Looming Liabilities

Looming Liabilities

How shall we spend the federal budget surplus? For months, lawmakers have been all too happy to count the ways. And after President Clinton's Jan. 5 announcement that he'll submit a balanced budget to Congress for the 1999 fiscal year, White House officials began publicly declaring a new era of fiscal bounty as well. "You'll see surpluses as far as the eye can see," enthused National Economic Council director Gene B. Sperling.

But even as the Administration prepares to roll out its February budget blueprint -- which will propose additional health care coverage for early retirees and a variety of other initiatives -- and Republicans meanwhile feud over whether to cut taxes, reduce the federal debt or build more roads, there are plenty of long-term fiscal burdens to address.

The best-known of these are the major entitlement programs for the elderly, Medicare and Social Security, whose costs will start exploding in the second decade of the 21st century, after the massive baby boom generation begins retiring. Republicans and Democrats alike are talking a good game about putting these programs on a sounder financial footing: Last year's balanced budget deal established a bipartisan commission on the future of Medicare, and Clinton says he wants to establish a plan to fix Social Security before he leaves office.

But fiscal experts say the federal government faces many other, less-discussed financial commitments in the future. These include bank deposit insurance, private pension insurance and a huge portfolio of guaranteed loans, all of which have some risk of going sour and costing the government substantial sums down the road. Then there's the cost of cleaning up contaminated nuclear waste sites overseen by the Energy Department -- not to mention hefty pension and health care expenses for current and future federal retirees. In March, the first-ever set of audited financial statements for the federal government will spell many of these out.

Budget mavens warn that the same budget practices that have masked our entitlement woes and permitted lawmakers to put off corrective action could also lead to unpleasant surprises where these other long-term expenses are concerned. Their message: It's time to take off those dancing shoes, stop the budget surplus party and start planning for the future. In other words -- to rephrase a famous economist's line -- without more careful budgeting today, in the long run we'll all be in the red.

The fundamental barrier to taking future government costs into account in the present is that many looming liabilities or other financial commitments simply aren't counted in the year-to- year budget process. "The budget is generally a short-term, cash-based spending plan focusing on the short- to medium-term cash implications of government obligations and fiscal decisions," observes an October 1997 report prepared for the Senate and House Budget Committees by the General Accounting Office (GAO). "Accordingly, it does not provide all of the information on the longer-term cost implications stemming from the government's commitments when they are made."

Alarm Bells

Simply put, says Donald F. Kettl, director of the LaFollette Institute of Public Affairs at the University of Wisconsin (Madison), "as long as the budget system focuses on the current deficit or surplus and you have a system where you only keep track of what you spend today, any expenditure you can put off until next year instead of spending this year is something that doesn't count in budgetary terms."

That explains why Social Security looks like a cash cow in the short term: Payroll taxes from the large generation of current workers provide far more money than is needed to finance benefits for today's retirees; the extra money is used for other government programs. The latest budget projections from the Congressional Budget Office (CBO), for instance, show a surplus of $14 billion in 2001, but only because they count the $130 billion in surplus Social Security revenues that will come in that year. In the future, however, the situation will be reversed, with too few workers paying for many more retirees -- and, unless current spending patterns change, no money from past years set aside to help with the costs.

While budget analysts generally agree that upcoming Social Security and Medicare costs pose the primary threat to the federal government's long-term solvency, federal insurance programs provide another example of the way substantial future costs can be masked by current accounting methods. These programs include bank deposit insurance, national flood insurance, federal crop insurance, pension insurance provided through the Pension Benefit Guaranty Corporation (PBGC), and a range of others that added up to almost $5 trillion in insurance commitments in fiscal year 1995. That doesn't mean the federal government is on the hook for the full $5 trillion, more than half of which represents insured deposits at financial institutions, but some portion of the total is at risk.

