State Budgets Are Downsizing

State budgets are expected to shrink substantially in fiscal year 2025 as the post-pandemic era of surging revenue, record spending, and historic tax cuts comes to a close. According to new data released by the National Association of State Budget Officers (NASBO), total general fund spending is expected to decline to $1.22 trillion, a more than 6% drop from estimated levels in fiscal 2024, which ended for most states on June 30.

It’s a vastly different picture from recent years, two of which were the fastest-growing years for general fund spending since NASBO first launched its fiscal survey in 1979. The final tally for fiscal 2024, for example, is expected to total $1.3 trillion—a 13% increase from fiscal 2023, even after adjusting for inflation.

Although the decline in spending is comparable to the declines in 2009 and 2010, when the economic turmoil of the Great Recession drove state spending down by 5.8% and 6.6%, respectively, the situation now is driven by very different factors. For starters, California’s 2025 budget closes an eye-popping $46.8 billion budget deficit in large part by cutting or delaying spending. That one state has an outsize influence on the total 50-state picture. In fact, NASBO estimates that about half of states are still planning on spending increases in 2025.

On the revenue side, 2025 is expected to mark the first real—albeit minimal—increase after several years of state tax cuts played a role in shrinking collections. Total revenue in the new fiscal year is expected to increase 1.6% to $1.2 trillion, following an estimated 0.8% decrease in 2024, adjusted for inflation. That’s an improvement from fiscal 2023, when state revenue fell 5.9%, according to NASBO. The 1.4% average annual inflation-adjusted revenue losses during the three-year period are a far cry from the 5% average annual revenue losses that states experienced from 2008 to 2010.

For most states, 2025 represents a return to more typical economic conditions after an atypical period for their budgets.

“The flattening of state revenue growth that began in fiscal 2023 and continued into fiscal 2024 can be attributed to a combination of tax policy decisions, as most states adopted tax cuts (both one-time and recurring) in recent years,” the NASBO report said, adding that “economic factors, including a weak stock market performance in calendar year 2022, slower growth in consumption, and slowing of inflation” also contributed.

Still, the spending and revenue stories vary dramatically by state. While some states this spring weighed whether to tap rainy day funds to close projected or actual budget deficits, others—such as Delaware—reported surpluses and are boosting spending in 2025. Still others reported lower-than-expected revenue but no budget deficits. Ohio, for example, has so far collected $430 million less than expected in fiscal 2024, but also spent less on Medicaid than anticipated after the pandemic-era federal funding boost ended earlier this year.

To make sense of the state budget picture, it’s important to look at the underlying spending and revenue trends, what’s driving them, and the fiscal options available to lawmakers.

Putting spending cuts in context

A big reason that states are heading into a spending slowdown is that much of the spending boosts in recent years were one-time expenditures. States used budget surpluses to pay down pension liabilities and fixed debt, boost their rainy day funds, invest in infrastructure, or issue one-time rebates to taxpayers. Some states, like Idaho, used surplus funds to reimburse local governments for property tax relief.

Among the states that are cutting spending in fiscal 2025, a handful are doing so because they were facing budget deficits. For example, Arizona lawmakers closed a $1.4 billion shortfall largely by cutting state education spending as well as budgets for most state agencies. For the second year in a row, California had a deficit to close; its $298 billion spending plan for fiscal 2025 is $12 billion less than the fiscal 2024 budget.

Much of the spending that California decided to pull back was from planned temporary boosts in funding or one-time expenditures, a move that Gabe Petek, the state’s legislative analyst, said helped to protect core services but delayed needed investment. “A lot of the temporary money was going toward very pressing priorities—homelessness, housing, climate-related projects, transportation,” he said in an interview with The Pew Charitable Trusts. So, he added, “while the decision [to pull back from the temporary spending] helped preserve core services, being unable to sustain some of those prior allocations presented a difficult trade-off.”

In other states, there’s a desire to tame record spending. Florida Governor Ron DeSantis (R) vetoed nearly $1 billion across a wide range of programs in the state’s 2025 budget, saying that some of the allocations weren’t “appropriate for state tax dollars,” reported the News Service of Florida. Last year, DeSantis had signed a record $117 billion budget.

One-time versus recurring revenue

Revenue changes have also included a large number of one-time tax cuts, making it difficult to pin down a state’s overall revenue trajectory. In fact, the NASBO report said that because of the “elevated number of one-time tax relief measures that have been proposed and adopted by states in recent years, supported with budget surplus funds,” its survey now asks states to “identify whether proposed revenue changes were one-time/temporary in nature, as opposed to recurring.”

Roughly half of state revenue reductions in recent years have been due to one-time changes, according to the survey.

Looking ahead, some states are still trimming their revenue via tax cuts, but the size of those reductions has changed dramatically—from $13.3 billion in fiscal 2024 to an expected $2.5 billion in fiscal 2025.

The full impact of permanent state tax cuts will continue to play out in budgets for years to come, directly affecting state spending growth. Arizona’s budget gap opened up after the state accelerated its income tax cut timeline. Other significant income tax cuts, such as those in Georgia and West Virginia, were phased in over several years and may not be fully realized until the end of the decade. As revenue in more places wavers, it’s becoming difficult for policymakers to determine whether the changes are due to permanent or temporary factors.

“The question at the moment is, why?” Ohio State Senate President Matt Huffman (R), a proponent of that state’s $3 billion in tax cuts, told the Statehouse News Bureau when asked about the state’s underperforming revenue. “Some of it has to do with refunds, while some has to do with, ‘Is the economy slowing down?’”

Still cutting taxes

Even with uncertainty about their effect, permanent tax cuts were still a major policy focus in several places this year. In June, Hawaii Governor Josh Green (D) signed into law the largest income tax cut in that state’s history—totaling $5.6 billion in lost revenue by 2031. Meanwhile, the Kansas Legislature went into a special session to decide on tax relief, ultimately passing property and income tax cuts totaling $2 billion over five years.

Nebraska is headed into a special session in late July to debate property tax cuts. And Arkansas passed its third income tax cut in less than two years, lowering top corporate and personal rates by half a percentage point each and making the cut retroactive to the beginning of 2024.

States also opted for targeted tax cuts in fiscal 2025 budgets. Illinois and Oklahoma, for example, eliminated their grocery tax. And several states, including Colorado and Illinois, expanded tax credit programs for lower-income families, thus reducing their taxes. (Illinois raised sports betting taxes to help offset the revenue loss.)

Final thoughts

How states manage spending in the coming years will depend largely on their revenue stability and savings levels. In many places, it’s difficult to figure out exactly what’s driving the current revenue trend because the past few years have been so unusual.

Policymakers can look to their states’ long-term revenue trends for broader context to support their decision-making. For example, by mid-2023, California’s tax collections dipped below trend after a year of declines, while Arizona’s had been declining for six months but still remained slightly above the long-term trend, according to Fiscal 50 data.

Lacking a sense of when revenue will stabilize, both states are guarding their rainy day savings. Arizona closed its budget deficit without dipping into its reserve at all. California plans to use $12.2 billion (about 45% of its savings) over the next two years, but the budget also mandates that lawmakers take up legislation requiring the state to collect and set aside projected surplus funds before spending that money in a subsequent budget year.

As states continue to adjust to a new growth landscape, their rainy day funds and other financial flexibility will be vital in managing revenue underperformance. However, as Fitch Ratings recently warned, “the effects of recent years’ tax cuts on revenues have not been tested by a cyclical downturn,” which could further shrink budgets.

Liz Farmer works on The Pew Charitable Trusts’ state fiscal policy project.