Long-Term Budget Outlook: Saving Our Future Requires Tough Choices Today
Published: 2007-01-11T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: This testimony, given by David M. Walker, Comptroller General of the United States before the Senate Committee on the Budget, addresses the nation's long-term fiscal outlook and the challenge it presents. However, the outlook is not good. Continuing down this current fiscal path would gradually erode, if not suddenly damage, out economy, our standard of living, and ultimately even our domestic tranquility and national security. The five major points of the testimony are: (1) The current fiscal condition is worse than advertised, (2) the long-term fiscal outlook is both imprudent and unsustainable, (3) improvements in information and processes are needed and can help, (4) meeting out long-term fiscal challenge will require tough choices, bi-partisan cooperation, and compromise, and lastly (5) the time for action is now.
section_title: What GAO Found
paragraphs: The specific policy choices made to address this fiscal challenge are the purview of elected officials, and the policy debate will reflect differing views on the role of government and differing priorities for this country. What can be done is laying out the facts, debunking various myths and preparing the way for tough choices by elected officials. If the American people can understand that (1) we cannot grow out way out of this problem, (2) eliminating earmarks will not solve the problem, (3) wiping out fraud, waste, and abuse will not solve the problem, (4) ending the way or cutting way back on defense will not solve the problem, and (5) letting the recent tax cuts expire will not solve this problem, they they can engage with the elected officials in a discussion about what the government should do and how.

section_title: Letter
paragraphs: I appreciate this invitation to talk with you about our nation’s long-term  fiscal outlook and the challenge it presents. Your decision to begin this  Congress with a hearing on this important issue demonstrates the  seriousness with which this Committee views this challenge and your  commitment to begin to address it.
The picture I will lay out for you today is not a pretty one and it’s getting  worse with the passage of time. But this nation has met difficult  challenges—including challenges to its very existence—in the past and I’m  confident that we can do so again. This is a great nation with much to be  proud of and much to be thankful for. But today we are failing in one of  our most important stewardship responsibilities—our duty to pass on a  country better positioned to deal with the challenges of the future than the  one we were given. As members of this Committee know, continuing on  our current fiscal path would gradually erode, if not suddenly damage, our  economy, our standard of living, and ultimately even our domestic  tranquility and our national security.
My “bottom line” message today is no surprise to members of this  Committee:    Our current financial condition is worse than advertised.    Our long-term fiscal outlook is both imprudent and unsustainable.   Improvements in information and processes are needed and can help.    Meeting our long-term fiscal challenge will require tough choices, bi- partisan cooperation and compromise.
The time for action is now!
As widely reported, the $248 billion fiscal year 2006 unified budget deficit  was lower than originally forecast and lower than last year’s deficit of  $318 billion. While this improvement in the 1-year fiscal picture is better  than a worsening in that picture, it did not fundamentally change our long- term fiscal outlook. In fact, the U.S. government’s total reported liabilities,  net social insurance commitments, and other fiscal exposures continue to  grow and now total approximately $50 trillion, representing approximately  four times the nation’s total output, or gross domestic product (GDP) in  fiscal year 2006, up from about $20 trillion, or two times GDP in fiscal year  2000.
The overall picture of the long-term fiscal outlook is not news to this  committee. However, the long-term challenge is fast becoming a short- term one as the first of the baby boomers become eligible for early  retirement under Social Security on January 1, 2008—less than one year— and for Medicare benefits in 2011—less than 4 years from now. The budget  and economic implications of the baby boom generation’s retirement have  already become a factor in Congressional Budget Office’s (CBO) 10-year  baseline projections and will only intensify as the baby boomers age.  Simply put, our nation is on an imprudent and unsustainable fiscal path.  Herbert Stein once said that something that is not sustainable will stop.  That, however, should not give us comfort. It is more prudent to change  the path than to wait until a crisis occurs.
