oversight

Fiscal Exposures: Improving the Budgetary Focus on Long-Term Costs and Uncertainties

Published by the Government Accountability Office on 2003-01-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Report to the Chairman, Committee on
               the Budget, House of Representatives



January 2003
               FISCAL EXPOSURES
               Improving the
               Budgetary Focus on
               Long-Term Costs and
               Uncertainties




GAO-03-213
               a
                                               January 2003


                                               FISCAL EXPOSURES

                                               Improving the Budgetary Focus on Long-
Highlights of GAO-03-213, a report to the      Term Costs and Uncertainties
Committee on the Budget, House of
Representatives




GAO and other budget experts                   The federal government undertakes a wide range of responsibilities,
have discussed that the current                programs, and activities that may either obligate the government to future
time horizons and content of the               spending or simply create an expectation for spending. GAO uses the
federal budget could be enhanced               concept of “fiscal exposure” (risk) to provide a framework to consider these
to more comprehensively reflect                long-term costs and uncertainties.
the government’s commitments or
signal emerging problems. GAO
was asked to (1) provide                       Fiscal exposures vary widely as to source, extent of the government’s legal
information on the range and                   obligation, likelihood of occurrence, and magnitude. These exposures
nature of responsibilities,                    include items such as retirement benefits, environmental cleanup costs, and
programs, and activities that may              future social insurance benefits. Given this variety, it is useful to think of a
explicitly or implicitly expose the            spectrum extending from explicit liabilities to implicit promises embedded
government to future spending and              in current policy or public expectations.
(2) present and discuss options for
increasing the attention paid to               Fiscal exposures warrant budgetary attention and oversight. Demographic
these items in the budget and                  trends, in particular, argue for considering the long-term sustainability and
budget process.                                flexibility of the government’s fiscal position. Regardless of whether the
                                               government is legally required or simply compelled by circumstances, some
                                               exposures may encumber future budgets and constrain fiscal policy. Not
GAO recommends that OMB report                 capturing the long-term costs of current decisions limits Congress’s ability to
annually on fiscal exposures.                  control the government’s fiscal exposures at the time decisions are made.
Where possible, OMB should report
the estimated costs—“exposure                  Current budget reporting, however, does not always fully capture or require
level”—of certain activities in the            explicit consideration of some fiscal exposures. For some exposures, such
Program and Financing schedules                as environmental cleanup costs, the government’s commitment occurs years
of the budget. In a few select areas,          before the cash consequences are reflected in the budget. Other potential
the ultimate objective might be to             draws on future resources, such as life-cycle costs for fixed assets and
include costs directly in the budget           disaster assistance, may not flow from commitments of a strictly legal nature
when doing so would enhance up-
                                               but from public expectations.
front control of spending.

Congress may wish to consider                  Determining how to improve the budgetary attention to fiscal exposures is
exploring options for improving the            complicated by difficulties in (1) determining the scope of items to be
budgetary information and the                  considered and (2) estimating costs. The variety of fiscal exposures and the
attention given to fiscal exposures.           difficulties in estimating their costs suggest that an across-the-board
If more explicit congressional                 approach may not be the best way to proceed. Improved supplemental
consideration is desired, as                   information may be helpful to increase transparency without introducing
estimates improve, Congress may                additional uncertainty and complexities into the budget. In cases where the
wish to develop budget process                 extent of the government’s obligation or ultimate costs (or both) is unclear,
mechanisms that prompt more                    supplemental reporting may be the most appropriate approach. Beyond
deliberation.
                                               increasing supplemental reporting, providing more opportunities to consider
                                               fiscal exposures in the budget process may help facilitate explicit
                                               consideration of certain exposures. Finally, in some cases where there is an
                                               explicit liability and accepted, reasonable cost estimates exist, additional
www.gao.gov/cgi-bin/getrpt?GAO-03-213.
                                               steps may be taken to directly incorporate costs in the budget when doing so
To view the full report, including the scope   would enhance up-front control of spending.
and methodology, click on the link above.
For more information, contact Paul Posner at
(202) 512-9573 or posnerp@gao.gov.
Contents



Letter                                                                                 1
           Results In Brief                                                            1
           Background                                                                  7
           Objectives, Scope, and Methodology                                          9
           Fiscal Exposure Could Be Considered on Several Levels                      12
           Fiscal Exposures are Wide-Ranging and Varied                               14
           Fiscal Exposures Involve Complex Measurement and Budgeting
             Challenges                                                               24
           Diversity of Fiscal Exposures Suggests that Tailored Approaches
             Would Be More Feasible than an Across-the-Board Approach                 27
           Conclusion                                                                 41
           Recommendations for Executive Action                                       43
           Matters for Congressional Consideration                                    43
           Agency Comments and Our Evaluation                                         43


Figures    Figure 1: Composition of Spending as a Share of GDP Assuming
                     Discretionary Spending Grows with GDP and the Tax
                     Cuts Do Not Sunset                                                8
           Figure 2: Spectrum of Fiscal Exposures                                     15
           Figure 3: Social Security, Medicare, and Medicaid Spending as a
                     Percent of Gross Domestic Product                                20
           Figure 4: Overview of Possible Approaches                                  27
           Figure 5: Possible Options For Improving Supplemental Reporting
                                                                                      29
           Figure 6: Possible Options for Providing Opportunities For
                     Explicit Consideration of Fiscal Exposures                       33
           Figure 7: Possible Options for Incorporating Costs Directly into the
                     Primary Budget Data                                              37




           Abbreviations

           CBO         Congressional Budget Office
           DOD         Department of Defense
           GDP         gross domestic product
           OMB         Office of Management and Budget


           Page i                                             GAO-03-213 Fiscal Exposures
Contents




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Page ii                                                      GAO-03-213 Fiscal Exposures
A
United States General Accounting Office
Washington, D.C. 20548



                                    January 24, 2003                                                              Leter




                                    The Honorable Jim Nussle
                                    Chairman
                                    Committee on the Budget
                                    House of Representatives

                                    Dear Mr. Chairman,

                                    As the central process by which the President and Congress select among
                                    competing demands for federal funds, the budget should provide complete
                                    cost information and adequate signals about emerging problems. For many
                                    programs, the current budget does this. It does not, however, always help
                                    policymakers consider the long-term costs associated with some activities
                                    that explicitly or implicitly commit the government to future spending or
                                    otherwise affect the long-term fiscal outlook of the nation. This may limit
                                    the attention given to the future sustainability and flexibility of the
                                    government’s fiscal position and the cost effectiveness of existing
                                    programs.

                                    You requested that we: (1) provide information on the range and nature of
                                    certain responsibilities, programs, and activities that may explicitly or
                                    implicitly expose the government to future spending and (2) present and
                                    discuss options for increasing attention paid to these items in the budget
                                    and the budget process. As discussed with your staff, this report covers a
                                    number of issues surrounding long-term costs and uncertainties that
                                    present risk for the fiscal future, including

                                    • the concept and different dimensions of fiscal exposures (risks)

                                    • the range and nature of specific fiscal exposures facing the federal
                                      government

                                    • the complexities and challenges surrounding cost measurement and
                                      budgeting for fiscal exposures and

                                    • approaches for increasing the attention given to fiscal exposures in the
                                      budget and the budget process.



Results In Brief                    The federal government undertakes a wide range of responsibilities,
                                    programs, and activities that may either obligate the government to future



                                    Page 1                                             GAO-03-213 Fiscal Exposures
spending or create an expectation for spending. In particular, demographic
trends facing the nation argue for considering the long-term sustainability
and flexibility of the government’s fiscal position. Profound demographic
changes, with the impending retirement of the baby boom generation, will
have significant implications not only for the Social Security, Medicare, and
Medicaid programs but also for the budget and the economy as a whole.
The approaching demographic tidal wave also serves to reinforce the
importance of looking beyond short-term budgetary consequences. The
savings and loan crisis in the 1980s and the resulting multibillion dollar
bailout serve as a vivid reminder of the shortcomings and consequences
when the federal budget does not adequately signal emerging problems.

Current budget reporting, however, is not designed to promote the
recognition and explicit consideration of some of these exposures. For
some claims, such as environmental cleanup and disposal costs, the
government’s commitment occurs years before the cash consequences are
reflected in the budget. Other potential draws on future resources, such as
future social insurance benefits or disaster assistance, may not flow from
commitments of a strictly legal nature but from expectations that the
public holds about the government’s responsibilities. For example, while
the federal budget shows annual Social Security tax receipts exceeding
annual cash benefit payments, the fiscal year 2001 consolidated Financial
Report of the United States Government estimates the net present value of
Social Security’s negative cash flow over a 75-year period as $4.2 trillion.1
Concerns have been raised that such potential draws on future federal
resources extending beyond current budget time frames may not be readily
apparent in current budget reporting and process.

Policy choices that may have significant implications for long-term budget
flexibility and for which future growth paths are uncertain can affect either
spending or revenue; thus, fiscal exposures could be thought of on several
levels. Aggregate projections of the cost of the government’s current
programs and policies provide important context for decision making. This
construct, however, may be too broad to highlight specific areas for reform.
To help address this concern, this report looks below the aggregate level on


1
 Net present value of the negative cash flow is the current amount of funds needed to cover
projected shortfalls, excluding trust fund balances, over a 75-year period. The trust fund
balance at the beginning of the valuation period (January 1, 2001) was $1,049 billion. The
net present value of negative cash flows shown in this report is from the fiscal year 2001
consolidated Financial Report of the United States Government and is a different measure
from the actuarial balance in the Trustees’ Report.




Page 2                                                       GAO-03-213 Fiscal Exposures
the spending side to provide insights on the range and nature of specific
fiscal exposures.

In this report, we use the term “fiscal exposure” to provide a conceptual
framework for considering the wide range of responsibilities, programs,
and activities that may explicitly or implicitly expose the federal
government to future spending. The budget treatment of items that could
be considered fiscal exposures varies—some have been captured in budget
obligations and some have not. Fiscal exposures include not only
liabilities,2 contingencies,3 and financial commitments4 that are identified
on the balance sheet or in the accompanying notes, but also
responsibilities and expectations for government spending that do not
meet the recognition and disclosure requirements for that statement. We
use the term implicit exposures in this report to refer to exposures that
stem not from a legal obligation of the federal government but rather from
implied commitments embedded in the government’s current policies or in
the public’s expectations about the role of government.5

Fiscal exposures vary widely as to source, extent of the government’s legal
obligation, likelihood of occurrence, and magnitude. Their ultimate costs
may or may not be measurable. Given this variety, it is useful to think of
fiscal exposures as falling on a spectrum extending from explicit liabilities


2
 For financial statement reporting, a liability represents a probable and measurable future
outflow of resources arising from past transactions or events. A liability is recorded on the
face of the balance sheet when an item is identifiable, its occurrence is probable, and its
cost can be reasonably estimated.
3
 For financial statement reporting, a contingency is an existing condition, situation, or set of
circumstances involving uncertainty as to possible gains or losses. The uncertainty will
ultimately be resolved when one or more future events occur or fail to occur. Contingencies
are disclosed in the notes of the financial statements if any of the conditions for liability
recognition are not met and there is at least a reasonable possibility that a loss may have
been incurred. Contingencies that are classified as remote are not required to be disclosed.
4
 For financial statement reporting, financial commitments refer to contractual obligations
that require the future use of resources. For example, although a liability generally is not
recognized on the balance sheet when a contract is signed because the contracted goods or
services have not been delivered, this transaction may be recognized as a commitment in
the notes. In contrast, budgetary accounting would record obligations at the time the
government enters into a contract and allows for deobligation if the contract is not fulfilled.
Budgetary accounting records obligations when an order is placed, contract awarded,
service rendered, or similar transaction takes place that will require payment.
5
 Some of these implicit exposures, such as the costs of future social insurance benefits, are
discussed in the stewardship section of the government’s consolidated financial statement.




