With a new administration in Washington and the long-expected end of federal pandemic aid, states are grappling with a new financial picture this year.
Changes to the tax code in Washington could affect revenues in states, as could increased tariffs. Medicaid is expected to be on the chopping block in Congress, to help pay for tax cuts. Serious cuts would have profound consequences for states’ bottom lines.
Still, states begin the year in pretty good financial shape. Budgets are mostly stable, with rainy-day funds remaining near record levels. A few states, however, are already seeing shortfalls — mostly blue states such as Maryland and Washington. Sales tax revenues have steadily been ticking down for months, while transportation spending has been ticking up.
Here’s a full picture of the biggest finance issues affecting states in 2025.
Budgets
After a period of rapid growth, overall state spending was flat last year. Heading into 2025, budgets are mostly in good shape, but there are several risk factors that should make lawmakers cautious. “It’ll be another year of slower spending and slower revenue growth,” says Brian Sigritz of the National Association of State Budget Officers.As has been long anticipated, extra federal aid from the pandemic era has mostly run out. State sales tax revenues have been in decline for several straight months. Expected tax and spending cuts at the federal level could have a profound effect on states, particularly if Medicaid is slashed. State and local governments receive a third of their revenues from Washington and Medicaid accounts for two-thirds of that money. “State budgets are facing significant risk with reduction of that support,” says Wesley Tharpe, a state tax expert at the Center on Budget and Policy Priorities, a left-leaning think tank.
States are facing their own challenges at home. California, Maryland and Washington all face budget gaps in the billions this year and in the years to come. Although it’s mostly blue states facing big shortfalls, largely due to spending increases in recent years, red states are not immune. Some, including Iowa, Mississippi and West Virginia, enacted tax cuts that are ratcheting up with the start of the year. And the spread of school vouchers throughout Republican states is increasing costs. Half of the new spending called for in the budget proposal from Arkansas GOP Gov. Sarah Huckabee Sanders is devoted to vouchers.
“At first glance, most state budgets seem relatively stable, in terms of not seeing sharp declines in either revenue or spending, and rainy-day funds are sound,” Tharpe says. “Still, states are facing a set of multiple risk factors or strains.” — Alan Greenblatt
Medicaid
Medicaid has been in expansion mode in recent years, increasing payments to providers, expanding coverage and even paying, in some states, for non-medical interventions that can affect health, such as housing.
Those days are over. Medicaid is entering a new era of austerity. But just how austere is a huge, unanswerable question at this point.
As Congress considers ways to pay for tax cuts and other expenses expected in budget reconciliation bills this year, Medicaid is clearly a target. With Medicare and Social Security cuts seemingly off the table, Medicaid is the biggest remaining source of potential savings. On Capitol Hill, there’s already discussion of a variety of ways to cut Medicaid spending, including work requirements, per capita caps and lifetime limits, or converting parts of the program to block grants. “These directionally represent a future in which the Medicaid program will be attacked,” says Andrea Ducas, vice president of health policy at the Center for American Progress, a progressive think tank. “I worry about existential threats to the program.”
Aside from looking for savings, some conservatives object to the current imbalance in funding levels under the program. The federal government picks up 90 percent of the cost for those eligible under the Affordable Care Act (ACA), who are able-bodied adults, but less than 60 percent on average of the traditional Medicaid populations of children, adults living in poverty and nursing home residents. Medicaid is not only a strain on federal and state budgets, but delivers “substandard care” while crowding out private health insurance options, according to the conservative Heritage Foundation.
Nine states have trigger laws on the books that would end their Medicaid expansion programs if the extra spending under ACA goes away, while three more have laws in place that could ultimately have the same effect. In the 10 states that never expanded Medicaid under the ACA, the current atmosphere of likely cuts probably stops any momentum toward doing so.
Medicaid makes up an enormous share of state budgets — it’s their largest single spending item, counting federal dollars, and the second-largest expenditure of their own funds, after education. In addition to pushback from hospitals and physicians, serious Medicaid cuts will likely encounter resistance from governors worried about the enormous gap these could create both in terms of their finances and the health-care systems in their states.
