The coming squeeze on state budgets

Yesterday, I wrote about the looming crisis in federal government finances. This will have impacts at the state level which policymakers should be preparing for.

A federal government with less money is going to be less able to support the states financially. The impacts of this will vary from state to state. As Figure 1 shows, according to data from the National Association of State Budget Officers (NASBO), in 2025 48.6% of “Total Spending (non-capital and capital)” in Louisiana comes from “Federal Funds Total Spending (non-capital and capital)” compared to 16.5% in Illinois. North Dakota sits below 24 other states in the share of its total spending covered by federal funds, at 34.5%.

Figure 1: Federal funds as a share of total state government spending, 2025

Nevertheless, this $2.7 billion represents nearly a third of state government spending and if the federal government tightens its belt, North Dakota’s state budget will feel the pinch.

If federal dollars dry up, it is likely that Medicaid will bear the biggest burden. Figure 2 shows the share of state government spending across five areas which is accounted for by federal funds. Higher education and corrections are least exposed to a decline in federal funding. The situation is very different for corrections, where three out of every ten dollars spent by the state government comes from the federal government, transportation where the share is nearly half of all dollars spent, and Medicaid, where it is six out of every ten.

Back in 2019, I wrote that the United States was heading toward a debt crisis. With federal deficits, debt, and interest rates on the rise, it might now be here. State policymakers should be preparing. We do not want to wait until it is raining before we fix the roof.