The first step in recovery is recognizing a problem. For decades, some U.S. states have had problems with indebtedness. But as we take stock of state finances today, we see many examples of recovery.
Each state has its own funding mix, but all combinations have worked well in the current cycle. States generally rely on some combination of sales taxes and personal and corporate income taxes. These revenue sources are sensitive to economic activity, but that risk has played out to the upside. Since 2021, state coffers have gained from a jobs rebound, steady consumer spending and strong profit growth.
Federal funding provides about 35% of state revenues, designated for specific purposes. The majority of federal dollars pay for Medicaid health coverage, which is managed at the state level. Washington may also provide funding for infrastructure, nutrition and education programs.
See more: US Set to Pay Most for 30-Year Debt in Quarter of a Century
Each state treasury keeps a budget stabilization or “rainy day” fund to draw on when needed. Funding shortfalls may also be filled through debt issuance. Use of debt must be prudent: unlike the federal government, states cannot issue currency to manage their debt burdens. If the states lose discipline, markets may bring it back.
Pandemic interventions helped to set states on a healthier course. The CARES Act of 2020 and American Rescue Plan Act of 2021 together allocated over $500 billion in funding to states. Unlike most federal grants in aid, these streams left wide discretion for states to use in the recovery. While not designed to support state finances, these funds allowed indebted states to make a fresh start.
The S&P rating or outlook for 16 states is higher today than it was at the start of the decade. In aggregate, state general funds have risen more than fourfold, and rainy funds have more than doubled, far outpacing inflation. Every state has benefitted from this shift.
States employ over 5.4 million workers (3.4% of US employment), about half of which are in state university systems. Higher education employment will face ongoing challenges from lower federal grant funding and flattening enrollment. But pension demands for former and current state employees will carry on regardless.