States Played Defense This Year but Bigger Fiscal Tradeoffs Ahead
Lawmakers used targeted tax changes and one-time maneuvers to deliver on affordability as budget conditions tighten
State lawmakers entered budget debates for fiscal year 2027 facing a delicate balancing act: respond to constituent calls for relief from rising costs of living while managing states’ own increasing costs—all amid a tricky revenue environment.
With reserves still stronger than pre-pandemic levels and tax revenue growth slow but stable, the focus in many statehouses appeared to be on locking in priority policies before it was too late. The varied paths that legislatures took along the way to passing their budgets for the new fiscal year, which for most starts on July 1, reflect a range of strategies to state fiscal policy at a time when the federal government is passing more fiscal responsibility to states.
Budget decisions this year tended to coalesce around two main approaches to constituent relief: either ease the cost of living through lower taxes or rebates, or provide indirect relief by making everyday expenses—such as childcare or utilities—more affordable. Analysts will be closely watching how these decisions play out over the next few budget cycles.
“As the federal government shrinks, the state responses to it will be just as diverse as there are states,” said Matt Fabian, a partner at the public finance research firm Municipal Market Analytics. From states’ management of government program cuts to their relationship with local governments as core service providers, he continued, “states are the new nexus of policy delivery in America.”
State policymakers adjusted their budgets this year in response to many of the immediate federal funding cuts and policy changes affecting tax codes, healthcare, and nutrition aid programs. But more significant cost increases outlined in last year’s federal reconciliation law are scheduled to take effect in fiscal 2028. Meanwhile, more states this year turned to one-time maneuvers to balance their budgets. The question that the next few months may begin to answer is whether the spending and revenue decisions that lawmakers made in 2026 left enough flexibility for next year’s more difficult tradeoffs.
“They’ve done enough for now,” said Geoff Buswick, a managing director at S&P Global Ratings. “They’re balancing their budgets; they’re maintaining reserve balances to where they see appropriate. But the next year’s budget cycle [is already] starting—so they're going to have to be thinking about what's enough for next year too.”
Budget pressures simmer
Tax revenue appeared to normalize into a low-growth mode in many states this year, though federal tax policy and economic shifts still dealt surprises to lawmakers. In some places, the surprise was welcome, thanks to tax collections meeting or exceeding expectations.
In Connecticut, for example, lawmakers entered the year warning of a sizable budget gap, but an April surge in income tax collections and other revenues reversed the state’s fortunes—analysts now project more than $580 million in added revenue over the next two years. Tax revenue is also beating initial estimates in Alaska, California, Florida, Indiana, North Carolina, New Jersey, and West Virginia, among others.
That’s a departure from last year’s downward revenue revisions, which led to late budgets and overtime legislative sessions. Though some uncertainty over federal policy changes remains, “we now know the economy has proved resilient during this period,” analysts with the Oregon Department of Revenue wrote in February. “At the national level, growth in economic output exceeded most forecasters’ expectations, labor conditions remained stable, and price pressures, while elevated, did not spike to the degree many forecasters feared.”
In West Virginia, the state budget’s exposure to historically volatile severance taxes, such as on coal and natural gas extraction, has shaped the Department of Revenue’s strategy into one of “undersell and overdeliver,” said Peter Shirley, the department’s deputy secretary. The idea, he added, is to help the state manage its spending to avoid tapping reserves when energy prices turn.
But in other states—particularly those where spending and revenue are chronically out of balance—improved outcomes may have only delayed the inevitable. State ending balances, once flush with cash from historic revenue growth, have declined for three straight years—a sign that states are increasingly turning to one-time funds in the budget process. And this year, 16 states built planned withdrawals from their rainy day funds into their fiscal 2027 budgets—an unusually high number outside of an economic downturn, according to an analysis by S&P.
In Maryland, lawmakers were yet again tasked with closing a structural deficit. They avoided raising taxes or fees to close the $1.5 billion gap, instead relying on one-time fund transfers and modest cuts.
Colorado’s rising Medicaid costs and constitutional limitations to revenue growth helped push its structural deficit to $1.2 billion this year. Lawmakers made painful cuts to healthcare and other core services but also used one-time transfers from other funds to close the shortfall.
