Is It ‘Raining’ Hard Enough?

Like a married couple arguing about dipping into savings to pay off their credit card bills, some governors and legislatures are fighting over whether it’s “raining” hard enough in their states to drain rainy day funds.

Faced with historic revenue drops, states have tapped their rainy day funds in fiscal 2009 and 2010 at levels not seen since the 2001 recession to help close budget gaps totaling some $290 billion. The decision to go to these funds has renewed the debate about how much states should be setting aside in these reserves and when to use the money.

A few states, meanwhile, have been able to leave their funds intact. Texas, for example, is sitting on $8 billion in its fund and has relied instead on federal stimulus money to balance its budget.

It’s a common perception that rainy day funds are like the couple’s savings account and can be spent in emergencies. But they actually are more like 401(k) or other accounts that put contraints on the funds.

“States have different restrictions on when and how the money can be taken out of the rainy day fund,” explains Scott Pattison, executive director of the National Association of State Budget Officers.

In some places, governors have the power to transfer funds from these accounts to deal with shortfalls. In more than a dozen states, however, only a supermajority of the legislature can approve withdrawals.

But a handful of states haven’t gone that route at all and can boast that their rainy day funds remain essentially untouched. Texas has so much set aside that its $8 billion and Alaska’s reserves of $6.9 billion are badly skewing the national average of what states hold in their rainy day fund and ending balances in their budgets. Figuring the two states in, the average comes to 4.8 percent of states’ annual expenditures. Without them, it’s a paltry 2.7 percent, according to NASBO. That’s far below the 5 percent that many budget experts and bond rating agencies typically recommend states hold in reserves.

In Indiana, Governor Mitch Daniels has refused to spend his rainy day fund, estimated at more than $1 billion, and some aren’t happy. He recently was greeted in Bloomington by protestors with umbrellas and signs that read “It’s raining, Mitch” and “Fund Education.”

“We will be using our carefully built reserves to get us through this next year and a half,” Daniels told lawmakers last month. “Any reserves most other states had have long since disappeared,” the Republican governor said in his state of the state address .

Indiana is still reaping benefits from its controversial $3.8 billion deal for a 75-year lease of its toll road in 2006, while states like Texas and Wyoming are rich in natural resources, which have helped them boost their reserves and weather the recession better than other states.

Daniels is right that several states have tapped their accounts dry to balance their current budgets, including Alabama, Arizona, California, Connecticut, Maine, New Jersey, Ohio, Oklahoma and Pennsylvania. At least 16 states relied on their reserves to help eliminate 2010 budget deficits, NASBO said in its latest survey. Sixteen may not sound like a lot, but that number is on top of the 25 states that had already done so the previous year. Plus, states at that time were receiving billions of federal stimulus dollars, which will shrivel this year and mostly end by 2012.

Mississippi Governor Haley Barbour, a Republican, wants to stretch the state’s rainy day fund over three years and has agreed, begrudgingly, to spend one-third of it this year, or about $78 million. Barbour calls a plan that the Democrat-controlled House passed in January “irresponsible” because it would empty almost half of the rainy day fund in a single year. “Draining the rainy day fund too soon will put Mississippi in a worse position as this recession slices deeper into our budget,” he said .

In Tennessee, term-limited Governor Phil Bredesen, a Democrat, wants to give his successor “breathing room at the beginning of his or her term” by using $200 million from the $900 million in reserve funds to cover key programs for two years, rather than one, he told lawmakers. Some members of the Tennessee Legislature, however, have more ambitious plans. House Speaker Kent Williams, a Republican, has said he is willing to spend half the fund.

Likewise in Oklahoma, Democratic Governor Brad Henry wants to spend about 80 percent of the state’s nearly $600 million rainy day fund to patch holes in the current budget, while key Republicans who control the legislature don’t want to tap more than $223 million for the current year, saving the rest for the coming fiscal year.

Even in resource-rich Wyoming, which was one of the last states to enter the recession, some are eyeing the states’ reserves, estimated at $800 million to $1 billion, to pay the bills, rather than cutting spending again, which the state had to do for the first time in 20 years last year. “While we all want to be optimistic, and I am optimistic about the long-term future of this state, I am not prepared to bet our financial future and to dip into those reserves,” Democratic Governor Dave Freudenthal told the Republican-controlled legislature. “I think we need to hold onto them.”

Some politicians are reluctant to take too much from their rainy day funds for fear of hurting their states’ bond ratings, which then makes it more costly for a state to borrow. But experts say that concern is unfounded. “We are frequently asked if the use of the reserve leads to a downgrade,” says Robin Prunty who tracks state and local governments’ finances as a senior director in the Public Finance Ratings Group at Standard and Poor’s Ratings Services in New York. “Our feeling is that the reserves are established exactly to manage volatility, and I think the expectation is that they are utilized during difficult economic periods.”

Liz McNichol, a senior fellow at the Center on Budget and Policy Priorities , a group that tracks government spending on low-income families, says states acted prudently between the last recession and the current one to build up reserves. She calls drawing down these funds “appropriate” to help avoid deep cuts to public services at the very time the services and programs are needed most.

But the concern now is that states continue to drain these funds with predictions of at least two more years of tight budgets. The debate is whether to “tap the last vestiges of the funds and/or increase caps to rebuild the funds,” Sujit CanagaRetna, senior fiscal analyst at the Council of State Governments.

Several states, including Georgia, Oklahoma and South Carolina, are mulling whether to rethink these caps that at least 38 of them have on how much money can accumulate in their rainy day funds.  McNichol, who has written several papers on rainy day funds, says states should get rid of the caps or, at the very least, raise them, preferably to 15 percent of the budget, rather than the 5 percent most bond-rating agencies prefer.

Meanwhile, the debate about how to use these reserves leaves behind a handful of states that don’t have rainy day funds at all. But in Kansas, talk has turned to creating one. Governor Mark Parkinson, a Democrat, wants the Republican-controlled Legislature to approve a bipartisan proposal from two state senators asking for an emergency fund. It would need voters to approve amending the state constitution. “It is time that we take steps to make sure that the state never again finds itself facing this kind of fiscal challenge,” Parkinson said, calling the $1 billion in budget cuts last year brutal. “There are many reasons for the budget problems that we have. One is that we came into last year without an emergency fund.  This is unacceptable.”

Arkansas and Montana also do not have rainy day funds, and some budget analysts do not consider Illinois’s “Budget Stabilization Fund” a traditional rainy day fund because any withdrawals are supposed to be paid back by the end of the fiscal year.