This is the accessible text file for GAO report number GAO-12-523SP 
entitled 'State and Local Governments' Fiscal Outlook: April 2012 
Update' which was released on April 5, 2012. 

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United States Government Accountability Office: 
GAO: 

State and Local Governments' Fiscal Outlook: 

April 2012 Update: 

GAO-12-523SP: 

GAO’s State and Local Fiscal Simulations: 

Fiscal sustainability presents a national challenge shared by all 
levels of government. Since 2007, GAO has published long-term fiscal 
simulations for the state and local government sector. These 
simulations show that, like the federal government, the state and 
local government sector faces persistent and long-term fiscal 
pressures. 

Using the Bureau of Economic Analysis’s (BEA) National Income and 
Product Accounts (NIPA) as the primary data source, our model shows 
the level of receipts and expenditures for the sector until 2060 based 
on current and historical spending and revenue patterns. A basic 
assumption of our model is that the current set of policies in place 
across state and local government remains constant. The model 
simulates the long-term fiscal outlook for the state and local sector 
as a whole, and while the model incorporates the Congressional Budget 
Office’s (CBO) economic projections, adjustments are made to capture 
the budgetary effects of near-term cyclical swings in the economy. 
Because the model covers the sector in the aggregate, the fiscal 
outcomes for individual states and localities cannot be captured. This 
product is part of a body of work on the nation’s long-term fiscal 
challenges. Related products can be found at [hyperlink, 
http://www.gao.gov/special.pubs/longterm/]. 

For more information, contact Stanley J. Czerwinski at (202) 512-6806 
or czerwinskis@gao.gov or Thomas J. McCool at (202) 512-2700 or 
mccoolt@gao.gov. 

The state and local government sector continues to face near-term and 
long-term fiscal challenges that grow over time. The fiscal challenges 
confronting the state and local sector add to the nation's overall 
fiscal challenges. The fiscal situation of the state and local 
government sector has improved in the past year as the sector's tax 
receipts have slowly increased in conjunction with the economic 
recovery. Nonetheless, total tax receipts have only recently returned 
to the prerecession levels of 2007 and the sector still faces a gap 
between revenue and spending. As shown in figure 1, the sector faces 
long-term fiscal challenges that grow over time. The model's base case 
simulations show that the fiscal position of the sector will steadily 
decline through 2060 absent any policy changes.[Footnote 1] 

Figure 1: State and Local Operating Balance Measure, as a Percentage 
of Gross Domestic Product (GDP): 

[Refer to PDF for image: line graph] 

Year: 2005: 0.1%; 
Year: 2006: 0.3%; 
Year: 2007: 0.1%; 
Year: 2008: -0.5%; 
Year: 2009: -0.5%; 
Year: 2010: 0%; 
Year: 2011: -0.4%; 
Year: 2012: -0.8%; 
Year: 2013: -1.2%; 
Year: 2014: -1.4%; 
Year: 2015: -1.4%; 
Year: 2016: -1.2%; 
Year: 2017: -1.2%; 
Year: 2018: -1.2%; 
Year: 2019: -1.3%; 
Year: 2020: -1.3%; 
Year: 2021: -1.4%; 
Year: 2022: -1.4%; 
Year: 2023: -1.5%; 
Year: 2024: -1.5%; 
Year: 2025: -1.6%; 
Year: 2026: -1.6%; 
Year: 2027: -1.7%; 
Year: 2028: -1.7%; 
Year: 2029: -1.8%; 
Year: 2030: -1.9%; 
Year: 2031: -1.9%; 
Year: 2032: -2%; 
Year: 2033: -2%; 
Year: 2034: -2.1%; 
Year: 2035: -2.1%; 
Year: 2036: -2.2%; 
Year: 2037: -2.2%; 
Year: 2038: -2.3%; 
Year: 2039: -2.3%; 
Year: 2040: -2.4%; 
Year: 2041: -2.5%; 
Year: 2042: -2.5%; 
Year: 2043: -2.6%; 
Year: 2044: -2.6%; 
Year: 2045: -2.7%; 
Year: 2046: -2.7%; 
Year: 2047: -2.7%; 
Year: 2048: -2.8%; 
Year: 2049: -2.8%; 
Year: 2050: -2.8%; 
Year: 2051: -2.9%; 
Year: 2052: -2.9%; 
Year: 2053: -2.9%; 
Year: 2054: -2.9%; 
Year: 2055: -3%; 
Year: 2056: -3%; 
Year: 2057: -3%; 
Year: 2058: -3%; 
Year: 2059: -3.1%; 
Year: 2060: -3.1%. 

Source: GAO simulations, updated April 2012. 

Notes: Historical data are from BEA's National Income and Product 
Accounts. Data in 2011 are GAO estimates aligned with published data 
where available. GAO simulations are from 2012 to 2060, using many CBO 
projections and assumptions, particularly for the next 10 years. 

The operating balance is a measure of the sector's ability to cover 
its current expenditures out of current receipts. The operating 
balance measure is all receipts, excluding funds used for long-term 
investments, minus current expenditures. To develop this measure, we 
subtract funds used to finance longer-term projects--such as 
investments in buildings and roads--from receipts since these funds 
would not be available to cover current expenses. Similarly, we 
exclude capital-related expenditures from spending. 

