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SMITH: Revenue forecasts are remarkably accurate

April 8, 2017

viewpoint-smith-saraleeann.jpgAn April 29 deadline looms for lawmakers laboring over Indiana’s new two-year budget, but April 12 is the critical date for them—it’s the day they’ll get a new forecast of the expected tax revenue for the next two fiscal years.

For three months, the governor and state agency heads have presented budget requests to the General Assembly’s fiscal policy committees. The House and Senate have voted on the proposals and the spending priorities are getting clearer, but it’s essentially an academic exercise until the revenue forecast.

Indiana’s forecast has been remarkably accurate except during the Great Recession, according to a report by the Indiana Fiscal Policy Institute. The report released April 6 examines the state’s major streams of tax revenue and compares them with revenue forecasts since 2002. A study by the Center on Budget and Policy Priorities also found Indiana’s revenue forecasting method is among the nation’s best.

The General Assembly accepts the revenue forecast as the amount of money available, so the debate among lawmakers centers on how to appropriate the available revenue. But it also places a premium on forecast accuracy.

Forecasts are inherently prone to errors because exact tax revenue to be collected is unpredictable. Individual income and spending choices are dependent on the economy, and many other indicators influence trends and overall economic stability.

Indiana is among 15 states that implement the best practices outlined by the non-partisan Center on Budget and Policy Priorities for methodology and processes. Kentucky is the only nearby state that can make a similar claim. But it’s Indiana’s process for forecasting tax revenue that stands out.

Indiana has a two-step process.

First, the consulting firm IHS Markit forecasts the nation’s economic output, findings that influence its state-level forecast. Then, Indiana’s Revenue Forecast Technical Committee uses this information to forecast the amount of tax revenue the state can expect.

This bipartisan group of fiscal policy experts uses a consensus-type process that incorporates input from the executive and legislative branches and includes non-government experts. The consensus approach guards against error and political bias. Its methodology and findings are available to the public for transparency.

Sales and use tax and individual income tax make up more than 80 percent of state revenue and are therefore most influential in the budgeting process. Much like the trends from these sources, overall revenue has been on a general upward tick. Corporate tax, gambling tax and other revenue streams account for a much smaller percentage of revenue and are much more volatile.

Indiana’s revenue forecast is generally known as one of the most accurate, according to an article in Public Administration Review written by two Indiana University professors.

Except for the years affected by the Great Recession, the forecast was within 3 percent of actual revenue collected. In pre-recession years, the forecast was a little below actual tax collections; post-recession, the forecast has generally been a little higher than collections.

With legislative changes, a renewed view of the economic climate, and various spending priorities, the General Assembly lacks just one data point before it moves forward with the budget deliberation. The April 12 revenue forecast will provide the last bit of information, and at some point before April 29, we’ll see how they use it.•

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Smith is a fellow with the Indiana Fiscal Policy Institute and is completing a master’s degree in public affairs at the IU School of Public and Environmental Affairs in Indianapolis.

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