U.S. Government Financial Statements: Fiscal Year 2009 Audit Highlights Financial Management Challenges and Unsustainable Long-Term Fiscal Path
Published: 2010-04-14T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO annually audits the consolidated financial statements of the U.S. government (CFS). Congress and the President need reliable, useful, and timely financial and performance information to make sound decisions and conduct effective oversight of federal government programs and policies. The federal government began preparing the CFS 13 years ago. Over the years, certain material weaknesses in internal control over financial reporting have prevented GAO from expressing an opinion on the accrual-based consolidated financial statements. Unless these weaknesses are adequately addressed, they will, among other things, continue to (1) hamper the federal government's ability to reliably report a significant portion of its assets, liabilities, costs, and other related information; and (2) affect the federal government's ability to reliably measure the full cost as well as the financial and nonfinancial performance of certain programs and activities. This testimony presents the results of GAO's audit of the CFS for fiscal year 2009 and discusses certain of the federal government's significant near- and long-term fiscal challenges.
section_title: What GAO Found
paragraphs: For the third consecutive year, GAO rendered an unqualified opinion on the Statement of Social Insurance (SOSI). Given the importance of social insurance programs like Medicare and Social Security to the federal government's long-term fiscal outlook, the SOSI is critical to understanding the federal government's financial condition and fiscal sustainability. Three major impediments continued to prevent GAO from rendering an opinion on the federal government's consolidated financial statements other than the SOSI: (1) serious financial management problems at the Department of Defense, (2) federal entities' inability to adequately account for and reconcile intragovernmental activity and balances, and (3) an ineffective process for preparing the consolidated financial statements. In addition to the material weaknesses underlying these major impediments, GAO noted material weaknesses involving improper payments estimated to be at least $98 billion for fiscal year 2009, information security, and tax collection activities. The recession and the federal government's unprecedented actions intended to stabilize the financial markets and to promote economic recovery have significantly affected the federal government's financial condition. The resulting substantial investments and increases in liabilities, net operating cost, the unified budget deficit, and debt held by the public are reported in the U.S. government's consolidated financial statements for fiscal year 2009. The ultimate cost of these actions and their impact on the federal government's financial condition will not be known for some time in part because the valuation of these assets and liabilities is based on assumptions and estimates that are inherently uncertain. Looking ahead, the federal government will need to determine the most expeditious manner in which to bring closure to its financial stabilization initiatives while optimizing its investment returns. In addition, problems in the nation's financial sector have exposed serious weaknesses in the current U.S. financial regulatory system. If those weaknesses are not adequately addressed, we could see similar or even worse crises in the future. Consequently, meaningful financial regulatory reform is of utmost concern. The federal government faces a long-term fiscal challenge resulting from large and growing structural deficits that are driven on the spending side primarily by rising health care costs and known demographic trends. GAO prepares long-term fiscal simulations that include projections of revenue and expenditures for all federal programs. As a result, these simulations present a comprehensive analysis of the sustainability of the federal government's long-term fiscal outlook. Many of the pressures highlighted in GAO's simulations, including health care cost growth and the aging population, have already begun to affect the federal budget--in some cases sooner than previously estimated--and the pressures only grow in the coming decade. For example, Social Security cash surpluses have previously served to reduce the unified budget deficit; however, the Congressional Budget Office recently estimated that due to current economic conditions the program will run small temporary cash deficits for the next 4 years and then, similar to the Trustees' estimates, run persistent cash deficits beginning in 2016. The fluctuation and eventual disappearance of the Social Security cash surplus will put additional pressure on the rest of the federal budget.

section_title: Letter
paragraphs: I appreciate the opportunity to be here today to discuss our report on the  U.S. government’s consolidated financial statements for fiscal years 2009  and 2008. Given the federal government’s near- and long-term fiscal  challenges, the need for transparency and for Congress, the  administration, and federal managers to have reliable, useful, and timely  financial and performance information is greater than ever. As our report  illustrates, however, even though certain progress has been made, much  work remains to improve federal financial management. Consequently,  financial management needs to be a top priority of this administration and  Congress. I would like to commend you, Madam Chairwoman, and this  Subcommittee, for continuing the annual tradition of oversight hearings on  this important subject. Your involvement is critical to assuring progress.
