Budget Process: Better Transparency, Controls, Triggers, and Default Mechanisms Would Help to Address Our Large and Growing Long-term Fiscal Challenge
Published: 2006-05-25T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The nation's long-term fiscal outlook is daunting. While the budget process has not caused the problems we face, the absence of meaningful budget controls and other mechanisms has served to compound our fiscal challenge. Conversely, a process that illuminates the looming fiscal pressures and provides appropriate incentives can at least help decision makers focus on the right questions. Meaningful budget controls and other mechanisms can also help to assure that difficult but necessary choices are made. The budget process needs to provide incentives and signals to address commitments the government has already made and better transparency for and controls on the long-term fiscal exposures being considered. Improvements would include the restoration of realistic discretionary caps; application of pay-as-you-go (PAYGO) discipline to both mandatory spending and revenue legislation; the use of "triggers" for some mandatory programs; and better reporting of fiscal exposures.
section_title: What GAO Found
paragraphs: Over the long term we face a large and growing structural deficit due primarily to known demographic trends and rising health care costs. Continuing on this imprudent and unsustainable fiscal path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security. Our current path will also increasingly constrain our ability to address emerging and unexpected budgetary needs and increase the burdens that will be faced by our children, grandchildren, and future generations. The budget process itself cannot solve this problem, but it can help policymakers make tough but necessary choices. If citizens and government officials come to better understand various fiscal exposures and their implications for the future, they are more likely to insist on prudent policy choices today and sensible levels of fiscal risk in the future. We cannot grow our way out of our long-term fiscal challenge. We must make tough choices and the sooner the better. A multi-pronged approach is needed: (1) revise existing budget processes and financial reporting requirements, (2) restructure existing entitlement programs, (3) reexamine the base of discretionary and other spending, and (4) review and revise tax policy and enforcement programs--including tax expenditures. Everything must be on the table and a credible and effective Entitlement and Tax Reform Commission may be necessary. Fundamentally we need a top-to-bottom review of government activities to ensure their relevance and fit for the 21st century and their relative priority.

section_title: Letter
paragraphs: I appreciate the opportunity to speak with you today about a budget  process that can help Congress deal with the large and growing fiscal  challenges facing our nation. As you know, I have been vocal about our  long-term fiscal imbalance and the need to make difficult but necessary  choices soon so that we do not burden our children and grandchildren  with a crushing debt. While the budget process has not caused the  problems we face, the absence of meaningful budget controls and other  mechanisms has served to compound our fiscal challenge. Conversely, a  process that illuminates the looming fiscal pressures and provides  appropriate incentives, transparency and control mechanisms can help  decision makers to slow the bleeding and put us on a more prudent and  sustainable long-range fiscal path.
When updating the budget process, you face a two-pronged challenge:  the need to reinstitute and strengthen controls to deal with both near-term  and longer-term deficits and  the need to design a process that helps Congress tackle our large and  growing long-term fiscal challenges facing this nation by, among other  things, improving the transparency of the long-term costs of current  decisions.
Today I want to focus on the long-term budget challenge and what role the  budget process can play in helping to deal with it. 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 broader  challenge of modernizing government for the 21st century.
subsections: section_title: The Long-term Fiscal Challenge
paragraphs: The nation’s long-term fiscal outlook is daunting under any realistic policy  scenarios and assumptions. For over 14 years, GAO has periodically  prepared various long-term budget simulations that seek to illustrate the  likely fiscal consequences of our coming demographic challenges and  rising health care costs. Indeed, the health care area is especially  important because the long-term fiscal challenge is largely a health care  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  soon. These simulations show that over the long term we face large and  growing structural deficits due primarily to known demographic trends  and rising health care costs. These trends are compounded by the  presence of near-term deficits arising from new discretionary and  mandatory spending as well as lower federal revenues as a percentage of  the economy. Continuing on this imprudent and unsustainable fiscal path  will gradually erode, if not suddenly damage, our economy, our standard  of living, and ultimately our national security. Our current path will also  increasingly constrain our ability to address emerging and unexpected  budgetary needs and increase the burdens that will be faced by our  children, grandchildren, and future generations of Americans.
