Pew Comments: Revenue Volatility Study Could Improve Rainy Day Fund Policy

On Feb. 23, Robert Zahradnik, director of state policy for Pew’s state fiscal health and economic growth project, testified before the Nebraska Appropriations Committee in support of Legislative Bill 33. The bill called for the state’s legislative fiscal analyst to produce a revenue volatility study that reflects several best practices identified in Pew’s research on state revenue volatility and rainy day fund policy.

L.B. 33 was signed into law by Governor Pete Ricketts on April 13, 2015.

The full text of the testimony is below. 

Testimony of Robert Zahradnik, director of state and local policy for The Pew Charitable Trusts, on April 23, 2015

Thank you Chairman Mello and members of the Appropriations Committee for inviting me to testify today on Legislative Bill 33.

My name is Robert Zahradnik and I’m a director of state and local policy at the Pew Charitable Trusts. Pew is a public charity that engages in research and technical assistance at the local, state and federal levels.

Across the country, volatility in state revenue is growing more dramatic. These swings, whether up or down, can confound the best efforts of state officials to forecast revenue and keep budgets in balance. To help states better manage uncertainty, The Pew Charitable Trusts recommends that policymakers periodically study their state’s economic and revenue volatility. Such analyses will help you develop policies for rainy day funds that can smooth budgets throughout  the business cycle and align with states’ individual objectives and characteristics.

LB 33 calls for the Legislative Fiscal Analyst to produce a revenue volatility study that reflects several best practices identified in Pew’s research on state revenue volatility and rainy day fund policy.

First, our research has found that the characteristics of a state’s economy and its tax policies contribute to volatility. The study required by LB 33 will give policymakers the ability to answer important questions such as:

• How much revenue volatility is the result of changes to state tax policy?
• Which taxes contribute the most to volatility?
• How much revenue volatility is caused by fluctuations in federal funds?

Our research has found that other states have gained important insights by asking and answering these questions. For example, a Legislative Analyst’s Office study in California concluded that major industries sensitive to the economic cycle, such as technology and housing, are one reason for the state’s above average revenue volatility.

Second, the revenue volatility study provides an opportunity to consider long-term trends. State budgets are often debated in the context of the previous year’s collections and spending, but this approach can fail to take into account underlying changes in the economy, particularly the areas that are subject to state taxation. By examining tax collections relative to longer term trends, policymakers can better understand to what degree revenue has become more volatile over time and which individual revenue sources have become more or less volatile. For example, the Minnesota state economist studies volatility in the areas of the economy that are subject to taxation in order to determine how much the state should save to weather future downturns.

Third, the analysis included in the revenue volatility study can help inform rainy day fund policies. LB 33 specifically calls for an analysis of the adequacy of current and projected balances of the cash reserve fund in relation to tax revenue volatility and the risk of the reduction in the amount of federal funds. The volatility study will also include a recommendation on the target size of the Cash Reserve Fund sufficient to sustain essential government operations in the event of a recession. This is consistent with best practices in other states. For example, policymakers in Utah used their statutorily required revenue volatility study to evaluate the adequacy of their rainy day fund and ultimately adjusted the maximum allowable balances. In addition, the volatility study can also include an analysis of the past performance of the rainy day deposit mechanism compared to alternatives to ensure the fund is working as intended.

In conclusion, this study will provide the data and evidence that you, as policymakers, need to decide how to best structure Nebraska’s savings account – the Cash Reserve Fund. 

Thank you for the opportunity to speak in support of LB 33. I am happy to address any questions the members of the committee may have.