GAO 

United States Government Accountability Office

Report to the Congress 

STATE AND LOCAL 

GOVERNMENTS’ 

FISCAL OUTLOOK 

March 2010 Update 

March 2010 

GAO-10-358 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

March 2010

STATE AND LOCAL GOVERNMENTS’ FISCAL 

OUTLOOK 

March 2010 Update 

Highlights of GAO-10-358 , a report to the 

Congress 

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 National Income and 

Product Accounts (NIPA) as the 

primary data source, GAO’s model 

projects the level of receipts and 

expenditures for the sector until 

2060 based on current and 

historical spending and revenue 

patterns. GAO assumes the current 

set of policies in place across 

federal, state, and local 

governments remains constant. 

This update incorporates NIPA 

data including increased federal 

grant funding made available to the 

sector through the American 

Recovery and Reinvestment Act of 

2009. The model simulates the longterm fiscal outlook for the state 

and local sector as a whole and, 

while the model incorporates the 

Congressional Budget Office’s 

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 longterm fiscal challenges. Related 

products can be found at 

http://www.gao.gov/special.pubs/lo

ngterm/. 

The state and local government sector continues to face near- and longterm fiscal challenges which grow over time. Although the sector’s nearterm operating balance remains negative, increases in federal grants-inaid—largely from the Recovery Act—alleviated some near-term pressure. 

As shown in the insert to the figure below, the March 2010 operating 

balance measure (including 2009 Recovery Act funds) shows an 

improvement compared to the January 2009 simulation. In the near-term, 

the sector’s fiscal position can be attributed to several factors, including 

steep revenue declines. 

GAO projects that the sector’s long-term fiscal position will steadily 

decline through 2060 absent any policy changes, as shown in figure 1. The 

decline in the sector’s operating balance is primarily driven by rising 

health care costs. The fiscal challenges confronting the state and local 

sector add to the nation’s overall fiscal difficulties. Because most state and 

local governments are required to balance their operating budgets, the 

declining fiscal conditions shown in GAO’s simulations suggest the fiscal 

pressures the sector faces and the extent to which these governments will 

need to make substantial policy changes to avoid growing imbalances. 

State and Local Operating Balance Measure, as a Percentage of Gross Domestic Product

-6

-5

-4

-3

-2

-1

0

1

2

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060

Percentage of GDP

Source: GAO simulations, updated March 2010 and January 2009 adjusted.

Year

-1.0

-0.8

-0.6

-0.4

-0.2

0

0.2

2008 2009 2010 2011 2012 2013

Percentage of GDP

Deficit 

(Negative balance)

Surplus 

(Positive balance)

Insert magnifying near-term fiscal position

March 2010

January 2009 

adjusted

Operating balance March 2010 Operating balance January 2009 adjusted

Notes: The operating balance is a measure of the sector’s ability to cover its current expenditures out 

of current receipts. Historical data are from the Bureau of Economic Analysis’s NIPA accounts from 

1980 to 2008. Data in 2009 are GAO estimates aligned with published data where available. GAO 

simulations are from 2010 to 2060, using many Congressional Budget Office projections and 

assumptions, particularly for the next 10 years. Simulations are based on current policy. 

View GAO-10-358 or key components.

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. 
Page i GAO-10-358 

Contents 

Letter 1

Infusion of Recovery Act Funds Helped State and Local 

Governments Address Budget Gaps in the Near-Term 2 

State and Local Sector Continues to Face Long-Term Fiscal 

Challenges Driven by Growing Health Care Costs 8 

Appendix I Scope and Methodology 15 

Appendix II GAO Contacts and Staff Acknowledgments 19 

Table 

Table 1: Modifications to Assumptions for March 2010 Update 16 

Figures 

Figure 1: State and Local Operating Balance Measure, as a 

Percentage of Gross Domestic Product 3 

Figure 2: State and Local Government Taxes, as a Percentage of 

Gross Domestic Product 5 

Figure 3: State and Local Government Current Receipts by 

Category, 2008 6 

Figure 4: State and Local Government Grants, as a Percentage of 

Gross Domestic Product 7 

Figure 5: Extent of State and Local Government Action Required to 

Maintain Balance (State and Local Expenditures, as a 

Percentage of Gross Domestic Product) 9 

Figure 6: Health and Non-Health Expenditures of State and Local 

Governments, as a Percentage of Gross Domestic Product 11 

Figure 7: Federal and State/Local Surpluses and Deficits, as a 

Percentage of Gross Domestic Product 13 

 State and Local Governments' Fiscal Outlook 
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Page ii GAO-10-358 State and Local Governments' Fiscal Outlook
Page 1 GAO-10-358 

 

United States Government Accountability Office

Washington, DC 20548 

 

March 2, 2010 

Report to the Congress 

Fiscal sustainability presents a national challenge shared by all levels of 

government. Recent economic events and state and local government 

efforts to maintain balance during the current recession have called 

attention to the immediate challenges facing these governments. The 

recession has substantially reduced states’ and local governments’ 

combined tax revenues. These immediate challenges exist alongside 

daunting long-term fiscal challenges for all levels of government. 

