Simply Dismal: Budget gap should spur look at improved forecasting

Everyone knew it would be bad. Could we have known it would be this bad?  Nearly one year ago, in February of 2009,  several months after the national economic recession finally hit Oklahoma, the Board of Equalization certified an official General Revenue (GR) estimate for the current fiscal year of $5.4 billion.  This amount was half a billion dollars, or 9.5 percent, less than actual revenue collections for the most recently completed fiscal year (FY ’08) and about $300 million less than anticipated collections for the fiscal year in progress.

With the benefit of hindsight, we know now that even those already dreary revenue forecasts were wildly optimistic. Through the first five months of FY ’10, GR collections are running $578 million, or 24.3 percent, below the estimate. In December, the Board of Equalization received a revised FY ’10 estimate that projects that GR for the full year will come in a whopping $1 billion below the estimate (or, to be precise, $1,000,405,068). That equates to an 18.5 percent revenue shortfall– although since the state can appropriate only 95 percent of the certified estimate, the actual mid-year budget shortfall is somewhat less.

The estimated revenue collections, prepared by the Oklahoma Tax Commission, were way off for every major source, as displayed in the graph below.  Gross production taxes, which assumed an average natural gas price for the year of $5.22 per MCF, have received the most attention but actually only account for $145 million of the projected $1 billion shortfall. Personal income tax collections are now projected at $392 million below the initial estimate, sales and use taxes are $279 million below, corporate income taxes are $135 million below, and all other taxes and revenue that go to GR are $51 million below. In percentage terms, corporate income tax collections are faring worst compared to expectations and are now projected to dribble in at some 44 percent below pre-year estimates. 

According to a November survey by the National Conference of State Legislatures reported in the Tulsa World, Oklahoma had the dubious distinction of suffering the largest FY ’10 budget gap, meaning that our revenue collections for the year are falling furthest from projections. While shortfalls are never easy to address, having large mid-year budget gaps is particularly problematic since the situation triggers automatic across-the-board cuts which fail to take into account the differing abilities of agencies and programs to absorb budget reductions and do not allow for full consideration of other strategies for balancing the budget.

Next year, we may face the opposite problem: forecasts that are overly pessimistic in assuming the pace of revenue recovery . Both OK Policy and UCO economist Mickey Hepner have forecast FY ’11 GR at $4.7 billion, or some $300 million above the initial FY ’11 estimate certified by the Equalization Board last month. This conforms to a historical pattern in which the state’s forecasts tend to underestimate the magnitude of both downturns and recoveries, leading to substantial revenue shortfalls when the economy enters a downturn and hefty surpluses once the economy returns to growth.

Is there a better way? Our new issue brief, based on this blog post, calls for the creation of an official forecasting body to develop short-term and long-term forecasts for the state. We argue:

Forecasts are usually technically improved and better understood when more experts are involved. Oklahoma should support the Board [of Equalization] 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.

Legislation to implement some of our ideas to conduct more frequent and better forecasts will be introduced during the upcoming legislative session. We hope these ideas will receive serious consideration.

Forecasting revenue collections for a period 6 to 18 months out will always be an inexact science, but this year’s frankly dismal  performance suggests that we need to be looking carefully at how to do our revenue projections differently and better.