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entitled 'Budget Issues: Accrual Budgeting Useful in Certain Areas but
Does Not Provide Sufficient Information for Reporting on Our Nation's
Longer-Term Fiscal Challenge' which was released on December 21, 2007.
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Report to the Committee on the Budget, U.S. Senate:
United States Government Accountability Office:
GAO:
December 2007:
Budget Issues:
Accrual Budgeting Useful in Certain Areas but Does Not Provide
Sufficient Information for Reporting on Our Nation's Longer-Term Fiscal
Challenge:
Accrual Budgeting:
GAO-08-206:
GAO Highlights:
Highlights of GAO-08-206, a report to the Committee on the Budget, U.S.
Senate.
Why GAO Did This Study:
The federal government’s financial condition and fiscal outlook have
deteriorated dramatically since 2000. The federal budget has gone from
surplus to deficit and the nation’s major reported long-term fiscal
exposures—a wide range of programs, responsibilities, and activities
that either explicitly or implicitly commit the government to future
spending—have more than doubled. Current budget processes and
measurements do not fully recognize these fiscal exposures until
payments are made. Increased information and better incentives to
address the long-term consequences of today’s policy decisions can help
put our nation on a more sound fiscal footing.
Given its interest in accurate and timely information on the U.S.
fiscal condition, the Senate Committee on the Budget asked us to update
our study of other nations’ experiences with accrual budgeting and look
at other ways countries have increased attention to their long-term
fiscal challenges.
What GAO Found:
In 2000, GAO reviewed the use of accrual budgeting—or the recording of
budgetary costs based on financial accounting concepts—in Australia,
Canada, Iceland, the Netherlands, New Zealand, and the United Kingdom.
These countries had adopted accrual budgeting more to increase
transparency and improve government performance than to increase
awareness of long-term fiscal challenges. Accrual budgeting continues
to be used in all six countries; Canada and the Netherlands, which use
accrual information selectively, considered expanding the use of
accruals but thus far have made only limited changes. Since 2000, other
countries have considered using accrual budgeting. For example, Denmark
and Switzerland began using accrual budgeting on a selective basis.
Norway and Sweden, however, rejected accrual budgeting primarily
because they believed cash budgeting enables better control over
resources.
Countries have taken different approaches in the design of their
accrual budgets. The figure below shows the range of approaches used.
Regardless of the approach taken, cash information remains important in
all the countries for evaluating the government’s finances. Other
countries’ experiences show that accrual budgeting can be useful for
recognizing the full costs of certain programs, such as public employee
pensions and retiree health, insurance, veterans benefits, and
environmental liabilities, that will require future cash resources.
However, these other countries do not use accrual budgeting to
recognize their long-term fiscal challenges that are primarily driven
by public health care and pension programs. Instead, many countries in
GAO’s study have begun preparing fiscal sustainability reports to help
assess these programs in the context of overall sustainability of
government finances. European Union members also annually report on
longer-term fiscal sustainability.
Figure: Range of Accrual Budgeting Use:
This figure is a combination of five text boxes, side by side. They are
as follows:
Full accrual at all levels of government;
Full accrual at all levels of government with cash controls;
Accrual limited to select government agencies;
Accrual limited to select programs;
Accrual limited to governmentwide surplus/deficit (agencies on a cash
basis).
Source: GAO (PhotoDisc, image).
[End of figure]
Although no change in measurement or reporting can replace substantive
action to meet our longer-term fiscal challenge, GAO believes that
better and more complete information on both the full-cost implications
of individual decisions and on fiscal sustainability of the
government’s finances can help.
What GAO Recommends:
The Congress should require increased reporting on the long-term
budgetary implications of major tax and spending programs. In addition,
Congress should explore using accrual budgeting for certain programs to
ensure the information affects incentives and budget decision making.
Congress should also require periodic reports on fiscal sustainability
for the government as a whole.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.GAO-08-206]. For more information, contact Susan
J. Irving at (202) 512-9142 or irvings@gao.gov
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Although Certain OECD Countries Continue to Use Accrual Budgeting,
Objectives and Approaches Vary Significantly:
Countries Faced a Number of Common Challenges Inherent to Accrual
Reporting That Led to Some Changes in Their Approach:
Accrual Cost Information Helped Inform Some Debates That Led to
Improvements in Fiscal Condition:
Countries Use Other Methods to Increase Awareness of Greatest Long-Term
Fiscal Challenges:
Although Accrual Budgeting Can Help in Certain Areas, It Does Not
Provide Sufficient Information to Understand Longer-Term Fiscal
Sustainability Issues:
Conclusions:
Matter for Congressional Consideration:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Major Reported Fiscal Exposures:
Table 2: Common Fiscal Indicators Used in Other Countries:
Figures:
Figure 1: Cash and Accrual Measures of Annual Fiscal Position:
Figure 2: Unified Surpluses and Deficits as a Share of GDP under
Alternative Fiscal Policy Simulations:
Figure 3: Range of Accrual Budgeting Use:
Abbreviations:
EU: European Union:
GAGAS: Generally Accepted Government Auditing Standards:
GDP: gross domestic product:
IPSAS: International Public Sector Accounting Standards:
OBEGAL: Operating Balance Excluding Gains and Losses:
OBERAC: Operating Balance Excluding Revaluations and Accounting
Changes:
OECD: Organisation for Economic Co-operation and Development:
PBGC: Pension Benefit Guaranty Corporation:
SGP: Stability and Growth Pact:
United States Government Accountability Office:
Washington, DC 20548:
December 20, 2007:
The Honorable Kent Conrad:
Chairman:
The Honorable Judd Gregg:
Ranking Member:
Committee on the Budget:
United States Senate:
The federal government's current financial condition and long-term
fiscal outlook present enormous challenges to the nation's ability to
respond to emerging forces reshaping American society, the United
States' place in the world, and the future role of the federal
government. Unfortunately, the federal government's financial condition
and fiscal outlook are worse than many may understand. In fact, the
nation's fiscal condition has deteriorated dramatically since 2000. The
federal budget has gone from surplus to deficit and the nation's major
reported long-term fiscal exposures--a wide range of programs,
responsibilities, and activities that either explicitly or implicitly
commit the government to future spending--have more than doubled.
Current budget processes and measurements do not fully recognize many
of these fiscal exposures until payments are made. Increased
information and better incentives to address the longer-term budgetary
consequences of today's policy decisions can help put our nation on a
more sound fiscal footing.
In 2000, in response to interest in whether accrual budgeting--or the
recording of budgetary costs based on financial accounting concepts--
would improve budget recognition of certain long-term
commitments[Footnote 1] and so encourage action to address them, we
looked at the use of accrual budgeting in Australia, Iceland, New
Zealand, and the United Kingdom.[Footnote 2] We also looked at two
other countries--Canada and the Netherlands--that used accrual
budgeting more selectively at that time and were considering expanding
the use of accrual budgeting. We reported that these countries had
adopted accrual budgeting more as part of broader public management
reforms to increase transparency and improve government performance
rather than as a way of increasing awareness of their longer-term
fiscal challenges. None used accrual budgeting for social insurance
programs.[Footnote 3]
We concluded that the current cash-and obligation-based budget[Footnote
4] in the United States provides equal or better control than full
accrual budgeting, but that the United States should consider expanding
the use of accrual measurement in the budget to certain areas where it
would enhance up-front control, namely federal employee pensions and
retiree health, insurance, and environmental liabilities.[Footnote 5]
For these programs, accrual measurement would move budgetary
recognition earlier to when benefits are earned or the insured event
occurs. However, for most other activities there is not a significant
difference between cash and accrual measures. Furthermore, the up-front
funding requirement under an obligation-based budget provides
policymakers greater control over capital investment.
Since our 2000 report, these nations have not only gained additional
experience with accrual budgeting but also have begun using other
measures, analyses, and reporting to improve the understanding of
broader long-term fiscal sustainability issues. Given your interest in
the importance of accurate and timely information on the U.S. fiscal
position, you asked us to update our report on the experiences of these
countries and look at other ways countries have increased attention to
their longer-term fiscal challenges. Reviewing the experience of other
countries with accrual budgeting and fiscal sustainability reporting
may identify some strategies for focusing more attention on the long-
term budgetary implications of the U.S. federal government's current
programs and policies.
Specifically, this report examines:
1. Where, how, and why is accrual budgeting used in select Organisation
for Economic Co-operation and Development (OECD)[Footnote 6] countries
and how has it changed since 2000?
2. What challenges and limitations have been discovered in the use of
accrual budgeting and how have select OECD countries responded to them?
3. What do select OECD countries perceive the effect of accrual
budgeting to have been on policy debates, program management, and the
allocation of resources?
4. Has accrual budgeting been used to increase awareness of long-term
fiscal challenges and, if not, what is used instead?
5. What does this and other GAO work tell us about where and how the
increased use of accrual concepts in the budget would be useful and
about ways to increase recognition of the long-term implications of
today's policy decisions?
We focused primarily on the six countries in our 2000 report:
* Australia,
* Canada,
* Iceland,
* the Netherlands,
* New Zealand, and:
* the United Kingdom.
We also did a limited review of two other nations--Denmark and
Switzerland--that recently expanded the use of accrual budgeting and
two countries--Norway and Sweden--that considered accrual budgeting but
decided against it.
Any analysis of budget processes, measurements, and concepts in other
nations must recognize that the role played by legislative bodies in a
parliamentary system of government is quite different than the role
played by the Congress of the United States, especially in the process
of resource allocation. All countries in our study that have adopted
accruals have parliamentary systems in which the government is formed
by the political party, or coalition of parties, that have the support
of a majority of Parliament. Many important decisions that are debated
during the annual budget and appropriations process in the Congress of
the United States occur in case study countries before the budget is
presented to Parliament for approval. The Parliaments in the countries
we studied regularly enact the government's budget without amendment;
failure to do so may be viewed as a lack of confidence in the
government. This difference is likely to influence perspectives on the
trade-offs associated with the use of accrual budgeting, particularly
in terms of accountability and legislative control.
The work on this report was done from June 2007 through December 2007
in accordance with Generally Accepted Government Auditing Standards
(GAGAS). Those standards require that we plan and perform the audit to
obtain sufficient, appropriate evidence to provide a reasonable basis
for our findings and conclusions based on our audit objectives. We
believe that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
Results in Brief:
Accrual budgeting continues to be used to some extent in all six
countries reviewed in 2000. The six countries have taken different
approaches in the design of their accrual-based budgets, and all
continue to use cash information particularly for evaluating the
overall fiscal condition. Since 2000, more OECD countries have expanded
the use of accrual measurement in the budget, including Denmark and
Switzerland. However, two countries in our study--Canada and the
Netherlands--which had considered broader expansions of accrual
budgeting, have thus far made only limited changes. Two other
countries--Norway and Sweden--also considered adopting accrual
budgeting in recent years but decided against it, primarily because
they believed the cash budget provides for better control, particularly
over capital investment.
When significantly expanding the use of accrual budgeting, there are
several common transitional challenges countries initially faced
including developing accounting standards for the budget and deciding
what assets to value and how to value them. Countries tended to work
through these issues over time. However, a number of implementation
challenges cited in our 2000 report still exist. These challenges
illustrate the inherent complexity of using accrual-based measures for
managing a nation's resources. For example, accrual-based measures
experience volatility due to changes in the value of assets and
liabilities or changes in assumptions (e.g., interest rates, inflation,
and productivity) used to estimate future payments whether or not there
has been a change in the underlying fiscal stance. Management and
oversight of noncash expenses[Footnote 7] were also cited as
challenges. These challenges have led some countries to modify their
approaches to accrual budgeting and to continue a reliance on cash-
based measures for broad fiscal policy making.
Despite these challenges, officials in many of the countries in our
2000 report believe that accrual-based cost information provides better
information on the cost of performance than cash-based measures.
Accrual budgeting, which recognizes resources as they are used to
produce goods and services, provides the full cost of all programs and
may allow for better comparisons between different methods of
delivering government services. Therefore, accrual budgeting is
expected to help program managers achieve efficiencies and better
allocate resources. Several countries cited examples of where the
provision of accrual-based cost information helped highlight the full
cost of programs, such as government employee pensions and insurance,
that were ultimately reformed. Although officials said that reform
might have occurred eventually, they believe the accrual-based cost
information helped spur action.
