Prediction problems

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,” noted the press release.

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%. That equated to an unexpected shortfall of nearly $50 billion in personal income, corporate income and sales tax revenues.

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.

"States have faced increased responsibilities and expenses at the same time revenues have become less predictable," Thomas L. Gais, director of the Rockefeller Institute of Government said in the statement. "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.

KEY REPORT FINDINGS
• Over two decades, half of all states’ revenue estimates were off by more than 3.5%, or $25 billion in 2009 dollars. What is notable is that these larger errors occurred more frequently in the past 10 years.

• During the 1990-92 revenue crisis, 25% of all state forecasts fell short by 5% or more. During the 2001-03 downturn, 45% of all state forecasts were off by 5% or more. In 2009, 70% of all forecasts overestimated revenues by 5% or more.

• Even Indiana, whose estimates were off by less than 1% over the length of this study, erred in its forecasts for 17 straight months until the streak ended in March 2010.

• Arizona, New Hampshire, North Carolina and Oregon are among the states that had the most difficult time estimating revenues in 2009, with error rates greater than 25%.

• The Great Recession also was notable because revenue forecasters were confounded by major declines in all three of the major state taxes to a much greater extent than before. States overestimated personal income taxes by 9.7% in 2009, corporate income taxes by 19% and sales taxes by 7.6%.

• State revenue estimates more often produce surpluses than shortfalls. In fact, in 16 of the 23 years covered by this study, the typical state underestimated revenue — leading to a median error of 1.5%, or $10 billion in surpluses in 2009 dollars.

• Facing an unexpected surplus, legislators may cut taxes, expand existing services or add new programs, but without the benefit of the planning time that would have been available with a more accurate forecast.