State and Local Governments: Knowledge of Past Recessions Can Inform Future Federal Fiscal Assistance
Published: 2011-03-31T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: The federal government provided fiscal assistance to state and local  governments in response to three of the six national recessions since  1974. The most recent recession, which began 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 about $282 billion in federal fiscal  assistance to state and local governments. The 2007 recession also  brought renewed focus to federal programs that provide fiscal assistance  to state governments during economic downturns. We have previously  addressed questions about such programs, noting that in providing  assistance to state and local governments, it is important to consider the  timing, targeting, and amount of assistance based on a variety of factors,  including the fiscal health of state governments and the federal  government’s goals for providing such assistance.
The Recovery Act assigned GAO a range of responsibilities to help  promote accountability and transparency as well as to evaluate specific  aspects of the act. This report, in conjunction with a companion GAO  report on aspects of federal fiscal assistance related to health care,  responds to a specific requirement to evaluate how national economic  downturns have affected states since 1974—especially with regard to  Medicaid—including any recommendations to help address those effects  in the future. Accordingly, our objectives for this report are to (1) analyze  how state and local government budgets are affected during national  recessions and (2) identify what strategies exist to provide federal fiscal  assistance to state and local governments during national recessions and  indicators policymakers could use to time and target such assistance.
To analyze how national recessions affect state and local governments’  revenues, expenditures, and borrowing, we examined data from the  Bureau of Economic Analysis’s (BEA) National Income and Product  Accounts (NIPA), the Census Bureau’s Annual Survey of State and Local  Government Finances, and the Census Bureau’s Census of Governments.  To describe state governments’ discretionary tax and fee changes and total  balances, we collected and analyzed states’ general fund data from the  National Governors Association (NGA) and National Association of State  Budget Officers’ (NASBO) The Fiscal Survey of States (Fiscal Survey). We  assessed the reliability of the data we used for this review and determined  that they were sufficiently reliable for our purposes. Appendix I provides  additional details about the scope and methodology of our review,  including certain limitations concerning the data available for our  purposes.
To identify federal strategies for providing federal assistance to state and  local governments during national recessions, we reviewed federal fiscal  assistance programs enacted since 1973. We identified these programs  and potential considerations for designing a federal countercyclical  assistance program by reviewing GAO, Congressional Budget Office  (CBO), and Congressional Research Service (CRS) reports and conducting  a search for relevant legislation. We used these and other reports to  identify issues policymakers should consider when selecting a strategy.  We also analyzed the legislative history and statutory language of past  federal fiscal assistance programs, as well as policy goals stated in the  statutes. To identify factors policymakers should consider when selecting  indicators to implement their strategy, we reviewed GAO, CBO, CRS,  Federal Reserve Banks, Department of the Treasury (Treasury), and  academic reports. We considered indicators’ availability at the state level  and timeliness (in terms of frequency and publication lag time) to identify  indicators policymakers could use to time and target federal fiscal  assistance during national recessions. Finally, we interviewed key  associations and think tanks familiar with the design and implementation  of programs providing federal fiscal assistance to state and local  governments to understand the range of perspectives regarding these  programs and to identify relevant related research on these issues.
We provided relevant sections of a draft of this report to the Bureau of  Labor Statistics and external experts. They offered technical suggestions,  which we incorporated as appropriate.
We conducted this performance audit from February 2010 to March 2011,  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: Recessions mark a distinct phase of the overall business cycle, beginning  with a business cycle “peak” and ending with a business cycle “trough.”  Between trough and peak the economy is in an expansion. The National  Bureau of Economic Research (NBER) identifies dates for national  recessions, which can vary in overall duration and magnitude. While  NBER sets dates for the peaks and troughs of national recessions, no dates  are set for turning points in state economies. State economic downturns  vary in magnitude, duration, and timing, and do not necessarily coincide  with dates identified for national recessions.
subsections: section_title: Characteristics of National Recessions
paragraphs: NBER defines a recession as a significant decline in economic activity  spread across the economy, lasting more than a few months, normally  visible in real gross domestic product (GDP), real income, employment,  industrial production, and wholesale-retail sales. NBER uses several  monthly indicators to identify national recessions. These indicators  include measures of GDP and gross domestic income (GDI), real personal  income excluding transfers, the payroll and household measures of total  employment, and aggregate hours of work in the total economy.
Since 1973, NBER has identified six national recessions. These recessions  have varied considerably in duration and magnitude (table 1). For  example, real GDP declined by 4.1 percent over the course of the 2007- 2009 recession, which lasted 18 months. Similarly, real GDP declined by  about 3 percent during the 1973-1975 and 1981-1982 recessions, both of  which lasted 16 months. In contrast, real GDP declined 1.4 percent and 0.7  percent in the 1990 and 2001 recessions, respectively, both of which lasted  8 months.
section_title: Characteristics of State Economic Downturns
paragraphs: States are affected differently by national recessions. For example,  unemployment rates have varied across states during past recessions.  During the course of the 2007-2009 recession, the national unemployment  rate nearly doubled, increasing from 5.0 percent to 9.5 percent. The  unemployment rate in individual states increased between 1.4 and 6.8  percentage points, with a median change of 4 percentage points (figure 1).  In contrast, a smaller national unemployment rate increase of 1.3  percentage points during the 1990-1991 recession reflected unemployment  rate changes in individual states ranging from -0.2 to 3.4 percentage points.
Recent economic research suggests that while economic downturns  within states generally occur around the same time as national recessions,  their timing—or entrance into and exit out of the economic downturn— and duration varies. Some states may enter or exit an economic  downturn before or after a national recession. Other states’ economies  may expand while the country as a whole is in recession. States can also  experience an economic downturn not associated with a national  recession. States’ differing characteristics, such as industrial structure,  contribute to these differences in economic activity. For example,  manufacturing states tend to experience economic downturns sooner than  other states in a recession, while energy sector states are often out of sync  with the country as a whole.
section_title: Federal Actions in Response to National Recessions
paragraphs: The federal government has multiple policy options at its disposal for  responding to national recessions, although federal policy responses are  not necessarily limited to the time periods of national recession. For  example, in response to the recession beginning in December 2007, the  federal government and the Federal Reserve together acted to moderate  the downturn and restore economic growth when confronted with  unprecedented weakness in the financial sector and the overall economy.  The Federal Reserve used monetary policy to respond to the recession by  pursuing one of the most significant interest rate reductions in U.S.  history. In concert with the Department of the Treasury, it went on to  bolster the supply of credit in the economy through measures that provide  Federal Reserve backing for a wide variety of loan types, from mortgages  to automobile loans to small business loans.
The federal government also used fiscal policy to confront the effects of  the recession. Existing fiscal stabilizers, such as unemployment insurance  and progressive aspects of the tax code, kicked in automatically in order  to ease the pressure on household income as economic conditions  deteriorated. In addition, Congress enacted legislation providing  temporary tax cuts for businesses and a tax rebate for individuals in the  first half of 2008 to buoy incomes and spending and created the Troubled  Asset Relief Program in the second half of 2008 to give Treasury  authority to act to restore financial market functioning.
