21st Century: Addressing Long-Term Fiscal Challenges Must Include a Re-examination of Mandatory Spending
Published: 2006-02-15T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: This testimony discusses entitlement and other mandatory spending programs in light of our nation's long-term fiscal outlook and the challenges it poses for the budget and oversight processes. In our report entitled 21st Century Challenges: Reexamining the Base of the Federal Government, we presented 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. We hope that this report, among other things, will be used by various congressional committees as they consider which areas of government need particular attention and reconsideration. Congress will also receive more specific proposals, some of them will be presented within comprehensive agendas. Our report provides examples of the kinds of difficult choices the nation faces with regard to discretionary spending; mandatory spending, including entitlements; as well as tax policies and compliance activities.
section_title: What GAO Found
paragraphs: Mandatory spending programs--like tax expenditures--are governed by eligibility rules and benefit formulas, which means that funds are spend as required to provide benefits to those who are eligible and wish to participate. Since Congress and the President must change substantive law to change the cost of these programs, they are relatively uncontrollable on an annual basis. Moreover, as we reported in a 1994 analysis, their cost cannot be controlled by the same "spending cap" mechanism used for discretionary spending. By their very nature mandatories limit budget flexibility. Mandatory spending has grown as a share of the total federal budget. Under both the Congressional Budget Office baseline estimates and the President's Budget, this spending would grow further. While the long-term fiscal outlook is driven by Medicare, Medicaid and Social Security, it does not mean that all other mandatory programs should be "given a pass." As we have noted elsewhere, reexamination of the "fit" between government programs and the needs and priorities of the nation should be an accepted practice. So in terms of budget flexibility--the freedom of each Congress and President to allocate public resources--we cannot ignore mandatory spending programs even if they do not drive the aggregate. While some might suggest that mandatory programs could be controlled by being converted to discretionary or annually appropriated programs, that seems unlikely to happen. If we look across the range of mandatories we see many programs have objectives and missions that contribute to the achievement of a range of broad-based and important public policy goals such as providing a floor of income security in retirement, fighting hunger, fostering higher education, and providing access to affordable health care. To these ends, these programs--and tax expenditures--were designed to provide benefits automatically to those who take the desired action or meet the specified eligibility criteria without subjecting them to an annual decision regarding spending or delay in the provision of benefits such a process might entail. Although mandatory spending is not amenable to "caps," that does not mean that mandatory programs should be permitted to be on autopilot and grow to an unlimited extent. Since the spending for any given entitlement or other mandatory program is a function of the interaction between the eligibility rules and the benefit formula--either or both of which may incorporate exogenous factors such as economic downturns--the way to change the path of spending for any of these programs is to change those rules or formulas. We recently issued a report on "triggers"--some measure which, when reached or exceeded, would prompt a response connected to that program. By identifying significant increases in the spending path of a mandatory program relatively early and acting to constrain it, Congress may avert much larger and potentially disruptive financial challenges and program changes in the future.

section_title: Letter
paragraphs: I appreciate this opportunity to talk with you about the need to look at  entitlement and other mandatory spending programs in light of our  nation’s long-term fiscal outlook and the challenge it poses for the budget  and oversight processes.
As I have said many times before, meeting our nation’s large, growing, and  structural fiscal imbalance will require a three-pronged approach:  restructuring existing entitlement programs,  reexamining the base of discretionary and other spending, and  reviewing and revising existing tax policy, including tax expenditures,  which can operate like mandatory spending programs.
Before I turn to the major driver of the long-term spending outlook—  rising health care costs combined with known demographic trends—I’d  like to step back and take a broader view of the need to reexamine and  reconsider what the federal government does, how it does it, and who  does it. We are in the first decade of the 21st century but the basis and  design for many of the federal government’s activities date from before I  was born.
In our report entitled 21st Century Challenges: Reexamining the Base of  the Federal Government, we presented 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. We  hope that this report, among other things, will be used by various  congressional committees as they consider which areas of government  need particular attention and reconsideration. You will, of course, also  receive more specific proposals, some of them will be presented within  comprehensive agendas—the President’s Budget released last week is just  one very prominent example.
