Report No.: GAO/OCG-93-1TR Date: December 1992
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Author: United States General Accounting Office
Office of the Comptroller General
Addressee: Transition Series
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CONTENTS
The Deficit--and Why It Is Bigger Than It Seems
Why the Deficit Has Grown
Future Deficit Trends Not Promising
Why the Deficit Matters
What Must Be Done
Strategies for Reducing the Deficit Will Have to Involve All Major Portions of
the Budget
- Controlling Mandatory Spending Means Containing Health Care Costs
- Discretionary Spending: Reexamining Roles
- Revenues Are Likely to Be Part of the Package
Conclusion
Related GAO Products
Transition Series
- Economics
- Management
- Program Areas
Tables
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Table 1: Deficits
Table 2: Outlays for Fiscal Years 1981, 1986, and 1991
Figures
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Figure 1: Debt Held by the Public (1980-2002)
Figure 2: Effect of the Budget Deficit on Net National Savings (1960-90)
Figure 3: Outlays for Federal Investment, Health, and Net Interest (1962-91)
Office of the Comptroller General
Washington, DC 20548
December 1992
The Speaker of the House of Representatives
The Majority Leader of the Senate
In response to your request, this transition series report discusses one of
the most urgent issues facing the new President and the new Congress--the
federal budget deficit. Since the issuance of our 1988 transition series
report on the budget deficit, despite the passage of the Budget Enforcement
Act, the budget deficit has grown. Unless we gain control of this deficit, we
will find it increasingly more difficult to address pressing national needs or
to increase long-term economic growth.
This report discusses the scope of the current deficit and describes the
factors that must be dealt with to bring it down. Other reports in this
transition series address specific program and management issues facing the
government. All of the reports in this transition series are based primarily
on detailed reports and testimony that GAO has provided to the Congress.
We are also sending copies of this report to the President-elect, the
Republican leadership of the Congress, the appropriate congressional
committees, and the designated heads of the appropriate agencies.
THE DEFICIT--AND WHY IT IS BIGGER THAN IT SEEMS
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The budget deficit remains among the most urgent issues facing the new
President and the new Congress. This deficit has preoccupied Washington over
the past decade, but concern about it has so far failed to galvanize the
action needed to resolve it.
In 1988, we reported in our transition series that the unified budget deficit
in that year was $155 billion, or 3.2 percent of Gross Domestic Product (GDP).
Since then, it has grown to $290 billion in fiscal year 1992, or 4.9 percent
of GDP.
The record $290 billion deficit in the unified budget measures the cash
position of the government. Although it is a fairly accurate indicator of the
macroeconomic impact of the deficit on the economy, it masks the composition
of the deficit and understates the problem. A $96 billion surplus in the trust
funds--including the Social Security trust funds--partially offsets a deficit
of $386 billion in federal funds, leading to a unified budget deficit of $290
billion.
This trust fund surplus is a temporary phenomenon that will begin to evaporate
within the next 20 years as the baby boom retires. The table below shows the
relationship between the unified deficit, the trust fund surpluses, and the
federal funds deficit.
Table 1: Deficits
(Dollars in billions)
1981 1992 1993 1997
actual actual estimate\a estimate\a
------------------------ ------ ------- ----------- -----------
Unified deficit $79 $290 $331 $290
Trust fund surpluses $7 $96 $108 $140
Federal funds $86 $386 $439 $430
deficit\b
\a Congressional Budget Office (CBO) estimates.
\b Federal funds projections are not provided beyond fiscal year 1997.
In addition, the deficit in 1992 was held down by a delay in providing funds
for Resolution Trust Corporation (RTC) activities. Since more funds will be
needed to complete the cleanup of the savings and loan disaster, this decision
merely shifted spending from fiscal year 1992 to fiscal year 1993 and beyond.
Finally, as we reported in 1988, an explosion of unfunded costs--many of which
constitute future claims on federal budgetary resources--is looming. Some of
these costs, including the following, are discussed in more detail in other
reports in this transition series:
-- The head of RTC estimates that an additional $25 billion will be needed for
the savings and loan cleanup. Furthermore, several billion dollars will be
needed to fund the new Savings Association Insurance Fund.
