The Red Zone

Comptroller General David M. Walker doesn't seem the type to get emotional about his work. After all, he comes from the buttoned-down world of public accounting, and his agency, the Government Accountability Office, is best known for crunching numbers and producing detailed analyses of federal programs.

But get Walker talking about the federal budget and one can hear echoes of the fire-and-brimstone Presbyterian minister of another age. "When you look back at history and see the great republics that have existed on this earth, none of them has lasted over 300 years," he says. "And one of the reasons was fiscal irresponsibility-when people realized that you could have things today and put off paying for it until tomorrow. But ultimately the day of reckoning comes."

Walker has spent much of the past year trying to raise awareness of the fiscal disaster he sees on the horizon. As the man who audits (and, so far, rejects) the government's annual financial statements, he says it's his professional duty to sound the alarm. As a grandfather of two, he says he is doing this for the coming generations of his family as well. And as a man who takes pride in an American ancestry dating back to Revolutionary times, he cites patriotism as another driving force.

Walker predicts a dramatic rethinking-and scaling back-of much that government does and a period of austerity perhaps never seen before. At the same time, he says, Americans will have to get used to higher tax rates, and elderly retirees should expect less generous government benefits. And that's the best-case scenario, assuming policymakers take responsibility for the fiscal challenges ahead. The worst case, Walker predicts, is an end to U.S. pre-eminence in the world.

Now in his seventh year of a 15-year term as comptroller general, Walker is uniquely positioned to serve as the conscience of the U.S. government on fiscal affairs. His lengthy tenure in office gives him room to raise the issue, even though GAO is an agent of Congress and at least one congressional leader has wondered out loud about Walker's activism.

Congress itself finds it difficult to act on behalf of fiscal discipline. That leaves President Bush as one of few other leaders who could convincingly make a case for the kind of far-ranging reforms that seem plainly necessary to the experts. The president has a chance to make that case as he unveils his second-term agenda this month. The State of the Union message, scheduled for Feb. 2, and his fiscal 2006 budget proposal, due five days later, will tell the tale.

Short- and Long-Term Pain

The American public can be forgiven if it hasn't acknowledged that a crisis is brewing. Deficit spending hasn't had any ill effects yet and it has fueled domestic economic growth. Indeed, the problem is best defined in the longer term, when explosive growth in Social Security costs-and in the outlay for Medicare and Medicaid programs-will outstrip currently projected revenues by huge amounts.

But the government already faces a difficult budget climate as tax cuts and a spending surge fueled by war have driven the federal budget from a surplus of $236 billion in 2000 to a record deficit of $413 billion in 2004. The consequence, not surprisingly, has been a gathering movement to cut back on discretionary spending. Its force became apparent in December, when the huge omnibus appropriations bill for fiscal 2005 denied many programs enough money to keep pace with the growth in demand for federal services. More of the same is in store for fiscal 2006 and beyond, as Office of Management and Budget Director Joshua Bolten strives to deliver on Bush's promise to cut the deficit in half by 2009.

To be sure, reining in government spending seems a reasonable goal, given a record of strong growth over the past decade. Every Cabinet department has benefited from spending growth greater than the 10-year inflation increase of 25 percent. Seven of the 13 departments more than doubled their discretionary budgets.

With the possible exceptions of the Defense and Homeland Security departments, that spending growth is coming to a screeching halt, budget expert George Krumbhaar argues. A longtime congressional staffer now working as a private consultant, Krumbhaar has meticulously examined federal budgets since 1999, tallying which programs received increases, freezes or cuts. For most of that time, presidents have proved generous, increasing funding for more programs than they have cut or frozen.

In the fiscal 2005 budget, however, that generosity begins to decline. And in fiscal 2006, austerity really will take hold, predicts Krumbhaar, on the basis of spending estimates published by OMB a year ago. If those numbers hold up, then some 54 percent of nondefense discretionary programs will see cuts in funding-nearly double the average of the previous seven years.