Our report provides examples of the kinds of difficult choices the nation  faces with regard to discretionary spending; mandatory spending,  including entitlements; as well as tax policies and compliance activities. It  is, I think, important to recognize that tax policies and programs financing  the federal budget can be reviewed not only with an eye toward the overall  level of revenue provided to fund federal operations and commitments,  but also the mix of taxes and the extent to which the tax code is used to  promote overall economic growth and broad-based societal objectives. In  practice, some tax expenditures are very similar to mandatory spending  programs even though they are not subject to the appropriations process  or selected budget control mechanisms. As we reported last September,  tax expenditures represent a significant commitment and are not typically  subjected to review or reexamination.
Mandatory spending programs—like tax expenditures—are governed by  eligibility rules and benefit formulas, which means that funds are spent as  required to provide benefits to those who are eligible and wish to  participate. Since Congress and the President must change substantive law  to change the cost of these programs, they are relatively uncontrollable on  an annual basis. Moreover, as we reported in a 1994 analysis, their cost  cannot be controlled by the same “spending cap” mechanism used for  discretionary spending.
By their very nature mandatories limit budget flexibility. As figure 1  shows, mandatory spending has grown as a share of the total federal  budget. For example, mandatory spending has grown from 27 percent  before the creation of Medicare and Medicaid to 42 percent in 1985 to 54  percent last year. (Total spending not subject to annual appropriations— mandatory spending and net interest—has grown from 56 percent in 1985  to 61 percent last year.) Under both the Congressional Budget Office  baseline estimates and the President’s Budget, this spending would grow  further.
While the long-term fiscal outlook is driven by Medicare, Medicaid and  Social Security, it does not mean that all other mandatory programs  should be “given a pass.” As we have noted elsewhere, reexamination of  the “fit” between government programs and the needs and priorities of the  nation should be an accepted practice. So in terms of budget flexibility— the freedom of each Congress and President to allocate public resources— we cannot ignore mandatory spending programs even if they do not drive  the aggregate.
While some might suggest that mandatory programs could be controlled  by being converted to discretionary or annually appropriated programs,  that seems unlikely to happen. If we look across the range of mandatories  we see many programs have objectives and missions that contribute to the  achievement of a range of broad-based and important public policy goals  such as providing a floor of income security in retirement, fighting hunger,  fostering higher education, and providing access to affordable health care.  To these ends, these programs—and tax expenditures—were designed to  provide benefits automatically to those who take the desired action or  meet the specified eligibility criteria without subjecting them to an annual  decision regarding spending or delay in the provision of benefits such a  process might entail.
Although mandatory spending is not amenable to “caps,” that does not  mean that mandatory programs should be permitted to be on autopilot and  grow to an unlimited extent. Since the spending for any given entitlement  or other mandatory program is a function of the interaction between the  eligibility rules and the benefit formula—either or both of which may  incorporate exogenous factors such as economic downturns—-the way to  change the path of spending for any of these programs is to change those  rules or formulas. We recently issued a report on “triggers”—some  measure which, when reached or exceeded, would prompt a response  connected to that program. By identifying significant increases in the  spending path of a mandatory program relatively early and acting to  constrain it, Congress may avert much larger and potentially disruptive  financial challenges and program changes in the future.
A trigger is a measure and a signal mechanism—like an alarm clock. It  could trigger a “soft” response—one that calls attention to the growth rate  or the level of spending and prompts special consideration when the  threshold or target is breached. Two examples of soft responses that could  be triggered include requiring the relevant agency to prepare a report  analyzing why the trigger was tripped and/or requiring the President to  submit a proposal to change the path or explain why he thinks it should  remain unchanged. The Medicare program already contains a “soft”  response trigger: The President is required to submit a proposal for action  to Congress if the Medicare Trustees determine in 2 consecutive years that  the general revenue share of Medicare spending is projected to exceed 45  percent during a 7-year period. Each year the Social Security and  Medicare Trustees test for program financial adequacy over the next 10  years. The results of the test are included in the respective Trustees’  reports to Congress, in which they note that failure to meet this test is an  indication that action is needed. A few Social Security reform proposals  have taken this further by including language requiring Presidential and  Congressional action if the Social Security Board of Trustees determines  that the balance ratio of either of the Social Security trust funds will be  zero for any calendar year during the succeeding 75 years. Given the  complexity and controversy associated with reforming entitlements,  commissions might be one means to come up with possible triggers  appropriate to the specific programs.