Figures 1 and 2 present our long-term simulations under two different sets  of assumptions. For both simulations, Social Security and Medicare  spending is based on the 2006 Trustees’ intermediate projections, and we  assume that benefits continue to be paid in full after the trust funds are  exhausted, although current law does not provide for such. Medicaid  spending is based on the Congressional Budget Office’s (CBO) December  2005 long-term projections under its midrange assumptions. In figure 1, we  start with CBO’s 10-year baseline, constructed according to the statutory  requirements for that baseline. Consistent with these specific yet  unrealistic 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 and revenue are  held constant as a share of gross domestic product (GDP) at the 2016  level. Under this fiscally restrained scenario, spending for Social Security  and health care programs would grow to consume over three-quarters of  federal revenues by 2040.
In figure 2, 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. In this less  restrained but possibly more realistic scenario, federal revenues will cover  little more than interest on the large and growing federal debt by 2040.
While many alternative scenarios could be developed incorporating  different combinations of possible policy choices and economic  assumptions, these two scenarios can be viewed as possible “bookends” to  a range of possible outcomes.
Budget flexibility—the ability to respond to unforeseen events—is key to  being able to successfully deal with the nation’s and the world’s  uncertainties. By their very nature, mandatory spending programs— entitlement programs like Medicare and Social Security—limit budget  flexibility. They 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. As figure 3 shows, mandatory  spending has grown as a share of the total federal budget. For example,  mandatory spending on programs (i.e., mandatory spending excluding  interest) has grown from 27 percent in 1965—the year Medicare was  created—to 42 percent in 1985 to 53 percent last year. (Total spending not  subject to annual appropriations—mandatory spending and net interest— has grown from 34 percent in 1965 to 61 percent last year.) Under both the  CBO baseline estimates and the President’s Budget, this spending would  grow even further.
Figure 3 illustrates that while it is important to control discretionary  spending, the real challenge is mandatory spending. Accordingly,  substantive reform of the major health programs and Social Security is  critical to recapturing our future fiscal flexibility.
The aging population and rising health care costs will have significant  implications not only for the budget but also our economy and competitive  posture. Figure 4 shows the total future draw on the economy represented  by Social Security, Medicare, and Medicaid. Under the 2006 Trustees’  intermediate estimates and CBO’s 2005 midrange and long-term Medicaid  estimates, spending for these entitlement programs combined will grow to  over 15 percent of GDP in 2030 from today’s 8.9 percent. It is clear that  taken together, Social Security, Medicare, and Medicaid represent an  unsustainable burden on the federal budget and future generations.  Ultimately, the nation will have to decide what level of federal benefits and  spending it wants and how it will pay for these benefits.
While Social Security, Medicare, and Medicaid are the major drivers of the  long-term spending outlook in the aggregate, they are not the only  promises the federal government has made for the future. The federal  government undertakes a wide range of responsibilities, programs, and  activities that may either obligate the government to future spending or  create an expectation for such spending. Specific fiscal exposures vary  widely as to source, likelihood of occurrence, magnitude, and strength of  the government’s legal obligations. If we think of fiscal exposures as  extending from explicit liabilities (like military and civilian pensions) to  specific contingencies (like pension, flood, and other federal insurance  programs) to the commitments implicit in current policy and/or public  expectations (like the gap between the present value of future promised  and funded Social Security and Medicare benefits), the federal  government’s fiscal exposures totaled more than $46 trillion at the end of  2005, up from about $20 trillion in 2000. This translates into a burden of  about $156,000 per American, or approximately $375,000 per full-time  worker—more than double what it was in 2000. These amounts are  growing every second of every minute of every day due to continuing  deficits, known demographic trends and compounding interest costs.
section_title: What Can Be Done?
paragraphs: Many are beginning to realize that difficult choices must be made, and  soon. A crucial first step in acting to improve our long-term fiscal outlook  will be to face facts and identify the many significant commitments  already facing the federal government. If citizens and government officials  come to better understand our nation’s various fiscal exposures and their  implications for the future, they are more likely to insist on prudent policy  choices today and sensible levels of fiscal risk in the future.
How do we get started? Today you are focusing on budget process  improvements. That’s a good start. While the process itself cannot solve  the problem, it is important. It can help policymakers make tough but  necessary choices today rather than defer them until tomorrow.  Restoration of meaningful budget controls—budgetary caps and a pay-as- you-go (PAYGO) rule on both the tax and spending side of the ledger—is a  start toward requiring that necessary trade-offs be made rather than  delayed. Although the restoration of caps and a PAYGO rule are important,  they are not enough. Among the characteristics a budget process needs for  that to happen are  increased transparency and better incentives, signals, triggers and default  mechanisms to address the fiscal exposures/commitments the federal  government has already made and    better transparency for and controls over the long-term fiscal  exposures/commitments that the federal government is considering.