The budget Bush sends to Congress might not be as harsh as earlier estimates indicated. And Congress, of course, could modify the president's spending proposals. But to reach his deficit reduction goals, Bush will have to target programs for children, welfare, education, the environment, community development, housing, energy, justice, transportation and more. Defense programs also will be on the block, as was telegraphed the week after Christmas when the administration leaked plans for sharp cutbacks in the planned purchase of the Air Force's F/A-22 fighter jets, each of which costs $258 million. The Pentagon is aiming to eliminate $10 billion in spending in 2006 alone and $60 billion over the next six years, according to a Dec. 29 report in The New York Times. Tentative plans include mothballing one of the Navy's 12 aircraft carriers, delaying purchase of a Navy destroyer and the Army's $120 billion Future Combat System, and reducing purchases of Marine Corps amphibious landing docks.

Many agencies already are feeling the pain. In the 2005 budget for domestic discretionary programs, Congress-at the urging of the Bush administration-held fast to one of the most sober spending plans in years. Overall funding for nondefense, nonhomeland security programs rose only 1 percent.

Congress froze funding for grants that help students attend college and reduced outlays for programs that help localities hire police officers and maintain sewer systems. The National Science Foundation incurred the largest budget cut in its history-$105 million below the fiscal 2004 level. Research grants and science education funding were slashed by $30 million. Housing and Urban Development saw cuts in programs for maintaining public housing and providing down payment assistance to lower income workers and aid to the homeless and people with AIDS. The Transportation Department's budget declined by 5 percent.

Transportation Inspector General Kenneth Mead says the cuts soon will prove unsustainable. Eighty percent of the department's budget is covered by trust funds for highways and aviation, generated largely by taxes on gasoline and airline passengers. But in recent years, trust fund revenue has not subsidized all of the agency's spending, forcing Congress to make up the shortfall out of general tax revenues. "You can expect incredible pressure not to make that incursion any greater than it is," says Mead, predicting pressure to boost existing transportation taxes.

In the midst of the budget cuts, agencies will have to find money for an average 3.5 percent pay increase in 2005 for federal employees. When compared with the cost of the 1.5 percent raise Bush originally proposed, that's a lot of money. At Treasury, for example, it represents "as much as $110 million they don't have," says Carl Moravitz, a former Treasury budget director who now works at IBM's Center for the Business of Government. Moravitz predicts Treasury will have to delay a tax compliance initiative as a result.

At the same time, agencies also must cope with large numbers of projects mandated by Congress with appropriations earmarks-often attached to agency spending bills without additional funding. Earmarks now account for $23 billion in federal spending, according to an analysis by the advocacy group Citizens Against Government Waste, which puts the total number of projects mandated by Congress for fiscal 2004 at 10,656.

Moreover, the year-end omnibus appropriations bill saddled domestic agencies with an across-the-board cut of 0.8 percent in their budgets.

All this will likely force agencies to cut back on administrative expenses, training and travel. If the shortfalls are severe enough, then agencies will furlough or lay off workers and freeze hiring. If that doesn't get the job done, then they'll have to delay or scale back acquisitions and nonmandatory programs.

Walker calls the practice of combining earmarks with across-the-board cuts "adding fat while cutting bone." He hopes that eventually Congress will take a more comprehensive approach to cost-cutting, built on performance-based reviews of government programs.

For example, Walker says, Congress could consider further cuts in defense acquisition programs that seem more suited to the Cold War than to today's global war on terror. He also argues that government might be better off without tax incentives for employer-based health care, which he says have contributed to health care inflation by fueling demand for what workers perceive as nearly "free" services. Health care deductions and other tax incentives, such as the home mortgage interest rate deduction and the state and local tax deduction, often cost the government more in revenue than all discretionary spending combined.

Entitlement Dilemma

Domestic discretionary spending-that unrelated to defense or homeland security-accounts for less than 18 percent of the budget. Even if it were completely eliminated, the long-term challenges posed by ballooning entitlement costs would remain.

