When to Use State Rainy Day Funds – Withdrawal policies to mitigate volatility and promote structurally balanced budgets

Source: Pew Charitable Trusts, April 2017

From the overview:
A robust and well-designed rainy day fund can give a state the flexibility it needs to weather the revenue impact of economic downturns. For this to work, states need to also have clear policies that ensure the funds are used in a way that is aligned with how their revenues respond to the business cycle. Pew’s examination of states’ rainy day fund withdrawal policies found that in some cases, those policies either fail to adequately safeguard savings from inappropriate use during times of economic and revenue growth or do not provide enough flexibility or accessibility in times of greatest need. States with flawed policies may find that their rainy day funds do not fulfill their primary intent: to keep their budgets stable regardless of how well the economy is performing.

Pew’s examination of state policies governing withdrawals from the 47 states with budget stabilization funds found that:
• Six states have no legal conditions for when funds should be withdrawn.
• Ten states have unclear conditions for when they can make withdrawals.
• Twenty-nine states do not include revenue or economic fluctuations as criteria for determining when withdrawals from these funds are appropriate.

Pew identified three elements that state policymakers should consider when designing budget stabilization funds:
1. The fund’s usage should be aligned with its purpose. Not all withdrawals from rainy day funds are consistent with the objective that the funds were created to meet. States should examine whether funds are meeting their statutory and/or constitutional purpose.
2. There should be a connection between fund withdrawal conditions and volatility. Ideally, guidelines should tie withdrawals to economic or revenue fluctuations in a clear and measurable way. Such guidance gives policymakers a clear signal on whether the time is right to use reserves.
3. The requirements for rebuilding the fund should be clear and achievable. Some states require that any money withdrawn from a rainy day fund be reimbursed within a specific time frame, which is intended to ensure that the state rebuilds its reserves. However, such requirements often fail to take the business cycle into consideration, and in some cases are so stringent that state leaders rarely authorize withdrawals—even in dire economic circumstances.