Arkansas' Long-Term Reserve Fund has a balance of $209.9 million and is scheduled to increase to over $700 million. That's a reason to celebrate. Congratulations to the governor and legislative leadership for a step toward a more resilient future.
According to the Tax Foundation, Arkansas' Long-Term Reserve Fund had a balance of $153 million, or 2.7 percent of general fund expenditures, at the beginning of fiscal year 2020. This balance left us with the sixth lowest rainy-day fund balance in the nation. Next fiscal year's general fund budget, which is established by the Revenue Stabilization Act, will be about $5.65 billion. Adding about $500 million to the Long-Term Reserve Fund would mean the fund would have about 12 percent of the general budget. Presuming that other states don't change, this moves us to 13th highest, a significant improvement.
Arkansas has a variety of funds, but the one most like a rainy-day fund is called the Long-Term Reserve Fund. This savings account is aimed at "rainy days," such as recessions. During a recession, the state's revenue needs to increase due to higher demand for unemployment insurance and Medicaid. However, recessions also mean less tax revenue. The state can put off some spending, but other spending, like education funding, is harder to suspend.
The stronger our rainy-day fund is, the better we can weather the next fiscal storm.
The economy is cyclical; last April, Arkansas unemployment hit 10 percent. We have recovered somewhat, but we will have another recession with high unemployment someday.
The present is a great time to build up our Long-Term Reserve Fund. State revenue is better than expected, and Arkansas will finish the current fiscal year with a healthy surplus. Furthermore, the American Rescue Plan Act includes about $350 billion in recovery funds for state and local governments. The federal stimulus efforts are putting more money into consumers' pockets, so state revenue in 2022 should be high as well.
There are many other ways to improve our budget resilience. My own research with Professor Dean Stansel at SMU on fiscal crises, published in the Cato Journal and in Public Budgeting and Finance, shows that limiting spending growth and having strong "rainy-day funds" have real impact on states' resilience through recessions. Don't go on spending sprees during the good times, but save for a recession instead. Common sense.
Research by Professors Erik Elder at the University of Arkansas at Little Rock and Gary Wagner at the University of Louisiana published in the Public Finance Review finds that the rules governing deposits and withdrawals determine how well a state is prepared for the next crisis: require deposits during good times and limit withdrawals to bad times.
Two improvements lawmakers should make to the Long-Term Reserve Fund: 1. Establish specific rules for deposits such as using large revenue increases up to a specific dollar amount. 2. Tighten the spending rules so the money can only be used for revenue shortfalls and not other programs.
Constitutional requirements binding future legislatures would be best. Constitutional deposit and withdrawal requirements remove the temptation of spending savings from future politicians. A serious rainy-day fund is large enough to be tempting. While spendthrift politicians can easily change a law, a constitutional amendment is more binding. We're fortunate now, but we don't know who will be in charge during the next recession.
According to research from Pew Charitable Trust's "When to Use State Rainy Day Funds," 10 states have constitutional requirements for their rainy-day funds. While each state's rules differ, constitutional requirements constrain legislatures from spending this money for reasons other than to protect the budget during a recession.
For example, Oklahoma, Texas, and Washington have rules in their state constitutions precluding spending for reasons other than state budget volatility. While Oklahoma weakened its rule in 2006, Oklahoma's rainy-day fund rules are still stricter than ours.
Back in 1933, Arkansas defaulted on bond payments. That was a black mark on our reputation. We're better off now. But there is more work to be done to truly be prepared for the next recession. Constitutional requirements to encourage saving and limit withdrawals would be a great next step toward weathering the next recession.
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.