State Savings Policies Evolve Amid a Decade of Economic Growth

When Myron Frans came on the job as Minnesota’s revenue commissioner, the state’s finances were stretched thin. It was 2011, less than two years after the official end of the Great Recession and the state was facing a $6 billion budget deficit. 

“Those were tough times,” recalled Frans, who now leads the Minnesota Management and Budget office.

Disagreements between Republican lawmakers and then-Gov. Mark Dayton, a Democrat elected the prior year, over how to contend with that shortfall would contribute to a state government shutdown that lasted about three weeks. 

An eventual deal that reopened the government relied on maneuvers like delaying state payments to school districts and borrowing against future legal settlement funds from the tobacco industry. 

With the recession’s end now about a decade past and the nation’s current economic expansion the longest on record, the state’s financial outlook is better these days. When Minnesota lawmakers this year crafted their $48 billion, two-year budget, they did so with a roughly $1 billion projected revenue surplus at their disposal.

But it’s not just the economy and the state’s balance sheet that have changed.

Minnesota in the years since the recession has also adopted new budget reserve, or “rainy day” fund policies, designed to better prepare the state with savings it will need to weather the next downturn.

Savings at an All-Time High

The state is not alone. Other states have also reworked how they save since the recession ended and the changes are yielding results in terms of the overall dollars they have set aside. 

Last month, the National Association of State Budget Officers reported that the median rainy day fund balance for states, as a share of general fund spending, reached a new all-time high of 7.5% in fiscal year 2019.

“It's this point where many states have saved more than they ever have before,” said Steve Bailey, who works on state fiscal policy research at The Pew Charitable Trusts.

Since the recession, he noted, 19 states have raised caps limiting rainy day fund balances. Many have also adopted more sophisticated practices to help guide how much they save.

One technique that’s become more common is “stress testing,” which involves modeling how revenues and expenditures might change under different economic scenarios. Utah was one of the states that took the lead in this area in recent years.

Nebraska in April became one of the latest states to adopt new policies along these lines when Gov. Pete Ricketts, a Republican, signed legislation that requires budget stress-testing in odd-numbered years, along with other new budget planning requirements.

There’s no rule for exactly how much a state should save. Some of it comes down to the level of risk lawmakers are willing to tolerate, competing budget priorities and other factors—like considering how susceptible key streams of revenue are to up and down swings. 

“The fact that they’re using evidence more to figure out what that savings target might be is really encouraging,” Bailey said. States, he added, have also been better about recognizing and setting aside one-time windfalls and surges in revenue not expected to recur regularly.

“This is a change," Bailey said. "A lot of states were just saving based on when they had a surplus or not and not really considering as well why that surplus might have occurred."

Prior to the recession, he noted, it was common for states that depend on oil and gas revenue to set some of it aside when it spiked or reached beyond certain levels.

More recently, other states, like California, Massachusetts, Maryland and Connecticut, have adopted similar approaches for handling their most volatile revenues, like taxes on certain income and capital gains.

But while many states have made strides preparing for the next recession, others are lagging. 

A Pew report published last month showed that at least 19 states still have smaller rainy day funds as a share of their operating costs than they did in 2007. And seven states in fiscal 2018 had less than one week worth of operating costs in reserve.

Meanwhile, in states with beefy savings accounts, lawmakers are often tempted to dip into reserve funds outside of a recession as they look to pay for near-term priorities. 

Changes Post-Recession in Minnesota

After the recession struck, Minnesota tapped its reserves to help soften the blow of declining revenues on state programs. The state emptied its rainy day fund and also cut into a separate “cash flow” account. It wasn’t until late 2012 that the state began to replenish those savings.

At that time Minnesota did not have an automatic process in place for setting aside money in reserve. “It was really left up to whatever budget deal you could come up with,” Frans explained.

But in 2014 the state passed a law that establishes a framework for transferring one-third of any surplus identified in the state’s November budget forecast into the reserve account until the reserve hits a level recommended by Minnesota Management and Budget.

This policy was put in place at a time when there was pent up demand for spending on education, transportation and other areas that saw funding ebb during the downturn. 

