Learning from the crisis (1): More frequent and better forecasting can help guide a path

As state leaders struggle with how to manage the enormous budget shortfalls the state faces this year and next, the focus is understandably on decisions that must be made over the coming weeks and months.  But while short-term challenges are the highest priority, this is also an opportune moment to draw some lessons from what has transpired during the downturn thus far that could leave us better equipped to manage the full length of the crisis and respond better the next time the economy takes a nosedive. This post will be the first of a series of blog posts and an upcoming issue brief that will recommend changes to our budget and tax system involving forecasting, reserve funds, multi-year revenue commitments, and tax expenditures. Our proposals are all intended to enhance the Legislature’s ability to respond to budget downturns without having to implement deep cuts to vital state services or enact tax increases.

Our first recommendations involve forecasts. As revenue collections have come in more than 25 percent below the estimate certified way back in February for the current fiscal year, state leaders have been severely hamstrung in developing a response by the absence of any formal revised budget estimates. The Office of State Finance has implemented 5 percent monthly across-the-board cuts to agency budgets knowing that additional revenues or deeper cuts will be need to bring the budget into balance. Governor Henry has argued that further decisions about the size of budget cuts and the use of reserve funds should wait until the Board of Equalization meets and delivers its revised projections for FY ’10 and its initial estimates for FY ’11.  The problem is that, in accordance with the Constitution, the Board of Equalization does not meet until the very end of December. The longer into the fiscal year decisions are put off, the more drastic any eventual measures that may be needed to bring this year’s budget into balance will have to be. (Cutting $1 million over 4 or 6 months is far more challenging than cutting the same amount over 9 or 12 months). This concern seems to be driving Senate and House leadership to urge that deeper cuts be implemented immediately. Others  contend that once we are already this far into the year, it is reasonable to wait a little longer until we have better information upon which to base informed decisions.

Whatever is decided about the timing of a special session, this year’s experience has made clear that waiting until half-way through the year to develop and release a revised forecast in the midst of severe revenue shortfalls is like waiting until you’re lost deep in the woods to pull out a compass. One response to avoid a repeat of this problem would be to require that any time revenue collections fall below the certified estimate, revised forecasts  of current year revenue collections should be developed within 30 or 60 days, and revised no less than every three months subsequently. These forecasts need not be officially binding in the way that the February certified estimate determines the amount available for appropriation by the Legislature.  However, they would be formal public estimates that would be available to help guide policy decisions.

At the same time, the state needs to expand and strengthen its forecasting capacities in good times as well as bad. Oklahoma should develop a broad-based and transparent process for forecasting state revenues. The state should estimate revenues for several years in advance to facilitate taxing and service-level decisions that make sense for the long run, not just the current year. State agencies and citizens need this information so they know how to plan and what to expect in the coming years. Oklahoma has a statutory requirement for long-term forecasting that has been in effect since 2007. The forecast [PPT] prepared under this requirement is a good start; it incorporates economic modeling and considers several different trends for future growth. Unfortunately, it is not sufficiently documented, widely circulated, or used in budget planning.

The Board of Equalization may be the appropriate body to oversee this expanded revenue forecasting capability, but it needs more technical support. Forecasts are usually technically improved and better understood when more experts are involved. Oklahoma should support the Board by creating a forecasting body that includes the Office of State Finance, legislative staff, and academic and private economists as well as the Tax Commission.

In addition, the annual revenue certification should include revenue estimates for at least two years beyond the coming year. The “out year” estimates need not be binding on future budgets, but they should be used by the Governor and Legislature and by state agencies in adopting tax and service levels.

All forecasts are highly imperfect, and even with the best information, policymakers will still need to make difficult decisions.  But as the ad hoc and contentious way this year’s budget shortfalls have been managed demonstrates, imperfect information is better than no information at all.