There’s a saying in the state budget world that there is no such thing as a “normal” budget cycle. Part of the budgeting process requires allowing for unforeseen events. The past five years have underscored that sentiment as state policymakers navigated new spending needs during the COVID-19 pandemic, the revenue surge that followed, and historic levels of federal aid.
Now, in the face of new policy proposals that would reduce federal assistance to states, budget officers are contemplating what that means for the traditional state-federal fiscal relationship.
Federal dollars are the second-largest source of funding for state governments, historically ranging from about a quarter to a third of total revenue; the vast majority goes toward Medicaid, the joint federal-state program that provides medical and health-related services to low-income people. During his first months in office, President Donald Trump and his administration have issued dozens of orders directly affecting aspects of these funding flows. Meanwhile, the legislative proposals to make significant changes to the tax code and drastically change Medicaid funding wait in the wings.
Questions about the shifting landscape of federal funding have taken on a heightened sense of urgency as states adjust to their own slowing revenue pictures and consider how changes at the federal level could further affect their economies. States must maintain a balanced budget, and any significant change in federal funding has a meaningful impact on the services that they provide. When federal funding for a program disappears, state policymakers must choose whether to let that program end or draw resources from some other priority.
Federal actions in a range of policy areas, including tariffs, immigration policy, and widespread federal workforce reductions, have created additional economic uncertainty that clouds revenue outlooks as state officials wrap up their own budget seasons.
Still, state budgeting has always been a balancing act. Any political change in Washington prompts questions about how programs and policies may shift. And while the scale, frequency, and nature of the new administration’s executive actions create immense uncertainty around federal funding for states, the strategies that policymakers will use to manage these risks are well-worn.
Since January, the types of federal policy or administrative changes that states have had to consider have accumulated rapidly. The durability of at least some of those developments is uncertain as legal challenges to the executive and administrative actions mount. But while those battles play out in courtrooms, states must address the very real short- and medium-term impacts of federal actions.
Amid those new challenges are more familiar ones. Revenue growth is once again strained, and state budgets are under more fiscal stress than at any time since at least 2020. Congress has started debating an expansion of the 2017 Tax Cuts and Jobs Act, and cutting federal spending to pay for continued or expanded tax cuts could add to the pressures on state finances.
“There’s always an art and craft of monitoring federal policy and how it affects the states in certain ways,” Philip Rocco, a Marquette University political science associate professor, said in an interview.
Many state and local governments fine-tuned their approaches to tracking rapid-fire developments during the pandemic era, and policymakers commonly step up their monitoring when a new president takes office.
“With Trump, there are rapid changes to monitor, and a lot of changes simultaneously,” Rocco said. “So, the question is, which member of your team is going to be opening up the executive orders page every day? Who’s monitoring the Federal Register?"
Systematically monitoring developments can help states quickly understand how federal actions could affect funding to states and how they should prioritize responses. During the pandemic, states had to build new management capacity and develop strategies to navigate rapidly shifting federal guidance. Minnesota was one of a number of states that established a new office to manage the pandemic-funding influx and keep track of the available funds and their uses.
As pandemic funding has tapered off, state budget officials were able to pivot this hard-won expertise in federal funding toward other needs, such as identifying opportunities in federal infrastructure funding. Given the current federal funding climate, states may continue to benefit from maintaining staff dedicated to navigating these shifting conditions. In anticipation of the change in administration, for example, Maryland hired a consultant in late 2024 to help develop a federal policy tracking tool that officials told The Pew Charitable Trusts is now in use across state agencies.
Strategizing and prioritizing what to monitor helps state budget officials decide how to weigh the potential fiscal effects on state spending plans. Much depends on whether the federal funding in question supports ongoing operations—such as Medicaid formula funding—or is a one-time initiative.
The administrative orders that freeze, downsize, or outright cancel federal grant funding for specific initiatives don’t immediately affect a state’s ability to balance its budget. Agencies might ultimately cancel the affected project or ask the state for additional funds in future budgets, but even partially making up the difference could require difficult trade-offs. For example, the clawback of federal pandemic-era grant funding set to expire in 2026 has Texas public health officials contemplating how that would affect planned spending on the response to the current measles outbreak.