Our testimony today discusses (1) the major issues relating to the  consolidated financial statements for fiscal years 2009 and 2008, including  continued major impediments to an opinion on the consolidated financial  statements other than the Statement of Social Insurance; (2) the impacts  of the economic recession and the federal government’s unprecedented  actions intended to stabilize the financial markets and to promote  economic recovery on the federal government’s financial condition; and  (3) challenges posed by the federal government’s current long-term fiscal  outlook. Our audit was conducted in accordance with U.S. 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.
Both the consolidated financial statements and our related audit report are  included in the fiscal year 2009 Financial Report of the United States  Government (Financial Report). Our audit report would not be possible  without the commitment and professionalism of inspectors general  throughout the federal government who are responsible for annually  auditing the financial statements of individual federal agencies. The  Financial Report was issued by the Department of the Treasury  (Treasury) on February 26, 2010. This report is available through GAO’s  Internet site, at http://www.gao.gov/financial/fy2009financialreport.html  and Treasury’s Internet site, at http://www.fms.treas.gov/fr/index.html.
subsections: section_title: Highlights of Major Issues Related to the U.S. Government’s Consolidated Financial Statements for Fiscal Years 2009 and 2008
paragraphs: Since the enactment of key financial management reforms in the 1990s, the  federal government has made significant progress in improving financial  management activities and practices. As shown in appendix I, 20 of 24  Chief Financial Officers (CFO) Act agencies were able to attain unqualified  audit opinions on their fiscal year 2009 financial statements. In contrast,  only 6 CFO Act agencies received unqualified audit opinions for fiscal year  1996. Also, accounting and financial reporting standards have continued to  evolve to provide greater transparency and accountability over the federal  government’s operations, financial condition, and fiscal outlook. Further,  we were able to render unqualified opinions on the 2009, 2008, and 2007  Statements of Social Insurance. Given the importance of social insurance  programs like Medicare and Social Security to the federal government’s  long-term fiscal outlook, the Statement of Social Insurance is critical to  understanding the federal government’s financial condition and fiscal  sustainability.
Although this progress is commendable, the federal government did not  maintain adequate systems or have sufficient, reliable evidence to support  certain significant information reported in the U.S. government’s accrual- based consolidated financial statements. Underlying material weaknesses  in internal control, which generally have existed for years, contributed to  our disclaimer of opinion on the U.S. government’s accrual-based  consolidated financial statements for the fiscal years ended 2009 and  2008. Those material weaknesses relate to the federal government’s  inability to  satisfactorily determine that property, plant, and equipment and  inventories and related property, primarily held by the Department of  Defense (DOD), were properly reported in the accrual-based  consolidated financial statements;   reasonably estimate or adequately support amounts reported for  certain liabilities, such as environmental and disposal liabilities, or  determine whether commitments and contingencies were complete  and properly reported;   support significant portions of the total net cost of operations, most  notably related to DOD, and adequately reconcile disbursement  activity at certain federal entities;  adequately account for and reconcile intragovernmental activity and  balances between federal entities;   ensure that the federal government’s accrual-based consolidated  financial statements were (1) consistent with the underlying audited  entities’ financial statements, (2) properly balanced, and (3) in  conformity with U.S. generally accepted accounting principles  (GAAP); and   identify and either resolve or explain material differences between  certain components of the budget deficit reported in Treasury’s  records, which are used to prepare the Reconciliation of Net Operating  Cost and Unified Budget Deficit and Statement of Changes in Cash  Balance from Unified Budget and Other Activities, and related  amounts reported in federal entities’ financial statements and  underlying financial information and records.