So what’s going to happen? No one knows. If Medicaid is cut, it will likely be part of a second reconciliation package, centered on tax cuts, that may not pass until the end of the year — well after state budget-writing seasons are over. “We’re not going to know what could be changing in Medicaid,” says Hemi Tewarson, president of the National Academy for State Health Policy. “So states are going to have to make decisions around programs based on the facts they have before them today, which right now is uncertainty at the federal level.” — Alan Greenblatt
Insurance
Even before the fires in the Los Angeles area, insurance had emerged as a key concern for state lawmakers. More companies are pulling out of markets, leaving homeowners short on sources of protection.
The frequency of billion-dollar climate and weather disasters has increased nearly 250 percent in recent years. Insurers have been pulling back from disaster-prone states such as California and Florida for decades, but warmer oceans and air are causing dangerous and costly drought, rain, flood, wind and wildfire events throughout the country.
Improving resilience will be a priority following a punishing 2024, creating pressure for owner and community-based mitigation efforts. California’s new requirement that insurers offer discounts for wildfire protection is being watched by other states in the West, who want more evidence that damage will actually be reduced and claim costs go down.
New legislation in Georgia will give premium discounts to property owners who retrofit or build structures with features that help them withstand windstorms. Florida is exploring a similar strategy for condominiums. Lawmakers in Hawaii have asked the state insurance commissioner to submit a study on wildfire risk and market-based approaches to insurance before they meet in 2025.
California’s insurance commissioner believes providers will begin to come back following regulatory changes that allow insurers to set rates using catastrophe modeling that takes expected future risks into account. In exchange, they will be required to sell more policies in high-risk areas and offer safety discounts for wildfire mitigation efforts by communities and homeowners.
Since 1968, 33 states have enacted laws creating last-resort programs in which insurers share risk. Some of these state-administered, privately funded programs are in danger from recurring disasters. Federal reinsurance has been proposed for them, but might not come from an administration focused on cost cutting.
To keep customers and attract new ones, the National Flood Insurance Program, the largest provider of flood coverage, recently announced it would accept monthly payments as an alternative to a single yearly one. The authors of Project 2025, a governing blueprint created for the Trump administration, would like to see this taxpayer-subsidized insurance privatized. — Carl Smith
Taxes
As noted earlier, state budgets are already under considerable pressure this year. Nevertheless, there’s still a good amount of appetite for cutting taxes. But the ambitions of tax-cutters will likely be reduced from recent years, when nearly every state cut taxes.
As recently as November, Louisiana cut personal income taxes by more than $1 billion. Some governors, such as incoming Missouri Republican Mike Kehoe, are talking about eliminating income taxes altogether. Although revenues are projected to decline in Kentucky, further income tax cuts remain a priority for the legislature’s Republican majority. Last year, states including Idaho, Kansas and West Virginia passed property tax cuts. Property taxes are mostly a local matter, but states remain interested in providing relief with bills going up due to increased housing values.
All this activity comes at a time when revenue growth has slowed and significant tax legislation is expected at the federal level. President-elect Trump has proposed eliminating the $10,000 cap on state and local tax deductions imposed by the tax-cut package enacted in 2017. He wants to extend personal income tax cuts included in that bill, which would otherwise expire at the end of 2025, while offering more breaks for businesses. “That could lead to declines in corporate income tax revenues, particularly for the states that conform to the federal code,” says Lucy Dadayan of the Urban-Brookings Tax Policy Center. “Potentially eliminating taxes on tips and Social Security can also have an impact on state tax revenues.”
Jonathan Williams, chief economist with the conservative American Legislative Exchange Council, opposes lifting the cap on state and local deductions, which he says forces the rest of the country to subsidize higher-tax jurisdictions. He favors the overall mission of extending the 2017 cuts, however. “State-level conformity with its expiring provisions, which broaden the income tax base and strengthen revenue for states, provided the ability for states to implement pro-growth tax relief in response, setting off this tax-cut revolution we’ve seen in states in recent years,” Williams says.
In states led by Democrats, lawmakers are considering tax hikes to help pay the bills, mostly on wealthy residents. Last month, outgoing Washington Gov. Jay Inslee prepared a budget that includes a new wealth tax to generate $10 billion over the next four years. Legislative leaders there say some sort of tax increase is likely, due to the state’s budget shortfall.
Taxes on wealth, as opposed to income, may face legal perils, but progressives around the country are still eyeing the strategy as a potential source of significant revenue. “For working people, they’re often taxed on the work that they do, and for wealthy people, they’re not very regularly taxed on the wealth that they hold,” says Jessie Ulibarri, co-executive director of the State Innovation Exchange, a consortium of progressive legislators. — Alan Greenblatt
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