Federal Debt: Answers to Frequently Asked Questions: An Update

Federal Debt: Answers to Frequently Asked Questions: An Update
(12-AUG-04, GAO-04-485SP).

This report updates information in our 1999 publication, Federal
Debt: Answers to Frequently Asked Questions--An Update
(GAO/OCG-99-27, May 28, 1999). At the time of our last
publication, the federal government was running budget surpluses,
and debt held by the public was projected to drop to historically
low levels. This report provides updated information to reflect
the changes in the nation's fiscal condition and outlook. Our
update addresses frequently asked questions about the federal
debt, deficits, and surpluses. In this update, we present current
information on how federal debt is defined and measured, the
relationship between federal debt and the budget and the economy,
federal debt management and ownership, and future policy issues
regarding federal debt.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-04-485SP
ACCNO: A11497
TITLE: Federal Debt: Answers to Frequently Asked Questions: An
Update
DATE: 08/12/2004
SUBJECT: Debt held by public
Federal debt
Gross federal debt
Deficit reduction
Economic analysis
Interest rates

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GAO-04-485SP

Preface

Section 1: What Is the Federal Debt?

Section 2: What Is the Relationship between the Budget and Federal Debt?

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . 1

How large is the federal debt? . . . . . . . . . . . . . . . . . . . . . .
. . . . 5
What is debt held by the public? . . . . . . . . . . . . . . . . . . . . .
. . . . 6
What is debt held by government accounts? . . . . . . . . . . . . . . . 8
What is the difference between the two types of
federal debt? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . 10
What is the debt limit? . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . 12

What does it mean to have a budget surplus or
deficit and how are they related to federal debt? . . . . . . . . . . 15
What are the historical trends regarding deficits
and debt held by the public as a share of the economy? . . . . 16
What is the role of trust funds in measuring budget
deficits or surpluses? . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . .21
What are the different measures of federal interest? . . . . . . 23
How does interest spending affect the federal budget
and the level of federaldebt? . . . . . . . . . . . . . . . . . . . . . .
. . . . 25
What are the uncertainties associated with debt and
interest projections? . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . 29

Section 3: What Is the Relationship between the Economy and Federal Debt?

Section 4: Federal Debt Management and Ownership

Section 5: Current and Future Policy Issues regarding Federal Debt

What short-term and long-term economic
developments may influence the level of federal
borrowing? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . 33
What are the pros and cons of federal borrowing? . . . . . . . . 37
What has been the interaction between federal
borrowing and saving? . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . 43

How does the government borrow, and what debt
instruments are used? . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . 47
What is the Treasury's goal for debt management? . . . . . . . . 50
What challenges does the Treasury face in
achieving its debt management goal? . . . . . . . . . . . . . . . . . . .
. 51
How do budget conditions affect debt management? . . . . . . 53
Who holdsTreasury securities? . . . . . . . . . . . . . . . . . . . . . .
. . 54

What are key considerations for thefuture? . . . . . . . . . . . . . . 59
How will the current fiscal policy path affect federal
borrowing and budgetary flexibility? . . . . . . . . . . . . . . . . . . .
. 60
Does the debt limit provide a way to control the
amount we borrow? What are some alternatives to the
debt limit? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . 62
Debt is one liability of the federal government. What
are other potential ways to look at exposures or
implicit commitments of the government? . . . . . . . . . . . . . . . 65

Appendix I: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .69
Selected
Bibliography

Appendix II: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .73 Glossary

Appendix III: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . .81
Scope and
Methodology

Tables Table 1: Schedule of Treasury Securities Auctions as of July 2004.
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48 Table 2:
Selected Fiscal Exposures: Sources and Examples (End of Fiscal Year 2003)
. . . . . . . . . . . . .66

Figures Figure 1: Gross Federal Debt and Its Components (End of Fiscal
Year 2003). . . . . . . . . . . . . . . . . . . . . . .6 Figure 2:
Estimated Ownership of Federal Debt Held by the Public (End of Fiscal
Year2003). . . . . . . . . . .8

Figure 3: Distribution of Federal Debt Held by Government Accounts (End of
Fiscal Year 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . .10

Figure 4: Surplus or Deficit as a Share of GDP (1797-2003). . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . .17 Figure 5: Federal
Debt Held by the Public as a Share of GDP (1797-2003) . . . . . . . . . .
. . . . . . . . . . . . . . . . .18

Figure 6: Federal Debt as a Share of GDP (1960-2003) . . . . 19 Figure 7:
Net General Government Debt of Selected Countries (2002). . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . 20 Figure 8: Unified Budget
Deficit or Surplus and Its Components (1968-2003) . . . . . . . . . . . .
. . . . . . . . . . 22 Figure 9: Net Interest as a Share of Total Federal
Outlays (1940-2003) . . . . . . . . . . . . . . . . . . . . . . . . . . .
26 Figure 10: Federal Outlays by Selected Budget Functions (Fiscal Year
2003) . . . . . . . . . . . . . . . . . . . 27 Figure 11: Selected Average
Interest Rates on the Federal Debt (1962-2003) . . . . . . . . . . . . . .
. . . . . . . . 28 Figure 12: Changes in Aged Population as a Share of
Total U.S. Population (1950-2080) . . . . . . . . . . . . . . . 34 Figure
13: Social Security Workers per Beneficiary

(1960-2080) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . 35 Figure 14: Labor Force Growth (1970-2080) . . . . . . . . . . . .
. . 36 Figure 15: Debt Held by the Public as a Share of GDP

under Alternative Fiscal Policy Simulations (2000-2075) . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . 40

Figure 16: Increase in GNP Per Capita Associated with Permanent Deficit
Reduction of 1 Percent of GDP (2003-2054). . . . . . . . . . . . . . . . .
. . 42

Figure 17: Composition of Net National Saving (Fiscal Years 1960-2003) . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . 44 Figure 18:
Average Gross National Saving Rates of Selected Countries (1984-2002) . .
. . . . . . . . . . . . . . . 45 Figure 19: Treasury Bills, Notes, and
Bonds Outstanding (1993-2003) . . . . . . . . . . . . . . . . . . . . . .
. 49 Figure 20: Estimated Ownership of Debt Held by the

Public (End of Fiscal Years 1993 and 2003) . . . . . . . 55 Figure 21:
Purchasing Treasury Securities. . . . . . . . . . . . . . . . 56 Figure
22: Composition of Federal Spending as a Share

of GDP Assuming Discretionary Spending
Grows with GDP after 2004 and That
Expiring Tax Provisions Are Extended . . . . . . . . . . . 61

Figure 23: Federal Debt Compared to Statutory Limit (EndofFiscal Years
1985-2005). . . . . . . . . . . . . . . . . 63

Although the federal government has carried debt throughout virtually all
of U.S. history, in the past publicly held debt rose substantially only as
the result of wars and recessions. However, annual budget deficits from
the 1970s through the mid-1990s sharply increased the total amount of debt
owed to the public during a period marked by the absence of a major war or
depression. The Congress and the President responded to the high deficits
and rising debt over the 1990s by enacting several deficit reduction
initiatives. These actions, along with economic growth, helped shrink
annual deficits and led to 4 consecutive years of surpluses in fiscal
years 1998 through 2001, which in turn reduced debt held by the public.
However, tax cuts, increased spending, and weak economic growth returned
the unified budget of the federal government to deficit in fiscal years
2002 and 2003. This budgetary climate comes at a time when the budget
controls enacted in the 1990s have expired, and there is no agreement yet
on what should take their place.

At the end of fiscal year 2003, debt held by the public stood at $3.9
trillion or 36 percent of the annual size of the U.S. economy. Debt held
by government accounts was $2.9 trillion. Debt held by the public plus
debt held by government accounts represent total debt, or gross federal
debt. The Congressional Budget Office's (CBO) current baseline projections
(assuming current laws and policies remain the same) show deficits and
rising debt for most of the next decade. As GAO and others have noted,1
over the longer term, the retirement of the baby boom generation and
rising health care costs will place additional pressures on the federal
budget. Long-term simulations by GAO, CBO, and the Office of Management
and Budget show that absent policy changes, debt held by the public would
rise to levels ultimately unsustainable by the U.S. economy.

1 See U.S. Government Accountability Office, Our Nation's Fiscal Outlook:
The Federal Government's Long-Term Budget Imbalance,
http://www.gao.gov/special.pubs/longterm. Also, see U.S. Congressional
Budget Office, The Long-Term Budget Outlook (Washington, D.C.: December
2003), and U.S. Office of Management and Budget, Analytical Perspectives,
Budget of the United States Government, Fiscal Year 2005 (Washington,
D.C.: February 2004).

Members of the Congress, other public officials, and many citizens have
recognized that rising federal debt has serious consequences for the
nation. Large deficits and rising federal debt constrain future economic
growth and living standards by reducing the amount of saving in the United
States available for private investment.2 Federal borrowing to finance
deficits may also put upward pressure on interest rates, which increases
household borrowing costs for such things as homes, cars, and college
loans.

In addition to these economic consequences, the budgetary effects of
deficits and growing debt reduce the federal government's flexibility in
funding various programs and activities. Spending on interest cannot be
directly controlled- interest costs are determined by the amount of past
borrowing and interest rates. In fiscal year 2003, net interest spending
was the sixth largest item in the federal budget-about 7 percent of total
federal spending was primarily used to pay interest on debt held by the
public rather than to finance other public priorities. With debt held by
the public increasing and interest rates expected to rise, interest
spending is bound to increase in the near future. Spending for interest
payments accompanied with the growth in mandatory programs over the longer
term will decrease budgetary flexibility in financing discretionary
programs.

This report updates information in our 1999 publication,

Federal Debt: Answers to Frequently Asked Questions-An Update
(GAO/OCG-99-27, May 28, 1999).3 At the time of our last publication, the
federal government was running budget surpluses, and debt held by the
public was projected to drop to historically low levels. This report
provides updated information to reflect the changes in the nation's fiscal
condition and outlook. Our update addresses frequently asked questions
about the federal debt, deficits, and surpluses. In

2 For additional information, see U.S. General Accounting Office, National
Saving: Answers to Key Questions, GAO-01-591SP (Washington, D.C.: June
2001).

3 For our previous work, see U.S. General Accounting Office, Federal Debt:
Answers to Frequently Asked Questions, GAO/AIMD-97-12 (Washington, D.C.:
Nov. 27, 1996).

this update, we present current information on how federal debt is defined
and measured, the relationship between federal debt and the budget and the
economy, federal debt management and ownership, and future policy issues
regarding federal debt. As in our earlier reports, we attempt to provide
the information in a clear, concise, and easily understandable manner for
a nontechnical audience.

In updating this report, we draw on our previously issued work on budget
issues, federal debt, national saving, and long-term fiscal challenges as
well as our review of relevant literature. See appendix I for a short
bibliography of relevant government publications. For easy reference, key
terms are defined in the glossary located in appendix II-these glossary
terms appear in bold type the first time they are used in the text. For
more detailed information on our scope and methodology, see appendix III.

This report was prepared under the direction of Paul L. Posner, Managing
Director, Federal Budget Analysis, Strategic Issues, and Susan J. Irving,
Director, Federal Budget Analysis, Strategic Issues, who may be reached at
(202) 512-9142 or [email protected] if there are any questions. Ali
Bonebrake, Rick Krashevski, Jose Oyola, MaryLynn Sergent, and Keith Slade
made key contributions to this publication. Copies of this report are
available upon request. In addition, this document will be available at no
charge on the GAO Web site at http://www.gao.gov.

[IMG]

David M. Walker Comptroller General of the United States

How large is the federal debt?�

A. Gross debt-also known as total debt-is the measure that captures all of
the federal government's outstanding debt, measured by outstanding bills,
notes, bonds, and other debt instruments of the U.S. government. Gross
debt-which totaled about $6.8 trillion at the end of fiscal year 2003-
consists of debt held by the public plus debt held by government
accounts,1 such as the Social Security and Medicare trust funds.2 (See
fig. 1.) In this update, our discussions focus primarily on debt held by
the public.

1 Debt held by government accounts is also known as intragovernmental debt
holdings.

2 Gross federal debt differs from U.S. gross external debt, which is the
debt owed by U.S. residents to nonresidents. See the glossary for
additional definitions.

Figure 1: Gross Federal Debt and Its Components (End of Fiscal Year 2003)

Source: GAO.

Note: Data from U.S. General Accounting Office, Financial Audit: Bureau of
the Public Debt's Fiscal Years 2003 and 2002 Schedules of Federal Debt,
GAO-04-177 (Washington, D.C.: Nov. 7, 2003), and U.S. Department of the
Treasury 2003 Financial Report of the United States Government
(Washington, D.C.: Feb. 27, 2004).

What is debt held by the public?

A. The federal debt held by the public is the value of all federal
securities sold to the public that are still outstanding- about $3.9
trillion at the end of fiscal year 2003. The level of debt held by the
public is a useful measure because it reflects how much of the nation's
wealth is absorbed by the federal government to finance its obligations.
Thus, debt held by the public best represents the cumulative effect of
past federal

borrowing on today's economy and on the current federal budget.

