More than a decade after the Great Recession began, just over half of states could cover a bigger share of spending with dedicated savings in their rainy day funds than before the downturn. Yet many states were still less financially equipped to manage budget uncertainties than just before the recession.
Thanks to a jump in tax revenue collections, states at the end of fiscal year 2018 had more savings set aside to weather the next economic downturn than at any point since the 2007-09 recession. The additional resources enabled states to increase their rainy day funds—also called budget stabilization funds—for the eighth straight year, reaching a record 50-state total of $59.9 billion. With these savings alone, states could have run government operations for a median of 23.2 days, also a new high, compared with 16.6 days just before the recession.
At least 26 states had saved enough in their rainy day funds to cover a greater share of spending in fiscal 2018 than in fiscal 2007, the last full budget year before the downturn. Although many factors determine how much each state should set aside, one gauge of states’ progress in building their savings is a comparison with pre-recession levels. For many states, though, even pre-recession levels were inadequate to plug huge budget gaps caused by the last recession, which forced states to use a combination of rainy day fund withdrawals, spending cuts, and tax hikes to balance their budgets.
Thirty-two states pumped a combined $9.8 billion into their rainy day funds in fiscal 2018, according to data collected by the National Association of State Budget Officers (NASBO). Only eight ended the budget year with less in their dedicated savings accounts than a year earlier. Overall, rainy day funds constitute the largest portion of states’ total reserves and balances.
Just as they did after the 2001 recession, policymakers in many states have used the current economic recovery to replenish and expand their rainy day funds to prepare for the next inevitable downturn. But 50-state tax revenue growth in this recovery has been slow, despite the spurt at the end of fiscal 2018, and there have been competing demands to use extra tax dollars to restore spending that had been cut.
States’ results for fiscal 2018 show:
Rainy day funds are not the only pot of money available in times of financial need. States also softened the blow to their budgets after tax revenue plunged in the last downturn by turning to ending balances, which are the dollars left over in what functions as a state’s main checking account—the general fund. Together, rainy day funds and ending balances make up a state’s total balances, which are another measure of resources available to a state in a sudden revenue shortfall.
For the past 10 years, most states failed to match their pre-recession benchmarks for total balances because slow recoveries in tax revenue and tight budgets meant fewer dollars left over in ending balances. But an unexpected tax revenue surge in the 2018 budget year—fueled in part by one-time money—resulted in the largest ending balances since fiscal 2015.
Total balances reached $90.5 billion in fiscal 2018, helping drive up by a third the median number of days that states could run government operations using their total balances to a post-recession high of 40.4, just shy of the 41.3 days’ worth of spending held before the downturn. Total balances in at least 23 states—the most since the recession—were large enough at the end of last fiscal year to cover a greater share of government spending than they could have heading into the 2007-09 recession. Ending balances, however, are expected to be lower in fiscal 2019, moderating these post-recession highs.
Ending balances vary from year to year and do not accumulate, so policymakers cannot count on them as cushions against future budget uncertainty to the degree that they can with rainy day funds, which are saved until policymakers decide to draw them down.
States’ results for fiscal 2018 show:
States use reserves and balances to manage budgetary uncertainty, including revenue forecasting errors, budget shortfalls during economic downturns, and other unforeseen emergencies, such as natural disasters. This financial cushion can soften the need for severe spending cuts or tax increases when states need to balance their budgets.
Because reserves and balances are vital to managing unexpected changes and maintaining fiscal health, their levels are tracked closely by bond rating agencies. For example, S&P Global Ratings downgraded Massachusetts’ debt rating in June 2017, citing its “failure to follow through on rebuilding its reserves.” A year later, Massachusetts deposited more than $492 million into its reserve fund. If left unaddressed, credit downgrades can lead to increased state borrowing costs for years to come.
Building up reserves is a sign of fiscal recovery, but there is no one-size-fits-all rule on when, how, and how much to save. States with a history of significant economic or revenue volatility may desire larger cushions. According to a report by The Pew Charitable Trusts, the optimal savings target of state rainy day funds depends on three factors: the defined purpose of funds, the volatility of a state’s tax revenue, and the level of coverage—similar to an insurance policy—that the state seeks to provide for its budget.
Reserves and balances represent funds available to states to fill budget gaps, although there may be varied levels of restriction on their use, such as under what fiscal or economic conditions they can be used. In addition, limits are often set on how much states may deposit into rainy day accounts in a given year when seeking to replenish their reserves.
General fund reserves and balances may not reflect a state’s complete fiscal cushion. States may have additional resources to soften downturns, such as dedicated reserves outside of their general funds or rainy day accounts. In addition, some states undertake considerable spending outside of the general fund, so comparisons across states should be made with caution. One way to standardize the size of reserves and balances is to calculate how many days a state could run solely on those funds, even though it is highly unlikely that would ever happen.