Let me elaborate.
subsections: section_title: Better Incentives and Signals
paragraphs: There is broad consensus among observers and analysts who focus on the  budget that the controls contained in the expired Budget Enforcement Act  constrained spending for much of the 1990s. In fact, annual discretionary  budget authority actually declined in real terms during the mid-1990s. I  endorse the restoration of realistic discretionary caps and PAYGO  discipline applied to both mandatory spending and revenue legislation. But  the caps can only work if they are realistic; while caps may be seen as  tighter than some would like, they are not likely to bind if they are seen as  totally unreasonable given current conditions. While PAYGO discipline  constrained the creation or legislative expansion of mandatory spending  and tax cuts, it accepted the existing provisions of law as given. Looking  ahead, the budget process will need to go beyond limiting expansions.  Cost increases in existing mandatory programs cannot be ignored and the  base of existing spending and tax programs must be reviewed and re- engineered to address our long-range fiscal gap.
Specifically, as I have said before, I would like to see a process that forces  examination of “the base” of the federal government—for major  entitlements, for other mandatory spending, and for so-called  “discretionary” spending (those activities funded through the  appropriations process).
Reexamining “the base” is something that should be done periodically  regardless of fiscal condition—all of us have a stewardship obligation over  taxpayer funds. As I have said before, we have programs still in existence  today that were designed 20 or more years ago—and the world has  changed. I would suggest that as constraints on discretionary spending  continue to tighten, the need to reexamine existing programs and activities  becomes greater. One of the questions this Congress is grappling with— earmarks—can be seen in this context. Whatever the agreed-upon level for  discretionary spending, the allocation within that total will be important.  How should that allocation be determined? What sort of rules will you  want to impose on both the allocation across major areas (defense,  education, etc.) and within those areas? By definition, earmarks specify  how some funds will be used. How will the process manage them? After  all, not all earmarks are bad but many are highly questionable. It is not  surprising that in times of tight resources, the tension between earmarks  and flexibility will likely rise.
Although mandatory spending is not amenable to caps, such spending  need not—and should not—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 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 their rules or  formulas. We recently issued a report on “triggers”—some measure that  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  of the level of spending and prompts special consideration when the  threshold or target is breached. 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-fiscal-year period. The most recent Trustees’  report to Congress for the first time found that the general revenue share  of financing is projected to exceed that threshold in 2012. Thus, if next  year’s report again concludes that it will exceed the threshold during the 7- fiscal-year period, the trigger will have been tripped and the President will  be required to submit his proposal for action.
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. In contrast, a trigger could lead to “hard” responses  under which a predetermined, program-specific action would 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—the default is the  constraining action. 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.
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 appropriate responses. At the same  time, with less than 40 percent 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.
section_title: Increased Transparency and Disclosure of Long- term Costs
paragraphs: Besides triggers, transparency of existing commitments would be  improved by requiring the Office of Management and Budget (OMB) to  report annually on fiscal exposures—the more than $46 trillion figure I  mentioned earlier—including a concise list, description, and cost  estimates, where possible. OMB should also ensure that agencies focus on  improving cost estimates for fiscal exposures. This should complement  and support continued and improved reporting of long-range projections  and analysis of the budget as a whole to assess fiscal sustainability and  flexibility.
Others have embraced this idea for better reporting of fiscal exposures.  Senator Voinovich has proposed that the President report each January on  the fiscal exposures of the federal government and their implications for  the long-term financial health and Senator Lieberman introduced  legislation to require better information on liabilities and commitments.  This year Representatives Cooper, Chocola, and Kirk have sponsored  legislation also aimed at improving the attention paid to our growing  federal commitments. And, in his last few budgets the President has  proposed that reports be required for any proposals that would worsen the  unfunded obligations of major entitlement programs. These proposals  provide a good starting point for discussion. Reporting is a critical first  step—but, as I noted above, it must cover not only new proposals but also  existing commitments, and it should be accompanied by some incentives  and controls. We need both better information on existing commitments  and promises and information on the long-term costs of any new  significant proposed spending increases or tax cut. Ten-year budget  projections have been available to decision makers for many years. We  must build on that regime but also incorporate longer-term estimates of  net present value (NPV) costs for major spending and tax commitments  comprising longer-term exposures for the federal budget beyond the 10- year window. Current budget reporting does not always fully capture or  require explicit consideration of some fiscal exposures. For example,  when Medicare Part D was being debated, much of the debate focused on  the 10-year cost estimate—not on the long-term commitment that was  obviously much greater. While the budget was not designed to and does  not provide complete information on long-term cost implications  stemming from some of the government’s commitments when they are  made, progress can and should be made on this front. For example, we  should require NPV estimates for major proposals—whether on the tax  side or the spending side—whose costs escalate outside the 10-year  window. And these estimates should be disclosed and debated before the  proposal is voted on.
