From the U.S. Government Accountability Office, www.gao.gov Transcript for: 2014 Update to GAO’s State and Local Fiscal Outlook Model Description: Audio interview by GAO staff with Michelle Sager, Director, Strategic Issues Related GAO Work: GAO-15-224SP: State and Local Governments’ Fiscal Outlook: 2014 Update Released: December 2014 [ Background Music ] [ Narrator: ] Welcome to GAO's Watchdog Report, your source for news and information from the U.S. Government Accountability Office. It's December 2014. Nationwide state and local governments face long-term fiscal sustainability challenges. Since 2007, GAO has published simulations of fiscal trends in the state and local government sectors. A team lead by Michelle Sager, a director in GAO's Strategic Issues team, recently updated GAO's state and local fiscal outlook. GAO's Jacques Arsenault sat down with Michelle to talk about what they found. [ Jacques Arsenault: ] The state and local fiscal outlook uses a 50-year fiscal gap as a way to measure fiscal challenges at the state and local level. Can you talk about what this gap is? And what does it tell us? [ Michelle Sager: ] To explain the fiscal gap and what it means, it's likely helpful to first explain a few key aspects of GAO's state and local model. In its simplest form, the state and local fiscal outlook looks at the revenues, or the receipts, coming in to all state and local governments compared to the expenditures going out for these governments. The difference between receipts and expenditures is what we refer to as the operating balance of state and local sector as a whole. In other words, the simple version of the model is to think of a math problem where expenditures are subtracted from receipts, and the difference is the operating balance. The model then simulates the state and local sectors ability to cover expenditures with receipts. One way of using these data to illustrate the long-term outlook for the state and local government sector is through a measure we refer to as the fiscal gap. The fiscal gap is an estimate of the action that would be needed today and then maintained for each year going forward to achieve fiscal balance during the next 50 years from 2014 to 2063. Closing this gap would require state and local governments to make policy changes to assure that receipts are at least equal to expenditures. So, we calculated that closing the fiscal gap would require action to be taken today and then maintained for each year going forward, roughly equivalent to an 18% reduction in state and local government current expenditures. Closing the gap through revenue increases would require action of a similar magnitude through increases in state and local tax revenues. More likely, closing the fiscal gap would require some combination of revenue increases and expenditure reductions. It's important to note that a key assumption of the model is that the current set of policies in place across state and local government remains constant just for purposes of the simulation. Now we know that state and local governments make policy changes to adjust their revenues and expenditures and maintain balanced budgets. But we do not attempt to predict what these changes might be. In other words, the fiscal gap provides an illustration of the pressures that are facing the sector rather than a prediction of future fiscal outcomes. [ Jacques Arsenault: ] So, then how has the outlook for states and localities changed since your last update? [ Michelle Sager: ] As a long-term outlook for the sector in the aggregate, the year-to-year variations and the findings tend to be fairly subtle. Since GAO first completed the state and local model in 2007, our simulations have consistently shown that state and local governments face long-term fiscal pressures. These pressures contribute to the overall fiscal challenges for the nation as a whole. [ Jacques Arsenault: ] One of the things that your report cited was healthcare costs as one of the primary drivers of costs for states and localities, can you talk about the impact of these costs? [ Michelle Sager: ] The rising health-related costs affect states and localities in two ways. First, state and local expenditures on Medicaid. And second, the cost of healthcare compensation for state and local government employees and retirees. The model simulation suggests that the sectors health-related costs will be about 3.9% of gross domestic product, or GDP, in 2014 and about 7.4% of GDP in 2060. In contrast, other types of state and local government expenditures such as wages and salaries for state and local employees decline as a percentage of GDP and by 2060 would drop below the sectors health-related cost in our model. [ Jacques Arsenault: ] And finally, for taxpayers and for state and local policymakers, what would you say is the bottom line of this report? [ Michelle Sager: ] The state and local government sector continues to face fiscal challenges, which contribute to the overall fiscal challenges of the nation as a whole. Our model simulation suggest that the sector could continue to face a gap between revenue and spending during the next 50 years and that state and local governments would need to make substantial policy changes to avoid these fiscal imbalances in the future. The bottom line is that fiscal sustainability presents a national challenge shared by all levels of government. [ Background Music ] [ Narrator: ] To learn more, visit GAO.gov and be sure to tune in to the next episode of GAO's Watchdog Report for more from the congressional watchdog, the U.S. Government Accountability Office.