Rainy Day Funds 'Inadequate,' Economists Warn

April 18, 2011— -- Washington. Wisconsin. California. Massachusetts. Every day this spring, it seemed yet another state was making headlines for its budget crisis.

To ease their pain, 70 percent of those states turned to rainy day funds.

But those savings may not be enough, and, in some cases, stringent rules make it tough to access that money, even during times of economic hardship.

"Every state's rainy day fund is inadequate to cover a true emergency," said Randall Holcombe, an economics professor of Florida State University.

Currently 45 states maintain some kind of rainy day fund, but most have caps on how much money can be deposited into the funds, many of which are typically between 5 and 10 percent of the state's general fund.

With the legislature's approval, states may use rainy day funds to fill gaps in their budgets; that money often finances specific public programs.

For example, Texas has considered using its reserve to fund education, health care programs or public safety initiatives. Arizona in 2007 planned to use rainy day funds to "accelerate highway construction" but the proposal was later killed.

Holcombe recommends funds be about 30 percent of a state's general fund, a catch-all type reserve that covers state expenditures and is financed by a slew of taxes.

Elizabeth McNichol, a senior fellow with the Center on Budget and Policy Priorities, recommends states have at least 15 percent of the size of their general funds in a rainy day fund.

"These funds smooth out the business cycle," she said. "They fill in unexpected budgetary gaps. If you have a larger fund, you can fill larger gaps."

Currently 13 states have capped their funds at 5 percent or less, and 30 limit their rainy day funds to 10 percent or less.

Next Stop in Budget Debate

With economists and think tanks warning that rainy day funds may not be big enough, some states are considering expanding their savings.

Oregon's legislature is currently considering a bill that would increase the state's rainy day reserves.

The bill, which is sponsored by Democrat Sen. Chris Edwards, calls for interest from the state's general fund to be deposited into the rainy day fund.

According to Sarah Hoyt, Edwards' legislative policy aide, the general fund earns about $10 million a year in interest on average, but could earn as much as $30 million in a good year.

"It has the potential to capture some really huge funds," Hoyt said. "It's funds that could fund programs that might otherwise be hurt when we hit rough economic times."

The bill has not been put to a vote yet, but Hoyt said it has garnered bipartisan support.

"It's an attractive option because it aids our budget without raising any taxes," she said. "Both Republicans and Democrats can get behind that."

The bill is also well received because the interest on the general fund does not currently fund any specific programs, said Hoyt.

"It's not like we're taking money away from anything," she said. "It's really win-win."

In January, Oklahoma governor Brad Henry encouraged the legislature to raise the state's rainy day cap from 10 percent to 15 percent, a proposal that was previously shot down, in 2006.

The Virginia State Senate is considering a similar proposal to raise its maximum annual deposit.

Both states hope an increase would make them better prepared for future economic recessions.