The 2025 budget reconciliation act, or the “One Big Beautiful Bill Act (OBBBA),” presents state lawmakers with key decisions. Weakening revenues, after years of state tax cuts and expiration of pandemic-era federal aid, have already put many states under budget pressure. And OBBBA’s provisions bring sweeping changes to federal taxes and spending. 

State policymakers will be assessing how those changes will interact with their state’s individual income tax structure, its reliance on federal programs, and state demographics. State lawmakers and agency leaders may need to act to protect tax revenue, support residents, or both.

The first state decision: To conform or not conform

OBBBA reshapes the federal tax code, but its state-level effects on taxpayers hinge on whether and how a state conforms to federal tax law. States generally conform in one of three ways. A state’s approach to conformity will shape the reach—and revenue impact—of OBBBA within its borders.

• Rolling conformity automatically aligns a state’s tax code to federal changes
• Static conformity connects a state’s tax code to the federal code as of a specific date and therefore requires state legislation to update  
• Selective conformity gives a state flexibility to adopt or reject individual federal changes 

The immediate effects of OBBBA will be most noticeable in rolling conformity states. Under static and selective conformity, states will decide how much of OBBBA to adopt—and when. In some cases, aligning with federal changes could help them; in others, conformity could lead to revenue losses.

A closer look at selected OBBBA changes that could impact state income tax revenues

Many of the OBBBA’s provisions—especially those that expand deductions or credits—will reduce taxable income and state revenue unless state lawmakers choose not to conform their tax code or adopt offsetting measures. On the other hand, provisions that limit deductions or repeal exemptions may increase revenue by broadening the tax base. Key individual provisions are outlined below.

Standard deduction and itemization limits: OBBBA makes permanent the 2017 Tax Cuts and Jobs Act’s larger standard deduction and extends and modifies limits on itemized deductions. For most conforming states, this has broadened the state income tax base, typically boosting income tax revenues. 

No more personal exemptions, but a new temporary senior deduction: OBBBA permanently terminates the federal personal and dependent exemptions, and adds a new temporary “senior deduction.” For taxpayers in conforming states, this could result in higher state income taxes, especially for households with multiple dependents. In non-conforming states, taxpayers may still be able to exempt dependents on their state income tax returns. 

Expanded child tax credit: OBBBA permanently enhances the federal child tax credit (CTC), increasing it to $2,200 and indexing it for inflation. While this helps many households, it reduces revenue in states that piggyback on the federal CTC. On the other hand, families receiving the enhanced CTC may end up less dependent on other state services, partly offsetting the state fiscal hit.

Higher SALT cap, clarified Pass-Through Entity Taxes (PTET) workarounds: OBBBA temporarily raises the state and local tax (SALT) deduction cap from $10,000 to $40,000 (phasing out for those earning $250,000 or more) and continues the federal deductibility of PTETs, a popular state workaround to the cap. In states with rolling conformity, the increased SALT cap will automatically reduce state taxable income. 

New OBBBA tax breaks: New deductions for tips, overtime pay, and car loan interest—are structured as below-the-line deductions, which are subtracted from federal adjusted gross income (AGI). Because most states begin their income tax calculations with federal AGI, these deductions won’t automatically apply unless the state explicitly conforms to the federal taxable income, or adopts these provisions separately.

States may implement income tax changes as soon as this tax year

States with rolling conformity are on track to adopt most OBBBA provisions starting with the 2025 tax year—unless lawmakers choose not to adopt specific changes. In static conformity states, conformity decisions are likely to resurface in next year’s legislative sessions. Some states’ legislatures are already choosing: For example, California lawmakers extended the PTET workaround through December 31, 2030.

New Jersey lawmakers have taken early action as well, passing legislation to align select state tax provisions with the OBBBA. This includes updates to Qualified Small Business Stock (QSBS) treatment—specifically, conforming to the federal exclusion percentages for capital gains, which aligns the state with recent federal changes.

States could face tough spending constraints

New York officials warn that up to 1.5 million New Yorkers could lose health insurance and 300,000 households may lose supplemental nutrition assistance benefits as a result of funding cuts under OBBBA. Estimates suggest that New York State could lose $7.5 billion annually in federal funding. Given the state’s nearly $750 million budget gap this year, Governor Kathy Hochul has called for agency-led cost reductions and legislative action to offset federal cuts. Democratic lawmakers are also urging state-level responses to safeguard Medicaid, food-security and other safety net programs.

In California, lawmakers have voiced the need for supplemental budget legislation as early as late summer, citing urgent concerns about OBBBA-related reductions to Medicaid and higher education funding.

New Mexico Governor Michelle Lujan Grisham (D) and state legislative leaders have similarly emphasized that addressing OBBBA’s tax implications as well as health and social service issues caused by federal cutbacks is a top priority.

Responding to these challenges won’t be easy

Nearly all states operate under balanced budget requirements, which leaves lawmakers with only three real options: cut spending, raise taxes, or tap reserves. And while record-high rainy-day balances are on some state ledgers, it’s risky to rely on them to cover ongoing shortfalls. Rainy-day balances are intended for unpredictable emergencies or economic downturns, not permanent federal cuts. 

The broader economic climate isn’t helping. High interest rates and new tariffs are increasing borrowing costs and inflation, raising the price of capital projects and the cost of safety net programs just as state tax revenue growth slows.  

Even with federal pandemic aid now expired, state revenue growth softening, and OBBBA-related federal funding cuts looming, states are not yet in crisis. But they are at a crossroads. 

Lawmakers’ decisions today will shape the sustainability of key state programs and whether those programs can protect vulnerable residents while maintaining fiscal stability. As they weigh their options, lawmakers will need to carefully consider how federal changes interact with their own state tax codes, safety net systems, and long-term obligations. 

A state’s challenge isn’t just responding to OBBBA—it’s anticipating what might come next.