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Federal Document Clearing House
Congressional Testimony
February 6, 2001, Tuesday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 10547 words
COMMITTEE:
SENATE BUDGET
HEADLINE: TESTIMONY
LONG-TERM BUDGETARY ISSUES
TESTIMONY-BY: DAVID M.
WALKER , COMPTROLLER GENERAL
AFFILIATION: OF THE UNITED
STATES
BODY: February 6, 2001 GAO Testimony Before
the Committee on the Budget, U.S. Senate GAO-01-385T LONG-TERM BUDGET ISSUES
Moving From Balancing the Budget to Balancing Fiscal Risk Statement of David M.
Walker Comptroller General of the United States Chairman Domenici, Ranking
Member Conrad, and other Senators, I am pleased to be here today to present
GAO's perspective on the long-range fiscal policy challenges facing this
Congress and our nation. In recent testimony before this committee, Federal
Reserve Chairman Alan Greenspan observed that the new, larger surplus
projections have reshaped the choices and opportunities before us.' That is
true. As I have noted before, this Administration and this Congress enter the
21st Century facing new opportunities-and new challenges. You have the
opportunity to respond to many of today's wants, but also the obligation to
prepare for the long term. As you face budget choices in a time of projected
surpluses, I'd like to Mt a few points: -First, as the Congressional Budget
Office (CBO) notes these projections are based on a set of assumptions that may
or may not hold-no one should design tax or spending policy pegged to the
precise numbers in any 10-year forecast. -Higher 10-year surplus projections
provide room to address pent- up demands for some tax cuts and/or additional
spending kept in abeyance during years of fighting deficits. It is important to
remember, however, that while projections for the next 10-year period, look
better, the long-term outlook looks worse. Without a change in entitlement
programs, demographics will overwhelm the surplus and drive us back into
escalating deficits and debt. -The rapid increase in surplus projections brings
closer the time at which the surplus is expected to generate cash above that
needed to redeem debt held by the public. Congress and the President face new
challenges in saving for the future as we approach a time when there will be
almost no publicly held debt. -Budget choices should be viewed in terms of a
balanced portfolio of options. In the aggregate, choices should be balanced
across different levels of fiscal risk to the long-term outlook by using a
portfolio approach. Attention must be paid not only to responding to current
needs but also to making choices that increase the capacity of future
generations to make their own choices by promoting long-term growth and reducing
the relative future burden of entitlement programs. Before looking ahead, I
think it is useful to take a moment to remind ourselves of how we got where we
are today. We face burgeoning surplus projections not only because of sustained
strong economic growth but also as a result of many difficult decisions made by
earlier Congresses. These decisions, taken at different times and maintained
over time, ultimately helped us to slay the deficit dragon. They included a
budget control regime that imposed caps on discretionary spending and a pay-as-
you-go (PAYGO) process on mandatories; and revenues. They included the difficult
spending and tax decisions that implemented this process. Fiscal discipline was
enforced. As these processes and measures took hold, little by little deficits
receded. As the unified budget went into surplus, a bipartisan consensus emerged
on saving the Social Security surpluses, and this consensus has also played an
important part in today's favorable fiscal outlook and reduced levels of debt
held by the public. Both the Office of Management and Budget (OMB) and CBO now
show not only Social Security surpluses but also increasing levels of non-Social
Security, or on-budget, surpluses over the next 10- year period. It is these
projected surpluses that have changed the budget landscape dramatically from
even a year ago. The surpluses offer a welcome opportunity to address the
legitimate pent-up demands held in abeyance during the era of deficits. At the
same time the surplus estimates imply that, absent policy or economic change,
debt held by the public could be virtually eliminated before the end of this
decade. As Chairman Greenspbai recently emphasized in testimony before this
Committee, the possible elimination of debt held by the public is an unexpected
aspect of the new budgetary environment. In modem times, it is unprecedented. As
you know, Mr. Chairman and Senator Conrad, GAO has done and is doing some work
on debt management, and later in this testimony I will discuss some of the
emerging issues in this area we have identified in our ongoing work. The
question before this Congress is how to balance today's wants and needs against
our long-term challenges. The advent of actual and projected surpluses provides
a window to respond to a wide range of demands held in abeyance during years of
