Experts Debate How Much States Should Put In Rainy Day Funds

Experts Debate How Much States Should Put In Rainy Day Funds

Experts on state "rainy day" funds, sometimes called budget stabilization accounts, disagree over what percentage of a state's general fund expenditures should be socked away to provide an effective cushion against an economic downturn.

Estimates range from 5 percent to 18 percent, with most states being a lot closer to the former percentage. The 46 states with rainy day funds salted away $18.7 billion in fiscal 1999, which was 4.3 percent of their general fund expenditures, according to the National Conference of State Legislatures.

"I would say that given what states have on hand now, if we have another recession of about the same length and severity that we had in the early 90s, we would have another fiscal crisis," says Iris Lave, deputy director of the Center on Budget and Policy Priorities.

From 1991 through 1992, "poor and low-income people bore the brunt of the distress states were feeling, that's why we're concerned about this," says Lave, who's a fan of 18 percent fund balances. During the last economic downturn, welfare benefits were frozen or reduced in 40 states in 1992, and 44 in 1993, she said.

Oregon is one of four states that lacks a rainy day fund, along with Arkansas, Montana and Illinois. Hawaii was a member of that club until last year.

Lave says fast-growing states such as Texas, Tennessee and Oregon have to remain especially vigilant about their ability to survive a downturn.

Texas had a $80.2 million FY 1999 rainy day fund, equivalent to 0.3 percent of its general fund expenditures. Tennessee, where Gov. Don Sundquist earlier this week proposed a 3.75 percent flat-rate income tax, stashed away $61.4 million (2 percent).

From a percentage standpoint, the King Kong of rainy day funds is held by Alaska, whose $2.8 billion account is 117.4 percent of the its fiscal year 1999 general fund expenditures. There's a reason for that impressive anomaly: Alaska crafted its impressive cushion in the early 1990s with settlement monies derived from oil companies after a dispute over oil royalties, the NCSL's Arturo Perez says.

Gloria Timmer, executive director of the National Association of State Budget Officers, says she regularly strove for 10 percent and 11 percent balances when she was Kansas' budget director.

While the majority of states "are in okay shape" to handle a downturn, Timmer tosses in a proviso. "They have to continue to be careful," she says. "States don't have to look back that many years to remember when balances went from something in the range of 5 percent down to 1 or 2 percent.

Establishing and managing a rainy day fund is a "Catch 22" for bureaucrats and lawmakers. Whether a state's economy is robust or flat, taxpayers want their taxes going to services, not being stockpiled. Politicians are aware of this, meaning that percentage rates in the teens are probably the upper limit for rainy days funds supported by taxes.

Rainy day funds could just as easily be called `rainy month' funds, because they're usually designed to get states through a few months of severe economic difficulty at best, says Steven Murphy, a managing director with Standard & Poors' Corp. who favors accounts containing at least 5 percent of general fund expenditures or better.

"What a rainy day fund really does is buy you time" when shortfalls occur, Murphy says. "It gives you time to get the legislature together and to talk about what programs can be cut, what expenses can be adjusted, or if a tax increase is necessary. These are not just one-person decisions in the political system that we live in."

Washington's legislature requires a two-thirds majority before the state's rainy day fund can be tapped. Texas also has a two-thirds requirement, while three-fifths of Delaware's state lawmakers have to agree before their stabilization fund can be touched.

Washington closed out FY 1999 with $964 million (9.8 percent) in rainy day funds. Delaware had $114.1 million (5.3 percent).

A handful of states manage their rainy days funds in exemplary fashion, says Hyman C. Grossman, another Standard & Poor's managing director.

"Florida ($847 million, 4.6 percent) lately is doing pretty well," Grossman says. "Delaware has nearly $120 million and has augmented their situation very well. Maryland ($635.8 million, 7.5 percent) and New Jersey ($608.1 million, 3.3 percent) closed the year with good cushions to go into the next year."

The only state with a double-digit percentage of its general fund expenditures saved at the end of fiscal 1999 was Michigan, whose $1.03 billion rainy day fund equaled 11.1 percent.

A state living somewhat on the edge, in Grossman's estimation, is West Virginia ($67. 6 million, 2.6 percent).

Although the nation's economy is still hot, states are expected to have less at the end of this fiscal year than the $35 billion they had at the end of FY 1999, slightly more than half of which went into rainy day funds. The surplus is expected to drop to $27 billion at the end of fiscal 2000 due to tax cuts, spending increases - especially in the area of healthcare -- and softening economies in a handful of states.

That should be offset somewhat by the first round of tobacco settlement payments being doled out to states this year.

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