WASHINGTON— The amount of money states collect is harder to predict than ever, according to a new report from The Pew Charitable Trusts and the Nelson A. Rockefeller Institute of Government. Managing Volatile Tax Collections in State Revenue Forecasts finds that rising volatility of tax collections has contributed to increases in the size and frequency of forecasting errors, and identifies specific steps that states can take to manage volatile revenue.
“Some level of forecasting error is inevitable, but the impact of this error can be mitigated by a mix of effective policy solutions,” said Brenna Erford, who manages Pew’s state budget policy research. ”States can adopt evidence-based rainy day fund policies to address budget shortfalls arising from unforeseeable economic and fiscal circumstances that make forecasting revenue increasingly difficult.”
According to the study, budget forecasting errors are generally larger when a long lag exists between a forecast and the adoption of the state budget, during and after recessions, in less populated states, in states that are heavily reliant on certain industries, and particularly when forecasting corporate income taxes.
“The increased volatility of tax collections compounds the difficulty of estimating revenue,” said Donald Boyd, senior fellow at the Rockefeller Institute of Government.
The research cautions that overly optimistic forecasts can prompt hurried, across-the-board spending cuts, tax increases, or borrowing when collections fall short. Alternately, forecasts that are too low can result in a one-time surplus, tempting lawmakers to cut taxes or commit to spending that is unsustainable over the long run.
The study identifies three best practices to help state policymakers manage volatile revenue and use the best available data when forecasting revenue:
The report, which updates and extends a 2011 analysis and includes findings from a new survey of state officials conducted by the Rockefeller Institute of Government, looked at state revenue forecasting errors by examining personal income, sales, and corporate income tax data from 1987 through 2013. It also draws from current research and interviews with government finance experts and elected officials.
The Pew Charitable Trusts is driven by the power of knowledge to solve today’s most challenging problems. Learn more at www.pewtrusts.org.