Welfare Reform: Challenges in Saving for a Rainy Day (26-APR-01, 
GAO-01-674T).							 
								 
This report discusses states' plans for operating their Temporary
Assistance for Needy Families (TANF) programs in the event of an 
economic downturn. GAO found that the data available on the	 
levels and adequacy of states' reserves is insufficient and	 
misleading. Furthermore, most states have done little planning	 
for economic contingencies. Many states cite obstacles to saving 
money for possible economic downturns. Although TANF funds can be
set aside in a budgetary reserve, state officials said that they 
are concerned that the accumulation of unspent TANF funds might  
signal that the funds are not needed. Another option for states  
would be to save their own funds in a general purpose rainy day  
account, but state officials said that welfare would have to	 
compete with other state priorities when these funds are released
from state treasuries. There are now federal contingency	 
mechanisms for states to access additional federal resources in  
the event of a recession or other emergency--the Contingency Fund
for State Welfare Programs and the Federal Loan for State Welfare
Programs. However, states generally found these programs too	 
complex and restrictive, and would most likely find other ways to
sustain their welfare programs. 				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-674T					        
    ACCNO:   A00907						        
  TITLE:     Welfare Reform: Challenges in Saving for a Rainy Day     
     DATE:   04/26/2001 
  SUBJECT:   Federal/state relations				 
	     Grants to states					 
	     State-administered programs			 
	     Welfare benefits					 
	     Future budget projections				 
	     Budgetary reserves 				 
	     Public assistance programs 			 
	     Recession						 
	     Funds management					 
	     HHS Temporary Assistance for Needy 		 
	     Families Block Grant				 
								 
	     HHS Temporary Assistance for Needy 		 
	     Families Program					 
								 
	     Contingency Fund for State Welfare 		 
	     Programs						 
								 
	     Federal Loans for State Welfare Programs		 
	     California 					 
	     Colorado						 
	     Connecticut					 
	     Louisiana						 
	     Maryland						 
	     Michigan						 
	     Oregon						 
	     Texas						 
	     Wisconsin						 

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GAO-01-674T

As currently structured, the reconciliation process favors states that are
?needy? within a single federal fiscal year compared with those that are
?needy? in months that overlap consecutive federal fiscal years.

As currently structured, the reconciliation process favors states that are
?needy? within a single federal fiscal year compared with those that are
?needy? in months that overlap consecutive federal fiscal years. A state
that is needy for all 12 months during a federal fiscal year would have to
match all funds drawn at its applicable fiscal year FMAP rate with no
adjustments for the number of months it was eligible because it was needy
throughout the year. However, a state that is needy for 12 consecutive
months that span 2 federal fiscal years (e. g., 6 months in each year) with
an identical FMAP rate will see its federal match rate reduced by half
because of the adjustment made for number of months the state was needy in
each year.

To illustrate, the state that was needy for an entire federal fiscal year
and was eligible for and had drawn $20 million of contingency funds would be
able to retain these funds, provided the state had spent the necessary
matching funds. In contrast, the state that qualified as needy for the same
number of months and was eligible for the same amount from the contingency
Fund but overlapping 2 fiscal years would initially obtain $10 million in
each year, reflecting its 6 months of eligibility in each year, but then the
state would have to remit half of these funds after each year?s
reconciliation. This latter reduction is the result of prorating the state?s
grant by the number of months it was eligible for contingency funds, even
though the state?s initial claim for each year was already based on the
number of months of eligibility. As a result, the second state would be
allowed to retain a total of $5 million of federal funds in that fiscal
year, $5 million of federal funds in the next fiscal year- a total of $10
million even though its eligibility over these 2 years was the same as the
state receiving $20 million. In addition, the second state would have to
meet the Contingency Fund MOE in both years.

Testimony Before the Subcommittee on Human Resources, Committee on Ways and
Means, House of Representatives

United States General Accounting Office

GAO For Release on Delivery Expected at 10 a. m. Thursday, April 26, 2001

WELFARE REFORM Challenges in Saving for a ?Rainy Day?

Statement of Paul L. Posner Managing Director, Strategic Issues

GAO- 01- 674T

Page 1 GAO- 01- 674T

Mr. Chairman and Members of the Subcommittee: Thank you for inviting me here
today to discuss states? plans for operating their welfare programs in the
event of an economic downturn. In the block grant environment, the federal
government has an interest in encouraging states to save for future
contingencies, but within a framework that recognizes that the size of the
reserve will remain largely a state determination made under conditions of
inherent uncertainty. In 1998 we reported on states? plans for financing
their welfare programs in the event that the economy unexpectedly turned
down. 1 At that time most states? budget forecasts predicted that the robust
economy would continue providing strong revenue growth potential and, more
important for states? Temporary Assistance for Needy Families (TANF)
budgets, diminishing costs in many social services programs. Last year, this
subcommittee asked us to revisit the states examined in our 1998 report and
to, among other things, look anew at their contingency plans. In part, my
statement today includes research we conducted in 10 states (California,
Colorado, Connecticut, Louisiana, Maryland, Michigan, New York, Oregon,
Texas, and Wisconsin).

