One Lesson From Kentucky's Devastating Tornadoes

The tragic loss of life and property destruction from December’s devastating tornadoes in western Kentucky are still fresh in the memories of Kentuckians. In the immediate aftermath, federal and state emergency management agencies stepped in to assess the damage and provide resources needed for initial relief. But rebuilding these shattered communities will be long and hard for those who lost everything.

During the 2021 legislative session, the General Assembly and Governor Andy Beshear prioritized deposits to the state’s rainy day fund. Thanks to this bipartisan effort, for the first time in a generation Kentucky has significant savings it can tap to support the communities that bore the brunt of the tornadoes; the General Assembly has already appropriated $200 million in relief funds. As policymakers reconvene for the 2022 legislative session, they should consider how to implement policies that will ensure that the state’s nearly $2 billion rainy day fund continues to serve the best interests of the commonwealth’s citizens.

The primary purpose of a rainy day fund is to offset the impact of revenue declines and stabilize a state’s fiscal position through economic ups and downs, natural disasters, and declared states of emergency. And research from The Pew Charitable Trusts suggests that rainy day funds should be targeted to one-time costs, not ongoing state expenses, to help keep budgets balanced over time.

The details of how rainy day funds are set up and managed make all the difference, and Kentucky should consider implementing the best practices outlined below. In states where policies governing rainy day funds are clear and consistently practiced, the funds can mitigate the impact of economic downturns.

Deposit extraordinary revenue into the rainy day fund: States should establish deposit rules that encourage a steady accumulation of reserves during periods of economic and revenue growth by tying deposits into the rainy day fund to above-normal revenue growth or one-time increases of revenue. Such rules require policymakers to determine what constitutes “above-normal” and “one-time collections.” Tennessee, for example, puts 10% of year-over-year additional revenue into its reserve fund, allowing lawmakers to set aside funds that are more than what’s needed or anticipated while ensuring the state has enough money to maintain ongoing services.

Define clear withdrawal conditions: To ensure that rainy day funds are used as intended, policymakers should establish clear withdrawal rules. Such a law can help lawmakers decide in advance when and how to use reserves, and which situations would trigger a withdrawal.

Calculate a risk-based savings target: Policymakers should tailor reserve caps and targets to their state’s fiscal situation. A state that experiences greater economic and revenue volatility than other states should aim for larger reserves than a state with a comparatively stable tax base. Regular volatility studies can provide insight on how frequent and deep a state’s revenue shortfalls have been.

Budget stress tests can also provide insights on how a state’s existing budget reserve balance would fare against economic shocks. A case in point is North Carolina. Pew worked closely with the state in 2017 to enact comprehensive savings reform, and North Carolina now sets its Savings Reserve Account target based on an analysis of its historic revenue volatility.

The last two years proved that states need robust reserves to deal with emergencies. And the resources needed to handle those emergencies must be adequately funded. By establishing clear rainy day fund policies that guide deposits, withdrawals, and savings targets, states can ensure that reserves are regularly collected, properly used, and well managed.

Andrew McNeill is a visiting policy director at the Bluegrass Institute for Public Policy Solutions. Angela Oh is a senior manager with The Pew Charitable Trusts’ state fiscal health initiative.

This piece was originally published by the Lexington Herald-Leader on February 11, 2022.