Rainy Day Funds can be a powerful tool in helping policymakers weather economic downturns and build a solid fiscal base for states. But the details of building and managing funds make all the difference. When state policies governing rainy day funds are clear and consistently applied, they mitigate the impact of recessions, thereby reducing the need for disruptive tax increases or spending cuts. They are also well received by the major rating agencies. Through research and technical assistance to states, The Pew Charitable Trusts’ State Fiscal Health Project identified best practices for rainy day funds:
- Maintain at least one reserve account specifically for fiscal stabilization.
- Deposit extraordinary revenue, including above-average tax revenue and one-off collections, into the Rainy Day Fund.
- Define clear withdrawal conditions.
- Calculate a risk-based cap or savings goal.
Maintain at least one budget stabilization reserve account
The main purpose of a rainy day fund is to offset the impact of declining income and stabilize a state’s fiscal position through economic ups and downs, natural disasters and states. emergency declared. By creating a separate savings account for this purpose, states can ensure that resources are available during times of fiscal stress.
Some states have other types of reserve funds, including investment funds that provide short-term resources for infrastructure projects, tax relief funds that can be used to fund one-time tax breaks and accounts. revolving cash flow to compensate for month-to-month imbalances. revenue collection. While these accounts can play an important role in fiscal policy, they do not offer complete protection against a recession.
Deposit Extraordinary Income into the Rainy Day Fund
One of the ways to build up funds for rainy days is to establish deposit rules that encourage a steady build-up of reserves during times of economic growth and income growth.
States can do this by tying rainy day fund deposits to above-normal income growth or one-time income inflows (such as legal settlements over $ 10 million or one-time transfers from the government). federal government). This forces policy makers to determine what is ‘above normal’ and to establish what qualifies as ‘one-time collection’. For example:
- VIRGINIA sets aside at least 50 percent of earnings that exceed the previous six-year average.1
- TENNESSEE sets aside 10 percent of additional income year over year.2
- MARYLAND devotes all or part of its non-withholding income tax revenues that exceed the ten-year average to its rainy days fund.3
Other states have linked rainy day fund deposits to extraordinary income growth in one or more particularly volatile income streams. For example:
- TEXAS sets aside 37.5 percent of all tax revenue from oil and gas severance packages in excess of 1987 levels for the State Economic Stabilization Fund.4
- MASSACHUSETTS transfers tax revenues on capital gains that exceed a threshold that adjusts with the economy. The state is also setting aside all rewards from major legal settlements in the Rainy Day Fund.5
Depositing at least a portion of extraordinary income or one-time income in the Rainy Day Fund can help increase or replenish a state’s reserves while discouraging lawmakers from earmarking extraordinary income for recurring expenses. which can lead to a longer-term budgetary imbalance. Analysts from S&P Global Ratings and Fitch Ratings said these rule-governed deposits are generally viewed favorably when assessing government debt issues.6
Define clear withdrawal conditions
To ensure that rainy day funds are used as intended, policymakers should create clear withdrawal rules and set them into law. These rules should make it difficult to use reserves when economic growth and income growth are strong, but should not prohibit access when money is needed. For example:
- MINNESOTA allows withdrawals when “a negative budget balance is projected and when objective measures, such as reduced growth in total wages, retail sales or employment, reflect slowdowns in the state economy” .7
- OREGONThe legislature can only draw on the rainy day fund after one of the following three conditions has been met:
- The latest quarterly economic and income forecasts for the biennium project that next year’s income will be at least 3 percent less than the general fund appropriations for the current biennium.
- There has been a decline for at least two consecutive quarters over the past 12 months in seasonally adjusted non-farm payroll employment.