As we will discuss more fully later in this testimony, the data available on
the levels and adequacy of states? reserves is insufficient and misleading.
Furthermore, our case studies suggest that most states have done little
planning for economic contingencies. Because states? new welfare programs
remain untested in times of downturn, these uncertainties make it difficult
for anyone to predict how states will respond and how former welfare
recipients will be affected if and when economic conditions change. Despite
the significant changes made to the nation?s welfare program, the economy
will no doubt play a role in determining how many people return to the
welfare rolls and how long they, and those currently on the rolls, will
remain if there are fewer job opportunities available.

As economic forecasts have begun to change, there is some concern that the
states might not be as prepared as they could be to manage the new fiscal
challenges under welfare reform. Many adults have left the rolls for work
since TANF was implemented- caseloads have dropped more than 50 percent
nationwide- and those remaining on the rolls have increased their work
efforts. Greater emphases on work implies a tighter link to

1 Welfare Reform: Early Fiscal Effects of the TANF Block Grant (GAO/ AIMD-
98- 137, August 22, 1998).

Page 2 GAO- 01- 674T

work and hence the economy. This could make TANF more sensitive to an
economic downturn than Aid to Families with Dependent Children (AFDC) if
former recipients return to the rolls when they are laid off, causing state
TANF budgets to rise. However, the flexibility of the grant combined with
significant unspent TANF balances may help mitigate the fiscal fallout from
economic downturns.

In today?s testimony I plan to address three points:

 The shifting fiscal balance between the states and the federal government
and the challenges this new partnership poses in financing and strengthening
the safety net during times of economic stress.

 The potential for states to draw on their TANF grants and state reserves
to cushion fiscal and economic shocks to the program.

 The complexity in the design of existing TANF contingency mechanisms that
limits the effectiveness of these mechanisms in responding to uncertainties
in the economy.

Finally, I would like to conclude with some options this Subcommittee might
consider that could lead to refinements in the new fiscal partnership on
welfare, giving the states more incentives to save while maintaining the
federal role in the safety net.

The Personal Responsibility and Work Opportunity Reconciliation Act of 1996
(P. L. No. 104- 193) (PRWORA) made sweeping changes to national welfare
policy. Principally, these reforms gave states the flexibility to design
their own programs and the strategies necessary for achieving program goals,
including how to move welfare recipients into the workforce. But because the
act also changed the way in which federal funds for welfare programs flow to
the states, most of the program?s fiscal risks also shifted to the states.
PRWORA created the TANF block grant, a fixed federal funding stream that
replaced the AFDC and related programs in which federal funding matched
state spending and increased automatically with caseload. Under AFDC, which
entitled eligible families to aid, the federal funding was largely open-
ended so that if a state experienced caseload and related cost increases,
federal funds would increase with state funds to cover expenditures for the
entire caseload. This open- ended federal commitment provided that financing
for every dollar spent on these programs was shared by the federal
government and the states, thereby limiting the states? exposure to
escalating costs. In contrast, the TANF block grant eliminated the federal
entitlement to aid. The federal government provides a fixed amount of funds
regardless of New Fiscal

Partnership Poses Challenges

Page 3 GAO- 01- 674T

any changes in state spending or the number of people the programs serve.
While the states must also provide a fixed level of funds from their own
resources- their maintenance of effort (MOE) 2 -they are now responsible for
meeting most of the costs associated with any increase in caseload on their
own. How they plan to manage this fiscal risk is what I refer to in this
testimony as contingency planning.

In this new welfare partnership, it is tempting to suggest that since
welfare reform devolved decisions regarding eligibility and program services
to the states, the potential volatility of the caseload is no longer a
federal concern. However, in light of both federal requirements and their
own fiscal limitations, states will be challenged during a downturn to
maintain or increase state funds for benefits when they are most needed.
States? decisions regarding who to serve, for how long, and with what
services will surely depend on how much flexibility they have with the
resources- state and federal- that are available to finance their welfare
programs. Although considerable uncertainties exist about the impacts of
downturns, the potential cyclical nature of program costs as well as the
fiscal constraints states face in responding to hard times heightens the
importance of fiscal planning. Helping states maintain their programs was
indeed recognized as a federal interest by Congress when it included the
Contingency Fund and Loan Fund- mechanisms for states to gain access to
additional federal funds- in TANF.