The federal government’s largest response to the recession to date came in  early 2009 with the passage of the Recovery Act, the broad purpose of  which is to stimulate the economy’s overall demand for goods and  services, or aggregate demand. Fiscal stimulus programs are intended to  increase aggregate demand—the spending of consumers, business firms,  and governments—and may be either automatic or discretionary.  Unemployment insurance, the progressive aspects of the tax code, and  other fiscal stabilizers provide stimulus automatically by easing pressure  on household incomes as economic conditions deteriorate. Discretionary  fiscal stimulus, such as that provided by the Recovery Act, can take the  form of tax cuts for households and businesses, transfers to individuals,  grants-in-aid to state and local governments, or direct federal spending. In  response, households, businesses, and governments may purchase more  goods and services than they would have otherwise, and governments and  businesses may refrain from planned workforce cuts or even hire  additional workers. Thus, fiscal stimulus may lead to an overall, net  increase in national employment and output.
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. Output, income, and employment all tend to fall  during recessions, causing state and local governments to collect less  revenue at the same time that demand for the goods and services they  provide is increasing. Since state governments typically face balanced  budget requirements and other constraints, they adjust to this situation by  raising taxes, cutting programs and services, or drawing down reserve  funds, all but the last of which amplify short-term recessionary pressure  on households and businesses. Local governments may make similar  adjustments unless they can borrow to make up for reduced revenue. By  providing assistance to state and local governments, the federal  government may be able to forestall, or at least moderate, state and local  governments’ program and service cuts, tax increases, and liquidation of  reserves. The federal government has provided varied forms of assistance  directly to state and local governments in response to three of the past six  recessions (figure 2). 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. See appendix III for a description of each piece of legislation.
Congressional decisions about whether to provide fiscal assistance to  state and local governments ultimately depend on what role policymakers  believe the federal government should take during future national  recessions. Perspectives on whether and the extent to which the federal  government should provide fiscal assistance to state and local  governments are far-ranging—some advocate for not creating an  expectation that federal fiscal assistance will be provided, while others  argue for a greater federal role in providing fiscal assistance to state and  local governments in response to national recessions.
Some policy analysts warn against creating an expectation that federal  assistance will be available to state and local governments. These  analysts contend that federal fiscal assistance can distort state and local  fiscal choices and induce greater spending of scarce state funds. For  example, the matching requirements of federal grants can induce state  governments to dedicate more resources than they otherwise would to  areas where these resources are not necessarily required. According to  these analysts, federal fiscal assistance to state and local governments  reduces government accountability and erodes state control by imposing  federal solutions on state problems. Those who hold this perspective see  little justification for insulating state governments from the same fiscal  discipline that other sectors of the economy follow during a recession.
In contrast, other policy analysts favor a federal role in promoting the  fiscal health of state and local governments during economic downturns.  Proponents of this view contend that during economic downturns, state  and local governments face the dilemma that demand for social welfare  benefits increases at the same time that state and local governments’  ability to meet these demands is constrained as a result of decreasing tax  revenues.
section_title: State and Local Governments’ Revenue and Expenditure Patterns during National Recessions Reflect Variations in Economic Circumstances and Policy Choices
subsections: section_title: State and Local Government Revenue Declines in National Recessions Vary in Magnitude, over Time, and across States
paragraphs: 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. Own-source revenues, which made up about 80  percent of state and local general revenues in 2008, and total tax revenues,  which made up about 68 percent of state and local own-source revenues in  2008, display similar cyclical behavior. In addition, state and local revenue  growth lagged the resumption of national economic growth after the 2001  and 2007-2009 recessions, but preceded it during the 1981-1982 and 1990- 1991 recessions.
State and local governments’ current tax receipts have declined in each of  the six national recessions since 1973. However, both the severity of these  revenue declines and the time it has taken for revenues to recover has  varied (figure 3). During the most recent recession, state and local  governments experienced more severe and long-lasting declines in  revenue than in past recessions. For example, over the course of the 2007- 2009 recession, current tax receipts declined 9.2 percent—from $1.4  trillion in the fourth quarter of 2007 to $1.2 trillion in the second quarter of  2009—and had not yet returned to the peak level 5 quarters after the end  of the recession. In contrast, the recessions beginning in 1980, 1981, and  1990 were less severe. For example, over the course of the 1990-1991  recession, current tax receipts declined less than 1 percent—from $789  billion in the third quarter of 1990 to about $785 billion in the first quarter  of 1991—and recovered as the recession ended in the first quarter of 1991.
Larger revenue declines during the two most recent recessions have  coincided with increased volatility in state and local government revenues  during the past two decades. This increased volatility can be attributed to  the fact that since 1973, states have become increasingly reliant on  individual income taxes, which are usually more volatile than other  revenues. Income tax receipts rose from 15 percent of current tax  receipts in 1973 to 20 percent in 2009. Analysts have attributed the  increase in income tax as a portion of state revenues to state policy  changes favoring income taxes and changes in the ways workers are  compensated. Over time, state and local government revenues have  become more volatile due to an increased reliance on income tax and a  decreased reliance on sales tax. Several factors have contributed to these  shifts, including sales tax exemptions for certain items, such as food and  medicine; an increase in the share of consumption represented by  services, as services are often excluded from sales tax; and increased  Internet sales, which can reduce opportunities for state tax collections.
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. The aggregate  revenue levels described earlier mask varying trends among individual  state and local governments, as some state and local governments  experience minimal or no revenue declines during national recessions,  while others face severe reductions in tax revenues. For example, the  median decline in state tax collections from the first quarter of 2008 to the  first quarter of 2009 was 11 percent. While variations ranged from a 72  percent decline to a 15 percent increase during this period, most individual  state tax collections declined between 16 percent and 6 percent.
To better understand the extent to which an individual state’s government  tax revenues decline during national recessions, we estimated how  responsive state government tax revenues are to changes in total wages, a  proxy for the amount of economic activity. We found that, on average,  state tax revenues decrease by 1 percent when wages decrease by about 1  percent. However, this effect varies substantially across individual states,  with state tax revenues falling by anywhere from about 0.2 percent to  about 1.8 percent in response to a 1 percent decline in wages. This means  that given the same reduction in wages, one state’s tax revenues may fall  at up to nine times the rate of another state.
section_title: 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
paragraphs: General expenditures by state and local governments are procyclical  (table 2). General expenditures also tend to lag the national business  cycle by one to two years, so they tend to decline relative to trend later  than GDP and also to increase relative to trend later than GDP. However,  general expenditures by state and local governments grew at an average  annual rate of about 4 percent during the period from 1977 to 2008, so  declines in general expenditures relative to trend do not necessarily  correspond to absolute declines in the level of general expenditures.
Both of the main components of general expenditures—capital outlays  and current expenditures—are procyclical. Capital outlays, which made  up about 13 percent of general expenditures in 2008, are expenditures on  the purchase of buildings, land, and equipment, among other things.  Current expenditures, which made up the remaining 87 percent of general  expenditures in 2008, include all non-investment spending, such as  supplies, materials, and contractual services for current operations; wages  and salaries for employees; and cash assistance to needy individuals.  Capital outlays show a stronger procyclical relationship than current  expenditures, and therefore typically fall relative to trend more than  current expenditures during national recessions. Trends in capital outlays  and current expenditures tend to lag the national business cycle by 1 to 2  years. However, like general expenditures, both capital outlays and  current expenditures by state and local government grew by  approximately 4 percent per year between 1977 and 2008, so declines  below their long-run trends do not imply that the levels of either capital  outlays or current expenditures declined.
