Local governments face a daunting set of challenges in 2008 and beyond, and even optimistic forecasts acknowledge cities and towns will have to make difficult, sometimes painful changes as they adapt to the reality of an extended fiscal squeeze.

Richard F. Dye, an economics professor at the University of Illinois at Chicago, looked at municipal finances in a new paper for the Federal Reserve Bank of Boston's New England Public Policy Center. His conclusion was gloomy.

"There is, in my view, reason to be concerned - even pessimistic - about future pressures on state and local budgets," Dye wrote.

As evidence, Dye pointed to four factors: the relentless rise in health care costs; longer lifespans, which will make retiree benefits more costly; low fertility rates, which mean fewer new taxpayers to support retirees; and the coming retirement of the Baby Boomers, which will both reduce tax revenue as retirees leave the workforce, and require increased spending on retiree benefits.

Michael Widmer, president of the Massachusetts Taxpayers Foundation, agrees.

"I'm not optimistic," he said. "Unless there's some really significant policy changes at either or both the state and local level, it's going to get significantly worse before it gets better." In its annual report on municipal finances, the taxpayers foundation warned: "Without a more dependable revenue stream and decisive action to address health care costs, there will be an acceleration of the cuts in programs and services that have already impacted a large number of communities." More cities and towns will likely start changing fees for school programs and government services, as well.

Clyde Barrow, of the Center for Police Analysis in Dartmouth, called the situation "dire."

"We are on the verge of a municipal meltdown," he said. "And I think as it happens, something will give. Something will have to."

The Massachusetts Budget and Policy Center's Noah Berger is also pessimistic, in part because he does not see state government being in a financial position to help.

Instead, Berger suggested the federal government could step in with aid to cities and towns, which he said would also be "a very effective form of fiscal stimulus."

But Dye, the Chicago professor, observed that the federal government will face the same pressures from health care costs and an aging population that will hurt municipalities. That will reduce aid to states, which in turn will reduce aid to municipalities, he said.

Widmer predicts a growing trend of municipalities effectively going bankrupt, as happened in 1991 to the city of Chelsea, which was taken over by the state.

Widmer said the state could see about five communities a year fail to balance their books for a number of years.

"It's unfortunate, but that's what I think it's going to take to finally get attention," he said. Not everyone is that grim, however.

"I'm always wary (that) big predictions that there's going to be some sort of demise or a 'big bang' are oversold," said the Pioneer Institute's research director, Steve Poftak.

Poftak thinks a combination of things will be done to stem the municipal budget crisis.

"I think you're going to see the state give municipalities more tools to control cost, and you're going to see more pressure put on municipalities to use those tools," he said, pointing as an example to the state opening up its GIC health coverage plan to municipalities.

Poftak also expects to see more cities and towns regionalize their services to cut costs.

In his paper, Dye noted that there also is an upside to the trend of an aging population - with fewer school-age residents, the demand for spending on education should decline.

But according to Dye, the bottom line is simple.

"Local governments," he wrote, "are going to have it hard."