In Brief:
California has been facing a massive budget shortfall — estimates vary, but in the $50 billion range — so it was not at all surprising that the spending package passed last month included serious cuts. The state will reduce its spending by about $16 billion, including an 8 percent reduction in funding for almost all departments.
Across the country in Florida, the situation looked a little different. With one of the healthiest economies in the nation, Florida’s revenues had continued to grow. Nonetheless, the state’s latest budget cuts spending in real terms by $500 million. While California drew down its rainy-day funds by $12 billion, Florida was able to set aside $17 billion.
For most states, the 2025 fiscal year began on July 1. After experiencing boom times in 2021 and 2022, thanks to strong stock market returns and a gusher of federal aid, things are slowing down. Most states met their revenue projections this year, but overall state revenues are essentially flat and in many cases declining.
Things are not dire, with most states still enjoying record savings in their rainy day funds, but there’s starting to be enough of a slowdown to put real pressure on policy ambitions. “We’re seeing state budget conditions return to normal,” says Brian Sigritz, director of state fiscal studies for the National Association of State Budget Officers. “We’re entering into a new environment where new money is limited.”
Overall tax revenues increased by 1.9 percent during the first 11 months of fiscal 2024, according to Lucy Dadayan, an analyst with the Urban-Brookings Tax Policy Center. But that number, she notes, was artificially inflated by California, where 2023 income tax revenues came in late due to filing deadlines being pushed back for months by natural disasters. Excluding California, total state tax revenues are down nationwide in nominal terms.
“With the income taxes, we’re seeing growth in one state but it’s going down in another,” Dadayan says. “With the sales taxes, there’s really poor performance across the board.”
States collectively received $175 billion in essentially non-designated money from the American Rescue Plan Act of 2021 (ARPA). That money has to be obligated by the end of the year. There’s still a lot of federal largesse from major infrastructure, science and clean energy laws, but that’s primarily grant money that comes with many more strings.
Inflation was states’ friend for a time, increasing revenues from both sales and income taxes as prices and salaries went up in response. Inflation has slowed, but states are still on the hook for greater expenditures when it comes to things like capital projects, while consumers remain wary.
“States saw a pretty historic revenue spike during the COVID response and recovery,” says Wesley Tharpe, a senior adviser for state tax policy at the left-leaning Center on Budget Policy and Priorities. “Revenue trends have been returning to normal over the past couple of years and now are showing year-over-year declines.”
Time for Tougher Choices
Tharpe warns that red states made policy decisions in recent years that will grow more expensive over time. He points specifically to the large numbers of permanent tax cuts, some of which contain triggers that could make them more costly in future years, as well as a rapid expansion in school voucher programs. “The bill is really going to start coming due,” he says.
Jonathan Williams, chief economist for the conservative American Legislative Exchange Council, warns of other dangers. With state revenues flattening, some of the holdout states that have never expanded Medicaid are considering doing so to draw down more federal revenue, but they would also be obligating themselves to pick up a portion of the tab.
He also notes that state lawmakers feel under pressure to buy down property tax burdens at the local level. Property tax bills lag market values and many states cap increases, but with housing prices at new highs, bigger tax bills will inevitably follow. Some lawmakers are concerned that at least some local governments used their share of ARPA money to take on permanent expenses such as salaries.
In recent years, both red and blue states were able to have their cake and eat it, too, offering tax relief even as they increased spending on education and other programs. That’s all changed.
“The other thing I’d mention is a return to tax increases in some states that haven’t seen them in a while,” Williams says. “This year, there was a return to serious discussion about pretty substantial tax increases in blue states for the first time in several years.”
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