In addition to the material weaknesses that contributed to our disclaimer  of opinion on the accrual-based consolidated financial statements, we  found three other material weaknesses in internal control. These other  material weaknesses were the federal government’s inability to    determine the full extent to which improper payments occur and  reasonably assure that appropriate actions are taken to reduce  improper payments,  identify and resolve information security control deficiencies and  manage information security risks on an ongoing basis, and  effectively manage its tax collection activities.
The material weaknesses discussed in our audit report continued to (1)  hamper the federal government’s ability to reliably report a significant  portion of its assets, liabilities, costs, and other related information; (2)  affect the federal government’s ability to reliably measure the full cost as  well as the financial and nonfinancial performance of certain programs  and activities; (3) impair the federal government’s ability to adequately  safeguard significant assets and properly record various transactions; and  (4) hinder the federal government from having reliable financial  information to operate in an efficient and effective manner.
Also, many of the CFO Act agencies continue to struggle with financial  systems that are not integrated and do not meet the needs of management  for reliable, useful, and timely financial information. Often, agencies  expend major time, effort, and resources to develop information that their  systems should be able to provide on a daily or recurring basis.
subsections: section_title: Addressing Impediments to an Opinion on the Accrual-Based Consolidated Financial Statements
paragraphs: Three major impediments continued to prevent us from rendering an  opinion on the U.S. government’s accrual-based consolidated financial  statements: (1) serious financial management problems at DOD that have  prevented DOD’s financial statements from being auditable, (2) the federal  government’s inability to adequately account for and reconcile  intragovernmental activity and balances between federal entities, and   (3) the federal government’s ineffective process for preparing the  consolidated financial statements. Additional impediments, such as certain  entities’ fiscal year 2009 financial statements that, as of the date of our  audit report, received disclaimers of opinion or were not audited, also  contributed to our inability to render an opinion on the U.S. government’s  accrual-based consolidated financial statements. Extensive efforts by DOD  and other entity officials and cooperative efforts between entity chief  financial officers, Treasury officials, and Office of Management and  Budget (OMB) officials will be needed to resolve these obstacles to  achieving an opinion on the U.S. government’s accrual-based consolidated  financial statements.
subsections: section_title: Improving Financial Management at DOD
paragraphs: Given DOD’s significant size and complexity, the resolution of its serious  financial management problems is an essential element in further  improving financial management governmentwide and ultimately to  achieving an opinion on the U.S. government’s consolidated financial  statements. Reported weaknesses in DOD’s financial management and  other business operations adversely affect the reliability of DOD’s  financial data; the economy, efficiency, and effectiveness of its operations;  and its ability to produce auditable financial statements. DOD continues to  dominate GAO’s list of high-risk programs designated as vulnerable to  waste, fraud, abuse, and mismanagement. Eight of the high-risk areas are  specific to DOD and include DOD’s overall approach to business  transformation, and financial and contract management.
To effectively transform its business operations, DOD management must  have reliable financial information. Without it, DOD is severely hampered  in its ability to make sound budgetary and programmatic decisions,  monitor trends, make adjustments to improve performance, reduce  operating costs, or maximize the use of resources.
DOD continues to take steps toward addressing the department’s long- standing financial management weaknesses. The current DOD  Comptroller’s focus on improving the department’s budgetary information  and asset accountability will result in a change in emphasis within the  Financial Improvement and Audit Readiness (FIAR) Plan, DOD’s plan for  improving its financial management. The emphasis is now on two areas— first, strengthening information and processes supporting the department’s  Statements of Budgetary Resources; and second, improving the accuracy  and reliability of management information pertaining to the department’s  mission-critical assets, including weapons systems, real property, and  general equipment, and validating improvement through existence and  completeness testing.
Budgetary and asset-accountability information is widely used by DOD  managers at all levels. As such, its reliability is vital to daily operations and  management. In this regard, the Marine Corps recently began an audit of  its fiscal year 2010 Statement of Budgetary Resources. DOD intends to  share with the other services the approaches and lessons learned from the  Marine Corps audit.
