In my role as lead partner on the audit of the U.S. government’s consolidated financial statements and the de facto Chief Accountability Officer of the United States government, I have become increasingly concerned about the state of our nation’s finances. In speeches and presentations over the past several years, I have called attention to our large and growing long-term fiscal challenge and the risks it poses to our nation’s future. Simply put, our nation’s fiscal policy is on an unsustainable course, and our long-term fiscal imbalance worsened significantly in 2004. GAO’s simulations—as well as those of the Congressional Budget Office (CBO) and others—show that 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 unsustainable fiscal path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security. Our current path also will increasingly constrain our ability to address emerging and unexpected budgetary needs. Regardless of the assumptions used, all simulations indicate that the problem is too big to be solved by economic growth alone or by making modest changes to existing spending and tax policies. Nothing less than a fundamental reexamination of all major spending and tax policies and priorities is needed. This reexamination should also involve a national discussion about what Americans want from their government and how much they are willing to pay for those things. This discussion will not be easy, but it must take place. In fiscal year 2004 alone, the nation’s fiscal imbalance grew dramatically, primarily due to enactment of the new Medicare prescription drug benefit, which added $8.1 trillion to the outstanding commitments and obligations of the U.S. government. The near-term deficits also reflected higher defense, homeland security, and overall discretionary spending which exceeded growth in the economy, as well as revenues which have fallen below historical averages due to policy decisions and other economic and technical factors. While the nation’s long-term fiscal imbalance grew significantly, the retirement of the baby boom generation has come closer to becoming a reality. 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 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 (GDP) in 2004 to 10.4 percent in 2015. Given these and other factors, it is clear that the nation’s current fiscal path is unsustainable and that tough choices will be necessary in order to address the growing imbalance. There are different ways to describe the magnitude of Social Security’s long-term financing challenge, but they all show a need for program reform sooner rather than later. A case can be made for a range of different measures, as well as different time horizons. For instance, the shortfall can be measured in present value, as a percentage of GDP, or as a percentage of taxable payroll. The Social Security Administration (SSA) has made projections of the Social Security shortfall using different time horizons. (See table 1.) While estimates vary due to different horizons, both identify the same long- term challenge: The Social Security system is unsustainable in the long run. Taking action soon on Social Security would not only make the necessary action less dramatic than if we wait but would also promote increased budgetary flexibility in the future and stronger economic growth. Although the Trustees’ 2004 intermediate estimates project that the combined Social Security Trust Funds will be solvent until 2042, within the next few years, Social Security spending will begin to put pressure on the rest of the federal budget. (See table 2.) Under the Trustees’ 2004 intermediate estimates, Social Security’s cash surplus—the difference between program tax income and the costs of paying scheduled benefits— will begin a permanent decline in 2008. (See fig. 1.) To finance the same level of federal spending as in the previous year, additional revenues and/or increased borrowing will be needed in each subsequent year. By 2018, Social Security’s cash income (tax revenue) is projected to fall below program expenses. At that time, Social Security will join Medicare’s Hospital Insurance Trust Fund, whose outlays exceeded cash revenues in 2004, as a net claimant on the rest of the federal budget. The combined OASDI Trust Funds will begin drawing on the Treasury to cover the cash shortfall. At this point, Treasury will need to obtain cash for those redeemed securities either through increased taxes, and/or spending cuts, and/or more borrowing from the public than would have been the case had Social Security’s cash flow remained positive. Today Social Security spending exceeds federal spending for Medicare and Medicaid, but that will change. While Social Security is expected to grow about 5.6 percent per year on average over the next 10 years, Medicare and Medicaid combined are expected to grow at 8.5 percent per year. As a result, CBO’s baseline projects Medicare and Medicaid spending will be about 30 percent higher than Social Security in 2015. According to the Social Security and Medicare trustees, Social Security will grow from 4.3 percent of GDP today to 6.6 percent in 2075, and Medicare’s burden on the economy will quintuple—from 2.7 percent to 13.3 percent of the economy. 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. Figures 2 and 3 present these simulations under two different sets of assumptions. In figure 2, we begin with CBO’s January baseline, constructed according to the statutory requirements for that baseline. Consistent with these 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 2015, discretionary spending is assumed to grow with the economy, and revenue is held constant as a share of GDP at the 2015 level. In figure 3 two assumptions are changed: discretionary spending is assumed to grow with the economy after 2005 rather than merely with inflation and the tax cuts are extended. For both simulations Social Security and Medicare spending is based on the 2004 Trustees’ intermediate projections, and we assume that benefits continue to be paid in full after the trust funds are exhausted. Medicaid spending is based on CBO’s December 2003 long- term projections under mid-range assumptions. Both these simulations illustrate that, absent policy changes, the 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. Neither slowing the growth in discretionary spending nor allowing the tax provisions to expire—nor both together—would eliminate the imbalance. Although revenues will be part of the debate about our fiscal future, the failure to reform Social Security, Medicare, Medicaid, and other drivers of the long-term fiscal gap would require at least a doubling of taxes—and that seems implausible. Accordingly, substantive reform of Social Security and our major health programs remains critical to recapturing our future fiscal flexibility. Although considerable uncertainty surrounds long-term budget projections, we know two things for certain: the population is aging and the baby boom generation is approaching retirement age. The aging population and rising health care spending will have significant implications not only for the budget but also for the economy as a whole. Figure 4 shows the total future draw on the economy represented by Social Security, Medicare, and Medicaid. Under the 2004 Trustees’ intermediate estimates and CBO’s long-term Medicaid estimates, spending for these entitlement programs combined will grow to 15.6 percent of GDP in 2030 from today’s 8.5 percent. It is clear that, taken together, Social Security, Medicare, and Medicaid represent an unsustainable burden on future generations. The government can help ease future fiscal burdens through spending reductions or revenue actions that reduce debt held by the public, thereby saving for the future and enhancing the pool of economic resources available for private investment and long-term growth. Economic growth can help, but given the size of our projected fiscal gap we will not be able to simply grow our way out of the problem. Closing the current long-term fiscal gap would require sustained economic growth far beyond that experienced in U.S. economic history since World War II. Tough choices are inevitable, and the sooner we act the better. Some of the benefits of early action—and the costs of delay—can be illustrated using the 2004 Social Security Trustees’ intermediate projections. Figure 5 compares what it would take to keep Social Security solvent through 2078 by either raising payroll taxes or reducing benefits. If we did nothing until 2042—the year SSA estimates the Trust Funds will be exhausted—achieving actuarial balance would require changes in benefits of 30 percent or changes in taxes of 43 percent. As figure 5 shows, earlier action shrinks the size of the necessary adjustment. Both sustainability concerns and solvency considerations drive us to act sooner rather than later. Trust Fund exhaustion may be nearly 40 years away, but the squeeze on the federal budget will begin as the baby boom generation begins to retire. Actions taken today can ease both these pressures and the pain of future actions. Acting sooner rather than later also provides a more reasonable planning horizon for future retirees. The Social Security program’s situation is but one symptom of larger demographic trends that will have broad and profound effects on our nation’s future in other ways as well. As you are aware, Social Security has always been a largely pay-as-you-go system.