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Why Arkansas’s Long-Term Reserve Fund May Not Weather the Next Rainy Day

By Dr. David Mitchell

In a recent op-ed for the Arkansas Democrat-Gazette, I pointed out that families need to have rainy day funds to provide for any loss of income. Similarly, when state governments have unexpected general budget shortfalls, they need a way to pay for them. 

And in the same way that families may see increased expenses after a job loss—pricier health insurance premiums, for example—states may have higher expenses during a recession as more people qualify for unemployment insurance, Medicaid, and other social services related to lost income. 

Rainy day funds, or budget stabilization funds, are what most states use to avoid spending cuts or tax increases during economic downturns. Arkansas has various funds with names that make them sound like rainy day funds, but they don’t quite function the way such funds are intended to.

During the last recession of 2007-2009, net available revenue in Arkansas’s general fund cumulatively declined by $262 million. Not only is the current Long-Term Reserve Fund balance too small to cover a decline of this size, the general fund is about 25 percent larger today than it was a decade ago. Even doubling the size of the Long-Term Reserve Fund would not be enough to offset a recession of similar size to 2007-2009. While that recession may have been an outlier, a good rainy day fund should prepare for the worst possible outcomes.  

How rainy day funds are supposed to work

It’s a tautology, but good rainy day funds have money set aside for rainy days. For that to happen, the funds need deposit and withdrawal rules. The rules matter: good rules lead to adequate funding.

But here’s where things can go wrong. There won’t be much money in the fund if…

  • …the legislature or governor can withdraw money any time they want; or
  • …the legislature and the governor don’t have to deposit money in the fund.

Our state has these problems. Arkansas doesn’t have good rules to grow and protect its rainy day funds. 

As I noted in my op-ed, “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, a nonprofit organization founded by former Federal Reserve Chairman Paul Volcker. It gave Arkansas a ‘C’ on its rainy-day report card [p. 41], and only two states got a lower grade.”

As Governor Hutchinson referenced in his response to my op-ed, he and the legislature have increased funding for Arkansas’s Long-Term Reserve Fund. (That fund used to be known as the Rainy Day Fund until Act 1 of the special session in 2016 renamed it.) 

The additional funding is a good first step, but much needs to be done to strengthen the fund and make it into a true rainy day fund. 

Research-based recommendations to bolster Arkansas’s reserve funds

My and others’ published academic research, such as The Determinants of the Severity of State Fiscal Crises (2016) and State Fiscal Crises: Are Rapid Spending Increases to Blame? (2008), informs the following recommendations for strengthening Arkansas’s reserve fund.

1. Establish clear rules for depositing funds.

Many states have these rules, but Arkansas has none. For example, Tennessee requires that 10 percent of revenue growth be deposited in its reserve fund, and Utah requires that 25 percent of any budget surplus be deposited (see appendix B of this report by the National Conference of State Legislatures). Deposits should be mandatory when economic growth is above a certain threshold. 

2. Continue to increase the balance until new rules are established. 

The current balance of Arkansas’s Long-Term Reserve Fund is only enough to cover about 2.7 percent of general revenue. The average state has about 8 percent of general revenue on deposit, but many have much more. Wyoming has enough to fund a full year of general fund expenditures. General fund expenditures in Arkansas consist of obligations such as K-12 education, higher education, and many state agencies. Arkansas should emulate these stronger states.

3. Tighten rules for disbursement. 

Withdrawals should only be possible if the state’s economy shrinks by a certain amount, or when the unemployment rate is above a certain threshold. The current rules allow funds to be spent if general revenue grows by less than 3 percent. Other states set a higher bar: they require the economy or tax revenue to actually shrink. 

For example, Indiana requires personal income growth to decline by 2 percent before its rainy day funds can be spent, while Michigan allows withdrawals when unemployment exceeds 8 percent, according to the NCSL. 

Arkansas also allows for withdrawals for economic development superprojects. Other states do not. Research by ACRE scholars shows that targeted business subsidies are not effective. 

4. Make the rules constitutional. 

While Arkansas’s current governor and recent legislators have been good stewards of the state’s rainy day funds, Arkansans deserve strong, ongoing protections. Embedding rainy day fund requirements in Arkansas’s constitution will prevent future governments from changing the rules through a simple majority vote.

Why Arkansas’s reserve funds are vulnerable

Governor Hutchinson, in his reply to my op-ed, attempted to discredit my claims. In the greater space that a blog post provides, I’d like to clarify my sources and arguments. 

I’d also like to emphasize that my op-ed was not intended as an attack on the governor or the legislature, but rather a rebuff of the current rules and an expression of concern that those rules won’t sufficiently protect Arkansans from the next economic downturn.

