Forty-eight states have a budget stabilization fund, commonly known as a rainy day fund, to set aside money in good times so that it’s available in the bad. Despite the widespread use of these funds, the policies that guide deposits, withdrawals, and a fund’s size vary greatly. Since 2014, Pew has released three reports—“Building State Rainy Day Funds” (2014), “Why States Save” (2015), and “When to Use State Rainy Day Funds” (2017)—that provide evidence-based best practices for those policies.
Deposit rules tied to volatility allow states to save more in high-growth years when funds are available, and to set aside less in leaner years. Withdrawal conditions that are tied to economic or revenue fluctuations give policymakers a clear signal on whether the time is right to use reserves. And regular analyses of revenue volatility can be used to determine the maximum size of a rainy day fund. Since the Great Recession, when states found that their rainy day funds and other reserves were insufficient given the scale of the downturn, many have moved to embrace these best practices.
During the 2017 legislative session alone, six states—Hawaii, Maryland, Montana, New Mexico, North Carolina, and North Dakota—made significant rainy day fund reforms aligned with these best practices.
In 2015, only four states—Colorado, Illinois, Kansas, and Montana—lacked a rainy day fund. These funds are distinct entities, often guided by rules governing deposits and withdrawals, as opposed to general fund reserves that are kept with an unassigned ending balance. Kansas created a rainy day fund a year later, and Montana followed suit in 2017.
Rainy day funds are most effective when they help smooth swings in revenue, capturing a share of rising revenue during times of growth that can be used to help shore up state budgets during times of fiscal stress. States can most effectively build their rainy day funds during growth periods by ensuring that extraordinary revenue is transferred to the rainy day fund.
When “Building State Rainy Day Funds” was published, 12 states had policies linking their rainy day fund deposits to observed revenue volatility. Since then, eight more states have adopted this practice. Before this year, three states linked their rainy day funds to volatility: California in 2014, Connecticut in 2015, and Oklahoma in 2016. During the 2017 legislative sessions, five states joined them:
Rainy day funds are best used for bolstering state budgets during cyclical downturns or other unexpected revenue shocks. Using balances in a rainy day fund during a period of economic growth—such as withdrawing money to help alleviate a structural imbalance—can result in fund overuse, leaving little or no money available during a downturn or emergency.
States therefore benefit by placing some conditions on rainy day fund use. These withdrawal conditions, ideally based on measures of economic or revenue volatility, can ensure that balances are available when they are most needed while discouraging rainy day fund use during a growth period.
During 2017, Hawaii, North Carolina, and North Dakota all put in place new withdrawal conditions tied to fiscal triggers:
States have often struggled to determine adequate savings targets for their rainy day funds. During the Great Recession, many found their balances were insufficient to cover the shortfalls that emerged. Since then, several states have increased their rainy day fund caps or savings targets. As Pew wrote in a 2015 report “Why States Save,” however, these savings targets are most effective if they are based on a rigorous evaluation of a state’s fiscal position, and if they tie rainy day fund use to clear, measurable objectives.
The 2017 legislative sessions saw two states – Montana and North Carolina—link rainy day fund or reserve targets to an evidence-based analysis.