It is unclear what impact a major economic downturn or recession will have
on welfare participation given the significant reforms in national welfare
policy. Recent studies have tried to establish a link between caseload
trends and certain macroeconomic indicators in part to determine how
sensitive welfare programs might be to changes in the economy. While the
research literature generally suggests that caseloads may very well increase
in an economic downturn, there is substantial uncertainty regarding the
extent of the impact. These studies point to the variety of other factors
affecting caseload levels, particularly with the advent of welfare reform.

2 States? MOE requirements are based on their own spending in federal fiscal
year 1994 on AFDC, Job Opportunities and Basic Skills (JOBS), Emergency
Assistance (EA), related administrative costs, and AFDC/ JOBS child care
programs: AFDC- Child Care Program, Transitional Child Care, and At- Risk
Child Care programs. A state that does not meet PRWORA?s work participation
rates must maintain at least 80 percent of its MOE. A state that meets its
work participation rate must maintain at least 75 percent of its MOE. Impact
of Economic

Cycles on TANF Caseloads Is Uncertain

Page 4 GAO- 01- 674T

For example, a 1999 Council of Economic Advisors (CEA) report suggests that
a 1 percent increase in the unemployment rate could produce a 5 to 7 percent
increase in welfare caseloads. However, this same study noted that changes
in family structure and welfare policies can significantly mitigate the
impact of an economic downturn on caseloads. In fact, the recent caseload
drop was at least partly due to reforms ushered in by TANF- the study
suggests that about one- third of the caseload reduction from 1996 through
1998- independent of the strong economy. 3

Just as the reforms may have prompted reduced caseloads during times of
economic expansion, greater emphases on work implies a tighter link to work
and hence the economy, making TANF more sensitive to an economic downturn
than AFDC. On the other hand, the reforms may pose significant disincentives
for people to return to the welfare rolls or to apply even if they are
eligible during downturns. For example, PRWORA imposes a 5- year lifetime
limit on federal assistance on individuals receiving on going assistance; 4
many may try other options first before returning to the welfare rolls. In
addition, many states now offer a variety of work supports such as child
care, transportation subsidies, and an earned income tax credit (EITC) to
families not receiving cash assistance. These supports may be enough to
allow earnings from even a part- time job to support a family without
returning to the cash assistance rolls.

Budgetary stress caused by caseload volatility may be compounded by the
limitations placed on most states by constitutional or statutory
requirements to balance their general fund budgets. During a fiscal crisis,
state policymakers face difficult choices regarding whom to serve, for how

3 A recent survey of the research literature on this topic notes that there
is a ?mixed bag? of evidence regarding policy reform?s influence on caseload
size. Some studies found that policy reforms did not independently cause- or
have an influence- on caseload declines. See Bell, Stephen H. ?Why Are
Welfare Caseloads Falling?? Urban Institute, March 2001.

4 In promulgating regulations concerning TANF, the Department of Health and
Human Services (HHS) makes a distinction between TANF- or MOE- funded
activities that are considered assistance and TANF- or MOE- funded
activities that are not considered assistance. The distinction is important
because activities that are considered ?assistance?

are subject to a variety of spending limitation and requirements- including
work, time limits, child support assignments, and data reporting. Activities
considered to be nonassistance would not have the same requirements
associated with them. Assistance includes benefits directed at basic needs
even when based on participation in a work experience or community service
activity. It also includes childcare, transportation, and supports for
families that are not employed. State Budget Processes

Could Have an Impact on TANF Programs

Page 5 GAO- 01- 674T

long, and with what services. But more important to the discussion today is
that each of these ?hard choices? must be financed in the context of fiscal
limitations- including legislative restrictions, constitutional balanced
budget mandates, or conditions imposed by the bond market- on state?s
ability to increase spending, especially in times of fiscal stress. For
example, revenues may come in lower than expected during an economic
downturn and a state?s enacted budget can fall into deficit. State balanced
budget requirements often motivate states to both reallocate resources
within their budgets and cut program spending or increase taxes during
recessions. Such difficulties, I am sure, come as no surprise to many of the
members of this Subcommittee who have had to make many of these difficult
choices while serving in state legislative bodies. For these reasons prudent
fiscal planning, especially contingency budgeting for a fiscal ?rainy day,?
becomes particularly important.

In a fiscal crisis, a state?s need to cut spending or increase revenues can
be alleviated if it has accumulated surplus balances in rainy day funds-
these surpluses may be used to cover a given year?s deficit. 5 However,
unless there are reserves specifically earmarked for low- income families,
welfare programs will have to compete with other state priorities for any of
the rainy day funds.

