State revenue forecasting: An institutional framework.

• Author: Stinson, Thomas F.
• Position: Minnesota

The revenue forecasting environment can be as important as the projections themselves, since credibility ultimately influences utility. The independence and transparency that characterize Minnesota's forecasting framework help keep the state's budget process on track.

All revenue forecasters know a sad truth: the only thing certain about their forecasts is that they will be wrong. Whether measured individually or as a whole, state revenue forecasts are never accurate. Individuals who are unable to work in an environment in which they will never be right, and where changes to their projections are broadcast widely, quickly find other forms of employment. Those who remain, however, derive satisfaction from the knowledge that their work is an essential part of the budgetary process. Revenue projections provide the starting point for dealing with the challenges that accompany each new budget. By quantifying the size of the gap between spending and expected revenues, forecasts help focus the budget discussion, providing necessary discipline for negotiations between the executive and legislative branches of government.

Forecasts are never popular, nor are they ever fully accepted by policymakers. In both good times and bad, everyone would like to believe that revenues will exceed projections. Because forecasts are never accurate, they are easy targets for those whose back-of-the-envelope projections are more optimistic. Projected surpluses, particularly large surpluses like those that were widespread in the late 1990s, are an irritant to elected officials who could have used the unanticipated revenues for additional tax cuts or spending increases in popular programs. However, projected revenue shortfalls pose even worse problems for policymakers, since shortfalls create difficult decisions. Criticism of revenue forecasts is particularly acute during economic downturns. When revenues fall short of estimates, the forecasting methodology always receives extra scrutiny.

This article describes the institutional framework surrounding the production of the State of Minnesota's revenue forecast. This framework served the state well during the 1990-1991 recession and has worked reasonably well during the current downturn. Of course, there is no guarantee that it will continue to work in the future, or that it would work for other state governments. Although the forecasting framework has evolved over time, much of the initial structure was established following some unfortunate political meddling with state revenue projections that produced an overly optimistic revenue forecast just as the national economy was entering the twin recessions of the early 1980s. (1)

Minnesota's Revenue Forecast: An Overview

Minnesota's revenue forecast is prepared and issued by the Finance Department. This department is also responsible for preparing the governor's budget and for operating the statewide accounting system. State statutes require that a forecast be issued each November and February. November's forecast serves as the basis for the governor's budget recommendations, while February's forecast provides the governor and the legislature with an updated revenue outlook just prior to the legislature's deadline for setting its expenditure and tax targets.

Minnesota is a biennial budget state, and the constitution prohibits an operating deficit for the current biennium. As such, spending and/or revenues are expected to be adjusted in the off-year session should a deficit be forecast. Spending and revenue adjustments also have been made when the forecast showed a surplus, although the current governor's policy has been to rebate any surplus forecast after approval of the biennial budget.

Under Minnesota statutes, the Finance Department's forecast must extend through the period covered by the budget under consideration. It also must provide revenue and expenditure planning estimates for the biennium that follows. (2) This means that the November forecast in even numbered years covers three fiscal years, looking forward 32 months. Revenue planning estimates cover a fourth and fifth fiscal year, extending the period under consideration to a total of 56 months. Revenue and expenditure forecasts are based on current law, and neither reflect any of the governor's tax and spending initiatives nor anticipate any potential legislative action.

The Finance Department's forecast is the only forecast available to state policymakers. There is no competing forecast prepared by a legislative budget office or legislative research staff. Neither the revenue outlook nor the underlying economic forecast is the result of negotiations between the governor and legislative leadership. Instead, a small, full-time...