Before the COVID-19 crisis, state rainy day funds and total balances were at an all-time high, after a decade of rebuilding reserves following the Great Recession. In spring 2020, when the pandemic first hit, this financial cushion softened the immediate blow for states facing revenue shortfalls and helped them to close budget deficits by the end of the fiscal year – something most states are required by law to do. At the same time, as state revenue projections were plummeting further, concerns grew that states might end up depleting the rainy day funds they had worked so hard to build in recent years.
As it turns out, these concerns did not come to pass, mainly because state revenues later performed considerably better than was expected early in the pandemic. This was driven by an influx of federal funds, higher-income workers being relatively insulated from the effects of the COVID-19 recession, the shifting of consumption from services to goods (more commonly taxed at the state level), and the expanded ability to tax online sales following the South Dakota v. Wayfair Supreme Court decision.
Now, nearly two years after the initial onset of the pandemic, state rainy day fund balances have reached new record levels. This is largely due to revenues exceeding lowered budget forecasts in the vast majority of states and increased federal aid, which led to substantial budget surpluses in some cases that were at least partly deposited into rainy day funds. However, it also has a lot to do with deliberate steps that states took in the years leading up to the pandemic to strengthen their reserves, informed by lessons learned from the Great Recession.
This blog examines current trends in state rainy day fund balances while also putting those trends into context by exploring historical data dating back to 2000. The full historical dataset on state rainy day fund balances from NASBO’s Fiscal Survey of States is also now available for download on NASBO’s website.
A Brief History of State Rainy Day Funds
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 events triggering a shortfall, if the specific restrictions on the use of the fund(s) are met. These funds play an important role in mitigating service disruptions when revenues come in below expectations and/or in helping states respond to unforeseen circumstances. They are one of many “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, particularly when that shortfall is understood to be ongoing.
Many states first established a rainy day fund in the early 1980s after wrestling with the budgetary challenges of successive recessions between 1980 and the end of 1982. NASBO began reporting state-by-state data on rainy day fund or budget stabilization fund balances in the Fall 1985 Fiscal Survey of States. By fiscal 1988, roughly half of states reported having a positive balance in a rainy day fund, while the remaining states either had a zero balance or had no such fund established. In NASBO’s 1987 edition of Budget Processes in the States, 35 states reported having some type of budget stabilization fund established.
Heading into fiscal 2000, the starting point for the data analysis in this blog, the number of states with at least one rainy day fund rose to 45, based on data reported in the 1999 edition of Budget Processes in the States. More than two decades later, the 2021 edition of that same publication for the first time reported that all 50 states had at least one rainy day fund established. The policies and restrictions that govern these funds vary considerably by state, as discussed more here.
Total Rainy Day Fund Balance Trends
As one would expect based on the intended purpose of rainy day funds, balance levels have fluctuated over time, rising during “good years” when the economy was strong and state revenue growth was robust, and falling during “bad years” – recessionary periods and their aftermath. It is worth noting here that in a typical recession, the effects on state budgets typically lag a downturn in economic activity; for example, while the Great Recession started in December 2007 – the middle of fiscal 2008 for states – the most severe impacts on general fund budgets were felt in fiscal 2009 and fiscal 2010 for most states.
Figure 1 below shows the rise and fall of rainy day fund balances in the aggregate, which roughly correspond with recessionary periods. However, looking only at aggregate rainy day fund levels over time can obscure state-by-state variations in reserve use during recessionary periods and gains during economic booms. For example, we observe only a modest dip in total rainy day fund balances during the Great Recession and its aftermath, whereas a number of states tapped these reserve funds to help cope with budget shortfalls during that time period. In fact, according to NASBO historical data, at least 18 states drained or nearly drained their entire rainy day funds between fiscal 2008 and fiscal 2011.