of dollars for site operations for each of the nine additional years of cleanup. However, according to DOE’s site manager, DOE has not yet revised its life cycle baseline to reflect the scope changes under the proposed accelerated cleanup approach and DOE may be able to reduce the cost of the cleanup. For example, DOE’s life cycle baseline currently includes the cost of excavating five burial grounds at a cost of about $550 million, but DOE’s draft site management plan calls only for capping the burial grounds unless further study indicates that the contamination from the burial grounds poses a risk above acceptable levels. However, the $1.6 billion cleanup estimate does not represent DOE’s total responsibilities at the site. In addition to cleaning up the contamination from past activities at the site, DOE will (1) build and operate a facility to convert more than 38,000 cylinders of depleted uranium hexafluoride stored at the site to a more stable form; (2) carry out final decontamination and decommissioning of the uranium enrichment plant and associated infrastructure once USEC ceases plant operations; and (3) perform long-term environmental monitoring at the site, which includes activities such as monitoring groundwater and surface water for residual contamination. According to DOE estimates, completing these activities will cost almost $5 billion in 2002 dollars. This will bring the total cost of DOE activities at the site, including remaining cleanup costs and the $823 million already spent, to over $7 billion, in 2002 dollars. Table 1 shows DOE’s past expenditures and estimated costs and time frames for future activities at the site. While DOE Has Achieved Some Progress, Much Remains to Be Done Since 2000, DOE has made some progress in cleaning up the contamination and waste at Paducah, but much of the cleanup work remains to be done. Cleanup progress has been slowed by several factors, including several disagreements over the scope and approach of the cleanup and technical details of specific cleanup projects, and difficulty resolving regulatory violations at the site. For example, an on-site landfill was unavailable for almost a year—from November 2002 to October 2003—as a result of a violation notice that Kentucky issued to DOE for improper waste disposal at the landfill. Until DOE and Kentucky resolved the violation, 25 cleanup projects involving 19,056 tons of various types of waste were delayed. A discussion of the cleanup categories, including DOE’s major accomplishments since our 2000 report (as of the end of fiscal year 2003) and the work remaining, follows. Groundwater After hazardous and radioactive contamination was found in the drinking water wells of residences near the Paducah plant in 1988, DOE discovered that plumes of groundwater contaminated with TCE and technetium-99 were moving toward the Ohio River. The largest identified source of the contamination is below the plant’s C-400 building, where TCE had been used for years to degrease parts and equipment. DOE’s strategy for addressing the groundwater contamination is to focus its resources on this and other large concentrations of accumulated TCE at the Paducah site. To address the source contamination, DOE conducted a pilot test of technology to remove TCE sources from the ground. According to DOE officials, the test results were promising. During the pilot test, about 1,500 gallons of TCE were removed from the largest source—about 99 percent of the TCE in the area treated. However, this represents only about 1 percent of the estimated 180,000 gallons of TCE that had leaked into the ground at the site. DOE contractor officials told us that full implementation of this technology at C-400 will not occur until 2006, after the regulators have approved DOE’s proposal and DOE has completed the system design. In spring 2004, DOE will conduct a study to investigate the second largest TCE source at the site and determine what additional actions are necessary. In addition to its actions to address major TCE sources, DOE has pumped from the ground and treated about 710 million gallons of groundwater from the contaminated groundwater plumes since our 2000 report to remove TCE and technetium-99 and prevent off-site contamination. About 1.3 billion gallons have been treated this way since the program began. DOE’s estimated completion date for currently planned groundwater cleanup activities is 2010. While this end date takes into account construction and implementation of a system to remove contamination, treatment actions could extend well beyond that date. Surface Water DOE discovered surface water contamination in creeks, ditches, and sludge lagoons—artificial ponds for the storage of wastewater. Historically, storm water runoff and wastewater from plant operations have been discharged into two streams flanking the plant—Bayou Creek and Little Bayou Creek—through a series of ditches. Each discharge point is monitored to ensure that the waste material entering the stream is within the parameters of the discharge permit issued by Kentucky. Contaminants of concern are technetium-99, solid uranium tetraflouride, uranium- contaminated silts and sediments, radionuclides, metals, and PCBs. To prevent contaminated runoff, DOE has removed about 4,500 tons of scrap metal from the site since 2000—primarily crushed drums that previously had contained uranium, and aluminum ingots. An estimated almost 50,000 tons of contaminated scrap metal remains to be removed from the site. At the north-south diversion ditch, a key wastewater conduit from the plant, surface water discharges and runoff have been rerouted and piped to bypass contaminated areas, and DOE has begun excavation work to remove contaminated soil. According to DOE officials, DOE has excavated section 2 of the ditch and plans to complete excavation of section 1 by summer 2004—a year ahead of schedule. DOE will also conduct additional investigations and risk assessments to determine what additional actions are required to address contamination associated with internal ditches; outfalls—outlets through which water leaves the site; sections 3, 4, and 5 of the north-south diversion ditch; and the storm sewer system, and whether additional sediment controls are needed. The estimated completion date for all currently planned surface water cleanup activities is 2017. Surface Soils Because soil contamination represents a lower risk for exposure and migration than, for example, groundwater contamination, and because other work, such as removal of scrap metal, must be performed before some soils can be reached for assessment and removal, surface soils have been a lower priority than other cleanup categories. However, DOE has performed a preliminary assessment of all accessible surface soils at the site to identify radioactive contamination and protect plant workers and has removed 2,500 cubic yards of contaminated soils—enough to cover a football field 17 inches deep. DOE estimates that it will need to remove and dispose of an additional 87,500 cubic yards of soils by 2015. In addition, other contaminated areas that are not currently accessible because they are still in use by USEC, as well as the soil under the 17 buildings and other structures being decontaminated and decommissioned during phase I of the cleanup, will be addressed after the plant ceases operations during phase II. Legacy Waste We reported in 2000 that the equivalent of 52,000 55-gallon barrels of waste was stored in various locations on the Paducah site. Most of this waste is materials that have a low level of radioactivity. All of this waste has undergone an initial characterization to determine proper on-site storage and may require additional characterization to determine proper treatment, if necessary, and disposal. Since 2000, DOE has disposed of the equivalent of over 7,000 barrels off-site and has repackaged another 6,000 barrels’ worth of waste that is ready for disposal. DOE plans to remove the 6,000 barrels ready for disposal and characterize and dispose of the remaining legacy waste—the equivalent of over 38,000 barrels—by 2011. In addition to the legacy waste, new waste generated during the course of the cleanup must be disposed of within a year of its generation. DOE Material Storage Areas In 2000, we reported that DMSAs were not included in the scope of the Office of Environmental Management’s cleanup plan. These storage areas were created in 1996 when DOE accepted responsibility for large amounts of material stored in USEC-leased buildings and outdoor areas to expedite the process USEC used to obtain an operating certificate. The materials in the 160 DMSAs include thousands of barrels of low-level radioactive waste and PCB wastes, barrels labeled as asbestos waste, contaminated uranium processing equipment, various items and containers whose contents are unknown, and scrap metal. Since our 2000 report, DOE has transferred responsibility for DMSAs from the Office of Nuclear Energy to the Office of Environmental Management so that they can be addressed as part of the comprehensive sitewide cleanup scope. DOE has also ranked the 160 DMSAs at the Paducah site on the basis of their potential to contain hazardous materials or contaminate the environment: 34 are high-priority, 11 are medium-priority, and 115 are low-priority. Of the 160 DMSAs, DOE has completely characterized materials from 28 high- and 10 low-priority DMSAs and has initiated characterization of an additional 41 DMSAs. As a result, two-thirds of the total volume of materials in all 160 DMSAs has been characterized as of March 2004. According to DOE officials, only 0.01 percent of the materials characterized to date have been determined to be hazardous waste. In addition to the progress made in characterizing DMSAs, all materials from 9 high-priority DMSAs—about 15 percent of all materials to be removed during phase I of the cleanup—have been removed and either shipped off- site or placed in an on-site landfill for final disposal. DOE plans to complete its characterization of the DMSAs by the end of fiscal year 2009 and dispose of all free-standing materials from the remaining DMSAs by 2010. Fixed equipment in the DMSAs, such as piping and equipment attached to buildings and facilities, will be disposed of during final decommissioning and decontamination of the site after the uranium enrichment plant ceases operations. Burial Grounds The 12 burial grounds at the site contain a variety of waste, including barrels of materials with low levels of radioactivity and/or hazardous chemicals, and pyrophoric uranium, which has a tendency to spontaneously combust in the presence of oxygen. To date, DOE’s activities at the 12 burial grounds have consisted of studies and environmental monitoring and maintenance, and DOE continues to conduct these studies. Currently, DOE’s planning assumption is that they will cap—cover with a layer of soil—the burial grounds and monitor nearby groundwater for contamination to evaluate the effectiveness of the caps. If contamination from the burial grounds is found to pose a risk above acceptable levels, some burial grounds may need to be excavated during phase II of the cleanup at the site, which is not scheduled to start until after the plant ceases operations. Groundwater monitoring will be ongoing through the end of phase I of the cleanup in 2019. Decontamination and Decommissioning of 17 Unused Buildings and Other Structures Seventeen buildings and other structures that were originally used as part of the uranium enrichment process, including two 250,000-gallon water storage tanks, a nitrogen generation plant, and an incinerator previously used for disposing of contaminated items are no longer in use and await decontamination and removal. In 2000, we reported that only 2 of 18 unused buildings and structures awaiting decontamination and decommissioning at the site were included in the scope of the Office of Environmental Management’s cleanup plan. Since then, 1 of the 18 buildings has been transferred to USEC for use in operations at the Paducah Gaseous Diffusion Plant, according to DOE contractor officials; the remaining 17 are now included in the scope of the Office of Environmental Management’s cleanup. DOE has completed its preliminary assessment of the contamination at the 17 buildings and other structures and has begun removing the infrastructure of one of the buildings. In addition, DOE continues to perform surveillance and maintenance on all 17 inactive facilities to prevent significant deterioration of the buildings and other structures until decommissioning and decontamination is complete. DOE’s plan proposes to demolish all of these inactive facilities by 2017; the underlying foundations and soil will be addressed during phase II of the cleanup. While Two Previously Identified Challenges Have Been Mitigated, Uncertainty about the Cleanup Scope and Reaching Stakeholder Agreement on Cleanup Approach Remain the Current Principal Challenges Two of the four challenges we identified in 2000—DOE’s plans to use untested technology and obtaining adequate funding for the cleanup—no longer pose the impediment to the cleanup effort they once did because of actions taken to mitigate their impact. The remaining two challenges— uncertainty over the scope of the cleanup and obtaining stakeholder agreement on the cleanup approach—are the principal challenges that remain for DOE to resolve to successfully complete the cleanup at Paducah. DOE Has Mitigated the Impact of Two Previously Identified Challenges In 2000, we reported some of the cleanup technologies contemplated, while not new, were untested for the specific environment in which they were to be applied. Since then, several technologies have been evaluated for treating groundwater for TCE contamination at Paducah, including permeable treatment barriers and six-phase heating. According to DOE officials, removing TCE is the most difficult cleanup task at Paducah. Specifically, TCE is difficult to treat when it has mixed with groundwater and soil—it migrates to the bottom of the aquifer making it difficult to access, and because it dissolves slowly in water, it can contaminate large quantities of groundwater for long periods of time. Permeable treatment barriers, which DOE assumed in 2000 would be the primary treatment strategy for addressing contaminated groundwater, could not be effectively installed at Paducah, according to DOE officials, because of unfavorable soil conditions and potential high costs to maintain the technology. Furthermore, such technologies only deal with the contaminated groundwater plume, not the source of the contamination. However, DOE has made progress in testing six-phase heating for removing TCE from the groundwater and soil at Paducah. In the six-phase heating process, electricity is applied to steel rods that have been drilled into the ground to heat the soil. When the soil is hot enough that the TCE and groundwater begin to boil, the resulting vapor is collected and condensed and then filtered to remove the TCE. DOE officials told us the results of the test exceeded their expectations, and their preliminary review of the test results concluded that the technology should be considered for full-scale implementation. DOE officials state that they have submitted a proposed plan to the regulators for approval and plan to begin full-scale implementation in 2006. The officials added that unless problems are encountered when the process is fully implemented, DOE should be able to remove the majority of the TCE source. In 2000, we also reported that assumptions about future increases in federal funding for the Paducah cleanup could affect DOE’s ability to meet cleanup milestones and that, if the planned increases did not occur, the cleanup could be delayed and costs could increase. DOE had estimated that, as the cleanup progressed, its funding would increase from $78 million in fiscal year 2001 to $307 million in fiscal year 2008. We now believe these assumptions were unrealistic considering that funding levels for the cleanup during the seven fiscal years prior to 2001 averaged only $43 million annually. Since 2000, DOE has revised its annual funding assumptions to reflect more consistent and appropriate funding levels. Currently, DOE estimates its annual funding needs at about $100 million. DOE’s contractor official for finance stated that annual funding of $100 million is sufficient to complete the cleanup given the scope of work and the 2019 end date proposed in its fiscal year 2004 draft site management plan. In addition, actual annual funding for the Paducah cleanup has increased significantly in recent years. In fact, in fiscal year 2003, Congress appropriated more than DOE’s $100 million request. However, if cleanup cost estimates increase, or appropriations for the cleanup are not maintained at their current level, funding could resurface as a challenge. Uncertainty Regarding the Scope of DOE’s Cleanup Remains a Challenge In 2000, we also reported that uncertainties about the contamination yet to be cleaned up could result in increased cleanup costs. These uncertainties remain a challenge, in part, for DOE because its fiscal year 2004 draft site management plan does not clearly define the entire scope and time frame for completing the cleanup. For phase I of the cleanup, DOE has identified a series of early actions for five of the seven cleanup categories. Some of these actions are currently under way, and DOE plans to have them all completed by 2019. DOE plans to study the effectiveness of phase I actions as they are completed. Phase II of the cleanup will include the final decontamination and decommissioning of the USEC plant and a comprehensive sitewide assessment that will evaluate the effectiveness of all cleanup actions conducted in phase I and assess the need for additional cleanup actions. For example, DOE’s planning assumption is to cover the 12 burial grounds with soil caps during phase I as a waste management measure and then monitor the burial grounds to assess the effectiveness of the caps in containing the waste. If DOE finds that contamination from these sites poses an unacceptable risk, DOE may need to excavate some of the burial grounds, at a cost of about $110 million each, during phase II. Additionally, since DOE does not plan to remove the foundations and soil underlying the 17 unused buildings and other structures to be decontaminated and decommissioned during phase I, additional cleanup actions may be necessary during phase II if the soil is found to be contaminated. DOE has also not yet determined when phase II will begin. DOE’s draft site management plan calls for phase II to begin once the USEC plant ceases operations. USEC has recently announced that the plant will operate until about 2010. However, DOE’s site manager stated that several options exist. For example, rather than begin phase II in 2010, DOE could decide to postpone the comprehensive sitewide assessment and some phase II cleanup actions until DOE has completed all of phase I. Alternatively, DOE could decide to start final decontamination and decommissioning shortly after the plant ceases operations in approximately 2010 and conduct phase II activities concurrently with phase I cleanup actions. If DOE selects this option, increases in annual funding would be needed to conduct both phases of the cleanup simultaneously. Until DOE decides when phase II will begin, any additional necessary actions, the costs of those actions, and the time frame for DOE to implement them are not known. DOE, Kentucky, and EPA Have Continued to Have Great Difficulty Agreeing on a Cleanup Approach In our 2000 report, we stated that DOE’s assumptions about the timely achievement of regulatory and stakeholder agreement on cleanup levels, strategies, and priorities were optimistic because the regulators had already disagreed with some of DOE’s proposed approaches and had not reached agreement on several contentious issues. Since then, DOE and the regulators have continued to have difficulty agreeing on an overall cleanup approach and individual projects. As table 2 shows, the draft fiscal year 2004 site management plan is only the latest of several cleanup plans proposed for the site since 1999, all of which have differed significantly in terms of costs, scope, and time frames for cleanup and were intended as solutions to problems at the site. According to DOE’s site manager, DOE has revised its plans for Paducah to incorporate additional scope and ensure that the requirements of the two statutes that govern the cleanup were met. On the other hand, EPA and Kentucky officials told us that these frequent changes have frustrated them and undermined their confidence that DOE would adhere to an agreed-to plan and achieve progress in cleaning up the site. As a result, their working relationship has deteriorated, slowing cleanup progress. The most significant example of the parties’ inability to reach and maintain agreement has been a dispute over the fiscal year 2001 site management plan that lasted from June 2001 to April 2003 and slowed overall cleanup progress. The dispute began when DOE headquarters decided they could no longer support the site management plan assumptions. According to Kentucky officials, this site management plan was developed collaboratively by high-level officials from DOE, EPA, and Kentucky who agreed on an overall cleanup approach. In addition, a midlevel working group was developed, called the Core Team, with representatives from DOE, EPA, and Kentucky who examined the technical requirements to plan individual projects. These two groups identified a number of cleanup actions for implementation, and the parties successfully agreed on the fiscal year 2001 site management plan. However, as a result of the increased cleanup scope identified by the Core Team, the resulting increase in costs, and DOE’s Top-to-Bottom Review, DOE headquarters questioned whether the planned cleanup actions were excessive in relation to the risk to human health and the environment and requested additional time from the regulators to further review the site management plan. The regulators denied the request. Because of its continuing concerns that the planned cleanup actions were excessive, DOE subsequently discontinued this collaborative approach, removed decision-making authority from the Core Team, and reduced the regulators’ role to reviewing DOE’s proposals. According to Kentucky officials, DOE also limited communication between DOE technical staff and the regulators. While DOE and Kentucky have made some progress in addressing near- term cleanup impediments, the three parties continue to have difficulty in reaching agreement on the overall approach. DOE and Kentucky signed a letter of intent in August 2003, followed in October 2003 by an agreed order that resolved all outstanding Kentucky environmental compliance violations pending against the department. The letter of intent also commits the two parties to promote an accelerated cleanup of the site, which is reflected in the draft fiscal year 2004 site management plan. Nevertheless, according to DOE’s site manager, DOE and the regulators are still negotiating the fiscal year 2004 site management plan, submitted by DOE on November 15, 2003. In February 2004, DOE received and responded to formal comments from EPA and Kentucky, and submitted a second draft of the site management plan to the regulators for review. It is uncertain when the 2004 site management plan, which was to be implemented during fiscal year 2004, will be finalized. Furthermore, as discussed earlier, many more decisions about the cleanup’s scope and DOE’s approach will require agreement by the three parties throughout the life of DOE’s cleanup efforts. Early involvement by all three parties could be helpful in avoiding similar lengthy and unproductive cycles of negotiations over the annual site management plans in the future. Involving the regulators early in planning the overall cleanup approach and specific projects has been a key element of DOE’s good working relationship with regulators at other DOE sites. For example, at Rocky Flats in Colorado, DOE involves the regulators when updating the site management plan and developing individual projects. This allows concerns to be communicated and addressed early in the process. According to officials at Colorado’s Department of Public Health and Environment, this has reduced the amount of time needed for regulatory reviews, since the number of “comment and revise, comment and revise” cycles has been reduced. Colorado state officials also told us that a successful working relationship requires up front and continual communication beyond just reviewing already developed documents and proposals. Additionally, they stated that a consultative process is an evolving process and must be worked through in good faith by all parties. Both EPA and Kentucky officials believe that their early involvement would aid cleanup progress at Paducah, such as early involvement in developing the annually submitted site management plan. EPA and Kentucky officials told us that they have been frustrated by their exclusion from the planning process for both the overall cleanup approach and specific projects and feel that the current process is more time-consuming than if they were involved early in the process. Not being involved in the planning process reduces their role to reviewing DOE’s project proposals and making comments on those proposals. Comments on proposals often necessitate more than one revision cycle. Multiple revisions can cause schedule changes and delays because DOE’s schedule for each project assumes only one revision to respond to regulators’ comments. At a December 6, 2003, hearing before the Senate Committee on Energy and Natural Resources in Paducah, the Secretary of Kentucky’s Natural Resources and Environmental Protection agency encouraged all parties to revisit the Core Team approach. He urged that a collaborative team be created and empowered to work effectively toward meaningful action. However, DOE’s site manager cautioned that such an approach would not necessarily hasten decision making, but agreed that early discussion of technical details could possibly help improve formal submission of DOE cleanup proposals to the regulators. The poor working relationship between DOE and the regulators has also prevented them from quickly reaching agreement on technical details of specific projects. According to Kentucky officials, DOE proposed using existing data about the north-south diversion ditch—a major wastewater conduit from the plant—to determine whether soil from the ditch could be disposed of in an on-site landfill. However, Kentucky’s response to DOE’s proposal was that these data were not sufficient because the samples were not representative of all the areas where waste entered the ditch. It took DOE and Kentucky 5 months to agree on a sampling plan. Similarly, DOE and Kentucky disagreed over whether available data demonstrated that the risk reduction to be obtained by installing sedimentation basins was significant enough to warrant their installation. In 2000, DOE planned to install two sedimentation basins at a cost of $4 million each, but the state wanted four basins. Currently, DOE’s position is that it does not believe that available data indicates any sedimentation basins are needed, but has agreed to collect additional data and install basins if new information warrants it. DOE and Kentucky are still negotiating the amount and type of data required to determine whether the basins are needed. As the cleanup progresses and individual projects are designed and implemented, DOE and the regulators will continue to have to reach agreement on the specifics of these projects. Given the past technical disagreements and the vast scope of work remaining at Paducah, additional technical issues such as those experienced with the north-south diversion ditch and the sedimentation basins are likely to arise in the future. However, DOE and the regulators do not currently use any mechanisms such as external technical peer reviews to assist them in resolving technical disputes in a timely manner. A 1997 National Academy of Sciences report on the use of peer review by DOE’s Office of Science and Technology cited several benefits of using such reviews to help resolve technical disagreements that could apply to Paducah. According to the report, peer reviews provide an effective way to increase the technical quality of projects, thereby enhancing the credibility of project decisions; add confidence that those decisions are based on the best scientific and technical information available; and introduce independent experts to a project who can recognize previously unrecognized technical strengths and weaknesses, challenge the status quo, and identify ways to improve the project that may have been overlooked. DOE and EPA officials told us that they believe the use of peer reviews could help resolve technical disagreements at the site. Kentucky officials told us that while they believe such reviews have value, they would not want the results of a review to usurp the state’s regulatory decision-making authority. Conclusions While some progress has been made in cleaning up the site and addressing previously identified challenges, DOE still faces significant challenges in completing the cleanup at Paducah. For example, DOE, EPA, and Kentucky have been unable to agree on an overall cleanup approach and technical aspects of individual projects. Even now, DOE and the regulators are still negotiating the draft fiscal year 2004 site management plan, submitted by DOE in early November 2003, and it is uncertain when it will be finalized. Moreover, despite past difficulties, which have slowed cleanup progress, and the many decisions that must be made in the future regarding scope and time frames, the parties have no mechanisms in place, such as early stakeholder involvement or technical peer review, to help resolve disagreements between the three parties in a timely manner. Unless DOE and the regulators can reach and maintain agreement on key aspects of the cleanup and quickly resolve technical disagreements, progress at Paducah could continue to be hampered by delays. Recommendations for Executive Action To help improve the likelihood that DOE and the regulators will reach timely agreement on the cleanup approach, we recommend that the Secretary of Energy direct the Assistant Secretary of the Office of Environmental Management to involve the Commonwealth of Kentucky and EPA early in the development of the annual site management plan and specific projects—before submitting formal cleanup proposals for regulatory approval—so that the parties can identify and resolve their concerns and reach consensus on cleanup decisions in a more timely manner, and in conjunction with Kentucky and EPA, identify and retain external technical peer review groups with environmental cleanup expertise to facilitate timely resolution of any future differences between DOE and the regulators. Agency Comments and Our Evaluation We provided DOE, EPA, and Kentucky with draft copies of this report for their review and comment. DOE’s written comments on our report did not address our recommendations, but DOE agreed that it still faces many challenges in accomplishing a safe, cost-effective cleanup at the Paducah site. However, DOE disagreed with our characterization of the department’s decision to discontinue the Core Team process and stated that we did not fully acknowledge DOE’s improving working relationship with the regulators. DOE also asserted that our report did not provide a balanced presentation of all three parties’ responsibilities for the past poor working relationship and delayed progress. Finally, DOE stated that our report did not adequately represent recent progress at the site and that we should not include post-closure environmental monitoring costs in comparison of past cleanup costs or estimates. We disagree with DOE’s view that we did not accurately characterize their decision to discontinue the Core Team approach. Our report clearly cites DOE’s rationale for discontinuing its participation. We also disagree that we did not fully acknowledge the progress DOE and Kentucky have made in improving their working relationship. For example, our report does reflect the progress they have made in addressing near-term clean up impediments, such as the signing of the agreed order that resolved outstanding regulatory violations. However, the inability of the three parties to agree to and sign the fiscal year 2004 Site Management Plan, issued in draft in November 2003, indicates that the parties’ working relationship continues to be a challenge. We also disagree with DOE’s statement that our report does not provide a balanced presentation of all three parties’ responsibilities for the past poor working relationship and delayed progress. We cite throughout our report examples of disagreements between DOE and the regulators, providing each side’s position on these issues. For example, we describe the disagreement over a sampling plan for soil excavation at the north-south diversion ditch, and present DOE and Kentucky’s rationales for including different numbers of sedimentation basins at the site. We have added to the report information on the recent progress made on the north-south diversion ditch, but we disagree with DOE’s assertion that we included post-closure costs in our comparison of past cleanup costs and schedules. We have, however, included post-closure costs as part of our discussion of DOE’s total financial responsibilities at Paducah. Nevertheless, we have revised the report to more clearly indicate that post-closure environmental monitoring costs are a separate activity from cleanup activities and related costs. In their written comments, EPA commended GAO for a fair and balanced analysis of the challenges that the three parties face in the environmental cleanup at the site. Kentucky stated that the report was a fair and accurate assessment of both the progress at the site and the working relationship among the three parties since 2000. Both EPA and Kentucky agreed with the report’s two recommendations. DOE and Kentucky also provided technical comments, which we incorporated into the report as appropriate. DOE’s, EPA’s, and Kentucky’s written comments are presented in appendixes I, II, and III, respectively. Appendix I also includes our responses to DOE’s comments. Scope and Methodology To determine the amount of money DOE has spent on cleanup-related activities, the purposes for which the money has been spent, and the estimated total for the site, we interviewed officials from DOE’s Oak Ridge Operations Office, which is responsible for managing costs for the Paducah site, and reviewed budget documents including appropriation data related to the cleanup. During two visits to the Paducah site, we interviewed the representative from Bechtel Jacobs responsible for finance, reviewed expenditure and project data from 1988 through 2003, and estimated out- year expenditures. Specifically, we obtained and analyzed historic and estimated expenditures for the major expenditure categories of the cleanup—remedial and removal actions, environmental risk assessments, base operations, and their subcomponents—as well as cost estimates for other activities required to close the site, including final decontamination and decommissioning of the uranium enrichment process plant, and long- term environmental monitoring at the site. We reported all 1998-2003 expenditures in 2002 dollars. To assess the reliability of the DOE cost information, we interviewed Bechtel Jacobs staff responsible for the databases containing the data that were provided. We obtained and reviewed descriptions of the databases, how data are entered into the databases, quality control checks on the data, and testing conducted on the data. We also reviewed in detail a year’s coding of the data into the categories of interest to us. After taking these steps, we determined that the data provided to us were sufficiently reliable for the purposes of this report. To assess the status of DOE efforts to clean up the contamination at the site, we had Bechtel Jacobs representatives provide a written status of what actions have been taken to address waste and contamination for each cleanup category: groundwater, surface water, surface soils, legacy waste stored at the site, DOE material storage areas, waste burial areas, and contaminated unused building and structures. We also reviewed various documents, such as an evaluation of a new technology for removing TCE from groundwater, to further document actions taken in the various categories. In addition, during two visits to the Paducah site, we interviewed representatives from Bechtel Jacobs responsible for finance and planning, as well as other activities regarding the status of DOE’s cleanup. We also interviewed DOE’s Office of Environmental Management site officials regarding progress achieved. During the two visits to Paducah, we toured the site to get a further understanding of how these cleanup actions were undertaken and implemented. We also interviewed officials from DOE’s Office of Environmental Management in Washington, D.C. To determine which of the challenges we previously identified continue to be issues for DOE at Paducah, we interviewed the Assistant Secretary and other headquarters officials from DOE’s Office of Environmental Management to obtain a high-level perspective on these challenges. We also interviewed DOE’s Office of Environmental Management site officials regarding progress achieved under each category. During our two visits to Paducah, we toured the site to develop a firsthand understanding of the cleanup challenges. Furthermore, on each visit we interviewed representatives from Bechtel Jacobs responsible for the cleanup, finance, and planning regarding the status of the challenges and actions taken to address them, and reviewed site-specific documents, including the September 2002 life cycle baseline, the federal facility agreement, and the May 2003 and November 2003 site management plans. To obtain a complete perspective on the four previously identified challenges, we interviewed officials from EPA Region IV, the Commonwealth of Kentucky’s Department for Environmental Protection, and the Governor of Kentucky, and reviewed related studies and correspondence. We also interviewed the Chairman of the Paducah Site Specific Advisory Board, attended one of the board’s monthly meetings, interviewed the Chairman of the Greater Paducah Economic Development Council and the Chairwoman of the Paducah Chamber of Commerce, and consulted with GAO’s Chief Technologist on these challenges. We reviewed studies of various cleanup technologies, site-specific progress reports, DOE’s Top-to-Bottom report, and testimony from congressional hearings. To identify potential solutions to the challenge of a lack of stakeholder agreement on the cleanup approach, we interviewed officials from DOE’s Office of the Inspector General and reviewed relevant reports, interviewed DOE and state officials at other cleanup sites where DOE has worked successfully with regulators to implement an accelerated plan such as Rocky Flats, Colorado, and reviewed National Academy of Science reports regarding the benefits of technical peer review. We are sending copies of this report to the Secretary of Energy, the Administrator of the Environmental Protection Agency, and the Secretary of the Kentucky Natural Resource and Environmental Protection Cabinet. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions on this report, please call me at (202) 512-3841. Other staff contributing to this report are listed in appendix IV. Comments from the Department of Energy The following are GAO’s comments on the Department of Energy’s letter dated March 12, 2004. GAO Comments 1. We disagree. We believe that the report accurately describes DOE's decision to discontinue the Core Team process. This approach, established as a result of congressional hearings held in 1999, was designed as a collaborate process to advance progress at the site. Furthermore, EPA and Kentucky viewed this effort as a collaborative process. As we state in the report, DOE became concerned about the growing scope of the cleanup and the associated increase in costs, and believed that the Core Team's recommended actions were excessive. While discussion of the cleanup did continue at the senior management level, according to Kentucky officials and DOE site staff and contractor officials, DOE staff at the Paducah site were instructed by DOE headquarters not to continue discussing the cleanup with regulatory officials. 2. Our report does reflect the progress DOE and Kentucky have made in addressing near-term cleanup impediments, such as the signing of the agreed order that resolved outstanding regulatory violations. However, the long history of mistrust and lack of shared vision on the cleanup approach at Paducah, and the inability of the three parties to agree to and sign the fiscal year 2004 Site Management Plan, issued in draft in November 2003, indicate that the parties' relationship remains a challenge. 3. We have modified the final report to reflect DOE's recent progress on the excavation of the north-south diversion ditch. 4. We disagree with DOE's statement that we included post-closure costs in our comparison of past cleanup costs and schedules. For example, post-closure costs are not included in the comparison of current and past cleanup estimates and schedules presented in table 2. However, because we believe that it is important to provide a complete picture of DOE's financial responsibilities at the Paducah site, we did include post-closure costs as part of our discussion of DOE's total financial responsibilities at Paducah. We have also revised our report to more clearly indicate that post-closure environmental monitoring costs are a separate activity from cleanup activities and related costs. 5. We disagree with DOE's statement that our report does not provide a balanced presentation of all three parties' responsibilities for the past poor working relationship and delayed progress. We cite throughout our report examples of disagreements between DOE and the regulators, providing each side's position on these issues. For instance, we describe the disagreement over a sampling plan for soil excavation at the north-south diversion ditch. We also present DOE and Kentucky's positions over whether available data was adequate to warrant the installation of sedimentation basins at the site. Comments from the Environmental Protection Agency Comments from the Commonwealth of Kentucky GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the individual named above, Nancy Crothers, Chris Ferencik, Kerry Dugan Hawranek, and Kurt Kershow also made key contributions to this report. GAO’s Mission The General Accounting Office, the audit, evaluation and investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO’s commitment to good government is reflected in its core values of accountability, integrity, and reliability. 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In 1988, radioactive contamination was found in the drinking water wells of residences near the federal government's uranium enrichment plant in Paducah, Kentucky. In response, the Department of Energy (DOE) began a cleanup program. In 2000, GAO reported that DOE faced significant challenges in cleaning up the site and that it was doubtful that the cleanup would be completed as scheduled by 2010 and within the $1.3 billion cost projection. GAO was asked to determine (1) the amount of money DOE has spent on the site, the purposes for which it was spent, and the estimated total costs for the site; (2) the status of DOE cleanup efforts; and (3) the challenges GAO previously identified that continue to be issues for DOE. From fiscal year 1988 through 2003, DOE spent $823 million (in 2002 dollars) at the Paducah site. Of this total, DOE spent about $372 million (45 percent) for a host of operations activities, including general maintenance and security; $298 million (36 percent) for actions to clean up contamination and waste; and $153 million (19 percent) for studies to assess the extent of contamination and determine what cleanup actions were needed. DOE currently projects that the cleanup will take until 2019 and cost almost $1.6 billion to complete--9 years and about $300 million more than DOE's earlier projection. The $1.6 billion, however, does not include the cost of other DOE activities required at the site after the plant ceases operations, including final decontamination and decommissioning of the plant and longterm environmental monitoring. DOE estimates these activities will cost almost $5 billion and bring DOE's total costs at the site, including the $823 million already spent, to over $7 billion through 2070 (in 2002 dollars). DOE has made some progress in cleaning up contamination and waste at Paducah, but much of the work remains to be done. For example, while DOE has removed about 4,500 tons of scrap metal, almost 50,000 tons of contaminated scrap metal remain. Similarly, while DOE's pilot test of a new technology for removing the hazardous chemical trichloroethene (TCE) from groundwater at the site had promising results--removing about 99 percent of the TCE in the test zone--the technology will not be fully implemented for more than a year. Two of the four challenges GAO identified in 2000--DOE's plans to use untested technology and questionable assumptions that funding for the cleanup would increase--no longer pose the impediment to the cleanup they once did. Two others--uncertainty over the scope of the cleanup and difficulty obtaining timely stakeholder agreement on the cleanup approach--are the principal challenges that remain. First, the actual scope of the cleanup is not yet known. As a result, any additional cleanup actions, the costs of those actions, and the time frame for DOE to implement them are also unknown. Second, DOE and the regulators--the U.S. Environmental Protection Agency (EPA) and Kentucky--have had difficulty agreeing on an overall cleanup approach, as well as on the details of specific projects. Over time, these disagreements have undermined trust and damaged the parties' working relationship. After involving EPA and Kentucky early in the cleanup planning process, as it has done successfully at other sites, DOE officials discontinued this approach early in 2001, due in part to concerns about the growing cleanup scope, associated costs, and that the planned actions were excessive in relation to the risk. The result was an almost 2-year dispute that delayed progress. This poor working relationship has also prevented the parties from quickly reaching agreement on the technical details of specific projects. Unless DOE and the regulators can reach and maintain agreement on key aspects of the cleanup and quickly resolve technical differences, progress at Paducah could continue to be plagued by delays.

Background Bilateral creditors and IFIs created the HIPC Initiative in 1996 to address concerns that certain poor countries had accumulated unsustainable debt burdens, despite receiving debt relief from bilateral creditors. In response to concerns over the continuing vulnerability of poor countries, the World Bank and IMF enhanced the initiative in 1999 by reducing the qualifying thresholds and increasing the number of potentially eligible countries. Countries must meet numerous criteria in order to qualify for HIPC Initiative debt relief, such as establishing a track record of reform and sound policies. To fully benefit from HIPC debt relief, countries must progress through different phases of the initiative (see fig. 1). At a country’s “decision point,” IDA and IMF use certain criteria to determine whether a country qualifies to receive HIPC Initiative debt relief. If a country is determined to qualify, it can begin to receive interim HIPC debt relief. Subsequently, at the “completion point,” IDA and IMF determine whether the country meets additional criteria and can receive full and irrevocable HIPC debt relief. As of November 2008, of the 41 countries that may benefit from debt relief efforts, 23 had reached the completion point and 11 more had reached the decision point. An additional seven countries are considered “pre-decision point” countries and have not yet qualified for debt relief. MDRI expands upon the HIPC Initiative and represents the most recent effort to provide debt relief to heavily indebted poor countries. To receive MDRI debt relief, countries must first complete the HIPC Initiative. In addition, IMF has determined that it will provide MDRI debt relief to member countries with debt outstanding to IMF and a per capita income at or below $380 at end-2004 that do not otherwise qualify for debt relief. While the HIPC Initiative provides for a reduction in the debt levels of eligible countries, the process associated with MDRI debt relief requires IDA and ADF to take additional actions that provide resources to poor countries beyond those countries benefiting from debt relief. We estimate that IDA, IMF, ADF, and IaDB will provide, in present value dollars, about $58 billion in debt relief (in end-2008 present value dollars) under the HIPC and MDRI Initiatives to 41 countries over the next several decades. The amount of total debt relief provided under each initiative will be about equal, with over $28 billion provided under the HIPC Initiative and about $30 billion provided under MDRI. IDA is to provide the greatest level of debt relief at $34 billion (almost 60 percent of the total). IMF is to provide $10.6 billion, while ADF and IaDB are to provide $9.1 billion and $4.1 billion, respectively. Table 1 provides data on the amount of funding each institution will provide for each program. For the 33 countries currently receiving debt relief under both programs, IDA has secured about $8.6 billion for the HIPC Initiative and $4.4 billion for MDRI (for more detailed information, see app. III). This total of $13.1 billion represents 47 percent of the total required IDA financing of almost $27.8 billion for these countries under both debt relief initiatives. ADF will provide about $7.5 billion in HIPC Initiative and MDRI debt relief and has secured about $5.7 billion, about 76 percent of this amount. IMF and IaDB have fully financed their $8 billion and $3.8 billion of HIPC Initiative and MDRI debt relief for the countries currently receiving such relief, respectively, using internal resources and donor-provided funds. Because these two institutions have fully funded their HIPC Initiative and MDRI debt relief, almost 65 percent of total debt relief costs for all four IFIs has been secured. Based on our projections, the United States has committed to provide a total of about $8.4 billion to the four IFIs to finance the total costs of their HIPC Initiative and MDRI debt relief (see table 2). We estimate that the U.S. government is to provide $6.2 billion, or 74 percent, of its debt relief financing to IDA and $1.3 billion, or 16 percent, to ADF. The U.S. government has already provided $0.5 billion to IDA and $0.9 billion to ADF, leaving the majority of these costs ($5.7 billion for IDA and $0.4 billion for ADF) to be paid in the future. The U.S. government has provided $0.8 billion to IMF and $0.1 billion to IaDB. Of the $2.3 billion that the United States has already provided, $2.0 billion was for the HIPC Initiative and $0.3 billion was for MDRI. (App. IV provides information on bilateral debt relief that the United States has provided to countries under the HIPC Initiative.) U.S. Approach to Financing MDRI Does Not Fully Fund Current and Future U.S. Commitments Treasury, IDA, and ADF have agreed to a financing approach for MDRI called early encashment, under which the U.S. government earns income for early replenishment payments to IDA and ADF. Since the U.S. government is currently in arrears on its replenishment payments to IDA14, early encashment does not fully fund the current U.S. MDRI commitment. We also estimate that U.S. early encashment income will be insufficient to fully finance future MDRI debt relief. Furthermore, the U.S. financing approach is more costly than other options. Treasury Uses Early Encashment to Generate Income The U.S. government currently uses an early encashment approach to fund U.S. MDRI obligations at both IDA and ADF. Early encashment income is earned by IDA and ADF when the United States allows the IFI to draw funds on, or encash, its replenishment commitment early, rather than according to a standard encashment schedule that spans 9 years for IDA and 10 years for ADF. The standard encashment schedule represents the IFI’s expected disbursement pattern of the funds committed during the 3- year replenishment period. Treasury has agreed to allow IDA and ADF to encash the U.S. replenishment commitment over an accelerated 4-year period. Since the early encashments exceed amounts required during the first 4 years under the regular 9-year or 10-year encashment schedule, IDA and ADF can invest these funds and earn income (see app. V). IDA and ADF guarantee fixed discount rates that determine the amount of income countries using the early encashment approach will receive for full and timely encashments according to the accelerated schedule, regardless of IDA’s and ADF’s actual earnings on early encashments over the period. These amounts are then credited to the U.S. government and can be used toward paying the U.S. MDRI commitment. Treasury has separate agreements with IDA and ADF regarding the methodology used to estimate the amount of early encashment income that the United States will earn. United States in Arrears on Its IDA14 Replenishment Commitment The World Bank requires that the U.S. IDA14 replenishment be paid in full before early encashment income can be earned and used to fund MDRI; however, the United States is currently in arrears on its replenishment commitment. In recent years, Congress has withheld a portion of the U.S. replenishment contribution to encourage the World Bank to undertake specified reforms such as strengthened efforts to enhance transparency and combat corruption. In fiscal year 2006, Congress required that 20 percent of the funds appropriated to IDA be withheld from disbursement until the Secretary of the Treasury reported to Congress that the World Bank had undertaken certain anticorruption reforms. In fiscal year 2006, most of these funds were eventually disbursed pursuant to the requirements in the law; however, there was a shortfall in fiscal year 2006 of approximately $41 million due to both the anti-corruption withholding provision and an across-the-board rescission. In fiscal year 2007 there was an additional rescission of about $9.5 million. In fiscal year 2008, Congress rescinded $7.7 million and required that 10 percent, or $94 million, of IDA funds be withheld until Treasury reported that the World Bank had undertaken anticorruption reforms, and that another 10 percent be withheld until Treasury reported that the World Bank had enacted certain transparency reforms. As of July 2008, Treasury had reported to Congress that the World Bank had enacted anti-corruption reforms called for in the fiscal year 2008 appropriations law and had disbursed the corresponding funds. However, Treasury still had not reported to Congress that the World Bank had accomplished all of the 2008 transparency reforms and continued to withhold funds. Treasury has complied with its legal obligation to withhold these funds that have created arrears. When funds are rescinded or withheld from IDA, the shortfall amounts become arrears of the United States that remain until the appropriated funds are released from Treasury. We estimate that the U.S. government has arrears to the IDA14 replenishment of about $152 million, since the U.S. nominal contribution of $2,698 million is less than the U.S. commitment of $2,850 million. U.S. Early Encashment Income Insufficient to Fully Finance Current MDRI Debt Relief Due to Arrears Because the United States is currently in arrears on its IDA14 replenishment commitment, the early encashment income the United States earns does not fully finance the current U.S. MDRI commitment. Under the early encashment process, the World Bank first uses early encashment income to fund the present value of the shortfall in the U.S. IDA replenishment before applying early encashment income to the U.S. MDRI commitment. As such, the present value of the U.S. replenishment to IDA14 will be fully funded before the MDRI obligation begins to be paid. As shown in figure 2, based on current U.S. payments, we estimate that the United States will generate sufficient early encashment income to fully fund the U.S. IDA14 replenishment commitment in present value dollars, with $83 million in encashment income applied toward the $232 million U.S. MDRI commitment. After applying its earned encashment income of $83 million, the United States will have a shortfall of $149 million in its MDRI commitment. Treasury officials noted that if the United States ultimately pays its arrears to the IDA14 replenishment, early encashment income will then fund the U.S. MDRI commitment. However, to fully fund the U.S. MDRI commitment, (1) Treasury will need to release a withholding of $94 million from the IDA14 replenishment, by reporting to Congress that the World Bank has accomplished transparency reforms required under U.S. law, and (2) Congress will need to appropriate approximately $49 million in funds to compensate for the rescissions. Both actions will need to be completed by June 30, 2009. We estimate that the additional encashment income generated from releasing the $94 million will amount to $97 million and the shortfall in the U.S. MDRI commitment will decrease from $149 million to $52 million. A congressional appropriation of approximately $49 million by June 30, 2009 would generate enough early encashment income to finance the remaining $52 million U.S. MDRI commitment. Although it is unknown whether there will be any future shortfalls in U.S. replenishment payments, we assessed the impact of a shortfall on U.S. financing of MDRI similar to those that have occurred in recent years. The U.S. replenishment obligation for IDA for 2009 through 2011 is $3.7 billion, which includes $375 million for IDA’s HIPC Initiative costs. In addition, the United States has agreed to pay $356 million for its MDRI commitment, which Treasury plans to finance using early encashment. We assumed a 5 percent across-the-board shortfall, slightly less than the current 5.3 percent shortfall during the 2006 through 2008 period. (See app. V for further information on this simulation.) Under this scenario, the U.S. government would make payments of $3.52 billion, leaving a shortfall of $185 million. U.S. early payments would generate investment income of $308 million. After first financing the replenishment shortfall, the remaining early encashment income of $146 million would be used to pay the U.S. MDRI commitment of $356 million, leaving a MDRI shortfall of $210 million. ADF and Treasury have agreed to a different approach to calculate early encashment income that does not prioritize paying replenishment shortfalls before funding MDRI. All encashment income is solely used to pay the U.S. MDRI commitment. Excess encashment income is used to pay future U.S. MDRI commitments when needed. Any arrears or shortfalls in U.S. replenishment payments reduce encashment income proportionately. None of the early encashment income is used to offset regular replenishment shortfalls. U.S. Early Encashment Income Insufficient to Fully Finance Future MDRI Debt Relief The approach of funding the U.S. share of MDRI through early encashment income will not generate sufficient funding to meet the future U.S. commitment under the projected growth rate for future IDA replenishments. As we reported in our July 2008 correspondence, even if the United States pays its replenishments on time and in full, early encashment credits will be insufficient to finance U.S. MDRI obligations by 2014 for IDA and ADF. Table 3 shows the relationship between the U.S. replenishments and the use of early encashment to finance U.S. obligations to MDRI under the World Bank’s projected average 7 percent growth rate for IDA replenishments. The first row in table 3 shows the U.S. MDRI commitment from 2006 through 2023 in nominal dollars. Under this scenario, even if the U.S. government pays the replenishments on time and in full, there will be funding shortfalls for each replenishment period that will increase over time. We found that the U.S. government would need to increase its future replenishments to IDA by an average of 31 percent over the next 15 years, in order to fully fund its MDRI obligation using early encashment. Early Encashment Is More Costly Than Other Options Treasury’s use of an early encashment approach to finance the U.S. share of MDRI debt relief has been more costly than paying U.S. MDRI costs directly because U.S. costs to borrow funds have been greater than the agreed-upon encashment interest rate for IDA and ADF. We estimate that during the replenishment period from 2009 through 2011, early encashment will cost the United States an additional $39 million, $41 million more for IDA and $2 million less for ADF. (See app. VI for more information on this cost differential.) In September 2008, the Congressional Budget Office (CBO) forecasted Treasury note borrowing interest rates. For the 4-year period from fiscal year 2009 through fiscal year 2012, CBO projected the average borrowing cost to the U.S. government to be 5 percent. This interest rate is greater than the 4 percent interest rate used by IDA and the 4.69 percent used by ADF to calculate early encashment credits. The Extent to Which Countries Spend Debt Relief Resources to Reduce Poverty Is Unknown We estimate that 41 countries are to receive nearly $44 billion in additional MDRI and HIPC resources from the four IFIs, but the degree to which the countries target these resources at poverty-reducing activities is unknown. The $44 billion consists of freed-up resources resulting from HIPC Initiative and MDRI debt relief, as well as a MDRI-related reduction and subsequent reallocation of IDA and ADF assistance. The estimated amount by which IFI assistance will increase or decrease as a result of MDRI resource reallocation varies by country. The World Bank and IMF encourage countries to spend debt relief resources on activities to reduce poverty and make progress toward the UN Millennium Development Goals (MDG). Although the World Bank and IMF have suggested an association between reduced debt service payments and increased poverty-reducing expenditures, the extent to which countries spend debt relief resources on poverty-reducing activities is unknown. It is difficult to establish that debt relief has led directly to increased poverty-reducing expenditures for two reasons: (1) debt relief resources are difficult to track and (2) country spending data are not comparable and also may not be reliable. Countries Projected to Receive Nearly $44 Billion in Additional HIPC Initiative and MDRI Resources Overall, we project that the 41 countries receiving debt relief are to receive $43.8 billion in additional resources from the four IFIs between 2000 and 2054. As shown in figure 3, this estimate is based on three projected amounts: $21.4 billion in HIPC debt relief, $28.3 billion in MDRI debt relief (IFIs will provide about 95 percent of MDRI debt relief by 2034), and $5.9 billion in reduced new IDA and ADF assistance resulting from MDRI’s two-step process. Under this process, IDA and ADF reduce their new assistance to MDRI debt relief recipients by the amount of debt relief provided, $18.9 billion, and reallocate $13.0 billion of this reduction to MDRI recipients. IDA and ADF then reallocate the remaining approximately $5.9 billion to all low-income countries eligible to receive only concessional resources from IDA or ADF that did not receive debt relief. IDA and ADF determine the amount of funding each country is to receive primarily on the basis of country performance. Net Change in IDA and ADF Assistance for Each Country due to MDRI Varies Based on our projections, individual countries will have different results from MDRI as they realize increases, decreases, or both in their annual IDA and ADF assistance due to the resource reallocation process. For example, while the overall net change in resources available due to MDRI is positive for each of the five countries we analyzed (Ethiopia, Ghana, Tanzania, Nicaragua, and Rwanda), the countries are projected to receive different amounts of new IDA and ADF assistance. Table 4 illustrates the overall projected impact of MDRI, including the net change in IDA and ADF assistance, for our five case study countries. We project that, even as MDRI debt relief frees up fiscal resources, Ghana and Nicaragua may experience a decrease in IFI assistance over the life of MDRI due to the MDRI netting out and reallocation process. In contrast, for Tanzania and Ethiopia, we project that this MDRI process may result in an increase in assistance from IDA and ADF. For Rwanda, MDRI may provide a mixture of increases and reductions in IDA and ADF’s annual assistance over the MDRI period. (See app. VII for additional information on the impact of MDRI for our five case study countries, and app. VIII for additional information regarding the mechanics of the MDRI process.) Countries Are Encouraged to Spend Debt Relief Resources on Poverty Reduction, but the Extent of Such Spending Is Unknown While IFI and U.S. government documents state that countries should spend savings from debt relief on activities to reduce poverty and make progress toward the MDGs, the extent to which countries do so is unknown. In 2008, the World Bank and IMF suggested an association between reduced debt service payments and increased poverty-reducing expenditures, while acknowledging that it is difficult to show causation. Specifically, these IFIs reported that since the late 1990s, the debt service payments of countries that received debt relief have declined by about 2 percent of GDP, while poverty-reducing expenditures have increased by about the same amount. However, it is difficult to establish that debt relief has led directly to increased poverty-reducing expenditures for two reasons: (1) debt relief resources are difficult to track, and (2) country spending data are not comparable and also may not be reliable. Debt Relief Resources Are Difficult to Track The IFIs have suggested an association between debt relief and increased poverty-reducing expenditures. However, IMF and World Bank officials told us that they are unable to link debt relief resources directly to poverty-reducing expenditures because it is difficult to separate debt relief resources from other types of financial flows, such as international assistance and fiscal revenue. Based on the five case study countries, we found that these other resources often represent a much larger percentage of country budgets than savings from debt relief. For example, in the 2007 budgets of Ethiopia and Ghana, tax revenue and grant assistance represented at least 67 percent of government revenue combined, while HIPC Initiative and MDRI debt relief resources represented less than 8 percent (see fig. 4). Spending Data Are not Comparable and also May not Be Reliable Although IMF and the World Bank publish aggregated poverty-reducing expenditures for all countries that received debt relief, individual countries can define and report such expenditures differently, resulting in data that are not comparable. We found that definitions of poverty- reducing expenditures vary. For most countries that receive debt relief, reported poverty-reducing expenditures include spending on primary education, basic health care, and rural development; however, countries can also choose to include additional categories. For example, as shown in figure 5, some countries consider expenditures in areas such as energy development, transport, or judicial systems as poverty reducing, while other countries do not. Country definitions of poverty-reducing expenditures can also change over time to include or exclude categories. For example, in 2005, Rwanda expanded its definition of poverty-reducing expenditures to include energy development, while Nicaragua no longer included institutional strengthening. Such differences in definitions between countries, as well as changing definitions for particular countries, complicate comparability across countries and over time. In addition, we found that three of our five case study countries report aggregate spending in broad areas such as education, health and rural development rather than providing a detailed breakdown of poverty- reducing expenditures in these areas. For example, as shown above, while two countries (Ghana and Rwanda) reported specific spending in primary education and public health in their country budget documents, three countries (Ethiopia, Nicaragua, and Tanzania) reported only on aggregate spending in these two areas. Aggregate spending data can include activities that do not directly affect the poor and may overestimate actual poverty-reducing expenditures. For example, a 2003 IMF and World Bank Poverty and Social Impact Analysis for Nicaragua found that almost no public spending on university education affects the extremely poor, who generally do not participate at that level of the educational system. Furthermore, country capacity to collect and report on poverty-reducing expenditures is questionable. According to several IFI assessments, countries receiving debt relief have numerous weaknesses in collecting and reporting information on poverty-reducing expenditures that raise doubts about the data’s reliability. For example, a 2005 IMF assessment of country capacity to track poverty-reducing expenditures found that 19 out of 26 countries needed substantial upgrades to their data management systems and had weaknesses in tracking budgetary expenditures in areas such as budget formulation, execution and reporting. IMF and the World Bank do not independently track poverty-reducing expenditures, and instead rely on country governments to provide such data even though the accuracy of these data and country capacity to provide such information are uncertain. Additionally, the 2005 IMF assessment found that while 20 countries define poverty-reducing spending in their PRSPs, not all countries could identify these areas of expenditures in their budgets or report on such spending. Limitations in country capacity to report on poverty-reducing spending raise further concerns about the reliability of the combined data published by IMF and the World Bank. Moreover, while it is difficult to establish that debt relief has led directly to increased poverty-reducing expenditures, it is even more difficult to determine if debt relief has improved progress toward the MDGs. We found that for all five of our case study countries, progress data on the MDG targets were often either lacking or incomplete. In 2008, IMF and the World Bank reported that it is difficult to quantify the impact of debt relief on the MDGs and that they have instead focused their analysis on linking debt relief and poverty-reducing expenditures. The World Bank and IMF Have Improved Their Country Debt Sustainability Analyses and Identified Numerous Actions Countries Should Take to Avoid Future Unsustainable Debt Levels The World Bank and IMF have improved their country debt sustainability analyses (DSA) since 2005, including by addressing weaknesses that GAO and others have previously identified. If countries do not realize the objectives outlined in the new DSAs, they once again may experience unsustainable debt levels. These objectives are ambitious and could prove difficult for these poor countries to achieve over the course of the 20-year projection period. World Bank and IMF Established New Approach That Improves Projections of Country Debt Sustainability The World Bank and IMF introduced the Debt Sustainability Framework (DSF) in 2005 to provide a new and improved approach to assessing debt sustainability in low-income countries. The DSF is intended to help guide financing for low-income countries’ development needs, while also reducing the chances of another excessive build-up of debt in the future; help detect potential problems early so that preventative action can be improve World Bank and IMF assessments and policy advice; and provide guidance for country borrowing and creditor lending decisions. Under the DSF, IMF and World Bank staff prepare DSAs, which project debt sustainability indicators over a 20-year period and are conducted roughly every 12 to 18 months for low-income countries. These DSAs include elements that were lacking in the past and address weaknesses that had previously been identified by GAO, such as overly-optimistic economic assumptions. Furthermore, DSAs now result in a linkage between debt sustainability and the composition of future IFI assistance (grants and concessional loans), thus addressing a previous GAO assessment that IFIs should provide grants as a way of addressing future debt concerns. DSAs Determine Risk Based on the Strength of Country Performance and Analysis of Numerous Possible Scenarios In a departure from prior DSAs, the new DSAs consider the strength of a country’s policies and institutions in assessing risk and determining sustainable debt loads; countries with strong policies and institutions are considered capable of successfully carrying greater levels of debt. The DSF uses the World Bank’s CPIA index to sort countries into three policy performance categories (strong, medium, or poor). Countries with strong policies and institutions have a higher CPIA rating. An acceptable risk of debt distress for current strong performers, such as Tanzania, allows for higher levels of debt compared to countries with currently low CPIA ratings, such as Sierra Leone. Furthermore, performance categories are updated annually according to the latest CPIA ratings and, therefore, certain countries’ annual performance categories have varied since the new process was introduced in 2005. For example, Burkina Faso’s 2007 DSA noted that the country was a strong performer, but the country’s CPIA rating was subsequently lowered and the 2008 DSA identified Burkina Faso as a medium performer. As a result, DSAs for Burkina Faso now require lower levels of debt in order to be categorized as debt sustainable. The new process provides flexibility to assess every country’s risk differently based on individual performance, as well as an ability to adjust risk assessments within a specific country’s DSA over time as CPIA ratings shift. Currently, of the 23 countries receiving HIPC Initiative and MDRI debt relief, a majority (14) have been identified as medium performers, 5 as poor performers, and 4 as strong performers. DSAs conducted under the DSF now consider debt burden “threshold” indicators when assessing a country’s debt sustainability position. Five thresholds have been established that provide key insights into a country’s debt situation and that vary according to a country’s CPIA-based performance category (see table 5). Other DSAs, on the other hand, assess primarily only one variable. Strong performers have higher thresholds, indicating an ability to carry higher debt levels while maintaining debt sustainability. In order to project a country’s risk of future debt distress, these threshold indicators are compared against a country’s performance under a “baseline” scenario based on assumptions of macroeconomic performance expected for the future in areas such as national income, inflation, exports, imports, and government revenues and expenditures. Various sensitivity scenarios are also used to test the robustness of the indicators to changes in key assumptions. These scenarios include the following: (1) numerous temporary standardized “stress” or “shock” scenarios that consider possibilities such as lower growth in national income or exports than experienced in the past; and (2) two additional scenarios: (a) a scenario that assumes a level of public loans on terms that are less concessional, and (b) a historical scenario that uses macroeconomic assumptions based on past performance (which has often, but not always, been less optimistic than the baseline scenario in the past). IMF and World Bank staff explained that baseline assumptions will diverge from the historical scenario if the institutions agree that the economic outlook of a country has changed. Such changes must be explained in the DSA. For example, in the case of Tanzania’s 2007 DSA, a baseline GDP growth rate of 7.6 percent was used, rather than the historical 5.3 percent growth rate. According to the DSA, this change reflected “strong overall ratings of Tanzania’s macroeconomic policies, as well as ongoing structural reforms in key areas.” A country’s risk of future debt distress is then categorized as follows: Low risk – All scenario debt burden indicators are well below the thresholds throughout the 20-year projection period, and sensitivity testing does not result in significant breaches of thresholds; Moderate risk – Debt burden indicators are below the thresholds under the baseline scenario, but sensitivity testing causes them to exceed thresholds; High risk – Debt burden indicators exceed thresholds under the baseline scenario, and sensitivity testing further exacerbates the situation; or In debt distress – Debt burden indicators are currently in significant or sustained breach of thresholds, and the country is already experiencing repayment difficulties. As shown in table 6, for the 23 countries receiving HIPC Initiative and MDRI debt relief, 9 are classified at “moderate” risk of future debt distress, 4 at “high” risk, and 10 at “low” risk. IFI officials have considered refinements to the “moderate” risk classification that would provide greater distinctions within risk assessments, but have determined that there is currently no need to revise the category. New DSA assessments of country debt sustainability under multiple scenarios address past concerns that DSAs only used one scenario, which may have contained overly-optimistic economic assumptions. For example, we reported in 1998, 2000, and 2004 that expected debt sustainability for debt relief countries was calculated based on one scenario that assumed high economic growth, including strong and sustained export growth. We noted that such growth could be unrealistic given that many countries had very narrow export diversity (i.e., a limited number of exported goods), and these exports tended to be concentrated in the area of commodities that are highly vulnerable to events outside a country’s control, such as drought or price fluctuations. IMF officials told us that current DSAs use assumptions that have been lowered to more realistic levels. They also stated that DSAs, which include descriptions of macroeconomic assumptions, are now transparent because they are publicly available and subject to scrutiny by outside parties. In addition, IMF officials noted that because DSAs are conducted on an annual basis, DSAs can now begin to incorporate events such as increases in food or fuel prices in a timelier manner. However, IMF officials also noted that the current approach for determining future macroeconomic performance assumptions is “not a perfect science,” particularly when it makes projections over a 20-year period, and cannot be executed without potential forecast errors. In addition, a debt management capacity building group concluded that the sensitivity analyses contained in DSAs do not alter all relevant variables and exclude additional or secondary effects. It also reported that DSAs do not necessarily reflect all the risks that a country may think are likely in its own economic or borrowing prospects. IFIs Now Base Future Country Assistance on Risk of Future Debt Distress IDA and ADF have adopted a revised system for providing future assistance based on DSA results. According to IDA officials, countries with a high risk of debt distress, or countries that are already in debt distress, receive 100 percent grant assistance, countries with a moderate risk of debt distress receive 50 percent grants and 50 percent concessional loans, and countries with a low risk of debt distress receive only concessional loans. ADF officials told us that ADF has adopted a similar system. According to World Bank officials, when a country’s risk of future debt distress changes, the change is reflected in IDA allocations annually. This approach directly aligns IDA and ADF assistance with a country’s assessed ability to repay debt, and is relevant to our past reporting that the increased use of grant assistance would have a positive impact on future debt sustainability. However, IDA and ADF reduce the volume of grant assistance provided under this system. Specifically, IDA and ADF reduce grant assistance by 20 percent for countries classified at a high or moderate risk of debt distress, thereby reducing resources available for poverty reduction. The 20 percent volume reduction is divided into an “incentives”-related portion and a “charges”-related portion. The incentives-related portion is reallocated to IDA-only countries based on performance, and the charges-related portion is provided to creditworthy blend countries. According to IDA, this grant reduction was instated to maintain IDA’s performance incentive. Other IFIs, such as IaDB and the Asian Development Bank, are also utilizing the new DSAs as part of their lending decision-making process, according to IMF and World Bank officials. In addition, OECD export credit agencies adopted a set of lending principles that adhere to IDA and IMF concessionality in January 2008. Conversely, regarding borrowing decisions, IDA, ADF, and IMF officials stated that they work with country governments to improve their understanding and use of DSAs in future borrowing decisions. For example, IMF officials noted that DSAs are discussed as part of regular economic consultations with countries. Furthermore, according to an IMF and World Bank report, since 2005 eight training workshops have been organized in Africa, Asia, and Latin America and attended by officials from all 23 countries receiving HIPC Initiative and MDRI debt relief. However, IMF officials pointed out that countries currently range widely in terms of their ability to use the DSA process to conduct their own analyses, and some country officials have said that they find the DSA process to be overly complicated. DSAs Have Identified Numerous Ambitious Actions Countries Should Take in Order to Avoid Unsustainable Debt Levels The new DSAs have cited many actions that countries receiving HIPC Initiative and MDRI debt relief should take in order to avoid unsustainable debt burdens in the future. Of the 23 countries receiving HIPC Initiative and MDRI debt relief, 13 (over 50 percent) have been found to have a moderate or high risk of future debt distress. These countries maintain this level of risk despite substantial HIPC Initiative and MDRI debt relief. DSAs have stressed numerous policies or growth scenarios that countries should achieve in order to avoid further eroding their debt sustainability. For example, DSAs note that projected debt sustainability could be eroded if countries do not realize broad objectives that affect their overall economy, such as the following: continued concessional borrowing, implementation of sound macroeconomic policies, strengthened debt management capacity, sustained national income or export growth, and increased export diversity. Such broad and ambitious objectives could prove difficult for countries to achieve over the course of the 20-year DSA period for various reasons. A country’s debt position may be at risk even after it receives significant debt relief if, for example, its economy remains overly dependent on one export. For instance, Burkina Faso still held a moderate debt risk in 2007 despite World Bank and IMF reports that the HIPC Initiative and MDRI had substantially reduced its debt burden, because its economy is highly dependent on cotton exports (60 percent of total export value in 2006) which are vulnerable to large price fluctuations and weather shocks such as drought. In 2008, Burkina Faso’s debt risk was elevated to high due to deteriorating country performance. Other unexpected factors beyond a country’s control, such as oil and food import prices, may also affect economic position and debt sustainability. IMF and the World Bank have projected that countries may eventually return to pre-MDRI debt positions as they accumulate new debt over time. Continued concessional borrowing is cited frequently as an action countries must take to maintain debt sustainability. IFIs have taken actions to address the issue of excessive nonconcessional borrowing. While IFIs aim to lower the risk of debt distress in low-income countries by providing new financial assistance on appropriately concessional terms, other creditors and borrowing governments may gain from nonconcessional lending that is made possible following large-scale debt relief or in conjunction with IFI grant assistance. According to the World Bank, rating agencies may upgrade commercial risk ratings for countries that have received MDRI debt relief, improving the countries’ ability to secure nonconcessional loans. The risk of realizing an unsustainable nonconcessional debt burden is particularly high in resource-rich countries that can more easily obtain nonconcessional borrowing by using expected future export earnings as collateral to back such loans. In addition, IDA has noted that countries are experiencing significant risks associated with their weak debt management capacity. Debt management offices in low-income countries lack adequate capacity to monitor and accurately record debt data and new resource flows, let alone effectively manage them. IDA established a nonconcessional borrowing policy in 2006 to prevent the rapid reaccumulation of unsustainable debt. This policy states that IDA has two instruments at its disposal to confront excessive nonconcessional borrowing— reducing its assistance volumes (primarily used in countries where debt sustainability is a major concern) and “hardening” its lending terms in countries with stronger debt sustainability and greater financial market access. According to IDA staff, hardened lending terms could include an increased interest rate, a shorter grace period, or a reduced repayment period. IDA has also reported that these options come with trade-offs as volume cuts reduce resources available to pursue poverty reduction, and hardened terms may exacerbate debt sustainability problems. As of June 2008, IDA reported that there had been two cases of hardened lending terms (Angola and Ghana) and, as allowed, one exception (Mali) granted under its nonconcessional borrowing policy. IMF can impose limits on nonconcessional loans for countries that have a current arrangement with the institution. For countries that do not have a loan arrangement with IMF, there is nothing IMF officials can do when countries borrow on a nonconcessional basis beyond consulting with borrowing country officials. Conclusions While HIPC Initiative and MDRI debt relief are projected to provide countries with additional resources, it is unknown how much of these additional resources countries will spend on poverty-reducing expenditures or pursuit of the MDGs. Furthermore, some countries may have difficulty maintaining debt sustainability, which requires demonstrating strong and sustained performance in numerous critical areas such as national income and export growth over the next several decades. The current U.S. approach for financing MDRI has several limitations. First, if the U.S. government does not fully pay its regular contributions to IDA on time, which is currently the case primarily due to withholdings, early encashment funding will be used to cover shortfalls in U.S. funding to IDA, rather than to solely fund debt relief. Second, according to our estimates, the U.S. financing approach will likely result in future shortfalls for funding MDRI for both IDA and ADF as early as 2014, even if the U.S. government provides full funding in a timely manner. Given these limitations, reassessing the options for funding U.S. MDRI commitments for IDA and ADF is critical. Recommendation for Executive Action To address limitations in the U.S. approach for financing MDRI, we recommend that the Secretary of the Treasury consider the use of different funding options that clarify the priority between paying U.S. arrears owed to IDA and paying MDRI obligations, such as requesting separate appropriations from Congress. Agency Comments and Our Evaluation The Department of the Treasury, the World Bank, and IMF provided written comments on a draft of this report, which are reprinted in appendixes IX, X, and XI. Treasury stated that it is open to our recommendation that alternative U.S. funding approaches for MDRI be considered in the future. Treasury emphasized its objective to fully meet its current IDA and MDRI funding commitments while also noting that a lack of full funding would jeopardize this objective. In addition, Treasury expressed a view that World Bank and IMF analyses produced under the Debt Sustainability Framework represent an improved ability to assess the debt sustainability outlook in low-income countries. Treasury explained that while debt relief can be a valuable tool, merely canceling debt is not sufficient to ensure long-term debt sustainability if underlying economic vulnerabilities remain. The World Bank stressed the importance of full funding for IDA and a sustainable U.S. funding approach to cover debt relief costs. The World Bank also noted that our report could more explicitly state that it will not be possible for the United States to fund future MDRI costs through early encashment of the regular IDA contributions. The World Bank reported that the annual MDRI costs of IDA will more than triple over the next two decades, reaching an estimated $1.8 billion per year by 2025. Continuing the current practice would presuppose a commensurate increase in regular IDA contributions from the United States. The World Bank further noted that funds from debt cancellation are small, relative to domestic revenues and external aid flows in countries benefiting from the debt relief, but represent a source of predictable financing for poverty-reducing expenditures. IMF stated that poverty-reducing spending has increased in countries that have benefitted from debt relief - a point also made by Treasury. IMF further noted its disagreement with our position that the impact of debt relief on poverty-reducing spending is unknown. We maintain that our position is accurate since, while data compiled by IMF report that poverty- reducing spending has increased in countries receiving debt relief, it is not possible to link such increases to debt relief. Multiple factors, including challenges in tracking how debt relief resources are used and data reliability concerns, make it difficult to establish a linkage. Treasury, the World Bank, IMF, and the African Development Bank provided technical comments on a draft of this report, which we have incorporated as appropriate. The World Bank’s technical comments are included as part of its formal comment letter and suggested, as did IMF technical comments, that we better distinguish between recent debt sustainability analyses conducted under the Debt Sustainability Framework and other analyses conducted to establish the amount of debt relief needed to lower external public debt to agreed HIPC Initiative thresholds. We have altered our report to address this point. The African Development Bank provided comments on the U.S. costs for funding MDRI. We requested comments from IaDB, but none were provided. We are sending copies of this report to other congressional offices and the Department of the Treasury, as well as the World Bank, IMF, AfDB, and IaDB. The report also is available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-9601 or at melitot@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last past of this report. Other contacts and major contributors are listed in appendix XII. Appendix I: Objectives, Scope, and Methodology Our objectives were to (1) analyze the U.S. financing approach for debt relief efforts, (2) review the extent to which the Multilateral Debt Relief Initiative (MDRI) might affect resources available to countries for poverty- reducing activities, and (3) assess revisions to the analyses conducted by the World Bank and IMF to review and promote future debt sustainability. U.S. Financing for Debt Relief To analyze U.S. financing for debt relief, we compiled data from Treasury and IFI staff and reviewed the U.S. contribution with these staff. To evaluate whether the U.S. approach to funding its IDA and ADF MDRI costs was adequate to fully pay U.S. commitments, we estimated total U.S. commitments in each IDA and ADF replenishment period and then used this amount in a simulation model of the U.S. payment schedule in order to estimate the amount of early payment credits that would be earned annually if Treasury continued to use the early encashment approach. To evaluate the early encashment approach the United States is using to finance its IDA and ADF MDRI costs during 2006-2011, we analyzed the statistical models that IDA and ADF are using to calculate U.S. encashment income. We performed simulations of shortfalls in U.S. replenishment payments and discussed our results with officials from Treasury and these IFIs. We developed a model to compare the costs to the United States of paying the MDRI obligation using the current early encashment approach rather than paying annual MDRI costs directly when due. Appendixes V and VI provide additional information regarding the costs associated with use of early encashment. We calculated and have presented all figures in this report in end-2008 present value dollars unless otherwise noted. We assessed the reliability of the data analyzed and found the data to be sufficiently reliable for the purpose of this report. MDRI and Resources Available for Poverty- Reducing Activities To estimate the impact of MDRI debt relief on countries’ resources, we calculated the aggregate net change in resources for MDRI recipient countries using an approach that considers the value of money over time. Our methodology reflects the three elements of MDRI’s structure: MDRI debt relief, IDA and ADF reductions of annual assistance to the countries by the amount of debt relief provided in that year, and the reallocation of a portion of the cancelled debt service to countries based on their performance. IDA, ADF, and IaDB provided aggregate, annual debt relief and country-specific annual MDRI debt relief data for all current and expected future MDRI recipient countries, including our five case-study countries. To calculate the aggregate reduction of annual assistance from IDA and ADF, we applied each IFI’s encashment schedule to the disbursement of the annual MDRI debt relief that both IDA and ADF provided. While 1 year’s debt relief is matched by a reduction in 1 year’s IDA or ADF assistance, the reduction in assistance takes place over a 9- year disbursement cycle for IDA and a 10-year disbursement cycle for ADF. This annual MDRI debt relief reduction, aggregated over all MDRI recipients, is the amount to be reallocated to IDA-only recipients—a larger subset of IDA recipients than those that receive MDRI debt relief—on the basis of performance. We refer to this as the performance-based reallocation, or PBA reallocation. We discussed our methodology with IMF and World Bank officials. The staff of both IFIs concurred that our approach was a valid way to analyze MDRI. To determine the portion of the MDRI debt relief to be reallocated to recipients as additional HIPC countries reach their completion point, we created a weighted allocation index based on data provided by the World Bank. The World Bank told us that the group of 23 completion point countries is currently receiving 50 percent of the reallocated cancelled debt relief funds, and that this would rise to 60 percent as the interim (decision point) countries reach their completion points, which is assumed to occur during 2009 and 2010. To determine the portion of the additional 10 percentage points that would go to each of the 10 interim countries, we created a weighted allocation index by dividing each country’s projected percentage of IDA14 assistance flows by the portion of IDA14 assistance going to this group of 10 countries. To compute each country’s share of the IDA PBA reallocation, we multiplied their weighted allocation index by the 10 additional percentage points to calculate the portion of the 10 percent that each would receive. Finally, to calculate the changing PBA allocation over the period as the individual countries reach their completion point, we added each country’s respective share of the 10 percentage points on to the 50 percent base, arriving at 60 percent in 2010. We used the same methodology to determine the additional portion of the MDRI pool of debt relief that would go to 8 pre-decision point countries, based on their projected completion point dates that the Bank provided. We assume that the pre-decision point countries will account for a proportional percentage of the 10 percentage points, reflecting their projected portion of IDA14 assistance flows. Based on this methodology, we estimate that, adding on the 8 pre-decision point countries, 41 HIPCs would receive about 67 percent of the reallocated MDRI debt relief and the remainder would go to all other low-income countries eligible to receive only concessional loans from IDA or ADF. ADF provided us with the amount of MDRI debt relief reallocated to all of its member countries, as well as the projected completion point dates for the HIPCs. To determine the portion of ADF’s MDRI debt relief to be reallocated to recipients as additional HIPC countries reach their completion point, we added each country’s percentage of total MDRI debt relief to the current reallocation percentage as countries successively reach their completion point. For ADF countries, by 2016, 33 HIPC countries would account for nearly 90 percent of ADF’s reallocated MDRI debt relief. For all efforts to review the impact of MDRI on country resources, we assessed the reliability of the data analyzed and found the data to be sufficiently reliable for the purposes of this report. We also included Enhanced HIPC Initiative debt relief in our analysis to present a more complete picture of the IFIs’ contribution to debt relief. IDA, ADF, IaDB, and IMF provided annual data for Enhanced HIPC, by country. We included these data in our reported estimate of overall debt relief resources. To calculate the impact of MDRI debt relief on individual countries, we selected five countries (Ethiopia, Ghana, Nicaragua, Rwanda, and Tanzania) as case studies based on several criteria, including dispersion of country ranking in terms of the percentage of total HIPC and MDRI debt relief they received from the four institutions, geographic diversity, and debt sustainability risk classification. In terms of percentage of debt relief received, we selected countries at or near the top, middle, and bottom of the ranking to use as examples of how the program works. Our choice of countries is meant to be illustrative, not representative. We used the same methodology to estimate the three components of MDRI debt relief for individual countries as we used in the aggregate. To determine whether countries receiving debt relief are using the savings toward poverty reduction and achieving the MDGs, we reviewed documents provided by Treasury, the World Bank, IMF, ADF and IaDB, and spoke with officials at Treasury and these four institutions. We also examined publicly-available online data sources for poverty-reducing expenditures in areas such as education and health. To illustrate the impact of debt relief on individual nations, we examined the spending data for the five countries cited above. We reviewed the most recent Poverty Reduction Strategy Papers (PRSP) of the five countries in order to examine their poverty-reducing goals and objectives. In addition, we reviewed the most recent (2007) online country budgets and IMF Article IV consultation documents for our five case study countries to examine how countries were reporting their poverty-reducing expenditures. Debt Sustainability Analyses In order to assess revisions to IMF and World Bank debt sustainability analyses (DSA) since 2005, we first reviewed prior GAO reports issued between 1998 and 2004 that identified weaknesses in past DSAs. We then examined IMF and World Bank documentation explaining the Debt Sustainability Framework (DSF) and the related DSAs and other relevant issues, the following in particular: Staff Guidance Note on the Application of the Joint Fund-Bank Debt Sustainability Framework for Low-Income Countries, October 6, 2008; Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI) – Status of Implementation, September 12, 2008; IDA’s Nonconcessional Borrowing Policy: Review and Update, June 2008; Applying the Debt Sustainability Framework for Low-Income Countries Post Debt Relief, November 6, 2006; How to Do a Debt Sustainability Analysis for Low-Income Countries, IDA Countries and Nonconcessional Debt: Dealing with the “Free Rider” Problem in IDA14 Grant-Recipient and Post-MDRI Countries, June 19, 2006; Review of Low-Income Country Debt Sustainability Framework and Implications of the MDRI, March 27, 2006; and Operational Framework for Debt Sustainability Assessments in Low- Income Countries – Further Considerations, March 28, 2005. We then collected and reviewed all DSAs performed for 23 completion point countries since the DSF was implemented in 2005 as part of IMF Article IV consultations, IMF Poverty Reduction Growth Facility (PRGF) arrangement requests or reviews, or other events. We identified the assumptions and scenarios used, and compiled the most recent risk determinations for each country. We did not independently assess the accuracy or comprehensiveness of the assumptions and data included in the DSAs. We discussed the DSA process with IMF and World Bank officials and found the DSA information sufficiently reliable for descriptive purposes. We compared the current process against the weaknesses we had previously identified to determine whether the new process addressed these limitations. Furthermore, we identified additional alterations to the process and interviewed IMF, World Bank, IaDB, and AfDB officials to obtain their views on the new DSA process and results. Finally, we compiled the results of DSAs to determine the debt distress risk of countries currently receiving HIPC Initiative and MDRI debt relief, as well as DSA recommendations for actions such countries should take in order to avoid future downgrading of their debt risk classification and deterioration of their debt sustainability. Our work focused on analyses related to external debt and not domestic public debt. We conducted this performance audit from December 2007 through January 2009 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Commercial Lawsuits to Collect Unpaid Debt from Debt Relief Countries Lawsuits by commercial creditors to collect on outstanding HIPC country debt can erode gains made through debt relief. International courts and U.S. federal courts have allowed commercial creditors to pursue legal action in order to recover funds owed to them, but these creditors are sometimes viewed as creating difficult circumstances for countries that have received debt relief from other creditors. As of the end of 2007, based on survey data provided by country governments, 47 litigating creditors had filed suits against 11 countries receiving HIPC Initiative and MDRI debt relief (see table 7). Over $1 billion has been awarded by courts and is due to commercial creditors. About one-third of this total, or over $440 million, has been awarded against the Republic of Congo, followed by over $350 million against Liberia, and $100 million against the Democratic Republic of the Congo. Treasury officials told us that while a court can award claims in favor of commercial creditors, actually enforcing the judgments and receiving payment is a separate, potentially more difficult exercise. The international community has taken numerous actions to address such cases: The World Bank’s Debt Reduction Facility (DRF) allows governments to buy back—at a deep discount—country debts owed to external, commercial creditors. Through grants, the DRF supports heavily indebted IDA-only countries that undertake reforms to retain professional services necessary in preparing these commercial debt reduction operations and assists the countries in funding the cost of these operations. For example, court judgments against Nicaragua were settled through the DRF-supported buyback. All four litigating creditors participated in the buyback operation and accepted a significant cut in the value of their legal claims. The Nicaragua buyback extinguished about $1.3 billion in commercial debt. Another buyback operation has been concluded for Mozambique. Furthermore, according to Treasury officials, a DRF operation is currently being prepared for Liberia, and the United States intends to contribute $5 million to help fund the cost of this buyback. Paris Club creditors have committed as a group not to sell claims on HIPC countries to creditors who do not intend to provide debt relief. In April 2008, AfDB approved a proposal to establish the African Legal Support Facility (ALSF), which would provide (1) technical legal advice to members of the facility in creditor litigation, and (2) technical legal assistance to members of the facility to strengthen their legal expertise and negotiating capacity in matters related to debt management and other issues. The U.S. government was the only participating state to vote against establishment of the ALSF, and Treasury officials have noted that countries that have been the target of recent litigation have had very able legal representation to date, calling into question the need for ALSF assistance. In addition, Treasury staff expressed a position that some of the proposed activities for the ALSF are not an appropriate use of AfDB funds and noted concerns over the substantial administrative costs associated with ALSF. Furthermore, Treasury staff have emphasized that the DRF—an option already in operation that is achieving results in reducing country debt burdens to commercial creditors—is a preferred alternative. Appendix III: Funding Provided for the HIPC Initiative and MDRI IDA and ADF have not secured all financing that will be required to meet their HIPC Initiative and MDRI debt relief commitments for countries currently receiving such relief, though IaDB and IMF have secured all necessary funding. Overall, about 65 percent of the $47 billion in funding required to cover debt relief over the next several decades has been secured. Countries have currently received about $14 billion in debt relief. Overall, we project that the U.S. government is committed to provide about $8.4 billion in funding for the HIPC Initiative and MDRI. IDA and ADF Have Not Secured All Necessary Financing Of the $27.8 billion required to finance IDA’s HIPC Initiative and MDRI debt relief for the 33 countries currently receiving such relief, IDA has secured about $8.6 billion for the HIPC Initiative and $4.4 billion for MDRI (see fig. 6). This total of $13.1 billion represents 47 percent of the total required financing for both debt relief initiatives. IDA previously financed the HIPC Initiative primarily through transfers from the World Bank’s International Bank for Reconstruction and Development. Beginning in July 2006, this financing process changed and became part of the regular 3-year replenishment process. Donors have agreed to finance MDRI costs on a “dollar for dollar” basis (i.e., total MDRI costs will be covered) in conjunction with, and in addition to, replenishment contributions through 2044. According to our projections, ADF is to provide about $7.5 billion in HIPC Initiative and MDRI debt relief and has secured about $5.7 billion, or more than 75 percent, of this amount. ADF has secured $4.6 billion for the HIPC Initiative and $1.1 billion for MDRI. ADF is financing the HIPC Initiative from internal African Development Bank resources and donor contributions, all of which are channeled through the HIPC Trust Fund administered by the World Bank. As with IDA, donors have agreed to finance ADF’s MDRI costs on a “dollar for dollar” basis in conjunction with, and in addition to, replenishment contributions through 2054. IMF and IaDB Have Secured HIPC Initiative and MDRI Funding IMF and IaDB have fully financed their $8 billion and $3.8 billion of HIPC Initiative and MDRI debt relief for the countries currently receiving such relief, respectively, using internal resources and donor-provided funds. Because these two institutions have fully funded their HIPC Initiative and MDRI debt relief for the countries currently receiving debt relief, almost 65 percent of total debt relief costs for all four IFIs have been secured. To fund HIPC Initiative and MDRI debt relief, IMF uses internal resources, including proceeds from its 1999 and 2000 off-market gold sales, and donor contributions. IMF has also secured some of the funds to cover its future debt relief costs for the countries not yet receiving debt relief. IaDB has fully financed its HIPC Initiative debt relief from internal resources and donor funding through the HIPC Trust Fund. With the advent of its MDRI-like program in 2007, IaDB created a blended loan product made up of concessional and nonconcessional funds, according to Treasury officials. The process of creating this blended product freed up resources to be used for debt relief while allowing IaDB to continue to provide concessional lending. Furthermore, Treasury officials noted that IaDB took other measures to obtain additional resources, such as canceling undisbursed portions of nonperforming concessional loans, to gain access to additional funding. IaDB freed up sufficient internal resources to provide debt relief for its four member countries receiving HIPC Initiative and MDRI debt relief as well as reserves of about $0.4 billion for Haiti when it completes both programs. Countries Have Realized $14 Billion in Debt Relief Assistance Countries currently receiving debt relief have thus far realized less than a third of expected assistance. Countries realize the benefits of debt relief as annual debt service payments to IFIs that would have come due are no longer required to be paid. Debt relief provides the countries with additional available resources that they can spend on other activities, such as poverty-reduction programs. Table 8 shows the amount of debt relief assistance that each IFI has delivered compared to the required amount of assistance that has been approved. The IFIs have delivered a total of $14.3 billion in debt relief, which is 30 percent of the approved $47.1 billion for the 33 countries. IDA has delivered the largest amount, $6.2 billion, representing 22 percent of its approved $27.8 billion in debt relief assistance. IMF has delivered $4.8 billion, or 60 percent, of its approved $8 billion in debt relief. The HIPC Initiative has delivered nearly 80 percent, or $11.4 billion, of the debt relief delivered to date. Countries began receiving HIPC Initiative debt relief benefits in 1998, whereas MDRI debt relief began in 2006. Appendix IV: U.S. Bilateral HIPC Initiative Debt Relief Table 9 shows the budget cost and the amount of bilateral debt relief the U.S. government has provided or is projected to provide to 30 countries under the HIPC Initiative. Appendix V: Calculation of Early Encashment Credits We calculated the outcome of the early encashment approach to funding the U.S. MDRI commitment under a scenario (1) where the U.S. government makes its payments in full and on time, and (2) where the U.S. contribution is 5 percent less than required. Our analysis demonstrates the significant impact on early encashment income and actual U.S. funding levels for MDRI when funding reductions, similar to those experienced in recent years, are realized. The following is our explanation of the early encashment process. We use the same assumptions that are being used by Treasury and IDA, but describe the process in nominal dollars. The U.S. government plans to pay its share of IDA’s debt relief costs for MDRI from the encashment income generated by paying its regular IDA replenishment commitment over a 4- year period, rather than over the standard 9-year period. Table 10 describes this process. The U.S. replenishment obligation for IDA15, which covers the period 2009 through 2011, is $3.7 billion. Column (a) describes the annual standard encashment or payment schedule over the 9-year period from 2009 through 2017. Column (b) is the annual U.S. payment over a 4-year period. Column (c) is the annual outstanding excess payment. In 2009, this amount consists of the difference between what the U.S. government pays, $1.1 billion, and the required amount of $252 million. In subsequent years, it consists of the annual excess in payment plus the outstanding excess payment balance. Beginning in the fifth year, no new payment is made. The excess payment balance is used to cover the required payment. In the ninth year, the excess payment balance is just sufficient to pay the last year’s required payment. Column (d) is the annual encashment investment income. This amount is the estimated earned income calculated by multiplying the excess payment balance by the agreed-upon interest rate, which is 4 percent for the IDA15 replenishment. The line “Total (nominal)” shows that the total payments under the standard encashment schedule is equal to the total under the early encashment schedule. The total nominal dollar earned income is $359 million. Treasury and IDA use a different method to compute early encashment income. Under their method, Treasury and IDA first calculate the present value sum of the payment schedules. The present value is a statistical method that takes into consideration the amount of annual payments, the time during which these payments are made, and the interest rate when computing the sum. Although the nominal sums of the two schedules are the same, the present value of the early encashment schedule, $3,414 million, is larger than that of the standard schedule, $3,114 million. Treasury and IDA compute the percent face value as the difference between these present values divided by the present value of the standard schedule. The percent face value, 9.63 percent in this example, is multiplied by the nominal sum of early encashment payments, $3,705 million, to calculate the early encashment income of $357 million. This is the agreed-upon methodology and $357 million will be used toward paying the U.S. IDA MDRI commitment of $356 million. The surplus $1 million can be used to pay future MDRI obligations. In the previous example, the U.S. government pays its replenishment in full and all the early encashment income is used to pay its MDRI obligation. In the next example, we assume that the U.S. government does not pay its replenishment in full, either due to a rescission or a decision to withhold payment until certain reforms are made by the World Bank. Under the agreed-upon methodology, early encashment income is first used to pay off the replenishment shortfall. Any remaining encashment income is then used to pay the U.S. IDA MDRI commitment. Table 11 describes the calculation of early encashment income when there is a replenishment shortfall. We assume an across-the-board shortfall in U.S. annual payments of 5 percent, resulting in a shortfall of $185 million. Thus, the total nominal early encashment payments are $3,520 million. Since the annual U.S. payments are less, the earned income in column (d) is less: $308 million or a 14-percent reduction. The calculated early encashment income to pay for the U.S. MDRI commitment is $146 million, a 59 percent reduction. Most of the earned encashment income is used to pay the replenishment shortfall. If the across-the-board shortfall were 8.8 percent or more of the replenishment, all of the earned encashment income would be used to pay the shortage and nothing would be used to pay the U.S. MDRI commitment. Treasury and ADF have agreed to use a different methodology to compute early encashment income. We applied this ADF approach to the IDA15 replenishment. If there is no funding shortfall, the results are identical between the two approaches. When there is a shortfall, the ADF approach implicitly reduces the standard encashment schedule payments by the average across-the-board percentage shortfall. Thus, the nominal total of the standard encashment schedule is the same as the total early encashment schedule payments. In the previous example with a 5 percent shortfall, the computed early encashment income would total $339 million and all of this amount would be used to pay the MDRI obligation. None of the earned encashment income would be used to pay the shortfall to IDA. Appendix VI: Early Encashment Costs More than Alternative Financing Under some conditions the early encashment approach to pay the U.S. MDRI commitment may be more costly than paying the annual MDRI obligations directly when they are due. If the cost for the U.S. government to borrow the funds exceeds the agreed upon interest rate used to compute early encashment income, then the early encashment approach is more costly than paying the U.S. replenishment and MDRI obligations annually as they come due. Conversely, if the borrowing cost to the U.S. government is less than the agreed-upon interest rate used to compute early encashment income, then the early encashment approach is less expensive. According to the Congressional Budget Office, the average medium-term cost to borrow funds during fiscal year 2009 through fiscal year 2012 is projected to be 5.0 percent. This amount is greater than the 4.0 percent agreed-upon interest rate used to compute early IDA encashment income. Under these conditions, the early encashment approach to finance the U.S. IDA MDRI commitment is more costly than paying the U.S. commitment directly. Assuming that the full replenishment and IDA MDRI commitments are paid, we estimate that the cost to the U.S. government for early encashment payments, including financing costs for IDA15, will be $3,347.2 million in end-2008 present value dollars. This is about $38 million more than the cost of paying IDA15 replenishment and MDRI obligations annually as they come due, a total of $3,309.6 million. In nominal dollars, we estimate the additional cost is $42 million. Since early encashment income earned is $1 million more than MDRI obligations, the net additional cost is $41 million. A similar cost analysis for ADF-11 in end-2008 present value terms shows that the early encashment cost, including financing costs, is $416.8 million, about $12.2 million more than the cost of paying ADF-11 replenishment and MDRI obligations annually as they come due, a total cost of $404.6 million. This reflects the higher government cost of borrowing, 5 percent, than the 4.69 percent used by ADF to calculate early encashment income. Again we have assumed that the United States pays its full replenishment and ADF MDRI commitment. In nominal dollars, we estimate the additional cost is $14 million. Since early encashment income earned is $16 million more than MDRI obligations, for ADF-11 early encashment results in a net benefit of $2 million as compared to paying replenishment and MDRI obligations annually as they come due. Based on CBO’s projections for the cost of U.S. borrowing, we estimate that during the replenishment period from 2009 through 2011, early encashment will cost the United States an additional $39 million, $41 million more for IDA and $2 million less for ADF. Appendix VII: Projected Impact of MDRI on Five Case Study Countries Based on our projections, while the overall net change in resources available due to MDRI is positive for each of the five countries we analyzed (Ethiopia, Ghana, Tanzania, Nicaragua, and Rwanda), individual countries may experience increases or decreases in their IFI assistance. The following graphs illustrate the projected overall impact of MDRI for these five countries. The shaded area indicates the negative (below the axis) or positive (above the axis) change in IDA and ADF assistance. Ghana and Nicaragua are projected to experience a decrease in IFI assistance due to reduced IDA and ADF assistance over the life of MDRI, even as MDRI debt relief provides freed-up resources. (See shaded area in figs. 7 and 8.) In contrast, for Ethiopia and Tanzania, MDRI is projected to result in an increase in assistance from IDA and ADF. (See shaded area in figs. 9 and 10.) As shown in figure 11, for Rwanda, MDRI is projected to provide a mixture of increases and reductions in IDA’s and ADF’s annual assistance over the MDRI period. Appendix VIII: Implementation of the Multilateral Debt Relief Initiative (MDRI) Process We found that countries receiving MDRI debt relief are projected to receive about $3 billion more than suggested in World Bank/International Development Association (IDA) documents describing MDRI. IDA documents state that, in a particular year, IDA is to reduce its commitments of financial assistance to countries receiving MDRI debt relief by the amount of debt relief provided, netting each other out. Donor governments have agreed to compensate IDA for the foregone debt service payments. IDA is to reallocate these funds to all countries eligible to borrow only from IDA, which includes countries that receive MDRI debt relief as well as those that do not. Thus, when IDA reallocates the donor funds, all IDA-only countries would be at the same starting point—with no net additional funds. We compared the projected amount of debt relief to the projected amount of reduced assistance under two scenarios, each incorporating the time value of money. In the first scenario, we assumed that IDA reduces its assistance by the amount of debt relief provided in the same year, as described in World Bank documents. In the second scenario, we considered the disbursement pattern that IDA actually uses to distribute the reduction in allocations for MDRI recipients as well as the reallocation of those funds. Under the second scenario, because the disbursement pattern takes place over a 9-year period, the dollar value of MDRI debt relief is greater than the actual reduction in IDA disbursements. In the first scenario, IDA is projected to provide $18.9 billion in debt relief and reduce its assistance commitments to MDRI recipients by the same amount. IDA is then projected to reallocate—on the basis of performance—a portion of this $18.9 billion of reduced assistance commitments to recipients of debt relief, $12.3 billion, and the remainder, $6.6 billion, to IDA-only countries that do not receive debt relief. (See fig. 12.) Under the second scenario, the overall annual amount of debt relief is greater than the overall annual reduction in assistance. When considering the disbursement pattern of IDA funds, the projected net present value of MDRI debt relief, $18.9 billion, is greater than the net present value of IDA’s reduction in assistance, $15.8 billion, by $3.1 billion. Countries that receive debt relief are projected to receive this $3.1 billion in addition to about $10.2 billion in reallocated assistance, for total MDRI benefits of $13.3 billion. (See fig. 13.) The additional $3.1 billion places debt relief recipients in a more advantageous position at the outset of the reallocation process than their non-debt relief counterparts. While IDA documents indicate that donor funding provided to compensate for MDRI debt relief is to be reallocated to IDA-only countries, IDA is using donor finances to provide the $3.1 billion in net debt relief benefits to debt relief recipients, in addition to their performance-based reallocation of donor funds. Thus, the $18.9 billion in donor financing for MDRI is allocated as follows: $3.1 billion to net debt relief benefits, $10.2 billion in IDA reallocations to debt relief recipients, and $5.5 billion in reallocations to non-debt relief recipients. Appendix IX: Comments from the Department of the Treasury The following is GAO’s comment on the Department of the Treasury’s letter dated January 9, 2009. GAO Comment 1. GAO could not identify sufficient empirical evidence to suggest that increases in spending for the poor are directly related to savings from debt relief. It is difficult to establish that debt relief has led directly to increased poverty-reducing expenditures for two reasons: (1) debt relief resources are difficult to track, and (2) country spending data are not comparable and also may not be reliable. Because of these limitations, it is difficult to establish if debt relief has caused these countries to increase or decrease their spending toward the poor. Appendix X: Comments from the World Bank The following is GAO’s comment on the World Bank’s letter dated January 12, 2009. GAO Comment 1. We have revised our report language to clarify this distinction between DSAs. Appendix XI: Comments from the International Monetary Fund The following is GAO’s comment on the International Monetary Fund’s letter dated January 8, 2009. GAO Comment 1. Based on our evidence, we found that the impact of debt relief on poverty-reducing expenditures is unknown. Our report shows that additional resources have been created by debt relief, but it is difficult to establish that debt relief has led directly to increased poverty- reducing expenditures for two reasons: (1) it is not possible to track how debt relief resources are used, and (2) country spending data are not comparable and also may not be reliable. In addition, based on our review of five MDRI case study countries, we found that debt relief resources are often much less than other types of resources such as tax revenue and grants. Therefore, while we agree that associations between debt relief and poverty-reducing expenditures may exist, the impact is unknown. Appendix XII: GAO Contact and Staff Acknowledgments Staff Acknowledgments In addition to the person named above, Cheryl Goodman, Assistant Director; Leslie Holen; Bruce Kutnick; RG Steinman; Farahnaaz Khakoo; Ashley Alley; and Debbie Chung made key contributions to this report. Related GAO Products Developing Countries: U.S. Financing for Multilateral Debt Relief Initiative Currently Experiencing a Shortfall. GAO-08-888R. Washington, D.C.: July 24, 2008. Developing Countries: Challenges in Financing Poor Countries’ Economic Growth and Debt Relief Targets. GAO-04-688T. Washington, D.C.: April 20, 2004. Developing Countries: Achieving Poor Countries’ Economic Growth and Debt Relief Targets Faces Significant Financing Challenges. GAO-04-405. Washington, D.C.: April 14, 2004. Developing Countries: Switching Some Multilateral Loans to Grants Lessens Poor Country Debt Burdens. GAO-02-593. Washington, D.C.: April 19, 2002. Developing Countries: Challenges Confronting Debt Relief and IMF Lending to Poor Countries. GAO-01-745T. Washington, D.C.: May 15, 2001. Developing Countries: Debt Relief Initiative for Poor Countries Faces Challenges. GAO/NSIAD-00-161. Washington, D.C.: June 29, 2000. Developing Countries: Status of the Heavily Indebted Poor Countries Debt Relief Initiative. GAO/NSIAD-98-229. Washington, D.C.: September 30, 1998.

In 1996, the Heavily Indebted Poor Countries (HIPC) Initiative was created to provide debt relief to poor countries that had reached unsustainable levels of debt. In 2005, the Multilateral Debt Relief Initiative (MDRI) expanded upon the HIPC Initiative by eliminating additional debt owed to four international financial institutions (IFI): the International Monetary Fund (IMF), World Bank's International Development Association (IDA), African Development Fund (ADF), and Inter-American Development Bank (IaDB). These four IFIs are projected to provide $58 billion in total debt relief to 41 countries. GAO (1) analyzed the U.S. financing approach for debt relief efforts; (2) reviewed the extent to which MDRI might affect resources available to countries for poverty-reducing activities; and (3) assessed revisions to the analyses conducted by the World Bank and IMF to review and promote future debt sustainability. GAO analyzed Treasury, IFI, and country documents and data, and interviewed officials at Treasury and the four IFIs. Treasury's approach to financing MDRI, known as early encashment, does not fully fund current and future U.S. commitments. The approach does not fully fund the current U.S. MDRI commitment because the United States is in arrears on its IDA replenishment. These arrears are due to requirements under U.S. law for withholdings and across-the-board rescissions. Under early encashment, the World Bank requires that the U.S. commitment to the IDA replenishment be paid in full before early encashment income can be used to fund MDRI. The World Bank deducts the U.S. arrears to IDA from any early encashment income before applying this income toward the U.S. MDRI commitment, resulting in a current MDRI shortfall of $149 million. Treasury officials said that if the United States ultimately pays its arrears to the IDA replenishment, early encashment income will then fully fund the U.S. MDRI commitment. However, to fully fund the U.S. MDRI commitment, (1) Treasury will need to release a withholding of $94 million by reporting to Congress that the World Bank has accomplished transparency reforms required under U.S. law, and (2) Congress will need to appropriate approximately $49 million to compensate for the rescissions. Moreover, GAO estimates that the early encashment approach will be insufficient to fully finance future U.S. MDRI commitments even if U.S. payments are made on time and in full because these commitments exceed projected early encashment income. GAO estimates that the HIPC Initiative and MDRI debt relief from the four IFIs combined may provide countries for which data are available with nearly $44 billion in additional resources over the next 50 years, but the extent to which countries spend these resources on activities to reduce poverty is unknown. In addition to providing debt relief, the MDRI program for IDA and ADF provides for a reallocation of assistance, based in part on a consideration of the strength of country policies and institutions. The estimated amount of this MDRI assistance individual countries receive will vary. Although IFIs and the U.S. government encourage recipient countries to spend resources generated from debt relief on efforts to reduce poverty, the extent to which such spending occurs is unknown for two reasons. First, debt relief resources are difficult to track, because these resources cannot easily be separated from other types of financial flows such as international assistance and fiscal revenues. Second, country data on poverty-reducing expenditures are not comparable across countries and also may not be reliable. The World Bank and IMF have improved their country debt sustainability analyses (DSA) since 2005, including by addressing weaknesses GAO previously reported. DSAs now consider the strength of a country's policies and institutions in determining sustainable debt loads and assess future debt sustainability under multiple scenarios that adjust economic assumptions. Furthermore, IDA and ADF now structure their assistance based on a country's risk of debt distress. While the new DSAs have identified numerous ambitious actions countries should take to avoid eroding their debt sustainability, implementing these actions could prove difficult.

Background The drawdown of equipment and personnel from Iraq is a highly complex operation of significant magnitude. According to DOD, as of February 2010, there were approximately 98,100 U.S. military personnel in Iraq, spread among 228 bases throughout the country. Additionally, as of February 2010, the Army reported that there were approximately 3.1 million pieces of equipment in Iraq, worth almost $28 billion, about 20 percent of which is DOD owned, theater provided equipment, which is a pool of permanent stay behind equipment that has accumulated in Iraq since combat operations began in 2003. Theater provided equipment includes both standard and non-standard equipment. Standard equipment refers to those items authorized on a military unit’s modified table of organization and equipment. Non-standard equipment refers to equipment issued to units that is not authorized on their modified table of organization and equipment, and includes a wide range of items such as construction equipment, materiel handling equipment, flat screen televisions, certain types of radios, and Mine Resistant Ambush Protected vehicles (MRAP). Figure 1 provides a more detailed breakdown of the U.S. Army equipment in Iraq. The logistics infrastructure supporting the redeployment and retrograde effort in the Iraqi theater of operations is large and complex, consisting of military organizations operating in both Iraq and Kuwait, and it is through Kuwait’s three seaports and two airports that the majority of U.S. forces, materiel, and equipment flow from the theater of operations. Moreover, myriad logistics organizations in both Iraq and Kuwait also support these operations, including elements of CENTCOM, U.S. Transportation Command, the Defense Logistics Agency, U.S. Army Central (ARCENT), the 1st Theater Sustainment Command, Army Materiel Command, U.S. Marine Corps Central Command, U.S. Naval Forces Central Command, U.S. Air Forces Central Command, and U.S. Special Operations Command. According to our previous reports and testimonies on Operations Desert Shield and Desert Storm, the retrograde of materiel and equipment is likely to consume the most time and resources throughout the drawdown effort. We have also reported extensively on the use of contractor personnel for combat and logistics support and the need for improvements in the management of contractors used to support military operations. DOD contracted services needed in Iraq and Kuwait as the drawdown progresses fall under two general categories: (1) services that will need to be decreased as the U.S. military presence declines and (2) services for which demand may temporarily increase due to drawdown-specific needs, such as transporting equipment for retrograde. Contracted services can be further categorized as those services provided under LOGCAP, including the majority of base and life support in Iraq such as meals, sleeping arrangements and laundry services, transportation within Iraq, and postal services, and those not provided by LOGCAP, such as security guards for bases. Coordinated Plans and New Organizations Have Facilitated Progress in the Drawdown from Iraq, but DOD Has Yet to Plan for All Contracted Support Needed During the Drawdown A number of DOD organizations have issued plans outlining a phased drawdown from Iraq that meet time frames set forth in the Security Agreement and presidential guidance while being responsive to security conditions on the ground. Furthermore, in accordance with these plans, DOD created several organizations to facilitate the retrograde of equipment and support unity of effort, and established goals and metrics to track its progress. According to DOD, these efforts to date contributed to the meeting or exceeding of targets for drawing down forces and retrograding equipment. However, while DOD has made significant progress executing the drawdown, there remains a large amount of personnel, equipment, and bases yet to be drawn down within the established timelines. Moreover, DOD has yet to fully plan for contracted services needed during the drawdown. DOD Has Issued Plans for the Drawdown, Taken Steps Toward Executing Them, and Exceeded Some Targets Beginning in May 2009, MNF-I and its subordinate command responsible for executing the drawdown from Iraq, Multi-National Corps-Iraq (MNC-I); Headquarters, Department of the Army; and USF-I issued coordinated plans outlining how the drawdown of military and contractor personnel, equipment, and bases should be managed over time. These plans support DOD’s goals for reducing, by August 31, 2010: (1) the number of military personnel to 50,000, (2) the number of contractor personnel to 55,000 while increasing the proportion of Iraqi contractor personnel, and (3) the number of bases to 134. In addition, to mitigate the risk of bottlenecks of equipment during the later phases of the drawdown, commanders were directed to identify organizational equipment and theater provided equipment no longer essential for ongoing operations and turn it in for retrograde. Accordingly, MNC-I set a goal of retrograding 1,500 non- mission essential items of rolling stock per month until April 2010, and 2,500 per month after this date to reach a level of 16,500 of these items remaining in Iraq by the change-of-mission date. Similarly, MNC-I set a goal of drawing down 3,000 containers full of other equipment through April 2010, and then 3,800 containers per month after that date, leaving 17,000 containers worth of non-rolling stock in Iraq. In support of its plans DOD created several organizations to oversee the drawdown and ensure unity of effort. In September 2008, we reported that the variety of organizations exercising influence over the retrograde process and the resultant lack of a unified or coordinated command structure was not consistent with joint doctrine, which led to confusion and inefficiencies in the retrograde process. To bolster unity of effort, MNF-I established a new organization, the Drawdown Fusion Center, to provide a strategic picture of drawdown operations, identify potential obstacles, address strategic issues, and assist in the development of policy and guidance related to several aspects of the drawdown. Assisting the Drawdown Fusion Center was ARCENT’s Support Element-Iraq, a liaison element established to enhance synchronization and coordination among MNF-I; MNC-I; ARCENT; Headquarters, Department of the Army; and Army Materiel Command. This organization also generated theater and Department of the Army disposition guidance for all forces and materiel redeploying and retrograding out of Iraq. USF-I has subsequently integrated the Drawdown Fusion Center, ARCENT’s Support Element-Iraq, and the MNF-I and MNC-I logistics offices into one organization under the USF-I Logistics Directorate. Moreover, it has established a Drawdown Synchronization Center as the single entity within USF-I responsible for synchronizing, analyzing, and capturing drawdown data and then disseminating the data to the appropriate DOD organizations. Finally, in order to assist with the provision of disposition instructions for materiel retrograding out of Iraq and synchronize those instructions with the reset of Army equipment, the Department of the Army, with Army Materiel Command as the lead agency, created a Responsible Reset Task Force. The drawdown from Iraq commenced with the publication of MNF-I’s plan in May 2009. According to the metrics DOD established to track drawdown progress, efforts to reduce personnel and retrograde equipment in the initial months of the drawdown exceeded targeted goals. For example, according to USF-I, as of February 8, 2010, there were just over 98,100 servicemembers in Iraq, approximately 3,200 fewer than had been projected. In addition, as of January 2010, DOD retrograded 2,610 more pieces of rolling stock than projected and, as of December 2009, 5,195 more containers of equipment than projected. While DOD’s progress since May 2009 exceeded some of its targets, a large amount of personnel, equipment, and bases remain to be drawn down within the established timelines. To meet the presidential target of reducing the number of U.S. forces in Iraq to 50,000 by August 31, 2010, USF-I must reduce its present force by almost 50 percent by this summer. Furthermore, to meet other drawdown targets for August 31, 2010, USF-I must draw down 45 percent of its contractor personnel workforce, retrograde 46 percent of its rolling stock, and close 41 percent of its bases in Iraq. The remaining forces, contractor personnel, and equipment will have to be drawn down during the final 16 months, from August 31, 2010 to December 31, 2011, during which time some of the largest bases in Iraq will also have to be closed or transferred to the Government of Iraq, a task the commanding general of USF-I stated could take 9 to 10 months to complete. Figure 2 illustrates the numbers of U.S. forces, contractor personnel, rolling stock, containers, and bases that have already been drawn down; what must be drawn down before the August 31, 2010 change-of-mission date; and what will remain to be drawn down before December 31, 2011. While DOD Has Planned for Some Contracted Services Needed to Support the Drawdown, Challenges Remain DOD took some steps to plan for and source contracted services needed during the drawdown. For instance, DOD planned for some LOGCAP requirements needed during the drawdown, including the number of transportation systems, Army post offices, and logistics support services required at specific bases. According to DOD documentation, operational commands in Iraq validated these requirements for LOGCAP at the bases that will remain open past August 31, 2010, and communicated these requirements to the LOGCAP program office which, in turn, took steps toward awarding the LOGCAP task orders. Additionally, other supporting contracting organizations in Iraq took steps to meet the needs for non- LOGCAP services that were identified as required by military units or other deployed organizations. For example, the Joint Contracting Command-Iraq/Afghanistan, an organization that manages non-LOGCAP service contracts, which comprise about 20 percent of all contracts in Iraq, plans to expand its use of theaterwide contracts to provide food services, medical support, fire protection, facilities and housing, and other base and life support needs. Despite these steps, limited operational planning for contracted support has challenged USF-I’s ability to identify the full range of its needs for contracted services to support the drawdown. According to joint doctrine and service guidance, operational personnel who plan, support, and execute military operations must also determine the contracted support needed to accomplish their missions. In Iraq and Kuwait, these operational personnel include combat force commanders, base commanders, and logistics personnel, among others, who are responsible for determining the best approach to accomplish their assigned tasks and, if the approach includes contractors, identifying the types and levels of contracted support needed. Army guidance also states that planning for contracted support must be integrated early in the deliberate planning process to ensure that it is adequately considered and that it must include specific requirements identified by operational personnel, such as the identification of the full extent of contractor involvement and how and where contracted support should be provided. MNF-I’s drawdown plan, however, delegated the responsibility for determining contracted support requirements to contracting agencies, such as the Joint Contracting Command-Iraq/Afghanistan, rather than to operational personnel. But according to Joint Contracting Command-Iraq/Afghanistan officials, they could not determine the theaterwide levels of contracted services required, or plan for mandated reductions based on those needs, because they lack sufficient, relevant information on future requirements for contracted services, information that should have been provided by operational personnel. For example, according to MNF-I documentation, during an October 2009 meeting between operational personnel and contracting officials, MNF-I reiterated that the levels of contracted services ultimately needed in Iraq during the drawdown were unknown. This is consistent with an overarching weakness identified by a Joint Staff task force, which recognized limited, if any, visibility of contracted support and plans and a lack of requirements definition. As a result, rather than relying on information based on operationally driven requirements for contracted services, MNF-I planned for, and USF-I is subsequently tracking, the reduction of contracted support in Iraq using historical ratios of contractor personnel to servicemembers in Iraq, which may not accurately reflect the actual levels of contracted support needed during the drawdown. Although several DOD officials have stated that uncertainties associated with the changing operational environment in Iraq hinders DOD’s ability to project the full range of contracted services needed, joint doctrine emphasizes that planning entails making logical and realistic assumptions and does not demand certainty, and that plans can be adjusted to reflect changes on the ground. Without incorporating appropriately specific details on contract support in its operational planning for the drawdown, USF-I risks hindering the communication of contract-related decisions to those who must implement and execute them, including decisions about funding, deployment and redeployment, operational and life support, force protection, and the location of contractors on the battlefield. Further, this may continue to limit USF-I’s ability to plan for the full range of contracted services needed during the drawdown and jeopardize its ability to provide the right service at the right place and time. Timely planning for contracted services needed to support the drawdown is also critical in order to avoid potential waste and ensure continuity of services. USF-I guidance, however, may not allow sufficient time for all contracted services needed during the drawdown to be put on contract in a responsible manner. Sound business practices specify that the full definition of requirements for contracted services should occur as early as possible to ensure the personnel responsible for putting the needed services on contract can do so on time and at the agreed-upon cost. If operational personnel fail to communicate their needs for contracted services with enough lead time for contracting officials to put these services on contract responsibly, DOD may incur unnecessary costs by authorizing undefinitized contract actions, as it has in the past, which allow contractors to begin work before reaching a final agreement on contract terms and conditions, including price. While a contract action remains undefinitized, the contractor has little incentive to control costs, creating the potential for waste. In addition, a lack of timely planning for contract support may lead to other poor outcomes, such as increased cost, lengthened schedules, underperformance, and service delays. According to MNF-I’s plan and the former Joint Contracting Command- Iraq/Afghanistan commander, DOD’s need for contracted services in Iraq, such as security, transportation, engineers, and materiel handling teams, may temporarily increase during the drawdown. Officials have also acknowledged that additional contractor personnel will be needed to provide services currently being provided by U.S. forces as these forces redeploy. For example, DOD officials stated that they contracted for airfield painting in Iraq and Kuwait because the servicemembers normally responsible for this task had redeployed, and that similar requirements regularly surface. As a result, senior contracting officials in Iraq expressed concern that the needs for some services may increase beyond levels available under existing contracts as the drawdown progresses. Because increasing the level of existing services or adding new ones may necessitate new contracts, additional time may be necessary to obtain these services. For example, contracting officials in Iraq stated that obtaining additional contracted security services outside of existing contracts would take about five months, compared to about three months necessary to increase the levels of services already on contract. Further, USF-I’s goal to increase the proportion of Iraqi contractors may entail greater lead time to put these vendors’ services on contract because it may take longer to review Iraqi vendor proposals. Yet USF-I’s standard operating procedures for requirements validation in Iraq only state that personnel should submit requirements for contracted services at least 90 days prior to the date funding is needed. Without directing operational personnel in Iraq to identify requirements for services with enough time for contracting officials to responsibly put them on contract, DOD increases its risk of not being able to obtain these services on time, or employing inefficient contracting practices such as undefinitized contract actions. Although DOD has established new organizations that are intended to facilitate efficient contracting during the drawdown, it has not clarified how these contracting organizations differ from one another or specified how they fit into the requirements identification and validation process. In accordance with joint doctrine and Army guidance, when planning for contractor support, planners must be aware of the operational principle of centralized contracting management to achieve unity of effort. Centralized management can be achieved through means intended to synchronize and coordinate all contracting support actions being planned for and executed in the operational area. The MNF-I drawdown plan called for the Joint Logistics Procurement Support Board, composed of senior operational personnel and contracting officials, to reduce costs and redundant contracting and develop and promote strategies for coordinating approaches to common or similar requirements. However, MNF-I’s drawdown plan also referred similar functions to the Strategic Sourcing Board, which also includes members from both the operational and contracting communities. Officials’ statements and DOD documentation illustrate differing views of the composition, roles, and responsibilities of these boards, such as the extent to which these boards review requirements for contracted services. For example, senior contracting officials told us that the Joint Logistics Procurement Support Board is responsible for collecting contract requirements as they emerge, yet one of these officials later told us that this board does not gather contract requirements. Moreover, USF-I’s process by which operational personnel and contacting officials review and validate requirements for contracted services includes two other boards—the Joint Facilities and Acquisition Review Board and the Contract Review Board— yet it is unclear how the previously mentioned Joint Logistics Procurement Support Board or the Strategic Sourcing Board fit into USF-I’s process, nor how these boards differ from one another. As a result, the specific functions of the Joint Logistics Procurement Support Board and the Strategic Sourcing Board, and the relationship of these boards to USF-I’s established processes, are unclear. Without clarifying the responsibilities of these boards and how they fit into the existing requirements validation process, DOD may not be able to ensure contracting unity of effort so that its requirements for contracted services needed during the drawdown are effectively consolidated and prioritized. Several Additional Challenges May Affect the Efficient Execution of the Drawdown Efficient execution of the drawdown from Iraq may be complicated by several challenges. First, challenges associated with the planned simultaneous transition of several key contracts may lead to the interruption of vital services and wasteful contracting practices. Second, insufficient analysis to quantify the costs and benefits of transitioning the LOGCAP contract in Iraq prevents DOD from ensuring that the transition will be beneficial to the government. Third, persistent shortages of contract oversight personnel may increase the potential for fraud, waste, and abuse. Fourth, a lack of clarity concerning the extent to which and for how long equipment retrograded from Iraq may be staged in Kuwait or other locations in southwest Asia may affect DOD’s plans for reset and equipping. And lastly, DOD lacks complete visibility over its inventory of equipment and shipping containers. DOD is aware of and has begun addressing some of these issues. For example, DOD is in the process of implementing new systems and procedures to improve its equipment disposition process. In addition, units in Iraq were required to complete a 100 percent inventory of their equipment, identify equipment that can be immediately retrograded, and account for previously undocumented equipment. Despite these efforts, however, challenges remain. Near-Simultaneous Transition of Key Contracts Creates Risk for Interruption of Services Lessons learned and documented during the LOGCAP transition in Kuwait indicate that other upcoming major contract transitions may be problematic. With the exception of the LOGCAP contract for Iraq, which is discussed in more detail below, four other major service contracts in Iraq and Kuwait, which provide field support maintenance, base and life support, and convoy trucking services, have reached their expiration dates. According to USF-I and Joint Contracting Command- Iraq/Afghanistan leadership, the services provided under these contracts, particularly in areas like maintenance and convoy trucking, are critical to mission success, highlighting the need to ensure continuity of these services during the drawdown. These four contracts, plus LOGCAP III in Iraq, are scheduled to be transitioned to new contracts or task orders between January 2010 and January 2012. According to Army Sustainment Command officials, DOD has re-competed one of the maintenance contracts and made an award in October 2009. However, it has not yet awarded new contracts for two other contracts which have already expired, and the first task order to be awarded under the new LOGCAP was delayed. Contract transition can be a time-consuming process requiring careful planning and management, and lessons learned during the LOGCAP transition in Kuwait indicate that the upcoming major contract transitions may be problematic. In light of the transition from LOGCAP III to LOGCAP IV in Kuwait, which occurred between February and June 2009, the Army, in conjunction with the Defense Contract Management Agency, created a lessons learned document to help inform planners of potential challenges they may face in managing future contract transitions. These lessons are particularly relevant given that contract management officials predict that the challenges experienced during the earlier transitions will likely be magnified during those scheduled to occur during the drawdown. According to Army guidance on the lessons learned process, lessons learned, which can result from an evaluation or observation of a positive finding worthy of continuing or emulating, should be integrated into planning activities in order to better prepare for future operations. One of the main lessons learned during the LOGCAP transition in Kuwait is that communication is the most essential element of the transition process. Accordingly, the Kuwait LOGCAP transition lessons learned document lists 10 practices used successfully during the transition in Kuwait to ensure effective communication between the government, outgoing contractor, and incoming contractor. For example, during the LOGCAP transition in Kuwait, representatives of the government, outgoing contractor, and incoming contractor formed an integrated planning team to ensure a common understanding of their respective roles, responsibilities, and approaches for executing the transition. In light of the positive results which could be achieved through these practices, the lessons learned document contains 11 recommendations to ensure continued effective communication that are applicable to future contract transitions. Accordingly, Army Material Command’s LOGCAP transition plan references the lessons learned document and establishes a synchronized methodology for ensuring effective information exchange and a common operational picture, such as by requiring kick-off meetings and rehearsal of concept drills. However, information from Army officials indicates that the plans for transitioning other major contracts may not be as extensive. Without extensive planning, to include steps necessary to establish and maintain effective communications such as those outlined in the lessons learned document, DOD may be unable to ensure that major contracts in Iraq will transition smoothly as the drawdown progresses. Transferring personnel between contracts is another key challenge identified in the lessons learned document. Certain contracted positions require specialized skills and experience. For example, operating the material handling equipment used to bring containers to wash racks for cleaning and customs inspection requires a materiel handling equipment license. Because the supply of personnel with this skill and qualification is limited, incoming contractors rely on hiring personnel who worked under the outgoing contract rather than hiring new personnel. Moreover, according to the lessons learned document, during the LOGCAP transition in Kuwait the incoming contractor intended to hire at least 80 percent of the outgoing contractor’s personnel to begin providing services according to schedule. Yet the outgoing contractor needed to retain its employees to continue to provide the services for which it was contracted. As a result, although the incoming and outgoing contractors agreed to a protocol for transferring employees, poor execution at some sites led to staffing shortages and some service interruptions. For example, according to the lessons learned document, a shortage of personnel available to operate large machinery in Kuwait forced officials to shut down the wash racks, which are critical to maintaining the flow of equipment out of Kuwait. According to a DOD report, analogous problems arising from an insufficient number of properly skilled and experienced workers have also been experienced during the LOGCAP transition in Afghanistan. A senior contracting official in Iraq expressed concern that similar challenges will occur during the drawdown as other contracts transition. Moreover, although the LOGCAP transition plan specified steps to facilitate the transfer of the outgoing contractors’ pool of trained individuals to the incoming vendor should these personnel decide to seek employment, it does not assess the risk of an insufficient number of these personnel deciding to work for the incoming contractor. Furthermore, the extent to which any of these issues are addressed for the other contracts scheduled for transition is unclear. Joint doctrine states that effective contract support planning must be based on a thorough mission analysis, including an assessment of risks. Without assessing the risk of an insufficient number of properly skilled and experienced contractor personnel available under each of the new contracts and developing appropriate mitigation strategies, DOD may not be able to ensure the full performance of tasks critical to the drawdown during the upcoming contract transitions. Issuing credentials to contractor personnel was another major challenge experienced during the LOGCAP transition in Kuwait. Of all contract transition issues, the need for timely credentialing, which includes badges such as common access cards and other location-specific badges, has caused some of the greatest concerns, according to DOD officials. According to those officials, DOD requires new badges for contractor personnel following contract transitions, regardless of whether a new contractor wins the award, because credentials are tied to specific contracts. According to the lessons learned document, this credentialing process can take between two and three weeks to complete. Consequently, contractors experienced delays in credentialing their employees during the LOGCAP transition in Kuwait. This may be exacerbated during contract transitions in Iraq because of the planned increase in the proportion of Iraqi nationals working under contract and the fact that obtaining credentials for them typically takes more time than it does for contractor personnel of other nationalities. Moreover, the contractor responsible for operating the credentialing office in Kuwait is also transitioning as a part of the Kuwait base and life support services contract, which may, in turn, create additional delays and illustrates a potential difficulty in conducting multiple, near-simultaneous contract transitions. Although the LOGCAP transition plan includes a process for facilitating the credentialing process for contractor personnel, neither this plan nor DOD’s other planning documents address possible stresses on credentialing offices that might occur during these contract transitions. Without fully incorporating the risks inherent to conducting multiple contract transitions concurrently into its planning for each contract scheduled to transition, including options to mitigate those risks derived from key lessons learned during the LOGCAP transition in Kuwait, DOD may be unable to effectively manage the timely transition of these contracts and prevent the interruption of key services needed to facilitate mission success during the drawdown. This is especially true because these transitions may need to occur within compressed time frames due to delays in awarding key contracts. DOD Has Not Determined Whether the Potential Benefits of Transitioning LOGCAP in Iraq Outweigh the Potential Costs and Risks Although the current active LOGCAP contract in Iraq, LOGCAP III, does not expire until after U.S. forces are scheduled to leave Iraq, officials plan to transition LOGCAP III to other means of contracted support in the midst of the drawdown. Specifically, USF-I plans to transition base and life support, logistics, transportation, and postal functions currently provided by LOGCAP III to other contracts, including LOGCAP IV, the Air Force Contract Augmentation Program, and individual sustainment contracts with Iraqi contractors. These transitions are expected to be completed by December 2010, although, according to LOGCAP officials, some of the locations at which base and life support services will transition remain uncertain. And while the LOGCAP transition in Iraq is intended to produce certain benefits, these benefits may not be fully attainable within the drawdown timelines, and may be outweighed by costs and risks that could be incurred during the transition. An analysis of whether the potential benefits of this transition outweigh the potential costs and risks is part of the planning and review process for transitioning to LOGCAP IV and other service contracts. Acquisition planning is intended to “ensure that the Government meets its needs in the most effective, economical, and timely manner.” To this end, acquisition plans should include an examination of costs, risks, and other considerations, such as feasible alternatives and the impact of prior acquisitions. Further, DOD guidance states that service acquisitions should receive adequate planning and management, including senior level reviews and in some instances independent management reviews, to achieve required cost, schedule, and performance outcomes. Although officials anticipate benefits from making the LOGCAP transition in Iraq, these benefits may not be fully realized. Senior DOD officials have stated that the rationale for making the transition away from LOGCAP III in Iraq includes reducing the cost of base and life support services, mitigating the risks associated with relying on a single contractor to provide essential services, and bolstering the Iraqi economy by transitioning services to local Iraqi vendors. However, these anticipated benefits may not be fully realized since DOD will have only until December 31, 2011, to realize potential cost savings before the U.S. military completely withdraws. This may leave insufficient time to recoup transition costs, compensate the government for taking on risk, and provide value to the government. In addition to the uncertainty regarding the realization of anticipated benefits from the LOGCAP transition in Iraq, DOD will likely incur additional costs and risks during the transition. Costs may increase because the outgoing and incoming contractors will need to perform work simultaneously to avoid the interruption of services, thereby increasing the number of contractor personnel needed to facilitate the transition. The LOGCAP transition in Iraq may also increase the contract management and oversight responsibilities for operational commanders, who play a significant role in the management and oversight of the LOGCAP contractor. For example, the Army requires commanders to periodically evaluate their contractors’ performance and provide feedback to the contractor during monthly performance evaluation boards. Because the Army intends to award several task orders for base and logistics services, possibly to multiple contractors, the number of monthly evaluations could increase for some commanders. Furthermore, an increase in the number of contracts and contractors during the transition may complicate commanders’ abilities to obtain essential contracted support. Under the current LOGCAP III contract in Iraq, commanders generally need to speak with one program manager to obtain the full range of contracted services. Under LOGCAP IV, however, services may be divided among multiple contractors for any particular location. As a result, the task of determining how to obtain particular services and correcting service problems may divert commanders’ limited resources from other responsibilities. Therefore, should the upcoming LOGCAP transition in Iraq proceed as planned, commanders will need to overcome challenges on which we have previously reported, such as inexperience in dealing with contractors, uncertainty regarding oversight responsibilities, and the inability to dedicate resources for oversight, or DOD risks having inadequate management and oversight. The planned LOGCAP transition in Iraq may also impact the continuity and quality of service provided to the warfighter. While service disruptions like those experienced during the transition to LOGCAP IV in Kuwait caused only temporary inconveniences, similar service disruptions in a continuously evolving environment like Iraq have a greater potential for negatively impacting ongoing operations. For example, according to a senior Defense Contract Management Agency official responsible for contract management and oversight in Iraq, there is concern about DOD’s plan to begin transitioning the theater transportation mission, since it could require a new contractor to assume the mission just as the department undertakes a significant troop level reduction planned for March-April 2010. Executing the rapid movement of troops and equipment out of Iraq will require significant truck assets, and transitioning the mission to a new contractor that must be immediately capable of providing 23,000 trucks and accompanying crews could be daunting. Transitioning contracts to local vendors may also impact the quality of services provided to the warfighter. Commanders in Iraq have already noted that some base and life support services that were being provided to U.S. forces through newly transitioned contracts managed by local vendors have not met the level of quality U.S. forces expect. Service interruptions and inefficiencies have also been experienced in Kuwait as a result of transitioning to local vendors. Finally, limited oversight resources coupled with a projected significant increase in oversight demands during the LOGCAP transition in Iraq heightens the risk of waste. The successful transition from LOGCAP III to multiple base and life support contractors requires a large number of government oversight personnel, as the transition from LOGCAP III to LOGCAP IV in Kuwait demonstrated. However, overseeing the LOGCAP transition in Iraq will be an added responsibility for the Defense Contract Management Agency, which is also responsible for the day-to-day management and administration of the LOGCAP III contractor, private security contracts, and the Air Force Contract Augmentation Program. A Defense Contract Management Agency official expressed concern about conducting LOGCAP transitions at multiple locations simultaneously throughout Iraq because this will require a greater number of oversight personnel than consecutive transitions at single locations. For example, Defense Contract Management Agency officials cited insufficient numbers of property administrators available to transfer billions of dollars worth of property from LOGCAP III to one of several dozen possible contracts. These personnel shortages may delay the transfer of property, such as materiel handling equipment critical for loading, unloading, and moving containers which, in turn, may inhibit the timely retrograde of equipment from Iraq. According to DOD documentation, similar difficulties in managing government property are currently complicating the transition of LOGCAP III to LOGCAP IV in Afghanistan. During its planning and review process for the planned transition from LOGCAP III to LOGCAP IV and other service contracts in Iraq, DOD has not determined whether the benefits of the transition will outweigh the costs and risks that could be incurred as a result. DOD has, during its acquisition planning, analyzed potential benefits and risks of transitioning the overarching LOGCAP IV contract worldwide. In addition, it has taken some steps to mitigate the risk of transitioning LOGCAP in Iraq, such as planning to transition base and life support from LOGCAP III to LOGCAP IV mainly on the bases that will remain under U.S. control after August 31, 2010. However, according to DOD officials, DOD has not analyzed the benefits of transitioning LOGCAP specifically for the major task orders it plans to award in Iraq. Given the unique circumstances in Iraq, where the anticipated benefits of making the LOGCAP transition may not be fully realized due to drawdown timelines and additional costs and risks the transition will incur, the current plan for LOGCAP transition in Iraq warrants additional consideration through DOD’s planning and review process. This is particularly important in light of the fluid nature of ongoing operations in Iraq, and the significant congressional interest in LOGCAP issues. In fact, according to CENTCOM, external pressure based on expectations of enhanced competition and reduced costs is the driving force behind the transition. Without adequate planning and review to identify and weigh the potential benefits, costs, and risks of making the LOGCAP transition in Iraq, DOD cannot ensure the transition will meet benefit expectations while minimizing the impacts of additional costs and risks. Long-Standing Contract Oversight Personnel Shortages Could Increase Potential for Fraud, Waste, and Abuse during the Drawdown DOD’s long-standing inability to provide an adequate number of trained oversight personnel in deployed locations will continue to challenge the department as it proceeds through the drawdown in Iraq despite apparent improvements in the number of contracting officer’s representatives (COR) assigned to contracts administered by the Defense Contract Management Agency. Joint doctrine emphasizes that commanders must ensure appropriate administration and oversight personnel are in place when using contractors. Although contracting officers are responsible for providing contract oversight, day-to-day oversight of contractors is generally the responsibility of CORs, who ensure that the government receives the agreed-upon services at the agreed-upon quality, avoids poor outcomes, and minimizes fraudulent practices. According to DOD documentation, it had been the Defense Contract Management Agency’s policy for the LOGCAP contract that a COR would be designated for each contractor-provided service at the location of the service. According to Defense Contract Management Agency officials and documentation, in recognition that units in Iraq were unable to provide all the needed CORs to oversee all aspects of the LOGCAP contract, the Defense Contract Management Agency now recommends that units assign CORs only to key services—which they define as high- and medium-risk services. Conversely, the new policy does not require units to provide CORs for services it considers low risk to mission success. Since implementing this policy, the Defense Contract Management Agency has reduced its requirement for CORs in Iraq from 1,000 in October 2009 to 580 in January 2010, and anticipates that it will be able to reduce the COR requirement further as it continues to designate additional services as low risk. Although the percentage of filled LOGCAP COR requirements has increased from 85 percent in November 2009 to 94 percent in January 2010 because of this policy, we have not evaluated the effectiveness of this risk- based approach to contract oversight. However, because this policy is specific to Defense Contract Management Agency oversight of LOGCAP, it does not apply to contracts awarded by the Joint Contracting Command- Iraq/Afghanistan, which in a recent update to USF-I’s drawdown plan, was given the goal of maximizing the use of Iraqi firms in its contracting efforts for drawdown-related requirements. According to senior officials in Iraq, local national contractors frequently require more oversight than U.S. firms because, as the former Joint Contracting Command-Iraq/Afghanistan commander explained, Iraqi firms lack experience, have limited capacity, are less capable than their U.S. counterparts, are unfamiliar with U.S. quality standards and expectations, and lack the quality control processes that U.S. firms have in place. Furthermore, according to DOD documents, some services, such as ice production, cannot be reduced despite a reduction in force levels, yet when force levels decrease, so does the pool of available CORs since CORs are drawn from military units. In addition, in some cases, USF-I is likely to require additional contract services to replace capabilities previously provided by the military. In its drawdown plan, for example, MNF-I anticipated an increase in the use of private security contractors, an increase that could require additional CORs depending on the types of services being provided and the location of the services. Without adequate contract oversight personnel in place to monitor its many contracts during the drawdown, DOD may not be able to obtain reasonable assurance that contractors are meeting their contract requirements efficiently and effectively at each location, especially given its planned increased reliance on Iraqi contractors. Shortages in available contract oversight personnel may also increase the risk of wasteful practices as the drawdown progresses. For example, an Army unit in Kuwait responsible for ensuring the steady flow of equipment out of Kuwait and for conducting certain maintenance tasks has 32 government personnel but oversees more than 3,000 contractor personnel. In January 2010, Army Materiel Command requested funding to double, to approximately 800, the number of this unit’s contractor personnel that conduct retrograde-specific tasks, including receiving, accounting for, sorting, and moving equipment, necessary to prevent equipment backlogs in Kuwait. In addition, according to contracting officials, this unit has requested a concurrent increase in oversight personnel. In July 2009, this unit identified the lack of oversight personnel as a significant concern to successfully moving equipment out of Kuwait. Given that these services will transition to a new contract which has not yet been awarded, it is unclear whether the current request will represent the total increase in contractor personnel needed during the drawdown, and thus whether sufficient oversight personnel will be in place as the drawdown progresses. Further, until the current request is filled, this unit risks not having the necessary oversight personnel in place, as has been the case in the past. In January 2008, we reported that this unit did not have adequate staff to conduct oversight of an equipment maintenance contract in Kuwait. As a result of the vacant oversight positions, its personnel were unable to fully monitor contractor performance. Further, we noted that poor contractor performance resulted in this unit spending $4.2 million to rework items that were initially presented to the Army as meeting contract standards but subsequently failed inspection. We have reported on DOD’s inability to provide an adequate number of oversight personnel in CENTCOM’s theater since 2004. For example, in 2008 we reported that the Army assigned seven CORs to provide oversight for about 8,300 linguists in 120 locations across Iraq and Afghanistan. In one case, a single person provided oversight for linguists stationed at more than 40 different locations spread throughout the theater of operations. Officials responsible for the contract agreed that there were not enough CORs to effectively oversee the contract. Improvements to the Equipment Disposition Process Have Been Made but Some Decisions Yet Remain According to DOD officials, it is essential that equipment move out of Iraq and Kuwait at a steady pace to accommodate the large amount of equipment needing to be retrograded within the drawdown time frames. This was underscored in a DOD report to Congress that stated that the successful removal, demilitarization, or transfer by the end of December 2011 of all items belonging to DOD is contingent upon the timely receipt of disposition instructions, among other factors. Hence, the issuance of disposition instructions, which dictate where a specific piece of equipment will be shipped after it is no longer needed in Iraq, is a critical component of the retrograde process, a fact we highlighted in our September 2008 report. Ensuring timely equipment disposition has therefore been a focus for officials in Iraq and Kuwait as they plan for and execute the drawdown. Specifically, their planning assumes that 90 percent of theater provided equipment being retrograded will have disposition instructions before it leaves Iraq, which they consider an essential step toward ensuring this equipment does not sit idle for long periods of time in Kuwait. Partly in response to our September 2008 report, representatives from the Secretary of Defense’s Lean Six Sigma office conducted six reviews to optimize theater logistics, one of which focused on the process for retrograding equipment from Iraq, including the issuance of disposition instructions. Results from the Lean Six Sigma studies influenced the development of a new data system—the Theater Provided Equipment Planner—which is intended to automate the issuance of disposition instructions for theater provided equipment while the equipment is still in Iraq, and to document all decisions for centralized visibility. Although its implementation was initially delayed, according to USF-I the system became fully operational on January 11, 2010, following a successful test during which disposition instructions were issued for over 25,000 items of equipment. Complementing the Theater Provided Equipment Planner is a second system, the Materiel Enterprise Non-Standard Equipment database, into which the Army’s Life Cycle Management Commands are cataloging all types of non-standard equipment in Iraq in order to facilitate its retrograde. According to USF-I, the Materiel Enterprise Non-Standard Equipment database has improved management and accountability of non- standard equipment, although we have not assessed this claim. From the perspective of ARCENT, Army Materiel Command, and Headquarters, Department of the Army, responsibly drawing down forces from Iraq requires maintaining a steady flow of equipment through Kuwait and onward to other locations. For example, the Army Materiel Command commander defines success as the smooth, efficient redeployment and redistribution of materiel to sources of repair or disposal facilities, which will enable regeneration of combat power for the Army. This view corresponds with Army Materiel Command’s mission and responsibilities, and reflects limiting factors in Kuwait such as storage capacity. According to senior logistics officials from the Office of the Secretary of Defense, they are looking to the military departments to ensure the smooth onward movement and redistribution of their retrograded equipment to meet current mission needs, rebalance their respective services, or satisfy future requirements. For example, Army officials told us that there are no plans to store any equipment, including MRAPs, in Kuwait. In fact, the Army has a preliminary strategy for incorporating MRAPs into its manned ground vehicle fleet, which may likely include adding these vehicles to transportation, medical, and explosive ordnance disposal unit modified tables of organization and equipment, while other MRAPs are to be shipped to military installations for use during predeployment training. However, given the amount of equipment that is and will continue to flow out of Iraq and through Kuwait, it is important that DOD develop contingency plans for the staging of this equipment or pursue alternative retrograde hubs. This is imperative to avoid equipment build-up in Kuwait as equipment awaits onward movement to its designated final destination. According to Army officials, much of this planning has been accomplished or is currently underway, although we have not yet assessed these plans. Decisions that have not yet been made about the Army’s future composition and equipment reset contribute to the current lack of final disposition instructions for some equipment being retrograded out of Iraq. For example, the Army has not decided what equipment and how much of each type of equipment it will transfer to Army Prepositioned Stocks and Theater Sustainment Stocks. Similarly, its strategy for incorporating MRAPs into its manned ground vehicle fleet is still pending final approval. In addition, Army officials stated they are considering changing one or more heavy brigade combat teams into Stryker brigade combat teams, a decision that will have a direct effect on equipment allocation. Other factors also add uncertainty to the disposition of equipment. For example, while the Army has taken steps to streamline the reset induction process for equipment in Iraq, disposition for reset depends on when the equipment is retrograded from Iraq and its condition. Finally, until recently, decisions were not finalized on the exact quantities and types of equipment that will be transferred from Iraq to Afghanistan to meet surge requirements. Given the amount of equipment being retrograded out of Iraq, and the uncertainty arising from the decisions listed above, there is a degree of risk associated with the potential build-up of equipment in Kuwait, which, as stated above, requires planning for the temporary staging of this equipment. For example, during our July 2009 visit to Kuwait, officials in charge of a retrograde lot stated that the lot was close to its capacity for holding tactical wheeled vehicles, which occurred in part due to limited capacity to process these vehicles elsewhere. Although the number of tactical wheeled vehicles in this lot has since decreased, the Army has directed the shipment of relatively few tactical wheeled vehicles from Kuwait to other locations, leaving a significant number of vehicles to be retrograded from Kuwait. Without the necessary contingency plans to stage equipment retrograded from Iraq, DOD may not be able to ensure that equipment required elsewhere is available when needed. DOD’s Lack of Precise Visibility Over Its Inventory of Equipment and Shipping Containers May Inhibit the Retrograde or Transfer of Equipment The execution of the drawdown from Iraq in accordance with established timelines may also be affected by the lack of a complete and accurate inventory of three broad types of equipment: contractor acquired property, non-standard equipment, and shipping containers. According to Army data, contractor acquired property and non-standard equipment comprise at least 30 percent of the total DOD property in Iraq as of February 2010. In order to establish a more complete and accurate record of equipment in Iraq, MNF-I directed its subordinate units to complete a 100 percent inventory of their equipment, identify equipment that can be immediately retrograded, and account for previously undocumented equipment by June 27, 2009. According to MNF-I guidance as well as several DOD officials, meeting drawdown requirements and timelines depends upon establishing an accurate and complete inventory of the amount and types of equipment that will have to be retrograded from Iraq. DOD officials have stated that overall accountability for property in Iraq has improved since 2006, especially with regard to theater provided equipment. In addition, officials stated that the MNF-I order calling for a 100 percent inventory by July 2009 was intended to account for undocumented items, which would then be entered onto unit property books, thereby making commanders responsible for them. The intent was to facilitate drawdown planning and execution by providing commanders an incentive to take action on items that otherwise may not have been factored into their retrograde plans. However, although DOD states that the inventory is complete, previously undocumented equipment continues to be found every month. Although USF-I’s current projections indicate that the amount of equipment that still needs to be brought to record is not sufficient to alter projected transportation requirements, we have not assessed this. During our visit in July 2009, officials in Iraq and Kuwait stated that, of all categories of equipment, they had the least visibility over contractor acquired property. As of February 2010, records indicate that 19 percent of total Army equipment in Iraq is contractor acquired property. However, officials have stated that although they have high confidence in the accountability of LOGCAP contractor acquired property, they have lower confidence in the accountability of non-LOGCAP contractor acquired property. This is because while contractors are typically required under the terms of their contract to maintain accountability over contractor acquired property, there is no standardized process for doing so, limiting DOD’s accountability and visibility over this equipment and frustrating officials’ efforts to establish and maintain such visibility. As a result, the total sum of contractor acquired property in Iraq is unknown which may, in turn, adversely affect DOD’s ability to efficiently retrograde or transfer this equipment to the Government of Iraq. In July 2009, ARCENT officials noted they have low confidence in accountability and visibility of non-standard equipment in Iraq, adding another potential risk to their ability to efficiently retrograde this equipment out of Iraq in accordance with established timelines. Moreover, despite recent initiatives such as the implementation of the Materiel Enterprise Non-Standard Equipment database, Army and ARCENT officials stated that obtaining an accurate inventory of non-standard equipment is complicated by the fact that many of these items have multiple identification numbers and that commanders have significant flexibility in accounting for this equipment. For example, a piece of non- standard equipment that is valued at greater than $5,000 must be recorded on a military unit’s property book, but after the value of that item depreciates below the $5,000 threshold it is left to the individual commander’s discretion whether to continue recording the property. In addition, according to ARCENT officials, even when these items are entered onto unit or theater property books, personnel responsible for making these entries have not done so in a consistent format. Not knowing the precise amount and types of non-standard equipment in Iraq further contributes to planning uncertainty for the organizations tasked with executing the drawdown, and also complicates the task of determining disposition using the Materiel Enterprise Non-Standard Equipment database, as discussed earlier. Although DOD has taken steps to improve its visibility over shipping containers available to retrograde equipment from Iraq, the number of containers in Iraq remains uncertain. Containers are unique in that not only are they items that have to be retrograded from Iraq, they are also a primary means of shipping non-rolling stock out of Iraq. During our July 2009 visit to Kuwait, ARCENT officials responsible for overseeing and managing containers in Iraq and Kuwait told us that the data system in place to track containers is inaccurate and incomplete primarily because unit personnel in Iraq had not updated the system every time a container left or arrived at a particular location. These officials also explained that units did not always have personnel available to monitor container flows and update the data system and that those personnel who were available received this tasking as an extra duty, which limited proper data entry. As a result, a September 2009 DOD report based on the data from this system indicated that the system was, at best, 25 percent accurate; that the location of 7,000 containers remained unverified; and that the serviceability—the extent to which the containers were seaworthy and thus available to retrograde equipment—of 39 percent was also unknown. Moreover, many containers in Iraq have been used for storage, office space, and living quarters, among other purposes, yet had not been documented as such. In an effort to improve visibility over containers, in May 2009, MNC-I issued an order directing a 100 percent inventory of containers in Iraq, including instructions for reporting their serviceability. According to DOD data, as of September 21, 2009, approximately 53,000 containers had been physically inventoried, which was more than 24,000 fewer than the number of containers entered into the data system. Subsequently, in an update to its drawdown plan USF-I added a container management plan which directed the appointment of container control officers at multiple levels of command to ensure accountability through monthly inventories, among other responsibilities, and established a list of prohibited container uses, including using them as offices and living quarters. Although this plan calls for container control officers to record the movements of containers as they enter or leave a location and establishes procedures to locate containers in case these movements are not properly recorded, it requires that only some of these officers be appointed container control officers as a primary duty. As a result, USF-I’s container management plan may not fully alleviate the root cause, as identified by ARCENT officials, of poor container accountability. Further, the monthly container inventory requirement existed prior to the new USF-I container management plan yet, during our visit to Kuwait in July 2009, we observed that these inventories were not always completed as directed. Finally, according to CENTCOM, personnel in Iraq and Kuwait report different levels of container accountability system accuracy, although these personnel are working together to rectify the discrepancies. Until these efforts are complete, the number of containers available to retrograde equipment from Iraq remains uncertain. DOD has taken steps to mitigate uncertainty regarding the number of containers it will need to retrograde equipment from Iraq and adjust its tracking of container retrograde. For example, to ensure that it has sufficient containers available to retrograde equipment, DOD operates two container repair facilities in Iraq and Kuwait that repair damaged containers to a standard at which they can be used to ship equipment. In July 2009, we visited a container repair facility in Kuwait that could repair between 15 and 20 containers per day that otherwise would remain unavailable for use. According to USF-I, its present container repair capability has increased to 3,000 containers per month. Additionally, officials have stated that DOD can buy additional containers as needed for the drawdown. Specifically, officials stated that, if needed, DOD could purchase about 30,000 containers and have them available for use in less than 2 months. Finally, in its metrics to track the retrograde of non-rolling stock, USF-I no longer uses containers as a unit of measure, focusing instead on the movement of individual pieces of equipment, which officials believe will provide them with greater operational flexibility and greater fidelity in forecasting transportation requirements. As a result of these efforts, USF-I anticipates that it will have sufficient containers on hand to complete the drawdown from Iraq. While DOD’s efforts to ensure the availability of containers for the drawdown and track their retrograde appear to be positive steps, their effects are still somewhat uncertain. Poor unit container loading practices and insufficient efforts to document some containerized equipment have also presented challenges. During our visit to Kuwait in July 2009, U.S. Navy customs officials told us that about 60 percent of unit owned containers shipped from Iraq to Kuwait must be unloaded and repacked in Kuwait because units in Iraq did not affix or fill out the proper customs documentation. As a result, customs officials had to unpack, re-inspect, and then repack the containers, which slowed the flow of equipment through the retrograde process in Kuwait and required significant man-hours, unnecessarily taxing an already limited pool of available experienced customs inspectors. In addition, during our July 2009 visit to Kuwait, officials stated that a large proportion of equipment sent to a retrograde lot for unserviceable items was not properly documented. As a result, the process of unloading and sorting the contents of these containers took longer than it otherwise would have, and although the process for unloading and documenting the items appeared orderly and the lot was nearly empty, personnel expected the flow of such containers to increase significantly as the drawdown progressed. This was underscored during a subsequent GAO visit to Kuwait in December 2009, when we observed undocumented containers and unidentified equipment that had filled a large portion of the staging area at a parts warehouse. While commands in Iraq and Kuwait have noted that improved process controls and additional training have been implemented, we have not evaluated these controls nor have we received updated information on the magnitude of containers with improper documentation. Further, USF-I has issued new guidance to improve container packing discipline. Although this guidance is a positive step in that it requires proper container packaging to avoid damage during shipment, it does not ensure that unit personnel properly document equipment or, for equipment shipped to the United States, affix the correct customs documentation to the containers. Conclusions The drawdown of equipment and personnel from Iraq is a highly complex operation of significant magnitude that is being conducted in a continuously evolving environment during a period of Iraqi political uncertainty. It is also an operation governed by timelines set by the Security Agreement and the President and requires for its execution the involvement of several DOD organizations. Moreover, it is an operation that may be impacted by the President’s decision, announced in December 2009, to increase the size of the U.S. force in Afghanistan by an additional 30,000 troops, a decision that will require the development of synchronized plans addressing operations in both countries. Much has been done to facilitate the drawdown from Iraq. For example, to ensure unity of effort, the DOD organizations most closely associated with the drawdown have issued coordinated plans outlining the specific means by which their respective drawdown-related tasks will be accomplished. Furthermore, several new DOD organizations have been created to oversee and help synchronize the effort, and goals and metrics have been established to measure progress. According to DOD reports, these efforts to date have contributed to the meeting or exceeding of established goals for drawing down forces and retrograding equipment. However, while DOD has made significant progress executing the drawdown, there remains a large amount of personnel, equipment, and bases yet to be drawn down, and several actions needed to facilitate this are incomplete. For example, while DOD has taken some steps to plan for its needs for contracted services as the drawdown progresses, the full extent of contracted services needed during the drawdown remains uncertain. Without an awareness of the spectrum of contracted services available and planning for the necessary contracted services during the drawdown, DOD may not be able to efficiently arrange for the contracted services necessary to support the drawdown, which may result in service gaps or opportunities for wasteful contracting practices. Moreover, without addressing challenges related to contract transitions and contract oversight, DOD increases the potential for fraud, waste, and abuse. And finally, a failure to efficiently manage and retrograde equipment from Iraq, especially high-demand items such as MRAPs, will likely impact DOD’s ability to get that equipment to wherever it is needed next. If these challenges delay the movement of equipment out of Iraq, the 50,000 U.S. forces remaining in Iraq after August 31, 2010, will likely have a greater workload than currently anticipated, which may strain logistics and transportation systems and thereby impact their ability to close bases, oversee contractors, provide security, train the Iraqi security forces, and complete equipment retrograde. While DOD has begun to address some of these issues, none of them has yet been fully resolved. Recommendations To facilitate DOD’s ability to efficiently conduct the drawdown of U.S. forces and equipment from Iraq in accordance with established timelines, we recommend that the Secretary of Defense direct the appropriate authorities to: Ensure that joint doctrine regarding operational planning for contract support is followed and that operational personnel identify contract support requirements in a timely manner to avoid potential waste and abuse and facilitate the continuity of services; Ensure unity of effort in contract management is attained through the clarification of the roles and responsibilities of the various contract review boards in the CENTCOM theater; Assess and develop options to mitigate the risks associated with the upcoming simultaneous contract transitions in Iraq and Kuwait; Conduct an analysis of the benefits, costs, and risks of transitioning from LOGCAP III to LOGCAP IV and other service contracts in Iraq under current withdrawal timelines to determine the most efficient and effective means for providing essential services during the drawdown; Evaluate the risk of having too few qualified contract oversight personnel in light of the planned proportional increase in the number of Iraqi contractors during the drawdown and take steps to rectify, if needed; Clarify in existing planning the extent to which Kuwait and other locations in southwest Asia can support the temporary staging of equipment and materiel retrograded from Iraq while DOD is finalizing the disposition instructions for certain types of equipment. Agency Comments and Our Evaluation In written comments on a draft of this report, DOD concurred with our first five recommendations listed above, but did not concur with an earlier version of our last recommendation. In its comments regarding the first five recommendations, the department highlighted a number of corrective actions it is taking to (1) improve contract support and contract management in the CENTCOM theater and (2) mitigate the risks associated with upcoming concurrent contract transitions, including the planned transition from LOGCAP III to LOGCAP IV in Iraq. Regarding our first recommendation, DOD commented that it recognizes that improvements can be made to DOD’s planning for contractor support and stated that the Joint Staff is working to improve strategic guidance, processes and tools available to plan for contracted support through the Chairman’s Operational Contract Support Task Force. DOD also commented that it recognizes the need for better synchronization between operational needs and contractor activities and, to that end, CENTCOM has taken steps to increase visibility and synchronization of operational contract support through initiatives such as the creation of the Joint Theater Support Contracting Command, instituting a Joint Contracting Support Board, and collaborating with the Joint Staff to improve guidance. DOD also agreed with our second recommendation and commented that the importance of unity of contract management through clarification of roles and responsibilities cannot be overstated. DOD further commented that, although the functions of various boards are articulated in Joint Publication 4-10, Operational Contract Support, the Joint Staff is recommending that new guidance on the roles and responsibilities of the various boards be incorporated in CENTCOM’s pending fragmentary order that will establish the Joint Theater Support Contracting Command. With regard to our third recommendation, DOD stated that a soon-to-be- released fragmentary order will require the standup of a Joint Contracting Support Board, with participation by all those delivering or executing contracted support in Iraq, Afghanistan, Kuwait, and Pakistan, and expects that this forum will help mitigate risks associated with contract transitions. In response to our fourth recommendation, DOD stated that the Army has completed an analysis of the benefits, costs, and risks of transitioning from LOGCAP III to LOGCAP IV inn Iraq and is in the process of assessing options to ensure that essential services are provided in the most effective and efficient manner. DOD also stated that the risk factors of going from LOGCAP III to LOGCAP IV will be based on operational conditions on the ground, and it will direct the appropriate authorities to provide the results of its analysis and corresponding courses of action to the CENTCOM commander to ensure operational risks are taken into account before going forward. Finally, regarding our fifth recommendation, DOD commented that the Contingency Contracting Administration Services Executive Steering Group has identified that the risk of having too few qualified contract oversight personnel in light of the planned proportional increase in the number of Iraqi contractors during the drawdown is a concern and has established a working group to study the matter and provide recommendations to mitigate the risks. In its comments regarding a previous version of our last recommendation that the Secretary of Defense direct the appropriate authorities to clarify in existing planning the extent to which Kuwait and other locations in southwest Asia can support the storage of equipment and materiel retrograded from Iraq, including the types of equipment and length of time it can be stored given possible requirements for the equipment elsewhere, DOD did not concur and commented that this recommendation was based on what it believed was a misinterpretation of statements made by senior DOD officials, taken out of context. Specifically, DOD commented that the section in our draft report that discussed the equipment disposition process for moving equipment out of Iraq and Kuwait misstated DOD’s policy regarding the speed at which equipment would be evacuated from Kuwait, and what GAO saw as the potential equipment build-up and long- term equipment storage in Kuwait that could result. As a result of DOD’s comments and subsequent meetings with senior officials from the Office of the Secretary of Defense and Department of the Army, we revised this section of the report, other related references throughout the report, and the related recommendation. Specifically, we revised these sections of the report to reflect the department’s position that, although equipment will be temporarily staged in Kuwait prior to its shipment elsewhere, there are no plans for long-term storage of equipment in Kuwait other than equipment stored in the Army’s Prepositioned Stocks. These officials subsequently commented that the information contained in this final report, as revised, is both accurate and reflective of the views of senior DOD officials. The department also provided a number of general and technical comments that we considered and incorporated, as appropriate. A complete copy of DOD’s written comments is included in appendix II. We are sending copies of this report to the appropriate congressional committees; the Secretary of Defense; the Secretaries of the Army, the Navy, and the Air Force; and the Commandant of the Marine Corps. We will also make copies available to others on request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. Should you or your staff have any questions on the matters discussed in this report, please contact me at (202) 512-8365 or solisw@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this letter. GAO staff who made key contributions to this report are listed in appendix III. Appendix I: Scope and Methodology To determine the extent to which DOD has planned for the drawdown and how these plans conform to the established timelines, we reviewed and analyzed the major plans that guide the execution of drawdown, including those published by CENTCOM, MNC-I, Headquarters, Department of the Army, MNF-I, and USF-I. We also reviewed other relevant documents, including command briefings, the Security Agreement between the United States and the Republic of Iraq, and transcripts of speeches in which the president established timelines for the drawdown of forces from Iraq. Additionally, we spoke with officials at many levels of the chain of command involved in the preparation and execution of drawdown plans to include: the Office of the Secretary of Defense, which worked with commanders in Iraq to weigh the merits of contending plans for the drawdown; the Joint Staff; U.S. Transportation Command; CENTCOM; ARCENT; MNF-I; USF-I; and MNC-I. We also spoke with officials from myriad supporting commands including Army Materiel Command, Army Sustainment Command; Joint Contracting Command-Iraq/Afghanistan; the Defense Contract Management Agency; the Defense Logistics Agency; Army Contracting Command; and the LOGCAP Program Executive Office. In support of this effort, we traveled to Kuwait and Iraq in July 2009, where we reviewed documents and interviewed DOD officials most directly involved with the execution of drawdown plans. We spoke with officials and reviewed documents from new organizations created to oversee, synchronize, and ensure unity of effort for the retrograde of equipment, including the Drawdown Fusion Center; U.S. ARCENT’s Support Element- Iraq; and Army Materiel Command’s Responsible Reset Task Force. Moreover, we observed the processes instituted to facilitate the drawdown, including the Theater Provided Equipment Planner and the Materiel Enterprise Non-Standard Equipment system. Throughout the engagement, the team relied upon staff working from our Baghdad Field Office to conduct interviews with officials in theater and to periodically refresh key information. To identify factors that may impact the efficient execution of the drawdown we reviewed DOD plans and interviewed officials in the United States, Iraq, and Kuwait on issues that may hamper the progress of the drawdown. In Iraq and Kuwait, we conducted over 60 interviews in which we learned about potential obstacles to the efficient execution of drawdown. We spoke with officials from: MNF-I, USF-I, MNC-I, Multi- National Security Transition Command-Iraq, Joint Contracting Command- Iraq/Afghanistan, ARCENT, U.S. Marine Corps Central, U.S. Air Force Central, U.S. Navy Central, U.S. Army Corps of Engineers, and the MRAP Program Executive Office. We also interviewed officials in the United States, including officials from CENTCOM, Army Sustainment Command, Army Materiel Command, and U.S. Transportation Command, to further inquire about challenges that may compromise the efficient execution of the drawdown, and to corroborate observations we made while in Kuwait and Iraq. We also obtained and analyzed relevant documents, including those pertaining to equipment transfers between the United States and the Government of Iraq, the retrograde of certain types of non-standard equipment, and the management and oversight of contract personnel. Our travel also enabled us to observe key elements of the retrograde process, including customs inspections, container repair facilities, systems used to issue disposition instructions, Retrograde Property Assistance Team yards, central receiving and processing lots, and management of Defense Reutilization Marketing Offices. Again, we also relied upon staff working from our Baghdad Field Office to conduct follow-up interviews with officials, travel to Kuwait to observe a drawdown rehearsal exercise, and periodically update key information. Finally, we used our body of issued work examining Iraq and drawdown-related issues as a basis of comparison to identify areas in which DOD has made improvements to its drawdown planning, as well as areas in which it continues to face challenges. We conducted our audit from January 2009 through March 2010 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Comments from the Department of Defense Appendix III: GAO Contact and Staff Acknowledgments GAO Contact Acknowledgments In addition to the contact named above, individuals who made key contributions to this statement include Vincent Balloon, John Bumgarner, Carolynn Cavanaugh, Carole Coffey, Timothy DiNapoli, Laurier Fish, Walker Fullerton, Guy LoFaro, Greg Marchand, Emily Norman, Jason Pogacnik, Mark Pross, David Schmitt, Cheryl Weissman, Gerald Winterlin, and Gwyneth Woolwine.

The drawdown from Iraq is a complex operation of significant magnitude. Established drawdown timelines dictate a reduction in forces to 50,000 troops by August 31, 2010, and a complete withdrawal of U.S. forces from Iraq by December 31, 2011. While DOD has made progress toward meeting these goals, a large amount of equipment, personnel, and bases remain to be drawn down. Moreover, escalating U.S. involvement in Afghanistan may increase the pressure on DOD to efficiently execute the drawdown. Due to broad congressional interest in drawdown issues, GAO performed this work under the Comptroller General's Authority. GAO examined (1) the extent to which DOD has planned for the drawdown from Iraq in accordance with set timelines, and (2) factors that may impact the efficient execution of the drawdown. To evaluate these efforts GAO reviewed documents and interviewed officials from over 20 DOD organizations in the U.S., Kuwait, and Iraq. Several DOD organizations have issued coordinated plans for the execution of the drawdown and created new organizations to oversee, synchronize, and ensure unity of effort during the drawdown. To date, DOD reports that its drawdown efforts have exceeded its goals. For example, in January 2010, DOD reported that it had exceeded its target figure for withdrawing wheeled and tracked combat vehicles in Iraq, among other items, by over 2,600 pieces, yet a large amount of personnel, equipment, and bases remain to be drawn down. However, DOD has not (1) fully included contracted support in its operational planning for the drawdown, (2) allowed sufficient time in its guidance to ensure that all contracted services can be put on contract in a responsible manner, or (3) clearly defined the roles and responsibilities of various contract validation review boards. Several other issues may impede the efficient execution of the drawdown from Iraq. First, challenges associated with the planned simultaneous transition of several major contracts may lead to the interruption of vital services. Second, DOD has not determined whether the benefits of transitioning its major base and life support contract in Iraq outweigh the costs and risks of doing so. Third, shortages of contract oversight personnel may increase the risk of fraud, waste, and abuse. Fourth, key decisions concerning equipment that will be retrograded from Iraq have yet to be made. And finally, DOD lacks precise visibility over its inventory of equipment and shipping containers. While DOD has begun to address some of these issues, GAO has not fully assessed DOD's actions.

