The unprecedented revenue wave that states experienced from mid-2020 to the end of 2022—attributed to multiple factors, including the influx of federal funds to confront the COVID-19 pandemic—enabled policymakers to make massive deposits into their rainy day funds. Several states filled these reserve accounts to their legal limits. And when that happens, the extra money that would have gone toward savings can become available for other purposes.
But, because they are nonrecurring, allocating these funds requires careful decision-making to mitigate fiscal risks. States should use these one-time funds for one-time commitments to avoid creating long-term obligations that they may not be able to afford once the money is exhausted.
According to The Pew Charitable Trusts’ review of state laws, several states adhere to this principle, committing rainy day fund surplus dollars to one-time, nonrecurring expenses or temporary tax relief. This can include capital projects, new permanent endowment funds, one-time tax relief, or paying down unfunded liabilities such as debt or public employee pensions.
State legislative proposals for 2025 also mirror these types of one-off uses. For example, New York lawmakers introduced a bill to allocate the surplus from the state’s Rainy Day Reserve Fund to the Retiree Health Benefits Trust Fund. In Oklahoma, proposed legislation would, among other things, establish a Budget Stabilization Fund with a cap of 15%. Funds above this threshold would be directed to taxpayer relief. Mississippi lawmakers, meanwhile, proposed a measure to dedicate surplus rainy day fund money to capital projects.
Pew researchers found that about 40 states and Washington, D.C., have caps on their rainy day funds with rules that require deposits under specified conditions.
According to the analysis, when rainy day funds reach their legal limit, 20 states keep the excess required deposits in the general fund; 15 states and D.C., direct the excess dollars to specific purposes; and the remaining states lack specific guidelines for handling these funds. Six of the states that dedicate excess reserve dollars to specific purposes use them to provide limited tax relief to residents, while the other nine states and D.C., use the money for nonrecurring spending.
Returning excess reserves to taxpayers can provide tax relief without creating structural imbalances. Ohio law calls for the rainy day fund surplus to be used to offer expanded sales tax holidays. The state provides residents an annual sales tax holiday on certain goods for three days in August to help families during back-to-school shopping season. When there are surplus dollars from the rainy day fund, such as in 2024, the state expands the sales tax holiday by the number of days and sometimes the items that are covered. On the other hand, under its state law, Iowa transfers surplus money to the taxpayer relief fund, which may be used for permanent tax cuts. That approach, however, can raise the possibility of structural problems down the road.
To provide tax relief using excess reserve dollars in Massachusetts, the state comptroller temporarily increases the income tax personal exemption for the next year. Taxpayers have received tax relief through this mechanism three times since the rainy day fund was created in 1986. Tax relief works best in these contexts when the initiatives are nonrecurring and limited to no more than the excess amount collected.
Finally, nine states and D.C. use these excess funds for nonrecurring spending, such as infrastructure maintenance or paying down debt. These approaches offer examples of how states can use temporary surplus funds to invest in long-term needs, while avoiding the creation of ongoing commitments.
Table 1
When rainy day funds are full, some states and Washington D.C. use excess to reduce taxes or pay for one-time costs
| State | Where are excess reserve funds directed? |
|---|---|
| California | Infrastructure (including deferred maintenance). |
| Connecticut | State Employees Retirement Fund and Teachers’ Retirement Fund. |
| District of Columbia | Housing Production Trust Fund and the General Capital Improvements Fund. |
| Florida | Tax relief: Surplus funds are “refunded to taxpayers as provided by general law.” |
| Iowa | Tax relief: A portion of the surplus is directed to the Taxpayer Relief Fund where it’s used for what can potentially be permanent tax relief. The remainder is directed to the General Fund. |
| Maine | Highway and Bridge Capital program, School Revolving Renovation Fund, and irrevocable trust funds for other postemployment benefits. |
| Massachusetts | Tax relief: Surplus funds are transferred to the tax reduction fund and then returned to taxpayers by temporarily increasing the personal exemption allowed on income tax. |
| Michigan | Tax relief through rebates to taxpayers on individual income tax returns filed for that fiscal year. |
| Montana | First to the Capital Developments Long-Range Building Program Account until it reaches 12% of all general revenue appropriations, then 75% of the remaining surplus goes to the Pension State Special Revenue Account and 25% stays in the General Fund. |
| New Mexico | Early Childhood Education and Care Fund and the Severance Tax Permanent Fund. |
| New York—Tax Stabilization Reserve | Tax relief: “Surplus moneys, ... shall be retained in such fund and be available for the reduction of state taxes.” |
| North Carolina | Any excess is transferred to the Unfunded Liability Solvency Reserve. |
| Ohio | Tax relief through expanded sales tax holidays. |
| Rhode Island | Rhode Island Capital Plan Fund. |
| Vermont—Rainy Day Reserve | 25% of excess funds goes to Vermont State Retirement Fund, 25% to the Postretirement Adjustment Allowance Account, and the remainder to the Transportation Fund Balance Reserve. |
| Washington | Education Construction Fund. |
Notes: The following states leave excess rainy day funds in the general fund: Arizona, Georgia, Hawaii, Idaho, Indiana, Kentucky, Louisiana, Maryland, Mississippi, Missouri, New Hampshire, New Jersey, New York—Rainy Day Reserve, North Dakota, Oregon, Texas, Utah, Vermont—Stabilization Reserve, Virginia, and Wisconsin. For the remaining states, Pew did not find any laws providing direction for handling excess rainy day funds. Researchers emailed the treasurers’ offices in these states to verify this finding, but not all offices responded. Percentage allocations are included when part of state law.
Source: Review of state statutes by staff of The Pew Charitable Trusts.
When California’s rainy day fund reaches its cap, any money that would have gone toward savings is instead used to support infrastructure costs or deferred maintenance. California voters enacted this spillover policy as part of Proposition 2, a 2014 ballot referendum that made sweeping changes to the state’s rainy day fund practices and debt repayment laws. Before this constitutional change, policymakers could use excess reserve funds for any public need.
Similar to California, Rhode Island and Maine have policies requiring that policymakers use excess funds for capital projects. In Rhode Island, where the rainy day fund cap is just 5% of general fund revenues, instances of spillover are common. For fiscal years 2019, 2020, 2022, and 2023, the state met its rainy day fund cap and allocated the excess reserve dollars to its Capital Plan Fund to support infrastructure projects. For that time period, the state transferred more than $500 million in total. These types of investments can help leaders chip away at the infrastructure investment gap. That’s the degree to which governments have fallen short of funding needs in deferred maintenance, modernization, and climate-change adaptation.
Infrastructure, however, is not the only option. For example, Connecticut uses excess reserve funds to pay down unfunded pension liabilities and debt. In New Mexico, which has had a rainy day fund cap since 2020, excess is transferred to the state’s Early Childhood Education and Care Fund. This has helped New Mexico add $2.8 billion to the fund across fiscal years 2021, 2022, and 2023. The state invests the endowment—turning one-time money into an ongoing source of revenue—and uses the earnings to pay for New Mexico’s cost-free child care program.
Preparing for extraordinary revenues can help ensure that funds are allocated thoughtfully. When crafting guidelines for the use of these resources, lawmakers should keep in mind principles congruent with sustainable fiscal management. For example, they should:
By planning ahead, policymakers can evaluate priorities and build consensus on how to strategically use excess reserve dollars to help meet evolving needs and achieve long-term priorities.
Sariah Toze works on The Pew Charitable Trusts’ state fiscal policy project.