Fiscal Year 2008 U.S. Government Financial Statements: Federal Government Faces New and Continuing Financial Management and Fiscal Challenges
Published: 2009-07-08T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO annually audits the consolidated financial statements of the U.S. government (CFS). The Congress and the President need reliable, useful, and timely financial and performance information to make sound decisions and conduct effective oversight of federal government programs and policies. Except for the 2008 and 2007 Statements of Social Insurance, GAO has been unable to provide assurance on the reliability of the CFS due primarily to inadequate systems and lack of sufficient, reliable evidence to support certain material information in the CFS. Unless these weaknesses are adequately addressed, they will, among other things, (1) hamper the federal government's ability to reliably report a significant portion of its assets, liabilities, costs, and other related information; and (2) affect the federal government's ability to reliably measure the full cost as well as the financial and nonfinancial performance of certain programs and activities. This testimony presents the results of GAO's audit of the CFS for fiscal year 2008 and discusses federal financial management challenges and the long-term fiscal outloo
section_title: What GAO Found
paragraphs: For the second consecutive year, GAO rendered an unqualified opinion on the Statement of Social Insurance; however, three major impediments continued to prevent GAO from rendering an opinion on the federal government's accrual basis consolidated financial statements: (1) serious financial management problems at the Department of Defense, (2) the federal government's inability to adequately account for and reconcile intragovernmental activity and balances between federal agencies, and (3) the federal government's ineffective process for preparing the consolidated financial statements. In addition, as of September 30, 2008, the federal government did not maintain effective internal controls over financial reporting and compliance with significant laws and regulations due to numerous material weaknesses. Moreover, financial management system problems continue to hinder federal agency accountability. The federal government still has a long way to go, but over the years, progress has been made in improving federal financial management. For example, audit results for many federal agencies have improved; federal financial system requirements have been developed; and accounting and reporting standards have continued to evolve to provide greater transparency and accountability over the federal government's operations, financial condition, and fiscal outlook. In addition, the federal government issued a summary financial report which is intended to make the information in the Financial Report of the U.S. Government more understandable and accessible to a broader audience. The federal government's response to the financial markets crisis and economic downturn has created new federal accountability, financial reporting, and debt management challenges. Such challenges will require utmost attention to ensure (1) that sufficient internal controls and transparency are established and maintained for all market stabilization and economic recovery initiatives; (2) that all related financial transactions are reported on time, accurately, and completely; and (3) these initiatives are effectively and efficiently financed. Moreover, while policymakers are currently understandably focused on efforts directed toward market stabilization and economic growth, once stability in financial markets and the economic downturn are addressed, attention will have to be turned with the same level of intensity to the serious longer-term challenges of addressing the federal government's large and growing structural deficits and debt. Finally, the federal government should consider the need for further revisions to the current federal financial reporting model to recognize its unique needs. A broad reconsideration of issues, such as the kind of information that may be relevant and useful for a sovereign nation, could lead to reporting enhancements that might help provide the Congress and the President with more useful financial information to deliberate and monitor strategies to address the nation's long-term fiscal challenges.

section_title: Letter
paragraphs: I appreciate the opportunity to be here today to discuss our report on the  U.S. government’s consolidated financial statements for fiscal years 2008  and 2007. The need for continued progress in improving federal financial  management and accountability to the American people is more critical  now than ever given the unprecedented actions that the federal  government has taken and continues to take to address the economic  downturn and restore stability to financial markets. I would like to  commend you for continuing the annual tradition of oversight hearings on  this important subject. The involvement of your subcommittee is critical to  ultimately assuring such progress.
Importantly, the ultimate effect of recent unprecedented actions on the  federal government’s financial condition are not yet fully known and will  not be fully reflected in the U.S. government’s consolidated financial  statements and The Budget of the United States Government until fiscal  year 2009 and beyond. However, the breadth and magnitude of such  actions will likely have a significant effect. Under the American Recovery  and Reinvestment Act of 2009, hundreds of billions of dollars are slated  for, among other things, new or additional spending for investments in  infrastructure and science, education and training, health programs,  investments in energy infrastructure and programs, assistance to  unemployed workers, health insurance assistance, health information  technology, and state fiscal relief. In addition, under the Housing and  Economic Recovery Act of 2008 and the Emergency Economic  Stabilization Act of 2008, additional hundreds of billions of dollars of  federal funding will include capital and loans to support and sustain key  financial institutions and other businesses, loans to assist certain  borrowers in trouble on their mortgages, and insurance for certain  securitized loans. The federal government’s response to the current  economic downturn and financial crisis has created additional  accountability, financial reporting, and debt management challenges.
