Historically, federal outlays and receipts generally have been reported on a cash basis. That is, receipts are recorded when received and outlays are recorded when paid without regard to the period in which the taxes and fees were assessed or the costs resulting in the outlay were incurred. This has an advantage in that the deficit (or surplus) closely approximates the cash borrowing needs (or cash in excess of immediate needs) of the government. However, over the years analysts and researchers have raised concerns that the current cash- and obligation-based budget does not adequately reflect the cost of some programs—such as federal credit or insurance—in which the government makes a commitment now to incur a cost, but some or most of the cash flows come much later. This means that for some programs the current cash- and obligation-based budget does not recognize the full costs up front when decisions are made or provide policymakers the information to compare the full costs of a proposal with their judgment of its benefits. Programs such as federal employee pensions, retiree health care, and environmental liabilities are examples where the cash basis of accounting does not represent the government’s full commitments. Environmental liabilities are the result of federal operations that create hazardous waste that federal, state, or local laws and/or regulations require the federal government to clean up. Because these cleanup costs are not usually paid until many years after the government has committed to the operation creating the waste, policymakers have not been provided complete cost information when making decisions about undertaking the waste-creating operation. Although all agencies are not yet in compliance, current federal accounting standards require agencies to estimate and report in their financial statements their liability for cleanup costs when they are deemed probable and measurable. Traditionally, budget guidance has required agencies to estimate the funds expected to be obligated for cleanup activities during the budget year in which the funds are needed. However, in recent years OMB also has issued guidance for agencies to estimate life-cycle costs when purchasing capital assets. Among the items to be included in the total amount of these life-cycle costs are decommissioning and disposal costs. The life-cycle cost estimates are reported to OMB in budget Exhibit 300 and do not separately break out cleanup and disposal costs. The exhibits are for OMB’s informational purposes only; they are not included in the President’s budget request or agency’s budget justification provided to Congress. Department of Energy (DOE) and Department of Defense (DOD) officials told us that the cleanup portion of these total costs has traditionally not been separated out or identified at the time of purchase. This is because estimates developed at that time were very preliminary, often based only on a percentage of total costs rather than specific unit costs. To examine ways that budgeting might be improved for environmental liabilities, we focused on three key questions: (1) What are the federal government’s reported environmental liabilities? (2) How are environmental liabilities currently valued for financial statements and budgeted at selected programs within DOD and DOE? and (3) How could budgeting for these environmental liabilities be improved? To determine the federal government’s reported environmental liabilities, we extracted data from agencies’ fiscal year 2001 consolidated balance sheets. Because this analysis showed that about 98 percent of the government’s reported environmental liabilities were associated with DOD and DOE, we focused our review on the practices of these two departments. We reviewed published reports, related guidance, and budget and financial statement documentation from each agency. We also interviewed DOD, DOE, and OMB staff to discuss current budget practices. To develop alternative approaches to improve budgeting for environmental liabilities, we discussed ideas with staff from DOD, DOE, OMB, and CBO. We also met with appropriations subcommittee staff with jurisdiction over DOD and DOE to discuss the type of information that they would find most helpful. We analyzed the pros and cons of the approaches based on the extent to which they would (1) provide meaningful, full-cost information to decision makers up front, (2) provide disincentives for artificially low cost estimates, and (3) present implementation issues, such as additional administrative burdens for agencies or increased complexity to the budget and appropriations process. Finally, to understand how private organizations provide for environmental cleanup, we conducted limited research of private sector budgeting practices. However, little information was available about up-front decision making. Our work was done in Washington, D.C., in accordance with generally accepted government auditing standards. We provided a draft of this report to the Secretary of Defense, the Secretary of Energy, and the Director of OMB. Comments are summarized in the “Agency Comments” section. Nearly all of the $307 billion in environmental liabilities reported for fiscal year 2001 was associated with DOD and DOE. About 78 percent of these liabilities were associated with DOE and represent the environmental legacy resulting from the production of nuclear weapons. The 21 percent associated with DOD is primarily for environmental restoration of military installations and disposal of nuclear materials. The remaining environmental liabilities associated with other federal