State Budget Stabilization Funds

Spring 2008 - Revised September 26, 2008
Daniel G. Thatcher

To mitigate the impact of economic fluctuations on state revenues, 47 states, the District of Columbia, Puerto Rico and the U.S Virgins Islands have established budget stabilization funds, commonly referred to as rainy day funds. States without budget stabilization funds are Arkansas, Kansas, and Montana. Reflecting each state’s unique constitutional and statutory history and tax structure, budget stabilization funds differ in design and purpose from state to state, but their underlying function funnels down to a common denominator: when capacity to generate revenue is strong, the state saves all or some of the surplus in a permanent fund for use when revenue generation is weak (thus the term "rainy day fund"). Over time states have expanded the rationale for a stabilization fund to encompass other budgetary concerns.

For the purposes of this report and its companion appendix (see Appendix A for comprehensive details on each state's budget stabilization fund(s)), any state fund that shared all of the following four elements was included in the analysis: 1) the fund is housed at and administered on the state level; 2) the fund is intended primarily for state -- not local -- use; 3) the fund is intended for general -- as opposed to department specific (e.g., department of education or criminal justice) -- use; and, 4) the fund is intended to be used as a hedge against revenue shortfalls or cash flow deficits that occur on the state level. Using these elements as a minimum threshold resulted in this report's inclusion of state funds that other observers do not consider to be traditional rainy day funds (e.g., Colorado's "Required Reserve" or Illinois's "Budget Stabilization Fund"). This report's inclusive approach is in harmony with its overall intent: to introduce the reader to the panoply of funds available that help provide stability to state budgets. This report specifically addresses six common elements that govern most budget stabilization funds:

  1. Legal authorization;
  2. Use of multiple funds;
  3. Methods for deposit;
  4. Methods for withdrawal;
  5. Repayment provisions; and
  6. Caps on the size of the funds.

Legal Authorization

State budget stabilization funds are created either through statutory or constitutional authorization. While most states' budget stabilization funds are statutorily created, 11 states (Alabama, Alaska, Delaware, Louisiana, Missouri, Oklahoma, Oregon, South Carolina, Texas, Virginia and Washington) have constitutionally authorized funds. Five states (Alabama, Alaska, California, Oregon and South Carolina) have one statutorily and one constitutionally authorized budget stabilization fund. Washington's "Rainy Day Fund" became the nation's newest fund when voters added it to the state's constitution in the 2007 general election. The measure passed with 68 percent of the vote.

Multiple Funds

At least eight states (Alabama, Alaska, California, Iowa, New York, Oregon, South Carolina and South Dakota) and the District of Columbia maintain at least two separately operating budget stabilization funds. States have often created multiple funds to house certain sources of unanticipated revenues, e.g., a one time carve-out of oil and gas royalty funds (Alabama), or money received from mineral extraction litigation and dispute settlements (Alaska).

Another reason states use more than one budget stabilization fund comes from the reliance states have on different sources of revenue, e.g., personal income, corporate income, sales, motor fuels, severance, and other taxes. Each of these revenue sources reacts differently to fluctuations in economic and business cycles. Brigham Young University professors Gary C. Cornia and Ray D. Nelson suggest that because state expenditure needs fluctuate with the same cycles, the use of multiple budget stabilization funds may more effectively address overall fluctuations in state budgets. (Cornia and Nelson, 2003).

Methods for Deposits

Most often, deposits come either from a line-item appropriation in an annual or biennial budget, or from a portion of a fiscal year-end surplus. Some states' constitutional or statutory language prescribes what percentage of the surplus must be deposited into the budget stabilization fund (e.g., Utah requires 25 percent of its general fund surplus, and in New Jersey, West Virginia and Wisconsin, that percentage is 50 percent). Washington's new budget stabilization fund will require the state to deposit 1 percent of general state revenues each fiscal year, regardless of economic conditions, into the budget stabilization fund until the balance reaches 10 percent of estimated general fund revenues. Similarly, the U.S. Virgin Islands must deposit $10 million and any fiscal year-end surplus into its fund until the balance reaches 5 percent of general fund appropriations for the fiscal year in progress.

