The Budget Forecast - $1.2 Billion Could Very Well Be the Tip of the Iceberg   

Key Points 

• Using General Fund growth rates of 5.1% and 5.0% for fiscal years 2026 and 2027, and reported potential appropriations, the state is faced with a projected $1.2 billion budget hole.
• Should the economy grow at rates consistent with the trends in employment growth and the unemployment rate, the budget hole gets larger, on the order of $2.8 billion for fiscal years 2026 and 2027.
• The relatively optimistic revenue growth figures suggest nothing about the downside risk. Should the economy have a moderate downturn, the budget hole becomes much larger, on the order of $3.9 billion and that’s before spending pressure is considered.
• Some might consider the weak revenue picture as evidence of a revenue problem. That isn’t correct. Spending has exploded in recent years.
• From 2010 through 2025, total General Fund spending is up 134%.
• Over the same period, spending from All Sources is up 127%.
• By contrast, population is up 19% and reported consumer inflation as measured by the Consumer Price Index is up 48%
• For two of the “big three” spending areas – health care and higher education – spending has far outpaced population and inflation.
• Rather than kicking the can down the road and making future policymakers’ jobs more difficult, current policymakers may want to not only slow the growth in spending in certain areas, but stop the growth completely until a clearer economic picture emerges.
• Failing to stop the growth in spending may lead to higher than expected tuition increases and other fee increases/budget reductions in coming years that could have been avoided with action today.

Economic Backdrop

On St. Patrick’s Day, the Legislature was presented with some not so welcome news from staff of the Governor’s Office and Legislative revenue forecasters – the budget outlook leaves a hole for policymakers to fill – to the tune of approximately $1.2 billion. 

The projected budget shortfall, presented to the Joint Budget Committee, is based upon key federal and state economic indicators. 

At the federal level, key indicators include the projected growth in GDP. Following growth rates of 2.5%, 2.9%, and 2.8% in 2022, 2023, and 2024, respectively, budget forecasters reported that U.S. economy would grow by 1.3%, 1.7%, and 1.9% in 2025, 2026, and 2027, respectively. CSI’s economic momentum index has more recently deteriorated from the highs seen in 2015-2018. Slowing job creation, lower relative growth in the labor force participation rate, and a slight increase in poverty rates following 2020 have all led to diminished economic momentum relative to other states.

Figure 1

At the state level, the revenue forecast depends on an economic picture that continues to generate jobs. The most recent figures have the state’s job growth at 0.8% and the U.S.’ at 1.2% (Figure 2). 

Figure 2

The revenue picture is further clouded by the state’s unemployment rate relative to where its 12-month moving average has been. Overall, at 4.6%, the rate is 0.35 percentage points higher than its 12-month moving average and trending higher. Typically, this is not a positive indication of strong economic conditions in the coming months. The unemployment rate typically trends higher than its 12-month moving average prior to the onset of a recession. Although not unheard of, the current trend of a higher unemployment rate compared to its 12-month history has been the case for seven months – long by historical standards without a recession (Figure 3). 

Figure 3

Revenue Risks

Given this background, how much risk is there on the horizon for the state’s budget? Per the Joint Budget Committee, the March 2025 forecast assumes revenue growth of 5.1% for fiscal year (FY) 2026 and 5.0% for FY 2027 (Figure 4).

Figure 4

Using these revenue growth figures and assumptions on Excess Reserve, 2024-2025 Long Bill Supplementals, FY 2025-26 Long Bill Appropriations, Capital Transfers, and Proposition 130, the Excess Reserve is -$1.161 billion, a $1.2 billion shortfall. Using Table 1E from the Economic & Revenue Forecast document, the budget hole is $1.2125 billion (Scenario B), rounded to a $1.2 billion projected budget hole. 

Given the revenue growth assumptions, how likely is it that the $1.2 billion shortfall is optimistic? One way to judge this is to use historical revenue growth. For the 27 years in Figure 4, the FY 2026 forecast would rank as the 13th best and the FY 2027 forecast would be 14th best – right in the middle of historical revenue performance. 