While there are new and many existing challenges to federal  accountability and reporting, we also cite in our reports improvements  made over the past decade. With this backdrop, our testimony today  discusses (1) the major issues relating to the consolidated financial  statements for fiscal years 2008 and 2007, including the significant  remaining impediments to an opinion on the consolidated financial  statements; (2) financial management systems problems that continue to  hinder federal agency accountability; (3) new federal accountability,  financial reporting, and debt management challenges created by the  federal government’s fiscal response to the financial crisis and economic  downturn; (4) challenges posed by the federal government’s current long- term fiscal outlook; and (5) the need for an improved federal financial  reporting model.
Both the consolidated financial statements and our related audit report are  included in the fiscal year 2008 Financial Report of the United States  Government (Financial Report). Our audit report would not be possible  without the commitment and professionalism of Inspectors General  throughout the federal government who are responsible for annually  auditing the financial statements of individual federal agencies. The  Financial Report was issued by the Department of the Treasury  (Treasury) on December 15, 2008. At that time, Treasury and the Office of  Management and Budget (OMB) in coordination with GAO also issued, for  the second year, a summary financial report, entitled The Federal  Government’s Financial Health: A Citizen’s Guide to the 2008 Financial  Report of the United States Government. This guide, which is included in  the printed Financial Report, as well as printed separately, is intended to  make the information in the Financial Report more understandable and  more accessible to a broader audience. Both of these reports are available  through GAO’s Internet site, at  http://www.gao.gov/financial/fy2008financialreport.html and Treasury’s  Internet site, at http://www.fms.treas.gov/fr/index.html.
subsections: section_title: Highlights of Major Issues Related to the U.S. Government’s Consolidated Financial Statements for Fiscal Years 2008 and 2007
paragraphs: As has been the case for the previous 11 fiscal years, the federal  government did not maintain adequate systems or have sufficient, reliable  evidence to support certain material information reported in the U.S.  government’s accrual basis consolidated financial statements. The  underlying material weaknesses in internal control, as summarized on the  following page, which generally have existed for years, contributed to our  disclaimer of opinion on the U.S. government’s accrual basis consolidated  financial statements for the fiscal years ended 2008 and 2007.
In summary, the material weaknesses that contributed to our disclaimer of opinion on  the accrual basis consolidated financial statements were the federal government’s  inability to:    satisfactorily determine that property, plant, and equipment and inventories and  related property, primarily held by the DOD, were properly reported in the accrual  basis consolidated financial statements;    reasonably estimate or adequately support amounts reported for certain liabilities,  such as environmental and disposal liabilities, or determine whether commitments  and contingencies were complete and properly reported;    support significant portions of the total net cost of operations, most notably related  to DOD, and adequately reconcile disbursement activity at certain agencies;    adequately account for and reconcile intragovernmental activity and balances    ensure that the federal government’s accrual basis consolidated financial  statements were (1) consistent with the underlying audited agency financial  statements, (2) properly balanced, and (3) in conformity with generally accepted  accounting principles (GAAP); and  identify and either resolve or explain material differences that exist between certain  components of the budget deficit reported in Treasury’s records, which are used to  prepare the Reconciliation of Net Operating Cost and Unified Budget Deficit and  Statement of Changes in Cash Balance from Unified Budget and Other Activities,  and related amounts reported in federal agencies’ financial statements and  underlying financial information and records.
Due to the material weaknesses and the additional limitations on the  scope of our work, as discussed in our audit report, there may also be  additional issues that could affect the accrual basis consolidated financial  statements that have not been identified.
In addition to the material weaknesses that contributed to our disclaimer  of opinion, which are discussed above, we found three other material  weaknesses in internal control as of September 30, 2008. These other  material weaknesses were the federal government’s inability to:    determine the full extent to which improper payments occur and  reasonably assure that appropriate actions are taken to cost-effectively  reduce improper payments,  identify and resolve information security control weaknesses and  manage information security risks on an ongoing basis, and  effectively manage its tax collection activities.
Further, our audit report discusses certain significant deficiencies in  internal control at the governmentwide level. These significant  deficiencies involve the following areas: implementing effective credit reform estimation and related financial  reporting processes for loans receivable and loan guarantee liabilities  at certain federal credit agencies, and    preparing the Statement of Social Insurance for certain programs.
Individual federal agency financial statement audit reports identify  additional control deficiencies, which were reported by agency auditors as  either material weaknesses or significant deficiencies at the individual  agency level. We do not consider these additional control deficiencies to  represent material weaknesses or significant deficiencies at the  governmentwide level. Also, due to the issues noted throughout our audit  report, additional material weaknesses and significant deficiencies may  exist that were not identified and reported.
subsections: section_title: Addressing Major Impediments to an Opinion on the Accrual Basis Consolidated Financial Statements
paragraphs: Three major impediments to our ability to render an opinion on the U.S.  government’s accrual basis consolidated financial statements continued to  be: (1) serious financial management problems at DOD, (2) the federal  government’s inability to adequately account for and reconcile  intragovernmental activity and balances between federal agencies, and   (3) the federal government’s ineffective process for preparing the  consolidated financial statements. Extensive efforts by DOD officials and  cooperative efforts between agency chief financial officers, Treasury  officials, and OMB officials will be needed to resolve these serious  obstacles to achieving an opinion on the U.S. government’s accrual basis  consolidated financial statements.