A concentrated focus such as the DOD Comptroller’s emphasis on budget  and asset information may increase the department’s ability to show  incremental progress toward achieving auditability in the short term. In  response to GAO’s recommendations, the department has also put in place  a process to improve standardization and comparability of financial  management improvement efforts among the military services. The  success of this process will depend on top management support and  oversight, as well as high-quality planning and effective implementation at  all levels.
GAO, Financial Management: Achieving Financial Statement Auditability in the  Department of Defense, GAO-09-373 (Washington, D.C.: May 6, 2009). develop standardized guidance for financial improvement plans by  components of the department;   establish a baseline of financial management capabilities and  weaknesses at the component level;    provide results-oriented metrics for measuring and reporting  quantifiable results toward addressing financial management    define the oversight roles of the Chief Management Officer (CMO) of  the department, the CMOs of the military services, and other  appropriate elements of the department to ensure that the FIAR  requirements are carried out;   assign to appropriate officials and organizations at the component  level accountability for carrying out specific elements of the FIAR    develop mechanisms to track budgets and expenditures for  implementation of the FIAR requirements; and    develop a mechanism to conduct audits of the military intelligence  programs and agencies and submit the audited financial statements to  Congress in a classified manner.
We are encouraged by continuing congressional oversight of DOD’s  business transformation and financial management improvement efforts  and the commitment of DOD’s leaders to implementing sustained  improvements in the department’s ability to produce reliable, useful, and  timely information for decision making and reporting. We will continue to  monitor DOD’s progress in addressing its financial management  weaknesses and transforming its business operations. As part of this  effort, we are also monitoring DOD’s specific actions to achieve financial  statement auditability for its components.
section_title: Reconciling Intragovernmental Activity and Balances
paragraphs: Federal entities are unable to adequately account for and reconcile  intragovernmental activity and balances. For both fiscal years 2009 and  2008, amounts reported by federal entity trading partners for certain  intragovernmental accounts were not in agreement by significant amounts.  Although OMB and Treasury require the CFOs of 35 federal entities to  reconcile, on a quarterly basis, selected intragovernmental activity and  balances with their trading partners, a substantial number of the entities  did not adequately perform those reconciliations for fiscal years 2009 and  2008.
In addition, these entities are required to report to Treasury, the entity’s  inspector general, and GAO on the extent and results of intragovernmental  activity and balance-reconciliation efforts as of the end of the fiscal year. A  significant number of CFOs were unable to adequately explain or support  the material differences with their trading partners. Many cited differing  accounting methodologies, accounting errors, and timing differences for  their material differences with their trading partners. Some CFOs simply  indicated that they were unable to explain the differences with their  trading partners with no indication as to when the differences would be  resolved. As a result of these circumstances, the federal government’s  ability to determine the impact of these differences on the amounts  reported in the accrual-based consolidated financial statements is  significantly impaired.
GAO has identified and reported on numerous intragovernmental activities  and balances issues and has made several recommendations to Treasury  and OMB to address those issues. Treasury and OMB have generally taken  or plan to take actions to address these recommendations. Treasury  continues to take steps to help resolve material differences in  intragovernmental activity and balances. For example, beginning in the  third quarter of 2009, Treasury required entities to perform additional  reconciliations related to certain intragovernmental appropriations and  transfer activity. Resolving the intragovernmental transactions problem  remains a difficult challenge and will require a strong commitment by  federal entities to fully implement guidance regarding business rules for  intragovernmental transactions issued by OMB and Treasury as well as  continued strong leadership by OMB and Treasury.
section_title: Preparing the Consolidated Financial Statements
paragraphs: While further progress was demonstrated in fiscal year 2009, the federal  government continued to have inadequate systems, controls, and  procedures to ensure that the consolidated financial statements are  consistent with the underlying audited entity financial statements,  properly balanced, and in conformity with GAAP. For example,    Treasury’s process did not ensure that the information in the  Statement of Operations and Changes in Net Position, Reconciliations  of Net Operating Cost and Unified Budget Deficit, and Statements of  Changes in Cash Balance from Unified Budget and Other Activities  was fully consistent with the underlying information in federal entities’  audited financial statements and other financial data.
