Well-designed rainy day policy an umbrella for reserve funds

Editor’s Note: The Bluegrass Beacon is a weekly syndicated newspaper column posted on the Bluegrass Institute’s website after being published by newspapers statewide.

During the early days of this year’s General Assembly session, lawmakers directed $200 million in relief funding to areas devastated by violent tornadoes which blew through Bowling Green and surrounding areas in early December.

Thanks to the healthiest “rainy day” fund in its history at nearly $2 billion, Kentucky was in a much-better position to provide this type of significant and immediate assistance than just a few years ago when such a large chunk of change would have eaten a large hole out of the state’s savings.

Other storms of various kinds will certainly blow through the commonwealth in the future, so it behooves lawmakers to ensure their commitment to building a hefty – and growing – contingency fund continues even while facing criticism from some constituencies for saving too much and not spending enough.

In a recently published Lexington Herald-Leader op-ed, Angela Oh, a senior manager with the Pew Charitable Trusts’ state fiscal health initiative, and Bluegrass Institute Visiting Policy Fellow Andrew McNeill offer best practices learned from other states on how to successfully set up and manage these funds to “mitigate the impact of economic downturns.”

First, establishing “deposit rules that encourage a steady accumulation of reserves” in the future by tying such deposits “to above-normal revenue growth or one-time increases of revenue” will help maintain sufficient cash during future economic tempests.

It would be easier for Kentucky to establish that policy now while the state is flush with excess funds, thanks to large budget surpluses and soon-to-arrive federal Covid relief dollars.

McNeill and Oh include Tennessee’s example of setting aside 10% of year-over-year additional revenue, allowing lawmakers to save “more than what’s needed or anticipated while ensuring the state has enough money to maintain ongoing services.”

North Carolina also makes contingency savings a priority by allocating 15% of its projected revenue growth to its Savings Reserve Account at the beginning of each fiscal year.

Second, lawmakers help themselves a great deal by taking a proactive approach and establishing rules for withdrawing from the state’s savings account before funding requests ramp up.

Without “explicit and objective conditions for withdrawals,” as Pew explains North Carolina approach, every day’s forecast will offer a 100% chance of rain with flooding likely in Frankfort caused by those who think dollars placed in savings could be better utilized with new government spending.

Finally, Oh and McNeill suggest legislators “tailor reserve caps and targets to their state’s fiscal situation.”

They advise that states with “greater economic and revenue volatility … should aim for larger reserves” than their counterparts with more stable tax bases.

In 2017, Pew helped North Carolina enact a Savings Reserve Account based on an analysis of its historic revenue volatility. When Covid struck a couple of years later, the state needed – and possessed – robust reserves to deal with the emergency.

Determining the size of an adequate rainy day fund can be informed by studies offering “insight on how frequent and deep a state’s revenue shortfalls have been” along with conducting budget stress tests to evaluate how states’ existing reserves “would fare against economic shocks,” Oh and McNeill write.

Once North Carolina understood its historical revenue changes, it was able to set an informed cap rather than continue its historical habit of installing arbitrarily placed ceilings upon its reserve funds.

“More states should adopt this practice,” Pew recommends in its analysis of North Carolina’s experience.

What could be better policy than a balanced, objective approach ensuring the Bluegrass State also has enough of a cushion during a downturn to weather storms – of both the literal and economic variety – without crowding out needed resources for other priorities?

Jim Waters is president and CEO of the Bluegrass Institute for Public Policy Solutions, Kentucky’s free market think tank. Reach him at jwaters@freedomkentucky.com and @bipps on Twitter.