The amount of any borrower's debt by itself is not a good indicator of the
burden imposed by that debt. A borrower's income and wealth are important
in assessing the burden of debt. Therefore, to get a sense of the burden
represented by the federal debt, that debt is often measured in relation
to the nation's income. Gross domestic product (GDP) is a commonly used
measure of domestic national income. GDP is the value of all goods and
services produced within the United States in a given year and is
conceptually equivalent to incomes earned in production. It is a rough
indicator of the economic earnings base from which the government draws
its revenues. Thus, the ratio of debt held by the public as a share of GDP
is a good measure of the burden on the current economy. In these terms,
the federal debt burden grew in all but 2 years from 1980 through 1993 and
then began a steady decline through 2001. Since then the federal debt
burden has increased to about 36 percent of GDP at the end of fiscal year
2003. (For additional information on the debt held by the public as a
share of GDP, see fig. 5 in sec. 2.) Current growth in the debt-to-GDP
measure does not necessarily create problems in the short term, but
continued growth would further reduce future budgetary flexibility and
ultimately lead to an unsustainable fiscal path.3

Debt held by the public is owed to a wide variety of investors, including
domestic private investors such as individuals, businesses, financial
institutions, and pension funds. Other investors include the Federal
Reserve System, state and local governments, and international investors.
The Treasury estimates that nearly two-thirds of the debt is owed to U.S.
residents and institutions. International investors, including central
banks as well as private investors, hold slightly greater than one-third
of this debt.4 (See fig. 2.)

3 Section 3 discusses the relationship between the debt and the economy,
and section 5 discusses the long-term outlook for federal borrowing and
budgetary flexibility.

4 Section 4 contains additional information on the estimated ownership of
federal debt held by the public.

Figure 2: Estimated Ownership of Federal Debt Held by the Public (End of Fiscal
Year 2003)

Sources: GAO and the Department of the Treasury.

Note: Estimated ownership data are from the U.S. Department of the
Treasury, Treasury Bulletin (Washington, D.C.: December 2003 and March
2004).

What is debt held by

government accounts?

A. Debt held by government accounts (intragovernmental debt)-about $2.9
trillion at the end of fiscal year 2003- represents balances in the
federal government's accounts, primarily trust funds, that accumulate
surpluses.5 The

5 Debt held by government accounts primarily reflects debt held by federal
trust funds, including Social Security. Other federal programs, such as
the Bank Insurance Fund, also hold government securities, but these
amounts represent only a small portion of the total debt held by
government accounts.

balances are invested in special, nonmarketable U.S. Treasury securities
that, like debt held by the public, are guaranteed for principal and
interest by the full faith and credit of the U.S. government. Debt held by
government accounts constitutes future obligations of the Treasury since
the Treasury must pay back this debt when an account needs to redeem its
securities to pay expenditures exceeding its annual receipts. From the
standpoint of the government as a whole, debt held by government accounts
represents amounts loaned from one part of the government to another-in
other words, debt the government owes itself.

The Social Security, Medicare, Military Retirement, and Civil Service
Retirement and Disability trust funds account for about 89 percent of the
total debt held by government accounts at the end of fiscal year 2003.
(See fig. 3.) A trust fund's total surplus (including intragovernmental
transfers6) adds to its balance and increases debt held by government
accounts. However, only cash surpluses (where receipts from the public
exceed spending)-as in the case of the Social Security trust funds-reduce
the government's need to borrow from the public.

6 Intragovernmental transfers include interest received on a trust fund's
assets, the employer portion of federal employee pension costs, and other
appropriated amounts.

Figure 3: Distribution of Federal Debt Held by Government Accounts (End of
Fiscal Year 2003)

Source: GAO.

Note: Data from U.S. General Accounting Office, Financial Audit: Bureau of
the Public Debt's Fiscal Years 2003 and 2002 Schedules of Federal Debt,
GAO-04-177 (Washington, D.C.: Nov. 7, 2003).

What is the difference between the two types of federal debt?

A. Debt held by the public approximates current federal demand on credit
markets. It represents a burden on today's economy, and the interest paid
on this debt represents a burden on current taxpayers. Federal borrowing
from the public absorbs resources available for private investment and may
put upward pressure on interest rates. Further, debt held by the public is
the accumulation of what the federal

government borrowed in the past and is reported as a liability on the
balance sheet of the government's consolidated financial statements.

In contrast, debt held by government accounts (intragovernmental debt) and
the interest on it represent a claim on future resources. This debt
performs largely an internal accounting function. Special federal
securities credited to government accounts (primarily trust funds)
represent the cumulative surpluses of these accounts that have been lent
to the general fund. These transactions net out on the government's
consolidated financial statements. Debt issued to government accounts does
not affect today's economy and does not currently compete with the private
sector for available funds in the credit market.

However, debt held by government accounts reflects a future burden on
taxpayers and the economy. The special federal securities held in the
accounts represent legal obligations of the Treasury and are guaranteed
for principal and interest by the full faith and credit of the U.S.
government. When a government account needs to pay expenditures exceeding
its receipts from the public, the Treasury must provide cash to redeem
debt held by the government account. For example, according to 2004
Trustees projections, the Social Security trust funds will have
insufficient tax income to pay scheduled benefits by 2018. The trust funds
will begin drawing on the Treasury to cover the cash deficit, first
relying on interest income and eventually drawing down accumulated trust
fund assets. The government must obtain cash to finance this spending in
excess of earmarked tax receipts either through increased taxes, spending
cuts, increased borrowing from the public, retiring less debt (if the
unified budget is in surplus), or some combination thereof.

Because debt held by the trust funds is not equal to the future benefit
costs implied by the current design of the programs, it cannot be seen as
a measure of the government's total future commitment to programs financed
by trust funds. The projected accumulated balances held by trust funds can
provide one signal about the underlying fiscal imbalances in these
programs. Trust fund balances do not provide

meaningful information about program sustainability. The critical question
is whether the government as a whole can afford the benefits in the future
and at what cost in terms of other claims on scarce resources. (See sec. 5
for more information on the long-term outlook and fiscal exposures.)

What is the debt limit?

A. Gross debt of the federal government is subject to a statutory
ceiling-known as the debt limit.7 Prior to 1917, the Congress approved
each issuance of debt. In 1917, to facilitate planning in World War I, the
law established a dollar ceiling for federal borrowing, which has been
raised periodically over the years. The current limit-$7,384 billion-was
enacted in May 2003. The gross debt, excluding some minor adjustments,8 is
the measure that is subject to the federal debt limit. At the end of
fiscal year 2003, the amount of debt subject to limit was about $6,737.6
billion. In January 2004, the Congressional Budget Office (CBO) estimated
that under current policies the current limit would be reached during
fiscal year 2004.9 In July 2004, the Treasury estimated the debt limit
would be reached in late September or early October 2004. The Office of
Management and Budget's July 2004 budget projections show

7 For previous GAO work on the debt limit, see U.S. General Accounting
Office, Debt Ceiling: Analysis of Actions Taken During the 2003 Debt
Issuance Suspension Period, GAO-04-526 (Washington, D.C.: May 20, 2004);
Debt Ceiling: Analysis of the Actions During the 2002 Debt Issuance
Suspension Periods, GAO-03-134 (Washington, D.C.: Dec. 13, 2002); Debt
Ceiling: Analysis of Actions During the 1995-1996 Crisis, GAO/AIMD-96130
(Washington, D.C.: Aug. 30, 1996); and Information on Debt Ceiling
Limitations and Increases, GAO/AIMD-96-49R (Washington, D.C.: Feb. 23,
1996). See also U.S. Office of Management and Budget, Analytical
Perspectives, Budget of the United States Government, Fiscal Year 2005
(Washington, D.C.: February 2004).

8 A very small amount of the gross debt-less than 1 percent at the end of
fiscal year 2003-is excluded from the debt limit. The amount excluded is
mainly issued by agencies other than the Department of the Treasury, such
as the Tennessee Valley Authority.

9 U.S. Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2005 to 2014 (Washington, D.C.: January 2004).

debt subject to the limit will be only $9 billion below the statutory
limit as of September 30, 2004.10 See section 5 for more on raising the
debt limit to accommodate further borrowing.

10 U.S. Office of Management and Budget, Fiscal Year 2005 Mid-Session
Review (Washington, D.C.: July 2004).

What does it mean to have a budget surplus or deficit and how are they related
to federal debt?

A. The budget surplus or deficit (also called the "unified" or "total"
budget surplus or deficit-including the trust funds) is the difference
between total federal spending and revenue in a given year. To finance a
budget deficit,1 the government borrows from the public. Alternatively,
when a budget surplus occurs, the government accumulates excess funds that
are used to reduce debt held by the public. In other words, deficits or
surpluses generally approximate the annual net change in the amount of
debt held by the public, while the debt held by the public generally
represents the total of all unified deficits minus all unified surpluses
accumulated over time.

When the Congress makes budgetary decisions, it is also indirectly making
decisions about the nominal level of debt held by the public. If the
budget is in balance, the amount of debt held by the public would remain
essentially unchanged. The Treasury incurs the interest costs on debt held
by the public, but government spending does not reflect cash used to
retire the principal of outstanding debt when it matures. The principal
that comes due is paid off with cash raised by issuing new securities, and
the debt is rolled over. If the budget is in deficit, the government must
both issue new debt to the public and roll over maturing debt. A unified
budget surplus allows the Treasury to reduce the nominal level of debt
held by the

1 The surplus or deficit is approximately equal to the yearly change in
the debt held by the public. However, several minor types of transactions
referred to as "other means of financing" account for differences between
the two amounts. These "other means" include changes in the Treasury's
operating cash balances, net purchases of nonfederal securities by the
National Railroad Retirement Investment Trust, and net financing
disbursements by the government's loan guarantee and direct loan financing
accounts.

public by rolling over less debt when it matures. (See sec. 4 for more
information about the Treasury's debt management.)

What are the historical trends regarding deficits and debt held by the public as
a share of the economy?

A. Figures 4 and 5 show the budget surplus or deficit and the debt held by
the public as shares of GDP. Short deficit periods have caused increases
in debt that lingered long after annual deficit levels declined. For
example, the federal budget deficit increased sharply from about 4 percent
to about 30 percent of the economy from 1941 through 1943, and
correspondingly, federal debt held by the public increased sharply until
it reached its zenith as a percentage of GDP in 1946. It then took 17
years, from 1946 until 1963, for the debt-to-GDP ratio to return to its
1941 level.

Figure 4: Surplus or Deficit as a Share of GDP (1797-2003)

10 Percentage of GNP/GDP

-5

-10

-15

-20

-25

-30

-35 1797 1820 1840 1860 1880 1900 1920 1940 1960 1980 2003 Fiscal year
Deficit or surplus

Sources: Department of Commerce, Office of Management and Budget, and CBO.
Note: Data until 1929 are shown as a percentage of gross national product
(GNP); data from 1930 to present are shown as a percentage of GDP.

As figure 5 shows, prior to the 1980s, the debt-to-GDP measure rose
substantially only as the result of wars and recessions. Borrowing during
these times helped protect the nation's security interests and stabilize
the economy. From the early days of the republic until the 1980s, debt
held by the public exceeded 30 percent of GDP during periods surrounding
the Civil War, World War I, the Great Depression, and World War II.

Figure 5: Federal Debt Held by the Public as a Share of GDP (1797-2003)
120 Percentage of GNP/GDP

100

0 1797 1820 1840 1860 1880 1900 1920 1940 1960 1980 2003 Fiscal year

Debt held by the public

Source: GAO analysis of Department of Commerce, Office of Management and
Budget, and CBO data.

Note: Data until 1929 are shown as a percentage of GNP; data from 1930 to
present are shown as a percentage of GDP.

Recent increases in the debt held by the public broke with historical
patterns by climbing significantly during a period marked by the absence
of either a major war or depression. Beginning in the late 1970s, rising
federal budget deficits fueled a corresponding increase in debt held by
the public, which essentially doubled as a share of GDP over a 15-year
period through the mid-1990s and reached about 50 percent of GDP in 1993.
The budget controls instituted in the 1990s successfully restrained fiscal
action by the Congress and the President and-together with economic
growth-contributed to the budget surpluses that materialized by the end of
the decade. These surpluses led to a decline in the debt held by the
public, and from fiscal years 1998 through 2001, the debt-to-GDP measure
declined from about 43 percent to about 33 percent.

Tax cuts, increased spending (including spending for increased homeland
security and defense commitments), weak economic growth, and
lower-than-expected capital gains receipts have led to a return to annual
deficits and a rise in the debt-to-GDP measure. In addition, the budget
controls that once helped to lower deficits have expired, and no agreement
has yet been reached on a successor regime. The sharp reversal in the
government's fiscal position is reflected in the debt numbers. From the
end of fiscal years 2001 through 2003, debt held by the public rose by
about $594 billion from $3.3 trillion to $3.9 trillion. As a share of GDP,
debt held by the public at the end of fiscal year 2003 was about 36
percent of GDP, still lower than about 49 percent of GDP reached in the
mid-1990s. Figure 6 shows debt held by the public and debt held by
government accounts as a share of GDP from 1960 through 2003.

Figure 6: Federal Debt as a Share of GDP (1960-2003)

80 Percentage of debt as a share of GDP

0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2003 Fiscal year

Debt held by government accounts Debt held by the public

Source: Office of Management and Budget.

