Several canaries are suffering in coal mines as tax policy changes, tariffs, and moves by the Trump administration to shrink the federal workforce are adding to state budget woes.
The Kroll Bond Rating Agency released a
"These changes are likely to create budgetary headwinds for many issuers across the municipal market, potentially necessitating difficult fiscal and policy decisions to absorb additional costs."
KBRA believes the major threats include reduced federal cost-sharing for Medicaid and the Supplemental Nutrition Assistance Program, tighter Medicaid eligibility, proposed changes to the Federal Emergency Management Agency, and cuts to the National Institutes of Health.
The agency is telegraphing possible ratings changes.
"KBRA's credit ratings will reflect these shifts, as the economic and fiscal effects of federal program changes flow through the municipal market."
Washington, D.C. and its neighboring states are already feeling the effects of a reduced federal workforce as policy changes expand beyond the Beltway.
"The impact is most severe in the D.C.–Maryland–Virginia region, where federal employment is concentrated, but states with major military bases, research labs, and federal offices are also seeing local economies and critical programs hit hard," said Lucy Dadayan, principal research associate at the Tax Policy Center, Urban Institute & Brookings Institution.
Last week a
"Looking ahead to fiscal 2026, many states have already revised revenue forecasts downward. The outlook: tighter budgets, shrinking reserves, and rising long-term obligations. In this constrained environment, policymakers will need to tighten their belts."
Despite the warning, the report shows personal income tax revenues up by 6.6% and corporate income taxes up 2.2% n the first quarter of 2025. Sales tax revenues declined by 0.4 percent.
Per the report. "This marks the eighth consecutive quarter of real declines in sales tax revenue, reflecting a continued shift in consumer spending from taxable goods to untaxed services."
The growth in personal income tax revenue was strongest in California, New York, and Oregon. Gains in California and New York are attributed to the stock market while Oregon's growth reflected a rebound from a weak base the previous year due to a large tax rebate."
Oregon and Colorado both employ rebate programs that automatically send state surpluses back to tax payers.
Colorado, Oregon, North Dakota, and Iowa all hew to rolling conformity that aligns state tax policy with federal and base their income tax on federal taxable income.
OBBBA provisions are sending a mix of other effects to the states through higher standard deductions and limited itemizations becoming permanent.
According to the report, "For most conforming states, this broadens the tax base and boosts personal income tax revenues."
An expanded Child Tax Credit reduces revenue in states that tie their tax codes to the federal CTC.
OBBBA also temporarily raises the cap on state and local tax deductions and keeps pass-through entity exemptions in place, which some municipal bond issuers see as a positive.
