The federal government’s financial condition and long-term fiscal outlook present enormous challenges to the nation’s ability to respond to emerging forces reshaping American society, the place of the United States in the world, and the future role of DOD as well as the rest of the federal government. The near-term deficits are daunting—a $412 billion unified budget deficit in fiscal year 2004 (including a $567 billion on-budget deficit and a $155 billion off-budget surplus) and a $368 billion deficit (not including any supplemental appropriations) forecast for fiscal year 2005 by the CBO. If these near-term deficits represented only a short-term phenomenon—prompted by such factors as economic downturn or national security crises—there would be less cause for concern. However, deficits have grown notwithstanding the economy recovery from the recession in 2001, and the incremental costs of responding to homeland security and the nation’s global war against terrorism represent only a relatively small fraction of current and projected deficits. Moreover, based on our long-range fiscal simulations, the current fiscal condition is but a prelude to a much more daunting long-term fiscal outlook. GAO’s long-term simulations illustrate the magnitude of the fiscal challenges associated with an aging society and the significance of the related challenges the government will be called upon to address. Absent significant policy changes on the spending or revenue side of the budget, our simulations show that growth in spending on federal retirement and health entitlements will encumber an escalating share of the government’s resources. Indeed, when we assume that recent tax reductions are made permanent and discretionary spending keeps pace with the economy, our long-term simulations suggest that by 2040 federal revenues may be adequate to pay little more than interest on the federal debt. In fact, the cost implications of the baby boom generation’s retirement have already become a factor in CBO’s baseline projections and will only intensify as the baby boomers age. According to CBO, total federal spending for Social Security, Medicare, and Medicaid is projected to grow by about 25 percent over the next 10 years—from 8.4 percent of Gross Domestic Product in 2004 to 10.4 percent in 2015. In addition, CBO reported that excluding supplemental funding appropriated in 2004 and requested in 2005 (mostly for activities in Iraq and Afghanistan), discretionary budget authority for defense programs is estimated to grow from $394 billion in 2004 to $421 billion in 2005, a 6.8 percent increase. The expected growth combined with the fact that DOD accounted for more than half of all discretionary spending in fiscal year 2004 raises concerns about the sustainability and affordability of increased defense spending. Despite the need to make strategic investment decisions to address these fiscal pressures, DOD’s current approach to planning often supports the status quo and results in a mismatch between programs and budgets. As we have reported, DOD has difficulties overcoming cultural resistance to change and the inertia of various organizations, policies, and procedures rooted in the Cold War era. Long-standing organizational and budgetary programs need to be addressed, such as the existence of stovepiped or siloed organizations, the involvement of many layers and players in decision making, and the allocation of budgets on a proportional rather than a strategic basis across the military services. DOD’s approach to planning does not always provide reasonable visibility to decision makers, including Congress, over the projected cost of defense programs. As we have reported in the past, DOD uses overly optimistic estimations of future program costs that often lead to costs being understated. For example, in January 2003 we reported that the estimated cost of developing eight major weapon systems had increased from about $47 billion in fiscal year 1998 to about $72 billion by fiscal year 2003. As a result of these inaccurate estimates, DOD has more programs than it can support with its available dollars, which often leads to program instability, costly program stretch- outs, and program termination. Increasingly limited fiscal resources across the federal government, coupled with emerging requirements from the changing security environment, emphasize the need for DOD to address its current inefficient approach to planning and develop a risk-based strategic investment framework for establishing goals, evaluating and setting priorities, and making difficult resource decisions. In its strategic plan, the September 2001 Quadrennial Defense Review, DOD outlined a new risk management framework consisting of four dimensions of risk—force management, operational, future challenges, and institutional—to use in considering trade-offs among defense objectives and resource constraints. We recognize what a large undertaking developing a departmentwide risk management framework will be and understand that DOD is still in the process of implementing this approach. However, it remains unclear how DOD will use the risk management framework to measure progress in achieving business and force transformation. It also remains unclear how the framework will be used to correct limitations we have previously identified in DOD’s strategic planning and budgeting. We are currently monitoring DOD’s efforts to implement the risk management framework. Numerous management problems, inefficiencies, and wasted resources continue to trouble DOD’s business