A decade after the Great Recession, states collectively have amassed their largest fiscal cushion in at least two decades. As most states closed out their 2019 budget year, a surge in tax collections drove the total held in savings and leftover budget dollars to a record high. More than two-thirds of states—the most yet—could cover a bigger share of spending with rainy day funds alone than they could just before the downturn.
Thanks in large part to two consecutive years of widespread budget surpluses, fiscal 2019 was a banner year for states’ financial reserves, which provide a pool of money to help plug budget gaps during economic downturns and respond to other unforeseen challenges, such as the coronavirus outbreak.
States collectively held record amounts and could cover a record share of spending with both rainy day funds and total balances, which include dedicated savings and money left over at the end of the fiscal year. Still, some states were more financially equipped to manage budget uncertainties than others.
Additional tax revenue enabled states to increase their rainy day funds—also called budget stabilization funds—for the ninth straight year, reaching a record 50-state total of $74.9 billion in fiscal 2019. With these savings alone, states could run government operations for a median of 27.9 days, equal to 7.7 percent of spending—also a new high—compared with 17.3 days, or 4.7 percent of spending, just before the recession.
As the United States marked its longest economic recovery, at least 34 states had saved enough to cover a greater share of government operating costs than in fiscal 2007, the last full budget year before the downturn.
Forty-one states grew their rainy day funds by a sum of $9.1 billion in fiscal 2019, according to data collected by the National Association of State Budget Officers (NASBO).
Overall, rainy day funds constitute the largest portion of states’ total balances, which comprise states’ intentional savings as well as dollars left over in what functions as a state’s main checking account—the general fund. Rainy day funds accounted for more than 66 cents of every dollar in total balances at the end of fiscal 2019, compared with 45 cents just before the recession.
Just as they did after the 2001 recession, policymakers in many states have used the current economic expansion to replenish and enlarge their rainy day funds to prepare for the next inevitable downturn. But until recently, slow state tax revenue growth had forced policymakers to make hard choices between replenishing savings or using any extra tax dollars to catch up on investments and spending that had been cut or deferred during 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. As a result, determining the optimal size of a state’s dedicated savings—by studying the volatility of its tax revenue and how an economic downturn would affect its budget—is increasingly on policymakers’ minds.
States’ results for fiscal 2019 show:
States held a record $113.2 billion in total balances at the end of fiscal 2019, driving up the median number of days that they potentially could run government operations using this fiscal cushion to 48.1, or 13.2 percent of spending—at least a 20-year high. That is nearly seven days more—and 1.8 percentage points higher—than total balances held just before the downturn.
For the first time, a majority of states—at least 28—had enough in total balances to cover a greater share of government spending than they could heading into the 2007-09 recession.
Total balances were higher not only because states added to their rainy day funds but also because many had unanticipated surpluses that swelled leftover funds known as ending budget balances to their largest dollar amounts since fiscal 2007. For much of the past decade, slow tax revenue growth and tight budgets meant fewer dollars left over in ending balances. But tax revenue surged in fiscal 2018 and 2019, fueled by federal and state policy actions, favorable economic conditions, and robust stock market returns.
Ending balances vary from year to year, 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. Looking ahead, enacted budgets for fiscal 2020 show that 31 states anticipated lower total balances relative to operating costs than in fiscal 2019, according to data reported by NASBO. Those data, however, are based on amounts appropriated in state budgets and routinely change significantly by the close of the fiscal year.
States’ results for fiscal 2019 show:
States use reserves and balances to manage budgetary uncertainty, including revenue forecasting errors, budget gaps 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 upgraded Connecticut’s credit outlook in March 2019 from stable to positive. In its rationale for the outlook change, the ratings agency noted the improved reserve size as a key factor.
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, the scope of each state’s general fund expenditures can differ, so comparisons across states should be made with caution. For example, some states—such as Michigan—spend considerable amounts outside of their general fund, and Ohio is unusual because it includes spending from federal Medicaid funds. 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 the scenario is highly unlikely.