Budget Blog

State Budget Processes Spotlight: Rainy Day Funds

By Kathryn White posted 02-03-2022 07:43 AM

  

One area of state budget processes that has received a lot of attention in recent years, including during the COVID-19 pandemic and recession, is state rainy day funds. In the 2021 edition of Budget Processes in the States, all 50 states reported having at least one rainy day fund for the first time in history. In the years following the Great Recession, a number of states made deliberate choices to strengthen their reserves by increasing deposits and reforming the laws and policies that govern these funds. This blog looks at recent process changes states made to bolster their rainy day funds before the pandemic, as reported in NASBO’s most recent Budget Processes report. A subsequent blog post will examine recent fiscal trends in state rainy day fund balance levels, based on data reported in NASBO’s Fiscal Survey of States.

How Rainy Day Funds Work

Rainy day funds, also known as budget stabilization funds, serve as states’ “savings accounts” and may be used to supplement general fund spending during an economic downturn or other event triggering a shortfall, if the specific restrictions on the use of the fund(s) are met. These funds play an important role in mitigating disruptions to services when revenues come in below expectations and/or in helping states respond to other unforeseen circumstances. They are one of a number of “tools in the toolbox” of budget management strategies available to a state facing a budget gap, along with spending reductions, other fund transfers, personnel actions, revenue increases, and other actions. Rarely do states rely on rainy day funds alone to address a shortfall.

A number of states maintain multiple rainy day funds. In addition to a general reserve or budget stabilization fund, some states also have a reserve dedicated to K-12 education funding, while a few states have contingency funds set aside for Medicaid expenditures, which can be hard to predict for a given year.  A couple states also have established reserve funds specifically for higher education.

Deposit Rules. States use varying methods to fund rainy day funds and determine deposit amounts. One of the most common deposit methods is for states to direct all or a portion of an unanticipated general fund balance (or “budget surplus”) to the rainy day fund. Alternatively, many states link rainy day fund deposits to revenue collections or revenue growth – either total general fund revenue or specific revenue sources. For example, a state may deposit a set percentage of general fund revenue growth or a share of tax collections from an especially volatile revenue source to its rainy day fund. Some states that link deposits to revenue determine deposit amounts based on how much revenue exceeded the state’s official forecast. Other states rely on the appropriations process to determine deposits to the rainy day fund, in some cases requiring that the state achieve a minimum required balance as a share of general fund revenue or appropriations.

Withdrawal Rules. Procedures to expend funds also differ across states, with some requiring a majority vote and others requiring super majority votes by the legislature to access the funds. Often, funds can only be accessed under certain circumstances, such as to address a revenue shortfall, to close an end-of-year deficit, or respond to a governor-declared emergency. In a few states, the governor can tap the rainy day fund under certain conditions without full legislative approval. Some states also have established requirements for how quickly withdrawals must be repaid into the fund.

State Actions to Strengthen Rainy Day Funds
In recent years, as state budgets continued to recover from the Great Recession, states took a number of concrete steps to strengthen their rainy day funds to help prepare for the next economic downturn. Below are some examples of states that reported making changes to their existing rainy day fund structures, or created new rainy day funds, in the 2021 edition of Budget Processes in the States, compared to the 2015 edition of the report. Note this listing is meant to be illustrative but not exhaustive in terms of the changes adopted by states over this period. [i]

