Too Much of a Good Thing? Exceeding Rainy Day Fund cap would leave critical needs underfunded

Oklahomans look to our state government to fund a wide range of critical investments – including schools, roads and bridges, public safety, and safety net supports – that contribute to our shared prosperity. For nearly a decade, year after year of shortfalls and revenue failures forced repeated cuts to critical services that caused grave harm to our families, businesses, and communities. Overall state appropriations fell by almost $1.5 billion compared to a decade before, adjusted for inflation. 

Last year, however, the state budget finally started back on the road to recovery. Lawmakers took bold action to raise new revenues, which were used to provide teachers an average 18 percent raise and partly reverse some cuts of prior years. Now, thanks to a continued strong economy, the state’s budget outlook remains healthy. Current year revenues through January are 17 percent above last year and nearly 6 percent above expected revenues. Last month, the State Board of Equalization projected that revenues will finish the year 5.4 percent above what was expected. Lawmakers will have at least $574 million more to appropriate for next year’s budget than they had this year.

Our healthy fiscal outlook provides a great opportunity to build on the progress made last year by making sizeable investments in critical needs that have long gone unmet. However, Governor Kevin Stitt, in his FY 2020 budget blueprint, suggested going in a different direction. His budget provided less than $100 million in additional funds to common education for a small teacher pay raise, a teacher recruitment bonus program, and health insurance costs, along with modest increases for criminal justice reform efforts and the DHS waiting list. However, he offered no additional dollars for other urgent needs, including the general support of schools, raises for school support staff, correctional workers, or other  state employees, or funding increases for higher education, mental health services, child welfare, public health and a host of other core services. Instead, he proposed that close to $400 million be set aside in reserves, on top of the automatic year-end deposit that will bring the Rainy Day Fund close to its constitutional cap. The Governor’s approach would tilt the budget too heavily towards savings at the expense of key investments that are urgently needed to promote Oklahoma’s prosperity and well-being.

The Rainy Day Fund in on track to hit a record balance

Oklahoma’s Rainy Day Fund (formally known as the Constitutional Reserve Fund) was created in 1985 in response to a dramatic revenue downturn. It is designed to collect surplus funds when times are good and to spend those funds when revenues cannot support ongoing state operations.

Under the state Constitution, deposits to the Rainy Day Fund (RDF) are made when annual collections to the General Revenue (GR) fund exceed 100 percent of the certified estimate.  The entire revenue surplus goes to the RDF up to a cap of 15 percent of the prior year’s GR collections. Voters raised the cap on the Rainy Day Fund to 15 percent from 10 percent of GR collections by SQ 757 in 2010.

As lawmakers struggled with large budget shortfalls in recent years, the RDF balance fell to $96 million by the start of last year and then to $72 million by the middle of the year. However, the state ended FY 2108 with an historically large surplus, which led to a $381.6 million deposit at the start of FY 2019, raising the balance to $453.8 million. Revenue collections are on track this year to provide an additional $359.7 million deposit at the start of FY 2020, according to the projections certified last month by the state Equalization Board. That would bring the Fund’s balance to $813.5 million, the largest amount ever, and within $65 million of its current constitutional cap of $878.2 million.

Should we be saving even more?

With a Rainy Day Fund that can grow to 15 percent of general revenue, Oklahoma falls at the high end of state reserve funds. Most states cap their rainy day funds between 5 and 15 percent of their general fund balances, with only Maine and Nevada having caps that exceed Oklahoma’s. Oklahoma’s fund is also in line with the best practice guidelines developed by the Governor’s Finance Officers Association (GFAO), which recommends that states should “maintain unrestricted budgetary fund balance in their general fund of no less than two months of regular general fund operations revenues or general fund operating expenditures.”

