KY Policy Blog

Kentucky Response to COVID-19: Inadequate Rainy Day Fund Heightens Need for Federal Aid and More State Revenue

By Jason Bailey
March 13, 2020

States set aside rainy day funds to draw on when economic downturns or crises hit. Governor Beshear may well need to tap the state’s rainy day fund to deal with the costs of directly addressing the COVID-19 pandemic, which he has the authority to do after declaring a State of Emergency.

But Kentucky has among the most depleted rainy day funds in the country, with only enough money for the equivalent of 4 days of state budget needs (and 10 days by the summer, after additional dollars are scheduled to be deposited). Because a possible economic downturn from the COVID-19 pandemic would mean less revenue and rising budget demands, that won’t be enough money to prevent more cuts to services and resulting economic harm.

The Kentucky House budget proposed to add more money to the fund over the next 2 years, but that will only bring the balance to the equivalent of 12 days of state budget needs by June of 2022. In contrast, the median state across the nation had 40 days of savings in its rainy day fund back in 2018.

Lessons from the Great Recession

The experience of the Great Recession shows how important rainy day funds are. Kentucky’s rainy day fund balance was just $232 million in 2007, or 2.7% of revenue. Two things happen when a downturn hits: Revenue goes down, and expenditures go up — especially for programs like Medicaid, for which more people become automatically eligible because of lost jobs and income.

In Kentucky between 2008 and 2010 as the Great Recession occurred, General Fund revenues fell by $439 million — more than the $232 million the state had in its rainy day fund. At the same time, as unemployment rose and the economy sank nearly 100,000 more Kentuckians became eligible for Medicaid, and that program’s expenditures grew by 20% over just that two-year period.

While the Great Recession set in motion consecutive rounds of budget cuts, the state budget would have been completely overwhelmed if the federal government hadn’t stepped in with major financial assistance. Through the American Recovery and Reinvestment Act (ARRA, or the “stimulus”), the federal government increased the share of Medicaid cost it paid, known as the Federal Medical Assistance Percentage (FMAP).

As a result, federal spending on Medicaid in Kentucky rose by $1.3 billion between 2008 and 2010 but state General Fund spending actually declined by $291 million — saving Kentucky over $1 billion in state funds in 2010. The federal government also shored up the state budget through large, flexible grants from ARRA’s State Fiscal Stabilization Fund, and provided assistance in a variety of other ways. All support to Kentucky’s state budget through ARRA totaled $3.4 billion over just 3 years.

By protecting against even deeper budget cuts, this assistance prevented steeper job loss that would’ve been an additional drag on the state economy.

Aggressive and quick federal and state action are needed  

An economic downturn from the COVID-19 pandemic may or may not be shallower than the Great Recession, but either way the weakness of our rainy day fund makes Kentucky vulnerable. And unlike at the beginning of the Great Recession, Kentucky’s budget has since been depleted through 20 rounds of cuts, which the legislature hasn’t yet begun to restore. COVID-19 and a resulting downturn will not only increase demand for programs like Medicaid, but also add strain to our public health system and other state services.   

Serious and fast action is needed especially at the federal level but also by the state in light of the concerning economic picture, including the following:

The federal government should immediately expand the FMAP and should then move on to enacting other forms of state fiscal assistance. Increasing the FMAP not only protects the state budget from rising Medicaid costs, ensures protection of eligibility and benefits and frees up the state budget for other expenses, but it can also be designed to directly help address the spread of COVID-19 by covering public health expenses related to testing and other needs. An increase in the FMAP is part of the Families First Coronavirus Response Act proposed in the House.

The state should include new revenue in the budget it will soon pass to help meet immediate needs, shore up the rainy day fund and better prepare for a potential downturn. In this blog post, we outline a set of commonsense revenue-raising measures — most all of which have already been introduced as legislation in the General Assembly — that can be tools to help protect against harmful cuts to core services.

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