Long-Term Fiscal Issues: Increasing Transparency and Reexamining the Base of the Federal Budget
Published: 2005-02-08T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: This testimony discusses the nation's long-term fiscal outlook and the challenge it poses for the budget and oversight processes. First, GAO provides results of its most recent simulations of the long-term fiscal outlook, updating a model GAO initially developed in 1992. GAO also discusses some ideas for increasing transparency of the long-term costs of government commitments and the range of fiscal exposures. Finally, GAO discusses a forthcoming report that it believes will help the Congress in dealing with a range of performance and accountability issues. This report will provide policy makers with a comprehensive compendium of those areas throughout government that could be considered ripe for reexamination and review based on GAO's past work and institutional knowledge.
section_title: What GAO Found
paragraphs: The nation's fiscal policy is on an unsustainable course, and its long-term fiscal gap grew much larger in fiscal year 2004. Long-term budget simulations by GAO, the Congressional Budget Office, and others show that, over the long term the nation faces 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, the nation's economy, its standard of living, and ultimately its national security. The long-term outlook challenges the budget process to provide more transparency about the specific exposures that will encumber the nation's fiscal future. GAO feels that elected representatives should have more explicit information on the present value dollar costs of major spending and tax bills--before they vote on them. All simulations indicate that the problem is too big to be solved by economic growth alone or by making modest changes to existing spending and tax policies. A fundamental reexamination of major spending and tax policies and priorities will be important to recapture fiscal flexibility and update the nation's programs and priorities to respond to emerging social, economic, and security changes.

section_title: Letter
paragraphs: I appreciate this opportunity to talk with you about our nation’s long-term  fiscal outlook and the challenge it poses for the budget and oversight  processes. Today, I will first provide the committee with the results of our  most recent simulations of the long term fiscal outlook, updating a model  we initially developed for members of this Committee in 1992. I will also  discuss some ideas for increasing transparency of the long-term costs of  government commitments and the range of fiscal exposures—work we first  did at the request of your counterparts in the House. Finally, I will talk  about a forthcoming report that we believe will help the Congress in  dealing with a range of performance and accountability issues. As this  Committee knows, we periodically pull together our work for the Congress  in ways we hope will help in its budget and programmatic deliberations and  oversight activities. Our recently issued High-Risk update is the most  recent example. All of these are part of our periodic efforts to provide our  professional insights about programs or operations needing oversight and  review through such series as high risk and budget options reports.
Next week we will issue another report that builds on our past and pending  work—90 percent of which is requested by the Congress or required by  law—to provide policy makers with a comprehensive compendium of  those areas throughout government that could be considered ripe for  reexamination and review based on our past work and institutional  knowledge. This report is entitled 21st Century Challenges: Reexamining  the Base of Government. In this report we will present illustrative  questions for policy makers to consider as they carry out their  responsibilities. These questions look across major areas of the budget and  federal operations including discretionary and mandatory spending, and  tax policies and programs. These questions are intended as one input  among many that Congress will receive as it decides what its agenda will be  for oversight and program review through its various committees. Others  have formulated very detailed comprehensive agendas with specific policy  proposals—the President’s budget released yesterday is one very  prominent example. We hope that this new report will be used by various  congressional committees as they consider which areas of government  need particular attention and reconsideration, recognizing that while  answers to these questions may draw on the work of GAO and others, only  elected officials can and should decide whether, how, and when to move  forward.
The overall picture on the long term fiscal outlook is not news to this  Committee. Simply put, our nation’s fiscal policy is on an unsustainable  course and our long-term fiscal gap grew much larger in fiscal year 2004.  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. Our current path also will  increasingly constrain our ability to address emerging and unexpected  budgetary needs and increase the burdens that will be faced by future  generations.
As this Committee knows, the long-term outlook challenges the budget  process to provide more transparency about the specific exposures that  will encumber our fiscal future. While the 10-year outlook is important,  Congress may wish to think more about what metrics and measures need  to be added to more clearly identify the long-term consequences of current  proposals before legislative action is taken. In my view, elected  representatives should have more explicit information on the present value  dollar costs of major spending and tax bills—before they vote on them. In  my testimony, I will discuss changes in the information provided and  budgetary incentives that could improve transparency, prompting more  deliberation about and improving budgetary incentives to address such  bills.
