Underestimation of Revenues: Review of Revenue Estimates

¶ … Revenue Estimates: Underestimation of Revenues

Although the United States has an excellent budget policy, she is yet to reach maximum efficiency with regard to revenue estimation. When it comes to public budgeting, ours is a picture that is far from the ideal. There has been a consistent pattern of underestimation of revenues in federal, state, local, as well as agency budgets. This trend may not be desirable for a recovering economy since government decisions on new policy initiatives and sustainable policy settings depend significantly on these annual revenue forecasts. This text hypothesizes that the current methodology, resourcing, and governance of forecasting activity has, year after year, played a role in the inaccurate estimation of revenues. The U.S. Department of Homeland Security and several security agencies in Florida will be utilized in an attempt to demonstrate just how prevalent an issue this is proving to be in public budgeting. Morgan et al. (2008) express that even the smallest of revenue forecast errors could have a somewhat significant effect on budget surpluses, leading to either reduced or insufficient spending or "program cutbacks partway through the budget cycle" (p. 225). To this end, there is need to prioritize best practice forecasting methods that cater for risks over the traditional processes and forecasting techniques.

Hypothesis: the current methodology, resourcing, and governance in forecasting activity has consistently contributed to the inaccurate estimation of revenues in federal, state, local as well as agency budgets.

Context of Revenue Forecasts

Revenue forecasts are a crucial budget management tool, providing a logical basis for decision-making in regard to new policy initiatives and sustainable policy settings (Klay, 1992). Revenues, when compared to expenses, seem more variable, and can, hence, be controlled minimally by the government. Klay (1992) posits that this could be due to not only the resource and export orientation of the U.S. economy, but also the exposure it has to volatile product prices. The role of revenue forecasts can, however, not be underestimated because even the smallest error is capable of eroding budget surpluses, causing a rapid spiral in debt, and making it quite a challenge for fiscal organs to achieve their targets, while at the same time retaining their credit rating statuses (Morgan et al., 2008). A budget that underestimates revenues could lead to reduced spending and in its wake, leave unmet critical needs; whereas one that overestimates the same could result in cutbacks partway through the cycle (Morgan et al., 2008). Either event would result "in citizen and employee disenchantment with the organization" (Morgan et al., 2008). Accurate revenue forecasting is therefore crucial to maintaining the taxpaying public's confidence as well as the trust of public employees (Morgan et al., 2008).

It would be prudent at this point to give a brief description, outlining among other things, the major sources of revenue for the four budgets that are the subject of this analysis; the DHS' budget, the State of Florida's budget, the Dade County budget, and the City of Miami Police Department budget.

The Department of Homeland Security ICE (Federal Budget)

In 2012, "the President requested $68.9 billion to fund homeland security activities in 2013" (CBO, 2012). The Department of Homeland Security (DHS) was assigned/allotted a massive 52% of this request, which translates to $35.5 billion. This was part of an overall budget of $60 billion, which included trust funds, fees, subsidies, and other funding that is not appropriated (CBO, 2012).

The 2013 budget prioritizes six mission areas outlined in DHS' 2010 Bottom-up and Quadrennial Homeland Security Reviews, and builds on the department's progress with regard to each of these six areas.

Mission 1: Transportation and border security (29% of request) -- preventing illegal activity and at the same time facilitating lawful trade and travel across America's sea, land, and air borders. The budget supports 21, 186 CBP officers and 21, 370 border patrol agents, and invests in the recapitalization of Coast Guard assets (DHS, 2013).

Mission 2: enforcement of immigration laws (36% of request) -- the budget funds the USCIS business transformation scheme; allocating $20 million towards the SAVE program, and $11 million towards Immigrant Integration (DHS, 2013). Furthermore, $112 million is provided for the facilitation of the E-Verify program. The FY 2013 budget reduces by $17 million the allocation to the 287(g) program. This can be attributed to the introduction of the more efficient Secure Communities program (DHS, 2013; National Immigration Forum, 2012).

The other four missions, which include warning and intelligence, defense against catastrophic threats, domestic counter terrorism, and emergency response and preparedness, received significantly lower allocations of the President's request - 1%, 7%, 8% and 8% respectively (COB, 2012). Four departments within homeland security -- Coast Guard, ICE, TSA, and CBP- take up 70% of the President' request, with ICE being allocated $12 billion, a 2% increase from its allocation in 2010 (DHS, 2013; National Immigration Forum, 2012).

The State of Florida's Budget FY 2011-12

The state budget can be categorized into the General Environment, the Judicial Branch, Natural Resources, Environment, Growth Management and Transportation, Criminal Justice and Corrections, and Human Services (FCFEP, 2010). The last three take up the highest amounts of revenues and are largely funded by tax/general revenue (FCFEP, 2010). Apart from the General government, and the Judicial Branch, both of which are relatively small and funded by a mix of sources, the other categories are funded by state and federal funds (FCFEP, 2010).