Accrual budgeting is not used by the countries in our study for
recognizing nations' longer-term fiscal challenges that are driven
primarily by public pension and health care programs (social insurance)
because, like the United States, the countries in our study do not
consider future social insurance benefit payments to be explicit
liabilities. Instead, many of these other countries have prepared or
are preparing reports assessing fiscal sustainability of their nation's
finances. The goal of these reports is to increase public awareness and
understanding of the long-term fiscal outlook in light of escalating
health care cost growth and population aging; to stimulate public and
policy debates; and to help policymakers make informed decisions. The
countries used several common measures, such as cash-flow measures of
future revenue and spending and summary measures of fiscal imbalance
and fiscal gaps, to assess fiscal sustainability. Each measure provides
a different perspective on the nation's long-term financing and each
measure has its limitations. Therefore, most countries use more than
one measure to assess fiscal sustainability.
Our study of these countries and our own work confirms the need for
better information to make trade-offs between individual programs and
to increase attention on longer-term fiscal challenges. Despite the
challenges that exist in estimating accrual-based cost information, it
may be preferable to be approximately right than exactly wrong. The
selective use of accrual budgeting in areas where it would enhance up-
front control of future cash resources would put programs on a more
level playing field and be beneficial. However, to improve the
understanding of the broader long-term fiscal challenges, additional
measures, analyses, and reporting, including fiscal sustainability
reporting, are needed.
As the Comptroller General has said before, our nation is on an
imprudent and unsustainable path. Continuing on our current fiscal path
would gradually erode, if not suddenly damage, our economy, our
standard of living, and ultimately even our domestic tranquility and
our national security. Although no change in measurement or reporting
can replace substantive action to meet our longer-term fiscal
challenge, we believe that increasing the use of accrual-based cost
information for budget decisions involving both existing and proposed
programs that require significant future cash resources could
facilitate consideration of competing demands. At the same time a
fiscal sustainability report would provide both the nation's citizens
and policymakers with a comprehensive picture of the long-term fiscal
condition of the government as a whole.
Background:
The U.S. federal budget[Footnote 8] serves as the primary financial
plan of the federal government and thus plays a critical role in the
decision-making process. Policymakers, managers, and the American
people rely on it to frame their understanding of significant choices
about the role of the government and to provide them with information
to make decisions about individual programs and overall fiscal policy.
The budget process helps highlight for policymakers and the public the
overall "cost" of government. Since the budget process also serves as a
key point of accountability between policymakers and managers, the way
"costs" are measured and reported in the budget can have significant
consequences for managerial incentives. The term "cost" has different
meanings in the budget and financial statements. In the budget, the
term "cost" generally refers to the amount of cash needed during the
period. In the financial statements, the term "cost" means the amount
of resources used to produce goods or deliver services during the
period regardless of when cash is used. Therefore, one goal of accrual
budgeting is to report the "full cost" of government services provided
during the year.[Footnote 9] The different methods of reporting (e.g.,
cash, obligations, or accrual) represent much more than technical means
of cost measurement. They reflect fundamental choices about the
information and incentives provided by the budget.
Cash-based measurement records receipts and outlays when cash is
received or paid, without regard to when the activity occurs that
results in revenue being earned, resources being consumed, or
liabilities being increased. In comparison, obligation-based budgeting--
which is used in the U.S. federal government--focuses on the legal
obligations entered into during a period regardless of when cash is
paid or received and regardless of when resources acquired are to be
received or consumed. Obligation-based budgeting provides an additional
level of control over pure cash budgeting by requiring that federal
agencies have statutory authority to enter into obligations to make
outlays of government funds. With limited exceptions, the amounts to be
obligated are measured on a cash or cash-equivalent basis. Therefore,
we generally refer to the U.S. federal budget as "cash based."[Footnote
10]
In contrast to cash-and obligation-based budgeting, accrual budgeting
generally involves aligning budget recognition with the period in which
resources are consumed or liabilities increased, rather than when
obligations are made or cash flows occur. Although accruals can be
measured in a variety of ways, the term accrual budgeting typically has
been used in case study countries to refer to the recording of
budgetary costs based on concepts in financial accounting standards.
Thus, accrual-based budgeting generally provides information similar to
that found in a private sector operating statement.
Choices about the appropriate method of budget reporting are
complicated by the multiplicity of the budget's uses and users,
including policymakers and managers. The federal budget is
simultaneously asked to provide full information and appropriate
incentives for resource allocation, control over cash, recognition of
future commitments, and the monitoring of performance. Given these
multiple and potentially competing objectives, choices about the method
of budget reporting involve trade-offs. For example, control over
spending is greatest if the budget recognizes the full cash cost at the
time the decision is made but assessing performance and its cost is
generally best supported by accrual-based cost information, which
recognizes resources as they are used to produce goods and services.
The up-front funding requirement under an obligation-based budget helps
ensure policymakers' control over the acquisition of a new building but
does not align its cost with its use. Conversely, accrual budgeting
better aligns the cost of the building with the periods that benefit
from its use, but in its simplest form it does not provide for up-front
control over entering a legally binding commitment to purchase the
building. Given the necessary trade-offs, the method of budget
reporting should be selected to meet the primary decision-making and
accountability needs of a governmental system while balancing the needs
of multiple users.
Cash and Accrual Measures of the Government's Annual Fiscal Condition:
The federal government reports both cash and accrual measures of its
current finances. The key focus of the policy debate is the unified
budget deficit/surplus. With limited exceptions,[Footnote 11] the
unified budget deficit/surplus is the difference between cash receipts
and cash outlays for the government as a whole including any Social
Security surplus.[Footnote 12] The second measure, the government's net
operating cost, is the amount by which costs--as reported on an accrual
basis--exceed revenue and is reported in the federal government's
financial statements.[Footnote 13] Figure 1 shows the cash and accrual
measures for fiscal years 2000 to 2007.
Figure 1: Cash and Accrual Measures of Annual Fiscal Position:
This figure is a combination line chart showing cash and accrual
measures of annual fiscal position. The X axis is the fiscal year, and
the Y axis represents billions of dollars.
[See PDF for image]
Source: Department of the Treasury.
Note: Data from the Financial Reports of the United States Government.
The fiscal year 2005 accrual results included a significant negative
actuarial adjustment, and 2006 included a significant positive
adjustment, primarily due to changes in interest rate assumptions used
to estimate the veterans compensation liability.
[End of figure]
The cash and accrual results are based on the same underlying
activities--the differences arise due to the timing of when the costs
of certain activities are recognized. As explained earlier, for the
cash-based budget deficit, costs are recorded when cash payments are
made for goods received or services performed. For the accrual deficit,
costs are recognized when goods are used or services are performed
regardless of when cash payments are made. For many program areas, the
timing difference is small but for others the timing differences can
amount to billions of dollars each year. Differences arise when a cost
is accrued (and affects the accrual deficit) in one fiscal year but
paid (and affects the cash deficit) in another fiscal year. The
following six areas account for the largest differences between cash
and accrual deficits:[Footnote 14]
* civilian employee benefits,
* military employee benefits,
* veterans compensation,
* environmental liabilities (e.g., cleanup and disposal),
* insurance programs, and:
* capital assets.
For example, the accrual deficit includes an expense for current
employees' pension and other retirement benefits, which are earned
during the employee's working years and are part of the annual cost of
providing government services but not paid until sometime in the future
when the employee retires. The cash budget deficit does not include
retirement benefits earned today, but it does reflect payments made to
current retirees. (These cash payments reflect past accrued expenses.)
The difference between the accrued retirement benefits recognized and
cash payments made during the year is the difference between the
accrual and cash measures due to employee benefits.
In the year that capital assets such as structures and equipment are
purchased, the budget recognizes the full cash cost to provide decision
makers with the information and incentives to make efficient decisions
at the only time that they can control the cost. Specifically, budget
authority for the asset's full cash cost must generally be provided up
front before the asset can be purchased. The full cash cost of a
capital asset is recorded as an outlay and included in the cash budget
deficit when the asset is paid for. However, under the accrual basis of
accounting used in the financial statements, the cash cost of the asset
is initially recorded on the balance sheet. The cash cost of the asset
is then spread over its expected useful life to match the asset's cost
with its use. Therefore, each year the accrual deficit only reflects
one year's worth of the cash cost, called depreciation expense.
We have previously noted that while both cash and accrual measures of
the government's overall finances are informative, neither measure
alone provides a full picture.[Footnote 15] For example, the unified
budget deficit provides information on borrowing needs and current cash
flow, but does not measure the amount of resources used to provide
goods or services in the current year. While the accrual deficit
provides information on resources used in the current year, it does not
provide information on how much the government has to borrow in the
current year to finance government activities. Nor does it provide
information about the timing of payments and receipts, which can be
very important. Therefore, just as investors need income statements,
statements of cash flow, and balance sheets to understand a business's
financial condition, both cash and accrual measures are important for
understanding the government's financial condition.
Although a more complete picture of the government's fiscal stance
today and over time comes from looking at both the cash and accrual
measures than from looking at either alone, even the two together do
not provide sufficient information on our future fiscal challenges. In
addition to considering the federal government's current financial
condition, it is critical to look at other measures of the long-term
fiscal outlook of the federal government. While there are various ways
to consider and assess the long-term fiscal outlook, any analysis
should include more than just the obligations and costs recognized in
the budget and financial statements. It should take account of the
implicit promises embedded in current policy and the timing of these
longer-term obligations and commitments in relation to the resources
available under various assumptions. For example, while the cash and
accrual measures showed improvement between fiscal year 2005 and fiscal
year 2007, our long-term fiscal outlook did not change. In fact, the
U.S. government's total reported liabilities, net social insurance
commitments, and other fiscal exposures continue to grow and total more
than $52 trillion, representing approximately four times the nation's
total output, or gross domestic product (GDP), in fiscal year 2007, up
from about $20 trillion, or two times GDP in fiscal year 2000 (see
table 1).
Table 1: Major Reported Fiscal Exposures:
Dollars in trillions.
Explicit liabilities: Publicly held debt Military and civilian pensions
and retiree health;
2000: 6.9;
2007: 10.8;
Percent increase: 57.
Commitments and contingencies: For example, PBGC,[A] undelivered
orders;
2000: 0.5;
2007: 1.1;
Percent increase: 97.
Implicit exposures;
2000: 13.0;
2007: 40.8;
Percent increase: 213.
Implicit exposure: Future Social Security benefits;
2000: 3.8;
2007: 6.8;
Percent increase: [Empty].
Implicit exposure: Future Medicare Part A benefits;
2000: 2.7;
2007: 12.3;
Percent increase: [Empty].
Implicit exposure: Future Medicare Part B benefits;
2000: 6.5;
2007: 13.4;
Percent increase: [Empty].
Implicit exposure: Future Medicare Part D benefits;
2000: [Empty];
2007: 8.4;
Percent increase: [Empty].
Total;
2000: 20.4;
2007: 52.7;
Percent increase: 158.
Source: Department of the Treasury.
Note: Data from 2000 and 2007 Financial Reports of the United States
Government. Estimates for Social Security and Medicare are at present
value as of January 1 of each year and all other data are as of
September 30. Totals and percent increases may not add due to rounding.
[A] Pension Benefit Guaranty Corporation.
[End of table]
Another way to assess the U.S. government's long-term fiscal outlook
and the sustainability of federal programs is to run simulations of
future revenues and spending for all federal programs, based on a
continuation of current or proposed policy. Long-term simulations by
GAO, the Congressional Budget Office, and others show that we face
large and growing structural deficits driven primarily by rising health
care costs and known demographic trends. As shown in figure 2, GAO's
long-term simulations--which are neither forecasts nor predictions--
continue to show ever-increasing long-term deficits resulting in a
federal debt level that ultimately spirals out of control. The timing
of deficits and the resulting debt buildup varies depending on the
assumptions used, but under either optimistic ("Baseline Extended") or
more realistic assumptions ("Alternative simulation"), the federal
government's current fiscal policy is unsustainable.[Footnote 16]
Figure 2: Unified Surpluses and Deficits as a Share of GDP under
Alternative Fiscal Policy Simulations:
This figure is a combination line graph showing unified surpluses and
deficits as a share of GDP under alternative fiscal policy simulations.