Regarding tax provisions, it is 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. Tax  expenditures represent a significant commitment and are not typically  subject to review or reexamination. This should not be allowed to  continue nor should they continue to be largely in the dark and on  autopilot.
Finally, the growing use of emergency supplemental appropriations raises  concerns that an increasing portion of federal spending is exempt from the  discipline and trade-offs of the regular budget process. Some have  expressed concern that these “emergency” supplementals are not always  used just to meet the needs of unforeseen emergencies but also include  funding for activities that could be covered in regular appropriation acts.  According to a recent Congressional Research Service report, after the  expiration of discretionary limits and PAYGO requirements at the end of  fiscal year 2002, supplemental appropriations net of rescissions increased  the budget deficit by almost 25 percent per year. On average, the use of  supplemental appropriations for all purposes has grown almost 60 percent  each year, increasing from about $17 billion in fiscal year 2000 to about  $160 billion in fiscal year 2005. Constraining emergency appropriations to  those which are necessary (not merely useful or beneficial), sudden,  urgent, unforeseen, and not permanent has been proposed in the past. The  issue of what constitutes an emergency needs to be resolved and  discipline exerted so that all appropriations for activities that are not true  emergencies are considered during regular budget deliberations.
section_title: Concluding Observations
paragraphs: We cannot grow our way out of our long-term fiscal challenge. We have to  make tough choices and the sooner the better. A multi-pronged approach  is necessary: (1) revise existing budget processes and financial reporting  requirements, (2) restructure existing entitlement programs, (3) reexamine  the base of discretionary and other spending, and (4) review and revise tax  policy and enforcement programs. Everything must be on the table.  Fundamentally, we need to undertake a top-to-bottom review of  government activities to ensure their relevance and fit for the 21st century  and their relative priority. Our report entitled 21st Century Challenges:  Reexamining the Base of the Federal Government presents illustrative  questions for policymakers 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.
The understanding and support of the American people will be critical in  providing a foundation for action. The fiscal risks I have discussed,  however, are a long-term problem whose full impact will not likely be felt  for some time. At the same time, they are very real and time is currently  working against us. The difficult but necessary choices we face will be  facilitated if the public has the facts and comes to support serious and  sustained action to address the nation’s fiscal challenges. That is why if an  Entitlement and Tax Reform Commission is created to develop proposals  to tackle our long-term fiscal imbalance, its charter may have to include  educating the public as to the nature of the problem and the realistic  solutions. While public education may be part of a Commission’s charge,  we cannot wait for it to begin. As you may know, the Concord Coalition is  leading a public education effort on this issue and I have been a regular  participant. Although along with Concord the core group is the Heritage  Foundation, the Brookings Institution, and the Committee for Economic  Development, others are also actively supporting and participating in the  effort—the state treasurers, auditors and comptrollers, the American  Institute of Certified Public Accountants, AARP, and the National  Academy of Public Administration. I am pleased to take part in this  national education and outreach effort to help the public understand the  nature and magnitude of the long-term financial challenge facing this  nation. This is important because while process reform can structure  choices and help, broad understanding of the problem is also essential.  After all, from a practical standpoint, the public needs to understand the  nature and extent of our fiscal challenge before their elected  representatives are likely to act.
Thank you, Mr. Chairman. This concludes my prepared remarks. I would  be happy to answer any questions you may have.
section_title: Contacts and Acknowledgments
paragraphs: Contact points for our Offices of Congressional Relations and Public  Affairs may be found on the last page of this testimony. For further  information on this testimony, please contact Susan J. Irving at (202) 512- 9142 or irvings@gao.gov. Individuals making key contributions to this  testimony include Christine Bonham, Assistant Director; Carlos Diz,  Assistant General Counsel; and Melissa Wolf, Senior Analyst.
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