Outlook still grim for US state, local budgets-GAO

April 5 Thu Apr 5, 2012 2:59pm EDT

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April 5 (Reuters) - U.S. state and local governments' fiscal situations have improved recently but will still deteriorate through 2060, the Government Accountability Office said on Thursday.

Each year, the federal auditing agency releases a long-term outlook for state and local budget conditions. Last year, it warned that rising healthcare costs and low revenue would create extraordinary pressures on public sector budgets for decades to come.

This year, the outlook improved for the near term, mostly due to an "increase in tax receipts following the decline during 2008 and into 2009," GAO said.

But the outlook remains gloomy for the future, with healthcare costs, both for public employees and for the Medicaid insurance program for the poor, swelling and weighing on budgets, GAO said.

"Specifically, state and local expenditures on Medicaid and the cost of healthcare compensation for state and local government employees and retirees are projected to grow more than GDP (gross domestic product)," it said.

The healthcare reform law that was recently debated in the U.S. Supreme Court will be the biggest wild card and its effects "will continue to evolve and will likely vary among the states," GAO said about the law, known as the Patient Protection and Affordable Care Act.

This was the first year the office estimated healthcare costs for state and local government employees and retirees. In many states, retiree healthcare, which many governments fund on a pay-as-you-go basis, is not considered part of the pension system, but an "OPEB," or "other post-employment benefit."

For most states, revenue has clawed back from the lows plumbed in 2009 and 2010 - the worst in decades.

GAO noted that from the second quarter of 2009 to the third quarter of 2011, "total tax receipts increased nearly 11 percent, returning to pre-recession levels of 2007" for state and local governments combined.

Still, the improvement was primarily in income and sales taxes and GAO warned that the housing market collapse that began in 2006 will haunt revenue in future decades.

Property tax receipts, a primary revenue source for most cities, counties and schools, flattened in 2011, and growth will remain sluggish, GAO said. Last year, it projected property taxes would represent 3.22 percent of national gross domestic product in 2060. Now it expects them to only represent 3.1 percent.

All states except Vermont must end their fiscal years with balanced budgets, and most local governments, too, must align spending with income. As revenue collapsed during the recession, many rushed to hike taxes, slash spending, borrow and turn to the federal government for help.

To avoid yawning budget gaps that will require further cuts and tax hikes "the sector would need to make substantial policy changes to avoid growing fiscal imbalances," GAO said.

One of the biggest causes of concerns in the public sector is pension under funding. The values of assets held by state and local pension systems dropped in the recession, and "have not recovered to match or exceed the 2007 value of $3.2 trillion," GAO said. Investments provide the lion's share of public pension revenue.

"While most state and local government pension plans have assets sufficient to cover benefit payments to retirees for a decade or more, plans have experienced a growing gap between assets and liabilities," GAO said. (Reporting by Lisa Lambert; Editing by James Dalgleish)

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