Background Insurance Risk in Health Care When issuers set their premiums, they consider a number of factors, such as trends in the cost of paying providers for medical services and data on the utilization of services in the population they are serving. Issuers are able to more accurately predict these costs when they have historic claims data for the population eligible to purchase coverage. However, issuers must also consider the risk that the cost of the healthcare delivered to their enrollees will exceed the premiums that they developed based on historic claims data. Prior to the implementation of PPACA, issuers offering individual and small group market health insurance plans generally mitigated risks for unexpectedly high health care costs by tailoring premiums to specific individuals and small groups through a process known as medical underwriting and, in the individual market, by denying coverage to certain individuals based on factors such as health status. Issuers generally were not subject to uniform federal requirements in regards to rules for setting premiums and guaranteed issuance of coverage for individuals, and therefore consumer protections varied among states. For example, we reported that, prior to the passage of PPACA, the majority of states did not prohibit issuers from denying enrollment of individuals because of their health status and issuers in many states were able to vary premiums based on the individual’s health status, gender, and age. PPACA Provisions Several PPACA provisions that became effective January 1, 2014, limited the ability of issuers to deny coverage or charge higher premiums to individuals and small groups based on health risks or certain other factors. For example, PPACA requires that issuers offering individual and small group market plans guarantee coverage regardless of the existence of a person’s pre-existing conditions. Further, issuers are restricted in the amount they can vary premiums based on age and tobacco use, and they cannot set premiums for individual and small group plans based on an individual’s health status, gender, or other characteristics.result, issuers may have an incentive to try to attract healthier individuals through certain marketing practices, benefit designs, drug formularies, and provider networks, leaving to other issuers those individuals who are in worse health and likely to require costly medical care. PPACA also included a requirement that most individuals purchase health insurance or pay a tax penalty if coverage meeting affordability standards is available (this is known as the “individual mandate”). As a result, many previously uninsured individuals entered the insurance market, possibly for the first time, and issuers lacked historical information about their health care and use of medical services.uninsured individuals who are most in need of health care may be more likely than others to purchase insurance during the transition, resulting in a pool of enrollees that have unknown and potentially higher medical costs than the broader population. In this situation, issuers might set plan premiums higher than they would otherwise due to uncertainty about enrollees’ health status. In addition, previously PPACA also required the creation in all states of health insurance exchanges—marketplaces where individuals and small employers can compare and select among insurance plans offered by participating private issuers. To participate on the exchanges issuers must offer plans that meet certain state and PPACA requirements for benefit design, rate setting, and other factors. Approved plans are referred to as qualified health plans. It is through the exchanges that qualifying individuals may apply for premium tax credits and cost-sharing reductions, and certain small employers may apply for small business health insurance tax credits. Issuers participating in an exchange must meet certain criteria; for example, criteria related to marketing, provider networks, and accreditation. PPACA does not require issuers offering coverage in the individual and small group markets to offer plans through the exchanges but, with limited exceptions, issuers in these markets are required to comply with other provisions, such as requiring coverage of specified benefit categories at standardized levels of cost-sharing and prohibitions on annual and lifetime limits on the dollar value of required benefits. Some of these market reforms do not apply to “grandfathered plans.” PPACA Risk Mitigation Programs To mitigate issuer risk in the individual and small group health insurance markets, PPACA required the creation of the permanent risk adjustment program and temporary reinsurance and risk corridors programs. States have the option to either establish their own state-run risk adjustment and reinsurance programs or allow the federal government to administer these programs.is required to administer the risk corridors program. The Department of Health and Human Services (HHS) Each of the risk mitigation programs applies to a different group of issuers. For example, the risk adjustment program transfers funds among individual and small group market issuers, while the reinsurance program collects funds from all issuers and third party administrators on behalf of group health plans and distributes it to only individual market issuers. Further, issuers do not have to comply with these requirements for certain types of plans. Specifically, grandfathered plans do not participate in the risk adjustment program, and they do not receive reinsurance payments. Similarly, HHS determined in 2013 that states could decide whether to allow enrollees to continue coverage under certain non-grandfathered plans established prior to 2014. plans—did not have to comply with all PPACA provisions and do not participate in the reinsurance or risk adjustment programs. These plans—referred to as transitional For a summary of each program’s key functions, years of operation, and the issuers required to participate, see table 1. Centers for Medicare & Medicaid Services, Center for Consumer Information & Insurance Oversight Letter to Insurance Commissioners (Washington, D.C.: Nov. 14, 2013). The Center for Consumer Information & Insurance Oversight (CCIIO), within CMS, is responsible for overseeing the implementation the provisions of PPACA related to private health insurance. Risk Adjustment Program Risk adjustment provides a way to correct for market imbalances that occur when some issuers attract a larger share of enrollees at low risk for expensive claims and other issuers attract a larger share of enrollees at high risk for expensive claims. Risk adjustment programs have previously been used in Medicare Advantage—the managed care option for Medicare beneficiaries—and Medicare Part D—the Medicare prescription drug program. PPACA’s requirements for the design of the risk adjustment program allowed for discretion by CMS in the design of the program. Under the program designed by CMS, payments are transferred from issuers with a larger share of enrollees at low risk for expensive claims to those with a larger share of enrollees at high risk for expensive claims. The amount to be transferred between issuers is determined using the following steps: determine individual enrollee risk scores—for example, how much more or less costly each enrollee is expected to be relative to the average enrollee—based on demographic and diagnostic information; determine the average risk score for each plan based on individual enrollee risk scores plus adjustments for a variety of factors, such as the extent of enrollee cost-sharing in the plan; compare each plan’s average risk score to the average risk score of the market within its geographic area; and calculate the amount that CMS will transfer between issuers. Reinsurance Program Reinsurance programs are designed to limit issuer risks for enrollees with very high-cost claims. Such reinsurance coverage has traditionally been available to issuers in the private insurance market, Medicare Part D, and through state-subsidized programs. Generally, a provider of reinsurance assumes full or partial liability when costs for any single enrollee during a year exceed a specified dollar threshold, while the issuer is usually required to retain at least some liability for costs so that it will have an incentive to continue managing the enrollee’s care. Under the PPACA reinsurance program, CMS expects that premium increases that might otherwise occur in the individual health insurance market because of the increased enrollment of higher risk individuals will be limited. CMS collects contributions from all issuers and third party administrators based on the size of their enrollment and then transfers payments to issuers in the individual market, both inside and outside the exchanges, that have enrollees with high claims costs. PPACA specified the total amount issuers are to contribute each year to cover payments for enrollees with high claims costs. For example, the amount of reinsurance funds that was to be collected from and distributed to issuers for the 2014 benefit year was $10 billion. Each year CMS specifies the per-enrollee contribution issuers must make and the parameters for determining the amount to be paid to issuers for their high cost enrollees. These payment parameters define the two elements that are used to calculate issuers’ reinsurance payments: “attachment point,” which is the dollar value above which an enrollee is considered high-cost and when reinsurance payments would begin, and the “coinsurance rate”, which is the percentage of issuer cost above the attachment point and below the cap of $250,000 that is eligible for reimbursement. For example, for 2014, CMS determined an attachment point of $45,000 and a coinsurance rate of 80 percent, which means that CMS reimburses issuers for 80 percent of an enrollee’s medical costs above $45,000 and up to $250,000. Costs above the $250,000 cap are fully paid by the issuer. For the reinsurance program contribution amounts and payment parameters for 2014 through 2016, see table 2. A risk corridors program, as has been used in Medicare Part D, helps limit excessive issuer profits or losses that may result from market volatility or inaccurate rate setting. Under the PPACA risk corridors program, CMS and issuers of qualified health plans may share in profits and losses that exceed a certain threshold. The program determines profits and losses by comparing an issuer’s actual spending to its expected spending. The actual spending is known as “allowable costs”—costs for medical care claims, quality improvement, and health information technology. The expected spending is known as the “target amount”—premiums collected less certain administrative costs and profits. CMS will make program payments to an issuer if its losses exceed a certain threshold, and issuers whose profits exceed a certain threshold will make program payments to CMS. The amount of that payment depends on the extent of the losses or profits. Issuers with allowable costs within a specified range, or corridor, of the target amount do not make or receive any payments. In total, the program has three corridors: one for issuers whose costs are within the specified range, and two others for issuers with relatively greater or lesser costs compared to the target amount. When an issuer’s costs are within 3 percent of its target amount, between 97 and 103 percent, the issuer makes no payments and receives no payments. Issuers whose profit or loss is greater than 3 percent of its target amount share in that profit or loss with CMS. An issuer whose profit or loss is greater than 8 percent of its target amount will pay a greater portion of its profit or will be reimbursed for a greater portion of its loss. (See fig. 1.) Risk Mitigation Programs in Medicare PPACA directed HHS to consider the design of the Medicare risk mitigation programs in developing the PPACA risk mitigation programs, although it also set requirements that differed from the Medicare programs. While PPACA established the risk corridors and reinsurance programs as temporary programs for the 3-year period 2014 through 2016, the Medicare Part D programs were not required to be temporary and have operated since 2006. In addition, according to CMS, the PPACA risk adjustment and reinsurance programs are budget neutral, in that payments to issuers will be adjusted to reflect, and not exceed, contributions. CMS originally indicated that the PPACA risk corridors program would not be operated in a budget neutral manner but subsequently indicated its intent to operate the program as budget neutral in 2014 and 2015, and then in 2016, if collections are insufficient to make payments, it would use other sources of funding subject to availability. For the Medicare Advantage and Medicare Part D risk mitigation programs, the payments that CMS makes to issuers are not limited to issuer contributions. CMS Considered Market Characteristics and Program Duration When Designing PPACA’s Three Risk Mitigation Programs CMS considered a range of insurance market characteristics—such as demographics and the availability of market data—in making decisions about how to design PPACA’s three risk mitigation programs. CMS’s design decisions also reflected the temporary status of the reinsurance and risk corridors programs. CMS’s Design of the Risk Adjustment Program Reflects Multiple Factors That Influence Cost Variation in the Individual and Small Group Markets under PPACA While the Medicare risk adjustment programs served as the basis for the PPACA risk adjustment program, CMS’s design of the PPACA program reflects key differences that exist between Medicare and PPACA markets, including differences in demographics, the availability of enrollee data, and each program’s benefit design and premium-setting structure. For example, while Medicare primarily serves the elderly and certain individuals with disabilities, the markets covered by the PPACA risk adjustment program provide coverage for the general non-elderly population. Therefore, while both the Medicare and PPACA risk adjustment programs incorporate information about enrollee age when estimating risk, the PPACA program includes separate analyses for infants, children, and adults to reflect the inherent differences in the medical needs and costs of these three population groups. On the other hand, the PPACA risk adjustment program does not incorporate certain demographic characteristics that are important for the Medicare population, such as Medicaid enrollment, and whether an individual resides in a nursing home. In designing the PPACA risk adjustment program, CMS also had to account for uncertainty surrounding the population that would enroll in 2014 health plans and for the lack of historical claims data for this population. Therefore, to develop risk adjustment rates for different age, sex, and diagnostic categories, CMS used claims data from private health plans including employer-based plans for a population that was similar to those individuals expected to enroll in individual and small group coverage in 2014. CMS also chose to develop a concurrent risk adjustment program model, which uses enrollees’ diagnoses during the current benefit year as the basis for developing the risk scores for that same year. In contrast, historical claims data was available on the Medicare population and its risk adjustment program is a prospective model, which uses data from a prior year to calculate the risk adjustment score in the current benefit year. CMS also considered other market characteristics in designing the PPACA risk adjustment program, such as the option for issuers to offer different benefit levels and the availability of subsidies that may affect enrollees’ use of health services. As with demographics and the availability of enrollee data, these characteristics are different in the Medicare and PPACA markets. See table 3 for additional information about key market characteristics and design features of the Medicare Advantage and PPACA risk adjustment programs. CMS’s Design of the PPACA Reinsurance and Risk Corridors Programs Reflects Their Temporary Nature and Specific Characteristics of the Insurance Market under PPACA PPACA Reinsurance Program CMS indicated that it designed the PPACA reinsurance program to minimize administrative burden for issuers and maximize simplicity, in part because the program is temporary. For example, CMS initially proposed basing the amount an issuer contributes to the reinsurance pool on a percent of the premiums paid by each of its enrollees. CMS indicated that this would be the fairest method as it would ensure that issuers with higher premiums and costs—and thus potentially higher reinsurance claims—contribute additional funds towards reinsurance. However, because of the temporary nature of the reinsurance program, and after reviewing comments from rule-making, which included comments from issuers, CMS ultimately chose to base contributions on a flat per-enrollee amount because it is more straightforward for issuers and less complex for CMS to administer. Additionally, in establishing the basis for identifying enrollees as high-cost, CMS chose to use actual claims costs incurred by the plan for each enrollee, rather than a list of medical conditions identified as high risk. Although CMS acknowledged that payments made solely on the basis of actual claims costs may not as strongly encourage efficient care, CMS chose this approach because issuers would still be responsible for costs above the reinsurance cap and because it was simpler and consistent with the structure of other CMS also initially proposed that issuers reinsurance programs.determine whether an enrollee’s costs exceeded the attachment point based on claims for essential health benefits in order to ensure that reinsurance payments are based on a comparable set of benefits across issuers. However, CMS subsequently decided to use all covered benefits—not only essential health benefits—because of the administrative burden for issuers of distinguishing claims for essential health benefits from other claims. CMS also considered specific characteristics of the insurance market under PPACA when designing the reinsurance program. For example, CMS developed a model to estimate market enrollment and expenditures in 2014 to help it set the rate that each issuer must contribute per enrollee in order for CMS to collect the full amount authorized by PPACA. also used the model to estimate what payment parameters—the attachment point, coinsurance rate, and cap—would allow it to distribute the full collected amount. The Affordable Care Act Health Insurance Model uses Current Population Survey data and was developed with reference to existing models such as those of the Congressional Budget Office and the CMS Office of the Actuary to characterize medical expenditures and enrollment choices across the 2014 market place. The model predicts coverage status of individuals and incorporates the effects of state and federal policy choices. See PPACA: HHS Notice of Benefit and Payment Parameters for 2014, CMS final rule, 78 Fed. Reg.15410, 15461 (Mar. 11, 2013)(preamble.III.C.3.a). reinsurance payments, CMS considered the variation among states in the relative size of the individual and group insurance markets that could affect the balance of contributions and payments. CMS determined that the availability of reinsurance contributions to make payments will vary significantly between states, and some states may not have sufficient contributions to meet the need for all reinsurance payments in that state. Therefore, after initially proposing that contributions would remain in each state, CMS determined that contributions would be pooled nationally and then distributed to issuers. CMS also modified the reinsurance program to accommodate market changes resulting from its policy allowing states to renew certain transitional plans until October 2, 2016. As a result of this policy, CMS was concerned that healthier individuals were more likely to remain enrolled in these non-PPACA compliant transitional plans, leaving less healthy and higher-cost individuals to enroll in PPACA-compliant plans. Because the policy was implemented in November 2013, after issuers had set their premiums for 2014, there was an increased risk that the premiums would not be adequate to cover higher than anticipated claims costs. Therefore, in March 2014, CMS lowered the attachment point for 2014 from $60,000 to $45,000 to provide increased protection to plans that enrolled individuals with high costs. PPACA Risk Corridors Program While various aspects of the risk corridors program were prescribed in statute, CMS officials told us that, due to the temporary nature of the program, they sought to minimize issuer burden for the elements of the program that were left to the agency’s discretion. Specifically, CMS aligned the risk corridors program formula with the definition of allowable costs under the medical loss ratio (MLR) requirements that issuers have For example, under both programs, been required to meet since 2011.the cost of certain health care quality improvement activities—such as developing quality data reporting—and certain health information technology activities are included in “allowable costs” and profits are included in “allowable administrative costs.” CMS modified the risk corridors program for the 2014 and 2015 benefit years to account for changes to the insurance market resulting from its policy to let states allow continued coverage by non-PPACA compliant transitional plans. CMS noted that issuers may incur increased claims costs because of this policy, but were not able to incorporate assumptions about additional costs into their premium rates because the policy was initiated after issuers had set their premiums. Therefore, CMS made certain adjustments to the risk corridors calculation to allow issuers to retain a larger share of profits. For benefit year 2014, CMS planned to make adjustments based on the number of enrollees in each state’s transitional plans. For benefit year 2015, CMS established a national adjustment to the risk corridors program formula, regardless of the presence of transitional plans in the state. CMS guidance to issuers about how it will manage the risk corridors program if collections do not cover required payments changed significantly over time: In March 2013, CMS confirmed that it would make payments to issuers as required under PPACA, and would not operate the risk corridors program in a budget neutral manner. In March 2014, after issuers had set 2014 premiums and after the start of the benefit year, CMS indicated that it would seek to operate the risk corridors program in a budget neutral manner by making all risk corridors payments with risk corridors collections. In April 2014 it issued further guidance explaining that if collections were insufficient for one year, the agency would reduce risk corridors payments to issuers proportionately and later use funds collected in the next year to make full payments. CMS also noted that it would issue future guidance indicating what it would do if collections did not cover payments as of the final year of the risk corridors program. In February 2015 CMS clarified what it would do in the event that risk corridors program collections for the three years of the program were not sufficient to cover payments to issuers. CMS indicated that “in the unlikely event of a shortfall in the 2016 benefit year, HHS will use other sources of funding, subject to availability of appropriations.” CMS Considered Privacy and Security in Developing Systems for Collecting Issuer Risk Mitigation Data and Experienced Significant Delays CMS Considered Privacy, Security, and Efficiency When Developing Data Collection Systems for PPACA’s Risk Mitigation Programs CMS chose data collection systems for the risk mitigation programs that were intended to address privacy and security concerns and maximize efficiencies. CMS delayed implementation of the new data collection system for the risk adjustment and reinsurance programs by nearly a year as it revised its plans for implementing the distributed data approach. Because of these changes, the agency was not able to adhere to its original timeline for collecting and reporting data to issuers. CMS chose a data collection system for the risk adjustment and reinsurance programs that was intended to address privacy and security concerns and to maximize efficiencies across the programs. According to CMS, the system it developed—known as the distributed data approach—allows enrollee claims data, which are needed to calculate risk adjustment payments and charges and reinsurance payments and contributions, to remain on the issuers’ own servers. CMS provides each issuer with software to calculate contributions but only the summary reports generated by CMS’s software are sent to the agency and not the actual claims data. CMS told us that the system was designed to (1) address privacy and data security concerns by minimizing the number of transfers and amount of enrollee health information transferred, (2) ensure that issuers’ proprietary data remains with the issuer, and (3) standardize software processes, timing, and rules uniformly across issuers. CMS elected to use the distributed data approach after considering comments from the industry through its rule-making process. In particular, CMS initially considered three data collection options: a centralized data collection system in which issuers send individual enrollee claims data directly to CMS, a state-level approach in which states collected enrollee claims data on behalf of CMS, and the distributed data approach. CMS indicated that it received many comments in favor of the distributed data approach because of the increased privacy and the fact that it eliminated the administrative complexity of issuers transmitting claims data to CMS. In selecting the distributed data approach, however, CMS identified potential tradeoffs. Specifically, it noted that this approach raises the possibility that issuers could make errors when calculating their risk scores. To address this concern, the agency said that it would augment its data audit processes. CMS also indicated that some issuers, particularly smaller companies, may be challenged by the administrative complexity of the distributed data approach, and therefore this approach may require more resources from CMS to support issuers with implementation. CMS decided to leverage the distributed data approach to collect data for both the risk adjustment and reinsurance programs in order to maximize efficiency. As reinsurance is a temporary program, agency officials believed it was not worth the resource investment for issuers or CMS to develop a separate data collection system. As a result, the distributed data approach is used for both programs, and issuers submit data to CMS on the same schedule for both programs. For the risk corridors program, CMS officials said that the agency is using an existing data system in an effort to maximize efficiency. Issuers will submit data to CMS for calculating payment transfers through CMS’s Health Insurance Oversight System (HIOS), which issuers already use to submit MLR data. Specifically, issuers use HIOS to submit data on their total medical claims costs, expenses for quality improvement activities, premiums, taxes and fees, and non-claims costs, which CMS will then use to calculate whether issuers qualify for risk corridors payments or owe contributions. As the calculations for the risk corridors program do not require transmitting enrollee claims data, CMS did not have the same privacy and security concerns related to data submission that they had for the risk adjustment and reinsurance programs. CMS Delayed Data Collection and Reporting for the Risk Adjustment and Reinsurance Programs CMS delayed implementation of data collection for the risk adjustment and reinsurance programs by nearly a year as it revised its plans for implementing the distributed data approach. An initial delay occurred when CMS changed the server requirements due to its concerns about the administrative burden for the agency and to accommodate issuer preferences. The servers used for the distributed data approach are called the external data gathering environment (EDGE) servers. CMS initially decided in May 2012 that each issuer would set up and maintain its own physical EDGE servers, with the issuer downloading CMS software to a server located on its premises. However, according to CMS officials, when the agency tested these servers with a small sample of issuers in late 2012 and early 2013, it found that it took the agency longer than expected to load the necessary software onto each issuer’s individual server. CMS officials also said that the issuers involved in the initial testing requested that CMS consider a virtual approach, in which another entity would host the server rather than the issuers themselves. In response to these concerns, CMS officials said that the agency decided to develop a virtual EDGE server for issuers in late 2013 and early 2014, furnished by Amazon Web Services. Once issuers uploaded their claims data on to the virtual EDGE server, CMS’s software would generate detailed and summary reports to be transmitted to CMS. CMS’s timeline for implementing the EDGE servers was delayed again when it changed its plan for these servers a second time. After CMS made the switch to the virtual EDGE server, some issuers that had already purchased a physical on-premise server to comply with CMS’s initial requirements requested that CMS allow them to use those servers. Therefore, in May 2014, CMS decided to allow issuers to use either option, as well as an option to use a virtual server provided by an entity other than Amazon Web Services—known as a virtual on-premise server. All three options allow issuers to maintain their data on private servers that are only accessible to the issuer and use CMS software to generate summary reports that are sent to the agency (see side bar). CMS officials said that in addition to being responsive to issuer requests for flexibility, they wanted to create multiple approaches to reflect the variation in issuer size. For example, smaller issuers might find the virtual server option more appealing if they do not have the administrative resources available to purchase and maintain a physical on-premise server. Because of these changes in CMS’s EDGE server requirements, the agency was not able to adhere to its original timeline for uploading data and providing program reports to issuers. CMS initially planned to have issuers acquire and set up their servers in the first part of 2013 and to then load software and configure the servers in the latter part of 2013. This would have allowed issuers to upload enrollment and claims data on a monthly basis starting in January 2014, and CMS planned to use these data to generate issuer reports during 2014: CMS planned to provide quarterly reports to issuers with the estimated amount of reinsurance program payments they would receive for benefit year 2014. CMS officials said that these estimates would allow issuers to more accurately account for reinsurance payments when setting their premiums for benefit year 2015 and beyond, as issuers set premiums in the year prior to the benefit year. CMS planned to provide interim estimate reports on risk adjustment calculations throughout the benefit year as it did with the reinsurance program. These reports were to include preliminary calculations of an issuer’s average risk score for each of its plans but not any data about how an issuer’s score compared to other issuers in its market, which would be necessary for an issuer to estimate its potential contribution or payment. CMS officials said that they did not plan to provide relative market data to issuers in the estimate reports because CMS may not have complete or correct data for all the issuers in a market until the final data submission deadline on April 30 of the year following the benefit year. They said that relative market data risk scores based on incomplete data could present a misleading estimate of an issuer’s potential contribution or payment. However, CMS’s plans for data collection and reporting were delayed. As issuers were not able to begin loading data onto the EDGE servers until September 27, 2014, CMS was not able to provide either quarterly reinsurance reports or interim risk adjustment reports for benefit year 2014. Therefore, issuers did not have estimates of reinsurance payments available from CMS to incorporate into their 2015 premium calculations. CMS next planned to produce two risk adjustment estimate reports for issuers, one in mid-December 2014 and one in May 2015. However, CMS experienced further delays as issuers began uploading their data to the EDGE servers. CMS officials noted that they were implementing a new technology in a compressed timeframe, and that there were ongoing fixes as they deployed the new software. As a result, CMS postponed the deadline for issuers to upload their data to the EDGE servers from the beginning to the end of December 2014, thus delaying CMS’s issuance of the first risk adjustment estimate reports to December 29, 2014, and the first reinsurance estimate report to January 12, 2015 (see fig. 2). CMS announced in January 2015 that it would provide monthly risk adjustment and reinsurance estimate reports for the remainder of the data collection period for benefit year 2014, which runs through April 30, 2015. Officials said that the purpose of these monthly estimate reports is to allow CMS to look at data discrepancies and quality issues before issuers upload their final data. After benefit year 2014, CMS officials said the agency plans to provide periodic risk adjustment and reinsurance estimate reports throughout each benefit year. For the risk corridors program, CMS indicated that it expects to propose and finalize a data collection tool from January to May 2015. Although CMS is using an existing data system, HIOS, CMS officials said the agency must still develop a new data collection tool within HIOS, which will include new fields specifically for the risk corridors program. However, the timeline for collecting these data is later, relative to the other two programs. The calculation of risk corridors payments, as is also the case with MLR rebates, incorporates risk adjustment program transfers and reinsurance program payments and therefore must take place after CMS makes those other calculations. Issuers must annually submit data for both the risk corridors program and MLR payments by July 31 of the year following the benefit year—for example, July 31, 2015, for the 2014 benefit year. CMS plans to collect risk corridors program contributions from issuers that are required to make them beginning in mid-September 2015 and to issue payments to eligible issuers beginning in mid-October 2015. CMS Established Some Processes to Monitor the Accuracy of Issuer Data for the Three Risk Mitigation Programs and Initiated Efforts to Evaluate the Permanent Risk Adjustment Program CMS Established Some Data Verification Processes and Audit Procedures for the Risk Mitigation Programs, and Others Are under Development To a varying extent, CMS has developed or has plans to develop data verification checks or audit procedures for each of PPACA’s three risk mitigation programs. In addition, CMS has initiated efforts to evaluate the permanent risk adjustment program but has not finalized the details of the evaluation. For the reinsurance and risk adjustment program data that issuers upload to the EDGE server, the software on the EDGE server allows issuers to conduct data verification checks to identify errors. Issuers are able to run test reports to identify errors in what is called the test zone. Each record included on the four files submitted to the EDGE server—enrollment, medical, pharmacy, and supplemental diagnoses—is either accepted or rejected, and records that are rejected are given an error code and a description of the erroneous field. For instance, a record may be rejected if it has a value that is not the correct data type or the value is outside the permitted range. The software on the EDGE server produces detailed error reports—with information on the errors in specific records—for issuers and provides summary error reports to CMS that aggregate the number of records that were submitted, accepted, and rejected by plan, year, and month. CMS plans to use the summary error reports to understand if issuers have submitted data for all of their plans and whether the data submission includes claims and enrollment data for all months of the benefit year. CMS officials said that the reports will also be used to identify software problems and particular issuers that may need additional support. Going forward, the agency plans to use the reports for additional analyses, such as analyses of the type and volume of issuer claims for the risk adjustment program. Issuers are also supposed to report data discrepancies to CMS for benefit year 2014 as they receive monthly estimate reports from January through May 2015, including if the results of the calculations in the reports are inconsistent with either the risk adjustment or reinsurance payment methodologies, or if any claims or enrollment data were incorrectly excluded from the calculations. For the risk corridors program, CMS officials told us that the agency was in the process of developing data verification procedures at the time of our report, including automatic data checks that were going to be built into the data collection system. Officials said that they are applying lessons learned from the MLR data verification procedures to the data verification procedures for the risk corridors program. In addition to automatic data verification checks, CMS requires issuers to conduct a third-party risk adjustment data validation audit of their risk adjustment program, starting with a 2015 audit of 2014 benefit year data. The third-party audits address individual claims data that CMS does not receive in the summary reports generated by issuers in the distributed data approach. CMS will require issuers to conduct the data audits annually in two phases. For the first phase, each issuer must have a sample of its risk adjustment data, as selected by CMS, audited by an independent party. The audit must include validation of all enrollment, demographic, and medical data for enrollees in the data sample. For the second phase, CMS will audit a sub-sample of validated data from the initial audit. Beginning with 2016 benefit year data, CMS will adjust the amount issuers owe or receive under the risk adjustment program based on the audit results. Given the complexity of the risk adjustment program and the audit process, the agency was concerned that adjusting payments and charges without first gathering information on the prevalence of data errors could lead to a costly and potentially ineffective audit program. CMS officials told us that they are in the process of developing standard operating procedures for auditing the reinsurance and risk corridors programs. They said that they are developing a contract for auditing issuers’ reinsurance and risk corridors data submissions. The audits will review a variety of things, such as compliance with definitions of terms used to identify issuers that are required to make reinsurance contributions and accurate enrollment reporting for reinsurance contributions. CMS Has Initiated Efforts to Evaluate the Risk Adjustment Program CMS officials told us that an evaluation of the risk adjustment program would be conducted under contract by an organization with expertise in design and evaluation of risk adjustment models. A permanent risk adjustment program that accurately predicts the expected costs of enrollees is a critical factor in ensuring the long-term stability of health insurance markets under PPACA. If certain groups of enrollees are not accurately scored under the program, it could undermine the program’s integrity and result in issuers seeking to avoid enrolling sicker individuals or deciding to leave the market. In November 2014, CMS issued a request for contractors to submit bids to conduct a range of services related to Medicare and the PPACA insurance market reforms, including research and development for the PPACA risk adjustment program. The bid request identified general research and development tasks for the risk adjustment program, such as analysis of the impact of market and enrollee factors on the model, evaluation of the accuracy of the risk adjustment program, and research to support adaptation of the model. The bid request also required the contractor to develop the specific details of the evaluation. At the time of this report, CMS was reviewing contract bids to evaluate the PPACA risk adjustment program. As of April 2015, CMS expected to award this contract in the spring of 2015, although the agency had not specified the timing and scope of the evaluation. In addition, CMS was in the process of procuring an audit contractor and expected to award the audit contract near the end of fiscal year 2015. Past evaluations of the Medicare risk adjustment program have improved the predictive accuracy of that model. Specifically, evaluations for Medicare Advantage and Medicare Part D have identified areas for improvement in these programs’ risk adjustment models and have led to greater predictive accuracy, which refers to how well the models predict the cost of enrollees. CMS contracted for five evaluations of the predictive accuracy of the Medicare risk adjustment models between 2004 and 2012—three of the Medicare Advantage program and two of the Medicare Part D program—and CMS officials told us that these evaluations have had important implications for the programs. It is critical that CMS similarly understands whether or not the new PPACA risk adjustment model is accurately reflecting costs, and CMS’s continued effort to carry out this evaluation will be important to the program’s success. Interviewed Issuers Described Benefits of the PPACA Risk Mitigation Programs, Although Some Had Concerns Related to Design and Implementation Most of the 12 issuers we interviewed said that the three risk mitigation programs encouraged their participation in the individual health insurance market, and two of the programs allowed them to lower their premiums. Issuers identified design concerns specific to each PPACA risk mitigation program and provided mixed responses regarding the effect of CMS’s implementation delays and technical assistance. Most Issuers Interviewed Said That All Three Risk Mitigation Programs Encouraged Their Participation in the Individual Health Insurance Market, and Two Programs Affected Their Premiums Most of the 12 issuers we interviewed said that, beginning in 2014, the PPACA risk adjustment program positively influenced their participation in the individual health insurance market and that the PPACA reinsurance and risk corridors programs positively influenced their participation in the market and also led them to set lower premiums than they otherwise would have offered. (See table 4 for specific counts for each program.) Results for each program are as follows: Risk adjustment: Eight issuers said that the risk adjustment program positively influenced their decision to participate in the individual market; for example, one issuer that was new to the market said that it would not have participated without the risk adjustment program because it believed that established issuers would seek to attract the healthiest individuals. With respect to premiums, seven issuers (six of which cited an influence on participation) said that the risk adjustment program had no impact on the premiums they offered for 2014. Some of these issuers indicated that the lack of market-wide risk score data limited the influence of risk adjustment on their premiums because issuers were only able to calculate estimates of their own risk scores and not relative market-wide risk scores. Without knowing its relative market-wide risk score, an issuer does not know whether it will be a payer or receiver under the risk adjustment program and therefore cannot incorporate such information into its financial planning and accounting processes. Two issuers specifically suggested that CMS should provide periodic risk adjustment reports that contain relative market-wide information. Another issuer said that such information would be useful, but that they would not rely on the information if it was incomplete—for example, if it was based on data from a portion of the year or did not include data for all issuers in the market. Reinsurance: Seven issuers said that the reinsurance program positively influenced their decision to participate in the individual market, including two issuers which described the reinsurance program as the most influential of the three risk mitigation programs on their decision to participate. With respect to premiums, ten issuers said that the reinsurance program allowed them to offer lower premiums in 2014 and 2015. Seven of these issuers reported this reduction to be in the range of 8 to 13 percent lower than they would have otherwise set for 2014. Five of these seven issuers indicated a smaller reduction for 2015, with some explaining that this smaller reduction reflects the decrease in funding statutorily available to pay reinsurance claims. Risk corridors: Nine issuers said that the risk corridors program positively influenced their decision to participate in the individual market in 2014. However, one of these issuers characterized the program as the least influential of the three risk mitigation programs for this decision. Three issuers that credited the program with encouraging their participation nevertheless expected that the program’s effect would diminish over time as they gain more experience. With respect to premiums, seven issuers said that the program influenced their premiums in 2014; five of these issuers said that the program allowed them to set lower premiums than they otherwise would have due to the mitigation of potential financial loss. Two issuers noted that their state regulators do not allow itemized references to the risk corridors program when the issuers submit their premiums to the states’ insurance regulators. Issuers Identified Design Concerns Specific to Each PPACA Risk Mitigation Program, Including Concerns about Data Sources, Funding Availability, and Program Tenure Issuers identified concerns with specific aspects of each of the three risk mitigation programs, including concerns about the sources of data used for the risk adjustment program and about the availability of funding for and temporary tenure of the reinsurance and risk corridors programs. Risk Adjustment: All 12 issuers we interviewed said that they would prefer the risk adjustment model to include prescription drug data in its risk score calculations.information about enrollee diagnoses, is available quickly, and would improve the accuracy of risk adjustment calculations and payments to issuers. Other issuers commented that prescription drug data is less prone to errors and misreporting and is administratively straightforward for issuers to manage, compared to other sources of diagnostic data. However, 2 issuers acknowledged that the inclusion of pharmacy data in the risk score calculation would pose an additional administrative burden on CMS. One issuer noted that such data provides useful Reinsurance: Most of the 12 issuers we interviewed expressed concerns about the availability of funding and about the timing of reinsurance payments and payment estimate reports. Six issuers expressed uncertainty about whether the program will receive its planned contributions. For example, 1 issuer said that because the contribution amount and the payment parameters are based on an estimate made by CMS, it is possible that CMS may collect less than it targeted if the estimate is incorrect. Eight issuers said that more frequent payments from CMS would improve cash flow. However, 2 other issuers said that more frequent payments would increase the temporary program’s administrative burden. With regards to the quarterly reports of estimated payments and contributions that CMS could not provide in 2014 due to the EDGE server implementation delays, 6 issuers said that these reports would have provided them with information to incorporate into their financial planning and reporting processes. However, several issuers noted that these reports are less important than those in the risk adjustment program, because issuers do not need additional data or modeling from CMS to generate their own reinsurance payments estimates. Risk Corridors: Most of the 12 issuers we interviewed cited uncertainty about the extent to which funds would be available. Ten issuers said that they did not support the agency’s decision to manage the risk corridors program in a budget neutral manner. One of these issuers described CMS’s decision to operate the program as budget neutral in 2014 and 2015 as a reversal of previous guidance, but noted that CMS has since been clear about operating in a budget neutral manner by limiting risk corridors payments for 2014 and 2015 to available collections.issuers described scenarios in which a budget neutral policy would not be sufficient to make needed payments; if an issuer priced premiums very low, that issuer may have significant losses and the remaining issuers may not have sufficient profit to cover those losses. Another 2 of these Two issuers indicated that the status of the program’s funding as budget neutral and the possibility that there will not be enough funds collected to pay for losses will have a material impact on their premium decisions for 2016. Tenure of Temporary Programs: Eleven of the 12 issuers we interviewed said that the 3-year timeline for the temporary reinsurance and risk corridors programs may not afford enough time for issuers to adjust to the market changes under PPACA. Some issuers said that this was particularly true given ongoing policy changes and delays that contributed to lower than expected enrollment and limited the availability of data on new enrollees. They said that without these data, they do not have sufficient information to confidently set premiums. For example, 6 issuers described lower than expected enrollment rates in their market due to CMS policy changes, such as delaying implementation of a requirement that certain employers provide health insurance to their employees, and allowing transitional plans. As a result of this lower than expected enrollment, issuers may have less information on the population that may eventually enroll under PPACA. When the programs expire, issuers will have less enrollee data than they originally expected with which to formulate their premiums. Two issuers who were new to the individual market in 2014 said that extending the temporary programs would provide more time for them to gather additional data. Otherwise, they will be at a disadvantage when the temporary programs expire in 2016 in contrast to more established issuers that already possess prior claims data. Due to concerns about the adequacy of the 3-year time period, 10 of the 12 issuers suggested extending the reinsurance program beyond its scheduled expiration. Nine of the 12 issuers suggested that the temporary reinsurance program be extended for 1 or 2 years and 5 of these issuers noted that they expect that premiums will rise significantly in 2017 in response to the expiration of the program at the end of 2016. Seven of the 12 issuers suggested extending the risk corridors program, with 5 of them specifying that the program be extended for either 1 or 2 years. Issuers Provided Mixed Responses Regarding the Effect of CMS’s Implementation Delays and Technical Assistance Most of the 12 issuers we interviewed supported CMS’s choice of the distributed data collection approach for the risk adjustment and reinsurance programs, although they offered mixed responses about how they were affected by CMS’s decision to change how it implemented the EDGE servers and the resulting delays in implementation: Six of the issuers we interviewed said that the delays in implementing the EDGE servers were exceedingly disruptive or significant to them. They indicated that CMS’s policy changes resulted in wasted time and resources and required them to redevelop their plans for procuring and launching the servers. Although noting that the policy changes caused problems for them, five of these six issuers said that they supported CMS’s final decision to allow issuers to use either virtual or on-premise EDGE servers. The other six issuers—four of whom were new to the individual market in 2014, including two COOPs—said that EDGE server delays did not affect them. Three of these issuers told us that they had already purchased a physical server when CMS announced that all issuers had to use the Amazon Web Services option. However, they said that they were able to repurpose the physical servers and chose to use the Amazon option; therefore, CMS’s decision did not have a significant negative effect on their companies. In addition, 8 of the 12 issuers we interviewed expressed concerns about CMS’s ongoing implementation of data collection systems. For example, these issuers noted that they have continued to experience challenges uploading data using the EDGE servers and incorporating CMS’s ongoing corrections to its software code. For instance, 1 issuer described how CMS released software code for issuers to use the following morning to run risk adjustment calculations, but then rescinded the code the following afternoon because of an error. The issuer said that this example illustrates how CMS was releasing software before conducting the necessary quality assurance checks and was correcting problems as it went. This issuer also described how CMS released software that was missing 7,000 diagnostic codes. Five issuers raised concerns about another aspect of CMS’s implementation of data collection systems. Specifically, these issuers noted that the small window of time CMS allotted between when it informs issuers of estimated payments and contributions and when issuers’ final data submissions are due could be problematic if there is a need for significant reconciliations between CMS’s and issuers’ calculations. Finally, nearly all 12 issuers said that they experienced challenges obtaining technical assistance from CMS during implementation of the EDGE servers. However, with respect to CMS’s ongoing technical assistance and timeliness in responding to requests, they reported both positive and negative experiences: EDGE server implementation. Ten issuers reported challenges with CMS technical assistance during EDGE server implementation, including several issuers who reported an extended period of time when CMS did not provide any guidance to issuers. Issuers reported that during the period from the fall of 2013 through the spring of 2014, they received no guidance from CMS about the EDGE servers. One issuer noted that previously active user groups were disabled, and therefore they had to put their implementation plans on hold. It was during part of this period that individuals were first able to enroll in health plans available on the health care exchanges. Ongoing technical assistance. Issuers noted both positive and negative experiences in terms of their ongoing efforts to get technical assistance from CMS. For instance, four issuers told us that CMS assigned individual account managers to each issuer in December 2014 to help with technical assistance, and two of these issuers said that the account managers have helped them get more timely responses from CMS. Another issuer said it had mixed results with this manager, who sometimes provided useful information and other times provided information that was contradicted by another source. With regard to other forms of technical assistance, five issuers said they were participating in regular calls and webinars with CMS officials, and three of these issuers said they found these sessions to be useful. However, some of these issuers also said that it was very difficult to get their questions answered during these sessions due to the high volume of questions being submitted to the agency. Timeliness. Issuers provided mixed responses about CMS’s timeliness in responding to current requests for assistance. Two issuers told us that the timeliness had improved. However, two other issuers told us that there were still unresolved requests related to data submission issues, even though the relevant submission deadline had passed. Agency Comments We provided a draft copy of this report to HHS for its review and HHS provided written comments, which are reprinted in appendix I. HHS explained that CMS implemented the data collection strategy for these programs utilizing new innovative technology as well as existing data systems, and carried out the implementation in a phased approach. HHS indicated that issuer data submissions through the EDGE server began in September 2014 and CMS was on target to meet the regulatory deadline of April 30, 2015, to upload final submissions by issuers of claims and enrollment data for benefit year 2014. Further, HHS described CMS’s efforts to ensure the appropriate level of technical support, including the use of cross-functional teams that include software developers and dedicated account managers for each issuer. HHS noted that CMS solicited feedback directly from issuers and provided technical guidance and multiple trainings. In addition, HHS provided technical comments, which we incorporated where appropriate. As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the Secretary of Health and Human Services, the Administrator of the Centers for Medicare & Medicaid Services, and other interested parties. In addition, the report will be available at no charge on the GAO website at http://www.gao.gov. If you or your staffs have any questions about this report, please contact me at (202) 512-7114, or dickenj@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of our report. Key contributors to this report are listed in appendix II. Appendix I: Comments from the Department of Health and Human Services Appendix II: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, William Hadley, Assistant Director; George Bogart; Keara Castaldo; Julianne Flowers; Mary Giffin; Sarah-Lynn McGrath; Laurie Pachter; Vikki Porter; and Leslie Powell made key contributions to this report.

PPACA resulted in significant changes to the private individual and small group health insurance markets in 2014 that expanded the availability and affordability of coverage. However, some of these provisions reduced issuers' ability to mitigate the risk of high-cost enrollees by limiting their ability to deny coverage or charge higher premiums based on individuals' health risks and other factors. Issuers also faced increased risk starting in 2014 because these provisions were expected to result in the enrollment of many previously uninsured individuals, who have unknown and potentially higher medical costs than the broader population. To limit these risks, PPACA required the establishment of three risk mitigation programs. GAO was asked to provide information on the design and development of these three programs and on issuer perspectives on them. In this report, GAO describes: (1) the factors that guided CMS's design of these programs, (2) the data collection systems CMS developed for these programs, (3) CMS's plans to monitor and evaluate the programs, and (4) issuer experiences with the programs. GAO reviewed regulations, guidance, and documentation about design and implementation activities and interviewed CMS officials. GAO also interviewed officials from a non-representative sample of 12 issuers that offered individual market coverage in 2014 and were selected based on variation in enrollment, location, and market experience. The Centers for Medicare & Medicaid Services (CMS) considered market characteristics and program duration in designing the three programs mandated by the Patient Protection and Affordable Care Act (PPACA) to mitigate the risks issuers of health insurance faced starting in 2014. Each of the three programs—risk adjustment, reinsurance, and risk corridors—was intended to account for a different source of issuer risk, such as enrollee health status or high-cost medical claims. CMS considered a range of market characteristics—including demographics and the availability of data—in making decisions about how to design each of the programs. CMS's design decisions also reflected the temporary status of the reinsurance and risk corridors programs, which are set to expire after 3 years. While CMS considered similar Medicare risk mitigation programs during the design process, key differences in the markets served by Medicare and the PPACA programs resulted in different approaches to their design. CMS considered privacy and security concerns in developing systems for collecting issuer data for the risk mitigation programs and experienced multiple implementation delays. For example, for the risk adjustment and reinsurance programs, CMS elected to use a system that allows sensitive enrollee claims data to remain with issuers while providing CMS with only summary data. However, CMS delayed implementation of data collection systems for these programs by nearly a year as it revised its plans to reduce administrative burden and accommodate issuer preferences. Therefore, CMS was unable to provide issuers with most of the periodic, interim reports it had originally planned to generate throughout 2014. CMS developed or had plans to develop data verification or audit procedures for all three programs. CMS had also initiated efforts to evaluate the permanent risk adjustment program but had not finalized the details of the evaluation. In November 2014, CMS issued a request for contractors to submit bids to conduct a range of services, including research and development tasks for the risk adjustment program such as: analyze the impact of market and enrollee factors on the model; evaluate the accuracy of the program; and conduct research to support adaptation of the model. As of April 2015, CMS officials expected to award the contract in the spring of 2015, although the agency had not finalized a date for completing that evaluation. CMS's continued effort to carry out this evaluation will be important to assessing the program's success. Most of the 12 issuers GAO interviewed said that the three risk mitigation programs encouraged their participation in the individual health insurance market, and two of the programs allowed them to lower their premiums. Issuers identified design concerns specific to each PPACA risk mitigation program and provided mixed responses regarding the effect of CMS's implementation delays and technical assistance. In commenting on a draft of this report, the Department of Health and Human Services described CMS's data collection strategy for these programs and its efforts to ensure the appropriate level of technical support for issuers.

Background The $17.9 billion THAAD is a ground-based weapon system being developed by the Ballistic Missile Defense Organization (BMDO) and the Army to defeat theater ballistic missiles. It supports the national objective of protecting U.S. and allied deployed forces, population centers, and industrial facilities from theater missile attacks. The THAAD system consists of four major components: (1) truck-mounted launchers, (2) interceptors, (3) the radar system, and (4) the battle management/command, control, communication, computer, and intelligence (BM/C4I) system. The launcher is to provide rapid reload of interceptors. Each interceptor is to consist of a single stage booster and a kill vehicle that is designed to autonomously home on an enemy missile during the last phase of interceptor flight and destroy the missile by colliding with it, called “hit-to-kill.” The radar is being designed to support the full range of surveillance, target tracking, and fire control functions and provide a communications link with THAAD interceptors in flight. The BM/C4I system is to manage and integrate all THAAD components and link the THAAD system to other missile defense systems to support an interoperable theater missile defense architecture. Figure 1 shows THAAD as the upper tier in a two-tier theater missile defense architecture. The THAAD program has undergone two major revisions. One revision delayed fielding from fiscal year 2002 until 2006 and was the result of DOD reducing planned funding by about $2 billion during the fiscal year 1997 budget process. The delay increased total system cost from $16.8 billion to $17.9 billion, or by $1.1 billion. The other revision accompanied DOD’s fiscal year 1998 budget request and involved accelerating fielding to fiscal year 2004 by adding a total of $722 million for fiscal years 1998 through 2003. To date, the Army has conducted four THAAD intercept tests. All four attempts failed. After the system failed the fourth attempt to intercept its target in March 1997, the Director, BMDO, established two independent teams to assess program requirements. One team was to determine if the system design can meet warfighter needs; and the other team was to evaluate the interceptor design and quality assurance. According to a THAAD project office representative, the teams’ results are to be used to revise the THAAD acquisition plan. Acquiring Significant Quantities of Hardware Before Key Performance Requirements Are Tested in an Operational Environment Increases Risk BMDO’s current schedule calling for award of the low-rate initial production contract almost 2 years before the start of operational testing and evaluation increases the risk associated with the THAAD program. The Director, BMDO, acknowledged that the initial THAAD schedule was high risk and contributed to THAAD development problems. In May 1997, he stated that THAAD’s aggressive schedule led to problems probably traceable to “hurry up.” The THAAD Project Manager informed us that both the contractor and the project office were overly optimistic regarding the test schedule. In addition, he pointed out that, in hindsight, additional component testing could have prevented some test flight failures. Prior to the last test flight, the number of test flights planned as the basis for entering the engineering and manufacturing development phase was reduced from 20 to 9 flights partly to stay on schedule. DOD established three successful intercepts as the criterion for THAAD entering the engineering and manufacturing development phase. Figure 2 shows the most current approved THAAD schedule for operational testing and production of units for deployment. The figure shows that contract award of the low-rate initial production contract will precede the start of operational testing and evaluation by almost 2 years. In light of recent test failures, the THAAD program is being revised. While BMDO and DOD have not yet approved a revision to the THAAD acquisition plan and schedule, a proposed plan currently being discussed within the Army, BMDO, and DOD would equip the first unit in fiscal year 2006. However, that proposed plan still calls for significant low-rate initial production before operational testing. According to 10 U.S.C. 2400, low-rate initial production is the minimum quantity needed to (1) provide weapons for operational test and evaluation, (2) establish an initial production base for the weapon, and (3) permit an orderly increase in production before full-rate production begins. With regard to the need for weapons used in operational test and evaluation, THAAD equipment produced during low-rate initial production is currently intended for deployment to operational units rather than for use in operational test and evaluation. The low-rate initial production contract was scheduled for award almost 2 years before beginning operational testing to assess operational effectiveness. During low-rate initial production, the Army plans to produce significantly more than the amount of THAAD system components needed to equip the first deployed unit (battery). For example, the first deployed unit is to consist of 9 launchers, 72 interceptors, 1 radar, and 3 BM/C4I systems. But the plan calls for production under the low-rate initial production contract of 32 launchers, 253 interceptors, and 3 radars. Of the 253 interceptors, 234 are planned for deployment and 19 are planned for production verification and reliability testing. The 234 interceptors are more than three times the number needed to equip the first fielded unit and would represent about 20 percent of the total 1,178 interceptors planned for full deployment. Concerning the other two purposes of low-rate initial production—establishing an initial production base and permitting an orderly increase in production before full-rate production begins—we believe that starting production of significant quantities of an unproven system 2 years before beginning operational testing increases risk. If the production line prove-out and ramp-up were delayed until after the completion of sufficient independent testing in an operational environment, initial quantities of unproven systems would be reduced and additional funding would become available to buy the proven systems at more efficient rates. As we previously reported, DOD often budgets available funding for unnecessary increases in low-rate production quantities of unproven weapons whose designs are not yet stabilized with the result that it is unable to buy proven weapons at originally planned full rates because of insufficient funds. The Army’s latest approved THAAD acquisition plan calls for initial fielding in fiscal year 2004. Under this schedule, a contract is to be awarded early in the engineering and manufacturing development phase to produce components for operational testing and later a $1.2-billion low-rate initial production contract for production of system components for deployment. In prior reports, we pointed out that an aggressive schedule is also the basis for the Army’s current plans to procure prototype interceptors well before it knows whether the interceptors will be operationally effective. Longer Range Target Requirement Is Not Funded According to a representative from the Office of the Director, Operational Test and Evaluation, several flight tests against targets having a range of more than 2,000 kilometers will be required during developmental and operational testing to validate THAAD’s operational effectiveness against longer range missiles. Because the velocity of attacking missiles increases with range, longer range targets represent a more formidable threat than shorter range targets. In addition, the longer range targets generally represent attacking missiles having a different flight trajectory than shorter range targets. Seven longer range THAAD flight tests are being planned by the Army Space and Strategic Defense Command’s Targets Office with an eighth target as a spare. A suitable longer range target does not exist. The Storm and Hera targets used in THAAD testing, to date, have only a maximum range of about 750 and 1,100 kilometers, respectively, rather than the roughly 2,000 kilometers needed. According to the Targets Office Product Manager, numerous studies were conducted between 1992 and 1997 to determine the best options for longer range theater missile defense targets. The options studied included land/sea-launched and air-launched/dropped targets. According to Army officials, however, the use of longer range target options and target launching platforms is limited by the 1991 Strategic Arms Reduction Talks and 1987 Intermediate Range Nuclear Forces Treaties. This makes selection of a longer range target more difficult. As of June 1997, BMDO had not selected a specific longer range target solution. In testimony on May 15, 1997, before the Subcommittee on Military Research and Development, House Committee on National Security, the Under Secretary of Defense for Acquisition and Technology acknowledged that targets built for lower tier systems simulate the short-range threat but do not provide the greater range targets that are needed for upper tier theater missile defense systems such as THAAD. The Under Secretary noted that BMDO had recently completed a study of long-range target alternatives to determine the best treaty compliant, cost effective, and flexible solution. The study recommended an air-launched target that would support testing of both Army and Navy upper tier theater missile defense systems. The Under Secretary stated that BMDO would examine the technical and programmatic feasibility of the air-launched concept in 1997. The Acting Director, BMDO Test and Evaluation Directorate, has advised us that longer range targets for THAAD are now a pressing need. While the specific target concept has not been defined, the Acting Director stated that about $55 million would be required to develop the target between fiscal years 1999 and 2001. Production of eight longer range THAAD targets is estimated to cost another $56 million to $72 million. BMDO expects to develop a more precise estimate in late fiscal year 1997. However, funding to develop and produce a longer range target for the system is not currently contained in DOD’s future years funding plan for fiscal years 1999 through 2003. Conclusions and Recommendations The current THAAD program review and evaluation provides DOD with an opportunity to (1) reduce risk in the acquisition program and minimize the number of initial quantities of unproven systems by reexamining the schedules for operational testing and production and (2) ensure that realistic targets will be used for testing. We recommend that you direct BMDO to delay low-rate initial production of the THAAD system until after the Director, Operational Test and Evaluation, has certified, based on sufficient independent testing in an operational environment, that the system can meet its key performance requirements. We also recommend that you include in DOD’s fiscal year 1999 budget submission, the estimated funds needed to implement a treaty compliant, longer range missile target program consistent with THAAD’s revised test schedule. Agency Comments and Our Evaluation In commenting on a draft of this report, the Director, Strategic and Tactical Systems, Office of the Under Secretary of Defense (Acquisition and Technology), disagreed with our recommendation concerning the delay of low-rate initial production until after certification of THAAD’s operational effectiveness. He partially concurred with our recommendation that the fiscal year 1999 budget submission should include funding for targets that is consistent with the THAAD revised schedule. He cited Title 10 of the United States Code, which describes low-rate initial production of a new system as the minimum quantity necessary to: (1) provide production-configured or representative articles for operational tests, (2) establish an initial production base for the system, and (3) permit an orderly increase in the production rate of the system. However, he also stated that THAAD low-rate initial production is not planned to provide representative articles for operational tests—although such an option still exists. The Director’s response does not address our main point. We recognize that the existing low-rate initial production legislation does not include specific standards on when and how programs should begin low-rate initial production, or on the type and amount of testing to be done before low-rate initial production begins. Instead, the thrust of our recommendation is that delaying production of system components intended for deployment until enough realistic testing information is secured would reduce risk and minimize the procurement of unproven equipment. As discussed in the report, current plans provide for producing about 20 percent of the THAAD interceptors during low-rate production. If DOD buys unproven weapons during low-rate initial production at minimum rates—the rate needed to complete initial operational test and evaluation and prove the production line—more funds would be available to buy proven weapons in full-rate production at more efficient rates and at lower costs. Implementing our recommendation could also reduce the number of THAAD systems that may have to be modified based on the results of operational testing and evaluation thus allowing full-rate production of more THAAD systems with demonstrated performance. Although the Director points out that an early operational assessment is planned prior to the commitment to low-rate initial funding, it is our view that such an assessment will not provide sufficient realistic and independent testing information. The Staff Assistant to DOD’s Director, Operational Test and Evaluation—the organization which is responsible for certifying that a new weapon system is operationally effective—confirmed that early operational assessments were never intended to, and do not, provide a basis for assuring operational effectiveness. He stated that early operational assessments are only interim assessments of equipment that indicate a system’s progress and problems. Thus, we continue to believe that our recommendation to delay the low-rate initial production is valid. Our recommendation has been clarified to reflect the basis of DOD’s certification as being the completion of sufficient independent testing in an operational environment. We agree with the Director’s statement that the statute and regulations envision that low-rate production will begin before completion of initial operational test and evaluation. We are not recommending that all initial operational test and evaluation be completed before beginning low-rate initial production. We recommend only that sufficient independent testing be conducted in an operational environment to show that the system can meet its key performance requirements. This is an appropriate criterion for systems being produced for deployment. Concerning our second recommendation, the Director stated that BMDO’s long-range target strategy is to pursue an air-launched target platform that will demonstrate its capability in fiscal year 2001, earlier than THAAD’s planned test requirement; but that BMDO is examining other options to meet its target needs. He stated that BMDO is reviewing funding shortfalls for inclusion in the fiscal year 1999 budget submission as we recommended. DOD’s comments are reprinted in appendix I. Scope and Methodology We performed our work at the Office of the Secretary of Defense and Headquarters, BMDO, in Washington, D.C.; the Office of the Director, Operational Test and Evaluation, Alexandria, Virginia; the U.S. Army Air Defense Artillery School at Fort Bliss, Texas; the White Sands Missile Range, New Mexico; and the THAAD Project Office and the U.S. Army Space and Strategic Defense Command in Huntsville, Alabama. At these locations, we interviewed responsible agency officials and analyzed pertinent acquisition and testing documents. We conducted our work from July 1996 to September 1997 in accordance with generally accepted government auditing standards. As you know, the head of a federal agency is required by 31 U.S.C. 720 to submit a written statement of actions taken on our recommendations to the Senate Committee on Governmental Affairs and the House Committee on Government Reform and Oversight not later than 60 days after the date of this report. A written statement also must be submitted to the Senate and House Committees on Appropriations with the agency’s first request for appropriations made more than 60 days after the date of the report. We are sending copies of this report to appropriate congressional committees; the Director of BMDO; and the Secretaries of the Army, the Navy, and the Air Force. We will also make copies available to others on request. If you or your staff have any questions concerning this report, please contact me on (202) 512-4841. Major contributors to this report are listed in appendix II. Comments From the Department of Defense Major Contributors to This Report National Security and International Affairs Division, Washington, D.C. Tom Schulz Lee Edwards Stan Lipscomb Leon Gill Tom Gordon The first copy of each GAO report and testimony is free. Additional copies are $2 each. 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GAO reviewed the Theater High Altitude Area Defense (THAAD) program to determine whether: (1) planned testing would demonstrate operational effectiveness before a significant number of units are produced for deployment; and (2) missile target resources are adequate to support testing plans. GAO noted that: (1) the current THAAD program review and evaluation provides the Department of Defense (DOD) with the opportunity to: (a) reduce risk and minimize the number of initial quantities of unproven system hardware by reexamining the schedule for operational testing and production; and (b) ensure that realistic targets will be used for testing; (2) the last approved THAAD acquisition plan calls for significant production of deployment hardware almost 2 years before beginning independent operational testing to assess the system's operational effectiveness; (3) the Army maintains that it needs to buy a number of THAAD systems during low-rate initial production to "ramp-up" to the full rate of production; (4) delaying production until after completing sufficient testing that provides assurance that key performance requirements can be met reduces the risk of buying unproven systems and facilitates production of proven systems at more efficient rates; (5) a suitable target for testing the THAAD system against longer range missiles does not exist, and funds have not been requested for target development and production; and (6) without a longer range test target to represent the more formidable, higher velocity missiles that THAAD could face, the system's operational effectiveness will remain in doubt and DOD will not have reasonable assurance that it could rely on THAAD in an actual conflict.

Background The Headwaters Forest in Humboldt County, California, includes the largest grove of virgin old-growth redwood timber in private U.S. ownership. It is currently owned by Pacific Lumber, but has been the focus of preservation efforts by the public for at least 10 years. Most recently, it has been identified as habitat for the marbled murrelet—a robin-sized seabird—which is listed as endangered under California law and as threatened under the Endangered Species Act (ESA). Both California and the United States provide protection for threatened and endangered species, as well as provide for the protection of habitat for listed species. Under ESA, it is unlawful for any person or entity to take any threatened or endangered species. The term “take” includes actions that harm, kill, capture, or collect such species. Furthermore, under Interior’s regulations, the term “harm” is defined to include significant habitat modification and degradation that kills or injures wildlife by impairing essential behavior, such as breeding and sheltering. The Secretary of the Interior may, under ESA, issue an incidental take permit for a threatened or endangered species in line with a habitat conservation plan, which, among other things, specifies the impacts that are likely to result from the taking and measures to mitigate these impacts. Additional protections of timberland exist under California law. Under the California Forest Practice Rules, timber harvesters must operate under approved timber harvest plans and be licensed. Additionally, large harvesters may submit a sustained yield plan for long-term harvesting. In 1995 and 1996, when Pacific Lumber applied for a permit to conduct a timber harvest operation on the Headwaters property, its application was denied by the state. The state determined that Pacific Lumber cannot harvest its timber without a habitat conservation plan and an incidental take permit. The company has filed two takings lawsuits against the state and federal governments claiming that the endangered species regulations for the marbled murrelet do not allow it to harvest the timber. As a result of negotiation efforts to preserve the redwood trees, in September 1996, Pacific Lumber, MAXXAM, Inc., the state of California, and the federal government agreed to exchange the Headwaters property for up to $380 million in state and federal assets. As part of the agreement, the federal and state governments will acquire almost 7,500 acres, including the Headwaters property, the Elk Head Springs property, and a portion of the Elk River property. The portion of the Elk River property that will remain with the Headwaters property is a wishbone-shaped parcel of about 1,700 acres; it includes a buffer for the old-growth trees and a 150-foot buffer on either side of the Elk River to protect the riparian habitat. Pacific Lumber will receive about $300 million and the remaining 7,704 acres of the Elk River property, including an island of land—essentially, an inholding —within the newly acquired Headwaters property and buffer zone. To this exchange, the federal government will contribute $250 million in funding and the state will contribute $130 million. One of the conditions of the acquisition agreement is that Pacific Lumber will develop, for the rest of its land, a habitat conservation plan for the purposes of receiving an incidental take permit for the marbled murrelet and other species. At the same time, Pacific Lumber will submit a sustained yield plan for timber harvesting to the state of California. Yet another condition of the agreement is that Pacific Lumber will dismiss its takings lawsuits filed in 1996 against the state and federal governments. The acquisition will not proceed if any of these conditions are not met. BLM and Justice officials stated that negotiations on these issues have been difficult and have threatened the completion of the agreement, which, if it falls through, could cause Pacific Lumber to continue its takings suits. The Congress, in its fiscal year 1998 appropriation for the Department of the Interior and related agencies, authorized and appropriated up to $250 million for Pacific Lumber’s Headwaters Forest. We noted in a report last year that there was uncertainty about the property’s fair market value, and the Congress subsequently required that the property be appraised before being acquired. According to the law’s conference report, the appraisal had to be done in compliance with federal appraisal standards and other applicable laws and regulations governing federal land acquisitions. Furthermore, according to the legislation, the appraisal had to be reviewed by the Comptroller General within 30 days of his receiving the appraisal and had to be provided to the House Committees on Resources and Appropriations and the Senate Committees on Energy and Natural Resources and Appropriations. The Chairmen of the House and Senate Appropriations Subcommittees on Interior and Related Agencies also requested that we do this work. Further legislative conditions for the use of federal funds to acquire the properties include the issuance to Pacific Lumber of an incidental take permit based on a habitat conservation plan for the remaining Pacific Lumber land, and approval by the state of California of a sustained yield plan for the remaining Pacific Lumber property. Originally, the federal side of the acquisition was being managed jointly by BLM and the Department of Agriculture’s Forest Service. In 1997, the Forest Service entered into a contract with an appraiser to determine the value of the Elk River property. BLM entered into a contract in 1997 with an appraiser to determine the value of the combined Headwaters and Elk Head Springs properties. Subsequently, in late 1997, BLM was made responsible for managing the entire Headwaters acquisition, including the Elk River appraisal process. The appraisals were to be completed in mid-March 1998; however, they were not completed until September 1998. During the summer of 1998, BLM contracted for peer reviews of the appraisals. After the peer reviews were completed, BLM reviewed and approved the appraisals, determined that they met federal appraisal standards, accepted the appraised values, and forwarded them to the Secretary of the Interior. The appraisals and the Secretary’s opinion of value were made available for our review on November 25, 1998. Appraisal Standards and Results of the Headwaters and Elk River Property Appraisals In its instructions for the Headwaters and the Elk River property appraisals, BLM instructed the appraisers to follow federal appraisal standards in valuing the properties. These standards state that the government should appraise a property to be acquired at the fair market value. According to the standards, fair market value is the amount for which a property would be sold—for cash or its equivalent—by a willing and knowledgeable seller who is not obligated to sell to a willing and knowledgeable buyer with no obligation to buy. Federal appraisal standards provide for several methods of determining fair market value, including analyzing prior sales of comparable properties or of the identical property. While the standards indicate that the use of a sales comparison approach is normally the most accurate method, other methods, such as the income approach or cost approach, may be used when comparable sales data are not available. The income approach involves estimating the value of a resource on the basis of the present value of the anticipated future income from production. Generally, the income method values the estimated future income stream from a project and adjusts the value of this income stream to its value today by using a discount rate. The cost approach also involves estimating the value of a resource but is based on the current costs to reproduce or replace the existing resource in addition to the value of the bare land. In cases where existing land use regulations could affect the value of an appraised property, professional standards require the appraiser to consider the effect of regulations on the use and value of the property. The harvesting of timber on the Headwaters property has been affected because the property contains habitat for the threatened marbled murrelet, as well as other species; harvesting has also been affected by state forest practice statutes and regulations. For the purposes of appraising the Headwaters property, BLM instructed the appraiser to assume that all land use plans and permits were in place to allow for the harvesting of the property. Although the Elk River property has identified threatened and endangered species, it does not have old-growth redwood stands, which provide a unique habitat for some threatened and endangered species. Professional appraisal standards permit limited departures from certain guidelines, but only if an appraiser determines that the appraisal results will not be confusing or misleading and if the report is clearly identified as a limited appraisal. For the appraisal of the Headwaters property, because it has been identified as threatened and endangered species habitat and no comparable habitat conservation plans for the species exist, the amount of timber harvest allowed is uncertain. Therefore, BLM instructed the appraiser to assume specific timber harvest levels to avoid speculation on the amount of timber that could be harvested. The appraiser was instructed to assume that the owner could harvest 25 percent, 50 percent, 75 percent, and 95 percent of the merchantable timber on the property.The appraiser determined that relying on this set of critical assumptions would result in a limited appraisal but would not confuse or mislead. BLM did not include specific instructions on the levels of harvest to be used in the Elk River appraisal. In cases in which the government does not acquire an entire property, but acquires only a piece of it, federal appraisal standards state that the preferred way to value the partial property is to use a “before and after” method. This method occurs when the government acquires property by condemnation or negotiated settlement. In the before and after method, the appraiser estimates the value of the whole property before the transaction and reduces it by the value of the property remaining in private ownership after the transaction is completed. Although Pacific Lumber owns approximately 200,000 acres of timberland in northern California, BLM’s instructions directed the appraiser to estimate the value of the Headwaters property as if it were not part of the larger Pacific Lumber holdings (i.e., a stand-alone property). The appraisal instructions included this direction because, according to a Justice official, the Headwaters agreement is not a negotiated settlement of the company’s lawsuits, but is an agreement to acquire land for which discussions have been ongoing for almost a decade. According to this official, if the property is acquired, an additional provision of the agreement is for the dismissal of the company’s two takings lawsuits against the state and federal governments. The Elk River property was also appraised as a stand-alone property. Estimate of Headwaters Property’s Value The Headwaters property appraisal covers the 4,500-acre Headwaters Forest and the 1,125-acre Elk Head Springs Forest, both of which are old-growth forests owned by Pacific Lumber. The appraiser estimated four values for the Headwaters property—one for each harvest premise provided by BLM in its instructions. In establishing these values, the appraiser used two approaches—the cost approach and a discounted cash flow approach, which is an income method. According to the appraiser, there are no timber properties or sales of properties like the Headwaters property—that is, large properties with both old-growth trees and marbled murrelet populations—which makes the sales comparison approach impossible. For both methods, the appraiser estimated the total amount of timber available for harvest, the time needed to harvest the timber under each premise, and the costs of logging the timber, which include the costs for transportation. Using timber inventory data provided by an outside consultant, the appraiser estimated that the property contains about 670 million board feet (mmbf) of timber. He then estimated that it would take 5 years to harvest 25 percent of the timber, 8 years to harvest 50 percent of the timber, 11 years to harvest 75 percent of the timber, and 15 years to harvest 95 percent of the timber on the property. The appraiser estimated that logging costs would be the same under each premise, about $90 per thousand board feet (mbf). The appraiser relied on the discounted cash flow analysis to establish the four premise values and used four values established using the cost approach to verify the discounted cash flow values. He then reconciled the two sets of values. In the discounted cash flow method, the appraiser estimated the net annual income under each harvest premise—for example, 25 percent over 5 years—and calculated the present value of the total net income stream. To this, he added the present value of the remaining land and trees as if they were sold at the end of the harvest period. For each premise, the appraiser used a discount rate of 9 percent and used appreciation rates for timber values of 1 to 4 percent, depending on the type of tree. In the cost approach, the appraiser estimated that the immediate harvest value of the land and timber would be $590 million; he then multiplied the four premise percentages—for example, 25 percent—to get the value of the timber harvested under each premise. Because the timber on the property could not be harvested in 1 year, the appraiser discounted the values using a rate of 8 percent. For the cost approach, the appraiser used a 3.5-percent appreciation rate. The Headwaters property appraisal established four values based on four separate harvest premises. These four values are displayed in table 1. Estimate of Elk River Property’s Value The Elk River property appraisal covers the 9,468 acres of second-growth timber commonly referred to as the Elk River Timber Company property, even though the owner of record is L.E.T., a joint venture. Over 1,700 acres of this property, which adjoins the north side of the Headwaters property, will be retained by the government to act as a buffer for the old-growth forest. The remaining acreage will be part of the exchange with Pacific Lumber for its Headwaters properties. The appraiser responsible for the Elk River property appraisal relied on a sales comparison approach and verified the value using a discounted cash flow approach. For both approaches, the appraiser estimated the total amount of timber available for harvest and the costs of logging the timber, which include the costs for transportation. Using timber inventory data provided by an outside consultant, the appraiser estimated that the property contains about 207 mmbf of timber. The appraiser estimated that logging costs would be the same under each approach, about $132 per mbf. Using the sales comparison approach, the appraiser gathered data on the price of logs delivered to mills and the sale price of standing timber. He calculated a price per thousand board feet for each type of timber—for example, redwood—and multiplied these prices by the amount of timber, according to type, that could immediately be logged. The appraiser estimated that about 109 mmbf of the timber on the property could be logged immediately. To this value, the appraiser added the present value for the remaining land and trees. The appraiser used a discounted cash flow analysis to verify the value established by the sales comparison approach. In the discounted cash flow analysis, the appraiser assumed that 12.5 mmbf of timber would be cut each year for 10 years and calculated the discounted value of the related net income stream. To do this, he used an 11-percent discount rate and an annual price appreciation rate of 3.5 percent. Finally, he added the net present value of the property as if sold at the end of the 10-year harvest. In an addendum to the appraisal, the appraiser allocated the timber assets and the associated value between the government’s and Pacific Lumber’s parcels. To do this, he estimated the volume of loggable timber on each parcel and multiplied this volume by the estimated price paid by lumber mills, adjusted for logging costs. The appraisal established a value of $78.4 million for the property. The appraiser then allocated $51.8 million of this value to the portion of the property to be given to Pacific Lumber and $26.6 million to the portion of the property to be retained by the government. Secretary of the Interior’s Opinion of Value The Secretary wrote an opinion of value that summarized the purpose of the Headwaters agreement and acquisition. This document also summarized the results of the two appraisals and concluded that the authorized public expenditure of $380 million is within the range of appraised values; the values range from $135 million to $405 million for the Headwaters property and include an additional $26.6 million for the portion of the Elk River property to be retained by the government. The opinion also found the acquisition to be in the best interests of the United States because it represents an opportunity to set aside an irreplaceable resource for the public. Key Assumptions Used in the Headwaters and Elk River Appraisals The Headwaters and Elk River property appraisals relied on several key assumptions. The need to make key assumptions during the appraisal process tended to increase uncertainty about the appraised values. In general, the need to make assumptions about key unknown factors increases the uncertainty associated with any estimate of appraised value. Although we have not determined the cumulative effect of relying on these assumptions, it appears that some of these assumptions tended to increase the appraised value of the property while others tended to decrease the appraised value. Although we note that using different assumptions would have resulted in different appraised values, we do not find the use of the assumptions unreasonable. Headwaters Appraisal In estimating the four fair market values of the Headwaters property, the appraisal relied on several key assumptions. The key assumptions made in the appraisal that we address are that (1) a past timber inventory was reliable for the purposes of the appraisal, (2) certain levels of harvest could be achieved, (3) the proper land use and environmental permits would be in place and harvesting could begin after 1 year, and (4) the acquisition of the parcel had no effect on the value of Pacific Lumber’s remaining holdings. According to Justice and BLM officials, with more time to do the appraisals, some of the assumptions might not have been necessary because more information might have been available. Under such circumstances, the habitat conservation plan, the sustained yield plan, and the incidental take permit for the remaining Pacific Lumber property could have been nearer completion, if not completed, before the appraisal occurred. These documents could have served as guidance to make some of the appraisal assumptions more precise. Although we note that using different assumptions in each of these four cases would have resulted in different appraised values, we do not find the use of the assumptions unreasonable. Government Assumed the 1992 Timber Inventory to Be Acceptable for Appraisal Purposes The Headwaters appraisal relied on a timber inventory for the Headwaters property (not including the Elk Head Springs property) performed in 1992. The 1992 inventory involved measuring trees in specific plots on the property; as a result of this sampling, the timber was categorized into seven types, or strata. In 1997, BLM hired a consulting firm to perform a verification sample of the property to determine whether the 1992 timber inventory would still be a reliable estimate of timber volume. The consultants sampled the four main old-growth timber types, and that sample yielded a timber volume estimate that was 9 percent less than the 1992 estimate. Statistical tests of the samples showed that the 9-percent difference was within the sampling error acceptable to BLM and that the two volume estimates were not significantly different. As a result, BLM used the 1992 timber inventory as the basis for determining volume in the appraisal. According to BLM officials and the forestry consultants who performed the work, the old-growth timber would not be expected to have much net growth, and for this reason, it would be appropriate to use the 1992 volume. However, in the young-growth strata of timber, which was not included in the sample, growth would occur. A new inventory might have led to a different estimate of timber volume, which, in turn, could have affected the appraised value. Government Assumed Levels of Harvest Because of marbled murrelet and forestry restrictions on the Headwaters property and the lack of comparable habitat conservation plans on other properties, the government instructed the appraiser to assume four levels of harvestability for the appraisal: 25 percent, 50 percent, 75 percent, and 95 percent. While the appraiser developed different time lines for each harvest premise, he used the same harvest scenario for each premise. This scenario included estimated discount rates, logging costs per thousand board feet, and price appreciation. However, a larger harvest—under the 95-percent premise, for example—might be delayed because of longer time frames for cutting and the possibility that harvest plans might be delayed or disapproved. Consequently, there is greater risk associated with a larger harvest. The appraiser did a sensitivity analysis for each harvest premise; however, he used the same range of discount values for both the large and small harvest levels. Given the higher risks that may be associated with larger harvest premises, a higher range of discount rates might be applied, resulting in lower appraised values for these premises. Furthermore, the appraiser assumed, on the basis of his interpretation of BLM’s instructions, that an even mix of timber types would be cut under each premise, regardless of the type or value of the timber. For example, under the 25-percent premise, 25 percent of each timber type would be cut, as opposed to cutting an equivalent volume consisting solely of old-growth redwood, the most valuable type. In reality, a purchaser interested in maximizing the profit of the property would likely harvest the most valuable timber first. As a result of this assumption, the lower harvest premises may be undervalued. The effect on the higher harvest premises would be less severe because more timber would be cut under these premises. Government and Appraiser Assumed That Permits Would Be Issued The appraisal relied on the assumption that a harvester would have received the required governmental permits and would have been able to commence harvesting in a timely manner. For each premise, the appraiser assumed harvesting would begin after 1 year, during which all harvest plans and permits would be finalized. Prior to harvesting, timber operators are required to be licensed, and in addition, operators must submit timber harvest plans for the state’s approval. Furthermore, when threatened and endangered species habitat is involved, a habitat conservation plan may need to be approved before timber harvest plans can be approved. At the time of the agreement for the acquisition of Headwaters, the company had submitted at least one timber harvest plan for this area but had not developed a habitat conservation plan. According to both state and BLM officials, although a timber harvest plan can be approved in about 10 weeks, there is less experience with processing a habitat conservation plan and this could take years to finalize. We believe the net present value of future income from the timber would have been lower if delays had occurred. If the appraiser had assumed, for example, a 2- to 3-year delay in obtaining permits, he would have obtained a lower appraised value under each premise. Government Assumed No Value Added to Remaining Pacific Lumber Holdings The Headwaters property makes up about 5,600 acres of the 200,000 acres owned by Pacific Lumber in Humboldt County. Because the government is acquiring only part of the property, BLM instructed the appraiser to estimate the value of the 5,600 acres without considering the fact that the property is part of a larger ownership. Justice officials and officials from Interior’s Office of the Solicitor believe the Headwaters acquisition is an independent transaction begun before the lawsuits and the negotiated agreement to dismiss the company’s takings lawsuits. Because of this view, BLM, Justice, and Interior’s Office of Solicitor officials instructed the appraiser to value the Headwaters property as if it were a stand-alone property and as if it were sold voluntarily. However, the company views the acquisition as part of a negotiated settlement of the company’s lawsuits. When the government acquires property through a negotiated settlement, the rules of appraisal are generally structured to measure what the property owner will lose. If only a portion of the property is acquired by a negotiated settlement, consideration is given to the damages and/or benefits that may accrue to the property owner’s remaining property. This is accomplished by estimating the market value of the entire ownership (larger parcel) before the government’s acquisition and then estimating the market value of the property remaining after the acquisition. The difference between the two values is the value the owner has lost, which is equal to the value of the acquired property. According to BLM officials, it would have been difficult to value the 200,000 acres owned by Pacific Lumber, because of both the time and work involved. Nevertheless, Pacific Lumber may benefit from the sale of the Headwaters property because the company may be able to harvest a significant portion of its remaining property under the habitat conservation plan developed as part of the Headwaters agreement. Because the appraisal instructions reflected the view that the company’s sale of the property was voluntary, the appraiser did not make an adjustment to the appraised value to account for possible increases in the value to the remaining property. As a result, each of the four values may be overstated. Elk River Appraisal In estimating the fair market value of the Elk River property, the appraisal relied on one key assumption. The appraisal assumed that the property to be valued includes the anticipated net timber growth occurring between the date of value and the date of the acquisition. As stated earlier, in general, the need to make assumptions about key unknown factors increases the uncertainty associated with any estimate of appraised value. Reliance on this assumption increased the appraised value of the property, although we have not determined the specific amount of increase. While we note that using different assumptions would have resulted in different appraised values, we do not find the use of the assumption unreasonable. Government Agreed to a Projected Increase in Timber Volume The timber volume upon which the Elk River property appraisal is based includes anticipated timber growth through the date of the expected acquisition. BLM instructed the appraiser to include the estimated growth on the basis of a memorandum of agreement among the state of California, the United States, Pacific Lumber, and the Elk River Timber Company. This memorandum stipulated that in exchange for including an estimate of timber growth, the Elk River Timber Company would forgo any timber harvests or other economic use of the property until the acquisition. Elk River had an approved timber harvest plan for portions of the property and could have harvested timber in those areas. The date of value for the appraisal is June 15, 1998, yet the timber volume used in the appraisal is projected to February 28, 1999-—more than 8 months later. This projection, which was calculated by forestry services consultants for BLM, relied on a 7-percent annual growth estimate. The consultants based the growth estimate on data from the Elk River Timber Company, tree core samples they took from the property, and historical growth data for the site. While the estimate is statistically based and BLM accepted the estimated increase in volume, the amount of growth is a projection and could be more or less than estimated. As a result, the appraised value reflects additional value based on projected growth. Observations In our review of the Headwaters and the Elk River property appraisals, we did not identify areas in which the appraisals deviated from federal appraisal standards. We also did not find that the use of assumptions in the appraisal was unreasonable given the imprecision involved in appraising timber properties and the unique circumstances of this property. The Secretary of the Interior recognized, in his opinion of value, the intrinsic worth of the irreplaceable natural resources of the Headwaters property, whereas the appraisals simply estimated the value of the properties on the basis of their use as timberlands. In the event that the Headwaters acquisition is not completed by March 1999, Pacific Lumber will have various alternatives for dealing with the limitations placed on harvesting timber on this property. One of these alternatives is the revival of its takings lawsuits. Alternatively, Pacific Lumber might seek to negotiate a habitat conservation plan, an incidental take permit, and state timber harvest plans for the Headwaters property in order to harvest timber. Agency Comments We provided the Department of the Interior with a draft of this report for review and comment. In its comments, Interior generally agreed with the information in the report. The Department also provided technical comments about the Secretary’s opinion of value, the requirements and application of the Endangered Species Act, and the memorandum of agreement among Pacific Lumber, the state of California, the United States, and the Elk River Timber Company, among other things. We incorporated Interior’s recommended changes or clarified the report’s language as appropriate. (Interior’s comments are reproduced in app. I.) Scope and Methodology We reviewed the Uniform Appraisal Standards for Federal Land Acquisitions, issued in 1992 by the Interagency Land Acquisition Conference, as well as the Uniform Standards of Professional Appraisal Practice issued in 1998, to become familiar with federal appraisal standards. We reviewed the appraisals themselves, Appraisal of Headwaters and Elk Head Springs, signed September 28, 1998, and Appraisal Report: The Elk River Timber Company, signed September 28, 1998, to become familiar with their methodology and data. We discussed both the standards and the appraisals with the Chief Appraiser and State Forester for BLM’s California State Office and the contract appraisers who conducted the appraisals. We interviewed an outside appraisal expert, officials with the state of California, and other experts in government land acquisition. We also met with officials from Justice and Interior’s Office of the Solicitor. Both these agencies provided BLM with legal advice on the appraisal process. In a December 1997 letter to the Secretary of the Interior, the Committee and Subcommittee Chairmen who requested our work recommended that the Interior coordinate the appraisal process with us before we received the final appraisal. While BLM officials did apprise us of the status of the appraisal process before we received the final appraisal on November 25, 1998, they declined to provide us with any analyses or drafts of the appraisal before that date because this information was subject to review and change. After doing some preliminary work in January and February 1998, we performed the bulk of our review in November and December 1998. Our work was conducted in accordance with generally accepted government auditing standards. We are sending copies of this report to the appropriate congressional committees and will make copies available to the Secretary of the Interior and other interested parties. We will make copies available to others upon request. If you or your staff have any questions, please call me on (202) 512-3841. Major contributors to this report were Jay Cherlow, Tim Guinane, Susan Iott, Diane Lund, Dick Kasdan, Sue Naiberk, and Victor Rezendes. Comments From the Department of Interior The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. 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Pursuant to a legislative requirement, GAO reviewed the appraisals of Headwaters Forest that were required to be conducted prior to its acquisition, focusing on: (1) whether they complied with federal appraisal standards and how the values of the appraisals were derived; and (2) key assumptions used in the appraisals. GAO noted that: (1) it did not identify any areas in which the appraisals of the Headwaters and Elk River properties deviated from federal appraisal standards; (2) federal appraisal standards state that the government should appraise a property to be acquired at its fair market value; (3) the appraiser of the Headwaters property produced a limited appraisal with four market values--one value for each of four timber harvest assumptions provided by the Bureau of Land Management (BLM); (4) in calculating these four values, the appraiser relied on two approaches: (a) estimating the current cost of the land and the timber from revenue and logging-cost estimates; and (b) estimating the total net income from future timber operations and adjusting this amount to the present value of the standing trees; (5) the appraiser of the Elk River property relied on one approach to derive fair market value, the use of comparable sale information to estimate value, and verified the result using a second approach, estimating the total net income from future timber operations and adjusting this amount to the present value of the standing trees; (6) following these standards led the appraiser to estimate the value of the Headwaters property at $135 million, $250 million, $350 million or $405 million, depending on the assumed harvest level; (7) the Elk River property was appraised at $78.4 million; (8) the Secretary of the Interior, in his opinion of value, determined that the $380 million authorized for the combined properties falls within these appraised values; (9) the Secretary's opinion of value also found the acquisition to be in the best interests of the United States because it represents an opportunity to set aside an irreplaceable resource for the public; (10) GAO's work found that in both appraisals, the need to make key assumptions during the appraisal process tended to increase uncertainty about the appraised values; (11) GAO did not estimate the specific monetary impact of these assumptions; (12) however, using different assumptions would have changed the appraised values; (13) the Department of Justice and BLM officials noted that the appraisals could not have been completed by statutory deadlines without making assumptions to address these issues; and (14) although GAO noted that using different assumptions would have changed the appraisal values, GAO did not find the use of the assumptions unreasonable.

Background Supplementals provide additional budget authority for government activities for the fiscal year already in progress, over and above any funding provided in regular appropriations laws, continuing resolutions, or omnibus appropriations. The President may also submit to Congress proposed supplemental appropriations the President decides are necessary because of laws enacted after the submission of the budget or that are in the public interest. Within a single supplemental appropriations law, some funds may be designated as emergency and others may not. Emergency-designated funds do not have to compete for scarce resources that are constrained by budget controls. Figure 1 shows the amount of supplemental gross budget authority (i.e., before rescissions) from fiscal year 1981 through fiscal year 2007. Although our review focused on supplementals enacted from fiscal year 1997 through fiscal year 2006, we included data from fiscal year 1981 through fiscal year 2007 in this figure to provide context. From fiscal year 1981 through fiscal year 1999, fiscal year 1991’s nearly $50 billion stands out even in the absence of a consistent pattern. Most of the $48.6 billion in supplemental appropriations provided that year was for the Gulf War. From fiscal year 2000 through fiscal year 2005, however, the amount grew steadily to a peak of over $160 billion. The amount in 2006 declined to just over $128 billion. For fiscal year 2007, just over $120 billion in supplemental gross budget authority was appropriated. As we previously noted, not all emergency funding is provided through supplementals. CBO has noted that until 1999 virtually all emergency- designated funds were provided as emergency-designated supplemental budget authority in response to natural disasters or international crises. But in the 1999 omnibus appropriation act more than $21 billion in appropriations were designated as emergencies. That number rose to $31 billion in 2000. This change illustrates two points of significance to this study: (1) a change in the way the emergency designation is used and (2) the fact that emergency funding can be provided through legislative acts other than supplementals. Although this report focuses on supplementals and so does not look at emergency-designated funds in regular appropriations, their existence emphasizes the fact that the decision on whether to use supplementals and the decisions regarding the emergency designation are separate. From fiscal years 1991 through 2002, appropriations were governed by the provisions of the Budget Enforcement Act of 1990 (BEA), which Congress and the President adopted in November 1990 as part of a multiyear budget agreement. The BEA established statutory limits on discretionary spending coupled with a “pay-as-you-go” (PAYGO) requirement designed to ensure that new legislation affecting mandatory spending or tax revenues did not increase the deficit. The discretionary spending limits applied to both budget authority and outlays. If the discretionary appropriations enacted for a given year caused any of the caps to be exceeded, the President had to order a sequestration of funds in the category of spending in which the breach occurred. The BEA did recognize that there would be emergencies for which Congress and the President would want to provide funds over and above the amounts envisioned in the discretionary spending caps and provided a kind of “safety valve.” If a provision was designated as “emergency” by both the President and Congress, the discretionary spending caps were raised for both the budget authority and outlays associated with the emergency spending (this is sometimes referred to as being exempted from the caps). Thus, supplemental appropriations designated as emergency spending did not cause a breach of the caps, did not trigger a sequestration, and were not required to be offset with a rescission. In addition, BEA treated all incremental costs associated with Operation Desert Shield as if they were designated emergency without requiring further action by Congress and the President. Under the BEA, nonemergency supplementals were subject to the discretionary spending caps. If a nonemergency supplemental under consideration by either the House or the Senate would have exceeded the amount allocated to the applicable budget function under the budget resolution, the supplemental was subject to a point of order. In practice, however, such points of order generally were not raised. In some cases, supplemental appropriations have been protected with waivers of the points of order in both the House and the Senate. Although most budget enforcement mechanisms expired in fiscal year 2002, Congress generally has included overall limits on discretionary spending and exemptions for emergency-designated funding in its Budget Resolutions. In addition, the Budget Resolutions for fiscal years 2005 and 2006 provided exemptions for all appropriations related to overseas contingency operations for the Global War on Terrorism. Increased Use of Supplementals is Largely Attributable to Defense Funding As figure 1 showed, the use of supplementals has increased over the last several years. Over the 10-year period from fiscal year 1997 through fiscal year 2006, 25 supplemental appropriations laws were enacted providing about $612 billion ($557 billion net of rescissions) in new gross budget authority. In contrast, during the 10 years immediately preceding this period, $126 billion in gross budget authority ($86 billion provided net of rescissions) was provided in 39 supplemental appropriations acts. The majority of the supplemental funds provided from fiscal years 1997 through 2006 received an emergency designation. Ninety-five percent of the total supplemental funds were appropriated to 11 departments, with the DOD receiving nearly 60 percent of the total (see fig. 2 for the distribution). In comparison, just over 14 percent of the total was appropriated to the Department of Homeland Security (DHS), with other departments receiving 5 percent or less of the total supplemental funds. Factoring in rescissions during the same time period shows that DOD received the most supplemental funds on both a gross and net basis. Ten percent of the total funds rescinded through supplementals over this 10-year period were rescinded from DOD. In contrast, 43 percent of the funds rescinded through supplementals were rescinded from DHS. When the emergency-designated provisions were analyzed by the type of emergency prompting the need for the supplemental, not surprisingly, defense-related emergencies received over 50 percent of the funds. As figure 3 shows, during fiscal years 1997–2006 the vast majority of supplemental appropriations were emergency designated— over $511 billion of the $612 billion in gross supplemental budget authority. Fiscal year 2003 stands out with a large amount of funds that were not emergency designated, primarily targeted to war-related efforts. The lack of emergency designation for these funds could have been the result of the close timing between the supplemental request and the introduction of the fiscal year 2004 Budget Resolution. The Budget Resolution was written to allow for the war-related supplemental. Supplemental funding for similar activities was emergency designated in later years. Although funds that are not emergency designated do not receive any special budgetary treatment, they may receive less scrutiny than appropriations made during the regular budget process. As shown in figure 4, more than 50 percent ($270 billion) of the emergency-designated supplemental funds were appropriated for defense- related activities. In comparison, 28 percent was directed to respond to natural or economic disasters and 16 percent went to antiterror, security, and post-9/11 activities. International humanitarian assistance, pandemic influenza, and other activities comprised 3 percent of the total emergency- designated supplemental funds provided over the 10-year period we studied. Additional Controls Could Reduce the Use of Supplementals and Increase Opportunities for Oversight Our analysis indicates that there are a number of issues to be addressed if the use of supplementals is to be limited to needs identified after the beginning of the fiscal year. Although Congress has specified criteria for the emergency designation in Budget Resolutions, these criteria are not self-executing and there are limited screening and enforcement processes. In our review of emergency-designated supplementals, we found provisions that were not clearly consistent with these criteria as well as provisions that did not contain sufficient information for us to make a determination. We also found that provisions in supplemental appropriations were not always related to the emergency events that may have prompted the supplemental, which raises questions about the potential use of supplementals to fund items that could have been included in the regular budget and appropriations process. In addition, we found that a number of accounts are regularly funded through supplementals, which may indicate that they are being funded through supplementals in lieu of the regular budget and appropriations process. Finally, we found that over one-third of the supplemental appropriations enacted were available until expended (referred to as “no-year” funds). Such funds provide agencies with great flexibility but do not prompt the annual or periodic Congressional review and reconsideration typical of funds that are available for a limited amount of time. Emergency-Designation Criteria Are Not Self- Executing and May Not Always Be Applied The term “emergency” is not defined in budget process law. However, in a 1991 report to Congress, the Office of Management and Budget (OMB) proposed what it described as a neutral definition of “emergency requirement,” and Congress has included this definition in its Budget Resolutions. The definition requires that for something to qualify as an “emergency” all five of the following criteria must be met: a necessary expenditure (an essential or vital expenditure, not one that is merely useful or beneficial); sudden (coming into being quickly, not building up over time); urgent (a pressing and compelling need requiring immediate action); unforeseen (not predictable or seen beforehand as a coming need, although an emergency that is part of an overall level of anticipated emergencies, particularly when estimated in advance, would not be “unforeseen”); and not permanent (the need is temporary in nature). These emergency criteria, modified slightly, have appeared in several proposed budget process reform bills. Although none of the proposed reform bills have been enacted, Congress incorporated the emergency criteria into its Concurrent Budget Resolution in years 2004, 2005, and 2006. In 2003, there was no Concurrent Budget Resolution. We interpreted the continued appearance of the criteria as a statement of Congress’ general acceptance of the definition. Critics of the use of the emergency designation cite numerous examples of funding designated as emergency that they believe meet none of the criteria listed above. In our review of emergency-designated supplemental provisions enacted from fiscal years 1997 through 2006, we found provisions that were not clearly consistent with these criteria as well as provisions that did not contain sufficient information for us to make a determination. These provisions totaled over $31 billion—or about 5 percent of the supplemental appropriations in the 10-year period. Specifically, we found 26 provisions with over $6 billion of the over $500 billion in emergency-designated supplemental funds that stood out as not being clearly consistent with the emergency-designation criteria of “sudden” and “unforeseen.” Most of these funds were appropriated in preparation for a potential emergency—the threat of pandemic influenza. While we do not question the importance or urgency of the pandemic work, applying the emergency designation to preparation for future events does raise questions regarding the application of the “sudden” or “unforeseen” criteria. The remaining funds were primarily provided for research and development activities. Although these are a relatively small portion of total supplemental funding, these examples raise questions about the credibility of the emergency-designation criteria in the budget enforcement process. In addition, nearly $25 billion was provided in emergency-designated provisions without sufficient explanation for us to determine their consistency with the emergency-designation criteria. Without further explanation in individual provisions as to what prompted the emergency designation, the use of emergency-designated supplemental appropriations for such activities reduces the transparency of the emergency designation. As we have previously reported, since fiscal year 2002 defense-related funds for GWOT have generally been provided as emergency-designated funds in either supplementals or a separate title (Title IX) of annual defense appropriations acts. Some have questioned the use of the emergency designation for the funds provided for the ongoing military operations related to GWOT—noting that it is problematic for an ongoing event to be considered “sudden” or “unforeseen.” However, we do not address this in our analysis, because Congress has provided that some of the funds for overseas contingency operations related to GWOT can be designated emergency and are exempt from certain points of order and other budget enforcement provisions. Proponents of the current approach note that it avoids inflating DOD’s “baseline” budget, while including some funds in the regular appropriations process. Indeed the question here is more whether these funds should be provided through supplementals or through the regular budget and appropriations process, not whether they are designated as emergency. We have previously encouraged the Administration to include known or likely projected costs of ongoing operations related to GWOT within DOD’s base budget requests. Whether designated emergency or not, continuing to fund GWOT through supplementals reduces transparency and avoids the necessary reexamination and discussion of defense commitments and funding trade- offs. Provisions in Supplemental Appropriations Were Not Always Related to Emergency Events That May Have Prompted the Supplemental Supplemental appropriations provide funds outside the regular, annual budget and appropriations process, typically in response to some need, event, or emergency that may arise after the fiscal year has begun. Unlike regular appropriation bills, which are under the jurisdiction of a single appropriations subcommittee in the House and the Senate, supplemental appropriations may include items under the jurisdiction of many subcommittees, with varying purposes and levels of urgency. In considering supplementals, appropriators must grapple with issues of grouping disparate items, considering emergency and nonemergency items together, and determining when requests form enough of a “critical mass” to warrant going forward with a supplemental appropriation bill. This raises two issues that were confirmed in our analysis. First, supplementals sometimes contain a mix of emergency-designated and nonemergency-designated provisions. Over the 10-year period we examined, 8 of the 25 supplemental appropriations laws that were enacted combined emergency-designated funding with that which was not so designated. In total, over $11 billion of the over $279 billion provided in these laws was not designated as emergency. Emergency-designated provisions may necessarily be on a fast track—and therefore receive less scrutiny—to facilitate a rapid response to some emergency event. Meanwhile, the items that are not emergency designated may benefit from the urgency of the legislation by avoiding the scrutiny and trade-offs that are inherent in the regular budget and appropriations processes. Second, our analysis showed that some supplementals contain emergency- designated provisions not related to the event/issue(s) that may have prompted the need for the supplemental. From fiscal years 1997 through 2006, over $710 million was provided in emergency-designated provisions found to be unrelated to the emergency that may have prompted the supplemental. Some of these appeared to be for other emergencies and some for activities for which the emergency nature was unclear. For example, $9 million in drought relief was provided in a law entitled “Emergency Supplemental Appropriations Act for Defense, the Global War on Terror, and Hurricane Recovery, 2006.” In another example, the Coast Guard received $110 million for a Great Lakes Icebreaker replacement as part of a $578 million appropriation for the Coast Guard in a section of law entitled “Kosovo and Other National Security Matters.” Although these sums are small in terms of the aggregate budget, they may be significant for a given agency or program. In addition, over $12 billion were provided in provisions in which the relationship to the event/issue(s) that may have prompted the supplemental was unclear. For example, one section of a law contained provisions with funding for a myriad of activities—including activities related to stemming illegal immigration, international health programs, and several highway and rail improvement projects—that did not provide information to determine the relationship to the event/issue(s) that prompted the need for “emergency” funding. The appearance of these provisions in supplemental appropriations raises the question of whether supplemental appropriations bills can become vehicles for funding some programs or activities while avoiding the greater scrutiny and trade-offs that occur in the regular appropriations process. Some Accounts Received Supplemental Funding on a Recurring Basis Although some supplementals are clearly necessary to provide for costs that were not contemplated in the regular budget and appropriations process, many people suspect that the availability of supplemental appropriations as a funding vehicle may contribute to the underfunding of some programs in the annual budget and appropriations process and subsequent funding through supplementals. For activities that regularly receive emergency-designated supplemental appropriations, there can be an incentive to provide funding in a supplemental rather than in the regular appropriations process where these activities would have to compete with others for limited resources in trade-off decisions. Even if the funds were emergency designated, including them in the regular budget and appropriations process provides greater transparency. When full funding information is not included in the regular budget and appropriations process, it understates the true cost of government to policymakers at the time decisions are made and steps can still be taken to control funding, which is even more important in a time of constrained resources. In our review of supplementals over the 10-year period, we found that 35 accounts received supplemental appropriations in at least 6 of the 10 years studied, totaling over $375 billion. The majority of these accounts fell within DOD. Table 1 details these accounts, the department in which the accounts reside, and the total new budget authority the account received over the studied 10-year period. DOD had 21 accounts that received supplemental funds in at least 6 out of the 10 years in question. In addition, the gross budget authority granted to these 21 DOD accounts ($258 billion) comprised over 40 percent of the total gross budget authority in supplemental appropriations enacted over the studied period. Overall, the 35 accounts receiving funds on a recurring basis accounted for 61 percent of the gross supplemental budget authority over the 10-year period. The Federal Emergency Management Agency’s (FEMA) Disaster Relief account repeatedly receives emergency-designated funds through both supplemental appropriations and the regular annual appropriations process. Funding for FEMA’s Disaster Relief account is shown in table 2. This analysis shows that on average the appropriations FEMA receives through regular appropriations are less than the average amount received through supplemental appropriations each year. Even when extraordinary events such as Katrina and 9/11 are removed, the supplemental appropriations are still of a significant size relative to the regular annual appropriations. The Department of the Interior’s Wildland Fire Management account also receives funds through regular and supplemental appropriations. This account, like FEMA’s Disaster Relief account, received supplemental funding in at least 6 of the 10 years studied. Regular budget requests for fire suppression activities are based on a historical 10-year average of suppression expenditures adjusted for inflation. Previous GAO work has found that these estimates often fall short of actual costs. In addition to funds provided through the regular budget and appropriations process, the Wildland Fire Management account received at least $936 million in supplemental appropriations over the studied 10-year period. In FEMA’s case, the imbalance between the amounts of appropriations provided through the annual and supplemental processes is by design. However, the fact that the imbalance exists even with the removal of extraordinary events may indicate a need to revisit how much is provided in the annual process. We have previously reached a similar conclusion in regards to Wildland Fire Management and the same may be true for other programs that receive supplemental funds on a recurring basis. Providing more in the regular appropriations process could result in less funding through supplementals. Again, when funds are regularly provided via supplemental appropriations, the true cost of government is not fully transparent in the regular appropriations process. Therefore, decision makers may not have full information when allocating resources. While No-Year Funds Provide Flexibility, They May Also Limit Periodic Oversight Given the timing of the budget process and the combination of the need to provide funds promptly with the desire that they be spent in a thoughtful and targeted manner, it is understandable that supplemental funds would need to be available beyond the current fiscal year. Indeed, in the cases of some emergency events it is likely that funding will need to be available for multiple years. Some funds are available until expended (referred to as “no-year” funding). Over the 10-year period we studied, over one-third of the supplemental appropriations provided (about $209 billion) were available for obligation until expended. These no-year funds provide flexibility but also limit opportunities for oversight and control. The expiration date of single or multiyear funds provides an automatic incentive for revisiting program needs. If the need for funding for a specific emergency continues for several years, it can be argued that such funding subsequently could be considered in the regular budget and appropriations process. No-year funding is available indefinitely and does not prompt annual or periodic Congressional oversight. Options to Control the Use of Emergency Supplementals We have identified four proposals that could help increase controls over and transparency of the use of supplementals. These proposals are intended to ensure the following: (1) emergency-designated provisions meet established criteria, (2) emergency supplementals do not become the vehicle for items that do not require the rapid enactment demanded to respond to an emergency event, (3) supplementals are not used where the regular budget and appropriations process should suffice, and (4) a balance exists between flexibility and oversight with regard to the time availability of funds. We consulted individuals with expertise in the budget and appropriations process and reform proposals to obtain opinions on the options that follow. These experts generally agreed that reform was needed but differed on how best to achieve this. Most of the experts suggested that the increased use of supplementals is symptomatic of breakdowns in the regular process—which has resulted in reliance on supplementals as a way to provide funding for federal activities. Given this, they expressed doubts about the likelihood of any reform unless a way was found to return to some “regular order” for the budget and appropriations process. In general they expressed a desire to reduce the complexity of the process and so preferred options that did not add significant procedural hurdles. Most agreed that some limitations on the availability of funds—i.e., a turn away from “no-year” funds—made sense. Codify Emergency- Designation Criteria and Establish New Mechanisms for Enforcement The frequent inclusion of the emergency-designation criteria in Budget Resolutions would seem to imply Congressional adoption of these criteria. However our review found some cases where provisions were not clearly consistent with the emergency-designation criteria and many cases where provisions did not contain sufficient information for us to make a determination. These cases raise questions about the credibility of the emergency-designation criteria in the budget enforcement process. The fact that they are in resolutions and not in law may affect the way they are treated. Therefore, codifying these criteria as an amendment to the Congressional Budget Act should be considered. However, most of the budget experts we consulted believed this would make little difference. Whether or not the criteria are codified, there are a variety of enforcement approaches that could help decision makers to better weigh priorities and assess trade-offs. For example, currently the criteria in Budget Resolutions are not self-enforcing in that they do not require affirmative action to move forward. Legislative language that has an emergency designation is subject to a point of order; it requires a Member (or Members) to make a motion to strike such a provision. This step is rarely taken; if the point of order is raised and sustained, then the provision making the emergency designation is stricken and may not be offered as an amendment from the floor. Congress could flip the default—requiring an affirmative vote to provide an emergency designation. Some of the budget experts we consulted saw merit in this idea, saying it might result in greater visibility and transparency in the process. Others thought it would have little impact. Two suggested retaining the current system but increasing the number of votes needed to overturn or waive any point of order. Another suggested that the point of order be more narrowly targeted—that it strike the emergency designation while leaving the funding provision in the bill. Depending on the statutory or Budget Resolution-imposed spending limits, such a system could require the funding to be offset—i.e., to have trade- offs considered more explicitly. A related idea would be to require that a statement or narrative justification describing how the provision meets the emergency criteria accompany any provisions carrying the emergency designation. Absent such a justification, the provision would be out of order and could not be considered without an affirmative vote. Provisions with accompanying justifications could still be challenged on substantive grounds, but they would not be subject to a point of order on procedural grounds. Another approach might be to require explicit review of all emergency- designated provisions (and proposed amendments that carry such a designation) by a special House or Senate “Supplementals Subcommittee” made up of the leadership of the appropriations subcommittees—or their senior designees—in the relevant body. This subcommittee could provide some consistency in the application of the emergency criteria. A number of the budget experts whom we consulted found this worth exploring; a few said it would be important to find a way to assure prompt consideration of emergency needs. This subcommittee might require that proposals be accompanied by a narrative justification of how a proposal meets the emergency criteria. One of the experts suggested the rule might be that if the Supplementals Subcommittee designated funds as “emergency” and provided an explanation of how the criteria were met, then there would be no point of order against the provision or its designation as emergency. This would not, of course, eliminate the ability of a Member to challenge the provision on substantive grounds. Separate the Consideration of Emergency and Nonemergency Items In considering supplementals, appropriators must grapple with issues of grouping disparate items, considering emergency and nonemergency items together, and determining when requests form enough of a “critical mass” to warrant going forward with a supplemental appropriations bill. This raises two issues that were confirmed in our analysis. First, supplementals sometimes contain a mix of emergency-designated and nonemergency-designated provisions. Emergency-designated provisions may necessarily be on a fast track—and therefore receive less scrutiny—to facilitate a rapid response to some emergency event. Meanwhile, those provisions that are not emergency designated may benefit from the urgency of the fast-track legislation by avoiding the scrutiny and trade-offs that are inherent in the regular budget and appropriations process. Second, our analysis showed that some supplementals contain emergency- designated provisions not related to the event/issue(s) that may have prompted the need for the supplemental. This raises questions as to whether “emergency” supplementals are not always used just to meet the needs of unforeseen emergencies but also include funding for activities that could be covered in regular appropriations acts, if funded at all. To address the first of these issues, Congress could consider establishing two tracks for supplemental appropriations: one for emergencies and one for nonemergencies. This would permit emergency-designated funds to proceed on their necessary fast track while allowing more time for the deliberation of nonemergency items. For those provisions not designated emergency, the aforementioned Supplementals Subcommittees could evaluate the necessity for action through supplementals rather than regular appropriations. One current legislative proposal suggests an even more stringent approach—a bill introduced in the House of Representatives on October 16, 2007, to establish requirements for the consideration of supplemental appropriation bills (H.R. 3857) proposes that all supplemental appropriations would have to be emergency designated in accordance with the emergency-designation criteria. For emergency-designated supplementals, Congress could change the budget process to require that all provisions in emergency supplemental appropriations bills be related to the event/issue(s) that prompted the supplemental. The Supplementals Subcommittees, if established, could be tasked with certifying that each supplemental bill and amendments that offer new areas to be funded meet this requirement. If such a subcommittee is not established, Congress will need to consider another enforcement mechanism. Another proposal, again from H.R. 3857, requires all supplemental appropriations acts to have a single purpose. Under this proposal, it would not be in order for Congress to consider any measure making supplemental appropriations for two or more unrelated emergencies. Several experts agreed that it made sense to separate emergency and nonemergency supplementals but questioned how this would be enforced. In this vein, one expert proposed eliminating the emergency designation altogether and requiring that all funds be counted under budget caps/resolutions. Other experts raised concerns that the separation potentially could slow the supplementals appropriations process. Experts discussed the need for controls over the timeliness of supplementals, suggesting that agencies should be required to submit disaster estimates within a certain period of time after a disaster and Congress should be required to report a bill related to that disaster a certain number of days after that. This would help avoid situations where “emergencies” that occurred 1 or more fiscal years previously receive emergency-designated supplemental funding. It could also help to ensure prompt consideration of funding for true emergencies. One expert, however, saw a real problem with the idea of creating separate tracks for supplementals, seeing the ability to package them together as an important legislative power that serves to balance against the President’s veto power. Provide More Funding in the Regular Budget and Appropriations Process Although some supplementals are clearly necessary to provide for costs that were not contemplated in the regular budget and appropriations process, many people suspect that the increased use of supplemental appropriations may contribute to the underfunding of some programs in the annual budget and appropriations process. We found that 35 accounts received supplemental appropriations in at least 6 out of the 10 years, raising questions about whether emergency supplementals are being used to fund activities that could have been included in regular appropriations. Many of the experts we asked suggested this tendency to fund activities through supplementals was a result of overly tight budget caps/resolutions. Most said that more of the federal government’s costs should be considered through the regular appropriations process rather than later through supplementals. However, there was not consensus on the best way to achieve this. To increase transparency by providing up-front recognition of the likely call on federal resources for some unforeseen situation, Congress could take several steps. For example, Congress could require that accounts that repeatedly receive supplemental appropriations be funded on a realistic historical average. Although some accounts—such as FEMA’s Disaster Relief and Interior’s Wildland Fire Management accounts—are funded on historical averages, data indicate that the methodologies used to develop these averages result in amounts that are frequently insufficient to cover annual costs. In conjunction with using realistic historical averages, Congress might establish an emergency reserve fund to fence off funds for extraordinary events that exceed those historical averages. That fund could be based on a historical average of all emergency spending, excluding military actions. The Securing America’s Future Economy (SAFE) Act of 2007 includes a proposal for such a fund. The reserve fund approach has several potential benefits—the use of emergency reserves may reduce the need for supplemental appropriations, encourage efforts to avoid or mitigate disasters, and highlight potential alternatives to federal action, such as state or local initiatives or private insurance. It also presents pitfalls which would have to be addressed in the design of the reserve fund. For example, there may be pressure to use the reserve even if a triggering emergency does not occur, especially if not all of the funds are needed in a given year. To mitigate against this, Congress might wish to establish more specific criteria for the release and use of such funds—the more specific and measurable the criteria, the more likely there would be agreement over when the funds can be used. Congress could also use the Supplemental Subcommittees that we discussed earlier to apply these criteria and govern the use of the funds. At least one expert openly supported the idea of an emergency reserve fund. However, he and several others cautioned that this fund would need to have explicit controls to determine when funds could be released to avoid a situation in which the fund is raided when budget caps/resolutions are unrealistic. Given the changing nature of the nation’s defense challenge, funding for military actions could be handled separately. Nevertheless, the use of supplementals could still be limited. The use of the separate title within DOD’s regular appropriations in recent years offers one model. As our analysis of GWOT funding has shown, however, whether the separate title model decreases the use of supplementals depends on how it is used. To date, it has been used as a bridge between the regular appropriation and a supplemental. However, more funding could be included in the regular budget and appropriations process in lieu of a supplemental. In addition, although emergency funding has historically been used to support unexpected costs of contingency operations, care needs to be taken with the use of the emergency designation for GWOT funds. Our recent work has shown that changes in DOD’s GWOT funding guidance have resulted in billions of dollars being added to GWOT funding requests for what DOD calls the “longer war against terror,” making it difficult to distinguish between base costs and the incremental costs to support specific contingency operations. Another expert suggested taking a different approach entirely by separating the concept of “contingency” from that of “reserve fund.” He suggested that both Presidential budgets and Congressional Budget Resolutions should recognize estimates of uncertainty and contingencies—both military and natural disaster—in a manner akin to budget function 920 “allowances.” This estimate would not include any real budget accounts or constitute a request for appropriations. Rather, it would be an amount leading to an alternative total—a total should these contingencies or emergencies occur. One approach for this would be to take a 10- or 15-year average of budget authority for natural disasters and show that as a measure of possible additional claims on federal resources. The expert analogized this to insurance—in most years the actual amount needed for emergencies would be less than this estimate, but in others it might be much more. A similar process could be established for military contingency operations. The “allowances” function, or its equivalent, would not provide funds but would be a way to inform budgetary trade- offs and decisions by highlighting the fact that there is uncertainty and that emergency calls on federal resources are likely. Limit the Legal Availability of Supplemental Appropriations to a Fixed Period of Time Given the timing of the budget process and the combination of the need to provide funds promptly with the desire that they be spent in a thoughtful and targeted manner, it is understandable that some supplemental funds would need to be available beyond the current fiscal year. Making funds available for obligation beyond the current fiscal year provides flexibility needed to address uncertainty, especially in the immediate aftermath of an emergency. However, some funds are available until expended (referred to as “no-year” funding), which provides flexibility but reduces opportunities for oversight. As time passes and requirements become clearer, the need for flexibility lessens. Limiting the availability of funds to a fixed period of time would provide Congress the opportunity to revisit funding needs once better information exists. Over the 10-year period we examined, over one-third of the supplemental appropriations enacted were no-year funds. To balance flexibility and oversight in determining how long funds will be available for obligation, Congress could consider using single or multiyear funds in lieu of no-year funds to the maximum extent possible in supplemental appropriations. Limiting the availability of funds to some fixed period of time could increase the opportunities for Congressional oversight, as well as reduce the use of supplementals by moving subsequent funding requests for past emergencies to the regular budget and appropriations process. One concern about limiting the time availability of funds is that agencies may rush to obligate expiring funds before the end of the relevant fiscal year. Our work on year-end spending has shown that problems occurred when budget execution was not monitored effectively. This can result in a lack of competition, poorly defined statements of work, inadequately negotiated contracts, and the procurement of low-priority items or services. However, mechanisms exist to limit year-end spending. For example, OMB requires that agencies report their quarterly obligations approximately 20 days after the close of each calendar year. Moreover, reforms in procurement rules have reduced the potential magnitude of problems with year-end spending. Most experts agreed that limiting the availability of funds would allow for increased Congressional oversight. One expert noted that he could not think of a reason why no-year funds should be in any part of the federal budget. Broad Views Expressed by Experts Although individual experts’ opinions on these process reform options varied, there was general agreement that returning to a more limited use of supplemental appropriations will be challenging. They noted that the issues surrounding supplemental appropriations stem from a greater breakdown of and failures in the regular budget and appropriations process. In addition, many noted that when discretionary budget caps are unrealistic there is an increased incentive to use supplemental appropriations. Other experts suggested that it was important to view supplementals as one piece of a broader system for budgeting for contingencies, noting that attention given to issues such as disaster mitigation, emergency reserve funds, government insurance programs, and realistic funding in the regular budget and appropriations process may lessen the need for supplemental appropriations. Conclusions To the extent possible, funds should be provided through the regular appropriations process to ensure that trade-offs are made among competing priorities, especially in an environment of increasingly constrained resources. Therefore, controls should be in place to ensure that emergency supplementals are enacted for their intended purpose—to address unforeseen needs that arise suddenly after the start of a fiscal year. The current incentives and controls surrounding supplemental appropriations may encourage the use of supplemental appropriations for items outside of this purpose. Supplementals are frequently “must pass” legislation with significant incentives for a quick response and are not subject to the same level of scrutiny and trade-offs as the regular budget and appropriations process. As a result, supplementals can be an inviting vehicle for passing legislation that is not directly related to the emergency that may have prompted the supplemental in the first place. Furthermore, the greater scrutiny of the regular budget and appropriations process combined with the expectation of recurring supplemental funds acts as a disincentive for activities to be fully funded through regular appropriations. Additionally, the controls over the process are relatively weak. The emergency-designation criteria are nonbinding and may be open to debate. The current governance process over emergency supplementals requires Members of Congress to take active steps to strike down the emergency designation—by raising a point of order—as opposed to requiring affirmation of the designation. The combination of multiple incentives to use supplementals and weaknesses in the controls governing their use could encourage policymakers to use supplemental appropriations in lieu of the regular appropriations process to fund certain activities. Matters for Congressional Consideration If the use of supplemental appropriations is to be limited, additional controls and increased transparency are needed. To better target the resources provided through supplemental appropriations, we recommend that Congress consider adopting procedures and rules to increase controls over and transparency of the use of supplementals. Specifically, we recommend that Congress consider establishing procedures and mechanisms to ensure that: 1. Emergency-designated provisions meet established criteria by establishing new mechanisms for enforcement of those criteria, possibly including codification of the criteria and/or creation of review procedures. 2. Emergency supplementals do not become the vehicle for items that do not require the rapid enactment demanded to respond to an emergency event. Among the approaches to be considered might be separate tracks for emergency and nonemergency provisions and/or excluding funding for emergencies that occurred in previous years. 3. Supplementals are not used where the regular budget and appropriations process should suffice by including a greater share of funding in the regular appropriations bills. 4. A balance exists between flexibility and oversight with regard to the time availability of funds by using single or multiyear funds in lieu of no-year funds to the maximum extent possible in supplemental appropriations. As we agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution of it until 30 days from the date of this letter. At that time, we will send electronic copies to others who are interested and copies of this report will be available at no charge on GAO’s Web site at http://www.gao.gov. If you or your staff have any questions about this report please contact me at (202) 512-9142 or irvings@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff making key contributions to this report are listed in appendix III. Appendix I: Objectives, Scope, and Methodology The objectives for this report were to evaluate (1) trends in supplemental appropriations enacted from fiscal years 1997–2006 and (2) steps that could be taken to increase transparency and establish additional controls over emergency supplemental appropriations. To address the first objective, we developed a database that contained information from the 25 supplemental appropriations laws that were enacted from fiscal years 1997–2006 and information from the Congressional Budget Office (CBO) scoring reports that accompanied these laws to permit summary analysis of the use of these supplementals over time. The database contained both general information about the laws—such as the public law number and the date of enactment—and information about individual provisions within the laws. Generally a provision included all of the information contained in a paragraph under an account name. However, in some instances we used our judgment to break out or combine information. In general, if a law provided for several actions under one account header—such as both appropriating and rescinding funds—we would separate out those actions. Additionally, if a law provided several amounts to different activities under one account heading, we might combine those amounts. In total, the database contained 2,662 provisions. For each provision, we included in the database the provision text; the division, title, and/or chapter in which the provision appeared; information about the entity to which the provision pertained (e.g., department, agency, program); and whether or not the provision provided or rescinded budget authority. If a provision provided new budget authority, we included the amount, how long it was available, and whether or not it was emergency designated. If a provision rescinded budget authority, we noted that and the amount. If a provision did not provide or rescind budget authority, we developed a very general description of what it did do (e.g., transfer funds between accounts, target or limit the use of funds, or amend another law). For emergency-designated provisions, we used the provision language and/or other information in the law, such as the title, to determine what type of emergency may have prompted the supplemental appropriation. The categories we developed for this analysis were as follows: Antiterrorism and Security Defense-Related International Humanitarian Assistance Natural and/or Economic Disasters (Domestic) Pandemic Influenza September 11, 2001 Other Not Specified In limited cases, these categorizations required some professional judgment on the part of the analyst. For example, if a provision was in a law or section of law for war-related activities but specified that it was providing funds to repair damage from a natural disaster within the United States, we categorized it as a “Natural and/or Economic Disaster (Domestic).” However, other funds provided in the same section of the law that did not contain language specifically relating them to a natural disaster would have been categorized as “Defense-Related.” From the CBO scoring reports, we input data on the budget function code, the subaccount identification code, and the amount of budget authority provided or rescinded. To address the second objective, we reviewed relevant literature to identify the rules and guidance that were in place in Congress to govern the use of supplemental appropriations from fiscal years 1997–2006. Then, we conducted a content analysis by having two GAO analysts independently review the information on each emergency-designated provision in the database to determine consistency with congressionally specified emergency-designation criteria. Our analysis focused on the application of the “sudden” and “unforeseen” criteria. We did not attempt to judge whether provisions were “necessary” or “urgent” as these are policy judgments, not based purely on objective information. We also did not make judgments on the “not permanent” criteria as it is not well defined. There is no time frame given regarding when an activity has become “permanent.” In addition, even “permanent” activities directed by legislation may cease when legislation is repealed or amended. The two analysts also determined whether the provision was related to the event that may have prompted the supplemental. The two analysts came to different conclusions in 29 instances (2.8 percent of the 1,014 emergency- designated provisions). For any provision where the two did not come to the same conclusion, a third GAO analyst reviewed the information and resolved the discrepancy. Although we had a high initial rate of agreement between the two independent reviewers, we fully recognize that this was a subjective judgment and other reviewers could reach different conclusions than we did given the same information. We drew on our analysis of all of the information in the database and a review of existing recommendations and proposals that have been put forth by GAO, CBO, the Congressional Research Service (CRS) and others to develop options for addressing the issues that we identified. We then sought opinions from recognized experts on these options to (1) determine whether they were appropriate and sufficient and (2) ensure that they were feasible and practical. To identify people with expertise in budgeting practices at the federal level, we relied on sources we had used in our background research and review of recommendations and proposals that have been put forth by GAO, CBO, CRS, and others, as well as our experience in this area, to compile a list of individuals with diverse backgrounds in the field. We sought comments on a draft document from experts from organizations such as the Center on Budget and Policy Priorities, Center for American Progress, Committee for a Responsible Federal Budget, Committee for Economic Development, and CBO, as well as knowledgeable former Congressional staff. Six of these people responded to our request. These comments were summarized and incorporated where appropriate. We conducted our work in accordance with generally accepted government auditing standards from November 2006 to January 2008. Appendix II: Supplemental Appropriations Laws Enacted from Fiscal Year 1997 through Fiscal Year 2006 6/12/1997 1997 Emergency Construction, 2001; (Div. B— Emergency Supplemental Act, 2000) Defense Appropriations Act, 2001 (Title IX—Additional Fiscal Year 2000 Emergency Supplemental Appropriations for the Department of Defense) Supplemental Appropriations Act for Recovery from and Response to Terrorist Attacks on the United States Defense and Emergency Supplemental Appropriations for Recovery from and Response to Terrorist Attacks on the United States, 2002 (2nd $20 billion - 9/11 attacks) Wartime Supplemental Appropriations Act, 2003 Supplemental for Disaster Relief Act, 2003 Branch, 2003 (Title III— Emergency Supplemental Appropriations Act, 2003) Supplemental Appropriations Act for Defense, the Global War on Terror, and Tsunami Relief, 2005 Interior, Environment and Related Agencies Appropriations Act, 2006 (Title VI—Veterans Health Care) Supplemental Appropriations Act for Defense, the Global War on Terror, and Hurricane Recovery, 2006 of Defense Appropriations Act, 2007 (Title X— Fiscal Year 2006 Wildland Fire Emergency Appropriations) Appendix III: GAO Contacts and Staff Acknowledgments GAO Contact Acknowledgments In addition to the individual listed above, Carol Henn, Assistant Director; Tiffany Mostert; Elizabeth Hosler; Farahnaaz Khakoo; and John Stradling made significant contributions to this report. Thomas Beall, Pedro Briones, John Brooks, Carlos Diz, Arthur James, Susan Offutt, Sheila Rajabiun, John Smale, and Elizabeth Wood also made key contributions to this report.

Supplemental appropriations laws (supplementals) are a tool for policymakers to address needs that arise after the fiscal year has begun. Supplementals provide important and necessary flexibility but some have questioned whether supplementals are used just to meet the needs of unforeseen events or whether they also include funding for activities that could be covered in regular appropriations acts. GAO was asked to evaluate (1) trends in supplemental appropriations enacted from fiscal years 1997-2006 and (2) steps that could be taken to increase transparency and establish additional controls over emergency supplemental appropriations. Also, GAO consulted with budget experts to discuss options for reform. The use of supplementals has increased over the last several years, largely as a result of an increase in Department of Defense (DOD) funding and the use of supplementals to provide that funding for activities such as the Global War on Terrorism (GWOT). Over the 10-year period from fiscal year 1997 through fiscal year 2006, supplemental appropriations provided about $612 billion ($557 billion net of rescissions) in new gross budget authority, a five-fold increase over the previous 10-year period. Ninety-five percent of the total supplemental funds were appropriated to 11 departments, with DOD receiving nearly 60 percent of the total. Further, an analysis of the type of emergency prompting the need for the supplemental shows that defense-related emergencies received over 50 percent of the emergency-designated funds. In comparison, 28 percent was to respond to natural or economic disasters and 16 percent went to antiterror, security, and post-9/11 activities. International humanitarian assistance, pandemic influenza, and other activities comprised 3 percent of the total emergency-designated supplemental funds provided over the 10-year period. The majority of the supplemental funds appropriated over this 10-year period were designated as emergency. Emergency-designated funds do not have to compete for scarce resources that are constrained by budget controls. Although Congress has specified criteria for the emergency designation in Budget Resolutions, these criteria are not self-executing and there are limited screening and enforcement processes. The increased use of supplementals raises questions about the current incentives and controls surrounding their use. GAO reviewed emergency-designated supplementals and found provisions that were not clearly consistent with emergency designation criteria or did not contain sufficient information for us to make a determination. Also, GAO identified provisions that raise questions about whether supplemental appropriations bills can become vehicles for funding some activities that could be covered in the regular budget and appropriations process. For example, we found $710 million in emergency-designated provisions that appeared to be unrelated to the event/issue(s) that may have prompted the supplemental. In addition, we found that 35 accounts received supplemental appropriations in at least 6 of the 10 years studied, totaling over $375 billion. Twenty-one of these accounts were in DOD and the gross budget authority granted to these 21 accounts ($258 billion) comprised over 40 percent of the total gross budget authority in the supplemental appropriations enacted over the studied period. Finally, over one-third of the supplemental appropriations enacted were available until expended ("no-year" funds). Such no-year funds provide agencies with important flexibility but do not prompt the annual or periodic Congressional oversight typical of funds that are available for a fixed amount of time. If the use of supplemental appropriations is to be limited to addressing unforeseen needs that arise suddenly after the start of a fiscal year, additional controls and increased transparency are needed. Budget experts GAO consulted generally agreed reform was needed but differed on how best to achieve this.

Background The SBIR program was initiated in 1982 and has four purposes: (1) to use small businesses to meet federal R&D needs, (2) to stimulate technological innovation, (3) to increase commercialization of innovations derived from federal R&D efforts, and (4) to encourage participation in technological innovation by small businesses owned by disadvantaged individuals and women. The purpose of the STTR program—initiated in 1992—is to stimulate a partnership of ideas and technologies between innovative small businesses and research institutions through federally funded R&D. The SBIR and STTR programs are similar in that participating agencies identify topics for R&D projects and support small businesses, but the STTR program requires the small business to partner with a research institution—such as a nonprofit college or university or federally funded R&D center. The programs are currently authorized through fiscal year 2022. The SBIR and STTR policy directives require participating agencies to submit data to SBA each year on the amount of their extramural R&D obligations and the amount obligated for awards, among other information. The Small Business Act also establishes certain reporting requirements for participating agencies and SBA. Among other things, agencies must, within 4 months of the enactment of their annual appropriations, report to SBA on their methodologies for calculating their extramural R&D obligations. Furthermore, SBA must annually report to Congress on the participating agencies’ SBIR and STTR programs. Additionally, the reauthorization act directed SBA to allow agencies to participate in a pilot program, known as the administrative pilot program, which permitted the funding of administrative and certain other costs in fiscal years 2013 through 2015. Under this administrative pilot program, agencies are allowed to use not more than 3 percent of the funding allocated to the SBIR program for new activities, including program administration; outreach; commercialization; standardization and simplification of program procedures; prevention of waste, fraud, and abuse; and congressional reporting. The SBIR and STTR policy directives specifically note that funding under the pilot program may not replace current agency administrative funding for SBIR or STTR activities. Instead, the administrative pilot program is intended to supplement existing administrative efforts. In November 2015, the National Defense Authorization Act for Fiscal Year 2016 extended the pilot program through September 30, 2017. In December 2016, the National Defense Authorization Act for Fiscal Year 2017 extended the SBIR and STTR programs through fiscal year 2022, but did not extend the pilot program. The reauthorization act required SBA to add fraud, waste, and abuse prevention requirements to the policy directives for agencies to implement. In 2012, SBA issued revised policy directives for the SBIR and STTR programs that included new requirements designed to help agencies prevent potential fraud, waste, and abuse in the programs. In addition to the requirements for the participating agencies, the reauthorization act included requirements for those agencies’ Offices of the Inspectors General (OIG). SBA and Participating Agencies Have Implemented About One-Third of Our Prior Recommendations SBA has implemented 5 of the 17 recommendations we have made on the SBIR and STTR programs and the participating agencies to which we have made recommendations—the Departments of Health and Human Services (HHS) and Defense (DOD)—have implemented 1 of the 3 recommendations we made. From September 2013 through April 2017, we made recommendations to SBA and participating agencies to improve oversight and implementation of the programs in four areas: (1) spending requirements; (2) other reporting requirements; (3) the administrative pilot program; and (4) fraud, waste, and abuse prevention requirements. The complete list of recommendations and the status of agencies’ implementation of the recommendations is included in appendix I. HHS Implemented Recommendation on Spending Requirements, and SBA Implemented Half of Recommendations Related to Those Requirements From September 2013 through April 2017, we made six recommendations to SBA and one to HHS to improve oversight and implementation of the SBIR and STTR spending requirements. SBA has fully implemented three of these recommendations and HHS has implemented its recommendation in this area (see app. I). Some actions that SBA and HHS have taken to address our recommendations include the following: In certain circumstances, amounts that the agencies spend for items other than awards count as part of the agencies’ spending for the programs. In our June 2014 report, we found that SBA did not request that agencies submit data on such spending and recommended that the agency clarify how to submit such data. In response to our recommendation, SBA revised its annual report templates for data reported since fiscal year 2013 to identify obligations for the programs outside of awards, such as funds spent on discretionary technical assistance to small businesses. This change has improved the accuracy of participating agencies’ obligations data that they report to SBA and that SBA, in turn, reports to Congress. In our September 2013 report, we found that SBA did not request that agencies include information in their annual reports that would enable SBA to conduct better oversight, including information on (1) whether agencies met the mandated spending requirements, (2) the reasons for any noncompliance with these requirements, and (3) the agencies’ plans for attaining compliance in future years. We recommended that SBA direct participating agencies to include this information in their annual reports to SBA. In response, SBA updated the annual report template to request this information starting in fiscal year 2015, which should help SBA more fully oversee the programs and provide more complete information to Congress. In our June 2014 report, we found that HHS used different extramural R&D budget data to calculate its SBIR and STTR spending requirements. We recommended that HHS include all of its extramural R&D budget in the calculation of STTR spending requirements and in the data submitted to SBA to help ensure that the agency spends the required amount for the STTR program. According to program documents and agency officials, HHS included all of its extramural R&D in its budget data for the STTR program beginning with its annual report for fiscal year 2014, which was submitted in March 2015. SBA has not yet fully implemented three of our recommendations related to the spending requirements. For example, in our May 2016 report, we found that USDA’s extramural R&D obligations exceeded the threshold for participating in the STTR program, but USDA did not start an STTR program. For that report, USDA officials told us that they did not establish an STTR program because they did not expect their extramural R&D obligations to exceed $1 billion in fiscal year 2014 and that they believed the agency’s obligations were an anomaly. Further, because the spending requirement is based on actual obligations, which cannot be known until after the end of the fiscal year, USDA was unaware of its actual obligations until it was too late to retroactively begin an STTR program. Although the Small Business Act is clear about the dollar threshold for starting an SBIR or STTR program, neither the law nor SBA’s guidance specifies when an agency should establish a program— for example, at the beginning of the year, partway through the year, or at the end of the year. We recommended that SBA review its guidance regarding when an agency is required to start up an SBIR or STTR program, and if necessary, update the guidance to provide greater clarity to agencies. SBA agreed with our recommendation and, as of April 2017, SBA officials said they were working to develop language to update SBA’s policy directives to provide guidance on when an agency must start an SBIR or STTR program. We continue to believe that fully implementing this recommendation is important because such information may help ensure that agencies will establish programs when required and ensure that the required amount of money is available for small businesses participating in the programs. SBA Implemented One of Five Recommendations to Improve Compliance with Other Reporting Requirements The Small Business Act requires SBA to report annually to Congress on the programs and requires participating agencies to report to SBA within 4 months of the enactment of appropriations on their methodologies for determining their extramural R&D budgets. We have made five recommendations to SBA to improve compliance with these reporting requirements. SBA has fully implemented one recommendation (see app. I), but four remain open. For example: In each of our four reports on agencies’ compliance with spending and other reporting requirements, we found that SBA had not submitted timely reports to Congress on the SBIR and STTR programs. The Small Business Act requires SBA to report to certain congressional committees on the SBIR and STTR programs not less than annually. SBA issued its most recent required report to Congress on the SBIR and STTR programs for fiscal year 2013 in March 2016. In our September 2013 report, we concluded that without more rigorous oversight by SBA and more timely and detailed reporting on the part of both SBA and participating agencies, it would be difficult for SBA to ensure that intended benefits of the SBIR and STTR programs were being attained and that Congress was receiving critical information to oversee these programs. In that report, we recommended that SBA provide Congress with a timely annual report that includes a comprehensive analysis of the methodology each agency used for calculating the SBIR and STTR spending requirements. SBA agreed and stated at the time that it planned to implement the recommendation. SBA officials told us that they have taken some steps to help them develop the required reports to Congress, but have not submitted SBA’s reports for fiscal years 2014, 2015, or 2016. We continue to believe that it is important for SBA to provide a timely annual report to Congress to further improve oversight of the programs. In our September 2013 report, we found that agencies submitted different levels of detail on their methodologies in their required reports to SBA. In that report, we recommended that SBA provide agencies with additional guidance on the format to use for methodology reports. Further, we found in our April 2015 report that, as a result of the varying detail that agencies provide in their methodology reports, it was difficult for SBA to complete its required analysis of the methodology reports. We recommended that SBA assess and update, if needed, the methodology reporting requirement to ensure it generates adequate information. In response to that recommendation, SBA proposed expanded guidance to agencies. However, the proposed guidance has not yet been finalized. According to SBA officials, SBA withdrew the draft policy directive from Office of Management and Budget consideration in January 2017 and it is under further internal consideration in light of a recent executive order. Without finalizing the proposed guidance, participating agencies are likely to continue to provide SBA with broad, incomplete, or inconsistent information on their methodologies for calculating their extramural R&D and SBA cannot ensure that it is able to provide Congress with an accurate analysis of how agencies calculate their extramural R&D. Additionally, in our September 2013 report—and others—we found that SBA had not consistently provided feedback to agencies on the content of their methodology reports, and recommended that SBA provide timely annual feedback to agencies on whether their methods for calculating their extramural R&D budgets complies with program requirements. We concluded that, without such review and feedback, agencies may be calculating their extramural R&D incorrectly, which could lead to their spending less than the required amounts on the programs. We continue to believe that updating its guidance on information to include in the methodology reports and providing feedback to agencies on their methodologies could help SBA ensure that agencies are spending the required amounts on the SBIR and STTR programs. SBA Has Implemented One of Two Recommendations Relating to the Administrative Pilot Program Since fiscal year 2013, agencies have been allowed to spend some of their SBIR funding for certain administrative costs related to the programs. We have made two recommendations to SBA to improve its oversight of the administrative pilot programs. SBA has implemented one of the two recommendations. In our April 2015 report, we found that for fiscal year 2013, SBA had requested that agencies submit information on the total amounts spent on the administrative pilot program, but it did not request agencies to submit information on how they used the funds. Fiscal year 2013 was the first year of the pilot program, and, as we found in that report, SBA officials were still determining the information they needed to report to Congress. We recommended that SBA require participating agencies to provide data on the use of the funds, rather than a total cost for all of the activities under the pilot. In response, SBA updated the annual report template used to collect program data from the agencies for fiscal year 2014, which was submitted in the spring of 2015, to collect this information. This improved the information available to SBA on the amounts spent on activities through the administrative pilot program. In our May 2016 report, we found that participation in the administrative pilot program had increased in fiscal year 2014 compared with prior years, but agency officials identified potential constraints that limited their participation, including the temporary nature of the program and the requirement to expend funds only on new activities. SBA is required to collect data and report on the use of funds to achieve the objectives of the administrative pilot program, but had not yet submitted a report. We recommended that SBA complete its required evaluation of the administrative pilot program, which could include an evaluation of the constraints that have hindered agencies’ participation in the administrative pilot program and steps to address these constraints. SBA has not submitted a report to Congress on the administrative pilot program for fiscal year 2014. We continue to believe that having SBA include an evaluation of potential constraints to participating in the administrative pilot program, whether as part of the annual report or in a separate report, could be useful if Congress decides to continue the program in the future. We concluded that, without such information, SBA and Congress will not have the information they need to address the constraints and help ensure agencies are implementing the administrative pilot program to the fullest extent if Congress chooses to extend the pilot program beyond fiscal year 2017. SBA and DOD Plan to Implement April 2017 Recommendations on Fraud, Waste, and Abuse Prevention Requirements In our April 2017 report on the SBIR and STTR programs, we reviewed the implementation of fraud, waste, and abuse prevention measures by SBA and the participating agencies and their OIGs. SBA amended the SBIR and STTR policy directives in 2012, as required by the reauthorization act, to include 10 minimum requirements to help agencies prevent potential fraud, waste, and abuse in the programs. In that report, we found that the extent to which the participating agencies have fully implemented each of the 10 minimum requirements varies. We made four recommendations to SBA and recommendations to HHS and DOD to improve implementation of the requirements (see app. I). HHS disagreed with our recommendation, but we continue to believe the recommendation is valid and should be implemented. SBA and DOD plan to implement all of their recommendations. For example: We found that SBA had taken few actions to oversee agencies’ implementation of the policy directives’ minimum requirements to address fraud, waste, and abuse in the SBIR and STTR programs. SBA officials said they checked on the implementation of one of the requirements but did not know whether the participating agencies were implementing the other requirements because they had not confirmed this information. We concluded that, without confirming that each participating agency is implementing the fraud, waste, and abuse prevention requirements in the policy directives, SBA did not have reasonable assurance that each agency has a system in place to reduce its’ vulnerability to fraud, waste, and abuse. SBA agreed with the recommendation and stated that it will request that each participating agency confirm its implementation of the minimum fraud, waste, and abuse prevention requirements. Although SBA updated the SBIR and STTR policy directives in 2012 to include the fraud, waste, and abuse prevention requirements, SBA officials said they have not taken action since 2012 to review them to determine whether they are effective or whether any revisions are needed. We identified requirements that some agency officials said were not clear or may be unnecessary, and we recommended that SBA review all of the SBIR and STTR fraud, waste, and abuse prevention requirements and clarify any that are unclear. SBA stated it will contact all agencies to inquire if additional clarity is needed regarding any of the fraud, waste, and abuse requirements, and will provide additional guidance, if necessary. We found that SBA had not evaluated the outcomes of the agencies’ implementation of the fraud, waste, and abuse prevention requirements and therefore did not have reasonable assurance that the requirements are necessary, appropriate, and meet the intended purpose of preventing fraud, waste, and abuse in the SBIR and STTR programs. We recommended that SBA ensure that the requirements are appropriate and meeting their intended purposes. In response to that recommendation, SBA stated that it would survey the participating agencies regarding whether the requirements are necessary and meeting their intended purposes; are placing undue burdens on the agencies; or need to be revised, updated, or eliminated. We look forward to reviewing the agencies’ progress in implementing these important recommendations. Chairman Knight, Chairwoman Comstock, Ranking Members Murphy and Lipinksi, and Members of the Subcommittees, this completes my prepared statement. I would be pleased to respond to any questions that you have. GAO Contact and Staff Acknowledgments If you or your staff have any questions about this testimony, please contact John Neumann, Director, Natural Resources and Environment at (202) 512-3841 or neumannj@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. Individuals making key contributions to this statement included Hilary Benedict (Assistant Director), Antoinette Capaccio, Rebecca Makar, and Kiki Theodoropoulos. Appendix I: GAO’s Prior Recommendations on Small Business Research Programs Table 2 lists our prior recommendations to the Small Business Administration (SBA) and the agencies participating in the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs, and the status of those recommendations, in four areas: (1) spending requirements, (2) other reporting requirements, (3) the administrative pilot program, and (4) fraud, waste, and abuse prevention requirements. Related GAO Products Small Business Research Programs: Additional Actions Needed to Implement Fraud, Waste, and Abuse Prevention Requirements. GAO-17-337. Washington, D.C.: April 25, 2017. Small Business Research Programs: Agencies Have Improved Compliance with Spending and Reporting Requirements, but Challenges Remain. GAO-16-492. Washington, D.C.: May 26, 2016. Small Business Research Programs: Challenges Remain in Meeting Spending and Reporting Requirements. GAO-15-358. Washington, D.C.: April 15, 2015. Small Business Innovation Research: Change in Program Eligibility Has Had Little Impact. GAO-15-68. Washington, D.C.: November 20, 2014. Small Business Research Programs: More Guidance and Oversight Needed to Comply with Spending and Reporting Requirements. GAO-14-431. Washington, D.C.: June 6, 2014. Small Business Research Programs: Agencies Did Not Consistently Comply with Spending and Reporting Requirements. GAO-14-567T. Washington, D.C.: April 24, 2014. Small Business Research Programs: Actions Needed to Improve Compliance with Spending and Reporting Requirements. GAO-13-421. Washington, D.C.: September 9, 2013. Small Business Research Programs: Agencies Are Implementing New Fraud, Waste, and Abuse Requirements. GAO-13-70R. Washington, D.C.: November 15, 2012. 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For about 35 years, federal agencies have made awards to small businesses for technology research and development through the SBIR program and, for the last 25 years, through the STTR program, totaling more than $40 billion. Currently, 11 agencies participate in the SBIR program, and 5 of these agencies also participate in the STTR program. The SBIR/STTR Reauthorization Act of 2011 included provisions for GAO to review aspects of the programs. This statement addresses GAO's key findings and recommendations related to the SBIR and STTR programs since 2012. This statement is based on GAO reports issued in response to the act's provisions from November 2012 through April 2017. Those reports examined SBA's and agencies' compliance with spending and other reporting requirements for the programs and their implementation of fraud, waste, and abuse prevention measures. For those reports, GAO compared documentation from SBA and participating agencies with the respective requirements. In April 2017, GAO updated the status of its prior recommendations. The Small Business Administration (SBA), which oversees the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs, and agencies participating in the programs have implemented about one-third of GAO's 20 prior recommendations regarding the programs. From September 2013 through April 2017, GAO made 17 recommendations to SBA and 3 to participating agencies to improve the oversight and implementation of spending requirements; reporting requirements; the administrative pilot program; and fraud, waste, and abuse prevention requirements. SBA has implemented 5 recommendations, and participating agencies have implemented 1 (see figure), although GAO made 4 of these recommendations to SBA and 2 to participating agencies in April 2017. SBA and participating agencies have taken some actions to address GAO's recommendations. For example, in June 2014, GAO recommended that SBA clarify how agencies are to submit data on allowable spending. In response, SBA revised its annual report template, requesting that agencies identify obligations for the programs outside of awards. This change has improved the accuracy of the data that agencies report to SBA. However, SBA and the participating agencies have not fully implemented 14 recommendations that, if implemented, could improve the oversight and implementation of the programs. For example, in each of its four reports on agencies' compliance with spending and other reporting requirements, GAO found that SBA had not submitted required annual reports to Congress on the programs. SBA issued its most recent required report on the programs for fiscal year 2013 in March 2016. In a September 2013 report, GAO concluded that without more rigorous oversight by SBA and more timely and detailed reporting, it would be difficult for SBA to ensure that intended benefits of the programs were being attained and that Congress was receiving critical information to oversee these programs. GAO recommended that SBA provide Congress with a timely annual report, as required by the act. SBA agreed and stated that it planned to implement the recommendation. However, SBA has not yet done so and, as of April 2017, SBA did not have an estimated date for submitting its reports for fiscal years 2014 through 2016. GAO continues to believe that it is important for SBA to provide a timely annual report to Congress to further improve oversight of the programs.

Background percentage of organ donors who belonged to racial and ethnic minority groups increased from about 16 to 23 percent. The organ donation process usually begins at a hospital when a patient is identified as a potential organ donor. Only those patients pronounced brain dead are considered for organ donation. Most organ donors either die from nonaccidental injuries, such as a brain hemorrhage, or accidental injuries, such as a motor vehicle accident. Other causes of death that can result in organ donation include drowning, gunshot or stab wound, or asphyxiation. Once a potential organ donor has been identified, a staff member of either the hospital or the OPO typically contacts the deceased’s family, which then has the opportunity to donate the organs. If the family consents to donation, OPO staff coordinate the rest of the organ procurement activities, including recovering and preserving the organs and arranging for their transport to the hospital where the transplant will be performed. One donor may provide organs to several different patients. Each cadaveric donor provides an average of three organs. In 1996, OPOs procured kidneys from 93 percent of organ donors and livers from 82 percent of them; other organs were procured at lower rates. Role of OPOs The national system of 63 OPOs currently in operation coordinates the retrieval, preservation, transportation, and placement of organs. For Medicare and Medicaid payment purposes, HCFA certifies that an OPO meets certain criteria and designates it as the only OPO for a particular geographic area. OPOs must meet service area and other requirements. As of January 1, 1996, each OPO had to meet at least one of the following service area requirements: 1. It must include an entire state or official U.S. territory. 2. It must either procure organs from an average of at least 24 donors per calendar year in the 2 years before the year of redesignation, or it must request and receive an exception to this requirement. 3. If it operates exclusively in a noncontiguous U.S. state, territory, or commonwealth, the OPO must procure organs at the rate of 50 percent of the national average of all OPOs for both kidneys procured and transplanted per million population. 4. If it is a new entity, the OPO must demonstrate that it can procure organs from at least 50 potential donors per calendar year. In addition, an OPO must be a nonprofit entity and meet other requirements for the composition of its board, its accounting, its staff, and its procedures. To ensure the fair distribution and safety of organs, OPOs must have a system to equitably allocate organs to transplant patients. In addition, OPOs must arrange for appropriate tissue typing of organs and ensure that donor screening and testing for infectious diseases, including the human immunodeficiency virus, are performed. OPOs use a variety of methods for increasing donation such as raising public awareness of organ donation and developing relationships with hospitals. The goal of public education is to promote the consent process, giving people the information they need to make decisions about organ and tissue donation and encouraging them to share their decisions with their families. Such public education campaigns include mass media advertising; presentations to schools, churches, civic organizations, and businesses; and informational displays in motor vehicle offices, city and town halls, public libraries, pharmacies, and physician and attorney offices. In addition, education efforts help hospital staff clarify organ and tissue recovery policies to ensure that potential donors are consistently recognized and referred. OPOs also conduct hospital development activities to build strong relationships with service area hospitals to promote organ donation. Problems With the Current Standard determined to be a new entity and not subject to meeting the performance standard. A population-based standard, however, does not accurately assess OPO performance because OPO service areas consist of varying populations. Although potential organ donors share certain characteristics, including causes of death, absence of certain diseases, and being in a certain age group, OPO service area populations can differ greatly in these characteristics. For example, motor vehicle accidents, the cause of death for about one-quarter of organ donors in 1994 and 1995, ranged from about 4.4 to about 17.9 per 100,000 population among the states and the District of Columbia. In addition, the rates of acquired immunodeficiency syndrome, a disease that eliminates someone for consideration as an organ donor, differ among the states and the District of Columbia—from 2.8 to 246.9 cases per 100,000 people in 1994. Furthermore, although most organ donors were between 18 and 64 years of age in 1994 and 1995, this age group constitutes from 56 to 66 percent of the population in different states. Thus, the number of potential organ donors can vary greatly for OPOs serving equally sized populations. Alternative Standards Could More Accurately Assess OPO Performance We identified several performance measures as alternatives to the current population-based standard. The alternatives we examined included measuring organ procurement and transplantation compared with (1) the number of deaths, (2) the number of deaths adjusted for cause of death and age, (3) the number of potential donors based on medical records reviews, and (4) the number of potential donors based on modeling estimates in an OPO service area. In developing its current OPO performance standard, HCFA considered using the number of service area deaths as the basis for assessing performance. Although some organs, typically kidneys, are obtained from living donors, OPOs recover organs from cadaveric donors. Therefore, the number of deaths in an OPO’s service area more accurately reflects the number of an OPO’s potential donors. In 1994, the United States had about 2.3 million deaths out of a population of about 260 million. Although using total deaths fails to consider other factors about and characteristics of potential donors, it would eliminate considering a portion of the population that an OPO clearly could not consider for organ donation. HCFA also considered using an adjusted measure of deaths for the performance standard. Measuring OPO performance according to the number of service area deaths adjusted for cause of death and age more accurately reflects the number of potential donors than measuring performance according to the number of all service area deaths. The number of service area deaths adjusted for cause of death and age better estimates the number of potential donors because it accounts for the small subset of the deceased that may be suitable organ donation candidates. Adjusting for cause of death and limiting consideration to deaths of those under age 75, we found that in 1994 about 147,000, or 6 percent, of the 2.3 million U.S. deaths involved these causes of death or were of people in this age group. This estimate, however, is much larger than the estimates some have made of a national donor pool of from 5,000 to 29,000 people per year. We found that both the death and adjusted-death measures have drawbacks that limit their usefulness, however, including lack of timely data and inability to identify those deaths suitable for use in organ donation. We ranked the OPOs, using 1994-95 OPO procurement and transplant data, according to the current population-based measure and these two alternative measures—number of deaths and adjusted deaths. Although three OPOs would not qualify for recertification under any of these measures, according to our review, the number of and which OPOs would not qualify vary depending on the measure used. More OPOs would have been subject to termination under either of these alternative measures. HCFA did not consider two other methods for determining the number of potential donors—medical records reviews and modeling—that show promise for determining OPOs’ ability to acquire all usable organs. Reviewing hospital medical records is the most accurate method of estimating the number of potential donors in an OPO’s service area. A medical records review involves reviewing all deaths at a hospital with an in-depth examination of those meeting certain criteria. Reviewing the records of these patients reveals the patients’ suitability for organ donation based on several factors, including cause of death, evidence of brain death, and contraindications for donation such as age and disease. Such reviews can identify that subset of deaths in which patients could have become organ donors—the true number of potential donors for an OPO service area. Most OPOs do conduct medical records reviews but at varying levels of sophistication. For records reviews to be useful for assessing OPO performance, the reviews would have to be conducted consistently among OPOs and the results would need to be available for validation. Such reviews, however, are labor intensive and therefore expensive. Although most OPOs are conducting some form of medical records reviews and therefore already incurring the costs of these reviews, HCFA must consider its own and the OPOs’ additional expense involved in standardizing such reviews. Other considerations include the extent to which the reviews would add to the cost of organs and whether these costs would outweigh the benefit of more accurately measuring the number of potential donors. Another alternative, modeling, shows promise and would be less expensive than medical records reviews. At least one group is developing a modeling method using substitute measures to provide a valid measure for estimating the number of potential donors. The goal of this effort is to design an estimating procedure that will be relatively simple to execute, inexpensive, and valid. This approach uses information from hospitals in the OPO’s service area on variables, such as total number of deaths, total staffed beds, Medicare case mix, medical school affiliation, and trauma center certification, to predict the number of potential donors. Using existing data would make this alternative less costly than medical records reviews; however, the accuracy of such a model has yet to be established. If the number of potential donors for an OPO can be reasonably predicted using a set of variables, this could eliminate concerns about the cost of implementing medical records reviews. Recommended Future Steps HCFA believes its current standard identifies OPOs that are poor performers. When publishing its final rule, however, the agency stated that it was interested in any empirical research that would merit consideration for further refining its standard. The approaches we identified in our report merit HCFA’s consideration. potential donors at a reasonable cost, it should choose one and begin assessing OPO performance accordingly. HCFA has concurred with our recommendation. It has indicated that when the ongoing research on medical records reviews and modeling are complete and it receives the studies, it will review the results to determine if it can support a better performance standard. HCFA’s continuous monitoring of the developments in approaches to identifying potential organ donors is important. Because the demand for organs surpasses the supply, OPOs are required by law to conduct and participate in systematic efforts to acquire all usable organs from potential donors. As we have reported, unless HCFA measures OPO performance according to the number of potential donors, the agency cannot determine OPOs’ effectiveness in acquiring organs. The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. Each day, GAO issues a list of newly available reports and testimony. 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GAO discussed: (1) whether the current standard for assessing the local organ procurement organizations' (OPO) effectiveness appropriately measures the extent to which OPOs are maximizing their ability to identify, procure, and transplant organs and tissue; and (2) alternatives to the current standard that could be more effective. GAO noted that: (1) the Health Care Financing Administration's (HCFA) current performance standard does not accurately assess OPO's ability to meet the goal of acquiring usable organs because it is based on the total population, not the number of potential donors within the OPOs' service areas; (2) GAO identified two alternative performance measures that would better estimate the number of potential organ donors--measuring the rates of organ procurement and transplantation compared with either the number of deaths or the number of deaths adjusted for cause of death and age; (3) both these approaches have limitations, however, in data availability and accuracy; (4) two other methods for assessing OPO performance--medical records reviews and modeling--show promise because they could more accurately determine the number of potential donors; and (5) because OPOs must meet performance goals to continue to operate, approaches that more accurately differentiate between OPOs that achieve greater or lesser proportions of all possible donations in their service areas can help increase donations.

Background DOE’s predecessor, the Atomic Energy Commission (AEC), established a program to prevent and respond to nuclear or radiological emergencies in 1974 after an extortionist threatened to detonate a nuclear device in Boston unless he received $200,000. Even though the threat turned out to be a hoax, AEC recognized that it lacked the capability to quickly respond to a nuclear or radiological incident. To address this deficiency, AEC established the Nuclear Emergency Search Team (NEST) to provide technical assistance to the Federal Bureau of Investigation (FBI) and the Department of State, which is the lead federal agency for terrorism response outside the United States. Under the Atomic Energy Act, the FBI is responsible for investigating illegal activities involving the use of nuclear materials within the United States, including terrorist threats. The NEST program was designed to assist the FBI in searching, identifying, and deactivating nuclear and radiological devices. However, the deployments of search teams were large scale and often slow because they were designed to respond to threats, such as extortion, when there was time to find the device. With the threat of nuclear terrorism and the events of September 11, 2001, DOE’s capabilities have evolved to more rapidly respond to nuclear and radiological threats. While NEST activities to prevent terrorists from detonating a nuclear or radiological device remain the core mission, DOE’s emergency response activities have expanded to include actions to minimize the consequences of a nuclear or radiological incident. For example, DOE maintains an aerial capability to detect, measure, and track radioactive material to determine contamination levels at the site of an emergency. DOE has used this capability to conduct background radiation surveys of most nuclear power plants in the country for the Environmental Protection Agency and the Nuclear Regulatory Commission. In the event of an accident at a nuclear power plant, a new radiation survey could be performed to help determine the location and amount of contamination. There are currently about 950 scientists, engineers, and technicians from the national laboratories and the Remote Sensing Laboratories dedicated to preventing and responding to a nuclear or radiological threat. In fiscal year 2005, DOE had a budget of about $90 million for emergency response activities. Under the National Nuclear Security Administration (NNSA), the Office of Emergency Response manages DOE’s efforts to prevent and respond to nuclear or radiological emergencies. In the aftermath of September 11, 2001, there is heightened concern that terrorists may try to smuggle nuclear or radiological materials into the United States. These materials could be used to produce either an improvised nuclear device or a radiological dispersal device, known as a dirty bomb. An improvised nuclear device is a crude nuclear bomb made with highly enriched uranium or plutonium. Nonproliferation experts estimate that a successful improvised nuclear device could have yields in the 10 to 20 kiloton range (the equivalent to 10,000 to 20,000 tons of TNT). A 20-kiloton yield would be the equivalent of the yield of the bomb that destroyed Nagasaki and could devastate the heart of a medium-size U.S. city and result in thousands of casualties and radiation contamination over a wider area. A dirty bomb combines conventional explosives, such as dynamite, with radioactive material, using explosive force to disperse the radioactive material over a large area, such as multiple city blocks. The extent of contamination would depend on a number of factors, including the size of the explosive, the amount and type of radioactive material used, and weather conditions. While much less destructive than an improvised nuclear device, the dispersed radioactive material could cause radiation sickness for people nearby and produce serious economic costs and psychological and social disruption associated with the evacuation and subsequent cleanup of the contaminated areas. While no terrorists have detonated a dirty bomb in a city, Chechen separatists placed a canister containing cesium-137 in a Moscow park in the mid-1990s. Although the device was not detonated and no radioactive material was dispersed, the incident demonstrated that terrorists have the capability and willingness to use radiological materials as weapons of terror. DOE Has Unique Capabilities and Assets to Prevent and Respond to a Nuclear or Radiological Attack in the United States DOE has unique capabilities and assets to prevent and respond to a nuclear or radiological attack in the United States. These include specialized teams and equipment to search for, locate, and deactivate nuclear or radiological devices and to help manage the consequences of a nuclear or radiological attack. To prevent an attack, search teams use a variety of clandestine and discreet methods, including the use of radiation sensors carried in backpacks and mounted on vehicles and helicopters, to detect and locate radiological sources. In the event of a nuclear or radiological attack, DOE would, among other things, use radiation-monitoring equipment, including sensors mounted on aircraft and vehicles, to detect and measure radiation contamination levels and provide information to state and local officials on what areas need to be evacuated. Table 1 summarizes DOE’s capabilities and assets to prevent and respond to a nuclear or radiological attack. DOE Has Specialized Teams That Use a Variety of Methods and Equipment to Prevent a Nuclear or Radiological Attack To prevent a nuclear or radiological attack, DOE has specialized teams to search for and deactivate nuclear or radiological devices. These teams are manned by full-time professionals and are ready to deploy on either civilian or military aircraft from the Remote Sensing Laboratories within 4 hours of notification from the FBI. To detect and locate nuclear or radiological devices, the teams use a variety of clandestine and discreet methods, including the use of radiation detectors carried in backpacks that silently transmit information to the searcher’s earphone and radiation detectors mounted in vehicles and helicopters. While backpacks and other hand-held equipment can detect and identify devices with greater accuracy, vehicle and helicopter-mounted radiation detectors allow DOE to cover a greater area in a shorter amount of time— which is particularly important when the exact location of a device is unknown and the teams need to search a large area. Once deployed, the searchers can also send information they are collecting from radiation detectors via a secure Internet line to scientists and technicians at the national laboratories to help them identify nuclear or radiological material and determine whether the material poses a threat. If the search teams need additional support to cover a large area, they can train and equip local responders, such as law enforcement and firefighters, to conduct search missions. Up to 16 people can become proficient in basic search techniques in less than an hour. Should a device be located, a team composed of nuclear weapons scientists, technicians, and engineers from the national laboratories as well as the FBI and military ordnance disposal experts would be deployed to deactivate the device and prepare it for safe transport away from populated areas to the Nevada Test Site. This would involve, among other things, clearing booby traps and separating the high explosives from the nuclear material. It also would involve the use of specialized equipment, such as a portable X-ray machine, to peer under a bomb’s outer shell and view the bomb’s components, identify the device, and determine the best way of deactivating it. This team maintains a comprehensive computer database of nuclear and radiological weapon design information for identifying and properly deactivating devices. Once a device is ready to be safely transported, scientists in an underground tunnel at the Nevada Test Site would disassemble and dispose of the device. Under certain circumstances, the team may not be able to safely transport the device and it may be necessary to destroy the bomb in place and mitigate the potential spread of radioactive material by, among other things, constructing a nylon tent around the device and filling it with thick foam. Since September 11, 2001, DOE has expanded its search capability beyond the Remote Sensing Laboratories to include teams at eight other emergency response sites, allowing for more rapid deployment across the country. These Radiological Assistance Program (RAP) teams traditionally have assisted state and local governments with responding to facility or transportation accidents involving radioactive material that may cause contamination and affect public health. Since these teams have experience and expertise in responding to nuclear emergencies—and are located in different regions across the country—their mission was expanded to include searching for nuclear or radiological devices. The RAP teams can drive to most cities in their geographic area and do not have to rely on air transport. In addition, since the two Remote Sensing Laboratories are located on the East and West coasts, the RAP teams can provide faster response to cities located in the center of the country. In fiscal year 2005, the specialized search teams from the Remote Sensing Laboratories and the RAP teams conducted about 30 search missions. Most of these missions involved assisting local and state officials in monitoring large public events, such as the Super Bowl and the State of the Union address, to provide assurance that no devices were hidden in the stands or inside the building before the event. A number of these missions also involved intelligence-driven searches to address potential radiological threats in U.S. cities. Despite the teams’ expertise and specialized equipment, DOE officials cautioned that it may still be difficult to detect nuclear or radiological devices. Radiation detection equipment may not detect nuclear materials with relatively low levels of radioactivity or radiological materials that are well-shielded. In addition, without good intelligence on the location of the device, search teams may not have time to find the device. In addition to preventing a nuclear or radiological attack, DOE is also responsible for responding to an accident involving a U.S. nuclear weapon. A DOE team made up of scientists, engineers, technicians, health physicists, and safety professionals from the national laboratories and nuclear weapons production facilities are ready to respond within 4 hours of notification of an accident, such as the crash of a military airplane transporting a nuclear weapon. In such a scenario, the team would assess the damage, if any, to the weapon by using, among other things, radiography to examine the weapon’s internal structure, and how best to recover it safely. Since nuclear weapons contain chemically reactive materials and radioactive elements, great care must be taken in gaining access to them. For damaged weapons, the team has special techniques to stabilize the internal components. After weapons are safe to move, they can be packaged and prepared for transport. DOE Has a Critical Role to Play in Minimizing the Consequences of a Nuclear or Radiological Attack DOE maintains capabilities to minimize the impact of a nuclear or radiological attack. An RAP team likely would be the first DOE team to respond to a nuclear or radiological emergency, whether resulting from a terrorist attack or an accident. The RAP teams, located in nine different parts of the country, would be responsible for assessing the situation and determining what additional resources would be necessary to manage the emergency. These teams are expected to arrive at the site of an emergency within 4 to 6 hours and conduct an initial radiological assessment of the area. RAP team members are trained to provide initial assistance to minimize immediate radiation risks to people, property, and the environment. In responding to an emergency, they would use radiation detectors and air-sampling equipment to measure contamination and help state and local officials reduce the spread of contamination. Large-scale contamination from a dirty bomb or nuclear device would require the deployment of consequence management teams from the Remote Sensing Laboratory at Nellis Air Force Base. These teams are responsible for setting up an operations center near the site of the emergency to coordinate environmental monitoring and assessment activities, conduct monitoring and assessment activities with specialized equipment, and collect and analyze data from the field on the type, amount, and extent of radiological release. This information would be used by state and local governments to determine what areas should be evacuated and how to properly respond to the emergency and by other federal agencies involved in decontamination and other cleanup activities. These teams would monitor the area where radioactivity was released until the area was fully evaluated and the effects known. In addition to the RAP and consequence management teams, DOE would collect information on the extent of contamination, using not only planes and helicopters fitted with radiation detectors but also sophisticated computer models. DOE has a limited number of planes and helicopters at the Remote Sensing Laboratories that detect, measure, and track radioactive materials to determine contamination levels. The aircraft can provide real-time measurement of low levels of ground contamination. They can also provide detailed imagery analysis of an accident site. The planes are deployed first to determine the location and extent of ground contamination. The helicopters are then used to perform detailed surveys of any ground contamination. This information is used to decide where to send ground monitoring teams. Based on information from the aircraft, scientists are able to develop maps of the ground hazards. In addition to their ability to track radiation from a dirty bomb or nuclear device, the aircraft have also been used to search for lost or stolen nuclear material and to locate medical isotopes left behind after natural disasters, as occurred in the aftermath of Hurricane Katrina, to ensure they do not endanger the public. Emergency response teams can also use computer models developed by the Lawrence Livermore National Laboratory to predict the consequences of a radiological release by modeling the movement of hazardous plumes. Based on the time, location, type of accident, and weather conditions, the model can predict the extent to which the material can spread and estimate the amount of the release. As technicians receive information from field teams, they can update the model. Lastly, DOE can mobilize medical personnel to treat injuries resulting from radiation exposure. Medical radiation experts are on call 24 hours a day and can provide medical and radiological advice to state and local governments or deploy directly to an accident site. These experts also track the treatment of radiation accident patients and conduct medical follow-ups. DOE’s Current Physical Security Measures May Not Be Sufficient to Protect Its Key Emergency Response Facilities DOE’s two Remote Sensing Laboratories are protected at the lowest level of physical security allowed by DOE guidance because, according to DOE, their emergency response capabilities and assets have been dispersed across the country and are not concentrated at the laboratories. However, we found a number of critical emergency response capabilities and assets that exist only at the Remote Sensing Laboratories and whose loss would significantly hamper DOE’s ability to quickly respond to a nuclear or radiological threat. Because these capabilities and assets have not been fully dispersed, current physical security measures may not be sufficient for protecting the facilities against a terrorist attack. DOE Is Protecting Its Key Emergency Response Facilities with the Lowest Level of Physical Security Measures Allowed under DOE Guidance Because Some Capabilities and Assets Have Been Dispersed DOE is protecting its two Remote Sensing Laboratories at the lowest level of physical security allowed under DOE guidance. According to DOE officials, the lowest level of security is adequate because emergency response assets and capabilities have been dispersed across the country and are no longer concentrated at these facilities. DOE policy guidance for safeguarding and securing facilities issued in November 2005 required a review of facilities protected at the lowest level of physical security to determine whether they were “mission critical.” Mission critical facilities have capabilities and assets that are not available at any other location and cannot be easily and quickly reconstituted. Under DOE guidance, facilities designated as mission critical must be protected at a higher level of physical security. For example, DOE Headquarters was designated as mission critical because the loss of decision makers during an emergency would impair the deployment and coordination of DOE resources. As a result, DOE strengthened the physical security measures around DOE Headquarters by, among other things, adding vehicle barriers around the facility. In April 2006, the Office of Emergency Response reviewed the capabilities and assets at the Remote Sensing Laboratories and found that they were not mission critical because if either one or both laboratories were attacked and destroyed, DOE would be able to easily reconstitute their capabilities and assets to meet mission requirements. Since September 11, 2001, DOE has dispersed some of the assets and capabilities once found exclusively at the Remote Sensing Laboratories. Specifically, DOE has expanded its search mission to include the RAP teams that are located at eight sites across the country. These teams receive training and equipment similar to the search teams at the Remote Sensing Laboratories, such as radiation detectors mounted in backpacks and vehicles. They have also participated in a number of search missions, including addressing potential threats at sporting events and national political conventions, or assisting customs officials with investigating cargo entering ports and border crossings. DOE Has Not Fully Dispersed the Capabilities and Assets at These Facilities, and Their Loss Would Significantly Hamper DOE’s Ability to Respond to Nuclear and Radiological Threats Contrary to DOE’s assessment that the Remote Sensing Laboratories’ capabilities and assets have been fully dispersed to other parts of the country, we found that the laboratories housed a number of unique emergency response capabilities and assets whose loss would significantly undermine DOE’s ability to respond to a nuclear or radiological threat. The critical capabilities and assets that exist only at the laboratories include (1) the teams that help minimize the consequences of a nuclear or radiological attack, (2) the planes and helicopters designed to measure contamination levels and assist search teams in locating nuclear or radiological devices, and (3) a sophisticated mapping system that tracks contamination and the location of radiological sources in U.S. cities. Furthermore, while the RAP teams have assumed a greater role in searching for nuclear or radiological devices, the teams at the Remote Sensing Laboratories remain the most highly trained and experienced search teams. The consequence management teams that would respond within the first 24 hours of a nuclear or radiological attack are located at the Remote Sensing Lab at Nellis Air Force Base. These teams have specialized equipment for monitoring and assessing the type, amount, and extent of contamination. They are responsible for establishing an operations center near the site of contamination to coordinate all of DOE’s radiological monitoring and assessment activities and to analyze information coming from the field, including aerial survey data provided by helicopters, planes, and ground teams monitoring radiation levels. Without this capability, state and local governments would not receive information quickly about the extent of contamination to assess the impact on public health and private property and how best to reduce further contamination. DOE’s emergency response planes and helicopters are designed to detect, measure, and track radioactive material at the site of a nuclear or radiological release to determine contamination levels. DOE has a limited number of planes and helicopters designed for this mission at the Remote Sensing Laboratories. These planes and helicopters use a sophisticated radiation detection system to gather radiological information and produce maps of radiation exposure and concentrations. It is anticipated that the planes would arrive at an emergency scene first and be used to determine the location and extent of ground contamination. The helicopters would then be used to perform more detailed surveys of any contamination. According to DOE officials, the planes and helicopters can gather information on a wide area without placing ground teams at risk. Without this capability, DOE would not be able to quickly obtain comprehensive information about the extent of contamination. The helicopters can also be used by search teams to locate nuclear or radiological devices in U.S. cities. The helicopters can cover a larger area in a shorter amount of time than teams on foot or in vehicles. The ground search teams can conduct secondary inspections of locations with unusual radiation levels identified by the helicopter. The Remote Sensing Laboratory at Nellis Air Force Base also maintains a sophisticated mapping system that can be used by consequence management teams to track contamination in U.S. cities after a nuclear or radiological attack. DOE collects information from its planes and helicopters, ground monitoring teams, and computer modeling and uses this system to provide detailed maps of the extent and level of contamination in a city. Without this system, DOE would not be able to quickly analyze the information collected by various emergency response capabilities and determine how to respond most effectively to a nuclear or radiological attack. This mapping system can also be used to help find nuclear or radiological devices more quickly before they are detonated. DOE officials told us the loss of these capabilities and assets that are unique to the Remote Sensing Laboratories would devastate DOE’s ability to respond to a nuclear or radiological attack. State and local governments would not receive information—such as the location and extent of contamination—that they need in a timely manner in order to manage the consequences of an attack and reduce the harm to public health and property. Despite the importance of these capabilities and assets, DOE has not developed contingency plans identifying capabilities and assets at other locations that could be used in the event that one or both Remote Sensing Laboratories were attacked. Specifically, DOE has not identified which RAP team would assume responsibility for coordinating contamination monitoring and assessment activities in the place of the consequence management teams from Nellis. During an emergency, the lack of clearly defined roles may hamper emergency response efforts. DOE officials told us that in the event that the capabilities and assets of both Remote Sensing Laboratories were destroyed, they could mobilize and deploy personnel and equipment from the RAP teams or national laboratories. The RAP teams and some national laboratories, such as Sandia, have similar equipment that could be used to measure contamination in a limited area. However, if both Remote Sensing Laboratories were destroyed, the RAP teams and the national laboratories would not have planes and helicopters to conduct large-scale contamination monitoring and assessment. The RAP teams also do not have the equipment or expertise to set up an operations center and analyze data that field teams would collect on contamination levels. In April 2006, DOE’s Office of Independent Oversight, which is responsible for independently evaluating, among other things, the effectiveness of DOE’s programs, reported that the RAP teams, during performance tests, could not quickly provide state and local governments with recommendations on what actions to take to avoid or reduce the public’s exposure to radiation and whether to evacuate contaminated areas. In addition, DOE officials told us that, based on training exercises, the demands of responding to two simultaneous nuclear or radiological events strained all of DOE’s capabilities to manage the consequences. According to DOE officials, if the consequence management teams at Nellis could not respond and there were multiple, simultaneous attacks, DOE’s capabilities to minimize the impact of a nuclear or radiological attack would be significantly hampered. DOE officials also told us that if Nellis Air Force Base were attacked, their aerial contamination measuring assets would not be lost unless the aircraft at Andrews Air Force Base were also destroyed. However, DOE policy generally requires that some of its aerial assets stationed at Andrews remain in the Washington, D.C., area to protect top government decision makers and other key government assets. During a nuclear or radiological emergency, DOE would need to rely on a limited airborne capability to measure contamination levels. In addition, if there were multiple simultaneous events, there would be considerable delay in providing information to state and local governments about the extent of contamination because DOE could assist only one city at a time. Some DOE officials suggested that if DOE helicopters were not available to provide assistance, DOE could request another helicopter and fit it with radiation detectors. However, during an emergency, we found that DOE would face a number of challenges in equipping a helicopter not designed for measuring contamination. DOE officials told us that DOE has a memorandum of understanding with the Department of Defense and other federal and state agencies to use their helicopters and planes for transport and other mission requirements, but that it is unlikely that DOD or any other agency would provide them with aircraft during an emergency because those agencies’ priority would be to carry out their own missions, not to assist DOE. Even if DOE were provided with helicopters, DOE does not have spare radiation detectors like those found on its own helicopters, and even if it did have spares, it would not have time to mount radiation detectors on the exterior of the aircraft. DOE officials told us that radiation detectors, like those found on their vehicles, could be placed inside an airplane or helicopter, but the ability to measure contamination would be significantly reduced compared with an exterior-mounted detector. Furthermore, DOE does not conduct training exercises to simulate the actions necessary to reconstitute the capabilities and assets unique to the Remote Sensing Laboratories, such as placing radiation detectors on helicopters or testing the ability of RAP teams to conduct large-scale contamination monitoring and assessment without the assistance of the consequence management teams from Nellis. DOE officials told us that all of their training scenarios and exercises involve the use of consequence management teams and the planes and helicopters from the Remote Sensing Laboratories. As a result, DOE does not know whether it would be able to accomplish mission objectives without the capabilities and assets of the Remote Sensing Laboratories. Lastly, while the RAP teams have assumed a greater role in searching for nuclear or radiological devices, Remote Sensing Laboratories have the most highly trained and experienced search teams. For example, the search teams at the Remote Sensing Laboratories are the only teams trained to conduct physically demanding maritime searches to locate potential nuclear or radiological devices at sea before they arrive at a U.S. port. The search teams can also repair radiation equipment for search missions in the field. Furthermore, these search teams are more prepared than the RAP teams to enter environments where there is a threat of hazards other than those associated with radiological materials, such as explosives. If there is a threat of explosives in an area where a search mission would be conducted, these teams have specialized equipment to detect explosives and can more quickly request FBI ordnance disposal assistance in order to complete their search mission. In April 2006, the Office of Independent Oversight reported that the RAP teams did not always complete their search missions when there was a high level of risk to the lives of the RAP team members from explosives. The report found that some RAP teams refused to perform the mission unless all risk from explosives around a device was removed and others completed the mission only after certain safety criteria were met. According to this study, leaders of the RAP teams had to make on-the-spot judgments weighing the safety of RAP team members against their ability to complete the search mission because there was a lack of guidance on how to respond. Current Physical Security Measures May Not Be Sufficient to Protect the Facilities against Terrorist Attack Under DOE guidance, the physical security measures for facilities in the lowest level of security may include barriers such as fences, walls, and doors. According to DOE officials, a facility can have, at a minimum, walls and doors and be in compliance with the guidance. Adding additional measures, such as fences and vehicle barriers, are under the discretion of the security officer in charge of the facilities. According to DOE security officials, the Remote Sensing Laboratory at Nellis Air Force Base exceeds current physical security requirements because DOE placed a fence around the facility and a vehicle barrier at the front entrance. These additional measures were taken because, at the time the Remote Sensing Laboratory was built, these measures were required. In contrast, the Remote Sensing Laboratory at Andrews Air Force Base does not have a fence or any vehicle barriers because it is located along the executive route used by the President and foreign dignitaries when they land at Andrews and exit the base. The buildings along this route must meet specific aesthetic standards, which prohibit the use of certain physical security measures, such as fences. Despite these limitations, DOE security officials told us that the laboratory still meets the minimum security requirements. According to these officials, the Office of Emergency Response, which is responsible for managing DOE’s emergency response capabilities, would have to classify the facilities as mission critical before more stringent measures would be required. While current physical security measures are consistent with DOE guidance and may protect the facilities against trespass and theft of classified government documents, these measures may not be sufficient to protect the facilities against a terrorist attack. Security officials told us that current physical security measures at the Remote Sensing Laboratories have not been hardened or designed to withstand certain types of terrorist attacks. Security officials told us that the physical security measures protecting these facilities have not been strengthened because, if there were credible intelligence that the facilities faced the risk of terrorist attack, DOE could take additional measures to protect the facility, such as deploying protective forces around the laboratories and limiting access to the parking areas near the facilities. However, security officials would have to rely on good intelligence to prevent such an attack. In addition, under DOE guidance, facilities that house nuclear weapons or substantial quantities of special nuclear material that could be used in nuclear weapons are required to have vehicle barriers and other protective measures. Since the Remote Sensing Laboratories do not have nuclear weapons or special nuclear material, additional security measures are not required unless the facilities are classified as mission critical. While the laboratories’ location on Air Force bases may appear to provide an additional level of security, access onto Nellis and Andrews Air Force Bases is not strictly limited, and any person with a federal government identification may gain entry. In addition, Air Force guards do not inspect every vehicle. Vehicles are randomly inspected, and Air Force security guards can use their judgment as to whether a car should be searched. In fact, GAO staff gained access to the bases multiple times with little or no scrutiny of their identification, and their vehicles were never searched. Despite the Benefits of Conducting Aerial Background Radiation Surveys, They Remain Underutilized Because Neither DOE Nor DHS Has Mission Responsibility for Funding and Conducting Them There are significant benefits to conducting aerial background radiation surveys of U.S. cities. Once surveys are complete, they can later be used to compare changes in radiation levels to (1) help detect radiological threats in U.S. cities more quickly and (2) measure radiation levels after a radiological attack to assist in and reduce the costs of cleanup efforts. Despite the benefits, there has been a survey of only one major U.S. city. Since neither DOE nor DHS has mission responsibility for funding and conducting surveys, there are no plans to conduct additional surveys or to inform cities about their benefits. Completing Baseline Aerial Surveys Can Later Help to Detect Radiological Threats in U.S. Cities and Measure Radiation Levels in the Event of a Radiological Attack DOE can conduct aerial background radiation surveys to record the location of radiation sources and produce maps showing existing radiation levels within U.S. cities. Background radiation can come from a variety of sources, such as rock quarries; granite found in buildings, statues, or cemeteries; medical isotopes used at hospitals; and areas treated with high amounts of fertilizer, such as golf courses. DOE uses helicopters mounted with external radiation detectors and equipped with a global position system to fly over an area and gather data in a systematic grid pattern. Figure 1 illustrates a helicopter conducting an aerial survey and collecting information on radiation sources in a city. Onboard computers record radiation levels and the position of the helicopter. This initial, or baseline, survey allows DOE technicians and scientists to produce maps of a city showing the locations of high radiation concentrations, also known as “hot spots.” DOE uses helicopters rather than airplanes because their lower altitude and lower speed permits a more precise reading. While conducting the baseline survey, DOE ground teams and law enforcement officials can investigate these hot spots to determine whether the source of radiation is used for industrial, medical, or other routine purposes. DOE officials told us that this baseline information would be beneficial for all major cities because law enforcement officials could immediately investigate any potentially dangerous nuclear or radiological source and DOE could later use the data in the event of an emergency to find a device more quickly or assist in cleanup efforts. For example, in 2002, DOE conducted a survey of the National Mall in Washington, D.C., just prior to July Fourth celebrations. Law enforcement officials used the survey to investigate unusual radiation sources and ensure the Mall area was safe for the public. Data from the baseline survey would help DOE and law enforcement detect new radiological threats more quickly. In the event of a dirty-bomb threat, DOE could conduct a new, or follow-up, survey and compare that radiation data to the baseline survey data to identify locations with new sources of radiation. Law enforcement officials looking for a nuclear or radiological device would focus their attention on these new locations and might be able to distinguish between pre-existing sources and potential threats in order to locate a dirty bomb or nuclear device more quickly. Conducting baseline surveys also provides a training opportunity for DOE personnel. DOE officials told us that regular deployments helped to keep job performance standards high for pilots, field detection specialists, and the technicians who analyze the data. DOE can also use a baseline radiation survey to assess changes in radiation levels after a radiological attack to assist with cleanup efforts. A follow-up survey could be taken afterward to compare changes against the baseline radiation levels. This information can be used to determine which areas need to be cleaned and to what levels. In 2004, DOD funded a survey of the area around the Pentagon in Northern Virginia in order to assist with cleanup efforts in case of nuclear or radiological attack. While no study has reliably determined the cleanup costs of a dirty-bomb explosion in an urban area, DOE estimates that cleaning up after the detonation of a small to medium-size radiological device may cost tens or even hundreds of millions of dollars. DOE officials estimated that information from background radiation surveys could save several million dollars in cleanup costs because cleanup efforts could be focused on decontaminating buildings and other areas to pre-existing levels of radiation. Without a baseline radiation survey, cleanup crews would not know the extent to which they would have to decontaminate the area. Efforts to completely clean areas with levels of pre-existing radiation, such as granite buildings or hospitals, would be wasteful and expensive. DOE officials cautioned that background radiation surveys have limitations and cannot be relied upon to detect all nuclear or radiological devices. Aerial surveys may not be able to detect certain nuclear or well-shielded radiological materials. Weather conditions and the type of building being surveyed may also reduce the effectiveness of detection systems. Furthermore, DOE may have to rely on good intelligence to find a device. Law enforcement officials would need intelligence information to narrow the search to a specific part of a city. Lastly, according to DOE officials, baseline background radiation surveys may need to be conducted on a periodic basis because radiation sources may change over time, especially in urban areas. For example, new construction using granite, the installation of medical equipment, or the heavy use of fertilizer all could change a city’s radiation background. Despite these limitations, without baseline survey information, law enforcement officials may lose valuable time when searching for nuclear or radiological threats by investigating pre-existing sources of radiation that are not harmful. In addition, if there were a nuclear or radiological attack, a lack of baseline radiological data would likely make the cleanup more costly and time consuming. DOE Has Conducted a Survey of Only One Major City In 2005, the New York City Police Department (NYPD) asked DOE to conduct a survey of the New York City metro area. NYPD officials were aware that DOE had the capability to measure background radiation and locate hot spots by helicopter because DOE used this capability at the World Trade Center site in the days following September 11, 2001. DHS provided the city with about $30 million in grant money to develop a regional radiological detection and monitoring system. NYPD decided to spend part of this money on a complete aerial survey of all five boroughs. DOE conducted the survey in about 4 weeks in the summer of 2005, requiring over 100 flight hours to complete at a cost of about $800,000. According to NYPD officials, the aerial background radiation survey exceeded their expectations, and they cited a number of significant benefits that may help them better respond to a radiological incident. First, NYPD officials said that in the course of conducting the survey, they identified over 80 locations with unexplained radiological sources. Teams of NYPD officers accompanied by DOE scientists and technicians investigated each of these hot spots and determined whether they posed a danger to the public. While most of these were medical isotopes located at medical facilities and hospitals, according to NYPD officials, awareness of these locations will allow them to distinguish false alarms from real radiological threats and locate a radiological device more quickly. Second, NYPD officers are now trained in investigating hot spots and they have real- life experience in locating radiological sources. Third, NYPD officials now have a baseline radiological survey of the city to assist with cleanup efforts in the event of a radiological release. In addition to identifying potential terrorist threats, a secondary benefit of the survey was identifying threats to public health. One of the over 80 locations with a radiological signature was a local park that was once the site of an industrial plant. According to NYPD officials, the survey disclosed that the soil there was contaminated by large quantities of radium. Brush fires in the area posed an imminent threat to public health because traditional fire mitigation tactics of pushing flammable debris into the middle of the park could release radiological contamination into the air. Investigating locations with unexplained radiological sources identified by the aerial background radiation survey alerted NYPD officials to this threat, and they were able to prevent public exposure to the material. Because the extent to which the background radiation of a city changes over time is not clear, NYPD officials have requested that DHS provide money to fund a survey every year. With periodic surveys, NYPD hope to get a better understanding of how and to what extent background radiation changes over time. NYPD officials also want to continue identifying radiological sources in the city and to provide relevant training to their officers. Despite the Benefits, Neither DOE Nor DHS Has Mission Responsibility for Aerial Background Radiation Surveys, Which Has Discouraged Both Agencies from Informing Cities about the Surveys Despite the benefits of aerial background radiation surveys, neither DOE nor DHS has embraced mission responsibility for funding and conducting surveys. In addition, neither agency is notifying city officials of the potential benefits of aerial surveys or that such a capability exists. According to DOE and DHS officials, New York City is the only city where a background radiation survey has been completed. DOE officials told us that DOE is reluctant to conduct large numbers of additional surveys because they have a limited number of helicopters that are needed to prevent and respond to nuclear and radiological emergencies. Furthermore, they assert that DOE does not have sufficient funding to conduct aerial background radiation surveys. In fiscal year 2006, the emergency response budget for aerial radiation detection was approximately $11 million to cover costs for items such as aircraft maintenance, personnel, fuel, and detection equipment. DOE relies on federal agencies and cities to reimburse them for the costs of surveys. However, even if DHS funded cities to pay for surveys, as it did in New York’s case, DOE officials stated that payment would need to include costs associated with the wear and tear on the helicopters. Furthermore, the extra costs could not be completely recovered by increasing the charges to the city because, according to DOE officials, DOE cannot accumulate money from year to year to pay for future lump-sum repairs. In addition, DOE officials view background radiation surveys as part of the homeland security mission to prepare state and local officials against terrorist attacks, not as part of their emergency response mission. However, DOE officials told us that because they possess the assets and expertise, they would be willing to conduct additional surveys if DHS funded the full cost of the surveys and covered the wear and tear on DOE’s equipment. DHS officials told us that it is not DHS’s responsibility to conduct aerial background radiation surveys or to develop such a capability. DHS’s Domestic Nuclear Detection Office (DNDO) told us it does not have the expertise or capability to conduct surveys and that surveys are DOE’s responsibility. However, DNDO is responsible for assisting state and local governments’ efforts to detect and identify illicit nuclear and radiological materials and to develop mobile detection systems. DNDO has not evaluated the benefits and limitations of background surveys and does not plan to conduct background surveys as part of this effort. DHS officials also told us that it is DHS’s responsibility to advise cities about different radiation detection technology and to help state and local officials decide which technologies would be most beneficial. However, DNDO does not currently advise cities and states on the potential benefits of background surveys. DHS also has a grant program to improve the capacity of state and local governments to prevent and respond to terrorist and catastrophic events, including nuclear and radiological attacks. In fiscal year 2006, there was about $2.5 billion available in grant funding for state and local governments. DHS officials told us that this grant funding could be used for radiation surveys if cities requested them. However, according to DHS officials, the agency has not received any requests for funding other than the 2005 request by New York City. While it is DHS’s responsibility to inform state and local governments about radiation detection technology, it has neither an outreach effort nor does it maintain a central database for informing cities and states about background radiation surveys. DHS maintains a lessons-learned information-sharing database, which is a national online network of best practices and lessons learned to help plan and prepare for a terrorist attack. However, it is the responsibility of state and local governments to enter information into this database, and DHS officials told us they were not aware if New York City officials had added any information to the database about the surveys. According to DHS officials, it is DOE’s responsibility to inform cities and states about the surveys, since DOE maintains the capability for conducting them. In the absence of clear mission responsibility, there are no plans to conduct additional surveys, and no other city has requested one, in part, because DOE and DHS are not informing cities about the benefits of these surveys. Conclusions Preventing a nuclear or radiological explosion that could kill or injure many people and severely disrupt the nation’s economy depends, in part, on DOE’s ability to search for and deactivate a device with little or no warning. Reducing the loss of life from radiation exposure and the spread of contamination in the event of a nuclear or radiological explosion also depends, in part, on DOE’s capability to determine what parts of a U.S. city have been contaminated and provide this information to local and state governments to help evacuate citizens that are at risk of exposure and to administer medical aid. A number of critical capabilities and assets for preventing and responding to nuclear and radiological attacks reside at DOE’s two Remote Sensing Laboratories. Despite efforts to disperse emergency response capabilities and assets to other regions, the Remote Sensing Laboratories still play a prominent role in DOE’s ability to search for and locate nuclear or radiological devices and to minimize the consequences of a nuclear or radiological attack. The capabilities and assets that are unique to the laboratories include consequence management teams that provide information to state and local governments about the extent of contamination; the planes and helicopters used to locate lost or stolen nuclear or radiological materials and measure contamination levels; and a sophisticated mapping system that contains information on the locations of radiological sources in U.S. cities. In addition, the Remote Sensing Laboratories house specialized teams that are highly trained in clandestine search techniques and can conduct physically demanding search missions, such as maritime boarding. Despite the importance of the assets and capabilities located at these facilities, the Remote Sensing Laboratories are protected at DOE’s lowest level of physical security. If DOE’s emergency response capabilities were fully dispersed, then providing only minimal security may be sufficient. However, since several DOE emergency response capabilities remain unique to the Remote Sensing Laboratories, we believe that the physical security measures around those facilities may not be sufficient to protect their capabilities. We recognize that physical protection measures may be costly and that DOE security officials must prioritize where to spend limited resources in a fiscally constrained environment. However, in our view, a modest improvement in security at the Remote Sensing Laboratories, such as installing vehicle barriers, would significantly enhance the protection of highly valuable assets against a terrorist attack. In responding to a nuclear or radiological emergency, DOE must rely on all of the capabilities and assets at its disposal. One capability that remains underutilized is aerial background radiation surveys. These surveys establish baseline radiological data that can later be used to more quickly detect radiological threats in U.S. cities and to measure changes in contamination levels after a radiological attack in order to better focus and reduce cleanup costs. Despite their benefits and relatively low cost, there has been a survey of only one major metropolitan area. Since neither DOE nor DHS has embraced mission responsibility for performing the surveys, they have not evaluated the costs, benefits, and limitations of conducting the surveys for metropolitan areas that may be most at risk from a terrorist attack. While DOE has the expertise to conduct the surveys, the department is reluctant to encourage cities to request the surveys because it has a limited number of helicopters at its disposal, and they are generally reserved for emergency response missions. DHS, which is responsible for assisting state and local governments in preparing for a nuclear or radiological attack and has a $2.5 billion grant program to improve state and local governments’ capacity to do so, has not considered aerial surveys to be part of its efforts to protect cities against such an attack. With no agency assuming responsibility for informing cities about the benefits of these surveys, U.S. cities are missing an opportunity to be better prepared for a terrorist attack. Recommendations for Executive Action To better ensure that all capabilities and assets are available and used to prevent or minimize the consequence of a nuclear or radiological attack, we are making the following three recommendations: The Administrator of NNSA, who implements the emergency response program within DOE, should review the physical security measures at the Remote Sensing Laboratories and determine whether additional measures should be taken to protect the facilities against a loss of critical emergency response capabilities or whether it is more cost- effective to fully disperse its capabilities and assets to multiple areas of the country. The Administrator of NNSA and the Secretary of Homeland Security should evaluate the costs, benefits, and limitations of conducting aerial background radiation surveys of metropolitan areas, especially those that are considered to be most at risk of a terrorist attack; determine whether they would help prevent and respond to a nuclear or radiological attack; and report the results to the Congress. If the Administrator of NNSA and the Secretary of Homeland Security determine that the surveys would help prevent and respond to a nuclear or radiological attack, the Secretaries should work together to develop a strategy for making greater use of the aerial surveys. In developing this strategy, the Secretary of Homeland Security should consider (1) the costs and benefits of funding these surveys through its existing grant program for state and local governments or through other means and (2) ways to inform state and local government officials about the benefits and limitations of aerial background radiation surveys so that these government officials can make their own decision about whether they would benefit from the surveys. Agency Comments and Our Evaluation We provided DOE and DHS with draft copies of this report for their review and comment. DHS agreed with our recommendations. DOE neither agreed nor disagreed with our recommendations, but raised concerns about one of our findings. In its written comments, DOE disagreed with our finding that the physical security of the Remote Sensing Laboratories may not be sufficient to protect them against terrorist attacks. According to DOE, physical security measures at these two facilities are sufficient because (1) two senior-level managers diligently reviewed the physical security measures around the facilities and believe that they are sufficient and (2) the laboratories are located on Air Force bases. We disagree with these rationales and stand behind our finding. First, while we acknowledge that current physical security measures for the two Remote Sensing Laboratories are consistent with DOE guidance, the laboratories are protected at the lowest level of physical security. This means that a facility can meet the requirements by having walls and doors but no other physical security measures. For example, the Remote Sensing Laboratory at Andrews Air Force Base does not have a fence or any vehicle barriers, but security officials told us that it still meets the minimum security requirements. Further, DOE’s justification for protecting the laboratories at the lowest level of physical security is that their emergency response capabilities and assets have been dispersed across the country and are not concentrated at the laboratories. However, although we found that DOE had dispersed some of its emergency response capabilities and assets, a number of critical emergency response capabilities and assets still exist only at the laboratories. Because these capabilities and assets have not been fully dispersed, current physical security measures may not be sufficient for protecting the facilities against a terrorist attack. Second, the security officials responsible for developing security plans for the laboratories told us that they do not rely on Air Force personnel to protect the facility against a terrorist attack. As we reported, while the laboratories’ location on Air Force bases may appear to provide an additional level of security, access onto Nellis and Andrews Air Force Bases is not strictly limited, and any person with a federal government identification may gain entry. Furthermore, guards at these installations do not inspect every vehicle. In fact, as discussed in our report, GAO staff gained access to the bases multiple times with little or no scrutiny of their identification, and their vehicles were never searched. In its written comments, DOE agreed that there may be value in performing additional aerial background radiation surveys. However, DOE was concerned that existing mission requirements may limit DOE’s ability to conduct aerial surveys. While we recognize that DOE has limited resources to conduct aerial surveys, we note that the agency does have the expertise and that there is funding potentially available under DHS’s grant program for state and local governments. If neither DOE nor DHS assume mission responsibility for conducting the aerial surveys and do not inform cities about the benefits of these surveys, U.S. cities will miss an important opportunity to be better prepared for a terrorist attack. DOE also noted that aerial background radiation surveys have limitations. For example, aerial surveys may not be able to detect well-shielded radiological materials. We acknowledged these limitations in our report. However, despite the limitations, without baseline survey information from an aerial survey, law enforcement officials may lose valuable time when searching for nuclear or radiological threats by investigating pre-existing sources of radiation that are not harmful. In addition, if there were a nuclear or radiological attack, the lack of baseline radiological data would likely make the cleanup more costly and time consuming. DHS provided comments via e-mail. Comments from DOE’s NNSA are reprinted in appendix I. DOE and DHS also provided technical comments, which we incorporated, as appropriate. We are sending copies of this report to the Secretary of Energy, the Administrator of NNSA, the Secretary of Homeland Security, and interested congressional committees. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-3841 or aloisee@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix II. Comments from the Department of Energy GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Leland Cogliani, John Delicath, Mattias Fenton, Glen Levis, Greg Marchand, Keith Rhodes, Rebecca Shea, and Ned Woodward made significant contributions to this report.

