What GAO FoundThe state and local government sector continues to face near-term and long-term fiscal challenges that grow over time. The fiscal challenges confronting the state and local sector add to the nation’s overall fiscal challenges. The fiscal situation of the state and local government sector has improved in the past year as the sector’s tax receipts have slowly increased in conjunction with the economic recovery. Nonetheless, total tax receipts have only recently returned to the prerecession levels of 2007 and the sector still faces a gap between revenue and spending. The sector faces long-term fiscal challenges that grow over time. The fiscal position of the sector will steadily decline through 2060 absent any policy changes.One of the primary factors contributing to the near-term improvement in the fiscal picture of the state and local government sector is the increase in tax receipts following the decline during 2008 and into 2009. Specifically, from the second quarter of 2009 to the third quarter of 2011, total tax receipts increased nearly 11 percent, returning to prerecession levels of 2007. Income and sales taxes accounted for most of the growth, increasing about 18 percent and 10 percent over the same period, respectively. However, property tax receipts, which had grown more than 3 percent from the second quarter of 2009 to the third quarter of 2010, flattened in 2011, increasing less than 1 percent from 2010 to 2011 as real estate values remained depressed. In addition, as most outlays from the American Recovery and Reinvestment Act of 2009 (Recovery Act) have already occurred, the state and local government sector will continue to adjust to a reduced level of federal assistance provided by the Recovery Act. This April 2012 update to our model incorporates these near-term changes for both revenues and expenditures but focuses primarily on the long-term fiscal outlook for state and local governments as a sector.In the long term, the decline in the sector’s operating balance is primarily driven by the rising health-related costs of state and local expenditures on Medicaid and the cost of health care compensation for state and local government employees and retirees. Since most state and local governments are required to balance their operating budgets, the declining fiscal conditions shown in our simulations suggest that the sector would need to make substantial policy changes to avoid growing fiscal imbalances in the future. That is, absent any intervention or policy changes, state and local governments would face an increasing gap between receipts and expenditures in the coming years.Why GAO Did This StudyFiscal sustainability presents a national challenge shared by all levels of government. Since 2007, GAO has published long-term fiscal simulations for the state and local government sector. These simulations show that, like the federal government, the state and local government sector faces persistent and long-term fiscal pressures.Using the Bureau of Economic Analysis’s (BEA) National Income and Product Accounts (NIPA) as the primary data source, our model shows the level of receipts and expenditures for the sector until 2060 based on current and historical spending and revenue patterns. A basic assumption of our model is that the current set of policies in place across state and local government remains constant. The model simulates the long-term fiscal outlook for the state and local sector as a whole, and while the model incorporates the Congressional Budget Office’s (CBO) economic projections, adjustments are made to capture the budgetary effects of near-term cyclical swings in the economy. Because the model covers the sector in the aggregate, the fiscal outcomes for individual states and localities cannot be captured. This product is part of a body of work on the nation’s long-term fiscal challenges. Related products can be found at www.gao.gov/special.pubs/longterm/.For more information, contact Stanley J. Czerwinski at (202) 512-6806 or czerwinskis@gao.gov or Thomas J. McCool at (202) 512-2700 or mccoolt@gao.gov.