The Draining of State Rainy Day Funds

In July 2019, at the beginning of fiscal year 2020, state rainy day funds were at their highest levels in decades, with many government leaders planning to make additional deposits.

But then, states were hit with a monsoon, in the form of the coronavirus. The pandemic will “cost states from at least $125 billion to $200 billion in lost revenue through fiscal 2021—and more if there is a second wave of coronavirus shutdowns,” according to a just-released report by the Pew Charitable Trusts, the source of the most current rainy day fund figures available.  

As of October 2020, at least 17 states took steps toward making rainy day fund withdrawals. And more will come in fiscal year 2021, reports Pew.

It’s for times like this that the rainy-day funds were established in the first place. In fact, according to a 2019 Volcker Alliance report, which we wrote, all but a handful of states have policies permitting them to make rainy day fund withdrawals in times of revenue shortfalls, below-trend revenue growth or an economic downturn. The remaining few simply don’t have policies elaborating on conditions necessary for reserve withdrawals.

Some details from Pew:

• As of June 30, when most states ended fiscal year 2020, at least 10 states tapped rainy-day funds to fill in budget holes. These include Alaska, Delaware, Maryland, Michigan, Mississippi, Nevada, New Jersey, New Mexico, Oklahoma, and Rhode Island.
• Both Alaska and Rhode Island used about half of their funds.
• Some states had so little money in their rainy day funds that, even if they were entirely drained, there wouldn’t be enough cash to help the states through a fine mist, much less a rainy day. Kansas, for example, established a rainy day fund in 2016, but has yet to fund it at all. Illinois is only a little better off. Its rainy day fund could only last the state a tenth of a day, were it the only source available to keep the state afloat. At the other end of the spectrum, Wyoming’s fund could keep the state going for 352 days.

One generally agreed-upon guideline for the use of rainy-day funds is that the money be withdrawn in increments, and not be used up at once, so there will continue to be a buffer in the next fiscal year. “When you use rainy day fund money, you lose the option to use it again,” says Tracy Gordon, senior fellow at the Urban-Brookings Tax Policy Center.

In fact, some states like Missouri and Virginia have policies prohibiting the withdrawal of more than half a rainy day fund in a single fiscal year, says Kathryn White, director of budget process studies at the National Association of State Budget Officers.

This is particularly critical right now, as economists are predicting that fiscal year 2021 will present even more need for reserves than 2020. This is because there is simply a lag in the tax revenue shortfalls that states experience. For state budgets, the high unemployment and lower consumer spending they are seeing right now are expected to result in tax revenue shortfalls in fiscal 2021 and beyond, according to the National Association of State Budget Officers

But restraining the use of rainy day funds may not always be a primary concern in some states. Take Nevada, which sucked its entire $401 million rainy day fund dry in mid-May, a decision made by an interim legislative finance committee at a time when the state’s legislature was not in session.  The decision was made on a party-line vote, with Democratic lawmakers and Gov. Steve Sisolak, also a Democrat, favoring this move.

Why didn’t Nevada keep any money in the rainy day fund? With the June 30th end of the fiscal year  approaching, new devastating fiscal calculations emerged that showed the state faced a gap of about $800 million in the fiscal year 2020 budget, according to Meredith Levine, director of economic policy at Nevada’s Guinn Center. This shortfall was largely attributable to the devastating impact of the coronavirus pandemic on hotel and gaming taxes. The rainy day fund, Democratic legislators believed, was the most sensible way to help fill the gap.

California, meanwhile, has dipped into its rainy day fund to the tune of $9.6 billion, about half of its total reserves, in the course of dealing with coronavirus expenditures in 2020 and to reduce shortfalls for the state’s 2021 budget. “Without the rainy day fund there would have been massive cuts,” says Chris Hoene, executive director of the California Budget and Policy Center.

At the same time, California’s Governor Gavin Newsom is sufficiently realistic to note that the worst may be yet to come, and so “that reserve will not exist after three years, without significant economic stimulus and support from the federal government.”

One of the great advantages to using rainy day fund dollars—even when there may be available cuts in the budget—is that it gives the executive and legislative branches time to think carefully through the best ways to move forward. The most expedient way to make cuts is to do so across-the-board, but that’s inefficient and lacks the kind of analysis that can help find cuts that will do the least damage.

“It buys you time,” says Don Boyd, principal of Boyd Research.

Boyd, who is also co-director of the State and Local Government Finance Project at the Center for Policy Research at the University of Albany, SUNY, also notes one political reason states may actually benefit from using up their emergency reserve funds.  “If their rainy-day fund is gone, that puts them in a better political position to get money from the federal government,” he says.