For almost two decades, 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.1

 Under the authority of the Comptroller General, GAO began 

publishing long-term fiscal simulations for the state and local government 

sector in 2007. This report updates GAO’s state and local fiscal model for 

the purposes of (1) analyzing the near-term effects of the recent economic 

downturn on the sector and (2) assessing the long-term outlook of the 

sector and identifying the key drivers of this outlook. 

Using the U.S. Bureau of Economic Analysis’s National Income and 

Product Accounts (NIPA) as the primary data source, our model projects 

the level of receipts and expenditures for the sector until 2060 based on 

current and historical spending and revenue patterns. We assume the 

current set of policies in place across federal, state, and local governments 

remains constant. This update incorporates NIPA data including increased 

federal grant funding made available to the sector through the American 

Recovery and Reinvestment Act of 2009 (Recovery Act). 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 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. Also, the model does 

1

See GAO, The Federal Government’s Long-Term Fiscal Outlook: January 2010 Update, 

GAO-10-468SP (Washington, D.C.: March 2010). This and related products can be found at 

http://www.gao.gov/special.pubs/longterm/. 

 State and Local Governments' Fiscal Outlook 
 

not identify whether the state or local government sector faces greater 

challenges. For additional information on the model’s key assumptions, 

see Appendix I. 

In summary, this March 2010 update to our model shows that the state and 

local government sector continues to face near-term budget and long-term 

fiscal challenges which grow over time. Although the sector’s near-term 

operating balance remains negative, increases in federal grants-in-aid—

largely from the Recovery Act—alleviated some near-term pressure. In the 

near-term, declines in the sector’s fiscal position are attributable to several 

factors, including steep revenue declines. 

In the long-term, we project that the fiscal position will steadily decline 

through 2060 absent any policy changes. The decline in the sector’s 

operating balance is primarily driven by rising health care costs. The fiscal 

challenges confronting the state and local sector add to the nation’s 

overall fiscal difficulties. Because most state and local governments are 

required to balance their operating budgets, the declining fiscal conditions 

shown in our simulations suggest the fiscal pressures the sector faces and 

foreshadow the extent to which these governments will need to make 

substantial policy changes and other adjustments to avoid growing fiscal 

imbalances. 

This March 2010 update to our model shows that the state and local 

government sector faces near-term declines in its operating balance 

(figure 1).2

 These declines in the sector’s fiscal position are attributable to 

several factors, including a reduction in projected tax receipts. An 

increase in federal grants-in-aid—largely from the Recovery Act—has 

helped state and local governments address fiscal challenges in the nearterm.3

 As shown in the insert to the figure below, the March 2010 operating 

balance measure (which includes the 2009 Recovery Act funds) shows an 

improvement compared to the January 2009 simulation. 

Infusion of Recovery 

Act Funds Helped 

State and Local 

Governments Address 

Budget Gaps in the 

Near-Term 

 

2

In figure 1, we use the term “January 2009 Adjusted” to refer to the results of our model 

published in GAO, Update of State and Local Government Fiscal Pressures, GAO-09-320R 

(Washington, D.C.: Jan. 26, 2009), which we adjusted to reflect the effect of reduced oil 

prices on the sector’s expenditures. “March 2010” refers to the results of our most recent 

simulation, published in this report. See table 1 for a description of adjustments made to 

our simulations since the January 2009 report. 

3

Pub. L. No. 111-5, 123 Stat. 115 (Feb. 17, 2009). 

Page 2 GAO-10-358 State and Local Governments' Fiscal Outlook
 

Figure 1: State and Local Operating Balance Measure, as a Percentage of Gross Domestic Producta

-6

-5

-4

-3

-2

-1

0

1

2

1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060

Percentage of GDP

Source: GAO simulations, updated March 2010 and January 2009 adjusted.

