While the pandemic may feel long over, the full economic implications are just beginning.
Amid a backdrop of rising public debt, state and local governments across the U.S. are facing significant fiscal challenges. A blend of shrinking tax revenues, increasing expenditures, and the gradual pullback of federal support has set the stage for what could be a financial crisis in many regions.
Currently, over half of U.S. states have too much debt to keep up with. And with their total debt levels swelling to unsustainable heights, local government finances are at a crossroads.
States home to major cities are under particular pressure due to their significant outstanding debt exacerbated by years of fiscal mismanagement and debts incurred to support state programs.
The most debt-ridden states now lead in per capita government debt—numbers that highlight the seriousness of the financial strain. Without strategic fiscal planning, they risk triggering a cycle of economic decline that impacts residents, businesses, and the overall quality of life.
Read on to learn:
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Why state-by-state debt is so high
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Which states have the highest total debt
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How declining property values impact property tax revenue in high-debt states
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How the urban "doom loop" accelerates fiscal decline in high-debt states
Pullback in Federal Support
During the pandemic, the federal government issued $800 billion in aid to state budgets. At the time, it served as a a critical lifeline, propping up state budgets and preventing financial crises during an unprecedented time.
In 2022, this federal funding made up 38% of state spending. While it gave local governments some wiggle room to increase revenue and state-funded programs and cut taxes, the extra capital obscured long-standing fiscal issues.
Now, as the aid is set to taper off by 2026, those temporarily masked underlying fiscal challenges need to be confronted. And even economically robust states are not immune to these impacts and are being forced to confront budget shortfalls that could shape their policy choices moving forward.
State by State Debt: Worst Offenders
State government debt is not uniform.
Certain big spenders are now in danger of drowning in the debt of the last few year’s decisions. States like Illinois, New Jersey, and Connecticut are facing the most mounting deficits. Let’s take a deeper look at their debt obligations.
Data Sources: Pew Foundation and CNBC
Why is this? What do these areas have in common? How about shrinking tax bases, slow economic growth, and population loss further straining revenue streams.
These deficits are also fueled by the spending habits of local governments, from years of fiscal mismanagement and heavy borrowing to underfunded pensions for government employees.
It also goes without saying that these states have historically supported Democratic candidates and often pursue policies associated with the party's platform, such as increased social spending and progressive initiatives.
But with no end in sight to a lot of these deep-rooted complications, something has got to give. Rising debt is a threat when we look at the numbers according to the respective populations. The statistics are staggering:
Data Sources: Pew Foundation and CNBC
Should State Government Debt be a Surprise?
Mounting debt obligations also emerge at the same time of a concurrent crisis: dropping property valuations and widespread vacancies among offices in metropolitan central business districts.
The states with the highest debt—such as California, New York, Illinois, New Jersey, Connecticut, and Massachusetts—are home to major metropolitan areas like Los Angeles, Chicago, New York City, and Boston.
Historically, these urban centers were economic powerhouses, contributing significantly to state revenues through business activity, real estate, and employment. However, with office buildings averaging a 50% occupancy rate and 20% vacancy, landlords struggle to cover tax obligations and debt service, creating a chain reaction. Cities then lose out on another massive source of income.
But that brings us to another major point: The states with the highest debt are also home to cities that have the most reliance on income from commercial property taxes. This is no coincidence. Without that stable tax revenue, local government finances are scrambling to keep up.
Take Boston, for instance. With 36% of the city’s revenue coming from property taxes, they were especially vulnerable to the effects of the Office Apocalypse.
With mounting debt obligations at the state level, the loss of this key revenue stream exacerbates the city's fiscal challenges, highlighting the dangerous overlap.
Illinois is no stranger to this issue, with Chicago as a prime example. The city is experiencing a double whammy of high debt and falling property tax income.
This sets the stage for an urban doom loop—a vicious cycle where falling property values lead to shrinking tax revenues, which in turn result in budget cuts, deteriorating public services, and further economic decline.
These states are running out of options. Moving money around to cover deficits may involve raising taxes. And unfortunately, many of these areas thinking of raising taxes already have the highest tax burden in the country.
The governments face a delicate balancing act. Any further tax increases could push residents and businesses over the edge, making these areas even less attractive to live and work in, especially considering the cost-of-living crisis.
Consider the tax rates:
Data Sources: Pew Foundation and CNBC
Raising taxes further by these state governments could exacerbate the already growing migration trend—residents and businesses alike are leaving high-tax states in droves, seeking relief in more affordable regions. This not only weakens the tax base but further fuels the doom loop, as cities are left with fewer resources to fund vital services, like infrastructure and education.
For example, in Illinois, to meet these debt obligations and cover budget gaps, the state would need to double the income tax rate—a move that could push even more residents and businesses to relocate.
Illinois would need to double the income tax rate to meet its debt obligations. |
Because the shift away from these high-tax states isn’t just happening on a personal level, but on a corporate scale as well, with companies seeking lower-tax states to avoid rising costs. Learn which 3 Fortune 500 Companies Ditched Illinois last year.
Without significant intervention, this migration away could trigger a quality of life crisis, with cities struggling to fund infrastructure, education, and other critical services. As fiscal shortfalls deepen and the doom loop takes hold, these cities risk sliding further into financial instability. The question remains: how long can they sustain this downward spiral before the consequences become irreversible?
Takeaways for Tenants
Going forward, corporate tenants with large-scale real estate portfolios need to be acutely aware of the risks posed by states and cities grappling with overwhelming debt. Because it’s not just ballooning debt but also shrinking tax bases and high property vacancies—key factors that threaten to strain local economies further.
As states like these continue to struggle with fiscal imbalances, corporate tenants may find themselves dealing with more than just rising taxes.
The migration away from high-tax states is already well underway, and businesses are seeking more favorable environments. Companies looking to expand or relocate must consider whether the cities they operate in have the fiscal stability to support long-term growth, particularly in light of a deteriorating tax base and shrinking budgets for critical services.
Amid these shifting dynamics, staying ahead of these challenges is critical.
Business-friendly environments will become even more important, as will understanding the broader fiscal landscape of the cities and states in which you operate. The doom loop—a cycle of fiscal deterioration and migration away from high-tax, high-debt states—is a very real threat to businesses that don't plan accordingly.
Corporate tenants need to act now, securing properties in areas that offer fiscal stability, manageable tax rates, and the infrastructure needed to thrive.
This environment is largely symbolic of a post apocalyptic office market. Learn how well your portfolio is positioned to success in the midst of these crises. Take the test now!