[End of figure] 

One of the primary factors contributing to the near-term improvement 
in the fiscal picture of the state and local government sector is the 
increase in tax receipts following the decline during 2008 and into 
2009. Specifically, from the second quarter of 2009 to the third 
quarter of 2011, total tax receipts increased nearly 11 percent, 
returning to prerecession levels of 2007. Income and sales taxes 
accounted for most of the growth, increasing about 18 percent and 10 
percent over the same period, respectively. However, property tax 
receipts, which had grown more than 3 percent from the second quarter 
of 2009 to the third quarter of 2010, flattened in 2011, increasing 
less than 1 percent from 2010 to 2011 as real estate values remained 
depressed. In addition, as most outlays from the American Recovery and 
Reinvestment Act of 2009 (Recovery Act) have already occurred, the 
state and local government sector will continue to adjust to a reduced 
level of federal assistance provided by the Recovery Act.[Footnote 2] 
This April 2012 update to our model incorporates these near-term 
changes for both revenues and expenditures but focuses primarily on 
the long-term fiscal outlook for state and local governments as a 
sector. 

In the long term, the decline in the sector's operating balance is 
primarily driven by the rising health-related costs of state and local 
expenditures on Medicaid and the cost of health care compensation for 
state and local government employees and retirees. Since most state 
and local governments are required to balance their operating budgets, 
the declining fiscal conditions shown in our simulations suggest that 
the sector would need to make substantial policy changes to avoid 
growing fiscal imbalances in the future. That is, absent any 
intervention or policy changes, state and local governments would face 
an increasing gap between receipts and expenditures in the coming 
years. 

Substantial Policy Changes Required in the State and Local Government 
Sector to Maintain Fiscal Balance over the Long Term: 

One way of measuring the long-term fiscal challenges faced by the 
state and local government sector is through a measure known as the 
"fiscal gap."[Footnote 3] The fiscal gap is an estimate of the action 
needed today and maintained for each year to achieve fiscal balance 
over the next 50 years. We measured the gap as the amount of the 
spending reductions or tax increases needed to prevent operating 
deficits (or negative operating balances). As shown in figure 2, under 
the base case, expenditures rise considerably as a percentage of GDP 
over the simulation time frame.[Footnote 4] In contrast, maintaining 
balance solely through spending restraint would require holding 
expenditure growth to a much lower rate than the base case. We 
calculated that closing the fiscal gap would require action to be 
taken today and maintained for each year equivalent to a 12.7 percent 
reduction in state and local government current expenditures.[Footnote 
5] Closing the fiscal gap through revenue increases would require 
action on that side of a similar magnitude. 

Figure 2: State and Local Government Action Required to Maintain 
Balance (Expenditures, as a Percentage of Gross Domestic Product--GDP): 

[Refer to PDF for image: multiple line graph] 

Year: 2005; 
Base case: 14.7%; 
Maintain balance: 14.7%. 

Year: 2006; 
Base case: 14.4%; 
Maintain balance: 14.4%. 

Year: 2007; 
Base case: 14.8%; 
Maintain balance: 14.8%. 

Year: 2008; 
Base case: 15.3%; 
Maintain balance: 15.3%. 

Year: 2009; 
Base case: 15.8%; 
Maintain balance: 15.8%. 

Year: 2010; 
Base case: 15.4%; 
Maintain balance: 15.4%. 

Year: 2011; 
Base case: 15.2%; 
Maintain balance: 14.8%. 

Year: 2012; 
Base case: 15.1%; 
Maintain balance: 14.3%. 

Year: 2013; 
Base case: 15.4%; 
Maintain balance: 14.2%. 

Year: 2014; 
Base case: 15.6%; 
Maintain balance: 14.3%. 

Year: 2015; 
Base case: 15.6%; 
Maintain balance: 14.3%. 

Year: 2016; 
Base case: 15.6%; 
Maintain balance: 14.4%. 

Year: 2017; 
Base case: 15.6%; 
Maintain balance: 14.4 

Year: 2018; 
Base case: 15.7%; 
Maintain balance: 14.5%. 

Year: 2019; 
Base case: 15.8%; 
Maintain balance: 14.6%. 

Year: 2020; 
Base case: 15.9%; 
Maintain balance: 14.6%. 

Year: 2021; 
Base case: 16.1%; 
Maintain balance: 14.7%. 

Year: 2022; 
Base case: 16.2%; 
Maintain balance: 14.8%. 

Year: 2023; 
Base case: 16.2%; 
Maintain balance: 14.8%. 

Year: 2024; 
Base case: 16.4%; 
Maintain balance: 14.9%. 

Year: 2025; 
Base case: 16.4%; 
Maintain balance: 14.8%. 

Year: 2026; 
Base case: 16.5%; 
Maintain balance: 14.9%. 

Year: 2027; 
Base case: 16.6%; 
Maintain balance: 14.9%. 

Year: 2028; 
Base case: 16.6%; 
Maintain balance: 14.9%. 

Year: 2029; 
Base case: 16.8%; 
Maintain balance: 14.9%. 

Year: 2030; 
Base case: 16.8%; 
Maintain balance: 14.9%. 

