States buckle in for federal cuts, budget shortfalls and economic uncertainty

Faced with deep cuts to federal funding and an economic future tethered to the whims of the president, states are readying a variety of strategies and contingency plans in hopes they can continue operating their critical services for the next four years.

Federal dollars represent the second-largest source of funding for states, ranging from a quarter to a third of their income. The lion’s share of that funding is for Medicaid, a program that provides health services for low-income people, and which House Republicans this week voted to cut deeply. Losing support for that program and others will mean states must make hard decisions about which programs to prioritize.

“With any fiscal cycle that has uncertainty, whether it is during the Great Recession or during COVID, almost every state has a constitutional requirement to have a balanced budget and all states do balance their budgets,” said Liz Farmer, an officer on the state fiscal policy team at The Pew Charitable Trusts. “But with that, like with any of us, when there’s a change in our income or a necessary change in our spending, there’s only so many dollars to go around.”

Cuts to federal funding, coupled with an uncertain economic forecast, will mean tradeoffs across a wide range of state programs, including technology spending. Farmer, who coauthored a recent financial analysis, recalled from her time as a news reporter that even in favorable economic conditions, state technology officials can struggle to find support from their governors and legislatures.

“One thing I remember was the constant hat-in-hand feeling they always had to have when it came to additional funding, because investment in tech is kind of similar to infrastructure investment. Most of it’s invisible,” Farmer said. “So it can be difficult to ask for more funding because a lot of folks say, ‘What are we getting from it? I don’t see anything.’”

Several state chief information officers said watching their legislative sessions this year has not inspired confidence. Many states are facing budget shortfalls and cutting programs, including California, which is forecasting a $12 billion deficit.

Washington Gov. Bob Ferguson inherited a $16 billion deficit when he took office last January. Bill Kehoe, the state’s chief information officer, said the governor asked agencies to find $4 billion in “efficiencies and cuts” for the coming biennium. Kehoe said he’s been part of the discussions of how the state will reset its priorities.

“We’re looking at some reduced costs for some of our projects and it’s really caused us to prioritize, look how we can move forward with the funding we did receive and be innovative around that and work with our industry partners in moving forward,” he said.

Farmer said that even before Donald Trump took office, state revenues had been in decline the past two years, a natural correction to the boom in federal funding provided after the COVID-19 pandemic. Pew’s research shows state budgets are now at the highest levels of financial strain since 2020.

Coupled with declining revenues are broader concerns about the economy. JPMorgan reduced its forecast for a recession to 50% after the United States and China this week reached a temporary truce on trade tariffs. But Trump has in recent weeks shown a readiness to quickly change course on that issue, by his own account making decisions “instinctively, more than anything else.”

“Uncertainty is not great for infrastructure investment planning in particular,” Farmer said of states’ near-term economic prospects.

States are employing a variety of economic hedges and strategies to prepare for Trump’s economy. Oklahoma is relying on a rate preservation fund it created in 2019, designed to offset fluctuations in federal Medicaid funding. Its balance has grown to $600 million, which is enough to continue reimbursing care providers for three years in the face of a 2.7% reduction in federal contributions. But with cuts to federal Medicaid spending estimated to reach $625 billion, states like Oklahoma will be forced either to raise taxes, offer benefits to fewer people or cut other programs.

Farmer’s analysis shows that states readied plans for the case of a federal government shutdown, and many states maintain contingency plans and rainy-day funds. A recent report from Utah’s legislature concludes the state has the budgetary reserves to weather a “severely adverse economic recession” but it’s unclear whether lawmakers had foreseen the full depth of the cuts the next presidential administration would make to Medicaid.

One silver lining, Farmer said, is that the past five years have primed states for economic turbulence. Many states responded to 2020’s health crisis with surprising agility, standing up network infrastructure that allowed vast workforces to continue their jobs from home, and eventually updating old IT systems that crumbled under unprecedented demand for services like unemployment insurance.

California lawmakers in February earmarked $50 in the state budget for anticipated legal battles with the federal government. Half of that funding was set aside for defense of immigrants, civil rights and the state’s “most marginalized communities,” while the other half is poised to defend the rule of law. A budget planning document shows California is preparing for federal actions that would violate legal commitments to climate change, clean water and reproductive health care. 

Farmer’s analysis offers a view of the complex interplay between the national economy, federal budgets and state governments, but she points out that each state is unique and is beholden to different revenue streams and cultural factors, from oil in Alaska to tourism and oranges in Florida.

Kehoe, the Washington CIO, suggested that technology offices could play a key role enabling states to meet their service obligations while balancing their budgets. He pointed to a new effort in his state to streamline permitting, which could use AI or other automation technologies to improve efficiency. Such tools could become essential for states under Trump’s scarcity regime.