SAN FRANCISCO — According to a
These include state practices that require deposits into a rainy day fund, or budget stabilization fund, when the state experiences unusual or above-average revenue or economic growth.
The deposits can be tied to overall revenue volatility or they can use a specific volatile revenue source, such as capital gains tax revenues or income tax revenues.
"By linking savings to volatility, states can take advantage of revenue increases while ensuring a greater flexibility in the future," according to the report, released Tuesday.
Pew identified several "promising practices" across the 12 states that enforce this type of policy, including Washington, Idaho, Virginia, Tennessee and Hawaii, which link deposits to volatility within their major or total revenue streams.
Alaska, Louisiana, Massachusetts, and Texas link fund deposits to specific tax streams. For example, Massachusetts links deposits to the capital gains tax and Texas links them to the severance tax.
Another method is linking deposits to economic volatility, rather than revenue volatility. For example, Arizona, Indiana, and Michigan use fluctuations in personal income — a broad measure of economic well-being that captures total earnings from wages, investment interest, and other sources — to trigger their deposits.
"There is no one size fits all for states," said Brenna Erford, manager of the states' fiscal health initiative at Pew. She recommends that each state undertakes regular studies to identify major sources of volatility in order to align budget stabilization fund policies with that volatility.
Pew also recommends setting fund size targets that match with the state's experience with volatility. For example, Minnesota requires the state to examine economic patterns to determine the ideal size of its budget stabilization fund.
The amount of money each state needs to have on hand for downturns will depend on their susceptibility to sudden swings.
The need to improve states' rainy day fund policies was highlighted during the recent recession, when states had to address massive budget gaps by raising taxes and imposing deep spending cuts.
Few states had sufficient budget stabilization fund balances to address the downturns they experienced.
According to a graph from the Pew report, total reserves among all 50 states in 2008 were $59.9 billion, while state budget gaps the next year totaled $117.3 billion.
"In one year alone, shortfalls outstripped savings nearly two to one," Erford said during a webinar Tuesday. "Of course, most states went on to experience massive shortfalls for several years past 2008-2009, so if anything, this graph actually understates the problems states face."
The most common rainy day fund policy among states is to make deposits based on surpluses, or how much money they have left at the end of the fiscal year.
Because surpluses have to be determined near the end of the year, these contributions are often the last — and frequently the lowest — priority in the budget process, the report said.
California, which has the most volatile income tax in the country and one of the most volatile tax systems overall, currently makes deposits based on surpluses or fixed requirements.
However, this could change in November when voters will decide whether to approve a constitutional amendment that would set aside money when capital gains taxes exceed 8% of general fund revenue, similar to the Massachusetts mechanism.
Another method is to make deposits based on forecast error, or the difference between actual and projected revenue. Five states follow this policy, setting aside any amounts that come in above the forecast.
This method can be misleading, according to the report. For example, if a state projects a downturn, but revenues are actually stagnant, then they might be forced to make contributions at the expense of other budget commitments. On the other hand, if collections are booming but forecasters predict even higher growth, there is no requirement to save, which would result in missed opportunities.
Another eight states use an ad-hoc or static deposit method, employing no formal consideration of either volatility or budget conditions. Some states require a certain percentage of revenue as a balance for the fund, but that percentage does not change with ups and downs in either revenue or the economy, the report said.
The remaining four states — Colorado, Illinois, Kansas, and Montana — do not have a budget stabilization fund, as defined by the Pew report.