Page 3                                                           GAO-03-213 Fiscal Exposures
to the implicit promises embedded in current policy or public expectations.
Some, such as environmental cleanup and disposal costs and
postretirement benefits, are reported in the financial statements as
liabilities. Some are reported as financial commitments—such as
contracted goods or services that have not yet been delivered—or
contingencies—such as insurance—that depend on future events. Others,
such as future social insurance benefits, are not explicitly stated or
reported as liabilities but rather are implied by current decisions or public
expectations about the role of government and shown as stewardship
responsibilities.

The budgetary treatment of these items varies—some have been included
in the budget and some have not. Some liabilities reported on the financial
statements, such as accounts payable and loan guarantees, are included in
the budget because agencies must have budget authority to cover them.
Others, such as environmental and disposal liabilities, are not included in
primary budget data6 beyond the amount for current cleanup activities.
Some implicit exposures, such as the cost of future Social Security
benefits, are not included in primary budget data for the budget year but
are captured in long-range budget projections. Other implicit exposures,
such as the risk assumed by insurance programs, may not be captured in
either primary budget data or in long-range budget projections.

This variety increases the difficulty of determining how and to what extent
fiscal exposures should be handled in the budget and budget process.
Specifically, budgeting for fiscal exposures is complicated by difficulties in
(1) determining the scope of programs that should be considered and
(2) estimating costs. There is no technical definition of fiscal exposures
and no universal agreement on which and to what extent specific activities
should be considered fiscal exposures or how they should be treated in the
budget and budget process. Further, the complexity and uncertainty
surrounding some exposures creates significant cost estimation
challenges, which in turn raises concerns about using these estimates as
the sole basis of budget and other policy decisions. These issues need to be
considered carefully to avoid subjecting the primary budget data to large
and volatile reestimates. Nevertheless, information on the existence and
estimated cost of fiscal exposures needs to be considered along with other
factors when making policy decisions. Not capturing the long-term costs of


6
  In this report, primary budget data refers to budget authority, obligations, outlays, and the
deficit/surplus.




Page 4                                                          GAO-03-213 Fiscal Exposures
current decisions limits Congress’s ability to control the government’s
exposure at the time decisions are made.

The variety of fiscal exposures, the difficulties in estimating their costs, and
the range of uncertainty surrounding such cost estimates suggest that an
across-the-board approach may not be the best way to proceed and that
approaches may evolve over time. A framework organized around possible
objectives can facilitate consideration and analysis of various approaches
to help improve the attention given to fiscal exposures. The three possible
objectives used to structure this analysis are (1) improving transparency,
(2) prompting more deliberation, and (3) improving budget incentives.

If the primary objective is to improve the transparency of fiscal exposures,
then supplemental reporting would help promote this objective. One
option for increased supplemental reporting would be to require, on an
annual basis, a report on fiscal exposures. Another option would be to
report, where appropriate, the future estimated costs of certain exposures
as a new budget concept—“exposure level”—as a notational item in the
Program and Financing schedule of the President’s budget. If, however, the
primary objective is to prompt more explicit deliberation of exposures,
then budget process mechanisms could be designed to provide
opportunities for such consideration—especially as the amount and quality
of cost information is improved over time. For example, as more
information on costs is provided, the budget resolution could include limits
on creating new or expanding existing exposures, with points of order
permitted against legislation violating such limits. Another option would
be to establish triggers to signal when the costs of existing exposures
exceed some predetermined amount. Any process mechanisms—whether
points of order or triggers—would need to take into account the
uncertainty inherent in all long-range estimates and be designed
accordingly. Finally, if the primary objective is to change budgetary
incentives, then estimates of the future costs of exposures might be
included directly into the primary budget data. For example, accrual-based
measurement could be used to record estimated costs when doing so
would enhance obligations-based control by recognizing costs up front at
the time decisions are made that might encumber future resources. The
general approaches outlined and the various options for implementing
them achieve the three objectives to differing degrees and also vary in the
implementation challenges they present.

We are recommending that the Office of Management and Budget (OMB)
report annually on fiscal exposures, including a concise list and description



Page 5                                                GAO-03-213 Fiscal Exposures
of such exposures, cost estimates, where possible, and an assessment of
methodologies and data used to produce cost estimates for such
exposures. In addition, where possible, OMB should report the estimated
costs associated with certain exposures as a new budget concept—
“exposure level”—as a notational item in the Program and Financing
schedule of the President’s budget. For select areas where an explicit
liability exists and there are accepted cost estimation methodologies, the
ultimate objective might be to include the accrual costs directly in the
primary budget data when doing so would enhance obligation-based
control. These steps should complement and support continued and
improved reporting of long-range projections and analysis of the budget as
a whole to assess fiscal sustainability and flexibility.

If more explicit congressional consideration of the potential costs of
certain exposures is desired, Congress may wish, as estimates improve
over time, to develop budget process mechanisms that prompt more
deliberation about fiscal exposures while recognizing the uncertainty
inherent in estimating some long-term costs.




Page 6                                            GAO-03-213 Fiscal Exposures
Background   A primary focus of current federal budget reporting is the cash implications
             of the government’s obligations over a period of 1 to 10 years. The federal
             budget is an obligation-based budget designed to ensure that agencies do
             not incur legal obligations unless and until Congress provides authority for
             that purpose. Obligation-based budgeting involves three stages
             (1) Congress must enact budget authority up front before government
             officials can obligate the government to make outlays, (2) government
             officials commit the government to make outlays by entering into legally
             binding agreements, and (3) outlays (cash disbursements) are made to
             liquidate obligations. However, with limited exceptions,7 the amounts to be
             obligated are measured on a cash or cash equivalent basis and the unified
             budget deficit/surplus8—a key focus of the policy debate—represents the
             difference between cash receipts and cash outlays in a given year. As a
             result, the U.S. budget is often referred to as cash-based as well as
             obligation-based.

             For many programs, the cash- and obligation-based budget provides
             sufficient information on and control over the government’s spending
             commitments. However, this focus does not require explicit consideration
             of some responsibilities, programs, or activities that may result in future
             spending. For some programs, obligations and cash outlays do not reflect
             the magnitude of the government’s commitment of future resources at the
             time decisions are being made. We and other federal budget experts have
             raised concerns that, in these cases, the current budget may neither
             adequately reflect the extent of the government’s commitment nor signal
             emerging problems.

             Demographic trends facing the United States argue for considering the
             long-term sustainability and flexibility of the government’s fiscal position.
             Profound demographic changes with the impending retirement of the baby


             7
              The U.S. budget uses accrual measures to recognize the government’s cost for certain
             programs. One example is the treatment of credit programs for which budget authority,
             obligations, and outlays are measured on an accrual basis. Interest on Treasury debt held by
             the public is almost entirely on an accrual basis.
             8
              Under the budget concepts set forth in the Report of the President’s Commission on
             Budget Concepts, the unified budget is a comprehensive budget in which receipts and
             outlays from federal and trust funds are consolidated. When these fund groups are
             consolidated to display budget totals, transactions that are outlays of one fund group for
             payment to another fund group (that is, intrafund transactions) are deducted to avoid
             double counting.




             Page 7                                                         GAO-03-213 Fiscal Exposures
boom generation will have significant implications not only for the Social
Security, Medicare, and Medicaid programs but also for the budget and the
economy as a whole. The share of the population that is age 65 or older is
climbing and is expected to surpass 20 percent by 2035. Our recent
simulations show that absent policy changes, social insurance and health
programs will encumber an increasing share of the government’s
resources, thus restricting fiscal flexibility to address other needs. As
shown in figure 1, our long-term budget simulations show that the aging of
the baby boom generation and rising per capita health care spending will,
absent meaningful reform, lead to massive fiscal challenges in future years.
Assuming, for example, that recent tax reductions are made permanent and
discretionary spending keeps pace with the economy, by midcentury,
federal revenues may only be adequate to pay Social Security and interest
on the federal debt. As a result, major spending reductions, tax increases,
or some combination of the two would be necessary to obtain balance.



Figure 1: Composition of Spending as a Share of GDP Assuming Discretionary
Spending Grows with GDP and the Tax Cuts Do Not Sunset

 40 Percent of GDP




 30

          Revenue


 20




 10




  0
           2000                  2015   2030   2050
      Fiscal year

               All other spending

               Medicare and Medicaid

               Social Security
               Net interest
 Source: GAO's August 2002 analysis.




Page 8                                                GAO-03-213 Fiscal Exposures
                         One need not look only to implications of the demographic shift to see the
                         disconnection between how some exposures appear in the budget in the
                         short term and the long term. The savings and loan crisis and the resulting
                         bailout serve as a vivid reminder of the shortcomings of the federal budget
                         in signaling emerging problems. During the 1980s, as hundreds of
                         institutions became insolvent and the government’s liabilities mounted, the
                         federal budget failed to provide timely information on the rising deposit
                         insurance costs accruing to the government. Although we and some
                         industry analysts raised concerns about these rapidly increasing deposit
                         insurance costs, corrective action was delayed and the government’s total
                         costs increased. Since the federal budget did not record outlays until the
                         institutions were closed and depositors paid, it provided little incentive to
                         act promptly. Indeed, budget treatment may have created incentives to
                         delay closing insolvent institutions, which raised the government’s ultimate
                         costs. Delayed budget recognition obscured the program’s, as well as the
                         government’s, underlying financial condition and limited the usefulness of
                         the budget process as a means for Congress to assess the problem.

                         Recent performance reforms also reinforce the need for full cost
                         information to assess and manage program performance. These reforms
                         emphasize the need for complete cost information—not just cash flows—
                         to assess and manage performance. However, for some activities, such as
                         deferred compensation, the current budgetary focus on annual cash flows
                         does not match full costs with the goods and services provided by the
                         government. By making it more difficult to assess and compare the costs
                         associated with a given level of performance, the failure to align budgetary
                         cost recognition with the consumption of resources may hamper the
                         government’s performance and accountability reform efforts.



Objectives, Scope, and   The Chairman of the House Committee on the Budget asked us to
                         (1) provide information on the range and nature of responsibilities,
Methodology              programs, and activities that may explicitly or implicitly expose the
                         government to future spending and (2) present and discuss options for
                         increasing attention paid to these items in the budget and the budget
                         process. Although some tax preferences may have uncertain or
                         accelerating future growth paths that have significant implications for the
                         long term, this report deals only with spending.