Spending associated with social safety net programs appears to behave  differently over the business cycle than other types of spending. For  example, current expenditures on health and hospitals and on public  welfare–expenditures associated with social safety net programs such as  Medicaid and Temporary Assistance for Needy Families (TANF)— typically increase relative to trend during national recessions (i.e., these  expenditures are countercyclical). In contrast, current expenditures on  elementary and secondary education, higher education, highways, and  police and corrections typically decrease relative to trend during  economic downturns (i.e., these expenditures are procyclical). Current  expenditures on health and hospitals and on public welfare may be  countercyclical because the number of people living in poverty is one of  the main drivers of both types of expenditures, and the number of people  living in poverty tends to increase during national recessions and to  decrease during national expansions.
In addition, current expenditures on some functions seem to lag the  business cycle more than others. For example, current expenditures on  elementary and secondary education and higher education seem to lag the  business cycle by 1 to 2 years, while current expenditures on other  functions do not seem to lag the business cycle. Thus, while state and local  governments tend to reduce total current expenditures relative to trend  during national recessions, they do not do so for every service.  Furthermore, current expenditures on some services, such as education,  take longer to recover than others after the recession is over. However,  current expenditures on all the services we analyzed grew every year on  average during the period of 1977 to 2008, so declines relative to trend  were not necessarily absolute declines in spending on these services.
If state and local government expenditures are typically procyclical, then  state and local governments may have difficulties providing services  during recessions. Reduced expenditures relative to trend during  recessions may be reflecting reduced revenues relative to trend rather  than reduced desire for services. For example, current expenditures on  elementary and secondary education tend to fall relative to trend during  recessions, but the population of elementary and secondary school-age  children is unlikely to vary much as a result of the business cycle. Current  expenditures on higher education also tend to fall relative to trend during  recessions even though enrollment in colleges and universities may  increase during recessions. 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. For example, we have previously reported that economic  downturns in states 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. Between  2001 and 2002, Medicaid enrollment rose 8.6 percent, which was largely  attributed to states’ increases in unemployment. During this same period,  state tax revenues fell 7.5 percent. The extent to which state  governments maintained the capacity to fund their Medicaid programs  differed during past recessions. These differences reflect variations in  state unemployment rate increases and varied increases in Medicaid  enrollment during recession periods.
section_title: State Governments Raise Taxes and Fees, Tap Reserves, and Use Other Budget Measures to Address Revenue Declines during National Recessions
paragraphs: 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. These decisions typically entail raising taxes, tapping reserves,  reducing spending (as described earlier), or using other budget strategies  to respond to revenue declines.
subsections: section_title: State Governments Increase Taxes and Fees to Respond to Revenue Shortfalls during National Recessions, but Individual State Policy Choices Vary
paragraphs: In our analysis of the discretionary changes state governments have made  to their revenue policies since 1990, we found that—in the aggregate— state governments made policy changes to increase taxes and fees during  or after every national recession since state fiscal year 1990 (figure 4).  For example, tax and fee increases as a percent of state general fund  revenue peaked at about 5.1 percent in state fiscal year 1992, about 1.8  percent in state fiscal year 2004, and about 3.9 percent in state fiscal year  2010. From state fiscal years 1995 to 2001, states reduced taxes and fees by  amounts ranging from 0.7 percent to 1.5 percent of general fund revenues.  From state fiscal years 2003 to 2008, discretionary changes in states’ taxes  and fees ranged from -0.3 percent to 1.8 percent.
Within these national trends, individual state revenue policy choices  varied considerably during our period of analysis. For example, in state  fiscal year 1992, state governments enacted changes equal to 5.1 percent of  general fund revenues for all states in the aggregate. However, during that  fiscal year, individual states’ policy changes ranged from reducing taxes  and fees by 1.4 percent to raising taxes and fees by 21.3 percent of general  fund revenues. In state fiscal year 2008, aggregate state policy changes  were about 0 percent of general fund revenues, but individual state policy  changes ranged from decreasing taxes and fees by 6.1 percent to  increasing taxes and fees by 19.3 percent.
section_title: State Governments Tap Fiscal Reserves to Address Declines in Revenue During and After Periods of National Recession
paragraphs: As we have previously reported, most state governments prepare for  future budget uncertainty by establishing fiscal reserves. NASBO has  reported that 48 states have budget stabilization funds, which may be  budget reserves, revenue-shortfall accounts, or cash-flow accounts.
State governments have tapped fiscal reserves to cope with revenue  shortfalls during recent national recessions, as indicated by their reported  total balances, which are comprised of general fund ending balances and  the amounts in state budget stabilization “rainy day” funds (figure 5).  Prior to the recessions beginning in 2000 and 2007, state governments built  large balance levels, in the aggregate. According to NGA and NASBO’s  Fiscal Survey of States, these balance levels reached 10.4 percent of  expenditures in state fiscal year 2000 and 11.5 percent in 2006. Total  balances typically reached their lowest points during or just after national  recessions. By state fiscal year 2003, states’ total balances dropped to 3.2  percent of expenditures, and in fiscal year 2010 they had fallen to 6.4  percent. These total balance levels appear inflated, however, because  individual state governments’ reserves can vary substantially. For  example, NASBO reports that for state fiscal year 2010, two states (Texas  and Alaska) represented $25.4 billion—more than 64 percent—of all state  governments’ total balances. Removing these states, total balances were  2.4 percent of expenditures for the remaining 48 state governments.
Since 1973, state and local governments have, in general, borrowed more  and saved less during national recessions. Net lending or net borrowing by  state and local governments—which is comprised of total receipts minus  total expenditures—has fallen after the peak of each business cycle since  1973 (figure 6). While the state and local government sector increased its  borrowing substantially during recent recessions, the sector did not  increase net investments to the same extent. For example, net borrowing  increased from 0.2 percent of GDP in the first quarter of 2006 to 1.15  percent of GDP in the third quarter of 2008 for all state and local  governments in the aggregate. In contrast, state and local government  investment ranged from 1.1 percent to 1.2 percent of GDP during the same  period.
The level of total state and local government debt per capita varies  substantially across states. Our analysis found that on average state and  local government total debt per capita was $7,695 in fiscal year 2008;  however, within individual states debt ranged from a minimum of $3,760  per capita to a maximum of $14,513 per capita. As a percentage of gross  state product (GSP), total state and local government debt averaged 16.9  percent and ranged from 6.6 percent to 25.4 percent in fiscal year 2008.  State and local government total debt levels appear to correlate with GSP,  suggesting that state and local governments within states with more fiscal  resources tend to hold more debt.
State budget officials have used other short-term budget measures to  address revenue declines while avoiding broad-based tax increases. Some  of these strategies include:  shifting revenues or expenditures across fiscal years,  securitizing revenue streams,  reducing payments or revenue sharing to local governments,  deferring infrastructure maintenance,  borrowing from or transferring funds from outside the general fund  to address revenue shortfalls, and  reducing funding levels for pensions.
