This wasn’t a recession. Revenues hadn’t collapsed. What had changed were the rules. In the current environment, the tools built to manage downturns remain essential. But if abruptly changing federal policies — from tax law to Medicaid rules to funding streams — continue to reshape the fiscal landscape, those tools alone will not be enough. It will be time to re-examine larger issues of governance.
I’ve been talking with state and local finance officers over the past several months, and I keep hearing a version of the same thing: We know how to plan for economic downturns. What we’re less prepared for is federal policy shifts mid-budget.
As Dave Maynard, Philadelphia’s legislative director, noted, while his city already had a budget in place last fall, policy volatility from Washington was throwing local fiscal assumptions into chaos. “When combined with random federal funds withheld so regularly as to force budget analysts to rely on refresh to see if the funds were free,” he told me, “budgeting and planning became mostly a joke.”
To be clear, today’s fiscal tightening is not primarily the result of chaos in Washington. State revenue growth has slowed since the pandemic-era surge. As Brian Sigritz of the National Association of State Budget Officers noted, “We’ve now had three consecutive years of slow revenue growth following the double-digit increases during the pandemic period.” Most states are projecting only modest growth for fiscal 2026, according to a National Association of State Budget Officers’ survey.
That’s normalization after one-time federal aid, unusually strong consumer spending and elevated asset values earlier in the decade. It’s tighter, but it’s not collapse. Local governments are experiencing similar recalibration. The National League of Cities’ City Fiscal Conditions 2025 report shows flattening revenue growth and declining fiscal optimism, with infrastructure and wage pressures continuing to weigh on budgets.
States and local governments alike are operating with thinner margins than they had just two years ago. But layered on top of that slower-growth environment is something different: abruptly changing federal policy. Economic cycles test fiscal resilience. Institutional instability emanating from Washington tests governance itself. And increasingly instability is not episodic — it is structural.
In the past year alone, states have had to revisit tax-conformity decisions tied to the One Big Beautiful Bill Act, sometimes facing immediate revenue consequences. Ongoing debate over Medicaid eligibility rules and work requirements has complicated long-term spending projections. Federal funding pauses and reimbursement delays have disrupted cash-flow planning. Uncertainty over the farm bill and suspended U.S. Department of Agriculture programs have affected agricultural states. Interruptions to research grants have rippled through state universities and local economies. Trade and tariff authority has expanded and contracted through executive and judicial action, shifting procurement assumptions mid-cycle.
Altered Assumptions
None of these developments, on their own, amount to large-scale fiscal shocks, but each alters the baseline assumptions on which budgets are built. When executive orders, regulatory reversals or sudden funding cutoffs change program rules midstream, forecasts lose stability. Financial management becomes reactive rather than strategic. Traditional fiscal planning assumes that downturns follow patterns. Revenues dip, lag and recover. Governments have decades of experience managing that rhythm. What they have less experience with is rule volatility that has no predictable endpoint. And that raises an uncomfortable question: What happens after the next election?
If a new administration and/or Congress doubles down on current policies, volatility may persist as federal rules continue to evolve. If a new administration reverses course wholesale — revisiting tax policies, altering Medicaid rules again, restoring or rescinding funding streams — another round of recalibration will follow. Either way, instability extends across election cycles. Unlike a business cycle, which historically returns to equilibrium, policy shifts can stack. Planning horizons shrink. Governments hesitate before committing to long-term infrastructure, workforce expansion or service innovation because the assumptions underpinning those commitments may not hold.
This is where the distinction between financial management and governance becomes more than theoretical. Financial management is about balancing this year’s budget. Governance is about whether the rules are stable enough to plan beyond this year. Shayne Kavanagh of the Government Finance Officers Association captured the shift succinctly: “Finance officers used to be book balancers. Now they are volatility managers.” He argues that governments need what he calls “diagnostic foresight” — the ability to recognize emerging risks early and structure flexible responses. In a more complex and fractured policy environment, traditional point forecasts may not be sufficient. Scenario planning must account not only for economic downturn but also for policy reversal.
Governance Under Stress
In my research and conversations with practitioners, I’ve seen how repeated recalibration affects behavior. When assumptions feel unstable, capital projects are deferred. Hiring slows. Spending plans become layered and conditional. Departments quietly pad contingencies because they no longer trust the durability of funding streams. None of that is irrational. It’s governance under stress.
If policy volatility becomes a recurring feature rather than a temporary disruption, state and local governments will need to adjust how they govern, not just how they budget. States may need to incorporate federal participation volatility more explicitly into baseline projections and examine carefully how tax-conformity decisions affect long-term revenue stability. Local governments may need stronger liquidity management, more flexible capital sequencing and scenario models that assume rule change, not just recession.
Public finance has always been about managing risk. The risk now is not simply economic fluctuation. It is structural volatility in the governing framework itself. The question isn’t whether state and local governments can manage another downturn. They’ve proven they can. The question is whether they can build governance systems durable enough to withstand what could be a decade of shifting federal rules.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.
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