Report Rainy Days Are Here: States Tap Reserve Funds to Plug Budget Holes

The COVID-19 pandemic had a big impact on state budgets. Economic shutdowns led to severe revenue reductions as commerce slowed and businesses shuttered. States also complicated matters by delaying tax filings, pushing collections from one fiscal year (FY) into another. At the same time, expenditures on unemployment, food assistance programs, health care and other pandemic needs increased. Lawmakers saw their once-rosy budget outlooks evaporate and found themselves closing unexpected budget shortfalls as they wrapped up FY 2020. Faced with an uncertain revenue outlook and anticipating more deficits going into FY 2021, policymakers created additional budget security by tapping into state reserve funds.

Policymakers have limited budget-balancing options in economic downturns that do not result in cuts, furloughs or tax increases. Reserve funds offer an alternative budget management tool. These funds—budget stabilization funds or rainy-day funds—are emergency funds set aside for use in an economic downturn. The concept of a rainy-day fund is straightforward: Save money when times are good to use when the economy takes a downturn.

States save for rainy days in drastically different ways. The structures for deposit and withdrawal of these funds vary greatly across states and can create challenges in accessing monies from those reserve funds. Many states cannot access their reserve funds without an act of the legislature. Other states have a cap on the amount that can be withdrawn in a fiscal year, or requirements that amounts withdrawn be replaced within the current or subsequent fiscal year. No two rainy-day funds are alike.

Lessons from the Great Recession

The importance of rainy-day funds as a safety net became apparent in the Great Recession. States were caught without adequate reserves and year-end balances (a combination of state reserve funds and any carry-forward balances) dropped to an average low of about 4.8% of state general fund spending in FY 2009. Since then, states that did not already have them developed frameworks for budget stabilization funds. And policymakers across the country took steps to replenish reserves during the economic expansion following the recession. Since FY 2013, year-end balances have on average hovered between 10% and 12% of general fund spending. This provided some flexibility as states grappled with the revenue fallout of the COVID-19 pandemic.

Before the pandemic, states were projecting to end FY 2020 with healthy reserves. Table 1 further illustrates the growth of rainy-day funds across states by comparing balances at the end of the recession in FY 2012 to expected balances in FY 2020. The data shows a lot of variation in states’ ability to build back savings after the recession.

Source: NCSL survey of Legislative Fiscal Offices, July 2019 and 2012

Fund Variability

Looking at it a different way, the map and Table 2 below document state year-end balances as a percent of state general fund spending. Year-end balances capture excess general funds and other funds that states carry forward from year to year. These funds, combined with rainy-day fund accounts, make up a state’s year-end balance, which is often a better indicator of overall state fiscal health.

Heading into the pandemic, states with the largest year-end balances as a percentage of their general fund spending tended to be states heavily reliant on volatile severance tax revenues. Alaska had a year-end balance of about 40% of general fund spending in FY 2019, North Dakota’s was 22% and New Mexico’s was nearly 20%. Wyoming had the largest year-end balances a percentage of its general fund spending at 109%. The great variation in reserve totals influences the degree to which states can rely on rainy-day funds to weather the economic downfall.

Source: NCSL survey of Legislative Fiscal Offices, summer 2019.

Note: Alabama, Michigan, Utah and Wyoming have secondary funds that are included in the table because they would be considered general funds in other states.

Using Reserves to Weather the Downturn

The pandemic and subsequent economic downturn was uneven in its impact. Some states faced catastrophic revenue declines while others remained flat or experienced small surpluses. Federal stimulus funds also provided a cushion, and in some states, it was enough to fill budget holes. For others, it was not nearly enough. These discrepancies played out in (virtual) statehouses across the country as lawmakers debated the best course of action.

Budget needs, combined with fund withdrawal rules and overall fund balances, shaped lawmakers’ decisions on whether to rely on rainy-day funds. A few states drained rainy-day funds completely. Others used only a portion. Some left rainy-day funds untouched, while some even added to them as they found other ways to balance the budget.

Nearly half the states tapped rainy-day funds to balance budgets in FY 2020 and in anticipation of spending needs FY 2021. These actions are detailed in Appendix A. The National Conference of State Legislatures’ database on State Actions to Close Budget Shortfalls provides additional details on reported use of rainy-day funds along with other measures to close budget gaps.