subsections: section_title: Financial Management at DOD
paragraphs: Essential to further improving financial management governmentwide and  ultimately to achieving an opinion on the U.S. government’s consolidated  financial statements is the resolution of serious weaknesses in DOD’s  business operations. Reported weaknesses in DOD’s business operations,  including financial management, adversely affect the reliability of financial  data, and the economy, efficiency, and effectiveness of its operations, and  prevent DOD from producing auditable financial statements.
DOD continues to dominate GAO’s list of high-risk programs designated as  vulnerable to waste, fraud, abuse, and mismanagement, bearing  responsibility, in whole or in part, for 15 of 30 high-risk areas. Eight of  these areas are specific to DOD and include DOD’s overall approach to  business transformation, as well as business systems modernization and  financial management.
The National Defense Authorization Act (NDAA) for Fiscal Year 2008,  codified Chief Management Officer (CMO) responsibilities at a high level  in the department—assigning them to the Deputy Secretary of Defense— and establishing a full-time Deputy CMO (DCMO) and designating CMO  responsibilities within the military services. While both of these positions  are now in place at DOD, the CMO is not a separate, full-time position, and  the DCMO, although full-time, does not have decision-making authority.
Importantly, DOD has taken steps toward developing and implementing a  framework for addressing the department’s long-standing financial  management weaknesses with the goals of enabling the department to (a)  provide timely, reliable, and accurate financial management information to  decisionmakers; (b) sustain improvements; and (c) achieve financial  statement auditability. Specifically, this framework, which is discussed in  both the department’s Enterprise Transition Plan (ETP) and the Financial  Improvement and Audit Readiness (FIAR) Plan, includes the  department’s Standard Financial Information Structure (SFIS) and  Business Enterprise Information System (BEIS). DOD intends this  framework to define and put into practice a standard DOD-wide financial  management data structure as well as enterprise-level capabilities to  facilitate reporting and comparison of financial data across the  department. DOD’s most recent FIAR plan update indicates that it has  implemented SFIS in legacy accounting systems for several components,  including the Air Force and Marine Corps.
We recently analyzed DOD’s FIAR Plan, and found the plan does not yet  provide the department or its components with clear, consistent, and  specific guidance for implementing, measuring, and sustaining corrective  actions, and for reporting incremental progress. Our report made several  recommendations designed to increase the FIAR Plan’s effectiveness as a  strategic and management tool for guiding, monitoring, and reporting on  financial management improvement efforts and increasing the likelihood  of meeting the department’s goal of financial statement auditability. DOD  management concurred with our recommendations and has begun  initiatives to address our concerns.
While further improvement is needed, DOD’s recent FIAR plans indicate  many continuing efforts to achieve financial statement auditability, as well  as new initiatives, including the following:    Focusing on improvements in end-to-end business processes, or  segments, that underlie the amounts reported on the financial  statements.
Updating auditability assertion criteria to require that only personnel  with sufficient objectivity assess the readiness of a segment for audit.
Ensuring sustainability of corrective actions and auditability by fully  implementing the requirements of OMB Circular No. A-123, Appendix  A, which requires an annual assessment and statement of assurance  regarding the continued effectiveness of internal control over financial  reporting.
Forming working groups to address issues in areas such as real  property cost management and imputed cost, and Fund Balance with  Treasury.  Implementing the Defense Agencies Initiative, with the goal of  achieving an auditable standardized system for smaller other defense  organizations.
A recent notable success for the department was the U.S. Army Corps of  Engineers (USACE), Civil Works’ ability to achieve an unqualified audit  opinion for fiscal year 2008. This accomplishment was the result of a  sustained commitment on the part of management to improve USACE’s  business systems, processes, and controls. In contrast to this success,  however, other DOD components’ recent assertions of audit readiness  have failed to withstand auditor scrutiny.
We are encouraged by DOD’s efforts and will continue to monitor DOD’s  efforts to transform its business operations and address its financial  management challenges. In the near future, we plan to review DOD’s:    process and controls over budgetary execution and accounting;  component enterprise resource planning efforts for adherence to  budget and schedule and the identification of common issues among  these efforts that have impeded successful implementation;  integration of strategic plans within the department that are intended  to address, monitor, and report progress and status of financial  management weaknesses;  component design and implementation of financial improvement  plans; and  component corrective plans and actions designed to bring financial  reporting segments to audit readiness.
section_title: Intragovernmental Activity and Balances
paragraphs: Federal agencies are unable to adequately account for and reconcile  intragovernmental activity and balances. OMB and Treasury require the  CFOs of 35 executive departments and agencies to reconcile, on a  quarterly basis, selected intragovernmental activity and balances with  their trading partners. In addition, these agencies are required to report to  Treasury, the agency’s inspector general, and GAO on the extent and  results of intragovernmental activity and balances reconciliation efforts as  of the end of the fiscal year. GAO has identified and reported on numerous  intragovernmental activities and balances issues and has made several  recommendations to Treasury and OMB to address those issues. Treasury  and OMB have generally taken or plan to take actions to address these  recommendations.
