A report released today by The Pew Charitable Trusts illustrates how states can save enough during economic boom years to better weather future recessions. Building State Rainy Day Funds: Policies to Harness Revenue Volatility, Stabilize Budgets, and Strengthen Reserves identifies the limitations of current rainy day funds, formally known as budget stabilization funds. It also contains three strategies to help states make saving a reliable and predictable practice in times of growth.
These funds are intended to smooth state finances over the ups and downs of the business cycle. The 50-state assessment reveals that only 12 states connect the rules for when, how, and how much to deposit into their funds with underlying revenue or economic fluctuation. Further, caps on the size of funds often are set too low, preventing states from saving enough to substantially offset revenue losses during economic downturns.
“Unanticipated peaks and valleys in revenue collection are unavoidable, and increasingly common,” said Brenna Erford, who manages Pew’s state budget policy research. “States with rainy day fund deposit rules tied to observed volatility are able to more reliably harness growth when times are good, prioritize saving during the budget process, and prepare for future downturns.”
The study identifies three best practices that can help policymakers manage volatility by designing responsive budget stabilization funds.
The report notes that setting aside money for the future requires tradeoffs. Although many state leaders have emphasized the need to rebuild savings, each dollar directed to a budget stabilization fund is a dollar that cannot be spent on public programs or tax reductions or used to pay down long-term debt. But these savings can mitigate tough decisions during recessions and help make state budgets more consistent and predictable throughout the business cycle. As the economy expands and states continue to see their revenue increase, policymakers have both a fiscal responsibility to rebuild budget stabilization funds and a rare opportunity to significantly improve them.
Pew examined the mechanisms for depositing money into budget stabilization funds and compared these rules to tax volatility patterns and drivers in all 50 states. State budget policy researchers at Pew adjusted U.S. Census Bureau data to remove the effect of tax policy changes from 1994 to 2012, which revealed the underlying cyclical volatility in these tax sources.
The Pew Charitable Trusts is driven by the power of knowledge to solve today’s most challenging problems. Learn more at www.pewtrusts.org.