Rainy Day Fund: Other states’ volatility is California’s lesson to learn

150 150 Courtney M. Fowler

(photo credit: Elena Pérez Melgarejo)

Every day, Californians grapple with personal finances. The ones who manage their money well likely set aside some portion of what they make for a so-called rainy day when suddenly, they don’t have as much money coming in. It’s a question that has been asked before, but it bears repeating: Why can’t the state behave the same way?

Clearly a state budget is far more complicated than one person’s monthly expenses. Markets go boom and bust and depending on how the state’s money is invested and what types of revenue its income is most dependent on, a rainy day can happen swiftly and arrive with dire consequences.

We’re in an upswing now.  But we saw what happened last decade when everything was decidedly not hunky dory. Safety net services are the first to go, but the hole that this state had dug itself was so deep that cuts were made seemingly everywhere to get back in the black.

It’s simple enough. California has a fairly volatile income stream due to its progressive tax structure. It’s heavily dependent on unpredictable income taxes and capital gains from a relatively small number of taxpayers, meaning market fluctuations can have a big impact on the state’s vital income tax revenue stream.

For that reason, it has become essential to maintain a set of emergency funds for times when the economy is declining and in need of backup resources. A “Rainy Day Fund” would allow the governor to capture spikes in revenue to save them in the reserve. Because we are in the middle one of those spikes, with state income beating projections recently, this conversation needs to happen now and happen quickly.

Before the Great Recession, revenues from the housing bubble produced a “spike” throughout the state that was used to increase General Fund expenditures from $79.8 billion in 2004 to $101.4 billion in 2006. By 2008, the recession had gotten worse and revenue from capital gains dropped by 60 percent and concurrently, spending dropped more than $14 billion over the following two years. The state’s volatility was at an unprecedented high, despite being such a low point before and further emphasizing the need for consistency in the state budget.

A recent Pew Report titled “Managing Uncertainty:  How State Budgeting Can Smooth Revenue Volatility is very illuminating in terms of how other states compare to California in this regard. Nevada and West Virginia specifically are good case studies that California could learn from. In Nevada, there are no income taxes and their primary revenue depends greatly on tourism and gaming, both unstable sources linked to the overall well-being of the general economy. They had one of the largest booms in the early 2000s but were one of the hardest hit states in the country when the housing bubble burst, construction and credit dried up and people all of a sudden didn’t have room in their budgets for a weekend in Vegas.

West Virginia, on the other hand, taxes income and counts on more reliable sources such as their statewide coal and natural gas supply for revenue. Because of these dependable streams, during the economic bust that affected rest of the U.S. in the late 2000s, West Virginia thrived and didn’t have to use their emergency fund at all.  

Utah was similar to Nevada in terms of volatility. However, in 2012, they proved successful in creating policies that would support the maintenance of a rainy day fund. The state legislature examined three sources of volatility including: changes in economic activity, an inconsistency between their tax base and rate as well as policy changes to the tax system over a 40 year span. Through that process, the state determined that tax revenue an unstable part of their economy and adjusted their fiscal policy to target two separate funds. Utah now has two major budget reserves and by 2013, the state legislature had added a clause that would track both federal and state funds within their economy.

Similarly, Minnesota’s lower their volatility state after over a decade of budget deficits. In 2008, the state released the Budget Trends Commission report. The report listed suggestions including: a higher budget reserve, avoiding permanent tax or spending changes that would take the budget out of balance and refilling a depleted reserve within. It also reported that the state could benefit from studying volatility more often. Since then, Minnesota has begun releasing two economic forecasts each year, in November and February. Recently, they’ve also enacted the tax policy, House File 1777, which adds $150 million dollars to their reserve and requires that state legislature set a higher recommended reserve level each year.

In Alaska, the business cycles are vastly different than other state and they depend on exporting oil as a primary revenue stream, which makes the economy significantly more volatile. As a result, the state has examined handled their volatility problem by releasing yearly budget forecasts which assess how much should be deposited into the Alaska Permanent Fund. Additionally, the state government recently released a comprehensive “10-Year plan” to better predict how revenue from oil and natural gas will be distributed to the reserve over that time span.

In general, volatility in state budgets is impossible to avoid, however, with proper planning, states can be prepared for times when downturns occur.


Courtney M. Fowler

All stories by: Courtney M. Fowler