Technical Articles

International Journal of Auditing – January 2004

Addressing Fiscal Risks: A Case for Greater Truth and Transparency in Government Financial Reporting

I recently gave a speech at the National Press Club in Washington, D.C., on a subject that, in my view, has not been getting the attention it deserves: the U.S. government’s worsening financial situation.1 In my remarks, I tried to present the facts, speak the truth, and explain to the American people that our country has a serious and growing fiscal imbalance.

The reality is that the United States faces a structural deficit that will only deepen as the baby boomers2 begin to retire and put unprecedented strains on the nation’s spending and tax policies. The impact of slower economic growth and the recent difficulty in maintaining fiscal restraint have not helped matters. The expected fiscal gap is now so large that there is little chance we will be able to simply grow our way out of the problem.

Yet, this sobering assessment would come as a surprise to many Americans, in part because government financial reporting provides an unrealistic and even misleading picture of the federal government’s overall performance and financial condition. Few agencies adequately show the results they are achieving with the taxpayer dollars they spend, and too many government commitments and obligations are reported in an incomplete or invisible way.

Every nation has its own set of fiscal challenges, and the United States is not unique. Most governments today face some degree of fiscal risk that is not as transparent as it should be. For instance, many industrialized nations will have to make difficult choices to meet the needs of their aging populations. Regardless of the specific issues involved, government financial reports generally fall short in conveying the threat that these long-term challenges can pose to future budgets, tax burdens, and spending flexibilities.

Particularly troubling are the many commitments that governments have made that may not show up in their budgets or financial statements for years. In the case of the United States, the government has pledged its support to a long list of programs and activities—including pension and health care benefits for senior citizens, veterans3 medical care, and government-sponsored entities—that will cost billions of dollars but whose future unfunded commitments do not appear in government financial statements.

Commercial accounting practices require companies to record their pension, health care, and other obligations on their balance sheets, but many governments fail to fully disclose similar costs, such as those of veterans and social insurance programs, in their financial statements. Too often, taxpayers and even some public officials become aware of these commitments only when a crisis is upon them. In recent years, countries from Latin America to East Asia have faced economic instability when their governments were suddenly forced to make good on obligations that few knew existed.

Greater truth and transparency in government reporting are essential if the United States and other nations are to address their long-term fiscal challenges. The fact is that the fiscal risks just mentioned can be managed only if they are properly accounted for and publicly disclosed.

Supreme audit institutions (SAI) can play a vital role in drawing attention to serious fiscal imbalances and promoting sound accounting and reporting practices in their respective countries. An agency insulated from day-to-day political pressures, such as an SAI, can afford to take a longer term view and provide professional, objective, and nonpolitical information on its government’s fiscal health.

SAIs should consider moving beyond routine oversight of day-to-day government operations to alert policymakers to long-term trends with serious implications. Through considered analysis based on foresight and strategic thinking, they can help to prepare their governments for the challenges of the future—before they reach crisis proportions. SAIs should encourage their governments to look beyond current year budget numbers and consider the long-term consequences of current policy decisions. Governments could then better manage their cash flow and make informed choices about future financing needs.

Educating key policymakers, opinion leaders, and the public is essential. To this end, SAIs can shed considerable light on fiscal risks. Importantly, history shows that with light comes heat, and with heat comes action. A crucial first step will be to identify and classify the significant commitments facing the government. If both citizens and government officials come to understand various fiscal exposures and their potential claims on future budgets, they are more likely to insist on prudent policy choices and sensible levels of future fiscal risk. In seeking to stimulate broader public discussion and debate, SAIs will need to be careful to provide constructive recommendations that do not compromise their independence or cross over into policy-making.

Increasing awareness of fiscal exposures, however, is not enough. To create incentives to better support sound decisions about how to finance or avoid such exposures, SAIs will need to encourage the development of accurate cost measurements and their integration into financial reporting, budgeting, and other policy processes. SAIs may also want to consider developing a single portfolio of a country’s fiscal exposures and using fiscal simulation models to help illustrate the nature, timing, and context of fiscal challenges and imbalances. SAIs should also consider encouraging the development and use of a set of key national indicators spanning economic, social, environmental, safety, and security issues to assess a nation’s position and progress over time and relative to those of other countries.