The X axis represents the fiscal year, and the Y axis represents the
percent of GDP. One line represents the Baseline extended, and the
dotted line represents Alternative simulation.
[See PDF for image]
Source: GAO.
Note: The data are from GAO's August 2007 analysis in GAO-07-1261R.
[End of figure]
One summary measure of the long-term fiscal challenge is called "the
fiscal gap." The fiscal gap is the amount of spending reduction or tax
increases that would be needed today to meet some future debt target.
To keep debt as a share of GDP at or below today's ratio under our
Alternative simulation would require spending cuts or tax increases
equal to 7.5 percent of the entire economy each year over the next 75
years, or a total of about $54 trillion in present value terms. To put
this in perspective, closing the gap would require an immediate and
permanent increase in federal tax revenues of more than 40 percent or
an equivalent reduction in federal program spending (i.e., in all
spending except for interest on the debt held by the public, which
cannot be directly controlled).
As demonstrated by these various measures, our nation is on an
unsustainable fiscal path. This path increasingly will constrain our
ability to address emerging and unexpected budgetary needs and will
increase the burdens that will be faced by future generations. Since at
its heart the budget debate is about the allocation of limited
resources, the budget process can and should play a key role in helping
to address our long-term fiscal challenge.
Although Certain OECD Countries Continue to Use Accrual Budgeting,
Objectives and Approaches Vary Significantly:
The six countries reviewed in 2000 continue to use accrual budgeting.
However, two countries that were considering broader expansions of
accrual budgeting have thus far made only limited changes. Although
each country's budgeting framework has unique features, the six
countries have taken one of two broad approaches toward accrual
budgeting:
* One approach uses accruals for most or all items in the budget
primarily to support broader efforts to improve government performance.
* A second approach more selectively uses accrual information in areas
where it increases recognition of future cash requirements related to
services provided during the year that are not fully recognized in a
cash-based budget.
Regardless of which approach is used, cash information remains
important in all the countries to evaluate overall fiscal position.
None of the countries reviewed include anticipated future payments for
social insurance programs (namely public pensions and health services)
in the current year's budget measure. Social insurance programs are
generally viewed as transfer payments rather than liabilities. Transfer
payments are benefits provided without requiring the recipient to
provide current or future goods or services of equivalent value in
return.
Accrual Budgeting Continues to Be Used in the Six Countries Studied but
Two Did Not Expand Their Use as Previously Anticipated:
Since 2000, three countries--Australia, New Zealand, and Iceland--have
continued to use the accrual budgeting frameworks in place in 2000. In
2000, we reported that the United Kingdom was planning to implement an
accrual-based budgeting framework, called Resource Accounting and
Budgeting. After Parliament passed the necessary legislation in 2000,
the United Kingdom implemented resource accounting and budgeting in
2001. The United Kingdom has continued to make some modifications to
its framework, including introduction of controls over cash.
Although two countries--the Netherlands and Canada--have considered
broader expansions of accrual budgeting since 2000, thus far they have
made only limited changes. In the Netherlands only budgets for some
government agencies are on an accrual basis and the governmentwide
budget remains on a modified cash basis. The Dutch government decided
against moving the governmentwide budget to an accrual basis in 2001.
Although the Dutch cabinet thought that the accrual-based system added
value at the agencies where it had been implemented, it thought the
cost of implementing accrual budgeting governmentwide, including
changing information systems, developing accounting standards, and
changing regulations would outweigh any advantages.
In 2003 Canada significantly expanded the use of accruals in the
governmentwide budget, but the information used to support
appropriations (called the Main Estimates) and the appropriations
themselves remain largely on a cash basis.[Footnote 17] Since the
1990s, there has been debate within the Canadian government concerning
the appropriate application of accruals. The Canadian Office of the
Auditor General and a key committee in Parliament, the House of Commons
Committee on Public Accounts, have advocated preparing the Main
Estimates on a full accrual basis. The current government agrees in
principle that accrual measurement can be useful but considers this to
be a complex issue that requires study and consultation with
parliamentarians. After consultation with parliamentarians, the current
government plans to present a model for a new accrual-based
appropriations process in 2008.
Although the use of accrual budgeting in other major industrialized
countries has grown, it is not currently the norm. Since 2000, the
number of OECD countries that report using accruals at least in part
has increased.[Footnote 18] For example, as noted previously, Denmark
and Switzerland recently expanded the use of accruals in the budget.
Some countries also report using both cash-and accrual-based accounting
in the budget. However, the majority of OECD countries reported using
either cash-or obligation-based budgeting or both.
The extent to which countries in our study used accrual budgeting
varied--from full accrual at all levels of government to more limited
use at either the agency or program level. Figure 3 illustrates the
broad range of use.
Figure 3: Range of Accrual Budgeting Use:
This figure is a combination of five text boxes, side by side. They are
as follows:
Full accrual at all levels of government;
Full accrual at all levels of government with cash controls;
Accrual limited to select government agencies;
Accrual limited to select programs;
Accrual limited to governmentwide surplus/deficit (agencies on a cash
basis).
[See PDF for image]
Source: GAO (PhotoDisc, image).
[End of figure]
The extent to which countries use accrual budgeting generally reflects
the objectives to be satisfied. Countries that switched to accrual
budgeting primarily as a way of providing better cost and performance
information for decision making generally used accruals to a greater
extent in the budget, as illustrated by the first two approaches--full
accrual at all levels of government. In general, these countries also
sought to put financial reporting and budgeting on a consistent basis.
Countries that switched to accrual budgeting primarily as a way of
increasing recognition of future cash requirements related to services
provided during the year generally use it only for selected programs
where accruals enhance up-front control and provide better information
for decision making (e.g., loans and government employee pensions);
this approach is similar to the United States' current use of accruals.
Regardless of the approach, cash information remains important. Most
countries in our study continue to use cash-based measures for broad
fiscal policy decisions. The following section describes each country's
objective and approach in more detail.
Most Countries Use Accruals Primarily to Increase Transparency and
Improve Government Performance:
Four countries--Australia, New Zealand, the Netherlands, and the United
Kingdom--primarily use accrual budgeting to support broader efforts to
improve the efficiency and performance of the public sector. Compared
to cash-based budgeting, accruals are thought to provide better cost
information and to encourage better management of government assets and
liabilities. Among this group of countries, however, there is
significant variation in the scope of accrual budgeting as well as the
linkage between performance goals and appropriations.
Australia and New Zealand:
Since the 1990s, Australia and New Zealand have extensively used
accruals in conjunction with output-based budgeting.[Footnote 19] The
introduction of accrual budgeting in both countries was a key element
of broader reforms meant to improve the efficiency and performance of
the public sector. Reformers in both countries thought that accruals
would provide better cost information and better management incentives
than the previous cash-based budgeting framework. Reformers also
thought it was important to have a consistent framework for budgeting
and financial reporting to allow actual performance to be compared with
expectations.
Accrual budgeting in both countries is also intended to provide funding
for the full cost of departments' activities. Australia and New Zealand
departments receive funding for noncash expenses, such as depreciation
of existing assets, accrued employee pension benefits,[Footnote 20] and
the estimated future costs of environmental cleanup resulting from
government activities. Reformers in both countries thought that
appropriating on a full-cost basis created compelling incentives for
department managers to focus on the full cost of their department's
activities as well as manage noncash expenses.
One important feature of Australia's and New Zealand's budgeting
frameworks is that departmental appropriations are closely linked to
outcomes and outputs, and department executives are given considerable
flexibility in managing their department's finances, provided that the
department meets its performance goals. It is thought that giving
department executives more flexibility generally contributes to better
performance. In comparison to the United States, the appropriations
acts in Australia and New Zealand place less emphasis on how
departments allocate their funding among different types of expenses.
Nevertheless, two key departments, the Treasury in New Zealand and the
Department of Finance and Administration in Australia, do centrally
review and must approve departmental plans for major capital purchases.
The Netherlands:
The Netherlands has used accrual budgeting in select government
agencies primarily as a tool for improving performance. In the early
1990s, the government allowed a limited number of government entities
(called agencies) to operate as if they were private sector contractors
by adopting a results-oriented performance-management model, including
accrual accounting and budgeting. Under the Dutch approach, the
agencies are effectively service providers for the central government's
ministries. These agencies receive funding for the accrual-based cost
from the ministries that they service. For example, although the
Ministry of Justice is appropriated funds on a cash basis to buy
services from the Prison Service, the Prison Service charges the
ministry the full cost of the services it provides. The number of
government entities participating in this program has increased from 22
in 2000 to approximately 40 in mid 2007. However, while the agencies
budgeting on an accrual basis represent about 60 percent of the
government in terms of employees, they are a small part of the
government's overall budget since the majority of the Dutch
government's expenditures are spent on transfer payments, which
continue to be budgeted on a cash basis.
The United Kingdom:
The United Kingdom implemented what it calls resource budgeting for
financial year 2001-2002. The United Kingdom's approach makes less use
of the Australia-New Zealand form of performance-based budgeting and
imposes tighter controls on cash than the Australia and New Zealand
approaches. The United Kingdom's Parliament votes both cash and
"resources" (i.e., the full accrual-based cost of a department's
services). The resource budget recognizes such noncash expenses as
accrued employee pension benefits as well as depreciation of existing
assets but limits the ability of departments to use funds appropriated
for noncash items to fund current spending. Treasury officials from the
United Kingdom told us that in practice this near-cash limit on
departmental spending is the focus of budgetary planning. Treasury
officials also noted that although departments have public service
agreements that include performance targets, the United Kingdom has not
really used outcome-based budgeting.
Some Countries Use Accrual Measures Selectively in Areas Where It
Enhances Transparency of the Government's Future Cash Requirements:
A second approach has been to use accrual information more selectively
for programs or areas where it highlights annual costs that are not
fully recognized in the cash-based budget. Iceland and Canada generally
have taken this approach.
Iceland:
Since 1998, Iceland has budgeted on an accrual basis except for capital
expenditures, which remain on a cash basis. Iceland's approach was
designed primarily to improve transparency and accountability in its
budget. The only areas with significant differences between cash-and
accrual-based estimates are government employee pensions, interest, and
tax revenue. Iceland also uses accrual budgeting for loan programs.
Accrual budgeting in Iceland has had only a limited effect on
department-level budgets for two reasons. First, capital budgeting
remains on a cash basis. Second, the oversight and administration of
employee pensions, tax revenue, and the subsidy costs for loans are
located in the Finance Ministry, not individual departments.
Consequently, for most Icelandic departments, there are only minor
differences between cash-and accrual-based estimates for the
department's operating budgets.
Canada:
The federal government of Canada currently uses both accrual and cash
for budgeting purposes. The governmentwide budget is largely on an
accrual basis; the information used to support appropriations (called
the Main Estimates) and the appropriations themselves remain largely on
a cash basis; certain areas such as the future pensions for current
employees are measured on an accrual basis.[Footnote 21] Canada's
current government has been considering moving the Main Estimates and
appropriations to a full accrual basis. Since the 1990s, the Canadian
Office of the Auditor General and a key parliamentary committee, the
House of Commons Committee on Public Accounts, have recommended moving
appropriations to an accrual basis so that managers would make more
informed decisions about the use of resources. The Office of the
Auditor General and the committee think it is important to use the same
accounting standards in the budget and the Estimates. The current
government agrees that moving to accrual-based budget and
appropriations may have benefits. Officials from Canada's Finance
Department and Treasury Board Secretariat told us that it was important
to study the experience of other governments with accruals before
designing a new, accrual-based appropriations process. The officials
also said the current government was consulting with members of
Parliament and plans to present a model for Parliament's consideration
in 2008.
