Characteristics of State Economic Downturns

States are affected differently by national recessions. States can also  experience an economic downturn not associated with a national  recession. The federal government may have an interest in providing fiscal assistance  to state and local governments during recessions because doing so could  reduce actions taken by these governments that could exacerbate the  effects of the recession. States have been affected differently during each of  these recessions. For example, unemployment rates, entry into, and exit  out of economic downturns have varied across states during past  recessions. State and Local Governments’ Revenue and Expenditure Patterns during National Recessions Reflect Variations in Economic Circumstances and Policy Choices

		State and Local Government Revenue Declines in National Recessions Vary in Magnitude, over Time, and across States

General revenues collected by state and local governments over the past  three decades are procyclical—typically increasing when the national  economy is expanding and decreasing during national recessions, relative  to their long-run trend. Revenue fluctuations during national recessions vary substantially across  states. Analysts have reported that this is due in part to states’ differing tax  structures, economic conditions, and industrial bases. State and Local Government Spending Increases during Economic Expansions and Decreases during National Recessions Relative to Long-Run Trends While Spending on Safety Net Programs Displays the Opposite Pattern

General expenditures by state and local governments are procyclical  (table 2). Furthermore, the finding that current  expenditures on health and hospitals and on public welfare tend to  increase relative to trend during recessions does not definitively indicate  the extent to which these increases are meeting increased demand during  recessions. State Governments Raise Taxes and Fees, Tap Reserves, and Use Other Budget Measures to Address Revenue Declines during National Recessions

As revenues decline and demand increases for programs such as Medicaid  and unemployment insurance during national recessions, state  governments make fiscal choices within the constraints of their available  resources. Strategies to Respond to National Recessions Require Decisions on Whether, When, and How to Provide Federal Fiscal Assistance to State and Local Governments

		GAO and Other Evaluations of Prior Federal Fiscal Assistance Strategies Identify Design Considerations Including Effective Timing and Targeting of Aid

Evaluations of prior federal fiscal assistance strategies have identified  considerations to guide policymakers as they consider the design of future  legislative responses to national recessions. Since it takes time for state and local  government revenues and service demands to return to pre-recession  levels, fiscal assistance that continues beyond the end of a recession  may help state and local governments avoid similar actions that slow  the economic recovery. Targeting—If federal fiscal assistance to state and local governments is  targeted based on the magnitude of the recession’s effect on each  state’s economy, this approach can facilitate economic recovery and  moderate fiscal distress at the state and local level. For example, policymakers could use a national  labor market indicator to begin assistance and a state-level indicator to  halt assistance. Policymakers could select indicators with the intent of responding to the  effects of a particular recession. Timely, state-level, publicly available indicators can be found primarily in  labor market data, but are also found in housing market and personal  income data. Federal responses to prior recessions have included  providing various forms of federal fiscal assistance directly to state and  local governments as well as decisions not to provide fiscal assistance in  response to national recessions. However, the Recovery Act did not allocate assistance based on  state variation in the ability to generate revenue. Objectives and Scope

The American Reinvestment and Recovery Act of 2009 (Recovery Act)  required GAO to evaluate how national economic downturns have affected  states over the past several decades. Finally, we interviewed analysts at associations and think  tanks familiar with the design and implementation of federal fiscal  assistance legislation. This includes indicators of fiscal stress, such as declines in  tax receipts or budget gaps. For example, tax receipts reflect states’ policy  choices, as states may change tax rates in response to declining revenues  able  in a recession. Depending on the specific policy strategy used, policymakers may want to  combine the indicators with other information, such as data on increased  demand for specific programs, to target assistance for specific programs or state circumstances. We contacted representatives of state and local government organizati ons  and public policy and research organizations to (1) gain insight into publicpolicy strategies and potential indicators for timing and targeting  assistance to states; (2) validate our selection of strategies and discuss  considerations for designing federal fiscal assistance to state and local  governments during national recessions; and (3) obtain views regard the feasibility and potential effects of these strategies. 1. Medicaid: Strategies to Help States Address Increased Expenditures  during Economic Downturns.
Why GAO Did This Study

