Association for Public Policy Analysis & Management

Facing the balanced budget requirement for almost all American states, state fiscal policymakers have three options to cope with the revenue shortfalls in fiscal recessions. The balanced budget may require cutting expenditures or raising taxes. An alternative way is to use the Budget Stabilization Funds (known as Rainy Day Funds, RDFs), which accumulate during economic booms, to make up for the budget shortfalls during fiscal downturns. Using the savings to reduce fiscal volatility in economic recessions is considered to be a viable approach given that expenditure cuts and tax raises are politically difficult. RDFs have similar characteristics and utilization with the general fund surplus in stabilizing states' budgets, while RDFs are used under different deposit, withdrawal, and usage restrictions.

Previous studies on RDFs focus on three fiscal crisis periods after the sharp emergence of RDFs in the early 1980s, that are, 1980 to 1982, 1990 to1991, and 2002 to 2003, and results and conclusions from these studies are various, or even contradictory. However, few studies have paid attention to the effect of RDFs in the most recent economic crisis that began in 2008, which is named the Great Recession, the most serious economic recession since the Great Depression.

The question that will be explored in this research is whether the RDFs exerted a significant constructive effect on alleviating the fiscal stress in American states during the Great Recession. In the case of great seriousness of the economic recession, the existence of RDFs in the vast majority of states, the accumulated experience of state policymakers in using RDFs in economic downturns, in addition to the “stimulus package” from the federal government, the effect of RDFs on alleviating fiscal stress in the recession should be newly evaluated.

The contributions of this research to literature come in at least three ways. First, it employs a new approach to estimate fiscal stress. Second, it evaluates the effect of RDFs, incorporating the unprecedented “stimulus package” to states from the federal government. At last, it analyzes the effect of RDFs in the most recent economic recession that began in 2008, which is rarely seen in the published research.