Rainy Day Funds 'Inadequate,' Economists Warn

States plan to set aside more money, nervous about the future.

April 15, 2011, 4:55 PM

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.

Accessing the Rainy Day Funds Proves Difficult

But the size of rainy day funds isn't the only challenge states encounter. Other governments find it difficult to even access what money they do have in reserves due to stringent rules determining when they can be used.Some states require a supermajority of votes in the legislature. Others use economic triggers, like a specific quota on revenue shortfalls, to determine when to tap into the funds.Such rules have their defenders.Strict rules and regulations that determine when funds can be accessed ensure the money is only used when it is truly needed, said Russell Sobel, economics professor at West Virginia University."It could be the best economic year in our nation's history, and states [without such rules] could be permitted to use rainy day funds," he said.However, Sobel also says that the rules need to be reasonable so that "states can actually get to the funds when they need them." He said using economic triggers is permissible, but in most states, requiring a supermajority vote is "too harsh."But others say the rules can be overprotective.The Wisconsin legislature – which captured national headlines earlier this year in its battle over Gov. Scott Walker's attempt to weaken collective bargaining rights for the state's unions -- is currently considering an amendment to the state constitution that would create a "fiscal responsibility fund" to be used when a recession hits.The state already has a rainy day fund, but according to said Jon Peacock of the Wisconsin Budget Project, it is an "insignificant account with almost no money in it." The Project is a nonprofit initiative that analyzes the effect of budget and tax issues on families of low and moderate income.Peacock believes that the regulations surrounding the proposed fund are too strict.The fund can only be accessed with a supermajority two-thirds vote in the state legislature. But if there's a projected drop in the national gross domestic product for two or more quarters of the fiscal year, only a majority vote is needed to withdraw funds.According to Peacock, if this amendment had been in place during the 2010 economic year, Wisconsin would have needed a supermajority to access the funds."It's a little absurd," he said. 'We had the worst recession in 80 years and we wouldn't have been able to take out money [without a two-thirds vote]. That kind of rigidity makes it counterproductive."The amendment calls for the state to deposit funds, at least one half of one percent of state revenue, into the savings account every year that it is not taking money out."That means we'd have to put money into the account during the latest recession," said Peacock. "This proposal would have completely failed us in the current economy. We're going through our rainiest days, and we couldn't have touched the rainy day fund."Peacock and the Wisconsin Budget Project favor the creation of a bigger rainy day fund but would like to see it created without such "rigid" rules.Using economic triggers, such as gross domestic, help the states differentiate between normal budgetary woes and true financial disasters, said Florida State's Holcombe."There's always the temptation to raid that fund when it's not an economic emergency," he said.But Holcombe also said regulations need to be "reasonable" in order to make it easy for states to get the funds when they truly need them.

State Budget Problems: Staying Focused

While the problems surrounding rainy day funds continue to be debated, some argue that states need to stay focused on today's budgets, not savings to be used in future years.Gary Wagner, economics professor at the University of Arkansas at Little Rock, warns that as the nation continues to recover from the recession, it's time to spend rainy day funds, not add to the reserves.In hard economic times, the nation needs money pumped into programs to encourage economic growth, he said."Every dollar you save, well, that's a dollar that you're not spending," Wagner said. "Someone who isn't working isn't going to save for retirement, and by that same logic, a state that is struggling financially shouldn't save for the future."McNichol echoes the sentiment. She encourages states with the legislative power to access their rainy day funds to use their funds now if they have not already done so."They're called rainy day funds, after all," she said. "Well, it's raining."ABCNews.com contributor Meg Wagner is a member of ABC News on Campus program in Gainesville, Fla.

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