Thanks to health care costs that are rising at twice the rate of inflation, an aging population and a declining birthrate, America's social safety net for the elderly-the Social Security and Medicare programs-is headed toward bankruptcy. To close the gap between promised benefits and anticipated revenues, government needs to come up with about $43 trillion during the next 75 years. That unfunded commitment dwarfs the current federal debt, which stands at more than $7 trillion.

Demographic trends have wreaked havoc on the finances of both Social Security and Medicare. When the Social Security system was created in 1935, 40 workers paid taxes for every retiree who received benefits. Today, only three workers do so, and the figure will drop to two by the time baby boomers stop working. Health care costs rising at rates double that of inflation-attributed to expensive new medical technologies and to an absence of market forces that might restrain spending-are a double whammy. The idea that these programs are supported by "trust funds" is a fiction, since Congress has used temporary "surplus" revenues in these programs to fund other federal activities, issuing debt that will have to be repaid by tomorrow's taxpayers.

Medicare taxes, levied at 2.9 percent of payroll, already do not cover the program's expenses. The hospital insurance program began drawing down assets in 2004 and is on course to go bankrupt in 2019. The prescription drug benefit added to the program in 2003 has only exacerbated the problem.

And here is where the story takes its most unsettling turn. To look at the long run of these programs is to realize that David Walker is no Chicken Little. Driven by demographics, both Social Security and Medicare will greatly increase their claim on national income in the future. Given present tax policies, revenues will not come close to covering federal spending, and the national debt will climb steeply. That, in turn, means that interest payments on the debt will consume an ever-greater share of the budget. Walker predicts that federal spending as a share of gross domestic product will soar past 30 percent of the nation's output in 2030 and approach 45 percent by 2040. Spending today stands at about 20 percent of GDP. Revenues in 2004 were only 16 percent of GDP, the lowest level since 1950.

The Fix

No fixes to the looming crisis are on the horizon. Indeed, recent trends create more problems. Making the round of tax cuts enacted from 2001 to 2003 permanent, as proposed by Bush and assumed in Walker's long-term projection, will cost about $1 trillion over 10 years. Modifying the alternative minimum tax, viewed as necessary by many in Congress to spare the middle class an added burden, will run more than $600 billion over the same period. The war in Iraq, which carries a price tag of more than $120 billion so far, is expected to require another $80 billion in 2005. And the Medicare prescription drug program, which takes full effect in 2006, will cost more than $500 billion over the next 10 years. In the short term, spending growth in these areas will make it difficult for Bush to meet his goal of cutting the deficit in half by 2009. Over the long haul, it will put heavy pressure on future budgets-which also would have to accommodate the heavy costs of the transition to a partly private Social Security program.

At the White House Conference on the Economy late last year, Bush acknowledged the long-term funding problem. "I fully recognize . . . we have a deficit when it comes to entitlement programs, unfunded liabilities," he said. "The first issue is to explain to Congress and the American people the size of the problem . . . in both Social Security and Medicare." Of Social Security, he said, "The crisis is now."

Bush has said that Social Security reform will be a key priority in his second term. Experts say the program's funding deficit is not terribly difficult to fix. It could be erased, for instance, by a relatively small increase in the payroll tax, from today's level of 12.4 percent of payroll to 14.3 percent. Reducing benefit streams by increasing the retirement age or other means also could help. But Bush has flatly rejected tax increases and has ruled out bene-fit cuts, at least for now.

His major proposal is to divert part of Social Security's revenue stream into private retirement accounts owned by individuals who contribute to the system. Over time, the higher returns that might accrue in these accounts could bolster benefit streams. But in the short term, the transition to the new system will cost a lot of money-$2 trillion over 10 years, experts say. These costs would be incurred because the existing stream of revenues is needed to pay today's retirees and there would be nothing left over to divert into the new private accounts. Absent new taxes, the $2 trillion would have to be borrowed, significantly increasing the national debt.

