Texas’ Rainy Day Fund Projected to Hit Cap for First Time Record Growth Fills State Savings Account

By Jamie Falconnier and Moise Julot Published March 2023

The extraordinary economic factors that have given the 88th Legislature an unprecedented amount of money for general-purpose spending also are generating record high revenues for Texas’ Economic Stabilization Fund (ESF), the state savings account that’s commonly called the Rainy Day Fund.

For the first time, the Comptroller’s office, in the 2024-25 Biennial Revenue Estimate (BRE), projects that the ESF in 2025 will hit the upper limit on its balance, which in each biennium can be no more than 10 percent of the amount of certain revenue deposited into the General Revenue Fund during the previous biennium. Comptroller Glenn Hegar, whose BRE sets parameters for the state budget, stresses the responsibility that goes along with unique funding opportunities.

“The revenue increases that we have seen truly have been historical and unprecedented. We have never seen anything like this in the past, and I don’t think we’ll see anything like this in the future,” Hegar says. “I am glad to see that lawmakers are giving careful thought to how this tremendous asset can be best put to work for Texans.”

Record growth in tax revenue collections in 2022 contributed to a projected $32.7 billion ending balance in 2022-23, aided by a remarkable economic rebound after pandemic restrictions were lifted, spikes in energy prices and — unfortunately — the highest rate of general price inflation in 40 years. In fiscal 2022, total tax collections rose by 25.6 percent (PDF) from the previous year; to put that in perspective, the maximum change in years prior was 13.4 percent. Sales taxes rose by 19.3 percent, motor vehicle taxes by 12.5 percent and severance taxes (i.e., taxes from oil production and natural gas production) by an astounding 116 percent in 2022 compared with 2021, all well above the average growth rates between 1996 and 2021 (Exhibit 1).

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BIRTH OF THE RAINY DAY FUND

The ESF was created by constitutional amendment in 1988 in the wake of an economic recession caused by plunging energy prices that forced a tax increase. The Legislature structured the fund to automatically set aside a portion of the state’s volatile severance tax revenues, lessening the reliance on this money to support day-to-day expenses. The structure of the fund showed great foresight, as oil and gas prices (and, thus, severance tax revenues) have remained highly volatile. Since fiscal 1997, annual percent changes in severance tax revenue have ranged from 116 percent in 2022 to -53 percent in 2002 (Exhibit 2).

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ESF REACHES RECORD HIGHS

The ESF has proved highly successful not only in reducing the state’s reliance on volatile severance tax revenue but also in becoming one of the largest state savings funds in the nation. Aided by strong growth in severance tax revenues and a large transfer from the unencumbered and unobligated balance of the state’s General Revenue Fund, the ESF balance is expected to rise sharply to $27.1 billion by the end of fiscal 2025, up from $10.7 billion at the end of fiscal 2022 (Exhibit 3).

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FUNDING FOR RAINY DAYS

The ESF is funded primarily with severance taxes. Until fiscal 2015, the ESF received 75 percent of the previous year’s oil production and natural gas production tax revenues exceeding the amounts they yielded in fiscal 1987 — $531.9 million and $599.8 million, respectively. To address urgent transportation needs, voters approved a 2014 constitutional amendment that shifted half of the oil and gas tax revenue that would have been transferred to the ESF to the State Highway Fund (SHF). Barring further legislative action, this arrangement will expire in December 2034, and the transfer to the ESF will return to 75 percent of oil and gas tax collections above the fiscal 1987 threshold in fiscal 2036.

Between fiscal 2023 and 2025, total severance tax transfers to the ESF would be $10.5 billion, with annual transfers well above historical norms. As the ESF is projected to reach its constitutional cap in 2025, about $690 million that would go to the fund will remain in general revenue, and the ESF is projected to receive $9.8 billion (Exhibit 4).

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“Having a state savings account that grows over time is a responsible mechanism to help ensure the fiscal health of the state. At the same time, it exists to be used when necessary. It allows us to weather unexpected downturns and has given us the opportunity to invest in critical needs.” – Comptroller Glenn Hegar

In addition to severance tax transfers, half of any unencumbered and unobligated general revenue balance remaining at the end of a biennium must be transferred to the ESF. An unencumbered balance is the amount not restricted or committed for future liabilities, such as payroll for work already performed, vendor payments, grants payable or future construction expenditures under an existing contract. Absent legislative action, the ESF is projected to receive about $5.71 billion in a transfer from the General Revenue Fund in fiscal 2024, the first unencumbered transfer to the ESF since 2008. Other projected proceeds during this period include $2 billion of interest earned on the ESF balance and investment returns from a portion of the fund.

Notably, lawmakers may take actions to eliminate or greatly reduce the amount of unencumbered general revenue to be transferred to the ESF in fiscal 2024, meaning the fund may not reach its cap in 2025.