Regardless of the assumptions used, all simulations indicate that the  problem is too big to be solved by economic growth alone or by making  modest changes to existing spending and tax policies. Rather, a  fundamental reexamination of major spending and tax policies and  priorities will be important to recapture our fiscal flexibility and update our  programs and priorities to respond to emerging social, economic, and  security changes. Ultimately, this reexamination will entail a national  discussion about what Americans want from their government and how  much they are willing to pay for those things. Many, if not most, current  federal programs and policies, in fact, were designed decades ago to  respond to trends and challenges that existed at the time of their creation.  Our recent entry into a new century has helped to remind us of how much  has changed in the past several decades—whether it be rapid shifts in the  security threats facing the nation, the aging of our population, the  globalization of economic transactions, the escalation of health care costs,  increased environmental concerns, or the significant advances in  technologies and transportation systems. This discussion will not be easy  since there is no “low hanging fruit” in the budget, but acting sooner will  enable us to avoid precipitous changes while providing more transition  time.
subsections: section_title: The Long-Term Budget Outlook
paragraphs: Three years ago when I appeared before this Committee, I spoke about a  large and growing long-term fiscal gap driven largely by known  demographic trends and rising health care costs. Unfortunately, despite a  brief period with budget surpluses, that gap has grown much wider. Last  year’s Medicare prescription drug bill was a major factor, adding $8.1  trillion to the outstanding commitments and obligations of the U.S.  government in long-term present value terms. The near-term deficits also  reflected-higher Defense, homeland security, and overall discretionary  spending which exceeded growth in the economy, as well as revenues  which have fallen below historical averages due to policy decisions and  other economic and technical factors. While the size of the nation’s long- term fiscal imbalance has grown significantly, the retirement of the “baby  boom” generation has come closer to becoming a reality. Given these and  other factors, it is clear that the nation’s current fiscal path is unsustainable  and that tough choices will be necessary in order to address the growing  imbalance.
The cost implications of the baby boom generation’s retirement have  already become a factor in CBO’s baseline projections and will only  intensify as the baby boomers age. According to CBO, total federal  spending for Social Security, Medicare, and Medicaid is projected to grow  by about 25 percent over the next 10 years—from 8.4 percent of GDP in  2004 to 10.4 percent in 2015. Although the Trustees’ 2004 intermediate  estimates project that the combined Social Security Trust Funds will be  solvent until 2042,program spending will constitute a rapidly growing  share of the budget and the economy well before that date. 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 beginning in 2008. To finance the  same level of overall federal spending as in the previous year, additional  revenues and/or increased borrowing will be needed in every subsequent  year. (See fig. 1.)
By 2018, Social Security’s cash income (tax revenue) is projected to 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. The combined  OASDI Trust Funds will begin drawing on the Treasury to cover the cash  shortfall, first relying on interest income and eventually drawing down  accumulated trust fund assets. At this point, Treasury will need to obtain  cash for those 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.
Ultimately, the critical question is not how much a misleadingly labeled  “trust fund” has in assets, but whether the government as a whole can  afford the benefits in the future and at what cost to other claims on scarce  resources. As I have said before, the future sustainability of programs is the  key issue policy makers should address—that is, the capacity of the  economy and budget to afford the commitment in light of overall current  and projected fiscal conditions.
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 2  and 3 present these simulations under two different sets of assumptions. In  the first, 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 the  second figure, two assumptions are changed: (1) discretionary spending is  assumed to grow with the economy after 2005 rather than merely with  inflation, and (2) 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.
As both these simulations illustrate, absent policy changes on the spending  or revenue side of the budget, 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, making no changes to 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.
Although considerable uncertainty surrounds long-term budget  projections, we know two things for certain: the population is aging and the  baby boom generation is approaching retirement age. The aging population  and rising health care spending will have significant implications not only  for the budget, but also the economy as a whole. Figure 4 shows the total  future draw on the economy represented by Social Security, Medicare, and  Medicaid. Under the 2004 Trustees’ intermediate estimates and CBO’s long- term Medicaid estimates, spending for these entitlement programs  combined will grow to 15.6 percent of GDP in 2030 from today’s 8.5  percent. It is clear that, taken together, Social Security, Medicare, and  Medicaid represent an unsustainable burden on future generations.
The government can help ease future fiscal burdens through spending  reductions or revenue actions that reduce debt held by the public, saving  for the future, and enhancing the pool of economic resources available for  private investment and long-term growth. Economic growth is essential,  but we will not be able to simply grow our way out of the problem. The  numbers speak loudly: Our projected fiscal gap is simply too great. 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.
The retirement of the baby boom generation is not the only demographic  challenge facing our nation. People are living longer and spending more  time in retirement. As shown in figure 5, 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 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.
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 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. The combination of these factors means that  annual 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. (See fig. 6.) Thus,  relatively fewer workers will be available to produce the goods and  services that all will consume. Lower 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.
Increased investment could increase the productivity of workers and spur  economic growth. However, increasing investment depends on national  saving, which remains at historically low levels. Historically, the most  direct way for the federal government to increase saving has been to  reduce the deficit (or run a surplus). Although the government may try to  increase personal saving, results of these efforts have been mixed. For  example, even with the preferential tax treatment granted since the 1970s  to encourage retirement saving, the personal saving rate has steadily  declined. (See fig. 7.) Even if the economic growth increases, the structure  of retirement programs and historical experience in health care cost  growth suggest that higher economic growth results in a generally  commensurate growth in spending for these programs over the long run.
