Economic Development:

Update of State and Local Government Fiscal Pressures

GAO-09-320R: Published: Jan 26, 2009. Publicly Released: Jan 26, 2009.

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Congress asked GAO to provide information on (1) the fiscal pressures facing state and local governments and (2) principles to consider in determining how to effectively target and time temporary assistance to states, especially for Medicaid. This information is intended to inform ongoing congressional deliberations regarding fiscal relief to state and local governments as a component of an economic recovery initiative to respond to the current recession. We have developed a model that enables us to simulate fiscal outcomes of the state and local sector in the aggregate for several decades into the future. The model is not designed to highlight the fiscal position of individual states. Rather, the model projects the level of aggregate receipts and expenditures of the state and local sector in future years based on current and historical spending and revenue patterns. We first published the findings from our state and local fiscal model in 2007. A January 2008 report provided a detailed methodology for how we constructed the model. For a November 19, 2008, Senate Committee on Finance hearing, we provided a statement which included updated model results based on August 2008 National Income and Product Account (NIPA) data from the Bureau of Economic Analysis. The findings from the model discussed in this letter include data released in the Congressional Budget Office's (CBO) Budget and Economic Outlook on January 8, 2009.

Recent updates to the data in our model demonstrate that the long-term fiscal challenges faced by the state and local government sector are exacerbated by the current recession. The magnitude of these challenges affects all levels of government. State and local governments work in partnership with the federal government to implement numerous federal programs, many of which experience increased demand during a period of economic downturn. Our model includes a measure of fiscal balance for the state and local government sector for each year until 2057. The operating balance net of funds for capital expenditures is a measure of the ability of the sector to cover its current expenditures out of current receipts. The operating balance measure has historically been positive most of the time, ranging from about zero to about 1 percent of gross domestic product (GDP). Our incorporation of the January 2009 CBO projections shows an operating deficit for the sector. Specifically, the update to our model depicts reduced receipts because of lower GDP, as projected by CBO. Our model simulates operating deficits of about $131 billion for 2009 and about $181 billion for 2010. The cumulative 2-year projected operating deficit totals approximately $312 billion. Since most state and local governments are required to balance their operating budgets, the declining fiscal conditions shown in our simulations suggest that, without intervention, these governments would need to make substantial policy changes to avoid growing fiscal imbalances. Recent economic events have also renewed interest in our work on state fiscal relief, especially our 2006 report on strategies to help states address increased Medicaid expenditures during economic downturns. In 2003, Congress, in response to the 2001 recession, provided $10 billion to the states through a temporary across-the-board increase in federal Medicaid funding. The principles outlined in our 2006 report for targeting and timing supplemental federal assistance for Medicaid apply to the current debate regarding supplemental Medicaid funding and general fiscal relief to state and local governments in response to the current recession. As described in our 2006 report, supplemental federal assistance for Medicaid could be targeted to states based on their increased unemployment rates. Using our approach, such assistance would be triggered on and off based on agreed-upon thresholds reflecting states' percentage increases in unemployment compared to a base quarter. Analysis of recent unemployment data indicates that, based on this strategy, fiscal relief would already have been triggered based on states' changes in unemployment for 2007 and 2008. We used unemployment as the key variable for targeting Medicaid-related assistance because it is (1) generally accepted as an indicator of increased Medicaid enrollment resulting from an economic downturn, (2) not easily influenced by outside sources or state policy choices and thus is less subject to manipulation, and (3) a reliable indicator collected in a consistent manner from all 50 states. In summary, considerations involved in developing any strategy for federal fiscal relief include (1) targeting assistance according to the extent of each state's downturn, (2) timing assistance so that it is delivered as soon as it is needed, (3) temporarily increasing federal funding so that it turns off when states' economic circumstances improve significantly, and (4) triggering mechanisms so the starting and ending points of assistance respond to indicators of states' economic distress.

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