To make the fiscal years 2009 and 2008 consolidated financial  statements balance, Treasury recorded net increases of $17.4 billion  and $29.8 billion, respectively, to net operating cost on the Statement  of Operations and Changes in Net Position, which it labeled  “Unmatched transactions and balances.” An additional net $8 billion  and $11 billion of unmatched transactions were recorded in the  Statement of Net Cost for fiscal years 2009 and 2008, respectively.  Treasury is unable to fully identify and quantify all components of  these unreconciled activities.
Treasury’s reporting of certain financial information required by GAAP  continues to be impaired. Due to certain material weaknesses noted in  our audit report—for example, commitments and contingencies  related to treaties and other international agreements—Treasury is  precluded from determining if additional disclosure is required by  GAAP in the consolidated financial statements, and we are precluded  from determining whether the omitted information is material.  Further, Treasury’s ability to report information in accordance with  GAAP will also remain impaired until federal entities, such as DOD,  can provide Treasury with complete and reliable information required  to be reported in the consolidated financial statements.
A detailed discussion of additional control deficiencies regarding the  process for preparing the consolidated financial statements can be found  on pages 226 through 229 of the Financial Report.
During fiscal year 2009, Treasury, in coordination with OMB, continued  implementing corrective action plans and made progress in addressing  certain internal control deficiencies we have previously reported regarding  the process for preparing the consolidated financial statements. Resolving  some of these internal control deficiencies will be a difficult challenge and  will require a strong commitment from Treasury and OMB as they  continue to execute and implement their corrective action plans.
section_title: Addressing Other Impediments
paragraphs: While not as significant as the major impediments noted above, financial  management problems at the Department of Homeland Security (DHS),  the National Aeronautics and Space Administration (NASA), and the  Department of State (State) also contributed to the disclaimer of opinion  on the federal government’s accrual-based consolidated financial  statements for fiscal year 2009. About $48 billion, or about 2 percent, of  the federal government’s reported total assets as of September 30, 2009,  and approximately $101 billion, or about 3 percent, of the federal  government’s reported net cost for fiscal year 2009 relate to these three  agencies. According to auditors for DHS, NASA, and State, these agencies  continue to have reported material weaknesses in internal control. While  the auditors for DHS and NASA noted certain progress in financial  reporting, each of the three agency auditors also reported that they were  unable to provide opinions on the financial statements because they were  not able to obtain sufficient evidential support for amounts presented in  certain financial statements. For example,   only selected DHS financial statements were subjected to audit, and  the auditors stated that DHS was unable to provide sufficient evidence  to support certain financial statements balances at the Coast Guard  and Transportation Security Administration;   auditors for NASA identified issues related to internal control in its  property accounting, principally relating to assets capitalized in prior  years; and  auditors for State reported that the department was unable to provide  sufficient support for the amounts presented in the fiscal year 2009  Combined Statement of Budgetary Resources and the property and  equipment balance.
The auditors for DHS, NASA, and State made recommendations to address  control deficiencies at the agencies, and management for these agencies  generally expressed commitment to resolve the deficiencies. It will be  important that management at each of these agencies remain committed to  addressing noted control deficiencies and improving financial reporting.
section_title: Impacts of the Recession and Stabilization Efforts on the Federal Government’s Financial Condition
paragraphs: The federal government reported a net operating cost of $1.3 trillion and a  unified budget deficit of $1.4 trillion for fiscal year 2009, significantly  higher than the amounts in fiscal year 2008. As of September 30, 2009, debt  held by the public increased to 53 percent of gross domestic product  (GDP). These increases are primarily the result of the effects of the  recession and the costs of the federal government’s actions to stabilize the  financial markets and to help promote economic recovery.