Year: 2031; 
Base case: 16.9%; 
Maintain balance: 15%. 

Year: 2032; 
Base case: 16.9%; 
Maintain balance: 14.9%. 

Year: 2033; 
Base case: 17%; 
Maintain balance: 15%. 

Year: 2034; 
Base case: 17.1%; 
Maintain balance: 15%. 

Year: 2035; 
Base case: 17.1%; 
Maintain balance: 15%. 

Year: 2036; 
Base case: 17.2%; 
Maintain balance: 15%. 

Year: 2037; 
Base case: 17.3%; 
Maintain balance: 15.1%. 

Year: 2038; 
Base case: 17.4%; 
Maintain balance: 15.1%. 

Year: 2039; 
Base case: 17.5%; 
Maintain balance: 15.1%. 

Year: 2040; 
Base case: 17.7%; 
Maintain balance: 15.3%. 

Year: 2041; 
Base case: 17.7%; 
Maintain balance: 15.3%. 

Year: 2042; 
Base case: 17.8%; 
Maintain balance: 15.3%. 

Year: 2043; 
Base case: 17.9%; 
Maintain balance: 15.3%. 

Year: 2044; 
Base case: 17.9%; 
Maintain balance: 15.3%. 

Year: 2045; 
Base case: 18%; 
Maintain balance: 15.3. 

Year: 2046; 
Base case: 18%; 
Maintain balance: 15.4%. 

Year: 2047; 
Base case: 18.1%; 
Maintain balance: 15.4%. 

Year: 2048; 
Base case: 18.1%; 
Maintain balance: 15.4%. 

Year: 2049; 
Base case: 18.1%; 
Maintain balance: 15.4%. 

Year: 2050; 
Base case: 18.1%; 
Maintain balance: 15.3%. 

Year: 2051; 
Base case: 18.2%; 
Maintain balance: 15.4%. 

Year: 2052; 
Base case: 18.2%; 
Maintain balance: 15.3. 

Year: 2053; 
Base case: 18.3%; 
Maintain balance: 15.4%. 

Year: 2054; 
Base case: 18.2%; 
Maintain balance: 15.3%. 

Year: 2055; 
Base case: 18.3%; 
Maintain balance: 15.4%. 

Year: 2056; 
Base case: 18.4%; 
Maintain balance: 15.4%. 

Year: 2057; 
Base case: 18.3%; 
Maintain balance: 15.3%. 

Year: 2058; 
Base case: 18.4%; 
Maintain balance: 15.3%. 

Year: 2059; 
Base case: 18.4%; 
Maintain balance: 15.4%. 

Year: 2060; 
Base case: 18.4%; 
Maintain balance: 15.4%. 

Source: GAO simulations, updated April 2012. 

Note: Historical data are from the Bureau of Economic Analysis's (BEA) 
National Income and Product Accounts (NIPA). Data in 2011 are GAO 
estimates aligned with published data where available. GAO simulations 
are from 2012 to 2060, using many CBO projections and assumptions, 
particularly for the next 10 years. 

[End of figure] 

State and Local Governments Continue to Face Long-Term Fiscal 
Challenges from Estimated Growth in Health-Related Costs: 

The primary driver of fiscal challenges for the state and local 
government sector in the long term continues to be the projected 
growth in health-related costs. Specifically, state and local 
expenditures on Medicaid and the cost of health care compensation for 
state and local government employees and retirees are projected to 
grow more than GDP.[Footnote 6] See figure 3. The model's simulations 
show that the sector's health-related costs will be about 3.9 percent 
of GDP in 2012 and 7.1 percent of GDP in 2060. In contrast, our model 
shows that other types of state and local government expenditures--
such as wages and salaries of state and local workers--are expected to 
decline as a percentage of GDP. The model projects that the sector's 
non-health-related costs will be about 10.4 percent of GDP in 2012 and 
7.8 percent of GDP in 2060. Our simulations for health-related and 
other expenditures are shown in figure 3. 

Figure 3: Health and Nonhealth Expenditures of State and Local 
Governments, as a Percentage of Gross Domestic Product (GDP): 

[Refer to PDF for image: multiple line graph] 

Year: 2005; 
Nonhealth care expenditures: 10.7%; 
Health care expenditures: 3.2%. 

Year: 2006; 
Nonhealth care expenditures: 10.7%; 
Health care expenditures: 3%. 

Year: 2007; 
Nonhealth care expenditures: 10.9%; 
Health care expenditures: 3.1%. 

Year: 2008; 
Nonhealth care expenditures: 11.3%; 
Health care expenditures: 3.2%. 

Year: 2009; 
Nonhealth care expenditures: 11.4%; 
Health care expenditures: 3.6%. 

Year: 2010; 
Nonhealth care expenditures: 10.9%; 
Health care expenditures: 3.7%. 

Year: 2011; 
Nonhealth care expenditures: 10.5%; 
Health care expenditures: 4%. 

Year: 2012; 
Nonhealth care expenditures: 10.4%; 
Health care expenditures: 3.9%. 

Year: 2013; 
Nonhealth care expenditures: 10.5%; 
Health care expenditures: 4.1%. 