Soft responses can help in alerting decision makers of potential problems  but they do not ensure that action to decrease spending or increase  revenue is taken. With soft responses, the fiscal path continues unless  Congress and the President take action. In contrast, a trigger could lead to  “hard” responses requiring a predetermined, program-specific action to  take place, such as changes in eligibility criteria and benefit formulas,  automatic revenue increases, or automatic spending cuts. With hard  responses, spending is automatically constrained, revenue is automatically  increased, or both, unless Congress takes action to override. For example,  this year the President’s Budget proposes to change the Medicare trigger  from solely “soft” to providing a “hard” (automatic) response if Congress  fails to enact the President’s proposal. Figure 2 below illustrates the  conceptual differences between hard and soft responses of a budget  trigger.
In our recent report on mandatory spending triggers, we discussed the  kinds of responses that might be triggered and the importance of program- specific design. Proposed changes in underlying benefits structure and  design of a mandatory program can be considered in the context both of  the factors that drive the growth of that program and the specific goals  and objectives of the program. For example, some mandatories are  intended to have a countercyclical effect; any triggered response in these  programs would have to be designed not to interfere with that function. Its  design, therefore, would have to be sensitive to whether growth comes  because the program is, in fact, working as an automatic stabilizer.
Both near- and long-term perspectives should be considered in the design  of triggers. For some programs, it might be appropriate to tie the trigger to  historical data—for example, to see whether spending growth was greater  than some historical average or path. For programs that expose the  government to long-term commitments, it might be more appropriate to tie  the trigger to projections of future spending. For “contributory” programs  that represent a long-term commitment of future earmarked resources,  such as Social Security, one appropriate measure could be the actuarial  projections of the 75-year outlook. Some similar approach might be used  for programs like pension or health insurance.
Any discussion to create triggered responses and their design must  recognize that unlike controls on discretionary spending, there is some  tension between the idea of triggers and the nature of entitlement and  other mandatory spending programs. These programs—as with tax  provisions such as tax expenditures—were designed to provide benefits  based on eligibility formulas or actions as opposed to an annual decision  regarding spending. This tension makes it more challenging to constrain  costs and to design both triggers and triggered responses. At the same  time, with only about one-third of the budget under the control of the  annual appropriations process, considering ways to increase transparency,  oversight, and control of mandatory programs must be part of addressing  the nation’s long-term fiscal challenges.
Before I turn to the largest driver of our long-term challenge—rising health  care costs—let me note that the idea of triggers need not only apply to  spending. The revenue side of the budget should also be addressed. If, for  example, one option to cover the increased costs of a mandatory spending  program was a premium increase or tax increase, it would serve to  increase public visibility and could make the American people more aware  of how much they are paying for services. More directly analogous to  mandatory spending programs is the extensive use of tax incentives,  rather than direct spending authority, to address various social objectives.  As we reported in September 2005, the sum of revenue loss estimates  associated with tax expenditures—such as tax exclusions, credits, and  deductions—was nearly $730 billion in 2004. Under the most recent  estimates, this has risen to more than $775 billion in 2005.
Let me be clear that in suggesting application of this analysis to tax  expenditures I am not addressing the appropriate level of taxation as a  share of GDP. Whatever level of revenue is deemed appropriate, tax  expenditures that seek to achieve programmatic or policy goals should— like other federal programs or activities—be reviewed to determine their  effectiveness, continued relevance, affordability, and sustainability. Tax  expenditures have a significant effect on overall tax rates—in that, for any  given level of revenue, overall tax rates must be higher to offset the  revenue forgone through tax expenditures—as well as the budget and  fiscal flexibility. They also contribute to the growing complexity of the  federal tax system. Many tax expenditures operate like mandatory  spending programs and generally are not subject to reauthorization. Such  tax expenditures are embedded in the tax system. They are not subject to  a performance test and are off the radar screen for the most part. This is a  concern from a budgetary standpoint because taxpayer dollars committed  to fund these expenditures do not compete in the annual appropriations  process and are effectively “fully funded” before any discretionary  spending is considered. The analysis we have applied to spending would  also be useful in examining tax expenditures.
subsections: section_title: Federal Health Care Spending Drives the Long-Term Fiscal Challenge
paragraphs: Among mandatory spending programs—and indeed tax expenditures—the  health area is especially important because the long-term fiscal challenge  is largely a health care challenge. Contrary to public perceptions, health  care is the biggest driver of the long-term fiscal challenge. While Social  Security is important because of its size, health care spending is both large  and projected to grow much more rapidly.