  • Arkansas created the Long Term Reserve Fund in 2016 to serve as a rainy day fund in the event of a “revenue shortfall”, as determined by the Governor upon recommendation by the Chief Fiscal Officer of the State.
  • California established two new rainy day funds dedicated to support certain programs if certain criteria are met: the Public School System Stabilization Account for K-14 spending and the Safety Net Reserve Fund for Medi-Cal (Medicaid) and CalWORKS (public assistance) services.
  • Connecticut began directing revenue received from certain more volatile tax sources, primarily related to capital gains, to the state’s Budget Reserve Fund, and also increased its maximum size limit from 10 percent to 15 percent of general fund appropriations.
  • Delaware created a second reserve fund, the Budget Stabilization Fund (BSF), whereby the budget director transfers any unencumbered general fund balance at the end of each fiscal year in excess of a 2-percent set-aside into the BSF. While the state’s traditional Rainy Day Fund (Budget Reserve Account) is constitutionally based and withdrawals require 3/5 majority vote, allocations from the BSF can occur through any appropriations act passed by the General Assembly.
  • Kansas created the state’s first separate rainy day fund, the Budget Stabilization Fund, in 2017. The fund is supported with a certain percentage of the amount of revenue in excess of the latest consensus revenue estimate.
  • Louisiana established a second rainy day fund, the Revenue Stabilization Fund, in 2016; the fund is supported by corporate income and franchise tax receipts above a certain threshold, as well as a certain percentage of mineral revenue once the state’s Budget Stabilization Fund reaches its maximum. In addition to being available for use in an emergency with 2/3 legislative approval, a portion of the Revenue Stabilization Fund balance can be appropriated for capital outlay projects or transportation once it reaches $5 billion.
  • Maryland modified the deposit rules for its rainy day fund, the Revenue Stabilization Account, to transfer all or a portion of above-average collections from nonwithholding income taxes (a more volatile revenue source) into the fund.
  • Montana created the state’s first rainy day fund, the Budget Stabilization Reserve, in 2017. Under statute, an allocation of general fund revenue above the official revenue estimate is directed to the fund.
  • New Mexico in 2017 reformed its General Fund Tax Stabilization Reserve to make it a true “rainy day fund,” supported with appropriations and investment income, and available for legislative appropriation after the governor declares it necessary for “public peace, health and safety.” The state has other general fund reserves as well.
  • North Carolina reformed its Savings Reserve’s structure so that it is now supported with deposits equal to 15 percent of general fund revenue growth, with a maximum size set at “an amount necessary to cover two years of need for 9 out of 10 scenarios involving a decline in general fund revenues.” Withdrawals may be authorized by a majority vote under certain circumstances below a certain threshold; a two-thirds vote is required for a withdrawal amount above that threshold.
  • North Dakota, in addition to increasing its maximum size limit, tightened its Budget Stabilization Fund withdrawal rules, requiring agency budget reductions of a certain amount before the governor may authorize a transfer from the rainy day fund.
  • South Dakota created a second rainy day fund, the General Revenue Replacement Fund, in 2015.
  • Virginia established the Revenue Reserve Fund in statute in 2018 as a secondary and more short-term cash reserve to address unanticipated revenue shortfalls.

In addition to the changes above, numerous states also made changes to increase the minimum size required and/or maximum size limit for their rainy day fund balance in recent years, with an eye towards bolstering reserves.

Outlook for Rainy Day Funds
As more and more states have refined and strengthened their rainy day funds, the regarded importance of these funds as a budget management tool has grown. The COVID-19 crisis, in the main, did not deplete or significantly reduce state rainy day fund levels as some feared would happen earlier in the crisis, due in large part to revenues exceeding lowered projections and federal COVID-19 relief aid. However, the pandemic did serve as a powerful reminder of how important it is for states to plan for uncertainty.  In governors’ budget proposals for fiscal 2023, messaging continues to emphasize how critical healthy reserves are for fiscal responsibility and sustainability.

At the same time, discussions are occurring in some states about how big is “too big” when it comes to a rainy day fund. After state revenue collections in fiscal 2021 exceeded budget forecasts in nearly all states – at times by a substantial margin – rainy day fund levels rose to historic levels in the aggregate and in numerous individual states.

A forthcoming blog post will take a closer look at and offer more discussion on recent rainy day fund balance data and trends.

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[i] For a full listing of state rainy day funds, deposit and withdrawal procedures, and other details, see NASBO, Budget Processes in the States (2021), Table 13.