The U.S. federal budget serves as the primary financial plan of the federal government and thus plays a critical role in the decision-making process. Policymakers, managers, and the American people rely on it to frame their understanding of significant choices about the role of the government and to provide them with information to make decisions about individual programs and overall fiscal policy. The budget process helps highlight for policymakers and the public the overall “cost” of government. Since the budget process also serves as a key point of accountability between policymakers and managers, the way “costs” are measured and reported in the budget can have significant consequences for managerial incentives. The term “cost” has different meanings in the budget and financial statements. In the budget, the term “cost” generally refers to the amount of cash needed during the period. In the financial statements, the term “cost” means the amount of resources used to produce goods or deliver services during the period regardless of when cash is used. Therefore, one goal of accrual budgeting is to report the “full cost” of government services provided during the year. The different methods of reporting (e.g., cash, obligations, or accrual) represent much more than technical means of cost measurement. They reflect fundamental choices about the information and incentives provided by the budget. Cash-based measurement records receipts and outlays when cash is received or paid, without regard to when the activity occurs that results in revenue being earned, resources being consumed, or liabilities being increased. In comparison, obligation-based budgeting—which is used in the U.S. federal government—focuses on the legal obligations entered into during a period regardless of when cash is paid or received and regardless of when resources acquired are to be received or consumed. Obligation- based budgeting provides an additional level of control over pure cash budgeting by requiring that federal agencies have statutory authority to enter into obligations to make outlays of government funds. With limited exceptions, the amounts to be obligated are measured on a cash or cash- equivalent basis. Therefore, we generally refer to the U.S. federal budget as “cash based.” In contrast to cash- and obligation-based budgeting, accrual budgeting generally involves aligning budget recognition with the period in which resources are consumed or liabilities increased, rather than when obligations are made or cash flows occur. Although accruals can be measured in a variety of ways, the term accrual budgeting typically has been used in case study countries to refer to the recording of budgetary costs based on concepts in financial accounting standards. Thus, accrual- based budgeting generally provides information similar to that found in a private sector operating statement. Choices about the appropriate method of budget reporting are complicated by the multiplicity of the budget’s uses and users, including policymakers and managers. The federal budget is simultaneously asked to provide full information and appropriate incentives for resource allocation, control over cash, recognition of future commitments, and the monitoring of performance. Given these multiple and potentially competing objectives, choices about the method of budget reporting involve trade-offs. For example, control over spending is greatest if the budget recognizes the full cash cost at the time the decision is made but assessing performance and its cost is generally best supported by accrual- based cost information, which recognizes resources as they are used to produce goods and services. The up-front funding requirement under an obligation-based budget helps ensure policymakers’ control over the acquisition of a new building but does not align its cost with its use. Conversely, accrual budgeting better aligns the cost of the building with the periods that benefit from its use, but in its simplest form it does not provide for up-front control over entering a legally binding commitment to purchase the building. Given the necessary trade-offs, the method of budget reporting should be selected to meet the primary decision-making and accountability needs of a governmental system while balancing the needs of multiple users. The federal government reports both cash and accrual measures of its current finances. The key focus of the policy debate is the unified budget deficit/surplus. With limited exceptions, the unified budget deficit/surplus is the difference between cash receipts and cash o the government as a whole including any Social Security surplus. utlays for The second measure, the government’s net operating cost, is the amount by mount by which costs—as reported on an accrual basis—exceed revenue and is which costs—as reported on an accrual basis—exceed revenue and is reported in the federal government’s financial statements. Figure 1 show reported in the federal government’s financial statements. The consolidated financial statements of the U.S. government are largely on an accrual basis. See Department of the Treasury, Financial Report of the United States Government, 2006. GAO is responsible for auditing the financial statements included in the Financial Report, but we have been unable to express an opinion on them because the federal government could not demonstrate the reliability of significant portions of the financial statements. Accordingly, amounts taken from the Financial Report may not be reliable. when cash payments are made. For many program areas, the timing difference is small but for others the timing differences can amount to billions of dollars each year. Differences arise when a cost is accrued (and affects the accrual deficit) in one fiscal year but paid (and affects the cash deficit) in another fiscal year. The following six areas account for the largest differences between cash and accrual deficits: civilian employee benefits, military employee benefits, veterans compensation, environmental liabilities (e.g., cleanup and disposal), insurance programs, and capital assets. For example, the accrual deficit includes an expense for current employees’ pension and other retirement benefits, which are earned during the employee’s working years and are part of the annual cost of providing government services but not paid until sometime in the future when the employee retires. The cash budget deficit does not include retirement benefits earned today, but it does reflect payments made to current retirees. (These cash payments reflect past accrued expenses.) The difference between the accrued retirement benefits recognized and cash payments made during the year is the difference between the accrual and cash measures due to employee benefits. In the year that capital assets such as structures and equipment are purchased, the budget recognizes the full cash cost to provide decision makers with the information and incentives to make efficient decisions at the only time that they can control the cost. Specifically, budget authority for the asset’s full cash cost must generally be provided up front before the asset can be purchased. The full cash cost of a capital asset is recorded as an outlay and included in the cash budget deficit when the asset is paid for. However, under the accrual basis of accounting used in the financial statements, the cash cost of the asset is initially recorded on the balance sheet. The cash cost of the asset is then spread over its expected useful life to match the asset’s cost with its use. Therefore, each year the accrual deficit only reflects one year’s worth of the cash cost, called depreciation expense. We have previously noted that while both cash and accrual measures of the government’s overall finances are informative, neither measure alone provides a full picture. For example, the unified budget deficit provides information on borrowing needs and current cash flow, but does not measure the amount of resources used to provide goods or services in the current year. While the accrual deficit provides information on resources used in the current year, it does not provide information on how much the government has to borrow in the current year to finance government activities. Nor does it provide information about the timing of payments and receipts, which can be very important. Therefore, just as investors need income statements, statements of cash flow, and balance sheets to understand a business’s financial condition, both cash and accrual measures are important for understanding the government’s financial condition. Although a more complete picture of the government’s fiscal stance today and over time comes from looking at both the cash and accrual measures than from looking at either alone, even the two together do not provide sufficient information on our future fiscal challenges. In addition to considering the federal government’s current financial condition, it is critical to look at other measures of the long-term fiscal outlook of the federal government. While there are various ways to consider and assess the long-term fiscal outlook, any analysis should include more than just the obligations and costs recognized in the budget and financial statements. It should take account of the implicit promises embedded in current policy and the timing of these longer-term obligations and commitments in relation to the resources available under various assumptions. For example, while the cash and accrual measures showed improvement between fiscal year 2005 and fiscal year 2007, our long-term fiscal outlook did not change. In fact, the U.S. government’s total reported liabilities, net social insurance commitments, and other fiscal exposures continue to grow and total more than $52 trillion, representing approximately four times the nation’s total output, or gross domestic product (GDP), in fiscal year 2007, up from about $20 trillion, or two times GDP in fiscal year 2000 (see table 1). Another way to assess the U.S. government’s long-term fiscal outlook and the sustainability of federal programs is to run simulations of future revenues and spending for all federal programs, based on a continuation of current or proposed policy. Long-term simulations by GAO, the Congressional Budget Office, and others show that we face large and growing structural deficits driven primarily by rising health care costs and known demographic trends. As shown in figure 2, GAO’s long-term simulations—which are neither forecasts nor predictions—continue to show ever-increasing long-term deficits resulting in a federal debt level that ultimately spirals out of control.