In recent years, personal saving by households has reached record lows,  while at the same time the federal budget deficit has climbed. Accordingly,  national saving has diminished, but the economy has continued to grow, in  part because more and better investments were made. That is, each dollar  saved bought more investment goods, and a greater share of saving was  invested in highly productive information technology. The economy has  also continued to grow because the United States was able to invest more  than it saved by borrowing abroad, that is, by running a current account  deficit. However, a portion of the income generated by foreign-owned  assets in the United States must be paid to foreign lenders. National saving  is the only way a country can have its capital and own it too.
The persistent U.S. current account deficits of recent years have translated  into a rising level of indebtedness to other countries. However, many other  nations currently financing investment in the United States also will face  aging populations and declining national saving, so relying on foreign  savings to finance a large share of U.S. domestic investment or federal  borrowing is not a viable strategy for the long run.
In general, saving involves trading off consumption today for greater  consumption tomorrow. Our budget decisions today will have important  consequences for the living standards of future generations. The financial  burdens facing the smaller cohort of future workers in an aging society  would most certainly be lessened if the economic pie were enlarged. This is  no easy challenge, but in a very real sense, our fiscal decisions affect the  longer-term economy through their effects on national saving.
Early action to change these programs would yield the highest fiscal  dividends for the federal budget and would provide a longer period for  prospective beneficiaries to make adjustments in their own planning.  Waiting to build economic resources and reform future claims entails risks.  First, we lose an important window during which today’s relatively large  workforce can increase saving and enhance productivity, two elements  critical to growing the future economy. We also lose the opportunity to  reduce the burden of interest in the federal budget, thereby creating a  legacy of higher debt as well as elderly entitlement spending for the  relatively smaller workforce of the future. Most critically, we risk losing the  opportunity to phase in changes gradually so that all can make the  adjustments needed in private and public plans to accommodate this  historic shift. Unfortunately, the long-range challenge has become more  difficult, and the window of opportunity to address the entitlement  challenge is narrowing.
section_title: Fiscal Exposures
paragraphs: Although Social Security, Medicare, and Medicaid drive the long-term  outlook, they are not the only federal programs or activities in which the  federal government has made long-term commitments. At GAO, we are in  the truth, transparency, and accountability business. A crucial first step is  to insist on truth and transparency in government operations, including  federal financial reporting, budgeting, and legislative deliberations. The  federal government must provide a fuller and fairer picture of existing  budget deficits, the misnamed “trust funds,” and the growing financial  burdens facing every American, especially younger Americans.
On the budget side, the current 10-year cash-flow projections are an  improvement over past practices. But given known demographic trends,  even these projections fail to capture the long-term consequences of  today’s spending and tax policy choices. In my view, elected  representatives should have more explicit information on the present value  dollar costs of major spending and tax bills—before they vote on them. We  believe that members of Congress, the President, and the public should  have information about any long-term commitments embodied in a current  policy decision. Some years ago, we developed the term “fiscal exposures”  to provide a conceptual framework for considering the wide range of  responsibilities, programs, and activities that may explicitly or implicitly  expose the federal government to future spending.
Fiscal exposures vary widely as to source, extent of the government’s legal  obligation, likelihood of occurrence, and magnitude. They include not only  liabilities, contingencies, and financial commitments that are identified on  the balance sheet or accompanying notes, but also responsibilities and  expectations for government spending that do not meet the recognition or  disclosure requirements for that statement. By extending beyond  conventional accounting, the concept of fiscal exposure is meant to  provide a broad perspective on long-term costs and uncertainties. Fiscal  exposures include items such as retirement benefits, environmental  cleanup costs, the funding gap in Social Security and Medicare, and the life  cycle cost for fixed assets. Given this variety, it is useful to think of fiscal  exposures as lying on a spectrum extending from explicit liabilities to the  implicit promises embedded in current policy or public expectations. Table  1 shows some selected fiscal exposures.
As currently structured, these fiscal exposures constitute significant and in  many cases growing encumbrances on the budgetary resources of the  future. The current budget projections primarily focus attention on the 5-  to10-year budget window. While this is an important and appropriate frame  for assessing the impacts of federal fiscal policy on the economy, longer- term estimates and projections can also help provide important  perspective. At the macro level, the long-term fiscal models we and CBO  have developed should help frame the near-term choices we face by  bringing in information on their long-term impact. At the micro level, better  information on the longer-term costs of selected exposures—particularly  those scheduled to grow rapidly—can help focus attention on those  program commitments presenting significant fiscal burdens over the longer  term.
For example, in considering the prescription drug legislation, much  controversy was focused on the specific 10-year cost estimate that should  be used in the congressional consideration of this new entitlement.  However, comparatively little attention was paid to the long-term costs that  this new commitment would pose for future generations over a 75-year  period—$8.1 trillion in present value terms, net of premiums. Since the full  costs of this new entitlement increase significantly over the longer term,  decision makers need to be better informed about the growth path and the  impact on the nation’s finances beyond the 10-year window.
