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. Minnesota sits below 31 other states in the share of its total spending covered by federal funds, at 31.0%.

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

Nevertheless, this $22 billion represents nearly a third of state government spending and if the federal government tightens its belt, Minnesota’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 largely self-supporting, with the federal government covering less than one half of 1% of total spending. The situation is very different for transportation, where one dollar out of every four the state government spends comes from the federal government, and Medicaid, where the figure is six dollars out of every ten.

Figure 2: Federal funds as a share of Minnesota state government spending, 2025

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.