State and local fiscal policy trends to watch in 2023

Happy Finance Friday! I’ve spent some time over the holiday break and this week thinking about some obvious and maybe not-so-obvious things that I think will be a big deal in state and local governments this year. Below is a list of top issues and sleeper topics (trust, tech and workforce happiness) that I expect to see in 2023.

Destabilizing budgets

We’ve been hearing for months now that inflation is cutting into government revenues and that the big boom we saw in 2021 started slowing in ‘22. This year will likely be a major year of adjustment for budget officers, particularly when it comes to spending. 

• Inflation may be boosting revenues but it’s also raising costs for governments, especially in construction and labor. 

• It’s also driving up interest rates which makes it more expensive for governments to borrow for their capital projects.

• From the LSS archive: Inflation is ruining everything

State officials will probably get through the upcoming budget season without sweating too much. Most states rely on sales and income taxes, both of which are strong. According to the latest National Association of State Budget Officers report, states are still pretty flush with cash and “better prepared than ever” to face a downturn thanks to record-high reserves.

• Route Fifty: The Outlook for State Budgets Heading Into 2023

Watch out: California and New York are exceptions to the trend and may have to dip into reserves to balance their budgets. Those two states rely heavily on income taxes from the wealthy and could be a bellwether for the rest of the country. It’s at least worth keeping an eye on.

Local government officials will likely feel the pressure more than their state capital counterparts. Cities and counties tend to rely on property and sales taxes to fund the majority of their annual budgets and the slowing housing market may cause some problems with the former. What’s more, downtown property tax revenues in major cities are also feeling the lower demand in office space.

• Read my Route Fifty story on property tax revenue

The ARPA ‘fiscal cliff’ 

Recovery funding from the American Rescue Plan Act expires in 2026 but governments have to allocate it by the end of 2024. That means that places that haven’t already approved how to spend their funding will want to do so this year rather than leave it to the next budget cycle. The good news is, they now have more spending flexibility.

Last year, the Volcker Alliance, a nonprofit group that promotes responsible government spending, warned that California, Illinois, and Pennsylvania were most in danger “of encountering a so-called fiscal cliff once the cash runs out” because they appear to be using a significant amount of the one-time federal funding to pay for recurring spending needs.

Watch out: A lot of places have also used recovery funding either for temporary positions and will have to either end those positions or find the funding elsewhere. Many of these workers have a really positive impact such as providing more mental health services in public schools or data scientists who are figuring out how to spend local government money more effectively. It would be a step backward to end these sorts of projects but governments need to start thinking now about how to keep them.

• California mayors warn of 'fiscal cliff' for homeless services

Climate risk and budgets