Economic cycles have unpredictable timing, but their inevitability is anything but. We do not know when it will occur, but we can say with certainty that the economy will eventually take a downturn. And when it does, Michigan’s state budget is not ready.
Why should we care about that now, as Michigan and the rest of the country are experiencing one of the longest national economic expansions in history?
We think it is important because the slow economic recovery and the desire by state policymakers to return services to pre-recession levels have not provided much opportunity to refill the state’s rainy day fund to levels that would lessen the impact of a recession.
For governments, whose revenue streams are very susceptible to changes in the economic cycles, rainy day funds can play an important role in weathering them, whether they come as showers or hurricanes. A healthy rainy day fund can lessen the need for budget cuts that hurt those who most need assistance, at a time when demand for services is often highest. A healthy fund can also reduce the need to raise taxes, which could create economic problems during a recession.
While saving money is not the most politically popular avenue to pursue during growth periods, it can help in the short term by building a cash pool, lowering the costs of financing capital projects, and preventing the need for cash-flow borrowing because of volatile revenue cycles. The long-term benefits of state savings are not realized until policymakers are faced with revenue reductions due to economic stagnation.
The good news: Michigan’s law that creates the rainy day fund is strong. It is structured in a way that protects funds for a recession, but allows money to be spent when needed; money can only be used when unemployment is high, economic growth is low, or an emergency allocation is made by the legislature. Unlike other states without these restrictions, these clear guidelines ensure that saved funds will still be there and easily accessible during a downturn.
However, the strength of the rainy day fund itself can only be judged by its ability to lessen the impact of a recession on the state budget. After sitting empty for most of the last 16 years due to back-to-back recessions, Michigan’s rainy day fund is starting to see some growth. The fund balance is projected to reach $890 million by the end of this fiscal year, marking the second highest level of such savings Michigan has amassed.
We can judge from previous recessions that even $890 million is not enough. Based on this experience and outside studies, it is estimated that Michigan would need roughly $1.5 billion to prevent budget cuts or avoid raising taxes for the General Fund alone. Adding in the needs of the School Aid Fund, that $890 million by the end of FY2018 would likely leave Michigan needing to make tough budgetary choices.
The Governor and Legislature’s efforts to rebuild the rainy day fund are commendable. But based on how severely past recessions have impacted Michigan and the relative size of the government operations that depend on state resources, $890 million, the 13th-lowest balance among all states when adjusted to state revenue, is not enough.
We encourage state leaders to keep saving for the inevitable bad weather ahead.