A substantial number of the agencies did not adequately perform the  required reconciliations for fiscal years 2008 and 2007. For these fiscal  years, based on trading partner information provided to Treasury through  agencies’ closing packages, Treasury produced a “Material Difference  Report” for each agency showing amounts for certain intragovernmental  activity and balances that significantly differed from those of its  corresponding trading partners as of the end of the fiscal year. Based on  our analysis of the “Material Difference Reports” for fiscal year 2008, we  noted that a significant number of CFOs were unable to adequately explain  the differences with their trading partners or did not provide adequate  documentation to support responses on the CFO Representations. For  both fiscal years 2008 and 2007, amounts reported by federal agency  trading partners for certain intragovernmental accounts were not in  agreement by significant amounts. In addition, there are hundreds of  billions of dollars of unreconciled differences between the General Fund  and federal agencies related to appropriation and other intragovernmental  transactions. The ability to reconcile such transactions is hampered  because only some of the General Fund is reported in the Department of  the Treasury’s financial statements. As a result of the above, the federal  government’s ability to determine the impact of these differences on the  amounts reported in the accrual basis consolidated financial statements is  significantly impaired.
In 2006, OMB issued Memorandum No. M-07-03, Business Rules for  Intragovernmental Transactions (Nov. 13, 2006), and Treasury issued the  Treasury Financial Manual Bulletin No. 2007-03, Intragovernmental  Business Rules (Nov. 15, 2006). This guidance added criteria for resolving  intragovernmental disputes and major differences between trading  partners for certain intragovernmental transactions and called for the  establishment of an Intragovernmental Dispute Resolution Committee.  OMB is currently working with the Chief Financial Officers Council to  create the Intragovernmental Dispute Resolution Committee. OMB is also  using a “Watch List” that lists federal agencies with large  intragovernmental imbalances. The Watch List was developed to facilitate  reductions in some of the largest intragovernmental imbalances, bring  federal agency reporting into alignment with the Intragovernmental  Business Rules, bring the appropriate representatives together from the  respective agencies, and document the issues and resolutions.
Treasury is also taking steps to help resolve material differences in  intragovernmental activity and balances. For example, Treasury is  requiring federal agencies to provide documentation on how and when the  agencies are resolving certain of their unresolved material differences.
Resolving the intragovernmental transactions problem remains a difficult  challenge and will require a strong commitment by federal agency  leadership to fully implement the required business rules and continued  strong leadership by OMB and Treasury.
section_title: Preparing the Consolidated Financial Statements
paragraphs: While further progress was demonstrated in fiscal year 2008, the federal  government continued to have inadequate systems, controls, and  procedures to ensure that the consolidated financial statements are  consistent with the underlying audited agency financial statements,  properly balanced, and in conformity with U.S. GAAP. Treasury’s process  for compiling the consolidated financial statements demonstrated that  amounts in the Statement of Social Insurance were consistent with the  underlying federal agencies’ audited financial statements and that the  Balance Sheet and the Statement of Net Cost were also consistent with  federal agencies’ financial statements prior to eliminating  intragovernmental activity and balances. However, Treasury’s process did  not ensure that the information in the remaining three principal financial  statements was fully consistent with the underlying information in federal  agencies’ audited financial statements and other financial data. During  fiscal year 2008, Treasury, in coordination with OMB, continued  implementing corrective action plans and made progress in addressing  certain internal control deficiencies we have previously reported regarding  the process for preparing the consolidated financial statements. Resolving  some of these internal control deficiencies will be a difficult challenge and  will require a strong commitment from Treasury and OMB as they  continue to implement their corrective action plans.
section_title: Federal Agencies’ Financial Management Systems
paragraphs: Under the Federal Financial Management Improvement Act of 1996  (FFMIA), as a part of the CFO Act agencies’ financial statement audits,  auditors are required to report whether agencies’ financial management  systems comply substantially with (1) federal financial management  systems requirements, (2) applicable federal accounting standards, and (3)  the U.S. Government Standard General Ledger (SGL) at the transaction  level. These factors, if implemented successfully, help provide a solid  foundation for improving accountability over federal government  operations and routinely producing sound cost and operating performance  information. Over a decade has passed since FFMIA was enacted and the  majority of agencies still do not have reliable, useful, and timely financial  information with which to make informed decisions and ensure  accountability on an ongoing basis. In fiscal year 2008, auditors reported  14 out of 24 CFO Act agencies’ financial management systems were not in  substantial compliance with one or more of the three FFMIA requirements  and the lack of compliance with federal financial management systems  requirements was the most frequently cited deficiency of the three FFMIA  requirements.
