Federal tax changes punch hole in Colorado’s fiscal 2026 budget

The federal government’s One Big Beautiful Bill Act will cause one big budget hole for Colorado in fiscal 2026, according to the state’s projections.

H.R. 1, the massive tax and spending bill signed into law by President Donald Trump on July 4, contains federal tax cuts that will reduce revenue for Colorado’s fiscal 2026 budget by $1.2 billion, with the biggest impact coming from increased corporate tax deductions, Mark Ferrandino, director of the Colorado Office of State Planning and Budgeting, told a legislative committee on Wednesday.

Expenses will increase by $50 million to $100 million starting in 2027, rising to nearly $1 billion by 2032 as the act shifts certain costs from the federal government to states, according to his presentation, which also pointed to an eventual loss of about $3 billion in federal Medicaid matching funds.

The financial hit comes as Colorado just started fiscal 2026 on July 1 with a $43.9 billion all-funds budget that includes $16.7 billion in general fund spending after addressing a $1 billion structural deficit.

“When the General Assembly adjourned three months ago, we had a balanced state budget and now we don’t,” Democratic House Speaker Julie McCluskie said in a statement. “The consequences for our state are devastating, and Republicans can’t hide the damage their party has caused.”

Senate Republican Minority Leader Cleave Simpson said Democrats, who control both legislative chambers, are at fault due to their “obsessive and irresponsible spending” that led to years of structural deficits. 

“This crisis is entirely self-inflicted, not because of H.R.1, but because of the Democrats’ mismatched priorities,” he said in a statement.

Ferrandino called for action to tackle the fiscal problem sooner rather than later.

“Every day that goes by, the problem gets more difficult,” he said.

The federal act poses long-term budgetary challenges for states, a Fitch Ratings report said last week. 

Federal spending cuts to Medicaid and SNAP (supplemental nutrition assistance plan) will add pressure to state budgets, “offset by long implementation timelines, reduced enrollment, and muted direct effects,” the report said. 

“States have some flexibility regarding Medicaid and SNAP outlays, particularly Medicaid, but we believe states will not significantly backfill reductions in federal spending or attempt to maintain enrollment with their own dollars, at least in the next one to two years,” it added.

Reductions in federal Medicaid and SNAP spending over the next 10 years will likely increase demand for public services and place greater demand on state and local resources, according to Fitch, which noted that a significant economic slowdown could impact states’ revenue growth, hampering their ability to offset increasing spending demands.

As for federal tax cuts, Fitch said several states indicated that changes to corporate taxes, particularly the ability for businesses to accelerate deduction of domestic research costs, could be material. It added that the impact of tax cuts in the federal act will vary among states depending on their conformity to the federal tax code.

Colorado, along with Oregon, North Dakota and Iowa, are the only states that base their income tax on federal taxable income and have rolling conformity with federal tax changes, making them the most susceptible to federal tax policy changes, according to Ferrandino’s presentation. 

Colorado’s revenue hit is greater in the current fiscal year, which must absorb 18 months of tax cuts, with losses estimated at about $700 million a year in fiscal 2027 and 2028.

Ferrandino cautioned lawmakers about tapping the state’s fiscal 2026 general fund reserve, which could fall an estimated $955 million below the statutory level of 15% of general fund spending due to the federal tax policy changes.

“I do not think using 6% of the reserve or even 5% of the reserve is a responsible way to go and budget given the risk of recession,” Ferrandino said, adding that a range of 1% to 3% could be “an acceptable risk” depending on other policy decisions that are made to deal with the shortfall.

He also urged lawmakers not to wait until the supplemental budget process begins early next year to address the financial fallout caused by the act. 

“The governor is also considering: Do we need to call back for a special session sometime in late August to deal with this in partnership with the legislature?” he said.

New Mexico’s legislature may also be back in session. Gov. Michelle Lujan Grisham’s press office did not respond to requests for comment, but the Democrat told a local TV news station on Friday she is “hungry for a special session.”

In a statement last week, Lujan Grisham said deep cuts to Medicaid included in the federal act could devastate New Mexico’s health care system, forcing rural hospitals to close. 

“Republicans in Congress have chosen to prioritize tax cuts for the ultra-wealthy over health care for working families,” she said.  

Colorado hospitals will see an estimated $10.4 billion decrease in their Medicaid hospital provider fee over the next five years, according to the Colorado Hospital Association.

“Loss of revenue will force hospitals to make cuts to services, jobs, and ultimately may affect their ability to survive,” the group said, adding that 70% of hospitals are already operating under financial pressure.

In a July 7 report, S&P Global Ratings said the act’s final provisions “have less near-term impact on ratings for U.S. public finance entities than earlier proposals, but longer-term implications for credit quality and stability could materialize as implementation occurs.”

It added that states generally have autonomy to change their Medicaid programs, which could help them manage an expenditure shift. 

“This, in turn, should limit the direct impact on ratings and credit quality,” the report said.

Colorado has issuer ratings of Aa1 from Moody’s Ratings and AA from S&P, both with stable outlooks. 

The state will be in the municipal market on Thursday with a competitive sale of $460 million of education loan program tax and revenue notes. The cashflow deal will fund interest-free loans for participating K-12 school districts.