-- The current administration has proposed a combination of management
initiatives, base closings, and weapons terminations to bring Department of
Defense (DOD) expenditures into line with the $1.4 trillion 1993-97
defense spending plan assumed in the budget. However, our work shows
that many of the assumed savings may not materialize. DOD may be
faced with additional program reductions of nearly $100
billion.
-- In addition, the defense plans do not account for weapons systems cost
growth. We estimate that these overruns will cost $35 billion between 1993
and 1997. (See _National Security Issues_, GAO/OCG-93-9TR, Dec. 1992.)
-- DOD must clean up the hazardous waste pollution that has been identified at
military facilities across the nation. DOD estimates the costs of cleaning
up the sites identified to date at $24.5 billion. This figure is likely
to increase. (See _National Security Issues_, GAO/OCG-93-9TR, Dec.
1992.)
-- The Department of Energy faces the task of cleaning up and modernizing its
aging and environmentally hazardous nuclear weapons production complex. We
estimate the long-term cost of cleanup and modernization to be at least
$160 billion, up from our 1988 estimate of $100 billion to $130
billion. (See _Energy Issues_, GAO/OCG-93-13TR, Dec. 1992.)
-- The Pension Benefit Guarantee Corporation has a current deficit of $2.3
billion, which could reach $17.9 billion by the year 2001. Seriously
underfunded pension plans create a large contingent liability for the
federal government. (See _Labor Issues_, GAO/OCG-93-19TR, Dec. 1992,
and _Pension Benefit Guaranty Corporation_, GAO/HR-93-5, Dec.
1992.)
-- The cost to renew the Department of Housing and Urban Development's current
contracts providing rent subsidies to low-income families will jump from an
estimated $7.5 billion in fiscal year 1993 to an estimated $17.1 billion
in fiscal year 1997. (See _Housing and Community Development Issues_,
GAO/OCG-93-22TR, Dec. 1992.)
-- The cost of the Federal Aviation Administration's program to modernize the
nation's air traffic control system has grown to $32 billion, an increase
of about $7 billion from projections 4 years ago. Virtually all ongoing
major projects are well over budget and years behind schedule. (See
_Transportation Issues_, GAO/OCG-93-14TR, Dec. 1992.)
-- The costs to modernize and update the Internal Revenue Service's (IRS) tax
processing systems now are estimated to be about $23 billion through the
year 2008. IRS needs experienced managers to direct modernization
projects so that results can be delivered on schedule. (See _Internal
Revenue Service Issues_, GAO/OCG-93-24TR, Dec. 1992.)
-- The National Weather Service's modernization program has exceeded its
expected cost and is far behind schedule. The initial cost estimate of $1.4
billion has risen to $4.6 billion, and the projected completion date has
slipped from 1994 to 1999. (See _Commerce Issues_, GAO/OCG-93-12TR,
Dec. 1992.)
-- It could cost from $5 billion to $10 billion to modernize the Social
Security Administration's computer systems over the next 10 years. (See
_Health and Human Services Issues_, GAO/OCG-93-20TR, Dec. 1992.)
In addition, public pressure is growing for government action on an agenda of
national problems, including the following:
-- The costs to modernize the public housing stock are estimated at over $20
billion. In addition, estimates of the costs to abate lead-based paint in
public housing range from $6 billion to $16 billion. (See _Housing and
Community Development Issues_, GAO/OCG-93-22TR, Dec. 1992.)
-- The Department of Transportation estimates the cost of merely maintaining
the condition of the nation's highways and bridges at 1989 levels over the
next 6 years to be about $250 billion; improving their condition would
increase costs to $425 billion. These estimates do not include funds
for mass transit or rail systems. (See _Transportation Issues_,
GAO/OCG-93-14TR, Dec. 1992.)
-- Pressure has grown to extend health insurance to the 35 million uninsured.
Cost estimates range from $12 billion to $30 billion per year. (See _Health
Care Reform_, GAO/OCG-93-8TR, Dec. 1992.)
WHY THE DEFICIT HAS GROWN
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The large deficit is a function of changes in both spending and revenue
policies and of the recession. In the early 1980s, the combination of spending
for an accelerated defense buildup and a simultaneous reduction in taxes
established a large deficit. Cuts in domestic programs were too small to
offset the net effect of increases for defense and cuts in taxes.