Year

Operating balance March 2010

Operating balance January 2009 adjusted

-1.0

-0.8

-0.6

-0.4

-0.2

0

0.2

2008 2009 2010 2011 2012 2013

Percentage of GDP

Deficit 

(Negative balance)

Surplus 

(Positive balance)

Insert magnifying near-term fiscal position

March 2010

January 2009 

adjusted

Notes: Historical data are from the Bureau of Economic Analysis’s National Income and Product 

Accounts from 1980 to 2008. Data in 2009 are GAO estimates aligned with published data where 

available. GAO simulations are from 2010 to 2060, using many Congressional Budget Office 

projections and assumptions, particularly for the next 10 years. Simulations are based on current 

policy. 

a

Data for this and other figures in this report can be downloaded at 

http://www.gao.gov/special.pubs/longterm/data.html. 

The model uses the operating balance as a measure of fiscal balance for 

the sector for each year until 2060.4

 As illustrated in figure 1, the operating 

balance generally was positive in the past except during and after recent 

 

4

The operating balance is a measure of the sector’s ability to cover its current expenditures 

out of current receipts. 

Page 3 GAO-10-358 State and Local Governments' Fiscal Outlook
 

recessions. This suggests that, in the aggregate, the sector had been able to 

cover its expenses with incoming receipts. 

The model results in near-term projected deficits, even after the inclusion 

of updated NIPA data which reflect Recovery Act grant funds received by 

state and local governments.5

 Specifically, the model estimates operating 

deficits for the state and local sector of about $39 billion for 2010 and $124 

billion for 2011. The cumulative two-year projected operating deficit is 

estimated to total approximately $163 billion for 2010 and 2011.6

 These 

results confirm our recent finding that while states’ near-term revenue 

shortfalls have been cushioned by the temporary infusion of Recovery Act 

funds, states will continue to be fiscally stressed.7

One of the factors contributing to the model’s projected near-term deficits 

is the sector’s decline in some tax receipt categories, as illustrated in 

figure 2. Total tax receipts for the sector declined from about 9.25 percent 

of GDP in 2008 to 8.80 percent of GDP in 2009. We project a slight increase 

in total tax receipts to 8.82 percent of GDP in 2010.8

 Personal income tax 

receipts declined from about 2.3 percent of GDP in 2008 to 1.9 percent in 

2009. We project that these receipts will increase as a share of GDP 

beginning in 2009. As a percentage of GDP, state and local personal 

income tax declines exceeded revenue shifts from sales and property tax. 

 

5

While most states have requirements related to balancing their budgets, deficits might 

arise because of unanticipated events such as recessions. These cyclical deficits can occur 

because the planned annual revenues are not generated at the expected rate, demand for 

services exceeds planned expenditures, or both, thus resulting in a near-term or cyclical 

operating deficit. 

6

These estimates do not attempt to assume forthcoming policy actions by federal, state or 

local governments and are based on analysis of historical data. Actual amounts will reflect 

policy actions taken by state and local governments to balance their budgets. Years are 

calendar years. 

7

See GAO, Recovery Act: Status of States’ and Localities’ Use of Funds and Efforts to 

Ensure Accountability, GAO-10-231 (Washington, D.C.: Dec. 10, 2009); and GAO, Recovery 

Act: Funds Continue to Provide Fiscal Relief to States and Localities, While 

Accountability and Reporting Challenges Need to Be Fully Addressed, GAO-09-1016 

(Washington, D.C.: Sept. 23, 2009). See also National Governors Association and National 

Association of State Budget Officers, The Fiscal Survey of States (Washington, D.C.: Dec. 

2009); National Association of Counties, How are Counties Doing? An Economic Status 

Survey (Washington, D.C.: Nov. 2009); and National League of Cities, Research Brief on 

America’s Cities, City Fiscal Conditions in 2009 (Washington, D.C.: Sept. 2009). 

8

We use historical data from BEA NIPA from 1980 to 2008. Data in 2009 are GAO estimates 

based on data available through the third quarter of 2009. GAO projections are from 2010 to 

2060. 

Page 4 GAO-10-358 State and Local Governments' Fiscal Outlook
 

Property tax receipts as a percentage of GDP increased from about 2.8 

percent in 2008 to about 3.0 percent in 2009. While property taxes 

increased as a percentage of GDP, property tax receipts increased just 2.7 

percent—from about $411 billion in 2008 to $422 billion in 2009, the lowest 

annual increase since 1995. In addition, GDP decreased 1.3 percent—from 

about $14.4 trillion to about $14.3 trillion during the same period. We 

project that property tax receipts will continue to be about 3.0 percent of 

GDP through 2015. 

Figure 2: State and Local Government Taxes, as a Percentage of Gross Domestic 

Product 

Sales tax

Property tax

Personal income tax

Year

Percentage of GDP

Source: GAO simulations, updated March 2010.