In other states (Arizona, Idaho, Indiana, Michigan, Tennessee and Virginia), deposits are triggered when state revenues or economic growth exceed specified levels. Triggers vary in variety and complexity. In Virginia, for example, deposits are triggered when the annual increase in tax revenues exceeds 8 percent, and the six-year average increase in certified tax revenue exceeds 1.5 percent, and estimated general fund revenues for the current fiscal year exceed 5 percent of the previous fiscal year's actual general fund revenues. The amount of the deposit is then determined by a separate formula. In Idaho, by comparison, deposits are triggered when current fiscal year revenues exceed the previous year's revenues by 4 percent.

Other states may draw upon revenue sources separate from the general fund. Oregon, for example, deposits 18 percent of net proceeds from its state lottery into its budget stabilization fund. Alaska, as mentioned previously, has a budget stabilization fund that houses money it receives from mineral dispute litigation or settlement agreements. In Louisiana, deposits are made from any revenues in excess of $750 million collected from taxes on the production of (or exploration for) minerals.

Methods for Withdrawals

As their name suggests, budget stabilization funds exist to provide stability to state budgets experiencing economic fluctuations. “Revenue shortfall" or “budget deficit" still remain the most common conditions for tapping budget stabilization funds (35 states). Typically, withdrawals are made pending approval of the legislature when revenues are insufficient to meet budget obligations. In 16 states, authorization for a withdrawal only comes after a supermajority (by three-fifths, two-thirds or three-fourths) of the legislature approves the withdrawal. Alternatively, Kentucky and North Dakota give their governors authority to make transfers from their budget stabilization funds to prevent cash deficits that may occur during the fiscal year.

In some states (e.g., Connecticut, Illinois, Indiana, Michigan and Virginia), withdrawals are triggered when anticipated revenues or other economic indicators fall below specified levels. In Illinois, the state comptroller may direct the state treasurer to make a withdrawal in order to meet cash flow deficits resulting from timing variations between disbursements and the receipt of funds within a fiscal year. In Indiana, a statutory formula that determines the amount that can be withdrawn is triggered when the annual growth rate in adjusted personal income is less than negative 2 percent.

Although each state and Puerto Rico maintain “contingency" or "emergency" funds to address unanticipated expenditures related to natural disasters or public safety, some states (e.g., Hawaii, Iowa, Massachusetts, Nevada, Oklahoma, West Virginia and the District of Columbia) have expanded the conditions for which budget stabilization funds may be tapped to include similar unanticipated or nonrecurring expenditures not directly related to revenue shortfalls or budget deficits. For example, Hawaii and Massachusetts allow withdrawals to maintain levels of spending essential to the public health, safety, welfare, or education. The key distinction between "contingency" or "emergency" funds and budget stabilization funds lies in who has the authority to withdraw monies from them and under what conditions. The former category of funds generally allow an administrative authority—e.g., the governor (21 states) or state budget director (three states)—to make withdrawals. State legislatures, on the other hand, by-and-large retain withdrawing authority over the latter category of funds and may only do so subject to constitutional or statutory provisions. (Eckl and Kee, 2005).

In the event a withdrawal is made, some states place caps on the size of withdrawals made (e.g., $50 million in Iowa and Mississippi, and one-half or three-eighths of the fund's balance in Missouri and Oklahoma, respectively).

Repayment Provisions

Fifteen states, the District of Columbia and the U.S. Virgin Islands require withdrawals to be repaid to their budget stabilization funds. The terms and conditions under which withdrawals must be repaid typically contain a due date for repayment or a statutorily prescribed repayment schedule. In Iowa and Mississippi, for example, withdrawals must be repaid to their funds by the end of the fiscal year in which the withdrawals occurred. In other states (e.g., Alabama, New York, Rhode Island, South Carolina, Utah) withdrawals must be repaid within two to 10 years of the date the withdrawals occurred. Florida and Missouri law outlines specific schedules for repayment (e.g., in Florida, withdrawals must be repaid in five equal annual transfers from the general revenue fund beginning in the third fiscal year after the withdrawal was made). Minnesota allows repayments to be made only after an "upturn in the state's economy."

Fund Size

The majority of states (37) limit the sizes of their budget stabilization funds by capping the size of the funds in relation to state general fund revenues or appropriations (see Table 1.). For example, New Jersey caps its "Surplus Revenue Fund" at 5 percent of total anticipated general fund revenues, while Connecticut’s "Budget Reserve Fund" cannot exceed 10 percent of net general fund appropriations for the fiscal year in progress. Minnesota is unique in that it caps its budget reserve and cash flow accounts at specific dollar amounts ($653 million and $350 million, respectively).

