State and local tax revenues grew modestly in real terms in early fiscal year 2026, with overall gains driven largely by personal income taxes and concentrated in a small number of states with progressive tax structures that benefited from strong financial market performance in 2025. Many other states experienced flat or modest growth after adjusting for inflation.
States also face mounting uncertainty from elevated energy prices, geopolitical tensions, and federal policy developments, including planned reductions in federal funding.
Trends in Tax Revenue
State tax revenue data for the third quarter of 2025 show notable variation across states and tax types. Key year-over-year trends include the following:
- State total taxes: Collections increased 3.0 percent in the median state in nominal terms, but growth varied widely across states, with 11 states reporting declines.
- Personal income taxes: Collections grew 5.2 percent in the median state, supported by a strong stock market. However, volatility persists, and states that recently cut income tax rates are reporting softer withholding growth.
- Corporate income taxes: Revenues declined 15.4 percent in the median state, reflecting both weaker corporate profits and recent policy changes that reduced liabilities. Declines were widespread across the states.
- Sales taxes: Collections remained sluggish, with year-over-year growth of 3.3 percent in the median state in nominal terms, reflecting muted consumer spending.
What We’re Focusing On
The special section of this quarterly report examines an increasing divergence in state tax policies: some states are raising taxes on high-income households, while others are cutting income tax rates or adopting flatter tax structures. Since 2020, many states have reduced top income tax rates or moved toward flat taxes, while a smaller group have increased taxes on high earners. These approaches reflect differing priorities around revenue stability, economic competitiveness, and tax fairness. Looking ahead, both strategies carry risks, as reliance on high earners can increase revenue volatility, while broad tax cuts may limit fiscal flexibility during economic downturns.
What to Expect in the Future
Looking ahead, sustained high energy prices and broader geopolitical instability could further increase inflationary pressures, raising costs for both governments and households and placing additional strain on state budgets. This environment underscores the need for more cautious and flexible revenue forecasting, stronger reserve management, and careful evaluation of tax policy choices.
