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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. . 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). 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. Stanley J. Czerwinski, Director, Strategic Issues, (202) 512-6806 or czerwinskis@gao.gov. homas J. McCool, Direc tor, Center for Economics, (202) 512- . 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. 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.

Summary: 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. 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.