States have been making more serious errors in estimating their revenues during tough economic times, according to a new report by the Pew Center on the States and The Nelson A. Rockefeller Institute of Government. This has significant implications for policy makers who need to know how much money they will have to spend on programs and services ¬as they grapple with severe budget shortfalls.
The report, States' Revenue Estimating: Cracks in the Crystal Ball, found that in fiscal year 2009—the first of the ongoing budget crisis—half the states overestimated revenues by at least 10.2 percent. That equated to an unexpected shortfall of nearly $50 billion in personal income, corporate income and sales tax revenues. In a year when state policy makers faced $63 billion in mid-year shortfalls—coming atop $47 billion they already had closed when crafting their budgets—this was a significant challenge. States had to close the gaps by cutting spending, increasing taxes and fees, tapping reserves and borrowing.
The study found that the primary culprit driving more serious and frequent errors is not the states' processes, methods and techniques, but rather, the increasing volatility of the revenue streams themselves. This appears to result from states' growing reliance on income taxes and the ways in which highly fluctuating capital gains affect income tax revenue.
“The stakes are high for policy makers as they continue to wrestle with significant budget gaps,” said Susan Urahn, managing director of the Pew Center on the States. “Errors in revenue estimating have been growing in size and frequency with each recession. This makes the challenging process of balancing state budgets even more difficult.”
“States have faced increased responsibilities and expenses at the same time revenues have become less predictable,” said Thomas L. Gais, director of the Rockefeller Institute of Government. “If elected officials don't get good revenue forecasts, they're not only forced to change their budgets and tax policies after they learn about errors, they're also contributing to citizens' skepticism about the budget process. Such skepticism, in turn, may make it even harder to build the coalitions needed to reduce large budget gaps.”
The report looks at state estimates for three major revenue sources—income, sales and corporate taxes—comprising 72 percent of states' total tax revenues. The research covers the period from 1987 to 2009, a 23-year span that takes in three recessions and three stretches of economic growth. The study is the first to determine the size of forecast errors using data for multiple taxes in all 50 states.
No one expects perfection in forecasting, even when the economy is stable and behaving predictably. There are a number of factors that contribute to a state's ability to predict revenues with accuracy—including national economic forecasts state officials rely on to estimate their revenues, a state's tax structure, its economic base and the budget processes in place—and the Pew-Rockefeller Institute study does not attempt to address them all or compare states directly. Rather, this study examined the trends in revenue estimating errors over time—in particular, over the business cycle—and what steps states could take to manage the unexpected shortfalls or surpluses.
Over two decades, half of all states' revenue estimates were off by more than 3.5 percent, or $25 billion in 2009 dollars. What is notable is that these larger errors occurred more frequently in the past 10 years.
Among the report's key findings:
The study also highlights promising approaches for states to improve their estimating processes and better manage the effects of the volatility of their revenue streams:
The Pew-Rockefeller Institute report relied on data from the Fall Fiscal Survey of the States published by the National Association of State Budget Officers and the National Governors Association.
Pew Center on the States
The Pew Center on the States is a division of The Pew Charitable Trusts that identifies and advances effective solutions to critical issues facing states. Pew is a nonprofit organization that applies a rigorous, analytical approach to improve public policy, inform the public and stimulate civic life. www.pewcenteronthestates.org
Rockefeller Institute of Government
The Nelson A. Rockefeller Institute of Government, at the University at Albany, is the public policy research arm of the State University of New York. The Institute conducts fiscal and programmatic research on American state and local governments. www.rockinst.org.