WASHINGTON (Reuters) - State and local governments can expect ever-widening budget gaps through 2060, as rising healthcare costs for both citizens and public employees surpass recent improvements in their revenue, the Government Accountability Office said on Monday.
Closing the gap may require drastic action.
If state and local governments were to end the shortfalls over the next 50 years solely through spending cuts, they would have to reduce their expenditures 14.2 percent each year, GAO found. If they relied only on tax increases, they would need to raise revenue by a "similar magnitude."
Each year, the federal auditing agency releases a long-term outlook for state and local budget conditions, and this year's forecast included the public sector's steadily rising revenue.
From the second quarter of 2009 to the third quarter of 2012, total tax receipts increased more than 12 percent, returning to the pre-recession levels of early 2008, GAO said. Income taxes were up 22 percent over that time, in particular.
Recently, the independent Rockefeller Institute of Government found that even when dollar amounts are adjusted for inflation states' revenues are higher than before the downturn. Meanwhile, states collected a record $794.6 billion in tax revenue in fiscal 2012, which for most ended on June 30, 2012, the U.S. Census reported earlier this month.
But the GAO warned that as a percentage of the country's gross domestic product their tax revenue "will remain below the 2007 historical high through 2060 due to the projected modest growth in receipts."
Meanwhile, rising medical costs will consume more of states' dollars, through the Medicaid health insurance program for the poor and public employees and retirees, GAO said.
Health-related costs will be about 3.8 percent of GDP in 2013 and 7.2 percent of GDP in 2060 for state and local governments. On the flip side, other expenditures such as employees salaries will likely decline to about 7.7 percent of GDP in 2060 from 10.5 percent this year.
The office has warned before that rising medical costs will bust state and local budgets, but this year it noted that the healthcare reform law known as Obamacare - which includes extra funds for Medicaid - has primarily created uncertainty for the state and local fiscal outlook.
Because states can opt out of the Medicaid expansion and because it is unclear how healthcare costs will grow under the law, the GAO cannot forecast specific effects of the law.
The 2007-09 recession hit state budgets late, with revenue beginning to dive in 2008 as unemployment rose. Because all states except Vermont must end their fiscal years with balanced budgets, they raced to make emergency spending cuts, institute temporary tax and fee increases and borrow.
They also turned to the federal government for help. The U.S. government now sends state and local governments more than 11 times the money it granted them in 1960, according to President Barack Obama's annual report on the economy to Congress released in March.
In a separate report on Monday, Standard & Poor's Investors Service warned that cutting the federal aid could make future recessions "a nastier experience for states."
GAO said it was hard to gauge the effects of current federal budget battles that could hurt state and local fiscal conditions, namely the across-the-board automatic spending cuts known as sequestration.
Reporting By Lisa Lambert; Editing by Cynthia Osterman