Health Care Costs Driving Dismal Picture for Governments

March 5, 2010 ( – A new report from the Government Accountability Office says state and local governments face persistent and long-term fiscal pressures.

According to the report, increases in federal grants-in-aid – largely from the Recovery Act – alleviated some near-term pressure on state and local government budgets. The GAO found that the March 2010 operating balance measure (including 2009 Recovery Act funds) shows an improvement compared to the January 2009 simulation.

However, the GAO projects that the sector’s long-term fiscal position will steadily decline through 2060 absent any policy changes.The agency said the decline in is primarily driven by rising health care costs.

Specifically, the report said state and local expenditures on Medicaid and the cost of health insurance for state and local retirees and employees are projected to grow more than the GDP. The GAO’s model also projects that the sector’s health-related costs will be about 3.5% of GDP in 2010 and 3.8% of GDP in 2011.

In contrast, the agency said it found that other types of state and local government expenditures -including wages and salaries of state and local workers and investments in capital goods – are expected to grow slightly less than GDP. It also found that revenue growth, excluding Medicaid grants from the federal government, is projected to be relatively flat as a percentage of GDP.

The report also noted that recent declines in pension asset values stemming from the current recession could also affect state and local governments’ long-term fiscal position. According to the report, the sector experienced a decline in pension asset values of 27.6%, from $3.2 trillion at the end of 2007 to $2.3 trillion at the end of 2008. The GAO’s March 2009 estimate of the sector’s required contribution rate rose to 9.9% of the sector’s wages, which is higher than the sector’s actual 8.3% of wages contributed in 2008.

However, in addition to declines in pension asset values and the challenge of fully funding pension benefits, state and local governments also face challenges funding their liabilities for other public employee benefits – which, the GAO noted, are primarily retiree health benefits.

The report lends credibility to the reaction some groups had to a recent Pew Center report on the states. Pew’s report, “The Trillion Dollar Gap,” indicated there was a $1 trillion gap at the end of fiscal year 2008 between what states had set aside to pay for employees’ retirement benefits and what they owed (see IMHO: Promises Premises). Following the report’s release, The National Association of State Retirement Administrators and the National Council on Teacher Retirement issued a statement saying that the vast majority of the financing gap is not attributable to pensions, but rather to health care programs that until recently were funded primarily on a pay-as-you-go basis (see Groups Dissect Pew Report on State Retiree Benefit Funding).

The GAO said it calculated that closing the fiscal gap would require action to be taken today and maintained for each and every year going forward equivalent to a 12.3% reduction in state and local government current expenditures. The report said closing the fiscal gap through revenue increases would require action of a similar magnitude through increased state and local tax receipts.

The GAO’s report is here.