                         Page 9                                              GAO-03-213 Fiscal Exposures
To identify examples of programs and activities that may either directly
obligate the government to future spending or simply create an expectation
for such spending, we reviewed the consolidated Financial Report of the
United States Government, relevant literature, the President’s budget
documents, and prior GAO work. To begin construction of the spectrum of
fiscal exposures, we reviewed the generally accepted federal accounting
standards, including the basis of conclusions for federal liabilities,
contingencies, and stewardship responsibilities. Data on estimated
exposures were drawn from the fiscal year 2001 consolidated Financial
Report of the United States Government, agency financial statements, and
the President’s budget. Although we used generally accepted federal
accounting standards as an initial framework in constructing the spectrum
of fiscal exposures outlined in the report, we also considered additional
items that may implicitly expose the government to future spending but
may not be fully captured in the financial statements or the budget. In
order to identify ideas and describe various approaches for improving the
budgetary attention given to fiscal exposures, we reviewed relevant
literature and our prior work, including discussions with budget experts.
We also drew upon our previous work looking at the experiences of other
nations with accrual budgeting9 and the recognition of fiscal risks, such as
federal insurance.10




9
 U.S. General Accounting Office, Accrual Budgeting: Experiences of Other Nations and
Implications for the United States, GAO/AIMD-00-57 (Washington, D.C.: Feb. 18, 2000).
10
 U.S. General Accounting Office, Budget Issues: Budgeting for Federal Insurance
Programs, GAO/AIMD-97-16 (Washington, D.C.: Sept. 30, 1997).




Page 10                                                    GAO-03-213 Fiscal Exposures
Our list of fiscal exposures is meant to be illustrative to provide perspective
on the range and nature of responsibilities, programs, and activities that
may explicitly or implicitly expose the government to future spending. It
should not be interpreted either as all-inclusive or universally agreed upon.
Further, although this report notes that the concept of fiscal exposure can
be thought of broadly, its main focus is the long-term costs and
uncertainties associated with certain items that may expose the
government to future spending. Rather than looking at the broad fiscal
outlook, it focuses only on certain parts of the spending side of the budget.
As such, it does not consider all federal spending and general revenues that
would need to be considered in order to assess long-term fiscal
sustainability. We have discussed long-term fiscal sustainability issues in
numerous reports and testimonies.11 As part of this work, our simulations
of the long-term economic impact of federal budget policy show that the
nation’s economic future depends, in part, upon today’s budget and fiscal
policy choices. This report builds on this previous work by looking below
the aggregate level to the long-term costs associated with certain specific
spending items.

Our work was done in Washington, D.C., in accordance with generally
accepted government auditing standards. Comments on a draft of this
report from OMB staff are discussed and incorporated as appropriate.

The remainder of this report discusses a number of issues, including

• the concept and different dimensions of fiscal exposures (risks)

• the range and nature of specific fiscal exposures facing the federal
  government

• the complexities and challenges surrounding cost measurement and
  budgeting for fiscal exposures and

• approaches for increasing the attention given to fiscal exposures in the
  budget and the budget process.



11
 For example, U.S. General Accounting Office, Budget Issues: Long-Term Fiscal
Challenges. Testimony before the Committee on the Budget, U.S. Senate, GAO-02-467T
(Washington, D.C.: Feb. 27, 2002) and U.S. General Accounting Office, Long-Term Budget
Issues: Moving From Balancing the Budget to Balancing Fiscal Risk, GAO-01-385T
(Washington, D.C.: Feb. 6, 2001).




Page 11                                                    GAO-03-213 Fiscal Exposures
Fiscal Exposure Could   We use the term fiscal exposure to provide a conceptual framework for
                        considering the wide range of responsibilities, programs, and activities that
Be Considered on        may explicitly or implicitly expose the federal government to future
Several Levels          spending. The treatment of items that could be considered fiscal
                        exposures in the current cash- and obligation-based budget varies—some
                        have been captured in budget obligations and some have not. Fiscal
                        exposures include not only liabilities, contingencies, and financial
                        commitments that are identified on the balance sheet or accompanying
                        notes, but also responsibilities and expectations for government spending
                        that do not meet the recognition or disclosure requirements for that
                        statement.12 By extending beyond conventional accounting and fiscal
                        analysis, the concept of fiscal exposure is meant to provide a broad
                        perspective on long-term costs and uncertainties. The aim is not to provide
                        strict definitional guidelines, but rather to improve understanding of the
                        exposures associated with certain activities.

                        It is possible to think about fiscal exposure on several levels. Aggregate
                        budget projections of the government’s current programs and policies
                        provide important context for considering the implications of specific
                        decisions. For example, long-range (approximately 75 year) current
                        service projections and simulations, such as those provided by our model
                        and in the Analytical Perspectives of the President’s budget, provide a
                        broad context for considering the sustainability and flexibility of the
                        government’s future fiscal position. However, such constructs are likely to
                        be too broad to highlight specific areas for reform. Further, the aggregate
                        outlook is driven largely by Social Security, Medicare, and Medicaid. As a
                        result, it provides little or no information to guide choices—or even signal
                        growth—outside those areas.




                        12
                          In this report, the term implicit exposures refers to exposures that stem not from a legal
                        obligation of the federal government but rather from implied commitments embedded in the
                        government’s current policies or in the public’s expectations about the role of government.
                        Some implicit exposures, such as the costs of future social insurance benefits, are discussed
                        in the stewardship section of the government’s consolidated financial statement.




                        Page 12                                                        GAO-03-213 Fiscal Exposures
While Social Security, Medicare, and Medicaid are large drivers, there are
other exposures and it is important for policymakers to have information
on their long-term costs. The budgetary treatment of these exposures
varies—some have been included in the budget and some have not. For
some federal programs, the government’s commitment or resource use
occurs years before the cash spending consequences are reflected in the
budget. Even though some of these exposures stem from liabilities and are
reported in the financial statements, their recognition in the cash- and
obligation-based budget may be delayed. Beyond explicit liabilities, there
are implicit and/or contingent13 exposures that may encumber future
budgets or reduce fiscal flexibility. Including this range provides a more
complete picture of the extent of exposure facing the government. For this
report, we discuss fiscal exposures in terms of the long-term costs
associated with certain spending items.14

In addition to the fiscal exposures from spending covered in this report,
certain tax expenditures15 may have uncertain or accelerating future
growth paths that have significant implications for the long term.
According to OMB, the largest reported tax expenditures tend to be
associated with the individual income tax. For example, an exclusion is
provided for employer contributions for medical insurance. In its special
analysis on tax expenditures included in the Analytical Perspectives of the
President’s budget, OMB includes estimates of the revenue effects, outlay
equivalents, and present value of revenue effects, but states that the
meaningfulness of tax expenditure estimates is uncertain. OMB notes that
estimates are uncertain because of the arbitrariness of the baseline and the
fact that each estimate is calculated assuming that all other parts of the tax
code remain unchanged.




13
 In this report, the term contingent exposures refers to exposures that are based on the
occurrence or nonoccurrence of some future event.
14
 For a more in-depth look at the fiscal exposure associated with environmental liabilities,
see U.S. General Accounting Office, Long-Term Commitments: Improving the Budgetary
Focus on Environmental Liabilities, GAO-03-219 (Washington, D.C.: Jan. 24, 2003).
15
  Tax expenditures are revenue losses attributable to a provision of the federal tax laws that
allows a special exclusion, exemption, or deduction from gross income or that provides a
special credit, preferential tax rate, or deferral of tax liability.




Page 13                                                        GAO-03-213 Fiscal Exposures
Fiscal Exposures are   The federal government undertakes a wide range of responsibilities,
                       programs, and activities that may either obligate the government to future
Wide-Ranging and       spending or create an expectation for such spending. Specific fiscal
Varied                 exposures vary widely as to source, likelihood of occurrence, magnitude,
                       and strength of the government’s legal obligation. They may be explicit or
                       implicit; they may currently exist or be contingent on future events. Their
                       ultimate costs may or may not be reasonably measurable. Given this
                       breadth, it is useful to think of fiscal exposures as lying on a spectrum
                       extending from explicit liabilities to the implicit promises embedded in
                       current policy or public expectations. Figure 2 shows a spectrum of
                       responsibilities, programs, and activities that may be viewed as fiscal
                       exposures.




                       Page 14                                            GAO-03-213 Fiscal Exposures
Figure 2: Spectrum of Fiscal Exposures

      Explicit liabilitiesa                      Financial commitmentsb                                Financial contingenciesc             Implicit exposuresd
        Dollars in billions

         Publicly-held                              Undelivered ordersf                                                                  Net future benefit payments
                                                                                                          Insurance programsi
            debt                                           $413                                                                            under Social Securityg
                                                                                                                  $18
           $3,320                                                                                                                                   $4,207
     Civilian and military                          Long-term leases                                                                         Net future benefit
                                                                                                            Unadjudicated
      pensions payable                                    $49                                                                                payments under
                                                                                                               claims
            $1,821                                                                                                                        Medicare Part A $4,730
                                                                                                                 $2
                                                                                                                                           and Medicare Part Bg
        Post retirement                                                                                                                           $8,084
        health benefits
             $786                                                                                                                              Life cycle costs for
                                                                                                                                                    fixed assets
       Veteran benefits                                                                                                                    (i.e., including, deferred/
           payable                                                                                                                         future maintenance and
            $692                                                                                                                                 operating costs)
     Environmental and
     disposal liabilities                                                                                                                     Unfunded portion of
           $307                                                                                                                              incrementally funded
                                                                                                                                                capital projects
      Accounts payable
            $96                                                                                                                          Risk assumed by insurance
                                                                                                                                                 programsi
           Insurance
           programsi
              $33                                                                                                                           Federal disaster relief

       Loan guarantees
             $28                                                                                                                         Potential financial bailout of
                                                                                                                                            significant public and
                                                                                                                                              private institutions
     Social Security due
       and payablee
             $42                                                                                                                              Net future benefit
                                                                                                                                          payments for other social
     Other benefits due                                                                                                                     insurance programsh
       and payablee                                                                                                                                  $15
            $44

 Explicit liabilities                                                        Spectrum of fiscal exposures                                        Implicit exposures




 Source: GAO. Cost data from the Financial Report of the United States Government, fiscal year 2001.


                                                                  a.
                                                                    A liability represents a probable and measurable future outflow of resources arising from past
                                                                  transactions and events. A liability is recorded on the face of the balance sheet only when an item is
                                                                  identifiable, its occurrence is probable, and its cost can be reasonably estimated.
                                                                  b.
                                                                     Commitments refer to contractual obligations that require the future use of resources. For example,
                                                                  although a liability generally is not recognized on the balance sheet when a contract is signed because
                                                                  the contracted goods or services have not been delivered, this transaction may be recognized as a
                                                                  commitment in the notes. In contrast, budgetary accounting would record obligations at the time the
                                                                  government enters into a contract and allows for deobligation if the contract is not fulfilled. Budgetary
                                                                  accounting records obligations when an order is placed, contract awarded, service rendered, or similar
                                                                  trnsaction takes place that will require payment.