Given the trends in employment, unemployment, and national economy, the question is whether the economy over the coming years will be business as usual? The answer is probably no for the state. 

Using the trend in employment and the unemployment rate for the state, and the reported projections for the national economy, the FY 2026 +5.1% has a good chance of being too optimistic. Using a model that adjusts for outliers in the historical growth rates and the aforementioned employment growth and unemployment rates, the model suggests a range of between -3.1% and +4.6% for FY 2026 and between 1.2% and 8.8% in FY 2027 (Figure 5).  

Figure 5

What do these figures mean for the broader budget picture? Well, instead of a $1.2 billion budget hole, the budget hole becomes larger, and not only because of the revenue picture weakening, but because the expenditure side of the balance sheet also deteriorates. For just the revenue picture, the budget hole worsens by $764 million in FY 2026 and $807 million in FY 2027, or another $1.6 billion over two fiscal years. In such a situation, the expenditure side of the balance sheet would put upward pressure on spending, making the budget situation materially more difficult.

What’s the Budget Hole If the Economy Experiences a Moderate Downturn and Spending Stays as Is?

The revenue assumptions underpinning the current projections suggest nothing about a potential moderate economic downturn. 

What does the budget picture look like if General Fund revenue growth experiences a decline of 5% as opposed to a 5% rise in FY 2026 and a weak recovery in FY 2027 of just 3%? How much of a budget hole do policymakers face? From the revenue side, the budget picture worsens by $1.7 billion in FY 2026 and by $2.2 billion in FY 2027, totaling approximately $3.9 billion over two fiscal years. The upward pressure on the expenditure side of the balance sheet would make the budget picture even more bleak, likely to the tune of more than $5 billion in additional funding issues on top of the $3.9 billion from the revenue side (Figure 6).

Figure 6

What’s the Problem with Assuming Healthy Revenue Growth When the Economy is Slowing?

Given that the future is unknown, what is the problem with assuming that the revenue picture will be better in the coming years? Well, because ignoring the problem makes budget discussions more difficult in the coming years. Rather than kicking the can down the road and making future policymakers’ jobs more difficult, current policymakers may want to not only slow the growth in spending in certain areas, but stop the growth completely until a clearer economic picture emerges.

Spending Pressure

Overall Expenditures

Within the weakness in the revenue picture is the spending picture. Over the past fifteen years, spending has exploded. 

From 2010 through 2025, total General Fund spending is up 134% (86% on an inflation-adjusted basis) and spending from all sources is up 127%. By contrast, population is up 19% and reported consumer inflation as measured by the Consumer Price Index is up 48% (Figure 7).

Figure 7

The “Big Three”

Behind the rise in spending are the so-called “big three” – education, higher education, and health care. These three are known as the big three because they will soon surpass 70% of all sources spending and over 75% of General Fund spending. 

Figure 8 shows the growth in health care spending compared with population and inflation. When compared with population and inflation, health care spending has exploded, up 333% since 2010 from General Fund sources and up 268% from All Sources. 

Figure 8

Higher education has also seen an enormous rise in spending, with spending up 288% from the General Fund and up 138% from All Sources. As with health care spending, spending on higher education has grown much faster than population and inflation (Figure 9). 

Figure 9

Figure 10

In Some Budget Areas, Spending Pressure Goes Up When the Economy Deteriorates

In times of stress, balancing the budget becomes more difficult because demand for government services rises when the economy destabilizes. For instance, Medicaid demand rises as unemployment rises, as shown in Figure 11. When the economy was performing well from 2017 through 2020, enrollment marginally declined (other policy-related factors were also impacting enrollment). When the economy weakened after the pandemic, enrollment rose. 

Figure 11

Bottom Line

Overall, the current projection for a $1.2 billion budget hole in the state may turn out to be too optimistic in the coming years if economic conditions continue to weaken. In a slower growth scenario, the revenue picture deteriorates by an additional $1.6 billion from FY 2025/26 through FY 2027. If the economy experiences a downturn, the revenue side pressure adds another $3.9 billion in funding problems to the already $1.2 billion and when spending pressures are added in, the budget problem becomes much larger, to the tune of over $5 billion.