restraint. The surplus does not, however, eliminate our obligation to be
penitent in dealing with the taxpayers' funds. As we noted recently in the
Performance and Accountability SerieS2 the newfound budget surpluses provide an
opportunity-to move from a focus on annual budget deficits to a reexamination of
what government does and how the government does business. Further, while we can
rejoice in the prospect of burgeoning surpluses, at the same time we need to
proceed with a measure of caution. It is important also to remember that only a
few years ago OMB and CBO projected deficits as far as the eye could see. I do
not say this to question the new projections but simply to remind us of their
limitations and how they are meant to be used. These new projections, like the
ones before them, are a "what-if- not a precise prediction of the future. The
projections are useful because they quantify the likely future budgetary
consequences if we continue current federal policies without change. As such,
they serve as a reference point and are a key tool for policymakers in choosing
between alternative policy courses. At the same time they are built on a complex
set of assumptions, and I want to talk a little about those later because we
need to understand these assumptions if we are appropriately to understand the
baseline projections. Clearly, these new surplus projections present us with
different- but not necessarily easier-issues and trade-offs than was the case in
the era of large and persistent deficits. Indeed, in my view these surpluses
present both opportunity and obligation as well. While much of the discussion
will properly concern the opportunities the surpluses afford, I believe it is
important to remember that they bring with them a stewardship obligation. By
stewardship obligation, I mean that today's budget decisions need to be made
with the future in mind. We must not only respond to the legitimate needs of
today but also take into account the longer term fiscal pressures that loom ever
larger in coming decades as the nation ages and the baby-boom generation
retires. Our long-term simulations, updated using CBO's new budgetary estimates,
show that spending for federal health and retirement programs eventually
overwhelms even today's projected surpluses. This is true even assuming no
additional spending for defense, education, or a
Medicare prescription
drug benefit-i.e., even if the entire unified surplus were saved. The
aging of our nation, which will truly begin to affect the budget just after the
10- year budget window ends, is one key backdrop for the choices this Congress
will make. These long-term pressures which cast a shadow on today's budgetary
deliberations are a kind of fiscal risk. Budget policy actions may be seen in
terms of their impact on the long term. Our work on budget choices in states and
other nations suggests an array of fiscal actions that may serve as a framework
for thinking about budget choices in a surplus environment. No one factor is
likely to dominate and the allocation of these surpluses among debt reduction,
new or increased spending, and tax cuts is inherently a matter for political
choice. However these choices can be made in the context not only of today's
needs but also of the future realities. Policymakers might think in terms of a
portfolio of actions in which a balanced approach may spread and moderate any
related fisc all risk. Current-Law Budget Projections May Understate Future
Spending and Overstate Future Revenues In using baseline budget projections, we
need to understand what assumptions they incorporate and how realistic these
assumptions may be. Intended as a neutral reference point for comparing
alternative policies, baseline projections make no assumptions about future
policy change. The overarching assumption is that current laws concerning tax
policy and spending continue unchanged. The conventions governing baseline
projections are appropriate and understandable in the context of budget
enforcement purposes. However, in using these projections as a basis for
policymaking, it is important to remember what they are and what are they are
not. The baseline is just that-a baseline from which to estimate the impact of
policy actions; one would expect the ultimate outcomes to be
different-particularly over a decade. Some analysts have suggested that baseline
projections may understate likely future discretionary spending while
overstating likely future revenues. Where current law does not provide a
determinative rule-as is the case for discretionary spending after expiration of
the caps--both CBO and OMB must make some assumptions. CBO's most commonly used
projection for discretionary spending-and the one we use for the first 10 years
of our long-term simulations-is the baseline under which discretionary spending
grows with inflation. A number of observers of the federal budget, including
former C130 directors Robert Reischauer and Rudolph Penner, have suggested that