Note: Data from U.S. Office of Management and Budget, Budget of the United
States Government for Fiscal Year 2005 - Historical Tables (Washington,
D.C.: February 2004).

CBO's January 2004 baseline projects that debt held by the public will
grow to about 40 percent of GDP in coming years. Debt held by government
accounts rises steadily during this time frame under CBO's projections.
(See sec. 5 for further discussion about budget projections and the
long-term fiscal outlook.)

In 2002 the United States was in the middle of a group of seven major
industrialized nations when comparing net general government debt-which
includes the consolidated debt of all levels of government (national,
state or regional, and local)- as a share of the economy. (See fig. 7.)

Figure 7: Net General Government Debt of Selected Countries (2002)

100 Percentage of nominal GDP 94.2

0 United Canada France United Germany Japan Italy Kingdom States

Source: Organisation for Economic Co-operation and Development.

Note: Data from Organisation for Economic Co-operation and Development,
OECD Economic Outlook No. 74, vol. 2 (Paris: December 2003).

What is the role of trust funds in measuring budget deficits or surpluses?

A. To understand the role of trust funds in measuring budget deficits and
surpluses, it is necessary to understand the two fund groups in the
unified budget: (1) trust funds and (2) federal funds. Trust funds
represent an accounting mechanism used to link earmarked receipts-receipts
dedicated for a specific purpose-with the expenditures of those receipts.2
All other budget accounts not explicitly designated as trust funds by law
are known as federal funds.3 The sum of trust fund and federal fund
surpluses and deficits comprise the annual unified budget total.
Currently, trust funds in aggregate are running total surpluses (including
interest and other intragovernmental transfers), and the remainder of the
budget-the so-called federal funds portion- has a deficit. At the end of
fiscal year 2003, the unified budget had a deficit of about $375
billion-the net result of a trust funds total surplus of about $178
billion and a federal funds deficit of about $554 billion. (See fig. 8.)

2 We identified 130 trust funds in fiscal year 1999; see GAO-01-199SP.

3 Within federal funds there are four types of fund accounts: (1) general
funds, (2) special funds, (3) public enterprise funds, and (4)
intragovernmental funds.

Figure 8: Unified Budget Deficit or Surplus and Its Components (1968-2003)
300 Dollars in billions

200

100

-100

-200

-300

-400

-500

-600 1968 1973 1978 1983 1988 1993 1998 2003

Fiscal year

Trust funds

Federal funds Unified budget deficit or surplus Source: Office of
Management and Budget.

Notes: Data from U.S. Office of Management and Budget, Budget of the
United States Government for Fiscal Year 2005 - Historical Tables

(Washington, D.C.: February 2004). Trust fund total surpluses include
interest and other intragovernmental transfers.

Trust fund total surpluses add to debt held by government accounts, but
only cash surpluses reduce the need for the federal government to borrow
from the public. The Social Security trust funds had the largest cash
surpluses in fiscal year 2003. Although the civilian and military
retirement programs had total surpluses-i.e., including federal employer
contributions and interest-these trust funds ran cash deficits. The Civil
Service Retirement and Disability trust fund receives contributions from
federal employees, but the Military Retirement trust fund has no cash
receipts; thus the federal

government spends more each year for these programs than it receives in
earmarked receipts from the public. Excluding about $344 billion in
intragovernmental transfers, trust funds in the aggregate had a cash
deficit of about $165 billion in fiscal year 2003.

When the funds needed to pay benefits and expenses of a trust fund program
exceed dedicated tax receipts, it redeems some of its Treasury securities
as necessary. The Treasury would need to obtain cash to redeem these
securities. Cash can be obtained in the following ways: increased taxes,
lower spending, increased borrowing from the public, retiring less debt
(if the unified budget is in surplus), or some combination thereof.

What are the different measures

of federal interest?

A. The federal government-like other borrowers-pays interest on its debt.
The way interest is reported in the federal budget varies depending on the
type of federal debt. The budget records outlays for the interest on debt
held by the public on an accrual basis; in other words, interest is
recorded as an outlay when the Treasury incurs the expense, not when the
Treasury makes the payment. Interest on inflation-indexed securities and
accrual savings bonds (such as Series EE savings bonds) are treated
somewhat differently than interest on other publicly held Treasury
securities.4 For debt held by government accounts, the budget normally
records outlays for

4 Inflation-indexed securities feature monthly adjustments to principal
for inflation and semiannual payments of interest on the
inflation-adjusted principal. Accrual savings bonds also feature monthly
adjustments to principal. The monthly adjustments to principal are
recorded as an increase in debt outstanding, to be paid at redemption, and
an outlay of interest.

interest on a cash basis, when the interest is actually credited to those
accounts.5

Interest on debt held by the public essentially constitutes net interest.6
This interest is part of current outlays by the government and represents
the burden of servicing the debt. Even with today's historically low
interest rates, the $153 billion in net interest in fiscal year 2003 was
the sixth largest category of spending and constituted about 7 percent of
total federal spending.

Gross interest in the budget essentially represents interest on all
Treasury debt securities, including interest paid to the public and
interest credited to government accounts. Trust funds and other government
accounts holding federal debt are also credited with interest on that debt
(since they are lending their surpluses to the Treasury). This
interest-which totaled $158 billion in fiscal year 2003-is an accounting
transaction that typically does not require cash payments from the current
budget or represent a burden on the current economy. In effect, one part
of the government pays the interest to another part of the
government-there is no net change in current spending. Like the rest of
the balances in the trust funds, the interest received on debt held by
government accounts represents a future priority claim on the U.S.
Treasury.

5 The budget treats interest somewhat differently for certain securities
held in government accounts, that is, zero-coupon bonds and securities
held by four trust funds in the Department of Defense. These securities
have large differences between the purchase price and par, which are
amortized over the life of each security. The budget records interest as
the amortization occurs.

6 In addition to the interest that the federal government pays on debt
held by the public, the government also earns some interest from various
sources and pays interest for purposes other than borrowing from the
public. These amounts are only a small portion of net interest and, taken
together, somewhat reduce its total.

How does interest spending affect the federal budget and the level of federal
debt?

A. The federal debt primarily affects the federal budget through the level
of interest spending. If interest on the federal debt is relatively large,
this reduces budgetary flexibility because unlike other federal spending,
interest cannot be changed directly. Rather, interest spending is a
function of interest rates and the amount of debt on which interest must
be paid. At any given interest rate, additional borrowing will drive up
interest payments. Similarly, at any given level of debt, higher interest
rates increase the amount of interest paid. The mix of Treasury debt also
affects interest payments as longer-term debt typically bears a higher
rate than shorter-term instruments; see section 4 for further discussion
of Treasury debt management.

Spending for net interest overall rose sharply from about 9 percent of
total federal spending in fiscal year 1980 to about 15 percent in fiscal
year 1996. Since then, net interest spending declined to about 7 percent
of total federal spending in 2003. (See fig. 9.) Currently, net interest
represents the sixth largest spending item in the federal budget. (See
fig. 10.)

Figure 9: Net Interest as a Share of Total Federal Outlays (1940-2003)

18 Percentage of total outlays

0 1940 1950 1960 1970 1980 1990 2000 2003

Fiscal year

Net Interest

Source: Office of Management and Budget.

Note: Data from U.S. Office of Management and Budget, Budget of the United
States Government for Fiscal Year 2005 - Historical Tables (Washington,
D.C.: February 2004).

Figure 10: Federal Outlays by Selected Budget Functions (Fiscal Year 2003)

Social security
National defense
Income security
Medicare
Health
Net interest
Education, training, employment, and social services
Transportation
Veterans benefits and services
Administration of justice
Natural resources and environment
Agriculture
General government
International affairs
General science, space and technology
Community and regional development

$475

Dollars in billions

Source: Office of Management and Budget.

Notes: Data from U.S. Office of Management and Budget, Budget of the

United States Government for Fiscal Year 2005 - Historical Tables

(Washington, D.C.: February 2004). The budget function classification
system

is a way of grouping budgetary resources that provides a comprehensive and

consistent means to capture federal spending according to area of national

need.

There is no one interest rate on the federal debt held; interest rates
vary with the specific type of debt security. Interest rates on the
federal debt have fluctuated over time. For example, interest rates began
to rise in the 1960s and grew to historically high levels in the early
1980s. Since then, interest rates have significantly declined. In 2003,
the average interest rate on Treasury bills declined to a historically low
level of about 1 percent. Figure 11 shows the average interest rates over
the past 40 years on Treasury securities at 1-year, 5-year, and 10year
constant maturities.

16 Average rate

1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2003

Year

1-year

5-year

10-year

Source: Federal Reserve.

Notes: Data from Federal Reserve, "Selected Interest Rates, Historical
Data," Federal Reserve Statistical Release H.15 (Washington D.C.: Feb. 2,
2004), http://www.federalreserve.gov/releases/h15/data.htm (downloaded
Feb. 4, 2004). Estimated rates reflect yields on actively traded issues
adjusted to constant maturities.

In the past, interest payments contributed to deficits and helped fuel a
rising debt burden. Rising debt, in turn, raised interest costs to the
budget, and the federal government increased debt held by the public to
finance these interest payments. This has been called the "vicious cycle."
The change from a budget deficit to a surplus in 1998 reduced federal debt
held by the public and replaced this "vicious cycle" with a "virtuous
cycle" in which budget surpluses resulted in lower debt levels. The lower
debt levels together

with relatively low interest rates led to lower interest payments. These
lower interest payments helped to bring about larger potential surpluses
and increased budget flexibility.

Today, although debt held by the public has started to increase,
relatively lower interest costs have lessened the pressure debt service
places on the budget. At the end of fiscal year 1997, the federal
government had a budget deficit and debt held by the public was
approximately $3.8 trillion. Similarly, at the end of fiscal year 2003,
the federal government had a budget deficit and debt held by the public
was about $3.9 trillion. Despite the relatively lower level of debt held
by the public in 1997, net interest spending was significantly higher than
in 2003. For example, net interest spending totaled about $244 billion at
the end of fiscal year 1997 compared to $153 billion at the end of fiscal
year 2003. The lower interest burden in 2003 reflects in part lower
average interest rates and a change in the debt mix. A higher share of
debt is in lower-rate short-term bills, and some maturing long-term debt
has rolled over at lower rates.

What are the uncertainties

associated with debt and interest projections?

A. Ten-year debt and interest projections prepared by CBO7 are based on
its baseline budget projections, which illustrate the size of projected
annual deficits and surpluses (assuming that current laws and policies
remain the same) as well as CBO's estimate of the government's other cash
needs. Debt projections approximate the accumulation of deficits to the
present and over the 10-year projection period. Net interest projections
are based on CBO's forecast for short-and longterm interest rates and its
assumption about the future mix of

7 The Office of Management and Budget also prepares baseline projections
as well as 5-year budget projections showing the President's proposed
policy changes.

debt held by the public. Like budget projections, debt and interest
projections are always uncertain and are not intended to be precise
predictions for the future. Actual debt and interest will differ from the
baseline projections because of policy changes the baseline is not
intended to predict.

The budget remains vulnerable to changes in interest rates, which are
expected to rise as the U.S. economy recovers and unemployment falls. For
example, CBO estimated that for a 1percentage point increase over the
baseline in interest on the federal debt at every maturity (assuming other
economic variables are unchanged), interest costs to the federal
government would increase by about $11 billion in fiscal year 2004. These
costs would be fueled largely by the extra costs of refinancing the
government's short-term debt, which makes up about 27 percent of
marketable debt.

Baseline projections are based on various estimates and assumptions about
how government programs will operate and how the economy will perform.
Uncertainties in projecting the baseline relate to forecasting the overall
performance of the economy; even small changes in economic projections can
have significant budgetary implications.8 Additionally, relationships
within the economy, such as the level of capital gains realizations or the
effects of technological innovation, are difficult to predict and can
substantially affect federal revenue or spending.

Ten-year budget projections are useful in that they allow policymakers to
consider the implications of legislation further out than the 1-to 5-year
budget window. However, 10 years is too short a time horizon for the
significant pressures driving the U.S. fiscal future. For example, while
the baby boom generation will first become eligible for Social Security
benefits in 2008 and for Medicare in 2011, the full impact of the

8 Predicting turning points in the business cycle is particularly
difficult, and according to CBO, revenues tend to be overestimated when
the economy enters a recession and underestimated when the economy enters
an expansion.

baby boom retirement will not be felt until several years later.9 The
retirement of this generation accompanied with rising health care costs
will place unprecedented and long-lasting stress on the federal budget.

9 Individuals in the baby boom generation were born from 1946 through
1964. Earliest eligibility for Social Security benefits occurs at age 62
and for Medicare benefits at age 65.

What short-term and long-term economic developments may influence the level of
federal borrowing?

A. Budget deficits or surpluses are affected not only by tax and spending
policy decisions but also by economic developments. Short-term
fluctuations in economic activity can cause tax or spending levels to
change without any deliberate government action. For example, income tax
collections are sensitive to economic fluctuations. During recessions the
government collects less tax revenue due to the reductions in payrolls and
the incomes of individuals and corporations. Correspondingly, during times
of economic recovery the government collects more income tax revenue when
payrolls and incomes rise. Spending for some government programs may also
change automatically with the economy-although the response is smaller
than on the tax side. For example, unemployment insurance costs increase
in a recession as those unemployed apply for benefits.1

Financial market conditions also influence the budget and federal
borrowing in the short term. From the mid to late 1990s, for example,
strongly rising stock markets led to increased tax receipts on realized
capital gains. The subsequent decline in the stock market that began in
2001 reduced revenue received from the capital gains tax and contributed
in part to the return of budget deficits.

