Kansas these days offers a host of lessons of what not to do when managing state finances. We’ve already noted one: don’t enact unaffordable tax cuts. Kansas’ massive income tax cuts have left it on the verge of a major fiscal emergency, as a Washington Post editorial pointed out. Here’s another: don’t go without a formal “rainy day” reserve fund. Kansas is one of only four states without one, which helps explain its current troubles.
Kansas’ tax cuts caused a revenue decline so severe that the state, in order to pay for this year’s spending, drew on fund balances intended to provide a temporary financial cushion during economic downturns or other unexpected events. That’s highly imprudent. When the next downturn hits, Kansas will have little or no cushion to draw on, forcing tax increases or deeper cuts to schools and other public services — on top of the major cuts Kansas imposed due to the recession — when the state economy already is weakened.
If those balances had been held in a well-designed rainy day fund, with specific rules on when the state must make deposits and when (and for what purposes) it can make withdrawals, the fiscal irresponsibility of using these one-time funds to pay for permanent tax cuts would have been more apparent. Lawmakers might have faced up to the tax cuts’ likely fiscal damage much earlier, by suspending them or even by not enacting them in the first place.
To be sure, Kansas law does require the annual budget to include a cushion equal to 7.5 percent of spending. But that’s not the same as a rainy day fund. Lawmakers have often suspended that requirement in recent years, including this year. Even when in effect, that cushion is too small; the average state needs a fund of 15 percent or more to weather a moderate recession.
Other states can learn these lessons about reserve funds from the Kansas experience:
- If you don’t have a rainy day fund, create one. A rainy day fund moderates the need for large tax increases or spending cuts during economic downturns. Colorado, Illinois, Kansas, and Montana are the only states without a formal one.
- Build up reserves in good times. As the economy slowly recovers from the Great Recession, this is a good time to replenish reserves before the next downturn. In Kansas, year-end balances grew from 2010 until 2013 but have since plunged as the state drew on them to offset the revenue lost through tax cuts (see chart). Kansas expects to have a balance near zero by next June (the end of fiscal year 2015) — and, in reality, it likely will reach zero well before then. This will leave the state unprepared for unanticipated revenue declines or spending increases. In contrast, states with formal rainy day funds are restocking them. State year-end balances have doubled since 2010, on average.
- Use rainy day funds only for temporary, unexpected revenue declines or expenses. A rainy day fund is designed to fill in short-term budget holes. Using one-time funds like balances from prior budgets for ongoing spending or tax cuts creates a future imbalance between revenues and spending. In Kansas, whose tax cuts will permanently reduce state revenues, the current budget is $326 million larger than the state forecasts it will collect in revenues — and the revenue forecast is optimistic, so the real problem likely is even larger.