The Task Force was charged with making three explicit recommendations. Each of the areas reviewed during the Task Force’s meetings, focused on the topics reviewed in the previous section, helped to define the broader recommendations from the Task Force. While there was not a formal vote on the recommendations, there was general support across the membership.
- Appropriate Stabilization Fund Size
Key Takeaways
The Commonwealth Stabilization Fund performs well against historic measures for a sufficiently funded reserve. Based on FY 2024 year-end totals, the Stabilization Fund represents 16.5% of General Fund expenditures. This exceeds the Center on Budget and Policy Priorities recommendation of 15% of said expenditures and is relatively close to the Government Finance Officers Association recommendation of two months of General Fund operations, or ~16.7% of general fund expenditures.
While the state performs well against these standards, the Task Force noted that a one-size-fits-all rule for reserve balances does not account for each state’s relative volatility or prioritized core programs, such as healthcare and education in Massachusetts.
Recommendations
The Task Force agreed that the more formal establishment of a multi-year budget forecast and stress test of the Stabilization Fund would strengthen the state’s policies around the appropriate size of the fund. Given the unpredictability of tax revenues and the ever-changing landscape of spending pressures, a stress test will create more specific metrics for what Massachusetts may need from its reserves, rather than using a one-size-fits-all measure.
The Task Force also coalesced around the idea that the group should be reconvened regularly to ensure that the state is consistently using best practices and collectively monitoring where the Stabilization Fund stands compared to our needs.
- Appropriate Level and Means of Funding Long-Term Liabilities
Key Takeaways
The current distribution of capital gains over the statutory threshold established by Section 5G remains reasonable (90% to the Stabilization Fund; 5% to the Pension Liability Fund; 5% to the State Retiree Benefits Trust Fund). This mechanism is the primary source for building the Stabilization Fund, while it provides a supplement to the other liabilities’ primary funding sources. Section 5G has contributed nearly 75% of the resources that have built the Stabilization Fund since the Section 5G policy went into effect in FY 2011.
The state is statutorily required to amortize its unfunded accrued actuarial pension liability by FY 2040. Annually, a pre-budget transfer is made to the Pension Liability Fund, based on a triennial schedule submitted to the Legislature by the Executive Office for Administration & Finance. The Task Force’s review of the state’s progress in funding this outstanding liability demonstrated that significant progress has been made. This is reflected in current forecasts projecting amortization of the liability by FY 2038 (based on the most recently adopted triennial pension schedule) compared to the required FY 2040.
Recommendations
Consistent with one of the recommendations in the previous section, the establishment of an annual multi-year budget forecast in tandem with budget stress testing can help determine reasonable adjustments to long-term liability financing policies. For example, budget stress testing can help the state determine adequate Stabilization Fund balances to manage various recessionary scenarios. While the current Section 5G transfer structure remains reasonable, forecasting and stress testing would allow the state to be more intentional with the use of the policy to meet current needs.
Similarly, the adoption of a regular pension risk reporting and stress testing process would help policy makers better plan for economic downturns and assess the sufficiency of the annual pre-budget transfer to pay down the liability. In addition, based on Pew analysis of other states, layered amortization was identified as a policy worth considering in the future. The methodology pays down the actuarial and investment losses experienced each year over a fixed payment schedule. Losses or gains in subsequent years are assigned a new payment period rather than being funded over a decreasing number of years. The state’s existing unfunded liability would still be amortized by FY 2040. Connecticut, Maryland, and Minnesota are peer states that have more recently switched to this approach.
- Amendments to the Mechanisms Funding the Stabilization Fund and Other Long-Term Liabilities
Key Takeaways
Pew analysis indicates that the Section 5G threshold dictating capital gains taxes available for the budget has fallen behind actual economic and revenue growth – indicating that a $300 M to $600 M prospective upward adjustment may be warranted. Additionally, adjusting the threshold based on annual GDP growth, versus the 5-year compound annual growth rate, or utilizing an inflation-adjusted moving average of actual capital gain receipts to set the threshold each year could help the threshold better keep pace with real-time economic activity.
The Task Force also discussed that better definition around Stabilization Fund withdrawal polices could strengthen the state’s efforts to ensure the fund’s long-term sustainability. Pairing stronger definitions of the appropriate use of the funds with a fuller recession tool kit can ensure that the state has best practices to guide planning during economic downturns.
In addition, the Task Force determined that, in light of disaster response, relief and mitigation continuing to be a growing liability, establishing a recurring financing mechanism for the Disaster Relief and Resiliency Fund would be impactful. Within this review, there was also agreement that allowing the fund to be used for more meaningful disaster resiliency and planning efforts could help mitigate future liabilities.
Recommendations
Data reviewed by the Task Force confirms that the current Section 5G capital gains threshold has not kept up with actual economic and revenue growth by between $300 M to $600 M. Therefore, it would be reasonable to adjust the threshold on a one-time basis by some amount within that range. This would be a more sustainable and fiscally prudent mechanism for supporting the budget than the use of excess capital gains over the threshold to support recurring spending – which was adopted in both the FY 2025 and FY 2026 budgets. Additionally, adjusting the threshold based on annual GDP growth or a rolling average of actual collections, versus the 5-year compounded annual growth in GDP, would help the threshold stay in line with actual economic and revenue trends. Regular review of the threshold would also be appropriate to better understand its relationship with actual capital gains collections.
Alongside more regular multi-budget forecasting and stress testing, the state should establish more formal best practices around Stabilization Fund withdrawal policies. While these best practices may not necessarily require statutory changes, developing strong guiding principles for the use of the fund will ensure that the state uses the best information to support its decision making.
The Task Force also coalesced around reconsidering the inclusion of the Disaster Relief and Resiliency Fund in the Section 5G excess capital gains distribution. Given the growing cost of natural disasters impacted by climate change, the establishment of a recurring funding mechanism for the fund could pay dividends in the future. Additionally, the allowance for the fund to support preemptive disaster mitigation and planning efforts could have major returns on investment by mitigating the need for future relief.
Lastly, the Task Force recommends that the group be deployed on a regular basis to evaluate the state’s long-term liability financing policies. Convening the Task Force on a regular cadence would allow it to review the policy changes it had previously proposed, as well as evaluate additional amendments to improve processes and the Commonwealth’s fiscal health.