Year: 2014; 
Nonhealth care expenditures: 10.4%; 
Health care expenditures: 4.5%. 

Year: 2015; 
Nonhealth care expenditures: 10.1%; 
Health care expenditures: 4.7%. 

Year: 2016; 
Nonhealth care expenditures: 9.9%; 
Health care expenditures: 4.8%. 

Year: 2017; 
Nonhealth care expenditures: 9.8%; 
Health care expenditures: 4.9%. 

Year: 2018; 
Nonhealth care expenditures: 9.7%; 
Health care expenditures: 5%. 

Year: 2019; 
Nonhealth care expenditures: 9.6%; 
Health care expenditures: 5%. 

Year: 2020; 
Nonhealth care expenditures: 9.6%; 
Health care expenditures: 5.2%. 

Year: 2021; 
Nonhealth care expenditures: 9.5%; 
Health care expenditures: 5.3%. 

Year: 2022; 
Nonhealth care expenditures: 9.5%; 
Health care expenditures: 5.4%. 

Year: 2023; 
Nonhealth care expenditures: 9.4%; 
Health care expenditures: 5.4%. 

Year: 2024; 
Nonhealth care expenditures: 9.4%; 
Health care expenditures: 5.5%. 

Year: 2025; 
Nonhealth care expenditures: 9.4%; 
Health care expenditures: 5.5%. 

Year: 2026; 
Nonhealth care expenditures: 9.3%; 
Health care expenditures: 5.6%. 

Year: 2027; 
Nonhealth care expenditures: 9.3%; 
Health care expenditures: 5.6%. 

Year: 2028; 
Nonhealth care expenditures: 9.2%; 
Health care expenditures: 5.6%. 

Year: 2029; 
Nonhealth care expenditures: 9.2%; 
Health care expenditures: 5.7%. 

Year: 2030; 
Nonhealth care expenditures: 9.2%; 
Health care expenditures: 5.7%. 

Year: 2031; 
Nonhealth care expenditures: 9.1%; 
Health care expenditures: 5.9%. 

Year: 2032; 
Nonhealth care expenditures: 9.1%; 
Health care expenditures: 5.8%. 

Year: 2033; 
Nonhealth care expenditures: 9%; 
Health care expenditures: 5.9%. 

Year: 2034; 
Nonhealth care expenditures: 9%; 
Health care expenditures: 6%. 

Year: 2035; 
Nonhealth care expenditures: 8.9%; 
Health care expenditures: 6%. 

Year: 2036; 
Nonhealth care expenditures: 8.9%; 
Health care expenditures: 6.1%. 

Year: 2037; 
Nonhealth care expenditures: 8.8%; 
Health care expenditures: 6.2%. 

Year: 2038; 
Nonhealth care expenditures: 8.8%; 
Health care expenditures: 6.2%. 

Year: 2039; 
Nonhealth care expenditures: 8.7%; 
Health care expenditures: 6.3%. 

Year: 2040; 
Nonhealth care expenditures: 8.7%; 
Health care expenditures: 6.5%. 

Year: 2041; 
Nonhealth care expenditures: 8.6%; 
Health care expenditures: 6.6%. 

Year: 2042; 
Nonhealth care expenditures: 8.6%; 
Health care expenditures: 6.6%. 

Year: 2043; 
Nonhealth care expenditures: 8.5%; 
Health care expenditures: 6.7%. 

Year: 2044; 
Nonhealth care expenditures: 8.5%; 
Health care expenditures: 6.7%. 

Year: 2045; 
Nonhealth care expenditures: 8.4%; 
Health care expenditures: 6.8%. 

Year: 2046; 
Nonhealth care expenditures: 8.4%; 
Health care expenditures: 6.8%. 

Year: 2047; 
Nonhealth care expenditures: 8.3%; 
Health care expenditures: 6.9%. 

Year: 2048; 
Nonhealth care expenditures: 8.3%; 
Health care expenditures: 6.9%. 

Year: 2049; 
Nonhealth care expenditures: 8.2%; 
Health care expenditures: 6.9%. 

Year: 2050; 
Nonhealth care expenditures: 8.2%; 
Health care expenditures: 6.9%. 

Year: 2051; 
Nonhealth care expenditures: 8.1%; 
Health care expenditures: 7%. 

Year: 2052; 
Nonhealth care expenditures: 8.1%; 
Health care expenditures: 6.9%. 

Year: 2053; 
Nonhealth care expenditures: 8%; 
Health care expenditures: 7.1%. 

Year: 2054; 
Nonhealth care expenditures: 8%; 
Health care expenditures: 6.9%. 

Year: 2055; 
Nonhealth care expenditures: 8%; 
Health care expenditures: 7%. 

Year: 2056; 
Nonhealth care expenditures: 7.9%; 
Health care expenditures: 7.1%. 

Year: 2057; 
Nonhealth care expenditures: 7.9%; 
Health care expenditures: 7%. 

Year: 2058; 
Nonhealth care expenditures: 7.9%; 
Health care expenditures: 7%. 

Year: 2059; 
Nonhealth care expenditures: 7.8%; 
Health care expenditures: 7%. 

Year: 2060; 
Nonhealth care expenditures: 7.8%; 
Health care expenditures: 7.1%. 