The Department of Energy (DOE) maintains an emergency response capability to quickly respond to potential nuclear and radiological threats in the United States. This capability has taken on increased significance after the attacks of September 11, 2001, because there is heightened concern that terrorists may try to detonate a nuclear or radiological device in a major U.S. city. This report discusses (1) the capabilities and assets DOE has to prevent and respond to potential nuclear and radiological attacks in the United States, (2) the physical security measures in place at DOE's two key emergency response facilities and whether they are consistent with DOE guidance, and (3) the benefits of using DOE's aerial background radiation surveys to enhance emergency response capabilities. DOE has unique capabilities and assets to prevent and respond to a nuclear or radiological attack in the United States. These include specialized teams to search for, locate, and deactivate nuclear or radiological devices and to help manage the consequences of a nuclear or radiological attack. These capabilities are primarily found at DOE's two key emergency response facilities--the Remote Sensing Laboratories at Nellis Air Force Base, Nevada, and Andrews Air Force Base, Maryland. DOE's two Remote Sensing Laboratories are protected at the lowest level of physical security allowed by DOE guidance because, according to DOE, capabilities and assets to prevent and respond to nuclear and radiological emergencies have been dispersed across the country and are not concentrated at the laboratories. However, we found a number of critical capabilities and assets that exist only at the Remote Sensing Laboratories and whose loss would significantly hamper DOE's ability to quickly prevent and respond to a nuclear or radiological emergency. These capabilities include the most highly trained teams for minimizing the consequences of a nuclear or radiological attack and the only helicopters and planes that can readily help locate nuclear or radiological devices or measure contamination levels after a radiological attack. Because these capabilities and assets have not been fully dispersed, current physical security measures may not be sufficient for protecting the facilities against a terrorist attack. There are significant benefits to conducting aerial background radiation surveys of U.S. cities. Specifically, the surveys can be used to compare changes in radiation levels to (1) help detect radiological threats in U.S. cities more quickly and (2) measure contamination levels after a radiological attack to assist in and reduce the costs of cleanup efforts. Despite the benefits, only one major city has been surveyed. Neither DOE nor the Department of Homeland Security has mission responsibility for conducting these surveys, and there are no plans to conduct additional surveys.

Identifying Federal Mandates in Statutes Is Complex Legislation must go through several steps to be identified as containing a federal mandate. Once mandates are identified based on UMRA’s definitions, exclusions, and exceptions, CBO determines whether the mandate meets or exceeds UMRA’s cost thresholds. As we reported last year, in 2001 and 2002, CBO identified few statutes containing federal mandates at or above UMRA’s cost thresholds. In addition, CBO reports and testimonial evidence indicate that UMRA may indirectly impact the costs of and number of federal mandates enacted at or above UMRA’s cost thresholds. However, when asked, some nonfederal parties said they continue to be subject to costs associated with laws containing mandates that do not meet the statutory definition of a mandate at or above UMRA’s cost thresholds. Legislation Must Undergo a Multistep Process to Be Identified as Containing Federal Mandates at or above Applicable Cost Thresholds UMRA does not require CBO to automatically review every legislative provision; further, the process takes several steps to determine whether a statutory provision would be identified as a federal mandate at or above UMRA’s cost thresholds (see fig. 1). Specifically, CBO does not automatically review provisions that are (1) not contained in authorizing bills or (2) not reported by an authorizing committee. This means that appropriations bills are not automatically subject to CBO review under UMRA. However, CBO told us that it will informally review provisions in appropriations bills and communicate their findings to appropriations committee clerks when CBO finds potential mandates in these bills. Although provisions contained in an authorizing bill are subject to automatic review by CBO, the bill also must be “reported” by that committee. UMRA also does not require an automatic CBO review of provisions added after CBO’s initial review. UMRA states, however, that “the committee of conference shall insure to the greatest extent practicable” that CBO prepare statements on amendments offered subsequent to its initial review that contain federal mandates. For example, CBO reported that for 2002, three laws were enacted that contained federal mandates not reviewed by CBO prior to enactment because they were added after CBO reviewed the legislation. For example, the Terrorism Risk Insurance Act of 2002 includes a provision requiring insurers of commercial property to offer terrorism insurance, which was added to after CBO’s UMRA review and thus not identified as a private sector mandate under UMRA prior to enactment. Once a decision is made about CBO’s review, CBO analyzes the provision to determine whether the provision is excluded under UMRA. An exclusion applies to any provision in legislation that 1. enforces Constitutional rights of individuals; 2. establishes or enforces any statutory rights that prohibit discrimination on the basis of race, color, religion, sex, national origin, age, handicap, or disability; 3. requires compliance with accounting and auditing procedures with respect to grants or other money or property provided by the federal government; 4. provides for emergency assistance or relief at the request of any state, local, or tribal government or any official of a state, local, or tribal government; 5. is necessary for the national security or the ratification or implementation of international treaty obligations; 6. the President designates as emergency legislation and that Congress so designates in statute; or 7. relates to the old age, survivors, and disability insurance program under title II of the Social Security Act (including taxes imposed by sections 3101(a) and 3111(a) of the Internal Revenue Code of 1986 relating to old-age, survivors, and disability insurance). Next CBO applies UMRA’s definition of a federal mandate—a provision that would impose an enforceable duty upon state, local, or tribal governments or upon the private sector. To be identified as a mandate, a provision must meet this definition of a mandate and not be classified as an “exception.” Generally, exceptions are defined as enforceable duties that are conditions of federal financial assistance or arise from participation in a voluntary federal program. Once the provision is identified as a mandate under UMRA, CBO determines whether the cost estimate, if feasible, exceeds the applicable threshold ($50 million for intergovernmental and $100 million for private sector mandates, in any of the first 5 fiscal years during which the mandate would be effective). If CBO determines that a cost estimate is not feasible, CBO specifies the kind of mandate contained in the provision, but reports that the agency cannot estimate the costs. For example, CBO reported that it could not estimate the costs of mandates in nine bills that ultimately were enacted during 2001 and 2002. Common reasons why a cost estimate may not be feasible include (1) the costs depend on future regulations, (2) essential information to determine the scope and impact of the mandate is lacking, (3) it is unclear whom the bill’s provisions would affect, and (4) language in UMRA is ambiguous about how to treat extensions of existing mandates. For intergovernmental mandates that exceed the cost threshold or cost estimates that are not feasible, a point of order is available under UMRA. However, UMRA does not provide for a point of order for private sector mandates. For intergovernmental or private sector mandates below the applicable cost threshold, CBO states in its report that a mandate exists with costs estimated to be below the applicable cost threshold. Although this highlights the provision as a mandate, it does not provide for a point of order under UMRA. UMRA also contains a mechanism designed to help curtail mandates with insufficient appropriations, but it has never been utilized. UMRA provides language that could be included in legislation that would allow agencies tasked with administering funded mandates to report back to Congress on the sufficiency of those funds. Congress would then have a certain time period to decide whether to continue to enforce the mandate, adopt an alternate plan, or let it expire—meaning the provision comprising the mandate would no longer be enforceable. Our January 2004 database search has resulted in no legislation containing this language. CBO Identified Few Laws in 2001 and 2002 as Containing Federal Mandates at or above UMRA’s Cost Threshold, but UMRA May Have an Indirect Effect Few laws containing federal mandates at or above the cost thresholds were enacted in 2001 and 2002. Further, there is some evidence that the existence of UMRA may have indirectly discouraged the enactment of some federal mandates in proosed legislation and reduced the potential costs of others. Of 377 laws enacted in 2001 and 2002, CBO identified at least 44 containing a federal mandate under UMRA. Of these 44, CBO identified 5 containing mandates at or above the cost thresholds, and all were private sector mandates. As we previously reported, from 1996 through 2002, only three bills with intergovernmental mandates and 21 private sector mandates with costs over the applicable threshold became law. UMRA may have indirectly discouraged the passage of legislation identified as containing mandates at or above the cost thresholds. Similarly, UMRA may have also aided in lessening the costs of some mandates that were enacted. From 1996 through 2000, CBO identified 59 proposed federal mandates with costs above applicable thresholds. Following CBO’s identification, 9 were amended before enactment to reduce their costs below the applicable thresholds and 32 were never enacted. The remaining 18 mandates were enacted with costs above the threshold. Although CBO has not done an analysis to determine the role of UMRA in reducing the costs of mandates ultimately enacted, it reported that “it was clear that information provided by CBO played a role in the Congress’s decision to lower costs.” CBO also testified in July 2003 that “both the amount of information about the cost of federal mandates and Congressional interest in that information have increased considerably. In that respect, title I of UMRA has proved to be effective.” Similarly, the Chairman of the House Rules Committee was quoted in 1998 as saying that UMRA “has changed the way that prospective legislation is drafted… Anytime there is a markup , this always comes up.” Finally, although points of order are rarely used, they may be perceived as an unattractive consequence of including a mandate above UMRA cost thresholds in proposed legislation. Nonfederal Parties Perceived Some Enacted Provisions to Be Unfunded Mandates Although CBO’s annual reports for 2001 and 2002 showed that most proposed legislation did not contain federal mandates as defined by UMRA, we asked CBO to compile a list of examples from among those laws enacted in 2001 and 2002 that had potential impacts on nonfederal parties but were not identified as containing federal mandates meeting or exceeding UMRA’s cost thresholds. We then analyzed these 43 examples to illustrate the application of UMRA’s procedures, definitions, and exclusions on legislation that was not identified as containing mandates at or above UMRA’s threshold, but might be perceived to be unfunded mandates. We then shared CBO’s list of 43 examples with national organizations representing nonfederal levels of government, and they generally agreed that those laws contained provisions their members perceived to be mandates. As figure 2 shows, for 12 of the 43 examples, an automatic UMRA review was not required for one of the reasons I discussed earlier, such as that they were in an appropriations bill or were not reported by the authorizing committee. Out of the remaining 31 laws that did undergo a cost estimate, 24 were found to contain mandates with costs below applicable thresholds, 3 contained provisions that were excluded from UMRA coverage, 2 contained provisions with direct costs that were not feasible to estimate, 1 contained a provision that did not meet UMRA’s definition of a mandate, and 1 was reviewed by the Joint Committee on Taxation and found not to contain any federal mandates. Of the 12 examples of laws with provisions that CBO was not required to review prior to enactment, CBO later determined that 5 contained mandates with direct costs below UMRA’s thresholds, 4 contained mandates with direct costs that could not be estimated, 1 was excluded under UMRA because it involved national security, 1 did not meet the definition of a mandate, and 1 had some provisions with costs below the threshold and some provisions excluded because it involved national security. For example, the Sarbanes-Oxley Act of 2002 contained both intergovernmental and private sector mandates but CBO determined that a cost estimate was not feasible for all mandates. Specifically, CBO estimated the costs of providing notification of blackout periods— specified periods of time when trading securities is prohibited—fell below the UMRA thresholds but provided no quantified estimate, and CBO estimated the cost of running the Public Company Accounting Oversight Board and an associated standard-setting body to be approximately $80 million per year, which would be funded from fees assessed on public companies. However, CBO stated it was uncertain if the rest of the mandates contained in Sarbanes-Oxley exceeded UMRA’s cost threshold of $115 million (inflation adjusted). Identification of Federal Mandates in Rules Is Less Complex Than for Statutes The process for identifying federal mandates in regulations is less complex than for legislation, but additional restrictions apply to identifying federal mandates. In 2001 and 2002, agencies identified few of the major and economically significant final rules as containing federal mandates as defined by UMRA. Most often, rules with financial effects on nonfederal parties did not trigger UMRA’s requirements because they did not require expenditures at or above UMRA’s threshold. We also determined that at least 29 rules that did not contain federal mandates defined under UMRA appeared to have significant financial impacts. UMRA Procedures for Rules Are Less Complex Than for Legislation, but More Restrictions Apply The process for rules is less complex than for legislation. However, in addition to the definitions and seven general exclusions for legislation, there are four additional restrictions that apply to federal mandates in rules: UMRA’s requirements do not apply to provisions in rules issued by independent regulatory agencies. Preparation of an UMRA statement, and related estimate or analysis of the costs and benefits of the rule, is not required if the agency is “otherwise prohibited by law” from considering such an estimate or analysis in adopting the rule. The requirement to prepare an UMRA statement generally does not apply to any rule for which the agency does not publish a general notice of proposed rule making in the Federal Register. UMRA’s threshold for federal mandates in rules is limited to expenditures, in contrast to title I which refers more broadly to direct costs. Thus, a rule’s estimated annual effect might be equal to or greater than $100 million in any year—for example, by reducing revenues or incomes in a particular industry—but not trigger UMRA if the rule does not compel nonfederal parties to spend that amount. UMRA generally directs agencies to assess the effects of their regulatory actions on other levels of government and the private sector. The agencies only need to identify and prepare written statements on those rules that the agencies have determined include a federal mandate that may result in expenditures by nonfederal parties of $100 million or more (adjusted for inflation) in any year. Within the OMB, the Office of Information and Regulatory Affairs (OIRA) is responsible for reviewing compliance with UMRA as part of its centralized review of significant regulatory actions published by federal agencies, other than certain independent regulatory agencies. Under Executive Order 12866, which was issued in September 1993, agencies are generally required to submit their significant draft rules to OIRA for review before publishing them. In the submission packages for their draft rules, federal agencies are to designate whether they believe the rule may constitute an unfunded mandate under UMRA. According to OIRA representatives, for such rules, consideration of UMRA is then incorporated as part of these regulatory reviews, and draft rules are expected to contain appropriate UMRA statements. The same analysis conducted for Executive Order 12866 may permit agencies to comply with UMRA requirements. UMRA requires agency consultations with state and local governments on certain rules, and this is something that OIRA will look for evidence of when it does its regulatory reviews. UMRA provides OIRA a statutory basis for requiring agencies to do an analysis similar to that required by this. (Unlike laws, however, executive orders can be rescinded or amended at the discretion of the President). Agencies Identified Few Final Rules Published in 2001 and 2002 as Containing Federal Mandates Because Most Rules Did Not Trigger UMRA’s Requirements Federal agencies identified 9 of the 122 major and/or economically significant final rules that federal agencies published in 2001 or 2002 as containing federal mandates under UMRA (see fig. 3). As we previously reported, the limited number of rules identified as federal mandates during 2001 and 2002 is consistent with the previous findings in our 1998 report on UMRA and in OMB’s annual reports on agencies’ compliance with title II. Of the nine rules that agencies identified as containing federal mandates under UMRA, only one included an intergovernmental mandate—EPA’s enforceable standard for the level of arsenic in drinking water. The remaining rules imposed private sector mandates ranging from Department of Energy rules that amended energy conservation standards for several categories of consumer products, including clothes washers and heat pumps, to a Department of Transportation rule that established a new federal motor vehicle safety standard requiring tire pressure monitoring systems, controls, and displays. Of the 113 major and/or economically significant rules in 2001 and 2002 not identified as including federal mandates under UMRA, we reported that 48 contained no new requirements that would impose costs or have a negative financial effect on state, local, and tribal governments or the private sector. Often, these were economically significant or major rules because they involved substantial transfer payments from the federal government to nonfederal parties. For example, the Department of Health and Human Services published a notice updating the Medicare payment system for home health agencies that was estimated to increase federal expenditures to those agencies by $350 million in fiscal year 2002. In the remaining 65 of 113 rules, we determined that the new requirements would impose costs or result in other negative effects on nonfederal parties. In 41 of the 65 published rules, the agencies cited a variety of reasons that these rules did not trigger UMRA’s requirements (see fig. 4). There were 26 rules for which the agencies stated that the rule would not compel expenditures at or above the UMRA threshold and 10 rules for which the agencies stated that rules imposed no enforceable duty. For the remaining 24 rules, the agency did not provide a reason. However, independent regulatory agencies, which are not covered by UMRA, published 12 of these rules, and there is no UMRA requirement for covered agencies to identify the reasons that their rules do not contain federal mandates. Some Rules That Did Not Trigger UMRA Had Potentially Significant Effects on Nonfederal Parties At least 29 of the 65 rules with new requirements published in 2001 and 2002 could have imposed significant costs or other financial effects on nonfederal parties. In these 29 rules, we reported that the agencies either explicitly stated that they expected the rule could impose significant costs or published information indicating that the rule could result, directly or indirectly, in financial effects on nonfederal parties at or above the UMRA threshold. For example, more than half of them imposed costs on individuals exceeding $100 million per year, reduced the level of federal payments to nonfederal parties by more than $100 million in a year, or had substantial indirect costs or economic effects on nonfederal parties. For the remaining 36 of the 65 rules that imposed costs or had other financial effects on nonfederal parties in 2001 and 2002, either the agencies provided no information on the potential costs and economic impacts on nonfederal parties or the costs imposed on them were under the UMRA threshold. For example, a Federal Emergency Management Agency interim final rule on a grant program to assist firefighters included some cost- sharing and other requirements on the part of grantees participating in this voluntary program. In return for cost sharing of $50 million to $55 million per year, grantees could obtain, in aggregate, federal assistance of approximately $345 million. Similarly, the U.S. Department of Agriculture’s interim rule on the noninsured crop disaster assistance program imposed new reporting requirements and service fees on producers estimated to cost at least $15 million. But producers were expected to receive about $162 million in benefits. Even when the requirements of UMRA did not apply, agencies generally provided some quantitative information on the potential costs and benefits of the rule to meet the requirements of Executive Order 12866. Rules published by independent regulatory agencies were the major exception because they are not covered by the executive order. In general, though, the type of information that UMRA was intended to produce was developed and published by the agencies even if they did not identify their rules as federal mandates under UMRA. In conclusion, UMRA was intended, in part, to provide more information to Congress and agencies when placing federal mandates on nonfederal parties by providing more information to help them determine the appropriate balance between desired benefits and associated costs. Based on CBO’s experience, there is some evidence that UMRA is in some ways achieving this desired goal. However, UMRA’s many definitions, exclusions, and exceptions result in many statutes and rules never triggering UMRA’s thresholds, which means they are not identified as federal mandates. As we reported last year, in 2001 and 2002 many statutes and final rules with potentially significant financial effects on nonfederal parties were enacted or published without being identified as federal mandates at or above UMRA’s thresholds. Further, if judged solely by their financial consequences for nonfederal parties, there was little difference between some of these statutes and rules and the ones that had been identified as federal mandates with costs or expenditures exceeding UMRA’s thresholds. Although the examples cited in our report were limited to a 2-year period, our findings on the effect and applicability of UMRA are similar to the data reported in our previous reports and those of others on the implementation of UMRA. The findings raise the question of whether UMRA’s definitions, exclusions, and exceptions adequately capture and subject to scrutiny federal statutory and regulatory actions that might impose significant financial burdens on affected nonfederal parties. Mr. Chairman, this completes my prepared statement. Contacts and Acknowledgments For further information, please contact Orice Williams at (202) 512-5837 or williamso@gao.gov or Tim Bober at (202) 512-4432 or bobert@gao.gov. Key contributors to this testimony were Boris Kachura and Michael Rose. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

The Unfunded Mandate Reform Act of 1995 (UMRA) was enacted to address concerns expressed by state and local governments about federal statutes and regulations that require nonfederal parties to expend resources to achieve legislative goals without being provided funding to cover the costs. Over the past 10 years, Congress has at various times considered legislation that would amend various aspects of UMRA. This testimony is based on GAO's report, Unfunded Mandates: Analysis of Reform Act Coverage ( GAO-04-637 , May 12, 2004). Specifically, this testimony addresses (1) the process used to identify federal mandates and what are federal agencies' roles, (2) statutes and rules that contained federal mandates under UMRA, and (3) statutes and rules that were not considered mandates under UMRA but may be perceived to be "unfunded mandates" by certain affected parties. GAO found that the identification and analysis of intergovernmental and private sector mandates is a complex process under UMRA. Proposed legislation and regulations are subject to various definitions, exclusions and exceptions before being identified as containing mandates at or above UMRA's cost thresholds. The Congressional Budget Office (CBO) is required to prepare statements identifying and estimating, if feasible, the costs of mandates in legislation. While a point of order can be raised on the floor of the House or Senate against consideration of any UMRA-covered intergovernmental mandate that lacks a CBO estimate or exceeds the cost thresholds, it contains no similar enforcement for private sector mandates. Conversely, federal agencies are required to prepare mandate statements for regulations containing intergovernmental or private sector mandates that would result in expenditures at or above the UMRA threshold. The Office of Information and Regulatory Affairs, within the Office of Management and Budget, is responsible reviewing compliance with UMRA as part of the rule making process. In 2001 and 2002, 5 of 377 statutes enacted and 9 of 122 major or economically significant rules issued were identified as containing federal mandates at or above UMRA's thresholds. All 5 statutes and 9 rules contained private sector mandates as defined by UMRA. One final rule also contained an intergovernmental mandate. Despite the determinations under UMRA, at least 43 statutes and 65 rules issued in 2001 and 2002 resulted in new costs or negative financial consequences on nonfederal parties. These parties may perceive such statutes and rules as unfunded or underfunded mandates even though they did not meet UMRA's definition of a federal mandate at or above UMRA's thresholds. For 24 of the statutes and 26 of the rules, CBO or the agencies estimated that the direct costs or expenditures, as defined by UMRA, would not meet or exceed the applicable thresholds. The others were excluded for a variety of reasons stemming from exclusions or exceptions specified by UMRA.

Background Nanomaterials come in a variety of forms based both on their chemical composition and physical structure. For example, carbon-based nanomaterials can be produced in a number of physical structures such as sheets (graphene), tubes (carbon nanotubes), and particles (carbon black). Nanomaterials can enter the marketplace as materials themselves, as intermediates that either have nanoscale features or incorporate nanomaterials, and as final nano-enabled products. The use of nanomaterials in commercial applications raises questions about the potential risks that might arise from exposures to nanomaterials and the differences in exposure during their manufacture, use, and disposal. For example, some, but not all, research studies have shown adverse respiratory or cellular effects in animals exposed to some types of carbon nanotubes. Observed effects include early onset and persistence of pulmonary fibrosis and interference with cell division. The risk posed by a material is a combination of the hazard or negative effect that material may have on an organism and the extent of the organism’s exposure to that material. Therefore, a highly poisonous material—that is, one with high hazard—may nonetheless pose little risk if susceptible groups have little or no contact with the material. For instance, many household chemicals are hazardous to human health but pose little risk when exposure is limited by safe handling. Conversely, a material with relatively mild health effects may pose a large risk if people or the environment are exposed to large amounts or over prolonged periods. NRC, A Research Strategy for Environmental, Health, and Safety Aspects of Engineered Nanomaterials (2012). Development has developed a list of 13 representative manufactured nanomaterials now or soon to be in commerce as priority testing targets. Regulatory agencies, like FDA, CPSC, and EPA, may not have complete information on the uses or risks of some nanomaterials. In 2010, we reported that uncertainties persist about how to evaluate the safety of engineered nanomaterials in food and that nanomaterials may enter the food supply in certain products generally recognized as safe without We also reported in 2010 that EPA has taken a FDA’s knowledge. variety of actions to better understand and regulate the risks of nanomaterials but that the agency faces challenges that might impede its ability to regulate nanomaterials effectively.that the Toxic Substances Control Act gives EPA authority to issue rules requiring companies to submit certain information about chemicals. EPA recently amended a regulation to require companies to report certain information regarding production of chemicals above certain thresholds but those thresholds may not capture nanomaterials if they are produced in amounts below the thresholds. EPA currently has no plans to further reduce the thresholds. In addition, according to officials at CPSC, which is charged with protecting the public from unreasonable risks of injury or death from thousands of types of consumer products, CPSC does not have the statutory authority to require pre-market approval for products, including those incorporating nanomaterials. For example, we reported The NNI was codified in law by the 21st Century Nanotechnology Research and Development Act in 2003. The act requires the President to implement a national nanotechnology program and charges the NSTC itself—or through a subgroup—with overseeing the planning, management, and coordination of the program. The NSTC carries out these tasks through the NSET Subcommittee, which includes a co-chair from OSTP as well as representatives from the member agencies of the NNI. The NSET oversees working groups, including the Nanotechnology Environmental and Health Implications (NEHI) working group which supports federal activities to protect public health and the environment. Figure 1 provides an overview of the organizational structure of the NNI. The NNI does not fund research directly; rather, each of its member agencies determines its nanotechnology activities based on its individual mission and priorities. The NNI provides a framework for a comprehensive nanotechnology research and development program by establishing shared goals, priorities, and strategies among member agencies; and providing avenues for member agencies to leverage the resources of all participating agencies. The four goals of the NNI are to (1) advance a world-class nanotechnology research and development program; (2) foster the transfer of new technologies into products for commercial and public benefit; (3) develop and sustain educational resources, a skilled workforce, and the supporting infrastructure and tools to advance nanotechnology; and (4) support responsible development of nanotechnology. Efforts of the NNI member agencies are reported through triennial strategic plans and annual budget supplements. The act directs the NSTC, itself or through an appropriate subgroup it designates or establishes, to develop and update every 3 years a strategic plan to guide the activities of the program. The NSTC published its most recent strategic plan in February 2011. In addition to the statutorily required strategic plan, in 2008, the NSTC published a Strategy for Nanotechnology-Related Environmental, Health, and Safety Research and updated this document in 2011. The EHS strategies published in 2008 and 2011 expand on the goal of the responsible development of nanotechnology by describing the state of science and research needed to ensure that nanotechnology provides maximum benefits to the environment and human well-being. The act also requires the NSTC to prepare an annual report to be submitted to congressional committees on the national nanotechnology program’s budget and an analysis of the progress made toward achieving the goals and priorities established for the program, among other things. In the NNI Supplements to the President’s Budget, the NSTC reports overall NNI spending and describes research efforts and investments within eight program component areas, as seen in table 1. These program component areas provide an organizational framework for categorizing the activities of the NNI. Data presented in the NNI annual supplements is collected from the NNI member agencies by OMB as part of the annual budget formulation process. The act requires triennial external reviews of the national nanotechnology program. Specifically, the act requires the NNCO to contract with the NRC to conduct the triennial evaluations of the national nanotechnology program. The NRC draws on expertise from outside government, including from academia, companies, and NGOs. The NRC completed reviews in 2002, 2006, and 2009 based on the work of 15 to 23 panelists chosen by the NRC and identified in the review. In addition, the NRC also published an independent research strategy to address EHS aspects of nanomaterials in 2012. The act also requires the President to establish or designate a National Nanotechnology Advisory Panel. The advisory panel, by statute, must consist primarily of members from academic institutions and industry, and panel members must be qualified to provide advice and information on nanotechnology research, development, demonstrations, education, technology transfer, commercial application, or societal and ethical concerns. Since 2004, the President has designated the President’s Council of Advisors on Science and Technology (PCAST) to function as the advisory panel. PCAST members are generally senior managers in major corporations and academia selected for diverse expertise in science and technology issues. The advisory panel is required to report not less frequently than once every 2 fiscal years on its assessment of the national nanotechnology program and recommendations for ways to improve the program. The advisory panel has produced three assessments to date, in 2005, 2008, and 2010. The first and second assessments were authored by a subset of PCAST membership, and the third assessment was authored by a working group of three PCAST members and additional external experts, but PCAST as a whole approved the assessments. The first and second assessments created Nanotechnology Technical Advisory Groups, which were comprised of approximately 40 members who provided written responses to questionnaires developed by PCAST. The membership of these groups is not identified in the assessments. The external members of the third assessment’s working group were selected by PCAST members and are identified in PCAST’s assessment. Funding of EHS Research by NNI Member Agencies Has Increased, but Quality of Funding Data Is Uncertain NSTC reported more than a doubling of funding for nanotechnology EHS research by NNI member agencies from fiscal years 2006 to 2010. Reported EHS funding also rose as a percentage of total NNI funding during this period, ending up at about 5 percent in 2010. We also identified several reporting problems related to the continued absence of detailed guidance on how agencies should report funding for their nanotechnology research, raising concerns about the quality of EHS funding data reported. EHS Research Funding by NNI Member Agencies More Than Doubled From 2006 to 2010 and Amounted to About 5 Percent of Total NNI Funding in 2010 From fiscal years 2006 to 2010, NSTC reported more than a doubling of NNI member agencies’ funding for nanotechnology EHS research in the NNI Supplements to the President’s Budget––from approximately $38 million to $90 million.reported to be by NSF, NIH, and EPA, and the largest increases in reported EHS research funding over this period were at NIH and EPA. EHS Research Funded in 2010 Focused On Metal- and Carbon-Based Nanomaterials In fiscal year 2010, EHS research at the seven NNI member agencies we reviewed focused on two categories of nanomaterials more than others— metal- and carbon-based nanomaterials, which are used in a variety of applications, including electronics, consumer products such as sunscreens, medical products, and protective coatings (see fig. 4). NNI has not prioritized nanomaterials for EHS research, but in October 2011 it outlined criteria for its member agencies to use in doing so. It is not yet clear what effect these criteria will have on how agencies prioritize the nanomaterials they focus on in their EHS research. As shown in figure 5, we found that in the 193 fiscal year 2010 research projects we determined were primarily directed at EHS, the nanomaterials that were most frequently the focus of this research were carbon nanotubes (70 projects), nanosilver (60 projects), and nanoscale titanium dioxide (48 projects). Carbon nanotubes are nanoscale cylinders consisting of seamlessly “rolled” sheets of graphene, a form of carbon. They are extraordinarily strong, flexible, lightweight, heat resistant, and have high electrical conductivity. Carbon nanotubes are currently used in a variety of applications including conductive coatings for touchscreens and solar cells, and sporting goods such as bicycle frames and baseball bats. According to a 2009 NIOSH report, carbon nanotubes have been shown to produce adverse effects in the respiratory systems of rats. Nanosilver is a metal-based nanomaterial that, according to a 2010 EPA report, is currently used in an increasing number of consumer and medical products because of its remarkably strong antimicrobial properties. For example, EPA reported that nanosilver is being incorporated into clothing, food contact materials such as packaging and cutting boards, household appliances, cosmetics, and children’s toys. It is also used in industrial processes because of its ability to catalyze many reactions. According to EPA’s 2010 report, there is clear evidence that nanosilver is toxic to aquatic and terrestrial organisms and may be detrimental to human health. In this report, EPA noted that several studies have shown that nanosilver can be released into the wastewater stream during washing, such as from socks containing nanosilver. The nanosilver released may disrupt the helpful bacteria used in wastewater treatment processes or be released into the environment. Nanoscale titanium dioxide is a metal-based nanomaterial used in sunscreens, protective coatings, and other materials to manage heat and light by blocking UV light from the sun’s rays. It is also being added to paints, cements, windows, tiles, and other products for its sterilizing and deodorizing properties and is being used for antifogging coatings and self-cleaning windows. In addition, it is being investigated for use in removing contaminants from drinking water. According to a 2011 NIOSH report, nanoscale titanium dioxide is a potential occupational carcinogen when inhaled. Regarding exposure to this nanomaterial in sunscreens, a 2010 FDA publication found that nanoscale titanium dioxide included in a formulation similar to currently marketed sunscreens is unlikely to significantly penetrate human skin. Particles,” Toxicological Sciences, vol. 115, no. 1 (2010):156-66. Effect of Recent NNI Criteria for Agencies’ Prioritization of Nanomaterials Is Not Yet Clear NNI has not prioritized nanomaterials for EHS research, but the 2011 NNI EHS research strategy outlines criteria to assist its member agencies in doing so. The main criteria NNI proposed are the extent to which (1) study of a particular nanomaterial may provide a major contribution to the research knowledge base, and (2) nanomaterials and nanotechnology- enabled products may pose a safety concern to workers, consumers, and the environment. NNI further identified five criteria for assessing whether a material may pose a safety concern: (1) the nanomaterial’s potential for hazard, (2) likelihood of exposure, (3) high reactivity, (4) biological novelty, and (5) the involvement of the material in an event that produced health or environmental impacts. However, because the criteria were published in October 2011, it is too soon to tell how they will influence NNI member agencies’ decisions about which nanomaterials to prioritize. Furthermore, it is unclear if the information needed to use the NNI criteria is available. As we reported in May 2010, predicting and assessing the potential hazards, exposures, and resulting risks from nanomaterials is difficult, and current understanding of nanomaterial toxicity and exposure is limited. For example, the findings from completed toxicity studies of a nanomaterial constructed in one manner may not be applicable to understanding the risks posed by the same nanomaterial constructed in a different manner and, therefore, studies of similar nanomaterials may not be comparable. Also, according to the NRC’s 2012 draft strategy for nanotechnology EHS research, there is incomplete information on the effects of the array of nanomaterials used in products and a lack of information on effects of chronic exposures. NRC reported that most toxicity studies test a single material and usually focus on effects of acute exposures. In addition, reliable, comprehensive information is not readily available on the likelihood of exposure to nanomaterials. Consumers and workers are more likely to be exposed to nanomaterials that are already produced in large quantities or incorporated into a larger number of products, but information on the prevalence or production volumes of nanomaterials or nanotechnology-enabled products is currently limited. As previously noted in this report, FDA, CPSC, and EPA may not receive complete information on what nanomaterials are already in use in the case of certain products. CPSC officials told us that one way the agency collects information on the use of nanomaterials in products to better understand potential exposures is by purchasing information from commercial vendors. However, we found that obtaining such information from commercial vendors such as market research companies can be costly, and it is difficult to assess the reliability of such research because it can involve data and methods, including modeling based on various assumptions, that may be proprietary. Another source of information on nanomaterials in commerce is the Woodrow Wilson International Center for Scholars’ Project on Emerging Nanotechnologies, which maintains an inventory of nanotechnology- based products. As of the March 2011 update to the list, the inventory contained approximately 1,300 nanotechnology-based products. However, the Wilson Center’s list is not comprehensive, and it consists of consumer products. As we reported in May 2010, occupational exposure is a particular concern because the exposure and risk to workers is potentially greater than the risk to consumers. At present, though, there is little information on the exposure of workers to nanomaterials in the workplace. NNI Member Agencies Have Collaborated Extensively on Nanotechnology EHS Research The NNI member agencies have collaborated extensively with each other and nonfederal stakeholders on EHS research and strategies. The NNI member agencies participated in interagency efforts to develop joint strategies related to EHS research. They have also undertaken over 40 collaborative nanotechnology EHS research projects in recent years, signing agreements with both federal and nonfederal stakeholders. Many of the nonfederal stakeholders responding to our questionnaire rated their collaborative activities with NNI agencies as very or generally useful, although they have identified some challenges. NNI Member Agencies Have Collaborated to Develop Joint Strategies NNI member agencies have collaborated through the NSTC to develop joint EHS research strategies. The NSTC primarily coordinates nanotechnology EHS research through the NSET Subcommittee and the NEHI, an interagency working group. The NEHI’s purpose includes providing for an exchange of information among agencies and with nonfederal stakeholders; facilitating the identification, prioritization, and implementation of nanotechnology EHS research; and managing the EHS interagency research strategy and facilitating its implementation. The 2011 NNI EHS research strategy was developed by NNI member agencies working through the NEHI working group. The strategy sets a common vision for nanotechnology EHS research, EHS research categories and needs, and key principles intended to assist the NNI member agencies make strategic decisions about research programs that will advance the NNI EHS research agenda while meeting their respective missions. According to several NNI member agency officials, individual agencies’ implementation efforts of the 2011 NNI EHS research strategy are discussed at NEHI meetings. However, since the strategy was finalized in October 2011, it is too soon to tell to what extent it will be used to integrate the NNI member agencies’ implementation plans. The 2011 NNI EHS research strategy updated and replaced the 2008 NNI Strategy for Nanotechnology-Related EHS Research, which had established common priority EHS research needs. The 2008 NNI Strategy for Nanotechnology-Related EHS Research was also developed by the NEHI working group and informed by earlier publications of NNI EHS research needs. Officials from five of the NNI member agencies told us that they use the NEHI working group as a forum to collaborate on nanotechnology EHS research projects. For example, CPSC officials told us that they identify agencies with expertise on testing nanomaterials found in consumer products through discussions in the NSET Subcommittee and NEHI working group, which has led to collaborative testing of exposure and release of selected nanomaterials. This collaboration has resulted in data that support the respective missions of the collaborative agencies. Officials from the National Toxicology Program at NIH noted that they selected nanomaterials for study based in part on discussions in the NEHI working group and NNI sponsored workshops. Officials from NIST told us that NNI member agencies are also working through the NEHI working group to develop an inventory of collaborative EHS research activities. Collaborative activities related to EHS research have been reported in the 2011 NNI EHS research strategy and annual NNI Supplements to the President’s Budget. NNI Member Agencies Have Engaged In Numerous Collaborative EHS Research Projects The NNI member agencies have recently initiated numerous nanotechnology EHS research projects in collaboration with other federal agencies and nonfederal stakeholders. We reviewed formal collaborative nanotechnology EHS research projects initiated from February 2008 to October 2011, while the 2008 NNI Strategy for Nanotechnology-Related EHS Research was in effect. The 2008 NNI Strategy for Nanotechnology- Related EHS Research called for the NEHI and the NNI member agencies to coordinate agency efforts to address priority research needs and, among others, identify opportunities for collaboration and joint development and use of resources where appropriate, facilitate partnerships with industry, and coordinate and support international efforts, support development of consensus-based standards, and facilitate wide dissemination of research results and other nonproprietary EHS information. During this period, NNI member agencies initiated 43 formal collaborative projects related to EHS research––24 interagency collaborations and 19 collaborations that included nonfederal stakeholders. Most of the interagency collaborations were among the NNI member agencies included in our review, but a few were with other federal agencies such as the Department of Defense, the Department of Labor’s Occupational Safety and Health Administration, and the Department of Agriculture. Nonfederal stakeholders included foreign governments, such as the United Kingdom (UK) and China; universities, such as the University of Massachusetts, Lowell and Rice University; and NGOs, such as the International Alliance for NanoEHS Harmonization (IANH) and the International Life Sciences Institute Research Foundation. NNI member agencies used these collaborative projects to extend their capability to achieve their individual missions. For example, CPSC collaborated with four agencies to conduct research on nanomaterials found in consumer products. NIOSH, an agency within the Centers for Disease Control and Prevention that conducts research and makes recommendations for the prevention of work-related injury and illness, partnered with entities that operate nanomanufacturing facilities to better understand the potential for occupational exposure to nanomaterials. NIST, which aims to advance measurement science, standards, and technology, signed an agreement with the IANH to jointly create protocols for toxicological tests of selected representative nanoparticles, confirming inter-laboratory reproducibility and verifying the predictability of certain procedures. Collaborative EHS research projects have resulted in transfers of funding as well as sharing of expertise, facilities, and other resources, as shown in the following examples: An interagency agreement between CPSC and NIOSH to study the pulmonary effects of titanium dioxide nanoparticles released from aerosol spray products involved CPSC providing the product to be tested and transferring funding to NIOSH to construct the testing equipment, with NIOSH providing expertise and staff time to run the tests and produce a report. An agreement among the NIH’s National Cancer Institute, the National Institute of Environmental Health Sciences (NIEHS), and the National Institute of Biomedical Imaging and Bioengineering to develop, maintain, and operate a web-based nanomaterial registry specified that the National Institute of Biomedical Imaging and Bioengineering will develop the registry to provide consistent and curated information on the biological and environmental interactions of well-characterized nanomaterials, as well as links to associated publications, modeling tools, computational results, and manufacturing guidance from existing databases. The National Cancer Institute and the NIEHS provided funding. NIEHS also committed to provide input to the constitution of an advisory board and attend its meetings, as well as be represented in the nano registry project management team. Agencies have also issued joint solicitations for grant applications, such as one between EPA and a number of UK agencies to solicit proposals for research on environmental and health implications of nanotechnology. EPA and the UK agencies signed an agreement that notes (1) the funding of grants will be made consistent with the budget priorities of each party and (2) they are to work jointly to define the scientific priorities, issue the request, assist with peer review and selection of grantees, and disseminate the research results. Details on these and other collaborative EHS research projects are provided in appendix II. Nonfederal Stakeholders We Surveyed Benefited from NNI Collaboration but Identified Some Challenges The 138 nonfederal stakeholders who responded to our questionnaire reported that they benefited from collaboration with NNI member agencies but faced some challenges. Most respondents indicated that the 2011 NNI EHS research strategy was very or somewhat effective at addressing the EHS research needs. Respondents reported that they also obtained information on nanotechnology EHS risks from NNI member agencies and nongovernmental sources. The following three formal mechanisms for collaboration with NNI member agencies were most frequently identified by respondents as generally or very useful to them: (1) joint data gathering and sharing; (2) joint research solicitations or funding of research consortia; and (3) competitive grants. See figure 6 for respondents’ ratings of seven formal collaborative mechanisms we identified for them to rate. Some respondents who provided comments in response to optional open-ended questions also identified public-private partnerships, such as joint academic, government, and industry information exchange and research programs, as collaboration mechanisms the NNI member agencies should consider. A few respondents who commented in response to optional open-ended questions also cited benefits to informal collaboration with NNI agencies, such as discussions during workshops and conferences. Since both the 2011 NNI EHS research strategy and its predecessor, the 2008 NNI Strategy for Nanotechnology-Related EHS Research, called for partnerships with industry and other nonfederal stakeholders, we included questions about collaboration with NNI member agencies in our questionnaire. When asked about the usefulness of their collaboration with the NNI member agencies, more than half of respondents rated their collaborative EHS research or related activities for each of the NNI member agencies as generally or very useful, as seen in figure 7. Stakeholders responding to our questionnaire indicated that certain challenges to collaboration with NNI member agencies we identified on EHS research apply to them. As seen in figure 8, more than two-thirds of those who rated the challenge of lack of funding and the challenge of limited awareness of collaboration opportunities indicated that each of these challenges apply to them. This is consistent with what we heard from representatives of a nanotechnology trade association and an NGO, who stated that there is limited funding for corporate EHS research and development efforts because they do not generate revenues. Some respondents who provided comments in response to optional open-ended questions stated that the private sector needs government funding for EHS research. A number of respondents also commented that government funding for EHS research was inadequate or an “after- thought” to other purposes. Some respondents also commented that funding seems to be targeted toward large, multiyear centers rather than smaller targeted projects that can help address near-term EHS needs. More than half of those responding noted that each of the challenges of regulatory uncertainty, lack of standardization—such as different terminology or protocols—and concerns regarding disclosure of proprietary or confidential business information, apply to them. Some respondents cited regulatory uncertainty—that is, lack of a clear regulatory environment to enable commercialization and protect consumers and the general public—as a challenge to collaboration with their work with NNI member agencies on nanotechnology EHS research. For example, a number of respondents who provided comments in response to optional open-ended questions pointed to regulatory uncertainty as limiting the ability of companies to determine their EHS responsibilities. Some respondents also commented on difficulties in collaborating with NNI member agencies resulting from differences in expertise and regulatory approaches across different government agencies or even within the same agency. With regard to lack of standardization as a challenge to collaboration on nanotechnology EHS research, some respondents provided examples related to the lack of scientific consensus on the definition of nanomaterials, the testing methods for toxicology research, and common terminology across research and regulatory agencies. When asked to rate the effectiveness of mechanisms we identified that NNI member agencies can use for obtaining input from nonfederal stakeholders on the development of the NNI EHS research strategies, respondents most frequently identified the following three mechanisms as being used somewhat effectively or effectively: (1) workshops, conferences, and other public speaking engagements; (2) advisory councils; and (3) the NNI web portal. When asked to rate the 2011 NNI EHS research strategy, most of those responding rated this strategy as somewhat or very effective at addressing nanotechnology EHS research needs. As seen in figure 10, while just over half of those responding to these questions indicated the 2008 NNI Strategy for Nanotechnology-Related EHS Research addressed these needs somewhat or very effectively, 79 out of 98 indicated the 2011 NNI EHS research strategy addressed these needs somewhat or very effectively. Some of the respondents who commented in response to optional open-ended questions commended the 2011 NNI EHS research strategy for accurately capturing the input of the workshops’ participants and summarizing the research needs, but others pointed to shortcomings, including a lack of prioritization and insufficient focus on implementation. For example, one respondent commented that the strategy would only be effective if it was implemented, and that it may not be sufficient to rely on the agencies’ voluntary implementation efforts. Additionally, respondents identified various sources, including the NNI member agencies, from which they obtained information on the potential EHS risks of nanotechnology. When asked to estimate the frequency with which they obtained nanotechnology EHS information from NNI member agencies in recent years, respondents reported obtaining information from the NNI member agencies in varying frequencies. More than half of the respondents to these questions reported occasionally or often obtaining information from EPA and NIOSH, as seen in figure 11. The 2011 NNI strategic plan calls for providing a “one-stop” Internet- based portal for nanotechnology information, including, among other things, scientific data such as characterization and toxicity measurements. About 80 percent of the 131 stakeholders responding to a question about how useful such a portal would be indicated that an Internet-based portal for nanotechnology EHS information would be generally or very useful to them. The NNI does not currently provide a portal that contains this information, but an NNCO official told us that the NNCO is implementing a web-based map that identifies the instrumentation and facilities for nanotechnology research at major universities and centers in the U.S. and federal labs. When asked to rate the frequency with which they obtained information on the potential EHS risks of nanotechnology from nongovernmental sources, as seen in figure 12, more than two-thirds of respondents reported that they occasionally or often obtained information from each of the following four sources: (1) peer-reviewed scientific publications; (2) in- house research; (3) online databases; and (4) news outlets. NNI Strategy Documents Address or Partially Address Desirable Characteristics of National Strategies NNI strategy documents address two and partially address four of the six desirable characteristics of effective national strategies that we identified in prior work and that offer policymakers and implementing agencies a management tool that can help ensure accountability and more effective results. The three NNI strategy documents––the 2011 NNI strategic plan, the 2011 NNI EHS research strategy, and the NNI Supplement to the President’s 2012 Budget––compose a national strategy for nanotechnology EHS research and create a framework for achieving NNI program goals and priorities. We rated the NNI strategy documents to determine how well they jointly addressed the six characteristics that we have identified for effective national strategies, as described in table 3. Ideally, effective national strategies should fully address all of these characteristics. However, we recognize that by their nature, national strategies are intended to provide broad direction and guidance—rather than be prescriptive, detailed mandates—to the relevant implementing agencies. Thus it is unrealistic to expect all national strategies to provide details on each and every characteristic we identified. Moreover, the NNI member agencies have different statutory authority and functions that may significantly affect their research and research priorities. Nonetheless, we believe the more detail a strategy provides, the easier it is for the responsible parties to implement it and achieve its goals. We reviewed the three NNI strategy documents for elements related to these characteristics, and based on the inclusion of these elements, rated how well the strategic documents address the six characteristics. According to our methodology, the strategy documents “address” a characteristic when they explicitly include all, or nearly all, elements of the characteristic and have sufficient specificity and detail. The documents “partially address” a characteristic when they include some or most of the elements of the characteristic with sufficient specificity and detail. The documents “do not address” a characteristic when they do not include any elements of a characteristic or references are too vague or general to be useful. Additional details about our ratings and the elements that make up these characteristics are available in appendix I. As described in table 4, we found, when reviewed as a whole, that the strategy documents address or partially address all of the desirable characteristics of a national strategy. Taken as a whole, the NNI strategy documents address the first two characteristics—purpose, scope, and methodology and problem definition and risk assessment—by including all, or nearly all, of their elements. These characteristics describe the scope of the strategy, describe how and why it was produced, define the problems the strategy intends to address, discuss causes and the operating environment, and provide a risk assessment or broad description of potential risks. Elements of these characteristics that are included in the documents are providing a clear statement of purpose, defining key terms, delineating what major functions or mission areas are covered, discussing problems with the current understanding of EHS implications of nanotechnology, and the quality of currently available data, among others. Goals, Subordinate Objectives, Activities, and Performance Measures (Desirable Characteristic 3) The NNI strategy documents partially address the third characteristic regarding goals, subordinate objectives, activities, and performance measures. This characteristic describes the overall desired results, hierarchy of strategic goals and subordinate objectives, priorities, milestones, outcome-related performance measures, and process for monitoring and reporting on progress, among others. The NNI strategy documents include a number of elements such as desired results, strategic goals, and subordinate objectives, but do not include, or do not fully develop, other elements such as priorities, milestones, or outcome- related performance measures. Performance information—such as outcome-related performance measures and milestones comprised of targets and time frames for meeting those measures—allows managers to identify performance problems and develop approaches that improve results. For the purposes of this report, we define performance information to mean data collected to measure progress toward achieving an established goal. A wide range of information can be relevant to program performance. Performance information can focus on various dimensions of performance such as outcomes, outputs, quality, timeliness, customer satisfaction, or efficiency. It can inform key management decisions such as setting program priorities, allocating resources, identifying program problems, and taking corrective action to solve those problems; or it can help determine progress in meeting the goals of programs or operations. The NNI strategy documents contain detailed research needs for nanotechnology EHS and report the annual funding of EHS research and the number of projects supported for selected years, but the documents do not prioritize among these needs or include outcome-related performance measures, targets, or time frames that allow for monitoring and reporting on progress toward meeting the research needs. Independent reviews of the prior NNI strategy documents also noted an absence of performance information. In 2010, the National Nanotechnology Advisory Panel recommended that the NNCO monitor metrics that assess, among other things, the NNI’s progress on developing methodologies to assess plausible risks of nanotechnology. The advisory panel also recommended that the NEHI working group develop and implement a strategy that links EHS research activities with knowledge gaps and decision-making needs. The 2009 NRC review concluded that the 2008 NNI Strategy for Nanotechnology-Related EHS Research could be an effective tool, but did not include a number of elements, including measures of research progress. We previously reported that, ideally, a national strategy would set clear desired results and priorities, outcome-related performance measures, and specific milestones while giving implementing parties flexibility to pursue and achieve those results within a reasonable time frame. The NNI strategy documents give agencies wide latitude to develop research programs to meet the goals and research needs of the NNI, but we found that NNI member agencies vary in their identification and reporting of agency-specific performance information for nanotechnology EHS research that could align with the NNI research needs. The 2011 NNI EHS research strategy states that prioritization, timing, and staging of the research needs identified by the strategy are components of an implementation plan and should be developed within agency missions and appropriations. Similarly, the 2011 NNI strategic plan states that the document serves as a guide for individual agency implementation. Six of the seven NNI agencies we reviewed have documented performance measures, targets, or time frames for their EHS research. Three of the NNI member agencies—CPSC, FDA, and NIH—annually report EHS- related performance information through their publicly available annual performance reports. Three other NNI member agencies—EPA, NIOSH, and NIST—identify strategic goals and performance measures and targets in their program-level nanotechnology EHS strategies, but have not collected, or have not publically reported results of these performance measures. NIOSH has previously published research summaries in its nanotechnology research progress reports. NIOSH officials told us that a forthcoming progress report will also document the results of performance measures identified in their nanotechnology EHS strategy. NSF reports planned EHS research activities as part of its annual budget request, but does not identify performance targets or measures for its nanotechnology EHS research beyond funding requested. According to an NNCO official, the NEHI working group is piloting an effort to gather information from the NNI member agencies to assess high-level progress toward meeting NNI research needs, but has not released the results of this work. Resources, Investments, and Risk Management and Organizational Roles, Responsibilities, and Coordination (Desirable Characteristics 4 and 5) The NNI strategy documents partially address the fourth and fifth characteristics describing resources, investments, and risk management and organizational roles, responsibilities, and coordination. We found that the documents include some, but not all, of the elements of these characteristics. With respect to the fourth characteristic, we found that the documents include elements relating to agency resources associated with the strategy such as descriptions of current activities of NNI member agencies and current investment levels. However, we found that the documents do not include, or do not fully develop, other elements such as the costs and types of resources—for example human capital or research and development costs—associated with implementing the strategy. An NNCO official told us that the NNI does not analyze the costs of resources to meet the EHS research needs because it does not control the funding for member agencies, and that each agency allocates funding and prioritizes its activities based on its mission area and available budget. According to this official, the 2011 NNI EHS research strategy identifies research goals, but it is up to the agencies to determine how their funding should be spent. Similarly, a NIST official told us that the NNI cannot dictate to agencies how or what research to fund. With respect to the fifth characteristic pertaining to organizational roles, responsibilities, and coordination, we found that the documents include elements such as lead, support, and partner roles for agencies and processes for coordination and collaboration, but do not include, or do not fully develop, other elements such as an accountability and oversight framework. The strategy documents include detailed descriptions of the NNI structure, describe coordination mechanisms such as the NEHI working group, and provide examples of collaborative activities related to EHS research. As we reported above, we found that NNI member agencies have engaged in numerous collaborative projects with federal and nonfederal partners and nonfederal partners generally rated these collaborations as generally or very useful. However, the strategy documents do not provide details on oversight of agency roles or how agencies will be held accountable to the goals and research needs of the NNI strategy documents. Integration and Implementation (Desirable Characteristic 6) The NNI strategy documents also partially address the sixth characteristic describing integration and implementation. This characteristic describes how the national strategy documents relate to subordinate levels of government and their plans to implement the strategy. As we have previously reported, to achieve a common outcome, collaborating agencies need to establish strategies that work in concert with those of their partners or are joint in nature. We found that the NNI strategy documents include limited information regarding the elements of this characteristic. For example, the 2011 NNI EHS research strategy describes a framework for implementation, but does not provide detailed implementation guidance. In addition, we found that the NNI strategy documents generally do not include information on the NNI member agencies’ nanotechnology EHS strategies or plans or their integration with the national strategy. Five of the seven NNI member agencies we reviewed have developed such agency-level nanotechnology EHS research strategies. As noted above, EPA, NIOSH, and NIST have developed strategic plans specifically for EHS research. In addition, FDA has published a strategic plan for its regulatory science research efforts, which include nanotechnology, and developed a research plan specifically targeting Furthermore, NSF officials told us that the agency nanotechnology. describes its strategic direction for nanotechnology, including current and proposed activities and funding by PCA, in its annual budget request.CPSC includes nanotechnology as an external risk factor for its agencywide strategic plan, but the plan does not address EHS research directly. NIH officials told us they do not have agency or institute-specific strategic plans that specifically address nanotechnology EHS research, but nanotechnology EHS research plans developed by its institutes conform to the NNI strategy. Of the five agencies with nanotechnology EHS-related strategies, two—FDA and NIOSH—explicitly align agency research goals in their strategic plans for nanotechnology to NNI EHS research needs. The FDA and NIOSH strategic plans describe the agencies’ EHS research goals, their framework for meeting those goals, and which NNI EHS research needs will be advanced. NIST’s Nano-EHS program plan, EPA’s Nanomaterial Research Strategy, and NSF’s budget request to Congress describe agency research objectives. The documents do not explicitly identify NNI research needs; however, agency officials told us that they reflect the NNI strategic documents. The 2011 NNI strategic plan reports that NNI member agencies have initiated a mapping exercise to evaluate how this strategic plan relates to NNI member agencies’ strategic plans and to the priorities of the administration. In addition, according to NNI member agency officials, individual agencies’ implementation efforts of the 2011 NNI EHS research strategy are discussed at NEHI meetings. However, the results of this mapping exercise and proceedings of the NEHI are not publically available. Conclusion The increasing commercialization of nanotechnology-enabled products and information gaps related to nanotechnology EHS impacts underscore the importance of ensuring progress toward meeting EHS strategic goals and research needs. The NNI strategy documents help shape the policies, programs, priorities, resource allocations, and standards related to nanotechnology EHS research and activities. The NNI strategy documents address or partially address the desirable characteristics of effective national strategies, including overarching strategic goals and objectives such as the EHS research needs. However, the documents do not include some elements of the characteristics, which could make it more difficult for federal agencies and other stakeholders to implement the strategy and achieve the identified results. For example, progress toward achieving the strategy documents’ goals and research needs cannot be tracked because the NNI does not report specific performance information, such as performance measures, targets, or time frames. In addition, the NNI strategy documents do not include estimates of the costs and types of resources associated with these goals and research needs. Developing and coordinating performance information and cost estimates for the NNI’s nanotechnology EHS research may be challenging because of the varied missions and priorities of the NNI member agencies. However, not having performance information that is aligned with the strategic goals and research needs of the NNI makes it difficult for agencies, policymakers, and stakeholders to determine the collective progress of the national nanotechnology program. Furthermore, developing performance information and including it in NNI strategy documents could help to strengthen two other desirable characteristics that the documents partially address. Specifically, this information could also support an accountability and oversight framework—that is currently not well-developed—by linking agency activities to specific measures of performance and creating consistent benchmarks to judge the overall progress of the NNI member agencies. In addition, developing this information could facilitate better integration between the NNI strategy documents and the NNI member agencies’ nanotechnology EHS research strategies and goals. Providing cost estimates related to the NNI EHS research needs would allow the NNI member agencies, policymakers, and stakeholders to assess if investments are commensurate with costs of the identified needs. The NSTC, which is administered by the OSTP, does not direct funding to meet the NNI research needs; however, rough estimates of their costs could serve as guidance to the NNI member agencies as they individually determine their own budgets and priorities. In addition, the NSTC is well-positioned to develop these estimates due to its coordinating role across the member agencies of the NNI and corresponding access to expertise at these agencies. Developing performance information and cost estimates could also support the analysis of the progress made toward achieving the goals and priorities established for the program, as required by the 21st Century Nanotechnology Research and Development Act. In addition, we are reiterating our 2008 recommendation that the Director of OSTP, in consultation with the Directors of the NNCO and OMB, provide better guidance to agencies on how to report their nanotechnology EHS research. The continued absence of detailed guidance on how to report research under PCA 7 has contributed to the data reporting problems we identified. Therefore, agencies, policymakers, and stakeholders do not have access to accurate, consistent, and complete data on the federal government’s investment in nanotechnology EHS research. Without reliable and up-to-date data, it will be difficult for agencies to accurately assess and report their progress toward their own performance measures, as well as the EHS research goals and needs identified in the 2011 NNI EHS research strategy. Recommendations for Executive Action To better offer policymakers and implementing agencies a management tool that can help ensure accountability and more effective results, we are making two recommendations to the Director of OSTP: We recommend that the Director of OSTP coordinate development by the NNI member agencies of performance measures, targets, and time frames for nanotechnology EHS research that align with the research needs of the NNI, consistent with the agencies’ respective statutory authorities, and include this information in publicly available reports. We also recommend that, to the extent possible, the Director of OSTP coordinate the development by the NNI member agencies of estimates of the costs and types of resources necessary to meet the EHS research needs. Agency Comments and Our Evaluation We provided a draft of this report to the Director, OSTP; Secretary, Commerce; Chairman, CPSC; Administrator, EPA; Secretary, Health and Human Services; and Director, NSF. OSTP and the agencies neither agreed nor disagreed with the recommendations. OSTP and Health and Human Services provided technical and clarifying comments, which we incorporated as appropriate. The Department of Commerce, CPSC, EPA, and NSF indicated they had no comments on the report. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the Director, OSTP; Secretary, Commerce; Chairman, CPSC; Administrator, EPA; Secretary, Health and Human Services; Director, NSF; and other interested parties. The report also will be available at no charge on the GAO website at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-3841 or ruscof@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III. Appendix I: Objectives, Scope, and Methodology Our review examines (1) changes in federal funding for nanotechnology environmental, health, and safety (EHS) research from fiscal years 2006 to 2010; (2) the nanomaterials that National Nanotechnology Initiative (NNI) member agencies focused on in their EHS research in fiscal year 2010; (3) the extent to which NNI member agencies collaborate with stakeholders on nanotechnology EHS research and related strategies; and (4) the extent to which NNI strategy documents address desirable characteristics of national strategies. To conduct this work, we reviewed EHS research efforts funded by seven NNI member agencies, which collectively funded 93 percent of EHS research dollars in fiscal year 2010: the National Science Foundation (NSF), National Institutes of Health (NIH), Environmental Protection Agency (EPA), National Institute for Occupational Safety and Health (NIOSH), Food and Drug Administration (FDA), National Institute of Standards and Technology (NIST), and the Consumer Product Safety Commission (CPSC). The first six of these agencies represent the top six providers of EHS research funding from fiscal year 2006 to fiscal year 2010, and CPSC has an important role in ensuring the safe use of nanotechnology in consumer products. To examine recent changes in federal funding for nanotechnology EHS research, we reviewed information published by the National Science and Technology Council (NSTC) in the NNI Supplements to the President’s Budget. Specifically, we reviewed the actual agency investments reported in each program component area for fiscal years 2006 through 2010 for all NNI member agencies funding nanotechnology research. For the dollar amounts that we adjusted for inflation, we used the Biomedical Research and Development Price Index to report funding in constant 2010 dollars. We consulted with the Office of Management and Budget (OMB) and officials at the seven selected agencies to determine the type of budget information reported as actual agency investments in these documents. For fiscal year 2010, the most recent year for which actual agency investment data were available, we also collected quantitative and qualitative project-level data (such as project funding amounts and project abstracts or progress reports) on all research projects that the seven selected agencies had categorized as Program Component Area (PCA) 7 (EHS research). The agencies do not report project-level data to OMB annually but report their total EHS research funding to OMB annually for inclusion in the NNI budget supplements published by NSTC. Therefore, we reviewed data on the individual projects included in the agencies’ total EHS research funding in 2010. We provided the agencies with a spreadsheet template to use in listing their projects, which we based on the spreadsheet OMB had used in its data calls to collect project-level data from agencies on their 2006 and 2009 EHS research projects. Consistent with the approach used in OMB’s data calls, we did not ask the agencies to use a standardized definition of what constitutes a “project;” instead, we deferred to each agency to identify their projects and consulted with agency officials as needed. For some projects at NIH, NIOSH, and NIST, we grouped together some of the agencies’ data entries and counted them together for the purposes of our analyses. Consequently, the numbers of projects we are reporting may not match the number reported by these agencies elsewhere. Specifically, for NIH, we grouped the 14 supplement grants together with their main grants and counted each of those groups as a single project. We also grouped together the individual subprojects of each of NIH’s multiproject “parent” grants reported as EHS and counted each of those groups as a single project, for a total of seven groups of multiproject grants. In addition, we grouped together two grants made by different NIH institutes for the same project. For NIOSH, we identified two project entries with identical project descriptions. After consulting with NIOSH officials, we grouped those two entries together and counted them as a single project. For NIST, the agency reported a separate entry for each of its Project Tracking Numbers and explained that a single technical project is often associated with more than one Project Tracking Number. NIST officials instructed us to group together the entries with identical titles and count each of those groups as a single project. To assess the reliability of the agencies’ fiscal year 2010 data, we sent each of the seven selected agencies a set of questions regarding the data and the information systems used to produce and store them. We also reviewed related supporting documentation, such as user manuals and data dictionaries for information systems, and, for some projects, copies of the associated interagency agreements. We examined the data for obvious errors, compared each agency’s total fiscal year 2010 PCA 7 funding reported to us to the totals reported in the NNI Supplement to the President’s 2012 Budget, and consulted with agency officials to understand the reasons for any differences. We determined that the data were sufficiently reliable for the purposes of our analyses. However, we did not attempt to verify the funding amounts reported for each project— for example, by reviewing documentation of agencies’ actual expenditures for each project. We reviewed the qualitative project data, including abstracts and project reports, to assess whether the agencies had appropriately categorized the research projects they reported as EHS research—that is, whether the projects met the definition of program component area (PCA) 7. As described in this report, the definition of PCA 7—research primarily directed at understanding the EHS impacts of nanotechnology development and corresponding risk assessment, risk management, and methods for risk mitigation—is the only written guidance available to agencies on how to report their nanotechnology research in this program component area. Determining whether research meets this definition is an inherently subjective process. Therefore, rather than definitively conclude that any projects did not meet the definition, we assigned projects a designation of “not clearly PCA 7” if we were ultimately unable to identify any EHS research, or it was not clear that EHS was the primary focus of the research. For example, some projects studied various nanotechnology-enabled drugs, but it was not clear to what extent the research was directed at the safety of the drugs versus their efficacy. Some other projects appeared to be closely related to program component areas other than PCA 7, such as PCA 4 (instrumentation research, metrology, and standards for nanotechnology) or PCA 8 (education and societal dimensions), and it was not clear that PCA 7 was the most appropriate category. To minimize bias and to ensure the consistency of our evaluation, two analysts independently analyzed the project data and used their professional judgment to assess whether each project met the PCA 7 definition. The two analysts discussed those projects where they did not agree on whether the research was primarily directed at EHS and reached agreement. For categorization of projects that appeared questionable to us, we generally asked agencies to explain why they had reported those projects as EHS research. We reviewed agencies’ responses and modified our determinations for projects as appropriate given the additional support provided by the agencies. For two projects funded by NIST and 18 by NSF, the agencies had reported only a portion of the total project funding under PCA 7. In those instances, we assessed whether at least some of the project was primarily directed at EHS. However, we did not verify that the funding amounts reported as EHS research were correct because that information is, according to these agencies’ officials, based on the discretion of the knowledgeable agency program staff. We also reviewed our 2008 report in this area, which found that 22 of 119 fiscal year 2006 projects reported as EHS research were miscategorized, and recommended that the Director of the Office of Science and Technology Policy (OSTP), in consultation with the Directors of the National Nanotechnology Coordinating Office and OMB, provide better guidance to agencies on how to report nanotechnology EHS research. GAO, Nanotechnology: Better Guidance Is Needed to Ensure Accurate Reporting of Federal Research Focused on Environmental, Health, and Safety Risks, GAO-08-402 (Washington, D.C.: Mar. 31, 2008). experience in nanotechnology helped identify the categories we used and verified that the materials were placed in the appropriate categories for each project. After reviewing the fiscal year 2010 EHS research by the selected agencies, we selected the five categories of nanomaterials we used, based on the primary composition of the materials, to encompass the range of materials identified in the projects. To inform our selection of the categories we used for grouping nanomaterials, we reviewed literature related to nanotechnology EHS issues from federal agencies (NIH and EPA), nonprofit organizations (the Woodrow Wilson International Center for Scholars’ Project on Emerging Nanotechnologies and the World Technology Evaluation Center, Inc.), and a market research firm that tracks nanotechnology (Lux Research). We found that various classes or categories were used to present information on nanomaterials. For materials identified as composites, we assigned them to categories based on the primary nanomaterials from which they were formed—for example, we assigned carbon nanotube nanocomposites to the carbon-based nanomaterials category. To determine the extent to which the NNI member agencies collaborate with stakeholders on nanotechnology EHS research and related strategies, we (1) discussed with agency officials how their agencies collaborate on nanotechnology EHS research and NNI’s role in facilitating that collaboration, and (2) we obtained documentation on these collaborative efforts. We conducted a review of formal collaborative efforts (i.e., those that are documented in written agreements) that focused on nanotechnology EHS research initiated from February 2008 to October 2011 while the 2008 NNI Strategy for Nanotechnology-Related EHS Research was in effect. We chose this time frame because this strategy—the first NNI strategy to focus on EHS research—established collaboration as necessary for its implementation efforts. The strategy was in effect for a number of years, which allowed us to get a more complete picture of the number of collaborative projects completed during its implementation. We only included collaborative efforts that were formalized by written agreements because those provided a clearer description of the agencies’ contributions of resources. We obtained an initial list of such efforts from published NNI sources as well as an OMB data call used to compile EHS-related nanotechnology projects for the 2011 NNI EHS research strategy. We sent our initial list to the selected NNI agencies for their review and revision, and analyzed supporting documents provided by the agencies. We provide relevant information from the supporting documents for each of the projects within our scope in appendix II. We administered a web-based questionnaire to a nonprobability sample of nonfederal stakeholders, including those affiliated with academia, companies, nongovernmental organizations (NGO), and state and local governments, to obtain their views on collaboration with the NNI member agencies on EHS research and the EHS research strategies. Because the population of nonfederal stakeholders is diverse, wide-ranging, and difficult to reliably define, we chose to use a nonprobability sample of individuals who (1) had expertise in the field of nanotechnology, and (2) had interacted with the NNI in the past few years, or who were representatives of organizations and companies suggested to us through our scoping interviews. We identified relevant potential respondents from several sources, including the list of participants in NNI workshops that were used to solicit input for the 2011 NNI EHS research strategy and participants in a review of the NNI by the President’s Council of Advisors on Science and Technology. We also included members of nanotechnology-related trade associations and other organizations through interviews with nanotechnology experts using an iterative process, often referred to as “snowball sampling.” We excluded federal employees and contractors, individuals or organizations that are not located in the United States, and those for whom we could not obtain contact information. In addition, individuals who were not considered to have expertise in the nanotechnology field based on their job titles were excluded.chosen as potential respondents. Of these 228 individuals, five subsequently were excluded from our sample because they had invalid e- mail addresses, were duplicates, or were not available for an extended period, giving us a final sample of 223 potential respondents. We categorized the population surveyed by affiliation type, usually based on information provided on each entity’s website, as follows: (1) “academic,” which includes universities or university-affiliated programs or centers; (2) “company,” which includes companies, corporations, or other for-profit entities whose primary purpose is to sell products, services, or information; (3) “organization,” which includes NGOs or other entities whose primary purpose is public interest or mutual benefit; and (4) “state and local government.” These sources provided us with a list of 228 stakeholders The questions included in the questionnaire were developed using issues raised in our scoping interviews and background literature search. Most of our questions provided respondents with answer options identified through our interviews and background literature searches. In certain cases, we also provided respondents with an “other” category which allowed them to write in additional responses we did not identify. However, because few respondents chose this option, we presented only some of these responses as illustrative examples. The questionnaire went through internal reviews, including independent GAO survey experts, as well as four pretests with two stakeholders who work for companies, one academic, and one stakeholder from an NGO. We chose the pretesters to reflect the diversity of affiliations of the nanotechnology experts included among our respondents. We revised and clarified the questions and introductory material to the questionnaire based on comments obtained in the internal reviews and from the pretesters. We administered the questionnaire through a secure server. When we completed the final survey questions and format, we sent an e-mail announcement of the questionnaire to the nonfederal stakeholders in our sample on September 23, 2011. Stakeholders were notified that the questionnaire was available online and were given unique passwords and user names on October 11, 2011. We sent follow-up e-mail messages on October 18, 2011, October 25, 2011, and November 2, 2011 to those who had not yet responded. Then we contacted all nonrespondents by telephone, starting on October 21, 2011. The questionnaire was available online until December 6, 2011. Because this was not a sample survey, it has no sampling errors. However, the practical difficulties of conducting any survey may introduce errors, commonly referred to as nonsampling errors. For example, difficulties in interpreting a particular question, sources of information available to respondents, or entering data into a database or analyzing them can introduce unwanted variability into the survey results. We took steps in developing the questionnaire, collecting the data, and analyzing them to minimize such nonsampling errors. For example, we worked with social science survey specialists to design the questionnaire. We pretested the draft questionnaire with four nonfederal stakeholders to ensure that the questions were relevant, clearly stated, and easy to understand. When we analyzed the data, an independent analyst checked all computer programs. Since this was a web-based questionnaire, respondents entered their answers directly into the electronic questionnaire, eliminating the need to key data into a database, minimizing error. Of the 223 potential respondents, 138 completed the questionnaire during our time frame, for an overall response rate of about 62 percent. The numbers responding by affiliation type as categorized by us were (1) “academic”—42 out of 62; (2) “company”—65 out of 114; (3) “organization”—24 out of 39; and (4) “state and local government”— 7 out of 8. To determine the extent the NNI strategy documents address desirable characteristics of national strategies, we compared three key NNI strategic documents against criteria for desirable characteristics of national strategies. Prior GAO reports have identified six desirable characteristics for national strategy documents that would help shape the policies, programs, priorities, resource allocations, and standards that would enable federal agencies and other stakeholders to implement the strategies and achieve the identified results. National strategies that address these characteristics offer policymakers and implementing agencies a management tool that can help ensure accountability and more effective results. Table 5 provides the desirable characteristics and the elements we looked for. To assess whether the documents addressed these desirable characteristics, two analysts independently reviewed the three NNI strategy documents for the elements of each characteristic. We examined the documents for inclusion of each element and for sufficient specificity and detail. The two analysts compared their assessments, discussed any discrepancies, and agreed upon a determination for each element. Each characteristic was then given a rating of “address,” “partially address,” or “does not address.” According to our methodology, the strategy documents “address” a characteristic when it explicitly includes all, or nearly all, elements of the characteristic and has sufficient specificity and detail. The documents “partially address” a characteristic when it includes some or most of the elements with sufficient specificity and detail. The “partially address” category includes a range that varies from explicitly including most of the elements to including as few as one of the elements of a characteristic. A strategy “does not address” a characteristic when it does not include any elements of a characteristic or references are too vague or general to be useful. Because the three NNI documents have different purposes and audiences, an individual document need not address each element of each desirable national strategy characteristic. Therefore, we reviewed the three NNI strategy documents as a whole. In the case of the 2011 NNI strategic plan and Supplement to the President’s 2012 Budget, we focused on sections related to EHS research, where applicable. We identified agency documents related to nanotechnology EHS research strategies and performance. Documents were identified based on interviews with agency officials, review of agency websites, and a data collection instrument sent to agencies requesting any documentation related to the planning or performance of their nanotechnology EHS research programs. In order to assess the extent of linkage between agencies’ nanotechnology EHS research and national priorities of the NNI, we evaluated agency management documents for explicit referrals to NNI activities or guidance, including strategic documents such as the NNI strategic plan or EHS research strategy, or activities of the NNI’s planning and coordinating bodies. We also reviewed agencies’ Performance Reports in order to assess agencies' use of performance information related to nanotechnology EHS research efforts. We conducted this performance audit from February 2011 through May 2012 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Collaborative Nanotechnology Environmental, Health, and Safety Research Agreements Table 6 identifies collaborative nanotechnology EHS research project agreements initiated by the NNI member agencies included in our review from February 2008 to October 2011. The table identifies only those projects specifically focused on nanotechnology. All the information in the table is based on the written agreements, which were provided by NNI member agencies’ officials. Appendix III: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Dan Haas (Assistant Director), Krista Anderson, Nirmal Chaudhary, Elizabeth Curda, Lorraine Ettaro, Alison O’Neill, Tind Shepper Ryen, Jeanette Soares, Ruth Solomon, Hai Tran, and Jack Wang made key contributions to this report.

Nanotechnology involves the ability to control matter at approximately 1 to 100 nanometers. Worldwide trends suggest that products that rely on nanotechnology will be a $3 trillion market by 2020. However, some of the EHS impacts of nanotechnology are unknown. The NSTC coordinates and oversees the NNI, an interagency program that, among other things, develops national strategy documents for federal efforts in nanotechnology. In this context, GAO examined: (1) changes in federal funding for nanotechnology EHS research from fiscal years 2006 to 2010; (2) the nanomaterials that NNI member agencies’ EHS research focused on in fiscal year 2010; (3) the extent to which NNI member agencies collaborate with stakeholders on this research and related strategies; and (4) the extent to which NNI strategy documents address desirable characteristics of national strategies. GAO’s review included seven NNI agencies that funded 93 percent of the EHS research dollars in fiscal year 2010. This report is based on analysis of NNI and agency documents and responses to a questionnaire of nonfederal stakeholders. From fiscal years 2006 to 2010, the National Science and Technology Council (NSTC) reported more than a doubling of National Nanotechnology Initiative (NNI) member agencies’ funding for nanotechnology environmental, health, and safety (EHS) research––from approximately $38 million to $90 million. Reported EHS research funding also rose as a percentage of total nanotechnology funding over the same period, ending at about 5 percent in 2010. However, GAO identified several reporting problems that raise concerns about the quality of EHS funding data reported. For example, for 18 percent of the 2010 projects GAO reviewed that were reported as EHS research, it was not clear that the projects were primarily directed at EHS risks. In addition, NNI member agencies did not always report funding using comparable data. The absence of detailed guidance on how agencies should report funding for their nanotechnology research has contributed to these problems, as GAO also reported in 2008 and made a related recommendation. In 2010, EHS research at the NNI member agencies GAO reviewed most frequently focused on carbon nanotubes, nanosilver, and nanoscale titanium dioxide. NNI has not prioritized nanomaterials for EHS research, but NNI’s 2011 EHS research strategy outlines criteria for NNI member agencies to use in doing so. It is too soon to tell how these criteria will influence NNI member agencies’ decisions about which nanomaterials to prioritize, and it is unclear if information needed to use the NNI criteria is available. The NNI member agencies have collaborated extensively on EHS research and strategies. They have collaborated through the NSTC to develop joint EHS research strategies and have initiated numerous formal collaborative EHS research projects. Nonfederal stakeholders who responded to GAO’s web-based questionnaire on nanotechnology EHS research told GAO that they benefited from collaboration with the NNI member agencies but identified some challenges, including a lack of funding and limited awareness of collaboration opportunities, among others. Most respondents rated the 2011 NNI EHS research strategy as somewhat or very effective at addressing nanotechnology EHS research needs. NNI strategy documents for EHS research issued by the NSTC address two and partially address the other four of the six desirable characteristics of national strategies identified by GAO that offer a management tool to help ensure accountability and more effective results. For example, the NNI strategy documents provide a clear statement of purpose, define key terms, and discuss the quality of currently available data, among others. However, they do not include performance information—such as performance measures, targets, and time frames for meeting those measures—that would allow stakeholders to evaluate progress towards the goals and research needs of the NNI. In addition, the documents do not include, or sufficiently describe, estimates of the costs and resources needed for the strategy. Without this information, it may be difficult for agencies and stakeholders to implement the strategy and report on progress toward achieving the research needs and assess if investments are commensurate with costs of the identified needs.

Background The use of information technology (IT) to electronically collect, store, retrieve, and transfer clinical, administrative, and financial health information has great potential to help improve the quality and efficiency of health care and is critical to improving the performance of the U.S. health care system. Historically, patient health information has been scattered across paper records kept by many different caregivers in many different locations, making it difficult for a clinician to access all of a patient’s health information at the time of care. Lacking access to these critical data, a clinician may be challenged to make the most informed decisions on treatment options, potentially putting the patient’s health at greater risk. The use of electronic health records can help provide this access and improve clinical decisions. Electronic health records are particularly crucial for optimizing the health care provided to military personnel and veterans. While in military status and later as veterans, many DOD and VA patients tend to be highly mobile and may have health records residing at multiple medical facilities within and outside the United States. Making such records electronic can help ensure that complete health care information is available for most military service members and veterans at the time and place of care, no matter where it originates. Key to making health care information electronically available is interoperability—that is, the ability to share data among health care providers. Interoperability enables different information systems or components to exchange information and to use the information that has been exchanged. This capability is important because it allows patients’ electronic health information to move with them from provider to provider, regardless of where the information originated. If electronic health records conform to interoperability standards, they can be created, managed, and consulted by authorized clinicians and staff across more than one health care organization, thus providing patients and their caregivers the necessary information required for optimal care. (Paper-based health records—if available—also provide necessary information, but unlike electronic health records, do not provide decision support capabilities, such as automatic alerts about a particular patient’s health, or other advantages of automation.) Interoperability can be achieved at different levels. At the highest level, electronic data are computable (that is, in a format that a computer can understand and act on to, for example, provide alerts to clinicians on drug allergies). At a lower level, electronic data are structured and viewable, but not computable. The value of data at this level is that they are structured so that data of interest to users are easier to find. At still a lower level, electronic data are unstructured and viewable, but not computable. With unstructured electronic data, a user would have to find needed or relevant information by searching uncategorized data. Beyond these, paper records can also be considered interoperable (at the lowest level) because they allow data to be shared, read, and interpreted by human beings. However, my discussion today focuses only on the three levels of electronic interoperability. Figure 1 shows the distinction between the various levels of interoperability and examples of the types of data that can be shared at each level. It is important to note that not all data require the same level of interoperability. For example, in their initial efforts to implement computable data, DOD and VA focused on outpatient pharmacy and drug allergy data because clinicians gave priority to the need for automated alerts to help medical personnel avoid administering inappropriate drugs to patients. On the other hand, for such narrative data as clinical notes, unstructured, viewable data may be sufficient. Achieving even a minimal level of electronic interoperability is valuable for potentially making all relevant information available to clinicians. Efforts to Adopt and Implement Federal Interoperability Standards Are Ongoing Any level of interoperability depends on the use of agreed-upon standards to ensure that information can be shared and used. In the health IT field, standards govern areas ranging from technical issues, such as file types and interchange systems, to content issues, such as medical terminology. Developing, coordinating, and agreeing on standards are only part of the processes involved in achieving interoperability for electronic health records systems or capabilities. In addition, specifications are needed for implementing the standards, as well as criteria and a process for verifying compliance with the standards. The President’s executive order of April 2004 that called for widespread adoption of interoperable electronic health records by 2014, established the Office of the National Coordinator for Health Information Technology within the Department of Health and Human Services (HHS) to, among other things, develop, maintain, and direct the implementation of a strategic plan to guide the nationwide implementation of interoperable health IT in both the public and private health care sectors. Under the direction of HHS (through the Office of the National Coordinator), three primary organizations were designated to play major roles in expanding the implementation of health IT: ● The American Health Information Community was created by the Secretary of Health and Human Services as a federal advisory body to make recommendations on how to accelerate the development and adoption of health IT, including advancing interoperability, identifying health IT standards, advancing nationwide health information exchange, and protecting personal health information. Formed in September 2005, the community is made up of representatives from both the public and private sectors, including high-level DOD and VA officials. The community determines specific health care areas of high priority and develops “use cases” for these areas, which provide the context in which standards would be applicable. The use cases convey how health care professionals would use such records and what standards would apply. ● The Healthcare Information Technology Standards Panel, sponsored by the American National Standards Institute and funded by the Office of the National Coordinator, was established in October 2005 as a public-private partnership to identify competing standards for the use cases being developed by the American Health Information Community and to “harmonize” the standards. The panel also develops the interoperability specifications that are needed for implementing the standards. Interoperability specifications were developed for each of the seven use cases developed by the American Health Information Community in 2006 and 2007. The community is also developing six use cases for 2008 for which interoperability specifications have not yet been released. The Healthcare Information Technology Standards Panel is made up of representatives from both the public and private sectors, including DOD and VA officials who serve as members and are actively working on several committees and groups within the panel. This panel is the successor to the Consolidated Health Informatics initiative, which was dissolved and absorbed into the panel on September 30, 2006. ● The Certification Commission for Healthcare Information Technology is an independent, nonprofit organization that certifies health IT products. HHS entered into a contract with the commission in October 2005 to develop and evaluate the certification criteria and inspection process for electronic health records. According to HHS, certification is to be the process by which the IT systems of federal health contractors are established to meet federal interoperability standards. Certification helps assure purchasers and other users of health IT systems that the systems will provide needed capabilities (including ensuring security and confidentiality) and will work with other systems without reprogramming. Certification also encourages adoption of health IT by assuring providers that their systems can participate in nationwide health information exchange in the future. In 2006, the commission certified the first 37 ambulatory—or clinician office- based—electronic health record products as meeting baseline criteria for functionality, security, and interoperability. In 2007, the commission expanded certification to inpatient—or hospital— electronic health record products, which could significantly increase patients’ and providers’ access to the health information generated during a hospitalization. To date, the commission has certified over 100 electronic health record products. DOD and VA Have Been Pursuing Efforts to Exchange Health Information for a Decade DOD and VA have been working to electronically exchange patient health data since 1998. As we have reported previously, their efforts have included both short-term initiatives to share information in existing (legacy) systems, as well as a long-term initiative to develop modernized health information systems— replacing their legacy systems—that would be able to share data and, ultimately, use interoperable electronic health records. In their short-term initiatives to share information from existing systems, the departments began from different positions. VA has one integrated medical information system—the Veterans Health Information Systems and Technology Architecture (VistA)—which uses all electronic records and was developed in-house by VA clinicians and IT personnel. All VA medical facilities have access to all VistA information. In contrast, DOD uses multiple legacy medical information systems, all of which are commercial software products that are customized for specific uses. For example, the Composite Health Care System (CHCS) which was formerly DOD’s primary health information system is still in use to capture pharmacy, radiology, and laboratory information. In addition, the Clinical Information System (CIS), a commercial health information system customized for DOD, is used by some facilities for inpatients. The departments’ short-term initiatives to share information in their existing systems have included several projects: ● The Federal Health Information Exchange (FHIE), completed in 2004, enables DOD to electronically transfer service members’ electronic health information to VA when the members leave active duty. ● The Laboratory Data Sharing Interface (LDSI), a project established in 2004, allows DOD and VA facilities to share laboratory resources. This interface, now deployed at nine locations, allows the departments to communicate orders for lab tests and their results electronically. ● The Bidirectional Health Information Exchange (BHIE), also established in 2004, was aimed at allowing clinicians at both departments viewable access to records on shared patients (that is, those who receive care from both departments—for example, veterans may receive outpatient care from VA clinicians and be hospitalized at a military treatment facility). The interface also allows DOD sites to see previously inaccessible data at other DOD sites. As part of the long-term initiative, each of the departments aims to develop a modernized system in the context of a common health information architecture that would allow a two-way exchange of health information. The common architecture is to include standardized, computable data; communications; security; and high- performance health information systems: DOD’s Armed Forces Health Longitudinal Technology Application (AHLTA) and VA’s HealtheVet. The departments’ modernized systems are to store information (in standardized, computable form) in separate data repositories: DOD’s Clinical Data Repository (CDR) and VA’s Health Data Repository (HDR). For the two-way exchange of health information, the two repositories are to be linked through an interface named CHDR, which the departments began developing in March 2004 (with implementation beginning in September 2006). Beyond these initiatives, in January 2007, the departments announced an addition to their information-sharing strategy: their intention to jointly determine an approach for inpatient health records. On July 31, 2007, they awarded a contract for a feasibility study and exploration of alternatives. According to the departments, one of the options would be adopting a joint solution, which would be expected to facilitate the seamless transition of active-duty service members to veteran status, and make inpatient health care data on shared patients more readily accessible to both DOD and VA. In addition, the departments believe that a joint development effort could enable them to realize cost savings. However, no decision on a joint inpatient health records system has yet been made. The departments’ officials stated that they received recommendations from the contractor on the possible approaches for the joint inpatient electronic health record in August, but added that they would not be prepared to release the findings from the study until senior leadership has fully reviewed and considered the recommendations—a step for which no date was provided. We have previously pointed out that the many tasks and challenges associated with the departments’ long-term goal of seamless sharing of health information made it essential that the departments develop a comprehensive project plan to guide these efforts to completion. Therefore, in 2004, we recommended that the departments develop such a plan for the CHDR interface and that it include a work breakdown structure and schedule for all development, testing, and implementation tasks. Further, as the departments undertook work on their short-term initiatives, we raised concerns regarding how all of these initiatives were to be incorporated into an overall strategy toward achieving the departments’ goal of a comprehensive, seamless exchange of health information. In response to our concerns, the departments began developing a comprehensive plan, which they called the DOD/VA Information Interoperability Plan. To provide input to the plan and determine priorities, in December 2007, the departments established the Joint Clinical Information Board, made up of senior clinical leaders from both departments. The board is responsible for establishing clinical priorities for electronic data sharing between the departments, determining essential health information to be shared, and further identifying and prioritizing data that should be viewable and data that should be computable. The departments produced the DOD/VA Information Interoperability Plan (Version 1.0) this month. While the scope of the plan includes health information interoperability, it also addresses interoperability of personnel and benefits information. According to the plan, it describes the scope and milestones necessary to achieve and measure progress toward interoperability goals. To this end, the plan identifies over 20 initiatives, including, for example, enhancing health information exchange between clinical information systems. The plan also incorporates information intended to address requirements in the National Defense Authorization Act for Fiscal Year 2008 that require schedules for establishing the interagency program office; establishing requirements for electronic health record systems; and acquiring, testing, and implementing electronic health record systems. DOD and VA Are Sharing Some, but Not All, Health Information at Different Levels of Interoperability DOD and VA are electronically sharing health information as a result of their long- and short-term initiatives to achieve interoperability; some of this information is exchanged in computable form, while other information is viewable only. However, not all electronic health information is yet shared. Further, although VA’s health information is all captured electronically, not all health data collected by DOD are electronic—many DOD medical facilities use paper-based health records. Data in computable form are exchanged as a result of the departments’ long-term initiative to develop the CHDR interface, which links the modernized health data repositories for the new systems that each department is developing. Implementing the interface required the departments to agree on standards for various types of data, put the data into the agreed standard formats, and populate the repositories with the standardized data. Currently, the types of computable health data being exchanged are limited to outpatient pharmacy and drug allergy data. According to the departments, the next type of data to be standardized, included in the repositories, and exchanged in computable form is laboratory data (i.e., chemistry and hematology laboratory results). However, DOD and VA officials told us that this data exchange is expected to be achieved by October 31, 2009. Currently, these computable data are not shared for all patients— rather only for those who are seen at both DOD and VA medical facilities, identified as shared patients, and then “activated.” Once a patient is activated, all DOD and VA sites can access information on that patient and receive alerts on allergies and drug interactions for that patient. According to DOD and VA officials, outpatient pharmacy and drug allergy data were being exchanged on almost 19,000 shared patients as of July 31, 2008; however, officials stated that they are unable to track the number of shared patients currently receiving care from both departments, so the number of patients for whom data could potentially be shared is unknown. Data in viewable form are shared as a result of the various short- term initiatives previously mentioned. Through BHIE, clinicians can query selected health information on patients from all DOD and VA sites and view current data onscreen almost immediately. Because the BHIE interface provides access to up-to-date information, clinicians at both departments have expressed strong interest in expanding its use, and DOD and VA have taken steps in this regard. For example, the departments completed a BHIE interface with DOD’s Clinical Data Repository in July 2007, and they began sharing viewable patient vital signs information through BHIE in June 2008. Extending BHIE connectivity could provide both departments with the ability to view additional data in DOD’s legacy systems, until such time as the departments’ modernized systems are fully developed and implemented. According to a DOD/VA annual report and program officials, the departments now consider BHIE an interim step in their overall strategy to create a two-way exchange of electronic health records. DOD has been using another short-term initiative, FHIE, to transfer information to VA since 2002, allowing VA clinicians to view service members’ electronic health information when the members leave active duty. Among the data elements transferred are laboratory results, radiology results, outpatient pharmacy data, allergy information, consultation reports, and demographic data. Further, since July 2005, FHIE has been used to transfer pre- and post- deployment health assessment and reassessment data. Transfers are done in batches once a month, or weekly for veterans who have been referred to VA treatment facilities. Another initiative that provides viewable data, LDSI, is deployed when local agencies have a business case for its use and sign an agreement to share laboratory resources. LDSI currently supports a variety of chemistry, hematology, toxicology, and serology laboratory results. If a test is not performed at a DOD or VA doctor’s home facility, the doctor can order the test, the order is transmitted electronically to the appropriate lab (the other department’s facility or in some cases a local commercial lab), and the results are returned electronically. Among the benefits of LDSI, according to DOD and VA, are increased speed in receiving laboratory results and decreased errors from manual entry of orders. Attachment 1 summarizes the types of health data currently shared via the DOD and VA initiatives, as well as additional types of data that are currently planned for sharing via these initiatives. While DOD and VA are sharing or plan to share a wide range of health information, questions nonetheless exist regarding when and to what extent electronic sharing capabilities will be fully achieved. Beyond the initiatives and types of data already discussed, the electronic sharing of health information between the departments has not been fully addressed. Although VA’s health information is all captured electronically, many DOD medical facilities continue to rely on paper records. Also, clinical encounters for those enrolled in the military’s TRICARE health care program are not captured in DOD’s electronic health system unless care is received at a military treatment facility. Addressing these conditions will be important to determining the outcome of the departments’ joint efforts. DOD and VA Have Adopted Standards to Allow Sharing and Are Engaged in Efforts to Establish Standards As previously discussed, interoperability standards are an essential element in the exchange of electronic health information. In this regard, DOD and VA have agreed upon numerous common standards that allow them to share health data, which include standards that are part of current and emerging federal interoperability specifications. The foundation built by this collaborative process has allowed the two departments to begin sharing computable health data (the highest level of interoperability). The standards agreed to by the two departments are listed in a jointly published common set of interoperability standards called the Target DOD/VA Health Standards Profile. The current version of the profile, dated September 2007, includes federal standards (such as data standards established by the Food and Drug Administration and security standards established by the National Institute of Standards and Technology); industry standards (such as wireless communications standards established by the Institute of Electrical and Electronics Engineers and Web file sharing standards established by the American National Standards Institute); international standards (such as the Systematized Nomenclature of Medicine Clinical Terms, or SNOMED CT, and security standards established by the International Organization for Standardization). According to the departments, they anticipate continued updates and revisions to the profile as additional federal standards emerge. For the two kinds of data now being exchanged in computable form through CHDR (pharmacy and drug allergy data), DOD and VA adopted the National Library of Medicine data standards for medications and drug allergies, as well as the SNOMED CT codes for allergy reactions. This standardization was a prerequisite for exchanging computable medical information—an accomplishment that, according to the Department of Health and Human Services’ National Coordinator for Health IT, has not been widely achieved. Further, DOD and VA are continuing their historical involvement in efforts to agree upon standards for the electronic exchange of clinical health information by participating in ongoing initiatives led by the Office of the National Coordinator that are aimed at promoting the adoption of federal standards and broader use of electronic health records. Health officials from both departments participate as members of the American Health Information Community and the Healthcare Information Technology Standards Panel. For example, high-level representatives of the 18-member Community include the Assistant Secretary of Defense for Health Affairs and the Director, Health Data and Informatics, Veterans Health Administration. DOD and VA are also members of the Healthcare Information Technology Standards Panel Board and are actively working on several committees and groups, including the Provider Perspective Technical Committee; Population Perspective Technical Committee; and Security, Privacy and Infrastructure Domain Technical Committee. The National Coordinator indicated that such participation is important and stated it would not be advisable for DOD and VA to move significantly ahead of the national standards initiative; if they did, the departments might have to change the way their systems share information by adjusting them to the national standards later, as the standards continue to evolve. In addition, according to DOD officials, their department is taking steps to ensure that the electronic health records produced by its modernized health information system, AHLTA (which is a customized commercial software application), are compliant with standards by arranging for certification through the Certification Commission for Healthcare Information Technology. AHLTA version 3.3 has been installed at three DOD locations for beta testing and has met specific functionality, interoperability, and security requirements. However, the officials stated that the commission cannot fully certify this version of AHLTA until it has verified that the system has been in operational use at a medical site. The departments’ efforts to share data and to be involved in standardization activities are important mechanisms for ensuring that their electronic health records are both interoperable and aligned with emerging standards. Further Actions Needed to Fully Establish the Interagency Program Office To accelerate the departments’ ongoing interoperability efforts, Congress included in the National Defense Authorization Act for Fiscal Year 2008 provisions establishing an interagency program office. Under the act, the Secretary of Defense and the Secretary of Veterans Affairs were required to jointly develop schedules and benchmarks for setting up the DOD/VA Interagency Program Office, and for other activities to achieve interoperable health information (that is, establishing system requirements, acquisition and testing, and implementation of interoperable electronic health records or capabilities). The schedules and benchmarks were due 30 days after passage of the act, or the end of February 2008. The departments did not meet the February 2008 date; however, just this month they produced the DOD/VA Information Interoperability Plan, which incorporates fiscal year 2008 and 2009 schedules and milestones that DOD and VA previously referred to in a draft implementation plan. Further, in an effort to set up the program office, the departments appointed an Acting Director from DOD and an Acting Deputy Director from VA. According to the Acting Director, the departments also have detailed staff and provided temporary space and equipment to a transition team. The official stated that, through the efforts of the transition team, the departments are currently developing a charter for the office, defining and approving an organizational structure, and preparing to begin recruiting permanent staff for the office, which is expected to number about 30. According to the plan, the departments expect to appoint a permanent Director and Deputy Director and begin recruiting staff by October 2008. The Acting Director added that program staff are expected to be in place, and the office is expected to be fully operational by December 2008. To fund the office, the departments have reported requesting $4.94 million for fiscal year 2008 and $6.94 million for fiscal year 2009. Within the plan, milestones and schedules have been included for achieving interoperable health information in two stages. The first stage—Interoperability I— is to be completed this month and is to make available those health data most commonly required by health care providers, as validated by the Joint Clinical Information Board, which sets the clinical priorities for what electronic health information should be shared. The first milestone for this stage, sharing vital signs information, was already achieved this past June as part of the BHIE initiative. According to department officials, the remaining milestones related to sharing questionnaires and forms, family history, social history, and other history are all due during this month. The second stage—Interoperability II— is to be completed by September 2009, and is to address additional health information enhancements. Department officials stated that the information to be covered by these enhancements is being defined, and that validation of the requirements for the enhancements by the Joint Clinical Information Board was completed in July 2008. Nevertheless, milestones for this stage have not been fully established. Specifically, of 52 activities identified for Interoperability II, 11 do not yet have defined milestones. For example, milestones have not been identified for completing requirements validation, acquisition, and testing for the scanning of service members’ paper medical records into DOD’s electronic health record system in order to share these records electronically with VA; a capability expected to be implemented by September 30, 2009. Department officials stated that decisions on these milestones will depend on clinical priorities, technical considerations, and policy decisions. Further, according to the plan, it is intended to serve as a “living document” that will be updated and refined as more detailed information becomes known on planned fiscal year 2008 and fiscal year 2009 initiatives, and as health care information needs change. However, although the plan (as a planning tool) is a living document, it is nonetheless important to complete the planning and make the decisions needed to finalize the plan, particularly in view of the fast approaching September 2009 deadline. In addition, according to department officials, the interagency program office will play a crucial role in coordinating the departments’ efforts to accelerate their interoperability efforts. An important aspect of this coordination will be managing implementation of the DOD/VA Information Interoperability Plan, which the departments recently finalized. According to these officials, having a centralized office to take on this role will be a primary benefit. However, the effort to set up the program office is still in its early stages. As has been noted, the positions of Director and Deputy Director are not yet permanently filled, permanent staff have not yet been hired, and facilities have not yet been designated for housing the office. In addition, the departments have not completed an interagency program office charter because the departments’ leadership broadened its scope to include sharing of personnel and benefits data instead of only health information. Until the program office is fully established, it will not be able to play this crucial role effectively. Thus, it remains vital that the Secretaries of Defense and Veterans Affairs fully establish the Interagency Program Office by expediting efforts to put in place permanent leadership, staff, and facilities. To better ensure that the effort by DOD and VA to achieve fully interoperable electronic health record systems or capabilities is accelerated, our July report included recommendations that the departments give priority to fully establishing the interagency program office and finalizing the implementation plan. Prompt action by the departments to address these recommendations is critical to developing and implementing electronic health record systems or capabilities that allow for full interoperability of personal health care information by September 30, 2009, as specified in the National Defense Authorization Act for Fiscal Year 2008. In their comments on our report, both departments concurred with these recommendations. In summary, through numerous efforts, DOD and VA are sharing electronic health information at different levels of interoperability. Moreover, as a result of their efforts, the departments are sharing more data than ever before. However, significant work remains to plan and implement new capabilities that could further increase the sharing of electronic health information between the departments and to determine the desired level of data interoperability. Recognizing the importance of timely implementation of such capabilities, Congress established a requirement for an interagency program office as a single point of accountability, and a deadline of about one year from now to achieve full interoperability of personal health care information between the departments. In view of this short timeframe and as we have recommended, a fully functioning program office and a finalized plan with set milestones are critical steps toward achieving interoperable electronic health records and capabilities. Although completion of the DOD/VA Information Interoperability Plan is an important and positive accomplishment, without permanent program office leadership, staff, and facilities or fully established milestones, the departments may nonetheless remain challenged in achieving interoperable electronic health information to the extent and in the manner that most effectively serves military service members and veterans. Mr. Chairman, this concludes my statement. I would be pleased to respond to any questions that you or other members of the committee may have. Contacts and Acknowledgements If you have any questions on matters discussed in this testimony, please contact Valerie C. Melvin, Director, Human Capital and Management Information Systems Issues, at (202) 512-6304 or melvinv@gao.gov. Other individuals who made key contributions to this testimony are Mark Bird, Assistant Director; Barbara Collier; Neil Doherty; Rebecca LaPaze; Lee McCracken; Barbara Oliver; Kelly Shaw; Eric Trout; and Robert Williams, Jr. Attachment 1: Current and Planned Health Data Sharing Table 1 summarizes the types of health data currently shared through the long- and short-term initiatives we have described, as well as types of data that are currently planned for addition.

The National Defense Authorization Act for Fiscal Year 2008 required the Department of Defense (DOD) and the Department of Veterans Affairs (VA) to accelerate the exchange of health information between the departments and to develop systems or capabilities that allow for full interoperability (generally, the ability of systems to use data that are exchanged) and that are compliant with federal standards. The act also established an interagency program office to function as a single point of accountability for the effort and whose role is to implement such systems or capabilities by September 30, 2009. Further, the act required that GAO semi-annually report on the progress made in achieving these goals; its first report was issued in July 2008. In that report, GAO described the departments' progress in sharing electronic health information, developing electronic health records that comply with federal standards, and establishing the interagency program office. In this testimony, GAO discusses its July 2008 report and updated information obtained from the departments. DOD and VA are sharing some, but not all, electronic health information. This includes exchanging some information in computable form, which is the highest level of interoperability. In other cases, data can be viewed only--a lower level of interoperability that still provides clinicians with important information. The departments have undertaken a number of initiatives, resulting in varied sharing capabilities. However, information is still being captured in paper records at many DOD medical facilities, and not all electronic health information is being shared. Further enhancing sharing and interoperability depends on adherence to common standards. The two departments have agreed on numerous common standards and are working with federal groups and each other to ensure adherence to such standards and to align their initiatives with emerging standards. These efforts, led by the Office of the National Coordinator for Health Information Technology (within the Department of Health and Human Services), include identifying relevant existing standards, identifying and addressing overlaps and gaps in the standards, and developing interoperability specifications and certification criteria based on these standards. The departments are also in the process of setting up a new interagency program office that will play a crucial role in accelerating their efforts to achieve electronic health records and capabilities that allow for full interoperability. However, the program office is not expected to be fully operational until the end of the year, which will allow the departments only 9 months to meet the deadline for full interoperability between the departments by September 2009. While DOD and VA have produced a plan for achieving interoperability within this time period, many milestones have yet to be determined. In view of the short timeframe and without a fully established program office and a complete plan with fully established milestones, the departments may be challenged in achieving interoperable electronic health records and capabilities that most effectively serve military service members and veterans.

Background SEC was created by Congress in 1934 primarily to protect investors; maintain fair, honest, and efficient securities markets; and facilitate capital formation. SEC’s oversight responsibilities include rule making, surveilling the markets, interpreting laws and regulations, reviewing corporate filings, conducting inspections and examinations, and determining compliance with federal securities laws. In addition, SEC monitors and regulates a variety of key market participants, which as of July 2004 included more than 7,200 broker-dealers, 900 transfer agents, almost 500 municipal and government securities dealers, and self-regulatory organizations (SRO). However, as we have reported previously, SEC has faced resource and management challenges that affected its ability to achieve its mission. The following sections include a discussion of SEC’s organizational structure and its human capital challenges, as well as a discussion of principles for human capital management and planning. SEC Staff and Organization As of August 2005, SEC had approximately 3,800 staff working in four divisions and 21 offices in Washington, D.C., and 11 regional and district offices. Approximately 41 percent of staff were attorneys, 25 percent were accountants or financial analysts, and 6 percent were investigators or examiners. The remaining 28 percent were other professional, technical, administrative, and clerical staff. Figure 1 depicts SEC’s organizational structure, including the Chairman’s office and the agency’s key divisions and offices. The Managing Executive for Operations and Management, who works in the Office of the Chairman, is responsible for overseeing all efforts to enhance agency productivity, retain qualified staff, and manage agency resources. In coordination with the Office of the Executive Director, the Managing Executive for Operations and Management has primary responsibility for OHR, which develops, implements, and evaluates SEC’s programs for human resource and personnel management. SEC Human Capital Management and Challenges Over the past years, we have produced several reports relevant to human capital and workforce planning issues at SEC. In 2001, we recommended that the Chairman of SEC include a strategy for succession planning and develop a comprehensive, coordinated workforce planning effort as part of the agency’s annual performance plan. In March 2002, we found that SEC had not reviewed its staffing and resource needs independent of the budget process and that SEC generally developed its annual budget request based on the previous year’s appropriation, not on what the agency actually needed to fulfill its mission. We also commented that SEC was making its staffing allocation decisions without the benefit of a strategic plan. We recommended that SEC broaden its strategic planning process to determine its regulatory priorities and the resources needed to fulfill its mission, including identifying the staff skills needed to do so. In July 2004, we found that although SEC received more flexible pay and hiring authority, it continued to face challenges filling critical vacancies, such as for accountants. Furthermore, we reported that although SEC’s allocation of its newly authorized positions was generally consistent with Sarbanes-Oxley directions, these decisions were made without the benefit of an updated strategic plan that outlined the agency’s priorities—a tool that could be used to help ensure that SEC was deploying its resources to maximize organizational effectiveness. Later, in November 2004, we reported the results of a GAO survey of human capital issues at SEC to benchmark employee views following the implementation of pay parity and several work-life programs. We found that the significant improvement in employee satisfaction with compensation and work-life programs could be attributed to SEC’s recent implementation of pay parity and an increased focus on the use of flexible work schedules and telework programs since 2001. In May 2005, we audited SEC’s financial statements for fiscal year 2004 and found that SEC’s preparation of its financial statements was manually intensive and consumed significant staff resources. To address the weaknesses found in the audit, SEC stated that it would increase the number of financial reporting staff. Finally, in August 2005, as a result of our review of SEC’s facilities project management and related budget planning, we recommended that SEC complete the hiring of new positions in the Office of Administrative Services and the Office of Financial Management. Strategic Human Capital Management and Workforce Planning Studies by several organizations, including GAO, have shown that successful organizations in both the public and private sectors use strategic management approaches to prepare their workforces to meet present and future mission requirements. For example, preparing a strategic human capital plan encourages agency managers and stakeholders to systematically consider what is to be done, how it will be done, and how to gauge progress and results. Federal agencies have used varying frameworks for developing and presenting their strategic human capital plans. More recently, various agencies have begun using OPM’s Human Capital Assessment and Accountability Framework (HCAAF) as the basis for preparing such plans. HCAAF, which OPM developed in conjunction with OMB and us, outlines six standards for success, key questions to consider, and suggested performance indicators for measuring progress and results. These six standards for success and related definitions are as follows: Strategic alignment. The organization’s human capital strategy is aligned with mission, goals, and organizational objectives and integrated into its strategic plans, performance plans, and budgets. Workforce planning and deployment. The organization is strategically utilizing staff in order to achieve mission goals in the most efficient ways. Leadership and knowledge management. The organization’s leaders and managers effectively manage people, ensure continuity of leadership, and sustain a learning environment that drives continuous improvement in performance. Results-oriented performance culture. The organization has a diverse, results-oriented, high-performance workforce, and a performance management system that effectively differentiates between high and low performance and links individual, team, or unit performance to organizational goals and desired results. Talent management. The organization makes progress toward closing gaps or making up deficiencies in most mission-critical skills, knowledge, and competencies. Accountability. The organization’s human capital decisions are guided by a data-driven, results-oriented planning and accountability system. Strategic workforce planning, an integral part of human capital management and the strategic workforce plan, involves systematic assessments of current and future human capital needs and the development of long-term strategies to fill the gaps between an agency’s current and future workforce requirements. Agency approaches to such planning can vary with each agency’s particular needs and mission; however, our previous work suggests that irrespective of the context in which workforce planning is done, such a process should incorporate five key principles: (1) involve management and employees, (2) analyze workforce gaps, (3) employ workforce strategies to fill the gaps, (4) build the capabilities needed to support workforce strategies, and (5) evaluate and revise strategies. Figure 2 provides a fuller description of each of the five principles. SEC Has Made Progress on Strategic Human Capital Initiatives and Is Developing a Strategic Human Capital Plan SEC has shown progress on a number of strategic human capital management initiatives that could help strengthen SEC’s efforts in workforce planning and is developing its strategic human capital plan. These initiatives include splitting its Office of Administrative and Personnel Management into the Office of Administrative Services and OHR in order to improve efficiency and effectiveness in both and creating a more structured and institutionalized human capital council by expanding the role of the ERB, now called the HCRB. Furthermore, SEC is in the process of creating its first strategic human capital plan. According to SEC, this plan is to be based on OPM’s HCAAF. SEC Has Developed More Formalized Process for Strategic Human Capital Management In 2003, after the passage of Sarbanes-Oxley, SEC undertook an extensive workforce and work-flow review, and the ERB became the vehicle through which SEC leadership met to align its programmatic goals and new responsibilities with its human capital approaches and existing and new resources. The ERB—composed of senior division managers, the Managing Executive for Operations, and the head of OHR (after the creation of that office)—met monthly and on an ad hoc basis to deal with special issues, and produced recommendations for the Chairman’s approval. The 2003 workforce and work-flow review process required division and office directors to present justifications for resource requests to the ERB for the board’s approval. One outcome of the 2003 review was the decision to split SEC’s Office of Administrative and Personnel Management into two offices—the Office of Administrative Services and OHR. According to OHR, the separation of the office’s administrative and personnel functions was made to improve efficiency and effectiveness in these functions, which was necessitated by the agency’s growth of approximately 1,000 individuals after the implementation of Sarbanes-Oxley. In addition, the split created an opportunity for SEC to hire an Associate Executive Director for OHR, who is tasked with assessing, developing, and implementing human resources programs. Following the creation of OHR, SEC broadened the role of the ERB—renamed the HCRB in April 2005—to include a senior executive review of all human capital issues. SEC staff said that the HCRB has a standing 2- to 3-hour biweekly meeting and is composed of (1) directors from the major divisions and offices—Divisions of Corporation Finance; Investment Management; Market Regulation; Enforcement; and the Office of Compliance, Inspections, and Examinations (OCIE); (2) a designee representing the interests of the field offices; (3) the Executive Director (who serves as Chair); (4) a representative from the Chairman’s office; and (5) the Associate Executive Director of OHR. According to SEC, although smaller offices do not regularly participate in the HCRB, the Executive Director is responsible for representing the interests of these offices. In addition, these offices make presentations to the HCRB on an as-needed basis. The HCRB approves all human capital decisions, including staffing allocations. Specifically, staffing allocations and current structures for each division and office can now only be amended with the approval of the HCRB. According to SEC officials, HCRB’s staffing decisions are made on a consensus rather than formal voting basis. SEC staff also said that although the commission does not directly participate in the agency’s human capital planning process, a representative from the Chairman’s office attends HCRB meetings. Furthermore, while the HCRB has the ability to approve staffing requests, larger allocations of staff slots and staff reorganizations are subject to final review and approval by the Chairman. Representatives from SEC’s key divisions and offices said they felt that the migration from the ERB to the HCRB was much more than a name change. Specifically, the HCRB has a greater focus on SEC’s strategic needs. Management staff from several SEC divisions attributed this change to the hiring of the new Associate Executive Director of OHR, who was formerly employed at OPM and who, they felt, is aware of what OPM and OMB expect from agencies in their strategic planning and human capital management processes. One division staff representative added that whereas they felt that the ERB met more “sporadically” and many did not feel compelled to gain board approval of staffing allocations, the HCRB now meets regularly and has more “rigor and structure.” SEC Is Developing a Strategic Human Capital Plan SEC has been developing its human capital plan to address its strategic planning goal of maximizing the use of agency resources. Specifically, OHR officials told us that the plan will address how SEC will implement and align its human capital strategies to achieve agency mission, goals, and outcomes. OHR officials also told us that they are in the process of developing a human capital plan based on OPM’s HCAAF (previously discussed in the report), which identifies six standards for success: (1) strategic alignment, (2) workforce planning and deployment, (3) leadership and knowledge management, (4) results-oriented performance culture, (5) talent management, and (6) accountability. A major component of the human capital plan, according to OHR officials, will be a strategy map and balanced scorecard to delineate and determine whether its strategies and action plans are meeting each of HCAAF’s six standards. A strategy map defines the strategic objectives and associated initiatives that support the organization’s vision and mission. A balanced scorecard is a management system that provides metrics and feedback about agency actions. The actual scorecard uses indicators to measure the relative success of each initiative. Following this approach, SEC plans to use some indicators suggested by HCAAF to measure the success of each of the initiatives. OHR officials told us that the balanced scorecard will also focus on OHR’s internal operations and the agency human capital outcomes for which it will be accountable. In early November 2005, OHR officials provided us with a draft strategy map and possible draft objectives and indicators for how OHR is planning to achieve SEC’s strategic planning goal of maximizing the efficient and effective delivery of human resource services. OHR has hired a contractor to help implement the balanced scorecard approach and plans to involve a number of internal stakeholders in developing the human capital plan, including the Executive Director, the HCRB, and a cross section of division and office managers. According to OHR officials, the contractor will interview branch chiefs and assistant directors within OHR to discuss how to apply the balanced scorecard to SEC, and will also interview managers from the divisions, but does not plan to obtain input from employees below the supervisory level. As of November 2005, OHR officials, working with the contractor, have identified a list of human capital initiatives and indicators to measure the success of these initiatives. OHR officials said that the next step is to communicate with division staff to determine the appropriate targets for these indicators. Once the development work is complete, the Executive Director will approve a presentation of the human capital plan to the HCRB. After receiving HCRB’s approval, OHR will disseminate the human capital plan throughout the agency. We discuss stakeholder involvement in developing the human capital plan and SEC’s communication strategy in greater detail later in the report. Once the strategic human capital plan is implemented, SEC officials intend to update the plan quarterly and annually. The process will begin with an evaluation of the results of the balanced scorecard measures. OHR management said that the quarterly assessments of the plan will focus on SEC’s ability to implement initiatives and demonstrate results in both leading and lagging indicators. OHR officials said that the office plans to conduct the quarterly review and present results to the Executive Director and then to the HCRB. OHR also stated that it plans to conduct an annual review to ensure that the human capital plan remains linked to the agency’s strategic plan and to correct any gaps between the plan’s human capital initiatives and the ability to meet the agency’s strategic goals. In addition to data used in the quarterly reviews, annual reviews are to include input from the HCRB and use performance management data and employee focus groups to determine gaps. Although the anticipated human capital plan should allow SEC to more consistently plan for its staffing needs and adjust staffing or program priorities, it does not appear to formally link resource needs to the budgeting process. As we have previously reported, the absence of this linkage results in reactive rather than proactive activities and planning that tends to be tactical rather than strategic. According to OHR, divisions and offices are not currently required to provide OHR with annual resource allocation information such as number of planned promotions because SEC’s divisions and offices do not have staff with the expertise to do strategic human capital planning. Although OHR can provide some minimal assistance to the divisions on long-term workforce planning and linking these efforts to the budget, OHR recognizes the benefit to increasing such assistance and plans to improve its capacity to provide this guidance. Components of SEC Workforce Planning Efforts Are Consistent with Established Principles, but Some Efforts Could Be Improved We found that many of SEC’s efforts related to workforce planning were consistent with our five key principles for effective strategic workforce planning; however, some of these efforts are still being developed or could be improved. Figure 3 summarizes how SEC had incorporated GAO’s key principles into its strategic workforce planning. Principle 1: SEC Has Engaged Top Management and Expanded the Role of Certain External Stakeholders In surveying SEC activities related to our first workforce planning principle, we found that the creation of the HCRB expanded the role of top management in strategic workforce decision making at SEC. As previously discussed, HCRB meetings create a forum for regular dialogue between OHR, key executives, and division leaders, and the HCRB now reviews and approves all human capital decisions. Moreover, during the ongoing development of its strategic human capital plan and other strategies, OHR officials said that it has also sought the assistance and guidance of various external stakeholders. In particular, SEC staff have been meeting regularly with OPM and using several of OPM’s key tools to assist the development of its strategic human capital plan. According to OHR officials, they have researched best practices in government, academia, and the private sector. However, SEC may have missed opportunities to conduct outreach with congressional stakeholders and the securities industry. In addition, SEC has not fully sought employee feedback during the development of human capital initiatives and, specifically, during the development of the strategic human capital plan. SEC Has a Formalized Process for Its Top Leadership and Executives to Establish and Implement Human Capital Strategies In our prior work, we have found that top management clearly and personally involved in workforce planning can provide the organizational vision that is important in times of change and generate cooperation within the agency to ensure that planning strategies are thoroughly implemented and sustained. Specifically, we have found that a key action in integrating human capital approaches with strategies for achieving programmatic results is the establishment of an entity, such as a human capital council, that is held accountable for linking human capital management and obtaining strategic goals. As demonstrated by their new responsibilities and participation in the HCRB, SEC’s key executives and top management have been actively engaged in SEC’s workforce planning efforts. As discussed previously, biweekly HCRB meetings are chaired by the Executive Director. This gathering of top leadership and executives helps determine and respond to current and changing workforce needs at SEC. For example, division managers we interviewed said that during HCRB meetings, senior managers representing SEC’s major divisions and offices make consensus-based determinations of staffing decisions at the agency. In addition, the HCRB is to have a role in the development of the strategic human capital plan. For example, OHR officials said it has presented status reports to the HCRB on the development of the human capital plan. According to OHR officials, once the plan’s proposed indicators and related targets are developed, some HCRB representatives will review and approve them for inclusion in the plan. Although a completion date for the plan has not been established, OHR officials said that HCRB will continue to work with OHR to make revisions and approve the strategic human capital plan. SEC Has Been Seeking Guidance from Certain External Stakeholders and Resources In prior work, we found that agencies should engage various stakeholders to identify ways to streamline processes, improve human capital strategies, and help the agency recognize and deal with the potential impact that the organization’s culture can have on the implementation of such improvements. Further, involvement of key congressional and other stakeholders during the strategic planning process also helps ensure that workforce planning efforts are clearly linked to the agency’s mission and long-term goals. In developing its strategic human capital plan, SEC has been using various methods to obtain the assistance and viewpoints of external resources. According to OHR officials, staff researched and identified a number of best practice studies from government, academia, and the private sector. For instance, OHR said that it is working with a private human capital consulting company to obtain information on best practices for integrating human capital functions at SEC. The human capital functions SEC plans to integrate are (1) selection (hiring), (2) performance management, (3) training, and (4) succession planning. These functions will be linked by a common competency platform—meaning all four functions will be linked to agencywide skills and competencies, which SEC is currently in the process of identifying. As part of the integrated human capital functions initiative, officials said SEC is planning to (1) implement the performance management system within OHR by the end of 2005 and then throughout the agency, (2) begin integrating performance management with its hiring or “selection” system in May 2006, (3) offer training that develops employee competencies used for selection and performance management, and (4) use performance management, selection, and training to help institute succession planning. OHR plans to completely implement these integrated functions by May 2007. SEC also plans to use written guidance developed by other government agencies, including OMB, OPM, and us. Specifically, OHR plans to incorporate measures outlined in HCAAF—and developed by OPM in conjunction with OMB and us—into the balanced scorecard being developed for SEC. OHR officials said that the office has consulted with OPM staff and hired a specialist from OPM to help implement its new human capital strategies, including the development of SEC University—one of the agency’s new initiatives that focuses on staff training. Furthermore, according to OHR officials, SEC formally and informally communicates with other financial regulators through networking events like the Small Agency Council, and also regularly receives operational information and survey data from other regulators, including compensation and benefit comparisons, labor relations discussions, and recruiting strategies. Although SEC has collected useful information and perspectives from various external parties, SEC has not met with congressional and industry stakeholders during the development of its strategic human capital plan. OHR officials said that SEC had not met with congressional staff to obtain their input on human capital planning at SEC and did not indicate any plans to do so since SEC has communicated human capital issues to Congress through congressional hearings and during the budget process. In addition, OHR officials told us they have collected best practice data from the private sector through a consulting firm, but they did not state that SEC has had discussion with industry stakeholders on how the evolving securities market may affect SEC’s resource needs. SEC Has Communicated Its Strategic Workforce Initiatives Agencywide but Has Not Fully Sought Feedback from Employees during the Development of New Human Capital Initiatives We have found that an effective communication strategy will create shared expectations, promote transparency, and report progress. In general, communication about the goals, approach, and results of strategic workforce planning is most effective when done early and clearly. Effective strategies also allow for a variety of two-way communication and are not limited to top-down dissemination. Efforts that address key organizational issues, like strategic workforce planning, are most likely to succeed if, at their outset, agencies’ top program and human capital leaders set the overall direction, pace, tone, and goals of the effort, and involve employees and other stakeholders in establishing a communication strategy that creates shared expectations for the outcome of the process. SEC communicates relevant information on human capital issues to its employees not only through SEC’s intranet and e-mail sent to administrative contacts within divisions and offices, but also through other forums such as staff meetings. In some cases, issues are communicated top-down from executives to managers and supervisors, and sometimes from managers and supervisors to nonmanagerial employees. For example, OHR officials said that the presentation of SEC’s new human capital plan is to be authorized by the Executive Director and then approved by the HCRB. Following HCRB approval, other top-level executives (those who are not on the HCRB), managers, and supervisors are to participate in group meetings to discuss the plan. Finally, OHR officials said that all SEC employees are to receive electronic presentations of the plan from OHR but will not have the opportunity to provide feedback prior to the approval of the plan. In general, informal methods of communicating human capital issues include performance discussions that occur during the employee evaluation process and impromptu communications between staff and liaisons from OHR assigned to each division. Overall, division officials said that OHR has been sensitive about the need to communicate about human capital issues, programs, and policies. However, one division manager noted that written agency communications sometimes assume that the reader has adequate knowledge of policies and procedures. For example, while SEC provides comprehensive new employee orientation training, such training could be enhanced by providing more basic information on federal government employment. This additional training may help ensure that when there are changes or new training opportunities, employees have a better understanding of the context in which changes occur. Another division manager said that OHR should e-mail employees directly regarding training opportunities instead of delegating this responsibility to the division’s OHR liaison. Although OHR has communicated with SEC staff on some human capital matters, it has not sought feedback from all employees in the development of SEC’s strategic human capital plan. Without such feedback, it is difficult to determine employees’ awareness of issues and fully determine the effectiveness of such human capital approaches. As previously discussed, participation in the development of this plan will not take place below the supervisory level. Nevertheless, OHR has indicated that it plans to use some employees to help with the development of some of its integrated human capital functions, such as performance management. Furthermore, OHR officials said it plans to seek feedback from employees and to use focus groups to evaluate the success of its strategic human capital plan. Principle 2: SEC Has Been Taking Steps to Track and Identify Critical Skills and Competencies; However, It Currently Lacks a Formal Process for Identifying and Linking These Skills to Strategic Goals SEC has been developing tools to measure needed skills and training for its employees, but currently relies on management’s informal knowledge of the skills and competencies possessed and needed within agency divisions. OHR has started interviewing division management to identify agencywide and position-specific competencies. As previously discussed, SEC also has begun to integrate its human capital functions with agencywide skills and competencies. Despite these efforts to identify and minimize gaps in workforce skills, SEC currently lacks a formal process to link critical skills and competencies to the goals and objectives outlined in its strategic plan. As a result, SEC may incorrectly estimate workforce gaps, information that helps agencies determine appropriate human capital strategies. SEC Has Made Efforts to Identify Staff Deficiencies but Does Not Maintain Information on Skills Possessed by Its Employees Our prior work suggests that maintaining information on the critical skills and competencies that an organization’s staff possess is especially important as the environment in which federal agencies operate changes. Shifts in priorities, advances in technology, budget constraints, and other factors all affect what sort of staff agencies will need to fulfill their missions. For SEC, such information is particularly useful for determining and addressing gaps in critical workforce skills or staff and making efficient resource allocations, because SEC must respond to changing regulatory conditions requiring its attention. For example, after the Energy Policy Act of 2005 (P.L. 109-58) repealed the Public Utility Holding Company Act of 1935 (PUHCA), the statute under which SEC is responsible for regulating public utility holding companies, SEC had to assess the skills of the 24 employees assigned to work in the Office of Public Utility Regulation (OPUR) to determine where they might be reassigned. Although SEC managers indicated that they were aware of the current knowledge, skills, and abilities of staff in their divisions, OHR officials stated that the agency does not currently maintain any formal inventory of the staff’s skills and competencies. Documentation of staff experience and skills may help management and OHR more effectively identify hiring strategies and training and developmental opportunities for current staff that would help eliminate skills gaps. In the OPUR case, OHR officials said it has been somewhat difficult to identify the skills of employees in this office. Nevertheless, during our interviews with divisions, senior staff indicated that, in general, they have informal knowledge, mainly through experience, of the skills and competencies of supervised staff. Also, division management said that it draws upon staff knowledge when hiring; in particular, this occurs when divisions work with OHR to write position descriptions. Despite lacking documentation of current skills, SEC has made efforts to identify deficiencies in staff skills. For example, OHR officials indicated that its office has interviewed directors and deputy directors at the agency to identify where knowledge and skills could be improved at the agency. The interviewees identified areas needing improvement, and branch chiefs ranked them in order of importance: (1) research and analysis; (2) knowledge of SEC process, rules, and regulations; (3) decision making; (4) writing; (5) oral communication; (6) information technology knowledge and skills; (7) management/supervisory skills; and (8) institutional knowledge. In another instance, in July 2004, OCIE completed a survey of examiners with higher degrees (e.g., MBA) to determine what skills were possessed and needed in the office. Further, division staff said they contact OHR when they need to identify persons with special skills and abilities. Division staff explained that OHR helps locate staff to complete work requiring special resources. Division staff interviewed generally agreed that these liaisons have proved to be an adequate resource for locating specialized skills and abilities on an as-needed basis. Although SEC currently does not document and centrally compile skills possessed by employees, OHR plans to use the skills and competencies needed for SEC positions as the basis for integrating the four human capital functions of selection (hiring), performance management, training, and succession planning. Furthermore, SEC plans to identify competencies that will be needed agencywide as well as for specific occupations. With the aid of a private contractor, OHR plans to conduct a competency-based job analysis for each occupation at SEC. OHR expects that, in consultation with its contractor, it will determine two or three competencies that may be applied agencywide, while other technical competencies will pertain to specific positions at the agency. According to OHR officials, the core competencies will be linked to broader agencywide strategic goals, and job-specific competencies may be linked to programmatic goals listed in the strategic plan. Eventually, all SEC employees will be evaluated through a competency-based performance management system. As part of its wider strategic human capital planning efforts, OHR is in the process of linking all of its human capital functions. These functions will be linked to the critical skills and competencies identified by the agency and provide information that can be used in all personnel-related functions. For instance, skills gaps identified by the performance management system may be remedied by hiring or training initiatives. SEC Is Taking Steps to Determine What Critical Skills and Competencies It Needs but Has Not Linked Them to Strategic Goals In our prior agencywide work, we have found that the scope of agencies’ efforts to identify the skills and competencies needed for their future workforces varies considerably, depending on the environment and responsibilities of a particular agency. The most important consideration is that the skills and competencies identified are clearly linked to the agency’s mission and long-term goals, as developed with stakeholders during the strategic planning process. SEC has already taken some steps to identify the type of knowledge and skills that would be beneficial. As discussed previously, OHR interviewed division directors and deputy directors to identify areas where staff knowledge and skills could be improved. According to OHR officials, these interviews also led to the conclusion that management should (1) create a career development plan, (2) develop an individualized training curriculum, (3) mitigate or prevent loss of institutional knowledge, and (4) promote knowledge transfer among its employees to strategically address its future workforce needs. In addition, SEC has been conducting the triennial needs assessment required by OPM. SEC has completed the first two phases of the assessment, which gathered information from executives and supervisors at the agency. According to officials, the assessment results will form the basis for questions to ask subject matter experts. Following interviews with subject matter experts, SEC anticipates that it will distribute a survey to all employees asking them to identify the skills needed to perform their jobs. The results of this assessment are to be used by OHR to determine if SEC’s existing training programs should be refocused and to identify additional courses or programs that should be developed. Although SEC has completed its 2004-2009 strategic plan, OHR officials stated that goals and objectives outlined in the plan have not been linked to specific skills or competencies. While the strategic plan lists potential performance indicators, they are not directly linked to particular critical skills or competencies. As it develops its integrated human capital functions and determines workforce gaps, SEC plans to link the critical skills and competencies it identifies to the strategic plan. According to OHR officials, this linkage will occur eventually as competencies are determined. SEC Is Making Efforts to Reshape Its Workforce to Increase Its Efficiency and Effectiveness through Re-engineering Work Processes When estimating the number of employees needed with specific skills and competencies, we found, based on prior work, it is also important to consider opportunities for reshaping the workforce by re-engineering current work processes or sharing work among offices and divisions within an agency. This is particularly important to SEC as it responds to changes in legislation affecting its responsibilities and substantial growth in the size of its workforce. Re-engineering processes have been particularly helpful as SEC considers more strategically how to use employees to perform a wider variety of functions at the agency, or seeks persons with differing skills to perform certain functions. According to OHR officials, the office is trying to improve employee versatility at the agency and is currently developing a “versatility index” to measure how well employees may perform a variety of tasks at the agency. Changes in the structure and responsibilities of SEC have contributed to some changes in workforce processes. SEC executives said that in an effort to more proactively regulate the securities industry, they are taking initiatives to identify emerging risks in securities markets and are working on creating more coordination among divisions. For example, the recently created Office of Risk Assessment (ORA) works with various divisions and offices to develop methodologies to address identified risk. ORA consults with risk-assessment committees that consist of staff from various divisions. Committees currently exist for the following areas: (1) full disclosure, (2) investment management and regulation, and (3) SEC infrastructure. ORA also uses software in coordination with divisions to identify how emerging risks have affected SEC’s workload and responsibilities. However, according to SEC management, ORA is not directly involved in workforce planning efforts at the agency. Various divisions have also modified work processes to respond to changing responsibilities and workload and identified skill gaps. For example, SEC’s Enforcement staff attorneys were responsible for collecting disgorgement, as well as investigating potential violations of securities law. Partly in response to the new Fair Fund provision under Sarbanes-Oxley, the Division of Enforcement hired attorneys dedicated to collections, as well as case management specialists, to assist with maximizing collections and addressing competing priorities and the growing workload of the Enforcement attorneys. Enforcement also stated that it is working with technology staff to improve systems, so that collection information is tracked in one system rather than captured in multiple systems. Furthermore, the Division of Investment Management is now conducting integrated disclosure reviews and participates in cross-divisional task forces, such as the Investor Education and Soft Dollar task forces, to leverage skills across divisions. In addition, as a result of using a risk-based approach to more proactively identify and address compliance risks, OCIE recently gained the approval of the HCRB to create 20 additional staff positions, to be filled by individuals with data analysis skills to collect surveillance data. SEC is also now responsible for overseeing investment firms that want to become a consolidated supervised entity (CSE). Because such oversight requires a combination of specialized technical and auditing skills currently not found within the agency, OCIE recently created a new unit to oversee CSEs. Principle 3: SEC Has Developed Some Human Capital Strategies to Address Gaps, but It Is Too Early to Assess Results SEC is using a variety of methods to address skill gaps and improve employee benefits and work life. For example, SEC uses its student loan repayment (SLR) program and teleworking opportunities to attract and retain employees. In addition, SEC is linking its human capital functions and focusing on developing skills and competencies to use for hiring, performance management, training, and succession planning. SEC also has been developing SEC University to expand employee training opportunities and minimize critical skills gaps. Recently, OHR has used hiring and retention data, focus groups, and surveys to assess the use of many of SEC’s work-life programs. However, because many of the human capital strategies have only recently been implemented, it is too soon to assess the effectiveness of these strategies. SEC Is Building More Comprehensive Human Capital Strategies to Recruit and Retain Employees and Address Skill Gaps In our prior work, we have found that much of the authority that allows agencies to tailor human capital strategies to their needs is already available under current laws and regulations. Therefore, in setting goals for their human capital programs and developing tailored workforce planning strategies to achieve these goals, agencies should identify and use all appropriate administrative authorities to build and maintain an effective workforce for the future. As mentioned earlier, SEC has been developing integrated human capital functions to better recruit and retain the right staff with the right expertise to help achieve its strategic goals and objectives. SEC indicated that selection, or hiring, is a critical tool to meet its changing needs, particularly following the increase in SEC’s responsibilities under Sarbanes-Oxley. SEC made several changes to its hiring process to fill accountant positions within Corporation Finance, which had been a challenging task for the agency partly due to the slowness of the hiring process and the reluctance of some candidates to relocate to Washington, D.C. First, SEC retained an executive recruiting firm to carry out some of the recruitment. Second, to expedite the hiring process, OHR introduced an automated hiring system to accelerate the review of applications by automatically disseminating information on job candidates to Corporation Finance. Third, to accommodate qualified applicants who might not want to relocate to SEC headquarters, Corporation Finance instituted a “virtual workforce” pilot where several of its employees can work from an alternate site and physically report to an SEC location on a limited basis. OHR staff indicated that the pilot phase of the program would be useful in helping managers learn how to manage off-site employees. However, it is unclear to what extent the program will be expanded, or whether it will be continued. Finally, OHR said that category rating will be introduced to the agency during 2006. In addition to exploring ways to improve the hiring processes, SEC also has tried to more strategically allocate skills and experience when creating or filling existing vacancies. For example, recognizing the need for more administrative support for its collection program, the Division of Enforcement recently filled a number of positions with paralegals and administrative personnel instead of attorneys. SEC also recognized that as an agency, it would benefit from the knowledge and skills possessed by individuals with business degrees. Therefore, as mentioned earlier, SEC developed a Summer Honors Business Program in 2001 to attract future MBA graduates to SEC. In September 2005, OHR implemented a 2-year program where MBA graduates rotate through various SEC divisions as associates before being permanently placed in a division. To increase employee retention, SEC has increased the use of its SLR program and telework arrangements. SEC began using the SLR program in the last half of fiscal year 2003 and reported making 384 student loan repayments totaling approximately $3.3 million in fiscal year 2004. This is an increase from fiscal year 2003, in which 257 employees received payments. To receive loan repayment, enrollees agree to work for an additional 3 years at SEC. According to SEC officials, few employees leave before the 3-year employment agreement terminates. SEC is also expanding the use of telework arrangements for its employees, with approximately 20 percent of its workforce now participating in the program. As of August 2005, SEC reported having 813 approved teleworking employees, an increase from March 2005, when it had 648 employees approved for telework. SEC also found that strategic use of recruitment and retention bonuses for employees with qualifications critical to SEC’s mission has been an effective way to achieve its hiring goals and an efficient use of funding. In addition, SEC has been expanding its training programs to eliminate gaps and maximize employee contributions. Training efforts at SEC previously focused on specific division and office needs, and division managers told us they have training units within their divisions. With the development of SEC University, OHR hopes to bring about a cultural change within the agency and encourage cross-divisional and agencywide training. Although OHR plans to consolidate various training programs at SEC through the university, some divisions indicated that they found in-house training on technical issues performed by division staff critical to meeting agency goals and felt such training should remain outside the main training center at SEC. To date, OHR has taken no action to discontinue training offered within divisions. In September 2005, SEC placed a new position announcement to hire a person from within SEC who would be devoted exclusively to directing SEC University. OHR officials expect this position to be filled by the end of November 2005. As part of the current SEC University plan, OHR is assessing employee training interests and relevancy to programmatic functions, and is exploring establishing training partnerships with government, public and private entities, and five or six law and business schools. According to OHR, SEC University also plans to provide supervisory training and help the agency maintain quality leadership, which will be particularly important because 14 percent of SEC managers will be eligible to retire by the end of 2005. In addition to developing a curriculum for SEC University, OHR is also working to automate and centralize employees’ training and skills information. OHR has proposed that SEC develop a learning management system to centrally track employees’ work experiences and training, as well as provide a forum to share work experiences among employees. OHR has produced a project plan outlining the business needs for the learning management system, including key deliverable dates for implementation and cost estimates. SEC Has Various Methods in Place to Measure the Success of Its Human Capital Approach, but Many of These Assessments Are Not Yet Complete Our previous agencywide work suggests that agencies could benefit by assessing key aspects of their human capital approach to identify possible obstacles and opportunities that may occur in meeting critical workforce needs. Specifically, an agency can use HCAAF to create indicators to measure the effectiveness of human capital approaches. According to OHR officials, the office has used various methods to assess recruitment, retention, and work-life issues at SEC, including (1) focus group research, (2) employee satisfaction surveys on human capital flexibilities, and (3) entrance and exit interviews. OHR has conducted focus groups of employees on recruitment effectiveness, as well as retention and job satisfaction. According to OHR officials, it has used the findings from its research studies and OPM’s Federal Human Capital Survey in developing SEC’s strategic human capital plan. For example, focus group results showed that SEC employees were most concerned about being recognized for good performance and agency procedures for dealing with poor performance. Consequently, OHR determined that performance management and training needed to be enhanced. OHR also determined that SEC needed to integrate the four human capital functions of selection (hiring), performance management, training, and succession planning. Specifically, OHR plans to enhance its performance management by using individual development plans for employees that include more comprehensive and targeted training and development opportunities. As indicated above, SEC is using results from various surveys and informal assessments to improve human capital management. However, many of its human capital strategies are new or under development, and it is too soon to gauge their effectiveness. As part of developing and implementing its human capital plan, SEC plans to use a balanced scorecard to more comprehensively assess the effectiveness of its human capital strategies and workforce planning efforts. As of November 2005, OHR has worked with a contractor to develop a list of indicators that SEC could use to measure the progress the agency has made on its human capital strategies. Principle 4: SEC Is Addressing Administrative, Educational, and Other Requirements Important to Supporting Workforce Strategies Overall, SEC has been addressing many of the administrative, educational, and other requirements to support human capital programs and workforce strategies, including (1) educating managers and employees on the use of flexibilities, (2) streamlining and improving administrative processes, and (3) building transparency and accountability into its human capital system. To this end, SEC requires some training for supervisors and new employees on the use of human capital flexibilities. OHR told us that it informally reviews its administrative processes and has been working to improve the administration of some human capital flexibilities. In addition, we found that SEC has promoted transparency and accountability in the use of these flexibilities. SEC Requires Some Training for Supervisors and New Employees on Flexibilities As discussed in prior GAO work, managers and supervisors can be much more effective in using human capital strategies that involve flexibilities if they are properly trained to identify when they can be used and how they can be administered. In addition, to avoid confusion and misunderstandings, it is also important to educate employees about how the agency uses human capital flexibilities and what rights employees have under policies and procedures related to human capital. According to OHR officials, supervisors are usually required to attend training on policies and practices related to newly implemented human capital programs. For example, SEC has focused on strengthening its telework program. In the spring of 2005, the agency hired a consultant to develop and deliver a comprehensive training program designed to better equip supervisors to manage remote workers. SEC management said that while the training was not mandatory, supervisors were strongly encouraged to participate. In addition, management from several divisions confirmed that all of their supervisors and managers had been briefed on available human capital flexibilities at SEC, especially alternative work schedules and telework. SEC also has disseminated information on human capital programs to new and current employees. New employees receive such information at a required orientation session. OHR officials told us that current employees can receive information concerning human capital flexibilities through administrative notices, technical training, daily consultation with OHR staff, and postings of human capital information on the agency’s intranet. SEC has also been finalizing an SEC employee handbook that provides information on human capital flexibilities. SEC Has Improved Administrative Processes That Support the Use of Some Flexibilities As suggested in our prior work, it is important that agency officials look for instances in which administrative processes can be re-engineered to more effectively administer flexibilities. OHR officials told us that while they do not conduct a formal evaluation of the effectiveness of existing administrative processes, they do solicit feedback from divisions and agencies and adjust processes to meet their needs. For example, to expedite the hiring process for a division that had a substantial number of positions to fill, SEC delegated authority to grant recruitment bonuses to the division’s director, allowing the division to more quickly and readily recruit highly desirable candidates. In another example, OHR officials told us they plan to develop and implement recommendations based on SEC managers’ suggestions provided in our 2005 study of SLR programs implemented by various federal agencies. Specifically, we recommended that SEC build on current efforts to measure the impact of the repayment program by determining now what indicators SEC will use to track program success, what baseline SEC will use to measure resulting program changes, what data SEC needs to collect, and whether SEC could use periodic surveys to track employee attitudes about the program. Additionally, OHR officials said that their office has surveyed managers and employees to gauge the ease of administering policies and procedures. Similarly, OHR has asked employees hired using flexibilities (such as recruitment bonuses) and employees who participate in the telework and student loan repayment programs for suggestions to improve administrative processes. According to OHR officials, OHR plans to continue to refine collection and analysis of this information as the office develops and implements the balanced scorecard. SEC Has Processes to Promote Transparency and Accountability in the Use of Flexibilities In our prior agencywide work, we found that clear guidelines for using specific flexibilities and holding managers and supervisors accountable for their fair and effective use are essential for successfully implementing workforce strategies. SEC has some processes in place to promote transparency and accountability in the use of flexibilities. According to SEC management, key stakeholders—OHR staff, Employee-Labor Relations (ELR) specialists, managers, and senior management officials—have assisted in developing guidelines for using flexibilities. In addition, OHR officials told us that the National Treasury Employees Union, the labor organization that represents SEC employees, is involved in all matters affecting employees in the union. In using human capital flexibilities, SEC generally requires employees to prepare and submit a written request that must then receive managerial approval and, in some cases, input from ELR as well as OHR. To help ensure accountability in the use of flexibilities, employees’ requests go through more than one level for approval or disapproval. For example, to telework, employees first submit a written request to their immediate supervisor, who then forwards it to a second-level supervisor for final approval or disapproval. If the request is denied, the second-level supervisor must document why. If there is a “close call” in approving or denying a telework request, ELR or OHR staff may be consulted. SEC officials told us that ELR usually gets involved when a request is denied. According to SEC officials, the agency requires written justification for denials of employee application for most types of flexibilities, not just telework. Outside agencies also play a role in ensuring accountability in SEC’s use of human capital policies, programs, and options. SEC’s use of flexibilities is subject to review by OPM, OMB, the Merit Systems Protection Board, Congress, and us. Specifically, OPM monitors SEC’s use of direct hire authority, as well as student loan repayment. Moreover, according to SEC, unionized employees can file a grievance under the provisions of the collective bargaining agreement, and there is an administrative grievance process in place for nonunionized employees. Principle 5: SEC Is Developing Additional Human Capital Measures and a Formal Process by Which to Link the Achievement of Its Human Capital and Strategic Goals Our prior agencywide work found that agencies should develop appropriate performance measures to link human capital measures with strategic goals. Performance measures, appropriately designed, can be used to gauge success and evaluate the contribution of human capital activities toward achieving programmatic goals. SEC management said that SEC has informally monitored the agency’s progress toward achieving some human capital goals using a few performance measures. SEC mainly has monitored hiring, attrition, and retention rates. These indicators, along with other indicators compiled by the divisions and offices to measure performance related to programmatic goals, compose SEC’s management “dashboards.” The “dashboards” are indicators compiled monthly by the Executive Director’s office and are designed to present regular snapshots of the divisions’ and offices’ progress in meeting budget, staffing, and performance objectives. One division official said that the turnover rates and measures of supervisors’ tenure included in the dashboards were particularly useful. Division managers said they consulted with OHR when the human capital indicators identified potential issues. For example, a division manager we interviewed noted that one human capital measure indicated few women in the division were applying for branch chief jobs, and the division has been working with OHR to determine the reasons why. Although SEC uses some human capital indicators, OHR officials acknowledged that they needed to develop additional measures because their current indicators capture output measures for overall human capital strategies, such as turnover, but do not directly link to specific human capital initiatives. OHR officials explained that the balanced scorecard, discussed earlier, will link human capital initiatives to outcomes. Identifying performance measures and discussing how the agency will use them to evaluate the human capital strategies—before it starts to implement the strategies—can help agency officials think through the scope, timing, and possible barriers to evaluating the workforce plan. However, as we have found in prior work, developing meaningful outcome-oriented performance measures for both human capital and programmatic goals, and collecting performance data to measure achievement of these goals are major challenges for many federal agencies. Further, one SEC division official said it was particularly difficult to develop performance measures in areas dealing with the enforcement of laws and regulations. For example, in 2002 we reported that SEC strategic and annual performance plans did not clearly indicate the priority that disgorgement collections should receive in relation to SEC’s other goals and did not include collection-related performance measures. In our 2005 report, we found that SEC needed to make further progress in establishing performance measures to better track the effectiveness of its collection efforts, and track both receivers’ fees and the amounts distributed to harmed investors. Finally, SEC said that evaluations of the linkage between human capital and strategic goals currently take place informally during various meetings, including HCRB meetings, and the results of these evaluations are addressed through periodic adjustments made to deal with short-term problems. More specifically, SEC management said that HCRB members used the management “dashboards” to help make staffing decisions, but noted that the dashboards were not tightly linked to the HCRB process. However, OHR anticipates that the implementation of the balanced scorecard and its indicators will strengthen and formalize the linkage between human capital activities and strategic goals. Observations With the enhancements being made to its human capital management, SEC has begun to use a planning and management approach that ensures ongoing attention to human capital issues. SEC has been making changes to ensure management focuses not only on traditional personnel functions, but also on the broader issues of human capital management. Further, senior managers are beginning to focus on strategic issues in decision making. In particular, SEC has undertaken a number of initiatives that demonstrate its commitment to human capital planning. When enacted, these initiatives should begin to help address the agency’s human capital challenges, some of which are long-standing and cannot be quickly or easily overcome, such as succession planning. To ensure the success of SEC’s strategic goals, it is critical that SEC complete its human capital initiatives—in particular, its strategic human capital plan. A well-documented plan is an essential tool that can serve as a guide for SEC in workforce management and direct an effective, ongoing communications strategy that genuinely engages employees and other stakeholders in the creation and administration of human capital programs. Based on our discussions with OHR, SEC is in the process of creating a human capital plan. SEC’s finalized human capital plan is to include many of the best practices outlined in our five principles for workforce planning. While we are encouraged by SEC’s progress, three areas may warrant management attention as SEC continues to develop its human capital plan: conducting outreach with congressional stakeholders and the securities industry on strategic workforce planning, obtaining employee feedback on human capital strategies before they are implemented, and taking steps to better identify, understand, and document existing skills among staff. Obtaining feedback from congressional stakeholders and the securities industry could enhance SEC’s ability to gain feedback from these important groups. Further, employee input prior to implementation may increase SEC’s ability to determine whether its human capital strategies are understood and supported by the staff. In addition, by formally identifying and documenting existing skills among staff, SEC may more accurately estimate workforce needs and skill gaps, which is information that helps agencies determine appropriate human capital strategies. Finally, we want to stress the importance of ensuring that the plan formally links human capital activities with the goals in SEC’s strategic plan. This linkage will help SEC to use its workforce to increase the agency’s operational effectiveness and responsiveness. Agency Comments and Our Evaluation SEC, in written comments on a draft of this report that are reprinted in appendix II, stated that it agreed with our findings. SEC commented that its strategic human capital plan will soon be completed and that it will provide the long-term infrastructure to ensure that the progress SEC has made in human capital initiatives are institutionalized. SEC stated that its strategic human capital plan will include a rigorous strategic planning system that, once implemented, will address our concerns regarding the alignment of SEC’s human capital and strategic goals. SEC also commented that the work being done on integrating its human capital systems will more formally capture SEC’s institutional knowledge, which was another concern cited in the report. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time we will provide copies to the Chairman and Ranking Minority Member of the House Committee on Government Reform; the Chairman and Ranking Minority Member of the House Committee on Financial Services; the Chairman and Ranking Minority Member of the Senate Committee on Homeland Security and Governmental Affairs; and the Chairman and Ranking Minority Member of the Senate Committee on Banking, Housing and Urban Affairs. We will also send copies to the Chairman of the SEC and other interested parties, and we will make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-8678 or williamso@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III. Scope and Methodology In order to describe the progress the Securities and Exchange Commission (SEC) made in developing a strategic human capital plan, we gathered and analyzed data from a variety of sources. We reviewed GAO’s recent prior work on human capital issues at SEC. We also obtained information on SEC’s operations and strategic planning efforts, recent budget requests, human capital plans and strategies, workforce data, milestones and timelines, and performance measures. To collect data not identified through prior work, we contacted and conducted interviews with SEC, the Office of Management and Budget (OMB), and Office of Personnel Management (OPM) to obtain relevant information. To evaluate how SEC was developing its long-term strategies for acquiring, developing, and retaining staff to achieve the agency’s mission, we used the key principles for effective strategic workforce planning developed in Human Capital: Key Principles for Effective Strategic Workforce Planning as our criteria for identifying workforce planning practices that SEC planned or had under way. Using these five principles, we also identified related tasks associated with each principle to provide more specific examples of how each principle might be implemented. Additionally, we met with SEC, OPM, and OMB to discuss and collect information on the agency’s former and current practices and future plans to address human capital issues. After these initial meetings, we held follow-up meetings with SEC’s Office of Human Resources and other key offices and divisions to gather relevant information. We conducted our work in Washington, D.C., from April 2005 through November 2005 in accordance with generally accepted government auditing standards. Comments from the Securities and Exchange Commission GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Karen Tremba, Assistant Director; Allison Abrams; Marianne Anderson; William R. Chatlos; Kenneth Scott Derrick; Marc Molino; and Barbara Roesmann made key contributions to this report.

Corporate failures and accounting scandals led to changes in legislation governing U.S. securities markets, which resulted in increased workload demands on the Securities and Exchange Commission (SEC). As a result, Congress provided SEC with substantial budgetary increases to obtain more resources to help fulfill the agency's mission. GAO was asked to review SEC's strategic workforce planning efforts to efficiently and effectively utilize its resources. This report discusses (1) the progress SEC has made toward developing a strategic human capital plan and (2) whether SEC uses effective strategic workforce planning principles for acquiring, developing, and retaining staff. SEC has taken steps to implement a number of strategic human capital management initiatives, including developing its strategic human capital plan. In 2004, SEC split its Office of Administrative and Personnel Management into the Office of Administrative Services and the Office of Human Resources (OHR), allowing the agency to separate its administrative and personnel functions and hire an associate executive director to focus on assessing, developing, and implementing human capital programs. In April 2005, SEC created a more structured human capital council by expanding the role of the Executive Resources Board (ERB), now called the Human Capital Review Board (HCRB). The HCRB includes senior management from all major divisions and offices, the Chairman's office, the Executive Director, and OHR and follows a more formalized and regular process for reviewing and approving human capital decisions. According to SEC, as of November 2005, the agency was in the process of creating its first strategic human capital plan, which will be based on the Office of Personnel Management's Human Capital Assessment and Accountability Framework, but it has not set a completion date. GAO also found that many of SEC's efforts related to workforce planning to date have been consistent with five key principles for effective strategic workforce planning; however, some of these efforts were still being developed or could be improved. Specifically: SEC has involved top management and a variety of stakeholders during the development of its strategic human capital plan, but only some employees will have the opportunity to provide feedback before the plan is finalized; SEC has been taking steps to identify needed critical skills and competencies, but it lacks a formal process for identifying existing skills among staff and linking them to SEC's strategic goals; SEC has been using human capital strategies to address workforce needs and skill gaps, but some of these strategies have not been in place long enough to assess results; SEC is developing or changing many of the administrative, educational, and other requirements to support workforce strategies, particularly pertaining to the use of human capital flexibilities; and SEC is developing additional human capital indicators and a more formal process by which to measure the achievement of its human capital goals. However, SEC currently does not formally evaluate the effectiveness of its human capital strategies in fulfilling SEC's strategic goals.

Limitations in the Inventory Undermine Ability to Determine Extent of Civilian IC Elements’ Reliance on Contractors Limitations in the core contract personnel inventory hinder the ability to determine the extent to which the eight civilian IC elements used these personnel in 2010 and 2011 and to identify how this usage has changed over time. IC CHCO uses the inventory information in its statutorily- mandated annual personnel assessment to compare the current and projected number and costs of core contract personnel to the number and IC CHCO reported that the number of core costs during the prior 5 years.contract personnel full-time equivalents (FTEs) and their associated costs declined by nearly one-third from fiscal year 2009 to fiscal year 2011. However, we found a number of limitations with the inventory, including changes to the definition of core contract personnel, the elements’ use of inconsistent methodologies and a lack of documentation for calculating FTEs, and errors in reporting contract costs. On an individual basis, some of the limitations we identified may not raise significant concerns. When taken together, however, they undermine the utility of the information for determining and reporting on the extent to which the civilian IC elements use core contract personnel. Additionally, IC CHCO did not clearly explain the effect of the limitations when reporting the information to Congress. We identified several issues that limit the comparability, accuracy, and consistency of the information reported by the civilian IC elements as a whole including: Changes to the definition of core contract personnel. To address concerns that IC elements were interpreting the definition of core contract personnel differently and to improve the consistency of the information in the inventory, IC CHCO worked with the elements to develop a standard definition that was formalized with the issuance of Intelligence Community Directive (ICD) 612 in October 2009. Further, IC CHCO formed the IC Core Contract Personnel Inventory Control Board, which has representatives from all of the IC elements, to provide a forum to resolve differences in the interpretation of IC CHCO’s guidance for the inventory. As a result of the board’s efforts, IC CHCO provided supplemental guidance in fiscal year 2010 to either include or exclude certain contract personnel, such as those performing administrative support, training support, and information technology services. While these changes were made to—and could improve—the inventory data, it is unclear the extent to which the definitional changes contributed to the reported decrease in the number of core contract personnel and their associated costs from year to year. For example, for fiscal year 2010, officials from one civilian IC element told us they stopped reporting information technology help desk contractors, which had been previously reported, to be consistent with IC CHCO’s revised definition. One of these officials stated consequently that the element’s reported reduction in core contract personnel between fiscal years 2009 and 2010 did not reflect an actual change in their use of core contract personnel, but rather a change in how core contract personnel were defined for the purposes of reporting to IC CHCO. However, IC CHCO included this civilian IC element’s data when calculating the IC’s overall reduction in number of core contract personnel between fiscal years 2009 and 2011 in its briefing to Congress and the personnel level assessment. IC CHCO explained in both documents that this civilian IC element’s rebaselining had an effect on the element’s reported number of contractor personnel for fiscal year 2010 but did not explain how this would limit the comparability of the number and costs of core contract personnel for both this civilian IC element and the IC as a whole. Inconsistent methodologies for determining FTEs. The eight civilian IC elements used significantly different methodologies when determining the number of FTEs. For example, some civilian IC elements estimated contract personnel FTEs using target labor hours while other civilian IC elements calculated the number of FTEs using the labor hours invoiced by the contractor. As a result, the reported numbers were not comparable across these elements. The IC CHCO core contract personnel inventory guidance for both fiscal years 2010 and 2011 did not specify appropriate methodologies for calculating FTEs, require IC elements to describe their methodologies, or require IC elements to disclose any associated limitations with their methodologies. Depending on the methodology used, an element could calculate a different number of FTEs for the same contract. For example, for one contract we reviewed at a civilian IC element that reports FTEs based on actual labor hours invoiced by the contractor, the element reported 16 FTEs for the contract. For the same contract, however, a civilian IC element that uses estimated labor hours at the time of award would have calculated 27 FTEs. IC CHCO officials stated they had discussed standardizing the methodology for calculating the number of FTEs with the IC elements but identified challenges, such as identifying a standard labor-hour conversion factor for one FTE. IC CHCO guidance for fiscal year 2012 instructed elements to provide the total number of direct labor hours worked by the contract personnel to calculate the number of FTEs for each contract, as opposed to allowing for estimates, which could improve the consistency of the FTE information reported across the IC. Lack of documentation for calculating FTEs. Most of the civilian IC elements did not maintain readily available documentation of the information used to calculate the number of FTEs reported for a significant number of the records we reviewed. As a result, these elements could not easily replicate the process for calculating or validate the reliability of the information reported for these records. Federal internal control standards call for appropriate documentation For 37 to help ensure the reliability of the information reported.percent of the 287 records we reviewed, however, we could not determine the reliability of the information reported. Inaccurately determined contract costs. We could not reliably determine the costs associated with core contract personnel, in part because our analysis identified numerous discrepancies between the amount of obligations reported by the civilian IC elements in the inventory and these elements’ supporting documentation for the records we reviewed. For example, we found that the civilian IC elements either under- or over-reported the amount of contract obligations by more than 10 percent for approximately one-fifth of the 287 records we reviewed. Further, the IC elements could not provide complete documentation to validate the amount of reported obligations for another 17 percent of the records we reviewed. Civilian IC elements cited a number of factors that may account for the discrepancies, including the need to manually enter obligations for certain contracts or manually delete duplicate contracts. Officials from one civilian IC element noted that a new contract management system was used for reporting obligations in the fiscal year 2011 inventory, which offered greater detail and improved functionality for identifying obligations on their contracts; however, we still identified discrepancies in 18 percent of this element’s reported obligations in fiscal year 2011 for the records in our sample. In our September 2013 report, we recommended that IC CHCO clearly specify limitations, significant methodological changes, and their associated effects when reporting on the IC’s use of core contract personnel. We also recommended that IC CHCO develop a plan to enhance internal controls for compiling the core contract personnel inventory. IC CHCO agreed with these recommendations and described steps it was taking to address them. Specifically, IC CHCO stated it will highlight all adjustments to the data over time and the implications of those adjustments in future briefings to Congress and OMB. In addition, IC CHCO stated it has added requirements for the IC elements to include the methodologies used to identify and determine the number of core contract personnel and their steps for ensuring the accuracy and completeness of the data. Inventory Provides Limited Insight into Functions Performed by Contractors and Reasons for Their Use The civilian IC elements have used core contract personnel to perform a range of functions, including human capital, information technology, program management, administration, collection and operations, and security services, among others. However, the aforementioned limitations we identified in the obligation and FTE data precluded us from using the information on contractor functions to determine the number of personnel and their costs associated with each function category. Further, the civilian IC elements could not provide documentation for 40 percent of the contracts we reviewed to support the reasons they cited for using core contract personnel. As part of the core contract personnel inventory, IC CHCO collects information from the elements on contractor-performed functions using the primary contractor occupation and competency expertise data field. An IC CHCO official explained that this data field should reflect the tasks performed by the contract personnel. IC CHCO’s guidance for this data field instructs the IC elements to select one option from a list of over 20 broad categories of functions for each contract entry in the inventory. Based on our review of relevant contract documents, such as statements of work, we were able to verify the categories of functions performed for almost all of the contracts we reviewed, but we could not determine the extent to which civilian IC elements contracted for these functions. For example, we were able to verify for one civilian IC element’s contract that contract personnel performed functions within the systems engineering category, but we could not determine the number of personnel dedicated to that function because of unreliable obligation and FTE data. Further, the IC elements often lacked documentation to support why they used core contract personnel. In preparing their inventory submissions, IC elements can select one of eight options for why they needed to use contract personnel, including the need to provide surge support for a particular IC mission area, insufficient staffing resources, or to provide unique technical, professional, managerial, or intellectual expertise to the IC element that is not otherwise available from U.S. governmental civilian or military personnel. However, for 81 of the 102 records in our sample coded as unique expertise, we did not find evidence in the statements of work or other contract documents that the functions performed by the contractors required expertise not otherwise available from U.S. government civilian or military personnel. For example, contracts from one civilian IC element coded as unique expertise included services for conducting workshops and analysis, producing financial statements, and providing program management. Overall, the civilian IC elements could not provide documentation for 40 percent of the 287 records we reviewed. Limited Progress Has Been Made in Developing Policies and Strategies on Contractor Use to Mitigate Risks CIA, ODNI, and the executive departments that are responsible for developing policies to address risks related to contractors for the six civilian IC elements within those departments have generally made limited progress in developing such policies. Further, the eight civilian IC elements have generally not developed strategic workforce plans that address contractor use and may be missing opportunities to leverage the inventory as a tool for conducting strategic workforce planning and for prioritizing contracts that may require increased management attention and oversight. By way of background, federal acquisition regulations state that certain functions government agencies perform, such as setting agency policy and issuing regulations, are inherently governmental and must be performed by federal employees. In some cases, contractors perform functions closely associated with the performance of inherently governmental functions. For example, contractors performing certain intelligence analysis activities may closely support inherently governmental functions. For more than 20 years, OMB procurement policy has indicated that agencies should provide a greater degree of scrutiny when contracting for services that closely support inherently governmental functions. The policy directs agencies to ensure that they maintain sufficient government expertise to manage the contracted work. The Federal Acquisition Regulation also addresses the importance of management oversight associated with contractors providing services that have the potential to influence the authority, accountability, and responsibilities of government employees. Our prior work has examined reliance on contractors and the mitigation of related risks at the Department of Defense, Department of Homeland Security, and several other civilian agencies and found that they generally did not fully consider and mitigate risks of acquiring services that may inform government decisions. Within the IC, core contract personnel perform the types of functions that may affect an IC element’s decision-making authority or control of its mission and operations. While core contract personnel may perform functions that closely support inherently governmental work, these personnel are generally prohibited from performing inherently governmental functions. Figure 1 illustrates how the risk of contractors influencing government decision making is increased as core contract personnel perform functions that closely support inherently governmental functions. More recently, OFPP’s September 2011 Policy Letter 11-01 builds on past federal policies by including a detailed checklist of responsibilities that must be carried out when agencies rely on contractors to perform services that closely support inherently governmental functions. The policy letter requires executive branch departments and agencies to develop and maintain internal procedures to address the requirements of the guidance. OFPP, however, did not establish a deadline for when agencies need to complete these procedures. In 2011, when we reviewed civilian agencies’ efforts in managing service contracts, we concluded that a deadline may help better focus agency efforts to address risks and therefore recommended that OFPP establish a near-term deadline for agencies to develop internal procedures, including for services that closely support inherently governmental functions. OFPP generally concurred with our recommendation and commented that it would likely establish time frames for agencies to develop the required internal procedures, but it has not yet done so. In our September 2013 report, we found that CIA, ODNI, and the departments of the other civilian IC elements had not fully developed policies that address risks associated with contractors closely supporting inherently governmental functions. DHS and State had issued policies and guidance that addressed generally all of OFPP Policy Letter 11-01’s requirements related to contracting for services that closely support inherently governmental functions. However, the Departments of Justice, Energy, and Treasury; CIA; and ODNI were in various stages of developing required internal policies to address the policy letter. Civilian IC element and department officials cited various reasons for not yet developing policies to address all of the OFPP policy letter’s requirements. For example, Treasury officials stated that the OFPP policy letter called for dramatic changes in agency procedures and thus elected to conduct a number of pilots before making policy changes. We also found that decisions to use contractors were not guided by strategies on the appropriate mix of government and contract personnel. OMB’s July 2009 memorandum on managing the multisector workforce and our prior work on best practices in strategic human capital management have indicated that agencies’ strategic workforce plans should address the extent to which it is appropriate to use contractors.Specifically, agencies should identify the appropriate mix of government and contract personnel on a function-by-function basis, especially for critical functions, which are functions that are necessary to the agency to effectively perform and maintain control of its mission and operations. The OMB guidance requires an agency to have sufficient internal capability to control its mission and operations when contracting for these critical functions. While IC CHCO requires IC elements to conduct strategic workforce planning, it does not require the elements to determine the appropriate mix of personnel either generally or on a function-by-function basis. ICD 612 directs IC elements to determine, review, and evaluate the number and uses of core contract personnel when conducting strategic workforce planning but does not reference the requirements related to determining the appropriate workforce mix specified in OMB’s July 2009 memorandum or require elements to document the extent to which contractors should be used. As we reported in September 2013, the civilian IC elements’ strategic workforce plans generally did not address the extent to which it is appropriate to use contractors, either in general or more specifically to perform critical functions. For example, ODNI’s 2012- 2017 strategic human capital plan outlines the current mix of government and contract personnel by five broad function types: core mission, enablers, leadership, oversight, and other. The plan, however, does not elaborate on what the appropriate mix of government and contract personnel should be on a function-by-function basis. In August 2013, ODNI officials informed us they are continuing to develop documentation to address a workforce plan. Lastly, the civilian IC elements’ ability to use the inventory for strategic planning is hindered by limited information on contractor functions. OFPP’s November 2010 memorandum on service contract inventories indicates that a service contract inventory is a tool that can assist an agency in conducting strategic workforce planning. Specifically, an agency can gain insight into the extent to which contractors are being used to perform specific services by analyzing how contracted resources, such as contract obligations and FTEs, are distributed by function across an agency. The memorandum further indicates that this insight is especially important for contracts whose performance may involve critical functions or functions closely associated with inherently governmental functions. When we met with OFPP officials during the course of our work, they stated that the IC’s core contract personnel inventory serves this purpose for the IC and, to some extent, follows the intent of the service contract inventories guidance to help mitigate risks. OFPP officials stated that IC elements are not required to submit separate service contract inventories that are required of the civilian agencies and DOD, in part because of the classified nature of some of the contracts. The core contract personnel inventory, however, does not provide the civilian IC elements with detailed insight into the functions their contractors are performing or the extent to which contractors are used to perform functions that are either critical to support their missions or closely support inherently governmental work. In our September 2013 report, we concluded that without complete and accurate information in the core contract personnel inventory on the extent to which contractors are performing specific functions, the civilian IC elements may be missing an opportunity to leverage the inventory as a tool for conducting strategic workforce planning and for prioritizing contracts that may require increased management attention and oversight. In our September 2013 report, we recommended that the Departments of Justice, Energy, and Treasury; CIA; and ODNI set time frames for developing guidance that would fully address OFPP Policy Letter 11-01’s requirements related to closely supporting inherently governmental functions. These agencies did not comment on our recommendation, and we will continue to follow up with them to identify what actions, if any, they are taking to address our recommendation. To improve the ability of the civilian IC elements to strategically plan for their contractors and mitigate associated risks, we also recommended that IC CHCO revise ICD 612 to require IC elements to identify their assessment of the appropriate workforce mix on a function-by-function basis, assess how the core contract personnel inventory could be modified to provide better insights into the functions performed by contractors, and require the IC elements to identify contracts within the inventory that include services that are critical or closely support inherently governmental functions. IC CHCO generally agreed with these recommendations and indicated it would explore ways to address the recommendations. In conclusion, IC CHCO and the civilian IC elements recognize that they rely on contractors to perform functions essential to meeting their missions. To effectively leverage the skills and capabilities that contractors provide while managing the government’s risk, however, requires agencies to have the policies, tools, and data in place to make informed decisions. OMB and OFPP guidance issued over the past several years provide a framework to help assure that agencies appropriately identify, manage and oversee contractors supporting inherently governmental functions, but we found that CIA, ODNI, and several of the departments in our review still need to develop guidance to fully implement them. Similarly, the core contract personnel inventory can be one of those tools that help inform strategic workforce decisions, but at this point the inventory has a number of data limitations that undermines its utility. IC CHCO has recognized these limitations and, in conjunction with the IC elements, has already taken some actions to improve the inventory’s reliability and has committed to doing more. Collectively, incorporating needed changes into agency guidance and improving the inventory’s data and utility, as we recommended, should better position the IC CHCO and the civilian IC elements to make more informed decisions. Chairman Carper, Ranking Member Coburn, and Members of the Committee, this concludes my prepared remarks. I would be happy to answer any questions that you may have. GAO Contact and Staff Acknowledgments For questions about this statement, please contact Timothy DiNapoli at (202) 512-4841, or at dinapolit@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. Individuals making key contributions to this testimony include Molly W. Traci, Assistant Director; Claire Li; and Kenneth E. Patton. This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

The IC uses core contract personnel to augment its workforce. These contractors typically work alongside government personnel and perform staff-like work. Some core contract personnel require enhanced oversight because they perform services that could significantly influence the government's decision making. In September 2013, GAO issued a classified report that addressed (1) the extent to which the eight civilian IC elements use core contract personnel, (2) the functions performed by these personnel and the reasons for their use, and (3) whether the elements developed policies and strategically planned for their use. GAO reviewed and assessed the reliability of the elements' core contract personnel inventory data for fiscal years 2010 and 2011, including reviewing a nongeneralizable sample of 287 contract records. GAO also reviewed agency acquisition policies and workforce plans and interviewed agency officials. In January 2014, GAO issued an unclassified version of the September 2013 report, GAO-14-204 . This statement is based on the information in the unclassified GAO report. Limitations in the intelligence community's (IC) inventory of contract personnel hinder the ability to determine the extent to which the eight civilian IC elements—the Central Intelligence Agency (CIA), Office of the Director of National Intelligence (ODNI), and six components within the Departments of Energy, Homeland Security, Justice, State, and the Treasury—use these personnel. The IC Chief Human Capital Officer (CHCO) conducts an annual inventory of core contract personnel that includes information on the number and costs of these personnel. However, GAO identified a number of limitations in the inventory that collectively limit the comparability, accuracy, and consistency of the information reported by the civilian IC elements as a whole. For example, changes to the definition of core contract personnel limit the comparability of the information over time. In addition, the civilian IC elements used various methods to calculate the number of contract personnel and did not maintain documentation to validate the number of personnel reported for 37 percent of the records GAO reviewed. GAO also found that the civilian IC elements either under- or over-reported the amount of contract obligations by more than 10 percent for approximately one-fifth of the records GAO reviewed. Further, IC CHCO did not fully disclose the effects of such limitations when reporting contract personnel and cost information to Congress, which limits its transparency and usefulness. The civilian IC elements used core contract personnel to perform a range of functions, such as information technology and program management, and reported in the core contract personnel inventory on the reasons for using these personnel. However, limitations in the information on the number and cost of core contract personnel preclude the information on contractor functions from being used to determine the number of personnel and their costs associated with each function. Further, civilian IC elements reported in the inventory a number of reasons for using core contract personnel, such as the need for unique expertise, but GAO found that 40 percent of the contract records reviewed did not contain evidence to support the reasons reported. Collectively, CIA, ODNI, and the departments responsible for developing policies to address risks related to contractors for the other six civilian IC elements have made limited progress in developing those policies, and the civilian IC elements have generally not developed strategic workforce plans that address contractor use. Only the Departments of Homeland Security and State have issued policies that generally address all of the Office of Federal Procurement Policy's requirements related to contracting for services that could affect the government's decision-making authority. In addition, IC CHCO requires the elements to conduct strategic workforce planning but does not require the elements to determine the appropriate mix of government and contract personnel. Further, the inventory does not provide insight into the functions performed by contractors, in particular those that could inappropriately influence the government's control over its decisions. Without complete and accurate information in the inventory on the extent to which contractors are performing specific functions, the elements may be missing an opportunity to leverage the inventory as a tool for conducting strategic workforce planning and for prioritizing contracts that may require increased management attention and oversight.

