Mounting Pressures Usher in a New Budget Era
State fiscal debates to watch in 2026
This is one in a series of five articles examining key debates that will unfold in the nation’s statehouses in the year ahead.
The budget decisions that states make in 2026 are likely to be defined by an increasingly perilous long-term fiscal outlook. For some states, the coming year might represent their last opportunity to prepare before budget stress begins in earnest. For others, budget shortfalls have already begun, and lawmakers will need to contend with short-term problems and get ready for long-term ones.
State policymakers have been in information-gathering mode for months, assessing the 2025 federal reconciliation bill’s implications for their budgets, awaiting federal guidance, and forecasting revenue and spending amid a perplexing economy that combines sky-high stock prices with slowing job growth. Now come the tough decisions about how to bring state budgets back into balance.
Danger ahead
Long-term economic and demographic trends always indicated that after federal COVID-19 aid ended, states would face a rocky recalibration as they sought to balance their budgets without that additional money. Medicaid is the largest payor for long-term care, such as nursing home stays, so states’ Medicaid budgets are vulnerable to cost increases for the aging Baby Boom generation. Further, natural disaster recovery and response is getting more expensive at a time when the Trump administration plans to reduce federal disaster funding. And states also will need to grapple with big infrastructure maintenance backlogs, but the revenue sources they traditionally use for this purpose, especially gas taxes, are at risk of stagnating. These factors help to explain why general fund spending rose faster than inflation for a fourth consecutive year in fiscal year 2025.
A series of state and federal policy decisions will add to the pressure, including the federal reconciliation legislation. Some of the effects of the law were immediate. For example, of the states that use the federal definition of taxable income, a handful are anticipating revenue declines in the hundreds of millions of dollars in the current fiscal year because the federal law exempts additional types of income, such as overtime pay and tips, from taxation.
The bigger effects, however, are still to come.
In October 2026, states will begin paying a larger share of the administrative costs for the Supplemental Nutrition Assistance Program (SNAP), formerly known as food stamps. From fiscal 2028 to fiscal 2030, many states may have to begin paying a share of SNAP benefits for the first time in the program’s history. But when, whether, and how much they pay will depend on their SNAP error rates.
Similarly, starting at the end of 2026, states must implement Medicaid work requirements and more frequent checks of enrollee eligibility—responsibilities that also carry substantial administrative costs. Further, from fiscal 2028 through fiscal 2032, the federal law will impose increasingly stringent limits on state taxes on health care providers—a primary source of state Medicaid funding. Together, these provisions mean that some states will face new spending obligations or revenue restrictions in each of the next six years, with eventual annual impacts in the tens of billions of dollars, collectively.
Beyond the federal reconciliation bill, some states have new spending commitments coming due. In November, Maryland forecast new budget deficits, the latest challenges for a state working to implement a multibillion-dollar education funding plan. Likewise, to help close its budget gap, Washington recently delayed by four years the scheduled launch of free prekindergarten for low-income families.
Other states—Kentucky, Mississippi, North Carolina, Pennsylvania, and West Virginia among them—are reducing revenue by phasing in personal or corporate income tax cuts, either on a set schedule or as the states reach specified triggers. The hope is that the tax cuts will prove affordable given that—as Jared Walczak, vice president of state projects at the Tax Foundation, told The Pew Charitable Trusts—state revenue has risen substantially, even after adjusting for inflation, since the 2017 federal Tax Cut and Jobs Act eliminated certain tax exemptions and deductions. “Most states are in pretty good shape,” Walczak said. “We've seen a slide in the last year or so, but it’s a slide from remarkable highs.”
New challenges
Whether states can sustain their fiscal health is an open question. Perhaps the most worrisome sign is that states that had maintained budget surpluses since the pandemic are increasingly expecting—or experiencing—budget challenges.
For instance, over the past decade, North Carolina built its reserves to record levels, maintained a top AAA credit rating, enacted substantial personal and corporate income tax cuts, and still managed to enhance some services, such as by implementing Medicaid expansion. However, this past March, the executive budget office projected that the state would face multibillion-dollar deficits as additional rounds of tax cuts kicked in.Under state law, personal income tax rates could fall through fiscal 2033 if certain revenue thresholds are met. Further, because the federal reconciliation law will force the state to pare back the provider taxes that it used to pay for Medicaid expansion, those costs may now have to be covered using general fund dollars. Meanwhile, the state has had to commit billions of dollars to recovery from Hurricane Helene but has not receivedfederal help commensurate with the size of the disaster.
This weakening outlook served as the backdrop for a months-long impasse over approval of a budget for fiscal years 2026 and 2027, leading to a series of “mini-budgets” instead. North Carolina Budget Director Kristin Walker told Pew that the mini-budgets provide a short-term solution to the fiscal challenges: The state is spending significantly less than it would have with a full state budget, but with more tax cuts looming, that solution can last only so long. “It’ll get us through the ’26 problem and maybe the ’27 problem,” Walker said. “But the ’28 problem is the bear.”
