A look at states’ recession-readiness

Erick M. Elder

As the first months of 2016 pass by, many states begin the difficult work of ironing out their next budget. And with the markets off to one of the worst starts in history, the painful choices made necessary by the Great Recession are no doubt still fresh in the minds of veteran policymakers. But does that mean states are truly prepared for another downturn?

It depends on which state you live in, according to my Mercatus Center at George Mason University research comparing each state’s “rainy day fund.”

Most states use a rainy day fund to save for a recession. RDFs are useful to supplement revenue when it dries up, helping to avoid tax increases or spending cuts to vital services during an economic downturn.

This is especially important because revenues tend to recover very slowly after a recession. For example, the Great Recession started in December 2007 and “ended” in June 2009. As a nation, gross domestic product fully recovered to pre-recession levels in the third quarter of 2011, but state government tax collections didn’t recover until 2014.

Despite states having accumulated savings equal to 11.5 percent of expenditures in 2006 (much greater than the historical average of 5.7 percent), the RDFs were generally wiped out by 2009 and 2010, due to the severity and duration of the Great Recession.

By measuring how quickly each state’s economy has grown during expansions, shrunk during recessions, and how long these periods have lasted, we can calculate how large of a budget shortfall each state is likely to experience during an economic slowdown. Comparing this information with the actual amount each state has already saved gives us an idea of how prepared each is for the next recession.

Alaska, West Virginia, Nebraska, Iowa, South Dakota, Texas, Wyoming, Indiana, Florida and South Carolina are the 10 states most prepared for a downturn. They should have enough saved to offset 80 percent or more of the revenue they’d be likely to lose.

At the other end of the spectrum are Illinois, Pennsylvania and New Jersey, which have only enough savings to weather a very mild economic downturn.

Whether your state is relatively prepared or unprepared for the next downturn, the good news for taxpayers and for people who rely on government services is that smart policymakers will learn from the past. States that save more money in anticipation of a future rainy day won’t be quite so jittery when the storm clouds begin to gather.

Erick Elder is a professor of economics at the University of Arkansas at Little Rock. He wrote this for InsideSources.com.