                                                                  Page 15                                                                GAO-03-213 Fiscal Exposures
c.
 A contingency is an existing condition, situation, or set of circumstances involving uncertainty as to
possible gains or losses. The uncertainty will ultimately be resolved when one or more future events
occur or fail to occur. Contingencies are disclosed in the notes of the financial statements if any of the
conditions for liability recognition are not met and there is at least a reasonable possibility that a loss
may have been incurred. Contingencies that are classified as remote are not required to be disclosed.
d.
   In this report, the term implicit exposures refers to exposures that stem not from a legal obligation of
the federal government but rather from implied commitments embedded in the government’s current
policies or in the public’s expectations about the role of government.
e.
 Due and payable amounts are the benefits owed to program recipients as of the fiscal year end that
have not yet been paid.
f.
 Undelivered orders represent the value of goods and services ordered that have not yet been
received.
g.
   The term net future benefit payments is used in this report to represent the net present value of
negative cashflow. Net present value of the negative cashflow is the current amount of funds needed
to cover projected shortfalls, excluding trust fund balances, over a 75-year period. This estimate of
cashflows is for an open system, meaning that it includes births during the period and individuals
below the age of 15 as of January 1 of the valuation year. The valuation date for the amount included in
the figure was January 1, 2001. The trust fund balances at the beginning of the valuation period that
were eliminated for this consolidation were: $1,049 billion for Social Security, $177 billion for Medicare
Part A, and $44 billion for Medicare Part B. This is a different measure from the actuarial balance in the
Trustees’ Report.
h.
   Includes Railroad Retirement and Black Lung (Part C). See footnote g. Trust fund balances at the
beginning of the valuation period that were eliminated for consolidation were: $19 billion for Railroad
Retirement and a negative balance of $7.2 billion for Black Lung.
i.
 Federal insurance programs are listed three times in figure 2. Under federal accounting standards, a
liability is recognized based on insured events that have been identified by the end of the accounting
period. The standard requires recognition of expected unpaid net claims inherent in insured events that
have already occurred, including (1) reported claims, (2) claims incurred but not yet reported and (3)
any changes in contingent liabilities that meet criteria for recognition. A contingency is an existing
condition, situation, or set of circumstances involving uncertainty as to a possible loss. Contingencies
that do not meet the conditions for liability recognition are disclosed in the notes to the financial
statements. Contingencies that are classified as remote are not required to be disclosed. The risk
assumed by federal insurance programs represents the cost of claims inherent in the government’s
commitment. Estimation of the cost of the risk assumed by the federal government can be thought of
as analogous to premium rate setting in that it would look at the long-term expected costs of the
insurance commitment at the time the insurance commitment is extended. The risk assumed by the
government is essentially that portion of the full risk-based premium not charged to the insured.


While our list of fiscal exposures provides some perspective on the range
and magnitude of exposures facing the federal government, it is neither
meant to be comprehensive nor to represent a universally agreed-upon list.
The cost data should be viewed in a similar way. Although most of the cost
data in this figure were drawn from the consolidated Financial Report of
the United States Government for fiscal year 2001, they should be used
with caution. In auditing these statements, we were unable to determine
the reliability of significant portions of the government’s assets, liabilities,
and costs due to serious financial management weaknesses. These
weaknesses may affect the reliability of estimates reported for certain
exposures, such as military postretirement health benefits and
environmental cleanup and disposal costs.




Page 16                                                                 GAO-03-213 Fiscal Exposures
Along the spectrum of fiscal exposures there is great variation in the extent
and magnitude of a government’s legal obligation, the certainty of expected
costs, their treatment in the budget, and the recognition of these items in
the financial statements. Some, such as deferred employee compensation
or environmental cleanup and disposal costs, are reported as liabilities on
the balance sheet. For financial statement reporting purposes, liabilities are
viewed as representing probable and measurable outflows of resources
arising from past transactions and events. Others that relate to a past event
but are contingent on future events, such as pending litigation, generally
are disclosed as contingencies. Others, such as undelivered goods or
services previously contracted for, are disclosed as financial commitments
in the notes to the financial statements. Some, such as future social
insurance benefits and some disaster assistance, do not flow from legal
obligations but are implied by current policies and/or expectations about
the role of government and are shown as stewardship responsibilities.16

In this report, we use the term implicit exposures to refer to the last
category of exposures that stem not from a legal obligation of the federal
government but rather from implied commitments embedded in the
government’s current policies or in the public’s expectations about the role
of government. While social insurance and health programs represent
significant implicit exposures, other activities may also create expectations
for future spending. For example, incrementally funded capital projects17
create an expectation for future spending since there is an expectation that
partially funded capital projects will be completed. In general, the decision
to purchase a building or another fixed asset implicitly commits the
government to the life-cycle costs associated with its future operation and
maintenance. Further, the earmarking of taxes or the establishment of trust
funds creates an expectation of future spending for the designated
purpose. Even an activity that appears to decrease government
involvement, such as privatization, may carry with it an implicit assumption
that the government will step in if necessary to provide the service or good.
Clearly, the range and nature of activities that may create an expectation


16
 Some implicit exposures, such as the costs of future social insurance benefits, are
discussed in the stewardship section of the government’s consolidated financial statement.
17
 An incrementally funded capital project is a project for which the budget authority
provided is for only part of the estimated cost of the capital acquisition or part of a usable
asset. For more information, see U.S. General Accounting Office, Budget Issues:
Incremental Funding of Capital Asset Acquisitions, GAO-01-432R (Washington, D.C.: Feb.
26, 2001).




Page 17                                                        GAO-03-213 Fiscal Exposures
for future spending increase the difficulty of determining the parameters of
what constitutes a fiscal exposure.

The budgetary treatment of these items varies—some have been included
in the budget and some have not. Some liabilities reported on the financial
statements, such as accounts payable and loan guarantees, are included in
the budget because agencies must have budget authority to cover them.
Changes in the debt level generally are reflected in the annual deficit or
surplus. Others, such as environmental and disposal liabilities, are not
included in primary budget data18 beyond the amount for current cleanup
activities. Some implicit exposures, such as the cost of future Social
Security benefits, are not included in primary budget data for the budget
year but are captured in long-range budget projections. Other implicit
exposures, such as the risk assumed by insurance programs, may not be
captured in either primary budget data or in long-range budget projections.

Despite the challenges of determining what should be considered a fiscal
exposure, efforts to improve the information on and incentives to consider
these exposures are important. Failure to understand and address fiscal
exposures can have significant consequences. Even those exposures that
are not legal obligations of the government may imply future government
spending—and that should be considered in making a program or budget
decision. Whether the government is legally required or simply compelled
by circumstances to provide funding, these exposures can encumber future
budgets and reduce fiscal flexibility. Understanding these items can also be
important to efforts to improve government performance. For some items,
such as deferred compensation, the budgetary focus on annual cash flows
does not match the full costs of an employee with the services the
employee provides. For example, federal employees earn their pension
while they are working but receive pensions after they have stopped
working. The accruing cost of the pensions earned by current employees is
really part of the costs of the goods and services they provide, but the
budget does not capture the full extent of these costs and total budget
outlays include only the cash payments made to current retirees. By
making it more difficult to assess and compare the costs associated with a
given level of performance, the failure to align budgetary cost recognition
with the consumption of resources may hamper the government’s efforts to
assess its performance.


18
  In this report, primary budget data refers to budget authority, obligations, outlays, and the
deficit/surplus.




Page 18                                                         GAO-03-213 Fiscal Exposures
Several exposures provide   A closer look at some fiscal exposures—although not necessarily
insight into challenges     representative of all fiscal exposures—provides a sense of the issues facing
                            the government. For example, the government faces a large and rapidly
facing the government       growing exposure for certain social insurance and health programs. Social
                            Security, Medicare, and the federal portion of Medicaid are expected to
                            grow considerably in the future due to the aging of the population and
                            impending retirement of the large baby boom generation. Figure 3 shows
                            the total draw on the economy represented by federal spending on Social
                            Security, Medicare, and Medicaid. Taken together, they represent an
                            unsustainable burden on future generations. Although significant
                            information is available on the estimated future costs of Social Security and
                            Medicare, the annual budget is not currently structured to fully capture
                            these growing costs. Current reporting of annual budget data focuses on
                            cash to current beneficiaries and thus does not capture the funding
                            shortfall for future benefits. For example, fiscal year 2001 Social Security
                            tax receipts exceeded cash benefit payments by more than $94 billion and
                            increased the unified federal surplus. The fiscal year 2001 consolidated
                            Financial Report of the United States Government, however, shows the
                            net present value of Social Security’s negative cash flow over a 75-year
                            period as $4.2 trillion.19 Similarly, the budgetary treatment of Medicare
                            focuses on the annual cash paid to current beneficiaries and cash revenues
                            from current workers. As a result, Medicare's significant and growing
                            actuarial shortfalls are not reflected in the annual budget.




                            19
                              Net present value of the negative cash flow is the current amount of funds needed to cover
                            projected shortfalls, excluding trust fund balances, over a 75-year period. The trust fund
                            balance at the beginning of the valuation period (January 1, 2001) was $1,049 billion. The
                            net present value of negative cash flows shown in this report is from the fiscal year 2001
                            consolidated Financial Report of the United States Government and is a different measure
                            from the actuarial balance in the Trustees’ Report.




                            Page 19                                                       GAO-03-213 Fiscal Exposures
Figure 3: Social Security, Medicare, and Medicaid Spending as a Percent of Gross Domestic Product
25 Percent of GDP




20




15




10




 5




 0
     2000                     2010                     2020                      2030                      2040                      2050                     2060                    2075

                                                                              Medicaid

                                                                              Medicare

                                                                              Social Security

Source: Office of the Chief Actuary, Social Security Administration, Office of the Actuary, Centers for Medicare and Medicaid Services, and Congressional Budget Office.


                                                                     Note: Projections based on intermediate assumptions of the 2002 Trustees’ Reports and
                                                                     Congressional Budget Office’s June 2002 long-term projections under midrange assumptions.
                                                                     Spending includes only the federal portion of Medicaid.


                                                                     Pensions and retiree health care costs of civilian and military employees of
                                                                     the federal government and veterans’ benefits payable comprise another
                                                                     large fiscal exposure. Together, these future benefits represent a liability of
                                                                     nearly $3.4 trillion for fiscal year 2001. Changes in benefits may result in
                                                                     long-term costs. For fiscal year 2001, a $293 billion increase in the military
                                                                     postretirement health benefits liability is attributed to provisions of the
                                                                     fiscal year 2001 National Defense Authorization Act (Public Law 106-398)
                                                                     that expand certain benefits to Medicare-eligible Department of Defense
                                                                     (DOD) retirees, their dependents, and survivors.