And that brings me to my next point. While restraint in the near term and  efforts to balance the budget over the next 5 years can be positive, it is  important that actions to achieve this also address the long-term fiscal  outlook. The real problem is not the near-term deficit—it is the long-term  fiscal outlook. It is important to look beyond year 5 or even year 10. Both  the budget and the budget process need more transparency over and focus  on the long-term implications of current and proposed spending and tax  policies. I will suggest a number of things that I believe will help in this  area in this testimony.
subsections: section_title: Our Fiscal and Financial Condition Is Worse Than Advertised
paragraphs: Our government produces two types of measures—budget and financial— which further break down into three different numbers that can be seen as  indicators of our current financial condition: the unified budget deficit, the  on-budget deficit and the net operating cost or accrual deficit. No one of  these alone is enough—we should look at all of them. The most commonly  reported measure is the unified budget deficit. This is a largely cash-based  number that represents the difference between revenues and outlays for  the government as a whole. It is an important measure since it is indicative  of the government’s draw on today’s credit markets—and its claim on  today’s economy. This measure, however, masks the difference between  Social Security’s cash flows and those for the rest of the budget. Therefore  we also need to look beneath the unified deficit at the on-budget deficit— what I like to call the “operating deficit.” And, finally, we should be  looking at the financial statements’ report of net operating cost—the  accrual-based deficit.
The difference between the on-budget deficit and the unified budget  deficit is the surplus in Social Security and the U.S. Postal Service.  Excluding consideration of the $185 billion surplus in Social Security’s  cash flows and a $1 billion surplus in the Postal Service, the on-budget  deficit was $434 billion in 2006. Figure 1 shows graphically how the on- budget deficit and the off-budget surplus have related and combine to lead  to the unified deficit. Since the Social Security trust fund invests any  receipts not needed to pay benefits in Treasury securities, this surplus  reduces the amount the Treasury must borrow from the public. As I will  note later, this pattern of cash flows is important—and it is projected to  come to and end just 10 years from now.
The third number, net operating cost, is the amount by which costs exceed  revenue and it is reported in the federal government’s financial statements,  which are prepared using generally accepted accounting principles. Costs  are recorded on an accrual basis—namely, in the period when goods are  used or services are performed as opposed to when the resulting cash  payments are made. However, most revenues, on the other hand, are  recorded on the modified cash basis––that is, they are recorded when  collected. The net operating cost can be thought of as the accrual deficit.  The accrual measure primarily provides more information on the longer- term implications of today’s policy decisions and operations by showing  certain costs incurred today but not payable for years to come, such as  civilian and military pensions and retiree health care.
All three of these numbers are informative. However, neither accrual nor  cash measures alone provide a full picture of the government’s fiscal  condition or the cost of government. Used together, they present  complementary information and provide a more comprehensive picture of  the government’s financial condition today and fiscal position over time.  For example, the unified budget deficit provides information on borrowing  needs and current cash flow. The accrual deficit provides information on  the current cost of government, but it does not provide information on  how much the government has to borrow in the current year to finance  government activities. Also, while accrual deficits provide more  information on the longer-term consequences of current government  activities, they do not include the longer-term cost associated with social  insurance programs like Social Security and Medicare. In addition, they  are not designed to provide information about the timing of payments and  receipts, which can be very important. Therefore, just as investors need  income statements, statements of cash flow, and balance sheets to  understand a business’s financial condition, both cash and accrual  measures are important for understanding the government’s financial  condition. Table 1 below shows the three measures for fiscal year 2005  and fiscal year 2006.
Although looking at both the cash and accrual measures provides a more  complete picture of the government’s fiscal stance today and over time  than looking at either alone, even these together do not tell us the full  story. For example, all of these show an improvement between fiscal year  2005 and fiscal year 2006. However, the fundamental drivers of our long- term challenge are largely the same. To understand the long-term  implications of our current path requires more than a single year’s  snapshot. In this regard, the long-term outlook has worsened significantly  in the last several years. That is why for more than a decade GAO has been  running simulations to tell this longer-term story.
