October 2016

Are We Ready for a Rainy Day?

By Amy K. Frantz

Shouldn’t we all aspire to set aside some funds in case of an emergency? If I need a new roof following a hail storm or I’m suddenly faced with a health crisis, ideally, I would like to have some savings set aside to take care of those unforeseen bills.  Shouldn’t states aspire to the same ideal?

Erick M. Elder of the Mercatus Center at George Mason University released a report earlier this year titled “Weathering the Next Recession: How Prepared Are the 50 States?” in which he evaluates the ability of each state to cope should a recession cause a revenue shortfall.  Elder writes, “A rainy day fund (RDF), sometimes referred to as a budget stabilization fund, is a tool used by almost all the states in the United States as a way to help mitigate fiscal stress during economic downturns by helping the states to smooth their spending and tax collections.”

According to Elder’s report, Iowa ranks 6th in the nation, meaning that “the state is amply prepared for the revenue shortfalls that would occur during a recession of average severity.”  The top five states in preparedness are Alaska, West Virginia, South Dakota, Nebraska, and Wyoming.

Iowa has two “Rainy Day” funds, the Cash Reserve Fund and the Economic Emergency Fund. According to the Iowa Department of Management, “The maximum balance of the [Cash Reserve] fund is the amount equal to 7.5% of the adjusted revenue estimate for the fiscal year.  If the amount of moneys in the Cash Reserve Fund is greater than the maximum balance, the excess is required to be transferred first to the GAAP Retirement Account and if not needed in this account, then transferred to the Economic Emergency Fund.”

The maximum balance of the [Economic Emergency] fund is the amount equal to 2.5% of the adjusted revenue estimate for the fiscal year. If the amount of moneys in the Iowa Economic Emergency Fund is greater than the maximum balance, the excess is required to be transferred to the General Fund. The moneys in this fund may be appropriated by the General Assembly for emergency expenditures,” according to the Iowa Department of Management.

There is often conflict in the divided Iowa Legislature over these Rainy Day funds, with some believing that these emergency funds should be spent for current programs, while others are steadfast that these funds should be held for a true emergency. In his report, Elder writes, “Most states have borrowing constraints, so they have limited options for dealing with the budget shortfalls and the fiscal stress that are associated with an economic downturn and the resulting decline in revenue. Increasing tax rates or reducing government spending are both procyclical polices that can exacerbate the underlying problem of business cycle volatility.”  Thus, it would seem prudent to reserve our state’s Rainy Day funds for an actual rainy day, not just to spend more on the day-to-day programs funded by state government.

Amy K. Frantz is Vice President of Public Interest Institute.

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation.  They are brought to you in the interest of a better-informed citizenry.