                                                                     Some of the accruing costs of postretirement benefits are captured in the
                                                                     budget authority and outlays for agencies. The full cost of pension benefits
                                                                     was recognized in budget authority and outlays at the agency level
                                                                     beginning in 1985 for military personnel and for civilian employees hired
                                                                     since 1984. Beginning in 2003, DOD will budget on an accrual basis for the
                                                                     retiree health care costs for Medicare-eligible military retirees. In these



                                                                     Page 20                                                                                    GAO-03-213 Fiscal Exposures
cases, payments are made between accounts within the budget so that
outlays are recorded as program costs but do not affect total budget
outlays and the deficit/surplus. However, for most civilian employees hired
before 1984, less than half the government’s share of accruing pension
costs are recognized in the budget and none of the accruing costs of retiree
health benefits for civilian or military retirees under the age of 65 are
recognized in the budget as earned. In an effort to improve the budgetary
treatment of accruing employee benefits, the Administration proposed that
agencies be required to request budget authority for the government’s full
share of the accruing costs of all pension and retiree health benefits for
their employees and pay it to the benefit paying funds.

Environmental cleanup costs resulting from federal operations represent
another fiscal exposure. These constitute an explicit liability since the
federal government is legally required to clean up hazardous wastes that
result from its operations. These costs, however, usually are not paid until
many years after the government has committed to the operation
generating the waste. As required under generally accepted federal
accounting standards, the fiscal year 2001 consolidated financial statement
reported a liability of $307 billion for estimated environmental cleanup and
disposal costs.20 Although a liability for future costs is reported on the
financial statements, current budget guidance requires agencies to request
only the budget authority expected to be obligated during the budget year
for cleanup activities. As a result, these future costs are not shown in the
budget and may not even be provided in backup materials to policymakers
at the time decisions are being made to undertake the operations that may
generate environmental cleanup costs. For example, when a weapon
system using nuclear materials is built, there would be no disposal costs
shown in the budget since the disposal would not occur until some time
after that budget period.21




20
  About 98 percent of the $307 billion in environmental liabilities that were reported in fiscal
year 2001 were associated with the Department of Energy and DOD. The Department of
Energy, which received a clean opinion on its financial statements, reported environmental
liabilities of $238 billion. DOD reported $63 billion in environmental liabilities. Auditors,
however, were unable to render an opinion on DOD’s fiscal year 2001 financial statements,
in part, because of DOD’s inability to comply with requirements for environmental liabilities.
21
 Unlike what is required in the budget, current federal accounting standards require
agencies to estimate and report the full liability of cleanup costs for weapon systems when
they are deemed probable and measurable.




Page 21                                                          GAO-03-213 Fiscal Exposures
Federal insurance is provided to individuals and businesses against a wide
variety of risks, ranging from natural disasters under the flood and crop
insurance programs to bank and employer bankruptcies under the deposit
and pension insurance programs. While the face value of insurance
overstates the likely cost to the government, these programs do expose the
government to future, and potentially significant, draws on resources that
may not be adequately reflected in the budget at the time the decision to
extend the insurance is being made. We have previously reported22 that
current budget reporting may not signal policymakers to the risk assumed
by the government at the time the decision to extend the insurance is made.
For example, at the time budget decisions were being made for fiscal year
2003, the budget showed a positive budget estimate (i.e., revenues) for the
Pension Benefit Guaranty Corporation of about $1.3 billion. The financial
statements available at the same time showed an estimated liability for
future benefits of $13.5 billion and a positive net position of about
$7.8 billion. At the same time, OMB estimated the future cost of the risk
assumed by the government for vested covered benefits as $51 billion.23
Clearly, these different estimates provided significantly different pictures
of the program’s health and its potential draw on future resources.




22
     See GAO/AIMD-97-16.
23
 According to OMB, this estimate is for the future costs of vested covered benefits and does
not assume future growth in such benefits.




Page 22                                                       GAO-03-213 Fiscal Exposures
The government’s purchase and ownership of government-owned facilities
and other assets may create an expectation for future spending. If budget
authority for a capital project is not fully funded at the time the
commitment to buy the asset is made, the government’s costs will likely be
understated. Future Congresses and administrations may be forced to
choose between having an incomplete and unusable asset and continuing
to fund the project. In cases where funding is provided for only part of a
project and that part by itself is not usable, then policymakers may feel
compelled to continue funding to complete the project. 24 Moreover, the
total life-cycle cost of an asset includes not only all initial direct and
indirect acquisition costs but also all periodic or continuing costs of
operation and maintenance over the asset’s expected useful life and any
costs to decommission or dispose of the asset. While OMB requires
agencies to develop capital asset plans for major acquisitions and
encourages long-term agency capital plans—both of which should include
life-cycle costs—these plans are not routinely provided to Congress.
Budget authority generally is provided only for the acquisition costs
associated with capital asset purchases, not for the life-cycle costs
necessary to operate, maintain, and dispose of the asset. While this may be
appropriate for budget control purposes, the result, in most cases, is that
the budgetary focus is on the initial cost of assets even if this cost
represents only a fraction of the total costs flowing from the purchase
decision.




24
  As part of our prior work on incremental funding, we reviewed selected agency budget
justifications and other agency data to identify the extent to which capital projects were
incrementally funded. The 2001 report identified civilian nondefense capital projects with
total estimated costs of $176 billion and determined that about $76 billion (44 percent) of
total costs were incrementally funded—an amount that does not include high technology
projects. Incremental funding can be justified for such projects because funding provided
on an incremental basis can provide useful knowledge even if no additional funding is
provided. This review also found that data supporting capital acquisitions in general may be
incomplete and/or unclear, thus making it difficult to determine future costs or whether the
funding provided would produce a usable asset. See GAO-01-432R.




Page 23                                                       GAO-03-213 Fiscal Exposures
                       Other exposures facing the government also present significant definitional
                       and measurement challenges because (1) the existence and scope of the
                       government’s commitment prior to the occurrence of the underlying event
                       is unclear, (2) the occurrence and timing of the underlying event is
                       unknown, and (3) the ultimate costs are difficult to predict. Examples
                       include the bailout of large institutions or disaster relief.25 The extent of the
                       government’s commitment to cover these costs may not be explicitly stated
                       before the event but rather may be implied by the role of government. Not
                       only is the extent of the government’s commitment unknown before the
                       occurrence of the event, the timing and magnitude of these exposures are
                       contingent upon the occurrence or nonoccurrence of some future event.
                       For example, even in cases where it is not explicitly required by law, the
                       federal government may be expected to provide for the financial losses that
                       arise from catastrophes and major disasters such as earthquakes,
                       hurricanes, terrorist attacks, and epidemics, the timing and magnitude of
                       which are unknown until they occur. There may also be an expectation that
                       the federal government would intervene to bailout the losses of state and
                       local governments and large institutions of economic significance.



Fiscal Exposures       Determining the appropriate budgetary treatment for fiscal exposures is
                       complicated by uncertainties. First, there is definitional uncertainty i.e.,
Involve Complex        uncertainty about what constitutes an exposure certain enough to include
Measurement and        as a claim on budgetary resources. In addition, there are difficulties in
                       estimating future costs. The extent to which either or both of these factors
Budgeting Challenges   contribute to the uncertainty about future costs varies among fiscal
                       exposures. As a result, policymakers should consider both the degree of
                       certainty of the government’s obligation and the availability of reasonable
                       cost estimates when weighing the trade-offs associated with various
                       approaches to help increase the attention paid to particular exposures
                       when making budget decisions.




                       25
                        Another issue associated with implicit, contingent exposures, such as bailouts and disaster
                       relief, is that recognition of these potential costs may create moral hazards in that private
                       parties may make too little effort to diminish their risk.




                       Page 24                                                        GAO-03-213 Fiscal Exposures
Whether an exposure is certain enough to be included as a claim on
budgetary resources is a key question. As noted earlier, the extent of the
government’s obligation varies along the spectrum of fiscal exposures.
Some fiscal exposures are reported as liabilities of the federal government
and represent legal obligations to make payments; others are not. For
example, the $3.3 billion in publicly held debt is a clear financial liability.
On the other hand, generally accepted federal accounting standards do not
view future social insurance benefits as a liability, except for the amount
due and payable at fiscal year end. The standard, however, also requires
that supplementary stewardship information be reported to facilitate an
assessment of the program’s long-term sustainability and the ability of the
program and the nation to raise resources from future program participants
to pay for benefits.26 The standard for social insurance is a compromise
between parties with widely divergent views about the government’s
obligation to make future benefit payments. Proponents of the standard
point out that the underlying laws establishing a claim to payment can (and
have been) changed and there is no legal obligation by the government to
pay benefits once the trust funds that finance these programs have been
exhausted. Others, however, believe that a liability should be recognized
for the net benefits expected to be paid in future periods to current
participants. Any changes in budgetary treatment would require similar
discussion and compromises concerning which items should be recognized
as exposures. There may be further disagreement over which of these
exposures should be directly recognized in the primary budget data.27
Finally, even if agreement can be reached that an exposure theoretically
should be included in the primary budget data, reasonable cost estimates
may not be available. For some exposures, estimates could be generated
given time and attention; for others that are contingent on future events,
estimates are more problematic.

Several factors affect whether reasonable cost estimates are currently
available or can be generated. The generation of reasonable cost estimates
depends not only on the development of appropriate methodologies but


26
 For example, stewardship information generally includes narrative and/or graphic
presentation of items including (1) long-range cashflow projections, (2) long-range
projections of the ratio of contributors to beneficiaries and (3) actuarial present values of
(a) future benefits for and (b) contributions and tax income from or on behalf of current and
future program participants.
27
  In this report, primary budget data refers to budget authority, obligations, outlays, and the
deficit/surplus.




Page 25                                                         GAO-03-213 Fiscal Exposures
also on the acceptance and quality of underlying assumptions and data.
Estimates for some exposures, such as pension benefits, are based on
accepted methodologies and are reported as liabilities in financial
statements. The future costs of some exposures are inherently more
difficult to estimate than others. For example, some exposures, such as
bank and pension insurance, are dependent on many economic and
behavioral variables. Since these are inherently uncertain, there will
always be some uncertainty surrounding the estimated future costs of such
programs. Lack of adequate data may also be a factor in the reliability of
cost estimates. For example, postretirement health benefits and
environmental cleanup and disposal costs are reported as liabilities on the
balance sheet because they are considered to meet the criteria of probable
and reasonably measurable, but audits have revealed weaknesses that may
affect the reliability of these reported amounts. The fiscal year 2000
liability for military postretirement health benefits could not be accurately
estimated because some of the underlying costs and demographic and
workload data used to develop the estimate were not reliable. The
estimate for environmental cleanup costs is uncertain, in part, because the
dimensions of the cleanup problem remain unclear and the technology to
address the problem is evolving.

Generally speaking, the more direct and explicit the fiscal exposure, and
thus the more certain the existence of a claim and its ultimate costs, the
greater the suitability of including estimated costs directly into the primary
budget data when doing so would enhance up-front control of spending.
Even when agreement can be reached that an explicit liability exists,
efforts may be needed to develop reasonable cost estimates. For
exposures that are implicit and/or contingent on future events, cost
estimation challenges and underlying questions about the existence of a
government commitment raise substantial questions. Perhaps most
challenging are those exposures that are both implicit and contingent on
unknown events, such as bailouts or disaster relief. In these cases, the
government may not have any current legal obligation and the magnitude
and timing of the underlying event is unknown. These exposures are very
difficult to estimate and uncertain as to whether they really represent
claims to future resources.




