Can State Do Better Budget Forecasting?

The OK Policy Blog, part of the Oklahoma Policy Institute, is asking an important question as state agencies prepare for a predicted budget shortfall that will trigger automatic cuts.

The question is simple: Can Oklahoma “do a better job of forecasting revenues.” If so, the state could obviously prepare better for economic downturns, limiting disruption to people’s lives and helping to prevent long-term damage to the state’s educational, health and social services systems.

Essentially, the annual state budget is based on revenue predictions. When those predictions are too high, the state must cut the budget. Automatic across-the-board cuts for state agencies go into effect unless the legislature deems otherwise. Unfortunately, the legislature will not be in session until February 2010, though it could meet for a special session in the fall.

As OK Policy Blog notes, budget forecasting can be especially difficult in a state like Oklahoma, which relies on gross production taxes, which can be erratic. State Treasurer Scott Meacham, who has said a budget shortfall is inevitable, has pointed to a steep drop in gross production taxes on natural gas as one of the reasons for predicted cuts.

OK Policy Blog notes:

…in five of the past eight years, actual GR collections have come in more than seven percent above or below the estimate. In only one year was the variance between estimates and actuals less than four percent. The pattern seems to be that in bad times, revenues do far worse than expected (2002-03, 2009-?) while in good time, revenues do far better than expected (2005-06).

In recent years, a majority of Oklahoma legislators voted to cut income taxes that primarily benefited wealthy people when the state collected more than the revenue estimates. (This is my take on the issue, which OK Policy Blog does not address in its current post.) One problem is that the state’s budget, tied partially to energy taxes, will always be somewhat erratic because of the boom/bust cycle of the gas and oil markets. During a bust cycle, recently enacted income tax cuts can devastate a budget in states that count on gross production taxes as a sizeable share of revenues. The cycle can also make it difficult to predict revenues.

Currently, according to OK Policy Blog, the Oklahoma Tax Commission relies on major tax revenue prediction models developed in conjunction with Oklahoma State University’s Center for Applied Economic Research.

OK Policy argues it could be time to look at the state’s budget forecasting system in comparison to similar states. The blog notes:

First, can we do a better job of forecasting revenues? There is no obvious or immediate answer, but it would seem worthwhile to study Oklahoma’s forecasting methods and outcomes in comparison to those of other states - particularly those with a similar reliance on gross production revenues - to see if others are having any greater success. If some states have better records of accuracy, we should think about borrowing their methods. While we are studying official and binding short-term forecasts, we should also be working to improve our capacity to develop professional five-year budget forecasts to guide longer-term decisions about revenues, expenditures and service levels, as we recently suggested.

OK Policy Blog argues that budget forecasting in Oklahoma can be “as much art as science.” Forecasting models must consider a large number of factors to come up with sensible predictions, and no one can argue that predicting revenues months in advance in Oklahoma is an easy thing to do, especially given the historical volatility of the gas and oil industries. But can we do better? It’s a valid question to ask, and it deserves more public discussion.