In addition, on January 9, 2009, OMB issued a revised Circular No. A-127,  Financial Management Systems, which redefines federal financial  management systems requirements. We are concerned that the revised  circular substantially reduces the scope and rigor of compliance testing  for agency financial management systems, omits compliance with the SGL  from the compliance indicators, and eliminates existing federal financial  management systems requirements for the financial portion of mixed  systems. Without independent auditor assessments of the financial portion  of mixed systems’ capabilities and compliance with these requirements,  the Congress and agency management cannot be assured that data in these  systems and not included in agency financial statements are reliable,  resulting in increased risk of making operating, budget, and policy  decisions based on faulty data reported in the financial portion of mixed  systems—such as benefit payment, logistics, and acquisition systems— which are the source of data for the core financial system. Because of the  importance of such data to routinely providing reliable, useful, and timely  financial information for managing day-to-day operations, we believe it is  important to retain financial management systems requirements for the  financial portion of mixed systems and require auditors to assess  compliance against such requirements. Further, the revised circular raised  additional concerns because it does not definitively establish  responsibilities for the agency, service provider, and auditor for assessing  compliance with FFMIA when utilizing a shared service provider under  OMB’s financial management line of business (line of business) initiative.
To reduce the cost and improve the outcome of federal financial  management systems implementations, OMB continues to move forward  on the line of business initiative, by leveraging common standards and  shared solutions. OMB anticipates that the line of business initiative will  help achieve the goals of improving the cost, quality, and performance of  financial management operations. As we reported in May 2009, although  OMB has made progress in implementing the line of business initiative, the  initiative focuses mainly on core financial systems and extensive work  remains before the goals of the initiative are achieved. For example, as  we previously recommended in 2006, OMB has yet to finalize a financial  management system concept of operations, which provides the foundation  to guide line of business-related activities. In addition, development of a  migration timeline reflecting agencies’ commitment for migrating to  shared service providers has not yet been completed. Consistent and  effective implementation of FFMIA will be needed to improve the  capability of agencies’ financial management systems to produce reliable,  useful, and timely information for management to efficiently and  effectively manage the day-to-day operations of the federal government  and ultimately provide accountability to taxpayers and the Congress—a  key goal of the CFO Act and FFMIA.
section_title: Federal Actions Create New Challenges
paragraphs: The Emergency Economic Stabilization Act of 2009 (EESA), which  authorized the Troubled Asset Relief Program (TARP); the Housing and  Economic Recovery Act of 2008 (HERA); and the American Recovery and  Reinvestment Act of 2009 (Recovery Act), enabled the federal government  to take certain unprecedented actions involving hundreds of billions of  dollars to stabilize the financial markets and promote economic recovery.  The nature and magnitude of these actions have created new challenges  for federal accountability, financial reporting, and debt management. Such  challenges will require utmost attention to ensure (1) that sufficient  internal controls and transparency are established and maintained for all  stabilization and recovery initiatives; (2) that all related financial  transactions are reported on time, accurately, and completely; and   (3) these initiatives are effectively and efficiently financed.
subsections: section_title: Federal Accountability and Financial Reporting Challenges
paragraphs: According to data provided by Treasury, as of June 26, 2009, the federal  government had disbursed about $339 billion of the approximate $700  billion limit on TARP funds for a number of initiatives, which included  among other things, preferred stock purchases of certain financial  institutions, loans to automotive companies, and funding to certain  financial institutions to facilitate home loan modifications. Under HERA,  the federal government placed the Federal National Mortgage Association  (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie  Mac) into conservatorship. As of July 2, 2009, the Federal Housing Finance  Agency had reported that the federal government had provided about $85  billion of capital to the entities through the first quarter of calendar year  2009 under senior preferred stock purchase agreements. In addition,  according to Treasury, the federal government held about $146 billion of  the entities’ mortgage-backed securities as of May 31, 2009.
Regarding TARP, we have reported on actions needed and the status of  efforts to address transparency and accountability issues, and have made  related recommendations to help ensure these issues are adequately  addressed. In our most recent report on TARP, we acknowledged  Treasury’s efforts to continue to improve the integrity, accountability, and  transparency of TARP transactions; however, we concluded that some  areas require ongoing attention. Among the challenges is the need to  properly measure and report each related purchase and loan transaction.  The challenges of estimating and managing costs and measuring and  reporting asset and liability values under TARP and other recent initiatives  are likely to be even greater than those associated with more traditional  federal lending activities given the fact that little, if any, historical  information is available for certain transactions from which to base  expected future cash flows. While contractual provisions may set forth  required payments for certain transactions such as preferred stock  purchases and debt obligations, for a substantial number of federal  transactions under TARP and HERA there is a significant amount of  uncertainty regarding the extent to which actual repayments to the federal  government will be made. There is simply little or no history for certain of  these large and unprecedented transactions. Moreover, the instability and  dramatic changes in financial markets, such as occurred within the last  year, make it very difficult to estimate the values of these assets and  liabilities with any level of certainty. Therefore, it is critically important for  adequate internal controls to be in place to help ensure that the cost of all  TARP and other loans and loan guarantees are properly measured and  reported and losses to the federal government minimized.
