Thesis: State fiscal year 2027 budgets reflect a commitment to financial discipline with a widespread desire to preserve ample fund balances, limit spending growth and plan ahead for revenue uncertainty. Processing Content Observation: While states are making prudent revenue and expenditure decisions, the room for error is narrowing as affordability pressures and federal cutbacks increasingly restrain limited budgetary resources. Call to action: Municipal market participants should look beyond headline budget balance and reserves and focus on how individual states are managing recurring revenues, spending priorities, federal funding exposure and the sustainability of essential services. |
As September concludes, all states have enacted FY 2027 budgets. In
The true test of a state's fiscal standing is not how it behaves when growth and productivity are driving strong revenue performance and creating less challenging spending decisions, but how it addresses declining resource availability while preserving its commitment to providing essential services, adhering to a balanced budget mandate and meeting timely debt service obligations.
States are actively surveilled by municipal bond analysts and other stakeholders across the public finance sphere. Many articles and white papers highlight them and they are often discussed in news media. Government officials are very interested in the market's perception of their debt and how investors and rating agencies analyze their credits.
I can recall a time when the municipal portfolio group at Chubb Insurance Co. produced a state survey index that compared the relative yield on a state general obligation bonds against a baseline benchmark state, which at the time was triple-A-rated New Jersey (can you believe that?) That index ended years ago with the broad market now using credit-spread matrices and benchmark yield curves provided by data platforms such as Bloomberg, S&P Global and Municipal Market Data.
Not all states are created equal and not all present recurring structural balance. A discerning eye focuses closely on what precise measures are used to achieve budgetary balance. A disproportionate use of one-time revenue fixes and reserve fund drawdowns does not follow conservative budgeting principals, and would not be characteristic of a triple-A-rated state.
Most, but not all, states issue general obligation bonds, with the authority to do so typically residing in state constitutions and state statutory codes. Most state constitutions detail debt limits and referendum provisions, while others contain restrictions on issuing bonds secured by a state's full faith and credit pledge.
Statutory codes generally outline authorization, procedural and structural rules as well as sale methodologies, such as competitive bid and negotiated transactions. Oftentimes, state bond acts and enabling legislation provide the legal framework for project-based issuance. Approvals and management for many state bond sales are supervised by state debt or finance commissions.
The National Association of State Budget Officers (NASBO) recently released its Summaries of Fiscal Year 2027 Enacted Budgets. Thirty-one states, the District of Columbia, Guam and Puerto Rico enacted budgets for fiscal 2027. Three states (Kentucky, Virginia, and Wyoming) enacted two-year budgets for fiscal years 2027 and 2028. Last year, 15 states enacted budgets for both FYs 2026 and 2027 (six of those states enacted revised or supplemental budgets this year), while North Carolina enacted a partial budget last year before enacting a full budget this year.
Forty-six states began their fiscal year on July 1. New York's fiscal year started on April 1, Texas on September 1, and Alabama and Michigan on October 1. Puerto Rico's fiscal year is effective July 1, with the District of Columbia, Guam, and the U.S. Virgin Islands having an October 1 start date.
Common themes are identified in the NASBO report, including widespread fiscal restraint backdropped by a commitment to maintain sizable reserve balances and moderate spending growth. NASBO notes, "Both the average and median general fund spending growth rates were approximately 2-3 percent, while some states reduced spending from fiscal 2026 levels."
Conservative strategies include limitations on discretionary spending growth, targeted budgetary cuts, reducing vacant positions, and applying reform initiatives. The budgetary cycle was certainly not immune to federal policy shifts, with various states taking responsive actions. Certain budgets allocated funding to support higher expenses tied to Medicaid and the Supplemental Nutrition Assistance Program (SNAP). Additional resources were earmarked for unforeseen cuts in federal funding.
On the revenue side, most state budgets forecast revenue growth of about 2-3 percent for FY 2027, in alignment with anticipated spending growth. NASBO remarks, "this would mark the fifth consecutive year of moderate revenue growth." Many state officials cite fiscal discipline, active consumer engagement and higher tax receipts as leading contributors to strength and resiliency.
On the flip side, ongoing geopolitical factors such as trade tariffs, the Iranian crisis — with attendant supply shocks and inflationary pressures — as well as tax policy changes are collectively having an impact upon projected FY 2027 revenue performance. At this time, it is difficult to predict the impact of geopolitical factors upon the budgetary revision process.
In most states, rainy-day funds and other reserve accounts held stable or increased to address unforeseen fiscal uncertainty. Budgetary priorities reflected the realities of fiscal constraints and affordability concerns and kept faithful to austere practices with a financial commitment to core services. Conservative debt management practices were evident and funding programs were strategically targeted and less broad based. Budget deliberations were heavily mindful of the need to achieve structural balance, a practice often subject to undermining forces.
Specific funding areas revealed little surprise with a focus on constituent-friendly priorities. A summary of NASBO's findings show:
Elementary and secondary education: school funding formulas; teacher compensation; special education; literacy; school safety; school meals; early childhood programs
Higher education: operating support; tuition affordability initiatives; workforce-oriented programs; community colleges; research; performance-based funding
Health and human services: preserving current Medicaid programs; cost containment; SNAP; behavioral health; long-term care; disability services; child welfare
Public safety: wage increases for public safety personnel; recruitment and retention; emergency management; courts; crime prevention initiatives; community-based safety programs; victim services
Infrastructure: maintaining or increasing funding for roads and bridges, transit, airports, water infrastructure; affordable housing; homelessness programs; environmental initiatives; disaster recovery; resiliency programs
Workforce and economic development: career and technical education; apprenticeships; small businesses; targeted industry development; state employee wage increases; efficiency initiatives to improve recruitment, retention, and operations
Tax policy: tax relief measures include reductions in individual and corporate income tax rates; property tax relief; expanded child tax credits; specific initiatives impacting retirement income, tips, overtime and fuel; selected tax expansion and targeted revenue increases in support of budget priorities or offset to revenue losses
Much of FY 2027 budgetary performance will likely remain exposed to inflationary pressures and fiscal constraints. Given a wide-ranging application of conservative revenue and expenditure forecasting, I do not expect substantive adjustments in most states.