Our most recent simulation results illustrate the importance of health care  in the long-term fiscal outlook as well as the imperative to take action.  Simply put, our nation’s fiscal policy is on an imprudent and unsustainable  course. These long-term budget simulations show, as do those published  last December by the Congressional Budget Office (CBO), that over the  long term we face a large and growing structural deficit due primarily to  known demographic trends and rising health care costs and lower federal  revenues as a percentage of the economy. 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.
Figures 3 and 4 present our long-term simulations under two different sets  of assumptions. In figure 3, we start with CBO’s 10-year 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 2016, discretionary spending is assumed to  grow with the economy, and revenue is held constant as a share of GDP at  the 2016 level. In figure 4, two assumptions are changed: (1) discretionary  spending is assumed to grow with the economy after 2006 rather than  merely with inflation, and (2) all expiring tax provisions are extended. For  both simulations, Social Security and Medicare spending is based on the  2005 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 2005 long-term projections under  mid-range assumptions.
As these simulations illustrate, absent significant policy changes on the  spending and/or revenue side of the budget, the growth in mandatory  spending on federal retirement and especially health entitlements will  encumber an escalating share of the government’s resources. Indeed,  when we assume that all the temporary 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 only some Social Security benefits and 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, assuming 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 highly implausible. 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.
Accordingly, substantive reform of the major health programs and Social  Security is critical to recapturing our future fiscal flexibility. Ultimately,  the nation will have to decide what level of federal benefits and spending it  wants and how it will pay for these benefits. Our current fiscal path will  increasingly constrain our ability to address emerging and unexpected  budgetary needs and increase the burdens that will be faced by future  generations. Continuing on this path will mean escalating and ultimately  unsustainable federal deficits and debt that will serve to threaten our  future national security as well as the standard of living for the American  people.
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 5 shows the total future draw on the economy represented by  Social Security, Medicare, and Medicaid. Under the 2005 Trustees’  intermediate estimates and CBO’s 2005 long-term Medicaid estimates  under mid-range assumptions, spending for these entitlement programs  combined will grow to 15.7 percent of gross domestic product (GDP) in  2030 from today’s 8.4 percent. It is clear that, taken together, Social  Security, Medicare, and Medicaid represent an unsustainable burden on  future generations.
Furthermore, most of the long-term growth is in health care. While Social  Security in its current form will grow from 4.3 percent of GDP today to 6.4  percent in 2080, Medicare’s burden on the economy will quintuple—from  2.7 percent to 13.8 percent of the economy—and these projections assume  a growth rate for Medicare spending that is below historical experience!  As figure 5 shows, unlike Social Security which grows larger as a share of  the economy and then levels off, within this projection period we do not  see Medicare growth abating. Whether or not the President’s Budget  proposals on Medicare are adopted, they should serve to raise public  awareness of the importance of health care costs to both today’s budget  and tomorrow’s. This could serve to jump start a discussion about  appropriate ways to control the major driver of our long-term fiscal  outlook—health care spending.
As noted, unlike Social Security, Medicare spending growth rates reflect  not only a burgeoning beneficiary population, but also the escalation of  health care costs at rates well exceeding general rates of inflation. The  growth of medical technology has contributed to increases in the number  and quality of health care services. Moreover, the actual costs of health  care consumption are not transparent. Consumers are largely insulated by  third-party payers from the cost of health care decisions.
The health care spending problem is particularly vexing for the federal  budget, affecting not only Medicare and Medicaid but also other important  federal health programs, such as for our military personnel and veterans.  For example, Department of Defense health care spending rose from  about $12 billion in 1990 to about $30.4 billion in 2004—in part, to meet  additional demand resulting from program eligibility expansions for  military retirees, reservists, and the dependents of those two groups and  for the increased needs of active duty personnel involved in conflicts in  Iraq, Bosnia, and Afghanistan. Expenditures by the Department of  Veterans Affairs have also grown—from about $12 billion in 1990 to about  $26.8 billion in 2004—as an increasing number of veterans look to federal  programs to supply their health care needs.
The challenge to rein in health care spending is not limited to public  payers, however, as the phenomenon of rising health care costs associated  with new technology exists system-wide. This means that addressing the  unsustainability of health care costs is also a major competitiveness and  societal challenge that calls for us as a nation to fundamentally rethink  how we define, deliver, and finance health care in both the public and the  private sectors. A major difficulty is that our current system does little to  encourage informed discussions and decisions about the costs and value  of various health care services. These decisions are very important when it  comes to cutting-edge drugs and medical technologies, which can be  incredibly expensive but only marginally better than other alternatives. As  a nation, we are going to need to weigh unlimited individual wants against  broader societal needs and decide how responsibility for financing health  care should be divided among employers, individuals, and government.  Ultimately, we may need to define a set of basic and essential health care  services to which every American is ensured access. Individuals wanting  additional services, and insurance coverage to pay for them, might be  required to allocate their own resources. Clearly, such a dramatic change  would require a long transition period—all the more reason to act sooner  rather than later.