The President and the Congress face the challenge of sorting out the many  claims on the federal budget without the budget enforcement  mechanisms—discretionary spending caps and pay-as-you-go (PAYGO)  discipline—or fiscal benchmarks that guided the federal government  through the years of deficit reduction into a brief period of federal  surpluses. While a number of steps will be necessary to address this  challenge, truth and transparency in financial reporting and budgeting are  essential elements of any attempt to address the nation’s long-term fiscal  challenges. The fiscal risks can be managed only if they are properly  accounted for and publicly disclosed, including the many existing  commitments facing the government. In addition, new budget control  mechanisms will be required.
So what can we do to frame information and decisions so that decision  makers can appropriately focus on fiscal exposures? The variety of  certainties—and uncertainties—associated with fiscal exposures means  that no single approach to increasing attention to them will work in all  cases. Instead, targeted approaches for different types of fiscal exposures  would, I think, be most useful for incorporating a longer-term perspective  into the budget. Changes in the information provided, the budget process,  or budgetary incentives could be tailored selectively for different  categories of fiscal exposures to improve transparency, prompt more  deliberation about them, or improve budgetary incentives to address them.
Several approaches that could be used, depending on the type of program  and information available, are  include fiscal exposures in the budget process, and  include fiscal exposures in budget data.
Figure 8 shows these alternative approaches and relates them to the  primary objective that each could help achieve. For example, approach III,  in which fiscal exposure cost estimates are incorporated directly into  budget data, would help achieve the objective of improving budgetary  incentives to address the fiscal exposures. Each approach could be  implemented in a number of ways, which I will briefly discuss.
Approaches depend upon  which primary objective is  sought.  A number of options  could be used to implement  each approach.
subsections: section_title: Approach I : Improve Supplemental Reporting
paragraphs: Improved supplemental reporting on fiscal exposures would make  information more accessible to decision makers without introducing  additional uncertainty and complexity directly into the budget. Estimates  of the government’s exposures would be reported in various budget  documents, but the current basis of reporting primary budget data—budget  authority, obligations, outlays, and deficit/surplus—would not be changed.  In some cases, improving supplemental reporting may simply be a matter  of highlighting or expanding existing analytical work, such as continuing  and improving long-range projections and simulations of the budget as a  whole. Other ways of providing additional supplemental information could  be special analyses for certain significant fiscal exposures in the Analytical  Perspectives of the budget or an annual report on fiscal exposures  prepared by OMB. In the congressional budget process, greater focus could  center on the long-term net present value of proposed new commitments  for items where the 10-year estimate does not fully capture the dimensions  of cost growth expected, similar to the Medicare prescription drug bill I  mentioned earlier.
But another idea that we have discussed in the past is to routinely report  the future estimated costs of certain exposures as a separate notational line  in the budgetary schedules in the President’s budget. For example, an  estimate of the future operating and maintenance costs associated with  capital acquisitions could be reported as the “exposure level” for capital  accounts that include the initial capital acquisition costs. Similarly, the  future funding needs associated with incrementally funded projects could  be included with the budget account that includes the capital acquisition.  And future environmental cleanup costs associated with an asset  acquisition could be handled the same way. The exposure levels might be  reported in present value terms. Including them as part of the budget  presentations at the account level would make such information available  along with the initial costs rather than in an additional document and  would clearly show the potential future costs associated with current  decisions.
section_title: Approach II: Include Fiscal Exposures in Budget Process
paragraphs: Budget process changes would go beyond simply providing more  information on fiscal exposures to establishing opportunities for explicit  consideration of these exposures. The Congress could modify budget rules  to provide for a point of order against any proposed legislation that creates  new exposures or increases the estimated costs of existing exposures over  some specified level. Or, revised rules could provide for a point of order  against any proposed legislation that does not include estimates of the  potential costs of fiscal exposures created by the legislation.
A different budget process approach would be to establish triggers that  address the growth in existing exposures. In that case, triggers would be  established to signal when future costs of exposures rise above a certain  level. Reaching the trigger would require some action. For example, the  Medicare drug law enacted in December 2003 requires the Medicare  trustees to estimate the point at which general revenues will finance at  least 45 percent of Medicare costs. If two consecutive trustee reports  estimate that this level will be reached within the next 6 years, the  President is required to include a proposal in his next budget and submit  legislation to change Medicare so that the 45 percent threshold will not be  exceeded. Congressional committees must then report Medicare legislation  by June 30. Like points of order, a trigger would require explicit  consideration of exposures facing the government without adding  uncertainty to primary budget data.
section_title: Approach III: Include Fiscal Exposures in Budget Data
paragraphs: Incorporating estimated future costs of fiscal exposures directly into  budget data by using accrual-based costs would represent the greatest  change of the three approaches I have outlined today. Accrual-based costs  could be used to measure budget authority and outlays for select programs  when doing so would enhance obligation-based control. This approach is  most suitable for explicit exposures for which reasonable cost estimates  are available.