Once this large deficit was established, interest payments increased
rapidly--growing from $69 billion in 1981 to $195 billion in 1991. At the same
time, federal spending on Medicare and Medicaid grew by 180 percent, from $56
billion in 1981 to $157 billion in 1991. Concurrently, spending for deposit
insurance and resolution of the savings and loan disaster exploded. In 1981,
the deposit insurance system took in more than it spent, but in 1991, outlays
for deposit insurance were $66.3 billion, or 5 percent of total outlays. Table
2 illustrates these trends.
Table 2: Outlays for Fiscal Years 1981, 1986, and 1991
(Dollars in billions)
1981 1986 1991 Percent
Actual Actual Actual change
outlays\a outlays\a outlays\a 1981-91
-------------------------- --------- --------- --------- --------
Defense $158 $273 $273 74
Net interest 69 136 195 183
Health
Medicare 39 70 104 167
Medicaid 17 25 53 212
Medicare and Medicaid 56 95 157 180
Deposit -1 1 66
insurance\b
All other 397 485 632 59
-------------------------- --------- --------- --------- --------
Total\c $678 $990 $1,323 95
\a Amounts in nominal dollars.
\b Calculated on a cash basis.
\c May not add because of rounding.
During this period, additional cuts in domestic programs and increases in
taxes--combined in the second half of the decade with a slowdown in defense
spending--were insufficient to eliminate the deficit built into the structure
of the budget. Between 1981 and 1991, federal spending as a whole increased to
24 percent of GDP while revenues generally remained at about 19 percent of
GDP. Indexing on the revenue side helped to hold revenues nearly flat and
removed another source of fiscal slack. In addition, tax expenditures have
grown rapidly in the last few years, despite the 1986 tax reform, thereby
further eroding the revenue base.
The federal debt grew rapidly with rising deficits. In 1981, debt held by the
public was $784.7 billion. In 1992, it was about $3 trillion. CBO projects it
to reach $6.5 trillion in 2002. The interest payments on this debt have
absorbed an increasing share of federal outlays, from 10 percent in 1981 to 15
percent in 1991. Furthermore, the debt has increased relative to GDP, growing
from 26 percent in 1981 to 50 percent in 1992, as figure 1 shows.
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Figure 1: Debt Held by the Public (1980-2002)
The following table represents the data for this chart in the printed version
of the report. The actual figure appears in the printed report.
FUTURE DEFICIT TRENDS NOT PROMISING
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The deficit will not resolve itself without major changes in the federal
policies responsible for the trends. Although improvements in the economy
could help reduce the deficit in the short term, a large structural deficit
would remain. Chronic deficits are embedded in federal fiscal policy, and
forecasts indicate that, absent further policy changes, the deficit will only
become worse over time.
Since we issued our 1988 transition series report, the 1990 Budget Enforcement
Act (BEA) established a renewed framework to control spending. It succeeded in
controlling the growth of discretionary spending provided through the
appropriations process, and it prevented the expansion of entitlements or tax
expenditures. It did nothing, however, to control growth in the cost of
existing entitlements or existing tax expenditures.
Although BEA succeeded in trimming $500 billion over 5 years, the deficit
nonetheless grew to record levels, thanks to a worsening economy, rapid growth
in health care costs, increasing interest payments, and the continued cost of
resolving the savings and loan crisis.
Current projections suggest that unless current policies are changed, high
deficits will persist even as the economy improves. CBO projects that under
current policy the deficit in 2002 will reach $514 billion, or 5.2 percent of
GDP. Spending for health care and net interest continues to drive the deficit.
However, deposit insurance should cease being a major contributor to the
deficit as the industry's problems are resolved.
