GAO: State, local budgets have tough road ahead

By Peter Schroeder - 04/05/12 12:52 PM ET

State and local governments have enjoyed a brief fiscal comeback since the bubble burst, but troubling times lie ahead, according to a new government study.

As the economy has dug out from under the recession, state and local governments are finally bringing in tax receipts equivalent to what they made in 2007, before the financial crisis hit.

But a new report from the Government Accountability Office (GAO) does not paint a rosy future picture for state and local finances, as expenses, driven primarily by climbing healthcare costs, will make it harder and harder to come up with balanced budgets.

"Absent any intervention or policy changes, state and local governments would face an increasing gap between receipts and expenditures in the coming years," the watchdog wrote.

According to its latest analysis, the GAO projects deficits at the state and local level will only get worse for the foreseeable future under existing policy. Without changes to shore up finances, the GAO projects deficits will continue to grow steadily for decades to come.

To be precise, the GAO estimates that if state and local governments wanted to close the gap between revenues and expenditures, they would have to either cut spending by 12.7 percent or increase taxes by the same amount.

The primary cause for the worsening fiscal picture is the projected growth of healthcare costs. For state and local governments, that means spending on Medicaid, coupled with the cost of providing healthcare to state and local government employees and retirees.

The GAO projects that from 2012 to 2060, healthcare costs will grow from 3.9 percent of the nation's economy to 7.1 percent. In contrast, other government spending, including paying government employees, is expected to decline in the future as a share of the economy.

The impact of the healthcare reform law will be mixed for state and local governments, according to GAO. For example, states that offer less Medicaid coverage now could see their costs climb as the law as implemented — although other portions of the law could reduce costs elsewhere.

Similarly, the impact of the budget deal struck to avert the summer's debt-limit fight could be a mixed bag at the state and local level. The GAO said it is still "unclear" exactly how they will be affected by the automatic cuts set to take effect in the new year.