section_title: The Long-term Fiscal Outlook
paragraphs: Long-term fiscal simulations by GAO, CBO and others all show that we  face large and growing structural deficits driven primarily by rising health  care costs and known demographic trends. GAO runs simulations under  two sets of assumptions. One takes the legislatively-mandated baseline  from CBO for the first 10 years and then keeps discretionary spending and  revenues constant as a share of GDP while letting Social Security,  Medicare, and Medicaid grow as projected by the Trustees and CBO under  midrange assumptions. The other perhaps more realistic scenario based  on the Administration’s announced policy preferences modifies this  baseline by letting discretionary spending grow with the economy and  extending all expiring tax provisions. As figure 2 shows, deficits spiral out  of control under either scenario. We will be updating these figures with the  release of the new CBO baseline later this month, but even with the lower  deficit in 2006, the long-term picture will remain daunting.
Looking more closely at each scenario gives a fuller understanding of what  the impact of continuing these trends would have on what government  does. And looking back to 2001 also shows us how much worse the  situation has become. As I noted, despite some recent improvements in  short-term deficits, the long-term outlook is moving in the wrong  direction.
Figures 3 and 4 show the composition of spending under our “Baseline  Extended” scenario in 2001 and 2006. Even with short-term surpluses, we  had a long-term problem in 2001, but it was more than 40 years out.  Certainly an economic slowdown and budget decisions driven by the  attacks of 9/11 and the need to respond to natural disasters have  contributed to the change in outlook. However, these items alone do not  account for the dramatic worsening. Tax cuts also contributed but the  single largest contributor to the deterioration of our long-term outlook  was the passage of the Medicare Prescription Drug Bill in 2003.
Figure 4 illustrates today’s cold hard truth, that neither slowing the growth  in discretionary spending nor allowing the tax provisions to expire—nor  both together—would eliminate the imbalance. This is even clearer under  the more realistic scenario as shown in figure 5. Estimated growth in the  major entitlement programs results in an unsustainable fiscal future  regardless of whether one assumes future revenue will be somewhat  above historical levels as a share of the economy as in the first simulation  (fig. 4) or lower as shown in figure 5.
Both these simulations illustrate that without policy changes on the  spending and/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. A government that in our children’s  lifetimes does nothing more than pay interest on its debt and mail checks  to retirees and some of their health providers is unimaginable.
Although Social Security is a major part of the fiscal challenge, contrary to  popular perception, it is far from our biggest challenge. While today Social  Security spending exceeds federal spending for Medicare and Medicaid  that will change. Over the past several decades, health care spending on  average has grown much faster than the economy, absorbing increasing  shares of the nation’s resources, and this rapid growth is projected to  continue. CBO estimates that Medicare and Medicaid spending will reach  6.3 percent of GDP in 2016, up from 4.6 this year (2007), while spending for  Social Security will only reach 4.7 percent of GDP in 2016 up from 4.2  percent this year. For this reason and others, rising health care costs pose  a fiscal challenge not just to the federal budget but also to states,  American business, and our society as a whole.
While there is always some uncertainty in long-term projections, two  things are certain: the population is aging and the baby boom generation is  nearly at retirement age. The aging population and rising health care  spending will have significant implications not only for the budget but also  for the economy as a whole. Figure 6 shows the total future draw on the  economy represented by Social Security, Medicare, and Medicaid. Under  the 2006 Trustees’ intermediate estimates and CBO’s long-term Medicaid  estimates, federal spending for these entitlement programs combined will  grow to 15.5 percent of GDP in 2030 from today’s 9 percent. It is clear that  taken together, Social Security, Medicare, and Medicaid under current law  represent an unsustainable burden on future generations.
While Social Security, Medicare and Medicaid dominate the long-term  outlook, they are not the only federal programs or activities that bind the  future. The federal government undertakes a wide range of programs,  responsibilities, and activities that obligate it to future spending or create  an expectation for spending and potentially limit long-term budget  flexibility. GAO has described the range and measurement of such fiscal  exposures—from explicit liabilities such as environmental cleanup  requirements to the more implicit obligations presented by life-cycle costs  of capital acquisition or disaster assistance.