Regarding Recovery Act programs, major accountability and reporting  challenges stem from the fact that nearly half of the approximate $580  billion of additional federal spending associated with the Recovery Act  will flow to nonfederal entities. In our April 2009 report on the Recovery  Act, we reported that certain states and the District of Columbia are taking  various approaches to ensure that internal controls exist to manage risk  including assessing known risks associated with spending under the  Recovery Act and developing plans to address those risks. However,  officials in most of the states we reviewed and the District of Columbia  expressed concerns about the lack of Recovery Act funding provided for  accountability and oversight. Such concerns are important given that the  Recovery Act includes many programs that are new or new to the  recipient and, even for existing programs, the sudden increase in funds is  outside of normal cycles and processes. Given that the majority of  Recovery Act funding was initially projected to be made available to states  and localities in 2009, 2010, and 2011, with lesser amounts available  beyond that, actions taken now would significantly improve the ability of  nonfederal entities to provide effective accountability over federal funding  under the Recovery Act. We made several recommendations to OMB in  April 2009 to help improve accountability and oversight of Recovery Act  spending, including modifying the single audit process to be a more timely  and effective audit and oversight tool for the Recovery Act. We are also  issuing our July 2009 report on the Recovery Act today. Going forward, it  will be important for qualified personnel at all levels of government to  implement proper controls and accountability measures to help ensure  separate tracking and clear reporting of this spending from the federal  level to the nonfederal recipients.
Over $200 billion of the Recovery Act stimulus effort takes the form of tax  expenditures—reductions in tax liabilities that result from preferential tax  provisions such as tax exclusions, credits, and deductions. GAO has long  been concerned that tax expenditures represent a substantial federal  commitment yet lack the level of transparency and accountability  associated with federal outlays. As we move forward, the federal  government needs to ensure that adequate information is obtained and  analyzed about these provisions to inform judgments about the success of  the entire stimulus package.
section_title: Federal Debt and Long- Term Fiscal Challenges
paragraphs: The nature and magnitude of the aforementioned actions to stabilize the  financial markets and promote economic recovery have also created debt  management challenges. As this Subcommittee knows, the Congress has  assigned to Treasury the primary responsibility to borrow funds needed to  finance any gap between cash in and cash out subject to a statutory limit.  Since the onset of the current recession in December 2007, the gap  between revenues and outlays has grown—even before any policy  response. Because Treasury must borrow the funds disbursed, actions  taken to stabilize financial markets—including aid to the auto industry— increase borrowing and so add to the federal debt. In addition, the revenue  decreases and spending increases enacted in the Recovery Act also add to  borrowing. Further, all of this takes place in the context of the longer-term  fiscal outlook, which will present Treasury with continued management  challenges even after the return of financial stability and economic  growth.
The federal government faced large and growing structural deficits—and  hence rising debt—even before the instability in financial markets and the  economic downturn. The current debt limit, which has been raised 8 times  since 2001, is at $12.1 trillion. As you can see from table 1 below, it likely  will have to be raised again this year.
These immediate challenges, however, have eliminated the window for  planning before the impending further ramp up in debt. As shown in   figure 1, the President’s budget projects debt held by the public growing  from 40.8 percent of gross domestic product (GDP) in fiscal year 2008 to  60 percent by the end of fiscal year 2009 and 67 percent by the end of fiscal  year 2010.
The near-term debt management challenge can be seen through several  measures. At the end of May 2009, Treasury’s outstanding marketable  securities stood at $6,454 billion—an increase of $657 billion since  December 31, 2008, and an increase of $1,918 billion since December  2007. Interest rates have dropped dramatically since the start of the  financial crisis, particularly for short-term debt. Although these relatively  low interest rates have reduced Treasury’s borrowing costs to date, the  amount of debt that must be rolled over in the short-term presents  challenges. As shown in figure 2, as of May 31, 2009, approximately $3,137  billion will mature in 2009 and 2010 and will have to be refinanced; this is  49 percent of the total outstanding marketable securities. Another 29  percent matures in 2011 through 2015. If the economy improves, Treasury  may have to refinance significant amounts of debt at higher rates.
