Multistate RDF solves revenue shortages

With each state effectively on its own, it should come as little surprise that state RDFs have not been adequate to fund large revenue shortfalls. 203 Self-insurance against uncorrelated risk is simply not the best move. Consider the inefficiencies of requiring every individual to self-insure against untimely death or property loss. This would lead to either massive over-saving or frequent painful consumption shocks. The counter-factual is absurd, simply because the market case for insurance in these situations is so clear that the product has existed for centuries. Why not a similar approach for states?

In its simplest form, a multistate RDF would function essentially like pooled insurance. Each state would pay an annual premium to the multistate RDF - much as they already are to their own independent RDFs - and the multistate RDF would pay out when revenue dropped below a particular level. 204 The premiums would be based on a combination of overall group risk, with perhaps some experience-rated variation to account for differences among states. The premiums would also depend on the size of the particular state's budget. The payout itself would be some percentage of the shortfall from expected revenues. For example, if a state is expected to raise (or, alternatively, had spending commitments of) $ 1000 per capita but only raised $ 700 per capita, the RDF could make up the shortfall. Depending on the degree of co-insurance, the RDF might pay out 100% of the $ 300 shortfall, or something less than 100%.

[*129] Premiums and payouts would thus depend on the relative size of the state's budget. A state like California would contribute much more, but also get larger payouts, than a state like Rhode Island. This raises the question, however, of when a state becomes large enough to be a sufficiently diverse risk pool on its own. California may be such a state, though further research and modeling would be required to be certain. California is limited in its ability to borrow, however, which means that it is still not as well-equipped to self-insure as it could be.