Offering frequent news and analysis from the majestic Evergreen State and beyond, The Cascadia Advocate is the Northwest Progressive Institute's unconventional perspective on world, national, and local politics.

Monday, February 06, 2006

Rainy Day Fund

"First, assume the can opener," said the economist to his fellow castaways. The motley group was tranded on a desert island, surrounded by miles of open sea, but blessed with the unlikely good fortune of having cases of canned goods float in on some wreckage. Unfortunately they had no way to open the cans. All the suggestions were messy or impractical, like hurling cans from atop the palm trees onto rocks or gnawing them open with their teeth. The economist penetrated the situation with logic.

You might say those of us who advocate a rainy day fund are like the economist assuming the can opener. We call for it when we need it, but forget about it when there is a surplus. (You might say that, I don't.) Here we have a budget shortfall. Wouldn't it be nice to have a rainy day fund so we don't have to raise taxes. Sheesh, of course, a rainy day fund instead of taxes. A no-brainer. So we set about creating a rainy day fund from our imagination. See how practical we are?

I was reminded of this when I was visiting Bellingham last weekend [to see a brilliant student production of Jean Anouilh's Antigone directed by Emily Harvey, a junior in the theater program there]. I stayed over with some friends, and the next morning opened the Bellingham Herald and found a piece by Dick Startz of the UW's Economics department.

Professor Startz does better than most. For example, he understands that job growth is the most reliable general-purpose economic indicator. He recommends not allowing a raid on the rainy day fund unless job growth is below 1%. That's fine.

But, a reminder: We don't have one to raid. Professor Startz implicitly suggests constructing one from the current state budget surplus. But as I've said here before, this surplus is really only a temporary cash flow anomaly. The "plus" now is from the housing boom. It will be a minus later, probably carrying over the same exclamation point.

Governor Gregoire has the right idea. Her $900 million in reserves does not constitute a rainy day fund, but a simple set aside for next biennium. Mandatory expenditures await us there that will swallow up the $900 million and come looking for more. (Did you see her State of the State speech where she was gesturing up and down to demonstrate the roller coaster. Made me queasy just to watch it.)

Now, on this stage, your humble servant is going to do what the economist on the desert island could not, what in spite of his endowed chair and many honors Professor Startz could not. I am going assume a rainy day fund that could actually come into being. Now. Today. Present tense. (Could. I'm not saying should.) Ready?

Debt-financed! Ta-da!

Yes. We borrow it now before interest rates get out of sight, and pay it back in good times.

Why is this better? One: We could have it when we need it. Two: Reducing state spending to fill the fund in good times, even if it were politically possible, would depress economic activity without a good reason. We might be forced to use our rainy day fund before we could even admire very long. State spending and services are key supports to our economy. The idea that government is a vampire feeding on the vigorous private sector economy is nuts. It is a story repeated often enough to gain currency among the easily persuaded, but it is still nuts. Three: It's cheaper to borrow in bad times. Not so much competition.

Objection 1: We cannot borrow like that. The state is required to balance its budget.

Wrong. Washington has a limit on the percentage of the budget going to debt service, and traditionally this has been reserved for capital construction bonds. But there is no constitutional requirement that the budget be balanced. (If you're about to rant about spendthrifty liberal pinko queers, check the federal budget deficit and your party affiliation, or log onto Tim Eyman and the Renegade Right. Then come back for a little liberal responsibility.)

Objection 2: You assume we can pay it back. With the current revenue architecture, that day will never come.

Touche. (Remember I said could?) It doesn't make sense to create a fund if we can't pay it back. And if you don't like debt financing, you're out of luck anyway, because we will never have a surplus big enough to fill such a fund. Our current revenues are barely adequate this year. They won't be in the next biennium and in all biennia thereafter. Budget drivers like health care costs on one side and eroding revenue from Eyman, et al, on the other, will open a gap that will never close.

Objection 3: We have no idea how big a rainy day fund should be. Downturns typically last more than a year. We want to get off the roller coaster, not just delay the drop.

Ouch. That's right. Some national groups have suggested five to fifteen percent of expenditures is a good size for a rainy day fund, but that not much more than an arbitrary, generalized guess. Individual states have idiosyncratic tax schemes and will thus have different variability from high to low. They have different economies as well, and different expenditure patterns. (The state with the biggest rainy day fund as a percentage of expenditures is Alaska. Alaska subsists on oil revenue, completely stable, not requiring any rainy day fund at all.)

I once calculated on the back of an envelope that Washington would need about 85 percent of its annual operating budget to completely iron out its historical ups and downs. That's $20 to $25 billion. Much more than the $5 billion that is most commonly talked about. Also much more than we could possible borrow for such a purpose.

But there is a concept that was once used at the federal level (when they knew what they were doing). It is called the "full employment budget." You may remember "structural deficits." Structural deficits were calculated from what revenues and expenditures would be at a level of "full employment," assuming away the current actual economic situation. This revealed the underlying adequacy of revenues (or excess of expenditures, if you like). The state of Washington has a structural deficit. A "structural budget" could tell us not only what size a rainy day fund should be, but would help us know what the baseline level of revenue should be.

A rainy day fund is only practical in the presence of a balanced and adequate revenue architecture -- the ultimate can opener.

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