Treasury’s primary debt management goal is to finance the federal  government’s borrowing needs at the lowest cost over time. Issuing debt  through regular and predictable offerings lowers borrowing costs because  investors and dealers value liquidity and certainty of supply. The mix of  securities, which changes regularly as new debt is issued, is important  because it can have a significant influence on the government’s interest  payments. Longer-term securities typically carry higher interest rates—or  cost to the government—primarily due to concerns about future inflation.  However, they can also offer the Treasury certainty about what its  payments will be.
We believe the large share of the debt that must be rolled over in the next  few years is cause for concern. Market experts generally believe that  Treasury needs to increase the average maturity of its debt portfolio. Large  and growing borrowing needs put a premium on understanding both  current and future demand for U.S. Treasury securities. To support  Congress’ oversight of the use of TARP funds, we have work under way  looking at how Treasury has financed borrowing associated with the  financial market instability and analyzing additional ideas for debt  management that might assist Treasury going forward. We encourage  Treasury to explore a range of borrowing options that could support its  lowest-cost-over-time borrowing objective and to take a strategic  approach to the analysis of various options—recognizing that the federal  government faces a long-term sustained increase in borrowing needs.
As I noted, the actions to restore financial market stability and economic  growth take place within the context of the already serious longer-term  fiscal condition of the federal government. While policymakers have been  understandably focused on dealing with these financial market and  economic growth challenges, attention also needs to be given to the long- term challenges of addressing the federal government’s large and growing  structural deficits and debt.
As discussed in the Financial Report, the federal government is on an  unsustainable long-term fiscal path. The Statement of Social Insurance, for  example, shows that projected scheduled benefits exceed earmarked  revenues for social insurance programs (e.g., Social Security and  Medicare) by approximately $43 trillion in present value terms over the  75-year projection period. GAO also prepares long-term fiscal simulations  that are based on the Social Security and Medicare Trustees’ projections,  but provide a more comprehensive analysis of fiscal sustainability because  they include revenue and expenditure projections for all other government  programs. Our most recent long-term fiscal simulation was issued in  March 2009. Figures 3, 4, and 5 below show the results of GAO’s March  2009 simulations.
A quantitative measure of the long-term fiscal challenge measure is called  the “fiscal gap.” The fiscal gap is the amount of spending reduction or tax  increases that would be needed today to keep debt as a share of GDP at or  below today’s ratio. The fiscal gap is an estimate of the action needed to  achieve fiscal balance over a certain time period such as 75 years. Another  way to say this is that the fiscal gap is the amount of change needed to  prevent the kind of debt explosion implicit in figure 5. The fiscal gap can  be expressed as a share of the economy or in present value dollars.
Under GAO’s alternative simulation, closing the fiscal gap would require  spending cuts or tax increases, or some combination of the two, equal to  8.1 percent of the entire economy over the next 75 years, or about $63  trillion in present value terms. To put this in perspective, closing the gap  solely through revenue increases would require an increase in today’s  federal tax revenues of about 44 percent, or to do it solely through  spending reductions would require a reduction in today’s federal program  spending (i.e., in all spending except for interest on the debt held by the  public, which cannot be directly controlled) of about 31 percent to be  maintained over the entire 75-year period.
section_title: The Federal Financial Reporting Model
paragraphs: The Financial Report provides useful information on the government’s  financial position at the end of the fiscal year and changes that have  occurred over the course of the year. However, in evaluating the nation’s  fiscal condition, it is critical to look beyond the short-term results and  consider the overall long-term financial condition and long-term fiscal  challenge of the government—that is, the sustainability of the federal  government’s programs, commitments, and responsibilities in relation to  the resources expected to be available.
Accounting and financial reporting standards have continued to evolve to  provide greater transparency and accountability over the federal  government’s operations, financial condition, and fiscal outlook. However,  it is appropriate to consider the need for further revisions to the current  federal financial reporting model, which could affect both consolidated  and agency reporting. While the current reporting model recognizes some  of the unique needs of the federal government, a broad reconsideration of  the federal financial reporting model could address the following types of  questions:    Do traditional financial statements convey information transparently?    What is the role of the balance sheet in the federal government  reporting model?
What kind of information is most relevant and useful for a sovereign  nation?
How should items that are unique to the federal government, such as  social insurance commitments and the power to tax, be reported?
In addition, further enhancements to accounting and financial reporting  standards are needed to effectively convey the long-term financial  condition of the U.S. government and annual changes therein. For  example, the federal government’s financial reporting should be expanded  to disclose the reasons for significant changes during the year in  scheduled social insurance benefits and funding. It should also include (1)  a Statement of Fiscal Sustainability that provides a long-term look at the  fiscal sustainability of all federal programs including social insurance  programs, and (2) other sustainability information, including  intergenerational equity and an analysis of changes in sustainability during  the year. Recently, the Federal Accounting Standards Advisory Board  (FASAB) unanimously approved a proposed new standard on fiscal  sustainability reporting.  Also, FASAB is currently considering possible  changes to accounting for social insurance.