Trust funds and general revenue are the primary sources of Florida's revenue (FCFEP, 2010). Taxes on utilities, fishing and hunting licenses, drivers' licenses, and automobiles titles are major sources of revenue for the state. In the FY 2011-12 period, the Medical Care Trust Fund was the largest trust fund, totaling $12.1 billion. The State Transportation Trust Fund "was the second-largest, appropriating almost $5.7 billion for highway and bridge construction and maintenance" (FCFEP, 2010, p. 14).

The sales tax is Florida's main source of recurring general revenue, estimated at $16.8 billion - approximately 75% of the total general revenue estimate of $22.4 billion in 2012 (FCFEP, 2010). Since the state is one of nine that do not have personal income tax, the remaining general revenue percentage is catered for by corporate income, documentary stamp, insurance premium, beverage, tobacco, and intangible taxes, interest earnings, and corporation fees (FCFEP, 2010).

Dade County Budget FY 2013-14

Dade County's operating budget brings together various budgets relating to distinct services, including fire rescue services within the Dade Fire Rescue Service District, library services within the library system, local services within the UMSA, and a number of other proprietary operations (Miami-Dade, n.d.).

The proposed budget for FY 2013-14 stands at $6.358 billion. $4.4 billion of this budget represents direct operating budget, and $1.9 billion, capital projects (Miami-Dade, n.d.). The capital budget is divided into seven strategic areas; General Government, Economic Development, Health and Human Services, Neighborhood, Recreation, Transportation, Public Safety, and Policy formulation (Miami-Dade, n.d.). The proposed Capital Improvement Plan is funded 49.95% by revenue bonds, 16.57% by proprietary operations, 15.49% by other county and non-county sources, 11.7% by general obligation bonds, 2.4% by state grants, 2.08% by impact fees, and 1.81% by federal grants (Miami-Dade, n.d.).

Property taxes are the main source of county revenue, estimated at $50.98 million, 3% higher than the 2011-12 budget amount (Miami-Dade, n.d.). The revenues are expected to rise steadily over the next few years following the passage of Amendment 10 to the State Constitution (Miami-Dade, n.d.).

The City of Miami Police Department Budget FY 2013-14

The FY 2013-14 budget for the police department stands at $3.458 billion. Taxes are the main source of revenue for the City of South Miami, under which the police department falls (City of South Miami, 2014). The budget supports the six fundamental goals of City Services, Fiscal Responsibility, Economic Development, Reinvestment, South Miami Downtown, and Sense of Community (City of South Miami, 2014).

The police department takes up $6milion in revenues (the highest among all departments); the department of solid waste management is second, taking up only $1.3 million in revenues (City of South Miami, 2014).

Ad valorem tax, the main source of revenue, is expected to increase over the next few years owing to the Save Our Homes Effect (Amendment 10), the Double Homestead Exemption, the Millage Cap established, the recent changes to the General fund Expenditure, Emergency Reserve Funds, and the Capital Projects Fund (City of South Miami, 2014).

Forecasting Track Record

A 2011 report by the Rockefeller Institute of the Government ranked Florida among the most accurate states in revenue forecasting, reporting a median percentage error of less than 1% over the year 2011. Local councils and agencies in Florida base their revenue forecasts on the forecasted revenue figures appearing on the state's Long-Range Financial Outlook. State funds and grants contribute approximately 17% of Miami-Dade County's revenue, and almost 40% of the City of Miami Police Department. To this end, the state's underestimation problem can rightly be assumed to spread to the Dade County Council and the City of Miami Police Department revenue estimates. The same ideology has been used to develop a similar relation between the federal and state budgets.

Table 1: Underestimation of Tax Revenues in the State of Florida (in $ millions)

08-09

Actual

09-10

New forecast

Change from old

10-11

New forecast

Change from old

11-12

New forecast

Change from old

12-13

New forecast

Change from old

Sales tax

16531.4

15871.1

16759.0

18133.7

19434.6

Beverage tax & licenses

7.2

6.0

5.4

5.2

Corporate income tax

2,216.8

1,833.4

93.2

1,848.2

70.2

2,015.6

49.1

2,144.7

28.8

Documentary stamp tax

20.3

23.3

2.1

(78.1)

(Source: Florida Revenue Estimating Conference, 2010, n.pag)

Table 2: Underestimation of Federal Grant Revenues (Urban Areas Security Initiative Grant) in the State of Florida

Year

Actual Grant Award

Forecasted Amount

Forecast Error

($millions)

Forecast Error Percentage

2007

$84,742,600

$57,613,272

$27,129,328

32%

2008

$77,483,211

$28,481,684

$49,021,527

63%

2009

$72,345,392

2,138,613

$70,206,779

97%

(Source: OIG, 2011, p. 7)

Table 3: Underestimation of Total General Revenue Fund in Florida ($ millions)

08-09

Actual

09-10

New forecast

Change from old

10-11

New forecast

Change from old

11-12

New forecast

Change from old

12-13

New forecast

Change from old

Total Revenue

21,623.8

21,566.4

22,857.8

24,652.3

26,417.9

91.4

(Source: Florida Revenue Estimating Conference, 2010, n.pag

What is causing the Errors?

i) Resourcing

Current Practice

In the case of the federal government, the responsibility and the locus of revenue sharing are separate and distinct (Klay 1992). The responsibility for economic forecasts in the executive lies with the CEA (Council of Economic advisors), "but it is the Office of Tax Analysis (OTA) of the treasury department that prepares the revenue forecasts that underlie the president's budget recommendation" (Klay, 1992, p. 233). In the legislative branch, the CBO (Congressional Budget Office) and the JCT (Joint Committee on Taxation) prepare separate revenue estimations, though the latter is often regarded "the only official source of revenue estimates during congressional debate" (Klay, 1992, p. 233).