Cash Information Remains Important, Particularly for Monitoring a
Country's Fiscal Position:
Regardless of the approach taken in use of accrual budgeting, all of
the countries consider cash information to be important, particularly
for monitoring the country's fiscal position even where fiscal
indicators are accrual based. Three of the countries--Australia, the
Netherlands, and the United Kingdom--calculate the governmentwide
surplus/deficit on either a cash or near-cash basis. In the other three
countries--Iceland, New Zealand, and Canada--aggregate fiscal
indicators are largely accrual based, but officials we spoke with said
that cash information continues to be important in evaluating fiscal
policy.
Although Australia extensively uses accruals for departmental
appropriations, Australian officials said that a key measure for
policymakers is the country's surplus measured on a cash
basis.[Footnote 22] This is due in part to a goal of running cash-based
surpluses over the business cycle to contribute to national savings.
Both the Netherlands and the United Kingdom, as members of the European
Union (EU), are required to report the net lending or borrowing
requirement, which officials described as a near-cash number.[Footnote
23] Officials from the United Kingdom also said that cash information
is important because the current government has pledged to avoid
borrowing to finance current expenditures and to keep net debt at
prudent levels. New Zealand makes several adjustments to the accrual-
based operating balance to remove items that do not affect the
underlying financing of government and must pay attention to its cash
position to ensure it meets its debt-to-GDP target.
Several Other OECD Countries Have Considered Accrual Budgeting since
2000 but Reached Different Decisions:
Since 2000, at least two additional OECD countries--Denmark and
Switzerland--have expanded the use of accruals in the budget without
moving to full accrual budgeting. Switzerland has recently expanded
accrual measurement as part of broader reforms to improve government
financial reporting. However, Switzerland's governmentwide surplus/
deficit continues to be calculated on a cash basis and some government
assets, such as defense assets, are not capitalized. Beginning in 2007,
Denmark moved departmental operating budgets and associated capital
spending to an accrual basis, primarily to support efforts to improve
the performance of government departments. However, Denmark does not
accrue capital spending on infrastructure, and both grants and transfer
payments are measured on a cash basis.
Sweden and Norway considered moving toward accrual budgeting but
decided against it. Between 1999 and 2003 Sweden developed a plan to
move from cash to accrual budgeting but in 2004 chose not to implement
these plans. Swedish officials said that the government was concerned
that accrual budgeting would diminish control of cash spending,
potentially undermine fiscal discipline and lead to bigger investments,
principally for infrastructure and war equipment. Norway went through a
similar decision process. In 2003, a government-appointed committee
recommended Norway move to full accrual budgeting, but the government
at that time argued that the fiscal policy role of the budget is better
served by cash-based appropriations and that the cash system enables
better control of investments. Parliament agreed. However, Norway is
testing accrual accounting at 10 agencies to achieve purposes similar
to those cited by other countries--namely to provide better cost
information; to establish a baseline for benchmarking costs, both
between government agencies and in relation to private organizations;
and to generate more complete information on the assets and liabilities
of the government.
Countries Faced a Number of Common Challenges Inherent to Accrual
Reporting That Led to Some Changes in Their Approach:
Any significant expansion in the use of accruals creates a number of
transitional challenges, including how to develop accounting standards
for the budget and deciding what assets to value and how to value them.
Beyond transitional issues however, there are several challenges
inherent to accrual budgeting, as we noted in 2000. These challenges
illustrate the inherent complexity of using accrual-based numbers for
managing a nation's resources and led to some modifications in
countries' use of accrual reporting in the budget, such as reliance on
more cash-based measures of the overall budget.
Countries Have Generally Addressed Challenges Related to Developing
Accounting Standards to Be Used in the Budget, Including Asset
Identification and Valuation:
Developing accounting standards to use in the budget and deciding what
public assets to value and how to value them were initial challenges
for countries moving to accrual budgeting. These took time to work out
and refinements continue. Some countries in our study sought to put the
government's financial reporting and budgeting on the same basis and to
make them comparable to the private sector. In all, three of the six
countries in our 2000 report and Denmark said that the technical
standards used in the budget were substantially based on private-sector
accounting standards. Only Canada and Switzerland said the technical
standards were based on public sector accounting standards. Three
countries--Australia, the Netherlands, and the United Kingdom--
reported that the standards used for aggregate measures were based on
national accounting standards (similar to the national income and
product accounts in the United States) set by an international
organization (e.g., the International Monetary Fund's Government
Finance Statistics or the European System of Accounts).
Some countries in our study thought that adopting standards and
concepts developed by independent bodies was important. While both cash
and accrual accounting can be subject to gaming, some believe that
accrual accounting in particular opens up the opportunity for
manipulation. Three countries responded that a commission of experts
outside of government developed the standards. Other countries,
however, said that although their standards were based on independent
standards, the finance ministry or bureau of statistics has the
ultimate responsibility for developing standards. In these countries,
accounting standards were generally not adopted intact from an
independent entity. For example, Switzerland's accrual budgeting system
is designed to be closely aligned with the international public sector
accounting standards (IPSAS), but there were some deviations from IPSAS
for constitutional reasons such as compliance with the cash-based
balanced budget requirement. Also, for practical reasons, Switzerland
does not capitalize defense investments, which is required under IPSAS.
Besides developing the accounting standards to be used in the budget, a
key challenge when switching to accrual budgeting, particularly for
countries that choose to treat capital on an accrual basis (i.e., to
capitalize assets and record them on the balance sheet) and provide
funding for noncash depreciation costs, is to ensure that the recorded
value of the capital asset is as accurate as possible. The value of the
capital asset is used to calculate annual depreciation costs and in
turn fund future capital acquisitions (replacements). If an agency
overvalued its assets, it could be difficult to reduce the level of
assets once accrual budgeting is implemented because the excess value
represents a source of funding for the agency in the form of
depreciation. On the flipside, if assets were undervalued, they may not
provide good information on the cost of maintaining or replacing the
asset. In 2004, for example, the New Zealand government purchased the
nation's rail network for only NZ$1. Officials with whom we spoke said
the NZ$1 value did not yield good information about annual depreciation
(maintenance) costs. Therefore the New Zealand government revalued the
network at NZ$10.3 billion in 2006; this revaluation led to an increase
in the New Zealand government's net worth. More importantly, the annual
operating balance used in the budget now reflects the associated
depreciation costs.
In Australia, the government thought that capitalizing assets would
lead to a better understanding of what is owned and what would be
needed in the future. However, an Australian official said departments
still request supplementary funding to replace old assets. An
Australian official said that this may be because some departments were
not fully funded for all capitalized assets in their opening balance
sheets during the move to accrual budgets. It could also be because new
asset purchases are not identical to the assets they replace or because
agencies did not have sufficient assets to carry out their goals in the
first place.
Asset identification and valuation were cumbersome and time-consuming
efforts for the countries that chose to capitalize assets. Indeed, one
of the reasons that Iceland decided against capitalizing assets was the
difficulty it would have faced identifying and agreeing on the asset
values. Valuing assets poses special problems in the public sector
since it owns unique assets such as heritage assets (e.g., museums and
national parks) and defense assets (e.g., weapons and tanks). By
nature, heritage assets are generally not marketable. Their cost is
often not determinable or relevant to their significance and they may
have very long life cycles (e.g., hundreds of years). Although the
recognition issues associated with heritage assets are challenging,
these assets are generally not very significant in terms of the overall
effect on fiscal finances. As a result, valuing heritage assets may be
seen as not worth the effort. Indeed, of all the countries we reviewed,
only Australia and New Zealand capitalize all assets. The other
countries exclude unique government assets such as highways, bridges,
national parks, historical buildings, and military assets.
The most common approaches for valuing assets are historical cost and
fair value. (Fair value is usually the same as market value; in the
absence of reliable market values, replacement cost is often used.)
Five of seven countries in our study that measure capital assets on an
accrual basis use fair or market value. Only two--Canada and Denmark--
use historical cost. Use of market value relies on professional
judgments to assess values and the values can fluctuate sharply between
reporting periods. Although historical cost is based on a verifiable
acquisition price and does not fluctuate, the reported amounts may not
reflect the current value of the asset. Furthermore, it is often very
difficult to estimate the original costs of government assets that are
hundreds of years old or for which cost records have not been
maintained.
Developing Reliable Financial Data Is Seen as a Prerequisite to Accrual
Budgeting in Some Countries:
We have reported that enhancing the use of performance and "full-cost"
information in budgeting is a multifaceted challenge that must build on
reliable cost and performance data, among other things.[Footnote 24]
Reliable financial information was also viewed as important to have
before moving to accrual budgeting in some countries we reviewed. For
example, in the Netherlands, an agency must receive a "clean audit" or
an unqualified audit opinion for the year prior to moving to accrual
budgeting and at least 6 months must have been spent in a trial run of
the accrual accounting system. Other criteria must also be met before
moving to accrual-based budgeting and receiving the associated
flexibilities including being able to describe and measure the agency's
products and services. Before moving to accrual budgeting in New
Zealand, a department had to define its broad classes of outputs,
develop an accrual-based system capable of monthly and annual
reporting, and develop a cost-allocation system to allocate all input
costs including depreciation and overhead to outputs and provide
assurance it had an adequate level of internal controls. There was not,
however, a requirement for an unqualified opinion for the agency.
Accrual budgeting can also lead to improvements in financial
information. Auditable financial accounts were not a prerequisite for
moving to accrual budgeting in the United Kingdom. When the United
Kingdom moved to accrual budgeting in 2001-2002, the government had 16
accounts for central government departments with "qualified"
opinions.[Footnote 25] However, since the introduction of accrual
budgeting, the United Kingdom reported that the number of qualified
accounts had declined and the timeliness of financial reporting, which
maximizes the usefulness of the information to managers, Parliament,
and other stakeholders, has improved.
Volatility in Aggregate Accrual Measures Can Lead to Use of More Cash-
Like Measures:
Both cash and accrual measures are subject to volatility. Cash
accounting may not be useful for measuring cost because spikes in
receipts or payments can cause swings in the apparent "cost" of a
program or activity. For example, if a program purchases a large amount
of equipment in one year, it will appear costly under cash accounting,
but under accrual accounting, only a proportion of the equipment's cost
in the form of depreciation would be shown in that year. Accrual
measures experience volatility for other reasons such as changes in the
value of assets and liabilities or changes in assumptions (e.g.,
interest rates, inflation, and productivity) used to estimate future
payments.
Because the accrual-based operating results can be volatile due to
events outside the government's control, New Zealand generally does not
use it as a measure of the government's short-term fiscal stewardship.
For example, under New Zealand's accrual-based accounting standards,
most assets are revalued at least every 3 years. New Zealand uses fair
value, which is usually the same as market value when there is an
active market. As noted above, market values tend to fluctuate between
reporting periods. The changing market values can cause swings in the
reported accrual-based operating results because such changes are
reflected as revenue or cost in the year revalued. Therefore, changes
in operating results may reflect not a fundamental change to the
government's finances but rather changes in the value of assets or
liabilities that do not affect the government's financing in the
current period. Fluctuations can also result from annual changes in the
value of liabilities when there are deviations between actual
experience and the actuarial assumptions used or changes in actuarial
assumptions. The liabilities for New Zealand's government pension and
insurance programs, for example, fluctuate from year to year partly due
to changes in the underlying assumptions such as interest rates and
inflation.[Footnote 26] To deal with this, the New Zealand Treasury
removes revaluations and other movements that do not reflect the
underlying financing of government from its operating balance. It is
this measure--the Operating Balance Excluding Revaluations and
Accounting Changes (OBERAC)--that has been the focus of policy debates
in New Zealand since about 2001.
More recently the New Zealand Treasury shifted its focus to a new
measure--Operating Balance Excluding Gains and Losses (OBEGAL). Gains
and losses can result when the value of an asset or liability differs
from the value booked on the balance sheet. If the government sells an
asset and the sales price equals book value, there is no gain or loss,
because a cash inflow equal to book value is the exchange of one asset
for another of equal recorded value. However, if the sales price is
more or less than the book value of the property, the difference is
reflected as a gain or loss. New Zealand set up a fund to partially
prefund future superannuation expenses.[Footnote 27] This fund reports
gains and losses on its investments. Because the current government
wishes to retain the investment returns in the fund, beginning with the
2007 budget the government has shifted its focus to the OBEGAL to
ensure the government is meeting its fiscal objectives. New Zealand
said that by excluding net gains and losses the OBEGAL gives a more
direct indication of the underlying stewardship of the government.