operations, resulting in billions of dollars of wasted resources annually at a time when our nation is facing an increasing fiscal imbalance. Specific business management challenges that DOD needs to address to successfully transform its business operations include DOD’s approach to business transformation, strategic human capital management, its personnel security clearance program, support infrastructure management, business systems modernization, financial management, weapons systems acquisition, contract management, and supply chain management. These management challenges are on our 2005 high-risk list of programs and activities that need urgent and fundamental transformation if the federal government is to function in the most economical, efficient, and effective manner possible. The 8 DOD specific high-risk areas, along with six government-wide areas that apply to DOD, mean that the department is responsible for 14 of 25 high-risk areas. As shown in table 1, we added DOD’s approach to business management transformation to this list in 2005 because it represents an overarching high-risk area that encompasses the other individual, DOD specific, high- risk areas, but many of these other management challenges have been on the list for a decade or more. DOD’s approach to business management transformation represents an overarching high-risk area, encompassing several other key business management challenges. Over the years, DOD has embarked on a series of efforts to reform its business management operations, including modernizing underlying information technology (business) systems. However, serious inefficiencies remain. As a result, the areas of support infrastructure management, business systems modernization, financial management, weapon systems acquisition, contract management, and supply chain management remain high-risk DOD business operations. We now consider DOD’s overall approach to business transformation to be a high-risk area because (1) DOD’s business improvement initiatives and control over resources are fragmented; (2) DOD lacks a clear strategic and integrated business transformation plan and an investment strategy, including a well-defined enterprise architecture, to guide and constrain implementation of such a plan; and (3) DOD has not designated a senior management official responsible and accountable for overall business transformation reform and related resources. Unless DOD makes progress in overall business transformation, we believe it will continue to have difficulties in confronting other problems in its business operations. DOD spends billions of dollars to sustain key business operations intended to support the warfighter. We have previously testified on inefficiencies in DOD’s business operations, such as the lack of sustained leadership, the lack of a strategic and integrated business transformation plan, and inadequate incentives. Moreover, the lack of adequate transparency and accountability across DOD’s major business areas results in billions of dollars of wasted resources annually at a time of increasing military operations and growing fiscal constraints. Business transformation requires long-term cultural change, business process reengineering, and a commitment from both the executive and legislative branches of government. Although sound strategic planning is the foundation on which to build, DOD needs clear, capable, sustained, and professional leadership to maintain the continuity necessary for success. Such leadership could facilitate the overall business transformation effort within DOD by providing the momentum needed to overcome cultural resistance to change, military service parochialism, and stovepiped operations, all of which have contributed significantly to the failure of previous attempts to implement broad-based management reform at DOD. Without such leadership, it is also likely that DOD will continue to spend billions of dollars on stovepiped, duplicative, and nonintegrated systems that do not optimize mission performance or effectively support the warfighter. DOD is attempting to address the critically important business management challenge of strategic human capital management through its proposed human resources management system, the National Security Personnel System (NSPS). Successful implementation of NSPS is essential for DOD as it attempts to transform its military forces and defense business practices in response to 21st century challenges. In addition, this new human resources management system, if properly designed and effectively implemented, could serve as a model for governmentwide human capital transformation. DOD is one of several federal agencies that have been granted the authority by Congress to design a new human capital system as a way to address the governmentwide high-risk area of strategic human capital management. This effort represents a huge undertaking for DOD, given its massive size and geographically and culturally diverse workforce. As I recently testified on DOD’s proposed NSPS regulations, our ongoing work continues to raise questions about DOD’s chances of success in its efforts to effect fundamental business management reform, such as NSPS. I would like to acknowledge, however, that DOD’s NSPS regulations take a valuable step toward a modern performance management system as well as a more market-based and results-oriented compensation system. On February 14, 2005, the Secretary of Defense and the Acting Director of Office of Personnel Management (OPM) released the proposed NSPS regulations for public comment.