Over the long term, federal borrowing will be heavily influenced by
financing needs of programs targeted to the elderly population.
Demographic trends, including the retirement of the baby boom generation,
increasing life

1 These effects are known as automatic stabilizers, which are provisions
built into the structure of the federal budget that alter tax or spending
levels based on economic fluctuations without any explicit government
action.

expectancy, and declining fertility rates will continue to contribute to
the dramatic growth of the elderly population. Since 1950, the share of
people age 65 or older has grown rapidly and accounts for an increasing
share of the total population. (See fig. 12.)

25 Percentage of total population

Year

Population aged 65 and over Source: Office of the Chief Actuary, Social
Security Administration.

Note: Projections based on the intermediate assumptions of The 2004 Annual
Report of the Board of Trustees of the Federal Old-Age and Survivors
Insurance and the Federal Disability Insurance Trust Funds.

As people live longer and have fewer children, there will be relatively
fewer workers for each retiree. In 1960, there were about 5 workers for
each Social Security beneficiary. Today, there are approximately 3.3
workers for each beneficiary, and the Social Security Trustees project
that this number will fall to 2.2 by 2030. (See fig. 13.) Unless
immigration or fertility rates change substantially, or unless retirement
patterns change, that figure will continue to decrease slowly after 2030.

195019551960196519701975198019851990199520002005201020152030203520402045205020552065207020752080

0 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080

Fiscal year Covered workers per Social Security beneficiary

Source: Office of the Chief Actuary, Social Security Administration.

These demographic trends mean that labor force growth will drop after
2010, and by 2025 is expected to be less than a third of what it is today.
(See fig. 14.) Relatively fewer workers will be available to produce the
goods and services that all will consume. Without a major increase in
productivity, low labor force growth will lead to slower growth in the
economy and slower growth of federal revenues. This in turn will only
accentuate the overall pressure on the federal budget and the need for
borrowing. Assuming no changes to currently projected benefits and
revenues, Social Security and Medicare ultimately will pose an
unsustainable burden on future

taxpayers and would significantly reduce the nation's economic growth.

2.5

2.0

1.5

1.0

0.5

1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080

Year

Labor force growth Source: GAO analysis of data from the Office of the
Chief Actuary, Social Security Administration.

Note: Percentage change is calculated as a centered 5-year moving average
of projections based on the intermediate assumptions of The 2004 Annual
Report of the Board of Trustees of the Federal Old-Age and Survivors
Insurance and the Federal Disability Insurance Trust Funds.

Over the longer term, economic growth can reduce the burden of annual
deficits and debt accumulated. Productivity growth leading to a larger
economy in turn would help tomorrow's slow-growing workforce as it
struggles to meet the burden of paying for the baby boomers' retirement
while achieving a rising standard of living for itself. However, faster
economic growth alone will not eliminate the long-term fiscal pressures
arising from an aging population and federal commitments to

Social Security and Medicare.2 With advances in medical technology likely
to keep pushing up the cost of providing health care, federal spending for
Medicare and Medicaid is expected to increase faster than the rest of the
economy. (See sec. 5 for more information on the long-term fiscal
outlook.)

What are the pros and cons of

federal borrowing?

A. Federal borrowing has both advantages and disadvantages that vary
depending upon economic circumstances. In addition, views of federal
borrowing generally vary with its size in relation to the economy and
stage of the business cycle. Borrowing, in lieu of higher taxes or lower
government spending, may be viewed as appropriate during times of economic
recession, war, and other temporary challenges or national needs.
Borrowing during a recession can help to maintain household income and
spending levels and reduce the severity of a recession.3 Similarly,
borrowing in times of war can finance increased defense spending without
reducing other government spending or enacting large tax increases that
could be disruptive to the economy. The federal government financed World
War II with huge deficits to avoid even larger tax increases and economic
distortions. Further, borrowing can finance higher government spending in
response to other temporary challenges or national needs, such as large
natural disasters or the terrorist attacks of September 11, 2001.
Borrowing for such short-term circumstances can permit the government to
hold tax rates relatively stable and avoid economic disruptions.

2 See Rudolph G. Penner, "Can Faster Growth Save Social Security?" Issue
In Brief No. 15 (Chestnut Hill, Mass.: Center for Retirement Research,
December 2003).

3 Federal borrowing may be higher during a recession because tax revenue
declines and federal benefit payments for programs such as unemployment
insurance automatically increase.

Federal borrowing might also be viewed as appropriate for federal
investment, such as building roads, training workers, and conducting
scientific research, contributing to the nation's capital stock and
productivity.4 Spending on physical capital, education, and research and
development (R&D) accounted for 16 percent of total federal outlays in
fiscal year 2003. Public facilities, such as transportation systems and
water supplies, are vital to meeting immediate as well as long-term public
demands for safety, health, and improved quality of life. R&D and
education have long been seen as areas for government action given the
private sector's inability to capture all of the societal benefits that
such investments provide. In concept, federal spending that is well
chosen, properly designed, and properly administered could ultimately
contribute to producing a larger economy from which to pay the interest
and principal on the borrowed funds. However in practice, CBO concluded
that many federal investments might not significantly increase economic
growth because some are selected for political or other noneconomic
reasons and others displace more productive investments by the private
sector or state and local governments.5

Any judgment about borrowing involves trade-offs and the costs of
borrowing could outweigh the benefits. Borrowing for additional spending
or lower taxes aimed at maintaining current consumption improves
short-term well-being for today's workers and taxpayers but does not
enhance our ability to repay the borrowing in the future. Although
reducing federal deficits is the surest way to increase national saving
available for private investment, the composition of federal spending also
matters. At some point, reducing federal deficits at the expense of
federal investment spending raises concerns about the outlook for the
nation's infrastructure, future

4 In addition to its own investment spending, the federal government can
also influence saving and investment by state and local governments and
the private sector by providing funding and tax incentives.

5 CBO reviewed evidence available on the economic value of federal
investments in infrastructure, education and training, and R&D. For more
information, see U.S. Congressional Budget Office, The Economic Effects of
Federal Spending on Infrastructure and Other Investments (Washington,
D.C.: June 1998).

workers' skills, technological advancement, and thus economic growth. For
any given fiscal policy path, policymakers can strive to allocate a
greater share of federal spending on well-chosen investment activities
aimed at enhancing long-term productivity.

In the near term, federal borrowing absorbs scarce savings available for
private investment and can exert upward pressure on interest rates. When
the economy is operating near full capacity, government borrowing can be
large enough to affect overall interest rates, making borrowing more
expensive for individuals and families who take out loans for homes, cars,
and college. Or, as discussed below, the United States has been able to
invest more than it saves by borrowing from abroad.

Over the long term, the costs of federal borrowing will be borne by
tomorrow's workers and taxpayers. Higher saving and investment in the
nation's capital stock-factories, equipment, and technology-increase the
nation's capacity to produce goods and services and generate higher income
in the future. Increased economic capacity and rising incomes would allow
future generations to more easily bear the burden of the federal
government's debt. Persistent deficits and rising levels of debt, however,
reduce funds available for private investment in the United States and
abroad. Over time, lower productivity and GDP growth ultimately may reduce
or slow the growth of the living standards of future generations.

The fiscal policies in place today-absent substantive entitlement reform
and dramatic changes in tax and spending policies-will result in large,
escalating, and persistent deficits that are economically unsustainable
over the long term. In other words, today's policies cannot continue
forever. Demographic trends; escalating health care costs; and the
projected growth in federal spending for Social Security, Medicare, and
Medicaid have created mounting fiscal pressures that will affect the
economy. GAO's fiscal policy simulations show that over the long term,
debt held by the

public will rise to unprecedented levels as a share of GDP.6 Previously,
debt held by the public peaked at about 109 percent of GDP in 1946
following the Great Depression and World War

II. (For additional information on the historical trends of debt held by
the public as a share of GDP, see fig. 5 in sec. 2.) Due primarily to
known demographic trends and rising health care costs, our long-range
budget simulations show debt held by the public far surpassing this level
in the coming decades. Figure 15 illustrates the growing debt burden
facing the nation.

200 Percentage of GDP

175 150 2000 2010 2020 2030 2040 2050 2060 2075

Fiscal year Source: GAO.

6 Long-term simulations provide illustrations-not precise forecasts-of the
relative fiscal and economic outcomes associated with alternative policy
paths. They are not predictions of what will happen in the future because
policymakers would likely take action before the occurrence of the
negative out-year fiscal and economic consequences reflected in some
simulated fiscal policy paths.

Notes: Simulations are from GAO's March 2004 long-term analysis.
Simulations assume currently scheduled Social Security benefits are paid
in full throughout the simulation period. GAO's "baseline extended"
simulation follows CBO's 2004 10-year baseline projections, which assume
that discretionary spending grows with inflation and tax provisions
scheduled to expire will actually do so. After 2014, discretionary
spending is assumed to grow with the economy, and revenue is held constant
as a share of GDP at the 2014 level of 20.1 percent. GAO's "discretionary
spending grows with the economy and all expiring tax provisions are
extended" follows CBO's January 2004 10-year baseline projections except
that discretionary spending grows with the economy after 2004 and all
expiring tax provisions are extended. After 2014, revenue is held constant
as a share of GDP at the 2014 level of 17.7 percent.

GAO's long-term simulations show that absent policy actions aimed at
deficit reduction, debt burdens of such magnitudes imply a substantial
decline in national saving available to finance private investment in the
nation's capital stock. The fiscal paths simulated are ultimately
unsustainable and would inevitably result in declining GDP and future
living standards. Even before such effects, these debt paths would likely
result in rising inflation, higher interest rates, and the unwillingness
of foreign investors to invest in a weakening American economy.

Conversely, reducing the deficit and associated borrowing can generate
increases in economic growth by increasing national saving and freeing
resources for private investment. Domestic investment can boost
productivity of the nation's workforce and lead to higher real wages and
greater economic growth over the long term. A simulation using GAO's
long-term budget model suggests that in 50 years a permanent deficit
reduction of 1 percent as a share of GDP could increase the gross national
product (GNP) per capita-a measure of living standards-by 2.3 percent.
Figure 16 shows that this amounts to almost $2,000 in higher income per
person in 2003 dollars.7

7 The effect of deficits on growth cannot be determined precisely because
the outcome depends on a number of factors subject to uncertainty,
including the response of private saving to a change in the deficit, the
extent to which an increase in national saving is invested overseas, and
the returns on those investments. If private savers were to respond by
reducing their saving by the same amount as the decrease in the deficit,
for example, deficit reduction would have no effect on economic growth.

Larger deficit reductions could provide commensurately larger increases in
future income.

Figure 16: Increase in GNP Per Capita Associated with Permanent Deficit
Reduction of 1 Percent of GDP (2003-2054)

2,500 2003 dollars

2,000

1,500

1,000 500 0

200320062009 201220152018 202120242027 203020332036 203920422045 204820512054

Fiscal year

Change in real GNP per capita Source: GAO.

Notes: Simulation is from GAO's long-term fiscal model. The effect of
deficits on growth cannot be determined precisely because the outcome
depends on a number of factors subject to uncertainty. Our model assumes
that private saving is unaffected by changes in the deficit and that
one-third of the increase in national saving that results from deficit
reduction is invested abroad. Increases are calculated in 2003 dollars.

What has been the interaction between federal borrowing and saving?

A. Federal deficits subtract from national saving by absorbing funds saved
by households, businesses, and other levels of government that would
otherwise be available for investment. Conversely, federal surpluses add
to national saving and increase resources available for investment. The
large amounts of federal borrowing in the 1980s and 1990s occurred at a
time when private saving was declining as a share of the economy. This
meant that large federal government deficits further decreased a shrinking
pool of domestic private saving available for private investment. The
federal government ran surpluses in fiscal years 1998 through 2001-for the
first time since 1969-so that it added to, instead of subtracting from,
the saving of other sectors. With the return of deficits, fiscal policy is
once again subtracting from national saving, which is particularly
important given the relatively low level of nonfederal saving. (See fig.
17.)

Figure 17: Composition of Net National Saving (Fiscal Years 1960-2003)

15 Percentage of GDP

1960-1969 1970-1979 1980-1989 1990-1999 `90 `91 `92 `93 `94 `95 `96 `97 `98 `99
`00 `01 `02 `03

Fiscal year

Net federal savinga

Net nonfederal saving

Net national saving Source: GAO analysis of National Income and Product
Accounts (NIPA) data from the Bureau of Economic Analysis, Department of
Commerce.

aNet federal saving is similar to the federal unified budget surplus or
deficit; however, there are some conceptual differences.