agencies include such things as replacement of underground storage tanks, asbestos removal, and lead abatement. Some of this remaining 1 percent will be paid out of Treasury’s judgment fund. DOD and DOE manage environmental cleanup quite differently: DOD’s decentralized activities are managed within the individual services, at the program level, while DOE’s activities are centralized within its Environmental Management (EM) program. For example, DOD considers environmental liabilities in two categories: (1) disposal and (2) environmental restoration/cleanup. Army’s chemical weapons and Navy’s nuclear-powered carriers, ships, and submarines dominate DOD’s disposal liabilities. Funding for disposal is provided to the Army, Navy, and Air Force Operation and Maintenance (O&M) accounts. Restoration/cleanup activities are largely addressed through the Defense Environmental Restoration Program (DERP), which is funded through five environmental restoration accounts for Army, Navy, Air Force, Formerly Used Defense Sites (FUDS), and Defense-wide. The funds in these accounts are then transferred to the service levels’ O&M budgets. In contrast, within DOE, facilities that have reached the end of their useful lives and require cleanup typically are transferred to EM, along with some additional funds for surveillance and maintenance. EM also receives budget authority directly through an appropriation. Thus, budgeting and funding for cleanup is almost entirely handled by EM, not individual program offices. EM’s program emphasis is on site closure and project completion. Its activities include environmental restoration, waste management, and nuclear material and facility stabilization. Figures 1 and 2 illustrate the flow of cleanup funds for these two departments. Current budget guidance and accounting standards both require agencies to estimate cleanup and disposal costs. However, neither requires that these costs be separately estimated for decisions when assets are being considered for purchase—before the government is legally committed to paying these costs. While information about private sector decision making on these costs is limited, at least some organizations set aside funds to address these future cleanup and disposal costs. Agencies have little or no budgetary incentive to develop estimates of future cleanup costs. With respect to primary budget data, agencies do not reflect associated cleanup costs in their budget requests for new waste- producing assets. Funding for such cleanup costs is not requested until many years later when the waste produced is ready to be cleaned up or disposed of. Budget guidance does require agencies to estimate cleanup costs as part of total life-cycle costs when requesting funds for new assets. However, agencies are not required to specifically break out the cleanup portion of these costs. DOD and DOE officials told us that separating out the cleanup/disposal component from total life-cycle costs would be relatively difficult because their estimates of cleanup costs are very preliminary. Often, a percentage of the purchase price instead of a specific unit cost is used as the cost estimate. Moreover, they noted that future, unknown changes in regulatory requirements and technology make it difficult to develop what they believe to be reasonable and credible cost estimates at the time an asset is acquired. However, since estimates for retiring assets are being made under today’s regulatory requirements and technology, the same methodology might be used for preliminary estimates with respect to new assets. This would permit comparisons between or across different assets. Over time, as laws and technology change, periodic cleanup cost reestimates could be made. Clear definitions for hazardous substances also may need to be resolved to ensure that reasonable estimates are developed. For example, the Federal Accounting Standards Advisory Board (FASAB) defines hazardous wastes in relatively broad terms (see footnote 1) for accounting purposes. However, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA), which requires the cleanup of waste sites, provides a substantially more detailed definition. While accounting standards promote an earlier recognition of environmental liabilities than does the budget, they do not call for estimates of environmental liabilities before an acquisition decision is made because they recognize these cleanup costs only after a transaction has occurred and an asset is put into service. Given that these conditions are met, agencies must estimate the environmental liabilities associated with all existing assets. Despite this, not all agencies comply with accounting standard requirements to estimate the environmental liabilities associated with all of their assets. For example, DOD typically records the liabilities associated with assets for which cleanup or disposal is imminent. DOD’s inability to comply with requirements for environmental liabilities was one of several reasons why independent auditors were not able to render an opinion about DOD’s fiscal year 2001 financial statements. Absent budgetary incentives to estimate future environmental liabilities, these cost estimates will not be developed as assets are considered for purchase—the time when decision makers still have an opportunity to judge whether the government should commit to these costs. Data about how non-federal organizations consider environmental liabilities when planning to purchase assets or start new projects were largely unavailable. However, there are cases where companies set aside funds for future cleanup costs.