Despite a chaotic year for state budgeters, some states still expect revenue to grow and are proposing either tax cuts or increased spending on new initiatives. Other states have been forced to close significant budget shortfalls and are forecasting structural deficits in future years.
Most states will end fiscal year 2025 at midnight on June 30. For now, state revenues for the remainder of the fiscal year appear stable, but shortfalls and uncertainty loom for FY 2026 and beyond.
An NCSL survey conducted earlier this year found that states expect to meet their latest revenue forecasts for the remainder of FY 2025. In addition to meeting revenue estimates for the current year, states have built up large rainy day fund reserves that can help them weather a moderate economic downturn. For the last few years, states have also anticipated slowing revenue growth, knowing that the robust growth following the pandemic recovery could not continue, and that federal aid provided during that time would end.
Despite these factors, states face significant challenges. They are experiencing increased spending pressures in some areas, and are keeping a close eye on changes at the federal level. Reducing federal spending and passing tax cuts have emerged as top priorities for the administration and many legislators in Washington. States receive a significant portion of their overall revenues from the federal government, and proposed changes could lead to significant state budget shortfalls and difficult choices for state lawmakers in FY 2026 and beyond.
Uncertainty over the U.S. economy is also weighing on state revenue forecasters, leading some states to lower revenue estimates for FY 2026 and future years. States are also required to pass balanced budgets during short legislative sessions. While waiting for the economic and federal budget pictures to come into focus, they are largely passing cautious budgets, knowing they may need to make adjustments in special sessions or next year, depending on the trajectory of the economy and federal policy decisions.
Top Issues and Challenges
Concerns about Medicaid and other health care spending emerged as top issues facing states in 2025 legislative sessions and in budgeting for the upcoming fiscal year and beyond. A budget plan released by the U.S. House of Representatives suggests cutting $880 billion in federal funding for Medicaid and other programs over the next decade. This would create a very challenging fiscal environment for states, which jointly fund Medicaid programs.
States also are seeing unexpectedly higher costs to Medicaid programs. The Medicaid budget squeeze is coupled with rising costs for state employee health care systems in many states, further straining health and future human service budgets.
Another immediate challenge across the board is contending with slowing revenue growth. Even in states with stable fiscal outlooks, slower growth will require readjustments. For the last few years, lawmakers have largely had robust revenues to fund many priorities, whether it was expanding programs, cutting taxes or funding one-time projects.
The new revenue reality is compounded by uncertainty in the U.S. economy, which could further pinch state finances. With fewer resources, legislators may find themselves facing more difficult decisions to align revenues and expenditures.
In recent years, lawmakers in many states have taken advantage of robust revenues to reduce personal income tax rates, cut property taxes and provide tax relief to families with children, among other strategies. Despite slowing revenue growth, some states may enact new or additional cuts, especially in the area of property taxes, continuing a trend from last year.
What We’re Watching
Federal budget: States will wrap up their FY 2026 budget writing by June 30, but the Congress has until Sept. 30 to replace a continuing resolution that was signed into law on March 14. If the budget cuts funding for state programs, states might need to revisit their budgets later in the year or address shortfalls in the next legislative session. In particular, states are watching for potential cuts to Medicaid funding. The magnitude of the cuts could have a drastic impact on state budgets.
Federal layoffs: Because of the large-scale federal layoffs starting in February, states with high numbers of federal employees could see downstream effects in personal income tax collections, unemployment insurance claims, Medicaid enrollment and other areas.
The U.S. and global economies: Uncertainty caused by shifting tariff and trade policies, geopolitical challenges, stubborn inflation and questions about consumer spending will affect state economies and revenue estimating as states move forward with future budgets.
Slow revenue growth: States expect a continued slowdown or slight decline in revenue growth. If the U.S. experiences a recession, more states will need to close budget shortfalls by drawing down reserve funds, cutting spending or raising revenues.
Erica MacKellar is a program principal in NCSL’s Fiscal Affairs Program.