In addition, a number of state governments have redesigned government  programs to improve efficiency and reduce expenditures. According to the  National Governor’s Association Center for Best Practices (NGA Center), a  recession provides state fiscal managers with an opportunity for cutting  back inefficient operations. The NGA Center tracked state governments’  efforts to restructure government, and in fiscal years 2009 and 2010, a  broad range of budget cuts and programmatic changes were enacted in  areas such as corrections, K-12 education, higher education, and employee  costs (salaries and benefits). While some of these changes were  temporary, the NGA Center contends these changes reflect a “new normal”  for state government in the long term. The NGA Center found that at least  15 state governments conducted governmentwide reviews to improve  efficiency and reduce costs; at least 18 state governments reorganized  agencies; and more than 20 state governments altered employee  compensation, including enacting pension reforms.
section_title: Strategies to Respond to National Recessions Require Decisions on Whether, When, and How to Provide Federal Fiscal Assistance to State and Local Governments
subsections: section_title: GAO and Other Evaluations of Prior Federal Fiscal Assistance Strategies Identify Design Considerations Including Effective Timing and Targeting of Aid
paragraphs: 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. To ensure that federal fiscal  assistance is effective, we and others have said that policymakers can  benefit from considering the following when developing a policy strategy.
Timing/triggering mechanisms—Fiscal assistance that begins to flow  to state and local governments when the national economy is  contracting is more likely to help state and local governments avoid  actions that exacerbate the economic contraction, such as increasing  taxes or cutting expenditures. 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. Federal policy strategies specifically intended  to stabilize state and local governments’ budgets may have to be timed  differently than those designed to stimulate the national economy,  because state budget difficulties often persist beyond the end of a  recession.
Securing legislative approval of fiscal assistance through Congress can  result in a time lag before such assistance is available. For example,  the Recovery Act was passed in February 2009, nearly five quarters  after the national recession began in December 2007. There can also be  a second lag that results from the time it takes for the federal  government to distribute fiscal assistance to the states. Further, state  governments often have to set up mechanisms for channeling the  funds into the necessary programs. All of this slows the process of  spending the money during a recession. In the case of the Jobs and  Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), for example,  we found that the first federal funds were distributed 19 months after  the end of the national recession. A trigger could automatically provide  federal assistance, or it could prompt policymakers to take action.  Economists at the Federal Reserve Bank of Chicago have described  the ideal countercyclical assistance program as one having an  automatically activated, pre-arranged triggering mechanism that could  remove some of the political considerations from the program’s design  and eliminate delays inherent to the legislative process. Such a trigger  could also specify criteria for ending assistance.
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. Targeting requires  careful consideration of the differences in individual states’ downturns  while also striking a balance with other policy objectives. As discussed  below, effective targeting of federal fiscal assistance is dependent  upon the selection of indicators that correspond to the specific  purpose(s) of the particular policy strategy.
Temporary—As a general principle, federal fiscal assistance provided  in response to national recessions is temporary. While a federal fiscal  stimulus strategy can increase economic growth in the short run, such  efforts can contribute to the federal budget deficit if allowed to run too  long after entering a period of strong recovery. The program can be  designed so that the assistance ends or is phased out without causing a  major disruption in state government budget planning. If federal  assistance is poorly timed, badly targeted, or permanently increases  the budget deficit, the short-term benefits of the assistance package  may not offset the long-term cost.
Consistency with other policy objectives—The design of federal fiscal  assistance occurs in tandem with consideration of the impact these  strategies could have on decision makers’ other policy objectives. Such  considerations include competing demands for federal resources and  an assessment of states’ ability to cope with their economic conditions  without further federal assistance. As the Peterson-Pew Commission  on Budget Reform recently noted in its report, current budget  practices recognize the costs of economic emergencies only when  these events occur. Although we do not know when recessions will  occur or how severe future recessions will be, the current practice of  waiting to act until these economic events occur can result in greater  public costs than if policy objectives of advance preparation (such as  reduced consumption and increased savings during economic  upswings) were incorporated into federal fiscal assistance strategies.  A standby federal fiscal assistance policy could induce moral hazard  by encouraging state or local governments to expect similar federal  actions in future crises, thereby weakening their incentives to properly  manage risks. For example, states could have less incentive to build,  maintain, and grow their rainy day or other reserve funds if they  believe they may receive assistance from the federal government  during future recessions. Another consideration is the policy objective  of maintaining accountability while promoting flexibility in state  spending. Past studies have shown that unrestricted federal funds are  fungible and can be substituted for state funds, and the uses of such  funds can be difficult or impossible to track.
section_title: Overall Design Considerations and Policy Goals Influence Selection of Indicators to Time and Target Federal Fiscal Assistance
paragraphs: When policymakers select indicators to time and target federal fiscal  assistance in response to a national recession, their selection depends on  the specific purposes of the proposed assistance program. For example,  during a recession, policymakers may choose to provide general fiscal  assistance or assistance for specific purposes such as supporting states’  Medicaid or education programs. The indicators chosen to time and target  general fiscal assistance could differ from those chosen for the purpose of  supporting Medicaid or education. Indicators chosen for Medicaid could  also differ from those chosen to provide assistance for education. In  addition, different indicators may be needed to determine the timing  (triggering on), the targeting (allocating), and the halting (triggering off) of  federal fiscal assistance. For example, policymakers could use a national  labor market indicator to begin assistance and a state-level indicator to  halt assistance. We previously reported on a policy strategy intended to  support state Medicaid programs during economic downturns. This  strategy used state unemployment rates to trigger the flow of aid on and  off. This strategy used state unemployment rates along with an additional  indicator—relative state Medicaid costs—to determine the amount of aid  each state receives.
Policymakers could select indicators with the intent of responding to the  effects of a particular recession. For example, if policymakers want to  begin providing fiscal assistance to state and local governments as states  enter an economic downturn, they are challenged by the fact that different  states may enter into economic downturns at different times.  Policymakers would need to select an indicator that provides information  on the overall amount of economic activity in individual states, that is  frequent enough to distinguish between different phases of the business  cycle, and is available with relatively little lag time.
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. The indicators in table 3 are all commonly used measures of  national macroeconomic activity that are also available at the state level.  At the national level, indicators such as employment, weekly hours, and  housing units authorized by building permits are procyclical, while other  indicators, such as unemployment, are countercyclical. The indicators in  table 3 are published either monthly or quarterly, and thus cover periods  shorter than the length of the typical national recession. These indicators  are available with less than a 6-month publication lag, as indicators with  publication lags greater than 6 months may not reveal the downturn until  it is already over and the recovery has begun.
The illustrative indicators shown in the table above exclude indicators of  fiscal stress (such as declines in tax receipts or budget gaps) because they  are dependent on state governments’ policy choices and because state  definitions and measurement techniques vary for calculations such as  budget gaps. For example, the list does not include state governments’  quarterly tax receipts because this measure reflects policy decisions  within each state. Data sources detailing state-level participation in  intergovernmental benefit programs are also excluded because program  enrollment data can understate the number of individuals eligible for the  program. For example, we did not include unemployment insurance claim  data from the Employment and Training Administration because BLS has  reported that unemployment insurance information cannot be used as a  source for complete information on the number of unemployed. We  excluded this indicator because claims data may underestimate the  number of unemployed because some people are still jobless when their  benefits run out, some are not eligible, and some never apply for benefits.