The U.S. national saving rate is not only low by historical standards but
has been well below that of other major industrial countries over the past
few decades. From 1984 through 2002, the U.S. average gross national
saving rate was sixth of seven major industrialized countries.8 (See fig.
18.) A low national saving rate can have serious implications for the
economy, particularly for its long-term growth. Saving provides the
resources to build new factories, develop new technologies, and improve
the skills of the workforce. Such

8 Gross national saving includes the saving of all sectors-households,
businesses, and government; whereas, net national saving is gross national
saving less consumption of fixed capital (depreciation).

investments may boost workers' productivity, which in turn produces higher
wages and faster economic growth. Less investment today means slower
economic growth tomorrow.

31.1

0 United United Canada France Italy Germany Japan Kingdom States

Source: Organisation for Economic Co-operation and Development.

Notes: Data from Organisation for Economic Co-operation and Development,
OECD Economic Outlook No. 74, vol. 2 (Paris: December 2003). Japan's
average gross national saving rate is calculated from 1984 through 2001.

A drop in national saving does not necessarily result in an immediate or
equivalent decline in investment because the United States can borrow from
abroad to help finance domestic investment. Indeed, part of the recent
decline in national saving has been offset by increased borrowing from
foreign investors. The effects of foreign borrowing, however, are mixed.
Foreign borrowing can benefit the United States by allowing increased
levels of consumption, investment, and government spending than otherwise
possible. However, it also constitutes a future burden on the economy as
interest payments on this investment flow abroad. Furthermore, the

increasing reliance on foreign borrowing could be detrimental to both the
domestic and global economies. If the willingness of foreigners to invest
in U.S. Treasury securities or other U.S. assets decreases, the value of
the dollar could fall, interest rates could rise, or consumer prices could
increase. (See sec. 4 for additional information on foreign holdings of
U.S. Treasury securities.)

The United States may have to pay higher interest rates to attract foreign
investment in the future because other countries have their own economic
and fiscal challenges, such as the aging of the baby boom generation.
Other countries could earn relatively higher returns on their savings at
home if there were more profitable opportunities available in their own
countries. Further, the U.S. dollar faces competition in international
capital markets. Some have suggested that the availability of the euro,
which is the single currency of 12 European countries,9 eventually could
eliminate the unique advantage held by U.S. securities-a broad, deep
market for low-risk securities denominated in an easily convertible
currency. As the market for euro-denominated securities broadens and
deepens, euro-denominated debt securities could become a closer competitor
for U.S. Treasury securities.

9 The euro area members are Austria, Belgium, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain.
The euro also circulates in a number of other countries and territories
around the world.

How does the government borrow, and what debt instruments are used?

A. The federal government borrows by issuing securities, mostly through
the Department of the Treasury. The U.S. Treasury has the single largest
outstanding stock of debt instruments in world financial markets. At the
end of fiscal year 2003, a total of $3.46 trillion in all forms of
marketable securities was outstanding. Most of the securities that
constitute debt held by the public are marketable, meaning that once the
government issues them, they can be resold by whoever owns them.1 These
marketable securities consist of bills, notes, and bonds with a variety of
maturities ranging from a few days with cash management bills to 30 years
with bonds. Since 1997, the Treasury has also offered inflationindexed
securities. Table 1 shows the Treasury's current auction schedule for
bills that mature in a year or less, notes with maturities of a year or
more to 10 years, and bonds with maturities of greater than 10 years. In
July 2004, the Treasury began auctioning 20-year inflation-indexed bonds.
Prior to this, the Treasury had not issued marketable bonds since its
decision to suspend issuance of 30-year bonds in October 2001.2

1 The government also issues nonmarketable securities, which cannot be
resold. Examples of nonmarketable securities include savings bonds and
special securities for state and local governments. The securities held by
government trust funds (such as Social Security and Medicare) and other
government accounts also are primarily nonmarketable.

2 The Treasury offers nonmarketable savings bonds with maturities up to 30
years.

Table 1: Schedule of Treasury Securities Auctions as of July 2004

Maturity Frequency

Treasury bills

28-day (4-week) Weekly

91-day (3-month) Weekly

182-day (6-month) Weekly

Cash management Irregular, as needed

Notes

2-year Monthly 3-year February, May, August, and November 5-year Monthly

10-year February, May, August, and November Reopened:a March, June,
September, and December

Inflation-indexed securities

5-yearb April and October

10-year January and July Reopened:a April and October

20-yearb January and July

Source: Department of the Treasury, Bureau of the Public Debt.

aReopening debt issues allows the Treasury to add new debt to existing
issues,
rather than create new issues. A reopened issue has the same maturity date
and interest rate as the original issue.
bTreasury announced the 5-year and 20-year inflation-indexed securities in
May of 2004. The 5-year inflation-indexed security will first be issued in
October 2004, and the 20-year was first issued in July 2004. These first
issues
will each be reopened twice. The first 5-year and 20-year
inflation-indexed
securities to be issued in 2006 will each only be reopened once, 6 months
after
their original issue.

Bills are issued at a discount from the par amount-or face value-and the
Treasury repays the par value at maturity. Notes are typically issued at a
small discount from par value and pay interest semiannually at a fixed
rate. Most notes (nominal securities) return the par value at maturity;
inflationindexed securities repay principal adjusted for inflation.
Interest payments on inflation-indexed securities are adjusted for
inflation as they are paid because they are figured on the
inflation-adjusted principal. However, the payment for inflation-adjusted
principal is made at maturity and, therefore,

is the largest payment to investors. Over the past decade, nominal notes
have constituted the largest portion of outstanding U.S. Treasury
securities while inflation-indexed securities constitute the smallest
outstanding portion. (See fig. 19.)

2,500 Dollars in billions

2,250

2,000

1,750

1,500

1,250

1,000

750

500

250

0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Fiscal year

Bills Notes Bonds

Inflation-indexed notes Inflation-indexed bonds Source: Department of the
Treasury, Bureau of the Public Debt.

Note: Data from the Bureau of the Public Debt's Monthly Statement of
Public Debt (September 1993-2003).

The mix of securities changes regularly as new debt is issued. The mix of
securities is important because it can have a

significant influence on the federal government's interest payments. For
nominal (i.e., not inflation-indexed) securities, longer-term securities
typically carry higher interest rates-or cost to the government-than
shorter-term securities because investors demand higher interest to
compensate for what they see as greater risks, such as higher inflation in
the future. However, longer-term nominal securities offer the government
the certainty of knowing what the Treasury's payments will be over a
longer period. Because bills roll over more frequently, changes in
interest rates on bills will more rapidly affect interest costs in the
federal budget. For inflation-indexed securities, small changes in
inflation can have a significant effect on interest payments. If inflation
is higher than expected, the government's borrowing costs of
inflation-indexed securities may be greater than the cost of nominal
securities. The converse would be true if inflation were lower than
anticipated.

What is the Treasury's goal for debt management?

A. The Treasury's overarching debt management goal is to ensure that the
federal government's financing needs are met at the lowest cost to
taxpayers over time. To do this, the Treasury aims to manage cash balances
sufficient to meet the government's obligations at the lowest cost to
taxpayers, and to secure borrowed cash at the lowest cost to taxpayers by
maintaining regular and predictable auctions and promoting liquid markets
for Treasury securities.

The Treasury receives revenues and pays expenses for the U.S. government.
When expenditures exceed revenues, the Treasury borrows to obtain
sufficient cash to meet its obligations. The Treasury's cash needs
throughout the fiscal year reflect government revenues and outlays, and
generally, the Treasury's borrowing cycles are determined by projections
of these cash needs. If actual revenue or outlays differ significantly
from projections, Treasury may need to issue cash

management bills to cover low points in available cash.3 Maintaining
sufficient cash balances allows the Treasury to absorb unexpected low
points in receipts or spikes in outlays and to limit issuance of cash
management bills. Of course, maintaining cash balances carries cost for
taxpayers.

Treasury officials believe maintaining regular and predictable auction
schedules, and issuing a variety of securities in sufficient amounts,
lowers the government's cost of borrowing over time. Regular and
predictable auction schedules provide investors greater certainty and
better information with which to plan their investments. The Treasury will
issue securities even when the short-term cost of borrowing is higher than
preferred in return for the long-term benefits of maintaining a regular
and predictable auction schedule. The Treasury does not seek to "time the
market" by issuing debt instruments when rates or other factors are
favorable because Treasury officials believe this will disrupt Treasury
security markets and raise the government's cost of borrowing over time.
Issuing securities with various maturities and in sufficient amounts to
appeal to the broadest range of investors promotes liquid markets for
Treasury securities by allowing investors to more easily buy and sell
Treasury securities. Overall, investors are willing to reward the Treasury
with lower borrowing costs in return for the benefits of certainty and
liquidity.

What challenges does the

Treasury face in achieving its debt management goal?

A. In achieving its debt management goal of lowest cost borrowing, the
Treasury deals with challenges of constantly changing financial markets
and uncertainties surrounding the government's future borrowing needs.
When making its management decisions, the Treasury considers the needs of

3 Cash management bills are announced, auctioned, and have maturity dates
based on the Treasury's immediate need.

investors and other market participants, such as brokers and dealers who
purchase Treasury securities for resale on the secondary market.4

The Treasury must consider the volume of securities to be issued at a
given maturity in relation to changing market demands for Treasury
securities. Treasury market participants purchase Treasury securities for
a variety of purposes, including securing stable sources of income,
trading to take advantage of interest rate movements, or reducing the risk
associated with financial transactions (also known as "hedging").
Constantly changing market demands make it difficult for the Treasury to
predict the type of Treasury securities investors prefer. Even in this
environment, the Treasury seeks to maintain a regular and predictable
auction schedule. If the Treasury offers too much of a given security, it
may have to pay a higher cost to attract investors. If the Treasury offers
too little of a given security, it may reduce the security's liquidity in
the secondary market.

The Treasury must make current debt management decisions with uncertain
information about the future of government borrowing needs. Policy changes
and national economic performance are difficult to project and can quickly
and substantially affect federal cash flow. (See sec. 2 for further
discussion of baseline projections and debt and interest uncertainties.)
The Treasury aims to anticipate and respond to often dramatically and
quickly changing borrowing outlooks, while positioning itself to
accommodate future changes in borrowing needs at the lowest cost to the
government. The Treasury sets its auction schedule to (1) appeal to the
broadest range of investors, thereby helping to promote liquidity and
efficiency in the markets for Treasury securities, and (2) build in a
certain amount of issuance flexibility in order to reduce the frequency of
future changes to the auction schedule, helping to promote predictability
in Treasury markets.

4 The Treasury formally solicits recommendations on debt structure and the
mix of securities from primary security dealers and from the Treasury
Borrowing Advisory Committee. Treasury officials meet quarterly with the
Treasury Borrowing Advisory Committee to discuss economic forecasts and
the government's borrowing needs.

How do budget conditions affect debt management?

A. The Treasury's debt management goal-to meet the government's financing
needs at the lowest cost over time- remains the same regardless of whether
the unified budget is in surplus or deficit. However, the Treasury will
vary the size and frequency of auctions, as well as the types of debt
instruments to be auctioned, according to anticipated budget conditions
and borrowing needs. Generally, during deficits the Treasury increases
debt sold to the public, and during surpluses, the Treasury sells less
debt to the public or reduces debt held by the public.

With the switch from decades of persistent federal deficits to annual
surpluses in fiscal years 1998 through 2001, debt held by the public
decreased by over $452 billion (12 percent). To accommodate this change in
borrowing needs, the Treasury adjusted its debt management strategy in
order to maintain liquid issues while reducing the overall supply of
Treasury debt. This can be challenging for debt managers. Generally, when
governments with budget surpluses reduce borrowing, continuing with
smaller, less liquid issues can increase government borrowing costs. With
the advent of sustained surpluses, a key Treasury strategy toward
achieving the lowest cost borrowing over time was to concentrate
outstanding debt into a fewer number of liquid benchmark issues. To do
this, the Treasury eliminated some instruments-like the 3-year note and
52-week bill-and reduced the auction frequency of other instruments-like
the 5-year note-in favor of fewer, larger auctions. The Treasury also
suspended nominal and inflation-indexed 30-year bonds in October 2001.
Finally, the Treasury introduced "reverse auctions" to buy back

approximately $67.5 billion in Treasury securities from fiscal years 2000
through 2002.5

With the return to deficits in fiscal years 2002 and 2003, debt held by
the public increased by $594 billion (about 18 percent). The Treasury's
focus has moved from maintaining market liquidity with a declining supply
of Treasury securities to offering the best mix of debt securities that is
most attractive to investors. The Treasury has adjusted its debt
management strategy to accommodate the government's increased borrowing
needs, which included increasing the size and frequency of new debt
offerings. The Treasury reintroduced the 3-year note and increased the
number of auctions for 5-year notes as well as 10-year inflation-indexed
and nominal notes. The Treasury also suspended debt buyback operations in
April 2002. Treasury began auctioning 20-year inflation-indexed securities
in July 2004 and plans to auction 5-year inflation-indexed securities
beginning in October 2004.

Who holds Treasury securities?

A. The federal debt held by the public is owed to a wide variety of
investors, including individuals, banks, businesses, pension funds, the
Federal Reserve banking system, state and local governments, and foreign
institutions. These buyers are attracted by the securities' perceived
freedom from credit risk, their ready marketability, their exemption from
state and local taxes, and the wide range of maturities. Ownership
information is estimated because many securities are continually resold
among investors and the Treasury does not track these sales. (See fig.
20.)

