Save the Surpluses for Another Rainy Day

The last several years have been bleak for state governments. Most had to tap, if not drain, rainy-day funds—money set aside for emergencies. But that usually wasn’t enough to bridge shortfalls. Some raised taxes and other revenue, but for the most part, states relied on cuts. Since 2007, states have slashed nearly $300 billion from their budgets, with health care and education being hardest hit; according to the Center on Budget and Policy Priorities (CBPP), a progressive think tank, over the last five years 23 states have made deep cuts to pre-K and public school spending, while 20 have made major cuts to health care. 

But the economic recovery that began nearly four years ago is finally beginning to come to states, albeit slowly. Only eight states made emergency mid-year cuts to their budget, and others are finding themselves with more money than they’d budgeted. According to the National Association of State Budget Officers, 34 states wound up with revenues higher than expected. (For most states, the fiscal years begin and end during the summer.) In total, the states collected nearly $11 billion more than they had in 2011—about a 2 percent increase. It may not be much money, but it’s a major reversal of fortune. 

That doesn’t mean funding to key programs will necessarily be restored, however. Instead, many states are trying to rebuild their rainy day funds. Laws on the books in 12 states and the District of Columbia require replenishing these funds soon after they’re used; others are doing it voluntarily. According to NCSL, 21 states will put some of their surplus money back in their emergency stabilization funds. 

On its face, the reasons for replenishing make sense. Rainy-day funds were an important tool during the economic crisis, softening the blow of declining revenues. The Center on Budget and Policy Priorities (CBPP) has noted that had states made their rainy day funds bigger and then drawn on them more, cuts to education and other key services might have been smaller or avoided altogether. At this point, these funds are largely depleted. Excluding Alaska and Texas—which have enormous rainy-day funds because of energy reserves—states’ cash reserves have fallen to 3.6 percent of spending. At the end of the 2012 fiscal year, NCSL estimated year-end balances in 21 states would be below 5 percent, the buffer most credit-rating companies like to see. Meanwhile, there’s concern about sequestration and cuts to federal support on the horizon. Todd Haggerty, a policy analyst at the National Conference on State Legislatures, says Virginia, Vermont, and Utah have made extra attempts to put more into their respective rainy day funds in order to help with reductions in federal support.

But given the slow nature of the recovery, Elizabeth McNichol, a CBPP senior fellow, says now is the wrong time to start replenishing. “You’re restocking your rainy-day fund before it makes sense,” she says. “It’s still early days.” Surpluses, it should also be noted, aren’t necessarily an indicator of fiscal health—in many instances they are the result of states cutting spending rather than the economy improving. While states are gradually restoring funding to those areas that were cut, the spending increases are still well below historic averages. Those increases also have not been enough to match increasing need in health care and education. The Center on Budget reports there are 540 more students in public schools than there were in the 2007-2008 school year and 4.8 million more people eligible for Medicaid.  Meanwhile, even if the slow recovery begins to gain steam, states still face a the likely cuts in federal funding that will likely come out of the debt ceiling negotiations in Washington.

For McNichol and many others in the progressive camp, economic trouble should spur state spending, rather than prompt budget cuts. While the economic situation is improving, states are not by any means in the clear. Building up cash reserves is an important part of revenue management in good years. But it would be hard for anyone to characterize the period as years of plenty. 

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