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How States Can Prepare for the Next Rainy Day

States entered the Great Recession of 2007-2009 with their biggest budget reserves in history, but those reserves filled only a modest share of the huge state budget gaps that the recession generated, in part because many states’ “rainy day” funds are poorly designed.  Now is the time to fix those flaws, as our new report explains.

Unlike actually replenishing the funds — which states shouldn’t do until their revenues rise well above pre-recession levels and states have restored the program cuts that they made during the recession — these design improvements cost nothing.  And they will help states weather the next economic storm with fewer cuts in services and tax increases.  The improvements include:

  • Create a rainy day fund if the state doesn’t already have one. Of the five states without rainy day funds (Arkansas, Colorado, Illinois, Kansas, and Montana), only Montana didn’t face serious budget problems during the downturn.  The lack of a rainy day fund left these states more vulnerable to the recession’s effects.
  • Raise the cap on the size of the fund. Some 33 states plus the District of Columbia cap their funds at inadequate levels.  These states should either remove the cap or raise it, such as to 15 percent of the budget.
  • Ease restrictions on when the fund can be used. Ten states either require a supermajority vote of lawmakers to use the fund or place an arbitrary limit on how much of the fund can be used at any one time.
  • Make it easier to replenish the fund in good economic times. Most states place a low priority on replenishing their funds, depositing only whatever surpluses are left over at the end of the year.  States should consider integrating rainy day fund transfers into the budget as part of an overall reserve policy that places a high priority on saving when times are good.

Several states have already improved their rainy day funds since 2009.  Georgia, Oklahoma, South Carolina and Virginia have raised the cap on the size of their funds, while Hawaii, Massachusetts, and Washington have made it easier to replenish their funds.  Other states should get on the bandwagon.