The GFAO and other experts that study public finances, such as the Pew Charitable Trust, recognize that the optimal size of reserve funds varies across states and that states that are dependent on more volatile revenue sources, such as oil and gas taxes, should consider higher caps in order to maintain a larger budget cushion. It was for this very reason that Oklahoma created the Revenue Stabilization Fund in 2016. Now, every February, the Board of Equalization compares the amount of money to be apportioned to the General Revenue fund for the upcoming year to the average collection of the last five years for the state’s most volatile revenue sources – the gross production tax on oil and gas and the corporate income tax. Once actual General Revenue collections for the preceding fiscal year exceed a threshold, if collections for the upcoming year for each of these taxes are projected to be above the five-year average, 100 percent of the difference from each tax is to be deposited in reserve funds.

This formula could translate to huge annual deposits to the Revenue Stabilization Fund when oil and gas revenues are high. Last year, the Legislature raised the threshold for when initial deposits would be made to the Revenue Stabilization Fund to $6.6 billion, which ensured that no deposit will be made in FY 2020. But had the threshold not been raised, the Revenue Stabilization Fund would have been set to receive $549 million in FY 2020, according to the 5-year averages certified last month by the Equalization Board. This deposit would have been just slightly less than the total amount of growth revenue – $574 million – that lawmakers will have available for next year’s budget.

While there won’t be a Revenue Stabilization Fund deposit in FY 2020, the $6.6 billion threshold for the Fund will be met next year. This would lead to a deposit of over $450 million to the RSF in FY 2021, according to a preliminary estimate shared by the Office of Management and Enterprise Services. As Secretary of Budget Mike Mazzei rightly noted, the size of the RSF deposit “means there could be no growth revenue in FY 2021.” This means there could be no additional money next year to fund critical needs like education and health care and gives greater urgency to using this year’s surplus in a timely and appropriate way

The projected size of the Revenue Stabilization Fund deposit means there could be no growth revenue in FY 2021

Saving our way to the poorhouse?

Maintaining a healthy reserve balance to prepare for the inevitable next downturn is, without question, an important and worthy goal. We know from painful experience that economic downturns can lead to large revenue shortfalls that force states to impose deep budget cuts or raise taxes. In the recessions of the early and late 2000s, the federal government provided substantial aid to help keep state finances afloat, but federal relief is an unlikely prospect going forward.

But while building up savings is important, we must be mindful of tilting the balance too far in the direction of saving at the expense of urgent needs. A financial advisor wouldn’t counsel a family that is behind on paying its monthly bills to increase its retirement account contributions. As Elizabeth McNichol of the Center on Budget and Policy Priorities argues:

A rainy day fund’s ultimate goal is to help maintain state support for education, health care, transportation, and other services that promote economic growth and meet residents’ needs.  If depositing money in the fund would jeopardize a state’s ability to support these programs adequately — especially after years of funding cuts in an economic downturn — program funding should take priority. 

This is precisely the situation Oklahoma faces after years of funding cuts. “We can save ourselves into the poorhouse”, Senate Appropriations Chair Roger Thompson recently stated in helping to defeat a measure to create a new reserve fund to capture a share of annual gross production revenues. We must continue to grow our savings to prepare for the next downturn, but we must not squander the opportunity to recover from a decade of cuts and reinvest in our core services.

Our Recommendations

  • Take advantage of continued strong revenue growth to prioritize to critical investments in education, health care, human services and public safety;
  • Consider using a small portion of available revenues (about $60 million) to bring the Rainy Day Fund up to its 15 percent cap at the end of FY 2019;
  • Revisit the threshold and rules for making deposits to the Revenue Stabilization Fund that could leave the state with no growth revenue for current budgetary needs in FY 2021.

ABOUT THE AUTHOR

David Blatt helped found OK Policy in 2008 and became the organization's Executive Director in 2010. David previously served as Director of Public Policy for Community Action Project of Tulsa County and as a budget analyst for the Oklahoma State Senate. He has a Ph.D. in political science from Cornell University and a B.A. from the University of Alberta. David has been selected as Political Scientist of the Year by the Oklahoma Political Science Association, Local Social Justice Champion by the Dan Allen Center for Social Justice, and Public Citizen of the Year by the National Association of Social Workers. He lives in Tulsa with his wife, Patty Hipsher, a special education teacher in Broken Arrow, and their son, Noah.

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