NCPA - National Center for Policy Analysis

State Tax Trend No. 8: Insufficient Rainy Day Funds

June 20, 2012

Most states have created budget stabilization, or "rainy day," funds to draw upon when economic conditions create a severe or sudden drop in tax revenues.  However, these cash reserves were for the most part inadequate in coping with the recent economic downturn, says Joseph Henchman, an attorney and policy analyst at the Tax Foundation.

Generally, states are required by their constitutions or by statute to contribute to their rainy day funds according to a formula or rule up to a preset limit or cap.  At a minimum, most are required to deposit some portion of year-end surpluses into their rainy day funds during good years.  Each state has its own methods and scale of savings.

  • Idaho must deposit any revenue in excess of 4 percent growth over the previous year's revenues, up to 1 percent of revenues.
  • Louisiana must deposit 25 percent of any non-recurring revenue, plus all surpluses in excess of $750 million.
  • Utah must dedicate 25 percent of year-end surpluses to the fund.
  • Virginia's deposits are based on a formula related to the growth in tax revenues over several years.
  • Washington must contribute 1 percent of state general fund revenues to the fund each year until the fund reaches a level of 10 percent of general revenues.

As a consequence of these varying systems for contributing to rainy day funds, states' preparedness for weathering the recession also varied dramatically.

  • Wagner & Elder found that the typical state can expect a revenue shortfall equal to 13 to 18 percent of revenue during a normal downturn.
  • Yet in 2006, the peak year for state rainy day funds between 2001 and 2012, only Alaska and Wyoming had accumulated at least 13 percent of their annual general fund spending level in reserve funds.
  • Aside from those two states, and North Dakota and Oklahoma, all states had accumulated less than 10 percent of their annual general fund spending amount in a reserve fund.

As a consequence of this inadequate saving behavior, many states are having more trouble balancing government budgets than they otherwise might.  Only Alaska and Texas have sizable rainy day fund amounts remaining while the fragile economic recovery persists.  This suggests that most states would do well to increase rainy day fund contributions in the future.

Source: Joseph Henchman, "Trend #8: Insufficient Rainy Day Funds," Tax Foundation, June 5, 2012.

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