Without action, the problem will only worsen over the longer term. In a
previous report, we adapted a long-term economic growth model developed at the
New York Federal Reserve Bank to estimate the potential results in 2020 of
alternative deficit reduction paths. If current policies remain unchanged,
deficits could explode to over 20 percent of Gross National Product (GNP) by
2020. In this no-action scenario, health care costs, retirement costs, and
ballooning interest costs combine to create a dramatic rise in spending;
higher deficits and lower savings slow the growth of real GNP. Our economy
could not possibly sustain deficits of this magnitude. Although this scenario
is implausible, the trends demonstrate that the choice facing the nation is
not _whether_ to reduce the deficit but _how_ and _when_. [ Footnote 1:
_Budget Policy: Prompt Action Necessary to Avert Long-Term Damage to the
Economy_, (GAO/OCG-92-2, June 1992). ]
WHY THE DEFICIT MATTERS
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Large and persistent federal deficits matter for three reasons. They constrain
the ability of government to address the pressing national needs discussed
above. Some economists say they also limit the ability of the government to
respond to economic downturns through fiscal stimulus because such action
might prompt offsetting increases in interest rates driven by markets already
nervous about the impact of growing deficits.
In addition, the deficit matters because it absorbs savings that would
otherwise be available to finance investment, and investment is critical to
long-term economic growth. [ Footnote 2: See _Investment_ (GAO/OCG-93-2TR,
Dec. 1992) and _Budget Policy: Prompt Action Necessary to Avert Long-Term
Damage to the Economy_ (GAO/OCG-92-2, June 1992). ] During the 1960s, the
budget deficit absorbed approximately 2 percent of net national savings.
Today, federal borrowing absorbs over 50 percent of a diminished pool of
national savings potentially available for economic investment. (See fig. 2.)
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Figure 2: Effect of the Budget Deficit on Net National Savings (1960-90)
The following table represents the data for this chart in the printed version
of the report. The actual figure appears in the printed report.
(Percent of Net National Product)
Savings available Savings absorbed
for new capital absorbed by the
formation budget deficit
----------------- ----------------
1960-69 8.8 0.2
1970-79 7.9 1.9
1980-89 4.4 4.0
1990 2.3 3.4
Source: _Economic Report of the President_ (Feb. 1992).
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During the 1980s, investment levels were lower than in the previous two
decades. Inflows of foreign capital kept investment higher than our savings
would otherwise have permitted. However, this foreign investment has some
cost--the United States must ultimately pay dividends or interest to the
foreign owners of the assets involved.
We may already be paying a price for the decline in national savings and
investment. Low savings rates have increased real interest rates and thus
reduced investment needed to raise productivity and economic output.
WHAT MUST BE DONE
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The nation needs to set a long-term fiscal policy path. The federal government
should assume responsibility for increasing the level of national savings and
investment enough to brighten the long-term prospects for healthy economic
growth. This suggests the establishment of a set of long-term fiscal goals,
perhaps stretching over a 30-year period, to promote accountability for the
long-term economic consequences of today's decisions.
The agenda is daunting but not impossible. Successful examples of such actions
include the creation of the interstate highway system, the enactment of credit
reform that recognizes the long-term cost implications of current actions, and
the enactment in 1983 of Social Security reforms that phased in changes over
time.
If short-term stimulus is needed to jump-start the economy, it should be part
of a long-run, credible plan for deficit reduction. [ Footnote 3: See
_Investment_ (GAO/OCG-93-2TR, Dec. 1992) for a discussion of the differences
between short-term stimulus and programs designed to promote longer-term
investment in infrastructure, human capital, and research and development. ]
Such a package would help assuage the financial markets and could forestall a
self-defeating rise in long-term rates that could choke off the desired
recovery. To ensure that measures introduced as temporary do not worsen the
long-term deficit problem, programs intended to provide short-term stimulus
should be phased out or paid for--either with cuts in other programs or new
revenues--as the economy improves.
Early action on the deficit is important for several reasons. First, it will
slow the growth in federal interest costs--and interest is the ultimate
example of an expenditure that does not provide any current public service.
Second, early action would take advantage of defense reductions arising from
the changing U.S. position in the post-Cold War world. Third, demographics
favor early action. Reforms in health care and retirement programs can be
introduced and phased in before a shift in the worker-to-retiree ratio
dramatically escalates both program costs and political obstacles.
