The long-term fiscal pressures created by the impending retirement of the baby boom generation, rising health care costs and increased homeland security and defense commitments sharpen the need to look at competing claims on existing federal budgetary resources and emerging new priorities. As we look ahead, our nation faces an unprecedented demographic challenge. Between now and 2035, the number of people who are 65 years old or over is expected to double, driving federal spending on the elderly to a larger and ultimately unsustainable share of the federal budget. Absent substantive entitlement reform and/or dramatic changes in tax and spending policies, we will face large, escalating, and persistent deficits. For over ten years, the 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. Our latest long-term budget simulations reinforce the need for change in the major long-range cost drivers—Social Security and health care programs. As shown in figure 1, by 2040, assuming no changes to currently projected benefits or revenues, projected federal revenues may be adequate to pay little beyond interest on the debt. Reducing the relative future burdens of Social Security and federal health programs is critical to promoting a sustainable budget policy over the longer term. Absent reform, the impact of federal health and retirement programs on budget choices will be increasingly felt as the baby boom generation retires. While much of the public debate concerning the Social Security and Medicare programs focuses on trust fund balances—that is, on the programs’ solvency—the larger challenge facing these programs is how to assure their longer-term security and sustainability. The Social Security and Medicare Health Insurance (HI) programs are currently running surpluses that are invested in U.S. Treasury securities, resulting in an accumulated balance of Treasury assets that can be drawn upon to pay future benefits. According to the 2003 Trustees’ projections, these trust funds would be considered insolvent in 2042 for Social Security and in 2026 for Medicare HI. The information on insolvency provides one signal to policy makers that claims will exceed trust fund balances, but this measure alone can provide a false sense of security regarding these important federal programs. If we rely solely on trust fund insolvency to trigger actions to reform these programs, we will have delayed action far past the point when these two programs have become a significant and unsustainable fiscal burden on the federal government as a whole. Based on the 2003 Trustees Reports, the cash flows for Social Security will shift to a deficit in 2018 and for Medicare HI in 2013—at these points, both programs will then have to draw on their accumulated IOUs from the Treasury to pay a portion of benefits. The only way that Treasury can pay off these IOUs is by increased taxes, spending cuts, or increased borrowing from the public, or some combination of the three. Moreover, the trust funds’ balances do not reflect the full future cost of existing government commitments. In addition, the HI trust fund reflects only a portion of the Medicare program, which is financed primarily through payroll taxes. Other parts of the Medicare program include the Part B Supplementary Medical Insurance component and the new Part D drug benefit, both of which are financed through general revenues and beneficiary premiums. Taken as a whole, the Medicare program is fiscally unsustainable in its present form as program expenditures are expected to exceed program revenues dramatically in the future. From a macro perspective the critical question is not how much a trust fund has in assets, but whether the government as a whole has the economic capacity to finance the benefits promised by these programs both now and in the future and, if so, at what cost, and with what implications. As a result, we need to incorporate new metrics and mechanisms into the budget process that better signal the long-term commitments and implicit promises made by the government—its fiscal exposures—so that decision makers’ attention and efforts can be more concentrated on their long-term sustainability. The difficulty of developing meaningful measures of sustainability is exacerbated by the length of time covered by our long- term commitments. The longer the span of time between the collection and the expenditure of funds, the greater the uncertainty involved in forecasting future needs. Since trust fund balances do not fully inform policymakers and the public about the long-term sustainability of the programs financed by earmarked funds, consideration is warranted of other ways to make the long-term implications of spending and tax proposals and policies more apparent when making budget decisions. The future sustainability of programs is the key issue policymakers should address—that is, the capacity of the economy and budget to afford the proposed actions. 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 to 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. They may be explicit or implicit; they may currently exist or be contingent on future events. Their ultimate costs may or may not be reasonably measurable. Given this breadth, it is useful to think of fiscal exposures as a spectrum extending from explicit liabilities to the implicit promises embedded in current policy and/or public expectations. Figure 2 shows some selected fiscal exposures. These liabilities, commitments, and implicit exposures have created a fiscal imbalance that will put unprecedented strains on the nation’s spending and tax policies. In addition, certain tax expenditures may have uncertain or accelerating future growth paths that have significant implications for the long term. Although economic growth can help, our projected fiscal gap is now so large that we will not be able to simply grow our way out of the problem. Tough choices are inevitable. Particularly troubling are the many existing “big-ticket” items that taxpayers will eventually have to deal with. The federal government has pledged its support to a long list of programs and activities, including pension and health care benefits for senior citizens, veterans’ medical care, and, implicitly, various government-sponsored entities, whose potential claims on future spending total tens of trillions of dollars. Despite their serious implications for future budgets, tax burdens, and spending flexibilities, these fiscal exposures often get short shrift in reporting on the government’s current financial condition and in budgetary deliberations. Even though some fiscal exposures stem from liabilities and are reported in the financial statements, their recognition in the current cash- and obligation-based budget process is wholly inadequate. And beyond explicit liabilities and contingencies, there are implicit exposures—implied commitments embedded in the government’s current policies or in the public’s expectations about the role of government—that may encumber future budgets or reduce fiscal flexibility. One example is the life cycle cost of fixed assets, including deferred and future maintenance and operating costs. An exposure recognized in the financial statements is the federal government’s gross debt which, as of September 2003, was about $7 trillion, or about $24,000 for every man, woman, and child in this country today. But that number excludes items such as the gap between promised and funded Social Security and Medicare commitments. If these items are factored in, the burden for every American rises to well over $100,000. In addition, the new Medicare prescription drug benefit will add thousands more to that tab. The new drug benefit is one of the largest unfunded commitments ever undertaken by the federal government. The Trustees of the Social Security and Medicare trust funds will include an official estimate of the discounted present value cost of this new benefit over the next 75 years in their annual report, which is scheduled for issuance today. Preliminary estimates of its long-term cost range up to $7-8 trillion in discounted present value terms over a 75-year period. To put that number in perspective, it is as much or more than the total amount of the federal government’s gross debt outstanding as of September 30, 2003. Even before the drug benefit was enacted, our long-term simulations showed that by 2040, the federal government may have to cut federal spending in half or double taxes to pay for the mounting cost of the government’s unfunded commitments. Either would have devastating consequences on the nation’s future economy and the quality of life for Americans in the future. Truth and transparency in government reporting are essential if the United States is to effectively address its long-term fiscal challenges. The fiscal exposures just mentioned can be managed only if they are properly accounted for and publicly disclosed. A crucial first step will be to face facts and identify the many significant commitments already facing the federal government. If citizens and government officials come to understand various fiscal exposures and their potential claims on future budgets, they are more likely to insist on prudent policy choices today and sensible levels of fiscal risk in the future. So how do we start this hard process? Today you are focusing on budget process improvements, so I will start there. We need a process that does two things better than the processes we have used in the past. The budget process needs (1) better transparency and controls about the fiscal exposures/commitments that the federal government is considering making and (2) better signals and incentives to address the fiscal exposures/commitments the federal government has already made. GAO has encouraged reforms that would help move forward on both fronts. Transparency of existing commitments would be improved by requiring that the Office of Management and Budget (OMB) report annually on fiscal exposures, 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 also embraced this idea for better reporting of fiscal exposures.