Are Virginia's Attempts to Save for a Rainy Day Enough?

Virginia, while not perfect, has some healthy fiscal practices for other states to look to.

Virginia ended its latest fiscal year with a massive $132 million surplus, providing a refreshingly positive story of state public finance. Elsewhere, alarming headlines about fiscal dilemmas dominate: Seven states passed late budgets this year, two are still working on theirs, and budget drama abounds just about everywhere.

Virginia, while not perfect, has some healthy fiscal practices for other states to look to. Of course, budgets are tricky, so there are some caveats.

In our new study published by the Mercatus Center at George Mason University, Virginia ranks as the 18th most fiscally healthy state. Although not in the top tier, it still performs better than neighbors West Virginia (42), Maryland (46), and Kentucky (47). Tennessee (8) and North Carolina (15) are in relatively better positions.

More important than a state’s ranking, or any particular number on its balance sheet, is whether its policymakers promote a culture of fiscal prudence. This can ensure wise decision-making in tough times that keeps the long-term health of a state in mind.

Virginia has much to be proud of in this regard. Two things stand out: Making regular deposits into the state rainy day fund and successfully weathering two recent revenue shortfalls.

Rainy day funds are one that states can promote fiscal responsibility. Virginia has made deposits into its fund a priority, and the rules surrounding it are among the best-structured in the nation. The Pew Charitable Trusts commends Virginia for its system.

When Virginia experiences an unexpected windfall, its constitution requires that a percentage of that money goes into the rainy day fund. Absent any such requirement, a state would have no obligation to set aside funds at what would be the most fiscally responsible time — and many do not. Then, when times are tougher, there are clear withdrawal guidelines in place, at least compared to most states.

Yet despite outperforming other states, Virginia’s well-structured deposit rules may not be enough.

In fiscal year 2015, Virginia had $715 million dollars in its rainy day fund and general fund combined, which would be enough cash to weather the average economic recession, according to Mercatus research. But preparing for a more severe recession, when the economy would decline at a faster rate, could require an additional $2.4 billion.

And if Virginia’s policymakers want to maintain the state’s fiscal health, they must not become too comfortable relying on that rainy day fund, especially for purposes it wasn’t designed for. The balance has declined steadily, falling from $1.2 billion in 2007 to $237 million in 2016.

Although a large portion of that drop is attributable to the Great Recession, inappropriate routine withdrawals have prevented these funds from being replenished. Last year, the state withdrew funds in order to fill budget holes despite undergoing an economic expansion.

By further strengthening its withdrawal rules, Virginia could prevent this from becoming routine. Currently the General Assembly may make a withdrawal if actual revenues fall short of what was estimated when the current state budget was enacted. Pew warns that doing so moves the rainy day fund’s focus toward correcting forecast errors rather than guarding against real revenue declines caused by the business cycle.

Standard & Poor’s has changed Virginia’s credit outlook from “stable” to “negative” over concerns about its slow recovery since the recession and vulnerability to cuts in federal spending. Policymakers face even more uncertainty as federal cuts could be coming in the fall that would harm Virginia’s military-dependent economy.

Even though Virginia’s fiscal outlook may be worsening, the good news is that the rainy day fund can still be its saving grace. If used properly, it can continue to be a critical tool in smoothing out revenue shocks. It isn’t there to fill every budget gap caused by a failure to control state spending, but for unpredictable emergencies — much like a personal savings account isn’t for buying groceries unless you happen to lose your job.

By continuing to make deposits and saving the withdrawals for events outside its control — whether economic or tied to decreases in federal funding — Virginia can become more fiscally autonomous and prepared for a rainy tomorrow.