States Cover a Wide Spectrum in Use of Rainy-Day Funds

Deciding when to use rainy-day funds is not an easy decision for policymakers, especially in uncertain economic times. The pandemic wreaked havoc on revenue-estimating models, and the uncertain trajectory of the virus left states with questions about their economies for the remainder of FY 2021 and into FY 2022. States faced a difficult choice of how much of their reserves to use immediately, and how much to save in case the negative economic effects of COVID-19 continued.

Two states opted early to use their reserve funds. Both New Jersey and Nevada drained their rainy-day funds to close FY 2020 budget shortfalls.

New Jersey was hit hard by the last economic downturn and struggled to build up its Surplus Revenue Fund. The state made its first large deposit into the fund in 2019 at the governor’s request after the state emptied the fund during the Great Recession. The lingering impact of the last recession left policymakers with difficult choices about responding to the current economic situation. In May 2020, the state forecasted a revenue shortfall of $10 billion through the end of FY 2020 and continuing through FY 2021.  With this large budget shortfall and uncertain revenues, New Jersey transferred all $421 million from the state’s Surplus Revenue Fund to the general fund to close its FY 2020 budget.

Nevada is another state that only recently began setting funds aside for rainy days when the pandemic hit. In 2017, the state made its first deposits into its reserve funds. Nevada was also one of the states hit hardest by the Great Recession, and state finances felt the impact of the recession long after the national economy rebounded. Nevada also relies heavily on tourism revenues, one of the hardest-hit sectors of the economy during the pandemic. The state’s projected revenue shortfall in June was roughly $812 million. In response to this projection, the state’s interim finance committee voted to transfer all $401 million from the state’s Account to Stabilize the Operation of State Government, or rainy-day fund, to the general revenue fund to help close its budget gap for FY 2020.

Because the pandemic hit most states toward the end of their fiscal year, they were able to collect much of the tax revenue anticipated for FY 2020. This allowed them to retain most of their savings, withdrawing only a portion of available funds to fill budget gaps. Some states that tapped a portion of their reserve funds used them to create pandemic funds in anticipation of further spending needs, while others used funds to close existing budget gaps and forestall future budget shortfalls.

Indiana used nearly $870 million of its combined surplus fund. The surplus fund consists of money from its rainy-day fund, Medicaid reserve fund and tuition reserve fund. The state used the surplus account to shore up its FY 2020 budget, leaving nearly $1.4 billion remaining in this combined surplus fund. Other states that addressed FY 2020 budget shortfalls with rainy-day funds include Alaska, California, Michigan, Rhode Island and West Virginia.

States also turned to reserve funds for FY 2021 budget needs. New Mexico passed legislation to balance its FY 2021 budget. HB 1 drew nearly $780 million from the state’s reserves. The withdraw brought the proportion of the fund’s percentage of the general fund from 25% down to 12%. Additionally, California, Delaware, Georgia, Mississippi, Oregon and Utah withdrew reserve funds to shore-up their FY 2021 budgets in anticipation of revenue shortages.

Maryland used its rainy-day funds for more than just revenue losses. The state drew down $250 million to provide financial relief to businesses struggling in the wake of the pandemic. This action was made possible with legislation granting the governor authority to transfer funds from the rainy-day account for the creation of a COVID-19 emergency fund. This move will leave the rainy-day fund with $935 million remaining.  Arizona, Montana and Nebraska also set aside funds for future pandemic relief.

Idaho avoided rainy days altogether and is still basking in the sun. The economic impact of the coronavirus there has been minimal, and lawmakers added $20 million to the state’s reserve fund in FY 2020 and another $30 million in FY 2021. A few other states, including Kentucky and Tennessee, contributed additional funds to their rainy-day accounts by turning to other budget management tools to close budget gaps.

Forecast Calls for More Rain

As COVID-19 continues to spread in the United States, the pandemic shows no sign of abating until later in 2021, when most Americans are expected to have received vaccines More revenue uncertainty lies ahead for state budgets. Lockdown measures are likely to shutter restaurants and businesses once more as governments attempt to keep the virus at bay. Additional federal aid to states is uncertain, so budget writers are likely to keep dipping into reserve funds as they close out FY 2021 and into future fiscal years.

Appendix A provides more information on use of state reserve funds in FY 2020 and FY 2021.

Data collected is based on NCSL research, state sources and media reports.