And analyses in a host of states show similar long-term deficits, Alaska, California, Florida, Illinois, Minnesota, New York, Pennsylvania, and Rhode Island among them. Even in some states with chronic fiscal challenges, this situation feels different. According to reporter and columnist Dan Walters, who has followed California’s budgets for 50 years, the state’s projected deficits are especially worrisome even though they are not huge by historical standards. Whereas previous fiscal problems at least partially stemmed from temporary weakness in the national economy, current projections show spending growth exceeding revenue growth over the long term. If anything, state analysts argue, revenue may be inflated in the short term because of the artificial intelligence boom. California, Walters said, “has a serious structural deficit.”
Seeking solutions
To deal with long-term deficits, states have three options: cut spending, raise taxes, or delay. Some cuts are already beginning. In Idaho, Governor Brad Little (R) ordered state agencies to permanently cut their budgets by 3%, and Illinois Governor JB Pritzker (D) told agencies to keep 4% of appropriated spending in reserve in fiscal 2026 to try to balance the budget and provide a cushion for federal cuts.
But states may struggle to cut because the federal reconciliation law is pushing them to spend more on administrative costs. In July, Arizona Governor Katie Hobbs (D) asked state agencies to limit budget increase requests to 2%, but by September, the health care agency was asking for about 300 new full-time equivalent employees to implement the law’s Medicaid requirements as part of the agency’s request for a 16% general fund budget boost.
On the revenue front, although some states started enacting targeted revenue-raising measures in 2025, the question for 2026 is whether broader-based income and sales tax increases—usually a last resort for states—will get a wider look. For example, Rhode Island’s most recent budget applied the sales tax to parking, instituted a fee on health insurers, and created a tax on high-value second homes. However, the state had also considered a tax hike on high-income earners, modeled on Massachusetts’ 2022 millionaire’s tax but with a lower income threshold. Persistent deficit forecasts could compel lawmakers to move ahead with this idea in 2026. Justine Oliva, director of policy and research at the Rhode Island Public Expenditure Council, which opposes the tax, acknowledged: “I think that with the budget, the General Assembly may face increased pressure with this proposal.”
Of course, policymakers across the country would prefer to avoid tax increases or service cuts, and they often find ways to do so—at least temporarily. California relied on $10 billion in informal borrowing and payment delays to balance its fiscal 2026 budget, actions that created a “new wall of debt,” in the words of the state’s nonpartisan Legislative’s Analyst’s Office.
The more straightforward delaying tactic is to rely on reserves. States’ savings remain high, offering a temporary source of money for lawmakers dealing with budget challenges. But worrisome forecasts may give lawmakers pause about the degree to which they depend on reserves, especially because they need to maintain savings for future recessions. For example, Colorado Budget Director Mark Ferrandino told Pew that his state—which has experienced some of the nation’s most serious deficits over the past year—opted during an August special session to close its budget hole through a roughly equal mix of revenue changes, spending cuts, and temporary measures, such as use of reserves. “There are always the tough choices that get you through the budget,” he said. “And it’s not pretty, but it’s balanced.”
Thinking long term
Although much attention will inevitably turn to states such as Colorado, which still expects a shortfall in 2026, for states that are still doing reasonably well, the question will be how—and whether—they prepare for what are likely to be more difficult years ahead.
Minnesota offers a case study in proactive budget approaches. When lawmakers convened in 2025, the state’s budget was in manageable shape for the next two years, but projections showed a $6 billion deficit in fiscal 2028 and fiscal 2029. With the state’s House of Representatives evenly divided across party lines, lawmakers reached a bipartisan compromise, chopping billions of dollars from the deficit by scaling back a plan to provide residents with state-funded health insurance regardless of immigration status and slowing the growth of a Medicaid program that provides home- and community-based care to people with disabilities. They also left billions of dollars in reserve to provide a cushion against federal cuts and the state’s budget problems.
Mark Haveman, executive director of the Minnesota Center for Fiscal Excellence, told Pew: “To their credit, and a little bit to my surprise, they took [the long-term deficits] on, trying to not hamstring a future legislature.” What Minnesota lawmakers did not do, Haveman noted, is touch many of the high-profile initiatives that legislators had put in place two years earlier, such as free school meals and free college for students from low- and middle-income families.
Minnesota’s decisions show the balancing act that lawmakers around the country are likely to attempt starting in 2026 as they seek to preserve recent policy achievements while reorienting their budgets toward a more sustainable path. It also shows the difficulty of the task. The state shrank projected budget gaps but did not eliminate them. “We made cuts,” Haveman told Pew. “We didn’t spend surplus money. But we still have this chronic structural deficit issue that the state has to deal with.”
Josh Goodman works on The Pew Charitable Trusts’ state fiscal health project.
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