States can take concrete steps now to improve the structure of their rainy day funds, helping them to more effectively weather the impact of inevitable future downturns, as we explain in our new paper.
States used their rainy day funds to avert over $20 billion in cuts to services, tax increases, or both, in each of the last two recessions, highlighting the funds’ importance. Yet these reserves filled only a modest share of states’ record-setting budget gaps; states would have weathered the storms better with bigger rainy day funds.
States shouldn’t make rapid replenishment of rainy day funds a priority until their revenues rise well above pre-recession levels, unemployment has declined further, and they have restored programs cut during the recession — and most states are not yet there.
But, when they are ready to replenish those funds, here are three steps they can take:
Create a rainy day fund, if they don’t have one. Four states — Colorado, Illinois, Kansas, and Montana — lack a designated rainy day fund. The budgets of all of these states except Montana were hit hard by the economic downturn, and the lack of a rainy day fund left them more vulnerable to the recession’s effects.
Loosen overly restrictive caps on the size of rainy day funds. One reason rainy day funds weren’t even more effective in the most recent downturn is that 31 states and the District of Columbia cap them at inadequate levels, such as 10 percent of the budget or less. States with overly restrictive caps could either remove the cap or raise it to a more adequate level, such as 15 percent of the budget.
Ease rainy day fund rules that make it difficult to make deposits in good 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 could integrate rainy day fund transfers into the budget as part of an overall reserve policy that places a high priority on saving.