The most recent recession, which started in December 2007, is generally believed to be the worst economic downturn the country has experienced since the Great Depression. In response to this recession, Congress passed the American Recovery and Reinvestment Act of 2009 (Recovery Act), which provided state and local governments with about $282 billion in fiscal assistance. The Recovery Act requires GAO to evaluate how national economic downturns have affected states since 1974. In this report, GAO (1) analyzes how state and local government budgets are affected during national recessions and (2) identifies strategies to provide fiscal assistance to state and local governments and indicators policymakers could use to time and target such assistance. This report is being released in conjunction with a companion report on Medicaid and economic downturns to respond to a related statutory requirement in the Recovery Act. GAO analyzed economic data and states' general fund budget data; reviewed past federal fiscal assistance and related evaluations; and interviewed analysts at key associations and think tanks. GAO shared relevant findings with policy research organizations and associations representing state and local officials, who generally agreed with our conclusions. We incorporated technical comments from the Bureau of Labor Statistics. GAO identifies strategies for Congress to consider but does not make recommendations in this report.

What GAO Found

Understanding state and local government revenue and expenditure patterns can help policymakers determine whether, when, where, and how they provide federal fiscal assistance to state and local governments in response to future national recessions. In general, state and local governments' revenues increase during economic expansions and decline during national recessions (relative to long-run trends). State and local revenue declines have varied during each recession, and the declines have been more severe during recent recessions. Additionally, revenue fluctuations vary substantially across states, due in part to states' differing tax structures, economic conditions, and industrial bases. State and local government spending also tends to increase during economic expansions, but spending on safety net programs, such as health and hospitals and public welfare, appears to decrease during economic expansions and increase during national recessions, relative to long-run trends. These trends can exacerbate the fiscal conditions of state and local governments given that demand for health and other safety net programs increases during recessions, and these programs now consume larger shares of state budgets relative to prior decades. This implies that, during recessions, state and local governments may have difficulties providing services. To mitigate the effect on services from declining revenues, state and local governments take actions including raising taxes and fees, tapping reserves, and using other budget measures to maintain balanced budgets. Although every recession reflects varied economic circumstances at the national level and among the states, knowledge of prior federal responses to national recessions provides guideposts for policymakers to consider as they design strategies to respond to future recessions. Considerations include (1) Timing assistance so that the aid begins to flow as the economy is contracting, although assistance that continues for some period beyond the recession's end may help these governments avoid actions that slow economic recovery; (2) Targeting assistance based on the magnitude of the recession's effects on individual states' economic distress; and (3) Temporarily increasing federal funding (by specifying the conditions for ending or halting the state and local assistance when states' economic conditions sufficiently improve). Policymakers also balance their decision to provide state and local assistance with other federal policy considerations such as competing demands for federal resources. Policymakers can select indicators to identify when the federal government should start and stop providing aid, as well as how much aid should be allocated. Timely indicators are capable of distinguishing states' economic downturns from economic expansions. Indicators selected for targeting assistance are capable of identifying states' individual circumstances in a recession. In general, timely indicators capable of targeting assistance to states can be found primarily in labor market data. Indicators such as employment, unemployment, hourly earnings, and wages and salaries also offer the advantage of providing information on economic conditions rather than reflecting states' policy choices (a limitation of data on state revenue trends). In some cases, it may be appropriate for policymakers to select multiple indicators or select indicators to reflect their policy goals specific to a particular recession. States have been affected differently during each of these recessions. For example, unemployment rates, entry into, and exit out of economic downturns have varied across states during past recessions. Federal responses to prior recessions have included various forms of federal fiscal assistance to these governments as well as decisions not to provide direct fiscal assistance to these governments.