The federal budget is the primary financial document of the government. The Congress and the American people rely on it to frame their understanding of significant choices about the role of the federal government and to provide them the information necessary to make informed decisions about individual programs and the collective fiscal policy of the nation. In practice, the budget serves multiple functions—it is used to plan and control resources, assess and guide fiscal policy, measure borrowing needs, and communicate the government’s policies and priorities. All of these uses are important, but they can lead to conflicting criteria for judging a budget. For example, the budget should be understandable to policymakers and the public yet comprehensive enough to fully inform resource allocation decisions. Since no one method of budget reporting can fully satisfy all uses, choosing a reporting method ultimately reflects some prioritization of the various uses—and a judgment about the quality of information and what an acceptable degree of uncertainty might be. When I refer to reporting methods, I mean how things are measured in the budget. Spending can be measured on different bases, such as cash, accrual, or obligation. The basis of budget reporting influences decision-making because the way transactions are recorded affects our understanding of the relative cost of different activities, the way critical choices are framed, and how the deficit (or surplus) is measured. For a simple example, suppose the government extends insurance for which it collects $1 million in premiums in the first year but expects total losses of $3 million in future years. If the primary objective of the budget is to track cash flows, then it is appropriate to show the $1 million cash inflow as a reduction in the deficit or increase in the surplus in the first year and to show the payouts as outlays when they occur. But if we want the budget to show the full cost of a decision, then it might be more appropriate to record a net cost of the present value of $2 million in the year the insurance is extended. Both numbers provide useful information and can be tracked over time. However, they provide very different information to policymakers and may lead to different decisions. Although a comprehensive understanding of this hypothetical program requires knowing both numbers, generally only one has been the primary basis upon which budget decisions are made. Historically, government outlays and receipts have been reported on a cash basis, i.e., receipts are recorded when received and expenditures are recorded when paid, without regard to the period in which the taxes or fees were assessed or the costs incurred. Although this has the advantage of reflecting the cash borrowing needs of the government, over the years, analysts and researchers have raised concerns that cash-based budgeting does not adequately reflect either the cost of some programs or the timing of their impact on economic behavior. As a general principle, decision-making is best informed if the government recognizes the costs of its commitments at the time it makes them. For many programs, cash-based budgeting accomplishes this. And, as noted earlier, because it reflects the government’s actual borrowing needs (if in a deficit situation), it is a good proxy for the government’s effect on credit markets. In general, then, the arguments for cash-based budgeting are convincing and deviations should not be lightly undertaken. The cash-based budget, however, often provides incomplete or misleading information about cost where cash flows to and from the government span many budget periods, and/or where the government obligates itself to make future payments or incur future losses well into the future. This is true for federal credit, insurance, and retirement programs. The Federal Credit Reform Act of 1990 addressed this mismatch between budget reporting and cost for credit programs. This act changed the budgetary treatment of credit programs by requiring that the budget reflect the programs’ costs to the government on a net present value basis. This means that, for example, rather than recording a cash outlay for the full amount of a direct loan, the budget records an estimate of what will ultimately be lost, taking into account repayments, defaults, interest subsidies, and any other cash flows on a net present value basis. Such accrual-based budgeting is also being done for the government’s contribution to pensions for civilian employees covered under the Federal Employees Retirement System and for military personnel. Accrual-based reporting recognizes the cost of transactions or events when they occur regardless of when cash flows take place. As I will discuss, cash-based budgeting is misleading for insurance programs. Federal insurance programs are diverse, covering a wide range of risks that the private sector has traditionally been unable or unwilling to cover. The risks include natural disasters under the flood and crop insurance programs and bank and employer bankruptcies under the deposit and pension insurance programs. The federal government also provides life insurance for veterans and federal employees, political risk insurance for overseas investment activities, and insurance against war-related risks and adverse reactions to vaccines. The face value of all of this insurance—the total amount of insurance outstanding—is around $5 trillion, but this dollar amount overstates the potential cost to the government because it is very unlikely that it would ever face claims from all outstanding insurance. The fiscal year 1997 Consolidated Financial Statements of the United States Government reported a $14.6 billion liability for insurance programs—payments already owed by the government because of past events. The financial statement records liabilities incurred for events that have already happened. But budgets are forward-looking documents. Decisionmakers need to make decisions about future commitments as they debate them—before insurance is extended. Therefore, a different measure may be more appropriate—the expected net cost to the government of the risk assumed by extending the insurance commitment (i.e., the “missing premium”), which is the difference between the full premium that would be charged based on expected losses and the actual premium to be charged the insured. At the request of the Chairman, we reported last September on the shortcomings of cash-based budgeting for federal insurance programs and the potential use of accrual concepts in the budget for these programs. In general, cash-based budgeting for insurance programs presents several problems. Its focus on single period cash flows can obscure the program’s cost to the government and thus may (1) distort the information and incentives presented to policymakers, (2) skew the recognition of the program’s economic impact, and (3) cause fluctuations in the deficit unrelated to long-term fiscal balance. With the current cash-based reporting, premiums for insurance programs are recorded in the budget when collected and outlays are reported when claims are paid. This focus on annual cash flows generally does not adequately reflect the government’s cost for federal insurance programs because the time between the extension of the insurance, the receipt of premiums and other collections, the occurrence of an insured event, and the payment of claims may extend over several budget periods. As a result, the government’s cost may be understated in years that a program’s current premium and other collections exceed current payments and overstated in years that current claim payments exceed current collections. These distortions occur even if the collections and payments for an insurance commitment are equal over time. This is similar to the problem with loans prior to the Credit Reform Act. The budget showed direct loans as costly in the year they were extended but then as profitable in future years when repayments exceeded new loans being made. The reasons for the mismatch between insurance premium collections and claim payments vary across the programs. In the case of political risk insurance extended by the Oversees Private Investment Corporation, the length of the government’s commitment can run for up to 20 years. Similarly, benefit payments for pension plans assumed by the Pension Benefit Guaranty Corporation (PBGC) may not be made for years or even decades after a plan is terminated. This is because participants generally are not eligible to receive pension benefits until they reach age 65 and, once eligible, they receive the benefits for many years. In other programs, temporary transactions or the erratic occurrence of insured events cause the mismatch between collections and payments and distort the insurance programs’ apparent costs in the cash-based budget. For example, during the savings and loan crisis, large temporary cash flows from the acquisition and sale of assets from failed institutions resulted in the government’s cost for deposit insurance never being clearly presented in the annual budget. In years when assets were acquired, the full amount of cash required was recorded as an outlay; later, when the assets were sold, the proceeds were recorded as income. Thus, the cash-based budget overstated the cost of the deposit insurance in some years and understated it in others. The inability of the cash-based budget to capture the cost of the government’s insurance commitments at the time decisions are made has significant implications. Cash-based budgeting for federal insurance programs may provide neither the information nor incentives necessary to signal emerging problems, make adequate cost comparisons, control costs, or ensure the availability of resources to pay future claims. The shortcomings of cash-based budgeting for federal insurance programs became quite apparent during the 1980s and early 1990s as the condition of the two largest programs—deposit insurance and pension insurance—deteriorated while the budget continued to show positive cash flows and did not even recognize failures that had actually happened. Although we and others raised concerns at the time about the government’s rapidly accruing deposit insurance costs, the cash-based budget was not effective in signaling policymakers of the emerging problem because it did not show a cost until institutions were closed and depositors paid. This delayed recognition obscured the program’s, as well as the government’s, underlying fiscal condition and limited the usefulness of the budget process as a means for the Congress to assess the problem. At approximately the same time, PBGC was facing growing losses and sponsors of insured pension plans were coming under severe financial stress, yet the cash-based budget showed large and growing cash income for the program.