Small Business: Taxpayers Face Many Layers of Requirements Mr. Chairman and Members of the Committee: I want to thank you for inviting me here today to discuss small business tax issues. As the Internal Revenue Service (IRS) is reorganizing into four operating units, one of which is dedicated to small businesses, the agency faces critical challenges in meeting the needs of taxpayers and its managers and employees. As my testimony underscores, small businesses are an important category of taxpayers. Not only do they account for nearly half the total taxes collected annually, but they also have extensive interactions with IRS about some very difficult and complex tax issues. As you requested, we focused on federal taxes in relation to four types of small businesses (including farmers)—sole proprietorship, partnership, S corporation, and corporation. My remarks today concern (1) the federal filing, reporting, and deposit requirements that apply to small businesses; (2) the actual experience of small businesses in meeting these requirements, including their involvement in IRS’ enforcement processes; (3) the burden small businesses can face in complying; and (4) IRS’ efforts to reduce small businesses’ compliance burden and improve customer service, especially IRS’ planned reorganization. My statement today is based on our ongoing small business tax work for the Committee. To develop the information, we reviewed IRS forms, publications, manuals, and related Internal Revenue Code (IRC) provisions; collected and analyzed relevant data; and interviewed agency officials who were cognizant of small business tax issues and IRS’ efforts to improve small business customer service and reduce compliance burden. We also drew from our past reports and testimonies and our current work related to small business tax issues. We experienced several limitations during the course of our work. As described later in this statement, much of the data we sought to obtain were not collected in IRS information systems or were not sufficiently reliable. To obtain and analyze the available data, we often had to rely upon sampling, matching, and ad hoc techniques. In addition, data were not available for a single year across all variables, so we had to use data from different years as needed. We did not verify the reliability of IRS data used in this testimony, except for some limited checking described in the statement. Lastly, our review did not address IRS activities related to small business nonfilers. Background Businesses established in the United States (including farmers) are generally structured in one of four forms: sole proprietorship, partnership, S corporation, or corporation. The IRC distinguishes small businesses from larger businesses in a number of ways, and IRS has used different definitions of small business for different internal operating purposes. Now, as part of its current reorganization effort, IRS is developing an agencywide definition of small business, which we have adopted for this testimony. Small businesses (including farmers) are sole proprietorships, partnerships, S corporations, and corporations that reported less than $5 million in assets. In this context, a large majority of all businesses are small businesses. Small Businesses Face Multiple Layers of Tax Requirements Small businesses, like large businesses, are subject to multiple layers of filing, reporting, and deposit requirements that reflect how the business is organized, whether it has employees, and the nature of its business operations. By our count, there are more than 200 requirements—which we grouped into four layers—that may apply to small businesses as well as larger businesses and other taxpayers. The requirements are designed to implement a variety of tax policies. Not only do they provide a way to collect taxes from businesses, but also to use businesses to collect taxes owed by third parties (e.g., employees’ personal income tax withholding and Social Security and Medicare (FICA) taxes). In contemplating the significance of the total number, it is important to know that many of the requirements apply to businesses generally and that it is highly unlikely that any business would need to complete all 200 requirements. This is because the forms, schedules, and other requirements that apply to a particular small business reflect how the business is organized, whether it has employees, and the nature of its business operations. It is also important to note that although a few of the requirements must be submitted more frequently than once a year, the vast majority is submitted annually. Appendix I provides a listing of all the requirements that we identified. Also, as described later in this statement, the requirements reflect the decisions and compromises of Congress and Administrations in keeping with their policy goals and objectives. Primary Income Tax Returns Represent One Layer of Requirements The requirements with which a small business must comply depend upon how it is organized—sole proprietorship, partnership, S corporation, and corporation. Each business type has its own primary income tax return, some of which include a set of schedules embedded in the form. For example, the primary corporate income tax return, Form 1120, U.S. Corporation Income Tax Return, contains eight embedded schedules. To further support their primary income tax return, certain types of businesses and individuals with business income must also attach a mandatory schedule to their return. (See table 1.) For example, sole proprietorships must file Form 1040, U.S. Individual Income Tax Return and Schedule C, Profit or Loss from Business. As pass-through entities, partnerships and S corporations each have two separate sets of returns– one for the entity and one for its owners. In addition to the primary income tax return filed by the entity, each owner must file a Form 1040 and a Schedule E, Supplemental Income and Loss. Employment Tax Adds a Second Layer of Requirements A small business’ decision to hire employees adds a second layer of tax requirements. We identified more than 10 different federal employment tax requirements that potentially apply to small businesses. The number of employment tax filings and deposits depends on the number of employees and the resulting employment tax liability owed at a particular time. (See table 2.) For each employee, a small business is generally responsible for collecting and remitting several federal taxes with varying frequency stipulations–withholdings for employees’ personal income tax along with the employer’s matching amount, FICA, and federal unemployment tax (FUTA). A small business employer must report quarterly the amount of personal income tax withheld and FICA paid for each employee on Form 941, Employer’s Quarterly Federal Tax Return. The employer must deposit income tax withheld, including the matching amount, and FICA taxes either by mail or electronically either quarterly, monthly, weekly, or the next business day, depending on the employers’ tax liability. If total deposits of withheld income taxes and FICA taxes were more than $50,000 in the preceding year, the employer must make electronic deposits using the Electronic Federal Tax Payment System (EFTPS). In addition, a small business employer must annually report and quarterly deposit FUTA taxes separately from FICA and withheld income tax. Lastly, an employer must send a federal Form W-2, Wage and Earnings Statement to each of its employees and file federal Forms W-3, Transmittal of Wage and Tax Statements and W-2 with the Social Security Administration. In sum, hiring employees—even just one employee—is a critical decision for small businesses in terms of their tax liability and the complexities of the tax administration processes that they face. Offering Employee Benefits Adds a Third Layer of Requirements The decision to offer employee pension, fringe, and welfare benefit plans adds another layer of requirements for a small business. Some benefit plans may substantially increase the number of filing requirements that small businesses face, while others are simplified and entail few if any filing requirements. We counted over 10 filing and reporting requirements pertaining to benefit plans, including requirements like the Form 5500 series and related schedules. filing and reporting requirements with IRS (Form 5500 series). In addition, most fringe and welfare benefit plans entail filing and reporting requirements with IRS (Form 5500 series). (For a complete list see table I.3 in app. I.) Other Business Operations Add a Fourth Layer of Requirements The remaining tax requirements that potentially apply to small businesses depend upon the nature of the business activities. A few of these secondary requirements are specific to a type of business, but most are generally applicable to all businesses. For example, there are requirements that pertain to the depreciation of assets, the sale of business property, and claims for a credit to increase research activities. These requirements, of which there are nearly 140, range across income taxes, excise taxes, and information reporting. (For a complete list see tables I.4, I.5, and I.6 in app. I.) Some of these requirements are used to implement provisions in the IRC (some of which were recently enacted) that can benefit small (and other) businesses. For example, businesses must complete Form 8861, Welfare-to-Work Credit, to receive a tax credit for hiring long-term family assistance recipients. Also, businesses must complete Form 4562 to claim deductions for depreciation and amortization of business assets or to make the election to immediately expense the cost of certain property. The election to expense property allows the taxpayer to take an immediate deduction instead of using the depreciation schedules to recover a portion of the costs annually over the property’s useful life. (The total cost that may be expensed is $18,500 for 1998). Among excise taxes alone, we identified about 70 requirements that potentially apply to small businesses. (For a complete list see tables I.5 and I.6 in app. I.) Generally, though, most small businesses are not responsible for filing excise taxes. According to IRS, fewer than 800,000 small businesses filed excise tax returns in 1997. IRS and the Bureau of Alcohol, Tobacco and Firearms (ATF) administer many of the federal excise taxes. The excise taxes administered by IRS consist of several broad categories, including environmental taxes, communications taxes, fuel taxes, retail sale of heavy trucks and trailers, luxury taxes on passenger cars, and manufacturers’ taxes on a variety of different products. ATF administers excise taxes on the production, sale, or import of guns, tobacco, or alcohol products or the manufacture of equipment for their production. Small Businesses’ Experience in Filing and Enforcement Processes Could Not Be Fully Determined Limitations in IRS’ information systems prevented us from fully determining the extent to which small businesses actually filed various required forms and schedules and which businesses made deposits, or determine the extent of small businesses’ involvement in IRS’ enforcement processes. We were, however, able to obtain and analyze limited data on small business filings of income tax forms in 1995. As we discuss in detail in the final section of this statement, the data limitations currently hinder IRS’ ability to effectively manage its activities and serve small businesses and, as IRS has acknowledged, will continue to be a serious impediment until the systems are improved. Information Systems Significantly Limit Access to Data The first problem we encountered pertained to locating information that we needed. IRS has dozens of discrete databases -- so many that it is difficult to determine what data are in them, what the data mean, how the files are structured, or even how many files there might be. The databases are function-specific (e.g., Examination) and designed to reflect transactions at different points in the life of a return or information report—from its receipt to its disposition. As a consequence, IRS does not have any easy means to access comprehensive information about taxpayers or their accounts in order to provide high quality customer service. Second, many of the IRS datasets do not allow for a detailed analysis of the information they contain. We were unable to separate out the four types of small businesses in some the datasets. For example, the Form 941 that employers are to use to file their employment taxes does not have information on business assets or gross receipts that would have allowed us to categorize employers by size. Without this information, our alternative was to use information from the Business Master File. Accessing the appropriate tax module in that file might have made it possible to capture information on assets. could have taken many months for the agency to complete. Thus, we decided not to request IRS to make the extractions. Filing Experience of Small Businesses Income Tax Although we weren’t able to obtain data on most types of requirements, we were able to obtain information pertaining to small business income tax requirements. Our analysis of 1995 IRS data for approximately 44 forms and 46 related schedules that IRS believes are those most commonly filed showed that small businesses, on average, filed one secondary form in addition to their primary income tax return, with little variation among the different types of business. The most commonly filed secondary income tax form among the 44 was Form 4562, Depreciation and Amortization. Approximately 74 percent of farmers, 62 percent of partnerships, 69 percent of S corporations, and 73 percent of corporations filed the depreciation and amortization form in 1995. The returns for sole proprietorships were lower, with slightly less than 40 percent filing the depreciation and amortization form in 1995. corporations must file a Schedule K-1, Partner’s or Shareholder’s Share of Income, with IRS for each partner or shareholder. As a result, Schedule K-1 filings accounted for a significant proportion of the multiple schedules filed by partnerships and S corporations in that year. Employment Tax and Pensions IRS does have information on federal employment taxes, but it could not be broken out by small businesses. Further, IRS did not have sufficient and reliable data on the number of small businesses that filed pension forms in 1995. Enforcement Experience of Small Businesses IRS also did not have the data we needed on the extent to which small businesses are involved in both Examination and Collection activities. We did obtain limited data on audit rates and some aspects of how the audits concluded (i.e., with refunds, no change, or recommended changes). When IRS has indications that a small business may have failed to meet one or more of the aforementioned requirements, the business can become involved in IRS’ enforcement processes. These processes are basically the same for small businesses as for other taxpayers. They involve examining returns for potential errors or compliance problems, notifying taxpayers of suspected discrepancies, settling disputes over additional taxes recommended, and collecting taxes assessed. (App. 2 provides a simplified picture of IRS’ audit and dispute resolution process.) Audits IRS’ primary technique for assessing compliance with tax laws is to examine the accuracy of the tax reported on filed tax returns. In selecting returns to be audited, IRS attempts to focus on those it believes are most likely to have compliance problems. IRS data showed that about 2.3 percent of the small business income tax returns filed by small businesses in 1997 were audited, generally through audits conducted by IRS’ district offices. By contrast, IRS audited 1.3 percent of all returns filed in 1997. The audit rate for sole proprietors (individuals filing Schedule C) was 3.2 percent compared to 1.2 percent for individuals not filing Schedule C. According to IRS officials, the audit rate for small business taxpayers is higher than the overall rate because small businesses tend to have more compliance problems than other taxpayers. For example, in the area of employment tax audits, a small business could fall short of operating capital. As a consequence, it might divert some or all of its estimated tax deposits or employment tax withholdings to make up the shortfall, hoping to pay IRS at a later date. According to IRS officials, the amount of these unpaid taxes, penalties, and interest can pyramid quickly. The danger is that a business, which must rely on these funds for working capital, is likely to have other liabilities and delinquencies that reflect financial problems so severe that it cannot recover. Table 3 provides detailed information on the audit rates for the four types of small businesses. Statement Small Business: Taxpayers Face Many Layers of Requirements Size Total Gross receipts < $25,000 Gross receipts $25,000 < 100,000 Gross receipts $100,000 and over Total Gross receipts < $100,000 Gross receipts $100,000 and over Total Total Total Assets < $250,000 Assets $ 250,000 < $1 million Assets $1 million < $5 million 3.2% 3.2 2.6 4.1 1.8 1.3 2.8 0.6 1.0 2.1 1.2 3.5 7.8 About 98 percent of S corporations and 94 percent of partnerships were small businesses in 1995 (i.e., they had less than $5 million in assets, based on GAO’s analysis of IRS’ Statistics of Income data). Recommended Additional Taxes and Penalties Small business audits often result in recommendations for the assessment of additional tax and penalties. For the small business audits closed in 1995, 67 percent resulted in some recommended change to the reported tax liability or refundable credits, while about 33 percent resulted in no such changes. Some audits resulting in no change to the reported tax liability did result in changes to other return items deemed significant by IRS examiners. For example, net loss, which can be carried forward and claimed in future years, may have been overstated on the return and adjusted by IRS. Table 4 provides more detailed information on small business audit results. In considering the information presented, it is important to note that the audit recommendations do not equate to final audit outcomes. For example, recommendations may be partially or fully overturned in IRS appeals or in court decisions. Collections IRS’ Collection process starts at the point IRS identifies a taxpayer as not having paid the amount of tax due as determined by the tax assessment.First, IRS is to send a notice (or series of notices) to the taxpayers informing them of the amount owed. If the amount is not paid, IRS is authorized to employ enforcement powers to collect what is owed. IRS can refer the delinquency to an automated collection system call site where an employee calls the taxpayer by telephone, asking for payment. The payment arrangements may include installment agreements or an offer-in-compromise from the taxpayers if the full amount owed cannot be paid. Information about large and chronic tax delinquencies can be referred directly to one of IRS’ 33 district offices where IRS revenue officers may contact the taxpayer in person. According to IRS officials, small businesses’ audits involving employment taxes are often referred directly to district offices. In addition to liens and levies, IRS Collection officials have authority to seize and sell taxpayers’ property, such as cars or real estate. Seizure is generally a last resort to get payment of the amount owed and the IRS Restructuring and Reform Act (RRA) now requires a district director’s approval. We were unable to obtain information on the number of small businesses undergoing enforced collection actions (i.e., liens, levies, or seizures). Compliance Burden Is Hard to Measure, but Significant Although IRS does not have a reliable way to measure tax compliance burden or the portion attributable to small business tax requirements, there is common agreement that the burden is significant. Employment taxes present a microcosm of these requirements, the tax provisions that underlie them, and an illustration of how burdensome the requirements can be. IRS Does Not Have a Reliable Measure of Compliance Burden IRS has acknowledged that the measure of burden that it now uses to meet requirements of the Paperwork Reduction Act is inadequate, and IRS is beginning work to change it. Until IRS develops such a measure, it will be difficult for IRS or others to assess the extent to which the compliance burdens of small businesses are being reduced or increased. Developing such a measure, including that portion that IRS can influence, will not be easy. A key problem involves defining the set of activities that contributes to burden and figuring what portion of the resources expended are the result of federal tax regulations, state and local regulations, or are part of business operations that would have been done in the absence of the requirement. Although business officials and tax experts we have interviewed for past work identified considerable anecdotal examples of such compliance costs, the businesses told us that they did not routinely need, nor did they keep, information on these costs. A reason may be that business tax compliance strategies are usually not done in isolation of other business operations. Some business activities serve multiple purposes, and it is difficult to separate out the activities conducted primarily for tax reasons. For example, businesses told us that it would be difficult to take payroll expenditures and isolate those associated with tax compliance. To be comprehensive, any measure of compliance burden would need to include more than the resources expended to fill in the returns, forms, and schedules that we identified as being required of small business. In addition to the time and resources that small businesses expend to complete a return or schedule are the resources they expend to learn of the form and determine whether and how it might apply to their facts and circumstances. They also expend resources to collect the information necessary to complete the form and store any supporting documentation that IRS later might ask to see in connection with an inquiry or audit. Employment Tax Requirements Illustrate the Complexity and Burden Small Businesses Can Face Employment taxes are a case in point. As discussed earlier, when a business hires an employee, the business generally becomes responsible for collecting and paying personal income taxes withheld, FICA, and FUTA. To meet these requirements, employers must answer four questions: (1) Is the worker an employee covered by the tax? (2) Are the compensation payments made to the employee to be considered wages for employment tax purposes? (3) What is the employer’s employment tax liability related to these wages? (4) What are the associated deposit and filing requirements? The answers to these questions are not always clear-cut. For example, we have identified perennial problems and inconsistencies in IRS’ administration of common law rules governing whether a worker is an employee for employment tax purposes or is an independent contractor, who is responsible for payment of such taxes. Our reviews also have pointed out the complexities in determining whether the compensation paid to the employee fits the category of nontaxable compensation for such payments as fringe benefits. Making proper calculations of the periodic tax liability of compensation payments and meeting filing and depositing requirements also can be difficult. For the federal income tax, wages are to be withheld for each payroll period; and the amount is to be based on the amount of wages and number of allowances claimed by the employee on his or her federal Form W-4, Employee’s Withholding Allowance Certificate. For FICA, the employer is to deduct a certain percentage of the employee’s wages up to a dollar limit and a lesser percentage of wages above that amount. FUTA is paid at a different rate, but the amount paid can be reduced with credit for payments to state unemployment tax. Added to all of this, in many cases, employers will also need to make an additional set of calculations and remittances for state employment taxes. The complexities of employment taxes were not created by happenstance. They, like other tax requirements, reflect the compromises that have been made to address assorted tax policy issues. IRS Has Tried Many Approaches to Reduce Compliance Burden With tax laws and the ensuing regulations, forms, and instructions so complicated, it is not surprising that over the years IRS has tried many different approaches to reduce the compliance burden and make it less difficult for small businesses to meet their tax obligations. IRS has used targeted mailings, expanded toll-free telephone service, experimented with one-stop service facilities dedicated to small business clients, expanded its Web site, and sponsored seminars and other face-to-face educational programs in partnership with the Small Business Administration as means to educate small business taxpayers. IRS also has sought to make filing easier by encouraging electronic filing of information returns and by establishing a nationwide telephone service that these businesses can use to file their quarterly federal employment tax returns. Through programs such as the Market Segment Specialization Program, IRS has worked to improve its employees’ capacity to deal effectively and efficiently with business tax issues affecting specific industries or market segments, including small business issues, in its enforcement processes. Other IRS programs, including the Simplified Tax and Wage Reporting System, have been intended to reduce burden by increasing opportunities to file tax and wage forms electronically and improving coordination among federal and state tax administrators. Still other IRS programs have focused on effective and timely identification of small businesses that have not paid their proper tax so that compliance problems are resolved before they become overwhelming. While the benefits of such programs may not yet have been realized, the Commissioner of Internal Revenue has recognized the importance of IRS’ working with taxpayers in a more proactive manner to ease these compliance burdens. He also recognizes the importance of modernizing IRS’ information systems to allow for better informed, proactive interactions with taxpayers. Reorganization and Other Reforms Show Promise organizational blueprints for the small business unit are nearly complete, and implementation blueprints are in process. The vision of a modernized IRS is compelling, but IRS’ agenda is formidable. As IRS has acknowledged, reorganization will not, in itself, change IRS’ business processes, its culture, or the way in which the agency deals with taxpayers. Management, performance, and information systems improvements will also be critical. Managing for Results Is as Important as Organizational Structure As our past work on the Government Performance and Results Act demonstrates, IRS should follow results-oriented management principles in addition to reorganizing its structure. Our case studies of leading organizations using performance and accountability principles found that the organizations had varied structures, but similar results-oriented management strategies. These organizations placed great emphasis on clearly defined missions and desired outcomes and measuring and using information on performance. Their leaders devolved decision making and accountability, developed incentives to achieve organizational objectives, built expertise, and used an integrated approach to manage reform. They made clear their commitment to the fundamental principles of this type of management and to steps to ensure that managers and staff at all levels of the organization recognized that they must do the same. Driving a results orientation down through all levels of the organization can be particularly important because, traditionally, the danger to such reforms is that they become hollow, paper-filled exercises. By integrating results-oriented management into the day-to-day activities and culture of the organization and holding managers accountable for doing the same, leaders can help to avoid that danger. significant a reform effort. Some of our work is being done at the request of this committee. Because we believe that a results orientation will be critical to IRS’ success, we expect to pay close attention to how IRS is progressing in this area. Organizational and Individual Performance Measurement Systems Could Change Incentives and Help Reinforce IRS’ New Mission Performance measures can create powerful incentives to influence organizational and individual behavior. In this regard, IRS recently announced a new set of organizational performance measures that it believes reflect the agency’s new customer service emphasis, while also striking a balance between customer satisfaction, employee satisfaction, and business results. IRS is now in the process of further defining and implementing the measures for organizational performance, using a phased approach. IRS has not yet announced its approach for applying the measures to individual performance. IRS does, however, list the establishment of a new employee evaluation system as one of more than 150 short-term customer service improvements it hopes to complete by mid-2000. Doing so will be important. Unless the performance of IRS employees is based on incentives that are in accord with the agency’s new mission statement and aligned with its organizational measures, managers and front-line workers might find it easy to fall back on measures such as enforcement results and other productivity statistics—measures that have created problems for IRS in the past. Alternately, if employees come to believe that they should place disproportionate value on customer satisfaction, they might not take enforcement actions, even where appropriate, because the perceived risks of taking action might be seen to outweigh the risks of not taking action. The potential for such a pendulum swing is an additional reason for putting the systems in place expeditiously. and whether the tone of some evaluative statements discourages customer service. If this concern were borne out, IRS would need to modify the system to achieve the types of cultural change to which Congress and IRS’ leadership are committed. Success Will Also Depend on Implementation of Information Systems to Support Customer Service and Management Needs As IRS has recognized, the information systems that it uses to keep records on taxpayers’ accounts are fundamentally deficient and thwart IRS’ ability to provide high-quality customer service. For years, IRS has struggled with this problem, and we have made numerous recommendations for actions that IRS could take. As IRS begins to implement aspects of its reorganization plans, in the near term, IRS also plans to modify its existing systems so that it can better identify taxpayers’ needs in each of the four operating units. In the long term, as part of its modernization blueprint, IRS is to develop new systems and databases. This long-term effort will take several years, and even near-term efforts will pose serious challenges. In the interim, the limitations will make it more difficult to manage and improve customer service, even in a reorganized environment. Many of IRS’ current systems reflect the agency’s stovepipe structure and transaction-based business approach. Now that IRS is to be structured along taxpayer lines, its information systems need to reflect the new environment. They should provide managers and employees with convenient access to reliable up-to-date information on all relevant transactions between taxpayers and IRS. For example, the type of information we sought presumably would be the type that managers would need to know about small business taxpayers and understand their problems—including the source of the problems. If this kind of information about small businesses is not readily available or in a form suitable for analysis, it will be more difficult for unit managers to devise effective strategies to target resources and improve service. several delinquencies have occurred. Confusion may result over what has been paid and what remains due. Such confusion may be particularly difficult to resolve if IRS and the taxpayer are corresponding over a protracted period. Also, interest on any tax liability due would continue to accrue and could eventually come to equal or exceed the amount owed. Employment tax situations like this illustrate how fragmented account information can make it difficult for IRS to work with taxpayers to resolve their problems and can frustrate taxpayers seeking to settle their account by paying the taxes owed. Also, the extra time and energy that the taxpayer might spend due to IRS’ systems limitations is time away from income-producing activities that an already struggling business might ill afford to miss. IRS has said it is taking interim steps to address some of its data problems. IRS expects to develop a way of linking a customer identifier to the case information in 35 of its most important information systems. When this “workaround” is complete, IRS managers and front-line workers should know whether the return or information report data they might be using are for a small sole proprietor, partnership, S corporation, or corporation. However, the interim solution will not provide real-time information about the full range of transactions currently ongoing for a particular taxpayer. Nor will it be easy or inexpensive to put in place. As with IRS’ initiative to make its information systems Year 2000 compliant, the workaround will affect a large number of systems and involve many steps to program, implement, and validate. Nevertheless, IRS may not have a choice as it will remain hamstrung in its efforts to assist taxpayers in complying with tax laws until its systems are replaced. without adequate systems, IRS was forced to use ad hoc programming and substantial manual intervention to overcome pervasive internal control and systems weaknesses. However, these costly and time-consuming efforts could not be duplicated for fiscal year 1998 due to IRS’ loss of key Chief Financial Officer staff who were managing the preparation of its administrative financial statements. As a consequence, IRS has received a qualified opinion from us on most of its fiscal year 1998 administrative financial statements. Concluding Observations Small businesses, like large businesses, are subject to multiple layers of filing, reporting, and deposit requirements. Together, the requirements are intended to implement a complicated mix of fiscal and other policies— some of which benefit as well as burden businesses. Although IRS does not have a reliable way to measure the full extent of the compliance burden associated with the policies, the burden is significant. The reforms underway at IRS hold promise for small businesses and all taxpayers. One of the most visible signs that IRS may be changing is its establishment of four new operating units. However, reorganization will not be enough. As my statement underscores, management, performance, and information systems improvements will also be critical. Mr. Chairman, this concludes my prepared statement. I would be happy to answer any questions you or other Members of the Committee might have. Tax Requirements that Potentially Apply to Small Businesses TitleForm 1040 - U.S. Individual Income Tax Return Schedule C - Profit or Loss from a Business (Sole Proprietor) Schedule C-EZ - Net Profit from Business Form 1040 ES – Estimated Tax for Individuals Form 2210 - Underpayment of Estimated Tax by Individuals, Estates, and Trusts Form 1040 - U.S. Individual Income Tax Return Form 1065 - U.S. Partnership Return of Income Schedule F - Profit or Loss from Farming Schedule J - Farm Income Averaging Form 990C- Farmers' Cooperative Association Income Tax Return Form 1040 ES – Estimated Tax for Individuals Form 2210F - Underpayment of Estimated Tax by Farmers and Fisherman Form 1065 - U.S. Partnership Return (info return only) Schedule K1 - (form 1065) Partners Share of Income, Credits, Deductions etc. Form 1040 - U.S. Individual Income Tax Return Schedule E - Supplemental Income and Loss (part II) Form 1040 - U.S. Individual Income Tax Return Schedule E - Supplemental Income and Loss (part II) If business has employees (must file on magnetic media if 250 or more Form W-2s) Schedule H (Form 1120) - Section 280H Limitations for a Personal Service Corporation (PSC) Schedule PH (Form 1120) - U.S. Personal Holding Company (PHC) Tax Form 1118 - Foreign Tax Credit (form 1120); (attached to Form 1118 are schedule I - Reduction of Oil and Gas Extraction Taxes and Schedule J - Separate Limitation Loss Allocations) Form 2438 - Undistributed Capital Gains (attach to 1120-RIC or 1120-REIT) Form 4626 - Alternative Minimum Tax-- Corporations (file with Form 1120) Annually (unless used for a partial year) TitleTax Information Authorization Excise Tax Return Excise Tax Return – Alcohol and Tobacco (Puerto Rico) Excise Tax Return – Alcohol and Tobacco (Puerto Rico) Specific Transportation Bond-Distilled Spirits Or Wines Withdrawn for Transportation to Manufacturing Bonded Warehouse – Class Six Specific Export Bond – Distilled Spirits or Wine Application and Permit to Ship Puerto Rico Spirits to the United States Without Payment of Tax Certification of Tax Determination - Wine Drawback on Wine Exported Drawback on Beer Exported Beer for Exportation Application and Permit to Ship Liquors and Articles of Puerto Rico Manufacture Tax paid to the United States Bond - Drawback of Tax on Tobacco Products, Cigarette Papers or Tubes Monthly Report – Manufacturer of Tobacco Products Computation of Tax Agreement to Pay Tax on Puerto Rican Cigars or Cigarettes Inventory – Manufacturer of Tobacco Products Federal Firearms and Ammunition Excise Tax Deposit Claim for Drawback of Tax on Tobacco Products, Cigarette Papers, or Cigarette Tubes Claim – Alcohol, Tobacco, and Firearms Taxes Special Tax Registration and Return (Alcohol and Tobacco) Application for Tax Paid transfer and Registration of a Firearm Application for Tax-Exempt Transfer and Registration of a Firearm Special Occupational Tax Printing Request Continuing Export Bond- Distilled Spirits and Wine Continuing Transportation Bond Distilled Spirits Or Wines Withdrawn for Transportation to Manufacturing Bonded Warehouse – Class Six Drawback Bind – Distilled Spirits and Wine Tax Deferral Bond – Beer (Puerto Rico) Certification of Prepayment of Tax on Puerto Rico Cigars, Cigarettes, Cigarette Papers, or Cigarette Tubes Report of Multiple Sales or Other Disposition of Pistols and Revolvers Firearms Transaction Record Part I Over-the-Counter Firearms Transaction Record Part I – Low Volume – Over-the-Counter Firearms Transaction Record Part I - Intra-State Over-the-Counter (English-Spanish) Firearms Transaction Record Part II – Non-Over-the-Counter Firearms Transaction Record Part II – Low Volumne – Intra-State Non-Over-the-Counter Floor Stocks Tax Return 1993 Floor Stocks Tax Return (Cigarettes) Certificate of Taxpaid Alcohol Drawback on Distilled Spirits Exported Tax Deferred Bond – Distilled Spirits Floor Stocks Tax Return – Pipe Tobacco Federal Firearms and Ammunition Excise tax Return Application for Registration for Tax Free Transactions Under 26 USC 4221 (Firearms and Ammunition) Statement of Adjustment to the Puerto Rico or Virgin Islands Tax Account Tax Collection Waiver Certification of Ultimate Vendor for Use in Tax Refund Claim Under Section 6416 (b) (2) of the Internal Revenue Code (27 CFR 53.179 (b) (iii)) Purchaser’s Certificate of Tax Free Purchase for use as Supplies for Vessels and Aircraft (27 CFR 53.134 (d) (2)) Purchaser’s Certificate of Tax Free Purchase for State or Local Government Use (27 CFR 53.135 (c) (1)) Vendor’s Certificate of Tax-Free Purchase for Resale for Export (27 CFR 53.133 (d) (2)) Vendor’s Certificate of Tax-Free Purchase for Resale for Further Manufacture (27 CFR 53.132 (c) (2)) Application for Extension of Time for Payment of Excise Tax Consent to Extend the Time to Assess ATF Excise Tax Special Tax “Renewal” Registration and Return Special Tax Location Registration Listing Special Tax Stamp Special Tax Registration and Return National Firearms Act (NFA) Special Occupational Tax Inquiry Letter IRC Guideline/Worksheet for Late Excise Payment/Deposit or Tax Return Bond for Spirits or Distilled Spirits or Rum Brought into the US Free of Tax (Used by Virgin Islands) Bond for Articles Brought into the US Free of Tax (Used by Virgin Islands) Simplified Audit and Dispute Resolution Processes This appendix illustrates a simplified process for auditing tax returns, resolving disputed taxes, and collecting taxes owed. For the small percentage of returns that are audited, most tax issues are resolved during the audit process. However, some audited taxpayers dispute their additional taxes to Appeals, and a few seek to resolve their disputes with IRS in the courts. The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. Each day, GAO issues a list of newly available reports and testimony. 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Pursuant to a congressional request, GAO discussed small business tax issues, focusing on the: (1) federal filing, reporting, and deposit requirements that apply to small businesses; (2) actual experience of small businesses in meeting these requirements, including their involvement in the Internal Revenue Service's (IRS) enforcement processes; (3) burden small businesses can face in complying; and (4) IRS' efforts to reduce small businesses' compliance burden and improve customer service, especially IRS' planned reorganization. GAO noted that: (1) small businesses are subject to multiple layers of filing, reporting, and deposit requirements; (2) GAO identified more than 200 different Internal Revenue Code (IRC) requirements that potentially apply to small businesses; (3) the requirements reflect IRS' administration of a variety of tax and other policies; (4) GAO also found that it is highly unlikely that any business would need to comply with all or even most of these requirements; (5) those that apply would depend on how the small business is organized; (6) limitations in IRS information systems prevented GAO from fully determining the extent to which small businesses filed the various forms and schedules or their involvement in key stages of IRS' enforcement processes; (7) IRS has dozens of discrete databases, so many that it is difficult to determine what data are in them; (8) many of the IRS databases do not allow for a detailed analysis of the information they contain; (9) the limitations hinder IRS' ability to effectively manage its activities and serve small businesses and, as IRS has acknowledged, will continue to be a serious impediment until the systems are improved; (10) although IRS does not have a reliable method to measure compliance burden, there is common agreement that the burden is significant for small businesses; (11) past GAO surveys and case studies illustrate that much of the burden can be traced to the IRC itself; (12) IRS has long tried to reduce small businesses' compliance burden and improve customer service to these taxpayers; (13) IRS also has worked to make filing and reporting easier and to increase IRS employees' expertise and understanding of small business tax issues and practices; (14) most recently, IRS has begun an extensive modernization effort that is intended to substantially improve customer service, thereby making it less burdensome for small businesses and other taxpayers to meet their tax obligations; (15) one of the most visible signs of IRS' commitment to improve its services to small businesses is the establishment of a separate operating unit dedicated to this group of taxpayers; (16) IRS will need to consistently follow results-oriented management principles, integrate the principles into its day-to-day activities and culture, and hold managers at every level accountable for doing the same; and (17) IRS must develop and use organizational and individual performance systems that support IRS' new mission statement and implement information systems that support customer service management in a reorganized environment.

Background DOE is undertaking the cleanup of contaminants that were dumped or leaked into the soil and water at its facilities during more than 50 years of nuclear weapons production. According to a recent DOE estimate, this contamination is spread over 7,000 sites at 15 major facilities and more than 100 smaller facilities across the nation. Under the Superfund program, EPA also is engaged in an expansive cleanup of some of the same contaminants at the nation’s worst nonfederal sites, except that EPA does not face the same potential for radioactivity that DOE does at its facilities. Both agencies perform laboratory analysis on samples of soil and water taken from polluted sites to determine the type and level of contamination. Contaminants include (1) organic chemicals such as benzene and fluorene, (2) inorganic chemicals such as arsenic and mercury, and (3) radiochemicals. DOE Pays Higher Prices Than EPA DOE pays substantially higher prices than EPA for the same types of laboratory analysis at commercial laboratories. Furthermore, the four DOE contractors we reviewed sometimes contracted with the same commercial laboratories used by EPA. Yet EPA paid an average of $111 for inorganic analysis, while DOE’s four contractors paid an average of $358, or 223 percent more. Likewise, EPA paid an average of $786 for organic analysis, while DOE’s contractors paid $1,099, or 40 percent more. In addition, as shown in table 1, the average price paid by the four contractors at each of the facilities was higher than the average price paid by EPA. Appendix I provides a more detailed comparison. DOE’s Decentralized Contracting Results in Higher Prices DOE’s decentralized approach of allowing contractors to independently procure laboratory analysis results in higher prices than the prices EPA pays for the same analysis. EPA basically conducts one central procurement for the organic analysis and one for the inorganic analysis commonly used at its Superfund sites. In contrast, at least 40 DOE contractor organizations independently contract with commercial laboratories for laboratory analysis. Lower prices can generally be achieved through the consolidated procurement of common-use items. The General Services Administration, for example, the federal agency tasked with economically and efficiently procuring property and services for most government agencies, combines the common needs of several federal agencies into a centralized procurement. In contrast, decentralized procurement of common-use items results in higher prices because this approach dilutes an agency’s overall buying power. Officials involved in laboratory analysis issues at major commercial laboratories and representatives from two industry associations generally agreed that DOE’s decentralized contracting approach contributed to the higher prices the agency paid. They stated that if DOE centralized its procurement for commonly used analyses, the prices could be reduced. They also cited other advantages of a centralized approach. They said, for example, that bids for laboratory analysis vary according to the number of samples to be analyzed and the contractor’s ability to provide a steady flow of samples to keep a laboratory operating efficiently. In their view, one of the reasons that DOE paid higher prices was the uncertain and irregular flow of samples from over 40 different DOE contractor organizations, in contrast to a steadier flow of samples from EPA. By consolidating samples, centralized procurement is more likely to result in a continuous flow of samples. It is difficult to quantify the overall savings resulting from a centralized approach on the basis of the differences between the average prices paid by EPA and DOE because DOE has only recently started collecting data on the number of analyses performed for the Department by commercial laboratories, and those data are not yet complete or precise. Commercial laboratory officials also told us that while savings could occur, some of DOE’s samples, unlike EPA’s typical samples, may be radioactive and require screening and special handling, increasing the price of the analysis. However, DOE’s most recent sampling statistics, for fiscal year 1994, show that 85 percent of the organic and inorganic samples were not radioactive. Recognizing these constraints, we developed two estimates that show possible savings over 30 years, ranging from about $0.49 billion to about $1.26 billion. The difference in the two estimates depends on the extent of radioactive samples. To develop the estimate of $0.49 billion in savings, we assumed that, under centralized procurement, DOE would obtain the equivalent of the prices paid at Rocky Flats because (1) they were the lowest prices paid at the DOE facilities we reviewed and (2) as at other DOE facilities, the samples are potentially radioactive, which would add to the cost of analysis. This estimate, therefore, assumes that the total difference between the prices paid by EPA and by the Rocky Flats contractor is caused by the potential for radioactivity and that, under centralized procurement, DOE could only match the prices paid by the Rocky Flats contractor and not the lower prices paid by EPA. The estimate of $1.26 billion uses EPA’s average prices as a baseline. This estimate shows the potential savings arising from centralized procurement because that is the approach EPA uses. However, this estimate does not reflect the cost effect of the potential for radioactivity in DOE’s samples, since EPA’s samples are not typically radioactive. (App. I explains the assumptions and calculations for these estimates.) DOE’s Decentralized Contracting Results in Administrative Inefficiencies Under DOE’s decentralized approach, the Department’s contractors duplicate many of their efforts in both awarding and managing contracts, especially as a result of redundant quality assurance evaluations at the commercial laboratories. In addition, when contractors try to decide whether to have analyses performed at commercial laboratories or perform them in the DOE laboratories they operate, they may not select the most efficient use of DOE’s resources because they do not know their true costs of doing the analysis in the DOE laboratories. Ultimately, DOE pays the costs of these inefficiencies in higher payments to contractors and in duplicate oversight of contractors. Inefficiencies result from the decentralized awarding of contracts. For any organization, including DOE and EPA, this process requires the same basic functions, such as soliciting bids, ensuring that the commercial laboratories can perform the analysis, and making the award. EPA basically conducts two procurements to meet its needs over a 3-year period—one for commonly used organic analysis and the other for commonly used inorganic analysis. EPA thus performs the related functions only once for each analysis. In contrast, DOE repeats these functions over and over again because its contractors award their own contracts covering their needs for varying time periods. DOE’s current contracts have resulted from at least 45 procurements for organic analysis, 43 procurements for inorganic analysis, and 38 procurements for radiochemical analysis. In some cases, duplication occurs within a single contractor’s organization. For example, at one facility, the contractor and two of its subcontractors conducted three separate procurements for the same kind of analysis. Further inefficiency results because the contracts for laboratory analysis allow DOE’s contractors to conduct quality assurance evaluations of the commercial laboratories’ work. Because DOE’s decentralized approach results in many individual contracts, DOE’s contractors award contracts to the same commercial laboratories and then conduct numerous evaluations of them. In a 1995 draft report, DOE’s Inspector General stated that the contractors performed 103 duplicate and redundant quality assurance evaluations on 38 commercial laboratories during 1993 and 1994. At one commercial laboratory, 11 redundant evaluations were performed by nine different DOE contractors. According to the commercial laboratories included in the Inspector General’s review, the evaluations frequently required a substantial investment of their staff’s time and disrupted their operations. Decisions made by DOE’s contractors in determining whether to have the analysis performed in the DOE laboratories they operate or in commercial laboratories may result in an inefficient use of DOE’s resources. Although DOE’s procurement regulation requires contractors to consider cost as a significant factor in deciding whether the work should be done in a contractor-operated laboratory or at a commercial laboratory, contractors may consider other factors in making their decisions. The DOE officials responsible for the program told us that the contractors do not comprehensively and completely account for the costs of the laboratories they operate. Furthermore, even when the contractors use such data to compare costs, they may not make the most cost-effective decisions. For example, DOE’s Inspector General, using costs developed for the Rocky Flats laboratory by the facility’s contractor, reported that the contractor was using its laboratory even though commercial laboratories were 44 percent less costly. DOE Is Making Some Improvements but Is Not Centralizing Its Contracting While DOE is not currently planning to centralize its contracting for laboratory analysis, it does plan to take actions it believes will improve the current system. DOE’s annual operating plan for 1994 outlines 17 initiatives designed to improve many phases of its laboratory analysis program. Three of these 17 initiatives, as well as another action taken in response to a recommendation made by DOE’s Inspector General, directly relate to the issues of price and inefficiency discussed in this report. Generally, however, these initiatives are likely to have only limited effects. They will not realize the cost savings possible as a result of centralized procurement, nor will they completely eliminate the inefficiencies of decentralization, except concerning the duplication of quality assurance audits. These four actions follow. First, in response to the Inspector General’s draft report showing duplication of effort in the contractors’ quality assurance evaluations, DOE is considering the report’s recommendation to authorize a third-party organization to qualify commercial laboratories for contracts. This organization would evaluate the laboratories and certify that they are able to perform the analysis. While DOE has not made its final decision, it believes that the same organization also could perform the quality assurance evaluations on the laboratories after the contracts are awarded to ensure continued quality performance. If such a plan is adopted, it could eliminate the duplicate evaluations that contractors are now conducting to qualify laboratories for contracts. Second, in August 1994 DOE’s Assistant Secretary for Environmental Management issued a policy requiring the operations offices to collect summary information on local sampling and analysis and communicate the information to headquarters so that headquarters could monitor the program. DOE program officials told us that while this effort appears limited, they hoped that it could eventually be expanded so that only one contractor at each of the agency’s operations offices will procure laboratory analysis. Third, DOE has been drafting model procurement guidance for its contractors that could incorporate standard provisions on such issues as the time allowed to analyze a sample and reduced prices when the analysis is not timely. However, as a result of the contractors’ continuing disagreements among themselves and with DOE about the various provisions, this effort has stalled. Fourth, DOE is attempting to improve the ability of its contractors to choose between having the analyses done in commercial laboratories and in their own laboratories. Among other things, DOE is developing guidance on what types of costs the contractors should allocate to their laboratories and to commercial laboratories in making this decision. Although such guidance can help, the costs that DOE will ask the contractors to use will reflect the inefficiencies and higher costs of decentralized procurement. Conclusions Unlike EPA, which consolidates its total requirements for commonly used analyses, DOE dilutes its massive buying power by procuring its commonly used analyses on a piecemeal basis through its contractors. The results of DOE’s contracting approach are higher prices and unnecessary costs resulting from duplication of the contractors’ efforts. Without centralizing its laboratory analysis procurements, DOE will not realize the cost benefits resulting from its massive buying power. Recommendations To realize the cost savings inherent in centrally procured laboratory analysis and to eliminate other related inefficiencies resulting from decentralization, we recommend that the Secretary of Energy centralize the procurement of its commonly used laboratory analyses for environmental contaminants in the cleanup of its nuclear facilities. In doing so, the Secretary should also identify and eliminate the contractor resources that will no longer be needed under a central procurement system. Agency Comments As requested, we did not obtain written agency comments on a draft of this report. However, we discussed the factual information in the report with the Deputy Assistant Secretary for Compliance and Program Coordination in DOE’s Office of Environmental Management; the Director, Analytical Services Division, Office of Environmental Management; and the Director, Contract Reform Project Office. These officials generally agreed with the facts presented and provided additional comments. They noted that DOE’s contractors have historically resisted change but that this resistance is diminishing and may not be a major impediment to implementing a centralized system for procuring laboratory analysis within DOE. They did state that centralization is contrary to DOE’s current efforts to decentralize many functions but said that decentralization is less important than achieving cost savings. Finally, these officials explained that their original cost estimate of $15 billion for laboratory analysis may be reduced in the future if plans to improve the current sampling process succeed in reducing the program’s costs. However, at this time these officials could not estimate the cost more accurately. We conducted our review from May 1994 through March 1995 in accordance with generally accepted government auditing standards. Details of our scope and methodology are presented in appendix I. As arranged with your office, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days after the date of this letter. At that time, we will provide copies to the Secretary of Energy; the Director, Office of Management and Budget; the House Committee on Government Reform and Oversight; the Senate Committee on Governmental Affairs; the House and Senate Committees on Appropriations; and other interested parties. We will also make copies available to others upon request. If you have any questions about this report, please call me at (202) 512-3841. Major contributors to this report are listed in appendix II. Scope and Methodology We conducted our review of the prices paid for analysis by contractors at the Department of Energy’s (DOE) facilities at Fernald, Ohio; Hanford, Washington; Rocky Flats, Colorado; and Oak Ridge, Tennessee because they accounted for 68 percent of DOE’s costs for commercial laboratory analysis in fiscal year 1994. Additionally, we interviewed the Director and staff of DOE’s Analytical Services Division and reviewed related documents. We reviewed the Environmental Protection Agency’s (EPA) contracts in Research Triangle Park, North Carolina, and interviewed the Chief and staff of the Analytical Operations Branch of EPA’s Contract Laboratory Program in Arlington, Virginia. Finally, we reviewed reports by DOE’s Inspector General on the laboratory analysis program. To obtain industry’s view of DOE’s contracting approach, we discussed our review with four commercial laboratories that had contracts with DOE’s contractors; two of these laboratories also had current contracts with EPA. We also talked with officials involved with laboratory analysis issues at two industry associations—the International Association of Environmental Testing Laboratories and the Association of Independent Scientific, Engineering and Testing Firms. Comparison of Prices Paid by DOE and EPA To compare the average prices that DOE and EPA paid for the same analyses of organic and inorganic contaminants, we used the prices that were in effect during the first 9 months of 1994. Our universe of prices included, for EPA, 35 contract prices for organic analysis and 19 contract prices for inorganic analysis and, for DOE’s contractors, 33 contract prices for organic analysis and 36 contract prices for inorganic analysis. We used this procedure because averaging prices over a period of time provides a more realistic average price since doing so reduces the impact of any one price. We also reviewed the contract documents that EPA and DOE’s contractors used and discussed their provisions with the Chief and staff of EPA’s Analytical Operations Branch of the Contract Laboratory Program and with officials in the contractors’ program and contracting offices. The organic analysis includes three separate analyses—for volatile organic compounds, semivolatile organic compounds, and pesticides/polychlorinated biphenyls. EPA procured these three analyses together in one procurement and paid one overall price. DOE’s contractors, on the other hand, procured these three analyses separately. To compare the prices paid by the two agencies, we added the prices of the three separate analyses to obtain the price DOE paid for the complete analysis. We discussed this procedure with commercial laboratories, which agreed that this comparison was acceptable and valid. EPA’s procurements of organic and inorganic analyses each included only one price for the analysis of contaminants in a water or soil solution, referred to as the matrix. DOE’s contractors paid separate prices for analyses in soil and water matrixes. Therefore, to compare DOE’s prices with EPA’s, we had to calculate an overall average price using the prices for the two matrixes. To do this, we identified the prices for each matrix and developed a weighted average for the overall average price for organic and inorganic analyses. For example, if a facility’s contractor paid six prices for analysis of contaminants in soil and seven prices for analysis of contaminants in water, we added the total of all 13 prices and divided by 13 to obtain the weighted average price at that facility. Table I.1 shows the average prices paid by the contractors for organic analysis in water and soil matrixes and the weighted average price for organic analysis. Table I.2 shows the same information for inorganic analysis. To determine the causes of the differences in the prices paid by the contractors, we identified the commercial laboratories that had contracts for analysis with each of the four contractors we reviewed. Table I.3 shows the average prices paid for organic and inorganic analyses at the same four laboratories by the contractors at Hanford, Oak Ridge, and Fernald. The average price paid by the Rocky Flats contractor includes the prices at only two of the four laboratories since only these two had contracts with Rocky Flats. We reviewed the four facilities’ contracts to identify reasons for the variations in price. Although actual differences in the facilities’ contracts caused by decentralization could account for some of the price differences, we could not segregate any one cause that significantly affected the price from the effect on price of other factors. Additionally, any such differences would not occur in a centralized contract since all of the facilities would use the same contract. Estimate of Potential Savings To show potential savings, we prepared two estimates that show possible savings over 30 years, ranging from about $0.49 billion to about $1.26 billion. We developed this range of savings because EPA’s prices, obtained through centralized procurement, do not reflect the costs resulting from potential radioactivity in the samples. On the other hand, DOE’s prices reflect the potential for such radioactivity but were obtained through decentralized procurement. Our estimates therefore, make several assumptions to give a general idea of potential savings. First, to develop the estimate of $0.49 billion in savings, we assumed that, under centralized procurement, DOE would pay the equivalent of the prices paid by the Rocky Flats contractor, because these were the lowest of the prices paid at the DOE facilities we reviewed and because the samples at Rocky Flats, as at other DOE facilities, are potentially radioactive. This estimate therefore assumes that the total difference between the prices paid by EPA and by the Rocky Flats contractor is caused by the potential for radioactivity and that under centralized procurement, DOE could only match the prices paid at Rocky Flats. We believe our assumptions make this a conservative estimate that reflects the low end of potential savings. Second, to develop the estimate of $1.26 billion in savings, we assumed that DOE could obtain the same prices that EPA obtained. While this estimate uses prices obtained through centralized procurement, it does not consider any effect due to the potential for radioactivity in DOE’s samples. Since this estimate does not consider the potential effect of radioactivity, we believe it reflects the high end of potential savings. Our first estimate is based on the difference between the prices paid at Rocky Flats and those paid at the other facilities. We began with DOE’s estimate that at least $15 billion will be spent on laboratory analysis and administrative costs over 30 years. Since the contractor at Rocky Flats paid the lowest prices and we are using them as our baseline, we eliminated the costs associated with laboratory analysis at Rocky Flats from the $15 billion. To do this, we deducted the costs at Rocky Flats—which amounted to 13 percent of the total expenditures for analysis for 1994—from the $15 billion. This resulted in an estimated cost for the remaining facilities of $13.05 billion. As shown in table I.4, we then multiplied the $13.05 billion by the amount that DOE’s contractors awarded to commercial laboratories during fiscal year 1994 (65 percent of the total expenditures for analysis) to show that about $8.48 billion eventually may be associated with the laboratory analysis performed by commercial laboratories. DOE estimates that 31 percent of all the commercial laboratory costs are allocated solely to analysis; the remainder is spent on such things as the DOE contractors’ costs of managing the procurement of laboratory analysis, shipping samples to the laboratories, and providing assurance that the laboratory’s analysis is valid. According to our estimate, 31 percent of $8.48 billion, or $2.63 billion, will be spent on laboratory analysis. Of the $2.63 billion, DOE estimates that 31 percent (or $0.82 billion) will be spent for organic analysis of various kinds, 33 percent (or $0.87 billion) for inorganic analysis of various kinds, and 36 percent (or $0.95 billion) for radiochemical analysis. Assuming that contractors at the other DOE facilities could obtain the same prices as Rocky Flats’ contractor, DOE could save 22 percent on its inorganic analysis and 17 percent on its organic analysis. These saving rates would result in a potential savings of about $0.14 billion for organic analysis and about $0.19 billion for inorganic analysis. If we applied the smaller savings associated with organic analysis—17 percent—to the $0.95 billion for radiochemical analysis, the additional potential savings would be $0.16 billion. The total potential savings for all of the analyses would then amount to $0.49 billion over 30 years. This estimate of savings assumes that there will be no offsetting costs due to the termination of any laboratory contracts. Percentage of costs for sample analysis (less overhead) Not applicable. Our second estimate is based on differences between the average prices paid by DOE and EPA. Although this comparison would more closely show the potential savings that could be obtained through centralization, it does not consider the effects of potential radioactivity in the samples on DOE’s prices. We believe this estimate shows the high end of potential savings. We began with DOE’s estimate that at least $15 billion will be spent on laboratory analysis and administrative costs over 30 years. As shown in table I.5, we then multiplied the $15 billion by the amount that DOE’s contractors awarded to commercial laboratories during fiscal year 1994 (65 percent of the total expenditures for analysis) to show that about $9.75 billion eventually may be associated with the laboratory analysis performed by commercial laboratories. Thirty-one percent of $9.75 billion, or $3.02 billion, will be spent on laboratory analysis. Of the $3.02 billion, DOE estimates that 31 percent (or $0.94 billion) will be spent for organic analysis of various kinds, 33 percent (or $1 billion) for inorganic analysis of various kinds, and 36 percent (or $1.09 billion) for radiochemical analysis. Assuming that DOE could obtain the same prices as EPA, DOE could save 69 percent on its inorganic analysis and 28 percent on its organic analysis. At these rates, the potential savings would be about $0.26 billion for organic analysis and about $0.69 billion on inorganic analysis. If we applied the smaller savings associated with organic analysis—28 percent—to the $1.09 billion for radiochemical analysis, the additional potential savings would be $0.31 billion. The total potential savings for all of the analyses would then amount to $1.26 billion over 30 years. As in our first estimate, this estimate assumes that there will be no offsetting costs due to the termination of any laboratory contracts. Percentage of costs for sample analysis (less overhead) Not applicable. We could not estimate the savings that would result from reducing the duplication and inefficiencies resulting from DOE’s decentralized contracting approach. Evaluation of DOE’s Inefficiencies and Assessment of DOE’s Efforts to Improve To evaluate the inefficiencies of DOE’s contracting approach caused by duplication of effort, we discussed the contracting function with contractors at the Department’s Fernald, Hanford, Los Alamos, Oak Ridge, and Rocky Flats facilities. Additionally, to get a better idea of the number of contractors that had contracts for laboratory analysis, we surveyed all other DOE contractors that the Department believed might have had contracts for laboratory analysis. To identify DOE’s actions to improve its program, we reviewed documents describing these improvement efforts and evaluated their potential to lower the prices DOE pays for laboratory analysis and to reduce its inefficiencies. We also discussed these efforts with the Director and staff of DOE’s Analytical Services Division. Major Contributors to This Report Resources, Community, and Economic Development Division Jeffrey E. Heil, Assistant Director Robert M. Antonio, Senior Evaluator David O. Bourne, Senior Evaluator Casandra D. Joseph, Senior Evaluator Gregory D. Mills, Evaluator James B. Hayward, Evaluator Sarah A. Renfro, Evaluator The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 6015 Gaithersburg, MD 20884-6015 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (301) 258-4066, or TDD (301) 413-0006. Each day, GAO issues a list of newly available reports and testimony. To receive facsimile copies of the daily list or any list from the past 30 days, please call (301) 258-4097 using a touchtone phone. A recorded menu will provide information on how to obtain these lists. Address Correction Requested

Pursuant to a congressional request, GAO reviewed the Department of Energy's (DOE) decentralized approach to laboratory analysis, focusing on: (1) the differences in prices and contracting approaches between DOE and the Environmental Protection Agency (EPA) for similar types of laboratory analyses; (2) whether the decentralized DOE approach has resulted in any administrative inefficiencies; and (3) key changes DOE is making in its contracting procedures. GAO found that: (1) DOE pays substantially higher prices than EPA for the same types of commercial laboratory analyses; (2) while savings could be achieved through centralization, the amount of savings is difficult to measure; (3) unlike DOE, EPA conducts two procurements for organic and inorganic analyses for Superfund sites, while the decentralized DOE approach results in numerous inefficiencies, such as contractors performing redundant quality assurance evaluations at numerous commercial laboratories; and (4) DOE has recently identified 17 initiatives designed to improve many phases of its laboratory analysis program, but it does not plan to change its decentralized approach to laboratory analyses.

Agencies’ Strategic Plans Generally Met Statutory Requirements the Agency for International Development improved its discussion of external factors, such as political unrest and natural disasters, that could affect its achievement of strategic goals and that are beyond its control by describing those factors and the way they can be offset by agency field missions. Critical Planning Challenges Remain to Be Addressed Although all of the strategic plans that we reviewed contained at least some discussion of each element required by the Results Act, we found that critical planning challenges remain. Among these planning challenges are the need to demonstrate (1) a clearly articulated strategic direction, (2) the coordination of crosscutting program efforts, and (3) reliable data systems and analytic capacity. A Clearly Articulated Strategic Direction We found that the strategic plans often lacked clear articulation of the agencies’ strategic direction, a sense of what they were trying to achieve, and how they would achieve it. For example, we found that the goals and objectives in many agencies’ strategic plans could be more results oriented and stated in a way to better enable the agency to make a future assessment of whether goals and objectives were being achieved. In addition, the plans often did not establish linkages among planning elements, such as goals, objectives, and strategies for achieving those goals and objectives. Another weakness of agencies’ strategic plans was incomplete and underdeveloped strategies for achieving long-term strategic goals and objectives. Specifically, we found that agencies did not always provide an adequate discussion of the resources needed to achieve goals. In particular, the role that information technology played, or can play, in achieving agencies’ long-term strategic goals and objectives was generally neglected in agencies’ strategic plans. For example, most of the Department of Defense’s (DOD) goals and objectives rely on the effective use of information technology to obtain a given goal as well as to measure progress toward its achievement. DOD’s strategic plan would be significantly enhanced if it more explicitly linked its strategic goals to a strategy for improving management and oversight of information technology resources. In addition, DOD’s strategic plan—as well as the plans of other agencies—did not fully recognize the dramatic impact the Year 2000 problem will likely have on DOD’s operations. The Department of State’s strategic plan also does not specifically address the serious deficiencies in its information and financial accounting systems. Rather, the plan notes, in more general terms, that it will take several years for State to develop performance measures and related databases in order to provide sufficient information on the achievement of its long-term goals. We believe that information technology issues deserve attention in strategic plans so as to provide assurance that agencies are (1) addressing the federal government’s long-standing information technology problems and (2) better ensuring that technology acquisition and use are targeted squarely on program results. Agencies can continue to address the critical planning challenges associated with setting a strategic direction as they develop their annual performance plans. Building on the decisions made as part of the strategic planning process, the Results Act requires executive agencies to develop annual performance plans covering each program activity set forth in the agencies’ budgets. Each plan is to contain an agency’s annual performance goals and associated measures. If successfully developed, those annual performance goals can function as a bridge between long-term strategic planning and day-to-day operations, thereby assisting agencies in establishing better linkages among planning elements. For example, agencies can use performance goals to show clear and direct relationships in two directions—to the goals in the strategic plans and to operations and activities within the agency. By establishing those relationships, agencies can (1) provide straightforward road maps that show managers and staff how their daily activities can contribute to attaining agencywide strategic goals, (2) hold managers and staff accountable for contributing to the achievement of those goals, and (3) provide decisionmakers with information on their annual progress in meeting the goals. As agencies gain experience in developing these annual performance goals, they likely will become better at identifying and correcting misalignment among strategic goals, objectives, and strategies within both their strategic and annual plans. Coordinated Crosscutting Program Efforts program efforts are mutually reinforcing. We have found that uncoordinated program efforts can waste scarce funds, confuse and frustrate program customers, and limit the overall effectiveness of the federal effort. This suggests that federal agencies are to look beyond their organizational boundaries and coordinate with other agencies to ensure that their efforts are aligned and complementary. Agencies’ strategic plans better described crosscutting programs and coordination efforts than their draft plans did. Some of the strategic plans we reviewed contained references to other agencies that shared responsibilities in a crosscutting program area or discussed the need to coordinate their programs with other agencies. These presentations provide a foundation for the much more difficult work that lies ahead—undertaking the substantive coordination that is needed to ensure that those programs are effectively managed. However, although agencies have begun to recognize the importance of coordinating crosscutting programs, it is important that they undertake the substantive coordination that is needed for the effective management of those programs. For example, in an improvement over its draft plan, the Department of Labor’s plan refers to a few other agencies with responsibilities in the area of job training programs and notes that the agency plans to work with them. But the plan contains no discussion of what specific coordination mechanism Labor will use to realize efficiencies and implement possible strategies to consolidate job training programs to achieve a more effective job training system. Our work has shown that the performance planning and measurement stage of the Results Act’s implementation will offer a structured framework to address crosscutting issues. For example, the Act’s emphasis on results-based performance measures as part of the annual performance planning process should lead agencies to more explicit discussions concerning the contributions and accomplishments of crosscutting programs. Furthermore, if agencies and OMB use the annual planning process to highlight crosscutting program efforts and provide evidence of joint planning and coordination of those efforts, the individual agency performance plans and the governmentwide performance plan should help provide Congress with the information needed to identify agencies and programs addressing similar missions. Once these programs are identified, Congress can consider the associated policy, management, and performance implications of crosscutting program efforts and whether individual programs make a sufficiently distinguishable contribution to a crosscutting national issue. This information should also help identify the performance and cost consequences of program fragmentation and the implications of alternative policy and service delivery options. These options, in turn, can lead to decisions concerning department and agency missions and the allocation of resources among those missions. Reliable Data Systems and Analytic Capacity Our previous work has shown that for agencies to set realistic goals, they need to have reliable data during their planning efforts. They also need reliable data, later, as they gauge the progress they are making toward achieving those goals. To provide such reliable data, agencies need a strong performance measurement system. In addition, to provide feedback on how well activities and programs contributed to achieving goals and to identify ways to improve performance, agencies need a strong program evaluation capacity. However, our work has found serious shortcomings in agencies’ ability to generate reliable and timely data to measure their progress in achieving goals and to provide the analytic capacity to use those data. The absence of both sound program performance and cost data and the capacity to use those data to improve performance is a critical challenge that agencies must confront if they are to effectively implement the Results Act. Efforts under the CFO Act have shown that most agencies still have a substantial amount of work to do before they are able to generate the reliable, useful, relevant, and timely financial information that is urgently needed to make our government fiscally responsible. The widespread lack of available program performance information is equally troubling. For example, in our June report on the implementation of the Results Act, we included the results of a survey of managers in the largest federal agencies. Our survey results indicated that fewer than one-third of those managers said that results-oriented performance measures existed to a great or very great extent for their programs. Moreover, our work has shown that in agency after agency, efforts to generate reliable data for measuring cost and results have been disappointing. As this Subcommittee is well aware, the federal government has had chronic problems harnessing the full potential of its vast expenditures in information technology. Further complicating efforts to collect reliable performance information is that many agencies must rely on data collected by parties outside the federal government. In a recent report, we noted that the fact that data were largely collected by others was the most frequent explanation offered by agency officials for why determining the accuracy and quality of performance data was a challenge. Under the Results Act, strategic plans are to contain discussions of how agencies used and planned to use program evaluations that are to provide feedback on how well an agency’s activities and programs contributed to the achievement of its goals and to assess the reasonableness and appropriateness of those goals. Although all of the strategic plans we reviewed included some discussion of program evaluations, we found weaknesses in those discussions. For example, many agencies did not discuss how they planned to use evaluations in the future to assess progress or did not offer a schedule for future evaluation as required by the Results Act. In contrast, the National Science Foundation’s strategic plan represents a noteworthy exception. The plan discusses how the agency used evaluations to develop key investment strategies, action plans, and its annual performance plan. It also discusses plans for future evaluations and provides a general schedule for their implementation. Agencies are also to discuss in their annual performance plans how they will verify and validate the performance information that they plan to use to show whether goals are being met. Verified and validated performance information, in conjunction with augmented program evaluation efforts, will help ensure that agencies are able to report progress in meeting goals and identify specific strategies for improving performance. Our Guide Is Intended to Assist Congress in Using Agency Performance Plans At the request of the Chairmen of the House Committees on Government Reform and Oversight, Appropriations, and the Budget, in May 1997, we developed a guide to assist the congressional consultations on the development of agencies’ strategic plans. As we entered the annual performance planning and measurement stage of the Act, those Chairmen, the Speaker of the House, the House Majority Leader, the Chairman of the House Committee on Science, and the Chairmen of the Senate Committees on the Budget and Governmental Affairs asked us to develop a guide to help congressional decisionmakers both elicit the information that Congress needs from agencies’ annual performance plans and assess the quality of those plans. That guide was issued last week. Our guide to facilitate congressional decisionmakers’ use of agencies’ performance plans is organized around three core questions that correspond to the Act’s requirements for performance plans. For each core question, we identify issues that need to be addressed and present key assessment questions that can help congressional users elicit the cost and performance information that is relevant to their decisionmaking from agencies’ performance plans: The first core question is—To what extent does the agency’s performance plan provide a clear picture of intended performance across the agency? This question has three related issues: defining expected performance; connecting mission, goals, and activities; and recognizing crosscutting efforts. The second core question is—How well does the performance plan discuss the strategies and resources the agency will use to achieve its performance goals? This question has two related issues: connecting strategies to results and connecting resources to strategies. The third core question is—To what extent does the agency’s performance plan provide confidence that its performance information will be credible? This question also has two related issues: verifying and validating performance and recognizing data limitations identified in the plan. The answers to the questions are intended to facilitate a complete assessment of agencies’ performance plans and address concerns that are likely to be common across a variety of congressional users. In summary, Mr. Chairman, although agencies have generally met the statutory requirements of the Results Act in their first cycle of strategic planning, federal strategic planning—and Results Act implementation in general—is still very much a work in progress. Some critical planning challenges remain before the type of performance-based management and accountability envisioned by the Results Act becomes the routine way of doing business in the federal government. As they develop their annual performance plans, agencies will likely need to revisit and improve upon their strategic planning efforts. The annual performance plans offer the opportunity for Congress and the agencies together to sustain the momentum of the implementation of the Results Act and of performance-based management. We are pleased that Congress has turned to us to assist in the implementation of the Results Act. Over the last few years, we have issued a number of products on the key steps and practices needed to improve the management of the federal government. These key steps and practices are based on best practices in private sector and public sector organizations. We look forward to continuing to support Congress’ efforts to better inform its decisionmaking, improve the management of the federal government, and strengthen accountability. This concludes my prepared statement. I would be pleased to respond to any questions you or other Members of the Subcommittee may have. Related GAO Products Agencies’ Annual Performance Plans Under the Results Act: An Assessment Guide to Facilitate Congressional Decisionmaking, Version 1 (GAO/GGD/AIMD-10.1.18, Feb. 1998). Managing for Results: Agencies’ Annual Performance Plans Can Help Address Strategic Planning Challenges (GAO/GGD-98-44, Jan. 30, 1998). Managing for Results: The Statutory Framework for Performance-Based Management and Accountability (GAO/GGD/AIMD-98-52, Jan. 28, 1998). Managing for Results: Building on Agencies’ Strategic Plans to Improve Federal Management (GAO/T-GGD/AIMD-98-29, Oct. 30, 1997). Managing for Results: Critical Issues for Improving Federal Agencies’ Strategic Plans (GAO/GGD-97-180, Sept. 16, 1997). Managing for Results: Using the Results Act to Address Mission Fragmentation and Program Overlap (GAO/AIMD-97-146, Aug. 29, 1997). Managing for Results: The Statutory Framework for Improving Federal Management and Effectiveness (GAO/T-GGD/AIMD-97-144, June 24, 1997). The Government Performance and Results Act: 1997 Governmentwide Implementation Will Be Uneven (GAO/GGD-97-109, June 2, 1997). Agencies’ Strategic Plans Under GPRA: Key Questions to Facilitate Congressional Review, Version 1 (GAO/GGD-10.1.16, May 1997). Performance Budgeting: Past Initiatives Offer Insights for GPRA Implementation (GAO/AIMD-97-46, Mar. 27, 1997). Executive Guide: Effectively Implementing the Government Performance and Results Act (GAO/GGD-96-118, June 1996). The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. 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GAO discussed its assessment of the strategic plans that executive agencies produced last September under the Government Performance and Results Act of 1993 and the current stage of the Results Act's implementation, annual performance planning and measurement, focusing on: (1) the extent to which agencies' strategic plans met statutory requirements; (2) critical planning challenges that remain to be addressed; and (3) a discussion of how GAO's recent congressional guide for agencies' annual performance plans can facilitate congressional use of those plans and thereby advance the implementation of the Results Act. GAO noted that: (1) the Results Act requires that strategic plans include six broad elements-mission statements, general goals and objectives, approaches (or strategies) for achieving goals, a description of the relationship between general goals and annual performance goals, key external factors, and a description of the actual use and planned use of program evaluations; (2) although all of the strategic plans that GAO reviewed contained at least some discussion of each element required by the Results Act, GAO found that critical planning challenges remain; (3) the strategic plans often lacked clear articulation of the agencies' strategic direction, a sense of what they were trying to achieve, and how they would achieve it; (4) a focus on results, as envisioned by the Results Act, implies that federal programs that contribute to the same or similar results should be closely coordinated to ensure that goals are consistent and, as appropriate, program efforts are mutually reinforcing; (5) uncoordinated program efforts can waste scarce funds, confuse and frustrate program customers, and limit the overall effectiveness of the federal effort; (6) this suggests that federal agencies are to look beyond their organizational boundaries and coordinate with other agencies to ensure that their efforts are aligned and complementary; (7) GAO's previous work has shown that for agencies to set realistic goals, they need to have reliable data during their planning efforts; (8) they also need reliable data, later, as they gauge the progress they are making toward achieving those goals; (9) GAO found serious shortcomings in agencies' ability to generate reliable and timely data to measure their progress in achieving goals and to provide the analytic capacity to use those data; (10) GAO developed a guide to assist the congressional consultations on the development of agencies' strategic plans; (11) the guide is organized around three core questions that correspond to the Act's requirements for performance plans; (12) the answers to the questions are intended to facilitate a complete assessment of agencies' performance plans and address concerns that are likely to be common across a variety of congressional users; and (13) although agencies have generally met the statutory requirements of the Results Act in their first cycle of strategic planning, federal strategic planning; and Results Act's implementation in general-is still very much a work in progress.

Background Medicare spending per beneficiary on physician services has varied substantially—both among geographic areas and in its growth over time. The geographic variation in spending—unrelated to beneficiary health status or outcomes—provides evidence that health needs alone do not determine spending. Consequently, policymakers have deemed it both reasonable and desirable to question the appropriateness of current and projected physician services spending and to explicitly consider the affordability of such spending when setting physician fees. The implementation of a national fee schedule and spending targets in 1992, for example, was designed, in part, to address issues of affordability and program sustainability by slowing spending growth. Moderating this growth remains part of the larger effort to ensure future Medicare program sustainability. Some Spending on Physician Services May Be Unnecessary, as Suggested by Unwarranted Regional Variation in Use of Physician Services In 1989, the Physician Payment Review Commission (PPRC) reported that from 1979 through 1989 (the decade prior to the establishment of spending targets), Medicare spending on physician services per beneficiary more than tripled, rising much more rapidly than general inflation. At that time, PPRC recommended an expenditure target for controlling aggregate spending on physician services. The target was to apply initially to all physician services nationally and later to evolve to separate targets for regions, categories of physician services, or both. Then, as now, utilization of physician services varied widely by geographic area, while the Medicare patient populations in these areas differed little from one another in their illnesses. Some studies report that variation in service use indicates that in some parts of the country compared with others, there was either overuse or underuse of services. Recent studies of Medicare expenditures show that regional variation in the use of medical services remains and that the spending disparities among areas are explained by physicians’ discretionary practices rather than by differences in patient populations’ health status. Physician Service Expenditures Have Grown Less Rapidly after Spending Targets and Fee Schedule Were Established Three periods from 1980 to the present describe Medicare’s recent experience in spending for physician services. Figure 1 shows growth in Medicare spending per beneficiary for physician services during the three periods. In the first period, 1980 through 1991, Medicare’s payment rates for physician services were based on historical charges for these services, and limits were placed on fees and fee updates but not on aggregate spending. In the 1992 through 1997 period, physician services were paid under a national fee schedule, and the first spending target system—called the Medicare volume performance standard (MVPS)—set an allowable growth rate for aggregate spending that was used to adjust physician fees. From 1998 on, services continue to be paid under a fee schedule and the SGR system replaced the MVPS system and uses a different method to set an acceptable growth rate for aggregate spending. In the 1980s, Medicare paid physicians on the basis of “reasonable charge,” defined as the lowest of the physician’s actual charge, the customary charge (the amount the physician usually charged for the service), or the prevailing charge (based on comparable physicians’ customary charges). Under this system, payment inconsistencies existed among physicians by services, specialties, and locations. The system also had an inflationary bias, as a rise in customary charges could increase prevailing charges over time. During this decade, expenditures for physician services grew rapidly: from 1980 through 1991, Medicare spending per beneficiary for physician services grew at an average annual rate of 11.6 percent. Although the Congress froze fees or limited fee increases in the 1980s, spending continued to rise because there were no limits on growth in the volume and intensity of services physicians provided to beneficiaries. Recognizing that the expenditure growth of the 1980s was not sustainable, the Congress reformed the way Medicare paid for physician services in the traditional FFS program by requiring the establishment of a national fee schedule for physician services and a system for controlling aggregate physician service spending, MVPS. The establishment of a fee schedule in 1992 was an attempt to break the link between physicians’ charges and Medicare payments. The fee schedule was designed to pay for services based on the relative resources used by physicians to provide different types of care and to address the inflationary bias of the charge-based system. The adoption of a spending target system was an attempt to control spending growth attributable to increases in the volume and intensity of physician services. Under MVPS, a performance standard for a given year was set, indicating a growth rate for expenditures that should not be exceeded. The extent to which actual expenditure growth fell above or below the performance standard helped to determine the update to physician fees 2 years later. For example, in 1993, CMS compared actual spending in 1992 with the performance standard for 1992; the difference largely determined the update to physician fees in 1994. The performance standard was based on changes in four factors: the number of FFS Medicare beneficiaries, practice cost inflation, the historical growth in volume and intensity, and laws and regulations that could affect spending for physician services. From 1992 through 1997—the period that MVPS was used to set fee updates—annual spending growth for physician services was far lower than in the preceding decade. The decline in spending growth during this period was the result, in large part, of slower volume and intensity growth. For example, from 1985 through 1991, spending per beneficiary grew at an average annual rate of 10.8 percent; during that period, volume and intensity of service use per beneficiary rose an average 7 percent annually. From 1992 through 1997, the growth in spending per beneficiary fell to 4.4 percent; during that period, average annual growth in volume and intensity of service use per beneficiary fell to 1 percent. (See fig. 2.) Physician Payment Review Commission, 1995 Annual Report to Congress (Washington, D.C.: 1995). system’s perceived shortcomings, the Congress took action in BBA in 1997 to replace it with the SGR system. In 1998 and 1999, the first 2 years of the SGR system, volume and intensity growth remained similar to the rate under MVPS. However, from 2000 through 2003, volume and intensity growth rose at an average annual rate of about 5 percent. Over the 1998– 2003 SGR system period, the average growth in volume and intensity of services per Medicare beneficiary was higher than the average for the 1992–1997 MVPS period—but substantially below that experienced before spending targets were introduced. Since the introduction of the SGR system, total spending on physician services is projected to grow by an average of 8 percent a year from 2000 through 2005. Controlling Spending for Physician Services Part of Larger Challenge to Maintain Fiscal Discipline in Medicare The MVPS spending target was based, in part, on a 5-year historical trend in volume and intensity reduced by a specified number of percentage points. Because of this design and the fact that volume and intensity growth dropped dramatically after the adoption of the MVPS system, the target for future volume and intensity increases fell too. in its present form. In light of physician service expenditures’ significant contribution to aggregate spending, containing their growth plays an important role in helping to address the program’s long-range and fundamental financing problem. SGR System Designed to Adjust Fee Updates to Bring Actual Spending for Physician Services in Line with Spending Targets The SGR system is designed to impose fiscal discipline and to moderate spending for physician services by adjusting annual fee updates to bring spending in line with targets. The SGR system, similar to the predecessor MVPS system, relies on spending targets because earlier attempts to achieve fiscal discipline through limits on fee increases did not control the spending that resulted from volume and intensity growth. The SGR system uses a formula specified in statute to establish each year an allowed spending growth rate, a spending target, and a fee update. Like MVPS, the SGR system includes an allowance for volume and intensity increases but, unlike MVPS, ties the allowance to a measure of the growth of the national economy. Spending Targets for Physician Services Used to Encourage Fiscal Discipline As noted, spending targets were established—first under MVPS and later under the SGR system—because policymakers contended that the fee schedule alone would not have adequately constrained expenditure growth for physician services. The fee schedule limits payment for individual services but does not moderate spending growth resulting from volume and intensity increases. Although the SGR system’s spending target does not cap expenditures for physician services, it serves as a budgetary control by automatically lowering fee updates in response to excess spending due to volume and intensity growth. In addition, reduced fee updates serve as a signal to physicians collectively and to the Congress that spending due to volume and intensity has increased more than allowed. An additional reason for spending targets was advanced by PPRC in its 1995 report to the Congress. PPRC explained that spending targets were intended, in part, to create a collective incentive for physicians. Specifically, the report stated that spending targets “provid the medical profession with a collective incentive to reduce inappropriate care by, for instance, developing and disseminating practice guidelines that promote cost-effective practice styles.” SGR System Sets Allowable Spending Growth and Targets for Physician Services Every year, CMS must estimate the allowed rate of increase in spending for physician services and use that rate to construct the annual spending target for the following calendar year. The sustainable growth rate is the product of the estimated percentage change in (1) input prices for physicians’ services; 27, 28 (2) the average number of Medicare beneficiaries in traditional FFS; (3) national economic output, as measured by real (inflation-adjusted) GDP per capita; and (4) expected expenditures for physician services resulting from changes in laws or regulations. CMS’s current estimate of the sustainable growth rate for 2005 is 4.6 percent, based on the agency’s estimates of the four factors. (See table 1.) SGR System Adjusts Fee Updates to Align Spending with Target Every fall, CMS determines whether the fee update for the following calendar year must be adjusted to help align spending with targets. To do so, the agency compares actual spending, measured cumulatively since 1996, to the cumulative value of the annual targets, measured over the same period. If the two are equal, the fee update is set to equal the estimated increase in physicians’ average cost of providing services—as measured by MEI. Otherwise, a performance adjustment factor (PAF) is used to increase or decrease the update relative to MEI in order to help bring spending back in line with the targets. (See app. I for the formula used to calculate the PAF.) The PAF is subject to limits and may not cause the update to be set at more than 3 percent above MEI or 7 percent below MEI. In part because of these limits, adjustments to realign actual cumulative spending with cumulative targets are spread out over more than 1 year. See BBRA, §211(b), 113 Stat. 1501A348-49. Revisions to targets first affected fee updates in 2001. In setting the target for that year, CMS revised only the 2000 SGR target. According to CMS, the agency was not authorized to revise the 1998 or 1999 SGR targets. The fee for each service is determined using a resource-based relative value scale in which the resources required for a service are valued in relation to the resources required to provide all other physician services adjusted for the differences in the costs of providing services across geographic areas. To arrive at a fee, the service’s relative value is multiplied by the dollar conversion factor. The update to the dollar conversion factor represents the aggregate of increases and decreases across all services. Because the relative value of individual services can change yearly, fee changes for specific services may be different than the overall fee update. Under SGR’s system of cumulative spending targets, excess spending that is not offset in one year accumulates in succeeding years until it is recouped. For 2005, MMA increased actual spending but did not adjust the target for this additional spending. Now the gap between actual spending and the target will result in an additional deficit that under the SGR system will have to be recouped through negative updates in future years. SGR System Ties Allowed Increases in Volume and Intensity to Growth in National Economy The parameters of the SGR system allow spending due to the volume and intensity of physician services to increase, but limit that growth to the same rate that the national economy (GDP) grows in real terms (that is, adjusted for inflation) over time on a per capita basis. Under the SGR system, if the volume and intensity of physician service use grows faster than the national economy, the annual increase in physician fees will be less than the estimated increase in the cost of providing services. Conversely, if volume and intensity grows more slowly, the SGR system permits physicians to benefit from fee increases that exceed the increased cost of providing services. To reduce the effect of yearly business cycles on physician fees, MMA required that economic growth be measured as the 10-year moving average change in real GDP per capita for each year beginning in 2003. This measure is projected to range from 2.1 percent to 2.5 percent during the 2005 through 2014 period. When the SGR system was established, GDP growth was seen as a benchmark that would allow for affordable increases in volume and intensity and also one that represented a significant improvement over the benchmark included in the previous MVPS system. In its 1995 annual report to the Congress, PPRC stated that limiting real expenditure growth to 1 or 2 percentage points above GDP would be a “realistic and affordable goal.” Ultimately, BBA specified the growth rate of GDP alone. This limit was an indicator of what the nation could afford to spend on volume and intensity increases. Whether this rate is a sufficient and appropriate allowance for volume and intensity increases is uncertain. Currently, volume and intensity is projected to grow by more than 4 percent per year, whereas the allowance for this growth under the SGR system is about 2.3 percent annually. Such excess volume and intensity growth is a key contributing factor to negative fee updates. Various Concerns Raised about SGR System and Its Components Physician groups are dissatisfied with SGR as a system to update physician fees and have raised various concerns about its key components. Noting that physicians are uniquely subject to a system of fee updates that are explicitly linked to spending controls, the groups contend that the SGR system has caused payment rates in recent years to fall behind physicians’ cost of providing services. The groups’ concerns with specific SGR system components center on the following issues: the fairness of including Medicare-covered outpatient drugs in the calculation of physician service expenditures; the appropriateness of tying allowable volume and intensity increases to the average growth in real GDP per capita; and the completeness, accuracy, and transparency of the method used to account for spending increases due to changes in laws and regulations. Physicians Dissatisfied That Medicare Spending for Physician Services Is Subject to Spending Targets Physician groups are concerned that physicians are the only Medicare provider type whose annual payment updates are subject to a spending target system. Payment rate updates for hospitals and other institutional providers, they note, are typically based on changes in the cost of providing services. However, as CBO, MedPAC, and others have noted, physicians are different from other providers in certain ways, which helps to provide a rationale for the application of targets solely to physician expenditures. Specifically, they note that physicians determine the services they deliver to their patients and influence the care delivered by other providers. In addition, under Medicare payment policies, physicians receive a separate payment for each service they provide. Thus, they can boost income by increasing the volume or intensity of services they provide. For example, a physician may follow up a patient’s visit by scheduling another visit, even when such a follow-up visit is discretionary and could be substituted with a telephone call. In contrast, Medicare typically pays institutional providers a fixed amount for a bundle of services; under this arrangement, no inherent incentive exists to provide extra services, as doing so would not increase payments. Physicians Question Fairness of Including Part B Outpatient Drugs in Calculation of Physician Service Expenditures One of physician groups’ chief concerns is that through fee schedule updates, the SGR system holds physicians accountable for the escalating growth in Medicare expenditures for the majority of Part B-covered drugs. (Drugs included in the SGR system are largely physician administered and do not include all Part B-covered drugs.) The groups contend that the SGR system should not include these drugs in the calculation of aggregate physician service expenditures or the spending targets. Although the targets account for increases in the drugs’ prices, the targets do not explicitly account for increases in their utilization or the substitution of more expensive drugs for less expensive ones. Physician groups note that the use of the outpatient drugs currently covered by Medicare is largely nondiscretionary and that physicians should not be penalized for prescribing these drugs. To the extent that expenditures for these Medicare-covered outpatient drugs grow faster than real GDP per capita—which is the SGR system’s allowance for volume and intensity increases—other physician spending must grow more slowly or aggregate spending will exceed the targets and fee updates for physician services will be reduced. In 2002, Medicare covered approximately 450 outpatient prescription drugs. The drugs that account for most of Medicare’s Part B drug expenditures are physician administered, such as those for cancer chemotherapy, accounting for 80 percent of total Medicare spending for Part B drugs in 2001. In 2001, oncologists submitted about 42 percent of prescription drug claims, while urologists accounted for 17 percent. Part B prescription drugs are not covered by the physician fee schedule, but the expenditures for most Part B drugs are included in the SGR system expenditures because, at the time spending targets were first introduced, the Secretary of Health and Human Services (HHS) included these drugs as services and supplies “incident to” physicians’ services. Since that time, Medicare spending for all Part B drugs has grown substantially, from about $700 million in 1992 to an estimated $8.5 billion in 2002. Much of the spending growth has resulted from increases in utilization and the substitution of newer, more expensive medications. Because SGR-covered Part B drug expenditures have grown more rapidly than other physician service expenditures, drug expenditures as a proportion of allowable spending under the targets have grown from 8.7 percent in 2002 to an estimated 12.3 percent in 2004. Such rapid growth in drug expenditures increases the likelihood that actual spending will exceed SGR system targets. Moreover, because only payments for services included in the physician fee schedule are offset when physician service spending deviates from the spending targets, the increase in the share of total expenditures attributed to prescription drugs magnifies the adjustment that must be made to the update to bring spending in line with the targets. Physicians Concerned That Key Spending Drivers Are Not Included in SGR System’s Allowance for Volume and Intensity Growth Physician groups have expressed concern that the SGR system’s allowance for volume and intensity growth—the 10-year moving average growth in real GDP per capita—is both too low and inflexible. They contend that tying the allowance to GDP results in targets that do not adequately account for appropriate increases in the demand for physician services and changes in medical practice, such as the following: A sicker beneficiary population. Physician groups reason that although health status drives demand for services, the GDP growth allowance would not account for any increases in physician spending that could be due to greater care demands per beneficiary. Technological advances. The groups note that new, expensive medical technologies can provide meaningful health gains for Medicare beneficiaries but that these technology costs are likely to grow faster than GDP. Site-of-service shifts. The groups note that patients with complex conditions formerly treated in hospitals are increasingly treated in physician offices and that treating such patients, who may require frequent office visits and costly procedures, is likely to contribute to volume and intensity growth. The MVPS system provided an explicit opportunity to address some of these concerns procedurally. In addition to the allowance for volume and intensity growth specified in statute, the MVPS system also provided specific authority for the HHS Secretary to recommend revising the allowed increase based on factors such as changes in technology and concerns about access to physician services. Under the MVPS system, the Secretary never exercised the authority to make recommendations other than implementing the MVPS default formula, but it still remained an option. Transparency Lacking in Process for Estimating Changes in Medicare Spending for Physician Services due to Laws and Regulations The SGR system is designed to account for changes in law and regulation that could affect aggregate spending for physician services. For example, for 2005, CMS estimates that increased spending resulting from MMA’s coverage of a preventive physical examination for new beneficiaries, cardiovascular screening blood tests, and diabetes screening tests, among other new increases, will be almost fully offset by new MMA-required payment adjustments for Part B drugs, which will lower physician service spending. Physician groups we spoke with contend that the process for developing such estimates may not be accurate or complete. Assessing the accuracy and completeness of these estimates is difficult, as CMS’s process for identifying the applicable statutory and regulatory changes and the methods used to arrive at dollar estimates are not fully transparent. Either data are lacking to quantify the effects of changes or consensus is lacking on the assumptions and interpretations made about the changes and their effects. Currently, CMS does not use a formal mechanism for soliciting input from physician groups or other experts before obtaining public comment when future fees are announced in the Federal Register. Physician groups contend that at least including physician representatives in the process of assessing changes in laws and regulations would improve CMS’s analysis of effects and would be more efficient than waiting for the public comment period. Variable Growth in Provision of Physician Services and Certain SGR System Design Elements Reduce Stability and Predictability of Physician Fee Updates Fee updates under the SGR system have varied widely within an allowed range, principally because of annual fluctuations in the growth of the volume and intensity of services that physicians provide to beneficiaries. Two of the SGR system’s design characteristics—the cumulative nature of spending targets and the use of estimated data elements in the spending target—also serve to reduce the stability and predictability of updates. The MMA provision that revised the allowance for growth in service volume and intensity from real GDP per capita growth rates each year to a 10-year moving average will reduce some of the swings in future SGR system updates. Fluctuating Volume and Intensity Growth Is a Principal Cause of Instability of Fee Updates Annual fluctuations in the growth of the volume and intensity of services that physicians provide to beneficiaries have been a principal cause of the instability of physician fee updates. Since the SGR system was implemented in 1998, volume and intensity growth has ranged from 1.2 percent in 1999 to 6.1 percent in 2002. (See fig. 2.) It is uncertain how much physicians’ discretion in the provision of their services contributes to the fluctuation in volume and intensity growth. Several studies have found that physicians respond to reduced fee updates by increasing the volume and intensity of services they provide to help maintain their total Medicare income. In estimating future spending and fee updates, both CMS and CBO assume that physicians will compensate, through volume and intensity increases, for a portion of any fee reductions. Consequently, both CMS and CBO project that for example, a 1 percent fee reduction would cause aggregate spending to fall by less than 1 percent. In addition, CBO assumes that physicians will respond to fee increases by reducing volume and intensity. Physician groups contend that volume and intensity growth is a necessary response to increased demand caused by factors outside of physicians’ control as noted earlier, such as the declining health status of Medicare beneficiaries, Medicare coverage of new benefits, and changing medical technology and practices that encourage beneficiaries to schedule more appointments with physicians. As long as the contributing factors are not fully understood and predictable, unexpected volume and intensity fluctuations will result in uncertain fee updates year to year. SGR System’s Cumulative Targets Increase Potential Fluctuation of Physician Fee Updates The cumulative nature of the SGR system’s spending targets increases the potential fluctuation of physician fee updates, as the system requires that excess spending in any year be recouped in future years. Conceptually, this means that if actual spending has exceeded the SGR system targets, fee updates in future years must be lowered sufficiently to both offset the accumulated excess spending and slow expected spending for the coming year. Conversely, the system also requires that if spending were to fall short of the targets, fees would need to be increased so that future spending would be raised to align with target spending. Estimation of the 2005 fee update illustrates how excess spending that is not addressed affects future fee updates. In 2004 actual expenditures under the SGR system are estimated to be $83.4 billion, whereas target expenditures for the same year will be $77.3 billion. As a result, 2005 fee updates need to offset a $6.1 billion deficit from excess spending in 2004 (plus accumulated excess spending of $5.8 billion in past years) and to realign the year’s expected spending with target spending. Because the SGR system is designed to offset accumulated excess spending over a period of years, the deficit for 2004 and preceding years will reduce fee updates for multiple years. According to projections made by CMS OACT, maximum fee reductions will be in effect from 2006 through 2012. Fee updates will be positive in 2014. (See fig. 3.) Uncertainty in Estimates of Underlying SGR System Data Elements Decreases Stability and Predictability of Physician Fee Updates The stability of fee updates under the SGR system depends, in part, on CMS’s ability to accurately estimate current spending and annual changes in the four factors that determine the sustainable growth rate: input prices, FFS enrollment, the 10-year moving average of real GDP per capita, and expenditures due to changes in laws and regulations. If reality proves different from these estimates, then the estimates are revised to incorporate more complete data, thereby contributing to the year to year fluctuation in fee updates. For example, in the fall of 2004, when CMS determines the update for 2005, the agency must estimate cumulative expenditures through the end of 2004 based on incomplete data. If actual spending is underestimated, the 2005 update will be set higher than it would have been set without the estimation error. This underestimate will be corrected, because in setting a fee update, the SGR system requires CMS to revise the spending estimates and the sustainable growth rates for the 2 preceding years. Therefore, when more complete spending data become available, the agency will revise its previous cumulative spending estimates through 2004 and reduce future fee updates relative to what they would have been if spending had not been underestimated. Uncertainty in long-term projections of FFS enrollment, in conjunction with the cumulative nature of the SGR system’s targets, makes long-term estimates of fee updates less predictable. Because the SGR system offsets accumulated excess spending by reducing the update for the fee paid for each service, a decline in the number of services results in less spending being offset. For example, currently, CMS estimates that over the next 10 years, enrollment in FFS will decline as more beneficiaries join private plans. CMS projects that the percentage of Medicare beneficiaries in the FFS program will decline from about 85 percent in 2005 to 67 percent in 2014. With fewer beneficiaries in FFS, fewer services would be provided. Therefore, the SGR system would call for more severe update reductions to offset accumulated excess spending relative to what would have occurred if FFS enrollment had remained stable. In contrast, CBO projected that FFS enrollment will increase over the 10-year period at about the same rate as the increase in overall Medicare enrollment. With more beneficiaries in FFS, and thus more services provided, update reductions would not need to be as severe to offset accumulated excess spending. Therefore, under CBO’s FFS projection, positive fee updates would be expected to return sooner than under CMS’s FFS projection. Switching to the 10-Year Moving Average of Real GDP Per Capita Will Increase Stability and Predictability MMA changed the SGR system formula to use a 10-year moving average of real GDP per capita, which is currently 2.3 percent. As noted in our 2002 testimony, this change will eliminate much of the cyclical variation in this factor that occurred in previous years under the formula when the SGR system target was tied to the yearly change in real GDP per capita. (See fig. 4.) Including a more stable measure of economic growth in the SGR system formula will help increase the stability of fee updates. Alternatives for Updating Physician Fees Would Eliminate Spending Targets or Revise Current SGR System The projected sustained period of declining physician fees and the potential for beneficiaries’ access to physician services to be disrupted have heightened interest in alternatives for the current SGR system. In general, potential alternatives we identified cluster around two approaches. One approach would end the use of spending targets as a method for updating physician fees and encouraging fiscal discipline. The other approach would retain spending targets but modify the current SGR system to address perceived shortcomings. These modifications could include one or more of the following options: removing the Part B prescription drug expenditures that are currently counted in the SGR system; resetting the targets and not requiring the system to recoup previous excess spending; using annual, rather than cumulative, targets; raising the allowance for increased spending due to volume and intensity growth; and permitting some flexibility in setting the volume and intensity allowance. The projections are included to aid comparisons among the various options and are not intended to serve as predictions for what would occur if the SGR system was replaced or modified. In addition, there is a degree of uncertainty surrounding any projection and that uncertainty tends to increase with the number of years for which the projection is made. For some of these options we present, CBO has developed budget scores, which are specific cost estimates that include only federal expenditures and exclude spending from other sources, such as beneficiary cost sharing. When available, we present CBO’s cost estimates for the options. use the same assumptions regarding volume and intensity growth for physician services and future FFS enrollment. Eliminate Spending Targets, Base Fee Updates on Physician Cost Increases In its March 2001 report to the Congress, MedPAC recommended eliminating the SGR system of spending targets and replacing it with an approach that would base annual fee updates on changes in the cost of efficiently providing care. Under this approach, efforts to control aggregate spending would be separate from the mechanism used to update fees. The advantage of eliminating spending targets would be greater fee update stability. However, CMS OACT estimates that this approach, compared with the current law projection, would result in cumulative expenditures that are 22 percent greater over a 10-year period. MedPAC reported that its recommendation could be implemented, in part, by basing the update on forecast changes in MEI. It suggested that other adjustments to the update might be necessary, for example, to ensure overall payment adequacy or correct for previous MEI forecast errors. In subsequent annual reports to the Congress, MedPAC has continued to recommend a physician fee update based on MEI. In its March 2004 report, for example, MedPAC stated that current Medicare payments for physician services were adequate and recommended an update of approximately 2.6 percent for 2005 to “help maintain physician willingness and ability to furnish services to Medicare beneficiaries.” MedPAC’s recommendation contrasts with the 1.5 percent minimum update provided for by MMA and the negative 3.6 percent update specified by the SGR system. In 2004 testimony, MedPAC stated that fee updates for physician services should not be automatic, but should be informed by changes in beneficiaries’ access to services, the quality of services provided, the appropriateness of cost increases, and other factors. Basing the update on MEI would result in positive and relatively stable fee updates. (See fig. 5.) According to CMS OACT simulations, such an approach would likely produce fee updates that ranged from 2.1 percent to 2.4 percent over the period from 2006 through 2014. Because physician fees would increase each year during the entire period, rather than decreasing each year until positive updates returned in 2014 as they would under the current SGR system, Medicare spending for physician services would rise. For the 10-year period from 2005 through 2014, CMS OACT estimates that this approach would result in cumulative expenditures that are 22 percent greater than projected under current law. (See fig. 6.) CMS OACT projects that under current law the net present value of total Medicare spending (both federal and beneficiary) over the next 75 years on all Part B services will be $16.9 trillion. If physician fee updates are based on the change in MEI, CMS OACT estimates that the net present value of total Medicare spending (both federal and beneficiary) over the next 75 years on Part B services would equal $19.1 trillion. Real spending per beneficiary would increase from $2,157 in 2005 to $2,802 in 2014, compared with real spending per beneficiary under current law, which would decrease to $1,774 in 2014. (See fig. 7.) Although MedPAC’s recommended update approach would limit annual increases in the price Medicare pays for each service, the approach does not contain an explicit mechanism for constraining aggregate spending resulting from increases in the volume and intensity of services physician provide. In 2001, when MedPAC first recommended eliminating the SGR system, it stated that volume and intensity increases had not been a major concern since 1992. It added, however, that if volume and intensity growth reemerged as a concern, Medicare might address the problem by trying to achieve appropriate use of services through outcomes and effectiveness research, disseminating practice guidelines and other tools for applying this research, and developing evidence-based measures to assess the application of the research findings. Since MedPAC’s 2001 report, volume and intensity growth has increased considerably. (See fig. 2.) Subsequent MedPAC reports and testimony have discussed trends in the use of physician services and have identified particular services—such as diagnostic imaging—that are growing rapidly, but the reports have not made recommendations for addressing volume and intensity growth. However, in 2004 testimony, MedPAC stated that it planned to study the efficacy of private insurers’ strategies for controlling spending for high-growth services and whether Medicare might be able to emulate them. Retain Spending Targets, Modify Current SGR System Another approach for addressing the perceived shortcoming of the current SGR system would retain spending targets but modify one or more elements of the system. The key distinction of this approach, in contrast to basing updates on MEI, is that fiscal controls designed to moderate spending would continue to be integral to the system used to update fees. The advantage of retaining spending targets as part of the system for updating fees is that the system would automatically work to moderate spending if volume and intensity growth began to increase above allowable rates. Although many options are possible under this approach, six are discussed below. All six would produce fee updates that are higher during the 10-year period from 2005 through 2014 than those projected under current law but would also result in higher aggregate spending ranging from 4 percent to 23 percent more, depending on the modification. Remove Part B Drugs from the SGR System The Secretary of HHS could, under current authority, consider excluding Part B drugs from the definition of services furnished incident to physician services for purposes of the SGR system. As discussed earlier, expenditures for these drugs have been growing rapidly, which, in turn, has put downward pressure on the fees paid to Medicare physicians. However, according to CMS OACT simulations, removing Part B drugs from the SGR system beginning in 2005 would not prevent several years of fee declines and would not decrease the volatility in the updates. Fees would decline by about 5 percent per year from 2006 through 2010. (See fig. 8.) There would be a positive update in 2011—3 years earlier than is projected under current law. From 2012 through 2014, fees would increase by approximately 5 percent per year. CMS OACT estimates that removing Part B drugs from the SGR system would result in cumulative spending over the 10-year period from 2005 through 2014 that is 5 percent higher than is projected under current law. (See fig. 9.) Real spending per beneficiary would increase from $2,157 in 2005 to $2,240 in 2014, compared with real spending per beneficiary under current law, which would decrease to $1,774 in 2014. (See fig. 10.) In 2002, we testified that physician spending targets and fees may need to be adjusted periodically as health needs change, technology improves, or health care markets evolve. Such adjustments could involve specifying a new base year from which to set future targets. Currently, the SGR system uses spending from 1996, trended forward by the sustainable growth rate computed for each year, to determine allowable spending. MMA avoided a fee decline in 2004, and a projected fee decline for 2005, by stipulating a minimum update of 1.5 percent in each of those 2 years, but the law did not similarly adjust the spending targets to account for the additional spending that would result from the minimum update. Consequently, under the SGR system the additional MMA spending and other accumulated excess spending will have to be recouped through fee reductions beginning in 2006. If policymakers believe that the resulting negative fee updates are inappropriately low, one solution is to use actual spending from a recent year as a basis for setting future SGR system targets. Using such an approach, policymakers could essentially forgive the accumulated excess spending attributable to MMA and other factors. The effect would be to increase future updates and, as with other alternatives presented here, overall spending. According to CMS OACT simulations, forgiving the accumulated excess spending as of 2005—that is, resetting the cumulative spending target so that it equals cumulative actual spending—would raise fees in 2006. (See fig. 11.) However, because volume and intensity growth is projected to exceed the SGR system’s allowance for such growth, negative updates would return beginning in 2008 and continue through 2013. Resulting cumulative spending over the 10-year period from 2005 through 2014 would be 13 percent higher than is projected under current law. (See fig. 12.) Real spending per beneficiary for physician services would grow from $2,157 in 2005 to $2,334 in 2014, compared with real spending per beneficiary under current law, which would decrease to $1,774 in 2014. (See fig. 13.) One option for reducing the fluctuation in fee updates would be to eliminate the cumulative aspect of the SGR system’s spending targets and return to a system of annual targets, as was used under MVPS. As previously discussed, the cumulative aspect of the SGR system’s spending targets—although rigorous as a budgetary tool—can produce updates that swing from the maximum fee reduction to the maximum fee increase. In contrast, MVPS’s annual spending target approach traded off some fiscal control for increased fee stability. The MVPS update for a year depended, in part, on whether actual spending 2 years earlier had exceeded or fallen short of the annual spending target for that year. For example, the MVPS update for 1996, which was determined in 1995, was affected by the relationship between actual and target spending in 1994. In principle, under MVPS excess spending from a single year, up to a limit specified by its update formula, was required to be recouped. Excess spending that could not be made up within those limits would, in essence, be forgiven. According to CMS OACT simulations, eliminating the cumulative aspect of the SGR system would result in fee updates that vary less than projected updates under current law. For example, under an MVPS-like system of annual targets, from 2006 through 2014, the largest negative update would be negative 0.6 percent instead of negative 5.0 percent under current law, and the largest positive update would be 0.9 percent instead of 3.9 percent. (See fig. 14.) Fees would be essentially flat over the period, instead of swinging from large fee declines to fee increases as they are expected to do under the SGR system. Relative to spending projected under current law, under an MVPS-like system total spending would be greater each year from 2006 through 2014. CMS OACT estimates that cumulative expenditures over the 10-year period from 2005 through 2014 would be 15 percent higher than under current law. (See fig. 15.) Real spending per beneficiary would increase from $2,157 in 2005 to $2,442 in 2014, compared with real spending per beneficiary under current law, which would decrease to $1,774 in 2014. (See fig. 16.) If policymakers agree with physician groups that the current SGR system’s allowance for volume and intensity growth does not adequately account for appropriate spending increases that result from technological innovation or changes in medical practice, the allowance could be increased by some factor above the percentage change in real GDP per capita. As stated earlier, the current SGR system’s allowance for volume and intensity growth is approximately 2.3 percent per year—the 10-year moving average in real GDP per capita—while projected volume and intensity growth is higher—about 3 percent per year for physician services alone, and about 4 percent per year including Part B drugs. To offset the increased spending associated with the higher volume and intensity growth, the SGR system will reduce updates below the increase in MEI. In its 1997 report to the Congress, PPRC recommended adopting an allowance equal to real GDP per capita plus 1 or 2 percentage points “to allow for advancements in medical capabilities.” According to CMS OACT simulations, increasing the allowance for volume and intensity growth to GDP plus 1 percentage point would likely produce positive fee updates beginning in 2012—2 years earlier than is projected under current law. (See fig. 17.) Because fee updates would be on average greater than under current law during the 10-year period from 2005 through 2014, Medicare spending for physician services would rise. CMS OACT estimates that cumulative expenditures over the 10-year period would increase by 4 percent more than under current law. (See fig. 18.) Real spending per beneficiary would change little from $2,157 in 2005 to $2,158 in 2014, compared with real spending per beneficiary under current law, which would decrease to $1,774 in 2014. (See fig. 19.) Congress could also modify the SGR system’s allowance for volume and intensity growth by providing flexibility similar to that afforded by the MVPS system. Although that earlier system of spending targets specified a default volume and intensity increase, it also allowed the HHS Secretary to recommend a different increase if changes in medical technology, beneficiary access to physician services, or other factors warranted an allowance that was higher or lower than the default increase. Combine Options Two alternatives illustrate the effects of combining individual options. For example, together the Congress and CMS could modify the SGR system by removing Part B drugs, resetting the base, and increasing allowed volume and intensity growth to GDP plus 1 percentage point. According to CMS OACT simulations, this combination of options would result in positive updates ranging from 2.2 percent to 2.8 percent for the 2006–2014 period. (See fig. 20.) CMS OACT projects that the combined options would increase aggregate spending by 23 percent over the 10-year period (see fig. 21.) and that real spending per beneficiary for physician services would increase from $2,157 to $2,866, compared with real spending per beneficiary under current law, which would decrease to $1,774 in 2014. (See fig. 22.) Another example of combined options could involve removing Part B drugs and implementing an MVPS-like system of annual targets, but not increasing the volume and intensity allowance. CMS OACT simulations project that this combination would result in fee updates that range from 0.8 percent to 1.3 percent over the period from 2006 through 2014. (See fig. 23.) Over the 10-year period from 2005 through 2014, cumulative spending for physician services would exceed those projected under current law by 18 percent. (See fig. 24.) Real spending per beneficiary for physician services would increase from $2,157 to $2,615, compared with real spending per beneficiary under current law, which would decrease to $1,774 in 2014. (See fig. 25.) Concluding Observations Medicare faces the challenge of moderating the growth in spending for physician services while ensuring that physicians are paid fairly so that beneficiaries have appropriate access to their services. Under the current SGR system, fees are projected to fall by about 5 percent per year for the next several years. Total payments to physicians will continue to rise because of expected increases in volume and intensity. However, on a per capita basis, real spending per beneficiary will decline, raising concerns that a sustained period of falling fees could discourage some physicians from participating in the Medicare program and serving beneficiaries. These concerns have prompted policymakers to consider alternative approaches for updating physician fees. One approach under consideration for solving the problem of declining fees is for Medicare to abandon the use of spending targets and separate the program’s attempts to control spending from its method for adjusting physician fees each year. This is the approach that has been recommended by MedPAC. Although projected future fee increases would be positive and relatively stable, eliminating spending targets would increase spending. The extent to which spending growth would be moderated would depend upon the efficacy of separate efforts to address growth in volume and intensity. Similarly, the other approach of retaining spending targets but modifying the SGR system to overcome its current perceived shortcomings, would also increase spending. These alternative approaches could also be augmented by separate efforts to moderate spending. Alternatives under this approach seek to preserve the fiscal discipline of spending targets while providing for reasonable fee updates. These alternative approaches could also be augmented by other efforts to moderate spending. To the extent that the growth in spending is moderated, physicians would benefit from an increase in fees that would be triggered under a spending target system. Almost any change to the SGR system is likely to increase Medicare spending above the amount that is currently projected. Either of the two broad types of approaches discussed above—replacing the SGR system and revising the SGR system—could be implemented in a way that would likely generate positive fee updates. Therefore, the choice between the two approaches under consideration may hinge on whether primary importance should be given to stable fee increases or to the need for fiscal discipline within the Medicare program. Agency and Industry Comments and Our Evaluation Agency Comments In written comments on a draft of this report, CMS agreed with our concluding observations that appropriately updating the physician payment rates requires a balance between adjusting physician fees in a stable and predictable manner and encouraging fiscal discipline with scarce Medicare resources. CMS expressed its commitment to ensuring that Medicare beneficiaries have access to high-quality health care and noted that achieving this goal requires paying physicians appropriately. CMS mentioned several administrative actions it has taken to improve Medicare’s payments to physicians, including specific adjustments to MEI that have both made the index a more accurate representation of inflation in physician practice costs and resulted in higher payments to physicians. In addition, the agency committed to considering further administrative actions and discussed ongoing efforts to implement various provisions of MMA that may reduce adverse incentives in the current payment system, allow the program to pay for higher quality care, and uncover innovative methods to control spending growth in the future. We have reprinted CMS’s letter in appendix III. Industry Association Comments We obtained oral comments from officials representing the American Medical Association (AMA), the Medical Group Management Association (MGMA), the American College of Physicians (ACP), and the Alliance for Specialty Medicine (ASM). In discussing the draft report with these groups, their overall reaction was that the report was a good analysis of the problems with the SGR system; however, they raised a number of concerns about the draft report. The bulk of their comments focused on OACT’s estimates of aggregate spending on physician services, the SGR system’s use of MEI as a measure of input price inflation for physician services, and the draft’s discussion of physicians’ concerns about the SGR system. The rest of their comments pertained to either issues related to physician behavior or to topics outside the scope of our review. A summary of the physician groups’ comments and our evaluation is provided below. Representatives from all four groups commented on CMS OACT’s estimates illustrating each option’s additional aggregate spending over a 10-year period relative to current law spending over the same period. The groups were confused by the difference between CMS OACT’s estimates and CBO’s budget impact estimates, which were available for some of the options. CBO’s budget scores—that is, cost estimates that show the impact of legislative changes on the federal budget—include only federal expenditures and exclude spending from other sources, such as beneficiary cost sharing. In contrast, CMS OACT’s aggregate spending estimates include both federal outlays and beneficiary cost sharing. Because any changes to the SGR system that result in increased spending would not only affect taxpayers but also Medicare beneficiaries (through increased cost sharing and part B premiums), we believe it is appropriate to include the estimated increase in aggregate spending. Nevertheless, because our focus is on the relative costliness of each option, we revised the draft to highlight the proportional difference between current law spending and the spending estimated for each option. In addition, we now include CBO’s budget scores for each option, where available. All four physician groups also expressed concern that the draft report did not discuss the use of MEI as a measure of input price inflation for physician services. The groups contended that MEI does not contain sufficiently current data on physician practice costs, stating that it does not account for or keep pace with the cost of items such as information technology. Examining MEI and other indices included in the SGR system was outside the scope of our report. Moreover, in responding to public comments on a federal regulation, CMS stated that the various expense categories constituting MEI capture all practice expenses and are based on the most recent available data. The physician groups commented that the projected payment reductions of 5 percent a year from 2006 through 2014 are unrealistically severe and that the draft report did not sufficiently emphasize the access problems that beneficiaries would experience in the event of these cuts. They further noted that the Congress has regularly made adjustments to the SGR system and would probably act again. We noted in the draft report that policymakers, physicians, and others are concerned about the impact that the projected fee reductions would have on beneficiary access to physician services, noting that the Medicare Trustees and other parties believe it is unlikely that the projected fee reductions will take place. Representatives from both ACP and ASM asserted that we should include a discussion about the effect of the spending targets on physician behavior and volume and intensity. They noted that evidence is lacking that directly correlates the introduction of both spending targets and the physician fee schedule in 1992 with the corresponding drop in volume and intensity in that year. They believe this reduction was likely caused by something other than the spending target, such as initiatives aimed at correctly coding claims for physician services. ACP stated that for the Congress to evaluate any alternatives, there must be a discussion of how the SGR system affects the volume and intensity of physician services. As noted in the draft report, we do not claim that spending targets and the fee schedule influenced individual behavior and reduced the volume and intensity of physician services in the early 1990s, we noted that PPRC claimed that a spending target system would provide a collective incentive for physicians to develop practice guidelines and control unnecessary utilization. Further, in the draft report we described spending targets as a method for automatically imposing fiscal discipline, not as a tool to modify the behavior of individual physicians. Representatives from ACP further noted that while the draft report included a discussion of geographic variation in physician service use, it did not mention that the SGR system is a blunt instrument in that it applies nationally to all physicians. In a year in which fees are reduced, physicians in regions that could be characterized as low spending would receive the same fee reduction as physicians in higher-spending regions. We agree that the SGR system does not distinguish between physicians whose discretionary practice patterns result in higher Medicare spending and those physicians whose practice patterns do not. As we stated in the draft report, at the time PPRC recommended expenditure targets, it initially envisioned a national target that would apply to all physician services and later the evolution of separate targets that would apply to regions, categories of physician services, or both. The physician groups raised additional topics that were beyond the scope of our study. For example, AMA contended that Medicare’s new preventive benefits and government-sponsored health campaigns create a government-induced demand among beneficiaries for services that, in turn, could increase volume and intensity of service use. To date, studies have not been conducted on whether new benefits and federal health campaigns have directly affected Medicare beneficiaries’ use of physician services. Our report notes, however, that the SGR system’s allowance for volume and intensity growth, unlike that of the MVPS system, is inflexible and would not take such factors into account. ACP noted that increased spending on physician services may be appropriate, as it may result in other program savings, such as reduced spending for hospital care. Whether such savings have been or can be achieved would require research outside this study’s scope. We are sending copies of this report to the Secretary of Health and Human Services and interested congressional committees. We will also provide copies to others on request. In addition, this report is available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have questions about this report, please contact me at (202) 512-7101 or James Cosgrove at (202) 512-7029. Other contributors to this report include Jessica Farb, Hannah Fein, and Jennifer Podulka. Appendix I: Calculation of the Performance Adjustment Factor Each year, CMS follows a statutory formula to compute a performance adjustment factor (PAF) and determines whether the physician fee update should be adjusted relative to the percentage change in the Medicare Economic Index (MEI) and, if so, by how much. (See fig. 26.) The PAF takes into account the difference between actual and target expenditures. If spending has equaled the targets, the PAF is equal to 1 and the update will equal the percentage change in MEI. If spending has been below the targets, the PAF is greater than 1, thus increasing the update. If spending has been above the targets, the PAF is less than 1, thus reducing the update. The PAF is a blend of the relative difference between target and actual spending in the current year, accounting for 75 percent, and the relative cumulative difference in expenditures from April 1996 through the current year, accounting for 33 percent. The weights were developed by the Centers for Medicare & Medicaid Services’ (CMS) Office of the Actuary (OACT) and included in statute to minimize the volatility of both fee updates and the time required to align actual spending with the targets. Applying these weights causes the difference between cumulative actual expenditures and cumulative target expenditures to be adjusted over several years rather than during a single year. As a result, the fee update is less volatile than would be the case if the full adjustment were made in 1 year. The PAF is subject to statutory limits and may not cause the fee update to be set at more than 3 percent above MEI or 7 percent below MEI. These limits may further increase the time necessary to align spending with targets. Appendix II: Corrections to Prior Estimates Caused the SGR System’s Cumulative Targets to Produce Negative Updates Since the introduction of the fee schedule in 1992 through 2001, physicians generally experienced real increases in their fee updates—that is, fee updates increased more than the increase in the cost of providing physician services, as measured by MEI. Specifically, during that period, fee updates increased by 39.7 percent, whereas MEI increased by 25.9 percent. In 2002, however, the sustainable growth rate (SGR) system reduced fees by 4.8 percent, despite an estimated 2.6 percent increase in the costs of providing physician services. (See fig. 27.) In 2002, corrections to prior estimation errors caused the SGR system’s cumulative targets to begin producing negative updates. The SGR system reduced fees in 2002 because estimated spending for physician services— cumulative since 1996—exceeded the target by about $8.9 billion, or 13 percent of projected 2002 spending. In part, the fee reduction occurred because CMS revised upward its estimates of previous years’ actual spending. Specifically, CMS found that its previous estimates had omitted a portion of actual spending for 1998, 1999, and 2000. In addition, in 2002 CMS lowered the 2 previous years’ spending targets based on revised gross domestic product (GDP) data from the Department of Commerce. Based on the new higher spending estimates and lower targets, CMS determined that fees had been too high in 2000 and 2001. In setting the 2002 physician fees, the SGR system reduced fees to recoup previous excess spending. The update would have been about negative 9 percent if the SGR system had not limited its decrease to 7 percent below MEI. Because the previous overpayments were not fully recouped in 2002, and because of volume and intensity increases, by 2003, physicians were facing several more years of fee reductions to bring cumulative Medicare spending on physician services in line with cumulative targets. Despite its recognition of errors, CMS had determined that its authority to revise previous spending targets was limited. In 2002, CMS noted that the 1998 and 1999 spending targets had been based on estimated growth rates for beneficiary FFS enrollment and real GDP per capita; actual experience had shown these growth rates to be too low. If the estimates could have been revised, the targets for those and subsequent years would have been increased. However, at the time that CMS acknowledged these errors, the agency concluded that it was not allowed to revise these estimates. Without such revisions, the cumulative spending targets remained lower than if errors had not been made. In late 2002, the estimate of the sustainable growth rate called for a negative 4.4 percent fee update in 2003. With the passage of the Consolidated Appropriations Resolution of 2003, CMS determined that it was authorized to correct the 1998 and 1999 spending targets. Because SGR system targets are cumulative measures, these corrections resulted in an average 1.4 percent increase in physician fees for services for 2003. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) averted additional fee reductions projected for 2004 and 2005 by specifying an update to physician fees of no less than 1.5 percent for those 2 years. The MMA increases replaced SGR system fee reductions of 4.5 percent in 2004 and an estimated 3.6 percent in 2005. The fee increases will result in additional aggregate spending. Because MMA did not make corresponding revisions to the SGR system’s spending targets, its fee increases will require the SGR system to offset the additional spending by reducing fees beginning in 2006. In addition, recent growth in spending due to volume and intensity, which has been larger than SGR system targets allow, will further compound the excess spending that needs to be recouped. Appendix III: Comments from the Centers for Medicare & Medicaid Services GAO’s Mission The Government Accountability Office, the audit, evaluation and investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. 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Concerns were raised about the current system Medicare uses to determine annual changes to physician fees--the sustainable growth rate (SGR) system--when fees were reduced by 5.4 percent in 2002. Subsequent administrative and legislative actions modified or overrode the SGR system, resulting in fee increases for 2003, 2004, and 2005. However, projected fee reductions for 2006-2012 have raised new concerns about the SGR system. Policymakers are considering whether to eliminate spending targets or modify them. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) required that GAO study SGR and potential alternatives to the system. This report examines (1) how the SGR system is designed to control spending for physician services, (2) what concerns have been raised about the SGR system and its components, (3) what affects the stability and predictability of physician fee updates under the SGR system, and (4) what alternatives to the current SGR system exist. GAO reviewed relevant laws and regulations and interviewed officials and organizations representing physicians. On the basis of this information, GAO identified potential alternatives to the SGR system and requested illustrative simulations of fee updates and spending on physician services from the Centers for Medicare & Medicaid Services (CMS). To moderate Medicare spending for physician services, the SGR system sets spending targets and adjusts physician fees based on the extent to which actual spending aligns with specified targets. If growth in the number of services provided to each beneficiary--referred to as volume--and in the average complexity and costliness of services--referred to as intensity--is high enough to cause spending to exceed the SGR target, fee updates are set lower than inflation in the cost of operating a medical practice. A wide enough gap between spending and the target results in fee reductions. Physician groups are dissatisfied with SGR as a system to update physician fees. For example, they question the fairness of including rapidly growing spending for physician-administered drugs in the SGR system's definition of physician services expenditures. The groups also contend that the allowance for growth in volume and intensity is too low and lacks the flexibility to allow for factors outside physicians' control. Fee updates under the SGR system have varied widely within an allowed range largely because of annual fluctuations in the growth of the volume and intensity of services that physicians provide to beneficiaries. Certain system design features, such as the use of cumulative spending targets and the need to estimate data, also reduce the stability and predictability of updates. However, MMA's revision of the allowance for growth in volume and intensity of services from an annual change to a 10-year moving average will help to make future updates more stable and predictable. Possible alternatives to the SGR system cluster around the two broad approaches under consideration: (1) end the use of spending targets and separate fee updates from explicit efforts to moderate spending growth or (2) retain spending targets but modify the current SGR system to address perceived shortcomings. CMS projects that either of the two approaches will result in higher aggregate spending, thereby increasing the difficulty of addressing Medicare's long-run financial challenges. The first approach emphasizes stable fee updates, while the second approach automatically adjusts fee updates if spending growth deviates from a predetermined target. While seeking to pay physicians appropriately, it is important to consider how modifications or alterations to the SGR system would affect the long-term sustainability and affordability of the Medicare program. In this context, the choice between the two approaches may hinge on whether primary consideration should be given to stable fee increases or to the need for fiscal discipline within the Medicare program. CMS agreed with the concluding observations in the draft report. Groups representing physicians commented that overall, the draft report offered a good analysis of problems with the SGR system, but did not fully reflect their concerns. We modified the draft as appropriate.

Background Since 2003, we have identified managing federal real property, including effectively managing excess and underused property and an overreliance on leasing, as a high risk issue facing the federal government. In June 2010, the President directed agencies to achieve real property cost savings through a number of measures, including disposal of excess real property and reducing leasing through consolidations and increased space utilization. In 2011, the administration proposed legislation, known as the Civilian Property Realignment Act (commonly referred to as CPRA), and accompanying bills were introduced in both legislative chambers, which would identify opportunities to consolidate, reduce, and realign the federal footprint as well as expedite the disposal of properties by building off the military base realignment and closure (commonly referred to as BRAC) processes. In May 2012, OMB issued a memorandum directing agencies to not increase the size of their civilian real estate inventory, stating that increases in an agency’s total square footage of civilization property must be offset through consolidation, co- location, or disposal of space from the inventory of that agency, a policy that became known as “freeze the footprint.” As a result, acquisition has become more about consolidation and identifying opportunities to share space rather than acquiring new space. Pursuant to the Government Performance and Results Modernization Act, OMB identified real property as a Federal Government priority goal. Agencies are currently working on 3-year Revised Real Property Cost Savings and Innovation Plans to maintain the fiscal year 2012 square footage baseline for federal office and warehouse inventory. Agencies have been encouraged to work collaboratively with other agencies and GSA to find opportunities for smarter space usage through co-locations and consolidations. We have previously reported that real property decisions draw considerable attention during congressional deliberations over federal appropriations. Stakeholders such as Congress, OMB, and the real property-holding agencies have an interest in how the federal government carries out its real property acquisition, management, and disposal practices. Ideally, when an agency has a real property need, such as repairing or altering its headquarters building, it determines how to meet that need through internal prioritization and the capital planning process. As part of the capital funding process, shown in Figure 1, an agency prepares a business case analysis and considers how to fund the project, including whether to request upfront funding. If an agency chooses to request upfront funding from Congress, it submits a business case to Congress through the annual appropriations process. If Congress approves the project, it may authorize spending for the project by appropriating full upfront funding to the agency. Once an agency has obtained upfront funding, it can obligate funds to complete “useful assets” of the project. During implementation as well as at completion of the project, an agency may realize returns, such as proceeds from disposal. The completion of the project informs agency prioritization and ongoing planning for future real property projects. Budget Scorekeeping Budget scorekeeping rules are meant to recognize costs as funding decisions are being made. These rules were established to ensure that the scorekeepers—that is, the House and Senate Budget Committees, the CBO, and OMB—can measure the effects of legislation consistently and conclude that they meet specific legal requirements. These rules are also used by OMB for determining amounts to be recognized in the budget when an agency signs a contract or enters into a lease. Scorekeeping in the Federal Budget What is scorekeeping? Scorekeeping is the process of estimating the budgetary effects of pending legislation and comparing them to a baseline. The process allows Congress to compare the cost of proposed budgetary policy changes to existing law and to enforce spending and revenue levels agreed upon in the budget resolution. Who are the scorekeepers? Guidelines are established by the OMB, the CBO, and the Senate and House Budget Committees. Scorekeepers have an ongoing dialogue and may revise rules as required. Budget Committees and CBO apply the rules to estimate the costs associated with proposed legislation. OMB uses the rules to determine amounts to be recognized in the budget when an agency signs a contract or enters into a lease. The House and Senate Budget Committees make available monthly summary scorekeeping reports. We have previously found that upfront funding is the best way to ensure recognition of commitments embodied in budgeting decisions and maintain government-wide fiscal control. As shown below, under scorekeeping rules, for a purchase or a capital lease the full cost of the project must be recorded in the budget in the year in which the budget authority is to be made available. In contrast, operating leases are intended for short-term needs, and under the scorekeeping rules, only the amount needed to cover the first year’s lease payments plus cancellation costs need to be recorded in the budget in that year. Summary of Scorekeeping Guidelines for Purchases and Leases When an agency is granted the authority to enter into a contract for the purchase, lease- purchase, capital lease, or operating lease of an asset, budget authority and outlays may be scored as follows: Lease-purchases and Capital Leases: budget authority will be scored against the legislation in the year in which the budget authority is first made available in the amount of the estimated net present value of the government’s total estimated legal obligations over the life of the contract, except for imputed interest and identifiable operating expenses. Operating leases: budget authority will be scored against the legislation in the year in which the budget authority is first made available in the amount necessary to cover the government’s legal obligation. The amount scored will include the estimated total payments expected to arise under the full term of the lease contract, or, if a cancellation clause is included in the lease, for the first fiscal year and the amount of cancellation costs. Purchases: no special rules apply to scoring purchases of assets (whether the asset is existing or is to be manufactured or constructed). Budget authority is scored in the year in which the authority to purchase is first made available in the amount of the government's estimated legal obligations. To distinguish lease purchases and capital leases from operating leases, the following criteria will be used for defining an operating lease: Ownership of the asset remains with the lessor during the term of the lease and is not transferred to the government at or shortly after the end of the lease period. The lease does not contain a bargain-price purchase option. The lease term does not exceed 75 percent of the estimated economic lifetime of the asset. The present value of the minimum lease payments over the life of the lease does not exceed 90 percent of the fair market value of the asset at the inception of the lease. The asset is a general purpose asset rather than being for a special purpose of the government and is not built to unique specification for the government as lessee. There is a private-sector market for the asset. Using an operating lease—or successive operating leases—for a long- term space need may result in resource allocation decisions for which the budgeting process may not have considered the full financial commitment over the full length of time the space need exists. Consequently, costly operating leases may appear on paper to be preferable to less-costly alternatives such as major construction or renovation projects that must compete for full funding. GSA’s Role Within the vast portfolio of government owned and leased assets, GSA plays the role of broker and property manager to many federal civilian agencies, although some agencies—including USDA, VA, and Interior— have independent authority related to real property. GSA has a large portfolio of federally-owned and leased properties that it rents to its federal agency customers. As of fiscal year 2011, GSA had a total of 374.6 million rentable square feet in its inventory, of which 192.7 million— slightly more than half—were leased. The Federal Buildings Fund (FBF), administered by GSA, is a fund established by the Public Buildings Act Amendments of 1972. The FBF is the primary source of funds for operating and capital costs associated with federal space. The FBF is funded primarily by income from rental charges assessed to tenant agencies occupying federally owned and GSA-managed and -leased space that approximate commercial rates for comparable space and services. Congress exercises control over the FBF through the appropriations process that sets annual limits on how much of the fund can be obligated for various activities. In addition, it periodically provides supplemental appropriations for the Fund. For example, the Fund received $5.6 billion as part of the American Recovery and Reinvestment Act of 2009. GSA may incur obligations and make expenditures from the FBF in five categories of activities: (1) rental of space, (2) repairs and alterations, (3) construction and acquisition of facilities, (4) building operations and maintenance, and (5) installment acquisition payments (funds debt incurred as the result of building acquisition and lease purchase arrangements). Revenue from the federally-owned facility inventory managed by GSA is the main source of the FBF’s operating income used to fund repair and alteration, new construction activities, and operations and maintenance. By statute, GSA is required to provide a prospectus for each proposed lease with a net annual rent above the prospectus threshold—$2.79 million in fiscal year 2013, which GSA’s Administrator is authorized to adjust annually—or capital project over that threshold, including acquisition, new construction, and repair and alteration projects. As shown in Figure 2, each prospectus is reviewed and approved by both OMB and Congressional authorizing committees. GSA has not conducted 30-year present value analyses as part of its prospectus process since the mid-1990s, as advised by OMB. Such analyses help weigh the cost over time of leasing versus owning an asset to promote efficient resource allocation for the civilian agencies within GSA’s real property portfolio. In September 2013 we reported that the decision to halt this type of formal analysis for high-value leases has limited the transparency of the prospectus process. We recommended that lease prospectuses include a description of the length of time an agency estimates a need for a space, how long the agency has leased that particular space, and major investments necessary. For spaces for which an agency has a long-term projected need, we recommended that GSA include an appropriate form of cost-to-lease versus cost-to-own analysis. GSA concurred with this recommendation. Although at times leasing versus owning analyses found leasing to be a more cost effective option, it often concluded that ownership would be cheaper than leasing; however, in many cases where ownership was found to be the better option, GSA ultimately recommended leasing due to funding constraints. Case Study Agency Officials Experienced Challenges Receiving Full Upfront Funding for Federal Real Property Projects Officials at four selected agencies—GSA, USDA, VA, and Interior— experienced challenges receiving full upfront funding for federal real property projects through the annual appropriations process. For example, GSA officials told us that obtaining upfront funding through appropriations is difficult and thus presents a barrier to ownership, resulting in a reliance on leased space. USDA officials said that, given current fiscal pressures, they do not routinely request acquisition funds. Interior officials told us that the Department has had a moratorium on new construction since 2010 and that any upfront funding received through the annual appropriations process goes towards necessary renovations to existing property. Although VA requests and receives appropriations for some real property construction projects, it has a significant backlog of incomplete major construction projects that have not received funding. The Veteran’s Health Administration (VHA) requested $215 million for major construction funding in fiscal year 2014 and estimates that it would require $5.8 billion to address its current backlog. Budget constraints have resulted in limited acquisitions at GSA, Interior, and USDA. For example, GSA’s sole acquisition between 2008 and 2012 resulted from exercising a purchase option on a preexisting lease. GSA renewed its lease at Columbia Plaza in Washington, D.C. for the Department of State (State) in 1992. As part of an agreement to invest $30.6 million in renovations to the building at that time, GSA was directed by congressional resolution to “attempt to include a purchase option in the lease contract.” GSA did not have the option to purchase the building in 1992 but it negotiated a purchase option as part of the terms of the 20- year lease. As the expiration of the lease neared, GSA concluded that a mission need for the building remained and that acquiring the building would be financially advantageous. Under the original contract, GSA could purchase the building for $100 million though the 2009 appraised value was $150 million. A 30-year present value analysis concluded that acquiring the building would result in an annual cost advantage of $12 million over continuing to lease and, in 2012, GSA exercised its purchase option. Because State was already occupying Columbia Plaza, GSA officials said that they mitigated a portion of the acquisition cost by avoiding certain costs typical to the construction process including acquiring land, phased funding for construction, paying for interim office space, and final relocation to the new space. However, purchase options may cost more over the life of a lease than buying a building upfront. Figure 3 shows that although the contract purchase price was $100 million, adding in the initial renovation costs and lease payments made over the 20-year term, in total the acquisition cost to the government was $258 million. Limitations on obligations constrain funding for real property, especially for repairs, alterations, and new construction. The difference between receipts collected in the FBF and the amount authorized for annual obligations affected one of our case study agencies that rents property through GSA. Interior officials said that GSA has been unable to obtain FBF funding through the annual appropriations process to complete renovations in Interior’s federally-owned and GSA-managed headquarters building. As a result, Interior officials said that they have not been able to realize the savings they anticipated for a full renovation, such as energy savings. The FBF’s balance has increased significantly in recent years, growing from $56 million at the beginning of fiscal year 2007 to $4.7 billion at the end of fiscal year 2013. As we previously reported, the increased balance has primarily resulted from the growing difference between the resources deposited into the FBF and the level of funds GSA is authorized to spend. GSA officials noted that when Congress provides less obligational authority than requested, repairs, alterations, and new construction projects for GSA-managed buildings are most affected because available funds are first used to pay leasing, operations and maintenance, and debt costs. As a result, GSA’s obligations authority for repairs and alterations projects decreased from $855 million in 2005 to $280 million in 2012. GSA officials noted that when prioritizing requests for repair and alteration projects, they consider asset condition and performance; life safety and compliance with laws and regulations; customer considerations, including consolidation and reduction in space; financial viability, including lease cost avoidance; and improvements to utilization rates and recapturing vacant space. With regard to the disposal of federal property, officials at USDA, which has authority to retain proceeds from sales and disposals, cited financial obstacles to these initiatives, such as little market demand. For example, USDA’s Forest Service was given authority in 2005 to retain proceeds from disposals; it typically uses these funds for critical maintenance work on its properties or to prepare other buildings for sale. Forest Service officials said that except for a few administrative buildings in affluent areas sold for a high return, the return on investment for disposals, often for structures on land Forest Service would like to retain, is minimal. In 2011, the Forest Service reported that it would cost $120 million to dispose of property with a salvage value of $5 million. Non-financial barriers to disposal also exist, resulting in underused agency property. These obstacles include remote locations, necessary environmental cleanup, or limitations on the use of property. Historically significant properties are also challenges. For example, VA officials said that VA’s historical buildings often require significant cleanup and preparation prior to disposal, and the agency must often address significant stakeholder interests. In addition, VHA’s buildings are often on campuses or are medical facilities, limiting potential buyers or lessees to those with missions similar to VA. VHA currently has about 250 vacant buildings with no defined need, totaling more than 4 million square feet. Interior officials stated that the land Interior owns is primarily stewardship land for preservation, and thus Interior has few buildings or land to sell. Instead, excess buildings on stewardship lands are typically demolished. To facilitate the disposal of excess property, Interior includes funding for disposals as part of its planning process—it requires each bureau to set aside 3 percent of its property budget for disposals of excess property. Officials at GSA and USDA noted that the authority to retain proceeds provides a key incentive to initiate disposal transactions. For example, officials at GSA, which provides disposal services across the federal government, stated that the vast majority of current disposal transactions are by agencies or components that have the authority to retain the proceeds from sales or disposals. They also said that agencies without this authority may have less incentive to dispose of underused property as they must take money from competing budget priorities to invest in readying a property for sale. USDA officials said that because resulting proceeds are remitted to the general fund of the U.S. Treasury as miscellaneous receipts, components without authority to retain proceeds have little incentive to request full upfront funding for disposal costs such as site cleanup, resource surveys, title and legal preparation, and auction fees. Alternative Funding Mechanisms Helped Agencies Meet Their Real Property Needs, but Also Posed Challenges Agencies Use a Variety of Funding Mechanisms to Meet Their Real Property Needs Selected agencies have been authorized to use a variety of funding mechanisms as an alternative to full upfront funding to meet their real property needs. Funding mechanisms leverage both monetary resources, such as retained fees, and non-monetary resources, such as property exchanged in a land swap or space offered in an enhanced use lease (EUL). In some cases, the funding mechanism may function as a public- private partnership intended to further an agency’s mission by working with a partner to leverage resources. Some of these mechanisms allow the private sector to provide the project’s capital—at their cost of borrowing. The U.S. federal government’s cost of borrowing is lower than in the private sector. When the private sector provides the project capital, the federal government later repays these higher private sector borrowing costs (e.g., in the form of lease payments). In some cases, factors such as lower labor costs or fewer requirements could potentially help balance the higher cost of borrowing, making partner financing less expensive. Table 1 outlines selected funding mechanisms, considerations for each mechanism based on our past work, and examples of mechanisms used by the selected agencies. Appendix III identifies prior reports where we provide more information on alternative funding mechanisms. Alternative funding mechanisms are not universally available to all agencies. Moreover, even within an agency, legal authorities may differ across agency components. For example, the Forest Service and ARS— both components of USDA—have different legal authorities to use alternative funding mechanisms. For example, the Forest Service has the authority to retain fees and ARS has the authority to enter into land swaps. Instead of upfront funding, NPS uses retained recreation fees to fund high-priority projects linked to visitor need. NPS’s recreation fees, which are authorized by the Federal Land Recreation Enhancement Act, require that not less than 80 percent of retained recreation fees be spent at the site at which fees are collected while the remaining 20 percent is pooled to fund projects that are national priorities. This 20 percent of the retained recreation fees provides NPS additional flexibility. In 2011 Interior determined that it would request line item construction funds in fiscal year 2014, but later identified fiscal year 2012 funds from an alternative funding mechanism, retained recreation fees, for the Herring Cove and Nauset Light Beach facilities renovations in Massachusetts, negating the need to seek additional funding. Interior has internal processes for prioritizing projects for line item budget requests and for allocating the retained recreation fees to high-priority projects, which NPS officials reported allowed Interior to complete the renovations more quickly than would have otherwise been possible with full upfront funding. In 1991, Congress authorized VA to enter into EULs. VA’s available legal authorities also framed its 2008 decision to enter into an EUL with a nonprofit organization in Dayton, Ohio. VHA’s partner in the EUL leveraged nonfederal funds to renovate a building and provide housing and services to homeless veterans. The Dayton, Ohio Veterans Affairs Medical Center had underused historic buildings. Officials reported that the buildings’ historic status made it difficult to dispose of or demolish the buildings. The Volunteers of America of Greater Ohio approached VA about entering into an EUL; they agreed to provide 50 beds of transitional housing and related services to homeless veterans in the property that VA wanted to take off its inventory in exchange for financial and nonfinancial considerations. VA determined that renovating the building with appropriated funds would result in the highest upfront costs to VA and would forgo the benefit of any private-sector funding or participation. VA accepted the Volunteers of America’s proposal and the Volunteers of America paid VA rent for the space and were responsible for renovating, operating, and maintaining the building as well as for providing housing and services to homeless veterans. By partnering with the Volunteers of America on this EUL, VA estimated that it has cumulatively achieved almost $2.8 million in cost avoidance and that the project has provided services valued at more than $2 million while costing the VA less than $500,000. Without the authority to enter into EULs or other alternative funding mechanisms, VA officials said that VA would not have been able to move forward with this project. VA’s EUL authority was amended in 2012. VA may no longer accept in-kind consideration for EULs and may only enter into an EUL for the provision of supportive housing. Risk Sharing, Managing Stakeholder Relationships, and Other Factors Affect Project Outcomes Projects with alternative funding mechanisms involve multiple forms of risk—both implicit and explicit—that must be shared between the agency and any partner or stakeholder. We have previously reported that project decisions should reflect both the likely risk and the organization’s tolerance for risk. Incorporating risk assessment and risk management practices into decisions can help ensure that the organization recognizes and is prepared to manage explicit risks (e.g., financial and physical) and implicit risks (e.g., reputational). For example, clearly defined lease terms helped VA manage financial risk associated with the Dayton, Ohio EUL when its partner sought to share costs for unexpected building repairs for the building leased. During renovation, asbestos was discovered in the building and VA’s partner sought a financial contribution from VA to help offset some of the cost of the cleanup. Because the contract clearly held the partner financially responsible for unexpected expenses, VA was not liable for the cleanup costs. We have also previously reported that when working with a partner, it is important to actively manage the relationship. Formalizing collaborations between the partners, including documenting dispute resolution processes, can enable productive partner interactions. For example, VA stepped in to more actively engage its partner, the city of New Orleans, in a land swap to build a hospital after Hurricane Katrina. To monitor project timelines and goals, officials representing all partners—including VA’s Chief of Staff, the logistics manager and city counterparts—participated in a steering group. When it became apparent that the city of New Orleans was unable to meet its initial goal of having the property in construction- ready condition within 1 year as outlined in a memorandum of understanding (MOU), the group began to meet weekly. VA and the city of New Orleans amended the MOU to permit phased delivery of the construction ready site. Additionally, New Orleans VA Medical Center continued to have quarterly meetings with the community. Officials reported that early coordination contributed to increased efficiency and improved outcomes and helped the project overcome challenges such as managing to meet different federal and state fiscal years and funding cycles, as well as different federal, state, and local policies. In addition to an agency’s ability to share risk and manage stakeholder relationships, the availability of an appropriate partner and the geographic location of the property may affect the use and success of an alternative funding mechanism. We have previously reported that partners should bring complementary resources, skills, and financial capacities to the relationship. Agency officials reported that the geographic location and the condition of a property can make it difficult to locate a willing buyer and expensive to dispose of the property. For example, according to Forest Service officials, many of the structures that may be disposed of are of little value and are on land Forest Service will retain, such as a cabin in the woods. Additionally, these facilities may be located in remote areas that are difficult and costly to access with the construction equipment necessary for demolition. As part of the auction process, Forest Service typically asks for bids at salvage value and requires that the structure be removed from the property at the buyer’s expense. However, because of the expense to the buyer of the building removal and any necessary environmental remediation, properties are usually sold for low prices. The Forest Service benefits from selling the property— even for a low value— because it is no longer financially responsible for costs such as maintenance, demolition, property removal, and environmental remediation. For example, ARS needed to acquire land or build an incinerator to dispose of excess manure. ARS does not have the legal authority to purchase land valued at more than $100 and the incinerator would have been significantly more expensive than this limit, prompting ARS to consider a land swap. Because of these legal, cost, and anticipated stakeholder challenges, ARS officials said that ARS held onto the land for about 10 years while seeking an appropriate partner with whom to exchange land. When ARS identified an appropriate partner, it completed a land swap with the city of Ames, Iowa. ARS officials reported that this outcome was more efficient and environmentally friendly than the alternative of building an expensive incinerator. Alternative Budgetary Structures Have Potential to Help Congress and Agencies Recognize the Costs and Returns of Real Property Projects Upfront and Over Time While different funding mechanisms have been used as an alternative to obtaining upfront funding for federal real property projects, changes to the budgetary structure itself—within the bounds of the unified budget that encompasses the full scope of federal programs and transactions—may also help agencies meet their real property needs. Alternative budgetary structures may be established to change budgetary incentives for agencies and therefore help Congress and agencies make more prudent long-term fiscal decisions. Such alternatives may include changing existing or introducing new account structures to fund real property projects. These alternatives could promote more complete consideration of the full costs of projects and associated returns over time as well as provide agencies with greater flexibility to manage their real property needs. This could be aided by agencies completing comprehensive business case analyses detailing project costs and returns in a process similar to GSA’s prospectus process. A business case analysis might include details about how the project aligns with an agency’s strategic plan, a needs assessment and gap identification, an alternatives evaluation, a life-cycle cost analysis, a schedule of project milestones and deliverables, and a cost-benefit analysis. We explored options for changes within the current discretionary budget structure and options on the mandatory side of the budget by reviewing our past reports and discussing possible options with federal budget specialists and industry experts. We make no recommendations with respect to adopting these options. However, understanding the tradeoffs associated with different aspects of alternative budgetary structures can provide decision makers with more information and support decisions about funding federal real property projects. Budgeting and Capital Planning Principles Offer a Framework for Considering Alternative Budgetary Structures To assist congressional and agency-level decision makers in considering alternative budgetary structures, we identified two key budgeting and capital planning principles. An alternative budgetary structure should do two things: promote transparency and fiscal control with regard to the funding of federal real property projects; and provide agencies the flexibility to facilitate the acquisition, repair and alteration, and disposal of federal real property in support of federal missions. The two principles are each further supported by elements that may help frame the consideration of alternative budgetary structures. As decision makers consider these budgetary structures, they must balance tradeoffs between the two principles to understand whether the options would allow for full upfront cost recognition, establish accountability mechanisms to track cost recovery and return on investment, and provide timely funding to promote an appropriately sized federal real property inventory. The principles may interact and conflict with each other and each alternative budgetary structure has benefits and challenges. Moreover, the weight that different decision makers might place on the principles will vary, depending on the desired level of involvement. Table 2 provides an overview of the principles. Discretionary Budget Authority Options Could Provide a Straightforward Means of Dedicating Funding to Real Property Projects Changes to the current discretionary structure for funding federal real property projects may provide a relatively straightforward means of dedicating funding to federal real property while creating room for additional agency flexibility. However, tradeoffs are inherent in budgeting and these changes may affect spending for other discretionary programs competing for mission critical resources. Modify the FBF: The FBF is a discretionary fund that receives revenue through rental payments from agencies that lease buildings that GSA manages. GSA’s authority to access these funds is determined through the annual appropriations process. As previously described, resources deposited into the FBF have exceeded the amount that Congress has appropriated to GSA in recent years, resulting in a $4.7 billion difference between the full balance of the FBF and amounts made available for spending in fiscal year 2013. Congress provides authority to GSA to incur obligations and make expenditures from the FBF in five categories of activities, such as repairing and altering GSA-managed buildings and constructing new buildings. However, GSA officials said that because available funds must first be used to pay costs associated with other authorized activities, such as leasing privately owned space, operations and maintenance of GSA-managed buildings, and debt incurred from building acquisitions and lease purchase arrangements, repairs and alterations and new construction are the most affected. For example, GSA’s obligational authority for repairs and alterations projects decreased from $855 million in 2005 to $280 million in 2012. As a result, customer agencies are being charged for services that the GSA may be limited in its ability to provide in a timely manner. To meet agencies’ real property needs, the FBF could be modified in the following ways: Make the full balance of the FBF available: Congress could make the full balance of the FBF available to GSA. GSA would then have resources to provide the full array of services for which it charges agencies, including repairs and alterations. In 2011, we reported that GSA’s overall obligational authority has trended downward in recent years, resulting in GSA reducing spending on repairs and alternations and new construction. GSA officials and OMB staff noted that such repairs have the potential to be more expensive if delayed. Making the full balance of the FBF available to GSA would increase funding for GSA to complete projects for agencies, but it would mean less congressional fiscal control and less funding for other mission critical needs. OMB staff noted that with access to all of its receipts, the FBF would be able to meet necessary recapitalization needs, such as major repairs and alterations. Adjust the FBF pricing structure to exclude certain major renovations: To ensure that the GSA charges cover all services provided under agreements with tenant agencies, GSA could choose to exclude certain major renovations from agreed upon services. GSA could then reduce rents to cover only operations and ongoing maintenance costs of federally-owned buildings. Appropriations decisions to fund capital repairs with rent savings would be made by the agencies’ appropriations subcommittees. In effect, this would shift the locus of decision making from GSA’s appropriations subcommittee to the appropriations subcommittees of affected agencies. With the change in pricing structure, agencies would have the ability to decide whether to complete funded repairs and alterations in house or use contractors or shared service providers. However, because this option addresses GSA-managed buildings, there may not be an incentive for agencies to carry out this devolution of responsibility amid other priorities and it may be difficult for multi-agency tenant buildings to obtain funding for necessary renovations from their respective appropriations subcommittees. Nevertheless, an agency that uses a GSA-managed building as its headquarters, such as Interior, which has been unable to complete renovations through GSA, would gain some flexibility in completing repairs and alterations by requesting funding directly from its subcommittee. GSA officials noted that separating capital investment funding decisions from operations and maintenance funding decisions could make it difficult to manage the portfolio of government-owned and -leased assets in a strategic manner. They and OMB staff agreed that, without the shared funding aspect of the FBF, it was unlikely that agencies would have sufficient funds available to complete repairs and alterations, even if they were able to maintain the same level of appropriations. Delay recognition of receipts until projects are ready for funding: To better match FBF receipts with expenses, the recording of receipts from agencies could be held in a temporary account until transferred to the FBF, temporarily recorded as a mandatory receipt until transferred to the FBF as a discretionary offsetting collection. The receipts would be recorded in the FBF account when funds are appropriated for each “useful asset” of a project. Receipts from agencies to the FBF would then be recorded as discretionary offsets in the fiscal year in which they are appropriated to GSA. Carve out spending from the discretionary allocations: One approach to further invest in federal real property projects and meet governmentwide priorities could be to allocate resources at the full appropriations committee level, outside the competing priorities of the appropriations subcommittees. The appropriations subcommittees have jurisdiction over different agencies and are responsible for appropriating resources among their relevant agencies. Congress could agree to carve out of the full appropriations committee’s 302(a) allocation—the level of spending that the full appropriations committee is authorized to distribute—the amount for federal real property, effectively decreasing the cap for the subcommittees’ 302(b) allocations—the level of spending that the subcommittees are authorized to distribute to their respective agencies. This would free up funds for acquiring, disposing of, or repairing and altering space and provide a guaranteed funding level to real property; it would also protect it from competition with other programs that are more focused on spending for consumption activities. In the past, Congress has similarly chosen to allocate resources at the full committee level for certain programs. For example, in 1999 there were five discretionary categories with a separate spending limit “carved out”— violent crime reduction, defense, non-defense, highway, and mass transit. As a result of these carve outs, total spending determinations were made at the full committee level rather than at the subcommittee level. Carving out of the full committee’s allocation spending for federal real property would also “crowd out” spending for all other discretionary programs that might represent a higher priority for the nation. For example, we have previously reported that if a guaranteed minimum funding level for a certain program is carved out of the full committee allocation, and total spending is not increased commensurately, then the remaining activities must compete for the reduced amount that is left. Alternatively, the total cap for the subcommittees’ allocation could be increased to dedicate funding to real property projects. The adjustment of the cap could be triggered by the approval of project proposals accompanied by business case analyses. Related Questions on the Implementation of Discretionary Options: 1. If individual agencies and their respective appropriators and authorizers are responsible for making decisions regarding real property projects, would they have the real property expertise to initiate, implement, fund, authorize, and oversee real property acquisition, repairs/alteration and disposal? 2. If an appropriations carve out for federal real property is made at the full appropriations committee level: How narrowly would those funds be defined? (Deferred maintenance, costs related to preparing properties for disposal) How would a business case analysis be incorporated into obtaining access to carved-out funds? How would the carve out be divided amongst appropriations subcommittees? Might the creation of a Reserve Fund achieve the same purpose? Mandatory Budget Authority Options Could Increase Agency Flexibility and Improve Cost-Benefit Recognition But Would Require a Different Means of Assuring Fiscal Control Mandatory budget authority options, such as creating a revolving fund with borrowing authority (e.g., a capital acquisition fund) or a dedicated fund with permanent, indefinite budget authority, could enable the recognition of costs and returns associated with complex real property projects upfront and over time. However, these options would require establishing new account structures and may present different challenges compared to discretionary budget authority options. Existing account structures, such as the Tennessee Valley Authority fund, may provide some insight for policymakers in considering the structure of the revolving fund with borrowing authority or permanent, indefinite budget authority. Borrowing authority and permanent, indefinite budget authority could be provided outside of the annual budget and appropriations cycle, allowing for a greater degree of agency flexibility when planning for and carrying out real property projects. Controls on access to funds in both scenarios could be based on comprehensive project proposals with a business case analysis completed by agencies and submitted to the fund manager, OMB and the Congress to ensure their agreement that the project warrants access to this type of funding. This analysis would describe, among other aspects, the nature of the project and potential savings or costs avoided. If the proposal was accepted, funding could be provided for each useful asset. For each useful asset, agencies might provide updated business case analyses, which could include reestimates of both costs and returns. Mandatory budget authority options may also present opportunities to promote collaboration among agencies with different appropriators and authorizers as well as allow for better alignment of upfront costs with longer-term returns. These options could result in a centralized funding source available to all agencies, which could facilitate consolidation, sharing space, and partnering among agencies for other real property needs. Mandatory options could also be established to receive returns, such as proceeds from disposals, or enforce the recognition of non- monetary returns, such as cost avoidance or cost savings, through revised business case analyses provided by agencies as they complete useful assets of projects. Despite these benefits, mandatory budget authority options could result in a shift of the locus of decision making from appropriators to authorizers, and would create new management and oversight responsibilities for federal entities. In addition, under the pay-as-you-go (PAYGO) budgetary enforcement mechanism, mandatory budget authority options would require costs to be offset by an increase in mandatory receipts or a decrease in mandatory spending for other programs. Nonetheless, these options could result in cost savings and cost avoidance over the long term. Create a capital acquisition fund (CAF): Congress could provide budget authority in the form of borrowing authority to a governmentwide capital acquisition fund (CAF) managed by a single agency, such as GSA. In contrast to a department-level CAF, which we have previously reported on, a centralized governmentwide CAF could provide funding for real property projects for all agencies. The fund could complement the FBF by providing upfront funding for complex, multi-prospectus level projects or projects estimated to exceed a certain total cost threshold while the FBF could be used for relatively straightforward rental and maintenance expenses. The governmentwide CAF could be subject to a borrowing limit and provide upfront funding for the full cost of projects (or useful assets of projects). As depicted in Figure 4, a governmentwide CAF could be established to: 1. Use its authority to borrow from the Federal Financing Bank (FFB) to fund real property projects agreed upon by Congress, OMB and the CAF manager on a project-by-project basis for all agencies. 2. Use annual payments made by agencies to the CAF to repay the loan from the FFB. The annual payments—provided by agencies’ subcommittee appropriators—would be principal and interest amortized over the useful life of the asset, allowing the agency to spread the project cost over time. 3. Automatically receive other monetary returns associated with real property projects to be used for future real property projects or deficit reduction. During implementation as well as at completion of projects, agencies would inform the CAF (along with Congress and OMB) about all returns, including nonmonetary returns, such as cost avoidance or cost savings, via revised business case analyses. Establish a dedicated fund with permanent, indefinite budget authority: Congress could pass legislation to establish a governmentwide, dedicated fund with permanent, indefinite budget authority instead of borrowing authority. Similar to the CAF, this fund could be managed by a single agency, such as GSA. As depicted in Figure 5, it could automatically receive sums as needed, eliminating the need for annual appropriation to acquire, dispose of, or repair and alter federal real property. The dedicated fund could be at least partially replenished as agencies return net proceeds, such as proceeds from the sale of a building. The fund could complement the FBF by providing upfront funding for complex, multi-prospectus level projects or projects estimated to exceed a certain total cost threshold while the FBF could be used for relatively straightforward rental and maintenance expenses. One concern with providing permanent, indefinite budget authority is that it could reduce agency incentives to provide credible cost estimates in their business case analyses; initial estimates might be artificially low if agencies are held harmless for additional costs that result from price changes. Related Questions on the Implementation of Mandatory Options: 1. What would be the budget enforcement implications for providing permanent, indefinite budget authority and borrowing authority in the mandatory options? Given that federal budgeting rules require that increases in mandatory spending be offset by decreases in other mandatory spending (or an increase in mandatory receipts), where would the offset come from to meet this condition? 2. How narrowly would the use of the mandatory options be defined? For example, would it be meant only for civilian federal real property needs? 3. Would the congressional locus of decision making regarding proposed projects reside with appropriators or authorizers? 4. How would the business case analysis process work? What criteria would be used to consider proposed projects for approval? 5. How would appropriators be involved in the business case analysis process? 6. What mechanisms could be used to ensure that returns are realized in future years? 7. What budget process changes would be needed to ensure that subcommittee appropriators would provide funding to agencies to make annual payments to the CAF to repay the FFB in future years? Concluding Observations A central goal of the budget process is to assist the Congress in allocating governmentwide resources efficiently. In the context of federal real property, recognizing costs up front when resource allocation decisions are made is one way to achieve this goal. Given that full upfront funding is an effective way to ensure recognition of commitments embodied in budgeting decisions, an examination of budgetary changes that could improve cost-benefit recognition provides an opportunity to help Congress achieve this goal. Our selected agencies have experienced challenges receiving full upfront funding for federal real property projects through the annual appropriations process and instead have used alternative funding mechanisms, such as public-private partnerships and operating leases to meet long-term needs. In times of fiscal pressure, employing alternative funding mechanisms to carry out real property projects can appear attractive to agencies because it does not first require obtaining full upfront funding. However, there are inherent risks in using an alternative funding mechanism and many factors affect the outcome. For example, employing alternative funding mechanisms may result in funding federal real property investments without recognizing their true, full costs. This could mean that assets financed through alternative mechanisms may be selected over other equally worthy projects that are competing for full upfront funding. Moreover, with the administration’s emphasis on “freezing the footprint,” investment decisions that do not recognize costs upfront and returns over time may not result in an appropriate assessment of the size and cost of the federal real property inventory. We have presented options for alternative budgetary structures that congressional decision makers may wish to consider. Alternative budgetary structures, such as modifying the Federal Buildings Fund (FBF) or establishing a mandatory dedicated fund, could help them recognize a project’s full upfront costs and returns over time. While these options could increase flexibility for agencies in addressing their real property needs, they could also result in less fiscal control for Congress. However, if accompanied by appropriate congressional oversight and rigorous financial management, these options may be useful in facilitating prudent real property investment within the current unified budget structure. There is no single best option, and all options we explored would have considerable challenges that would need to be weighed against potential benefits. In addition, there are broader considerations associated with funding real property projects beyond the scope of this report. Both Congress and agencies have a role in effectively managing real property projects. The authorization or use of an alternative funding mechanism or an alternative budgetary structure requires consideration of tradeoffs to arrive at a deliberate choice that neither creates disincentives for agencies to seek upfront funding nor minimizes fiscal control required by Congress. We provided a draft of this report for review and comment to the Secretaries of the Departments of Agriculture (USDA), Interior, and Veterans Affairs (VA), and to the Administrator of the General Services Administration (GSA). All agencies generally concurred with our findings. In his written response, the VA Chief of Staff discussed challenges with several of the potential alternative budgetary structures outlined in the report. As we say in our report, while we explored alternative budgetary structure options, each option has both benefits and challenges and we make no recommendations with respect to adopting any of these options. Further, our report states that any potential mandatory alternative budgetary structure to fund large projects would be used by agencies voluntarily, complementing upfront funding through the appropriations process and the Federal Buildings Fund. We further clarified this point in our report. In his written statement, GSA’s Administrator expanded upon the challenges that we report agencies experience in funding upfront costs that could lead to long-term savings. He also stated that some of the described alternative budgetary structures would be more effective than others. USDA, Interior, and VA provided technical comments, which we incorporated as appropriate. We also provided a copy of the report to the Office of Management and Budget, which provided technical comments that we incorporated as appropriate. We are sending copies of this report to the Secretaries of Agriculture, Interior, and Veterans Affairs and to the Administrator of the General Services Administration. In addition, the report is available at no charge on the GAO website at http://www.gao.gov. If you or your staff have any questions about this report please contact me at (202) 512-6806 or irvings@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made key contributions to this report are listed in appendix IV. Appendix I: Comments from the General Services Administration Appendix II: Comments from the Department of Veterans Affairs Appendix III: Selected Related GAO Work Alternative Funding Mechanisms GAO, Capital Financing: Partnerships and Energy Savings Performance Contracts Raise Budgeting and Monitoring Concerns, GAO-05-55 (Washington, D.C.: Dec. 16, 2004). GAO, Budget Issues: Alternative Approaches to Finance Federal Capital, GAO-03-1011 (Washington, D.C.: Aug. 21, 2003). GAO, Federal Buildings: Funding Repairs and Alterations Has Been a Challenge—Expanded Financing Tools Needed, GAO-01-452 (Washington, D.C.: Apr. 12, 2001). GAO, Federal Real Property: GSA Should Clarify Savings Goals for the National Broker Program, GAO-14-14 (Washington, D.C.: Oct. 31, 2013). GAO, Federal Real Property: Greater Transparency and Strategic Focus Needed for High-Value GSA Leases, GAO-13-744 (Washington, D.C.: Sept. 19, 2013). GAO, Federal Real Property: Overreliance on Leasing Contributed to High-Risk Designation, GAO-11-879T (Washington, D.C.: Aug. 4, 2011). GAO, Department of Energy: Status of Loan Programs, GAO-13-331R (Washington, D.C.: Mar. 15, 2013). GAO, Military Bases: Opportunities Exist to Improve Future Base Realignment and Closure Rounds, GAO-13-149 (Washington, D.C.: Mar. 7, 2013). GAO, Federal Real Property: Improved Cost Reporting Would Help Decision Makers Weigh the Benefits of Enhanced Use Leasing, GAO-13-14 (Washington, D.C.: Dec. 19, 2012). GAO, Renewable Energy Project Financing: Improved Guidance and Information Sharing Needed for DOD Project-Level Officials, GAO-12-401 (Washington, D.C.: Apr. 4, 2012). GAO, Excess Facilities: DOD Needs More Complete Information and a Strategy to Guide Its Future Disposal Efforts, GAO-11-814 (Washington, D.C.: Sept. 19, 2011). GAO, Defense Infrastructure: The Enhanced Use Lease Program Requires Management Attention, GAO-11-574 (Washington, D.C.: June 30, 2011). GAO, Military Housing: Installations Need to Share Information on Their Section 801 On-Base Housing Contracts, GAO-11-60 (Washington, D.C.: Oct. 28, 2010). GAO, Defense Infrastructure: Army's Privatized Lodging Program Could Benefit from More Effective Planning, GAO-10-771 (Washington, D.C.: July 30, 2010). GAO, Military Housing Privatization: DOD Faces New Challenges Due to Significant Growth at Some Installations and Recent Turmoil in the Financial Markets, GAO-09-352 (Washington, D.C.: May 15, 2009). GAO, Federal Real Property: Progress Made in Reducing Unneeded Property, but VA Needs Better Information to Make Further Reductions, GAO-08-939 (Washington, D.C.: Sep. 10, 2008). Partnering GAO, Congressionally Chartered Organizations: Key Principles for Leveraging Nonfederal Resources, GAO-13-549 (Washington, D.C.: June 7, 2013). GAO, Federal Real Property: Strategic Partnerships and Local Coordination Could Help Agencies Better Utilize Space, GAO-12-779 (Washington, D.C.: July 25, 2012 ). Federal Real Property Reports GAO, Federal Real Property: Improved Standards Needed to Ensure That Agencies’ Reported Cost Savings Are Reliable and Transparent, GAO-14-12 (Washington, D.C.: Oct. 29, 2013). GAO, Federal Real Property: National Strategy and Better Data Needed to Improve Management of Excess and Underutilized Property, GAO-12-645 (Washington, D.C.: June 20, 2012). GAO, Streamlining Government: Questions to Consider When Evaluating Proposals to Consolidate Physical Infrastructure and Management Functions, GAO-12-542 (Washington, D.C.: May 23, 2012). GAO, Federal Real Property: Progress Made Toward Addressing Problems, but Underlying Obstacles Continue to Hamper Reform, GAO-07-349 (Washington, D.C.: Apr. 13, 2007). GAO, Federal Real Property: Actions Needed to Address Long- standing and Complex Problems, GAO-04-119T (Washington, D.C.: Oct. 1, 2003). Appendix IV: GAO Contacts and Staff Acknowledgements GAO Contact Staff Acknowledgements In addition to the contact name above, Carol M. Henn, Assistant Director, Alexandra Edwards, Vida Awumey and Melissa King made major contributions to this report. Also contributing to this report were Virginia Chanley, Deirdre Duffy, Felicia Lopez, and Donna Miller. In addition, the following individuals provided programmatic expertise: Michael Armes, Keith Cunningham, Brian Lepore, David Sausville, and David J. Wise.

Federal real property projects are fully funded when Congress provides budget authority and appropriations for the estimated full cost of the projects up front—at the time they are undertaken. However, as agencies work to balance limited resources with mission demands, many have turned to approaches other than full upfront funding to acquire, renovate, or dispose of federal real property, such as buildings, structures, and land. GAO was asked to review alternative models for managing federal real property. This report examines (1) agency experiences funding federal real property projects, (2) some of the alternative funding mechanisms selected agencies use, as well as agency experiences using selected mechanisms, and (3) alternative budgetary structures within the current unified budget that may potentially help Congress and agencies better recognize the cost of real property projects and associated returns, promoting both transparency and fiscal control. GAO reviewed case study projects from 4 agencies among the top 10 in federal real property holdings and chosen based on their use of alternative funding mechanisms, as identified in our past and ongoing work. Finally, GAO identified alternative budgetary structures that may support real property projects and principles for considering them by reviewing published reports and interviewing federal budget staff and experts. GAO is not making any recommendations in this report. GSA, USDA, VA, and Interior generally agreed with our findings. USDA, Interior and VA provided technical comments that were incorporated as appropriate. Officials at four selected agencies—the General Services Administration (GSA), U.S. Department of Agriculture (USDA), the Department of Veterans Affairs (VA), and the Department of the Interior (Interior)—experienced challenges receiving full upfront funding for federal real property projects through the annual appropriations process. For example, due to budget constraints, GSA acquired one property between 2008 and 2012. In addition, GSA has been unable to access funding to complete renovations in Interior's headquarters building due to obligation limitations in the GSA-administered Federal Buildings Fund (FBF). The FBF, which is the primary funding source for operating and capital costs associated with federal space, held an unobligated carryover balance of $4.7 billion at the end of fiscal year 2013 as a result of congressional limits on obligations. Officials noted that authority to retain proceeds provides a key incentive to initiate disposals, as agencies without this authority must request upfront funding for disposal costs while resulting proceeds are paid to the Department of the Treasury. Nonetheless, officials at selected agencies with the authority to retain disposal proceeds cited barriers to disposals, such as poor market demand, historical status or necessary remediation. Instead of full upfront funding, selected agencies sometimes used a variety of alternative funding mechanisms to meet their real property needs by leveraging authorized monetary resources, such as retained fees, and non-monetary resources, such as property exchanged in a swap or space offered in an enhanced use lease. Alternative funding mechanisms are not universally available to all agencies; even within an agency, legal authorities may differ across agency components. For alternative funding mechanisms that involve working with a partner, such as in a land swap, the agency's ability to find an appropriate partner, manage that partnering relationship, and share risk—both explicit and implicit—with the partner affected project outcomes. For example, because of legal, cost, and other challenges, officials from USDA's Agricultural Research Service (ARS) said that ARS held onto land for about 10 years while seeking an appropriate partner to successfully complete the land swap. Changes to the budgetary structure itself—within the bounds of the unified budget—might provide a more consistent way to meet real property needs while helping Congress and agencies make more prudent long-term fiscal decisions. Alternative budgetary structures should balance tradeoffs across two key GAO-identified budgeting and capital planning principles: (1) promoting transparency and fiscal control with regard to the funding of federal real property; and (2) providing agencies the flexibility to facilitate the acquisition, repair and alteration, and disposal of federal real property in support of federal missions. GAO provides alternative budgetary structure options for Congress to consider. For example, in one option Congress would make the full balance of the FBF available for funding real property projects, which could create room for additional agency flexibility but may reduce fiscal control. Another option would establish a government-wide capital acquisition fund with authority to borrow from the Federal Financing Bank for approved projects, which could improve transparency of both costs and benefits upfront and over time while business case analyses could provide a means of assuring fiscal control.