However, the geopolitical climate can upend this outlook. States will continue to navigate declining federal support and are likely to focus on essential services and core constituency needs in response to affordable housing shortages and rising costs tied to healthcare, higher education and critical infrastructure investments. States are not expected to compromise on their commitments to preserve reserves and budgetary balance.
As previously mentioned, not all states are created equal. If they were, they would all have the same ratings. Prime-quality triple-A-rated and double-A-rated states are characterized by strong and proactive management well-positioned to make timely budgetary adjustments as appropriate. These states typically exercise prudent financial and operational oversight as well as maintain a commitment to conservative debt practices. Some triple-A-rated states have heavier debt metrics than others.
Certain states do not issue general obligation debt — as previously described in my comments surrounding state constitutional and statutory frameworks. However, these states can carry issuer credit ratings from the rating agencies. For example, the state of Indiana does not issue general obligation bonds as expressed in Article 10, Section 5 of the Indiana Constitution, but the state does maintain a triple-A issuer credit rating. In Indiana, state-level debt often carries an appropriation mechanism or a moral obligation structure, like that utilized by the Indiana Bond Bank.
While many states enter FY 2027 with strong reserve balances, large reserves are not the only barometer of fiscal health, and should not be disproportionately relied upon as a lone indicator of credit strength. Structural budgetary imbalance, for example, should be given overriding attention despite the presence of ample reserves.
For triple-A-rated states, common fiscal attributes include moderate spending growth, positive revenue growth, significant liquidity and overall budgetary flexibility. These elements would help states offset a recession, combat a natural disaster or manage through declining tax receipts.
Recurring revenue volatility and unchecked spending can lock states out of triple-A credit standing. Certain states exhibit strong liquidity, but are challenged by revenue volatility. States that are heavily dependent on high-income taxpayers, capital gains taxes and economically sensitive revenue streams — such as California, New York, and Massachusetts — can benefit from sizable reserves.
California's relatively disciplined FY 2027 budget is highlighted by $251.5 billion in general fund spending — a 2.5% increase from FY 2026 — a $3.6 billion rainy-day deposit, a $6.4 billion transfer into a holding account for allocation in FY 2028, approximately $28 billion in reserves, no projected deficit for FY 2027 or FY 2028, and a substantial reduction to the projected structural deficits for FYs 2029 and 2030. This backdrop places California in a good position to weather revenue volatility.
While Illinois displays improved fiscal management — reinforced by recent ratings upgrades by Moody's Ratings and S&P Global Ratings (part of an upward migration since 2021) — long-term pension liabilities remain a challenge for the state. Consecutive balanced budgets, increasing rainy-day fund balances and better financial transparency have driven the credit improvement, but tighter margins of protection may expose Illinois to renewed budgetary pressure during the next recessionary cycle.
As noted, federal policy represents a budgetary challenge for states. Given a lagged effect, deficit implications for FY 2027 are not part of the narrative. States have learned how to leverage both financial flexibility and creativity as a way to preserve overall credit health. Responses to reduced federal support could include utilization of reserves, interfund transfers, spending cuts, delayed capital plans and tax changes. Having said this, preserving structural balance is needed for ratings stability. States with large Medicaid programs and relatively weak fiscal cushions could encounter greater budgetary headwinds.
Fiscal stress does not necessarily equate to fiscal distress, but we must be mindful of situations where spending pressures are beginning to outpace recurring revenue growth, with attendant erosion in fiscal cushions. A watchful eye must also be placed on those energy-producing states heavily reliant on volatile commodity revenue as erratic energy prices can challenge budgetary performance.
While state finances are not deteriorating, fiscal resilience is becoming increasingly uneven. If economic growth comes in below forecast, corresponding declines in revenue growth can be expected. Material funding shifts in healthcare, education, pensions, infrastructure, disaster costs and federal support could push expenditure growth higher.
An analysis done by the Tax Policy Center concluded that the median state was projecting only 2.3% nominal tax revenue growth for FY 2027, down from 4.1% in FY 2025. A Pew Charitable Trust survey reveals that 16 states incorporated planned rainy-day fund withdrawals into their FY 2027 budgets — unusually high in the absence of a recession.
Going forward, state credit analysis will be about distinguishing between those having the fiscal breathing room to weather expanding headwinds and those less fiscally agile, revealing tighter margins of protections and broadening structural imbalances. As I have consistently stated, state credit analysis is less about default risk and more about headline risk and spread distinctions.
Across the 50 states, credit profiles can be broken down into different classifications. Certain states can be categorized as strong and well-positioned, others stable but vulnerable, some under increasing pressure, and a few labeled as high concern.
The FY 2028 budgetary cycle is likely to reveal deeper constraints. Program affordability and prioritization will be subject to greater compromise and even essential services spending may have to be cut back in some states. Thankfully, reserve fund balances are well-anchored across the state sector and there is reason to believe that a commitment to fiscal austerity will be captured in near-term budget deliberations.
