The structural deficit measures how much more the state spends than it brings in. For years, lawmakers have balanced budgets on paper using temporary measures — delaying payments, tapping one-time funds, and relying on accounting shifts. But the IFO warns those options are largely exhausted.

"Permanent policy changes need to be enacted," IFO Director Matthew Knittel said during a presentation of the office's findings Thursday, "especially if the Rainy Day Fund is to be maintained."

A key example of the stopgaps now running dry: during negotiations earlier this year, lawmakers agreed to a "cycle roll" that delayed two months of payments to managed care organizations serving Medicaid patients into the next budget cycle. That maneuver reduced projected spending relative to revenue by $2.6 billion on paper, but the same savings cannot be claimed again. Residual COVID-19 funds have also helped balance recent budgets, but Knittel said that well is likely tapped out.

"At this point, we think those are largely used up, as are most of the larger one-time measures that can be used," he said. "For that reason, we do think that permanent revenue changes or spending changes are needed to address the structural deficit."

The IFO's outlook also assumes that recent booming economic growth will level off. A surging stock market driven largely by tech and artificial intelligence companies has boosted corporate profits and, in turn, corporate net income tax collections for three years running. But the office expects those gains to moderate, and it has built in a modest slowdown for the next calendar year. A one-time boost of roughly $230 million from taxable tariff refunds also propped up revenues this cycle.

Meanwhile, demographic changes are expected to strain the budget. Pennsylvania's population is aging, with retirees making up a growing share while school-age and working-age cohorts shrink — a shift that typically increases spending on health care and other services.

Democrats, who have long sought to legalize and tax marijuana and skill games, may finally have the votes to do so. Gov. Josh Shapiro has estimated those measures could bring in $2 billion annually. But the IFO cautions against relying on such projections. Knittel noted that a 2013 law legalizing small games of chance was estimated to generate about $156 million annually, yet actual collections in the latest year were just $1 million.

"The downside of these estimates is there's a lot of uncertainty and variability associated with them," Knittel said. "One reason for that is that oftentimes we have little or no data."

Instead, the IFO recommends budgeting based on more predictable revenue sources — such as a 0.5% increase to the personal income tax or sales tax — that could be quickly implemented if projections from new sources fall short. But that could be a hard sell: lawmakers in both parties have said they want to lower taxes, and Democrats have resisted cutting spending on education and health care.

Other Democratic proposals target corporations. Earlier this year, some Democrats pushed a 5% gross receipts tax on digital advertising platforms like Meta and Google, estimated to bring in as much as $500 million. Shapiro has also proposed "combined reporting," which would require parent companies and subsidiaries to file taxes as a collective organization, closing the so-called Delaware loophole. His office projected that could net up to $1.1 billion annually.

The IFO also advises against using the state's Rainy Day Fund, currently around $8 billion, to cover recurring expenses. Shapiro has previously called for transferring money from the fund to cover deficit spending, but the IFO says it should be preserved for a crisis. A Pew Charitable Trusts report found that intact rainy day funds help states navigate downturns and emergencies.

The IFO has warned about Pennsylvania's structural deficit for years, and the state has managed to balance its budgets and even improved its credit rating in 2024, according to Moody's. Asked what is different now, Knittel was blunt.

"The difference is the deficits are real, and they're large," he said, noting that past boons like COVID-19 funds and tobacco settlement money helped stabilize budgets. "But right now, as we discussed, the one-time transfers and the delays and shifts have been largely used up … and the general fund surplus is exhausted. So this time it is different, and we do feel that permanent changes will be required."

Spokespeople for Shapiro and Democratic leaders in the House and Senate did not respond to requests for comment, nor did spokespeople for Republican caucus leaders.