Finding the right balance between saving and investing resources in programs
that help people make the transition from welfare to work continues to be
one of the main challenges for states as they develop strategies to address
the needs of low- income families. To set aside reserves for future welfare
costs, states have two options: they can save federal TANF funds and/ or
they can save their own funds. However, states noted significant
disincentives to save associated with both of these options. State officials
told us that there is concern that accumulating unspent TANF balances might
signal that the funds are not needed and that they have been under
considerable pressure to spend their TANF balances more quickly to avoid the
accumulation of large unspent balances in the U. S. Treasury. States have
accumulated a portion of their own funds in general purpose rainy day funds,
but welfare would have to compete with other claims for these dollars when
these dollars are released from state treasuries.

5 Budgeting for Emergencies: State Practices and Federal Implications (GAO/
AIMD- 99- 250, September 30, 1999). Reserves Are Key to

States? Contingency Plans But States Cite Disincentives to Save

Page 6 GAO- 01- 674T

Under TANF, the amount of each state?s block grant was based on the amount
of federal AFDC funds spent by the state when caseloads and spending were at
historic highs. Because caseloads have fallen so dramatically, generally
states have been able to reap the fiscal benefits of welfare reform by
parlaying abundant federal resources into new programs and savings. Any
federal funds they choose to reserve must remain at the U. S. Treasury until
the states need them for low- income families. 6 As of September 30, 2000
states reported leaving $9 billion in unspent TANF funds at the U. S.
Treasury; this amounts to 14.5 percent of the total TANF funds awarded since
1996. 7

Although many might view these balances as a de facto rainy day fund for
future welfare costs, in fact there is probably less here than meets the
eye. First, as we will discuss in more detail, the data reported by the
states is misleading. Second, the reported balances themselves vary greatly
among the states, suggesting that some states may not be as prepared to
address the fiscal effects an economic downturn may have on their welfare
programs without additional federal assistance while others may have saved
substantially more than they might need. For example, some states report
spending all their federal funds- essentially holding nothing in reserve-
while others report accumulated reserves totaling more than their annual
block grants. For example, Wyoming reports that nearly 70 percent of the
TANF funds it has been awarded since 1997 remain unspent whereas Connecticut
reports spending all of its TANF funds.

States do not report unspent balances in a consistent manner making it
difficult to ascertain how much of these balances is truly uncommitted and
available for future contingencies. Therefore, federal policymakers lack
reliable information to help assess states? plans for economic
contingencies, whether the levels of available funds are adequate, and
whether all states have access to these funds.

Department of Health and Human Services? (HHS) regulations require that if a
state has allocated a portion of its TANF grant to a rainy day fund, the

6 HHS regulations stipulate that a state must obligate by September 30 of
the current fiscal year any funds for Expenditures on Non- Assistance. The
state must liquidate these obligations by September 30 of the immediately
succeeding federal fiscal year for which the funds were awarded. Unobligated
funds from previous fiscal years may only be expended on ?assistance? and
the administrative costs related to providing ?assistance?.

7 These data are based on preliminary analysis of state- reported data. As
of April 2001, HHS? Administration for Children and Families (ACF) has not
publicly released this data. Flexibility of TANF Grants

Allows States to Build Reserves

Reliable Data on Adequacy of State Reserves Are Not Available

Page 7 GAO- 01- 674T

state should report these balances as unobligated. 8 But, state rainy day
funds for welfare programs represent only a portion of the total reported
unobligated balances. These balances can represent funds the state has saved
for a rainy day, funds for which the state has made no spending plans, or
funds the state has committed for activities in future years. For example,
in developing a budget for a new child care program, officials in Wisconsin
assumed that once the program was fully subscribed it would require all
available resources- including any unobligated TANF funds from previous
fiscal years. State officials said that even though at the end of federal
fiscal year 2000 the state reported $40 million TANF funds as unobligated,
the state has programmed these funds to pay child care subsidies to low-
income families in future reporting periods. This is a case where a reported
unobligated balance provides very little information about whether these
funds are committed or simply unbudgeted.

States also report unspent TANF funds as unliquidated obligations, which
means that, to varying degrees, an underlying commitment exists for the
funds either through a contract for services for eligible clients or to a
county for expenses it will incur in operating a county- administered
welfare program. But it is unclear how much of what is currently obligated
is committed for future needs. For example, both California and Colorado
have county- administered welfare systems. These states pass most of their
annual block grant directly to the counties. As caseloads have continued to
decline in both states, the budgets over- estimated expenditures leaving
considerable balances unspent. Although these funds remain in the U. S.
Treasury until a county needs to spend them, they remain as unliquidated
obligations committed to the counties. California reports that it has over
$1.6 billion in unliquidated TANF obligations. But the state reports no
unobligated balances, implying that all these funds are earmarked. Recently,
California amended its state statute to allow the state to deobligate some
of these funds, if necessary, and make them available to other counties.
Likewise, as of September 30, 2000 Colorado reports about $95 million in
unliquidated obligations, but passes virtually all TANF resources to the
counties. As of June 30, 2000 the state estimated that counties hold about
$67 million in reserves- or about 70 percent of the total unliquidated
obligations- for future contingencies.