As shown in figure 7, despite improvement in both the fiscal year 2006  reported net operating cost and the cash-based budget deficit, the U.S.  government’s major reported liabilities, social insurance commitments,  and other fiscal exposures continue to grow. They now total  approximately $50 trillion—about four times the nation’s total output  (GDP) in fiscal year 2006—up from about $20 trillion, or two times GDP in  fiscal year 2000. We all know that it is hard to make sense of what  “trillions” means. One way to think about it is: if we wanted to put aside  today enough to cover these promises, it would take $170,000 for each and  every American or approximately $440,000 per American household.  Clearly, despite recent progress on our short-term deficits, we have been  moving in the wrong direction in connection with our long-range  imbalance in recent years.
section_title: Process and Presentational Changes to Increase Transparency and Focus on Long-term Consequences Can Help
paragraphs: Since at its heart the budget debate is about the allocation of limited  resources, the budget process can and should play a key role in helping to  address our long-term fiscal challenge and the broader challenge of  modernizing government for the 21st century. I have said that Washington  suffers from myopia and tunnel vision. This can be especially true in the  budget debate in which we focus on one program at a time and the deficit  for a single year or possibly the costs over 5 years without asking about  the bigger picture and whether the long term is getting better or worse. We  at GAO are in the transparency and accountability business. Therefore it  should come as no surprise that I believe we need to increase the  understanding of and focus on the long term in our policy and budget  debates. To that end—as I noted earlier—I have been talking with a  number of members of the Senate and the House as well as various groups  concerned about this issue concerning a number of steps that might help.  I’ve attached a summary of some of these ideas to this statement. Let me  highlight several critical elements here.
The President’s budget proposal should again cover 10 years. This is  especially important given that some policies—both spending and tax— cost significantly more (or lose significantly more revenue) in the second 5  years than in the first. In addition, the budget should disclose the impact of  major tax or spending proposals on the short, medium and long term.
The executive branch should also provide information on fiscal  exposures—both spending programs and tax expenditures—that is, the  long-term budget costs represented by currently individual programs,  policies or activities as well as the total.
The budget process needs to pay more attention to the long-term  implication of the choices being debated. For example, elected  representatives should be provided with more explicit information on the  long-term costs of any major tax or spending proposal before it is voted  upon. It is sobering to recall that during the debate over adding  prescription drug coverage to Medicare, a great deal of attention was paid  to whether the 10-year cost was over or under $400 billion. Not widely  publicized—and certainly not surfaced in the debate—was that the present  value of the long-term cost of this legislation was about $8 trillion!
Of course, when you are in a hole, the first thing to do is stop digging. I  have urged reinstitution of the statutory controls—both meaningful caps  on discretionary spending and pay-as-you-go (PAYGO) on both the tax and  spending sides of the ledger—that expired in 2002. Given the severity of  our current challenge, Congress may wish to look beyond the return to  PAYGO and discretionary caps. Mandatory spending cannot remain on  autopilot. We have suggested that Congress might wish to design “triggers”  for mandatory programs—some measure that would prompt action when  the spending path increased significantly. In addition, Congress may wish  to look at rules to govern the use of “emergency supplementals.” However,  as everyone in this committee knows, these steps alone will not solve the  problem. That is why building in more consideration of the long-term  impact of decisions is necessary.
section_title: Meeting the Long- Term Fiscal Challenge Requires Cooperation and Compromise— and Action Should Not Be Delayed
paragraphs: The government can help ease future fiscal burdens through spending  reductions, revenue actions, or both that reduce debt held by the public  and enhance 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. To “grow our  way out” of the current long-term fiscal gap would require sustained  economic growth far beyond that experienced in U.S. economic history  since World War II.
