State Rules Can Complicate Rainy Day Fund Withdrawals

Rainy day funds represent the first line of defense for states facing serious budget gaps caused by the COVID-19 pandemic and steep declines in revenue associated with the economic downturn. As policymakers look to plug holes, however, they may find their ability to access their savings accounts limited by rules that govern three key questions: when and how withdrawals can be made, how much can be withdrawn, and how soon the money must be paid back.

Withdrawal conditions

States looking to their rainy day funds for assistance should take time to review the withdrawal rules that most have included in the statutes setting up the savings programs. Of the 48 states with rainy day funds, all but five—Kentucky, Maryland, Nebraska, Ohio, and Wyoming—have withdrawal conditions spelled out in law.

Clearly written rules are important because they help ensure that the funds are safeguarded during good times and accessible when needed most. And states have greater resources available now than before the Great Recession. In fiscal year 2019, they reached a record 50-state total of $74.9 billion in rainy day funds. Before the current economic downturn, at least 34 states had saved enough to cover a greater share of government operating costs than in fiscal 2007, the last full budget year before the Great Recession.

But state restrictions on the funds’ use can create impediments to quick action. For example, Washington’s constitution requires a three-fifths vote of the Legislature before money can be withdrawn from the state’s Budget Stabilization Account—except in the case of a catastrophic event or weak economic growth. When Governor Jay Inslee (D) proposed  withdrawing approximately $300 million to address homelessness in December, the request did not meet those conditions.

A few months later, the state faced much more significant problems connected to the pandemic. Although the supermajority requirement probably could have been waived, lawmakers voted unanimously to withdraw $100 million for coronoavirus efforts.

In fiscal 2010, Delaware used a combination of budget cuts and tax increases to close a $750 million shortfall. Drawing from the state’s Budget Reserve Account could have reduced the need for such measures, but the law that created the fund did not clearly define whether the budget conditions warranted such a step. To ensure that the state would be able to use reserves to weather the next revenue downturn, Governor John Carney (D) established a separate Budget Stabilization Fund for that explicit purpose in 2018.

Withdrawal limits

Early estimates show that even in states with substantial reserves, withdrawing all saved funds may not be enough to cover coronovairus-related gaps. For example, in California, there is concern that the state’s $20 billion in reserves will not be sufficient to mitigate the fiscal fallout. Lawmakers in Texas expressed similar  concerns about their own rainy day fund, which holds $11 billion.

Some states cannot withdraw the full amount even if it is needed. By statute, Mississippi policymakers can withdraw only $50 million per year from the rainy day fund, regardless of the size of the fund balance or the severity of the shortfall. As a result, if the fiscal distress lasts three years, the state would not be able to use more than half of its savings unless legislators suspended the withdrawal limit provision.

Repayment rules

In New York, the impact of the coronavirus on public health and economic activity could cut state revenue by an estimated $9 billion to $15 billion on top of the increases in spending required to fight the pandemic. Money set aside in two funds would cover a relatively small but significant portion of this cost. However, state law requires that the Tax Stabilization Reserve Fund be repaid in six years and the Rainy Day Reserve Fund be repaid in three years. Under those conditions, the state could be forced to start paying back the money before its budget begins to stabilize.

New York and nine other states have rules that require them to repay any money taken out of the rainy day fund within specified time periods. Overly strict repayment rules can prevent state leaders from using these funds, even at appropriate times. For example, officials in Missouri said this is one of the reasons they did not tap their rainy day fund to close budget gaps during the last recession. Under state law, one-third of the amount withdrawn must be paid back in each of the three subsequent years.

Building back reserves is important, but states are better served if they do so by requiring above-normal revenue growth or one-time influxes of revenue to be deposited into savings. That way, the funds are replenished as the state’s fiscal outlook begins to recover. Such rules help smooth out revenue volatility.

Rules should be well designed

Rainy day funds need rules to be effective, but poorly designed guidelines can have the opposite effect. As policymakers consider how they will manage their budgets during a national emergency and broad economic downturn, a review of withdrawal and repayment rules may help ensure that they can access the funds when needed.

Jeff Chapman is a director, Angela Oh is a senior manager, and Airlie Loiaconi is a senior associate with The Pew Charitable Trusts’ state fiscal health project.