Background The Chesapeake Bay is the largest of the nation’s estuaries, measuring nearly 200 miles long and 35 miles wide at its widest point. Roughly half of the bay’s water comes from the Atlantic Ocean, and the other half is freshwater that drains from the land and enters the bay through the many rivers and streams in its watershed basin. As shown in figure 1, the bay’s watershed covers 64,000 square miles and spans parts of six states— Delaware, Maryland, New York, Pennsylvania, Virginia, and West Virginia—and the District of Columbia. Over time, the bay’s ecosystem has deteriorated. The bay’s “dead zones”— where too little oxygen is available to support fish and shellfish—have increased, and many species of fish and shellfish have experienced major declines in population. The decline in the bay’s living resources has been cause for a great deal of public and political attention. Responding to public outcry, on December 9, 1983, representatives of Maryland, Virginia, and Pennsylvania; the District of Columbia; the EPA; and the Chesapeake Bay Commission signed the first Chesapeake Bay agreement. Their agreement established the Chesapeake Executive Council and resulted in the Chesapeake Bay Program—a partnership that directs and conducts the restoration of the bay. Subsequent agreements in 1987 and again in 1992 reaffirmed the signatories’ commitment to restore the bay. The partners signed the most current agreement, Chesapeake 2000, on June 28, 2000. Chesapeake 2000—identified by the Bay Program as its strategic plan—sets out an agenda and goals to guide the restoration efforts through 2010 and beyond. In Chesapeake 2000, the signatories agreed to 102 commitments—including management actions, such as assessing the trends of particular species, as well as actions that directly affect the health of the bay. These commitments are organized under the following five broad restoration goals: Protecting and restoring living resources—14 commitments to restore, enhance, and protect the finfish, shellfish and other living resources, their habitats and ecological relationships to sustain all fisheries and provide for a balanced ecosystem; Protecting and restoring vital habitats—18 commitments to preserve, protect, and restore those habitats and natural areas that are vital to the survival and diversity of the living resources of the bay and its rivers; Protecting and restoring water quality—19 commitments to achieve and maintain the water quality necessary to support the aquatic living resources of the bay and its tributaries and to protect human health; Sound land use—28 commitments to develop, promote, and achieve sound land use practices that protect and restore watershed resources and water quality, maintain reduced pollutant loadings for the bay and its tributaries, and restore and preserve aquatic living resources; and Stewardship and community engagement—23 commitments to promote individual stewardship and assist individuals, community- based organizations, businesses, local governments and schools to undertake initiatives to achieve the goals and commitments of the agreement. As the only federal signatory to the Chesapeake Bay agreements, EPA is responsible for spearheading the federal effort within the Bay Program through its Chesapeake Bay Program Office. Among other things, the Chesapeake Bay Program Office is to develop and make available information about the environmental quality and living resources of the Chesapeake Bay ecosystem; help the signatories to the Chesapeake Bay agreement develop and implement specific plans to carry out their responsibilities; and coordinate EPA’s actions with those of other appropriate entities to develop strategies to improve the water quality and living resources in the Chesapeake Bay ecosystem. The Bay Program’s Measures Had Not Been Integrated to Assess Overall Restoration Progress The Bay Program had established 101 measures to assess progress on individual aspects of the Bay. For example, the Bay Program had developed measures for determining trends in individual fish and shellfish populations, such as crabs, oysters, and rockfish. The Bay Program had also developed other measures to provide the information it needs to make management decisions. For example, to help inform its decisions regarding the effects of airborne nitrogen compounds and chemical contaminants in the bay ecosystem and to help establish reduction goals for these contaminants, the Bay Program had a measure to estimate vehicle emissions and compare them to vehicle miles traveled. While the Bay Program had established these 101 measures, it had not developed an approach that would allow it to translate these individual measures into an overall assessment of the progress made in achieving the five broad restoration goals. For example, although the Bay Program had developed measures for determining trends in individual fish and shellfish populations, it had not yet devised a way to integrate those measures to assess the overall progress made in achieving its Living Resource Protection and Restoration goal. According to an expert panel of nationally recognized ecosystem assessment and restoration experts convened by GAO, in a complex ecosystem restoration project like the Chesapeake Bay, overall progress should be assessed by using an integrated approach. This approach should combine measures that provide information on individual species or pollutants into a few broader- scale measures that can be used to assess key ecosystem attributes, such as biological conditions. The signatories to the Chesapeake Bay agreement have discussed the need for an integrated approach over the past several years. However, according to an official from the Chesapeake Bay Program Office, until recently they did not believe that the program could develop an approach that was scientifically defensible, given their limited resources. The program began an effort in November 2004 to develop, among other things, a framework for organizing the program’s measures and a structure for how the redesign work should be accomplished. In our report, we recommended that the Chesapeake Bay Program Office complete its efforts to develop and implement such an integrated approach. In January 2006, the Bay Program formally adopted an initial integrated approach for assessing both bay health and management actions taken to restore the bay. However, according to a Bay Program official, more work is needed before a fully integrated approach for assessing restoration progress can be implemented. The Bay Program’s Reports Did Not Effectively Communicate the Status of the Bay’s Health The Bay Program’s primary mechanism for reporting on the health status of the bay—the State of the Chesapeake Bay report—was intended to provide the citizens of the bay region with a snapshot of the bay’s health. However, our review found that the State of the Chesapeake Bay report did not effectively communicate the current health status of the bay because it mirrored the shortcomings in the program’s measures by focusing on the status of individual species or pollutants instead of providing information on a core set of ecosystem characteristics. For example, the 2002 and 2004 State of the Chesapeake Bay reports provided data on oysters, crab, rockfish, and bay grasses, but the reports did not provide an overall assessment of the current status of living resources in the bay or the health of the bay. Instead, data were reported for each species individually. The 2004 State of the Chesapeake Bay report included a graphic that depicts oyster harvest levels at historic lows, with a mostly decreasing trend over time, and a rockfish graphic that shows a generally increasing population trend over time. However, the report did not provide contextual information that explained how these measures are interrelated or what the diverging trends meant about the overall health of the bay. Our experts agreed that the 2004 report was visually pleasing but lacked a clear, overall picture of the bay’s health and told us that the public would probably not be able to easily and accurately assess the current condition of the bay from the information reported. We also found that the credibility of the State of the Chesapeake Bay reports had been undermined by two key factors. First, the Bay Program had commingled data from three sources when reporting on the health of the bay. Specifically, the reports mixed actual monitoring information on the bay’s health status with results from a predictive model and the results of specific management actions. The latter two results did little to inform readers about the current health status of the bay and tended to downplay the bay’s actual condition. Second, the Bay Program had not established an independent review process to ensure that its reports were accurate and credible. The officials who managed and were responsible for the restoration effort also analyzed, interpreted, and reported the data to the public. We believe this lack of independence in reporting led to the Bay Program’s projecting a rosier view of the health of the bay than may have been warranted. Our expert panelists believe that an independent review panel—to either review the bay’s health reports before issuance or to analyze and report on the health status independently of the Bay Program—would significantly improve the credibility of the program’s reports. We recommended that the Chesapeake Bay Program Office revise its reporting approach to improve the effectiveness and credibility of its reports. In response to our recommendation, the Bay Program developed a new reporting format that was released for public review and comment in March 2006. The new report, entitled Chesapeake Bay 2005 Health and Restoration Assessment, is divided into two parts: part one is an assessment of ecosystem health and part two is an assessment of progress made in implementing management actions. The new report appears to have a more effective communications framework and clearly distinguishes between the health of the bay and the management actions being taken. In addition, the Bay Program plans to have its Scientific and Technical Advisory Committee independently review the new report and the process used to develop it. This review is planned for completion by late summer. Federal Agencies and States Provided Billions of Dollars in Both Direct and Indirect Funding for Restoration Activities Eleven key federal agencies; the states of Maryland, Pennsylvania, and Virginia; and the District of Columbia provided almost $3.7 billion in direct funding from fiscal years 1995 through 2004 to restore the bay. Federal agencies provided a total of approximately $972 million in direct funding, while the states and the District of Columbia provided approximately $2.7 billion in direct funding for the restoration effort over the 10-year period. Of the federal agencies, the Department of Defense’s Army Corps of Engineers provided the greatest amount of direct funding—$293.5 million. Of the states, Maryland provided the greatest amount of direct funding— more than $1.8 billion—which is over $1.1 billion more than any other state. Typically, the states provided about 75 percent of the direct funding for restoration, and the funding has generally increased over the 10-year period. As figure 2 shows, the largest percentage of direct funding— approximately 47 percent—went to water quality protection and restoration. Sound land use ($1.1 billion) Water quality protection and restoration ($1.7 billion) Ten of the key federal agencies, Pennsylvania, and the District of Columbia provided about $1.9 billion in additional funding from fiscal years 1995 through 2004 for activities that indirectly affected bay restoration. These activities were conducted as part of broader agency efforts and/or would continue without the restoration effort. Federal agencies provided approximately $935 million in indirect funding, while Pennsylvania and the District of Columbia together provided approximately $991 million in indirect funding for the restoration effort over the 10-year period. Of the federal agencies, the U.S. Department of Agriculture provided the greatest amount of indirect funding—$496.5 million—primarily through the Natural Resources Conservation Service. Of the states, Pennsylvania provided the greatest amount of indirect funding—$863.8 million. As with direct funding, indirect funding for the restoration effort had also generally increased over fiscal years 1995 through 2004. As figure 3 shows, the largest percentage of indirect funding—approximately 44 percent—went to water quality protection and restoration. Despite the almost $3.7 billion in direct funding and more than $1.9 billion in indirect funding that has been provided for activities to restore the bay, the Chesapeake Bay Commission estimated in a January 2003 report that the restoration effort faced a funding gap of nearly $13 billion to achieve the goals outlined in Chesapeake 2000 by 2010. Subsequently, in an October 2004 report, the Chesapeake Bay Watershed Blue Ribbon Finance Panel estimated that the restoration effort is grossly underfunded and recommended that a regional financing authority be created with an initial capitalization of $15 billion, of which $12 billion would come from the federal government. The Bay Program Has Not Always Effectively Coordinated and Managed the Restoration Effort Chesapeake 2000 and prior agreements have provided the overall direction for the restoration effort over the past two decades. Although Chesapeake 2000 provides the current vision and overall strategic goals for the restoration effort, along with short- and long-term commitments, we found that the Bay Program lacked a comprehensive, coordinated implementation strategy that could provide a road map for accomplishing the goals outlined in the agreement. In 2003, the Bay Program recognized that it could not effectively manage all 102 commitments outlined in Chesapeake 2000 and adopted 10 keystone commitments as a management strategy to focus the partners’ efforts. To achieve these 10 keystone commitments, the Bay Program had developed numerous planning documents. However, we found that these planning documents were not always consistent with each other. For example, the program developed a strategy for restoring 25,000 acres of wetlands by 2010. Subsequently, each state within the bay watershed and the District of Columbia developed tributary strategies that described actions for restoring over 200,000 acres of wetlands—far exceeding the 25,000 acres that the Bay Program had developed strategies for restoring. While we recognize that partners should have the freedom to develop higher targets than established by the Bay Program, we are concerned that having such varying targets could cause confusion, not only for the partners, but for other stakeholders about what actions are really needed to restore the bay, and such varying targets appear to contradict the effort’s guiding strategy of taking a cooperative approach to achieving the restoration goals. We also found that the Bay Program had devoted a significant amount of their limited resources to developing strategies that were either not being used by the Bay Program or were believed to be unachievable within the 2010 time frame. For example, the program invested significant resources to develop a detailed toxics work plan for achieving the toxics commitments in Chesapeake 2000. Even though the Bay Program had not been able to implement this work plan because personnel and funding had been unavailable, program officials told us that the plan was being revised. It is unclear to us why the program is investing additional resources to revise a plan for which the necessary implementation resources are not available, and which is not one of the 10 keystone commitments. According to a Bay Program official, strategies are often developed without knowing what level of resources will be available to implement them. While the program knows how much each partner has agreed to provide for the upcoming year, the amount of funding that partners will provide in the future is not always known. Without knowing what funding will be available, the Bay Program is limited in its ability to target and direct funding toward those restoration activities that will be the most cost effective and beneficial. The Chesapeake Bay Program Office recognizes that some of the plans are inconsistent and unachievable. The office told us that it was determining how to reconcile the program’s various plans and stated that these plans were developed to identify what actions will be needed to achieve the commitments of Chesapeake 2000 and were not developed considering available resources. The office also recognizes that there is a fundamental gap between what needs to be done to achieve some of the commitments and what can be achieved within the current resources available. According to Chesapeake Bay Program Office officials, the development of an overall implementation plan that takes into account available resources had been discussed, but that the partners could not agree on such a plan. We recommended that the Chesapeake Bay Program Office develop a comprehensive, coordinated implementation strategy that takes into account available resources. In response to our recommendations, the Bay Program has taken several actions. The Chesapeake Bay Program Office is currently developing a Web-based system to link and organize the program’s various planning documents. In addition, program partners adopted a funding priorities framework in October 2005 that designates three broad funding priorities—agriculture, wastewater treatment, and developed and developing lands—for accelerating the implementation of the states’ tributary strategies. While these actions are important, they fall short of the comprehensive, coordinated implementation strategy we recommended. The program still needs to reconcile the inconsistencies of the program’s various planning documents and clearly link the 10 keystone commitments with the funding priority framework adopted by program partners. We continue to believe that the development of a comprehensive, coordinated implementation strategy that lays out what the program plans to accomplish and that is directly linked to the funding that is available would allow the program to move forward in a more strategic and well-coordinated manner. In closing, Mr. Chairman, it is well recognized that restoring the Chesapeake Bay is a massive, difficult, and complex undertaking. While the Bay Program has made significant strides, our October 2005 report documented how the success of the program has been undermined by the lack of (1) an integrated approach to measure overall progress; (2) independent and credible reporting mechanisms; and (3) coordinated implementation strategies. These deficiencies have resulted in a situation in which the Bay Program could not present a clear and accurate picture of what the restoration effort had achieved, could not effectively articulate what strategies would best further the broad restoration goals, and could not identify how limited resources should be prioritized. We are encouraged that the Bay Program is taking actions to address our recommendations because, without these actions, we do not believe the Bay Program will be able to change the status quo and move the restoration effort forward in the most cost-effective manner. Mr. Chairman, this concludes my prepared statement. I would be happy to respond to any questions that you or Members of the Subcommittee may have. Contacts and Acknowledgments For further information about this testimony, please contact Anu Mittal at (202) 512-3841. Other individuals making significant contributions to this testimony were Sherry McDonald, Assistant Director; Bart Fischer; and James Krustapentus. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

The Chesapeake Bay Program (Bay Program) was created in 1983 when Maryland, Pennsylvania, Virginia, the District of Columbia, the Chesapeake Bay Commission, and the Environmental Protection Agency (EPA) agreed to establish a partnership to restore the Chesapeake Bay. The partnership's most recent agreement, Chesapeake 2000, sets out an agenda and five broad goals to guide the restoration effort through 2010. This testimony summarizes the findings of an October 2005 GAO report (GAO-06-96) on (1) the extent to which appropriate measures for assessing restoration progress have been established, (2) the extent to which current reporting mechanisms clearly and accurately describe the bay's overall health, (3) how much funding was provided for the effort for fiscal years 1995 through 2004, and (4) how effectively the effort is being coordinated and managed. The Bay Program had developed over 100 measures to assess progress toward meeting certain restoration commitments and providing information to guide management decisions. However, the program had not yet developed an integrated approach that would allow it to translate these individual measures into an assessment of overall progress toward achieving the five broad restoration goals outlined in Chesapeake 2000. For example, while the Bay Program had appropriate measures to track crab, oyster, and rockfish populations, it did not have an approach for integrating the results of these measures to assess progress toward the agreement's goal of protecting and restoring the bay's living resources. In response to GAO's recommendation, the Bay Program adopted an initial integrated approach in January 2006. The State of the Chesapeake Bay reports did not provide effective and credible information on the current health status of the bay. Because these reports focused on individual trends for certain living resources and pollutants, it was not easy for the public to determine what these data collectively said about the overall health status of the bay. The credibility of these reports had been undermined because the program had commingled actual monitoring data with results of program actions and a predictive model, and the latter two tended to downplay the deteriorated conditions of the bay. Moreover, the Bay Program's reports were prepared by the same program staff who were responsible for managing the restoration effort, which led to reports that projected a rosier picture of the bay's health than may have been warranted. In response to GAO's recommendation, the program has developed a new reporting format and plans to have the new report independently assessed. From fiscal years 1995 through 2004, the restoration effort received about $3.7 billion in direct funding from 11 key federal agencies; the states of Maryland, Pennsylvania, and Virginia; and the District of Columbia. These funds were used for activities that supported water quality protection and restoration, sound land use, vital habitat protection and restoration, living resources protection and restoration, and stewardship and community engagement. During this period, the restoration effort also received an additional $1.9 billion in funding from other federal and state programs for activities that indirectly contributed to the restoration effort. The Bay Program did not have a comprehensive, coordinated implementation strategy to help target limited resources to those activities that would best achieve the goals outlined in Chesapeake 2000. Although the program had adopted 10 key commitments to focus the partners' efforts and had developed numerous planning documents, some of these documents were inconsistent with each other or were perceived as unachievable by program partners. In response to GAO's recommendation, the Bay Program is currently developing a Web-based system to unify its various planning documents and has adopted a funding priority framework. These actions, while important, fall short of the strategy recommended by GAO.

Background FOIA establishes a legal right of access to government records and information, on the basis of the principles of openness and accountability in government. Before the act (originally enacted in 1966), an individual seeking access to federal records had faced the burden of establishing a right to examine them. FOIA established a “right to know” standard for access, instead of a “need to know,” and shifted the burden of proof from the individual to the government agency seeking to deny access. FOIA provides the public with access to government information either through “affirmative agency disclosure”—publishing information in the Federal Register or on the Internet, or making it available in reading rooms—or in response to public requests for disclosure. Public requests for disclosure of records are the best known type of FOIA disclosure. Any member of the public may request access to information held by federal agencies, without showing a need or reason for seeking the information. Not all information held by the government is subject to FOIA. The act prescribes nine specific categories of information that are exempt from disclosure: for example, trade secrets and certain privileged commercial or financial information, certain personnel and medical files, and certain law enforcement records or information (app. IX provides the complete list). In denying access to material, agencies may cite these exemptions. The act requires agencies to notify requesters of the reasons for any adverse determination (that is, a determination not to provide records) and grants requesters the right to appeal agency decisions to deny access. In addition, agencies are required to meet certain time frames for making key determinations: whether to comply with requests (20 business days from receipt of the request), responses to appeals of adverse determinations (20 business days from filing of the appeal), and whether to provide expedited processing of requests (10 calendar days from receipt of the request). The Congress did not establish a statutory deadline for making releasable records available, but instead required agencies to make them available promptly. The FOIA Process at Federal Agencies Although the specific details of processes for handling FOIA requests vary among agencies, the major steps in handling a request are similar across the government. Agencies receive requests, usually in writing (although they may accept requests by telephone or electronically), which can come from any organization or member of the public. Once received, the request goes through several phases, which include initial processing, searching for and retrieving responsive records, preparing responsive records for release, approving the release of the records, and releasing the records to the requester. Figure 1 is an overview of the process, from the receipt of a request to the release of records. During the initial processing phase, a request is logged into the agency’s FOIA system, and a case file is started. The request is then reviewed to determine its scope, estimate fees, and provide an initial response to the requester (in general, this simply acknowledges receipt of the request). After this point, the FOIA staff begins its search to retrieve responsive records. This step may include searching for records from multiple locations and program offices. After potentially responsive records are located, the documents are reviewed to ensure that they are within the scope of the request. During the next two phases, the agency ensures that appropriate information is to be released under the provisions of the act. First, the agency reviews the responsive records to make any redactions based on the statutory exemptions. Once the exemption review is complete, the final set of responsive records is turned over to the FOIA office, which calculates appropriate fees, if applicable. Before release, the redacted responsive records are then given a final review, possibly by the agency’s general counsel, and then a response letter is generated, summarizing the agency’s actions regarding the request. Finally, the responsive records are released to the requester. Some requests are relatively simple to process, such as requests for specific pieces of information that the requester sends directly to the appropriate office. Other requests may require more extensive processing, depending on their complexity, the volume of information involved, the need for the agency FOIA office to work with offices that have relevant subject-matter expertise to find and obtain information, the need for a FOIA officer to review and redact information in the responsive material, the need to communicate with the requester about the scope of the request, and the need to communicate with the requester about the fees that will be charged for fulfilling the request (or whether fees will be waived). Specific details of agency processes for handling requests vary, depending on the agency’s organizational structure and the complexity of the requests received. While some agencies centralize processing in one main office, other agencies have separate FOIA offices for each agency component and field office. Agencies also vary in how they allow requests to be made. Depending on the agency, requesters can submit requests by telephone, fax, letter, or e-mail or through the Web. In addition, agencies may process requests in two ways, known as “multitrack” and “single track.” Multitrack processing involves dividing requests into two groups: (1) simple requests requiring relatively minimal review, which are placed in one processing track, and (2) more voluminous and complex requests, which are placed in another track. In contrast, single-track processing does not distinguish between simple and complex requests. With single-track processing, agencies process all requests on a first-in/first-out basis. Agencies can also process FOIA requests on an expedited basis when a requester has shown a compelling need or urgency for the information. As agencies process FOIA requests, they generally place them in one of four possible disposition categories: grants, partial grants, denials, and “not disclosed for other reasons.” These categories are defined as follows: Grants: Agency decisions to disclose all requested records in full. Partial grants: Agency decisions to withhold some records in whole or in part, because such information was determined to fall within one or more exemptions. Denials: Agency decisions not to release any part of the requested records because all information in the records is determined to be exempt under one or more statutory exemptions. Not disclosed for other reasons: Agency decisions not to release requested information for any of a variety of reasons other than statutory exemptions from disclosing records. The categories and definitions of these “other” reasons for nondisclosure are shown in table 1. When a FOIA request is denied in full or in part, or the requested records are not disclosed for other reasons, the requester is entitled to be told the reason for the denial, to appeal the denial, and to challenge it in court. The Privacy Act Also Provides Individuals with Access Rights In addition to FOIA, the Privacy Act of 1974 includes provisions granting individuals the right to gain access to and correct information about themselves held by federal agencies. Thus the Privacy Act serves as a second major legal basis, in addition to FOIA, for the public to use in obtaining government information. The Privacy Act also places limitations on agencies’ collection, disclosure, and use of personal information. Although the two laws differ in scope, procedures in both FOIA and the Privacy Act permit individuals to seek access to records about themselves—known as “first-party” access. Depending on the individual circumstances, one law may allow broader access or more extensive procedural rights than the other, or access may be denied under one act and allowed under the other. Consequently, the Department of Justice’s Office of Information and Privacy issued guidance that it is “good policy for agencies to treat all first-party access requests as FOIA requests (as well as possibly Privacy Act requests), regardless of whether the FOIA is cited in a requester’s letter.” This guidance was intended to help ensure that requesters receive the fullest possible response to their inquiries, regardless of which law they cite. In addition, Justice guidance for the annual FOIA report directs agencies to include Privacy Act requests (that is, first-party requests) in the statistics reported. According to the guidance, “A Privacy Act request is a request for records concerning oneself; such requests are also treated as FOIA requests. (All requests for access to records, regardless of which law is cited by the requester, are included in this report.)” Although FOIA and the Privacy Act can both apply to first-party requests, these may not always be processed in the same way as described earlier for FOIA requests. In some cases, little review and redaction (see fig. 1) is required, such as, for example, a request for one’s own Social Security benefits records. In contrast, various degrees of review and redaction could be required for other types of first-party requests: for example, files on security background checks would need review and redaction before being provided to the person who was the subject of the investigation. Roles of OMB and Justice in FOIA Implementation OMB and the Department of Justice both have roles in the implementation of FOIA. Under various statutes, including the Paperwork Reduction Act, OMB exercises broad authority for coordinating and administering various aspects of governmentwide information policy. FOIA specifically requires OMB to issue guidelines to “provide for a uniform schedule of fees for all agencies.” OMB issued this guidance in April 1987. The Department of Justice oversees agencies’ compliance with FOIA and is the primary source of policy guidance for agencies. Specifically, Justice’s requirements under the act are to make agencies’ annual FOIA reports available through a single electronic access point and notify the Congress as to their availability; in consultation with OMB, develop guidelines for the required annual agency reports, so that all reports use common terminology and follow a similar format; and submit an annual report on FOIA litigation and the efforts undertaken by Justice to encourage agency compliance. Within the Department of Justice, the Office of Information and Privacy has lead responsibility for providing guidance and support to federal agencies on FOIA issues. This office first issued guidelines for agency preparation and submission of annual reports in the spring of 1997. It also periodically issues additional guidance on annual reports as well as on compliance, provides training, and maintains a counselors service to provide expert, one-on-one assistance to agency FOIA staff. Further, the Office of Information and Privacy also makes a variety of FOIA and Privacy Act resources available to agencies and the public via the Justice Web site and on-line bulletins (available at www.usdoj.gov/oip/index.html). Annual FOIA Reports Were Established by 1996 Amendments In 1996, the Congress amended FOIA to provide for public access to information in an electronic format (among other purposes). These amendments, referred to as e-FOIA, also required that agencies submit a report to the Attorney General on or before February 1 of each year that covers the preceding fiscal year and includes information about agencies’ FOIA operations. The following are examples of information that is to be included in these reports: number of requests received, processed, and pending; median number of days taken by the agency to process different types of determinations made by the agency not to disclose information and the reasons for not disclosing the information; disposition of administrative appeals by requesters; information on the costs associated with handling of FOIA requests; and full-time-equivalent staffing information. In addition to providing their annual reports to the Attorney General, agencies are to make them available to the public in electronic form. The Attorney General is required to make all agency reports available online at a single electronic access point and report to the Congress no later than April 1 of each year that these reports are available in electronic form. (This electronic access point is www.usdoj.gov/oip/04_6.html.) In 2001, in response to a congressional request, we prepared the first in a series of reports on the implementation of the 1996 amendments to FOIA, starting from fiscal year 1999. In these reviews, we examined the contents of the annual reports for 25 major agencies (shown in table 2). They include the 24 major agencies covered by the Chief Financial Officers Act, as well as the Central Intelligence Agency and, until 2003, the Federal Emergency Management Agency (FEMA). In 2003, the creation of the Department of Homeland Security (DHS), which incorporated FEMA, led to a shift in some FOIA requests from agencies affected by the creation of the new department, but the same major component entities are reflected in all the years reviewed. Our previous reports included descriptions of the status of reported FOIA implementation, including any trends revealed by comparison with earlier years. We noted general increases in requests received and processed, as well as growing numbers of pending requests carried over from year to year. In addition, our 2001 report disclosed that data quality issues limited the usefulness of agencies’ annual FOIA reports and that agencies had not provided online access to all the information required by the act as amended in 1996. We therefore recommended that the Attorney General direct the Department of Justice to improve the reliability of data in the agencies’ annual reports by providing guidance addressing the data quality issues we identified and by reviewing agencies’ report data for completeness and consistency. We further recommended that the Attorney General direct the department to enhance the public’s access to government records and information by encouraging agencies to make all required materials available electronically. In response, the Department of Justice issued supplemental guidance, addressed reporting requirements in its training programs, and continued reviewing agencies’ annual reports for data quality. Justice also worked with agencies to improve the quality of data in FOIA annual reports. Executive Order Required Agencies to Take Several Actions to Improve FOIA Operations On December 14, 2005, the President issued an Executive Order setting forth a policy of citizen-centered and results-oriented FOIA administration. Briefly, FOIA requesters are to receive courteous and appropriate services, including ways to learn about the status of their requests and the agency’s response, and agencies are to provide ways for requesters and the public to learn about the FOIA process and publicly available agency records (such as those on Web sites). In addition, agency FOIA operations are to be results oriented: agencies are to process requests efficiently, achieve measurable improvements in FOIA processing, and reform programs that do not produce appropriate results. To carry out this policy, the order required, among other things, that agency heads designate Chief FOIA Officers to oversee their FOIA programs, and that agencies establish Requester Service Centers and Public Liaisons to ensure appropriate communication with requesters. The Chief FOIA Officers were directed to conduct reviews of the agencies’ FOIA operations and develop improvement plans to ensure that FOIA administration was in accordance with applicable law as well as with the policy set forth in the order. By June 2006, agencies were to submit reports that included the results of their reviews and copies of their improvement plans. The order also instructed the Attorney General to issue guidance on implementation of the order’s requirements for agencies to conduct reviews and develop plans. Finally, the order instructed agencies to report on their progress in implementing their plans and meeting milestones as part of their annual reports for fiscal years 2006 and 2007, and required agencies to account for any milestones missed. In April 2006, the Department of Justice posted guidance on implementation of the order’s requirements for FOIA reviews and improvement plans. This guidance suggested a number of areas of FOIA administration that agencies might consider in conducting their reviews and developing improvement plans. (Examples of some of these areas are automated tracking capabilities, automated processing, receiving/responding to requests electronically, forms of communication with requesters, and systems for handling referrals to other agencies.) To encourage consistency, the guidance also included a template for agencies to use to structure the plans and to report on their reviews and plans. The improvement plans are posted on the Justice Web site at www.usdoj.gov/oip/agency_improvement.html. In a July 2006 testimony, we provided preliminary results of our analyses of the improvement plans for the 25 agencies in our review that were submitted as of the end of June; in our testimony we focused on how the plans addressed reducing or eliminating backlog. We testified that a substantial number of plans did not include measurable goals and timetables that would allow agencies to measure and evaluate the success of their plans. Several of the plans were revised in light of our testimony, as well as in response to feedback to agencies from the Department of Justice in its FOIA oversight role. Status of FOIA Processing Appears Similar to Previous Years, but Limitations in Annual Report Data Present Challenges The data reported by 24 major agencies in annual FOIA reports from 2002 to 2005 reveal a number of general trends. (Data from USDA, which were reported in our July 2006 testimony, are omitted in what follows, because we determined that data from a major USDA component were not reliable.) For example, the public continued to submit more requests for information from the federal government through FOIA, but many agencies, despite increasing the numbers of requests processed, did not keep pace with this increased volume. As a result, the number of pending requests carried over from year to year has been steadily increasing. However, our ability to make generalizations about processing time is limited by the type of statistic reported (that is, the median). Taking steps to improve the accuracy and form of annual report data could provide more insight into FOIA processing. Not All Data from USDA’s Farm Service Agency Are Reliable, but Its Improvement Plan Provides Opportunity to Address This Weakness We omitted data from USDA’s annual FOIA report because we determined that not all these data were reliable. Although some USDA components expressed confidence in their data, one component, the Farm Service Agency, did not. According to this agency’s FOIA Officer, portions of the agency’s data in annual reports were not accurate or complete. This is a significant deficiency, because the Farm Service Agency reportedly processes over 80 percent of the department’s total FOIA requests. Currently, FOIA processing for the Farm Service Agency is highly decentralized, taking place in staff offices in Washington, D.C., and Kansas City, 50 state offices, and about 2,350 county offices. The agency FOIA officer told us that she questioned the completeness and accuracy of data supplied by the county offices. This official stated that some of the field office data supplied for the annual report were clearly wrong, leading her to question the systems used to record workload data at field offices and the field office staff’s understanding of FOIA requirements. She attributed this condition to the agency’s decentralized organization and to lack of management attention, resources, and training. Lacking accurate data hinders the Farm Service Agency from effectively monitoring and managing its FOIA program. The Executive Order’s requirement to develop an improvement plan provides an opportunity for the Farm Service Agency to address its data reliability problems. More specifically, Justice’s guidance on implementing the Executive Order refers to the need for agencies to explore improvements in their monitoring and tracking systems and staff training. USDA has developed an improvement plan that includes activities to improve FOIA processing at the Farm Service Agency that are relevant to the issues raised by the Farm Service Agency’s FOIA Officer, including both automation and training. The plan sets goals for ensuring that all agency employees who process or retrieve responsive records are trained in the necessary FOIA duties, as well as for determining the type of automated tracking to be implemented. According to the plan, an electronic tracking system is needed to track requests, handle public inquiries regarding request status, and prepare a more accurate annual FOIA report. In addition, the Farm Service Agency plans to determine the benefit of increased centralization of FOIA request processing. However, the plan does not directly address improvements to data reliability. If USDA does not also plan for activities, measures, and milestones to improve data reliability, it increases the risk that the Farm Service Agency will not produce reliable FOIA statistics, which are important for program oversight and meeting the act’s goal of providing visibility into government FOIA operations. Except for SSA, Increases in Requests Received and Processed Are Generally Slowing The numbers of FOIA requests received and processed continue to rise, but except for one case—SSA—the rate of increase has flattened in recent years. For SSA, we present statistics separately because the agency reported an additional 16 million requests in 2005, dwarfing those for all other agencies combined, which together total about 2.6 million. SSA attributed this rise to an improvement in its method of counting requests and stated that in previous years, these requests were undercounted. Further, all but about 38,000 of SSA’s over 17 million requests are simple requests for personal information by or on behalf of individuals. Figure 2 shows total requests reported governmentwide for fiscal years 2002 through 2005, with SSA’s share shown separately. This figure shows the magnitude of SSA’s contribution to the whole FOIA picture, as well as the scale of the jump from 2004 to 2005. Figure 3 presents statistics omitting SSA on a scale that allows a clearer view of the rate of increase in FOIA requests received and processed in the rest of the government. As this figure shows, when SSA’s numbers are excluded, the rate of increase is modest and has been flattening: For the whole period (fiscal years 2002 to 2005), requests received increased by about 29 percent, and requests processed increased by about 27 percent. Most of this rise occurred from fiscal years 2002 to 2003: about 28 percent for requests received, and about 27 percent for requests processed. In contrast, from fiscal year 2004 to 2005, the rise was much less: about 3 percent for requests received, and about 2 percent for requests processed. According to SSA, the increases that the agency reported in fiscal year 2005 can be attributed to an improvement in its method of counting a category of requests it calls “simple requests handled by non-FOIA staff.” From fiscal year 2002 to 2005, SSA’s FOIA reports have consistently shown significant growth in this category, which has accounted for the major portion of all SSA requests reported (see table 3). In each of these years, SSA has attributed the increases in this category largely to better reporting, as well as actual increases in requests. SSA describes requests in this category as typically being requests by individuals for access to their own records, as well as requests in which individuals consent for SSA to supply information about themselves to third parties (such as insurance and mortgage companies) so that they can receive housing assistance, mortgages, disability insurance, and so on. According to SSA’s FOIA report, these requests are handled by personnel in about 1,500 locations in SSA, including field and district offices and teleservice centers. Such requests are almost always granted, according to SSA, and most receive immediate responses. SSA has stated that it does not keep processing statistics (such as median days to process) on these requests, which it reports separately from other FOIA requests (for which processing statistics are kept). However, officials say that these are typically processed in a day or less. According to SSA officials, they included information on these requests in their annual reports because Justice guidance instructs agencies to treat Privacy Act requests (requests for records concerning oneself) as FOIA requests and report them in their annual reports. In addition, SSA officials said that their automated systems make it straightforward to capture and report on these simple requests. According to SSA, in fiscal year 2005, the agency began to use automated systems to capture the numbers of requests processed by non-FOIA staff, generating statistics automatically as requests were processed; the result, according to SSA, is a much more accurate count. Besides SSA, agencies reporting large numbers of requests received were the Departments of Defense, Health and Human Services, Homeland Security, Justice, the Treasury, and Veterans Affairs, as shown in table 4. The rest of the agencies combined account for only about 5 percent of the total requests received (if SSA’s simple requests handled by non-FOIA staff are excluded). Table 4 presents, in descending order of request totals, the numbers of requests received and percentages of the total (calculated with and without SSA’s statistics on simple requests handled by non-FOIA staff). Most Requests Are Granted in Full Most FOIA requests in 2005 were granted in full, with relatively few being partially granted, denied, or not disclosed for other reasons (statistics are shown in table 5). This generalization holds with or without SSA’s inclusion. The percentage of requests granted in full was about 87 percent, which is about the same as in previous years. However, if SSA’s numbers are included, the proportion of grants dominates the other categories—raising this number from 87 percent of the total to 98 percent. This is to be expected, since SSA reports that it grants the great majority of its simple requests handled by non-FOIA staff, which make up the bulk of SSA’s statistics. Three of the seven agencies that handled the largest numbers of requests (HHS, SSA, and VA; see table 4) also granted the largest percentages of requests in full, as shown in figure 4. Figure 4 shows, by agency, the disposition of requests processed: that is, whether granted in full, partially granted, denied, or “not disclosed for other reasons” (see table 1 for a list of these reasons). As the figure shows, the numbers of fully granted requests varied widely among agencies in fiscal year 2005. Six agencies made full grants of requested records in over 80 percent of the cases they processed (besides the three already mentioned, these include Energy, OPM, and SBA). In contrast, 13 of 24 made full grants of requested records in less than 40 percent of their cases, including 3 agencies (CIA, NSF, and State) that made full grants in less than 20 percent of cases processed. This variance among agencies in the disposition of requests has been evident in prior years as well. In many cases, the variance can be accounted for by the types of requests that different agencies process. For example, as discussed earlier, SSA grants a very high proportion of requests because they are requests for personal information about individuals that are routinely made available to or for the individuals concerned. Similarly, VA routinely makes medical records available to individual veterans, and HHS also handles large numbers of Privacy Act requests. Such requests are generally granted in full. Other agencies, on the other hand, receive numerous requests whose responses must routinely be redacted. For example, NSF reported in its annual report that most of its requests (an estimated 90 percent) are for copies of funded grant proposals. The responsive documents are routinely redacted to remove personal information on individual principal investigators (such as salaries, home addresses, and so on), which results in high numbers of “partial grants” compared to “full grants.” Processing Times Vary, but Broad Generalizations Are Limited For 2005, the reported time required to process requests (by track) varied considerably among agencies. Table 6 presents data on median processing times for fiscal year 2005. For agencies that reported processing times by component rather than for the agency as a whole, the table indicates the range of median times reported by the agency’s components. As the table shows, seven agencies had components that reported processing simple requests in less than 10 days (these components are parts of the CIA, Energy, the Interior, Justice, Labor, Transportation, and the Treasury); for each of these agencies, the lower value of the reported ranges is less than 10. On the other hand, median time to process simple requests is relatively long at some organizations (for example, components of Energy and Justice, as shown by median ranges whose upper end values are greater than 100 days). For complex requests, the picture is similarly mixed. Components of four agencies (EPA, DHS, the Treasury, and VA) reported processing complex requests quickly—with a median of less than 10 days. In contrast, other components of several agencies (DHS, Energy, EPA, HHS, HUD, Justice, State, Transportation, and the Treasury) reported relatively long median times to process complex requests, with median days greater than 100. Six agencies (AID, HHS, NSF, OPM, SBA, and SSA) reported using single- track processing. The median processing times for single-track processing varied from 5 days (at an HHS component) to 173 days (at another HHS component). The changes from fiscal year 2004 to 2005 also vary. For agencies that reported agencywide figures, table 7 shows how many showed increased or decreased median processing times. Table 8 shows these numbers for the components that were reported separately. In general, these tables show that no trend emerges across tracks and types of reporting, and the numbers of agencies and components involved vary from track to track. The picture that emerges is of great variation in processing times according to circumstances. To allow more insight into the variations in median processing times, we provide in appendix X tables of median processing times as reported by agencies and components in the annual FOIA reports in fiscal years 2004 and 2005. This attachment also includes information on the number of requests reported by the agencies and components, which provides context for assessing the median times reported. Our ability to make further generalizations about FOIA processing times is limited by the fact that, as required by the act, agencies report median processing times only and not, for example, arithmetic means (the usual meaning of “average” in everyday language). To find an arithmetic mean, one adds all the members of a list of numbers and divides the result by the number of items in the list. To find the median, one arranges all the values in the list from lowest to highest and finds the middle one (or the average of the middle two if there is no one middle number). Thus, although using medians provides representative numbers that are not skewed by a few outliers, they cannot be summed. Deriving a median for two sets of numbers, for example, requires knowing all numbers in both sets. Only the source data for the medians can be used to derive a new median, not the medians themselves. As a result, with only medians it is not statistically possible to combine results from different agencies to develop broader generalizations, such as a governmentwide statistic based on all agency reports, statistics from sets of comparable agencies, or an agencywide statistic based on separate reports from all components of the agency. In rewriting the FOIA reporting requirements in 1996, legislators declared an interest in making them “more useful to the public and to the Congress, and the information in them more accessible.” However, the limitation on aggregating data imposed by the use of medians alone impedes the development of broader pictures of FOIA operations. A more complete picture would be given by the inclusion of other statistics based on the same data that are used to derive medians, such as means and ranges. Providing means along with the median would allow more generalizations to be drawn, and providing ranges would complete the picture by adding information on the outliers in agency statistics. More complete information would be useful for public accountability and for effectively managing agency FOIA programs, as well as for meeting the act’s goal of providing visibility into government FOIA operations. Agency Pending Cases Continue to Increase In addition to the governmentwide increase in number of requests processed, many agencies (10 of 24) also reported that their numbers of pending cases—requests carried over from one year to the next—have increased since 2002. In 2002, pending requests governmentwide were reported to number about 138,000, whereas in 2005, about 200,000—45 percent more—were reported. (In addition, the rate of increase grew in fiscal year 2005, rising 24 percent from fiscal year 2004, compared to 13 percent from 2003 to 2004.) Figure 5 shows these results, illustrating the accelerating rate at which pending cases have been increasing. These statistics include pending cases reported by SSA, because SSA’s pending cases do not include simple requests handled by non-FOIA staff (for which SSA does not track pending cases). As the figure shows, these pending cases do not change the governmentwide picture significantly. Trends for individual agencies show mixed progress in reducing the number of pending requests reported from 2002 to 2005—some agencies have decreased numbers of pending cases, while others’ numbers have increased. Figure 6 shows processing rates at the 24 agencies (that is, the number of requests that an agency processes relative to the number it receives). Eight of the 24 agencies (AID, DHS, the Interior, Education, HHS, HUD, NSF, and OPM) reported processing fewer requests than they received each year for fiscal years 2003, 2004, and 2005; 8 additional agencies processed less than they received in 2 of these 3 years (Defense, Justice, Transportation, GSA, NASA, NRC, SSA, and VA). In contrast, two agencies (CIA and Energy) had processing rates above 100 percent in all 3 years, meaning that each made continued progress in reducing their numbers of pending cases. Fourteen additional agencies were able to make at least a small reduction in their numbers of pending requests in 1 or more years between fiscal years 2003 and 2005. No Regular Mechanism Is in Place for Aggregating Annual Report Data Legislators noted in 1996 that the FOIA reporting requirements were rewritten “to make them more useful to the public and to the Congress, and to make the information in them more accessible.” The Congress also gave the Department of Justice the responsibility to provide policy guidance and oversee agencies’ compliance with FOIA. In its oversight and guidance role, Justice’s Office of Information and Privacy (OIP) created summaries of the annual FOIA reports and made these available through its FOIA Post Web page (www.usdoj.gov/oip/foiapost/mainpage.htm). In 2003, Justice described its summary as “a major guidance tool.” It pointed out that although it was not required to do so under the law, the office had initiated the practice of compiling aggregate summaries of all agencies’ annual FOIA report data as soon as these were filed by all agencies. These summaries did not contain aggregated statistical tables, but they did provide prose descriptions that included statistics on major governmentwide results. However, the most recent of these summaries is for fiscal year 2003. According to the Acting Director of OIP, she did not know why such summaries had not been made available since then. According to this official, internally the agency found the summaries useful and was considering making them available again. She also stated that these summaries gave a good overall picture of governmentwide processing. Aggregating and summarizing the information in the annual reports serves to maximize their usefulness and accessibility, in accordance with congressional intent, as well as potentially providing Justice with insight into FOIA implementation governmentwide and valuable benchmarks for use in overseeing the FOIA program. Such information would also be valuable for others interested in gauging governmentwide performance. The absence of such summaries reduces the ability of the public and the Congress to consistently obtain a governmentwide picture of FOIA processing. Agency Improvement Plans Generally Included Areas of Improvement Emphasized by the Executive Order As required by the Executive Order, all the 25 agencies submitted improvement plans based on the results of reviews of their respective FOIA operations, as well as on the areas emphasized by the order. The plans generally addressed these four areas, with 20 of 25 plans addressing all four. In particular, for all but 2 agencies with reported backlog, plans included both measurable goals and timetables for backlog reduction. Further, to increase reliance on dissemination, improve communications on the status of requests, and increase public awareness of FOIA processing, agencies generally set milestones to accomplish activities promoting these aims. In some cases, agencies did not set goals for a given area because they determined that they were already strong in that area. All Agencies Addressed Reducing Backlog, and Most Set Measurable Goals and Milestones The Executive Order states that improvement plans shall include “specific activities that the agency will implement to eliminate or reduce the agency’s FOIA backlog, including (as applicable) changes that will make the processing of FOIA requests more streamlined and effective.” It further states that plans were to include “concrete milestones, with specific timetables and outcomes to be achieved,” to allow the plan’s success to be measured and evaluated. In addition, the Justice guidance suggested a number of process improvement areas for agencies to consider, such as receiving or responding to requests electronically, automated FOIA processing, automated tracking capabilities, and multitrack processing. It also gave agencies considerable leeway in choosing “means of measurement of success” for improving timeliness and thus reducing backlog. All agency plans discussed avoiding or reducing backlog, and most (22 out of 25) established measurable goals and timetables for this area of focus. One agency, SBA, reported that it had no backlog, so it set no goals. A second agency, NSF, set no specific numerical goals for backlog reduction, but it had minimal backlog (in fiscal year 2005, NSF reported 273 requests received and 17 pending at the end of the reporting period), and its median processing time in fiscal year 2005 was 14.26 days. Its plan includes activities to increase efficiency (such as improving its ability to process requests electronically and investigating the acquisition of an improved automated tracking system) and to monitor and analyze backlogged requests to determine whether systemic changes are warranted in its processes. Given NSF’s minimal backlog and other improvement activities planned, the treatment of backlog reduction in its plan seems reasonable. A third agency, HUD, set a measurable goal for reducing backlog, but did not include a date by which it planned to achieve it. However, it achieved this goal, according to agency officials, by November 2006. The goals chosen by the 22 remaining agencies varied considerably (which is consistent with the flexibility in choosing measures that Justice provided in its implementation guidance). Some agencies linked backlog reduction to various different measures. For example, EPA’s goal was to reduce its response backlog to less than 10 percent of the number of new FOIA requests received each year. Energy set a goal of achieving a 50 percent reduction by June 2007 in the number of pending FOIA cases that were over 1 year old. NRC chose to focus on improving processing times, setting percentage goals for completion of different types of requests (for example, completing 75 percent of simple requests within 20 days). Labor’s plan sets goals that aim for larger percentages of reduction for the oldest categories of pending requests (75 percent reduction for the oldest, 50 percent reduction for the next oldest, and so on). A number of agencies included goals to close their oldest 5 to 10 requests (Justice, the Treasury, Education, Commerce, Defense, GSA, NASA, SSA, and VA). According to the Attorney General’s report to the President, in concentrating on their oldest requests, many agencies followed Justice’s lead. OPM and DHS plan to eliminate their backlogs, Transportation is planning to substantially reduce previous fiscal year backlogs, and several agencies chose goals based on a percentage of reduction of existing backlog (for example, CIA, Commerce, Education, Defense, the Interior, Justice, SSA, the Treasury, and USDA). Some agencies also described plans to perform analyses that would measure their backlogs so that they could then establish the necessary baselines against which to measure progress. For example, Labor’s plan includes activities to monitor and determine the department’s oldest pending requests. The plan states that Labor will use as its baseline the number of requests that it identifies as pending for various lengths of time as of December 31, 2006. Similarly, Defense’s plan included activities to establish backlog levels and use these as the basis for its objective of reducing backlog by 10 percent annually. In addition to setting backlog targets, agencies also describe activities that contribute to reducing backlog. For example, the Treasury plan, which states that backlog reduction is the main challenge facing the department and the focus of its plan, includes such activities (with associated milestones) as reengineering its multitrack FOIA process, monitoring monthly reports, and establishing a FOIA council. The agency plans thus provide a variety of activities and measures of improvement that should permit agency heads, the Congress, and the public to assess the agencies’ success in implementing their plans to reduce backlog. Most Agencies Plan to Increase Public Dissemination of Records through Web Sites The Executive Order calls for “increased reliance on the dissemination of records that can be made available to the public” without the necessity of a FOIA request, such as through posting on Web sites. In its guidance, Justice notes that agencies are required by FOIA to post frequently requested records, policy statements, staff manuals and instructions to staff, and final agency opinions. It encourages agencies not only to review their activities to meet this requirement, but also to make other public information available that might reduce the need to make FOIA requests. It also suggests that agencies consider improving FOIA Web sites to ensure that they are user friendly and up to date. Agency plans generally established goals and timetables for increasing reliance on public dissemination of records, including through Web sites. Of 25 agencies, 24 included plans to revise agency Web sites and add information to them, and 12 of these are making additional efforts to ensure that frequently requested documents are posted on their Web sites. For example, Defense is planning to increase the number of its components that have Web sites as well as posting frequently requested documents. Interior is planning to facilitate the posting of frequently requested documents by using scanning and redaction equipment to make electronic versions readily available. Agencies planned other related activities, such as making posted documents easier to find, improving navigation, and adding other helpful information. For example, besides reviewing its Web site to verify and add links, AID plans to establish an “information/searching decision tree” to assist Web site visitors by directing them to agency public affairs staff who may be able to locate information and avoid the need for visitors to file FOIA requests. Besides adding frequently requested documents, CIA plans to improve navigation and review its site quarterly. HUD plans activities to anticipate topics that may produce numerous FOIA requests (“hot button” issues) and post relevant documents. Education is planning to use its automated tracking technology to determine when it is receiving multiple requests for similar information and then post such information on its Web site. Based on its FOIA review, NRC determined that it would be helpful to requesters for the agency to provide examples of the types of information in NRC documents that might be covered by FOIA exemptions, and it established goals to achieve this. The Treasury plan does not address increasing public dissemination of records. Treasury’s plan, as mentioned earlier, is focused on backlog reduction. It does not mention the other areas emphasized in the Executive Order, list them among the areas it selected for review, or explain the decision to omit them from the review and plan. Treasury officials told us that they concentrated in their plan on areas where they determined the department had a deficiency: namely, a backlog consisting of numerous requests, some of which were very old (dating as far back as 1991). By comparison, they did not consider they had deficiencies in the other areas. With regard to increasing dissemination, they noted that their Web sites currently provide frequently requested records. However, without a careful review of the department’s current dissemination practices or a plan to take actions to increase dissemination, Treasury does not have assurance that it has identified and exploited available opportunities to increase dissemination of records in such a way as to reduce the need for the public to make FOIA requests, as stressed by the Executive Order. Most Agency Plans Included Improving Status Communications with FOIA Requesters The Executive Order sets as policy that agencies shall provide FOIA requesters ways to learn about the status of their FOIA requests and states that agency improvement plans shall ensure that FOIA administration is in accordance with this policy. In its implementation guidance, Justice reiterated the order’s emphasis on providing status information to requesters and discussed the need for agencies to examine, among other things, their capabilities for tracking status and the forms of communication used with requesters. Most agencies (22 of 25) established goals and timetables for improving communications with FOIA requesters about the status of their requests. Goals set by these agencies included planned changes to communications, including sending acknowledgement letters, standardizing letters to requesters, including information on elements of a proper FOIA request in response letters, and posting contact information on Web pages. Both NASA and Interior planned to establish toll free numbers for requesters to obtain status information. NASA also included plans to acquire software that would allow a requester to access and track status of his or her request. Interior planned to develop and post frequently asked questions to provide requesters with information about where to submit their requests, processing times, fees charged, and how to check on the status of their requests. HUD’s plan included posting information on its Web site, providing training on customer service, and gauging progress through public forums at which it can receive comments on improving FOIA performance. Three agencies did not include improvement goals because they considered them unnecessary. In two cases (Defense and EPA), agencies considered that status communications were already an area of strength. Defense considered that it was strong in both customer responsiveness and communications. Defense performed extensive surveys of the opinions and practices of its FOIA staff and Public Liaisons and concluded that “FOIA personnel routinely contact requesters to try to resolve problems and to better define requests.” Defense’s Web site provides instructions for requesters on how to get information about the status of requests, as well as information on Requester Service Centers and Public Liaisons. Defense officials also told us that this information is included in acknowledgement letters to requesters. In addition, these officials stated that planned revisions to Defense FOIA Web sites would promote improving status communications, and that the department is working to implement an Interactive Customer Collection tool that would enable requesters to provide feedback. Similarly, EPA officials told us that they considered the agency’s activities to communicate with requesters on the status of their requests to be already effective, noting that many of the improvements planned by other agencies were already in effect at EPA. For example, EPA sends out an acknowledgment letter within a day of the request that includes a tracking number, the department that will be involved, and a contact name and telephone number. Officials also stated that EPA holds regular FOIA requester forums, the last held on November 1, 2006, and that EPA’s requester community had expressed satisfaction with EPA’s responsiveness. EPA’s response to the Executive Order describes its efforts to communicate with requesters, including activities of staff at its FOIA Service Center and a FOIA hotline through which callers may receive information on the status of their requests. It also describes the enterprise FOIA management system, deployed in 2005, that provides “cradle to grave” tracking of incoming requests and responses. The third agency, Treasury, did not address improving status communications, as its plan is entirely focused on backlog reduction. As required by the Executive Order, Treasury did set up Requester Service Centers and Public Liaisons, which are among the mechanisms envisioned to improve status communications. However, because Treasury omitted status communications from the areas of improvement that it selected for review, it is not clear that this area received attention commensurate with the emphasis it was given in the Executive Order. Without such attention to communication with requesters, Treasury increases the risk that its FOIA operations will not be as responsive and citizen centered as the Executive Order envisioned. Agencies Generally Plan to Rely on FOIA Reference Guides to Increase Public Awareness of FOIA Processing The Executive Order states that improvement plans shall include activities to increase public awareness of FOIA processing, including (as appropriate) expanded use of Requester Service Centers and FOIA Public Liaisons, which agencies were required to establish by the order. In Justice’s guidance, it linked this requirement to the FOIA Reference Guide that agencies are required to maintain as an aid to potential FOIA requesters, because such guides can be an effective means for increasing public awareness. Accordingly, the Justice guidance advised agencies to double-check these guides to ensure that they remain comprehensive and up to date. Most agencies (23 of 25) defined goals and timetables for increasing public awareness of FOIA processing, generally including ensuring that FOIA reference guides were up to date. In addition, all 25 agencies established Requester Service Centers and Public Liaisons as required by the Executive Order. Besides these activities, certain agencies planned other types of outreach: for example, the Department of State reported taking steps to obtain feedback from the public on how to improve FOIA processes; GSA plans to post information about what GSA can and cannot release; the Department of the Interior plans to initiate feedback surveys on requesters’ FOIA experience; and the Department of Labor is planning to hold public forums and solicit suggestions from the requester community. Defense did not set specific goals and milestones in this area; according to Defense, it did not do so because its FOIA handbook had already been updated in the fall of 2005. The department also established Requester Service Centers and Public Liaisons, as required. Department officials told us that in meeting their goals and milestones for revising FOIA Web sites, they expect to improve awareness of Defense’s FOIA process, as well as public access and other objectives. As mentioned earlier, Treasury did not address this area in its review or plan. However, Treasury has established Requester Service Centers and FOIA Public Liaisons, as required. Treasury’s Director of Disclosure Services also told us that Treasury provides on its Web site a FOIA handbook, a Privacy Act handbook, and a citizen’s guide for requesters. In addition, this official told us that Treasury had updated its FOIA handbook in 2005 and conducted staff training based on the update. However, at the time of our review, the FOIA handbook on the Web site was a version dated January 2000. When we pointed out that this earlier version was posted, the official indicated that he would arrange for the most recent version to be posted. Because Treasury did not review its efforts to increase public awareness, it missed an opportunity to discover that the handbook on the Web site was outdated and thus might not provide assurance to the public that the information provided was fully up to date, reducing its effectiveness as a communication tool. Without further attention to increasing public awareness, Treasury lacks assurance that it has taken all appropriate steps to ensure that the public has the means of understanding the agency’s FOIA processing. Conclusions The annual FOIA reports continue to provide valuable information about citizens’ use of this important tool to obtain information about the operation and decisions of the federal government. The value of this information clearly depends, however, on its accuracy. In the case of the USDA’s Farm Service Agency, which is not assured of the accuracy of its data, the department’s FOIA improvement plan is an opportunity to address data reliability along with other processing improvements. In addition, one value of the annual reports lies in the possibility they provide of seeing trends and drawing generalizations. However, our ability to generalize about processing times, whether from agency to agency or year to year, is limited because only median times are reported. Since processing times are an important gauge of government responsiveness to citizen inquiries, this limitation is significant. Medians are useful as representative numbers that are not skewed by a few outliers, but the addition of averages (arithmetic means) and ranges would enhance the ability to make useful comparisons and provide a more complete picture. Finally, in the absence of aggregated statistics and summaries, as formerly provided by the Justice Department, it is difficult to obtain a governmentwide picture of FOIA processing. Providing such statistics and summaries could increase the value of the annual reporting process for assessing the performance of the FOIA program as a whole. The Executive Order provided a useful impetus for agencies to review their FOIA operations and ensure that they are appropriately responsive to the public generally and requesters specifically. The 25 agencies submitted FOIA improvement plans that generally responded to elements emphasized by the Executive Order and form a reasonable basis for carrying out the order’s goals. In general, all the plans show a commendable focus on making measurable improvements. One agency (Treasury) submitted a plan that could be improved by closer adherence to the other elements, besides backlog, specified by the Executive Order. Implementing the improvement plans and reporting on their progress should serve to keep management attention on FOIA and its role in keeping citizens well informed about the operations of their government. However, to realize the goals of the Executive Order, it will be important for Justice and the agencies to continue to refine the improvement plans and monitor progress in their implementation. Matters for Congressional Consideration To improve the usefulness of the statistics in agency annual FOIA reports, the Congress should consider amending the act to require agencies to report additional statistics on processing time, which at a minimum should include average times and ranges. Recommendations for Executive Action To provide a clearer picture of FOIA processing both in a given year and over time, we recommend that the Attorney General direct Justice’s Office of Information and Privacy to use data from annual reports to develop summaries and aggregate statistics (as appropriate) for categories of agencies (such as major departments), as well as governmentwide. To ensure that USDA data in FOIA annual reports are accurate and complete, we recommend that the Secretary of Agriculture direct the Chief FOIA Officer for the department to revise the department’s FOIA improvement plan to include activities, goals, and milestones to improve data reliability for the Farm Service Agency and to monitor results. To ensure that its plan includes an appropriate focus on communicating with requesters and the public, we recommend that the Secretary of the Treasury direct the department’s Chief FOIA Officer to review its FOIA operations in the other areas emphasized in the Executive Order (increasing reliance on public dissemination of records, improving communications with FOIA requesters about the status of their requests, and increasing public awareness of FOIA processing) and, as appropriate, revise the improvement plan for fiscal year 2007 to include goals and milestones in these areas. Agency Comments and Our Evaluation We provided a draft of this report to OMB and the 25 agencies for review and comment. All but one agency (the Department of the Treasury) generally agreed with our assessment and recommendations or had no comment. Seven agencies provided written comments: the Departments of Agriculture, Justice, the Treasury, and Veterans Affairs, along with AID, EPA, and NSF (printed in apps. II through VIII). In addition, OMB, the Interior, Transportation, HUD, OPM, and SSA provided technical comments, which we incorporated as appropriate. The Acting Director of Justice’s Office of Information and Policy concurred with our assessment and stated that Justice agrees with our recommendation and plans to implement it (see app. III). The Acting Director stated that the office plans to resume compiling summaries of the annual reports, beginning with those for fiscal year 2006. The Chief FOIA Officer of Agriculture provided additional information on actions that the department has taken to improve FOIA processing, as well as actions that the Farm Service Agency is taking to ensure that its data are reliable (see app. II). Except for Treasury, other agencies providing written comments generally provided additional information on their FOIA programs or provided suggestions on the draft. EPA and NSF offered additional information about their FOIA operations. Both VA and AID stated their view that ample time should be given to accommodate reporting changes. VA also suggested including cases both received and processed in our discussion of the increase in pending requests. We augmented the section on pending requests to include a reference to statistics on cases received and processed. In written and e-mail comments, the Acting Deputy Assistant Secretary for Headquarters Operations indicated that the department generally agreed with our premise that Treasury’s plan needs to more thoroughly integrate the Executive Order and noted that the plan is a living, dynamic document that will accommodate changing circumstances. (Treasury’s written comments are provided in app. IV.) The Acting Deputy Assistant Secretary stated that the department will be evaluating its improvement plan and taking action to improve its FOIA administration. However, Treasury also partially disagreed with our assessment, and it disagreed with our recommendation. According to Treasury, our assessment and recommendation minimize the importance of reducing backlog in the Executive Order and Justice guidance and do not give sufficient weight to other aspects of its improvement plan, such as the establishment of a FOIA council to improve FOIA administration, the establishment of FOIA Requester Service Centers and Public Liaisons, and its compliance with the e-FOIA amendments’ requirement that frequently posted records be posted on agency Web sites. Further, Treasury considered that our assessment does not sufficiently recognize the activities and programs that the department already had in place (beyond backlog reduction) before the order was issued, which were not included in its plan (such as technology improvements to upgrade the department’s FOIA tracking system in 2005 and to upgrade IRS databases). We do not believe that we minimize the importance of reducing backlog; our report indicates that this is a major focus of the Executive Order. However, it was not the only focus of the Executive Order, which also emphasized a citizen-centered approach to FOIA implementation. The three areas of emphasis that we suggest would benefit from further attention are all related to a citizen-centered approach in that they focus on communication with the public and especially with requesters. It may be that Treasury’s FOIA council will provide this focus; however, this was not clear from the agency’s plan, which included no milestones or goals in these areas to guide the council’s future activities. We also disagree with Treasury’s view that we do not give sufficient weight to the activities that the plan included or that Treasury officials indicated were already in progress. Although we took these into account, they did not provide evidence that Treasury was already giving or planned to give the level of attention to the three areas of emphasis that was envisioned by the Executive Order. For example, although Treasury’s compliance with the 1996 e-FOIA amendments is important, the Executive Order asks agencies to look for opportunities to go beyond complying with legal requirements to disseminate records. Similarly, although the technology improvements that Treasury described have the potential to improve FOIA processing (including improvements in the three areas of emphasis), the plan did not tie these improvements and actions to goals or milestones in the three areas. As a result, we did not change our assessment. However, we have clarified the language of the report to emphasize that our assessment is based on meeting the level of attention emphasized in the Executive Order. We note, however, that Treasury in its comments indicates that it does plan to continue to reevaluate its improvement plan and modify it to accommodate changing circumstances. If future modifications specifically address external communications, particularly with requesters, the goal of our recommendation may be achieved. We are sending copies of this report to the Attorney General, the Director of the Office of Management and Budget, and the heads of departments and agencies we reviewed. Copies will be made available to others on request. In addition, this report will be available at no charge on the GAO Web site at www.gao.gov. If you should have questions about this report, please contact me at (202) 512-6240 or via e-mail at koontzl@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix XI. Scope and Methodology To gauge agencies’ progress in processing requests, we analyzed the workload data (from fiscal year 2002 through 2005) included in the 25 agencies’ annual FOIA reports to assess trends in volume of requests received and processed, median processing times, and the number of pending cases. All agency workload data were self-reported in annual reports submitted to the Attorney General. To assess the reliability of the information contained in agency annual reports, we interviewed officials from selected agencies and assessed quality control processes agencies had in place. We selected 10 agencies to assess data reliability: the Departments of Agriculture (USDA), Defense, Education, the Interior, Labor, and Veterans Affairs, as well as the National Aeronautics and Space Administration, National Science Foundation, Small Business Administration, and Social Security Administration. We chose the Social Security Administration and Veterans Affairs because they processed a majority of the requests. To ensure that we selected agencies of varying size, we chose the remaining 8 agencies by ordering them according to the number of requests they received, from smallest to largest, and choosing every third agency. These 10 agencies account for 97 percent of the received requests that were reported in the 25 agencies’ annual reports. Of the 10 agencies that were assessed for data reliability, we determined that the data for USDA’s Farm Service Agency were not reliable; these data account for over 80 percent of the reported USDA data. We therefore eliminated USDA’s data from our analysis. Because of this elimination, our analysis was of 24 major agencies (herein we refer to this scope as governmentwide). Table 9 shows the 25 agencies and their reliability assessment status. To determine to what extent the agency improvement plans contain the elements emphasized by the order, we first analyzed the Executive Order to determine how it described the contents of the improvement plans. We determined that the order emphasized the following areas to be addressed by the plans: (1) reducing the backlog of FOIA requests, (2) increasing reliance on public dissemination of records (affirmative and proactive) including through Web sites, (3) improving communications with FOIA requesters about the status of their requests, and (4) increasing public awareness of FOIA processing including updating an agency’s FOIA Reference Guide. We also analyzed the improvement plans to determine if they contained specific outcome-oriented goals and timetables for each of the criteria. We then analyzed the 25 agencies’ (including USDA) plans to determine whether they contained goals and timetables for each of these four elements. We evaluated the versions of agency plans available as of December 15, 2006. We also reviewed the Executive Order itself, implementing guidance issued by OMB and the Department of Justice, other FOIA guidance issued by Justice, and our past work in this area. We conducted our review in accordance with generally accepted government auditing standards. We performed our work from May 2006 to January 2007 in Washington, D.C. Comments from the Department of Agriculture Comments from the Department of Justice Office of Information and Privacy Washington, D. C. February 20, 2007 Linda D. Koontz Director Information Management Government Accountability Office 441 G Street, NW Washington, DC 20548 Thank you for the opportunity to review and comment on the Government Accountability Office's (GAO's) draft report entitled "Freedom ofInformation Act: Processing Trends Show Importance ofImprovement Plans" (GAO-07-441). The Department believes that GAO's draft report accurately depicts the status and trends ofFOIA processing at twenty-five major agencies as reflected in those agencies' annual reports and FOIA improvement plans required by Executive Order 13,392. We would like to take this opportunity to address GAO's recommendation that the Department of Justice's Office of Information and Privacy (OIP) use the data collected in agencies' annual reports to develop summaries of governmentwide FOIA activities. As noted in GAO's draft report, in the past, although not required to do so under the law, OIP compiled summaries of the annual FOIA reports and made these available through Justice's FOIA Web page. The Department agrees with GAO that such summaries provide the public and the Congress a governmentwide picture ofFOIA processing. Accordingly, OIP will resume compiling the aforementioned summaries beginning with a summary of the fiscal year 2006 annual reports. These summaries will follow the same format and include the same type of information as provided in OIP's prior summaries. Again, we appreciate the opportunity to comment on GAO's draft report, and we look forward to additional collaboration in our efforts to further improve FOIA processing governmentwide. If you have any questions regarding our comments, please contact Richard P. Theis, Assistant Director, Audit Liaison Group on (202) 514-0469. Comments from the Department of the Treasury Comments from the Department of Veterans Affairs Comments from the Agency for International Development Comments from the Environmental Protection Agency Comments from the National Science Foundation Freedom of Information Act Exemptions Matters that are exempt from FOIA (A) Specifically authorized under criteria established by an Executive Order to be kept secret in the interest of national defense or foreign policy and (B) are in fact properly classified pursuant to such Executive Order. Related solely to the internal personnel rules and practices of an agency. Specifically exempted from disclosure by statute (other than section 552b of this title), provided that such statute (A) requires that matters be withheld from the public in such a manner as to leave no discretion on the issue, or (B) establishes particular criteria for withholding or refers to particular types of matters to be withheld. Trade secrets and commercial or financial information obtained from a person and privileged or confidential. Inter-agency or intra-agency memorandums or letters which would not be available by law to a party other than an agency in litigation with the agency. Personnel and medical files and similar files the disclosure of which would constitute a clearly unwarranted invasion of personal privacy. Records or information compiled for law enforcement purposes, but only to the extent that the production of such law enforcement records or information could reasonably be expected to interfere with enforcement proceedings; would deprive a person of a right to a fair trial or impartial adjudication; could reasonably be expected to constitute an unwarranted invasion of personal privacy; could reasonably be expected to disclose the identity of a confidential source, including a State, local, or foreign agency or authority or any private institution which furnished information on a confidential basis, and, in the case of a record or information compiled by a criminal law enforcement authority in the course of a criminal investigation or by an agency conducting a lawful national security intelligence investigation, information furnished by confidential source; would disclose techniques and procedures for law enforcement investigations or prosecutions, or would disclose guidelines for law enforcement investigations or prosecutions if such disclosure could reasonably be expected to risk circumvention of the law; or could reasonably be expected to endanger the life or physical safety of an individual. Contained in or related to examination, operating, or condition reports prepared by, on behalf of, or for the use of an agency responsible for the regulation of supervision of financial institutions. Geological and geophysical information and data, including maps, concerning wells. Median Processing Times Reported The attached tables present median processing times as reported by agencies in their annual FOIA reports in fiscal years 2004 and 2005. To provide context, we include numbers of requests processed for each agency or component. We also indicate (in columns headed “±”) whether the median days to process rose (+), fell (–), or remained unchanged (=). (We also use “~” to indicate other types of changes, such as the establishment of a new component.) Agencies report median processing times according to processing tracks: that is, some agencies divide requests into simple and complex categories and process these in separate tracks, whereas others use a single track. Accordingly, the tables show these tracks where applicable. In addition, agencies are required to subject some requests to expedited processing, and these are reported as a separate track. Department of Health and Human Services Department of Housing and Urban Development National Aeronautics and Space Administration Social Security Administration (Continued From Previous Page) Agency for International Development No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Central Intelligence Agency No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Department of Homeland Security No. No. (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Component did not exist. Department of Commerce No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Department of Defense No. = number of requests processed; Days = median days to process; ± = No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Department of Energy No. No. (a) (a) (a) (a) (a) No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Component did not exist. Department of the Interior No. No. (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) (a) + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Statistics not broken down by component. Department of Justice No. No. (b) (b) No. No. (c) (c) (a) (a) (a) (a) (a) No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Component did not exist. In addition to the expedited track, the FBI maintains three tracks for reuests: small (0 to 500 pages), medium (501 to 2,500 pages), and large (more than 2,500 pages). The former is reported in the “simple reuests” category; the latter two are reported as “complex reuests.” Therefore FBI’s complex reuests were excluded from analysis. Justice Management Division used average days opposed to median days, so it was excluded. Department of Labor No. No. No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Department of Transportation No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Department of Education No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Environmental Protection Agency No. No. No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) General Services Administration No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Department of Health and Human Services Two tables are provided for this department, because its components report both multitrack (simple and complex) processing and single-track processing. No. No. (a) (a) (a) (a) No. No. (a) (a) (a) (a) No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Component did not exist. Department of Housing and Urban Development No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) National Aeronautics and Space Administration No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Nuclear Regulatory Commission No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) National Science Foundation No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Office of Personnel Management No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Small Business Administration No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Social Security Administration No. No. No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Department of State No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Department of the Treasury No. No. + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Department of Veterans Affairs The department reports all processing in one track, but it refers to this track as complex, rather than single track. No. No. (a) (a) (a) No. No. (a) (a) (a) (a) + increase – decrease = no change ~ other change (change in reporting, new component, etc.) Component did not exist. GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, key contributions to this report were made by Barbara Collier, Acting Assistant Director; Alan Stapleton, Assistant Director; James Ashley, Marisol Cruz; Wilfred Holloway; Vernetta Marquis; David Plocher; Kelly Shaw; Shawn Ward; and Elizabeth Zhao.

The Freedom of Information Act (FOIA) establishes that federal agencies must provide access to their information, enabling the public to learn about government operations and decisions. To help ensure proper implementation, the act requires that agencies report annually to the Attorney General, giving specific information about their FOIA operations, such as numbers of requests received and processed and median processing times. Also, a recent Executive Order directs agencies to develop plans to improve FOIA operations, including decreasing backlog. For this study, GAO was asked to examine the status and trends of FOIA processing at 25 major agencies as reflected in annual reports, as well as the extent to which improvement plans contain the elements emphasized by the Executive Order. To do so, GAO analyzed the 25 agencies' annual reports and improvement plans. Based on data in annual reports from 2002 to 2005, the public continued to submit more requests for information from the federal government through FOIA. Despite increasing the numbers of requests processed, many agencies did not keep pace with the volume of requests that they received. As a result, the number of pending requests carried over from year to year has been steadily increasing. Agency reports also show great variations in the median times to process requests (less than 10 days for some agency components to more than 100 days at others). However, the ability to determine trends in processing times is limited by the form in which these times are reported: that is, in medians only, without averages (that is, arithmetical means) or ranges. Although medians have the advantage of providing representative numbers that are not skewed by a few outliers, it is not statistically possible to combine several medians to develop broader generalizations (as can be done with arithmetical means). This limitation on aggregating data impedes the development of broader pictures of FOIA operations, which could be useful in monitoring efforts to improve processing and reduce the increasing backlog of requests, as intended by the Executive Order. The improvement plans submitted by the 25 agencies mostly included goals and timetables addressing the four areas of improvement emphasized by the Executive Order: eliminating or reducing any backlog of FOIA requests; increasing reliance on dissemination of records that can be made available to the public without the need for a FOIA request, such as through posting on Web sites; improving communications with requesters about the status of their requests; and increasing public awareness of FOIA processing. Most of the plans (20 of 25) provided goals and timetables in all four areas; some agencies omitted goals in areas where they considered they were already strong. Although details of a few plans could be improved, all the plans focus on making measurable improvements and form a reasonable basis for carrying out the goals of the Executive Order.

Background TCB assistance is based on the premise that international trade can positively benefit a country’s overall growth and development. The United States and other countries increasingly view TCB assistance as an important tool in promoting economic growth and reducing poverty. Expanding trade with and among developing countries can be a critical driver of economic growth and poverty reduction because it encourages entrepreneurship, human resource development, technology transfer, technological innovation, and good governance. Developing countries have increasingly integrated into the global trading system, and some of those countries have become important U.S. trading partners. According to the World Bank, exports from developing countries have grown twice as fast as those of high-income countries since 2000. Moreover, imports in developing countries grew at almost twice the rate of high-income countries. As a result, developing countries account for a growing share of world imports. Furthermore, since 2000, many developing countries have acceded to the WTO. Currently, about two- thirds of WTO members are developing countries or least-developed countries. In addition, many developing countries have entered into free trade agreements (FTA) with the United States. FTAs phase out barriers to trade in goods with particular countries or groups of countries and contain rules designed to improve access in services, investment, and intellectual property rights. However, many developing countries—in particular the least developed— face constraints that severely limit their ability to implement trade agreements and benefit from trade. Many developing countries lack the physical, institutional, or human capacity to participate effectively in global trade. Additionally, developing countries sometimes lack the financial and human resources to fulfill their trade commitments. USTR has indicated that TCB assistance is important to enable developing countries to negotiate and implement market-opening and reform-oriented trade agreements. In addition, some view TCB assistance as important to securing broad-based reforms across countries so that all countries benefit from the trade rules negotiated in the WTO and in other trade agreements. In 2001, the WTO Doha Ministerial Declaration advised that technical assistance should be designed to assist developing, least- developed, and low-income countries to meet their WTO obligations, and draw on the benefits of an open, rules-based multilateral trading system. The WTO created the Doha Development Agenda Global Trust Fund to help developing countries build capacity and establish a reliable basis for funding WTO-related technical assistance. The 2005 Hong Kong WTO Ministerial Declaration called for the expansion and improvement of this type of assistance and set in motion a process to achieve this known as the Aid-for-Trade Initiative. Partnering with the WTO on this initiative, the Organization for Economic Cooperation and Development (OECD) jointly created a database to provide comprehensive information on bilateral donor and multilateral/regional agency support for TCB. The OECD has issued a number of reports on aid-for-trade issues and attempts to share good practices so that developing countries can capitalize on the opportunities of international trade. To identify and quantify the U.S. government’s TCB activities in developing and transitional economies, USAID conducts an annual survey on behalf of USTR. The data gathered from this survey are used to inform and respond to inquiries from Congress, the executive branch, the general public, and multilateral organizations such as the WTO. USTR officials use the database regularly and, according to these officials, it is a useful tool for identifying U.S. agencies’ TCB activities and funding in a particular country or region, as well as the full extent of assistance the U.S. government provides in that area. USAID oversees a contractor that collects and maintains the survey results in a publicly available online database. The survey defines TCB and asks agencies to place their assistance into a range of categories and estimate funding obligated for each category (table 1 provides further information on these categories). In addition to administering this survey, USAID is also tasked with reviewing completed survey forms, and checking for accuracy and consistency in the reporting of funding and allocation into TCB categories. A variety of U.S. agencies have a role in providing TCB assistance, including the Departments of State, the Army, Labor, the Treasury, and Commerce; MCC; and USAID. In our 2005 report on U.S. TCB efforts, focusing on the period from 2001 to 2004, we found that U.S. TCB assistance was primarily a collection of a variety of trade and development activities. We noted that 18 agencies had self-reported that they obligated almost $2.9 billion for TCB activities in more than 100 countries and that USAID provided 71 percent of overall U.S. TCB assistance. We also found that the six agencies we reviewed were neither systematically monitoring nor measuring program performance in terms of TCB and recommended USAID and USTR develop a strategy to systematically monitor and measure results and evaluate effectiveness. In response, USAID, in consultation with USTR, took steps to develop a multicountry evaluation to measure the effectiveness of U.S. TCB assistance, which was issued in November 2010. USAID and State Conduct TCB Activities Aligned with Their Primary Goals; TCB Is Secondary to Goals of Other Agencies Of the four agencies we reviewed that fund and implement TCB activities, only USAID and State have strategic plans that include TCB-focused goals. USAID has developed a strategic plan for TCB, and State’s joint strategic plan with USAID for fiscal years 2007 to 2012 supports USAID’s goal of advancing developing countries’ participation in and benefits from trade agreements. MCC and the Army conduct TCB-related activities that support their broader strategic and agency mission goals. However, they do not have strategic plans and goals that specifically relate to TCB. USAID and State Provide Assistance that Directly and Indirectly Supports USAID’s TCB Strategic Plan USAID and State have strategic goals specific to promoting TCB and have incorporated these goals in the planning of their assistance. (For further information on USAID’s planning of its TCB activities, see app. II.) In 2003, USAID issued a formal strategic plan on TCB, to focus its TCB efforts and guide the selection of new activities. The plan calls for USAID’s TCB projects to support the three primary objectives of helping countries participate in trade negotiations, implement trade agreements, and take advantage of trade opportunities. In addition, State supports USAID’s TCB efforts outlined in its strategy. The USAID and State joint strategic plan for fiscal years 2007 to 2012 calls for supporting USAID’s strategic goal of providing assistance to help countries participate in and benefit from trade agreement negotiations. We found that USAID and State planned and provided assistance that supported TCB strategic objectives. USAID also provided assistance that aligns with its April 2008 strategy for economic growth that includes the goals of (1) developing well functioning markets in developing countries, primarily through supporting policy and regulatory reforms and (2) strengthening the international framework of policies and institutions that support countries’ economic growth and opportunities by promoting international standards. USAID and State, in collaboration with other U.S. government agencies, have provided TCB assistance as part of USTR-created TCB working groups in developing countries where the United States is negotiating a FTA. (For further information on interagency efforts to coordinate TCB assistance, see app. III.) These working groups meet during the negotiations to identify and select TCB activities that assist developing country negotiating partners through regional and bilateral TCB programs. In particular, TCB working groups were a feature of the bilateral negotiations in support of the ratified Central America-Dominican Republic Free Trade Agreement (CAFTA-DR) and Peru FTA, and the signed FTAs with Colombia and Panama. For example:  During the CAFTA-DR negotiations, USAID, State, and other U.S. agencies helped to provide technical assistance to the Central American countries to address a variety of trade capacity issues, including the strengthening of plant and animal health and food safety regulatory systems, and the strengthening of customs procedures. In conjunction with the U.S.-Colombian free trade negotiations a USAID program assisted the government of Colombia in adopting and implementing policy and regulatory reforms to facilitate the conclusion and implementation of the FTA. The program included 18 components of trade-related policy reforms that led to Colombia’s development of new regulations and procedures consistent with the FTA’s requirements. For example, the program supported the establishment of a national food safety policy that ensured consistency with U.S. sanitary and phytosanitary standards. In addition, USAID provided TCB assistance to support countries’ efforts to accede to the WTO. In fiscal year 2009, USAID provided TCB assistance supporting the accession and membership of nine countries to the WTO. USAID’s activities supported foreign governments’ implementation of regulatory reforms and the adoption of domestic policies, laws, and regulations that align with international standards. For example, under a 5-year joint-funded program with State, USAID provided the government of Laos with legal and economic analysis of needed reforms, particularly in the areas of services, and intellectual property rights and standards. USAID and State have provided TCB assistance to support the implementation of U.S. FTAs with developing country partners. The final texts of FTAs, including CAFTA-DR, and the Peru FTA, have provisions that created committees on TCB to assist partner countries in implementing the trade agreements and adjusting to more liberalized trade. USAID, State, and other U.S. agencies have provided TCB assistance in support of the work of these committees. For example, USAID’s Regional Trade Program for CAFTA-DR provided training relevant to compliance with the provisions of the CAFTA-DR agreement, including training to some partner countries’ foreign government officials, judicial officials, and private sector representatives in the area of intellectual property rights protections and investment regulations. The program also strengthened CAFTA-DR partner countries’ customs operations and administration to meet international standards as well as the FTA’s provisions. USAID also conducts TCB activities with the objective of building the capacity of firms to capitalize on the benefits of FTAs. For instance, in 2005, USAID created a program to provide technical assistance to Moroccan firms in various sectors, including apparel, textiles, leather footwear, and processed foods, with the goal of developing business opportunities between the United States and Morocco under the U.S.- Morocco FTA. Under the program, Moroccan firms and trade associations received technical assistance, including seminars and workshops on a variety of trade-related topics such as sales planning, transport logistics, and production standards and certification. USAID also assists countries in adopting requirements related to WTO agreements, and supports countries seeking to benefit from regional trade agreements. USAID funds and implements projects to help recipient countries comply with WTO agreements in areas such as government procurement, agriculture, the application of sanitary and phytosanitary measures, and the agreement on intellectual property rights. In addition, USAID provided technical assistance to address developing countries’ capacities for meeting standards under regional trade agreements. For example, a primary objective of USAID’s Southern Africa Trade Hub is to increase international competitiveness and intraregional trade in the Southern African Development Community region. In addition, USAID provides TCB assistance in support of opportunities provided under trade preference programs, most prominently the African Growth and Opportunity Act of 2000 (AGOA). To help countries take full advantage of increased trading opportunities under AGOA, USAID provides TCB assistance primarily through trade hubs in East, West, and Southern Africa and bilateral missions in sub-Saharan Africa. The trade hubs assisted firms in taking advantage of opportunities under AGOA by helping them develop market linkages, adapt products to the U.S. market, and facilitate business deals. One trade hub also developed national export strategies identifying countries’ constraints and opportunities for exporting under AGOA, and another trade hub conducted workshops to help African firms and foreign government officials increase their understanding of AGOA. In conjunction with objectives other than TCB, USAID conducts TCB- related activities that indirectly support TCB by helping countries take advantage of trade-related economic opportunities. These activities aim to address a wide range of development needs in the public and private sectors. In conducting our fieldwork and research, we identified USAID projects that missions conducted for various objectives in addition to TCB, but that mission officials identified as achieving outcomes related to international trade:  The mission in Mozambique conducted a TCB-related agriculture development program with the primary objective of increasing the sustainability and profitability of the country’s private sector to strengthen rural income growth. While TCB was not an explicit objective, as part of the program, USAID funded a commercial food laboratory that provides screening services to reduce illnesses from contaminated local food supplies, which also helped producers meet quality standards for the export of commercial food products.  USAID implemented TCB-related programs in Colombia with the primary objective of generating economic alternatives to illicit crop production. However, the program also helped agricultural producers expand sales, including exports, and assisted the government of Colombia in implementing economic policies and institutional reforms to enhance the competitiveness of the Colombian economy in general, including those related to international trade. In Morocco, the mission conducted TCB-related activities aimed at improving the general business environment and promoting broad- based economic growth, in part through a reduction in trade and investment barriers. One TCB-related program provided technical assistance in support of regulatory and legal reforms to promote investment and enhance the general ease of doing business, for instance. In addition, USAID implemented a program to improve the productivity and competitiveness of certain agricultural products, including those for export. TCB Is Secondary to the Goals of MCC and the Army Other agencies we reviewed do not have TCB-focused strategic goals, but conduct activities that have trade-related effects and that are considered TCB to fulfill their broader mission goals. While 23 other U.S. agencies, in addition to USAID, reported funding for TCB-related activities from fiscal years 2005 to 2010, MCC, in particular, reported obligating almost half of total U.S. government TCB funding over this period. In addition, over the same period, the Army reported obligating the fourth largest amount of funding for TCB among U.S. agencies, following MCC, USAID, and State. However, MCC and the Army do not have strategic plans and goals that specifically relate to TCB, but sometimes conduct TCB-related activities to fulfill their strategic and agency mission goals. MCC generally identifies TCB-related activities as part of its poverty reduction goals in its 5-year country compacts and threshold programs, although TCB is not an explicit objective. The Army conducts trade- related physical infrastructure projects, such as roads and telecommunications projects, that it reports as TCB to respond to its emergency and disaster response objectives in Afghanistan and in support of its reconstruction efforts in Iraq and Afghanistan. Although from 2005 to 2010 MCC reported obligating the largest amount of TCB-related assistance funding of any U.S. government agency— approximately $4.7 billion, or 65 percent, of its total assistance—MCC does not fund TCB-related activities for the specific objective of TCB, according to officials. It funds TCB activities as part of its larger mission to reduce poverty and stimulate economic growth through its compact agreements, and to help countries address policy weaknesses through its threshold programs. MCC provides monetary assistance through multiyear compact agreements with developing countries that create and maintain sound policy environments. Its threshold programs fund a limited amount of assistance to certain developing countries to help them become eligible for compact funding. TCB is not an explicit objective of the agreements and programs, according to officials, and MCC funds are not earmarked for specific TCB projects. Compact countries define their own development priorities and project proposals, which may include projects considered as TCB. MCC first reported obligating funding for TCB assistance when it signed its initial compacts with recipient countries in fiscal year 2005. MCC has continued to report high levels of funding for TCB assistance as countries sign compacts, but the levels of funding and types of TCB-related activities depend on whether countries include TCB as a component in their proposals. MCC operates differently than USAID and other U.S. agencies in that it only provides assistance to developing countries based on criteria involving governance and economic reform measures. For a country to be selected as eligible for MCC’s compact assistance program, it must have demonstrated a commitment to ruling justly, encouraging economic freedom, and investing in people by performing well on 17 indicators that MCC uses to assess policy performance. Each compact is unique, and MCC works in partnership with eligible countries that identify the greatest constraints to their own development and establish priorities. In consultation with the private sector and nongovernmental organizations, a country government submits a proposal that may include TCB-related projects. The proposal forms the basis for the compact. To help focus the proposal on the root causes of constraints to private investments and identify the appropriate activities, MCC and country partners use a written analysis of a country’s constraints. The analyses facilitate the consultative process for developing compacts that address country priorities. For example, according to MCC officials in Mozambique, MCC funded prefeasibility analyses of four potential TCB-related projects. Three of the projects were included in the compact. However, following consultations, a free trade zone project was determined not to be viable. As of fiscal year 2010, MCC reported TCB-related activities in 20 compact countries and 9 threshold program countries. TCB-related activities in compact countries primarily consisted of physical infrastructure development activities, while activities in threshold program countries focused on customs operation and administration, such as strengthening border inspections to improve import and export monitoring. For example, in Benin, Honduras, Mali, Mozambique, and Tanzania, MCC has funded a variety of physical infrastructure projects, including port and airport improvement projects, as well as road construction and rehabilitation. The Moldova, Sao Tome and Principe, and Zambia threshold programs included a variety of activities related to customs operations and administration, including the upgrading and modernization of customs systems and enhancements to custom operations and inspection procedures. The Army does not have TCB-focused strategic objectives, according to Army officials. However, the Army funds trade-related physical infrastructure projects considered TCB as part of the Commander’s Emergency Response Program in Afghanistan and in support of its infrastructure development efforts in both Iraq and Afghanistan. Since fiscal year 2009, the Army has reported $615 million in total obligated funding for TCB-related activities that support the Army’s broader goal to achieve U.S. security objectives, provide basic humanitarian aid and services, and support economic stability and development as a means of responding to security concerns. For example, as part of its funding for humanitarian assistance, the Army constructed and restored a variety of physical infrastructure in Afghanistan that it reported contributed to trade, including telecommunications and electrical systems projects. Although the objectives of these projects are not directly focused on TCB, according to officials of one Army command, these projects further increase economic integration and trade by providing communication and electrical power linkages between Afghanistan and neighboring countries. The Army also undertook food production and distribution processes in Afghanistan that also helped meet sanitary and phytosanitary standards. In addition, as part of its mission, the Army supports economic stability and sustainable development to promote security, in part, through the development of infrastructure, such as roads, that facilitate trade. For example, the Army funded the restoration and construction of roads in 20 regions in Afghanistan, which it reported contributed to the development of physical infrastructure needed to promote trade. In addition, the Army reported funding to repair, improve, and create new infrastructure in Iraq and Afghanistan, including roads and bridges, necessary for trade routes and market access improvements. According to officials of one Army command, the road projects facilitated regional and international trade flows by linking Afghanistan with neighboring countries. Officials noted that recipient countries of the Army’s assistance are identified through Department of Defense guidance and with input from in-country U.S. agencies on recipient countries’ needs. The TCB Database Does Not Provide Adequate Information Necessary to Understand Significant Changes in the Composition of Reported TCB Activities USAID does not adequately describe certain key factors underlying significant changes in the composition of TCB funding as reported by the TCB database. According to the database, from 2005 to 2010, overall annual funding increased 25 percent, from $1.35 billion to $1.69 billion. This increase is largely the result of the inclusion of funding from MCC beginning in 2005, and the Army beginning in 2009. Correspondingly, there has been a steep decline in the share of total funding reported by USAID and other agencies. MCC and the Army reported TCB funding primarily in the category of physical infrastructure, which has contributed to a steep rise in overall funding in that category. In addition, agencies that are newly identified for inclusion in the database, such as the Army, are sometimes unable to provide data for previous years, which may imply a certain amount of under reporting. Although the annual TCB survey attempts to identify and quantify just the trade-related components of projects, this can be difficult for officials to fully achieve in practice. It may also be challenging for survey administrators to fully clarify the distinction between direct and indirect TCB funding. The limitations involved in collecting and reporting TCB-related data do not necessarily invalidate the figures in the database; however, USAID is not providing sufficient context or explanation of these limiting factors with the dataset. Clear reporting and transparency in methodology and collection are essential for users of the data to understand changes in the nature of TCB over time. The Inclusion of MCC and the Army Has Significantly Increased the Reported Levels of and Changed the Composition of Total TCB Funding Since our previous review of TCB assistance in 2005, there have been significant changes in the level and composition of total TCB funding as reported by the U.S. TCB database. Our past report reviewed TCB funding obligated from 2001 to 2004. Over that period, the average annual amount reported by all agencies was about $735 million. In comparison the average annual amount reported by agencies during the period 2005–2010 was more than twice as much—$1.65 billion. From 2005 to 2010, total funding levels have generally increased, with annually reported funding growing from $1.35 billion to $1.69 billion, a 25 percent increase. Since 2005, the number of agencies reporting TCB obligations has grown from 18 to 24. However, the significant increase in total TCB funding is attributable to two agencies in particular—MCC, which was established in 2004 and began reporting TCB funding in 2005, and the Army, which began reporting TCB funding in 2009 (see fig. 1). Over 2005–2010, MCC reported obligating $4.7 billion, or 48 percent of total TCB funding. In 2009, the first year Army began submitting data to the survey, it reported $497 million in funding or 27 percent of the total for that year. Combined funding from MCC and Army comprised 54 percent of total TCB over 2005–2010. The significant amount of funding reported by MCC and the Army lowered the relative share of total TCB funding provided by USAID and other agencies. For example, over 2001–2004, USAID reported obligating 70 percent of total TCB funding, the largest share of any U.S. agency; while over 2005–2010, USAID’s share declined to 29 percent of total funding. While the amount of TCB funding provided by USAID declined over that period, this does not account for such a large decline in relative share. In addition, the relative combined share of total funding for all other U.S. agencies also declined, going from 25 percent over 2001–2004 to 10 percent over 2005–2010. Annual TCB funding in the category of physical infrastructure has grown from $346 million in 2005 to $787 million in 2010, a 127 percent increase. Over 2005–2010, physical infrastructure was the largest category of total TCB funding, at 45 percent of the total, or $4.5 billion out of $9.9 billion. In contrast, over 2001–2004, physical infrastructure comprised only 8 percent of total funding, or $226 million out of $2.9 billion. The share of funding for all other TCB categories has declined between those two periods. For example, there has been a decline in the overall share of funding of trade facilitation, which was the largest category over 2001– 2004, from 27 percent to 16 percent, and a decline from 17 to 6 percent in human resources and labor standards, which was previously the second largest category. Figure 2 illustrates the large increase in the category of physical infrastructure and the proportional decline in the other categories of TCB, from 2001–2004 to 2005–2010. The increase in the category of physical infrastructure since 2005 has been driven by the TCB funding reported by MCC and the Army. Physical infrastructure and trade-related agriculture constitute the primary categories of TCB assistance obligated by MCC. Over 2005–2010, MCC reported obligating $3.3 billion in the category of physical infrastructure development and $667 million in trade-related agriculture. MCC’s funding made up a majority share of overall TCB funding for both categories. MCC accounts for 74 percent of total funding in physical infrastructure and for more than half of total funding in trade-related agriculture. Similarly, the $497 million in TCB funding reported by the Army in 2009 was exclusively for physical infrastructure development. This amount accounts for 13 percent of total funding in physical infrastructure, the majority of which—$396 million—the Army reported as funding for road and bridge projects in Afghanistan. Figure 3 shows the amount of funding for each category of TCB by agency over 2005–2010. MCC and the Army have also impacted the regional distribution of TCB as reported by the database. Since 2005, U.S. agencies have provided TCB funding to 143 recipient countries in 6 geographic regions, including Southern Asia, Europe and Eurasia, East Asia/Oceania, Latin America and the Caribbean, the Middle East and North Africa, and sub-Saharan Africa. The sub-Saharan African region received the most funding, driven primarily by projects funded by MCC (see fig. 4). Funding for Southern Asia was largely made up of the Army’s reported 2009 funding of physical infrastructure projects in Afghanistan. In contrast, USAID funding is spread more evenly worldwide. (For a more detailed table of country funding, including TCB assistance to least developed countries, see app. IV). The methodology of the TCB survey, the multiyear nature of MCC compacts, and the relatively large size of those compacts are factors that drive the impact of MCC funding on the TCB funding landscape. The TCB survey collects and reports funding for each fiscal year on an obligation basis, as opposed to reporting funding in the year in which it was distributed. MCC obligates full funding for its 5-year compact agreements in the year the compacts enter into force. The TCB survey methodology captures the amount obligated in that year, resulting in large spikes in MCC annual figures. This is unique in that other U.S. agencies generally fund their multiyear projects through ongoing annual obligations. As a result, any comparisons between MCC funding and other agencies in any given year may be distorted. USAID officials noted that it may not be feasible to alter the data collection process in such a way as to address this issue. As we have previously reported, MCC’s actual disbursements have substantially lagged behind planned disbursements for countries with compacts in force. This is because initial compact disbursement plans underestimated the time required for compact countries to establish the structures, agreements, and capabilities to begin implementing compact projects. For example, MCC signed a compact with Mozambique in fiscal year 2008 for $507 million and reported $222 million of that total as TCB- related funding in that fiscal year. However, as of December 31, 2010, MCC reports having expended only $39 million, or just less than 8 percent of the total compact amount. Furthermore, due to the multiyear nature of MCC compacts, MCC funding usually constitutes a significant amount of total annual TCB funding, so the MCC obligations that appear in the TCB database are large relative to other agencies and have an increased impact on overall TCB statistics (see fig. 1). USAID management officials acknowledge the potential for the database to distort the portrayal of TCB funding by comparing what is, in effect, 5- year funding for MCC with 1-year funding for other agencies, but they maintain that it is not possible to reconfigure the data in any meaningful way due to the survey’s methodology. They also note that they sometimes remove MCC from the dataset when conducting their own analyses. In response to the concerns we noted, USAID updated the TCB Web site in July 2011 to include a prominent notice on the Web site’s home page of the unique nature of MCC obligations. Given the relative size and impact of MCC funding, such explanation is necessary to fully understand the data. The TCB Database Does Not Adequately Explain Significant Factors Driving Changes in the Composition of TCB Funding The Database Does Not Fully Explain Limitations That May Cause Prior Years’ Reporting to be Understated Difficulties reporting previous years’ data for newly identified sources of TCB funding may mean that funding levels for those years are understated in certain cases. The TCB survey team under contract with USAID annually reviews various sources, such as the President’s budget request, to identify any TCB-related funding that is not currently being reported to the survey. In this way, the survey team identified the Army as a provider of TCB funding and requested that Army officials began submitting data beginning in 2009. The Army provided this funding for physical infrastructure development projects in Afghanistan and Iraq. The Army had provided funding for similar activities for a number of years prior; however, survey officials told us it was not practical to attempt to capture previous years’ data. Although the TCB Web site notes that 2009 was the first year USAID received a submission from any of the U.S. Armed Services, it does not provide any further information. Specifically, it does not make users aware of the possibility that prior years’ reporting is highly likely to be understated due to the challenges in reporting on the Army’s previous funding. Furthermore, the TCB Web site does not note the process or describe the limitations of identifying new TCB funding sources in its methodology. The Army’s funding made up 27 percent of the total TCB for 2009. Given the relative size and impact of Army funding, such an explanation is necessary to fully understand the data and the future impact of newly-identified agencies. Reporting and measuring TCB-related funding and activities, particularly for physical infrastructure projects, can be difficult, largely because of the need to distinguish between assistance focused on improving trade capacity, in particular, and support to promote economic growth or some other goal in general. While agencies such as USAID fund activities that have clear and direct links to TCB, other agencies, including MCC and the Army, fund activities that are sometimes more indirectly related to international trade. For example, technical assistance USAID provides to aid in a country’s accession to the WTO has a clear and direct relation to trade, but activities such as constructing roads or electrical grids may not. In addition, certain types of projects might be related to trade in one context but not in another. For instance, an energy project might relate to trade if it is servicing a tourism complex but not if it is providing electricity to local neighborhoods. The TCB survey was developed to capture any and all U.S. government TCB-related funding at the activity level of all participating agencies. USAID and USTR officials have noted that the design of the TCB survey enables them to determine on a case-by-case basis the extent to which a project or program may relate to TCB because reporting officials understand the specific trade-related components of the project for which they are reporting data. USAID officials explained that the TCB survey is designed to solicit such a determination because it surveys those officials responsible for managing the projects “on the ground.” Although the TCB survey attempts to identify and quantify just the trade- related components of a physical infrastructure project, we found examples where the application of this distinction was challenging. Officials with whom we spoke during our fieldwork agreed that the definition of TCB used in the survey was quite broad, which could sometimes make it difficult to identify the activities to report in their survey responses. They relied on the categorical definitions provided by the TCB survey and survey guidance. However, we found instances in which officials experienced challenges in clearly discriminating between components of projects that were TCB or non-TCB related, particularly in large TCB-related infrastructure projects. For example:  The Army reported $396 million in TCB funding for infrastructure projects in Afghanistan that consisted of activities intended to repair, restore, or build roads to respond to urgent humanitarian relief and reconstruction requirements and that also had trade-related effects. Army officials cited concerns about reporting the entire road project as related to TCB because it may only be minimally used for international trade. However, survey administrators advised Army officials responsible for reporting the Army’s TCB data that the entire funding for the road project should be counted as TCB-related assistance “so long as the project is not designed to exclusively support a military installation and so long as the power/utility project is not designed to exclusively support residential use.” As one official put it, “a road will support the ability of farmers to transport their products to a local market as well as to an export facility.” “Fishing is one of the most important industries in Morocco. Morocco is unable to satisfy current domestic demand for quality fish. Demand is expected to increase, driven by an expanding tourist sector and expected growth in domestic fish consumption. The Small Scale Fisheries Project seeks to modernize the means of catching, storing, and marketing fish, thereby improving the quality of the catch, maintaining the value chain, and increasing fishers’ access to both local and export markets.” According to MCC and foreign officials in Morocco, external trade was not in the forefront of their thinking on this particular project when the compact was being developed. When we originally discussed this project with one MCC official in Morocco, we were told that 100 percent of the catch was intended for domestic consumption. However, we later learned from a host country project manager that an estimated 20 to 30 percent of the catch would go to outlets that might be considered exports. There was no readily available quantitative data to verify this. Differing from both those estimates, MCC had previously reported to the survey that all $116 million of funding for the project was TCB-related. Other entities that report TCB-related funding face similar challenges. For example, the 2005 WTO Hong Kong Ministerial Conference established the Aid-for-Trade Initiative that prompted a joint effort by the OECD and the WTO to track TCB activities by all global donors in a manner similar to the approach of the TCB database. The U.S. TCB survey is used to generate the TCB activities and funding the U.S. government reports to that joint database. While the OECD and WTO effort collects and tracks aid-for-trade data using definitional categories similar to those used in the U.S. TCB survey, they more explicitly acknowledge the challenges associated with physical infrastructure projects. One OECD report notes that it is almost impossible to provide sound criteria that differentiate between trade-related infrastructure and general economic infrastructure. In addition, they report that few international donors can identify the trade- related share in individual projects and programs. As stated earlier in this report, USTR maintains that the U.S. TCB survey has the ability to determine on a case-by-case basis the extent to which projects may have trade-related components. USTR has explained that this ability to dissect programs into their component parts is an important difference between the U.S. TCB definition and OECD’s aid-for-trade definition. However, we have noted examples when agency officials submitting TCB estimates have found it difficult to make this distinction. USAID does not provide any information on the difficulties involved in making these determinations on the TCB database Web site. In contrast, the 2007 report on global aid-for-trade issued jointly by the OECD and the WTO dedicates an appendix to discussing the difficulties in collecting data on infrastructure (as well as other categories of TCB) and the possibility that a significant over-estimation of the actual TCB-related volume is possible. The U.S. TCB survey attempts to make this differentiation but does not provide a clear explanation of how such a differentiation operates or the degree to which some of these determinations are subjective. Although the database states that the physical infrastructure category only includes assistance to establish telecoms, transport, ports, airports, power, water, and industrial zones that have a direct link to trade, it does not include a discussion of whether those projects are primarily for a non-TCB goal and how that might affect the project’s value to TCB efforts. Furthermore, the TCB database Web site does not distinguish or explain “direct” and “indirect” linkages between projects and TCB. USAID recognizes in its annual Congressional Budget Justification that there is a distinction between direct and indirect TCB. It cites examples of “direct TCB” that include support for countries’ efforts to streamline customs and examples of “indirect TCB” that include modernizing transport. In neither of the examples above, where we noted instances in which officials experienced challenges in clearly discriminating between components of projects that were TCB or non-TCB related, was TCB explicitly the primary goal of the project. However, USAID officials provide no such distinctions or explanations on TCB database Web site, which could lead to users misunderstanding the data. USAID Has Improved Its Assessment of TCB, but Has Not Made Plans to Make Use of Insights from a Recent Multicountry Evaluation, or to Conduct Additional Evaluations USAID has made improvements in assessing the results of its TCB assistance, including developing indicators and taking the positive step of commissioning its first independent agencywide multicountry evaluation of TCB activities, as we recommended in our 2005 report. The evaluation provided valuable information about the effectiveness of USAID’s TCB assistance worldwide, and the factors associated with project success; however, the agency has yet to make specific plans to incorporate the evaluation’s key insights into its planning and management of activities and conduct such evaluations in the future. To assess the immediate results of its TCB activities, USAID uses standard trade and investment indicators, and missions may develop additional custom indicators. In addition, it has commissioned a limited number of evaluations of specific TCB programs to assess longer-term results. However, most significantly, in 2010, USAID took the positive step of issuing an independent multicountry evaluation of U.S. government TCB assistance that focused on activities USAID administered. The evaluation provided the agency useful information on the effectiveness of USAID’s activities across countries, the factors that influenced project success, and the means by which monitoring and evaluation could be improved. Although the agency is developing training based on the results of the evaluation, it has not developed plans for disseminating best practices to missions nor has it made plans for conducting such evaluations on an ongoing basis. USAID Has Developed Indicators to Monitor Short-Term TCB Results, but Assessing Quality of Results Is Difficult To assess and report on the immediate results of its TCB-related programs, USAID uses standard and custom indicators. (For further information on the frameworks agencies use for monitoring and evaluating their TCB activities, see app. V.) USAID requires missions to report performance against standard indicators, which include agencywide trade and investment indicators. Activities in the trade and investment program area relate to TCB, and USAID uses 20 trade and investment standard indicators to measure the immediate results of its TCB activities. Missions and offices report on a subset of the standard indicators that relate to the trade and investment program elements they are funding. Examples of USAID trade and investment standard indicators include:  Number of customs harmonization procedures implemented in accordance with internationally accepted standards as a result of U.S. assistance.  Number of investment measures made consistent with international investment agreements as a result of U.S. assistance.  Reduction in the number of procedures required to trade goods across borders as a result of U.S. assistance.  Number of firms receiving capacity building assistance to export.  Number of participants in U.S. government-supported trade and investment capacity building trainings.  Number of trade and investment capacity building diagnostics conducted.  Number of U.S. government supported training events on topics related to investment capacity building and improving trade. The standard indicators are complemented by custom indicators that USAID missions and offices select to further measure and monitor particular programs. USAID uses the indicators in performance plans and reports summarizing project results. Some USAID officials noted that the standard indicators largely measure program outputs rather than results or outcomes of TCB assistance. Standard indicators generally gauge activities undertaken or services provided by USAID; for example, missions we visited used such output- oriented standard indicators as the number of U.S. government supported training events on topics related to investment capacity building and improving trade. However, they do not measure whether such activities contributed to a beneficiary country’s capacity to trade. Our review of documentation of countries where USAID has conducted TCB activities revealed that these standard indicators serve certain USAID management purposes, but USAID mission officials told us it was difficult to use to such indicators to inform decisions about how TCB assistance could improve a country’s capacity to trade. On the other hand, some USAID officials in recipient countries explained that in addition to the agencywide standard indicators, missions can develop project-specific custom indicators that tend to be more outcome-focused. For example, the mission in Morocco used the custom indicators, “total value of sales in target sectors (disaggregated by domestic sales and exports)” and “value of private investment (disaggregated by domestic and foreign direct investment).” Some program officers said that outcome-oriented custom indicators were more useful than the standard indicators for evaluating activities’ effects on trade. Thus, based on data collected from a custom indicator that measured the volume of agricultural exports, program officials in Mozambique said that the mission modified the focus of an agriculture TCB-related program to target assistance to new crops with better export potential. While the agency uses project-specific custom indicators for virtually every project, USAID management and mission officials cited challenges in developing meaningful outcome custom indicators. Some USAID officials explained that it is difficult to identify indicators that measure the effects of TCB directly attributable to U.S. government assistance. For example, one USAID official noted that many missions supporting TCB activities may track export growth as an outcome indicator, but according to mission officials, a variety of factors may impact a country’s exports, including fluctuations in market prices and currencies, and it is difficult to isolate these factors from the effects of TCB assistance. Similarly, mission officials cited challenges to collecting and using valid and reliable data to gauge an indicator. For instance, in Mozambique, mission officials explained that local government trade data are not reliable, so they may have to rely solely on private sector data from firms targeted by the mission’s TCB-related programs to measure exports. They said that this makes it difficult to compare the export performance of targeted beneficiary firms in the same sector. In addition, many USAID TCB- related activities are implemented as part of broader programs that have primary development objectives other than TCB. Consequently, the programs are assessed in relation to other objectives, and monitoring the effects on trade capacity may not be feasible if the performance indicators developed were not intended for that purpose. USAID Has Commissioned a Limited Number of Evaluations of TCB Programs to Assess Longer-Term Results USAID also commissioned longer-term evaluations of a small proportion of specific TCB programs. These include evaluations of its regional TCB- focused programs, including the Regional Trade Program for CAFTA-DR, the Andean Regional TCB Program, and the regional trade hubs in sub- Saharan Africa. In addition, USAID has commissioned evaluations of its bilateral TCB programs, including the Colombia Trade Capacity Building Program implemented to support the U.S.-Colombia FTA negotiations. The evaluations are intended to help missions and offices understand the progress of programs and any needed actions to improve performance. Although mission officials stated that evaluations are useful for identifying best practices and lessons learned, USAID’s recent agencywide multicountry TCB evaluation found that only 15 percent of the agency’s TCB projects were found to have been independently evaluated. Mission officials informed us that they conduct few independent evaluations of their TCB programs because of the resources required, and the difficulty of evaluating impact in the area of TCB. In addition, they noted that program evaluations had not been required. According to USAID’s 2010 evaluation guidance, missions are encouraged, but not required, to conduct program evaluations during implementation unless certain management issues arise. USAID’s Recent Agencywide Multicountry Evaluation Provided Valuable Insights, but USAID Has Yet to Take Action to Address Results To learn from experience and identify ways to improve the implementation and assessment of TCB activities, and in response to our 2005 recommendation, USAID took the positive step of commissioning its first independent multicountry evaluation of U.S. government TCB assistance that focused on activities USAID administered. We support the evaluation as an important means of providing objective information on the progress of USAID’s TCB efforts. It provided the agency valuable insights on the positive effects of USAID’s TCB assistance across countries, particularly with regard to its impact on trade and income growth in recipient countries. It also provided useful information on the factors that contributed to and hindered project success, and the means by which monitoring and evaluation could be improved. Issued in November 2010, the evaluation examined documentation for 256 ongoing and completed USAID TCB projects the agency implemented in 78 countries from 2002 to 2006. Overall, the evaluation concluded that USAID and other U.S. government agencies’ TCB activities are associated with increases in the value of recipient countries’ exports, after controlling for other factors that have influenced international trade. According to the evaluation’s findings:  USAID TCB activities had a positive effect on developing countries’ exports, even in very poor countries, but the relationship between TCB assistance and export gains varied by country depending on factors that are known to influence export performance, including world prices and economic growth rates, and domestic economic and business policies.  USAID’s TCB activities resulted in export gains in terms of value, but not volume, which suggested that exporters earned more from the same volume of production they exported.  Export gains associated with USAID’s TCB projects stemmed from trade facilitation activities and from improvements in government practices, as well as from projects that work directly with exporters.  USAID’s TCB activities contributed to employment and income growth for those firms and individuals directly reached by USAID projects, although the evaluation did not find sufficient information on projects’ effects on net employment or poverty rates at a regional or national level. The evaluation calls attention to characteristics that contributed to the success of USAID TCB projects and that tended to lead to sustainable outcomes. Some of these factors were associated with the focus of TCB assistance provided. For example, assistance that was directed at one type of beneficiary generally enjoyed better results than projects that included various categories of recipients. In addition, TCB projects that concentrated on a single sector generally performed better than projects that focused on multiple sectors. Thus, TCB projects that concentrated on the agricultural sector were more likely to successfully achieve their objectives than projects that attempted to cover diverse sectors, such as manufacturing and services, as well as agriculture. Conversely, projects that combined different types of assistance, such as performing a trade diagnostic study as well as providing training, were more likely to achieve their performance targets and objectives than projects that relied on a single approach. In some cases a combination of technical assistance, training and use of communications technologies helped change private sector practices, resulting in trade-related gains, such as new products for export and more timely delivery of goods. The evaluation also describes certain factors related to beneficiaries’ participation that were found to contribute to successful project results. For example, encouraging participation of beneficiaries in project design and promoting private sector involvement were also found to be associated with assistance efforts that met performance targets or objectives. Projects characterized by adversarial relations among participants were, however, less likely to succeed. Other factors that the evaluation cited as hindering project success included excessive host government regulation and unexpected shifts in the recipient government’s priorities. The evaluation also found that improvements resulting from TCB assistance were more likely to be sustained beyond the life of the project when anticipated funding sources, such as revenues from export earnings, were clearly set forth. Recognizing the importance of learning from experience and improving the implementation of TCB activities, USAID and USTR commissioned the evaluation to inform their efforts to develop an interagency strategy to systematically monitor results and evaluate the effectiveness of TCB assistance. Accordingly, the evaluation identified certain gaps in the monitoring and evaluation of TCB projects and recommended ways to improve USAID’s performance management practices. The evaluation found that USAID’s practices for monitoring the performance of its TCB projects does not correspond, in many instances, to the agency’s performance guidelines, and its evaluations of TCB projects are limited in number and suffer from methodological weaknesses. For example:  A large proportion of projects did not include baseline data for the performance indicators selected.  While most projects identified performance indicators, most of these TCB projects did not include performance targets for the indicators to track results.  While evaluations used both qualitative and quantitative data, most evaluations lacked data with which to compare circumstances before and after TCB projects to determine whether the project’s activities or some other factor were the likely cause of the results.  Certain performance indicators intended to assess changes in institutional capacity, such as strengthening a given country’s ministry of trade, lacked clarity in the outcome results they were designed to measure. To improve USAID’s monitoring and evaluation of its TCB projects, the evaluation recommended steps the agency should take to better align its performance management practices with its existing guidance. These include adopting tools to facilitate the development of appropriate indicators and data collection methods with which to measure results, and helping missions improve performance baseline data and targets for those projects that currently lack these data. In addition, the evaluation recommended that USAID update its current TCB strategy to better reflect findings from recent studies on trade facilitation and on other factors that influence developing countries’ export performance. USAID Has Yet to Take Action on the Evaluation’s Results or Plan for Additional Evaluations Although the evaluation examined the results of USAID’s TCB activities for the purpose of learning from experiences, improving the design and implementation of TCB assistance, and informing efforts to systematically monitor and evaluate results, it has yet to take action to incorporate the results of the evaluation into its management of TCB activities. USAID management officials explained that the evaluation has been helpful in identifying the factors that contribute to the success of TCB projects and the agency agreed with the evaluation’s findings and recommendations, particularly with regard to needed improvements in monitoring and evaluation practices. According to these officials, the agency has identified the need to incorporate the evaluation’s findings into USAID’s trainings, guidance, and strategies, as well as implement its recommendations, but further actions are needed to do so. Officials explained that the written evaluation is lengthy, and technical officers managing TCB activities are not likely to easily understand its findings or find it useful for management purposes in its current form. USAID management officials stated that the evaluation’s findings must be “repackaged” to help USAID missions and offices understand and use the information to improve the design, implementation, and the monitoring and evaluation of TCB activities. We have reported that performance information should be useful for decision making throughout an agency, and that agencies need to consider users’ needs. Currently, the agency is in the initial phases of developing ways to use the evaluation’s findings to help missions develop better defined and more useful indicators, baselines, and targets with which to measure the results of TCB activities. For example, based on the results of the evaluation, USAID commissioned the development of a pilot training course on methods for developing outcome measures for monitoring and evaluating TCB programs. The pilot course provided an overview of the evaluation, described challenges of developing indicators to assess the outcome results of policy and institutional reforms on TCB, and discussed approaches to defining indicators and collecting measurements. The pilot course was presented to mission officials in Bangkok, Thailand, which one USAID management official explained had been a useful preliminary effort to incorporate the evaluation’s findings into mission training. The official stated that a more comprehensive training program will likely be developed and disseminated to missions, although the agency has no specific plans in place. Differences in countries’ trade and investment environments have proven a challenge to developing training and guidance that would be useful to missions worldwide, according to officials. In addition, according to management officials, USAID has not determined its plans for conducting additional TCB evaluations to assess the effectiveness of its TCB activities on an ongoing basis. As the evaluation, published in November 2010, focused on TCB projects funded during the period 2002–2006, the agency does not have current plans to systematically evaluate its TCB projects worldwide and on an agencywide basis beyond this period. While USAID management officials stated that replicating the evaluation’s methodology is likely to be too resource- intensive for future evaluations, any subsequent evaluations would similarly aim to assess a variety of TCB projects implemented across countries to identify those that are most successful in achieving their objectives and the factors that contribute to these successes. We have reported that it is important that agencies use timely performance information to assess the results of their activities to understand how they contribute to their agency missions and broader results. Conducting evaluations on an ongoing basis increases accountability and would help ensure that assistance is effectively delivered and implemented to maximize development. It also would provide opportunities to learn from project implementation by identifying which activities work, under what circumstances, and why. For example, USAID officials could use future evaluations to identify approaches to providing TCB assistance that have worked well and consider alternative approaches where improvements could be made. Furthermore, such evaluations might inform other donor and recipient countries’ efforts to determine instances in which TCB assistance can be effective. Conclusions The U.S. government and international organizations acknowledge the critical role of trade in promoting development and have made TCB an important aspect of making trade more effective in reducing poverty and increasing enduring economic growth. The U.S. government TCB database is a useful tool for identifying the many agencies and activities of the U.S. government that contribute to other nations’ development through trade. In particular, the inclusion of MCC’s funding and activities in the database creates opportunities to identify ways in which TCB funding and development goals relate. In addition, the Army’s recent reporting highlights the linkage between security and development, as there is a recognition that economic stability and development contribute to peace and security. However, some U.S. agencies, including MCC and the Army, struggle to report their trade-related infrastructure assistance using the survey methodology of the database. The definition of TCB includes a wide array of activities implemented by multiple agencies to fulfill a variety of objectives. Some relate more directly to trade than others. While some agencies, such as USAID and State, conduct activities that are easily identified as intended to help a country build its capacity to trade, agencies such as MCC and the Army conduct activities that have trade-related effects but do not directly support TCB. This distinction has become increasingly important because of the significant funding reported by these two agencies, particularly for physical infrastructure, in USAID’s TCB database. As a primary source of information on TCB funding for Congress and the public, it is important that its information create a clear picture of funding trends. But without explanations of the database’s limitations, it may distort users’ understanding and create misperceptions. While USAID has taken positive steps to track the progress of individual TCB activities, like other development organizations it continues to struggle to link this assistance to important trade and development benefits. USAID’s recent agencywide evaluation of the effectiveness of its TCB activities in multiple countries is an important step, but USAID officials have not yet signaled how they plan to address the evaluation’s valuable findings. Without planning actions to utilize the results of its evaluation, the agency may miss opportunities to take advantage of the insights from that analysis to improve the effectiveness of its TCB assistance. Moreover, by evaluating its TCB activities across countries on an ongoing basis, USAID could gain a better understanding of the linkage between TCB and development. It could also gain valuable experience regarding the types of assistance important for the diverse set of countries and situations that could potentially benefit from U.S. TCB assistance. Recommendations for Executive Action To enhance the management and evaluation of TCB activities, we recommend that the Administrator of USAID take the following two actions:  Explicitly and publicly report the identified limitations associated with the methodology used to collect and report data in the U.S. government TCB database, including MCC and the Army’s data issues, and consider ways to differentiate between categories of assistance that directly and indirectly relate to TCB.  Develop a written plan that details the actions the agency intends to take to address the findings and recommendations of its recent multicountry evaluation of TCB, and its plans for conducting evaluations of its TCB activities on an on-going basis. Agency Comments and Our Evaluation We received written comments from USAID, which are reprinted in appendix VI. USAID stated that it has already taken steps consistent with our recommendations. USAID also noted that it would take our recommendations into account in its ongoing plans and provided additional information and observations. USAID stated that it updated the TCB database to include fiscal year 2010 data and noted it had revised the Web site for the database to clarify the unique nature of MCC obligations. We believe this is a positive step, and will improve users’ ability to accurately compare and assess data over time. USAID further noted that it is reviewing its plans for the fiscal year 2011 survey of TCB activities and anticipates revamping and streamlining components of the database consistent with our recommendations. Clear reporting and transparency in methodology and collection are essential for users of the TCB database; the actions USAID has already taken, as well as those they state they intend to take, should facilitate the ability of users to understand changes in the nature of TCB over time. Further, USAID noted it had recently completed a synopsis of the TCB evaluation which it is distributing to key stakeholders and other target audiences both within and outside the agency to highlight elements of the evaluation. In addition, USAID stated it is building on the pilot training of the evaluation’s lessons, which we noted in the report, and is actively developing further training modules. However, at the time of our review USAID did not provide us with specific documentation of the actions it is planning to take to make use of the evaluation’s findings and recommendations. Without developing a plan documenting specific actions the agency intends to take to utilize the results of its evaluation, the agency may not take full advantage of opportunities for improving the effectiveness of its TCB assistance identified in the TCB evaluation. USAID also stated that under the agency’s recently issued January 2011 evaluation policy, it is committed to a systematic monitoring and evaluation of USAID’s entire portfolio of activities, including TCB activities, as the policy is fully implemented. While USAID’s January 2011 evaluation policy encourages evaluations across the agency’s portfolio of activities, the policy is not focused on TCB activities and does not specify the type of evaluation USAID will conduct on its TCB activities. We are suggesting that USAID document its specific plans for conducting TCB evaluations on an ongoing basis. MCC, State, the Army, and USTR received a draft copy of the report but did not provide formal comments. State, USAID, and USTR provided technical comments, which we have incorporated in the report, as appropriate. We are sending copies of this report to appropriate congressional committees, the Secretary of the Army, the Secretary of State, the Administrator for the U.S. Agency for International Development, Chief Executive Officer of the Millennium Challenge Corporation, and the U.S. Trade Representative. This report will also be available at no charge on GAO’s Web site at http://www.gao.gov. If you or your staffs have any questions about this report, please contact me at (202) 512-4347 or yagerl@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix VII. Appendix I: Objectives, Scope, and Methodology This report examines (1) how agencies’ trade capacity building (TCB) activities are aligned with the agencies’ goals, (2) the extent to which the U.S. TCB database provides sufficient information on key trends and funding, and (3) the extent to which U.S. Agency for International Development (USAID) monitors and evaluates the effectiveness of its TCB activities. To address these objectives we built upon information collected for our 2005 report on the same topic. We conducted fieldwork in Colombia, Morocco, and Mozambique. We selected these countries because they (1) were among the 10 countries receiving the most TCB funding from fiscal years 2005 to 2009, (2) had a mix of U.S. agencies providing assistance and categories of TCB assistance provided in- country, and (3) had a diversity of geographic regions and country income levels. We limited our review to four agencies that provided more than 90 percent of total U.S. TCB assistance from fiscal years 2005 to 2010—the most recent fiscal year for which data are available. These include the Millennium Challenge Corporation (MCC), the Departments of the Army (Army) and State (State), and USAID. In addition, we included the Office of the U.S. Trade Representative (USTR) in our review due to its role in trade policy coordination. To understand how agencies’ TCB activities are aligned with the agencies’ goals, we analyzed strategic, budget, and programmatic documents describing these agencies’ TCB funding and activities. We assessed these agencies’ reports and strategic plans to determine the extent they addressed agencies’ TCB-related strategies and objectives. We examined U.S. government reports on TCB assistance, annual agency reports, and agency TCB planning and project documents. In each country we examined program documents and interviewed agency officials to understand the types of TCB programs the agencies managed. In conjunction with our work at the missions, we held meetings with other key U.S. government officials, USAID contractors, host government ministry officials, and various TCB recipients. To assess how U.S. agencies coordinate the allocation of TCB assistance, we reviewed published reports on TCB activities, agency strategies, and program documents. We interviewed U.S. officials in the field responsible for implementing TCB programs and officials at agency headquarters, including the USTR. To describe the composition of TCB and determine the extent to which the TCB database provides sufficient information on key trends and funding, we analyzed available data on agencies’ TCB activities and funding from the U.S. government TCB database. USAID is responsible for maintaining the database and gathering data annually through a governmentwide survey. We analyzed data from the database to identify the major funding categories, agencies, and recipients of TCB assistance. As part of our previous and ongoing work, we have assessed this data and determined that they are sufficiently reliable to identify TCB funding by agency, country, and category; although we found limitations to the use of the data, as discussed in this report. We examined the guidance, protocols, and definitions specified in the TCB survey. We also reviewed documents from the Organization for Economic Cooperation and Development and the World Trade Organization (WTO) to understand definitions and data collection methodologies used globally for trade- related funding. In addition, we interviewed the USAID contractor that manages the data collection and analyzed the steps the contractor took to ensure data reliability. For example, we asked the contractor how the survey data were collected, what quality checks were performed, and what other internal controls were in place. At the missions overseas, we reviewed various TCB activities and interviewed U.S. and host country officials to corroborate the descriptions and funding levels reported in the TCB database. To understand the extent to which USAID monitors and evaluates the effectiveness of their TCB activities, we analyzed strategic, budget, and programmatic documents describing these agencies’ TCB funding and activities. We reviewed data and information these agencies use to measure the performance of their activities, and, where available, evaluations of programs or projects they undertake that may be related to TCB. In particular, we reviewed a recent USAID evaluation study, commissioned in response to our previous recommendations and intended to present findings of a cross-country evaluation of U.S. government TCB assistance. In each country we visited we reviewed agencies’ strategy documents and performance plans and reports for activities reported as TCB. We also interviewed agency officials, host government officials, and contracted implementing partners and visited TCB projects. In addition, we examined performance and monitoring principles used by multilateral donors and international organizations, such as the Organization for Economic Cooperation and Development. We conducted this performance audit from July 2010 through July 2011 in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: USAID Plans Trade Capacity Building- Related Activities In-Country, Often in Collaboration with Recipient Governments and Stakeholders USAID field missions plan TCB-related projects primarily in recipient countries, often in collaboration with recipient country governments and other in-country stakeholders. USAID’s TCB strategy recognizes that priorities vary from country to country depending on the levels of income and development, and the missions’ country strategic plans and resources will inform the selection and prioritization of the TCB activities the agency implements. According to USAID officials, mission officials understand country-specific factors such as the activities of other TCB donors and the composition of trade. The USAID officials informed us that missions identify their TCB projects as part of their mission strategic plans, which USAID’s headquarters bureaus review in conjunction with the agency’s budget planning process. They further explained that USAID’s headquarters bureaus provide missions guidance and training, and help missions develop and design specific programs when necessary; however missions primarily identify the country-specific trade- related constraints and TCB assistance needs in consultation with governments and associations in recipient countries. In addition, missions use trade diagnostic studies and analyses of trade-related constraints and TCB needs. According to USAID officials, missions plan TCB activities using analyses of trade-related constraints and TCB-related needs prepared by the recipient government and in-country stakeholders, including business and trade associations. For example, specific activities of the USAID TCB programs related to the U.S.-Colombia free trade agreement (FTA) negotiations responded to priorities defined in collaboration between USAID and the government of Colombia as the negotiations were carried out. Specifically, USAID officials stated that they collaborated with the government of Colombia to identify 52 TCB initiatives. Following the completion of the FTA negotiations in 2006, USAID continued to provide technical assistance to support the initiatives, and by 2010 the mission had addressed all but two of these initiatives. According to mission officials, the mission in Mozambique identified TCB activities, in part, based on the country’s trade association’s evaluation of trade-related constraints. Mission officials cited the importance of involving the business association and various government ministries to identify feasible policy reforms and foster the collaboration. For example, the mission has worked with the business association and the Ministry of Commerce to reduce import and export barriers, and reform licensing and shipment processes. In addition, these officials explained that they have daily interactions with officials of various ministries and these discussions will often identify potential areas for TCB assistance. USAID missions also use trade diagnostic studies sponsored by USAID and developed by multilateral agencies to identify trade-related constraints and TCB needs. According to mission officials in Colombia and Mozambique, these diagnostic studies are important to encourage recipient governments to undertake needed reforms. For example, USAID commissioned three diagnostic studies to identify and plan TCB assistance in support of the U.S.-Colombia FTA negotiations. Based on study results, USAID developed seminars to increase awareness of both the Colombian congress and civil society about the importance of the FTA and how regions and productive sectors would benefit from it. In Mozambique, multilateral and bilateral stakeholders developed a diagnostic study that mission officials said contributed to the mission’s decisions regarding sectors and areas of the country where it provided technical assistance under its TCB-related agribusiness and tourism programs. For example, according to mission officials, the study contributed to the agribusiness program’s focus on commodities such as cashews and coconuts from the country’s northern region that have the greatest export potential. Furthermore, according to one government of Mozambique official, the mission utilized the study results to encourage the government to develop a national strategy to address trade-related constraints to economic growth. We also found that USAID missions generally select TCB-related activities that align with broader country development strategies. In countries we visited, mission officials cited the importance of consulting with recipient governments’ national development strategies and with foreign officials of recipient countries to identify potential TCB-related activities that have the support of the recipient governments. For example, the mission in Mozambique identified TCB-related activities under its agribusiness and policy reform programs that directly supported the implementation of priorities identified in national strategies of various ministries. In Morocco, the mission supported the government of Morocco’s strategy of providing jobs, economic opportunities, and political stability through free trade. The mission identified the potential economic challenges posed by the FTA, particularly in the area of agriculture, and outlined activities to help the government of Morocco respond to the challenges and opportunities posed by the FTA. According to mission officials, the mission worked with Moroccan associations to promote transparent and simplified investment procedures, increase access to finance for small businesses, and increase assistance to the Ministry of Agriculture to promote a shift in the country’s agricultural production to higher value crops. Appendix III: Coordination of U.S. Trade Capacity Building Assistance among Agencies USTR leads efforts to coordinate the TCB activities of USAID and other U.S. agencies through interagency groups and committees tied to FTAs and in response to multilateral initiatives related to TCB. USTR-led interagency groups often seek U.S. agencies’ input into TCB-related issues and identify the types of assistance agencies have provided and may be able to provide in a particular area. In addition, U.S. agencies coordinate their TCB-related activities in recipient countries as part of interagency groups that discuss general development assistance activities, but which do not focus on TCB specifically. For example, USAID coordinates its TCB-related activities with other U.S. agencies in- country, as appropriate, through embassy-led task forces and working groups focused on development assistance in the area of economic growth. These interagency groups seek to prioritize projects with broader foreign assistance strategies, eliminate duplication of efforts, and identify where assistance gaps exist, for instance. USTR Leads Efforts to Coordinate U.S. TCB Assistance among U.S. Agencies USTR leads efforts to coordinate the TCB activities of USAID and other U.S. agencies through interagency groups and committees tied to FTAs. USTR has created TCB interagency groups in free trade negotiations with developing countries and committees on TCB to prioritize and coordinate TCB activities to help FTA partner countries participate in negotiations and implement trade rules during the transition and implementation periods. Interagency groups have been a feature of the FTAs with Bahrain, Central America-Dominican Republic, Chile, Jordan, Morocco, Oman, and Peru. According to USTR officials, these interagency groups do not influence the outcomes of FTA negotiations; however, interagency groups and committees meet periodically in conjunction with ongoing and completed negotiations to discuss partner countries’ TCB needs, determine the types of TCB activities agencies already provide, and identify the types of TCB assistance agencies might provide in the future. According to USTR officials, the interagency groups tied to the FTAs offer USTR the opportunity to work with other agencies to try to identify the types of assistance they may be able to provide in a particular area. USAID and other U.S. agencies participate in these working groups and committees so that identified TCB needs are incorporated into ongoing assistance programs. For example, according to USTR officials, during a 2008 meeting of the Central America-Dominican Republic FTA TCB Committee, agencies identified sanitary and phytosanitary assistance as a priority, and with USDA assistance, each partner country’s sanitary and phytosanitary system was assessed and gaps or deficiencies in those systems were identified. In response, State, USAID, USDA, and USTR reached agreement to provide further sanitary and phytosanitary assistance. In addition, in 2010, USAID, U.S. Customs and Border Protection, and USTR developed training sessions in all Central America- Dominican Republic FTA partner countries to address textiles compliance issues the interagency committee had identified, according to USTR officials. USTR also leads the coordination of agencies’ TCB-related activities resulting from Trade and Investment Framework Agreements (TIFA) between the United States and partner countries. According to USTR officials, USTR works with other agencies—including the U.S. Patent and Trademark Office and the Departments of Commerce, Justice, and State—in working groups that respond to partner countries’ assistance needs and priorities. TIFAs also prompt regular meetings between the U.S. government and the partner country. Officials explained that these discussions are led by USTR for the United States, but a number of other agencies also participate and TCB is often a part of these dialogues. For example, officials noted that USTR recently chaired a meeting with the government of Mauritius in which the Department of Commerce presented TCB tools and trainings that it provides. Similar meetings with South Africa and Nigeria have also included representatives from a number of different agencies and included TCB discussions. In addition, USTR coordinates TCB efforts with USAID and other agencies through the Trade Policy Staff Committee (TPSC) and its associated subcommittees. Following the Hong Kong WTO Ministerial in 2005, the U.S. administration formed a TPSC Subcommittee on TCB. According to officials, the subcommittee has focused on WTO developments in the area, including USTR’s sharing of information regarding the WTO and other multilateral initiatives related to TCB, such as the Enhanced Integrated Framework, and seeking other agencies’ input. As these initiatives had near- and long-term implications for the WTO, a permanent subcommittee of the TPSC was deemed the appropriate mechanism for interagency coordination, according to USTR officials. All members of the TPSC are invited to participate in meetings of the TPSC Subcommittee on TCB. In addition, other agencies that have a particular interest or expertise in TCB assistance are also invited, including MCC. USTR utilizes other TPSC subcommittees to coordinate U.S. agencies’ TCB efforts in various contexts. For example, the TPSC Subcommittee on Africa has discussed TCB issues particularly related to the African Growth and Opportunity Act, and the TPSC Subcommittee on Labor has discussed TCB issues related to FTA labor commitments and trade preference program labor obligations. U.S. Agencies Coordinate TCB Activities In-Country as Part of Interagency Groups Focused on Broader Assistance Objectives U.S. agencies generally coordinate their TCB-related activities in-country, primarily through mechanisms that do not focus on TCB, but which discuss TCB-related assistance in connection to broader foreign assistance objectives. In conducting our fieldwork we found that embassy-led task forces and working groups sometimes discuss agencies’ TCB-related activities, as appropriate. For example, according to officials in Morocco, USAID, State, MCC, and other agencies discuss their TCB-related activities as part of the embassy’s foreign assistance working group that aims to prioritize projects in alignment with broader foreign assistance strategies, eliminate duplication of efforts, and identify where assistance gaps exist. Through Ambassador-led working group meetings and communications with headquarters in Washington, D.C., agencies have identified and coordinated their specific TCB-related activities, such as USAID and State’s collaboration on activities that promote access to finance, and USAID’s focus on working with the government of Morocco to promote policy reforms, particularly in support of MCC’s projects. In Mozambique, the mission coordinates TCB-related activities through the embassy’s private sector working group that focuses on foreign assistance covering multiple economic sectors, according to officials. Officials noted that the working group has reviewed the mission’s TCB-related agricultural development projects in conjunction with similar projects conducted by other agencies. In particular, through the working group mission officials have worked regularly with USDA officials to coordinate the processing and storage of agricultural production supported by each agency’s TCB-related projects. Appendix IV: Recipient Countries of Bilateral U.S. Trade Capacity Building Assistance and Funding Levels, Fiscal Years 2005–2010 Table 2 shows the 143 countries that received roughly $8.5 billion in bilateral TCB funding between fiscal years 2005 and 2010. Of the 20 countries receiving the largest obligations, all but 5—Afghanistan, Colombia, Sudan, Iraq, and Egypt—are MCC compact countries. These 20 countries received $6.3 billion, or 74 percent, of total U.S. TCB assistance over the period. Among these 20 countries, 8 are least developed countries (LDC) according to the definition used by the United Nations. In total, 43 LDCs received $3.6 billion or 43 percent of total bilateral TCB funding. Of the four agencies we reviewed, MCC obligated the most funding, $2.3 billion, to LDCs, while USAID obligated $618 million, the Army obligated $550 million, and State obligated $8 million. Figure 5 illustrates the shares of TCB funding obligated to LDCs in total and for each agency. Appendix V: MCC and the Army Assessments of Trade Capacity Building-Related Activities MCC and the Army do not use TCB-specific performance indicators and evaluations to assess the progress of their activities in terms of TCB. Each agency uses its overall monitoring and evaluation framework to assess their TCB-related activities in relation to the agency’s missions and program goals. MCC monitors its TCB-related activities in terms of the progress they make towards the objectives of the compacts and threshold programs in which they are included. The procedures the Army uses to assess individual TCB-related projects are based on the types of project funding and the primary project objectives. Millennium Challenge Corporation MCC does not monitor the results of its TCB-related activities in terms of TCB, but monitors progress using its overall policies for monitoring the results of its compacts and threshold programs. MCC monitors TCB- related activities in terms of their progress towards the immediate results and final program objectives of the compacts and threshold programs in which they are included. During compact development, project appraisals and development procedures include defining the objectives and benchmarks that will be used to measure progress over the duration of the compact. MCC performs an economic analysis on each compact project proposal, which includes assessing the economic growth rationale for the investment, calculating an economic rate of return, and estimating its poverty reduction impacts. The economic analysis results in the indicators MCC uses to monitor its compact projects, including those that it reports as TCB. Project managers may monitor additional indicators for their own management purposes. While the economic analysis and the selection of additional indicators may result in indicators meaningful to measure the effects of activities on trade, MCC does not identify a particular set of TCB-specific performance indicators to monitor TCB- related compact projects in terms of their effectiveness in building the trade capacity of the compact country. Similarly, the indicators used to monitor TCB-related activities included in threshold programs are not specific to TCB, but are identified during program development. The selection of performance indicators for threshold programs are based on information on the policies and actions that may have affected the threshold country’s standing in relation to the MCC’s eligibility criteria. In the two compact countries we visited—Morocco and Mozambique— most projects MCC reported as related to TCB were not assessed using performance indicators meaningful for measuring progress in terms of TCB, according to in-country MCC officials. These officials explained that projects MCC reported as TCB could have been assessed using trade- related indicators, such as the volume and value of exports stemming from projects, because they have trade-related effects. However, these officials explained the economic analysis of the compact projects and the project manager’s selection of additional indicators did not result in indicators that directly measured the results of projects in terms of trade. For example, in Morocco, officials noted that the performance indicators used to monitor three TCB-related compact projects did not provide information to track results in terms TCB, but monitored projects’ effects on household incomes and employment. Similarly, in Mozambique, none of the three compact projects MCC reported as TCB-related were monitored in terms of their effects on trade, according to in-country officials. Although these officials explained that all three projects result in trade-related outcomes, including a road rehabilitation project that facilitates the transport of goods for export and an agriculture development project that resulted in production for export, the projects were monitored in terms of other objectives. For example, the objectives of a TCB-related roads rehabilitation project in the Mozambique compact included reduced transport costs, and increased public transport access for individuals to take advantage of job and other economic opportunities. The economic analysis of the project focused on the reduction of transport costs, including savings in vehicle operating costs, and time savings. Examples of performance indicators for the project included measures of the roughness of the road and the dollar value of time saved due to shorter trip times and increased speed on upgraded roads. In addition, MCC conducts independent evaluations of its compacts and threshold programs to better understand the effectiveness of its development programs; however, these evaluations are not intended to directly evaluate projects in terms of TCB. According to MCC’s monitoring and evaluation policy, every compact project and each threshold program must undergo a comprehensive, independent evaluation after completion, and compact projects may be evaluated during compact implementation as necessary. The evaluations are intended to compile lessons learned and improve the effectiveness and efficiency of project implementation. Evaluations also are meant to compare projects’ final results with a credible estimate of what would have happened without the project, including changes in individual, household, or community income that result from a particular project or program. According to MCC officials in the countries we visited, evaluations had not yet been conducted on compact projects, including TCB-related projects, but each project would be evaluated upon the completion of the compact. These officials explained that the evaluation will be conducted in accordance with agency guidance to assess the performance of specific activities and contribute to a broader understanding of development effectiveness. While the evaluation may assess the trade-related results of projects as trade may contribute to the economic growth and poverty reduction objectives of the compact, officials explained that an assessment of the effectiveness of compact projects in terms of TCB would not be a specific focus. The Department of the Army The Army does not have a specific process for monitoring and evaluating the performance of projects reported as TCB, but uses its general guidance and processes for assessing projects. According to officials of one command, the infrastructure projects identified as TCB are not monitored using performance indicators specific to TCB, and the Army does not evaluate the effectiveness of its TCB-related infrastructure projects in terms of TCB. Officials explained that the monitoring and evaluation procedures used to assess individual TCB-related projects depend on the types of funding used for specific projects and the project’s primary objectives. For example, according to officials, TCB-related projects funded under the Commander’s Emergency Response Program (CERP), which include TCB-related projects implemented to respond to humanitarian and reconstruction requirements in Afghanistan, are monitored and evaluated using processes outlined in CERP guidance, which do not include methods for monitoring and evaluating projects’ effects on trade. TCB-related projects funded under CERP include the repair and restoration of telecommunications and electrical systems, and irrigation projects. According to the July 2009 CERP guidance, performance indicators for CERP projects are selected based on each project’s scope, complexity, and period of usefulness. In identifying procedures for evaluating projects, officials are to consider certain factors, including the benefits of the project to the local population, and the number of individuals in the local population engaged in and benefiting from the project; also the project must meet engineering standards. Appendix VI: Comments from the U.S. Agency for International Development GAO Comments 1. In response to the updated TCB database and the inclusion of information on the unique nature of MCC obligations, we incorporated fiscal year 2010 data into our analysis and revised our report as appropriate to reflect these developments. 2. We welcome USAID’s recent actions to make use of the findings of its recent evaluation. However, during the course of our review, USAID officials were unable to provide us with documentation of its synopsis of the evaluation and its specific plans for addressing the evaluation’s findings and recommendations. We believe documenting specific actions the agency plans to take to make use of the evaluation’s valuable information would provide a structured approach that would help ensure the lessons learned will be incorporated into the design, implementation, monitoring, and evaluation of TCB projects. 3. We support USAID’s commitment to systematically monitor and evaluate its portfolio of activities, including those related to TCB, and the agency’s intent to conduct evaluations of new and ongoing TCB interventions in order to generate new knowledge and apply those lessons to its development activities. However, USAID’s January 2011 evaluation policy covers evaluations across the agency’s portfolio of activities and thus is broad-based and does not target TCB specifically. We believe that USAID still should document its specific plans for conducting TCB evaluations on an ongoing basis as laid out in the November 2010 evaluation. Appendix VII: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the individual named above, the following persons made major contributions to this report: Juan Gobel, Assistant Director; Bradley Hunt; Karen Deans; David Dornisch; Ernie Jackson; and Brian Tremblay. Miriam Carroll Fenton, Howard Cott, Timothy Fairbanks, Victoria Lin, and Christina Werth provided technical assistance.

From 2005 to 2010, 24 U.S. agencies provided more than $9 billion in trade capacity building (TCB) assistance to help more than 100 countries reduce poverty, increase economic growth, and achieve stability through trade. To report on TCB funding, the U.S. government conducts an annual survey of agencies and publicly reports the data in a TCB database administered by the U.S. Agency for International Development (USAID). GAO examined (1) how agencies' TCB activities are aligned with the agencies' goals, (2) the extent to which the TCB database provides sufficient information on key trends and funding, and (3) the extent to which USAID monitors and evaluates the effectiveness of its TCB activities. GAO focused on the agencies that reported the most funding for TCB activities since 2005--the Departments of the Army and State, the Millennium Challenge Corporation (MCC), and USAID--and the Office of the U.S. Trade Representative (USTR). GAO analyzed U.S. government data; reviewed agencies' strategic, budget, and program documents; and met with U.S. and foreign government officials in select countries. USAID and State conduct TCB activities that are aligned with their primary goals, but TCB is secondary to the goals of other agencies. USAID and State have developed strategic plans that include TCB-focused goals. Aligned with these goals, USAID and State assist countries in negotiating and implementing trade agreements. In addition, USAID assists countries in taking advantage of economic growth opportunities stemming from trade, often in conjunction with other agency goals. TCB is not a primary focus of MCC and the Army, however, they conduct activities to meet their broader agency goals that have trade-related effects. MCC identifies trade-related assistance it considers TCB as part of its programs' poverty reduction goals. The Army implements TCB-related physical infrastructure projects as part of its disaster response objectives and in support of its reconstruction and economic development efforts in Iraq and Afghanistan. The U.S. government TCB database has reported that annual TCB funding has increased from $1.35 billion in 2005 to $1.69 billion in 2010, but the database does not adequately describe certain factors underlying this growth and other significant changes in the composition of TCB funding. From 2005 to 2010, two agencies--MCC and the Army--began reporting significant TCB funding, primarily for physical infrastructure projects. Their funding comprised 54 percent of total TCB, and physical infrastructure projects comprised 45 percent of total TCB. However, the TCB database does not adequately explain significant factors driving changes in the composition of TCB funding. In particular, the annual TCB survey methodology attempts to identify and quantify just the trade-related components of projects, but this can be difficult in practice, particularly for physical infrastructure projects. Although GAO found the survey data to be generally reliable, these factors can lead to limitations in the data that are not described for its users. Clear reporting and transparent methodology and data collection are essential to understanding levels of funding and changes in the nature of TCB over time. USAID has improved its assessment of TCB activities, including developing performance indicators and taking the positive step of commissioning a multicountry evaluation of the effects of TCB, but it has yet to develop plans to make use of the evaluation's valuable insights. USAID uses trade and investment indicators to assess the immediate results of its TCB activities. However, officials explained that it is difficult to attribute trade-related trends revealed by the indicators to the effects of TCB assistance and collect valid and reliable data to measure progress. To assess longer-term results, USAID has commissioned evaluations of TCB programs in specific countries, but these are limited in number. It recently commissioned a multicountry evaluation of the long-term effectiveness of its TCB activities agencywide. While USAID is beginning to incorporate the evaluation's results in its training, it has yet to develop plans for disseminating best practices to missions and offices on the methods they may use to better manage and assess their activities. Furthermore, it has not made plans for conducting evaluations on an ongoing basis.

Background The nation’s transportation system depends increasingly on innovations from research to improve its performance. Improving performance is vital because transportation figures prominently in the nation’s economy and quality of life. The nation’s expenditures on transportation illustrate its importance—spending on passenger and freight transportation exceeds $1 trillion annually, constituting about 11 percent of the nation’s gross domestic product. U.S. consumers spend more on transportation than on any other item except housing. In addition, governments invest heavily in the nation’s transportation system. During 1992, the federal government and state and local governments invested an estimated $113 billion in transportation. Decisions about surface transportation research have important consequences because such research provides knowledge, products, and technologies to improve the efficiency, effectiveness, and safety of the nation’s transportation system. Decisions about research are assuming more importance as aging highway, transit, and rail systems deteriorate; demands on the transportation system increase; and constraints on resources grow. Surface Transportation Research Includes a Wide and Growing Range of Activities Surface transportation research embraces different transportation modes and serves different purposes. Such research spans three distinct modes—highways, mass transit, and railroads. It also encompasses issues such as safety and the connections between modes. Five agencies in the Department conduct surface transportation research: the Federal Highway Administration (FHWA), the Federal Railroad Administration (FRA), the Federal Transit Administration (FTA), the National Highway Traffic Safety Administration (NHTSA), and the Research and Special Programs Administration (RSPA). Surface transportation research supports several of the Department of Transportation’s (DOT) missions, including making policy (research informs decisions on transportation issues and regulating modes of transportation (research supports regulatory responsibilities for safety compliance with legislative mandates, such as auto safety standards); responding to national needs (research identifies means of improving transportation safety and mobility); and overseeing operations (research improves technologies for inspecting train wheels and tracks). Traditionally, research has been viewed as a continuum that begins with basic and applied research and moves toward development, demonstration, and technology transfer. Table 1.1 represents this progression. This traditional linear view of research has been changing. Increasingly, research is seen as a process of continuous feedback involving interactions between activities on the continuum. In addition, opportunities for using new technologies and emerging transportation needs influence research. DOT’s surface transportation research concentrates primarily on applied research, development, demonstration, and technology transfer. Research Has Improved Surface Transportation According to public and private officials we consulted, investments in research have provided benefits to surface transportation users and the economy. One expert pointed out that these benefits continue for a long time. DOT officials said that although research produces important results, its benefits may not be recognized because they are taken for granted. These benefits include crash protection devices, such as seat belts, motorcycle helmets, and car seats for infants and children; programs to reduce alcohol-related deaths; longer-lasting highway surfaces that reduce maintenance costs; and improved roadside safety hardware, such as guardrails and road signs that yield to the force of a collision. States have realized benefits from their surface transportation research programs. Through a study of drivers’ behavior, for example, university researchers for the Ohio Department of Transportation found little to no benefit from using steady-burn lights on barrels in construction zones. (Steady-burn lights are low-wattage yellow electric lamps, which may be used to mark obstructions or hazards.) When the study showed that the lights did not influence drivers’ speed or other behavior in construction zones, the state stopped requiring the lights. The Department estimated that this change would save more than $4 million annually without affecting safety. The Indiana Department of Transportation also benefited from its research programs. Its maintenance engineers, in cooperation with university researchers, developed a computer-aided system for planning efficient routes to remove snow and ice. The Department, which is responsible for more than 30,000 lane-miles of roadway, expected that this system would enable it to eliminate about 120 snow removal routes and save between $86,000 and $120,000 per year for each eliminated route. ISTEA Provided New Direction and Funding for Surface Transportation Research The Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA) expressed the need for a new direction in surface transportation research, finding that despite an annual federal expenditure of more than $10 billion on surface transportation and its infrastructure, the federal government lacked two key components for an effective surface transportation research program: (1) a clear vision of the role of federally funded surface transportation research and (2) an integrated framework for the fragmented surface transportation research programs dispersed throughout the government. In response to these concerns, ISTEA established a framework for changing surface transportation research. Overall, the act underscored the need for a “more active, focused surface transportation research and development program” that would foster cooperation among the federal government, industry, and universities. It called for an integrated national surface transportation research framework that would include “consensus on the goals.” The act also stated that the federal role should be to sponsor and coordinate research and development on new technologies that would provide safer, more convenient, and more affordable future transportation systems. ISTEA also reflected congressional concerns about the adequacy of the funding for advanced transportation systems, suggesting that too little funding would increase the nation’s dependence on foreign technologies and equipment. The act therefore increased the funding for many existing and new research programs, especially for the Intelligent Transportation Systems (ITS) program, which applies numerous electronics, communications, and information-processing technologies to intelligent vehicle-highway systems. Figure 1.1 shows how the funding for surface transportation research has changed since 1970. From 1970 to 1981, the bulk of the funding supported research on transit and railroad technologies that could revitalize cities and make rail services more productive. According to estimates from the John A. Volpe National Transportation Systems Center (Volpe Center),this research absorbed nearly half of DOT’s annual research budget between 1975 and 1981. From 1981 to 1991, the support for rail and transit research declined, as did the total funding for research. Projects sponsored by NHTSA and FHWA were cut less than others because both the Congress and the administration supported these agencies’ missions of increasing safety and completing the Interstate highway system. In 1987, the Congress authorized the Strategic Highway Research Program, providing a modest increase in the funding for highway research. In 1991, ISTEA continued to direct funds into highway research via its support for ITS. Objectives, Scope, and Methodology To prepare for reauthorizing the Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA), the Chairman and Ranking Minority Member of the Senate Committee on Environment and Public Works and the Chairman of that Committee’s Subcommittee on Transportation and Infrastructure asked us to provide information on the Department of Transportation’s surface transportation research programs. This report discusses (1) the public and private funding for surface transportation research, (2) the transportation community’s views on the federal role for research and DOT’s ability to fulfill that role, and (3) the issues that the transportation community believes the Congress and DOT should consider during ISTEA’s reauthorization. To identify the public and private funding for surface transportation research, we reviewed DOT’s research program budgets, three surface transportation research plans, and program and budget information from other sources. In addition, we interviewed officials in FHWA, FRA, FTA, NHTSA, RSPA, and the Office of the Secretary. To obtain knowledgeable views on the federal role in surface transportation research and DOT’s ability to fulfill this role and to identify directions for research, we interviewed DOT officials, representatives of state departments of transportation, university researchers, representatives of transportation organizations and the transportation industry, and other experts with direct knowledge of surface transportation research. Appendix I lists the groups we consulted. In addition, we reviewed documents on research, including a survey of state transportation research staff published in 1995 by the American Association of State Highway and Transportation Officials’ (AASHTO) Research Advisory Committee. We also reviewed many public and private analyses of transportation research. We analyzed the proceedings of the Forum on Future Directions in Transportation R&D (Forum), sponsored in 1995 by the Transportation Research Board and the National Science and Technology Council (NSTC), to identify participants’ comments about potential federal roles in surface transportation research. This analysis provided additional support for our findings because approximately 170 representatives from the federal government, state and local governments, industry, universities, private and public interest groups, and transportation users participated in this forum. In addition, we conducted extensive interviews and observed operations at the John A. Volpe National Transportation Systems Center. We performed our review from August 1995 through August 1996 in accordance with generally accepted government auditing standards. We provided a draft of this report to the Department of Transportation for its review and comment. We met with RSPA’s Associate Administrator for Research, Technology, and Training and with officials from the Office of the Secretary, FTA, FHWA, FRA, and NHTSA to obtain DOT’s comments. DOT generally concurred with the information presented and the observations made throughout the report. DOT provided information to update our report, which we incorporated in chapter 3. DOT also provided additional information on its basic research program, discussed at the end of chapter 4. Public and Private Funding for Surface Transportation Research Since ISTEA’s enactment in 1991, the federal funding for surface transportation research has totaled nearly $2.9 billion. DOT’s modal agencies have used these funds to support several research programs, but much of the funding has gone to FHWA’s ITS program. Although ISTEA required the states to spend more funds on research, the states’ support for research is relatively small compared with the federal support. Because data on industry’s total funding for surface transportation research is proprietary, this information is limited. Most of DOT’s Surface Transportation Research Budget Has Gone to FHWA Between fiscal year 1992 and fiscal year 1996, DOT budgeted about $2.9 billion (in appropriations and contract authority) for surface transportation research—about 2 percent of its total surface transportation budget. Table 2.1 shows how these funds were divided among DOT’s surface modal agencies—FHWA, FRA, FTA, NHTSA, and RSPA. Through fiscal year 1996, FHWA received 75 percent of the total funding for surface transportation research. Yet FHWA, like the other modal agencies, spent a relatively small percentage of its total budget for research. (See table 2.2.) Although NHTSA devoted a much higher percentage of its budget (20 percent) to surface transportation research than FHWA (2 percent), FHWA budgeted nearly eight times as much ($444 million) for research as NHTSA ($55 million). RSPA devoted 13 percent of its budget to surface transportation research, FRA 6 percent, and FTA 1 percent. ITS Program Dominates Surface Transportation Research Programs DOT’s five modal agencies’ surface transportation research programs differ not only in the size of their budgets but also in the focus of their research and in their customers. However, FHWA’s ITS program overshadows the other programs, reflecting both the traditional dominance of highways in surface transportation and congressional statutory requirements, which established the ITS program under ISTEA. Although the modal administrations set the surface transportation research agenda, their programs, budgets, and customers contrast sharply, as indicated in table 2.3. As figure 2.1 shows, ITS is FHWA’s largest research program. It received $204 million in fiscal year 1996, or nearly half of FHWA’s funding for research. ITS is about four times as large as either FRA’s or FTA’s research program. ISTEA established ITS and authorized $659 million for it for fiscal years 1992-97. The appropriations process provided additional funding, bringing the total for fiscal years 1992-96 to $1.01 billion. The ITS program uses research in computer and information technology to identify ways of improving highway capacity and safety. Much of FHWA’s research is designed to benefit state and local governments by developing new materials and techniques. Through its research, NHTSA develops a scientific basis for its vehicle safety and driver safety programs. The largest portion of its funding—$17 million in fiscal year 1996—is directed to its data programs. The National Center for Statistics and Analysis is responsible for maintaining large-scale databases that are used to support highway safety, vehicle rulemaking, and safety recall programs. These databases are also the primary source of information on motor vehicle and highway safety for DOT’s other modal agencies, especially FHWA, as well as for state and local governments, the automobile and insurance industries, and consumers. Much of FRA’s recent funding for research—$21 million in fiscal year 1996—has supported work on high-speed ground transportation. The technology deployment portion of FRA’s Next Generation High-Speed Rail Development Program supports strategies that FRA believes are essential to the success of high-speed rail in the United States. Through the program, FRA has developed partnerships with suppliers, railroads, and state agencies to make high-speed rail more financially feasible, thereby seeking to encourage states to develop high-speed rail in selected corridors. FTA’s largest research program—$8 million in fiscal year 1996—is the Transit Cooperative Research Program, an applied research program designed to yield innovative and near-term solutions to transit problems. While sponsored by FTA, the program is carried out under an agreement among FTA, the National Academy of Sciences acting through the Transportation Research Board, and the Transit Development Corporation, an educational and research arm of the American Public Transit Association. The program supports a broad range of research projects and activities to address the immediate and practical needs of transit, as well as to facilitate the transfer of technical information. State and local transit and planning agencies are the program’s primary customers. RSPA’s largest research program—$3 million in fiscal year 1996—is the Research Management and Application Program, whose focus is to develop a database of advanced transportation technology topics and ensure that the results of research and development on these topics are widely available. RSPA’s customers include DOT’s modal agencies, state and local governments, the transportation community, and academia. States, Universities, and Industry Support Surface Transportation Research ISTEA encouraged the states, universities, and the private sector to become more involved in surface transportation research. ISTEA required the states to devote 2 percent of their federal-aid funds to planning and research and to direct at least 25 percent of these funds solely to research, development, and technology transfer. Although DOT does not monitor the states’ annual expenditures of federal-aid funds for research, AASHTO reported that between 1989 and 1995 the states increased these expenditures by 66 percent (from $53 million to $88 million). ISTEA also encouraged the states to use their federal-aid funds to leverage additional funds from state and other sources. According to AASHTO, between 1989 and 1995 the states increased their own annual funding for research by 130 percent (from $33 million to $76 million). Now that ISTEA requires the states to spend a minimum percentage of their federal-aid funds on research, AASHTO estimated that about 53 percent of the states’ fiscal year 1995 funding for transportation research came from the federal government. AASHTO also found that, in keeping with ISTEA’s intent, most states have increased their expenditures for research in surface modes other than highways. ISTEA has continued to involve universities in surface transportation research, bringing five new universities into the University Transportation Center program. These centers, like the original 10 established by the Surface Transportation and Uniform Relocation Assistance Act of 1987, are funded by both FHWA and FTA. ISTEA also authorized $38 million over 6 years for five additional university research institutes, which receive funding through the Highway Trust Fund. Finally, ISTEA authorized $18 million over 6 years for the National Transit Institute, which provides training for anyone involved in federal-aid transit work. Although ISTEA encourages cooperation between the public and private sectors in conducting surface transportation research, the Transportation Research Board has generally found information about the private sector’s expenditures for research and development difficult to obtain. The private sector’s research is conducted or sponsored primarily by major national industrial and engineering associations. According to the Transportation Research Board, these associations spent about $21 million on highway research and technology in 1993. Meanwhile, the Association of American Railroads spent $26 million for rail research in 1994. Except for projects supported by a handful of major companies, research programs sponsored by individual companies are difficult to identify and characterize because they are so numerous and their findings remain proprietary. Progress and Limitations in Moving Toward a More Strategic Role for Surface Transportation Research Representatives of five groups of transportation stakeholders—federal, state, university, industry, and other experts—agreed that DOT should lead the nation’s surface transportation research effort and fulfill three principal roles—funding research, establishing a strategic agenda, and acting as a focal point for technology transfer. DOT has established councils and committees to coordinate its research both internally and externally. However, DOT’s modal organizational structure and lack of both a focal point and a strategic plan for surface transportation research, together with congressional directives to initiate or maintain specific research efforts, may limit DOT’s ability to lead. Until these constraints are addressed, the federal government may not be able to respond effectively to ISTEA’s call for an integrated framework for specifying national research goals. DOT Brings a National Perspective to Surface Transportation Research DOT’s role as the leader in surface transportation research stems from the Department’s national perspective, which transcends the interests and limitations of nonfederal stakeholders: The states generally focus on applied research that is geared to solving specific transportation problems; industry focuses on research that is often proprietary and geared to developing new or increased markets for selling goods and services; and universities focus on training future transportation specialists and conducting research that reflects the interests of its funders. Although all of these stakeholders advance knowledge, it is unlikely that they could replace the federal government as the focal point for surface transportation research. The states generally focus their research agendas and dollars on applied research—research that addresses specific questions and is designed to result in the information needed to produce a certain technology or service. According to the Transportation Research Board, highway problems are often of local interest and can best be addressed by state highway departments. For example, the Colorado Department of Transportation has many ongoing projects aimed at predicting where and when avalanches are likely to occur. In 1993, the Colorado Transportation Institute began exploring less costly measures to protect travelers from avalanches. The Institute tested two new monitoring systems that “listen” for sound waves signaling the approach of an avalanche. These advanced systems will allow the state to warn traveling motorists 40 to 60 seconds before an avalanche reaches the roadway. Private companies also focus on applied research. According to the Transportation Research Board, the private sector’s highway research is sponsored by national associations representing industry and the engineering professions or by companies that design and construct highways and supply highway-related products. According to a federal research official, the private sector has few incentives to conduct highway research because its main service—constructing highways and bridges—occurs in a contracting environment in which payment for completing services is based more on adhering to rigid design standards than on finding innovative means of building better highways. The private sector’s rail research is supported through the Association of American Railroads, whose researchers confirmed that they focus on applied research that is targeted to improving safety and building better equipment. For example, the association is coordinating research on the effects of 125-ton cars on conventional track structures. In addition, when the private sector conducts research, it often does not share its results with the research community because its findings are proprietary. A Civil Engineering and Research Foundation study noted that the private sector’s research is designed to gain a competitive advantage and firms protect the rights to their results. Finally, universities focus on educating future transportation professionals and spending the funds provided by government agencies or the private sector. Much of the highway research funded by FHWA, the states, and the private sector is performed by universities, especially those with specialized testing facilities and technical experts. However, as some university stakeholders observed, universities do not have the funds to conduct their own research and often shift their research agendas to focus on the areas with the most federal funding. Accordingly, the potential for universities to compensate for reductions in federal funding is limited. The Federal Government Provides Leadership Given the specific interests of nonfederal stakeholders, the members of the transportation community with whom we spoke agreed that the federal government should lead the nation’s surface transportation research. They said that DOT should fund research, especially research that generates new ideas; establish a strategic agenda; and act as a focal point for technology transfer. DOT’s Role in Funding Research Representatives of the five groups we interviewed—federal, state, industry, university, and other experts—agreed that DOT should support surface transportation research. Without federal support, they said, there would be no innovation in the transportation industry—especially in areas of general rather than particular interest, such as social objectives, land use, data collection, and the transportation system as a whole. Federal officials said that the federal government should support research to find solutions to national needs and problems. University representatives emphasized the importance of federal funding because it supports their research. In addition, according to representatives of the transportation industry, academia, local governments, and state governments who attended the March 1995 Forum on Future Directions in Transportation R&D (Forum),financial support for research is a federal responsibility. Private-sector participants believed, and state representatives concurred, that the federal government has a responsibility to fund transportation research and share the risk of investing in new technologies whose public acceptance, market acceptance, and technical feasibility are uncertain. DOT’s Role in Establishing a Research Mission and Developing a Strategic Plan Representatives of the five stakeholder groups agreed that the federal government should establish an overall research mission and provide strategic planning and management to achieve this mission. According to DOT’s Surface Transportation Research and Development Plan, DOT, as steward of the nation’s transportation system, must lead the effort to set transportation standards and develop a national surface transportation research and development agenda to achieve these standards. A former DOT official noted, for example, that DOT leads the national research and development efforts in safety and regulatory issues because other stakeholders have little or no incentive to support such research. Under DOT’s leadership, the use of safety belts increased from 11 percent in 1982 to 68 percent in 1995 and the proportion of traffic fatalities involving alcohol declined from 57 percent in 1982 to 41 percent in 1994. In addition, by focusing on transportation’s strategic goals, DOT can develop solutions to intermodal problems. Without a federal strategy, problems such as traffic congestion, which require an intermodal solution, may go unaddressed. Industry representatives discussing the National Science and Technology Council’s draft Strategic Implementation Plan for Transportation Research and Development at the Forum also agreed that the federal government has a role in setting standards and sponsoring research. The stakeholders also agreed that DOT should cooperate with others in the transportation community and direct resources toward achieving its research mission and goals. University officials said, for example, that as part of its strategic planning role, DOT must build relationships among the various stakeholders, since the solutions to transportation problems require more than research on building a sturdier road. Transportation officials also stated that DOT should direct resources toward achieving its research mission and goals by coordinating the efforts of other stakeholders. AASHTO indicated in its policy statement on ISTEA’s reauthorization that the federal government should coordinate the development of technologies of national interest. DOT’s Role as a Focal Point for Technology Transfer Finally, representatives from three of the five stakeholder groups—federal, state, and other experts—said that the federal government should act as a clearinghouse for information on surface transportation research and its results and ensure that new technologies are transferred to users. According to a DOT official, the federal government is in a good position to disseminate the results of surface transportation research to many users—states, cities, and the industry. In addition, in its policy statement on ISTEA’s reauthorization, AASHTO recommended that DOT continue its ongoing programs to transfer technology to state and local highway agencies and private organizations. According to the policy statement, one such program, the Strategic Highway Research Implementation Program, has produced valuable products, from pavement designs to snow removal technologies. Finally, according to Forum participants, the federal government needs to act as a focal point for gathering and disseminating information on ongoing as well as completed research because other parties are unlikely to perform these tasks. DOT Has Made Progress in Coordinating Research Programs To improve the external and internal coordination of DOT’s surface transportation research program, the Secretary, in 1993, formed the Coordinating Committee on Transportation Research and Development (Coordinating Committee) under the National Science and Technology Council. He also created the position of Director of Technology Deployment within the Office of the Secretary and established the Research and Technology Steering Committee (Steering Committee) and the Research and Technology Coordinating Council (Coordinating Council) within DOT. These actions have helped to improve the coordination of DOT’s research programs. Figure 3.1 displays the linkages among DOT’s research-related committees and councils and other federal departments. At the interdepartmental level, the Coordinating Committee sets federal priorities in transportation research and exchanges information about research programs among the executive branch departments involved in transportation research. The Committee’s members represent DOT and the departments of Commerce, Defense, and Energy. DOT has three mechanisms for coordinating research—the Director of Technology Deployment in the Office of the Secretary, the Steering Committee, and the Coordinating Council. The Director of Technology Deployment is responsible for coordinating DOT’s transportation research and development programs externally, with those of other federal agencies, and internally, among DOT’s modal agencies. The value of this position lies in its day-to-day involvement and interaction with the Secretary and Deputy Secretary, allowing for quick intervention when opportunities arise to emphasize DOT’s research. The position also offers modal research directors a focal point for bringing issues to the Secretary. This position increased the visibility of DOT’s research programs and emphasized their coordination, but since May 31, 1996, the position has been vacant. The Steering Committee establishes policies on research and technologies, budget priorities, and strategic plans for the Department, and its members include the administrators of DOT’s modal agencies and certain assistant secretaries. The Coordinating Council implements the policies set by the Steering Committee and consists of the associate administrators and office directors associated with DOT’s research program. According to the former Director of Technology Deployment, the Coordinating Council has done more to coordinate research than the Steering Committee. DOT officials indicated that the Steering Committee meets only once or twice a year and its mission has become blurred with that of the National Science and Technology Council’s Coordinating Committee. The Coordinating Council, however, meets monthly and its members are committed to furthering DOT’s research agenda. According to DOT, the Coordinating Council provides a forum for sharing information about areas of common interest, such as human factors, physical infrastructure, and nondestructive testing. Furthermore, members of the Coordinating Council may identify opportunities for further research that researchers themselves have not perceived because they are too close to their work. Organizational Factors Constrain the Establishment of an Agencywide Strategic Plan for Surface Transportation Research Several organizational factors limit DOT’s ability to develop a strategic approach to, and establish a clear agenda for, surface transportation research across all modes. Most importantly, surface transportation research within DOT is modally focused and lacks a central focal point. An Assistant Secretary for Research and Development might serve as a focal point, but DOT does not have such a position. The Director of Technology Deployment, within the Office of the Secretary, could also act as a focal point. However, as noted, this position remains vacant. Although RSPA was established to foster cross-cutting research, it does not have the resources or the internal clout to function effectively as a strategic planner for surface transportation research. In addition, congressional earmarks limit DOT’s ability to guide surface transportation research. DOT’s Surface Transportation Research and Development Plan illustrates problems that the Department faces in taking a more strategic approach to changing transportation needs. DOT’s Modal Organization Limits Strategic Planning Although some coordination of the modal agencies’ research agendas occurs through the Steering Committee and the Coordinating Council, surface transportation research is largely a modal initiative. Each modal agency has separate research programs and budgets, congressional authorizing committees, and programmatic and fiscal controls over its research programs. The modal organization allows each modal agency to focus on its own environment, goals, and users. For example, FHWA’s main focus is public roads and highways (publicly owned infrastructure). The primary users of FHWA’s research are state and local transportation departments, which look to research to help repair the public infrastructure and find new and better materials for pavements. FRA’s focus is the rail industry and its privately owned infrastructure. Users of its research—freight railroads, Amtrak, commuter railroads, and shippers—look to FRA to conduct research that will reduce track failure, equipment failure, and human error. According to the transportation stakeholders we consulted, DOT’s modal organization inhibits centralized decision-making and coordination and works against cross-modal cooperation. Government and university officials and other transportation experts told us that having separate modal agencies with their own constituencies works against a strategic approach. Each modal agency handles its budget independently and responds to its own constituency. This modal structure makes it difficult for DOT to develop a surface transportation system mission; accommodate the need for types of research—such as intermodal and systems assessment research—that do not have a modal focus; identify and coordinate research that cuts across modes; and evaluate research. Evaluation is particularly difficult because DOT has no single database that provides complete information on its research programs and projects. DOT Has No Focal Point for Surface Transportation Research A March 1996 study by the Transportation Research Board stated that when DOT was created, the intent was to have an Assistant Secretary for Research and Development, analogous to the Director of Defense Research and Engineering in the Department of Defense (DOD). Such a position was established when DOT was first created but was abandoned in the late 1970s with the formation of RSPA. DOT attempted to reorganize and consolidate its research program in fiscal year 1996, when it proposed, in its budget submission, to consolidate the surface modal agencies and their research programs. DOT also proposed to create a new position—an Assistant Secretary for Transportation Technology—and centralize the budgeting and programming for its research under this position. According to DOT, an assistant secretary would be able to look beyond the modal perspective and scrutinize all research programs, thereby improving the coordination of the Department’s research agenda. The Congress did not approve either proposal in 1995. In the absence of an Assistant Secretary for Transportation Technology, DOT’s primary focal point for coordinating research is the Director of Technology Deployment in the Office of the Secretary. Although this position does not have the centralized budgeting and programming authority that DOT sought for an Assistant Secretary for Transportation Technology, the former Director encouraged strategic planning and coordination among the modal agencies’ research functions. The position has not been filled since it became vacant in May 1996. However, the Deputy Secretary of Transportation announced on August 21, 1996, that RSPA’s newly appointed Associate Administrator for Research, Technology, and Training would assume the coordination functions formerly assigned to the Director of Technology Deployment on an interim basis. The Department has yet to decide whether the position of Director of Technology Deployment will be retained. Although DOT has made RSPA’s Associate Administrator for Research, Technology, and Training responsible for coordinating the Department’s research, RSPA does not have the resources or the authority to fill the role of an Assistant Secretary for Transportation Technology. According to RSPA, its mission is to make America’s transportation systems more integrated by conducting and fostering cross-cutting research and special programs. In contrast to DOT’s operating agencies, which focus on specific sectors of the transportation system, RSPA concentrates on the system as a whole. However, a 1991 study by the National Academy of Public Administration found that RSPA had played only a limited role in research and development policy, in part because its budget is small compared with the modal agencies’ research budgets. In addition, RSPA acts in an advisory capacity and has no control over the modal agencies’ budgets or policies. Congressional Directives Limit DOT’s Ability to Guide Research The Congress limits DOT’s ability to set research priorities by including directives in the modal agencies’ appropriations budgets to initiate or maintain specific research efforts. These directives, or earmarks, take a variety of forms, from specifying dollar amounts for particular recipients to suggesting areas of research for consideration. The earmarks also represent different proportions of the agencies’ research budgets. For example, FTA calculated that the Congress earmarked 80 percent of one of its primary research programs in fiscal year 1996. A DOT official noted that other agencies, such as FHWA, can better accommodate earmarks because their research budgets are larger and some earmarks are compatible with ongoing research programs. However, FHWA officials stated that without earmarks, the agency would have more latitude to match funds with critical needs. The appropriations committees’ conferees recognized that earmarking funds may be detrimental to meeting research programs’ goals when they stated in the fiscal year 1996 conference report on DOT’s appropriations that they would seriously consider discontinuing their earmarking of the ITS program in fiscal year 1997. DOT’s Research Plans Do Not Reflect a Strategic Approach DOT is attempting to develop a strategic surface transportation plan with clear goals and objectives for the federal role. The plans that the Department has issued to date are useful inventories of the five modal agencies’ research activities, but they cannot be used as ISTEA directed—to make surface transportation research more strategic, integrated, and focused. ISTEA required the Secretary of Transportation to develop an integrated national surface transportation research and development plan focusing on urban, suburban, and rural areas in the next decade. This plan was to include both strategic and nonstrategic elements. On the one hand, ISTEA placed the plan in a strategic framework, linking it to DOT’s efforts to develop transportation technologies and maintain long-term advanced research for next-generation surface transportation systems. On the other hand, ISTEA required the plan to include descriptions of the Department’s surface transportation research programs, including their funding, milestones, preliminary cost estimates, work scopes, personnel requirements, estimated costs, and goals over a 3-year period. ISTEA required the first plan to be submitted by January 15, 1993, and updated annually thereafter. RSPA’s Volpe Center prepared the initial plan and the two updates that DOT has submitted to the Congress since 1993. The first two plans, submitted in 1993 and 1995, responded primarily to ISTEA’s requirement for descriptive information. These plans, according to DOT officials, provided the Department with the first inventory of its major modal surface transportation research programs. However, both the Secretary and the Congress asked RSPA to give the third plan a more strategic and intermodal focus. The third plan, submitted in August 1996, tries to take a more strategic approach to research by projecting the modal agencies’ research needs and programs into the future. However, strategic questions posed by ISTEA, such as what surface transportation research should provide to meet users’ needs in the future, receive limited attention. As a former DOT official observed, the third plan moves in a more strategic direction, but it is far from being a strategic plan. A DOT official involved in preparing the 1996 research plan noted his difficulty in encouraging the modal agencies to take a long-term view when their research budgets consist of mandates and earmarks limiting their discretion. Conclusions Transportation stakeholders generally agree that the federal government should remain a leader in surface transportation research, serving as the primary source of funds, developing a strategic plan, and acting as a focal point for technology transfer. The role of strategic planner is particularly important because it gives DOT the opportunity to define the best uses for the nation’s limited research dollars. However, without a focal point for surface transportation research at the departmental level, DOT will have difficulty assuming the leadership role envisioned by stakeholders and achieving the strategic goals set forth in ISTEA. Mismatch Between Research Investments and Changing Needs As surface transportation problems become more complex in the next decade, transportation experts contend that the current surface transportation research portfolio must change to prepare the nation for a transportation system whose present use is expected to double by 2030. As the Congress considers the successor to ISTEA, federal decisions about the surface transportation research portfolio may determine whether new knowledge and technologies will be available to address future transportation problems. According to public and private transportation officials, federal surface transportation research currently neglects two areas that will grow more important. First, it does not address the total surface transportation system, giving limited attention to system assessment, policy, and intermodal research. Second, it does not include enough basic, long-term, high-risk research to respond to complex, persistent problems. Targeting funds to changing priorities will be important when reauthorizing ISTEA’s research programs. Emerging Needs Are Not Reflected in the Research Portfolio Industry participants in a Forum session stressed that transportation providers and their customers plan business activities on the basis of a safe, efficient, and productive transportation system, rather than on what each mode of transportation can offer. As a result, private and public transportation officials expressed concern that the current surface transportation research portfolio was weighted toward current, modal problems rather than emerging system problems. Public and private officials viewed the current research efforts as inadequate to build knowledge in three areas: system assessment, policy research, and intermodal research. System Assessment Research Transportation officials stated that understanding how the nation’s complex surface transportation system functions—system assessment research—is vital to making transportation more efficient and effective for users. System assessment uses analytic tools to measure, monitor, and model systems and people’s performance in them. According to Forum participants, system assessment applies models and simulations, cost-benefit analyses, and risk assessment to understanding how vehicles, the physical infrastructure, and the nonmaterial infrastructure (policies, regulations, laws, and institutions that govern transportation) interrelate. For example, a university official noted that system assessment would allow persistent problems that are not improving—particularly congestion—to be examined on a larger scale. The Texas Transportation Institute estimated that congestion costs the nation $40 billion annually in lost time and fuel. DOT officials noted that system assessment’s broad focus and attention to the interrelationships among the individual components of a national system make it an appropriate area for federal research. However, DOT officials stated that research in this area is limited and funding is difficult to obtain. A federal research manager explained that it is difficult to put system assessment into research language and get funding because funders do not see a tangible product. As a result, a DOT official stated that the inability to look at issues as part of systems has constrained DOT’s ability to manage research. Research on Transportation Policy Public and private officials stated that research to support transportation policy decisions should be a high priority in the federal research portfolio. These officials noted that although the federal government and state and local governments face increasingly complex transportation problems, policy research to resolve these problems is not a high priority. A university researcher added that without reliable research, decisions risk depending on conventional wisdom—which can be wrong. As a result, scarce funds may be spent inefficiently to deal with spurious cause-and-effect relationships. For example, a university researcher noted that local government initiatives to restrict downtown traffic have been made with little information about their payoffs. According to federal and university officials, policy research may be least available to local transportation groups, such as the Metropolitan Planning Organizations (MPO) that received new decision-making responsibilities under ISTEA. For example, MPOs are required to conform their transportation plans to air quality goals. However, a federal official observed that standard models are not available for the MPOs to use in identifying the effects of transportation on air quality. Intermodal Research Public and private transportation officials stated that intermodal research—how people and freight move between highways, mass transit and rail—should be an important part of the federal research portfolio. Intermodal research is important because it affects the nation’s productivity and competitiveness by focusing on the efficient movement of people and freight from one mode to another. Although intermodal research is viewed as important, a recent report by the Transportation Research Board noted that the Department spent only about $2 million to $5 million on intermodal research in fiscal year 1995. Public and private officials said that additional research is needed in two intermodal areas: overcoming institutional barriers and improving the movement of freight. Representatives of local governments participating in the Forum identified institutional research as one of three research priorities for them. They explained that public and private institutions involved in transportation often have conflicting interests that can constrain intermodal planning, funding, and decision-making. For example, implementing ITS will require institutional cooperation among local and state governments and private industry. Both state and local Forum participants called for more research to identify models that would reduce local institutional barriers to intermodal transportation planning. Public and private officials stated that research on how freight moves between rail, truck, and sea is also needed. To date, research has focused principally on how people, rather than freight, move between modes. Additional intermodal research is needed to determine how to transport the nation’s huge volume of freight without major tie-ups. University researchers noted that the problem is significant because fewer goods are shipped to local markets than to regional, national, and international markets. Basic, Long-Term, High-Risk Research Is Not Adequately Addressed Public and private officials pointed out that current and future research payoffs require a federal research portfolio that includes a mix of basic and applied, short- and long-term, low- and high-risk research. They emphasized that basic, long-term, high-risk research is important to provide fundamental knowledge that is the “seed corn” for developing future technologies and information. The National Research Council and other experts noted that major advances in technology come from basic research. They cited the Global Positioning System—rapidly becoming crucial to ITS—to show that decades of basic research in diverse areas converged to create new technology that is paying off. University researchers also cited two examples of basic, long-term research that have benefited surface transportation. First, behavioral demand modeling began as an esoteric study, but in 15 years it has altered methods of predicting the market’s responses to changes in transportation pricing. Second, mathematical logistics, funded by the National Science Foundation as long-term research, has become crucial to the transportation industry and the nation’s competitiveness. U.S. automakers have used mathematical logistics to operate a just-in-time inventory system and help recover their competitive position. Despite the need for a research mix, transportation experts said, the current surface transportation research portfolio has too little basic, long-term, high-risk research. Public and private officials viewed the portfolio as weighted heavily toward applied, short-term, low-risk research. Because about 80 percent of the portfolio’s research projects are applied, short-term, or low-risk, a transportation official was concerned that quantum leaps—generally credited to basic research—would not occur and users’ needs would not be met. A university official stated, for example, that surface transportation research is focusing on incremental improvements in asphalt rather than on fundamental questions, such as whether asphalt for highways will be needed in 20 years. In 1995, the National Research Council reported to the Congress that balancing the surface transportation research portfolio with more basic, long-term research would require a long-term commitment from the United States. However, public and private officials noted that the United States has difficulty sustaining long-term research—unlike Japan and Germany—and tends to lose interest after a few years. A university researcher whose department moved from transit to paratransit research to follow federal funds characterized surface transportation research as a highly fashion-conscious field where the tendency is to move from one area to another before solutions are found. Agency Comments In commenting on a draft of this report, FHWA officials said that the report gave the impression that the Department funds insufficient basic, long-term, high-risk research. They believe, however, that their agency’s program includes a significant amount of this type of research. According to FHWA, its research program has a 15-50-35 split—that is, about 15 percent of the funding is directed to exploratory or long-term research projects, which are likely to be completed in 10 years or more; 50 percent is directed to applied research projects, which are likely to be completed within 2 to 5 years; and 35 percent is directed to refining and delivering the products of research to the transportation community. They cited two ITS projects—the Crash Avoidance Research Program and the Automated Highway Systems Program—as examples of exploratory, long-term research. Our purpose was not to evaluate the Department’s commitment to basic, long-term, high-risk research but to convey the views of five groups of transportation stakeholders—federal, state, university, industry, and other experts. According to these stakeholders, the current surface transportation research portfolio includes too little basic, long-term, high-risk research.