5 The Treasury used a program of ongoing, regularly scheduled reverse
auctions to buy back Treasury securities with targeted maturities. Reverse
auctions allow market participants to competitively offer to sell Treasury
securities back to the Treasury. The Treasury can accept the most
competitive offers.

Fiscal year 1993 Fiscal year 2003

Domestic private investors

State and local governments

International investors

Federal Reserve

Source: Department of the Treasury.

Notes: Estimated ownership data from the U.S. Department of the Treasury,
Treasury Bulletin (Washington, D.C.: December 1993 and March 2004).
Numbers may not add to 100 percent due to rounding.

The Treasury estimates that domestic private investors-nonforeign-based
private sector investors-including individuals and other investors, owned
approximately 32 percent of debt held by the public as of September 2003.
Larger investors such as depository institutions, pension funds, and
insurance companies hold the majority of this amount. However, smaller
investors also directly own Treasury securities. For example, anyone who
owns a United States savings bond holds a portion of the debt. (See fig.
21.)

Source: Department of the Treasury, Bureau of the Public Debt.

aCash management bills, 4-week Treasury bills, and STRIPS are not
available through TreasuryDirect. Treasury has not offered new marketable
bonds since it suspended issuance of the 30-year bond in October 2001.

Federal Reserve banking system ownership of debt held by the public
increased from 10 percent to 17 percent from 1993 through 2003 in line
with the growth in demand for depository

institution reserves and currency. The Federal Reserve, as part of its
monetary policy operations, purchases and sells Treasury securities to
affect the level of reserve funds at depository institutions and
short-term interest rates and, ultimately, influence national employment,
output, and the general level of prices. Broad and active Treasury
security markets allow the Federal Reserve to buy and sell large
quantities of Treasury securities without unduly disrupting the market.

State and local government holdings amounted to approximately 14 percent
of debt held by the public in 2003- down from 19 percent in 1993 but up
from 11.7 percent in 1997. State and local governments purchase marketable
Treasury securities as investments for their pension funds or for other
purposes, such as investing otherwise idle tax revenues until they are
needed. In addition, state and local governments purchase special
nonmarketable Treasury securities, known as the State and Local Government
Series, to invest borrowed funds temporarily until they are needed for
other purposes, such as financing capital projects.

The Treasury estimates that nearly two-thirds (63 percent) of the debt
held by the public is owed to U.S. investors including the Federal
Reserve, which means that interest and principal payments are made mainly
to individuals and institutions residing in the United States.
Foreign-based investors hold slightly more than one-third (37 percent) of
the debt held by the public.6 Nearly 60 percent of this amount is held by
foreign official institutions like central banks, ministries of finance,
or similar institutions. After averaging about 18 percent in the early
1990s, estimated foreign holdings rose to 32 percent by 1997 as the net
increase in foreign holdings of Treasury securities outpaced the net
increase in federal borrowing in those years. From the late 1990s to
September 2003, foreign holdings increased to roughly 37 percent. U.S.
Treasury

6 For a discussion of the system used to estimate foreign holdings,
including methodological limitations, see William L. Griever, Gary A. Lee,
and Francis E. Warnock, "The U.S. System for Measuring Cross-Border
Investment in Securities: A Primer with a Discussion of Recent
Developments," Federal Reserve Bulletin (Washington, D.C.: October 2001).

securities play a prominent role in world financial markets. Foreign and
domestic investors are attracted to their credit quality, the ability to
easily buy or sell Treasury securities around-the-clock, and their
worldwide status as a benchmark security. The United States benefits from
foreign purchases of government securities because foreign investors fill
part of our borrowing needs. However, to service this foreign-held debt,
the United States government must send interest payments abroad, which
adds to the incomes of residents of other countries rather than to the
incomes of United States residents.

What are key considerations for the future?

A. With the recent expiration of provisions of the 1990 Budget Enforcement
Act in 2002, the Congress and the President face the challenge of sorting
out the many claims on the federal budget without the discretionary
spending caps or other pay-as-you-go enforcement mechanisms that served to
reduce deficits and guide the federal government into a brief period of
surplus. New accounting and reporting approaches, budget control
mechanisms, and metrics are needed for considering and measuring the
impact of tax and spending decisions over the long term.

Waiting to take action entails risks. First, we lose the opportunity to
reduce the burden of interest in the federal budget, thereby creating a
legacy of higher debt as well as elderly entitlement spending for the
relatively smaller workforce of the future. Second, the nation would lose
an important window where today's relatively large workforce can increase
saving and enhance productivity, two elements critical to growing the
future economy. Third, and most critically, we risk losing the opportunity
to phase in changes gradually. Addressing the nation's fiscal imbalance
requires a three-pronged approach to (1) restructure existing entitlement
programs, (2) reexamine the base of discretionary and other spending, and
(3) review and revise the federal government's tax policy and enforcement
programs.

How will the current fiscal policy path affect federal borrowing and budgetary
flexibility?

A. While considerable uncertainty surrounds both short-and long-term
budget projections, we know two things for certain: the population is
aging and the baby boom generation is approaching retirement age. The
aging population and rising health care spending will have significant
implications not only for the Social Security, Medicare, and Medicaid
programs but also for the budget and the economy. The demographic trends
facing the nation affect the long-term flexibility and sustainability of
the government's fiscal position. Growth in the debt-to-GDP measure does
not necessarily create problems in the short term, but continued growth
will further reduce budgetary flexibility going forward and ultimately
lead to an unsustainable fiscal path. (See fig. 15 in sec. 3 for future
debtto-GDP shares under alternative fiscal policies.)

Absent policy changes, the growth in spending on federal entitlements for
retirees will encumber an escalating share of the government's resources.
Assuming, for example, that recent tax reductions are made permanent and
discretionary spending keeps pace with the economy, GAO's long-term
simulations show that by 2040 federal revenues may be adequate to pay
little more than interest on the federal debt. (See fig. 22.) Neither
slowing the growth in discretionary spending nor allowing the tax
provisions to expire-nor both together-would eliminate the imbalance.

50 Percentage of GDP

0 2003 2015 2030 2040 Fiscal year

Net interest

Social Security

Medicare and Medicaid

All other spending

Source: GAO's March 2004 analysis.

Notes: Although expiring tax provisions are extended, revenue as a share
of GDP increases through 2014 due to (1) real bracket creep, (2) more
taxpayers becoming subject to the Alternative Minimum Tax, and (3)
increased revenue from tax-deferred retirement accounts. After 2014,
revenue as a share of GDP is held constant.

Under this scenario, borrowing to finance these obligations would add
substantially to the national debt. Rising debt, in turn, raises spending
on interest, which further swells the deficits, resulting in a vicious
cycle. Budgetary flexibility is greatly reduced; massive spending cuts,
tax increases, or some combination of the two would be necessary to obtain
balance. Borrowing to finance these obligations is ultimately
unsustainable because borrowing cannot in perpetuity grow at

a greater rate than the economy. At some point the economy will not
produce enough resources to allow the government to service the debt. The
government can help ease future fiscal burdens through spending reductions
or revenue actions that reduce debt held by the public, saving for the
future, and enhancing the pool of economic resources available for private
investment and long-term growth. Economic growth can help, but we will not
be able to simply grow our way out of the problem. Closing the current
long-term fiscal gap would require sustained economic growth at levels so
high as to be implausible. That is, closing the gap would require
sustained economic growth far beyond that experienced in U.S. economic
history since World War II. Tough choices are inevitable, and the sooner
we act the better.

Does the debt limit provide a way to control the amount we borrow? What are
some alternatives to the debt limit?

A. The debt limit does not determine federal borrowing needs. These needs
result from all of the revenue and spending decisions the government makes
as well as the performance of the economy. Whenever the government
approaches the debt limit, the Congress and the President must eventually
raise the limit to pay the government's bills as they come due. Major
increases in the debt limit accompanied budget agreements in 1990, 1993,
and 1997. The debt limit was also raised in 1996, 2002, and 2003, each
time after debt approached the limit and the Treasury had to use its
statutory authorities available to avoid exceeding the limit. (See app. I
for GAO work on the debt limit.) CBO's January 2004 budget projections
showed that debt will reach the limit of $7,384 billion during fiscal year
2004. (See fig. 23.) In July 2004, the Treasury estimated the debt limit
would be reached in late September or early October 2004. The Office of

Management and Budget's July 2004 budget projections show debt subject to
the limit will be only $9 billion below the statutory limit as of
September 30, 2004.1

9 Trillions of dollars 1985
19861987198819891990199119921993199419951996199719981999200020012002200320042005
End of fiscal year

Federal debt subject to limit

Projected federal debt subject to limit Statutory debt limit

Sources: Office of Management and Budget and CBO.

1 U.S. Office of Management and Budget, Fiscal Year 2005 Mid-Session
Review (Washington, D.C.: July 2004).

Notes: Historical data from U.S. Office of Management and Budget, Budget
of the United States Government for Fiscal Year 2005 - Historical Tables

(Washington, D.C.: February 2004). Projections from U.S. Congressional
Budget Office, The Budget and Economic Outlook: Fiscal Years 2005 to 2014
(Washington, D.C.: January 2004). The debt limit represents a statutory
ceiling on the total outstanding amount of most types of federal debt.
Generally, debt issued by the Treasury to the public or to government
accounts, as well as obligations whose principal and interest are
guaranteed by the U.S. government, is subject to the limit. The statutory
debt limit is changed through legislation. This figure shows the debt
limit at the end of the fiscal year. The limit could be raised multiple
times throughout the course of the fiscal year.

Some believe that debate over raising the debt limit may provide an
additional opportunity for the Congress and the President to consider the
implications of past and future fiscal policy decisions for federal
borrowing. However, limiting the Treasury's ability to issue debt
securities does not address the broader scope of the government's fiscal
policies or exposures, nor does it promote predictability in the markets
for Treasury securities when Treasury seeks to borrow but is constrained
by the debt limit. (See below for a discussion of the nation's fiscal
exposures.) As policymakers explore budget process options, some have
suggested replacing the statutory limit on total debt outstanding with a
limit on debt held by the public or a limit on federal debt as a share of
GDP. Some countries have adopted debt-to-GDP targets to guide fiscal
policymaking; however, there is no consensus on the optimal level of
government debt as a share of the economy.

Debt is one liability of the federal government. What are other potential ways
to look at exposures or implicit commitments of the government?

A. Debt held by the public is the largest explicit liability of the
federal government. However, the federal government undertakes a wide
range of programs, responsibilities, and activities that may explicitly or
implicitly expose it to future spending. These "fiscal exposures" 2 vary
widely as to source, extent of the government's legal obligation,
likelihood of occurrence, and magnitude. Given this variety, it is useful
to think of fiscal exposures as a spectrum extending from explicit
liabilities to the implicit promises embedded in current policy or public
expectations. (See table 2.) For example, the current liability figures
for the U.S. government do not include the difference between scheduled
and funded benefits in connection with the Social Security and Medicare
programs.

2 GAO uses the fiscal exposure concept to provide a framework for
considering long-term costs and spending uncertainties. U.S. General
Accounting Office, Fiscal Exposures: Improving the Budgetary Focus on
Long-Term Costs and Uncertainties, GAO-03-213 (Washington, D.C.: Jan. 24,
2003).

Table 2: Selected Fiscal Exposures: Sources and Examples (End of Fiscal Year
2003)

Dollars in billions

Type Examplea

Explicit liabilities Publicly held debt ($3,913) Military and civilian
pension and post-retirement health ($2,857) Veterans benefits payable
($955) Environmental and disposal liabilities ($250) Loan guarantees ($35)
Explicit financial Undelivered orders ($596) commitments Long-term leases
($47)

Financial contingencies Unadjudicated claims ($9) Pension Benefit Guaranty
Corporation ($86) Other national insurance programs ($7) Government
corporations, e.g., Ginnie Mae

Exposures implied by Debt held by government accounts ($2,859)b current
policies or the Future Social Security benefit payments ($3,699)c public's
expectations Future Medicare Part A benefit payments ($8,236)c about the
role of Future Medicare Part B benefit payments ($11,416)c government
Future Medicare Part D benefit payments ($8,119)c

Life cycle cost, including deferred and future maintenance and operating
costs (amount unknown) Government Sponsored Enterprises, e.g., Fannie Mae
and Freddie Mac

Source: GAO analysis of data from the Department of the Treasury; the
Office of the Chief Actuary, Social Security Administration; and the
Office of the Actuary, Centers for Medicare and Medicaid Services.

Notes: This list is illustrative and should not be interpreted as all
inclusive or
universally agreed upon. Information updated March 30, 2004.

aAll figures are for end of fiscal year 2003, except Social Security and
Medicare
estimates, which are end of calendar year 2003.
bThis amount includes $774 billion held by military and civilian pension
funds
that would offset the explicit liabilities reported by those funds.
cFigures for Social Security and Medicare are net of debt held by the
trust funds
($1,531 billion for Social Security, $256 billion for Medicare Part A, and
$24 billion for Medicare Part B) and represent net present value estimates
over
a 75-year period. Over an infinite horizon, the estimate would be $10.4
trillion
for Social Security, $21.8 trillion for Medicare Part A, $23.2 trillion
for Medicare
Part B, and $16.5 trillion for Medicare Part D.