For some time we have advocated the selective use of accrual measures in  the budget to better reflect costs at the time decisions are made. For some  major exposures, such as employee retirement benefits, insurance, and  environmental clean-up costs, the use of accrual-based measurement  would result in earlier cost recognition. This earlier recognition of costs  improves information available to decision makers about the costs  associated with current decisions and may improve the incentives to  manage these costs. Because the future costs of some exposures are  dependent upon many economic and technical variables that cannot be  known in advance, there will always be uncertainty in cost estimates. Such  uncertainty makes using accrual-based measurement directly in the budget  more difficult. It may make sense for some exposures but not for others,  because the certainty of the government’s commitment and the availability  of reasonable, unbiased estimates vary across the different fiscal  exposures.
section_title: 21st Century Challenges: Reexamining the Base of the Federal Government
paragraphs: As I noted earlier, nothing less than a fundamental review, reexamination,  and reprioritization of all major spending and tax policies and programs is  needed. We at GAO believe we have an obligation to assist and support you  in this endeavor. So I would like to take some time this morning to tell you  more about the report we will soon be issuing on reexamining the base of  government—both to tell you why we are issuing this report and to  illustrate some of the specific questions we plan to raise. Having identified  the large and growing fiscal challenges facing the nation and the other  major trends and challenges facing the United States as outlined in our  strategic plan for serving the Congress, we thought we should look to our  work and provide examples of the kinds of hard choices stemming from  those challenges—in the form of questions for policy makers to consider.  These 21st century questions will cover discretionary spending; mandatory  spending, including entitlements; as well as tax policies and programs—all  in one accessible volume.
Mr. Chairman, we are talking about a major transformational challenge that  may take a generation to resolve. Traditional incremental approaches to  budgeting will need to give way to more fundamental and periodic  reexaminations of the base of government. Many, if not most current  federal programs and policies were designed decades ago to respond to  trends and challenges that existed at the time of their creation. If  government is to respond effectively to 21st century trends, it cannot accept  what it does, how it does it, who does it, and how it gets financed as  “given.” Not only do outmoded commitments, operations, choices of tools,  management structures, and tax programs and policies constitute a burden  on future generations, but they also erode the government’s capacity to  align itself with the needs and demands of the 21st century.
Confronting the fiscal imbalance would be difficult enough if all we had to  do is fund existing commitments. But a wide range of emerging needs and  demands can be expected to compete for a share of the budget pie.  Whether it be national or homeland security, transportation or education,  environmental cleanup or public health, a society with a growing  population—and ours is projected to grow by about 50 percent by the  middle of the 21st century—will generate new demand for federal action on  both the spending and tax sides of the budget. Reexamining older programs  and operations may enable us to free up resources to address some of these  emerging needs.
The specific 21st century questions were developed based on GAO’s  strategic plan, which identified major trends that will shape the federal role  in the economy and our society going forward. (See table 2.)
These trends, along with GAO’s institutional knowledge and issued work,  helped us identify the major challenges and specific questions. The specific  questions were informed by a set of generic evaluation criteria useful for  reviewing any government program or activity, which are displayed in table  3.
In the report, we will describe the forces at work, the challenges they  present, and the 21st century questions they prompt, in each of 12 broad  areas based in large measure on functional areas in the federal budget, but  also including governmentwide issues and the revenue side of the budget.  Table 4 lists those 12 areas, which involve discretionary spending;  mandatory spending, including entitlements; and tax policies and  programs—all of them are a part of the base.
Our forthcoming report contains over 200 individual illustrative questions  in these 12 areas. But today I would like to highlight for you—to give you a  flavor of what the report will contain—several of the challenges we have  inventoried in 4 of these areas, as well as some of the questions those  challenges prompt.
subsections: section_title: Defense Challenges
paragraphs: In the past 15 years, the world has experienced dramatic changes in the  overall security environment, with the focus shifting away from  conventional threats posed during the Cold War era to more  unconventional and asymmetric threats evidenced by the events of  September 11, 2001. Concerns about the affordability and sustainability of  the rate of growth in defense spending will likely prompt decision makers  to reexamine fundamental aspects of the nation’s security programs, such  as how DOD plans and budgets; organizes, manages, and positions its  forces; acquires new capabilities; and considers alternatives to past  approaches. To successfully carry out this reexamination, DOD must  overcome cultural resistance to change and the inertia of various  organizations, policies, and practices that became well rooted in the Cold  War era.
While DOD has taken steps to meet short term operational needs, it still  faces the fundamental challenge of determining how it will meet the longer  term concerns of reorganizing its forces and identifying the capabilities it  will need to protect the country from current, emerging, and future  conventional and unconventional security threats. As DOD seeks to meet  the demands of the new security environment, it continues to bear the  costs of the past by maintaining or continuing to pursue many of the  programs and practices from the Cold War era. Moreover, DOD faces  serious and long-standing challenges in managing its ongoing business  operations. Complicating its efforts are numerous systems problems and a  range of other long-standing weaknesses in the key business areas of  strategic planning and budgeting, human capital management,  infrastructure, supply chain management, financial management,  information technology, weapon systems acquisition, and contracting. In  fact, DOD alone has 8 of the 25 items and shares in the 6 cross-cutting ones  on our recently-issued high-risk list.