Pursuant to a congressional request, GAO provided information on surface transportation research, focusing on: (1) public and private funding for surface transportation research; (2) the transportation community's views on such research and the Department of Transportation's (DOT) ability to fulfill that role; and (3) issues that the transportation community believes that Congress and DOT should address during the reauthorization of the Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA). GAO found that: (1) between fiscal years 1992 and 1996, DOT provided $2.9 billion for surface transportation research programs to five modal agencies, with the Federal Highway Administration (FHwA) receiving $2.1 billion; (2) FHwA allocated almost half of its funding to its Intelligent Transportation Systems Program, and other agencies conducted research on vehicle and driver safety, high-speed ground transportation, mass transit operations, and advanced transportation technologies; (3) ISTEA has encouraged greater public and private cooperation as well as university involvement, and states have increased the amount of federal and state money they spend on such research; (4) the transportation community generally agreed that DOT should lead the nation's surface transportation research program and serve as a focal point for technology transfer, since it has broader interests and a wider perspective than the other parties; (5) DOT has improved external and internal coordination of its surface transportation research program, but lacks the resources and authority to create an integrated framework or strategic plan for surface transportation research; and (6) the transportation community believes that the surface transportation research program does not adequately address the total surface transportation system, giving limited attention to system assessment, policy, and intermodal research, and does not include enough basic, long-term, high-risk research to respond to complex, persistent problems.

Background In pursuing its mission of aiding small businesses, SBA provides them with access to credit, primarily by guaranteeing loans through its 7(a) and 504 loan programs. The 7(a) and 504 loan guarantee programs are intended to serve small business borrowers who could not otherwise obtain credit under reasonable terms and conditions from the private sector without an SBA guarantee. Under the 7(a) program, SBA generally provides guarantees of up to 85 percent on loans made by participating lenders that are subject to program oversight by SBA. Many of these participating lenders are preferred lenders that have delegated underwriting authority. Loan proceeds can be used for most business purposes, including working capital, equipment, furniture and fixtures, land and buildings, leasehold improvements, and certain debt refinancing. The 504 program provides long-term, fixed-rate financing to small businesses for expansion or modernization, primarily of real estate. Financing for 504 loan programs is delivered through about 270 certified development companies, nonprofit corporations that were established to contribute to the economic development of their communities. For a typical 504 loan project, a third- party lender provides 50 percent or more of the financing pursuant to a first-lien mortgage, a certified development company provides up to 40 percent of the financing through a debenture that is fully guaranteed by SBA, and a borrower contributes at least 10 percent of the financing. Although SBA’s 7(a) and 504 loan guarantee programs serve different needs, both programs rely on third parties to originate loans (participating lenders for 7(a) loans and certified development companies for 504 loans). Because SBA generally guarantees up to 85 percent of the 7(a) loans and up to 40 percent of the financing for 504 loan projects, SBA faces the same kind of risk as the lenders if the loans are not repaid. The Small Business Programs Improvement Act of 1996 required SBA to establish a risk management database that would provide timely and accurate information to identify loan underwriting, collections, recovery, and liquidation problems. In 2003, SBA obtained a service from Dun & Bradstreet that would allow it to, among other things, predict the likelihood of a loan defaulting using a combination of SBA performance data and loan-level credit data. In 2004, we assessed the new service and found that the system was on par with industry best practices by providing a tool that could help SBA better assess the risk exposure of loans in its lenders’ portfolios. For example, we reported that the Small Business Predictive Score (SBPS), which is provided through the Dun & Bradstreet service, appeared to be consistent with private sector best practices because it was based on sound models. The models used to score the loans rely on data managed by Dun & Bradstreet and are commercial, off- the-shelf risk scoring models developed by Fair Isaac and validated to SBA’s 7(a) and 504 portfolios. We concluded that without the Dun & Bradstreet service, it was unlikely that SBA would be able to continue the same level of risk management of its overall portfolio, its individual lenders, and their portfolios. However, we also reported that SBA needed to make better use of the service in overseeing its lenders and recommended, among other things, that resources within SBA be devoted to developing policies for the use of the loan monitoring service. As a result, SBA contracted with Dun & Bradstreet to develop a system that would rate lenders based on risk. Dun & Bradstreet subcontracted with another company, TrueNorth, to develop the lender risk ratings—that is, custom scores calculated using L/LMS data. Work on the lender risk rating system started in 2004. The purpose of the lender risk rating system is to improve the way SBA monitors lenders. The lender risk rating system uses the following factors for 7(a) lenders: past 12 months’ actual purchase rate—a historical measure of SBA purchases from the lender in the preceding 12 months; problem loan rate—the current delinquencies and liquidations in a lender’s 3-month change in SBPS—a score that was developed to predict the likelihood of severe delinquency (61 or more days past terms) over the next 18 to 24 months, including bankruptcies and charge-offs; and projected purchase rate—a measure of the amount of SBA guaranteed dollars in a lender’s portfolio that is likely to be purchased by SBA. Most of the data used to calculate these factors are loan and lender performance information that come from SBA. The remaining data are SBPSs or related scores provided by the Dun & Bradstreet service (see table 1). For 504 lenders, the risk rating is based on three factors: (1) the past 12 months’ actual purchase rate, (2) the problem loan rate, and (3) the average SBPS on loans in the 504 lender’s portfolio. The third factor replaced the third and fourth factors used for 7(a) lenders because it was found during the testing process to be more predictive of SBA purchases for 504 lenders. Some federal financial regulators and lenders rely on similar tools to conduct off-site monitoring. For example, FDIC relies on various off-site monitoring tools, including a system called the Statistical CAMELS Off-site Rating that helps the regulator identify institutions that have experienced noticeable financial deterioration since the last on-site exam. The Federal Reserve also relies on multiple tools to conduct off-site monitoring, including a system that enables the regulator to predict how the risk level of a bank likely will change in comparison to other banks that received similar ratings on on-site exams. OCC relies on a process called a core assessment that helps examiners assess the risk exposure for nine categories of risk, including quantity, quality, and direction of risk. Moreover, lenders frequently use models to summarize available relevant information about borrowers and reduce the information into a set of ordered categories, or scores, that estimate the borrower’s risk of delinquency or default at a given point in time. Such tools are playing a progressively more important role in the banking industry. In general, the goal of these models—whether they are generic or custom, developed internally or by third parties—is to obtain early indications of increasing risk. SBA’s Lender Risk Rating System Is Similar to Those Used by Federal Financial Regulators but Is Limited by Insufficient Validation SBA’s Contractor Uses a Multistep Process to Assign Lender Risk Ratings SBA’s contractor takes four steps to assign lender risk ratings each quarter. First, the contractor separates lenders into peer groups based on the size of their SBA loan portfolios in order to compare similarly sized lenders. Second, for each lender, the contractor computes values for each of the factors. As discussed in more detail in the background, the four factors for 7(a) lenders are the (1) past 12 months’ actual purchase rate, (2) problem loan rate, (3) 3-month change in the SBPS, and (4) projected purchase rate. Third, the contractor inputs the value for each of the factors into an equation to compute a score for each lender. Fourth, the contractor uses the scores to place lenders into one of five risk rating categories (1 through 5, with 1 indicating the least risk). Figure 1 illustrates this process for 7(a) lenders, and the shaded area represents a specific example. The process is generally the same for 504 lenders. According to SBA officials, this process for calculating lender risk ratings will likely change in the near future because its contractor is redeveloping the lender risk rating system. Several major changes are being contemplated. First, the contractor plans to use an updated version of the SBPS. Second, the contractor may use additional variables to calculate lender risk ratings. Finally, rather than varying the equation by peer group, SBA officials stated that they are considering a new variable that captures the size of the lender’s portfolio and the age of its loans. The contractor is still in the process of designing, testing, and documenting the new risk rating system. SBA rarely overrides risk ratings, but it may do so for several reasons. These include early loan default trends; abnormally high default or liquidation rates; lending concentrations; rapid growth in SBA lending; inadequate, incomplete, or untimely reporting to SBA; and nonpayment of required fees to SBA. In addition, SBA may override a lender risk rating due to issues identified during an on-site review. For the quarter ending September 30, 2008, SBA overrode the risk rating assigned by the contractor in 20 cases; in each case, the risk rating increased. SBA’s Lender Risk Rating System Uses Some of the Same Types of Data That Federal Financial Regulators and Selected Lenders Rely on to Conduct Off-Site Monitoring SBA’s lender risk rating system uses some of the same types of data that federal financial regulators and selected lenders rely on for off-site monitoring. The federal financial regulators we interviewed rely on lender information, performance data, and prospective measures to conduct off- site monitoring. Although the specific factors included in each regulator’s off-site monitoring tools can vary, each regulator uses these three types of data. Much of the lender and performance information they use are from the call reports that banks submit quarterly and include data on equity, loans past due, and charge-offs. Prospective measures include—when available—borrowers’ credit scores from lender files. One federal regulator is also working with a third party to obtain predictive scores, similar to the SBPS, to use as part of its off-site monitoring. The large lenders with whom we spoke also use performance data to rate loans, focusing on factors such as portfolio performance, delinquencies, and trends by state and industry type in order to forecast future losses. Lenders also incorporate prospective measures, such as FICO scores and SBPSs. Like federal financial regulators and large lenders, SBA uses performance data and prospective measures to calculate lender risk ratings. As we have seen, to calculate risk ratings for 7(a) lenders, SBA relies on performance data (the past 12 months’ actual purchase rate and the problem loan rate) and prospective measures (the 3-month change in the SBPS and the projected purchase rate). The 3-month change in the SBPS is also a portfolio trend that has been incorporated into the rating system. However, unlike the federal financial regulators, SBA does not use lender information such as equity and loan concentrations as inputs into its lender risk rating system. Although the federal financial regulators and SBA both oversee lenders, their missions differ, and as a result they may choose to focus on different variables in conducting off-site monitoring. In general, the mission of the federal financial regulators is to maintain stability and public confidence in the nation’s financial system. In contrast, SBA’s mission is to aid, counsel, assist, and protect the interests of small business concerns, including guaranteeing loans to businesses in industries that lenders may avoid. Therefore, it is understandable that SBA might not include the same variables as federal financial regulators. In addition, while it is not an input into the lender risk rating system, SBA evaluates information such as equity and loan concentrations as part of other monitoring efforts. Figure 2 summarizes how the data that SBA uses in its lender risk rating system compare with the data included in the risk rating systems used by the federal financial regulators and lenders we interviewed. SBA’s Lender Risk Rating System Better Predicted the Performance of Larger Lenders than Smaller Lenders When we performed our own independent assessments of the reliability of the lender risk ratings, we found that they were more reliable at predicting the performance of the largest lenders. To perform this independent assessment, we assessed how well the lender risk ratings predicted the actual performance of lenders (that is, lenders’ default rates). Because of data limitations, our analyses focused on lenders with larger SBA- guaranteed portfolios. Overall, we found that SBA’s ratings were able to distinguish between high- and lower-risk lenders for a majority of the 7(a) and 504 lenders in our sample for 2007 and 2008. However, when we focused on the ratings’ ability to predict the performance of different-sized lenders, we found that the ratings were more effective at predicting the performance of lenders with the largest SBA-guaranteed portfolios (that is, lenders with SBA-guaranteed portfolios of at least $100 million). (See app. III for further discussion of how well the lender risk ratings predicted the performance of 7(a) and 504 lenders.) How the system was developed may have contributed to the lender risk ratings being more effective at predicting the performance of the largest lenders (that is, lenders with SBA-guaranteed portfolios of at least $100 million). In order to determine how SBA developed the risk rating system, we reviewed the available documentation of the development process and discussed the process with SBA officials and the contractor. According to the contractor, it considered 32 variables to determine those that were the most predictive for each peer group. SBA then made a policy decision to use the same factors across all of the peer groups. Although the documentation did not provide the justification for this policy decision, SBA officials stated that the decision was made so that every lender’s risk rating was based on consistent information. Officials were concerned that lenders might be confused if the factors upon which the ratings were based varied by peer group, particularly since lenders do move between peer groups. The contractor ultimately selected four factors, each of which was a statistically significant predictor of lender performance for at least one of the peer groups. However, only for the largest peer group (those with guaranteed portfolios of at least $100 million) were all four factors statistically significant. According to SBA officials, in peer groups where a factor was statistically insignificant, it did not affect the lenders’ risk ratings—that is, for some peer groups, the ratings are determined by less than four factors. Usefulness of SBA’s Lender Risk Rating System Has Been Limited because SBA Does Not Ensure That Its Contractor Follows Sound Validation Techniques The effectiveness of SBA’s lender risk rating system has been limited because the agency’s contractor does not follow sound validation practices. According to one federal financial regulator, the ability of models to accurately predict outcomes can deteriorate over time. For example, changes in economic conditions and industry trends can affect model outcomes. Validation—the process of assessing whether ratings adequately identify risks by, for example, comparing predictions to actual results—helps to ensure that models remain reliable. Federal financial regulators (OCC, FDIC, and the Federal Reserve) and the Basel Committee on Banking Supervision (Basel Committee) have developed a number of common principles that financial institutions should follow in validating the models they use to manage risk, whether the models are purchased from a vendor or developed in-house. Validating some aspects of models developed by vendors may be difficult because of the proprietary nature of the information. But the guidance from federal financial regulators and the Basel Committee states that organizations have a responsibility to ensure that vendors follow good model validation practices. We identified four key elements of a sound validation policy that federal financial regulators and our internal control standards recommend and that some lenders we interviewed implemented. First, all three parts of a model—the data, processes, and results—should be validated using multiple techniques. Second, validation should be done by an independent party. Third, validation should include an ongoing assessment of the factors used in the model. Finally, the validation procedures should be documented. We found, however, that SBA had not adhered to the guidance in validating its lender risk rating system. First, SBA’s validation procedure does not include techniques to validate all parts of its model. Second, the model is not validated by an independent party. Third, SBA does not reassess which variables are the most predictive of lender performance on a routine basis. Finally, SBA’s documentation of the validation procedures and the results of the validation is not complete. Figure 3 shows how SBA’s practices align with commonly accepted practices. Guidance from the federal financial regulators we interviewed and the Basel Committee states that each of the three parts of a model—the data, processes, and results—should be validated using a variety of techniques. According to FDIC guidance, validation should include ensuring that the data used in the model are accurate and complete, evaluating the model’s conceptual soundness, and analyzing the estimates the model produces against actual outcomes. The Basel Committee also states the importance of assessing all the components of a model. In addition, OCC guidance prescribes three generic procedures that could be used for validating each part of a model—a review of logical and conceptual soundness, comparison against other models, and comparison against subsequent actual events. Further, guidance from the Federal Reserve states that financial institutions should use a variety of techniques when validating their models. For example, some lenders we interviewed compared their internal rating systems with other commercially available models or compared model predictions against historical information to test the reliability of their models. In addition, GAO’s internal control standards specify that agencies should ensure the accuracy of data inputs and information system processing and results. For example, validation should be performed to verify that data are complete and to identify erroneous data. Furthermore, these standards state that management should establish controls over information processing and that output reports should be reviewed. Consistent with commonly accepted practices, SBA’s contractor has a documented process for validating the data used in the lender risk rating system. On the basis of previous reviews and recent interviews with contractor staff, we found that the contractor’s data quality control process, referred to as DUNSRight, appeared reasonable. In June 2004, we reported that the commercial data that Dun & Bradstreet collects go through a five-step quality assurance process that includes continuously updating databases and matching SBA records with Dun & Bradstreet records, with a 95 percent match of the data on critical pieces of information. In the same report, we also concluded that SBA’s controls over the 7(a) and 504 data used in the models helped to ensure that the data inputs were sufficiently reliable. Appendix IV provides information on Dun & Bradstreet’s procedures for ensuring the reliability of the SBPS and how well it predicts the likelihood that a loan will default. The contractor that developed the lender risk rating system also conducts periodic validations of the system that include using statistical tests to measure the model’s predictive ability and comparing the results of the model against lenders’ actual performance. For the years 2005 through 2007, SBA’s contractor assessed whether the broad risk ratings were generally consistent with the actual performance of the lenders within each rating group. The contractor also determined whether each group of lenders (for example, those lenders rated as 1) performed better than other groups of lenders with lower risk ratings (that is, 2 through 5). However, we did not see evidence that the contractor validated the processes used to calculate the ratings. Specifically, neither SBA nor its contractor could provide documentation showing that the contractor had validated the theory behind the system or the logical and conceptual soundness of the model. For example, there was no documentation describing the processes followed or the link between the computer program and output that was used to produce the lender risk ratings. Therefore, we could not rerun the analysis to determine if we would have arrived at the same conclusion regarding the four factors used in the model. In addition, the contractor could not provide documentation showing that it had ensured that the mathematics and computer code were free of errors. According to officials from the contractor, they took steps to verify that the processes they followed were sound, including verifying the computer code they used; however, they did not document these steps. Further, the contractor’s validation of the model’s results was limited. Consistent with industry standards, SBA’s contractor has used a variety of statistical measures to validate the risk rating system’s results. But the documentation did not show that the contractor checked the model’s results against available benchmarks (such as the default rate or the currency rate) to validate whether the risk ratings reliably predicted individual lender performance. Rather, the documentation indicated that the contractor focused its validation on whether the broad risk ratings were generally consistent with the actual performance of the lenders within each rating group—groups that can be comprised of over 2,000 lenders with a wide range of portfolio sizes and performance levels. Although this technique compares the model’s results to actual performance benchmarks, as suggested by industry standards, it is limited because it does not provide information on individual lender performance. According to SBA officials, the contractor tested how well individual scores produced by the lender rating system predicted individual lender performance; however, the results of this analysis were not included in the documentation we received and were not provided to SBA. Because lender performance can vary widely within the broad risk categories, the results of a more refined analysis would allow SBA to identify specific lenders placed in incorrect risk categories. Because SBA has never requested documentation from the contractor on its validation of the model’s processes, the agency cannot ensure that the processes used are sound. In addition, because the contractor does not document how well the lender risk ratings predict individual lenders’ performance, SBA may not be able to identify which lenders within the broad risk rating categories are not being rated accurately. As a result, SBA may be relying on inaccurate ratings or missing out on opportunities to identify risky lenders and target them for closer monitoring. Validation Is Not Conducted by an Independent Party Each of the regulators we interviewed (OCC, FDIC, and the Federal Reserve) recommends in its guidance that validation include an independent review of the model. For example, OCC guidance states that model validation should be done by a party that is as independent as possible from the personnel who constructed the model. In addition, FDIC guidance states that validation should include competent and independent review by a reviewer who is as independent as practicable. Further, Federal Reserve and Basel Committee guidance notes that the validation process should be independent from the model development and implementation processes. Our internal control standards also emphasize the importance of independent review. They state that to reduce the risk of error, no one individual should control all key aspects of an activity. For example, an individual who is responsible for developing a model should not be responsible for validating it. An independent party can be either inside or outside the organization—for example, the internal audit staff, a risk management unit of the institution, an external auditor, or another contracted third party. Some lenders we interviewed that had internal risk rating systems have had them validated by a separate group within the institution, and others have invited independent auditors to review their systems. Contrary to common industry practices and internal control standards, the same contractor staff that developed and maintain the lender risk rating system are the officials who validate it. We have previously reported on SBA’s failure to ensure that independent parties routinely assess the reliability or integrity of its contractors’ models. Specifically, we reported in June 2004 that third parties did not validate the SBPS model that another contractor maintained because SBA believed that the model was stable and that clients would inform the company if the models were not reasonably predicting borrower behavior. Similarly, SBA and its contractor thought it was sufficient for someone to review the validation conducted by the staff who developed the model and for Dun & Bradstreet and SBA officials to review the contractor’s work. However, industry standards require that personnel other than those who developed the model validate it. Because SBA has not ensured that an independent party validates its lender risk ratings, certain systemic and structural issues with the design of the system may go undetected, and the predictive value of the risk ratings is more uncertain. SBA Does Not Perform Ongoing Validation to Ensure That the Factors Used in the System Are the Most Predictive Guidance from federal financial regulators and the Basel Committee states that validation of the factors used in the model should be ongoing and should take into consideration changes in the environment (such as changes in economic conditions or industry trends) or improvements in modelers’ understanding of the subject. For example, OCC guidance states that models are frequently altered in response to changes such as these. In addition, Federal Reserve guidance states that a model’s methodology should be validated periodically and modified to incorporate new events or findings as needed. Further, the Basel Committee notes that validation is an ongoing, iterative process. Failure to do so could cause the model to become less predictive and lose its ability to rank order risk over time. According to FDIC guidance, characteristics of a model need to be validated and refined when necessary because if management does not select and properly weight the best predictive variables, the model’s output will likely be less effective. Our internal control standards also specify that agencies that procure commercial software are responsible for ensuring that it meets the user’s needs and is operated properly. These standards state that controls should be in place to ensure that computer systems are modified safely by reviewing and testing them before placing them into operation. The standards also specify that management should ensure that ongoing monitoring is effective and will trigger separate evaluations where problems are identified. SBA’s contractor takes some steps to validate the lender risk rating system’s ability to reliably predict lender performance but does not ensure that the variables used to calculate the risk ratings are the most predictive of lender performance. We reviewed the validations of the risk rating system that the contractor conducted in 2005, 2006, and 2007. These validation efforts included testing of the statistical importance of each of the four factors used in the lender risk rating system. However, these validations did not routinely include testing of other factors to account for changes in economic conditions or industry trends. The 2005 validation effort was the only one that tested additional factors. SBA’s contractor tested three new variables to determine if they improved the model’s ability to predict lender performance and found that they did not. Neither of the subsequent validations included assessments of additional variables, and SBA did not requested them. According to SBA officials, SBA and the contractor identified possible additional variables over the past several years that they did not test for use in the model because they wanted more experience with it and the data. They also noted that they always had plans to redevelop the model within 5 years but could not do so until the agency had signed a second contract with Dun & Bradstreet that provided funds for a redevelopment. However, if SBA had asked the contractor to test additional factors on a regular basis, the agency may have found that an earlier redevelopment effort or incremental adjustments could have improved the predictive ability of the model. Because new variables that might take into account economic changes or industry developments have not been routinely assessed, the ratings may not be as effective as they could be. In addition, according to the contractor’s validation reports, the lender risk rating system’s predictive ability for 7(a) lenders decreased from 2005 to 2007. This decrease led the contractor to suggest in 2007 that SBA redevelop the model to improve its predictive ability and prevent further deterioration. SBA officials agreed, and the contractor is currently redeveloping the model, including testing new variables, to keep up with changing economic conditions and to reflect SBA’s and the contractor’s experiences working with the data and the model over the last several years. It will be important for SBA to ensure that the contractor conducts sound testing as part of its redevelopment. SBA’s Documentation of Validation Procedures and Results Is Incomplete The federal financial regulators’ guidance states that a sound validation policy should include documentation of the validation. For example, FDIC and OCC guidance states that model validation documentation should describe the model, how it is used, and its limitations. Federal Reserve guidance also notes that the validation process should be documented. In addition, FDIC and OCC have said that the procedures used to validate the model on an ongoing basis and the results of these validations should be documented, even if the institution uses a model developed by a vendor. For example, OCC guidance states that an institution should seek assurances that the vendor’s model is defensible and works as promised. Further, the Basel Committee guidance notes that even vendors that are not willing to reveal proprietary information should provide information on the validation techniques they use. Complete documentation of the results of ongoing validations assists users in understanding the model and facilitates independent reviewers’ assessments of the model’s validity. Our internal control standards also specify the importance of documenting information systems. For example, these standards state that all significant events in developing and maintaining computer systems should be clearly and completely documented. This documentation should describe the system, how the data used in the system are handled, and other controls in place to maintain the system. SBA did not ensure that the contractor provided complete documentation of the results of its validations or documented its validation procedures. SBA provided us with some documentation of the contractor’s process for validating the data used in the lender risk rating system, but documentation of the results of the validations was inconsistent and did not have information on the procedures for validating the model’s processes. For example: The validation reports we reviewed (2005 to 2007) did not always include information on the statistical measure the contractor used to describe the model’s predictive abilities. The 2006 validation report did not contain this statistic for the 7(a) ratings, and only the 2007 report included it for 504 lender risk ratings. The validation reports did not describe the contractor’s validation procedures. As noted previously, SBA did not provide documentation showing that the contractor validated the mathematics and computer code used in the model. The validation reports did not explain why in 2005 the contractor considered whether additional variables would improve the model’s ability to predict lender performance but did not consider additional variables in other years. The validation reports did not describe any limitations of the model that would have helped SBA to use the results accurately. Officials from the contractor explained that the documentation provided was typical of that seen in the private sector for such models, but stated that they would provide more detailed documentation in the future. Because SBA does not ensure that its contractor completely documents its validation procedures and results, it is difficult to assess the sufficiency of the validations performed. Further, as we noted previously, it is important for an independent party to validate a model’s reliability. Without clear documentation explaining the model’s limitations, the validation procedures, and the results of the validations, an independent reviewer would have difficulty conducting a thorough assessment of SBA’s model. SBA Does Not Use Its Own Data to Assess or Supplement the Contractor’s Validation of the Lender Risk Rating System In addition to not ensuring that its contractor follows sound validation techniques, SBA does not conduct its own analysis of data to supplement the contractor’s validation of the lender risk rating system. According to the Basel Committee guidance we reviewed, organizations must have clearly articulated strategies for regularly reviewing the results of vendor models and the integrity of the external data used in these systems. Further, OCC guidance states that vendor models should generally be held to the same minimum validation standards as internally developed models. When full and complete details concerning aspects of a vendor product are lacking, OCC and Basel Committee guidance states that organizations should rely more heavily on alternative validation techniques to compensate for the lack of access to full information. This guidance notes that in such cases, it is critical for organizations to test the results of the vendor’s model at least once a year using their own data on actual performance to assess the model’s predictive ability. This procedure helps to ensure that the models continue to function as intended and verifies the reliability and consistency of any external data used. Our internal control standards state that monitoring should be performed continually and that it should involve comparisons and reconciliations. For example, these standards specify that agencies should compare information generated from computer systems to actual records. Agencies should also analyze and reconcile any differences that might be found. SBA does not use its own data to independently assess the lender risk rating system’s results. According to a 2007 SBA Inspector General report, SBA has previously rejected using its own data to develop lender performance benchmarks that could be used in lieu of or in conjunction with the risk ratings because doing so would be time-consuming and the benchmarks would have to be monitored and replaced as program and economic conditions changed. However, we found that SBA data could be useful for developing alternate measures of lender performance in order to independently validate the lender risk rating system’s results. For example, SBA could perform analyses similar to those we performed by using its own data to compare risk ratings with actual lender default rates. Further, SBA could use its own data to develop alternate measures, such as currency rates, as performance benchmarks. As we did in our analyses, SBA could compare how well lender risk ratings predicted actual performance to how well an alternate measure demonstrated lender’s actual performance. Because of data limitations, our analyses focused on lenders with larger SBA-guaranteed portfolios. As a result, we were unable to determine how well these alternate measures predict the performance of lenders with smaller portfolios, but SBA has more years of data available to facilitate such analyses. Without performing its own assessment, the agency may not be able to identify issues with the model’s ability to reasonably predict lender performance and notify the contractor. As a result, SBA may miss opportunities to identify risky lenders and mitigate the risks they pose to SBA’s portfolio. SBA Does Not Use Lender Risk Ratings to Target Lenders for On-Site Review or Tailor the Scope of the Reviews SBA Has Used the Lender Risk Rating System to Conduct Some Off-Site Monitoring of Lenders and Their Portfolios SBA uses its lender risk rating system to conduct off-site monitoring of lenders and their portfolios. In addition to routine on-site reviews, federal financial regulators and lenders use off-site tools to monitor lenders’ performance and portfolio trends. As part of a comprehensive risk management strategy, federal financial regulators use risk ratings to conduct portfolio analysis and identify problem trends. FDIC relies on a number of off-site monitoring tools to perform horizontal analyses (that is, compare similar lenders) and analyze emerging lending trends. For example, when subprime lending first began, the agency tracked the amount of subprime lending that each of its lenders did. The Federal Reserve uses various off-site monitoring tools that focus on asset quality and credit risk to identify banks whose ratings appear to have deteriorated since their most recent on-site reviews. For example, it analyzes information related to nonperforming and performing loans and the changing composition of loan concentrations. OCC uses its core assessment process to assess how much risk lenders have taken on and the quality of their risk management to determine aggregate risk. Lenders also use off-site monitoring tools to oversee loan portfolios. For example, one 7(a) lender we interviewed uses various scoring models to determine, among other things, how each loan’s risk rating has changed since the loan was originated. Other 7(a) lenders with whom we spoke use off-site monitoring tools that analyze factors such as geography, industry, management quality, company performance, and collateral to predict the risk of loans. Another 7(a) lender relies on several off-site monitoring systems to track portfolio performance—including delinquencies and trends by state, industry, and North American Industry Classification System (NAICS) code—and forecast losses. In addition, bank officials we interviewed stated that they reviewed all troubled loans on a monthly basis. Similarly, SBA uses its lender risk rating system to obtain quarterly performance information on all lenders and determine portfolio trends. SBA officials stated that before they had the risk rating system, they were not able to analyze the performance of all lenders, especially lenders with the smallest volume of SBA-guaranteed loans. SBA has formed a Portfolio Analysis Committee that meets monthly to discuss portfolio trends identified by analyzing loan and lender performance data. Comprised of top SBA officials, the committee typically discusses delinquencies, liquidations, charge-offs, and purchase rate trends by delivery method (that is, various SBA loan programs) for the 7(a) and 504 portfolios. The committee also discusses changes in loans’ SBPSs (from the end of the quarter in which the loan was disbursed to the most recent quarter) and the scores’ performance in ranking loans. To date, SBA has taken some actions as a result of these meetings. For example, SBA officials told us that as a result of discussions about portfolio performance during these meetings, they discontinued an SBA program that allowed borrowers to provide limited documentation. SBA officials told us that the agency also recently began using the results of the lender risk rating system to conduct “performance-based reviews.” According to SBA officials, the purpose of these reviews is to perform more in-depth, off-site monitoring that incorporates lenders’ information, such as lender financial ratios from call reports, that is currently not part of the lender risk rating system. Specifically, SBA financial analysts are assigned lenders that they will monitor over time. Each year, the analysts will focus on lenders with outstanding balances on their SBA portfolios of at least $10 million that are not scheduled for on-site reviews and on all other preferred lenders regardless of size. With the remaining resources, they will review small problem lenders—for instance, those with guaranteed portfolios that are less than $10 million but that received a lender risk rating of 4 or 5. SBA had conducted 517 of these reviews as of August 2009. SBA Has Not Effectively Integrated Its Lender Risk Rating System into the On- Site Examination Process Although SBA has begun some off-site monitoring using its risk rating system, it does not use the ratings to target lenders for on-site reviews. FDIC and the Federal Reserve use risk ratings as the primary tool for identifying lenders that need to be reviewed. For example, FDIC stated that they relied on off-site monitoring to determine the scope and frequency of on-site exams. Our internal control standards require that agencies assess and mitigate risks using quantitative and qualitative methods and then conduct a thorough and complete analysis of those risks. Although SBA identifies the risks that lenders pose, it does not mitigate these risks because it chooses not to target high-risk 7(a) and 504 lenders for on-site reviews. Instead, the agency targets lenders for reviews based on the size of their portfolios, focusing primarily on the largest lenders—that is, 7(a) lenders with at least $10 million in their guaranteed loan portfolio and 504 lenders with balances of at least $30 million. Only when prioritizing large lenders for review does SBA consider their risk ratings. We found that in calendar years 2005 to 2008, most of SBA’s 477 on-site reviews were of large 7(a) and 504 lenders that posed limited risk to SBA. Ninety-nine percent (472 of 477) of the lenders reviewed were large lenders, and 80 percent (380 of 477) posed limited risk to SBA (that is, were rated as a 1, 2, or 3 by the lender risk rating system). The agency has increased the number of on-site reviews performed (from 69 in 2005 to 188 in 2008) because it can now charge lenders for them. However, SBA continues to conduct a limited number of reviews of high-risk lenders or those with a lender risk rating of 4 or 5 (see fig. 4). In 2005, 20 percent (14 of 69) of SBA’s on-site reviews were of lenders that posed significant risk to the agency. In 2008, that proportion was 22 percent (42 of 188 reviews). As a result, a substantial number of high-risk lenders were not reviewed each year. For example, in 2008, only 3 percent of the 1,587 lenders that posed significant risk to SBA were reviewed. Because SBA relies on lenders’ size to target lenders for on-site reviews, smaller lenders that, based on their high-risk ratings, pose significant risk to SBA have not received oversight consistent with their risk levels. Our findings are similar to those of SBA’s Inspector General. In a 2007 report, the Inspector General concluded that SBA had made limited use of lender risk ratings to guide its oversight activities. It observed that the agency reviewed large lenders regardless of their risk ratings and did not do on-site reviews of smaller lenders with high-risk ratings. The report recognized that some of the smaller lenders might not have a sufficient number of loans in their portfolio to warrant an on-site review but noted that others could have a significant number of loans. The Inspector General recommended that SBA develop an on-site review plan or agreed- upon procedures for all high-risk 7(a) lenders with guaranteed loan portfolios in excess of $4 million. We agree that although not all of the small lenders with high-risk ratings warrant more targeted monitoring, some do. Of the 1,545 high-risk lenders that we found were not reviewed in 2008, 215 lenders had an outstanding portfolio of at least $4 million. According to SBA officials, the agency is developing agreed-upon procedures for conducting additional reviews of smaller lenders in response to the Inspector General’s recommendation. Lender Risk Ratings Do Not Inform the Scope of SBA’s On-Site Reviews, and Reviews Do Not Include an Assessment of Lenders’ Credit Decisions Unlike federal financial regulators, SBA does not rely on its lender risk ratings to help focus the scope of on-site reviews, and the reviews do not include an assessment of the lenders’ credit decisions. The federal financial regulators we interviewed rely on results from their off-site monitoring systems to identify which areas of a bank’s operations they should review more closely. Using the results of the off-site monitoring, they are able to tailor the scope of their on-site reviews to the specific areas of lenders’ operations that pose the most risk to the bank. In addition, during on-site reviews, the federal financial regulators often include an assessment of the quality of lenders’ credit decisions. They told us that the results of their on-site reviews helped not only to assess the risk that lenders posed, but also to identify emerging lending trends and areas of banking operations that may pose significant, new risk to banks in the future. They are then able to use the results to inform their off-site monitoring systems. For example, regulators stated that when their on-site reviews showed an increase in subprime lending, they incorporated subprime lending data into their off-site monitoring tools. Although SBA’s mission differs from the mission of the federal financial regulators, internal control standards require all federal agencies to identify and analyze risk, as well as to determine the best way to manage or mitigate it. According to SBA’s Standard Operating Procedure for on-site reviews, the agency assesses a lender’s (1) portfolio performance, (2) SBA management and operations, (3) credit administration practices, and (4) compliance with statutes and SBA regulations and policies. For the portfolio performance component, SBA uses L/LMS data to review the size, composition, performance, and credit quality of a lender’s SBA portfolio. When assessing a lender’s SBA operations, SBA evaluates, among other things, the lender’s internal policy and procedural guidance on SBA lending; the competence, leadership, and administrative ability of management and staff who have responsibility for the SBA loan portfolio; and the adequacy of the lender’s internal controls. For the credit administration component, SBA assesses the lender’s policies and procedures for originating, servicing, and liquidating SBA loans. An SBA contractor then uses this information during file reviews to determine the degree to which lending policies and procedures are followed. For the compliance component, SBA’s contractor performs file reviews that focus on the lender’s compliance with SBA-specific requirements. When performing file reviews, contractor staff do not rely on results from the lender risk rating system to tailor the scope of the reviews. Instead, contractor staff rely on a standard form—the lender review checklist—to conduct all file reviews, regardless of the lender risk rating or other information available to SBA about the lender’s portfolio. Moreover, these file reviews do not include an assessment of the quality of the credit decisions made by lenders. Rather, the lender review checklist focuses primarily on the lenders’ adherence to SBA policies, including those based on statutes or regulations, when making SBA-guaranteed loans. The checklist includes questions related to, among other things, the determination of borrower eligibility (including whether the borrower had any other outstanding SBA loans that are not current), the calculation of collateral value, and evidence that all required forms were obtained and reviewed. According to SBA officials, the file reviews focus on compliance with SBA policy because it is not SBA’s role to evaluate lenders’ credit decisions. The officials did not believe that the agency should be setting policy or underwriting standards for lenders. However, because SBA relies on lenders with delegated underwriting authority to make the majority of its loans, we believe that SBA should take a more active role in ensuring that these lenders are making sound credit decisions. We originally reported on SBA’s compliance-based reviews in 2002, when we found that SBA’s automated checklist lacked the substance to provide a meaningful assessment of lender performance. We reported that SBA’s on-site reviews were based on reviewers’ findings from a lender questionnaire and a review checklist in order to ensure objective scoring. The lender questionnaire addressed organizational structure, oversight policy, and controls. SBA officials said that prior to the implementation of the automated worksheet scoring process, on-site reviews were done in a narrative format, and reviewers’ assessments of lender performance were subjective. They noted that the worksheet format made the reviewers’ assessments of lenders more consistent and objective. As previously mentioned, SBA has since expanded the scope of its on-site reviews to include more than just a compliance component and revised the checklist used to conduct file reviews. But, as noted previously, the revised checklist still focuses on compliance with SBA policies and procedures. An example from our February 2009 report on compliance with the credit elsewhere requirement illustrates SBA’s emphasis on ensuring policy compliance rather than verifying lenders’ credit decisions during on-site reviews. Because the 7(a) and 504 programs are intended to serve borrowers who cannot obtain conventional credit at reasonable terms, lenders making 7(a) and 504 loans must ensure that borrowers meet the credit elsewhere requirement. This statutory requirement stipulates that to receive loans, borrowers must not be able to obtain financing under reasonable terms and conditions from conventional lenders. During an on- site review, the contractor is to determine whether lender policies and practices adhere to SBA’s credit elsewhere requirement. During the review, SBA’s contractor explained that it checks to see that the lender documented its credit elsewhere determination and cited one of the six factors that SBA has determined are acceptable reasons for concluding that a borrower could not obtain credit elsewhere. However, it does not routinely assess the information lenders provide to support credit elsewhere determinations. Contract staff answer “yes” or “no” on the checklist that “written evidence that credit is not otherwise available on terms not considered unreasonable without guarantee provided by SBA” was in the file. Contractor officials stated that when the documentation standard is not met, the examiner will sometimes look at the factual support in the file to independently determine whether the credit elsewhere requirement was actually met. Because SBA officials choose not to rely on lender risk ratings to inform file reviews conducted during on-site reviews or assess lenders’ credit decisions during the reviews, the agency does not have the type of information related to the quality of the underwriting standards and practices of lenders that is necessary to understand the risks that banks pose to SBA’s portfolio. Without this information, the agency cannot make informed improvements to the lender risk rating system that would enable it to take into account new emerging lending trends. Conclusions Because SBA relies heavily on its lenders to determine if loans are eligible for an SBA guarantee and to underwrite the loans, lender oversight is of particular importance. By working with a contractor to develop a lender risk rating system, SBA has taken a positive step toward improving its oversight of lenders. The lender risk rating system enables SBA for the first time to systematically and routinely monitor the performance of all lenders, including lenders with the smallest loan portfolios, which SBA had not routinely monitored. However, SBA does not ensure that its contractor follows sound practices when validating the system. Guidance from the federal financial regulators we interviewed states, among other things, that validation should be performed by an independent party and should routinely reassess the factors used to determine risk, taking into consideration changes in the environment (such as changes in industry trends). SBA did not require its contractor to ensure that personnel other than the staff who developed the model validated it or to routinely reassess the factors used in the system as part of its validations. Unless SBA ensures that its contractor follows sound model validation practices, the agency’s ability to identify inaccurate ratings, detect systemic or structural issues with the design of the model, and determine whether the ratings are deteriorating over time as economic conditions change will be limited. SBA’s contractor is currently redeveloping the lender risk rating system to improve its predictive ability. However, the benefits that may be achieved through the redeveloped lender risk rating system will be limited if SBA continues the practice of not ensuring that its contractor adopts sound validation practices. In particular, testing to ensure that the system effectively evaluates risk is an important element to improve a risk rating system, regardless of whether such testing occurs during routine validation efforts or during model redevelopment. In addition, contrary to federal financial regulator guidance and our internal control standards, SBA has not used its own data to conduct independent assessments of the risk rating system to help ensure the usefulness of the risk ratings. We found that SBA data could be useful for developing alternate measures of lender performance in order to independently validate the lender risk rating system’s results. Without performing its own assessment, the agency may not be able to identify issues with the model’s ability to reasonably predict lender behavior or to notify the contractor of any suspected deterioration. As a result, SBA may miss opportunities to identify risky lenders and mitigate the risks they pose to SBA’s portfolio. If SBA improves its validation of the lender risk ratings, the agency could rely more on them to determine which lenders need an on-site review. Currently, unlike FDIC and the Federal Reserve, SBA does not take full advantage of its risk ratings to set the schedules for on-site reviews. The agency targets lenders for on-site reviews based on size rather than risk level. As a result, we found that SBA conducted on-site reviews of only 3 percent of the lenders that the lender risk rating system identified as high risk in 2008. Of these, 215 had an outstanding SBA portfolio of at least $4 million. Relying more on the risk ratings to target lenders for review would enable the agency to focus on the lenders that pose the most risk to the agency. Although SBA has made improvements to its off-site monitoring of lenders, the agency will not be able to substantially improve its lender oversight efforts unless it improves its on-site review process. Federal financial regulators rely on results from their off-site monitoring to tailor the scope of their on-site reviews. SBA does not rely on its lender risk ratings to inform file reviews conducted during on-site reviews but rather consistently uses a checklist to examine lenders. In addition, federal financial regulators routinely assess the quality of lenders’ credit decisions as part of their on-site examination process. SBA fails to include this component but instead focuses more on compliance with SBA policies and procedures. For example, rather than assessing the quality of lender underwriting, contractor staff focus on whether lenders ensured that the borrowers met eligibility requirements, including whether borrowers had any other outstanding SBA loans that are not current. By including an assessment of lenders’ credit decisions as a routine part of their on-site review process, SBA would be able to determine the quality of the lenders’ underwriting standards and practices and make any necessary changes to its lender risk rating system to ensure that the tool is relevant and includes emerging lending trends. Recommendations for Executive Action We recommend that the Administrator of the Small Business Administration take the following four actions: To ensure that the lender risk rating system effectively evaluates risk, when validating the system and undertaking any redevelopment efforts, the Administrator should ensure that SBA’s contractor follows sound model validation practices. These practices should include (1) testing of the lender risk rating system data, processes, and results, including a routine reassessment of which factors are the most predictive of lender performance; (2) utilizing an independent party to conduct validations; and (3) maintaining complete documentation of the validation process and results. use SBA’s own data to assess how well the lender risk ratings predict individual lender performance. To make better use of the lender risk rating system in SBA’s oversight of lenders, the Administrator should develop a strategy for targeting lenders for on-site reviews that relies more on SBA’s lender risk ratings. consider revising SBA policies and procedures for conducting on-site reviews. These revised policies and procedures could require staff to (1) use lender risk ratings to tailor the scope of file reviews performed during on-site reviews to areas that pose the greatest risk, (2) incorporate an assessment of lenders’ credit decisions in file reviews, and (3) use the results of expanded file reviews to identify information, such as emerging lending trends, that could be incorporated into its lender risk rating system. Agency Comments and Our Evaluation We requested SBA’s comments on a draft of this report, and the Associate Administrator of the Office of Capital Access provided written comments that are presented in appendix II. SBA generally agreed with our recommendations and outlined some steps that it plans to take to address them. The agency also provided one technical comment, which we incorporated. SBA provided detailed comments on each of our four recommendations. In response to our recommendation to ensure that SBA’s contractor follows sound model validation techniques, SBA noted that the agency is currently undertaking a redevelopment of its lender risk rating system and plans to ensure that best practices are incorporated into the redevelopment validation process. According to the agency, the redevelopment contract will give SBA greater flexibility to reassess the predictiveness of the factors used in the model and to refine the model if necessary. SBA stated that it is also developing an independent review process as well as increasing the level of documentation of the validation process. Regarding our recommendation to use its own data to assess how well the lender risk ratings predict individual lender performance, SBA stated that although it remains confident that the lender risk ratings provide accurate predictions, the agency will determine whether alternative measures would be useful to supplement the lender risk ratings. In response to our recommendation to develop a strategy for targeting lenders for on-site review that relies more on the lender risk ratings, SBA stated that it agreed with our finding that between 2005 and 2008 on-site reviews had been limited and primarily focused on the largest lenders, but pointed out that the agency had significantly increased the number of lenders reviewed since it began charging for on-site reviews late in fiscal year 2007. The agency also noted that the largest lenders account for approximately 85 percent of SBA’s entire guaranteed portfolio, while the high-risk lenders that were not reviewed in 2008 represent 2 percent of SBA’s total 7(a) and 504 portfolios. In our report, we recognize that while not all of the small lenders with high risk ratings warrant more targeted monitoring, some do. Of the 1,545 high-risk lenders that we found were not reviewed in 2008, 215 lenders had significant portfolios—that is, portfolios of at least $4 million. While SBA indicated that it plans to continue to focus on-site reviews on the largest lenders that account for the majority of the guaranteed portfolio, it stated that it will consider revising its internal policies to make better use of the lender risk ratings to prioritize on-site reviews. Regarding our recommendation to consider revising policies and procedures for conducting on-site reviews, SBA stated that the agency is in the process of reprocuring its on-site review contract. According to the agency, SBA included the ability to conduct on-site reviews that can be better tailored to specific concerns about individual lender performance as part of the reprocurement process. SBA also stated that the agency is in the process of evaluating our recommendation to include an assessment of lender credit decisions in the on-site review process and will investigate ways to use the results of the on-site reviews to inform the lender risk rating system. As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies of this report to interested congressional committees, the Administrator of the Small Business Administration, and other interested parties. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staffs have any questions about this report, please contact me at (202) 512-8678 or shearw@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix V. Appendix I: Objectives, Scope, and Methodology In this report, we examined (1) how the Small Business Administration’s (SBA) risk rating system compares with the off-site monitoring tools used by federal financial regulators and lenders and the system’s usefulness for predicting lender performance and (2) how SBA uses the lender risk rating system in its lender oversight activities. To determine how SBA’s lender risk rating system compares with off-site monitoring tools used by federal financial regulators and lenders, we conducted interviews and reviewed documents to identify common industry standards. We interviewed officials from three federal financial regulators—the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (the Federal Reserve), and the Federal Deposit Insurance Corporation (FDIC)—five of the largest 7(a) lenders, and the five largest 504 lenders. We identified the largest lenders based on the size of their SBA-guaranteed portfolio in 2007, the most recent data available when we began our review. The documents we reviewed included relevant literature, procedural manuals and other related federal guidance to banks on loan portfolio monitoring, and lender procedural manuals. We then obtained and analyzed documents from SBA on its lender risk rating system and conducted interviews with agency and contractor officials responsible for maintaining the system to determine how the system was developed and validated. We assessed SBA’s lender risk rating system against common industry standards and our internal control standards. In addition, we reviewed our previous work on SBA and guidance on model validation from the Basel Committee on Banking Supervision, which provides a forum for banking regulators from around the world to regularly cooperate on banking supervisory matters and develop common guidelines. To assess the lender risk rating system’s usefulness for predicting lender performance, we performed independent statistical tests to determine how well it predicted individual lender performance. To perform these tests, we first obtained the following data from SBA: administrative data on loans approved in 2003 through the end of 2007 (including the date the loan was approved, the size of the loan, and whether and when the loan was purchased); the March 2007 and March 2008 lender performance reports containing risk ratings; and the currency rate for each lender. We assessed the reliability of these data by reviewing information about the data and performing electronic data testing to detect errors in completeness and reasonableness. We found that the data were sufficiently reliable for the purposes of this report. Using SBA’s data, we undertook a number of evaluative steps to test the agency’s model. First, we assessed how well the lender risk ratings predicted lender default rates (our measure of actual lender performance). In order to test how well the lender risk ratings predicted lender performance, we estimated how well a lender performed during either the year or 6 months after the score was developed (depending on the amount of data available) using a logit regression. A logit regression is a statistical technique that estimates how the odds of an outcome changes with an attribute of the unit of analysis. In our case, we estimated how the odds of a loan being purchased by SBA varied by the lender that made the loan. Additionally, we controlled for the age of loans and how default rates for all loans changed over the year or 6 months. To control for the age and changing default rates over time, we employed a methodology called a discrete time hazard model. We restructured the data so that there was a separate observation for every quarter that a loan was at risk of being purchased. Then we estimated a logit regression and predicted whether the loan was purchased that quarter. In that regression, we included a dummy variable for each lender, a dummy variable for each quarter, and a dummy variable for each quarter since that loan was approved, to capture the age of the loan. The following describes the regression equation we used: P(loan i was purchased at time t) = logit(α ,α ,α ) where the parameters of interest, α, can be transformed to express the relative odds of a loan being purchased or defaulting for each lender, with one lender excluded as a reference. We used the coefficients α as the measures of lender risk. In addition, the coefficients α control for the differential rate of default by time period, and the coefficients α control for the age of the loans. Once we estimated the performance for each lender, we matched it with each lender’s record in the lender performance report, which contained the risk rating. For 7(a) loans, we matched our performance measures with the lender risk rating using a “crosswalk” file obtained from SBA. Because the data we obtained from SBA only included loans that were approved from January 2003 to December 2007 and a lender had to have made at least 100 loans during that time period to make our analysis meaningful, we were only able to obtain measures for 308 of the 4,673 7(a) lenders in the March 2008 lender performance report. We were more likely to obtain measures for larger lenders. For example, we were able to obtain measures for 56 of the 60 lenders with more than $100 million in outstanding SBA-guaranteed loan balances. In all, the 308 lenders, plus the lender excluded as the reference case, represented approximately 79 percent of the outstanding balance and 85 percent of the outstanding loans reported in the March 2008 lender performance report. For 504 lenders, we were able to obtain measures for 86 of the 270 lenders. We were able to obtain 47 of the 48 lenders in the largest peer group—that is, those lenders with more than $100 million in outstanding SBA-guaranteed loan balances. To determine how SBA uses the lender risk rating system in its lender oversight activities, we reviewed agency documents and conducted interviews to document SBA’s practices for assessing and monitoring the risk of lenders and loan portfolios. We then compared these practices against (1) the industry standards we identified through our interviews with federal financial regulators and lenders and reviews of their documents and (2) our internal control standards. We also obtained and analyzed SBA data on risk ratings and on-site examinations from 2005 through 2008 to determine the role that the lender risk ratings played in identifying lenders for an on-site review. To analyze the data on risk ratings and on-site examinations, we had to make a number of assumptions because the risk ratings were reported by quarter and we planned on reporting them by year. First, we assigned lender risk ratings in two different ways. For those lenders that were reviewed, we assigned them the risk rating that they received during the quarter that immediately preceded the on-site review. For those lenders that were not reviewed, we assigned them the lowest risk rating that they received during that given year. Second, we assigned lenders to peer groups in two different ways. For those lenders that were reviewed, we assigned them the peer group that they were in during the quarter that immediately preceded their on-site review. For those lenders that were not reviewed, we assigned them the peer group they were in when they received their lowest risk rating. Because lenders are assigned a risk rating four times in a given year, there were some instances when they received the same low-risk rating multiple times in a given year but were in different peer groups when these ratings were assigned. In these instances, we relied on the most recent, lowest-risk rating score. For example, a lender could have received a lender risk rating of 4 in the second, third, and fourth quarter of a given year. However, the lender was in the highest peer group during the second and third quarters and in the second highest peer group in the fourth quarter. We would rely on the most recent quarter’s information and assign this lender a risk rating of 4 and the second highest peer group. Third, we determined the on-site review date in two ways. For on-site reviews completed in 2005 and 2006, we relied on the date that the final report for the on-site review was issued to determine when an on-site review was completed. For on-site reviews completed in 2007 and 2008, we were able to rely on an additional variable included in the data that identified the date the on-site review was completed to determine when the on-site review was completed. We conducted this performance audit from August 2008 to November 2009 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Comments from the Small Business Administration Appendix III: Predictive Performance of the March 2007 and March 2008 Lender Risk Ratings We performed two types of statistical tests to determine how well SBA’s lender risk ratings predicted individual lender performance. For both tests, we focused on how well the March 2007 lender risk ratings predicted the performance of lenders for the following year and how well the March 2008 lender risk ratings predicted the performance of lenders for the following 6 months. First, we compared raw scores from SBA’s lender risk rating system to actual default rates for 7(a) and 504 lenders to determine how well the lender risk ratings identified the best and worst performing lenders. We divided lenders into two groups—those with lender default rates in the top 50 percent of all lender default rates and those with default rates that were in the bottom 50 percent of all lender default rates. We found that SBA’s risk ratings were generally successful at distinguishing the performance of about two-thirds of the 7(a) and 504 lenders in our sample (see tables 2 and 3). For example, table 2 shows that 96 of the approximately 300 lenders in our sample were in the top 50 percent based on the March 2007 lender risk ratings and actual lender default rates, while another 99 lenders were in the bottom 50 percent based on both rankings. We also compared how well an alternate measure of lender performance—the currency rate—divided lenders into these same two performance groups and found that overall, it also correctly separated about two-thirds of the lenders in our sample. We used the same data to perform the second statistical test: determining the correlation between the rankings based on lender default rates and (1) the lender risk ratings and (2) the alternate measure—currency rate. We found that for both 7(a) and 504 lenders, there was a positive correlation between actual performance (lender default rates) and the lender risk ratings and currency rate. For the largest 7(a) lenders (that is, those lenders with SBA-guaranteed portfolios of at least $100 million), the lender risk ratings were more correlated to the lender default rates than was the currency rate. For 504 lenders, we found that both measures—the lender risk rating and the currency rate—performed about the same (see table 4). Appendix IV: Small Business Predictive Score The Small Business Predictive Score (SBPS) predicts loan performance. Specifically, it predicts the likelihood of severe delinquency (61 or more days past terms) over the next 18 to 24 months, including bankruptcies and charge-offs. It is an off-the-shelf product that was developed by Fair Isaac using consumer and business credit bureau data. The model is able to produce scores—ranging from 1 to 300, 1 being highest risk and 300 being lowest risk—using either a mix of consumer and business data, only data from the consumer credit bureaus, or only business data from Dun & Bradstreet. According to SBA officials, approximately 74 percent of its 7(a) loans and 83 percent of its 504 loans are scored using both consumer and business data. Approximately 17 percent of its 7(a) loans and 8 percent of its 504 loans are scored using consumer data only, while 9 percent of its 7(a) loans and 504 loans are scored with Dun & Bradstreet data only. As we reported in 2004, Dun & Bradstreet collects these data from various sources and processes them through a five-step quality assurance process. First, Dun & Bradstreet collects data from more than 150 million businesses globally and continuously updates its databases more than 1 million times daily based on real-time business transactions. Second, it matches SBA records with its records and achieves at least a 95 percent match of the data on 11 critical pieces of information used to identify the borrower. Third, Dun & Bradstreet assigns a unique identifier to each company. Fourth, Dun & Bradstreet identifies the corporate linkage of a business’s branches or subsidiaries with their parent entity to help SBA understand their complete corporate exposure between borrowers and their parent entities. Finally, Dun & Bradstreet generates predictive indicators of a business’s potential inability to repay a loan. Dun & Bradstreet officials refer to this process as the DUNSRight process. We performed independent tests to determine how well the SBPS predicted the performance of 7(a) loans. Specifically, we used a logit regression to determine how well the SBPS at loan origination predicted the default of loans with disbursement amounts above and below $150,000. We examined loans that were approved between 2003 and 2007 and default rates over the period of January 2007 to September 2008. We found that the origination SBPS was predictive for loans that were both less than $150,000 and more than $150,000. However, the SBPS was estimated to have a larger effect on the performance of loans that were less than $150,000. Table 5 shows the coefficients from the logistic regression we ran. The coefficient estimated for the sample of loans that were less than $150,000 is more negative than that for loans that were more than $150,000, indicating that an increase in the SBPS (which represents a decrease in the predicted risk of the loan) lowers the rate of default by a greater increment. Additionally, as shown in the last column, the difference in the coefficients between the two groups is statistically significant. Appendix V: GAO Contact and Staff Acknowledgments Staff Acknowledgments In addition to the contact named above, Paige Smith (Assistant Director), Triana Bash, Ben Bolitzer, Tania Calhoun, Emily Chalmers, Marc Molino, Jill Naamane, Anh Nguyen, Carl Ramirez, and Stacy Spence made key contributions to this report.

The Small Business Administration (SBA) guarantees individual loans that lenders originate. The agency uses its Loan and Lender Monitoring System (L/LMS) to assess the individual risk of each loan, and SBA's contractor developed a lender risk rating system based on L/LMS data. However, questions have been raised about the extent to which SBA has used its lender risk rating system to improve its oversight of lenders. The Government Accountability Office (GAO) was asked to examine (1) how SBA's risk rating system compares with those used by federal financial regulators and lenders and the system's usefulness for predicting lender performance and (2) how SBA uses the lender risk rating system in its lender oversight activities. To meet these objectives, GAO reviewed SBA documents; interviewed officials from three federal financial regulators and 10 large SBA lenders; analyzed SBA loan data; and interviewed SBA officials. SBA's lender risk rating system uses some of the same types of information that federal financial regulators and selected large lenders use to conduct off-site monitoring, but its usefulness has been limited because SBA has not followed common industry standards when validating the system--that is, assessing the system's ability to accurately predict outcomes. Like the federal financial regulators and 10 large lenders GAO interviewed, SBA's contractor developed lender risk ratings based on loan performance data and prospective, or forward-looking, measures (such as credit scores). Using SBA data, GAO undertook a number of evaluative steps to test the lender risk rating system's predictive ability. GAO found that the system was generally successful in distinguishing between higher- and lower-risk lenders, but it better predicted the performance of larger lenders. However, the system's usefulness was limited because the contractor did not follow validation practices, such as independent and ongoing assessments of the system's processes and results, consistent with those recommended by federal financial regulators and GAO's internal control standards. For example, the agency did not require a party other than the one who developed the system to perform the validation, and SBA's contractor did not routinely reassess the factors used in the system as part of its validations. Further, SBA does not use its own data to develop alternate measures of lender performance that could be used to independently assess or supplement the risk ratings, citing resource constraints. Because SBA does not follow sound validation practices or use its own data to independently assess the risk ratings, the effectiveness of its lender risk rating system--the primary system SBA relies on to monitor and predict lender performance--may deteriorate as economic conditions and industry trends change over time. Although SBA's lender risk rating system has enabled the agency to conduct some off-site monitoring of lenders, the agency does not use the system to target lenders for on-site reviews or to inform the scope of the reviews. Unlike the Federal Deposit Insurance Corporation and the Federal Reserve, which use their off-site monitoring tools to target lenders for on-site reviews, SBA targets for review those lenders with the largest SBA-guaranteed loan portfolios. As a result of this approach, 97 percent of the lenders that SBA's risk rating system identified as high risk in 2008 were not reviewed. Further, GAO found that the scope of the on-site reviews that SBA performs is not informed by the lenders' risk ratings, and the reviews do not include an assessment of lenders' credit decisions. The federal financial regulators use the results of off-site monitoring to identify which areas of a bank's operations they should review more closely. Moreover, their reviews include an assessment of the quality of the lenders' credit decisions. Federal financial regulators are able to use review results to update their off-site monitoring systems with data on emerging lending trends. Regardless of the lender's risk rating, SBA relies on a standard on-site review form that includes an assessment of lenders' compliance with SBA policies and procedures but not an assessment of lenders' credit decisions. According to SBA officials, it is not the agency's role to assess lenders' credit decisions. Without targeting the most risky lenders for on-site reviews or gathering information related to lenders' credit decisions, SBA cannot effectively assess the risk posed by lenders or ensure that its lender risk rating system incorporates updated information on emerging lending trends.

Background The Energy Star program was introduced by the U.S. Environmental Protection Agency (EPA) in 1992, under the authority of the Clean Air Act, as a voluntary labeling program designed to promote—and a llow consumers to identify—energy-efficient computers and monitors. Through 1995, EPA expanded the label to additional office equipment and residential heating, ventilation, and cooling (HVAC) equipment, and partnered with the U.S. Department of Energy (DOE) in 1996. The Energy Star label is now found on over 60 product categories, including major appliances, office equipment, lighting, home electronics, new homes, and commercial and industrial buildings, with a reported energy-efficiency savings of up to 10 to 25 percent over the minimum federal standards. As of 2009, over 40,000 individual product models were Energy Star-qualified by over 2,400 manufacturers. Manufacturers who wish to use the Energy Star logo must enter into a Partnership Agreement with either the EPA or DOE, under which the manufacturer agrees to comply with Energy Star eligibility criteria and identity guidelines. Manufacturers apply to be a partner of the Energy Star program by identifying which product category or categories under which the company seeks to qualify products, completing a partne rship agreement packet, certifying their agreement to the general program requirements, and submitting the packet to EPA or DOE contractors either online or via mail. The Energy Star program provides approved partners with usernames and passwords so that they may access logos and other marketing materials directly from the Energy Star Web site. The use of the logo on products and promotional materials must be consistent with the Energy Star identity guidelines. Figure 1 below shows the Energy Star partnership and product certification logos. Manufacturers who make products that meet Energy Star specifications must then report each product’s specifications by submitting Qualified Product Information (QPI), using either the QPI forms available on the Energy Star site, or for certain products (home electronics and office equipment) by using the Online Product Submittal (OPS) Tool. Certain product categories require third-party independent testing results to be submitted in addition to the QPI forms. The criteria for Energy Star product qualification vary depending on the specific product category and whether the product is for residential or commercial use. Generally, qualified Energy Star products are 10 to 25 percent more efficient than required by the federal minimum standard while providing top performance and innovative features. For example, the Compact Fluorescent Light (CFL) bulb requires manufacturers to provide third- party test results from an accredited independent laboratory. In contrast, a refrigerator requires manufacturers to submit a QPI form stating minimal energy efficiency specifications without any third-party test results. Energy Star requires manufacturers to certify in their application that the product meets energy-efficiency specifications for the product type. Energy Star, according to officials, largely relies on manufacturers or others to identify and report products claiming to meet Energy Star criteria that are violating the rules. In that regard, Energy Star officials stated that some companies test products of competitors. The federal government has placed significant emphasis and allocated tax dollars to encourage the use of energy-efficient products. Specifically, federal agencies must procure Energy Star-qualified or DOE Federal Energy Management Program (FEMP)-designated products, unless the head of the agency determines in writing that a statutory exemption applies. The General Services Administration (GSA) and Defense Logistics Agency (DLA) are also required, except in narrow circumstances, to supply only Energy Star or FEMP-designated products for all product categories covered by either program. In addition, the American Recovery and Reinvestment Act (ARRA) of 2009 increased and extended the energy tax credits for homeowners who make energy-efficient improvements to their existing homes. The new law extended the tax credits in place for 2009 to 2010, and increased the tax credit rate to 30 percent of the cost of all qualifying products placed in service in 2 2010, up to a maximum aggregate credit limit of $1,500. removed the cap on the tax credit, currently in place through 2016, of 30 al percent of the cost of materials and installation for installing geotherm te heat pumps and other renewable technologies. DOE also created a sta RA, rebate grant program, with nearly $300 million in funding from the AR for the purchase of new Energy Star-qualified appliances. Under the program, eligible consumers can receive rebates to purchase new energy- efficient appliances and are encouraged to replace used, less efficient appliances. Each state and U.S. territory was allowed to design its own rebate program and all 56 plans have been app roved by DOE. While not part of the Energy Star program, manufacturers may also receive federal tax credits for producing energy-efficient clothes washers, dishwashers, or refrigerators. Efficiency requirements for each particular product are statutorily defined and not reliant on Energy Star standards. 26 U.S.C. §§ 25C – 25D. However, products meeting Energy Star efficiency requirements frequently meet federal tax credit requirements. The Energy Improvement and Extension Act of 2008 modified and extended the manufacturer’s tax credit to eligible models produced in the United States during calendar years 2008, 2009, and 2010. The amount of the credit per unit produced varies according to the energy efficiency of the appliance, with higher energy-efficient models being eligible for larger credits. The aggregate amount of credit allowed with respect to a manufacturer for any taxable year shall not exceed $75 million reduced by the amount of the credit allowed to the taxpayer (or any predecessor) for all prior taxable years beginning January 2008. Exempt from the $75 million limit are the highest energy-efficient categories of refrigerators and clothes washers eligible for the highest per unit tax credits. Based on the Joint Committee on Taxation projections, billions of dollars in energy-efficiency tax credits will be claimed by individuals and corporations between 2009 and 2013. Numerous investigations and reports have recently identified Energy Star program successes and weaknesses. As noted by the Consortium for Energy Efficiency, the EPA Office of the Inspector General (OIG), Consumer Reports, DOE OIG, and a prior GAO report there is currently no requirement for independent third-party verification of energy performance reporting for most product categories prior to gaining access to Energy Star logos and promotional materials. Specifically, in 2007 the EPA OIG stated that there was no evidence that the self-certification process was effective and noted that the Energy Star program lacked in both quality assurance and sufficient oversight. Moreover, the EPA OIG identified that there was no methodology in place to verify manufacturers’ claims of energy efficiency and that products may be labeled with the Energy Star logo and sold prior to submitting certification results to the agency. In addition, an October 2008 issue of Consumer Reports detailed further problems, including lax qualifying standards, federal testing procedures that were outpaced by current technology, and reliance on industry self-policing—manufacturers testing competitors’ appliances and reporting misconduct—without evidence of the effectiveness of that approach. The GAO report mentioned above found that products may qualify for Energy Star status based on criteria other than the estimated total energy consumption. In addition, Consumer Reports and DOE OIG officials found that manufacturers may use computer controls to manipulate energy consumption testing results, and for some categories Energy Star no longer highlighted only the most energy-efficient products in those categories. A recent settlement between DOE and an Energy Star partner has highlighted the potential for noncompliance of products in the program. In January 2010, DOE and Haier America entered into a Consent Decree over an investigation into whether Haier violated DOE’s energy-efficiency standards and Energy Star program requirements for certain freezers. DOE’s investigation led Haier to determine that a parts defect might have caused four standalone upright freezer models to consume more energy than the manufacturer had reported. Additionally, following complaints raised by competitors, LG Electronics and DOE entered into an agreement in 2008 to clarify appropriate energy-efficiency testing methods for certain LG refrigerators. The agreement has led to litigation in federal district court over whether both parties are complying with its terms regarding testing methods. Undercover Tests Result in 15 Products Gaining Bogus Energy Star Certification Our investigation found that companies can easily submit fictitious energy- efficiency claims in order to obtain Energy Star qualification for a broad range of consumer products. Based on our investigative results, we found that the current process for becoming an Energy Star partner and certifying specific products as Energy Star compliant provides little assurance that products with the Energy Star label are some of the most efficient on the market. Control weaknesses associated with the general lack of upfront validation of manufacturer self reported data allowed all of our bogus firms to become Energy Star partners, and allowed most of our products to be certified as Energy Star compliant. Using four bogus manufacturing companies and fictitious identities, we obtained Energy Star partnership, facilitating the submission of bogus products for qualification. We conducted tests of the program by submitting qualified product information (QPI) forms and efficiency information via the Online Product Submittal (OPS) tool for 20 bogus products. Of the products submitted, 15 were approved, 2 were denied Energy Star qualification, and 3 products were voluntarily removed by GAO because we had not received an official qualification determination by the time our investigation was completed. Our proactive testing revealed that the Energy Star program is primarily a self-certification program relying on corporate honesty and industry self-policing to protect the integrity of the Energy Star label. Table 1 below summarizes the certification details of bogus products submitted for Energy Star qualification during the course of our investigation. Energy Star Partnership Agreements We found that companies can easily become an Energy Star manufacturing partner, and subsequently have unlimited access to Energy Star logos and other promotional resources. Using fictitious information, we were able to attain Energy Star partnership for four bogus manufacturing firms, using only Web sites, commercial mailboxes, and cell phones to serve as a backstop corporate presence. To become an Energy Star partner, we submitted an Energy Star partnership commitment form for each bogus company listing basic contact information, a fictitious point of contact, and pertinent manufacturing categories. All four bogus companies were granted Energy Star partnership by EPA and/or DOE within 2 weeks. The bogus companies were granted access to digital logo templates and other marketing materials, without first having any qualifying products. For two of the companies, Energy Star administrators did not review the Web site prior to granting Energy Star manufacturing partner status. For all cases, Energy Star did not call our bogus firms or visit our firm’s addresses. Further, our bogus manufacturing companies received product and service solicitations stemming from partner listing on the Energy Star Web site. For example, one company received requests for large recurring orders of an external power supply adapter, based on the company being listed on the Energy Star Web site. These solicitations are an example of the value placed on being an Energy Star partner, and emphasize why rigorous screening is necessary. Energy Star Product Certifications We successfully obtained Energy Star qualification for 15 bogus products, including a gas-powered alarm clock and a room cleaner represented by a photograph of a feather duster adhered to a space heater on our manufacturer’s Web site. Twenty products were created for proactive testing. Each product submitted met Energy Star guidelines and was selected based on FEMP designation, tax credit eligibility, and the presence of potential preventative controls. The EPA was the overseeing entity for 16 of the products submitted for Energy Star qualification, and the DOE was the overseeing agency for the other 4 products. Of the products submitted to the EPA, 12 were approved, 1 was rejected, and 3 never received a final determination from Energy Star. DOE qualified 3 bogus appliances and rejected a (CFL) bulb due to failure to provide third- party test results from an accredited independent laboratory. Figure 2 below is a photograph displayed on one of our bogus company’s Web site depicting the air room cleaner certified by the energy star program. We found that the level and depth of administrative oversight varied by product category. Qualification response time, scrutiny of product information, and mode of submission of qualifying data varied across products. The product qualification response time from Energy Star varied from minutes to months. For example, a computer monitor submitted for qualification was approved within 30 minutes of submission, whereas the bogus battery charging system and end-use product did not receive a response from officials by the conclusion of our investigative work, a period of over 3 months. Several other products, including a refrigerator, dishwasher, and clothes washer received Energy Star certification within 1 day of submission. We also attained qualification for products with exaggerated efficiency claims submitted via the QPI form with little scrutiny. For example, Energy Star officials approved a dehumidifier, geothermal heat pump, and room air cleaner that were each at least 20 percent of more efficient than all other similar products listed on the Energy Star Web site. We received a request for confirmation that the reported Energy Factor (EF) for our dehumidifier was accurate because it seemed excessive. However, after confirming the EF factor via e-mail without providing additional support, the dehumidifier was qualified. In addition, we were not contacted by Energy Star with questions regarding efficiency performance of the geothermal heat pump and the room air cleaner. Our fictitious products were submitted two ways, via the OPS tool and e- mailed QPI forms to Energy Star administrative contractors. We found that the Energy Star OPS tool expedited the certification of bogus products. EPA officials confirmed that the OPS tool is an automated system designed to reduce administrative costs and a specific review only occurs if outlier data triggers programmed flags in the system. For example, we submitted and qualified a gas-powered alarm clock under the newly formed audio-video product category via the OPS tool. Although the efficiency information met Energy Star criteria, the product description section on the form clearly indicated that the clock radio was gas- powered, the dimensions were similar to those of a small portable generator, and the product model name was “Black-Gold”. EPA officials confirmed that because the energy-efficiency information was plausible, it was likely that no one read the product description information. Figure 3 below shows the information we submitted via the OPS tool. Our investigation determined that when officials required independent third-party testing of products prior to certification, that control sometimes prevented our fictitious products from becoming certified. Specifically, for our ventilation fan, when submitting our product for certification, we indicated that we had tested our product with the specific third-party testing company designated by Energy Star. However, when officials reviewing the application attempted to validate that information with the third party, they found that the Home Ventilating Institute (HVI) had not tested our product. This control resulted in the fan being rejected. A similar control prevented our bogus firm from having its CFL bulb certified. However, our investigation found that Energy Star officials did not always verify testing results with third parties. Specifically, on the product application for our room air cleaner, we stated that we met the specific safety standard for ozone emission set forth by Underwriters Laboratories, an actual independent third-party laboratory designated by Energy Star. However, while Energy Star officials asked if we met this standard, they never verified our certification with the Underwriters Laboratories or requested the specific testing file as required on the QPI form. Undercover Tests Expose Weaknesses in Fraud Prevention Controls We found that for most of the bogus products we submitted, the Energy Star program preventive controls were ineffective, rendering the program vulnerable to fraud and abuse. Our work was not designed to systematically test all controls within the Energy Star program, but approval of 15 fictitious products submitted with bogus energy-efficiency data shows weaknesses in the programs preventative controls. A lack of controls over the access to Energy Star product certification labels exposes the program to unauthorized use. Ineffective and nonexistent controls over validation of claimed energy efficiencies could also allow firms to fraudulently overstate product efficiencies. In addition, the overreliance on manufacturer integrity, industry self-policing, and after- market product testing ignores the potential for products to be put on the market and sold to consumers before fraudulent activity is identified. Despite the lack of up-front controls, there have been a few recent examples of successful identifications of fraudulent or inaccurate energy- efficiency claims by manufacturer’s competitors that resulted in action from DOE. Controls over Access to Energy Star Labels Preventing unauthorized access to promotional material for the Energy Star program is the first step in maintaining consumer confidence in the label. However, our undercover tests showed that ineffective controls could allow firms to utilize Energy Star logo without ever having a product certified. Specifically, all four bogus manufacturing companies received user account information soon after achieving partnership. Account information is needed to access My Energy Star Account (MESA), a secure section of the Energy Star site containing all of the program labels, including product certification labels, for download and application by approved partners. Program protocols state that account information granting access to MESA should be restricted until a partner has successfully qualified a product designated in the Partnership Agreement package by submitting energy use data. However, we gained access to MESA prior to having any products approved by Energy Star. Additionally, we found that some Energy Star labels were publicly accessible. For example, the Energy Star linking label was found unrestricted on the QPI forms for three appliance products—the clothes washer, dishwasher, and refrigerator models—we submitted. Consequently, label access, a cornerstone in protecting the integrity of the Energy Star label, was found susceptible to fraud and misuse. Product Certification Controls The primary purpose of the Energy Star program is to help consumers identify the most energy-efficient products on the shelf. Therefore, controls that verify product energy-efficiency claims are key to the integrity of the overall program. However, we found that controls over specific product certifications were not effective in preventing firms from submitting bogus energy-efficiency data. We found that Energy Star is for the most part an online self-certification program. Only 4 of 20 products we tested required independent verification of energy use and other industry standards by a third party. This control was effective in two cases because Energy Star officials verified our test results with the third party instead of trusting our self-certification. For example, the ventilating fan product category required registry listing by the Home Ventilating Institute (HVI)—the industry-recognized independent laboratory for residential ventilating products sold in North America, and the CFL product category required certification by a designated laboratory accredited under the Department of Commerce National Institute of Standards and Technology (NIST) National Voluntary Laboratory Accreditation Program (NVLAP). The result was that both the fictitious ventilating fan and CFL bulb were effectively rejected due to follow-up on designated third-party verification requirements. However, for a third product, a room air cleaner, Energy Star officials failed to verify that our product met specific industry standards. We left the section requiring a UL file number blank on the QPI form, and when questioned by Energy Star officials we confirmed by e- mail that we met the standard, which was accepted as sufficient evidence and the product was approved. We did not receive a response from Energy Star by the end of our investigation for the fourth product, a decorative light string, and were unable to make any determination as to the effectiveness of the third-party verification related to this specific product. Recent Examples of Self- Policing A recent case of inaccurate energy-efficiency claims being identified by competitors shows that there is potential for noncompliance within the program. DOE recently entered into a Consent Decree with Haier America on January 7, 2010, resolving an investigation into Haier’s adherence to DOE’s energy-efficiency standards and Energy Star program requirements for four freezer models. Among other obligations outlined in the decree, Haier agreed to conduct on-site unit repairs at no cost to consumers and submit a report to DOE by July 9, 2010, summarizing efforts made toward fulfilling its obligations. The Haier Decree was the first entered into by DOE to enforce federal efficiency standards. LG Electronics and DOE entered into an agreement in November 2008 to resolve matters arising from DOE concerns regarding testing procedures for measuring energy consumption levels for purposes of LG’s certification with the Energy Star program. Subsequently, DOE ordered LG to remove the “Energy Star” energy-efficiency label from some of its refrigerators by January 20, 2010. DOE is currently involved in litigation in federal district court with LG Electronics over a dispute as to the methods that may be employed in testing for energy efficiency of some of its LG refrigerators. Corrective Action Briefing We briefed officials from DOE and EPA on the results of our investigation and control weaknesses identified based on our testing. Officials acknowledged that currently the Energy Star program relies on self- policing, manufacturer integrity, and after-market testing for high volume products in cases where there is not a third-party testing requirement for certification. Our ability to obtain product certifications with unverified test results illustrates the need for, at a minimum, some level of third-party testing for the program to be one of certification versus self-certification. Officials stated that based on a new Memorandum of Understanding between DOE and EPA, the program will be shifting toward a more rigorous up-front screening process. Specifically, according to EPA’s Enhanced Program Plan for Energy Star Products issued in December 2009, Energy Star is in the process of identifying and certifying testing labs and industry trade organizations that will begin to independently test products in most product categories prior to certification. It is important to note that the Energy Star program has been in place certifying products such as computer monitors since 1992. However, 18 years later we were able to obtain product certification for a computer monitor since third- party verification of manufacturer efficiency data had not been implemented by Energy Star. We support DOE and EPA plans to enhance testing prior to certification. Officials also stated during our briefings that the program has a variety of other controls in place to prevent and detect fraudulent energy-efficiency claims and label misuse after a product is put onto retail shelves and Web sites. Specifically, officials cited recent cases of industry self-policing, annual after-market product verification testing, and semiannual product shelf inventory of label guideline compliance as substantive controls. Because all of these controls occur after a product has been certified by Energy Star and placed on the market, we were not able to test their effectiveness and did not validate agency representations. However, in our briefing, we reiterated the importance of preventing fraud before a product is on the shelf and before consumers are placed at risk. In addition, recent IG reports have found that there is not a robust process in place at either DOE or EPA to proactively test Energy Star products on the market. In our briefings, EPA officials acknowledged that after-market product verification testing was not conducted for all product categories, but rather was limited to “high-volume” products. EPA officials stated that limited resources and other EPA priorities necessitated a select review of products for compliance. Furthermore, while EPA officials discussed their Web site follow-up as part of their efforts to ensure Energy Star labels are used appropriately, the officials agreed that in at least one case—the room air cleaner model depicted by a feather duster attached to a space heater on the manufacturer’s Web site—the Web site review was either ineffective or not performed. Finally, during our briefings, EPA and DOE officials stated that they felt there was some deterrent value to their citation of United States Code Title 18, Section 1001—False Statement Act—listed on Energy Star QPI forms and the OPS tools. Officials stated that the potential legal costs associated with violations of the Act would deter manufacturers from submitting false energy-efficiency claims. However, in our corrective action briefing we noted the exact text on the certification documents during our investigation read “I understand that intentionally submitting false information to the U.S. government is a criminal violation of the False Statements Act, Title 19 U.S.C. section 1001.” We pointed out that the citation to Title 19, as noted, is inaccurate, is not found on Partnership Agreement forms, and is only found on some QPI forms. We suggested that the citation be updated to reflect the appropriate legal authority and consistently applied to all partnership documentation. Officials acknowledged the above issues associated with use of the incorrect citation, and agreed that documentation be updated to reflect the proper legal citation. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the date of this letter. We will then send copies of this report to interested congressional committees, the Administrator of EPA, the Secretary of DOE, the Chairman of FTC, and other interested parties. The report will also be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff members have any questions about this report, please contact me at (202) 512-6722 or kutzg@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix II. Appendix I: Scope and Methodology To perform the undercover test of attaining Energy Star partnership and earning Energy Star qualification for fictitious products, we consulted publicly available audit reports by federal agencies and consumer advocacy publications to identify program vulnerabilities to inform our methodology. Using publicly available information, we designed proactive tests to assess the partnership and product certification controls in place to prevent fraud and ensure the integrity of the Energy Star label. The Energy Policy Act of 2005 mandates that federal buyers purchase products that are Energy Star qualified or otherwise designated by the Federal Energy Management Program (FEMP) as energy efficient. We used FEMP guidelines and the General Services Administration (GSA) schedule of federally designated products to select 20 Energy Star products for testing. Our investigation was designed to test controls over the process for becoming an Energy Star partner to certify products and acquire access to Energy Star product certification labels. Our work was not designed to test other potential controls in place for monitoring use of the Energy Star label on retail products or verifying energy efficiency through shelf tests of products selected from retail locations. We used bogus front companies, using rented domestic personal mailboxes for business listings, and fictitious identities when submitting documentation to Energy Star, meaning that we conducted our work with fictitious names and contact information that could not be traced back to GAO. We developed Web sites for each of the four bogus manufacturing firms to establish an internet presence. Undercover cell phones used as company telephone numbers and out-of-service numbers used as fax numbers were listed as contact information on each of the four bogus manufacturer Web sites and Energy Star program documentation. We submitted Energy Star Partnership Agreements for each of the four bogus manufacturing firms and fictitious product energy-efficiency specifications via e-mail to the Energy Star program to obtain partnership and certify products. After attaining Energy Star partnership status, we submitted a total of 20 products under selected categories, including appliances, home envelope products, computers and electronics, heating and cooling products, and lighting. The product specifications varied in sophistication and energy efficiency to test the level of scrutiny at each stage of the Energy Star product certification process. For example, at the beginning of testing, products mirroring efficiency standards of listed Energy Star products were submitted, whereas in the later stages of the proactive testing phase of this investigation, we submitted an implausible product for Energy Star certification. We briefed program officials with the Department of Energy, Environmental Protection Agency (EPA) and EPA OIG as well as attorneys with the Consumer Protection division of the Federal Trade Commission (FTC) on the results of our work, and incorporated their comments concerning controls in place to protect the Energy Star label from fraud and abuse. Appendix II: GAO Contact and Staff Acknowledgments Acknowledgments In addition to the individual named above, the following individuals made major contributions to this report: Julia DiPonio, Robert Fletcher, John Ledford, Barbara Lewis, Vicki McClure, Jonathan Meyer, James Murphy, Andrew O’Connell, Timothy Persons, April Van Cleef, Abby Volk, and John Wilbur.

American consumers, businesses, and federal agencies rely on the Energy Star program to identify products that decrease greenhouse emissions and lower energy costs. In addition, the federal government and various states offer tax credits and other incentives to encourage the use of energy-efficient products including Energy Star products. Specifically, approximately $300 million from the American Recovery and Reinvestment Act will be used for state rebate programs on energy-efficient products. The Energy Star program, which began in 1992, is overseen jointly by the U.S. Department of Energy (DOE) and the U.S. Environmental Protection Agency (EPA). Given the millions of dollars allocated to encourage use of Energy Star products and concerns that the Energy Star program is vulnerable to fraud and abuse, GAO was asked to conduct proactive testing to (1) obtain Energy Star partnership status for bogus companies and (2) submit fictitious products for Energy Star certification. To perform this investigation, GAO used four bogus manufacturing firms and fictitious individuals to apply for Energy Star partnership and submitted 20 fictitious products with fake energy-savings claims for Energy Star certification. GAO also reviewed program documents and interviewed agency officials and officials from agency Inspector General (IG) offices. GAO's investigation shows that Energy Star is for the most part a self-certification program vulnerable to fraud and abuse. GAO obtained Energy Star certifications for 15 bogus products, including a gas-powered alarm clock. Two bogus products were rejected by the program and 3 did not receive a response. In addition, two of the bogus Energy Star firms developed by GAO received requests from real companies to purchase products because the bogus firms were listed as Energy Star partners. This clearly shows how heavily American consumers rely on the Energy Star brand. The program is promoted through tax credits and appliance rebates, and federal agencies are required to purchase certain Energy Star certified products. In addition, companies use the Energy Star certification to market their products and consumers buy products relying on the certification by the government of reduced energy consumption and costs. For example, in 2008 Energy Star reported saving consumers $19 billion dollars on utility costs. The table below details several fictitious GAO products certified by Energy Star. GAO found that for our bogus products, certification controls were ineffective primarily because Energy Star does not verify energy-savings data reported by manufacturers. Energy Star required only 4 of the 20 products GAO submitted for certification to be verified by an independent third party. For 2 of these cases GAO found that controls were effective because the program required an independent verification by a specific firm chosen by Energy Star. However, in another case because Energy Star failed to verify information provided, GAO was able to circumvent this control by certifying that a product met a specific safety standard for ozone emission. At briefings on GAO's investigation, DOE and EPA officials agreed that the program is currently based on self-certifications by manufacturers. However, officials stated there are after-market tests and self-policing that ensure standards are maintained. GAO did not test or evaluate controls related to products that were already certified and available to the public. In addition, prior DOE IG, EPA IG, and GAO reports have found that current Energy Star controls do not ensure products meet efficiency guidelines.

Background Medicaid and SCHIP are the nation’s largest health-financing programs for low-income people, accounting for about $232 billion in federal and state expenditures in 2001 to cover about 40 million people. Medicaid was established in 1965 under title XIX of the Social Security Act to provide health care coverage to certain categories of low-income families and aged and disabled individuals. SCHIP was established in 1997 under title XXI of the Social Security Act to provide health care coverage to children living in low-income families whose incomes exceed the eligibility requirements for Medicaid. Both are federal-state programs whereby, within broad federal guidelines, states have considerable flexibility in whom and what they cover. Medicaid establishes a framework that states must follow in order to receive federal funding, known as federal matching payments, for a share of a state’s Medicaid program expenditures. States are required to cover certain groups of individuals and offer a minimum set of services, such as physician, hospital, and nursing facility services, as well as early and periodic screening, diagnostic, and treatment (EPSDT) services for individuals under the age of 21. States can also receive federal matching payments to cover additional optional groups of individuals. For example, while states are required to cover children under age 6 in families with incomes at or below 133 percent of the federal poverty level (FPL), children in families above this level may also be covered at a state’s option. States may also choose to provide optional services—such as vision and dental services and prescription drugs—but if they do so, they must provide the same benefits to all covered beneficiaries. At present, nearly two-thirds of Medicaid expenditures are for optional populations and services, largely for long-term care services. Medicaid is an open- ended entitlement, meaning the federal government will pay its share of state expenditures for people covered under a state’s approved Medicaid plan, and enrollment for those eligible cannot be limited. Like Medicaid, SCHIP is administered by states under broad federal guidelines to offer coverage to children in families with incomes up to 200 percent of the FPL who do not qualify for Medicaid. The federal government pays a higher share of states’ expenditures under SCHIP than under Medicaid. SCHIP programs must provide a benefit package that meets certain standards. In contrast to Medicaid, SCHIP is not an open- ended entitlement. The Congress in 1997 appropriated a fixed amount for the program—specifically, $40 billion in federal matching funds over 10 years (fiscal years 1998 through 2007) for SCHIP purposes. Annual allotments are made to states for use over a 3-year period and the Secretary is required to determine an appropriate procedure for redistributing the unused SCHIP funds to those states that have already spent their SCHIP allotments. In certain circumstances states may restrict enrollment if their allotment of federal funds has been expended, but to date, SCHIP spending for most states has fallen well below allotment levels for a variety of reasons. According to the Congressional Research Service, despite the fact that 42 states began their SCHIP programs in late 1997 or 1998, new programs take time to get off the ground and the participation rates have been lower than expected. Section 1115 of the Social Security Act gives the Secretary of HHS broad authority to (1) allow states to provide services or cover individuals not normally eligible for Medicaid and SCHIP, and (2) provide federal funds for services and populations not otherwise eligible for a federal match. Title XIX governing Medicaid is one of several titles to which section 1115 specifically applies, and the Congress, in establishing SCHIP, extended section 1115 to SCHIP “in the same manner” as it applies to Medicaid. According to one report, in 2001 more than 20 percent of total federal Medicaid spending was governed by section 1115 demonstration terms and conditions rather than usual Medicaid rules. Past demonstrations have significantly influenced the development of Medicaid policy, for example, by allowing states to restrict the enrollment of beneficiaries to managed care. The first statewide section 1115 waiver was approved for Arizona in 1982, requiring managed care for all beneficiaries and paying health plans a fixed amount per person to provide all covered services. Other examples of large-scale changes approved through waivers include programs begun in Oregon and Tennessee in the early 1990s. Recognizing its fiduciary obligations, HHS has since the early 1980s required that states justify that their section 1115 waiver demonstrations will not cost the federal government more money than the programs would have cost without the waivers. However, we have previously reported that section 1115 demonstration waivers approved for several states in the mid-1990s were not budget neutral. HHS’s HIFA initiative, using the section 1115 authority, gives states flexibility to increase cost sharing and reduce benefits for some program beneficiaries in order to help fund coverage for uninsured populations within existing Medicaid and SCHIP program resources. HIFA allows states to provide different benefit packages to different groups of people covered under the waiver. To be considered, proposals must be statewide and seek to coordinate coverage with private health insurance options for low-income uninsured individuals. Responding to states’ expressed concerns about HHS’s prolonged review process for pending waivers, HHS has promised more expedited reviews and decisions. To facilitate this, as part of its HIFA initiative HHS has developed a standard template for states to use in applying for the waivers. Like HIFA, the Pharmacy Plus initiative uses section 1115 waiver authority. The Secretary introduced the Pharmacy Plus initiative in January 2002 to encourage states to provide pharmacy benefits to low- income elderly populations. While HHS has described the initiative in budget and other documents, it has not published an application template and policy guidelines. HHS Has Approved Four Section 1115 Waivers to Expand Insurance or Drug Coverage Since HHS announced the HIFA initiative in August 2001, states submitted 13 proposals for section 1115 demonstration waivers designed to respond to HHS’s goals of covering more low-income uninsured individuals and expanding pharmacy benefits as of May 1, 2002. Eight of these 13 are designed to expand coverage for the uninsured, including 6 HIFA applications and 2 expansions that were not submitted in HIFA format, that is, using the HIFA template and following all of the HIFA principles. Five waivers proposed to expand pharmacy benefits, as envisioned by the Pharmacy Plus initiative. As of May 1, HHS had approved 4 of the proposals: 2 HIFA waivers for Arizona and California; an expansion offering primary and preventive care for the uninsured in Utah; and a pharmacy benefit waiver in Illinois. The remaining proposals were still under review as of early June 2002. Four Waivers Have Been Approved Quickly to Expand Coverage HHS has approved four section 1115 demonstration waivers to expand coverage for the uninsured and pharmacy benefits since August 2001. Formal review times for three of these four waivers, which averaged just 3-½ months (109 days), ranged from 60 days for the Utah application to 182 days for the Illinois pharmacy demonstration. These review times compare with roughly 10 months’ review, on average, for approved section 1115 waivers submitted in 2000 or earlier. These average review times do not include preliminary discussions and reviews of draft proposals and concept papers that state and federal officials indicated occurred for varying lengths of time before formal application, depending on the particular waiver. The HIFA demonstrations approved for California and Arizona both allow expansions using unspent SCHIP funds, but the two differ in the populations to be added. The California waiver will add coverage for uninsured low-income parents, caretaker relatives, and legal guardians of children who are enrolled in Medicaid and SCHIP, testing whether covering these individuals will increase enrollment of eligible children and improve their continuity of care. The approved Arizona waiver will use unspent SCHIP funds to cover childless adults as well as parents of Medicaid and SCHIP children. HHS’s terms and conditions for the approved Arizona waiver specify that SCHIP children are the first priority for coverage, then parents of SCHIP- and Medicaid-enrolled children, and last priority, childless adults. Arizona was, however, allowed to retroactively cover childless adults effective November 2001, and parental coverage is not required until October 2002. In response to an objective of the HIFA initiative, both the Arizona and California waiver approvals include feasibility studies of whether and how an employer-sponsored insurance component might be incorporated into the demonstrations. The Utah waiver will expand coverage to some formerly uninsured adults for primary care and preventive services, but exclude other services, such as inpatient hospital and specialist care. In addition to enrollment fees and cost sharing for services used by this expansion population, the waiver will be funded by increased cost sharing and limits on some optional services for certain groups of currently eligible adults, including some with mandatory eligibility. Among the optional services being limited are mental health services, vision screening, and physical therapy. Illinois received approval for the first Pharmacy Plus waiver. The Illinois Senior Care program will expand pharmacy coverage to low-income seniors, most of whom participate in an existing state-funded pharmacy benefits program. The premise as to how the waiver program can be implemented without committing additional federal resources is that expanded access to medically necessary drugs will help keep seniors healthier and avoid medical expenses, including hospitalization and nursing home placement, that would reduce their incomes to the level of Medicaid eligibility. Table 1 presents highlights about the section 1115 waivers approved for Arizona, California, Utah, and Illinois. (See app. I for further details about these four waiver programs.) Nine Waiver Proposals Are Still under Review As of June 3, 2002, 9 of the 13 section 1115 waiver proposals to expand coverage and pharmacy benefits were still under review by HHS (see app. II for highlights of these proposals). Most were submitted since January 2002. These proposals included pending HIFA applications from Illinois, Maine, Michigan, and New Mexico. Three of these proposals would use unspent federal SCHIP funds to expand coverage to various groups, including children, parents, and in some cases, childless adults. Most of the HIFA applications require increased cost sharing for the expansion groups, and one proposal would reduce benefits for an optional eligibility group. One additional proposal under review from Washington, which was not submitted in HIFA format, would also expand coverage for uninsured individuals, including childless adults using unspent SCHIP funds. Four states—Connecticut, New Jersey, South Carolina, and Wisconsin— had pharmacy benefit waiver proposals under review that were consistent with the Pharmacy Plus concept. In all cases, pharmacy benefits would be expanded to low-income seniors who are not currently eligible for Medicaid, and the states would fold in participants from state-only funded pharmacy programs. HHS Has Not Always Ensured That Approved Waivers Are Consistent With the Goals and Fiscal Integrity of Medicaid and SCHIP HHS has not, with its recent approvals of waivers under the new flexibility initiatives, consistently ensured that waivers are in line with program goals and are budget neutral. Under the first approved HIFA waivers, HHS is allowing the use of unspent federal SCHIP funding to cover adults, including adults who have no dependent children. When the Congress established SCHIP, it required the Secretary to redistribute unspent funds to states that had exhausted their allotments to use for the program purposes of covering children. These waivers raise legal and policy concerns in light of SCHIP’s stated purpose of expanding health coverage to low-income children. Similarly, HHS did not adequately ensure that the waivers will be budget neutral. Our review of the documents supporting the traditional budget neutrality test used in the two states subject to this requirement—Utah and Illinois—found that HHS’s review process did not adequately ensure that the costs to the federal government for the Medicaid program would be no higher under the waivers than they would have been without the waivers. The approval of the Illinois waiver also raises questions about the potential financial risk for the state and implications for covered elderly beneficiaries, and the extent to which HHS is ensuring that waivers are fiscally sound. Allowing SCHIP Funding for Adults Raises Legal and Policy Concerns SCHIP is a program created specifically for low-income children. The program is designed to enable states to initiate and expand health assistance to low-income, uninsured children in an effective, efficient, and coordinated manner. In establishing SCHIP, the Congress directed that funds made available under the program be used only for program purposes. Further signaling the importance of spending SCHIP funds on uninsured children, the Congress also provided for the Secretary to redistribute states’ annual allotments remaining unspent after a 3-year period of availability to states that have exhausted their SCHIP allotments. In April 2002, CMS announced that 18 states and territories would receive $1.6 billion in reallocated funds because they had exhausted their own allotments. Given the statutory objective of reducing the number of uninsured children, however, HHS’s approvals of waivers that allow states to use unspent SCHIP funds on adults raise certain legal and policy questions about appropriate uses of the SCHIP allotments. In our view, HHS has not established that its approval of SCHIP funding for childless adults in Arizona was reasonable and, therefore, authorized. Arizona plans to use $126 million in unspent federal SCHIP funds for childless adults. In approving the Arizona waiver, HHS stated that the Arizona project would demonstrate whether covering single adults and childless couples will improve the overall health of the community and reduce overall rates of uninsurance, and asserted that this result would “promote the objectives of the Act.” However, HHS did not assert that insuring these childless adults would improve the provision of health assistance to low-income children. We are not aware of any basis for suggesting that the use of SCHIP funds to cover childless adults would promote the objectives of SCHIP. “the language of section 1115 permits approval of demonstration projects based on the overall purposes of all of the listed Social Security Act programs (rather than segregating each program). In other words, in approving a Medicaid or SCHIP demonstration, the Secretary may consider the likelihood of promoting the objectives of the programs authorized under any of the titles of the Social Security Act listed in section 1115.” The structure and language of section 1115 do not support HHS’s interpretation of its authority. Section 1115 identifies the titles of the Social Security Act for which demonstration projects may be authorized. It also lists the statutory provisions within each title containing the requirements or expenditure limitations that may be waived and clearly indicates that waiver of requirements or expenditure limitations are to correspond to the associated titles of the Social Security Act. As a result, we believe that section 1115 requires HHS to justify that a demonstration project will likely assist in promoting the objectives of the particular title of the Social Security Act in which the waived program requirements or expenditure limitations appear. With respect to programmatic requirements or expenditure limitations applicable to SCHIP funds, section 1115 requires HHS to establish that a demonstration project would promote the objectives of title XXI, which established SCHIP. As stated above, HHS has not asserted that the use of SCHIP funds to cover childless adults would promote the statutory objectives of the program, although it contends that the Arizona waiver, considered in its entirety, does serve program objectives. HHS’s interpretation of section 1115 effectively eliminates the distinctions among the programs authorized under the identified titles of the Social Security Act and would allow the agency to waive requirements or authorize otherwise impermissible expenditures under one program to promote the objectives of any other program. If HHS were to take this interpretation to an extreme, it could bypass funding limitations and mechanisms established for individual programs by funding any of the programs authorized in the identified titles of the Social Security Act with funds made available for any other title. This interpretation of section 1115 is particularly problematic in the context of SCHIP, given the congressional direction that allocated funds not spent for program purposes be redistributed to states that have exhausted their allotment. Arizona’s use of SCHIP funds for childless adults raises two additional concerns. First, Arizona had already received approval from HHS to use Medicaid funds to expand coverage to certain childless adults. As a result of the waiver, the federal government will now pay about 77 percent of the costs under the SCHIP matching rate, instead of about 66 percent if this same population was covered under Medicaid. Second, if Arizona expends all of its federal SCHIP allotment, it arguably could qualify for reallocated unspent federal SCHIP funds from other states. It could then apply these reallocated funds to childless adults. HHS’s approval of Arizona’s and California’s use of unspent federal SCHIP funds to cover parents illustrates the changing policy with regard to the use of waiver authority to allow states to cover adults. In creating SCHIP, the Congress authorized states to cover the entire family—both the parents or custodians and their children—if it was cost effective to do so. The cost-effectiveness test for family coverage specifies that the expense of covering both adults and children in a family must not exceed the cost of covering the children. Under these circumstances, achieving cost- effectiveness appears possible only when the cost to SCHIP of covering a family is subsidized by employer contributions or other state funds. This stringent cost-effectiveness test clearly showed congressional priority for covering children over their parents. However, we reported in 1999 that some states and advocacy groups were seeking increased flexibility to tailor their SCHIP programs to cover uninsured parents through the use of section 1115 waiver authority. CMS, then called the Health Care Financing Administration, had questioned requests for section 1115 waivers to cover parents during the first year of SCHIP’s implementation, expressing a concern that the SCHIP goal of providing insurance to low- income children should not be circumvented by the waiver process. The agency had indicated to states that the purpose of section 1115 waivers was to test innovative approaches and not to waive statutory provisions that the states found objectionable. In our first report on SCHIP implementation in 1999, we noted that, as of April 1, 1999, only two states had been able to demonstrate cost-effectiveness and had received approval to use SCHIP funds to cover adults in families with children. Since our earlier report, HHS has changed its policy and no longer requires that states demonstrate the cost-effectiveness of family coverage in section 1115 waiver proposals. On July 31, 2000, HHS announced to states that it would consider section 1115 waivers to use unspent federal SCHIP funds to cover parents of SCHIP- and Medicaid-eligible children, but was silent on the application of the cost-effectiveness test. Since this announcement, four states, in addition to Arizona and California, have requested and obtained approval for these types of waivers. In our view, this change raises broad policy questions about the use of section 1115 authority to waive those statutory requirements that states have found objectionable but that the Congress put in place clearly to demonstrate the priority of SCHIP to fund insurance coverage for children. It further raises the issue of which statutory objectives should take precedence—the Congress’s direction to allow family coverage only if states could demonstrate its cost-effectiveness, or the Secretary’s authority under section 1115 to allow states to spend money on individuals other than children. Budget Neutrality Not Ensured in Utah and Illinois Waivers Our review of the supporting documentation for the Utah and Illinois waiver approvals found inadequate justification that the waivers would be budget neutral—that is, the initiatives would result in no more cost to the federal government than under the existing program. To establish that a waiver is budget neutral, HHS requires the state to compare estimated program costs under two scenarios: (1) costs if the existing program was continued (“without-waiver” costs) and (2) costs with the new waiver program (“with-waiver” costs). We found that the states’ estimates of without-waiver costs included inappropriate costs in Utah and impermissible costs in Illinois. Including these amounts inflated each state’s estimate and inappropriately increased the amount the federal government could pay in the absence of the proposed waiver. Utah’s without-waiver estimate was inflated because it included the estimated cost of services for a new group of people who were not being covered under the existing Medicaid program. By including these costs, the state in effect inflated the without-waiver costs by about $59 million— 10 percent—over the 5-year life of the waiver. Without this amount, Utah’s waiver would not be budget neutral. The costs for this group were included based on the “hypothetical population” concept, under which HHS has previously allowed states to include the costs of populations that they could have hypothetically covered under Medicaid as an optional group, but did not actually cover. In 1995, we reported that states were using this hypothetical argument to justify higher without-waiver costs, making budget neutrality easier to achieve. We concluded that, because state officials indicated that cost containment was a primary consideration in seeking section 1115 waivers, it was questionable that these states would have added optional eligibility groups to their Medicaid programs without the waiver. For Utah, however, the use of this methodology goes beyond our earlier concern because the group in question does not meet the criteria for designation as a hypothetical population. The group could not have been covered without a waiver, because it will receive a limited primary-care-only benefit package that would not be allowed under Medicaid’s rules for comprehensive coverage. During the review process, some officials within HHS voiced concerns about allowing the use of this methodology; however, the waiver was still approved by HHS as a matter of policy. Illinois’s without-waiver estimate was inflated for a different reason: it failed to account for mandatory reductions in program costs planned for the 5-year course of the waiver. These reductions pertain to the state’s use of upper payment limit (UPL) arrangements. We and the HHS Inspector General have reported numerous times about state funding arrangements that inappropriately generated excessive federal matching funds, including UPL abuses. The Congress and HHS subsequently revised the upper payment limits and required states to reduce their claims for these excessive payments over the next several years. Over the course of its 5- year waiver, Illinois will have to reduce its claims by $1.4 billion in accordance with these requirements. Over this time period, the state’s total payments to the facilities involved in the UPL arrangements will decline by 39 percent. Based on this decrease, we estimate that at least $275 million in impermissible UPL expenses are included in the estimate. This occurred because Illinois’s calculations of without-waiver costs did not reflect the required reduction in UPL expenses. Rather, the Illinois without-waiver cost estimate projected increases in UPL payments by 51 percent over the 5-year life of the waiver. It appears that, in reviewing Illinois’s budget neutrality justification, HHS did not consider the extent to which any UPL-related impermissible funds were included. The Secretary has the authority, however, to revisit this decision and to require the state to recalculate its estimated without-waiver costs to appropriately account for the reduction in the amount of UPL expenses. We have previously reported similar concerns with the approval of demonstration waivers that were not budget neutral and that could increase federal Medicaid expenditures. In our 1995 report, we found that, contrary to the administration’s assertion, the approved spending limits for demonstration waivers in Oregon, Hawaii, and Florida were not budget neutral. At that time, we warned that the granting of additional section 1115 waivers merited close scrutiny in part because of the potential budgetary impact. Illinois Waiver Approval Raises Questions about the Extent That HHS Is Ensuring That Waivers Are Fiscally Sound Another concern related to HHS’s approval of the Illinois waiver is the extent to which the agency’s oversight ensures that approved waivers are fiscally sound, in particular related to their likelihood of achieving projected savings. This concern is separate from budget neutrality; it centers instead on whether the waiver project is placing the Medicaid or SCHIP programs in a vulnerable position. The waiver may put Illinois at financial risk even if federal budget neutrality is maintained. A major premise behind this initiative is that the prescription drug benefit will pay for itself by preventing low-income elderly individuals from becoming Medicaid eligible because of high health care costs, such as those for hospital and nursing home care. The Congressional Budget Office (CBO), OMB, and CMS’s own actuary, however, have not accepted this premise, in assessing the cost of a Medicare prescription drug benefit. There are many reasons for this caution. According to a preliminary assessment by CBO, Medicare beneficiaries without any drug coverage already consume a large number of prescription drugs, and any additional or more expensive drugs beneficiaries might receive in gaining coverage would probably provide less-dramatic improvements in health than the drugs they are already taking. CBO’s assessment stated that greater use of drugs, especially in an older population, would increase the chances of side effects, allergic reactions, medication errors, and other adverse drug events, which could increase the use of hospitals, emergency rooms, and other health care services. CBO found that research indicating there might be some savings in providing a Medicare prescription drug benefit have been difficult to interpret, and concluded that the magnitude of any savings would probably be quite small. CBO stated that recent evidence has suggested that the net effect of providing coverage may be to lower the cost of other services, but that the studies are difficult to interpret, especially in the context of a Medicare drug benefit, and that more evidence is expected from evaluations of state-level drug programs for low-income elderly people. While Illinois’s approved waiver is intended to evaluate the extent to which a drug benefit may be able to generate cost savings, it makes several risky assumptions with regard to the extent of savings, potentially setting a precedent for other states’ Pharmacy Plus proposals. In Illinois, many of the people who would gain drug coverage under the waiver are already receiving some drug coverage benefits under an existing, more limited, state-funded program. Despite this, the success of the Illinois waiver relies on assumptions that (1) providing the expanded prescription drug benefit under the waiver will divert 7,500 people by keeping them from becoming Medicaid-eligible, when an estimated 20,000 elderly individuals normally enter Medicaid in a given year, (2) this high diversion rate will occur immediately, the first year that the drug benefit is provided under the waiver, and (3) once diverted, aged individuals would stay out of Medicaid for at least 5 years. The waiver’s underlying assumptions offer little margin of error. For example, if only half of the projected number of seniors are diverted in the first year of the waiver, we estimate that the cost of the waiver could increase by $339 million. The implications for elderly Medicaid beneficiaries of not achieving the high rate of savings could be significant. HHS limited total federal risk for this waiver by establishing an aggregate “cap” for payments to the state for all services to the elderly, including the drug benefit. However, this cap also means that once the state has spent up to this limit then it cannot receive additional federal matching funding for Medicaid services for the elderly. One assessment of the Illinois financing approach noted that, for any number of reasons, Illinois could find the costs of operating its new drug program or of serving elderly Medicaid beneficiaries to be higher than expected. If the state is unable to achieve savings from diverting people from Medicaid, then as Illinois officials acknowledge, it may need to choose other options. Such options could include cutting spending on elderly Medicaid beneficiaries, cutting spending on its prescription drug program, or paying for any unanticipated program costs entirely with state funds. The state could also roll back eligibility for optional elderly beneficiaries, increase cost sharing, reduce provider reimbursement rates, reduce the size of the waiver benefit, or eliminate the waiver altogether. HHS officials stated that this approval represents a true demonstration or policy experiment, in that the waiver will test whether it is possible to provide a drug benefit without increasing costs. Officials also pointed out that the federal risk was limited by the aggregate cap approach. As indicated earlier, four states have pending waiver proposals similar to Illinois’s Pharmacy Plus waiver. HHS Policy to Ensure Public Input to Waivers Has Not Been Consistently Followed HHS has not consistently followed its stated policy to ensure that people who may be affected by waivers have the opportunity to learn about and comment on waiver proposals. Recognizing that people who may be affected by a demonstration project “have a legitimate interest in learning about proposed projects and having input into the decision-making process,” HHS established policies and procedures in a 1994 Federal Register notice for both a federal- and state-level public notice and comment process. HHS has not provided a federal level notice and comment period in line with the policy since 1998, and instead has relied on states to have a public process. The extent of public input varied greatly among the four states with recently approved waivers. Although HHS recently affirmed the public input requirements for states, its new streamlined review process under HIFA may not be sufficient to guarantee effective public involvement at the federal level. HHS Has Not Followed Its Stated Federal Process For Public Input Since 1998 The 1994 notice specifies HHS’s intent to publish regular notices of all proposals for section 1115 waivers it receives and to allow a 30-day period to receive and review written comments before taking official action. The notice describes the policies and procedures HHS will be guided by when reviewing section 1115 applications, but is not legally binding. We found that the last Federal Register notice of a section 1115 application submission and 30-day comment period was published in 1998. According to an HHS official, the current agency policy does not include publication of notices with a 30-day comment period while applications are under review at HHS because the states are considered to be a more appropriate forum for public input. Our discussions with HHS officials during the spring of 2002 indicated that current agency policy was not to release copies of pending waiver applications to interested parties, but to refer them to states. In May, the Secretary stated that the agency would publish waiver applications and background information on its Web site as soon as possible after receipt; HHS officials subsequently clarified to us that this includes applications that have been formally submitted but not yet approved. We were able to find copies of all but one of the pending HIFA proposals on CMS’s Web site, along with CMS contact names and phone numbers for each proposal. However, copies of any Pharmacy Plus or other section 1115 proposals that were not in the HIFA format were not yet available on the CMS Web site. One problem with HHS’s decision to defer to the states is that states have not always released copies of pending waivers when requested by interested parties. Advocates reported such difficulty obtaining a copy of Arizona’s waiver application that one organization requested a copy from HHS under the Freedom of Information Act (FOIA) after the application had been submitted for review. The FOIA request was made on November 15, 2001, and the agency responded in January 2002 stating that it was responding to requests in order of receipt and would notify the requester “as soon as possible” about the availability of the documents. Meanwhile, the waiver had already been approved in December 2001. The approved waiver is now posted on the agency’s Web site, but was not available to the public during the time it was under review. State Compliance with the 1994 Policy Varied Widely in Recently Approved Waivers The 1994 policy contains provisions for state-level public participation, including a list of one or more approaches states are expected to follow. These include public meetings with copies of the proposal and opportunities to using a commission where meetings are open to the public; legislation containing the outline of the waiver proposal; formal notice and comment through the state’s administrative procedures act with notice given at least 30 days prior to submission of the waiver; publication of notice in a newspaper of general circulation including information on how to obtain a copy and submit comments, with a comment period of at least 30 days; or any similar process providing an opportunity for interested parties to learn about and comment on the proposal. Such state-level activities allow the public to be informed of and comment on proposed demonstration programs, but do not necessarily guarantee consensus on a state’s planned waiver. We found wide variation in the approaches and level of effort states made to seek and incorporate public comment on written copies or descriptions of the waiver proposals, as well as the degree of controversy concerning the state proposals, as illustrated in the following examples. California had an extensive public process as well as a statute providing authorization to seek a waiver. In addition, California conducted extensive outreach activities, including mailing hundreds of copies of the waiver application and soliciting comments, holding public hearings, and presenting the approach at a special legislative hearing. Illinois, like California, had a statute authorizing the state to seek a waiver for the pharmacy program expansion, which allowed the state to claim federal financial participation. The interest groups we contacted did not raise concerns about the adequacy of the public process. Utah provided opportunity for groups to discuss the proposed waiver through meetings that state officials held with provider groups and committees involved with improving health coverage in the state. Despite these meetings, advocates and others indicated that in their view the public process was inadequate given the significance of the state’s proposal and planned tradeoffs. Participants in some of these meetings indicated they had little or no opportunity to formally comment on and influence the waiver proposal. Among other issues, advocates and providers expressed concern about reduced optional benefits and increased cost sharing for current beneficiaries, the planned enrollment fee and co-payments, and lack of specialty services and inpatient hospital coverage for the waiver expansion population. Specialty physicians and hospitals would be expected to contribute their services on a volunteer basis, and community health centers would receive lower payments for the expansion group. After the waiver was approved, state officials indicated that inpatient hospital specialty physician services would be reimbursed, with state-only funds, under certain circumstances. Arizona did not release copies of its proposal until after it was approved. Officials indicated that this was because they were negotiating the waiver with HHS and did not want to release a document that was changing. Arizona’s HIFA waiver application stemmed from a proposition approved by state voters in 2000 to extend Medicaid coverage to low-income childless adults, and a state law enacted in spring 2001 to provide coverage to parents of SCHIP- and Medicaid-eligible children. Although the HHS policy lists legislation as an acceptable way to fulfill the public process requirement, there was a significant change in Arizona’s waiver application request from what was originally authorized. The section of the HIFA waiver covering childless adults with SCHIP funding was not included in the state statute or otherwise made public before the waiver was approved. Streamlined Review Process Raises Additional Concerns HHS’s new initiatives further reduce the information states must provide on the extent of their public process. Prior to HIFA, states were required to indicate in their section 1115 applications specifically how they complied with HHS’s policy for a public process. The 1994 policy directed states to include a narrative description of their public process with their applications, which became part of the administrative record for the waiver’s approval. Such documentation provided a basis for HHS to determine whether the state provided an effective notice and comment process. Consistent with the agency’s commitment to streamlining the waiver approval process, the HIFA waiver application template allows states to simply check a box indicating that they followed a public process that allowed beneficiaries and other interested stakeholders to comment on the proposal. No description of the state’s public process is required. HHS has recently emphasized to states that a public process is a priority, but has not similarly committed to a federal-level process. On May 3, 2002, CMS sent a letter to all state Medicaid directors encouraging the use of a public participation process, and stating that the agency would continue to review section 1115 waiver applications to ensure adherence to the 1994 policy. The letter did not, however, indicate that HHS intended to address public input at the federal level in line with its stated policy. The extent to which HHS’s notice to states will ensure a process that provides for appropriate public input and consideration of comments remains to be seen. Concerns about the lack of an appropriate public process have been voiced in other states with pending HIFA waivers. Conclusions In providing section 1115 program demonstration authority under the Social Security Act, the Congress has indicated its willingness to allow states to experiment with innovative approaches in certain public programs to enhance their reach and effectiveness, including coverage of populations that might otherwise be ineligible for those programs. Over the years, many uninsured people in various states have benefited from such experimentation, receiving health insurance coverage otherwise unavailable to them. Using this same authority, HHS has recently committed to work with states to provide additional flexibility and more expedited approvals, including developing specific initiatives, such as HIFA and Pharmacy Plus. While only a handful of demonstrations have been approved to date, several other states have similar waivers under consideration that will likely be influenced by prior decisions and precedents. Our review of recently approved waivers, however, raises certain legal and policy concerns that indicate the need to clearly establish purposes and populations for which SCHIP funds may be spent. While section 1115 authority provides the Secretary with broad discretion in approving demonstrations that further the program’s objectives, it also creates the opportunity for HHS to approve state-operated programs that may not be consistent with program objectives established by the Congress. In exercising the section 1115 authority available for the SCHIP program, recent HHS approvals have allowed SCHIP funds to be spent on individuals other than the statute’s stated target population: uninsured low-income children. At issue is the appropriateness of covering two distinct groups of adults: childless adults and parents or other custodians of SCHIP- and Medicaid-eligible children. With respect to childless adults, we believe that HHS has not presented a reasonable basis for authorizing states to cover childless adults under SCHIP. Furthermore, allowing states to cover parents with SCHIP funds without demonstrating its cost effectiveness allows limited program funds to be spent on individuals not targeted in the statute. In this regard, it is not clear which statutory objectives should take precedence—those of the SCHIP statute, which allows for family coverage only to the extent that it does not exceed the cost of insuring eligible children, or section 1115 authority, which allows certain statutory provisions—such as cost-effectiveness tests—to be set aside. Flexibility and program experimentation must be accompanied by accountability, as the HIFA name implies. Fiscal accountability is an important aspect of the Medicaid and SCHIP federal-state partnerships to ensure, among other things, that both the federal and state governments pay their fair share of program costs. We found, however, that HHS’s review did not adequately ensure that two newly approved waivers were budget neutral, as required as a condition of section 1115 waiver approvals, because their ceilings included inappropriate or impermissible costs. Consequently, these waivers have put the federal government at increased financial risk. HHS approval of waivers that were based on use of inappropriate methods for demonstrating their budget neutrality is not a new problem, as we have earlier reported. However, as more states pursue additional flexibility in their Medicaid and SCHIP programs, HHS has an opportunity—if not an obligation—to develop more specific and consistent criteria on acceptable methodologies to predict permissible future costs and to ensure greater accountability in guarding against inappropriate federal financial risk. Accountability should also entail a process of public input that is adequate to allow for the expression of issues and concerns that affected parties may have. Expediting the waiver review and approval process is an important goal. But it is also important to allow for public input into new and pending program proposals to help assure that proposals are consistent with overall program goals and that the benefits of waiving certain provisions justify forgoing their original purposes. Doing so at the state level facilitates informing those potentially most affected by new program approaches. However, a federal-level notice and comment opportunity is also important because approved waivers represent federal policy that may have influence beyond a single state. It also provides for a more visible and transparent process for all affected and interested parties, including the Congress—something that may be better accomplished at the federal level. For these reasons, we believe there is a need to adhere to some minimal federal input process for waiver proposals, such as the HHS policy established in 1994—in response to earlier concerns about the lack of an open process—that provided for notification in the Federal Register and a 30-day comment period. Matters for Congressional Consideration We believe the Congress should address three issues we identified in the course of our work. Two issues pertain to the availability of SCHIP funding to provide health insurance coverage to two distinct groups of adults: childless adults and parents or guardians of SCHIP-eligible children. The third pertains to the need for an improved federal-level process for public notification and input for state applications for Medicaid and SCHIP section 1115 demonstration projects. In our view, HHS’s use of section 1115 authority to allow states to use SCHIP funds to cover childless adults is not consistent with the program’s statutory objectives to expand health coverage to uninsured, low-income children. Therefore, SCHIP funds should not be available for this purpose. Further, states’ use of SCHIP funds to cover childless adults decreases the amount of unspent SCHIP funds available for redistribution in future years to states with unmet SCHIP needs. HHS disagrees with our view, asserting that the objectives of the Arizona HIFA waiver must be viewed as a comprehensive approach in providing health insurance coverage to those who were previously uninsured, including childless adults and parents. Because of the difference in our positions on whether SCHIP funds are available to cover childless adults, we are raising this to the attention of Congress for resolution. Resolving this issue is important not only for the Arizona waiver but also because of the precedent it sets for additional pending section 1115 demonstration applications currently under consideration and for the future availability of SCHIP funds for uninsured, low-income children. Therefore, the Congress should consider amending title XXI of the Social Security Act to specify that SCHIP funds are not available to provide health insurance coverage for childless adults. In addition, the Congress should establish, for parents or guardians of SCHIP-eligible children, which statutory objectives should take precedence—those of title XXI, which allow for family coverage only to the extent it does not exceed the cost of insuring eligible children, or section 1115 authority, which allows certain statutory provisions—such as cost-effectiveness tests—to be set aside. The Congress should also consider requiring the Secretary of HHS to improve the public notification and input process at the federal level to ensure that beneficiaries and groups affected by Medicaid and SCHIP section 1115 demonstration waiver proposals receive opportunity to review and comment on proposals before they are approved. Recommendations for Executive Action To ensure that SCHIP funds are spent only for authorized purposes, we recommend that the Secretary of HHS amend the approval of Arizona’s HIFA waiver to prevent future use of SCHIP funds on childless adults, and deny any pending or future state proposals to spend SCHIP funds for this purpose. To meet its fiduciary responsibility of ensuring that section 1115 waivers are budget neutral, we recommend that the Secretary of HHS better ensure that valid methods are used to demonstrate budget neutrality, by developing and implementing consistent criteria for consideration of section 1115 demonstration waiver proposals, and reconsider Utah and Illinois’s budget neutrality justifications, in light of our conclusions that certain costs were inappropriate or impermissible and, to the extent appropriate, adjust the limit on the federal government’s financial obligation for these waivers. To improve the opportunity for public input into HHS consideration of state Medicaid and SCHIP program proposals that waive statutory requirements, we recommend that the Secretary of HHS provide for a federal public input process that includes, at a minimum, notice of pending section 1115 waiver proposals in the Federal Register and a 30-day comment period in line with HHS’s 1994 policy. Agency and State Comments and Our Evaluation We provided a draft of this report for comment to HHS, OMB, Arizona, California, Illinois, and Utah. OMB and California declined to provide written comments. In its general comments, HHS emphasized that increasing access to health insurance and providing prescription drugs to senior citizens are among its top priorities, and that given the current state of the economy, its actions to increase coverage through waivers are appropriate if not imperative. HHS also highlighted its history of using section 1115 waivers in the Medicaid program to expand health insurance coverage for individuals who would not otherwise be eligible for the program. HHS also commented that, since January 2001, the agency has approved nearly 1,800 Medicaid and SCHIP state plan amendments, managed care waivers, home- and community-based waivers, and section 1115 waivers and amendments, but noted that, because of the scope of our study, our report focused on only 4 of them. We reviewed new section 1115 demonstration waivers in line with the goals of HHS’s new HIFA and Pharmacy Plus initiatives—initiatives of particular interest because of the significance of their goals and HHS’s plans to grant states new flexibility to achieve them—and only 4 had been approved at the time we conducted our work. We also considered, in addressing certain issues such as budget neutrality, earlier HHS actions and our own prior work. HHS disagreed with each of our three recommendations for executive action. Arizona, Illinois, and Utah also disagreed with various aspects of our findings leading to these recommendations. A summary of their concerns and our evaluation follows. HHS’s and states’ comments are included in appendixes IV through VII. SCHIP Funding for Adults With regard to our recommendation that the Secretary amend the approval of Arizona’s HIFA waiver to prevent future use of SCHIP funds on childless adults, and deny any pending or future state proposals for this purpose, HHS commented that our analysis was extremely narrow and did not recognize that the approval of the Arizona HIFA waiver promotes the objectives of SCHIP by providing health insurance coverage to those who were previously uninsured. HHS and Arizona both commented that the approved section 1115 SCHIP demonstration waiver prioritizes spending SCHIP (title XXI) funds for children. States are not permitted to limit or cap children’s enrollment, and are required to ensure the availability of funds for children over funding adult expansion populations. We revised the report to better clarify these priorities and requirements for the Arizona waiver. HHS also noted that there were no states that were entitled to redistributed SCHIP funds that did not receive such funds as a result of expenditures on section 1115 demonstrations. We acknowledge that covering the uninsured is an important public policy goal and that HHS has established coverage of children as a priority for use of SCHIP funds in the Arizona waiver terms and conditions. We also acknowledge that states that received redistributed funds in 2002 were not affected by HHS’s approval of the Arizona waiver. However, any unspent SCHIP funds available for redistribution to states in future years to cover uninsured low-income children would be reduced because of the Arizona approval, and any similar approved state proposals. We continue to believe that neither HHS nor Arizona has adequately explained how the objectives of the SCHIP statute—to provide health assistance to uninsured low-income children—is promoted by insuring childless adults. In its comments, HHS introduced a new rationale for this approval: that these adults could become parents or caretaker relatives in the future. This statement does not clarify how SCHIP funds used for this purpose would likely support the program’s objectives. To the contrary, HHS’s assertion that it may use SCHIP funds for childless adults suggests that it could approve virtually any demonstration project and, thus, effectively eliminates the requirement that section 1115 demonstration projects be likely to promote the objectives of the particular program for which they are authorized. Similarly, HHS’s discussion of the broader community benefits of the Arizona HIFA waiver does not clarify how it would likely promote the provision of health assistance to low-income children. In its detailed comments (number 12), HHS indicated that our discussion of the scope of the Secretary’s authority under section 1115 is unnecessary and overbroad in view of the HHS position that the Arizona HIFA waiver—in its entirety—will promote SCHIP objectives. As indicated, our discussion was included in response to HHS’s position that the Secretary need not exercise the section 1115 waiver authority on a program-by-program basis. Because our positions differ on whether SCHIP funds are allowable for this purpose, we believe it is important for the Congress to address this issue. Resolving it is also important because the Arizona waiver approval sets precedent for future waiver approvals and funding commitments that could potentially impact on SCHIP funds available for redistribution to states with unmet SCHIP needs. As a result, we elevated this issue to a matter for congressional consideration. Neither HHS nor the states commented on the draft report’s matter for congressional consideration concerning the use of section 1115 authority to approve spending SCHIP funds on parents or guardians of SCHIP- eligible children without regard to the statutory cost-effectiveness test. Budget Neutrality HHS, Utah, and Illinois disagreed with our findings supporting the recommendation that the Secretary better assure that valid methods are used to demonstrate budget neutrality. For Utah’s estimate, HHS and Utah stated that the methods used to assure budget neutrality were valid. They commented that including the costs of a hypothetical population in the without-waiver costs was appropriate because the state has “current law” flexibility to cover that population at its own option, that is, the state could have covered the expansion population through its Medicaid program and thus should be allowed to consider the associated costs of their coverage as without waiver costs. We continue to maintain—despite HHS’s disagreement both currently and in response to our 1995 report—that states should not be allowed credit for the costs of covering certain hypothetical populations in their without-waiver cost estimates. Indeed, the Medicaid statute provides states wide latitude in terms of covered populations and services and payment rates for those services, and the federal government will pay its share of covered expenditures in an open- ended manner when the states cover the services under their state Medicaid plan. If states choose, however, to pursue broader authority under section 1115, they are required to meet the budget neutrality test. In the case of Utah and other states we have examined in the past, states had previously chosen not to cover such optional populations. In our view, to allow the inclusion of hypothetical costs for hypothetical populations not previously covered—in an attempt to demonstrate budget neutrality of new section 1115 demonstration proposals—turns the test of budget neutrality into a rather hollow exercise. Regarding our conclusion that HHS allowed Illinois to include impermissible UPL costs in its baseline, HHS and Illinois each raised a different concern. HHS indicated that the final regulation implementing the UPL reduction was not in place at the time of the Illinois waiver approval. We disagree. The final rule that set new UPLs for nonstate- governmental facilities, including a 150-percent UPL for nonstate- government-owned hospitals and a mandated phase-out of payments above this limit, was published in January 2001 and effective March 2001, well before the Illinois waiver was approved in January 2002. A second rule, to which HHS may have been referring, reduced the UPL for nonstate-government-owned hospitals from the 150-percent level to 100 percent of what Medicare would pay and was effective May 2002. We revised the report to clarify the effective dates of these two rules. HHS in its comments recognized that the UPL reduction may now apply, and indicated that it was reviewing the budget neutrality cap in light of the new rules. Illinois disputed that its budget neutrality projections are inflated by impermissible costs. The state said that other spending authority found in the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act (BIPA) could have been used by the state in its waiver projection which would have offset the impact of the inappropriately included UPL funds. Illinois officials indicated that these costs that could be incurred in future years should have been considered in our assessment of their without-waiver estimate. However, the budget neutrality justification that Illinois submitted to, and was approved by, HHS did not include these hypothetical costs in the ceiling. The state in its comments did not provide any evidence that it intended, in the absence of the waiver, to modify its program so that some of these hypothetical costs would be incurred by the population covered by the waiver. Illinois officials also indicated that, even if these BIPA-related costs were not considered, that several technical corrections should be made to our estimate of impermissible costs. After the state provided additional documentation for its budget neutrality analysis, we adjusted our estimate of impermissible UPL costs accordingly, to $275 million from $356 million. We note, however, that our methodology and estimate are conservative. We reduced the amount of UPL payments included in the without-waiver estimate at a lower rate than what would actually occur, because the detailed data needed to determine the actual and higher rate of reduction were not available at the time of our review. We maintain that our estimate, which remains higher than the estimate that the state developed using its own calculation, is a reasonable approximation of the impermissible costs included in Illinois’s justification, and that HHS should revisit the Illinois budget neutrality justification and source documentation in light of this finding as it has committed in its comments to do. Illinois and HHS also disagreed with our conclusions about the fiscal soundness of the Illinois Pharmacy Plus demonstration, restating that the premise that the low-income elderly who are provided prescription drug coverage will be less likely to become eligible for the Medicaid program is valid. Illinois stated that our report fails to cite any of the studies that show drug coverage can reduce other medical costs. In the course of our work, we reviewed all of the supporting research that Illinois cited in its waiver application. While the cited studies indicated that access to prescription drugs yielded positive health benefits for people in poor health, all of them focused on access for people already diagnosed with specific conditions, such as diabetes, heart disease, and human immunodeficiency virus (HIV). In our view, the cited research did not sufficiently support Illinois’s theory that a full pharmacy benefit for the general near-poor elderly population will yield the amount of savings that the state depends on for its budget neutrality commitment. Illinois also commented that we did not identify the full range of actions the state could take should its estimated savings not materialize, such as establishing an enrollment cap for the waiver population or increasing cost sharing. We modified our report to clarify this point. We do not question that some savings from providing a prescription drug benefit to low-income elderly may be realized and agree that the premise may be appropriate for an evaluation. Our major observation remains— that HHS is allowing a high level of risk for the state and its elderly beneficiaries in the Illinois demonstration, given the specific assumptions the state has made regarding the substantial savings it expects to gain from offering a drug benefit to this elderly low-income population. The state assumes that a drug benefit can largely pay for itself by diverting thousands of people from becoming Medicaid-eligible and from entering nursing homes. The state assumes this high diversion rate even though the majority of the people expected to be covered under the waiver already receive some drug benefit, albeit a more limited one, under the state’s existing drug program. A broader point, as we report, is that the diversion premise is being accepted and applied on a broad scale before its validity is tested. HHS has encouraged states to submit Pharmacy Plus waivers and several have done so. Public Process HHS disagreed with our recommendation that the Secretary of HHS should improve the federal public process, commenting that the current opportunity for public comment in the waiver process is more than adequate at both the federal and state levels. HHS stated that CMS currently posts some proposals on the CMS Web site, such as HIFA proposals, and intends to post all pending and approved proposals on the Internet in the future. However, HHS did not specify when in the future it would do so. When we checked CMS’s Web site, we were able to find copies of all but one of the pending HIFA proposals, but none of the Pharmacy Plus proposals and none of the pending proposals requesting section 1115 waiver authority that were not presented in the HIFA standard format. Consequently, reliance on the Web site provides an incomplete source of public information and does not substitute for the widely accepted Federal Register notice process. Our broader point remains that because of the variation in the level of public process at the state level, and because a waiver approval in one state sets precedent for others, a more formal and consistent federal approach is needed to ensure that people potentially affected by waivers are aware of the proposals and have a structured venue for providing input prior to their approval. It would also provide a centralized focus on issues of national public policy interest for the Medicaid and SCHIP programs that is otherwise absent when relying on individual states as the focal point for public dialogue. Because HHS disagreed with our recommendation to improve the public notification and input process at the federal level, we elevated this issue to a matter for congressional consideration. Utah suggested that we reconsider the discussion in the draft report of the state’s public process and the concerns raised at the state level with its waiver. The state indicated that the concerns expressed about the waiver were apart from whether there was appropriate notice and opportunity for comment. We agree and have revised the report accordingly. We have retained, however, some discussion of the concerns with the waiver that groups we contacted felt were not adequately considered during the state’s public process. We believe it helps demonstrate the importance of public input, particularly when proposed demonstration projects are viewed as controversial. Other Comments HHS and the states provided other comments that were not specific to our recommendations. Illinois and Utah expressed concerns that the report implied that HHS’s expedited review was too fast to provide an adequate review. Utah, for example, indicated that much negotiation between the state and HHS took place before the waiver was formally submitted. It was not our intent to link the amount of time that applications were under consideration with the results of HHS’s approval process for individual waivers. We revised the report to reflect that more time may be spent than indicated by formal approval times, because states and HHS may negotiate waiver proposals prior to their formal submission. We note, however, that beneficiary advocates raised concerns that these “behind-the-scenes” negotiations also result in less public awareness and scrutiny of the specific components of the proposals and that the expedited review times of the formal proposals may leave less time for public input and discussion of the written proposals. We believe that these concerns further support the need for a public process at the federal level once the state has submitted its proposal, to ensure adequate public notification of the proposals’ specific components. Finally, HHS provided additional technical comments. We revised the report to address these comments as appropriate. As arranged with your offices, unless you release its contents earlier, we plan no further distribution of this report until 30 days after its issuance date. At that time, we will send copies of this report to the Secretary of Health and Human Services, the Administrator of the Centers for Medicare and Medicaid Services, the Director of the Office of Management and Budget, and others who are interested. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions, please contact me at (202) 512- 7119. Another contact and other major contributors are included in appendix VIII. Appendix I: Description of Four Recent Section 1115 Waiver Approvals As of May 1, 2002, HHS had approved 4 of the 13 section 1115 new demonstration waivers submitted and under review since August 2001. These include the first 2 HIFA waivers, for Arizona and California; the expansion of primary care for uninsured individuals in Utah; and the first Pharmacy Plus waiver for Illinois. The table below provides further specific details about these 4 approved waivers. Appendix II: Section 1115 Waiver Applications under Review Nine of the 13 section 1115 waiver applications submitted since August 2001 to expand coverage for the uninsured and pharmacy benefits were still under review by HHS as of June 3, 2002. These proposals—including 4 HIFA applications, 1 uninsured expansion not in HIFA format, and 4 pharmacy proposals—are briefly described below. Appendix III: HHS Office of the General Counsel Response to GAO Inquiry Appendix IV: Comments from the Department of Health and Human Services Appendix V: Comments from the State of Arizona Appendix VI: Comments from the State of Illinois Appendix VII: Comments from the State of Utah Appendix VIII: GAO Contact and Staff Acknowledgments GAO Contact Acknowledgments In addition to those named above, Tim Bushfield, Helen Desaulniers, Behn Miller, Amy Murphy, Suzanne Rubins, Ellen M. Smith, and Stan Stenersen made key contributions to this report. Related GAO Products Medicaid: HCFA Reversed Its Position and Approved Additional State Financing Schemes. GAO-02-147. Washington, D.C.: October 30, 2001. Medicaid: State Financing Schemes Again Drive Up Federal Payments. GAO/T-HEHS-00-193. Washington, D.C.: September 6, 2000. Medicare and Medicaid: Implementing State Demonstrations for Dual Eligibles Has Proven Challenging. GAO/HEHS-00-94. Washington, D.C.: August 18, 2000. Children’s Health Insurance Program: State Implementation Approaches are Evolving. GAO/HEHS-99-65. Washington, D.C.: May 14, 1999. State Medicaid Financing Practices. GAO/HEHS-96-76R. Washington, D.C.: January 23, 1996. Medicaid: Spending Pressures Spur States Toward Program Restructuring. GAO/T-HEHS-96-75. Washington, D.C.: January 18, 1996. Medicaid Section 1115 Waivers: Flexible Approach to Approving Demonstrations Could Increase Federal Costs. GAO/HEHS-96-44. Washington, D.C.: November 8, 1995. Medicaid: State Flexibility in Implementing Managed Care Programs Requires Appropriate Oversight. GAO/T-HEHS-95-206. Washington, D.C.: July 12, 1995. Medicaid: Statewide Section 1115 Demonstrations’ Impact on Eligibility, Service Delivery, and Program Cost. GAO/T-HEHS-95-182. Washington, D.C.: June 21, 1995. Medicaid: Spending Pressures Drive States Toward Program Reinvention. GAO/T-HEHS-95-129. Washington, D.C.: April 4, 1995. Medicaid: Spending Pressures Drive States Toward Program Reinvention. GAO/HEHS-95-122. Washington, D.C.: April 4, 1995. Medicaid: Experience With State Waivers to Promote Cost Control and Access to Care. GAO/T-HEHS-95-115. Washington, D.C.: March 23, 1995. Medicaid: States Use Illusory Approaches to Shift Program Costs to Federal Government. GAO/HEHS-94-133. Washington, D.C.: August 1, 1994.

States provide health care coverage to about 40 million uninsured, low-income adults and children under two federal-state programs--Medicaid and the State Children's Health Insurance Program (SCHIP). To receive federal funding, states must meet statutory requirements, including providing certain levels of benefits to specified populations. Under section 1115 of the Social Security Act, the Secretary of Health and Human Services (HHS) can waive many of the statutory requirements in the case of experimental, pilot, or demonstration projects likely to promote program objectives. Since August 2001, HHS has approved four of 13 waiver proposals from states to either expand health insurance to uninsured populations or extend pharmacy coverage to low-income seniors, consistent with the new goals. Of the nine proposals still under review, five seek to expand coverage to uninsured populations, while four would provide pharmacy benefits for low-income seniors. GAO has both legal and policy concerns about the extent to which the approved waivers are consistent with the goals and fiscal integrity of Medicaid and SCHIP. The legal concern is that HHS has allowed Arizona to use unspent SCHIP funding to cover adults without children, despite SCHIP's objective of expanding health coverage to low-income children. GAO found that HHS' approval of the waiver to cover childless adults is not consistent with this objective, and it is not authorized. A related policy concern is that HHS used its waiver authority to allow Arizona and California to use SCHIP funds to cover parents of SCHIP and Medicare-eligible children with no regard to cost effectiveness when the statute provides that family coverage may be provided only if it is cost-effective to do so--that is, with no additional costs beyond covering the child. An opportunity for the public to learn about and comment on pending waivers has not been consistently provided in accordance with policy adopted by HHS in 1994. At the federal level, since 1988 HHS has not followed established procedures to publish notification of new and pending section 1115 waiver applications in the Federal Register with a 30-day comment period.

Background Tax-exempt bonds are valid debt obligations of state and local governments. Under Section 103 of the Internal Revenue Code (I.R.C.), the interest earned on most bonds issued by state and local governments is tax-exempt. This means that the interest paid to bondholders is generally not included in their gross income for federal income tax purposes. The tax exemption lowers the bond issuer’s borrowing costs and may provide equivalent or higher after-tax yields to investors than alternative investments that are not tax-exempt. Tax-exempt bond financing can apply to different types of debt financing arrangements, including notes, loans, commercial paper, certificates of participation, and tax-increment financing. The tax-exempt status remains throughout the life of the bonds provided that all applicable laws are satisfied. IRS’s Tax-Exempt Bond Office in its Tax Exempt and Government Entities division is responsible for administering tax laws pertaining to tax-exempt bonds. Tax-exempt bonds can be characterized as new money and refunding issues. New money issues refer to bonds used to finance a new project. A refunding issue refers to any bond issue used to pay debt service on and retire an outstanding issue. Typically, refunding is done for reasons such as to reduce the interest rate and ease restrictions on the original bond contract. Refunding issues are either current or advanced based on the timing between the issuance of the new bonds and the maturity date of the outstanding bonds. Current refunding occurs when new bonds are issued within 90 days of the final payment on the prior issue and advance refunding occurs if the new bonds are issued more than 90 days before final payment on the prior issue. For federal tax purposes municipal bonds are classified as either governmental bonds or private activity bonds. In general, governmental bonds are tax-exempt and are used to build public capital facilities and serve the general public interest. The I.R.C. does not specifically define governmental bonds; rather, all municipal bonds that do not meet the criteria to be classified as private activity bonds are governmental bonds. Municipal bonds are classified as private activity bonds, which provide financing to private businesses, if they pass both the private payment and the private business use test. These tests specify that if more than 10 percent of the bond proceeds are used for private business purposes and more than 10 percent of the bond proceeds are secured by payments from property used for private business use, then the bond is a private activity bond. A bond that is classified as a private activity bond can be taxable or tax-exempt. Congress has specified certain private activities (see tables 4 and 5) that can be financed with tax-exempt bonds. Private activity bonds that receive tax-exempt status are called qualified private activity bonds. Private activities that are not “qualified” are taxable. Generally, qualified private activity bonds are subject to a number of restrictions that do not apply to governmental bonds, including a 2 percent limit on using proceeds of the bond sale to pay issuance costs, annual state-by-state limitations on the volume of bonds that can be issued, and the disallowance for advanced refunding. In addition, the interest income from qualified private activity bonds is an addition to income for purposes of calculating the alternative minimum tax (AMT) whereas the interest on governmental bonds is not. However, some exceptions to these restrictions exist for qualified 501(c)(3) private activity bonds issued by or on behalf of nonprofit entities. Qualified 501(c)(3) bonds do not count toward annual state-by-state volume limits; the interest income on these bonds issued after August 7, 1986, is not subject to AMT rules; and unlike other qualified private activity bonds, qualified 501(c)(3) bonds can be advance refunded. Tax-exempt bonds can be structured as general obligation or revenue bonds. General obligation bonds, also known as full faith and credit obligations, are secured by revenues obtained from the issuer’s general taxing powers, including sales taxes, property taxes, and income taxes. Most general obligation bonds are used to build public infrastructure, such as school buildings, jails, police stations, and city halls, and are classified as governmental bonds for tax purposes. In contrast, revenue bonds are issued to finance specific projects or enterprises and investors get paid from the revenues generated by the financed projects. Revenue bonds can be either governmental bonds or private activity bonds for tax purposes. In addition to issuing tax-exempt bonds directly, state and local governments may establish other entities to issue bonds “on behalf of” such governmental units, or any political subdivision thereof. For example, a specifically constituted nonprofit corporation acting on behalf of governmental units might own, operate, and issue debt to finance a local airport. In addition to issuing bonds for government operations and services, qualified governmental units are permitted to issue qualified private activity bonds to provide tax-exempt financing for certain private activities. In these cases, the qualified governmental unit generally acts as a conduit, meaning that the qualified governmental unit issues the bonds, but the nongovernmental entity receiving the benefit of tax-exempt financing is required to provide the funds to repay the bonds. Municipal governments incur costs to issue their bonds. Bond issuance costs include the underwriting spread, which is the difference between the price paid to the issuer by the underwriter and the price at which the bonds are reoffered to investors, and fees for bond counsel, financial advisors, public hearings, printing, and other costs. In addition, at the time bonds are issued, issuers may choose to purchase bond insurance or secure a line of credit to further ensure that principal and interest payments will be made on time. This additional security can improve the bond’s credit rating and result in lower interest costs over time for bond issuers. Bond insurance or other types of credit designed to ensure the timely repayment of bonds may not count as issuance costs for the purposes of calculating the 2 percent limit with which qualified private activity bonds generally must comply. Bond issuers have two principal avenues for marketing their bonds in the primary market—competitive bids and negotiated sales. In competitive bids, underwriters who sell the bonds compete against each other to market the bonds for the issuer, while in negotiated sales, the issuer selects the underwriter and negotiates the terms of the bond sale. The majority of tax-exempt bonds are issued through negotiated sales. Guidance issued in 1996 and revised in 2007 by the Government Finance Officers’ Association on the preferred method of sale emphasized that both methods offer advantages in different circumstances. Generally, competitive sales are favored in cases when the bond has a relatively high credit rating; the bond is secured by strong, long-standing revenue streams; and the structure of the bond does not include innovative financing methods that require explanation to the bond market. Negotiated sales may be preferred in cases where a bond with relatively complex features is to be issued during a time period with volatile interest rates, giving the underwriter and the issuer more flexibility in terms of the timing of the bond issue and the underwriter more time to search for investors better suited to more complex bonds. The revised guidance on the preferred method of sale puts more emphasis on the advantages for issuers to obtain financial advice that is independent from the underwriter. In offering bonds for sale, various documents may be prepared, including a preliminary (announcing the prospective bond sale) and final (after the bonds have been issued) official statement. Official statements contain information describing the bond issue, including the dollar amount, maturity dates, financing arrangements, and information on the types of facilities and activities being financed. A copy of the final official statement is required to be sent to the Municipal Securities Rulemaking Board (MSRB), a congressionally chartered organization that regulates securities firms and banks involved in underwriting, trading, and selling municipal securities. In Recent Years, the Dollar Amount of Long-term Tax- Exempt Bonds Issued Annually Has Been at Historically High Levels, and the Tax Exemption Is One of the Largest Federal Tax Expenditures Based on IRS data, the dollar amounts of long-term tax-exempt bonds issued have been at their highest levels in recent years. Since 2002, the dollar amount of long-term, tax-exempt bonds issued has exceeded $395 billion annually. In only 2 earlier years from the period 1991 through 2001, did the annual amount of bonds issued exceed $350 billion. Furthermore, during this same period, municipal governments never issued more bonds than in recent years. Figure 1 shows the annual dollar amount of long-term, tax-exempt governmental and private activity bonds, including new money and refunding bonds, issued from 1991 through 2005. The recent increases in the dollar amounts of governmental bonds issued have been a leading factor contributing to the high volume of tax-exempt bonds issued since 2002. Figure 2 compares the annual dollar amounts of governmental and qualified private activity bonds issued from 1991 through 2005. In recent years, that is, 2002 through 2005, at least $295 billion of governmental bonds have been issued annually, or on average about $314.8 billion per year. In comparison, in the earlier years of 1991 through 2001, the average amount of governmental bonds issued annually was about $194.3 billion, or about 62 percent less than the average annual amounts from 2002 through 2005 after adjusting for inflation. Similar to governmental bonds, the amounts of private activity bonds issued annually has also been at peak levels since 2002. From 2002 through 2005, over $100 billion dollars in qualified private activity bonds were issued each year. About $116 billion of qualified private activity bonds were issued in 2005, more than in any other year since 1998. The average dollar amount of qualified private activity bonds issued annually from 2002 through 2005 was about $106.7 billion. In comparison, in the earlier years of 1991 through 2001, the average amount of qualified private activity bonds issued annually was about $86.1 billion, or about 24 percent less than the average annual amounts from 2002 through 2005 after adjusting for inflation. Thus, though not as large as the comparable increase for governmental bonds, there has been a noticeable increase in the amount of qualified private activity bonds issued recently. While both governmental and qualified private activity bonds reached historically high levels recently, the amount of governmental bonds issued annually has fluctuated to a greater extent. For example, from 1992 to 2005, the dollar amounts of governmental bonds issued annually either increased or decreased by an average of about 25 percent per year. In contrast, qualified private activity bonds fluctuated to a lesser extent, by an average of about 13 percent per year. The wider fluctuation in governmental bonds could be in part because governmental bonds are not subject to as many restrictions, including annual state-by-state volume caps, as qualified private activity bonds. Even if the volume cap for private activity bonds is not reached for all states, the volume cap can place constraints on the volume of private activity bonds issued because some individual states may reach their limits and this would restrict them from issuing any additional qualified private activity bonds that year. Another way to analyze the dollar amount of tax-exempt bonds is to compare new money bonds to refunding bonds. Although the amount of refundings substantially increased around 2002, new money bond issues were generally higher than refunding issues each year since 1991. Since 1991, the dollar amount of refundings has been greater than new money issues in only 3 years—1992, 1993, and 2005. From 2001 through 2005, the amount of new money tax-exempt bond issues has exceeded $200 billion annually (in constant dollars). This is greater than any year from 1991 through 2000. Table 1 shows the annual volume and percentage of long- term, tax-exempt bonds issued for new money and refunding purposes from 1991 through 2005. Tax-exempt bond issuers tend to issue more debt when interest rates decline. Since 1991, years when interest rates were at their lowest levels generally have corresponded with the years in which the amounts of tax- exempt bonds issued, including bonds for refunding, were the highest. For example, since 2002, average interest rates on tax-exempt bonds have fallen to their lowest levels since the early 1970s. During this same time period, the dollar amount of tax-exempt bonds issued has been at the highest level since 1993. Figure 3 shows how changes in interest rates have corresponded with the amounts of new money and refunding bonds. As the figure illustrates, generally, increases in the dollar amounts of bonds that were refunded have accompanied declines in interest rates. This indicates that municipal governments tend to take advantage of interest rate declines to restructure existing bond debt to obtain more attractive financing terms, such as obtaining a lower interest rate to reduce borrowing costs. On the other hand, changes in the dollar amounts of new bond issues do not appear to correspond as closely to interest rate changes as the amounts of refundings. One explanation for this could be that municipal governments tend to issue new bonds based on current needs to finance operations and activities, and decisions regarding new financing are likely to be less sensitive to interest rates. The Estimated Revenue Loss from Outstanding Tax-Exempt Bonds Is One of the Largest Federal Tax Expenditures Because the interest earned by investors who purchase tax-exempt bonds is generally excluded from federal income taxes, the federal government incurs a revenue loss each year. Revenue loss estimates are based on the total dollar value of outstanding tax-exempt bonds and not on the dollar amounts of tax-exempt bonds issued in a given year. Both Treasury and JCT provide estimates of the revenue loss associated with tax-exempt bonds. Though calculated differently, both estimates show that the revenue loss is in the billions of dollars annually. According to our analysis of Treasury’s estimates, the revenue loss from excluding the interest earned on tax-exempt bonds from federal income tax is the ninth largest tax expenditure in the I.R.C. in 2007. Figure 4 shows our analysis of Treasury’s revenue loss estimates from 2000 to 2012. The estimates indicate that the federal government could lose about $37 billion in 2007—$25.4 billion from interest on governmental bonds and $11.6 billion from interest on qualified private activity bonds. As figure 4 shows, the estimated revenue loss from governmental bonds has fluctuated from a high of $30.1 billion in 2003 to a low of $23.6 billion in 2006. According to our analysis of Treasury’s estimates, the revenue loss is likely to be about $27.9 billion from governmental bonds and about $12.6 billion from qualified private activity bonds by 2012. JCT estimates also suggest a similar pattern of higher estimated revenue losses attributable to excluding the interest earned on tax-exempt bonds from federal gross income in future years. For example, in 2007, JCT reported that the federal government would forgo about $27.8 billion due to tax-exempt governmental bonds and projected that the revenue losses would grow to about $31.9 billion in 2011. For qualified private activity bonds, our analysis of JCT estimates shows the revenue loss increasing from $8.6 billion in 2007 to about $10.1 billion in 2011, an 18 percent increase. Tax-Exempt Bonds Are Used to Finance a Wide Range of Facilities and Activities Tax-exempt governmental and private activity bonds are used to finance a wide range of facilities and activities, primarily in support of the entity responsible for paying the bond debt service. Information describing the types of facilities and activities that are financed with tax-exempt bonds is available from several sources. In addition, tax-exempt governmental bonds can be used to finance some facilities and activities for which most tax-exempt private activity bonds cannot, including some facilities that Congress specifically prohibited from being financed with qualified private activity bonds. To illustrate the wide range of purposes for which tax-exempt bonds are used, we reviewed the most recent information available on bonds in Thomson Financial’s Bond Buyer Yearbook and IRS’s SOI data. We also reviewed a limited sample of official statements to further illustrate the uses of tax-exempt bonds. Because most of the information is summarized by broad descriptive categories, it does not fully reveal the wide range of facilities and activities for which tax-exempt bonds can be used. Appendix II describes the primary sources for information on the facilities and activities financed with tax-exempt bonds. Governmental Bonds Can Be Used to Finance Certain Projects That Generally Cannot Be Financed with Qualified Private Activity Bonds Over the last several decades, Congress has prohibited qualified private activity bonds from being used to finance certain projects. For example, the Tax Reform Act of 1986 prohibited the use of qualified private activity bonds to finance a number of specific facilities, including hotels adjacent to airports, professional sports stadiums, and private golf courses. Although qualified private activity bonds can no longer be used to finance such facilities, these types of facilities can be financed with tax-exempt governmental bonds because, as previously discussed, they fail either the private payments or private business use test. In addition, governmental bonds could be issued by authorities that directly operate facilities, such as golf courses, that qualify as general public use. Under current law, state and local governments have broad discretion to make decisions on the types of projects and activities they finance with tax-exempt bonds. Further, while the 1986 act prohibited qualified private activity bonds from being used to finance certain projects such as hotels, Congress did not prohibit such projects from being financed with governmental bonds. According to legislative history surrounding the 1986 change, Congress directed Treasury to liberalize guidelines regarding the treatment of third- party use pursuant to management agreements. The liberalization of the guidelines has permitted governmental entities to use third parties to operate facilities financed with tax-exempt governmental bonds under management agreements so that the third-party use of the bond-financed property is not treated as a private trade or business. Generally, the guidelines issued by Treasury in Revenue Procedure 97-13 provide that tax-exempt governmental bonds can be used to finance certain facilities provided ownership of the facility remains with the governmental entity issuing the bonds and that payments to the facility operator are not based on the facility’s net profits. The facility operator may be compensated based on the gross operating revenues of the facility, a per unit fee, or a per person fee. As you requested, we are providing information on newly constructed hotels and golf courses that were recently financed, at least in part, with some amount of tax-exempt bonds. Our information is limited because we could not identify any comprehensive lists of hotels and municipal golf courses that were financed with tax-exempt bonds. Neither the Bond Buyer Yearbook nor the SOI data had information on hotels and golf courses that were financed with tax-exempt bonds. We considered recent years for our analysis because information on financing would more likely be available than information for facilities financed in earlier years. For hotels, we limited our analysis to hotels that were financed with tax- exempt bonds issued from 2002 through 2006, and for golf courses we limited our analysis to municipal courses that opened in 2005. We found 18 hotels and 6 golf courses that we could confirm had some tax-exempt bond financing in those years. In general, the hotels were large, full-service hotels. Not all the hotels were yet rated by the American Automobile Association (AAA), but those with AAA ratings were all three- or four-diamond hotels, meaning that at a minimum the hotels provided multifaceted, comprehensive services and, in the case of four-diamond hotels, were considered upscale with extensive amenities. In 14 of the 18 cases, the hotels contained conference facilities or were located near convention centers. According to the official statements, the hotels that were built in connection with convention centers were usually intended to enhance the competitive position of convention center facilities, making the convention center a more appealing and convenient location to hold large meetings, and to contribute to economic development in the areas where they are being built. Table 6 summarizes information on the hotels we identified. In general, the six golf courses we identified and confirmed as being constructed, at least in part, with tax-exempt governmental bond financing were considered among the better golfing facilities in their respective regions. For example, in 2006, Golf Styles magazine recognized the Lorton, Virginia, course as one of the “100 Must Play Courses of the Middle Atlantic.” Additionally, Golf Digest recognized the publicly financed course in Patterson, Louisiana, as one of the best new public courses in 2006. Table 7 provides information on the municipal golf courses we identified. While tax-exempt governmental bonds are typically used to support traditional governmental functions with a public purpose, they are sometimes used for activities that are essentially private in nature, as illustrated by the hotels and golf courses we identified. Municipal governments have used their broad discretion to finance projects and activities, such as hotels, that are essentially private with tax-exempt governmental bonds on the grounds that the facilities and activities serve broader public purposes. Broader public purposes may include providing benefits to a community that extend beyond the purpose of the facility being financed by the bonds or providing certain services to those who would not otherwise be able to use them. It is not clear whether facilities like these provide public benefits to federal taxpayers that extend beyond the purposes of the facilities. The state and local governments that issued the bonds to finance hotels and golf courses generally justified the projects on the grounds that they would generate economic development, including new jobs and businesses. However, in some cases, it is not clear whether the facilities generate public benefits that would be underprovided by the private market or whether the facilities generally make services available to those who would not otherwise be able to use them. For example, in 2005, about 85 percent of existing golf courses had been financed privately, offering a range of fees and services often similar to those offered by publicly financed courses. As a result, the use of tax-exempt governmental bonds for facilities and activities like hotels and golf courses, which are routinely financed with private funds, raises questions about how much public benefit is produced at the local level and what, if any, benefits federal taxpayers receive for subsidizing these and other kinds of facilities that are essentially private in nature. The House Committee on Oversight and Government Reform’s Subcommittee on Domestic Policy recently held hearings that focused primarily on whether tax-exempt governmental bonds should be used to finance professional sports stadiums that are privately used. In 1986, Congress removed sports stadiums, along with other facilities, including certain hotels and golf courses, from the list of facilities eligible for tax- exempt private activity bond financing. Participants in congressional hearings leading up to the restrictions placed on tax-exempt private activity bonds in 1986 debated allowing stadiums and other facilities that were routinely financed with private funds from being financed with tax- exempt private activity bonds. However, stadiums and other facilities, including hotels and golf courses, continue to be financed with tax-exempt governmental bonds if they satisfy certain requirements for governmental bonds or safe harbors pertaining to private use. For example, according to Treasury’s Assistant Secretary for Tax Policy, under current law, the requirements to use governmental bonds for stadiums can generally be met when state and local governments subsidize the projects with governmental revenues or governmental sources of funds, such as generally applicable taxes. He also stated that from a tax policy perspective, the ability to use governmental bonds to finance stadiums with significant private business use when the bonds are subsidized with state or local governmental payments possibly represents a weakness in the targeting of the federal subsidy for tax-exempt bonds under the existing legal framework. A similar situation may exist with the continued financing of hotels and golf courses using tax-exempt governmental bonds. Borrowing Costs Vary Depending on Bond Characteristics, and Some Bonds Appear to Exceed the Statutory Limit on Issuance Costs Paid from Bond Proceeds Borrowing costs paid by bond issuers include interest and issuance costs. Although study results varied, most studies that we reviewed indicate that bonds sold through competitive sales generally have lower interest costs than bonds sold through negotiated sales after taking other factors into account that might influence interest costs. Median issuance costs paid from bond proceeds as a percentage of bond proceeds vary by the size and type of tax-exempt bond. Slightly over half of the qualified private activity bonds issued from 2002 through 2005 had issuance costs paid from bond proceeds—with nearly half leaving the reporting line blank—and some of the bonds had issuance costs that exceeded statutory limits. For example, from 2002 to 2005, between 17 and 39 qualified private activity bonds annually—about 1 to 2 percent of qualified private activity bonds that reported issuance costs paid from bond proceeds—reported issuance costs that exceeded applicable statutory limits. Although Study Results Varied, Most Studies Generally Found That Competitive Bond Sales Have Lower Interest Costs after Controlling for Other Factors Researchers have attempted to determine whether the method of sale (i.e., competition between underwriters or negotiation with underwriters) has an effect on the interest costs that bond issuers pay investors. From the federal government’s perspective, lower interest costs for municipal governments may be preferable because this might result in less forgone federal tax revenue and better target the subsidy to its intended beneficiaries. However, even if the competed method of sale generally yields lower interest costs to municipal governments, the negotiated method of sale may still be preferable in some instances. We reviewed studies published from 1996 through 2007 that address whether there is a difference in interest costs for bonds sold on a competitive basis versus bonds sold on a negotiated basis. The studies we reviewed generally used statistical analysis techniques to identify the effect that the method of sale (i.e., competitive or negotiated) has on the interest cost paid by bond issuers. In addition to the method of sale, a number of other factors in the municipal bond market could affect interest costs, and the studies we reviewed attempt to control for these factors to isolate the effect that the method of sale has on interest costs. Other factors that could affect a bond issuer’s borrowing costs include marketwide factors, such as the average level of tax-exempt interest rates and the recent volatility of these rates; issuer-specific factors, such as economic characteristics of the issuing jurisdiction and the amount of experience the issuer has in issuing bonds; and bond-specific factors, such as the number of years until the bond matures, the amount of the bond, the purpose of the bond, the funding source that backs the bond, the bond’s credit rating, and whether the issuer purchased bond insurance or other credit enhancers. In general, after controlling for other factors that may affect interest costs, research suggests that bonds issued on a competitive basis will likely have lower interest costs than bonds sold on a negotiated basis because bond issuers are likely to benefit from multiple underwriters bidding on the right to sell the bonds. In addition, several of the studies suggested that as the number of competitive bids on a bond issue increase, the interest costs that state and local governments pay decline further. However, one of the studies we reviewed found no significant differences in interest costs for competitive and negotiated sales and one found some advantage for negotiated bonds. The studies included in our literature review had several limitations. Because of limited data availability, some key variables are not available to be included in the study. No study that we reviewed had data on the extent to which issuers that used a negotiated sale searched among several underwriters before making a selection. Also, none of the studies we reviewed included a comprehensive, recent review of competitive and negotiated bond sales for the entire municipal bond market. Most of the studies we identified were limited to certain states for certain time periods or focused on a particular market sector, such as bonds issued specifically for hospitals. See appendix V for a list of the studies we reviewed addressing whether interest costs vary by method of bond sale. Some Qualified Private Activity Bond Issuers Reported Issuance Costs Exceeding Legal Limits, and Issuance Costs Vary Depending on Bond Characteristics IRS requires qualified private activity bond issuers to report issuance costs paid from bond proceeds on the Form 8038, and for most types of private activity bonds, issuance costs that can be paid from bond proceeds are limited to 2 percent of bond proceeds. From 2002 to 2005, bond issuers reported issuance costs paid from bond proceeds on slightly more than half of the filed Form 8038s. For example, bond issuers reported issuance costs paid from bond proceeds between 51 percent and 59 percent of the time annually for 2002 to 2005. Bond issuers for the remaining bonds left the line for issuance costs paid from bond proceeds blank. Issuers of smaller bonds, meaning those with bond proceeds of less than $1 million, reported issuance costs less frequently than issuers of larger bonds; however, issuers of large bonds, meaning those with proceeds over $100 million, also did not report issuance costs about 35 percent of the time. According to the Director of IRS’s Tax-Exempt Bond Office, IRS would need to contact the issuer to determine whether a tax-exempt bond information return that a bond issuer submitted to IRS reporting no issuance cost is a problem. He said that there may be legitimate reasons why issuance cost was not reported on the form, such as when issuance costs are paid from other sources or special funds. Currently, IRS does not have mechanisms in place to routinely determine whether unreported issuance cost is a compliance problem or a bond issuer’s mistake. IRS’s instructions for Form 8038 require bond issuers to enter the amount of proceeds that will be used to pay bond issuance costs, including underwriters’ spread and fees for trustees and bond counsel. However, the instructions do not provide any guidance for instances when issuance costs are not paid from bond proceeds. For qualified private activity bonds with reported issuance costs, the median issuance costs as a percentage of bond proceeds varied by the size and type of the bond. For all qualified private activity bonds that reported issuance costs paid from bond proceeds, the median issuance cost as a percentage of bond proceeds ranged from a low of 1.6 percent in 2005 to a high of 1.8 percent in 2002. For bonds under $10 million, the median issuance cost as a percentage of bond proceeds reached or came close to the 2 percent limit annually from 2002 to 2005. Larger bonds reported lower issuance costs as a percentage of bond proceeds, possibly indicating that issuance costs include fixed fees or other payments that are not based on the size of the bond. When considering bond purposes, the median issuance costs as a percentage of bond proceeds for qualified private activity bonds issued reached or came near the 2 percent statutory limit for numerous categories of bonds. Table 8 shows median issuance costs paid from bond proceeds as a percentage of bond proceeds for long-term qualified private activity bonds issued from 2002 to 2005. Of the qualified private activity bonds with reported issuance costs, we identified 38 bonds in 2002, 39 bonds in 2003, 25 bonds in 2004, and 17 bonds in 2005 that reported issuance costs as a percentage of bond proceeds that exceeded statutory limits. This accounts for 1 to 2 percent of qualified private activity bonds issued annually. According to the Director of IRS’s Tax-Exempt Bond Office, IRS does not routinely check to determine if all issuers of qualified private activity bonds are complying with the statutory 2 percent limit on using proceeds for issuance costs. He said that if the limit is exceeded, it may be a potential compliance issue. During its examinations of tax-exempt bonds, IRS routinely assesses whether issuance costs exceed legal limits. The Director recognized the importance of bond issuers adhering to the statutory issuance cost limit; however, he also stated that because of resource constraints, IRS places more emphasis on tax-exempt bond compliance examinations and checks that have the most impact. He stated that in considering how best to address potential compliance issues regarding issuance costs, IRS would want to ensure that these inquiries are not automatically construed as audits. Once IRS initiates an audit, it is precluded from auditing the same return again in the same tax year even if more substantial compliance issues arise. The Director indicated that IRS has plans to conduct more special initiatives to monitor compliance with tax-exempt bond rules than it has in the past, such as starting to provide “soft notices” to certain bond issuers that could be used to identify potential issues related to compliance. Soft notices alert taxpayers to potential errors they made and encourage them to correct such errors. In a number of cases, IRS has found many taxpayers do take corrective actions. Because soft notices do not require taxpayers to send IRS any information from their books and records, they are not considered audits. Although it would need to be tested, the Director thought it might be cost- effective to begin using soft notices, when appropriate, to inform bond issuers that they reported issuance costs paid from bond proceeds that exceed statutory limitations. Unlike qualified private activity bonds, issuance costs for governmental bonds are not subject to any limits; however, like qualified private activity bonds, they vary based on the type of bond and the size of the bond issue. For all governmental bonds issued from 2002 through 2005 where bond issuers reported issuance costs on the Form 8038-G, median issuance costs paid from bond proceeds as a percentage of bond proceeds ranged from 1.51 percent in 2005 to 1.67 percent in 2003. For bonds with reported issuance costs, from 34 to 39 percent indicated that issuance costs exceeded 2 percent of bond proceeds, the statutory limit for most qualified private activity bonds. Governmental bonds issued for housing generally had the highest median issuance costs paid from bond proceeds as a percentage of bond proceeds while bonds issued for education and health and hospital purposes generally had the lowest median issuance costs paid from bond proceeds as a percentage of bond proceeds. Table 9 shows the median issuance costs paid from bond proceeds as a percentage of bond proceeds for long-term governmental bonds issued from 2002 to 2005 by bond purpose and size of bond. Like qualified private activity bonds, smaller governmental bonds generally had higher median issuance costs as a percentage of bond proceeds. For example, for bonds under $1 million, the median issuance cost paid from bond proceeds as a percentage of bond proceeds exceeded 2.5 percent in all years for 2002 through 2005. Median issuance costs as a percentage of bond proceeds for governmental bonds issued for amounts greater than $100 million were about 0.6 percent from 2002 to 2005. Conclusions State and local governments have broad discretion in deciding which activities and facilities to finance using tax-exempt bonds. In particular, the broad discretion afforded to state and local governments allows them to use tax-exempt governmental bonds to finance facilities and activities that cannot be financed with private activity bonds. Recently, the dollar amount of tax-exempt governmental bonds reached peak levels as municipal governments issued bonds for a wide variety of purposes ranging from traditionally public facilities, such as schools, fire stations, and roads, to facilities that are essentially private in nature, such as sports stadiums. Congressional policymakers have recently shown interest in whether certain facilities providing benefits that are essentially private in nature, such as stadiums, should be financed with tax-exempt governmental bonds. However, similar attention has not been given other types of facilities, like hotels and golf courses that also provide benefits that are essentially private in nature. As Congress continues to hold discussions on whether sports stadiums are appropriate uses of tax-exempt governmental bonds, it should also consider whether other facilities that are privately used, such as hotels, should continue to be financed with tax-exempt bonds. However, if Congress still views these and other facilities that are essentially private in nature as appropriate uses of tax-exempt governmental bonds, then legislative changes would not be necessary. Issuers of qualified private activity bonds must adhere to the limits on using bond proceeds for issuance cost that are imposed by law. In part, this helps to ensure that the federal subsidy afforded to issuers of bonds for private uses is appropriately targeted to the purposes for which the bonds were issued. This is equally important to ensure that the bonds’ tax- exempt status remains intact. In addition, it would be more beneficial to IRS if its forms and instructions included specific directions to bond issuers that did not use bond proceeds for issuance costs to indicate this on the form. Although this may require that IRS revise Form 8038, we believe that it would be beneficial for IRS to know positively whether issuers used bond proceeds for issuance costs and, if so, how much was used. This would better equip IRS to determine if there are any compliance issues that need to be addressed. We believe that if the Form 8038 is revised, the benefits to IRS would likely outweigh the costs. Matter for Congressional Consideration As Congress considers whether tax-exempt governmental bonds should be used for professional sports stadiums that are generally privately used, it should also consider whether other facilities, including hotels and golf courses, that are privately used should continue to be financed with tax- exempt governmental bonds. Recommendations for Executive Action To better ensure that IRS can routinely and cost effectively determine whether issuers of qualified private activity bonds are complying with the statutory limits on using bond proceeds for issuance costs, we recommend that the Commissioner of Internal Revenue take the following two actions: Clarify IRS’s forms and instructions for reporting issuance cost paid from bond proceeds to require that bond issuers clearly designate on the form instances when bond proceeds were not used to pay issuance costs. Develop cost-effective methods to address apparent noncompliance with the statutory limits on using bond proceeds for issuance costs in such a manner that it would not preclude IRS from examining the bonds for more substantive compliance issues in the future. Agency Comments We provided a draft of this report to IRS and Treasury for comment. The Acting Commissioner of Internal Revenue provided comments on a draft of this report in a February 7, 2008, letter, which is reprinted in appendix VI. IRS said that it agreed with our recommendations. Regarding our recommendation that IRS clarify its forms and instructions for reporting issuance cost paid from bond proceeds to require that bond issuers clearly designate on the form instances where bond proceeds were not used to pay issuance costs, IRS said that it will clarify instructions for IRS Form 8038 to require that bond issuers clearly indicate when no bond proceeds were used to pay issuance costs. Concerning our recommendation that IRS develop cost-effective methods to address apparent noncompliance with the statutory limits, IRS said that it will develop a compliance project to address apparent noncompliance with the issuance cost requirements for the fiscal year 2009 tax-exempt bonds work plan that will likely incorporate sending soft-contact letters similar to ones previously used with success in other areas. In a February 8, 2008, letter, Treasury’s Assistant Secretary for Tax Policy commented that the use of tax-exempt governmental bonds to finance stadiums and other projects with significant private business use is arguably a structural weakness in the targeting of the federal tax expenditure for tax-exempt bonds under the existing legal framework. Treasury pointed out that while the existing framework might have a tax policy justification in giving municipal governments flexibility to use governmental bonds for a range of public-private partnerships, it may also be debatable in certain cases, such as for certain stadium financings. Treasury noted its recent testimony that outlined several options to address the possible structural weakness in the targeting of tax-exempt bond subsidy relative to tax-exempt governmental bonds for stadium financings. Treasury’s comments are reprinted in appendix VII. As arranged with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution of it until 30 days after its date. At that time, we will send copies of this report to the Commissioner of Internal Revenue and the Secretary of the Treasury and other interested parties. We will also provide copies to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff members have any questions about this report, please contact me at (202) 512-9110 or brostekm@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made contributions to this report are listed in appendix VIII. Appendix I: Objectives, Scope, and Methodology The objectives of this report were to (1) describe recent trends in the dollar volume of tax-exempt bonds; (2) provide information on the types of facilities and activities that are financed with tax-exempt bonds, in particular, information on hotels and municipal golf courses that were recently financed with tax-exempt bonds; and (3) provide information on borrowing costs that bond issuers pay when issuing bonds by summarizing relevant research on whether bond interest costs vary by the method of sale, considering characteristics of the bond and bond issuer and provide information on how bond issuance costs vary between governmental and private activity bonds, including the extent to which private activity bond issuers exceed the statutory limit for issuance costs as a percentage of bond proceeds. To provide information on trends in the volume of tax-exempt bonds, we relied primarily on data from the Internal Revenue Service’s (IRS) Statistics of Income Division (SOI), which collects statistical data from information returns that tax-exempt bond issuers are required to file with IRS. We used SOI data from 1991 through 2005, the most recently available data, to provide information on the overall volume of tax-exempt bonds issued, the volume of governmental and private activity bonds issued, and the volume of new money versus refunding bonds issued. We also relied on the 20-Bond Index in the 2007 Bond Buyer Yearbook, which presents average interest rates on a set of 20 investment grade general obligation bonds maturing in 20 years, to compare interest rate changes from 1992 through 2005 with the volume of new money and refunding tax-exempt bond issues. We used data from the Technical Appendix of the President’s Budget for fiscal years 2002, 2004, 2006, and 2008 and data from the Joint Committee on Taxation’s 2007 Estimates of Federal Tax Expenditures to provide estimates of the amount of forgone revenue resulting from the exclusion of interest earned on tax-exempt bonds from federal income taxes. To describe the types of activities and facilities that are being financed with tax-exempt bonds, we relied on data in the 2007 Bond Buyer Yearbook, IRS’s SOI data, and a limited random sample of official statements. We used Bond Buyer Yearbook information because it provided us with more information about the purposes of tax-exempt bonds than other private data sources we identified. Data in the 2007 Bond Buyer Yearbook provide summary information on the uses of municipal bonds in 10 main categories and 48 subcategories. Information in the Bond Buyer Yearbook is obtained from Thomson Financial’s municipal bond database, one of the most comprehensive data sources on tax-exempt bonds. One limitation of the Bond Buyer Yearbook is that it does not provide separate breakouts of the uses of governmental and private activity bonds and includes taxable bonds. Taxable municipal bonds generally account for less than 10 percent of all municipal bonds. We used SOI data to provide information on the uses of governmental and private activity bonds. IRS’s SOI collects data on the purposes of governmental and qualified private activity bonds as reported on Form 8038-G and Form 8038, respectively. The information is summarized into broad categories for governmental bonds and by allowable uses for qualified private activity bonds. IRS generates summary tables on tax- exempt bond uses that are posted on IRS’s Web site and published in regularly issued bulletins. We used IRS’s SOI tax-exempt bond data for 2002 through 2005 to analyze the other category for governmental bond purposes and the nonhospital 501(c)(3) category for qualified private activity bond purposes. In some cases, information from the Bond Buyer Yearbook and information from the SOI database differ for similar types of bonds and for statistics about similar bond characteristics. Several possible reasons exist for the difference between summary information from SOI and the Bond Buyer Yearbook. For example, SOI relies on bond issuers to timely and accurately report bond information while Thomson Financial relies on automated reporting systems from the financial marketplace to develop reports in the Bond Buyer Yearbook. Even though the amounts differ in some instances for SOI and Bond Buyer data, our testing of these data allowed us to conclude that both sources were sufficiently reliable for providing information on tax-exempt bonds used in this report. We reviewed a limited random sample of official statements to provide more detailed information about the specific uses of tax-exempt governmental bonds than can typically be found in other data sources, such as the Bond Buyer Yearbook and the SOI data. The sample was not designed to provide projectable data on the uses of tax-exempt bonds. We drew the sample using the Municipal Securities Rulemaking Board’s (MSRB) database of official statements that it received in calendar year 2006. MSRB is a congressionally chartered organization that regulates securities firms and banks involved in underwriting, trading, and selling municipal securities, and based on its rules, bond issuers are required to send a copy of their final official statements to it. We reviewed the randomly ordered official statements until we identified five official statements that we determined would likely be included in each of the eight categories in the SOI data. For providing information on hotels that were financed with tax-exempt bonds, we could not find a comprehensive, reliable source with information on the numbers of hotels financed with tax-exempt bonds. Thus, we provide some limited data from the best available sources we could find for hotels financed with tax-exempt bonds from 2002 through 2006. We used these recent years because information on financing for these hotels would more likely be available than information for hotels financed in earlier years. To identify the hotels, we used information from a previous GAO report; HVS International, a global consulting services firm that focuses on hotel and hospitality services; and Bond Buyer daily publications that provide additional information on municipal bonds. From these sources we identified a number of hotels that may have been financed with tax-exempt bonds. However, we were only able to confirm that the 18 hotels identified in our report were financed, at least in part, with tax-exempt bonds by reviewing official statements and government financial reports and contacting local officials. The list of hotels we present likely is not a comprehensive list of all hotels financed with tax- exempt bonds. For providing information on municipal golf courses that were financed with tax-exempt bonds, we could not find a comprehensive, reliable source with information on the number of municipal golf courses financed with tax-exempt bonds. Thus, similar to our review of hotels, we provide limited data from the best available sources we could find. We used the National Golf Foundation’s database to identify municipal golf courses that opened in 2005. We identified nine municipal golf courses that opened in 2005. However, the National Golf Foundation’s database did not have information on whether the golf courses were financed with tax-exempt bonds. To confirm whether these nine municipal golf courses were financed with tax-exempt bonds, we contacted city, county, and golf course officials. From these contacts, we determined that six of the nine municipal golf courses were financed with tax-exempt bonds, and we obtained the official statements for those municipal golf courses. To provide information on borrowing costs, we conducted a literature review of previous studies that reviewed whether bond issuance costs vary by method of sale, including characteristics of the bond and bond issuers, and we analyzed IRS data on issuance costs. We reviewed studies published in peer-reviewed academic journals from 1996 through 2007. Because the studies we reviewed had several limitations, including that they were limited to certain states for certain time periods or focused only on certain market sectors, we initially attempted to conduct original research on this topic by obtaining a broad set of data on tax-exempt bonds and developing similar econometric analysis to the studies we reviewed that would have covered a wider range of bonds over a longer time period. However, we determined that the available data were not sufficiently reliable for our purposes. As a result, we confined our review of bond issuance costs to a summary of previous studies that attempt to address the same issue, but not on as wide of a scale as we had initially intended. We analyzed IRS’s SOI data on tax-exempt bonds from 2002 to 2005 to identify how issuance costs vary between governmental and private activity bonds. We reviewed issuance costs as a percentage of total bond proceeds for the various categories of governmental and qualified private activity bonds and by bond size. We also used IRS data to identify the extent to which issuance costs for qualified private activity bonds exceed the statutorily required 2 percent limit and the extent to which bond issuers do not report issuance costs on the IRS Forms 8038 and 8038- G. We interviewed officials in IRS’s Tax-Exempt Bond Office in its Government Entities and Tax-Exempt Division and Treasury’s Office of Tax Policy and other experts in taxation and government finance, such as representatives of the Government Finance Officers’ Association, the Securities Industry and Financial Markets Association, and the Congressional Research Service, to gain an understanding about the volume and uses of tax-exempt bonds. We determined that the data we evaluate in this report were sufficiently reliable for our purposes. We performed our work from December 2006 through January 2008 in accordance with generally accepted government auditing standards. Appendix II: Sources of Information on the Facilities and Activities Financed Using Tax- Exempt Bonds Information on the types of facilities and activities that are financed with tax-exempt bonds is available from several sources, including the official statements prepared by underwriters to market the bonds, IRS, and private vendors, such as Thomson Financial. Specific information on what tax- exempt bonds are used for varies by source. Overall, the official statement generally contains the most detailed descriptive information. However, because there are no standard guidelines on the format and content of official statements, the level of detailed information they contain on the facilities and activities financed with tax-exempt bonds varies. For example, an official statement for a bond issued in 2006 stated that the bond was to be used to construct and improve the water facility for a municipality. Another official statement for a bond issued the same year showed that the bonds were to be used for various capital improvements. While in the first instance, the official statement more clearly discloses what the bond is to be used for, it is not fully apparent from the other example what specific capital improvements were financed by the bond. The information IRS collects on tax-exempt bonds is transcribed from information returns bond issuers are required to send IRS. By law, bond issuers are required to file IRS Form 8038-G, Information Return for Tax- Exempt Government Obligations for Governmental Bonds for bonds with an issue price of $100,000 or greater, or IRS Form 8038, Information Return for Tax-Exempt Private Activity Bonds. In filling out the form, a bond issuer checks boxes that best describe the types of facilities and activities to be financed with the bonds. For governmental bonds, the form has eight broad categories, including education, transportation, public safety, and other. If the other category is checked, the bond issuer is also asked to write in information that describes the intended use of bond proceeds. While the information that IRS collects from the form is useful in presenting summary information on the facilities and activities financed with governmental bonds, it only presents a very broad picture of the facilities for which the bonds are used. For example, if the bond issuer checked education, it is only apparent that the bonds were intended for educational facilities and activities. However, the specific nature of the educational facilities and activities is unknown based on the type of data IRS collects. For instance, it would not be apparent whether the bonds were used to finance new educational facilities, such as public and charter schools; fund teachers’ pension plans; construct a college athletic field; or pay for computer equipment used in a school. Likewise, issuers of private activity bonds are required to send IRS a similar form wherein they check boxes that broadly describe the facilities and activities financed with the bonds. IRS publishes descriptive statistics from these forms. Another source of information on the facilities and activities financed by tax-exempt bonds that we used was the Bond Buyer Yearbook, a publication by Thomson Financial that summarizes information on municipal bonds on a yearly basis. Information in the Bond Buyer Yearbook is obtained from several sources and provides one of the most comprehensive sources of information describing the facilities and activities financed by municipal bonds. The Bond Buyer Yearbook categorizes the facilities and activities financed by municipal bonds based on 10 broad categories and 48 subcategories. Even though the Bond Buyer Yearbook categorizes municipal bonds into many categories, the information only presents a general picture of the range of facilities and activities for which the bonds are used. For example, the Bond Buyer Yearbook development category has 3 subcategories—industrial, economic, and office buildings. From this summarized information, it is not apparent whether facilities such as hotels financed with tax-exempt governmental bonds are included as economic development. It is also important to note that Bond Buyer Yearbook information on the uses of bonds does not distinguish between tax-exempt governmental, qualified private activity, and taxable municipal bonds. However, according to Bond Buyer Yearbook information, generally less than 10 percent of all municipal bonds issued annually are taxable. Despite that, the Bond Buyer Yearbook is a useful source for summarized information on the types of facilities and activities that are financed using municipal bonds, including tax-exempt bonds. Appendix III: Summary of Thomson Financial 2007 Bond Buyer Yearbook Data, Use of Proceeds, 2002-2006 Combined Dollars in thousands (constant 2007 dollars) Dollars in thousands (constant 2007 dollars) Appendix IV: Amount and Number of New Money, Long-term Governmental Bonds Issued by IRS SOI Purpose Categories, 2001- 2005 Combined Dollars in millions (constant 2007 dollars) Appendix V: List of Studies Reviewed on Interest Costs in Competitive and Negotiated Sales Gershberg, Alec Ian, Michael Grossman, and Fred Goldman. “Competition and the Cost of Capital Revisited: Special Authorities and Underwriters in the Market for Tax-Exempt Hospital Bonds.” National Tax Journal, vol. 54, no. 2 (2001): 255-280. Kriz, Kenneth A. “Comparative Costs of Negotiated versus Competitive Bond Sales: New Evidence From State General Obligation Bonds.” The Quarterly Review of Economics and Finance, vol. 43 (2003): 191-211. Leonard, Paul A. “An Empirical Analysis of Competitive Bid and Negotiated Offerings of Municipal Bonds.” Municipal Finance Journal, vol. 17, no. 1 (1996): 37-66. Peng, Jun and Peter F. Brucato, Jr. “Another Look at the Effect of Method of Sale on the Interest Cost in the Municipal Bond Market—A Certification Model.” Public Budgeting and Finance, vol. 23, no. 1 (2003): 73-95. Robbins, Mark D. and Bill Simonsen. “Competition and Selection in Municipal Bond Sales: Evidence From Missouri.” Public Budgeting and Finance, vol. 27, no. 2 (2007): 88-103. Simonsen, Bill, Mark D. Robbins, and Lee Helgerson. “The Influence of Jurisdiction Size and Sale Type on Municipal Bond Interest Rates: An Empirical Analysis.” Public Administration Review, vol. 61, no. 6 (2001): 709-717. Simonsen, William and Mark. D. Robbins. “Does It Make Any Difference Anymore? Competitive versus Negotiated Municipal Bond Issuance.” Public Administration Review, vol. 56, no. 1 (1996): 57-64. Appendix VI: Comments from the Internal Revenue Service Appendix VII: Comments from the Department of the Treasury Appendix VIII: GAO Contact and Staff Acknowledgments Acknowledgments In addition to the individual named above, Charlie Daniel, Assistant Director; Terry Draver; Thomas Gilbert; Nancy Hess; Larry Korb; John Mingus; Ed Nannenhorn; David Perkins; Cheryl Peterson; Katrina Taylor; and Walter Vance made key contributions to this report.

