Budget Blog

Rainy Day Funds Reach Historic Levels, Leaving States More Prepared than Ever for a Future Downturn

By Kathryn White posted 01-25-2023 03:14 PM


As inflationary pressures, high interest rates, geopolitical conflict and other factors contribute to slower projections for economic growth, many economists are predicting that the next recession will occur sometime in 2023. How prepared are state governments to weather a possible downturn? After two consecutive years of widespread and sizeable budget surpluses and recent state policy actions to strengthen their reserves, states are now more financially prepared than ever to handle an economic downturn. Rainy day fund balances reached new heights in fiscal 2022, after already growing sharply in fiscal 2021. Based on enacted fiscal 2023 budgets, state reserves are projected to increase further by the end of the current year. While not all states would necessarily have to tap their reserves in the event of a recession, having a robust rainy day fund is a helpful tool many states rely on to manage fiscal uncertainty.

Rainy Day Funds Saw Substantial Growth During the Pandemic

Before the onset of the COVID-19 crisis, state rainy day funds were at a then all-time high in fiscal 2019, after a decade of rebuilding reserves following the Great Recession. In spring 2020, when the pandemic first hit, this financial cushion softened the immediate blow for states facing revenue shortfalls as well as cash flow challenges due to the tax filing deadline shift, helping them to close budget deficits by the end of fiscal 2020 – something most states are required by law to do.  At the same time, as state revenue projections were plummeting further, concerns grew that states might end up depleting the rainy day funds they had worked so hard to build in recent years.

These concerns did not come to pass, as state revenues proved far more resilient than anticipated despite the pandemic’s economic impacts. Instead of dwindling, state rainy day fund balances increased 58 percent over fiscal 2020 levels to reach a new high of $121.8 billion, according to the latest data reported in NASBO’s Fiscal Survey of States. This steep increase in reserves was largely the result of stronger than anticipated revenue growth in fiscal 2021 that led to large surpluses and additional rainy day fund deposits in many states. Rainy day funds continued growing in fiscal 2022 to total $134.5 billion, another all-time high; this growth was widespread, with 43 states recording year-over-year increases. According to enacted budgets, a majority of states plan to continue increasing their rainy day funds in fiscal 2023.

Source: NASBO’s Fiscal Survey of States. Note: Fiscal 2023 figure is based on enacted budgets and excludes balance data for two states that do not estimate future balance levels.

Comparing Rainy Day Fund Levels Over Time

Measuring rainy day fund balances as a share of general fund spending is useful for comparing balance levels at different points in time, as it avoids having to adjust nominal dollars for inflation and population growth. Additionally, it appropriately measures reserves in proportion to the level of spending that those reserves are there to help support in the event of a downturn. As a share of general fund spending, total rainy day fund balances reached 13.3 percent in fiscal 2021 and dropped slightly to 12.4 percent in fiscal 2022 due to a significant increase in expenditures that year (driven in part by one-time investments). The median rainy day fund balance as a share of general fund spending – whereby all 50 states are weighted equally and which is less likely to be skewed by outlier states – was 10.3 percent in fiscal 2021 and 11.6 percent in fiscal 2022. In fiscal 2023 enacted budgets, rainy day fund balances are expected to represent 12.4 percent of general fund expenditures in total, with a median balance for the “average” state at a similar level, 11.9 percent.

Source: NASBO’s Fiscal Survey of States.

Comparing Rainy Day Fund Levels Across States

Looking at rainy day fund balances as a share of general fund spending can also be helpful for drawing comparisons across states, as this metric accounts for differences in the size of state budgets. Rainy day funds as a percentage of general fund expenditures vary by state, ranging in fiscal 2022 from a low of 0 percent to a high of 96 percent. This variation is related to differing rainy day fund structures, policy decisions, fiscal conditions, and other factors. Also, states that rely on more volatile revenue sources are likely to carry a larger relative balance in their rainy day funds than states with more stable revenue sources. This explains why, for example, energy-producing states that rely heavily on highly volatile severance taxes have historically held a greater amount of funds in budget reserves. While reserve levels continue to vary by state, 44 states reported rainy day fund balances representing at least 5 percent of their general fund expenditures in fiscal 2022 – including 30 states with reserve balances exceeding 10 percent of spending. In fact, 19 states reported rainy day fund balances exceeding 15 percent of general fund spending. Rainy day funds of this magnitude have never been so widespread across states.

Source: NASBO’s Fiscal Survey of States. Note: Fiscal 2023 figures are based on enacted budgets and exclude balance data for two states that do not estimate future balance levels.

