December 3, 2004
The Devilish Details of Revenue Forecasting
It’s forecasting season, so if you’re not an economist, you might want to wear a bright orange vest so you won’t get hit in the cross-fire. We’re up there on podiums and writing in newspaper columns, carrying on about something called GDP – that’s Gross Domestic Product – and what it might do next year. And I’ve got a little confession to make – it’s a lot of fun.
It’s fun because GDP is the bottom line on the largest economy in the world, the sum total of everything that is produced and sold here. Because it is so large, it can also be quite forgiving when it comes time to make a forecast. If, say, consumer spending doesn’t quite grow as fast as you thought it would, there’s always business spending, or the export sector, or something else to bail you out. Our forecasts at Ball State have been pretty decent over the years, and we’re pretty happy about it.
But if you can find someone in your household or your workplace that cares about GDP, please have them give us a call. While predicting the sum total of everything may put a spring in our step, there are precious few people in the real world that have much interest. They’d like to know about things that are a whole lot closer to earth.
Right now, for instance, states and municipalities around the country are pulling together what they can find to make revenue projections for the next fiscal year. They need to get a solid feel for what’s going to happen to their tax base in the next few years. And GDP has surprisingly little to do with it.
That’s part of the reason why many of those revenue forecasts have been so wrong over the last six years or so. No one cared much when the forecasts came in low, and legislatures had more money to spend than they thought they would, as happened in the late 1990’s. But smiles turned to alarm when the errors swung in the other direction, leaving governments with shortfalls and deficits.
Income tax collections have proved to be especially difficult to forecast in recent years. In one sense, that’s hard to understand. Personal income, which is the fundamental basis of taxation, makes up more than four out of every five dollars earned. Surely if we have a good handle on the total, we’re a leg up on predicting what’s going on with 80 percent of it, right?
For the last six years the answer has been, surprisingly, no. The last few years, in particular, have been good for the overall economy, but not so good for household earnings. In fact, over the last eight years, the share of total income going to households and individuals has been on a virtual roller coaster ride, taking a lot of forecasters for a ride in the process.
In 1997, personal income comprised about 83 percent of total income, but climbed rapidly in the next three years. The reasons why are not precisely understood, but during the period when the stock market was exploding, personal income’s share of the total pie rose to 87 percent, near an all-time high.
Then came the crash. Since 2000, personal income’s share has fallen swiftly, and now stands at just 82 percent of total income. That means that income has been increasingly directed towards capital consumption and profits during, and after, the recession. Household income, and the tax collectors around the country who count on it, have seen less.
This trend can’t continue, but that doesn’t mean it will end tomorrow. And if you’re the unlucky person making a revenue forecast, you’ll have to call it.
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