Last week, it was reported that Ohio collected $1.2 billion in taxes more than it expected. More revenue means more flexibility for policymakers, more resources for public services, and potentially more room for tax relief. There will inevitably be debate about what the best way to use this extra revenue is, so I wanted to briefly talk about some of the potential options.
Why do we save money?
This is a rhetorical question, but I want to take a second to spell it out formally because it highlights an important economic concept. Consumption smoothing is the idea that people have a tendency to consume fairly consistently, even though incomes may be inconsistent.
A very simple example of this is that we need to eat every day, even though most people don’t get paid every day. Humans aren’t able to consume two weeks worth of calories at once and internally dole out that energy over time. We need to spread out our consumption over different periods than our incomes because even if we can predict both accurately, they almost always operate on different time frames.
On a longer time horizon, saving for long-term expenses like retirement allows us to smooth consumption over the course of our lives. Most people earn the majority of their income during a few decades of working age adulthood, but they still need to consume before entering the workforce and after leaving it. Saving allows us to transfer purchasing power from periods where our income is high to periods where our income is low. In many ways, government budgeting works similarly. Tax revenues can fluctuate significantly from year to year depending on economic conditions, while the demand for public services tends to remain relatively stable.
That creates a challenge for states. During economic booms, tax revenues can increase unexpectedly. Similarly, revenues can fall during recessions which happen to coincide with a higher demand for services. If governments dramatically expand spending during good years and then suddenly cut programs during downturns, residents experience the same instability that individuals try to avoid in their own lives. Saving during prosperous years can help smooth that cycle out.
So, what should Ohio do?
Impacts of spending this extra revenue
The value of the state spending money is entirely dependent on what they choose to spend it on. Some forms of spending create lasting economic benefits while others primarily provide short-term political rewards. Investments in infrastructure, education, or maintenance can potentially raise future productivity and improve quality of life for years after the money is spent. In those cases, spending today may generate returns that exceed the benefits of simply holding onto the cash.
There is also an argument that taxpayers themselves may be better positioned to decide how to use the money. If the surplus exists because taxes collected exceeded what was necessary to fund government services, then returning some of that money through tax relief could allow households and businesses to make spending and investment decisions based on their own priorities rather than political ones.
At the same time, temporary revenue spikes can create long-term obligations if states use them to fund permanent spending increases. Hiring large numbers of new employees or creating ongoing programs with one-time revenue sources can leave governments vulnerable when revenues eventually return to normal levels.
Impacts of saving this extra revenue
One of the biggest drawbacks of saving this revenue is that people have a preference for things today over things in the future. Saving is really just deferring our consumption to a later date, so it seems on its surface that it would be better to get the consumption out of the way and see if it can lead to long-term benefits. Using this lens, it becomes clear that saving this money would be a better decision if there were something in the future it could be spent on that would be even more valuable than anything we could spend it on today.
The state could put this surplus into its rainy day fund which functions similarly to an emergency savings account for households. Recessions, natural disasters, or unexpected budget shortfalls are inevitable at some point, even if their timing is uncertain. Building reserves during strong economic periods gives policymakers flexibility when conditions worsen. It can also reduce the need for abrupt tax increases or spending cuts during downturns, both of which can intensify economic pain.
According to research by Pew, Ohio’s rainy day fund could currently finance the state’s obligations for 47.4 days, putting it basically right at the national average. This extra cushion has become more important as a result of unreliable funding at the federal level. The pendulum swings between administrations make it much more difficult for states to predict how much money they might be able to expect for certain programs. Big changes to SNAP and Medicaid are two prominent examples that state governments might want to have extra reserves to help cover.
Ultimately, the best use of a surplus depends less on whether the money is spent or saved and more on whether policymakers understand the tradeoffs involved. A surplus is not free money. It represents resources that can either improve current consumption or provide stability and flexibility in the future. The difficult part is deciding which of those goals matters more today.