In December 2007, the United States entered what has turned out to be its  deepest recession since the end of World War II. Between the fourth  quarter of 2007 and the third quarter of 2009, GDP fell by about 2.8  percent. The nation’s unemployment rate rose from 4.9 percent in 2007 to  10.2 percent in October 2009, a level not seen since April 1983. Federal tax  revenues automatically decline when GDP and incomes fall, and at the  same time, spending on unemployment benefits and other income-support  programs automatically increases.
As of September 30, 2009, the federal government’s actions to stabilize the  financial markets and to promote economic recovery resulted in an  increase in reported federal assets of over $500 billion (e.g., Troubled  Asset Relief Program (TARP) equity investments, and investments in the  Federal National Mortgage Association (Fannie Mae) and the Federal  Home Loan Mortgage Corporation (Freddie Mac) and mortgage-backed  securities guaranteed by them), which is net of about $80 billion in  valuation losses. In addition, the federal government reported incurring  additional significant liabilities (e.g., liquidity guarantees to Fannie Mae  and Freddie Mac) and related net cost resulting from these actions.  Because the valuation of these assets and liabilities is based on  assumptions and estimates that are inherently subject to substantial  uncertainty arising from the uniqueness of certain transactions and the  likelihood of future changes in general economic, regulatory, and market  conditions, actual results may be materially different from the reported  amounts.
In addition, the federal government’s financial condition will be further  affected as its actions continue to be implemented in fiscal year 2010 and  later. For example, several hundred billion dollars of the total estimated  $862 billion cost under the American Recovery and Reinvestment Act of   2009 (Recovery Act) remain to be disbursed. Also, continued  implementation of TARP, which was extended through October 3, 2010,  is likely to result in additional cost, and the Federal Housing  Administration (FHA) mortgage guarantee program could result in  additional cost. Consequently, the ultimate cost of the federal  government’s actions and their effect on the federal government’s financial  condition will not be known for some time.
Further, there are risks that the federal government’s financial condition  could be affected in the future by other factors, including the following:   Several initiatives undertaken in 2009 by the Federal Reserve to  stabilize the financial markets have led to a significant change in the  reported composition and size of the Federal Reserve’s balance sheet,  including the purchase of over $900 billion in mortgage-backed  securities guaranteed by Fannie Mae, Freddie Mac, and the  Government National Mortgage Association as of the end of 2009. If  the Federal Reserve sells these securities at a loss, additional federal  government deposits at the Federal Reserve may be needed, future  payments of Federal Reserve earnings to the federal government may  be reduced, or both.
Although the Recovery Act provided some fiscal relief to the states,  expected continued state fiscal challenges could place pressure on the  federal government to provide further relief to them.
Looking ahead, the federal government will need to determine the most  expeditious manner in which to bring closure to its financial stabilization  initiatives while optimizing its investment returns. In addition to managing  these actions, problems in the nation’s financial sector have exposed  serious weaknesses in the current U.S. financial regulatory system, which,  if not effectively addressed, may cause the system to fail to prevent similar  or even worse crises in the future. The current system, which was put into  place over the past 150 years, is fragmented and complex and simply has  not kept pace with the major financial structures, innovations, and  products that emerged during the years leading up to the recent financial  crisis. Consequently, meaningful financial regulatory reform is of utmost  concern. In crafting and evaluating proposals for financial regulatory  reform, it will be important for Congress and others to be mindful of the  need to use a framework that facilitates a comprehensive assessment of  the relative strengths and weaknesses of each proposal. GAO has  previously set forth such a framework that involves nine key elements that  are critically important in establishing the most effective and efficient  financial regulatory system possible: (1) clearly defined regulatory goals;  (2) appropriately comprehensive; (3) systemwide focus; (4) flexible and  adaptive; (5) efficient and effective; (6) consistent consumer and investor  protection; (7) regulator provided with independence, prominence,  authority, and accountability; (8) consistent financial oversight; and (9)  minimal taxpayer exposure.
