States often depend on their rainy day funds, more formally known as budget stabilization funds, to help them weather economic downturns and uncertainty. These funds act as savings accounts that allow states to set aside above-normal revenue growth when the economy is strong so it can be used in times of recession when revenues drop sharply. With significant reserves, states can rely less on program reductions or tax increases to close a budget gap when their residents can least afford it.
For many states, the Great Recession, which ran from late 2008 through the middle of 2010, served as a wake-up call to re-evaluate their savings policies. In total dollars, state budget shortfalls outstripped savings nearly 2 to 1 in the first year of the downturn alone. A decade later, many states have improved their reserve policies, but more remains to be done as governments prepare for the next recession. For example, a September 2018 analysis by Moody’s Analytics found that 32 states fell short of having enough reserves to offset even a moderate recession.
As states work to balance saving for future needs against funding other important priorities, an increasing number are using evidence-based approaches to determine how much they want to have on hand to navigate the next recession.
Collectively, U.S. states have more set aside in their rainy day funds now than they did before the Great Recession. In fiscal year 2008, immediately prior to the downturn, the 50-state median rainy day fund balance was equivalent to 4.8 percent of expenditures. That figure is now 5.5 percent, but many still lag well behind. The bottom half of states have saved only 3.0 percent of expenditures, a level likely well below what they might need to mitigate a recession (see Figure 1).
This year, many are making positive strides. Higher than expected revenue growth left several states with budget surpluses at the end of fiscal 2018. Anticipating some of those gains may be temporary or one-time in nature, some invested a portion of the extra cash in their rainy day funds; a few added to their savings accounts for the first time in years.
In July, for example, Pennsylvania announced its first deposit to the rainy day fund since 2006. Kansas, which created its fund in 2016, put a plan in place this year to fund the account if revenue exceeds projections in 2020, 2021, or 2022.
Massachusetts, which was downgraded by S&P Global Ratings last year because of excessive use of reserves during an economic expansion, recently said it will deposit $514 million of its $1.7 billion capital gains revenue for the year in its fund. Policymakers cited the one-time nature of much of the revenue. Following the recession, the state enacted a rule requiring that above-normal collections of capital gains revenue be set aside to ensure Massachusetts is better prepared for any downturn.
With the start of fiscal 2019, policymakers in many states are asking whether they are saving enough. They are trying to determine how best to balance preparing for the future with other, more immediate priorities. They know that each dollar saved is a dollar that cannot be used now on important programs, services, or revenue reductions. To make these decisions, more are turning to evidence-based approaches, rather than setting savings targets to an arbitrary percentage of state revenue or spending. For example:
Although state approaches to replenishing their rainy day funds differ, evidence-based savings targets are critical for maintaining state budgets. These targets can help policymakers reach consensus around how much a state needs to save. They bring increased transparency about the reasons for holding money in reserve, and they prevent states from under—or over-saving—during times of economic growth.
Mary Murphy is project director and Steve Bailey is an associate manager with The Pew Charitable Trusts’ states’ fiscal health project.