Source: GAO simulations, updated April 2012. 

Note: Historical data are from the Bureau of Economic Analysis's (BEA) 
National Income and Product Accounts (NIPA). Data in 2011 are GAO 
estimates aligned with published data where available. GAO simulations 
are from 2012 to 2060, using many CBO projections and assumptions, 
particularly for the next 10 years. 

[End of figure] 

Our simulations also showed that, consistent with our April 2011 
update, revenue growth over the long term, excluding Medicaid grants 
from the federal government, is projected to decrease as a percentage 
of GDP.[Footnote 7] For example, non-Medicaid grants are projected to 
decline as a percentage of GDP. One difference in the current update 
relative to our April 2011 update relates to the slower growth of 
property tax receipts as a percentage of GDP. Specifically, the 
current model projects that property tax receipts, as a percentage of 
GDP, will be 2.89 percent in 2012 and 3.10 percent in 2060, compared 
to the 3.22 percent projected for 2060, in last year's projections. In 
addition, our model projects that property tax receipts would not 
reach the 2009 peak level of 3.01 percent of GDP until 2039, 
reflecting the general downward trend in real estate values and 
property tax assessments in recent years. 

Declines in state and local pension asset values stemming from the 
2007 to 2009 economic recession could also affect the sector's long-
term fiscal position. Pension asset values increased by 26 percent, 
from $2.3 trillion at the end of 2008 to $2.9 trillion at the end of 
2010. However, as of 2010, values have not recovered to match or 
exceed the 2007 value of $3.2 trillion. We recently reported that 
while most state and local government pension plans have assets 
sufficient to cover benefit payments to retirees for a decade or more, 
plans have experienced a growing gap between assets and liabilities. 
In response, state and local governments have begun taking a number of 
steps to manage their pension obligations, including reducing benefits 
and increasing member contributions.[Footnote 8] 

Patient Protection and Affordable Care Act and Budget Control Act 
Could Affect State and Local Government Fiscal Outlook: 

The state and local government sector's fiscal outlook will likely be 
affected by the implementation of the Patient Protection and 
Affordable Care Act (PPACA) in the long term.[Footnote 9] Exactly how 
the enacted legislation will affect state costs in the long term will 
continue to evolve and will likely vary among the states. State costs 
will likely increase most where current Medicaid eligibility 
requirements now provide less coverage than that required by PPACA, 
although other provisions in PPACA may decrease health-related costs. 
Further, the Social Security and Medicare Trustees (Trustees), the 
Congressional Budget Office (CBO), and CMS's Office of the Actuary 
have expressed concerns about the effectiveness of certain cost-
control measures over the long term in PPACA. 

State and local governments may also be affected by the Budget Control 
Act of 2011, which enacted certain deficit reduction measures for the 
fiscal years 2012 to 2021.[Footnote 10] However, the degree to which 
this will affect the intergovernmental transfer relationship between 
the federal government and the state and local government sector is 
unclear. 

Assumptions Used in Our 2012 State and Local Model Simulations: 

Our long-term model results reflect the federal government assuming a 
greater share of state and local government health care expenditures 
(primarily Medicaid), approximately 60 to 63 percent in 2014 and 
beyond (on an aggregate basis).[Footnote 11] The state share is 
approximately 40 to 37 percent in 2014 and later years. Expressed as a 
share of GDP, our model simulates that the federal share of Medicaid 
costs will be about 2.0 percent of GDP in 2014 and 4.3 percent of GDP 
in 2060.[Footnote 12] In contrast, the state share expressed as a 
share of GDP represents 1.4 percent in 2014 and approximately 2.6 
percent in the later years. 

This update uses NIPA data prepared by BEA as a primary data source. 
Our state and local model simulates the level of receipts and 
expenditures for the sector in future years based on current and 
historical spending and revenue patterns.[Footnote 13] To develop 
these long-run simulations, we make simulations for each major receipt 
and expenditure category of the state and local government sector in 
future years.[Footnote 14] We simulate growth in each category of 
receipts and expenditures using CBO's economic assumptions wherever 
possible.[Footnote 15] In several cases we were not able to obtain 
existing projections and needed to develop our own assumptions about 
the likely future growth path of certain receipts or expenditures. 
Overall, our model assumes current policies remain in place. 

For this year's update we changed our method and assumption for GDP 
growth in our simulations to a GDP growth assumption that matches the 
Trustees' intermediate assumptions over the long term. This GDP growth 
assumption is more consistent with the growth in labor force, wages, 
and other factors underlying the Trustees' Social Security and 
Medicare estimates used in our federal budget simulations. Previously, 
GDP in our model was determined by growth in the labor force, capital 
stock, and total factor productivity after the first 10 years, and 
projections of Social Security spending were adjusted accordingly. 

In addition, for this year's update we used data to estimate health 
care compensation costs for state and local government employees and 
retirees. We made projections on a pay-as-you-go basis for health care 
expenditures for the sector, in each year until 2060. Beginning with 
this update, to simulate health care compensation costs, we used 
estimates from BEA as a starting value of the sector's health care 
expenditures on behalf of employees and retirees. 

