How Rainy Day Funds Help Cities Prepare for Revenue Volatility

During and after the Great Recession, tax revenue plunged in many U.S. cities and states, forcing government officials to lay off employees and cut public services.

Today, more than a dozen major cities have rainy day funds to prepare for the next downturn. On Sept. 28, The Pew Charitable Trusts hosted a panel discussion in Philadelphia on the pros and cons of these reserves—and their role in city finances and credit ratings.

Ben Ceja, assistant administrative officer for Los Angeles, told the audience that he sees his city’s rainy day fund as one part of a financial toolkit. “We don’t want to be in crisis management” in the next downturn, Ceja said. “We want as many tools as possible for when times are not as good as they are now.”

Other panelists included Andrew Kleine, Baltimore’s former budget director; and Lisa Schroeer, senior director and sector lead at S&P Global, which produces municipal government credit ratings. Also in attendance were credit analysts and public finance experts, academics, and Philadelphia government officials and representatives. Mary Murphy, a director of Pew’s state and local fiscal health project, led the conversation.

Rainy day funds, separate from general operating funds and account balances, are meant for accumulating money during good economic times for use in bad ones. Baltimore created its fund in 1993, accelerated deposits after the most recent recession, and now has about $140 million available. The fund in Los Angeles, created in 2008, contains about $107 million.

Philadelphia established a fund in 2011 through a ballot initiative but has yet to put in any money. Baltimore, Los Angeles, and Philadelphia also have unreserved balances and other reserves for specific purposes. Philadelphia, for instance, has budgeted about $71 million in reserve in case of higher labor costs or cutbacks in federal aid.

Pew research at the state level has identified three best practices for rainy day funds that may apply to cities as well: The funds should be designed with clear objectives on how much financial cushion will be needed in the event of a downturn or emergency, deposits should be directly tied to revenue volatility to take advantage of increases during good economic times, and withdrawals should be made in accordance with clearly established criteria.

The research also shows that rainy day funds can affect a government’s credit rating, which in turn has an impact on borrowing costs and operating expenses. Whether the fund helps, hurts, or has no impact on credit ratings depends on how it’s managed.

Murphy told attendees that a well-designed and -maintained fund, “all else equal, is a credit positive.” On the other hand, having a fund with no money or withdrawing from it outside of the rules may not help.

“If you have a [reserve] policy and you’re not implementing it, it’s not a strengthening factor,” said S&P’s Schroeer, one of the analysts on Philadelphia’s credit rating.

Under Philadelphia’s rainy day fund policy, codified in the city charter, the government is required to make a deposit if projected year-end revenue exceeds budget expenses by 3 percent. In the past five years, projected revenue has been below that threshold, although actual year-end revenue has exceeded it. In Baltimore and Los Angeles, officials are required to look backward at actual revenue over several years and make deposits if current revenue exceeds the past average by a certain amount.

In March, S&P Global Ratings downgraded Philadelphia from A+ with a negative outlook to A with a stable outlook, mainly because of the city’s municipal pension and school costs.

“You’re looking at a city dealing with a lot of competing needs,” Schroeer said. “There are pension costs, there is the school district, there are the regular operations, and there is the rainy day fund. Is it bad that the rainy day fund is at zero? I would say it is just part of what explains the A rating.”

The panelists agreed that cities need to make policy choices based on their own fiscal situations and any trade-offs as to where surplus money is budgeted.

Kleine, Baltimore’s budget director from 2008 to 2018 and designer of the city’s rainy day policy, said educating elected leaders and stakeholders about the true value of savings is key, although he acknowledged that can be tough in high-poverty cities like his and Philadelphia.

“A rainy day fund is not just good fiscal policy. It’s also good economic policy,” Kleine said, noting the repercussions beyond city hall. In a recession, “if the city government lays off a lot of people, it has a ripple effect across the whole economy.”

Larry Eichel directs and Thomas Ginsberg is a senior officer with The Pew Charitable Trusts’ Philadelphia research initiative.