this inflated discretionary assumption is unrealistic. One analysis has pointed
out that a growth rate no higher than inflation would mean that future
per-capita discretionary spending would decline in real terms during an era of
budget surpluses.3 In addition, projections based on current-law assumptions may
overstate likely future revenues. For example, the baseline projections assume
expiration of a set of about 20 tax credits-including the research and
experimentation tax credit-which have been routinely extended in the past. The
baseline projections also assume no change to the alternative minimum tax, which
is expected to affect an increasing number of middle- class taxpayers. All
projections are surrounded by uncertainty. In using budget estimates, we need to
keep in mind that budget estimates are not- and are not meant to be-a crystal
ball. CBO itself has warned against attributing precision to its projections,
stating that actual budgetary outcomes will almost certainly differ from the
baseline projections-even absent any policy changes.4 CBO notes that its
estimate of the 2006 surplus could vary by as much as $400 billion in either
direction. As CBO has said, the value of the 10-year estimates is that they
allow Congress to consider the longer-term implications of legislation rather
than focus only on the short-term effects.6 No policy should assume the
exactness of baseline projections; relatively small shifts can lead to large
year-to-year differences. Despite Today's Outlook for Large and Growing
Surpluses, the Long Term Deficits Will Re- emerge While considerable uncertainty
surrounds both short- and long- term budget projections, we know two things for
certain: the population is aging and the baby boom generation is approaching
retirement age. In addition demographic trends are more certain than budget
projections! Although the 10-year horizon looks better in CBO's January 31
projections than it did in July 2000, the long-term fiscal outlook looks worse.
In the longer term- beyond the 10-year budget window of CBO's projections- the
share of the population over 65 will begin to climb, and the federal budget will
increasingly be driven by demographic trends. Figure 1: Aged Population as a
Share of Total U.S. Population Continues to Grow Found on hard copy As more and
more of the baby boom generation enters retirement, spending for Social
Security, Medicare, and Medicaid will demand correspondingly larger shares of
federal revenues. Federal health and retirement spending will also surge due to
improvements in longevity. People are likely to live longer than they did in the
past, and spend more time in retirement. Finally, advances in medical technology
are likely to keep pushing up the cost of providing health care. In contrast to
the improvement in the 10- year projections, our updated simulations-shown in
figure 2-show a worsening in the long-term fiscal outlook since July. This
worsening is largely due to a change in the assumptions about health care costs
over the longer term. Figure 2: Comparison of Unified Deficits as a Share of GDP
Under the Save the Social Security Surpluses Simulation, July 2000 Update and
January Found on hard copy In recent months there has been an emerging consensus
that the long-term cost growth assumption traditionally used in projecting
Medicare and Medicaid costs in the out-years is too low. A technical panel
advising the Medicare Trustees stated this conclusion in its final report.
Charged with reviewing the methods and assumptions used in the Trustees'
Medicare projections, the panel found that the methods and assumptions were
generally reasonable with the exception of the long-term cost growth assumption.
Basing its finding on recent research and program experience, the panel
recommended that in the last 50 years of the 75-year projection period,
per-beneficiary program costs should be assumed to grow at a rate one percentage
point above per-capita gross domestic product (GDP) growth.6 CBO made a similar
change to its Medicare and Medicaid long- term cost growth assumptions its
October 2000 report on the long term.7 Given this convergence of views, we have
incorporated higher long- term health care cost growth consistent with the
Medicare technical panel's recommendation into our January update.8 The message
from our long-term simulations, which incorporate CBO's 10- year estimates,9
remains the same as it was a year ago. Indeed, it is the same as when we first
published long-term simulations in 1992.10 Even if all projected unified
surpluses are saved and used for debt reduction, deficits reappear in 2042. If
only the Social Security surpluses are saved, unified deficits emerge in 2019.
(See figure 3.) In both scenarios deficits would eventually grow to
unsustainable levels absent policy changes. Figure 3: Unified Deficits as a
Share of GDP Under Alternative Fiscal Policy Simulations Found on hard copy only
To move into the future with no changes in federal health and retirement
programs is to envision a very different role for the federal government.