0

1

2

3

4

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Notes: Historical data are from the Bureau of Economic Analysis’s National Income and Product 

Accounts from 1980 to 2008. Data in 2009 are GAO estimates aligned with published data where 

available. GAO simulations are from 2010 to 2060, using many Congressional Budget Office 

projections and assumptions, particularly for the next 10 years. Simulations are based on current 

policy. 

The state and local government sector’s receipts in 2008 totaled almost $2 

trillion. As illustrated in figure 3, 68 percent—or about $1.3 trillion in 

2008—of the sector’s receipts are comprised of tax receipts, including 

personal income, sales, and property taxes. Federal grants-in-aid comprise 

Page 5 GAO-10-358 State and Local Governments' Fiscal Outlook
 

the second largest source of receipts for the sector, providing about $39

billion to the sector. In 2008, the sector had about $246 billion in other 

receipts, inc

2 

luding income on assets and contributions for government 

insurance. 

Figure 3: State and Local Government Current Receipts by Category, 2008

12%

20%

68%

Source: GAO analysis of NIPA data.

Other receipts

Federal grants-in-aid

Current tax receipts

Notes: Other receipts includes income on assets, contributions for government insurance, surplus 

om government enterprises, and transfer receipts from businesses and persons. 

e of GDP 

cted to 

 

fr

In the near-term, federal grants-in-aid—which in 2009 included funding 

from the Recovery Act—helped offset the sector’s tax receipt declines. 

Medicaid and other federal grants are projected to grow as a shar

through 2010 (figure 4).9

 After 2010, the model projects that as a 

percentage of GDP, Medicaid grants will decline through 2012 and then 

begin to increase. Other federal grants—including those for education, 

highways, weatherization, housing, and other programs—are proje

9

Medicaid is a joint federal-state program that finances health care for certain categories of 

low-income individuals, including children, families, persons with disabilities, and persons 

who are elderly. The federal government provides assistance to states (known as the 

Federal Medical Assistance Percentage, or FMAP) for Medicaid services according to a 

formula based on each state’s per capita income in relation to the national average per 

capita income. Under the Recovery Act, states are eligible for an increased FMAP for 

expenditures that states make in providing services to their Medicaid populations. The 

Recovery Act provides eligible states with this increased FMAP for 27 months between 

October 1, 2008, and December 31, 2010. 

Page 6 GAO-10-358 State and Local Governments' Fiscal Outlook
 

decline as a percentage of GDP after 2010, consistent with CBO’s 

assumptions. 

Figure 4: State and Local Government Grants, as a Percentage of Gross Domestic 

Product 

Note: H

Medicaid grants

Other grants

Year

Percentage of GDP

Source: GAO simulations, updated March 2010.

0

1

1.5

2

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

istorical data are from the Bureau of Economic Analysis’s National Income and Product 

ccounts from 1980 to 2008. Data in 2009 are GAO estimates aligned with published data where 

vailable. GAO simulations are from 2010 to 2060, using many Congressional Budget Office 

rojections and assumptions, particularly for the next 10 years. Simulations are based on current 

policy. 

A

a

p

Page 7 GAO-10-358 State and Local Governments' Fiscal Outlook
 

The fiscal challenges confronting the state and local sector add to the 

nation’s overall fiscal difficulties. As we have reported in previous model 

updates, and as shown in figure 1 above, the sector faces growing longterm fiscal challenges.10 We project that the fiscal position of the sector 

will steadily decline through 2060 absent any policy changes.11 The decline 

in the sector’s operating balance is primarily driven by rising health care 

costs. Because most state and local governments are required to balance 

their operating budgets, the declining fiscal conditions shown in our 

simulations suggest the fiscal pressures the sector faces and foreshadow 

the extent to which these governments will need to make substantial 

policy changes to avoid growing fiscal imbalances. 

State and Local Sector 

Continues to Face 

Long-Term Fiscal 

Challenges Driven by 

Growing Health Care 

Costs 

One way of measuring the long-term challenges faced by the state and 

local sector is through a measure known as the “fiscal gap.” The fiscal gap 

is an estimate of the action needed today and maintained for each and 

every year to achieve fiscal balance over a certain period. We measured 

the gap as the amount of spending reduction or tax increase needed to 

prevent operating deficits (or negative operating balances). As shown in 

figure 5, we calculated that closing the fiscal gap would require action to 

be taken today and maintained for each and every year going forward 

equivalent to a 12.3 percent reduction in state and local government 

current expenditures. Closing the fiscal gap through revenue increases 

would require action of a similar magnitude through increased state and 

local tax receipts. 

