Storms can show you how strong the roof of your house is. A fiscal storm – like the one states have just experienced -- can serve a similar purpose.
The stormy economy of the last decade has both highlighted the importance of state “rainy day funds” – budget reserves to protect states from the effects of unexpected revenue declines or spending increases – and revealed some of their flaws as we explain in our new report, "Why and How States Should Strengthen Their Rainy Day Funds."
- In the aftermath of the recent recession, roughly three out of four states reported that they used their rainy day funds to address budget shortfalls. These reserves reduced the need for large immediate spending cuts or tax increases, giving many states time to consider ways to maintain needed services despite depressed revenues.
But the downturns also revealed serious flaws in the design of many states’ funds. Here are some of the lessons learned:
- Having a rainy day fund is critical. Five states – Arkansas, Colorado, Illinois, Kansas, and Montana – do not have designated rainy day funds. All of their budgets except Montana’s were hard hit by the recession and their lack of rainy day funds left them more vulnerable.
- Existing rainy day funds are often too small. Our research and recent history suggests that states need reserves of at least 15 percent. But two-thirds of the states cap their funds, making it impossible for them to reach adequate levels.
- Many states make it too difficult to use these funds when they are needed. Some states require more than a simple majority of legislators to access these funds. Others require that the states pay back the funds too quickly, without regard to whether revenues have recovered.
States can raise or remove the caps on their rainy day funds, eliminate supermajority requirements, and make them more accessible in other ways. In addition, once revenues have recovered from the recession, states can make saving a higher priority by making deposits to rainy day funds a part of the regular budget process rather than waiting until the end of the year to see if they have any money left over.
The time to improve rainy day funds is now, while memories of the last recession are still fresh. Voters seem to agree. Last fall, five states considered ballot initiatives to improve their rainy day funds and they all passed.
If more states follow their lead, the next fiscal storm may be a little easier to handle.