Fiscal exposures represent significant commitments that ultimately have to
be addressed. The burden of paying for these exposures may encumber future
budgets and constrain fiscal flexibility. Not capturing the long-term
costs of current decisions limits policymakers' ability to control the
government's fiscal exposures at the time decisions are made. In addition,
the lack of recognition of long-term fiscal

exposures may make it difficult for policymakers and the public to
adequately understand the government's overall performance and true
financial condition. Determining how to improve budgeting for fiscal
exposures is complicated by difficulties in (1) determining the scope of
items to be considered exposures and (2) estimating their costs. GAO has
recommended annual reporting on fiscal exposures and, where possible,
reporting the estimated costs for fiscal exposures in the budget.3

The fiscal exposures concept focuses only on items that may expose the
government to future spending. In addition to exposures on the spending
side of the budget, certain tax expenditures may have uncertain or
accelerating future growth paths that have significant implications for
the long term. Tax and revenue items would need to be considered
concurrently with spending exposures in order to assess the nation's
long-term fiscal sustainability.

3 For more information, see GAO-03-213.

Government Accountability Office (www.gao.gov)

Debt Ceiling: Analysis of Actions Taken During the 2003 Debt Issuance
Suspension Period. GAO-04-526. Washington, D.C.: May 20, 2004.

Our Nation's Fiscal Outlook: The Federal Government's Long-Term Budget
Imbalance.

http://www.gao.gov/special.pubs/longterm/.

Budget Process: Long-term Focus Is Critical. GAO-04-585T. Washington,
D.C.: March 23, 2004.

Fiscal Year 2003 U.S. Government Financial Statements: Sustained
Improvement in Federal Financial Management Is Crucial to Addressing Our
Nation's Future FiscalChallenges.

GAO-04-477T. Washington, D.C.: March 3, 2004.

Financial Audit: Bureau of the Public Debt's Fiscal Years 2003 and 2002
Schedules of Federal Debt. GAO-04-177. Washington, D.C.: November 7, 2003.

The Honorable David M. Walker, Comptroller General of the United States.
Truth and Transparency: The Federal Government's Financial Condition and
Fiscal Outlook. Address to the National Press Club. September 17, 2003.

Fiscal Exposures: Improving the Budgetary Focus on Long-Term Costs and
Uncertainties. GAO-03-213. Washington, D.C.: January 24, 2003.

Debt Ceiling: Analysis of the Actions During the 2002 Debt Issuance
Suspension Periods. GAO-03-134. Washington, D.C.: December 13, 2002.

Budget Issues: Long-Term Fiscal Challenges. GAO-02-467T. Washington, D.C.:
February 27, 2002.

Debt Management: Insights and Tools From Selected Nations. GAO-02-14.
Washington, D.C.: November 21, 2001.

Budget Issues: Budget Enforcement Compliance Report. GAO-01-777.
Washington, D.C.: June 15, 2001.

National Saving: Answers to Key Questions. GAO-01-591SP. Washington, D.C.:
June 2001.

Federal Debt: Debt Management Actions and Future Challenges. GAO-01-317.
Washington, D.C.: February 28, 2001.

Long-Term Budget Issues: Moving From Balancing the Budget to Balancing
Fiscal Risk. GAO-01-385T. Washington, D.C.: February 6, 2001.

Federal Trust and Other Earmarked Funds: Answers to Frequently Asked
Questions. GAO-01-199SP. Washington, D.C.: January 2001.

Federal Debt: Debt Management in a Period of Budget Surplus.
GAO/AIMD-99-270. Washington, D.C.: September 29, 1999.

Federal Debt: Answers to Frequently Asked Questions-An Update.
GAO/OGC-99-27. Washington, D.C.: May 28, 1999.

Federal Debt: Answers to Frequently Asked Questions. GAO/AIMD-97-12.
Washington, D.C.: November 27, 1996.

Debt Ceiling: Analysis of Actions During the 1995-1996 Crisis.
GAO/AIMD-96-130. Washington, D.C.: August 30, 1996.

Information on Debt Ceiling Limitations and Increases. GAO/AIMD-96-49R.
Washington, D.C.: February 23, 1996.

A Glossary of Terms Used in the Federal Budget Process: Exposure Draft.
GAO/AFMD-2.1.1. Washington, D.C.: Revised January 1993.

Congressional Budget Office (www.cbo.gov)

The Uncertainty of Budget Projections: A Discussion of Data and Methods.
Washington, D.C.: April 2004.

The Budget and Economic Outlook: Fiscal Years 2005 to 2014. Washington,
D.C.: January 2004.

The Long-Term Budget Outlook. Washington, D.C.: December 2003.

Statement of the Honorable Douglas Holtz-Eakin, Director. The Economic
Cost of Long-Term Federal Obligations. Before

the Committee on the Budget, House of Representatives. July 24, 2003.

Federal Debt and the Commitments of Federal Trust Funds. Long-Range Fiscal
Policy Brief No. 4. Washington, D.C.: October 24, 2002; Revised May 6,
2003.

The Impact of Trust Fund Programs on Federal Budget Surpluses and
Deficits. Long-Range Fiscal Policy Brief No. 5. Washington, D.C.: November
4, 2002.

Federal Debt and Interest Costs. Washington, D.C.: May 1993.

Library of Congress, Congressional Research Service (www.crs.gov)

Cashell, Brian W. The Economics of the Federal Budget Deficit. CRS Report
RL31235. Washington, D.C.: Updated May 15, 2003.

Cashell, Brian W. The Federal Government Debt: Its Size and Economic
Significance. CRS Report RL31590. Washington, D.C.: November 7, 2003.

Jackson, James K. Foreign Investment in U.S. Securities. CRS Report
RL32462. Washington, D.C.: June 30, 2004.

Keith, Robert and Bill Heniff Jr. Legislative Procedures for Adjusting the
Public Debt Limit: A Brief Overview. CRS Report RS21519. Washington, D.C.:
Updated May 28, 2003.

Labonte, Marc. Baseline Budget Projections: A Discussion of Issues. CRS
Report RL31414. Washington, D.C.: Updated May 13, 2003.

Labonte, Marc. Do Budget Deficits Push Up Interest Rates and Is This the
Relevant Question? CRS Report RL31775. Washington, D.C.: Updated May 13,
2003.

Labonte, Marc and Gail Makinen. The National Debt: Who Bears Its Burden?
CRS Report RL30520. Washington, D.C.: Updated May 1, 2003.

Office of Management and Budget (www.omb.gov)

Budget of the United States Government for Fiscal Year 2005

- Analytical Perspectives. Washington, D.C: February 2004. Budget of the
United States Government for Fiscal Year 2005

- Historical Tables. Washington, D.C.: February 2004.

Department of the Treasury (www.treasury.gov)

2003 Financial Report of the United States Government. Washington, D.C.:
February 27, 2004. (Period covered is fiscal year 2003.)

Bureau of the Public Debt. Monthly Statement of Public Debt of the United
States. Washington, D.C.: April 2004.

Financial Management Service. Treasury Bulletin. Washington, D.C.: March
2004.

Financial Management Service. Monthly Treasury Statement. Washington,
D.C.: May 2004.

Treasury International Capital System. Major Foreign Holders of Treasury
Securities. Washington, D.C.: May 2004.

Federal Reserve Board of Governors (www.federalreserve.gov)

Dupont, Dominique and Brian Sack. "The Treasury Securities Market:
Overview and Recent Developments." Federal Reserve Bulletin. Washington,
D.C.: December 1999.

Griever, William L., Gary A. Lee, and Francis E. Warnock. "The U.S. System
for Measuring Cross-Border Investment in Securities: A Primer with a
Discussion of Recent Developments." Federal Reserve Bulletin. Washington,
D.C.: October 2001.

Accrued Interest (See Interest.)

Bills (See U.S. Treasury Securities.)

Bonds and Notes (See U.S. Treasury Securities.)

Baseline An estimate of spending, revenue, the deficit or surplus, and
debt held by the public during a fiscal year under current laws and
current policy. For revenues and mandatory spending, the Congressional
Budget Office (CBO) projects the baseline under the assumption that
present laws continue without change. The baseline projections also
reflect anticipated changes in the economy, demographics, and other
factors that affect the implementation of these laws. For discretionary
spending subject to annual appropriations, CBO is required to adjust the
current year's discretionary budget authority to reflect inflation, among
other factors.

Benchmark Debt Issue A benchmark issue is a debt instrument that is large
enough and attractive enough that it will be readily bought and sold by
participants in the debt market. Governments issue a set of benchmark
securities at different maturities to build a yield curve that can be used
as a reference point by capital markets and others to price other
financial transactions. U.S. Treasury securities are used for this purpose
in the United States as well as in international capital markets.

Budget Enforcement Act Title XIII of the Omnibus Budget Reconciliation Act
of 1990. The Budget Enforcement Act modified procedures and definitions
for sequestration and deficit reduction, reformed budgetary credit
accounting, maintained the off-budget status of the Old-Age Survivors
Insurance and Federal Disability Insurance Trust Funds, and removed Social
Security trust fund receipts and outlays from deficit and sequestration
calculations.

Congressional Budget Office (CBO) This legislative branch agency's mission
is to provide the Congress with objective, timely, nonpartisan analyses
needed for economic and budget decisions and with the information and
estimates required for the Congressional budget process. CBO is required
to develop a cost estimate for virtually every bill reported by
congressional committees to show how it would affect spending or revenues
over the next 5 years or more. For most tax legislation, CBO uses
estimates provided by the Joint Committee on Taxation, a separate
congressional analytic group. For CBO's Web site, visit www.cbo.gov.

(Continued)

Debt There are three basic measures of federal debt: (1) debt held by the
public, (2) debt held by government accounts, and (3) gross debt.

Debt Held by the Public Federal debt held by all investors outside of the
federal government, including individuals, corporations, state or local
governments, the Federal Reserve banking system, and foreign governments.
When debt held by the Federal Reserve is excluded, the remaining amount is
referred to as privately held debt.

Debt Held by Government Accounts (Intragovernmental Debt) Federal debt
owed by the federal government to itself. Most of this debt is held by
trust funds, such as Social Security and Medicare.

Gross Debt (Total Debt) The total amount of outstanding federal debt,
whether issued by the Treasury or other agencies and held by the public or
federal government accounts.

U.S. Gross External Debt Debt owed by U.S. residents to nonresidents.

Debt Limit A legal ceiling on the amount of gross federal debt (excluding
some minor adjustments), which must be raised periodically to accommodate
additional federal borrowing.

Debt Subject to Limit Gross debt less a small amount of debt excluded from
the debt limit. Excluded are amounts issued by either the Federal
Financing Bank, an arm of the Treasury, or agencies other than the
Treasury, such as the Tennessee Valley Authority.

Deficit The amount by which the government's spending exceeds its revenues
for a given period, usually a fiscal year.

Unified Deficit The amount by which the government's on-budget and off

(or Total Deficit) budget outlays exceed the sum of its on-budget and
off-budget receipts for a given period, usually a fiscal year.

Federal Funds Deficit A measure of the deficit that excludes the spending
and revenue totals of federal government trust funds, such as Social
Security.

Trust Fund Cash Deficit The amount by which a trust fund's outlays exceed
its receipts from the public (excluding intragovernmental transfers) for a
given period, such as a fiscal or calendar year.

Trust Fund Total Deficit The amount by which a trust fund's outlays exceed
its total receipts (including receipts from the public and
intragovernmental transfers) over a given period, such as a fiscal or
calendar year.

Federal Debt (See Debt.)

(Continued)

Federal Fund Accounts Accounts composed of moneys collected and spent by
the federal government other than those designated as trust funds. Federal
fund accounts include general, special, public enterprise, and
intragovernmental fund accounts.

Federal Funds Rate Rate charged by a depository institution on an
overnight sale of federal funds to another depository institution; rate
may vary from day to day and from bank to bank.

Federal Reserve System The central bank of the United States. It is
responsible for the conduct of monetary policy. (See monetary policy.) For
the Web site of the Federal Reserve System, visit www.federalreserve.gov.

Fiscal Year Any yearly accounting period, regardless of its relationship
to a calendar year. The fiscal year for the federal government begins on
October 1 of each year and ends on September 30 of the following year; it
is named by the calendar year in which it ends. Prior to fiscal year 1977,
the federal government began its fiscal year on July 1 and ended it on
June 30.

Gross Debt (See Debt.)

Gross Domestic A commonly used measure of domestic national income. GDP

Product (GDP) is the value of all goods and services produced within the
United States in a given year and is conceptually equivalent to incomes
earned in production. It is a rough indicator of the economic earnings
base from which the government draws its revenues.

Gross Interest (See Interest.)

Gross National Product The output of all goods and services produced in a
given

(GNP) period by labor and capital supplied by residents of a nation,
regardless of the location of the labor and capital. The principal
difference from GDP is that GNP includes the income that residents earn
from investments abroad and excludes the capital income that nonresidents
earn from domestic investments.

Inflation A rise in the general price level.

Interest The amount that a borrower pays a lender for the use of funds.
Two main measures of federal interest spending in the budget are (1) gross
interest and (2) net interest. Methods of measuring interest are (1)
accrued interest and (2) interest paid.

