These huge gains can be a mixed blessing: They provide revenue for states but can become a risk later when interest rates ease and earnings drop. The questions for states now are how far this revenue will fall and whether policymakers are prepared for the decline.
The surge in earnings came even though states generally invest money from operating surpluses and reserves conservatively; they prioritize maintaining liquidity and minimizing losses over maximizing gains. States often combine dollars from various accounts into pooled investment funds, which they use to buy safe investments such as U.S. Treasury bonds. The earnings from these pooled investments are sometimes directed to states’ general funds, which are states' primary operating accounts.
In several states recently, these pooled investments have turned into a much larger source of revenue than in previous years. In New Hampshire, such earnings were the state’s largest source of revenue growth in dollar terms in fiscal year 2024. In Florida, interest and investment earnings before the COVID-19 pandemic were $223 million; by fiscal 2024, this revenue was over a billion dollars. Alabama reported a 902 percent increase on interest earnings from state deposits for fiscal 2023 compared with fiscal 2022. Illinois’ revenue earned from interest and investments rose 1,257 percent during the same period.
To understand how states are using this unexpected revenue and whether they’re preparing for the expected drop, The Pew Charitable Trusts corresponded with fiscal staffers in 14 states in which budget documents or news media reports highlighted rapid growth in investment earnings. The responses revealed that several of the states are using the earnings for ongoing expenses — potentially setting themselves up for budget problems when the expenses continue but the revenue to pay for them does not. Others, however, have recognized this risk and have implemented practices to mitigate it — practices that focus on ensuring that temporary revenue is used only for temporary costs.
Why Earnings Surged and Why They Will Fall
Although high inflation hurt states’ bottom lines in certain ways — for example, states had to pay more for workers and goods — the increase in investment earnings provided clear short-term benefits. There was a substantial increase in investment earnings, which are usually directed to the general fund in Florida, Maryland, Michigan, Montana and Pennsylvania (five states chosen because they had data on investment earnings directed to the general fund going back to fiscal 2019 and had projections through fiscal 2026). The five states saw increases from fiscal 2022 to fiscal 2023 ranging from a 216 percent increase in Florida to a whopping 2,729 percent increase in Pennsylvania. Other states had similar experiences.
However, Figure 1 these states estimate that revenue from this source may have peaked. As states have less to invest — states’ total balances, including rainy day funds and leftover general fund dollars, declined by $124.3 billion from fiscal 2023 to fiscal 2024 — and as interest rates drop, almost inevitably investment earnings will not be as large as they have been in the last few fiscal years. The data collected suggests that Florida, Maryland, Montana, and Pennsylvania’s earnings from this source peaked in fiscal 2024, while Michigan’s peaked in fiscal 2023.
Earnings Spike and Then Crash
Interest earnings typically only make up a small portion of general fund revenue for states. In 2019, prior to the pandemic, Michigan’s revenue from this source made up only 0.1% of general fund revenue. However, in 2024 it was 4.2%. The increase in revenue from this source is so unusual and the expected decline is sufficiently steep that the loss of this source of revenue growth could meaningfully change states’ fiscal outlooks.
Even with the expected decline in interest and investment earning revenue, states don’t inevitably face fiscal problems. In fact, some states are implementing strategies to avoid such challenges in the years ahead.
One straightforward solution is simply to not use investment dollars for general fund expenses — thus avoiding a shortfall when the revenue sources decline. For example, in 2023, Ohio Republican Gov. Mike DeWine vetoed a measure that would have directed rainy day fund interest earnings to the general fund, noting that “allowing the [rainy day fund] to continue retaining its interest ... will preserve budget stability.” And legislators in Montana, recognizing the extraordinary nature of the state’s investment earnings, passed a law for fiscal years 2023-25 requiring all interest earnings that otherwise would be deposited into the general fund to be transferred instead to a newly created fund to pay down existing state debt. Like Montana, several states are using interest earnings for purposes that lawmakers will not feel obliged to continue after the revenue declines, such as one-off infrastructure projects or special debt payments.
Of course, not all the interest and investment earning revenue will disappear in the future. When states analyze how much of this revenue is truly out of the ordinary, they can then safely use the ongoing portion to pay for recurring expenses while using the temporary portion for one-time costs. In Utah, for instance, fiscal staff conduct a trend analysis and then treat as a one-time increase any revenue from interest and investments that is above the long-term trend.
Similarly, Alabama puts interest earnings in the general fund but recognizes that such revenue will not continue at the same level. Kirk Fulford, deputy director of Alabama’s Legislative Service Agency, Fiscal Division, told Pew, “We have been preparing for the inevitable decline as more of the funds are expended and the rates decline over the next couple of years. We have attempted to focus the ‘extra’ or abnormal growth in these funds toward one-time and not ongoing expenses.”
States such as Alabama and Utah that routinely identify nonrecurring revenue have a head start at implementing this type of approach to manage extraordinary investment earnings.
Projections of interest and investment revenue have helped policymakers in other states determine how much ongoing spending they can afford. For example, New Hampshire uses long-term projections to determine the amount of investment revenue that lawmakers can spend in the operating budget, with the thinking that the state doesn’t want to commit to spending more now if it can’t sustain that spending in the future.
Although the surge in interest and investment revenue going into general funds is unprecedented in recent state government history, the basic policy problem — what to do with a temporary increase in revenue collections — is not. States often experience spikes in one-time revenue, whether from higher tax collections during an economic boom, temporary federal aid, a major legal settlement, or something else. Many of the strategies states are using now to avoid budget problems from interest and investment revenue declines can also be used to manage temporary revenue more generally. By limiting the use of one-time dollars for ongoing expenses, states reap benefits from revenue surges without putting themselves on paths to painful fiscal cliffs.
This story was first published in The Pew Charitable Trusts. Read the original here.