8 HHS regulations require states to report on the status of their unspent
TANF funds. Under HHS regulations the states use two categories to report on
the status of these funds: (1) unobligated balances represent funds not yet
committed for a specific expenditure by a state and (2) unliquidated
obligations represent funds states have committed but not yet spent.

Page 8 GAO- 01- 674T

As highlighted in the above examples, the difference between unobligated
balances and unliquidated obligations is often unclear and varies by state.
Significant portions of California?s and Colorado?s unspent funds are not
yet actually committed for specific expenditures but these facts cannot be
determined based on the aggregate data, in part because of the way HHS
requires states to report funds. Reporting a significant share of their
unspent balances as unliquidated obligations implies that there is an
underlying commitment on these funds when, in fact, these funds are no more
committed than the funds Wisconsin must report in its unobligated balances
but which are budgeted for expected outlays in Wisconsin?s child care
subsidy program.

Even though some states might consider their unobligated balances for TANF
to be rainy day funds, it does not appear that the amounts reserved were
based on any kind of contingency planning or analysis. For example, 5 of the
10 states we studied told us that they consider a portion of the funds left
at the U. S. Treasury to be rainy day funds for unanticipated program needs.
But the levels of the reserves established in those five states were not
determined through a fiscal planning process that reflects budgetary
assumptions about projected future needs. Instead, these states? statutes
merely designate all TANF funds not already appropriated by the state
legislature for other purposes as constituting the state?s welfare rainy day
fund, a method that clearly is not based on anticipated needs or
contingencies.

The lack of transparency regarding states? plans for their unspent TANF
funds prompted us, in 1998, to recommend that HHS and the states work
together to explore options for enhancing the information available
regarding these balances. Although HHS, the National Governor?s Association
(NGA), and the National Conference of State Legislatures (NCSL) all agreed
with us that more information regarding unspent TANF balances would be
useful, little progress has been made implementing this recommendation and
HHS? final regulations, issued on April 12, 1999 did not address this issue.
States were already concerned that the TANF reporting requirements would
pose a substantial burden on state program administration and argued that
adding another reporting requirement to allow states to signal their
intentions for their unspent balances would only add to those burdens.
However, the lack of useful information on these balances continues to
weaken the effectiveness of congressional oversight over TANF funding
issues, including how well prepared states may be to address a fiscal
downturn. Contingency Planning Receives

Little Attention as States Cite Few Incentives to Save

Improved Reporting Requirements Could Improve Federal Oversight and Provide
States With Incentives to Save

Page 9 GAO- 01- 674T

Our 1998 recommendation proposed a strategy that state and federal officials
had tried before and found to be successful. In 1981, a number of
categorical grants were block granted to states to provide maximum
flexibility in developing and managing programs, along the same lines that
TANF was designed in 1996. However, due to variations in the way states
reported information to the federal government on activities funded by some
of these block grants, Congress had no national picture of the grants?
impact. States and some national organizations recognized that these
aggregate data were important and developed their own strategies to collect
the data. 9 We found that a cooperative data collection approach was easier
to implement when (1) there was federal funding to support data collection
activities, (2) national- level staff worked with state officials, and (3)
state officials helped in systems design. We continue to believe that better
information on the status of these unspent balances is crucial to effective
oversight and could even enhance states? incentives to save some of their
TANF funds. Absent credible information on balances, there may be a greater
risk that Congress could take action to recoup TANF funds- a prospect that
has prompted some states to draw down and spend their TANF funds rather than
leave them in the Treasury.

Although many states have healthy general rainy day funds from which all
programs would compete for funds during times of fiscal stress, only one of
the states in our review, Maryland, has earmarked state funds in a reserve
specifically for contingencies in its welfare program. Setting aside state
funds in reserve for welfare requires tradeoffs for state decisionmakers
among competing needs for the funds during a downturn. In addition, any
funds a state sets aside for future welfare contingencies cannot count
toward a states? maintenance of effort in the year they are reserved- in
order to qualify as MOE, the funds must be spent. Therefore, it is a very
expensive proposition indeed for a state to budget both for a welfare
reserve and to meet its MOE because it then would have far fewer resources
available to finance other state priorities.

