There is nothing about the nature of state and local governments that prevents them from running deficits in the same manner as the U.S. federal government. A fiscal deficit is brought about whenever government revenue fails to meet government expenditures – an accounting reality that can strike any government. However, most state and local governments carry some form of legal requirement for balanced budgets.
Only one state (Vermont) does not carry a balanced budget requirement, but there are varying degrees about the severity of these laws. Per the U.S. Government Accountability Office (GAO), certain balanced budget requirements "are based on interpretations of state constitutions and statues rather than on explicit statements that the state must have a balanced budget." Some states have a judicial mandate for balanced budgets, but it is up to the legislature to create legal enforcement mechanisms to ensure enforcement.
According to the National Conference of State Legislatures, there are three types of balanced budget requirements:
• A requirement that the governor's proposed budget must be balanced.
• A requirement that the state legislature pass a balanced budget.
• A requirement that the budget must actually be balanced at the end of any given fiscal year so that no fiscal deficit may be carried forward.
However, there are only two real constraints on state and local governments that do not balance their budgets according to constitutional or legislative statute. States cannot issue debt in the same way that the federal government can. Debt requires approval of the legislature or even the voting public. The last state government to borrow long-term funds was Connecticut in 1991. Non-federal government spending is capped by revenue. The second major constraint is the democratic process itself. Officials who run up government debt can be voted out of office if they fail to uphold their own laws.
State and local governments do not really have the economic ability to run fiscal deficits to encourage aggregate demand like the federal government. With this macroeconomic handicap, many state and local economies ask for federal aid during times of hardship.