What does it mean when a state has a budget gap? With state and territory fiscal conditions tightening, it is important to remember the various ways the term may be used and what it does and doesn’t mean. This explainer addresses several common questions including:
- What is the difference between a budget gap, a budget deficit, a revenue shortfall, and a structural deficit?
- When a state budget gap is identified, how can a state respond and how does this vary based on timing?
- Why is it so hard to find standardized data on state budget gaps?
Defining Budget Gaps & Other Key Terms
A state’s budget gap (also commonly referred to as a budget shortfall) is commonly defined as the amount by which expenditures and other obligations are projected to exceed that state’s revenues and other available resources during a given fiscal year or budget cycle.
However, it is also worth noting that states and territories may use different terms to describe the concept of a budget gap or use various terms interchangeably, including those listed below. That said, for the purposes of this explainer, the terms below are defined as concepts distinct from (but related to) budget gaps.
Revenue shortfall. When a state’s revenue collections are lower than projected for the current fiscal year or budget cycle, this can result in a revenue shortfall. Revenue shortfalls may but do not always lead to a budget gap as states may be able to absorb a revenue shortfall, especially a small one. Below are three hypothetical examples of revenue shortfalls identified in the middle of a fiscal year or budget cycle, with only one leading to a budget gap.
Case #1, expenditures are also less than projected: The state updates its revenue forecast for fiscal 2026, projecting $100 million less in annual general fund revenue compared to the forecast used to enact the budget. Meanwhile, due to underspending based on lower than budgeted health and human service program caseloads, general fund expenditures are anticipated to come in at least $100 million lower than budgeted for fiscal 2026. The state does not have a budget gap, since lower spending offsets the revenue shortfall.
Case #2, a budgetary cushion exists: State general fund revenue collections are $300 million less than the forecast used to enact the budget. When the state adopted its budget, it was projecting an undesignated (not obligated or reserved) general fund ending balance of $700 million. Revenues coming in below target mean the state now projects an ending balance of $400 million. The state does not have a budget gap, since the state had a large enough unobligated balance to absorb the revenue shortfall.
Case #3, expenditures will exceed available resources: The state updates its revenue forecast for fiscal 2026, projecting $200 million less in annual general fund revenue compared to the forecast used to enact the budget. With this new estimate, the state determines it will not have enough resources to cover planned spending for the rest of the fiscal year. The state has a budget gap and takes steps (e.g., spending cuts, tapping reserves, etc.) to close the gap before the end of the fiscal year.
Revenue Decline. A state may report decreased revenues year-over-year without experiencing a budget gap. For example, if a revenue decrease was expected when a state set its budget (perhaps driven by tax policy changes), then that state will have planned accordingly for this decrease by adjusting spending and/or taking other steps to ensure the adopted budget was balanced.
Structural Deficit. A state may identify the presence of a structural deficit or gap (sometimes referred to as an “operating deficit”) in its budget. This typically refers to the amount by which ongoing expenditures exceed ongoing revenues in a given fiscal year or budget cycle. In other words, a state must use one-time resources for ongoing spending needs. A state may have a structural deficit in a given fiscal year without having a budget gap, as prior-year balances or other one-time resources may be available to cover the deficit. However, states can and do take steps to address structural deficits to ensure they do not become chronic.
Budget Deficit. When a state ends the fiscal year with a negative ending balance, this can be referred to as a budget deficit. In other words, a budget deficit results for a state if it does not take steps to close a budget gap by the end of the fiscal year. States have a range of management tools that may be available to close a budget gap and avoid ending the year with a deficit, as explained in the next section. Most states by law are prohibited from carrying over a deficit into the next fiscal year, and limitations on borrowing for operating expenses and other policies and procedures further restrict a state’s ability to end the year with a deficit. In some states, a deficit at year-end must be addressed through withdrawing from a rainy day fund, while in some cases, if a deficit exists at year-end the state must take steps to correct it in the budget for the next fiscal year.
Interpreting Budget Gaps: Timing Matters
In virtually all cases, states are legally required to balance their operating budgets. Therefore, when a state is projecting a budget gap, it takes steps to close it. Actions to close budget gaps may include some combination of program spending cuts, personnel actions, revenue increases, and one-time maneuvers such as fund sweeps, tapping a rainy day fund, payment deferrals, and so on.
