Reserve fund requirements

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Reserve Fund Requirements (also: "rainy day fund requirements" or "contingency fund requirements") are mandatory or recommended regulations to establish budget reserves. The reserves are to be used during recessions or other unexpected events, which cause revenue declines or spending increases. These requirements are a financial stabilizing policy, a legally-binding governmental savings mechanism, formed to shield the government against reducing service levels or raising taxes due to temporary revenue shortfalls or unpredicted one-time expenditures. Moreover, the use of the fund during periods of high unemployment may even assist in offsetting the effects of recessions. The requirements usually include a minimum level of unrestricted fund balance, a maximum level (a “cap”), regulations on revenues withdrawal and a replenishment timeline.

CONCEPT


Goals
Example

A State experiences high levels of fluctuation in its tax revenues due to a heavy reliance on sales taxes, which are significantly correlated with the macroeconomic business cycle. During the past recession, this state saw tax receipts plunge, and at a time when it would have preferred to have increased its spending to provide local stimulus, it instead had to cut back on government services, exacerbating many of the problems brought on by the recession. The state legislature decides to establish a reserve fund from excess revenues, with unrestricted fund balance in the general fund of no less than two months (16%) of regular general fund operating expenditures. The state decided to set a replenishment rule of 4 years after using the fund. Using the reserve fund allows the government to mitigate the impacts of the recession, for example through increasing its infrastructure spending and providing jobs for more unemployed construction workers.

Tradeoffs

Tradeoffs of implementing this policy may include:

  1. Reduced funding available for current operating or capital needs (e.g., education, infrastructure, etc.) due to prioritization of unknown potential future needs
  2. Reduced fiscal responsibility due to over-utilizing of the reserve fund
  3. Reduced budgetary flexibility of legislatures and executives, potentially increasing budgetary conflict and running afoul of legislative entrenchment restrictions
  4. Increased levels of centralization in government funds, where all or most revenues are saved under one category and not in separate departments
  5. Reduced current tax payers' benefits due to the shifting of revenues to future needs
Compatibility Assessment

If answered yes, the following questions indicate superior conditions under which the policy is more likely to be appropriate:

  1. Are revenues usually forecast accurately?
  2. Are tax revenues considerably volatile (e.g., a large share of tax revenues is sales tax revenues)?
  3. Is the government vulnerable to extreme events or other conditions likely to result in uneven and significant future cash outlays (e.g. wildfires, floods, snowstorms etc.)?
  4. Is the government significantly impacted by broader macroeconomic recessions or local financial crises?
  5. Is the government legally and/or practically able to bind future legislatures to comply with reserve fund requirements (vs. subject to legislative retrenchment requirements)?
  6. Are alternative policies that might also protect the government from budgetary fluctuation (e.g., tax reforms designed to prioritize less volatile revenues, economic development initiatives to diversify the local economy) less feasible, desirable, or otherwise inadequate
Design

The following questions should be considered when determining how to implement this policy:

  1. What would be the fund's purposes? Which goals will it serve? (e.g. assisting in times of natural disasters, covering unexpected expenditures, covering deficits due to revenues shortfalls, mitigating unanticipated economic downturns, etc.)
  2. What will be the restrictions, criteria, and procedures for permitting withdrawals from the reserve account?
  3. What, if any, would be the fund's magnitude limitations (e.g. minimum and maximum amounts to be accumulated and maintained)?
  4. When and how would revenues be deposited to the fund - according to which factors and in what intervals?
  5. What conditions or triggers will be used to ensure the fund is replenished following its use or decline to a certain balance level (e.g., required replenishment deadlines, positive economic indicator-based replenishment requirement triggers, etc.)?
  6. What timeline or triggers will be assigned for modifying the terms of the reserve fund requirements (e.g. every 3/5/10 years, due to changes in the government's financial position, automatic inflationary increases, etc.)?

ADOPTION


PolicyGraphics
  • Has adoption of: Common. In the U.S. 46 states have some level of reserve fund, as well as many local governments, especially cities. Arkansas, Illinois, Kansas and Montana have no reserve fund requirements. [1] In addition, many countries around the world establish some level of reserve fund, usually referred to as "contingency fund", especially in OECD countries. [2]
Adopters


STAKEHOLDERS


Supporters
Opponents


REFERENCES


Research
Resources
Footnotes
  1. McNichol, Elizabeth. "When and How States Should Strengthen Their Rainy Day Funds." Center on Budget and Policy Priorities. APRIL 17, 2014. http://www.cbpp.org/research/state-budget-and-tax/when-and-how-states-should-strengthen-their-rainy-day-funds#_ftnref6.
  2. "OECD Public Governance Reviews Colombia: Implementing Good Governance." OECD. 2013: p. 176.
  3. Riera Lopez, Marta. "Spain's contingency confusion." Public Finance International. January 28, 2014. http://www.publicfinanceinternational.org/opinion/2014/01/spains-contingency-confusion
  4. "Analysis of the FY 2016 Maryland Executive Budget, 2015. http://mgaleg.maryland.gov/pubs/budgetfiscal/2016fy-budget-docs-operating-Y01A-State-Reserve-Fund.pdf
  5. Miller, Jushua. "State’s rainy day fund has dwindled over past decade." The Boston Globe. October 4, 2015. https://www.bostonglobe.com/metro/2015/10/04/state-rainy-day-fund-depleted/gX3v8T9erHrlyBvGFpOefL/story.html
  6. Gonen, Yoav and DeFalco, Beth "Mayor’s budget has a $1 billion rainy day fund." The New York Post. February 13, 2014. http://nypost.com/2014/02/13/mayors-budget-has-a-1-billion-rainy-day-fund/
  7. Gay, Mara. "NYC Comptroller Scott Stringer Says Rainy Day Fund Needs a Boost." The Wall Street Journal. August 3,2015. http://www.wsj.com/articles/nyc-comptroller-scott-stringer-says-rainy-day-fund-needs-a-boost-1438652110
  8. "The Permanent Umbrella: A Constitutionally Mandated Rainy Day Fund for Massachusetts." Greater Boston Chamber- The Hub of Business. 2004. https://bostonchamber.com/wp-content/uploads/2012/01/2004-rainy-day-fund_LK.pdf
  9. Feit, Josh. "In Budget Fight with Mayor Murray, Homeless Advocates Want $2.3 Million from Rainy Day Fund: “It’s Raining Now!” They Say." Seattle Met. November 12, 2015.
  10. Thomas, Ralph. "Plan for “rainy day fund” is headed to lawmakers." The Seattle Times. February 5, 2007. http://www.seattletimes.com/seattle-news/plan-for-rainy-day-fund-is-headed-to-lawmakers/
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