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Why the shortfall reserve is important
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Over the past few months, we have discussed the perspective of bond rating agencies and their opinion of Georgia’s fiscal governance. In review, Georgia keeps the highest bond rating available because of these factors:

Georgia has a well diversified economy that, while lagging the national recovery, still is positioned to recover in the medium term.
Georgia, unlike our national counterparts, has a history of making tough decisions when faced with budget shortfalls.

Georgia has always been committed to good financial practices and oversight.  Retirement and debt obligations are properly funded and treated with caution.

Georgia has a revenue shortfall reserve (RSR) that has provided a cushion when economic downturn has struck the state budget.

This week we will discuss this last item by exploring how the RSR works, how it has buffered the state in the past and how to ensure it is there the next time it is needed.

RSR overview

The RSR was set up to be the “rainy day” fund of the state. Any revenue collected over budgeted expenditures is automatically added to the RSR along with any unspent state agency funds at the end of the fiscal year. The RSR is capped at 15 percent of prior year revenues according to state law.

Withdrawing funds from the RSR can happen in one of three ways:

If revenues have not come in as budgeted, the RSR can be used to cover the deficit.

If the RSR exceeds 4 percent of the prior year revenues, the governor can include in the revenue estimate and appropriate any excess above 4 percent.

One percent of prior year revenues can be released from the RSR in order to fund K-12 needs.

At the end of FY2011, the RSR stood at $445 million, which is the equivalent of 2.69 percent of prior year revenues. Putting this amount of money into context is very important because while that seems like a lot of money, it really isn’t.

Currently the state of Georgia collects over $18 billion in state taxes and fees. This easily puts Georgia on the scale of a Fortune 500 company in terms of revenue collections. The state’s current services range from educating preschoolers to university students, providing safety net health care for over 2 million people, incarcerating over 50,000 prisoners and providing patrolled and maintained roadways among other things.

On average, the state spends approximately $40 million-$50 million a day for state operations (a third of this indirectly is for teacher salaries alone). An RSR of $445 million, while seemingly large, would only support state operations for nine to 11 days. It should also be noted that this figure also includes $165 million that will be utilized in the amended budget for K-12 needs. Many companies would argue that having 30 days of operations is prudent. 

The RSR since 2000

The size of the RSR is debatable because Georgia is not a private company. Since the funds in the reserve are primarily the result of tax collections, fiscal leaders have tried to set a balance of providing a cushion to the state budget without unnecessarily tying up taxpayer dollars.  Probably the best way to gauge the appropriate level of reserves is to look at the RSR since 2000. Since that time, Georgia has weathered two recessions with the help of the RSR.

In 2000, the RSR stood at approximately $1.66 billion, well over the 30-day mark. In 2001, the reserves rose to its record peak of $1.8 billion. It was around this time that the economic downturn following 9-ll started to take its toll on Georgia’s economy and budget. In 2002, budget writers utilized approximately $700 million of the RSR to cover the loss of revenue. By the time the recession ended in 2004, the RSR stood at approximately $197 million.

In three years, the state had utilized $1.6 billion.

The years 2005 to 2007 saw an uptick in the economy so that by December 2007, the reserves were hovering at about $1.7 billion. In 2008, Georgia’s economy started to wane and required approximately $500 million in reserves in June 2008 for year ending balancing. But prior to this, in the spring of 2008, the governor was looking at positive economic news and accordingly proposed the largest revenue estimate ever for FY2009.

As the economy got gloomier and gloomier, this revenue estimate had to be adjusted five times.  Even these corrections were not enough to avoid utilizing the RSR to the tune of over $900 million in FY2009. At the end of FY2010, the RSR hovered around $250 million.

This rapid replenishment and usage is the main reason why bond raters monitor the RSR so closely. It is interesting to see that Moody’s, one of the three credit agencies has the RSR in both Georgia strengths and the credit weaknesses categories. The RSR is credit strength because Georgia has a “history of rapid reserve building (after the 2001 recession)” but is a credit weakness because of “near depletion of reserves.”

The future of the RSR

As we think about the upcoming session and the budgetary choices state leaders have to make, it will be important to keep the RSR in the back of our mind. With anxiety about the national economy and the recovery, it is not farfetched to believe if the state budget will need the RSR again. It will be important to make budget decisions so that the RSR will be ready if we need it again. There will always be a decision to be made as to whether to spend increased tax collections or to carve out funds for building up the RSR. 

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