Separately, the funding freeze on certain projects from the Infrastructure Investment and Jobs Act has put initiatives such as the National Electric Vehicle Infrastructure Formula Program in a holding pattern in at least six states while others are weighing options.
“Certainly, when it comes to our climate goals and project ambitions, if we don’t have federal funding, it’s going to be very difficult to hit our goals,” Maryland Secretary of Budget and Management Helene Grady told Pew.
Funding changes to programs in which the state and federal government have a cost-sharing partnership, however, could swiftly alter a state’s spending plans and potentially force decisions that would reverberate through its budget. For example, cuts to federal Medicaid funding or food assistance would force states to decide to make significant changes to current service levels or consider how to backfill at least some of that lost funding with their own revenue.
States have approaches to planning for this sort of uncertainty, ranging from specific line items in their budgets to broader assessments. California lawmakers in February amended their budget to include $50 million to help pay for anticipated legal battles. Meanwhile, the Montana Legislature added contingency funding to its 2027 biennial budget for additional Legislative Finance Committee meetings if federal funds to the state are reduced in certain ways.
Other types of risk mitigation efforts are ongoing. Oklahoma, for example, manages annual fluctuations in the federal Medicaid match rate with a rate preservation fund tied to the Federal Medical Assistance Percentage. More broadly, Utah’s triennial revenue volatility report addresses such potential uncertainty with a section dedicated to fluctuations in federal funding, while Tennessee’s biennial report on federal aid includes agency plans in the event of any significant reductions.
States also create contingency plans for unusual and disruptive events. In 2024, as the obligation deadline for pandemic fiscal relief funds neared, some created alternative plans to ensure that those funds could be used for state priorities if they couldn’t be obligated for their initial purpose before the deadline. States have also produced action plans in the face of looming federal shutdowns covering issues from how the shutdown could affect state employees in federally funded positions to whether the state would pay to keep national parks open.
The downstream economic repercussions of federal policy changes are probably the hardest to assess, and any potential outcomes will depend on each state’s industrial composition.
For example, a potential trade fight with China, Canada, or Mexico could be felt more sharply in import/export states such as Michigan or Louisiana, according to a December 2024 Fitch Ratings analysis. Meanwhile, federal workforce cuts are more likely to affect local economies with a concentration of federal workers, such as in Washington, D.C., and its Maryland and Virginia suburbs. But federal workforce cuts could also affect private sector employment. For example, cuts to funding for federal food safety inspectors could affect the supply chain, prices, and ultimately jobs.
To game out every scenario would be impossible. Even in cases where federal policy actions have been swift and decisive, it is too soon to determine how the ripple effects of events such as research lab closures, an increase in unemployment, or federal tax law changes could influence annual state budgets.
Policymakers can, however, assess how federal funds are spent in their state’s economy and consider how their budgets may fare in the event of any substantial changes. Several are already doing so. In California, the Legislative Analyst’s Office presented to state legislators a breakdown of how $452 billion in annual federal funding flows to individuals and state entities. Vermont has set up a special task force to assess the economic impact of the new administration’s policies. And Nebraska’s most recent stress test report analyzed the impact of a potential federal shutdown on the state’s overall economic picture.
State leaders are in a time of intense fiscal uncertainty. In addition to assessing their budgetary exposure to changes in federal spending, they may also need to adjust to any changes that may come from congressional tax legislation expected this year. Among the policies up for debate are reducing or eliminating the municipal bond tax exemption, which could increase infrastructure financing costs for states and localities. On the revenue side, changes to federal personal or business income tax exemptions could also alter tax collections for states that automatically link to the federal code.
Between the Trump administration’s rapid-fire policy changes and potential legislative ones later this year, the fiscal questions facing state budget officers may be very different than in previous years. But with established federal funding expertise, risk assessments, contingency planning, and stress testing, states already have a robust set of policy tools to meet these new challenges.