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Why State Fiscal Forecasts Are Far Off the Mark

Budget prediction is an inexact non-science.


Donald F. Kettl

Governing columnist, former dean of the School of Public Policy at the University of Maryland, and a nonresident senior fellow at the Volcker Alliance and the Brookings Institution

For besieged states confronting the Great Recession, the only thing worse than making hard budget decisions is having to make them all over again. In state after state, officials who thought they were done in June found themselves confronting forecasts in August that showed gallons of new red ink splashing across their budgets.

In Idaho, Governor Butch Otter told reporters just before Labor Day that revenues were down 6.8 percent from the level assumed in the budget adopted this spring. "We've been here before," he said soberly, pointing to past tough decisions as he warned citizens of more cuts to come. Meanwhile, Maryland Governor Martin O'Malley faced a new $700 million shortfall just six weeks after the legislature passed what it thought was a balanced budget.

Of course, some states, such as California and Pennsylvania, sidestepped the problem by delaying their budget battles into the late summer, but that only begs a larger problem. Why can't the forecasters get it right? Even politicians who are willing to face up to hard choices don't like doing it twice in the space of a few months.

In truth, it's been a miserable year for state economic forecasters. Very few saw last fall's crash coming. Since then, they have consistently underestimated the depth of the downturn. That's dragged state and local budgeteers through a revolving door of ever-deeper spending cuts.

Just as almost no one saw the collapse coming, there was no consensus once it started on how bad things were going to get or how long we'd struggle. As the economy staggered, Indiana Governor Mitch Daniels predicted more dark times. "State government finances are a wreck," he wrote in July, and "what the radar tells me is that we ain't seen nothin' yet." For the cities, the situation is no better. Philadelphia Mayor Michael Nutter laid out a doomsday budget in case new state aid did not materialize, with trash pickup cut back to every two weeks and every library and recreation center shut down. A compromise in September seemed to avert that disaster, but the deal worked out by legislative leaders and the governor still had several hurdles to climb.

Making these difficult decisions is tough enough. But why has it been so hard getting the forecasts right?

Part of the answer lies in the nature of this economic crisis. Unlike past recessions, which have tended to begin in the industrial sector, this one exploded out of the housing market and the shaky schemes put together by huge financial companies to profit from it. Because of that, it hasn't behaved like the recessions that economists are used to. It has been harder than usual to predict its evolution.

Another piece of the puzzle is that while economists sometimes do pretty well in predicting the national economic picture, they do much worse in predicting some kinds of economic activity than others. A recent look by Richard Pullin at forecasting in Japan showed that economists there are fairly accurate in estimating large-scale industrial output and inflation. But they do a poor job when it comes to forecasting household expenditures.

The Japanese and American economies are very different, but Pullin's study provides clues for the botched forecasts in this country. Take a downturn where the decline of savings and home values has spooked families. Add the impact of these dual blows on consumer confidence. Consider the documented difficulty of predicting household spending, and you already have a prescription for many wrong guesses.

Then add in the heavy dependence of state and local governments in the United States on personal income, sales and property taxes. Together, these three account for almost 80 percent of state and local revenue. In just the past decade, property tax collections alone have risen from 31 percent to 37 percent of all state and local government receipts. And that doesn't figure in the money these governments have come to depend on from other housing-related activity, such as transfer taxes on real estate transactions and corporate tax levies on real estate company income. If you don't know what real estate tax collections are going to look like six months from now, it's tough to make an accurate fiscal forecast for the state as a whole.

Then there's what public finance guru John Petersen calls the "food chain of uncertainty," with "the locals not knowing where the states are going, the states uncertain about where the feds are going, and the feds unable to address their huge, growing deficit." With health care costs at the core of so much federal spending, the uncertainty about health reform only adds more uncertainty to the food chain.

The forecasters may have done a lousy job in estimating the recession. But the reasons why they missed so badly make for a pretty clear crystal-ball reading of the more distant future. State and local tax systems are increasingly out of whack with the 21st-century economy, and health care is driving their spending up. Without an attack on both of these problems, forecasting might turn out to be the least of the troubles that state and local governments face in the years down the road.

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