Maryland found a way to transfer the costs of saving state funds to the
federal government. In state fiscal year 2001, the state identified nine
program accounts with annual expenditures of state funds totaling about

9 Block Grants: Federal- State Cooperation in Developing National Data
Collection Strategies (GAO/ HRD- 89- 2, November 29, 1998) and Block Grants:
Federal Data Collection Provisions (GAO/ HRD- 87- 59FS, February 24, 1987).
States Have Few

Incentives to Create StateFunded Welfare Reserves

Page 10 GAO- 01- 674T

$30 million that, under the broad and flexible rules governing TANF
expenditures, could be funded with federal funds. In developing the budget,
the state replaced these state funds with federal funds. Instead of using
the ?freed- up? state funds for nonwelfare activities the state used them to
establish a dedicated reserve for its welfare program.

While the ability to carry forward TANF balances is likely viewed as the
principle mechanism by which states can prepare for a rainy day, PRWORA also
created two safety- net mechanisms for states to access additional federal
resources in the event of a recession or other emergency- the $2 billion
Contingency Fund for State Welfare Programs (Contingency Fund) and the $1.7
billion Federal Loan Fund for State Welfare Programs (Loan Fund).

The Contingency Fund is authorized through 2001, at which time it expires.
The President?s fiscal year 2002 budget proposal did not include a request
to reauthorize the Contingency Fund. Because of a provision in the Adoption
and Safe Families Act of 1997 that reduced the TANF Contingency Fund by $40
million, the current balance in the Contingency Fund is $1.96 billion. 10
States are deemed ?needy? and eligible to receive funds from the Contingency
Fund if they trigger one of two criteria: (1) the state?s unemployment rate
exceeds 6.5 percent for 3 months and is equal to at least 110 percent of its
rate in the same period of the previous year or (2) its average monthly food
stamp caseload for the most recent 3- month period is equal to at least 110
percent of the average monthly caseload from the same 3- month period in
fiscal year 1994 or 1995. Once eligible, a state must certify that it has
increased its own current spending to prewelfare reform levels before it can
gain access to the fund.

Requiring states to increase their own financial stake in their welfare
programs before giving them additional federal funds is, in principle, a
reasonable approach that seeks to balance both the federal government?s
interest in ensuring that states in trouble have access to additional funds
and its interest in ensuring that states have done everything possible to
address the shortfalls before turning to the federal treasury. Not only does
the statute require states to bring their spending up to the prewelfare
reform levels at a time when states are experiencing fiscal stress, but

10 The Adoption and Safe Families Act of 1997 reduced the contingency fund
for state welfare programs by $40 million over four years (P. L. No. 105-
89, sect.404, 111 Stat. 2134) Design of Federal

Contingency Mechanisms Is Complex and Restrictive

Page 11 GAO- 01- 674T

PRWORA establishes a different and more challenging base for the Contingency
Fund?s MOE. While a state?s MOE requirement under the basic TANF program can
include state funds expended under certain state programs and child care
expenditures, the MOE requirement for the Contingency Fund does not include
these items.

Because states spend a significant share of their MOE funds on activities
that do not qualify as Contingency Fund MOE expenditures, state budget
officials told us that, rather than shifting their spending priorities to
meet the Contingency Fund MOE, they would find other ways to manage deficits
in their TANF budgets before they could consider turning to the Contingency
Fund. In 1997 eight states qualified for contingency funds. 11 However, only
two states requested and were awarded contingency funds- North Carolina and
New Mexico. In the end, only New Mexico complied with the Fund?s
requirements and accepted $2 million. No state has used the Fund since 1997.

Equally important as the requirement that states raise their own financial
commitment in order to gain access to additional federal funds is a
requirement that states share in all additional program costs- even beyond
the MOE requirements. Requiring a match encourages states to be more cost-
conscious than if the costs of an expanding caseload were covered only with
federal dollars. While the Contingency Fund requires states to match all
federal dollars at the states? federal medical assistance percentage (FMAP)
rate 12 the statute goes a step further. The statute limits the monthly
draws to one- twelfth of 20 percent of a state?s annual block grant. This
limitation requires a complex annual reconciliation process to certify that
the state meets its matching requirement but also that it did not receive
more than its monthly proportional share of contingency funds (see figure
1). 13 Prorating a state?s draws from the Contingency Fund- especially if
the state qualifies for a period that spans two federal fiscal years-
reduces the share of federal funds to which it is entitled. This effectively
increases the matching requirement (even higher than required under AFDC),
thus raising the state?s costs for gaining access to the funds.

11 These states are Alaska, California, District of Columbia, Hawaii, New
Mexico, New York, North Carolina, and Washington. 12 Under AFDC, state
spending was matched at a rate based on each state?s per capita income. This
rate, FMAP, is also used for other federal- state matching programs such as
Medicaid. It ranges from 50 percent for wealthy states to 80 percent for
poorer states.