The yearly premiums collected for these programs often don't jibe with their likely future costs, the GAO noted in a September 1997 report on how to budget for federal insurance programs. From 1981-92, for instance, the PBGC reported positive net cash flows each year, even though its accumulated deficit grew from $190 million to $2.4 billion. "Thus, PBGC appeared financially sound in the cash-based budget despite its deteriorating condition," the GAO said. Similarly, the flood insurance program showed premiums outstripping claim payments in six of 10 years between 1986 and 1995. "This made the program appear [to be] in good financial shape, even though a significant portion of the policies receive an unfunded subsidy and the program has not been able to build sufficient reserves to cover expected future high-loss years," the report said.

Probably the favorite cautionary tale cited by advocates for changing the cash-budgeting status quo is the savings and loan crisis of the 1980s. The GAO all but says "I told you so" when recounting the S&L disaster. It notes that "GAO and some industry analysts" sounded the alarm bells about the rising costs to the government of deposit insurance, but that little was done as the situation worsened. "The cash-based budget provided little incentive to address the growing problem, because it did not recognize the costs until institutions were closed and depositors paid," the report says.

The GAO recommends that federal budgeteers begin developing methods of making current cost estimates for these programs based on expected future costs, or moving in the direction of accrual-based budgeting. It acknowledges that estimating future risks is difficult. But it says federal policy makers would make better decisions about entering into long-term commitments if they had better information up-front about future liabilities.

"If we took some of those insurance programs and put them outside the budget, we would show a bigger deficit rather than a budget that's almost in balance," said CBO analyst Marvin Phaup. "The question is whether or not the Congress would react to the bigger deficit by changing policies in ways that they wouldn't change them if they see that we have a surplus." He says the answer is probably yes. "If we have a surplus or balance, I believe there's tremendous pressure on the Congress to increase spending. If we show a bigger deficit or a budget that's barely in balance, those pressures can be abated."

The quasi-governmental organizations known as government- sponsored enterprises, or GSEs, provide still another example of what Kettl has called "the budgetary twilight zone." A recent study for the libertarian Cato Institute calls the two largest GSEs -- Fannie Mae, the home-financing company; and Freddie Mac, the Federal Home Loan Mortgage Corp. -- "financial time bombs." These two GSEs, which buy mortgages from lenders, package them into securities and then resell them to investors, don't receive taxpayer funds directly. But the study contends that the implicit federal guarantee behind the GSEs exposes taxpayers to "potential contingent liability that could ultimately cost tens of billions of dollars to rectify" should a bailout ever be required.

Costly Surprises

In March, there may be a good deal more attention paid to the government's long-term costs. That's when the first-ever set of audited financial statements for the federal government will be issued, as mandated by the Government Management Reform Act of 1994. The federal balance sheet for fiscal year 1997 will cover such items as Energy Department estimates for cleaning up its contaminated nuclear waste sites, which were pegged in last year's unaudited financial statements, covering fiscal year 1996, at $229 billion. It will also include actuarial estimates for unfunded health costs for military and other federal retirees, which were estimated at $344 billion in last year's statements. And it will look at the costs of civil and military pensions owed to current and future retirees, which the 1996 actuarial estimates placed at some $1.6 trillion.

In the meantime, the GAO is continuing its work on long- term budget costs, looking at everything from entitlements, federal pensions and railroad retirement benefits to insurance programs, environmental cleanup, and deferred maintenance and life-cycle costs for equipment and infrastructure. "We know we're faced with long-term costs, and they don't show up in our budget numbers that well," said Paul L. Posner, the GAO's director of budget issues. "The challenge is: How do we make those long-term costs more immediately understandable and compelling to people in the short term?"

The latest GAO work was requested by House Budget Committee chairman John R. Kasich, R-Ohio, who's taken a particular interest in future liabilities.

"We not only have a $5.5 trillion national debt, but we also have about $14 trillion in unfunded liabilities related to Medicare and Social Security that doesn't even appear on the books," Kasich said at an October Budget Committee session he convened to discuss the post-balanced-budget era. Kasich reaches the arresting $14 trillion total by using projections of the unfunded liability for Social Security's old-age, survivors and disability funds and Medicare's hospital insurance program over the next 75 years. Budget analysts note that the use of the term "liabilities" is imprecise, because Congress can rewrite entitlement laws to change its future commitments, as it did when it overhauled Social Security in 1983. Still, Kasich's fundamental point is certainly correct: The government faces sobering future costs.