Table 1. Caps on Budget Stabilization Funds as a Percent of Appropriations or Revenues

 

Appropriations

Revenues

2.0%

New York, District of Columbia

South Carolina

2.5%

 

Iowa

3.0%

New York

Rhode Island, South Carolina

4.0%

Colorado, District of Columbia

Louisiana

5.0%

North Dakota, Tennessee, Vermont, Wisconsin, U.S. Virgin Islands

California, Delaware, Idaho, Illinois, Kentucky, New York, Ohio, Oregon

6.0%

Utah, Puerto Rico

Pennsylvania

7.0%

 

Arizona, Indiana

7.5%

Mississippi

Iowa, Maryland, Missouri, Oregon

10.0%

Alabama, Connecticut, South Dakota, South Dakota, Virginia, West Virginia

Florida, Georgia, Michigan, New Hampshire, Oklahoma, Texas, Washington

12.0%

 

Maine

15.0%

Nevada

Massachusetts

No Cap

Alaska, California, Hawaii, Nebraska, New Mexico, North Carolina, Wyoming

 

Other

Minnesota (Cash Flow Account capped at $350 million, Budget Reserve Account capped at $653 million)

 

Note: A state may appear more than once because of variations between the state's multiple funds.

Budget experts and observers debate the amount states should accumulate in their budget stabilization funds. The National Conference of State Legislatures’ Fiscal Affairs and Oversight Committee (and informally used by municipal bond rating agencies) suggests that the combination of general fund surpluses and budget stabilization funds should equal at least 5 percent of total state expenditures. Other organizations, such as the Center on Budget and Policy Priorities, suggest a target fund level of at least 15 percent of expenditures. (CBPP, 2007). Suggested levels can vary according to individual state circumstances, specific economic conditions or access to atypical revenue sources, such as vast mineral resources. Professors Cornia and Nelson caution against "a one-size-fits-all [budget stabilization fund]," because of the "heterogeneity among state economic conditions and tax codes." (Cornia and Nelson, 2003). For example, states with highly elastic revenue sources, such as a progressive income tax system, might opt for larger balances because revenues from these sources tend to experience greater fluctuations during economic swings.

At the end of FY 2007, the median amount accumulated in budget stabilization funds across the nation neared 5 percent of total general fund appropriations. Alaska led the states with the highest percent accumulated, 47 percent. For a current update of state rainy day fund balances, see this table: Budget Stabilization Funds, FY 2006, FY 2007 (estimated) and FY 2008 (projected).

Conclusion

States are finding budget stabilization funds more attractive as a tool to weather tumultuous economic conditions. Over the last decade, especially since the 2001 recession, the number of budget stabilization funds across the nation has expanded along with the scope of existing funds. Since 2000, at least eleven states have raised the percentage caps on their funds, allowing for their funds to play a larger role in the event of economic instability. (At the end of FY 1996, the median amount accumulated in states' budget stabilization funds was 2.7 percent of total general fund appropriations compared to 4 percent at the end of FY 2006.) States have also expanded the allowable purposes to make withdrawals from their funds to include not only pressure placed on their budgets due to poor revenue performance, but also pressure from unanticipated state expenditures resulting from catastrophic events (e.g., September 11th or Hurricane Katrina). The public's support for budget stabilization funds appears strong, too. During the last decade when the creation of a state budget stabilization fund has been put to them, voters have overwhelming approved its creation.

References

  • Cornia, Gary C., and Ray D. Nelson. "Rainy Day Funds and Value at Risk." State Tax Notes, August 25, 2003, 563-567.
  • Eckl, Corina, and Jed Kee. "Rainy day funds (budget stabilization, budget reserve funds)." Encyclopedia of Taxation & Tax Policy, edited Joseph J. Cordes, Robert E. Ebel and Jane G. Gravelle, 327-328. Washington, D.C.: The Urban Institute Press, 2005.
  • McNichol, Elizabeth, and Brian Filipowich. Rainy Day Funds: Opportunities for Reform. Washington, D.C.: Center on Budget and Policy Priorities (CBPP), 2007.
  • National Conference of State Legislatures (NCSL). State Budget Update: November 2007. Denver: NCSL, December 2007.

Posted October 1, 2008.
E-mail statefiscal-info@ncsl.org for more information.