One particular operational challenge involves managing large and growing  military personnel costs, which comprise the second largest component of  DOD’s total fiscal year 2005 budget. The growth in military personnel costs  has been fueled, in part, by increases in basic pay, housing allowances,  recruitment and retention bonuses, and other special incentive pays and  allowances. Health care costs have grown to comprise a larger share of the  budget, reflecting expanded health care provided to reservists and retirees.  As the total and per capita cost to DOD for military pay and benefits grows,  we need to reexamine whether DOD has the right pay and compensation  strategies to sustain the total force in the future in a cost-effective manner.
The foregoing challenges suggest certain key questions be considered by  policy makers.
How should the historical allocation of resources across services and  programs be changed to reflect the results of a forward-looking  comprehensive threat/risk assessment as part of DOD’s capabilities- based approach to determining defense needs?
What economies of scale and improvements in delivery of support  services would result from combining, realigning, or otherwise changing  selected support functions (e.g., combat support, training, logistics,  procurement, infrastructure, health care delivery)?
How might DOD’s recruitment, retention, and compensation strategies,  including benefit programs, be reexamined and revised to ensure that  DOD maintains a total military and civilian workforce with the mix of  skills needed to execute the national security strategy while using  resources in a more targeted, evidence-based and cost-effective  manner?
section_title: Retirement and Disability Challenges
paragraphs: The challenges facing retirement and disability programs are long-term,  severe, and structural in nature. For example, Social Security faces a large  and growing structural financing challenge. Social Security faces this long- term financing shortfall largely because of several concurrent demographic  trends—namely, that people are living longer, spending more time in  retirement, and having fewer children. Social Security could be brought  into balance over the next 75 years through changes in the program and  related benefits and/or taxes; however, ensuring the sustainability of the  system beyond 75 years will require even larger changes.
Beyond Social Security, our nation’s retirement and disability programs are  further challenged by serious weaknesses that have become manifest in  our nation’s private pension system. Despite sustained large federal tax  subsidies, total pension coverage continues to hover at about half of the  total private sector labor force. The number of traditional defined-benefit  plans has been contracting for decades, and recently, plan terminations by  bankrupt sponsors of large defined-benefit plans have threatened the  solvency of the Pension Benefit Guaranty Corporation (PBGC), the federal  agency that insures certain benefits under such plans. While growth in the  number and coverage of defined contribution plans—where each worker  has an individual account that receives contributions—has helped mitigate  the decline of more traditional defined-benefit plans, these plans have also  experienced problems. Policy makers will need to consider how best to  encourage wider pension coverage and adequate and secure pension  benefits, and how such pensions might best interact with any changes to  the Social Security program.
Meanwhile, federal disability programs, such as those at the Social Security  Administration (SSA) and the Department of Veterans Affairs (VA), are  challenged by significant growth over the past decade that is expected to  surge even more as increasing numbers of baby boomers reach their  disability-prone years. Federal disability programs remain mired in  concepts from the past and are poorly positioned to provide meaningful  and timely support for workers with disabilities. Advances in medicine and  science have redefined what constitutes an impairment to work, and the  nature of work itself has shifted toward service and knowledge-based  employment—these developments need to be reflected in agencies’  eligibility and review processes.
The mounting challenges faced by our national retirement and disability  programs raise important questions. For example:  How should Social Security be reformed to provide for long-term  program solvency and sustainability while also ensuring adequate  benefits and protection from disability (e.g., increase the retirement age,  restructure benefits, increase taxes, and/or create individual accounts)?
What changes should be made to enhance the retirement income  security of workers while protecting the fiscal integrity of the PBGC  insurance program?
How can federal disability programs, and their eligibility criteria, be  brought into line with the current state of science, medicine, technology,  and labor market conditions?
section_title: Health Care Costs, Quality, and Access Challenges
paragraphs: Overall health care spending doubled between 1992 and 2002 and is  projected to nearly double again in the following decade to about $3.1  trillion. Despite consuming a significant share of the economy—over 15  percent of GDP—U.S. health outcomes lag behind other major  industrialized nations. For example, the U.S. performs below par in infant  mortality and life expectancy rates as well as premature and preventable  deaths. At the same time, access to basic health care coverage remains an  elusive goal for nearly 45 million Americans without insurance. Americans  with good health insurance have access to advanced technology  procedures and world-class health facilities, but clinical studies suggest  that not all of this care is desirable or needed. Rising health costs are  compelling both public and private payers to examine whether these  procedures can continue to be financed without better accounting for their  clinical effectiveness. Additional health care spending over time will draw  resources away from other economic sectors and could have adverse  economic implications for all levels of government, individuals, and other  private purchasers of health care. Defining differences between needs,  wants, affordability, and sustainability is fundamental to rethinking the  design of our current health care system.
