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DAVID T. MITCHELL: Rainy days ahead

Is state ready for next recession? by David T. Mitchell Special to the Democrat-Gazette | November 7, 2019 at 3:22 a.m.

How would your family deal with an unexpected drop in your income? We've all heard the expression "save for a rainy day." When your income falls, you still need groceries and rent.

State governments face the same problems. But when a recession hits, state government faces an additional challenge. Governments have more expenses during a recession since more people qualify for programs such as unemployment insurance, Medicaid, and other social services.

One issue that economists are in broad agreement upon is that the economy cycles through growth and contractions. The last recession, the Great Recession, ended in June 2009. The current expansion is over 10 years long, one of the longest expansions in U.S. history. The recent measures of economic health like inverted yield curves on bond interest rates and stock market drops are reasons to worry that a recession could come sooner rather than later. I don't know when, but a storm is coming.

That's why prudent household budgeters set aside savings over the long term--a rainy-day fund--to cushion against the unexpected shocks and setbacks that inevitably come. The same is true for states like Arkansas that in good times have policies in place to bolster their rainy-day funds. Think of it as the state's savings account.

How is Arkansas doing in these good economic times? Well, let's just say that the state could be doing much better.

Only two states--Arkansas and Kansas--lack statutes or other rules that ensure that budget reserves are replenished after they are drawn down and continue to be replenished until the next emergency, according to a recent report from the Volcker Alliance. It gave Arkansas a "C" on its rainy-day report card, and only two states get a lower grade.

According to The Pew Charitable Trusts' "State Rainy Day Funds in 2017," Arkansas is one of only six states that doesn't have "meaningful" deposit rules for its rainy-day funds. This is happening at a time when many states are bolstering funds and tightening rainy-day spending rules to an extent not seen since the Great Recession. Arkansas only has enough rainy-day funds to pay for about eight days of spending, according to Pew's article, "Budget Surpluses Are Helping Many States Boost Their Savings."

While the state had about $150 million in its Long-Term Reserve Fund in July, these funds are often spent on projects that have nothing to do with long-term budget stability. According to the Bureau of Legislative Research, from 2009 to 2017 more than $261 million was deposited. And during this period of economic growth, over $224 million was "released" or spent. Back in May, $5 million from the state's rainy-day fund was committed to the Arkansas Arts Center. Funds have also been used to support the State Fair, community colleges, and to fight illegal drugs.

These projects have merit, but they don't qualify as a rainy-day expenditures.

When the economy heads south and tax receipts began to dip, Arkansas taxpayers will not be clamoring to fund the State Fair or an arts center. During a recession, voters will prioritize mandated Medicaid spending and crucial education funding.

"Medicaid spending tends to increase during a recession as more people become eligible because of hardships," Pew observed in a recently released report, "Rainy Day Funds in 2019: Are States Ready for the Next Recession?" Researchers warn that because state revenue growth relies today on more volatile sources--stock market gains or self-employment taxes--"policymakers may need to plan for steeper declines by accruing more reserves."

My 2016 research, "The Determinants of the Severity of State Fiscal Crises," published in the academic journal Public Budgeting & Finance with Dean Stansel, a senior research fellow at the O'Neil Center for Global Markets and Freedom at SMU, suggests that both deposits and withdrawals should be based on specific economic conditions. For example, deposits should be mandatory when economic growth is above a certain threshold. Withdrawals should only be possible if the state's economy shrinks by a certain amount, or when the unemployment rate is above a threshold.

"State Fiscal Crises: Are Rapid Spending Increases to Blame," published in the Cato Journal by myself and Stansel in 2008, finds that states that spend new revenue suffer in the recession. So new revenue from sources like Internet sales taxes should go toward lowering other taxes. And moving away from volatile revenue sources, such as income taxes, can also help to stabilize state revenue over the business cycle.

Most importantly, specific rules for deposits and withdrawals force state government to have a real rainy-day fund. Hard and fast rules lead to stronger rainy-day funds

Eliminating discretion eliminates temptation. Eliminating temptations gives us a better shot at weathering the next storm.


David T. Mitchell, Ph.D., is director of the Arkansas Center for Research in Economics and associate professor of economics at the University of Central Arkansas. The views expressed are the author's and do not necessarily reflect those of UCA.

Editorial on 11/07/2019

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