March 18, 2014
Across the states, there has been a fair amount of discussion about rainy day funds in governors’ state of the state
speeches and throughout legislative sessions this year. Rainy day funds are also known as budget stabilization funds because they are budget reserves specifically designated to guard against revenue or expenditure volatility. Rainy day funds are different from other surplus amounts, such as ending balances, because the funds have special features like restrictions on use, required contributions, statutory caps or limits on the fund size relative to general funds, and repayment requirements. In other words, monies in rainy day accounts are like funds kept in a special lock box that can often only be used if a number of conditions are met.
For these reasons, decisions about the build-up or use of a rainy day fund can be difficult because the money is not always easily accessible once placed in reserve. This can result in a disincentive to make contributions during good economic times or to access the funds when legitimate needs arise. In seven states, authorization for a withdrawal only comes after a super majority (three-fifths, two-thirds or three-fourths) of the legislature approves the withdrawal. And in 15 states, there are terms and conditions under which withdrawals must be repaid.
Some have argued that more states would increase the size of their rainy day fund if restrictions and controls were loosened to make contributions feel less permanent. Meanwhile, other
researchers have found the additional restrictions are justified to safeguard the funds from plundering for reasons unrelated to fiscal instability, such as constituent demands for spending increases or tax cuts. More about how budget officers view the build-up and use of rainy day funds can be found in NASBO’s report
State Budgeting and Lessons Learned from the Economic Downturn.
There is no economic theory that determines the appropriate size of a state’s rainy day fund, but a number of considerations can help inform executive and legislative discretion. For example, state tax structures, revenue volatility and the composition of a state’s economy are all factors that can influence budget volatility. States are beginning to look beyond just the size of the rainy day fund and are focusing efforts on how their rainy day fund policies can account for these fiscal risks. According to a
report from Pew’s state and consumer initiative, a dozen states, including Massachusetts, Texas, Virginia, and Utah, link deposits directly to unexpected surges in volatile tax streams. Such findings indicate that states are thinking about rainy day funds differently than in decades past, but the report’s authors suggest more could be done in the majority of states.
The level of total reserves relative to expenditures has been climbing since the end of the recession, although states have still not accumulated reserves above levels reached during the pre-recession years from fiscal 2006 to 2008. Rising reserve levels may be an indicator of increased fiscal conservatism in state legislatures or the result of policy changes that better match contribution levels to improvements in state tax collections and the economy. With the one-time revenue effects of the federal fiscal cliff now
over, it remains to be seen if states will continue to build reserves in fiscal 2015. Enacted fiscal 2014 budgets show rainy day funds increasing by $3.1 billion, or 0.4 percent of general fund expenditures, compared to fiscal 2013.