State and local tax revenues have declined, expenditures for social insurance programs have increased, and federal assistance has begun to recede as federal aid related to the American Recovery and Reinvestment Act (ARRA) expires. Part of this concern has focused on debt issued by state and local governments. More generally, Congress has also held several hearings on policies addressing the fiscal health of state and local governments. The relative safety of state and local government debt and the federal income tax exclusion on interest payments on state and local bonds has created a strong demand for state and local government debt. The discussion relies on data provided publicly by the Federal Reserve Board and U.S. Bureau of the Census and attempts to establish the current debt position of state and local governments and how it has changed over time. State and Local Government Finances: 2002 to 2009

The recession that began in December 2007 and ended June 2009 created significant fiscal strain on state and local governments. These levels reflect a change in the mix of funding sources. Payments for already retired or separated workers are a significantly larger expense ($191 billion in FY2009). Currently, states are preparing the FY2012 budgets and are anticipating the need to increase revenue and reduce expenditures to replace the lost federal aid. As shown in Figure 6 (and Table A-3 ), state and local debt ranged from $2.4 billion in Wyoming to $373.7 billion in California. Economics of State and Local Government Debt

The use of public debt has important economic consequences that extend beyond the comparative metrics presented in this report. As such, the economic impact of state and local government debt issuance is generally perceived as of congressional interest as is the role of the federal government in either promoting or impeding the issuance of state debt. The latest estimate of the federal tax expenditure for tax-exempt state and local government debt is $177.6 billion over the 2011 to 2015 forecast window. Congress has recently held hearings examining the fiscal health of state and local governments and has offered legislation in two areas related to state and local fiscal health analyzed in this report: government debt and government pensions. In response, Congress may seek to increase oversight of the municipal bond market.
The financial consequences of the recession that spanned from December 2007 through June 2009 have increased congressional interest in the fiscal health of state and local governments. State and local tax revenues declined, expenditures climbed, and debt increased. Even though tax revenue has begun to rebound, expenditures for unemployment benefits and other social programs remain elevated. Also, federal aid to states, which had increased as part of the American Recovery and Reinvestment Act, has receded. Federal outlays for grants in aid to state and local governments rose from $538 billion in FY2009 to $608.4 billion in FY2010 and are estimated to be $625.2 billion in FY2011. The FY2012 budget provides $584.3 billion in outlays for aid to state and local governments in 2012.
In response to these state and local government fiscal headwinds, several hearings were held in the first session of the 112th Congress to examine the health of state and local government finances and the potential effects on the economic recovery. The hearings focused on a range of issues important to state and local governments as well as federal policy makers. The role of state and local government debt was one of these issues. The federal government has a significant stake in this debt market, as the tax expenditure for tax-exempt bonds issued by state and local governments was recently estimated to be $161.6 billion over the 2010 to 2014 budget window.
This report first provides a broad overview of state and local government finances and how these governments incorporate borrowing into their budgets. The second section reports data on state and local government debt and how that debt has changed over time. This section includes a comparative analysis of these debt parameters for each state. The third section discusses different economic perspectives on the use of debt by governments and if governments are intrinsically biased toward borrowing more than is considered economically optimal. The discussion provides background for Congress as it deliberates potential changes in the oversight of the primary and secondary markets for state and local government debt.
Issues related to state and local government finances, such as government pensions and health benefits, are also addressed. This report will be updated as legislative events warrant.