 

10The most recent prior update is GAO, Update of State and Local Fiscal Pressures, 

GAO-09-320R (Washington, D.C.: Jan. 26, 2009). See also GAO, State and Local Fiscal 

Challenges: Rising Health Care Costs Drive Long-term and Immediate Pressures, 

GAO-09-210T (Washington, D.C.: Nov. 19, 2008). 

11The explicit definition of our 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. 

Page 8 GAO-10-358 State and Local Governments' Fiscal Outlook
 

Figure 5: Extent of State and Local Government Action Required to Maintain Balance (State and Local Expenditures, as a 

Percentage of Gross Domestic Product) 

Percentage of GDP

Source: GAO simulations, updated March 2010.

Year

0

14

16

18

20

22

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060

Base case

Maintain balance

Note: Historical data are from the Bureau of Economic Analysis’s National Income and Product 

Accounts from 1980 to 2008. Data in 2009 are GAO estimates aligned with published data where 

available. GAO simulations are from 2010 to 2060, using many Congressional Budget Office 

projections and assumptions, particularly for the next 10 years. Simulations are based on current 

policy. In the “base case” model 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. That is, a basic 

assumption of our model is that the current set of policies in place across state and local government 

remains constant. 

The primary driver of fiscal challenges for the state and local government 

sector continues to be the growth in health-related costs. Specifically, 

state and local expenditures on Medicaid and the cost of health insurance 

for state and local retirees and employees are projected to grow more than 

Page 9 GAO-10-358 State and Local Governments' Fiscal Outlook
 

GDP.12 The model also projects that the sector’s health-related costs will 

be about 3.5 percent of GDP in 2010 and 3.8 percent of GDP in 2011. In 

contrast, we found that other types of state and local government 

expenditures—including wages and salaries of state and local workers and 

investments in capital goods—are expected to grow slightly less than 

GDP. We also found that revenue growth, excluding Medicaid grants from 

the federal government, is projected to be relatively flat as a percentage of 

GDP. As such, the projected rise in health-related costs is the root of the 

fiscal difficulties these simulations suggest will occur. Our simulations for 

health-related and other expenditures are shown in figure 6.13

 

12One of the most central assumptions we must make to estimate the pay-as-you-go health 

expenditures for employees and retirees in future years is the cost growth of health care. 

The extent to which the per-person cost of health care is expected to grow beyond GDP 

per capita is called the “excess cost factor.” We estimate the excess cost factor using 

unpublished data from the Centers for Medicare & Medicaid Services’ (CMS) Office of the 

Actuary. Between 2008 and 2009, CMS reduced its assumption for average annual excess 

cost growth during 2010-2080 from 1.3 percent to 0.8 percent, which we incorporated into 

our model. This reduced the growth in our Medicaid and employee and retiree health 

spending projections from our January 2009 simulation. 

13Interest payments that these governments will need to pay on their outstanding debt will 

also likely be a rising expense for the sector in the future. Rising interest costs are merely a 

reflection of the sustained deficits the model predicts across future years. 

Page 10 GAO-10-358 State and Local Governments' Fiscal Outlook
 

Figure 6: Health and Non-Health Expenditures of State and Local Governments, as a Percentage of Gross Domestic Product 

0

2

4

6

8

10

12

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060

Percentage of GDP

Source: GAO simulations, updated March 2010.

Year

 Non-health care expenditures

 Health care expenditures

Note: Historical data are from the Bureau of Economic Analysis’s National Income and Product 

Accounts from 1980 to 2008. Data in 2009 are GAO estimates aligned with published data where 

available. GAO simulations are from 2010 to 2060, using many Congressional Budget Office 

projections and assumptions, particularly for the next 10 years. Simulations are based on current 

policy. 

Recent declines in pension asset values stemming from the current 

recession could also affect the sector’s long-term fiscal position. The 

sector experienced a decline in pension asset values of 27.6 percent—from 

$3.2 trillion at the end of 2007 to $2.3 trillion at the end of 2008. Our March 

2009 estimate of the sector’s required contribution rate rose to 9.9 percent 

of the sector’s wages, which is higher than the sector’s actual 8.3 percent 

of wages contributed in 2008. While governments can postpone increasing 

the annual contribution rate, postponing action could increase the rate 

needed to fully fund pensions. In addition to declines in pension asset 

values and the challenge of fully funding pension benefits, state and local 

Page 11 GAO-10-358 State and Local Governments' Fiscal Outlook
 

governments also face challenges funding their liabilities for other public 

employee benefits (which are primarily retiree health benefits).14

Similar to these state and local model findings, our most recent long-term 

federal model simulations continue to show health spending as one of the 

key drivers of long-term, unsustainable structural deficits.15 As we, the 

CBO, and others have previously reported, the continued rise in health 

care costs poses challenges to not only the budgets of federal, state, and 

local governments, but also to American businesses, families, and societies 

as a whole. Figure 7 shows two simulations for the federal fiscal path 

under alternative assumptions and overlays the simulated fiscal imbalance 

of the state and local government sector. The overlay of the state and local 

government model’s simulations in both the baseline and alternative 

scenarios shows that state and local governments’ fiscal challenges 

impose further fiscal challenges on the nation’s economy in the next 

several decades. 