Complexity of Accrual-Based Accounting and Use of Cash-Based Fiscal
Targets Makes It Difficult for Policymakers to Focus on Accrual
Measures:
Accrual accounting is inherently more complex than cash-based
accounting, which is like managing a checkbook. One Australian official
noted that using accrual measures can be challenging because many
cabinet ministers and members of Parliament are trained in professional
fields other than finance and accounting and may be more familiar with
cash budgeting.
Focusing on accrual-based numbers can be difficult given the existence
of cash-based fiscal policy targets. For example, several countries--
Canada, New Zealand, and the United Kingdom--have fiscal policy targets
that target the amount the country can borrow; borrowing (or debt) is
based on cash measures. Also, while accrual numbers are used at the
agency level in Australia, Australia has had a goal of running cash-
based surpluses over the business cycle. This is due in part to a long-
standing goal in Australia to improve national savings. At the time of
our study,[Footnote 28] Australia's Treasurer primarily focused on the
cash-based fiscal position to show the government's effect on national
savings.[Footnote 29] Agency managers therefore have an obligation to
manage both the cash and accrual implications of their resource use.
New Zealand also pays attention to its cash position. New Zealand's
current fiscal policy goal is to maintain gross debt at around 20
percent of GDP. This means that New Zealand's cash position must be
such that cash receipts equal cash outlays excluding interest
expense.[Footnote 30] It also means the accrual-based operating surplus
must be sufficient to cover investments--cash needed today but not
expensed until the future.
Cash information is still used at both the overall fiscal policy level
and department level in the United Kingdom. The current United Kingdom
government has pledged to avoid borrowing to finance current
expenditures and maintain public debt at a prudent level. Both of the
government's fiscal targets are measured on a near-cash basis.
Consequently, United Kingdom Treasury officials said that Treasury has
imposed limits on departmental cash spending because spending directly
affects the country's cash-based fiscal position.
Concerns about Management and Oversight of Noncash Expenses Can Lead to
Increased Use of Cash Controls:
Different countries have taken different approaches to managing noncash
expenses, particularly in regard to capital assets. In Australia and
New Zealand, cash is appropriated for the full accrual amounts,
including noncash items such as depreciation for existing assets.
Agencies are expected to replenish their current assets from funding
provided for depreciation and they have the funding to do so (subject
to the oversight discussed below). The full cost of government is the
focus of the operating budget rather than the immediate cash
requirement. The downside of this approach is that control of cash and
capital acquisitions to replace assets can become challenging. If an
agency is given cash to fund depreciation expense, there is a risk that
agencies may use the funds to cover other expenses. Similarly,
Parliament may lose control over the acquisition of capital assets
since it will have funded them through depreciation provided in
previous years.
To address these concerns, countries have implemented cash management
policies and specific controls over capital acquisitions. For example,
like Australia and New Zealand, the United Kingdom initially provided
funding for the full cost of programs, outputs, or outcomes with the
thought that it would generate efficiencies. Over time, however, United
Kingdom Treasury officials said they became concerned that some
departments were shifting noncash expenses to cash expenses, which
adversely affected the government's borrowing requirement. As a result,
the United Kingdom has imposed controls on cash. Departments' budgets
now include both the amount of the full accrual costs and the cash
required. The Parliament approves both numbers. This not only helps
ensure that department spending is in-line with the government's fiscal
policy goals but also reinforces Parliament's control over capital
acquisitions.
Australia also reported that it is considering a model that would give
the Parliament both cash and accrual information in a form that better
meets its needs and preferences. On the basis of reports by the
Australian National Audit Office and others that departments could
potentially use funds provided for depreciation of existing assets to
fund noncapital acquisitions or that agencies are not appropriately
using the funds to repair or replace existing assets, the Australian
Senate expressed concern about the transparency of funding for
depreciation and the potential loss of control over new capital
purchases.[Footnote 31] The Senate recommended that the government
consider reporting and budgeting for capital expenditures separately,
including a subdivision of expenditures between asset replacement
(i.e., the depreciation component) and asset expansion.
All countries we reviewed that accrue capital investments have a
process in place to facilitate oversight over capital. While most of
these countries include depreciation of existing assets in operating
budgets, most also preserve up-front control of capital by approving
capital purchases above a certain threshold. For example, in New
Zealand, all capital purchases above NZ$15 million must be approved by
the cabinet. In Australia, any capital purchase above A$10 million in
any one year must have a business case prepared and must be included in
the budget proposal to be submitted for government approval. The United
Kingdom Treasury reviews departmental capital plans. In the
Netherlands, capital purchases by agencies are made through loans
provided by the Ministry of Finance. The Ministry of Finance has to
approve the level of loans per agency.
Some Governments Have Had to Address Parliamentary Concerns:
As previously noted, all of the countries in our study are
parliamentary systems in which the political party that controls the
current government has primary control over budgetary matters. However,
as noted above, in some countries Parliaments have expressed general
concerns that the budget presentations are confusing under accrual
budgeting. Several countries in our study use more than one method of
budget accounting, which can be confusing for Parliament and other
users. In Australia, for example, where two accounting standards are
currently used in the budget, the Senate has recommended the adoption
of a single agreed-upon accounting standard. In Canada, the government
reports the budget surplus/deficit on an accrual basis but department-
level appropriations remain on a cash basis. Canadian audit officials
we spoke with said the Parliament wants the department-level
appropriations prepared on an accrual basis in part because the two
different measures and crosswalks are confusing. Canada is considering
moving department-level budgets to an accrual basis in order to provide
consistent financial information for all levels of government and a
better linkage between the budget and appropriations.
In the United Kingdom, some members of Parliament said it was unclear
how the accrual-based appropriations related to the nation's fiscal
goals, which are largely cash based. As a result, the government is
undertaking an "alignment project" to better align budget accounts with
the government's two fiscal rules to (1) avoid borrowing to finance
current expenditures and (2) keep net debt at prudent levels.
Australia's Senate expressed concern about reduced transparency of some
information and said that the budget could be improved if data were
presented at the program level (in addition to outcomes). The
Australian government official we spoke with said that the government
already provides the Parliament and public with extensive information
on both the full costs of government activities and the performance of
agencies. It was not clear to the official, however, that providing
more detailed information would improve the quality and usefulness of
information considering the administrative workload involved and the
potential for creating more "red tape" for managers. The Australian
official thought more concise and relevant reports might be more useful
than more information.
Accrual Cost Information Helped Inform Some Debates That Led to
Improvements in Fiscal Condition:
Despite the inherent challenges, our six case study countries have
continued to use accrual budgeting and additional countries have
adopted accrual budgeting since 2000. These countries view having
accrual-based cost information available to program managers for
resource allocation decisions as outweighing the associated
difficulties. In several countries, officials we spoke with said they
believe accrual budgeting provides better information on the cost of
annual operations and performance than cash-based budgeting
particularly in regard to the use of capital assets and programs that
incur costs that are not paid in cash today.
Accrual Budgeting May Provide Better Cost Information than Cash
Budgeting for Resource Allocation Decisions:
In general, countries said that accrual-based cost information
contributes to improved resource allocation and program management
decisions. Under cash budgeting, a program's budget shows only the
immediate cash outlay and not the cash that will have to be paid in the
future for the service provided today. Accrual budgeting, which
recognizes resources as they are used to produce goods and services,
provides the full cost of all programs and may allow for better
comparisons between different methods of delivering government
services.
New Zealand officials, in particular, believe the cost information
provided by accrual-based budgeting has led to efficiencies and better
resource allocation decisions. New Zealand attributed the cost
information provided by accrual budgeting as helping them identify
where and how to cut spending to put the country on a more sound fiscal
footing in the early 1990s. Several of the countries have attributed
specific improvements on the departmental level to accrual budgeting.
For example, under accrual accounting, the cost of a loan includes the
subsidy cost--the cost of lending below market rates and provisions for
bad debt. When New Zealand recently made student loans interest free,
the cost of the subsidy was taken into consideration during the policy
debate. The United Kingdom also reported the more complete information
on student loans directly affects lending decisions at the Department
of Education and Employment.[Footnote 32]
In several of the countries, one perceived advantage of accruals was to
facilitate comparisons between the public sector and private sector.
Accrual-based cost estimates could be used to "benchmark," or compare
the cost of existing public service providers to alternative providers
in either the public or private sectors. The OECD reported in 2005 that
both agencies and core ministries in the Netherlands were content with
the results from accrual budgeting at the agencies.[Footnote 33]
Agencies, which now receive a budget for the full cost of their
activities, like the flexibilities under accrual budgeting, while core
ministries value the output and price information they receive from the
agencies. The ministries also reported that agencies' use of accrual
budgeting enables them to consider the performance of the agencies
relative to alternatives (i.e., decentralization to subnational
government or contracting out). At the same time, the availability of
the alternatives enabled ministries to put more pressure on agencies to
improve cost efficiency and to reduce prices. New Zealand, however,
reported that there is little evidence available that similar types of
outputs are compared or benchmarked in a way that was thought desirable
at the time the reforms were initiated. Concerns about the usefulness
and robustness of cost accounting systems continue and there remains a
concern that the specification of outputs is not at a sufficient
standard to ensure high-quality government performance.
Accrual Budgeting Attributed with Helping to Control or Manage Certain
Long-Term Commitments:
In several case study countries, accrual budgeting helped policymakers
recognize the full cost of certain programs at an earlier point and
make decisions that limited future cash requirements. For example, as
reported in 2000, both New Zealand and Iceland credited accrual
budgeting with highlighting the longer-term budgetary consequences
associated with public sector employee pension programs. In Iceland,
accrual budgeting showed the consequences of wage negotiations on
future public sector employee pension outlays. The full costs of these
agreements were not fully realized by the public until the adoption of
accrual budgeting. At that time, Icelandic officials told us that there
was no longer public support for decisions that were so costly in the
long term. Similarly, New Zealand officials decided to discontinue the
defined benefit public employee pension program after pension
liabilities were recognized on the balance sheet and the expense
incurred was included in the budget.
Since 2000, reforms aimed at putting government employee pensions on a
more sustainable footing were enacted in Australia and the United
Kingdom. In Australia, unfunded pension liabilities for government
employees are currently the largest liability on Australia's balance
sheet (which is part of its budget documents). To cover this liability,
the Australian government recently established an investment fund
called the "Future Fund" to help pay future pension payments.[Footnote
34] Government employee pensions in the United Kingdom were also
reformed. In 2007, the United Kingdom government raised the pension age
to 65 for employees hired beginning in July 2007 and limited the
government's contribution to pensions to 20 percent. United Kingdom
officials acknowledged that there was already recognition that the
program needed significant reform before the introduction of accrual
measures, but said accrual budgeting helped highlight the full cost of
pension liabilities and forced the debate on pension reform to happen
sooner.
Accrual budgeting has also changed the information available for
insurance programs, veterans benefits, and environmental liabilities.
As reported in 2000, New Zealand officials attributed reforms of the
Accident Compensation Corporation program to recognizing the liability
and expenses from providing accident coverage in the budget.
Recognizing the estimated future outlays associated with current
accidents reduced budget surpluses by NZ$500 million. At that time,
officials attributed New Zealand's decision to raise premiums and add
surcharges largely to this inclusion of program costs in the budget.
Also, in 2002 New Zealand ratified the Kyoto Protocols committing to
reduce net emissions of greenhouse gases over the 2008-2012 period.
Consistent with financial accounting standards, New Zealand recognized
a liability for the obligation created by this commitment. New Zealand
officials attributed accrual accounting with helping them focus on ways
to manage environmental liabilities.
Canadian officials attributed accrual information with leading to
recent changes in veterans benefits. The use of accrual accounting
requires Veterans Affairs Canada to record the full cost of veteran
benefits in the year they are earned rather than paid. Therefore when
considering changes to veterans benefits, Veterans Affairs Canada
considered the effect of future cash flows in discounted terms. Initial
results indicated that the planned changes to veteran benefits
represented a substantial expense for the year. As a result, Veterans
Affairs Canada modified the admissibility requirements limiting the
financial effect of the changes.