- A quarterly forecast indicates that income for the current biennium will be at least 2% lower than the forecast on which the current budget was based.8
- WASHINGTONThe legislature demands a simple majority vote to appropriate rainy day fund balances during declared states of emergency or periods of economic downturn, using job growth as a trigger. However, at all other times, the members of each chamber must obtain a qualified three-fifths majority.9
While rating agencies can downgrade a state’s creditworthiness when reserves are depleted during periods of economic growth or income growth, they do not penalize the proper use of funds for rainy days. In fact, analysts have suggested looking favorably upon states that dip into their reserves during a recession, provided they take other steps, such as cutting spending and raising taxes, and replenishing their reserves when possible.ten
Calculate a risk-based savings goal
Policymakers should tailor reserve ceilings and targets to their state’s economy, tax structure, income volatility, and financial flexibility.11 A state that experiences greater economic and income volatility should aim for larger reserves than a state with a relatively stable tax base.
Regular volatility studies and budget stress tests can provide insight into the frequency and depth of revenue declines. From there, policymakers should answer the following questions:
- How much of any shortfall, all or only part, should the reserves cover?
- How long should the state expect to rely on reserves?
- How much should the state guard against a severe downturn?
Answering these questions can help legislators set an appropriate savings target, which can be applied to a budget stabilization fund or cash reserves more broadly.
- MINNESOTA, for example, has been asking its budget office since 2014 to recommend a savings target each year. The bureau performs a risk analysis based on the performance of state revenues and recommends a figure that should offset nine out of 10 potential recession-related deficits for a period of up to two years. Fitch Ratings praised the technique when it upgraded the state to “AAA” in July 2016.12 By the end of 2019, the state had reached its target.13
Rainy day funds help states prepare for downturns or other unforeseen emergencies. They reduce the need to cut spending or raise taxes, counterproductive actions in times of recession. By establishing clear policies that guide deposits, withdrawals, and savings goals, states can ensure that reserves are regularly collected, properly used, and well managed.
- Constitution of Virginia, tax or income limit; Income Stabilization Fund (2016), https://law.lis.virginia.gov/constitutionexpand/article10/.
- The Pew Charitable Trusts, “Building State Rainy Day Funds” (2014), https://www.pewtrusts.org/en/research-and-analysis/reports/2014/07/15/building-state-rainy-day- funds-policies-to-exploit-the-revenues.
- Maryland limits the amount of estimated and final payments (income tax collections not withheld can include income from interest, dividends, partnerships, self-employment taxes, and most importantly, capital gains ) which can be integrated into its budget. Appropriations are limited to the ten-year average of estimated and final payments, although the restriction is lifted if projected unsuccessful revenue exceeds 2% of total revenue. See The Pew Charitable Trusts, “State Budget Strategies: States Pioneer Ways to Mitigate Swings in Personal Income Tax Revenue” (2018), https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2018 / 03 / States-pioneers-ways-to-mitigate-the-oscillations-in-income-from-personal-income-tax.
- Texas Transportation Funding Amendment, Proposition 1 (2014), https://ballotpedia.org/Texas_Transportation_Funding_Amendment,_Proposition_1_(2014). Prior to 2015, Texas spent three-quarters of all severance pay tax revenue above 1987 levels on its Economic Stabilization Fund. A constitutional amendment approved by voters in 2014 devoted half of that amount to financing highways.
- The Pew Charitable Trusts, “Building State Rainy Day Funds”.
- The Pew Charitable Trusts, “Rainy Day Funds and State Credit Ratings” (2017), https://www.pewtrusts.org/en/research-and-analysis/reports/2017/05/rainy-day-funds-and- state credit ratings.
- Minnesota Statistics. § 16a.152 (2019), https://www.revisor.mn.gov/statutes/cite/16A.152.
- Oregon Rainy Day Fund 293.144 (2017), https://www.oregonlaws.org/ors/293.144.
- Washington Constitution, Article VII, Revenue and Taxation, Section 12, Budget Stabilization Account (2007), http://leg.wa.gov/CodeReviser/Pages/WAConstitution.aspx.
- The Pew Charitable Trusts, “Rainy Day Funds and State Credit Ratings”.
- Fitch Ratings, “AAA” AAA; Upgrades Outstanding Debt ”, press release, July 28, 2016, https://www.fitchratings.com/site/pr/1009660#solicitation.
- Minnesota Management and Budget, “State of Minnesota Releases Budget and Economic Forecast,” press release, December 5, 2019, https://mn.gov/mmb/mmbhome/#/detail/appId/1/id/412276.