13 For more information see GAO/ AIMD- 98- 137 .

Page 12 GAO- 01- 674T

Figure 1: The Contingency Fund?s Annual Reconciliation Process

Unlike the Contingency Fund, the Loan Fund does not have triggers. Instead,
states that have not incurred penalties for improper use of TANF funds are
eligible for loans from the Loan Fund. Such loans are to have a maturity of
no more than 3 years at an interest rate comparable to the current average
market yield on outstanding marketable obligations of the U. S. Treasury
with comparable maturities. Some state officials told us that they are
eligible for better financing terms in the tax- exempt municipal bond
market. More important, officials in some states indicated that borrowing
specifically for social welfare programs in times of fiscal stress would not
receive popular support.

In summary, neither the Contingency Fund- as currently designed- nor the
Loan Fund is likely to be used by states in a fiscal crisis to obtain more
resources for their welfare programs. The Loan Fund is most likely the wrong
mechanism to provide assistance to states in a fiscal crisis. However, if
the Contingency Fund is reauthorized, Congress could also contemplate
improvements to enhance its usefulness in addressing budgetary shortfalls in
states? welfare programs that, at the same time, could provide stronger
incentives for states to save for a rainy day.

Page 13 GAO- 01- 674T

Although PRWORA struck a new fiscal balance between the federal government
and the states in terms of welfare spending, both the states and the federal
government have a significant interest in preparing the program to meet
challenges in times of fiscal distress. Contingency planning is about being
prepared for the unknown- as the economy shows possible signs of weakening,
we need to begin to think about how prepared we are to maintain this
important aspect of the nation?s safety net. Although many view the states?
large unspent TANF balances as the de facto contingency fund, these balances
vary across states; this implies that some states may be better prepared for
a recession than others. More important, current reporting requirements do
not give us reliable, consistent information regarding states? actual plans
for these monies. According to NGA, few states have engaged in a systematic
fiscal planning process to project their needs under a variety of economic
scenarios. While we don?t know how states? welfare programs will respond to
a weakened economy, we know both the federal government and the states have
a responsibility to ensure the viability of TANF in good times and bad.

Before addressing how contingency planning can be improved for the future,
the federal government needs better information on states? current plans. At
the same time, Congress could consider ways to both strengthen federal
contingency mechanisms and give states greater incentives to save for the
future.

In 1998, we recommended that the Secretary of Health and Human Services
explore with the states various options to enhance information regarding
states? plans for their unused TANF balances. We said that such information
could

 include explicit state plans for setting aside TANF- funded reserves for
the future,

 provide more transparency regarding these funds and enhance congressional
oversight, and

 provide states with an opportunity to more explicitly consider their
longterm fiscal plans for TANF.

Although HHS concurred with our recommendation, to date, we have seen no
progress in this area. We continue to believe that Congress would benefit
from more complete information on states? plans for future contingencies,
including unspent TANF balances. While states often face burdens with
respect to federal financial reporting requirements, states Options to
Strengthen

Contingency Planning Improved National Reporting

Page 14 GAO- 01- 674T

have historically recognized the benefits of cooperative data collection and
reporting efforts and worked successfully with federal agencies to collect
data that can give oversight officials a broad, national perspective of how
they are using federal block grant funds. Allowing for more transparency
regarding states? fiscal plans for TANF funds could enhance congressional
oversight over the multi- year timeframe of the grant and provide states
with an opportunity to more explicitly consider their longterm fiscal plans
for the program. While the opportunity to more clearly signal their
intentions for these funds could prompt states to save, Congress must have
some assurance that states? estimates of their contingency needs were
developed using credible, realistic estimating procedures.

In order for a state to report to the federal government a balance in a
rainy day fund, and in order for the federal government to have some level
of confidence in such a figure, the federal government could give states
guidance on how it could designate its TANF balances as a valid rainy day
fund. Such guidance could include requirements that a state rainy day fund
(1) include criteria both for estimating the appropriate reserve balances
and for releasing funds and (2) be auditable. This guidance could help
states signal that much of these balances are, in fact, committed.
Furthermore, requiring that reserves be determined by credible, transparent
estimating procedures would help provide better estimates of the potential
need for federal contingency funds.

The Contingency Fund, as currently designed, has not proven to be an
inviting option to the states that have actually experienced fiscal stress
to date. Should Congress decide to reauthorize the Contingency Fund,
consideration could be given to approaches that could both improve the
usefulness of the fund for hard- pressed states as well as ensure that
states contribute their fair share to future welfare costs. Such approaches
could include (1) eliminating the more restrictive the Contingency Fund- MOE
and substituting the more flexible basic TANF- MOE and (2) eliminating the
Monthly Payment Limitation (MPL) on the amount of contingency funds to which
each state has access. These actions could help strengthen the role of the
Contingency Fund in state contingency budgeting.

