Proven Practices Can Help States Better Manage Their Budgets

In Colorado, as in many states, the abrupt onset of the COVID-19 pandemic in early 2020 and the ensuing recession presented significant, urgent budgetary challenges. Although the immediate fiscal crisis has abated thanks to a recovering economy and federal relief funding, states continue to face uncertainty related to the pandemic and long-term concerns, such as rising health care costs, unfunded liabilities, and aging populations.

Throughout 2021, experts from The Pew Charitable Trusts sent four memos to Colorado’s Office of State Planning and Budgeting that describe effective analytic tools and strategies to guide budget decisions. This guidance is broadly applicable and can help state leaders nationwide make informed budget decisions to better prepare for both short-term and long-term budgetary challenges. The topics include:

• Estimating revenue volatility to set savings targets. Rainy day funds are states’ best line of defense against budget shortfalls caused by economic downturns and other temporary events—but only if states have saved enough. This memo outlines a key first step that policymakers should take to determine how much money to save in reserves.
• Setting principles for allocating federal relief funding. The American Rescue Plan Act (ARPA) approved by Congress in March provides states with $195 billion in flexible funding. Although the relief is welcome, states face the risk that additional spending will rise to levels that could prove impossible to sustain. To avoid that outcome, this memo recommends that states balance one-time and ongoing spending commitments. It also identifies ways that states can take advantage of the temporary surpluses afforded by ARPA to improve their long-term fiscal positions, including rebuilding reserves and unwinding temporary budget balancing maneuvers, such as borrowing.
• Developing and using budget stress tests. Budget stress tests, which forecast how budget conditions would change under multiple scenarios, are a proven tool to help state policymakers identify how much risk they may face from adverse events, such as economic downturns. This memo describes methodologies for budget stress testing and how leaders can use the analyses to inform policy decisions.
• Crafting strategies to implement budget projections and contingency plans. By forecasting revenue and spending multiple years into the future, states can determine whether they can afford new investments or if they need to scale back. By developing budget contingency plans, policymakers can be prepared to close midyear budget gaps. This memo discusses key considerations for implementing these two proven fiscal tools.

Although these memos were drafted for Colorado, policymakers in other states could find them useful as they navigate this new budget landscape, allocate available ARPA dollars, and prepare for their futures.

Jeff Chapman is a director, and Sheanna Gomes and Jen Janson are senior associates with The Pew Charitable Trusts’ state fiscal health project.