	The State and Local Government Sector Faces Increasing Fiscal Challenges

Fiscal sustainability presents a national challenge shared by all levels of  government. To provide Congress and the public with a  broader perspective on our nation’s fiscal outlook, we developed a fiscal  model of the state and local sector. This model enables us to simulate  fiscal outcomes for the entire state and local government sector in the  aggregate for several decades into the future. This model complements GAO’s long-term fiscal simulations of  federal deficits and debt levels under varying policy assumptions. We first  published the findings from our state and local fiscal model in 2007. Our model shows that the state and local government sector faces growing  fiscal challenges. We recently  updated the model to incorporate current data available as of August 2008. Rapidly Rising Health Costs Drive Long- term State and Local Sector Fiscal Difficulties

Growth in health-related costs serves as the primary driver of the fiscal  challenges facing the state and local sector over the long term. The projected rise in health- related costs is the root of the long-term fiscal difficulties these  simulations suggest will occur. Sales taxes of the sector are expected to  experience a slight decline as a percentage of GDP in the coming years,  reflecting trends in the sector’s tax base. Considerations for Targeting Supplemental Funds to States through the Medicaid Program during Economic Downturns

The outlook presented by our state and local model is exacerbated by  current economic conditions. During economic downturns, states can  experience difficulties financing programs such as Medicaid. Economic  downturns result in rising unemployment, which can lead to increases in  the number of individuals who are eligible for Medicaid coverage, and in  declining tax revenues, which can lead to less available revenue with  which to fund coverage of additional enrollees. Such a supplemental assistance strategy would leave the existing Medicaid  formula unchanged and add a new, separate assistance formula that would  operate only during times of economic downturn and use variables and a  distribution mechanism that differ from those used for calculating  matching rates. Using data from the past three recessions, we simulated the provision of  such targeted supplemental assistance to states. To determine the amount  of supplemental federal assistance needed to help states address increased  Medicaid expenditures during a downturn, we relied on research that  estimated a relationship between changes in unemployment and changes  in Medicaid spending. Considerations involved in such a strategy include:    Timing assistance so that it is delivered as soon as it is needed,    Targeting assistance according to the extent of each state’s downturn,    Temporarily increasing federal funding so that it turns off when states’  economic circumstances sufficiently improve, and    Triggering so the starting and ending points of assistance respond to  indicators of states’ economic distress. Any potential legislative response would need to be considered within the  context of broader health care and fiscal challenges—including  continually rising health care costs, a growing elderly population, and  Medicare and Medicaid’s increasing share of the federal budget. Conclusions

The federal government depends on states and localities to provide critical  services including health care for low-income populations. States and  localities depend on the federal government to help fund these services.
Why GAO Did This Study

GAO was asked to provide its views on projected trends in health care costs and their effect on the long-term outlook for state and local governments in the context of the current economic environment. This statement addresses three key points: (1) the state and local government sector's long-term fiscal challenges; (2) rapidly rising health care costs which drive the sector's long-term fiscal difficulties, and (3) the considerations involved in targeting supplemental funds to states through the Medicaid program during economic downturns. To provide Congress and the public with a broader perspective on our nation's fiscal outlook, GAO previously developed a fiscal model of the state and local sector. This model enables GAO to simulate fiscal outcomes for the sector in the aggregate for several decades into the future. GAO first published the findings from the state and local fiscal model in 2007. This statement includes August 2008 data to update the simulations. This Committee and others also asked GAO to analyze strategies to help states address increased Medicaid expenditures during economic downturns. GAO simulated the provision of such supplemental assistance to states. As we previously reported, the simulation model adjusts the amount of funding states would receive based on changes in unemployment and spending on Medicaid services.

What GAO Found

Rapidly rising health care costs are not simply a federal budget problem. Growth in health-related spending also drives the fiscal challenges facing state and local governments. The magnitude of these challenges presents long-term sustainability challenges for all levels of government. The current financial sector turmoil and broader economic conditions add to fiscal and budgetary challenges for these governments as they attempt to remain in balance. States and localities are facing increased demand for services during a period of declining revenues and reduced access to capital. In the midst of these challenges, the federal government continues to rely on this sector for delivery of services such as Medicaid, the joint federal-state health care financing program for certain categories of low-income individuals. Our model shows that in the aggregate the state and local government sector faces growing fiscal challenges. Incorporation of August 2008 data shows that the position of the sector has worsened since our January 2008 report. The long-term outlook presented by our state and local model is exacerbated by current economic conditions. During economic downturns, states can experience difficulties financing programs such as Medicaid. Downturns result in rising unemployment, which can increase the number of individuals eligible for Medicaid, and declining tax revenues, which can decrease revenue available to fund coverage of additional enrollees. GAO's simulation model to help states respond to these circumstances is based on assumptions under which the existing Medicaid formula would remain unchanged and add a new, separate assistance formula that would operate only during times of economic downturn. Considerations involved in such a strategy could include: (1) timing assistance so that it is delivered as soon as it is needed, (2) targeting assistance according to the extent of each state's downturn, (3) temporarily increasing federal funding so that it turns off when states' economic circumstances sufficiently improve, and (4) triggering so the starting and ending points of assistance respond to indicators of economic distress.