Local governments across the nation are facing major threats to their fiscal stability – a sweeping federal tax overhaul that would strip health care and food assistance from millions of families and shift costs to states and localities; a surge of state tax cut proposals that will leave state budgets less equipped for revenue-sharing with localities; and the sunsetting of federal pandemic aid that many states and localities depended on. Given this environment, local leaders must do what they can to preserve and strengthen progressive revenue tools, advocate for expanded local taxing authorities and flexibility, and push their state leaders to decouple from harmful federal tax changes.

Stripping Health Care and Food Assistance Hurts Localities

The House of Representatives recently passed a reverse Robin Hood reconciliation bill that would largely benefit the wealthiest households and corporations while shrinking the federal tax base. It would grant the richest 1 percent of Americans a total of $121 billion in net tax cuts in 2026. This reconciliation package would severely reduce federal Medicaid funding to states and at least 13.7 million people would lose health coverage.

The stakes are high: In Missouri, Oklahoma, and South Dakota, Medicaid expansion is constitutionally mandated so these states must figure out a way to make up the funds once the federal match drops and enrollment costs rise. Since they’re locked into higher Medicaid obligations, local governments may be the ones forced to pick up the slack. Local hospital budgets will be increasingly strained due to rising uncompensated care; since county or local governments are the primary backstops for public health systems, counties will need to allocate more tax dollars just to keep the public hospitals afloat. Rural hospitals that already operate on razor-thin margins are at the highest risk of closure, and if they shut down, there will be devastating consequences for their local economies.

The bill would also strip nearly $300 billion in food assistance (SNAP) over the next 10 years, increase states’ obligations, and mandate new work requirements. Many states cannot absorb these costs so they will be forced to drastically cut or even opt out of administering a SNAP program entirely. As states are forced to spend more on offsetting these federal cuts, localities are likely to find themselves scrambling to maintain basic safety-net infrastructure like public health services, housing, education, and mental health care.

Ripple Effects of the Tax Provisions

Most states and localities with personal and corporate income taxes link their tax codes to federal tax law in some way; the most common way is by beginning state income tax calculations with the federal definition of income called adjusted gross income (AGI). States then apply their own deductions, exemptions, and other adjustments to arrive at taxable income, apply state tax rates to the taxable income amount, and finally apply any additional credits. Some states conform to federal law more closely than others.

The House tax bill includes several major deduction-related provisions such as raising the State and Local Tax Deduction (SALT) cap, extending the higher standard deduction from the TCJA, and excluding overtime pay and tips from income – provisions that would reduce federal taxable income and have varying impacts on state and local revenues. For example, the car loan interest deduction is an “above-the-line” deduction that directly reduces federal AGI, and since many states base their income tax calculations on federal AGI, this would have a widespread impact across states.

The SALT deduction cap would be set noticeably higher than the one states have become accustomed to in recent years: $40,000 in 2026, up from $10,000 in 2025 (with the higher cap phasing out for married couples with incomes above $500,000). Extending the SALT cap would primarily benefit high-income taxpayers in Democratic-leaning states and potentially reduce state revenues that strongly conform to federal AGI. In these states, increasing the SALT cap would reduce taxable income for high earners, lowering state income tax liabilities unless the state decouples from the new federal provision. Additionally, because many local income taxes are tied to state taxable income, local governments in these jurisdictions may also see reduced revenue. Similarly, states that conform to federal definitions of taxable income could face significant revenue shortfalls if legislators permanently extend the higher standard deduction introduced by TCJA.

The House bill would also exempt qualified tips and premium pay overtime from income taxation. Although these are below-the-line adjustments and would affect fewer states, the revenue loss could still be substantial in those jurisdictions where the changes apply. By extension, these provisions will also hurt localities that tie their tax systems to the state structure.

The House bill also includes a number of immigrant-restricted provisions in the tax code, creating a harsher, parallel tax system for immigrant filers and their U.S. citizen family members. Again, this is likely to have negative ripple effects on local revenues given its potential impact on tax compliance and taxable income reported at the state and local levels. For example, if immigrants leave formal employment to reduce risks, cities and counties that collect payroll or income taxes will see declines in local tax receipts. Further, if US citizen children in mixed-status families lose access to the Child Tax Credit or other benefits, there may be a greater demand for local safety net programs. The provisions, along with the current administration’s unprecedented use of deportations, add to a general climate of fear among unauthorized immigrants. Large-scale deportations or even “self-deportations” can lead to longer-term population and revenue declines. As immigrant families are deported, cities and counties could reasonably experience lower sales and property tax revenues given a shrinking consumer base and declining housing demand – not to mention the cascading impacts of losing immigrant-owned businesses.

State Tax Cuts Add Fuel to the Fire

Despite this deep fiscal uncertainty, many states are doubling down on their aggressive tax cut agendas, which can destabilize local governments that are already bracing for federal funding reductions. Ironically, many of the states that are most hell-bent on cutting taxes are the same states that rely heavily on federal dollars, have financially struggling rural counties, and legally constrain local governments from raising new revenue.

