This paper discusses budgetary problems facing state governments, and explores the relationship between state government fiscal conditions and potential impacts on municipal governments and school districts. It examines how state budget cuts have affected the state funding of municipal governments and how these governments are likely to respond to reductions in state funding. The paper discusses the possibilities that the state government budget crisis will increase unfunded mandates imposed on local governments or result in an implicit shifting of costs from the state to local governments. A version of this paper was published in State and Local Government Review, vol. 36, no. 2, (Spring 2004): 86-102.