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EYE ON THE PIE: Let's ditch revenue forecasting

September 4, 2006

"This humidity is the worst part of living in a Hoosier forest. I can't take off more clothes and maintain an appropriate degree of decency. Even then, this soggy air still would be oppressive."

Faye of the Forest was perched on my deck railing complaining about the weather. I just endured, puffing a cigar as if I were Sydney Greenstreet in one of those 1940s movies set in the jungle. All I was missing was the white suit.

"So," she said, swatting a mosquito, "what are you thinking? You're just sitting there Buddha-like."

"I have been thinking about what political conservatives would do if they were serious about being fiscally conservative," I said.

"And what would that be?" Faye asked indifferently.

"It's rather simple," I replied. "I would say that you cannot spend money you don't have. I would limit government expenditures in one year to the receipts of that government in the previous year. If data for the previous year are incomplete, then it would be two years earlier."

"That sounds sensible," Faye sighed, burdened by the heavy air.

I became emboldened by this small demonstration of interest.

"Of course, it means reducing employment for economists," I said. "It puts an end to revenue forecasting. Today, Hoosier governments set their spending plans before they know how much money they have to spend. At the state level, they have a formal revenue-forecasting system that is always 'wrong.' Too high or too low, but how could it be otherwise?"

"I don't know," Faye yawned.

"Exactly," I said, leaning forward. "Other states have the same problem. Indiana is neither better nor worse than others in forecasting state revenue. But we expect counties, cities, school corporations and other units of government to set budgets before they know what revenue they will have.

"Now," I said expansively, "what if we stopped that disappointing practice? Let's operate government without the excitement of uncertainty. Just do what the prudent household does. Spend what you know you have, not what you hope you will have.

"Revenue forecasts," I plowed on, despite noting that Faye's head was bobbing on her chest, "are extremely difficult. First, they presume we can forecast national economic conditions with considerable accuracy. Second, they assume fairly consistent relationships between the state's economy and the nation's. This holds for some places, for some industries, but not for all.

"Third, forecasts require detailed data we don't have. For example, revenue from the personal-income tax fluctuates widely with changes in capital gains. Indiana has no timely data on capital gains realized by its citizens. Therefore, our income-tax forecasts are bound to be off when there are major changes in capital gains."

"I'm sure," Faye muttered politely from somewhere in the haze.

"Hence," I continued, talking now to the spiders, bats and other night creatures, "we could take last year's revenue, subtract perhaps 5 percent for a rainy day or emergency fund, then set the remaining amount as the limit of state spending. After a few years, that set-aside fund would be large enough that it could be used prudently for addressing specific public needs.

"It's not going to be a process that responds quickly to change. But that's the whole idea of conservative policy: government by rule rather than discretion and cautious involvement in new areas of responsibility."

Faye's voice drifted in.

"Very Milton Friedman-ish," she said. "Yes, it is," I agreed. "I'm going back to the stream bed," Faye said. "Perhaps the cranes are stirring the air by flapping their wings." She left. I puffed my cigar, alone with my imaginary heresies.



Marcus taught economics more than 30 years at Indiana University and is the former director of IU's Business Research Center. His column appears weekly. To comment on this column, go to IBJ Forum at www.ibj.comor send e-mail to mortonjmarcus@yahoo.com.
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