On Dec. 8, The Pew Charitable Trusts released the report Why States Save: Using Evidence to Inform How Large Rainy Day Funds Should Grow, which describes the difficulties state governments have in determining how much to save. In many cases, states have failed to establish policies, provide guidance, or gather the information necessary to set an evidence-based savings target.
In this report, Pew recommends that state policymakers consider three factors before arriving at an optimal savings target:
1. What is the fund’s purpose?
State officials must first decide what they want to accomplish with the fund and when the balances can be drawn upon. Ideally, the fund should have an explicitly stated purpose that is narrowly defined in law.
2. How volatile is the state’s revenue?
Historical data on the state’s revenue volatility can inform policymakers as they determine a savings target that will help safeguard against future revenue downturns.
3. How much risk is the fund meant to offset?
Some states may want to insure themselves against large budget shortfalls that can last several years, while others may choose to cushion themselves for much smaller downturns that last only a year or two. To set an appropriate savings target, policymakers must first determine how much risk the fund is meant to offset.
The report examines these three factors in additional detail and offers appendixes categorizing the purpose of each state’s rainy day funds, as well as their caps and targets.