Page 26                                             GAO-03-213 Fiscal Exposures
Diversity of Fiscal                      The variety of certainties (and uncertainties) associated with fiscal
                                         exposures suggests that no single approach to increasing attention to these
Exposures Suggests                       future costs will work in all cases. Various approaches might be
that Tailored                            considered in a framework organized around three possible objectives:
                                         (1) improving the transparency of fiscal exposures, (2) prompting more
Approaches Would Be                      deliberation about fiscal exposures, and (3) improving budget incentives to
More Feasible than an                    address fiscal exposures. Several broad approaches for helping to achieve
Across-the-Board                         these objectives discussed here are (1) improving supplementary reporting,
                                         (2) providing opportunities for explicit consideration in the budget
Approach                                 process, and (3) incorporating the costs of fiscal exposures into the
                                         primary budget data. A number of options could be used to implement
                                         each of these approaches. Figure 4 displays how different approaches
                                         could be used to achieve a primary objective by providing illustrative
                                         options for implementing each approach. These options are meant to
                                         illustrate how different approaches may be used depending on the primary
                                         objective to be achieved and what may be feasible to implement. Not only
                                         do these approaches achieve the various objectives to differing degrees,
                                         but they also vary in the implementation challenges involved.



Figure 4: Overview of Possible Approaches

 Primary objective:           Approach I:                    Option:
 To improve transparency      Improve supplemental           • Provide special analysis for select exposures in the
 of fiscal exposures          reporting                        Analytical Perspectives of the President’s budget
                                                             • Report, for select exposures, the “exposure level” by
                                                               budget account in the Program and Financing schedule of
                                                               the President’s budget
                                                             • Require report on fiscal exposures

 Primary objective:            Approach II:                  Option:
 To prompt more                Provide opportunities for     • Permit a point of order to encourage explicit consideration of
 deliberation about fiscal     explicit consideration of       exposures
 exposures                     fiscal exposures in the       • Establish a trigger to signal when exposure level increases
                               budget process                  beyond a specified amount

 Primary objective:            Approach III:                 Option:
 To improve budgetary          Incorporate cost              • Use accrual-based costs to measure budget authority and
 incentives to address         estimates of fiscal             possibly budget outlays for select exposures when doing so
 fiscal exposures              exposures directly into
                                                               would enhance up-front control of spending
                               primary budget data

Source: GAO.




                                         Page 27                                                  GAO-03-213 Fiscal Exposures
                         The diverse nature of exposures and the significant differences in the
                         strength of the government’s underlying obligation, combined with the
                         varying quality and amount of cost information available outside the budget
                         process, suggest that across-the-board changes in budget reporting or
                         process would not be appropriate. Instead, targeted approaches for
                         different types of fiscal exposures would be most useful for incorporating a
                         longer-term perspective into the budget. Changes in the information
                         provided, the budgetary process, or budgetary incentives could be tailored
                         selectively for different categories of fiscal exposures to address specific
                         budgetary objectives and implementation challenges. A discussion of each
                         of the three approaches and related options follows.



Approach I: Improve      Improved supplemental reporting on fiscal exposures would make
Supplemental Reporting   information more accessible to decisionmakers without introducing
                         additional uncertainty and complexity directly into the budget. With this
                         approach, estimates of the government’s exposure would be reported in
                         various budget documents, but the current basis of reporting primary
                         budget data—budget authority, obligations, outlays, and the
                         deficit/surplus—would not be changed. This type of supplemental
                         information is currently available in various places for some programs. For
                         example, the stewardship section in the Analytical Perspectives of the
                         President’s budget has included long-range (75 year) budget projections
                         assuming continuation of current policies as well as a discussion of the
                         government’s balance sheet, which includes some liabilities not yet
                         included in the primary budget data. The stewardship section of financial
                         statements contains information to facilitate the assessment of the long-
                         term sustainability of social insurance programs. In some cases, improving
                         supplemental reporting may simply be a matter of highlighting or
                         expanding existing analytical work. For example, long-range projections
                         and simulations of the budget as a whole could be continued and improved,
                         including analysis to help assess driving factors, such as demographics and
                         economic changes, and to improve understanding of the range and
                         magnitude of alternatives.

                         As outlined in figure 5, improved supplemental reporting on fiscal
                         exposures could be achieved in a number of ways. In addition to the
                         continuation and further development of long-range projections of the
                         budget as a whole, three options to consider include (1) providing special
                         analyses for certain, significant fiscal exposures in the Analytical
                         Perspectives of the President’s budget, (2) reporting estimated costs of
                         certain fiscal exposures as a separate notational line—“exposure level”—in



                         Page 28                                            GAO-03-213 Fiscal Exposures
                                                 the Program and Financing schedule of the President’s budget, or
                                                 (3) requiring a report on fiscal exposures.



Figure 5: Possible Options For Improving Supplemental Reporting

                                                     Objective:
                                     To improve transparency of fiscal exposures


                                                    Approach I:
                                           Improve supplemental reporting




 Option:                                    Option:                                 Option:
 Provide special analysis for select        Report the “exposure level” by budget   Require report on fiscal exposures
 exposures in Analytical Perspectives       account in the Program and Financing
 of the President’s budget                  schedule of the President’s budget




  Advantages:                                                Disadvantages:
  Discloses potential future costs                           Does not directly affect budgetary incentives to address exposures

  Does not subject budget data to increased estimation       Does not require explicit consideration of exposures
  uncertainty
                                                             Does not provide strong incentives to improve cost estimates
  Allows time to develop, test, and improve estimation
  methodologies                                              Raises implementation issues:
                                                              - need criteria to determine which items should be included as
  Allows time to assess feasibility of further integration       “exposures” for supplemental reporting
  of cost estimates into budget data                          - increases reporting burden
                                                              - reporting by account would require determining the alignment of
                                                                 “exposure level” to specific budget accounts
 Source: GAO.




                                                 Page 29                                                    GAO-03-213 Fiscal Exposures
Federal government insurance programs provide a prime example of where
special analysis of a particular type of exposure may be appropriate. Our
previous work has shown that the current cash- and obligation-based
budget generally provides incomplete or misleading information on the
government’s cost of federal insurance programs.28 One reform option
would be to require an estimate of the budget authority likely to be needed
to cover an estimate of the cost of the risk assumed29 by the government.
However, given the difficulties in estimating the cost of risk assumed, we
concluded that supplemental reporting of the cost of the risk assumed by
federal insurance programs had several attractive features. It would allow
time to (1) assess the reliability of cost estimates, (2) develop and refine
estimation methodologies, and (3) formulate cost-effective reporting. As
another example, supplemental analysis could be provided for uncertain
exposures, such as future operation and maintenance costs associated with
asset acquisitions.




28
     See GAO/AIMD-97-16.
29
 The estimation of the cost of the risk assumed by the federal government would be
analogous to premium rate setting in that it would look at the long-term expected costs of
the insurance commitment at the time the insurance commitment is extended. The risk
assumed by the government is essentially that portion of the full risk-based premium not
charged to the insured.




Page 30                                                       GAO-03-213 Fiscal Exposures
While providing a special analysis in the Analytical Perspectives would
provide additional information, it is not as directly linked to specific budget
proposals as is possible. Another option would be to routinely report the
future estimated costs of certain exposures as a separate notational line in
the Program and Financing schedule of the President’s budget. This would
move beyond the current budget practice of generally including only
budget authority, obligations, and outlays for initial acquisition costs of an
asset to adding a new measure that reports the “exposure level” as a
notational item in the Program and Financing schedule. For example, an
estimate of the future operating and maintenance costs associated with
capital acquisitions could be reported as the “exposure level” in the
Program and Financing schedule for capital accounts that include the
initial capital acquisition costs. Similarly, the future funding needs
associated with incrementally funded projects could be included in the
Program and Financing schedule of the budget account that includes the
capital acquisition. This type of notational approach in the Program and
Financing schedule could also be used for future environmental cleanup
costs associated with an asset acquisition. In these cases, the “exposure
level” could be used to capture the exposure associated with the capital
acquisitions in each year.30 As opposed to cash, the “exposure level” might
be reported in present value terms. Including exposure levels as part of the
budget presentations at the account level directly in the budget documents
would make such information available along with the initial acquisition
costs, rather than in an additional document. Specifying the estimated
potential future costs associated with current decisions would promote
transparency.

Another approach, which could stand alone or be done along with
including exposure levels in the Program and Financing schedule, would be
to require a report on fiscal exposures. For example, such a report could
provide a concise list and description of fiscal exposures, cost estimates,
where possible, and an assessment of the methodologies and data used to
produce cost estimates. Explicitly and directly integrating the report on
specific fiscal exposures with long-range projections and analysis of the
budget as a whole would increase its usefulness for assessing the potential
implications for long-range fiscal sustainability and flexibility. If this type
of report was issued as part of or near the time of the release of the
President’s budget, it could be used to help inform and provide long-term
context to budget deliberations.


30
     See GAO-03-219.




Page 31                                              GAO-03-213 Fiscal Exposures
                             These types of supplemental reporting have the advantage of providing
                             policymakers with a long-term perspective when making current decisions
                             and enabling those concerned about exposures to raise questions and
                             challenges in the budget debate. However, they do not in themselves
                             change incentives or require explicit consideration of costs. This is
                             because estimates of future costs would not directly affect spending or the
                             overall budget totals. Since this information would be excluded from the
                             primary budget data, it may or may not be used in budget decisions. As a
                             result, there may be little incentive to improve cost estimates or to fully
                             consider these potential costs. However, the uncertainties around such
                             cost estimates may argue for proceeding gradually with efforts to further
                             incorporate them into the budget. Supplemental reporting would allow
                             time to improve cost estimation methodologies and increase users’ comfort
                             levels with the estimates. Such reporting might then be seen as a first step
                             toward more explicit consideration in the budget. In addition, because the
                             primary budget data are not affected, this type of supplemental reporting
                             would avoid increasing the gap between the deficit and borrowing needs.



Approach II: Provide         Further along the continuum from supplemental reporting to including
Opportunities for Explicit   costs in the primary budget data are budget process changes. Budget
                             process mechanisms would go beyond simply providing more information
Consideration of Fiscal
                             on fiscal exposures to establishing opportunities for explicit consideration
Exposures in the Budget      of these exposures. Two possible options to consider are shown in figure 6.
Process                      Congress could modify budget rules to provide for a point of order against
                             any proposed legislation that creates new exposures or increases the
                             estimated costs of existing exposures over some specified level.
                             Alternatively, revised rules could provide for a point of order against any
                             proposed legislation that does not include estimates of the potential costs
                             of fiscal exposures created by the legislation. A second budget process
                             option would be to establish triggers that require some action when the
                             estimated future costs of a given exposure rise above some specified
                             threshold.




