Volatility in revenue streams leads to more errors in estimates.

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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 local governments and other policy makers who need to know how much money they will have to spend on programs and services as they grapple with 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.

The study found that the primary reason for overestimating is the increasing volatility of the revenue streams, not the states' processes, methods, and techniques. 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 report looks at state estimates for three major revenue sources--income, sales, and corporate taxes--which comprise 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.

Over two decades, half of all states' revenue estimates were off by more than 3.5 percent, or $25 billion in 2009 dollars, and these larger errors occurred more frequently in the past 10 years.

Estimates grew progressively worse during the last three economic downturns. During the 1990-92 revenue crisis, 25 percent of all state forecasts fell short by 5 percent or more. During the 2001-03 downturn, 45 percent of all state forecasts were off by 5 percent or more. In 2009, 70 percent of all forecasts overestimated revenues by 5 percent or more. In New York, for instance, officials had to revise their fiscal year 2011 estimate five times in 2009. Even Indiana, whose estimates were off by less than 1 percent 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 of more than 25 percent.

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