Budget leaves state finances still rickety
Hobbs and the legislature keep spending virtually all of any surplus in the very next budget year.
A lot of attention has been paid to the politics of the recently enacted state budget. And, indeed, the exercise revealed who the pragmatists and ideologues are in all the legislative caucuses, since the political question was whether to accept the constraints of divided government, in which the governor is a Democrat and Republicans control both chambers of the legislature.
However, scant attention has been paid to the question of what the end result means for the condition of state government finances. The answer isn’t encouraging. The condition of the state fisc remains rickety.
From a macro perspective, what the governor and legislative pragmatists did was to use a large carryforward surplus to engage in spending whose sustainability is questionable going forward.
The state’s fiscal years runs from July to June, and are, by custom, referred to by the year in which they end. So, the fiscal year just completed in June is denominated FY 2025 and the budget just adopted is for FY 2026.
The FY 2026 budget assumes a carryforward from FY 2025 of $1.1 billion. The budget spends more than $880 million of that. In other words, the budget spends $880 million more next year than is expected to be collected in revenue during the year.
That might be OK if the projections were that future revenue growth would be sufficient to support state programs going forward. That’s not only not the case, but it might not even be true for FY 2026.
It’s impossible to accurately predict state revenues and difficult to accurately project state spending. Midcourse corrections of hundreds of millions of dollars are not at all unusual. A prudent budget includes a sizable contingency fund to handle deficiencies in revenue or overages in spending.
The budgeted contingency for FY 2026 is a tad over $200 million. That might suffice, but it's skirting the edge. After that, things fall off the edge of prudency.
As part of this budget exercise, projections are made for three years out, through FY 2028. Projecting revenues and expenses just a year ahead has a large enough margin of error. Projecting them three years into the future magnifies the margin of uncertainty. But, it’s still a useful exercise to provide at least some sense of where the policy choices of today are taking the state.
The three-year budget projection shows state spending actually going down in FY 2027 by some $200 million. And even with a reduction in spending, a highly improbable occurrence, the contingency fund for that year is just $54 million. That’s just three-tenths of a percent of overall spending, even at the reduced level. That won’t even cover rounding errors.
Things don’t get better in the projections for FY 2028. Spending nudges up a little, but falls short of likely inflation and population growth between now and then. And the contingency fund is still a woefully insufficient $57 million.
The revenue projections are conservative, growth of roughly 4% a year. The increase in FY 2025 was running closer to 5%. A percentage point faster revenue growth produces around $160 million in additional annual revenue, compounded going forward.
So, there might be some upside on revenues that would improve the sustainability outlook somewhat. But, with the erratic tariff policies of the Trump administration and the economic uncertainty they create, that’s also an imprudent bet to make.
The budget initially adopted by House Republicans was marginally, but not fundamentally, better from the sustainability perspective than the bipartisan budget ultimately adopted. It still spent $630 million more in FY 2026 than the state expects to collect in revenue that year. The contingency funds going forward were larger than in the bipartisan budget, but still less than a comfortable level. And also with unrealistically low projections of future spending.
The state appears to have a fiscal imbalance at least in the intermediate term, in which revenues aren’t expected to cover expenses year to year with a sufficient contingency to manage what Donald Rumsfeld would call the known unknowns.
The argument could be made that this is a spending problem. The bipartisan budget spends 8.1% more in FY 2026 than was spent in FY 2025. The House Republican budget boosted spending by 6.3%. Both vastly exceed population growth and inflation.
To stitch together the votes to pass the budget, the legislature has fallen into the habit of pork-barrel spending. The FY 2026 bipartisan budget includes over a billion dollars in what is denominated one-time expenditures. A lot of the dough will go to quintessentially local projects more appropriately the responsibility of county or city governments.
The argument could also be made that this is a revenue problem. Funding for K-12 public schools offers an illustration. The base level, the starting point for the state education finance formula, is supposed to receive an inflation adjustment each year. However, the mandatory adjustment is limited to 2%, while inflation over the last several years has been running higher than that, much higher in some years. The adjustments, however, have been limited to the mandatory cap. So, the purchasing power for the schools has actually been going down, even though dollars allocated have nominally been increasing. There doesn’t appear to be room in the budget going forward to restore this diminished purchasing power for the schools.
I would argue that is, instead, chronic budgetary imprudence. Legislative Republicans have reduced income tax rates while engaging in pork-barrel spending and enacting a costly expansion of the state’s voucher program. That puts stress on the state’s fisc.
However, the state has also periodically experienced large budget surpluses. Prudently used, these surpluses could have provided a path to sustainability, in which revenue growth ultimately caught up with realistic spending growth. Instead, legislative Republicans and Gov. Katie Hobbs keep spending virtually all of any surplus in the very next budget year.
That was the bipartisan budget consensus. Bipartisan, yes. Prudent, no.
Reach Robb at robtrobb@gmail.com.