Arkansas has two main funds that could be considered rainy day funds. Neither has appropriate rules to protect the taxpayers who fund them and rely on them.

Fund 1: Arkansas’s Long-Term Reserve Fund

The Long-Term Reserve Fund (LTRF) was created by Act 1 of a special session in 2016, renaming the Rainy Day Fund without changing the rules regarding funding and disbursements. Arkansans should know the following key facts about the LTRF: 

  1. Funding Rules: The LTRF is funded at the discretion of the legislature.
  2. Disbursement Rules: Disbursements from the LTRF are allowed when general revenue grows by less than 3 percent annually, or for economic development superprojects.
  3. Disbursement Examples: No funds have been dispersed from the LTRF since its renaming in 2016.
  4. Current Balance: According to the governor’s op-ed, the LTRF had a balance of $152.5 million (about 2.7 percent of FY 2020 projected general revenue) as of November 2019. (Recall from earlier that the average state’s rainy day fund has reserves of about 8.0 percent of general revenue.)

Fund 2: Arkansas’s New Rainy Day Fund

As mentioned earlier, the LTRF used to be called the Rainy Day Fund. Arkansas now has a new Rainy Day Fund that was created in 2017 by Act 1084. Arkansans should know the following key facts about their state’s new Rainy Day Fund:

  1. Funding Rules: The Rainy Day Fund is funded from the former General Improvement Fund, Attorney General settlement funds, or at the discretion of the legislature.
  2. Disbursement Rules: Arkansas’s Rainy Day Fund has no clear disbursement rules.
  3. Disbursement Examples: Rainy Day Funds have been disbursed many times in the past few years, including for the state fair, highways, senior centers, and a theater. The act itself refers to the fund as a “miscellaneous fund” (p. 1); it is not a true rainy day fund.
  4. Current Balance: $15.9 million was allocated to the Rainy Day Fund in Arkansas’s fiscal year 2020 budget (p. 5). Given the fund’s small allocation, the Governor clearly envisions it not as a solution for unexpected general budget shortfalls, but as a way to cover small expenses.

How Arkansas can improve its reserve funds 

Neither Arkansas’s Long-Term Reserve Fund nor its Rainy Day Fund has allocation rules in line with the standards for state fiscal responsibility as determined by experts like Pew Charitable Trusts. Arkansas would be better prepared for the future and for the next recession by improving how money is appropriated and spent—especially from the Long-Term Reserve Fund, which serves as Arkansas’s true rainy day fund.

It is great that the Long-Term Reserve Fund, under Governor Hutchinson’s tenure, is now better funded than it was when he took office in 2015. But, it lacks adequate rules for deposits. Deposits are completely at the legislature’s discretion, which leaves the door open for poor decision making. 

Withdrawal rules could be better, too. Arkansans need a stronger requirement than the current slow economic growth requirement. Instead, withdrawals should be allowed only in the event of a revenue shortfall. 

Further, because the Long-Term Reserve Fund serves as the state’s de facto rainy day fund, the governor should not be allowed to transfer funds out of it and into the Economic Development Superprojects Project Fund. That fund is used to provide for payment of all or a part of debt service on bonds and to directly fund superprojects, and transferring funds in this way would represent an imprudent use of rainy day funds. While Governor Hutchinson has never made such a decision, Arkansas’s Long-Term Reserve Fund needs strong rules to prevent such transfers from happening under future leadership.

We’ve enjoyed a prolonged economic expansion over the last 10 years, but expansions are always followed by recessions, and Arkansas is underprepared. Our state 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.”

Conclusion 

To summarize, our recommendations for changes Arkansas could make to its Long-Term Reserve Fund, or any other fund designed to serve as a true rainy day fund, are as follows:

  1. Establish rules for depositing funds (such as a percent of surpluses up to a dollar-amount cap).
  2. Until new rules are established, freeze withdrawals and continue to increase the balance.
  3. Tighten rules for disbursement so that rainy day funds are used for revenue shortfalls only and not for other programs, such as economic development.
  4. Make the rules constitutional to bind future legislators to husband rainy day funds in the same way the current administration has.

I commend Governor Hutchinson and the legislature for taking the initiative to strengthen a true rainy day fund in the form of the Long-Term Reserve Fund. But despite this good first effort, Arkansas is still unprepared for a significant economic downturn. The LTRF needs to be better funded and have better rules for deposit and withdrawal.

Many other states have achieved these goals, and Arkansas should emulate the best examples. For example, North Carolina also did not have clear rules for deposits and withdrawals, but the state made major improvements in 2017 and is now a national leader in this area. I believe Arkansas can be a leader, too.