Facing facts about America's true financial condition and fiscal outlook: the outlook is grim and will get worse unless we act soon

Business Economics, July, 2004 by David M. Walker

In addition to external security threats, America is threatened from within by growing fiscal imbalances. The combination of entitlement programs, demographics, and rising health care costs create the need to make choices that will only become more difficult the longer they are postponed. The difficulty of making such choices is magnified by inadequate information, unfunded commitments being an especially important example. Truth and transparency in government financial reporting is badly needed, and the public must be made aware of the magnitude of the problems that will be imposed by ever-increasing fiscal imbalances and must demand change.

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Considerable attention has been focused lately on the war on terrorism. From the recent rail attacks in Spain to the continuing unrest in Iraq, it is clear that America and its allies confront increasingly diverse and diffuse security threats. But it would be wrong to conclude that the only threats to our way of life come from outside our borders. Here at home, we face a large and growing fiscal imbalance that, if left unchecked, will impede economic growth and imperil government programs that directly affect the well-being of the American people.

It seems only yesterday that many economists and government officials were projecting surpluses for years to come. Several of the underlying conditions for a long-term structural deficit, however, existed even during the economic expansion of the 1990s. In particular, largely because of rising health care costs and a looming demographic tidal wave that is unprecedented in American history, we now face decades of deficits. Difficult choices are inevitable.

If we look at changes in federal spending over time, the powerful effects of long-term trends become clear. In 1964, more than two-thirds of the federal budget was discretionary, and nearly half was spent on national defense. In 2004, less than 40 percent of the federal budget is discretionary, and only 20 percent is spent on national defense. Steady growth in entitlement programs has crowded out other government expenditures: Two out of every five federal dollars are spent now on Social Security and Medicare.

The status quo, however, is unsustainable. Take Social Security, for example. In 1950, more than 16 workers were paying into the system for every retiree drawing benefits. By 2040, that ratio will have dwindled to two to one. Without changes to current policy, the twin burdens of paying for costly medical care and supporting a growing elderly population will put increasing pressure on the nation's spending and tax policies. I am reminded of the title of one of last year's hit movies--Something's Gotta Give.

Unfortunately, the way in which our government keeps score provides an incomplete and misleading picture of our true financial condition and fiscal outlook. For instance, the Congressional Budget Office's (CBO) "baseline" projections, which are designed to be a reference point against which to measure policy changes, are often misinterpreted as projections of likely budget outcomes. But CBO is required to assume that discretionary spending will rise at the rate of inflation, that recent tax cuts will be phased out, and that there will be no changes to current law. Historically, however, discretionary spending has generally exceeded the rate of inflation, and considerable support exists to extend at least some of the tax cuts passed in recent years. Moreover, spending pressures continue to mount for such big-ticket items as the war in Iraq and homeland security. On the revenue side, current law assumes that a growing number of taxpayers will pay higher taxes under the alternative minimum tax--an assumption that many taxpayers and elected officials are likely to take issue with.

Timely, reliable, and useful financial and management information on current government operations can also be difficult to come by. This year, my agency, the U.S. General Accounting Office (GAO), was unable for a seventh consecutive year to express an opinion as to whether the U.S. government's consolidated financial statements were fairly stated. The good news was that 20 of the 23 major federal agencies received an unqualified opinion on their individual financial statements. GAO was unable to express an opinion on the federal government as a whole, however, because of continuing financial management weaknesses at the Department of Defense, the government's inability to properly account for intra-governmental transactions, and various technical obstacles to preparing the consolidated financial statements. Ultimately, we should not settle for anything less than a "clean opinion" on these financial statements.

When it comes to federal financial reporting, too few agencies adequately show the results that they are getting with the taxpayer dollars they spend, and too many significant government commitments and obligations are not fully disclosed. Particularly troubling are the many promises for future spending made in connection with various programs and policies: Social Security and Medicare, veterans' health care, and contingencies arising from a range of government-sponsored activities and entities. (See Table 1.) Despite their sobering implications for future budgets, tax burdens, and spending flexibilities, these unfunded commitments are often minimized or even ignored in the government's financial statements and in budget deliberations.