State Year-End Balances
Legisbrief vol. 15, no. 15, March 2007
Corina Eckl
Looking at general fund year-end balances is one of the most common ways to assess state fiscal conditions. When shown as a percentage of general fund spending, these balances show the magnitude of state reserves and allow meaningful comparisons across states. Large year-end balances tend to indicate strong or stable fiscal conditions, while small ones can be a cause for concern, depending upon a state's specific circumstances. Whether the balance is rising or falling from prior year levels also is important in gauging state fiscal health.
State year-end balances have two components: unobligated ending balances (revenues in excess of expenditures) and rainy day fund amounts. Forty-four states have rainy day funds, also called budget stabilization accounts. Because these funds represent additional resources available to states, they typically are added to unobligated year-end balances to show the total reserves states have available. In some cases, however, these funds are subject to restrictive withdrawal provisions that limit their use.
The Importance of Maintaining Reserves. Although practices vary, most states attempt to end the fiscal year or biennium with a reserve to hedge against errors in revenue or expenditure estimates and to manage cash flow. Lawmakers also recognize the prudence of setting funds aside because it is difficult to accurately predict future economic trends, which directly affect revenue and expenditure growth.
A state's concern about prudent financial management, however, is not the only reason to maintain a reserve. Bond rating analysts consider state reserves as one component of a state's credit review when assigning bond ratings, and higher ratings tend to reduce state borrowing costs. In the early 1980s, rating agencies recommended that states hold reserves of 5 percent. More recently, some ratings analysts have recommended a reserve in the range of 3 percent to 5 percent, depending upon individual state circumstances such as the volatility of the state's revenue stream or the availability of other funds to augment the general fund.
State Year-End Balances as a Percentage of General Fund Expenditures, FY 1981 to FY 2007 (projected)
Recent Trends. The most important external factor affecting state finances--and, consequently, year-end balances--is the national economy. As the figure shows, the lowest state balances during the last 25 years coincided with national economic downturns. During the recession in the early 1980s, state balances fell to 1.5 percent. They fell even further, to 0.7 percent, during the early 1990s recession. Balances fell again during the last downturn, but not to the dangerously low levels experienced one and two decades earlier.
As the national economy recovers, state finances typically improve and year-end balances tend to rise. One of the largest gains in recent history occurred after the early 1990s recession. Aggregate year-end balances rose for eight consecutive years, peaking at 10.4 percent, before declining with the onset of the recession in 2001.
Because year-end balances are considered one of the best indicators of state fiscal health, recent growth in balances demonstrates an important turnaround in state budget conditions. At the end of fiscal year (FY) 2006, the aggregate state year-end balance reached 9.9 percent. Healthy budget conditions were widespread, with 39 states reporting balances above 5 percent.
State Year-End Balances as a Percentageof General Fund Expenditures, FY 2006
Based on FY 2007 forecasts of revenues and expenditures, the aggregate state year-end balance is projected to fall to 6.5 percent by the end of the current fiscal year as states dip into reserves to restore previously enacted funding cuts or bolster state programs and services--education, health care and public safety chief among them. Numerous other fiscal challenges, such as unfunded pension liabilities and costs for public employee retiree health care, are looming and carry sizeable price tags. Lawmakers also are concerned about federal-to-state cost shifts that could derail balanced state budgets. Although state revenue performance appears solid at present, the combination of these numerous pressures could overwhelm state budgets and demand large spending increases. As a result, year-end balances are expected to decline over time as expenditure growth outpaces expected revenue growth.
Selected References
National Conference of State Legislatures. State Budget Actions. Denver, Colo.: NCSL, various years.
National Conference of State Legislatures. State Budget Update: November 2006. Denver, Colo.: NCSL, December 2006.
Published March 2007; posted June 2007. This document is available to constituents in pdf.
Email statefiscal-info@ncsl.org for more information.
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