Countries Use Other Methods to Increase Awareness of Greatest Long-Term
Fiscal Challenges:
Accrual budgeting was not used to increase awareness of long-term
fiscal challenges that are primarily driven by old-age public pensions
and healthcare programs. None of the countries in our study include
future social insurance payments in the budget. Like the United States,
the other countries do not consider future social insurance payments to
be liabilities. Instead, in recent years, several countries have begun
reporting on the sustainability of the government's overall finances
over longer-term horizons, given demographic and fiscal trends.
Aging-Related Expenditures Are Major Drivers of Long-Term Fiscal
Challenges in Other Countries:
Aging is a worldwide phenomenon. One of the key challenges that all
developed economies are facing over the coming decades is demographic
change. This demographic shift--driven by increased life expectancies,
falling fertility rates, and the retirement of the baby boom
generation--will place increased pressure on government budgets (i.e.,
public pensions and health care). For example, by 2047, a quarter of
Australia's population is projected to be aged 65 and over--nearly
double the current proportion. Similarly, by 2050, New Zealand projects
that the number of people over 65 is expected to grow almost threefold,
while those 85 and over will grow sixfold. Similar trends hold for the
other countries we studied.
Although public pension benefits are a major driver, the most
challenging aspect of the long-term fiscal outlook in many of the
countries we studied--as in the United States--is health care spending.
Health spending is expected to increase significantly over the next 40
years due to population aging, new medical technologies, new drugs, and
other factors. For example, Australia projects that health care
spending as a share of GDP will nearly double by 2046---2047.
Similarly, the United Kingdom projects that its health spending will
increase faster than other types of spending--from around 7½ percent of
GDP in 2005-2006 to around 10 percent of GDP by 2055-2056. New Zealand
projects a rise in the ratio of health spending to GDP of 6.6
percentage points between 2005 and 2050 resulting in health spending of
about 12 percent of GDP. Similar trends are projected in the other
countries we reviewed.
Long-Term Fiscal Sustainability Reports Used by Many Countries to Raise
Awareness of Long-Term Fiscal Challenges:
In recent years, many countries in our study have started preparing
long-term fiscal sustainability reports. Frequently cited reasons for
this are:
* to improve fiscal transparency and provide supplemental information
to the budget;
* to increase public awareness and understanding of the long-term
fiscal outlook;
* to stimulate public and policy debates; and:
* to help policymakers make informed decisions.
These reports go beyond the effects of individual pension and health
care programs to show the effect of these programs on the government
budget as a whole. Unlike accrual or cash budgeting, which are intended
to provide annual cost information, fiscal sustainability reporting
provides a framework for understanding the government's long-term
fiscal condition, including the interaction of federal programs, and
whether the government's current programs and policies are sustainable.
In fiscal sustainability reports, countries measure both the effect of
current policy on the government's fiscal condition and the extent of
policy changes necessary to achieve a desired level of sustainability.
These countries hope that a greater understanding of the profound
changes they will experience in the decades ahead will help stimulate
policy debates and public discussions that will assist them in making
fiscally sound decisions for current and future generations and in
achieving high and stable rates of long-term economic growth.
Fiscal sustainability is generally described by countries as the
government's ability to manage its finances so it can meet its spending
commitments now and in the future. A sustainable fiscal policy would
encourage investment and allow for stable economic growth so that
future generations would not bear a tax or debt burden for services
provided to the current generation. An unsustainable condition exists
when demographic and other factors are projected to place significant
pressures on future generations and government finances over the long
term and result in a growing imbalance between revenues and
expenditures.
Four of six case study countries produce reports on long-term (i.e.,
more than 10 years) fiscal sustainability. The Netherlands first issued
a report on the long term in 2000. Both the United Kingdom and
Australia followed, issuing their first reports in 2002. New Zealand
issued its first report in 2006. Of our case study countries, only
Canada and Iceland currently do not issue long-term fiscal
sustainability reports.[Footnote 35] However, Canada is planning to
issue a comprehensive fiscal sustainability and intergenerational
report in the near future. Of our limited review countries, Norway
reported that it has traditionally provided Parliament reports on long-
term budget projections as well as fiscal sustainability analyses.
Further, Switzerland is planning to issue a long-term fiscal
sustainability report in early 2008.[Footnote 36]
The European Commission is also increasing its focus on the fiscal
sustainability of the EU member states, including the Netherlands,
United Kingdom, Denmark, and Sweden, as part of the Stability and
Growth Pact (SGP). The SGP, an agreement by EU member states on how to
conduct, facilitate, and maintain their Economic and Monetary Union
requirements, requires member states to submit Stability or Convergence
Reports, which are used by the European Council to survey and assess
the member's public finances.[Footnote 37] The guidelines for the
content of these reports were changed in 2005 to include a chapter with
long-term projections of public finances and information on the
country's strategies to ensure the sustainability of public finances.
The European Commission uses this information to annually assess and
report on the long-term sustainability of all EU members, including
consideration of quantitative measures (e.g., primary balance, debt-to-
GDP) and qualitative considerations of other factors, such as
structural reforms undertaken and reliability of the projections. Such
reporting includes an assessment of the sustainability of member
countries' finances, policy guidance to EU members to improve
sustainability, and discussion of the effect of significant policy
changes on the sustainability of member countries' finances. The
Commission released its first comprehensive assessment on the long-term
sustainability of public finances in October 2006.[Footnote 38]
Whether a government will be able to meet its commitments when they
arise in the future may depend on how well it reduces its debt today so
the burden does not fall entirely to future generations. Countries may
have different assumptions about what is sustainable but one aim is to
keep debt at "prudent levels." Several of our case study countries have
set debt-to-GDP targets in their efforts to address fiscal
sustainability issues. For example, Canada wants to reduce its net debt
(i.e., financial liabilities less financial assets) for all levels of
government to zero by 2021. Similarly, New Zealand's current objective
is to reduce debt to around 20 percent of GDP over the next decade. The
United Kingdom, under its sustainable investment rule, requires that
public sector net debt is to be maintained below 40 percent of GDP over
the economic cycle. Australia and the Netherlands have no explicit debt
level targets, although the Netherlands is subject to EU limits on
general government debt.[Footnote 39]
Several Common Measures Are Used to Assess Fiscal Sustainability:
The countries studied used a number of measures to assess the fiscal
sustainability of their policies. Common approaches to assessing fiscal
sustainability include cash-flow measures of revenue and spending and
public debt as a percent of GDP as well as summary measures of fiscal
imbalance and fiscal gap (see table 2). Each measure provides a
different perspective on the nation's long-term financing. Cash-flow
measures are useful for showing the timing of the problem and the key
drivers, while measures such as the fiscal imbalance or fiscal gap are
useful for showing the size of action needed to achieve fiscal
sustainability. Each measure has limitations by itself and presents an
incomplete picture. Therefore, most countries use more than one measure
to assess fiscal sustainability.
Table 2: Common Fiscal Indicators Used in Other Countries:
Measure: Indicators that show the timing of long-term problem but not
overall size.
Measure: Indicators that show the timing of long-term problem but not
overall size: Future annual cash flows (as a percent of GDP);
Used by: Indicators that show the timing of long-term problem but not
overall size: Australia;
Netherlands;
New Zealand;
United Kingdom;
Description: Indicators that show the timing of long-term problem but
not overall size: Illustrates the timing of and future trends in
spending components, total spending, and revenue and their relationship
over time.
Measure: Indicators that show the timing of long-term problem but not
overall size: Future primary balance (as a percent of GDP);
Used by: Indicators that show the timing of long-term problem but not
overall size: Australia;
Netherlands;
United Kingdom;
Description: Indicators that show the timing of long-term problem but
not overall size: The primary balance excludes net interest payments
from underlying cash balances. Primary balances offer useful parameters
for the part of the budget that is controllable.
Measure: Indicators that show the timing of long-term problem but not
overall size: Future annual projections of public debt (as a percent of
GDP);
Used by: Indicators that show the timing of long-term problem but not
overall size: Australia;
Netherlands;
New Zealand;
United Kingdom;
Description: Indicators that show the timing of long-term problem but
not overall size: Illustrates the relationship between public debt and
GDP over time. The debt-to-GDP ratio provides an indication of a
nation's ability to repay its public debt by comparing the size of its
debt to the size of its economy.
Measure: Indicators that show the timing of long-term problem but not
overall size: Future primary operating balance;
Used by: Indicators that show the timing of long-term problem but not
overall size: New Zealand;
Description: Indicators that show the timing of long-term problem but
not overall size: Illustrates the relationship between future revenues
and expenses excluding financing costs (measured on an accrual basis)
over time.
Measure: Indicators that show the size of long-term problem but not
timing: Fiscal gap (as a percent of GDP)[A];
Used by: Indicators that show the size of long-term problem but not
timing: Australia;
Norway;
United Kingdom;
Description: Indicators that show the size of long-term problem but not
timing: Illustrates the change in fiscal policy needed to achieve a
particular debt target at some point in the future. This change can be
calculated in terms of the adjustment needed today or at some point in
the future.
Measure: Indicators that show the size of long-term problem but not
timing: Fiscal imbalance or intertemporal budget constraint (as a
percent of GDP)[A];
Used by: Indicators that show the size of long-term problem but not
timing: Netherlands;
United Kingdom;
Description: Indicators that show the size of long-term problem but not
timing: The fiscal imbalance is similar to the fiscal gap except that
it is more stringent; it assumes that all government debt must be
repaid by the end of the period. It illustrates whether and to what
extent the government's future revenues cover future expenditures and
public debt.
Source: GAO.
[A] These measures can be presented as either percents of GDP or in
present value dollars, however, case study countries focused on the
percents of GDP.
[End of table]
Two measures--the fiscal gap and fiscal imbalance--show the size of the
problem in terms of action needed to meet a particular budget
constraint. Changes in these measures over time are useful for showing
improvement or deterioration in the overall fiscal condition. The
fiscal gap shows the change in revenue or noninterest spending needed
immediately and maintained every year to achieve a particular debt
target at some point in the future. The fiscal imbalance (or
intertemporal budget constraint) is similar to the fiscal gap but the
calculation assumes all current debt is paid off by the end of the
period. These summary measures can also be calculated in terms of the
adjustment needed in the future if adjustment is delayed (which would
increase its size). The change in policy can be in the form of
adjustments to taxes, spending, or both. A positive fiscal gap or
imbalance implies that fiscal policy should be tightened (i.e.,
spending cut or taxes raised) while a negative fiscal gap or imbalance
implies that fiscal policy could be loosened (i.e., spending increased
or taxes reduced). A fiscal gap or imbalance implies potential harm to
future generations if action to make public finances sustainable is
deferred thus requiring more budgetary actions (or higher interest
costs) in the future than today. It should be noted that a fiscal gap
or imbalance of zero over a finite period does not mean that current
fiscal policy is sustainable forever. For example, debt could still be
rising faster than GDP at the end of the period. Another limitation to
these summary measures is that by definition they do not provide
information on timing of receipts and outlays, which is important.
Most of the countries we studied used share of GDP measures rather than
present value dollar measures. In part this is to avoid the situation
in which a small change in the discount rate assumption leads to large
swings in the dollar-based sustainability measures. Present value
dollar measures are highly sensitive to assumptions about the discount
rate. An increase of 0.5 percentage points in the discount rate used to
calculate the U.S. fiscal gap reduces the present value of the fiscal
gap from $54.3 trillion to $47.7 trillion; in contrast such a change
results in a smaller proportional change to the gap as a share of GDP
from 7.5 to 7.3 percent.[Footnote 40] Also, since the numbers can be so
large, it may be difficult for policymakers and the general public to
understand without placing the numbers in context of the resources
available in the economy to finance the fiscal gap.