Gross Interest Essentially represents interest on all Treasury debt
securities, including interest on debt held by the public and interest
credited to government trust funds and other government accounts that hold
federal debt.

(Continued)

Net Interest Primarily interest on debt held by the public. In addition to
interest on debt held by the public, the government also earns some
interest from various sources and pays interest for purposes other than
borrowing from the public. These amounts are only a small portion of net
interest and, taken together, slightly reduce its total.

Accrued Interest Interest that has accumulated on a fixed income security
since the last interest payment was made. Notes and bonds pay interest
semiannually. When a bond is sold on the secondary market between interest
payment dates, the buyer pays the seller the bond's price plus the accrued
interest from the last interest payment date up to, but not including the
settlement date.

Interest Paid Payments by the U.S. Treasury to investors for interest
earned on U.S. Treasury securities.

Interest Rate The cost of borrowing or the price paid for the rental of
funds (usually expressed as a percentage).

Liability Assets owed for items received, services received, assets
acquired, construction performed (regardless of whether invoices have been
received), amounts received but not yet earned, or other expenses
incurred.

Accounting Liability For financial statement reporting, a liability
represents a probable and measurable future outflow of resources arising
from past transactions or events. A liability is recorded on the face of
the balance sheet when an item is identifiable, its occurrence is
probable, and its cost can be reasonably estimated.

Legal Liability A claim that may be legally enforced against the
government in a variety of ways, such as by signing a contract, grant, or
cooperative agreement, or by operation of law.

Legal Obligation A definite commitment that creates a legal liability of
the government for the payment of goods and services ordered or received.

Liquidity A liquid debt issue is one that is large enough to be traded at
will, and one for which the offer and purchase prices differ only
slightly.

Liquidity Premium The incremental price that market participants are
willing to pay for securities that are part of large issues that can be
easily traded.

Marketable Securities (See U.S. Treasury Securities.)

(Continued)

Monetary Policy The use of reserve requirements, discount rates, and
purchases and sales of U.S. Treasury securities (open market operations)
by the Federal Reserve System (the nation's central bank) to affect the
rate of growth of the nation's money supply.

National Saving National saving is the portion of the nation's income not
used for consumption during a given period. Gross national saving includes
the saving of all sectors-households, businesses, and government; net
national saving is gross national saving less consumption of fixed capital
(depreciation).

Nonmarketable Securities (See U.S. Treasury Securities.)

Net Interest (See Interest.)

Notes (See U.S. Treasury Securities.)

Present Value The amount of cash today that is equivalent in value to a
specified cash payment or stream of cash payments to be received in the
future.

Savings Bonds (See U.S. Treasury Securities.)

STRIPS (See U.S. Treasury Securities.)

Surplus The amount by which the government's revenues exceed outlays in a
given period.

Unified Surplus The amount by which the government's on-budget and off

(or Total Surplus) budget receipts exceed the sum of its on-budget and
offbudget outlays for a given period, usually a fiscal year.

Trust Fund Cash Surplus The amount by which a trust fund's receipts from
the public exceed its outlays for a given period, such as a fiscal or
calendar year.

Trust Fund Total Surplus The amount by which a trust fund's total receipts
(including receipts from the public and intragovernmental transfers)
exceed its outlays for a given period, such as a fiscal or calendar year.

Tax Expenditure Revenue losses attributable to a provision of the federal
tax laws that allows a special exclusion, exemption, or deduction from
gross income or that provides a special credit, preferential tax rate, or
deferral of tax liability.

Treasury Inflation-Indexed (See U.S. Treasury Securities.) Securities

(Continued)

Trust Fund Accounts Federal budget accounts that are designated as "trust
funds" by law. These accounts usually have a designated, or "earmarked,"
source of revenue. These revenues are authorized to be spent for the
programs and activities supported by the trust funds. Examples are the
Social Security and Medicare trust funds.

Unified Budget A comprehensive budget in which receipts and outlays from
federal funds and trust funds are consolidated; generally a cash or cash
equivalent measure in which receipts are recorded when received and
expenditures are recorded when paid, regardless of the accounting period
in which the receipts are earned or the costs incurred.

U.S. Treasury The Treasury issues two major types of debt securities to
the Securities public: marketable and nonmarketable securities. Marketable
securities, which consist of Treasury bills, notes, and bonds (see below),
can be resold by whoever owns them while nonmarketable securities, such as
savings securities and special securities for state and local governments,
cannot be resold. Marketable securities are auctioned at regular intervals
during the year and, at the end of fiscal year 2003, accounted for 88
percent of outstanding federal debt securities held by the public. In
addition to the nonmarketable securities issued to the public, the
Treasury also issues securities to federal government accounts, primarily
trust funds that have the authority or are required to invest excess
receipts in special U.S. Treasury securities.

Bills, Notes, and Bonds Treasury bills (or T-bills) are short-term
securities that mature in 1 year or less from their issue date. Investors
pay less than the T-bills' par or face value, and when bills mature they
receive the par or face value.

Treasury bonds and notes are securities that pay a fixed rate of interest
every 6 months until they mature, which is when they pay their par value.
The only difference between a note and a bond is their length until
maturity. Treasury notes mature in more than 1 year, but not more than 10
years from their issue date. Bonds, on the other hand, mature in more than
10 years from their issue date. Treasury sells two kinds of notes and
bonds, fixed-principal and inflation-indexed. Both pay interest twice a
year, but the principal value of inflation-indexed securities is adjusted
to reflect inflation as measured by the Consumer Price Index. Semiannual
interest payments on inflation-indexed securities are based upon the
inflationadjusted principal value of the security.

(Continued)

Savings Bonds Different types of savings bonds are offered by the Treasury
and can be purchased for as little as $25 through TreasuryDirect, savings
institutions, or payroll savings plans offered by many employers. Series
EE savings bonds have a variable semiannual interest rate. Series I
savings bonds have an interest rate based upon a combination of a fixed
rate of return and a variable semiannual rate. Both series EE and I
savings bonds pay their issue price plus accrued interest when the bonds
are redeemed. For more information, visit Treasury's Web site:
www.treasurydirect.gov.

STRIPS STRIPS is the acronym for Separate Trading of Registered Interest
and Principal of Securities. When a Treasury security is stripped, the
cash flows from the principal and interest components of the security are
separated and traded as if each component was a separate security. STRIPS
can only be purchased through financial institutions and government
securities brokers and dealers.

Treasury Inflation-Indexed Treasury inflation-indexed securities are also
known as

Securities Treasury inflation-protected securities. The principal value of
these securities is tied to inflation using an index prepared by the
Bureau of Labor Statistics. Interest payments and the final payment at
maturity are based on this inflation-adjusted principal.

Yield Curve A graphical description of the current relationship between
interest rates and time to maturity, holding other factors (such as credit
risk) constant.

This report updates descriptive information about federal debt last
presented in GAO's 1999 publication, Federal Debt: Answers to Frequently
Asked Questions-An Update (GAO/OCG-99-27, May 28, 1999).1 At the time of
that publication, the federal government was running budget surpluses and
debt held by the public was projected to drop to historically low levels.
This report provides updated budget and economic data to reflect the
nation's current fiscal outlook. In addition, this update provides current
information on debt management during periods of budget deficits.

Our update addresses questions that are frequently asked about the federal
debt, deficits, and surpluses. Specifically, we present current
information on (1) the definitions and measures of federal debt, (2) the
relationship between the budget and federal debt, (3) the relationship
between the economy and federal debt, (4) federal debt management and
ownership, and (5) the current and future policy issues regarding federal
debt.

This update draws upon our previously issued work on budget issues,
federal debt, national saving, and long-term fiscal challenges.2 We also
reviewed relevant literature and interviewed individuals with specialized
expertise from government, nonprofit, and financial service organizations.

Historical data on budget deficits, surpluses, federal debt, and net
interest were collected from GAO's financial audit of the Bureau of the
Public Debt's (BPD) Schedules of Federal Debt for fiscal year 2003,3 the
Office of Management and Budget's (OMB) fiscal year 2005 budget
documents,4 and the

1 For previous work, see U.S. General Accounting Office, Federal Debt:
Answers to Frequently Asked Questions, GAO/AIMD-97-12 (Washington, D.C.:
Nov. 27, 1996).

2 See app. I. for a list of related GAO products.

3 U.S. General Accounting Office, Financial Audit: Bureau of the Public
Debt's Fiscal Years 2003 and 2002 Schedules of Federal Debt, GAO-04-177
(Washington, D.C.: Nov. 7, 2003).

4 U.S. Office of Management and Budget, Budget of the United States
Government for Fiscal Year 2005 - Analytical Perspectives (Washington,
D.C.: February 2004), and Budget of the United States Government for
Fiscal Year 2005 - Historical Tables (Washington, D.C.: February 2004).

Department of the Treasury's 2003 Financial Report of the United States
Government.5 Budget projections from fiscal year 2004 through fiscal year
2015 were obtained from the CBO's January 2004 10-year baseline of
budgetary and economic projections.6

Additionally, we analyzed information from Department of the Treasury
publications, including the Monthly Statement of Public Debt, Treasury
Bulletin, and Treasury International Capital System. We used the
Treasury's Monthly Statement of Public Debt for historical data on the
amount of outstanding Treasury securities. We obtained information on
holdings of U.S. Treasury securities for 1993 and 2003 from the Treasury
Bulletin as well as summary data from the Treasury International Capital
System (a joint venture between the Federal Reserve Board and the
Treasury). The ownership information in these publications is estimated
because the Treasury does not track sales among investors, and foreign
holding data reflect the country of purchase and not the residence of the
owner.7

We relied on the Organisation for Economic Co-operation and Development's
Economic Outlook for international comparisons of historical data on net
general government debt and gross national saving.8 For selected average
interest rates on the federal debt, we used historical data from the
Federal Reserve's Statistical Release H.15, which reflects yields on

5 U.S. Department of the Treasury, 2003 Financial Report of the United
States Government (Washington, D.C.: Feb. 27, 2004). (Period covered is
fiscal year 2003.)

6 U.S. Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2005-2014 (Washington, D.C.: January 2004).

7 For a discussion of the system used to estimate foreign holdings,
including methodological limitations, see William L. Griever, Gary A. Lee,
and Francis E. Warnock, "The U.S. System for Measuring Cross-Border
Investment in Securities: A Primer with a Discussion of Recent
Developments," Federal Reserve Bulletin (Washington, D.C.: October 2001).

8 Organisation for Economic Co-operation and Development, OECD Economic
Outlook No. 74, vol. 2 (Paris: December 2003).

actively traded issues adjusted to constant maturities.9 We used saving
data from the National Income and Product Accounts compiled by the Bureau
of Economic Analysis to analyze the composition of net national saving.

We used our long-term model to simulate how alternative fiscal policies
affect future deficits, debt, and living standards. Long-term simulations
provide illustrations-not precise forecasts- of the relative fiscal and
economic outcomes associated with alternative policy paths. They are not
predictions of what will happen in the future because policymakers would
likely take action before the occurrence of the negative out-year fiscal
and economic consequences reflected in some simulated fiscal policy paths.
However, such simulations can help policymakers assess the long-term
consequences of today's fiscal policy choices and simulated fiscal policy
paths.

We present two fiscal policy simulations: (1) Baseline Extended and (2)
Discretionary Spending Grows with the Economy and all Expiring Tax
Provisions are Extended. Baseline Extended follows CBO's 2004 10-year
baseline projections, which assume that discretionary spending grows with
inflation and tax provisions scheduled to expire will actually do so.
After 2014, discretionary spending is assumed to grow with the economy,
and revenue is held constant as a share of GDP at the 2014 level of 20.1
percent. Discretionary Spending Grows with the Economy and All Expiring
Tax Provisions are Extended follows CBO's January 2004 10-year baseline
projections except that discretionary spending grows with the economy
after 2004 and all expiring tax provisions are extended. After 2014,
revenue is held constant as a share of GDP at the 2014 level of 17.7
percent.

In both simulations after the first 10 years, Social Security and Medicare
spending is based on the Trustee's March 2004

9 Federal Reserve Board of Governors, "Selected Interest Rates, Historical
Data," Federal Reserve Statistical Release H.15 (Washington D.C.: Feb. 2,
2004), http://www.federalreserve.gov/releases/h15/data.htm (downloaded
Feb. 4, 2004).

intermediate projections.10 Medicaid spending is based on CBO's December
2003 long-term projections under Scenario 2 (per enrollee Medicaid
spending assumed to grow over the long term with GDP per capita plus 1
percent). The simulation assumes Social Security and Medicare benefits are
paid in full after the trust funds are exhausted through borrowing from
the general fund to meet any payroll tax shortfall.

We did our work from August 2003 through June 2004 in accordance with
generally accepted government auditing standards. We requested agency
comments from the Department of the Treasury and technical comments from
OMB, CBO, and other subject matter experts. Their comments are
incorporated as appropriate.

(450250)

10 Board of Trustees, Federal Old-Age and Survivors Insurance and
Disability Insurance Trust Funds, The 2004 Annual Report of the Board of
Trustees of the Federal Old-Age and Survivors Insurance and Disability
Insurance Trust Funds (Washington, D.C.: March 2004).

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