The State of Florida, like many others, operates a pattern that is markedly similar to that of the federal government (Klay, 1992; FCFEP, 2010). Neither of the two branches has revenue forecasting as its exclusive prerogative; however, revenue forecasters on either side relate their forecasts with those of the other (FCFEP, 2010). In this regard, the state can rightly be said to be a step ahead of the federal government. However, although members from the two branches interact, the state does not have a formal procedure for such interaction, and the forecasts often have to compete for the senate's acceptance (FCFEP, 2010; Klay, 1992).

Issues and Improvements

Klay (1992) expresses that jurisdictions should strive to create consensus among the two branches of revenue forecasting because under such an approach, "underlying assumptions are likely to be questioned within the context of the forecasting process rather than on the floor of a legislature" (p. 234). Furthermore, jurisdictions could advocate for independent forecast because these are often better-placed to identify, and bring to light questionable underlying assumptions (Klay, 1992). Competing forecasts with no clear-cut means of reaching consensus create room for partisan interests, and are "likely to be motivated more by political agendas than by the desire to improve accuracy" (Klay, 1992, p. 234).

Jurisdictions ought to review the resourcing and structure of their forecasting activity, and ensure that it i) takes into account and ensures the succession of the knowledge/skill transfer of revenue forecasting staff; and ii) allows for an ongoing research program focusing on emerging issues and trends in the revenue forecasting field (Department of Treasury and Finance, 2006).

ii) Methodology

a) Taxation Revenue

Current Situation

Florida's publication of estimates cut-off dates are determined in the mid-year review and the State Budget. The conveyance duty estimate over the budget year reflects judgment about turning points and cyclical patterns; economic growth and population projection; and some external advisory (FCFEP, 2010). The conveyance duty estimates include a separate 'specials' component covering transactions generating assessments exceeding $1 million (FCFEP, 2010). The growth of mortgage duty is assumed to keep close track of conveyance duty.

Issues and Improvements

It is evident from the data presented earlier on that underestimates of conveyance duty, sales tax and corporate income tax, and total taxation revenue are a major source of forecast error in Florida. Thanks to these consistent underestimates of taxation revenue, underlying growth has proceeded for long periods, norming at 27.3% over the last decade (Rockefeller Institute, 2011). For this reason, the state has "been through a period of believing 'this is the peak year', only to discover otherwise" (Department of Treasury and Finance, 2006, p. 17).

Increasing the use of expert views by, for instance, increasing the frequency of consultation with market property leaders would be crucial for informed judgment (Rockefeller Institute, 2011). However, the Department of Treasury and Finance (2006) warns against over-relying on such views at the expense of fact-monitoring, and puts forth financial institutions as a more objective source of information. To this end, expert views should not be used as the primary basis for revenue forecasts; rather, they could be used as a source of "timely, anecdotal information that could be used in testing the forecasts and helping to identify risks" (Department of Treasury and Finance, 2006, p. 17).

The validity of the incremental, escalation-based budget-derivation process has been questioned in the past, with the assumed relationship between the growth variable and the tax base attracting the most controversy (Department of Treasury and Finance, 2006). An ongoing program of monitoring and revising could be used in place of the current one-off review process (Department of Treasury and Finance, 2006). Such an approach would provide avenues for jurisdictions to integrate economic and revenue forecasts; and consequently, "to estimate long-term or underlying revenue collections independently of current year collections" (Department of Treasury and Finance, 2006, p. 17).

b) Federal Grants:

Current Situation

National grant revenue estimates and Florida's share of this estimate are both crucial inputs into the forecast of federal grants. The latter reflects per-capita relativities recommended by the various grant commissions. Each state's shares are dispatched by the various commissions before the finalization of the budget year estimates.

Issues and Improvements

National grant revenue estimates have been found to be a significant source of error in regard to revenue forecasting (Pew/Rockefeller Institute, 2011). The timing of Florida's budget often implies that the state has to rely on dated fiscal outlook and mid-year economic forecasts, both of which are usually published almost three months before the state budget's cut-off date (Pew/Rockefeller Institute, 2011). Improving the federal grant revenue estimates would require that either the state be developed to carry out its own forecasting, or the release of federal grant estimates be made timelier (Pew/Rockefeller Institute, 2011). Moreover, the state could closely monitor the actual monthly grant collections and check for clear variations between the national pool and the forecasts (Pew/Rockefeller Institute, 2011). Integrating the federal grants system budget and collection information into a single analytical report on the state's tax collections could be an effective way of achieving this.