The outstanding amount of state and local government tax-exempt bonds has increased over the years. Congress is interested in whether the bonds are used for appropriate purposes since the federal government forgoes billions in tax revenues annually by excluding the bonds' interest from investors' federal gross income. Questions also exist over the bonds' borrowing costs as they can divert funds from the funded projects. This report (1) describes recent trends in tax exempt bonds, (2) provides information on the types of facilities financed with tax-exempt bonds, and (3) discusses borrowing costs considering the methods of selling bonds and compares issuance costs paid from bond proceeds for governmental and qualified private activity bonds. In addition to interviewing relevant officials, we analyzed IRS's Statistics of Income (SOI) data and data from Thomson Financial to address these objectives. In recent years, the volume of tax-exempt bonds issued annually for both governmental and private activity bonds has reached historically high levels. Generally, the volume of new money bond issues has been greater than bonds issued for refunding purposes. The volume of tax-exempt bonds issued, particularly bonds issued for refunding, tends to be highest when interest rates decline. Because the interest earned by investors who purchase tax bonds is generally excluded from federal income taxes, the federal revenue losses amount to billions of dollars annually. Tax-exempt governmental and private activity bonds are used to finance a wide range of projects and activities, with bonds issued for "educational purposes" generally being the largest category of governmental bonds annually. Nonprofit organizations are the largest issuers of qualified private activity bonds. Previous legislation prohibited using qualified private activity bonds for certain facilities, including professional sports stadiums, hotels, and private golf courses. However, many of these types of facilities are still being financed with tax-exempt governmental bonds. Congress has held hearings on this issue primarily focusing on sports stadiums. Although the evidence is not definitive, studies have generally shown that interest costs are lower for bonds sold when competition between underwriters exists compared to when bond sales are negotiated with underwriters after controlling for other factors. About half of all issuers of qualified private activity bonds reported paying issuance costs from bond proceeds from 2002 to 2005. IRS's guidance does not indicate what to report when no issuance costs are paid from bond proceeds. Of those reporting issuance costs, some private activity bond issuers reported paying issuance costs from bond proceeds that exceed statutory limits.

The Commission’s Report Made Valuable Contributions Overall, the Commission’s report provides a valuable contribution to assist Congress, the Service, the executive branch, and stakeholders in considering the actions needed to transform the Postal Service into a more high-performing, results-oriented, and accountable organization. Tomorrow, we plan to hold a forum at GAO with Postmaster General Jack Potter and other national leaders and experts to discuss ways in which Congress and the executive branch can foster federal agencies’ and their networks’ efforts to become high-performing organizations. We are pleased that the Commission’s report facilitated consideration and debate by presenting the issues in a way that can be understood by a general audience, and we commend the Commission for the open and transparent process used to engage stakeholders in developing its report. We also share the report’s emphasis on a customer-oriented Postal Service that can continue to meet the nation’s vital need for universal postal service. Citizens and businesses depend on the Service to provide affordable postal services that are essential for communications and commerce on a universal basis. The Commission’s report also made an important contribution by addressing difficult infrastructure and human capital issues. We agree with the Commission that transforming the Service will require a fundamental reexamination and realignment in both of these areas, which collectively account for most of the Service’s costs and are the linchpin to delivering high-quality service. As the Commission noted, the nation’s communications, technology, and delivery markets have seen vast changes since the Postal Service was created by the Postal Reorganization Act of 1970. New types of electronic communications include the use of e-mail, wireless technology, and electronic bill payment services. These changes appear to have placed First-Class Mail volume in the early stages of what may be a long-term decline. In this new environment, unless the Service’s operating expenses can be reduced correspondingly, with a rightsizing of both its infrastructure and workforce, it is questionable whether affordable universal mail service can be sustained over the long term with a self-financing public institution. Further, it takes time for an organization as large and complex as the Service to make fundamental changes, particularly when some of these may hinge on congressional action. Fortunately, the Commission and others, including the Service, have identified numerous changes, many of them possible within existing law, which can reduce the Service’s operating costs while maintaining and enhancing the quality and value of postal services. With respect to human capital issues, the Commission has recognized that management reform and improvements in managing the Service’s employees will be vital to comprehensive postal transformation. We applaud the Commission’s efforts to develop new approaches in these areas. While postal stakeholders may differ over the Commission’s recommendations, we share the Commission’s view that the status quo is not a viable option. All options for statutory and discretionary change need to be on the table for discussion. If the Service and its employee unions do not believe that some of the Commission’s workforce recommendations are viable, we believe that alternative solutions, or a package approach, to the workforce issues raised by the Commission and us in our previous work need to be explored. The Need for Comprehensive Postal Reform Legislation The Commission recognized that comprehensive reform to the nation’s postal laws is needed so that the Service can successfully meet the formidable challenges it faces and continue to provide affordable and high-quality universal postal services. The Commission reported that “it is the Commission’s emphatic view that an incremental approach to Postal Service reform will yield too little too late given the enterprise’s bleak fiscal outlook, the depth of current debt and unfunded obligations, the downward trend in First-Class Mail volumes and the limited potential of its legacy postal network that was built for a bygone era.” We agree. Our prior reports and testimonies have concluded that comprehensive postal reform legislation is needed and have provided information on key issues to be considered. The Commission’s findings are generally consistent with our past work, and its recommendations address postal reform issues in a comprehensive manner. Now that the Commission has finished its work, the time has come for Congress to act. The Commission’s recommendations represent a thoughtful package that would preserve the historic values of universal postal service; make important statutory changes in many key areas, including governance, oversight, and human capital; and create a mechanism for making further changes over time. In our view, the Postal Service’s current financial breathing room gives Congress an opportunity to carefully consider postal transformation issues and “get it right” when making fundamental decisions about rechartering the nation’s postal system for the 21st century. Consistent with the need for Congress to rethink the role of the federal government in the 21st century, now is the time to rethink and clarify the mission and role of the Postal Service. The Commission’s report concluded that a number of trends are driving the need for a sweeping exploration of the Postal Service’s role and operations in the 21st century. In this regard, we share the Commission’s concerns about the likelihood of declining First-Class Mail volumes in both the short-term and the long- term. First-Class Mail generates more than half of the Service’s revenue. The revenue generated by First-Class Mail was used to cover about 69 percent of the Service’s institutional cost in fiscal year 2002. The loss of contribution from declining First-Class Mail volume would be difficult to recover from other classes of mail. However, the rate of growth for First- Class Mail has been in long-term decline since the 1980s. First-Class Mail volume has steadily declined since it peaked 2 years ago. Its volume is estimated to have declined by 3.1 percent in fiscal year 2003 and is projected to decline by 1.3 percent in fiscal year 2004 (see figure 1). Looking ahead, we share the Commission’s concern that electronic diversion of First-Class Mail threatens to significantly accelerate the decline in the Service’s mail volume. Although the role of the Internet has been much commented on, it can be easy to overlook the fact that the Internet is a relatively recent historical phenomenon, with use of the World Wide Web greatly increasing in the 1990s. As recently as 5 years ago, only 37 percent of U.S. households had a computer, and only 19 percent of U.S. households were connected to the Internet (see figure 2). The rapid diffusion of computer and Internet technologies has led to high adoption rates among those with high levels of income and education—the same groups that send and receive a disproportionate share of First-Class Mail. Thus, the trend data point to the strong potential for further electronic diversion. Raising postal rates to offset this trend may provide an immediate boost to the Service’s revenues, but over the longer term will likely accelerate the transition of mailed communications and payments to electronic alternatives, including the Internet. A report prepared for the Commission found that growth in electronic payments is likely to be an important factor in its forecast of gradual declines in First-Class Mail volume. The Commission’s report highlighted why the status quo has not produced satisfactory results and is ill suited for the 21st century. Key weaknesses include: Uncertain financial future: In theory, the Postal Service is self- supporting through postal revenues. In practice, as the Commission noted, even after recent statutory changes reduced the Service’s unfunded liability for Civil Service Retirement System (CSRS) pension benefits, the Service has accumulated about $92 billion in liabilities and obligations over the past three decades. These liabilities and obligations include debt, large unfunded obligations for retiree health benefits obligations, and remaining unfunded pension and workers’ compensation liabilities. Thus, current ratepayers have not fully covered the total costs generated to provide the postal services they have received. A continuation of these trends would be diametrically opposed to the Commission’s vision of a fiscally sound Postal Service that can sustain universal postal service, particularly if the Service’s core business of First-Class Mail continues to decline in the coming years. Difficulty financing capital needs: In recent years, the Service has found it problematic to obtain adequate financing for capital needs. Thus, the Service has often increasingly resorted to borrowing to finance its capital improvements. In fiscal year 2001, the Service was faced with insufficient cash flow from operations and with debt balances that were approaching statutory limits. Consequently, the Service imposed a freeze on capital expenditures for most facilities that continued through fiscal years 2002 and 2003. The Service was able to repay some of its debt in fiscal year 2003, primarily because it generated a positive cash flow from a reduction in its pension costs. However, looking forward, it may be difficult for the Service to obtain adequate funds to address its long-term capital needs, including modernizing its aging network of postal facilities, without significantly increasing rates or debt. The Commission’s recommendations in the areas of retained earnings and disposition of excess Postal Service real estate represent carefully considered alternatives to help provide the Service with sufficient revenue for both its operating and capital needs. Lack of incentives for good financial performance: The “break-even” mandate requires the Service’s revenues and appropriations to equal its total estimated costs as nearly as practicable. For many years, this mandate has been interpreted to mean that the Postal Service should break even over time. As such, the break-even mandate removes the profit motive, and the rate-setting structure allows the Postal Service to cover rising costs by raising rates. Further, the lack of a provision for retained earnings also limits incentives for productivity improvement and cost reduction. Under the current structure, whatever cost reductions the Service achieves in one rate cycle are used to reset the estimated costs that the Service is to recover in the next rate cycle. In contrast, a limited retained earnings provision would enable the Service and its employees to benefit from whatever cost reductions are achieved. Lack of efficiency: The Service has improved its efficiency in recent years, but much more progress needs to be made. The Commission identified significant variation in efficiency among mail processing plants and called for more efficient operations through standardization. We agree with the Commission that the Service has significant opportunities to improve its efficiency through best execution strategies in which those who can do it best and at the best price would perform postal activities while the Service rightsizes its infrastructure and workforce. However, as we have previously reported, both legal and practical constraints have hindered progress in these areas. Disincentives for maximizing allocation of postal costs: Under the current regulatory model, all classes of mail and types of service must cover their attributable costs, while institutional costs (i.e., common or overhead costs) are allocated based on judgment informed by broad statutory criteria. In effect, the Postal Service loses pricing flexibility as costs are allocated to specific postal products and services, creating a structural disincentive for the Service to maximize cost allocation to various classes of mail and types of service. Understanding, measuring, and reporting postal costs have greatly improved over the years. However, the proportion of postal costs allocated by the Service has increased by only 9 percent since postal reorganization. Further, cost allocation disputes persist, as illustrated by the different methodologies used by the Service and the PRC for allocating mail processing costs— that is, the Service allocated 58 percent of postal costs in fiscal year 2002, while the PRC allocated 62 percent. We recognize that it may be difficult to use the data that are currently collected by the Service to allocate a higher proportion of costs. Nevertheless, the Commission’s conclusion that more postal costs can and should be allocated raises the issue of whether increasing regulatory authority over cost allocation would be necessary to ensure that all costs that can be rationally attributed are properly allocated. Furthermore, improvement in the Service’s data collection could also enable greater allocation. Postal Service Mission and Role Need Clarification It is important for Congress to consider how best to clarify the mission and role of the Postal Service as part of a fundamental reexamination of the role of the federal government in the 21st century. The starting point is to consider the Commission’s recommendation that Congress amend the nation’s postal laws “to clarify that the mission of the Postal Service is to provide high-quality, essential postal services to all persons and communities by the most cost-effective and efficient means possible at affordable, and where appropriate, uniform rates.” This recommendation is coupled with proposals to create a mechanism for change by giving broad authority to a newly created Postal Regulatory Board, including authority to review and issue binding decisions on certain Postal Service proposals to redefine delivery frequency requirements; uniform postal rates; and the Postal Service’s monopoly to deliver mail and place items in mailboxes. The Commission sought to clarify the nature of the Service’s universal postal service mission by recommending that Postal Service activities be limited to accepting, collecting, sorting, transporting, and delivering letters, newspapers, magazines, advertising mail, and parcels and providing other governmental services on a reimbursable basis when in the public interest. The Commission recognized that the nation’s postal laws did not envision the challenge of setting appropriate boundaries on the Service’s commercial activities and maintaining fair competition between the Service and the private sector. These issues need to be addressed because the Service has repeatedly strayed from its core mission. We have reported on the Service’s money-losing initiatives in electronic commerce and remittance processing, among other things. The Service’s ill-fated ventures were also questioned by some postal stakeholders as unfair competition, since they were cross-subsidized by a tax-exempt entity that is also exempt from many laws and regulations governing the private sector. Further, such ventures have raised the fundamental issue of why the federal government is becoming involved in areas that are well served by the private sector. Although the current Postmaster General has appropriately focused on the Service’s core business of delivering the mail and sharply curtailed its nonpostal initiatives, the Commission recommended codifying this policy. In our view, the time has come for Congress to clarify the Service’s core mission and ensure continuity across changes in postal management. However, it will be important to understand the implications of generally limiting the Postal Service to its traditional role of handling the nation’s mail, as the Commission has recommended. In that event, the Service will face the formidable challenge of maintaining affordable universal postal service by growing revenues or significantly cutting its costs as its core business of First-Class Mail declines. In order to achieve net cost savings, the Service’s cost-cutting efforts must currently offset billions of dollars in annual cost increases for general wage increases, cost-of-living adjustments, and rising benefits costs, particularly in health insurance premiums, as well as costs associated with having to deliver mail to over 1.5 million new addresses every year. Declining First-Class Mail volume will intensify the financial squeeze by reducing the volume of highly profitable mail. Thus, if the Service is limited to its traditional role, maintaining the quality and affordability of postal services would likely require dramatic improvement in the Service’s efficiency. The Service would need to become a much leaner and more flexible organization and rightsize its network of mail processing and distribution facilities. Consistent with our past work and the testimony of many key stakeholders, the Commission recognized that comprehensive reform of the nation’s postal laws would be necessary to facilitate changes in these areas. In the next section of this statement, we discuss the Commission’s recommendations involving governance, transparency, accountability, rate setting, and human capital. In our view, revisiting these areas may involve taking substantive and political risks, but we agree with the Commission that such risks must be taken if the Service is to remain successful in the coming decades. In our view, key questions related to clarifying the Service’s mission and role include: How should universal postal service be defined, given past changes and future challenges? Should the Service be allowed to compete in areas where there are private-sector providers? If so, in what areas and on what terms? What laws should be applied equally to the Service and to its competitors? What transparency and accountability mechanisms are needed to prevent unfair competition and inappropriate cross-subsidization? Should the Service’s competitive products and services be subject to antitrust and general competition-related laws? Should they be subject to consumer protection laws? Should the Service retain governmental authority, including its regulatory responsibilities and law enforcement functions? On a related issue, the Service’s current statutory monopoly on the delivery of letter mail and its monopoly over access to mailboxes have historically been justified as necessary for the preservation of universal service. However, questions have been raised regarding whether these restrictions continue to be needed, and if so, to what extent and whether the Service should be able to define their scope. A key issue is whether the Postal Service, as a commercial competitor in the overnight and parcel delivery markets, should have the authority to regulate the scope of competition in these areas. The Commission has recommended separating these functions so that the Postal Service cannot define and regulate the scope of its own monopoly. As the Commission noted, it is a fundamental premise of American justice that parties that administer laws should not have a financial interest in the outcome. Accordingly, the Commission recommended that an independent entity should be responsible for reviewing the costs and benefits of the monopoly as well as for reviewing the thicket of vague and contradictory regulations in this area and modernizing the law to define the postal monopoly in clear and understandable terms. The independent entity could narrow the postal monopoly over time if and when the evidence shows that suppression of competition is not necessary to the protection of universal service without undue risk to the taxpayer. Narrowing or eliminating the monopoly could increase consumer choice and provide incentives for the Service to become more effective and efficient. For example, in recent years, FedEx has expanded its role in delivering residential parcels and UPS has shortened its guaranteed transit time on ground shipments traveling to some of the country’s biggest metropolitan areas. As Congress considers the Commission’s recommendations relating to the postal monopoly, we believe that key questions include: Is a government monopoly needed to enable affordable universal postal service, especially if such service is provided at uniform rates? If so, what scope of monopoly is needed to accomplish its goal? Should the Service continue to have the power to define (and redefine) its own statutory monopoly through suspensions and regulations? Should a regulatory body have authority to redefine and narrow the postal monopoly and the mailbox monopoly, or should such decisions be made through the legislative process? If authority is delegated to a regulatory body, should a clear statement of congressional intent be provided to guide regulatory decisions, or should the regulator have unfettered discretion to consider options to expand or contract the Service’s monopoly? What principles should guide the process, and what key players should be involved? Similarly, should the regulator be able to consider opening up access to the mailbox? If so, under what circumstances? Would it be cost- effective for private delivery companies to deliver items to mailboxes if individuals could veto access and redefine mailbox access as they move from one home to another? Should any regulatory decisions be governed by process requirements to enable stakeholder input? Should such processes facilitate congressional review of any changes, as is the case for some other types of communications regulated by the federal government? Protecting the Public Interest through Enhanced Transparency, Accountability and Public Policy Oversight The Commission concluded that the Postal Service must have greater flexibility to operate in a businesslike fashion, but that with this latitude comes the need for enhanced transparency to enable effective management and congressional and other oversight. We agree. As the Commission noted, managerial accountability must come from the top, with the Service governed by a strong corporate-style board that holds its officers responsible for performance. The Commission concluded that giving the Service greater flexibility while preserving its monopoly would require enhanced oversight by an independent regulatory body endowed with broad authority, adequate resources, and clear direction to protect the public interest and ensure that the Postal Service fulfills its duties. The Commission cited reports that we have issued since September 2000 urging greater financial transparency and expressing concern about sharp declines in the Service’s financial position that were accompanied by too little explanation. To enable sufficient accountability, oversight, and transparency, the Commission recommended changes to the Service’s governance structure, the creation of a Postal Regulatory Board that would have broad powers, and mechanisms to facilitate and ensure greater transparency of the Service’s financial and performance results. Key issues include whether the Commission’s recommendations are necessary, have struck the appropriate balance between multiple objectives, and would be practical to implement. Governance Structure The Commission found that given its importance to the country and the challenges to its future, the Postal Service should meet the highest standards of corporate leadership, including a strong, strategic Board of Directors coupled with enhanced oversight and financial transparency. Specifically, the Commission concluded that if the Postal Service is to adapt successfully to a changing postal market, overcome its significant financial challenges, and emerge an efficient and more businesslike institution, then it must be guided by a nimble and results-oriented management and corporate governance structure charged with applying the best business practices of the private sector to the public-spirited mission of delivering the nation’s mail. We agree. As we have reported, if the Service is to successfully operate in a more competitive environment, the role and structure of a private-sector board of directors may be a more appropriate guide in this area. Having a well-qualified, independent, adequately resourced, and accountable board is critical for a major federal institution with annual revenues approaching $70 billion and approximately 829,000 employees. Another concern is what qualification requirements would be appropriate for the Postal Service’s governing board to ensure that it possesses the kind of expertise necessary to oversee a major government business. Consistent with this view, the Commission recommended that all directors should be selected based on “business acumen and other experience necessary to manage an enterprise of the Postal Service’s size and significance.” The report also suggested that the board possess “significant financial and business expertise” and that among other things, board members have no material relationship with the Service or its management team. However, the Commission recommended that these criteria be incorporated into the Board’s bylaws or governance guidelines rather than into statute. In this area, we believe that potential issues include: Would the proposed qualification requirements be sufficient to produce a well-qualified board with outstanding and experienced directors, in part because of the flexibility inherent in the appointment process? Would the proposed board become politicized, in part because most directors would be subject to approval and removal by a political appointee, (i.e., the Secretary of the Treasury), with no Senate confirmation, no requirement for the board to have a bipartisan membership, and the possibility of removal for any reason? Would the pool of qualified candidates be unduly restricted because some corporations have a material relationship with the Service, while some retired corporate leaders would be over the proposed mandatory retirement age of 70 for Service board members? Would selection of members of the proposed board of directors by an official other than the President be consistent with the Appointments Clause in Article II, section 2, clause 2 of the Constitution, which requires that the heads of executive branch departments be appointed directly by the President with the advice and consent of the Senate? We believe that these concerns merit careful consideration, as well as other concerns on which we have previously reported. In particular, it is debatable whether it would be appropriate for the Secretary of the Treasury to have the authority to approve most future appointments to the governing board of the Service, which fulfills vital government functions and includes nearly one-third of the federal civilian workforce. An alternative option may be to have a number of persons, including the Secretary of the Treasury, to advise the President on such appointments. Another key issue is whether these appointments should continue to be made with the advice and consent of the Senate, which is a mechanism to involve the legislative branch in matters of postal governance. However, we agree with the Commission’s conclusion that the legacy governance structure of the Service is increasingly at odds with its mission in the modern environment and that the Service’s governing structure needs to consist of members with the requisite knowledge and experience. The Commission’s report made a contribution in identifying the fundamental activities necessary for good corporate governance. The report made a number of recommendations for the proposed board of directors to more effectively discharge its duties, including refocusing the board on a high-level strategic focus on cost reduction and service quality, as well as minimizing the financial risk to taxpayers and restoring the fiscal health of the institution as a whole. In this regard, we believe that the current Board of Governors should refocus its activities along the lines suggested by the Commission. Accountability Mechanisms We have reported that a major issue related to the Service’s mission and role is whether the Service should be held more directly accountable for its performance, and if so, to what extent, to whom, and with what mechanisms. Specifically, how should the Service’s governing board be held accountable? The Commission found that the Service urgently needs a vigilant, broadly empowered and independent regulatory body to focus on its ability to fulfill its core duties in an appropriate and effective manner. The Commission recommended that the Postal Rate Commission be abolished and replaced with a newly created Postal Regulatory Board endowed with broad public policy responsibilities as well as broad mandates and authority for accountability and oversight. The regulator would also have authority in numerous areas including rate setting, retained earnings, financial transparency, service standards, performance reporting, and enforcing pay comparability, among others. A key objective of the Commission’s recommendations was to focus the proposed Postal Service board of directors on the business aspects of the Postal Service while transferring public policy responsibilities from the Service to an independent regulator with no stake in the outcome. The recommendations also would transfer key public policy responsibilities from Congress to the regulator. For example, the newly created regulatory body could, over time, redefine the Service’s universal service mission and statutory monopoly. The Commission’s accountability and oversight provisions would make major changes to the current structure. Thus, the Commission’s recommendations in this area raise fundamental issues. In our view, key questions include: Who should make public policy decisions regarding the Postal Service: the Service, an independent regulator, or Congress? What accountability should apply to a monopoly provider of vital postal services that also is a major competitor in the communications and delivery marketplace? How should the Service be held accountable if it remains an independent establishment of the executive branch? To what extent should the Service be accountable to Congress and the executive branch without being subject to undue political control? To what extent should a regulatory body exercise accountability? For what purpose? With what authority? Although additional oversight of the Service appears necessary, would the Service have sufficient management flexibility given the fairly broad authority the Commission proposes be given to the regulatory body? How should the regulatory body be structured to preserve its independence from political control and minimize the risk of regulatory capture? What statutory guidance and constraints should apply to regulatory actions, including due process and recourse to judicial and/or congressional review? What transparency of financial and performance results is appropriate for the Service as a federal establishment and would be necessary for oversight and accountability? What mechanisms should be established to facilitate and ensure transparency? Should the Service comply, either on a voluntary basis or through a statutory requirement, with major Securities and Exchange Commission (SEC) reporting requirements? Enhancing Transparency of Financial and Performance Information The Commission noted that as a public entity, the Postal Service is wholly owned by the American people, who, as the Service’s shareholders, are due a regular and full accounting of the fiscal health and challenges facing this vital national institution. The Commission stated that the Service has a responsibility to the public to be transparent in its financial reporting. We agree. Reporting requirements should ensure accountability and transparency of financial and organizational reports. We have recommended that the Postal Service improve its transparency, and to the Service’s credit, it has made progress in providing greater transparency on its financial results and outlook. The Service has instituted quarterly financial reports, expanded the discussion of financial matters in its annual report, and included more information and explanation in the financial and operating statements prepared for each 4-week accounting period. The Service has also upgraded its Web site to include these and other reports in a readily accessible format. The Service is clearly moving in the right direction. However, we agree with the Commission that more progress can and should be made. In an area where we have particular concern that the Service have transparent, appropriate accounting, the Commission recommended that the Service’s governing board work with its independent auditor to determine the most appropriate accounting treatment of the Service’s unfunded retiree health benefit obligations in accordance with applicable accounting standards. The Commission also recommended that the board consider funding a reserve account to address these obligations to the extent that Postal Service finances permit. These recommendations are similar to our previous statements, which noted that the Service’s current accounting treatment does not reflect the legal nature and the economic reality of its related obligation to pay for these costs; the Service’s treatment of retiree health benefit costs in its financial statements has not sufficiently recognized the magnitude, importance, or meaning of this obligation to decision makers or stakeholders; and because the retiree health benefit obligations are funded on a pay-as- you-go basis, rather than on a full accrual basis, current ratepayers are not paying for the full costs of the services they are receiving. We continue to believe that the time has come for the Service to formally reassess how it accounts for and discloses these very significant financial obligations. In our view, given the legal nature, economic substance, and stakeholder implication of these obligations, the Service should account for these retiree health costs and related obligations in its financial statements on an accrual basis. We recognize that a change to accrual accounting could have a significant impact on rates. However, the Service could work with the PRC and other stakeholders to determine how best to phase in such a change to mitigate the immediate impact on ratepayers. Regardless of whether the Service changes its accounting for retiree health costs, we continue to believe the Service should disclose the funded status of all of its retiree health and pension obligations. The Commission enunciated an ambitious standard for the Service when it stated that “As a unifying force in American commerce and society, and as a customer-financed government endeavor, the Postal Service should be setting the standard for financial transparency by which all other Federal entities are judged.” The Commission also found that given its important public mission and central role in the nation’s economy, changes in the Service’s economic health should not come as a surprise to those responsible for or impacted by its performance. In this regard, the Commission found that while the Service often conducts financial reporting over and above what is required by federal agencies, it remains behind the level of disclosure offered by its corporate peers. We believe that technical compliance with accounting and reporting requirements should be a floor for financial transparency, not a ceiling. Thus, we were pleased that in keeping with its theme of incorporating best practices, the Commission said it “strongly recommends” that the Service voluntarily comply with major Securities and Exchange Commission (SEC) reporting requirements. The Service has the opportunity to proactively work with the SEC to define how it could voluntarily comply with SEC requirements in a manner appropriate to its unique legal status. Enhanced financial transparency is particularly important because the Service is the hub of a $900 billion mailing industry and is a vital part of the nation’s communications and payment network. Its recent financial difficulties have accentuated the need for stakeholders to be well apprised of the Service’s financial situation and to understand how future operating results may be affected by impending events. Although the Service has traditionally provided a range of detailed financial and operating data to stakeholders throughout the fiscal year, its periodic financial reports did not clearly explain changes in its financial condition, results of operations, and its outlook, and were not always readily available to the public. Thus, in April 2001, we recommended that the Service provide quarterly financial reports to Congress and the public with sufficiently detailed information for stakeholders to understand the Service’s current and projected financial condition and how its outlook may have changed since the previous quarter. In November 2002, we found that the Service’s financial reports provided to date had provided only limited analysis and explanations to help stakeholders understand what had changed, why it had changed, and how these changes affected the Service’s current financial situation and expected outlook. Since then, the Service has improved its quarterly financial reports. We also discussed the SEC’s reporting structure as a model for the Service to consider. As the Commission recognized, the Service remains a public institution with a monopoly on providing vital postal services to the nation, and enhanced financial information will be essential to improve managerial accountability and public policy oversight. In this regard, there are areas where stakeholders have little information, such as the Service’s unmet financial needs to maintain and modernize its infrastructure, or the true market value of the Service’s vast real estate holdings. Therefore, progress in enhancing the Service’s financial transparency is worthy of continued congressional attention. In addition to the above areas, we have reported on, and continue to have concerns about, the Service’s annual performance reporting that is required under the Government Performance and Results Act (GPRA).The Service’s recently filed 5-Year Strategic Plan for Fiscal Years 2004- 2008 contained a clear mission statement and presented a useful discussion of the prospects for mail volume, including three specific forecasts. However, the plan represented a missed opportunity because it failed to adequately communicate what the Service intends to accomplish over the period covered by the plan. For example, the plan contained little new information on the Service’s goals and strategies for network and workforce realignment over the next 5 years. The plan continues a trend in which the Service’s GPRA reports have provided less and less new information to Congress, postal stakeholders, and the American people. We also continue to be concerned that the Service does not communicate its delivery performance for all of its major mail categories, particularly those covered by its statutory monopoly to deliver letter mail. The Service’s customers should have a right to know what they are getting for their money, particularly captive customers with few or no alternatives to using the mail. However, the Service’s public reporting is limited to on- time delivery of First-Class Mail deposited in collection boxes and does not include bulk mailing of First-Class Mail by businesses. In addition, stakeholders and individuals have expressed concerns about the accuracy of mail delivery, but no public information is provided for this aspect of mail service. The Commission recognized that information about service quality would become even more important if the Service obtains more flexibility and incentives to cut its costs. Accordingly, the Commission recommended that the Postal Regulatory Board be required to prepare a comprehensive annual report assessing the Postal Service’s performance in meeting established service standards. If such a report is to be meaningful, the regulator may also need authority to require the Service to collect service performance data. Without sufficient transparency, it is difficult to hold management accountable for results and conduct independent oversight. The Service has the opportunity to seek out best practices and continually improve as standards evolve and experience accumulates, and its recent track record suggests that some improvement is possible. A key issue is whether statutory change is needed to enhance the level of transparency that the Service must provide, particularly if it obtains greater flexibility along the lines recommended by the Commission. Rate-setting Structure The Commission concluded that it is imperative that the Postal Service, an institution with a statutory monopoly over the delivery of letter mail, have clear, independent regulatory oversight that includes oversight over its postal rates. The Commission found that the current statutory structure produced independent review of postal rates and had the laudable goals of protecting postal customers against undue discrimination while restricting cross-subsidies. However, the Commission stated that the current rate- setting structure should be abolished so that these goals can be accomplished more efficiently and effectively, by establishing an incentive-based rate-setting system. We agree that major changes are needed in this area. As we have testified, improvements in the postal rate- setting structure will be a fundamental component of a comprehensive transformation. The existing statutory structure is increasingly ill suited to meeting the needs of the Postal Service and the American people. Its shortcomings include the following: Lengthy and burdensome rate-setting proceedings - The Commission found that the current rate-setting structure imposes a litigious, costly, and lengthy rate-setting process that can delay needed new revenues by more than a year. We agree. The Service and other stakeholders report spending millions of dollars in each rate case on attorneys, economists, statisticians, and other postal experts who pore over many thousands of pages of testimony, interrogatories, and rebuttals. The high cost of participation, coupled with the increasing complexity of rate-setting data and methods, make it difficult for smaller stakeholders to effectively participate in the regulatory process. Bias toward adversarial relationships - As the Commission noted, every significant change requires a major proceeding that places the Postal Service in an adversarial relationship with its major customers and at a distinct competitive disadvantage. Rate cases tend to pit the Service and many postal stakeholders against each other, since the zero-sum nature of the revenue requirement provides powerful incentives for parties to attempt to shift postal costs in ways that serve their immediate self-interests. The adversarial rate-setting process has consumed the attention of all of the parties involved, increasing the difficulty of focusing on constructive efforts to find mutually acceptable approaches to difficult technical issues. During lengthy rate cases, rules against ex parte communications help preserve due process and fairness, but also make it difficult for rate-setting experts at the Service and the PRC to constructively discuss technical issues and resolve problems as they arise. Despite these structural impediments, rate-setting experts at the Service and PRC have made some progress in improving communications in recent years, notably during the 1999 Data Quality Study on the quality of data used for rate-setting purposes, as well as during subsequent efforts to improve data collection systems. We are pleased that the Service has convened periodic briefings with representatives of the PRC, the Service’s Office of the Inspector General, and us, in which it engaged with the parties and provided detailed status reports on initiatives to improve rate-setting data systems. We are also encouraged that the Service has started to engage with the PRC in planning some improvements to its rate-setting systems, and we commend the Service for offering public briefings to provide additional transparency on modifications to key data systems. These efforts facilitate constructive dialogue on data quality issues, providing opportunities for the parties to make continuous progress as postal operations, technology, and data systems change. Perennial disagreements - Cost allocation issues have been debated for many years and are frequently a key reason why postal rate cases are so lengthy and litigious, since their disposition can directly affect postal rates. The statutory structure seeks to assure all parties due process by enabling them to raise whatever issues they wish, regardless of how many times the same issues may have been considered in the past. The Postal Service has a special opportunity to repeatedly raise issues by building them into its initial proposals for changes to postal rates. For example, the Postal Service and PRC have strongly disagreed on the allocation of mail processing costs in rate cases dating from 1997—to the point that two sets of postal costs are routinely prepared, one according to the Postal Service’s preferred methodology and one according to the PRC’s methodology. This situation epitomizes the downside of enabling parties to repeatedly litigate the same issues in the name of due process. Although the Commission noted that interested parties should have an opportunity to participate in rate-setting matters, the need to address complex cost allocations in each and every rate proceeding conflicts with the Commission’s vision of a streamlined rate-setting process that can swiftly resolve complaints about postage rates. Poor incentives for data quality - The current statutory model gives the Service opportunities to seek advantage in litigious rate-setting proceedings through its control over what data are collected and how those data are analyzed and reported. The PRC cannot compel the Service to collect data, or update data it has collected. The PRC also cannot subpoena data that the Service has collected. The 1999 Data Quality Study found that key postal cost data had not been updated for many years and were used regardless of their obsolescence. Although the Service has worked to address these and other deficiencies identified by the study, as noted above, it is fair to question why the regulatory process had enabled these problems to continue for so many years. Further, regarding the sufficiency of data in the recent negotiated service agreement (NSA) case, the Service provided no mailer-specific cost data corresponding to mailer-specific discounts, creating uncertainty regarding whether the discount was set appropriately in relation to the cost savings that the Service should be expected to achieve as a result of the NSA. Disputes over cost allocation - The Service is generally opposed to PRC proposals that would require the Service to provide more detailed annual information on postal costs and information on cost allocation methodologies used to produce that data. In support of its view, the Service has asserted that the current statutory structure generally limits the PRC to a reactive role in considering proposed rates and supporting information provided by the Service in rate and classification cases. This perspective contrasts with the Commission’s vision of independent regulatory oversight in which the outcome cannot be unduly influenced through the selective provision of information to the regulator. To this end, the Commission recommended that the Service periodically report on the allocation of costs in accordance with form, content, and timing requirements determined by the Postal Regulatory Board, the recommended successor to the PRC. Lack of mailer-specific data - Looking forward, a key issue is what data on the mailer-specific costs, volumes, and revenues of the Postal Service, if any, should be provided to justify mailer-specific discounts that result from NSAs. The Service has generally opposed providing such mailer-specific data in the future as overly burdensome, unwise, and impractical, in part because its cost measurement systems are geared to providing aggregate data at the subclass level. The PRC is currently reviewing what cost data should be provided to justify mailer- specific postal rates, and key stakeholders have filed conflicting testimony on the issues in this area. Regardless of the outcome, it is reasonable to ask how the Service can effectively identify, prioritize, and negotiate mutually beneficial NSAs if little reliable data are available on the cost savings that the Service should realize as a result of the mailer-specific requirements of each NSA. The above problems are well documented. They have been cited in numerous independent reviews over the years, including some by us. The parties are familiar with the status quo, and we suspect that the high stakes involved make parties understandably reluctant to make changes, particularly when the financial consequences are difficult to foresee. In recent public meetings held to discuss possible changes to the rate-setting process within existing law, the Service dismissed many of the suggestions that were made. Moreover, the Service and other stakeholders have reached no consensus about proposals for legislative reform. Therefore, the Commission was advocating bold action when it concluded that the current rate-setting process should be abolished and replaced with a more streamlined structure that continues to impose rigorous standards on rate setting, but does so without impeding the ability of Postal Service officials to manage and lead. The Commission’s report built on the legislative debate in which price cap regulation has emerged as a leading alternative to the current statutory model for regulating postal prices. Specifically, the Commission recommended that the existing system of setting postal rates be abolished and replaced with a price-cap system to regulate the rates of noncompetitive postal products and services, coupled with providing the Service with pricing flexibility for competitive postal products and services, subject to a rule against cross-subsidization. The Commission’s proposed price-cap system is intended to enhance the Service’s management flexibility to set rates within ceilings established by the Postal Regulatory Board, so that if the rate ceiling is appropriately constructed, the Postal Service will feel intense pressure to rein in spending and improve efficiency and productivity. A price-cap system could enable the Service to implement a strategy of smaller, more frequent changes in postal rates, as opposed to a strategy of more infrequent, significant increases. The Commission’s recommended price-cap system has some similarities with price-cap systems that were offered in successive postal reform bills introduced by Rep. John M. McHugh. These proposals were reviewed in numerous hearings, and the extensive record surfaced many issues and concerns. In our view, key questions include the following: Would a price-cap system provide the intended incentives for the Postal Service to maximize its financial performance, since the Service is a public institution that is not accountable to shareholders who hold stock and demand management accountability? Would a price cap provide incentives for the Postal Service to reduce the quality of service for captive customers? If so, what transparency and accountability mechanisms would be needed to ensure the quality of universal postal service? Could the Service use its flexibility to raise rates within the price cap to unfairly shift the burden of institutional costs away from competitive products and services and onto its most captive customers? Should postal rates be required to cover attributable costs? If so, at what level (e.g., mail class, subclass, rate category, etc.)? Could the Service generate sufficient revenues if its rates were constrained by a price cap? If not, under what circumstances, if any, should the Service be authorized to raise rates in excess of the cap? How can ratepayers be assured that it would not be too easy for the Service to obtain such increases, which would vitiate the intent of the price cap? What process should apply to such “exigent” rate increases? Would a price cap restrain the growth of postal wages? If so, to what extent and would such a result be desirable? How would a price cap system affect historic preferences that have been provided to certain mailers, such as mailers of nonprofit mail, periodicals, and library mail? How could the Postal Service redesign the rate and classification system, as it did through the 1995 reclassification case, if it were subject to a price cap? Would adopting a price cap system be too risky, given the problems that have surfaced in some price-cap models adopted by other regulated industries? How could flexibility be built into the price-cap system itself to minimize risk and handle “the law of unintended consequences?” Should provisions of a price-cap system be specified by the legislative process? If so, which features should be codified in statute and which should be left to the regulatory process? What issues should be considered in adapting price-cap regulation from other industries and foreign postal systems to the unique context of regulating postal rates in the United States? What transition features should be required, such as a “baseline” rate case, in order to successfully implement a price-cap system? Should a revised and streamlined cost-of-service model be considered as an alternative to abolishing the current rate-setting structure and replacing it with a new model? If so, what statutory changes should be considered? Would such changes prove sufficient to remedy the shortcomings of the current rate-setting structure? As the above discussion demonstrates, the need for changing the postal rate-setting structure is clear. The current structure delays price changes through lengthy, contentious, and burdensome proceedings and has poor incentives for providing quality data. However, many questions remain about what changes should be made to the rate-setting process and the potential problems associated with those changes. Specifically, the option of adopting a price-cap model for regulating postal rates has emerged as a main alternative to a cost-of-service regulatory model but raises many issues that deserve thoughtful consideration. By its very nature, such fundamental change to the rate-setting system would necessarily entail substantial uncertainty, risks, and the possibility for further change to deal with unanticipated consequences. In this regard, the benefits and risks of adopting a price-cap system need to be carefully considered and weighed against the benefits and risks of the status quo. If the Service is to be limited to its core mission, the flexibility inherent in a price cap system could become a key management tool to successfully managing the transition to a leaner, more efficient postal system. Rate-Setting Oversight In our view, as long as the Service remains a federal entity protected by the postal monopoly, it is appropriate that the Service’s ability to compete with the private sector be balanced with oversight and legal standards to ensure fair competition between the Service and private competitors. The Commission sought to create such a balance by recommending enhanced powers for the newly created Postal Regulatory Board, including a complaint process in which rates can be reviewed against statutory limits that provide for due process and resolution of the complaint within 60 days. Depending on the outcome, the regulator could order rate adjustments to bring rates into conformity with statutory criteria. In our view, clear lines of authority in this area must be established if the rate- setting process is to be streamlined and speeded up. A key issue for Congress to consider is whether the Commission’s recommendations have struck the appropriate balance between flexibility and accountability. Another issue is what due process rules should be established in order to enable stakeholders to provide meaningful input and participate in rate- setting matters, including the right to appeal regulatory decisions. The Commission also proposed requirements for worksharing discounts that are established based on the costs that the Postal Service is estimated to avoid as a result of mailer worksharing activities to prepare, sort, and transport the mail. Specifically, the Commission stated that a specific requirement should be “that no new workshared discount for a non- competitive product should exceed costs saved (including the present value of projected future costs saved) and that the Postal Regulatory Board should have the authority to conduct an expedited, after-the-fact review upon written complaint that such a discount is excessive.” In that case, the Commission said the regulator should be authorized to perform an expedited, after-the-fact review upon written complaint to ensure discounts do not exceed savings to the Postal Service. These recommendations raise the issue of whether different standards should apply for new and existing worksharing discounts. By way of background, worksharing discounts did not exist when the Service was created by the Postal Reorganization Act of 1970. Thus, there is little statutory guidance in this area except for the mandate for the PRC to consider—along with other factors—the degree of preparation of mail for delivery into the postal system performed by the mailer and its effect upon reducing costs to the Service. Over time, the PRC developed a guideline for recommending worksharing discounts so that the estimated reduction in Postal Service revenues would equal the estimated reduction in its costs. The objective of this guideline is to create incentives for the lowest-cost provider to perform certain postal activities, which can be either the mailer performing worksharing activities or the Service performing additional activities when mailers do not workshare. Because worksharing discounts have become an integral part of the rate-setting structure, a key issue is whether statutory guidance would be appropriate in this area; and if so, whether hard-and-fast rules for worksharing discounts should be established in law. Because postal rate-setting is at the heart of proposals for comprehensive legislative reform, it is important for Members of Congress to be aware of the many issues and questions that have been raised in this area. We believe that some of the issues and questions that arise from the Commission’s recommendations include the following: Should the break-even mandate continue to govern the postal rate- setting process, or should the Service be allowed to retain a certain amount of earnings? How would the proposed Postal Regulatory Board consider postal costing issues under the Commission’s proposals, since the Commission would abolish the current mechanism used to resolve these issues on a case-by-case basis (i.e., litigation in postal rate cases)? Specifically, what process should govern regulatory decisions regarding the measurement, allocation, and reporting of postal costs and revenues? Should the regulatory body also be given the authority to compel the Postal Service to collect data, as some have suggested? Would meaningful after-the-fact review of changes in postage rates be difficult to accomplish within the recommended 60-day time frame for considering complaints? Should stakeholders also be given the opportunity to obtain information through a discovery process; and if so, would a longer time frame be needed to consider complaints? What due process rules should be established for stakeholder participation in rate complaints and other rate-setting matters? Should the Commission’s recommendation to allow NSAs be adopted, and, if so, what specific criteria are appropriate in this area? Could NSAs create competitive harm, and, if so, what measures should be taken to mitigate this risk (e.g., prior review and other limitations)? If mailer-specific discounts are authorized, should data be required on the mailer-specific cost savings that the Postal Service expects to achieve? If so, how should the regulator balance its needs for such information with limitations relating to the practicality and burden of producing it? Is after-the-fact rate review incompatible with the need to ensure fair competition by an organization that can leverage the revenues and infrastructure obtained through its monopoly on delivering letter mail? If not, should measures be taken to limit the potential for unfair competition, such as providing limitations on the introduction of subsidized new products and services? Should the regulator be authorized to order the discontinuance of postal products and services that consistently fail to cover their costs? Would the complaint process, as the only means for stakeholders to seek to alter postal rates under the Commission’s proposals, create an incentive for numerous complaints that could become a de facto review of virtually all postal rates? Even if a regulator could order changes in rates after-the-fact, would it be reluctant to exercise that authority, given the potential financial impact and disruption for the Service and the mailing community? The Commission’s report did not address whether the proposed Postal Regulatory Board could be held accountable for its actions in the rate- setting area through appellate review. Should the Postal Regulatory Board’s actions be subject to appellate review, and if so, under what criteria? Another potential issue is whether a transition period would be needed to successfully implement a vastly different rate-setting system similar to what the Commission has recommended. For example, would a transition period be needed to enable the proposed Postal Regulatory Board to address major unresolved cost allocation issues, as well as for the Postal Service to make improvements to its cost allocation methods and underlying data systems that collect information for costing purposes? The Need for Progress on Rate- Setting Issues under the Current Structure The Service and the PRC continue to have long-standing disagreements on rate-setting issues that have added to the length, cost, and burden of litigating rate cases. These issues have been a major focus of contentious rate proceedings, and, if left unresolved, will likely be re-litigated in the next rate case. As noted previously, a key unresolved issue is the allocation of mail processing costs, which has implications for most postal rates since the Service’s mail processing and distribution network handles most mail. Specifically, the Service and the PRC disagree over the extent to which mail processing costs vary with mail volume and thus can be allocated to various mail categories, as opposed to being classified as institutional costs (i.e., overhead costs that the Service incurs regardless of mail volume). This disagreement has generated thousands of pages of evidence in rate cases and disagreements over the underlying assumptions, data, and analytic techniques. Although the arguments on both sides are rather arcane, the resolution of this dispute could have important practical consequences for postal rates and worksharing discounts. The estimated savings resulting from worksharing discounts— which is a key basis for establishing these discounts—is reduced as more mail processing costs are classified as institutional costs, since such costs do not vary regardless of how much mail is processed. Thus, the rates that apply to workshared mail, which accounts for three-quarters of total mail volume, could be affected by the resolution of this technical dispute. In our opinion, the gap between rate cases provides a rare opportunity for the parties to take a fresh look at the issue of mail processing volume variability. Key postal cost dynamics have changed in recent years, including the shift from increasing to decreasing mail volume, the prospect for further declines in First-Class Mail volume, and the Service’s initiative to realign its mail processing and distribution network. Such changes create uncertainty about whether historical relationships between mail volume and mail processing costs continue to apply, since historically mail processing costs increased as mail volume increased and the Service expanded its mail processing infrastructure incrementally. We urge the parties to reconsider their reliance on formal litigation so that this issue can be addressed before the inception of the next rate case. Progress in this area could diminish the burden on the Service and other stakeholders who participate in rate cases. In this regard, we note that the parties have worked hard to reach negotiated settlements to the last rate case and several other rate and classification proceedings since then. Given these outcomes, it is reasonable to expect similar progress in the area of mail- processing volume variability if the parties have the will to resolve their differences. If the parties do not make progress, that will further indicate the need for a new rate-making structure, as the Commission has recommended, so that technical issues can be resolved in a more businesslike and expeditious manner. Human Capital Issues The Postal Service’s human capital—its people—is critical to providing vital postal services to the American people and achieving a successful postal transformation. The Commission concluded that as valuable as the Postal Service is to the nation, its ability to deliver that value is only as great as the capability, motivation, and satisfaction of the people who make possible the daily delivery of mail to American homes and businesses. We agree. Only through the efforts of its workforce are more than 200 billion pieces of mail delivered, 6 days each week, to the American people. Thus, we agree with the Commission’s conclusion that few of the reforms outlined in its report would be possible without the support and contributions of the Service’s most mission-critical asset: its people. As we recently reported, an organization’s people must be at the center of any transformation effort. For this reason, the Commission focused on serious, long-standing issues in the human capital area that impose both statutory and practical constraints on the transformation of the organization. The problems can be grouped into three areas: (1) poor labor-management relations characterized by poor communication, lack of trust, excessive grievances, and difficulty negotiating labor contracts; (2) difficulty controlling workforce costs, including issues of workforce size, flexibility, pay comparability, workers’ compensation, and escalating benefits costs; and (3) inadequate incentives for individual performance and the need for a stronger linkage between individual and organizational goals. The Commission proposed important changes in each of these areas, some of which would require the commitment of the parties to address them in a constructive manner, and some of which would require changes to existing law. Given the central importance of the Service’s human capital, all of these proposals deserve close scrutiny and a fair hearing, despite the strong negative reactions that have been voiced by some stakeholders. Rather than declaring such proposals to be politically off-limits, we encourage Congress and the parties to approach these issues with open minds to explore whether a package of changes can be made that is mutually beneficial to the Service, its people, and the public. Much has changed in this area over the past 30 years, and the time is right to consider what statutory structure would be appropriate to enable the Postal Service to incorporate best practices and improve working conditions for its employees. Achieving Effective Labor- Management Relations Will Be Fundamental to Making Progress We and others have reported that adversarial labor-management relations have been a persistent issue for the Service and its major labor unions and have been a root cause of problems in improving the Service’s operational efficiency as well as improving its culture and the quality of work life. Poor communications, lack of trust, an excessive number of grievances, and difficulty negotiating labor contracts have been at the heart of labor- management issues. Such problems have increased the difficulty in constructively working on difficult issues involving the size, flexibility, compensation, benefits, incentives, and culture of the workforce. We are encouraged by recent progress in this area, such as reports by union officials of better communications, sharp reductions in the number of outstanding grievances, and labor contracts that were successfully negotiated between the parties without the need for binding arbitration. However, progress has been uneven and much more work remains to be done. We agree with the Commission’s bottom line that Postal Service management must repair its strained relationship with postal employees. Historically, autocratic management, persistent confrontation and conflict, and ineffective performance systems often characterized the organizational culture on the workroom floor. These problems resulted in an underperforming organization with major deficiencies in morale and quality of work life; huge numbers of grievances with high costs for the Service and its employees; and protracted, acrimonious contract negotiations. In our past reports, we found that these conditions have existed over many years because labor and management leadership, at both the national and local levels, have often had difficulty working together to find solutions to their problems. Under these circumstances, it was difficult for the parties to develop and sustain the level of trust necessary for maintaining a constructive working relationship and agreeing on major changes to maximize the Service’s efficiency and the quality of work life. Poor labor-management relations are incompatible with the Commission’s vision of achieving a more positive and productive climate necessary for a high-performing organization with a culture of excellence. Such a culture change will require better labor-management relations in which the parties maintain open communications, develop trust, and are willing to take risks to achieve mutually beneficial results. On the positive side, officials from some of the Service’s unions have told us that they have seen improvements in labor-management relations in recent years. They cited examples of improved communication and collaboration at the national and local levels, including Quality of Worklife and Employee Involvement programs, in which union and management officials reportedly have successfully communicated and made progress on finding ways to improve efficiency and the work environment; Joint Contract Interpretation manuals, as well as training implemented jointly by labor and management officials, which are intended to prevent disputes as well as help resolve current disputes and the backlog of grievances; and An Ergonomic Strategic Partnership among the Occupational Safety and Health Administration (OSHA) and postal labor unions to improve workplace safety and reduce risk factors, particularly ergonomic- related hazards. As the Commission noted, employee morale is an essential element of an incentive-based culture, but is undermined when employee-management relations are acrimonious. We agree with the Commission that the high number of remaining grievances and the large backlog of grievances pending arbitration are an indication of strained relations between postal managers and workers, to the detriment of morale, productivity, and, ultimately, service to ratepayers. As the Commission concluded, satisfied employees are of far more value to the nation’s postal endeavor than those in a contentious relationship with their employer. Thus, we agree with the Commission that it is imperative that the Service give clear direction that settlement of problems and cooperative labor-management relations are a priority. Rather than allowing problems to fester on the workroom floor, better communications and improved working relationships are needed to resolve problems as they arise, minimizing the need to resort to the grievance process to resolve disputes. This will require greater accountability for both supervisors and those they supervise, as well as for top management. We agree with the Commission that the Service must hold managers accountable for any behavior that results in poor labor- management relations, and we believe this principle should apply equally to employees at all levels of the organization. The Commission noted that encouraging progress is being made by the Service and the National Association of Letter Carriers in resolving grievances using a restructured and streamlined grievance process. It recommended that such progress be used as a model, with the Service working diligently with other unions to institute procedures aimed at reducing the time to process grievances and the number of grievances appealed to arbitration. Recognizing that the success of any process depends on the collective commitment of the parties, we encourage the Service and its unions to make continued progress in this area. Since postal reorganization, the Service and its major labor unions have often found it difficult to negotiate labor contracts without resorting to binding arbitration. The Commission criticized the collective bargaining process as overly lengthy and litigious, providing few incentives for the parties to reach negotiated settlements. It made detailed statutory recommendations to improve the process, including mandating the use of a “mediation and arbitration” approach and specific deadlines for completing various process steps and accelerating final resolution period. Postal union officials have strongly opposed these recommendations, stating that the parties have used the “mediation and arbitration” approach in the past and have the flexibility within existing law to mutually agree on any process for contract negotiations. Union officials have also said that existing deadlines are already difficult to meet, in part due to scheduling difficulties involving the availability of mediators and arbitrators. In their view, success is dependent on “people” issues, including good working relationships, communications, and trust, rather than on the formal process. They also have noted that the current contracts between the Service and three of its four major postal labor unions were negotiated without the use of an arbitrator and asserted that these outcomes demonstrate that progress has been made within the existing structure. We recognize these points, but believe that, as with other human capital issues, the time has come to re-examine all aspects of a structure that was developed more than 30 years ago. Difficulty Controlling Workforce Costs Progress on controlling human capital costs will be critical to efforts to achieve “best execution” to sustain affordable universal postal service and to enhance the value of the mail. The Postal Service employed about 829,000 people at the end of fiscal year 2003, whose pay and benefits accounted for more than three-quarters of the Service’s expenses. In this regard, we note that a recent analysis prepared by PRC staff showed that for the period between fiscal years 1998 and 2002 postal wage costs increased by 3.3 percent over inflation and postal benefits costs rose 28.1 percent over inflation. The Commission concluded that the size of the workforce largely determines its costs, observing that it will be critical for management and labor to work together constructively to determine the right size of the postal workforce and to ensure appropriate flexibilities in its deployment. As we have previously reported, nearly half of the Service’s career workforce will reach retirement eligibility by 2010, creating an opportunity for the Service to gain resource flexibility through the attrition of retiring employees, while also minimizing disruption to its workforce. We note that the Postmaster General initiated a constructive working relationship between national postal management and the leadership of its labor unions and management associations to deal with issues of mail security after anthrax was found in the mail. Such communication and partnerships cannot be legislatively mandated. However, better working relationships would help the Service and its employee organizations address difficult workforce size and flexibility issues in a manner that would allow the Service to rightsize its workforce in the least disruptive manner possible, including the ranks of both managers and their employees. All issues should be on the table, including work rules that constrain greater efficiency; working conditions that constrain the treatment, morale, and discretionary effort of the workforce; and constraints on having the most effective and efficient provider perform postal activities, including limitations on outsourcing. We agree with the Commission’s conclusion that the most thorny issue in collective bargaining today is pay and benefit comparability. Although the parties disagree about whether a wage and benefit premium exists and about the basis for making these comparisons, the Service’s ability to control costs in this area will be critical to achieving a more efficient organization. As we have previously testified, one of the limitations in the existing collective bargaining process is that the interests of all postal stakeholders, such as ratepayers, do not appear to have been sufficiently considered. The Commission recommended that the Postal Reorganization Act be amended to clarify the term “comparability” and that the new Postal Regulatory Board should be authorized to determine comparable total compensation for all Postal Service employees. These recommendations have been strongly opposed by the Service’s major labor unions, variously opposing them as “draconian” measures that would “destroy” collective bargaining for postal workers. The unions have also questioned why a regulatory body headed by three political appointees should have the power to effectively set a cap on postal wages. With respect to clarifying the comparability standard, one option could be to revisit the guiding principles incorporated into the statutory wage and comparability standard so that it would more fully reflect all stakeholder interests and the Service’s overall financial condition and outlook. These principles could specify that comparability includes total wage, compensation, and benefit costs, as well as the relationship of these costs to total costs, their impact on rates and revenues, and the Service’s overall financial condition. Another option could be to delete pay comparability provisions from the statute, as some postal union officials have suggested. This option would raise the issue of what, if any, standard would remain to guide negotiators and arbitrators in the collective bargaining process. With respect to shifting authority over total postal compensation to a newly created regulatory body, we note that this change would appear contrary to the Commission’s principle that the Service needs additional flexibility to manage its operations. A related issue is how the Service will be able to pay competitive compensation for certain skills. We also question why a second body—in addition to the system of third-party arbitration—should be added to the already complex processes for determining postal pay and benefits. Thus, it is not clear whether this recommendation would add value to the collective bargaining process. Another controversial Commission recommendation was that the Postal Service pension and postretirement health benefit plans should be subject to collective bargaining—meaning that the Service and its unions should have the flexibility to develop new plans that are separate and apart from existing federal pension and retiree health benefit plans. The Commission recognized that such a change could have an uncertain impact on the entire federal pension and retiree health benefit programs. Although the Service may have the authority under existing law to withdraw from the federal health program for its current employees under certain circumstances, it would still be required to contribute to the health costs of its current retirees. The Commission recommended that the Service work with the Department of the Treasury, the Office of Personnel Management (OPM), and other pertinent parties to determine the potential impacts that separate funds would have. Because these recommendations could have major effects on all federal employees, much more information would be needed in order to determine the potential impact of statutory changes in this area on the federal budget and employees. It is also not clear whether, as a practical matter, expanding the scope of collective bargaining to all postal benefits would result in cost savings for the Postal Service. For example, where the Service has flexibility, the Service has agreed in collective bargaining agreements to pay a higher percentage of health insurance premiums for its employees as compared to other federal agencies (about 85 percent vs. up to 75 percent). We agree with the Commission that the Service’s substantial obligations for its retirement-related benefits need to be addressed, including benefits for pensions and retiree health. Key issues include how to assign responsibility and structure a mechanism for covering the costs of providing retirement-related benefits and how the accounting standards should be applied. In addition, concerns have been raised about how changes in funding these obligations could impact the federal budget, as well as postal ratepayers. The recently enacted law (P.L. 108-18) changed the method by which the Service funds the Civil Service Retirement System (CSRS) pension benefits of its current and former employees to prevent a projected overfunding from materializing, while at the same time shifting responsibility for funding benefits attributable to military service from taxpayers to postal ratepayers. The law also required that, beginning in fiscal year 2006, the difference between the Service’s contributions under the new and old funding methods—the “savings”—be held in an escrow account until the law is changed. To facilitate consideration of which agency—the Postal Service or the Treasury Department—should fund military service costs, the law required the Postal Service, the Office of Personnel Management, and the Treasury Department to each submit proposals to the President, Congress, and the GAO by September 30, 2003. The law also required the Postal Service to submit a proposal to the same recipients on how it planned to use the future “savings.” We, in turn, have until November 30, 2003, to analyze these proposals and will provide our reports to Congress before Thanksgiving. The Service submitted two proposals for use of the “savings,” both of which would affect postal rates to varying degrees. The first proposal recommends that the Service be relieved of the burden of funding benefits attributable to military service, and that the Service, in turn, would prefund its retiree health benefits obligations for current and former employees, which has been estimated at approximately $50 billion. This proposal is consistent with the Commission’s recommendation that responsibility for funding CSRS pension benefits relating to the military service of postal retirees should be returned to the Department of the Treasury. The second proposal is based on the premise that the Postal Service will remain responsible for funding military service benefits as currently required by P.L. 108-18. Under this proposal, the Service said that it would fund its retiree health benefits obligations only for its employees hired after fiscal year 2002 and use the remaining “savings” in priority sequence, to repay debt; and to fund productivity and cost-saving capital investments. This proposal appears consistent with the Commission recommendation that the Service should consider funding a reserve account for unfunded retiree health care obligations to the extent that its financial condition allows. There are a number of key questions related to the Service’s proposals that we are considering as part of our mandated review, including What is the relationship of military service to federal civilian service and benefits? What have been the historical changes to the funding of CSRS benefits to Postal Service employees and retirees? What correlation exists between the cost attribution and funding methods of the Federal Employees Retirement System (FERS) and the current CSRS methods applicable to USPS? How have other self-supporting agencies funded CSRS benefits? What are the various options for allocating military service costs? What would be the effects of the Service’s proposals on the unified federal budget? On ratepayers? On the Service’s overall financial situation and transformation efforts? What alternatives exist for funding health benefit obligations to existing postal retirees and employees and distributing that responsibility between current and future ratepayers? What issues need to be addressed regarding the Service’s accounting treatment of retiree benefit obligations? What are the potential consequences to the Service and postal rates should the Service be required to make payments, beginning in fiscal year 2006, into an escrow account without the authority to spend the escrowed funds for postal purposes? Another benefit area where costs have been difficult to control is the Service’s workers’ compensation benefits. The Commission found that under the Federal Employees’ Compensation Act (FECA), the Service has maintained a broad and effective workers’ compensation program and that recent efforts have lowered injury rates considerably. However, the Commission also concluded that the Service, given its unique status, should be provided relief from FECA provisions that were creating costly unintended consequences. The Commission recommended making the Service’s workers’ compensation program more comparable to programs in the private sector in order to control costs, provide adequate benefits, and address the Service’s unfunded liability of $6.5 billion in this area. We believe that placing workers’ compensation benefits on a par with those in the private sector merits careful consideration. Inadequate Performance Incentives As the Commission pointed out, a key goal of human capital reform should be to establish an incentive-based culture of excellence. We have reported that leading organizations use their performance management systems to accelerate change, achieve desired organizational results, and facilitate communication throughout the year so that discussions about individual and organizational performance are integrated and ongoing. Modern, effective, and credible performance appraisal systems are a key aspect of performance management. The Commission concluded that the level of success achieved by the Postal Service will hinge on its ability to successfully deploy and motivate a talented, capable, nimble workforce of a size appropriate to the future postal needs of the nation and to give its employees a personal stake in the success of the institution’s ambitious goals. In this regard, we have reported that the need for results-oriented pay reform is one of the most pressing human capital issues facing the federal government today. Successful implementation of results-oriented pay reform, commonly referred to as “pay for performance,” requires modern, reliable, effective, and as appropriate, validated performance management systems. Such systems need adequate safeguards, including reasonable transparency and appropriate accountability mechanisms. In fiscal year 1995, the Service implemented a pay-for-performance system for its executives, managers, postmasters, supervisors, and other nonbargaining employees. This system was discontinued in fiscal year 2002, in part because of concerns that large payouts were made when the Service was recording large deficits. The Service revised its merit-based pay program for its executives and officers in fiscal year 2002 and revised its merit- based pay program for its postmasters, managers, and supervisors in fiscal year 2004. Given the concerns that led to the overhaul of the Service’s previous merit- based pay systems, it is important that these systems be evaluated to ensure that they are administered fairly and provide meaningful incentives. Such incentives would require valid measures that correspond with individual and organizational performance goals, as well as targets that are sufficiently challenging that they are not met automatically. For example, any productivity-based measures should result in real and measurable savings. In addition, as we have reported, proposed changes to the Senior Executive Service could provide a model for better linking pay and performance of senior executives. For example, the proposed Senior Executive Service Reform Act of 2003 includes a number of important reforms that would increase the pay cap for senior executives while also linking their pay more closely to performance. Similar issues would appear to apply to lifting the statutory pay cap for postal executives. Over the years, the Service’s major labor unions have consistently opposed extending a pay-for-performance system to craft employees. Presidential Commissioner Norman Seabrook shared their concerns, stating that in practice, pay for performance systems are characterized by nepotism, favoritism, and horrible morale among the workers. Union concerns also include tying employee compensation to results that depend in part on external events beyond their control as well as on the quality of postal management. It is reasonable to question whether a pay-for-performance system could be agreed on, implemented, and successful in the face of strong opposition of national and local union leaders. Union concerns are understandable because past history has led some union officials to question whether a pay-for-performance system could be successfully implemented. Nevertheless, as the Commission pointed out, properly designed performance-based compensation can serve as a powerful communications and motivational tool, helping employees understand how they can contribute to the Service’s financial health and success—and be rewarded for their efforts. In our view, aligning the interests of individual workers with the specific performance goals of the Service will be essential for the future. As the Commission concluded, the desire of the workforce to make the modernization of the nation’s postal network a success, along with its willingness to make possible the Service’s ambitious goals to rein in costs while improving productivity and service, will in no small part determine the success or failure of the entire transformation endeavor, and, ultimately, the fate of universal service at affordable rates. As the above discussion illustrates, human capital reform is necessary, but many issues remain to be resolved. We believe that key questions for Congress to consider include: What statutory changes can be made that would provide additional incentives for the Service, its employee organizations, and its employees to resolve their differences in an appropriate and expeditious manner, including through the grievance process and at the bargaining table? What opportunities exist to facilitate better communication, streamline lengthy processes, and minimize their cost? Should the existing statutory standards for comparability of postal wages and benefits be clarified to include specific performance criteria and factors upon which a comparison must be made, such as the Service’s overall financial condition and outlook? If comparability standards are retained, should they be enforced by an outside regulatory body or should they be considered self-enforcing through the collective bargaining process? What practical consequences could be expected if all postal benefits, including all health and retirement benefits, became subject to the collective bargaining process? What would be the potential effects on the financing of benefits for employees of both the Service and the rest of the federal government? Could increases in postal benefits costs also be expected over time, given the Service’s history of agreeing to pay a larger share of insurance premiums than other federal agencies pay? Should workers’ compensation benefits for Service employees be greater than those generally available to private sector employees? What opportunities exist to provide incentives to minimize workers’ compensation costs? Should the statutory pay cap on postal executives be lifted, and, if so, how would executive pay be linked to performance? Would increased accountability apply to postal executives for individual and organizational results, particularly when problems arise? What disclosure of postal executive compensation—including bonuses and other forms of compensation—would be appropriate to incorporate best practices that have been put into place in the private sector? The Postal Service Needs to Maximize Progress within Its Current Legislative Structure While the Commission made a number of recommendations that require legislative changes, it also made suggestions for improving efficiency and service that can be implemented under the current law. These recommendations centered on standardizing and streamlining the postal network, both the processing and distribution infrastructure and retail facilities, with major efficiency gains accruing from changes in the processing and distribution network. The Commission commended the Postal Service for undertaking an ambitious effort, the Network Integration and Alignment project, to rationalize the processing and distribution network. We agree that this project could exert meaningful influence on the Service’s efficiency, but we have concerns about the lack of publicly available information on the Service’s plans and related funding strategies in this area. The Commission also pointed out that better postal data would aid the Service’s efforts to increase efficiency. We believe that the availability, accuracy, and relevance of postal data should be central to any meaningful transformation effort. The Commission recommended a core philosophy for an improved national mail service—the concept of best execution. This concept, as described by the Commission, includes employing corporate best practices in all operations, as well as selecting the provider who can perform the service at the highest level of quality for the lowest cost. Best execution has important implications for the Postal Service because it means that the Service should consider who could perform the work best, postal employees or private sector providers, when considering outsourcing and expanding worksharing opportunities. Some postal union officials have stated that the Service can provide better execution than private sector providers. While this may be true, best execution may be difficult to realize under the existing environment due to lack of incentives to perform at the highest level possible; an outdated, inefficient infrastructure; and insufficient data to assess the true cost of operations. We have addressed the issue of lack of incentives in a previous section. In the next sections we will discuss the importance of economy and efficiency in the postal network and related data issues. Factors That Hinder Economy and Efficiency in the Postal Network The Commission characterized the current postal network as too costly, too inefficient, too large, and lacking standardization. It envisioned a streamlined, standardized network capable of delivering universal service in the most efficient and cost-effective manner possible. We believe this vision is achievable if approached in a comprehensive, integrated fashion, and supported by postal stakeholders. However, practical impediments may hinder the Postal Service from rightsizing its infrastructure. Historically, the Service has encountered resistance from employees, mailers, communities, and Congress when it attempted to close facilities. Proactively working with stakeholders to garner input and support for its infrastructure initiatives may address legitimate concerns and thereby alleviate some of this resistance. Another impediment has been the Service’s limited options for funding capital improvements. Earlier we discussed how retained earnings could increase the Postal Service’s funding flexibility. However, this change would require legislative action. If the Service is to achieve best execution, it should increase current efforts to address problems with its infrastructure. The Service also needs to identify its funding needs for implementing its plans in this area. For purposes of our discussion we have separated the postal infrastructure into two distinct, yet inter-related, areas: (1) the network of post offices and other retail facilities and (2) the network of mail processing and distribution facilities. Difficulties in Optimizing the Postal Retail Network The Commission concluded that the Service needs to constructively address the fact that many of the nation’s post offices are no longer necessary to the fulfill the universal service obligation. We understand that making changes to retail operations is often controversial because communities do not like to lose their local post offices and changes in this area are often perceived as a reduction in services. Unfortunately, the Postal Service has not done enough to inform the public of the many retail options currently available. Currently there are over 70,000 locations where stamps are sold, such as ATMs, grocery and other retail stores, and postal vending machines. Stamps can also be purchased via the Internet, through the mail, or from rural carriers. In addition, the Service is extending retail access to 2,500 self-service kiosks and Hallmark Gold Crown card shops. Yet, about 80 percent of all stamp revenue is still generated at the retail counter. Two Commission recommendations in this area that we concur with were: (1) the Service should dramatically escalate its efforts to increase alternative access to postal services, and (2) the Service should market these alternatives more aggressively. We believe that the Service should strive to improve accessibility to postal retail services as it implements its strategy of rationalizing its retail network, including closing post offices. The Service’s Transformation Plan stated that the Service would create new, low-cost retail alternatives to extend the times and places that its services are available, including self- service, partnerships with commercial retailers, and Internet access to retail services. The plan said that the Service has begun a retail network optimization process, in which redundant retail operations would be consolidated, starting with poor-performing contract postal units, and replaced with alternative methods of retail access. The optimization process involves a national retail database that is to be used with a criteria-based methodology for modeling retail optimization and restructuring scenarios. The Service has also said it intends to expand retail service in markets where it is underrepresented, while reducing retail infrastructure in markets where it is overrepresented. Under current law, the Service is not allowed to close post offices for economic reasons alone. The Commission recommended that legal restrictions that limit the Service’s flexibility in this area be repealed and that the Service be allowed to close post offices that are no longer necessary for the fulfillment of universal service. While we agree that the Service should have the ability to align its retail network with customer needs in order to fulfill its universal service obligation in a cost-effective, efficient manner, we also believe that the Postal Service must assure Congress that the alignment will be done in a fair, rational, and fact-based manner. In contemplating the Commission’s recommendation to repeal the post office closing law, we have identified the following key questions: What national standards, if any, should apply to universal access to postal retail service? What criteria and process should be used to realign the Service’s retail infrastructure? Should the Service have greater freedom to reshape its retail infrastructure, or should Congress have involvement in such decisions, possibly by using a model such as the military base-closing process to close post offices that are no longer needed? Should current statutory restrictions on closing post offices be retained, modified, or repealed? What transparency and accountability is appropriate in this area? Difficulties in Optimizing the Postal Processing and Distribution Network The Commission found that the Service’s processing and distribution network is plagued with problems, including lack of standardization, inefficiency, and excess capacity. The Service has approximately 500 facilities dedicated to processing the mail that do not share a standard footprint for architectural design, equipment complement and layout, or mail processing procedures. The lack of standardization may be one of the contributors to variations in productivity among mail processing facilities. Smaller facilities, as measured by volume, number of employees, and physical space, tend to have higher productivity, which is a possible indication of diseconomies of scale. For example, on average, small facilities tend to handle more mail, relative to work hours expended, than large facilities (see fig. 3). Standardizing operations across facilities may minimize diseconomies of scale and should be considered as part of planning plant consolidations or closings. In addition, standardization of processing and distribution facilities is widespread in process-oriented industries where standardization is viewed as vital to increased flexibility and efficiency. It may be difficult for the Service to become a world-class organization without establishing a standard footprint throughout its processing and distribution network. In addition to the lack of standardization, the Service’s processing and distribution facilities may not be optimally located. To a large degree, the processing and distribution network has evolved gradually in response to volume growth. Figure 4 shows the location of the Service’s processing facilities in the continental contiguous United States. Distributing mail between these facilities utilizes thousands of transportation lanes and results in too many partially full trucks traveling between plants. Better utilization of trucks and lanes may save the Postal Service money and, if properly executed, could improve service. Another issue raised by the Commission related to the processing and distribution network is the assertion that the Postal Service has too many facilities, and the ones it has are not always used effectively, resulting in excess capacity throughout the network. Excess capacity can be very costly as it may require increased maintenance, facility, and labor costs. With changes in the types and volumes of mail and advances in both processing and information technology, the current network may be too large. We caution, however, that any consolidation plan should consider the effects of potential diseconomies of scale. Consolidating small facilities that may be more efficient into inefficient large facilities may not achieve the desired cost savings or service improvements. To achieve sustained cost savings, the Service will need to take a critical look at how to standardize and rightsize the processing and distribution network to maximize efficiency. As we have previously reported, any effort to rationalize the Service’s processing network must also take into consideration the increased safety and security needs created by the anthrax attacks and the proper extent and location of mail safety equipment. Other considerations also include how network realignment could affect the need for a mix of workforce skills and abilities, as well as workforce diversity and demographics. No Public Plan and Limited Stakeholder Engagement on Network Rationalization Strategy The Commission noted the importance of the Service working with stakeholders to successfully implement best execution strategies, streamline the postal network, and decide the fate of unnecessary postal facilities. We agree. However, to date, the Service has not made public a comprehensive infrastructure rationalization plan and has had limited engagement with stakeholders who may be affected. Such a plan should lay out the Service’s vision and how it plans to reach it, including the criteria, process, and data it uses to make its decisions. In our view, the lack of this type of information will likely lead to suspicion and lack of trust about the objectivity, fairness, and impartiality of Service decisions and the lack of input from stakeholders could prevent the Service from achieving the goal of a more efficient network. Further, we believe that it is essential for the Service to engage its stakeholders in its plan development process to address legitimate concerns and minimize disruption, thus alleviating some of the resistance that is often encountered when the Service tries to close facilities. A comprehensive network integration and rationalization plan will be important for Congress to have regardless of whether a commission is established to consider network rationalization. One of the most important deliverables in the Service’s Transformation Plan, the Network Integration and Alignment (NIA) project, is a set of processes and tools used to analyze the optimal number, locations, and functions of mail processing and transportation facilities. The NIA strategy was to have been developed by the fall of 2002. The Service did not meet this time frame, and the Commission has reported that the Service hopes to begin putting the new strategy into effect at the end of this year. It has already begun to close some types of facilities and build others, without disclosing how these activities fit into the NIA strategy. To succeed in optimizing its networks, the Service must work with its key stakeholders, including employee organizations, the mailing industry, affected communities, and Congress. However, based on difficulties it has encountered in the past, the Service appears to be reluctant to divulge its network optimization plans, including the timing and funding needs associated with these plans, to Congress or its stakeholders. We believe that the Service will face more resistance if it approaches transformation in an insular, incremental fashion. For example, some union representatives have acknowledged that the Postal Service needs to rationalize its infrastructure, and they have committed to working with the Service to achieve this goal. However, they have received limited information to date concerning the Postal Service’s plans for closings and consolidations. Likewise, various mailers have expressed concern that the Postal Service does not adequately seek input regarding customer needs when planning major changes. This concept is anathema to best practices employed in private sector service industries. Recognizing the difficulties the Service has experienced in rationalizing its network, including closing unneeded facilities, the Commission recommended that Congress establish a Postal Network Optimization Commission (P-NOC), similar to the base-closing model and provisions in proposed postal reform legislation introduced by Senator Carper. The P-NOC would be charged with making recommendations to Congress and the President relating to the consolidation and rationalization of the Service’s mail processing and distribution infrastructure. Under the Commission’s proposal, P-NOC recommendations would become final unless Congress disapproves them in their entirety within 45 days. The intent of this recommendation corresponds with our observation that a base-closing model may prove necessary to address politically sensitive changes to postal facilities. Regardless of whether or not a P-NOC is implemented, the following three key factors will be needed to guide decisions: principles for rationalizing infrastructure that are fact-based, clearly defined, and transparent; players who should be involved in making the decisions; and processes that should govern how decisions are made and implemented. Identify Funding Needs and Strategies To accomplish major transformation, the Service will need to identify its funding needs related to its major transformation initiatives and its strategies for funding these initiatives. Historically, postal policy has been to fund capital expenditure as much as possible through cash flow from operations, with shortfalls financed through debt. By law, the Postal Service’s total debt cannot exceed $15 billion, and annual increases in the Service’s outstanding debt cannot exceed $3 billion. In fiscal year 2001, the Service was faced with insufficient cash flow from operations and with debt balances that were approaching statutory limits. Consequently, the Service imposed a freeze on capital expenditures for most facilities that continued through fiscal years 2002 and 2003. Implementing best execution strategies is difficult under these circumstances, especially since the Service has not specified what its funding needs will be to rationalize its infrastructure and implement other Transformation Plan initiatives. More information in this area would be useful for Congress and other stakeholders to understand the Service’s future financial needs. It would also be useful for the Service to assess what funding it could receive from continuing to identify and dispose of surplus real estate. The Commission recommended that the Postal Service be encouraged to include policy and goals related to the active management of its real estate in future strategic plans. Disposing of surplus real estate would not only save the Postal Service maintenance and repair expenses but may also provide a source of funds that can be used to finance capital projects. Furthermore, aggressive management of its underutilized real estate assets could also facilitate local redevelopment. In addition, passage of the Postal Civil Service Retirement System Funding Reform Act of 2003 (P.L. 108-18) provided the Postal Service with some financial relief. Outstanding debt at the end of fiscal year 2004 is budgeted to be $2.6 billion to $3.1 billion, down from an estimated $7.3 billion at the end of fiscal year 2003 and $11.1 billion at the end of fiscal year 2002. We believe the Service has a window of opportunity for financing major infrastructure changes that may not last long if First-Class Mail volumes continue to decline. Taking advantage of this opportunity could better position the Service for the future. Opportunities to Strengthen Information Technology Investment Management As the Service has recognized, improving its information technology (IT) infrastructure should be considered as part of any network rationalization project. We share the view of the Commission that transformation should include enhanced information systems because streamlined and integrated operations will require a strong IT infrastructure. The Service has a number of IT initiatives designed to enhance the efficiency of the processing and distribution network that are currently at various levels of deployment. Among these is the Intelligent Mail program, the Surface Air Management System, and the Transportation Optimization Planning and Scheduling system. While the Service’s IT initiatives may provide enhanced IT capabilities, it is not clear how they will be integrated or when they will be fully deployed. As we have previously reported, the Service has established significant capabilities for managing its IT investments, but shows mixed progress in managing its IT investments as a portfolio. The Service has not utilized criteria that adequately address cost, benefit, schedule, and risk so that it can effectively analyze, prioritize, or select its investments from a portfolio perspective. Also, the Service does not regularly evaluate completed projects and currently has no institutionalized processes that enable it to learn from its current practices and investments and from other organizations. Accordingly, the Service cannot ensure that it is selecting leading-edge IT investments that will maximize returns to the organization and achieve strategic change. Data Issues Related to Achieving Greater Efficiency Accurate cost and performance data are the cornerstone of efficiency improvements and are vital if the Service is to achieve best execution. In this regard, the Commission noted that the Service could use better real- time information on the location of individual mail pieces and the containers they travel in to improve its efficiency, such as re-routing mail to less busy facilities to ensure its more rapid processing, as well as adjusting for weather conditions or vehicle breakdowns. In addition, to determine best execution, the Service would need to know how much each process, function, and operation actually costs to perform and how these functions interrelate. For example, when determining what portion of overall operations may be performed cheaper by the private sector, it would be necessary to know what the actual cost and quality of each function is and what the effect on overall costs and quality would be if this function were contracted out. Some unions, mailers, and other groups have raised concerns about the information used to make outsourcing decisions, as well as the accuracy of data systems used to measure performance and productivity. Recognizing that it will need improved cost information, the Service reports that it is currently implementing an activity-based costing system in over 380 mail processing facilities, which is intended to provide specific data to managers to help them evaluate and reduce operational costs. In addition, the Service has continued implementing the recommendations of the 1999 Data Quality Study to improve key postal cost data. Data quality issues continue to be of interest to the House Committee on Government Reform, which has asked GAO to follow up on the Service’s progress in this area. Others with expertise in postal data quality issues, such as the Postal Rate Commission and the Postal Service’s Office of Inspector General, may have insights on costing and performance data necessary to address issues that have been raised by the Commission’s proposals. Later this year, the Postal Rate Commission plans to host public sessions where staff from the Service will provide briefings on changes the Service has made to update data systems related to carrier costs and on recent changes in the Service’s accounting and reporting systems. Such constructive exchanges help to further mutual understanding and progress on data quality issues. Continued focus on improving the quality of postal costing and performance data would also be necessary to successfully implement the Commission’s proposals. Conclusion We and the Commission agree that the Service faces an uncertain future. Also, we agree that both congressional action on comprehensive postal reform legislation and continued actions by the Postal Service to make improvements under its existing authority are necessary to ensure the future viability of the Postal Service. The Commission’s key conclusions, consistent with our past work, were that the Service faces financial pressure due to its outmoded business model, significant financial obligations, operating inefficiencies, electronic diversion and mail volume trends, and statutory and practical constraints. The Service’s current business model is not sustainable in today’s competitive environment. Thus, we believe that now is the time to “get it right” and modernize the statutory framework that governs the Service. In addition to statutory reform, we agree with the Commission that the Service can and should do more within its existing authority to work toward “best execution” that incorporates corporate best practices and enables those who can perform best and for the best price to provide postal activities, whether that is the Service, the mailing industry, transportation firms, or other companies. The Service has many opportunities to become more efficient, such as by standardizing its operations and reducing excess capacity of its network. Impending retirement of much of the Service’s workforce also creates an opportunity for the Service to realign its workforce through attrition. The Commission’s vision of rightsizing the Service’s infrastructure and workforce is achievable if approached in a comprehensive, integrated fashion, and supported by postal stakeholders. However, since the Service issued its Transformation Plan in April 2002, it has not provided adequate transparency on its plans to rationalize its infrastructure and workforce; the status of initiatives included in its Transformation Plan; and how it plans to integrate the strategies, timing, and funding necessary to implement its plans. In addition, the Service has had limited constructive engagement with employee organizations, the mailing industry, affected communities, and Congress with regard to its efforts to implement its key transformation initiatives related to rationalizing its infrastructure and workforce. As the Service knows from the difficulties it has encountered when it has tried to make changes to its facility locations in the past, these decisions can be highly controversial. However, if those who are potentially affected by such decisions do not have sufficient information about how they may be impacted by proposed facility changes, the Service is unlikely to gain the necessary support to successfully achieve a much more efficient network. Matter for Congressional Consideration In view of the Service’s continuing financial, operational, and structural problems, as well as trends that increase the urgency of making rapid progress in transforming its organization, we believe that Congress should consider the Commission’s recommendations as well as GAO’s reform suggestions and enact comprehensive postal reform legislation. Some of the key areas that need to be addressed as part of comprehensive reform legislation include clarifying the Service’s mission and role; enhancing governance, accountability, oversight, and transparency; improving regulation of postal rates; and making human capital reforms. Recommendation for Executive Action To facilitate the Service’s progress in implementing actions under the existing system, we recommend that the Postmaster General develop an integrated plan to optimize its infrastructure and workforce, in collaboration with its key stakeholders, and make it available to Congress and the general public. In addition, the Postmaster General should provide periodic reports to Congress and the public on the status of implementing its transformation initiatives and other Commission recommendations that fall within the scope of its existing authority. Postal officials have agreed to take these actions. Chairman Collins, that concludes my prepared statement. I would be pleased to respond to any questions that you or the Members of the Committee may have. Contact and Acknowledgments For further information regarding this testimony, please call Bernard L. Ungar, Director, Physical Infrastructure Issues, on (202) 512-2834 or at ungarb@gao.gov, or call Linda Calbom, Director, Financial Management and Assurance, on (202) 512-8341 or at calboml@gao.gov for pension and retiree health issues. Individuals making key contributions to this testimony included Teresa Anderson, Gerald P. Barnes, Joshua Bartzen, Alan Belkin, Amy Choi, Margaret Cigno, Keith Cunningham, William Doherty, Brad Dubbs, Kathleen A. Gilhooly, Kenneth E. John, Roger Lively, Scott McNulty, and Lisa Shames. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

Last year the President established a commission to examine the future of the U.S. Postal Service (the Service). Its report, issued in July 2003, contained a proposed vision for the Service and recommendations to ensure the viability of postal services. GAO was asked to discuss (1) its perspective on the commission's report and (2) suggestions for next steps. This testimony is based on GAO's analysis of the Commission's report and prior GAO reports and testimonies. The Commission found that the Service faces a bleak fiscal outlook. The Service has an outdated and inflexible business model amid a rapidly changing postal landscape. First-Class Mail appears to be on the brink of long-term decline as Americans take advantage of cheaper electronic alternatives. Thus, universal postal service is at risk. These findings are similar to our past work and point to the need for fundamental reforms to minimize the risk of a significant taxpayer bailout or dramatic postal rate increases. The Commission made recommendations to Congress and the Service aimed at achieving such reforms, which GAO believes merit consideration. GAO agrees with the Commission that now is the time to modernize the nation's postal laws rather than waiting until a financial crisis occurs that limits congressional options. Key aspects of the Service's existing legislative framework that need to be addressed are 1) a broadly defined mission that enables the Service to engage in unprofitable and controversial endeavors, 2) a governance structure that does not ensure governing board members who have the requisite knowledge and skills, 3) the need for additional accountability, oversight, and transparency provisions; 4) a lengthy, burdensome rate-setting process, and 5) provisions that hinder the Service in rationalizing its infrastructure and workforce. GAO also agrees with the Commission that the Service can take steps now to modernize and increase efficiency and effectiveness, improve its financial position, and rationalize its infrastructure and workforce. The Service has begun to implement its Transformation Plan initiatives, cut its costs and the size of its workforce, and improve its efficiency. However, since the Service issued its Transformation Plan in April 2002, it has not provided adequate transparency on its overall plans to rationalize its infrastructure and workforce; the status of initiatives included in its Transformation Plan; and how it plans to integrate the strategies, timing, and funding necessary to move toward becoming a high-performing organization. The Service's vision of rightsizing its infrastructure and workforce is achievable if approached in a comprehensive, integrated fashion, with appropriate communication and coordination with postal stakeholders.

Background MARAD’s Office of Ship Operations maintains the NDRF as a reserve of ships for defense and national emergencies. When ships are no longer considered useful for defense or aid missions, the Office of Ship Disposal, which reports to the Associate Administrator for National Security, arranges for their responsible disposal. NDRF ships are located at three sites: the James River Reserve Fleet at Fort Eustis, Virginia; the Beaumont Reserve Fleet in Beaumont, Texas; and the Suisun Bay Reserve Fleet at Benicia, California. In addition, as established in a Memorandum of Agreement with the Navy in 2011, MARAD disposes of certain non-combatant ships from the Naval Inactive Ship Maintenance Facilities in Pearl Harbor, Hawaii and in Philadelphia, Pennsylvania. Naval Inactive Ship Maintenance Facilities are used to hold decommissioned U.S. Navy and auxiliary ships pending determination of their disposal. MARAD’s Ship Disposal Program’s mission is to dispose of obsolete NDRF ships through the most expedient, best value, and environmentally safe disposal methods. The program’s approach is to remove all ships that present the highest risk to the environment as soon as possible, and to have disposal alternatives and the necessary funding in place to ensure that obsolete ships can be disposed of at a faster rate than ships in the NDRF are designated as obsolete. MARAD’s Ship Disposal Program is authorized to consider alternative ship disposal methods in addition to recycling obsolete NDRF ships, including, for example, artificial reefing and donation. MARAD has made limited use of these methods because of a number of environmental, financial, and legal barriers. According to MARAD, recycling is the most expedient, environmentally sound, and cost-effective method of disposal available. After MARAD determines that a ship is ready for recycling, it first offers the ship for sale to qualified contractors through sales contracts. If it receives no offers to purchase the ship, MARAD will then procure services to dispose of the ship through a contract for services—in which the government pays the contractor to recycle the ship’s material. When acquiring services through a contract, MARAD uses simplified acquisition procedures, as defined in the FAR, which allow for simplified processes to MARAD is generally not award contracts under a certain dollar threshold.required to follow the procedures delineated in the FAR when awarding sales contracts because the government is not acquiring supplies or services with appropriated funds. However, MARAD officials explained that because they are required to adhere to the FAR when awarding contracts for services, to be consistent, they adopted similar procedures for sales contracts. In the past two years, MARAD has disposed of the ships exclusively through domestic recycling using sales contracts. See appendix II for more information on the ship disposal options used since 2001. In its most recent announcement in November 2013, however, three ships were announced as ready for recycling and MARAD received no sales offers. As a result, MARAD plans to procure the services to recycle the ships through contracts for services. MARAD officials explained that, while they cannot know all the factors the contractors considered when deciding whether or not to submit a sales offer on a ship, the specific ships in this announcement may not have looked profitable to the contractors for a variety of reasons. One ship was tested and proven to have polychlorinated biphenyls, which must be removed through a very costly process before the steel can be sold to recyclers. The other two ships were small, and MARAD officials noted that contractors may have estimated that the costs of towing the ship to the facility plus the labor were not likely to be recovered in the sale of the steel. MARAD’s Two-Step Source Selection Process Uses A Best Value Process Consistent with the Federal Acquisition Regulation Since 2005, MARAD has been using a two-step source selection process for ship recycling. The first step is to qualify the facilities of ship recycling contractors that respond to MARAD’s solicitation for ship disposal, thereby creating a pool of qualified facilities for contracts for either sales or services. In this step, MARAD determines if a ship recycling facility is qualified by evaluating the facility against multiple criteria as outlined in the solicitation. The second step is to award ship recycling contracts for specific ships to qualified contractors. Qualified contractors submit offers in response to MARAD’s announcements—which inform the contractors about the location, names, and work to be completed on multiple ships available for recycling. MARAD then evaluates the offers and determines which offer is the best value for the government, consistent with the FAR, using price and non-price factors such as schedule, capacity, and past performance. MARAD’s Qualification Process Is Based on Multiple Criteria and Varies in the Time It Takes to Complete The first step for a contractor interested in having their facility qualified is to submit a proposal in response to MARAD’s solicitation. MARAD’s process for determining if a ship recycling facility is qualified consists of evaluating the facility’s proposal against multiple criteria as outlined in MARAD’s solicitation for ship disposal. These criteria include considering how a contractor plans to dismantle ships and the extent that the site is capable to support that effort. Beginning in 2005, MARAD began using an open solicitation process—in which interested vendors can respond at any time as opposed to by a specific date. Periodically, MARAD will update and reissue the solicitation, as it did in fiscal year 2009 and again in fiscal year 2014. When the solicitation was updated in fiscal year 2014, previously-qualified facilities needed to re-qualify based on any new criteria incorporated into the updated solicitation. Once the interested recycling contractor submits a proposal, MARAD follows the steps indicated in figure 1 to determine if the ship recycling facility is qualified. MARAD reviews the proposal—including a technical compliance plan that addresses performance capability and ability to comply with all applicable local, state, and federal environmental, safety, and health laws and regulations—for completeness in its initial evaluation. Once MARAD determines that the proposal is complete, it begins evaluating the proposal against multiple criteria including: feasibility and likelihood of success of the engineering, technical, and management approach for disposal of obsolete ships and associated risks; productivity of the proposed approach including schedule and cost assessments; type and sufficiency of proposed methods, processes, and procedures; and depth, relevance, and currency of requisite experience of the facility. The length of the qualification process—which has been as short as a few months or as long as five years—varies for several reasons. One reason for the variation, according to MARAD officials, is that the initial proposals are rarely complete. This part of the process is iterative and MARAD officials stated that they work closely with individual contractors to obtain the necessary information to enable the completion of the evaluation process. In its fiscal year 2014 solicitation, MARAD’s stated goal is to complete the initial evaluation of proposals within eight weeks from the date the proposals are submitted. This timeline, according to officials, is based on the availability of MARAD’s resources. However, MARAD officials noted that the contractor’s responsiveness to requests for additional explanation or information is out of their control and can impact their ability to move forward with the qualification process. In some cases, a contractor may opt to not continue with the qualification process. Another reason for the different timetables for qualification, according to MARAD officials, is that each facility is unique and faces individual challenges. MARAD officials explained that it is incumbent upon the contractor to identify all of the local, state, and federal laws and regulations that apply to ship recycling for the location where the facility is located, and to comply with those laws. For example, a facility in California took over five years to qualify because, according to MARAD officials, it had to address strict state and local environmental laws and regulations and experienced significant delays in obtaining necessary permits from state environmental regulators. Further, the proposed location had not been used for many years, and MARAD needed additional assurances to ensure qualification criteria were met. When a new process is introduced by a ship recycling facility, qualification may take more time. For instance, a contractor recently proposed a new method for ship recycling that involves dismantling the ship while afloat. MARAD considers the procedures for maintaining the stability of the ship; environmental abatement of hazardous materials, such as asbestos and paint disposal; worker safety; and health considerations under this new approach before making a qualification decision. As shown in figure 2, MARAD currently has six qualified recycling facilities, represented by four contractors, in two states: Louisiana and Texas. As of October 2013, there were 27 MARAD and two Navy-owned ships awaiting disposal. After a facility is deemed qualified, MARAD conducts regular oversight, to include bi-weekly teleconferences and quarterly visits to the facilities. During its visits, MARAD checks the facility’s compliance processes and issues deficiency notices if corrective action is needed. In addition, MARAD conducts oversight of the environmental protection and worker safety procedures for the facility. If there is a deficiency found, MARAD refers the issue to the appropriate federal agency, such as the Environmental Protection Agency or Occupational Safety and Health Administration. Further, through its announcement process, MARAD requires existing qualified contractors to report changes made to their ship recycling facilities. These changes could range from a minor change to one part of its recycling process, such as a change in paint removal process, or a significant change such as when a facility is changing ownership. MARAD’s Best Value Process for Source Selection of Its Ship Recycling Contracts is Consistent with the Federal Acquisition Regulation After becoming qualified, a contractor’s facility is eligible to compete for ship recycling contracts, and does so by providing offers in response to MARAD’s announcements on specific ships. Approximately three to four announcements are issued per year, with three to six ships offered per announcement. MARAD’s announcement includes the location and names of the ships that MARAD would like recycled, and the work to be accomplished for each ship. According to MARAD officials, including multiple ships in each announcement optimizes competition and minimizes costs. To decide which facility should receive contracts for the ships in the announcement, MARAD uses a source selection process to determine which offer provides the best value to the government. This process allows the government to accept an offer other than the best priced offer, considering both price and non-price factors. MARAD uses the following three evaluation criteria to determine which offers provide the best value for the government: price, past performance. schedule and capacity, and Because it is using simplified acquisition procedures, MARAD is not required to disclose the relative importance assigned to each evaluation factor. For example, MARAD is not required to state in the announcement whether price is more, less, or equal in importance to past performance. Although not required to state the relative importance of the evaluation criteria, MARAD’s source selection process generally addresses the criteria in a specific order. Initially, MARAD ranks contractors’ sales offers on individual ships by highest to lowest price, then by shortest to longest schedule. MARAD then determines a competitive range—in other words, a subset of all the offers that represents the most highly rated offers. Once the competitive range is determined, MARAD requests multi-ship recycling schedules from contractors with competitive offers on more than one ship to gain insight into what the schedule would be if the facility wins more than one ship in the announcement. For example, if a contractor made offers on two ships that were determined to be in the competitive range, MARAD would ask the contractor to provide a revised schedule showing how many days it would take the contractor’s facility to recycle both ships. MARAD then reviews capacity at each facility in the competitive range. Capacity, according to MARAD, refers to the facility’s ability to take possession of and actively work on the ship(s) at its facility, which reflects current and future ship recycling work from all sources at the recycling facility. Finally, MARAD considers past performance, which can include timeliness on past contracts, a change in management, or the amount of time since the facility last recycled a MARAD ship. Figure 3 describes in more detail the steps MARAD uses in its best value source selection for ship recycling contracts. As indicated in figure 4, most contracts were awarded to the contractor with the best price offer. For fiscal year 2009 through fiscal year 2013, about 78 percent of MARAD’s contract awards for ship recycling, including both sales contracts and contracts for services, were awarded to the contractor that offered the best price. Half of all contracts were awarded to the contractor that offered both the best price and shortest schedule. Another 19 percent of the awardees were selected based on factors other than the best price, and 3 percent were awarded non-competitively, which means these awards were not subject to MARAD’s typical source selection process. For example, one contract was awarded non-competitively because it was in the best interest of the government to support an increased industrial base of ship recycling facilities on the west coast. MARAD Has Taken Steps to Clarify Its Source Selection Process, but Could Strengthen Its Communication Strategy MARAD has made some efforts over the last year to clarify certain parts of its source selection process; however, during our review, contractors told us that they do not fully understand how it works. Almost all of the contractors were unsure as to how MARAD determines best value under sales contracts. Most of the contractors told us that they did not always understand why they lost a ship recycling contract. Three contractors noted it was particularly confusing when they offered the best price with what they believed to be a reasonable schedule compared to other contractors, yet still lost the contract. A couple admitted that there were instances where they did not understand why they won a contract. One consistent source of confusion was that they did not know how MARAD values past performance when awarding contracts for ship recycling—both in how past performance affected the chance to be awarded a future contract and in what factors were considered. For example, they did not know if environmental infractions or late performance on previous contracts played a role in the ability to win future MARAD ship recycling contracts. MARAD, for its part, explained to us that past performance has rarely affected a contractor’s ability to win a contract for one ship in an announcement, but has had a greater affect when MARAD considers the award of more than one ship to the contractor. In addition, in our review of contract documentation, we found several instances where MARAD considered past performance in combination with capacity. For example, a contractor may have had schedule delays on prior ships which were then exacerbated when the contractor was managing the recycling schedule for multiple ships. How MARAD considers the multiple factors when making a best value award varies depending on the specific circumstances of the procurement. As a result, the basis for each award may be unique, which may contribute to the contractor’s confusion on how MARAD is making these decisions. To clarify past performance, in the fiscal year 2014 solicitation, MARAD has elaborated on what will be evaluated within the past performance criterion—stating that it includes the contractor’s history of reasonable and cooperative behavior, record of integrity, and business relationships with the customer. Although a positive step, lack of communication with contractors regarding effects of their past performance, if any, on their future offers remains a source of confusion. Further, MARAD recently improved its contractor debriefing process by adding two more narrative sections to its pre-debriefing form, one on capacity and one on best value. Under the simplified acquisition process, if a contractor requests information on an award that was based on factors other than price alone, MARAD is to provide a brief explanation of the basis for the contract award decision. Although not required to do so, about two years ago, MARAD decided to offer more formal debriefings to convey this information. The debriefings are intended to help contractors understand how their offer compared to the winning offer and to help improve offers for the next time. Once a facility contractor requests a debriefing, MARAD creates a pre-debriefing report that compares the contractor’s offer—price and schedule—to the successful contractor’s price and schedule. The pre-debriefing report is then sent to the requesting contractor with an invitation to participate in a debriefing meeting. MARAD told us that all contractors have been informed of the availability, upon request, of debriefing after a contract award. However, according to MARAD, after the last four ship recycling announcements, only three of the six contractors that bid on the ships asked for a debriefing. These three contractors stated that MARAD’s debriefing process did not help them understand why they lost the contract or how MARAD considered price and non-price factors in its best value determinations. MARAD revised the debriefing form to include the additional narrative sections; however, it has not informed contractors of this change. Contractors may not be aware that the additional information is available unless they request a debriefing. MARAD officials told us that they plan to inform contractors of the new debriefing form through an amendment to the solicitation. If MARAD communicates the additions to the debriefing form in an open and transparent way, facility contractors may seek to obtain information in order to improve their offers for the next announcement, which ultimately could lead to better results for the government. Contractors that we spoke with also expressed confusion about other parts of MARAD’s source selection process, including its qualification process. For example, four contractors said that they notified MARAD of a change to an element of their recycling process at a facility, and that MARAD acknowledged receipt of the notification but did not indicate whether the change was approved or not approved. These contractors were confused about whether certain changes made would affect their eligibility to compete for a contract. In one instance, a contractor told us they informed MARAD about newly-installed ship cutting pads and some dredging they had completed at their facility, but they heard no response from MARAD. According to the contractor, a MARAD official only recognized the changes during a site visit to the facility. In response to these concerns, MARAD officials explained that they are always available to hear questions from contractors should any questions arise, and contractors should feel comfortable contacting them with any questions. Standards for Internal Control in the Federal Government state that management should ensure there are adequate means of communicating with external stakeholders that may have a significant impact on the agency achieving its goals. Although MARAD has improved some aspects of communication with facility contractors, it could strengthen its communication strategy. For example, one method to improve communication could involve an annual industry day or conference where all contractors can ask questions and request clarification on any part of MARAD’s source selection process or other aspects of ship disposal resulting in all contractors hearing the same responses at the same time. Regular individual meetings might also be scheduled with contractors where their specific concerns are discussed. Improving its communication strategy with its contractors could help MARAD maximize the transparency of its source selection process. MARAD’s Strategic Plan Does Not Reflect Current Conditions In our 2005 report, we found MARAD had not developed a comprehensive management approach that could address the myriad of environmental, legal, and regulatory challenges that the program faces. As a result, we recommended that it develop a comprehensive approach to manage its ship disposal program.comprehensive management plan, or strategic plan, which outlined short and long-term strategies for the disposal of the agency’s obsolete ships; however, several key elements are outdated or no longer applicable. The plan stated that MARAD will annually assess and report on its progress and all factors affecting the program, and if necessary, revise the short- and long-term strategy and implementation plan. Since then, however, it has not updated its plan, because, according to program officials, the principles of the plan remain relevant. MARAD was required, however, to provide regular reports to Congress for several years, the last of which was in March 2011. The reports provided information on the progress made to address the backlog, and other activities accomplished since the In 2006, MARAD issued a last report, but did not provide the strategic short- and long-term direction for the program. The 2006 strategy does not take into account current market conditions, goals, and external risks. For example, one of MARAD’s stated goals was to eliminate the backlog of high priority ships that accumulated in the 1990s. MARAD officials we spoke with acknowledge that the backlog has been addressed and they are now focused on maintaining a steady stream of ships entering the NDRF to be removed from the fleet for disposal. As shown in figure 5, from fiscal years 2005 through 2013, 168 ships were removed from the fleet in preparation for disposal. MARAD has 27 NDRF and 2 Navy ships for disposal at the start of fiscal year 2014 and about three to five obsolete ships will be added to its inventory during fiscal year 2014. Further, MARAD’s target is to remove 12 ships for disposal in fiscal year 2014. The 2006 plan also discusses options for ship disposal that are no longer applicable. The plan points to available domestic recycling facilities located along the East and Gulf Coasts; however, as of October 2013, the East Coast facility is no longer considered a qualified facility. The plan notes that one of the critical factors that will impact MARAD’s goals for ship disposal is making foreign recycling a viable disposal option in 2006 and beyond. Foreign recycling is not an option because the Duncan Hunter National Defense Authorization Act for Fiscal Year 2009 generally prohibited sales to foreign facilities, unless, among other things, no domestic capacity is available. The plan describes sales contracts as an option that is of occasional interest and not considered a trend that can be relied upon. MARAD has experienced a trend of sales contracts starting in fiscal year 2011. (See appendix II) Further, MARAD officials expressed concern about maintaining the supplier base to help ensure adequate competition among contractors as the number of ships available for disposal decreases, a concern that is not addressed in the 2006 plan. Competition is a cornerstone of federal contracting and a critical tool for achieving the best return on the government’s investment. Achieving effective competition, in which the government receives more than one offer in response to a solicitation, has been a focus of other agencies, such as the Office of Management and Budget and Department of Defense, because of its noted benefits to the government, including the ability to consider alternative solutions in a reasoned and structured manner. MARAD officials also expressed concerns about the potential effect on the capacity of three of their qualified facilities that were recently awarded Navy contracts to recycle three large aircraft carriers. According to them, one aircraft carrier is approximately equivalent to eight MARAD ships, and they are concerned that this will reduce the capacity of these facilities which will in turn reduce their availability to compete on future MARAD announcements. Standards for Internal Control in the Federal Government call for identifying risks to the agency arising from external and internal factors, and developing a thorough analysis of the possible effect of the risks and an approach for risk management.updating the current goals and ship disposal options available, MARAD can use the plan to assess future risks and strategies to address internal and external factors, such as supplier base. For example, MARAD has a fiscal year 2011 Memorandum of Agreement with the U.S. Navy to dispose of certain non-combatant ships, a fiscal year 2013 Letter of Agreement with the General Services Administration to disposed of certain federally-owned excess ships, and a Memorandum of Agreement with the U.S. Coast Guard to dispose of certain excess cutters, none of which are included in the 2006 plan. An updated strategic plan that reflects the current external environment and risks could better position MARAD to identify challenges and opportunities confronting the future management of the ship disposal program, including maintaining long- term participation in and competition within the industrial base for ship disposal. Conclusions Over the last decade, MARAD’s ship disposal program has made ample progress disposing of obsolete ships, effectively eliminating the past backlog. MARAD’s current process for making source selection decisions is consistent with the FAR’s procedures and processes for simplified acquisitions and determining best value. However, MARAD could improve its information sharing with its qualified contractors to be more transparent. Ship recycling contractors have been concerned whether changes in their facility and processes are being approved by MARAD. Contractors were also uncertain about how best value determinations are made. MARAD, on the other hand, believes it is always available to discuss concerns and relies on the contractors to reach out and ask for clarification. Until MARAD improves its communication strategy with contractors, it is not maximizing transparency in its efforts. Moreover, an updated strategic plan or new strategic plan reflecting the current external environment and risks could help MARAD improve its ship disposal program. Recommendations for Executive Action To enhance MARAD’s transparency in its source selection processes or other aspects of ship disposal and strategic direction for its efforts, we recommend that the Secretary of Transportation direct the MARAD Administrator to take the following two actions: Improve MARAD’s communication strategy, such as by holding an annual industry day or annual meetings with qualified contractors, to transparently communicate information to qualified contractors and to respond to their questions; and Update MARAD’s 2006 comprehensive management plan, i.e. strategic plan, or create a new strategic plan to reflect its current goals, external factors affecting the disposal program, and future risks and strategies based on those goals and factors, and periodically update this plan. Agency Comments and Our Evaluation We provided a draft of this report to DOT for review and comment. DOT did not take a position on our recommendations, but generally agreed with the facts presented. DOT provided technical comments, which we incorporated as appropriate We are sending copies of this report to the Secretary of Transportation and appropriate committees. In addition, the report will also be available at no charge on our website at http://www.gao.gov. If you or your staff have questions about this report, please contact me at (202)-512-4841 or makm@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix IV. Appendix I: Objectives, Scope and Methodology The Coast Guard and Maritime Transportation Act of 2012 mandated that GAO conduct an assessment of the source selection procedures and practices used to award the Maritime Administration’s (MARAD) ship recycling contracts, including the process, procedures and practices used for qualification of ship disposal facilities, whether MARAD’s contract source selection procedures and practices are consistent with the law, and best practices associated with making source selection decisions, as well as any other aspect we deem appropriate to review. This report assesses MARAD’s (1) source selection process; (2) communication strategy with ship disposal facility contractors; and (3) long-term ship disposal strategy. To assess MARAD’s source selection process—including facility qualification and best value determination—and its communication strategy, we reviewed federal laws and regulations, guidance, and other documentation associated with the agency’s source selection procedures, including simplified acquisition procedures and how best value determinations are addressed in the Federal Acquisition Regulation (FAR). We compared MARAD’s procedures to those in the FAR, as applicable. We analyzed its solicitations for fiscal years 2005, 2009, and 2014 that describe the facility qualification process, which represent all the solicitations issued since the agency stopped using Program Research and Development Announcements in 2005. We also reviewed examples of correspondence between MARAD and facilities, specific ship announcements, and required reports and briefings for Congress and other communications with contractor facilities, such as debriefing forms, and recent bid protests related to facility qualification and source selection procedures. We compared MARAD’s communication strategy to criteria in Standards for Internal Control in the Federal Government related to effective communications. In addition, we reviewed facility qualification documents, e.g. the facilities’ submitted general technical plans, MARAD’s letters of concern to contractors, and the notification of results from the evaluation of technical plans to determine the length of time it took to become qualified and how monitoring by MARAD was conducted. To identify how MARAD determined best value during the source selection process, we identified and reviewed a random non- representative sample of source selection documents for fiscal year 2010 through 2013, e.g., sales announcements for 18 obsolete ships, facility proposals and MARAD notification memorandums, and contracts, to determine the steps and analysis MARAD uses to select a contractor through a best value process. We selected contracts awarded from fiscal year 2010 to 2013 to include both sales contracts and contracts for services in our sample. We also interviewed MARAD Ship Disposal Program officials and six contractors representing all seven qualified facilities at the time of our review to determine the processes that are used to select and award contracts. We also interviewed one contractor with one facility going through the qualification process at the time of our review. Through interviews with these officials, we determined (1) how the qualification process was applied for facilities to become technically acceptable and qualified; (2) how MARAD monitors a facility’s qualification status and any changes to the facility; (3) the process for source selection, including how best value determinations are made for specific ship announcements for disposal; (4) how MARAD communicates its source selection process with contractors; and (5) challenges identified by facilities or MARAD relating to the award of ship disposal contracts. MARAD’s pool of qualified ship disposal facilities at the time of GAO review included: 1. All Star Metals, LLC 2. Mare Island Shipyard, LLC (formerly Allied Defense Recycling, LLC) 3. Bay Bridge Texas, LLC (undergoing qualification) 4. BB Metals Enterprises, Inc. 5. Esco Marine, Inc. 6. International Shipbreaking Ltd. 7. Marine Metals, Inc. 8. Southern Recycling, LLC To assess MARAD’s long-term strategy for its ship disposal program, we reviewed its current strategy—the fiscal year 2006 Comprehensive Management Plan for the Disposal of MARAD Non-Retention Vessels. In reviewing MARAD’s most recent strategy, we identified its decision making framework and its schedule and milestones for ship disposal, which included planning up through fiscal year 2007. We reviewed Standards for Internal Control in the Federal Government related to strategic planning, and assessed MARAD’s actions against these standards. We also reviewed MARAD’s agreements with other agencies to dispose of their obsolete ships, e.g., its memorandums of agreement with the U.S. Navy, General Services Administration, and U.S. Coast Guard to dispose of certain ships. We also obtained data from MARAD about the number of obsolete ships on hand and removed for disposal through MARAD’s Ship Disposal Program for fiscal years’ 2005 through 2013. We spoke with MARAD officials and facility contractors to identify concerns related to MARAD’s strategy, including supplier base concerns for the ship recycling industry, and how it communicates its future ship disposal plans with qualified facilities. We conducted this performance audit from May 2013 to February 2014 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Maritime Administration’s Ship Disposal Options The Maritime Administration’s (MARAD) available ship disposal options include: domestic recycling, artificial reefing, deep-water sinking (called SINKEX), donations, and sale for reuse. Domestic recycling—MARAD sells the ships to qualified contractors or purchases recycling services from these contractors. Artificial reefing—MARAD accepts applications from coastal states, U.S. territories and possessions, and foreign governments for use of obsolete NDRF ships as offshore reefs for the conservation of marine life. SINKEX—Navy and MARAD jointly operate ship disposal projects through the Navy’s sink at-sea live-fire training exercises (SINKEX Program). Ship donations—MARAD may convey obsolete NDRF ships to a non-profit organization, state, commonwealth, or U.S. possession for ship reutilization including historic restoration of ships as memorials and museums, and the operational restoration of ships to support non-profit humanitarian missions. Sale for reuse—MARAD sells ships to another buyer for reuse. Appendix III: Maritime Administration’s Process for Qualifying Ship Disposal Facilities Table 1 presents the information in figure 1 in a non-interactive format. Appendix IV: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above Tatiana Winger, Assistant Director; Suzanne Sterling, and Alyssa Weir made contributions to this report.

Timely and proper disposal of obsolete ships in the National Defense Reserve Fleet-older ships designated for use in national emergencies-is critical to protecting the environment. Because these ships often contain hazardous materials, members of Congress and others have raised issues about the environmental concerns. As part of the Department of Transportation, MARAD's Ship Disposal Program serves as the federal government's agent for competing and awarding contracts for recycling the ships' materials. Congress has required MARAD's ship disposal program to award ship recycling contracts to qualified ship recycling facilities on the basis of best value. The Coast Guard and Maritime Transportation Act of 2012 mandated that GAO review MARAD's source selection procedures and practices used to award ship recycling contracts. In this report, GAO assessed MARAD's (1) source selection process; (2) communication strategy with ship recycling contractors; and (3) long-term ship disposal strategy. To complete this work, GAO reviewed and analyzed documentation on MARAD's qualification process, source selection procedures, and strategies; and interviewed MARAD and all of its qualified ship recycling contractors. The Maritime Administration (MARAD) uses a two-step source selection process, first by qualifying contractors and then awarding contracts for ship recycling services based on best value, consistent with the Federal Acquisition Regulation (FAR). In the first step, MARAD qualifies contractors' ship recycling facilities. The qualification process involves evaluating ship recycling facilities' proposals based on multiple criteria, including how a facility plans to dismantle ships and the extent to which the contractor-including its ability to meet local, state, and federal regulations-supports that effort. For the second step, MARAD awards ship recycling contracts for specific ships using a best value source selection process. The best value source selection process allows the government to accept an offer other than the best-priced offer, considering both price and non-price factors, that provides the greatest overall benefit to the government. MARAD considers three evaluation criteria-price, schedule and capacity, and past performance. MARAD has made some efforts over the last year to clarify certain elements of its source selection process; however, MARAD could strengthen its communication strategy with its contractors. All of the qualified contractors GAO spoke with were confused about MARAD's source selection process-including how MARAD uses past performance to evaluate contractors' offers. MARAD has made an effort to clarify its past performance criterion by further explaining what is considered in its most recent solicitation. However other concerns remain. For example, some contractors expressed concern as to whether changes to their facility were approved by MARAD. GAO's standards for internal controls state that management should ensure adequate means of communicating with external stakeholders that may have a significant impact on the agency achieving its goals. Improving its communication strategy with its contractors could help MARAD maximize the transparency of its source selection process. In 2006, MARAD issued a comprehensive management plan, or strategic plan, that outlined short- and long-term strategies for the disposal of MARAD's obsolete ships; however several key elements are now outdated or no longer applicable. According to program officials, MARAD was required to provide regular reports to Congress for several years, the last of which was in March 2011, on the progress made to address the backlog of obsolete ships. However, these reports did not provide the strategic short- and long-term direction for the program. Further, they indicated that the principles of the plan remain relevant; but the 2006 strategy does not take into account current market conditions, goals, and external risks. For example, concerns about maintaining the supplier base are not addressed in the plan. MARAD wants to maintain a supplier base to ensure competition for future ship recycling contracts, but has not fully considered risks and options to address this pending issue. Competition is a cornerstone in federal contracting and a critical tool for achieving the best return on the government's investment. An updated strategic plan that reflects the current external environment and risks could better position MARAD to identify future challenges and opportunities to help ensure the long-term participation and competition of the industrial base for ship disposal.

Background OPM is the central management agency of the federal government charged with administering and enforcing federal civil service laws, regulations, and rules and aiding the President in carrying out his responsibilities for managing the federal workforce. OPM has policy responsibilities related to hiring, managing, compensating, and separating federal employees. Moreover, OPM endeavors to ensure compliance with civil service policies through a program of overseeing the personnel activities of covered federal agencies. OPM helps federal program managers in their personnel responsibilities through a range of programs. For example, OPM sponsors various seminars on human resources issues, runs executive and leadership programs, provides guidance, and develops special materials such as its self-paced materials for managers dealing with poorly performing employees. OPM also promulgates regulations related to federal employee benefits, including retirement, health, and life insurance benefits. OPM directly administers all or major portions of these benefit programs, which serve millions of current and former federal employees. Top OPM officials said they envision OPM as providing human resource management (HRM) leadership for the federal government. Through that leadership, OPM officials said they intend to ensure that the merit principles that are the basis for the federal civil service system are followed throughout the government and that HRM is effective. As the government’s central personnel management agency, OPM has a critical role in ensuring that the Results Act’s goal of improved performance throughout the government is complemented by supportive and effective human capital management policies and practices. Although Congress has provided statutory frameworks for financial and information technology management and the Results Act for performance-based management practices, it has not addressed human capital management practices in a systematic fashion since the 1978 Civil Service Reform Act. In the interim, additional challenges to effective human capital practices have arisen. OPM’s success in ensuring that human capital management policies and practices support results-oriented management depends on addressing these emerging challenges. The standard way of managing human resources is under pressure, as Congress and the public expects better performance and agencies compete in an increasingly tight labor market. Agencies like the Internal Revenue Service, the Federal Aviation Administration, and the student financial assistance function in the Department of Education have been granted broad new flexibility in managing HRM with expectations that organizational performance will improve. At the same time, a principal tool for achieving organizational high performance—meaningful recognition of excellent individual performance—is impeded by a performance appraisal system that routinely identifies zero, or virtually zero, employees as performing unacceptably and nearly 80 percent of employees as performing in the highest two performance categories. These and other challenges impose a high expectation for planning, thereby communicating a vision for the federal workforce, if OPM is to be an effective leader during this period of dynamic change. The Results Act is intended to improve the efficiency and effectiveness of federal programs by establishing a system to set goals for program performance and to measure results. Specifically, the Results Act requires executive agencies to prepare multiyear strategic plans, annual performance plans, and annual performance reports. OPM and other agencies submitted their first cycle of agency multiyear strategic plans to OMB and Congress in September 1997. Like other agencies, OPM has now submitted two annual performance plans to OMB and Congress. In these plans, agencies are required to identify annual performance goals that reflect the agency’s strategic goals and mission. Agencies initial annual performance plans are submitted to Congress after the release of the President’s budget each February. Scope and Methodology To develop our observations, we compared the OPM fiscal year 2000 annual performance plan to the Results Act requirements, OPM fiscal year 1999 annual performance plan, and OPM fiscal years 1997 to 2002 strategic plan. We also discussed these plans with OPM staff in Washington, D.C. In addition, our observations were generally based on our knowledge of OPM’s operations and programs, our numerous reviews of OPM and federal workforce issues, and other existing information available at the time of our assessment. Specifically, we used the criteria in the Results Act; the Office of Management and Budget’s (OMB) guidance on developing the plan (Circular A-11, part 2); our guidance on assessing agency performance plans; and our report on agency performance plans, which cites examples of practices that can improve usefulness to decisionmakers. We did our work between March and June 1999 in accordance with generally accepted government auditing standards. We obtained written comments on a draft of this report from the Director of OPM. These comments are discussed at the end of this letter and are reprinted in appendix II. OPM’s Performance Plan Provides a General Picture of Intended Performance Across the Agency The plan includes performance goals and measures that address major programs and priorities and provides a general picture of intended performance across the agency. OPM’s plan specifies over 100 performance goals, with each OPM unit linking its planned activities and processes to OPM’s 5 strategic goals. However, the plan only partially discusses its coordination with other agencies on crosscutting activities and could have been more useful if it had contained cost-based performance goals and measures. OPM’s key responsibilities as a central management agency include providing HRM leadership and services to federal agencies and administering governmentwide compensation, earned employee benefits, and automated information systems. Many of OPM’s performance goals address these programs. For example, the Employment Service (ES) has a goal to develop a model for workforce planning, analysis, and forecasting so that agencies can enhance workforce quality for mission-critical occupations, by selecting from a diverse pool of well-qualified applicants and by conducting effective succession planning. In several cases, OPM’s fiscal year 2000 plan also includes projected target levels of performance for multiyear goals. For example, OPM’s plan has an objective for fiscal year 2002 to simplify and automate the current General Schedule position classification system, reducing the number of position classification standards from more than 400 to fewer than 100. The plan shows that OPM projects that it will reduce the number of classification standards to 320 by the end of fiscal year 1999 and further reduce the number to 216 by the end of fiscal year 2000. OPM’s plan in several instances makes use of baseline and trend data on past performance to assess and set targeted performance levels. For example, the Retirement and Insurance Service (RIS) reported customer satisfaction rates, claims processing times and accuracy rates for fiscal years 1996 through 1998 and targets for fiscal years 1999 and 2000. Specifically, for customer satisfaction with RIS’ claims processing services, OPM reported that in fiscal year 1998, 88 percent of annuitants surveyed indicated an overall satisfaction with the handling of their retirement claims. The proposed customer satisfaction performance goal for fiscal year 2000 is 90 percent. Similar past performance and target data for processing times and accuracy rates were provided. OPM’s plan acknowledges that internal and external reviews and audits have identified internal and management control weaknesses in its financial administrative and trust funds areas. The identification of these weaknesses and corresponding goals to be met for improvement are a positive step toward improving OPM’s operations. The plan states that improving its financial management operations, systems, policies, and procedures is a top priority for fiscal year 2000; and it includes goals to resolve material weaknesses and to improve the Financial Management System, the Employee Benefits System, and internal controls. However, the plan does not detail how these goals will be achieved, and some of the goals appear unachievable. For example, for accounts receivable delinquency, the percentage went from 49 percent in fiscal year 1997 to 37.8 percent in fiscal year 1998. The goal for fiscal year 1999 is 5 percent. Achieving this percentage in fiscal year 1999 seems questionable based on past experience and because OPM does not have total control over payment of accounts receivable. The plan identifies actions the agency plans to take to maintain the integrity of the earned employee benefits trust funds and OPM’s appropriated and reimbursable funds, such as expanding overall system capabilities to include functions currently performed by stand-alone systems. OPM’s plan partially addresses the need to coordinate with other agencies and individuals who have an interest in OPM’s mission and services. In many cases, the plan discusses OPM’s planned efforts to coordinate crosscutting functions with the federal community. For example, OPM’s plan states that the agency will work in collaboration with federal agencies, various federal organizations (e.g., Chief Financial Officers, Information Technology Association, Critical Infrastructure Coordination Group), and educational institutions to conduct occupational studies and to develop strategies for recruitment, selection, training, and retention. However, in some cases, a more explicit discussion of OPM’s intended coordination with other agencies would be useful. For example, OPM has a performance goal in which information and strategies are to be available to help agencies increase the levels of underrepresented groups in key federal occupations and at key grade levels. The means, or strategies, that OPM proposes to achieve this goal do not describe either the extent or status of OPM’s proposed coordination with the Equal Employment Opportunity Commission, the federal agency with responsibility for eliminating the historic underrepresentation of women and minorities in the workforce. In commenting on our report, OPM agreed that they only partially addressed the need to coordinate with other agencies that have an interest in OPM’s mission and plans do a better job of this in its fiscal year 2001 plan. We previously reported that OPM’s fiscal year 1999 plan could have been more useful if the plan contained cost-based performance goals and measures. OPM’s fiscal year 2000 annual performance plan also does not contain cost-based performance goals and measures, where it appears appropriate to do so, to show how efficiently OPM performs certain operations and activities. Such measures might include, for example, the cost of doing business per unit of output, such as the cost to process civil service retirement payments made either by electronic funds transfer or check. The Social Security Administration’s Fiscal Year 1998 Accountability Report includes operational efficiency measures such as the unit cost to process earnings information and the unit cost to process claims. Cost-based efficiency measures could be useful to managers as they attempt to improve their operations. If such cost-based measures were developed, however, it would be important for OPM’s salaries and expenses fund to have accurate financial and cost data. The reliability of this data is not currently determinable since OPM’s Inspector General (IG) has been unable to express an unqualified opinion on this fund’s financial statements because of inadequate internal controls and standard accounting policies, procedures, and records. OPM agrees that its performance plan could be improved by including cost-based measures that are related to program outputs and said it will provide such measures in its fiscal year 2001 plan. The fiscal year 2000 annual performance plan indicates moderate progress in addressing the weaknesses that we identified in our assessment of the fiscal year 1999 annual performance plan. Among improvements in OPM’s fiscal year 2000 plan are the addition of explanatory information on the goals and performance measures that help show the relationship among results-oriented goals, measures, and program outputs and services. For example, unlike OPM’s fiscal year 1999 plan, OPM’s fiscal year 2000 plan includes a goal that explains not only that OPM intends to identify needed changes in all significant OPM program policies but also that the changes are intended to help equip federal agencies to respond to changing human resources and agency needs in the 21st century. OPM’s Performance Plan Provides a General Discussion of the Strategies and Resources the Agency Will Use to Achieve Its Goals OPM’s plan provides a general discussion of the resources the agency will use to achieve performance goals and identifies strategies for achieving each of its performance goals. The plan generally links the agency’s strategies to specific performance goals and describes how the strategies will contribute to achieving those goals. OPM’s plan could have been improved by identifying how external factors like the current legal framework for the civil service and a highly competitive labor market might affect OPM in achieving its goals and in how it will mitigate adverse effects. OPM’s plan generally relates funding from its program activities, which are frequently managed by dedicated units within OPM, to sets of performance goals. In addition, for a few individual goals, the plan also shows how budgetary resources are related to achieving these goals. For example, to achieve its goal of governmentwide adherence to the merit system principles, OPM’s budget request included 9 additional full-time equivalents (FTE) and $600,000 to increase the number of review sites from 120 to 134 annually (a 12 percent increase) and to augment the provision of technical assistance and oversight of agencies outside the standard civil service system. Also, OPM’s plan includes a goal that its information security program will provide adequate computer security. OPM’s strategies for achieving this goal include conducting internal and external evaluations of its systems, such as engaging the assistance of the National Security Agency to review its security capabilities, and implementing appropriate recommendations to improve its security. In addition to training staff, OPM said it would have in place a tested disaster recovery capability for information systems. OPM’s plan also identifies major management challenges raised by OPM’s IG, such as internal and management-control weaknesses in its financial, administrative and trust funds. The plan introduces strategies the agency said it will take to strengthen the financial oversight of the employee benefit trust fund, such as expanding overall system capabilities, establishing adequate cost accounting standards, and building on carrier financial reporting requirements implemented in fiscal years 1998 and 1999. We previously reported that OPM’s fiscal year 1999 plan did not discuss external factors that could significantly affect performance. Although OPM’s fiscal year 2000 annual performance plan’s analysis suggested that its ability to carry out its goals is influenced by several external factors, the plan does not specify how external factors might affect OPM and how the agency is planning to mitigate the effects of these external factors. For example, changes in the labor market may affect recruitment, delivery of employment information, and staffing policies and processes. However, the plan does not identify the likely changes in the labor market or which of OPM’s goals would be affected or how. For many of its program activities, OPM discusses the size and composition, in terms of knowledge, skills, and abilities, of the human capital needed to support the achievement of that activity’s performance goals. For example, the ES has designed and implemented a capacity model that reflects core competencies and skills needed to carry out its mission. Based on that model, ES intends to recruit skilled individuals from a variety of sources. According to OPM’s plan, the ES also utilizes a contingent workforce of temporary and term employees and experienced staff from other agencies, who can offer operational experience to supplement its existing professional staff in areas where the ES is designing new and innovative policy. As needed, the ES is to contract with leading private sector companies and contractors to provide functional and technical expertise in application development, Y2K (Year 2000) compliance, operational support, and other areas. The fiscal year 2000 annual performance plan indicated moderate progress in addressing the weaknesses that we identified in our assessment of the fiscal year 1999 annual performance plan, as it relates to providing a complete discussion of strategies and resources that the agency plans to use to achieve performance goals. In reviewing the fiscal year 1999 plan, we observed that OPM’s performance plan could have more fully discussed the strategies and resources that the agency is to use to achieve its performance goals. Among improvements in the fiscal year 2000 plan are some fuller discussions of proposed strategies and resources and their relationships to the performance goals. For example, OPM has a goal to modernize its Central Personnel Data File (CPDF). The performance plan specified that to implement the CPDF modernization, its budget request included $1,200,000 and five FTEs in fiscal year 2000, as the first installment of a multiyear program to be completed by fiscal year 2002. In addition to allocating the resources among specific tasks, the plan documented strategies that were clearly related to CPDF plan modernization, such as contracting for the design of a CPDF information retrieval system that identifies the most appropriate database management systems and telecommunication requirements and also estimates the maintenance costs. OPM’S Performance Plan Provides Limited Confidence That Agency Performance Information Will Be Credible OPM’s fiscal year 2000 annual performance plan provides limited confidence that its performance information will be credible. The fiscal year 2000 plan has an overall verification and validation section for its performance measures as well as more specific sections on verification and validation. However, these sections do not always indicate the methods that are to be used to ensure reliability nor do they fully address overcoming known problems, such as not being able to routinely produce valid and reliable financial management data in a timely manner and coming into compliance with the Federal Financial Management Improvement Act of 1996. Although OPM addresses verification and validation in its fiscal year 2000 annual performance plan, several areas raise concerns. For example, in its overall section on verification and validation, OPM discusses several customer satisfaction surveys that are key elements in OPM’s measurement program, with varied response rates of up to 57 percent. One of these surveys, a nationwide survey of a sample of human resources specialists at all grade levels and geographic locations, received only a 29 percent response rate. However, this survey was used to provide baseline data for OPM’s strategic goal to provide advice and assistance to help federal agencies improve their HRM programs. Customer satisfaction levels with OPM assistance in various program areas are given based on this initial survey--ranging from 54.3 to 83.7 percent--and a modest 2- percent increase in overall levels of satisfaction is established as a fiscal year 2000 performance target. The verification and validation section for this goal states that ongoing customer service assessment efforts through daily contacts and regularly scheduled meetings provide continuous feedback about program delivery and customer service. Also, plans to develop an executive survey are cited. At this point, it appears too early to tell how well OPM will be able to verify and validate information related to this performance measure due to the low survey-response rate and the prospective nature of other verification methods. Lower response rates generally increase the uncertainty about the reliability and validity of the survey results. OPM acknowledges the low response rates for its surveys but believes enough surveys were returned to provide confidence in using the data to establish baselines for improvement. In addition, OPM plans to take steps to improve the response rates in the next year. For example, OPM said it is (1) making changes to the survey-delivery process to reduce the impact of undeliverable surveys, (2) shortening the questionnaires and revising specific questions to ensure that survey respondents are not confused by them and therefore reluctant to fill out the surveys, and (3) providing more follow-up to survey recipients. In addition, OPM plans to administer the survey at other times than in the summer. OPM’s Office of Contracting and Administrative Services has several quantitative goals and measures. These goals include reducing procurement costs and reducing telecommunications costs. OPM’s related performance measures include reduced cost of purchases, as a result of increased purchase-card use and lower monthly charges for telecommunications due to corrections of billing errors. The corresponding verification and validation section is short and states “Compile data from existing tracking systems and refine tracking system as necessary.” This does not appear to be an adequate verification and validation section. Rather, a discussion on how the data are to be verified, such as through periodic audits of data, would seem more appropriate. In some cases, the plan’s verification and validation sections cite the financial audits performed under the Chief Financial Officers Act as the source of data verification. For example, OPM’s Retirement and Insurance Service states that the identical performance information is reported in the Program Performance Overviews of OPM’s Annual Financial Statements and, therefore, is included in the independent audits of these statements. However, a measure that is reported in the overview of an audited report actually may not have been audited. For example, the report on OPM’s fiscal year 1998 retirement program financial statements stated that the information in the overview of the retirement program was not audited. For fiscal year 1998, as in past years, OPM’s salaries and expenses and revolving funds continued to receive disclaimers of opinion on their financial statements. To have reliable financial data, OPM would need to receive unqualified opinions on all its financial statements. In addition, specific cost data would also need to be audited to ensure the accuracy of performance measures. On a positive note, the fiscal year 1998 financial statements of OPM’s Retirement, Health, and Life Insurance Programs received unqualified opinions. For fiscal year 1998, all five of OPM’s programs were reported by its auditors as not complying with the Federal Financial Management Improvement Act of 1996. The three benefit programs (retirement, health, and life insurance) were reported as being in noncompliance because of their (1) core financial management system, (2) recording of transactions, and (3) financial management system not supporting all program decisionmaking. OPM’s fiscal year 2000 annual performance plan does not specifically address its noncompliance with the Federal Financial Management Improvement Act of 1996. However, it does have several goals to make improvements in this area, such as its goal to improve financial systems and receive unqualified opinions on its financial statements. Overall, OPM’s fiscal year 2000 plan provides limited confidence that the data used to measure performance would reflect actual performance. The plan’s recognition that data reliability is important is a good step. But, data integrity is critical to the success of any performance measurement initiative, and as such, decisionmakers must have assurance that the program and financial data being used are complete, accurate, and reliable. The fiscal year 2000 annual performance plan would be improved if OPM were to describe the major controls it plans to use to verify and validate performance information on an ongoing basis. Such controls could include periodic data reliability tests, computer edit controls, and supervisory or independent review of data used to develop performance measures. The fiscal year 2000 plan relies on many different types of data for its measures and indicators. Although OPM may not be able to verify all data in a given year, it should be able to do so over a period of time. Thus, a schedule showing when data are to be verified, by whom, and how would provide useful information. OPM said it would be improving future plans by strengthening discussion of the verification and validation of its performance information. OPM’s fiscal year 2000 annual performance plan indicated moderate progress in addressing the verification and validation of data weaknesses that we identified in our assessment of its fiscal year 1999 annual performance plan. For example, it included specific goals for improving the reliability of some data, such as those provided by the salaries and expenses fund. However, in other areas, the fiscal year 2000 plan does not provide assurance that reliable data will be used because of low survey- response rates or because of reliance on financial audits that generally do not provide assurance that performance measures are reliable. The fiscal year 2000 plan also fails to identify or discuss any significant data limitations and their implications for assessing the achievement of performance goals. OPM’s Fiscal Year 2000 Annual Performance Plan Presents a Moderate Improvement Over the 1999 Plan In reviewing the fiscal year 1999 annual performance plan, we observed that the plan’s goals typically were activity or output oriented rather than results oriented, and that the plan could also be improved by including more information on how resources would be used to achieve goals. We also noted that the fiscal year 1999 annual performance plan did not discuss known data limitations that could affect the validity of various performance measures that OPM had planned to use. Among improvements in the fiscal year 2000 plan are the increased number of results-oriented performance goals and quantifiable measures and the use of baseline and trend data for past performance. For example, the plan includes a goal to further simplify the General Schedule classification system to fewer than 225 classification standards and another goal to maintain or increase the fiscal year 1999 level of customer satisfaction, processing times, and accuracy rates for processing new claims for annuity and survivor benefits. Agency Comments and Our Evaluation We provided OPM a copy of our draft report on its fiscal year 2000 annual performance plan and on July 19, 1999, the Director of OPM provided us written comments. The Director said OPM officials were pleased to receive our overall favorable review of its fiscal year 2000 annual performance plan and were particularly pleased that we noted many improvements--often made at our suggestion--compared with its fiscal year 1999 plan. The Director also agreed that some areas in OPM’s future plans would need more attention. Finally, she suggested some corrections and offered a few comments that we have addressed and incorporated into this report as appropriate. OPM concurred that it has a critical role in ensuring that the Results Act goal of improved performance throughout government is achieved and said it has taken steps to provide agencies a performance management framework to achieve that result. OPM said that until timely, reliable, and objective measures of output and outcome efficiency and effectiveness are readily available, managers will remain reliant on less meaningful measures that are more vulnerable to inexorable inflationary pressures and that fail to support making robust distinctions among levels of performance. OPM also said it looks to leaders of the program and financial communities, including GAO, to improve the availability of better measures. We are encouraged that OPM has expressed concern that current measures for assessing employees’ performance have been subject to inflationary pressures and fail to support robust distinctions among levels of performance. We look forward to progress in achieving a performance management framework that more realistically differentiates among employees’ performance and supports an effective pay-for- performance approach. In relation to our observation that a 5-percent accounts receivable delinquency rate seems unachievable in fiscal year 2000, OPM said it established the 5-percent delinquency rate for this fund as a “stretch goal.” OPM said that it has collected over $7 million and resolved over $2 million in accounts receivable that have been delinquent for many years. In addition, OPM said that a comprehensive analysis of the collectibility of all these accounts and the appropriate level of the “bad debt” allowance is in progress for all the revolving fund programs/subfunds. OPM also said that it is working aggressively with its programs and customers to achieve its “stretch goal.” We believe this more complete description of OPM’s efforts to reduce accounts receivable delinquencies provides a better perspective on the commendable, but challenging, goal OPM has set for itself. Concerning our observation that OPM’s plan had only partially addressed the need to coordinate with other agencies that have an interest in its mission, OPM said future plans would describe more fully how it regularly coordinates with other agencies. In response to our specific example regarding OPM’s coordination with EEOC, OPM said that both agencies jointly identify, using OPM’s Federal Equal Opportunity Recruitment Plan report, where underrepresentation exists and where “best practices” are in place that have a positive impact on the historical underrepresentation of women and minorities in the workforce. OPM said that its fiscal year 2001 plan will clearly describe that OPM and EEOC share the common objective of seeking a diverse federal workforce and that both agencies continue to work together toward that goal. OPM agreed that its performance plan could be improved by including cost-based measures that are related to program outputs. OPM said that it has tracked such measures for internal management purposes for many years and will include them in the Transfers From the Trust Funds Section of its fiscal year 2001 plan. Specifically, regarding its salaries and expense fund, OPM said it maintains a disciplined work-reporting system that tracks the cost of salaries; and in fiscal year 2000, it plans to develop and begin testing data validation reviews to ensure the accuracy of its cost- based measures. We believe that OPM’s plans could be more useful if they contained cost-based performance goals and measures, and we look forward to OPM’s plan including this data in fiscal year 2001. OPM shares our concerns about the response rates to several of the surveys used in its measurement process. On the basis of OPM’s comments, we included additional information in this report on OPM’s plans to improve the response rates in future years. In relation to our observations on the results of audits of OPM’s financial systems, OPM stated that the most recent fiscal year 1998 audit of the three benefit programs administered by OPM resulted in an unqualified opinion. OPM also stated that, effective October 1, 1998; a new financial system was implemented for these programs, which is fully compliant with OMB Circular A-127. Although we have not reviewed these systems, we commend any progress toward achieving unqualified opinions. Finally, OPM said it would strengthen its discussion in future plans on steps it has taken to assess the validity of its performance plans. We are sending copies of this report to the Honorable Elijah E. Cummings, Ranking Minority Member of your Subcommittee; the Honorable Janice R. Lachance, Director of OPM; appropriate congressional committees; and other interested parties. We will also make copies available to others on request. This report was prepared under the direction of Steven J. Wozny, Assistant Director. Clifton G. Douglas was also a major contributor to this report. Please contact Steven J. Wozny or me at (202) 512-8676 if you or your staff have any questions regarding this report. Management Challenges In January 1999, we reported on governmentwide major management challenges and program risks that must be addressed to improve the performance, management, and accountability of federal agencies. The Office of Personnel Management (OPM), as the federal government’s central personnel agency, has a leading role in many of these areas. In December 1998, OPM’s Office of Inspector General (OIG) reported on the 10 most serious management challenges in OPM. The following table lists the issues covered in those two reports and the applicable goals and measures in OPM’s fiscal year 2000 annual performance plan. Management challenges Y2K readiness (GAO governmentwide high- risk) Information security (GAO governmentwide high-risk) OPM lacks specific, measurable, and results-oriented long-term goals in its strategic plan and annual goals that met these criteria in their performance plan (OIG) OPM must implement the retirement system modernization initiative (OIG) a tested disaster recovery capability that is in place for OPM’s general support and major financial, benefits, and workforce information systems. OPM’s fiscal year 2000 annual performance plan contains more results-oriented performance goals and measures than its fiscal year 1999 annual performance plan. No changes had been made to the OPM strategic plan. Accelerated information technology solutions for a modernized retirement system are designed, developed, and implemented. Financial management policies and procedures are not documented correctly (OIG) Financial policies and procedures are documented as planned. By mid-fiscal year, complete and distribute an internal Financial Management Manual that will document the policies and procedures used in processing and recording financial transactions. Management challenges There are inadequate controls over the accuracy of annuity payments (OIG) Debt collection and the accounts receivable processing systems are weak (OIG) Applicable goals and measures in the fiscal year 2000 annual performance plan Increase accuracy rates for processing new annuity and survivor benefit claims over fiscal year 1999 levels as follows: 96 percent for Civil Service Retirement System annuity claims; 95 percent for Federal Employees Retirement System annuity claims; and 99.9 percent overall accuracy from annuity roll audit. Accounts receivable delinquency of 2 percent (compared with the fiscal year 1999 goal of 5 percent). Inadequate internal controls related to the accuracy and completeness of payroll withholdings and information provided by other agencies (OIG) Achieved timeliness of at least 99 percent of collections (compared with the fiscal year 1999 goal of 95 percent). Fiscal year 2000 annual financial statements for all three-benefit programs, published in fiscal year 2001, receive “unqualified” opinions. Enhanced oversight is needed for financial management of the Federal Employees Health Benefits Program (FEHBP) (OIG) The audit report on the benefit programs’ fiscal year 2000 financial statements, published in fiscal year 2001, describe no new material weaknesses in internal controls. None specific to FEHBP, but the above goals and indicators apply to FEHBP financial statements. Unreconciled discrepancies between OPM’s general ledger accounts and Treasury records (OIG) Reconcile cash account differences with Treasury within 30 days (same as fiscal year 1999 goal). Material weaknesses in accounts payable processing and reporting (OIG) Improved responsiveness and on-time compliance for financial reporting to OMB and Treasury. (No measure for “improved.”) All material weaknesses are resolved and the Financial Management System, the Employee Benefits System, and internal controls are improved. Achieve timeliness of at least 98 percent for payments. Inadequate controls over investments (OIG) All material weaknesses are eliminated. Improved audit results from independent public accountant, IG, and GAO. Fiscal year 2000 trust fund annual financial statements receive unqualified audit opinions from an independent auditor. Comments From the Office of Personnel Management The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. Each day, GAO issues a list of newly available reports and testimony. To receive facsimile copies of the daily list or any list from the past 30 days, please call (202) 512-6000 using a touch-tone phone. A recorded menu will provide information on how to obtain these lists.

Pursuant to a congressional request, GAO reviewed the Office of Personnel Management's (OPM) fiscal year (FY) 2000 annual performance plan. GAO noted that: (1) past work done by others and GAO has documented poor workforce planning in federal agencies that can hinder their movement toward performance-based management; (2) major human capital challenges are also emerging, such as the aging of the federal workforce, skills imbalances that arose during downsizing, and a highly competitive market for the kinds of talented employees federal agencies need to meet modern demands for efficient and effective services; (3) because OPM is the central management agency responsible for assisting the President and agencies in managing the workforce, OPM's leadership will be critical to addressing the government's human capital challenges; (4) OPM's FY 2000 annual performance plan provides a general picture of intended performance across the agency; (5) GAO found that the plan's performance goals address OPM's major programs and priorities; (6) however, OPM's plan could have been more useful to decisionmakers in some areas, if it contained cost-based performance measures to show how efficiently OPM performs certain operations and activities, such as processing civil service retirement payments; (7) OPM's annual performance plan includes a general discussion of strategies and resources the agency will use to achieve its goals; (8) for each of its goals, the plan discusses a strategy for achieving that goal; (9) for example, the plan discusses OPM's strategy to enhance its information security program by conducting internal and external evaluations of its systems; (10) OPM's FY 2000 annual performance plan provides a fuller discussion of its performance information than its FY 1999 annual performance plan but overall provides limited confidence that agency performance information will be credible; (11) although the plan discusses OPM's verification and validation of its performance measures, the discussion does not always provide assurance that the methods used will be reliable; (12) the plan proposes using survey results of a sample of human resources specialists as a key element in its measurement program, but the survey received only a 29 percent response rate; (13) in general, the lower the response rates the larger the uncertainty about the reliability and validity of the survey results; and (14) overall, OPM's FY 2000 annual performance plan represents a moderate improvement over the FY 1999 plan in that it addresses a number of weaknesses that GAO identified in its assessment of the FY 1999 plan.

Background The National Priorities List (NPL) is EPA’s list of hazardous waste sites that present the greatest long-term threats to human health and the environment. After being placed on the NPL, a site generally proceeds through the remedial program, which is responsible for conducting long-term cleanups. A remedial cleanup starts with a remedial investigation, which assesses in detail the contamination and related environmental and health risks, and a feasibility study, which evaluates alternative remedies for cleaning up a site. After one or more cleanup remedies are selected, EPA or, under EPA’s oversight, the parties responsible for contaminating the site design the technical drawings and develop specifications for the remedial actions. The remedial actions are then constructed or implemented. To organize cleanup activities, EPA may divide a site into two or more “operable units” corresponding to different physical areas at the site or different environmental media, such as soil or groundwater. Under CERCLA, EPA has the authority to compel parties responsible for the contamination at a site to perform the cleanup. EPA may also pay for the cleanup and attempt to recover the costs. Site cleanups conducted by EPA are financed through a trust fund, commonly called the Superfund, established under CERCLA. The state in which a site is located may also carry out a CERCLA cleanup and related actions at the site under an agreement with EPA. In addition to using the Superfund to pay for remedial actions at NPL sites, EPA can use the fund to pay for removal actions at NPL and other sites. Removals are shorter-term actions that generally address immediate threats from hazardous substances—such as removing leaking hazardous waste containers. These actions may be performed instead of or in addition to the remedial actions. Removal actions may use some of the same cleanup methods as the remedial program but are typically faster because they use a simpler site assessment and remedy selection process. EPA uses a database called the Comprehensive Environmental Response and Liability Information System (CERCLIS) to track activities at NPL and other sites. CERCLIS also contains the dates by which EPA regions are planning to select remedies at NPL sites. Data entries to CERCLIS must be supported by specific documents required by the Superfund/Oil Program Implementation Manual. For example, an entry showing the completion of a remedy design by a responsible party must be supported by an EPA-approved final design document. EPA allocates the annual Superfund appropriation it receives from the Congress for various program functions. For example, it estimates the funds that will be needed to continue work at ongoing remediation projects and to conduct emergency removal actions. After these and other needs are provided for, it assigns the remaining funds to new cleanup actions. It uses a National Prioritization Panel to allocate these remaining funds to sites ready to start new remedial actions and to unusually large removal actions beyond what can be funded through the regular removal allocation. The Prioritization Panel, which consists of regional and headquarters officials, ranks new remedial and removal actions proposed by the regions in order of priority based on the risks the sites pose and other factors. EPA approves funding for projects based on these priority rankings. Remedies Have Been Selected at Most NPL Sites As of September 30, 1997, EPA had selected all remedies at about 70 percent of the NPL sites listed as of that date. It plans to complete the selection of remedies for an additional 22 percent of these sites by the end of fiscal year 1999. Status of Remedy Selection As of September 30, 1997, EPA had completed the selection of remedies at 926 (about 70 percent) of the 1,327 NPL sites listed as of that date that the Superfund program is expected to clean up. In addition, EPA had selected at least one remedy at another 222 sites. Almost 60 percent (133) of the sites with at least one remedy selected had only one more remedy to be selected. In total, 1,925 (almost 70 percent) of the 2,753 remedies expected to be selected for the sites listed by September 30, 1997, had been chosen. No remedies had been selected for 179 of the NPL sites. (App. I contains summary data on the status of remedy selection as of September 30, 1997, for nonfederal and federal sites; app. II summarizes remedy selection activity by state; app. III shows the remedy selection status of each NPL site; and app. IV list sites with at least one remedy selected and only one more to be selected.) Remedy selection was not as far along at federal sites as at nonfederal ones. All remedies had been selected for about 76 percent of the nonfederal sites (890 of 1,169 sites) compared with about 23 percent of the federal sites (36 of 158 sites). EPA had selected about 81 percent of the cleanup remedies planned for nonfederal sites (1,444 of 1,792 remedies) and about 50 percent of the cleanup remedies planned for federal sites (481 of 961 remedies). EPA officials said that the slower pace of remedy selection at federal sites occurred because many were listed on the NPL after nonfederal sites and were larger and more complex. They said that their latest data showed that federal sites had an average of 8 operable units, while nonfederal sites contained 1.8 operable units on average. (See fig. 1 for the relative status of remedy selection at nonfederal and federal sites, as of September 30, 1997.) Planned Remedy Selection We developed information from the CERCLIS database and a survey of EPA regions to show the number of sites that are expected to complete remedy selection in future years and the number of remedies planned to be selected at all sites in those years. (Appendix V shows the steps we took to confirm the planned remedy selection dates recorded in CERCLIS.) Our analysis indicates that in fiscal year 1998, EPA expects to complete remedy selection for 138 of the NPL sites that were listed as of September 30, 1997, and in fiscal year 1999, it expects to complete remedy selection for another 151 sites. If these plans are realized, by September 30, 1999, EPA will have selected all remedies for 1,215 sites, or 92 percent, of the 1,327 NPL sites listed as of September 30, 1997, that are expected to require remedies. Remedies will have been selected for about 95 percent of nonfederal sites (1,109 of 1,169 sites) and for about 67 percent of federal sites (106 of 158 sites). See fig. 2 for the number and percentage of nonfederal and federal sites that had all remedies selected by the end of fiscal year 1997 or that are expected to have all remedies selected by the end of fiscal years 1998 or 1999, or later. Only 112 sites listed as of September 30, 1997, are not expected to have all remedies chosen by the end of fiscal year 1999. These consist of 52 federal and 60 nonfederal sites. A list of these 112 sites with the date they were listed on the NPL is shown in app. VI. Data on the Progress of Cleanup Were Accurate for 95 Percent of Sites CERCLIS contains information on the phase of cleanup reached by each operable unit at each NPL site. These cleanup phases include, in chronological order, the start and completion of a site study, the selection of a remedy, the start and completion of a remedial design, and the start and completion of a remedial action. CERCLIS also indicates whether all remedies have been constructed at sites. To test the reliability of CERCLIS data regarding the cleanup phase reached at NPL sites, we selected a random sample of 98 NPL sites that had not reached the “construction complete” stage as of September 30, 1997, and sought confirmation from EPA’s regional offices of the most recent remedial activity reported by CERCLIS for each operable unit at the sites. We excluded sites at which construction was complete at all operable units because EPA’s Inspector General had recently confirmed that the status of these sites has been accurately reported by EPA. We selected from CERCLIS the most recent remedial action for 270 operable units at the 98 sampled sites. We requested that the regions provide us with documentation to support these actions. We considered the documentation provided to be adequate to confirm actions at 95 percent (93) of the sites. Regions reported that at five sites CERCLIS incorrectly recorded the status of cleanup work. At two of these sites, one or more operable units had not reached the cleanup stage recorded in CERCLIS; at two other sites, an operable unit had progressed beyond the stage indicated by CERCLIS; and at the fifth site, an action that was recorded as a remedial action in CERCLIS was actually a removal action. Regional information management personnel attributed these errors to data entry problems and agreed to correct the database. On the basis of our sample results, we estimate that the cleanup status of NPL sites reported by CERCLIS, as of September 30, 1997, was accurate for 95 percent (plus or minus 4.4 percent) of these sites. Our estimate of accuracy is limited to the CERCLIS data showing the status of cleanup work. Not Enough Funds Are Available to Start Remedial Actions at All Sites More sites are expected to be ready to begin cleanup actions requiring expenditures from the Superfund in fiscal year 1998 than can be started with the funds allocated for new actions. As of June 5, 1998, EPA had approved about $33 million in funding for new cleanup actions at 8 sites and had identified 38 other sites that could begin cleanup actions in fiscal year 1998 at an estimated cost of $230 million. EPA officials expect that about $100 million will be available to fund new cleanup actions by the end of the fiscal year, leaving a shortfall of about $163 million. EPA officials believe that $100 million will fund cleanup actions at up to 20 sites; the exact number will be determined by the cost of the individual projects selected. According to our analysis of EPA’s data, there could be at least 26 sites where new cleanup actions cannot be started in fiscal year 1998 because funds will not be available. Estimates of the funds available for cleanup and the identity and number of the sites ready for cleanup action are subject to revision as the year progresses. Sites Ready for Remedial Action According to the Senior Process Manager in EPA’s Office of Solid Waste and Emergency Response, who chairs the National Prioritization Panel, a site is considered ready for a remedial action requiring Superfund financing in fiscal year 1998 if four conditions are expected to be met by the end of the fiscal year: (1) The remedial design is complete, (2) the contracting capacity exists to begin work, (3) the state in which the site is located has agreed to pay its share of the project’s costs, and (4) settlement with the responsible parties is not likely. EPA’s regional officials have identified 38 sites that are expected to be ready for cleanup actions in fiscal year 1998 but that had not been approved for funding as of June 5, 1998. (See app. VII for a list of these sites.) Removal actions are scheduled for 10 of the 38 sites, and remedial actions are scheduled at the other 28 sites. The ten removal actions are expected to cost $56.5 million. According to the Chair of the National Prioritization Panel, top Superfund management will make a decision before the end of the fiscal year about how much of the $100 million available for new cleanup actions can be spent on these removals. He estimated that about $10 million will be allocated for removal actions. Factors Affecting Funding Availability and Needs According to EPA officials, the number and identity of the sites that will ultimately receive funding in fiscal year 1998 for new cleanup actions depend on events that may unfold during the year. These events could affect both the supply of funds and the readiness of sites for cleanup action. The Chair of the National Prioritization Panel said that $100 million is his best estimate of the funds that will be available for new cleanup actions for fiscal year 1998. However, he said that the actual amount could vary from the estimate because of changes in expected expenditures for competing Superfund activities, such as ongoing remedial action projects, and the results of negotiations with responsible parties over EPA’s contribution to certain new cleanup projects. The amount available for new remedial actions could also be affected by the amount of unspent funds that is recovered from Superfund contracts. The number and identity of sites ready for remedial actions in fiscal year 1998 could also change. For example, the scheduled completion of remedial designs could slip, thereby postponing the start of remedial actions, or settlements with responsible parties not now anticipated might be achieved, thereby negating the need for Superfund financing. Panel members in the EPA regions we interviewed thought there was a possibility of such settlements for 2 of the 38 sites not funded as of June 5, 1998. The estimates of cleanup costs for individual sites are also subject to some revision. The estimates for some sites are based on preliminary design estimates. In addition, at sites where remedial action costs are estimated at over $5 million, cleanup may be financed over more than one fiscal year when possible. Fifteen of the 38 unfunded sites have estimated remedial action costs exceeding $5 million. Agency Comments We provided copies of a draft of this report to EPA for review and comment. EPA responded that the report and the data reported in it were accurate and that the agency had no further comments. Scope and Methodology To determine the progress the Superfund program has made in selecting remedies, we obtained a copy of the CERCLIS database dated December 15, 1997. We analyzed this database to calculate the number of sites with all remedies selected by September 30, 1997, and the number of remedies planned for both nonfederal and federal sites. We adjusted the CERCLIS remedy selection data in accordance with information provided by EPA’s regions as described in app. V. To verify the accuracy of the information in CERCLIS on sites’ cleanup progress, we selected a statistically random sample of 98 sites. For each operable unit at each site, we obtained CERCLIS data showing the latest remedial action as of September 30, 1997, such as the start of a site study or the completion of a remedial design. We asked each EPA region to provide us with documents to demonstrate that the action indicated by CERCLIS had taken place. If documentation was unavailable, we talked to information management coordinators and site managers to obtain testimonial evidence that the information recorded in CERCLIS was accurate and reviewed published reports of work completed at the sites. On the basis of this survey, we estimated the accuracy of the CERCLIS data on site status. We also checked with the responsible EPA regional offices on the accuracy of the information in CERCLIS about sites at which remedy selection was planned to be completed in fiscal years 1998 and 1999. Using the CERCLIS database, we developed lists of 586 sites with remedies planned for completion by September 30, 1999. From these lists, we determined that 166 sites fit into one of three categories: (1) The study phase that precedes remedy selection had not started, (2) the study phase was started during calendar year 1997, or (3) the study phase was started before calendar year 1990. The first two categories presented questions as to the completion of the remedies in the time forecast by CERCLIS, since studies take an average of over 4 years to complete, and the third category raised questions because of the long apparent delays in completing the studies. We provided the lists to EPA’s regions and asked them to confirm the study and remedy dates or to revise the dates. We also asked regional officials to explain why they thought that the remedy selection dates could be met and to state how confident they were that the dates could be met. The regions were asked to add to the lists any sites that would have remedies completed by September 30, 1999, if those sites were not shown on the lists. We followed up by telephone to clarify the regions’ responses and to obtain missing or incomplete information. (The results of this work are provided in app. V.) To determine the number of cleanup projects that cannot be started in fiscal year 1998 because of a lack of funding, we interviewed the chair of the National Prioritization Panel and other EPA officials, obtained lists of sites considered by the Panel for funding, and confirmed with regional officials that the listed sites were expected to be ready for new cleanup actions in fiscal year 1998. We conducted our review in accordance with generally accepted government auditing standards from October 1997 through August 1998. As arranged with your offices, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days after the date of this letter. At that time, we will send copies of the report to other congressional committees; the Administrator, EPA; the Director, Office of Management and Budget; and other interested parties. We will also make copies available to others on request. Should you need further information, please call me at (202) 512-6111. Major contributors to this report are listed in appendix VIII. Completed and Planned Remedies at Sites on the National Priorities List, as of September 30, 1997 Summary of Remedy Selection by State/Territory, as of September 30, 1997 Status of Remedy Selection at Nonfederal and Federal Sites, as of September 30, 1997 Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Sites with all remedies selected by 1999 (continued) Nonfederal and Federal Sites With at Least One Remedy Selected and Only One Left to Be Selected, as of September 30, 1997 Olin Corp. (McIntosh Plant) Stauffer Chemical Co. (LeMoyne Plant) T.H. Agriculture & Nutrition (Montgomery Plant) Motorola, Inc. (52nd Street Plant) Brown & Bryant, Inc. (Arvin Plant) Chemical Sales Co. Dover Gas Light Co. Halby Chemical Co. Standard Chlorine of Delaware, Inc. Petroleum Products Corp. Marzone Inc./Chevron Chemical Co. (continued) Outboard Marine Corp. Parson’s Casket Hardware Co. Pester Refinery Co. National Southwire Aluminum Co. Kane & Lombard Street Drums Sand, Gravel & Stone W.R. Grace & Co., Inc. (Acton Plant) Ott/Story/Cordova Chemical Co. Rockwell International Corp. (Allegan Plant) Spartan Chemical Co. Thermo-Chem, Inc. (continued) Nebraska Ordnance Plant (Former) Bridgeport Rental & Oil Services Chemical Insecticide Corp. Chemsol, Inc. Diamond Alkali Co. Hercules, Inc. (Gibbstown Plant) Imperial Oil Co., Inc./Champion Chemicals Industrial Latex Corp. Roebling Steel Co. Shield Alloy Corp. (continued) Universal Oil Products (Chemical Division) White Chemical Corp. Forest Glen Mobile Home Subdivision Goldisc Recordings, Inc. Hooker Chemical/Ruco Polymer Corp. York Oil Co. Avco Lycoming (Williamsport Division) Fischer & Porter Co. (continued) Peterson/Puritan, Inc. Koppers Co., Inc. (Charleston Plant) Portland Cement (Kiln Dust 2 & 3) Atlantic Wood Industries, Inc. Greenwood Chemical Co. Commencement Bay, Near Shore/Tide Flats Harbor Island (Lead) Fike Chemical, Inc. Total (112 nonfederal sites) Anniston Army Depot (SE Industrial Area) Sangamo Electric Dump/Crab Orchard National Wildlife Refuge (DOI) Materials Technology Laboratory (U.S. Army) Weldon Spring Former Army Ordnance Works Monticello Mill Tailings (DOE) Fairchild Air Force Base (4 Waste Areas) (continued) Hanford 300-Area (DOE) Naval Undersea Warfare Station (4 Areas) Puget Sound Naval Shipyard Complex Total (21 federal sites) Steps We Took to Confirm the Planned Remedy Selection Dates Recorded in the CERCLIS Database The Comprehensive Environmental Response and Liability Information System (CERCLIS), a database of information on National Priorities List (NPL) and other sites, contains the dates by which EPA regions are planning to select remedies at NPL sites. To get the most accurate estimates of the expected progress on remedy selection through fiscal year 1999, we checked many of the planned dates recorded in CERCLIS with officials in the regional offices that are responsible for choosing the remedies. We asked regional officials to confirm or revise the planning dates recorded in CERCLIS to reflect their latest estimates of when remedy selection would be completed. CERCLIS indicated that remedy selection is expected to be completed at 586 sites in fiscal years 1998 and 1999. We asked EPA’s regional officials whether they believed they could meet the planned dates for about 166 planned remedies at 135 of these sites. We selected these sites because although their planning dates were for the near future, fiscal years 1998 and 1999, the sites’ remedy selection studies (which must be completed before remedies are chosen and which take an average of about 4 years to complete) (1) had not begun, (2) were started in fiscal year 1997, or (3) had been going on for much longer than 4 years without a decision having been made on remedies. Officials in EPA’s regional offices confirmed or revised 159 of the 166 remedy planning dates in CERCLIS. They said that the remaining seven remedies were combined with other remedies or were for sites that had been transferred to other authorities for cleanup. The officials confirmed that the expected remedy selection date recorded in CERCLIS was accurate for 64 of the 159 planned remedies (40 percent). These officials revised the expected completion date for 95 remedies (60 percent). Most of the revisions moved the remedy completion date less than 1 year beyond the date shown in CERCLIS. Regional officials were generally confident that they could select remedies at the sites we surveyed by the dates given in CERCLIS or the revised dates. Of the 159 planned completion dates, regions reported that 11 had already been reached and another 128 would probably or definitely be met. They were uncertain or doubtful about the remaining 20 dates. The most common reasons given by regional officials for their confidence were that the site study was almost completed, the potentially responsible party was cooperating on the study, prior site action reduced the study’s scope, or remedy selection was routine. Federal and Nonfederal Sites for Which Final Remedies Will Be Selected After Fiscal Year 1999 Table VI.1: Nonfederal Sites for Which Final Remedies Will Be Selected After Fiscal Year 1999 Number of remedies selected as of 9/30/97 (continued) Number of remedies selected as of 9/30/97 (continued) Table VI.2: Federal Sites for Which Final Remedies Will Be Selected After Fiscal Year 1999 Number of remedies selected as of 9/30/97 (continued) Number of remedies selected as of 9/30/97 (continued) Sites Expected to Be Ready for Cleanup Action in Fiscal Year 1998 but Not Approved for Funding as of June 5, 1998 Table VII.1 shows sites that are expected to be ready for new cleanup actions requiring Superfund outlays in fiscal year 1998 and that had not been approved for funding as of June 5, 1998. The table is based on a list prepared by EPA headquarters and on discussions we had with representatives from the National Prioritization Panel from six EPA regions representing almost 90 percent of the sites on the headquarters’ list. Table VII.1: Sites Expected to Be Ready for Cleanup Action in Fiscal Year 1998 but Not Approved for Funding as of June 5, 1998 Ottati & Goss/Kingston Steel Drum Cosden Chemical Coatings Corp. Imperial Oil Co., Inc./Champion Chemicals Nascolite Corp. Roebling Steel Co. Genzale Plating Co. North Penn - Area 6 Coleman-Evans Wood Preserving Co. American Creosote Works (Jackson Plant) Parson’s Casket Hardware Co. Sauget Site Qa, b Continental Steel Corp. Parsons Chemical Works, Inc. MacGillis & Gibbs Co./Bell Lumber & Pole Co. (continued) Better Brite Plating Chrome & Zinc Shops Madisonville Creosote Works, Inc. RSR Corp. Mid-America Tanning Co. Bee Cee Manufacturing Co. Proposed for the NPL. Major Contributors to This Report James F. Donaghy, Assistant Director Angelia V. Kelly, Evaluator-in-Charge James B. Musial, Senior Evaluator Mitchell B. Karpman, Assistant Director The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537. Each day, GAO issues a list of newly available reports and testimony. 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Pursuant to a congressional request, GAO provided information on the status of sites on the Environmental Protection Agency's (EPA) National Priorities List (NPL), focusing on the: (1) progress the Superfund program has made in selecting remedies at both federal and nonfederal sites; (2) accuracy of the information in the Superfund database on sites' cleanup progress; and (3) number of cleanup projects that cannot be started in FY 1998 because of a lack of funding. GAO noted that: (1) as of September 30, 1997, EPA had completed the selection of cleanup remedies at about 70 percent of the 1,327 NPL sites listed as of that date that were expected to require a Superfund remedy; (2) no remedies had been selected at 13 percent of the sites; (3) EPA had selected 1,925 remedies at NPL sites and planned to select another 828 remedies; (4) remedy selection at federal sites has lagged behind selection at nonfederal sites because, according to EPA officials, many of the federal sites present more complex cleanup problems and were added to the NPL after nonfederal sites; (5) at the end of FY 1997, EPA had completed remedy selection for about 76 percent of the nonfederal sites and for about 23 percent of the federal sites; (6) EPA plans to complete remedy selection at an additional 19 percent of nonfederal sites and an additional 44 percent of federal sites by the end of FY 1999; (7) if these plans are realized, EPA will have completed remedy selection at about 95 percent of the nonfederal sites and about 67 percent of the federal sites that were listed as of September 30, 1997; (8) GAO tested the accuracy of the data in EPA's Superfund database on the progress of sites through the cleanup process for a statistically random sample of 98 NPL sites; (9) GAO estimates that the cleanup status of NPL sites reported by the Superfund database as of September 30, 1997, was accurate for 95 percent of the sites; (10) GAO found that this database incorrectly recorded the status of cleanup work at five sampled sites; (11) two of these sites had not progressed as far as the database indicated, two other sites had progressed beyond the cleanup phase indicated by the database, and at the fifth site, an action had been classified incorrectly; (12) EPA identified 46 sites that could start cleanup actions requiring Superfund financing in FY 1998 at an estimated cost of about $263 million; (13) EPA officials expected to have about $100 million available for new actions, an amount that they said could fund up to 20 sites; (14) as a result of this anticipated funding shortfall, at least 26 sites could be ready for cleanup but have no work begun in FY 1998; and (15) the amount of funds that proves to be available for cleanup by the end of the fiscal year and the number and the identity of sites ready for funding could vary from EPA's estimates, depending on the funding demands of competing Superfund activities, the progress of sites toward completing cleanup design, and other factors.