Assuming, for example, that Congress and the President adhere to the
often-stated goal of saving the Social Security surpluses our long-term model
shows a world by 2030 in which Social Security, Medicare, and Medicaid
increasingly absorb available revenues within the federal budget. Under this
scenario, these programs would require more than three- quarters of total
federal revenue. (See figure 4.) Figure 4: Composition of Federal Spending as a
Share of GDP Under the Save the Social Security Surpluses Simulation Found on
hard copy Little room would be left for other federal spending priorities such
as national defense, education, and law enforcement. Absent changes in the
structure of Social Security and Medicare, some time during the 2040s government
would do nothing but mail checks to the elderly and their healthcare providers.
Accordingly, substantive reform of Social Security and health programs remains
critical to recapturing our future fiscal fle3dbility. Since these simulations
assume current-law entitlement benefits, they both overstate and understate the
challenge. They overstate it because they assume Congress and the President
would take no action to change the cost structure of these programs. However,
they under-state it because they also assume no benefit enhancements such as the
addition of coverage for prescription drugs. In addition, these simulations-like
the budget--do not recognize the long-term cost implications of insurance
programs, environmental cleanup liabilities and other long-term commitments. In
other words, in some ways this could be seen as an optimistic scenario! The
government undertakes other activities and programs that directly obligate it to
spend in the future. While some steps have been taken to improve financial
statement reporting of a number of these commitments, more needs to be done. In
addition, many future costs are not reflected in either budget projections or
long-term simulations. Explicit liabilities not reflected in the budget can be
sizable. For example, estimates indicate that environmental cleanup of
government-caused waste is expected to cost the federal government at least $300
billion. Other future financial commitments and contingencies are also important
considerations. The future costs of other activities are often difficult to
estimate, but nonetheless can add to future fiscal stress. Some, such as credit
subsidy costs, are in the budget and thus in the baseline; others, like the risk
assumed by federal insurance programs, are not. AR of these as well as demands
for increased federal support in areas ranging from health insurance to national
defense will compete for a share of the fiscal pie in the future-a pie that will
already be increasingly encumbered by higher costs for the elderly. This
highlights the government's stewardship responsibility to provide future
generations with sufficient budgetary flexibility to make their own choices and
an economic base sufficient to finance current commitments as well as future
needs. Budget Policy in a Time of Surplus Today Congress and the President face
a very different set of budget choices than did your recent predecessors. For
over 15 years fiscal policy has been seen in the context of the need to reduce
the deficit. The policies and procedures put in place to achieve a balanced
budget do not provide guidance for fiscal policy in a time of surplus. At the
same time, as Chairman Greenspan warned last month, we "need to resist those
policies that could readily resurrect the deficits of the past and the fiscal
imbalances that followed in their wake." As you know, we have looked at a number
of other countries that have already faced this challenge." Like the United
States, these nations achieved budget surpluses largely as the result of
improving economies and sustained deficit reduction efforts. After years of
restraint, there are pent-up demands-for tax cuts and/or for spending. In
several notable cases, these countries met current demands while retaining
surpluses for longer-term economic goals. How do countries meet these demands
without abandoning restraint? The countries we reviewed articulated a compelling
case for sustaining surpluses and developed a fiscal policy framework that
addressed current needs within the context of broader economic targets or goals.
Some adopted fiscal targets such as debt-to- GDP ratios as a guide for
decision-making while others such as Australia attempted to focus on the impact
of fiscal policy on national saving and economic growth. Achieving consensus on
a long-term fiscal policy goal this year may seem unlikely. Nevertheless, I
believe it is important that Congress and the President look at budget choices
today in the context not only of today's needs and demands but also of the
long-term pressures we know loom on the horizon. Today's surpluses create, in
effect, a unique window of opportunity to better position the government and the
nation to address both current needs as well as the longer-term budget and
economy we will hand to succeeding generations. Our long-term model illustrates
how important it is for us to use our newfound fiscal good fortune to promote a
more sustainable longer-term budget and economic outlook so that future
generations can more readily afford the commitments of an aging society.