Telling the Full Story: States’ Total Balances

While this analysis focuses mainly on rainy day funds, it is important to recognize that states have other resources that may be used to help smooth revenue and expenditure volatility from year to year, namely general fund ending balances. NASBO calculates a state’s “total balance” as the sum of its rainy day fund balance and its general fund ending balance. In some states, the rainy day fund balance is stored within the general fund and therefore shows up in the reported ending balance, so this is accounted for in NASBO’s calculations to avoid any double-counting.

Total balances have seen tremendous growth over the past two years, roughly tripling in nominal dollars from fiscal 2020 to fiscal 2022, according to NASBO’s latest Fiscal Survey of States data. In fiscal 2021, total balances more than doubled to reach a new high of $241.3 billion, equivalent to 26.4 percent of total general fund spending that year. The median balance was even higher, at 27.1 percent, for fiscal 2021. This rapid growth in state balance levels was driven mostly by revenues beating state forecasts – by a considerable margin in many cases. Based on preliminary actual data, state total balance levels continued to grow rapidly in fiscal 2022 from an already high baseline, reaching $342.9 billion, or 31.7 percent as a percentage of general fund spending. In states’ enacted budgets for fiscal 2023, total balance levels are expected to decline; this likely reflects states’ plans to spend down a portion of their larger-than-expected ending balances from the prior year, including for one-time investments. Additionally, fiscal 2023 balance projections based on enacted budgets in NASBO’s Fall 2022 Fiscal Survey are likely to be less up-to-date (and less reflective of more recent improvements in revenue performance) than fiscal 2022 balance figures that were reported based on preliminary actual data for most states.

Source: NASBO’s Fiscal Survey of States.

Understanding the Difference Between Rainy Day Funds and Ending Balances

There are often more restrictions on when a state can withdraw from its rainy day fund balance compared with its general fund ending balance. If the rainy day fund is a state’s “savings account,” the general fund balance may be viewed as more analogous to a “checking account”. Therefore, states’ total balance levels (which including general fund ending balances) tend to fluctuate more year-to-year compared with states’ rainy day fund balances. In some states, a portion of the ending balance is designated or reserved to be spent in a subsequent year. That said, for some states, the general fund ending balance is intended to serve as a reserve, for example with a minimum balance requirement in statute. It is important to consider this nuance when evaluating and comparing state reserve levels. According to a previous NASBO analysis, 11 states had in most years since fiscal 2000 maintained a total balance equivalent to at least 10 percent of general fund spending, while keeping less than 50 percent of that total balance in the rainy day fund in most years over the same period.

In the aggregate, rainy day fund balances have comprised roughly 60 percent of total balances, on average, since fiscal 2000, with the largest digression from this trend occurring during the Great Recession when sizeable rainy day fund balances in Alaska and Texas made up the lion’s share of total balance levels. More recently, beginning in fiscal 2021, rainy day fund balances have made up a smaller portion of total balances compared to historical averages – dropping to 39 percent by fiscal 2022. This can be explained by the extraordinary recent growth in states’ total balances driven mostly by tax collections exceeding original revenue projections. Most of those surplus funds wound up in states’ ending balances in fiscal 2021 and again in fiscal 2022, though a portion of these funds were eventually directed to states’ rainy day funds. In fiscal 2023, enacted budgets show states are planning to spend a portion of those ending balances on one-time uses such as paying off debt, supplemental pension payments, capital construction, economic development, and other expenditures to strengthen their fiscal resiliency over the longer term. With ending balances set to decline, this has the effect of estimated rainy day funds once again increasing their share of total balances by the end of fiscal 2023.

Source: NASBO’s Fiscal Survey of States.

Outlook for State Rainy Day Funds

With rainy day fund balances at historically high levels, what is in store for state reserves in fiscal 2024? Based on NASBO’s analysis of budget proposals and state-of-the-state addresses so far, governors continue to prioritize rainy day funds as a critical component of sound fiscal management. In some states, particularly those where rainy day funds have already reached the legal maximum balance, governors propose to maintain these reserves at their current “full” level. Meanwhile, some governors propose to continue growing their rainy day funds in the coming fiscal year by making additional deposits. Governors are also taking additional steps to strengthen their fiscal resiliency and prepare for the next downturn, including saving money for natural disasters, paying off debt, using surplus funds for capital construction to reduce the need for new borrowing, making supplemental pension payments, and using one-time money for one-time investments. These actions – combined with strong reserves – leave states well-positioned to weather a recession, whenever the next one strikes.