section_title: The Near- and Long-Term Fiscal Challenges
paragraphs: The economic downturn and the nature and magnitude of the actions  taken to stabilize the financial markets and to promote economic recovery  will continue to shape the federal government’s near-term budget and debt  outlook. Actions taken to stabilize financial markets—including aid to the  automotive industry—increased borrowing and added to the federal debt.  The revenue decreases and spending increases enacted in the Recovery  Act also added to borrowing and debt. As shown in figure 1, the  President’s budget projects debt held by the public growing from 53.0  percent of GDP in fiscal year 2009 to 63.6 percent by the end of fiscal year  2010 and 68.6 percent by the end of fiscal year 2011. While deficits are  projected to decrease as federal support for states and the financial sector  winds down and the economy recovers, the increased debt and related  interest costs will remain.
Further, all of this takes place in the context of the current long-term fiscal  outlook. The federal government faced large and growing structural  deficits—and hence rising debt—before the instability in financial markets  and the economic downturn. While the drivers of the long-term fiscal  outlook have not changed, the sense of urgency has. As table 1 shows,  many of the pressures highlighted in GAO’s simulations, including health  care cost growth and the aging population, have already begun to affect  the federal budget—in some cases sooner than previously estimated—and  the pressures only grow in the coming decade. For example, Social  Security cash surpluses have previously served to reduce the unified  budget deficit; however, the Congressional Budget Office (CBO) recently  estimated that due to current economic conditions the program will run  small temporary cash deficits for the next 4 years and then, similar to the  Trustees’ estimates, run persistent cash deficits beginning in 2016. The  fluctuation and eventual disappearance of the Social Security cash surplus  will put additional pressure on the rest of the federal budget. With the  passage of time the window to address this challenge narrows.
The federal government is on an unsustainable long-term fiscal path driven  on the spending side primarily by rising health care costs and known  demographic trends. The Statement of Social Insurance, for example,  shows that the present value of projected scheduled benefits exceed  earmarked revenues for social insurance programs (e.g., Social Security  and Medicare) by approximately $46 trillion over the 75-year period.  Since GAO’s long-term fiscal simulations include projections of revenue  and expenditures for all federal programs, they present a comprehensive  analysis of the sustainability of the federal government’s long-term fiscal  outlook. Figures 2, 3, and 4 show the results of our most recent long-term  fiscal simulations that were issued in March 2010.
Absent a change in policy, federal debt held by the public as a share of  GDP could exceed the historical high reached in the aftermath of World  War II by 2020 (see fig. 2) —10 years sooner than our simulation showed  just 2 years ago. As a result, the administration and Congress will need to  apply the same level of intensity to the nation’s long-term fiscal challenge  as they have to the recent economic and financial market issues. Although  the economy is still fragile, there is wide agreement on the need to begin  to change the long-term fiscal path as soon as possible without slowing the  recovery because the magnitude of the changes required grows with time.  Congress recently enacted a return to statutory PAYGO—a budgetary  control requiring that the aggregate impact of increases in mandatory  spending or reductions in revenue generally be offset. Although this can  prevent further deterioration of the fiscal position, it does not deal with  the existing imbalance. In February, the President established a  commission to identify policies to change the fiscal path and stabilize the  debt-to-GDP ratio.
One quantitative measure of the long-term fiscal challenge is called the  “fiscal gap.” The fiscal gap is the amount of spending reductions or tax  increases, over a certain time period such as 75 years, that would be  needed to keep debt as a share of GDP at or below today’s ratio. Another  way to say this is that the fiscal gap is the amount of change needed to  prevent the kind of debt explosion implicit in figure 2. The fiscal gap can  be expressed as a share of the economy or in present value dollars.
Under GAO’s Alternative simulation, closing the fiscal gap would require  spending cuts or tax increases, or some combination of the two averaging  9.0 percent of the entire economy over the next 75 years, or about $76.4  trillion in present value terms. To put this in perspective, closing the gap  solely through revenue increases would require annual increases in federal  tax revenues of about 50 percent on average, or to do it solely through  spending reductions would require annual reductions in federal program  spending (i.e., in all spending except for interest on the debt held by the  public, which cannot be directly controlled) of about 34 percent on  average over the entire 75-year period.