Deficits, Debt, and National Saving Today's budget decisions have important
consequences for the living standards of future generations. The financial
burdens facing the smaller cohort of future workers in an aging society would
most certainly be ameliorated if the economic pie were enlarged. This is no easy
challenge, but in a very real sense, our fiscal decisions affect the longer-term
economy through their effects on national saving. Recent research estimated that
increasing saving as a share of GDP by one percentage point each year would
boost GDP enough to cover 95 percent of the increase in elderly costs between
now and 2050. Simply put, we are not saving enough as a nation. Personal saving
is at a 40-year low. As shown in figure 5, the reduction of federal deficits and
the emergence of budget surpluses in recent years have slowed the long-term
decline in national saving. While investment needed to promote growth has been
supported by foreign capital in recent years, the profits due to foreign
investment go abroad. What would happen if in the future foreign investors found
more attractive opportunities elsewhere? The most viable strategy for expanded
growth in the long run is to increase saving from our own economy. Since
expanding the nation's productive capacity through saving and investment is a
long-term process, increasing saving now is vital since labor force growth is
expected to slow significantly over the next 20 years. Figure 5: Composition of
Net National Saving (1960-1999) Found on hard copy Traditionally, the most
direct way for the federal government to increase saving has been to reduce the
deficit or-more recently- to rim a surplus. Although the government may try to
increase personal saving, results of these efforts have been mixed. As a general
rule the surest way for the federal government to affect national saving has
been through its fiscal policy. In general, saving involves trading off
consumption today for greater consumption tomorrow. When the government saves by
reducing debt by the public, it helps lift future fiscal burdens by freeing up
budgetary resources encumbered for interest payments which currently represent
more than 12 cents of every federal dollar spent-and by enhancing the pool of
economic resources available for private investment and long-term economic
growth. This is especially important since-as I noted a year and a half ago-we
enter this period of surplus with a large overhang of debt held by the public.
Indeed, we should be a little more subdued in congratulating ourselves on the
decline in debt held by the public-we are still significantly above the debt/GDP
ratio of the late 1970s. Given the demographic pressures loon-ting, today's
level of publicly held debt is not a good benchmark. However, current
projections show that-depending on the budget policies adopted-the United States
could reach a point in this decade at which annual budget surpluses could not be
fully used to reduce debt. Although estimates of exactly when this might occur
vary, most put it between 2004 and 2011. If the entire unified surplus is saved,
this point is likely to be reached in sometime in the next 5 years; if only the
Social Security surplus is saved, this point will be delayed until the second
half of the decade. This would raise a number of issues: whether and if so how
the government should hold nonfederal assets; whether and if so how a market for
debt held by the public should be maintained; how do we as a nation raise the
level of national saving if reducing federal debt held by the public is not an
option. The issues Chairman Greenspan raised concerning government ownership of
nonfederal assets deserve careful consideration. I note that while Chairman
Greenspan opposed such a step, he also said that if the government were to
acquire nonfederal assets, he would prefer that they be allocated to the Social
Security Trust Funds. At GAO we have looked both at the experiences of other
countries during times of declining debt and at the question of trust fund
investments in equities. We believe this work can assist you in your
deliberations. For example, in our ongoing work looking at other nations'
experiences with declining debt, we found that some have decided to hold some
nonfederal assets as part of their efforts to deal with long-term pressures.
With the advent of surpluses, Norway established a goal of sustained surpluses
in order to build up savings to address long-term fiscal and economic concerns
resulting primarily from an aging population and declining petroleum reserves.
As a vehicle for accumulating assets, the government created the Government
Petroleum Fund in 1991 to help manage Norway's petroleum wealth over the long
term. The Fund serves several important fiscal and economic functions. By
investing surpluses, the Fund is an instrument for saving part of Norway's
petroleum revenues for the next generation. During the 1990s, Canada modified
its pension system to invest in nonfederal assets as one way to improve the
system's sustainability. Sweden also invests a portion of its pension funds in
nonfederal assets. Management of Norway's Petroleum Fund is the responsibility
of the Ministry of Finance, which has delegated the task of operational
management of the Fund to Norway's central bank. Both Canada and Sweden have
established separate boards to oversee the investment of their fund assets. In
the near future, we plan to conduct a study of other nations that invest in
nonfederal assets in order to learn more about how they deal with governance
issues. In 1998, we reported on the implications of allowing the Social Security
Trust Funds to invest in nonfederal assets, specifically equities. 12 One of the
implementation issues we looked at was that of governance-at the concern that
there would be tremendous political pressures to steer the trust funds'
investments to achieve economic, social, or political purposes. We concluded
that passively investing in a broad-based index would reduce, but not eliminate,
the possibility of political influence over the government's stock selections.