Recent research suggests that some indicators may be better able to  trigger assistance on and off than other indicators, depending on the  specific purpose of the assistance. Economists from the Federal Reserve  Bank of Chicago found that a trigger based on the national aggregate of  the Federal Reserve Bank of Philadelphia’s State Coincident Indexes— which are comprised of nonfarm payroll employment, average hours  worked in manufacturing, the unemployment rate, and wage and salary  disbursements—would turn assistance on close to the beginning of a  national recession and would turn assistance off close to the end of a  national recession. They found that a trigger based on the national  unemployment rate also triggered the flow of assistance on close to the  beginning of a national recession, but did not trigger the assistance off  until well after the national economic recovery was under way, reflecting  the lag in employment recovery after recessions. If the goal of aid is to  maintain state and local government spending only during the recession,  then the State Coincident Indexes may be an appropriate indicator.  However, if the goal of aid is to maintain state and local government  spending until an individual state’s economy fully recovers, the  unemployment rate may be an appropriate indicator.
section_title: Future Approaches to Federal Fiscal Assistance Can Benefit from Knowledge of Results, Challenges, and Unintended Consequences of Previous Federal Responses
paragraphs: Knowledge of the results, challenges, and unintended consequences of  past policy actions can inform deliberations as policymakers determine  whether and how to provide federal fiscal assistance in response to future  national recessions. 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. When the federal government has  provided fiscal assistance, such assistance has fallen into two general  categories: (1) unrestricted or general purpose fiscal assistance, which  can include general revenue sharing programs; and (2) federal fiscal  assistance through grants for specific purposes. This second category of  assistance has included funding for existing grant programs (including  both categorical and formula grants) as well as funding for new grant  programs to state and local governments.
Unrestricted or general purpose grants to states and localities maximize  spending discretion for state and local governments. This approach has  included antirecession payments and general revenue sharing funds to  increase state and local expenditures or forestall potential tax increases.  Because there are minimal restrictions on the use of these funds, they  offer the advantage of not interfering with state spending priorities as well  as the opportunity to use the funds quickly. However, our past evaluations,  as well as work by others, have noted that this approach also presents  challenges and unintended consequences. Due to the nature of such  assistance, state and local governments may use unrestricted federal funds  for activities that would have otherwise been funded using non-federal  sources. Also, in an example from the 1970s, federal antirecession  payments were provided through the Antirecession Fiscal Assistance  (ARFA) program, which distributed more than $3 billion between July  1976 and September 1978 to state and local governments. State and local  governments could use the ARFA funds for the maintenance of basic  services customarily provided by these governments, such as public  welfare, education and police protection. The ARFA funds were intended  to facilitate state spending. However, because the funds were subject to  states’ standard appropriations procedures, this slowed states’ spending of  the funds. In its study of ARFA, the Department of the Treasury reported  that states appropriated ARFA funds on average 7 months later than the  states appropriated their own revenues, thereby delaying entry of the  funds into the states’ spending stream.
More recently, we found similar issues in our 2004 review of the  component of the JGTRRA that provided $10 billion in unrestricted,  temporary fiscal relief payments to states that were allocated on a per  capita basis. We found that these fiscal relief funds were not targeted to  individual states based on the impact of the recession and found it  doubtful that these payments were ideally timed to achieve their greatest  possible economic stimulus. JGTRRA fiscal relief payments were first  distributed to the states in June 2003, about 19 months after the end of the  2001 recession and after the beginning of the economic expansion.  However, because employment levels continued to decline even after the  economy entered an expansion period, we found that the JGTTRA fiscal  relief payments likely helped resolve ongoing state budgetary problems.
Some prior federal fiscal assistance strategies have included use of  existing grant programs to deliver assistance to states. This approach has  the advantage of targeting funding to reflect federal policy priorities while  avoiding the delays involved in establishing and implementing entirely new  programs. For example, an amendment to the Comprehensive  Employment and Training Act of 1973 (CETA) created Title VI, Emergency  Jobs Programs (Title VI), which provided federal fiscal assistance in  response to the recession that began in 1973. Title VI adapted the existing  CETA federal jobs program to mitigate cyclical unemployment by  providing funding to temporarily hire employees in federal, state, and local  governments. While policy analysts found that Title VI provided visible and  useful services to communities and fiscal relief to some localities, they  also found that there were unintended consequences resulting from  implementation of the program. According to our prior work, and the  work of others, these consequences included the practice by some state  governments of laying off current employees and later rehiring the same  employees using Title VI funds, instead of using their existing state  government funds.
The federal government’s responses to the recessions beginning in March  2001 and December 2007 provide recent examples of the use of existing  grant structures to expedite the implementation of fiscal assistance. The  federal response to both recessions included temporarily increasing the  rate at which states are reimbursed for Medicaid expenditures through an  increase to the existing Federal Medical Assistance Percentage (FMAP)  formula. Both JGTRRA and the Recovery Act distributed increased FMAP  funds to states through the existing Medicaid payment management  system. We have reported that increased FMAP funds provided by the  Recovery Act were better timed and targeted for state Medicaid needs  than funds provided following the 2001 national recession. Overall, the  timing of the initial provision of Recovery Act funds responded to state  Medicaid needs because assistance began during the 2007 national  recession while nearly all states were experiencing Medicaid enrollment  increases and revenue decreases. However, state budget officials also  referred to the temporary nature of the funds and the fiscal challenges  expected to extend beyond the timing of funds provided by the Recovery  Act. Officials discussed a desire to avoid what they referred to as the “cliff  effect” associated with the dates when the funding ends. The increased  FMAP funds provided by the Recovery Act were well targeted for state  Medicaid enrollment growth based on changes in state unemployment  rates. However, the Recovery Act did not allocate assistance based on  state variation in the ability to generate revenue. As a result, the increased  FMAP funding did not reflect varying degrees of decreased revenue that  states had for maintaining Medicaid service. The increased FMAP funds  provided to states following the 2001 recession were provided well after  the recession ended and not targeted based on need.
The Recovery Act also increased funding for other existing grant programs  to provide fiscal assistance to state and local governments. For example,  the Recovery Act provided an additional $2 billion in funds for the Edward  Byrne Memorial Justice Assistance Grant (JAG) Program. Consistent with  the pre-existing program, states and localities could use their Recovery  Act JAG grant funds over a period of 4 years to support a range of  activities in seven broad statutorily established program areas including  law enforcement, crime prevention, and corrections. In a recent report, we  found that of the states we reviewed, all reported using Recovery Act JAG  funds to prevent cuts in staff, programs, or essential services. Recipients  of Recovery Act JAG funding received their money in one of two ways— either as a direct payment from the Bureau of Justice Assistance or as a  pass-through from a state administering agency (SAA)—and they reported  using their funds primarily for law enforcement and corrections. Localities  and SAAs that received funds directly from the Department of Justice  expended their awards at varying rates, and the expenditure of Recovery  Act JAG funds generally lagged behind the funds awarded by the SAAs.
Federal fiscal assistance using existing grant programs can also result in  the unintended consequence of hindering the countercyclical intent of the  particular assistance program. This can occur because funds flow to states  through existing funding formulas typically established for purposes other  than providing federal fiscal assistance in response to a national recession.  For example, in the case of Medicaid, the regular (base) FMAP formula is  based on a 3-year average of a state’s per capita income (PCI) relative to  U.S. per capita income. PCI does not account for current economic  conditions in states, as lags in computing PCI and implementing regular  (base) FMAP rates mean that the FMAP rates reflect economic conditions  that existed several years earlier. In the case of Recovery Act JAG  funding, the Bureau of Justice Assistance allocated Recovery Act JAG  funds the same way it allocated non-Recovery Act JAG funds by  combining a statutory formula determined by states’ populations and  violent crime statistics with the statutory minimum allocation to ensure  that each state and eligible territory received some funding. This approach  offers expedience by relying on the existing formula. However, the  purpose of the formula does not take into account states’ fiscal  circumstances during national recessions.
