Study Finds Rainy Day Funds Would Dry Up In Recession

By: - March 15, 1999 12:00 am

WASHINGTON – More than three-quarters of states are unprepared for even a mild future recession and need to invest more money in their rainy day funds to provide for that eventuality, according to a new report released by the Center on Budget and Policy Priorities, a liberal-leaning Washington think tank.

“Financial woes abroad should be a reminder that another U.S. recession is possible and even probable in the next few years,” said Iris Law, co-author of the report and Deputy Director of the Center. “Nobody is hoping for another recession, but it’s only prudent to ask whether states have done enough to prepare for the next one.”

The study placed Michigan and Minnesota at the top of a list of eight states that would be able to deal with a recession without having to enact tax increases or spending cuts. The six others are Delaware, Indiana, Iowa, Maine, Massachusetts and North Dakota.

At the other end of the spectrum, eleven states would fall short of sufficient reserves by amounts equivalent to more than 20% of fiscal year 1999 expenditures. The eleven are Idaho (33%), Oregon (29%), Texas (29%), West Virginia (28%), Wisconsin (25%), Tennessee (25%), South Dakota (25%), Nevada (23%), Utah (23%), New Hampshire (22%), and Georgia (21%).

The report examines a hypothetical recession beginning in calendar year 2000 and extending for the subsequent three years, paralleling the relatively mild recession of the early 1990s. Data from the National Association of State Budget Officers and National Conference of State Legislatures was used in the hypothetical downturn.

Alaska and Hawaii were excluded from the study because Alaska’s revenue is based almost solely on oil and Hawaii’s is based almost solely on tourism.

To cope with budget shortfalls caused by the recession of the early nineties, states approved record tax increases and cut expenditures sharply, the report said. Healthy rainy day fund balances would negate the need for such actions in the future.

“Although the last recession was considered relatively mild and officially lasted only nine months, many states faced fiscal shortfalls beginning in 1989 and lasting into 1992,” study co-author Alan Berube said. “While state reserve balances totaled 4.7 percent of expenditures when the recession began, thirty-five states faced a potential budget deficit at one point from 1990 to 1992, and many faced problems throughout the period.”

The Center produced the study to determine the validity of the widely held 5% rule, which mandates that a reserve equal to 5% of a state’s operating budget be held in case of future problems.

States need to hold reserve balances totaling 18% of current spending, the report found. Currently, forty-five states have rainy day funds, holding what the National Association Of State Budget Officers projects will be .4 billion at the end of the current year. The Center on Budget and Policy Priorities estimates an additional .5 billion would be necessary to weather a three-year recession.

The report based that figure on the assumptions that state tax revenues would fall at a rate similar to that of the last recession while spending would continue at rates equal to the past three years.

The report’s projected scenario contrasted the best and worst prepared states. With a projected budget surplus of .14 billion at the end of fiscal 1999, Michigan would have million more than it needs to deal with a three-year recession. The million is equal to 8% of Michigan’s 1999 state budget.

Idaho, with a projected reserve of million, would fall short of its needs by million. The million represents 33% of Idaho’s 1999 budget.

Among the report’s recommendations:

Proposals for new or accelerated tax cuts should be considered in light of how the reductions would affect a state’s ability to fund current programs.

States that used a variety of holding measures during the last recession, such as delaying tax refunds or delaying vendor payments, should use a portion of their surpluses to restore more standard fiscal practices. States that changed state-local relationships during the last recession should reassess those changes.

States should ensure that budget reserves are healthy enough to keep pace with increases in personal income, which generally track with costs of social programs. States with substantial declines in expenditures as a percentage of personal income include Maine, Massachusetts, Michigan, Nevada, New Jersey, New York, North Dakota, and Washington. 

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