The question of how to handle stock voting rights, however, seemed likely to be
more difficult to resolve. To blunt concerns about potential federal meddling,
the government's stock voting rights could be restricted by statute or delegated
to investment managers. The issue of how to select stock investments also
emerged when the federal employees' Thrift Savings Plan (TSP) was created. To
eliminate political influence in TSP's stock investment decisions, the Congress
restricted TSP investments to widely recognized broad-based market indexes; thus
the portfolio composition is automatically determined by the market index chosen
and consideration of nonfinancial objectives is precluded. TSP board members and
employees are subject to strict fiduciary rules, and breaching their fiduciary
duty would expose them to civil and criminal liabilities. The fiduciary rules
require board members and employees to invest the money and manage the funds
solely for the benefit of the owners of the individual accounts- the
participating federal employees and their beneficiaries. TSP board members and
employees are prohibited from exercising stock voting rights, and voting instead
is delegated to investment managers according to their own guidelines.
Obviously, the design and management of any federally owned assets win be
critical to mitigate the risks of political interference. Since TSP assets are
owned by federal employees, it cannot be seen as directly analogous to
government investment. Nevertheless, it can be helpful in considering these
issues. Government ownership of nonfederal assets is obviously complicated and
would carry certain risks. Although the governance issues may not be
insurmountable, another possible concern is the magnitude of federal involvement
in the financial markets. Although the federal government would become the
largest single investor, the amounts invested might not seem disproportionately
large in terms of the size of the U.S. financial markets. Under our Save the
Social Security Surpluses simulation, the federal government would buy
nonfederal assets for about a decade and cumulative federal holdings would peak
at about 2 percent of GDP assuming that a federal debt market is not maintained.
This would represent about 1 percent of the stock market or 4 percent of the
corporate bond market today. Any price effects associated with the federal
government acquiring and then selling these assets are uncertain. However, the
government would not necessarily be selling its nonfederal assets in this
window. If nonfederal assets are to be held by the government, the question
arises whether they could be used to prefund a portion of federal commitments
and liabilities. Since a successful stock investment strategy should be grounded
in a long-term outlook, the idea of investing in nonfederal assets could be
considered appropriate for federal programs with a long time horizon. For
example, federal civilian and military retirement programs could buy and hold
assets that match the expected tin-ting of their liabilities. As I have already
noted, there is a growing body of experience in other nations that might help us
understand this new landscape better. It is worth noting that investing in the
financial markets is a standard practice for state and local governments, and
the experiences of public pension funds may yield some insights into the
implications of the federal government investing on behalf of Social Security or
other federal retirement programs. Other nations have decided that the potential
risks of political interference with markets can be managed and are outweighed
by what they perceive as a risk of failing to save for the future or providing a
cushion for contingencies. These trade-offs are inherently political
decisions-and although we can look to others for insights, we will have to
resolve these issues in our own way. If the governance, control and size issues
loom so large that there is a consensus the federal government should not hold
nonfederal assets, we face a new set of issues: should we avoid eliminating debt
held by the public, and if so, how? How then would we accumulate sufficient
national saving to promote the level of economic growth needed to finance the
baby boom retirement? The surest way for the federal government to raise
national saving has been by raising government saving. How to raise national
saving in an environment of zero federal debt is a complex question. The
government could aim for a balanced budget once the federal debt held by the
public is eliminated. In such a case, all national saving would have to be
achieved through increased private saving. Whether e3dsting federal incentives
for people to save have been effective in increasing private saving and
ultimately national saving is open to question. Even with preferential tax
treatment granted since the 1970s to encourage retirement saving, the personal
saving rate has steadily declined, as shown in figure 6. Figure 6: Personal
Saving Rate (1960-1999) Found on hard copy Some have suggested that one option
would be using the surpluses to finance individual saving accounts. Various