 

14See GAO, State and Local Government Retiree Health Benefits: Liabilities Are Largely 

Unfunded, but Some Governments Are Taking Action, GAO-10-61 (Washington, D.C.: Nov. 

30, 2009). Most state and local governments pay for employee and retiree health insurance 

on a pay-as-you-go basis—that is, these benefits are generally not prefunded. To estimate 

expenditures for employee and retiree health insurance in future years, we assume that the 

same percentage of employees and retirees of state and local governments will be enrolled 

in health insurance through their previous employer as we observe were enrolled in 2005. 

The Agency for Healthcare Research and Quality updated its Medical Expenditure Panel 

Survey (MEPS) data in the fall of 2009 covering the period through 2008, which we have 

incorporated into this update. 

15GAO-10-468SP 

Page 12 GAO-10-358 State and Local Governments' Fiscal Outlook
 

Figure 7: Federal and State/Local Surpluses and Deficits, as a Percentage of Gross Domestic Product 

-50

-40

-30

-20

-10

0

10

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060

Percentage of GDP

Source: Historical data from NIPA and GAO analysis.

Year

Alternative: federal, state, and local

Alternative: federal only

Baseline extended: federal, state, and local

Baseline extended: federal only

Deficit 

(Negative balance)

Surplus 

(Positive balance)

Note: Historical data are from the Bureau of Economic Analysis’s National Income and Product 

Accounts from 1980 to 2008. Data in 2009 are GAO estimates aligned with published data where 

available. GAO simulations are from 2010 to 2060, using many Congressional Budget Office 

projections and assumptions, particularly for the next 10 years. The state and local balance measure 

is similar to the federal unified budget measure. The baseline simulation uses CBO projections and 

assumes that taxes and expenditures during the next 10 years are in line with current law. The 

alternative simulation assumes expiring tax provisions are extended and that discretionary spending 

grows with GDP. 

Our federal baseline simulation uses CBO projections for the next 10 years 

and assumes that taxes and expenditures during this time period are in 

line with current law. For example, we assume that a variety of federal tax 

provisions—mostly tax reductions—that are set to expire are allowed to 

expire, and that discretionary expenditures of the federal government 

grow with inflation. After the first 10 years, we use the Social Security and 

Medicare Trustees’ 75-year intermediate estimates for those programs and 

CBO’s mid-range Medicaid estimates. All other expenditures, as well as 

receipts, are held constant as a share of GDP after the first 10 years. 

Page 13 GAO-10-358 State and Local Governments' Fiscal Outlook
 

Our alternative federal simulation assumes that during the next 10 years, 

expiring tax provisions are extended and that federal discretionary 

spending grows with GDP—a faster pace than inflation. After the 10-year 

timeframe, we assume that action is taken to return revenue to its 

historical share of GDP. The alternative simulation also incorporates 

somewhat higher Medicare estimates reflecting historical trends that 

physician payments are not reduced as specified under current law. 

We conducted our work for this model update from August 2009 to March 

2010 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. 

We are sending copies of this report to interested congressional 

committees. The report is part of a body of work on the long-term fiscal 

challenge and is available free of charge at 

http://www.gao.gov/special.pubs/longterm/. 

If you or your staffs have any questions about this report, please contact 

Stanley J. Czerwinski at (202) 512-6806 or czerwinskis@gao.gov or Thomas 

J. McCool at (202) 512-2700 or mccoolt@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on the 

last page of this report. GAO staff who made major contributions to this 

report are listed in appendix II. 

Stanley J. Czerwinski 

Thomas J. McCool 

Director, Strategic Issues 

Director, Center for Economics 

Page 14 GAO-10-358 State and Local Governments' Fiscal Outlook
Appendix I: Scope and Methodology Appendix I: Scope and Methodology 

To answer our two reporting objectives, we incorporated updated data 

into and analyzed output from GAO’s State and Local Fiscal Model. While 

the model’s key data sources and assumptions are summarized below, a 

detailed explanation of the model’s methodology is available in 

Appendices I-IV of GAO, State and Local Governments: Growing Fiscal 

Challenges Will Emerge During the Next 10 Years, GAO-08-317 

(Washington, D.C.: January 2008). 

