Governing for a Rainy Day

Healthy reserve funds allow governments to be careful and smart.
by | April 30, 2013 AT 12:00 PM

Apple has enough money in its “rainy day fund” to withstand a storm the size of Sandy. By this September, the company is projected to have $156 billion in cash on hand, an amount essentially equal to its total revenue for all of 2012. No government could hold on to that much money. The pressure to spend it or give it back to the taxpayers would just be too great. But if a year’s worth of revenue is too much, where should a fiscally prudent government draw the line?

Michigan Gov. Rick Snyder was hit from both sides when the budget he put forward earlier this year proposed setting aside $75 million more for the state’s reserve fund, bringing it up to $580 million. Conservatives want the money to be used to cut taxes. As Scott Hagerstrom, director of the Michigan chapter of Americans for Prosperity, put it to the Detroit Free Press, “If you have $500 million sitting there in a bank account, why are you asking citizens to pay more taxes?” Meanwhile, liberals want the money spent to help struggling families. “For lots of families, it is raining right now,” says Gilda Jacobs, president and CEO of the Michigan League for Public Policy.

Read the May issue of Governing magazine.

Both sides are wrong. Citizens, struggling or otherwise, are better served when their governments are smart with their money. Governments are difficult to turn around quickly, and when hard times come, the demand for services increases. A solid reserve fund gives a government time to make careful and smart adjustments to economic downturns without resorting to slash-and-burn cuts that will interrupt service delivery to citizens, especially the most vulnerable, and cause serious damage to the jurisdiction’s overall fiscal health. One of the lessons of the Great Recession is that the purpose of a reserve fund is to serve as a bridge to ensure cash flow and service continuity.

What a reserve fund is not is a means to avoid tough choices. As soon as economic realities begin to change -- not after the bottom has fallen out -- a government needs to begin adjusting its expenditures. The long-term damage inflicted by the recession was far greater for governments that burned through their cash, wishing and hoping that circumstances would change, than for those that took immediate action at the earliest signs of trouble and that had reserve funds large enough to carry them until their actions began to produce results.

How large? The Government Finance Officers Association recommends that “at a minimum” governments have reserve funds equal to at least two months of general-fund operating revenue. By that measure, Michigan would need $1.55 billion in its rainy day fund, so Snyder can hardly be accused of taking fiscal prudence to an extreme.

But prudence is certainly something we need plenty of, now more than ever. We have entered the fiscal equivalent of climate change. As the State Budget Crisis Task Force made clear, state tax revenue has become increasingly volatile as the tax base has narrowed and reliance on the most economically sensitive revenues has increased.

We will see more bubbles and crashes, of course, and each is a dangerous threat to basic government service delivery. Superstorm Sandy seems to have been a wake-up call for a lot of public officials. The recession should have been one as well. Now is the time to be smart with the money by building up our rainy day funds.