Background For federal tax purposes state and local government bonds are classified as either “governmental bonds” or “private activity bonds.” In general, governmental bonds are used to build public capital facilities and serve the general public interest. Governmental bonds are tax-exempt and can be issued for a variety of public facilities and projects. Tax exemption lowers municipalities’ borrowing costs and provides higher after-tax yields to investors. Private activity bonds, on the other hand, provide financing to private businesses or individuals and are either tax-exempt or taxable depending on two tests. Tax exemption is granted to certain qualified private activity bonds, such as those for certain housing projects and activities, but the borrowed amounts are limited and the interest earned by investors can be subject to alternative minimum tax. In addition, bonds issued by state and local governments can be structured as general obligation (G.O.) or revenue bonds. G.O. bonds, also known as full faith and credit obligations, are secured by revenues obtained from the issuer’s general taxing powers, including sales taxes, property taxes, and income taxes. Most G.O. bonds are used to build public infrastructure, such as school buildings, jails, police stations, and city halls, and are classified as governmental bonds for tax purposes. In contrast, revenue bonds are issued to finance specific projects or enterprises and investors get paid from the revenues generated by the financed projects. Revenue bonds can be either private activity bonds or governmental bonds for tax purposes. In addition to the limitations and restrictions placed on the issuance of tax-exempt bonds by state and local governments, there are additional restrictions on tribal governments’ issuance of tax-exempt bonds. Specifically, I.R.C. §7871 (c) provides that tribal governments may use tax- exempt bonds only if substantially all of the proceeds from those bonds are used to exercise an essential government function. In 1987, I.R.C. §7871 (e) was added to the I.R.C. to provide that “essential government function” shall not include any function not customarily performed by state and local governments with general taxing powers. With the exception of certain manufacturing activities, tribal governments are not eligible for the tax benefits of qualified private activity bonds. No regulations have been issued yet addressing what is or what is not an essential government function since the provision in 1987 was added. Congress in the legislative history to I.R.C. § 7871(e) provided some examples, such as schools, roads, and government buildings. This limited direction for tribes’ use of tax-exempt bonds does not fully address the types of activities that state and local governments are financing, a principal criterion for determining an essential government function. State and Local Governments Provide Substantial Financing for Housing We were unable to determine the number of rental housing facilities that were financed, constructed, or operated by state and local governments. According to experts in state and local government financing, affordable housing projects are commonly provided by state and local governments to low-income individuals. We found the following details on debt financing for multi-family housing. From 2000 through 2004 municipalities borrowed, in 2004 dollars, a total of $46.4 billion in 3,557 bond issues for multi-family housing projects, according to Thomson Financial data. State and local governments allocated from about 6 percent to 10 percent from 2000 through 2004 of total bond issuances for housing. Of the municipal bonds issued over the period for housing, 33 percent to 45 percent went to multi-family dwellings. The bond issuances totaled from $7.2 billion to $12.2 billion in constant 2004 dollars. Table 1 shows nominal amounts of borrowings by category—single family and multi-family borrowings, and tax-exempt, taxable and amounts subject to alternative minimum tax. The magnitude of bond issuances suggests significant state and local government support for both single-family and rental housing in the form of multifamily dwellings. As can be seen in table 1, tax-exempt borrowings provided less than 50 percent of total borrowings for housing. The I.R.C includes housing financing as a “qualified private activity” subject to volume caps. Transportation Facilities Often Are Publicly Financed by a Variety of Methods We were unable to determine the number of road infrastructure facilities that have been constructed, financed, or operated by state and local governments. According to experts in state and local finance, transportation and schools are the largest categories of capital projects financed by state and local governments. We found the following details on debt financings of road projects. According to Thomson Financial data, from 2000 through 2004 municipalities borrowed, in 2004 dollars, a total of $61.4 billion in 1,094 issues for toll roads and highways. In 2002, debt financing represented about 10 percent of total state funding for highways. In addition to tax- exempt bonds, transportation facilities received federal support in the form of highway credit programs and loans, and highway tax revenues. We were able to provide some details on debt financing of transportation facilities. Thomson Financial data indicate that while state and local governments allocated 9 percent to 13 percent of total bond issuances to transportation facilities in the period from 2000 through 2004, between 27 and 38 percent of those issues went toward toll roads and highways. These bonds averaged about $12 billion in constant 2004 dollars over the period from 2000 to 2004. Table 2 shows the nominal amounts of borrowings by category—air, sea, and road facilities, and tax-exempt, taxable and amounts subject to alternative minimum tax. Categories in bold are closest to the types of facilities that are the subject of this report. However, some facilities of interest may have been bundled within the other categories. Wide Prevalence of User Charges for Parking Suggest Customary Provision by State and Local Governments We were unable to obtain the number of parking facilities constructed, financed, or operated by state and local governments. According to municipal finance experts parking facilities, like housing and transportation facilities, are commonly financed with tax-exempt bonds by state and local governments. We found the following details on debt financing for parking facilities. According to Thomson Financial data, from 2000 through 2004 municipalities borrowed, in 2004 dollars, a total of $3.5 billion in 220 issues for parking facilities. Details on debt financing for parking facilities from Thomson Financial data are listed in the previous section on transportation facilities and in table 2. Total taxable and tax-exempt bond issuances for parking facilities ranged from $0.5 billion to $1 billion in 2004 constant dollars, accounting for on average 2 percent of total (taxable and tax-exempt) transportation bond issues. The data for parking facilities bond issues do not provide a breakdown between taxable and tax-exempt bond issuances. According to government finance experts, determining the use of tax- exempt bonds to finance parking facilities can be difficult because a variety of capital projects are often combined into one bond issuance. In addition, state and local governments have relied on a combination of tax- exempt and taxable financing to construct parking garages that are meant to promote economic development in specific districts. For example, the City of Virginia Beach built several parking garages in two tax increment financing (TIF) districts wherein the incremental real property taxes above a base level are used to pay the revenue bonds issued to build the garages. As of December 2005, the city had issued $34.9 million tax-exempt and $4.7 million taxable revenue bonds to build parking garages in the TIF districts. In order to reduce the construction risk to the city, a private developer built the garages and the city’s Development Authority purchased them as they were built. User fees received by state and local governments for providing parking services are a direct indicator of the extent of their involvement in parking facilities in the form of on-street metered parking, off-street parking garages, or both. According to 2002 Census of Governments data, about 73 percent of the population of the United States lived in MSAs that reported user charges on government-owned parking facilities. Table 3 lists the largest 171 MSAs by their level of parking user charges. Figure 1 shows the location of the largest 171 MSAs and their level of parking user charges. These 171 MSAs accounted for about 75 percent of the population in the United States in 2002 and include all MSAs with populations of 250,000 or more. Ninety-two percent of the MSAs listed reported positive user charges, and 97 percent of the population in the largest MSAs lived in MSAs that reported positive user charges. The prevalence of user charges suggests that most of the population is provided with some publicly supported parking by state and local governments. We examined selected government comprehensive annual financial reports in large MSAs, and found that some cities report their parking operations in business-type proprietary funds that disclose operating results and debt levels. For example, in 2005 the City of Miami Beach’s Parking Fund reported $30.5 million tax-exempt revenue bonds and $10.4 million in income from operating the city’s 68 parking lots and garages. Governments Provide Financing for a Wide Variety of Recreational Facilities We did not find readily available data that identify community recreational facilities as a specific category and were unable to determine the number of these facilities financed, constructed, or operated by state and local governments. According to government finance experts, state and local governments play a large role in the financing and construction of a variety of recreational facilities. However, it is difficult to identify the specific amount of financing for these facilities because available information is presented in overlapping categories and single bond issuances can be used for more than one purpose. We found the following details on debt financing of different types of recreational public facilities. From 2000 through 2004 municipalities borrowed, in 2004 dollars, a total of $60.9 billion in 3,085 tax-exempt issues to build public facilities, according to Thomson Financial data. This general category includes several recreation-related facilities, including libraries and museums ($7.5 billion in 470 issues); convention centers ($11.1 billion in 236 issues); theaters ($0.6 billion in 29 issues); parks, zoos, and beaches ($6.1 billion in 723 issues); stadiums and arenas ($5.3 billion in 119 issues); and other recreation facilities ($4.6 billion in 420 issues). Table 4 shows nominal amounts of borrowings by category—convention centers; parks, zoos, and beaches; other recreation; and other public facilities; and tax-exempt, taxable and amounts subject to alternative minimum tax. From 2000 through 2004, state and local governments devoted between 2 percent and 5 percent of total bond issuances to public facilities. Of the municipal bonds issued over the period for public facilities between 6 percent and 13 percent were issued for facilities such as parks, zoos, and beaches, and between 5 percent and 11 percent were devoted to other recreational facilities. These bonds totaled from $0.6 billion to $1.7 billion in constant 2004 dollars. Given that the recreational facilities category overlaps with some of the other categories, such as golf courses and convention centers, additional information relevant to recreational facilities is available in other sections of this report. Similar to parking facilities, we used the 2002 Census of Governments to obtain an indirect indicator of the state and local governments’ support for community recreational facilities. However, this indicator is less precise than the Census indicator for user parking charges because Census defines park and recreational facilities to include many community recreational facilities, including swimming pools, marinas, golf courses, tennis courts, and museums. Also, determining the number and amounts of tax-exempt financings related to community recreational facilities was difficult because state and local governments can include these facilities with other capital projects in a single financing package. According to the Census data, all of the largest 171 MSAs reported positive user charges for parks and recreation. Thus, 75 percent of the population has access to some form of publicly provided recreational facility, as shown in figure 2. Numerous Municipal Golf Courses Exist, Some with Lodging Facilities According to National Golf Foundation data, in 2005 there were about 16,000 public and private golf courses in the United States. Of those, about 2,400 (15 percent) are municipal golf courses, that is, they are owned by state and local governments. Municipal golf courses do not include daily fee golf courses, about 9,000, that are not owned by a tax-supported entity but provide at least limited public access. Table 5 shows the regional distribution of municipal golf courses. All states have municipal golf courses. Three percent, or about 80, municipal golf courses have been constructed with different forms of lodging, ranging from cabins to resort hotels with convention facilities. In some cases, municipal resort golf courses have been built with resort hotels and facilities and have been constructed both as stand-alone courses and as part of park districts. These resort courses may vary significantly in different ways, including lodging and dining facilities and course design. Figure 3 shows the trend in nonpark municipal resort golf facilities. Over many years there has been a consistent increase in the number of nonpark municipal resort golf courses. In addition to the nonpark resort golf courses, there were an additional 24 resort golf courses inside park districts as of 2005. According the National Golf Foundation, there are also close to 70 municipal golf courses associated with real estate developments. These courses, which are owned by municipalities, have been built together with planning for private real estate abutting the course, or have been purchased by the municipality from private real estate developments that included golf courses. In some cases the private real estate development was planned in order to cover part of the costs of building the municipal course. Over the past 10 years an increasing number of golf courses have been built as part of larger real estate developments. Figure 4 shows the trend in municipal real estate development golf courses. We did not find the full extent of tax-exempt financing of municipal golf courses. According to data provided by Akin Gump Strauss Hauer & Feld LLP, a major law firm, at least 120 golf courses in 29 states have been financed, at least in part, with tax-exempt bonds. We identified, using National Golf Foundation data, over 25 of these tax-exempt financed courses as associated with resort or real estate facilities. According to these data many more of these courses have banquet facilities and conference centers. An illustration of the use tax-exempt bonds to build a municipal golf course is provided by the 27-hole municipal golf course in the City of North Charleston. In the late 1990s the city issued $11.1 million in mortgage revenue bonds to build a municipal golf course and $4.6 million in general obligation bonds to finance the construction of roads and infrastructure improvements in the surrounding area. In 2003 the city refunded the outstanding golf-related bonds by issuing $11.7 million in mortgage revenue bonds, for an estimated $1.6 million in debt service savings. In 2005 the municipal golf course had a $1 million operating loss, but the city expects that the course’s situation in the center of a residential and commercial development eventually will contribute over $200 million in taxable property value. Daily fee courses, while not explicitly owned by state or local governments could have been financed with municipal tax-exempt bonds. For example, the Maryland Economic Development Corporation (MEDCO) has issued about $176 million limited-obligation revenue bonds to build two resorts that feature a hotel, a conference center, and a golf facility. MEDCO owns the Hyatt Regency Chesapeake Bay Conference Center, with 400 hotel rooms, 35,000 square feet of meeting and banquet space, an 18-hole championship golf course and 150-slip marina. MEDCO also owns the Rocky Gap Golf Course and Hotel/Meeting Center, with an 18-hole Jack Nicklaus signature golf course, a 243-acre lake, and a resort lodge. Some municipal finance experts believe state and local governments can also provide indirect support to private golf courses through lower taxable property values. Private golf courses may be subject to agricultural assessment rules, which provide a tax break on property taxes, given that golf courses also provide an open space. They also noted that there may be other cases where land apportioned off by state and local governments near residential property is transferred to private companies in order to build golf courses. Public Financing Is Provided to Numerous Convention Centers Although the number of convention centers financed, constructed, or operated by state and local governments is not known, we were provided information on over 300 convention centers owned by state and local governments by Akin Gump Strauss Hauer & Feld LLP. According to government finance experts, most convention centers are financed with tax-exempt bonds. We found the following details on debt financing of a number of different types of recreational public facilities. From 2000 through 2004 municipalities borrowed in 2004 dollars $11.1 billion in 236 issues for financing convention centers, according to Thomson Financial data. (See table 4 for details of debt financing of convention centers, in nominal amounts in billions.) The municipal bonds issued for convention or civic centers totaled from $1.2 billion to $3.4 billion in constant 2004 dollars. Figure 5 shows the cumulative number of major new bond issues for convention centers over the past 8 years. According to some bond finance and convention industry experts, convention centers have been mostly financed by city governments. Experts we interviewed said that in order to promote urban economic development, a growing number of cities have in recent years built convention centers and also built hotels nearby in order to draw more convention visitors to their communities. Even though convention centers may operate at a financial loss, cities have financed them expecting to generate additional spending in related businesses, including restaurants and entertainment, and increased property values. Different Sources Show Public Financing of Hotels and Related Facilities According to lists we obtained from government finance experts, 39 hotels associated with convention centers or airports or golf courses that have been financed with tax-exempt bonds have been identified. These facilities may vary significantly in different ways. As table 6 shows, the value of tax-exempt bond financing for hotels totaled in the billions. According to selected government financial reports we examined, 12 hotels have been financed with tax-exempt bonds in recent years. Table 6 shows the location of these hotels and bond financing details. State and Local Governments Support Gaming, but Extent of Public Financing Is Difficult to Estimate We were unable to determine the number of state-owned gaming support facilities. According to government finance experts, it is common for states to issue large bond issuances for different capital projects. However, data are not available to determine the extent, if any, that these bonds have included facilities for public gaming activities and infrastructure projects that benefit private gaming enterprises. Facilities associated with lotteries are sometimes provided in some government buildings and in convenience stores with lottery ticket terminals. We found the following information on the prevalence of gaming throughout the states. According to states’ financial reports and gaming studies all but 2 states— Hawaii and Utah—have some form of legal gaming. Forty-one states and the District of Columbia reported assets and revenues related to lotteries. Some municipalities have provided tax-exempt and taxable financing to build transportation infrastructure in localities that depend on private gaming enterprises to generate employment and gaming revenues to finance basic government functions. The prevalence of lotteries is one indicator of state and local governments’ support of gaming facilities. Forty-one states and the District of Columbia have lottery systems, with annual operating incomes ranging from $2 million to $2 billion and net assets from lotteries from -$12 million to $290 million. Similar to other facilities, the number of state-owned gaming facilities that have been financed with tax-exempt bonds is difficult to estimate because a single bond issue may finance several capital projects, including lotteries’ offices and equipment. In lieu of or in addition to a state-sponsored lottery, some states allow for legalized private gaming, such as casinos. According to the American Gaming Association, in 2004 16 states had legal operational casinos and some states allowed gambling in the form of pari-mutuel activities, such as horse or greyhound racing, and gaming machines. Seven of these states have also introduced variations in gambling activities, such as racetrack casinos or “racings,” which usually consist of slot machines associated with racetracks. Seven states have video lottery terminals (VLT), which are similar to slot machines. State and local governments can issue tax-exempt bonds to finance the infrastructure that directly benefits private casinos or gaming facilities. We found three examples of tax-exempt financing related to gaming facilities. New Jersey’s Casino Reinvestment Development Authority (CRDA) relies on tax-exempt borrowings, casino parking fees, and investments to finance eligible projects. In 2004 CRDA issued $93 million in tax-exempt hotel room fee revenue bonds to finance Atlantic City casino expansion projects and provide funds to the New Jersey Sports and Exhibition Authority for horse racing purse enhancements. Another example of tax-exempt financing that benefits private casinos is the monorail in Las Vegas. The monorail was financed with a combination of tax-exempt and equity funds and provides seven stations - MGM Grand, Bally’s/Paris, Flamingo, Harrah’s/Imperial Palace, Las Vegas Convention Center, Las Vegas Hilton, and the Sahara. In 2005, California’s Del Mar Race Track Authority sold about $50 million in tax-exempt bonds to refund existing debt and improve facilities at the horseracing track. In addition to concessions and racetrack revenues, the bonds will also be backed by satellite-wagering receipts. As agreed with your office, unless you publicly release its contents earlier, we plan no further distribution of this report until 30 days from its date. At that time, we will send copies to interested congressional committees, the Secretary of the Treasury, the Commissioner of the Internal Revenue Service, and other interested parties. We will also make copies available to others upon request. The report will also be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-9110 or brostekm@gao.gov. Contact points for our Office of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix II. Appendix I: Objective, Scope, and Methodology The objective of this report was to provide information on state and local governments’ financing, construction, and operation of the following eight types of facilities: 3. Parking garages and parking lots 4. Community recreational facilities 7. Hotel and tourist accommodations 8. State-owned gaming support facilities We performed an extensive review of possible data sources and did not find a comprehensive, reliable source of data for the above facilities. We provide instead limited data on the number and amount of financings of broader categories of facilities, describe tax-exempt financings of selected state and local governments, and provide other available indicators of public support. The following provides detailed descriptions of the data sources, limitations of the data sources we used, and the links between the information and the eight facilities in the original request. Rental Housing We used a recognized source for bond information, Thomson Financial data contained in the Bond Buyer Yearbooks to provide details on the bond issuances for single- and multifamily housing according to the category provided in the yearbooks as a related category to rental housing. This data source provides 2000-2004 aggregate values and the number of bonds issued. However, there are a number of limitations to these data. The category for multi-family housing could contain more than just rental housing, although bond experts have suggested that is unlikely. Because municipalities can issue large combined bond issuances some bond issues related to housing or rental housing could be contained in other categories, thus the information provided relies on the categorization of bond issues in the categories listed. The breakdown of bond issuances did not allow us to determine the amount of multifamily housing issuances that were tax-exempt, only the amount of total housing issuances that are tax-exempt for the years covered. This data source only provides information on a particular method of housing finance and therefore does not provide information on the total government rental housing expenditures; the number of rental housing units constructed, financed, or owned by state and local governments; or other forms of government financing for rental housing. However, the magnitude of debt financing on multifamily housing is suggestive of government provision of rental housing. Furthermore, we do not address the ultimate purpose of the housing projects financed by state and local governments, although bond experts stated these were almost always designed to provide affordable housing to lower-income individuals. Road Infrastructure As with the rental housing category we used Thomson Financial data contained in the Bond Buyer Yearbooks to provide details on the bond issuances for a variety of transportation categories, including toll roads and highways, bridges, and tunnels, according to the category provided in the yearbooks as a related category to road infrastructure. This data source provides 2000-2004 aggregate values and the number of bonds issued. However, there are a number of limitations to these data. Because municipalities can issue large combined bond issuances some bond issues related to road infrastructure, such as capital, could be contained in other categories—for example, economic development—and thus the information provided relies on the categorization of bond issues. The breakdown of bond issuances did not allow us to determine the amount of toll road and highway issuances that were tax-exempt, only the amount of total transportation issuances that are tax-exempt for the years covered. This data source only provides information on a particular method of transportation finance and therefore does not provide information on total government transportation expenditures; the number of transportation facilities constructed, financed, or owned by state and local governments; or other forms of government financing for transportation. Particularly with transportation finance, state and local governments rely on other financing methods, including general funds and tolls. Furthermore, we do not address the ultimate purpose of the transportation projects financed by state and local governments or where they are constructed. Parking Garages and Parking Lots We used three main sources to provide information addressing state and local governments’ construction, operation, and financing of parking garages and parking lots. We use Thomson Financial data on bond issuances, the U.S. Census Bureau’s (Census) 2002 U.S. Census of Governments user charges, and selected comprehensive annual financial reports to provide some case studies. We used Thomson Financial data, contained in the Bond Buyer Yearbooks, to provide details on the bond issuances for parking facilities according to the category provided in the yearbooks as a related category to parking garages and lots. This data source provides 2000-2004 aggregate values and the number of bonds issued. However, there are a number of limitations to these data. Because municipalities can issue large combined bond issuances some bond issues related to parking garages and lots could be contained in other categories, such as economic development, thus the information provided relies on the categorization of bond issues. The breakdown of bond issuances did not allow us to determine the amount of parking facilities issuances that were tax-exempt, only the amount of total transportation issuances that are tax-exempt for the years covered. This data source only provides information on a particular method of parking facilities financing and therefore does not provide information on total government parking expenditures; the number of parking facilities constructed, financed, or owned by state and local governments; or other forms of government financing for parking. Furthermore, we do not address the ultimate purpose or location of the parking facilities financed by bond issuances. We used the 2002 Census of Governments to provide user charges for parking facilities for the top 171 metropolitan statistical areas (MSA). There are some limitations to the use of these charges. User charges received by municipalities for parking do not provide any information on the number of existing facilities or the number of parking facilities constructed or financed by state and local governments. Since the data rely on user charges this source may not be representative of total parking provide nationally, as it would not include free public parking. We also do not provide total public expenditures on parking facilities. There are also some limitations in the definition of the parking facilities category. The Census category defines parking as the “provision, construction, maintenance, and operation of local government public parking facilities operated on a commercial basis.” These facilities include parking meters, on-street parking, and parking lots, but exclude parking facilities for the exclusive use of government employees and parking areas connected to specific types of facilities, such as those for a public sports stadium, which are reported with the function of the facility involved, such as parks and recreation. The user charges, therefore, represent revenue from on-street and off-street parking meters and charges and rentals from locally owned parking lots or public garages. Lastly, we used the selected state and local government financial reports of cities and counties located in large MSAs that contained detailed information to provide specific examples of parking facilities that have been financed by state or local governments. As these are examples they cannot be generalized to state and local financing, construction, and operation of parking facilities. Community Recreational Facilities We used the 2002 Census of Governments to provide user charges for parks and recreation facilities for the largest 171 MSAs. Community recreation facilities easily overlap into a numerous other categories, and we did not identify any data that specifically focused on this category. There are some limitations with the use of user charges. User charges received by municipalities for parks and recreation do not provide any information on the number of existing facilities or the number of parks and recreational facilities constructed or financed by state and local governments. Since the data rely on user charges this source may not be representative of the total park and recreational facilities provided nationally, as it would not include free facilities. We also do not provide total public expenditures on parking facilities. There are also some limitations in the definition of the park and recreational facilities category. The census category defines park and recreational facilities as the “provision and support of recreational and cultural-scientific facilities maintained for the benefit of residents and visitors.” This category includes a variety of facilities, such as golf courses, public beaches, swimming pools, parks, camping areas, recreational piers and marinas, but excludes any recreational facilities operated as part of a school system and marinas for commerce. It would also include support of private facilities; galleries, museums, zoos, and botanical gardens; auditoriums, stadiums, recreational centers, convention centers, and exhibition halls; community music and drama facilities; and celebrations, including those in public support of cultural activities. User charges represent revenue of facilities operated by a government; auxiliary facilities in public recreation areas (refreshment stands, gift shops, etc.); lease or use fees from stadiums, auditoriums, and community and convention centers; and rentals from concessions at such facilities. Golf Courses We used data from the National Golf Foundation to provide details on the number and form of municipal golf courses in the United States. As verification, we interviewed those who maintain the database about their methodology for building and maintaining the database. A foundation representative considered the database to be largely comprehensive, as the foundation has measures in place to ensure its list includes all golf courses, and did not express any concerns regarding the reliability of the data. This data source did limit the type of information we could provide. Data were not available on the public financing of golf courses, via tax-exempt bonds or other methods, or on any aid provided by state and local governments to privately owned public golf courses. While the database may be largely comprehensive, at any one time it may not include every single golf course in the United States. Since municipalities can engage in a variety of joint public and private golf courses establishments, the data may not be representative of the total number of golf courses constructed or originally financed by state and local governments. We also used data on high-end golf courses provided by Akin Gump Strauss Hauer & Feld LLP to provide estimates of the number of golf courses financed with tax-exempt bonds. As verification, we interviewed the official providing the data about the methodology for determining the tax-exempt financing and golf course listings. Conference Centers We used two sources of data to provide information on the financing and ownership of convention centers: bond issuance data and data on the number of government-owned convention centers. We used Thomson Financial data contained in the Bond Buyer Yearbooks to provide details on the bond issuances for a variety of public facility categories, including convention centers; parks, zoos, and beaches; and other recreation, according to the categories provided in the yearbooks as related to conference centers. This data source provides 2000-2004 aggregate values and the number of bonds issued. However, there are a number of limitations to these data. Because municipalities can issue large combined bond issuances some bond issues related to convention centers, could be contained in other categories, such as economic development, thus the information provided relies on the categorization of bond issues into the categories. The breakdown of bond issuances did not allow us to determine the amount of convention center issuances that were tax- exempt, only the amount of total transportation issuances that are tax- exempt for the years covered. This data source only provides information on a particular method of public facilities financing and therefore does not provide information on total government public facilities, and thus convention center, expenditures; the number of public facilities constructed, financed, or owned by state and local governments; or other forms of government financing for public facilities. Furthermore, we do not address the ultimate purpose of the public facilities projects financed by state and local governments or where they are constructed. However, bond experts have stated that state and local governments finance convention centers to attract outside revenue and stimulate economic development through tourism. We also relied on a list of government-owned convention centers provided by Akin Gump Strauss Hauer & Feld LLP. We use this list as an estimation of the number of government owned convention or civic centers. As verification, we interviewed the responsible contact about the methodology and obtained financing data on selected observations using comprehensive annual financial reports (CAFR). Hotels and Tourist Accommodations We used four separate data sources to provide a combined listing of the number of hotels financed by tax-exempt bonds that have been identified by experts in the field of government finance. The individual lists came from Orrick, Herrington & Sutcliffe LLP; HVS International; Piper Jaffray; and Akin Gump Strauss Hauer & Feld LLP. Each of these data sources provided a listing of hotels financed with tax-exempt bonds along with estimates of the amount of financing. Because these lists were produced at different times and multiple bonds can be issued for single projects, the estimates of facilities from these lists may not represent all facilities financed with tax-exempt bonds or include all the bond issuances prior or since the date the data source. As verification, we conducted interviews to assess the methodologies for determining the lists and provide a list of hotels and their financing structure, which we determined from looking at selected government financial reports. The combined estimate from the lists may also not represent every hotel that has been financed in part or whole by state and local governments, but rather provide the number of identified hotels financed with tax-exempt bonds. State-owned Gaming Support Facilities We used three sources of data to provide limited information on state and local governments’ support of gaming facilities: state lottery data, survey data on private casino gaming, and specific examples of government aid in connection with private gaming. We used financial data on lotteries from state CAFRs to provide the number of states with lotteries and the capital assets for those lotteries. We use the level of capital assets for state lotteries as an indication of the financing of state-owned gaming facilities. However, there are a number of limitations to these data. The asset data do not provide information on other state-owned gaming facilities. Because government facilities may have multiple uses the asset figures may not represent the actual portion of assets devoted to lottery use. These data may also not include all forms of state-owned gaming facility assets, such as state gaming terminals. We used information from the American Gaming Association’s 2005 Survey of the States to provide contextual information on the number of states with legalized gaming. As verification we reviewed data from the source listed in the survey for selected states. The survey data also provide the number of states with publicly run video lottery terminals (VLT) at racetrack casinos. This data source does not provide any information on state and local expenditures related to either the public VLTs or private gaming facilities or the number of state-owned gaming support facilities. We used gaming articles identified through the literature searches on the Internet and in finance and bond journals and testimony from bond finance experts including officials from the Government Finance Officers Association, and the Bond Market Association, to elaborate on examples of states’ financing of projects directly related to or aiding private gaming. As these data provide examples they cannot be generalized to total state and local aid to private gaming. We conducted our work from February 2006 through August 2006 in accordance with generally accepted government auditing standards. Appendix II: GAO Contact and Staff Acknowledgments Acknowledgements In addition to the contact named above, Jose Oyola, Assistant Director; Robert Dinkelmeyer; Jennifer Gravelle; Cheryl Peterson; and Walter Vance made key contributions to this report.

Unlike state and local governments, Indian tribal governments are in general restricted to using tax-exempt bonds for activities that are an "essential government function," where "essential government function" does not include functions not customarily performed by state and local governments. This restriction has been difficult to enforce by the Internal Revenue Service (IRS) and increased the tax compliance burden on Indian tribal governments. GAO was asked for information on the number of facilities that state and local governments finance, construct, and operate in eight categories: (1) Rental housing, (2) Road infrastructure, (3) Parking garages and lots, (4) Community recreational facilities, (5) Golf courses, (6) Conference centers, (7) Hotel and tourist accommodations, and (8) State-owned gaming support facilities. GAO did not find a comprehensive, reliable source of the number of facilities. Instead, GAO searched and found a variety of public and private sources that had limited information on the amounts of financing provided by state and local governments in related categories. Data sources showed state and local governments (municipalities) provided a wide range of financial support in the following types of facilities: (1) Rental housing: From 2000 through 2004 municipalities borrowed, in 2004 dollars, a total of $46.4 billion in 3,557 bond issues for multi-family housing projects. Over the period these borrowings accounted for 33 to 45 percent of debt issued for housing projects. (2) Road transportation: From 2000 through 2004 municipalities borrowed, in 2004 dollars, a total of $61.4 billion in 1,091 issues for toll roads and highways. Over the period these borrowings accounted for 27 to 38 percent of debt issued for transportation facilities. (3) Parking facilities: From 2000 through 2004 municipalities borrowed, in 2004 dollars, a total of $3.5 billion in 220 issues for parking facilities. In addition, about 73 percent of the U.S. population lived in metropolitan statistical areas (MSA) that reported positive user charges for parking facilities. (4) Park and recreation facilities: From 2000 through 2004 municipalities borrowed, in 2004 dollars, a total of $60.9 billion in 3,085 tax-exempt issues to build public facilities, including $0.6 billion in 29 issues for theaters; $6.1 billion in 723 issues for parks, zoos and beaches; $5.3 billion in 119 issues for stadiums and arenas; and $4.6 billion in 420 issues in other recreation facilities. In addition, about 75 percent of the U.S. population lived in MSAs that reported positive user charges for park and recreation facilities. (5)Golf facilities: In 2005 there were about 2,400 municipal golf courses, about 15 percent of total golf courses in the United States. Municipal golf courses exist in all states. At least 120 golf courses in 29 states have been identified as financed, at least in part, with tax-exempt bonds. About 5 percent of municipal golf courses are connected to resorts or real estate developments. (6) Convention centers: Over 300 government owned convention centers have been identified by government finance experts. In addition, from 2000 through 2004 municipalities borrowed, in 2004 dollars, a total of $11.1 billion in 236 issues related to convention centers. (7) Hotels: GAO identified 12 hotel projects related to convention centers or airports that were financed with tax-exempt bonds in recent years and additional data sources identify 39 tax-exempt financed hotel projects. (8) Gaming support facilities: According to financial and gaming reports all but 2 states have some form of legal gaming, and 41 states and the District of Columbia providing state lotteries. In addition, tax-exempt financing has been used for capital projects related to the gaming industry.

Background The Arizona-Mexico border extends about 370 miles, accounting for almost 20 percent of the 2,000-mile U.S.-Mexico border. About 51 percent of the land in the Arizona border region is managed by the federal government, primarily by the Forest Service within the Department of Agriculture, four agencies within the Department of the Interior—the Bureau of Indian Affairs (BIA), Bureau of Land Management (BLM), Fish and Wildlife Service (FWS), and National Park Service (NPS)—and the Department of Defense (DOD). The remainder of the land is local or private (21 percent), state-managed (16 percent), or tribal (12 percent). Figure 1 shows the areas managed by these various entities. Each federal agency that manages land within the border region has a distinct mission and set of responsibilities, which may include managing the land for multiple uses, such as recreation; conserving natural and historic resources; conserving and enhancing fish, wildlife, plants, and their habitats; and providing rangeland for grazing. Federal agency responsibilities for land units in the Arizona border region include the following:  The Forest Service manages the Coronado National Forest, which covers almost 1.8 million acres of southeastern Arizona and New Mexico and ranges in elevations from 3,000 feet to over 10,000 feet. In addition to the preservation of natural resources, the forest is used for recreational purposes and ranchers use some of the forest for grazing. In October 2010, we reported that more illegal border crossers migrate through the Coronado National Forest than any other federal land unit along the southwestern border. The Forest Service has reported that the number of illegal border crossers traveling in the area threatens natural resources and creates a dangerous environment for the public and for Forest Service employees.  BIA provides services to several Indian tribes, including the Tohono O’odham Nation, Colorado River Nation, Fort Yuma-Quechan Nation, Ak-Chin Tribal Community, and Gila River Indian Community within the Arizona border region. The Tohono O’odham Nation, the largest Indian tribe within the Arizona border region, covers about 2.9 million acres, an area approximately the size of Connecticut. Tohono O’odham officials have previously reported that illegal border crossers cause significant damage to their lands.  BLM manages numerous public lands in the border region, including the nearly half-million-acre Sonoran Desert National Monument, San Pedro National Conservation Area, and Ironwood Forest National Monument. BLM lands are used for multiple purposes, including recreation, grazing, mining, and wildlife habitat. In our November 2010 report, we reported that BLM officials posted warning signs at 11 entrance locations of the Sonoran Desert National Monument to warn the public against travel on portions of the monument because of potential encounters with illegal border crossers.  FWS works to preserve and enhance fish, wildlife, plants, and their habitats in wildlife refuges in the region, including the Buenos Aires, Cabeza Prieta, Imperial, and Kofa National Wildlife Refuges. In December 2010, we reported that the Refuge Manager of Buenos Aires National Wildlife Refuge testified before Congress that illegal border crossers have disturbed wildlife and created more than 1,300 miles of illegal trails, causing the loss of vegetation and severe erosion. In addition, a portion of the refuge adjacent to the border has been closed to the public due to safety concerns caused by illegal border crossers.  NPS is responsible for conserving the scenery, natural and historical objects, and wildlife of the national park system, which includes Coronado National Memorial, Organ Pipe Cactus National Monument, and Saguaro National Park in the Arizona border region. As was the case with the Buenos Aires National Wildlife Refuge, the Organ Pipe Cactus National Monument has previously been closed to the public because of the safety concerns associated with illegal border crossers. Officials at other sites, such as the Fort Bowie National Historic Site, have reported that the cultural and historical integrity of the site has been compromised by illegal border crossers because of the waste they have left in the area—including clothing, cans, water jugs, plastic bags, and human waste.  DOD manages a number of installations and facilities used for testing and training its forces in the region, including Fort Huachuca, the Yuma Proving Grounds, the Barry M. Goldwater Range, and Davis- Monthan Air Force Base. DOD officials told us that training missions at the Barry M. Goldwater Range have been delayed or altered due to the presence of illegal border crossers. Additionally, agents of the U.S. Border Patrol—an office within the Department of Homeland Security (DHS)—patrol federal and nonfederal lands near the border to find and apprehend persons who have illegally crossed the U.S. border. Border Patrol is responsible for controlling and guarding the boundaries and borders of the United States against the illegal entry of people who are not citizens or nationals. Border patrol agents have the authority to search, interrogate, and arrest undocumented aliens and others who are engaging in illegal activities, such as illegal entry and smuggling of people, drugs, or other contraband on federal lands and other areas up to 100 miles from the border. Each of the federal land management agencies also has responsibility to respond to wildland fires on federal lands, while the Arizona State Forestry Division and other entities—including tribal and local fire departments—have primary responsibility for responding to wildland fires on state, local, and private lands. When a wildland fire starts on federal land, federal policy directs federal agencies to consider land management objectives—identified by land and fire management plans developed by each land management unit—and the structures and resources at risk when determining whether and how to suppress it. Historically, the Forest Service and the Interior agencies attempted to suppress all wildland fires quickly because of their potentially damaging effects on local economies and natural environments; in recent decades, however, the agencies fundamentally reassessed their understanding of naturally occurring wildland fire’s role on the landscape, and they began to see more benefits from these wildland fires. For instance, fire can limit the spread of insects and diseases, reduce brush and weeds, and return the nutrients to the soil, where they help produce a new generation of plants. For ranchers whose cattle are dependent on the new generation of plants, fire can burn unwanted brush and allow grasses to flourish in future years. If agencies determine that a naturally ignited wildland fire can promote land management objectives, they may use less aggressive fire suppression strategies that not only can reduce fire suppression costs in some cases but can also be safer for firefighters by reducing their exposure to unnecessary risks. In contrast, interagency policy calls for these agencies to initiate suppression activities immediately for all human-caused wildland fires. Fire suppression efforts are mobilized through an interagency incident management system, which depends on the close cooperation and coordination of federal, state, tribal, and local fire protection entities. Fighting wildland fires—which can burn across federal, state, and local jurisdictions—can require investments of personnel, aircraft, equipment, and supplies and can result in substantial fire suppression expenditures. To document fire occurrence, fire personnel prepare a fire incident report, and the information from these reports populates the agencies’ fire data management systems. The information collected in these reports includes basic data such as date the fire started, location, general cause (natural or human), number of acres burned, and the date the fire was extinguished. Firefighters can also include narrative information in these reports, such as information about suppression activities or fire cause. Number, Cause, Size, and Location of Wildland Fires in the Arizona Border Region From 2006 through 2010, at least 2,467 wildland fires occurred in the Arizona border region. Most of these fires were caused by human activity, burned less than 1 acre each, and were ignited on federal or tribal land. Federal and state agencies determined that 2,126 of these fires, or about 86 percent, were caused by human activities (see fig. 2). This percentage is consistent with the national average for wildland fires caused by human activities; according to NIFC data, about 87 percent of all wildland fires that occurred nationally from 2006 through 2010 were caused by human activities. Most of the human-caused wildland fires—1,364, or 64 percent—burned less than 1 acre of land each; 508 fires burned from 1 to 10 acres each; and 241 fires were significant, burning 10 or more acres each. These 241 significant human-caused wildland fires burned a total of more than 123,000 acres, which accounts for about 99 percent of all acres burned during this time by human-caused wildland fire in the region; the largest of these wildland fires—the 2009 Elkhorn Fire—burned more than 23,000 acres. See figure 3 for the location of significant human-caused wildland fires during this period. The 2011 Horseshoe Two and Monument fires, which occurred after the period for which we analyzed data, were much larger than any of the fires that occurred from 2006 through 2010. Based on preliminary information, federal agencies reported that these two fires burned more than 250,000 acres—more than twice the cumulative total of all significant human-caused wildland fires in the area during the previous 5 years. Of the 341 fires that federal and state agencies determined to be natural ignitions—caused by lightning—156, or 46 percent, burned less than 1 acre each; 87 burned from 1 to 10 acres each; and 98 fires were significant, burning 10 acres or more. Naturally ignited wildland fires burned nearly 74,000 acres, although agency officials explained that some of these fires were allowed to burn (i.e., they were not suppressed by firefighters) for ecological and resource management purposes. Of the 2,467 wildland fires included in our review, the majority of the fires—1,553, or 63 percent—were ignited on federal or tribal lands. The remaining fires were ignited on state, local, or private lands (see table 1). The Economic and Environmental Effects of Significant Wildland Fires in the Arizona Border Region Are Not Fully Known Significant human-caused wildland fires in the Arizona border region have resulted in a number of economic and environmental impacts. Economic impacts include millions of dollars in fire suppression costs, destruction of homes and ranching operations, and impacts on regional tourism. Environmental impacts include damaged habitat for endangered species and expansion of nonnative plants in the region. However, it is not possible to fully quantify the effects of these fires on the region’s economy or environment because complete information needed for such analyses is not available. Significant Human-Caused Wildland Fires Have Resulted in Various Economic Impacts, but the Full Impact on the Region Is Unknown Significant human-caused wildland fires in the Arizona border region have had various economic impacts. These impacts include (1) the costs associated with suppressing wildland fires; (2) the destruction of property, including homes and ranching infrastructure; and (3) impacts on tourism. While we were able to identify specific examples of these fires’ impacts on the area’s economy, we could not determine the overall impact of these fires on local economies because complete information is not available that would allow such an analysis. Fire suppression costs. In response to significant human-caused wildland fires that occurred from 2006 through 2010 in the Arizona border region, federal land management agencies obligated more than $33 million for suppression activities, and the state of Arizona obligated almost $2 million. Forest Service suppression obligations accounted for more than $26 million, or about 80 percent of all federal obligations to suppress these fires. The amount of funding obligated for individual significant human-caused wildland fires varied widely. For a majority of these fires, federal and state agencies obligated less than $25,000 per fire. Conversely, for 23 fires, or about 10 percent, agencies obligated more than $250,000 each, with the 2010 Horseshoe Fire, which burned more than 3,400 acres on the Coronado National Forest, accounting for more than $10 million—nearly a third of all federal obligations for significant human-caused wildland fires in the region from 2006 through 2010. Characteristics affecting suppression costs include fire size; fuel types; fire intensity; physical terrain; proximity to the nearest community; total value of structures close to the fire; and special management considerations, such as whether the fire was burning in a wilderness or other designated area. It is also important to note that suppression costs may represent only a fraction of the total true costs for these fires. For example, one study that reviewed six fires of at least 40,000 acres in the western United States found that, in these cases, other costs associated with the fires, such as damage to properties and ecosystems and loss of economic activities, were generally several times higher than suppression costs. Destruction of property and injuries to homeowners. Significant human- caused wildland fires in the region have destroyed houses and other property and injured residents. For example, according to the Forest Service, the 2009 Canelo Fire, which burned over 4,000 acres, destroyed at least three residences, several outbuildings, and numerous vehicles. In addition, one homeowner was seriously burned during that wildland fire and required hospitalization. Similarly, the 2011 Monument Fire destroyed more than 60 homes, according to preliminary agency estimates. Impacts on ranching operations. Significant human-caused wildland fires have also affected ranching operations in the region. Such fires have damaged grazing allotments and related improvements—such as fences, water tanks, and pipelines—located on federal lands and used by private ranchers. The Forest Service reported obligating more than $100,000 in long-term restoration and rehabilitation funds to repair fences, protect watersheds, and clean water tanks on federal grazing allotments damaged by four significant human-caused wildland fires. Additionally, from 2006 through 2010, Forest Service officials told us they provided about $56,000 in fencing and pipeline materials to repair damage on 15 allotments burned by significant human-caused wildland fires. Forest Service officials told us the agency does not always have supplies to provide, however, and generally does not provide labor to repair damage to allotments. As a result, local ranchers can incur costs for labor and materials to repair damage to allotments. One rancher whose federal grazing allotment was burned during the 2009 Hog Fire told us that, although the Forest Service has offered to provide the materials to replace fencing that was burned during the fire, in order to use the allotment again, he would have to spend about $250,000 for labor costs to build the new fence to Forest Service specifications. Additionally, federal agency officials and private ranchers told us that, in some circumstances, ranchers must move their cattle from federal grazing allotments because agencies have determined that the damage to the vegetation on which the cattle feed requires time to recover— typically 1 to 3 years, according to federal officials. As a result of significant human-caused wildland fires from 2006 through 2010, Forest Service officials reported that some cattle were removed from 20 allotments, and grazing schedules were altered for at least an additional 5, to allow vegetation to recover. A Forest Service official told us that the grazing capacity for 17 of these allotments has been reduced by 25 percent because of wildland fires. Additionally, one allotment that covers more than 50,000 acres was affected by 13 significant human-caused wildland fires from 2006 through 2010, according to federal agency officials, resulting in the repeated removal of cattle from the allotment and an altering of grazing schedules. According to industry representatives and private ranchers, moving cattle from an allotment negatively affects ranchers because they must either find alternative locations to graze their cattle or purchase additional feed. Further, private ranchers stated that the value of their cattle can potentially decrease as a result of the stresses to the animals associated with the fires and transfers between allotments. Impacts on tourism. Significant human-caused wildland fires can also affect tourism. According to a representative from the Cochise College Center for Economic Research, as well as local residents that we spoke with, fires can affect tourism because access to trails, campgrounds, and roads can be temporarily restricted and, more broadly, fires can diminish the appeal of the region for tourists. For example, local residents told us that hospitality businesses in Portal, Arizona, have been particularly vulnerable to the economic impacts of wildland fires because these businesses are dependent on visitors to the Coronado National Forest. If access to the forest is restricted, as it was in 2010 as a result of the Horseshoe Fire, these residents told us it can have a direct impact on local businesses. While the preceding examples provide some understanding of the nature of the economic impacts of significant human-caused wildland fires in the Arizona border region, we could not quantify the overall effect of these fires on the region because comprehensive and consistent data are not available. For example, we found no data that would allow us to determine the extent to which the closures of national forests and other public lands have affected tourism in the region, and we likewise did not find data that would allow us to identify the cumulative impact of significant human-caused wildland fires on tourist-related businesses. Moreover, the economic researcher from the Cochise College Center for Economic Research noted that it is difficult to assess the overall economic impact of such incidents because the Arizona border region is rich in ecotourism resources. As a result, it is possible that visitors who could not visit a specific location may have still visited the region, simply choosing to visit other local areas. Additionally, as noted in one study we reviewed, identifying the real cost of wildland fires on the economy is difficult because few data sources are consistent from fire to fire, and many lack any data at all. According to this study, the effects resulting from individual fires are unique to each fire and cannot be generally extrapolated to other fires. The representative we spoke to from the Cochise College Center for Economic Research also noted that the economic effects of wildland fire can be mixed and, therefore, difficult to delineate. For example, while wildland fires can provide a temporary boost to several industries in the region—such as construction and retail and restaurant sales—that boost could be offset by increases in home insurance premiums in the area and lost revenue and wages from other displaced businesses or workers. Significant Human-Caused Wildland Fires Have Damaged the Environment, but the Full Extent Is Unknown Significant human-caused wildland fires have damaged the natural environment in the Arizona border region, but the comprehensive effects are unknown, in part because—as with the economic effects of wildland fires—complete information is not available on the environmental effects of wildland fire. According to our analysis of federal emergency treatment plans and discussions with federal agency and tribal officials, the most common environmental effects of wildland fire in the region are expansion of nonnative plant species, degraded endangered species habitat, and soil erosion. These effects may result from both significant human-caused wildland fires and other fires. The following are descriptions of these environmental effects and examples of the effects that have been noted from individual instances of significant human-caused wildland fires in the region. Expansion of nonnative plant species. Plant species that are not native to southern Arizona, such as buffelgrass and tamarisk––commonly known as salt cedar––can regenerate more quickly following wildland fires than native species and may displace such species from their traditional ranges. The expansion of these species can also alter natural fire patterns by making areas susceptible to burning with more severity or frequency than they traditionally would. For example, the 2009 Powers Fire, a human-caused wildland fire that burned 260 acres, destroyed native vegetation such as cottonwood and willows along the Gila River. As a result, BLM predicts that nonnative salt cedar will increase in density along the river. BLM noted in its postwildfire environmental damage assessment that the increased density of salt cedar will degrade the habitat because salt cedar actively resprouts after wildland fires and can create enough fuel to burn again within 5 years. Damage to endangered species habitat. Southern Arizona is home to a number of federally listed threatened and endangered plant and animal species. Some wildland fires can damage the habitats of these species and, in turn, threaten their continued existence. For example, the 2007 San Luis Fire—a human-caused wildland fire that burned 68 acres of mostly BLM land—damaged riparian areas that are habitat for two bird species federally listed as endangered, the Southwestern Willow Flycatcher and the Yuma Clapper Rail, as well as another that is a candidate for listing, the Yellow-Billed Cuckoo. Increased soil erosion. Soil erosion can also result from wildland fires in the region. During the seasonal “monsoon rains” that Arizona typically experiences in the summer, areas where wildland fires have burned away the vegetation holding soil together may experience increased runoff and mudslides that can damage natural habitats, watersheds, roads, and trails. For example, an official with the Tohono O’odham Nation told us that the nation is concerned about the impact the human-caused 2009 Elkhorn Fire will have on the Kearney’s Blue Star, which is an endangered plant species. The fire itself did not damage the plant’s population, but as a result of the fire, water runoff and soil erosion are expected to increase, which would threaten the plant’s population at lower elevations. To mitigate such impacts on federal lands in the region, from 2006 through 2010, federal agencies obligated nearly $1.9 million through the Burned Area Emergency Response program—a federal program that provides funds to stabilize and prevent degradation to natural and cultural resources resulting from the effects of wildland fires. Agencies prioritize and fund emergency treatments based on risks identified in damage assessments. According to Forest Service guidance, Burned Area Emergency Response program assessments should be conducted for fires that burn more than 300 acres, though damage from smaller fires can be assessed if federal land management agency officials believe that life, property, or damage to natural or cultural resources are at risk. From 2006 through 2010, federal agencies assessed damage from 20 significant human-caused wildland fires in the Arizona border region for emergency treatment funding under this program. Based on these assessments, federal officials recommended that funds be used to provide emergency treatment in response to damage from 9 of these fires and approved at least partial funding for 7 of these fires. For 10 of the 11 assessed fires for which they did not recommend emergency treatment funding, officials believed that the damaged areas would recover naturally in 5 years or less without any treatment program. The above examples provide some understanding of the types of environmental effects of significant human caused wildland fires in the Arizona border region, but we were unable to quantify the full environmental impacts for the region because comprehensive information is not available. For example, according to federal agency officials, the amount of funding provided through the Burned Area Emergency Response program reflects only a portion of the total monetary value of the environmental damages resulting from significant human-caused wildland fires, in part because not all such fires receive funding under the program. In addition, federal officials told us that many of the significant human-caused wildland fires that have occurred in the Arizona border region have likely resulted in at least some environmental damage, but these effects are generally not formally documented or recorded by federal agencies, and often it is many years before the extent of the damage is fully evident. Similarly, state agencies such as the Arizona State Forestry Division and the Arizona State Land Department could not provide us with data regarding the environmental consequences of significant human-caused wildland fires that occurred on state lands because, according to state officials, they do not maintain such data. Federal Agencies Did Not Conduct Investigations of All Human-Caused Wildland Fires and Thus Cannot Determine the Number Ignited by Illegal Border Crossers The frequency with which illegal border crossers have caused wildland fires on federal lands in the Arizona border region is not fully known, in part because federal land management agencies did not conduct investigations of all human-caused wildland fires that occurred on their lands as called for by interagency policy. Further, the fires that were investigated—about 18 percent of the fires we examined (77 of 422 fires)—were selected for investigation based primarily on the availability of fire investigators, according to agency officials, rather than on the specific characteristics of the fires, such as their size or location. Without more information on the specific causes of these fires, the agencies lack key data that could help them target their fire prevention efforts. Federal Agencies Did Not Conduct Investigations of All Human-Caused Wildland Fires As Called for by Interagency Policy Federal agencies cannot identify all of the human-caused wildland fires that were ignited by illegal border crossers on federal lands, in part because they did not conduct the investigations called for by interagency policy. This policy—Interagency Standards for Fire and Fire Aviation Operations, which applies to the Forest Service, BLM, FWS, and NPS— calls for these agencies to determine the general cause—human or natural—for all wildland fires on federal lands they manage. If a wildland fire is determined to be human-caused, the interagency policy calls for a more in-depth investigation to be conducted, typically by personnel trained to conduct fire cause investigations. Similarly, the Wildland Fire and Aviation Program Management Operations Guide, which applies to BIA, also calls for thorough cause investigations for all wildland fires suspected to be human caused. There were 422 human-caused wildland fires that burned 1 or more acres on federal or tribal lands between 2006 and 2010. Of these, federal fire investigators conducted investigations for 77—or about 18 percent. Table 2 and figure 4 provide additional information on the fires investigated. Officials from the Forest Service, BIA, BLM, and FWS told us that the primary reason that many human-caused wildland fires were not investigated was because the agencies lacked available trained fire investigators. For example, both BLM and Forest Service officials told us the agency’s law enforcement officers, who are trained to conduct such investigations, do not have the time to investigate all human-caused wildland fires because of other responsibilities, such as providing security for firefighters and their equipment. Similarly, an official from the Tohono O’odham Nation stated that, although he believes it is important to determine the cause of these fires, the nation’s fire management program does not have adequate funding to support a wildland fire investigator. This official also stated that he has requested assistance from federal agencies to investigate some fires, but the agencies have been unable to provide such assistance because of other priorities. The lack of fire investigations is not a recent issue. A 1998 Department of the Interior Inspector General report found weaknesses with the agency’s ability to investigate fires, stating that seven of the eight BLM district offices reviewed by the Inspector General did not give sufficient priority to fire investigations and did not adequately document the fire investigations that were completed. Even for those fires that are investigated, federal officials told us a decision on whether to investigate a fire is generally not based on the specific characteristics of the fire, such as its size or location. Rather, they said the decision generally depends on the availability of a trained wildland fire investigator at the time of the fire. Although it appears the agencies have concluded they cannot investigate all fires because they do not have sufficient resources, they have not developed a strategy for determining which fires to investigate. Such a strategy could include specific criteria for identifying which fires to investigate, such as fires that are larger than average, that stand to burn sensitive areas, or that otherwise may have effects that make their origins important to understand. Without such a strategy, the agencies are unable to ensure that those human-caused wildland fires with the greatest effects are consistently investigated. Federal Fire Investigators Identified Illegal Border Crossers as a Suspected Cause of Ignition in 30 of the 77 Fires They Investigated Based on our review of agency investigation reports, illegal border crossers were a suspected cause of ignition for 30 of the 77 investigated wildland fires, or about 39 percent. Five of the 30 wildland fires in which illegal border crossers were a suspected cause burned less than 10 acres each, 16 burned from 10 to 100 acres each, and 9 burned more than 100 acres each. These 30 wildland fires were all located within 40 miles of the U.S.-Mexico border and occurred on the Coronado National Forest, Buenos Aires National Wildlife Refuge, or Organ Pipe Cactus National Monument (see fig. 4 for the location of wildland fires that occurred on federal lands and which illegal border crossers were identified as a suspected cause). Investigation reports identified illegal border crossers as a suspected cause of 15 wildland fires that resulted from efforts to signal for help, provide warmth, or cook food. For example, the investigation report for the 2006 Black Mesa Fire, which burned about 170 acres, states that the wildland fire was ignited because a border crosser was injured and needed assistance. According to the report, a group of about 20 individuals crossed illegally into the United States and, during the trip, one person was injured and could not continue. The group continued without the injured person, but first started a fire to keep animals away and to attract attention in the hope that someone would rescue the injured person. In another instance— the 2009 Bear Fire, which burned 15 acres—the investigation report states that a campfire was the probable cause, noting several indicators regarding a potential source of ignition: (1) discarded bottles and food wrappers with Spanish language labels were found in the area of origin; (2) the area is frequented by illegal border crossers and is adjacent to a heavily used smuggling trail; and (3) the fire was ignited at a time when illegal border crossers are often known to travel. The investigation reports for the remaining 15 wildland fires suspected to be ignited by illegal border crossers did not explicitly indicate a purpose for the ignition, though a couple of investigation reports for these fires noted that the area of ignition is known for drug smuggling. For instance, the investigation report for the 2010 Horseshoe Fire, which burned about 3,400 acres, stated that evidence found during the investigation suggests that drug smugglers were in the area of ignition. For the other investigated human-caused wildland fires that were not linked to illegal border crossers, federal agency investigation reports identified a number of other potential human causes that could have caused the ignition, and in some cases the investigation reports did not identify any specific cause. Examples from investigation reports include the following:  Resident campfires were a suspected source of 13 wildland fires, including the 2009 Carr Link Fire, where a visitor to the Coronado National Forest was suspected of leaving a campsite for a day hike without properly extinguishing the campfire.  Other activities such as recreational shooting, welding accidents, sparks from all-terrain vehicles, and fireworks were a suspected source of 25 fires, such as the 2009 Mile Post 6 Fire on the Coronado National Forest, where target shooters shot rocks and sparks from the bullets ignited dry grass; and the 2007 San Antonio Fire, where a resident accidentally ignited the fire while welding. Investigation reports indicate that investigators could not determine a cause or did not document a suspected cause for 17 fires. These wildland fires ranged in size from 1 acre to 5,070 acres. To obtain additional information on possible causes of wildland fires, we also reviewed fire incident reports for the 1,123 human-caused wildland fires that occurred on federal and tribal land in the region from 2006 through 2010. Fire incident reports are distinct from investigation reports in that they are completed for each wildland fire and contain overall information on the fires’ size, location, and general cause, but they are not formal investigations into the fire’s origin. In addition to collecting general fire information, these incident reports allow firefighters to include comments regarding their views on the fires’ causes—although such comments are not mandatory and firefighters completing the fire incident reports often choose not to include this kind of information. Of the fire incident reports we reviewed, 57 included firefighter comments noting illegal border crossers as a suspected cause of the fire. Most of these (32 of the 57) were for wildland fires that occurred on the Tohono O’odham tribal land. According to a tribal official, illegal border crossers are a significant cause of wildland fires on tribal land and the purpose of the fires is usually to signal for assistance, cook food, or to provide warmth. Appendix III includes additional information about the fire incident reports we reviewed and a map identifying the location of the 57 wildland fires. Without Comprehensive Fire Investigation Results, Federal Agencies Lack Key Data Needed to Target Their Fire Prevention Efforts Without complete data on the cause of wildland fires on the lands that they manage, federal agencies are hampered in their ability to target their efforts and resources at preventing future wildland fires. According to interagency guidance, the Wildfire Origin and Cause Determination Handbook, identifying trends in fire causes is critical to the success of fire prevention programs, and the results of fire investigations can assist in policy development. Similarly, a Forest Service document states that the first step in the prevention of human-caused wildland fires is to determine the group most likely to start fires. However, in reviewing several agency fire prevention plans for the region, we found that they included only broad wildland fire awareness programs and activities but did not identify specific trends or discuss groups likely to start fires or discuss the possible role of illegal border crossers in contributing to fires in the region. Without either additional data on the ignition source of fires in the Arizona border region or a systematic process for using the information identified in investigation reports, it will be difficult for the land management agencies to identify more specific wildland fire prevention activities or better target fire prevention efforts and resources. In contrast, the experience of the Cleveland National Forest in California provides an example of the potential benefits of better targeting fire prevention efforts. In 1996, the Forest Service formed the Border Agency Fire Council in Southern California to help identify activities that could prevent future wildland fires. Using data on the cause of wildland fires, the council determined that a number of wildland fires were the result of improperly extinguished campfires left by illegal border crossers. In response, officials from the Cleveland National Forest created a border fire prevention crew that hikes daily on trails known to be used by illegal border crossers and extinguishes abandoned campfires. In 2008 alone, the forest reported that the fire prevention crew extinguished 101 abandoned campfires that, had they not been suppressed, could have grown into larger and more damaging wildland fires. This example demonstrates that with better information about the specific ignition source of human-caused wildland fires, the agencies could be better equipped to take actions that may prevent future wildland fires. The Presence of Illegal Border Crossers Has Complicated Fire Suppression Activities, and Agencies’ Responses May Not Fully Address the Issue The presence of illegal border crossers has increased the complexity of fire suppression activities in the border region, according to federal agency officials, because it can endanger firefighters’ safety, complicate the use of radio communications, and limit the use of certain types of fire suppression activities. Agencies have taken a number of actions to mitigate the threats to firefighters in the Arizona border region, but these actions may not be sufficient to ensure that agency resources are being used most effectively, and none of the agencies has developed a risk- based approach for using resources to support fire suppression activities in the region. The Presence of Illegal Border Crossers Has Complicated Wildland Fire Suppression Activities in the Arizona Border Region The presence of illegal border crossers has complicated wildland fire suppression activities in the Arizona border region, according to federal agency officials, largely because of concerns about firefighter safety. In 2006, the Forest Service issued a report stating that the Arizona border region is made more dangerous for firefighters because they may encounter smugglers; high-speed law enforcement pursuits; environments littered with trash and other biological hazards; and illegal border crossers who are seeking food, water, transportation, or rescue. While federal agency officials we interviewed, including fire response and law enforcement officials, did not identify any specific incidents in which firefighters had been assaulted or threatened by illegal border crossers, they identified several aspects of illegal cross-border activity that firefighters must account for while suppressing fires in the region. Firefighters may encounter armed smugglers. Federal agency officials told us that violence could result if firefighters encounter armed smugglers while suppressing fires in remote areas. They did not provide any examples of specific situations in which firefighters had experienced such violent encounters with smugglers; however, officials cited instances in which individuals they believed to be illegal border crossers were encountered during fire suppression activities. The fire investigation report for the recent 2011 Horseshoe Two Fire indicates that drug smugglers continued to use that area even as fire suppression activities were underway. Illegal border crossers may be injured or killed by suppression activities. A number of fire response officials told us that they believe many illegal border crossers generally try to avoid contact with firefighters in the region—which, while reducing concern for firefighters’ safety, raises concerns about the safety of illegal border crossers who could be harmed or killed by fire suppression activities. For example, firefighters sometimes set backfires—the burning of grass, leaves, brush, and other fuels located between an advancing fire and an established control line, such as a road—to halt the spread of wildland fires. Given the concern about the possible presence of illegal border crossers in the Arizona border region, firefighters—or, in some cases, U.S. Border Patrol agents—will, in some instances, first conduct a search of an area to attempt to identify whether illegal border crossers are in harm’s way before igniting a backfire. This additional step can increase the resources and time needed to suppress the fire. Firefighters may reduce their use of nighttime firefighting activities. The potential presence of illegal border crossers has caused agencies to reduce their use of nighttime fire suppression activities and temporary overnight camps for firefighters because of the perceived threat to firefighters’ safety. As a result, firefighters may have to forgo or delay some firefighting tactics, which in turn may allow fires to grow larger and more damaging. For example, a Forest Service official told us that on the first day of the 2009 Hog Fire, firefighters were unable to set up an overnight camp at the scene of the fire because no law enforcement support was available to provide security. According to this official, this allowed the fire, which had burned 200 to 300 acres at the time, to grow to more than 3,000 acres by the next morning; the fire ultimately burned nearly 17,000 acres and cost more than $700,000 to suppress. Illegal cross-border activity may interfere with radio communications. According to agency officials from several land management agencies, communicating by radio is difficult as a result of illegal cross-border activity in the Arizona border region. For example, according to federal agency and tribal officials, illegal border crossers may use the same radio frequencies as firefighters, causing interference and limiting their ability to safely coordinate fire suppression activities. In one instance, a tribal official told us that the Tohono O’odham Nation’s sole radio repeater— which allows firefighters to communicate over long distances—had its frequency taken over by illegal border crossers and is now unusable to firefighters. The tribal official stated that the lack of access to a repeater limits firefighters’ ability to communicate. We were also told by Forest Service officials that firefighters are instructed not to use radios when they encounter illegal border crossers because illegal border crossers may believe that firefighters are reporting their location to law enforcement and react violently. Volume of air traffic increases the importance of interagency coordination. According to federal and tribal officials, aerial fire suppression activities in the Arizona border region require extra caution because of the high volume of other federal air traffic in the area—particularly DHS aircraft conducting border security operations, such as drug interdiction or search and rescue, and DOD aircraft conducting training flights. According to the officials, both fire suppression and DHS aircraft often operate at low altitude and in the same areas along the border, making the risk of a midair collision higher than in other areas across the country. To enhance safety, they emphasize the importance of coordinating with agency dispatch centers to ensure that airspace is clear of other traffic when conducting aerial fire suppression activities. Firefighters may be distracted by the presence of illegal border crossers. More broadly, officials from several land management agencies told us the potential presence of illegal border crossers is a distraction to firefighters that can result in firefighters focusing more on their own security, or that of illegal border crossers, than on suppressing the fire. In addition, agency officials stated that firefighters have discovered the bodies of illegal border crossers, which further distracts them and affects their morale. Agencies Have Taken Steps to Mitigate Threats to Firefighters in the Arizona Border Region but Do Not Have a Formal Risk-Based Approach for Using Their Resources The Forest Service has taken a number of actions to mitigate the threats to firefighters’ safety in the Arizona border region—which other agencies have generally followed. In 2008, the Forest Service published an instructional DVD to educate federal, state, local, and tribal employees working along the U.S.-Mexico border on safety concerns and work practices that can reduce on-the-job risks. One of the training modules specifically discusses illegal border crossers’ effects on fire suppression activities in the region and special precautions that firefighters should take. The Forest Service also produces and distributes “International Border Watchouts” cards to all firefighters conducting suppression activities on the Coronado National Forest. These cards highlight specific risks that firefighters might face when suppressing fires on the forest and include a map identifying where—based on proximity to the border—they are most likely to encounter these risks. 1. Expect high speed driving and law enforcement pursuits 2. Expect drivers to be distracted 3. All aircraft operations have increased collision risk 4. Radio frequency interference from Mexico likely 5. Radio/cell phone dead spots increase employee risks 6. Cell phone connections to Mexico likely 7. Language barriers increase risk 8. Threats to employees are present 24/7/365 9. You are not clearly identified as F.S. employee 10. Every visitor contact has potential risk 11. Higher occurrence of unexpected visitor encounters 12. Traditional responses may not be appropriate, check your gut 13. Responding to situations inconsistent with assigned authority and training 14. Night operations require special considerations 15. Unattended vehicles will be damaged or stolen 16. Illegal uses in remote areas likely 17. Heightened risk of biological contamination 18. Always know your location and be able to describe it 19. Let others know your expected route and destination (checkin/check-out) The Forest Service has also developed a Border Fire Response Protocol, which recommends that firefighters working in the Arizona border region consider taking certain actions to mitigate the potential risks posed by illegal cross-border activity. One of the recommended actions is for fire responders to request that law enforcement support be dispatched to fires in the region to provide security for firefighters and their equipment. Officials from all five federal land management agencies explained that law enforcement provides security in multiple ways, including providing an armed presence while firefighters are suppressing fires or camping overnight, clearing areas of any illegal border crossers that might be hiding in an area where fire suppression activities—such as backfires— are going to occur, and guarding fire suppression vehicles and equipment to prevent theft. Officials from all of the other federal land management agencies in the region—BIA, BLM, FWS, and NPS—told us they generally follow the Forest Service’s fire response protocol informally but that they have neither formally adopted it nor developed their own guidance to account for the impacts that illegal border crossers have on wildland fire suppression activities in the region. A number of federal officials in the border region from these agencies identified the lack of formal protocols for the four Interior land management agencies as a major concern, in part because without formal policies it is unclear that these agencies will provide the most appropriate and consistent fire response actions for the region. Under the Standards for Internal Control in the Federal Government, agencies are to employ control activities, which are the policies, procedures, techniques, and mechanisms to ensure effective program management and help ensure that actions are taken to avoid risk. In this case, such activities would include protocols for federal land management agencies responding to wildland fires in the region. More broadly, the land management agencies have recognized risks associated with fighting wildland fires in the Arizona border region, but none of the agencies use a risk-based approach for allocating law enforcement resources in support of wildland fire suppression activities specific to the region. Instead, law enforcement is dispatched to most wildland fires whether any specific threats have been identified or not. Both federal fire response and law enforcement officials told us that not all fire suppression activities need security because the threat posed to firefighters by illegal border crossers varies by fire. Further, fire response officials told us that waiting for law enforcement to arrive can delay firefighting efforts; similarly, law enforcement officials told us that being dispatched to all fires regardless of the level of safety concerns has hampered their ability to do other high-priority work, such as conducting drug interdiction or fire investigations. We have previously recommended that, when making decisions about needed law enforcement resources and how to distribute those resources, federal land management agencies should adopt a risk management approach to systematically assess and address threats and vulnerabilities. This recommendation, which the agencies agreed with, noted that, in keeping with the Standards for Internal Control in the Federal Government, such an approach should identify risks, assess their magnitude and likelihood of occurrence, and use information from these assessments in determining the law enforcement resources needed and the best way to distribute those resources. However, such an approach has not been developed or implemented for the Arizona border region. Without a systematic risk-based approach that incorporates a consideration of the threats associated with individual fires, the agencies lack assurance that they are using their limited law enforcement resources in the most efficient manner. Conclusions Federal land management agencies in the Arizona border region face a set of complex and diverse challenges in carrying out their responsibilities, including those posed by illegal border crossers and wildland fires. In general, the agencies are well aware of the threats associated with wildland fire suppression activities in the border region and have taken some steps to address them, such as following the Forest Service’s Border Fire Response Protocol. However, gaps in information and inefficient deployment of limited law enforcement resources create operational challenges limiting the agencies’ ability to fully address the complications they face. The agencies do not have in-depth information about the specific ignition sources of human-caused wildland fires in part because they have not conducted investigations for all human-caused fires—often because of limited resources—as called for by interagency policy. In a time of constrained resources and competing needs, we recognize that investigating all human-caused wildland fires in the Arizona border region may not be feasible. However, the agencies have not developed a strategy for determining which fires to investigate, including specific criteria to help identify and prioritize those fire incidents that should be investigated. Further, agencies do not have a systematic process for using the information identified in the investigations to inform decisions on prevention efforts. Without this information, it will be difficult for agency efforts to target fire prevention activities and resources and potentially reduce the incidence of human-caused wildland fires in the region. Further, the practice of dispatching law enforcement support to most fires, rather than considering the risk or safety concerns associated with individual fires, may delay fire suppression activities and prevent law enforcement from conducting other high-priority work, such as drug interdictions or fire investigations. Without a systematic risk-based approach that incorporates a consideration of the risks associated with individual fires, the agencies lack assurance that they are using their limited law enforcement resources in the most efficient manner. Finally, the Interior agencies have taken an important step by informally following the Border Fire Response Protocol developed by the Forest Service, but without formally adopting the protocol or developing corresponding protocols of their own, they lessen the chances that the procedures in the protocol will be consistently followed. Recommendations for Executive Action We recommend that the following five actions be taken:  To ensure agencies have the data needed to identify wildland fire prevention activities and to ensure resources are effectively targeted, the Secretaries of Agriculture and the Interior should direct the Chief of the Forest Service, the Directors of the Bureau of Land Management, Fish and Wildlife Service, and National Park Service, and the Assistant Secretary for Indian Affairs to take the following actions: (1) re-examine the policy that all human-caused wildland fires be investigated; (2) once the agencies have determined the appropriate level of investigations, develop a strategy for determining which fires to investigate, including specific criteria to help select and prioritize those fire incidents that should be investigated; and (3) develop a systematic process to use the information identified in the investigations to better target fire prevention activities and resources.  To ensure that fire suppression activities are not unnecessarily delayed and that law enforcement resources are efficiently allocated, the Secretaries of Agriculture and the Interior should direct the Chief of the Forest Service and the Directors of the Bureau of Land Management, Fish and Wildlife Service, and National Park Service to develop a coordinated risk-based approach for the region to determine when law enforcement support is warranted for each wildland fire occurrence and adjust their response procedures accordingly. In developing this approach, officials in the region should consult with agencies’ headquarters to ensure consistency in the approaches being developed for the region and for all land management agency units nationwide.  The Secretary of the Interior should direct the Directors of the Bureau of Land Management, Fish and Wildlife Service, and National Park Service, and the Assistant Secretary for Indian Affairs to develop border-specific fire response guidance or review existing guidance to determine whether it is sufficient and, if so, formally adopt it. Agency Comments and Our Evaluation We provided the Departments of Agriculture, Defense, Homeland Security, and the Interior with a draft of this report for their review and comment. In its written comments, the Forest Service, responding on behalf of the Department of Agriculture, agreed with our observations and the two recommendations addressed to the agency. The Forest Service’s comments are reproduced in appendix IV. The Department of the Interior did not provide written comments to include in our report. However, in an e-mail received October 24, 2011, the agency liaison stated that Interior generally concurred with our recommendations and that implementing the recommendations will require consultation with the Department of Agriculture to ensure interagency consistency. Regarding our second recommendation, Interior noted that it disagrees that there is a lack of coordinated risk-based law enforcement support, but concurred that improvements and adjustments can be made. While we are encouraged that Interior acknowledges improvements can be made, based on our observations we continue to believe that the agency does not use a systematic risk-based approach that incorporates a consideration of the risks associated with individual fires when allocating law enforcement resources. Interior also noted that it agrees that coordination and consultation within the region and across the nation for both responses with wildland fire and law enforcement in a refined risk-based approach can ensure that appropriate fire suppression responses are implemented. Interior also provided technical comments in its e-mail response, which we have incorporated as appropriate. In its written comments, the Department of Homeland Security agreed with our observations about the complex and diverse challenges that federal land management agencies face in the Arizona border region. The department’s comments are reproduced in appendix V. The Department of Defense did not provide written or technical comments in response to our report. As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the Secretaries of Agriculture, Defense, Homeland Security, and the Interior; the Chief of the Forest Service; the Assistant Secretary for Indian Affairs; the Directors of the Bureau of Land Management, Fish and Wildlife Service, and National Park Service; appropriate congressional committees; and other interested parties. In addition, the report will be available at no charge on the GAO website at http://www.gao.gov. If you or your staffs have questions about this report, please contact me at (202) 512-3841 or mittala@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix VI. Appendix I: Scope and Methodology The objectives of our review were to determine (1) the number, cause, size, and location of wildland fires in Arizona that occurred within 100 miles of the U.S.-Mexico border from 2006 through 2010; (2) economic and environmental effects of significant human-caused wildland fires (i.e., those fires that burned 10 or more acres); (3) the extent to which federal agencies determined that illegal border crossers were the ignition source of fires on federal lands; and (4) ways, if any, in which the presence of illegal border crossers has affected fire suppression activities in the Arizona border region. To determine the extent of wildland fire occurrence in the Arizona border region, we collected federal and state fire occurrence data from databases at the National Interagency Fire Center (NIFC) for fires that occurred within Arizona during calendar years 2006 through 2010. We obtained data for the Forest Service through its Fire Statistics System, extracting data from this system for all fires that occurred within the Coronado National Forest. We obtained data for the Department of the Interior’s Bureau of Indian Affairs (BIA), Bureau of Land Management (BLM), and National Park Service (NPS) through its Wildland Fire Management Information Database, extracting data for all fires that occurred on Interior land units in Arizona. We obtained data for the Department of the Interior’s Fish and Wildlife Service (FWS) through its Fire Management Information System, extracting data for all fires on the agency’s land units within the Arizona border region. Lastly, we obtained data for lands managed by the state of Arizona, local governments, and private residents through the Fire and Aviation Management Data Warehouse, extracting data for all fires in the state of Arizona. From these data, we geographically located each fire based on latitude and longitude coordinates using geographic mapping software. We filtered the data to include only fires that occurred in Arizona within 100 miles of the U.S.- Mexico border. A number of records in the data set did not include geographic coordinates, preventing us from verifying the location of the fires—and, as a result, these fires are not included in our analysis. For the fires we were able to verify as within the Arizona border region, we then analyzed the data to identify the acreage burned and general cause— human or natural—cited for ignition. We assessed the reliability of the data we used by reviewing information about the underlying database systems and discussing the data with agency officials responsible for managing these databases, and determined that the data were sufficiently reliable for the purposes of presenting acreage burned and general cause of fires occurring during calendar years 2006 through 2010. Because NIFC does not manage the Department of Defense’s (DOD) fire occurrence data, we also obtained information from DOD regarding wildland fire occurrence on its lands in the region and included these data in our overall figures. DOD officials identified and provided data for those fires on DOD-managed lands located within the Arizona border region. In our assessment of the data, we determined that these data were not sufficiently reliable for our purposes of presenting a comprehensive account of fires and acreage burned on DOD lands during calendar years 2006 through 2010. However, we included the information we were provided because they were the only data available. During the course of our review, in 2011, two significant fires occurred in the Arizona border region—the Horseshoe Two and Monument fires. We could not include information on these two fires in our data analysis because at the time of our review, the data from the federal agencies on these fires were not complete and could not be determined as reliable. However, given the significance of these fires, we have included some descriptive and preliminary information about them throughout the report, as appropriate. To determine the economic and environmental effects of significant human-caused wildland fires, we first identified those human-caused fires that burned 10 or more acres (which we consider significant fires for the purposes of this report) using the data collected in the previous objective. We then obtained additional information on these fires from the federal and state land management agencies included in our review. Each agency provided us with the amount of funds obligated to suppress the fires. Because some funding obligations for individual fires occurred over multiple years, we did not adjust these figures for inflation. In addition, the federal land management agencies provided us with data on environmental assessments conducted in response to these fires, as well as data on environmental restoration funds requested or provided in response to significant human-caused wildland fires. (The state of Arizona does not conduct such assessments or provide such funds.) We also identified the grazing allotments on Forest Service lands that were within the Arizona border region and could have been affected by human- caused wildland fires. For these allotments, we requested data from Forest Service’s range management officials for any damages and repairs to these lands as a result of significant human-caused wildland fires. In addition, we reviewed studies conducted by academicians and wildland fire organizations on the economic impact of wildland fires. Our review of the economic impact studies was not comprehensive to include all studies that may exist. Finally, we visited the region and discussed with federal, tribal, and state officials, as well as private industry representatives and private citizens in the ranching community, the economic and environmental damage that has occurred as a result of human-caused wildland fires. To determine the extent to which federal agencies determined that illegal border crossers were the ignition source of wildland fires on federal lands, we reviewed agency documents to identify criteria for conducting investigations into the ignition source of human-caused wildland fires. We then identified all human-caused wildland fires and requested fire investigation reports for each fire from Forest Service and the Interior agencies. Because of extensive resource commitments on the part of the agencies in response to the severe 2011 wildland fire season in Arizona and the amount of resources needed to provide us with investigation reports, we limited our request to investigation reports for human-caused wildland fires burning at least 1 acre, which cumulatively comprised more than 99 percent of the acreage burned by human-caused wildland fires in the region from 2006 through 2010. We reviewed and evaluated the fire investigation reports to determine the extent to which fire investigations were conducted for human-caused wildland fires, and, for those fires for which investigations were conducted, we identified the extent to which officials identified illegal border crossers as the source of ignition. Additionally, we reviewed fire incident reports created by fire response personnel for all human-caused wildland fires to identify the extent to which they cited illegal border crossers as a potential source of ignition. To determine ways in which the presence of illegal border crossers have affected fire response activities in the Arizona border region, we reviewed national and regional land management wildland fire guidance to identify any practices unique to regional land management units developed in response to illegal cross-border activity. We also identified and reviewed training materials and other documentation, such as the Forest Service’s Working Along the United States-Mexico Border DVD and the Coronado National Forest’s Border Fire Response Protocol, and interviewed land management, firefighting, and law enforcement officials to further identify specific actions taken in the border region. Further, during our site visits, we discussed with federal and nonfederal officials their experiences fighting wildland fires in the region. We conducted this performance audit from December 2010 to November 2011 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Information on Significant Human-Caused Wildland Fires in the Arizona Border Region, 2006 through 2010 Table 3 shows size, duration, and suppression cost data for all significant human-caused wildland fires in the Arizona border region from 2006 through 2010. Appendix III: Additional Information on Wildland Fires That Federal Agencies Suspect Were Ignited by Illegal Border Crossers Table 4 provides information on those wildland fires in which officials documented through formal fire investigations that illegal border crossers are a suspected cause for the wildland fire. In addition to the formal investigations into ignition sources, fire incident reports—documentation completed by fire responders on the size, location, and general cause of each fire—sometimes contain fire responders’ views on the cause of the wildland fire. Fire incident reports we reviewed noted illegal border crossers as a suspected cause for 57 wildland fires in the region. However, the purpose of these reports is to document general wildland fire occurrence data and the reports are not indicative of a formal investigation into the fire’s origin (see fig. 5 for location of wildland fires). Table 5 provides information on wildland fires in which officials documented through fire incident reports that illegal border crossers are a suspected cause for the wildland fire. Appendix IV: Comments from the U.S. Department of Agriculture Appendix V: Comments from the Department of Homeland Security Appendix VI: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, Steve Gaty, Assistant Director; Mehrzad Nadji; Alison O’Neill; Steven Putansu; Jeanette Soares; Jay Spaan; and Matt Tabbert made significant contributions to this report.

Wildland fires can result from both natural and human causes. Human-caused wildland fires are of particular concern in Arizona--especially within 100 miles of the U.S.-Mexico border because this is a primary area of entry for illegal border crossers and GAO has previously reported that illegal border crossers have been suspected of igniting wildland fires. Over half of the land in the Arizona border region is managed by the federal government--primarily by the Department of Agriculture's Forest Service and four agencies within the Department of the Interior. These agencies collaborate with state, tribal, and local entities to respond to wildland fires. GAO was asked to examine, for the region, the (1) number, cause, size, and location of wildland fires from 2006 through 2010; (2) economic and environmental effects of human-caused wildland fires burning 10 or more acres; (3) extent to which illegal border crossers were the ignition source of wildland fires on federal lands; and (4) ways in which the presence of illegal border crossers has affected fire suppression activities. GAO reviewed interagency policies and procedures; analyzed wildland fire data; and interviewed federal, tribal, state, and local officials, as well as private citizens.. From 2006 through 2010, at least 2,467 wildland fires occurred in the Arizona border region. Of this number, 2,126, or about 86 percent, were caused by human activity. The majority of these fires--1,364--burned less than 1 acre each. About 63 percent or 1,553 of the 2,467 fires were ignited on federally managed land or tribal land. Human-caused wildland fires that burned 10 or more acres had a number of economic and environmental impacts on the Arizona border region, but these impacts cannot be fully quantified because comprehensive data are not available. Specifically, these fires resulted in (1) over $35 million in fire suppression costs by federal and state agencies, (2) destruction of property, (3) impacts on ranching operations, and (4) impacts on tourism. Similarly, these fires had several environmental impacts, such as the expansion of nonnative plant species, degraded endangered species habitat, and soil erosion. However, the full economic and environmental impacts cannot be determined because complete information about these impacts is not available. The total number of fires ignited by illegal border crossers on federal lands in the Arizona border region is not fully known, in part because federal land management agencies have not conducted investigations of all human-caused wildland fires that occurred on these lands, as called for by agency policy, and the agencies do not have a strategy for selecting fires they do investigate. Of the 422 human-caused wildland fires that occurred on Forest Service, Interior, or tribal lands and burned at least 1 acre from 2006 through 2010, only 77 were investigated. According to land management agency officials, the lack of trained fire investigators was the primary reason for the limited number of investigations. Of the investigations conducted, 30 identified illegal border crossers as a suspected source of ignition. Agency policy notes that identifying trends in fire causes is critical to the success of fire prevention programs, but without better data on the specific ignition sources of human-caused wildland fires in the region, the agencies are hampered in their ability to target their efforts to prevent future wildland fires. The presence of illegal border crossers has complicated fire suppression activities in the Arizona border region. According to agency officials, the presence of illegal border crossers has increased concerns about firefighter safety and, in some instances, has required firefighters to change or limit the tactics they use in suppressing fires. For example, the presence of illegal border crossers has limited firefighting activities at night and complicated the use of aerial firefighting methods. The agencies have taken some steps to mitigate the risks to firefighters by, for example, using law enforcement to provide security. However, none of the agencies have developed or implemented a risk-based approach for addressing these challenges. Consequently, law enforcement resources are routinely dispatched to all fires regardless of the risk, which may prevent the agencies from using their limited resources most efficiently. Moreover, while the Forest Service has developed a formal policy for addressing the risks to firefighters in the region, the other agencies have neither formally adopted this policy nor developed their own.

Background EPA offers three types of grants. First, discretionary grants fund activities such as environmental research and training, and EPA has the discretion to independently determine the recipients and funding levels for these grants. In fiscal year 2005, EPA awarded about $644 million in discretionary grants. Second, nondiscretionary grants are awarded primarily to state and local governments and support projects often on the basis of formulas prescribed by law or agency regulation. In fiscal year 2005, EPA awarded about $2.4 billion in nondiscretionary grants. Finally, continuing environmental program grants contain both nondiscretionary and discretionary features. In fiscal year 2005, EPA awarded about $1 billion in grants for continuing environmental programs. EPA administers and oversees grants primarily through the Office of Grants and Debarment in the Office of Administration and Resources Management, 10 program offices in headquarters, and program offices and grants management offices in EPA’s 10 regional offices. As of September 30, 2005, 119 grant specialists in the Office of Grants and Debarment and the regional grants management offices were largely responsible for administrative and financial grant functions. Furthermore, 2,064 project officers were actively managing technical and programmatic aspects of grants in headquarters and regional program offices. Unlike grant specialists, however, project officers also have nongrant responsibilities, such as using their scientific and technical expertise. EPA Has Strengthened the Award Process, but Lack of Key Documentation Raises Accountability Concerns EPA has strengthened its award process by, among other things, expanding competition to select the most qualified applicants. In September 2002, EPA issued a policy that for the first time required competition for many discretionary grants. EPA issued a revised competition policy, effective January 2005. It enhanced competition by, among other things, reducing the threshold for competition from $75,000 to $15,000. EPA also issued a policy to require certain nonprofit organizations to document that they have administrative and financial systems to manage grants. As part of its Grants Management Plan, the agency developed a performance measure for increasing the percentage of new grants subject to the competition policy that are actually competed and set increasing targets for achieving this measure. According to EPA, about $249 million of the approximately $3.1 billion it awarded in new grants in fiscal year 2005 were eligible for competition. EPA reports it now competes a higher percentage of eligible grants, up from 27 percent in fiscal year 2002 to 93 percent in fiscal year 2005, exceeding its targets for fiscal years 2003 through 2005. The 7 percent of eligible new grants that EPA reported it did not compete—which totaled about $10 million of the $249 million eligible for competition in fiscal year 2005—resulted from exceptions to the policy. While EPA has improved its award process, its internal reviews in program and regional offices have found that staff do not always fully document their reviews of grantees’ cost proposals. For example, in 2004 and 2005, in six of the seven program and regional offices it reviewed, the Office of Grants and Debarment found either no documentation of cost reviews or insufficient documentation. Furthermore, we also found this problem in one of the three regions we visited. Region 5 has a checklist to ensure that staff members who are responsible for each aspect of the cost review have completed and documented their review before awarding a grant. For most of the 12 approved award files we reviewed, we found instances in which the resolution of the issues between the project officer and grant specialist was not documented. This documentation problem may hinder EPA’s ability to ensure the reasonableness of its grantees’ estimated costs for performing the proposed work. Because of the continuing problems with documenting cost reviews, EPA is reexamining its cost review policy for grants. EPA Has Improved In- depth Monitoring to Identify Agencywide Problems, but Weaknesses Remain in Ongoing Monitoring and in Closing Out Grants EPA has improved some aspects of monitoring, but long-standing problems in documentation and grant closeouts continue. Specifically, (1) in-depth monitoring results can be analyzed nationwide, but staff do not always document corrective actions; (2) inadequate documentation of ongoing monitoring hinders accountability; and (3) EPA has reduced its closeout backlog, but grant closures are often delayed and sometimes improperly executed. In-depth Monitoring Results Can Be Analyzed Nationwide to Identify Problems, but Staff Do Not Always Document Whether Corrective Actions Have Been Taken EPA has begun to review the results of its in-depth monitoring to identify systemic grantee problems, but staff do not always document whether grantees have taken corrective actions. In fact, the Office of Grants and Debarment found that corrective actions were documented for only 55 percent of the 269 problems identified through administrative and programmatic reviews. We reported similar results in August 2003. According to an Office of Grants and Debarment official, while some EPA staff took corrective actions, they did not document those actions in EPA’s grantee computer database. Inadequate Documentation of Ongoing Monitoring Hinders Accountability EPA and we found that grant specialists and project officers do not always document ongoing monitoring. Ongoing monitoring is critical because, at a minimum, EPA conducts it on every grant at least once a year throughout the life of the grant and uses the results to determine whether the grantee is on track in meeting the terms and conditions of the grant. However, our analysis of EPA’s internal reviews indicates that several offices experienced recurring problems in 2004 and 2005. For example, an August 2004 Office of Grants and Debarment internal review cited one regional office as having “very limited” documentation of ongoing monitoring; and in the following year, the regional office’s self-assessment found the same documentation problem with project officer files. A lack of documentation raises questions about the adequacy of the project officers’ and grant specialists’ ongoing monitoring of grantee performance. Because of these documentation problems, two of the three regional offices we visited have committed to using checklists to document their ongoing monitoring. Regions 1 and 9 had implemented such checklists at the time of our review. However, of the 40 project officer and grant specialist files we reviewed in Regions 1 and 9, more than half of the checklists were either missing, blank, or incomplete. Similarly, in Region 5, which did not use a checklist, none of the six grant files requiring annual contact with the grantee had documentation showing that the contact had occurred. In the three regions, we also found that project officers’ files did not always contain grantees’ progress reports, which, according to EPA’s project officer manual, are the project officer’s primary mechanism for determining if the grantee is fulfilling its grant agreement obligations. Thirteen of the 32 project officer grant files we reviewed were missing at least one or more required progress reports. When EPA staff do not obtain progress reports, they cannot monitor effectively, which may hinder accountability. The lack of documentation for ongoing monitoring occurs because of weaknesses at the staff, supervisory, and management level in the three regions we visited. Specifically: Grant specialists and project officers do not consistently document key monitoring efforts, or they rely on other staff with technical expertise to assist with ongoing monitoring who may not provide the documented results for inclusion in the grant file. This situation occurred in two of the three regions we visited. Supervisors do not always effectively review grant files for compliance with grant policies in the three regions we visited. Senior EPA managers in the regions do not always ensure that their commitments to improve monitoring documentation are being met. For example, two regions had committed to using checklists to document ongoing monitoring. However, more than half of the checklists we reviewed in these regions were missing, blank, or incomplete. Despite the importance of ongoing monitoring, EPA has not created a performance measure for documenting ongoing monitoring that would underscore its importance to managers and staff. Furthermore, EPA’s grants database has a data field for recording ongoing monitoring, but recording this information is optional. Establishing a performance measure and/or requiring the entry of information could enhance accountability for implementing the monitoring policy. EPA Has Reduced Its Closeout Backlog, but Grant Closures Are Often Delayed and Sometimes Improperly Carried Out EPA incorporated grant closeout into its monitoring policy and its Grants Management Plan. During closeout, EPA ensures that the grant recipient has met all financial requirements and provided final technical reports, and ensures that any unexpended balances are “deobligated” and returned to the agency. Delays in closing out the grant can unnecessarily tie up obligated but unexpended funds that could be used for other purposes. EPA’s policy states that closeouts should occur within 180 days after the grant’s project end date. In the past, EPA had a substantial backlog of grants that it had not closed out. EPA reported that, by 1995, the agency had amassed a backlog of over 18,000 completed grants that had not been closed out from the past two decades. In fact, EPA had identified closeout, among other things, as a material weakness—an accounting and internal control weakness that the EPA Administrator must report to the President and Congress. As we reported in 2003, however, EPA improved its closeout of backlogged grants, eliminating backlog as a material weakness. Specifically, for fiscal year 2005, using its historic closeout performance measure, EPA reported that it had closed 97.8 percent of the 23,162 grants with project end dates between the beginning of fiscal year 1999 and the end of fiscal year 2003. EPA came close to its 99-percent target of closing out this backlog. EPA developed a second closeout performance measure—which we call the current closeout performance measure. As EPA reported, the agency closed out 79 percent of the grants with project end dates in fiscal year 2004 by the end of reporting fiscal year 2005 (September 30, 2005) but did not meet its performance target of 90 percent. However, EPA’s current closeout performance measure does not calculate whether EPA closed the grant within 180 days. Rather, this measure only reports whether EPA closed the grant by the end of the following fiscal year (the fiscal year in which it reports on closeouts—the reporting year). The measure, in fact, can allow for a much more generous closeout time—from 183 days beyond the 180 days to as much as 547 days (18 months) beyond the 180 days— because EPA does not report the performance measure until September 30, the end of the current fiscal year. EPA’s current performance measure for closing out grants is a valuable tool for determining if grants were ultimately closed out. However, we believe that this performance measure—taken alone—is not a sufficient way to measure closeout because it does not reflect the 180-day standard specified in EPA policy. To determine the percentage of grants that were closed within 180 days, we examined EPA’s analysis of closeout time frames for regional offices, headquarter offices, and agencywide. EPA is having significant difficulty in meeting the 180-day standard. In fact, for fiscal year 2005, EPA closed out only 37 percent of the grants within the 180 days. Table 1 shows that EPA’s current performance measure is masking the fact that the agency is having significant difficulty in closing out grants within 180 days. Overall, a combination of grantee lateness and internal inefficiencies contributed to late closeouts. For example: In Region 5, it took 795 days—615 days beyond the 180-day standard—to close out a 2-year wetland grant for $56,778. The grantee submitted the final financial status report 114 days late because a key grant contact had died. However, it took the region an additional 591 days after the grantee provided the final reports to close out the grant. According to the grant specialist, closeout was delayed, in part, because of internal administrative delays and because the grant was “lost” under a stack of other closeout files. In Region 1, closure of a nonpoint source grant that provided $796,532 over 10 years was delayed primarily because of a lack of documentation. According to the project officer who inherited the file from a retiring employee, the file had unusually poor documentation. Moreover, the state employee who assumed responsibility for the grant also did not have a complete file. Consequently, it took the project officer nearly 5 months beyond the allotted 180 days to complete close out. Adding to the agency’s closeout problems, 8 of the 34 closed grants we reviewed in the regions were not closed out properly. Specifically: In Region 5, one grant specialist’s file was missing the final financial status report, which is a key report that describes how the grantee spent the grant funds and whether any unspent funds remain that need to be deobligated. Region 1 grant specialists had not adequately reviewed the indirect cost rate grantees submitted as part of their final financial status report, which, in turn, led to improper closeout in 5 of the 10 files we reviewed. In Region 9, Lobbying and Litigation Certification Forms—whose purpose is to ensure that federal dollars are not spent for lobbying or litigation activities—were missing from two grant files. As with monitoring, without effective supervisory review of the grant and project officer files, grants may be improperly closed out. With more effective supervision, grants would be more likely to be properly closed out. EPA has formed a work group to review its monitoring and closeout policies and plans to revise these policies in 2006. EPA Has Initiated Actions to Obtain Results from Grants, but Its Efforts Are Not Complete EPA has taken steps to obtain environmental results from its grants, but its efforts are not complete. EPA included a performance measure in its Grants Management Plan for identifying expected environmental results from grants and issued an environmental results policy, effective in January 2005. This policy, for the first time, requires EPA staff to ensure that grant workplans specify well-defined environmental results, which enables EPA to hold grantees accountable for achieving them. To assess the agency’s effectiveness in implementing its environmental results policy, EPA identified seven criteria that grant agreements should meet. However, EPA’s current performance measure does not take into account the new criteria for identifying and measuring results from grants established by the policy. Furthermore, EPA acknowledges that it has not identified better ways to integrate its systems for reporting on the results of grants. Until recently, EPA recognized—but had not addressed in its results policy—the known complexities of measuring environmental outcomes, such as demonstrating outcomes when there is a long lag time before results become apparent. While EPA has taken positive steps by issuing a results policy, OMB’s evaluation of EPA grant programs in 2006 indicate that EPA must continue its concerted efforts to achieve results from its grants. Specifically, OMB found that 5 of 18 EPA grant programs in 2006 are “ineffective” or “results not demonstrated,” although there has been some improvement from 2004 through 2006. Despite this progress, a closer examination of the ratings for 2006 indicated that, with one exception, the scores for the results component were lower than the scores for other components, such as planning and management. EPA Has Taken Steps to Manage Grants Staff and Resources More Effectively but Still Faces Major Management Problems EPA has taken steps to manage grants staff and resources more effectively in four key areas: (1) analyzing workload; (2) providing training on grant policies; (3) assessing the reliability of the agency’s grants management computer database; and (4) holding managers and staff accountable for successfully fulfilling their grant responsibilities. Nevertheless, management attention to these four issues is still needed. Analyzing workload. Fulfilling an objective identified in the Grants Management Plan, in April 2005, an EPA contractor’s analysis of project officers and grant specialists showed that EPA had an overall shortage of project officers and grant specialists, expressed in full-time equivalents. The contractor recommended that before EPA add staff, it take steps to improve the effectiveness and efficiency of its grants management operations. As a result, grant offices are preparing project officer workforce plans—due this year—that incorporate the workload analysis. Providing training. EPA has provided some training on grant policies; however, according to EPA staff, the amount of training has not been sufficient to keep pace with the issuance of new grant policies. Region 1 provided training for its project officers on the new awards process. However, only about 25 of the region’s 200 project officers attended the optional 90-minute course, although they had three opportunities to do so. Assessing the reliability of the grants computer database. In 1997, EPA began developing the Integrated Grants Management System to better manage its grants; EPA now also uses this database to inform the public and the Congress about its $4 billion investment in grants. Data quality problems in this database could impair EPA’s ability to effectively manage grants and provide accurate information. In 2005, we recommended that EPA conduct a comprehensive data quality review of its Integrated Grants Management System. EPA expects to complete this review in 2006. Holding managers and staff accountable. In 2005, EPA’s Inspector General reported that EPA was not holding supervisors and project officers accountable for grants management. In response, EPA issued a plan in January 2006 to ensure that the agency’s new performance appraisal system addresses grants management responsibilities. For the 2007 performance appraisal process, EPA plans to establish a workgroup to develop final performance measures to assess the grants management performance of project officers and supervisors and to incorporate these measures into 2007 performance agreements. Our review is consistent with the Inspector General’s findings. As previously discussed, EPA grants staff told us that their supervisors were not reviewing their grant files to determine compliance with grant monitoring policies. It is possible that the awarding, monitoring, and closeout problems we found would have been mitigated by effective supervisory review. Mr. Chairman, about 3 years into its Grants Management Plan, 2003- 2008, EPA has made important strides in achieving its grant reforms, but it has not resolved its long-standing problems in documenting ongoing monitoring and closing out grants. As it revises its management plan, EPA has an opportunity to tackle these continuing problems. In our report, we recommended that the Administrator of EPA take actions to strengthen ongoing monitoring, closing out grants, and obtaining results from grants, and the agency has agreed to implement our recommendations. At the same time, we believe that congressional oversight has contributed to EPA’s progress to date and that continuing oversight is important to ensuring that EPA builds accountability into the agency’s efforts to achieve results from its $4 billion annual investment in grants. Mr. Chairman, this concludes my prepared statement. I would be happy to respond to any questions that you or Members of the Subcommittee may have. For further information, please contact John B. Stephenson at (202) 512- 3841. Individuals making key contributions to this testimony were Andrea Wamstad Brown, Bruce Skud, Rebecca Shea, Lisa Vojta, Carol Herrnstadt Shulman, Omari Norman, David Bobruff, Matthew J. Saradjian, and Jessica Nierenberg. 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The Environmental Protection Agency (EPA) has faced challenges for many years in managing its grants, which constitute over one-half of the agency's budget, or about $4 billion annually. EPA awards grants through 93 programs to such recipients as state and local governments, tribes, universities, and nonprofit organizations. In response to concerns about its ability to manage grants effectively, EPA issued its 5-year Grants Management Plan in 2003, with performance measures and targets. This testimony is based on GAO's May 2006 report, Grants Management: EPA Has Made Progress in Grant Reforms but Needs to Address Weaknesses in Implementation and Accountability (GAO-06-625). GAO examined EPA's progress in implementing its grant reforms in four key areas: (1) awarding grants, (2) monitoring grantees, (3) obtaining results from grants, and (4) managing grant staff and resources. EPA has made important strides in achieving the grant reforms laid out in its 2003 Grants Management Plan, but weaknesses in implementation and accountability continue to hamper effective grants management in four areas. First, EPA has strengthened its award process by, among other things, (1) expanding the use of competition to select the most qualified applicants and (2) issuing new policies and guidance to improve the awarding of grants. However, EPA's reviews found that staff do not always fully document their assessments of grantees' cost proposals; GAO also identified this problem in one region. Lack of documentation may hinder EPA's ability to be accountable for the reasonableness of a grantee's proposed costs. EPA is reexamining its cost review policy to address this problem. Second, EPA has made progress in reviewing its in-depth monitoring results to identify systemic problems, but long-standing issues remain in documenting ongoing monitoring and closing out grants. EPA and GAO found that staff do not always document ongoing monitoring, which is critical for determining if a grantee is on track in meeting its agreement. Without documentation, questions arise about the adequacy of EPA's monitoring of grantee performance. In addition, grant closeouts are needed to ensure that grantees have met all financial requirements, provided their final reports, and returned any unexpended balances. For fiscal year 2005, EPA closed out only 37 percent of its grants within 180 days after the grant project ended, as required by its policy. EPA also did not always close out grants properly in the regional files GAO reviewed. Third, EPA has initiated actions to obtain environmental results from its grants, but these efforts are not complete. For example, EPA's 2005 environmental results policy establishes criteria that grants should meet to obtain results. However, EPA has not established a performance measure that addresses these criteria. Furthermore, EPA has not yet identified better ways to integrate its grant reporting systems. The Office of Management and Budget's 2006 assessment also indicates that EPA needs to continue its concerted efforts to achieve results from grants. Finally, EPA has taken steps to manage grant staff and resources more effectively by analyzing workload, providing training, assessing the reliability of its grants management computer database, and holding managers and staff accountable for successfully fulfilling their grant responsibilities. Management attention is still needed because, among other things, EPA has just begun to implement its performance appraisal system for holding managers and staff accountable for grants management.

Background As we and OMB have noted, duplicative, wasteful, and low-value investments have proliferated over the years, highlighting the need for agencies to avoid such investments whenever possible. To help agencies manage their IT more effectively, reduce duplication, and achieve cost savings, OMB implemented a series of initiatives beginning in 2010: Data Center Consolidation and Optimization. In February 2010, the Federal Chief Information Officer (CIO) established the Federal Data Center Consolidation Initiative (FDCCI) to address the growing number of federal data centers. This initiative’s four high-level goals were to reduce the overall energy and real estate footprint of government data centers; reduce the cost of data center hardware, software, and operations; increase the overall IT security posture of the government; and shift IT investments to more efficient computing platforms and technologies. OMB estimates that the initiative has the potential to provide about $3 billion in savings by the end of 2015. In March 2013, OMB issued a memorandum that expanded FDCCI to include measuring the extent to which agencies have optimized their core data centers in areas such as energy, labor, and storage, and subsequently released a set of 11 data center optimization metrics to measure agency progress. IT Reform Plan. In December 2010, the Federal CIO established a 25- Point IT Reform Plan designed to address challenges in IT acquisition, improve operational efficiencies, and deliver more IT value to the American taxpayer. The plan set forth action items and required activities to consolidate the growing number of federal data centers, shift to increased use of cloud computing, and promote the use of shared service solutions. In addition, as part of an effort to reduce the risk associated with IT acquisitions, the plan calls for federal IT programs to deploy capabilities or functionality in release cycles no longer than 12 months, and ideally, less than 6 months. Cloud Computing Strategy. In order to accelerate the adoption of cloud computing solutions across the government, OMB’s 25-Point IT Reform Plan included a “Cloud First” policy that required each agency CIO to fully migrate three services to a cloud solution by June 2012, and implement cloud-based solutions whenever a secure, reliable, and cost-effective cloud option exists. Building on this requirement, in February 2011, OMB issued the Federal Cloud Computing Strategy, which provided definitions of cloud computing services; benefits of cloud services, such as accelerating data center consolidations; case studies to support agencies’ migration to cloud computing; and roles and responsibilities for federal agencies. According to OMB, shifting from building custom systems to adopting cloud technologies and shared solutions will improve the government’s operational efficiencies and result in substantial cost savings. PortfolioStat. In March 2012, OMB launched the PortfolioStat initiative, which requires agencies to conduct an annual agency-wide IT portfolio review to, among other things, reduce commodity IT spending and demonstrate how its IT investments align with the agency’s mission and business functions. PortfolioStat is designed to assist agencies in assessing the current maturity of their IT portfolio management process, make decisions on eliminating duplication, and move to shared solutions in order to maximize the return on IT investments across the portfolio. OMB reported that the PortfolioStat effort has the potential to save the government $2.5 billion between fiscal years 2013 and 2015 by consolidating and eliminating duplicative systems. IT Shared Services Strategy. In May 2012, building on a requirement established in its 25-Point IT Reform Plan, OMB released its Federal IT Shared Services Strategy. The strategy requires agencies to use shared services—IT functions that are provided for consumption by multiple organizations within or between federal agencies—for IT service delivery in order to increase return on investment, eliminate waste and duplication, and improve the effectiveness of IT solutions. Examples of commodity IT areas to consider migrating to a shared environment, as described in the strategy, include software licenses, e-mail systems, and human resource systems. According to OMB, a review of over 7,000 federal agency IT investments reported in budget year 2013 revealed many redundancies and billions of dollars in potential savings that could be achieved through consolidation and a shared approach to IT service delivery within and between agencies. OMB Required Agencies to Establish Plans to Reinvest Their Savings With the potential for significant savings, and in continuing its focus on increasing efficiency and reducing costs, OMB established both one-time and ongoing requirements for agencies to establish plans to reinvest their savings. These requirements include the following: Long-range (e.g., 3-5 year) reinvestment plans. In March 2013, OMB issued a memorandum that consolidated previously collected IT- related plans, reports, and data submissions, and introduced a new requirement for submitting reinvestment information. Specifically, the memorandum required each of the 26 agencies that participate in the PortfolioStat initiative to describe how they plan to reinvest savings resulting from the consolidation of commodity IT resources (including data centers) in their IRM strategic plan. Fiscal year 2014 reduction and reinvestment plans. OMB’s fiscal year 2014 budget guidance required 27 agencies to propose, in their budget submissions for that fiscal year only, reductions in IT that represented 10 percent of their overall IT spending, and propose reinvestments of at least 50 percent, and up to 100 percent, of the savings. More specifically, agencies were required to reduce agency spending in the following IT areas: duplicative commodity IT investments or contracts; underperforming projects or investments of any type; and lower-value or lower-priority investments of any type. Regarding reinvestments, agencies were required to propose reinvestments that were expected to demonstrate a favorable return on investment (quantitative or qualitative) to the agency within 18 months from the enactment of the fiscal year 2014 appropriations. OMB’s guidance further stated that these proposed reinvestments were to address, among other things, improvements to citizen services or administrative efficiencies, adoption of shared services, and consolidation of commodity IT. Quarterly reinvestment plans. OMB’s March 2013 memorandum also required the 26 agencies that participate in the PortfolioStat initiative to report quarterly on cost savings and avoidances related to the migration to shared services and data center consolidation, among other areas, in their integrated data collection submissions to OMB. As part of these submissions, OMB also required agencies to describe their plans to use the cost savings and avoidances resulting from any cost savings and avoidance initiatives reported. Recent Legislation Requires Improvements to the Acquisition and Management of IT Recognizing the importance of reforming the government-wide management of IT, in December 2014, Federal Information Technology Acquisition Reform provisions (commonly referred to as FITARA) were enacted as a part of the Carl Levin and Howard P. ‘Buck’ McKeon National Defense Authorization Act for Fiscal Year 2015. Among other things, the law includes the following requirements: Agencies, except for the Department of Defense (Defense), shall ensure that CIOs have a significant role in, among other things, programming and budgeting decisions, as well as management, governance, and oversight processes related to IT. For example, agencies (other than Defense) may only enter into contracts for IT and IT services that are reviewed and approved by the agency CIO. OMB shall require, in its annual capital planning guidance, that CIOs certify that IT acquisitions are adequately implementing incremental development. OMB shall issue guidance that requires the CIO to adequately reflect each major IT investment’s cost and schedule performance in the investment evaluation. OMB shall make available to the public a list of each major IT investment including data on cost, schedule, and performance. The General Services Administration (GSA) shall identify and develop a government-wide program, as provided for in the statute, for the acquisition, dissemination, and shared use of software and that allows for the purchase of government-wide software licenses. In addition, the law also includes the following requirements related to the reporting of IT reform-related cost savings: OMB, in consultation with agency CIOs (except for Defense), shall implement a process to assist them in reviewing their IT portfolios, including developing a multi-year strategy to identify and reduce duplication and waste and to identify projected cost savings resulting from the strategy. OMB’s Administrator of the Office of Electronic Government shall submit a quarterly report to specified congressional committees on the cost savings and reductions in duplicative IT investments identified during reviews of agency IT portfolios. Agencies (except for Defense) shall annually report to OMB’s Administrator of the Office of Electronic Government about federal data center inventories and strategies to achieve consolidation, including yearly calculations of investment and cost savings. OMB’s Administrator of the Office of Electronic Government shall develop, and make publicly available, yearly goals for the amount of planned cost savings and optimization improvements achieved through FDCCI, and for each year thereafter, compare reported cost savings against those goals. In June 2015, OMB released guidance on how agencies are to implement the law. OMB’s guidance stated that it is intended to, among other things, assist agencies in aligning their IT resources with statutory requirements; establish government-wide IT management controls that will meet the law’s requirements, while providing agencies with flexibility to adapt to unique agency processes and requirements; clarify the CIO’s role and strengthen the relationship with agency CIOs and bureau CIOs; and strengthen CIO accountability for IT cost, schedule, and performance. Further, the guidance includes several actions agencies are to take within specified time frames to implement a basic set of roles and responsibilities for CIOs and other senior agency officials (referred to as the “common baseline”) needed for the management of IT and to implement the specific authorities described in the legislation. Such roles and responsibilities described include those related to budget formulation and planning, acquisition and execution, and organization and workforce. To implement the common baseline, the proposed guidance includes the following more specific requirements: By August 15, 2015, each agency is to conduct a self-assessment and articulate a plan describing the changes it will make to ensure that all common baseline responsibilities are implemented by December 31, 2015. Agencies are to submit their plans to OMB’s Office of E-Government for review and approval and make the plans publicly available on agency websites no later than 30 days after approval. By December 31, 2015, agencies are to implement specific responsibilities and processes for the management of IT from the common baseline. By April 30, 2016, agencies are to update their self-assessment to identify any obstacles or incomplete implementation of common baseline responsibilities over the preceding 12 months. The self- assessment is to be updated on an annual basis thereafter. Finally, OMB’s guidance also includes requirements to help support agency implementation of the common baseline. For example, through the end of fiscal year 2016, the Federal CIO Council is to meet quarterly to discuss topics related to the implementation of the common baseline and to assist agencies by, for example, sharing examples of agency governance processes and IT policies. Additionally, by June 30, 2015, the President’s Management Council is to select three members from the council to provide an update on government-wide implementation of FITARA on a quarterly basis through September 2016. The updates are to improve the agencies’ awareness of policies and procedures that have worked well in other agencies. GAO Has Reported and Testified on Issues Related to OMB’s IT Reform Efforts Since 2011, we have reported and testified that OMB’s IT reform initiatives can help to improve the efficiency and effectiveness of the federal government and have the potential to save billions of dollars. These key initiatives include FDCCI, PortfolioStat, and cloud computing. Between July 2011 and September 2014, we issued several reports and testified on agency efforts to consolidate federal data centers and achieve cost savings. Most recently, in September 2014, we reported that 19 of the 24 agencies that participate in FDCCI collectively reported achieving an estimated $1.1 billion in cost savings between fiscal years 2011 and 2013, and that, by 2017, that figure was estimated to rise to a total of about $5.3 billion. However, we found that planned savings may be higher because six agencies that reported closing as many as 67 data centers reported limited or no savings. In addition, 11 of the 21 agencies with planned cost savings had underreported their fiscal years 2012 through 2015 figures to OMB by approximately $2.2 billion. While several agencies noted communication issues as the reason for this, others did not provide a reason. We concluded that until agencies fully report their savings, the $5.3 billion in total savings will be understated. Accordingly, we recommended that OMB assist agencies in reporting savings, and that agencies fully report their consolidation cost savings. OMB and the agencies to which we made recommendations generally agreed and described planned actions to implement them. Further, Defense noted in a November 2014 response to our report that, in addition to the $2.6 billion in cost savings planned by fiscal year 2017, the department expects that figure to increase to $4.7 billion in future years as efficiencies are gained. We have also previously reported on the implementation of OMB’s PortfolioStat initiative. Specifically, in November 2013, we determined that additional OMB and agency actions were needed to achieve savings from OMB’s PortfolioStat initiative. For example, although all of the 26 federal agencies that were required to participate in the PortfolioStat initiative had fully addressed four of seven key requirements established by OMB, only 1 of the 26 agencies addressed all the requirements. Further, agencies had not developed action plans that addressed all elements, such as criteria for identifying wasteful, low-value, or duplicative investments, or migrated two commodity IT areas—such as enterprise IT systems and infrastructure—to a shared service by the end of 2012. In addition, we reported that OMB’s estimate of about 100 consolidation opportunities and a potential $2.5 billion in savings from the PortfolioStat initiative was understated because, among other things, it did not include estimates from the Departments of Defense and Justice. Our analysis, which included these estimates, showed that, collectively, the 26 agencies were reporting 204 opportunities and at least $5.8 billion in potential savings through fiscal year 2015. To address these shortcomings, we made a total of 64 recommendations, including that OMB require agencies to fully disclose limitations in CIOs’ ability to exercise their authority and that 24 agencies take steps to improve their PortfolioStat implementation. OMB agreed with some of the recommendations and disagreed with others; likewise, responses from the 24 other agencies we made recommendations to varied. More recently, in April 2015, we reviewed OMB’s second iteration of PortfolioStat and reported that agencies had achieved a total of approximately $1.1 billion in PortfolioStat-related savings during fiscal years 2013 and 2014. However, agencies’ total planned PortfolioStat savings from fiscal year 2013 to fiscal year 2015 had decreased by about 66 percent (from at least $5.8 billion to approximately $2 billion) compared to what they had reported in 2013. In addition, agencies had not consistently included savings from FDCCI in their PortfolioStat reporting, which means that the total savings amount is understated. Finally, the report notes that, while three selected agencies were able to explain how they reinvested their PortfolioStat savings, they were not always able to provide support for how such savings were used. We recommended, among other things, that OMB ensure that its reports to Congress accurately reflect savings generated from all PortfolioStat initiatives, including those associated with FDCCI, and require agencies to document how such savings are being reinvested. OMB agreed with our recommendations and described plans to implement them. We have also reported on agencies’ cloud computing efforts. For example, we reported in September 2014 that, while agencies had made progress in implementing OMB’s “Cloud First” policy, additional opportunities for implementing cloud services and achieving savings needed to be pursued. Specifically, although the seven agencies reviewed had increased their cloud computing services since we last reported on their progress in 2012, the overall increase in their IT budgets was just 1 percent. We determined that the relatively small increase in cloud spending was attributed, in part, to the fact that these agencies collectively had not considered cloud computing services for about 67 percent of their investments, which was inconsistent with OMB’s policy that calls for cloud solutions to be considered first whenever a secure, reliable, and cost-effective option exists regardless of where the investment is in its life cycle. We also found that the seven agencies collectively reported cost savings of about $96 million from the implementation of cloud services, but that other cloud services implemented did not save money, in part, because the associated costs negated any savings. We concluded that, until the agencies fully assess all their IT investments, they will not be able to achieve the resulting benefits of operational efficiencies and cost savings. To address these shortcomings, we recommended that the seven agencies assess the IT investments identified in the report that have yet to be evaluated for suitability for cloud computing services. The seven agencies generally agreed with our recommendations. Finally, in light of the project failures that continue to plague the federal government and the duplicative and wasteful management of IT operations, in the February 2015 update to our High-Risk List, we designated the management of IT acquisitions and operations as a new government-wide high-risk area. In doing so, we emphasized the importance of federal agencies expeditiously implementing the requirements of the December 2014 IT acquisition reform legislation to (1) improve the transparency and management of IT acquisitions and operations across the government and (2) strengthen CIOs’ authority to provide needed direction and oversight. Our High-Risk List update also notes that, beyond implementing legislation, OMB and the agencies need to continue to implement our previous recommendations in order to improve their ability to effectively and efficiently invest in IT. Finally, OMB and agencies should demonstrate measurable government-wide progress in key areas, including achieving planned PortfolioStat and FDCCI cost savings. Agencies Reported Achieving Billions of Dollars in Savings from Implementation of OMB’s IT Reform Efforts As previously stated, beginning in 2010, OMB launched a series of IT reform initiatives in the areas of data center consolidation, cloud computing, and shared services migration, among other things, intended to help agencies achieve greater efficiency in their IT investments, as well as identify and execute opportunities for savings. In March 2013, OMB issued a memorandum that included a requirement for the 26 agencies that participate in the PortfolioStat initiative to begin reporting quarterly on their planned and actual cost savings and avoidances achieved or expected through their IT reform efforts. OMB uses these data to report quarterly to Congress on the status of federal IT reform efforts. In total, 24 of the 26 agencies reported achieving approximately $3.6 billion in cost savings and avoidances from the implementation of OMB’s IT reform efforts between fiscal years 2011 and 2014. The 2 agencies that did not report any savings were the National Aeronautics and Space Administration (NASA) and Office of Personnel Management (OPM). NASA officials stated that, as of June 2015, previously reported cost avoidances (of about $54 million) had been reduced to zero due to the inclusion of additional requirements that were not accounted for in the new, consolidated contract that initially led to the avoidances. OPM officials said that, while planned IT consolidation initiatives had been executed, savings were minimal and not quantifiable. Of the 24 agencies with reported cost savings and avoidances, 4— Defense, Department of Homeland Security (DHS), Department of the Treasury (Treasury), and SSA—accounted for approximately $2.5 billion (or about 69 percent) of the total. Treasury reported the highest amount of cost savings and avoidances, about $1.1 billion, followed by DHS reporting approximately $671.4 million. See table 1 for a listing of the 26 agencies’ cost savings and avoidances between fiscal years 2011 and 2014. Data center consolidation and optimization cost savings and avoidances comprise slightly more than half of the $3.6 billion total, while PortfolioStat and other initiatives (such as cloud computing and shared services migration) comprise the remainder of the cost savings and avoidances. Figure 1 shows the key areas where the cost savings and avoidances have been reported by agencies and the associated amounts. See table 2 for a listing of OMB’s key IT reform areas and selected examples of agency-reported savings or avoidances in each. While agencies have reported significant savings to us, they have not fully reported their savings to OMB, as required. In turn, OMB does not have the information to use in its statutorily required quarterly reports to Congress on the status of federal IT reform efforts. Specifically, OMB noted in its May 2015 quarterly report to Congress that 25 agencies reported total cost savings and avoidances of approximately $2.89 billion between fiscal years 2012 and 2014. In contrast, 24 agencies reported to us approximately $3.38 billion in cost savings and avoidances over that same time frame, which is approximately $484 million higher than the savings and avoidances being reported by OMB to Congress. See figure 2 for a graphical depiction of the differences in reported cost savings and avoidances. The $484 million shortfall in OMB’s report to Congress is due, in part, to agencies not yet fully implementing our prior recommendations related to reporting all their data center consolidation cost savings and avoidances to OMB. Specifically, in September 2014, we reported that 11 agencies had underreported (through the integrated data collection process) their fiscal year 2011 through 2015 data center consolidation cost savings to OMB by a total of approximately $2.2 billion. Accordingly, we recommended that the agencies report all data center consolidation cost savings and avoidances to OMB in accordance with established guidance. The agencies generally agreed with our recommendation; however, as of June 2015, only 3 of the 11 agencies—the Departments of Commerce (Commerce) and Energy (Energy) and the Environmental Protection Agency (EPA)—had implemented our recommendation by reporting their data center consolidation cost savings to OMB. The remaining 8 agencies had not yet fully implemented our recommendation, although many had taken action by reporting a portion, but not all, of their data center consolidation cost savings and avoidances to OMB. The shortfall can also be attributed to other inconsistencies in how the amounts are being reported by agencies and OMB. Specifically, in April 2015, we reported on the implementation of OMB’s second iteration of the PortfolioStat initiative and identified dozens of examples of cost- savings initiatives that were reported to OMB but not to us, or initiatives that agencies reported to us but not to OMB. We attributed these inconsistencies to several reasons, including that agencies did not always follow OMB’s instructions regarding what savings information to report, or when to report it, and that several agencies had stated that their reported savings were not always included in OMB’s report to Congress. We concluded that, until these inconsistencies are addressed, it will be difficult to determine the extent to which the PortfolioStat initiative is meeting its goals. As a result, we recommended that OMB ensure that its reports to Congress related to the results of IT reform efforts accurately reflect savings generated from all PortfolioStat initiatives, including those associated with FDCCI. OMB agreed with our recommendation. The importance of agencies identifying and reporting their cost savings to OMB, and OMB reporting such savings to Congress, has also been emphasized in recent legislation. Specifically, as previously mentioned, in December 2014, Congress enacted IT acquisition reform legislation (commonly referred to as FITARA) that requires, among other things, agencies to work with OMB to increase the efficiency and effectiveness of their IT portfolios and identify potential cost savings. The legislation also requires agencies to report to OMB on cost savings realized from the implementation of FDCCI, as well as progress on optimization and consolidation. Further, the legislation requires OMB to submit a goal of planned cost savings and optimization improvements to Congress. Finally, OMB shall provide an annual update of aggregated cost savings and optimization improvements achieved to date through FDCCI and compare the savings to the projected cost savings and optimization improvements. Until agencies implement our prior recommendations to report all aggregated cost savings and avoidances, and OMB implements our prior recommendation to ensure that its quarterly reports to Congress accurately reflect such information, Congress may be limited in its ability to oversee agencies’ progress in achieving savings from OMB’s IT reform efforts. Agencies Have Incomplete Plans for Reinvesting Savings Most agencies did not fully implement OMB’s guidance for submitting reinvestment plan information. As previously stated, OMB has established both one-time and ongoing requirements for agencies to establish plans to reinvest their savings. Specifically, for long-range reinvestment plans, OMB’s fiscal year 2013 PortfolioStat memorandum included a requirement for agencies to describe plans to reinvest savings resulting from the consolidation of commodity IT resources, including data centers, in their IRM strategic plans. Further, OMB’s fiscal year 2014 budget guidance required federal agencies to develop one-time fiscal year 2014 reduction and reinvestment plans as part of its “cut and reinvest” initiative. Specifically, agencies were to cut 10 percent from proposed IT spending based on their average IT spending between fiscal years 2010 and 2012 and propose reinvestments of 50 to 100 percent of the savings into priority investments that were expected to demonstrate a favorable return on investment (quantitative or qualitative) to the agency within 18 months from the enactment of the fiscal year 2014 appropriations. Each of the proposed reductions and reinvestments was also to include supplemental information, such as the reduction or reinvestment type and explanations of the changes in funding. In addition, each of the proposed reinvestments was to include a priority level and a description of the favorable return on investment. Finally, agencies were to submit quarterly reinvestment plans via their integrated data collection submissions to OMB, which were to describe agency plans to use the resulting cost savings or avoidances for each IT reform-related savings and avoidance initiative reported. Of the 27 agencies required to submit reinvestment plan information to OMB, 5 had fully implemented OMB’s guidance, while the remaining 22 agencies had partially implemented the guidance. More specifically, although about two-thirds of agencies had established long-range reinvestment plans in their IRM strategic plans, most agencies had not fully implemented OMB’s guidance for establishing fiscal year 2014 reduction and reinvestment plans. In addition, half of the agencies had not fully implemented OMB’s guidance for submitting quarterly reinvestment plans in their integrated data collection submission. See table 3 for a summary of agencies’ cost savings and avoidances and the completeness of their reinvestment plans provided to OMB. A more detailed discussion of agencies’ reinvestment plans follows the table. About Two-thirds of Agencies Had Long-range Reinvestment Plans About two-thirds of agencies provided a long-range reinvestment plan in their IRM strategic plan, in accordance with OMB’s guidance. Specifically, of the 26 agencies required to submit an IRM strategic plan, 18 included a reinvestment plan and the remaining 8 did not, as detailed in table 4. For the 18 agencies that implemented OMB’s guidance, their long-range reinvestment plans included a wide range of reinvestment initiatives. For example, DHS plans to invest in its secure network to improve its security posture and improve its capability to use and protect classified information. Interior plans to capture savings generated by the consolidation of IT infrastructure and other streamlining efforts and to reinvest those savings into subsequent phases of IT transformation, such as migration of applications and services to the cloud. EPA also plans to reinvest savings into its E-Enterprise initiative to modernize the delivery of environmental services to industry and the public by creating an interactive set of shared services for use by agency and state data systems. According to EPA’s plan, this is intended to improve environmental protection and reduce the burden on EPA’s regulated community. However, approximately one-third of agencies did not include long-range reinvestment plan information in their IRM strategic plans and provided varied reasons for not doing so. For example, Treasury’s Chief Technology Officer stated that the reinvestment plans for the department were not available when the IRM strategic plan was developed and submitted to OMB, most recently in February 2014. He added that the department is waiting to add such reinvestment information until OMB finalizes its guidance on how to implement the December 2014 IT acquisition reform legislation. In addition, U.S. Army Corps of Engineers officials agreed that the reinvestment information in the agency’s current IRM strategic plan was incomplete and stated that the agency was awaiting feedback from OMB on the plan before making additional updates. Finally, Department of Health and Human Services (HHS) officials stated that the department requested additional guidance regarding the reinvestment information to include from OMB and had not received it. In the absence of further clarification from OMB, HHS officials stated that they did not include specific reinvestment plans in the department’s IRM strategic plan. Until agencies update their strategic plans to include their approach to reinvesting savings from the consolidation of commodity IT resources, including data centers, they will lack an important tool to help ensure that savings are being used in the most efficient and effective manner possible. Only One-Third of Agencies’ Fiscal Year 2014 Reduction and Reinvestment Plans Were Complete Most agencies did not follow OMB’s guidance for proposing one-time fiscal year 2014 IT reductions of 10 percent and reinvestments of between 50 and 100 percent of the savings in their budget submissions for that fiscal year. Specifically, of the 27 agencies required to submit fiscal year 2014 reduction and reinvestment plan information, 9 had fully met OMB’s guidance by meeting or exceeding OMB’s reduction and reinvestment targets and including all required supplemental information, but 18 had not. Specifically, 11 agencies had partially met the guidance, 5 had not met it, and 2 had not submitted the required document. See table 5 for an assessment of agencies’ one-time fiscal year 2014 proposed reductions and reinvestments against OMB’s guidance. Of the nine agencies that had fully met or exceeded OMB’s one-time reduction and reinvestment targets and included all required supplemental information, two agencies—DHS and Interior—accounted for more than $650 million of proposed IT reductions and $400 million in reinvestments. For example, DHS was required by OMB’s guidance to submit $563 million in reductions and provided almost $574 million in reductions, in areas such as enterprise IT systems and data centers. The department also proposed reinvesting $316 million of its savings across 39 IT investments aimed at improving shared services, security posture, and citizen services. In addition, Interior proposed reductions to 51 IT investments, collectively totaling about $99 million, primarily in the areas of IT infrastructure and business systems, and planned to reinvest the full amount across 79 reinvestments, in areas such as administrative efficiencies and commodity IT. Eleven agencies only partially met OMB’s guidance because they either did not meet OMB’s one-time reduction and reinvestment target or did not include the required supplemental information for each of the proposed reductions and reinvestments (e.g., reduction or reinvestment type, explanation of the changes in funding, and description of the favorable return on investments). For example, OPM met the guidance for providing reductions amounting to 10 percent and proposing reinvestments for at least half of that amount, but did not provide a description of the favorable return on investment for each of its reinvestments. According to OPM’s Chief of Investment Management, Operations Technology Management, the agency’s offices did not provide a description of the favorable return on investment, so the information could not be provided in the department’s submission. As another example, Energy did not meet OMB’s guidance for the percentage of reductions and reinvestments, but did provide complete supplemental information for the reductions and reinvestments that the department reported. Energy officials acknowledged that the department did not meet the target IT reduction set by OMB, but stated that they felt that the target did not account for significant IT reductions already achieved in fiscal years 2012 and 2013 in response to other OMB and internal IT cost savings initiatives. Officials further noted that several programs had just completed significant IT reduction efforts in the previous years and found it difficult to identify additional reductions for the fiscal year 2014 budget submission. Similarly, NASA also did not meet OMB’s guidance for reductions and reinvestments, but provided complete supplemental information. According to NASA officials, the agency could not meet the target for reinvestment due to having already completed many of its projects that would have provided OMB’s expected benefits and that the agency was working with its Office of the Chief Technologist to identify new IT investments for future years. Five agencies did not meet OMB’s guidance because they did not meet OMB’s one-time reduction and reinvestment targets for fiscal year 2014 and did not provide supplemental information for all required fields. Agencies’ reasons for not meeting the guidance varied. For example, a Department of Justice official from the Office of the CIO stated that the department had made significant reductions in its IT spending in the previous two budget cycles and did the best it could to meet OMB’s guidance, but ultimately fell short. In addition, the Department of Housing and Urban Development’s (HUD) Deputy CIO for Customer Relations and Performance Management stated that the department had focused on proposing reductions that were possible to achieve as opposed to reductions that were not feasible. Although the department did not meet OMB’s targets, the official added that, since OMB did not convey any objection to HUD’s approach, the department inferred that OMB did not have any objection to the reductions and reinvestments that HUD provided. As another example, EPA officials stated that their initial submission was rejected by OMB because the information was not submitted according to OMB’s guidance. As a result, the agency submitted a revised version to address OMB’s feedback; however, our assessment of that version showed that it did not meet OMB’s guidance. Finally, Veterans Affairs (VA) officials stated that the department believed that the OMB target did not take into consideration spending reductions made in prior years. As a result, VA submitted $120 million in proposed spending reductions (compared to its target of $316 million) for fiscal year 2014 that the Deputy Assistant Secretary believed were appropriate. The officials stated that the $196 million difference was funding that was being spent on mission-related priorities (instead of IT-related priorities). The two agencies that did not submit one-time fiscal year 2014 reduction and reinvestment plan information—Defense and HHS—provided varying reasons for not doing so. Specifically, rather than submit the required documentation, Defense requested an exemption from the requirement from OMB on the basis that an arbitrary 10 percent reduction was not in the best interests of national security and also cited system limitations that prevented the department from providing the requested information. Defense officials also stated that OMB’s guidance on what information to include in the reduction and reinvestment plans was issued too late to make changes to the department’s budgeting process in order to provide the requested information. In addition, HHS did not submit fiscal year 2014 IT reduction and reinvestment plans. According to HHS officials, the department requested additional guidance from OMB on how the reductions and proposed reinvestments submitted would be incorporated into the department’s budget request, but did not receive a response, so the department chose not to submit the required documentation. Because not all agencies followed OMB’s guidance, the totals of agencies’ proposed reductions and reinvestments were substantially short of OMB’s overall goals for its “cut and reinvest” initiative. Specifically, agencies should have submitted a total of $7.6 billion in reductions and proposed reinvestments between $3.8 and $7.6 billion. Instead, agencies collectively proposed reductions of about $3.0 billion and reinvestments of $2.1 billion in their fiscal year 2014 budget submissions. The difference is primarily due to two agencies—Defense, which was expected to propose about $3.5 billion in reductions and between $1.75 and $3.5 billion in reinvestments, and HHS, which was expected to propose $662 million in reductions and between $331 and $662 million in reinvestments. See figure 3 for a graphical depiction of the total of agencies’ proposed reductions and reinvestments compared to OMB’s guidance. Agencies were also required to assign an area to each of their proposed reductions (e.g., IT infrastructure, data centers, underperforming investment) and proposed reinvestments (e.g., citizen services, administrative efficiencies, energy efficiency). IT infrastructure accounted for the largest area of proposed reductions, about $978 million, while citizen services accounted for the largest area of reinvestment, about $480 million. See figure 4 for a graphical depiction of the total proposed reductions and total proposed reinvestments in each area assigned by agencies and the associated dollar values. As previously discussed, several agencies that only partially followed or did not follow OMB’s guidance stated that their submissions reflected the best that could be done after consideration of other cost reduction efforts in the preceding years. In addition, the lack of agency compliance with OMB’s guidance is also due, in large part, to OMB not enforcing the requirements in its guidance. Most agencies reported that they did not receive explicit approval or disapproval of their IT reduction and reinvestment proposals. As a result, many of the agencies considered their submissions to be approved once the budget request submission process had been concluded, even in cases where they did not meet the expected reduction or reinvestment targets. According to staff from OMB’s Office of E-Government and Information Technology, all agencies, except for Defense, adhered to the requirements for the IT reduction and reinvestment plan submission; however, OMB was unable to provide documentation to support this claim. In addition, as previously stated, the results of our analysis showed that most agencies did not follow OMB’s guidance for their submissions, including submitting IT reductions and reinvestments that met OMB’s defined targets. Half of Agencies’ Quarterly Plans Did Not Provide Reinvestment Details Half of the agencies did not provide complete quarterly reinvestment plan information in their integrated data collection submissions, in accordance with OMB guidance. Specifically, of the 26 agencies required to submit this information, 12 had provided both the reinvestment category and reinvestment details, 12 had provided partial information, and 2—NASA and OPM—had not reported any cost savings or avoidances. See table 6 for an assessment of the reinvestment information in agencies’ integrated data collection submissions. For the 12 agencies that included complete information, their quarterly submissions provided insight into key cost savings and avoidance initiatives and related reinvestment plans. For example, HHS reported that it had reduced the number of data centers and servers, which resulted in a reduction in operating expenses. The resulting $16.4 million in cost avoidances since 2012 has been used to help fund projects related to data center operations, as well as other mission-related projects and initiatives. In addition, the National Archives and Records Administration has saved $6.0 million in Electronic Records Archives activities in fiscal years 2013 and 2014 that it plans to use to help adapt its archives into a cloud-based solution to support increases in the volume of records managed. As another example, SSA has expanded use of its Electronic Case Analysis Tool that automatically identifies and speeds the processing of people’s cases with severe medical conditions. This has resulted in approximately $128.1 million in cost avoidances over the last 3 fiscal years, which the agency plans to use to fund other disability determination investments. The remaining 12 agencies provided partial information about their reinvestment plans. For example, 6 of the 12 agencies provided only reinvestment category information (e.g., administrative efficiencies, shared services, innovative investments), but did not provide the related details of their reinvestment plans. The remaining 6 agencies provided reinvestment categories and the related reinvestment details for a portion, but not all, of their cost savings and avoidance initiatives. For example, Commerce reported that it had migrated existing and built new IT infrastructure in a virtualized environment to reduce its IT footprint. This resulted in $11.8 million in cost avoidances that were expected to be used to reduce physical infrastructure procurement requirements year-over- year. However, the department was missing detailed reinvestment information for 13 of its 18 initiatives. The agencies that submitted partial reinvestment plan information in their quarterly submissions provided various reasons for why information was missing. For example, U.S. Agency for International Development officials indicated that they were not aware of the requirement to provide reinvestment information in their integrated data collection submission. In contrast, a Commerce official stated that the integrated data collection information is provided by the department’s component-level organizations and that the Office of the CIO does not have insight into why complete information was not provided. Interior’s Director of IT Planning also stated that missing information in their integrated data collection submission was also due to its component agencies not tracking and reporting complete information for their savings and avoidance initiatives. Without complete reinvestment plans in their integrated data collection submissions, agencies will lack important information that could be used to better ensure that cost savings and avoidances from OMB IT reform efforts are being used in the most efficient and effective manner possible. Selected Agencies Documented Key Governance Processes in Planning IT Reinvestments, but Did Not Track Performance Results According to our IT Investment Management Framework, organizations should establish IT governance processes that include one or more decision-making bodies or boards that are involved in making decisions on which investments to fund and ensuring that such decisions meet stakeholder needs and are made in the best interests of the organization. Additionally, standards for internal control emphasize the need for federal agencies to put in place mechanisms to achieve their objectives, such as comparing actual performance against plans and goals, and analyzing significant differences. Finally, leading practices of government and industry have established the importance of developing performance measures, including identifying targets, to gauge progress. They should be measurable, outcome-oriented, and actively tracked and reported. The four selected agencies—SSA, Interior, Education, and Labor— documented the role of key investment boards and related IT governance processes to guide the development of their fiscal year 2014 budget submission (which included planned IT reductions and reinvestments). See table 7 for a detailed description of each agency’s key governance responsibilities and processes for developing the fiscal year 2014 IT budget submission. In executing their fiscal year 2014 budget formulation processes, the four selected agencies proposed $350 million in total IT reductions and $350 million in IT reinvestments for fiscal year 2014. The largest amount of reductions, approximately $240.9 million, were planned in the area of IT infrastructure, while the largest amount of reinvestments, approximately $240.2 million, were planned in the area of commodity IT. Table 8 outlines the selected agencies’ approved reductions and reinvestments for fiscal year 2014, according to the key areas. However, three of the four selected agencies did not track performance results against their planned reductions. One agency—SSA—was able to provide supporting documentation that it had tracked the results of its proposed reductions. Specifically, the agency reported that it had achieved an estimated $106.7 million in total reductions, primarily in the area of IT infrastructure, as compared to total planned reductions of $150.1 million (see table 9.) The remaining three agencies—Education, Labor, and Interior—had not tracked performance results against their planned IT reductions. In addition, none of the four selected agencies had tracked the performance results of their planned reinvestments. While SSA had provided information regarding how spending had increased in their planned reinvestment areas (e.g., data centers, office automation, etc.), the agency was unable to track the amounts against the reinvestment amounts in their fiscal year 2014 budget submission. Interior officials stated that their proposed fiscal year 2014 IT reductions and reinvestments were likely executed as planned, while Labor’s IT Governance Director stated that their reinvestment amounts were likely equal to or slightly higher than planned due to certain component agencies increasing IT service levels; however, neither was able to provide supporting documentation. Labor, Interior, and Education officials also stated that the execution of the reductions and reinvestments was not tracked because the fiscal year 2014 plan was a one-time submission and not an ongoing OMB reporting requirement. While none of the agencies had tracked their proposed fiscal year 2014 reinvestments, two agencies—SSA and Education—had established policies and processes to oversee the reallocation (i.e., reinvestment) of funds to other investments. Specifically, according to SSA’s Capital Planning and Investment Control policy, dated November 2014, budget changes are required to be submitted to the Deputy Commissioner for Systems/CIO for approval through the agency’s IT investment management system using the IT funding change request process. The policy further states that such change requests should include an explanation and justification of budget adjustment and discuss the impact of the change on the investments providing the additional funds as well as the investment receiving the funds. Further, according to Education’s IT Investment Management Process Guide, dated March 2014, when additional funding becomes available, Education’s Investment Review Board will convene and take under consideration recommendations for IT investment funding from the department’s Planning and Investment Review Working Group. The guide further states that projects or project components that previously did not receive funding may be reconsidered along with any new investment proposals. The remaining two agencies—Interior and Labor—stated that they did not track performance results of their fiscal year 2014 reinvestments because their CIO offices did not have information regarding such reinvestments at their component agencies. For example, Interior’s officials stated that because the department has a decentralized business structure and investment management autonomy within its 14 bureaus and offices, with each having primary control over their IT spending, it was difficult to be able to track their specific reinvestments. In addition, officials added that a tracking mechanism was not put in place, since the fiscal year 2014 reduction and reinvestment plan was a one-time submission and not an ongoing requirement. Labor’s IT Governance Director cited similar difficulties in tracking the reductions and reinvestments of their component agencies. Incomplete OMB Requirements Have Resulted in Lack of Tracking of Reinvestment Performance The lack of agency tracking of the actual performance of their reinvestments is due, in part, to weaknesses in OMB’s requirements for submitting reinvestment information. Specifically, while agencies were required to establish proposed reductions and reinvestments for fiscal year 2014, OMB did not require agencies to track the actual performance against those reductions and reinvestments. A policy analyst from OMB’s Office of E-Government and Information Technology indicated that agencies were not expected to assess performance against their planned reductions and reinvestments because the exercise was considered to be complete when the fiscal year 2014 President’s budget was issued. However, OMB did not formally convey this information to agencies in its fiscal year 2014 budget guidance or in other guidance documents. Officials from several agencies included in this review stated that the lack of guidance from OMB left them unsure of how to proceed with the reductions and reinvestments in their fiscal year 2014 budget submissions. Further, although OMB’s ongoing requirements for reinvestment information include providing long-range reinvestment plans in agency IRM strategic plans and more specific quarterly reinvestment plans for each cost savings and avoidance initiative, it has not established a requirement for agencies to track the actual performance of their reinvestments. As previously stated, as part of the quarterly integrated data collection submissions, OMB requires agencies to document, for each cost savings and avoidance initiative, their plans to use such savings or avoidances. However, in addition to the fact that most agencies did not provide complete information in these submissions, there is no OMB requirement for agencies to document whether the reinvestment was executed as planned or to report the performance results through the integrated data collection process. In addition, while OMB had previously established targets to guide agencies in their one-time fiscal year 2014 IT reduction and reinvestment plans, its ongoing requirements for reinvestment plans do not include any targets. For example, as previously discussed, OMB’s fiscal year 2014 budget guidance included a reinvestment dollar amount range for each agency. However, the ongoing requirements for reinvestment plans only require agencies to provide narrative on their reinvestment plans and do not require agencies’ reinvestments to meet any specific dollar amounts, specific percentages of planned reductions, or other performance indicator. Established targets are important because, as previously stated, they provide an indicator for gauging progress and improving performance if they are outcome-oriented and actively tracked and reported against. Until OMB requires agencies to report actual reinvestment performance and defines performance targets to guide agency reinvestment efforts, it will be limited in its ability to ensure that agencies are reinvesting funds as planned and may not be able to hold agencies accountable. Further, without visibility into agencies’ reinvestment performance, OMB may not be able to provide effective budgetary oversight. Finally, without improved tracking of reinvestments through the use of existing governance mechanisms and the implementation of FITARA, Interior and Labor may lack assurance that their component agencies are reinvesting in areas consistent with agency-wide goals. Conclusions In the more than 5 years since OMB began its IT reform efforts, agencies have reported more than $3 billion in savings from their implementation of such efforts—most notably, Defense, DHS, Treasury, and SSA, which account for 69 percent of the reported government-wide savings to date. However, continued discrepancies of more than $484 million in the savings being reported by agencies and those being reported in OMB’s quarterly reports to Congress indicates that agencies are still not reporting all of their savings to OMB. OMB and agency implementation of our prior recommendations in this area could help ensure that agencies report all data center consolidation savings, and that OMB’s quarterly reports to Congress accurately reflect savings achieved. Ensuring accurate reporting is increasingly important in light of the December 2014 IT acquisition reform legislation that specifically addresses agency and OMB reporting of IT reform-related savings. The extent of savings reported through fiscal year 2014 makes evident the increasing importance for agencies to establish complete reinvestment plans. While several agencies have established plans in accordance with OMB’s guidance, most ongoing agency reinvestment plans—including the long-range plans in their IRM strategic plans and quarterly plans in their integrated data collection submissions—are incomplete, which raises questions about whether these agencies are in the best position to reallocate funding to the appropriate investments after savings are realized. Until such plans are completed, agencies will be challenged to ensure that their considerable savings are being used in the most efficient and effective manner possible. While the four agencies that we selected documented key governance processes and fully embraced OMB’s “cut and reinvest” guidance by proposing to reinvest the full amount of their proposed reductions in their fiscal year 2014 budget submissions, none of the four agencies was able to provide support that they had tracked the actual performance of their proposed reinvestments. Although SSA and Education have since established policies and processes to oversee reinvestment, two agencies—Interior and Labor—attributed the weaknesses in this tracking to a lack of visibility into component agencies’ reinvestment activities. Expeditiously implementing the requirements of the December 2014 IT acquisition reform legislation in conjunction with OMB’s recent implementation guidance will help to ensure that these agencies have better oversight of their component agencies’ reinvestments. The weaknesses in agency tracking of actual reinvestment performance are also due, in part, to OMB not having established a requirement for reporting such information. When combined with the lack of established performance targets—similar to those used by OMB in the fiscal year 2014 budget cycle—it will be difficult for OMB to gauge agency progress in reinvesting their savings going forward. In the absence of a requirement for agencies to track actual reinvestment performance and defined targets, OMB will be limited in its ability to ensure that agencies’ reinvestments are occurring as planned and may not be able to hold agencies accountable for continued progress. Recommendations for Executive Action To better ensure that agencies’ IT savings are being reinvested in the most efficient and effective manner possible, we are making two recommendations to OMB. Specifically, we recommend that the Director of OMB direct the Federal CIO to ensure that agencies complete their reinvestment plans, in accordance with established requirements, and maintain those plans on an ongoing basis; and require agencies to track actual reinvestment performance and define performance targets for agencies’ reinvestments, as done previously. In addition, we are making 22 recommendations to 17 of the departments and agencies in our review to improve their reinvestment planning and oversight. Appendix II contains these recommendations. Agency Comments and Our Evaluation We received comments on a draft of our report from OMB, the 17 agencies to which we made recommendations, and the remaining 10 that had no recommendations. Specifically, OMB and 12 agencies agreed with our recommendations, while 1 (State) did not state whether it agreed or disagreed, 3 had no comments, and 1 (Defense) partially agreed. The 10 agencies without recommendations stated that they had no comments. Multiple agencies also provided technical comments, which we have incorporated as appropriate. Comments from the agencies to which we made recommendations are discussed in more detail here. In comments provided via e-mail on August 27, 2015, an OMB official from the Office of the General Counsel stated that the agency generally agreed with our report and recommendations and noted that the recommendations would be realized in future budget guidance should OMB engage in a similar effort in the future to realize and reinvest savings. However, OMB also stated that, because the reinvestment plans were included in the fiscal year 2014 budget guidance, changing the rules at this point to have better transparency into the reinvestment decisions would likely outweigh the value of having that detail. Further, the agency stated that, if OMB changed the rules at this stage to require agencies to report investment decisions with greater detail, agencies would invest an inordinate amount of effort for the benefit. We disagree with these statements. As we note in our report, the extent of savings reported through fiscal year 2014 makes evident the increasing importance for OMB to immediately require agencies to complete their reinvestment plans and track reinvestment performance. Until such requirements are in place, agencies may be challenged to ensure that their considerable savings are being used in the most efficient and effective manner possible and OMB will be limited in its ability to ensure that agencies’ reinvestments are occurring as planned. We therefore believe our recommendations are warranted. In written comments, Agriculture’s Assistant Secretary for Administration stated that the department concurred with our recommendation. Agriculture also noted that it supports our recommendations to OMB to define targets for agency reinvestment and require that agencies complete their reinvestment plans and track actual performance. The department’s comments are provided in appendix III. In written comments, Commerce’s Deputy Secretary stated that the department agreed with the report’s recommendations and described actions to address the recommendations. Specifically, Commerce stated that it will review and update its IRM strategic plan to establish a means to oversee reinvestments rendered from the consolidation of commodity IT resources. In addition, the department noted that it will continue to collect and report all initiatives resulting in cost savings and avoidances to ensure IT savings are being realized. The department’s comments are provided in appendix IV. In written comments, Defense’s CIO provided comments for both the department and the U.S. Army Corps of Engineers. It partially concurred with the recommendation made to the Defense CIO related to ensuring that the department’s integrated data collection submission to OMB includes complete plans to reinvest any resulting savings and avoidances from OMB-directed IT reform-related efforts. Specifically, Defense stated that it will continue to use its Planning, Programming, Budget, and Execution process as the framework for decision making on all resource decisions and that savings achieved as a result of Defense IT efficiency efforts will be directed to defense capabilities as determined by the department’s existing process. The department also noted that it is making progress in making these IT resource decisions and associated cost savings and avoidances more transparent. We support the department’s efforts to be more transparent and acknowledge in our report that Defense had approximately $380 million in reported cost savings and avoidances between fiscal years 2011 and 2014. However, considering the magnitude of the department’s reported savings and avoidances, we believe that the department should develop reinvestment plans in accordance with OMB’s guidance. Further, without complete reinvestment plans, the department will be challenged to ensure that its considerable savings are being used in the most efficient and effective manner possible. We therefore believe our recommendation is warranted. The department concurred with the recommendation we made to the U.S. Army Corps of Engineers, stating that the agency will include information in its next IRM strategic plan regarding the approach to reinvesting savings from the consolidation of commodity information management and IT resources in accordance with OMB’s guidance. The department’s comments are provided in appendix V. In written comments, Energy’s CIO stated that the department concurred with our recommendation and described planned actions to address it. Specifically, the CIO stated that the department will ensure that its integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Energy’s written comments are provided in appendix VI. In written comments, HHS’s Assistant Secretary for Legislation stated that the department concurred with our recommendation and described planned actions to address it. Specifically, the department stated that HHS’s Office of the CIO will address reinvestment of cost savings when the department’s IRM Strategic Plan is next updated. The department also provided technical comments, which we have incorporated as appropriate. HHS’s written comments are provided in appendix VII. In written comments, DHS’s Director of the Departmental GAO-OIG Liaison Office stated that the department concurred with our recommendation and described planned actions to address it. Specifically, the department stated that the DHS CIO will ensure that the integrated data collection submission to OMB includes complete plans to reinvest any resulting savings and avoidances from OMB- directed IT reform-related efforts for all reported initiatives. DHS also elaborated on existing IT governance processes in place to facilitate planning for the reinvestment of cost savings, as well as other decision-making processes for budget and acquisition used to enable investment recommendations. However, the department also noted that OMB does not currently require agencies to document reinvestment plans for cost savings achieved and cited our prior report on the implementation of OMB’s PortfolioStat initiative. We disagree with this statement. As mentioned in this report, agencies are required to submit quarterly reinvestment plans via their integrated data collection submissions to OMB, which are to describe agency plans to use the resulting cost savings or avoidances for each IT reform-related savings and avoidance initiative reported. In our prior report on OMB’s PortfolioStat initiative, we determined that there was no OMB requirement for agencies to report whether they had actually reinvested the funds as planned—an issue that raises questions about whether reinvestments actually occurred. As such, we believe we have accurately presented OMB’s requirements for reporting reinvestment plan information in this report. DHS’s written comments are provided in appendix VIII. In written comments, HUD’s CIO stated that the department concurred with our recommendation. HUD’s written comments are provided in appendix IX. In written comments, Interior’s Principal Deputy Assistant Secretary of Policy, Management and Budget stated that the department generally agreed with our findings and concurred with our recommendations. The department also described planned actions to address the recommendations, including that the Office of the CIO will update its integrated data collection template to make reinvestment plans a required field and review the reinvestment plans for completeness prior to submission to OMB. In addition, the department stated that these new procedures, along with existing and improved governance mechanisms, will be used to facilitate better tracking of how savings are reinvested. Interior’s written comments are provided in appendix X. In comments provided via e-mail on August 11, 2015, a Labor audit liaison stated that the department had no comments on the report. In written comments, State’s Comptroller did not agree or disagree with our recommendation, but described planned actions to update its strategic planning guidance to provide additional information on the allocation and reinvestment of IT resources. The department also elaborated on efforts to initiate IT reforms, cost reductions, and reinvestment efforts since 2011, and stated that it is working to ensure that the cost savings yielded by data center consolidation activities are reinvested into the department’s strategic priorities. State’s written comments are provided in appendix XI. In comments provided by e-mail on August 12, 2015, an audit liaison from Treasury’s Office of the CIO stated that the department had no comments on the report. In written comments, VA’s Chief of Staff stated that the department generally agreed with our conclusions and concurred with our recommendation. The department also described planned actions to address our recommendation, stating that its Office of Information and Technology plans to establish a program management office to track cost savings, avoidance, and reinvestment opportunities by the end of 2015. VA’s written comments are provided in appendix XII. In written comments, EPA’s CIO stated that the agency concurred with our recommendation. In addition, the CIO noted that it would resolve our finding that its one-time fiscal year 2014 reduction and reinvestment plan did not meet OMB’s guidance. However, the agency did not provide additional documentation to support a revision to our evaluation. As such, we continue to believe our evaluation is appropriate. EPA’s written comments are provided in appendix XIII. In written comments, NRC’s Deputy Executive Director for Corporate Management stated that NRC staff agreed with our findings and recommendations. NRC also noted that, while OMB has issued guidance requiring agencies to report cost savings, the guidance is general in nature. The agency added that a discussion of how agencies’ IT reinvestment and reporting would benefit from specific cost definitions and categorization would be useful in our report and would facilitate more meaningful comparisons among agencies. While we acknowledge NRC’s comments, this report focused on agencies’ progress in achieving savings from their IT reform efforts and did not review the adequacy of OMB’s guidance on reporting cost savings, including related cost definitions and categorizations. As a result, we do not have a basis to recommend improvements to OMB’s guidance in these areas. NRC’s written comments are provided in appendix XIV. In written comments, OPM’s CIO stated that the agency concurred with our recommendation and noted that, in future updates to OPM’s Strategic IT Plan, information will be provided regarding the approach to reinvesting savings from the consolidation of commodity IT resources (including data centers) in accordance with OMB’s guidance. OPM’s written comments are provided in appendix XV. In comments provided via e-mail on July 17, 2015, a systems accountant from USAID’s Office of the Chief Financial Officer, Audit, Performance and Compliance Division stated that the agency had no comments on the report. The agency also provided technical comments, which we have incorporated as appropriate. Comments from the agencies without recommendations are discussed in more detail here. In comments provided by e-mail on August 11, 2015, a policy analyst from Education’s Office of the Secretary stated that the department had no comments on the report. The department also provided technical comments, which we have incorporated as appropriate. In comments provided by e-mail on August 11, 2015, a Justice audit liaison specialist stated that the department had no comments on the report. In comments provided via e-mail on July 27, 2015, Transportation’s Deputy Director, Office of Audit Relations, stated that the department had no comments on the report. In comments provided via e-mail on August 11, 2015, a financial management analyst from GSA’s Office of Administrative Services, GAO/IG Audit Response Division stated that the department had no additional comments on the report. Our draft report provided to GSA for comment included a recommendation that the agency ensure that its integrated data collection submission to OMB include, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. This was based on the agency’s quarterly integrated data collection submission to OMB not including reinvestment plan information for 3 of the agency's 13 cost savings and avoidance initiatives. Subsequently, GSA provided additional documentation that included reinvestment plans for all of its initiatives. As a result of GSA's action, we have removed the recommendation and made appropriate changes in the report to reflect the updated information. In comments provided via e-mail on August 12, 2015, NASA’s GAO/OIG Audit Liaison Team Lead stated that the agency had no comments on the report. In written comments, the Archivist of the United States stated that the agency had no comments on the report. NARA’s written comments are provided in appendix XVI. In written comments, NSF’s CIO stated that the agency had no comments on the report. NSF’s written comments are provided in appendix XVII. In comments provided via e-mail on August 5, 2015, the program manager for SBA’s Office of Congressional and Legislative Affairs stated that the agency had no comments on the report. In comments provided via e-mail on August 17, 2015, an official from Smithsonian’s Office of Government Relations stated that the agency had no comments on the report. In written comments, SSA’s Executive Counselor to the Commissioner stated that the agency had no comments on the report. SSA’s written comments are provided in appendix XVIII. We are sending copies of this report to interested congressional committees, the Director of OMB, the secretaries and agency heads of the departments and agencies addressed in this report, and other interested parties. In addition, the report will be available at no charge on GAO’s website at http://www.gao.gov. If you or your staffs have any questions on the matters discussed in this report, please contact me at (202) 512-9286 or pownerd@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix XIX. Appendix I: Objectives, Scope, and Methodology Our objectives were to (1) assess agencies’ progress in achieving savings from their information technology (IT) reform efforts; (2) evaluate the extent to which agencies have established plans to reinvest their savings; and (3) evaluate how selected agencies have reinvested their savings, including the extent to which IT governance processes are in place to oversee such reinvestments. To assess agencies’ progress in achieving savings from their IT reform efforts, we obtained and analyzed the cost savings and avoidance documentation from the 26 departments and agencies (agencies) that are required to implement the Office of Management and Budget’s (OMB) PortfolioStat initiative. This documentation included, but was not limited to, quarterly status reports to OMB and other agency-developed spreadsheets and reporting tools. We then identified the total agency- reported savings and avoidances achieved from fiscal years 2011 to 2014. To assess the reliability of agencies’ savings and avoidance data, we reviewed agency documentation for missing data or other errors (e.g., incorrect calculations). We compared the cost savings and avoidances reported to us by agencies with cost savings identified in OMB’s quarterly reports to Congress on the status of IT reform efforts. In addition, we interviewed agency officials to confirm our understanding of their reported savings and avoidances and obtain additional supporting information regarding the steps that the agency took to ensure the reliability of its figures and validate these figures. We also discussed with agency officials any discrepancies or potential errors identified during our review of their supporting documentation to determine the cause or request additional information. We determined that the data were sufficiently reliable to report on agencies’ cost savings and avoidances achieved to date. However, as part of our reliability assessment, we identified issues with the reliability of OMB’s quarterly reports to Congress, including that agencies’ cost savings and avoidances were not being fully reflected in OMB’s report. We have highlighted this issue in our report. To evaluate the extent to which agencies have established plans to reinvest their savings, we compared 26 PortfolioStat agencies’ long-range (e.g., 3-5 year) reinvestment plan information in their information resource management (IRM) strategic plans to OMB’s guidance, as documented in OMB’s March 2013 PortfolioStat memorandum. This guidance states that agencies are to describe plans to reinvest savings resulting from the consolidation of commodity IT resources, including data centers, in their IRM strategic plans. We rated this requirement as “fully implemented” if the agency’s IRM strategic plan or equivalent document contained this information and “not implemented” if the agency’s IRM strategic plan did not contain this information. We also compared 27 agencies’ fiscal year 2014 IT reductions and reinvestments plans, as documented in their budget submissions for that fiscal year, to requirements in OMB’s fiscal year 2014 budget guidance. More specifically, we assessed whether each agency had met OMB’s targets for proposed reductions and reinvestments and whether the agency had included supplemental information for each reduction and reinvestment, including OMB budget account number, reduction and reinvestment types, explanation of the changes in funding, priority level, and description of the favorable return on investments, in accordance with OMB’s guidance. We rated this requirement as “fully implemented” if the agency’s submission met or exceeded OMB’s reduction and reinvestments targets and included all required supplemental information; “partially implemented” if the agency’s submission either did not meet OMB’s reduction and reinvestment targets or did not include the required supplemental information for each of the proposed reductions and reinvestments; and “not implemented” if the agency did not meet OMB’s reduction and reinvestment targets and did not provide supplemental information for all required fields, or the agency did not submit the required documentation to OMB. To assess the reliability of agencies’ IT reduction and reinvestment plans in their fiscal year 2014 budget submission, we checked the submissions for obvious omissions (i.e., fields left blank), mistakes (e.g., incorrect calculations), outliers, and other potential errors (e.g., IT reinvestments occurring in the same areas as the reductions). We also interviewed agency officials and, in some cases, obtained written responses from agencies regarding the processes and methods used to determine their IT reductions and reinvestments, the related supporting documentation, and the steps that the agency took to review and approve its submission and ensure the reliability of and validate its figures. In cases where we found missing data or potential errors, we interviewed agency officials to determine the cause or request additional information. We found the data sufficiently reliable for reporting on the completeness of agencies’ IT reduction and reinvestment plans. However, certain agencies were missing supplemental information related to their proposed IT reductions and reinvestments, such as reduction and reinvestment types and explanations of the changes in funding. We highlight this issue in our report. Finally, we compared the 26 PortfolioStat agencies’ quarterly reinvestment plans, as documented in their status reports to OMB (known as the integrated data collection submission), against OMB’s instructions for submitting such reports. These instructions state that agencies are to include both a category and details regarding their plans to use any cost savings and avoidances resulting from the savings and avoidance initiatives reported in their quarterly submission. We rated agencies as “fully implemented” if they included both the category and details for each cost savings and avoidance initiative reported; “partially implemented” if the agency provided reinvestment category, but not details, or did not include category and details for all cost savings and avoidance initiatives reported, and; “not implemented” if the agency did not include reinvestment category and details for all cost savings and avoidance initiatives reported. For evaluating how selected agencies have reinvested their savings, including the extent to which IT governance processes are in place to oversee such reinvestments, we selected four federal agencies (the Departments of Education, Interior, and Labor, and the Social Security Administration) based on their fiscal year 2014 proposed IT reductions and reinvestments, as documented in their budget submission documentation. We chose these agencies because, of the agencies with the highest percentage of proposed reinvestment (i.e., 100 percent reinvestment of proposed reductions), these agencies had the four highest proposed reinvestment dollar amounts. We compared the governance processes used by these agencies to develop their fiscal year 2014 budget submission (including planned IT reductions and reinvestments) to key practices for establishing investment boards in our IT Investment Management Framework. We also analyzed agencies’ actual performance against their proposed fiscal year 2014 IT reductions and reinvestments. Finally, we interviewed agency officials to further our understanding of how agency IT governance processes were involved with the development of the fiscal year 2014 budget submission and to discuss the extent to which the agency had documented actual fiscal year 2014 reductions and reinvestments. We conducted this performance audit from October 2014 to September 2015 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Recommendations to Departments and Agencies Department of Agriculture To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of Agriculture direct the CIO to take the following action: Ensure that the department’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Department of Commerce To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of Commerce direct the CIO to take the following two actions: As part of any future update to the department’s IRM strategic plan or equivalent document, include information regarding the approach to reinvesting savings from the consolidation of commodity IT resources (including data centers) in accordance with OMB’s guidance. Ensure that the department’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Department of Defense To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of Defense direct the Defense CIO to take the following action: Ensure that the department’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. In addition, to improve the U.S. Army Corps of Engineers’ IT savings reinvestment plans, we recommend that the Secretary of Defense direct the Secretary of the Army to take the following action: As part of any future update to the U.S. Army Corps of Engineers’ IRM strategic plan or equivalent document, include information regarding the approach to reinvesting savings from the consolidation of commodity IT resources (including data centers) in accordance with OMB’s guidance. Department of Energy To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of Energy direct the CIO to take the following action: Ensure that the department’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Department of Health and Human Services To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of Health and Human Services direct the CIO to take the following action: As part of any future update to the department’s IRM strategic plan or equivalent document, include information regarding the approach to reinvesting savings from the consolidation of commodity IT resources (including data centers) in accordance with OMB’s guidance. Department of Homeland Security To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of Homeland Security direct the CIO to take the following action: Ensure that the department’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Department of Housing and Urban Development To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of Housing and Urban Development direct the CIO to take the following action: Ensure that the department’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Department of the Interior To improve the department’s IT savings reinvestment plans and tracking of reinvestments, we recommend that the Secretary of the Interior direct the CIO to take the following two actions: Ensure that the department’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Use existing governance mechanisms and any improvements resulting from the implementation of FITARA to improve tracking of how savings have been reinvested. Department of Labor To improve the department’s tracking of reinvestments, we recommend that the Secretary of Labor direct the CIO to take the following action: Use existing governance mechanisms and any improvements resulting from the implementation of FITARA to improve tracking of how savings have been reinvested. Department of State To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of State direct the CIO to take the following action: As part of any future update to the department’s IRM strategic plan or equivalent document, include information regarding the approach to reinvesting savings from the consolidation of commodity IT resources (including data centers) in accordance with OMB’s guidance. Department of the Treasury To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of the Treasury direct the CIO to take the following two actions: As part of any future update to the department’s IRM strategic plan or equivalent document, include information regarding the approach to reinvesting savings from the consolidation of commodity IT resources (including data centers) in accordance with OMB’s guidance. Ensure that the department’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to use any resulting cost savings and avoidances from OMB-directed IT reform- related efforts. Department of Veterans Affairs To improve the department’s IT savings reinvestment plans, we recommend that the Secretary of Veterans Affairs direct the CIO to take the following action: Ensure that the department’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Environmental Protection Agency To improve the agency’s IT savings reinvestment plans, we recommend that the Administrator of the Environmental Protection Agency direct the CIO to take the following action: Ensure that the agency’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Nuclear Regulatory Commission To improve the agency’s IT savings reinvestment plans, we recommend that the Chairman of the U.S. Nuclear Regulatory Commission direct the CIO to take the following two actions: As part of any future update to the agency’s IRM strategic plan or equivalent document, include information regarding the approach to reinvesting savings from the consolidation of commodity IT resources (including data centers) in accordance with OMB’s guidance. Ensure that the agency’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Office of Personnel Management To improve the agency’s IT savings reinvestment plans, we recommend that the Director of the Office of Personnel Management direct the CIO to take the following action: As part of any future update to the agency’s IRM strategic plan or equivalent document, include information regarding the approach to reinvesting savings from the consolidation of commodity IT resources (including data centers) in accordance with OMB’s guidance. U.S. Agency for International Development To improve the agency’s IT savings reinvestment plans, we recommend that the Administrator of the U.S. Agency for International Development direct the CIO to take the following two actions: As part of any future update to the agency’s IRM strategic plan or equivalent document, include information regarding the approach to reinvesting savings from the consolidation of commodity IT resources (including data centers) in accordance with OMB’s guidance. Ensure that the agency’s integrated data collection submission to OMB includes, for all reported initiatives, complete plans to reinvest any resulting cost savings and avoidances from OMB-directed IT reform-related efforts. Appendix III: Comments from the Department of Agriculture Appendix IV: Comments from the Department of Commerce Appendix V: Comments from the Department of Defense Appendix VI: Comments from the Department of Energy Appendix VII: Comments from the Department of Health and Human Services Appendix VIII: Comments from the Department of Homeland Security Appendix IX: Comments from the Department of Housing and Urban Development Appendix X: Comments from the Department of the Interior Appendix XI: Comments from the Department of State Appendix XII: Comments from the Department of Veterans Affairs Appendix XIII: Comments from the Environmental Protection Agency Appendix XIV: Comments from the Nuclear Regulatory Commission Appendix XV: Comments from the Office of Personnel Management Appendix XVI: Comments from the National Archives and Records Administration Appendix XVII: Comments from the National Science Foundation Appendix XVIII: Comments from the Social Security Administration Appendix XIX: GAO Contact and Staff Acknowledgments GAO Contact Staff Acknowledgments In addition to the contact named above, individuals making contributions to this report included Dave Hinchman (Assistant Director), Justin Booth, Chris Businsky, Corey Evans, Nancy Glover, Lisa Hardman, and Jonathan Ticehurst.

Beginning in 2010, OMB initiated a series of IT reform efforts to consolidate the growing number of data centers and eliminate duplicative spending. In May 2012, the agency began a “cut and reinvest” effort that required agencies to propose fiscal year 2014 IT reductions and reinvestments. GAO was asked to review agencies' savings from OMB's IT reform efforts and determine how those savings are being reinvested. The objectives were to (1) assess agencies' progress in achieving savings from their IT reform efforts, (2) evaluate agencies' plans to reinvest their savings, and (3) evaluate how selected agencies have reinvested their savings and governance processes to oversee the reinvestments. GAO assessed 26 agencies' cost savings and avoidance documentation, evaluated 27 agencies' (including the Smithsonian Institution) reinvestment plans against OMB's guidance, and compared 4 of the agencies' governance processes against best practices. The 4 agencies were selected, in part, because they had the highest dollar amounts of proposed IT reinvestments. Twenty-four of the 26 federal agencies participating in the Office of Management and Budget's (OMB) information technology (IT) reform initiatives reported achieving an estimated total of $3.6 billion dollars in cost savings and avoidances between fiscal years 2011 and 2014. Slightly more than half (or about $2.0 billion) of the savings and avoidances were from data center consolidation and optimization efforts. Notably, of the $3.6 billion total, the Departments of Defense, Homeland Security, Treasury, and the Social Security Administration accounted for about $2.5 billion (or 69 percent). Most agencies did not fully meet OMB's requirements to submit reinvestment plan information. Of the 27 agencies required to submit reinvestment plans (including one-time and ongoing plans), 5 agencies had fully implemented OMB's guidance, while the remaining 22 had only partially implemented it. For example, most agencies had not fully implemented OMB's guidance for submitting one-time fiscal year 2014 IT reduction and reinvestment plans as part of OMB's “cut and reinvest” effort. As a result, agencies' plans were substantially short of OMB's overall fiscal year 2014 targets: $3.0 billion in proposed reductions and $2.1 billion in proposed reinvestments, compared to OMB's targets of $7.6 billion in reductions and as much as $7.6 billion in reinvestments. Agencies provided varied reasons for not meeting OMB's requirements, such as that their components had not fully tracked and reported how their savings were to be reinvested. Until agencies complete their ongoing reinvestment plans, they will be challenged to ensure that their considerable savings are being used in the most efficient and effective manner possible. Four selected agencies—the Departments of Education, Interior, Labor, and the Social Security Administration—had documented key governance processes to guide the development of their fiscal year 2014 budget submission, which included proposed IT reinvestments of $350 million. However, none of the four agencies had tracked the reinvestment performance results. They provided varied reasons for not doing so, and two agencies noted the lack of visibility into their components' reinvestments. The lack of performance tracking is also due to OMB not requiring agencies to document actual results. In addition, OMB has not defined targets for reinvestments beyond fiscal year 2014. Until OMB requires agencies to track actual reinvestment performance and defines targets, it will be limited in its ability to ensure that agencies are actually reinvesting funds as planned and may not be able to hold them accountable. Finally, without improved tracking, selected agencies may lack assurance that their components are reinvesting in areas consistent with agency-wide goals.