The Partisan Politics of Rainy Day Fund Investment

Rainy day funds (RDFs) are potentially an important countercyclical tool for states to stabilize their budgets and the overall economy during economic downturns. However, U.S. states have often found themselves exhausting their RDFs and having to raise tax rates or reduce expenditure while still experiencing a downturn. Therefore, how much each state should save in its RDF has become an increasingly important policy question. To address this issue, this paper develops target RDF levels for each U.S. state, based on the estimated short-term revenue component associated with business cycles and also on states’ preferences for stable tax rates and expenditure. The analysis shows that in the last 25 years at least 21 states have never saved enough in their RDFs relative to their needed RDFs. The paper provides policy recommendations on reforming the RDF caps.

This study explores the stabilization effect of state rainy day funds (RDFs) on government general fund expenditures (GFEs). We discuss and explicitly illustrate the concept of stabilization effect. Moreover, we utilize the current year’s actual RDF usage as the explanatory variable of interest rather than the previous year’s RDF balance, which most existing studies focus on. A panel data set of states for fiscal years 1998 to 2014 is used in the empirical analysis. Due to the pro-cyclicality of the defined GFE gap and the countercyclicality of RDF usage, their positive correlation revealed in the empirical results demonstrates that the actual RDF usage helps to stabilize state government GFEs in both economic recessions and expansions. We also verify that the previous year’s RDF balance, when interacted with RDF deposit and withdrawal rules, can influence government GFEs, thus demonstrating the importance of RDF rules.

Rainy Day Funds (RDFs) have an important role in the USA. They allow States — which usually have rules requiring a balanced budget for current revenue and spending — to limit pro-cyclical fiscal policies. This paper examines the possible role of RDFs in the European fiscal framework. The analysis suggests that RDFs would not fundamentally alter the incentive problems at the root of the difficulties in the implementation of the Stability and Growth Pact. Moreover, RDFs are not an option for countries with high deficits. However, for low-deficit countries, RDFs can lessen the rigidity of the 3 per cent threshold in bad times. RDFs could be introduced on a voluntary basis at the national level and could contribute to make the rules more country-specific. The introduction of RDFs would require a change in the definition of the ‘Maastricht deficit’: deposits and withdrawals should be considered respectively as budget expense and revenue. In this way, the balances held in RDFs could be spent in bad times without an increase in the deficit. To ensure that RDFs are not used opportunistically, deposits should only be made out of budget surpluses and circumstances allowing withdrawals should be specified ex ante.KeywordsEuropean UnionFiscal PolicyEuro AreaEuropean Monetary UnionMaastricht TreatyThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

Saving for a rainy day: Estimating the needed size of U.S. state budget stabilization funds

This chapter summarizes the experience with Rainy Day Funds (RDF) in the United States, provides new empirical evidence on the cyclicality of fiscal policy in Europe, and discusses whether introducing RDFs in EU Member States (MS) would be appropriate. The survey of the experience of RDFs in US States is illuminating, and the discussion of the scope for introducing RDFs in Europe is well argued and balanced. Regarding the introduction of RDFs in Europe, the authors emphasize the need to (i) adjust ESA rules so that RDF withdrawals during bad times would be considered as revenue, and would thus not increase the deficit; (ii) invest RDF funds only in highly liquid assets that would be readily available in bad times; and (iii) restrict the use of RDF funds to significant downturns (possibly subject to a European Commission’s recommendation).

ObjectivesTo determine if state governments utilize rainy day funds (RDFs) for political purposes in the aftermath of disasters rather than their intended purpose of combating state cyclical economic downturns.MethodsThis research draws from multiple state‐level data sources to construct a panel data set from 1992 to 2010.ResultsDisaster damage, relief funds, and politics all influence the usage of states’ RDFs. We also find that the RDF balance is lower when disaster damages increase, when it is an election year, and the same party holds party control of the governor and legislature.ConclusionThe findings of this empirical research are consistent with the literature about the importance state‐level politics plays in the use of state stabilization funds intended for cyclical economic downturns as opposed to providing more politically expedient disaster relief.

What factors influenced a state’s timeline in its adoption of a rainy day fund (RDF)? This paper utilizes event history analysis to determine the characteristics associated with the probability of state adoption of a rainy day fund between 1970 through 1995. We find that a state was more likely to adopt a RDF when its nearest largest neighbor had already adopted one. However, contrary to earlier studies, we found no association between the presence of a TEL or the amount of long-term outstanding debt on RDF adoption. As expected, states experiencing high revenue volatility were more likely to adopt a RDF.

