State and Local Tax Policy: What are rainy day funds and how do they work?
Budget stabilization or "rainy day" funds allow states to set aside excess revenue for use in times of unexpected revenue shortfall or budget deficit. In fiscal 2008, forty-seven states and the District of Columbia maintained rainy day funds. Only Arkansas, Kansas, and Montana lacked such funds. At the end of fiscal 2008, state rainy day funds (excluding that of the District of Columbia) totaled $35.0 billion, or 5.1 percent of the combined general fund expenditures. In addition, during times of economic expansion, when actual revenues exceeds projected revenues, states accumulate reserves in their general fund balances, which can then act as de facto rainy day funds in later years.
- Rainy day fund balances in 2008 varied significantly across states, from zero in California and Wisconsin and less than 1 percent of annual expenditures in Michigan to 17 percent in Nebraska and nearly 150 percent in Alaska (figure 1). Twenty-two states had rainy day fund balances greater than 5 percent of annual expenditures, and funds in eight states exceeded 10 percent.
- States typically transfer resources to rainy day funds through line-item budget appropriations or by designating portions of budget surpluses. Some states make deposits from specific revenue sources, such as mineral revenues in Alaska and Louisiana and oil and natural gas revenues in Texas. Forty of the states with rainy day funds cap their funds at levels that range from 2 to 15 percent of revenues or expenditures.
- States most often use their rainy day funds in times of budget deficit-every state except Vermont has some sort of requirement to balance its budget each year. Some states allow withdrawals for any purpose deemed appropriate by the governor or the state legislature, whereas others allow withdrawals only if the deficit is due to a revenue shortfall, and others only if it is caused by unexpected expenditures. Still others permit fund withdrawals to address a natural disaster or other declared emergency. Colorado’s Taxpayer Bill of Rights (TABOR) mandates an emergency fund (instead of a rainy day fund) that does not allow withdrawals in response to economic conditions, revenue shortfalls, or government salary increases; the fund may only offset shortfalls caused by natural disasters. Sixteen states require a supermajority vote of the legislature in order to transfer money out of the rainy day fund.
- An economic downturn can cause significant fiscal stress for states, because given no changes in policy, revenues will decline as expenditure needs increase to meet greater demands for programs such as unemployment insurance and Medicaid. Savings in a rainy day fund may help states weather a fiscal downturn with fewer expenditure cuts. Analysis of state spending during the 2001 recession suggests that state savings in rainy day funds or end-of-year general fund balances at the start of the recession allowed states (in the aggregate) to maintain relatively constant spending even as revenues declined.
- Rainy day fund savings peaked at the start of the 2001 recession, totaling 6.0 percent of aggregate state expenditures at the end of fiscal 2000, before declining to 1.4 percent of expenditures in 2002 (figure 2). Thereafter fund balances climbed to 5.2 percent of expenditures in 2006. Fund balances totaled 5.1 percent of expenditures at the end of fiscal 2008.