As inflation and flatlining real wages squeeze household budgets across the United States, public finance and credit markets are facing a turning point, according to S&P Global Ratings analysts.
The increasing cost of living, shifting demographics, and growing utility demands are reshaping the credit profiles of municipal issuers and public utilities for the worse, the analysts said during a webinar.
"Rising costs in housing, food, and fuel are outpacing income growth and creating an affordability crunch that is pushing consumers to prioritize necessities over discretionary spending," S&P analysts wrote in an Aug. 18 report. "Less spending can lead to lower sales tax revenues, which is particularly challenging as governments try to close widening budget gaps."
Affordability concerns can also translate to less voter willingness to approve levy increases and bond referendums, and a more limited ability to withstand higher user fees, which makes raising revenue difficult, said Sarah Sullivant, an S&P Global Ratings managing director and sector lead for U.S. local government.
"These affordability risks are a long term issue," Sullivant said. "We are seeing rising insurance and affordability costs, which can affect households and where businesses choose to locate. It can weaken long-term sales tax growth and limit revenue options."
Around the country, states are altering their tax systems, she said.
Changes made by states "facing intensifying strain from sweeping federal tax and spending changes," were a mixed bag, according
Seven states — Hawaii, Maine, Rhode Island, Washington, Illinois, New York and Virginia — enacted significant revenue-raising policies to advance key priorities and mitigate the massive federal cuts to health coverage, food assistance and clean energy investments in Republicans' 2025 reconciliation law, according to the CBPP report.
Hawaii, Maine, Rhode Island and Washington enacted millionaires' taxes, "which will raise considerable revenues from wealthier households, who are best able to pay and receive outsized gains from highly skewed federal tax cuts," according to the CBPP report.
Among the three other states that raised revenues: Illinois approved up to $1.8 billion in new annual revenue from multiple sources, including new levies on advertising and social media companies and limits on how federal tax changes affect the state's tax code; New York adopted progressive revenue-raisers including a new tax on high-value second homes in New York City and an extension of the state's 7.25% top corporate income tax rate; and Virginia enacted a temporary tax on the energy consumption of data centers to bring in $1.2 billion over the next two years.
The seven states have Democratic governors and Democratic leadership in the state legislature.
Other states took different tactics.
In Kentucky and Louisiana lawmakers paused additional income tax cuts. In North Carolina, legislators also agreed to delay some scheduled tax cuts to 2030, though that move was part of a broader policy package that the CBPP report described as leaving the state's destructive fiscal trajectory largely intact. All three have GOP-run legislatures, though North Carolina and Kentucky have Democratic governors.
Some other states took steps the CBPP report saw as harmful and weakening their revenue systems through expensive and regressive income tax cuts. "These policies will exacerbate the fiscal pressures stemming from the federal reconciliation law, and in some states compound the growing cost of previous state tax cuts," according to the CBPP.
Those states include Arkansas, Georgia, South Carolina, Utah and West Virginia, all GOP-run.
For municipal issuers, affordability pressures represent a slow-burn, but significant credit risk, according to S&P analysts.
"Real income has flatlined since 2019 in the face of inflation and nominal income gains are eroding," said Bruce Thomson, global specialist of credit research and insights-sustainability. "We are seeing consumption rely on credit. Households are feeling the squeeze on all sides. It's not just increased energy prices, it's hitting food, healthcare etc."
Escalating costs — particularly for housing and insurance — influence where families and businesses locate, ultimately weakening long-term sales tax growth and restricting municipal revenue, Sullivant said.
This is compounded by demographic shifts like an aging population, which shrink the active taxpayer base and force local governments to distribute rising infrastructure costs across fewer taxpayers, Sullivant said. Simultaneously, tax rollbacks in some states are eroding municipal financial flexibility, she said, threatening long-term fiscal sustainability. School districts face similar pressures, as declining enrollment directly impacts funding, she said.
Utility and Infrastructure Capex
A major driver of household strain is the rising cost of utilities, with electricity bills outpacing inflation.
Gabe Grosberg, S&P's sector lead for utilities infrastructure, points to extreme weather, volatile natural gas prices, and rising power demand as primary drivers.
According to a Fitch Ratings commentary, U.S. public power utilities are delaying capital spending, pushing expected spending peaks to 2027 and 2028 due to supply chain bottlenecks and management conservatism. While wholesale issuers project a 42% year-over-year capex increase from 2025 to 2026, long-term credit concerns are rising. If expected load growth from data centers does not materialize, utilities risk overbuilding and stranded assets. Issuers have broadly absorbed higher capex thus far, and credit quality remains sound, according to the report.
"Utilities are still moving ahead with large capital programs, but the timing remains variable as supply-chain and project execution challenges persist," said Patrick Goggins, a Fitch Ratings director.
Furthermore, as bills become unaffordable, regulatory commissions face intense public pressure to disallow cost pass-throughs, directly harming utility credit profiles.
Investor-owned utilities cannot just pass through costs because they are higher, but they will file a rate case with their regulators, Grosberg said.
The utilities have been increasingly reflecting increased capital spending for technology in their requests for rate hikes, said Alan Bonilla, S&P's director of sustainable finance. For instance, if they invest in renewables and then close a coal plant, Grosberg said.
"Everything the utilities spend money on [results in] a rate case filing," Grosberg said. "But when the customer's bill becomes less and less affordable, more customers will put pressure on the commissions to deal with it, because they can't afford the higher rates. The commissioners can then disallow certain costs, which can lower the return on equity for the utilities."
As utility bills become increasingly unaffordable, it becomes an enormous credit consideration that can negatively affect the credit profile for a utility, he said.
Rising power prices, meanwhile, impact every person and organization that uses electricity.
"Electricity demand continues to be high, which puts pressure on rate affordability in the for-profit and non-profit sectors," Sullivant said. "That is important to watch in terms of what happens in the infrastructure bill and from a policy standpoint."
The K-Shaped Economy
The pressure on public finance is mirrored in the consumer sector, where a "K-shaped" economy has developed, Thomson said. While higher-income households ride the upward slope of the "K" to sustain high levels of consumption, real income for lower-income groups has stagnated since 2019, he said, tumbling them down the downward slope.
Bea Chiem, S&P managing director and sector lead for consumer products and retail, notes that frontline wage gains have eroded, leading to recession-like consumer behavior. Retailers report a major transition toward value, with consumers trading down to private labels and discount stores like Walmart. This consumer strain limits local sales tax growth, further complicating the fiscal outlook for public finance.
Amidst these pressures, affordable housing and sustainable debt are serving as critical stabilizers, Bonilla said. Favorable federal policies have lowered development barriers, allowing affordable housing agencies and securitizations to achieve record issuance years despite high interest rates, Bonilla said.
Social and sustainable bonds are playing an increasingly vital role, he said.
Beyond housing, labeled debt is funding cost-of-living resilience projects, including energy burden reduction retrofits, equitable public transit, and community health centers, Bonilla said. These instruments provide critical capital to safeguard vulnerable populations, helping bridge the affordability gap and preserve credit stability in communities nationwide, he said.
