State Rainy Day Funds and the COVID-19 Crisis
From: taxfoundation.org
Key Findings
- State revenue stabilization funds, often called rainy day funds, are better funded now than they were at the start of the Great Recession and can be a valuable tool as states face a sharp pandemic-linked economic contraction.
- The median rainy day fund balance is 8 percent of state general fund expenditures, but several states have little or no reserve funding.
- Withdrawal conditions vary, with states differing on whether access to the rainy day fund is triggered by budget gaps, economic or revenue volatility, or forecast errors, or whether any specific reason is required at all.
- Governors or agency officials are empowered to make fund withdrawals without a legislative appropriation in 24 states, while legislatures may appropriate from rainy day funds in 33 states, with an overlap of seven states in which there is concurrent authority.
- Twelve states restrict how much can be withdrawn from a rainy day fund in a given year, capping withdrawals based on a percentage of the prior year’s general fund appropriations, a percentage of the current balance of the rainy day fund itself, or a specific dollar amount.
- Eight states impose repayment requirements on their primary rainy day fund, with four requiring some or all of the money to be repaid in the next fiscal year.
- Rainy day funds are a valuable tool for state governments as they address the present crisis, but they are only one tool of many and should not be used as an excuse to postpone necessary budget decisions.
Introduction
There is nothing new about the idea of saving for a rainy day. Aesop, in his fable, contrasted the industrious ant who saved for the winter with the grasshopper who lived only for the day; the Bible records the story of Joseph, who, foreseeing a time of bounty to be followed by seven years of famine, advised Pharaoh to set aside grain in storehouses in the good years to get Egypt through the lean years. Today’s officials may not posses the ability to interpret dreams, and certainly never planned for an economic contraction like the one brought on by the COVID-19 pandemic, but they too could see the specter of lean years ahead.
Some states, much like the biblical Joseph or the Aesopic ant, made preparations, using revenue stabilization funds—often termed “rainy day funds”—to store some of the excess in the good years to get them through the sort of crisis we now face. Others, unfortunately, did little to prepare for a downturn that was inevitable, even if these particular circumstances were not predictable.
Much has been written on these funds, and much is still to be written. What follows is not intended to be a comprehensive description or evaluation of these funds, their structure, or their use. Rather, it is designed as a quick field guide to states’ reserves and their ability to use them as revenues decline during the COVID-19 crisis.
Each rainy day fund’s design is unique. In some states, only part of the balance can be used in a given year. Often, certain conditions must be met in order to make a withdrawal. The mechanics of approving a withdrawal also differ. And of course, states vary on how much they have in reserves. All these details will matter now that the longest period of economic expansion in U.S history has given way to a sharp, pandemic-linked economic contraction.
Sources of Revenue Shortfalls
The current crisis will affect almost every meaningful source of state revenue. The timing and intensity of these effects will, however, vary. Income taxes, which are always volatile, fall sharply during a recession as workers are laid off or see their incomes reduced, and as many taxpayers claim substantial capital losses. With record numbers of unemployment compensation claims,[1] states have good reason to fear highly significant declines in income tax revenue.
Corporate income taxes tend to decline even more steeply than individual income taxes during a recession, and to take longer to recover. This is because corporate income taxes are imposed on net income, and many businesses lose money during a downturn while accruing losses that can carry forward even after the recovery begins.
Sales taxes are usually among the most stable during economic contractions, because consumption patterns remain considerably more constant than income. Savings tend to be reduced before, and more aggressively than, personal expenditures, and those who begin receiving unemployment benefits or other government assistance see the decline or elimination of their taxable income but continue to have taxable expenses. However, the COVID-19 pandemic is unique inasmuch as social distancing and shelter-in-place orders, along with mandatory closures of many non-essential businesses, have led to a sharp contraction of consumer spending. The goods and services seeing spikes in demand, moreover, such as groceries and digital entertainment, are less likely to be subject to state sales tax.
If the public health crisis extends for months, therefore, sales tax revenues will be among the hardest hit. If, however, closure orders can be lifted more quickly, sales tax revenues should recover far more quickly than income tax revenues, because (at least when people can leave their homes) even in periods of economic contraction, consumption patterns do not decline commensurate with income. If those newly unemployed no longer have any taxable income, they would still make taxable purchases.
Excise tax revenues will be adversely affected as well and may be eliminated entirely in some cases. Telework and other reductions in travel will wreak havoc on revenue from motor fuel taxes, while special excise taxes on tourism and hospitality will plummet. Closures of casinos, bars, and other establishments responsible for considerable “sin tax” revenue will also impact states’ bottom lines.
Even timing issues will come into play, particularly as states permit tax filing and payment delays as a means of financial assistance and a way to help taxpayers avoid collecting receipts and visiting tax preparers’ offices during a pandemic. Income taxes are typically withheld throughout the year, or paid quarterly, limiting the impact of delayed filing and payment, but postponing an income tax payment date from April 15 to July 15, or delaying requirements for remitting sales or other taxes, can still be significant, pushing some collections into the next fiscal year just as states are trying to close out the current one.
Meanwhile, the coronavirus crisis will dramatically expend the use of public benefits and social insurance programs, from unemployment benefits to SNAP benefits and other assistance funded wholly or in part by states. The Great Recession is the most analogous situation, but early indications of initial unemployment benefit claims, and the potential for a lengthy societal dislocation, could quickly make the comparison inadequate.
Most states will curtail spending. Some will raise taxes, though they may try to hold out until the economic recovery has begun. Federal transfers will help. So will rainy day funds, which are intended for just such a time as this, helping states bridge both timing shifts and real revenue shortfalls.