Finally, since our April 2011 model update, we made several 
adjustments in light of recent economic trends.[Footnote 16] 
Specifically, we reevaluated the relationships of our tax variables 
for the first time since our initial state and local fiscal model in 
2007 and made a number of modifications based on this reevaluation. 
[Footnote 17] These modifications are summarized in table 1. 

Table 1: Modifications to Assumptions for April 2012 Update: 

Variable: Bond Buyer GO 20-Bond Municipal Bond Index (RMMUNIBB20); 
Original assumption: Our standard approach for the Bond Buyer GO-20 
Bond Municipal Bond Index has been to use an estimated relationship 
between that rate and the 10-year Treasury yield, with an adjustment 
for the amount by which the relationship under-or overpredicts the 
last historical value; 
Updated assumption: Because municipal bond rates were unusually high 
relative to Treasury yields in the year preceding our projections, our 
standard assumption results in what appears to be excessively high 
projections for the municipal bond rate. We added an adjustment factor 
that gradually brings the municipal bond rate below the 10-year 
Treasury note rate. 

Variable: State personal income tax receipts (TXPGSTATE); 
Original assumption: We simulated future state personal income tax 
receipts by estimating the long-run responsiveness, or elasticity, of 
receipts to taxable personal income. The long-run elasticity estimate 
depicts the extent to which tax receipts grow in response to income 
growth but does not capture their short-run reaction to changes in 
income over the business cycle; 
Updated assumption: Our updated estimated elasticity between state 
personal income tax and taxable personal income increased from 1.1067 
to 1.1396, when controlling for both policy changes and unusual swings 
in capital gains tax receipts. 

Variable: Real Estate Asset (REST_ALT); 
Original assumption: Based on data for the market value of real 
estate, obtained from the sectors' balance sheets in the Federal 
Reserve Board's flow of funds accounts, we estimated that the long-run 
responsiveness, or elasticity, of property values to GDP is 1.1257; 
Updated assumption: Our estimated relationship between real-estate 
market value and GDP is used to estimate the future property tax base. 
Property tax grows with the property tax base in our model. The 
updated estimate showed a decrease in the elasticity between the 
property tax base and GDP, from 1.1257 to 1.0623. 

Variable: Other sales tax receipts (TXIMGSLSOTH); 
Original assumption: Because the amount of the unit tax is adjusted 
only periodically, selective sales tax receipts tend to grow less 
rapidly than the value of the sales on which they are levied and less 
than incomes. Accordingly in previous updates, we estimated the 
responsiveness of selective sales tax receipts to income rather than 
the responsiveness of the tax base to income. Our estimates indicated 
that the long-run elasticity, based on historical data, was 0.8023; 
Updated assumption: Our estimated elasticity between other sales tax 
(excise/selective sales tax) and personal salary and wages showed an 
increase from 0.8023 to 0.8342 when incorporating the latest data. 

Variable: Federal investment grants (IGRANTCBO) and federal non-
Original assumption: Medicaid grants or other federal grants 
(GFAIDSLO); 
We assume that federal investment grants grow at the same rate as 
CBO's projections for federal capital transfers for the first 10 
years. We project other federal grants by subtracting CBO's Medicaid 
grant projections from CBO's total grants for current expenditures. 
For both federal investment and other federal grants, we assume that 
grants grow with inflation plus population growth after the first 10 
years; 
Updated assumption: To estimate federal investment grants, we multiply 
the January 2012 GDP projection with an estimate of each variable's 
respective share of GDP derived from CBO's most recently available 
projections. After the 10th year we assume investment grants grow with 
population plus inflation. 

Variable: Total state and local government retirement fund assets 
(L1TOTALFA); 
Original assumption: Our original assumption was to use the last year-
end historical value of pension fund assets, along with other 
elements, to calculate the contribution that governments must make to 
fully fund employee pension benefits; 
Updated assumption: Because asset values can exhibit substantial 
volatility, governments typically smooth asset values in their pension 
funding calculations. Accordingly, in this update, we use the average 
value of pension fund assets over the previous 5 years to calculate 
the contribution rate needed to fully fund pensions. 

Variable: Personal consumption (CBASE); 
Original assumption: We developed a broad consumption measure as a 
proxy for the tax base. The proxy used here is total consumption 
expenditures excluding food and services, because the two categories 
are often not part of the sales tax base. In addition, because the 
sales tax base has been negatively affected by increases in mail order 
and Internet purchases, we also used Census data to remove an estimate 
of remote sales from the tax base. We then estimated the long-run 
elasticity of this sales tax base with respect to aggregate wages and 
salaries using historical data; 
Updated assumption: Our estimated elasticity between personal 
consumption and wages and salary is used to estimate future 
consumption for the sales tax base. The sales tax base is used to 
estimate future general sales and other taxes. The updated equation 
shows the elasticity increased from 0.9267 to 0.9725 when 
incorporating the latest data. 

Variable: Employee Contribution (EECONPENR); 
Original assumption: In previous updates, our standard assumption was 
that employee contribution grows at the same rate as aggregate wages, 
thus keeping the contribution level constant as a share of aggregate 
wages; 
Updated assumption: To reflect the response to state and local pension 
cost pressures, we raise employee contributions in 2011 by the same 
amount that they rose in 2010 as a share of wages and hold the value 
constant thereafter. 