proposals have been advanced that would create a new system of individual
accounts as part of comprehensive Social Security reform, while other proposals
would create new accounts outside of Social Security. Individual account
proposals also differ as to whether individuals' participation would be
mandatory or voluntary. If the goal of individual account proposals is to
increase national saving, careful consideration must be given to the specifics
of design. 13 Matching provisions may affect how much such accounts increase
national saving. On another dimension, allowing early access to these accounts
increases people's willingness to put money in them-but reduces their usefulness
as retirement accounts. One possible approach might be to use part of any
realized surplus as a kind of surplus dividend that could be returned in the
form of an individual saving account. Again, design features including targeting
and limitations on access would be important. Entitlement Reform As I discussed
earlier, reducing the relative future burdens of Social Security and health
programs is critical to promoting a sustainable budget policy for the longer
term. Moreover, absent reform, the impact of federal health and retirement
programs on budget choices will be felt as the baby boom generation begins to
retire. While much of the public debate concerning the Social Security and
Medicare programs focuses on trust fund balances- that is, on the programs'
solvency-the larger issue concerns sustainability. Absent reform, the impact of
federal health and retirement programs on budget choices will be felt long
before projected trust fund insolvency dates when the cash needs of these
programs begin to seriously constrain overall budgetary flexibility. The 2000
Trustees Reports estimate that the Old-Age and Survivors Insurance and
Disability Insurance (OASDI) Trust Funds will remain solvent through 2037 and
the Hospital Insurance (HI) Trust Fund through 2025. This date does not
incorporate either the technical panel's suggested higher cost growth assumption
or any benefit expansions such as prescription drug coverage. Furthermore,
because of the nature of federal trust funds, HI and OASDI Trust Fund balances
do not provide meaningful information about program sustainability-that is, the
government's fiscal capacity to pay benefits when the program's cash inflows
fall below benefit expenses. From this perspective, the net cash impact of the
trust funds on the government as a whole-not trust fund solvency-is the
important measure. Under the Trustees' intermediate assumptions, the OASDI Trust
Funds are projected to have a cash deficit beginning in 2015 and the HI Trust
Fund a deficit beginning in 2009 (see figure 7). At that point, the programs
become net claimants on the Treasury. In addition, as we have noted in other
testimony,14 a focus on HI solvency presents an incomplete picture of the
Medicare program's expected future fiscal claims; the Supplementary Medical
Insurance (SMI) portion of Medicare, which is not reflected in the III solvency
measure, is projected to grow even faster than HI in the future. Figure 7:
Social Security and Medicare's Hospital Insurance Trust Funds Face Cash Deficits
as Baby Boomers Begin to Retire Found on hard copy To finance these cash
deficits, Social Security and the Hospital Insurance portion of Medicare will
need to draw on their special issue Treasury securities acquired during the
years when these programs generated cash surpluses. In essence, for OASDI or Hl
to 'redeem' their securities, the government must raise taxes, cut spending for
other programs, or reduce projected surpluses. Our long-term simulations
illustrate the magnitude of the fiscal challenges associated with our aging
society and the significance of the related challenges that government will be
called upon to address. As we have stated elsewhere, 15 early action to change
these programs would yield the highest fiscal dividends for the federal budget
and would provide a longer period for prospective beneficiaries to make
adjustments in their own planning. This message is not changed by the new
surplus numbers. It remains true that the longer we wait to take action on the
programs driving long-term deficits, the more painful and difficult the choices
will become. Moving From Balancing the Budget to Balancing Fiscal Risk While
these new surplus projections offer an opportunity to address today's needs and
the many pent-up demands held in abeyance during years of fighting deficits,
they do not eliminate our obligation to prepare for the future. Today's choices
must be seen not only in terms of how they respond to today's needs, but also
how they affect the future capacity of the nation and our ability to meet our
looming demographic challenge. When we looked at how other nations responded to
budget surpluses, we discovered that most found a way to respond to pressing
national needs while also promoting future fiscal flexibility and saving. Their
actions could be seen as constituting a range of actions across a continuum by
the degree of long-term fiscal risk they present. Figure 8 illustrates this