Reports Stem from Law and Political Commitments:
Fiscal sustainability reports are required by law in two countries--
Australia and New Zealand.[Footnote 41] The legislation underpinning
both countries' fiscal sustainability reports does not dictate in
detail what measures should be included in the report. Rather, the law
specifies only the frequency of reporting (i.e., every 4 years for New
Zealand and every 5 years for Australia), the years to be covered, and
the overall goal. Both Australia and New Zealand are required to assess
the long-term sustainability of government finances over a 40-year
horizon. Switzerland is required by law and an accompanying regulation
to issue a sustainability report periodically, but at least every 4
years.
Neither the Netherlands' nor the United Kingdom's reports are required
by law. Instead, the reports stem from political commitments of the
current government. The Netherlands prepared its first report in 2000
and reported again in 2006. In the United Kingdom the current
government made a political commitment to annually report on the long-
term fiscal challenges as part of the current government's fiscal
framework and has prepared reports annually since 2002. Canada's
upcoming report also stems from a commitment made by the current
government.[Footnote 42] A drawback of not having any legal or
legislative requirement for the report is that future governments may
or may not continue what the current government started.
Selection of Time Horizon Is Important:
The size of a nation's fiscal gap or fiscal imbalance will depend on
the time period chosen. Even if a particular sustainability condition
is satisfied over the chosen period, there may still be fiscal
challenges further out. Extending the time period can partially address
this limitation, but it increases uncertainty. Most of the case study
countries that prepare fiscal sustainability reports cover the next 40
to 50 years. However, the Netherlands report goes out through 2100. The
United Kingdom calculates the intertemporal budget constraint over an
infinite time horizon, which poses a high degree of uncertainty.
Choosing the horizon for the fiscal gap or imbalance calculations
therefore involves a trade-off in that it should be long enough to
capture all the major future budgetary developments but also short
enough to minimize uncertainty. It may be best to present these
measures over a range of horizons.
Countries Use Sensitivity Analysis to Deal with Uncertainty:
As with any long-term projection, uncertainty is an issue. To deal with
the uncertainty of projections, countries have done sensitivity
analysis. For example, the United Kingdom performed a sensitivity
analysis using different assumptions for productivity growth and
interest rates. The United Kingdom found that the fiscal gap was robust
to changes in productivity growth, meaning that the required policy
action changed little. However, the fiscal gap was more sensitive to
changes in the interest rate assumption. For example, in the United
Kingdom, an increase in the interest rate assumption from 2.5 percent
to 3.0 percent increases the fiscal gap for the 50-year period by 50
percent from 0.5 percent to 0.75 percent of GDP.
In Some Countries, There Are Indications That the Long-Term Report Is
Affecting Nearer-Term Decisions:
Sustainability requirements are important when setting short-and medium-
term policy targets. The sooner countries act to put their governments
on a more sustainable footing, the better. Acting sooner rather than
later permits changes to be phased in more gradually and gives those
affected time to adjust to the changes. Citizens can adjust their
savings now to prepare for retirement. In the Netherlands, a medium-
term fiscal target has been set based on the information presented in
the sustainability report. The current government has explicitly linked
expenditure ceilings and revenue targets to attaining a structural
fiscal surplus of 1 percent of GDP at the end of 2011, which the
Netherlands Bureau of Economic Policy Analysis has estimated is needed
for public finances to be sustainable given the impending population
aging.[Footnote 43] In addition a study group recommended that the
adjustments should be introduced gradually so that they are bearable
for all generations.[Footnote 44]
According to New Zealand officials, its fiscal sustainability report
shows that long-term demographic pressures will make it increasingly
hard to meet fiscal objectives and therefore policy adjustments will be
required. Recognizing that small changes made now will help to prevent
making big changes later on, officials said the report has encouraged
and enabled greater consideration of long-term implications of new
policy initiatives in the budget process. New Zealand intends to link
departments' annual Statements of Intent to long-term projections.
Under this approach, departmental objectives will have to be modified
or justified to meet the long-term objectives.
Although Accrual Budgeting Can Help in Certain Areas, It Does Not
Provide Sufficient Information to Understand Longer-Term Fiscal
Sustainability Issues:
Before implementing accrual budgeting some countries were experiencing
moderate to large deficits. Some countries' dependence on trade and
foreign borrowing led to concerns that increased deficits could lead to
rising interest rates and devaluation of the currency, and ultimately a
financial crisis. As a result, fiscal discipline was necessary. Accrual
budgeting was adopted as part of larger reforms to improve
transparency, accountability, and government performance. The United
States faces long-term fiscal challenges that, absent reforms, could
have adverse effects in the form of higher interest rates, reduced
investment, and more expensive imports ultimately threatening our
nation's well-being.
The range of approaches used by countries in our study illustrate that
accrual budgeting need not be viewed as a "one size fits all" choice.
The experiences of countries in our study show that the switch to
accrual budgeting was most beneficial for programs where cash-or
obligations-based accounting did not recognize the full program cost up
front. As we stated in 2000 and in other GAO reports, increased accrual
information in certain areas of the budget--insurance, environmental
liabilities, and federal employee pensions and retiree health[Footnote
45]--can help the Congress and the President better recognize the long-
term budgetary consequences of today's operations and help prevent
these areas from becoming long-term issues. However, accrual budgeting
raises significant challenges for the management and oversight of
capital purchases and noncash expenses, especially depreciation. Many
of our case study countries implemented additional controls to maintain
up-front control over resources within their accrual budget frameworks.
Indeed, in the U.S. system of government where the Congress has the
"power of the purse," maintaining control over resources is important.
While cost and performance information provided under accrual budgeting
can be useful, this information must be reliable if budget decisions
are to be based on it. We have reported that the financial management
systems at the majority of federal agencies are still unable routinely
to produce reliable, useful, and timely financial information.[Footnote
46] Until there is better financial information, a switch to full
accrual budgeting may be premature. As we reported in a previous report
on U.S. agencies' efforts to restructure their budgets to better
capture the full cost of performance, the use of full-cost information
in budget decisions may reflect rather than drive the development of
good cost information in government.[Footnote 47]
Further, challenges exist in estimating accrual-based cost information
for some areas, including veterans compensation, federal employee
pensions and retiree health, insurance, and environmental liabilities,
that require a significant amount of the government's future cash
resources. For example, estimates of future outlays for pensions or
veterans compensation depend on assumptions of future wages, inflation,
and interest rates that are inherently uncertain and subject to
volatility. Trends in health care costs and utilization underlying
estimates of federal employee postretirement health benefits have also
been volatile. The estimated cleanup costs of the government's
hazardous waste are another area where the accrued expenses may not be
based on reliable estimates. Not all environmental liabilities have
been identified and cleanup and disposal technologies are not currently
available for all sites. However, in areas such as these, it may be
preferable to be approximately right than exactly wrong. Failure to pay
attention to programs that require future cash resources can further
mortgage our children's future.
Although accrual budgeting can provide more information about annual
operations that require future cash resources, it does not provide
sufficient information to understand broader long-term fiscal
sustainability. An accrual budget does not include costs associated
with future government operations and thus would not help recognize
some of our greatest long-term fiscal challenges--related to Social
Security, Medicare, and Medicaid. A growing trend in other countries is
to develop reports on fiscal sustainability that evaluate the fiscal
condition of not only the key drivers of the nation's long-term fiscal
outlook but government as a whole. Fiscal sustainability reports that
show future revenue and outlays for social insurance programs and the
interrelationship of these programs with all federal government
programs would provide a comprehensive analysis of the nation's fiscal
path and the extent to which future budgetary resources would be
sufficient to sustain public services and meet obligations as they come
due. By highlighting the trade-offs between all federal programs
competing for federal resources, such a report would improve
policymakers' understanding of the tough choices that will have to be
made to ensure future generations do not bear an unfair tax or debt
burden for services provided to current generations.
Most countries recognize the need for various measures of fiscal
position, including the projected debt-to-GDP ratios and fiscal gap
measures. Since no single measure or concept can provide policymakers
with all the information necessary to make prudent fiscal policy
decisions, it is necessary to use a range of measures or concepts that
show both the size of the problem and the timing of when action is
needed.
Conclusions:
This study and the deterioration of the nation's financial condition
and fiscal outlook since 2000 confirm our view that the Congress should
consider requiring increased information on the long-term budget
implications of current and proposed policies on both the spending and
tax sides of the budget. In addition, the selective use of accrual
budgeting for programs that require future cash resources related to
services provided during the year would provide increased information
and incentives to manage these long-term commitments. While the
countries in our study have found accrual-based information useful for
improving managerial decision making, many continue to use cash-based
information for broad fiscal policy decisions. This suggests that
accrual measures may be useful supplements rather than substitutes of
our current cash-and obligations-based budget. Presenting accrual
information alongside cash-based budget numbers, particularly in areas
where it would enhance up-front control of budgetary resources would
put programs on a more level playing field and be useful to
policymakers both when debating current programs and when considering
new legislation.
Since accrual-based budgeting would not provide policymakers with
information about our nation's largest fiscal challenges--Social
Security, Medicare, and Medicaid--fiscal sustainability reporting could
help fill this void. The reports could include both long-term cash-flow
projections and summary fiscal gap measures for the whole of government
that would show both the timing and overall size of the nation's fiscal
challenges.
Accrual budgeting and fiscal sustainability reporting are only means to
an end; neither can change decisions in and of itself. The change in
measurement used in the budget provides policymakers and program
managers with different information, but the political values and
instincts of policymakers may not change. While recognizing fuller
costs could help inform policymakers of the need to reform, it will
require action on their part to address them. Any expansion of accrual-
based concepts in the budget or increased reporting requirements would
need to be accompanied by a commitment to fiscal discipline and
political will.
Matter for Congressional Consideration:
To increase awareness and understanding of the long-term budgetary
implications of current and proposed policies for the budget, the
Congress should require increased information on major tax and spending
proposals. In addition, the Congress should consider requiring
increased reporting of accrual-based cost information alongside cash-
based budget numbers for both existing and proposed programs where
accrual-based cost information includes significant future cash
resource requirements that are not yet reflected in the cash-based
budget. Such programs include veterans compensation, federal employee
pensions and retiree health, insurance, and environmental liabilities.
To ensure that the information affects incentives and budgetary
decisions, the Congress could explore further use of accrual-based
budgeting for these programs.
Regardless of what is decided about the information and incentives for
individual programs, the Congress should require periodic reports on
fiscal sustainability for the government as a whole. Such reports would
help increase awareness of the longer-term fiscal challenges facing the
nation in light of our aging population and rising health care costs as
well as the range of federal responsibilities, programs, and activities
that may explicitly or implicitly commit the government to future
spending.
We are sending copies of this report to interested parties. Copies will
also be sent to others upon request. In addition, the report will be
available at no charge on the GAO Web site at [hyperlink,
http://www.gao.gov]. Please contact Susan Irving at (202) 512-9142 or
irvings@gao.gov if you have any questions about this report. Key
contributors are listed in appendix II.
Signed by:
Susan J. Irving:
Director, Federal Budget Analysis Strategic Issues:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
To update the findings of our 2000 report, we examined (1) where, how,
and why accrual budgeting is used in select Organisation for Economic
Co-operation and Development (OECD) countries and how it has changed
since 2000; (2) what challenges and limitations were discovered and how
select OECD countries responded to them; (3) what select OECD countries
perceived the effect to have been on policy debates, program
management, and the allocation of resources; (4) whether accrual
budgeting has been used to increase awareness of long-term fiscal
challenges and, if not, what is used instead; and (5) what the
experience of select OECD countries and other GAO work tell us about
where and how the increased use of accrual concepts in the budget would
be useful and ways to increase the recognition of long-term budgetary
implications of policy decisions.
To address these objectives, we primarily focused on the six countries
in the 2000 GAO report:
* Australia,
* Canada,
* Iceland,
* the Netherlands,
* New Zealand, and:
* the United Kingdom.
We also did a limited review of two other nations--Denmark and
Switzerland--that have recently expanded the use of accrual measures in
the budget. Since these countries may not provide a complete picture of
the potential limitations or the use of alternative ways to increase
the focus on long-term fiscal challenges, we also looked at two
countries--Norway and Sweden--that considered expanding the use of
accrual measurement in the budget but decided against it, to understand
why.