Policymakers could phase in policy changes so that tax increases or  spending cuts or both would grow over time allowing time for the  economy to recover and for people to adjust to the changes. However, the  longer action to deal with the long-term outlook is delayed, the greater the  risk that the eventual changes will be disruptive and destabilizing.
Comprehensive long-term fiscal projections will be required in the federal  government’s financial statements beginning in fiscal year 2010, under a  new accounting standard. Such reporting will include information about  the long-term fiscal condition of the federal government and annual  changes therein, and will expand upon the information currently provided  in the Management’s Discussion and Analysis section of the Financial  Report.
It is not only the federal government that faces a long-term fiscal  challenge. Figure 4 shows the federal and combined federal, state, and  local surpluses and deficits as a share of GDP from our most recent  simulation results.
section_title: Closing Comments
paragraphs: In closing, even though progress has been made in improving federal  financial management activities and practices, much work remains given  the federal government’s near-and long-term fiscal challenges and the need  for Congress, the administration, and federal managers to have reliable,  useful, and timely financial and performance information to effectively  meet these challenges.
The need for such information and transparency in financial reporting is  clearly evident. The recession and the federal government’s  unprecedented actions intended to stabilize the financial markets and to  promote economic recovery have significantly affected the federal  government’s financial condition, especially with regard to certain of its  investments and increases in its liabilities and net operating cost.  Importantly, while such increases are reported in the U.S. government’s  consolidated financial statements for fiscal year 2009, the valuation of  certain assets and liabilities is based on assumptions and estimates that  are inherently subject to substantial uncertainty arising from the  uniqueness of certain transactions and the likelihood of future changes in  general economic, regulatory, and market conditions. Going forward, a  great amount of attention will need to be devoted to ensuring (1) that  sufficient internal controls and transparency are established and  maintained for all financial stabilization and economic recovery initiatives;  and (2) that all related financial transactions are reported on time,  accurately, and completely.
Further, sound decisions on the current and future direction of all vital  federal government programs and policies are more difficult without  reliable, useful, and timely financial and performance information. In this  regard, for DOD, the challenges are many. We are encouraged by DOD’s  efforts toward addressing its long-standing financial management  weaknesses and its efforts to achieve auditability. Consistent and diligent  top management oversight toward achieving financial management  capabilities, including audit readiness, will be needed. Moreover, the  civilian CFO Act agencies must continue to strive toward routinely  producing not only annual financial statements that can pass the scrutiny  of a financial audit, but also quarterly financial statements and other  meaningful financial and performance data to help guide decision makers  on a day-to-day basis. Federal entities need to improve the government’s  financial management systems to achieve this goal.
Moreover, of utmost concern are the federal government’s long-term fiscal  challenges that result from large and growing structural deficits that are  driven on the spending side primarily by rising health care costs and  known demographic trends. This unsustainable path must be addressed  soon by policymakers.
Finally, I want to emphasize the value of sustained congressional interest  in these issues, as demonstrated by this Subcommittee’s leadership. It will  be key that, going forward, the appropriations, budget, authorizing, and  oversight committees hold the top leadership of federal entities  accountable for resolving the remaining problems and that they support  improvement efforts.
Madam Chairwoman and Ranking Member Bilbray, this concludes my  prepared statement. I would be pleased to respond to any questions that  you or other members of the Subcommittee may have at this time.
section_title: GAO Contacts and Acknowledgments
paragraphs: For further information regarding this testimony, please contact Jeanette  M. Franzel, Managing Director, and Gary T. Engel, Director, Financial  Management and Assurance, at (202) 512-2600, as well as Susan J. Irving,  Director, Federal Budget Analysis, Strategic Issues, at (202) 512-6806. Key  contributions to this testimony were also made by staff on the  Consolidated Financial Statement audit team.