                             Page 32                                            GAO-03-213 Fiscal Exposures
Figure 6: Possible Options for Providing Opportunities For Explicit Consideration of Fiscal Exposures

                                                           Objective:
                                        To prompt more deliberation about fiscal exposures

                                                            Approach II:
                                 Provide opportunities for explicit consideration of fiscal exposures
                                                       in the budget process



  Option:                                              or        Option:
  Permit a point of order to encourage explicit                  Establish a trigger to signal when exposure level increases beyond a
  consideration of exposures                                     specified amount




   Advantages:                                                         Disadvantages:
   Encourages explicit consideration of potential future costs         Raises significant implementation issues:
                                                                         -   increases complexity of already complex process
   Does not subject primary budget data to increased
                                                                         -   need accepted criteria to determine which items should be
   estimation uncertainty
                                                                             included as “exposures” subject to point of order or trigger
   Allows time to assess feasibility of further integration of           -   need to determine responsibility for developing estimates
   cost estimates into primary budget data                               -   increases reporting burden
                                                                         -   need to agree on acceptable threshold
                                                                       Raises questions about effectiveness:
                                                                         -   inherent uncertainty of estimates
                                                                         -   ability to waive point of order
 Source: GAO.




                                                  Page 33                                                          GAO-03-213 Fiscal Exposures
A key advantage of permitting points of order with respect to fiscal
exposures is that they could result in explicit consideration of these
potential costs without subjecting the primary budget data to increased
uncertainty from estimation difficulties. It would be similar to procedural
rules for Social Security that permit points of order against the
consideration of legislation that would weaken the program’s financial
condition. A different point of order method would be to permit a point of
order that could block legislation lacking appropriate cost information
about an exposure. This would be similar to unfunded mandates legislation
that permits a point of order to be raised against proposed legislation that
imposes mandates if a Congressional Budget Office mandates estimate has
not been published in the committee report or the Congressional Record.31
This alternative would provide a greater incentive to improve cost
information than simply requiring supplemental information because it
presents congressional members with an opportunity to challenge the
creation of programs without sufficient information on long-term costs.

Despite the potential benefits of permitting some type of point of order,
such a budget process change is not without significant implementation
challenges. Criteria would have to be agreed on for determining which
activities and programs would be considered as fiscal exposures subject to
a point of order. Mechanisms also would need to be developed to deal with
the uncertainties and volatility inherent in cost estimates associated with
fiscal exposures. Further, this type of budget process change would
increase the complexity of an already complicated process. Since many
activities—including most capital acquisitions—routinely would result in
exposures, such as life-cycle costs, a point of order may become
burdensome and potentially ignored. Points of order also are limited
because they apply only to new legislation and then only if raised. Further,
they can be waived or overruled by a vote of the Members. Finally, a budget
process change establishing a point of order would require an amendment
to the Congressional Budget Act of 1974 or a change to committee rules.




31
     Unfunded Mandate Reform Act of 1995, Pub. L. 104-4, §423.




Page 34                                                          GAO-03-213 Fiscal Exposures
A different budget process approach would be to establish triggers that
address the growth in existing exposures. In this case, triggers would be
established to signal when the future costs of exposures rise above a
certain level. Reaching the trigger threshold would require some action.32
One possible trigger could be the future costs of a specific exposure
exceeding a specified dollar amount, but other thresholds are also possible.
For example, for the Medicare program, these might be a specified floor in
the trust fund, such as the balance falling below 1-year’s worth of
payments, the percentage of gross domestic product devoted to Medicare,
or program spending per enrollee. The use of triggers would require
agreement not only on the limits but on what will happen when the limits
are reached. A trigger could be “hard”—including specific provisions that
would automatically go into effect if the trigger is reached—or “soft”—
requiring some action to be taken to address costs or reaffirm acceptance
of the increase in potential fiscal exposure.33 For example, reaching a
trigger could require the policymakers to propose how to deal with growth
in the Medicare program. This type of “soft” trigger would help ensure that
Congress and the President periodically review and decide how to address
exposures.

Like a point of order, the key benefit of a trigger is that it would require
explicit consideration of exposures facing the government without adding
uncertainty to primary budget data. However, like points of order,
establishing triggers would increase the complexities of an already
complex budget process. Further, the implementation issues associated
with determining the trigger threshold and the type of action required
would have to be addressed.34 A budget process change establishing a
trigger would require an amendment to the Congressional Budget Act of
1974 or a change to committee rules.




32
 U.S. General Accounting Office, Medicare Reform: Issues Associated With General
Revenue Financing, GAO/T-AIMD-00-126 (Washington, D.C.: Mar. 27, 2000).
33
     Rules established by the current Congress can be changed by a subsequent Congress.
34
     Such a procedure would require some assurance of unbiased estimates.




Page 35                                                        GAO-03-213 Fiscal Exposures
Approach III: Incorporate     Incorporating the estimated future costs of fiscal exposures directly into
Cost Estimates of Fiscal      the budget would represent the greatest change outlined in our spectrum.
                              For example, as shown in figure 7, accrual-based costs could be used to
Exposures Directly into the   measure budget authority needed and possibly outlays for select programs
Primary Budget Data           when doing so would enhance obligation-based control. Since estimated
                              costs would be incorporated directly into the primary budget data, these
                              options are most suitable for explicit exposures for which reasonable cost
                              estimates are available.




                              Page 36                                           GAO-03-213 Fiscal Exposures
Figure 7: Possible Options for Incorporating Costs Directly into the Primary Budget
Data

                                          Objective:
                               To improve budgetary incentives to
                                    address fiscal exposures


                                         Approach III:
                               Incorporate cost estimates of fiscal
                               exposures directly into the primary
                                          budget data



                Option:
                Use accrual-based costs to measure budget authority and
                possibly budget outlays for select exposures when doing so
                would enhance up-front control of spending



                         Advantages                         Disadvantages

           Provides earlier cost recognition       Subjects primary budget data to
           at time decisions are being made        estimation uncertainty

           Improves budgetary incentives to        Raises potential oversight and
           address costs/risks                     implementation issues:

                                                     - need criteria to determine
                                                       which exposures should be
                                                       accrued

                                                     - increases reporting burden

                                                     - increases complexity of an
                                                       already complex process

                                                     - for outlay approach,
                                                       increases difference between
                                                       reported deficit/surplus and
                                                       government’s borrowing
                                                       needs

          Source: GAO.




The budget’s measurement basis can greatly affect the timing of when a
program or activity appears in the budget. Accrual-based measurement
recognizes cost at the time the activity generating the revenue, consuming
the resources, or increasing the liability takes place regardless of when the
associated cash flows occur. Conversely, cash-based measurement
recognizes receipts and outlays at the time cash is received or paid
regardless of when the activity generating the revenue, consuming the



Page 37                                                               GAO-03-213 Fiscal Exposures
resources, or increasing the liability occurs. The U.S. budget is neither
accrual nor pure cash; it is obligation based. Obligation-based budgeting is
designed to ensure that agencies do not incur legal obligations unless and
until Congress provides authority for agencies for that purpose. However,
with limited exceptions, the amounts to be obligated are measured on a
cash or cash equivalent basis and the deficit/surplus—a key focus of the
policy debate—represents the difference between cash receipts and cash
outlays in a given year. As a result, the U.S. budget is often referred to as
cash based as well as obligation based. Cash measurement for budgeting
has the advantage of being recognized as an accepted measure of the
government’s impact on the economy, which is an important gauge of fiscal
policy.

Although the current cash- and obligation-based budget has several
benefits, the United States has recognized the contribution accrual-based
measurement can make to budgeting. Since about 1955, interest has been
accrued in the budget for Treasury securities held by the public. Even
before 1955, a portion of the accruing costs for civilian employee pensions
had been recognized in the budget. We have advocated the selective use of
accrual measures in the budget to better reflect costs at the time decisions
were made. The budget has been modified gradually to use accrual-based
measurement for certain programs in areas where doing so would enhance
up-front recognition of costs. For example, the accruing costs of military
pension benefits have been included in the budget at the program level
since 1985 and the Federal Credit Reform Act of 1990 changed the method
of controlling and accounting for credit programs to an accrual basis to
provide more timely recognition of their costs.

Prior to credit reform, obligations measured on a cash basis for credit
programs sent the wrong signals about the government's exposure. The
full amount of direct loans was reported as an outlay, ignoring the fact that
many would be repaid. In contrast, for loan guarantees, initially no outlays
were reported, ignoring the fact that some guaranteed loans would be
defaulted upon and require budget outlays. Consequently, the use of cash-
based measurement overstated the cost of direct loans in the year they
were made and understated the costs of loan guarantees in the year they
were issued. This deficient reporting skewed cost comparisons between
credit and grant programs with similar purposes but different funding
approaches. The relative cost of credit programs and other federal
spending was misrepresented. Credit reform addressed the shortfalls of
cash-based measurement for credit programs by requiring the budget to
include the estimated cost to the federal government over the entire life of



Page 38                                             GAO-03-213 Fiscal Exposures
the loan or loan guarantee, calculated on a net present value basis. By
incorporating accrual cost measures in the budget for credit programs,
credit reform improved cost comparisons and better reflected the
government’s ultimate costs at the time decisions to extend the credit were
being made.

Similar concerns about the shortcomings of cash-based measurements for
other programs that involve cash flows over many years, such as pensions
and insurance, stimulated interest in whether further incorporation of
accruals in the budget would be useful. We reviewed the experiences of six
countries that had adopted, or planned to adopt, accrual-based budgeting.35
In this work, we noted that the use of accrual-based measurement
selectively within the obligation-based budget would result in earlier cost
recognition for some major exposures such as employee retirement
benefits, insurance, and environmental clean-up costs. In these cases, if
reasonable cost estimates are available, the use of accrual-based
measurement would help reinforce the up-front control focus of the
obligation-based budget.

However, we also noted some limitations and concerns. We pointed out
that relative to the obligation-based budget, accrual-based measurement
would delay cost recognition of capital assets by spreading the costs over
the life of the assets36 and for some government activities, such as salaries
and grants, there generally would not be significant differences between
cash and accrual amounts. Further, the use of accrual measurement needs
to be considered carefully to avoid subjecting the primary budget data to
large and volatile reestimates. We also pointed out that accrual budgeting
based on current federal accounting standards would not recognize social
insurance benefits because those standards do not view social insurance as
a liability beyond the amount due and payable to current beneficiaries at
the end of the period. We suggested alternative budgetary approaches
could be used to recognize the future costs of Social Security benefits. For
example, Social Security outlays could be recorded in the same amount as
Social Security receipts to reflect the government’s commitment to spend
those amounts on benefits in the future. Such an approach may serve to
prompt earlier recognition of future claims supported by earmarked

35
     See GAO/AIMD-00-57.
36
  Accrual budgeting for capital assets based on depreciation matches budget costs with the
provision of goods and services but, without compensating controls, raises issues about up-
front cost recognition and control over capital asset acquisitions.




Page 39                                                      GAO-03-213 Fiscal Exposures
receipts. On the other hand, this approach would represent a significant
change in budgetary treatment and could reduce fiscal discipline for
spending in programs financed by earmarked receipts.