“There was a real serious fight over resources,” Frans said. “But then there was this realization that these recessions really can throw you for a loop.”

The budget reserve recommendation Frans’s office comes up with once each year, which provides a target amount for savings, takes into account how volatile revenue streams could affect the state’s finances.

Capital gains covered by Minnesota’s individual income tax, and taxes on corporations tend to be the state’s most volatile revenue sources. 

The state’s reserve account now totals around $2 billion and is about $145 million shy of the latest target the state has set. 

But it is still robust by historical standards. The state’s peak savings balance from 2002 to the onset of the recession was only about $1 billion, including $350 million in the cash flow account. “Certainly for almost two decades this is the largest it’s been,” Frans said.

New Requirements in Nebraska

Nebraska state Sen. Tony Vargas introduced the bill that established the state’s new stress-testing requirements. It drew broad support, passing 49-0 in the unicameral legislature.

Vargas, who sits on the appropriations committee, noted that about two years ago when he took office, the state had a nearly $1 billion budget shortfall and lawmakers had to make spending cuts. “What this all told me is we need to be more prepared for the future,” he said.

In addition to the stress-testing mandate, the legislation requires the state’s legislative fiscal analyst to produce a long-term budget document every four years that extends cost and revenue projections beyond the state’s two-year budget cycle.

The fiscal analyst under existing law already produces a revenue volatility report in even-numbered years.

Vargas’ hope is that the processes the legislation calls for will help give lawmakers a fuller understanding of the budget and how it aligns with the state’s priorities.

“More legislators need to have an accurate picture and a standardized way of viewing it,” he said. “Not one-off conversations, not just the financial balance sheet, a real in-depth look.”

He described the information provided under the new law as a way to help lawmakers think about the budget more in the way a company or a nonprofit comes up with a strategic plan. 

“Where do we actually want to be?” Vargas added. “What are the things that we have historically invested in, and should be investing in more, that matter the most to our state?”

Deciding When to Withdraw Funds

Lawmakers have drawn from Nebraska’s rainy day fund in recent years to balance the state’s budget. Beginning in fiscal year 2015, the state’s cash reserve was $719 million. The projected balance for the fund in fiscal 2021 is now around $322 million.

The only transfer from the fund lawmakers enacted in this year’s legislative session was moving $54.7 million to a capital construction fund, primarily to help pay for added prison capacity.

Vargas acknowledges that his bill does nothing directly to prevent lawmakers from using rainy day fund dollars outside of a recession.

But he says there are ways it could help. “My colleagues and I are equipped with the right information and the right tools so that we can’t hide from the fact that our cash reserve is meant to be what it is,” he said. “It’s meant to be a cash reserve. And if we are consistently dipping into it, that should tell us something is wrong.”

Nebraska is not the only place where a rainy day fund has proven to be a tempting pot of money. “There is this constant pressure on lawmakers to solve current problems,” Frans said.

“How do you let $2 billion sit in a bank account when you’ve got problems that you haven’t fully solved or you think need to be solved? It’s a legitimate tension,” he added.

Minnesota’s long range budget plan this year included a $491 million rainy day fund withdrawal in the two-year spending cycle beginning in 2022. The funding is not for one particular cost, but rather to balance the budget overall through the 2022-23 biennium.

The state is slated to have two legislative sessions between now and then, so other funding could become available. “I will be advising the governor and the legislature depending upon on how we do in the next several forecasts to not use that reserve if we can avoid it,” Frans said. 

“We really do want to keep it for a potential economic downturn,” he added.

Pew’s Bailey says a next frontier for rainy day fund policy making may involve states giving greater thought to the reasons they have for piling up savings, and then using this rationale to help guide both the size of reserve accounts and when it’s okay to tap into them.

“That’s kind of the next step,” he said.

While some states might want the money on hand only for recessions, others might view it more as a contingency account, or a way to cover costs during natural disasters.

Frans says officials who were in office during the recession tend to understand why savings are important to have in a downturn. 

“If you’ve gone through a $6 billion deficit and you realize how hard it is to cut and come up with new revenues,” he said, “then I think you sort of respect more the need to maintain these reserve balances.”