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Raccoons in the Driveway: the Temptation of the Rainy Day Fund

The COVID recession and its fiscal aftermath should remind politicians, advocates and labor that budget reserves are not piggybanks for new discretionary spending. Economic cycles have not been repealed.

A,Table,With,The,Figures,Of,Revenue,And,Expenditure.,Photo
(Shutterstock)
Unlike some other cultures, many Americans don’t like to save. So it should come as no surprise that one of the endless professional challenges for state and local government executives, finance officers, budgeters and labor negotiators is trying to explain the need for a healthy rainy day fund. They must perpetually respond to voices chiding, “Why not just tax tomorrow when you can spend today?” And then there are the politicos and advocates who never saw a revenue surplus or a nonrecurring “found dollar” that they couldn’t wait to “invest” in a pet cause.

Some of this is self-inflicted: The accounting conventions don’t help, by labeling these prudent reserves with terms like “unassigned fund balances.” That bit of fuzzy ambiguity invites trouble: It sounds like idle cash just aching to be spent. And there are innumerable special interests and fiscal spendthrifts prowling like raccoons around the driveway garbage can at midnight to find some way to pry open the lid.

With hundreds of billions in pandemic recovery money flowing from Washington and the stock markets hitting records, the pressure to just spend it now only intensifies, even when the money is supposedly locked up in a formal budget stabilization fund or similar designated fiscal reserve. This “pro-cyclical” advocacy for higher and higher spending when the economy booms is a perennial problem for the financial professionals who look beyond their noses to the next economic downturn, with lessons learned from prior experience.

For the federal government, it’s a moot issue. Perpetual deficits and mounting debt burdens are the problem, not fiscal surpluses. Unlike states and localities, Uncle Sam can run deficits and figure out how to pay for it in the future, whether it’s through higher taxes, lower spending, more deficits, inflation or (more likely) “some combination of the above.”

But state and local governments are legally bound to balance their budgets in most states, and many of them have explicit upper limits on their ability to raise tax rates without specific voter approvals. Even for those jurisdictions with available future taxing authority, the concept of “spend now and tax later” runs against time-honored concepts of interperiod and intergenerational equity.

And some governmental units need larger rainy day funds than others. Those with high percentages of volatile income and sales tax revenues, for instance, will need a larger reserve for cyclical fluctuations than those that rely on more-stable property taxes. So one single percentage won’t be optimal for all.

Best Practices and Professional Guidance


As a result, thoughtful financial professionals have developed guidelines and recommended practices. One of the most notable is the Government Finance Officers Association (GFOA), which has published a set of best practices to guide those responsible for financial policies, financial reporting and budget administration. GFOA’s guidance on fund balances is an excellent place to begin a policy review. This becomes even more important where the COVID-19 recession drained some states’ official rainy day funds and many of the formal and informal reserves built up over the years by municipalities.

GFOA is not the only source. The Pew Charitable Trusts staff has done considerable research on the topic and released a series of articles that also provides guidance to state-level officials, somewhat less technical in its focus and more policy-oriented. The National Association of State Budget Officers covers rainy day funds in its publication on state budget processes. Other associations have addressed the topic in one way or another, so there are ample resources available to state and local officials as they look ahead to a post-COVID economy.

And it’s never too early to look beyond the recent trifecta of good luck, with Congress sending helicopter money to households and rescue money to the states in the COVID-19 relief packages, along with the unprecedented 2020 stock market rally generating extraordinary capital gains tax revenues for the states this year. As a policy presumption, that public finance trifecta is as unreliable a steady revenue generator as it is at the horse track. Let’s not forget that many states and localities had to first fall back on their rainy day reserves before they received the federal aid. Even California’s liberals, who benefit the most from capital gains taxes, should thank former Gov. Jerry Brown for building up the rainy day cushion that he insisted upon in the face of cries for more social spending.

As Brown knew all too well, and despite all the Keynesian macroeconomic tools that we now deploy in recessions, economic cycles have not been repealed. Free-market growth and exuberance eventually produce excesses (whether it’s inventories, bad loans, inflated stock prices, investment manias or whatever). The booms lead to busts, and government revenues follow.

A Rainy Day Time Capsule?


In times like these, the wisdom of rainy day funds, both formal and informal, should become more obvious, even to the perpetual spenders. Almost every government’s budgetary and financial report issued in the coming months should make some reference to the role played in fiscal stabilization by the jurisdiction’s policies and strategies.

It cannot be said often enough that the time to plant the seeds for the next crop of budget stabilization funds is now, especially where the field is barren and the blisters and scars are fresh. Here’s a thought: Make a “time capsule” video of today’s elected officials, ideally in public meetings, lauding the benefits of the rainy day funds they inherited, to save for future budget sessions.

And before they start spending on new programs, policymakers should first make sure that public employees’ foreseeable pent-up wage increases are provided for, given pandemic pay freezes and the inflation trends now obvious to all, especially in housing prices and rental rates. Public employees who endured COVID-19 austerity measures should not have to play second fiddle to either the rainy day fund or the newest squeaky wheel at budget sessions.

In 2022, the professional associations can do taxpayers a great favor by surveying their members on the number of jobs saved, pay cuts avoided or mitigated, service levels maintained, benefits provided to citizens, and tax hikes minimized by their members’ official and unofficial rainy day reserves during both the pandemic and the Great Recession. Because of the different triggers and federal interventions in each downturn, such a comparison will be enlightening. And whenever the next recession hits, a follow-up study would be a welcome sequel. Budget officers need data to support their case for fiscal prudence. Meanwhile, elected officials must be reminded that federal helicopter money will not always fall out of the sky as it did in 2020 and 2021.



Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management
Girard Miller is the finance columnist for Governing. He can be reached at millergirard@yahoo.com.
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