States will have to bolster their rainy day funds to withstand the fiscal impacts caused by the Great Recession, according to a report on the lessons learned from the financial crisis.
The National Association of Budget Officers published a 38-page report Wednesday that seeks to provide detailed and less formal state budget management practices that deal directly with difficult fiscal circumstances.
“Some states will first need to address their statutory caps that keep rainy day funds below levels necessary to ensure budget stability under severe fiscal stress,” the report said.
The report is a summary of state budget officer commentary and analysis that suggests solutions to budgetary dilemmas that states faced during the recession such as: when to implement budget cuts or revenue measures; when to use reserve funds; how to reduce expenditures while minimizing service disruptions; and what level of autonomy to expect from federal funding arrangements.
The recommendations and findings in the report are designed to help limit public service disruptions in future recessions by improving budgetary planning and preparedness.
States reduced general fund expenditures by $64 billion over the two-year period for fiscal years 2009 and 2010, and enacted $39.7 billion in revenue increases over this same time, according to the report.
“States need to plan on the idea that there will be times when they have to rely on themselves first and a strong rainy day fund is how we plan on doing that,” said Mike Morrissey, NASBO president-elect and budget officer of Texas.
The right amount to hold in a rainy day fund depends partly on the revenue system. States with more volatile revenue systems that rely heavily on collections from taxes sensitive to changes in the economy should plan to hold more in reserve to withstand economic downturns, the report said.
Another key finding is that federal aid to states can be improved by timing the delivery in conjunction with state revenue and expenditure patterns.
In response to the Great Recession, the federal government “provided additional state aid quickly; however, state tax revenues lag improvements in the economy and elevated expenditure pressures persist long after the economy has turned around,” the report said.
The report suggested that the timing of federal aid during a recession can be improved by increasing flexibility and targeting aid to changes in state revenue and expenditure patterns rather than the economic cycle.
For example, the majority of flexible funds from the American Recovery and Reinvestment Act of 2009 expired at the end of fiscal 2011, yet state revenues did not reach pre-recession levels until fiscal 2013, the report said. This indicated that states had to account for substantially less federal funds before tax revenues fully recovered.
To reduce budget instability, states should have long-term plans on how to deal with volatile revenue sources like capital gains and dividends, the report said. In addition, states should develop fiscal plans to reduce reliance on volatile revenue sources for operating purposes to a level that is sustainable and predictable from one fiscal year to the next.
The timing of temporary tax increases can be improved to reduce budget difficulties, the report suggested. Throughout the recession, a handful of states that enacted tax increases did so on a temporary basis which resulted in continued fiscal stress as the national economy sluggishly improved.
“To better ensure that revenues will recover and budget stability is reached before revenue actions expire or sunset, states can tie temporary tax increases to economic conditions or revenue collections rather than the fiscal or calendar year,” the report said.
Finally, the report recommended that disruption to essential government services can be minimized through balanced approaches such as a combination of across-the-board and targeted spending cuts. While this type of action can quickly result in significant savings it can “often carry specific exemptions and limit policy decisions.”
Targeted cuts, the report argues, require more time and political debate, but can allow priorities to drive spending decisions.