While the appropriate level of 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 ever  increasing tax levels—and that seems both inappropriate and implausible.  Accordingly, substantive reform of Social Security and our major health  programs remains critical to recapturing our future fiscal flexibility.  Similarly, given demographic and health care cost trends, the size of the  spending cuts necessary to hold revenues at today’s share of GDP seems  inadequate and implausible. Waiting only makes matters worse. GAO’s  simulations show that if no action is taken, balancing the budget in 2040  could require actions as large as cutting total federal spending by 60  percent or raising federal taxes to 2 times today’s level. There are no “easy  answers” and everything must be on the table.
Although the long-term outlook is driven by Social Security and health  care costs, this does not mean the rest of the budget can be exempt from  scrutiny. Many tax expenditures operate like entitlement programs—but  with even less scrutiny. Other programs and activities were designed for a  very different time. To recapture our fiscal flexibility and bring our  government and its programs in line with 21st century realities requires a  fundamental reexamination of major spending and tax policies and  priorities. 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. This discussion will not be easy, but it is  critical.
For many years those of us who talk about the need to put Social Security  on a sustainable course and to reform Medicare have talked about the  benefits of early action. Acting sooner rather than later can turn  compound interest from an enemy to an ally. Acting sooner rather than  later permits changes to be phased in more gradually and gives those  affected time to adjust to the changes. Delay does not avoid action—it just  makes the steps that have to be taken more dramatic and potentially  harder. Unfortunately, there has already been too much delay. And now  the future is upon us.
Next year members of the baby boom generation start to leave the labor  force. Reflecting this demographic shift, CBO projects the average annual  growth rate of real GDP will decline from 3.1 percent in 2008 to 2.6 percent  in the period 2012-2016. This slowing of economic growth will come just as  spending on Social Security, Medicare and Medicaid will begin to  accelerate—accounting for 56 percent of all federal spending by 2016  compared to 43 percent in 2006.
As I noted earlier, today Social Security’s cash surplus helps offset the  deficit in the rest of the budget, but growth in Social Security spending is  expected to increase from an estimated 4.8 percent in 2008 to 6.5 percent  in 2016. The result, as shown in figure 8, is that the Social Security  surpluses begin a permanent decline in 2009. At that time the rest of the  budget will begin to feel the squeeze since the capacity of Social Security  surpluses to offset deficits in the rest of the budget will begin to shrink. In  2017 Social Security will no longer run a cash surplus and will begin  adding to the deficit. That year Social Security will need to redeem the  special securities it holds in order to pay benefits. Treasury will honor  those claims—the United States has never defaulted. But there is no free  money. The funds to redeem those securities will have to come from  higher taxes, lower spending on other programs, higher borrowing from  the public, or a combination of all three.
section_title: Concluding Remarks
paragraphs: It is a hopeful sign that we are here today.  By beginning the year not with  a discussion of the current year’s budget but with a focus on the long term,  this committee is showing the kind of leadership needed to tackle this  challenge.
I have long believed that the American people can accept difficult  decisions as long as they understand why such choices are necessary.  They need to be given the facts about the fiscal outlook: what it is, what  drives it, and what it will take to address it. As most of you know, I have  been investing a good deal of time in the Fiscal Wake-Up Tour (FWUT) led  by the Concord Coalition. Scholars from both the Brookings Institution  and the Heritage Foundation join with me and Concord in laying out the  facts and discussing the possible ways forward. In our experience, having  these people with quite different policy views agree on the nature, scale  and importance of the issue—and on the need to sit down and work  together—resonates with the audiences. Although the major participants  have been Concord, GAO, Brookings and Heritage, others include such  organizations as the Committee for Economic Development (CED); the  American Institute of Certified Public Accountants (AICPA); the  Association of Government Accountants (AGA); the National Association  of State Auditors, Comptrollers and Treasurers (NASACT); and AARP. The  FWUT also has received the active support and involvement of community  leaders, local colleges and universities, the media, the business community  and both former and current elected officials. We have been to 17 cities to- date. The discussion has been broadcast on public television stations in  Atlanta and Philadelphia. Just this morning I returned from an event at the  John Glenn School of Public Affairs at Ohio State University in Columbus,  Ohio, in which OMB Director Portman and former Senator Glenn  participated.
