Is California’s Rainy Day Fund A Pipe Dream?

California Rainy Day Fund

When It Rains in California

Revenues are not “going gangbusters,” as we used to say in the heady days of the housing market bubble. Rather, moderate revenue growth is exceeding the cautious forecasts of economists. It’s good the economists have erred on the low side. This is an important distinction, not understood (or reflecting feigned ignorance) by interests who want to either spend the extra money, or “give it back to the people” as tax cuts, as soon as possible.

California’s Governor Brown apparently doesn’t want to do either. He’s out front, advocating a “rainy day fund” to help the state smooth out its boom and bust cycles. “Good government” politicians, and the fiscal wonks advising them, have been advocating sound rainy day funds since feudal lords started collecting taxes in the middle ages, and realized their armies still needed to be fed and clothed when the crop was bad.

All states have something they call a rainy day fund, accompanied by some sort of spending or revenue limitation that’s designed to make money available for a reserve fund. Practically all such mechanisms have failed or fallen short. At best, they’ve worked well for two or three budget periods, before collapsing.

By proposing a limit on revenue, rather than a spending limit, Governor Brown is off to a good start. Spending limits are much more porous, leaky, and easier to game, than revenue limitations. Revenue limits work a lot better, simply because, as former Federal Reserve chief, William McChesney Martin, once remarked, “our main job is to take the punch bowl away just as the party is getting good.”

But, writing the full proof revenue limit isn’t easy either. Which of the vast array of state revenues are covered by the limit?  Does it apply only to “new” revenue?  What if the federal government increases it’s grants to the states, freeing up state revenue for other uses?  Indeed, what is “revenue?” Or, what is a “tax?”

You can ruin a revenue limit pretty quickly by just calling a new tax “Gertrude” (or “Irving”) instead of a “tax.” Or you can tinker with the complex formula that’s supposed to channel excess revenue to the rainy day fund. A really easy way to undermine a revenue limit is to go on a tax cutting binge, as soon as the amount in the reserve becomes material. Or you can send the extra money back to the taxpayers. How many politicians can resist announcing that “a check is in the mail,” rebating your property taxes for the last year?

Tax rebates are actually better than cutting taxes, because tax reductions erode the tax base permanently. Then, using the reserve when its raining becomes irresponsible, because it’s not sustainable. Of course, why even go through all these maneuvers. All you have to do is suspend the formula that directs extra revenues to the reserve……”just this one time.” “Not to worry, we won’t do it again.”   Or “we’ll do it till we need glasses.”

Easier still, is repealing the annoying revenue limit. After all, its just a law, like any other; there’s nothing to bind future Governors or Legislators. But how many voters will really care about the reserve when they’re getting more services or lower taxes? And, if your state has a really “progressive” initiative and referendum” process, any well funded interest group can gain voter approval to demolish the revenue limit or steal money from the rainy day fund.

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If You Know How to Fish, You Don’t Need an Umbrella

1) The revenue limit, needs to be backed up by a simple requirement that a small percent (maybe 1%) of all forms of revenue — user fees, interest earnings, money from unclaimed properties, and even “Gertrude” monies – need to be deposited quarterly in the rainy day fund, no matter what, even during bad times. During bad times, you can take the money right out again, but it needs to go into reserve first, just like the automatic deposits you set up for your daughter’s college fund.

2) The 1% requirement, along with a (simple) rule governing when and how the money can be removed from the reserve and spent, also needs to be enshrined in the state constitution. Placing this sort of thing in the constitution is dreaded by some and laughable to others. But the whole point is to make it hard to evade.

3) Because the rule for when the money can be accessed needs to be relatively short and simple — you want to avoid a 10,000 word amendment to a constitution — it needs to be backed by a constitutionally enshrined body which interprets and applies the rule. Sure, that can make it porous again, but if this commission has equal membership from the two top caucuses in the state legislature, with the tie breaking member appointed by this initial group, there are a lot of protections.