For example, Oklahoma Gov. Kevin Stitt recently signed off on legislation to entirely phase out the state’s income tax over time, a cut that would overwhelmingly benefit the state’s richest residents and cost billions in funding. Further, Oklahoma is constitutionally mandated to require Medicaid expansion under the Affordable Care Act; between that and state income tax elimination, cities like Tulsa and Oklahoma City are likely to see sweeping cuts to education and infrastructure.

Earlier this year, Missouri finalized legislation to fully exempt capital gains from the state’s income tax such as corporate stock, real estate, antiques and artwork. Eighty percent of the tax cuts from the capital gains exemption are projected to benefit the richest 5 percent of households, and it could cost the state $600 million or more per year. If that wasn’t enough, Gov. Mike Kehoe plans to bring lawmakers back for a special session in June to divert state tax dollars towards stadium bond payments to pay for stadium upgrades for the Kansas City Chiefs and Royals.

In March, Mississippi passed a bill that would, over time, fully phase out the state’s personal income tax (with limited exclusions) and reduce the state’s sales tax on groceries. To partially offset the cost, the legislation would claw back state sales tax revenue that currently flows to municipalities, and put the onus on local governments to increase their own local sales tax rates. Instead of raising state revenue to protect localities and make them whole, Mississippi is adding fuel to the fire – intensifying fiscal pressures on local governments in a state already heavily reliant on federal support and restrictive of local fiscal autonomy.

As it stands, most states share revenue with local governments through general revenue-sharing from state-collected taxes and grants earmarked for specific purposes like education, transportation, housing, and public health. With less state aid, local governments will be forced to cut vital services or raise local revenues – or even more painfully, they may have to do both. To the extent possible, local policymakers must focus on strategies to progressively raise revenue and protect vulnerable communities from further cuts.

Higher Borrowing Costs for Local Governments

Many local policymakers were alarmed earlier this year when the House Ways and Means Committee floated the idea of capping or eliminating the longstanding federal exemption on interest earned from municipal bonds, a move that would have significantly upended how localities fund infrastructure. The final version of the House bill did not make the change but local governments should still be concerned about borrowing costs, and market volatility continues to reflect this uncertainty.

Since the House bill is estimated to add trillions to the U.S. deficit, the federal government will likely need to issue more Treasury bonds to finance the gap. This influx of Treasuries could put upward pressure on yields across the bond market, including for municipal debt.  While municipal bonds and Treasury securities serve different investor bases, municipal bonds are often priced relative to Treasury yields since local governments are forced to stay competitive for investors. That competition is further complicated by the fact that many large institutional investors, such as international buyers, pension funds, and endowments, do not benefit from the muni bond exemption and often prefer Treasuries outright, creating less demand for municipal debt even as borrowing needs rise.

Further, confusion around erratic tariff policies and fears of inflation have increased turbulence in the municipal bond market, and bond prices have swung wildly. Tariffs and global supply chain disruptions also contribute to higher infrastructure project costs, since materials are increasingly expensive. At the same time, some of the broader cost-shifting to states and deep cuts discussed above could weaken credit ratings across the sector. Moody’s recently downgraded the United States, citing rising national debt and an unstable fiscal outlook.

In other words, even without changes to the municipal bond tax exemption, the House bill could still indirectly contribute to higher borrowing costs, tighter budgets, and difficulty funding critical infrastructure.

Options for Local Governments

As federal tax policy continues to favor wealthy households and corporations through rate cuts, watering down the Alternative Minimum Tax, increasing the estate tax exemption, creating a tax shelter for private school vouchers, and countless other provisions, local governments face greater and greater fiscal and moral imperatives to offset these changes.

While it might make sense in the short-term to quickly fill budget gaps through regressive fee increases and sales tax hikes, these policies will exacerbate the inequalities that this House-passed legislation is already widening. Instead, local leaders should prioritize progressive revenue options that are not only more equitable, but also more effective at raising adequate, sustainable revenue streams.

For example, local income taxes, especially those with graduated income tax rates, remain a largely untapped resource. Local policymakers should also explore local mansion taxes on high-value real estate transactions and vacancy taxes on unused properties.

Unfortunately, many states have also restricted the ability of local policymakers to adopt different revenue sources. In fact, most local governments are only permitted to collect one or two of the three major tax types: property, sales, and income taxes.

In these situations, local policymakers could at least scrutinize and rein in costly corporate tax exemptions that do not serve the public interest, particularly when those same corporations stand to gain from the federal tax breaks. Localities can also avoid harmful proposals such as weakening property taxes and replacing property tax revenues with sales tax hikes. Lastly, local leaders can engage with associations of counties or school boards and other coalitions to push back against state-level SALT cap increases that would create pressure on state budgets and eventually harm local funding.

Instead, the focus should be on raising revenue from those who have the greatest ability to pay to offset state cuts to public services and ideally to provided targeted aid to low-income communities through policies like property tax circuit breakers local earned income tax credits, and local child tax credits.

Realistically, it will be extremely difficult if not impossible for any local government to single-handedly reverse the monumental damage of the federal tax cuts, but minimizing harm is a worthy goal. In this moment of compounding fiscal threats from deep federal and state tax cuts, local leaders can either double down on the regressive policy trends that deepen inequality or take proactive steps to safeguard public services and advance equity for their communities.

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