Prior federal fiscal assistance provided for specific purposes has also  included funding for new grant programs. For example, the Recovery Act  created a new program, the State Fiscal Stabilization Fund (SFSF), in part  to help state and local governments stabilize their budgets by minimizing  budgetary cuts in education and other essential government services, such  as public safety. SFSF funds for education distributed under the Recovery  Act had to first be used to alleviate shortfalls in state support for  education to local education agencies and public institutions of higher  education. States had to use 81.8 percent of their SFSF formula grant  funds to support education and use the remaining 18.2 percent to fund a  variety of educational or noneducational entities including state police  forces, fire departments, corrections departments, and health care  facilities and hospitals. In our prior work, we found budget debates at the  state level delayed the initial allocation of education-related funds in some  states.
In contrast to these approaches to providing fiscal assistance, in three of  the six recessions since 1974, the federal government did not provide fiscal  assistance directly to state and local governments (Jan. to July 1980, July  1981 to Nov. 1982, and July 1990 to March 1991). Our prior report has  noted that by providing state and local governments with fiscal assistance  during downturns, the federal government may risk discouraging states  from taking the actions necessary to prepare themselves for the fiscal  pressures associated with future recessions. Other analysts have  suggested that a recession provides state and local officials with an  opportunity for cutting back inefficient operations. If the federal  government immediately steps in with fiscal assistance, such an  opportunity may be lost. Consequently, policymakers could respond to a  future recession by deciding that the federal government should  encourage state and local government accountability for their own fiscal  circumstances by not providing federal fiscal assistance.
As a possible alternative to direct federal fiscal assistance to state  governments, policy analysts have also considered the concept of a  federally sponsored tool to help states prepare for future recessions. We  previously discussed proposals for other new programs that would help  states respond to recessions but may not provide direct federal fiscal  assistance. Examples of these proposed strategies include a national rainy  day fund and an intergovernmental loan program that would help states  cope with economic downturns by having greater autonomy over their  receipt of federal assistance. None of these options have been included in  federal fiscal assistance legislation to date.
A national rainy day fund would require individual state governments to  pay into a fund that would assist states during economic downturns, while  a quasigovernmental agency would administer the fund. The concept of a  national rainy day fund is based on establishing a national risk pool to  provide countercyclical assistance to states during economic downturns.  The national rainy day fund could be modeled on the private  unemployment compensation trust fund in that states would be given  experience ratings that would require larger contributions based on their  individual experience using their own rainy day funds. Proponents of the  national rainy day fund argue that it could reduce state governments’ fiscal  uncertainty by allowing states to use national rainy day funds instead of  raising taxes or modifying or cutting programs. An intergovernmental loan  program could be an alternative to a national rainy day fund program. The  funding for such a loan program could come from either the federal  government or from the private capital market, and it could be subsidized  and possibly guaranteed by the federal government.
These alternative strategies to direct federal fiscal assistance to state  governments face several design and implementation challenges.  Convincing each state to fully fund its required contribution would be an  initial challenge to the viability of a national rainy day program. With  regard to an intergovernmental loan program, such a program could also  delay state governments’ budget decisions, as states may need to dedicate  portions of future budgets to pay for interest on loans. Determining the  appropriate amount of money each state should pay into a national rainy  day fund and controlling the risk and cost of any direct intergovernmental  loan program would present additional challenges. In addition,  representatives from the state organizations and think tanks we spoke  with told us they did not see proposals for a national rainy day fund or  intergovernmental loan programs as politically feasible. The skepticism  regarding these programs included concerns such as accountability issues  with a national rainy day program, as well as issues with states’ ability to  pay back loan interest in a program patterned after the unemployment  insurance trust fund.
We are sending copies of this report to interested congressional  committees. The report will be available at no charge on GAO’s Web site at  http://www.gao.gov. If you or your staff have any questions about this  letter, 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 IV.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: This appendix describes our the work w local budgets during national recessi that exist to provid governments. We also include a list of the organiza during the course of our work.
subsections: section_title: Objectives and Scope
paragraphs: 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.
Pub. L. No. 111-5, Div. B, title V, § 5008, 123 Stat. 115 (Feb. 17, 2009). nance variable is procyclical if the correlation of its cyclical component  To describe the cyclical behavior of state and local government revenues  and expenditures, we first plotted the cyclical components of the finance  variables and the cyclical component of GDP—our benchmark indicator the business cycle—to visually examine how they move in relation to one  another. We then estimated the correlations of the cyclical components the finance variables with the cy clical component of GDP for the same  year, for 1 to 3 years in the past, and 1 to 3 years in the future. In general, a  fi with the cyclical component of GDP for the same year is positive, and a finance variable is countercyclical if the correlation of its cyclical  component with the cyclical component of GDP for the same year is  negative. Specifically, we correlation was greater than or equal to 0.2 and as countercyclical if the  correlation was less than or equal to -0.2. The larger the correlation is in  absolute value, t relationship. A maximum correlation for, say, the previous year indicates that a finance variable tends to lag the business cycle by 1 year.   identified a finance variable as procyclical if the  he stronger the procyclical or countercyclical  e used three alternative methods to estimate the cyclical components of  W the state and local government finance variables and of GDP: (1) by  linearly detrending the natural logarithms of the variables, (2) by usin Baxter-King bandpass filter, and (3) by using the Christiano-Fitzgerald  random walk bandpass filter. Figures 7-9 graph the cyclical compo selected finance variables and GDP as estimated by linear detrending.  Table 4 shows the correlations we calculated using the cyclical  components of the finance variables and GDP as estimated by linear  detrending. All three methods produced similar results. nents of  nd loc ver e dar y cal ye ach g ear-b ars. t financ nt’s own rting pe lly, a survey yea e vari  fisca riod t ables we use are collect l ye er tha hat t,  ar basis,  ed  n a  s which governments maintain their financial records. Any attempt to  standardize the time frame for more than 80,000 governments would  create an insurmountable data collection challenge and would be cost  prohibitive.
We analyzed data from BEA NIPA table 3.3 “State and Local Government  Current Receipts and Expenditures” to identify tre owing, inds in state and loca gox recvernme net borreipts,nt tanvestm nt and savings from 1e to 2010. W ed theP price in GDe usrted  BEA to deflate value dex repoow revenss hars. Tes vaween states durby  ue declind beter-year changes in states’ rie 2009 dollear-ov o asse the most recent recession, we calculated y quarterly tax receipt d a from the U.S. Census Bureau. We calculated at variation ment ded local gopita acrosbt per cain state ans statvern es us Census Bureau. Finally, we reviewed  fiscal year 2008 data from the U.S.  economic and finance literature to better understand how state budgets  are affected during national business cycles.
section_title: Identifying Federal Countercyclical Assistance Strategies and Design Considerations
paragraphs: To identify strategies for providing federal assistance to state and local  governments during national recessions, we reviewed federal fiscal  assistance programs enacted since 1973. We identified these programs  and potential considerations for designing a federal assistance program by  reviewing GAO, Congressional Research Service (CRS), and Congressional  Budget Office (CBO) reports and conducting a search for relevant  legislation. The federal fiscal programs we selected to review for this  report were designed to help state governments address the fiscal effects  of national recessions. This legislation was not intended to address long- term fiscal challenges facing state and local governments. We analyzed the  legislative history and statutory language of past federal assistance  programs, as well as any policy goals articulated in the statutes  themselves. Finally, we interviewed analysts at associations and think  tanks familiar with the design and implementation of federal fiscal  assistance legislation.