Some states are just beginning to face similar challenges. Idaho, Iowa, and Nebraska are among those now contending with structural budget gaps as tax relief measures enacted during flush years are now colliding with more modest revenue growth, as well as with revenue reductions related to tax changes in the federal reconciliation bill.
For Idaho, the revenue whiplash has been dramatic. As recently as 2022, the state enjoyed a $2 billion surplus, but the 2026 legislative session started with an $80 million gap to close and Governor Brad Little (R) directed lawmakers to cut agency spending by 3%. Lori Wolff, administrator of Idaho’s Division of Financial Management, said the governor was focused on managing the gap without dipping into reserves. “We save that for economic downturns, and we are not in a downturn,” she said. “These are adjustments to support ongoing spending.”
Heading into fiscal 2027, the state still has more than $1 billion in total reserves, equal to roughly 20% of general fund spending. But unresolved costs related to Idaho’s conformity with the federal reconciliation law—estimated to be anywhere from $115 million to $400 million—mean that the cushion may face more pressure in fiscal 2028.
Pocketbook policies
Across the spectrum of balancing acts, many states sought ways to ease affordability challenges for their constituents. Though not as prevalent as the pandemic-era tax cuts made when revenue surpluses were common, the revenue picture in some states still cleared the way for new tax cuts while others moved ahead with scheduled ones.
North Carolina continued its trigger-driven income tax reductions, Arkansas passed its fourth income tax cut in a row, and West Virginia enacted a new income tax cut that was long a priority for lawmakers there.
In other cases, the revenue picture threatened scheduled tax cuts but lawmakers still found ways to balance the books. In Hawaii, Governor Josh Green (D) recommended pausing scheduled income tax reductions after a budget gap opened up last year. Instead, to help close the gap, lawmakers preserved the cuts for middle- and lower-income earners and enacted higher tax rates for high-income individuals. In Georgia, lawmakers passed an income tax cut that was projected to create a $1.3 billion budget deficit—Governor Brian Kemp (R) signed the bill, then cut $300 million from the budget before signing it the next day. The state also plans to use rainy day funds to help bridge the gap.
S&P analyst Scott Shad said that reducing revenue in favor of lower taxes can pay off over time by drawing more population and business growth. But, he added, it could also complicate spending and revenue debates in the years ahead as the full cost of federal policy changes become evident.
“That’s something we’ll be watching and evaluating on a year-by-year basis as states encounter and evaluate those cost pressures and [whether they] implement structural solutions on a recurring basis,” he said.
Other states addressed affordability by increasing revenue to pay for key programs. Maine and Rhode Island are expanding programs for children and families in part through higher taxes on annual incomes over $1 million. And after months of debate, Washington state passed its first ever tax on wage income— but only on annual earnings over $1 million—to support planned spending on early childhood, K-12 education, expanded tax credits for low-income earners, among other initiatives.
In New York, state lawmakers reached a deal more than a month after their fiscal year started in April that included state aid to help close New York City’s $12 billion budget gap, a new tax on luxury homes in the city, and $1.7 billion to expand childcare throughout the state. And in South Dakota, state lawmakers raised sales taxes to help fund property tax relief for homeowners.
Final thoughts
The rising pressure in statehouses to address affordability this year came at a critical time of fiscal transition for state budgets. Many entered the budget season facing structural deficits while others were just beginning to grapple with one. In a few cases, revenues are still hitting or exceeding targets—which helped build the case for enacting desired spending increases or tax cut policies. But as some states are finding, revenue patterns now are trickier than ever: It can be difficult to distinguish one-time boosts linked to economic events from regularly recuring revenue. And the projections don’t always pan out.
In the meantime, more big cost shifts are coming. States have responded to the immediate administrative cost increases related to the federal reconciliation law, but the next few years will deliver bigger challenges, such as higher administrative workloads, further restrictions on Medicaid funding, and an estimated $15 billion in cumulative additional annual costs for the Supplemental Nutrition Assistance Program.
“It’s kind of like a fiscal bomb with a delayed fuse,” said Justin Marlowe, a public finance professor at the University of Chicago. “In many ways, 2027 could be the actual manifestation of a lot of the really dramatic changes that some people were expecting to see sooner.”
Liz Farmer works on The Pew Charitable Trusts’ Fiscal 50 project.
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