Identifying for what period of time the budget gap exists is critical to understanding the implications for the state and how it may respond to resolve the gap. For example:
- Current-Year Gap: If a budget gap exists for the current fiscal year, this means a state must act quickly to close the gap and ensure the budget is balanced at year-end. States in this situation may respond by adjusting spending mid-year (for example, through executive authority to withhold funds, imposing hiring or travel freezes, delaying spending, etc.) and/or relying on one-time strategies such as tapping reserves or other state funds. While a state may turn to revenue increases too, this strategy is less commonly used for current-year gaps that need to be resolved quickly, especially when those gaps occur later in the fiscal year.
- Upcoming-Year Budget Gap: If a budget gap is projected for the upcoming fiscal year (or budget cycle) for which the budget is currently being developed, a state has more time and options to close the gap. If the gap is identified before the governor proposes the budget, the executive budget may recommend a set of strategies for closing the projected gap that could include spending reductions, revenue increases, and other strategies. If the gap is identified after the governor releases the budget, the legislative and executive branches may work together to negotiate a plan to address the shortfall.
- Gap in the Out-Years: A budget gap may refer to the amount by which projected expenditures exceeds projected revenues in future fiscal years or budget cycles – commonly referred to as the “out-years”. This situation is fairly common to observe in state budgeting, especially for states that publish long-term expenditure and revenue forecasts. States use these budget gap projections to plan and adjust spending and/or revenue to achieve structural balance over time.
In addition to differences in timing, budget gaps can also range in their scale, which influences what combination of steps may be taken to close them.
Measuring Budget Gaps: State Processes and Methods Vary
Comparing projected budget gap amounts from state to state is challenging for several reasons. First, budget gap estimates are moving targets as actual spending and revenue data become available and forecasts for current and future fiscal years are revised. States update their official revenue estimates on differing schedules and with varying frequency. States facing budget gaps may announce them on differing schedules, particularly for out-year gaps. Moreover, not all states have a formal method for publicly identifying and reporting budget gaps.
Additionally, budget gaps are the product of revenue and expenditure forecasts, and as such are dependent on assumptions made in a state’s forecast, especially in reference to the “out-years”. For example, when measuring a budget gap for a future fiscal year or budget cycle, one state may apply an inflation factor when estimating future state expenditure needs while another state may not or may only adjust certain items for inflation in its long-term expenditure forecast. When referring to the next budget cycle, a state may calculate the projected budget gap as the difference between total spending requested by agencies and total forecasted revenues, in which case that state may nearly always kick off its budget development with a “gap” to resolve, even in good fiscal times.
Furthermore, it is important to keep in mind that some states budget on an annual basis while others budget on a biennial (two-year) basis. For biennial states especially, budget gap estimates cited in media reports or state documents may represent projected gaps over two years (or more), while other estimates may only reflect a single-year gap.
State Budget Gaps: Key Takeaways
Understanding state budget gaps and what they do (and do not) represent can enhance one’s broader understanding of state budget processes and ability to assess fiscal conditions. As explained above, it can be helpful to keep the following points in mind when discussing or comparing state budget gaps.
Definition.
A state’s budget gap (or budget shortfall) may be defined as the amount by which expenditures and other obligations are projected to exceed that state’s revenues and other available resources during a given fiscal year or budget cycle.
Revenue Shortfall ≠ Budget Gap.
While a state with a revenue shortfall may also have a budget gap, this is not always the case, as a state may be able to absorb a shortfall (especially a small one) without taking deliberate budget action.
Structural Gap vs Budget Gap.
A state can have ongoing expenditures exceed ongoing revenues in a given fiscal year without having a budget gap.
Deficits Are Rare.
While budget gaps at various points in the state budget process are somewhat common, budget deficits – whereby a state ends the fiscal year with a negative ending balance in the general fund – are rare.
Timing Matters.
Identifying for what period of time a budget gap exists (current fiscal year, upcoming budget cycle, or the “out-years”) is critical in understanding the implications of the gap for the state and what strategies the state may take to resolve the gap.
Forecast Assumptions.
Budget gap estimates are the product of revenue and expenditure forecasts, and as such are dependent on assumptions made in a state’s forecast, especially in reference to the “out-years”. Budget gaps are also moving targets as actual spending and revenue data become available and forecasted estimates for current and future fiscal years are revised.
Methodology Varies by State.
States measure budget gaps using different methodologies, which can make state-to-state comparisons difficult. Moreover, not all states have a process for formally identifying and publishing budget gap estimates.