To identify factors policymakers should consider when selecting  indicators to time and target federal countercyclical assistance, we  reviewed reports from GAO, CBO, CRS, Federal Reserve Banks, the U.S.  Department of the Treasury (Treasury), and academic institutions. We  considered indicators’ availability at the state level and timeliness (in  terms of frequency and publication lag time) to identify indicators  policymakers could potentially use to target and time countercyclical  federal assistance during downturns. We used several decision rules to  assess indicators’ availability and timeliness. In terms of availability,  indicators created by private sources were excluded because they may be  available only for a fee, may not produce the data in the future, or th methodology may be proprietary, making analysis of the data’s reliability  difficult. In terms of timeliness, we selected indicators that were publish at least quarterly and with less than a 6-month publication lag. Quarterly  publication ensures the indicator covers time periods that are shorter th the length of the typical economic downturn, as indicators that cover mor than 3 months may not be able to differentiate between phases of the  business cycle. We selected indicators with a relatively short publication  lag because indicators with publication lags greater than 6 months may not reveal the downturn until it is already over and the recovery has begun.  For example, we did not include Treasury’s total taxable resources—a  measure of states’ relative fiscal capacity—as a potential indicator  because it is available on an annual basis with a 3-year lag.  s’  We also excluded indicators that may be influenced by state government policy choices. 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. We excluded state governments’ tax receipts from the tbecause this measure is heavily dependent on and reflects policy decisions within each state. In addition, by choosing an indicator independent of  policy choices, policymakers may reduce the potential for unintended  consequences such as discouraging states from preparing for budge uncertainty (sometimes referred to as moral hazard) when desig federal fiscal assistance program.
We also excluded data  intergovernmental benefit programs because program enrollment data  . For  may understate the number of individuals eligible for the program example, we did not include unemployment insurance claims data fr the Department of Labor’s Employment and Training Administration  because the Bureau of Labor Statistics (BLS) has reported that  unemployment insurance information cannot be used as a source for  e  complete information on the number of unemployed. This is becaus claims data may underestimate the number of the unemployed because some people are still jobless when their benefits run out, some individua are not eligible for unemployment assistance, and some individuals ne apply for benefits.  sources detailing state-level participation in  The indicators discussed in this report are not an exhaustive list of  indicators available to time and target federal fiscal assistance to states.  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. For example, GAO has reported on a policy  strategy that combined information on the change in a state’s  unemployment rate with an index of the average level of Medicaid  expenditures by state.
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. The o we contacted included:    American Enterprise Institute,    Center for State & Local Government Excellence    Center on Budget and Policy Priorities,    Federal Reserve Bank of Chicago,    Federal Reserve Bank of St. Louis,    National Association of State Budget Officers,    National Governors Association,    National Conference of State Legislatures,    National League of Cities    The Nelson A. Rockefeller Institute of Government, and   The Pew Center on the States.
We assessed the reliability of the data we used for this review and  determined that they were sufficiently reliable for our purposes.
We conducted this performance audit from February 2010 to March 2011 in accordance with generally accepted government auditing standards Those standards require that we plan and perform the audit to o btain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.  .
section_title: Appendix II: Definitions of Selected Categories of State and Local Government Expenditures and Revenues
paragraphs: This appendix provides summaries of the U.S. Census Bureau’s definition of state and local government revenues and expenditures used in our  analyses of how state and local government budgets are affected during  national recessions. These summaries are adapted from U.S. Census  Bureau, Government Finance and Employment Classification Manual,  October 2006. We have excluded categories that were not discussed in this  report. Employee and retiree health benefits and government pension  contributions on behalf of current employees are accounted for in the  sector (e.g., education) for which the employees work.
General expenditures—All expenditures except those classified as utilit liquor store, or social insurance trust expenditures.  1. Capital outlays—Direc contract or government employee, construction of buildings and other  improvements; for purchase of land, equipment, and existing structures;  and for payments on capital leases.  t expenditures for purchase or construction, by  2. Current expenditures—Direct expen officers and employees and for supplies, materials, and contractual  services except any amounts for capital outlay (current operations),  amounts paid for the use of borrowed money (interest on debt), direct  cash assistance to foreign governments, private individuals, and  nongovernmental organizations neither in return for goods and services  nor in repayment of debt and other claims against the government  (assistance and subsidies), and amounts paid to other governments for  performance of specific functions or for general financial support  (intergovernmental expenditure), including the following categories:  ditures for compensation of own  a. Elementary and secondary education—Current expenditures for  the operation, maintenance, and construction of public schools and  facilities for elementary and secondary education, vocational- technical education, and other educational institutions except tho for higher education; operations by independent governments (scho districts) as well as those operated as integral agencies of state,  county, municipal, or township governments; and financial support of  public elementary and secondary schools.  b. Health and hospitals—Current expenditures for the provision of  services for the conservation and improvement of public health, other  than hospital care, and financial support of other governments’ health  programs; for a government’s own hospitals as well as expenditures  for the provision of care in other hospitals; for the provision of care in  other hospitals and support of other public and private hospitals.  c. Higher education—Current expenditures for higher education  activities and facilities that provide supplementary services to  students, faculty or staff, and which are self-supported (wholly or  largely through charges for services) and operated on a commerci basis (higher education auxiliary enterprises) and for degree-grant institutions operated by state or local governments that provide  academic training beyond the high school level, other than for  auxiliary enterprises of the state or local institution (other higher  education).  d. Highways—Current expenditures for the maintenance, operation,  repair, and construction of highways, streets, roads, alleys, sidewal bridges, tunnels, ferry boats, viaducts, and related non-toll structures (regular highways) and for highways, roads, bridges, ferries, and  tunnels operated on a fee or toll basis (toll highways).  e. Police and corrections—Current expenditures for residential  institutions or facilities for the confinement, correction, and  rehabilitation of convicted adults, or juveniles adjudicated, delinqu or in need of supervision, and for the detention of adults and charged with a crime and awaiting trial (correctional institutions); fo correctional activities other than federal, state and local residential  institutions or facilities (other corrections); and for general police,  sheriff, state police, and other governmental departments that  preserve law and order, protect persons and property from illegal  acts, and work to prevent, control, investigate, and reduce crime  (police protection).  f. Public welfare—Current expenditures associated with  Supplemental Security Income (SSI), Temporary Assistance for Need Families (TANF), Medical Assistance Program (Medicaid) (public  welfare—federal categorical assistance programs); cash payments  made directly to individuals contingent upon their need, other than  those under federal categorical assistance programs (public welfare— other cash assistance programs); public welfare payments made  directly to private vendors for medical assistance and hospital or  health care, including Medicaid (Title XIX), plus mandatory state  payments to the federal government to offset costs of prescription  drugs under Medicare Part D and payments to vendors or the federal  government must be made on behalf of low-income or means-tested  y  beneficiaries, or other medically qualified persons (public welfare— vendor payments for medical care); payments under public welfare  programs made directly to private vendors (i.e., individuals or  nongovernmental organizations furnishing goods and services) for  services and commodities, other than medical, hospital, and health  care, on behalf of low-income or other means-tested beneficiaries  (public welfare—vendor payments for other purposes); provision,  construction, and maintenance of nursing homes and welfare  institutions owned and operated by a government for the benefit of  needy persons (contingent upon their financial or medical need veterans (public welfare—institutions); and all expenditures for  welfare activities not classified elsewhere (public welfare—other).  g. Other—Current expenditures for all other functions.  eral revenue—General revenue is all revenue except that classified as  r store, utility, or insurance trust revenue.  1. Intergovernmental revenue from the federal government—Amounts  received directly from the federal government. For states, this includ fedety,  reimral grants and aid, payments-in-lieu-of-taxes on federal proper tranbursements for state activities, and revenue received but later  govesmitted through the state to local governments. For local rnments, this category includes only direct aid from the federal  government.  2. Ow by a emp insu improvements (taxes), charges imposed for providing current services or  for t t activities  (cur own n-source revenue—Revenue from compulsory contributions e  government for public purposes, other than for employee and  loyer assessments and contributions to finance retirement and soc rance trust systems and for special assessments to pay capital  he sale of products in connection with general governmen rent charges), and all other general revenue of governments from their   sources (miscellaneous general revenue).
