States Probably Need to Start Cutting Spending Now

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Thomas Young
July 25, 2025

For observers of state budgets, the continued strength in overall spending is probably surprising to many. State budgets have swelled since 2018, driven by booming tax revenue and big federal aid during the pandemic. General funds – the money states raise from taxes and fees (like income or sales taxes) to pay for schools, courts, health programs and other core services – have seen record growth. For example, state general fund spending rose roughly 16.0 percent in fiscal 2022 and another 11.8 percent in fiscal 2023, the fastest back-to-back increases in decades. By FY2024 the aggregate total was about $1.24 trillion (up ~9.7 percent from 2023). This follows much slower growth in the late 2010s – about +5.8 percent in 2019 – and reflects the huge rebound after the 2020 recession. Budgets enacted for FY2025 showed only modest real growth (about +3–4 percent after inflation) and governors’ plans for FY2026 generally assume flat or even shrinking general fund spending as one-time windfalls fade.

Where did all that money go? Education and health care were big winners. In particular, K–12 schools continued to eat up the largest slice of state general funds by far. In FY2024 state-funded K–12 spending alone grew 10.9 percent. Public colleges and universities also received an enormous share of the additional funding. Overall, elementary and secondary schools grew to more than 19 percent of total state spending and more than 33 percent of states’ general funds in 2024.

Health care (especially Medicaid) also ate up funding. Medicaid accounted for about 18.7 percent of all state general fund spending in FY2024, making it the second-largest category after K–12 schools. Medicaid budgets have jumped as pandemic protections ended. Those rising costs put pressure on state budgets even as revenues cool.

Other major areas that saw big boosts include transportation and infrastructure. In FY2024, states sharply increased transportation outlays. New federal infrastructure grants (from the 2021 Bipartisan Infrastructure Law) plus states’ own capital spending pushed highway and transit to the highest levels ever.

The COVID-19 pandemic had an enormous budget impact. Initially, tax collections plunged in early 2020. But states quickly recovered – and then some. Two factors explain the big spikes in 2021–2022 spending: federal relief and a rebound in revenue. Congress sent states unprecedented aid through the CARES Act and American Rescue Plan. States used this money for public health, unemployment benefits, water projects, broadband and other needs. The economy also rebounded decently. Tax revenues surged beyond forecasts.

States responded to enormous revenue growth by rapidly increasing spending in 2021–22 and by saving excess cash. Many governors used the windfall in various ways: paying off debt, boosting reserves, cutting taxes or funding new initiatives.

State budgets distinguish between operating (day-to-day) and capital expenditures. Operating budgets cover routine services: teacher and state worker pay, health benefits, social services and so on. Capital budgets pay for long-lived projects: building or repairing schools, highways, dams, IT systems and so forth. Because the pandemic surpluses were mostly one-time windfalls, some states deliberately used them for capital and other non-recurring purposes, but these “cautious” states are in the minority of states. Most states simply assumed the good times would last forever.

Now that the revenue surge has ebbed, states face new risks. Most analysts expect general fund revenues to grow only slowly (or even shrink) in 2025–2026. Meanwhile, many of the commitments made during boom years are ongoing. For example, many states enacted raises for public employees and large increases for public education when money was flush. Pew Research warns that such policies are now posing challenges as revenues flatten – creating a higher risk of structural deficits (where routine costs outstrip routine income).

Key cost drivers like Medicaid and education are still rising, at least on the surface. Medicaid, in particular, takes a growing share. If tax growth slows to a normal pace, states may need to adjust priorities. Many policymakers are starting to use remaining surplus balances and rainy-day funds cautiously, knowing that today’s big budgets may not be sustainable without either higher revenues or spending cuts.

In short, it is increasingly becoming the case that states now are starting to “live within their means” more strictly again, balancing popular commitments (like education funding or tax relief) with the reality of flattening income. Which states keep to such a commitment of reasonable expenditure growth and moderately sized budget cuts may come out ahead in the coming years of competitive economic growth.

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Author: Thomas Young, Ph.D. is an economist who works in/has worked in the think tank world, boutique economic consulting, federal, state and local governments and investment management. 

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