State and local budgets are under threat from restrictions on Medicaid funding, less money for higher education and other unforeseen complications from the Trump administration's tax reform bill.
"States with a July 1 fiscal year, just passed their budgets," said Tracy Gordon, VP of tax policy, co-director and Robert C. Pozen director at the Urban-Brookings Tax Policy Center.
"If we were to look at those, we could say it's pretty much smooth sailing. Revenues are sluggish, but not horrible. Their rainy-day funds are very healthy, but then there is this thing around the corner."
The One Big Beautiful Bill is a 1000-page piece of legislation that fundamentally changes several interactions between how federal dollars will be used to help fund state and local governments.
The comments came during a panel discussion at the Brookings 14th Annual Municipal Finance Conference on Wednesday that saw academics and public finance pros looking for signs of trouble on the horizon.
"There's not one state rated by Fitch (Ratings) with a negative outlook right now, not one," said Dan Hartman, managing director and immediate past CEO of PFM Financial Advisors LLC.
"There's 15 with a positive outlook. There's 18 with the triple-A rating, some that are now rated higher than the federal government. It does not suggest that the sky is falling from Fitch's perspective."
While most states appear to be good financial shape there have been ratings repercussions related to the Trump administrations attempts at shrinking the size of the federal workforce.
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Maryland and the city have both executed successful bond sales since the downgrades.
Many of the cuts from the OBBB won't be felt until 2027 but Hartman is eying one sector for early signs of stress.
"One area that's kind of interesting that's going to be crowded out by some of these other issues is transit," he said.
"There is a cliff in transit this year where the COVID era money has run out. New York has tried to address that with congestion pricing. But there are other places, SEPTA in Pennsylvania, the CTA in Chicago or BART (San Francisco) that have really significant challenges."
The $10,000 cap on the state and local tax deduction proved to be a major battlefield with representatives from high tax state and some muni advocates emerging as the winners, so far.
States may start looking at adjusting their tax policies in response to the new rules on SALT.
"There was no way this legislation was going to happen without increasing the cap," said Gordon. "It's now $40,000 and it's temporary, so we'll be having this fight again in a couple of years."
Government at the local level will also be forced to adjust to whatever is coming down the pike, with rural hospitals and higher education looking especially vulnerable.
"They're worried about funding freezes, and some of the immigration enforcement stuff is going to affect their lives," said Gordon. "Immigrants are a big deal in the housing sector, in the hospitality industry and in the long-term care industry."