section_title: Appendix III: Examples of Congressional Responses to Assist State and Local Governments in Response to National Recessions Since 1973
subsections: section_title: Countercyclical legislation
paragraphs: CETA—Provided job training and employment for  economically disadvantaged, unemployed, and  underemployed persons through a system of federal, sta and local programs. grams (Added by Title 1  ub. L. No. 93-567)
Titles II and VI—Provided transitional state and local  government public service jobs in areas with high  unemployment rates.
Provided emergency financial assistance to create,  maintain or expand jobs in areas suffering from unusually high levels of unemployment.
Title Capital Development and  Investment Act of 1976    I—Local Public Works  Authorized funds to establish an antirecess and increased federal funding to states and localities to  improve the nation’s public infrastructure—roads, bridges,  sanitation systems, and other public facilities.
Title II—Antirecession  Fiscal Assistance (ARFA)
ARFA intended to offset certain fiscal actio ns taken by state  governments during recessions, including raising taxes and  layoffs. It was designed to achieve three objectives: to  maintain public employment, maintain public services, an counter the November 1973—March 1975 recession.  Under the ARFA program, state governments receive third of the allocation, while local governments received  two-thirds.
The State and Local Fiscal Assistance Act of 1972 in to help assure the financial soundness of state and local  governments through general revenue sharing. The  Amendments of 1976 extended and modified this Act.
For payments to the State and Local Government Fiscal  Assistance Trust Fund, as authorized by The State and  Local Fiscal Assistance Act of 1972, which was intended to help assure the financial soundness of state and local  governments through general revenue sharing.
See Antirecession Fiscal Assistance (ARFA) above. An  additional amount for ARFA was to remain available until  September 30, 1978.
Employment And Training  Made economic stimulus a Assistance and training.
Made economic stimulus appropriations for CETA.
Made economic stimulus appropriations for the fiscal year  ending September 30, 1977, as well as for other purposes.
Increased the authorization for the Local Public Works  Capital Development and Investment Act of 1976 (see  above) and provided funding for the im works projects which were to be performed by cont awarded by competitive bidding.
Did not include federal counte governments.
Federal countercyclical legislation enacted provided som assisting state and local governments.
Provided (1) fiscal relief through a temporary increase in federal Medicaid funding for all states, as well as (2)  general assistance divided among the states for essen government services. The funds were allocated to the  states on a per capita basis, adjusted to provide for  minimum payment amounts to smaller states.
Division B, Title V: State  Fiscal Relief Fund (FMAP)
Education Jobs and Recovery  Act FMAP Extension, Pub. L.  No. 111- 226 (federal legislation  enacted on August 10, 2010, to  amend the Recovery Act.)
Funds awarded to local educational agencies under this law  may be used only to retain existing employees, to recall or  rehire former employees, and to hire new employees, in  order to provide educational and related services. These  funds may not be used to supplement a rainy-day fund or  reduce debt obligations incurred by the state.
Provided for an extension of increased FMAP funding  through June 30, 2011, but at a lower level.
section_title: Appendix IV: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
paragraphs: Stanley J. Czerwinski, Director, Strategic Issues, (202) 512-6806 or  czerwinskis@gao.gov.  homas J. McCool, Direc tor, Center for Economics, (202) 512- .
section_title: Staff Acknowledgments
paragraphs: Michelle Sager (Assistant Director), Shannon Finnegan (Analyst-in- Charge), Benjamin Bolitzer, Anthony Bova, Amy Bowser, Andrew Ching,  Robert Dinkelmeyer, Gregory Dybalski, Robert Gebhart, Courtney  LaFountain, Alicia Loucks, Donna Miller, Max Sawicky, and Michael  Springer also made key contributions to this report.
section_title: Related GAO Products
paragraphs: Medicaid: Improving Responsiveness of Federal Assistance to Sta During Economic Dow 2011.  nturns. GAO-11-395. Washington, D.C.: March 31,  Recovery Act: Oppo Accountability over States’ and Localities’ Uses of Funds. GAO-10-999.  Washington, D.C.: September 20, 2010.  rtunities to Improve Management and Strengthen  State and Local Governments: Fiscal Pressures Could Have Implication for Future Delivery of Intergovernmental Programs. GAO-10-899.  Washington, D.C.: July 30, 2010.
Recovery Act: States’ and Localities’ Uses of Funds and Actions Needed  to Address Implementation Challenges and Bolster Accountability.  GAO-10-604. Washington, D.C.: May 26, 2010.
Recovery Act: One Year Later, States’ and Localities’ Uses of Funds and  Opportunities to Strengthen Accountability. GAO-10-437. Washington,  D.C.: March 3, 2010.
State and Local Governments’ Fiscal Outlook: March 2010 Update.  GAO-10-358. Washington, D.C.: March 2, 2010.
Recovery Act: Status of States’ and Localities’ Use of Funds and Efforts  to Ensure Accountability. GAO-10-231. Washington, D.C.: December 10,  2009.
Recovery Act: Recipient Reported Jobs Data Provide Some Insight into  Use of Recovery Act Funding, but Data Quality and Reporting Issues  Need Attention. GAO-10-223. Washington, D.C.: November 19, 2009.
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.: September 23, 2009.
Recovery Act: States’ and Localities’ Current and Planned Uses of Funds  While Facing Fiscal Stresses. GAO-09-829. Washington, D.C.: July 8, 2009.
Recovery Act: As Initial Implementation Unfolds in States and  Localities, Continued Attention to Accountability Issues Is Essential.  GAO-09-580. Washington, D.C.: April 23, 2009.
American Recovery and Reinvestment Act: GAO’s Role in Helping to  Ensure Accountability and Transparency. GAO-09-453T. Washington,  D.C.: March 5, 2009.
Update of State and Local Government Fiscal Pressures.  GAO-09-320R.Washington, D.C.: January 26, 2009.
State and Local Fiscal Challenges: Rising Health Care Costs Drive Long- term and Immediate Pressure. GAO-09-210T. Washington, D.C.:  November 19, 2008.
Medicaid: Strategies to Help States Address Increased Expenditures  during Economic Downturns. GAO-07-97. Washington, D.C.: October 18,  2006.
Federal Assistance: Temporary State Fiscal Relief. GAO-04-736R.  Washington, D.C.: May 7, 2004.