Variable: Pension Benefits (PENBENR); 
Original assumption: In previous updates, our standard assumption for 
pension payments was based on the demographic changes and growth of 
beneficiaries (new retirees, continuing, and deceased) and wage growth; 
Updated assumption: To reflect the response to state and local pension 
cost pressures, we let real pension benefit per recipient grow 1/10 of 
1 percent slower than employees' real wages. 

Source: GAO. 

[End of table] 

We conducted our work for this model update from August 2011 to April 
2012 in accordance with all sections of GAO's Quality Assurance 
Framework that are relevant to our objectives. The framework requires 
that we plan and perform the engagement to obtain sufficient and 
appropriate evidence to meet our stated objectives and to discuss any 
limitations in our work. We believe that the information and data 
obtained, and the analysis conducted, provide a reasonable basis for 
any findings and conclusions. 

GAO Contacts: 

Stanley J. Czerwinski, (202) 512-6806 or czerwinskis@gao.gov: 

Thomas J. McCool, (202) 512-2700 or mccoolt@gao.gov: 

Acknowledgments: 

In addition to the contacts listed above, Michelle Sager (Acting 
Director), Richard Krashevski and Brenda Rabinowitz (Assistant 
Directors), Jason Vassilicos (analyst-in-charge), and Andrew Ching 
made significant contributions to this report. 

[End of section] 

Related GAO Products: 

This product is part of a body of work on the long-term fiscal 
challenges. Related products are listed below and can be found at 
[hyperlink, www.gao.gov/special.pubs/longterm/longtermproducts.html]. 

State and Local Government Pension Plans: Economic Downturn Spurs 
Efforts to Address Costs and Sustainability. [hyperlink, 
http://www.gao.gov/products/GAO-12-322]. Washington, D.C.: March 2, 
2012. 

State and Local Governments' Fiscal Outlook: April 2011 Update. 
[hyperlink, http://www.gao.gov/products/GAO-11-495SP]. Washington, 
D.C.: April 6, 2011. 

State and Local Governments: Knowledge of Past Recessions Can Inform 
Future Federal Fiscal Assistance. [hyperlink, 
http://www.gao.gov/products/GAO-11-401]. Washington, D.C.: March 31, 
2011. 

State and Local Government Pension Plans: Governance Practices and 
Long-term Investment Strategies Have Evolved Gradually as Plans Take 
on Increased Investment Risk. [hyperlink, 
http://www.gao.gov/products/GAO-10-754]. Washington, D.C.: August 24, 
2010. 

State and Local Governments: Fiscal Pressures Could Have Implications 
for Future Delivery of Intergovernmental Programs. [hyperlink, 
http://www.gao.gov/products/GAO-10-899]. Washington, D.C.: July 30, 
2010. 

State and Local Governments' Fiscal Outlook: March 2010 Update. 
[hyperlink, http://www.gao.gov/products/GAO-10-358]. Washington, D.C.: 
March 2, 2010. 

Update of State and Local Government Fiscal Pressures. [hyperlink, 
http://www.gao.gov/products/GAO-09-320R]. Washington, D.C.: January 
26, 2009. 

State and Local Fiscal Challenges: Rising Health Care Costs Drive Long-
term and Immediate Pressures. [hyperlink, 
http://www.gao.gov/products/GAO-09-210T]. Washington, D.C.: November 
19, 2008. 

State and Local Government Pension Plans: Current Structure and Funded 
Status. [hyperlink, http://www.gao.gov/products/GAO-08-983T]. 
Washington, D.C.: July 10, 2008. 

State and Local Government Retiree Benefits: Current Funded Status of 
Pension and Health Benefits. [hyperlink, 
http://www.gao.gov/products/GAO-08-223]. Washington, D.C.: January 29, 
2008. 

State and Local Governments: Growing Fiscal Challenges Will Emerge 
during the Next 10 Years. [hyperlink, 
http://www.gao.gov/products/GAO-08-317]. Washington, D.C.: January 22, 
2008. 

State and Local Governments: Persistent Fiscal Challenges Will Likely 
Emerge within the Next Decade. [hyperlink, 
http://www.gao.gov/products/GAO-07-1080SP]. Washington, D.C.: July 18, 
2007. 

[End of section] 

Footnotes: 

[1] The "base case" simulation assumes that the tax structure is 
unchanged in the future and that the provision of real government 
services per capita remains relatively constant. 

[2] Pub. L. No. 111-5, 123 Stat. 115 (2009). In fiscal year 2011, the 
Department of the Treasury paid out $65.7 billion in Recovery Act 
funds for use in states and localities. For fiscal year 2012, GAO's 
analysis of data from CBO, Federal Funds Information for States, and 
Recovery.gov estimates that $23.3 billion in Recovery funds will be 
paid out for use in states and localities. 

[3] The fiscal gap is calculated for the years 2013 to 2062. 

[4] As noted earlier, in the "base case" simulation, we assume that 
the tax structure is not changed in the future and that the provision 
of real government services per capita remains roughly constant. 