In addition, there is a need for a combined report on the performance and  financial accountability of the federal government as a whole. This report  would include, among other things, key outcome-based national indicators  (e.g., economic, security, social, and environmental), which could be used  to help assess the nation’s and other governmental jurisdictions’ position  and progress.
Engaging in a reevaluation of the federal financial reporting model could  stimulate discussion that would bring about a new way of thinking about  the federal government’s financial and performance reporting needs. To  understand various perceptions and needs of the stakeholders for federal  financial reporting, a wide variety of stakeholders from the public and  private sector should be consulted. Ultimately, the goal of such a  reevaluation would be reporting enhancements that can help the Congress  deliberate on strategies to address the federal government’s challenges,  including its long-term fiscal challenge.
section_title: Closing Comments
paragraphs: In closing, it is important that the progress that has been made in  improving federal financial management activities and practices be  sustained by the new administration. Across government, financial  management improvement initiatives are under way, and if effectively  implemented, they have the potential to greatly improve the quality of  financial management information as well as the efficiency and  effectiveness of agency operations. However, the federal government still  has a long way to go before realizing strong federal financial management.  For DOD, the challenges are many. We are encouraged by DOD’s efforts  toward addressing its long-standing financial management weaknesses  and its efforts to achieve auditability. Consistent and diligent top  management oversight toward achieving financial management  capabilities, including audit readiness, will be needed. The civilian CFO  Act agencies must continue to strive toward routinely producing not only  annual financial statements that can pass the scrutiny of a financial audit,  but also quarterly financial statements and other meaningful financial and  performance data to help guide decision makers on a day-to-day basis.  Federal agencies need to improve the government’s financial management  systems to achieve this goal.
The nature and magnitude of actions the federal government has taken to  stabilize the financial markets and promote economic recovery have  created new challenges involving accountability, financial reporting, and  debt management. A great amount of attention will need to be devoted to  ensuring (1) that sufficient internal controls and transparency are  established and maintained for all stabilization and recovery initiatives; (2)  that all related financial transactions are reported on time, accurately, and  completely; and (3) these initiatives are effectively and efficiently  financed. Importantly, the recent increase in federal debt that has resulted  largely from the federal government’s response to the crisis in financial  markets and the economic downturn must be viewed within the context of  the nation’s unsustainable long-term fiscal path. The longer action is  delayed to address long-term fundamental fiscal problems, the greater the  likelihood that actions to address such problems will be disruptive and  destabilizing. The federal government faces increasing pressures to  address the fiscal problems of Social Security and Medicare, yet a  shrinking window of opportunity for phasing in adjustments. GAO is  committed to sustained attention to this critically important matter.
Given the federal government’s current financial condition and the  nation’s serious long-term fiscal challenge, the need for the Congress and  federal policymakers and management to have reliable, useful, and timely  financial and performance information is greater than ever. Sound  decisions on the current and future direction of vital federal government  programs and policies are more difficult without such information. We  also will continue to stress the need for development of more meaningful  financial and performance reporting on the federal government.
Finally, I want to emphasize the value of sustained congressional interest  in these issues, as demonstrated by this Subcommittee’s leadership. It will  be key that, going forward, the appropriations, budget, authorizing, and  oversight committees hold agency top leadership accountable for  resolving the remaining problems and that they support improvement  efforts.
Madam Chairwoman and Ranking Member Bilbray, this concludes my  prepared statement. I would be pleased to respond to any questions that  you or other members of the Subcommittee may have at this time.
section_title: GAO Contacts and Acknowledgments
paragraphs: For further information regarding this testimony, please contact Jeanette  M. Franzel, Managing Director, and Gary T. Engel, Director, Financial  Management and Assurance, at (202) 512-2600, as well as Susan J. Irving,  Director, Federal Budget Analysis, Strategic Issues, at (202) 512-6806. Key  contributions to this testimony were also made by staff on the  Consolidated Financial Statement audit team.
section_title: Appendix I: Fiscal Year 2008 Audit Results
paragraphs: Ernst & Young, LLP  Urbach Kahn & Werlin LLP  Leonard G. Birnbaum and Company, LLP  For fiscal year 2008, only the Consolidated Balance Sheet and the related Statement of Custodial  Activity of the Department of Homeland Security were subject to audit; the auditor was unable to  express an opinion on these two financial statements.
The auditors reported no material weaknesses, no noncompliance with FFMIA, and no  noncompliance with laws and regulations, except for a potential matter of noncompliance with respect  to the Anti-Deficiency Act.
This is a work of the U.S. government and is not subject to copyright protection in the  United States. The published product may be reproduced and distributed in its entirety  without further permission from GAO. However, because this work may contain  copyrighted images or other material, permission from the copyright holder may be  necessary if you wish to reproduce this material separately.