Forecasting revenue for state tricky task

By Larry DeBoer

Forecasting is hard. It’s a guess about the future. You try to make an informed, internally consistent guess — but the operative word is “guess.”

People make plans based on your forecast. And then comes the embarrassing moment when the future becomes the present and they see how wrong you were.

But we have to do it. Back on Dec. 15, the Indiana General Assembly required their forecasters to guess about the future of state revenue. They’ll be passing a budget during the 2017 session, which will set spending for biennium, fiscal years 2018 and 2019 (that’s July 1, 2017 to June 30, 2019).

A budget is a plan for spending, so they need to know how much money to plan for. That’s the revenue forecast. You can see the forecast on the State Budget Agency’s webpage, at in.gov/sba/2701.htm.

Indiana’s forecast starts with a prediction about what will happen to the economy. How fast will incomes grow? How about consumer spending? Gas prices? The stock market? Housing starts? They all enter the revenue forecast.

Once our forecasters have an economic prediction, they apply past relationships between the measures of the economy and state revenues. They calculate what will happen to sales tax revenue if incomes, gas prices and housing starts change as predicted. They predict income tax revenue based on the forecast of wages and the stock market changes.

Indiana hires the IHS Global Insight company to do their economic forecast. They apply a detailed model of how the economy works to current trends and expected future policies, and come up with predictions about all the economic measures needed by the revenue forecasters.

And yes, that means they have to predict what the Trump administration will do. They’re upfront about it. Page 3 of their handout is titled “Policy change in the December forecast.” They’re expecting a federal income tax cut, a corporate income tax cut, a big increase in federal infrastructure spending and more rapid increases in interest rates by the Federal Reserve.

Tax cuts should increase business and consumer spending. The government will spend more on infrastructure. But the unemployment rate is already low. There aren’t that many more people available to be hired. How will businesses produce all the added goods and services? Global Insight predicts that productivity will rise, meaning that the average worker will produce more.

Greater demand for workers and higher productivity will increase wages. Higher spending and higher wages will increase inflation. Higher inflation will cause the Federal Reserve to raise interest rates. That’s what is meant by an internally consistent guess.

The revenue forecast that results from this economic forecast is “bad news, good news.” The spending stimulus won’t get started until the policies take effect, probably by mid-2017. Revenues have been running behind forecast during the fiscal year we’re in now. So the revenue forecast for the whole fiscal year showed a $301 million shortfall below last December’s forecast.

Legislative leaders weren’t too concerned. That’s what the nearly $2 billion in state balances are for, to cover small shortfalls in revenue.

Revenues are predicted to be 1.5 percent higher in 2017 than they were in 2016. Starting in fiscal 2018, the forecast gets more optimistic. Expected revenues grow 2.9 percent in 2018 and 3.9 percent in 2019. That’s the result of rising wages and salaries, more housing construction and higher stock values.

That’s pretty optimistic compared to recent forecasts. Two years ago, the December 2014 forecast looked ahead to our current biennium, and saw 2.4 percent revenue growth in fiscal 2016 and 3.2 percent growth in 2017. Four years ago, the December 2012 forecast predicted 2.2 percent and 2.9 percent growth for fiscal years 2014 and 2015. The future looks brighter today.

Of course, that’s the embarrassing part of forecasting. Two years ago, forecasters had 2016 revenue at $15.1 billion. It fell 1.8 percent short, $271 million less than expected. Two years ago they had 2017 revenue growth at 3.2 percent. Now it looks more like 1.5 percent. Actual revenues in fiscal 2014 and 2015 fell short of December 2012 forecasts too.

The leadership asked legislators and lobbyists not to get too excited about the optimistic forecast. Perhaps they recognized our recent pattern: optimism when the budget is written, disappointment when the results come in.

Larry DeBoer is a professor and extension specialist in Agricultural Economics at Purdue University. Send comments to awoods@tribtown.com.