Two methods could be used to incorporate accrual-based costs directly
into the budget for fiscal exposures. One method (the aggregate outlay
method) would be to use accrual-based measurement to recognize costs in
both budget authority needed and net outlays. Under this method, the
accrued cost of the fiscal exposure would be included in the budget totals
and therefore in the budget deficit/surplus. This method is similar to that
used for credit programs under credit reform. Another method (the
aggregate budget authority method) would use accrual-based
measurement to recognize costs in budget authority at the account level
and in the aggregate budget totals. Accrued costs would also be reflected
in net outlays at the account level but then would be offset by a transfer
within the budget to another account. Aggregate net outlays and thus the
deficit/surplus would continue to be reported on a cash basis. This is
similar to the method currently used for some employee pension costs.

A key advantage of budgeting for the accruing costs of exposures is the
recognition of the government's costs at the time decisions are being made
to commit the government. This earlier recognition of costs improves the
information available to policymakers about the costs associated with
current decisions and may improve the incentives to manage these costs.
However, this benefit is dependent on reasonable, unbiased estimates of
the government's costs. For some programs, such as life insurance,
reasonable cost estimates may be available, but for other programs such as
deposit insurance, health care costs, or social insurance benefits, estimates
are less certain. Because the future costs of some exposures are
dependent upon many economic and technical variables that cannot be
known in advance, there will always be uncertainty in cost estimates. Such
uncertainty makes using accrual-based measurement directly in the budget
more difficult. Budgeting for accruing costs may make sense for some
exposures but not for others because the certainty of the government’s
commitment and the availability of reasonable, unbiased estimates varies
across the different fiscal exposures.




Page 40                                             GAO-03-213 Fiscal Exposures
             Using accrual-based measurement in the budget has the potential to
             increase the complexity of the budget in several ways. Complexity may be
             increased through the use of (1) sophisticated estimation models,
             (2) multiple budget accounts and/or presentations to reflect cash flows and
             program reserves, and (3) procedures to handle reestimates of costs
             reported as budget authority and/or outlays. Although recognition of costs
             may be improved, general understanding of budget data and the budget
             process may decline. Further, if estimates are seen as short-term gaming or
             overly erratic, credibility is eroded. Stopping short of using accrual-based
             measurement for aggregate outlays and measuring only budget authority
             and agency outlays on an accrual basis would mitigate some of the
             potential problems associated with accrual budgeting while providing
             information on future costs. For example, if aggregate outlays remain on a
             cash basis and only budget authority and agency outlays are accrual based,
             there would be no need for nonbudgetary accounts37 that are necessary to
             hold reserves under an aggregate outlay approach. This aggregate budget
             authority option also would avoid introducing estimation uncertainty into
             the budget deficit/surplus that with limited exception is calculated as net
             cash outlays. However, since the accrual-based cost would not be reflected
             in the budget deficit/surplus, it is unclear how much this approach would
             affect the budget decision-making process.



Conclusion   Today’s budget decisions, in part, shape the choices and resources
             available to future decisionmakers and taxpayers. Accordingly, today’s
             budget decisions involve tradeoffs between satisfying current needs and
             fulfilling stewardship responsibilities to future generations’ budget and
             economy. The federal government undertakes a wide range of
             responsibilities, programs, and activities that may obligate the government
             to future spending or simply create an expectation for such spending.
             Current budget reporting, however, is not always designed to promote the
             recognition and explicit consideration of some of these “fiscal exposures.”
             These exposures range from explicit liabilities to the implicit promises
             embedded in current policy or public expectations. Failure to understand
             and address these exposures can have significant consequences.
             Regardless of whether the government is legally required or simply


             37
               Nonbudgetary accounts appear in the budget document for information purposes but are
             not included in the budget totals for budget authority or outlays. They account for
             transactions of the government that do not belong within the budget because they are a
             means of financing and do not represent a cost to the government.




             Page 41                                                   GAO-03-213 Fiscal Exposures
compelled by circumstances to provide funding in the future, these
exposures may encumber future budgets and constrain fiscal policy. Not
capturing the long-term costs of current decisions limits Congress’s ability
to control the government’s fiscal exposures at the time decisions are
made.

The diversity of items that could be considered fiscal exposures increases
the difficulty of determining which items should be considered and how
and to what extent they should be handled in the budget process.
Specifically, budgeting for fiscal exposures is complicated by difficulties in
(1) determining which items should be considered fiscal exposures and
(2) estimating their costs. Despite these challenges, the potentially
significant effects of these items on the nation’s future fiscal condition
warrant efforts to improve disclosure and oversight.

The diversity of fiscal exposures suggests that across-the-board changes in
budget reporting or process would not be the most appropriate way to
proceed. Instead, it would be more useful to look at different types of fiscal
exposures and tailor changes to address specific budgetary objectives and
implementation challenges. Improved supplemental reporting would be
helpful in increasing awareness without introducing uncertainty and
complexity into the primary budget data. In cases where the extent of the
government’s obligation or ultimate costs (or both) is unclear,
supplemental reporting may be the most appropriate approach. Beyond
simply increasing awareness, adapting the budget process to facilitate
explicit consideration of fiscal exposures might be possible. Finally, for
exposures where the government’s obligation is explicit and reasonable
cost estimates are available, additional steps could be taken to directly
incorporate costs in some primary budget data when doing so would
enhance up-front control of spending. The direct incorporation of accrual-
based measures in the budget may be appropriate for selected exposures
where such treatment would enhance obligation-based control by
prompting the recognition of expected future costs of decisions when they
are made.

With complete and highly visible reporting of fiscal exposures,
decisionmakers are better positioned to address future costs and to help
prevent unexpected changes in fiscal policy. Since today’s decisions affect
the choices and resources available for the future, improvements in
budgeting for fiscal exposures are critically important.




Page 42                                             GAO-03-213 Fiscal Exposures
Recommendations for   OMB should report annually on fiscal exposures, including a concise list
                      and description of such exposures, cost estimates, where possible, and an
Executive Action      assessment of methodologies and data used to produce cost estimates for
                      such exposures. In addition, where possible, OMB should report the
                      estimated costs associated with certain exposures as a new budget
                      concept—“exposure level”—as a notational item in the Program and
                      Financing schedule of the President’s budget. For select areas where an
                      explicit liability exists and there are accepted cost-estimation
                      methodologies, the ultimate objective might be to include the costs directly
                      in the budget when doing so would enhance obligation-based control.
                      OMB also should ensure that agencies focus on improving cost estimates
                      for fiscal exposures. These steps should complement and support
                      continued and improved reporting of long-range projections and analysis of
                      the budget as a whole to assess fiscal sustainability and flexibility.



Matters for           Congress may wish to consider exploring options for improving the
                      information available and the attention given to fiscal exposures in the
Congressional         budget and budget process. If more explicit congressional consideration is
Consideration         desired, as estimates improve, Congress may wish to develop budget
                      process mechanisms that prompt more deliberation about fiscal exposures
                      while recognizing the uncertainty inherent in estimating some long-term
                      costs.



Agency Comments and   We provided a draft of this report to the Office of Management and Budget
                      for comment. In consultation with OMB staff, they commended GAO for
Our Evaluation        tackling the important problem of the government’s exposure to future
                      fiscal demands. OMB staff agreed that our concept of “fiscal exposure” is a
                      valuable one, noting that it focuses attention on the fact that 1-year’s
                      surplus or deficit is not the only, or even the best, measure of the
                      government’s fiscal condition. They noted that the Administration endorses
                      the view that long-range fiscal exposures should be more prominently
                      highlighted in the budget documents and in the budget process, and noted
                      that some of the specific recommendations are more or less consistent
                      with legislation the Administration has proposed to Congress (accruals for
                      pensions and retiree health care). OMB staff, however, raised two general
                      concerns that are discussed below. First, they questioned whether the
                      broad conceptual framework used to describe fiscal exposures had been
                      fully developed to sufficiently cover all future spending. Secondly, they
                      argued that the analysis of ideas for improving the recognition of fiscal


                      Page 43                                            GAO-03-213 Fiscal Exposures
exposures in the budget could be improved by more fully considering the
various purposes of the federal budget, such as resource allocation and
controlling spending. In addition, they provided specific comments that we
have incorporated in the report as appropriate.

OMB staff stated that the term “exposure” is particularly laudable because
it captures the contingent nature of some future budgetary requirements,
which are critical to distinguish from the more definite, legally binding
requirements that are categorized as “liabilities” on the financial
statements. OMB staff also noted that the draft appropriately emphasizes
that fiscal exposures lie along a continuum and recognized that this
heterogeneity requires that different fiscal exposures be addressed in
different ways for the budget documents. They, however, commented that
the discussion of fiscal exposures could be improved by explicitly
recognizing that in concept all, or virtually all, future spending appears on
the continuum of fiscal exposure. For example, OMB staff pointed out that
the Constitution establishes a responsibility to “provide for the common
defense” and the authority for an Army and a Navy, and more than two
centuries of experience have created an expectation that this responsibility
will be met and the cost will be high. They stated that while the future
costs of these functions do not appear in the financial statements, they are
no less basic expectations of government than others that do appear there.
We agree that it is important to model the long-term outlook for the budget
as a whole at the macro level. Indeed, we have been doing such long-term
modeling since 1992 and we commend OMB’s efforts to present long-term
scenarios in the Analytical Perspectives of the President’s budget. While
long-term modeling simulates the long-term implications of all current
spending and revenue policies, the fiscal exposure concept is intended to
highlight a discrete subset of programs and activities whose long-term
costs and uncertainties warrant greater attention in current budgetary
deliberations.

OMB staff also stated that a number of the ideas and recommendations in
the draft are very good, and point to improvements that should be made in
the budget. OMB staff, however, argued that the analysis of
recommendations should more explicitly consider their effects on the main
purposes of budgetingto allocate resources, control agency spending, and
set aggregate fiscal policy. We agree that the various purposes of the
budget should be considered in assessing the merits of approaches and
options for improving the budget treatment of fiscal exposures. We did, in
fact, structure our discussion of potential approaches for improving the
budget treatment of fiscal exposures around objectives of budget reforms.



Page 44                                             GAO-03-213 Fiscal Exposures
           As part of our illustrative examples, we provided insights into the potential
           issues for the multiple, and sometimes conflicting, purposes of the federal
           budget. We agree, however, that these issues warrant further investigation
           if specific reforms are pursued.


           As agreed with your office, unless you release this report earlier, we will
           not distribute it until 30 days from the date of this letter. At that time we
           will send copies to the Ranking Minority Member of the House Committee
           on the Budget and the chairmen and ranking minority members of the
           Senate Committee on the Budget. We are also sending copies to the
           Directors of the Office of Management and Budget and the Congressional
           Budget Office. Copies will also be made available to others upon request.
           In addition, the report is available at no charge on GAO’s Web site at
           http://www.gao.gov.

           This report was prepared under the direction of Christine Bonham,
           Assistant Director, Strategic Issues, who may be reached at (202) 512-9576.
           Elizabeth McClarin was a major contributor to this report. Please contact
           me at (202) 512-9573 if you or your staff have any questions concerning this
           report.

           Sincerely yours,




           Paul L. Posner
           Managing Director, Strategic Issues
           Federal Budget Analysis




(450021)   Page 45                                             GAO-03-213 Fiscal Exposures
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