 4) And, the amount in the reserve needs to be capped – perhaps, at 5%, 7% or 10% of total revenue, so the politicians can experience the joy of sending a (one time) check in the mail (with their names on the signature line) back to the taxpayers.  There’s got to be something in this for the politicians.

Is all of this hard and nerdy? It sure is. But it’s the only approach that has a chance of working. It just might provide a real reserve, if you can keep it.

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5 thoughts on “Is California’s Rainy Day Fund A Pipe Dream?

  1. Rosemary Ryan

    I appreciate your economist’s view of public policy issues that are familiar to me from a social welfare perspective. Can’t recall now what the topic was, but I do remember a sense of delight in what, to me, was the novelty of your approach.

    I am enjoying your blog. It’s fun to be privy to the variety topics you think about.

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    1. Irv Lefberg

      Thank you RR. The rainy day fund piece was a little nerdy. I tried to consolidate the key things I learned about that from my horrible 601 experience. I don’t necessarily favor such limits, but i do know which type work (maybe) and which don’t, and how to get around them or make them hard to game. With 601, the lawyers (unintentionally) gutted it because they didn’t understand how the budget worked, and made interpretations that made it useless as a limit. Then everybody else piled on Lots of fun.

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  2. Alex MacLachlan

    Yes its a pipe dream. It reminds me of all the people who stopped paying their mortgage in the last few years and stayed in their homes. All of the sudden they are driving new cars and going on vacations and pretending they don’t have a 30 yr obligation they are defaulting on. Irv, you often speak of tipping points. In San Diego, pensions take up 25% of the current budget. I doubt California is much different than that, but haven’t looked it up. At what point does deferred maintenance of public needs dissect the line of rising pension costs? There must be a point at which the public notices higher and higher taxes and fees and deteriorating or non existent public services. Salaries already take up 60% of our school budgets at a time when music, arts etc get moth balled unless PTA Moms turn into permanent unpaid fundraisers for their kids school. That’s why there are have and havenot schools, because poorer neighborhoods don’t have non working parents to donate a lot of time to the school. These are only a couple examples of a government that won’t live within its means causing disadvantage at the street level. That we have one that will boldly insult our intelligence with claims of surplus and sound management, just shows we are at a higher level of financial danger than one that will take on its biggest obstacles first before playing Happy Days Are Here Again.

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  3. Irv Lefberg Post author

    Hi Alex

    Thanks for another provocative comment with a lot of good insights. I agree with you (perhaps more than you may think) on a lot of what you say about the fiscal mess around public sector pension plans in many places. I know less than I should about California the State (regarding pension obligations) than I do about the pension problems of large and mid size California cities and counties. A lot of them are in deep trouble. I believe it has been worse in California than most anywhere else.

    I would be very happy if most workers (private and public) had reasonable, sustainable pensions, by any number of means (including self funded; or non defined benefit, where employees share the risks). But we don’t have that. In fact, we have less of that now than before the 401-Ks were decimated in the 2007-10 financial collapse. And, as long as the typical (private) worker and taxpayer is pension-less, it was a huge mistake for many governments to fund Cadillac (or even Buick) plans for government workers, at taxpayer expense, and at expense of public services, while the typical taxpayer didn’t have any.

    It would be useful, BTW, to research what percent of government workers in the country have Cadillac versus Buick versus Chevy versus Yugo pension plans. Washington State went from the Cadillac to the Buick (some say it’s a Chevy) fairly early, so its not in quite the same mess as California.

    I am naïve enough to believe that the more mature Brown (Brown II) genuinely believes in a real rainy day fund and understands that California’s debt problems are not on the verge of being solved just because it ran some current account surpluses for a couple of years. But I don’t think a lot of his compatriots in the D caucuses are ready (at all) to put the state on a sustainable path. What I think is really going to happen is that Governor Gerry will get some sort of bill passed that enables him to say “we now have a rainy day fund,” but it will have more holes than swiss cheese.

    I actually do think that if they locked you, me, O’Keefe and Rosemary in a room for a few months, with lots of pizza and avocado salads, we could solve a lot of problems. But that ain’t going to happen unless we contributed a few hundred million to both RNC and DNC.

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