Using the National Income and Product Accounts prepared by the U.S. 

Bureau of Economic Analysis as a primary data source, our state and local 

model projects the level of receipts and expenditures for the sector in 

future years based on current and historical spending and revenue 

patterns.1

 To develop these long-run simulations, we make projections for 

each major receipt and expenditure category of the state and local 

government sector in future years. We project the growth in each category 

of receipts and expenditures using CBO’s economic assumptions 

whenever possible.2

 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. 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. Our model assumes current policies 

remain in place. Since our last simulation in January 2009, we have made 

several adjustments to the model in light of recent economic events, as 

summarized in table 1. 

 

1

The model incorporates data available after BEA’s comprehensive revision of the NIPA in 

July 2009. 

2

In Congressional Budget Office, CBO’s Economic Forecasting Record: 2009 Update 

(Washington, D.C.: July 2009), 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.

Page 15 GAO-10-358 State and Local Governments' Fiscal Outlook 
Appendix I: Scope and Methodology 

Table 1: Modifications to Assumptions for March 2010 Update 

Variable Previous assumptions Updated assumptions 

State and local 

consumption excluding 

employee compensation 

and capital 

consumption—or “other 

consumption” (GSLCO) 

Other consumption expenditures grow with 

population plus inflation. In our January 2009 

simulations, we adjusted the projected 2008 

value of this variable upward because 

energy price increases raised other 

consumption expenditures far more than the 

growth of population plus inflation. 

In 2009, oil prices fell greatly, and the level of other 

consumption expenditures was below the level our standard 

assumption implies. In 2010 we increased this spending 

category to its 2000-2007 average as a share of GDP. 

Thereafter, we let other consumption expenditures grow 

with population plus inflation as per our standard 

assumption. 

In figure 1, we adjusted the January 2009 simulation (now 

labeled January 2009 adjusted) to incorporate the same 

assumptions for this spending category. Specifically, we 

used the same percentage of GDP for other consumption in 

the January 2009 adjusted simulation as we are using in the 

March 2010 simulation. This adjustment for years 2008, 

2009, and 2010 removes the over-prediction of other 

consumption caused by our assumption in January 2009 

that the 2008 historical peak in consumption expenditures 

was permanent rather than temporary. 

Total state and local 

government retirement 

fund assets 

(L1TOTALFA) 

In previous updates, we used the last yearend historical value of pension fund assets, 

along with other elements, to calculate the 

contribution that governments must make to 

fully fund employee pension benefits.a 

Because asset values can exhibit substantial volatility, 

governments typically use smoothed asset values in their 

pension funding calculations. Accordingly, in this update, we 

use the average value of pension fund assets over the 

previous five years to calculate the contribution rate needed 

to fully fund pensions. Even though this smoothing 

somewhat dampens the effect of the recent drop in asset 

values, that drop still raises our estimate of the required 

contribution rate significantly from previous estimates. 

Medium and long-term 

municipal securities 

outstanding (DBTGSLLT) 

The model’s estimate of state and local 

governments’ issuance of medium- and longterm debt depends on the difference 

between capital acquisitions and federal 

investment grants, municipal bond rates, and 

a first-order autoregressive error term, which 

adjusts the current year’s estimate by some 

portion of the amount by which the equation 

over- or under-estimated the previous year’s 

value. 

Because an anomalously low amount of debt was issued in 

2008, the year before the first projection year, the model 

under-predicted the change in debt in the early projection 

years. This overstated the model’s estimate for the 

operating deficit because it implies a greater portion of 

general revenues must be used to finance investment rather 

than operating expenditures.b

 To address this issue, we now 

generate projections for debt issuance by excluding the 

autoregressive error term, which produces debt issuance 

values closer to general historical trends. 

Employment cost 

indexes for private wages 

and salaries (JECIWSP) 

and state and local 

government wages and 

salaries (JECISTLC) 

Our standard assumption is that both private 

wages and salaries and state and local 

government wages and salaries grow at the 

rate CBO assumes for the employment cost 

index in the final years of its ten-year 

economic projections. 

We used a wage growth assumption of 3.1 percent, which is 

0.1 percent higher than CBO’s 3.0 percent assumption, to 

offset the 0.1 percent increase in CBO’s GDP price inflation 

assumption from 1.7 percent in August 2009 to 1.8 percent 

in January 2010. If we had used CBO’s wage growth 

assumption, wages would decline as a share of GDP when 

compared with our previous projections, which is 

inconsistent with our projections’ unchanged rates of real 

GDP growth. 

