‘Unsettled normalcy’: Gone, for now, are wild revenue swings, but other budgeting uncertainty lies ahead

An era of budget extremes for states — large, pandemic-induced losses in revenue followed by never-before-seen, year-over-year gains — has ended and been replaced by a period of relative fiscal normalcy.

How long will it last?

Lawmakers heard from two experts on state fiscal policy in July, both of whom highlighted factors that could bring uncertainty in state budgets over the short and long term. Organized by the Midwestern Legislative Conference Fiscal Leaders Forum, the session was part of this year’s MLC Annual Meeting.

In her presentation, Stacey Mazer, a consultant for the National Association of State Budget Officers, pointed to several spending pressures, including increased demands on state Medicaid programs and emerging priorities in areas such as housing. She also noted that over the past two fiscal years, states made a combined $28 billion in one-time or recurring tax cuts. In the Midwest, income tax rates have been reduced and/or tax brackets consolidated in Indiana, Iowa, Kansas, Michigan, Nebraska, North Dakota, Ohio and Wisconsin. In many of these states, the changes are permanent.

“With the amount of tax reductions that have occurred, there’s certainly an interest in monitoring, making sure your revenue base is able to do what you think you should be doing,” Mazer said.

States, as a whole, are more prepared for a downturn.

For fiscal year 2025, the median balance of state rainy day funds (balance as a percentage of general fund expenditures) is expected to be 15.0 percent, a record level. But there is risk in having rainy day funds run too high, according to Phil Dean, chief economist and senior fellow at the University of Utah Kem C. Gardner Policy Institute.

“You’ve taken that money out of the economy; it’s just sitting there,” he said.

To address those concerns, Utah has established a separate “working rainy day fund”: During good times, some surplus revenue goes into the capital budget to fund infrastructure projects. During bad times, that revenue is repurposed to close budget shortfalls, with the state putting the projects on hold or issuing bonds to continue them.

Calling the current fiscal environment “a period of unsettled normalcy,” Dean suggested a careful dissection of the causes of the steep rises in state revenue in recent years. Yes, more federal dollars and temporary shifts in consumer spending were contributors, he said. But that’s not all.

“There is a lot of spending right now, or at least an increasing share of spending, that’s coming out of wealth from the Baby Boomers,” Dean said. “That’s why I think we’ve under-forecasted [in recent years].”

On the flip side, and over the longer term, less wealth accumulation among younger generations could result in less spending. That ultimately affects states’ bottom lines. Dean noted generational differences in his own family to underscore the point.

“What I really worry about is my kids,” Dean said. “They’re going to be out there renting and not having that asset [of a house], and not having what in economics is called the wealth effect — even if you’re not actually using your assets, you spend.”