In recent years, policy analysts have discussed a number of incremental  reforms that take aim at moderating health care spending, in part by  unmasking health care’s true costs. (See fig. 6 for a list of selected  reforms.) Among these reforms is to devise additional cost-sharing  provisions to make health care costs more transparent to patients.  Currently, many insured individuals pay relatively little out of pocket for  care at the point of delivery because of comprehensive health care  coverage—precluding the opportunity to sensitize these patients to the  cost of their care.
Develop a set of national practice standards to help avoid unnecessary  care, improve outcomes, and reduce litigation.
Encourage case management approaches for people with expensive  acute and chronic conditions to improve the quality and efficiency of  care delivered and avoid inappropriate care.
Foster the use of information technology to increase consistency,  transparency, and accountability in health care.
Emphasize prevention and wellness care, including nutrition.
Leverage the government’s purchasing power to control costs for  prescription drugs and other health care services.
Revise certain federal tax preferences for health care to encourage the  more efficient use of appropriate care.
Create an insurance market that adequately pools risk and offers  alternative levels of coverage.
Develop a core set of basic and essential services with supplemental  coverage being available as an option but at a cost. Use the Federal  Employees Health Benefits Program (FEHBP) model as a possible  means to experiment and see the way forward.
Limit spending growth for government-sponsored health care  programs (e.g., percentage of the budget and/or the economy).
Other steps include reforming the policies that give tax preferences to  insured individuals and their employers. These policies permit the value of  employees’ health insurance premiums to be excluded from the  calculation of their taxable earnings and exclude the value of the premium  from the employers’ calculation of payroll taxes for both themselves and  employees. Tax preferences also exist for health savings accounts and  other consumer-directed plans. These tax exclusions represent a  significant source of forgone federal revenue and work at cross-purposes  to the goal of moderating health care spending. As figure 7 shows, in 2005  the tax expenditure responsible for the greatest revenue loss was that for  the exclusion of employer contributions for employees’ insurance  premiums and medical care.
Another area conducive to incremental change involves provider payment  reforms. These reforms are intended to induce physicians, hospitals, and  other health care providers to improve on quality and efficiency. For  example, studies of Medicare patients in different geographic areas have  found that despite receiving a greater volume of care, patients in higher  use areas did not have better health outcomes or experience greater  satisfaction with care than those living in lower use areas. Public and  private payers are experimenting with payment reforms designed to foster  the delivery of care that is proven to be both clinically and cost 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. The development of uniform standards of  practice could lead to ensuring that people with chronic illnesses, a small  but expensive population, received more and cost-effective and patient- centered care while reducing unwarranted medical malpractice litigation.
The problem of escalating health care costs is complex because  addressing federal programs such as Medicare and the federal-state  Medicaid program will need to involve change in the health care system of  which they are a part—not just within federal programs. This will be a  major societal challenge that will affect all age groups. Because our health  care system is complex, with multiple interrelated pieces, solutions to  health care cost growth are likely to be incremental and require a number  of extensive efforts over many years. In my view, taking steps to address  the health care cost dilemma system-wide puts us on the right path for  correcting the long-term fiscal problems posed by the nation’s health care  entitlements.
I have focused today on health care because it is a driver of our fiscal  outlook. Indeed, health care is already putting a squeeze on the federal  budget.
Health care is the dominant but not the only driver of our long-term fiscal  challenge. Today it is hard to think of our fiscal imbalances as a big  problem: the economy is healthy and interest rates seem low. We,  however, have an obligation to look beyond today. Budgets, deficits, and  long-term fiscal and economic outlooks are not just about numbers: they  are also about values. It is time for all of us to recognize our stewardship  obligation for the future. We should act sooner rather than later. We all  must make choices that may be difficult and unpleasant today to avoid  passing an even greater burden on to future generations. Let us not be the  generation who sent the bill for its consumption to its children and  grandchildren.
Thank you Mr. Chairman, Mr. Spratt, and members of the Committee for  having me today. We at GAO, of course, stand ready to assist you and your  colleagues as you tackle these important challenges.
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