Health care costs pose a larger problem. Medicare now accounts for one-eighth of federal outlays. Ten years from now, it will account for one-fifth, and 10 years after that it will surpass Social Security as the government's largest entitlement program. Costs of the federal-state Medicaid program, funded from general revenues, likewise are rising fast.

Tax reform, potentially another major element of Bush's fiscal program, could be designed to produce more revenue while also meeting the administration's goal of encouraging savings and investment. But for the moment, Bush has said that any tax reform package must be "revenue neutral." And the odds against an ambitious tax reform package seem long indeed, given the large number of sacred cows that would have to be led to slaughter.

Persuading the Public

President Bush's economic forum in mid-December wasn't focused principally on deficit reduction, but Walker devoted much of a Dec. 2 forum on the fiscal future to a discussion of how the public might be persuaded to take an interest. The gathering of fiscal experts, public opinion specialists and others took as a given the gravity of the problem, spending little time outlining its dimensions.

At the forum, a panel of journalists explained how difficult it was to persuade editors, and the reading and viewing public, to pay attention to fiscal issues. A few in the media have tried-including USA Today, The Kansas City Star, The Wall Street Journal and Washington Post columnist David Broder. But Americans clearly see other issues as more pressing. An October 2004 Pew Research Center poll found that Americans ranked Social Security sixth and the deficit ninth on a list of issues they considered most important in deciding whether to vote for George W. Bush or John Kerry in the 2004 election. The economy, terrorism, jobs, education and Iraq all ranked higher.

The absence of public pressure regarding fiscal issues has given Congress free rein to spend. When budget control rules were set to lapse in 2002, Congress simply let them expire. So now there are no caps on discretionary spending, as there once were, and no "pay-as-you-go" rules forcing tax cuts or entitlement increases to be offset by measures that would keep deficits from growing. President Bush reportedly will propose a "Spending Control Act" to set limits on growth of the entitlement programs, but such a measure would be difficult both to enact and to enforce.

Walker, more ambitiously, continues to advocate a top-to-bottom examination of the government's spending portfolio. His is a worthy goal, says Alice Rivlin, "but in a democracy, it's hard to do." She made an effort along these lines while serving as President Clinton's budget director. "There are representatives who care deeply about particular things and they are able to convince colleagues to keep them or trade votes" to preserve favored programs," Rivlin says.

Daniel Yankelovich and Ruth Wooden, respectively chairman and president of Public Agenda, an organization that studies long-term public opinion trends, told participants at Walker's forum that there's no dearth of expert information available, but the public simply doesn't trust what it hears from experts and elected leaders. To engage the public, they said, would require a dialogue focused on a stewardship ethic: the moral obligation to leave the nation in better shape for the coming generations.

Some members of Congress see the issue through this lens. One is the new Republican senator from Oklahoma, Tom Coburn. "The deficit is a moral issue," he told National Journal recently. "I believe it is immoral when you tie your children to spending you can't control."

But on the other side of the ledger, many see important spending programs as morally essential as well. Among them are Republican and Democratic governors who are greatly concerned about preserving the federal contribution to Medicaid. "I certainly understand the need to balance the federal budget," Republican Gov. Mike Huckabee of Arkansas told The New York Times in late December. "But people need to remember that to balance the federal budget off the backs of the poorest people in the country is simply unacceptable. You don't pull feeding tubes from people. You don't pull the wheelchair out from under the child with muscular dystrophy."

At Walker's forum, economists speculated that foreign investors who hold huge amounts of government debt might provoke a fiscal response by the U.S. government by cutting back on their holdings, precipitating an interest spike and further deterioration in the international value of the dollar. But it's unlikely that would lead to the kind of orderly, systematic process of reform that Walker is seeking. Later this month, Walker will release a list of "21st century questions," aimed at prompting policymakers to consider what role government will play in the coming era of fiscal crisis.

"I am confident that we will ultimately come to grips with the challenge," he says. "I'm just concerned that we do it sooner, rather than later."