State and Local Governments:

Persistent Fiscal Challenges Will Likely Emerge within the Next Decade

GAO-07-1080SP: Published: Jul 18, 2007. Publicly Released: Jul 18, 2007.

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For over a decade GAO has run long-term simulations showing that absent a change in policy, the combined effects of demographic changes and growing health care costs drive ever-increasing federal deficits and debt levels. The Comptroller General has repeatedly warned that the current fiscal path of the federal government is "imprudent and unsustainable". State and local governments provide an array of services to their residents, and the federal government relies on these governments to assist in the realization of national goals. State and local governments also rely on federal grants to varying extents. These subnational governments may also face fiscal stress. To provide Congress and the public with a broader national context, GAO has developed a fiscal model of the state and local sector. The GAO state and local model projects the level of receipts and expenditures of the sector in future years based on current and historical spending and revenue patterns. In the "base case" model we assume that the current set of policies in place across federal, state, and local governments remains constant. The primary data source for the model is the National Income and Product Accounts. The timeframe for the simulations parallels that of our federal fiscal model--the simulations extend until 2050. The state and local model examines the aggregate fiscal outcomes for the sector and does not examine the condition of any individual state or local government.

Our simulations for the state and local government sector indicate that in the absence of policy changes, large and growing fiscal challenges for the sector will begin to emerge within the next few years. We measure this gap in two ways. In one case we examine, for a given year, all receipts--including grants from the federal government for infrastructure projects--and all expenditures--including not only operating expenditures but also expenditures on such items as investments in buildings and roads. This provides a balance measure similar to the federal unified budget. While historically, total expenditures have usually exceeded total receipts--and the sector therefore issues debt to cover part of the cost of its capital projects--the simulations suggest that the size of the gap will exceed the historical range starting within the next decade. Unlike the federal government, most states have some sort of requirement for balancing their operating budgets, which do not include budgeting for longer-term investments. Therefore, we also examine a second case in which we evaluate a balance measure that we call an operating balance. Our definition of the operating balance is receipts available to fund current expenditures minus current expenditures. These receipts usually have exceeded current expenditures. But the simulation suggests that within the next decade current expenditures will outstrip available receipts resulting in a deficit (e.g., a negative operating balance). This deficit--worsening throughout the projection timeframe under an unchanged policy scenario--indicates that state and local governments will need to make tough choices on spending and tax policy to meet their budget requirements and to promote favorable bond ratings.

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