Realigning the MOE and eliminating the MPL would make the Contingency Fund
more accessible and, therefore, more responsive. If states had better access
to federal contingency funds, they might be more likely to use the money
when needed. However, greater accessibility must be balanced by fiscal
responsibility. It is important to be mindful of this balance so as not
Options to Improve the

Federal Contingency Mechanism

Page 15 GAO- 01- 674T

to make it too easy for states to access federal contingency funds because
they might be less likely to save for a rainy day on their own, which could
pose risks to the federal Treasury.

The changes discussed above would still require states to increase their own
spending to pre- TANF levels (i. e., meet a 100 percent MOE) to gain access
to the Contingency Fund- a higher level than they must maintain for the
regular TANF program- as well as provide a matching share for the additional
federal funds. By broadening the fiscal base that states can draw upon to
meet this higher MOE, these changes might not only make the fund more
accessible in times of need but prompt states to save their own funds in
anticipation of accessing the federal funds.

There are other options that could strengthen states? incentives to save.
For example, Congress could (1) allow states to count rainy day funds
towards their MOE and (2) allow states to draw down their entire TANF grant
and save these funds in their own treasuries.

Allowing states to count rainy day funds towards their MOE would give them a
greater incentive to save. However, ?maintenance of effort? implies an
actual expenditure, and is a critical aspect of PRWORA. If states save their
own funds instead of spending them, they might be more likely to draw down
all of their TANF dollars now to replace the state dollars they save for the
future. However, this outcome can be mitigated by limiting the amount of
rainy day funds that states could count towards their MOE. In addition, as
we suggested earlier when discussing the TANF balances saved by states,
states could also be required to certify that state rainy day funds are in
fact auditable and include criteria for estimating and releasing the funds.

Some state officials have argued that their incentive to save TANF funds for
the future could be bolstered by allowing states to keep unspent TANF funds
in their own accounts rather than at the U. S. Treasury. They believe that
this might reduce incentives for Congress to rescind unspent balances since
the outlays would be recognized earlier at the time of the grant award, not
when the money is actually spent for a program need. State officials also
told us that this would alleviate the perceived pressure to spend TANF funds
rather than save them. However, it is important to note that, regardless of
where these federal funds are ?stored,? states are accountable for these
funds. As such, Congress still needs consistent, reliable, and auditable
information on these funds. Options to Increase States?

Incentives to Save

Page 16 GAO- 01- 674T

There are significant issues associated with this proposal. First, if states
draw down all unspent balances in the current year, the rate of outlays
recorded for the TANF program would shift forward. Accordingly, the federal
budget surplus would be proportionately lower in the near term. Second, the
federal government would incur interest costs while states could realize
interest earnings. The Cash Management Improvement Act of 1990 (CMIA) helps
ensure that neither the states nor the federal government incur unnecessary
interest costs or forgo interest income in the course of federal grant
disbursement by prohibiting states from drawing down funds until they are
needed. If Congress permitted, notwithstanding CMIA, states to draw down
their TANF balances to establish reserves, it could also require states to
reimburse the U. S. Treasury for any interest they earn on the drawdowns.
This would maintain the spirit of the CMIA by preserving fiscal neutrality
for the federal government and the states, since the states could use
interest earnings they gain on investing the drawdowns to reimburse the
Treasury.

Essentially, states would have to justify why TANF deserves an exemption
from a governmentwide grant policy that settled years of intergovernmental
conflicts between federal and state administrators. The permanent nature of
the appropriation to each state as well as the significant devolution of
responsibilities to states for addressing the program?s fiscal risks may
argue for such a change, but other federal interests would have to be
weighed as well. For example, some may argue that CMIA promotes transparency
by ensuring that states? unspent balances remain in the federal Treasury
rather than in state treasuries. This concern could be addressed through
federal reporting on states? expenditures and reserves.

In conclusion, the TANF program has established a new fiscal partnership
that has supported the transition to work- based welfare reforms. Because
the partnership has yet to be tested in times of fiscal stress, now is the
time for both federal and state governments to consider actions to prepare
for more uncertain times and the possibility of higher program costs.
Although TANF currently contains certain mechanisms to provide a fiscal
cushion, the options we have presented provide an opportunity to promote
greater assurance that all states will be poised to respond to future fiscal
contingencies affecting their TANF programs.

Mr. Chairman, this completes my prepared statement. I would be happy to
respond to any questions you or other Members of the Subcommittee may have
at this time.

Page 17 GAO- 01- 674T

For future questions regarding this testimony please call Paul L. Posner at
(202) 512- 9573. Individuals making key contributions to this testimony
included Thomas M. James, Bill J. Keller, Jacqueline M. Nowicki, Patricia L.
Elston, Gale Harris, and Raymond G. Hendren. Contacts and

Acknowledgements

(450040)
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