The specific policy choices made to address this fiscal challenge are the  purview of elected officials. The policy debate will reflect differing views  of the role of government and differing priorities for our country. What the  FWUT can do—and what I will continue to do—is lay out the facts,  debunk various myths and prepare the way for tough choices by elected  officials. If the American people understand that there is no magic bullet— if they understand that    we cannot grow our way out this problem;    eliminating earmarks will not solve the problem;    wiping out fraud, waste and abuse will not solve the problem;    ending the war or cutting way back on defense will not solve the problem;  and  letting the recent tax cuts expire will not solve this problem.
Then they can engage with you in a discussion about what government  should do and how.
This is a great nation. We have faced many challenges in the past and we  have met them. It is a mistake to underestimate the commitment of the  American people to their children and grandchildren; to underestimate  their willingness and ability to hear the truth and support the decisions  necessary to deal with this challenge. We owe it to our country, children  and grandchildren to address our fiscal and other key sustainability  challenges. The time for action is now.
Mr. Chairman, Senator Gregg, members of the Committee, let me repeat  my appreciation for your commitment and concern in this matter. We at  GAO stand ready to assist you in this important endeavor.
section_title: Contacts and Acknowledgments
paragraphs: For further information on this testimony, please contact Susan J. Irving at  (202) 512-9142 or irvings@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this testimony. Individuals making key contributions to this testimony  include Jay McTigue, Assistant Director, and Melissa Wolf.
section_title: Appendix I: Ideas for Improving the Transparency of Long-term Costs and the Attention Paid to These Costs before Decisions Are Made
subsections: section_title: Supplemental Reporting in the President’s Annual Budget Submission
paragraphs: Produce an annual Statement of Fiscal Exposures, including a concise list  and description of exposures, cost estimates where possible, and an  assessment of methodologies and data used to produce such cost  estimates.  Increase the transparency of tax expenditures by including them in the  annual Fiscal Exposures Statement and, where possible, also showing  them along with spending and credit programs in the same policy area.
Provide information on the impact of major tax or spending proposals on  short-term, midterm, and long-term fiscal exposures and on the path of  surplus/deficit and debt as percent of gross domestic product (GDP) over  10-year and longer-term horizons (and assuming no sunset if sunset is part  of the proposal).
Cover 10 years in the budget.    Consider requiring the President to include in his annual budget  submission a long-term fiscal goal (e.g., balance, surplus, or deficit as  percent of GDP).
section_title: Additional Executive Branch Reports
paragraphs: Prepare and publish a Summary Annual Report or Citizen’s Summary that  summarizes, in a clear, concise, plain English, and transparent manner,  key financial and performance information included in the Consolidated  Financial Report.
Prepare and publish a report on long-range fiscal sustainability every 2 to 4  years.
section_title: Additional Cost Information on Proposals before Adoption
paragraphs: Require improved disclosure—at the time proposals are debated but  before they are adopted—of the long-term costs of individual mandatory  spending and tax proposals over a certain size and for which costs will  ramp up over time.
section_title: GAO Reports
paragraphs: An annual report or reports by GAO including comments on the  Consolidated Financial Statement (CFS), results of the latest long-term  fiscal simulations, comments on the adequacy of information regarding  long-term cost implications of existing and proposed policies in the  previous year as well as any other significant financial and fiscal issues.
section_title: Other Areas in Which GAO Has Suggested That Congress Might Consider Changing the Budget Treatment
paragraphs: Use accrual budgeting for the following areas where cash basis obligations  do not adequately represent the government’s commitment:    employee pension programs (pre-Federal Employee Retirement System  employees),  retiree health programs, and  federal insurance programs, such as the Pension Benefit Guaranty  Corporation and crop insurance.
Explore techniques for expanding accrual budgeting to    environmental cleanup and    social insurance—could consider deferring recognition of social  insurance receipts until they are used to make payments in the future  (this was suggested in GAO’s accrual budgeting report as an idea to  explore, possibly with a commission designed to explore budget  concepts).
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