Page 16 GAO-10-358 State and Local Governments' Fiscal Outlook
Appendix I: Scope and Methodology 

Variable Previous assumptions Updated assumptions 

Total state and local 

government employment 

(EGSLALL) 

Our standard assumption is that state and 

local government employment grows at the 

same rate as total population. We obtain 

data from NIPA to estimate this variable. 

Because 2009 data on total employment was not available 

from NIPA at the time of our analysis, we used data from 

the Bureau of Labor Statistic’s Current Employment 

Statistics program to estimate the sector’s 2009 

employment level. Also, we chose not to use our standard 

assumption because the economy was in recession during 

2009. Instead, we estimated a non-recessionary 

employment level for 2010 by multiplying the average share 

of total population during the 2001-2009 period by 2010’s 

projection population. After 2010, we assume the 

employment level grows with total population. 

Rate on AAA-rated 

municipal bonds 

(RMMUNIBB20) 

In previous models, we used the rate on 

Moody’s AAA-rated municipal bonds 

(RMMUNIAAA) as the interest rate to derive 

the effective rate on the sector’s credit 

market debt (RATEOWED). Our standard 

approach to project the AAA-rated municipal 

bond rate 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 underor over-predicts the last historical value. 

To align our methods with other major sources, we now use 

the Bond Buyer GO 20-Bond Municipal Bond Index as our 

data source and adjusted our relationships for RATEOWED 

accordingly. 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. 

Federal investment 

grants (IGRANTCBO) 

and federal non-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. 

At the time of our March 2010 update, CBO ‘s NIPAconsistent values for federal grants were not available. To 

estimate federal investment and other federal grants, we 

multiplied the January 2010 GDP projection with an 

estimate of each variable’s respective share of GDP derived 

from CBO’s most recently available projections. 

State personal income 

tax receipts 

(TXPGSTATE) 

We simulate 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. 

We assumed a delay in adjustment that kept receipts onetenth of one percent of GDP below the long run level in 

2010. In 2011, we let state personal tax receipts return to 

their long run level. 

General sales tax 

receipts 

(TXIMGSLSGEN) 

We estimated the long-term responsiveness 

of our measure of the sales tax base to 

aggregate wage and salary income. Given 

projections of aggregate income, this 

elasticity provides a future path for the sales 

tax base. 

Because this long-run relationship does not capture cyclical 

adjustments well, we adjusted the 2010 level downward by 

a tenth of a percent of GDP so that the category of which it 

is a part is the same share of GDP as IHS Global Insight 

projections in 2010. 

Page 17 GAO-10-358 State and Local Governments' Fiscal Outlook
Appendix I: Scope and Methodology 

Variable Previous assumptions Updated assumptions 

Property tax receipts 

(TXIMGSLPROP) 

Property tax receipts are assumed to grow 

with our projections of the property tax base. 

In turn, property tax base projections are 

based on our estimate of the relationship 

between real GDP and the real market value 

of real estate owned by both the household 

sector and the nonfarm, nonfinancial 

business sector. 

Because our standard assumption does not adequately 

capture shorter term developments—particularly in recent 

years—we set property taxes in 2010 equal to their 2.8 

percent average share of GDP during the non-recessionary 

years from 2002 through 2008. Thereafter, we let receipts 

grow from this level according to the long run relationship. 

Source: GAO analysis. 

Note: See Appendices I-IV of GAO, State and Local Governments: Growing Fiscal Challenges Will 

Emerge During the Next 10 Years, GAO-08-317 (Washington, D.C.: January 2008) for a description 

of all assumptions made in the state and local model. Appendix V in GAO-08-317 provides a list of all 

model variables and definitions. 

a

Other elements include employment growth, beneficiary growth, wage growth, inflation, mortality, the 

real rate of return, and the employees’ own contributions. 

b

In developing the operating balance measure, we subtract an estimate of general funds used to 

finance longer-term projects—such as investments in equipment and roads—from total receipts since 

these funds would not be available to cover current expenses. The estimate of general funds used for 

investment equals total investment minus the sum of federal grants and the change in debt. 

Page 18 GAO-10-358 State and Local Governments' Fiscal Outlook
Appendix II: 

A

GAO Contacts and Staff 

cknowledgments 

Page 19 GAO-10-358 

Appendix II: GAO Contacts and Staff 

Acknowledgments 

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

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

In addition to the contacts listed above, Richard Krashevski and Michelle 

Sager (Assistant Directors), Shannon Finnegan (Analyst-in-Charge), 

Andrew Ching, and Kathleen Padulchik made significant contributions to 

this report. 

 State and Local Governments' Fiscal Outlook 

GAO Contacts 

Staff 

Acknowledgments 

(450786) 
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