"There's an almost instinctive sense here that if people start thinking there are surpluses, it's going to reduce the desire to restrain spending," said a Republican Budget Committee aide. "If we begin to see that these long-term commitments are unmanageable, it may force us... to undertake more-efficient ways" of dealing with problems such as environmental cleanups. "In a sense, we may be making commitments now that we're never going to be able to keep."

Wrong Assumptions

One notable exception to the problem of insufficiently reflecting future costs in today's budgets is the Credit Reform Act of 1990. In the past, federal budgeteers could record direct federal loans and guarantees -- used for everything from housing and education to aid to farmers and small businesses -- on a yearly cash-flow basis. That created various perverse financial incentives, because loan guarantees didn't appear to "cost" the government anything in the short term, even though some guaranteed loans ultimately default. What's more, direct loans seemed more expensive than they really were because cash-based budget methods didn't take into account that many direct loans are paid back. The 1990 legislation required the government to estimate how much money it was likely to lose in the future on its loans and guarantees and to budget each year for those expected losses.

The result, according to Phaup and his CBO colleague David Torregrosa, is that lawmakers now have a much greater inducement to look at the long-term costs of these programs. "Single-year cash flows are now seen as irrelevant, while cash flows over the life of the credit contract are properly regarded as the key component of cost," they write in a chapter of a book due out later this year, The Handbook of Government Budgeting.

Nevertheless, despite the changes that credit reform made, some budget-watchers worry that serious risks to federal coffers remain. "In theory, loan guarantees could be the biggest reason the federal budget goes bust," said fiscal expert Stanley E. Collender, who works in the Washington office of the New York City-based public affairs firm Burson-Marsteller.

Under credit reform, the federal budget must reflect what's known as the "net present value" of loan subsidies based on a calculation of the risk of default. Nevertheless, Collender said, "budget assumptions are notoriously wrong." He said, for example, that a large number of student loans could go belly-up unexpectedly -- and very expensively.

Some long-term costs aren't really unexpected but could, nevertheless, strain resources at a time when the government needs every penny it has. The Center on Budget and Policy Priorities harshly criticized last year's tax bill because of the "sharply escalating costs" over the next 20 years of the cuts it made in the estate tax, the capital gains tax and the corporate alternative minimum tax. Robert Greenstein, the group's director, said in an interview that he's worried Congress may pass another tax bill this year, sidestepping pay-as-you-go budget rules on the grounds that a budget surplus is in the works. "We could end up with another backloaded tax bill that has very large costs in the years the boomers start retiring," he said.

The unexpected economic growth and revenue surges of recent years lead some analysts to conclude that the long-term fiscal picture is unlikely to be unremittingly gloomy. "I would agree with the idea that people are being a bit myopic," said budget scholar Roy T. Meyers, a political science professor at the University of Maryland (Baltimore County). "In the past, there certainly have been some very costly surprises," he said, citing the huge price tag of the savings and loan bailout. On the other hand, added Meyers, a former CBO analyst and editor of the forthcoming government budgeting handbook: "If you look at the 1980s, there were actually some great surprises which actually reduced costs -- particularly with the breakup of the Soviet Union. Most of the discretionary spending savings since the late 1980s have been there" because of reduced defense outlays. In other words, just as fiscal bad news can be hard to predict, so can fiscal good news. "It's conceivable to me that, yes, although there might be some very costly surprises, there might also be some additional surprises in terms of reducing spending obligations," Meyers said. "It's important to keep that in mind."

There's no question that budget predictions are imperfect. Plus, there are many good reasons not to treat the federal government's accounts the same way a corporation's balance sheets are treated. Still, as the era of surplus politics begins, greater attention to the future bottom line could help prevent the giddiness from getting out of hand.

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