Pennsylvania faces significant budget challenges in the coming years, with projected annual deficits reaching as much as $7.4 billion, according to a new report released Nov. 12 by the Independent Fiscal Office (IFO).
The IFO’s 2026 Fiscal Outlook examines the commonwealth’s financial condition and the potential impact of current policy proposals. The report warns that the state’s General Fund surplus will be depleted during the current fiscal year, leaving policymakers with difficult budget decisions as spending continues to outpace revenue.
Nathan Benefield, chief policy officer of the Commonwealth Foundation, said the report highlights the seriousness of the state’s financial situation.
“The IFO is spot on: Pennsylvania is in a precarious fiscal position that cannot be ignored,” he told Pennsylvania Business Report. “Raiding the state’s Rainy Day fund only closes the gap for one year but would drain emergency reserves and jeopardize taxpayers when the next recession hits.”
The projected structural deficit is roughly $6.65 billion for the 2027-28 fiscal year (FY), with annual deficits expected to range from $6.6 billion to $7.4 billion beginning in FY 2026-27 and continuing through FY 2031-32, the report says.
For the current FY 2026-27, the IFO estimates that supplemental appropriations will result in $218 million in additional spending, primarily because of higher-than-expected Medicaid costs. Those expenses will consume much of the additional revenue generated by recent tax collections, the IFO says.
Although state revenues have shown strong year-over-year growth, the report cautions that short-term revenue gains do not resolve the underlying structural imbalance between spending and revenue.
The IFO also recommends preserving most of Pennsylvania’s $8.1 billion Rainy Day Fund rather than relying on those reserves to cover ongoing budget shortfalls.
In addition to preserving the Rainy Day Fund, the IFO offers several other recommendations to the governor’s Budget Office as it prepares the 2027-28 Executive Budget, including using a current-services approach when estimating mandatory spending, and providing alternatives to speculative revenue estimates used to close budget deficits.
For instance, “the outlook recommends that the Executive Budget use a current services approach to make long-term spending forecasts for mandatory spending such as Department of Human Services (DHS) programs,” says the report.
For FY 2026-27, DHS is the largest state agency and comprises 41 percent of total state General Fund spending. At the same time, most DHS spending is mandatory: if a resident qualifies for a program, then the state must provide services.
Recent Executive Budgets have assumed long-term growth rates of 1.0 percent to 1.5 percent per annum, while actual growth rates have ranged from 5.9 percent to 12.8 percent, the report says.
“Given its size, the DHS spending forecast will be a primary driver of any permanent changes needed to address projected shortfalls,” adds the IFO. “If policymakers must enact permanent, broad-based revenue or spending changes, they require a realistic assessment of future budget challenges to do that effectively. Therefore, forecasts should reflect recent historical rates for healthcare inflation and the demographic impact from an aging population.”
Benefield said that continued spending growth could eventually lead lawmakers to consider higher taxes on residents.
“If we don’t control spending growth, lawmakers will have to raise income and/or sales tax on working families, making Pennsylvania even less affordable and less competitive,” he said.
Lawmakers, Benefield added, should focus on reducing spending growth and preserving the state’s financial reserves.
“Don’t ask more of Pennsylvania families,” he said. “Lawmakers need to control spending, stop borrowing and raising taxes, reduce the structural deficit, and maintain the Rainy Day Fund to protect taxpayers.”
Republican lawmakers have previously criticized state spending increases, questioned the reliability of proposed revenue sources, and called for preserving the state’s Rainy Day Fund.
The report raises several issues that could put Democrats in a difficult position as they prepare to govern with majorities in both chambers of the General Assembly.
For instance, Gov. Josh Shapiro has previously supported using money from the state’s Rainy Day Fund to help cover budget shortfalls. The IFO recommends preserving the reserves for emergencies and economic downturns.
Democrats also have supported legalizing and taxing recreational marijuana and expanding taxes on gambling, including skill games. Shapiro previously estimated those proposals could generate approximately $2 billion annually.
However, the IFO cautions against relying on speculative revenue estimates to balance the budget.
Benefield agrees, noting that the state “cannot continue to overspend and widen a structural deficit, and it is unrealistic to think that gambling or marijuana taxes will patch over a $7 billion hole.”