In the past several decades, the responsibility for financing health care has  shifted away from the individual patient. In 1962, nearly half—46 percent— of health care spending was financed by individuals. The rest was financed  by a combination of private health insurance and public programs. By 2002,  the amount of health care spending financed by individuals’ out-of-pocket  spending—at the point of service—was estimated to have dropped to 14  percent. Tax preferences for insured individuals and their employers have  also shifted some of the financial burden for private health care to all  taxpayers. Tax preferences can work at cross-purposes to the goal of  moderating health care spending. For example, the value of employees’  health insurance premiums are permitted to be excluded from the  calculation of their taxable earnings and are also excluded from the  employers’ calculation of payroll taxes for both themselves and their  employees. These tax exclusions represent a significant source of foregone  federal revenue.
Public and private payers are experimenting with payment reforms  designed to foster delivery of care that is clinically proven to be effective.  Ideally, identifying and rewarding efficient providers and encouraging  inefficient providers to emulate best practices will result in better value for  the dollars spent on care. However, the challenge of implementing  performance-based payment reforms, among other strategies, on a  systemwide basis will depend on system components that are not currently  in place nationwide—such as compatible information systems to facilitate  the production and dissemination of medical outcome data, safeguards to  ensure the privacy of electronic medical records, improved transparency  through increased measurement and reporting efforts, and incentives to  encourage adoption of evidence-based practices. These same system  components would be required to develop medical practice standards,  which could serve as the underpinning for effective medical malpractice  reform.
In meeting these pressing health care system challenges, the following  questions might be considered.
How can technology be leveraged to reduce costs and enhance quality  while protecting patient privacy?
How can health care tax incentives be designed to encourage employers  and employees to better control health care costs? For example, should  tax preferences for health care be designed to cap the health insurance  premium amount that can be excluded from an individual’s taxable  income?
How can “industry standards” for acceptable care be established, and  what payment reforms can be designed to bring about reductions in  unwarranted medical practice variation? What can or should the federal  government do to promote uniform standards of practice for selected  procedures and illnesses?
section_title: Tax System Challenges
paragraphs: As I discussed earlier, the imbalance between federal revenues and  expenditures, if allowed to persist long term, will affect economic growth  and require greater scrutiny of both tax revenues and expenditures. The  level and types of taxes have major impacts on the financing of  government, as well as on the economy as a whole and on individual  taxpayers, for both today and tomorrow.
The success of our tax system hinges greatly on the public’s perception of  its fairness and understandability. Compliance is influenced not only by the  effectiveness of IRS’s enforcement efforts, but also by Americans’ attitudes  about the tax system and the government. Disturbing recent polls indicate  that about 1 in 5 respondents say it is acceptable to cheat on their taxes.  Furthermore, the complexity of and frequent revisions to the tax system  make it more difficult and costly for taxpayers who want to comply to do  so, and for IRS to explain and enforce tax laws. Many argue that complexity  creates opportunities for tax evasion—through vehicles such as tax  shelters—which, in turn, motivate further changes and complexity in tax  laws and regulations. The lack of transparency also fuels disrespect for the  tax system and the government. Thus, a crucial challenge for  reexamination will be to determine how we can best strengthen  enforcement of existing laws to give taxpayers confidence that their  friends, neighbors, and business competitors are paying their fair share.
The growing complexity of the tax system stems in part from the extensive  use of tax incentives to promote social and economic objectives. The tax  system includes hundreds of billions of dollars in such incentives—the  same magnitude as total discretionary spending—yet relatively little is  known about the effectiveness of tax incentives in achieving the objectives  intended by the Congress. Furthermore, as you know, tax incentives are off  the radar screen for the most part and do not compete in the budget  process. They are effectively “fully funded” before any discretionary  spending is considered. Incentives for savings are a particular concern:  Private sector savings are near historical lows, and government savings,  due to federal budget deficits, are negative. In addition, these incentives are  complex, and although the issue is not completely settled, research has  suggested that the incentives often do not stimulate much, if any, net new  saving by individuals. As far back as 1994, we have reported that tax  incentives deserved more scrutiny.
The debate about the future tax system is partly about whether the goals  for the nation’s tax system can be best achieved using the current structure,  which is heavily dependent on income taxes, or a fundamentally reformed  structure, which might include more dependence on consumption taxes, a  flatter rate schedule, and/or fewer tax preferences. Increasing  globalization, which makes it easier to move assets, income, and jobs  across international borders, is another motivator for the debate. As policy  makers grapple with such issues, they will have to balance multiple  objectives, such as economic growth, equity, simplicity, transparency, and  administrability, while raising sufficient revenue to finance government  spending priorities. The appropriate balance among these objectives may  also be affected by (1) how, if at all, to take into account that, including  both the employer and employee share, an estimated two-thirds of  taxpayers would pay more in payroll taxes—which are levied to fund Social  Security and Medicare benefits—than they would pay in income taxes in  2004 and (2) whether and how to tax wealth.
Today’s pressing tax challenges raise important questions. For example:  Given our current tax system, what tax rate structure is more likely to  raise sufficient revenue to fund government and satisfy the public’s  perception of fairness?
Can we increase compliance with tax laws and reduce the need for IRS  enforcement through greater use of withholding and information  reporting? Could increased disclosure and penalties reduce the use of  abusive tax shelters?