WHEN TO SPEND

The Texas Constitution authorizes the Legislature to make appropriations from the ESF in response to a budget deficit during a biennium or a projected revenue shortfall in an ensuing biennium. These circumstances require approval by three-fifths of the Legislature. The Legislature may also make appropriations for any purpose it chooses at any time, requiring a two-thirds majority for passage.

The Legislature has authorized a total of $17.4 billion in expenditures from the ESF since its inception. The targets of these appropriations have included water projects, disaster relief, public education, economic development and health and human services. One appropriation —$3.2 billion in 2011 — was made to cover a budget gap.

The Texas Education Agency (TEA) has received the most funding from the ESF, followed by the Texas Water Development Board (TWDB) and the Texas Comptroller of Public Accounts (Exhibit 5). TEA has received contributions in several fiscal cycles, the largest being $1.75 billion for the Foundation School Program in 2013. TWDB received $2 billion in ESF appropriations to establish the State Water Implementation Fund for Texas in 2014 and about $1.5 billion in 2019 for various infrastructure and hazard mitigation projects. The Comptroller’s office received the largest amount paid by the fund in 2011 to cover the budget gap; it also received a $211 million contribution in 2019 to the Texas Tomorrow Fund.

Hurricane Harvey relief funding was a major expense and a fulfillment of one of the fund’s core functions — disaster recovery. Across 11 state agencies, the Legislature appropriated $1.78 billion in 2019 toward direct relief, plus additional Medicaid, rehabilitation and reimbursement costs.

ESF REFORMS

State leaders have reformed the ESF in recent years to ensure sufficient funds are on hand for an emergency and to maintain the fund’s purchasing power.

The November 2014 constitutional amendment that authorized redirecting a portion of oil and gas tax revenue to the SHF also included a requirement that the ESF retain a “sufficient balance” on hand. Beginning in fiscal 2022, a new statute required the Comptroller to set the sufficient balance at 7 percent of general revenue-related appropriations for that biennium. If the ESF falls below its sufficient balance, transfers to the SHF are reduced or eliminated until the ESF reaches its sufficient balance. The sufficient fund balance for the 2022-23 biennium is set at $8.3 billion.

In 2015, the Legislature authorized the Texas Treasury Safekeeping Trust Company (TTSTC) to invest the portion of the ESF balance above the sufficient fund balance in prudent but higher yield investments through its Texas Economic Stabilization Investment Fund (TESTIF) (PDF), with the goal of maintaining the fund’s purchasing power. Prior to this reform, the TTSTC had invested fund balances in short-term, low-yield, highly liquid instruments, to keep the funds readily available if needed.

In 2019, the Legislature authorized TTSTC to manage the entire non-appropriated balance of the ESF through the TESTIF. This decoupled the sufficient balance from the amount TTSTC can invest to exceed the Treasury return and maintain purchasing power, with the requirement that at least 25 percent of the fund be invested in a manner that is liquid and readily available.

“Despite a difficult environment for investment returns in fiscal 2022, the TESTIF portfolio has produced positive returns over time,” says Anca Ion, chief investment officer at TTSTC. “The latest figures as of Jan. 31, 2023, indicate an annualized total return of 1.8 percent per year since inception, compared with a return of 1.3 percent per year for the State Treasury. Cumulative total return since inception is just under 14.4 percent, which equates to a cumulative value add of approximately $700 million.”

“Despite a difficult environment for investment returns in fiscal 2022, the TESTIF portfolio has produced positive returns over time.” – Anca Ion

CHALLENGING ENVIRONMENT AHEAD

Notwithstanding a record budget surplus and an enviable savings account, uncertainty and challenges persist. Texas’ record revenues are due partly to high general price inflation, adding a considerable burden on Texans’ pocketbooks. And in the near term, as the Federal Reserve raises interest rates to fight inflation, the Comptroller anticipates a mild recession. That makes good stewardship of these funds even more important.

As its population grows, Texas faces a mounting list of issues that require attention — aging infrastructure, broadband connectivity, state workforce salaries and a host of others. With a positive financial outlook and a substantial balance for the 2023 legislative session, lawmakers will face numerous competing interests and ideas on what to prioritize.

Addressing current needs while ensuring that the state remains prepared for economic downturns is a difficult but necessary task for the well-being of Texas. The Rainy Day Fund is a valuable tool in that effort.

“Having a state savings account that grows over time is a responsible mechanism to help ensure the fiscal health of the state,” Hegar says. “At the same time, it exists to be used when necessary. It allows us to weather unexpected downturns and has given us the opportunity to invest in critical needs.” FN

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See additional materials from the Comptroller’s Biennial Revenue Estimate to the 88th Legislature.