Rainy Day Funds: Opportunities For Reform, 3/9/05

As states slowly emerge from the fiscal crisis, policymakers can evaluate how well their state reserve funds worked to cushion deficits during the downturn. This is an opportune time to strengthen state reserve policies and to begin to rebuild depleted state reserve funds.

Since 2001, states have used about $30 billion in reserve funds — which includes both general fund balances and rainy day fund balances — to help close cumulative deficits of over $250 billion. In particular, states used reserves extensively to help close gaps in the early part of the fiscal crisis. Reserves closed about one-quarter of the deficits that developed through fiscal year 2003.

Arguably, states need to do an even better job of saving than they did in the 1990s. States entered the most recent downturn with reserves equivalent to 10.4 percent of a year’s expenditures, far more than they had on hand in either of the previous two downturns. Nevertheless, deficits during the downturn were five times the amount states had accumulated. A 1999 study by the Center on Budget and Policy Priorities as well as recommendations from the Government Finance Officer’s Association suggests that an adequate level of total reserves is 15 percent of a year’s expenditures spending — or more.

The need to build stronger reserves argues for states beginning to rebuild those reserves as soon as possible. Many years are required to reach an adequate level of reserves.

Some states may not yet be ready to make deposits. Many states are still feeling the lingering effects of the fiscal crisis and the slow economic recovery. About half the states are working to close FY 2006 deficits of over $30 billion. While these states may not have the resources to begin rebuilding their financial reserves now, there are steps they can take in preparation for rebuilding. Policymakers have an opportunity to enact some critical policy changes to improve their reserve policies so that they are better prepared for the next fiscal crisis. These steps include the following.

Since 2001 states have struggled to close cumulative deficits of over $250 billion. Roughly $30 billion in state reserve funds have been used to help close state budget deficits and prevent the need for additional spending cuts or tax increases.

While the $30 billion in drawn down reserve funds represents less than one-eighth of the total deficits states faced, the reserves were critically important during the early part of the fiscal crisis. States were able to use reserves to close the unexpected deficits — particularly mid-year deficits — that occurred in the first years of the fiscal crisis, giving states needed time to develop longer-term tax increase and spending reduction proposals. Reserves closed about one-quarter of the deficits that developed through fiscal year 2003.

The primary reason that reserve funds played an important role in balancing state budgets is that states did a better job of saving during the years leading up the fiscal crisis than they did in the years leading up to the previous economic downturn of the early 1990s. In fact, state balances stood at 10.4 percent of spending at the end of 2000. Prior to the last recession of the early 1990s, states had total balances of only 4.8 percent of expenditures.

Overall, state reserves have declined from a twenty-year high of 10.4 percent of spending, $49 billion, at the end of FY 2000 to an estimated 3.3 percent of spending, $18 billion, at the end of FY 2005. Over 40 percent of these remaining reserves are concentrated in just five states — Alaska, Florida, Georgia, New York and Texas.[1]

Because states used a large portion of their reserves during the fiscal crisis, many states now have low reserve levels. Between 2000 and 2005, the number of states with reserves of 5 percent or more of spending declined from 39 to 13. Over the same period, the number of states with reserves of 10 percent or more spending declined from 23 to 6. (See Table 1 for state-by-state data on appropriated FY 2005 rainy day fund balances, general fund balances, total reserve balances, and total reserves as a percent of spending.)

States need to begin re-building reserves now, or as soon as possible. Building adequate reserves takes time, and the $50 billion reserves with which states entered the most recent downturn were accumulated over the full decade of economic prosperity. It is impossible to predict how long the growth segment of the current business cycle will last, but ten years was an usually long period of prosperity.

**Table 1**
State	FY 2005 Appropriated Rainy Day Fund Balance	FY 2005 Appropriated General Fund Balance	FY 2005 Appropriated Total Reserves	FY 2005 Appropriated Total Reserves as a % of Spending
Alabama	140	65	205	3.5%
Alaska	2,059	-	2,059	88.3%
Arizona	25	8	33	0.4%
Arkansas	-	-	-	0.0%
California	-	783	783	1.0%
Colorado	-	246	246	4.1%
Connecticut	286	-	286	2.2%
Delaware	148	430	578	20.3%
Florida	999	868	1,867	7.8%
Georgia	-	1,145	1,145	7.0%
Hawaii	-	292	292	7.1%
Idaho	21	77	98	4.7%
Illinois	-	458	458	2.0%
Indiana	46	291	337	3.0%
Iowa	-	88	88	2.0%
Kansas	-	210	210	4.5%
Kentucky	117	-	117	1.5%
Louisiana	-	-	-	0.0%
Maine	-	11	11	0.4%
Maryland	520	87	607	5.4%
Massachusetts	624	25	649	2.7%
Michigan	-	1	1	0.0%
Minnesota	631	1	632	4.4%
Mississippi	43	-	43	1.2%
Missouri	232	26	258	3.6%
Montana	-	140	140	10.6%
Nebraska	177	8	185	6.7%
Nevada	1	160	161	6.3%
New Hampshire	17	(50)	(33)	-2.5%
New Jersey	288	110	398	1.4%
New Mexico