What Did States Do With Their Budget Surpluses?

The sudden wave of state revenue growth and budget surpluses that followed the onset of the COVID-19 pandemic appears to be winding down.

While most states reported a fourth straight year of budget surpluses at the end of fiscal year 2024, according to the National Association of State Budget Officers (NASBO), the surpluses are smaller on average than they were in the last few years. Tax revenues are lower than expected based on long-term projections in more states than at any time in the last decade, according to The Pew Charitable Trusts. And states have started to curb spending after years of one-time and temporary investments.

“We’re entering this period now where in many ways states are experiencing a return to normal,” says Brian Sigritz, director of state fiscal studies at NASBO.

According to some estimates, states collected as much as $152 billion in unexpected revenue over the last few years. Where has the money gone?

Where the Surpluses Came From 

The early days of the COVID-19 pandemic were marked by stay-at-home orders and a sudden drop in business activity. Most states predicted economic disaster, anticipating massive reductions in revenue collections followed by painful spending cuts.

“Instead, what states saw after a very short, sharp, two-month-long recession was a completely unexpected wave of tax revenue,” says Page Forrest, a senior associate in Pew’s State Fiscal Health project. “This brought states not only back to where they were before the pandemic, but completely surpassed it.”

States saw historic economic growth over the next few years, boosted by pandemic relief funds and other federal spending. States can define budget surpluses in different ways, indicating either that they’re collecting more revenue than they officially projected or that revenue collection exceeds spending. By any definition, the years following 2020 were surplus years — a welcome trend for state budgets, on a scale that many policymakers hadn’t seen before.

“States don’t really have a set playbook that they follow in this kind of scenario,” Forrest says.

One-Time Investments and Rainy-Day Funds

While states have enjoyed the influx of revenue, they have had to figure out how to use the money without overcommitting themselves in future years, during periods of slower growth or economic recessions.

One way they’ve done so is by increasing contributions to their rainy-day funds, which help cover unexpected revenue shortages. States’ rainy-day fund balances reached a cumulative $164 billion, an all-time high, in fiscal year 2022, according to NASBO. That could help states weather future shortfalls.

“A rainy-day fund is great for a temporary problem,” says Josh Goodman, a senior officer at Pew. “If you have a recession and you know that eventually revenue will bounce back, but you need help for two years or something to balance the budget — it’s wonderful for that.”

States have also used surplus funds to make one-time investments in infrastructure, bolstered by larger federal grant programs following the passage of the Infrastructure Investment and Jobs Act and other bills. Some states, including Mississippi, have put surplus funds into long-planned highway construction projects, for example. Committing surplus money to one-time capital projects can increase states’ overall operations and maintenance demands — but it avoids the pitfall of establishing new programs with funds that are unlikely to recur.

“There’s really been an emphasis on making sure one-time revenues are not being used for ongoing obligations, ensuring spending does not exceed available resources,” Sigritz says.

Tax Cuts and Revenue Projections

On the other hand, most states have passed some type of tax cut or tax relief during the last several years of revenue growth. Between 2021 and 2023, 48 states and the District of Columbia cut taxes on personal income, corporate income and property. They also expanded tax credits or gave one-time rebates to taxpayers.

Some states, particularly those that are in the practice of making long-term budget assessments, are beginning to project deficits in future years. Florida, Pennsylvania, Illinois and other states are expecting deficits in the coming years, according to Goodman. That reflects a variety of factors, including changing economic conditions, the expiration of federal stimulus programs, and potentially the impact of states’ own tax cuts.

“It doesn’t necessarily mean the [states’] individual actions were irresponsible, but the combination of them has put the budget on a course where something will need to be done in the future to make those numbers match — the revenue and spending numbers,” Goodman says.

Decisions about how to spend revenues are mostly made by elected officials, but they’re often based on projections about future collections, a tricky task carried out mostly by public employees. California went from record surpluses to record deficits in the course of a year, partly because of erroneous projections of future revenue. Projecting future revenues is particularly hard in states that collect a large portion of revenue from volatile sources, like taxes on high-income people that fluctuate a lot from year to year.

Oregon is on the verge of giving its taxpayers another state-mandated rebate called a “kicker” after several years of better-than-projected revenue collections. The rebate is required when state collections outpace projections by a certain amount. The projections are made by state economists, who say the tumult of the COVID-19 years made it especially difficult to estimate how big future revenues would be — and how much of the revenue can be expected to recur.

“We have all this unexpected revenue,” says Mark McMullen, Oregon’s former chief economist, now a vice president of policy and research at the Common Sense Institute. “How much of it is a windfall and one-time stuff we have to be careful about? And how much of it suggests we have a bigger economy going forward?”