array along one dimension. At one end debt reduction and entitlement reform
actually increase future fiscal flexibility by freeing up resources. One-time
actions-either on the tax or spending side of the budget-may neither increase
nor decrease future flexibility-although here many would distinguish between
types of actions; devoting funds to previously underfunded liabilities or to
one-time capital investments may be seen as different than actions that increase
consumption. Permanent or open- ended tax cuts and/or spending increases may
reduce future fiscal flexibility-although that is likely to depend on their
structure and implementation. For example, many would argue that certain
permanent changes in the tax structure and/or funding for well-chosen
investments can enhance economic growth and build for the future. Figure 8:
Array of Fiscal Choices Found on hard copy The decision on how to allocate
surpluses is by its very nature inherently a political one-and I am not here to
advocate any particular tax or spending proposal. Rather, my point is that since
surplus projections are more uncertain than demographic trends, prudence would
argue for seeking to balance risk. You might think about the budget choices you
face today as a portfolio of fiscal actions balancing today's unmet needs with
tomorrow's fiscal challenges. If the experience of other nations and the states
is any guide, we will most likely choose actions across an array of choices. In
thinking about balanced risk, it is not the merits of any individual proposal
that are key but the impact of these decisions in the aggregate or from a
portfolio perspective. This suggests that whatever the fiscal choices made in
allocating the surplus among debt reduction, tax cuts, and spending increases,
approaches should be explored to mitigate risk to the long term. For example,
provisions with plausible expiration dates-on the spending and the tax side-may
prompt re-examination taking into account any changes in fiscal circumstances. A
mix of temporary and permanent actions may also reduce risk. In our recent
Performance and Accountability series, we also suggested that, given the
inherent uncertainty of surplus projections, consideration be given to linking a
portion of new fiscal commitments to the actual levels of surpluses achieved. As
I mentioned earlier, one possible approach could be a kind of "surplus dividend"
that had to be saved. Whatever the form, linking new commitments to actual
results can be seen as a kind of contingency planning. Others have suggested
considering a portion of the surplus as a kind of contingency fund. Some states
have developed approaches to limiting fiscal risk by linking temporary tax cuts
or spending to actual fiscal results. In Ohio, an Income Conclusion Tax
Reduction Fund was established as a mechanism to return surplus revenues to
taxpayers based on the size of the actual surplus in excess of the amount
required to maintain the budget stabilization fund. Minnesota has refunded
surplus revenues beginning in 1997 and has since instituted a requirement that a
revenue surplus exceeding 0.5 percent be designated for a tax rebate. Arizona
developed triggers which designate the use of surplus revenues for specific tax
reductions, or new appropriations based on the amount of actual surpluses
achieved. Arizona also has increased the balances in the Budget Stabilization
Fund. The excess surplus funds triggered reductions in vehicle license and
corporate taxes as well as increased education funding. Surpluses challenge our
nation to move beyond a focus on reducing annual deficits to a broader agenda.
They offer us an opportunity to look more closely at what government does and
how it does business. With the advent of surpluses in the near-term, the nation
needs to develop a new fiscal paradigm-one that will prompt greater attention to
the long-term implications of current programs and policy choices and help to
better balance today's wants against tomorrow's needs. For more than a decade,
budget processes have been designed with the goal of reaching a zero deficit.
Now that goal has been reached-indeed passed. Clearly, the limits imposed to
achieve a balanced budget are not working in the world of surplus. At the same
time eliminating all controls would be a mistake. You face the need not only to
make choices about tax and spending policy, but also to design a process for the
future. Now that the goal of "Zero Deficit" is, gone, what should replace it?
Whatever measure you select, we believe that the budget and the budget process
must pay more attention to the long-term cost implications of today's budget and
program decisions. We have recommended, for example, budgeting for the fully
accrued costs for insurance and pensions in current budgets to reflect the
future commitments made in current programs. 16 Ultimately, the federal
government needs a decision-making framework that permits it to evaluate fiscal
good fortune and choices against both today's needs and the longer-term fiscal
future we wish to hand to future generations.
LOAD-DATE: February 7, 2001, Wednesday