Over the last decade, discretionary spending has fallen as a share of the
budget from 45 percent in 1981 to 40 percent in 1991. One of the consequences
of that decline has been a reduction in funding for federal programs with a
potential long-term impact on economic investment. [ Footnote 4: See
_Investment_ (GAO/OCG-93-2TR, Dec. 1992). ] . (See fig. 3.) The budget and
accounting process does not recognize the long-term economic benefits of these
programs, and funding for them has declined as a percent of GDP since 1980,
from 3.3 percent to 2.5 percent in 1991.
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Figure 3: Outlays for Federal Investment, Health, and Net Interest (1962-91)
The following table represents the data for this chart in the printed version
of the report. The actual figure appears in the printed report.
Source: _Budget of the U.S. Government_
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Federal programs promoting long-term investment should be highlighted, even as
deficit reduction occurs. A shift in the composition of federal spending to
investment could be supported, particularly if well-designed investment
programs can be developed that promise significant returns for economic
growth.
The nation's fiscal policy stance should be determined on macroeconomic
grounds. The choice between spending for consumption and investment is a
trade-off that should occur within the overall budgetary constraints of the
previously selected fiscal policy path. While public investment programs can
help promote economic growth, the large deficit remains as a critical
impediment to private investment and long-term economic growth.
Better budgetary decisions could be facilitated by restructuring the way the
budget is presented. For the investment debate, a restructured budget could
highlight the investment portion of the budget. A restructured budget could
also illuminate other structural aspects or trends in the budget, such as the
role of trust fund surpluses in masking the federal funds deficit.
STRATEGIES FOR REDUCING THE DEFICIT WILL HAVE TO INVOLVE ALL MAJOR PORTIONS OF
THE BUDGET
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The conclusion that we reached in our 1988 transition series report remains
valid today--there are no quick or painless solutions to the deficit. It will
be difficult, if not impossible, to achieve either balance or a surplus early
in the next century if any major areas of spending or potential revenues are
set "off the table." The very magnitude of the changes needed is likely to
prompt a major debate over the role of the federal government and how to pay
for it. It is also possible that the search for budgetary savings could prompt
a reexamination of ways to achieve federal program goals at less cost.
To achieve the necessary deficit reduction, decisionmakers will need to look
at large and/or growing areas of the budget--mandatory spending, defense,
domestic discretionary spending, and revenues.
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CONTROLLING MANDATORY SPENDING MEANS CONTAINING HEALTH CARE COSTS
Controlling the growth of mandatory spending is critical to regaining control
over priorities in the budget and obtaining the flexibility needed to
introduce new programs in response to changing needs. Most programs in this
category are growing at a moderate rate. Within this category, health care
costs both are now and will be the most rapidly growing segment. Social
Security costs will not become a major problem until the second decade of the
21st century, when the Social Security surplus will disappear and outlays
begin to exceed revenues.
Major health care reform is a necessary part of any effort to control the
budget. Such reform would have to achieve major changes in the structure and
incentives provided by our health care financing system to attain effective
cost control. Across-the-board budget caps on federal health care spending, or
on all mandatory programs, have been suggested as a way of controlling these
costs. To be meaningful, however, such caps must be accompanied by the
definitive changes in program structure and design that will be required to
conform to the caps. Not making these fundamental choices simply postpones the
hard choices and raises doubts about the enforceability of the caps.
As is the case for overall fiscal policy, a long-term plan is important in
recapturing control over programs that seem to be out of control in the short
run. Furthermore, long-range plans can help obtain consensus for major policy
changes by giving affected beneficiaries and providers enough time to adapt.
Such a strategy was used with considerable success in the 1983 Social Security
reform to phase in potentially disruptive increases in the age that
participants become eligible for benefits.
Although defense spending has declined, it might become a candidate for
further reduction as the nation continues to redefine its role in the
post-Cold War world. Continued attention will be given to reducing U. S.
overseas commitments, perhaps with a concurrent increase in the share of the
defense burden borne by others. In 1991, the United States spent about 5.5
percent of its GDP on defense, compared with about 3.0 percent for other NATO
nations and 1.0 percent for Japan.
