Revenue Forecasting and the Fragility of Traditional Wisdom.

• Author: Pagano, Michael A.
• Position: COMMENTARY - Reprint

One of the most significant managerial challenges for state and local budget officers is to accurately forecast revenues and expenditures in coming years. Errors are inevitable, of course, and yet many elected officials continue to live in the hazy delusion that once they've balanced a budget based on seemingly solid forecasts, it's going to stay balanced. This, as we know all too well in hindsight, is often not the case; forecasting is as much art as science, and predicting upcoming revenues precisely can be as much attributable to luck as to intellect.

Consider the National League of Cities' annual survey conducted at the start of the Great Recession. It asked a sample of city chief financial officers: "Overall, would you say that your city is better or less able to meet financial needs in the current fiscal year than last year? In the next fiscal year compared to this fiscal year?"

The response to the survey suggested that, overall, most CFOs and their staffs were blind to an upcoming fiscal disaster despite warning signs such as the unfolding subprime mortgage crash. More than half (55 percent) responded that they expected their city would be in a better position in 2008 to meet their financial needs than in 2007. When asked the question in 2008 about their fiscal position in 2009, that percentage plummeted to approximately 20 percent. No great surprise there. It's much easier for fiscal managers to make an accurate prediction of hard fiscal times when they're already dealing with them.

One element of overoptimistic thinking among budget managers as the recession began was the notion that sales taxes would continue to provide a steady flow of revenues. Nearly one in four (24 percent) of cities that collected sales taxes were confident in 2008 that 2009 would be a healthy year for their economies. In fact, state and local general tax receipts fell by $16 billion in 2009 from their 2008 levels, a decline of 3.5 percent as the recession hiked unemployment and diminished consumer spending.

But although the recession's negative impact on sales taxes should not have been the surprise it was, it's perhaps easier to understand why the decline in property values and the tax revenues based on them was so largely unforeseen, given the traditional management wisdom among the men and women responsible for keeping programs intact without the need to raise taxes.

The widely held belief is that the property tax is reliable. That's part of the reason...