A federal umbrella for state rainy days?

As state legislatures return for what promises to be yet another difficult budget year, they ought to be starting to refill their rainy day funds–those accounts that set aside money for future hard times. That’s a tough decision. After all, for the past three years, states have been raising taxes and cutting spending just to keep their budgets balanced. Why would any elected official want to do more of both?

But there are good reasons why they should and why, perhaps, the federal government should help encourage some prudent saving on the part of states. 

Here’s the problem: Ideally, states should try to stimulate their economies during recessions, or at least avoid raising taxes, eliminating public-sector jobs, or cutting other spending.  But balanced budget rules make recessions exactly the time when revenues crash and states must cut spending–just when residents need services the most. Rainy day funds can help prevent that death spiral. While most states do try to save in good times, most have drained their reserves over the past few years. Few states save enough to cover revenue shortfalls during recessions. 

It’s no surprise. Politicians prefer to spend money and keep taxes low to win reelection. Cutting spending and raising taxes to save for the future is rarely a winning political strategy.  And taxpayers may assume that they will retire somewhere else before the next recession, and prefer tax cuts over saving during good times. Besides, Americans are not very good about saving for the future.    

In a new paper, forthcoming in the Indiana Law Journal, Kirk Stark and I explain why national policymakers should care about the states’ rainy days and suggest some ways to help fill them.

Given its own fiscal mess, why should the federal government care about states? Because we live in an interconnected economy where state problems rapidly become national problems. Besides, national government should step in to prevent human suffering when local governments can’t.  For example, ARRA (the federal “stimulus” legislation) gave states additional money for Medicaid, education, and expanded unemployment programs. But there is a downside: If states come to expect federal “bailouts” whenever they get in fiscal trouble, they’ll almost certainly be less careful with their own funds. .

However, small amounts of federal money could encourage states to become more self-reliant.  For example, the federal government might exploit the fact that officials and voters all prefer goodies now and pain later. Why not offer states a relatively small bonus today, in exchange for their commitment to save later—a sort of “Save More Tomorrow” for states?  Enforcing that promise would be tricky, but so is managing any federal/state program. 

Information might also be a surprisingly useful tool as well. One reason politicians don’t keep their budget promises is because voters have trouble sorting out who’s naughty and who’s nice.  An independent federal agency could rate states on their preparation for fiscal emergencies, giving voters credible information to evaluate candidates. While the rating agencies do some of this, having a federal agency publicly scoring savings might encourage states to concentrate on building up their rainy day fund balances.

If states were characters from Aesop’s Fables, they’d be more grasshopper than ant. So think of it like this: With a little help from the federal government, maybe more states could find their inner ant.

Brian Galle is an assistant professor at Boston College Law School. From June to December, 2011, he was a visiting fellow at the Urban-Brookings Tax Policy Center.