Our simulations for the state and local government sector indicate that in the absence of policy changes, large and growing fiscal challenges for the sector will begin to emerge within the next few years. … As is true for the federal sector, it is the growth in health-related costs that is a primary driver of the fiscal challenges facing the state and local government sector. In particular, two types of state and local expenditures will likely rise quickly because of escalating medical costs. The first is Medicaid expenditures, and the second is the cost of health insurance for state and local employees and retirees. Conversely, we found that other types of expenditures of state and local governments—such as wages and salaries of state and local workers, pension contributions, and investments in capital goods—are expected to grow slightly less than gross domestic product (GDP). At the same time, most revenue growth is expected to be approximately flat as a percentage of GDP. As such, the projected rise in health-related costs is the root of the fiscal difficulties these simulations suggest will occur.