[5] The "maintain balance" spending path shown in figure 2 is only 
illustrative. Our model assumes no economic effects from closing the 
state and local fiscal gap. Because abrupt spending declines or tax 
increases would likely have negative effects on both state and local 
governments and the economy as a whole, the adjustments needed to 
achieve fiscal balance would need to be adopted gradually. 

[6] The health-related cost growth assumption in our model includes 
adjustments in response to the March 2010 passage of the Patient 
Protection and Affordable Care Act (PPACA). See Pub. L. No. 111-148, 
124 Stat. 119 (2010), as amended by the Health Care and Education 
Reconciliation Act of 2010, Pub. L. No. 111-152, 124 Stat. 1029 
(2010). Our model assumes health care excess cost growth of about .5 
percent, based on information provided by the Centers for Medicare & 
Medicaid Services (CMS). 

[7] Our most recent prior model update is GAO, State and Local 
Governments' Fiscal Outlook: April 2011 Update, [hyperlink, 
http://www.gao.gov/products/GAO-11-495SP] (Washington, D.C.: Apr. 5, 
2011). 

[8] GAO, State and Local Government Pension Plans: Economic Downtown 
Spurs Efforts to Address Costs and Sustainability, [hyperlink, 
http://www.gao.gov/products/GAO-12-322] (Washington, D.C.: Mar. 2, 
2012). 

[9] Patient Protection and Affordable Care Act, Pub. L. No. 111-148, 
124 Stat. 119 (2010), as amended by the Health Care and Education 
Reconciliation Act of 2010, Pub. L. No. 111-152, 124 Stat. 1029 (2010). 

[10] Pub. L. No. 112-25, 125 Stat. 240 (2011). The Budget Control Act 
established limits on discretionary budget authority for the fiscal 
years 2012 through 2021. In addition, it specified additional limits 
on discretionary spending and automatic reductions in mandatory 
spending, including Medicare, which would take effect if lawmakers did 
not enact legislation originating from the Joint Select Committee on 
Deficit Reduction that would reduce projected deficits by at least 
$1.2 trillion. Because no such legislation was enacted, those 
procedures are now scheduled to go into effect. 

[11] In 2008, the most recent year data are available prior to the 
infusion of funds from the American Recovery and Reinvestment Act of 
2009 (Recovery Act), the federal government share was approximately 
58.1 percent and the state share was approximately 41.9 percent. 

[12] For additional information on the effects of Medicaid on state 
expenditures see, GAO, Prototype Formula Would Provide Automatic, 
Targeted Assistance to States During Economic Downturns, [hyperlink, 
http://www.gao.gov/products/GAO-12-38] (Washington, D.C.: Nov. 10, 
2011); GAO, Medicaid: Improving Responsiveness of Federal Assistance 
to States during Economic Downturns, [hyperlink, 
http://www.gao.gov/products/GAO-11-395] (Washington, D.C.: Mar. 31, 
2011); Recovery Act: Increased Medicaid Funds Aided Enrollment Growth, 
and Most States Reported Taking Steps to Sustain Their Programs, 
[hyperlink, http://www.gao.gov/products/GAO-11-58] (Washington, D.C.: 
Oct. 8, 2010); Medicaid Strategies to Help States Address Increased 
Expenditures during Economic Downturns, [hyperlink, 
http://www.gao.gov/products/GAO-07-97] (Washington D.C.: Oct. 18, 
2006); and Medicaid Formula: Differences in Funding Ability among 
States Often Are Widened, [hyperlink, 
http://www.gao.gov/products/GAO-03-620] (Washington, D.C.: July 10, 
2003). 

[13] The model incorporates data available after BEA's comprehensive 
revision of NIPA in July 2009 and its annual revision of NIPA in 
August 2011. 

[14] Key categories of receipts for state and local governments 
include several types of taxes (personal income, sales, property, and 
corporate), income on assets owned by the sector, and grants from the 
federal government. Categories of expenditures include wages and 
salaries of state and local employees, health insurance costs, pension 
costs, payments of social benefits (e.g., Medicaid and unemployment), 
depreciation expenses on state and local capital stock, interest 
payments on state and local financial debt, and other expenditures of 
the sector. 

[15] See Congressional Budget Office, The Budget and Economic Outlook: 
Fiscal Years 2012 to 2022 (Washington, D.C.: January 2012) and The 
Budget and Economic Outlook: An Update (Washington, D.C.: August 
2011). In Congressional Budget Office, CBO's Economic Forecasting 
Record: 2010 Update (Washington, D.C.: July 2010), CBO warns that the 
uncertainty inherent in its current forecasts exceeds the historical 
average because the current degree of economic dislocation exceeds 
that of any previous period in the past half-century. 

[16] While the model's key data sources and modifications to 
assumptions are discussed in this section of the report, a detailed 
explanation of the model's methodology is available in apps. I-IV of 
GAO, State and Local Governments: Growing Fiscal Challenges Will 
Emerge during the Next 10 Years, [hyperlink, 
http://www.gao.gov/products/GAO-08-317] (Washington, D.C.: January 
2008). 

[17] See GAO, State and Local Governments: Persistent Fiscal 
Challenges Will Likely Emerge within the Next Decade, [hyperlink, 
http://www.gao.gov/products/GAO-07-1080SP] (Washington, D.C.: July 
2007). 

[End of section] 

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