Which tax incentives need to be reconsidered because they fail to  achieve the objectives intended by the Congress, their costs outweigh  their benefits, they duplicate other programs, or other more cost  effective means exist for achieving their objectives?
Should the basis of the existing system be changed from an income to a  consumption base? Would such a change help respond to challenges  posed by demographic, economic, and technological changes? How  would such a change affect savings and work incentives? How would  reforms address such issues as the impact on state and local tax systems  and the distribution of burden across the nation’s taxpayers?
section_title: Where Do We Go From Here?
paragraphs: Congress faces a challenge many would find daunting: the need to bring  government and its programs in line with 21st century realities. This  challenge has many related pieces: narrowing the long-term fiscal gap;  adapting Social Security to meet the new demographic reality; tackling the  challenge of health care access, cost and quality; deciding on the  appropriate role and size of the federal government—and how to finance  that government—and bringing the panoply of federal activities into line  with today’s world. We believe that we at GAO have an obligation to assist  and support the Congress in this effort. The reexamination questions  discussed today and the forthcoming report of which they are a part are  offered in that spirit: they are drawn primarily from the work GAO has  done for the Congress over the years. We have attempted to structure  questions that we hope you will find useful as you examine and act on  problems that may not constitute an urgent crisis but pose important  longer term threats to the nation’s fiscal, economic, security and societal  future.
Although it is not easy, the periodic reexamination of existing portfolios of  federal programs can weed out ineffective or outdated programs while also  strengthening and updating those programs that are retained. Such a  process not only could address fiscal imbalances, but also improve the  responsiveness, effectiveness, and credibility of government in addressing  21st century needs and challenges. Given the unsustainability of our current  fiscal outlook, the real question is not whether we will deal with the fiscal  imbalance, but how and when.
Given the size of the long-term fiscal imbalances, all major spending and  revenue programs in the budget should be subject to periodic reviews and  reexamination. While it is important to consider the role and size of  government, how we finance government, and the major programs driving  the long-term spending path—Medicare, Medicaid, and Social Security— our recent fiscal history suggests that exempting major areas from  reexamination and review can undermine the credibility and political  support for the entire process.
We recognize that this will not be a simple or easy process—there are no  “quick fixes.” Such a process reverses the focus of traditional incremental  reviews, where disproportionate scrutiny is given to proposals for new  programs or activities, but not to those that are already in the base. Taking  a hard look at existing programs and carefully reconsidering their goals and  their financing is a challenging task. Reforming programs and activities  leads to winners and losers, notwithstanding demonstrated shortfalls in  performance and design. Given prior experience and political tendencies,  there is little real “low-hanging fruit” in the federal budget. Across-the- board approaches to fiscal challenges may be easier in the short run, but  they do not address the longer term fiscal cost drivers and cut both  effective and ineffective programs alike.
Given the severity of the nation’s fiscal challenges and the wide range of  federal programs, the hard choices necessary to get us back on track in a  sustainable manner may take a generation to address. Beginning the  reexamination and review process now would enable decision makers to  be more strategic and selective in choosing areas for review over a period  of years. Reexamining selected parts of the budget base, over time rather  than all at once, will lengthen the process, but it may also make the process  more feasible and less burdensome for decision makers. And by phasing in  changes to programs or policies that might otherwise have prohibitively  high costs of transition, the impact can be spread out over longer time  periods.
Although reexamination is never easy, the effort is not without precedent.  The federal government, in fact, has reexamined some of its programs and  priorities episodically in the past. Programmatic reexaminations have  included, for example, the 1983 Social Security reform, the 1986 tax reform,  and the 1996 welfare reform. They have also included reforms such as the  creation of the Department of Homeland Security and, most recently, the  ongoing reorganization of the U.S. intelligence community. From a broader  fiscal standpoint, the 1990s featured significant deficit-reduction measures  adopted by the Congress and supported by the President that made  important changes to discretionary spending, entitlement program growth,  and revenues that helped eliminate deficits and bring about budgetary  surpluses. States and other nations also have engaged in reexamination  exercises.
In our system, a successful reexamination process will in all likelihood rely  on multiple approaches over a period of years. The reauthorization,  appropriations, oversight, and budget processes have all been used to  review existing programs and policies. Adding other specific approaches  and processes—such as temporary commissions to develop policy  alternatives—has been proposed.
Fortunately the Government Performance and Results Act (GPRA) of 1993  and other result-oriented management laws enacted over the last 12 years  have built a base of performance information that can assist the Congress  and the President in this effort. In the last few years, OMB has been  working to rate the effectiveness of programs under the program  assessment rating tool (PART). There are also many nongovernmental  sources of program evaluation and analysis. And, finally, Congress has its  own analytic support—your staff and that of the Congressional support  agencies. As always, GAO stands ready to assist the Congress as it develops  its agenda and to help answer any of the questions the Congress wishes to  pursue.
Mr. Chairman, Senator Conrad, and Members of the Committee this  concludes my testimony. I would be happy to answer any questions you  may have.
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