By Jon Kamp

Faced with weak revenue, sluggish growth and possible federal funding cuts, many governors and state lawmakers face a tough budget season.

On the revenue front, states are dealing broadly with a mix of challenges, including low energy prices and tax collections that are forecast to continue to grow slowly into the next fiscal year. Meanwhile, states also face an uncertain menu of big changes, including Republicans' potential repeal of the Affordable Care Act and cuts to federal payrolls.

"Many cities and many states still are in a fragile position," Virginia Gov. Terry McAuliffe, a Democrat, said during a National Governors Association meeting in Washington last week. "We have to be very, very concerned about what is going to happen next with our economy."

The federal spending cuts known as the sequester badly hurt Virginia by cutting jobs in the Washington neighbor, Mr. McAuliffe said last week. Virginia would be further hurt by President Donald Trump's federal hiring freeze , Mr. McAuliffe said, because the government is a major employer in his state.

States' finances vary widely, but revenue challenges remain common. In fiscal 2016, revenue came in below forecasts in 25 states, which is the highest level since the latest recession, according to the National Association of State Budget Officers. At least 24 states face the same challenge in the current fiscal year, which runs through June in most states, the association, known as Nasbo, said in a December report.

Low oil prices are amplifying the strain by weakening tax collections in energy-producing states like Alaska and North Dakota. But the effect is much broader, with states ranging from Hawaii to Indiana and Mississippi also lagging, despite a long period of national economic recovery.

"It's been a trend since the end of the recession," said Nick Samuels, vice president and senior credit officer at Moody's Investors Service. Revenue hasn't rebounded like it normally does after downturns, he said.

The reasons are manifold, including the tilt toward job growth in lower-paying industries, he said. Moody's in December forecast 2% to 3% in state tax revenue growth over the next 12 to 18 months, below the 4% five-year average.

"That is certainly a challenge for states at the same time they confront higher pension costs," Mr. Samuels said.

Some states face significant fiscal challenges, including Illinois, which has a budget crisis and unfunded pension liabilities that lawmakers have yet to resolve, and Kansas, where past tax cuts opened budget holes. Louisiana's Democratic governor last week called for a special session of the legislature for mid-February to fix that state's budget hole.

The revenue shortfalls are modest in most cases, said John Hicks, Nasbo's executive director. The group credited many states for beefing up rainy-day funds despite the budget challenges. General-fund collections for fiscal 2017 were on target in 16 states, while four states -- Arkansas, Maine, New Hampshire and North Carolina -- were running ahead of forecasts, Nasbo said in December.

Still, the revenue pressure is forcing states to cover shortfalls and make tough choices. Mr. Samuels said new budget proposals show slowing state aid for higher education. Massachusetts Gov. Charlie Baker, a Republican, vetoed a legislative pay-raise measure on Friday, calling it "fiscally irresponsible."

Governors in New Mexico, Vermont and South Dakota addressed revenue challenges in recent addresses, citing issues including weakness in oil and gas, a shrinking workforce and lower sales-tax receipts.

Nebraska Gov. Pete Ricketts said his state missed revenue forecasts by $95 million in the latest fiscal year and are forecasting a $172 million miss for the current year, hurt by sharp declines in farm income.

"As Nebraskans, we don't spend money we don't have," the Republican governor said. To contain costs, the state has curtailed travel and put on a hiring freeze for state employees.

States are also dealing with uncertainty in Washington and federal funds account for nearly one-third of state revenues, according to Pew Charitable Trusts. Medicaid, paid for by both the federal and state governments, is the second-biggest expense in most states after education, according to Pew.

With a new administration and GOP lawmakers promising to repeal the Affordable Care Act, and with uncertainty about what might replace it, states are watching closely for Medicaid-funding changes. Some Republican governors -- many of states that expanded Medicaid under the health law -- have warned against repealing the law until a new law is in its place.

"It's a very big question mark" for state budget planners, Nasbo's Mr. Hicks said. "And they know there's nothing yet to wrap their arms around."

--Jennifer Levitz contributed to this article.

Write to Jon Kamp at jon.kamp@wsj.com

(END) Dow Jones Newswires

January 29, 2017 21:13 ET (02:13 GMT)

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