While there is no easy solution to improving government financial reporting, nations around the world are making progress little by little. Some nations have already made great strides. In 1992, New Zealand became the first country to present central government financial statements on an accrual basis. In addition to enhancing the transparency of its financial commitments in budget documents and including items such as capital charges and cost allocations, New Zealand has also embraced various modern management practices, including strategic plans and executive performance agreements.

Some SAIs have begun to increase understanding of their government’s long-term fiscal outlooks. For several years, the U.S. General Accounting Office (GAO) has been simulating the interactions of the federal budget and the economy to show the long-term effects of current law and various fiscal policy alternatives, including the projected growth in existing social insurance programs. Several SAIs have been trying to measure potential fiscal contingencies. The United Kingdom’s National Audit Office, for example, recently reported on fiscal exposure arising from the clinical negligence of employees of the National Health Service, including hospital doctors.

An informal Auditor General’s Global Working Group, of which the United States is a member, has also been addressing many of these challenges. At its 2003 meeting in the Hague, SAIs from more than a dozen major countries were joined by their senior budget officials to discuss the role that audit institutions can play in deliberations over current budgets and future fiscal challenges. Treasury officials acknowledged that SAIs can and have been essential to disclosing underlying fiscal commitments and claims. The SAIs and the budget officials agreed that the independence and credibility of audit institutions can be a powerful force to enhance the transparency of a nation’s fiscal standing and condition in both the short and long terms.

INTOSAI’s Public Debt Committee has also issued valuable guidance to audit institutions on how to work more actively with government officials to reform reporting practices and procedures. The goal is to produce government financial reports that more systematically disclose and highlight the nature of existing budget commitments and claims and their future fiscal implications. In a recent report, the committee developed a framework for defining and disclosing long-term commitments facing various nations. The committee concluded that this framework would help promote full information on the nature and the level of commitments entered into by nations that encumber future resources.4

In the United States, we are starting to see efforts to address the shortcomings in federal financial reporting. The President’s most recent budget submission and the latest annual report of the U.S. government focus more on the nation’s long-range fiscal imbalance. The President’s Management Agenda, which closely reflects GAO’s list of high-risk government programs, is bringing additional attention to problem areas across government. The government is also taking steps to assess the results that programs are achieving with the resources they are given.

GAO recently published a framework for analyzing various Social Security reform proposals and will soon publish a framework for analyzing health care reform proposals.

GAO has also helped to create a consortium of “good government” organizations to stimulate the development of a set of key national indicators to assess the United States’ overall position and progress over time and in comparison to those of other industrialized nations.

GAO and other budget experts continue to urge enhancements to the federal budget process to better reflect the government’s commitments and signal emerging problems. Among other things, GAO has recommended that the government issue an annual report on major fiscal exposures.

“We might hope to see the finances of the Union as clear and intelligible as a merchant’s books,” U.S. President Thomas Jefferson wrote his Secretary of the Treasury in 1802, “so that every member of Congress, and every man of any mind in the Union, should be able to comprehend them, to investigate abuses, and consequently to control them.” Unfortunately, timely, reliable, and useful government financial information can seem as elusive in 2004 as it did in Jefferson’s day.

But the way in which a government measures and keeps score still matters. Government auditors and policymakers alike need to start facing fiscal facts squarely so that future financial stresses can be anticipated and addressed. The importance of speaking out on these issues cannot be overemphasized. Elected officials will have more incentive to make difficult but necessary choices if the public knows the truth and comes to support serious and sustained action to address fiscal risks. Without meaningful public debate, however, real and lasting change is unlikely. SAIs, with their reputation for professionalism, independence, and integrity, are in a unique position to lay the facts on the table and get the discussion going. The time to start is now.