We reviewed budget publications and used a set of questions to gather
information on how and why accrual concepts are used in the budget in
the selected countries and how this has changed since 2000. For
context, we also reviewed the results of a recent survey done by the
OECD on budgeting practices in all OECD countries and compared to older
survey results to understand general trends in the use of accrual
budgeting over time. To identify factors that facilitated accrual
budgeting; strategies for addressing commonly cited implementation
challenges; and how and where accrual has or has not changed the budget
debate, we primarily focused on the six countries studied in 2000. We
interviewed (by e-mail, telephone, and videoconferencing) officials
from the budget and national audit offices in select countries and
reviewed official budget documents and related literature to gather
information on the challenges and limitations of accrual budgeting; how
the use of accruals in the budget has affected policy debates, resource
allocation decisions, and program management; and other approaches used
to address long-term fiscal challenges. We did not interview
parliamentary officials or staff or program managers. The information
on foreign laws in this report does not reflect our independent legal
analysis, but is based on interviews and secondary sources. We
identified key themes from the experience of other nations, reviewed
past GAO work, and considered the differences between other nations and
the United States to identify useful insights about how to use more
accrual-based or other information to inform budget debates.
The experience of any one OECD country is not generalizable to other
countries. In analyzing other countries' experiences and identifying
useful insights for the United States, it is important to consider the
constitutional differences between Parliament in parliamentary systems
of government and the Congress of the United States, especially in the
role each legislature plays in the national budget process. The U.S.
Congress is an independent and separate, but coequal, branch of the
national government with the constitutional prerogative to control
federal spending and resource allocation. Many important decisions that
are debated during the annual budget and appropriations process in the
United States occur in case study countries before the budget is
presented to Parliament for approval. Also, most case study countries
generally deal with the approval of obligations through agency or
bureaucratic controls whereas in the United States congressional
approval (i.e., "budget authority") is required before federal agencies
can obligate funds. Further, most case study countries used purely cash
reporting for budgeting before adopting accrual budgeting. In contrast,
the United States' obligation-based budgeting already captures many
obligations not apparent in a purely cash system. These differences are
likely to influence perspectives on the trade-offs associated with the
use of accrual budgeting, particularly in terms of accountability and
legislative control.
[End of section]
Appendix II: GAO Contact and Staff Acknowledgments:
GAO Contact:
Susan J. Irving, (202) 512-9142 or irvings@gao.gov:
Acknowledgments:
Key contributors to this assignment were Jay McTigue, Assistant
Director; Melissa Wolf, Analyst-in-Charge; Michael O'Neill; and Margit
Willems Whitaker.
[End of section]
Footnotes:
[1] In this report, the term "commitment" is used to mean a promise to
provide a good or service. It does not necessarily mean a legally
binding obligation unless noted.
[2] GAO, Accrual Budgeting: Experiences of Other Nations and
Implications for the United States, GAO/AIMD-00-57 (Washington, D.C.:
Feb. 18, 2000).
[3] In this report, social insurance programs are generally defined as
government programs intended to protect households or individuals
against certain social risks including loss of income. These programs
typically require payment by the participant (or another party on their
behalf) of contributions through payroll taxes or premiums. Social
insurance benefits are generally viewed as transfer payments and
recorded in the budget as benefits due and payable (accrual basis) or
when benefits are paid (cash basis). Transfer payments are benefits
provided without requiring the recipient to provide current or future
goods or services of equivalent value in return.
[4] In the United States, federal agencies are required to have
authority to enter into obligations to make outlays of government
funds. Obligations and outlays are usually measured on a cash basis, so
we generally refer to the U.S. federal budget as "cash based." See the
background section for more information.
[5] For some areas, such as federal credit programs and some federal
employee pension benefits, the U.S. budget already records outlays on
an accrual basis rather than a cash basis in order to recognize the
full cost of the government's commitment up front when the commitment
is made.
[6] The OECD currently consists of 30 member states that share a
commitment to democratic government and the market economy.
[7] Noncash expenses are expenses related to services provided but not
paid during the year, such as depreciation.
[8] For this report, the "federal budget" is used broadly to refer to
the planning and debate during the federal budget process by both the
executive and legislative branches. For an overview of the federal
budget process, see GAO, A Glossary of Terms Used in the Federal Budget
Process, GAO-05-734SP (Washington, D.C.: September 2005).
[9] In this report, the term "full cost" is used in the financial
reporting sense unless otherwise noted.
[10] For a discussion of the methods for tracking funds in the federal
government, see GAO-05-734SP at app. III, 120-3.
[11] The budget surplus/deficit includes the outlays for credit
programs and certain interest payments measured on an accrual basis.
Federal agencies record outlays on an accrual basis for several other
items, including some federal employee pensions; however, these outlays
do not affect the unified budget deficit because the outlays are
intragovernmental--paid by one agency to another.
[12] The unified budget is a comprehensive measure of all federal
activities both on-budget and off-budget. The on-budget deficit
includes all budgetary accounts other than those designated by law as
off-budget. The off-budget accounts are the Postal Service and Social
Security trust funds. Because the unified deficit is compatible with
the accrual deficit that also includes both on-and off-budget accounts,
we focus on the unified budget number.
[13] The consolidated financial statements of the U.S. government are
largely on an accrual basis. See Department of the Treasury, Financial
Report of the United States Government, 2006. GAO is responsible for
auditing the financial statements included in the Financial Report, but
we have been unable to express an opinion on them because the federal
government could not demonstrate the reliability of significant
portions of the financial statements. Accordingly, amounts taken from
the Financial Report may not be reliable.
[14] For a discussion of how the accrual and cash deficits relate to
each other, see GAO, Understanding Similarities and Differences between
Accrual and Cash Deficits, GAO-07-117SP (Washington, D.C.: December
2006).
[15] GAO-07-117SP.
[16] For more information on the assumptions underlying our
simulations, see GAO, The Nation's Long-Term Fiscal Outlook: August
2007 Update, GAO-07-1261R (Washington, D.C.: Sept. 28, 2007).
[17] Canada does provide departments with appropriations for the
accrued cost of employee pensions.
[18] Based on our analysis of OECD surveys conducted in 2000, 2003, and
2006. The most recent survey results can be found at [hyperlink,
http://webnet4.oecd.org/budgeting/Budgeting.aspx] (as of Oct. 3, 2007).
We were unable to validate some of the responses to the surveys and
there were changes in the response categories over time; therefore our
use of the survey results is limited.
[19] Australia transitioned to accrual budgeting in financial year 1999-
2000; New Zealand transitioned to accrual budgeting on the departmental
level in 1992 and 1994 for the governmentwide budget.
[20] Australia and New Zealand government departments are generally not
responsible for funding health benefits for current or retired
government employees. Australia's and New Zealand's governments provide
health care for all citizens, although some citizens purchase
supplementary private health insurance.
[21] The budget provides the government's overall fiscal plan for
revenues and expenses and details spending proposals for the
government's new initiatives. The Main Estimates are detailed plans for
all government expenditures by department and agency. Appropriations
are the legislation necessary to implement the Main Estimates.
[22] Unusual transactions such as large receipts from asset sales are
excluded from the cash surplus in Australia.
[23] Net borrowing (or lending) is a national accounting concept and is
similar to the unified budget surplus or deficit. Unlike accruals, the
national accounts in the United Kingdom recognize pensions paid in the
current year and do not recognize costs associated with "provisions,"
which are cases where there is uncertainty about whether a liability
exists, the amount to settle it, or the timing of the payments. The
United Kingdom's national accounts also record the cost of single-use
military equipment in the year purchased rather than depreciating them.
[24] GAO, Performance Budgeting: Efforts to Restructure Budgets to
Better Align Resources with Performance, GAO-05-117SP (Washington,
D.C.: February 2005).
[25] A "qualified" opinion means that the auditor disagreed with the
treatment or presentation of financial information.
[26] Such fluctuations also occur in the U.S. government's financial
statements. For example, in the United States, changes in the interest
rate assumptions used to estimate the value of future benefits led to
wide fluctuations in the veterans compensation liability. The liability
increased by $105.6 billion in 2003, decreased by $30 billion in 2004,
and then increased by $197.8 billion in 2005.
[27] New Zealand Superannuation is financial assistance for people 65
years of age or older who have lived in New Zealand for a certain
amount of time. It is not based on income. This entitlement is
recognized in the budget when due and payable.
[28] A new government was sworn in on December 3, 2007, just before
issuance of this report. This statement refers to the government in
power prior to December 3.
[29] Australia's underlying cash balance is the difference between
revenues and expenditures measured on a cash basis and excludes unusual
transactions such as large receipts from asset sales.
[30] This rule of thumb holds precisely if the interest rate on debt
equals the rate of GDP growth. If, however, the interest rate exceeds
GDP growth, cash receipts must exceed cash outlays excluding interest
in order to keep the debt-GDP ratio constant. Conversely, New Zealand
can run cash deficits if GDP growth exceeds the interest rate on debt.
[31] In Australia, both houses of Parliament approve all
appropriations, but the Senate has more authority to review and amend
appropriations for new government activities.
[32] Credit programs are already recorded on an accrual basis in the
U.S. budget.
[33] Dirk-Jan Kraan, "Typically Dutch," OECD Journal on Budgeting, vol.
4, no. 4 (2005).
[34] For background information on the Future Fund, see [hyperlink,
http://www.futurefund.gov.au/about_the_future_fund/outline.html].
[35] Canada issued a report called The Sustainable Development Strategy
2007-2009, which discusses strategies and progress relating to broad
fiscal, social, and environmental goals. This report is required by the
1995 amendment to the Auditor General Act. The report has been prepared
every 3 years since 1997 and is available at [hyperlink,
http://www.fin.gc.ca/toce/2006/sds2007e.html].
[36] Both Canada and Switzerland are federal systems and are planning
to report on fiscal sustainability for all levels of government--not
just the central government.
[37] The European Commission requires member states that have adopted
the euro (e.g., the Netherlands) to submit stability program updates
annually that cover at least the preceding year, the current year, and
the next 3 years. Member states that have not adopted the EU currency
(e.g., Denmark and Sweden) prepare a "Convergence Report" annually that
is similar to the Stability Report but includes more information on
monetary policy objectives.
[38] Economic Policy Committee and European Commission, "The impact of
ageing on public expenditure: projections for the EU25 Member States on
pensions, health-care, long-term care, education and unemployment
transfers (2004-2050)," European Economy, Special Reports, no. 1
(Luxembourg, 2006).
[39] An important condition for successfully moving to a single
European currency is that economies of the participating countries
should converge toward each other and remain healthy. Therefore,
members of the EU are expected to avoid excessive budgetary deficits
(i.e., above 3 percent) and to ensure their debt-to-GDP ratio stays
within the reference value limit of 60 percent.
[40] Under GAO's Alternative simulation that is based on recent trends
and policy preferences. For more information on this simulation, see
GAO-07-1261R.
[41] In Australia the legislation requiring the report is the Charter
of Budget Honesty Act of 1998 and in New Zealand the Public Finance
Act, as amended in 2004.
[42] See Department of Finance Canada, Budget 2007 (Mar. 19, 2007), p.
155, which can be downloaded from [hyperlink,
http://www.fin.gc.ca/access/budinfoe.html].
[43] See Netherlands Bureau of Economic Policy Analysis, Ageing and the
Sustainability of Dutch Public Finances (2006).
[44] See Government of Netherlands, Ageing and Sustainability, Twelfth
Report by the Study Group on the Budget Margin (Jun. 22, 2006).
[45] For civilian employees hired since 1984 and personnel in military
service after October 1, 1984, the full cost of pension benefits is
recognized in the budget at the department level as they are earned.
Also, since 2001 the full cost of retiree health benefits for military
retirees eligible for Medicare is also recognized in the budget.
However, the remainder of federal pension and health benefits needs to
be addressed. The federal budget currently recognizes only about 40
percent of the cost of pensions for civilians hired before 1984.
[46] See GAO's Auditor's Report in the 2006 Financial Report of the
United States Government (Washington, D.C.: Dec. 15, 2006).
[47] GAO-05-117SP.
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