Domestic discretionary programs bore the brunt of the budget cuts in the
1980s. This does not mean that these programs should now be exempt from
examination. Some could be better designed or made more efficient to reduce
program costs. Alternative sources of support, such as user fees and increased
cost sharing, might be considered for some programs. [ Footnote 5: For a
discussion of potential changes in the financing of federal natural resource
programs, see _Natural Resources Management Issues_ (GAO/OCG-93-17TR, Dec.
1992). ] In other cases, less costly means could be considered to achieve
federal goals; for example, alternatives to traditional imprisonment--
uch as halfway houses, electronic home detention and "boot camps"--could help
reduce the escalating costs of constructing and operating federal prisons. [
Footnote 6: See _Justice Issues_ (GAO/OCG-93-23TR, Dec. 1992). ]
However, it seems likely that, within the discretionary category, the question
may be less reducing the total than changing the mix of spending, by, for
example, shifting toward programs that support long-term economic growth and
away from those that finance current consumption. Although such a shift might
not reduce the deficit, it would represent a healthy adaptation of the budget
to changing social needs.
Further major cuts in domestic discretionary spending would necessitate a
wide-ranging reassessment of the federal role in such areas as education,
transportation, and housing. The federal role was originally premised on the
inability or unwillingness of states and localities to provide sufficient
services in these areas. Dramatic changes in state and local managerial and
programmatic profiles, due in part to the presence of many federal grant
programs, may argue for a change in the federal role.
===============================================================================
REVENUES ARE LIKELY TO BE PART OF THE PACKAGE
It is likely that spending cuts alone will not suffice to eliminate the
deficit. The size of the deficit and our recent budgetary history suggest that
revenue increases are likely to be part of any credible strategy to
substantially reduce the deficit. Proposals to raise taxes provoke controversy
because tax increases take resources out of the economy. However, borrowing
also takes resources from the economy, albeit in a less visible and less
direct way.
Revenues are likely to be part of any package because a major factor driving
up the deficit has been that growth in revenues has not kept pace with federal
spending. Spending rose to nearly 24 percent of GDP while revenues remained at
19 percent. These figures alone, however, do not tell the whole story. The mix
of revenues has also changed. Taxes supporting government operations other
than social security dropped from 15.3 percent of GDP in 1980 to 13.5 percent
in 1991 while social security taxes rose from 4 percent to 5.2 percent of GDP.
If revenue increases are to be a part of the deficit reduction equation,
several major revenue-raising options are available. The choice among them
involves not only the amount of revenue that each raises but also differences
in their impacts on economic choices, on who bears the burden, and on tax
administration. Major revenue options include income tax rate increases, base
broadening through reductions in tax expenditures, gasoline or general energy
taxes and environmental taxes, and/or a value-added or consumed income tax.
Tax rate increases can raise significant revenues with little administrative
difficulty. However, it could be argued that, although technically simple,
raising rates beyond a certain level could unravel the consensus behind the
1986 tax reform, which broadened the income tax base in exchange for reduced
rates.
Tax expenditures have continued to grow, resulting in $374 billion in lost
revenues in 1992. Reviewing these "programs" could both reduce revenue losses
and prompt a much needed examination of the programmatic goals and impacts of
these provisions. Our previous studies have questioned the efficiency of many
of these provisions, finding that many subsidize activities that would be
undertaken anyway. Further, the concept of shared sacrifice could prompt
efforts to scrutinize this sector of the federal budget at a time when outlay
programs benefiting other groups are being examined and perhaps reduced.
A gasoline tax and other energy and environmental taxes could provide both
revenue and financial incentives promoting national goals in these areas.
Concern about low savings in the United States periodically gives rise to
interest in value-added or consumed income taxes. Most recently, the
Strengthening of America Commission recommended replacement of the income tax
with a consumed income tax as a way of both providing savings incentives and
reducing the deficit.
Current budget deficits hamper the government's ability to respond to economic
downturns and pressing national needs and also absorb savings that would
otherwise be available for investment to help increase long-term economic
growth.
Action is necessary on two fronts. The deficit must be brought down. The
composition of federal spending must be shifted to put a greater emphasis on
investment than on consumption.
Reversing these patterns will require difficult decisions affecting spending
and taxes. The benefits of doing so, however, are great. A credible program to
put the long-term deficit on a downward path will help ensure a rising
standard of living for ourselves and for succeeding generations.
