Throughout the 1990s states created budget stabilization (rainy day) funds to help provide counter-cyclical support in their budgeting process. Today 46 states have rainy day funds. Despite the sweeping popularity of such funds, many states have failed to adopt either contribution or expenditure rules that would create significant balances in their rainy day accounts. The recent state fiscal crisis found only 4 states with fund balances in excess of 10% and consequently many states found that their rainy day funds failed to provide significant fiscal relief during the latest recession.
This paper ask the question; what would happen if a national rainy day fund were established for the states with specific contribution and expenditure rules? The proposed fund would borrow from the unemployment compensation trust fund model by creating experience ratings for each state that would trigger differential fund contributions. Also like the UI system, borrowing would be permitted from the pooled fund, with interest being charged to the borrowing state. Simulations on fund performance under differing rules are provided.
This national fund would be designed to create an aggregate rainy day balance of 15% of state expenditures. By constructing a national fund, local state pressure to spend reserve balances whenever they reach significant levels, could be avoided. In addition, a more tightly constructed fund might improve state credit ratings and reduce capital financing costs for states.