In this paper we investigate the interplay between national rainy-day funds and supra-national transfers in a fiscal union. Given that the EU has established rules limiting deficits, national rainy-day funds could in theory provide a way for countries to obey the rules and use fiscal policy, yet avoid using austerity measures during a recession. The rainy-day fund is self-insurance and we examine the funding of a national rainy-day fund for a country in isolation. We then introduce a fiscal union while allowing member countries to retain some fiscal policy control. We find that moral hazard leads to lower contributions to a rainy day fund with a fiscal union present, and further that the higher the fiscal transfer, the lower will be the contributions to the rainy-day fund. The optimal size of the fiscal union trades-off the ex-post insurance provided by the union and the moral hazard which reduces national ex-ante preparation for stabilization policies. Optimally, the insurance provided by the fiscal union should be lower (1) the more effective is own-fiscal policy; (2) the more the presence of the fiscal union reduces rainy-day fund savings; (3) the lower is the relative probability of recession; and (4) the lower is the utility gain of redistribution in the union. We also find that commitment to a transfer policy is essential. A fiscal union that is prone to break the rules on transfers negatively impacts the ex-ante contributions to individual members’ rainy day funds.

State higher education funding in the U.S. plays an important role in enabling a state’s residents to access postsecondary education but recessions, competing spending priorities and institutional features of a state’s political system put downward pressure on such funding. On the other hand, states that have significant state savings in the form of a rainy day fund (RDF) are less subject to spending tradeoffs, cuts in government spending or increase in taxes. Using data from Pew Charitable Trust, Urban Institute and the U.S. Bureau of Economic Analysis, this study finds that states that have more fiscal cushion in the form of RDFs spend a higher proportion of their general budget on higher education. The concern that higher RDF balances would benefit other spending areas while negatively or weakly affecting higher education funding is not confirmed. Instead, states with stronger fiscal health appear better equipped to prioritize investments in higher education.

This paper examines the effect of rainy day funds (RDFs) on state savings behavior. We find that states with RDFs have higher total balances than states without such funds and also have higher bala...

In this paper we investigate the interplay between national rainy-day funds and supranational transfers in a fiscal union. We find that moral hazard leads to lower contributions to a rainy day fund with a fiscal union present, and further that the higher the fiscal transfer, the lower will be the contributions to the rainy-day fund. The optimal size of the fiscal union trades-off the ex-post insurance provided by the union and the moral hazard which reduces national ex-ante preparation for stabilization policies. Optimally, the insurance provided by the fiscal union should be lower (1) the more effective is own-fiscal policy; (2) the more the presence of the fiscal union reduces rainy-day fund savings; (3) the lower is the relative probability of recession; and (4) the lower is the utility gain of redistribution in the union. We also find that commitment to a transfer policy is essential. A fiscal union that is prone to break the rules on transfers negatively impacts the ex-ante contributions to individual members rainy day funds.

Rainy day funds are a common tool that most US states use to help mitigate the fiscal stress caused by economic slowdowns that reduce state government revenue. Except for a very brief (but very severe) recession in 2020 caused by the pandemic, most states have generally experienced an economic expansion since the end of the Great Recession in 2009 giving them well over a decade to accumulate savings in a Rainy-Day Fund (RDF) to help weather an economic downturn. This paper examines how state RDF’s have changed over the past decade and how these changes have affected each state’s ability to weather an economic downturn.

A Study on the Direction of Financial Stability for Korean Local Finance: Focusing on the Rainy Day Fund(RDF) in the U.S.

Amid the focus of public management reforms on improving the performance of public organizations and their managers, there has been little empirical attention to the links between performance and management systems and activities; little attention has been paid to how and under what circumstances `management matters.' This study reports data from the Government Performance Project (GPP), with information of all 50 states. The GPP model argues that fundamental management systems are not only amenable to comparison across states but can provide critical components of the capacity that is basic to longer term effectiveness and performance. This article considers the extent to which capacity facilitates performance in financial management, analyzing the factors that contribute to the maintenance of rainy day funds (RDFs). The authors argue that arriving at positive performance for such indicators requires not only administrative capacity but also rules that shape political behavior that will support performance.

Should societies (governments) save during economic expansions in order to cover the costs of extraordinary situations, such as natural or biological catastrophes or, more generally, economic crises? This question has been raised once again by the economic and social crisis linked to the confinement measures implemented to control the spread of the COVID-19 pandemic and the enormous public spending required to mitigate its impact. There are two general approaches in the economic literature to this debate, which are not mutually exclusive. First, the more standard approach indicates that governments, in these situations, should resort to borrowing. This allows the impact of shocks to be smoothed over time, as long as governments are sufficiently disciplined to rebuild the necessary room for manoeuvre during upswings. However, the evidence available shows that debt tends to decline only very gradually in post-crisis periods. Under the second approach, governments build up contingency funds or rainy-day funds during economic booms. International experience has numerous examples of national and regional funds of this type. This paper reviews the experience of such funds, with a view to drawing lessons as to their potential usefulness as an instrument of support in crisis situations and fiscal emergencies. Although the international evidence on their use is highly heterogeneous, it shows that when these funds are appropriately structured and sufficiently large they contribute to mitigating the impact of shocks and improving fiscal discipline.